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FOCUS: Aid Effectiveness

Summer 2012 Stephen Knack

Donors are more likely to use country systems, and untie their aid, where they have a large share of the aid market

Donor organizations recognize that political support for maintaining or increasing levels of aid depends on improving perceptions of its effectiveness. In 2005, in response to concerns about the quality of aid, the Paris Declaration on Aid Effectiveness moved implementation issues to the top of the international aid effectiveness agenda. Donors committed to improving interdonor coordination and to practices more consistent with the principle of country “ownership” of development strategies. But these commitments are justified largely by intuition and anecdotes, not by rigorous and systematic theory and evidence. Two recent papers add to our understanding of donors’ behavior relating to aid practices—and of whether there may be tradeoffs among some of the Paris Declaration’s objectives.

Tying aid to purchases from the donor country is widely believed to reduce its effectiveness. More recently a consensus has also emerged on the importance of reducing aid fragmentation and the transactions costs it imposes on recipient countries. Knack and Smets analyze theoretically and empirically the impact of aid fragmentation on decisions to tie aid to purchases from contractors based in the donor country.

Building on collective action theory, they argue that a donor with a larger share of the aid market in a country has stronger incentives to maximize the development impact of its aid, by tying less of it. In countries with severe corruption problems, however, aid tying can be an efficient response by donors. Empirical tests strongly and consistently support the prediction that higher donor aid shares are associated with less aid tying.

When recipient countries are grouped by their scores on corruption perception indexes, higher shares of aid are significantly related to lower aid tying only in the less corrupt sub-sample. When aid tying is more costly, as proxied by donor country size and income, it is less prevalent. Aid tying is lower in the least developed countries, consistent with the recommendation of the OECD Development Assistance Committee (DAC).

The study reassuringly finds that the Paris Declaration’s objective of untying more aid does not conflict with another of its goals: sharpening donors’ division of labor among recipients. Results instead are consistent with the view that reducing fragmentation—by increasing donors’ share of aid in the countries they assist—enhances their reputational stake in producing favorable development outcomes.

Donors’ reputational stake, as proxied by their share of the aid market in a country, also turns out to matter for another objective: increasing the use of recipient country systems for managing aid. The Paris Declaration urges recipient countries, with technical assistance from donors, to strengthen their public financial management systems. In the meantime, using these systems—despite their flaws—is believed to strengthen them, while bypassing them undermines them by diffusing accountability and fragmenting policy and planning processes.

Where recipient aid management systems are weaker, corruption scandals tarnishing the donor agency’s reputation are more likely to occur, and aid-funded programs are less likely to be selected and implemented more efficiently. These costs are short term and fully internalized by the donor. The benefits of using country systems are mostly external (benefiting other donors) and realized only over the long term. Donors’ use of country systems in the aggregate is therefore likely to be suboptimal. When a donor undertakes any action to strengthen recipient country systems, it is in effect providing a public good for other donors. The benefits are not wholly external,however: when a donor has a larger share of the aid market in a country, it will internalize more of the benefits from any investments in strengthening country systems. A donor’s use of country systems is then expected to be positively related to its share of the aid received by a given country, controlling for quality of recipient systems.

Knack tests this prediction using a panel data set based on three OECD-DAC surveys designed to monitor progress toward Paris Declaration goals. Tests show
that a donor’s use of the recipient country’s systems is positively related to the donor’s share of aid provided to the recipient, perceptions of corruption in the recipient country, and public support for aid in the donor country (a proxy for the donor’s risk tolerance).

Despite pressure from the Paris Declaration campaign, there were no significant increases in the use of country systems in 2005–10. Such increases may depend largely on quality improvements in public financial management systems or on progress in donors’ division of labor by country and sector. Quality improvements often occur only over long periods, however, and concentrating aid in fewer countries and sectors risks reducing a donor’s visibility. But the rate of aid tying has fallen sharply since the OECD-DAC began measuring it.

Stephen Knack. 2012. “When Do Donors Trust Recipient Country Systems?” Policy Research Working Paper 6019, World Bank, Washington, DC.

Stephen Knack and Lodewijk Smets. 2012. “Aid Tying and Donor Fragmentation.” Policy Research Working Paper 5934, World Bank, Washington, DC.Washington, DC.

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