Aid Allocation and Poverty Reduction

Abstract

This paper derives a poverty-efficient allocation of aid and compares it with actual aid allocations.We build the poverty-efficient allocation in two stages.We first utilize new World Bank ratings of twenty different aspects of national policy to establish the current relationship between aid, policies and growth.Onto this we add a mapping from growth to poverty reduction which reflects the level and distribution of income.We compare the effect of using the headcount and poverty-gap measures of poverty.We find that the actual allocation of aid is radically different from the povertyefficient allocation.In the efficient allocation, for a given level of poverty, aid tapers in with policy reform.In the actual allocation aid tapers out with reform.In the efficient allocation aid is targeted disproportionately on countries with severe poverty and adequate policies: a category of country in which 75% of the world's poor people live.In the actual allocation such countries receive a much lower share of aid (53%) than their share of the world's poor.We show that even with the present allocation, aid is effective in lifting around 16 million people per annum sustainably out of absolute poverty.With a poverty-efficient allocation this would increase to around 30 million people.Even with the introduction of political constraints keeping the allocation for India constant, poverty reduction would increase to around 25 million.While the reallocation of aid is politically difficult, it may be considerably less difficult than the tripling of aid budgets which we estimate would be necessary to achieve the same impact on poverty reduction given the existing aid allocation.The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors.They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent.We thank Aart Kraay and Martin Ravallion for useful advice and Charles Chang and Dennis Tao for excellent research assistance.

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