Has More Aid Worsened Governance since 1995? a Large-n Study of Six Quality

—Good governance—as measured by Kaufmann’s, Kraay’s, and Zoido-Lobatón’s six dimensions (voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption)—is empirically positively associated with good development outcomes. More recent empirical literature, however, has also revealed a link between aid dependence and bad governance. This poses a serious quandary for international development and requires a reexamination of what type of governance is affected by aid and why. This paper investigates this link by asking whether more aid has worsened or improved governance since 1995, and if so what type of governance has been affected. The first half of the paper surveys the concept of governance and adopts a definition. It also delves into issues of measurement. The author then constructs an entirely new dataset for up to 142 developing countries using existing sources (OECD and World Bank) for the purpose of analyzing the relationship between change in aid and change in the quality of governance across the six KKZ dimensions. The second half of the paper describes this data, with an emphasis on strengths and weaknesses, and performs crosscountry statistical analyses. A highly statistically significant finding is that government effectiveness improved with an increase in aid. Less robust findings are that political stability, regulatory quality, and rule of law worsened as a result of increasing aid. This suggests that a change in aid affects different types of governance differently. Change in aid had no effect on change in voice and accountability or change in control of corruption (the null hypothesis could not be rejected). Several findings are robust to changes in the sample and to alternative forms of estimation. Potential reverse causality was partially controlled for using a change-on-change model ex post. In addition, change in HIV/AIDS prevalence was used an instrumental variable for change in aid, but was not found to be statistically significant. Keywords—Governance, Foreign Aid, Economics of Development *I thank professor David Leonard for excellent comments on an earlier paper (Ear, 2001) from which material for the first half of this paper is based. I thank professor Jim Robinson, Dr. Steve Knack (World Bank), Dr. Hana Ross (UI-Chicago), professors Hu (Berkeley-SPH), Merriman (Layola University Chicago), and Peck (UI-Chicago) for econometric advice used in the second half of this paper. For unwavering intellectual and moral support and for introducing me to research on governance in the first place, I thank Dr. Clay Wescott (Asian Development Bank). The usual caveats apply; all errors remain my own responsibility. ROUGH DRAFT NOT FOR QUOTATION Please contact [email protected] for permission Preface This paper is divided into six sections.