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How should donors give foreign aid? Project aid versus budget support

Izabela Jelovac () and Frieda Vandeninden ()
Additional contact information
Frieda Vandeninden: MGSoG, Universiteit Maastricht

No 813, Working Papers from Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon

Abstract: We develop a theoretical model to compare the two major foreign aid modalities: project aid and budget support. These two modalities have a different impact on the production of ‘developmental goods’. Firstly, conditionality can be associated with budget support, but only a subset of the developmental expenses – the observable ones – can be subject to conditionality. Secondly, when using project aid, the donors control the overall allocation of the aid resources. However, we consider that, because of limited harmonisation and coordination, project aid can be associated with a cost of imperfect fit. We develop a unified framework to compare these two modalities where we allow the simultaneous utilisation of both instruments. We show that all the aid should be given via budget support, no matter whether conditionality is used or not. Furthermore, we show that the optimal use of conditionality depends on the recipient’s developmental preferences, the productivity of the inputs and the level of aid compared to the recipient’s budget: when these parameters are relatively high, conditionality should be enforced. Otherwise, the optimal aid allocation is such that all the aid is given through unconditional budget support. We conclude that conditionality does not always improve the aid effectiveness.

Keywords: conditionality; foreign aid; optimal contract (search for similar items in EconPapers)
JEL-codes: D82 F35 O19 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2008
New Economics Papers: this item is included in nep-dev and nep-ppm
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Citations: View citations in EconPapers (4) Track citations by RSS feed

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