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An empirical analysis of foreign aid and the provision of international public goods

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An empirical analysis of foreign aid and the provision of international public goods

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Content AN EMPIRICAL ANALYSIS OF FOREIGN AID AND THE PROVISION OF INTERNATIONAL PUBLIC GOODS Copyright 2005 by Raechelle Mascarenhas A Dissertation Presented to the FACULTY OF THE GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (POLITICAL ECONOMY AND PUBLIC POLICY) August 2005 Raechelle Mascarenhas Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. UMI Number: 3219880 INFORMATION TO USERS The quality of this reproduction is dependent upon the quality of the copy submitted. Broken or indistinct print, colored or poor quality illustrations and photographs, print bleed-through, substandard margins, and improper alignment can adversely affect reproduction. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if unauthorized copyright material had to be removed, a note will indicate the deletion. ® UMI UMI Microform 3219880 Copyright 2006 by ProQuest Information and Learning Company. All rights reserved. This microform edition is protected against unauthorized copying under Title 17, United States Code. ProQuest Information and Learning Company 300 North Zeeb Road P.O. Box 1346 Ann Arbor, Ml 48106-1346 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. ACKNOWLEDGEMENTS This dissertation could not have been completed without the support of many people who are gratefully acknowledged here. My greatest debt is to Dr. Todd Sandler, who has been a dedicated advisor and judicious mentor. During my years in the doctoral program, he provided me with constant guidance and support. He taught me how to ask questions, express my ideas and the need to be persistent to accomplish any goal. He has always stressed the importance of getting articles published and has painstakingly taught me how to prepare articles for submission. I also truly appreciate his patience and tolerance during my numerous mishaps and constant complaints. This dissertation work would not be in the current form without his insightful guidance and constructive criticism. I admire his unwavering enthusiasm in conducting research and zeal to be creative. I hope in the future I can emulate at least some fraction of his work ethic. I am very grateful to Dr. Peter Rosendorff who has served on my dissertation committee and offered advice from the outset of the process, during the formulation of my thesis proposal. He encouraged me to develop a dissertation that provides theoretical as well as empirical insights. I am also grateful to Dr. Gary Painter who willingly agreed to be my external member and has been most cooperative Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. throughout the process. I am appreciative of their intellectual perspectives and general encouragement. My parents have always encouraged me to pursue my goals and for that I am very grateful. Ryan and Anindita have been a constant source of support for me through the long years in the doctoral program. I also gratefully acknowledge the numerous friends and relatives whose acquaintance has enriched my experience as a student at use. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. TABLE OF CONTENTS ACKNOWLEDGEMENTS............................................................................................ii LIST OF TABLES..........................................................................................................vi LIST OF FIGURES..................................................................................................... viii ABSTRACT....................................................................................................................ix Chapter 1 Introduction.....................................................................................................1 1. Overview................................................................................................................... 1 2. Overview of Essay 1................................................................................................3 3. Overview of Essay 2 ................................................................................................ 5 4. Overview of Essay 3................................................................................................ 7 Chapter 2 Do Donors Cooperatively Bear the Burdens of Funding Bilateral Foreign Aid?................................................................................................................................. 10 2.1 Introduction.......................................................................................................... 10 2.2 Literature Review ............................................................................................... 12 2.3 Theoretical M odels............................................................................................. 15 2.4 Empirical Specification ..................................................................................... 22 2.5 Data .....................................................................................................................30 2.6 Results..................................................................................................................31 2.7 Concluding Remarks ......................................................................................... 48 Chapter 3 Donor Burden Sharing in Funding Multilateral Aid Agencies................ 50 3.1 Introduction.......................................................................................................... 50 3.2 Multilateral Assistance in Total Foreign Aid.................................................... 52 3.3 Literature Review and Alternative Explanations..............................................54 3.4 Theoretical Models and Empirical Specification..............................................58 3.5 Data....................................................................................................................... 66 3.6 Results...................................................................................................................68 3.7 Concluding Remarks...........................................................................................78 Chapter 4 Donors’ Mechanisms for Financing International and National Public Goods: Loans or Grants?...............................................................................................79 4.1 Introduction..........................................................................................................79 4.2 The Donors and their Objectives........................................................................84 4.3 Theoretical M odel...............................................................................................86 4.4 Data and Methodology....................................................................................... 90 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 4.5 Empirical Results ...............................................................................................99 4.6 Policy Implications and Concluding Remarks................................................ I l l Chapter 5 Conclusions ............................................................................................... 114 REFERENCES............................................................................................................ 118 APPENDIX..................................................................................................................123 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. LIST OF TABLES Table 2.1: Donors’ Allocation Behavior for Total Bilateral Commitments to ODA (1970-2001)....................................................................................................................33 Table 2.2: Parameter Estimates of the Joint-Product Nash-Coumot Model for Total Bilateral Commitments................................................................................................. 34 Table 2.3: Donors’ Allocation Behavior for Bilateral Commitments to Africa .........................................................................................................................................37 Table 2.4: Estimates of the Joint-Product Nash-Cournot Model for Bilateral Commitments to Africa................................................................................................. 40 Table 2.5: Donors’ Allocation Behavior for Bilateral Commitments to America (1970-2001)....................................................................................................................41 Table 2.6: Estimates of the Joint-Product Nash-Cournot Model for Bilateral Commitments to America.............................................................................................42 Table 2.7: Donors’ Allocation Behavior for Bilateral Commitments to Asia ........................................................................................................................................ 44 Table 2.8: Estimates of the Joint-Product Nash-Cournot Model for Bilateral Commitments to A sia................................................................................................... 46 Table 2.9: Estimates of the Joint-Product Nash-Cournot Model for Bilateral Commitments to Europe............................................................................................... 47 Table 3.1: Donors’ Share of Total Multilateral Assistance and Total Multilateral Contributions as a share of Donors’ GDP....................................................................54 Table 3.2: Parameter Estimates of the Joint-Product Nash-Cournot Model for Donors’ Commitments to All Multilateral Institutions...............................................70 Table 3.3: Restricted Parameter Estimates of the Joint-Product Nash-Cournot Model for Donors’ Commitments to Multilateral Institutions...............................................72 Table 3.4: Parameter Estimates of the Joint-Product Nash-Cournot Model for Donors’ Commitments to Global Institutions and UN Agencies.............................. 74 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Table 3.5: Parameter Estimates of the Joint-Product Nash-Cournot Model for Donors’ Commitments to Regional Development Banks.......................................... 77 Table 4.1: Global Institutions, Regional Institutions and Bilateral Donors..............86 Table 4.2: Loan and Grant Elements in Total Commitments for Select Donors 97 Table 4.3: Results of the ANOVA procedure........................................................... 100 Table 4.4: Scheffe Grouping for Institutions by Sector............................................104 Table 4.5: Mean Share of Grants for IPGs and NPGs.............................................. 110 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. viii LIST OF FIGURES Figure 2.1: Bilateral Foreign Aid Commitments by Region (1970-2001)................ 36 Figure 2.2: Bilateral Foreign Aid Commitments to Africa (1970-2001).................. 38 Figure 2.3: Bilateral Foreign Aid Commitments to Asia (1970-2001)..................... 43 Figure 3.1: Share of Multilateral Assistance in Total Foreign A id........................... 53 Figure 4.1: Multilateral Institutions Commitments by Sector (1980-2000).............93 Figure 4.2: Bilateral Donors’ Commitments by Sector (1980-2000)........................93 Figure 4.3: Regional Institutions’ Commitments by Sector (1980-2000)................94 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. IX ABSTRACT This dissertation theoretically and empirically analyzes the strategic nature of donors’ interactions in committing foreign aid that yields both private benefits to the donor and public benefits to all donors and recipients i.e. foreign aid is a joint- product activity. The dissertation consists of three essays: In the first essay, donor’s demand equations for bilateral aid are derived for three allocation processes: strategic Nash-Cournot, Lindahl cooperative, and bureaucratic. I apply non-nested tests to distinguish between Nash-Cournot and Lindahl reduced- form equations for 15 major donor nations. Noncooperative behavior characterizes most donors, with a few abiding by bureaucratic behavior. Strong evidence emerges for the presence of donor-specific benefits. For noncooperative donors, donations are either substitutes or complements depending upon spatial propinquity to the donors, the size of donations, and other considerations. In essay two demand equations that account for strategic interactions amongst donors are theoretically derived for funding of multilateral institutions. The study estimates the demand equations using a two-stage least squares procedure that accounts for endogeneity. Evidence shows that donors receive private benefits from contributing to multilateral agencies. There is strong support for complementarity in donors’ contributions to all multilaterals and regional development banks. Substitutability Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. X characterizes donations of the larger nations to agencies with a more global operational focus. The taste shifting variable in the demand equation, private capital flows to developing and transition countries, tends to crowd-out multilateral donations for donors that free ride on others’ commitments. Essay three investigates whether three classes of donors - global organizations, regional institutions, and bilateral donors - tailor their mix of grants and loans to reflect international benefit spillovers derived from aid-funded activities. To account for recipient benefit shares, donors should use a greater share of grants when supported activities yield a larger portion of international public benefits. Using statistical comparisons, my analysis establishes that donor classes apply different grant-loan mixtures when supporting different sectors of recipient countries: bilateral donors do the best job in tailoring their grant-loan mix; global organizations’ grant- loan mix is intermediate of the three types of donors; regionals do not discriminate their grant-loan mix by either sectors or associated public good spillovers. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 1 Chapter 1: Introduction 1.1 Overview Foreign aid transfers from developed countries to the developing countries and countries in transition (since the collapse of the Soviet Union) have been an established feature of the international system for the last several decades.1 The Organisation for European Cooperation and Development (OECD), especially the Development Assistance Committee (DAC), has become the main agency for coordinating and tracking the flow of development assistance to recipient countries. DAC member nations bestow foreign aid on less developed countries for myriad reasons ranging from economic interests to political considerations to humanitarian ideals to pure altruism (McKinlay and Little 1977, Lumsdaine 1993, Alesina and Dollar 2000, Degnbol-Martinussen et. al. 2003). In the past few decades cross-border flows of people, animals and goods have increased rapidly with the improved means of transport and communication, facilitating the globalization of the world’s economy. This trend of movement across borders will only intensify in the future as nations become more connected. 1 Foreign aid (also referred to as development assistance) consists of Official Development Assistance (ODA) and Official Aid (OA). Grants and concessional loans that have at least a 25 per cent grant component given to developing countries are termed ODA. The OA meets the same tests as ODA but is directed at countries in transition. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 2 Globalization has often been associated with increased privateness in terms of augmented reliance on markets but it is also accompanied by greater publicness in terms of greater interdependence (Kaul et al. 2003). The effects of environmental disasters, terrorist events, financial crises and infectious disease outbreaks spread swiftly across the globe. Therefore, the spillovers from most events are no longer confined within the borders of a single country (Sandler 1997, 2004, Kaul et al. 1999). An effective way of dealing with these global challenges is the provision of public goods to internalize cross-border spillovers. Foreign aid might be directly utilized for the provision of public goods that address international concerns or used to build up the recipients’ internal capacity to address cross-border problems. For example, if foreign aid is utilized for facilitating the recipient’s adoption of environmentally-friendly technologies, then the recipient benefits from the transfer of technology and all recipients and donors gain from the reduced production of environmentally damaging effluents by the developing nation. Therefore, development assistance yields benefits not only to the recipient countries but also to the donor(s). Donors’ foreign aid contributions can be viewed as a joint-product activity that yields multiple outputs that vary in their degree of publicness (Cornes and Sandler, 1996). Analyzing foreign aid within the joint-product framework allows me to test for a rich array of public good provision models, examine the underlying allocation behavior of donors’ contributions to foreign aid and determine Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 3 the appropriate mechanisms for financing the provision of public goods through development assistance. In the three essays of my dissertation therefore, I study the following aspects of foreign aid within the context of the provision of public goods: (1) whether donor nations cooperate in the provision of foreign aid via direct bilateral transfers to developing and transition countries, (2) whether donor nations share the burdens of funding multilateral aid agencies, (3) whether donors’ tailor their mix o f loans and grants to reflect international spillover benefits in giving foreign aid. 1.2 Overview of Essay 1 A sizeable portion of foreign aid (on average almost 74%) is transferred directly from donor nations to recipient developing and transition countries. Since the DAC was set up with the purpose of coordinating donors’ foreign aid transfers, it is a worthwhile exercise to unearth whether donors cooperate when making commitments to fund activities in less developed countries. With the exception of Hayashi (2002) for multilateral institutions, rigorous examination of the behavior underlying donors’ bilateral commitments to development assistance, using models of the private provision of a public good, has not received attention in the literature on foreign aid. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 4 This essay explores three allocation processes: (i) Nash-Cournot or noncooperative strategic behavior, (ii) Lindahl or cooperative behavior, and (iii) Bureaucratic behavior. Donors’ demand equations based on the pure public good and joint- product specifications are theoretically derived for the Nash-Cournot'and Lindahl allocation processes. I utilize a two-stage least squares estimation procedure, which accounts for endogeneity, to estimate the donors’ demand equations for these alternate allocation procedures. When neither the Nash-Cournot model nor the Lindahl model is applicable, I test for three types of bureaucratic behavior. Based on OECD data for official development assistance over the period 1970-2001, I analyze bilateral aid flows in total as well as flows to four main geographical regions: Africa, America, Asia and Eastern Europe as well as sub-divisions within these areas (e.g. Sub-Saharan Africa and North of the Sahara). I apply a non-nested test to distinguish between Nash-Cournot and Lindahl reduced-form demand equations for 15 major donor nations. Despite more than five decades of giving foreign aid I find no evidence of Lindahl behavior, while a few donors abide by bureaucratic behavior. The overwhelming evidence shows that noncooperative Nash-Cournot behavior characterizes most donors for total foreign aid commitments and assistance to different regions. Since most donors abide by noncooperative strategic behavior, the concern is that a sub-optimal outcome characterizes foreign aid donations (Olson, 1965). Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 5 This study finds strong evidence of donor-specific benefits from committing foreign aid indicating that the joint-product model is the more appropriate representation. For noncooperative donors, using the estimated coefficients I can determine if donors’ treat other nations’ contributions either as substituting for or complementing their own donations. Donor complementarity is driven by spatial propinquity of the recipient to the donor, the magnitude of donations, and the recipient’s status as a former colony. The presence of complementarity reduces free riding since donors’ only receive benefits from their own bilateral aid contributions. The sub-optimality that characterizes Nash-Cournot behavior is mitigated, to some extent, by the presence of donor-specific benefits from contributing and the complementarity of donors’ commitments that typify bilateral foreign aid. In future if foreign aid is to be effectively disbursed to meet the needs of developing and transition countries, then donors need to better coordinate their foreign commitments not only in total but also by region of allocation. 1.3 Overview of Essay 2 Donors channel almost a quarter of total development assistance through multilateral institutions like the World Bank, the United Nations and the regional development banks. Several studies have analyzed the motivations behind donations to multilateral institutions, the lending behavior of these institutions and donor burden sharing in funding these agencies (Rodrik 1995, Milner 2004, Neumayer 2004b, Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 6 Addison et al. 2004). This essay attempts to fill a gap in the foreign aid literature by analyzing the strategic nature of donors’ commitments to multilateral institutions. In addition, this study analyzes the effect that private capital flows have on multilateral development assistance. This essay focuses on understanding if donors treat other nations’ commitments to multilateral agencies as complementing or substituting for their own donations. Once again, the funding of multilateral institutions is treated as a joint-product activity that yields private benefits to the donor as well as public benefits to the recipients and all other donors. In addition, the study analyzes the relationship between private capital flows to developing and transition countries and donors’ commitments to multilateral institutions. The analysis proceeds by first considering commitments to all multilateral institutions collectively and then considers separately commitments to institutions with a global focus and agencies with a regional mandate. A reduced-form demand equation based on the joint-product representation and accounting for strategic interactions amongst the donors is derived. Using the two stage least squares procedure, which utilizes instrumental variables to address endogeneity, demand equations for multilateral assistance are estimated for the seventeen main donor nations over the time period 1970-2003. I find significant Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 7 support for donor-specific benefits validating the representation of multilateral commitments as a joint-product activity rather than as a pure public good. The large donors treat other nations’ contributions to all multilateral agencies as complementing their own donations and this bodes well for overall level of commitments to these institutions. Complementarity is most strongly exhibited for donations to regional development institutions, which is heartening since these agencies are clamoring for a greater role in dealing with localized problems. For institutions with a global operational focus I find that some of the larger contributors free ride on other countries multilateral donations. Private capital flows to less developed countries produce mixed effects on assistance to multilateral agencies. For donors that treat others’ contributions to multilateral agencies as substitutes, private capital flows tend to crowd-out multilateral donations. 