Arvind Subramanian, Chief Economic Adviser to the Government of India, and co-authors have a nice summary of the effect of internal domestic aid on governance (the longer version is a chapter in the excellent Indian Economic Survey.) The bottom line is this:
The evidence suggests that all the pathologies associated with foreign aid appear to manifest in the context of intra-country transfers too
In particular, using one measure of aid to states, Redistributive Resource Transfers or RRT the authors find:
Higher RRT seem to be associated with:
- Lower per capita consumption
- Lower gross state domestic product (GSDP) growth
- Lower fiscal effort (defined as the share of own tax revenue in GSDP)
- Smaller share of manufacturing in GSDP, and
- Weaker governance.
Causality likely goes both ways of course but using an instrumental variable of distance to New Delhi (which correlates with transfers) the authors find suggestive evidence, as shown in the figure, that transfers are a cause of weaker governance.
It’s interesting to read an official government report which discusses instrumental variables!