Trade versus Aid

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James Wolfensohn, the current head of the World Bank, has called on the leading industrialized nations to double their current level of development assistance from 50 billion to 100 billion dollars per year. He argues that 50 billion dollars, if properly spent, could have a huge impact on the developing world, while not overburdening the industrialized nations. He has been denounced as a fool by many critics of aid in United States, and his views so far have not gained much support, although the US and EU are proposing to increase their aid by 12 billion dollars per year.

The opposite view is that the economic policies of the developing countries are the critical element in progress, and aid acts a band-aid, covering up mistakes or at worst fueling corruption, thereby worsening the economies of these countries. These critics argue that the industrialized world should avoid direct government aid loans and grants, and instead focus on pressuring developing countries to adopt sound policies.

In the 1980s, the developed world set a goal of donating 0.7% of their economies annual production (the GDP) in the form of aid to the developing world. Except for Scandinavia, none of the wealthy countries have lived up to this commitment. America is among the stingiest, contributing about 10 billion dollars per year, which is only 0.1% of the mammoth 10 trillion dollar US economy (which suggests that economic arguments about billion dollar pipelines in Central Asia motivating America make no sense, a billion dollars is not real money to the US). If America were to commit to the 0.7% figure, its aid budget would increase to 70 billion dollars per year. The interesting thing is that the average American has no idea of how little the government spends on foreign aid. Polls on this issue suggest that many Americans think 20% of the US budget is for foreign aid. The image of foreign aid is wildly exaggerated in the American mind.

But this doesn’t address the issue of aid effectiveness. The reality is that aid, for any reasonably functional country, is of little or no value, especially if it is in the form of loans rather than grants. It is the private sector investment flows that are far larger and more important. Historically speaking, the West developed without foreign aid, as did Japan. China receives no foreign aid, but has increased its economic output from 250 billion dollars per year to 1 trillion dollars over the last 20 years. One of the main engines of that growth has been private investment of over 30 billion dollars per year in the last few years. On the other hand, no country was more heavily subsidized than Castro’s Cuba by the Soviet Union, but it failed to yield development. Sub-Saharan Africa has received huge amounts of aid as a percent of their economic size for decades, but with nothing to show for it. Even in Pakistan, the huge run-up in foreign debt in the 1990s did not yield growth. For Pakistan, a good three-year stretch of 7% growth would add 15 billion dollars to annual economic production, dwarfing the 600 million-dollar aid package from the US.

The most important thing for economic development is not foreign aid, which often comes with strings attached and ends up in the wrong pockets, but sound government policy. These policies include human resource development, universal literacy, adequate healthcare, good infrastructure, and an open market economy. Free enterprise has been shown to be the most reliable way to increase the wealth of a society in the most rapid manner policy. Social justice is a matter of wealth distribution, but cannot be pursued until wealth is created. It is gratifying to see Pakistan pursue these policies. During the Musharraf period, tariffs have been reduced, exports have risen, domestic regulation has been reduced, and the major state owned enterprises are being privatized. These policies are far more significant than the size of the American goodies granted in exchange for Pakistan’s political support of the war in Afghanistan. By creating a stable and open economy, Pakistan will be able to attract foreign investment. These investors will build factories and plants, hire Pakistanis, both as workers and managers, and over time a significant upgrading of the quality of Pakistani workforce will occur. Aid is not necessary, sound policy and friendly relations with developed world will suffice.

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