Foreign Aid and Corruption
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Foreign Aid and Corruption Jihyuk John Lim 4/25/13 IPEC-401 Professor Anders Olofsgard Abstract: Foreign aid and corruption have received a lot of scholarly attention in the recent decades, but there have only been a few papers empirically examining the causal relationship between the two. This paper uses a unique, large-scale panel dataset and an instrumental variable methodology to show that total foreign aid has a positive impact on the recipient country’s level of corruption, while the effects of the different subcategories of assistance are mixed. Additional specifications of the model also lead to varied results. Thesis Submitted in Partial Fulfillment of the Requirements for the Award of Honors in International Political Economy, Edmund A. Walsh School of Foreign Service, Georgetown University, Spring 2013. Table of Contents I. Introduction ····················································································································3 II. Literature Review···········································································································4 A. Corruption ················································································································5 B. Foreign Aid ··············································································································7 C. Foreign Aid and Corruption ·····················································································8 III. The Econometric Model ······························································································11 IV. Description of the Data ································································································17 V. Main Results ················································································································21 A. OLS Regression Results ························································································21 B. 2SLS Regressions Results······················································································24 VI. Sensitivity Analysis ·····································································································31 A. Regional Dummies·································································································31 B. Education Variables ·······························································································34 C. Democracy Variables ·····························································································36 D. Monterrey Consensus·····························································································38 E. Paris Declaration ····································································································39 F. Fixed Effects ··········································································································40 G. Previous Corruption ·······························································································41 VII. Conclusion ···················································································································42 VIII. Appendices ···················································································································44 IX. Bibliography ················································································································69 2 I. Introduction In 2003, according to the World Bank, Sudan received over 620 million dollars in official assistance from the international community. While the amount it received in 2003 was large, other countries and multilateral institutions even more generous towards Khartoum in subsequent years. In 2004, Sudan saw a 60% increase in the aid that it received from foreign sources compared to the previous year, for a total of close to 994 million dollars. The assistance provided by the international community nearly doubled the following year to over 1.8 billion dollars in 2005. By 2010, Sudan’s annual intake from official bilateral and multilateral sources amounted to larger than 2 billion dollars a year, an increase of 234.5% compared to what it received in 2003.1 During these years, Sudan remained one of the most corrupt countries in the world. In 2003, Sudan received a score of 2.3 out of 10 on the Corruption Perceptions Index compiled by Transparency International. Its score tied Khartoum with such bastions of clean government as Bolivia, Honduras, Macedonia, Serbia & Montenegro, Ukraine, and Zimbabwe, which all ranked 106th out of 133 countries in the index that year. While Sudan’s level of corruption was far from desirable, it managed to slip further down during the ensuing years that saw increased funding from the outside world. By 2010, Sudan had fallen to 1.6 out of 10 on the Corruption Perceptions Index, tying it with Turkmenistan and Uzbekistan for the 172nd place out of 178 countries. Only Iraq, Afghanistan, Myanmar, and Somalia, all countries with a long-running reputation for corruption, fared worse on the index that year.2 Sudan’s dismal experience with foreign aid and corruption is only one case out of a much larger group of countries that have received assistance from abroad, but it appears to confirm a 1 World Bank, “Net Official Development Assistance and Official Aid Receive (Current US$),” World Development Indicators. 2 Transparency International, Corruption Perceptions Index. 3 popular perception, and perhaps even an intuition, that the corruption and foreign aid are connected and that the latter leads to more of the former. It is this suspicion that has led to my research. A vast majority of countries receives foreign aid from bilateral and multilateral sources, often for decades, and every government struggles with at least some level of corruption. The causal relationship between official assistance from abroad and corruption, if one were to exist, would seem to pose an important challenge for international development. Through this paper, I attempt to test out that perception, that foreign aid breeds corruption, using a cross-section of countries over a sixteen-year period. The rest of the paper is as follows. Section II discusses the previous literature on corruption and foreign aid in order to highlight how my work builds upon and contributes to the vast amount of research that has already been conducted in these areas. Section III presents the model utilized to test out the data on the question of what impact official assistance from abroad has on the level of corruption of the recipient country. Section IV describes the data, including their sources, and what the variables are. Section V examines the results of the main model. Section VI is devoted to the sensitivity analysis of the model. Section VII concludes the paper. II. Literature Review Corruption and foreign aid have each received increasing attention from policymakers and academics over the last couple of decades. As a result, academic research on these topics has proliferated greatly during this time. Interestingly, most of what has been written about corruption and foreign aid has treated them as separate issues, often tying them not with each other, but with other related topics, such as economic growth. 4 A. Corruption The literature on corruption can be divided broadly into two categories: works examining the causes of corruption—whether economic, political, or cultural—and studies looking at the effects of corruption. Papers studying the causes of corruption include “The Quality of Government” (1999) by Rafael La Porta, 3 Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny, “The Causes of Corruption: A Cross-National Study” (2000) by Daniel Treisman,4 “Sources of Corruption: A Cross-Country Study” (2002) by Gabriella Montinola and Robert Jackman, 5 and “Causes of Corruption: A Survey of Cross-Country Analyses and Extended Results” (2007) by Lorenzo Pellegrini and Reyer Gerlagh.6 “Corruption in Empirical Research—A Review” 7 (1999) by Johann Graf Lambsdorff provides an overview of the literature up to that point in time on corruption, showing the increasing academic interest on this subject and the differing results of the research. While the results of these studies vary, and every author greater emphasis on some factors over others, they all stress that there are several distinct causes for why some countries have higher levels of corruption, while others have lower levels. The results of the last two decades of research in this area has suggested that these causes include historical and cultural factors, such as religion, ethno-linguistic heterogeneity, colonial past, and origins of countries’ legal systems, political conditions like the level of democracy and government structure, and economic issues, such as the levels of economic development and economic competition. 3 Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny, “The Quality of Government,” Journal of Law, Economics, and Organization 15.1 (1999). 4 Daniel Treisman, “The Causes of Corruption: A Cross-National Study,” Journal of Public Economics 76.3 (2000). 5 Gabriella Montinola and Robert Jackman, “Sources of Corruption: A Cross-Country Study,” British Journal of Political Science 32.1 (2002). 6 Lorenzo Pellegrini and Reyer Gerlagh, “Causes of Corruption: A Survey of Cross Country Analyses and Extended Results,” Economics of Governance 9 (2008). 7 Johann Graf Lambsdorff, “Corruption in Empirical Research—A Review,”