All Commentary
Thursday, December 1, 1966

Foreign Aid: An Instrument for Progress?

Foreign aid is clearly not a neces­sary condition of economic devel­opment. This fact is obvious from the history of the developed coun­tries, all of which began poor and have invariably progressed with­out government-to-government aid. It is clear also from the his­tory of many underdeveloped coun­tries — Hong Kong, Japan, Malaya — which have advanced in recent decades without foreign aid.

Nor is foreign aid a sufficient condition of economic advance or even a generally effective force in its promotion. Indeed, its failure to advance living standards in poor countries after more than a decade of its operation is recognized in current discussions which empha­size the continued low living stand­ards in the recipient countries and insist on the need for indefinite continuation of aid at present or higher levels.

India is perhaps the most fa­miliar example. Thirteen years after the beginning of Western aid and the inception of the five-year plans, the country experienced in 1964-65 the most acute of its recurrent, almost annual, food and foreign exchange crises. For a long time advocates of foreign aid to India, Professor Walt W. Rostow among many others, insisted that the turning point was just around the corner, and that after only an additional limited injec­tion of aid the country would reach “self-sustaining growth”—to use the popular, though largely meaningless, catch phrase. For years now India has been dependent on large-scale foreign aid and gifts of food, without which there would have been mass starvation in 1964-65. External dependence has now come to be taken for granted. Algeria, Burma, Ceylon, Indonesia, and the United Arab Re­public are among other countries with acute domestic economic dif­ficulties after prolonged foreign aid.

Analogy with Marshall Aid

Marshall aid to Western Europe is often instanced in support of the potential value of foreign aid to poor countries. Its experience suggests the exact reverse. The economies of Western Europe had to be restored while those of pres­ent recipients have to be developed. Europe after 1945 was demon­strably short of capital resources, especially stocks of food and raw materials, but not in the necessary human resources and market op­portunities. Its peoples had the attitudes, motivations, and institu­tions favorable to development, as was clear from the performance of Western Europe for centuries be­fore the Second World War. This distinction explains the rapid re­turn of prosperity to Western Eu­rope (in spite of the inflow of millions of refugees into West Germany and the continued dis­mantling of plants for reparations superimposed on war-time destruc­tion), and the termination of the Marshall aid program in four years. Almost all the aid repre­sented the cost of food and raw materials and was essentially an emergency program. The contrast with the economic plight of India, and of many other recipients of aid after a much longer period, is clear.

The difference in effectiveness between Marshall aid to Western Europe and foreign aid to poor countries is also recognized by the widely-held assumption that aid to poor countries must be continued for many years to come.

The large-scale expenditure by the United States government on the surviving Navajo Indian popu­lation (a large group with a terri­tory of its own) may appear more relevant to the assessment of for­eign aid than is the Marshall plan. Very large sums, amounting to thousands of dollars a head, have been spent in an unsuccessful at­tempt, extending over decades, to improve the material position of these Indians. This experience re­inforces the conclusion suggested by more than a decade of foreign aid to poor countries: foreign aid is not a sufficient condition of de­velopment, and is indeed unlikely to promote it substantially. If a poor country has failed to develop without aid, its provision alone is unlikely to lead to development.

Poverty and Pauperization

The flow of sustained indefinite aid implies an obvious and yet widely ignored danger—the pau­perization of the recipients. A pauper is one who relies on un­earned public assistance, and “pau­perization” accordingly denotes the promotion and acceptance of the idea that unearned doles are a main ingredient in the livelihood of nations. This danger of foreign aid is reinforced by the practice of linking it to the balance-of-pay­ments difficulties of the recipients. Foreign aid and its relation to these payments crises clearly un­dermine the status and prestige of the self-reliance required for ma­terial progress.

This danger of pauperization which derives from the advocacy and flow of aid is enhanced by the prevalence in many underdevel­oped countries of certain attitudes and customs, notably the recog­nized status of beggary and the absence of social stigma in the ac­ceptance of indiscriminate charity which is conspicuous in South Asia. Indeed by now the pauperi­zation of some major recipients of aid is a reality rather than a dan­ger. The recent economic history of India can be summed up as pro­gression from poverty to pauper­ism.

The likelihood of the pauperiza­tion of the recipients is increased when the gifts are indiscriminate or unconditional on efforts by the recipients to improve their posi­tion. This applies to the operation of foreign aid. The advocates, ad­ministrators, and recipients of aid insist that it should be given with­out strings on the policies of the governments or the economic con­duct of the population. The only significant exceptions are the pref­erential treatment of countries in balance of payments difficulties or governments engaged in compre­hensive development planning. As I shall argue, these conditions will not improve the prospects of re­cipients becoming independent of external assistance.

