Aid for Trade and the Real Exchange Rate

ABSTRACT

The current analysis contributes to the literature on the real exchange rate effect of development aid by separating the real exchange rate effect of the development aid allocated to the trade sector (Aid for Trade – AfT) from the effect of other aid flows. The empirical findings show that higher AfT flows lead to a depreciation of the real exchange rate in recipient economies, while other development aid flows generate an appreciation of the real exchange rate. The real exchange rate effect of total AfT flows works through trade openness, export product diversification, and inward foreign direct investment stock.

KEYWORDS:

• Aid for Trade
• non-aid for trade
• real exchange rate

Acknowledgments

This article represents the personal opinions of individual staff members of the WTO and is not meant to represent the position or opinions of the WTO or its Members, nor the official position of any staff members. The author expresses his sincere gratitude to the two reviewers and the Editor for their very useful and in-depth comments on the earlier versions of the paper. Any errors or omissions are the fault of the author.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Supplementary material

Supplemental data for this article can be accessed on the publisher’s website

Notes

¹ These studies include, for example, Adams (2005); Adam and Bevan (2006); Addison and Baliamoune-Lutz (2017); Adu and Denkyirah (2018); Arhenful (2013); Edwards and van Wijnbergen (1989); Issa and Ouattara (2008); Nkusu (2004); Nyoni (1998); Ouattara and Strobl (2008); Vos (1998); White (1992); White and Wignaraja (1992); and Younger (1992). A recent literature review on the real exchange rate effect of development aid has been provided by Adu and Denkyirah (2018).

² The list of countries contained in the category of LDCs is designated by the United Nations. The latter considers LDCs as the poorest and most vulnerable countries in the world to economic and environmental shocks (see http://unohrlls.org/for further information).

³ This expansion might not be in the same proportion for both output of tradables and output of non-tradables.

⁴ It is worth noting here that human capital accumulation and institutional improvement also play an important role in the expansion of the tradables sector, as they are essential for the improvement of countries’ exports performance.

⁵ A literature survey on the matter could be found in Cadot et al. (2014) and OECD-WTO (2017).

⁶ See, for example, Bearce et al. (2013); Busse, Hoekstra, and Königer (2012); Cadot et al. (2014); Calì and te Velde (2011); Gnangnon (2019a); Ghimire, Mukherjee, and Alvi (2013), (2016); Helble, Mann, and Wilson (2012); Hoekman and Shingal (2020); Hühne, Meyer, and Nunnenkamp (2014a), (2014b); Hynes and Holden (2016); Martinez-Zarzoso, Nowak-Lehmann, and Rehwald (2017); Vijil (2014); and Vijil and Wagner (2012).

⁷ For example, Bernard, Jensen, and Schott (2006) have shown the positive effect of trade costs reduction on growth productivity within firms.

⁸ Hühne, Meyer, and Nunnenkamp (2014a) found that AfT flows can result in higher recipient countries’ imports from donor-countries.

⁹ The Appendix can be found online at www.tandfonline.com/uitj.