1.4 Overview of Essay 3 Recent studies have focused on cross-border spillovers arising from the increasing inter-connectedness of nations (Sandler 1997, Kaul et. al. 1999, Kaul et. al. 2003). Some amount of foreign aid is channeled towards providing international public goods (IPGs) that directly address cross-border spillovers. Often, foreign aid is utilized to fund activities that build the capacity of developing and transition countries to absorb IPGs and these activities are termed national public goods Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 8 (NPGs). Both IPGs and NPGs play a vital role in addressing regional and global problems. The mechanisms for funding foreign aid (i.e. the mix of loans and grants) based on the nature of the activity being financed have been a relatively recent concern amongst development policymakers (Ferroni 2002, Kanbur 2002). To account for recipient benefit shares, donors should use a greater share of grants when supported activities yield a larger portion of international public benefits. A greater reliance on loans is appropriate when a large portion of recipient-specific benefits are associated with the assistance. By reflecting recipient benefit shares in the grant-loan mix, donors’ assistance also promotes allocative efficiency. This essay investigates whether three classes of donors - global organizations, regional institutions, and bilateral donors - tailor their mix of grants and loans to reflect international benefit spillovers and recipient-specific benefits, derived from aid-funded activities in developing and transition countries. Using the Credit Reporting System (CRS) database from OECD for 1980-2000, my analysis establishes that various donor classes apply different grant-loan mixtures when supporting the environment, health, knowledge, and governance sectors of recipient countries. I employ analysis of variance and other statistical comparisons of the mean share of grants to investigate differences among donor classes. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 9 The study demonstrates that bilateral donors do the best job in tailoring their grant- loan mix to accord with the extent of international public good benefits embodied in the aid-supported activity. Global organizations’ grant-loan mix is intermediate of the three types of donors, with some evidence of them relying more on grants to finance activities that possess a larger share of international public good spillovers. Regional institutions, however, do not discriminate their grant-loan mix by either sectors or the associated public good spillovers. This finding suggests that regional development banks need to adjust their grant-loan mix to better account for international benefit spillovers if these institutions are to warrant the increased funds to underwrite regional public goods that they have been seeking. If, however, their mix is institutionally set, then the stakeholders must give these institutions greater flexibility to tailor their grants and loans to who benefits from the aid-supported public goods. This is the first study to empirically ascertain whether the grant-loan mix is tied to the inherent publicness of the aid-funded activities. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 10 Chapter 2: Do Donors Cooperatively Bear the Burdens of Funding Bilateral Foreign Aid? 2.1 Introduction Foreign aid flows are often perceived as conferring purely public benefits so that free riding amongst donors may be a problem (Kanbur, Sandler, and Morrison, 1999). For example, funding a recipient’s adoption of non-ozone-depleting technology provides benefits worldwide. If, however, aid flows generate joint products (i.e., multiple outputs that vary in their degree of publicness), then aid-funded activities may yield purely public and donor-specific private benefits (Comes and Sandler, 1996). Tied aid, like technical assistance, often involves using manpower from the donor that yields excludable benefits to the latter, while the recipient gains purely public benefits. Donor-specific benefits dissuade donor nations from free riding on other nations’ foreign aid contributions. Foreign aid is targeted at the core sectors of developing countries like health, education, environment, governance, and security. The activities financed through foreign aid transfers can be viewed as yielding transnational public goods (TPGs), whose benefits are at least regionally, if not globally, nonrivalrous and Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 11 nonexcludable.2 As donors disburse funds to the same set of less-developed nations, donors may collectively be viewed as members of an alliance, whose efforts reduce poverty. Coordination amongst donors in disbursing foreign aid is an ideal aspired to by the Development Assistance Committee (DAC) of the Organization for Economic Cooperation and Development (OECD), which provides guidance for donors in pursuing their foreign aid programs. Aid flows to developing countries are channeled either through multilateral agencies (like the World Bank and the United Nations) or through direct bilateral transfers from a donor country to the recipient. The purpose of this study is to identify, where possible, the underlying allocation process that drives donors’ contributions to bilateral foreign aid donations that provide national and TPGs while alleviating poverty. By analyzing foreign aid commitments and donations to different geographical regions, the paper determines whether donors’ foreign aid contributions adhere to one of three allocation processes: noncooperative (Nash-Cournot) behavior, cooperative (Lindahl) behavior, or bureaucratic behavior. To accomplish this identification, I derive reduced-form donor’s demand equations for giving aid for each of these processes. Based on OECD data for 15 primary donor nations for 1970-2001,1 apply non-nested tests to distinguish between noncooperative and cooperative behavior among donors. Thus, 2 Kaul, Stem, and Grunberg (1999), Kaul et al. (2003), Sandler (1997, 2004) and Arce and Sandler (2002) cover several issues related to global and regional public goods, ranging from financing considerations to the underlying nature of these public goods. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 12 I ascertain whether donor nations cooperatively share the burden for funding foreign assistance. Bureaucratic behavior is tested for those nations whose demand for aid provision abides by neither noncooperative nor cooperative behavior. 2.2 Literature Review The literature on allocation processes within collectives is extensive with most empirical applications pertaining to military alliances that share a public good of defense (McGuire and Groth, 1985; Olson and Zeckhauser, 1966, Sandler and Murdoch, 1990). Olson (1965) highlights the suboptimality of provision levels when allies share a purely public defense output whose benefits are nonrival in consumption (i.e., one ally’s defense consumption does not detract from the amount available for other allies to consume) and nonexcludable among allies. Olson and Zeckhauser (1966) determine whether allies assume their appropriate share of the defense burden based on some ability-to-pay principle.3 Alternative resource allocation processes may underlie allies’ contributions to defense or contributors’ financing of a shared public good. Noncooperative Nash- Cournot behavior is where each agent chooses its public good provision to optimize its welfare, while taking the choice of the public good by the other agent(s) as given. Noncooperative behavior for a purely public good generally results in suboptimal 3 Sandler and Hartley (2001) provide a comprehensive overview of the literature on the economic theory of alliances. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 13 provision levels that worsen as group size increases. An alliance providing purely public defense is characterized by disproportionate burden sharing with the exploitation of the large nations (in terms of gross domestic product) by the small nations (Sandler, 2004). The presence of ally-specific benefits in conjunction with alliancewide public benefits implies that each ally has to make its own contribution to ensure receipt of private benefits. A larger share of the jointly produced private benefits diminishes the incentive for free riding and thereby reduces the extent of provision suboptimality. A second kind of allocative process is Lindahl or cooperative behavior, where each country chooses the ideal total defense provision, given a set of contribution shares for the allies. When all members choose the same overall public good level based on the announced set of shares, a Lindahl equilibrium is obtained that is Pareto optimal and, thus, desirable. Both behavioral assumptions treat the nation as a unitary actor that decides provision levels. Sandler and Murdoch (1990) engineer an empirical method for using non-nested tests to distinguish between Nash-Cournot and Lindahl behavior. A simple bureaucratic process represents a third allocation method to determine a nation’s public good provision. For instance, donors’ current period Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 14 commitment to development assistance may reflect some proportion of the previous period’s commitment.4 A group of donors contributing to foreign aid is analogous to an alliance sharing the burden of defense because donors receive benefits from their own donations as well as those of other countries. Few attempts have been made to study the underlying allocation process of donor nations’ commitments to foreign aid. To account for the recent inability of the Olson-Zeckhauser model to explain burden sharing in international organizations, Kwon (1998) proposes that donors’ contribution incentives are shaped by characteristics of the international system. Using data on burden sharing for financing the United Nations, Kwon (1998) finds that the decreasing interest of large donors in funding multilateral organizations is a result of the more dispersed nature of international influences. Rowlands and Ketcheson (2002) test for two broad concepts of coordination: complementary (i.e., donors coordinate their activities to achieve an overall distributional goal) and supplementary (i.e., donors share the burden of foreign aid in an equitable manner). The authors test these concepts for data on Sub-Saharan Africa for sample donors, and find little support for supplementary coordination. Overall, no clear pattern was discernible. The only research paper to test between Nash-Cournot and Lindahl behavior for a set of donor countries funding multilateral aid agencies is Hayashi 4 Sandler and Hartley (1995, 90-92) discuss bureaucratic models within the context of military arms races. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 15 (2002), which assumes that donor nations are contributing to a purely public activity. Hayashi finds that the United States conforms to the Lindahl model. The standard Nash-Cournot model is invalidated. For the other DAC countries in Hayashi’s study, a few conform to the Lindahl model, while almost none subscribe to Nash-Cournot behavior. Unlike Hayashi (2002), I am interested in bilateral donations and present alternative theoretically constructed reduced-form equations that are tested while accounting for simultaneity bias. 2.3 Theoretical Models Foreign aid supports, in part, public good activities whose benefits may spill over the borders of the recipient nation. For example, efforts to rid a country of a pest provide protection to neighboring countries. Even actions to alleviate poverty make for a healthier population which is more resistant to diseases that can spread abroad. Spillovers may also arise from altruistic rewards as a recipient population’s well being is improved. Thus, foreign aid is an activity that yields global purely public and recipient-specific benefits. I treat a donor nation as a single decision-making entity in order to test the allocation process that underlies foreign aid commitments among donors. The theoretical analysis draws on Sandler and Murdoch (1990) that not only provides a method for distinguishing pure public goods from joint-product activities but also a procedure for distinguishing between Nash-Cournot and Lindahl behavior. For donor countries not abiding by either behavior, I provide some Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 16 alternative bureaucratic models where today’s allocations to foreign aid are based on yesterday’s variables. Nash-Cournot Pure Public Goods and Joint-Product Models First consider the Nash-Cournot pure public goods representation of foreign assistance. Each donor nation consumes a pure private good, y l, and a pure public activity, Q , to which each nation contributes q‘. The public good, which represents the worldwide gain from alleviating poverty, abides by a summation technology where the total amount of the good available to all donor countries is a simple sum of all donor nations’ provision levels; i.e., Q = q' +Ql , where Q is the contribution to the public activity of all donor nations excluding nation i. Nation /’ s utility function is assumed to be strictly increasing and strictly quasi-concave, and is represented by: U 'i y '^ + Q 1 ). (2.1) Nation z’s budget constraint is Ii =Pyy + P Q ^, (2-2) where I' is the national income of nation z , p y is the price of the private good, and p Q is the price of the public activity. The term p Q & is added to both sides of (2.2) to convert the budget constraint to the full-income form. Full income, Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 17 F' = T + p j y , indicates the total disposable income available to nation / and includes the spillovers from the other donor nations’ provision of the pure-public- good-yielding activity. The problem confronting nation i is: in which each donor views itself as choosing the total foreign assistance, subject to a budget constraint incorporating the value of the exogenously fixed donations from others. This full-income representation results in a demand equation system that can be compared with that derived from a Lindahl process, as shown below. In (2.3), I associated with (2.3) immediately give the donors’ demand for total foreign assistance as a function of the three exogenous arguments - the price of the private good, the price of foreign assistance, and full income - for donor i as follows: A Nash-Cournot equilibrium results when each donor nation desires the allocation Qe = Q‘ (Py, Pq , F l). The resulting equilibrium implies a Pareto-suboptimal allocation. If the public activity is a normal good, then a change in full income will increase each nation’s equilibrium demand, so that dQ / CF‘ > 0 for every nation i and the Nash equilibrium is unique. max {Ul ( / , Q ) F 1 = p yy' + p Q Q }, (2.3) implicitly assume that Q > Q for all donor countries. The first-order conditions Qi =Q\py,pe,n - (2.4) Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 18 Next, I allow foreign assistance to represent a joint-product-yielding activity q' that gives a public benefit z! = (ql) that all nations can consume and a donor-specific benefit x' = h (q‘) that accrues only to nation i. Both f and h, are twice-continuously differentiable, increasing concave functions. The total amount of the public benefit available to all nations is Z = z + Z ', where Z' = g (0 ‘) denotes the contribution of all nations, excluding nation /, to the jointly-produced public good. The utility function is again assumed to be strictly increasing and quasi-concave and can be represented in activity space as: U '{ y \x \Z ) . (2.5) Using the relationships which define x1 and Z, I can rewrite the utility function for donor i as: U \y lM q l) J M l) + g(Q1 ))- (2.6) I again depict the representative donor country as though it is choosing total foreign assistance based on a fiill-income approach. Since ql =Ql - Q , where Q1 is donor /’s choice for total bilateral donations, I can alter the utility function by replacing q and expressing Vs choice problem as: max A U X y M Q '- Q X m - & ) + g(Q ‘))\F ' = p J + P qQ ), (2.7) where F' = I' + p Q Ql is full income. Solving the associated first-order conditions yields donor z’s demand equation for foreign assistances as a joint-product activity: Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 19 Q' = Q \P y,P Q,F \Q ) - (2.8) As a joint product, donor /’ s foreign assistance demand depends on the price of the private good, the price of the foreign assistance activity, full income, and the spillin bilateral contributions of other donor countries. The Nash-Cournot equilibrium results when every donor nation chooses the same level of Q for (2.8). The partial effect of a change in foreign aid spillovers on the total provision of the joint-product activity can be broken down into: - d(ff + 1 . If dqL / dQl > 0, then dQ‘ dQ dQ donor nation /' views its own contribution to the joint-product activity as complementary to the contributions of all other donors. If dq' / dQ' < 0 , then donor nation i views the other donor nations’ contributions to the joint-product activity as a substitute for its own assistance. It indicates whether a donor nation free rides on the bilateral donations of others. For complementary joint products, increased donations by others induce i to augment its own donations to get more of the donor- specific complementary output (e.g., prestige in the international community, political concessions, or trade agreements) that can come only from its own charity. Complementarity curbs free riding (Comes and Sandler, 1996). Comparison of the Nash-Cournot demand in (2.4) for the pure public representation and (2.8) for the joint-product representation of foreign assistance indicates the Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 20 presence of an added Q term in equation (2.8). This allows for a simple nested test to distinguish between the two models based on the significance of the coefficient associated with the spillin term Q1. Lindahl Pure Public Goods and Joint-Product Models Lindahl behavior involves donor nations cooperating with each other to determine the total amount of foreign aid to be committed. The share of the total cost of the public good, PqQ, borne by nation / is 6 '. The sum of the cost shares for the set of donor nations must add up to unity; i.e., ^ 0 ’ =1 so that bilateral donors bear the i total cost of bilateral aid provision. I first consider the case where foreign assistance is purely public among donors so that donor i faces the following problem: The associated first-order conditions yield the Lindahl demand equation for foreign assistance as a function of the price of the private good, the aid share contributed by nation /, and the income of nation i . An equilibrium under the Lindahl process is reached when every nation desires the same overall level of foreign assistance, Qe = O' such that ^ 0 ' = 1. If foreign-aid i financed activities are perceived as normal goods, then dQ‘ / 811 > 0. A change in max { y .e b {u\y\Q)\r=pyy+ffpQ Q} (2.9) Qi=Q{py,0ipQ , n (2.10) Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 21 the cost share term & results in an income effect and a substitution effect. The substitution effect is negative owing to the quasi-concavity of the utility function. For normal goods, an increase in the cost share results in a decrease in the nation’s demand for foreign assistance. If donor nations view foreign assistance as yielding public altruistic benefits and donor-specific private benefits, then I can use the procedure of the Nash-Cournot joint-product case to derive the underlying demand function. This procedure, however, yields a foreign assistance demand function of precisely the same form as (2.10) (see Sandler and Murdoch, 1990). Unlike the Nash-Cournot case, there is no ready procedure for distinguishing pure public and joint-product representations for foreign assistance. As a cooperative process, the Lindahl equilibrium represents a Pareto-optimal solution because donor nations internalize all benefit spillovers. Bureaucratic Allocation Processes When nations subscribe to neither Nash-Cournot nor Lindahl behavior, there may be some underlying bureaucratic allocation process that determines foreign aid commitments. In such instances, the bureaucracy is assumed to be a single entity that decides the nation’s foreign aid commitments. The simplest bureaucratic allocation process involves setting the current-period commitment as a proportion of the previous year’s commitment: Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 22 q\ = kq\A, (Model 51) (2 .11) where q\ is /’ s foreign aid commitment in the current period, q) , is its commitment in the previous period, and A : is a constant. A donor nation’s allocation in the current period could also be a proportion of its previous period’s national income A joint model with both the previous year’s aid commitment and income is also considered as a possible bureaucratic allocation process: These bureaucratic models capture some sort of inertia that allocates foreign aid based on past allocations or a share of past national income. The goodness of fit of the model (in terms of the coefficient of determination) is utilized to conclude which of these three models best describes the type of bureaucratic allocation process when such a process appears relevant. 