Does foreign aid promote economic growth? Such a question has typically been at the very heart of the long running debate over aid effectiveness. This thesis instead poses the question "Under what conditions is foreign aid effective?" Is aid more effective under the "right policies", good governance, in a post-war environment, as insurance against trade shocks, or in countries not ruled by the tyranny of geography? And if so, what are the implications for aid allocation and economic development?
A modified Ramsey-Cass-Koopmans model which incorporates the probability of receiving returns to investment shows that aid-effectiveness may be influenced by all of these factors. To systematically test these theoretical intuitions we construct panel data covering 61 countries for the years 1970 to 1999. Empirical tests of these relationships are applied by interacting foreign aid with over forty potential conditions of aid effectiveness, which include measures of policy, governance, poltical regime characteristics, conflict, geographical disadvantage and external shocks. The sensitivity of results to a number of alternate methodologies is also tested.
Results indicate that a numerous factors appear to systematically and differentially determine aid effectiveness, including one heretofore unconsidered by the previous literature: foreign direct investment flows. On the basis of these results three general precepts of conditional aid effectiveness are extracted for the benefit of donors. First, aid effectiveness is determined by a wide and varied array of factors, amongst which "getting the prices right" may play only a limited role. Second, aid is more effective in countries with less access to foreign investment in particular, and poorer countries in general. And third, aid effectiveness results are sensitive to sampling, choice of estimator, model specification and the presence of outliers. Despite the latter caveat, we nevertheless conclude that studies of this nature do present a promising avenue for future research; in particular, the reemergence of a theory of development which is willing to consider the potentially complex interactions between the causes and correlates of development.