Aid - Trade Linkages : Analysis of the Trading Costs in the Least Developed Countries
Foreign aid is the subject in development economics that created controversies about its influences on the economy of the recipient countries. This study is an attempt to explain the effects that aid may have on trade, with a focus on the trade costs associated with the creation of business ties. Tied aid creates incentives for the developing countries to keep positive trading relationships with their donors, mainly because of the diminishing trad-ing costs associated with long term contacts. Subsequently, programs related to infra-structure and trade enforcement have been launched, that work towards the integration of the Least Developing Countries into the world economy.This study includes the analysis of the trade flows and foreign aid disbursement be-tween the “Group of Seven” countries (G7) and the Least Developing Countries, for a time span of 22 years (1988-2009). The results show that aid does have a significant ef-fect on the trade flows between the developed and developing countries. The explana-tion to this is related to the trading costs and the infrastructure development that tends to diminish the costs linked to distance- and border-related issues, and the sunk costs of market research and entry. In accordance, the distance coefficient is smaller after 1997, as result of decreased trade costs and increased export flows from recipients to donors.
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