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We are grateful to Craig Burnside, Guido De Blasio, Ana Paula Fialho Lopes, Paolo Mauro, Gian Maria Milesi-Ferretti, Timothy Lane, Alex Mourmouras, Ashoka Mody, Alessandro Rebucci, Peter Wickham, and Jeromin Zettelmeyer, for useful comments and suggestions.
Berlage et al. (2000) report that 84 percent of the countries with a human development indicator lower than 0.5 belong to the list of high indebted poor countries, (hereinafter referred to as HIPCs).
Of course, there is a large disagreement on how much debt relief is either necessary or desirable. For an estimation of the real amount of debt relief implicit in the HIPC initiative, see Cohen (2000). For a generous plan for completely extinguishing the outstanding debt of 49 poor countries by year 2015, see Berlage et al., (2000).
As common in the recent theoretical literature on aid (see Svensson (2000b), Azam and Laffont (2001), Federico (2001)), we assume that the motivations for aid (debt relief) are fully altruistic. Of course, this is not necessarily (and often has not been) the case. Indeed, foreign aid has often been motivated by political and strategic considerations, as Alesina and Dollar (2000) show. We abstract from this important issue, as our interest is that of addressing the normative question of how conditionality should be designed when the donor community exclusive interest is that of fighting poverty in aid recipient countries.
For example, the recipient government could be subject to the influence of special interest groups opposing socially oriented reforms (see Mayer and Mourmouras, 2002).
Using the taxonomy proposed by Collier (1997), our model is a model of paternalistic conditionality. However, the success of the poverty reduction program depends upon monitorable and nonmonitorable inputs, so that conditionality is necessarily imperfect.
In addition to greatly simplify the analysis, this assumption is quite realistic for the debt relief program under the HIPC initiative. In such case, the amount of debt relief is a function of the existing stock of external debt, and thus, at least in principle, not the outcome of negotiations between donors and recipient governments
The assumption that there is substantial heterogeneity in how HIPCs allocate public resources between military and social expenditures is a very reasonable one. According to World Bank data for 1997, the ratio of health to military expenditure varied from the 0.13 of Vietnam to the 4.3 of Guyana (data are available for 29 HTPCs).
For many aid recipients (such as the HIPCs) such an assumption is hardly a controversial one.
Notice, however, that when ρ→0, and thus when the utility function tends to a Cobb-Douglas,
Notice that this is always the case when
Throughout the analysis we will assume that the donor’s objective is to grant relief to the largest number of countries that “deserve” it, rather than maximize some aggregate welfare function across countries.
In a companion paper, Cordelia and Dell’Ariccia (2001), we show that, because of the distortions associated with incomplete conditionality, under certain conditions donors may obtain better results by providing assistance in the form of direct project financing.