Aid, Nontraded Goods, and the Transfer Paradox in Small Countries

This paper constructs a model of the transfer paradox for a small open economy with nontraded goods. It demonstrates that increased production of nontraded goods can change their domestic price so as to offset the otherwise beneficial effect of aid and, under certain conditions, to create a transfer paradox even in a small country. The model is estimated with time-series data for 44 aid-dependent countries for the period 1970–1990. The results support the model and show that the nontraded goods expansion effect is more likely to cause immiserization than Johnson's tariff-distorting export-displacement effect. (JEL F0, O1)