How Donor Corruption Affects Responses to Recipient Corruption in Foreign Aid Allocation

Corruption and Bilateral Aid: A Dyadic Approach
Author(s): Carl Jan Willem Schudel

Source: The Journal of Conflict Resolution, Vol. 52, No. 4 (Aug., 2008), pp. 507-526
Published by: Sage Publications, Inc.
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Journal of ConflictResolution
Volume 52 Number 4
August 2008 507-526
? 2008 Sage Publications
Corruption and Bilateral Aid

10.1177/0022002708316646
http://jcr.sagepub.com
hosted at
A Dyadic Approach ne. sagepub .com
http://onli
Carl JanWillem Schudel

Department of Government
University ofEssex, United Kingdom
Corruption in developing states reduces the effectiveness of foreign aid that is allo
cated to them, because government officials in corrupt countries use this money for
private rather than public purposes. Despite this, existing studies do not find different
aid policies from donor governments toward corrupt and less corrupt recipients. How
ever, most of these studies have not taken account of variation among donor states.
This is an important omission, because donor states behave differently. This article
argues that the responsiveness states to corruption
of donor in recipient states depends
on their own level
of corruption: less corrupt donor states allocate more aid to less
corrupt recipient states than to corrupt recipients, whereas corrupt donor states do not
make such a clear distinction. This proposition is tested by both pooled ordinary least
squares and fixed effects estimations. The data support the argument that corruption
levels in donor states determine their reaction to corruption in recipient states.
Keywords: corruption; foreign aid; OECD countries; dyadic relationships
1. Introduction
Corruption is a widespread problem inmany countries throughout theworld, as

it slows down economic growth and development. Corrupt practices, such as brib
ery, favors for favors, and are costly to companies and thereby reduce
nepotism,
chances for corrupt states to attract necessary amounts of foreign This can
capital.
have severe consequences for both and in these states.
production employment
Therefore, it is legitimate to say that corrupt behavior of governments creates one
of the most important obstacles to economic development.
Corruption in developing statesmay also reduce the effectiveness and efficiency

of foreign aid. Yet, even thoughpractically all aid donor countries claim to give aid
to foster in developing countries,1 itmust come as a that economic
growth surprise
assistance through the allocation of bilateral foreign aid is not restricted to develop
ing countries that are not corrupt. Perhaps
even more remarkable is that despite the
Author's Note: The author is very grateful to Thomas Plumper and Vera E. Troeger for comments and
to Eric Neumayer for help with the data. The data set as well as a codebook and Stata do-file are avail
able for replication at http://jcr.sagepub.com/.
507

508 Journal of Conflict Resolution
fact that virtually all donor countries have introduced criteria as

"good governance"
for aid allocation in recent years, many countries with a
guidelines corrupt reputation
still seem to attractconsiderable sums of aid (see, e.g., Neumayer 2003; Hout 2004;
Br?utigam and Knack 2004). This raises the question of towhat extent corruption in
states matters to donor states.
recipient
This article argues that in a bilateral (donor-recipient) aid relationship, the respon
siveness of a donor state to corruption in a recipient state depends
on the level of
corruption in the donor state itself.Governments of donor stateswith a low level of

corruption allocate less aid to corrupt recipients than to better performing countries,
whereas more corrupt donor governments do not make such a distinction.
Less corrupt donor governments dislike the prevalence of corruption in recipient

countries, because they respect the interests of the electorate in their own country
and thus use aid to foster the economic development of poor countries. As corrup
tion economic a donor allocates less aid to
impedes growth, responsive government
corrupt Donor governments with a high level of however,
recipients. corruption,
are predominantly interested in private gains rather than in the desires of the popu
lation and are thus less inclined to answer to the demands of the electorate (Shleifer
and Vishny 1993; Warren 2004). Consequently, corrupt donors do not so much
allocate aid for developmental reasons but more so to serve more
strategic (e.g.,
political and/or economic) goals.
This article contributes to the rapidly growing literatureon the economic effects of
corruption.Most published research has found that contrary to the claims of most
donor governments, the existence of corruption in recipient states does not significantly
reduce aid flows to them. Poor countries with bad governance records still receive a
large share of theirgross domestic product (GDP) as foreignaid (Br?utigam and Knack
2004). Moreover, existing studies show no significantrelationshipbetween corruption
in recipient states and the allocation of aid to these states (Svensson 2000; Burnside
and Dollar 2000). In fact, corrupt recipients sometimes receivemore aid than their less
corrupt counterparts (Alesina andWeder 2002). A recent study into the determinants
of bilateral aid allocation has not even included corruptionas an independentvariable
anymore,because ithad been shown to have no effect (Berthel?my 2006).2
Nevertheless, these studies share a omission. None of the research on
potential
this topic so far has taken account of the level of corruption in donor countries.
This is an important issue, because these studies find evidence that the determinants
of aid allocation vary among donors. Also, recent research has identified the salient
effects of political institutions on aid transfers (Bueno de Mesquita and Smith
2007). This study relates the apparent heterogeneity to a structuralcause to explain
the allocation behavior of donor governments.
To test this argument a three-dimensional cross-sectional time series
empirically,
(or panel) data set (donor state x recipient statex year) has been developed. Drawing
on the existing literatureand in consideration of the nature of the data, both pooled
ordinary least squares (OLS) and fixed effectsOLS estimations are used.

