The Political Economy of Multilateral Aid Funds

23 Pages Posted: 9 May 2016

See all articles by Jenny Simon

Jenny Simon

Stockholm Institute of Transition Economics

Justin Valasek

Norwegian School of Economics (NHH)

Date Written: April 19, 2016

Abstract

In 2014 over $60 billion was mobilized to help developing nations mitigate climate change, an amount equivalent to the GDP of Kenya. Interestingly, breaking from the traditional model of bilateral aid, donor countries distributed nearly fifty percent of their aid through multilateral aid funds (OECD, 2015). In this paper, we show that by delegating aid spending to an international fund, donor countries mitigate a “hold-up” problem that occurs when donor countries are tempted to allocate aid based on, say, a regional preference. That is, under bilateral aid, donor country bias decreases the incentive of recipient countries to invest in measures such as good governance that increase the effectiveness of aid. By delegating allocation decisions to a fund, however, donor countries commit to allocating aid via centralized bargaining, which provides recipient countries with an increased incentive to invest. Additionally, we show that allocating funding by majority rule further increases recipient-country investment, since higher investment increases the probability that a recipient's project will be selected by the endogenous majority coalition, and detail conditions under which majority is the optimal voting rule.

Keywords: aid policy, climate change, international organizations

JEL Classification: F350, O190, H870

Suggested Citation

Simon, Jenny and Valasek, Justin, The Political Economy of Multilateral Aid Funds (April 19, 2016). CESifo Working Paper Series No. 5857, Available at SSRN: https://ssrn.com/abstract=2777431 or http://dx.doi.org/10.2139/ssrn.2777431

Jenny Simon

Stockholm Institute of Transition Economics ( email )

Sveavägen 65
Stockholm, 11383
Sweden

HOME PAGE: http://www.jennysimon.net

Justin Valasek (Contact Author)

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen, NO-5045
Norway

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