The Roles of Aid in Politics Putting China in Perspective

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Mitchell, John (1991), “Public Campaigning on Overseas Aid in the 1980s,” in Bose, Anurdha and Burnell, Peter (eds.) (1991), Britain’s Overseas Aid Since 1979: Between Idealism and Self-Interest, pp. 146-157, Manchester: Manchester University Press.

The 1980s were a period of mixed fortunes for public campaigning on Britain’s overseas aid. There are some successes and also some failures. The 1990s opened with campaigning proceeding from a rather higher base – better informed as a result of the lessons of the experience of the last decade, and with several notable ‘firsts’ to its credit; and, in the case of the World Development Movement a membership that was seven times larger than in 1980. The aid programme of the British government will undoubtedly have to face up to some new challenges and also some exciting opportunities. But, because of the widespread acknowledgement that global environmental matters concern everyone, there is now a real chance of mobilizing new and powerful sources of public support.

Moon, Bruce E. (1983), “The Foreign Policy of the Dependent State,” in International Studies Quarterly, Vol. 27, No. 3, pp. 315-340.

The above conclusion makes it very tempting to imagine that it is possible to extend the dependency model to offer an explanation of longitudinal as well as cross-sectional findings. Richardson (1976, 1978) and Richardson and Kegley (1980) have succumbed to this temptation and attempted a longitudinal test of the proposition that increasing dependence leads to increasing foreign policy compliance. In so doing, however, they have merged the bargaining and dependence models in a mistaken way. Substituting measures of dependence for measures of aid-giving in the above longitudinal formulation does not produce a test of the dependency model, since the essense of the dependency view lies in the focus upon structural characteristics of relationships which persist over time. To examine yearly changes in measures of external reliance is to invite measurement error and/or conceptual confusion. For example, while the precise volume of exports (the measure of dependence employed by Richardson and Kegley) certainly fluctuates over the short term, this says very little about changes in external reliance. Indeed, even the sense of dependence most often utilized in discussions of national power and influence (as opposed to the formulations associated with dependencia) involves the sensitivity of one nation to conditions in another (Caporaso, 1978). Such sensitivity or responsiveness cannot be measured in the short-term but only in the longer run. To say that a nation depends upon exports is to say that in years when exports are high, the nation prospers and that in years when exports fall, the nation suffers. Thus, yearly fluctuations in export levels do not constitute a measure of dependence such that dependence is higher when exports are good and lower when exports are bad. More significantly, however, dependence is simply not a concept which makes very much sense within a framework whose foundation is the notion of short-term bargaining.

This is not to say that the attempt to merge the two models is either impossible or undesirable. Rather, a different fusion is called for. Cross-sectionally, measures of dependent relations are impressively correlated with voting agreement. Not all features of dependent relations are as immutable over time as the dependencia tradition would seem to indicate, however. Substantial year-to-year fluctuation in voting behavior, for example, does occur. But much of this change seems to occur with change in regime. It seems plausible that the syndrome of dependent relations, based upon a foundation of external reliance, generates strong, though not always irresistible, pressure towards the establishment of a government whose views are compatible with those of the dominant nation and which is then supported by foreign aid flows. The foreign policy of that government can be viewed as the result of a process of distortion in the sense that in the absence of such dependent relations, a very different policy would probably have been generated. Short-term influence has very little place within this view, since the need to influence a government whose orientation is already fundamentally similar is rather small. However, external reliance does not deterministically generate a foreign policy distortion and in this sense some element of tacit bargaining may be said to be involved. The promise of American aid (and most likely other benefits such as trade and policy support) implicit in the choice of a government with pro-American views is likely to influence the course of political events in a poor nation. In this sense, bargaining of a sort does occur; the cost-benefit calculations of individuals within a society must surely be altered by the knowledge that American aid (of a variety of forms) will follow certain kinds of choices.

