Equal opportunity and poverty reduction: How should aid be allocated?

• Published date: 01 February 2023
• Author: Patrick Guillaumont,Phu Nguyen‐Van,Thi Kim Cuong Pham,Laurent Wagner
• Date: 01 February 2023
• DOI: http://doi.org/10.1111/rode.12939

REGULAR ARTICLE

Equal opportunity and poverty reduction:

How should aid be allocated?

Patrick Guillaumont

1

| Phu Nguyen-Van

2

|

Thi Kim Cuong Pham

2

| Laurent Wagner

1

1

FERDI, University of Auvergne

63, boulevard François-Mitterand,

Clermont-Ferrand, France

2

EconomiX, CNRS, University of Paris

Nanterre and UPL, Nanterre cedex,

France

Correspondence

Thi Kim Cuong Pham, EconomiX, CNRS,

University of Paris Nanterre and UPL,

200 avenue de la République, F-92001

Nanterre cedex, France.

Email: pham_tkc@parisnanterre.fr

Abstract

This paper analyzes a model of aid allocation equalizing

the opportunity between recipient countries to reach a

common poverty reduction goal. We propose a fair and

efficient aid allocation based on a multicriteria principle.

The model considers structural handicaps in recipient

countries in terms of lack of human capital and eco-

nomic vulnerability, their initial poverty, and the natural

gap between the growth rate required to reach a devel-

opment goal and the observed one. We show that our

proposed aid allocation favors poor and vulnerable

countries with our multicriteria principle. It substan-

tially differs from the observed allocation. Analyses also

shed light on the impact of the donors' aversion to the

low natural growth gap in recipient countries on the

optimal aid allocation and the marginal efficiency of aid.

KEYWORDS

development aid, efficiency, equity, growth deviation, poverty

reduction, vulnerability

JEL CLASSIFICATION

D63, F35, I30, O19

1|INTRODUCTION

Developing countries, particularly the most vulnerable and low-income countries, need foreign

aid to build up favorable conditions to generate economic growth and attain sustainable devel-

opment. One of the most relevant questions concerns the aid allocation and factors determining

Received: 10 February 2021 Revised: 31 January 2022 Accepted: 20 May 2022

DOI: 10.1111/rode.12939

550 © 2022 John Wiley & Sons Ltd. Rev Dev Econ. 2023;27:550–607.wileyonlinelibrary.com/journal/rode

an efficient allocation. Several donors, such as World Bank's International Development Associ-

ation, Asian Development Bank, the European Development Fund, employ performance-based

allocation systems, prioritizing the countries in need and those with absorption capacity.

Several empirical analyses on aid allocation (Easterly, 2007, Easterly & Pfutze, 2008, Knack,

Rogers, & Eubank, 2011, etc.) emphasize two main characteristics in recipient countries: their

need for assistance (low gross domestic product (GDP) per capita, low human development

index (HDI), high child mortality, or post-conflict country), and their ability to use aid effec-

tively (high government effectiveness index, high institutional performance, etc.). Other ana-

lyses underline the link between aid allocation and donors' preferences represented by colonial

ties and language homogeneity between aid organizations and recipients (Berthélemy &

Tichit, 2004; Maiden & Brockway, 2018). Donors' interests (strategic allies, commercial allies)

are potential criteria influencing their decisions. For instance, Couharde, Karanfil, Kilama, and

Omgba (2019) underline the role of oil on bilateral aid policy, while in Nunnenkamp and Öhler

(2011), donor strategic interests are reflected by the recipient's relative importance as a donor's

export market and by the degree of recipient UN voting coincidence with a donor.

From a normative point of view, many issues are under debate regarding the optimal

choice for aid allocation (Collier and Dollar (2001,2002), Wood (2008), Llavador and Roemer

(2001), Cogneau and Naudet (2007), Carter (2014), etc.) For instance, Collier and Dol-

lar (2001,2002) adopt a utilitarian vision by maximizing a social welfare function (the sum

of aid-recipient countries' utilities). A country's utility is measured in terms of the number of

poor people in that country, which is a decreasing aid function. Following Collier and

Dollar (2001,2002), an optimal allocation of aid should maximize the reduction in the

number of the poor in recipient countries. According to the effectiveness principle, the

optimal aid allocation proposed by Collier and Dollar is determined by the initial deprivation

of recipient countries, institutional quality, and policy quality. In other words, compared to

the observed allocation of aid, the Collier and Dollar's allocation gives more aid to the

poorest countries implementing the highest policy quality (high CPIA). Similarly, Wood

(2008) includes an intertemporal aspect in his analysis and considers initial poverty and

future poverty in aid donors' objective function.

