Collusion Among Interest Groups: Foreign Aid and Rent-Dissipation

This paper develops a game-theoretic model of public policy in a developing country in order to explain a number of empirical regularities. It is shown that under certain circumstances, an increase in government revenue will be completely crowded out by increased rent dissipation, leaving the provision of public goods unaltered. In this model, there are two possible ways in which foreign aid may a®ect the outcome. First, as foreign aid to a large extent can be seen as general budget support, the paper provides an explanation for why increased disbursements do not necessarily lead to higher provision of public goods. Second, the mere fact that the donor is expected to allocate aid according to the recipients' future needs may increase rent dissipation and reduce the number of periods in which e±cient policies can be sustained. ¤I am grateful for many useful discussions and suggestions by Torsten Persson and Peter Norman, and for comments by Henrik Horn, Lars Persson, Peter Svedberg, Lars E.O. Svensson, and participants in seminars at Institute for International Economic Studies. Correspondence to: Jakob Svensson, IIES, Stockholm University, 106 91 Stockholm, Sweden. E-mail: [email protected].