The foreign aid community increasingly asserts that stronger institutions are critical for development and for aid to have beneficial effects. Can aid reform institutions? The findings of the new institutional economics support the premise that better institutions are required for development, but challenge the proposition that aid can reform institutions. The realities of aid and the nature of aid organizations are at odds with what we know about institutional change: that it is often gradual, path dependent, context specific, and contrary to notions of best practice in Western countries. Empirical analyses find no positive correlation between aid and better institutions or between aid and growth in GDP per capita. Can aid avoid institutions? Efforts to avoid the ill effects of damaging institutions by relying on NGO’s or beneficiary participation, have met with mixed success. Efforts to aid only those poorer countries that are improving their institutions have confronted serious measurement and incentive problems. This paper calls for more experiments, better local information, and greater local capacity to design sustainable institutional reforms.

Mary M. Shirley is President of the Ronald Coase Institute, and co-founder and Past President of the International Society for New Institutional Economics.