Third World Development: Foreign Aid or Free Trade?

by John Majewski

Third World poverty is one of the most pressing problems of our age, condemning billions of people to lives of hardship and misery. Such poverty has led many Americans to want to help Third World peoples, both for humanitarian reasons and to increase our own trade and national security.

In response to Third World poverty, the U.S. government has provided over $321 billion in assistance since World War II.[1] As this figure indicates, foreign aid is politically popular. Besides its humanitarian supporters, many special interest groups lobby for foreign aid. For example, American farmers back food assistance because such programs help eliminate politically embarrassing food surpluses caused by agricultural subsidies.[2]

While foreign aid is a political success, it is an economic and social failure. By increasing government power, destroying economic incentives, promoting unprofitable enterprises, and subsidizing misguided policies, foreign aid increases Third World poverty. In this essay we will examine two types of foreign aid: humanitarian and development assistance. We will then discuss alternatives to aid in helping the Third World, especially the policy of free trade.

Humanitarian Assistance

Humanitarian assistance -- aid designed to avert immediate disaster -- mainly takes the form of food aid that is allocated through Public Law 480, widely known as the Food for Peace program. Since the establishment of FFP in 1954, the United States has distributed some $34 billion worth of food to the Third World, and currently provides some $1.2 billion a year in food transfers.[3] Although it reduces the surpluses of our government farm programs, Food for Peace has actually increased hunger abroad in the long run.

One problem with food aid is that the dumping of free food in Third World countries depresses prices for local farmers, therefore resulting in less domestic production. According to George Dunlop, chief of staff of the Senate Agricultural Committee, millions of Indians may have died of starvation because American wheat dumped in India bankrupted thousands of Indian farmers.[4] Thousands of Guatemalan farmers were likewise hurt when food aid poured into the country after the 1976 earthquake. For these unfortunate farmers, "the price of domestic crops dropped at a time when farmers desperately needed cash to improve and repair their homes...."[5] In Bangladesh, the upper and middle classes receive free food from foreign aid programs, thus impoverishing local farmers with artificially low prices.[6]

A second major problem with food aid is that it encourages the recipient nations to adopt policies that discourage production. With food aid to "cover-up" the most grievous results of their actions, Third World governments can pursue such counter-productive policies as forced collectivization and price controls on farm products. For example, Tanzanian President Nyerere was able to collectivize farms and engage in massive relocations of peasants because food aid "hid" the consequences of such actions.[7] In many cases, such as in Bangladesh, food aid leads to the neglect of agricultural production because of the belief that other nations will provide sufficient amounts of free food:

      Bangladesh officials are convinced that the
      international donors will not allow them to starve.
      Since it is easier to order a shipment of food through
      the embassy in Washington than to spend time and money
      on a domestic procurement program, a definite
      complacency has settled over the bureaucracy.  The
      technocrats who dominate the powerful ministries of
      finance, planning and food are resigned to continued
      reliance on American, Canadian, and Australian surpluses
      of food grains.  One symptom of the relief mentality
      is a reluctance to invest too much of the country's
      limited resources away from the more glamorous
      industrial sector and into low profile agricultural
      projects.[8]

The end result of programs such as Food for Peace is a complete dependence on food aid for many countries. Food aid destroys Third World food production, creating a perpetual crisis that requires more aid to avoid famine. The cycle continues until the country is completely dependent upon free food from abroad. As one analyst put it, foreign aid has become "the opiate of the Third World" that keeps the less developed countries (LDCs) permanently dependent on the West for their very existence.[9]

A third consequence of government-to-government food aid is the destruction of more efficient private efforts. Before World War II, private charities provided hundreds of millions of dollars in emergency aid. Because private food aid is administered directly to the poor -- it is an exchange between individuals, not governments -- it does not destroy markets through indiscriminate dumping or lead to destructive farm policies. Government food aid hinders private efforts by limiting the feeling of moral responsibility among citizens of more wealthy nations. Even more important, government food aid has "politicized" many private organizations by providing the bulk of their budgets, therefore destroying their incentives to be efficient. Without private alternatives, Third World nations are quick to accept public aid that increases the likelihood of future food shortages.[10]

Development Aid

Development aid attempts to promote long-run growth of the LDCs by building large projects, giving budgetary and balance of payments help, and funding a variety of research and planning efforts. Since 1946 the United States has given over $131 billion in development assistance.[11] Despite the scale of these international transfers, they have not led to sustained growth. Rather, aid has significantly impaired LDC progress by expanding the role of the public sector in the recipient nations.

Development aid is based on the premise that Third World nations don't grow because they lack of financial resources. But financial resources have relatively little impact on growth rates when compared to other factors. As P. T. Bauer argues, "Economic achievement depends on personal, cultural, social and political factors, that is people's own faculties, motivations and mores, their institutions and the policies of their rulers."[12] Even if financial resources were vital to growth, the Third World does not lack the means of obtaining international credit. If anything, the more than $800 billion total debt accumulated by LDCs shows that they may have had too much financial capital, rather than too little.[13]

As with food aid, development assistance politicizes Third World economic life. Aid helps incumbents expand their power through political patronage. According to economist Doug Bandow, "The tendency of ruling groups, particularly in societies where political power is so important, is to use aid, or funds released by aid, to strengthen their own position, reward their supporters, and buy off or crush opposition movements."[14] By limiting political competition, foreign aid inhibits the implementation of badly needed market-oriented reforms.

