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This paper studies the pattern of allocation of foreign aid from various donors to receiving countries. We find considerable evidence that the direction of foreign aid is dictated as much by political and strategic considerations, as by the economic needs and policy performance of the recipients. Colonial past and political alliances are major determinants of foreign aid. At the margin, however, countries that democratize receive more aid, ceteris paribus. While foreign aid flows respond to political variables, foreign direct investments are more sensitive to economic incentives, particularly “good policies” and protection of property rights in the receiving countries. We also uncover significant differences in the behavior of different donors.
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