Ian Vásquez, Cato Institute
The federal government runs an array of aid programs aimed at promoting economic development in less-developed countries. Aid programs include those operated by the U.S. Agency for International Development, the Millennium Challenge Corporation, the Peace Corps, the Department of State, and the Department of Agriculture. In addition, the federal government pays a share of the funding for multilateral aid agencies, including the World Bank, Inter-American Development Bank, Asian Development Bank, and African Development Bank.
The federal government spends about $33 billion annually funding these foreign aid organizations.1 U.S. foreign aid spending has more than doubled in the past two decades. It averaged $14 billion annually during the 1990s, $24 billion during the 2000s, and $32 billion so far during the 2010s.2 Total foreign development aid from all wealthy countries has also increased greatly, and today amounts to about $143 billion a year.3
Despite the political enthusiasm for foreign aid spending, there is little evidence that aid is effective, and it is often counterproductive. There is no correlation between foreign aid and economic growth, and aid that goes to countries that follow poor economic policies certainly does not work. Efforts to condition the receipt of aid on market reforms have also failed.
On the other hand, decades of experience show a strong relationship between economic growth and market-oriented policies. Countries that have achieved growth through market reforms have generally done so because of domestic factors unrelated to the receipt of foreign aid. The upshot is that countries eager to spur economic development can do so themselves with reforms such as securing property rights, reducing arbitrary and bureaucratic regulations, and encouraging entrepreneurship and investment. As such, the U.S. government should end its development aid programs.
The Dismal Record of Foreign Aid
By the 1990s, the failure of conventional government-to-government aid programs had become widely recognized, and the foreign aid process was coming under increased scrutiny. For example, a Clinton administration task force conceded, “despite decades of foreign assistance, most of Africa and parts of Latin America, Asia, and the Middle East are economically worse off today than they were 20 years ago.”4 As early as 1989, a bipartisan task force of the House Foreign Affairs Committee concluded that U.S. aid programs “no longer either advance U.S. interests abroad or promote economic development.”5
Multilateral aid has also played a prominent role in the post–World War II period. The World Bank was created in 1944 to provide aid mostly for infrastructure projects in countries that could not attract private capital. The World Bank has since expanded its lending functions, as have the regional development banks that were created on the World Bank model, including the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, and the European Bank for Reconstruction and Development. The International Monetary Fund (IMF), also established in 1944, long ago abandoned its original role of maintaining exchange-rate stability around the world, and today engages in long-term lending on concessional terms to most of the same countries as the World Bank.
Despite record levels of lending, the multilateral development banks have not achieved any more success at promoting economic growth than has the U.S. Agency for International Development (USAID). Numerous self-evaluations of World Bank performance over the years, for example, have uncovered high failure rates of bank-financed projects. In 2000, the bipartisan Meltzer Commission found a 55 to 60 percent failure rate of World Bank projects based on the bank’s own evaluations.6 A World Bank report concluded that aid agencies “saw themselves as being primarily in the business of dishing out money, so it is not surprising that much [aid] went into poorly managed economies — with little result.”7 The report also said that foreign aid has often been “an unmitigated failure.”8 “No one who has seen the evidence on aid effectiveness,” commented Oxford University economist Paul Collier in 1997, “can honestly say that aid is currently achieving its objective.”9
There are numerous reasons why transfers from the developed to the developing world have not boosted prosperity. One reason is that aid has traditionally gone to governments, and essentially supported intervention in economies. By lending to governments, USAID and the multilateral development agencies have helped expand the state sector at the expense of the private sector in many poor countries. U.S. aid to India from 1961 to 1989, for example, amounted to well over $2 billion, almost all of which went to the Indian government.10 Much aid has also gone to autocratic governments.
Foreign aid has thus financed governments — both authoritarian and democratic — whose policies have been the principal cause of their countries’ impoverishment. Trade protectionism, byzantine licensing schemes, inflationary monetary policy, price and wage controls, nationalization of industries, exchange-rate controls, state-run agricultural marketing boards, and restrictions on foreign and domestic investment, for example, have all been supported explicitly or implicitly by U.S. foreign aid programs.
A lack of economic freedom kept literally billions of people in poverty, and interventionism has politicized the economies of developing countries. The centralization of economic decisionmaking in the hands of political authorities has meant that resources in poor countries have been diverted to unproductive activities and investments.