External Grants and the Growth of Resources

The contrasting experience of the rapid success of Marshall aid and the ineffectiveness of pro­longed aid to poor countries is ul­timately related to differences be­tween the impact of resources pro­vided in the form of aid and that of resources produced locally or obtained in exchange for the cur­rent or expected proceeds of local production. When resources are both generated and used locally, the required conditions for further economic development are likely to be present in the form of suitable human qualities, social institu­tions, and economic opportunities.

Building up resources (in which formal education may or may not play a part) both requires and ad­vances social and economic proc­esses that serve to develop quali­ties, attitudes, arrangements, and institutions, the presence of which promotes the effective use of the resources generated. When, how­ever, the increase in the resources takes the form of the inflow of free or subsidized aid from abroad, the essential process of generating them is lost.

Here, as in many other spheres of human life, time, experience, and perhaps other qualifications and requirements of achieve­ment, cannot be bought. A social process cannot be telescoped without affecting both its nature and the outcome of the process. And we are not discussing ma­chines, pieces of equipment, but human society or, more often, collections of societies. Develop­ment is indisputably a social process requiring much more than the provision of money from abroad.

The Impact of Aid

When foreign aid is given by one country to another, it is re­ceived not by the people, but by the government: it does not go to individuals or firms in the pri­vate sector, but to the central government. This necessarily in­creases the weight of the govern­ment in the economy, which in turn must increase the concen­tration of power, even if the re­cipient government does not in­tend this result. And if, as often happens, the government does wish to extend its power, the in­crease in its resources helps it to do so, chiefly but not only by ex­tending the public sector and by enabling the government to con­trol the economy more closely.

These effects are enhanced by the influential support or even pressure in the donor countries for comprehensive development planning and compulsory saving by the recipient countries, i.e., for government determination of the direction of economic activity outside subsistence agriculture and for special taxation to finance government expenditure. These policies have come to be regarded in the donor countries as a condi­tion of economic development in poor countries, and their adoption by recipient countries is accord­ingly considered as an earnest of their intention to promote it. This belief is unfounded. The historical evidence both of developed coun­tries and of underdeveloped coun­tries suggests more nearly the re­verse. Development planning was not used in the early history of the now developed countries of the West. Nor was it employed in the many underdeveloped coun­tries which progressed rapidly in recent decades, such as Japan, Hong Kong, Malaya, Thailand, and a number of African and Latin American countries. Only in the Soviet economies is it an essential element of economic or­ganization, and the texture of these societies reflects its perva­sive effects.

However, comprehensive devel­opment planning has been specified as a criterion or even as a condi­tion for the receipt of aid by some of the most influential advocates and administrators of American aid, including Professors Max F. Millikan, Walt W. Rostow, and John P. Lewis. It was also speci­fied as a condition of aid in Presi­dent Kennedy’s special message on this subject in 1961. In various aid programs, including those of American aid to India and Turkey, the flow of aid is closely linked to comprehensive development plan­ning.

Moreover, the amount of aid is often geared to the shortfall of re­sources required for the plan, par­ticularly as reflected in the bal­ance-of-payments difficulties of the country. This criterion not only encourages, or even forces, the governments to engage in com­prehensive development planning but also encourages them to make their plans as ambitious as pos­sible. The governments are thus induced to pursue, or at least not discouraged from pursuing, an in­flationary policy which eventually brings about balance-of-payments difficulties (under the prevailing system of fixed exchange rates). Balance-of-payments crises in turn serve as an effective basis for an appeal for aid.

Thus we have a situation in which aid depends on a means test, and the absence of means is regarded as a result of laudable endeavor. The link between for­eign aid and payments difficulties is an important specific influence in the direction of the pauperiza­tion of the recipients of aid which I have already noted as a general danger of foreign aid. It is hard to think of a more effective way of discouraging self-reliance.

These are among the reasons why foreign aid promotes and in­tensifies the control of recipient governments over the economic and social life of their countries.

The Instruments of Control

The principal elements of com­prehensive economic control in un­derdeveloped countries are famil­iar. They include: a large public sector and heavy taxation; the establishing of trading monopolies, including state trading monopolies in agricultural exports; extensive licensing of industrial and commercial activities; and the estab­lishment of many government owned and operated enterprises, including state sponsored, orga­nized, and run cooperatives.

