The History of Foreign Aid Programs

0:00So today we're going to talk about the history of foreign aid programs because as I was saying before we're very flexible in this series we can sort of pick and choose what's sort of interesting or what's of contemporary relevance and there's still a lot of discussion of foreign aid and there's increased debate about how useful it is and the economic consensus on this question has flipped and flopped over the years and I'm going to trace that for you. The link to foreign aid that appears in my book really starts with the Marshall Plan. And then I use that as a jumping off point to talk about other foreign aid programs. Now, as we all know, the Marshall Plan, so-called, originated a couple years after World War II, and the purpose was to assist in the reconstruction of Europe.

0:55Initially, the Marshall Plan was not restricted to Western Europe, any European country could apply for assistance through the Marshall Plan, although Stalin did not permit any of the countries behind the Iron Curtain to do so. However, Western Europe did get a substantial amount of Marshall aid, and what I want to point out here is that the conventional wisdom with regard to the Marshall Plan is that it was responsible for jump-starting the West European economy. Now, it's easy to understand why people would draw that conclusion because before the Marshall Plan, economic conditions were very poor in Western Europe. Then you had the Marshall Plan and then economic conditions got better. So naturally, the easy conclusion to draw is that the Marshall Plan caused the prosperity.

1:44But that can be a logical fallacy. There may not be any direct relationship between the Marshall Plan and the prosperity. Prosperity, there may be no connection whatsoever. Sometimes we get arguments like this that are sort of like saying that umbrellas cause it to rain or that sort of thing. We have to make sure we understand correlation, causation, what caused what, what's responsible for what. Perhaps the prosperity would have been greater in the absence of the Marshall Plan. We can't know that on the basis of historical data alone. We have to think, we have to think through what the incentives of this program were. It is worth noting though that we do have at least this historical data to consider. That France, Germany and Italy began their economic recoveries before they started getting martial aid.

2:33So they were already picking up and by Germany of course I mean West Germany which had an explosive economic recovery. Austria and Greece received a lot of martial aid per capita and yet their recovery really got going only as martial aid was being phased out. Britain received twice as much martial aid as West Germany did and yet British economic growth dramatically lagged behind that of the Germans. So given this, I think it's increasingly plausible to suggest that perhaps the Marshall Plan was not itself responsible for the recovery. What was responsible for the recovery? Well, the return to market economies after the war. There were tremendous wartime economic controls in all these countries.

3:18And with the end of the war came the end of those controls, gradually, in some cases. And the result was great prosperity. And I quote German economic minister Ludwig Erhard, who said, We decided upon and reintroduced the old rules of a free economy, the rules of laissez-faire. We abolished practically all controls over allocation, prices and wages, and so on and so forth. So we just moved away from the controls, and in fact West Germany's economy recovered so dramatically that it's still one of the great miracles or success stories of the 20th century. So it does not seem to have borne much relationship to the Marshall Plan and I also point out that the way the Marshall Plan was set up for every dollar that you got in Marshall Plan assistance, the government of the recipient country had to increase its public expenditures by one dollar.

4:15So obviously you're expanding the size of the public sector which is not necessarily the path to recovery. Well, whatever the truth of the Marshall Plan situation, what's worth remembering is that people thought the Marshall Plan had been successful. That's the important thing. People thought it had been successful. They thought that this was how you take a depressed economy and you revive it again. You just infuse it with money. You just throw money at it. The point is that this conclusion, which I think is an erroneous conclusion was then applied to the third world, the less developed nations if they're sometimes called. And the thinking was that we need to infuse them with capital the same way we did in Western Europe and they'll have wonderful results to show for it as well.

5:08It's not so clear that that really is such a good idea and so this is what I really want to spend time talking about here. I'm sure you all remember a few years ago when the Asian tsunamis hit and when that terrible tragedy occurred, some people took the opportunity to lecture the US government for its supposedly inadequate commitment to development aid to the third world, that not only was the US government was very un-stingy when it came to disaster relief, such as for the tsunamis, but that in general the United States had, it was argued, a very poor record in general over the years, leading up to the tsunami, not just disaster relief, but development aid to the third world in general was not forthcoming from the United States in substantial amounts, and some conservatives immediately rushed to the defense of the US government and said that, well, there was $108.5 billion was given in foreign aid by the nations of the world in 2003, the year before the tsunamis,

6:13and the US alone had contributed nearly 38 billion, which was over a third of the total. Now this argument is certainly true, but it misses the point, because this argument takes for granted that development aid is a good program in the first place. But in fact, development aid from the West to the less developed nations was one of the more expensive failures of by the end of the Cold War, over $2 trillion, that's inflation adjusted dollars, had been given to less developed countries, sometimes just called LDCs. Well, what did they have to show for it? Not much. The U.S. Agency for International Development in a 1989 report acknowledged, and I'm quoting the report, It should be noted that only a handful of countries that started receiving US assistance in the 1950s and 1960s has ever graduated from dependent status.