2.4 Empirical Specification The allocation behavior of fifteen primary bilateral donors - Australia, Austria, Belgium, Canada, Denmark, France, Germany, Italy, Japan, the Netherlands, Norway, Sweden, Switzerland, United Kingdom, and United States - are investigated. Foreign aid commitments for 1970-2001 are judged to be the outcome ql = kll ,. (Model 52) (2.12) q‘ t = kq‘ t , +ml't v {Model 53) (2.13) Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 23 of an equilibrium process involving either Nash-Cournot or Lindahl behavior. Not all DAC donor countries are examined in this study, since there are insufficient observations for some donors to carry out a meaningful data analysis. Countries like Finland, Ireland, Iceland, Luxembourg, New Zealand, Portugal, and Spain give aid to developing countries but not for all 32 sample years. Because the foreign aid contributions given by these countries are substantial in a few years, these flows are included in the contribution spillins that each donor receives from other donor nations so that the spillover effects are not underestimated. Given the diverse activities funded in developing countries by foreign aid transfers, the prices of these activities cannot be gauged. For this study, I assume that the prices of foreign assistance and the private numeraire good change by the same proportion over time, while this assumption might be regarded as highly restrictive there is no reasonable alternative to capture this proportion. Deflated expenditure figures for all variables - F ,F ',Q l and 0 ‘ - are used to incorporate the price of the private good. A log-linear statistical specification of the models is utilized that allows me to interpret the coefficients as elasticities. The statistical model for the joint-product Nash-Cournot demand based on (2.8) is: InODAt = J 3 t0 +pn InFULLINCOMEit + j3l2 InSPILLINlt + e", (2.14) Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 24 where ODAt is the total official development assistance (ODA) given by all DAC donor countries in time period t\ FULLINCOMEit is the sum of donor z’s national income (i.e., gross domestic product) and the spillins from the other nations’ bilateral aid donations; SPILLINit is the bilateral contributions from all DAC nations, excluding nation z; and sft is the error term. The /(s are unknown parameters. By setting Pi2 =0,1 get the Nash-Cournot pure public representation of foreign assistance. A nested test of this coefficient thus distinguishes between the pure public good and the joint-product Nash-Cournot representation of foreign assistance. Given the log-linear specification, the /?, coefficient indicates the responsiveness of O' ( da' total bilateral aid provision levels to changes in aid spillovers: fii2 = — — =- + 1 ,5 Q \P Q Therefore, the partial effect of a change in nation z’s bilateral aid commitments in response to a change in spillovers consists of — L- = ~^'2 - 1. dQ' Q' / Q' The log-linear specification of the Lindahl model, based on (2.10), is: In O D A , = Al0 + An In G I)P it + J ,2 In S H A R E ,, + sft , (2.15) The elasticity of total bilateral commitments equals 0 _ d Q '!Q ' dQ Q' Q' dq' dQ Pi2 ~ ~ ~ ~ ~ . + dQ'/Q' d Q 'Q ' Q 'ldQ ' dQ A A Q L Q ' dq' ~d@ + 1 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 25 where GDPit is donor f s gross domestic product in time period t\ SHAREit is donor /’ s share of the total contributions made to ODA by all DAC donor countries [i.e., SHAREjt = (Commitmentit / ODAt) where Commitmentit is the contribution of nation i in time period /]; As are unknown parameters; and s't is the error term. Some empirical issues arise from the above specifications. Endogeneity is a concern because the FULLINCOMEit and the SPILLINit terms are correlated with the error term in the Nash-Cournot specification, while the SHAREit term is correlated with the error term in the Lindahl specification. To address this problem, I apply two- stage least squares (2SLS) with the exogenous variables in the system (i.e. the GDPs of all donor nations) as instrumental variables. The standard practice in the literature is to use all the exogenous variables in the system that are not correlated with the error term as instruments to estimate the endogenous variables. Autocorrelation of the error terms in both models is also a problem and the Durbin- Watson test was performed to check for the presence of autocorrelation. If the autoregressive process is found to be of the first order, it can be represented as sft = p N sft_ x + ujt for the Nash-Cournot model and sft = p's[iM + vit for the Lindahl model (Greene, 1997). Reliable estimates for p N and p L can be obtained using the residuals from the 2SLS procedure and are given by: Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 26 32 Z ^-i P] =A i , for j = N,L. (2.16) Z(^)2 t= 2 These estimates for p N and p L are then used to transform the variables in both models and the Nash-Cournot joint product and Lindahl specifications to be estimated are: (In ODAt - p N In ODA, ,) = J 3 l0 + J 3 n (In FULLINCOMEit - p N In FULLINCOMElt_ x) +Pi2 (In SPILLINit - p N In SPILLINit_ x ) + e%, (2.17) and (In ODAt - p L In ODAt_ x) = l i( ) + An (In GDPU - p L In GDPit l) +Al2 (In SHAREit - p L In SHARElt_ _ x ) + s r it, (2.18) Whenever autocorrelation is found to be a problem the coefficients used to transform the variables are displayed in the tables along with the other parameter estimates. Note, transforming the variables using the autocorrelation coefficient does not alter either the value or the interpretation of the parameter estimates. The empirical specification for bureaucratic behavior again uses the log-linear form, where the three models are: In Commitmentit = St o + Sn In Commitmentit_ x + p it, (2.19) In Commitmentit = < j ) t ( ) + < f > n In GDPit_ x + ”«, (2-20) Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 27 In Commitmentit = c p M +(pn In Commitmentn x + c p a In GDPit x + c o it, (2.21) where juit, uit, and c o it denote the error terms. In (2.19)-(2.21), c> s, ^s, and < p s represent unknown parameters. Since autocorrelation of the error terms in the bureaucratic models is a possibility, it was tested and corrected whenever encountered. Choosing between the Nash-Cournot and the Lindahl Allocation Process: J Test On comparing the foreign assistance demand equations for the joint-product Nash- Cournot representation in (2.8) and the Lindahl model in (2.10), I see that these equations are non-nested, but since they can be made to share the same dependent variable, a /te s t (MacKinnon, White, and Davidson, 1983) can be utilized to distinguish between the two models. The / test requires the two models to have the same instrumental variables, independent and identically distributed error terms, and identical dependent variables. The first condition is satisfied, and the second condition is assumed. Due to the presence of autocorrelation, the variables in the models are transformed using the estimated coefficients p N and p ' as in equations (2.17) and (2.18). After correcting for autocorrelation, I transform the dependent variables in the two specifications so that both have the identical dependent variable, In ODAt. The lagged value of the dependent variable appears on the right hand side Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 28 in both estimated equations due to this transformation. The Nash-Cournot demand equation is written as: In ODA, = jB i0 + J 3 n p N In ODAt_l + j3n (In FULLINCOMEit - p N In FULLINCOMEit_x ) + j3i2 (In SPILLINit - p N In SPILLINlt_ x ) + uit, (2.22) while the Lindahl demand equation is given by In ODAt = Al0 + Ai3 p L In ODAt_ x + An (In GDPit - p L In GDPit_ x) + Ai2(In SHAREit - p L In SHAREit X ) + v ,, (2.23) where ujt and vit are independently and identically distributed. Equations (2.22) and (2.23) are estimated by 2SLS to obtain predicted values of the dependent variable In ODAt under the two behavioral assumptions. The predicted value of In ODAt under the Lindahl model (i.e., In ODA'/) is plugged into the Nash-Cournot specification and the combined model is then estimated. The coefficient associated with this predicted value in the combined model is a f . Similarly, the predicted value of In ODAt under the Nash-Cournot model (i.e., In O D A f) is plugged into the Lindahl specification with the coefficient a f in the combined model. The J test is based on the significance of the /-ratios associated with the coefficients a f and a f . The following two hypothesis and their alternatives must be tested: Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 29 Hypothesis 1: Maintain the Nash-Cournot Joint-Product Model. This hypothesis can be tested by using the following linear restrictions: Hl0: a f = 0, H1a : a f ^ 0, for each i. The null hypothesis implies that the Lindahl predicted value does not significantly explain the dependent variable under the Nash-Cournot specification. Failure to reject Hl0 provides support for Nash-Cournot behavior. If, however, Hl0 is rejected, I must reject Nash-Cournot as the allocative process. Next, I define: Hypothesis 2: Maintain the Lindahl Specification. This hypothesis is tested with the following linear restrictions: H20: a f = 0, H2A: a f ^ 0, for each If I accept the null hypothesis 2, then the Nash-Cournot predicted value should not be significant, so that Lindahl behavior applies. If, instead, I reject null hypothesis 2, then the Lindahl allocative mechanism does not describe the allocative behavior of donors. With the ./test, it is possible that both models are rejected or that neither model is rejected, in which case there is no way to choose between competing paradigms. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 30 2.5 Data The International Development Statistics Online Database of the OECD provides data on the foreign aid commitments of DAC donor countries.6 This database provides information on volume, origin, and types of aid and resource flows to over 180 aid recipients. The present study utilizes transfers categorized as Official Development Assistance (ODA) and Official Aid (OA) that encompass bilateral aid flows from donors to developing nations and countries in transition, respectively, that are concessional in nature and aimed at poverty alleviation and fostering economic development. Total foreign aid commitments, rather than actual disbursements, by donors are utilized for the analysis. Commitments constitute a written obligation backed by funds on the part of the donor to provide these resources for development assistance.7 Disbursements involve placing these funds at the disposal of the recipient country, and may be measured in different ways depending on the transfer process and length of the project. For this study, the annual outlays of donor countries are viewed as the outcome of some equilibrium process and, hence, commitments are the more appropriate measure. 6 The paper uses data from the Destination of Official Development Assistance and Official Aid Commitments (Table 3a) which is part of the DAC online Database on Annual Aggregates. The International Development Statistics database that encompasses the DAC online database is available online at http://www.oecd.org/dataoecd/50/17/5037721.htm. 7 The DAC Statistical Reporting Directives provide the guidelines that donors use for reporting foreign aid. The directives are available online at http://www.oecd.org/dataoecd/36/32/31723929.htm. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 31 The database provides information on the geographical destination of commitments that allows an investigation of aid flows to specific regions. Regional analysis of aid flows provides a better mapping of donors with benefits accruing to them from giving development assistance. Foreign aid commitments to four main regions: Africa, America, Asia, and Europe are studied as well as sub-regional groupings within these larger areas. The data covers 1970-2001 so there are 32 years of observations, unless otherwise noted. Data on individual donor countries’ GDP and price deflator are taken from the World Development Indicators maintained by the World Bank. GDP for each donor is in current US dollars employing the current exchange rate for the conversion from the local currency. The implicit GDP deflator of the United States is then used to obtain the real GDP for all donor countries with the base year 1995. Estimates for OfO are obtained by taking the average of the ratio of SPILLINS to total bilateral aid commitments for each donor over the entire £ ® / 0 time period under consideration; i.e., Average Q kQ j t=1 T where T= 32. 2.6 Results The analysis of the data proceeds by first considering total bilateral commitments to all developing countries and then narrowing down the analysis based on the region receiving funds. Equations (2.14) and (2.15) or equations (2.17) and (2.18) when Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 32 autocorrelation is encountered are estimated for all donor nations for total bilateral commitments as well as for the four regions. Tables within the text provide the outcome of the / test for all donor nations as well as the estimated parameters associated with the demand equations for the relevant specification. The tables also include the parameters for the three bureaucratic models that were estimated when a donor’s behavior subscribed to neither of the other two allocation models. Total Bilateral Commitments Table 2.1 presents the results of testing for the allocation behavior of donors for total bilateral commitments. Austria, Canada, Germany, Italy, Netherlands and Sweden abide by strategic Nash-Cournot behavior with respect to other donors when making bilateral commitments to ODA. The J test is not a very robust test and in the case of Australia, Belgium, the United Kingdom and the United States neither the noncooperative nor cooperative model can be rejected. For those donor countries not abiding by either Nash-Cournot or Lindahl behavior, I tested whether their contribution behavior conformed to one of the three bureaucratic models. Norway’s and France’s behaviors are consistent with Model Bl, where last year’s commitment to bilateral aid explains much of the variation in current donations. Denmark and Japan conform to Model B2 in which its current bilateral commitments are based on the previous year’s GDP. Switzerland bases current bilateral aid on the previous year’s contributions and GDP. Relevant coefficients are displayed in Table 2.1. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 33 TABLE 2.1 Donors’ Allocation Behavior for Total Bilateral Commitments to PDA (1970-2001) Nash-Cournot Behavior Bureaucratic Behavior ■ Austria Model B1 ■ Canada ■ Norway (R2= 0.83, Sn =0.8155**) ■ Germany ■ Italy ■ France (R2= 0.73, 5 n =0.8617**) ■ Netherlands ■ Sweden Model B2 ■ Denmark (R2 =0.73, ( j ) n = 1.2706**) ■ Japan (R2 =0.93, ( f > n = 1.0464**) Model B3 ■ Switzerland (R2 = 0.84, (pn = 0.5236**, < p i2 = 0.7485**) Note: Australia, Belgium, the United States and the United Kingdom do not appear to conform to any of the models. * Statistical significance at the 10% two-tailed level of significance. ** Statistical significance at the 5% two-tailed level of significance. The Nash-Cournot parameter estimates are presented in Table 2.2 along with the autocorrelation coefficient, p N, when a correction is needed. The full-income term indicates the responsiveness of donors to income in its two forms - income and spillins (i.e. the purely public spillins associated with bilateral donations). The full- income coefficient is positive for most donors and significant for seven donors indicating that donors’ view bilateral foreign aid as a normal good. The estimated full-income coefficients also appear to be fairly similar for several donors. In Table 2.2, the joint-product Nash-Cournot specification can be seen to dominate the pure public specification by examining the estimates on the spillin coefficient, (5 n . Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 34 TABLE 2.2 Parameter Estimates of the Joint-Product Nash-Cournot Model for Total Bilateral Commitments Country p N P (intercept) P (fullinc) P 2 (spillin) dg A j dQ Q/Q Australia - 0.541719** 0.009556 0.968283** -0.009320 Austria - -0.231208* 0.009922 0.999281** 0.007098 Belgium 0.661995 0.040942 0.025931** 0.967854** -0.017625 Canada 0.367983 0.587598* 0.002174 0.961169** 0.003794 Denmark - -0.209596** 0.021721** 0.986218** 0.000216 France — 0.007181 -0.034253 1.043876** 0.179989 Germany 0.648166 0.115017 0.003385 0.988042** 0.126246 Italy 0.801096 -0.051977 0.041773 0.964777** -0.006869 Japan - 0.241777 0.239535** 0.716646** -0.107826 Netherlands 0.527173 -0.053617 0.055876** 0.945839** -0.009521 Norway - -0.167547** 0.028240** 0.977659** -0.009627 Sweden - -0.309921* 0.042200** 0.968527** -0.003815 Switzerland — -0.237270 0.011081* 0.998296** 0.008854 United Kingdom 0.488488 0.407621* 0.011532 0.956457** 0.010440 United States 0.389955 4.857467** -0.031334 0.720413** -0.012951 Note: * Statistical significance at the 10% two-tailed levels of significance. ** Statistical significance at the 5% two-tailed level of significance. For all donors the spillin coefficients are positive and highly significant; hence, a nested test on this coefficient would reject the pure public good hypothesis in favor of the joint-product specification. Thus, most donor countries view foreign aid as providing donor-specific gains along with purely public altruistic benefits.8 The spillin coefficient indicates the elasticity of a change in the total provision of bilateral foreign aid due to a change in the other nations’ bilateral donations. The term dq/dQ is calculated based on this elasticity in the last column of Table 2.2. 8 Tables with the Lindahl parameter estimates are not displayed because none of the countries abide by Lindahl behavior for total bilateral giving as a whole or for the individual regions. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 35 When this partial derivative is less than zero, donors view their contributions as substitutes; when this partial derivative is greater than zero, donors view their contributions as complements. Substitutes imply free riding, whereas complements limit free riding and bolster a more optimal outcome. Some of the donors - Austria, Canada, Denmark, France, Germany, Switzerland and the United Kingdom - view bilateral donations as complementary. Thus, donor-specific benefits have a silver lining in promoting aid donation despite some donor publicness. However, a couple of the large donors, namely the United States and Japan, free ride on the contributions of others donors. The distribution of development assistance to the four major aid receiving regions is illustrated in Figure 2.1, where all amounts are in constant US dollars with a base year of 1995. Bilateral assistance peaks around 1990-1991 after which there is a decline, with the shares going to different regions remaining more or less stable. The largest shares of bilateral aid donations go to Africa and Asia which are home to some of the world’s least developed nations. Much smaller amounts are given to the Americas (South and Central) and the developing and transition economies of Europe. The residual (i.e., total bilateral commitments minus the amount committed to the four regions) represents the amount that either goes to the Oceania region or are not classified as flowing to a particular region. The Oceania region is not studied due to insufficient observations. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 36 FIGURE 2.1 Bilateral Foreign Aid Commitments by Region (1970-2001) 70000 ----------------------------------------------------------------------------------------- 40000 @ Residual 30000 ■ 1 Europe a 20000 4 H America □ Africa Year Africa Africa as a whole indicates that the majority of sample donors behave noncooperatively with none of the donors acting cooperatively (see Table 2.3). Austria, the United Kingdom and the United States do not display behavior consistent with any of the three allocation processes. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 37 TABLE 2.3 Donors’ Allocation Behavior for Bilateral Commitments to Africa Region Nash-Cournot Behavior Bureaucratic Behavior Africa ■ Australia Model B1 ■ Belgium ■ Italy (R2= 0.83, 8 n =0.8996**) ■ Canada ■ Denmark ■ Germany (R2= 0.67, 8 n =0.7632**) ■ France ■ Japan ■ Netherlands ■ Norway ■ Sweden ■ Switzerland Note: Austria, the United Kingdom and the United States do not subscribe to any of the three behavioral models._______________________________________________________________ Africa: South o f the Sahara ■ Australia Model B1 ■ Austria ■ Italy (R2 = 0.79, 5 n = 0.8617**) ■ Canada ■ Denmark ■ Germany ■ Japan (R2= 0.73, 5 a =0.7541**) ■ Netherlands ■ Sweden ■ Switzerland ■ United Kingdom ■ United States Note: Belgium, France and Norway does not subscribe to any of the three behavioral models. Note: * Statistical significance at the 10% two-tailed level of significance. ** Statistical significance at the 5% two-tailed level of significance. Foreign aid commitments to Africa are divided into two regional groupings: North and South of the Sahara, with most aid going to the South of the Sahara region. Commitments to the continent reach a peak around 1991, with a large share going to the North of the Sahara in the aftermath of the Gulf War, after which aid to this region declined (see Figure 2.2). Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 38 FIGURE 2.2 Bilateral Foreign Aid Commitments to Africa (1970-2001) 35000 30000 25000 20000 s 15000 o a 10000 5000 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 0 North Saharan Africa £3 South Saharan Africa Years For the South of the Sahara region, many of the sample donor nations (excluding Belgium, France, Germany, Italy and Norway) adhere to the Nash-Cournot model, thus implying that the donors behave strategically and that the foreign aid commitments are suboptimal. Sub-Saharan Africa consists not only of some of the world least developed nations but are also governed by some of the most corrupt governments that have squandered large amounts of development assistance. Donors have in the past viewed themselves as far removed from the problems on the African continent (especially South of the Sahara); thus, donors understandably behave strategically by attempting to free ride on other donors’ aid contributions. For both Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 39 total commitments to Africa as well as commitments to the South of the Sahara region Italy and Germany abide by bureaucratic model B 1. For the North of the Sahara region, most donor nations do not subscribe to any of the three behavioral models considered in this study so this region’s empirical results are not displayed. Table 2.4 provides the parameter estimates for the Nash-Cournot model for Africa and the South of the Sahara region. The coefficient for the full-income term is significant for only six donors that give to either Africa or to its southern region. This provides evidence that few donors view foreign aid contributions as yielding purely public benefits. The full-income coefficient is positive for thirteen of the fifteen donors for both Africa as a whole as well as the South of the Sahara region indicating the income normality of bilateral foreign aid. The spillin term is highly significant for most donors for Africa as a whole as well as for the South of the Sahara region. This again indicates strong evidence that the donors perceive private benefits accruing to them from providing of foreign aid. Donors like Belgium, France, Germany and the Netherlands, with the exception of the United Kingdom, that had former colonies in Africa view bilateral aid commitments to the Africa as complementary because dq/dQ is positive. This joint-product complementarity curbs free riding. In the South of Sahara region, there is evidence of strong complementarity. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 40 TABLE 2.4 Estimates of the Joint-Product Nash-Cournot Model for Bilateral Commitments to Africa Country p N P o (intercept) /?! (fullinc) P 2 (spillin) Sq K j 8Q Q/Q Africa Australia 0.551112 -0.050658 0.005408 0.998866** 0.002605 Austria — -0.220160 0.010329 0.998491** 0.008620 Belgium 0.582208 -0.049702 0.006284 0.999215** 0.027957 Canada 0.368623 1.277679** -0.053038 0.976408** 0.023657 Denmark - -0.282238** 0.022222** 0.988541** 0.008717 France 0.303739 1.558372* 0.054880 0.847523** 0.100314 Germany 0.579305 0.192804 0.006385 0.978432** 0.122489 Italy 0.785594 -0.082598 0.071592 0.934167** -0.015912 Japan - -1.465894** 0.092771** 0.952549** 0.029179 Netherlands 0.527517 -0.232266 0.045252** 0.971638** 0.013023 Norway - -0.218778** 0.024663** 0.983221** 0.002957 Sweden 0.344967 0.106096 0.005263 0.988642** 0.024873 Switzerland - -0.295508** 0.013166** 0.998485** 0.009953 United Kingdom 0.481465 0.361060 0.045054* 0.919286** -0.019773 United States 0.333279 0.734421 -0.080074 1.065688** 0.367804 Africa'. South o f the Sahara Australia 0.338783 -0.092772* 0.005736 0.999710** 0.004246 Austria — -0.255995** 0.022661** 0.986035** -0.007447 Belgium + 0.450701 0.370920 0.007888 0.963109** 0.001022 Canada 0.483516 1.137580* -0.052475 0.967862** 0.023451 Denmark - -0.361457** 0.023641** 0.990548** 0.017169 France - 2.319677* 0.049392 0.849134** 0.122825 Germany 0.651204 0.177767 -0.034578 1.026552** 0.181627 Italy 0.722232 -0.271986 0.066833 0.965081** 0.019041 Japan 0.304624 -1.133285** 0.086625** 0.966555** 0.041794 Netherlands 0.603480 -0.229489 0.053763** 0.965795** 0.019341 Norway - -0.258876* 0.022902** 0.986998** 0.013503 Sweden 0.468773 0.062211 0.026024 0.967285** 0.014824 Switzerland - -0.366668** 0.005517 1.010415** 0.024910 United Kingdom 0.466774 0.519045 0.066887** 0.880479** -0.038537 United States 0.668601 -0.139703 0.081425 0.919107** 0.050881 Note: + Denotes countries have less than 32 years of observations. * Statistical significance at the 10% two-tailed level of significance. ** Statistical significance at the 5% two-tailed level of significance. