DP13163 Should a Poverty-Averse Donor Always Increase the Share of Governance-Improving Countries?
In this paper we revisit the problem of inter-country aid allocation with a single donor and two recipient countries. The donor has a given amount of aid to distribute and is sensitive to both needs and governance considerations. Conventional wisdom, as articulated in a well-known paper of Collier and Dollar (2002), holds that when a country improves its governance, it should receive more aid for a given level of poverty. We challenge this view by showing that this conclusion is not necessarily warranted. If the donor has strong enough aversion to poverty, the aid share of a country whose governance has improved will be reduced, thereby punishing instead of rewarding that country for its better institutional environment. Yet, the aid that reaches the poor will have risen. In this framework, the allocation rules actually used by important international organizations appear as implicitly based on a preference pattern that privileges governance over need considerations.