Academic journal article East Asian Economic Review

Korea's Tied Aid for Export and Competition with China

Academic journal article East Asian Economic Review

Korea's Tied Aid for Export and Competition with China

Article excerpt

(ProQuest: ... denotes formulae omitted.)

I. Introduction

Korea has been a leading country regarding tied aid. According to the statistics from the Development Assistance Committee (DAC) of the OECD, it has held the highest status in terms of the share of its tied bilateral commitments in total bilateral commitments among all member countries of the OECD-DAC for many years.1 As shown by Kemp and Kojima (1985), tied aid can trigger the welfare paradox of an income transfer. In other words, a recipient faces a welfare immiserizing transfer while a donor goes through a welfare enriching. Furthermore, Kemp and Wong (1993) specified that tied aid might seriously raise recipient's import costs although it can relax its budget constraints and increase its import demand. This occurs as it induces a number of distortions in the recipient and in the donor that deteriorate the recipient's terms of trade. These distortive effects might eventually tighten its budget constraints. For such reasons, Korea, heavily dependent on tied aid, is criticized by other countries including its export competitors and international organizations. In fact, Korea has been receiving a considerable amount of pressure from foreign countries since it became a member of the OECD-DAC in 2009. Thus, it is inevitable for Korea to reduce the share of tied aid in its total aid steadily to keep step with other OECD-DAC members. As for the way to increase the amount of untied aid, this study intends to offer the direction.

The positive impacts of Korea's aid on its exports to its recipients can be offset by China's market-stealing effects. Lall et al. (2005) contended that with a similar export structure to China, the likelihood of damaging trade diversion effects in a common export destination is strengthened. In addition, Greenaway et al. (2008) demonstrated that high income Asian exporters experience a greater displacement effect from export competition with China. Therefore, Korea might be affected by China's export-diverting effects at the export markets where the export competition between them is fierce. Consequently, it is expected that the export-creating effects of Korea's aid are offset by the export-diverting effects deriving from China's export expansion, depending on the level of the export competition between Korea and China in the export destinations. This idea suggests that it is desirable to consider Korea's aid recipient markets, in which the offset-level is low, as the places where the share of its tied aid should be preferentially brought down because its net gains from the tied aid are large in these destinations. This study attempts to link the export-creating effect of Korea's tied aid and the export-diverting effect caused by competitive Chinese exportable to derive some implications regarding Korea's aid allocation policy on this wise.

However, to the best of my knowledge, the existing literatures did not deal with the link between them. Thus, this paper intends to investigate the net export-creating effects between the positive impacts of Korea's aid on its exports to its recipients and the China's market-stealing effects.

The structure of this paper is as follows: It scrutinizes its conceptual aspects in section II; in section III, empirical evidences are provided regarding the net export-creating effects; and finally in section IV, it offers a brief conclusion.

II. Aid, Trade, and China's Market-stealing Effects

There are a number of existing studies on the relationship between aid and trade. They mainly deal with the effects of aid on trade and vice versa. Concerning the former case2, Nilsson (1997) analyzed the effects of aid on exports for European Union donors to 108 recipients. He used the gravity model for the period 1975-92 and found an elasticity of exports with respect to aid of 0.23 that translates into a $2.6 increase of exports for each dollar of aid given. Wagner (2003) also investigated the effects of aid on trade regarding 20 donors to 109 recipients for the years 1970-1990. …

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