Transfers, Trade Taxes, and Endogenous Capital Flows: With Evidence from Sub-Saharan Africa

Abstract

Sub-Saharan Africa (SSA) is highly dependent on imported capital goods that are used in the import competing industrialized sector. The exporting sector focuses on primary products where land and labor are predominantly used. We build a two-good general equilibrium model, where the import competing sector uses imported capital input. Transfers induce changes in commodity terms of trade, which in turn affects capital inflows and the price of imported capital. The welfare effect of transfers is considered in the context of induced changes in these variables. In the context of an exogenous export tax, we find_x000D_ that endogenous capital flows aggravate the transfer problem that exists under trade taxation. When trade liberalization is tied to transfers, we find that the tying of aid may_x000D_ worsen or alleviate the transfer problem, depending on how the existing export tax_x000D_ compares with the optimum. We complement our theoretical analysis with an empirical_x000D_ analysis of the transfer problem in the context of endogenous capital inflows. This is done_x000D_ by estimating a regression model with fixed effects for a panel of 14 countries in SSA. Our_x000D_ findings substantiate the concerns raised by the theoretical analysis.