Of course it remains that structural relations of dependence are sufficiently powerful that choices counter to the preferences of the dominant nation are at best difficult and in some circumstances impossible. These constraints appear to operate broadly, however, at the level of the creation of structural political and economic forms rather than in the short-term and relatively narrow areas suggested by the bargaining model. The kinds of longitudinal change in dependent relations which may indeed carry the implications suggested by the dependency formulation are not likely to occur except in the case of quite massive and step-level transformations such as that identified in the literature as a dependency reversal (Orton and Modelski, 1979; Holsti, 1982). The processes by which such transformations occur are worthy of study since it appears that it is at such junctures that American influence is most likely to be manifested. It may also be the case that the constraints imposed by political dynamics within the nation are equally powerful in preventing substantial changes in foreign policy except in the case of a massive lurch in which one set of elites are replaced by another.

The contribution of this study is to point the way toward a reconceptualization of the sources of American influence/policy distortion in the Third World in recognition of the rather limited role that influence as an on-going bargaining process seems to play. A number of tasks remain, however. The generally disappointing findings of the bargaining model may suggest to some that either the theoretical formulations of bargaining must be re-examined (probably with respect to scope conditions) or that better measures and tests be designed. They may be correct.

It seems more likely, however, that the findings correctly identify the correspondence of American and Third World foreign policy orientations as a consequence of consensus, rather than compliance. If so, the dependency perspective would seem to offer a promising track, though, it must be noted, far from the only such possibility. With the issue framed in this way – why do various nations arrive at roughly similar foreign policies? – we see clearly that we have returned the question to the mainstream of comparative foreign policy concerns. Why does a nation arrive at the foreign policy it does? While we have arguably eliminated one possible answer (bargaining) we have not conclusively chosen between two broad tracks. One, not discussed here, pursues the problem by searching for parallel processes operating across nations which operate independently to yield similar outcomes. The other, centering around dependency conceptions, pursues the possibility that the foreign policymaking processes (broadly conceived) of nations are as joined as their economic, political, social and cultural relations. Our very crude findings seem generally supportive of efforts along these latter lines.

Morgenthau, Hans J. (1962), “A Political Theory of Foreign Aid,” in The American Political Science Review, Vol. 56, No. 2, pp. 301-309.

The major conclusions for policy to be drawn from this analysis are three; the requirement of identifying each concrete situation in the light of the six different types of foreign aid [humanitarian foreign aid, subsistence foreign aid, military foreign aid, bribery, prestige foreign aid, and foreign aid for economic development] and of choosing the quantity and quality of foreign aid appropriate to the situation; the requirement of attuning, within the same concrete situation, different types of foreign aid to each other in view of the over-all goals of foreign policy; and the requirement of dealing with foreign aid as an integral part of political policy.

The task of identifying concrete situations with the type of foreign aid appropriate to them is a task for country and area experts to perform. Can country A not survive without foreign aid? Is its government likely to exchange political advantages for economic favors? Would our military interests be served by the strengthening of this nation's military forces? Does this country provide the non-economic preconditions for economic development to be supported by foreign aid? Are our political interests likely to be served by giving this nation foreign aid for purposes of prestige? Can a case be made for foreign aid in order to alleviate human suffering? What kind and quantity of foreign aid is necessary and sufficient to achieve the desired result?

To answer these questions correctly demands first of all a thorough and intimate knowledge and understanding of the total situation in a particular country. But it also requires political and economic judgment of a very high order, applied to two distinct issues. It is necessary to anticipate the receptivity of the country to different kinds of foreign aid and their effects upon it. When this analysis has been made, it is then necessary to select from a great number of possible measures of foreign aid those which are most appropriate to the situation and hence most likely to succeed.

