It is widely expected that at the G8 meeting in July the leaders of the wealthiest countries in the world will agree to forgive $40 billion of third world debt and may also increase economic aid to Africa. If adopted, these policies will not help poor countries develop because they fail to address Africas underlying problems.
Tony Blair has recently been the leading political advocate of debt forgiveness and foreign aid. He succeeded in getting the G8 finance ministers to recommend canceling the $40 billion of debt for 18 poor countries. Hes also calling for a doubling of aid to Africa.
A definition of insanity is doing the same thing over and over but still expecting a different result. Foreign aid and debt forgiveness have failed to promote growth, and there is no reason to believe Blairs latest proposals will be any different.
Between 1970 and 2000 over $400 billion was poured into Africa yet little development was achieved. Money was often stolen by corrupt government officials. Even when aid actually translated into investment, the projects were often white elephants that failed to be economically viable because governments do not make decisions based on the same profit and loss expectations that investors do.
There is some rationale for debt forgiveness. After all, poorly administered loans and bad advice from Western governments helped create the debt problem. However, when debt is forgiven without addressing underlying problems, new debt just replaces the old.
From 1989 to 1997, Western creditors forgave $33 billion of debt held by 41 poor countries, but during those same years, these countries borrowed an additional $41 billion. Debt was forgiven, new debt was accumulated, little growth occurred.
Africa needs investment, not aid, if it is going to grow. Private investment is naturally channeled to the most profitable projects in a market economy. Because decisions are based on expected profits and losses, investors have the right information and incentives to make the right decisions.
Africa needs to create an environment of greater economic freedom and security in property rights to attract investment. Recent research using the Fraser Institutes economic freedom index has shown that countries with more economic freedom attract more foreign investment and have higher overall levels of investment per worker.
On a scale of 1 to 10, countries scoring lower than 5 in economic freedom only generate $845 per worker of investment, and they attract only $68 of foreign investment per worker. Meanwhile countries that score higher than 7 in economic freedom generate $10,871 of investment and $3,117 in foreign investment per worker.
Countries that are more economically free also make more productive use of their investment. Recent research by Capital University economics professor Robert Lawson found that investment generates higher economic growth rates in freer countries than in less free countries. Further, he found that even in the least free countries, private investment still generates economic growth more efficiently than public investment.
Unfortunately, development aid can discourage private investment by hampering the economic freedom that is necessary to attract it. Noted development economist P.T. Bauer long contended that government-to-government aid promoted statism by politicizing economic life and enlarging the relative size of the public sphere. Recent research by Matt Ryan and myself supports Bauers claim. We found that higher levels of economic aid depress economic freedom scores. Yet it is higher freedom that is necessary to attract investment and grow.
Aid and debt forgiveness will not promote the institutional environment of economic freedom and property rights that Africa needs to grow. Unfortunately, it is unlikely that Western nations can do much to get African nations to adopt pro-investment policies. President Bushs Millennium Challenge Accounts pay lip service to this type of policy but the program has distributed little money and it is not clear that it would avoid the pitfalls of previous aid programs. Blairs recent call to double aid doesnt account for the importance of property rights at all.
G8 nations can still help, though. Instead of focusing on debt relief and aid, we should reform our domestic policies that harm the third world. The U.S. and E.U. both protect our farm sectors from third world competition. Opening our borders to third world farm products would give an immediate boost to the standard of living in many poor countries. Blair and the G8 could do more to help the impoverished people of the world by freely trading with them instead of repeating failed policies of aid and debt forgiveness.