Category Archives: Aid and Development

DID IRAQ CHEAT THE UNITED NATIONS?

DID IRAQ CHEAT THE UNITED NATIONS? UNDERPRICING, BRIBES AND THE OIL FOR FOOD PROGRAM

C.T. Hsieh & E. Moretti

The Quarterly Journal of Economics, Vol. 121, No.4 (2006) pp. 1211-48

Principal Research Question and Key Result Did Iraq cheat the UN oil for food program by setting prices for its oil lower than market value in order that extracted rents could be shared between oil purchasers paying bribes, and the Iraqi government/leadership? The key result is that yeas they did. Around $4.3bn in rents were extracted, and of this they estimate that $1.3bn accrued directly to the Iraqi government. However, this was only 2% of the total value of the programme, so is not actually that bad by international standards.

 

Theory This is not a theoretical paper as such.

In general the mechanism at work is as follows. After the sanctions against Iraq were enforced, the oil for food programme allowed Iraq to sell tis oil provided that the proceeds were used for humanitarian purposes. Iraq could freely choose the buyers of Iraqi oil. They also had some discretion over the selling price of the oil. This incentivized Iraq to underprice its oil relative to the world price, and then share the generated rents with purchasers who would pay bribes to the administration, and receive oil at a lower than market price.

If prices are set endogenously (by Iraq), then they would ideally set the official price at 0, which would allow them to collect 100% of the revenue generated by selling oil at the unofficial price. As it was, they were constrained from doing so because the UN had to agree on the official price, and Iraq would be punished if the UN was reasonably certain that they were setting the official price too low. The probability of detection is assumed to be increasing with the distance between the official prices i.e. f(Pmarket – Pofficial/SD). The price differential is normalized by the standard deviation of prices to capture the idea that it was more difficult for the UN to determine whether the official price was too low in periods of high oil market volatility. Given this constraint, Iraq would set the official price such that the marginal gain from lowering the official price was equal to the marginal increase in detection from doing so. This yields two hypotheses:

  1. Increased volatility in oil prices decreases the official price paid for Iraqi Oil
  2. Cost of detection was probably higher for respected multinational companies than it was for obscure individual trades (who are more willing to pay bribes), thus as the scope for rent extraction increased (with volatility), the make-up of purchasers would shift toward individual traders (although it is still possible that supply was such that only multinational companies were able to absorb Iraq oil output).

 

Motivation The oil for food programme was in terms of $$$ one of the largest humanitarian efforts undertaken in recent history. It is a rough example of conditional assistance (in that the proceeds from oil sales could only be used for humanitarian projects, and prices had to be agreed by the UN). This paper looks at how the designs of such initiatives can create incentives or opportunities for cheating/corruption. In general then, lessons learned from this episode could be used when thinking about how to design interventions. In particular, that there are striking differences between outcomes when the later policy of retroactive pricing was introduced shows how small details of programme design can have large effects on results.
Data  
Strategy Two strategies:

  1. Compare the price official selling price of Iraqi oil to its nearest substitute (Arabian light, and Urals [the Iraq equivalents being Basrah light and Kirkuk respectively]). The show evidence that the price gap between the Iraqi oil and its substitutes averaged 0 in the year pre-programme, and again after retroactive pricing is introduced. The following is estimated relative to the years before the programme (1980-1995) which is the excluded category captured by the constant alpha:

ΔPt = α + β1Program1t +  β3Program2t  + β3Program3t + εt

Where the program variables are periods within the years of the program 1997-99 2000-01, 2002.

  1. 2. Compare the official selling price of Iraqi oil to the eventual spot price (net of transportation costs). The data for this estimation are not as of high a quality due to different sources used, but the estimates are consistent with the story.

 

Results
  • Results of the first model indicate an average difference in price of $2.44 for the whole period, and $2.07 for the 1997-99, $3.91 for 2000-01, and 0.68 for the period after retroactive pricing was introduced (and the coefficient is insignificant). This generated rents between $2.28 and $4.12 bn.
  • Results are similar for the spot rate comparison, although generally less strong and there seems to be a significant effect for Basra Light even after retroactive pricing was introduced which is rather confusing.
  • They examine the relationship between volatility and underpricing in the years before and after retroactive pricing, and find that price differentials are higher in weeks of high volatility in the pre retroactive pricing period, but insignificant afterwards, which adds weight to the story about volatility allowing greater underpricing.
  • There is some suggestive evidence as scope for rent extraction increased there were more individual trader purchases. The correlation is 0.48
  • They cannot say for sure how the rents were shared as between Iraq and the traders, but they estimate that $1.3bn was had by Iraq (for details of the estimation see the paper).

 

Robustness Looking at documentation from the Volcker review of a specific set of 5 trades made, they estimate the gains from rent extraction using their model for the same limited time period and get very similar numbers. The Volcker review was based upon review of the small amount of documentary evidence that exists.

