results were not robust to small changes in the time period and the countries included in the
sample. Rajan and Subramanian (2008) also failed to report a positive aid-growth effect, even for
recipients with good policy environments. Brumm (2003) went further and argued that if
long-run averages rather than panel data are employed, then both the Burnside and Dollar and
Easterly et al. samples indicate a significantly negative effect of aid on growth, regardless of
the policy environment.
A number of political economy concerns are associated with the provision of foreign aid
to developing economies. These concerns suggest that foreign aid is likely to have
deleterious effects on recipients’institutional quality. North and Thomas (1973) and
North (1990) were seminal in focusing researchers’attentions on the role of institutional
quality in economic development. They emphasized the importance of the “rules of the
game”and how they shape human action, channeling it toward relatively productive or
unproductive endeavors. Studies by Knack and Keefer (1995), Barro (1996), Hall and Jones
(1999), Acemoglu et al. (2001, 2002), Rodrick et al. (2004), and Acemoglu and Johnson (2005)
subsequently reported evidence of a robust, positive relationship between the strength of
property rights and the rule of law on the one hand, and income levels and growth on the
other. A large empirical literature now supports the consensus view that institutions rule
(Rodrick et al., 2004).
If aid is, at best, effective in promotingeconomic growth in good policy environments, then
the potential for aid flows to cause deteriorations in institutional quality is doubly troubling.
Aid may tend to degrade the very institutional arrangements that are necessary for it to be
potentiallyhelpful. Moreover, the cold hard fact is thatcountries tend to be poor because they
have poor institutional qualityin the first place. This suggests that tobe effective, aid must be
conditional on improvements in the policies and institutions of recipients.
In this paper, we review the political economy concerns associated with foreign aid and
the existing evidence suggesting that they are important. These concerns suggest that aid is
likely to have harmful effects on recipients’institutions, and that attempts to give aid
conditional on reforms are unlikely to succeed. Then we turn our attention to a recent
multilateral aid program that is explicitly designed to foster improvements in policies and
institutional quality and to monitor the progress of those improvements. Established in
1996, the Heavily Indebted Poor Country (HIPC) Initiative aims to help low-income countries
(LICs) burdened with large amounts of debt achieve robust economic growth and
development. The HIPC Initiative represents the best attempt by the IMF and the
World Bank to acknowledge and overcome the political economy concerns associated with
foreign aid. To date it has provided over $76 billion in debt relief, conditional (at least
nominally) on recipient reforms.
We present evidence that the track record of the HIPC Initiative has been lackluster.
On examination of measures of economic and political institutional quality, it was found
that about one-third of countries experienced decreases while participating in the Initiative.
In almost every single case where participating countries experienced increases in these
measures, the increases were negligible. Furthermore, we present the results of regressions
that relate changes in the institutional measures to the HIPC Initiative aid. The partial
correlations between aid and institutional change are never statistically significant.
When the point estimates are positive, they suggest miniscule effects. The best shot by the
IMF and the World Bank to link foreign aid to policy and institutional reforms has failed to
overcome the perverse incentives that aid creates.
2. Foreign aid and institutional quality
The ostensible motivation for developed economies and international agencies to give
foreign aid is twofold. First and foremost, donors desire that poor economies do not remain
poor. Poverty is characterized by a lack of income and wealth; rich economies can fill the gap