Abstract:
This dissertation sets out to understand how the effectiveness of foreign aid in promoting
economic growth in low-and middle-income countries could be improved. It does this by
merging the political economy/public choice literature, the industrial organization
literature, and the literature on development aid effectiveness and then developing a
theory based on this previous work. The dissertation is in eight chapters. Chapter I
introduces and outlines the arguments of the paper and demonstrates that institutions,
more than any other factor, are the fundamental cause of long-run economic growth.
Chapter II reviews the literature on barriers to institutional reform, exploring the political
economy/public choice problems in-depth and demonstrating that countries can get
caught in a trap of non-development and therefore a case for intervention exists. Chapter
III reviews the literature on Official Development Assistance (ODA) effectiveness,
demonstrating that it largely finds that ODA in the form of subsidized inputs such as
capital has failed to achieve its stated objective of facilitating economic growth in low-and
middle-income countries and outlining possible theoretical reasons for this failure.
Chapter IV reviews the history of ODA designed to influence policy outputs, such as
conditional loans and selective disbursements, finding that such efforts also failed to
make ODA directly cause growth, yet arguing that such innovations were a very positive
step in the right direction. Chapter V demonstrates empirically that foreign aid has been
moving in the right direction by rewarding improved institutions as it is found that
changes in ODA are increasingly positively correlated with changes in indicators of
institutional quality over time, thus supporting the notion that even though ODA may not
support economic growth directly, the future of foreign aid is to function as a mechanism
to produce political incentives compatible with the creation of institutions that lead to
good economic outcomes. Chapter VI analyzes advantages realized by moving away
from the practice of subsidizing inputs and outputs and toward a system where cash-transfer
type “prizes” are awarded on a rule-based system. Grants or prizes that are
conditioned on pre-defined improvements in institutional and/or economic outcomes
solve most of the informational, principal-agent, and political economy problems outlined
in the previous chapters. Chapter VII provides further applications by suggesting ways
that poor governments can support infrastructure development and spur industrialization
at home using the model developed here. Finally, Chapter VIII is a short conclusion that
reviews the arguments of the dissertation.