They explore a variety of alternative explanations:

  1. There was a stigma associated with buying Iraqi oil and this lead to lower prices: this is not really feasible, as there is a persistent gap between the official price and the oil’s own spot price in the market (for exactly the same oil). Additionally, there is not likely to have been any major shift in moral perception of Iraq oil in 2001 when the price differential all but disappears.
  2. Decline in Shipping facilities: There is no reason to think that facilities improved drastically post 2001. Additionally, they collected data on waiting times for ships at oil terminals in Iraq and find no significant relationship between the official price and the waiting times.
  3. Decline in quality – again, they are comparing markets for the same oil, so this can’t explain differences in official/spot prices. Also, oil quality can’t have improved dramatically in 2001.
  4. Increased supply: There is no relationship between output and the price differentials, so it is unlikely that lower prices were caused by shifts in output.
  5. Market volatility: underpricing estimates are not changed significantly when controls for volatility are included.
Problems This only looks at one possible source of rent extraction. Iraq could also have been overbilling for humanitarian supplies.

External validity is pretty low as this was a remarkable series of events.

 

Implications Programme design is of great importance. The paper does not show that aid is not effective, indeed the programme was thought to be a success in terms of its humanitarian goals, and as the extracted rents represent only around 2% of the total value of the programme, and this is quite low by other development programme standards. However, there is no guarantee that humanitarian investment would continue after the programme was to end.

 

 

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HOW MUCH IS A SEAT ON THE SECURITY COUNCIL WORTH?

HOW MUCH IS A SEAT ON THE SECURITY COUNCIL WORTH? FOREIGN AID AND BRIBERY AT THE UNITED NATIONS

I. Kuziemko & E. Werker

Journal of Political Economy, Vol. 114, No. 5 (2006) pp.905-30

Principal Research Question and Key Result Does having a temporary seat on the UN Security council increase aid receipts due to vote buying type behaviour? In other words, is aid allocated pursuant to geo-strategic positions? The results indicate that on average non-permanent seat holders receive a 59& increase in total development aid from the US, and 8% increase from the UN itself.
Theory There is good reason to think that aid will not increase to non-permanent seat holders. Firstly, candidates may be seeking the non-financial benefits of the seat (increased geopolitical influence, access to information etc.). Secondly sticks could be used instead of carrots (e.g. Yemen had its aid cut for not supporting Iraq War II). Thirdly nonpermanent members have very little power as the permanent 5 have vetoes, and so it may not be worth actually buying anyone off.

 

However, there are other reasons to think that aid might increase. There are three theorized reasons as to why:

  1. Vote selling
  2. The public eye on the seat holder allows them to raise the profile of their internal needs, and as the west becomes more aware of their internal problems, more aid is given.
  3. A country becoming more integrated into the world economy may improve their chances of being on the council, and the West’s willingness to supply aid and this could be driving the correlation.

 

Motivation If aid is allocated strategically then this may be a partial explanation as to why it is so difficult to quantitatively uncover benefits from aid spending across countries.

 

Data The council had 10 non-permanent members, and every year two new ones join and two leave. There is competition and a beauty parade to get on the council so it is by no means exogenous as to which countries accede to the council seat.

The data they use is limited to developing countries. Aid measures are taken from the USAID figures. ODA data for grants from the UN come from the OECD.

 

Strategy They run a fixed effects model with log(Aid) in country i at time t as the dependent variable, and a dummy for being a security council member on the right, with  controls for whether the country was at war, and the Polity variable of ideology. Additionally they interact the membership dummy with dummies that indicate whether it was an “important” year to be on the security council as measured by the number of mentions the council gets in the NYT (e.g. lead up to Iraq, Falklands, etc. were important). If the ability of a country to get aid, and a seat on the security council is driven by some omitted variable (such as increased economic integration), then there should be no differential effect between being on the council in an important year, as opposed to a non-important year. If the interaction is significant, then it is plausible that the security council effect on aid is causal.

 

Additionally they have time dummies indicating the year before election, the election year, the two years of service, and the two years after service on the council. If aid increased in the year before election, this would undermine the causal story. Similarly if aid remains high after the years of service, then this would indicate that the country in question had permanently raised the awareness of its needs, and this would detract from the vote buying story.