Precisely because aid operates within the (usually deficient) political and institutional environments of recipient countries, even when it goes to countries that do not rely on development planning, it can have detrimental effects. That is all the more true with higher levels of foreign assistance, as has been the case with Sub-Saharan African countries, most of which have received 10 percent or more of their national income in foreign aid for at least three decades. As Nobel laureate in economics Angus Deaton notes, “large inflows of foreign aid change local politics for the worse and undercut the institutions needed to foster long-run growth. Aid also undermines democracy and civic participation, a direct loss over and above the losses that come from undermining economic development.”11
Aid expert and World Bank economist, Stephen Knack, concluded in one of his cross-country analyses:
Aid dependence can potentially undermine the quality of governance and public sector institutions by weakening accountability, encouraging rent-seeking and corruption, fomenting conflict over control of aid funds, siphoning off scarce talent from the bureaucracy, and alleviating pressures to reform inefficient policies and institutions. Analyses of cross-country data in this paper provide evidence that higher aid levels erode the quality of governance, as measured by indices of bureaucratic quality, corruption, and the rule of law.12
It has become abundantly clear that, as long as the institutional conditions for economic growth do not exist in a country, no amount of foreign aid will produce economic growth. Indeed, a comprehensive study by economists for the National Bureau of Economic Research found no relationship between aid and growth.13 Raghuram Rajan and Arvind Subramanian found “little robust evidence of a positive (or negative) relationship between aid inflows into a country and its economic growth.”14
Economic growth in poor countries does not depend on transfers from other governments. If it did, no country on earth could ever have escaped from initial poverty. The long-held premise of foreign aid — that poor countries were poor because they lacked capital — ignores thousands of years of economic development history, and is contradicted by contemporary events in the developing world.
Promotion of Market Reforms
Even aid to poor countries intended to advance market reforms can produce undesirable results. That is because such aid takes the pressure off recipient governments to proceed with needed domestic reforms. Ernest Preeg, former chief economist at USAID observed the problem in the Philippines after the collapse of the Marcos dictatorship in the 1980s: “As large amounts of aid flowed to the Aquino government from the United States and other donors, the urgency for reform dissipated. Economic aid became a cushion for postponing difficult internal decisions on reform. A central policy focus of the Aquino government became that of obtaining more and more aid rather than prompt implementation of the reform program.”15
The suspension or elimination of foreign aid is far more effective at promoting market reforms. Although USAID lists South Korea and Taiwan as success stories from U.S. aid, those countries began taking off economically only after massive U.S. aid was cut off. As even the World Bank has conceded, “Reform is more likely to be preceded by a decline in aid than an increase in aid.”16
Still, much aid is delivered on the condition that recipient countries implement market-oriented economic policies. Such conditionality is the basis for the World Bank’s structural adjustment lending, which it began in the early 1980s after it realized that pouring money into unsound economies with poor institutions would not lead to self-sustaining growth. But aid conditioned on reform has been ineffective at inducing reform. One 1997 World Bank study noted that there “is no systematic effect of aid on policy.”17 A 2002 World Bank study admitted, “too often, governments receiving aid were not truly committed to reforms.”18 And it noted, “the Bank has often been overly optimistic about the prospects for reform, thereby contributing to misallocation of aid.”19 Stephen Knack of the World Bank summed up the literature saying, “analysts generally conclude that conditioning aid on policy and governance reform is largely ineffective.”20
Oxford’s Paul Collier explains: “Some governments have chosen to reform, others to regress, but these choices appear to have been largely independent of the aid relationship. The microevidence of this result has been accumulating for some years. It has been suppressed by an unholy alliance of the donors and their critics. Obviously, the donors did not wish to admit that their conditionality was a charade.”21
Lending agencies have an institutional bias toward continued lending even if market reforms are not adequate. Yale University economist Gustav Ranis explains that within some lending agencies, “ultimately the need to lend will overcome the need to ensure that those [loan] conditions are indeed met.”22 In the worst cases, lending agencies do suspend loans in an effort to encourage reforms. When those reforms begin or are promised, however, the agencies predictably respond by resuming the loans in a process Ranis has referred to as a “time-consuming and expensive ritual dance.”23
In sum, focusing aid on reforming nations, however superficially appealing, does not produce rapid and widespread liberalization. Just as Congress should reject funding for regimes that are uninterested in reform, it should reject funding for countries on the basis of their reforms. This includes funding through the Millennium Challenge Corporation (MCC), a federal agency created in 2004 to direct funds to poor countries that have sound policy environments. The MCC is premised on a conceptual flaw since countries that are implementing the right policies for growth will be receiving the aid, yet those countries do not need foreign aid. In practice, the effectiveness of such selective aid was questioned by Rajan and Subramanian, who found “no evidence that aid works better in better policy or geographical environments, or that certain forms of aid work better than others.”24
The MCC and other similar programs require government officials and aid agencies — all of which have a poor record in determining when and where to disburse foreign aid — to make complex judgment calls on which countries deserve the aid and when. Moreover, it is difficult to believe that bureaucratic self-interest, micromanagement by Congress, and other political or geostrategic considerations will not continue to play a role in the disbursement of this kind of foreign aid. It is important to remember that the creation of the MCC was not an attempt to reform U.S. foreign aid. Rather, the MCC aid is in addition to the larger aid from traditional programs run by USAID — in many cases in the very same countries.
