Inducing efficiency in the use of foreign aid: The case for incentive mechanisms

Abstract

In this article we point out that one of the main problems in foreign aid allocation is the efficient use of these funds: as resources available for foreign aid are intrinsically scarce, their efficient use would be in the interest of donors, and especially recipient countries. The aim of this paper is to show how it is possible to design incentive schemes which, by relating the allocation of aid to the way it is used, may induce the recipient country to use these resources appropriately. We discuss potential benefits and problems of different contractual forms, showing how comparing the performances of different countries may help to design optimal incentive mechanisms. Finally, we illustrate a proposal of performance conditioning of the grant element, which may help in tackling the efficiency problem.