Governance Institutions and Outcomes
- New Directions in Modern Economics series
Edited by Mehmet Ugur and David Sunderland
Chapter 7: Taxes, Foreign Aid and Quality of Governance Institutions
José Antonio Alonso, Carlos Garcimartín and Luis Rivas INTRODUCTION Economists have traditionally identified the causes of development in terms of the amount of inputs available and the aggregated level of efficiency. However, a new perspective, unlike this vision but not necessarily incompatible, has emerged in recent decades. This view calls for attention to be paid to the ways in which governance institutions condition development by defining incentives and penalties, shaping social behaviour and articulating collective action. (See for example, Hall and Jones, 1999; Acemoglu et al., 2002; Rodrik et al., 2002; Henisz, 2000; Tavares and Warcziarg, 2001; Varsakelis, 2006.) Once the role of institutions in development is acknowledged, it becomes important to investigate whether aid fosters (or hinders) institutional quality. In this sense, it has been argued that the former can be detrimental to the latter, giving rise to a sort of ‘aid curse’. Although empirical research is scarce in this area, some works have reported a negative impact of aid on institutional quality. Yet, in our opinion, most of these studies suffer from two main shortcomings. On the one hand, a prior investigation of the determinants of institutional quality is usually not implemented and, as a consequence, a serious problem of omitted variables can emerge, leading to biased results. On the other hand, as suggested in the literature on the aid–development nexus, aid may show decreasing returns, but this possibility is rarely taken into account. With the aim of overcoming these shortcomings, we have first analysed the...
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