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 41 America Most donors abide by Nash-Cournot behavior when committing development assistance to South and Central America (see Table 2.5). Canada and the United States, both major donors based on the American continent, do not appear to conform to any of the three behavioral models discussed in the paper. Only Belgium displays bureaucratic behavior based on its previous year’s bilateral aid commitment to the region. TABLE 2.5 Donors’ Allocation Behavior for Bilateral Commitments to America (1970-2001) Nash-Cournot Behavior Bureaucratic Behavior ■ Australia Model B2 ■ Austria ■ Belgium (R2= 0.74,( f ) n = 2.2216** ) ■ Denmark ■ France ■ Germany ■ Italy ■ Japan ■ Netherlands ■ Norway ■ Sweden ■ Switzerland ■ United Kingdom Note: Canada and the United States do not appear to conform to any of the models. ** Statistical significance at the 5% two-tailed level of significance. In Table 2.6, the full-income coefficient is positive and significant for nine of the donors, which provides strong evidence of the income normality of bilateral foreign aid to South and Central America. For all sample donors the spillin term is positive and significant at the 5% level, thus supporting the presence of donor-specific joint products. The computed dq/dQ term indicates that eight of the donors view their Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 42 bilateral assistance as complementary. Oddly, the nearest two donors - Canada and the United States - see others aid as substituting to for its own contributions to the Americas, though it must be noted that these two donors abide by none of the three behavioral models. TABLE 2.6 Estimates of the Joint-Product Nash-Cournot Model for Bilateral Commitments to America Country p N P o (intercept) P (fullinc) j32 (spillin) dq A j 9 2 Q/Q Australia + 0.37404 0.008601* -0.000729* 1.000258** 0.000433 Austria + — -0.073800 0.009128 0.993007** -0.001514 Belgium + - -0.238297** 0.014010** 0.994716** 0.002835 Canada 0.451116 -0.560451 0.108212* 0.916155** -0.042519 Denmark - -0.182080** 0.008201** 0.998991** 0.003704 France - 0.090078 0.002191 0.995593** 0.050016 Germany 0.344048 -0.198122 0.175256** 0.797244** -0.075545 Italy 0.636705 -0.464015 0.049279 0.998176** 0.031103 Japan - -2.419610** 0.223899** 0.827463** -0.026810 Netherlands - 0.965766 0.166647** 0.761497** -0.159866 Norway + - -0.238439** 0.011889** 0.997403** 0.003460 Sweden - -0.557968 0.010451 1.013746** 0.031561 Switzerland - -0.279854** 0.003454 1.009097** 0.020048 United Kingdom - 1.002212** 0.047574** 0.897570** -0.059967 United States 0.585847 -0.114037 0.400260 0.490449** -0.220747 Note\ + Denotes countries that have less than 32 years of observations. * Statistical significance at the 10% two-tailed levels of significance. ** Statistical significance at the 5% two-tailed level of significance. Asia I next consider Asia and three of its subregions: South and Central, Far East, and the Middle East. For Asia as a whole, no donor country displays Lindahl behavior, and just Australia, Italy, Netherlands, United Kingdom and the United States adhere to Nash-Cournot behavior, so the results for Asia as a whole are not reported. The Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 43 largest amounts of bilateral aid go to South and Central, and Far East Asia, with the share going to latter increasing rapidly during the 1990s (see Figure 2.3). The Middle East receives a small share of Asian-bound bilateral aid flows, mainly because the region has many oil-rich nations that do not need development assistance. For the Middle East, the analysis could not be carried out owing to an insufficient number of observations. FIGURE 2.3 Bilateral Foreign Aid Commitments to Asia (1970-2001) cl u n a a o O 25000 20000 15000 10000 5000 0 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 E l Middle East Asia ] Far East Asia m South Central Asia Year For South and Central Asia, Belgium, Denmark, France, the Netherlands, Sweden and the United States adhere to Nash-Cournot behavior; while eight donor nations do not subscribe to any of the behavioral models (refer to Table 2.7). Canada displays Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 44 the third bureaucratic type of behavior. For the Far East, Austria, Canada, France, Germany, Italy, Japan and the United Kingdom behave noncooperatively, while none of the fifteen sample donors behaves cooperatively. The United States bases its current level of commitments on its past commitments ( §n = 0.8207), consistent with the first type of bureaucratic model. Some donors may abide by none of the three allocation processes because they are uninterested in regional breakdowns, while others may be acting according to a yet-unidentified allocation process. TABLE 2.7 Donors’ Allocation Behavior for Bilateral Commitments to Asia Region Nash-Cournot Behavior Bureaucratic Behavior South and Central Asia ■ Belgium Model B3 ■ Denmark ■ Canada ■ France (R2 = 0.71, mn =0.5681**, ■ Netherlands v 7 T 11 7 ■ Sweden tpa =-1.1970**) ■ United States Note: Australia, Austria, Germany, Italy, Japan, Norway, Switzerland and United Kingdom do not abide any of the three behavioral models. Far East Asia ■ Austria Model B1 ■ Canada ■ United States * France (R2= 0.76, ■ Germany 5 i X =0.8207**) ■ Italy ■ Japan ■ United Kingdom Note: Australia, Belgium, Denmark, Netherlands, Norway, Sweden, and Switzerland do not abide by any of the behavioral models. Note: * Statistical significance at the 10% two-tailed level of significance. ** Statistical significance at the 5% two-tailed level of significance. The parameter estimates for the joint-product Nash-Cournot model for the two Asian subregions are displayed in Table 2.8. In South and Central Asia, nine full-income Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 45 terms are significant at the 10% level or better. The positive sign is consistent with income normality, while the negative sign indicates income inferiority for bilateral assistance. For this region, the spillin term is positive and significant for all sample donors thus strongly supporting jointly derived donor-specific benefits. Most countries view bilateral donations as complementary, which is true for the two nearest donors - Australia and Japan- and thus, spatial propinquity is related to complementarity. With the exception of the United States, seven of the eight biggest donors (i.e., Japan, Germany, the United Kingdom, Canada, the Netherlands, France, and Sweden) to the region display complementarity. The estimates for the Far East are listed in the bottom half of Table 2.8. Eight donors have positive and significant full-income coefficients, indicative of income normality. The spillin term is significant for all donors, which indicates the presence of joint products. Australia and Japan again treat their bilateral donations as complementary to those of other donors. Four of the five most generous donors (i.e., Japan, Germany, France, and Australia excluding the United States) view their donations as complementary to those of the other countries. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 46 TABLE 2.8 Estimates of the Joint-Product Nash-Cournot Model for Bilateral Commitments to Asia Country p N J3a (intercept) /?! (fullinc) P 2 (spillin) dq 0 2 j dQ QlQ South and Central Asia Australia -0.025323 -0.000793 1.002593** 0.014408 Austria 0.362573 0.025287 0.001949* 0.996088** -0.001765 Belgium 0.446208 -0.005196 -0.000929 1.001667** 0.005511 Canada - 3.162196** -0.145994** 1.037468** 0.106424 Denmark - -0.174417 0.012798* 0.994096** 0.014178 France 0.23636 0.223060 -0.009367 0.999973** 0.032389 Germany - -0.497111 -0.023099 1.058252** 0.228871 Italy - 0.155361 -0.005181 0.999805** 0.009011 Japan - -0.173972 0.221889** 0.737239** 0.032869 Netherlands - -1.830428** 0.027509* 1.052112** 0.113126 Norway - -0.040870 0.007625** 0.993870** 0.009542 Sweden - -0.073851 -0.018948 1.026706** 0.057823 Switzerland - 0.015520 0.012704** 0.985221** -0.000205 United Kingdom 0.337128 2.199104* -0.064572* 0.935432** 0.038964 United States - 16.066069** -0.251036** 0.618223** -0.213088 Far East Asia Australia -0.027251 0.010773 0.990013** 0.021556 Austria - -0.351822** 0.008812* 1.005906** 0.013745 Belgium 0.296729 0.001086 0.012084** 0.986383** -0.006964 Canada -0.059976 0.016111 0.984366** 0.004779 Denmark + - 0.007551 0.009361* 0.989415** -0.003561 France - -0.257491 0.024187* 0.986855** 0.023099 Germany 0.275351 -0.731728 0.063179 0.970553** 0.066011 Italy 0.472738 -0.159373 0.018889 0.990944** 0.001669 Japan - -7.474627** 0.510433** 0.510433** 0.118497 Netherlands - 0.528484** 0.017704 0.957347** -0.013030 Norway - 0.007754 0.005870** 0.993272** -0.002114 Sweden - 0.040901 0.045912** 0.946360** -0.032056 Switzerland - -0.055854* 0.004781** 0.997153** 0.000956 United Kingdom 0.261176 -0.053993 -0.003686 1.008534** 0.027427 United States 0.778274 0.119348 0.108151 0.838129** -0.003581 Note\ + Denotes countries have less than 32 years of observations. * Statistical significance at the 10% two-tailed level of significance. ** Statistical significance at the 5% two-tailed level of significance. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 47 Europe For Europe, Germany, Italy and the United Kingdom abide by the Nash-Cournot model, while none of the sample donors act cooperatively or provide foreign aid based on some bureaucratic process. The remaining donor countries, excluding Denmark for which there are insufficient observations, do not subscribe to any of the three allocation models and may follow an alternative unspecified process. TABLE 2.9 Estimates of the Joint-Product Nash-Cournot Model for Bilateral Commitments to Europe Country P N P (intercept) P ] (fullinc) P 2 (spillin) _ A j 3Q Q/Q Australia + — -0.072033 0.001345 1.001791** 0.002768 Austria — -1.726414** 0.057080** 1.014337** 0.049230 Belgium - 0.103261* -0.000695 0.996246** 0.003022 Canada + - 0.093504 -0.016241 1.017029** 0.029706 France — 0.384102 0.003679 0.979063** 0.027793 Germany - -1.896122 0.492588* 0.441901** -0.304817 Italy - -0.430180 0.049170 0.959414** 0.024865 Japan - -0.596453 0.131942** 0.852994** -0.062724 Netherlands + - -1.282367** 0.016446 1.042058** 0.071290 Norway + _ -0.907950** 0.029061** 1.008993** 0.025392 Sweden + - -0.823518* 0.033596 0.998290** 0.011696 Switzerland + - -0.527881* -0.006839 1.034310** 0.047493 United Kingdom _ 1.244521 -0.065136 1.028234** 0.076455 United States - 1.602615 0.193595 0.661990** -0.100419 Note: + Denotes countries have less than 32 years of observations. * Statistical significance at the 10% two-tailed level of significance. ** Statistical significance at the 5% two-tailed level of significance. The parameter estimates for the joint-product Nash-Cournot model are given in Table 2.9. Only four of the full-income coefficients are significant, which indicates that bilateral giving in Europe is not driven by the donors’ ability to pay. The spillin Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 48 coefficient is positive and significant for all sample donors, thus supporting the presence of joint products. Moreover, the dq/dQ term is consistent with donor complementarity when the spillin term is significant, except in the case of Germany, Japan and the United States. Spatial propinquity is the primary determinant of donation complementarity in Europe. 2.7 Concluding Remarks This is the first study to test for the allocation process that underlies bilateral foreign aid commitments. To accomplish this task, I theoretically derive reduced-form equations for noncooperative Nash-Cournot and cooperative Lindahl behavior. A nested test distinguishes purely public from joint-product motives of giving. Additionally, a non-nested test distinguishes between Nash-Cournot and Lindahl behavior. Despite decades of bilateral donations, I uncover only no evidence of cooperative behavior. Thus, there is strong circumstantial evidence that a suboptimal outcome characterizes bilateral donations, because most donor countries either act noncooperatively or bureaucratically. Unlike Hayashi’s (2002) study for multilateral donations, the current study finds convincing proof that most countries donate independently in terms of their bilateral efforts. This is not only true for total bilateral donations but also for assistance to the four major recipient regions. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 49 On the more hopeful side, there is overwhelming evidence that bilateral donors derive donor-specific joint products from their assistance to other countries. For overall bilateral giving and for each of the regions, there are numerous instances where bilateral donations are viewed by donors as complementary to the generosity of other donors. Complementarity has three drivers: spatial propinquity (especially in Asia and Europe), past colonial ties (in Africa), and donors’ overall generosity to the region. In Europe, for example, eleven European D AC donors increase their aid commitments in response to those of other donors. In addition, the larger donors to the region tend to display donation complementarity. Complementarity attenuates free riding because donors can only obtain their donor-specific benefits through their own generosity. If, in the future, foreign aid is to be effectively channeled to less- developed nations, then donors must better coordinate their bilateral commitments, not just in total but also on a regional basis. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 50 Chapter 3: Donor Burden Sharing in Funding Multilateral Aid Agencies. 3.1 Introduction: Member countries of the Development Assistance Committee (DAC) commit foreign aid to developing countries and countries in transition either via direct bilateral transfers or by delegating funds to multilateral institutions. Bilateral transfers (i.e. from the donor nation directly to the recipient country) are given, in part, to propagate the strategic interests of the donor such as furthering a political agenda, bolstering the economies of trading partners, supporting former colonies and so on (Mckinlay and Little 1977, Schraeder et. al. 1998, Alesina and Dollar 2000). By entrusting funds to multilateral institutions (like the World Bank, the United Nations agencies and the regional development banks) the donor nation, to a large extent, relinquishes control over the distribution of funds to developing and transition countries. Channeling funds through multilateral agencies increases the degree of publicness of benefits from foreign aid; nonetheless donors’ receive some private benefits like lower costs of monitoring recipients’ utilization of foreign aid. While bilateral foreign aid transfers were the focus of the last chapter, this essay attempts to understand donors’ contributions to multilateral institutions by analyzing the joint-product representation of such activities. This study provides answers to Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 51 three questions: First, do donors’ receive private benefits from channeling funds through multilateral agencies or do such funds generate solely purely public benefits? Second, do donors’ view their contributions to multilateral institutions as complementary to or substituting for the donations’ of other nations? Third, do donors’ private capital flows to developing countries and countries in transition enhance or crowd-out contributions to multilateral institutions? Reduced form demand equations that account for strategic interactions amongst donors are estimated to arrive at answers to these questions. Strong evidence emerges of private benefits to donors from contributions to multilateral institutions, thereby validating the representation of such donations as a joint-product activity. The larger donors treat other nations’ donations as complements to their own, thus mitigating the possibility of free riding. Complementarity is most robustly exhibited by donors for contributions to regional development agencies. Private capital flows to developing countries and countries in transition produce mixed effects on assistance to multilateral agencies. For donors that treat others’ contributions to multilateral agencies as substitutes, private capital flows tend to crowd-out multilateral donations. The essay is divided into seven sections. Section 2 illustrates the share of multilateral assistance in total foreign aid for the DAC member nations. Section 3 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 52 provides an overview of the literature on foreign aid given by multilateral institutions. Section 4 outlines the underlying theoretical model and its empirical specification. Section 5 discusses the sources of the data, while Section 6 presents the results from the empirical estimation. Section 7 provides some concluding remarks and policy recommendations. 3.2 Multilateral Assistance in Total Foreign Aid Multilateral agencies disbursed a total of 17.8 billion US dollars (in nominal terms) in 2002 as low-interest loans or grants to developing and transition countries. The proportion of total development assistance channeled through multilateral institutions averages about 26 per cent over the time period 1970-2003 with some variation over time (see Figure 3.1). Given that almost a quarter of development assistance is routed through multilateral institutions, my interest lies in understanding the strategic nature of interactions between donors contributing to these agencies. The share of multilateral assistance in total assistance varies by donor; studies by Milner (2004) and Degnbol-Martinussen et al. (Ch.7, 2003) provide ample evidence of these cross-donor differences. The share of the burden of all multilateral funding for the 18 main DAC donor countries is presented in Table 3.1. The United States was the largest contributor in 2002 supplying 16 per cent of total multilateral funding. This denotes a fall from a Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 53 high of 35 per cent of all funding in 1970, though throughout the time period 1970- 2003 the United States remains the largest contributor. Germany, France, the United Kingdom, Italy and Japan were the other large donors in order of magnitude in 2002. Australia, Austria, Belgium, Canada, Denmark, Finland, the Netherlands, Norway, Sweden and Switzerland contributed less than 3 per cent of total multilateral funding in 2002. Figure 3.1: Share of Multilateral Assistance in Total Foreign Aid 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 Years Looking at the proportion of multilateral funding in Gross Domestic Product (GDP), Belgium, Denmark, Finland, France, Norway and Sweden are the most generous (i.e. contribute more than 0.15 per cent of GDP) in 2002. This proportion is relatively higher for most donors in 1985 than in either of the other two years presented in Table 1. Interestingly, the larger contributors to multilateral agencies (i.e. donors Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 54 that give a bigger share of total contributions) are not the same as the more generous donors in terms of share of GDP devoted to multilateral assistance. The remaining DAC donors including Greece, Luxembourg, Portugal and Spain are omitted from the table as they do not provide funds in several of the years under consideration. TABLE 3 .1 Donors’ Share of Total Multilateral Assistance and Total Multilateral Contributions as a share of Donors’ GDP 1970 1985 2002 Country Share o f Share o f Share Share o f Share o f Share o f Total GDP o f Total GDP Total GDP (%) (%) (%) (%) (%) (%) Australia 1.36 0.05 2.84 0.14 1.58 0.07 Austria 0.44 0.04 0.93 0.12 1.52 0.13 Belgium 3.08 0.18 1.52 0.16 2.55 0.18 Canada 7.66 0.13 7.00 0.17 2.88 0.07 Denmark 2.28 0.20 2.71 0.39 3.78 0.38 Finland — - 1.37 0.21 1.48 0.20 France 8.21 0.08 9.35 0.15 13.75 0.17 Germany 13.59 0.07 13.16 0.12 14.66 0.13 Ireland — — 0.26 0.11 0.75 0.11 Italy 5.77 0.08 13.14 0.26 8.06 0.12 Japan 7.58 0.05 14.99 0.10 7.87 0.03 Netherlands 2.63 0.11 4.51 0.29 2.05 0.09 New Zealand _ — 0.19 0.07 0.18 0.06 Norway 1.34 0.16 3.22 0.43 3.14 0.29 Sweden 5.41 0.23 3.04 0.25 2.40 0.18 Switzerland 0.89 0.06 0.86 0.08 0.52 0.03 United Kingdom 4.88 0.06 7.79 0.15 10.65 0.12 United States 34.87 0.05 13.13 0.03 15.98 0.03 3.3 Literature Review and Alternative Explanations Several studies analyze donors’ contributions to multilateral institutions, motivations behind donors’ commitments to multilateral assistance, and the effectiveness of these agencies in utilizing funds to relieve poverty in the recipient country. Addison et al. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 55 (2004) evaluate donor funding of multilateral aid agencies and find that donor countries with larger economies bear a greater share of the financing burden. This study also investigates characteristics of the donor, like pro-poor focus and inherent donor generosity, which might impact their funding of multilateral agencies. Rowlands and Ketcheson (2002) test for two broad concepts of coordination: complementary (i.e. donors coordinate their activities to achieve an overall distributional goal) and supplementary (i.e. donors share the burden of foreign aid in an equitable manner). The authors test for these concepts of coordination for data on Sub-Saharan Africa for donors and find some support for supplementary coordination, though overall no clear pattern was discernible for the donors. Attempts have been made to unearth the possible reasons for donors’ channeling funds through multilateral agencies instead of direct bilateral aid transfers. Rodrik (1995) proposes two motives based on the multilateral nature of these organizations. First, multilateral institutions fulfill the role of information provision on the investment climates in different developing countries especially through their analysis of government policies. Second, multilateral agencies are able to impose conditions on the transfer of funds without it being construed by the recipients as driven by donor interests. Rodrik (1995) tests for these two motivations by empirically assessing the link between private capital flows and multilateral flows to recipient developing nations, with the expectation that recipients attracting more Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 56 multilateral lending are perceived by donors as having good policy environments. The study finds no evidence for the argument that multilateral flows act as a catalyst for private flows to developing countries. An inquiry by Ratha (2001) unearths a counter-cyclical relationship between private capital flows and multilateral lending in the short-term, though in the medium-term he finds a complementary relationship between these two variables. Ratha (2001) concludes that multilateral lending signals (and possibly fosters) a better investment environment in developing countries in the medium term. Utilizing a principal-agent framework, Milner (2004) suggests that donor governments delegate aid delivery through multilateral agencies to signal to their publics that the foreign aid funds are being utilized for humanitarian purposes and not for furthering the donors’ strategic interests. Using data from opinion polls and controlling for various economic and political variables, Milner (2004) shows that public opinion displays a negative relationship with multilateral aid giving. This result indicates that when publics are doubtful of the humanitarian usefulness of aid (i.e. low public opinion of the effectiveness of aid) donor governments are likely to provide more multilateral aid to reassure their citizens. One of the more comprehensive efforts at examining the determinants of aid allocation by multilateral institutions is by Neumayer (2003b), who analyzes the Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 57 lending behavior of two sets of multilateral agencies: the United Nations (UN) and the regional development banks. The study finds some evidence of the multilateral aid agencies persisting bilateral strategic interests in disbursing funds like giving more aid to less populous nations and countries that were former colonies. Some multilateral institutions, especially the UN agencies, do take account of other features of the recipient country like the quality of life, size of the population and political freedom. The regional development banks in general are found to focus mainly on the economic needs of the recipient as measured by per capita income. Hayashi (2002) utilizes a model of pure public good provision to explain donor contributions to multilateral assistance and tests for cooperative versus strategic behavior amongst the donors. The study finds little evidence of strategic behavior, though a few donors behave cooperatively. Unlike Hayashi (2002), this paper treats each donor’s contributions to multilateral institutions as yielding both public benefits as well as private benefits and therefore treats commitments to multilateral institutions as a joint-product activity (Cornes and Sandler 1996). The donor might receive two types of private benefits from channeling funds through multilateral institutions. Firstly, multilateral aid agencies have well-developed infrastructure for the monitoring and evaluation of the recipients’ utilization of foreign aid — i.e. multilateral agencies have a comparative advantage over bilateral aid efforts in the implementation of projects which require technical expertise or have greater cross- Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 58 border spillovers (Seabright 2002). Delegating funds to multilateral institutions lowers the donors’ transaction costs of disbursing foreign aid. Secondly, multilateral institutions by their lending activities in developing countries and countries in transition provide signals on the investment environment prevalent in these countries to the donor (Rodrik 1995, Ratha 2001). Multilateral institutions lending to developing countries also produces public benefits which accrue to both the donors and the recipient(s). For example, funds given to improve the health of people in the developing world (like programs aimed at curbing the spread of infectious diseases) provide direct benefits to the recipient in terms of a more healthy population as well as benefits to the donor in terms of reduced likelihood of infectious diseases crossing borders. Utilizing the joint-product representation for multilateral commitments, I am able to analyze whether donors treat others’ contributions as complementing or substituting for their own donations. 