 

Results
  • Overall the coefficient on the membership dummy is 0.47, which translates to a 59% increase in aid from the US. The interaction terms indicate that when it was an unimportant year, the seat holder received essentially no extra aid, but when the council was most newsworthy the interaction becomes significant, and translates into an extra 170% of aid. Adding the political controls does not change this result. This is consistent only with the vote buying story.
  • The year prior to election does not see any increases in aid, but there are significant increases in the year of election, reaching a highly significant figure in the second year of service, that drops off pretty much immediately after service is terminated, indicating that aid increases are intimately tied to council membership. This is consistent with the vote buying story.
  • The results are similar for the UN funding although the magnitudes are smaller (presumably as more people have to approve it).
  • When the split the ODA by UN agency they find that the biggest increases are from UNICEF and the UNDP which are generally thought to be controlled by the US.
Robustness n/a
Problems The conclusions of the paper may be slightly overblown in terms of implication for aid in general. Whilst it may be the case that aid is used strategically in the UN, there is no evidence supplied that this is the case for the entire US aid budget. Additionally, if on average there is an increase of only 8% for ODA supplied by the UN, then there must be a large amount of ODA that is not applied for strategic purposes, and we might then wonder why we can see no cross country effects from this type of assistance.

 

Implications
  • There is support for the US power hypothesis. This indicates that aid is allocated strategically.
  • These results may explain why it is hard to uncover the positive effects of aid in macro studies; because it is being applied not based on either need or effectiveness, but on strategy. In a way, this is a sanguine finding, because it indicates that if aid is actually directed to developmental ends it may have positive effects.

 

 

AID POLICIES AND GROWTH: COMMENT

AID POLICIES AND GROWTH: COMMENT

W. Easterly, R. Levine & D. Roodman

The American Economic Review, Vol. 94, No. 3 (2004) pp. 774-80

In a Nutshell

They reconstruct the Dollar and Burnside data set, but add additional countries for which data are newly available, and extend the analysis to 1997. They otherwise maintain the exact same methodology. The DB results do not hold – the interaction term coefficient changes sign and is insignificant, and this is so for the 2SLS and OLS and the restricted (low income) sample. The results chop and change sign depending upon the specification but are rarely ever significant, showing how fragile the results are on aid effectiveness (perhaps because the aid figures involved are so small relative to other sources of finance).

This paper indicates that we should treat the DB results cautiously. Often the literature around this question is not informed by theory, and there can more plausible specifications than there are data points in the sample.

 

AID POLICIES, AND GROWTH

AID, POLICIES AND GROWTH

C. Burnside & D. Dollar

The American Economic Review, Vol. 90, No.4 (2000) pp. 847-68

Principal Research Question and Key Result  Is aid only effective when it is applied in a good policy environment? They cannot detect a significant effect of aid on growth except when aid is interacted with a good policy variable. Therefore aid is effective conditional on a good policy environment.
Theory Aid is an income transfer, and this transfer may or may not produce growth depending upon whether it is invested or consumed. To the extent that it is invested it will be effective. In turn, the extent to which is invested is dependent upon a good policy environment being in place in the recipient country. 

 

Motivation Aid can be unrestricted, or conditional. In the case of unrestricted aid, governments receive lump sum transfers to use as they please. This is attractive as it preserves the sovereignty of the state, and it is possible that the home government knows best how to direct aid. On the other hand, it may then be used to finance personal consumption by the politicians, and there is likely to be misalignment between the preferences of the donor and the recipient.

Thus conditional transfers may be preferred, where a type of contract is agreed upon between donor and recipient about the use of funds. This has the benefit of aligning preferences and restricting rent seeking (to a degree), but there are enforcement issues as well as issues relating to “ownership” of the aid programme. Additionally, as money is fungible, aid for one project, may then reduce the amount the government has to spend in that area from its own budget, and those freed up funds can then be directed to arms, or other projects that may be unrelated to development.

If it can be shown that aid is only effective in good policy environments, then this suggests that aid should be directed only to those states that have good policies. However, the states that have those policies may not be the neediest, in which case an argument could be made for directing aid to where it is most needed, but attaching conditions that create some incentive to create a good policy environment.

 

Data Panel of 56 countries and 6 four year time periods.

They have data on GDP growth; they include the Sachs/Warner openness dummy (trade policy proxy), inflation (proxy for monetary policy), budget surplus and consumption over GDP (measure of government consumption policy).

The aid data is a novel and welcome improvement to past studies as it includes not only grants, but the grant component of concessionary loans.

 

Strategy  Basic growth equation with time/country fixed effects. The key coefficient is on the (Policy_Index*Aid) interaction.

Initially they interacted each policy variable with aid, but they could not get precisely estimated coefficients (i.e. they were insignificant). So they created a single policy index which measured overall policy. They did so by regressing growth on the policy variables with controls and used the separate coefficients to construct weights for the policies that would be used in the index (the justification being that the coefficients show how important each policy is for growth).

The OLS estimates could be biased due to correlation of aid with the error term. This could be negative if donors respond to negative growth shocks by providing more aid, or positive if donors supply aid strategically, so as countries grow in income (and hence influence) more of an effort to court them is made by the international powers. Hence the also do an IV.

