Effects of aid for trade on extensive and intensive margins of greenfield FDI

• Author: Dung Ly‐My,Hyun‐Hoon Lee
• Date: 01 July 2019
• DOI: http://doi.org/10.1111/twec.12787
• Published date: 01 July 2019

ORIGINAL ARTICLE

Effects of aid for trade on extensive and intensive

margins of greenfield FDI

Dung Ly-My

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Hyun-Hoon Lee

Department of International Trade and Business, Kangwon National University, Chuncheon, Korea

KEYWORDS

aid for trade, developing countries, FDI, greenfield

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INTRODUCTION

The World Trade Organization (WTO) member countries launched the Aid for Trade (AfT) Initia-

tive at the Hong Kong Ministerial Conference in December 2005. Since then, AfT has become a

major component of foreign aid distribution. The main objective of the AfT Initiative is to assist

developing countries, and especially the least developed countries (LDCs), to “build the supply‐

side capacity and trade‐related infrastructure that they need to assist them to implement and benefit

from WTO Agreements and more broadly expand their trade”(WTO, 2005, paragraph. 57).

Many researchers have proved that AfT is effective in promoting international trade. For example,

Helble, Mann, and Wilson (2012) find that total AfT increases both recipient exports and imports.

Pettersson and Johansson (2013) also find that AfT is positively associated with both donor exports

and recipient exports. A report by OECD/WTO (2013, Chapter 5) also provides empirical evidence

that AfT is correlated with increases in trade, while increases in other aid (i.e. non‐AfT) tend to dam-

pen export performance. Some researchers find that only part of AfT is positively associated with

trade. Cali and te Velde (2011) find that among the three components of AfT, aid for “economic

infrastructure”is associated with greater recipient‐country exports. Vijil and Wagner (2012) also find

empirical evidence that infrastructure AfT promotes trade. Thus, most studies find positive effects of

AfT on trade, particularly when AfT is in the form of aid for economic infrastructure.

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One country can raise the total value of its trade either by boosting its export diversification or

by upgrading the quality of its exported products. Indeed, Gnangnon and Roberts (2017) find that

AfT positively affects export diversification and export quality improvement.

Export diversification, increase in employment, and increase in foreign investment are the most

desired targets of AfT by the recipient countries (OECD/WTO, 2015). In fact, AfT aims to pro-

mote not only international trade of the recipient countries but also FDI flows to these countries

(World Bank, 2011).

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Some researchers have shown AfT reduce the trade costs facing aid recipients (e.g. Tadesse, Shukralla, & Fayissa, 2017).

Some other researchers have assessed how the AfT has been allocated (e.g. Gamberoni & Newfarmer, 2014; Lee, Park, &

Shin, 2015).

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“An important dimension of AfT support spans measures to make countries more attractive to foreign direct investment

(FDI)”(World Bank, 2011, p. 13).

Received: 12 July 2018

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Revised: 13 January 2019

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Accepted: 22 January 2019

DOI: 10.1111/twec.12787

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© 2019 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/twec World Econ. 2019;42:2120–2143.

The investment climate can be enhanced as a result of improved infrastructure in developing

countries. That is, AfT may encourage FDI flows to the recipient countries by improving the recip-

ient country's economic infrastructure such as roads, communications, and electricity, thereby

removing bottlenecks that would otherwise prevent FDI inflows. AfT to develop productive capac-

ity may also promote FDI flows to the recipient countries by making the target industries more

productive and more competitive internationally.

Selaya and Sunesen (2012) find that aid for economic (and social) infrastructure is associated

with more FDI, while aid for building productive capacity deters investment. Donabauer, Meyer,

and Nunnenkamp (2016) also find evidence that aid for economic infrastructure has a strong direc t

effect on FDI. However, Kimura and Todo (2010), considering five donor countries and 98 recipi-

ent countries during the period 1990–2002, find only a significant positive impact of Japanese

infrastructure aid on Japanese investment in recipient countries. Kang, Lee, and Park (2011) extend

Kimura and Todo (2010) to show that not only aid from Japan but also aid from Korea promotes

bilateral FDI during the period 1980–2003.

While none of these studies explicitly considers AfT, Lee and Ries (2016) provide empirical

evidence more comprehensively on the effects of AfT on FDI. Using bilateral data for 25 donors

and 120 recipient countries for the period 2004–12, they estimate the effects of bilateral AfT on

greenfield FDI, relying on a “structural”gravity model. They find a strong and significant effect of

AfT on greenfield investment, particularly when the donors are among the top five donors. Among

the three categories of AfT, both aid for infrastructure and that for building productive capacity are

found to exert strong effects. Another unique finding of Lee and Ries (2016) is that AfT increases

not only the total value of greenfield FDI but also the extensive margin of greenfield projects (i.e.

number of greenfield projects).

The main objective of this paper is to examine whether AfT not only increases the dollar value

of FDI flows to developing countries but also whether it helps diversify FDI flows to these coun-

tries by increasing the counts of projects as well as the number of source countries. For this pur-

pose, we classify the total dollar value of greenfield FDI flows into four layers: the extensive and

intensive margins of projects (i.e. total counts of projects and average dollar value of each project)

as well as the extensive and intensive margins of source countries (i.e. total number of source

countries and average dollar value of FDI from each source country).

This paper further examines whether AfT from developed donor countries increases FDI more

from the like‐minded developed countries than from developing countries. For this purpose, we

also classify total greenfield FDI into FDI from DAC countries and from non‐DAC countries.

Our dataset for regression analysis is a panel of 105 developing countries for the period 2003–

15. Applying the system GMM estimator, this paper finds that AfT not only increases the dollar

value of FDI but also helps diversify the greenfield projects and source countries. In addition, this

paper finds that AfT has a greater effect for greenfield FDI from donor (developed) countries than

from non‐donor (developing) countries. Among the three components of AfT, aid for trade ‐related

infrastructure and aid for trade policy regulations are found to have positive links with greenfield

FDI, irrespective of source‐country groups, yet their effects are larger for developed source coun-

tries. In contrast, aid for building productive capacity hinders greenfield FDI flows from non‐donor

countries, while it promotes greenfield FDI from donor countries. We offer some explanations for

this finding.

This paper is organised as follows. In Section 2, we discuss the trends and patterns of green-

field FDI flows and AfT during the period 2003–15. Section 3 explains empirical specifications.

Section 4 offers the empirical results. Section 5 presents a summary and conclusions.

LY‐MY AND LEE

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