This paper analyzes decentralization as an instrument of development policy. The positive experience of high developed countries with federal government structures has shifted the focus of international development organizations to decentralization. In particular, decentralization should promote economic prosperity and reduce corruption. This paper argues, however, that the particular institutional framework of developing countries should be taken into account. This study demonstrates that fiscal decentralization tends to harm the effectiveness of foreign aid, whereas forms of political decentralization are less problematic. Moreover, decentralization can increase corruption in less liberal countries. In light of these findings, national and international development agencies should carefully consider potential negative consequences from decentralization.