Taxing Fragmented Aid to Improve Aid efficiency

Abstract

We present a model with two donors-principals that provide funds to a unique recipient-agent. Each donor decides how to allocate his aid funds between a pooled and a donor specific unilateral project. Both principals and the agent value the output produced with the principals' pooled and two unilateral funded projects. However the donors have a bias in favor of their own unilateral project, which leads them to over-invest in these projects. The agent establishes a tax on the unilateral projects, which acts as a protection measure against biased allocation by the principals. The optimal tax imposed by the recipient on unilateral projects varies depending on the total amount of aid provided by the donor and on the productivity of his unilateral project. We present empirical support on the donors' preferences for unilateral projects, and how allocations and fragmentation are affected by recipient's characteristics.

Keywords

Aid fragmentation; incentives; multi-principal; Development;

JEL codes

D82: Asymmetric and Private Information • Mechanism Design
D86: Economics of Contract: Theory
F35: Foreign Aid
O19: International Linkages to Development • Role of International Organizations