Does Aid for Trade Promote Vertical Specialization?

We study the impact of Aid for Trade (AfT) and analyze whether aid recipients participate in bilateral vertical specialization. Using data from 15 donors and 106 recipients for the years 2002 to 2018, we investigate whether bilateral AfT increases bilateral vertical specialization. To focus on the variation between donors and recipients over time, we absorb other sources of variation through donor–year, recipient–year and donor–recipient fixed effects. Our findings show that AfT helps expand bilateral vertical specialization for a particular group of countries, upper middle‐income countries. Subsequent analysis reveals that AfT improves the infrastructure of upper middle‐income countries, which promotes participation in vertical specialization. Our findings suggest that to promote vertical specialization in lower income countries, AfT should be provided more directly to improve their infrastructure.