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Reorienting Foreign Aid*

This chapter applies the theory of targeted development to foreign aid and analyzes bilateral aid allocation from 23 donors to 156 recipient for the period 1973–2012. The targeted development framework predicts that donors will use aid where it can most benefit themselves by decreasing negative spillovers from underdevelopment, and that this concern with spillovers will have grown as globalization has increased. The analysis shows that in the post-2001 period, donors give more aid to nearby countries and to those that are linked to themselves through trade, migration, or historical ties. These countries have an increased likelihood of transmitting spillovers to the donor state. This marks a change from the Cold War period, when non-development considerations were leading determinants of aid policy. The analysis also shows that donors alter the composition of aid based on the quality of governance in a recipient, consistent with an attempt to increase aid effectiveness.