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Institute for International Economic Studies, Stockholm University Seminar Papers, Institute for International Economic Studies, Stockholm University

No 600:
When is Foreign Aid Policy Credible? - Aid Dependence and Conditionality

Jakob Svensson ()

Abstract: In spite a vast amount of both theoretical and empirical work on foreign assistance and development, little is known about the incentive effects of aid. In fact, recent surveys of aid only briefly mention the possibility of moral hazard situations in the recipient-donor relation, but conclude that conditionality is a way to deal with the problem. However, in this paper we show that an aid contract, as proposed in the literature, is not time-consistent. This may be one explanation for the poor results of the vast amount of foreign aid disbursed to the developing world. Moreover, we show that tied aid, or delegation to a donor agency with less aversion to poverty may improve the equilibrium for all parties in the discretionary environment. Finally, we provide some evidence supporting the basic idea of the paper, namely that aid induces weak fiscal discipline and that increased fiscal difficulties lead to higher inflow of aid.

Keywords: foreign aid; moral hazard; tied aid; fiscal discipline; fiscal difficulties; inflow of aid; (follow links to similar papers)

JEL-Codes: F35; (follow links to similar papers)

37 pages, November 5, 1997

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This paper is published as:
Svensson, Jakob, (2000), 'When is Foreign Aid Policy Credible? - Aid Dependence and Conditionality', Journal of Development Economics, Vol. 61, No. 1, pages 61-84



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