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The goal of this dissertation is to investigate how foreign aid can be used as means to induce a recipient country to engage in trade policy reforms. For this purpose, we develop a two-good and two-country model where the donor commits to give foreign aid in the first period and disburses in the second period. The donor`s commitment for foreign aid is based on an equation where the volume of foreign aid is a function of the recipient tariff rate. We analyze the donor and the recipient actions in two types of game: a passive donor game and an active donor game. The active donor game has two sub-games: a simultaneous game and a sequential game. This dissertation is composed of two theoretical chapters and one empirical chapter. The two theoretical chapters use a similar theoretical model but they differ on the assumptions we make the recipient country economy. In the first chapter, we assume that the recipient country government is lobbied by interest groups that own its stock of capital. We find evidence that the donor can, under certain conditions, influence the recipient`s trade policy even when interest groups lobby the government. In the second chapter, we assume that the recipient country has borrowing constraints because it faces a quantitative restriction on its borrowing set by the international credit markets. Our results suggest that the recipient engages in trade liberalization depending on the type of games that the recipient and the donor participate. In the third chapter, we ask two questions: First, is the allocation of aid based on trade policy reforms; particularly, trade liberalization? Second, does foreign aid spur economic growth when we take into account the allocation of foreign aid based on trade liberalization? For this purpose, we use a panel data set of 137 countries from 1995 to 2009 which we estimate using the system GMM estimator. We find evidence of a negative relationship between trade liberalization and foreign aid. Our results suggest that foreign aid spurs economic growth.
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