Is there Anything Wrong with Tied Aid?

The paper examines the effects of tied-aid on the welfare of both the donor and the recipient countries. We depart from the previous literature by assuming pre-existence of quantitative trade distortions. To migrate these distortions the donor dountry provides aid that is tied to the rationed good. In this framework we show that the important factors that determine the welfare effects are the price elasticity of the donor's net supply of the export good, the degree of tiedness of the aid, and the quota rent retention parameter. Conditions for the presence of the transfer paradox are derived and interpreted under stability conditions. Furthermore, conditions where both countries gain from tied-aid are derived.