1 Aid effectiveness and donor behaviour How aid modalities and incentives in aid agencies affect aid outcomes Bertin Martens (ODI London, May 2004)

2 Several angles to aid effectiveness Effectiveness at macro-economic level Many papers: Burnside & Dollar, Hansen & Tarp, etc. Black-boxes the set-up of the aid delivery process Micro-economic approach: agency theory Looks at behavioural incentives in aid set-up Not a judgement on the behaviour of individuals, but on the incentives they are confronted with

3 Foreign versus domestic aid Domestic aid recipients can give feedback to decision-makers Political decision makers Implementation agency Recipients-voters

4 Foreign versus domestic aid Foreign aid recipients live in a different political constituency: broken feedback loop Aid decisions are taken in function of donor preferences: ownership is a problem in foreign aid Political decision-makers in donor country Donor country implementation agency Recipients are not voters in donor country Donor country voters

5 Solutions to the ownership problem 1. Give recipient full ownership: Purest form of aid « hand over the money » Only if donor and recipient preferences are aligned 2. Create an intermediary: the aid agency

6 Why do aid agencies exist? The official explanation: to bridge the financing gap, the knowledge gap: not credible Agency theory perspective: Aid agencies introduce ownership restrictions (« packaging » of aid flows) Aid agencies exist only on the donor side, not on the recipient side: credible commitment problem Two basic forms of « packaging »: « Projects »: input conditionality, managed by donor « Budget support »: output conditionality, managed by recipient

7 types of agencies for problems Aid Agency = joint delegation by multiple principals Donors with homogenous preferences can use NGOs as filters to select recipients with similar preferences, and to reduce transaction costs Donors with heterogenous preferences delegate implementation to an official aid agency: compromise and access to tax revenue Countries with heterogenous preferences delegate to a multilateral agency ( between loans and grants)

8 External incentives for aid agencies Joint delegation and multiple objectives prevent a Pareto optimal allocation of resources Joint delegation: agencies aim to drive a wedge between donor groups, and/or donors-recipients, necessary to reach compromise but also to achieve their own budget maximisation objective (Niskanen) Multiple hard-to-measure objectives with incoherent trade-offs result in inefficient allocations ( private profit- maximizing companies)

9 Internal incentives in aid agencies Both input and output conditionality programmes are subject to asymmetric information and observability of results, Staff, experts performance = fn (observability): moral hazard and adverse selection are facts of life Aid agencies are budget maximizers, so spending pressures will contribute to actual performance More weakly identified objectives will result in performance biased towards inputs (rather than results)

10 Conclusions There is a wide gap between stated objectives of foreign aid and the reality of incentives in the aid delivery set-up Aid agencies are intermediaries between donor and recipient interests; outcomes are compromises Aid agencies can not be fully efficient Incomplete (shared) ownership is the rule, full ownership the exception