This study tests two opposing hypotheses about the impact of aid fragmentation on the practice of aid tying. In one, when a small number of donors dominate the aid market in a country, they may exploit their monopoly power by tying more aid to purchases from contractors based in their own countries. Alternatively, when donors have a larger share of the aid market, they may have stronger incentives to maximize the development impact of their aid by tying less of it. Empirical tests strongly and consistently support the latter hypothesis. The key finding -- that higher donor aid shares are associated with less aid tying -- is robust to recipient controls, donor fixed effects and instrumental variables estimation. 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. This finding is consistent with the argument that aid tying can be an efficient response by donors when losses from corruption may rival or exceed losses from tying aid. 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 OECD Development Assistance Committee's recommendation to its members.
A consensus in the international aid community holds that tying aid to purchases from the donor country reduces its e ectiveness. More recently a consensus has also emerged on the importance of reducing aid fragmentation and the transactions costs it imposes on recipient countries. This study explores possible trade-o s and complementarities between these two objectives. We test two opposing hypotheses about the relationship between aid fragmentation and aid tying. Some observers caution that reducing aid fragmentation can reduce the bargaining power of a recipient country government relative to that of its remaining donors. If reducing the number of donors implies they have more monopoly power, donors may exploit this increased power by tying more of their aid to purchases from contractors based in their own countries.1 An opposing view stresses the bene ts from concentrating aid among fewer donors: responsibility for development outcomes is less di used, and donors are less likely to indulge in practices that undermine aid's e ectiveness.
A donor with a larger share of the aid market in a country has a stronger incentive to maximize the development impact of its aid instead of pursuing commercial or other non-development objectives. Thus, more concentrated aid should be associated with less tying of aid.
Our empirical tests strongly and consistently support the second of these two arguments. Untying aid and reducing fragmentation turn out to be complementary rather than conicting objectives. Higher donor aid shares, and lower values on fragmentation indexes, are associated with lower rates of aid tying. These ndings are robust to recipient controls, donor xed e ects, and to instrumental variables estimation.
When recipient countries are grouped by their scores on corruption perception indexes, donors with higher aid shares are found to tie signi cantly less aid only in the less-corrupt sub-sample. This nding is consistent with the argument that aid tying can be an e cient response by donors where losses from corruption may rival or exceed losses from tying aid.
Where aid tying is more costly, as proxied by donor country size and income, it isless prevalent. Furthermore, we nd aid tying is lower in the Least Developed Countries,consistent with the OECD-DAC's recommendation to its members on aid tying.
The remainder of the paper is organized as follows. Section 2 reviews the relevant literature on aid tying and on donor fragmentation, from aid scholars and aid organizations (most notably the OECD-DAC). In section 3 we present a simple model of donor behavior, similar to common pool resource models of voluntary collective action, that predicts larger aid shares (and lower fragmentation index values) will be associated with less aid tying.
The model also generates the trivial but testable prediction that aid tying will be inversely related to its costs. A straightforward extension of the model generate the prediction that donor aid shares will be more weakly (or even positively) related to aid tying if corruption is a su ciently severe problem in recipient governments. The data are described and empirical ndings presented in section 4, including results from both OLS and IV estimation and various robustness tests. Section 5 concludes.
Author:Knack, Stephen ; Smets, Lodewijk; Document Date: 2012/01/01. Document Type: Policy Research Working Paper.Report Number: WPS5934.