Financial Openness and Aid for Trade in Developing Countries

• Date: 01 March 2019
• Published date: 01 March 2019
• Author: Sèna Kimm Gnangnon
• DOI: http://doi.org/10.1111/saje.12210

© 2018 Economic Society of Sout h Africa. doi : 10.1111/ saje .12210

46

South African Journal of Economics Vol. 87:1 March 2019

FINANCIAL OPENNESS AND AID FOR TRADE IN

DEVELOPING COUNTRIES

SÈNA KIM M GNANGNON*

Abstract

This article examines the effect of De Jure financial openness in developing countries on the total

amount of bilateral AfT inflows that accrues to these countries. The analysis relies on 126 countries

over the period 1995–2015 and uses both the within fixed effects and the two-step system GMM

estimators. Results suggest that the effect of financial openness on AfT depends on the level of

financial openness, whose values range between 0 and 100. A positive and significant effect is

obtained for levels of financial openness lower than the value 48. In contrast, the effect becomes

negative for countries whose level of financial openness is higher than 62. Countries whose degree

of financial openness is comprised between 48 and 62 experience no significant effect of financial

openness on the amount of the AfT flows that they receive. Overall, the analysis shows that

financial openness does matter for the amount of AfT that recipient-countries receive from

donor-countries.

JEL Classification: F1, F35, F36

Keywords: Financial op enness, aid for trade

1. INTRODUCTION

A number of studies (e.g. Gamberoni and Newfarmer, 2009; Tadasse and Fayissa, 2009;

Gamberoni and Newfarmer, 2014; Lee et al., 2015; Gnangnon, 2016a, 2016b) have

been carried out on the macroeconomic determinants of Aid for Trade (Af T). The AfT

Initiative was born in the World Trade Organization (WTO), in particular at the 2005

WTO Hong Kong Ministerial Conference (Trade Ministers Conference). Paragraph

57 of the Hong Kong Ministerial Declaration (see WTO Secretariat document WT/

MIN(05)/DEC) provides that the Af T Initiative aims to “help developing countries,

particularly 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 to expand their trade.” AfT inf lows that accrue

to developing countries are part of the overall Official Development Assistance (ODA)

inflows and include three major categories, according to the Organization for Economic

Cooperation and Development. These categories are Af T for Economic Infrastructure,

AfT for productive capacities and AfT for Trade Policy and Regulations.

To mobilise additional financial resources (which would complement development

aid and in particular, AfT) with a view to addressing their development challenges,

* Corresponding author: World Trade Organization, Rue de Lau sanne 154, CH-1211 Geneva

21, Switzerland. Tel: +41 (0)22 739 51 11, Fax: +41 (0) 22 739 5795. E-mails: SenaKimm.

Gnangnon@wto.org, kgnangnon@yahoo.fr, kignangnon@gmail.com

South African Journal

of Economics

47South African Journal of Economics Vol. 87:1 March 2019

© 2018 Economic Society of Sout h Africa.

developing countries have engaged into a number of economic reforms, including fina n-

cial liberalisation (that we refer here to as financial openness reforms). The functions of

the financia l in an economy have been emphasised by Levine (1997): by helping mobilise

savings, facilitating risk management, enhancement of resource allocation, the improve-

ment in corporate control and the ease of exchange in goods and services, the financial

sector leads to higher capital accu mulation and technological innovation. Several st udies

have been carried out on the macroeconomic effect of f inancial globalisation (e.g. on gross

domestic product (GDP) growth and volatility, investment, consumption, asset prices,

exchange rates and f inancial stability indicators) and have found overall mixed evidence

(e.g. Schmukler and Abraham, 2017 provide a summary of this literature). Schmukler

and Abraham (2017) have noticed that there is no universally admitted def inition of

the widely used concept of financia l liberalisation, which has sometimes been associated

with other terms such as international financial integration or financial globalisation

(e.g. Schmukler, 2004; Arestis et al ., 2005; Gudmundsson, 2008; Kose et al., 2010; Levy

Yeyati and Williams, 2014).

Drawing from Schmukler and Abraham (2017), financial openness (or financial

liberalisation) is the process by which countries reduce legal or “de jure” controls that

restrict cross-country capital movement. Therefore, it includes e.g. the elimination of

restrictions on capital inf lows and outflows, the removal of limits on equity holding by

foreigners, and the abandonment of multiple exchange rates or limits to the acquisition

of foreign currency. International financial integrat ion is the actual or “de facto” increase

in cross-country capital movement (or the potential for those movements to take place),

tightening the linkages between the economies. Financial globalisation is defined as the

process in which financial markets and institutions around the globe increasingly allow

agents and firms from any country to buy and sell securities, lend and borrow, or per-

form any other financial transactions.

Based on these definitions, financial libera lisation appears to be a precondition for

financial globalisation to occur (with restrictions, it is more diff icult to move across

borders), whereas financial integration is one dimension or one manifestation, among

others, of financial globalisation (see Schmukler and Abraham, 2017).

The current article aims to complement the existing studies on the macroeconomic

determinants of Af T by examining the effect of developing countries’ financial open-

ness on the AfT that they receive from donors. To the best of our knowledge, this is

the first article that sheds light on the link between financial openness and AfT. The

argument underlying this assessment is simple and goes as follows. First, donors may

be willing to provide higher levels of Af T to recipient-countries that do not experience

a high level of financial openness, with a view to supplementing the deficiencies in

financial resources in these countries. In so doing, they could encourage recipients to

further open up financially their economies in order to obtain additional resources so as

to finance the development of their trade capacity. However, beyond a certain level of

financial openness in recipient-countries, donors may believe that the latter have already

open-up sufficiently to start att racting the requisite capital flows that they would need to

address their development needs, including developing their trade capacity. As a result,

we could expect a non-linear relationship, in the form of an inverted U curve, between

recipient-countries’ level (or degree) of financial openness a nd the Af T amount that they

receive from donors.