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The Independent Institute
Contest Essay

The Politics of Development Economics


Student Winner. First Prize ($2,500)

Although a wide array of seemingly immortal economic fallacies persist in the face of overwhelming logical and empirical evidence refuting them, few have managed to win such universal and uncritical acceptance as have those surrounding foreign aid programs. Boisterously lavishing praise upon such schemes, celebrities such as singers Bono and Dave Matthews have made supporting foreign aid appear exciting, hip, and fashionable, not to mention morally required. For proponents of aid, the moral necessity of wealth redistribution from the United States to the rest of the world is always the preeminent concern; of notably insubstantial importance are the actual effects of such redistributive measures. The characteristic tendency of supporters of foreign aid to erroneously attribute the indigence of the third world to capitalist depredations, instead of to the distinctly anti-capitalist encroachments against the free market in these countries, accounts for the fact that the effect of foreign aid has consistently been to solidify regimes hostile to free markets and to further depress the standard of living for the poor in recipient countries. Enduring supporters of foreign aid in the face of such obviously abysmal results cannot be seriously considered idealistic humanitarians, but merely unflappable cheerleaders for the State and central economic planning. Remedying poverty requires wealth creation; the worst thing that the United State can do for the third world poor is to continue to enable their governments to suppress market activity.

It is of course true but very inadequate to say merely that the allocation of aid money within recipient countries is subject to a substantial amount of corruption. In The Road to Serfdom, F.A. Hayek famously argued that any government that attempts to engage in economic planning inevitably will be run by the most devious and unscrupulous of men. Because central economic planning requires oppressive oversight of economic activity aimed at obstructing voluntary interactions and coercing non-voluntary interactions, the politicians most successful at enforcing any given plan will be those most willing and skilled at manipulating and controlling the population. Thus, the amount of power any one politician will be able to achieve for himself will be directly proportional to his malevolence in exerting it. Hayek cautioned, “There are strong reasons for believing that what to us appear as the worst features of the existing totalitarian systems are not accidental byproducts but phenomena which totalitarianism is sooner or later to produce.”[1] Since many nations that receive aid are ruled by governments that attempt to engage in aggressive and sweeping economic planning, rampant corruption is to be expected, and the historical record of the allocation of aid money in recipient countries unequivocally confirms this prediction. James Bovard, policy advisor for The Future of Freedom Foundation, reported:

A 2003 report from a leading Bangladesh university estimated that 75 percent of all foreign aid received in that country is lost to corruption. Northwestern University political economist Jeffrey Winters estimated that more than 50 percent of World Bank aid is lost to corruption in some African countries. President Olusegun Obasanjo of Nigeria announced in 2002 that African leaders “have stolen at least $140 billion from their people in the decades since independence.”[2]

However, even if the politicians in recipient nations were not as malicious as Hayek and Bovard expose them to be, all foreign aid schemes are destined to succumb to corruption according to the undeniable truth that funds transferred to a government will necessarily be directed toward meeting that government’s most pressing political needs, rather than the economic needs of its citizenry. Because the primary goal of any incumbent politician is to retain power, the resources that he commands can logically be expected to be diverted to serving that end and away from alternative uses. As a result, aid money rarely if ever reaches the rural poor in recipient nations, who as a group, generally lack political power and are thus unimportant to a politician’s reelection chances. Instead, the money is far more likely to be diverted to buying the votes of the much more politically influential middle and upper classes.[3]

Indeed recipient governments would not even have the first clue about how to satisfy the economic needs of their citizenries since all governments suffer from an inexorable inability to perform economic calculations. Attacking socialist central planning, Ludwig von Mises conclusively proved that since government is not subject to a profit and loss test because it does not sell its services, nor compete for revenue in a competitive market with other providers, all of its market interventions are economically arbitrary. Because recipient governments have literally no rational basis for deciding how to spend their aid money in the interest of meeting the economic needs of their citizenry, it should be no surprise when they opt to spend the money on meeting their own political needs instead.[4]

