1. International Development Cooperation: Theory & Practice
SNU GSIS
Determinants of Aid Flows I 1. Who Gives Foreign Aid to Whom and Why? (Alesina and Dollar 2000)

2. Purpose of the Research
To explain behavior of bilateral donors
in aggregate and individually
To see the relative importance of political-strategic interests of donors by:
Creating better measures of strategic interests
Estimating a full model of donor behavior
What is their attempt?

3. Background Literature review on foreign aid: two parts
Effectiveness of aid 1 (recipients) - Pros - Cons
Effectiveness of aid 2 (sectors) - Pros - Cons
Determinants of aid flows (donors) - No solid evidence on relative importance of different variables - different donors have different reasons
Skepticism about effectiveness of aid
Do the patterns of aid giving contribute to the ineffectiveness?
Division of academic literatures into the following streams

4. QUESTIONS
Q1: Aggregates analysis - Do developed countries respond to the variables that make aid effective in reducing poverty? - Or is the pattern of aid giving dictated largely by political or strategic considerations? - Comparison of Aid and FDI determinants? Q2: Individual analysis - Do donors show differences behaviors of aid giving? - Whether pattern of aid giving in advanced industrialized countries contributed to failure of aid in reducing poverty and enhancing growth? Q3: Whether aid has been used to foster process of democratization or not?
Research questions that the authors had

5. LITERATURE REVIEW Literature on Foreign Aid: Effects of Aid
Jepma (1997): Broad survey of literature from 70s – Foreign aid crowds out private saving, supports public consumption, and has no significant impact on recipients’ macroeconomic policies and growth
Boone (1994, 1996): Foreign aid has no effect on investment and growth
Burnside & Dollar (2000): Study on interactions amongst choices of macroeconomic policies, aid and growth – Aid is beneficial to countries that adopt appropriate and stable policies, otherwise it is wasted – No evidence that foreign aid causes adoption of “good” macroeconomic policies – Donors’ strategic interests may be more important than quality of policies of receiving countries
Collier & Dollar (1998): Allocation of aid that has the maximum effect on poverty reduction is a function of recipients’ level of poverty and quality of economic institutions and policies
Look into details of literature review.

6. LITERATURE REVIEW (cont’d)
Literature on Foreign Aid: Determinants of Aid
Lumsdaine (1993): Colonial history, democratic status of recipients, income levels, etc. – only simple correlations, thus cannot study interactions and relative magnitude of effects of different explanatory variables - Emphasis of “moral vision” which underlies aid giving
Maizels & Nizzanke (1984): Good survey on voluminous literature arguing that strategic foreign policy concerns explain the pattern of foreign aid – measurement of “strategic interest” varies, fragmented literature, and relatively little attempt at confronting the impact of different variables and their interactions
Schraeder, Hook & Taylor (1998): Concentration on Africa, highlighting interesting differences between donors, related to positions in world order, strategic interest, relationship with former colonies

7. DATA & VARIABLES Data Variables Converted into constant 1985 US$
Average of 5-year periods ( , 75-79, 80-84, 85-89, 90-94)
21 donors including the major four: US, Japan, France & Germany (counts 70%)
Variables
Recipients’ economic condition (poverty)
Initial income (real GDP pc of beginning year)
Population
Direct Foreign Investment (net FDI flow relative to GNP)
Quality of institutions and policy of recipients
trade openness (0-1, Sachs & Warner, 1995)
democracy (scale of 1-7 Freedom House Index)
civil liberties (correlation 0,9 with democracy variable, Freedom House index)
Strategic interests of donors
colonial status: N of years as a colony since 1990
UN friend: UN voting patterns of each pair
Each variable why they used? – discuss each of them.
* Risk of using donor-recipient pair in general assembly in UN. - first, UN votes are mostly meaningless in practice. Diplomatic gestures
- second, patterns of voting behaviour of big donors is similar but not indeed US-Japan 0.37, US-Frech 0.53, Ukfriend 0.72 thus voting blocs ok.
** still the risk maybe, - 찬성하거나 반대하는데, 전략상 할 수 없어서 무효표 던지는 것
무조건 따라가는 것, 이 아닐 수도 있다는 점.

8. DATA & VARIABLES (cont’d)
Table 1 – correlation of bilateral aid per capita with variables
Strongest relationship with population(-0.34), implying smaller countries get more aid per capita, and with colonial status(0.21).
Slight positive relationship between initial income and aid, surprising in that presumably poverty reduction is an important aim for aid giving. Also, modest positive association of aid with openness and democracy.
Table 2 – Share of aid going to former colonies (showing influence of colonial past for bilateral aid allocation)
For individual donors, share of aid going to former colonies varies from 99.6%(Portugal) to 2.9%(U.S.) or zero(Cananda, Sweden).

