A modeling framework for enhancing aid effectiveness

ABSTRACT

The development literature lacks consensus about the link between aid effectiveness and governance improvement. A basic rational actor model is introduced to clarify how donors can influence recipient behaviors and more broadly how foreign aid can support or impede governance quality improvement. Adopting the underutilized perspective of donor behavior, this study identifies mechanisms through which aid hinders governance improvement and offers substantive recommendations about how donors can enhance aid effectiveness, including strategies for donors to raise the level of effort recipients devote to project success.

KEYWORDS:

• Foreign aid
• official development assistance
• corruption

JEL CLASSIFICATION:

• O10
• O12
• D03
• F35

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Governance quality is a fundamental determinant of long-term economic development. See Rodrik, Subramanian, and Trebbi (2004) for a related analysis.

2. The approach is inspired by the model developed by Basu and Pham (1998).

3. For example, infrastructure projects accounted for more than 67% of Japan’s ODA in 2015 (source: OECD data on ODA by sector; available at https://data.oecd.org/oda/oda-by-sector.htm).

4. Both functions satisfy the conditions assumed by the model ($m\left(0\right)=0$;$m^{\prime }=\alpha .M^{\alpha -1}>0$; and $m^{\prime \prime }=\alpha .\left(\alpha -1\right).M^{\alpha -2}<0$. $a\left(0\right)=0$;$a^{\prime }=\beta .A^{\beta -1}>0$; and $a^{\prime \prime }=\beta .\left(\beta -1\right).A^{\beta -2}<0$.

5. For example, Taiwan and South Korea in the 1960s made transformational development progress using foreign aid from the US and Japan, with their effort and commitment even surprising experts from donor countries. The two countries’ experiences share thee features: aid played a significant role in economic progress, aid was not given for longer than roughly a decade, and recipient economies became much stronger after aid was curtailed (see Chang 1965; CBO 1997).

6. The case of Zambia’s aid dependence presented by Dollar and Svensson (2000) provides an excellent illustration of this problem.

7. If the donor is bureaucratic, it is indifferent to the government’s effort level. As such, if the government lapses into low-effort status, it may become trapped in that equilibrium indefinitely. Regarding this point, Easterly (2002) identifies factors contributing to the “dysfunctional bureaucracy” deeply rooted in donor organizations. This helps explain why aid dependence has been persistent in many countries. Araral (2005) provides an insightful study of this problem as present in the Philippines’ irrigation sector. On the other hand, Svensson (2000) shows that with binding policy commitment, the donor community can use aid to mitigate incentives for rent-seeking activities in the recipient country.

8. The model assumes that the parameter $\alpha$, which reflects the government’s acceptance of risk, is constant.