In most cases, however, the task is not that simple. Typically, an underdeveloped country will present a number of situations indicating the need for different types of foreign aid simultaneously. One type given without regard for its potential effects upon another type risks getting in the way of the latter. One of the most conspicuous weaknesses of our past foreign aid policies has been the disregard of the effect different types of foreign aid have upon each other. Bribes given to the ruling group, for instance, are bound to strengthen the political and economic status quo. Military aid is bound to have an impact upon the distribution of political power within the receiving country; it can also have a deleterious effect upon the economic system, for instance, by increasing inflationary pressures. Similarly, the effect of subsistence foreign aid is bound to be the support of the status quo in all its aspects. Insofar as the giving nation desires these effects or can afford to be indifferent to them they obviously do not matter in terms of its over-all objectives. But insofar as the giving nation has embarked upon a policy of foreign aid for economic development which requires changes in the political and economic status quo, the other types of foreign aid policies are counterproductive in terms of economic development; for they strengthen the very factors which stand in its way.

This problem is particularly acute in the relations between prestige aid and aid for economic development. The giving nation may seek quick political results and use prestige aid for that purpose; yet it may also have an interest in the economic development of the recipient country, the benefits of which are likely to appear only in the more distant future. Prestige aid is at best only by accident favor- able to economic development; it may be irrelevant to it, or it may actually impede it. What kind of foreign aid is the giving country to choose? If it chooses a combination of both it should take care to choose an innocuous kind of prestige aid and to promote economic development the benefits of which are not too long in coming. Afghanistan is the classic example of this dilemma. The Soviet Union, by paving the streets of Kabul, chose a kind of prestige aid that is irrelevant to economic development. The United States, by building a hydroelectric dam in a remote part of the country, chose economic development, the very existence of which is unknown to most Afghans and the benefits of which will not appear for years to come.

It follows, then, from the very political orientation of foreign aid that its effect upon the prestige of the giving nation must always be in the minds of the formulators and executors of foreign aid policies. Foreign aid for economic development, in particular, which benefits the recipient country immediately and patently is a more potent political weapon than aid promising benefits that are obscure and lie far in the future. Furthermore, the political effects of foreign aid are lost if its foreign source is not obvious to the recipients. For it is not aid as such or its beneficial results that creates political loyalties on the part of the recipient, but the positive relationship that the mind of the recipient establishes between the aid and its beneficial results, on the one hand, and the political philosophy, the political system, and the political objectives of the giver, on the other. That is to say, if the recipient continues to disapprove of the political philosophy, system, and objectives of the giver, despite the aid he has received, the political effects of the aid are lost. The same is true if he remains unconvinced that the aid received is but a natural, if not inevitable, manifestation of the political philosophy, system, and objectives of the giver. Foreign aid remains politically ineffectual – at least for the short term – as long as the recipient says either: “Aid is good, but the politics of the giver are bad”; or “Aid is good, but the politics of the giver good, bad, or indifferent – have nothing to do with it.” In order to be able to establish psychological relationship between giver and recipient, the procedures through which aid is given, and the subject matter to which it is applied, must lend themselves to the creation of a connection between the aid and the politics of the giver which reflects credit upon the latter.

The problem of foreign aid is insoluble if it is considered as a self-sufficient technical enterprise of a primarily economic nature. It is soluble only if it is considered an integral part of the political policies of the giving country – which must be devised in view of the political conditions, and for its effects upon the political situation, in the receiving country. In this respect, a policy of foreign aid is no different from diplomatic or military policy or propaganda. They are all weapons in the political armory of the nation.

As military policy is too important a matter to be left ultimately to the generals, so is foreign aid too important a matter to be left in the end to the economists. The expertise of the economist must analyze certain facts, devise certain means, and perform certain functions of manipulation for foreign aid. Yet the formulation and over-all execution of foreign aid policy is a political function. It is the province of the political expert.

It follows from the political nature of foreign aid that it is not a science but an art. That art requires by way of mental predisposition a political sensitivity to the interrelationship among the facts, present and future, and ends and means. The requirements by way of mental activity are two-fold. The first is a discriminating judgment of facts, ends and means and their effects upon each other. However, an analysis of the situation in the recipient country and, more particularly, its projection into the future and the conclusions from the analysis in terms of policy can only in part be arrived at through rational deduction from ascertainable facts. When all the available facts have been ascertained, duly analyzed, and conclusions drawn from them, the final judgments and decisions can be derived only from subtle and sophisticated hunches. The best the formulator and executor of a policy of foreign aid can do is to maximize the chances that his hunches turn out to be right. Here as elsewhere in the formulation and conduct of foreign policy, the intuition of the statesman, more than the knowledge of the expert, will carry the day.

