Foreign aid and corruption: Unveiling the obstacles to effective development

Abstract

Empirical evidence suggests that foreign aid may be ineffective and have a corruption‐promoting effect. This article presents a growth model in which foreign aid can enhance the government's ability to acquire productive public goods. However, foreign aid incentivizes corrupt firms to engage in bribery and divert public resources, reducing the provision of public goods and hindering productivity and growth. This corruption‐promoting effect renders foreign aid counterproductive when it surpasses a certain threshold, particularly in the presence of weak institutions. The article proposes anti‐corruption policies to enhance the effectiveness of foreign aid, stressing the importance of conditionality in foreign aid and coordination among donor countries in giving the right incentives to the recipient country's governments.