7:08A Clinton administration task force later on into the 1990s conceded that, and this is again quoting a Clinton administration, despite decades of foreign assistance, most of Africa and parts of Latin America, Asia and the Middle East have become economically worse off today than they were 20 years ago. In 1997, a World Bank report that looked back on the world's experience with foreign aid concluded as follows. Governments, that is, recipient governments, embarked on fanciful schemes. Private investors lacking confidence in public policies or in the steadfastness of leaders held back. Powerful rulers acted arbitrarily. Corruption became endemic.

7:53Well, the economic arbitrariness encouraged by foreign aid was to be expected because governments don't have to pass a profit and loss test, the way private investors do, so governments can get away with allocating money toward economically dubious projects that may yield high-profile jobs and therefore support for the regime in the short run. Well, individual examples of economic retrogression among recipient governments are everywhere. Over the past decade, for example, Egypt's percentage of people in extreme poverty has remained unchanged despite the billions that country has received. Egypt, as you may know, is the second largest beneficiary of USA. When Zambia became independent in 1964, its people's annual income per capita was $540.

8:44Peter Boone is an economist who has done some work in this area, and he compiled data for 97 countries receiving aid over a 20 year period, and found no significant correlation between the two countries.

9:14between Aid and Poverty Reduction. He likewise found nothing to indicate that aid increases life expectancy figures or primary school enrollment in countries receiving it. Foreign aid, if anything, has likely slowed the process of economic reform. Even the World Bank, which is largely, or at least partly responsible for this, admits that governments are more likely to pursue economic reforms when they are feeling economic pressures. And of course, when you receive foreign aid, that takes economic pressure off you. In a separate study, the World Bank concluded that, quote, reform is more likely to be preceded by a decline in aid than by an increase in aid. South Korea, Taiwan and Chile, for example, when faced with a cut-off in U.S. aid, finally embraced the free market and prospered.

10:03Tom Bethel, who's written a book on the history of private property basically, suggests that foreign aid has retarded economic development by masking the destructive consequences of these government's economic policies. Well, in some cases even basic humanitarian assistance has severely disrupted third world economies. Sending free goods to these countries has devastated local producers who cannot compete against a price of zero and has therefore all but destroyed local incentives to produce. A study of the UN World Food Programme's response to 84 emergencies found that it took that world body an average of 196 days to respond to a crisis and that the European Economic Community took over twice as long.

10:49Denis Avery, an agricultural expert, contends that aid was too late to relieve hunger but just in time to depress prices for local farmers who tried their best to respond. Governments who receive such assistance oftentimes use the food not to feed the hungry, but to build support for their regimes by making food available to groups whose political support they need. So, for instance, Peter Bauer, who is a great economist of this, says, the poor, particularly the rural poor, who are the great majority, are politically ineffective and thus of little interest to the rulers. The Wall Street Journal published this interesting report, No wonder the effectiveness of food aid around the world is under suspicion in the United States. Some critics have concluded that this low-cost food is merely a device for keeping elites in power by propping up foreign government budgets and feeding influential middle classes.

11:44Food aid has discouraged food production, these analysts say, and has failed to address the basic challenge of helping the poor earn enough to buy the food already available. That was from the Wall Street Journal. In Bangladesh, the food never reaches the hungry, because it is distributed by the regime according to calculations of political gain, and back to the journal here. It comes as a surprise to the layman, but not at all to the experts, that food aid arriving in Bangladesh and many other places isn't used to feed the poor. Governments typically sell the food on local markets and use the proceeds however they choose. Here the government chooses to sell the food in cut-rate ration shops to members of the middle class. And incidentally somebody buying food in a cut rate ration shop needs a ration card. The poor have no way to get one.

12:30Now Americans who have grown cynical about foreign aid because it seems correlated with corruption are actually onto something according to the latest research. In particular an article that appeared a few years ago in the American Economic Review argued that, and this is from their words, The fact that increases in aid are associated with contemporaneous increases in corruption and that corruption is positively correlated with aid received from the United States. Parade Magazine, not long ago, published a ranking of the 20 worst dictators currently in power. The US government, it turns out, has contributed aid to all but one of them. That's Saudi Arabia's King Abdullah. You're keeping score here. According to a Brookings Institution report, the history of US assistance is littered with tales of corrupt foreign officials using aid to line their own pockets, support military buildups and pursue vanity projects. It is no wonder that few studies show clear correlations between aid flows and growth.

