(Reprinted from HKCER Letters, Vol. 12, January 1992)
The Failure of Foreign Aid:
With Special Reference to the SoviShyam Kamath
The collapse of communism in the ex-Soviet Union has prompted insistent calls for massive aid to its disintegrating nations. Helmut Kohl, the Chancellor of Germany, pledged up to 10 billion dollars, saying that the West has a duty to provide aid to the Soviet Union and Eastern Europe. An American journalist suggested that for 100 billion dollars, Soviet democracy could be purchased on the cheap. Harvard economist Jeffrey Sachs recommended a Marshall plan for the Soviet Union, with 150 billion dollars, based on the scaling up of the 1.7 billion originally given to the Marshall Plan.
In the 1950s and the 1960s, the same arguments were made and accepted with regard to newly decolonized nations. In reading the text of some of the statements that are being made today, one finds almost exactly the same words used to grant aid to the Soviet Union as those that were used in the case of India and Africa, for example, in the 1950s and 1960s. But after more than 40 years of ever-increasing foreign aid, only a bare handful of nations among those that did receive a massive amount of aid can be said to have developed successfully, and very often and most likely, after the foreign aid was stopped.
The development experience of India provides a classic example of the failure of foreign aid. India receives more aggregate aid than any other developing nation on earth. It received a total of 55 billion U.S. dollars over a 43-year period. That, in current dollar terms, is a massive amount of aid.
India had a system similar to that of the Soviet Union throughout the 40 years. It did have a private property market -- it still does -- and in fact, that part of the system is growing. Yet, through the period of central planning in India, its average growth was 1.5 percent per annum. Not unlike the Soviet Union today, we had a vast and diversified natural and human resource base, a large domestic market, a semi-industrial and infrastructural base and a committed leadership, at least so it seems. Unlike the present Soviet Union, it had a domestic pool of entrepreneurs, property rights, a dominant private sector, links with the international trading system, and a unified democratic political system. Yet after more than 40 years and the 55 billion dollars in foreign aid, it still remains one of the poorest countries in the world. Foreign aid has played a significant role in financing the growth of one of the largest and most inefficient public sectors in the noncommunist world. It has fostered a pervasive regime of statism, intervention, and control in the economy. Private investors have to spend something like 63 months to get a medium-size industrial project cleared through the government, with thousands of dollars of bribes and other rent-seeking behavior to be encountered along the way. India's experience has been mirrored in other ostensibly market-oriented economies such as Israel, Mexico till recently, Brazil, and Pakistan.
In practice, foreign aid means transferring resources from one government to another government. The lesson from Hong Kong is clear: You do not need foreign aid. Completely self-sustained and sustainable development takes place in the private market. Foreign aid precisely short-circuits that process. During the 1960s and 1970s, India's bureaucracy, predictably enough, used foreign aid to fuel the growth of the country's burgeoning public sector. Government expenditure as a proportion of the gross domestic product increased from about 19 percent in 1960-61 to about 40 percent in 1985-86. In 1980-81, the public sector companies lost more than 160 million dollars on 20 billion dollars of capital employed. The top 100 private sector companies, on the other hand, made an overall profit of 415 million dollars on 9 billion dollars of total capital employed. The point is that, in India, where the public sector holds near or complete monopolies in all production and distribution, aid is likely to slow the pace of privatiation -- and it would just be the same in the Soviet Union. By operating exclusively between governments, foreign aid will buttress the Soviet bureaucracy and forestall economic reform.
To the extent that it displaced private saving as a reliable pool of capital, foreign aid retarded self-financing growth in India. Ironically enough, the lack of domestic savings was seen as one of the major reasons for nationalizing the private commercial banks in 1969. So foreign aid essentially contributed to the socialization of the Indian economy. Foreign aid to the Soviet Union is equally likely to have similar effects regarding domestic savings, and to impede the development of private financial institutions.
No one is going to let the Soviet Union starve this winter. In fact, already, humanitarian food aid is flowing out of the United States. But large scale U.S. food aid in the 1960s in India bankrupted Indian farmers and depressed food prices, transferred wealth from the rural poor to the urban rich because of the very regressive public distribution system that existed and still continues to exist in the Indian economy, and increased the control of the government over the economy. Unless policymakers think it through in these countries, massive food aid would plant the seed of destruction in the Soviet agricultural system which, as we already know, is in a very moribund state.
One of the clear facts that comes through on foreign aid is that there is not one single example of a country that has successfully developed with foreign aid. There are close to 100 examples of countries that have failed with vast infusions of foreign aid. South Korea might be mentioned as an example of success. However, South Korea is a latecomer to both World Bank and IMF external assistance, and it began using IMF credit only in the middle 1970s, well after the nation's economic miracle was under way.
The Marshall Plan again is cited by a number of people who want to provide aid to the Soviet Union, as an example of successful development with aid. A George Mason University economist pointed out in the 1980s that the Marshall Plan was not the linchpin of Western European post-War economic recovery, and in fact, it influenced many nations to increase both economic planning and controls and hold down economic growth. He examined the recovery records of the major Marshall Plan recipients, and found the countries that had received the relatively largest amount of aid per capita, such as Great Britain, Greece, and Austria, were the growth lagers. On the other hand, France, Germany, Belgium, and Italy began their recovery well before the inception of the Marshall Plan. I think the lesson in case after case is clear. Economic freedom precedes any kind of political freedom; it definitely precedes any kind of country-to-country development assistance, and that is what the Soviet Union ought to be focusing on.
I think the best way in which the developed nations can help the Soviet Union is by encouraging private foreign direct investment, and the provision of private international finance for economic development -- presuming that somewhere along the line there are property rights of some sort. Most importantly, the developed nations can and should open up their markets to Soviet and Eastern European products. In addition, they should actively encourage and support the establishment of private property, voluntary exchange institutions through the well-functioning market order.
Professor Shyam Kamath is a Professor of Economics at California State University at Hayward, and an advisor to the Smith Center for Private Enterprise Studies. He is Co-Director of the Soviet Executive Development Program.
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