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December 2009 Stephen Knack

Aid and Trust in Country Systems

Obstacles to achieving Paris Declaration targets

The 2005 Paris Declaration on Aid Effectiveness sets targets for increased use by donors of recipient country systems for managing aid. A consensus view holds that country systems are strengthened when donors trust recipients to manage aid funds, but undermined when donors "micro-manage" aid through their own separate parallel systems. Despite this consensus, there are many obstacles to achieving the Paris Declaration targets[1].

The Paris Declaration encourages donors to make greater use of recipient´s public financial management (PFM) systems, specifically in the areas of budget execution, financial reporting, auditing, and procurement. Where these systems are sufficiently weak, however, donors will have little faith that aid funds will be put to productive use. The choice then may be between managing aid through parallel systems accountable to the donor, or providing no aid at all.

Donors will rely more on strengthened systems

Source: OECD (2008).

Quality of countries´ PFM systems, not surprisingly, turns out to be an important determinant of donors´ use of those systems. Figure 1 shows, for 28 countries in Sub-Saharan Africa, the positive relationship between the share of aid managed using country PFM systems and a World Bank indicator of the quality of budgetary and financial management. The Paris Declaration recognizes that there are limits to donors´ willingness to rely on untrustworthy systems, and accordingly includes targets for strengthening PFM systems, with the help of technical assistance provided by the World Bank and other donors.

Even where PFM systems are not so weak, donors´ use of parallel systems is sometimes encouraged by government officials within recipient countries. Central ministries typically prefer that aid be managed via country systems, but line ministries often face different incentives. Projects with parallel funding and management mechanisms can generate benefits for the ministers and civil servants in whose sectors they are located, in the form of "salary top-ups, allowances, vehicles, training and travel opportunities and prestige"[2].

Use of country systems is not wholly determined, however, by recipient country characteristics or preferences of their officials. Reliance on country systems varies dramatically across donors. Country procurement systems are used for 68% of the UK´s aid but for only 5% of aid from the US, according to results from the OECD-DAC’s Paris Declaration Monitoring Survey[3]. These sorts of disparities suggest that a closer look into donors´ incentives is warranted.

Donors confront tradeoffs among aid objectives

Even if donors agree that increased use of country systems will improve aid effectiveness and development outcomes overall, they may still face strong incentives to bypass country systems. Donors typically have multiple motives. They value development outcomes, but they are also concerned about the success (or perceived success) of their own aid projects. "Donor agencies benefit from the visibility associated with separately managed and "branded" projects... where more programmatic multi-donor ventures are introduced, visibility is lost and the attribution of development results to the particular donor´s support becomes problematic"[4]. The development benefits from using country systems (and thereby strengthening them) will be long-term and diffuse, while the costs—in the form of increased risks to project success—are short-term and specific to the donor.

From this perspective, achieving the Paris Declaration´s targets on use of country systems can be viewed as a collective action problem among donors. In general, then, donors´ use of country systems is likely to be sub-optimal. An individual donor will want to "free ride" to some degree on other donors’ contributions to the "public good" of strengthened systems, in their efforts to minimize risks to their own projects and programs.

As noted above, however, some donors "free ride" in this sense much more than others. Moreover, use of country systems varies across recipients for a given donor, to a greater degree than can be attributed to differences in quality of their PFM systems. How can these variations in donor behavior be explained?

Donors differ in their mandates and constituencies

Analysis of the Paris Declaration Monitoring Survey data provides several insights. First, "type" of donor matters. Multilateral donors on average rely more on country systems in managing aid, consistent with the fact that they were established in part to get around some of the political constraints to aid effectiveness confronting bilateral aid agencies. Among bilaterals, DAC members make greater use of country systems, likely reflecting in part "peer pressure" to conform to the DAC´s aid effectiveness messages and objectives. Among DAC members, use of country systems is greater in countries with stronger public support for aid as measured by cross-national opinion polls.

Source: Eurobarometer and OECD (2008).
Figure 2 depicts this positive relationship for 14 DAC bilateral donors included in Eurobarometer´s surveys. Where support for aid is relatively weak, aid agency officials will be under more pressure (1) to show that the funds they are provided are not stolen, diverted or misused, and (2) to produce visible results directly attributable to its efforts, precluding the use of budget support and discouraging use of country PFM systems.

Donors may have an "encompassing interest" in some recipients

Where there is only one donor aiding a recipient country, it "internalizes" all of the benefits of its investments in strengthening country systems. More generally, a donor´s interests will be better aligned with long-term development objectives where it has a larger share of the aid"market." Consistent with this view, data analysis finds that a given donor tends to rely more on country systems in managing its aid where it accounts for a larger share of the recipient´s total aid.

Providing a large share of a recipient´s aid is not the only factor that may raise a donor´s reputational or other stakes in a country´s long-term development. Other things equal, a bilateral donor may be more willing to invest in the long-run development of its former colonies, and its geographic neighbors. Data analysis shows that donors´ reliance on country systems increases with geographic proximity of recipient countries, but is no higher in former colonies.

Implications for donors

Reducing aid fragmentation is commonly advocated as a means of reducing transactions costs imposed on recipients. Results summarized here suggest it would also increase use of country systems. Sharper division of labor geographically may be politically difficult for some donors. But many of the benefits from reduced fragmentation may apply at the sector level. Even with many donors in a country, sectoral division of labor can increase a donor’s reputational stake in the success of a given sector, such as education.

Incentives within aid agencies should also be re-examined with the goal of ensuring that time horizons of their personnel are not overly short. Staff incentives should be appropriately balanced between short-term goals such as disbursing funds quickly and minimizing risks to ongoing projects, and long-term goals of strengthening country PFM and other public management systems.

Finally, the arguments and results summarized here confirm the importance of donors’ provision of technical assistance and other support for PFM reforms, as reflected in the Paris Declaration itself.

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STEPHEN KNACK is a Lead Economist in the Development Research Group and the Poverty Reduction and Economic Management Network of the World Bank. His research interests include the impact of aid on policy reform and on public sector capacity and accountability.

Notes

1. Knack, Stephen, and Nicholas Eubank. 2009. "Aid and Trust in Country Systems." World Bank Policy Research Working Paper 5005, July.

2. Williamson, Tim, and Zainab Kizilbash Agha. 2008. "Stumbling Blocks or Building Blocks? The Effectiveness of NewApproaches to Aid Delivery at the Sector Level."ABIA Project Working Paper No. 6. London: Overseas Development Institute.

3. OECD. 2008a. 2008 Survey on Monitoring the Paris Declaration: Effective Aid by 2010? Paris: OECD. (www.oecd.org/dac/hlfsurvey).

4. Williamson, Tim, and Zainab Kizilbash Agha. 2008. "Stumbling Blocks or Building Blocks? The Effectiveness of New Approaches to Aid Delivery at the Sector Level."ABIA Project Working Paper No. 6. London: Overseas Development Institute.

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