This approach of Collier and Dollar is criticized for its lack of consideration for fairness. In

that regard, Llavador and Roemer (2001) propose an alternative way of calculating the optimal

allocation of aid based on the Rawlsian principle. They analyze how aid can be distributed

equalizing growth opportunities between recipient countries. Therefore, aid donors should give

an allocation that compensates countries for bad initial circumstances so that the final differ-

ences in outcomes between countries can be attributed only to differences in their efforts, not to

their initial circumstances.

1

They then propose another method including equal opportunity

but separating effort and circumstances of recipient countries. Their aid allocation shares pov-

erty risk more fairly among the world's population, and their results show that donors should

give more aid to the poorest countries than the observed aid allocation.

More recently, Carter (2014) proposes an aid allocation rule that maximizes recipient coun-

tries' welfare rather than economic growth and considers recipient countries' absorptive capac-

ity (measured by the World Bank's Country Performance Rating). Donors target a range of

development outcomes by putting more weight on aid-funded consumption and less weight on

economic growth. The division of aid between consumption and investment maximizes house-

holds' utility in recipient countries. In this setting, the objective of welfare maximization in

recipient countries may lead to an optimal allocation giving more aid to countries that are least

able to stimulate economic growth.

GUILLAUMONT ET AL.551

The debate on foreign aid allocation in developing countries is still lively today. Our

paper aims to design an efficient and fair distribution of aid based on a multicriteria princi-

ple and within a utilitarian framework where aid donors maximize the sum of recipient

countries' utilities. Our goal is not to dichotomize fairness and efficiency as two different aid

allocation criteria. On the contrary, we show that it is possible to determine a fair allocation,

which is also efficient. The difference between our paper and Collier and Dollar (2001,

2002), Llavador and Roemer (2001), Cogneau and Naudet (2007)stemsfromthreemajor

points.

First, aid policy should address uneven economic conditions between countries and

compensate them with foreign aid. As in McGillivray and Pham (2017) and Guillaumont,

McGillivray, and Wagner (2017), our analysis considers structural growth handicaps

in recipient countries by introducing economic vulnerability and lack of human capital

in the growth equation. We assume that a country with low human capital and a high

economic vulnerability may encounter difficulties in formulating high-quality economic

and social policies, inducing a low possibility of achieving its development goal. It is

therefore fair to consider the lack of human capital and economic vulnerability in recipient

countries.

Second, unlike previous studies, we focus on structural factors, mainly structural economic

vulnerability, as an essential driver of aid effectiveness. Indeed, according to Guillaumont and

Chauvet (2001), aid is growth-enhancing in countries with a high economic vulnerability.

Accounting for economic vulnerability in recipient countries is then compatible with an aid

effectiveness principle.

Third, aid policy should be fair. However, unlike Llavador and Roemer (2001) and Cogneau

and Naudet (2007), which adopt the Rawlsian principle, we propose an alternative way to

model this fairness. We assume that donors are sensitive to the natural growth deviation or gap

in recipient countries. Their goal is to equalize the opportunity between recipient countries to

reach a common poverty reduction goal. To formalize this assumption, we posit the utility of a

country depending on the gap between its current growth rate (depending on received aid and

structural handicaps) and its expected (or targeted) growth rate. The latter represents the

growth rate that a country has to reach if it wants to achieve a specific development goal. There-

fore, an efficient and fair allocation of aid should reduce poverty in recipient countries by con-

sidering the particular conditions (e.g., structural handicaps and poverty rate) and the natural

growth deviation or gap in these countries.

Our optimal aid allocation with poverty reduction objective is then based on a multicriteria

principle that incorporates initial poverty, lack of human capital, economic vulnerability, and

natural growth deviation in recipient countries. Our analysis is implemented in two steps. The

first step corresponds to estimating a growth equation depending on factors such as lack of

human capital, economic vulnerability, and received aid amount. The second step uses the com-

puted growth rates in recipient countries, obtained from the first step, to perform a simulation

exercise showing a substantial difference between the optimal and observed allocation. We also

indicate the meaningful impact of the donors' aversion to low growth deviation or gap in recipi-

ent countries on the optimal aid allocation.

The rest of the paper is structured as follows. Section 2presents the theoretical model.

Section 3reports estimation results concerning the economic growth equation. Section 4dis-

cusses the efficient and fair allocation of aid, as well as the marginal efficiency of aid. Section 5

concludes. Other details are presented in the Appendices A–F.

552 GUILLAUMONT ET AL.