Aid Dependence and the Quality of Governance: A Cross-Country Empirical Analysis

Abstract

Good governance--in the form of institutions that establish a predictable, impartial, and consistently enforced set of rules for investors--is crucial for the sustained and rapid growth in per capita incomes of poor countries. Aid dependence can potentially undermine institutional quality, by weakening accountability, encouraging rent seeking and corruption, fomenting conflict over control of aid funds, siphoning off scarce talent from the bureaucracy, and alleviating pressures to reform inefficient policies and institutions. Analyses of cross-country data in this paper provide evidence that higher aid levels erode the quality of governance, as measured by indexes of bureaucratic quality, corruption, and the rule of law. This negative relationship strengthens when instruments for aid are used to correct for potential reverse causality, and is robust to changes in the sample and to several alternative forms of estimation.