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Why is it that there is almost universal agreement that foreign aid— sometimes called donor aid or development assistance—has not been particularly effective (Collier 2002; Espina and Zinnes 2003; Easterly 2006a and 2006b; World Bank 1998)?1 Slowly the donor community has come to realize that the problem is not primarily one of insufficient funding.2 Rather, it appears to be related to the incentives created by the relations among donor country voters, donor organizations, technical assistance implementers, intermediary recipient governments, and final aid beneficiaries, among others (Murrell 2002). Clearly, some of these relationships are horizontal and some are vertical. In some there may be “teamwork” or competition; in others there is hierarchy, which may be well or poorly managed (or supervised). In short, the root of the problem of aid effectiveness is institutional. By institutions I mean the set of rules, strategies, payoffs, and players, as well as player beliefs about all of these.3 Thus “institution” may refer to culture, norms, markets , firms, government, organizations, and legislation. It also includes donorrecipient assistance contracts. Associated with this insight is the ever greater attention paid to governance, monitoring and evaluation, indicator design, 1 Introduction 1 1. See also William Easterly, “Dismal Science,” Wall Street Journal, November 15, 2006, p. A18; “The U.N. Millennium Project for Ending World Poverty,” Wall Street Journal, December 5, p. A19. 2. There are those (Sachs 2005) who nevertheless believe that a significant increase in funding is a central part of the solution. I revisit this view in section 6.5.3. 3. See Weingast (1995) and Williamson (2003) for discussions of the role of institutions in economic development. 11601-01_Ch01-rev.qxd 5/4/09 11:19 AM Page 1 public participation, and participatory development (Williams and Kushnarova 2004). Likewise, these are not issues limited to donor aid but are also applicable to local-level government services and regulation as well as private sponsors of diverse initiatives. Part of the reason for the emerging deeper understanding of these challenges comes from advances made over the last two decades in what is now called the new institutional economics (NIE).4 1.1 Challenges to Effecting Change Consider briefly the sponsors’ conundrum.5 They wish to provide development assistance to recipients (or, in the case of a central government, revenues to decentralized local governments) in an environment foreign to the sponsors and in such a way that the sponsors’ explicit and implicit objectives are met.6 These tend to be highly multidimensional (Alesina and Dollar 2000) and include a desire for the consequences of sponsor intervention to be sustainable in the long run.7 Likewise and at least officially, sponsors would like their funds to be applied in a cost-effective fashion. Unfortunately, this is more of a challenge than first meets the eye. To understand why one must examine the path or steps through which this process might typically pass.8 First, the sponsor must manage and empower its own staff to identify an appropriate area for recipient country improvement and then determine the requisite intervention to address the problem. It must then find and contract an implementer, which it must monitor. The implementer will generally have to interact with agencies of the recipient government, which may in turn need to delegate to their subordinate territorial units. When presented this way, the opportunities for mistakes as well as malfeasance or shirking are formidable . Given the limited local knowledge as well as operative control the sponsor has in a typical situation, it is no wonder things do not always go the sponsor’s way, ignoring whether its own objectives were appropriate in the first place. 2 INTRODUCTION 4. See Furubotn and Richter (1999) for an extensive treatment or Azfar (2003) for a review of NIE. 5. The word “sponsor” rather than “donor” has been chosen to underscore that the mechanisms upon which the present work focuses apply to most non-market initiatives organized by an outsider. 6. “Foreign” here is in the sense of “unfamiliar,” for example, a given municipality’s environment is generally foreign to its central government. With regard to objectives, the U.S. Agency for International Development (USAID), for example, in spite of having an explicit Results Review and Resource Request (R4) framework (see section 3.1.4), also wants to promote trade and business with the United States, American air carriers, U.S. small business, and U.S. female entrepreneurs, not to mention having a case-specific political agenda. The question...

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