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.
32 pages, November 3, 1997
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