Tariff Overhang and Aid: Theory and Empirics

In this paper, we consider aid payments as a possible explanation for tariff overhangs. According to our hypothesis, rich countries may use development aid to pay for tariff concessions. Developing countries, in turn, may anticipate such a policy in the negotiations for tariff bindings. Setting the bound tariff rate at a relatively high level may then serve as a mechanism to incentivize rich countries to carry on with aid payments in the subsequent ``aid for trade’’ game. We empirically examine this hypothesis using detailed data (at the 6-digit HS level) on bound and applied tariff rates under the Uruguay agreement. Our results provide strong support for the view that aid recipients are more likely to adopt tariff overhangs, that they implement larger tariff overhangs than nonrecipient countries and that recipients of larger aid payments adopt tariff overhangs more frequently. We also find strong support of the theoretical model prediction that larger tariff overhangs are implemented by countries that receive more aid.