How Can Conditional Foreign Aid Reduce Poverty? Evidence from the Millennium Challenge Corporation (MCC)

Details

Supervisors

Gomes, Joseph

Faculty

Faculté des sciences économiques, sociales, politiques et de communication

Degree label

Master [120] en sciences économiques, orientation générale, à finalité spécialisée

Abstract

enThis paper studies the impact of foreign aid on poverty reduction through the case of the Millennium Challenge Corporation (MCC). Historically, analyses of foreign aid effectiveness have often relied on income-based metrics such as GDP (Burnside & Dollar, 2000; 2004; Collier & Dollar, 2002; Doucouliagos & Paldam, 2006; Minoiu & Reddy, 2009; Galiani et al., 2016). This research goes beyond these traditional measures, proposing to analyse the MCC’s impact using the Human Development Index (HDI) as a proxy for poverty reduction, a more precise indicator of well-being that includes health, education, and income. The MCC, a U.S. government initiative, allocates aid based on countries’ performance in governance, economic freedom, and investment in human capital. Using a difference-in-differences event study regression approach, specifically the normalised event study estimator developed by de Chaisemartin and D'Haultfœuille (2020), this study tests the causal effect of MCC aid on HDI in recipient countries. Our findings indicate that MCC aid has statistically significant positive impact on reducing poverty indicators through the HDI variable. More specifically, the effects are positive and statistically significant in the third- and fifth years following programme signing, suggesting that conditional aid can lead to long-term development results when specific conditions are met. While the results of these effects are small, they represent meaningful progress. We acknowledge many issues such as a violation of the parallel trends assumption due to pre- treatment divergence, potentially reflecting an “MCC incentive effect” where countries improve policies in anticipation of aid. Despite these complexities and data limitations, the consistency of results across multiples estimation strategies reinforces the validity of the hypothesis that MCC assistance positively impacts HDI. This research contributes to the foreign aid literature by providing evidence on conditional foreign aid effectiveness using new statistical event study methods.