The Foreign Aid Effectiveness Debate: Evidence from Malawi

Working Paper 6 March 2015 Rajlakshmi De and Charles Becker Understanding the role of foreign aid in poverty alleviation is one of the central inquiries of development economics. To augment past cross-country studies, this paper offers a first step toward addressing the absence of disaggregated estimates of the allocation and impact of foreign aid. Newly geocoded aid project data from Malawi are used in combination with multiple rounds of living standards data to assess the allocation and impact of health aid, water aid, and education aid. Allocation is modeled using living standards variables, geographic indicators, and other aid bundling. Significant, positive effects of health aid on decreasing disease severity and of water aid on decreasing diarrhea incidence were estimated through both IV and PSM difference-in-differences approaches. An appropriate instrument for education aid could not be determined, but propensity score matching methods indicate a potential positive effect of education aid on school enrollment. Different aid donors’ allocation behaviors are also assessed. The aid impact results suggest that a sub-national framework provides sufficient granularity for detecting the impacts of foreign aid on poverty alleviation in Malawi and that policymakers and governments should use geographic living standards information to inform future aid allocation. Acknowledgement: The views that we express are our own and do not necessarily represent those of the Federal Reserve Bank of New York or the Federal Reserve System. We are grateful for comments and suggestions received at the 7th Annual Southeastern International Development Economics Workshop (Federal Reserve Bank of Atlanta, December 2013) and the Economics Department seminar at the College of William & Mary (November 2014). We thank Kehinde Ajayi, Ariel BenYishay, David Feldman, Lori Leachman, Laura Paul, Felix Rioja, Susan Steiner, Duncan Thomas, Ed Tower, and Elizabeth Wilke for detailed and useful comments. We also thank aiddata.org, the World Bank, and the National Statistical Office of Malawi for the data used in our study. All errors of fault and interpretation remain our own.