The instrument is based on the notion of “political influence” and is constructed using measures of population, arms imports, Egypt dummy, franc zone dummy and central America dummy. It is quite a weak instrument, although it does just pass the F-test rule of thumb test.

 

Results In the regressions without the interaction term aid never enters significantly in either the OLS or the 2SLS estimations.

The interaction term enters significantly in the OLS regression, but not in the IV regression. They include an interaction between (aid^2*Policy_Index) which enters negatively implying that the impact of aid is a positive function of policy, but a negative function of the amount of aid (diminishing returns).

They run regression with aid a dependent variable in order to see how aid is allocated. They find that smaller and poorer countries get more aid. Egypt gets 2 % of its GDP in extra aid, and the policy index has a positive coefficient, although the magnitude is small and it is not significant.

They also use government consumption as the dependent variable and find that bilateral aid is more closely associated with increased consumption than multilateral aid.

 

Robustness They drop middle income countries (Brazil etc.) and find that both the OLS and 2SLS coefficients are significant on the interaction term of interest. This implies that policy is more important for aid effectiveness in low income countries

 

Problems The good policy definition is pretty restrictive, and may not really capture what is important about the domestic policy environment. For example, free press/separation of powers could be equally important if sections of society/government are able to hold the executive to account for his spending decisions. Additionally, that the individual policy interactions were not reported, and then dropped as they could not be precisely estimated makes me suspicious. That they then composed a policy index using a method that whilst intuitive, was not backed up by any theory, and this was found to get the results they wanted, makes me even more suspicious – it starts to look like data manipulation.

The exclusion restriction almost certainly does not hold. For it to do so, the measure of population and arms (to take but two elements) need have effects on growth only through their effect on aid. This is clearly absurd, as the size of the population, and population growth is a key component of the neoclassical growth model irrespective of aid.

Throughout they treat policy as exogenous, which it very likely is not.

The significance of the results is pretty variable and fragile to the specification. The 2SLQ estimates are only significant for the lower income countries. Whilst this is not necessarily a problem, it indicates that the evidence is not particularly firm – as will be confirmed by Easterly (see later summary).

 

Implications That bilateral which is presumably most closely tied to donor interests, increases government consumption, may be evidence of why aid is typically not found to have desired growth effects in recipient countries.

Given the problems associated with the estimation, it is hard to have a huge amount of faith in the results. In a sense, they are intuitive – if a government has policies conducive to growth and they invest aid pursuant to those policies, then by definition growth will increase. However, the question remains as to how aid should be allocated, need or effectiveness? There may be political constraints that prevent governments from allocating to where aid may be most effective, as those countries may also be wealthier. However allocating on need may be equally difficult if there are no benefits from doing so. Conditions could be used, but these have their own problems as documented elsewhere.

 

 

AID AND DEVELOPMENT

AID AND DEVELOPMENT – GENERAL NOTES 

There are generally thought to be two rationales for the giving of aid:

  1. Fix market failures – such as building institutions, legal systems etc.
  2. Get resources to needy individuals – this may look more like humanitarian relief.

However, the actual resources devoted to aid are tiny when compared with the total amount of resources devoted to development (i.e. government expenditure, personal expenditure etc.). However, it is a very visible political issue and hence there is generally a lot of media/academic attention devoted to whether aid achieves its goals. However, given the small amount of resources that are actually devoted to aid (only 4 countries maintain the UN goal of donating 0.7% GDP), perhaps it is not that surprising that quantitative studies find it difficult to uncover any beneficial impact of aid on growth etc.

Often aid is seen as a political instrument, e.g. rewards for assisting in war on terror, and historically Egypt received lots of funds due to the presence of the US military in that country.  Thus, if aid is a political tool that is directed at strategic interests rather than based on need/effectiveness, then we should not be surprised if it is difficult to uncover meaningful benefits of aid programmes.

The debate is quite high profile. Sachs and his crew argue strongly in favour of aid, whereas Easterly tends to assert that we need to search for mechanisms of improving outcomes rather than just throwing money at the problem. Moyo argues that aid actively harms. It is hard to model a situation where aid is bad as opposed to simply a waste (although it may cause conflict, crowd out local markets, encourage rent seeking and a dependency culture).

What do the data say? Well macro data is hard to analyze as aid is not applied in the same way in different regions, and this heterogeneity leads to difficulties in interpretation. Additionally the debate is rarely theoretically justified. If poverty traps are real, then aid will be useless until it is applied such that capital accumulation can occur at such a level that the trap is broken. Thus is aid is constantly applied to poverty trap countries, the results will always be negative growth until the right level of aid is disbursed. As ever, we do not observe the counterfactual, so even if growth is negative in the presence of aid, it may have been even more negative without it. Detecting results may also be difficult for the reasons noted in the opening paragraphs.

Potentially, micro studies could be of use, but without taking into the general equilibrium effects of aid, results will likely be of limited use due to poor external validity.