Japan emerged as a leading foreign aid donor in the 1980s. Since aid diplomacy has received so much attention in Japan, it needs to be asked how effective the use of aid has been both politically and economically. Furthermore, has Japanese aid been qualitatively different from the aid by the other donors? Is there scope for changing the policy and institutional framework so that Japanese aid can become more effective?

Not much in the way of rigorous economic analysis was done to understand the mode of aid allocation and its economic impact until recently. Based on some of this recent work, this paper addresses the issues related to the economic effectiveness of Japanese aid in South and Southeast Asia. Starting with the basic economics of aid allocation, some estimates of the impact of aid on development and non-development expenditures are presented. The effect on domestic revenue-raising efforts of the recipients can also be estimated with the help of a decision making model with boundedly rational policymakers. However, the mode of aid management and its changing objectives also need further consideration in order for aid to optimally raise the economic well-being of the people in the recipient countries. I conclude by asking some questions about the future course of Japanese aid in this context and outlining a broader agenda for assessing the objectives and management of Japanese aid.