Do Aid for Trade Flows Help Reduce the Shadow Economy in Recipient Countries?

Abstract

Abstract The present analysis has assessed the effect of Aid for Trade (AfT) flows on the shadow economy using an unbalanced panel dataset of 106 countries over the period from 2002 to 2015. Empirical results obtained by means of the two-step system generalized method of moments, show that higher AfT flows are associated with a fall in the size of the shadow economy, with less developed countries experiencing a greater negative effect of AfT flows on the shadow economy than relatively advanced countries among recipient countries of AfT flows. AfT interventions reduce the size of the shadow economy in countries that face high trade costs as well as in those that experience a depreciation of the real exchange rate. Finally, AfT interventions reduce the size of the shadow economy in countries that improve economic sophistication.