Developing countries need trade, not aid

Many development economists have regularly given advice based on the belief that aid is essential for growth in countries that are lacking capital, education, entrepreneurs, infrastructure and access to foreign capital markets. It is thought that aid transfers will allow developing countries to escape from a vicious cycle of poverty – commonly referred to as the poverty trap. The underlying argument of the poverty trap is simple: growth of income depends on investment, investment depends on savings, and savings depends on income. Thus the low level of incomes in poor developing countries prevents the investment that is required to grow incomes and economies.

Development economists thought that foreign aid would fill the gaps in the poverty cycle and create the conditions for ‘take-off’, after which growth would be self-sustaining. They also thought that without aid, poverty would persist indefinitely. Their solution was for aid to provide a ‘breathing-space’ for a short period to enable the recipient country’s economy to start growing by itself, ending the need for it to be an aid recipient and they popularised this theory from the 1940s to the 1970s.

African countries have disproved the ‘hand-up’ theory of aid. Despite receiving billions of dollars in foreign aid over many decades most of the countries have not reached the ‘self-sustaining’ stage visualised in the economic theory and the continent remains the world’s poorest. The United States alone has provided massive aid to Africa. In 1992 it was estimated that U.S. taxpayers gave Africa in excess of a billion dollars (Sheehy, 1993). The recent proposal by the Blair Commission to double the amount of foreign aid to African governments is unlikely to solve any more problems than previous Western generosity succeeded in doing. In the early eighties the Brandt Commission called for similar actions after the first round of aid failed to show any signs of improving economic conditions in Africa.

Since aid consists of transfers from one government to another, most of it is spent on government consumption and very little is actually invested, strengthening governments and increasing their size at the expense of the private sector. The late Lord Peter Bauer recognised this phenomenon as early as the 1960s. ‘Foreign aid’ he said, ‘is demonstrably neither necessary nor sufficient to promote economic progress in the so-called third world and is indeed much more likely to inhibit economic advance than it is to promote it.’ Countries that are reliant on aid have no incentive to attract private capital. There is no pressure whatsoever on politicians in recipient developing countries to adjust distortionary policies. In fact, they are encouraged to continue with them, having learned that poor policies encourage the continuation and even increase the flow of funds.

History has demonstrated a much better way to help developing countries grow and prosper. Trade with them free of artificial barriers such as tariffs, quotas and subsidies to your own farmers and manufacturers, and they will rapidly become more prosperous while your consumers pay lower prices. Indeed, Adam Smith noted over 200 years ago that trade is the engine of economic growth. However, recent trade statistics for Africa show that Africa’s trade with the rest of the world has been declining. UNCTAD notes that Africa’s share in world exports fell from about 6 per cent in 1980 to 2 per cent in 2002, and its share of world imports from about 4.6 per cent in 1980 to 2.1 per cent in 2002. A major reason for the substantial decrease in Africa’s share of total trade is the negative effect of unfriendly trade policies and practices applied by the developed world.

Developed countries, and particularly E.U. members, have persistently prevented access to their markets for those commodities in which African producers have a comparative advantage. For instance, a World Bank study estimated that European Union trade regulations cost African exporters approximately US$400 million in exports of cereals, dried fruits and nuts each year. African countries, on the other hand, have for decades hidden behind myriad protectionist barriers, claiming essential ‘infant industry’ protection of the kind that doesn’t go away because the infant never grows up. Such import-substituting policies have imposed substantial costs on African consumers and greatly reduced the well-being of citizens. Import-substitution is widely recognised as a failed strategy, clearly demonstrated by the dismal performance of the Latin American nations that have followed this industrialisation strategy. Compare their results with the South East Asian countries that have followed more outward-orientated trade regimes.

In recent decades no country has achieved economic success without opening itself to trade with the rest of the world. Rather than propose asymmetric adjustment in trade barriers, except insofar as they counter the pernicious effects of farm subsidies and non-tariff barriers, the Blair Commission should encourage African countries to open their borders to trade and investment with the rest of the world. The evidence shows that open trade is the surest path to increased and sustained economic growth. For example, Hong Kong received virtually no aid but has achieved great per capita wealth through free trade, supported by its limited government and secure property rights policies. This is not surprising, given the potential gains to developing countries from eliminating the remaining trade barriers. The World Bank estimates that their potential gain from eliminating all barriers to merchandise trade ranges from US$250 billion to US$680 billion per year.

Developed countries of the North who sincerely wish to help African countries are faced with a rather important decision. They can continue to impose extra taxes on their citizens, making aid a regular fixture in their budgets, at the same time depriving their citizens of cheaper imported products. Alternatively, they can allow poor developing countries access to their markets by abolishing offending subsidies to their producers and removing both tariff and non-tariff barriers to trade with Africa, cut the aid, and allow their citizens to benefit from the resultant cheaper imports. As Anne Krueger notes, ‘Trade liberalisation will deliver more rapid growth based purely on the fact that trade liberalisation is the only means to move from an inward-orientated strategy to a more market based outward-orientated strategy.’

Author Jasson Urbach is an economic researcher at the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Free Market Foundation.

FMF Feature Article/23 November 2004