This paper constitutes the second stage of our effort to elucidate the mechanism of inter-country aid allocation by a single donor when the latter is sensitive to both needs and governance considerations and is moreover able to influence local governance through its own disciplining effort. In conformity with observations from the real world, it is also assumed that there is a negative correlation between the extent of needs and the quality of governance: in a one-donor-two-recipient framework, the poorer recipient country is less well governed than the richer one. Many rich insights are gained from the analysis. In particular, the poorer and less well governed country is more likely to receive a higher share of aid if governance is endogenized. And the share of a country will always increase if it has succeeded in improving its internal governance thanks to its own effort. This is true even in the case where this effort leads to a fall of aggregate governance as a result of an over-reaction by the donor. Finally, a decrease in the cost of external discipline will favour the poorer and less well governed country provided that the inter-country governance gap is large enough.
Image: ©IRD - Tiphaine Chevallier