Morrissey, Oliver (1993), “The Mixing of Aid and Trade Policies,” in World Economy, Vol. 16, No. 1, pp. 69-84.

We have argued that tied aid, or more generally aid that is used to further the export objectives of donors, provides less benefit to recipients than untied aid (there is a presumption that aid from multilateral agencies will generally be preferable to tied bilateral aid). We see no need to summarise the issues here but make two points. First, donor self-interests rather than recipient-interests are the principal determinants of bilateral aid policy for most of the major donors, although the strength of trade within donor self-interests does vary considerably (the US, for example, appears to place most emphasis on its foreign policy objectives). Second, export competition between donors is the dominant trade objective for which aid is used, as an export subsidy (such as mixed credits) or in more general support for exports (such as tying). Use of aid in this way induces rent-seeking in the donor economy, as exporters try to capture aid policy, and may well reduce net donor welfare in addition to reducing the potential benefits of aid to recipients. The essence of our argument is that the use of aid to further trade interests does not serve the recipient’s objectives for aid nor does it necessarily serve the donor’s trade objectives.

It will be clear by now that we advocate the use of public procurement rules to institute EC-wide tying of aid; this will increase the competition in supplying many aid-supported goods to LDCs and will benefit recipients. Donors which support tying, such as France and Italy, should take heed of the increased transnational links between major EC companies as these imply that they cannot be sure that it is their domestic producers who actually benefit from tying (this is particularly relevant to mixed credits, see Morrissey, 1991). Furthermore, we advocate that the DAC take a stronger, more restrictive, line on tying and mixed credits. The recommendations listed below derive from this conclusion, as does our view on the ‘optimal’ mix of aid and trade policies, which is no mix at all - aid and trade policies should be independent of each other.

Mosley, Paul (1981), “Models of the Aid Allocation Process: A Comment on McKinlay and Little,” in Political Studies, Vol. 29, No. 2, pp. 245-253.

Within individual donor countries, two separate forces have recently been tending to induce greater progressivity in allocations of aid, with the results shown in Tables 1 and 2. The first is a decision on the part of many donors to be more selective in the allocation of aid and concentrate it on countries that need it more, originating some ten years ago but borne into policy under the impetus of the famines in much of Africa and the oil price rise in 1973-4, which between them drove a large wedge between the more fortunate and the less fortunate developing countries. Such a decision to concentrate aid on the poorest countries of the world had by 1977 been taken by, amongst DAC countries, the Netherlands, Sweden, Australia, Canada, Switzerland, the UK and the USA.12 Whether one sees these decisions as altruistic or not is irrelevant: to the extent that they are carried through into policy, they produce ipso facto greater conformity with the predictions of the recipient need model.