Schudel /Corruption and Bilateral Aid 509
The results largely support the argument. Less corrupt donor states allocate less
bilateral aid to corrupt recipient countries than to recipients that are not corrupt.
Donors with a higher level of corruption do not allocate significantlymore or less
aid to corrupt than to less corrupt ones.
recipients
These findings contribute to the existing literature to the extent that they do not
only identify the existence of differences between the aid allocation behavior of
various donor states but also because offer an for these differ
they explanation
ences. on in donor states, this article the of
Focusing corruption expands scope
studies that exclusively focus on of recipient states.
existing properties
2. Corruption and Bilateral Aid: A Theory
The central argument of this article is that the level of corruption in donor coun
tries determines their responsiveness to in recipient countries with
corruption
respect to the allocation of bilateral aid. In a dyadic rela
foreign donor-recipient
tionship of bilateral aid allocation, a high level of corruption in a recipient state
results in less bilateral aid transfer from donors with a low level of corruption,
while donor governments with a relatively high level of corruption do not respond
to the level of recipient corruption. Similarly, better performance with respect to
fighting corruption on the side of the recipient state is "rewarded" by less corrupt
donor states but not necessarily more donors.
by corrupt
Corruption and Donor State Interests
Governments in industrialized donor states claim to use bilateral aid allocation to

promote economic development in less wealthy countries.3 The existence of corrup
tion in developing statesundermines economic growth (Mauro 1995), as corrupt gov
ernments are interested in private rather than in supporting the
predominantly gains
development of theircountries as a whole (Shleifer and Vishny 1993; Bardhan 1997).
Corruption in recipient governments results in the extraction of capital from the
economy to the private sphere of government officials. Bilateral foreign aid is noth
ingmore than an influxof capital in the economy of recipient states, and it often is
fungible (Goldsmith 2001). It can thus be expected that aid policy also is affected
by the emergence of corruption. A corrupt recipient government ismore likely to
abuse aid for its private benefit, and by consequence, the general population in
these states receives a smaller share of the received funds. of
relatively Examples
this behavior are numerous ifwe consider themillions of dollars transferredby
officials in some developing countries every year to bank accounts in tax havens.
Corruption in recipient states thus results in a less efficient use of foreign aid
from the perspective of the donor state,which intends to support the development
of the country as a whole. It works the interests of the donor
against population,

which expects that its taxmoney (bymeans of aid) is spent to serve the benefit of
the general population in the recipient state rather than to enrich some officials in
its government. The result of this is that governments in donor states attempt to
limit the damage that corruption does to the development of recipient countries by
allocating less aid to these countries.
However, this line of reasoning does not take into account the fact that corrup
tion also exists in donor governments. This is an important point, because corrup
tion affects the behavior of governments and thereby also the response of donor
governments to corruption in recipient states. donor governments that are

Again,
not corrupt are mainly interested in the public aspects of their office and wish to
keep the electorate in their countries satisfied for the purpose of staying in power
(Bueno de Mesquita and Smith 2007). Such donor governments allocate bilateral
aid primarily for developmental purposes, so the emergence of corruption in recipi
ent states a reaction from these
triggers negative governments.
Corrupt governments, however, respond differently, because are interested
they
in private gains rather than in public benefits (Shleifer and Vishny 1993; Warren
2004). This has two implications. First, the allocation of aid normally does not pri
serve a interest of a donor which is why a corrupt donor
marily private government,
is less willing to allocate bilateral aid in the firstplace. Second, the development of
the recipient state is not as to a corrupt donor as to a less donor.
important corrupt
Therefore, corrupt donor governments are less sensitive to the existence of corrup
tion in recipient countries.
The Effects of Corruption on Aid: Four Possible Situations
The argument can be illustrated by describing the effects of four possible situa
tions of corruption levels in donor and recipient countries on the allocation of bilat
eral aid. In the first situation, the level of corruption in both the donor and recipient
countries is low. In the second, corruption in the recipient state is high, while the
donor has a low level of corruption. In the third, corruption in the reci
government
pient state is low, while the donor government has a high level of corruption. In the
last situation, the corruption level of both the donor and recipient countries is high.
In situation 1, the level of recipient corruption is low, so the recipient govern
ment uses aid efficientlywith respect to economic development. This situation ben
efits the interests of the donor population, which prefers development in the
recipient state. As the donor government also has a low level of corruption, its pre
ferences are similar to those of the donor and it attempts to serve those
population,
interests.This will result in relatively large bilateral aid allocations.
In situation 2, the high level of recipient corruption results in higher private
gains-oriented on the side of the recipient and in a smaller
preferences government
share of aid destined for the recipient population. This is not in the interest of
the donor population, which intends to enhance the economic development of the

state. As a result, the donor does not want to allocate aid to the
recipient population
For a donor that has a low level of corruption, the
corrupt recipient. government
interests of its electorate are relatively important. Consequently, high levels of cor
ruption in a recipient country lead to less bilateral aid allocation from a less corrupt
donor government.
In situation 3, the recipient government's level of corruption is low, while the
donor has a level of corruption. In this case, the recipient govern
government high
ment is relatively oriented, as a lower level of corruption increases
development
public interestsand thus the efficiency of aid policy. However, due to itshigh level
of corruption, this type of donor government is not predominantly interested in
maximizing recipient development. On the contrary, it is interested in private gains
from public policy, so the lack of corruption in an aid recipient country does not
a response from such a donor.
provoke
In the final situation, both the donor and the recipient countries are relatively
corrupt.Also, here there is no significant response to be expected from the donor
government, as it is ambivalent toward the existence of corruption in a recipient
Its private-gains oriented interests are not affected

country. by recipient corruption,
and the developmental damage that such behavior can cause is not a source of
direct concern to this type of donor.
In short, less corrupt donors are to recipient whereas corrupt

