The Logic of Aid Allocation

Bill Easterly takes issue with the logic behind the creation of the Millennium Challenge Corporation, a new US aid agency, in a recent blog post:

So a few years ago, some World Bank research found that “aid works {raises economic growth} in a good policy environment.” This study got published in a premier journal, got huge publicity, and eventually led President George W. Bush (in his only known use of econometric research) to create the Millennium Challenge Corporation, which he set up precisely to direct aid to countries with “good policy environments.”

Unfortunately, this result later turned out to fail the data mining tests. Subsequent published studies found that it failed the “new data” test, the different time periods test, and the slightly different specifications test.

All good points, but Dr. Easterlty overstates the case that the primary motivation for the creation of the MCC was the Burnside and Dollar result that aid works in good policy environments. The other main argument for the MCC was that it would, potentially, create a set of incentives for countries to pursue good policies. I don't claim to know what went on inside former president Bush's and his advisors' heads when they decided to create the MCC, but if you take their statements at face value, the potential incentive effect played a much larger role in their thinking. (Check out Bush's original speech announcing the creation of the MCC -- the word "reward" is used multiple times while the Burnside and Dollar result is only alluded to in passing.)

Not that the incentive argument is that compelling either, but then again, you have to allocate aid on the basis of something, right? At least adhering to a strict set of rules reduces the degree to which aid is allocated on the basis of foreign policy priorities which, I think, is a good thing.