3.4 Theoretical Model and Empirical Specification The theoretical model presented here provides the donors’ demand equations for multilateral development assistance. Each donor nation is considered to be a unitary actor deciding the amount of funds to be channeled through multilateral institutions. A Nash-Cournot model with a joint-product activity is derived to account for the nature of multilateral contributions which yield multiple benefits that may vary in Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 59 their degree of publicness. The Nash-Cournot pure public good representation is a special case of this more general joint-product model (Sandler and Murdoch, 1990). Assume that each donor nation has a neoclassical utility function, Ul, that is strictly increasing in all its arguments and twice differentiable and can be depicted in commodity space as U1 = U i( y \ x \ Z \ E > ). (3.1) The main arguments yielding utility to donor / are: a private good ( y '), a nation- specific benefit from contributing to the multilateral institution ( x!), a purely public component also derived from donating to multilateral institutions ( Z ‘), and a taste- shifting variable ( E ). The purely public benefit Z' abides by a summation technology so that the total amount available to donor i is simply the sum of the public components of donor i and the other (n - 1) nations i.e. Z! = £ + Z ‘ (3.2) where Z' = y j z ] denotes the spillins from the contributions of all other nations to multilateral institutions. Let q1 represent the donation of nation i to multilateral institution, where q1 is a joint-product activity yielding two outputs x‘ and z '. The production relationships for x1 , z' and Z' are given by: x '= g ‘(^), (3.3) z '= h \q ') , (3.4) Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 60 Zl = k \Q l), (3.5) where Q' is the sum of the contributions of all the (n - 1) nations. Note g ', h‘ and k' are assumed to be continuously twice-differentiable increasing concave functions of activity q' or O '. The taste-shifting variable E could be any factor that affects donors’ utility from contributions to multilateral institutions. A considerable amount of private capital flows from the developed nations to developing countries and countries in transition (Rodrik 1995, Ratha 2001). Net private capital flows to developing countries are used to capture this taste-shifting parameter, since it can be argued that multilateral institutions through their lending activities and research output provide donors’ with insights into the investment climates in developing countries. Using the relationships defined in equations (3.3), (3.4) and (3.5) the utility function can be presented in activity space as: U1 =Ui( y \ g i(qi) ,h \ q i) + k'(Qi\ E ) . (3.6) Since the total amount of the joint product activity Q is the summation of nation /’ s donation to multilateral institutions and the contributions of all other (n - 1) nations, I can represent q = Q '- Q‘ in (6) so that the utility function for nation i can be rewritten as: Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 61 Ul = U‘(.y1 , g !(Q - Q ‘),ti(Q -Q') + k'{Q ),E). (3.7) Each nation is assumed to be a positive contributor to multilateral assistance i.e. Q > Q and therefore I am dealing only with interior solutions. Nation i derives utility from total multilateral assistance Q , but only contributes ql to multilateral agencies. Nation / is constrained in choosing y ‘ and q‘ by a budget constraint of the form: I '= P yy + P e4 (3-8) where I 1 is the gross domestic product of nation i , p y is the price of the private good and p Q is the price of the joint-product activity. By adding pQ Q' to both sides of equation (3.8), I obtain the full-income budget constraint: F '= P yy + P Q Q \ (3.9) where F l = V + pQ 0 ‘ (Bergstrom, Blume and Varian 1986). Using the full-income approach allows me to analyze the problem facing nation i with total multilateral commitments Q as the choice variable. Nation i chooses Ql and y 1 to maximize utility in equation (3.7) subject to the full-income budget constraint in equation (3.9) that includes the exogenously determined multilateral contributions of other nations. The first-order conditions associated with this problem yield the following demand equation for total multilateral assistance as a joint-product activity: Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 62 Q = Q \ p y,PQ, F \ Q \ E ‘): (3.10) Donor f s demand for total multilateral assistance depends on the prices of the private good and joint-product activity, full income, spillins and private capital flows. For normal goods, the total amount of multilateral assistance is negatively related to an increase in the price of the joint-product activity and positively related to an increase in the full income (Sandler and Murdoch, 1990). Funding for multilateral agencies could be positively or negatively related to increases in the spillins in contributions from other donors and the donors’ own private capital flows. I assume that the decision making process is independent for each donor so that the resulting equilibrium level of total multilateral contributions can be viewed as a Nash equilibrium. The neutrality problem (i.e. the Nash-Cournot provision of the public good is invariant to income redistribution, given that the set of contributors remains unchanged) does not apply to the joint-product representation since donors’ only receive private benefits from their own provision of the joint-product activity. In the purely public representation, neutrality would be a problem since the donor nation does not distinguish the source of the donation to the multilateral institution (Warr 1983). As discussed in the previous chapter the joint-product Nash-Cournot model differs from the pure public good Nash-Cournot model in the presence of the spillin term Q1 in the demand equation. A simple nested test would then allow me to distinguish between the pure public and joint-product representations of the Nash- Cournot model. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 63 The specification to be estimated based on the demand equation in (3.10) is given by: TotMultit = + /3nFullincomen + j3i2Spillinit + fii3 Pvt _ K it + p jt (3.11) for each nation i, where TolMullit represents the total amount contributed by all n nations to multilateral institutions in a given year; Spillinjt is the contribution of all the (n -1) other nations to multilateral institutions; Fullincomeit is sum of the GDP of nation i and the Spillin; Pvt _ K it represent the net private capital flows from the donor nation i to all developing countries and countries in transition; and p it is the random disturbance term. For all variables the first subscript represents the donor nation and the second subscript indicates the time period. Note that the prices have been dropped from this equation since I do not have information on the relative price of disbursing development assistance. I assume that the price of the private good and the joint product activity change in the same proportion. All the variables in the model are deflated using a price deflator. The linear functional form is utilized since the variable net private capital flows can take negative values. Since the Fullincomeit term and the Spillinit term are likely to be correlated with the random disturbance term p it, I utilize an instrumental variable procedure to deal with the endogeneity problem and estimate these two variables as follows: Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 64 n n Fullincomeit = a 0 + Z a uGDPit + ^ o c2 iPvt _ Kit + sit (3.12) and n n Spillinit = r 0 + Z YuGDPu + Z r2 iP v t- K,t + Ft- (3.13) 1=1 The estimation of the endogenous variables employs all the exogenous variables in the system i.e. the GDP of all nations and the Pvt _ K it of all nations. The terms sit and vit represent the random errors. The equations (3.11)-(3.13) are then estimated as a system of equations for each of the donor nations. Autocorrelation of the disturbance term is a potential problem since I am using time series data. I estimate equations (3.11 )-(3.13) and if autocorrelation is found to exist, I then employ the estimate of the autocorrelation coefficient p to transform all the variables in (3.11) and re-estimate the set of equations (3.11)-(3.13). Transforming the variables when autocorrelation is found to exist does not alter either the value or the interpretation of the parameter estimates. The interpretation of the parameter estimates in equation (3.11) is relatively straightforward. Significance of the Fullincome coefficient /? , indicates the presence of purely public benefits from the donor’s contribution to multilateral assistance. If the estimate of the coefficient fii2 is not significantly different from zero, then the joint-product model collapses to the pure public good model Nash- Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 65 Cournot model. However, fii2 ^ 0 reveals the presence of donor-specific benefits from provision of multilateral assistance. Since = dQ / dQ' , the partial effect of a change in nation/’ s multilateral aid contributions in response to spillins from the da' other donor nations is —t- = Bn -1 . 9 A /?., > 1 indicates that donor i treats its own dQ' donations to multilateral assistance as complementing the contributions of other donors. A Pi2 < 1 denotes that nation i treats other donors’ multilateral contributions as substituting for its own donations. The Pvt _ K coefficient could take either positive or negative values and needs to be determined empirically. On one hand, a positive Pn indicates that donor countries have a greater stake in wanting to see aid- assisted development to make these recipient developing countries a better venue for private capital flows. On the other hand, donors that already have a considerable amount of private investment flowing into developing countries might not wish to contribute large amounts to multilateral institutions, since they have enough information about the investment climates in developing countries. In this case, private capital flows crowd-out donations to multilateral agencies and I would expect to take negative values. ’ Note: The coefficient fii2 = ^ ^ + 1 dQ' dQ' dQ' Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 66 Some donors make decisions on contributions to multilateral institutions at common meetings or with a common overall objective. Studies have suggested that the Scandinavian countries often make similar decisions when funding multilateral assistance (White and Feeny 2003, Degnbol-Martinussen et. al. 2003). For the Spillin term, using an F-test, I evaluate the following null hypothesis and its alternative Ho: Pl2 =Pj H f for i * j for different groupings of countries. When the coefficients associated with the Spillin term are found to not be significantly different for a group of countries, then it is possible to impose equality restrictions on this parameter across countries. This reduces the number of coefficients to be estimated and is expected to improve the efficiency of the estimators. 3.5 Data The data on contributions to multilateral institutions is available from the OECD online DAC database from the section on the Destination of Official Development Assistance and Official Aid Commitments.1 0 I use data on commitments to multilateral institutions which constitute a written obligation by the donor to provide 1 0 The DAC online Database on Annual Aggregates (Table 3a) and (Table 4) are available online at http://www.oecd.org/dataoecd/50/17/5037721.htm. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 67 funds. Disbursements involve placing the funds at the disposal of the recipient and can be given in a piecemeal manner over the life of the project being financed in the recipient. Since I am interested in whether donors treat their donations to multilateral institutions as complements to or substitutes for other nations’ contributions, commitments are the more appropriate measure as this is what the donors observe in any given year. Data on net private capital flows is available from the same DAC online database under the section Destination of Private Direct Investment and Other Private Capital. For the purposes of the present study I use net private capital flows, which include foreign direct investment, total bank flows and total non banks flows but exclude debt relief. Data for the time period 1970-2003 are considered in this study so in all there are 34 years of observations unless stated otherwise. The data on the GDP, population and price deflator are taken from the World Bank’s World Development Indicators database. The paper analyzes contributions to multilateral institutions for 18 main donors belonging to the DAC. Other DAC donors including Greece, Luxembourg, Portugal and Spain are omitted from the study since there are not enough observations available for these countries to carry out a meaningful analysis. The multilateral institutions considered in this study comprise the World Bank, International Monetary Fund, the United Nations agencies, the European Union and the regional development banks (refer to Appendix 1). Therefore, contributions to multilateral institutions include all Official Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 68 Development Assistance (ODA) and Official Aid (OA) committed by donors to this set of institutions.1 1 3.6 Results The estimation results using an instrumental variable approach based on equations (3.11 )-(3.13) for each of the 18 main donor nations over the period 1970-2003 are presented in this section. The analysis proceeds by first considering commitments to all multilateral institutions and then separately investigates the demand equations for donations to global institutions and regional development agencies. Total Multilateral Commitments The results of the estimation procedure for total multilateral commitments are presented in Table 3.2. The Fullincome parameter is positive and significant at the 5% level for Belgium, Denmark, Finland, France, Germany, Ireland, Japan, Norway, Sweden, Switzerland and the United Kingdom. A positive and significant Fullincome coefficient affirms that these donors perceive contributions to multilateral institutions as yielding some purely public benefits to all other donors and possibly to all recipient nations. In addition, the positive Fullincome coefficient is indicative of the income normality of donors’ contributions to multilateral 1 1 ODA refers to grants and concessional loans that have at least a 25 per cent grant component given to developing countries. The OA meets the same tests as ODA but is directed at countries in transition. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 69 institutions. The parameters associated with the Spillin term are highly significant for all sixteen donors, thereby reaffirming my choice of the joint-product representation for donations to multilateral institutions. Significance of the Spillin parameter indicates that donors’ receive private benefits from contributions to multilateral institutions. The partial effect of a change on donor Vs contribution to multilateral institutions in response to the donations of other countries is obtained by subtracting unity from the Spillin coefficient. This partial effect is positive for Australia, Austria, Canada, Denmark, France, Germany, Italy, Japan, the Netherlands, Norway, United Kingdom and the United States. These include some of the larger contributors (in terms of share of total commitments- refer to Table 3.1) to multilateral institutions and it is encouraging that these donors’ treat their own donations as complementary to others’ contributions. The larger stakeholders of multilateral institutions have a greater say in the manner in which funding is distributed to developing countries and this may explain the greater complementarity associated with contributions by the larger donors. Belgium, Finland, Ireland, New Zealand, Sweden and Switzerland treat other donors’ commitments as substitutes for their own donations. These countries lower their own contributions in response to an increase in others’ contributions. Interestingly, countries like Belgium, Finland, Ireland, New Zealand, Sweden and Switzerland that perceive the presence of purely public benefits also treat others’ donations as substitutes for their own commitments. The purely public nature of the activity encourages free riding and substitutability. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 70 TABLE 3 .2 Parameter Estimates of the Joint-Product Nash-Coumot Model for Donors’ Commitments to All Multilateral Institutions. Country /?j {Fullincome) P 2 {Spillin) & {P vt_K ) . Australia+ -0.000073 1.007927** 0.000997 Austria 0.000522 1.003438** 0.038349** Belgiunf 0.001557** 0.993808** -0.001294 Canada+ 0.000293 1.001679** -0.036403* Denmark+ 0.004507** 1.002287** -0.035315 Finland+b 0.003938** 0.984669** -0.006738 France+ 0.001731** 1.020819** 0.003278 Germany^ 0.001272** 1.090812** 0.019126* Ireland b 0.000842** 0.999198** 0.016048** Italy+ 0.000810 1.076681** -0.043220** Japan 0.000524** 1.015402** -0.012314 Netherlands -0.000507 1.073240** 0.006072 New Zealand b 0.000237 0.999421** -0.040257 Norway+ 0.001430** 1.003895** -0.022601 Sweden+ 0.002045** 0.985217** -0.013679 Switzerland 0.002290** 0.981255** 0.022743** United Kingdom 0.000995** 1.040530** 0.001410 United States -0.000240 1.068931** 0.000853 Note'. * Statistical significance at the 10% two-tailed levels of significance. ** Statistical significance at the 5% two-tailed level of significance. +Indicates the data was corrected for autocorrelation. b Donor has less than 34 years of observations. For total commitments to all multilateral institutions the Pvt _ K coefficient is positive for several countries but significant only for Austria, Germany, Ireland and Switzerland. As donors’ increasingly invest funds in developing countries and countries in transition they augment their multilateral contributions, since these multilateral institutions may be providing vital information on the business environment in recipient countries. The parameter for the Pvt _ K term is negative Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 71 and significant for only four donor countries: Canada and Italy. If donors have significant amounts of private capital flowing to developing countries, then donors do not feel the need to bolster conditions in developing countries through multilateral development assistance and therefore free ride on other nations’ contributions to multilateral agencies. A glance at the Spillin coefficients for the Scandinavian countries reveals that these coefficients look quite similar for three of these donors. I test for the hypothesis Pn = Pij f°r the Scandinavian countries with the resulting F-value=0.23 indicating that the null hypothesis cannot be rejected and I can pool across the Spillin coefficient for these countries. In addition, the Fullincome coefficients also appear to be fairly similar and testing the null hypothesis I get an F-value=0.72 indicating that the null hypothesis cannot be rejected. The results with the pooling restrictions on the Spillin and Fullincome parameters are presented in Table 3.3. The pooled Fullincome term is positive and significant for the Scandinavian countries providing support for income normality. The Spillin coefficient is significant and less than unity for these countries, implying that the Scandinavian donors treat other donors’ contributions to multilateral institutions as substitutes for their own donations. The estimated Pvt _ K parameter is positive but not significant for Denmark and Finland indicating that increased multilateral contributions are concurrent with rising private Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 72 capital flows. This coefficient is negative and but not significant for Norway and Sweden. TABLE 3.3 Restricted Parameter Estimates of the Joint-Product Nash-Coumot Model for Donors’ Commitments to Multilateral Institutions. Countries /?! (Fullincome) P 2 (Spillin) J B 3 (PvtK) Scandinavian Countries Denmark+ 0.002730** 0.998052** 0.018287 Finland+b 0.002730** 0.998052** 0.061598 Norway+ 0.002730** 0.998052** -0.091686 Swedeif 0.002730** 0.998052** -0.015840 Larger Contributors France+ -0.002256 1.152645** 0.000704 Germany4 -0.000505 1.152645** 0.010338 Italy4 0.002762 1.152645** -0.053426 Japan4 0.000476 1.152645** -0.003122 United Kingdom4 -0.001388 1.152645** 0.012944 United States4 0.000413 1.152645** -0.000300 Note: * Statistical significance at the 10% two-tailed levels of significance. ** Statistical significance at the 5% two-tailed level of significance. + Indicates the data was corrected for autocorrelation. b Donor has less than 34 years of observations. I conduct a similar exercise for the larger contributors by estimating the equations (3.11)-(3.13) by pooling the Spillin term across donors. For these larger donors the Spillin parameter estimate is greater than unity and highly significant for the pooled regression indicating that these donors view their contributions to multilateral agencies as complementing the contributions of other nations (refer to Table 3.3). The Fullincome parameter and the Pvt _ K coefficient are not significant for any of the donor. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 73 Commitments to Global Institutions Next, I consider commitments made by donors to institutions that have a global focus like the World Bank, the International Monetary Fund and the various UN agencies (see Appendix 1). These agencies are committed to providing assistance to all developing countries and countries in transition irrespective of geographic location. Almost 70 per cent of multilateral assistance is channeled through global aid agencies. The demand equations for sixteen donors’ contributions to global institutions are presented in Table 3.4. Note that Ireland and New Zealand have been excluded from the analysis as these countries did not provide funds to global institutions in a sufficient number of years to yield meaningful estimates. In Table 3.4 the Fullincome coefficient is positive and significant for Austria, Belgium, Denmark, Finland, France, Germany, Italy, Japan, Netherlands, Norway Sweden and the United Kingdom, indicating that these donors view contributions to global aid agencies as giving some purely public benefits as well as the income normality of contributions to global institutions. The Spillin parameter estimate is significant for all donors validating the choice of the joint-product representation for the donors. The coefficient /?, is greater than unity only for Canada implying complementarity of donor contributions to global agencies. For all the other donor nations, including Finland, Germany, Italy, Sweden, Switzerland and the United Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 74 States, P2 is significant and less than one implying that these donors free ride on other donors’ contributions. Again several of the donors that treat other nations’ donations as substitutes for their own contributions are countries that also have positive and significant Fullincome parameters indicative of pure publicness of assistance to global agencies. TABLE 3.4 Parameter Estimates of the Joint-Product Nash-Coumot Model for Donors’ Commitments to Global Institutions and UN Agencies._______________ Country /?j (Fullinccome) j32 (Spillin) P pP vtJC ) Australia+ 0.000405 0.999584** -0.00000000023** Austria1 0.000833** 0.999167** -0.00000000012 Belgium1 b 0.001029** 0.998971** -0.00000000048** Canada1 -0.000037 1.000023** -0.00000000046 Denmark1 0.002532** 0.997471** -0.00000000094 Finlandlb 0.002653** 0.989100** -0.00000000035 France1 0.001318** 0.998688** 0.00000000172 Germany1 0.001221** 0.998769** -0.00000000264 Italy1 0.000917** 0.999067** -0.00000000089 Japan1 0.000441** 0.999551** -0.00000000226 Netherlands1 0.001235** 0.998757** -0.00000000270* Norway1 0.001232** 0.998765** 0.00000000123 Sweden1 0.001147** 0.998854** -0.00000000139 Switzerland 0.006811 0.993210** -0.00000004430** United Kingdom 0.000666** 0.999306** 0.00000000015 United States1 -0.000043 0.999960** -0.00000000115 Note\ * Statistical significance at the 10% two-tailed levels of significance. ** Statistical significance at the 5% two-tailed level of significance. +Indicates the data was corrected for autocorrelation. b Donor has less than 34 years of observations. There appears to be some evidence of crowding out of commitments as a result of larger private capital flows to developing countries for several donors that have a Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 75 negative and significant Pvt _ K coefficient. Interestingly, donors that have a negative Pvt _ K coefficient are also countries that treat other nations’ contributions as substitutes for their own donations. For twelve of the donors private capital flows augment contributions to institutions with a global operational focus. Commitments to Regional Development Institutions Donors channel 15 to 20 per cent of their multilateral assistance through regional development agencies like the African Development Bank, Asian Development Bank, Inter-American Development Bank and so on (see Appendix 1). The Fullincome coefficient is significant and in the expected direction for Denmark, Finland, France, Germany, Netherlands, Norway, Sweden and the United Kingdom. Twelve of the donors have positive estimated Fullincome coefficients affirming the income normality of contributions to regional development agencies. The Spillin parameter estimate is significant at the 5% level for all donors and is greater than unity for all donors except Norway and the United States indicating the presence of strong complementarity in donors’ contributions to regional development institutions. This result is quite unlike the case of the more global institutions where I find several instances of free riding by the donors. Donors are increasingly aware that dealing with many environmental disasters, disease outbreaks, financial crises and other cross-border issues require cooperation amongst nations (Sandler 1997, 2004, Kaul et al. 1999). Many problems plaguing developing countries and Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 76 countries in transition can be dealt with regionally and the regional development banks are ideally placed to address these issues (Arce and Sandler, 2002). Given that most of the DAC donors view their contributions to regional agencies as complementing other nations’ contributions bodes well for the future role of regional development banks in fostering development. Another possible driver of complementarity in regional donations might be the donors’ perception of relatively more tangible private benefits from contributing to a particular region than funding global activities. The Pvt _ K parameter estimate loses much of its significance for the donors’ demand for regional assistance. It is positive and significant for only five donors: Austria, Belgium, Denmark, France and the United Kingdom, and negative and significant for two nations. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 77 TABLE 3.5 Parameter Estimates of the Joint-Product Nash-Coumot Model for Donors’ __________ Commitments to Regional Development Banks.__________ Country /?! (Fullincome) P 2 (Spillin) (Pvt JT) Australia+b 0.000092 1.011385** -0.000000000014* Austria b -0.000053 1.006397** 0.000000000477** Belgium b -0.000024 1.008815** 0.000000000231** Canada+ b -0.000356** 1.037246** -0.000000000126 Denmark+b 0.000330** 1.000395** 0.000000000595** Finland+b 0.000263** 1.004151** 0.000000000061 France+b 0.000117** 1.069774** 0.000000001706** Germany+b 0.000237** 1.132511** -0.000000000088 Italy b 0.000143 1.147702** -0.000000000116 Japan+b 0.000059 1.017048** -0.000000000130 Netherlands b 0.000275** 1.019454** -0.000000000027* Norway1 " b 0.000376** 0.998056** 0.000000000009 Sweden + b 0.000234** 1.001133** 0.000000000071 Switzerland1 1 0.000188 1.004818** -0.000000000003 United Kingdom b 0.000056** 1.034866** 0.000000001618** United States’ 1 -0.000091** 0.958443** 0.000000000003 Note: * Statistical significance at the 10% two-tailed levels of significance. ** Statistical significance at the 5% two-tailed level of significance. +Indicates the data was corrected for autocorrelation b Donor has less than 34 years of observations 3.7 Concluding Remarks This essay provides interesting insights into donors’ commitments to multilateral institutions by estimating theoretically derived donor demand equations for multilateral assistance that account for strategic interactions between donors. Overwhelming evidence emerges for the presence of donor-specific private benefits from the provision of multilateral assistance. Convincing support for complementarity surfaces from donations by the large donors to all multilateral institutions as well as to regional development agencies. The existence of strong Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 78 complementarity in donations to regional development agencies implies that increases in contributions by any donor will lead other donors to augment their commitments. Additional funds should be channeled through the regional institutions since they possess the capacity to deal with localized cross-border spillovers. The combination of private benefits to the donors and strong complementarity of contributions bodes well for the magnitude of assistance channeled through multilateral institutions. For institutions with a more global operational focus some of the large donors attempt to free ride on other nations contributions. This result is at odds with the finding in the last chapter on bilateral foreign aid transfers, where the large donors treated their own contributions to total and regional bilateral aid as complementing the donations of other nations. While studies by Rodrik (1995) and Ratha (2001) have attempted to unearth the relationship between contributions to multilateral agencies and private capital flows to developing countries, this is the first study to analyze the relationship between private capital flows and the strategic nature of donors’ commitments to multilateral institutions. This study finds that private capital flows crowd-out funding for multilateral institutions mainly for donors that attempt to free ride on others’ multilateral commitments. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 79 Chapter 4: Donors’ Mechanisms for Financing International and National Public Goods: Loans or Grants? 4.1 Introduction In an increasingly interconnected world, events in one country may have a profound impact on another country, even one halfway across the globe. The effects of environmental disasters, terrorist events, financial crises, and infectious disease outbreaks may spread rapidly from one country to another. Because the costs or benefits of some goods or activities are not confined within the borders of a single nation, there has been a concerted effort on the part of academicians and policymakers to raise awareness that dealing with such global challenges requires increased provision of the appropriate international public goods (IPGs) to internalize these spillovers (Kanbur et al., 1999; Kaul et al., 1999; and Sandler, 1997 and 2004). The issue of how to finance the provision of public goods with cross- border spillovers through foreign aid for developing countries has been receiving increasing attention (Arce and Sandler, 2002; Kaul et al., 2003; and Sandler, 2004). The composition of foreign aid (i.e, whether funding should be given as concessional loans, non-concessional loans, or grants) is of importance if foreign aid is to be effective. Prior debate on the grant-loan issue has arisen within the context of the Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 80 debt burden facing highly indebted poor countries, with grants and highly concessional loans viewed as a means to reduce the debt overhang (Easterly, 2002). The Meltzer (2000) Commission report recommended that the development banks (including the World Bank and regional development banks) should award mainly grants to developing countries for the purpose of alleviating poverty, because loans saddle these countries with high interest payments and limited monetary and fiscal policy options. Sanford (2002) outlined the implications of switching all International Development Association (the arm of the World Bank that lends at highly concessional rates to the world’s poorest nations) funding to grants from the political standpoint of the donor nations. Odedokun (2003 and 2004) conducted the first analytical studies on the division between loans and grants in foreign aid commitments of bilateral donors by examining the factors that affect this combination from the donor’s perspective and its impact on governance in the recipient nation. These studies also addressed issues like the sustainability of aid volume, the implications for the future debt burden, and the impact on efficiency and fiscal discipline of recipients. Following the pioneering study by McKinlay and Little (1977), research on foreign aid can be divided into studies that focused on donor interest, recipient needs, good governance, or some combination of the three (Neumayer, 2003a, ch. 3; and Morrissey, 2004). Donor interest stresses military advantage, political concessions, Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 81 or other self-interested motivations of the donors in disbursing foreign aid to particular developing nations. Studies on recipient needs emphasized humanitarian aid to assist the poorest developing countries, with per-capita income often used as an indicator of the level of indigence. Neumayer (2003a and 2003b) contributed along a third dimension by analyzing whether governance standards in developing countries matter to bilateral donors, global agencies, and regional banks when distributing aid. Many of the development strategies over the decades, financed through foreign aid, have been failures mainly because they were not aligned with the derived benefits of recipients. The notion of gearing foreign aid commitments to the derived benefit share of the recipient country has been absent in much of the literature on foreign aid. The composition of foreign aid commitments (i.e., whether assistance is given in the form of loans or grants) from a donor to a recipient developing nation has important implications if viewed from the perspective of public economics. In the context of this paper, recipient benefit share reflects the willingness on the part of the recipient nation to accept a particular combination o f loans and grants from the institution or nation disbursing funds to finance an activity. If an aid-funded activity is more purely public yielding large cross-border benefit spillovers to nations other than the aid recipient, then this increases the possibility for free riding and thus suboptimal provision, so that a grant is the preferred financing instrument (Ferroni, 2002). If Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 82 loans are extended to finance such public goods, then these need to be multi-country loans to internalize the spillovers (Kanbur, 2002). However, most funding extended by the bilateral donors, global institutions, and regional institutions is to individual developing and transition countries rather than to a group of countries. When there are only recipient-specific benefits accruing from the provision of the aid-supported activity, loans are the appropriate financing mechanism as all benefits remain in the recipient. If, however, there is a mix of recipient-specific and jointly derived cross- border public benefits, then the ratio of loans to grants should roughly mirror this mix.1 2 This paper explores the extent to which grants and loans have been utilized by various donors to finance IPGs and national public goods (NPGs)1 3 through Official Development Assistance (ODA) and Official Aid (OA) in five sectors: health, environment, governance, knowledge, and peacekeeping over the 1980-2000 period. Appendix 2 lists the various activities that fall under these five sectors. The recipient country’s per-capita income level is not considered when analyzing aid commitments to a particular sector. Poor countries may, however, receive more aid for their health sector compared with, say, governance, because infectious disease outbreaks may be a greater international concern. I cannot control for the possibility that funding with 1 2 Because I can only observe the donor’s funding behaviour, I used this data to ascertain whether the grant-loan mix is aligned to a proxy for the recipient’s benefit share. 1 3 For NPGs, only the recipient nation receives the public good’s benefits. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 83 a larger grant element might go to poor recipients to curb infectious diseases, whereas funding with a smaller grant element might go to richer countries to improve governance. Because almost 94 per cent of total aid commitments, 91 per cent of health sector commitments, and 94 per cent of governance sector commitments since 1999 are classified as ODA given to developing countries, I can be reasonably sure that any grant-loan variations by sectors uncovered are independent of per-capita income considerations. The primary purpose of the paper is to apply analysis of variance (ANOVA) statistical tests to ascertain whether the mix of grants and loans differs among the three categories of donors - global organizations, regional institutions, and bilateral donors - across sectors and over time. I am particularly interested in whether the funding policies of these three classes of donors correspond to the recipients’ share of benefits, as suggested by the publicness of the activities supported. I first establish that the grant-loan mix differs among donors for some sectors’ activities for two sub periods. Next, I identify precisely how the mean share of grants varies for sectors and time periods for the three sets of donors. I then investigate how this mean share differs by the type of public good funded in the aid recipients. I find that bilateral donors on average choose a grant-loan mix most in line with the notion that grants should be favored for aid-funded activities with a high degree of Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 84 IPG spillovers. Global institutions’ behavior is judged intermediate in gearing their funding arrangement to publicness considerations. Regional institutions do virtually nothing to tailor the division between grants and loans to reflect the publicness aspects of the aid-supported activities or the recipient country’s share of gain. This outcome inhibits the ability of regional institutions to promote recipient ownership and overall allocative efficiency. Ironically, the regional institutions are trying to assume a greater role in supporting public good provision in developing countries (Ferroni, 2002). A change in their aid-disbursement policy appears necessary if these regional institutions are to warrant this enhanced role. 4.2 The Donors and their Objectives Table 4.1 presents the sample institutions and donors in the three categories, germane to this study. Some of the most important global institutions - e.g., the International Development Association (IDA) and the International Fund for Agricultural Development (IFAD) - are in the Credit Reporting System (CRS) data used in this study. Lending activities by the other concessional arm of the World Bank - the International Bank for Reconstruction and Development (IBRD) - are not included in the CRS data. The four regional development banks or their funding agencies are part of the sample regional institutions. In addition, one regional development fund - the European Investment Bank (EIB) - is part of this sample. Twenty-two individual countries are included that represent the world’s primary Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 85 bilateral donors. The goal of the global institutions is to alleviate poverty in the poorest developing nations. Such institutions have a worldwide assistance orientation; thus, I classify the Commission of the European Communities (CEC) as a global institution given its global development focus. In contrast, the regional institutions channel collections from myriad donors to fund development projects and programs in its regional jurisdiction. Finally, the bilateral donors are individual nations that pursue multiple objectives, ranging from humanitarian relief to self- interested concerns (e.g., stability in a trading partner). Donor nations can give directly in a bilateral fashion or through their support of global and regional institutions. In the latter case, donor nations can save on transaction costs, but relinquish much of the control over the funds. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 86 TABLE 4.1 Global Institutions, Regional Institutions, and Bilateral Donors Global Institutions Regional Institutions Bilateral Donors • International • African Development • Australia Development Rank (AfDB) • Austria Association (IDA) • Belgium • International Fund for • Asian Development Bank • Canada Agricultural (ADB) • France Development (IFAD) • African Development Fund • Germany • United Nations (ADF) • Greece Development Program • Inter-American Development • Ireland (UNDP) Bank (IDB) Special Fund • Italy • United Nations Children • European Investment Bank • Japan Fund (UNICEF) (EIB) • Denmark • Commission of the European Communities (CEC) • Finland • Luxembourg • Netherlands • New Zealand • Norway • Portugal • Spain • Sweden • Switzerland • United Kingdom • United States 4.3 Theoretical Model To depict the benefit share of the recipient country, I display its demand for the activity q that is partly funded through foreign assistance. This exercise is normative to show what grant-loan mix would ideally reflect the recipient’s derived benefits. Nation /' is assumed to allocate its income, I \ between a private good, y l, and an activity, q'. The country’s budget constraint is: r = y + p q \ (4.1) Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 87 where the price ofy is one and the price of q is p. The recipient’s income derives from its gross domestic product and foreign assistance. An interest payment on past loans must be netted out of this assistance. This budget constraint reflects the fungibility of foreign aid because it may be used for intended (e.g., support of q) and unintended uses (e.g., support of y). Conditionality on aid alters the form of the budget constraint but typically leaves some fungibility. Activity q yields joint products: a nation-specific private benefit, x!, and a pure public benefit, z\ to n - 1 other nations (Cornes and Sandler, 1984). The public output from the activity benefits a wide range of nations that may include the donor nations. For example, aid-financed vaccinations against an infectious disease not only keeps the recipient nation’s people healthier (the x component) but also keeps all at-risk nations healthier (the z component). Similarly, aid-supported governance makes the recipient country a more attractive venue for foreign direct investment (the x component), while it also protects past and future investors from all countries (the z component). A simple fixed-proportion technology applies to the joint products activity, where: x‘ = M (4.2) and zl =pq\ (4.3) Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 88 in which each unit of q provides /?' > 0 units of x' and p > 0 units of zl. Other nations also produce the public component through their own joint product activity. Thus, for example, other countries - rich and poor - may vaccinate their population or institute financial and other governance measures that benefit them and other countries. These other nations’ (i.e., other than recipient i) provision of the public component is denoted by Z'=pQ, (4.4) where Q = ^ q J is the sum of the joint product activity’s provision in nations other than nation i. As is standard, I simply assume that the total amount of the public good available to all countries is: Z = z'+Z\ (4.5) The aid-recipient nation allocates its income to maximize its utility, while satisfying its budget constraint and the joint product technologies in equations (4.2)-(4.4). Solving this problem gives a demand for the aid-supported activity q' as follows: <i =q-(r,p,Q',P,p) (4.6) The recipient’s demand depends positively on its income if the joint product activity is a normal good. Thus, increases in aid would then raise the recipient’s income and, Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 89 hence, its demand for this activity. An increase in the price of activity q reduces demand. If aid is given as a matching grant, then p is reduced and this augments the recipient’s demand for q. The efforts, by other countries to provide their own q, as reflected by Q1, has a negative impact on the aid recipient’s demand for the joint product activity, because the recipient can then free ride on the public, but not the private, component of this activity supplied by others. The extent to which an aid recipient derives country-specific benefits from providing the joint product activity dampens free-riding motives, because the recipient must provide its own q to experience these private benefits. Thus, the fixed-proportion parameters play an essential role in reflecting the recipient’s share of benefits from an aid-financed activity. An indicator is the ‘ index ofpublic benefits' ( 4 -7 > P +P which reflects the recipient’s ratio of public benefits to total benefits derived from activity q. When this index is zero, the aid-recipient nation receives country-specific gains from the joint product activity and has the strongest stake in its provision. In this instance, the recipient is motivated to accept the transfer as a loan to finance the activity. If, however, the index is one, then all derived benefits are gained by a set of nations that may include the donors, and the recipient’s responsibility to underwrite the activity’s Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 90 cost is limited. Now, a grant makes more sense. Between these extremes lie the more interesting real-world scenarios. If, for instance, the index of public benefits is two-thirds, then roughly two-thirds of the transfer should be in the form of a grant and the remainder in a loan. By reflecting recipient benefit shares in aid-funded activities, this index provides a rough rule of thumb for the grant-loan mix consistent with the recommendations of Ferroni and Mody (2002) and the World Bank (2001). The more public is the activity, the greater should be the share of grants in the transferred funds. 