Overcoming Barriers to Reform: On Incentive-Compatible International Assistance

September 1, 2007

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Wolfgang Mayer, and Alex Mourmouras. Overcoming Barriers to Reform: On Incentive-Compatible International Assistance, (USA: International Monetary Fund, 2007) accessed November 23, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

International financial assistance (loans and grants) can potentially raise recipients' welfare in two ways, by affecting a direct resource transfer and by facilitating efficiency-enhancing reforms. In practice, barriers to reform limit the potential of assistance to deliver these two dividends. In this paper, we analyze assistance programs designed to ensure that recipient governments voluntarily adopt reforms and overcome barriers associated with: (i) the reaction of special interests to the prospect of reform; (ii) the possibility of default and political instability in the recipient country; and (iii) adverse selection and moral hazard. Reform barriers raise the cost of incentive-compatible assistance and may result either in no assistance being forthcoming or assistance that ensures repayment but not the implementation of reforms. Critical to the choice of assistance programs is the size of the rent accruing to special interests in the absence of reform and the limited liability rents needed to ensure that repayment terms do not threaten the country's political stability. Optimal assistance contracts feature flexible repayment terms related to real economic growth in recipient countries.

Subject: Foreign aid, Loans, Moral hazard, Personal income, Tax incentives

Keywords: Adverse selection, Expected return, WP

Publication Details

Pages:

28
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2007/231
Stock No:

WPIEA2007231
ISBN:

9781451867954
ISSN:

1018-5941

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