9. AGGREGATE RESULTS (1) Column (1)
Income and population- regressed linearly and quadratic form. - Implies that amount of aid received is increasing for countries with higher income level, but at decreasing rate. - Also, amount of aid goes more to larger countries but at decreasing rate (paper also mentions that “elasticity of aid with respect to population is about 0.6 evaluated at the mean of population; that is, small countries receive more aid per capita).
Democracy and open trade policies - (higher index indicates more democratization in the regression, FHI 1 most democratic FHI7 least democratic in the original data) - Positive coefficients indicate positive relationship between democracy and aid, and openness and aid. Thus, more open and more democratic countries receive more aid.
Years as colony – countries with a colonial past are favored.
UN Friend - Variable for “donors’ strategic interest” (constructed by using correlation of voting patterns in UN General Assembly – definition: percentage of times in which the recipient has voted in the UN as the U.S.) - Friends of Japan receive more aid, while U.S. friends do not. - But in fact, when adding indicator variables for Egypt and Israel (because US aid is vastly concentrated to the Middle East), the results are very large and highly significant. - When variables for Egypt and Israel are omitted (Column (4)), only change in the regression results is that the coefficient on U.S. Friend becomes statistically significant. This suggests that issues of Middle East are important determinants of votes in the UN. - all other major donors friendly, no effect on results.
Cultural affinity (proxied by religion) - no significant coefficients on Muslims or Catholic variables. - Only significant relationship is for Other religions, which has a negative coefficient. - % of population for particular religion
Column(2) – communist countries dropped from sample (to check whether the result of “democracy” is driven by the fact that communist countries did not receive much aid from western donors) - Democracy: coefficient on democracy falls in value but remains significant
Column (3) and (5) – addition of civil liberties in column (3) and addition of rule of law in column (5) (to investigate which of the institutional characteristics of the recipient countries are especially “targeted” by donors) Both variables are insignificant while the democracy variable is still significant, suggesting that donors pay more attention to democratic institutions rather than civil rights or law enforcement. These results are interesting when comparing to the case of FDI (in columns (6) and (7)). FDI responds positively to rule of law, but is insensitive to democratic institutions. Also, openness is more important for FDI than for aid (higher t-value). Many of the strategic variables (UN friend, colonial past, Israel) lose significance in FDIS regressions. This is reasonable, since private investors should respond primarily to economic incentives, not political ones. And after controlling for rule of law and openness (column (7)), FDI disproportionately goes to larger countries (larger markets).

10. AGGREGATE RESULTS (2) In general, more aid goes to recipients with:
high income, less population, democratic institutions, open trade policies, colonial past with the donors
UN voting pattern: ambiguous (Japan vs US)
Cultural affinity (religion): not significant
Relative importance of variables
1 standard deviation from the mean receives - Relatively open, 20% more aid receipt. - more democratic, 39% more aid - long colonial past, 87% more aid - japan freind, 172% more
Egypt, 481% / Israel 400$ more aid per capita
** in the paper, another way of measuring importance of variable is incremental inclusion of variables.
more political variables increases R2, but that is a false interpretation. Because, the more variables your include, R2 increases whether that variable is a good explanatory variable or not.
Most of the case r2 is the explanatory power but not necessarily it means literally.

11. AGGREGATE RESULTS (4) Implications
Political-strategic variables explain better than measures of poverty, democracy, policy
Different in FDI regressions
Colonial past is more important than democracy or openness

12. INDIVIDUAL DONOR RESULTS (1)
In analysis of individual donors, considered whether it was appropriate to remain with OLS estimation
If each donor favored a small number of countries (so that the dependent variable included a lot of zeroes), then it would be important to use a tobit procedure that recognized the truncation of the variable.
However, it was striking that there were very few zeroes, actually, implying that major donors were giving some aid to just about every developing country.
Thus, as is to be expected when the number of zeroes is small, OLS results and tobit results are extremely similar.
Colonial past – two colonial variables: log of number of years since 1900 in which a recipient was a colony of the donor (own colony); number of years in which the recipient was a colony of another donor (other colony). Virtually in all regressions the “own colony” variable is highly significant (coefficients can be interpreted as elasticities, for example, doubling the length of time as a colony of France would result in a 151% increase in aid). The “other colony” variable checks whether donors compensate by discriminating against other donor’s former colonies. The answer is generally no, since results for this variable is either non-significant or has the wrong sign (expected to be (-) in case of discrimination), indicating that donors give more, rather than less, to other donors’ colonies.
UN Friend – generally significant, especially significant for all major players (U.S., Japan, France, Germany, U.K.). Interpretation is that donors favor their “friends” in disbursing aid, since an observable manifestation of “friendship” is the pattern of UN votes.
Egypt and Israel – Due to conflict in the Middle East, these two countries have received much political and economic support from western powers. Not surprisingly, the indicator variables for these two countries are statistically significant and very large for U.S. Israel also got large support from Germany, Italy, Austria and the Netherlands. Egypt gets unusually large support from many donors: France, Australia, Austria.
Income of recipient (simple report of elasticity of aid with respect to income calculated at the mean of income; income regressions both linearly and quadratically) – Most donors give more to poorer countries. However, there is quite a large variation among donors, highest elasticity being for Nordic countries (Netherlands, Scandinavia), and U.S. Lowest elasticity to income of reicipients among major donors are France and Japan.
Openness – For most of the donors the coefficient is around 1, indicating that open economies get about twice as much assistance as closed ones ceteris paribus, indicating that donors are making efforts to reward good economic policy.
Democracy – clear differences among major donors. Strongest positive response to democratic institutions are from U.S., U.K., Dutch, Nordics, and Canada. Of the major donors, France seems least attentive to democracy of recipient.
Religion – In general, religious preferences of recipient countries do not have much influence on the pattern of aid flows.
In summary, Nordic countries target their assistance to the poorest countries(?), rewarding good policies and political institutions of recipient countries. U.S. behavior is similar, with additional feature of aid allocating in favor or UN friends and Middle East allies. France and Japan are on the opposite extreme among major donors, which seem to care mostly about own former colonies

