Competition for Aid and Trade Policy

This paper considers the optimal allocation by a donor country of a given amount of foreign aid between two recipient countries. It is shown that, ceteris paribus, a country following a more restrictive trade policy would receive a smaller share of the aid if the donor country maximises its own welfare. If, on the other hand, the donor country maximises the sum of the welfare of the two recipient countries, the result is just the opposite. We also analyse the situation where the recipient countries compete with each other for aid taking into account the behaviour of the donor. It is shown that this competition tend to lower the level of optimal tariffs in the recipient countries.