An altruistic donor can give aid by combining a discretionary budget and infrastructure projects targeted to the rich or to the poor. Under imperfect information on the income available for redistribution, pooling contracts are often optimal, and provide the donor a higher expected payoff than the expectation of the full information equilibrium allocations. Aid has a detrimental effect on the recipient country’s incentives to develop institutions only when institutional development mainly improves the income of the country. If institutional development mainly increases the redistribution motive of the rich, aid can enhance development.
This is a revision of a paper that has circulated under the title “Altruistic Donors, Development and Redistribution.”