Chapter 5: Samaritan’s dilemma, time-inconsistency and foreign aid: a review of theoretical models
The issue of foreign aid as a tool of development has been highly controversial. One view is that foreign aid can play a very important role in spurring development and reducing poverty in poor countries (Stern, 2002; Stiglitz, 2002; Sachs et al., 2004). The second view is that foreign aid has been harmful to poor countries as it reduces their incentives to mobilize their own resources and develop and adopt good policies and institutions and has led to aid-dependency (Bauer, 1972). Aid is largely wasted on unproductive expenditures and at best it has little effect on the economy of recipient countries (Easterly, 2003). The third view is that effectiveness of aid depends on the policy and institutional environment of the recipient countries. It is effective only in countries with good policy and institutional environment (Burnside and Dollar, 2000). Empirical studies provide a mixed evidence with regard to the effectiveness of foreign aid in achieving its stated goals. Some studies find that it has a significant positive effect on the growth of recipient countries with good policy environment (for example, Burnside and Dollar, 2000; Collier and Dollar, 2002). Other studies find that it has an insignificant effect on growth (Boone, 1996; Hansen and Tarp, 2001; Easterly, 2003; Rajan and Subramanian, 2008).
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