Export Upgrading in Donor and Recipient Countries and Bilateral Development Aid Allocation.

Author:Gnangnon, Sena Kimm
 
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  1. Introduction

    The role of trade in aid allocated by donors to recipient-countries has been the subject of many studies in the body of the aid literature (1) that explores the determinants of donors' aid supply, either for aggregate aid or for bilateral aid.

    On the one hand, the literature on the determinants of aggregate ODA supply has demonstrated that several factors can affect the supply of foreign aid by donors to recipients, including macroeconomic factors, international and domestic political factors. Trade, in particular, is considered an important determinant of donors' ODA allocation. A detailed literature survey on these determinants can be found in Fuchs et al. (2014). The survey of these authors shows that the findings of studies exploring the impact of trade on foreign aid supplied by donors remain inconclusive. For example, Bertoli et al. (2008) show empirical evidence that foreign aid increases when donor countries enjoy a strong positive trade balance. Tingley (2010) has questioned whether trade-dependent donor countries--with trade dependency measured by the sum of exports and imports relative to gross domestic product (GDP)--tend to be more "generous" in terms of aid supply than countries that are less dependent on trade. However, he does not find a significant effect of this variable. Lundsgaarde et al. (2007) provide empirical evidence that increased imports in a donor country from developing countries are associated with diminishing aid budgets (the amount of aid allocated by donors to recipient-countries). However, this impact observed by the authors is "loosely" significant, that is, significant at only the 10% level. In relation to bilateral aid allocation, Alesina and Dollar (2000) observe that donors allocate more aid to reward developing countries for the good quality of their economic policies, in particular their trade liberalization policies.

    On the other hand, an important strand of the literature has underscored the role of donors' exports on the aid they allocated. In particular, Claessens, Cassimon, and Van Campenhout (2009) highlight that earlier contributions to the aid allocation literature often reported a positive effect of donors' exports on aid.

    Berthelemy (2006) ranks various donor countries according to the elasticity of aid with respect to bilateral exports of the donor to the recipient country and obtains that most of the larger donors are rated "moderately egoistic" by this criterion. He concludes that export-related self-interest drives the donors' aid allocation. Likewise, Hoeffler and Outram (2011) find that all top five donor countries (France, Germany, Japan, the United Kingdom, and the United States) provide more aid to trading partners. It is worth noting that in contrast to Berthelemy (2006), Hoeffler and Outram (2011) have considered the flow of exports and imports between a donor and a recipient country. Dudley and Montmarquette (1976), Neumayer (2003) and Younas (2008) have demonstrated that a higher total of exports from donor countries to the recipient countries results in greater aid allocation. Barthel et al. (2014) use sector-specific aid data and examine whether donor-countries compete for export markets for foreign aid allocation. They find that the five largest donors react to aid giving by other donors with whom they compete in terms of exporting goods and services to a specific recipient country at both stages of their allocation of aid for economic infrastructure and production sectors. However, they find no evidence that export competition drives aid allocation for more altruistic donors and for aid in social infrastructure.

    Despite this important literature on the role of trade on the supply/allocation of development aid, to the best of our knowledge, the role of export product upgrading on aid allocation has not been investigated. In this study, export product upgrading entails either export product diversification or improvement in export product quality. Improvement in export product quality refers to improvement in the quality of existing products.

    Yet, some studies such as Munemo (2011) have shown that aid flows received by recipient countries matter for the degree of the export product diversification, but none study explores the relationship in the other direction. This paper aims to fill this gap in the empirical literature by exploring the impact of export product upgrading in both donor-countries and recipient-countries on donors' aid allocation. This is all the more relevant that the international trade literature has highlighted the importance for countries, in particular developing countries to upgrade their export products, including by diversifying their export products away from the primary sector, towards the manufacturing sector.

    This paper posits two main arguments: the first argument stipulates that donors would be willing to allocate higher aid to recipient-countries with a view to helping them spur their export performance--including, upgrade their export product--and better integrate into the multilateral trading system. Hence, recipient-countries with lower degree of export product diversification (or higher degree of export product concentration) would likely enjoy higher donors' bilateral aid. This willingness of donors is particularly in line with the World Trade Organization (WTO) Members commitments--through the Aid for Trade (AfT) Initiative--to provide higher AfT to recipient countries in order to "help them build the supply-side capacity and traderelated infrastructure that they need to assist them to implement and benefit from WTO Agreements and more broadly to expand their trade" (WTO Secretariat document WT/MIN(05)/DEC).

    Nonetheless, rather than focusing here only on AfT flows, we rely on total official development aid because the degree of export product upgrading in a recipient-country could affect both AfT as well non-AfT component of ODA. It is important to emphasize while the literature on the determinants of AfT effectiveness is scant, some studies such as Lee, et al. (2015) and Gnangnon (2016) have shown the importance of trade for AfT allocation by obtaining evidence of positive impact of trade openness in recipient-countries on AfT received by recipients.

    Likewise, donors could also provide higher aid flows to recipient-countries that upgrade their export products in order to further encourage them to do so. As a result, while we mainly expect export upgrading in recipient-countries to be associated with lower donors' bilateral aid supply, it is still possible to obtain a positive impact of export upgrading in recipient-countries on the bilateral aid that they receive.

    The second argument puts forth in this analysis is related to the influence of export upgrading in donor-countries on their bilateral aid allocation. In effect, we argue that as donors increase the diversification of their export products or as they improve the quality of their export products, they would likely experience lower unemployment rate, lower GDP volatility and higher economic growth that would in turn affect positively (and indirectly) their overall government revenue and consequently, their supply of development aid. Likewise, export product upgrading, by reducing the exposure of donor-countries to external shocks, could likely reduce the need for these countries to increase their expenditure to address the adverse consequences of external shocks and consequently improve the room in their budget to supply higher aid to recipient-countries.

    The empirical analysis is carried out in a donor-recipient bilateral relationship framework, i.e., by relying on dyadic data analysis. It suggests evidence that overall export product diversification in donor-countries does not matter for donors' bilateral aid supply to developing countries, but improvement in the overall export product quality in donor-countries does exert a positive impact on their bilateral aid allocation. At the same time, we obtain evidence that recipient-countries' overall export product concentration (or diversification) does not matter for the amounts of development aid inflows they receive from donors. Meanwhile, recipient-countries that improve the overall quality of their existing export products experience lower bilateral aid from donors. Furthermore, the analysis suggests evidence that the impact of recipientcountries' export upgrading (export product concentration and export product quality) on donors' bilateral aid supply depends on recipient-countries' level of economic development.

    The rest of the paper is organized as follows: Section 2 provides a discussion on the channels through which export product diversification in both recipient-countries and donor-countries could affect donors' aid allocation. Section 3 describes the model specification to be estimated, while Section 4 discusses the estimation strategy. Section 5 interprets the estimations' results and Section 6 concludes.

  2. Discussion on the effect of export product upgrading in recipient-countries and donor-countries on donors' aid allocation

    The literature has put forth several reasons to justify the need for diversification of export products. The structural models of economic development (see for e.g. Chenery, 1979; Syrquin, 1989) argue that countries should diversify their exports from primary products into manufactured products. This is in line with the Prebisch-Singer thesis (Prebisch, 1950; Singer, 1950) that vertical export diversification (which takes place by moving up the value chain to produce manufactured products) reduces declining terms of trade for commodity-dependent countries. Export diversification is an important engine for economic growth (see for e.g., Al-Marhubi, 2000; Lederman and Maloney, 2007; Agosin, 2007; Hesse, 2008). Export diversification also contributes to mitigating countries' vulnerability to economic shocks, including the volatility and...

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