Chapter 6 When Can Competition for Aid Reduce Pollution?

We examine the allocation of a pre-determined amount of aid from a donor to two recipient countries. The donor suffers from cross-border pollution resulting from production activities in the recipient countries. It is shown that the recipient with the higher fraction of aid allocated to public abatement and with the lower emission tax, receives a higher share of the aid when the donor allocates aid so as to maximize its own welfare. Competition for aid reduces cross-border pollution to the donor when recipients use the fraction of aid allocated to pollution abatement as a policy to divert aid from each other. But, it increases cross-border pollution when recipients use the emission tax to divert aid from each other.