While we received several, mostly supportive, comments on the post on "The World Bank and poverty reduction in South Asia", one of them hoisted me on my own petard:            

Why do you guys give loans when you know the policies [pursued] by these governments are - by your own assertions -...simply wrong? why do you go about subsidising wrong policies, by...financing over-staffed, over-spending, governments? especially budget support?

The comment highlights an important aspect of foreign aid in the current era.  Traditionally, foreign aid was aimed at correcting market failures--building public goods, such as bridges (like the Jamuna Bridge in Bangladesh pictured on the left) and dams, or subsidizing goods with positive externalities, such as primary education or immunization.

There was an alignment between the wishes of government and those of the aid donors: both wanted to correct market failures. 

More recently, though, another set of problems are confronting development:  government failures.  These are when the government, for various reasons, does not fulfill the functions it seeks to perform.  A classic example is the high degree of absenteeism among teachers (25 percent) or doctors (40 percent) in Indian public primary schools and primary health centers, respectively.  Now the preferences of the aid donor and government may not be so well-aligned.  The donor would like to see better education and health outcomes, including less absenteeism among service providers.  Even if there are people in government who would like to see this, the absentee teachers and doctors are also public servants, and in some cases can be quite powerful politically.  In such a situation, what is the role of aid?  Correcting government failure is deeply political (these failures didn't occur by accident), so aid donors can't "demand" that they be corrected (even though sometimes they try!).  Rather, the correction will come from sufficient public pressure to reform the policies that have been impeding poverty reduction.  The role of aid in these circumstances is not to "finance" a particular bridge or road, but rather to help build the climate for reform by, on the one hand, supporting public debate on these issues (by, say, publicizing information about absentee rates in different districts) and on the other, by focusing attention on the outcomes, such as educated and healthy children, by making these the basis for aid, as a comment from Nancy Birdsall and Kate Vyborny suggests.