The so-called new economics of foreign aid was ushered in with the establishment of the Millennium Challenge Account (MCA) in 2004. A partial concession to those who criticized the corruption endemic to foreign aid, the MCA was designed and implemented to selectively provide aid to governments that are thought to “govern justly, invest in their people, and encourage economic freedom.”[5] By applying greater selectivity in determining the proper recipients of aid, donor governments such as the United States hope to encourage the expansion of government in third world countries, but only in benevolent ways and by altruistic politicians. The plan sounds as though it could have been borrowed directly from President Kennedy—who recommended just such an approach over 40 years ago. It seems odd that a plan without any demonstrable success is being re-recommended, despite the fact that in over 50 years, virtually no aid recipients have eliminated their aid dependence*, and benefits such as increased longevity or reduced poverty have not appeared in recipient countries**. The key fallacy of such proposals championing greater selectivity in determining recipients is the mistaken belief that big government, if only run by the right sort of people, is an indispensable facilitator of prosperity, rather than the inevitable enemy of it. Central economic planning is always counterproductive and often disastrous, no matter the intension or identity of the planners. Thomas DiLorenzo, professor of economics at Loyola College, noted:

Thus, the predominant effect of foreign aid has always been to enlarge the size and scope of the state, which always ends up impairing prosperity and diminishing the liberty of the people. Worse yet, it leads to the centralization of governmental power, since the transfers are always to the recipient country’s central government.[6]

The rise of the world’s preeminent economic power, the United States, occurred without external aid but rather in the face of significant net foreign opposition. The distinguishing feature of the origin of the United States was a fear and distrust of central government among its population. From the beginning, central government power was denounced in the strongest possible terms: Individuals were born with God-given inalienable rights; government existed only to secure these natural rights. Liberty, understood to be freedom from government interference, was cherished as the defining feature of the new nation and private property was the ostensible display of this liberty. Milton and Rose Friedman observed:

For close to 150 years, spending by Washington showed no tendency to rise as a fraction of national income….Its share stayed about 3 percent while the population of the United States swelled from 5 million persons hugging a narrow strip along the Atlantic coast to 125 million spread across a vast continent, while the United States changed from an overwhelmingly agricultural to a predominantly industrial country and became the driving force of the industrial revolution that transformed the world in the nineteenth and twentieth centuries, while the United States moved from a minor country of only peripheral interest to the Great Powers to the Greatest Power of them all. This remarkable fact should destroy once and for all the contention that economic growth and development require big government and especially centralized government.[7]

Peter Bauer, a long time student of development economics, pointed out that only in countries in which the free market is allowed to flourish unmolested by constant governmental meddling is economic progress possible. Even for densely populated countries lacking in natural resources such as Hong Kong, the determining factor for economic development is never whether they are recipients of foreign aid, but rather, whether they provide an environment conducive to economic activity. Bauer admonished:

There is not a single instance in history when external donations were required for the economic development of a country. Economic prosperity depends on peoples’ attributes, attitudes, motivations, morays, and political arrangements. If the conditions for development other than capital are present, the capital required will either be generated locally or will be available commercially from abroad to government or to businesses.[8]

Thus, despite Hong Kong’s dearth of natural resources and history of colonialism, it has managed to thrive economically by committing to fiscal conservatism, low taxation, free trade, and minimal governmental intervention into the market.[9] To the extent that any government insists on beleaguering its citizenry with oppressively high taxation, restrictions on free trade, and crippling business regulations, to that same extent does it impoverish its country, regardless of whether and how much outside aid it accumulates. James Otteson, professor of philosophy at the University of Alabama concluded likewise, “Those countries that respect private property and efficiently administer justice prosper, and those that do not do not. It is as simple as that.”[10]

Although unlikely to spur economic growth in countries where property rights are not protected, foreign aid does have a proven history of inciting economic retrogression in recipient countries. At least since the time of David Ricardo, it has been recognized that the return on capital tends toward a uniform rate throughout any economy. That is, if return on capital is higher in one particular industry, labor, entrepreneurial skills, and capital goods will be diverted toward the higher capital return, and normally, the increased competition within this particular industry will cause profitability and hence its return on capital to fall into line with the remainder of the economy. When the United States adopts a protectionist trading policy, it lowers the return on capital that third world countries can obtain from their exports--often in the critical areas of agriculture and textile manufacture where these countries frequently enjoy their greatest relative competitive advantages. Worse, by funding foreign countries, we effectively divert capital toward their governments. Thus, foreign aid, coupled with protectionist policies works to thwart economic development by attracting labor, entrepreneurial skills and capital goods toward obtaining aid money and away from production of goods. Bauer elaborated:

When economic or social life is extensively politicized people’s fortunes come to depend on government policy and administrative decisions. The stakes, both gains and losses, in the struggle for power, increase greatly. These circumstances encourage or even force people to divert attention, energy, and resources from productive economic activity to concern with the outcome of political and administrative decisions; and the deployment of people’s energy and resources necessarily affects the economic performance of any society.[11]