4.4 Data and Methodology The CRS database,1 4 maintained by the Organisation for Economic Cooperation and Development (OECD), provides information on sectoral and geographical distribution of grants and loan commitments made by the bilateral donors, global organizations, and regional institutions to developing and transition countries. By necessity, I utilize data on foreign aid commitments rather than disbursements, because the CRS data are in terms of the former except for two donors - Belgium and Spain - whose aid is reported as disbursements. Figures 1-3 present the distribution of commitments in constant 1995 US dollars to the sectors by the three types of donors over the 1980-2000 period. These figures display foreign aid commitments to just those activities that have been deemed to be public goods (NPGs or IPGs) according to the classification scheme outlined in Appendix 2 and, 1 4 Available online at http://www.oecd.org/dataoecd/50/17/5037721.htm Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 91 hence, do not include all aid transfers to developing countries. On average, 48 per cent of total CRS commitments can be considered as providing public benefits either nationally or internationally. CRS’s support of NPGs and IPGs increased from 37 per cent in 1980 of its committed funds to 62 per cent in 2000. Figures 4.1-4.3 provide some interesting insights into the changing emphasis of development assistance over time. The 1980s were dominated by the view that economic growth, via structural adjustment programs, was the vehicle for lowering poverty and meeting basic needs in developing countries. Around 1987, there was greater international awareness of environmental issues with the publication of the Brundtland Report (Carlsson, 1998). Environmental activities received a larger share of commitments with the regional institutions (see Figure 4.3) displaying this trend most markedly. In the 1990s, the emphasis of development thinking shifted to capacity building (Carlsson, 1998). North’s (1990) ideas placed the onus on the emergence of institutions that could create the right incentives for economic growth. Through the 1990s I observe that governance and capacity-building-related activities received the largest share of commitments from the global institutions, bilateral donors, and regional institutions, with environment and health-related activities receiving the next largest shares. There is a marked increase in governance sector funding around the time of the East Asian financial crisis in 1997, which impacted countries around the globe. This change of emphasis indicates a recognition of these Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 92 negative “spillovers” from distant venues. The share of foreign aid commitments to knowledge-related activities displays some fluctuations overtime, especially for global and regional institutions. Compared with the first half of the 1980s, bilateral donors have increased their commitment to knowledge-related assistance (see Figure 4.2). The bilateral donors extend the largest amount of knowledge-related commitments, followed by the global institutions. The regional institutions play a much smaller role. The regional institutions do not fund peacekeeping activities in most years, while the global and bilateral donors fund peacekeeping activities. This funding is almost exclusively through grants. Because peacekeeping activities include post-conflict rebuilding and other emergency services (refer to Appendix 2) of a more international public nature, financing such activities through grants is appropriate. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Figure 4.1: Global Institutions' Commitments by Sector 1980-2000 g 5000 o 4000 - 2000 - 1000 - fa 3000 o O 0 Governance 1! Peacekeeping ■ Knowledge □ Environment ■ Health q S ^ qO** 0 - ^ n ^ n G q ^ b cP) C \V pCV Cx5 C\0 f \ \ r\b r& C& Figure 4.2: Bilateral Donors' Commitments by Sector 1980-2000 a .g 3 5 V 6 § o O 40000 - 35000 30000 25000 15000 10000 0 Governance 0 Peacekeeping H Knowledge 0 Environment O Health q $ 5 q \ qi2* q 2 ? n q 5 } q 2 \ q ^ b q ^ q 5 v r t V b i b N V ^ Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 94 Figure 4.3: Regional Institutions' Commitments by Sector 1980-2000 1800 g 1200 ■ M rS a o e - *2 § o O 800 - 0 Governance □ Peacekeeping H Knowledge 0 Environment B Health Because the CRS database includes the form of the transfer (i.e., grant, grant-like, or loan and equity investment), this information can indicate which mechanism (i.e. loans or grants) is used to finance activities in different sectors. I combine grants and grant-like activities into a single category called grants, while loans and equity investment are joined into a single category labeled loans. The database provides information about the grant element that measures the concessional nature of a loan in the form of the present value of an interest rate below the market rate (conventionally taken as 10 per cent) over the life of a loan. Thus, the grant element is nil for a loan carrying an interest rate of 10 per cent and it is 100 per cent for a grant with no payback. This grant element lies between these two limits for a soft Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 95 loan.1 5 If the face value of a loan is multiplied by its grant element, the result is then referred to as the grant equivalent of that loan. The grant element of concessional loans is included under the category grants to provide a more accurate account of what has been transferred and not repaid at the market rate of interest. The unit of analysis is the mean share o f grants and denotes the share of commitments given as grants. For a given year, I compute the share of grants by aggregating the total grant element in committed funds for the group of donors. This mean share of grants is computed for a time period, say 1980-89, by averaging the grant share over all activities in a particular sector for the group of donors over the intervening ten years. Table 4.2 displays the mix between loans and grants utilized by select donors for three sample years. The IDA and IFAD gave all funds in the form of soft loans, while the CEC, UNDP, and UNICEF provided all funds in pure grants (i.e., funds that have a 100 per cent grant element). The UNDP and UNICEF did not contribute to foreign aid in all years and, hence, are excluded from Table 4.2. In 1990, the IDA and IFAD commitments constituted the bulk (approximately 85 per cent) of all global funding. Therefore, combining the five global donors into a single category should not greatly bias my findings. The loan-to-grant ratio remained fairly stable over time for the IDA, but the ratio rose from 0.42 in 1980 to 0.77 in 1990 before declining to 0.35 in 1999 for IFAD. The regional donors, such as AfDB, ADB, and 1 5 See the OECD website at http://www.oecd.org/dataoecd/58/24/31426795.pdf. which provides the formulas and examples for the calculation of the grant element on soft loans. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 96 IDB, used soft loans for funding activities in recipient countries. For the IDB, the loan-to-grant ratio decreased from 0.47 in 1980 to 0.35 in 1999. This ratio was fairly constant for the AfDB and ADB. The IDA and the regional donors partly financed future activities from the repayments of past loans; hence, they may be institutionally bound to give a particular mix of loans and grants. Most bilateral donors used a mix of pure grants and soft loans, but some donors (e.g., Australia and Norway) relied solely on pure grants. Table 4.2 indicates a strong trend amongst bilateral donors toward increasing the grant element in their funding of aid. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 97 TABLE 4.2 Loan and Grant Elements in Total Commitments for Select Donors Donors1 1980 1990 1999 Loan/ Grant Pure Grant2 % Loan/ Grant Pure Grant % LoanI Grant Pure Grant % Global Institutions IDA 0.21 0.0 0.25 0.0 0.25 0.0 IFAD 0.42 1.2 0.77 0.0 0.31 0.0 CEC 0.11 73.6 0.00 100.0 0.00 100.0 Regional Institutions AFDB 0.22 0.0 0.21 0.0 0.26 0.0 ADB 0.28 0.0 0.30 0.0 0.32 0.0 IDB 0.47 0.0 0.32 0.0 0.35 0.0 Bilateral Austria 2.01 0.0 0.59 0.0 0.14 77.0 Australia 0.00 100.0 0.00 100.0 0.00 100.0 Belgium 0.16 20.2 0.08 69.7 0.00 97.9 Canada 0.13 43.8 0.01 94.3 0.00 100.0 Denmark 0.09 54.7 0.00 100.0 0.00 100.0 France 0.75 32.7 0.62 35.4 0.12 81.0 Germany 0.25 60.6 0.38 61.3 0.11 78.6 Japan 0.60 23.9 0.55 24.7 0.29 28.4 Italy 1.09 0.0 0.25 72.4 0.02 93.3 Netherlands 0.21 69.9 0.08 88.4 0.00 100.0 Norway 0.00 100.0 0.01 99.7 0.00 100.0 Sweden 0.02 99.1 0.00 100.0 0.00 100.0 Switzerland 0.02 92.9 0.00 100.0 0.00 100.0 United Kingdom 0.10 91.7 0.00 99.9 0.00 100.0 United States r .. 1 « ■ I • . • ____ >• . 0.16 69.5 0.04 93.5 0.01 99.2 Notes: 1 Abbreviations listed in Table 4.1. 2 Pure grant share equals (pure grants/total grants) Loan: commitments excluding the concessional element that is added to grants Grant: sum of pure grant and the grant element of the concessional loan. Analysis of variance (ANOVA) techniques are utilized to determine whether donors’ policies with respect to giving grants or loans vary significantly over time (Hoaglin et al., 1991). This is achieved by testing if the mean share of grants in ODA and OA differs significantly by donor type for a particular sector. In particular, I test for the following null hypothesis, Ho, and its alternative, Hi. Hq : The three types of donors - global organizations, bilateral donors, and Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 98 regional institutions - do not differ significantly from each other with regards to the mean share of grants in foreign aid commitments given to a particular sector. Hj : The three types of donors differ significantly from each other with regards to the mean share of grants in foreign aid commitments given to a particular sector. The data analyzed covers the period 1980-2000, which is split into two time periods, 1980-89 and 1990-2000, to ascertain if any of the donor types changed funding policy for aid-supported public goods over time. In each period, the dependent variable is the share of grants in the total ODA and OA given to each sector. While the ANOVA procedure indicates if there is significant variation in the mean share of grants by donor type, it does not reveal how much the policies of the three types differ from each other. To conduct such a pair wise comparison of donors’ policies, I apply the Scheffe grouping,1 6 which indicates whether the mean share of grants is significantly different for a donor type when compared with each of the other two types. In particular, I test the following hypotheses: 16 Scheffe test statistic t (A -Xj ) MSE — + — \ n n ■ j V ' j / where (x. - x.) is the difference in means for the ' i j ' two donor classes under consideration, « , ■ and n} are the sample sizes for the donor classes, and MSE is the mean squared error. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 99 Ho: The mean share of grants in ODA and OA commitments for the donor types does not differ for a given sector. H i: The mean share of grants in ODA and OA commitments for the donor types differs significantly for a given sector. The alphabet indicators for the Scheffe grouping are lexicographic in magnitude, implying that the donor class corresponding to the indicator A has the highest mean share of grants, B the second highest, and C the lowest. If the Scheffe grouping has the same alphabet indicator for any two donor types, then these types do not differ significantly in terms of their mean share of grants in ODA and OA commitments and I cannot reject the Ho. If the Scheffe grouping has different alphabet indicators for any two donor classes, then they differ significantly in terms of their mean share of grants in ODA and OA commitments and I reject the Ho. 4.5 Empirical Results For both time periods, Table 4.3 reports the ANOVA results by sector for the first hypothesis presented in the previous section. Because peacekeeping activities are financed almost exclusively through grants by all donor classes, this sector is excluded from analysis. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 100 TABLE 4.3 Results of the ANOVA procedure Sector Time Period P r > F Results Environment 1990-2000 1980-1989 0.0344 0.0149 Cannot reject H0 Cannot reject Ho Health 1990-2000 1980-1989 <.0001 0.0100 Reject H0 Reject H0 Knowledge 1990-2000 1980-1989 <0001 <0001 Reject Ho Reject Ho Governance 1990-2000 1980-1989 0.0048 <.0001 Reject H0 Reject H0 Note: The confidence level of 0.01 was utilised in evaluating the F-value. In Table 4.3, the third column displays the probability (Pr) of obtaining an F-value greater than the critical value. I reject the H0 and accept Hi when this probability is less than or equal to 1 per cent. Over both time periods, I reject the Ho and conclude that the three donor types differ significantly from each other with regards to the share of grants in foreign aid commitments given to the health, knowledge, and governance sectors. However, I cannot reject the Ho in the case of the environment sector for either time period. I should note that a less conservative level of significance would have led to a rejection of the Ho for the environment. Nevertheless, the findings in Table 4.3 indicate that, when Pr > F is consulted, the donor classes treated aid policy in supporting public goods more alike for the environment than for other sectors. This then suggests that either there are greater donor-perceived index of public differences in the other three sectors, or else the Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 101 actions of diverse donor classes are bureaucratically determined in the other sectors - e.g., an inability of a donor type to vary its grant share based on perceived publicness. The cause for this variation among donor types within the sectors is now explored in greater depth with the Scheffe framework, which identifies the extent of differences in the grant share among donor types. For each time period and sector, Table 4.4 indicates the mean share of grants for each donor type. Based on these mean shares, the Scheffe grouping is then calculated for each donor class. For environment-related activities during 1990- 2000, the mean share of grants for bilateral donors is the largest, but is not significantly different from that of global institutions. The mean share of grants for regional institutions, however, differs from those of global institutions and bilateral donors for this period. When I observe the Scheffe test results for 1980-89 for the environment sector, I see that the global institutions gave the largest mean share of grants (83.5 per cent), while the bilateral donors and the regional agencies followed virtually the same policy. Over the two time periods, the bilateral donors increased the share of grants in their contribution to environmental activities, which may be a result of the earlier mentioned shift toward funding environmental activities after the Brundtland report. The shift may also be due to the evolution of technology, which allowed better monitoring of the spillovers from environmental-related disasters. The global institutions slightly reduced their share of grants, which may have arisen Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 102 from the shift in emphasis of these institutions towards capacity building in developing nations. The regional institutions pursued the same policy over both time periods and did not appear to have followed any change in development policy thinking. For 1990-2000, the Scheffe grouping for the health sector indicates that all three donor classes differ significantly from one another in terms of their funding instruments. Bilateral donors gave an average of 89.5 per cent of their funds in the form of grants, reflective of a keen recognition of their interconnectedness with the developing world. ‘UN Secretary General Kofi Annan recently said that the earth’s populations seem to him to be crowded into a “small boat” and, in that boat, what touches one - whether it is illness or anger - can touch us all’ (Thompson, 2002, p. 1). Health sector funding goes toward activities aimed at curbing infectious and sexually transmitted diseases including Acquired Immune Deficiency Syndrome (AIDS). The recent Severe Acute Respiratory Syndrome (SARS) epidemic and its global fallout will only serve to accentuate the rationale for providing grants to fund health-related activities. Bilateral donors increased somewhat their share of grants during 1990-2000, which suggests that they perceived a greater share of public benefits coming from supporting the health sector in developing countries. According to the Scheffe grouping, bilateral donors’ share of grants is significantly higher than that of global institutions, which, in turn, is greater than the share of Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 103 grants given by regional institutions. The Scheffe test results for 1980-89 show that it is the global agencies that disbursed the largest share of health assistance to developing countries in the form of grants (90.3 per cent), but this share does not differ significantly from that of the bilateral donors (86.2 per cent) over the same time period. The policy of the global agencies to reduce their share of grants over time to the health sector may be due to the shift in emphasis toward governance and capacity-development activities. Once again, the regional development agencies maintained the policy of disbursing 76.9 per cent in the form of grants over both sample periods and not distinguishing between the publicness of activities in the various sectors. Knowledge-related activities, like research into medicine, agriculture, technological innovation, and so on, are of a purely public nature with potential benefit spillovers for all nations. Funding of the education sector (i.e., primary, secondary, and tertiary) has strong complementarity in terms of aiding absorption of knowledge advancements even though most benefits accrue to the recipient nation. For knowledge-related foreign assistance, the Scheffe grouping for both time periods indicates that each of the three donor types is markedly different in terms of their policy for giving grants to developing nations. For both time periods, bilateral donors gave approximately 95 per cent of all funding in the form of grants, suggesting that they viewed knowledge-generating activities as more purely public Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 104 than the other sectors financed. The regional institutions again did little to distinguish among activities and gave 77-78 per cent of their funding in the form of grants. The global agencies policy was intermediate as they gave approximately 82- 85 per cent in the form of grants. Apparently, the regional institutions did the least to recognize the publicness of this sector and, thus, could not reflect recipients’ benefit shares. TABLE 4.4 Scheffe Grouping for Institutions by Sector 1980-89 1990-2000 Sector Donor Type Mean Share of Grants Scheffe Grouping Mean Share of Grants Scheffe Grouping Bilateral 77.7 % B 83.2% A Environment Global 83.5 % A 80.9 % A Regional 77.6 % B 76.3 % B Bilateral 86.2 % A 89.5 % A Health Global 90.3 % A 82.5 % B Regional 76.9 % B 76.9 % C Bilateral 94.8 % A 95.3 % A Knowledge Global 85.2 % B 82.1 % B Regional 78.2 % C 76.9 % C Bilateral 68.8 % C 80.7 % B Governance Global 85.2 % A 85.3 % A Regional 76.7 % B 76.3 % C Note: The Scheffe Grouping is evaluated at the 5% level of significance. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 105 For governance-related activities, the bilateral donors only gave 68.8 per cent in the form of grants for 1980-89. This share is even lower than the regional institutions, which again maintained the same policy over the two periods. The bilateral donors seemed to view contributions to governance and capacity building in developing nations as conferring more private benefits on the recipient. Looking at the activities subsumed under this category in Appendix 2 ,1 see that many activities, like private sector management and transport services, provide large county-specific benefits to the developing country. Nevertheless, over the two time periods, the bilateral donors increased their share of grants from 68.8 per cent to 80.7 per cent, and this may derive from a better recognition that financial crises or other forms of market contagion originating in developing countries can impact markets and investors worldwide. The global institutions emphasized governance and capacity-building activities the most (also shown in Figure 1) with the largest share of grants (over 85 per cent) of the donor types being given to this sector across both time periods. This funding policy may reflect recognition that building capacity in developing countries is necessary to propel growth and reduce poverty. Moreover, global agencies’ reliance on grants indicates that they viewed governance in developing countries as helping all countries. The above classification and analysis demonstrate that donor classes behave differently when choosing the mix of grants and loans to support the various sectors Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 106 in foreign-aid recipients. Unlike the regional institutions, the global institutions and bilateral donors vary their share of grants over sectors and time. For the knowledge sector, their relatively high share of grants is consistent with one’s intuition about the large degree of public benefits conferred on countries beyond the recipient nation. A reliance on grants is then in keeping with the derived benefit shares of the recipient. This classification analysis, however, does not directly separate out funded activities with more global public good spillovers from those with more recipient-specific benefits. Such a separation would provide an even clearer picture of the appropriate split between grants and loans. To engineer this separation, I examine the activities funded in each sector and classify them as IPGs with large cross-border spillovers and NPGs with no spillovers (see Appendix 2). For example, biosphere protection (e.g., ozone layer preservation, air pollution control, and marine pollution) benefits a wide set of countries in contrast to agricultural development, which offers mostly nation-specific gains owing to geoclimatic considerations. For the environment sector, I thus classify biosphere protection as an IPG and agricultural development as anNPG. This separation of activities is accomplished for the two time periods for the three sets of donors. As is apparent from the Appendix 2, the division of activities into IPGs and NPGs is by no means airtight, because it is difficult to gauge the exact range of spillovers. With this caveat, my classification indicates where benefits from Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 107 foreign assistance were recipient specific or international in scope. Most of the categorization is similar to te Velde et al. (2002), but some entries differ, since judgments on such an exercise will vary. The ANOVA procedure is utilized to test the following null hypothesis and its alternative: H0: For a particular sector and donor type, the share of grants in foreign aid commitments does not differ for IPGs and NPGs. H i: For a particular sector and donor type, the share of grants in foreign aid commitments differs for IPGs and NPGs. Rejection of the null hypothesis implies that the donor class varies its grant share in commitments based on the range of benefit spillovers. When the null hypothesis is rejected, I anticipate that the mean share of grants for IPGs would exceed the mean share for NPGs. One might expect that NPGs would have almost no grant share if benefits were accruing solely to the recipient country. However, the argument that NPGs often play a complementary role by building capacity for absorption of core activities (which produce IPGs) provides a rationale for financing NPGs to some extent through grants (World Bank, 2001). Any altruism that rich countries derive from NPG provision in developing countries also justifies a positive grant share. The results for the ANOVA procedure based on the range of spillovers are presented Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 108 in Table 4.5. For the global institutions, I cannot reject the null hypothesis for the health, environment and governance sectors for both time periods, thus indicating that these institutions did not tailor their financing of activities to the range of benefit spillovers. Hence, global agencies made no distinction between IPGs and NPGs for these sectors. For knowledge-related activities during 1990-2000, the global institutions distinguished between IPGs, which received 86.73 per cent of ODA and OA as grants, and NPGs, which receive 82.07 per cent of ODA and OA as grants. No distinction was, however, made between IPGs and NPGs for knowledge sector activities during 1980-89. In approximately 57 per cent of cases considered where the mean share of grants differed by more than 1 per cent, the grant share for IPGs is greater than that for NPGs. During 1990-2000, the bilateral donors distinguished between IPGs and NPGs in the expected direction for governance and health-related activities (see Table 4.5). For the earlier period, I reject the null hypothesis only for health sector. Bilateral donors distinguished between IPGs and NPGs and financed virtually all of the assistance for the health-sector IPGs with grants. Glancing at the activities included under health IPGs (e.g., sexually transmitted diseases control, including AIDS, and infectious disease control), I discover that these activities yield purely public benefits, thereby providing justification for grant financing. Bilateral donors supported knowledge- related activities almost exclusively through grants irrespective of the range of Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 109 benefit spillovers. This is perhaps due to an awareness that knowledge NPGs have a strong complementary role to play in enabling the recipient developing nation to absorb essential, at least from the developed nation’s perspective, core IPGs in all sectors. Contrary to my intuition, the bilateral donors made no significant distinction between environmental IPGs and NPGs. I should, however, point out that a less conservative significance level of 0.05 would identify a significant distinction in the anticipated direction for 1990-2000. The complementary nature of NPGs ensures that they receive a substantial proportion of grants for all sectors. For all cases where the mean share of grants differed by more than 1 per cent, the bilateral donors gave a larger share of grants for IPGs than for NPGs. Only for the environment sector during 1980-89 did the NPG share of grants exceed the IPG share of grants, but the difference was less than 1 per cent. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 110 TABLE 4.5 Mean Share of Grants for IPGs and NPGs Institution Sector Time Period IPGs Mean NPGs Mean Pr>7^ Results Environment 1990-2000 1980-1989 81.92% 85.97% 80.27% 82.92% 0.2933 0.1263 Cannot Reject H0 Cannot Reject H0 Global Health 1990-2000 1980-1989 83.17% 88.73% 83.20% 90.73% 0.9806 0.3147 Cannot Reject H0 Cannot Reject Ho institutions Knowledge 1990-2000 1980-1989 86.73% 89.67% 82.07% 85.25% 0.0037 0.0283 Reject H0 Cannot Reject H„ Governance 1990-2000 1980-1989 83.23% 83.04% 86.22% 85.86% 0.058 0.1567 Cannot Reject H0 Cannot Reject H0 Environment 1990-2000 1980-1989 85.28% 77.77% 81.13% 78.28% 0.0387 0.8055 Cannot Reject H0 Cannot Reject Ho Bilateral Health 1990-2000 1980-1989 99.85% 96.54% 87.33% 85.15% <.0001 <.0001 Reject H0 Reject Ho donors Knowledge 1990-2000 1980-1989 98.03% 95.06% 95.42% 94.71% 0.1902 0.8655 Cannot Reject H0 Cannot Reject H0 Governance 1990-2000 1980-1989 88.49% 70.36% 78.04% 68.34% <.0001 0.326 Reject Ho Cannot Reject Ho Environment 1990-2000 1980-1989 76.50% 77.93% 77.05% 77.58% 0.7042 0.8462 Cannot Reject H0 Cannot Reject Ho Regional Health 1990-2000 1980-1989 79.08% 80.76% 76.91% 75.52% 0.143 0.0041 Cannot Reject Ho Reject Ho institutions Knowledge1 1990-2000 1980-1989 68.52% 69.28% 76.80% 78.67% 0.0209 0.0006 Cannot Reject HQ Reject H0 Governance 1990-2000 1980-1989 75.41% 78.16% 76.36% 76.39% 0.5173 0.3184 Cannot Reject H0 Cannot Reject H „ Notes:1 Indicates that observations not available for all years. 2 The E-value is evaluated at a confidence level of 0.01 for each sector. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. I l l The regional institutions did not make any consistent distinction in their funding policy based on the range of benefit spillovers associated with their foreign assistance of public goods. I cannot reject the null hypothesis for any sector for these donors for 1990-2000. I, however, reject H0for the health and knowledge sector for the earlier period. For the knowledge sector, the grant share for NPGs exceeds that of IPGs, contrary to the desired difference. The regional institutions mainly supported NPGs, and this could provide some justification for loans being utilized to a larger extent than the other donor types. Nevertheless, this focus does not explain why the grant share distinction between IPGs and NPGs do not match standard policy recommendations. 4.6 Policy Implications and Concluding Remarks I Based on CRS data, this paper applies ANOVA tests to ascertain any differences among the mix of grants and loans given by three classes of donors to fund public goods in developing countries. To reflect the benefit share of recipients, this mix should be closely associated with an index of public benefits, which measures the share of international public benefits characterizing aid-funded activities. Those activities with a relatively large share of international benefit spillovers should be funded by a large share of grants; in contrast, activities with more recipient-specific benefits should attract a larger share of loans. This funding policy would serve to reflect recipients’ derived benefits and promote allocative efficiency. After Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 112 establishing that donor classes differ in their mix of grants and loans given to the health, knowledge, and governance sectors, I display the nature of this difference over sectors and time. My analysis indicates that on average bilateral donors increased their share of grants given to all four sectors in recent years. This finding suggests a greater recent awareness by these donors of international benefit spillovers, especially in the environment, health, and governance sectors. In recent years, bilateral donors used a greater share of grants than global and regional institutions to fund key sectors in developing countries. Global institutions gave the second greatest share of grants for aid-supported activities, while regional institutions gave the smallest share of grants. Moreover, the regional institutions applied virtually the same share of grant to all sectors over time. Because supported sectors possess diverse degrees of international public benefits, this bureaucratic policy fails to account for the derived benefits of recipients. For each sector, I then use the data to separate out IPG and NPG components to determine whether the donor types chose a grant-loan combination consistent with the implied public character of the funded activities. I find that the bilateral donors’ combination is the most appropriate, followed by the global institutions. Regional institutions did little to tailor their grant-loan mix to public good considerations, thereby failing to satisfy recipient interests. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 113 My analysis has a couple of important policy implications. In recent years, regional institutions have been clamoring to assume a larger role in disbursing funds to support regional public goods in developing countries (Ferroni, 2002; Ferroni and Mody, 2002; and Sandler, 2004). If regional development banks and related institutions are to be given more funds - say, from the World Bank - to provide such IPGs, then they need to adjust their grant-loan mix to account for the extent of international benefit spillovers. If, as is likely, this mix is institutionally set by the stakeholders and donors, then greater flexibility needs to be given to the regional institutions to adjust this mix to reflect recipient benefit shares. Global institutions also must better tailor their grant-loan mix to capture the division of recipient- specific and international benefits associated with activities that they support. A failure to tailor this mix properly means that these institutions are not truly accounting for the derived benefits of recipients, which surely do not want to be saddled with debts when a large share of derived benefits is international. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 114 Chapter 5: Conclusions The voluminous literature on foreign aid has addressed various aspects of donor interests, recipient needs and good governance.1 To date, the literature on foreign aid has not focused on the underlying publicness associated with giving development assistance to developing and transition countries. This dissertation is therefore, distinct in its attempt to theoretically and empirically analyze the strategic nature of donors’ interactions in committing foreign aid that yields both private benefits to the donor and public benefits to all donors and recipients i.e. foreign aid is a joint- product activity. Using this framework the three essays of my dissertation analyze the behavior of donors committing foreign aid through direct bilateral transfers and through multilateral institutions as well as the appropriate mechanisms for financing the provision of development assistance. Despite several decades of giving assistance, the dissertation finds no evidence of cooperation amongst donors in committing bilateral foreign aid. Some donors make contributions based on bureaucratic behavior, while most donors abide by Nash- Coumot noncooperative behavior. Since cooperative Lindahl behavior is Pareto optimal, the overwhelming support for noncooperative behavior raises the possibility of bilateral foreign aid donations being suboptimally provided. 1 Neumayer (2003a) provides a comprehensive overview o f the literature on foreign aid. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 115 The findings in the first two essays of the dissertation provide ample support for the joint-product representation of foreign aid. The joint-product model out-performs the pure public good model for both bilateral transfers and contributions to multilateral institutions. This indicates that donors’ receive private benefits in addition to the purely public benefits that accrue to all donors and recipient nations. The presence of private benefits for donors’ from giving development assistance mitigates the neutrality effect that characterizes contributions to a pure public good wherein donors’ treat others donations are substitutes for their own (Warr 1983). Despite the noncooperative nature of interactions amongst donors, suboptimality in provision levels need not characterize foreign aid due to the prevalence of donor- specific private benefits. The dissertation also finds evidence of complementarity of donors’ contributions for bilateral transfers and commitments to multilateral agencies. For bilateral transfers the drivers of complementarity are the recipients’ proximity to the donors, the recipients’ past as a former colony and the donor’s magnitude of contributions. For commitments to multilateral agencies complementarity is strongly exhibited for total multilateral contributions and contributions to regional development agencies. For agencies with a more global focus I find some evidence of free riding. Given that the bulk of multilateral assistance flows through global agencies, it is especially Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 116 worrying that some of the large donors treat other donors’ contributions as substitutes for their own donations. Given the strong support for the joint-product representation the next concern is what mechanism (i.e. mix of loans and grants) should be utilized to finance the joint- product activity. Based on the joint-product model, I derive an index that provides a rough rule of thumb measure to determine the optimal combination of loans and grants to finance aid related activities. Utilizing data on foreign aid commitments, the study attempts to find out if the mix of loans and grants for different activities is in accordance with the recipient’s share of the benefits. The lending behavior of three sets of institutions is analyzed— bilateral donors, global agencies and regional institutions. The bilateral donors are found to do the best job of tailoring the mix of loans and grants based on the publicness of the activity being financed. The global agencies are intermediate in their lending policy, while the regional institutions make no attempt to alter the financing mechanism for any type of aid funded activity. This is problematic especially since the regional agencies have been clamoring to play to a larger role in funding aid assisted development. The regional institutions must make an effort to tailor the mix of loans and grants in accordance with the recipient’s share of benefits, otherwise the recipient will be saddled with huge debts when most of the benefits are global. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 117 Overall, the dissertation answers important questions raised by the public nature of development assistance: whether donors cooperate in giving bilateral aid, the strategic nature of donors’ commitments to multilateral institutions and the appropriate mechanisms for financing development assistance based on the publicness of the activity being funded. Analyzing the public nature of foreign aid provides a fertile ground for future research. A single model exploring the effects of bilateral and multilateral assistance as separate joint-product activities might yield interesting insights into how donors concurrently make bilateral aid transfers and support multilateral institutions. Further analysis of the types of international and national public goods and the incentives of different actors to finance these goods is also an area that requires more in-depth study. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 118 References Addison, Tony, Mark McGillivray, and Matthew Odedokun (2004), ‘Donor Funding of Multilateral Aid Agencies: Determining Factors and Revealed Burden Sharing’, The World Economy, 27 (2), February, 173-91. Alesina, Alberto and David Dollar (2000), ‘Who Gives Foreign Aid to Whom and Why?’, Journal o f Economic Growth, 5 (1), 33-63. Arce, Daniel and Todd Sandler (2002), Regional Public Goods: Typologies, Provision, Financing, and Development Assistance, Swedish Ministry for Foreign Affairs, Expert Group on Development Issues (distributed by Almqvist and Wiksell International, Stockholm). Bergstrom, Theodore, Lawrence Blume and Hal Varian (1986), ‘On the Private Provision of Public Goods’, Journal o f Public Economics, 29, 25-49. Carlsson, Jerker (1998), ‘Swedish Aid for Poverty Reduction: A History of Policy and Practice’, Working Paper 107 (Overseas Development Institute, London, in collaboration with the Nordic Africa Institute, Uppsala, Sweden). Cornes, Richard and Todd Sandler (1984), ‘Easy Riders, Joint Production, and Public Goods’, Economic Journal, 94 (3), 580-98. Degnbol-Martinussen, John and Poul Engberg-Pedersen (2003), Aid: Understanding International Development Cooperation, (Zed Books Ltd., New York). Easterly, William (2002), ‘How Did Highly Indebted Poor Countries Become Highly Indebted? Reviewing Two Decades of Debt Relief, World Development, 30 (10), 1677-96, Ferroni, Marco (2002), ‘Regional Public Goods in Official Development Assistance’, in Marco Ferroni and Ashoka Mody (eds.), International Public Goods. Incentives, Measurements and Financing (Kluwer Academic Publishers, Boston), 157-86. Ferroni, Marco and Ashoka Mody (2002), ‘Global Incentives for International Public Goods’, in Marco Ferroni and Ashoka Mody (eds.), International Public Goods: Incentives, Measurements and Financing (Kluwer Academic Publishers, Boston) 1-29. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 119 Greene, William, (1997), Econometric Analysis, (Prentice Hall Inc., New Jersey). Hayashi, Masayoshi (2002), ‘How Do Nations Behave? The Case of National Contributions to Multilateral Foreign Aid’, Unpublished Manuscript, Meiji Gakuin University. Hoaglin, David, Frederick Mosteller and John Tukey (1991), Fundamentals o f Exploratory Analysis o f Variance (John Wiley & Sons, New York). Kanbur, Ravi (2002), TFI’s and IPG’s: Operational Implications for the World Bank’, Paper prepared for G24 Technical Group Meeting, Beirut, March 1-2, 2002 . Kanbur, Ravi, Todd Sandler and Kevin Morrison (1999), The Future o f Development Assistance: Common Pools and International Public Goods (Overseas Development Council, Washington DC). Kaul, Inge, Marc Stern and Isabelle Grunberg, eds. (1999), Global Public Goods: International Cooperation in the 21st Century (Oxford University Press, New York). Kaul, Inge, Pedro Concei<?ao, Katell Le Goulven and Ronald Mendoza, eds. (2003), Providing Global Public Goods. Managing Globalization (Oxford University Press, New York). Kwon, Gi-Heon (1998), ‘Retests on the Theory of Collective Action: The Olson and Zeckhauser Model and its Elaboration’, Economics and Politics, 10(1), 37- 62. MacKinnon, James, Halbert White, and Russell Davidson (1983), ‘Test for Model Specification in the Presence of Alternative Hypothesis: Some Further Results’, Journal o f Econometrics, 21(1), 53-70. McGuire, Martin and Carl Groth (1985), ‘A Method for Identifying the Public Good Allocation Process within a Group’, Quarterly Journal o f Economics, lOO(Supplement), 914-34. McKinlay Robert and Richard Little (1977), ‘A Foreign Policy Model of U.S. Bilateral Aid Allocation’, World Politics, 30 (1), 58-86. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 120 Meltzer, A. H., (2000), ‘Report of the International Financial Institution Advisory Commission’, website http://www.house.gov/jec/imI7meltzer.htm. Milner, Helen (2004), ‘Why Delegate the Allocation of Foreign Aid to Multilateral Organizations? Principal-Agent Problems and Multilateralism’ Unpublished Manuscript, Columbia University. Morrissey, Oliver (2004), ‘Conditionality and Aid Effectiveness Re-evaluated’, The World Economy, 27 (2), 153-71. Neumayer, Eric (2003a), The Pattern o f Aid Giving: The Impact o f Good Governance on Development Assistance (Routledge, London). Neumayer, Eric (2003b), ‘The Determinants of Aid Allocation by Regional Multilateral Development Banks and United Nations Agencies’, International Studies Quarterly, 47 (1), 101-22. North, Douglass (1990), Institutions, Institutional Change and Economic Performance (Cambridge University Press, Cambridge). Odedokun, Matthew (2003), ‘Economics and Politics of Official Loans versus Grants: Panoramic Issues and Empirical Evidence’, WIDER Discussion Paper WPD 2003/2004 (Helsinki UNU/WIDER). Odedokun, Matthew (2004), ‘Multilateral and Bilateral Loans versus Grants: Issues and Evidence’, The World Economy, 27 (2), 239-63. Olson, Mancur (1965), The Logic o f Collective Action, (Harvard University Press, Cambridge, MA). Olson, Mancur and Richard Zeckhauser (1966), ‘An Economic Theory of Alliances’, Review o f Economics and Statistics, 48(3), 266-79. Ratha, Dilip (2001), ‘Complementarity between Multilateral Lending and Private Flows to Developing Countries: Some Empirical Results’, Policy Research Working Paper 2746, World Bank. Rodrik, Dani (1995), ‘Why is there Multilateral Funding?’, Working Paper No. 5160, National Bureau of Economic Research, Inc. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 121 Rowlands, Dane and Ian Ketcheson (2002), ‘Multilateral Aid Coordination by the International Financial Institutions: An Examination of Canadian Development Assistance to Sub-Saharan Africa’ in B. Arvin Mak (ed.) New Perspectives on Foreign Aid and Economic Development (Praeger Publishers, Westport, CT.) 27-55. Sanford, Jonathan (2002), ‘World Bank: IDA Loans or IDA Grants’, World Development, 30 (5), 741-62. Sandler, Todd and James Murdoch (1990), ‘Nash-Cournot or Lindahl Behavior?: An Empirical Test for the Nato Allies’, Quarterly Journal o f Economics, 105(4), 875-94. Sandler, Todd and Keith Hartley (1995), The Economics o f Defense, (Cambridge University Press, Cambridge). Sandler, Todd (1997), Global Challenges: An Approach to Environmental, Political and Economic Problems (Cambridge University Press, Cambridge). Sandler, Todd and Keith Hartley (2001), ‘Economics of Alliances: The Lessons for Collective Action’, Journal o f Economic Literature, 39(3), 869-96. Sandler, Todd (2004), Global Collective Action (Cambridge University Press, Cambridge). Schraeder, Peter, Steven Hook, and Bruce Taylor (1998), ‘Clarifying the Foreign Aid Puzzle: A Comparison of the American, Japanese, French and Swedish Aid Flows’, World Politics, 50 (2), January, 294-323. Seabright, Paul (2002), ‘Conflicts of Objectives and Task Allocation in Aid Agencies’ in Berten Martens, Uwe Mummert, Peter Murrell and Paul Seabright (eds.) The Institutional Economics o f Foreign Aid (Cambridge University Press, New York) 34-68. te Velde, Dirk Willem, Oliver Morrissey and Adrian Hewitt (2002), ‘Allocating Aid to International Public Goods’ Marco Ferroni and Ashoka Mody (eds.), International Public Goods: Incentives, Measurement, and Financing (Kluwer Academic Publishers, Boston) 119-56. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 122 Thompson, Dick (2002), ‘Coordinates 2002: Charting progress against AIDS, TB and Malaria’, (World Health Organization, Geneva), website http://www.who.int/infectious-disease-news/IDdocs/Coordinates22.pdf Warr, Peter (1983), ‘The Private Provision of a Public Good is Independent of the Distribution of Income’, Economic Letters, 13, 207-11. White, Howard and Simon Feeny (2003), ‘An Examination of the Long-Run Trends and Recent Developments in Foreign Aid’, Journal o f Economic Development, 28 (1), June, 113-135. World Bank (2001), Global Development Finance: Building Coalitions fo r Effective Development Finance (World Bank, Washington, DC). Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 123 Appendix Type A PPEN D IX 1 Multilateral institutions classified by geographical operation focus Institutions Global International Development Association (IDA) International Bank for Reconstruction and Development (IBRD) International Finance Corporation (IFC) Multilateral Investment Guarantee Agency (MIGA) International Monetary Fund (IMF) World Trade Organization (WTO) Commission of the European Communities (CEC) United Nations Development Programme (UNDP) United Nations Children’s Fund (UNICEF) United Nations Relief and Works Agency(UNRWA) World Food Programme (WFP) United Nations High Commission on Refugees (UNHCR) United Nations Population Fund (UNFPA) Other UN funds Regional African Development Bank (AfDB) Andean Development Corp. Asian Development Bank (ADB) Caribbean Development Bank (CBD) Central American Bank for Economic Integration (CABEI) Eastern Caribbean Central Bank (ECCB) European Investment Bank (EIB) European Bank for Reconstruction and Development (EBRD) Other Regional Banks_________________________ Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 124 APPENDIX 2 Sector Identifications of IPGs and NPGs Sector International Public Goods (IPGs) National Public Goods (NPGs) Environment • Biosphere Protection • Power generation (non • Bio-diversity renewable and renewable) • Site preservation • Geothermal energy • Environmental Research • Nuclear Power plants • Energy Research • Solar energy • Energy education/ training • Wind power • Environmental education/ • Ocean power training • Biomass • Education and training in • Agricultural policy water supply and sanitation • Agricultural development • Water resource policy • Agricultural land resources • Water resource protection • Agrarian reform • Waste management/ disposal • Agricultural alternative • River development development • Forestry development • Forestry policy • Fishing policy • Fishery development • Environment policy • Flood prevention/ control • Energy policy • Fishery Research • Forestry Research • Forestry education/ training • Fishery education/ training • Fishery services Peacekeeping • Narcotics Control • Elections (Conflict • Nonagricultural alternative • Human Rights prevention and development • Settlement post conflict • Post-conflict peace building • Landmine clearance assistance) • Demobilization • Reconstruction relief • Emergency assistance Governance • Communications • Economic and development (Economic and • Banking and Financial policy/ planning financial capacity Services • Public sector financial building) • Business and other services management • Trade policy and • Government administration administrative management • Strengthening of civil society • Legal and judicial • General government services development • Transport and storage Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 125 Appendix 2 Continued Knowledge • Medical research • Statistical capacity building • Research/ scientific institutions • Technological research and development • Free flow of information • Agricultural research • • Education sector (including primary, secondary and tertiary education) Culture and recreation Health • STD control including • Medical education/ HIV/AIDS training • Health education • Medical services • Infectious disease control • Basic healthcare • Health policy • Basic health infrastructure • Basic nutrition • Health personnel development • Population policy and administrative management • Reproductive health care • Family planning • Personnel development for reproductive health • Water supply and sanitation (large and small systems) • Development food aid Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.

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Creator Mascarenhas, Raechelle (author)

Core Title An empirical analysis of foreign aid and the provision of international public goods

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Degree Doctor of Philosophy

Degree Program Political Economy and Public Policy

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Advisor Sandler, Todd (committee chair), Painter, Gary D. (committee member), Rosendorff, Peter (committee member)

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