Why has Foreign Aid Been Untied?

The more cynical among us have sometimes thought that rather than recipient welfare the purpose of “foreign” aid is to provide a cover for domestic aid. Foreign aid pork, i.e. using foreign aid to subsidize special interests in the donor country has certainly been common. Historically, most foreign aid has been tied; that is, the recipient was required to spend the money on the donor country’s exports. Relative to cash, tying raises prices and reduces choice and recipient welfare–the deadweight loss of Christmas problem.

US food aid is a classic example. US food aid tends to peak after a glut. It’s cheaper for us to give food away when we have lots and not coincidentally giving food away after a glut helps to keep prices higher, benefiting US farmers. It’s precisely when food is plenty, however, that prices are low and aid is less needed. When food is scarce, prices are high and aid is more needed but then we would rather sell our food than give it away. In addition, we typically require food aid to be transported on US ships which raises costs. Finally, the food we give away is not always best suited to the recipient’s preferences or needs.

For a public choice theorist the fact that foreign aid benefits domestic special interests is not at all surprising. What is surprising is that tied aid is way down. Great Britain banned most tied aid in 2002 and indeed tied aid is down across all of the major OECD donor countries. Food aid and technical assistance are still tied but these aid categories are down and untied grants and loans are up. In 1984-1986, for example, about 60% of aid was tied and today only 10-25% of aid is tied (depending on source).

Why has aid become untied? Could this be a case of improved public policy due to lobbying from the aid industry? It is interesting to note that although tied aid is down in the US, the US continues to tie a lot of aid, considerably more than the Europeans. One explanation may be that the decentralized US political system gives more weight to local domestic interests so tied aid continues to sell here despite opposition from most aid groups.

Special interests are also not the only explanation for tied aid. Tied aid can reduce corruption in the recipient country. If donors have become less worried about corruption, perhaps because governance has improved in the developing world, this could offer a public interest explain for an increase in untied aid.

Overall, I find it puzzling that foreign aid has become untied as the major beneficiaries appear to be poor foreigners with little political power.


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