Yet aid averaged only 0.22 percent of donor country GDP in 1997. In these circumstances, increasing aid, and allocating this aid to countries that can use it well, is a very cost-effective way to reduce poverty. In addition, recent reforms in developing countries have greatly increased the opportunities to use aid well. Our research suggests that nearly two billion people in dire poverty live in countries where more aid would speed poverty reduction. There is clear evidence that when a poor country such as Ethiopia or Uganda reforms, private investment does not immediately take off.
Investors are cautious about rushing in to recently-reformed countries.
This is because aid increases confidence in a reforming government and helps it provide services that investors rely on, such as infrastructure and social services. In countries with weak policies large-scale finance has not had the same beneficial effect, nor has it typically led to policy improvements. The track record indicates that making aid conditional on policy reforms does not always lead to policy reforms. When countries desire reform, conditional loans enable governments to lock in policy gains. To be effective in this, they need to focus on a small number of truly important measures.