responsive corruption,
donors are not. As a result, the level of donor corruption helps to explain the extent to
which donor governments respond to the level of corruption in aid recipient countries.
This argument results in the following hypothesis.
Hypothesis 1: Donor countries with a low level of corruption allocate more bilat
eral aid to less corrupt countries than to more corrupt but
recipient recipients,
more corrupt donors do not make this distinction.
In addition to this hypothesis, twomore general claims can be derived from the
The first is that, on average, donors to allocate bilateral aid to less
argument. prefer
countries. of the level of donor a corrupt
corrupt recipient Irrespective corruption,
recipient harms the developmental interestsof the donor. Even though the effect is
relatively large for donors that have a low level of corruption and very small for
very donors, at any position in the continuum between these extreme
corrupt
a response from a donor government will be the result.
points, negative
Hypothesis 2: Donor countries allocate more bilateral aid to less corrupt recipi
ent countries than to more corrupt recipients.
Second, it can be derived from the above argument that highly corrupt donor
countries allocate less bilateral aid than less corrupt donors, keeping the level of
constant. As argued above, corrupt donor governments focus
recipient corruption

more on private rather than public aspects of public policy. Consequently, this type
of government has a smaller interest in the development of a recipient country than
a less corrupt donor. As bilateral aid is allocated for developmental reasons to some
extent at least, corrupt donor countries have less incentive to allocate aid to recipi
ents than donor countries that are less corrupt. Therefore, corrupt donors allocate
less aid to recipients than less corrupt donors, keeping the level of recipient corrup
tion constant.
Hypothesis 3: Donor countries with a low level of corruption allocate more bilat
eral aid than donors that are relatively more corrupt.
All in all, the above framework shows how the level of corruption in aid donor
states determines the effect of recipient corruption on the allocation of bilateral for
eign aid. In thisway, taking account of donor corruption can help to explain the
responsiveness of donor states toward recipient corruption. Thus, the donor hetero
geneity that is observed by existing studies can be overcome.
3. Research Design
This section tests the three hypotheses introduced above by means of a cross
sectional time series analysis of two alternative models. The dependent variable in
both estimations is the natural log of bilateral aid allocation flows. The estimation
procedures thatare employed here are pooled and fixed effectsOLS.
Model Estimation
The models draw from a three-dimensional cross-sectional

empirical dyadic
time series or panel data set (donor state x recipient state x year) that encompasses
a total of 45,274 observations. The units of analysis are dyads of countries, because
this article focuses on bilateral aid, for which we need to take account of both
donor and recipient variables. The included donor states consist of 22 Organisation
forEconomic Cooperation and Development (OECD) member states,4whereas the
list of recipients includes 147 (non-OECD) independent states.Nearly all countries
in theworld are included in the data set,with the exception of those with a popula
tion of less thanhalf a million inhabitants.5
The time period of analysis ranges from 1990 to 2003. This period has been cho
sen because the year 1990 marked the beginning of the post-cold war era, during
which the determinants of aid policies inmost industrialized states have been shift
from mostly interests. has as a relatively
ing away strategic Corruption emerged
new topic in the studyof aid policies after the end of the cold war (Meernik, Krueger,
and Poe 1998; Hout 2004).

The statistical for using a data set rather than a cross-sectional

arguments panel
data set are well known. A contains more information than a cross section,
panel6
increasing the degrees of freedom and variation (Plumper, Troeger, and Manow
2005). Also, because of the time dimension, panel data allow researchers to control for
individual unobserved heterogeneity by using fixed effectsestimation (Hsiao 2003).
The estimation techniques used in the analysis are pooled OLS and fixed effects
with correlation control (the Durbin-Watson statistic indicates serial
autoregressive
correlation) and dyadic clustered standard errors. The decision not to include a
lagged dependent variable instead is based on the fact that the theoryand thehypoth
eses in this article are not in nature, at least not so. a
dynamic explicitly Including
lagged dependent variable implies a strong assumption that all variables have the
same structure. This would make the interpretation of the models unne
one-year lag
as we do not have any or make any on
cessarily complex, knowledge predictions
how it takes a donor state to react to a recipient state's corruption changes.
long
The reasons for using both a pooled OLS and a fixed effectsOLS model are as
follows. As themain interestof this article concerns the effects of corruption levels
on bilateral aid allocation, the baseline model uses a pooled OLS estimation proce
dure. As pointed out by Plumper, Troeger, and Manow (2005), the level effects of
independent variables are best analyzed by a pooled OLS model, even though this
estimator is likely to produce biased coefficients due to endogeneity. A fixed
effects estimator is often less biased, as it excludes level effects due to thewithin
transformation, which demeans all variables within each unit over time.
Still, a Hausman test prescribes the use of fixed effects for the estimation of the
model employed here. Also, using this additional model and comparing its results
to the pooled OLS model can indicate a degree of robustness. Therefore, a fixed
effects model is included in the table, even though the interpretation of such a
model is different: the coefficients do not reflect level effects but the effects of
changes in the level of corruption.
A final general remark tomake on themodels is that the number of observations
differs between the twomodels. This is due to the fact that the fixed effectsmodel
with Prais-Winsten transformation takes away one year of all the observed dyads.
Variables and Data Sources: Dependent and Independent Variables7
The dependent variable in all models is dyadic bilateral aid allocation from a donor
to a recipient state. Unlike some other studies, the focus of this article is on the alloca
tionof aid ratherthanon the eligibility of potential aid recipient states.Likewise, only
those cases in which donors actually transferred(or intended according to the data
source) bilateral aid have been included in the analysis. The data for thisvariable come
from the OECD (Organisation for Economic Cooperation and Development 2007).
It concerns the official development assistance (ODA) data from theDevelopment
Assistance Committee. These data show thebilateral aid thateach OECD countryhas

