Scandinavian Working Papers in Economics

Working Papers in Economics,
University of Bergen, Department of Economics

No 16/08: Dancing the H-Street Waltz? Policy Choice in Aid-Dependent Countries

Rune Jansen Hagen ()
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Rune Jansen Hagen: University of Bergen, Department of Economics, Postal: Hermann Fossgt. 6, N-5007 Bergen, Norway

Abstract: A new aid rhetoric emphasises the selective allocation of otherwise unconditional funds in support of recipients drafting their own sensible plans, in contrast to the old practice of lumping money and policies together in donor-wrapped packages. This line of thinking is supported by both the empirical literature on aid conditionality as well as studies underscoring the need for tailoring policies and institutions to country characteristics. I study the signalling game that arises when recipients have private policy-relevant knowledge. I show that while real ownership might result from their strategic interaction with donors in such a regime, conformity in policy-choice is a de?nite possibility. The lure of generous aid might induce recipients to play to the sensibilities of outcome-oriented donors, making the latter con?dent of having sizeable impact even when the former thinks the result is less bang for the aid-buck. In extensions I explore what happens when the actors do not share a common view of how the economy works. When the recipient faces a biased donor, the scope for pooling (separation) is reduced (increased), indicating that "groupthink" is costly. When both actors have their own biases the range of equilibria is much wider. The recipient then sometimes ignores its private information not because it wants to deliver what the donor considers good news, but because it gambles on ending up with the highest possible aid-impact from its perspective. It is shown that donor coordination can, but need not, be bene?cial. Finally, if the donor cares about need as well as impact policy-making might improve with aid, but only for countries close to graduating from such external support.

Keywords: Aid; public policies; signalling

JEL-codes: F35; F55; F59; H11

60 pages, March 23, 2011

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