The nature of aid and trade relationships

Researchers have analysed the relationship between aid and trade flows from donors to recipients to address one of two questions: (a) do donors use aid to increase their trade with recipients (aid leads to trade)? (b) Is trade a determinant of aid allocation decisions of donors (trade leads to aid)? As the 'aid and trade' relationship is bilateral, it may differ between donor and recipient pairs. For some pairs (a) may apply, for others (b), for others both and for others neither. This paper argues that appropriate testing for the nature of the aid and trade relationship must allow and 'test for these alternatives. Rather than pooling all observations into a sample to test for (a) or (b), which is shown to give misleading results, one should test if the underlying relationship differs in sub-samples. Using appropriate pooled samples, we find no evidence that tied aid increases trade, although donors providing a higher share of aid tend to trade more with the recipient. In terms of aid allocation, donors appear to be concerned with relative aid and trade shares rather than absolute volumes.