The political economy of IMF conditionality: A common agency model

The paper models the relationship between an aid-providing international financial institution (IFI) and an aid-receiving government whose economic policy choices are influenced by a domestic interest group. Two assistance schemes are evaluated: conditional aid in which the IFI makes assistance contingent on less-distorting economic policies and unconditional aid which is provided without such conditions. Conditional aid is shown to raise welfare of the receiving country and the world as a whole relative to unconditional aid. The paper also examines how conditional and unconditional aid schemes are influenced by the IFI's opportunity cost of providing assistance and the receiving government's political dependence on a domestic interest group.