committed itselfto, given per year. ODA is given inU.S. dollars and has been deflated
using thedeflation index from theOECD.
The independent variables have been chosen in consideration of the variables
used in previous research as well as of the here. The most relevant
theory presented
independent variable in this study is the level of corruption, because it serves as an
indicator for the relative size of private and public interests of donor and recipient
governments. Corruption, because of its secret nature (see, e.g., Lambsdorff 2002),
is difficult to measure: governments do not publish information on how corrupt
they are. Nevertheless, a number of indices have been developed by specialist insti
tutions. Examples of this are the Corruption Perception Index (CPI) by Transpar
ency International (2006); the Kaufmann, Kraay, and Mastruzzi (KKM) (2004)
index of governance by theWorld Bank; and the International Country Risk Guide
(ICRG) by thePolitical Risk Studies Group (2007).
In this article, the corruption index from the ICRG is used. This is one of the
few data sources thathave informationon both a large number of states and a long
period of time.The downside to the ICRG index is that ithas relatively few inter
vals in comparison to the other two indices. Using theCPI has been considered, as
it offersmore intervals and thusmore variation, but due to the fact that it has few
observations over time (from 1995 onward in a few states, from 2000 onward in
most states), it is not employed here. The KKM index also lacks some intervals in
time and does not include as many states as the ICRG.
The index is designed as follows: very corrupt states have a value of 0, while as
states become less corrupt, this increases by steps of 0.5 up to 6 for states that are not
corrupt at all. For the sake of clarity, the index has been reversed in this data set so
that a higher value on the scale represents a
higher level of corruption. Data on cor
ruption levels inboth donor and recipient countries have been taken from the ICRG.
To address the first hypothesis, namely that the responsiveness of donor govern
ments to recipient corruption levels increases with the level of corruption in their
own countries, an interaction term of the donor and variables
has been included in the estimation in addition to the original variables.
Variables and Data Sources: Control Variables
The control variables that are included in themodels can be divided in a dyadic
and a monadic group, the former containing informationon both the donor and the
recipient state,while the latteronly gives informationon either one of them.The first
dyadic variable isUnited Nations (UN) voting agreement (Gartzke and Voeten 2005).
This variable indicates the extent towhich two states vote similarly to one another in
theUnited Nation's General Assembly. If states always vote similarly, they score 1 on
the scale. If theynever do so, they score -1. Similarity inUN votes indicates political
agreement between donor and recipient states on important issues. Rai (1980) has
shown thatUN voting agreement oftenplays an importantrole in aid policy.

The second variable is bilateral trade. Trade can serve as a measure of

dyadic
the economic interests of the donor government, and it has been used in most
previous studies (see, e.g., Schraeder, Hook, and Taylor 1998; Alesina and Dollar
2000; McGillivray and Oczkowski 1992). Ceteris paribus, a donor state is more
interested in giving aid to a developing state with which it has economic ties
through mutual trade.
Trade can further indicate generally good political relations between the donor
and the recipient, that adversaries do not trade as much as friends do. In
assuming
thisway, trade is not only an indicator for economic but also political donor inter
ests. The trade data come from theOECD data on trade.Another dyadic economic
indicator is bilateral (direct) investment,which shows a somewhat more durable
economic between a donor and a state. A variable for
relationship recipient dummy
the existence of a bilateral investment treaty has also been included (see, e.g.,
Neumayer and Spess 2005; Elkins, Guzman, and Simmons 2006).

Two other dyadic variables thathave been included in themodels are physical
a
(geographical) distance (see, e.g., Schraeder, Hook, and Taylor 1998) and dummy
variable for colonial ties. These two variables represent the political and strategic
interestsof the donor state.Proximity between the donor and the recipient indicates
geopolitical interestsby being in a similar area (e.g., Latin America for theUnited
States, Eastern Europe forWestern Europe, East Asia for Japan and Australia). Dis
tance is calculated between capital cities and in kilometers. Former colonies indi
cate a historical bilateral relationship (Alesina and Dollar 2000). This has a
differentmeaning for theUnited States, which never really had any colonies in the
traditional sense. The United States, however, has an important (and generous) aid
relationship with both Egypt and Israel forhistorical reasons.8 Because of the large
of assistance that these countries receive, two dummy variables have
quantities
been added to underline these special dyadic relationships.
The distance data have been obtained fromKristian Gleditsch's (2007) "Dis
tance between Capital Cities" database. The colonial tie dummy variables have
been developed with information from the CIA World Factbook (Central Intelli
gence Agency 2007). If a country has been colonized over the years by more than
one donor state, it has a dummy variable for both donor states.
Other (monadic) variables are also likely to affect aid allocation. Drawing from
research, a number of economic, political, and developmental variables
previous
are included in themodels here. First, income or wealth is expected to be an impor
tant indicator for economic income can be used to measure
development. Recipient
recipient need. Most studies on aid allocation have included an indicator of recipi
ent need, because poor states need aid more than richer states. Here, also the
income of the donor state has been included, because it is expected that richer
donor states allocate more aid than less wealthy donors. The most logical indicator
for a country's wealth isGDP per capita. These data are widely available and have
been taken from theUN Common Database (United Nations Organisation 2007).

