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Taxing fragmented aid to improve aid efficiency

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Abstract

We present a model with multiple donors-principals that provide funds to a unique recipient-agent. Each donor decides how to allocate his aid funds between a pooled and an unilateral project. Both the principals and the agent value the output produced with the pooled funds and the unilateral projects. However donors have a bias in favor of their own unilateral project, which leads them to over-invest in these projects. We propose a tax scheme on the unilateral projects, which acts as a protection measure against biased allocation by the principals. The optimal tax imposed on unilateral projects varies depending on the total amount of aid provided by the donor and on the productivity of his unilateral project. Such a mechanism fits into the current discussion on bilateral negotiations on aid funds tax exemptions.

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Notes

  1. For surveys of this literature see for instance Rajan and Subramanian (2008) and Doucouliagos and Paldam (2009).

  2. See for instance Tingley (2010), Kilby and Dreher (2010), and Dreher et al. (2013) and Dreher et al. (2015).

  3. See Gehring et al. (2017) for a survey of this literature and discussion in Section 2.

  4. See Walz and Ramachandran (2011) for a review of emerging donors behavior and Dreher et al. (2011) for a comparison of DAC and non-DAC donors.

  5. For instance US foreign assistance programs are fragmented across more than 50 bureaucracies and USAID is overseeing only 45% of total US foreign aid (Brainard 2007). Similarly in Germany the ministry for international cooperation coordinates less than 40% of all German development aid. See http://ipsnews.net/news.asp?idnews=46043

  6. For example, the Tanzanian government has to prepare over 2000 reports to donors and 1000 delegations every year (Easterly and Birdsall 2008). The management of donor visits became such a big problem that the country had to declare a ‘mission holiday’ – a four month period to take a break from visiting delegations (Birdsall 2005). Each of the donors represents different accountability and procurement rules, and the need to make the project the donors want to fund match with the existing recipient country’s portfolio.

  7. We focus on the donor’s allocation of funds between unilateral projects and projects coordinated with other donors at the recipient country level. We do not include in our model the donor’s choice between multilateral and bilateral aid. The literature on multilateral versus bilateral aid is extensive (see Gulrajani (2016) for a recent survey, and Findley et al. (2017) for discussion on effectiveness of each type of aid) and the discussion on the proliferation of multilateral institutions is active (see Kellerman 2018), as is the literature on the political influence in these institutions.

  8. For instance among the 3700 aid relationships tracked down in the OECD Development Co-operation Report (OECD 2008a), 600 are micro-aid schemes of under USD 250 000 per year each, and amounting to only 0.1% of country programmable aid. More generally in 2005-06, 38 partner developing countries had more than 25 official donors, most of them small. In 24 of these developing countries, 15 or more donors provided less than 10% of that country’s total aid (OECD 2008b).

  9. See http://www.worldbank.org/en/programs/platform-for-tax-collaboration and https://www.addistaxinitiative.net/fordetailsontheseinitiatives.

  10. See for example Balogun (2005) for the distinction between harmonization of procedures, alignment of objectives and ownership.

  11. There is a vast literature on aid contracting, including among others Azam and Laffont (2003), Svensson (2003), and Morrissey et al. (2012), that works on conditionality. This literature also looks at the issue of aid effectiveness from the donors perspective: The problem is the recipient behavior and aid conditionality is a tool to control the use of aid.

  12. See OECD (2008a) for more detail on the Accra Agenda for Action or http://www.oecd.org/dac/effectiveness/parisdeclarationandaccraagendaforaction.htm.

  13. Appendix available at the Review of International Organizations’ webpage.

  14. We focus on a Cobb-Douglas production function to keep the exposition simple as it yields closed form solutions. However our results are robust to production functions that are increasing and concave in the aid investments and exhibit complementarity in the different aid projects. In the limit the aid budgets are strictly complementary (i.e., Leontief production function). With such extreme production function our results are exacerbated as aid is wasted when the different budgets are not in the right proportion of each other. By contrast if all the aid projects are perfect substitutes (i.e., the development production function is proportional to the sum of all the aid money), it does not matter how much each donor puts in his “project” as they are all substitutable. This is a case where any allocation is efficient, conditional on the fact that the recipient can handle it.

