Do Donors Care About Declining Trade Revenue From Liberalization? An Analysis of Bilateral Aid Allocation

Many developing-country governments rely heavily on trade tax revenue. Therefore, trade liberalization can be a potential source of significant fiscal instability and may affect government spending on development activities - at least in the short run. This article investigates whether donors use aid to compensate recipient nations for lost trade revenue or perhaps to reward them for moving toward freer trade regimes. The authors do not find empirical evidence supporting such motives. This is of some concern because binding government revenue constraints may hinder development prospects of some poorer nations. The authors use fixed effects to control for the usual political, strategic, and other considerations for aid allocations.