We examine the allocation of foreign aid by 41 donor agencies, bilateral and multilateral. Our policy selectivity index measures the extent to which a donor's assistance is targeted to countries with sound institutions and policies, controlling for per capita income and population. The poverty selectivity index analogously looks at how well a donor's assistance is targeted to poor countries, controlling for institutional and policy environment as measured by a World Bank index. Our main finding is that the same group of multilateral and bilateral aid agencies that are very policy focused are also very poverty focused. The donors that appear high up in both rankings are the World Bank's International Development Association (IDA) facility, the International Monetary Fund's Enhanced Structural Adjustment Facility (ESAF), Denmark, the United Kingdom, Norway, Ireland, and the Netherlands. As a robustness check we alternatively use institutional quality measures independent of the World Bank and find the same pattern of selectivity. We also find that policy selectivity is a new phenomenon: in the 1984-89 period, aid overall was allocated indiscriminately without any consideration to the quality of governance, whereas 10 years later there was a clear relationship between aid disbursements and institutions. This increasing selectivity of aid is good news for aid effectiveness. The bad news is that the aid agencies that we survey vary greatly in size. Some donors that are largest in absolute size, such as France and the United States, are not particularly selective. Japan comes in high on the policy selectivity index but far down on the poverty selectivity index, reflecting its pattern of giving large amounts of aid in Asia to countries that are well governed but in many cases not poor.

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Much of the academic debate on the effectiveness of foreign aid is centered on the relationship between aid and growth. Different aid-growth studies find conflicting results: aid promotes growth everywhere; aid has a zero or negative impact on growth everywhere; or the effect of aid on growth depends on recipient-specific characteristics, such as the quality of institutions and policies. Although these studies fuel an interesting debate, cross-sectional macroeconomic studies cannot be the last word on the topic of aid effectiveness. In this paper, Dollar and Levin introduce microeconomic evidence on factors conducive to the success of aid-funded projects in developing countries. The authors use the success rate of World Bank-financed projects in the 1990s, as determined by the Operations Evaluation Department, as their dependent variable. Using instrumental variables estimation, the authors find that existence of high-quality institutions in a recipient country raises the probability that aid will be used effectively. There is also some evidence that geography matters, but location in Sub-Saharan Africa is a more robust indicator of lower project success rate than tropical climate. The authors proceed to disaggregate the success rate of World Bank projects by lending instrument type and by investment sector, finding that different institutions are more important for different types of projects. The finding of a strong relationship between institutional quality and project success serves to provide further support to the hypothesis that aid effectiveness is conditional on institutions and policies of the recipient country.

Much of the academic debate on the effectiveness of foreign aid is centered on the relationship between aid and growth. Different aid-growth studies find conflicting results: aid promotes growth everywhere; aid has a zero or negative impact on growth everywhere; or the effect of aid on growth depends on recipient-specific characteristics, such as the quality of institutions and policies. Although these studies fuel an interesting debate, cross-sectional macroeconomic studies cannot be the last word on the topic of aid effectiveness. In this paper, Dollar and Levin introduce microeconomic evidence on factors conducive to the success of aid-funded projects in developing countries. The authors use the success rate of World Bank-financed projects in the 1990s, as determined by the Operations Evaluation Department, as their dependent variable. Using instrumental variables estimation, the authors find that existence of high-quality institutions in a recipient country raises the probability that aid will be used effectively. There is also some evidence that geography matters, but location in Sub-Saharan Africa is a more robust indicator of lower project success rate than tropical climate. The authors proceed to disaggregate the success rate of World Bank projects by lending instrument type and by investment sector, finding that different institutions are more important for different types of projects. The finding of a strong relationship between institutional quality and project success serves to provide further support to the hypothesis that aid effectiveness is conditional on institutions and policies of the recipient country.