1. Challenges to Aid Effectiveness: Recipient Institutions
International Development Cooperation:
Theory & Practice
SNU GSIS
Challenges
to Aid Effectiveness:
Recipient Institutions

2. Aid-Institution Relationship
Which comes first?
One of the objectives of aid is to improve public institution
Good institution is a condition for aid to work, so aid allocation should be selective
Debates on the relationship between aid and institutions
Pros: Aid promotes good institution/governance by
Technical assistance for capacity building of recipients’ public institutions and philosophy transmission
Incentives to receive more aid when/where improved governance
Cons: Aid damages institutional quality by
Easy access to resources
Rent-seeking behaviors
Encourage not to use unpopular taxation

3. Curse of Aid? Curse of natural resources Causes and effects
Economies with abundant natural resources tend to have less economic growth than those with fewer natural resources.
natural resources are detrimental to institutional quality, and have a negative impact on growth via their effect on institutions
Causes and effects
Dutch disease
Natural resource discovery (or any event resulting in a large inflow of foreign currency) causes increase of the real exchange rate and wage, undermining the competitiveness of export sectors
Vulnerability to external shocks
Rent seeking activities/corruptions
Internal conflict
Less dependency on taxation and weak accountability
Can be applied to foreign aid?

4. Aid dependency and institutions
A large volume of aid over a long period can have negative effects on the development of good public institutions in low income countries.

5. Aid dependency and institutions
Policy ownership
Aid can weaken government’s economic decision- making process, e.g., budgeting and planning
volatility and uncertainty (gap between commitment and disbursement)
towards satisfying donors
Government expenditure
Aid treated as an increase in income tends to increase government spending, more toward gov’t consumption rather than public investment
Quality of civil service
Proliferation of agencies and projects can cause competition for staff, resulting in brain-drain in civil service
Bureaucrats are often rewarded not for their development function but rather on getting money from donors

6. Aid dependency and institutions
Revenue collection
Taxation is a key mechanism to establish accountability between state and society/citizens.
Foreign aid as a substitute for domestic revenue mobilization, gives a government less incentive to tax and improve its tax administration.
It’s easier to manage donor demands than the slow and difficult task of building or improving domestic revenue collection.
Weakening accountability to citizens (tax payers) and encouraging moral hazard
Democracy
Aid can undermine popular participation
As aid is external assistance the assent of the population is less important to government
Pressure is external, not from below

7. Aid dependency and institutions
Negative correlation between aid and tax revenue
<Moss, T., et al. (2006). “An Aid-Institutions Paradox?”>

8. Some empirical studies…
Djankov, et al. (2008). "The curse of aid”
Tracking aid and democracy
Negative relationship between annual average of aid/GDP and the level of democracy
in Africa
in the world

9. Some empirical studies (Djankov, et al. 2008)
Impact of aid to political institution (1)

10. Some empirical studies (Djankov, et al. 2008)
Impact of aid to political institution (2)
conclusions
Foreign aid has a negative impact on institutions.
Curse of aid seems bigger than the curse of natural resources.

11. Some empirical studies
Svensson (2000). "Foreign aid and rent-seeking"
Relationship between aid and the corruption and other rent-seeking activities
A game-theoretic rent-seeking model: (social) groups compete over common-pool resources
each group will be better off if all reduced their costly appropriation efforts unilaterally, but it is not rational for the individual social group.
However, since the social groups interact repeatedly, this may provide a mechanism that can reduce the conflict of interest
these forces may not suffice to deliver the first-best outcome
Results
An increase in government revenues may lower the provision of public goods: large disbursements of aid do not necessarily lead to increased welfare.
Mere expectation of aid according to the recipients’ future needs may increase rent dissipation and reduce the expected number of periods in which efficient policies can be sustained.
Negative relationship between annual average of aid/GDP and the level of democracy

12. Svensson (2000)
On average, foreign aid is positively associated with corruption in countries more likely to suffer from competing social groups

13. Some empirical studies (Svensson 2000)
Conclusions
the provision of public goods does not need to increase with government income, thus large inflows of foreign aid do not necessarily result in general welfare gains.
expectations of aid in the future may suffice to increase rent dissipation and reduce the level of public goods provision.
Implications
Importance of the interaction between the political process shaping public policy and foreign aid.
Aid may influence policy in the recipient country without any actual disbursement, implying that evaluations of project may overestimate the total impact of foreign aid.
Donor community’s binding policy commitment may mitigate the incentives for social groups to engage in rent-seeking activities.
Democracies seem to be less subjective to the perverse effect of aid on corruption suggests that political liberalization should have an important priority in the donors’ policy agenda.

14. Q & A