Should aid be allocated according to need or governance capacity?

UNU-WIDER / Oct 2012

The donor community is becoming increasingly focused on two goals; increasing aid supply and improving aid effectiveness. These two goals are clearly interdependent as in order for aid to be increased both politicians and the public must be convinced that it is being used effectively. Despite this glaring fact there is little literature on the topic. In the WIDER Working Paper 'Does Aid Availability Affect Effectiveness in Reducing Poverty' François Bourguignon and Jean-Philippe Platteau set out to address part of this gap by looking at how aid supply can affect aid effectiveness.

Three Approaches

It is important to begin by discussing why the level of aid supply is likely to have an impact on how effectively aid is used. One reason is that aid is thought to be subject to the law of diminishing returns. The first million dollars of aid is likely to be more effective than the second million as countries give priority to the areas where aid is most needed. Furthermore, an increase in aid supply, and consequently the number of recipients a donor has, will have an effect on the overall effectiveness of development aid as each country's ability to use aid effectively will differ.

It is this second causal relationship between aid supply and effectiveness which Bourguignon and Platteau focus on. They point out that the fact that those countries which are most in need of aid are often those with the worst governance levels. This puts donors in a catch-22 situation. Should they give aid to those most in need who may not use it effectively, or to those most able to use it effectively, who do not have the same level of need? Faced with this trade-off there are three different models of aid allocation Bourguignon and Platteau argue donors could adopt when deciding how to spend additional aid. Each of the models is likely to lead to a different relationship between aid supply and aid effectiveness.

1. Donors could adopt a needs-based approach where those countries with the highest levels of poverty are the focus of aid. Bourguignon and Platteau point out that there is a limit to how much aid a country can absorb and as aid levels increase this limit could be reached quickly. If this happens then the additional aid would go to the country next in line in terms of need which would, in theory, would have better governance, and thus make more effective use of the aid. If this pattern holds, then we would expect that the needs-based approach would generally lead to more aid being more effective, as countries with better governance start to be included in the aid programme when its volume expands.

2. Donors could focus on the governance factor instead and distribute aid primarily to those countries with the best governance records. Bourguignon and Platteau suggest that if aid supply continued to be expanded, there would come a point where the countries with better governance, but relatively less need, could not make use of the additional aid. In this case development assistance would necessarily expand to include countries with worse governance records. Consequently an increase in aid supply would lead to a decrease in overall aid effectiveness as more of the aid budget would be directed to countries less able to use it effectively.

Bourguignon and Platteau suggest that both of these approaches have problems, need and governance are both important considerations when thinking about aid allocation, and excluding one of these criteria as a consideration for disbursement completely is unlikely to result in the best possible outcome. The third possible approach involves accepting that there must be a trade-off between need and governance. However, without a formal rule for how this trade-off should be managed, it is very difficult to predict how it will affect the relationship between aid supply and aid effectiveness. It is this problem which Bourguignon and Platteau move on to address.

The Trade-off Approach and the Relationship between Aid Supply and Aid Effectiveness

To get a better understanding of how the trade-off approach would function Bourguignon and Platteau look to their previous work in which they elucidated a 'needs-adjusted aid ineffectiveness measure'. According to this measure aid is at its most ineffective when it is provided to the extremes; a country that barely needs it with good governance record, or a country that has high level of need but cannot properly direct the money towards the worst off.

If donors chose to follow this rule they would then distribute their aid disbursements in such a way as to minimize the 'needs-adjusted aid ineffectiveness'. Increases in aid budgets would also be distributed according to this measure, however the effect such an aid increase would have on aid effectiveness depends, at least in part, on the extent to which the donor country is able to use aid as a disciplining tool to encourage better governance in the recipient country.

Aid as an Incentive for Better Governance

Bourguignon and Platteau point out that if the donor can have no influence on domestic governance then the relationship between aid supply and aid effectiveness is quite easy to project. For example, if there is a strong negative correlation between needs – i.e. low income level -  and governance, donors who disburse smaller amounts of aid will tend to focus on richer countries where the effectiveness of the aid will tend be higher. However, if development aid funds increase, they are likely to introduce more inclusive aid disbursements policies due to the fact that at some point the income of the richer country will reach a level at which giving further aid becomes deeply ineffective.

However it is more realistic to expect that by using aid as a disciplining tool donors can have, at least some, influence on domestic policy. In this case poorer countries are likely to receive a  higher share of total aid than they would otherwise. But the same pattern holds true if  aid increases, because aid to poorer countries is then likely to increase. The first effect follows from the fact that  disciplining can be used as a tool to encourage better governance, and as such can reduce the negative impact on aid effectiveness caused by weak governance.

It seems then that, in general, a trade-off approach to aid distribution would mean that as aid increases, more aid will flow to poorer countries. This leads to the result that aid effectiveness, as defined by how much aid gets through to the intended recipients, may decrease as aid supply increases. However, Bourguignon and Platteau point out that the trade-off approach specifically denies that aid effectiveness is the only thing that matters. What really matters is not only how much aid gets through to the intended recipients, but also the extent to which the intended recipients are in need of aid, and this is precisely what the needs-adjusted aid ineffectiveness measure seeks to assess.

The authors further underline that their work shows that aid coordination is particularly important in ensuring that the positive inclusive effects of higher aid budgets materialize. If there is a large number of independent donors, making separate decisions about how they disburse their aid, then the shift towards more inclusive policies as aid budgets grow is less likely to occur. Furthermore a lack of communication amongst donors is also partly responsible for the phenomena of aid-orphans and aid-darlings. Donor coordination can also lead to efficiency savings in terms of the cost of monitoring and sanctioning recipient countries.

This report by James Stewart summarizes UNU-WIDER working paper no. 2012/54, 'Does Aid Availability Affect Effectiveness in Reducing Poverty?', by François Bourguignon and Jean-Philippe Platteau.

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