Effect of Aid for Trade on Financial Development: Exploring the Channel of Manufactured Exports

Abstract

Many studies have considered the macroeconomic effects of Aid for Trade (AfT) flows, that is, the part of official development assistance allocated for the development of the trade sector. The present paper aims to expand this literature by investigating the effect AfT flows on financial development notably through channel of manufactured exports. The analysis has covered a set of 120 countries over the period 2002–2017, and relied primarily on the two-step system Generalized Methods of Moments (GMM). Results show that total AfT flows, notably its components AfT for economic infrastructure and AfT for productive capacity promote financial development, and the magnitude of these positive effects rises as countries' share of manufactured exports increases. Additionally, total AfT flows influence positively financial development in countries that diversify their export product basket towards manufactured exports. These findings highlight the key role of AfT flows in promoting financial development in recipient-countries, and therefore call on donor-countries to scale up AfT flows in favour of developing countries, given the importance of financial development for economic development.