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. Developing countries, in turn, may anticipate such a policy in the negotiations for tariff bindings. Setting the bound tariff rate at a relatively high level can serve as a mechanism to incentivize rich countries to carry on with aid payments in the subsequent “aid for trade” game. We empirically examine this hypothesis using detailed data on WTO members’ bound and applied tariff rates under the Uruguay agreement. The data sample contains almost all aid recipients participating in the Uruguay round negotiations. Our results provide strong support for the model’s prediction that larger tariff overhangs are implemented by countries that receive more aid.