Smoothing the Way or Stirring the Pot: The Impact of Foreign Aid Shocks on Conflict in Recipient Countries

For many developing countries, aid constitutes a large share of state revenue, a high proportion of which is vastly volatile and unpredictable. This paper focuses on the impact of shocks in foreign aid disbursement on the stability of poor countries, specially on two-sided conflict (internal armed conflict), one-sided conflict from the government (purges) and one-sided conflict from the opposition (assassination, riots and terrorism). The effect of erratic aid disbursement is conditional on how recipient governments react to these shocks and on their ability to make credible commitments. To estimate the effect of an aid shock on conflict and to test how state capacity mediates this relationship, an instrumental variable strategy is proposed based on donors’ Gross National Income (GNI). The main findings indicate that (1) negative (positive) aid shocks increase (decrease) one-sided conflict from the opposition, suggesting that negative aid shocks primarily trigger social unrest from the population; and (2) the effect of negative aid shocks on one-sided conflict from the opposition is especially large in countries with weak state capacity.