  15. In kind aid of left overs is generally a poor match for the recipient needs. To illustrate what a SWEDON is, see for instance “Bad Charity? (All I Got Was This Lousy T-Shirt!)” By Nick Wadhams in Time May 12, 2010 available at http://content.time.com/time/world/article/0,8599,1987628,00.html.

  16. As Bobba and Powell (2006) show, donors face a trade-off between coordination costs and dilution of individual objectives when choosing between bilateral and multilateral contributions.

  17. We abstract here of interactions among the different projects on effort costs. For example, Knack and Rahman (2007a) study how recipient’s bureaucratic quality is affected by donor’s preferences and number of projects.

  18. It is worth noting that even if they are fully benevolent (i.e. if ζk = 0 and Γ = 0), the donors and the recipient do not have the same objective function. The donors do not internalize the administrative cost imposed by aid management. In practice administrative capacity is a public good, which yields problem of free-ridding: everybody would like the other to finance it. It is also a black box for the donors that could hide corruption. At least development outcome is a “clean” objective and is easier to sell politically to their constituencies (i.e., taxpayers in advanced economies). It is easier to communicate around new schools or new dams than around elusive “better state capacity.”

  19. To get \(u_{2}^{\ast }= 0\) requires c2 to be so that \({\partial U_{2}(u_{1}, u_{2})\over \partial u_{2}} = -(1+c_{2})\alpha _{p} u_{1}^{\alpha _{1}}p^{\alpha _{p}-1} +\zeta H^{\prime }(u_{2}) <0\).

  20. When ζ = 0, Eq. 29 yields \(\hat {u}_{1}={\frac {\alpha _{1}}{\alpha _{1}+\alpha _{p}}}\frac {B_{2}+B_{1}}{1+c_{1}}\) so that \(\hat {u}_{1}\) increases with B2, while for Eq. 27 to be satisfied it requires that \(B_{1}\geqslant \frac {\alpha _{1}}{\alpha _{p}}B_{2}\).

  21. We set \(x=\sqrt {\frac {p}{u_{1}}}\) and solve the second order equation (32): x2 + 2ζ1x − (1 + c1) = 0. Taking the square of the only positive root, yields \(\frac {p}{u_{1} }=\left (\sqrt {1+c_{1}+{\zeta _{1}^{2}}}-\zeta _{1}\right )^{2} \). Substituting p = B − (1 + c1)u1 in this equation and solving it yields \(u_{1}^{\ast \ast }\) in Eq. 33.

  22. http://www.norad.no/globalassets/import-2162015-80434-am/www.norad.no-ny/filarkiv/vedlegg-til-publikasjoner/nordic-plus---practical-guide-to-delegated-cooperation1.pdf

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Acknowledgments

The authors are grateful for the nancial support of the French Development Agency (AFD). We thank for their comments seminar audiences at the University of Padova and at the French Development Agency (AFD). We are also extremely grateful for the insightful comments and suggestions of Nicolas Vincent, Paola Valbonesi and GaŁelle Balineau. Finally we want to thank four anonymous referees for their comments and suggestions that helped us to greatly improve the paper. All remaining errors are ours.

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  1. Toulouse School of Economics, University of Toulouse Capitole, Toulouse, France

    Emmanuelle Auriol & Josepa Miquel-Florensa

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  1. Emmanuelle Auriol
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Correspondence to Josepa Miquel-Florensa.

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Auriol, E., Miquel-Florensa, J. Taxing fragmented aid to improve aid efficiency. Rev Int Organ 14, 453–477 (2019). https://doi.org/10.1007/s11558-018-9329-0

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