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Aid effectiveness and donor behaviour

How aid modalities and incentives

in aid agencies affect aid outcomes

Bertin Martens

(ODI London, 13-14 May 2004)

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Several angles to aid effectiveness

Effectiveness at macro-economic level• Many papers: Burnside & Dollar, Hansen & Tarp, etc.• Black-boxes the set-up of the aid delivery process

Micro-economic approach: agency theory• Looks at behavioural incentives in aid set-up• Not a judgement on the behaviour of individuals, but on

the incentives they are confronted with

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Foreign versus domestic aid

Domestic aid recipients can give feedback

to decision-makers

Political decision makers

Implementation agency

Recipients-voters

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Foreign versus domestic aid

• Foreign aid recipients live in a different political constituency: broken feedback loop

• Aid decisions are taken in function of donor preferences: ownership is a problem in foreign aid

Political decision-makers in donor country

Donor country implementation

agency

Recipients are not voters

in donor country

Donor country voters

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Solutions to the ownership problem

1. Give recipient full ownership:• Purest form of aid « hand over the money »• Only if donor and recipient preferences are aligned

2. Create an intermediary: the aid agency

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Why do aid agencies exist?

• The official explanation: to bridge the financing gap, the knowledge gap: not credible

• Agency theory perspective: Aid agencies introduce ownership restrictions (« packaging » of aid flows)

• Aid agencies exist only on the donor side, not on the recipient side: credible commitment problem

• Two basic forms of « packaging »: « Projects »: input conditionality, managed by donor

« Budget support »: output conditionality, managed by recipient

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≠ types of agencies for ≠ problems

• Aid Agency = joint delegation by multiple principals• Donors with homogenous preferences can use NGO’s

as filters to select recipients with similar preferences, and to reduce transaction costs

• Donors with heterogenous preferences delegate implementation to an official aid agency: compromise and access to tax revenue

• Countries with heterogenous preferences delegate to a multilateral agency (≠ between loans and grants)

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External incentives for aid agencies

• Joint delegation and multiple objectives prevent a Pareto optimal allocation of resources

• Joint delegation: agencies aim to drive a wedge between donor groups, and/or donors-recipients, necessary to reach compromise but also to achieve their own budget maximisation objective (Niskanen)

• Multiple hard-to-measure objectives with incoherent trade-offs result in inefficient allocations (↔ private profit-maximizing companies)

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Internal incentives in aid agencies

• Both input and output conditionality programmes are subject to asymmetric information and observability of results,

• Staff, experts performance = fn (observability): moral hazard and adverse selection are facts of life

• Aid agencies are budget maximizers, so spending pressures will contribute to actual performance

• More weakly identified objectives will result in performance biased towards inputs (rather than results)

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Conclusions

There is a wide gap between stated objectives of foreign aid and the reality of incentives in the aid delivery set-up

• Aid agencies are intermediaries between donor and recipient interests; outcomes are compromises

• Aid agencies can not be fully efficient• Incomplete (shared) ownership is the rule, full ownership

the exception