FOREIGN-AID AND PUBLIC-GOODS

Most less-developed countries (LDCs) use foreign economic aid to finan ce public consumption goads, or public intermediate inputs. This paper constructs a two-country general equilibrium trade model, where an in come transfer that takes place between the two countries is used by th e recipient to finance a public consumption good. Within this framewor k, the paper identifies the conditions under which the income transfer improves or deteriorates the donor country's terms of trade, and show s that the transfer can be welfare enriching for the donor, and welfar e immiserizing for the recipient country. The paper also demonstrates that the transfer can raise (reduce) world welfare, in which case a we lfare increase (decrease) in both the donor and the recipient country is possible.