Tariff overhang and aid: Theory and empirics

Abstract

In this paper, we consider aid payments as a possible explanation for tariff overhangs. We set up a theoretical model in which rich countries use development aid to pay for tariff concessions by poorer countries. The more aid they receive as compensation, the more poor countries reduce the applied tariff below the bound tariff rate. Anticipating this mechanism, countries can negotiate a bound tariff rate that induces the joint optimal applied tariff and aid as outcomes. We empirically examine the relationship between tariff overhangs and donor aid preferences using detailed data on WTO members’ bound and applied tariff rates under the Uruguay agreement. The data sample contains a predominant majority of WTO members that are aid recipients under the Uruguay agreement. Our results provide support for the model’s aid-for-trade mechanism.