Foreign aid, domestic investment and welfare

This paper examines the welfare implications of temporary foreign aid in a simple two-period, two-country model of trade. Domestic investment is endog enous, providing an important link between aid in period one and the terms of trade in periods one and two. Transfer-induced changes in the terms of t rade redistribute present and future income between the donor and the recip ient. In the presence of barriers to international borrowing and lending, s uch redistribution gives rise to the possibility of temporary aid being bot h potentially and strictly Pareto improving.