Separately from this, however, donors are likely to be pressured in the direction of greater responsiveness to recipient needs by the recipients themselves. It is a constraint on the validity of McKinlay and Little’s general approach that it is wholly donor-centred: a given donor, on their approach, has a certain sum of money to hand out, which he then allocates to recipients either on criteria of ‘donor interest’ or on those of ‘recipient need’. Such an approach obscures the bargaining power of recipient countries in the process of aid allocation. In fact, if a particular country experiences an event which causes it to have sudden ‘needs’, for example natural disaster (Bangladesh 1972, Ethiopia 1973) or balance of payments crisis, then these needs will generate requests from recipients which will be met ‘passively’ by aid to the limit of the donor’s capacity. But the aid thus given, of course, builds up aid-dependent vested interests and commercial channels, which are unlikely to lapse when the immediate emergency does. There is thus a gradual, and in general irreversible, shift of aid to the more disaster-prone countries; and as these are in general the poorest,13 it is likely that aid donors’ practice of responding to emergency requests will of itself tend over time to push aid programmes in a more ‘recipient-need centred’ direction. To argue this way is, of course, to do no more than to apply to the specific case of overseas aid expenditure a general principle applying to all public expenditures, namely Wildavsky’s principle of budgetary incrementalism. Just as, in Wildavsky’s analysis, the allocation of a government’s expenditure between spending departments generally remains locked in the conventional channels of past practice but can alter at the margins if one spending department puts up a particularly plausible case for an increase in its share of the total budget,14 so also the pattern of a donor’s aid allocation is, in the absence of any external stimulus, locked in the conventional channels of past obligation (including, in many cases, ex-colonial ties) in ‘normal’ times but can alter at the margins if particular recipients evince an exceptional ‘need’ for aid. Such alterations, we have argued, are most likely to occur in favour of the poorer countries; and they are subject to a ratchet effect which makes them unlikely to be reversed however transient the circumstances which led to their being implemented. Additional to these factors making for a greater salience of ‘recipient need’ criteria within donor countries, it is also the case that there has been a drift of the over-all OECD aid burden from countries whose ability to apply such criteria is constrained by past colonial and strategic ties, and in particular the United States, to countries subject to no such constraints (for example West Germany, Canada, and the Scandinavian countries). Table 3 illustrates this; it should be noted that the United States is included among the ‘constrained’ countries on account of the large quasi-colonial military commitments it built up among Third World countries, particularly Asia, during the 1950s.

The ‘unconstrained’ donor countries, of course, are freer to respond to the promptings of recipient need than are the ‘constrained’ countries. This partly explains the fact that for 1977 the recipient need model fits the total of DAC donor countries (Table 1, bottom part) much better than any of the individual donors in Table 2.

We therefore conclude that if an appropriate model is used it is not possible, contrary to the contention of McKinlay and Little, to reject the hypothesis that recipient need is a significant determinant of the pattern of aid allocation for most Western capitalist countries. As one moves forward from the 1960s in time and outwards from the special case of donors who are ex-colonial powers to consider the case of aid donors not constrained by historical commitments to specific less developed countries, the explanatory power of the recipient need model increases.

Mosley, Paul (1985), “The Political Economy of Foreign Aid: A Model of the Market for a Public Good,” in Economic Development and Cultural Change, Vol. 33, No. 2, pp. 373-393.

What determines the type and quantity of overseas aid given by individual donor countries? Answers to this question in the existing literature are polarized into two groups. One of them offers a theoretical treatment based on the theory of public goods which is not consistent with the available data, and the other offers empirical correlations without any explanatory theory. The first group – for example, Pincus and Olson and Zeckhauser – treats aid, like defense, as an “international public good.” Small countries, on this approach, are free riders, spending relatively little themselves while deriving benefits from the expenditures of larger countries. But this approach is not consistent with even a casual scrutiny of the OECD aid community in which, broadly speaking, the smallest countries are the most generous donors. The second group – for example, Hoadley and Beenstock – discover correlations between a country’s ratio of aid to GNP and certain independent variables which may be expected to influence it (e.g., that country’s GNP, its dependence on foreign trade, its government’s position in the ideological spectrum, and the state of the domestic economy). However, these findings are not fitted into any theoretical framework, so that it is difficult to work out what they really mean.

The approach of this paper is to treat foreign aid as a public good for which there is a market, albeit a highly imperfect one because the consumers – donor country taxpayers – are ignorant about the very nature, let alone the price, of the commodity they are buying. On this view, factors on the demand side (i.e., taxpayers’ response to their country’s aid program) will help to determine the quantity of aid disbursed as well as factors on the supply side such as the donor government’s desire to obtain strategic or trading benefits from aid. This view will be shown to be consistent in many cases with the available data; it contrasts with the approaches previously discussed, all of which consider only supply side influences on aid disbursement. […]

In conclusion, there are three perceptible patterns of adjustment in the market for international aid. In the first pattern, electorates are responsive to the quality of aid which their governments provide, and their governments respond to the pressures they impose by altering the quantity of their aid. In the second pattern, governments respond to such pressures from citizens by changing the quality rather than the quantity of their aid. In the third and last pattern, governments do not respond to public pressure by altering the pattern of their aid, but rather by seeking to persuade the electorate to accept the pattern of aid which they have already decided to adopt. The implication of the existing literature is that only this last pattern of adjustment is worth considering; this preliminary study suggests, however, that it is not the only pattern of adjustment which exists, and that the aid-giving process is by no means as exclusively characterized by market leadership on the part of the state as that literature has implied.

