Academic journal article Economic Inquiry

International Charity: For the Poor?

Academic journal article Economic Inquiry

International Charity: For the Poor?

Article excerpt

I INTRODUCTION

Charities transfer billions of dollars annually to help people in other countries survive famines and other hardships due to natural and man-made disasters such as droughts and civil wars. In this article we address the difficulties charities have ensuring the survival of the life-threatened poor overseas without exacerbating income inequality, encouraging free-riding, or undermining recipient countries' incentives to invest in the kinds of public works that could reduce their needs.

International charitable activities are subject to moral hazard, principal-agent, and adverse selection problems due to information asymmetries. Thus too little charity can go to the truly needy and too much to countries that exaggerate their needs and/or shirk. Indeed, the empirical literature is rich with evidence of these effects. For example, Lele and Jain (1991) Ruttan (1993), Kanbur et al. (1994), Maren (1997), and the World Bank (1998) document the disincentive effects of aid. Alesina and Weder (1999) show that more aid goes to countries that are more corrupt. Cashel-Cordo and Craig (1997)provide empirical evidence that the more aid a country receives the less it taxes.

Cashel-Cordo and Craig (1997) found statistically significant evidence of an inverse relationship between the amount of soft aid (grants) received and the amount of tax revenues subsequently collected by recipient governments. In addition to this evidence of shirking, they also found significant evidence of fungibility, in which the recipient government spends released funds on other, nontargeted budget items. Furthermore, they show that donors appear to be complicit in this fungibility. Larger soft aid is associated with higher institutional spending, such as for public administrators' salaries. Inflows of hard aid (loans), targeted explicitly to economic development or public works projects, show up in expanded spending on social services, not expanded investment in public works.

Alesina and Weder (1999) found statistically significant evidence of a positive relationship between the share of aid in a government's budget and corruption. They argued that "high corruption may imply that domestically raised public resources are low and that a higher fraction of public resources are covered by foreign aid" (14). Also, according to Tornell and Lane's (1999) "voracity effect," when power over redistributive mechanisms is highly concentrated, aid encourages shirking by recipient governments. Thus, in this article we model charities that expect recipients to reallocate revenues but not to reduce tax collections or spending on public works.

To formally analyze this international income transfer problem, we apply the mechanism design techniques of Laffont and Tirole (1986) that have proven very useful in the design of domestic income maintenance programs. There is a long tradition of optimal tax/income maintenance program design literature about how aid encourages personal choices that are socially inefficient or self-enriching; see for example Mirlees (1971), Besley and Coate (1992), or Crane (1996). The key issue is that participants may reduce work effort or migrate to qualify for more benefits. The impacts of information asymmetries on domestic program costs and implementation are also well known, as in Besley and Coate (1991, 1995). But with the exception of Besley and Coate (1998), the emphasis in that literature is on the design of domestic policies with respect to the incentives of individuals. In this article, we focus on charity with respect to the incentives of national governments.

Our work on this problem is motivated by the desire to design programs that can address acute life-threatening poverty, defined as the inability to acquire the level of consumption goods necessary for life as in Sen (1985) or Ravaillon (1997). We assume that the charitable objective is that everyone has at least a minimum income. …

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