building institutions is key for increasing the effectiveness of aid. The empirical results clearly show that development effectiveness does not depend on the initial quality of a recipient country’s institutions, but it does depend on whether that quality, or capacity, is improving or not. It implies that even a country with lower institutional quality has the possibility of achieving higher growth, unlike the continuing debates on policy conditions for aid effectiveness. This suggests that development practitioners and policy makers should take this potential into consideration in their decision-making about aid allocation. This study also proposes that providing aid packages with institutional capacity-building schemes or projects could increase development effectiveness. This is new insight for the voluminous aid-growth literature. Past studies regarded institutional quality in their estimations as something that does not change for a long time (often using one indicator for the entire period); nevertheless, this study indicates the importance of change in institutional quality for development effectiveness.

Second, pro-poor country specific factors, or pro-poor institutions, are key for development effectiveness. The empirical evidence shows that the effectiveness of aid is positive and more significant in countries with a positive pro-poor fixed effects. Therefore, the study suggests that identifying pro-poor country fixed effects, and pro-poor institutions in particular, would help to increase development effectiveness. The combination of pro-poor country fixed effects and pro-poor effects of aid could bring about a synergetic effect for development effectiveness. This study also proposes policy makers and people in the development community take into consideration not only growth-enhancing policies and institutions, but also pro-poor institutions in allocating aid. With the optimal mix of pro-growth/investment-conducive institutions and distributional pro-poor/poor-empowering institutions, development effectiveness will be further increased. Here, a comprehensive survey of best practices and best pro-poor institutions could contribute to an enhancement in development effectiveness in our future practices.

These findings make contributions to two fields of literature: globalization and inequality, and aid effectiveness. First, the discovery of the significant pro-poorness of social aid and aggregate aid could shed new light on the controversial debate on globalization and inequality, where the current discourse asserts that there is no factor of globalization that has significant systematic effects on the poor (Dollar & Kraay, 2002; Dollar et al., 2013). Second, this study provides new perspective on the aid effectiveness controversy that has continued for the last 60 years. This study shows that aid is good for the poor by extracting the effects on different sectors and by looking at both the growth effects and distributional effects of aid. We argue that the reason why past cross-country empirics could not confirm the significant impact of aid is not because aid is ineffective, but because past efforts overlooked the distinct natures, and the corresponding distributional effects, of sector-specific aid, and thereby did not accurately assess aid effectiveness.

We hope this study will offer some evidence for policy makers, researchers, practitioners, and people in the development community to rethink the role of aid in effectively reducing poverty in a globalized world.

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