Second, the population size of both donor and recipient states needs to be
included. size serves as an economic, and developmental indi
Population political,
cator. donor states are to allocate more aid than small ones on an
Large likely
aggregate level. Similarly, large recipient countries are likely to receive more aid
than small ones. Data on size have also been taken from the UN Com
population
mon Database (United Nations Organisation 2007).
In the analysis, the natural log of the dependent variable is used rather than the
original variable. This has been done for reasons of distribution (a logged variable
has a more normally shaped distribution) as well as to reduce the potential driving
effects of outliers. Along with the dependent variable, all continuous independent
variables have been logged to assess elasticities or percentage which
point changes,
facilitate the interpretationof coefficients.
4. Empirical Results
This section reports and discusses the results of the estimated models. The
empirical findings largely support the hypotheses that are derived from the theoreti
cal argument. The two models are discussed
separately.
Model 1
Corruption in donor and recipient countries pushes down the allocation of bilat
eral aid, while themarginal effect of corruption in either unit is dependent on the
corruption level of the other unit. The interaction term (donor x
corruption recipi
ent corruption) has a positive and significant coefficient. This implies that (1) the
negative effect of recipient corruption on bilateral aid diminishes when the level of
donor corruption is higher and (2) the negative effect of donor corruption on bilat
eral aid decreases with increasing levels of recipient However, the size
corruption.
of the interaction coefficient is relatively small in comparison to those of the consti
tutive variables, so there remains a of how salient this interaction term is.
question
Also, coefficients of interaction terms are often difficult to interpret, and one cannot
limit oneself to looking at just the sign, size, and significance of coefficients (see,
e.g., Brambor, Clark, and Golder 2006; Braumoeller 2004).
A way to deal with thisproblem is by looking at a graphical display of the interac
tion effect. Using information about the means and standard errors of the donor and
recipient corruption variables as well as the coefficients of these variables and of the
interaction term,one can portray the behavior of the interaction effect for different
values of these variables. This helps to interpretthe coefficient of the interaction term
and to assess whether there is really a separate effect of this variable.
The figure demonstrates that less corruptdonor statesmake a distinction between
less corrupt recipients and recipient countries with a higher level of corruption,
while more corruptdonor states do notmake such a distinction. The diamond (which

Table 1
OLS Equations for Bilateral (donor-recipient) Aid Allocation
Model 1 Model 2
Pooled OLS Fixed Effects
Donor corruption -0.353*** -0.289***

(5.87) (4.84)
-0.111*** -0.061 **
Recipient corruption
(3.70) (2.14)
Donor corruption x recipient corruption 0.047*** 0.056***
(2.86) (3.41)
0.067 **
UN voting agreement -0.249
(0.62) (2.12)
Ln (bilateral trade) 0.030*** 0.021**
(3.42) (2.54)
Ln (donor GDP per capita) 2.281 *** 1 071***
(20.50) (3.83)
Ln (recipient GDP per capita) -0.413*** -0.159
(11.85) (0.90)
Ln (donor population) 0.795*** 0.080
(24.78) (0.98)
Ln (recipient population) 0.403*** 0.055
(13.97) (0.41)
Bilateral investment treaty 0.538***
(5.64)
Ln (physical proximity) -0.336***
(5.05)
Colonial ties 2.153***
(12.04)
United States-Israel 5.633***
(37.92)
United States-Egypt 2.908***
(22.24)
Intercept -22 775 *** 2.907 **
(15.68) (15.14)
R2 .691 .262
Observations 13,569 11,896
Note: /-values (based on dyad clustered standard errors) in parentheses. All models have Prais-Winsten
AR1 autoregressive control. OLS = ordinary least squares; UN = United Nations; GDP = gross domestic
product.
**/?<.05. ***p<.01.
represents less corrupt recipients) is clearly located above the square (which stands
for the highly corrupt recipient countries) in the leftpart of the figure.On theright
side, theynearly overlap. The index of thebilateral aid allocation variable on thever
tical axis is negative because without the effects of the other independent variables

(which are kept constant at a value of 0), themarginal effects of the corruption vari
ables on aid are
negative.
The of donor countries to corruption in recipient countries with
responsiveness
respect to the allocation of bilateral aid is thus related to the level of donor corrup
tion. Less corrupt donor countries clearly prefer less corrupt recipients, whereas
more donors do not seem to make a distinction between these two groups
corrupt
of recipient states.9
Two examples from the data set can illustrate this statistical relationship. After
thefirstfree elections since the 1960s in 1992,10Guyana entered a period of relative
The new democratic government caused levels to drop
stability. corruption gradu
ally throughout the decade. The effect of this on development aid was heteroge
neous: whereas some donor states redefined their aid policies toward others
Guyana,
did not. The Netherlands, one of the least corruptOECD member states, responded
to the corruption decrease by allocating rather drastically more bilateral aid to
Guyana. Over a period of seven years, Dutch aid increased by nearly a hundredfold.
Japan,which is one of the relativelymore corruptOECD members, did not express
a clear response and kept its aid flow to Guyana constant.
fairly
A country where the level of corruption rapidly increased during the period of
studyhere isNiger. This development is related to the surge in political instability
after 1993, which culminated during the 1996 coup d'?tat and remained imminent
during the following years. The deteriorating governance and corruption record
influenced the aid allocation policies of many OECD member countries.11 The
response of the donor community was the opposite of what happened to Guyana:
less corrupt donors responded to the political changes by decreasing theirallocation
of bilateral aid toNiger. The Netherlands even lowered its aid by a factor of fifty
over half a decade. However, donor countries that were more
relatively corrupt,
such as Japan, did not respond to the increased corruption.
In addition to this dyadic (interactive) relationship, corrupt recipients receive
less aid than less corrupt recipient states, irrespective of the donor. Graphically, the
support for the second hypothesis comes from the observation that the "low recipi
ent corruption" line lies above the "high recipient corruption" line, irrespective of
the level of donor corruption. Examples of this trendcan be found, for instance, in
Africa. Nigeria, traditionally a large recipient of aid, has seen a steady decline in
received assistance over the 1990s due to its failings to deal with the rampant cor
ruption in its governments (La Franiere 2005). On the other side of the medal,
Mozambique has managed to attractmore aid over this period of time, thanks to
improved corruption policies (Washington Post 2007).
the donor countries, more donors allocate less aid than less
Concerning corrupt
corruptones. Both lines of the graph go down as theymove to theright of the figure,
which indicates thatcorruptdonors allocate less aid irrespectiveof the level of recipi
ent corruption. The least corrupt countries in the world, such as Scandinavian coun
triesand theNetherlands, are also theones thatallocate the largest share of theirGDP

