Foreign aid, the environment, and welfare

Using a two-country, general equilibrium model with environmental goods, this paper examines the welfare effect of tying aid to environmental clean-up. Because of the gain resulting from environmental clean-up, tied aid can lead to a win-win situation, i.e., Pareto improvement, for both donor and recipient countries despite the presence of a terms-of-trade deterioration. However, if the environmental gain is small, the paradoxical result of donor enrichment and recipient immiserization can occur. Furthermore, the conditions for transfer caused normal welfare effects, i.e., donor immiserization and recipient enrichment, are identified and interpreted.