Why has the macroeconomic impact of foreign aid seemingly been so poor? Is there a relationship between the widespread level of corruption and other types of rent-seeking activities and concessional assistance? To answer these questions we provide a simple game-theoretic rent-seeking model. The model has a number of implications. First, under certain circumstances, an increase in government revenue lowers the provision of public goods. Second, the mere expectation of aid may suffice to increase rent dissipation and reduce productive public spending. This result may be reversed, however, if the donor community can enter into a binding policy commitment. We also provide some preliminary empirical evidence in support of the hypothesis that foreign aid and windfalls are on average associated with higher corruption in countries more likely to suffer from competing social groups. We find no evidence that the donors systematically allocate aid to countries

on Aid Effectiveness for detailed comments on an earlier draft. Support from the Bank’s research support budget is gratefully acknowledged. The findings, interpretations, and conclusions expressed in this paper are those of the authors. They do not necessarily reflect the views of the World Bank, its Executive Directors, or the countries they represent. Does Economic Analysis Improve the Quality of Foreign Assistance? What is the benefit of the millions of dollars of foreign assistance provided to developing countries in the form of economic analysis and advice? This is a difficult question to answer for two reasons. First, in the absence of a clear market test, there is no simple way of valuing the contribution of analytical work; most of it is provided free of charge or else embedded in an investment or program loan. Second, the impact of economic analysis on some ultimate objective-- such as development or poverty reduction-- is almost impossible to identify because it is only one of many factors that determine outcomes. Yet, the issue is of obvious importance. One would like to know whether past analytical work has generated measurable economic benefits that would justify its continued provision in an environment of increased scarcity of resources. Moreover, with increasing access of developing countries to nonconcessional sources of finance, the comparative advantage of international institutions such as the World Bank will shift, it is claimed, towards the provision of analytical services (see for example Rodrik, 1995).

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.

This paper is based on Besley’s Presidential Address to the European Economic Association

Abs t ra ct Donors who try to impose policy conditionality on countries receiving their aid commonly face con‡icting incentives between using aid to induce income-increasing reforms and using aid to assist low-income countries: this con‡ict can lead to a time-consistency problem. This paper o¤ers a contractual analysis of conditionality, showing how conditionality contracts are a¤ected by con‡icting donor incentives in the presence of limited commitment power. Conditionality is shown to survive in an environment with weak donor commitment power, and it can eliminate the ine¢ciency associated with the no-conditionality outcome. However, even when conditionality is successfully imposed by donors, there may be an inverse relationship between aid and reform across di¤erent aid recipients. Multi-recipient and hidden-information extensions of the baseline model are also considered.

Empirical evidence shows that developing countries with opaque institutions receive procyclical Official Development Aid (ODA) while developing countries with transparent institutions receive acyclical or countercyclical ODA. This paper provides a dynamic equilibrium model of optimal aid policy that quantitatively accounts for this fact. In the model, the donor wants to (a) encourage actions by the aid receiving government that increase output and (b) smooth out economic fluctuations. The transparency of institutions in the country affects the donor’s ability to distinguish downturns caused by exogenous shocks, from those caused by government actions. The solution to the donor’s mechanism design problem is dependent on the transparency of government actions. If the donor has good information about government actions, aid policy is countercyclical and aid acts as insurance. However, if the donor is unable to infer perfectly the cause of the downturn, aid policy is procyclical to encourage unobservable good actions. The model predicts a similar pattern for ODA commitments for the following year which is supported by the data. For countries with opaque institutions procyclical aid is the result of optimal policies given the information constraints of donors.

This paper examines the political economy of donor inspired economic models in the context of African political transition. It is a product of ongoing research on interactions between western economic models and homegrown programs. This paper, therefore examines whether or not there is a recognizable pattern of strategic policy transformation in the context of change in domestic political dispensation. Malawi provides an appropriate study setting. This is on account of the recent shift from one party dictatorship to multiparty democracy. The research is predicated upon the overarching orthodoxy of economic programs based on IMF and World Bank models. This paper therefore examines whether or not political liberalism in Malawi has made economic strategy more accessible to ideals of the free market economy. The study finds that World Bank and IMF had opposed the top down strategy of the Banda regime that excluded the poor from the means of driving economic growth. They opposed Banda’s strategy of an expanded public sector, which weakened

Paper prepared for NCDE-2. Very preliminary- please do not quote

This chapter is from a prepublication

Abstract: The Harrod-Domar growth model supposedly died long ago. But for over 40 years, economists working on developing countries have applied (and still today apply) the Harrod-Domar model to calculate short-run investment requirements for a target growth rate. They then calculate a “Financing Gap ” between the required investment and available resources, and often fill the “Financing Gap ” with foreign aid. This paper traces the intellectual history of how a longdead model came to influence today’s aid allocation to developing countries. The paper then asks if the model’s surprising afterlife has been due to its consistency with the 40 years of data that have accumulated during its use. The answer is “no.” 1 Views expressed here are not to be taken as those of the World Bank. I am grateful to John Adelman, Nicholas Carter, Norman Hicks, and John Holsen for sharing their reminiscences about modelling in the