Aid effectiveness and donor behaviour

1. Aid effectiveness and donor behaviour How aid modalities and incentives in aid agencies affect aid outcomes Bertin Martens (ODI London, 13-14 May 2004)

2. 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

3. Foreign versus domestic aid Domestic aid recipients can give feedback to decision-makers Political decision makers Implementation agency Recipients-voters

4. 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 Recipients are not voters in donor country Political decision-makers in donor country Donor country implementation agency Donor country voters

5. 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

6. 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

7. ≠ 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)

8. 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)

9. 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)

10. 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