An Empirical Analysis of the Effects of Aid for Trade on Foreign Direct Investment: International Evidence

Abstract

This thesis investigates the relationship between Aid for Trade (AfT) and foreign direct investment (FDI) to draw policy implications for ways to maximize the effectiveness of aid so as to lay the foundations for sustainable development.

In the era of the Sustainable Development Goals (SDGs), all nations have been called upon to lead more prosperous and sustainable development paths by 2030. As a result, the need for more effective development aid could not be greater in order to finance this transformation. Nevertheless, there has been controversy over the effectiveness of aid in reducing poverty and promoting economic growth in recipient countries.

Acknowledging FDI as an integral part of development finance and its positive impact on economic growth, this paper emphasizes the role of AfT in recipient countries to create more favorable investment conditions through the removal of critical impediments to higher levels of FDI.

This paper empirically examines whether AfT and its components affect FDI inflows on a balanced panel of 128 developing countries from 2002 to 2015 by using a fixed effects model. Overall, the results show that AfT has a significant and substantive effect in promoting FDI inflows to recipient countries, while ODA has no statistically significant effect. Specifically, aid invested in economic infrastructure and towards building productive capacity is most effective in attracting FDI inflows. Moreover, analysis at the regional level shows that AfT is effective in promoting FDI across regional groups, with the exception of sub-Saharan Africa, which receives the largest share of AfT.