AbstractThe paper examines the role of policy intervention in catalyzing institutional change. We identify two effects of development policy as a tool for institutional change. By increasing political accountability, it may encourage nascent democratic governments to invest in good institutions. However, it also increases incentives of the rentier elite to tighten their grip on political institutions. Which of these effects dominate determine if development policy will lead to democratic consolidation and economic improvement or to the worsening of existing institutions. If the elite are deeply entrenched, then modernization may require combining development policy with subsidies.