The first part of this thesis demonstrates how economic inequality in the aid recipient country is detrimental to aid effectiveness. We model a recipient country that is characterised by a relatively rich local elite and poor rest of the population that compete over economic resources. Foreign aid is shown to be more effective when there is lower economic inequality, because of the lower contesting ability of the elite in this scenario. This hypothesis is supported by evidence using data from 59 recipient countries over 1971-2005. The second part of the thesis analyses two types of aid using a neoclassical growth framework, integrating the economies of aid donor and recipient. The focus is on the comparison between aid invested in social projects, such as building schools, hospitals, and aid invested in economic projects, such as building roads and bridges. Both types of aid are assumed to raise the productivity of the households in the recipient country, but social aid is also allowed to have a `direct effect' on the utility of these households. The projects can also differ in terms of their productivity and aid wastage levels. Because of this `direct effect' social aid has an advantage over economic aid. However, when the social-aid wastage exceeds a certain level, the advantage of the social aid rapidly decreases in the level of social aid wastage, up to a point of becoming negligible. This questions whether the recent surge in social aid can be justified in countries with social sectors characterised by high aid wastage
