An Assessment of the “Policy View” in Foreign Aid under Asymmetric Information

The policy view, which argues that foreign aid is effective only in a good policy environment, suggests that aid ought to be given to countries with good policies. This has generated a lot of interest and controversy. We argue that the key recommendation of the policy view runs contrary to other prescriptions, particularly those that arise under asymmetric information. Inefficiencies that derive from information problems often require that policy makers do not base the amount of foreign assistance on the recipient's policy effort. This suggests that donors should be cautious in applying the policy view. We also briefly discuss problems that are likely to emerge in estimating aid's productivity given policy in the light of potential information problems