The Economics of Effective Budget Support

Over the last years, a strong consensus has emerged among development researchers and practitioners alike that in order to reach the ambitious development goals set out in the Millennium Declaration, the effectiveness of external support to developing countries needs to be improved substantially. Among practitioners in international aid, there is a similarly strong consensus (mostly shared by donors and recipients) that Programme-based Approaches (PBAs), in particular in the form of General Budget Support (GBS), currently represent the most promising avenue to make aid a more effective tool to promote poverty reduction and reach the Millennium Development Goals (MDGs) in developing countries. This consensus, however, sometimes seems to be primarily based on plausible criticisms of the traditional project-based approach to aid (locally confined impact, high transaction costs, following donor priorities, lack of government ownership, little impact on structural problems, undermining recipients’ own administrative and political capacities). Conversely, there is relatively scarce work aimed at establishing a sound theoretical foundation to the underlying hypothesis that aid in the form of budget support (through financing, policy dialogue, and accompanying technical assistance) can effectively contribute directly or indirectly to poverty reduction and economic growth in recipient countries.

Although not always made explicit, this hypothesis is primarily based on two important assumptions:

- That sustainable development processes can be induced and/or supported by means of well targeted and sufficient public spending

- That institutions play a key role for development, mainly in two aspects: First, as they determine the environment within which private actors engage in economic activities and thus the prospects for private sector led development. Second, good institutions are thought to lead to good policy choices not least with regard to public expenditure and appropriate allocation decisions.

There is a considerable amount of evidence and, thus, little controversy with regard to the important role of effective and transparent public sector institutions as a key environment variable for private sector development and the efficiency of public spending. Conversely, knowledge about the effectiveness of public spending, i.e. what makes public expenditure pro-poor and/or pro-growth is much more limited. Thus, the international discussion on budget support often moves little beyond the common assumption that increased funding of essential social services reduces poverty.

The proposed research aims at contributing to fill this gap by mainly recurring to models from several branches of economic theory and – where necessary – adapting them to questions related to the effectiveness of budget support as an aid instrument.

This project forms the first phase of a larger research program aimed at formulating success criteria for budget support as an effective aid instrument. To achieve this, it is intended in a first step to draw on several branches of economic theory (in particular growth theory and public finance) to establish a more solid theoretical foundation to the ongoing debate on budget support and other forms of programme-based approaches (PBAs) as an effective aid modality.

Based on these findings, in a second phase an attempt shall be undertaken to further develop existing models of the political economy of aid provision as well as allocation decisions taken by governments receiving budget support. The aim is to derive theoretically well-founded insights into influencing factors determining the success of budget support operations. Where possible, the relevance of the factors identified will be substantiated through empirical testing. From this, conclusions are to be drawn concerning the appropriate design of budget support operations with regard to appropriate financial resources, the design and content of the policy dialogue, conditionalities, country selectivity, etc.