(up to 1 percent) to development aid. Italy and Japan, two of theOECD countries that
have a relatively high corruption level, spend a much smaller percentage (about 0.25
percent) on aid (Global Issues 2006). Interestingly,the figure indicates that less cor
rupt donors even allocate more aid to corrupt than more donors do.
recipients corrupt
The graphical support for the second and third hypotheses is important also
because the coefficients of the constitutive variables cannot be simply interpreted
from the table as one would assume. Because the model includes an interaction
term, the coefficients of the constitutive variables do not represent the marginal
effect of these variables but rather the effect while keeping the other corruption
variable at 0 (Brambor, Clark, and Golder 2006). This can be problematic from an
of view, as the variable cannot take on this
empirical point recipient corruption
value. However, a similar model without the interaction term produces equally sig
nificant and negative coefficients.
Therefore, all hypotheses are supported by themodel. The coefficient of donor

corruption is in absolute terms larger than the coefficient,
which implies that the level of donor corruption influences the allocation behavior
of donor states to a much larger degree than the level of recipient corruption. This
acknowledges the proposition made in the beginning of this article that donor cor
ruption helps explain responsiveness to recipient corruption levels.
Most of the other results are in line with common sense and with the outcomes
of previous research. There seems to be no between
relationship voting agreement
among donors and recipients in theUN General Assembly. The positive but insig
nificant result could be related to the fact that the influence of most donors in the
UN is relatively small compared to thatof theUnited States.
Bilateral trade relations, an indicator for economic interests of the donor state,
are positively related to aid allocation. This is clearly in line with previous studies,
inwhich the economic interests of the donor state in recipients have consistently
been found to be important determinants of bilateral aid. This also holds for the
existence of a bilateral investment treaty, another economic variable.
Being close to a donor increases the amount of aid that a receives,

recipient
because donor states have a interest in their own vari
strategic region. Strategic
ables, such as physical distance and the existence of colonial ties between donor
and recipient (as well as the "special" relationship of theUnited States with Israel
and Egypt), show a coherent This is no For
relationship. surprise. example, Japan
has been shown to concentrate its political and economic efforts on East Asia.
Germany has a traditional interest inEastern Europe, Italy in the SouthernMediter

ranean, and theUnited States inLatin America. Also, the existence of colonial ties
can be argued to be important.An example of this is theUnited Kingdom, which
has a traditional interest in its ex-colonies united in the commonwealth.
Finally, richer donors allocate more aid (Sweden spends more than Portugal),
and richer recipients receive less aid (Chile receives less than Peru). Donor states
with a large population allocate more aid: theUnited States is by far the largest

Figure 1
Interaction Effect inModel 1
-24
-24.5H
c
.2
CO
?
O
<
-25J
<
?3
i_
<D
"* -
-*
-25.5-
-^>^
-26-J-,
Low donor corruption High donor corruption
- -.- --.
-Low recipient Hjgh recipient
corruption corruption
supplier of foreign aid. Recipient countries that are more receive more
populous
aid than smaller recipients.
Model 2
All main coefficients of the fixed effectsmodel have a similar sign as those in
the pooled OLS model and are statistically significant.Therefore, the results found
in the firstmodel are reinforced by the inclusion of the second model. However, it
must be repeated that the interpretationof thismodel is different from the pooled
OLS model, as the coefficients do not display the level effects of corruption.
Rather, the fixed effectsmodel indicates the effects of changes in corruption levels
on bilateral aid allocation. Nevertheless, one might argue that if a
change of the
corruption level affects aid, the level of corruption itself is also likely to affect aid.

Figure 2
Interaction Effect inModel 2
c
o
(0
O
o
<
g
'<
o
+
?j
m
Low donor corruption High donor corruption
-
-Low recipient High recipient
corruption corruption
Note: The different scale of the dependent variable, which is positive here, is caused by thewithin trans
formation of the fixed effects estimator.
The main difference between the two estimation results concerns the coefficient
size of the variables. Both constitutive variables have smaller coeffi
corruption
cients in the fixed effectsmodel, while the coefficient of the interaction term is
slightly larger.This implies that ifwe control for unit heterogeneity (by demeaning
all variables for each dyad and only analyzing thewithin variation), the
impact of
the interaction effect relative to its constitutive variables is larger than ifwe do not
control for this.
In Figure 2, the effect of these different coefficient sizes is
easily visible. The
difference between the allocation behavior of corrupt donor countries and less cor
rupt donors ismuch larger inmodel 2 than inmodel 1, even though thismight not
be the interpretation if one only looks at the regression coefficients in the table.