Even aid that is not used for overt political repression leads to the growth of large, unproductive bureaucracies. According to a recent Agency for International Development report: "Many African institutions officially responsible for planning and implementing development are saturated with development assistance, paralyzed by administrative inefficiency, staggering beneath a burden of complex and differing donor requirements, and are themselves in danger of becoming obstacles to development."[15] Some countries that receive large amounts of development aid, such as Zambia, use over 20 per cent of their GNP to provide civil service employees with a standard of living which is "totally out of synch with the rest of the economy."[16]

Through these large bureaucracies, development aid fosters political exploitation. There are many examples of Third World governments using aid to enrich the ruling elite at the expense of the masses. President Sese Seko of Zaire, for instance, used foreign aid money to partly fund the construction of eleven presidential palaces.[17] Foreign aid is also used to build expensive capital cities, such as Brasilia, Islamabad, Abuja in Nigeria, Lilongwe in Malawi, and Dodoma in Tanzania, that benefit few people except the ruling classes.[18] In some of the poorest parts of Africa, government officials are known as "Wabenzi" -- men of the Mercedes-Benz.[19] Foreign aid is also used to subsidize expensive Third World airlines. These airlines benefit only the elite of the country, while taking away resources from needed private sector activities.[20]

Even if development aid didn't lead to political exploitation, it would still foster economic inefficiency. Unlike firms in the private sector, government projects are not subjected to the discipline of profit and loss accounting. Because they operate outside the market, government projects -- the kind financed by foreign aid -- have low or negative rates of return. In many cases, aid agencies explicitly undertake such projects because the private sector refuses to finance them. Foreign aid thus channels the recipient nation's resources into unproductive areas of investment:

      The broadest ill effect of development assistance is
      that it distorts market signals and incentives.  It
      therefore diverts economic resources from their most
      productive uses in developing nations.  Whenever
      resources are made available outside of normal market
      channels, buyers and sellers in related market
      activities receive inappropriate signals and change
      their behavior, reducing locally generated incomes.  The
      resulting distortions may be major or minor, but they
      always occur.[21]

Without the price system to guide them, Third World nations have attempted to develop by simply building the same type of enterprises that flourish in more advanced countries. Steel plants, aluminum factories, and oil refineries funded with aid money dot the Third World, despite the fact that the markets for these products are already saturated. Because they cannot hope to compete with more established firms, these aid projects drain skilled labor and other resources away from the private sector with no corresponding benefits.[22]

Foreign aid not only wastes scarce resources in the very nations which can least afford waste, it also creates international tensions. Foreign aid has united the governments of the Third World into a cohesive unit that has but one goal: secure more aid. To accomplish this, the Third World has found that the politics of confrontation work best. In their eyes, the world is divided between rich and poor, with the former having an obligation to help the latter. The result is international conflict:

      The West has created an entity hostile to itself -- this
      is the biggest and most intriguing of the many anomalies
      of aid.  Individual Third World countries are often
      neutral or even friendly to the West, but the organized
      and articulate Third World is at best critical and more
      often hostile.  The purpose of the Third World qua
      collectivity is to coax or extract money from the
      West.[23]

Finally, we must note that development aid significantly drains our own resources. Many people support foreign aid because of the perception that it helps our export industries. In fact, there are stipulations on most aid packages requiring the use of American goods whenever possible. Because foreign aid subsidizes American companies which deal with the Third World, it shifts assets from more efficient firms, thereby reducing our overall economic performance. Supporting aid in the hope that some of it might be spent in the United States is like a supermarket giving money away in the hope that consumers will spend part of it in the store -- there is always a net loss.[24]

Another Way?

The basic problem with both types of foreign aid is that they strengthen the institutions which prevent progress while weakening the institutions of the Third World which could bring true prosperity. Aid increases the role of government and bureaucracy in the economic life of the Third World, while it minimizes the role of markets and private entrepreneurship. If we are to help developing nations prosper, we must find a method that creates a bigger role for institutions such as the market.

One way of aiding Third World nations is through free trade. By lowering our import barriers, we can allow the private sectors of the Third World easier access to our markets. With the huge markets of the United States available for their products, entrepreneurs will have the opportunity to develop new industries or expand old ones. As Lord Bauer writes, removing protectionist barriers will allow more Third World countries to experience the success of such Pacific Basin countries as Hong Kong and Singapore:

      As for economic development, the West can best promote
      this by the reduction of its often severe barriers to
      imports from poor countries.  External commerce is an
      effective stimulus to economic progress.  It is
      commercial intercourse with the West which has
      transformed economic life in the Far East, South-East
      Asia, and parts of Africa and Latin America.[25]

Free trade also has the advantage of helping our own economy. While this is no place to explode the numerous protectionist fallacies, free trade will increase our wealth with a great influx of goods and services from abroad. Like all voluntary exchanges, international trade is a positive sum activity; both America and the Third World benefit from it. Even if we make the heroic assumption that foreign aid actually helps Third World countries, it would still be only a zero sum activity; it can only help the recipient nation by hurting the donor nation.

Conclusion

Foreign aid fails as a development policy because it destroys the incentives of the marketplace and extends the power of ruling elites. Because it leads the Third World away from the free market, it actually increases Third World poverty. On the other hand, the alternative policy of free trade will give the private sector of the LDCs an opportunity to expand and flourish.

It must be emphasized that free trade alone will not solve all the problems of Third World poverty. Free trade only increases the opportunities of the less developed nations. It will not eliminate the shackles of government regulation and intervention that dominate Third World economies. That task can only be done by the people of the Third World themselves. Yet, eliminating foreign aid and instituting free trade will at least encourage Third World peoples to develop institutions such as private property rights and free markets which will lead to growth and prosperity.