Foreign aid and rent-seeking

Abstract

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 with less corruption.