Aid for Trade and Foreign Direct Investment: Effects on Poverty Reduction

Abstract

We assess the role of aid for trade (AFT) and foreign direct investment (FDI) in poverty reduction. We analyze their impacts across different country-level income groups and between agriculture-dependent economies and those that are not. Based on data for 91 developing countries, and employing fixed effects and random effects models, our empirical analyses indicate that AFT flows have a robust and positive effect on poverty reduction but the effect differs across countries by income groups and the impact is largest in LDCs. The analyses also show that while AFT may be effective, the extent to which it reduces poverty depends on the policies and quality of institutions in the recipient country. AFT is most effective in reducing poverty: (1) when directed to infrastructure and to trade policies and regulations; and (2) for economies with relatively small dependencies on agriculture. Also, AFT directed to infrastructure and trade policies and regulations increase, while AFT to productive capacity reduces net FDI inflows. Acknowledgement : Support for this paper was provided by the South Dakota Agricultural Experiment Station.