Aid effectiveness: Opening the black box

Controversy over the aggregate impact of foreign aid has focused on reduced form estimates of the aid-growth link. The causal chain, through which aid affects developmental outcomes including growth, has received much less attention. We address this gap by: (i) specifying a structural model of the main relationships; (ii) estimating the impact of aid on a range of final and intermediate outcomes; and (iii) quantifying a simplied representation of the full structural form, where aid impacts on growth through key intermediate outcomes. A coherent picture emerges: aid stimulates growth and reduces poverty through physical capital investment and improvements in health.