Moss, Todd, Roodman, David and Standley, Scott (2005), “The Global War on Terror and US Development Assistance: USAID Allocation by Country, 1998-2005,” Center for Global Development Working Paper No.62.

The launch of the Global War on Terror (GWOT) soon after September 11, 2001 has been predicted to fundamentally alter US foreign aid programs. In particular, there is a common expectation that development assistance will be used to support strategic allies in the GWOT, perhaps at the expense of anti-poverty programs. In this paper we assess changes in country allocation by USAID over 1998-2001 versus 2002-2005. In addition to standard aid allocation variables, we add several proxies for the GWOT, including the presence of foreign terrorist groups, sharing a border with a state sponsor of terrorism, troop contributions in Iraq, and relative share of Muslim population. […]

We do not find that any of our GWOT proxies (or their interactions) are significantly correlated with changes in country allocation of aid flows to the rest of the world, including to sub-Saharan African countries. Concerns that there is a large and systematic diversion of US foreign aid from fighting poverty to fighting the GWOT do not so far appear to have been realized.[…]

Before drawing any conclusions about the impact of the GWOT on aid flows, several important caveats are required. First, we have only looked at the provision of development assistance, which is but one aspect of U.S. foreign policy. Second, our measure of U.S. development assistance has been circumscribed by using only bilateral aid from only one U.S. agency. Third, we have only looked at total aggregate flows to countries and not at the composition of flows by sector or other substantive category. Fourth, we have also chosen five particular GWOT proxies, but many others could be envisioned. Lastly, it may simply be too early to pick up any significant differences in aid allocation. Changes in allocation criteria and systems may take years to become established and refined, and the pipeline effect for aid is well documented, often requiring several years for actual changes to occur.

Despite these caveats, one conclusion, even if only preliminary, does emerge from the data: any major changes in aid allocation due to the GWOT appear to be affecting only a handful of critical countries, namely, Iraq, Afghanistan, Jordan, and the Palestinian Territories. The extra resources to these countries also seem to be coming from overall increases in the bilateral aid envelope, combined with declines in aid to Israel, Egypt, and Bosnia and Herzegovina. Since the aid curtailments to Israel and Egypt were planned well before 2001, and the decline to Bosnia and Herzegovina is the result of the end of the immediate post-conflict reconstruction phase having nothing to do with the GWOT, this increased availability of funds may be a coincidence, but also is clearly an enabling factor to allow aid to be channeled elsewhere. There may also have been a subtle shift outside such countries toward those with higher shares of Muslim population. Time may tell whether this is the beginning of a larger trend. But at this point, concerns that there is a large and systematic diversion of U.S. foreign aid from fighting poverty to fighting the GWOT do not appear to have been realized.

Mourmouras, Alex and Rangazas, Peter (2004), “Conditional Lending Under Altruism,” IMF Working Paper WP/04/100.

IFI loan programs help liquidity-constrained LICs raise human capital investments. If IFIs could commit in advance to demanding full loan repayment from their low-income borrowers, unconditional loans would produce efficient outcomes. This paper examined the implications of IFI altruism for the effectiveness of such loan programs when IFIs cannot commit to require full repayment. When IFIs cannot commit in advance to demanding any agreed repayment from poor countries, unconditional loans are inefficient. The LIC would set investment too low in the attempt to gain loan repayment forgiveness in the future. We have demonstrated that IFIs can design time-consistent conditional loan programs that overcome this moral hazard. In our model, conditionality preserves pareto optimality and achieves first-best redistribution even in the presence of complications related to uncertain LIC investments and selfish recipient governments.

