coefficient of aggregate aid (Column 12) was observed. These increasing significance levels of social and aggregate aid could be attributed to joint effects from change in institutional quality. In other words, the impact of aid on growth can be more significant in a recipient country whose institutional quality and capacity in particular are improving. In contrast, the positive coefficient of economic aid lost its significance in this set of variables (Column 10) due to a statistical limitation. This supposedly inaccurate result came from the high correlation between economic aid and change in institutional quality that the current study confirmed in the correlation matrix.

On top of these estimations of institutions and aid, we added inflation as a selected policy variable (Columns 14-16). Inclusion of inflation did not change the core results; it only increased the coefficients’ size and significance of all aid variables. Columns 15 and 16 proved the robustness of this key finding with an additional insight: the effectiveness of social and aggregate aid is larger and more significant with improving institutional quality, and it further increases in a country where monetary policy is appropriately managed. The estimation of economic aid (Column 14) did not show the same result, regardless of our hypothesis that economic aid would work better where institutional quality is improving. The insignificance attached to economic aid simply indicates that the statistical problem arising from the high correlation between economic aid and change in institutional quality remains in this estimation. This issue prevents us from adding these two variables together in growth regressions in the current study. The distorted result cannot be directly compared with the results of social and aggregate aid, which do not have the correlation problem with change in institutional quality. Therefore, the regression results of economic aid with change in institution (Columns 10 & 14) are presented only for reference in this paper.

We also should not ignore the fact that the negative coefficient attached to the SSA regional dummy persisted. The SSA nations tend to lag behind in promoting growth and effectiveness of aid. This suggests that the characteristics of the region should be taken into consideration in formulating and implementing development strategies.

# **4.2 Building Institutions Matters for Development Effectiveness**<sup>**21**</sup>

Table 3 shows the impact of aid on countries with different institutional levels and rates of change in institutions. We estimated the effects of aid by dividing samples based on different conditions of institutional quality: high, low, improving, or not improving, as defined in the section detailing model specification. Using the estimation results of Columns 6, 7, and 8 in Table 2 as a base (these are listed again in Columns 1, 6, & 11 in Table 3 for quick reference), we further examined the impact of economic, social, and aggregate aid in the respective sample groups.

When we tested the sample groups divided by initial level of institutional quality, we found that the impact of aid became less significant (Columns 2, 3, 7, 8, & 12) no matter how high or low the institutional

> 21 Some parts of this chapter are drawn from Hirano (2014).

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