International aid and political economy: The Delivery of Aid in the Recipient Countries

International aid and political economy

International aid and political economy: The Incentives of Donors and Aid Agencies

International aid and political economy: The Interaction between Donors and Country Recipients

International aid and political economy: The Market for Aid

The distribution of aid at the operational level is also subject to a principal-agent relationship and to a moral hazard problem. The moral hazard problem exists because the benefit of the contract to the donor depends on the actions taken by the recipient, and the recipientmay not have incentives to behave properly after the donor has provided the funds. The recipient will take the action most beneficial to his own preferences. Therefore, the terms of the contractmust be modified to provide the recipient enoughmotivation to behave properly. Bureaucracies are even more important in recipients’ countries than in donors’ agencies. The civil servants of the public bureaucracies of developing countries have a long-term contract with a low wage. Public regulation makes it difficult to fire government workers even if their performance is not appropriate. One particularly important consequence of this lack of incentives in the provision of education and health in developing countries is the so-called missing doctors and teachers. For example, Banerjee and Duflo (2006) report that, in India, the absence rate for teachers is more than 24 percent and for health providers ismore than 40 percent. This is the usual shirking behavior predicted by the principal-agent theory. 

In addition, since salaries forworkers in the public bureaucracies of developing countries are low, they tend to run privatemoneymaking activities or extract side payments from citizens (extort payment for free health services, demand money for a license, etc.). Corruption and rent-seeking behavior are often the result of severe moral hazard problems combined with the absence of clearly defined property rights. One important explanation for the lack of effect of foreign aid on growth and social development is the capture of aid by government officials and politicians. The measurement of the extent of corruption in the allocation of foreign aid in developing countries is difficult because accounting systems work poorly and local accountability is weak. The World Bank has used Public Expenditure Tracing Surveys (PETS) to calculate how much money is diverted from the time the central government receives the funds until they reach the final beneficiaries. The proportion of funds that reach the intended beneficiaries tends to be very low. For instance, Reinikka and Svensson (2004) analyze a large public educational program (a capitation grant to cover schools’ nonwage expenditures) in Uganda financed by the central government using district offices for its distribution. They find that many schools received nothing. On average, schools got only 13 percent of the government spending in the program. In Tanzania the analysis of the Primary Education Development Plan launched in 2002 by the World Bank and bilateral donors shows that, on average, only 20 percent of the funds disbursed at the central level finally reached the schools. 

Rent-seeking activitiesmay even produce negative consequences in the recipient countries. Djankov, Montalvo, and Reynal-Querol (2006) provide empirical evidence that a suddenwindfall of resources in the form of foreign aid can damage the political institutions of the receiving country by reducing checks and balances in government and democratic rules. They label this effect the curse of aid. Other authors provide evidence that Somalia’s civil war was caused by the desire of different factions to control the large amount of food aid that the country received.