Our aim is to understand if and when aid is effective. This paper measures the
impact of foreign aid, conditional on how and where it is spent. If aid has diminishing
marginal returns, then aid should have the greatest impact when allocated to where
it is needed most. Relatedly, when aid allocation is based on political favoritism, such
aid may have less impact because need is not so high, or because the goal is merely
to deliver aid projects to politically important constituencies rather than to achieve
development goals. Our analysis has a two-stage approach that identifies first the
determinants of aid allocation and then the impact of aid. We improve upon previous
observational studies on the impact of foreign aid by focusing on how sector-specific
aid projects affect outcomes in their respective sectors, rather than examining gross
aid flows’ effect on general outcomes like economic growth. Our analysis draws on
multiple data sources from Malawi that measure need for development aid, geo-coded
distribution of aid projects, and development outcomes.