13:32The situation, as I think we all know, is especially serious in Africa. African government officials have become so well known for their attachment to fancy automobiles that Swahili The Theory now has a word, wabensi, that means men of the Mercedes-Benz. A Kenyan human rights activist reports that since independence in Africa, government has been seen as the personal fiefdom a leader uses to accumulate wealth for himself, his family, his clan. He cannot be subjected to criticism by anyone and everything he says is final. It has been said that what Africa needs is its own Marshall Plan. Now, as I said, I've already suggested the Marshall Plan itself may not have been responsible for Western Europe's recovery, but let's assume that the Marshall Plan was a wonderful thing, even if we assume that it was appropriate and wise.

14:24The fact is that Africa has already received the equivalent of five Marshall Plans and continues to receive annual aid packages comparable to what Western Europe received in each of the four years of the original Marshall Plan. The results are, I think, obvious enough. Even the New York Times, which always takes three decades longer to recognize a truth than anybody else, admitted during the 1990s that three decades of foreign development assistance in the third world has failed to lift the poorest of the poor in Africa and Asia much beyond where they have always been. It had simply fattened political elites. Well, that came as a big surprise to the New York Times, but not to anyone who knew anything about the subject. The Times gave its readers the impression that no one could have known the dismal results that third world development programs funded by the West would have.

15:17Well, somebody did know and tried for decades to warn people of the effects that these policies would have. And that man in particular was Peter Bauer. Peter Bauer is one of these people who spent decades of his career as that lone voice in the wilderness, crying out and being ignored by everybody. by everybody. However, because there is occasionally some justice in this world, he lived to see his own vindication. By the time of his death not long ago, just a matter of a few years ago, Bauer was recognized as a prophet for the things he had said that were ignored in the 60s when all the fashionable economists were arguing to the contrary. Bauer actually shortly before he died was honored with something called the Milton Friedman Prize Achievement Prize, which is a lifetime achievement award that carries a monetary prize of $500,000.

16:11So, you know, he suffered for a while, but then he turned out he did okay. Well, Bauer taught economics at Cambridge University and later at the London School of Economics, which is really where he spent the bulk of his career. For years, Bauer once said, the field of development economics had remained immune to inconvenient evidence. Well, by the last two decades of Bauer's life, that had finally begun to change by the 1980s, thanks in no small part to his own work. The fact is, foreign aid has served to prop up brutal and corrupt regimes and shelter them from the economic consequences of their own destructive policies. It has subsidized programs, such as, for example, import substitution, we'll talk about that later, that have destroyed developing countries' export sectors.

16:59It has politicized life in these countries as hostile groups struggle with each other to seize control of the increasingly lucrative coffers of the state apparatus. It has delayed or derailed essential economic reforms, and after five decades of such assistance, the results are essentially all bad. Now, it wasn't supposed to happen this way, of course. Of course, in the decades following World War II, foreign aid was sold to Western taxpayers as a profound moral obligation that no person of goodwill could oppose. What are you, some kind of extremist? Outside aid, according to the conventional wisdom, was absolutely essential to the prosperity of the world's less developed countries. These countries, it was said, were trapped in a vicious circle of poverty.

17:45What does vicious circle of poverty mean? It means that a high savings rate is necessary in order to fund the capital investment that would increase these countries' productive capacities and lift them out of poverty. But since they were so poor, they could not produce adequate savings in the first place and therefore couldn't get this process started. Foreign aid programs were intended to provide this capital. Hauer insisted from the beginning that this argument, that outside infusions of capital were essential in order for countries to escape the vicious circle of poverty, he argued that this was invalid, even laughable. He said, if it were really true that infusions of outside capital were necessary to spur economic development, then how did the first countries to develop manage to do so?

18:35Imagine a world in which everybody is basically living at the level of the Stone Age. If it's true that you need outside infusions of aid to get started developing, nobody could have developed, where would the aid have come from? There were no, by definition in the Stone Age, there were no developed countries. Did Martians come and give development aid? Well then how did the Martians become prosperous? There's no way to answer this question. So at a time when there were no developed countries to aid them, the first country to develop managed to develop anyway. So, again, Bauer himself said it would have been impossible for any country to develop and everyone would still be living in the Stone Age if this vicious circle of poverty thesis were correct. He said, There is not a single instance in history when external donations were required for the economic development of a country.

