Encouraging Trade Liberalization: Theoretical and Empirical Analysis of Foreign Aid as Prize

32 Pages Posted: 15 Jul 2011

See all articles by Malokele Nanivajo

Malokele Nanivajo

Southern Illinois University at Carbondale - Department of Economics

Sajal Lahiri

Southern Illinois University Carbondale - Department of Economics

Date Written: July, 15 2011

Abstract

We examine how foreign aid can be used to induce a recipient country to engage in trade-policy reforms. First, we develop a two-country and two-period theoretical model where the donor's promise of aid in period 2 depends on the recipient's chosen tariff in period 1. Without aid, optimal tariff is positive because of the presence of lobbying in the recipient country. We consider three variants of the model depending on whether the donor government is passive or active, and, when the donor government is active, whether the two governments move simultaneously or sequentially. When the donor government is active, it optimally chooses the degree of ex-post conditionality on aid. We find, inter alia, that if a passive donor government increases the level of ex-post unconditional aid, or decrease the degree of ex-post conditionality, optimal tariff goes up. Using a panel data, we then examine if there is any evidence for the ex-post conditionality of aid, and how this conditionality has affected the effectiveness of aid. We find some positive evidence on both counts.

Keywords: Foreign Aid, Tariffs, Ex-post conditionality, Welfare, Lobbying

JEL Classification: F35, F13, I31, O19

Suggested Citation

Nanivajo, Malokele and Lahiri, Sajal, Encouraging Trade Liberalization: Theoretical and Empirical Analysis of Foreign Aid as Prize (July, 15 2011). Available at SSRN: https://ssrn.com/abstract=1886361 or http://dx.doi.org/10.2139/ssrn.1886361

Malokele Nanivajo

Southern Illinois University at Carbondale - Department of Economics ( email )

Mail Code 4515
Carbondale, IL 62901-4515
United States

Sajal Lahiri (Contact Author)

Southern Illinois University Carbondale - Department of Economics ( email )

MC 415
1000 Faner Drive
Carbondale, IL 62901
United States

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