Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 610: Collusion Among Interest Grops: Foreign Aid and Rent Dissipation

Jakob Svensson ()
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Jakob Svensson: The World Bank, Postal: The World Bank, PRDMG N11-057, 1818 H Street NW, Washington DC 20433, USA, and, IIES - Institute for International Economic Studies, Stockholm University, 10691 Stockholm SWEDEN

Abstract: This paper develops a game-theoretic model of public policy in a developing country in order to explain a number of empirical regularities. It is shown that under certain circumstances, an increase in government revenue will be completely crowded out by increased rent dissipation, leaving the provision of public goods unaltered. In this model, there are two possible ways in which foreign aid may affect the outcome. First, as foreign aid to a large extent can be seen as general budget support, the paper provides an explanation for why increased disbursements do not necessarily lead to higher provision of public goods. Second, the mere fact that the donor is expected to allocate aid according to the recipients' future needs may increase rent dissipation and reduce the number of periods in which efficient policies can be sustained.

Keywords: game-theoretic model; public policy; developing country; government revenue; crowding out; foreign aid

JEL-codes: O10; O19; O20

32 pages, November 3, 1997

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