Although research has established the importance of state capacity in economic development, less is known about how to build that capacity and the role of external partners in the process. This paper estimates the impact of a typical development project designed to build state capacity in a low-income country. Specifically, it evaluates a multilateral development bank project in Tanzania, which incentivized investments in local state capacity by offering grants conditional on institutional performance scores. The paper uses a difference-in-differences methodology to estimate the project impact, comparing outcomes between 18 project and 22 non-project local governments over 2016–18. Outcomes were measured through two rounds of primary surveys of nearly 500 local government officials and nearly 3,000 households. Over the course of the project, measured state capacity improved in project areas, but due to comparable gains in non-project areas, the project’s value-added to change in state capacity is estimated to be zero across all the dozens of relevant variables in the surveys. The data suggest that state capacity is evolving in Tanzania through endogenous changes in trust and legitimacy in the country rather than from financial incentives offered by external partners.

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