These measures are often accom­panied by substantial expropria­tion of private property in many underdeveloped countries of Asia, Africa, and the Middle East, nota­bly Algeria, Burma, Ceylon, Indo­nesia, Syria, and the United Arab Republic (and to some extent India). And compulsory collectivi­zation of much of agriculture is a common feature in countries as different as Algeria and Indonesia.

In addition, economic controls extend to close surveillance of out­side economic contacts. External trade, capital movements, and im­migration are closely controlled and restricted by most if not all recipients of aid. These flows usu­ally serve as vehicles not only of physical commodities and financial transactions, but also of new ideas, crops, methods of produc­tion, wants, and attitudes. Perhaps most important, they can engender a new outlook toward material progress.

Some Economic Repercussions of the Flow of Aid

Some advocates of aid may not like the kind of society which emerges from their recommenda­tion, but they nevertheless accept it as the price of rapid develop­ment. They might, so to speak, be ready to trade some or even much freedom and security of person and property for an increase in the flow of goods and services. They might support the policies outlined above in the belief that they promote economic progress. But do they?

The drastic policies often pur­sued in the name of comprehensive development planning, and pro­moted by foreign aid, do not aug­ment resources: they only central­ize power. Nor do they promote or strengthen the human qualities, attitudes, and social institutions conducive to progress. Indeed, as I have already suggested, for a number of reasons they are much more likely to obstruct than to promote the emergence and growth of such attitudes and institutions.

The enlargement of the re­sources and power of the govern­ment does, of course, enable it to expand some industries and sec­tors by a transfer of resources from other uses, perhaps even quickly and on a large scale. But this power does not in the least ensure development in the sense of an increase in the total flow of goods and services, let alone in those which make up general liv­ing standards, as is amply clear from the experience of centrally planned economies over the last few decades. Only too often in­creased activity and expanded in­dustries are treated somehow as a net gain, a net addition to out­put, irrespective of the level of demand for the product and with­out regard to costs in terms of al­ternative uses of resources.

The government can also easily enough restrict consumption and increase investment expenditure. However, this objective could be achieved without close control of the economy by such means as a budget surplus or the encourage­ment of private saving and invest­ment. Moreover, an increase in in­vestment expenditure, especially in public expenditure made pos­sible by high taxation or the im­position of direct controls, does not guarantee economic progress. It only ensures reduced living standards now without ensuring higher living standards later. In this effect it is somewhat similar to foreign aid, which certainly im­poverishes the donors without nec­essarily enriching the peoples of the recipient countries.

Investment Expenditure and Economic Development

Government policies and public discussions on this subject are pervaded by the widely prevalent investment fetish, the belief that economic development depends es­sentially on investment, which is assumed to be highly productive. But a piece of expenditure does not become productive by being termed investment, in the sense of any expenditure other than on current consumption. There is no assurance that it will increase the total flow of goods and services compared with alternative uses of the resources, let alone that it will improve living standards. And in considering the net result of an in­crease in investment, it is neces­sary to examine the various reper­cussions of the collection of the funds and of other measures in­troduced to increase investment, especially government investment. For instance, the additional taxa­tion or the restriction on the pro­duction or import of consumer goods required by the increase in investment often discourages or even prevents subsistence farmers from producing for sale. And in­vestment can be productive only if it is embodied in physical capi­tal combined with complementary human resources operating in an appropriate institutional setting and producing output for which there is an effective demand. In many different ways investible funds supplied by foreign aid are not complementary to local re­sources in the promotion of econ­omic development in the sense of increasing their productivity.

It is by no means certain that foreign aid does increase invest­ment in the recipient countries. The various repercussions which I have already noted, particularly the imposition of extensive con­trols and higher taxation and the pursuit of inflationary policies which bring about payments dif­ficulties, may serve to reduce pri­vate investment, notably direct in­vestment in agriculture. More­over, both the flow of aid and its method of operation encourage and enable the recipient govern­ments to discourage the inflow of private capital.

Foreign Aid and Private Capital

Foreign aid is likely to discour­age the recipient governments from securing capital on market terms, which from their point of view may be both unprofitable and politically unwise if foreign aid is available, i.e., if investible funds are available gratis. And indeed, almost all recipients of foreign aid restrict the inflow and deployment of private foreign capital. During the last decade or so these restric­tions have increasingly developed into expropriation of foreign capi­tal, often accompanied by the ex­pulsion of the owners and their employees. Examples abound in Africa and Asia. Governments which clamor for foreign aid be­cause of lack of capital neverthe­less severely restrict and circum­scribe the inflow and operation of private capital.

