Foreign Aid Effectiveness and the Strategic Goals of Donor Governments

This paper argues that foreign aid can promote economic growth in recipient countries by facilitating economic reform, but only when the strategic benefits associated with providing aid are small for donor governments. When the strategic benefits are large, foreign aid becomes ineffective because Western governments cannot credibly enforce their conditions for economic reform. This paper presents evidence consistent with both the cause and effect of this argument. Based on the understanding that Western aid was driven more (less) by strategic factors during the Cold War era (post-Cold War era), it shows that aid has been positively associated with economic reform, but only after 1990 when Western governments could more credibly threaten to curtail their aid if such reform was not forthcoming. It also shows that aid has promoted economic growth, but only after 1990 when the strategic benefits associated with aid provision declined for most Western donors.