13. INDIVIDUAL DONOR RESULTS (2)
Considering there may be lots of zeros, Tobit is appropriate.
Indeed, very few zeros… thus the results are simlliar to that of OLS

14. INDIVIDUAL DONOR RESULTS (3)
General Interpretation
Colonial Past: highly significant
Own vs of anther donor, number of colonies
UN Friend: significant for all major donors
Political alliance as an important determinant
Egypt and Israel: very significant
especially for the US regressions
앞에서 나온 내용 서머리 한 것.

15. INDIVIDUAL DONOR RESULTS (4)
Income of the recipient:
large variations among donors
(e.g., Nordic vs Japan/France)
Openness: little importance
Democracy: clear differences between donors (e.g., US vs France)
Religion: little influence
Income elasticity
Highest elasticity being Nordic countries, followed by the US, (and the Netherlands)
Major donors with lowest elasticity is France and Japan
France – no much relationship between aid and recipients’ income
Japan – aid increases with income up to a level of 1500$ per capita GDP.

16. Democratization time-series Result (1)
Aid response to democratization or trade liberalization
For 75% of cases, aid increased during democratization
Asymmetry in donors’ reaction to opposite events
No systematic response to economic policy reform
Democracy causes aid increase, but no causation in reverse

17. Democratization time-series Result (2)
Individual country analysis shows some notable democratizations and varied response of aid.
Philippines: overthrow of Marcos regime was followed by a large increase in aid
Bolivia and Peru: similar
Africa: varied experiences – Senegal: quite close relationship between democracy and aid, while in Zambia: there was a steady increase in aid while democracy was introduced only recently.

18. FDI time-series Result (1)
Analysis to investigate whether a particular country that democratizes or liberalizes trade can expect to see an increase in aid – using panel approach, since these two variables vary over time
First, isolated cases in which, over a 3-year period, there was a change of at least 1 standard deviation (1.9 points) in the Freedom House index of democracy (also for trade openness as defined by Sachs and Warner(1995))
This approach resulted in 59 democratization “episodes” (with some countries having more than one episode) and 42 episodes in which the democracy measure goes down by at least 1.9 points in a 3-year period.
For the democratization episodes, average aid was $27 per capita in the 3 years prior to the onset of democratization, $41 during the episode (50% increase), and $35 in the 3 years afterward. Thus, there is a clear tendency for bilateral donors to reward countries that democratize.

19. FDI time-series Result (2)
FURTHER ANALYSIS…
Similar exercise for trade liberalization episodes, as defined by Sachs and Warner (1995).
In about 75% of trade liberalizations, aid receipts rise. Average receipt goes from $29 per capita pre-reform to $36 (about 25% increase) during reform. 3 years after reform, however, average was $28 per capita, about the same as pre-reform.
Results show that there have not been much responses of aid flows to policy improvements.
Also get consistent results from fixed effects panel regressions (table 10).
Coefficient on democracy is positive and significant, and similar to the coefficient in table 4(column 2). However, the coefficient on openness is actually negative and significant.
Thus, for democratization, consistent positive relationship with aid is found using 3 different approaches (regressions with 5-year averages, isolation of democratization periods, and fixed effects regression with annual data). As for the economic policy reform, no such consistent relationship (positive and significant but small in the regressions with 5-year averages, weak when focus on liberalization episodes, and negative with fixed effects).

20. CONCLUSIONS (1)
Q1: Whether pattern of aid giving in advanced industrialized countries contributed to failure of aid in reducing poverty and enhancing growth?
Considerable evidence that pattern of aid giving is dictated by political and strategic considerations
- Economically closed and non-democratic former colonies receives more foreign aid than other countries with similar level of poverty, a superior policy stance, but without a past as a colony
- Aid allocations of the “big three” donors (U.S., Japan, France) may be very effective at promoting strategic interests, but as a result, bilateral aid had only a weak association with poverty, democracy and good policy.

21. CONCLUSIONS (2)
Q2: Whether aid has been used to foster process of democratization?
Despite cross-country differences explained by political factors (colonial links, alliances, strategic interests, etc.), aid tends to reward democratization over time
- However, no strong tendency for reward on economic reforms - While aid responds more directly to “political” openness, FDI responds more directly to “economic” openness (i.e. improvement in policy management, trade liberalization, better protection of property rights)
Q3: Strategic interests vary among donors?
US in the Middle East
France with the former colonies
Japan on investment and trade relationship

22. Questions?