Certain aspects of foreign aid, especially the criteria of alloca­tion, have even encouraged the flight of private capital from the recipient countries. The donors en­courage the recipient countries to impose extensive controls in the name of development planning. And as we have seen, they are also encouraged to pursue inflationary policies, since the amount of aid often depends on the payments dif­ficulties of these countries. These policies engender a widespread feeling of insecurity, which in turn discourages the local popula­tion from saving and investing, and encourages the export of capital. Although capital exports are banned throughout practically the whole of the underdeveloped world, they are difficult to prevent. As a result, the inflow of foreign aid is matched by an outflow of both domestic and foreign private capital. And the outflow is of cap­ital likely to be more productive than foreign aid funds, because its deployment is geared much more closely to local conditions, espe­cially to consumer demand and to the supply of co-operant factors.

The Performance of Governmental Functions

I have just noted that the pre­occupation with aid, investment, and development planning has served to divert attention from more important factors in devel­opment which are influenced by government policy. This same pre­occupation has also served some­what paradoxically to bring about a serious neglect of essential tasks of government. Governments seem anxious to plan but unable to govern. The neglect extends to such familiar and essential tasks as the maintenance of law and order, the effective management of the monetary and fiscal system, and the provision of basic trans­port and educational facilities. Indonesia is only one of the sev­eral poor countries where the gov­ernment cannot maintain law and order but tries to control the econ­omy closely.

The proliferation is familiar of heavily subsidized state airlines, steel mills, and industrial plants in African and Asian countries with illiterate populations whose activities are restricted by cus­toms and institutions adverse to material progress. In India, with a huge illiterate and caste-bound population, the development ex­penditure on elementary education under the second five-year plan was less than one-half the cost of each of the three steel plants in the public sector under that plan. The administration of Hong Kong is one of the exceptions to the in­clination of governments of under­developed countries to neglect es­sential functions (including the maintenance of law and order) while attempting closely to con­trol social and economic life. This emphasis on government functions partly accounts for the rapid prog­ress of that country. Indeed, Hong Kong is being gradually omitted from the category of underde­veloped countries in much the same way as Japan.

Framework of Law and Order

The promotion of a suitable in­stitutional framework for the ac­tivities of individuals conducive to economic development is a task which few governments of under­developed countries have at­tempted to solve. In this sphere the activities of the recipients of foreign aid are largely confined to the expropriation of politically weak and unpopular classes (such as landowners, ethnic minorities, or successful traders) in the name of land reform, social justice, or the removal of exploitation, re­gardless of the repercussions of these measures on economic de­velopment or general living stand­ards. Institutional changes favor­ably affecting the determinants of economic progress and thus pro­moting material advance are gen­erally neglected.

Altogether the policies, attitudes, and outlays encouraged by foreign aid tend to lead to expend­itures more likely to retard than to promote material advance. This applies both to foreign aid funds and to domestic resources whose deployment is diverted from uses more likely to lead to material progress.

Human Progress

In conclusion, I return to my main theme. Material progress de­pends primarily on the develop­ment of suitable human qualities, attitudes, and social institutions, and not on the inflow of external grants of money. Foreign aid does not affect the major factors be­hind the material backwardness of underdeveloped countries; the con­tinued poverty of the recipient countries is therefore not surpris­ing. The policies of the recipient countries have on the whole served to retard or obstruct possible ad­vance. And while many of them would probably have been pursued even without foreign aid, its op­eration has encouraged and rein­forced them, generally by the sup­ply of funds and personnel and more specifically by the criteria of allocation. The suggestion that the peoples of the recipient countries are likely to be damaged by large-scale gifts to their governments is paradoxical and requires drastic readjustment of ideas. But I be­lieve it is true, and that such a re­adjustment is accordingly neces­sary. The longer this readjustment is delayed the more difficult it be­comes, both because of the en­trenchment of vested political, ad­ministrative, financial, and intellec­tual interests, and because of the magnitude of the costs already in­curred. The greater the sacrifices, the more difficult it is to question the principles in the name of which they have been imposed.

This article is condensed and reprinted by permission from Two Views on Aid to De­veloping Countries, by Barbara Ward and Professor Bauer, published as Occasional Paper 9 by The Institute of Economic Affairs, Ltd., Eaton House, 66A Eaton Square, Lon­don SW1, 1966 (Seven shillings and six­pence).

  • Peter T. Bauer is Professor of Economics (with special reference to Underdeveloped Countries and Economic Development) in the University of London at the London School of Economics.