Dynamic aid allocation

Abstract

This paper introduces a framework for studying the optimal dynamic allocation of foreign aid among multiple recipients. We pose the problem as one of weighted global welfare maximization. A donor in the North chooses an optimal path for international transfers, anticipating that consumption and investment decisions will be made by optimizing households in the South, and accounting for limits in the extent to which recipients can effectively absorb aid. We present quantitative results on optimal aid policy by applying our approach to a neoclassical growth model, where the scope for aid-funded growth is determined by the recipients' distance from steady-state.

Virtuous Circles and the Case for Aid

“…But a formal analysis calls this belief into question: in the neoclassical growth model, an amplification effect 21 Gimbel (1976) discusses the wide range of objectives that have been attributed to the Marshall Plan. 22 For an informal discussion of this role for aid, see Rogerson (2011).…”

“…In the next section, we will examine whether the result can be overturned by a model with a medium-run poverty trap. Our calibration draws on Carter, Postel-Vinay and Temple (2015), including the choices of the structural parameters. We adopt isoelastic utility with σ = 2 and set ρ = 0.03, δ = 0.06.…”

“…We study this using Hicksian equivalent variation (HEV) as in Gourinchas and Jeanne (2006) and Carter, Postel-Vinay and Temple (2015). This allows us to compare lifetime utility with aid to the lifetime utility that would obtain under a zero-aid baseline scenario.…”

“…If aid sparks a moribund economy into life, the comparison between the growth path and the no-aid benchmark might be more favourable to aid. 22 Hence, a more ambitious theoretical project would consider alternative models in which aid is a catalyst for growth. There are many models of multiple equilibria and poverty traps, and some of these suggest a case for a 'Big Push' based on high aid flows; but there are fewer models in which relatively modest aid flows can prompt a growth take-off.…”

Determinants of China's and Japan's Foreign Aid Allocations in Africa

“…The flow of FDI into African countries, however, is not sufficient to fulfil this function. Instead of FDI, foreign aid is well positioned to provide resources necessary to propel economic development in the continent (Carter et al, ). Secondly, some capital goods are needed to ensure a smooth process of economic development and foreign aid enables African countries to purchase these capital goods.…”