Donors' Mechanisms for Financing International and National Public Goods : Loans or Grants?

This paper investigates whether three classes of donors - multilateral organisations, regional institutions and bilateral donors - tailor their mix of grants and loans to reflect international benefit spillovers and recipient-specific benefits, derived from aid-funded activities in developing and transition countries. To account for recipient benefit shares, donors should use a greater share of grants when supported activities yield a larger portion of international public benefits. A greater reliance on loans is appropriate when a large portion of recipient-specific benefits are associated with the assistance. By reflecting recipient benefit shares in the grant-loan mix, donors' assistance also promotes allocative efficiency. Using the Credit Reporting System (CRS) database from OECD for 1980-2000, our analysis establishes that various donor classes apply different grant-loan mixtures when supporting the environment, health, knowledge and governance sectors of recipient countries. We employ analysis of variance and other statistical comparisons of the means to investigate differences among donor classes. We demonstrate that bilateral donors do the best job in tailoring their grant-loan mix to accord with the extent of international public good benefits embodied in the aid-supported activity. Multilateral organisations' grant-loan mix is intermediate of the three types of donors, with some evidence of them relying more on grants to finance activities that possess a larger share of international public good spillovers. Regional institutions, however, do not discriminate their grant-loan mix by either sectors or the associated public good spillovers. This finding suggests that regional development banks need to adjust their grant-loan mix to better account for international benefit spillovers if these institutions are to warrant the increased funds to underwrite regional public goods that they have been seeking. If, however, their mix is institutionally set, then the stakeholders must give these institutions greater flexibility to tailor their grants and loans to who benefits from the aid-supported public goods. This is the first paper to empirically ascertain whether the grant-loan mix is tied to the inherent publicness of the aid-funded activities