The problem with foreign aid.
One of the first attempts by the second Trump administration to cut government waste was massive cuts and layoffs at USAID. Now, the same administration is pressuring the United Nations to adopt more trade-focused policies rather than aid-focused ones—the “trade not aid” strategy. While it is not obvious how Trump’s tariffs are helping poor nations through trade, we still need to rethink foreign aid.
Development economics was shaped in part by the intellectual discussions among Soviet economists after Lenin’s death, as Peter Boettke writes in The Political Economy of Soviet Socialism. Out of those discussions came ideas like five-year plans. Those ideas contributed to the creation of development economics, which at the start was heavily focused on planning development through massive state intervention. Decades after the collapse of the Soviet Union, traces of that thinking can still be found in development policy.
One such trace is foreign aid. Although foreign aid can be practical and useful, such as providing vaccines, it has not been successful as a long-term growth strategy. For example, 80% of Afghanistan’s budget came from foreign aid, without any significant achievement.
To understand foreign aid, we should first understand the idea of the poverty trap. A poverty trap is defined as a self-reinforcing cycle in which a lack of resources, such as education and capital, prevents people from escaping poverty. In other words, you are poor because you are poor, not because of specific choices—and the only way to break that cycle, in theory, is for a third party to provide the resources that are lacking, such as capital, schools, or other assistance.
The idea may sound intuitive, but there is a problem with it. It is a compelling explanation of poverty and its self-reinforcing nature, but it lacks a description of how wealth is actually created. If we take the poverty trap seriously, the policy implication is obvious: rich countries should give foreign aid to poor countries to help them escape poverty. But one fundamental question of economic science remains unanswered: How did some countries become rich when others remained poor? Three hundred years ago, when every country was poor relative to modern standards, who gave foreign aid to Victorian Britain to help it escape poverty? Who gave money to the United States to industrialize?
What Deirdre McCloskey calls the Great Enrichment—the 3,000% increase in real income per person since 1800—was not a product of aid or planning, but of recognizing the dignity of the individual and the importance of liberty. The idea of liberty became fundamental to Western society, and commerce was no longer viewed as dishonorable. Merchants became part of the elite in both the Netherlands and England.
The missing element, in essence, in much development thinking is the liberty of the poor. Populations in developing countries are often seen as people who need plans and guidance from large governments, rather than individuals whose liberty should be protected so they can discover, create, and innovate. What changed was not merely policy, but ideas—most notably the idea of progress itself. Anne Robert Jacques Turgot, a French physiocrat who influenced Adam Smith, was one of the first thinkers to defend progress as both possible and desirable. Before that, progress was not widely regarded as a good thing.
Yet many leading economists still look to foreign aid as the solution. Nobel Prize-winning economist Esther Duflo argued in a 2024 interview with the Financial Times that the West has a “moral debt” of $500 billion to poorer nations. But can $500 billion solve the problem? In the last half-century, Western countries have spent more than $2 trillion on foreign aid, and instead of development, it has often created dependency. The reason is clear: aid does not change the institutions, culture, or economic model of poor countries. William Easterly points this out in his criticism of the World Bank, arguing that it has an obsession with the word governance while avoiding the word democracy. As he noted, “the World Bank Press Office explained to this author that the World Bank is legally not allowed by its own charter to use the word democracy.”
The problem facing developing nations is not primarily one of resources, but of ideas. As Ludwig von Mises wrote in Money, Method, and the Market Process:
The problem of rendering the underdeveloped nations more prosperous cannot be solved by material aid. It is a spiritual and intellectual problem. Prosperity is not simply a matter of capital investment. It is an ideological issue. What the underdeveloped countries need first is the ideology of economic freedom and private enterprise.
If ideas do not change, institutions cannot change. And without rules that promote liberty and free enterprise, no amount of foreign aid will ever be enough. Foreign aid without limited government, democracy, and the rule of law—and an intellectual culture that supports those things—becomes a self-reinforcing cycle of dependency in which countries stop thinking about growth and instead think only about the next round of foreign aid. Perhaps it is time to think less about the poverty trap and more about the foreign aid trap.
