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ABSTRACT aid can be effective in promoting economic growth and reducing poverty but there are also cases where aid has been wasted by the recipient nation. This study examines the effectiveness of foreign aid on income inequality, as measured by the GINI coefficient. Several studies have documented that foreign aid has a positive effect on economic growth, but few studies have focused on the impact that aid has on income inequality. While economic growth should benefit the economy as a whole, economic growth does not imply that income inequality will improve. Using data for twenty-nine countries and controlling for a variety of factors, the results of the study suggest that increased aid may actually be associated with higher levels of income inequality in the recipient nations. However, the results are sensitive to model specification. INTRODUCTION Foreign aid has at times been a spectacular success--and an unmitigated failure. Assessing Aid: What Works, What Doesn't, and Why, World Bank Policy Paper (1998) aid is a heavily researched topic. It is controversial from the standpoint that, when used correctly, aid has a tremendous impact on a developing economy. But, when used incorrectly, it is squandered, or worse, lines the pockets of a few individuals. aid levels reached their peak during the 1970s and 1980s and started to decline in the 1990s. Up until the 1990s, research indicates that foreign aid was given equally to countries with good and poor economic management. However during the 1990s, this changed due to the finding that foreign aid is more effective in countries with stable macroeconomic policies. This study enhances the body of literature on aid effectiveness by investigating the influence that foreign aid has on changes in income inequality for a sample of 29 countries. After controlling for various factors, the results of the study suggest that foreign aid negatively impacts changes in income inequality. The results, however, are sensitive to model specification. LITERATURE REVIEW Although very little research could be found on the direct relationship between foreign aid and income inequality, there is a plethora of research on the effectiveness, if any, of aid on recipient countries. There is also a significant body of research on the determinants of aid policy in donor nations and the main focus from this area will be how these policies appear to have been changing in recent years. Evidence that aid has begun to be allocated differently is provided by Dollar and Levin (2004), where they examined the allocation of foreign aid by 41 donor agencies. They found that there is a clear tendency among donor agencies to allocate more assistance to poor counties that have good economic governance. This contrasted with previous policies where aid was allocated on the basis of perceived need or other, possibly politically motivated, reasons, regardless of how corrupt or undeveloped the country's governance policies may have been. There is still an abundant amount of aid allocated based more on the purported needs of the donor country than the poverty levels of the recipient country. However, when aid is allocated based on poverty, the level of development of the country's institutions and policies is becoming increasingly important. Ireland, McGregor, and Saltmarshe (2003) discuss some of the major changes occurring at donor agencies. Donor agencies are increasingly concerned with the effectiveness of their assistance programs and many have instituted results-based approaches to assistance. Ireland, McGregor, and Saltmarshe (2003) examine the policies of donor agencies and review the relevant literature and identify four common areas of concern that have emerged as agencies institute performance assessment; ownership, decentralization and leadership, accountability, and learning and complexity. They conclude that performance assessment takes place in a very complex environment, an environment often made more complex by the agencies themselves. …
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