Worse yet, by subsidizing the chronically bad economic policies of recipient countries with foreign aid, donor countries enable third world governments to persist in their economically devastating market interventions. Alan Waters, former chief economist of the Agency for International Development argued:

Foreign aid is inherently bad. It retards the process of economic growth and the accumulation of wealth, which is the only means of escape from poverty and depredation. It weakens the coordinating effect of the market process. It pulls entrepreneurship and intellectual capital into non-productive and administrative activities. It creates a moral and ethical tone, which denies the hard task of wealth creation. Foreign aid makes it possible for a society to transfer wealth from the poor to the rich.[12]

As Henry Hazlitt mentioned in a criticism of the Marshall Plan, even if foreign aid was effective, the United States simply does not possess a sufficient amount of wealth to eradicate global poverty through foreign aid alone. Consequently, according to Hazlitt, “It should be obvious that the real solution is not to distribute scarcity, but to restore production.”[13] Even supporters of foreign aid are thus forced to admit that depending on the perpetual largess of already developed nations is simply not an option for third world countries wanting to develop economically. Because the only hope that these countries have for achieving material prosperity is cultivating an internal environment friendly to investment, foreign aid, which does nothing to promote such an environment and much to obstruct it, is no solution.

The mindset of development aid is the mindset of current Western political philosophy. Large, powerful, democratic governments are, almost by definition, good governments. Individual economic freedom and property rights, when recognized at all, are thought to be of secondary import. Developing countries, first and foremost, are deemed to need a strong, benevolent government to offer protection to the helpless or barbaric people who cannot be imagined to be able to function productively in its absence; never minding that such an arrangement has never been associated with an outbreak of economic progress, world “leaders” are anxious to retry failed policies while claiming a “more selective, multilateral approach” is likely to help this time, and “anyway,” they say, “it’s the only moral thing to do.”

Mises observed that it was workers, not capitalists, who benefited most from the economic freedom of a market economy. Further, that poverty and economic stagnation were not associated with capitalism, but instead, with a lack of capitalism, and that only private property, saving, and the careful employment of accumulated capital made possible the productivity advances that allowed workers to enjoy luxuries (such as cars, refrigerators, etc.) that had been previously unavailable even to history’s richest rulers. It was these productivity gains that led to higher standards of living, greater longevity, and shorter working hours for the workers much more dramatically so than for the rich. Governmental regulations that interfered with the free use of capital he recognized as impoverishing the poor to a far greater extent than the rich.

Perhaps it’s time that we stopped expecting naive hope to triumph over experience. Perhaps encouraging economic freedom in foreign countries by promoting private property, rule of law, tariff-free trade and limited government is worth a try. If the United States became an economic success without a powerful government, why insist that others cannot do the same?


Works Cited

1. F.A. Hayek, The Road to Serfdom, (Chicago: Chicago University Press, 1944), p. 149

2. James Bovard, “Bush’s Foreign-Aid Fraud,” 10/25/2005, http://www.lewrockwell.com/bovard/bovard13.html

3. Thomas Woods, “The History of Foreign Aid Programs” Quoting Peter Bauer

4. Ludwig von Mises, Economic Calculation in the Socialist Commonwealth

5. President George W. Bush at United Nations Financing for Development Conference in Monterrey, Mexico. “President Outlines U.S. Plan to Help World's Poor,” http://www.whitehouse.gov/news/releases/2002/03/20020322-1.html

6. Thomas DiLorenzo, “A Foreign Aid Disaster in the Making,” 1/6/2005, http://www.mises.org/fullstory.aspx?Id=1715

7. Milton and Rose Friedman, Tyranny of the Status Quo, (Harcourt, 1984), p. 16

8. P.T. Bauer, Equality, Third World and Economic Delusion (Cambridge: Harvard University Press, 1983), p. 100.

9. P.T. Bauer, “Hong Kong,” in From Subsistence to Exchange (Princeton: Princeton University Press, 2000), p. 109-115

10. James Otteson, Actual Ethics, (Cambridge University Press, 2006), p. 160

11. P.T. Bauer, “Foreign Aid,” in From Subsistence to Exchange (Princeton: Princeton University Press, 2000), p. 48

12. Thomas Woods, “The History of Foreign Aid Programs”

13. Henry Hazlitt, Will Dollars Save the World? (The Ludwig von Mises Institute, 2007), p. 25.

*. Op. cit. Woods. Referring to a 1989 report from the U.S. Agency for International Development.

** Ibid. Referring to Peter Boone’s study of 97 aid recipients over a 20 year period.