Can Foreign Aid Motivate Institutional Reform? An Evaluation of the HIPC Initiative

A number of political economy concerns are associated with the provision of foreign aid to developing economies. These concerns suggest that foreign aid is likely to have harmful effects on a recipient's institutional quality; also that attempts to give aid conditional on policy and institutional reforms are unlikely to succeed. Established in 1996, the Heavily Indebted Poor Country (HIPC) Initiative is a comprehensive, structured attempt to provide multilateral foreign aid conditional on recipient reforms. We present evidence that the HIPC Initiative's track record has been lackluster. Based on the Economic Freedom of the World (EFW) index and the Freedom House political rights (PR) and civil liberties (CL) indices we find that most participating countries experienced either meager increases or outright decreases in institutional quality. Based on regressions of EFW, PR, and CL changes on HIPC Initiative aid disbursements, we find no evidence that the Initiative affects meaningful reforms. The best shot by the IMF and World Bank to link foreign aid to policy and institutional reforms has failed to overcome the perverse incentives that aid creates