Tied Aid, Trade-Facilitating Aid or Trade-Diverting Aid?

Donor aid is often regarded as being informally tied (aid increases donor-recipient exports) and this effect is in general interpreted as being harmful to aid recipients. However, in this paper, using a gravity model, we show that aid is positively associated with recipient-donor exports as well. That is, aid increases bilateral trade flows in both directions. Our interpretation is that an intensified aid relation works as to reduce the effective cost of geographic distance. We analyse the effects from various foreign development assistance variables on the recipient as well as donor country exports. We find a particularly strong relation between aid in the form of technical assistance and exports in both directions, supporting our interpretation that market knowledge through interpersonal relations is an important driver for exports. Moreover, when disaggregating aid to specifically study the effects from trade-related assistance (Aid for Trade), the positive correlation shows up with donor exports only. The link between donor export and aid is particularly strong in the case of export to Sub-Saharan African countries while the relation between recipient export and aid seems to be robust across regions. While the statistical relations between aid and trade seems robust to changes in specification and time-periods, it is intrinsically hard to provide clear evidence on a causal relation. Our sample includes all 184 countries for which there are data available during the period from 1990 to 2005.