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South Asia Without Borders Seminar

Javed Younas, Aman Fellow, South Asia Institute

Chair: Asim Khwaja, Sumitomo-FASID Professor of International Finance and Development, Harvard Kennedy School

The aid allocation literature reveals a negative association between the recipients’ income and aid inflows, implying that, all else equal, poorer nations receive more aid. This literature has assumed that two forms of aid flows – grants and concessional loans – are determined identically. Thus, its findings reflect average behavioral patterns based on an aggregate of these two distinct transfer types. This study unveils different incentive effects of grants and concessional loans. We show that the findings of the aid allocation literature apply to grants but not to concessional loans. In particular, the amount of grants decreases with income, whereas the amount of concessional loans increases with income. The analysis is also notable for using exogenous variations in remittances and temperature as instruments for income. Other econometric issues such as cross-sectional dependence and multiple endogenous variables are also taken into account. The implications of the findings for aid effectiveness debates will discussed. Further tests reveal a larger impact of concessional loans on investment.