Aid and the Soft Budget Constraint*

This paper applies the theory of the soft budget constraint to explain some stylized facts regarding the outcomes and practice of international aid, including ineffectiveness, white elephants, and volatility. The soft budget constraint can also make aid counterproductive. Nonetheless, actual aid institutions may be constrained optimal responses to soft budgets and commonly suggested reforms such as improved donor coordination, focus on fewer countries and projects, and less volatility may lower the effectiveness of aid. The soft budget is also consistent with conservative project selection and the recent focus on “ownership”.