19:21Economic prosperity depends on people's attributes, attitudes, motivations, mores and political arrangements. If the conditions for development other than capital are present, the capital required will either be generated locally or be available commercially from abroad to governments or to businesses. If the required conditions are not present, then aid will be ineffective and wasted. Well, over the course of his many books and articles, Bauer showed that cultural attitudes and institutional arrangements have played a critical role in determining the economic performance of a nation. So, for example, the people who believe in fatalism or collectivism, rather than in personal responsibility, will be less likely to undertake the risks associated with entrepreneurship. Hernando de Soto demonstrated the importance of institutions when he investigated the poor economic performance of his native Peru.

20:14He found that insecure or poorly defined property rights were at the root of much of what ailed his country. He also showed that the suffocating effects of regulation, a factor almost entirely neglected in the economic development literature, had played a substantial role in Peru's woes. So he found, for instance, that it took the equivalent of 289 workdays, 81 meters of forms, and 8 overt bribes to legally establish a small clothing factory in Peru. And then people scratched their heads, why is Peru not doing well? I wonder. In spite of all this scholarly work, and the second thoughts that so many former supporters of foreign aid had begun to have as the last century, the 20th century came to a close. By the early years of the 21st century though, the old long-exploded platitudes of foreign aid advocates were back in force once again, almost as if Bauer had never existed.

21:09Even the vicious circle of poverty made a comeback. According to the United Nations Millennium Project, many reasonably well-governed countries are too poor to make the investments to climb the first steps of the ladder. There it is again. Jeffrey Sachs, supposedly one of the world's greatest experts on the subject of international development, likewise contended that outside aid was necessary to fund what he called a big push in public investments essential to overcoming African poverty. And he said, the claim that Africa's corruption is the basic source of the problem does not withstand practical experience or serious scrutiny. Well, one of the most effective critics of this suddenly renewed confidence in foreign aid is a man named William Easterly, Bill Easterly.

21:57Easterly left the World Bank following the controversy surrounding his 2002 book, The Elusive Quest for Growth, which criticized traditional foreign aid programs. Now a professor at New York University, Easterly consistently throws cold water on this propaganda. Here's an excerpt from Easterly's work. Easterly, by the way, found he had to leave the World Bank in effect because here he had just written this book, Condemning the World Bank's Programs. It suddenly became uncomfortable for him to work there any longer. So he's a professor at NYU now, but here's what he says, Jeffrey Sachs says that large aid increases would finance a big push in public investments to produce a rapid step increase in Africa's underlying productivity, both rural and urban.

22:43Over 1970 to 1994, there is good data on public investment for 22 African countries. These countries' governments spent $342 billion on public investment. The donors gave these same countries' governments $187 billion in aid over this period. Unfortunately, the corresponding step increase in productivity, measured as per capita growth over this period, was zero. Still, proponents of what has been called the new economics of foreign aid remain confident that aid can work wonders so long as it is directed at countries with good policy environments. Greater selectivity by donors can ensure that only trustworthy and responsible regimes are rewarded with loans or grant money.

23:28Those regimes in turn will direct the aid money to fruitful and worthwhile enterprises. Well, there are problems with what we call this new economics of foreign aid that has all this confidence in foreign aid and what it can accomplish. Now one of these difficulties is that this new confidence is based entirely on a very small number of studies conducted by the World Bank whose conclusions have proven either impossible to verify by outside researchers or when the bank's data can be independently evaluated are flatly contradicted by other scholars. For example, much research suggests that even when aid is directed toward countries with relatively sound economic policies, the overall result is still negative. A recent International Monetary Fund study concluded that there is no evidence that aid works better in better policy or geographical environments, and that no subcategories of aid have any significant impact on growth.

24:24But even if, after over a half century of missteps, aid could somehow be channeled only to the best behaved and least predatory regimes, the problem is that the aid, per se, is nevertheless harmful. It consistently results in the expansion of the public sector, because governments, after all, administer the aid, at the expense of the productive private economy, and it contributes to the politicization of economic life. By which I mean, it tends to direct entrepreneurial energies toward political agitation so that you can get a share of the grant money instead of toward productive efforts aimed at satisfying consumers. Frederick Erickson, writing in the Journal of Economic Affairs, writes, Aid dependency alters incentives and strategies, creating a political economy entrenched in every fiber of society where additional wealth is easiest created by more aid, not by reforms or producing more efficiently.

25:23Aid dependency dilutes the very same process that makes societies affluent. It hampers the true source of wealth creation, namely behavioral change. Unsurprisingly, ethnic and other tensions have sometimes risen as competition for control of the state apparatus and its foreign largesse has intensified. The results have at times been violent, particularly in the cases of such Western aid recipients as Burundi, Kampuchea, Ethiopia, Indonesia, Iraq, Nigeria, Pakistan, Tanzania, Uganda, Vietnam and Zaire. The politicization of economic life for which aid serves as an important catalyst has even led to large-scale expulsion and even massacre tolerated, encouraged or perpetrated by the rulers.

