30 June 2021

Do elites capture foreign aid?

Niels Johannesen and co-authors publish in Journal of Political Economy

The research paper documents that aid disbursements to highly aid-dependent countries coincide with sharp increases in bank deposits in offshore financial centers known for bank secrecy and private wealth management. The implied leakage rate is around 7.5 percent at the sample mean and tends to increase with the ratio of aid to GDP. The findings are consistent with aid capture in the most aid-dependent countries.

The effectiveness of foreign aid remains controversial. A concern often voiced by skeptics is that aid may be captured by economic and political elites. The fact that many of the countries that receive foreign aid have high levels of corruption invokes fears that aid flows end up in the pockets of the ruling politicians and their cronies. This would be consistent with economic theories of rent seeking in the presence of aid and resonate with colorful anecdotal evidence about failed development projects and self-interested elites. Yet, there is little systematic evidence on diversion of aid.

In this paper, Niels Johannesen and co-authors (Jørgen Juel Andersen (BI Norwegian Business School) and Bob Rijkers (The World Bank) study aid diversion by combining quarterly information on aid disbursements from the World Bank (WB) and foreign deposits from the Bank for International Settlements (BIS). The former dataset covers all disbursements made by the World Bank to finance development projects and provide general budget support in its client countries. The latter dataset covers foreign-owned deposits in all significant financial centers, both havens whose legal framework emphasizes secrecy and asset protection and non-havens.

Equipped with this dataset, they study whether aid disbursements trigger money flows to foreign bank accounts. In their main sample comprising the 22 most aid-dependent countries in the world, they document that disbursements of aid coincide, in the same quarter, with significant increases in the value of bank deposits in havens. Specifically, in a quarter where a country receives aid equivalent to 1% of GDP, its deposits in havens increase by 3.4% relative to a country receiving no aid; by contrast, there is no increase in deposits held in non-havens. While other interpretations are possible, these findings are suggestive of aid diversion to private accounts in havens.

You can read more in the working paper “Elite Capture of Foreign Aid: Evidence from Off-shore Bank Accounts” here