The changes with respect tomodel 1 seem be the strongest for cases inwhich the
level of donor corruption is high: Figure 2 indicates that corrupt donors actually
allocate more bilateral aid to corrupt than to less countries, while
corrupt recipient
1 shows no clear allocation on the side of these donors. Less cor
Figure preference
ruptdonors prefer less corrupt recipients,which is similar to the results inFigure 1.
This result is reflectedby, for example, Burkina Faso, which received gradually
more bilateral aid from Japan over the 1990s despite the fact that its corruption
record was deteriorating. Also, Indonesia received less aid from Italy during the
firsthalf of thatdecade, even though corruptionwas slowly becoming less rampant.
such as these demonstrate an even mutual of the
Examples stronger conditionality
two corruption variables than in the other model.
The general results of fixed effects estimation are thus in line with those of the
pooled OLS estimation; one could argue that the results of the former are even
stronger than those of the latter.Both figures show clearly that there exist major
differences between the responsiveness of more corrupt and less corrupt donor
states to the level of corruption in recipient states with respect to the allocation of
bilateral aid. The coefficients as well as the graphical representations of the interac
tion effect, therefore,give consistent support to the firsthypothesis.
The argument thatboth donor and recipient corruption has a negative effect on
bilateral aid is supported by themodel. Figure 2 (as well as Figure 1) clearly shows
that more corrupt donors allocate less aid, no matter what the level of corruption in
the recipient country is. Both graphical linesmove down when followed to the right
side of the scale, even though less strongly so than in Figure 1. This is in line with
thenegative (and significant) sign of the donor corruption variable and is confirmed
by a double check with a model without the interaction term.12The second hypoth
esis cannot be easily interpretedfrom the graph, but also in this case, the coefficient
of the recipient corruption variable is negative and significant in the estimation
with and without the interaction term.
The other results are similar inboth models, with the exception of theUN voting
agreement variable (which is negative and significant in the fixed effects estima
tion): model 2 seems to indicate that voting agreement has a negative effect on
bilateral aid allocation ifwe control for donor heterogeneity. There is no clear rea
son why thiswould be the case. Also, the recipient income and population effects
are not significant under fixed effects. This can be explained by the fact that these
variables are invariant over time, which can make the estimation of such
fairly
variables inefficient(Plumper and Troeger 2007).
Finally, it needs to be noted that the bilateral investment treaty,physical proxi
mity, colony, and United States-Israel/Egypt variables have not been included in
thefixed effectsmodel. This is due to the fact that these variables are invariant over
time and are thus absorbed by the fixed effects. This is not problematic, as these
are control variables, of which the coefficients are not the primary interest of this
article.

The results presented here have undergone an additional13 robustness check with
a groupwise jackknife, which assesses the effects of deleting different continents
from the estimation on the coefficients. Doing so does not dramatically change the
coefficients, but it is notable to see the extent to which corruption plays a strong
role inLatin America and Africa, while it does less so in theMiddle East. Taking
this region out of the analysis increases the coefficient of recipient corruption,
whereas doing so with Africa or Latin America pulls the coefficients slightlydown.
In sum, all three hypotheses are consistently supported by the empirical evi
dence here. The level of donor seems to have a determining
presented corruption
influence on how donor states react to levels of recipient corruption. Nevertheless,
it needs to be stressed that themodels not only show that corruption is a relevant
issue in the study of bilateral aid allocation but also that it is only one of themany
factors that influence the aid policies of donor states. It is not the intentionhere to
claim that corruption is themost importantfactor, only that it is an issue thatneeds
to be taken into account in addition to political and economic determinants.
5. Conclusion
reduces bilateral aid. On average, aid donor states allocate less bilat
Corruption
eral aid to recipient states with high levels of corruption, whereas they allocate
more aid to recipients that are less Still, not all donor states are
corrupt. equally
responsive to recipient corruption. Donor states that are less corrupt react relatively
strongly to recipient corruption, as they allocate less bilateral aid to corrupt recipi
ent states and more aid to recipients that are not corrupt. Donors that are relatively
do not seem to respond negatively to recipient corruption levels. These
corrupt
findings support the firsthypothesis. One of the estimations even suggests that cor
to allocate aid to corrupt countries.
rupt donors prefer recipient
The results also indicate that the level of corruption has an effect on bilateral aid
allocation in general. First, recipient states with high levels of corruption receive
less bilateral aid from donor countries. Keeping the level of donor corruption con
stant, the response from donor states to corruption in recipient countries is negative.
These results support the second hypothesis. Second, corrupt donor states allocate
less bilateral aid than less corrupt donors, keeping the level of recipient corruption
equal. This supports hypothesis 3.
Corruption is thusnot as irrelevantas previous studies have claimed. Still, the fact
that there exists a great deal of indifferenceamong some industrialized states toward
corruption despite itsdetrimental effectson development suggests thatmore needs to
be done to fight it.Allocating foreign aid throughmultilateral channels could be an
effectiveway to do this,because itwould be harder to let private interestsof indivi
dual governments influence the allocation process. Nowadays, multilateral aid only
comprises about one-third of total aid, so there is plenty of room forpolicy change.