Help for the Private Sector
Enterprise funds are another initiative intended to help market economies. Under this approach, the U.S. government, typically through USAID, has established and financed venture funds throughout the developing world. The purpose is to promote economic progress and “jump start” the market by investing in the private sector. Some of these funds have expired, some still exist, and others are being proposed.
It was never clear exactly how such government-supported funds would find profitable private ventures in which the private sector is unwilling to invest. Numerous evaluations have found that most enterprise funds have lost money, and many have simply displaced private investment. There is also no evidence that the funds have generated additional private investment, had a positive effect on development, or helped create a better investment environment in poor countries.
Similar efforts to underwrite private entrepreneurs are undertaken by the World Bank and by U.S. agencies such as the Export-Import Bank, the Overseas Private Investment Corporation, and the Trade and Development Agency. U.S. officials justify the programs on the grounds they help promote development and benefit the U.S. economy. Yet providing loan guarantees and subsidized insurance to the private sector relieves underdeveloped countries of the need to create an investment environment that would attract foreign capital on its own. To attract investment, countries should establish secure property rights and sound economic policies, rather than relying on Washington-backed programs that allow avoidance of those reforms.
Moreover, while some corporations benefit from foreign aid programs, the U.S. economy and American taxpayers do not. Subsidized loans and insurance programs are corporate welfare. Overall macro- and microeconomic policies and conditions, not corporate welfare programs, determine indicators such as the U.S. unemployment rate and the size of the trade deficit. Programs that benefit specific interest groups only rearrange resources within the U.S. economy and do so in a wasteful manner. Indeed, the United States did not achieve its status as the world’s largest exporter because of agencies like the Export-Import Bank, which finances less than two percent of U.S. exports.
Even USAID has claimed that the main beneficiary of its lending is the United States because close to 80 percent of its contracts and grants go to American firms. That argument is fallacious. “To argue that aid helps the domestic economy,” renowned economist Peter Bauer explained, “is like saying that a shop-keeper benefits from having his cash register burgled so long as the burglar spends part of the proceeds in his shop.”25
By the mid-1990s, dozens of countries suffered from inordinately high debt owed to foreign creditors. In response, the World Bank and the IMF devised a $75 billion debt-relief initiative that benefited 39 heavily indebted poor countries. The initiative was an implicit recognition of the failure of past lending to produce self-sustaining growth, especially since an overwhelming percentage of eligible countries’ public foreign debt was owed to bilateral and multilateral lending agencies. Indeed, in 2006, at about the time the debt relief initiative began taking effect, 96 percent of those countries’ long-term debt was public or publicly guaranteed.26
Forgiving poor nations’ debt is a sound idea, on the condition that no other aid is forthcoming. Unfortunately, the multilateral debt initiative promises to keep poor countries on a borrowing treadmill, since they will be eligible for future multilateral loans based on conditionality. There is no reason, however, to believe that conditionality will work any better in the future than it has in the past. A World Bank study emphasized, “A conditional loan is no guarantee that reforms will be carried out — or last once they are.”27
Nor is there reason to believe that debt relief will work better now than in the past. As former World Bank economist William Easterly has documented, donor nations have been forgiving poor countries’ debts since the late 1970s, and the result has simply been more debt.28 From 1989 to 1997, 41 highly indebted countries saw some $33 billion of debt forgiveness, yet they still found themselves in an untenable position by the time the current round of debt forgiveness began. Indeed, they began borrowing ever-larger amounts from aid agencies. Easterly notes, moreover, that private credit to the heavily indebted poor countries had been virtually replaced by foreign aid and that foreign aid itself was being lent on increasingly easy terms.29
The debt relief initiative has reduced debt, but only time will tell whether this latest round of forgiveness will be yet another failed attempt to resolve poor countries’ financial problems. Unfortunately, there are already worrying signs. For example, debt owed to official and private creditors has been rising steadily again in African countries that made up the bulk of the heavily indebted poor countries initiative. The public debt of Sub-Saharan African countries was 35 percent of gross domestic product in 2015, up from 27 percent just four years earlier.30
The ineffectiveness of government-to-government aid programs has prompted an increased reliance on nongovernmental organizations (NGOs). NGOs, or private voluntary organizations (PVOs), are said to be better at delivering aid because they are less bureaucratic and more in touch with the on-the-ground realities in poor countries.