26:10And by the way, the reason, of course, that all this happens, you have all this tension, is that you've got tension to begin with between competing groups, then you throw all this free money into the picture, and now they're all at each other's throats to get a portion of it. That's how you get rich in these countries, not by producing more, but by getting your hands on the aid money. So aid programs and these types of incentives that they have introduced have to share some of the responsibility for these terrible outcomes. So, it is not a question of taking a good program and applying it to deserving countries. Foreign aid is not a good program in the first place. The former chief economist for USAID, which is the Agency for International Development, Alan Waters, once wrote,

27:05and the financial capital into non-productive and administrative activities. It creates a moral ethical tone which denies the hard task of wealth creation. Foreign aid makes it possible for societies to transfer wealth from the poor to the rich. But as of 2002, the administration of President Bush began to adopt this new selectivity approach. In March 2002, President Bush agreed to attend the United Nations Summit on Global Poverty Perhaps to disarm some of his detractors, because Bush had spoken against foreign aid numerous times in the past. Shortly before leaving for Monterrey, the president announced his intention to increase foreign aid by $5 billion over the next three years. But instead of the global huzzahs they expected, the White House heard only crickets.

27:53James Bovard tells what happened next. The White House was chagrined when Bush's proposal for five billion more dollars in foreign aid did not generate massive international applause. So on the day before he left for Mexico, White House officials revealed that there had been a glitch in the original announcement and that Bush actually planned to give away more than twice as much money under the new program. White House spokesman Ari Fleischer said the mistake was simply a result of confusing math. National Security Advisor Condoleezza Rice explained, we didn't want to go out there with essentially false or phony numbers. You know how conscientious they are about getting their facts straight. The New York Times noted that skeptics said that the White House was just adding on billions to make sure that the President was a hit in Monterey.

28:46In his speech in Monterey, Bush echoed the familiar refrain of the new economics of foreign aid, that greater selectivity and identifying recipients of aid would set the developing world on the road to prosperity. This new program in which foreign aid would be more selectively dispersed than in the past would be known as the Millennium Challenge Account, MCA. Now, naturally Congress had been consulted about none of this and legislation establishing the new program didn't reach Congress till the next year. Now, Americans are supposed to believe that this new commitment to greater selectivity Selectivity and determining worthy recipients of foreign aid will overcome the problems that have plagued these programs for decades. Well, we've already seen that there's plenty of evidence that foreign aid is inherently bad, no matter how selectively it's awarded.

29:31But beyond that, the fact is we've heard all this before, again and again. In 1963, John F. Kennedy outlined, quote, and, quote, objective number one, to apply stricter standards of selectivity in aiding developing countries. The Pearson Commission called for the same thing six years later. In 1985, a special task force on foreign aid declared, the relief of poverty depends both on aid and on the policies of the recipient countries. Another major government report, nearly 30 years after the original statement by Kennedy, was still noting, even very well designed projects cannot succeed in a poor policy environment. We've been hearing this again and again and again. So if programs that have entrenched human misery and consistently failed for five decades cannot be called failures, then nothing can.

30:23If history is any guide, no one should place his hopes in yet another new and improved foreign aid program. But there are some things Westerners can do for their brethren in the developing world. for example, give sound economic advice, showcase success stories like Hong Kong which has prospered fantastically without foreign aid even though it seems like a natural candidate for foreign aid no local energy sources, shortages of water, shortages of everything and yet it adopted the free market, it exploded with prosperity it's got very secure property rights there and what do you know, as I point out in my book As time went on, Hong Kong became so productive, so successful, that Britain and the United States began asking it not to export so many wonderful products to them, because they couldn't cope with it all.

31:14They could repeal agricultural subsidies and some of their tariff restrictions, which would help the developing world more than all these foreign aid programs put together. This is not brain surgery. Economist Mankir Olson said very simply in 1993 that the world's economically successful countries all possessed relatively secure property and contract rights, while all the unsuccessful ones did not. And by the way, even with all this talk about this new approach to foreign aid, the old review is still very much present. Even in this age of the millennium challenge account, the US government is still set to disperse about the same amount of standard foreign aid and we'll continue to ship about 10 billion abroad annually even with this new program in effect. So that'll just be on top of the standard aid.

32:00So there, in case anyone needed it, is more evidence that the only thing we learn from history is that nobody learns from history.