Foreign Aid and the Theory of Alliances

Abstract

ARE per-capita expenditures on foreign aid by different donor countries interrelated? In particular, do small countries tend to be free riders, exploiting the larger countries by spending relatively little themselves while deriving benefits from larger countries' expenditures? The participants in the 1960s debate over the allocation of defense expenditures among Western nations tended to assume that the answer to both questions was yes. Lumping foreign aid with defense, they argued that the smaller countries were assuming an insufficient share of the common burden of promoting world security. 1 In a provocative article, Olson and Zeckhauser (1966) proposed a theory of alliances to explain this phenomenon. The study developed the notion of a reaction function for each country, which determines its expenditures for any given level of the expenditure of other members of the alliance. Equilibrium for the alliance occurs when each country is in equilibrium given the spending of the other members. Since small countries benefit from the expenditures of large countries whatever they themselves do, they have little incentive to spend very much themselves. In the case of defense spending, this argument was supported by cross-section evidence of a positive correlation between defense spending as a percentage of GNP and GNP itself. However, in the case of foreign aid the evidence was less clear: for 1960 the authors found a positive relationship; for 1962 the relationship was not statistically significant. The Olson-Zeckhauser (O-Z) paper gives rise to a number of questions. The preferences of each country are expressed in terms of a social utility function, but no attempt is made to relate this function to the preferences of individuals within the country or to the domestic political process. Conceptually, one may distinguish three different reasons why foreign aid expenditures as a proportion of GNP might be related to the level of GNP. First, there is the influence of per-capita income. If foreign aid expenditures (or rather the returns from such expenditures) are a luxury good, aid as a percentage of per-capita income will vary positively with per-capita income. Second, there is the influence of population. It is reasonable to assume that what is generated by foreign spending is a public good consumed by residents of the donor country. Other things being equal, the price of that public good for the residents of different donor countries will be a decreasing function of their country's population. In other words, since a large country will have a greater number of taxpayers, the cost per taxpayer of a given total amount of aid spending will be lower than in a small country. Finally, there is the effect which O-Z had in mind; namely, the influence of spending by other members of the country's reference group or alliance. It would seem worthwhile to separate these three influences. Since the O-Z paper was primarily concerned with defense alliances, the implications for foreign aid spending were not studied in detail. However, there is evidence that multilateral aid, that is, funds from several countries channeled through a joint organism, is determined by a mechanism quite different from allocations of bilateral aid, which is transferred directly from donor to recipient.2 It would be desirable, therefore, to disaggregate total aid into these two components. This paper attempts to bridge the gap between individual and group preferences by means of the median-voter hypothesis, at the same time extending this approach to cases where group Received for publication February 24, 1978. Revision accepted for publication August 24, 1978. * Universite de Montreal. The author is greatly indebted to Claude Montmarquette for advice and encouragement offered in the preparation of this study. The suggestions of anonymous referees were also very helpful. Benoit Audet prepared the data and carried out the estimations. The research was supported by the Canada Council. I See, for example, Ypersele de Strihou (1967). However, Mason (1963) notes that in 1961 the United States was spending a smaller percentage of its GNP on aid than the other members of the OECD's development assistance committee. 2 Price (1967) examines the determinants of member shares for a number of international organizations. However, his capacity-to-pay model overlooks the relationship between member shares and the preferences of residents of member countries.