Aid Conditionality in a Decentralized Health System

The effects of foreign aid on a decentralised health system are analysed in a theoretical framework where the donor has imperfect information about the local health needs while the central and local governments do not engage in self-interested efforts upon receiving aid. I discuss the implications of conditionality of aid on local health expenditures, intergovernmental transfers and social welfare. I then examine these consequences in a health system with two levels of care when the donor restricts aid on Primary Health Care. Conditional aid is found to increase local health expenditures more than unconditioned aid only at the expenses of local government’s attempts to compensate for the donor’s mistargeting. This mechanism presents an apparent benefit of using aid conditionality to increase local spending whilst ignoring the adverse effects on aid effectiveness