Our solution to the Samaritan’s dilemma is for the altruistic donor to present recipients with a loan schedule where both the loan amount and its interest rate are conditional on investment. The optimal loan schedule creates incentives for the recipient to choose investment efficiently while at the same time receiving an interest subsidy, and thus a transfer, that varies with investment and future income realizations. The optimal interest rate subsidy balances the tension between the IFIs’ altruistic concerns for LICs and its fiduciary responsibilities to IFI creditors. The solution does not require commitment on the part of the donor and does not trigger renegotiation to write principal down at the time of repayment—a recurrent practice with loans to LICs.

Conditional loans to some LICs have not always been associated with solid results in the past (see Dollar and Svensson, 2000; IMF, 2002a; and Ivanova, Mayer, Mourmouras, and Anayiotos, 2003). Some countries have not been able to grow out of their poverty despite long-standing IFI engagement. Our analysis suggests that IFI altruism does not need to be a fundamental source of this failure. If IFI altruism is properly reflected in the financial terms and conditionality of IFI loans, full efficiency can be achieved, encompassing pareto optimality and first-best redistribution.

Reconciling the prediction that conditional loans will help poor countries achieve first-best allocations with the mixed results of conditional loans on the ground is a challenge. One possibility, not examined in this paper, is that IFIs and their LIC borrowers face incentives to systematically overstate LIC repayment prospects, leading to boom-bust cycles in which IFI lending is followed by LIC debt distress and ex post debt relief. Empirical evidence does suggest that IFI projections of LIC economic growth and export earnings are consistently overoptimistic, leading to understatement of future LIC debt and debt-servicing burdens. Partly in response to this problem, the IMF has recently revamped its framework for assessing debt sustainability (IMF, 2002b). A second issue concerns the effectiveness of conditionality in the presence of domestic policy failures and IFI commitment problems. The present paper provided a welfare case for conditionality based on the IFIs’ inability to commit in a model that abstracted from policy inefficiencies in recipient countries. In a companion paper (Mourmouras and Rangazas, 2004) we examine a model of special interest groups that features inefficient fiscal redistribution. In this environment, the effectiveness of conditional loans in mitigating domestic policy inefficiencies is circumscribed by the IFI’s commitment problem.

Mourmouras, Alex and Rangazas, Peter (2009), “Foreign Aid with Voracious Politics,” in IMF Staff Papers, Vol. 56, pp. 786-810.

Countries with voracious politics divert large amounts of public resources to unproductive transfers to powerful interest group [sic]. This is a source of poverty, because resources devoted to such redistribution reduce the efficiency of resource allocation and lower national welfare. Fractious politics also makes it more difficult for the international community to assist developing countries. Loans conditioned on public investment alone may not improve welfare in countries with voracious politics. The higher taxes needed to pay back foreign debt may further increase rent-seeking, which could lower the returns to public investment below the cost of debt repayment.

When confronted with a highly contentious political environment in recipient countries, donors may require additional conditions to guarantee that their loans will increase the recipient’s national welfare. One guiding principle for the donor community is to develop conditions that shift the burden of debt repayment away from the taxation of productive work and toward the taxation of rent-seeking. This may be accomplished by insisting that debt be repaid by cuts in programs susceptible to rent-seeking. Because the susceptible programs are likely to vary from country to country, it is critical that the recipient country’s finance minister, and similar officials are involved in establishing the appropriate conditions in partnership with donors. In working with recipient country officials, donors should help weak central governments reduce the incentives to engage unproductive rent-seeking.

Consistent with our analysis, donors have sought to place conditions on their assistance to developing countries that aim at increasing government investment and reducing government consumption (which may also include corrupt public “investment” projects). Empirical evidence suggests that lowering government consumption raises economic growth (see, for example, Barro, 1997, Chapter 1; and Baldacci, Clements, and Gupta, 2003). Our analysis offers a new supporting argument for loan conditions that require cuts in government consumption, rather than increases in taxes, to finance loan repayment.

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