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This paper dealt with the effectiveness of several alternatives of aid allocation in terms of poverty reduction. We use a model that admits the presence of diminishing returns to aid in the output and poverty functions. We shall discuss the impact of aid on poverty in a single country, showing that conditional aid to improve policies has a deeper impact than the other alternatives of aid allocation. But if the donor's aim is to maximise poverty reduction in a group of countries in presence of conflicts of interest between donor and recipient, a general rule to distribute aid cannot be stated a priori. Decreasing returns can offset the positive impact on incentives to improve policies and aid policy should be tailored according to the recipient characteristics.

Poverty Reduction and Aid Policy