This article opens up possibilities for furtherresearch. Studies on thedeterminants

of aid can be widened by lookingmore carefully at donor states. In addition to donor
interests, recipient needs, and recipient quality of governance, the quality of govern
ance in donor countries also is likely to affect theiraid policies. Therefore, one could
expand on the results by assessing how corruption affects the eligibility stage of aid.
In addition, future studies could look at bilateral investment to obtain a clearer pic
ture of the economic (industrial) interests of donor governments.
Appendix
Descriptive Statistics
Observations Mean Standard Deviation Minimum Maximum
Bilateral aid allocation (logged) 23,696 14.449 2.477 9.210 22.492

Donor corruption 45,276 1.034 04
0.967
Recipient corruption 30,338 3.264 26

1.062
UN voting agreement 37,644 0.528 0.2491
-0.603
Bilateral trade (logged) 40,669 15.956 5.165 -11.513 26.220
Bilateral investment treaty 45,276 0.181 1
0.385
0
Physical distance (logged) 45,276 8.805 0.6194.127 9.858

Colonial ties 45,276 0.036 01
0.188
United States-Israel 45,276 0.001 010.018
United States-Egypt 45,276 0.001 01
0.018
Donor GDP per capita (logged) 45,276 9.948 0.391 9.010 10.751
Recipient GDP per capita (logged) 41,316 6.956 1.297 4.035 10.172
Donor population (logged) 45,276 16.519 1.42912.853 19.489
Recipient population (logged) 44,638 15.394 1.973 9.888 20.977
Note: GDP = gross domestic product; UN = United Nations.
Notes
1. See http://www.oecd.org (accessed July 12, 2007). Organisation for Economic Cooperation and
Development (OECD) member states contribute about 96 percent of all bilateral aid.
2. Aid determinants that have been shown to be themost important among most donor states encom
pass national interests (such as economic and political gains) rather than recipient needs (such as poverty or
illiteracy) or corruption (see, e.g., McKinlay and Little 1977; Akram 2003; Maizels and Nissanke 1984). A
number of studies have indicated thatdonor interestsoutclass recipient needs: self-interest ismore important
to donor states than the interests of recipient states (see, e.g., McKinlay and Little 1977; Schraeder, Hook,
and Taylot 1998; McGillivray and Oczkowski 1992; Alesina and Dollar 2000). Corruption, representing a
measurement of recipient governance rather than recipient needs (Neumayer 2003, 30) does not seem to be
nearly as important as donor interests.

3. See official aid policies of any Organisation forEconomic Cooperation and Development (OECD)
member state. OECD member states contribute more than 96 percent of all bilateral aid allocation in the
world (Neumayer 2003, 3).

4. Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Ireland, Italy,
Japan, Luxembourg, theNetherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the
United Kingdom, and theUnited States.
5. Russia is a notable exception to this rule. It has not been included due to a lack of data in the
OECD data set.
6. Panel data set is used here instead of cross-sectional time series, but the same structure ismeant.
7. A table with descriptive statistics is printed in the appendix.
8. The 1978 Camp David Peace Agreement between Israel and Egypt incorporated a promise by
theUnited States to allocate large sums of development aid to both countries.
9. In addition to the interaction term used here, one can also engage in a separate analysis of each
donor country to assess whether more corrupt donors really behave differently from less corrupt donor
countries. Such an analysis shows that, indeed, less corrupt donors (e.g., Sweden, Finland, or Canada)
respond more strongly to recipient corruption than countries that are more corrupt, such as Italy or
Spain.
10. See U.S. State Department (2008a).
11. See U.S. State Department (2008b).
12. See the discussion of constitutive variable coefficient interpretation under model 1.
13. Additional ifwe consider the use of the two alternative models as a way to assess robustness.
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Corruption and Bilateral Aid: A Dyadic Approach

Author(s): Carl Jan Willem Schudel

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Corruption and Bilateral Aid

Carl JanWillem Schudel

Keywords: corruption; foreign aid; OECD countries; dyadic relationships

Corruption is a widespread problem inmany countries throughout theworld, as

of the most important obstacles to economic development.

Corruption in developing statesmay also reduce the effectiveness and efficiency

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fact that virtually all donor countries have introduced criteria as

corruption in the donor state itself.Governments of donor stateswith a low level of

Less corrupt donor governments dislike the prevalence of corruption in recipient

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2. Corruption and Bilateral Aid: A Theory

Corruption and Donor State Interests

Governments in industrialized donor states claim to use bilateral aid allocation to

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governments to corruption in recipient states. donor governments that are

The Effects of Corruption on Aid: Four Possible Situations

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Its private-gains oriented interests are not affected

direct concern to this type of donor.

In short, less corrupt donors are to recipient whereas corrupt

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geneity that is observed by existing studies can be overcome.

The models draw from a three-dimensional cross-sectional

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The statistical for using a data set rather than a cross-sectional

Variables and Data Sources: Dependent and Independent Variables7

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Variables and Data Sources: Control Variables

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The second variable is bilateral trade. Trade can serve as a measure of

Neumayer and Spess 2005; Elkins, Guzman, and Simmons 2006).

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Pooled OLS Fixed Effects

Donor corruption -0.353*** -0.289***

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Therefore, all hypotheses are supported by themodel. The coefficient of donor

Being close to a donor increases the amount of aid that a receives,

Germany has a traditional interest inEastern Europe, Italy in the SouthernMediter

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Low donor corruption High donor corruption

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Low donor corruption High donor corruption

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This content downloaded from 188.26.134.49 on Mon, 14 Oct 2013 15:41:25 PM

This content downloaded from 188.26.134.49 on Mon, 14 Oct 2013 15:41:25 PM

This article opens up possibilities for furtherresearch. Studies on thedeterminants

Bilateral aid allocation (logged) 23,696 14.449 2.477 9.210 22.492

Recipient corruption 30,338 3.264 26

Physical distance (logged) 45,276 8.805 0.6194.127 9.858

Recipient population (logged) 44,638 15.394 1.973 9.888 20.977

Note: GDP = gross domestic product; UN = United Nations.

nearly as important as donor interests.

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Global Issues. 2006. US and foreign aid assistance. http://www.globalissues.org/TradeRelated/Debt/

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