Does Institutional Quality Determine Aid Allocation?

Abstract: This thesis seeks to address the allocation of development aid in relation to institutional quality of recipient countries by focusing on General Budget Support (GBS) – an aid modality associated with increased aid effectiveness and un-earmarked funds to recipient governments that display high institutional quality, but also with risks of moral hazard. The thesis departs from a theoretical framework based on previous research concerned with aid allocation and an on-going debate on aid effectiveness taking place within main donor organizations. On the one hand, aid effectiveness could theoretically be enhanced when aid is allocated in the form of un-earmarked funds, allowing for recipient governments to pursue their own policies and decrease the transaction costs often associated with aid. On the other hand, previous research indicates that donors may allocate aid based on strategic self-interest rather than altruism and the performance of recipients, and associates aid-inflows with risks in the form of moral hazard and misuse of funds. In relation to GBS, these two theoretical strands can be seen as somewhat conflicting. Is GBS only allocated to recipients with high institutional quality, as often claimed by donors? Similar to other sources cited in this thesis, a quantitative, cross-country approach is adopted. Departing from a dependent variable measuring GBS provided by the European Union within the framework of the Cotonou Agreement, OLS regressions are used. Three features of institutional quality are used as independent variables. The results obtained do not indicate that the institutional quality of recipients determines the allocation of GBS.