Optimal decision rules in multilateral aid funds

Axel Dreher,Justin Valasek,Jenny Simon

doi:10.1007/s11558-020-09406-w

Abstract

While existing research has suggested that delegating foreign aid allocation decisions to a multilateral aid fund may incentivize recipient countries to invest in bureaucratic quality, our analysis links the fund’s decision rules to recipient-country investment by explicitly modeling the decision-making within multilateral aid funds. We find that majority rule induces stronger competition between recipients, resulting in higher investments in bureaucratic quality. Despite this advantage, unanimity can still be optimal since the increased investment under majority comes at the cost of low aid allocation to countries in the minority. The qualitative predictions of our model rationalize our novel empirical finding that, relative to organizations that use a consensus rule, organizations that use majority are more responsive to changes in recipient-country quality.

Highlights

When allocating foreign aid, donor countries face a problem of incentivizing recipient countries to invest in bureaucratic quality in an effort to increase the effectiveness of aid spending
We find that multilateral institutions that take decisions via majority rule provide recipient countries with a higher incentive to invest, which is consistent with our novel empirical finding that multilateral organizations that take decisions via majority are more responsive to changes in their recipient countries’ governance policies
2 Empirical analysis of decision rules and multilateral aid Before we proceed with the model, we provide descriptive evidence regarding the relationship between voting rules in multilateral organizations and the sensitivity of aid allocation to changes in their recipient countries’ governance policies

Summary

Introduction

When allocating foreign aid, donor countries face a problem of incentivizing recipient countries to invest in bureaucratic quality in an effort to increase the effectiveness of aid spending. To address this problem, a new wave of aid conditionality—political conditionality—has emerged with the intention of incentivizing needed investments and reforms (see Molenaers et al 2015). Delegation is a wellknown solution to hold-up problems in general (see Aghion and Tirole 1997), and may facilitate commitment to aid conditionality in the case of the Samaritan’s problem This solution depends on the existence of an independent party with verifiable preferences that diverge from the donor country’s in the precise direction that facilitates recipient-country investment. Delegation to international aid agencies may not always mitigate the Samaritan’s problem—as argued by Easterly (2003) and Hagen (2006), aid agencies often focus on ease of disbursement or recipient-country need rather than aid effectiveness

Methods

Findings

Discussion

Conclusion