Although channeling aid through PVOs has been referred to as a “privatized” form of foreign assistance, it is often difficult to make a sharp distinction between government agencies and PVOs beyond the fact that the latter are subject to less oversight and are less accountable. Michael Maren, a former employee at Catholic Relief Services and USAID, notes that most PVOs receive most of their funds from government sources.31
Given the PVO dependence on government, Maren and others have described how the charitable goals on which some PVOs are founded have been undermined. The nonprofit organization Development GAP, for example, observed that USAID’s “overfunding of a number of groups has taxed their management capabilities, changed their institutional style, and made them more bureaucratic and unresponsive to the expressed needs of the poor overseas.”32 Maren adds, “When aid bureaucracies evaluate the work of NGOs, they have no incentive to criticize them.”33 For their part, NGOs naturally have an incentive to keep official funds flowing. The lack of proper impact assessments plagues the entire foreign aid establishment, prompting former USAID head Andrew Natsios to acknowledge, “We don’t get an objective analysis of what is really going on, whether the programs are working or not.”34 In sum, government provision of foreign aid through PVOs instead of traditional channels does not produce dramatically different results.
Microenterprise lending is another popular approach among aid advocates. It is designed to provide small amounts of credit to the world’s poorest people to establish livestock, manufacturing, trade, and other enterprises. Many microloan programs, such as the one run by the Grameen Bank in Bangladesh, appear to be highly successful. Grameen has disbursed almost $20 billion since the 1970s and achieved a repayment rate of about 97 percent, according to its founder. Microenterprise lending institutions are intended to be economically viable, to achieve financial self-sufficiency within three to seven years.
Given those qualities, it is unclear why microlending organizations would require subsidies. Indeed, microenterprise banks typically refer to themselves as profitable enterprises. For those and other reasons, Jonathan Morduch of New York University concluded in a 1999 study that “the greatest promise of microfinance is so far unmet, and the boldest claims do not withstand close scrutiny.”35 He added that, according to some estimates, “if subsidies are pulled and costs cannot be reduced, as many as 95 percent of current programs will eventually have to close shop.”36 More recently, David Roodman of the Center for Global Development found little evidence for the grand claims of the microcredit movement, including that it can noticeably reduce poverty.37 He advocated reducing funding for microlending and increasing its effectiveness.
Microenterprise programs may alleviate the conditions of the poor, but they do not address the causes of the lack of credit faced by the poor. In developing countries, for example, about 90 percent of poor people’s property is not recognized by the state. Without secure private property rights, the poor do not have collateral to obtain loans. The Institute for Liberty and Democracy, a Peruvian think tank, found that when poor people’s property in Peru was registered, new businesses were created, production increased, asset values rose by 200 percent, and credit became available.38 Of course, the scarcity of credit is also caused by a host of other policy measures, such as financial regulation that makes it prohibitively expensive to provide banking services for the poor.
In sum, microenterprise programs can be beneficial, but successful programs need not receive subsidies. The success of microenterprise programs, moreover, will depend on specific conditions, which vary greatly from country to country. For that reason, microenterprise projects should be financed privately by people who have their own money at stake rather than by international aid agencies.
Government aid programs have a poor record in generating growth in less-developed countries. As such, Congress should abolish USAID, the MCC, and other federal programs that hand out international development aid. It should also withdraw from the World Bank and regional multilateral development banks, and eliminate agencies that hand out international business subsidies, such as the Export-Import Bank, the Overseas Private Investment Corporation, and the U.S. Trade and Development Agency.
The good news is that numerous studies have found that growth is spurred by reforms that increase a nation’s economic freedom. Those reforms include free trade, stable money, restrained taxing and spending, private property rights, and the rule of law. Cross-country analyses show that the greater a nation’s economic freedom, the higher its average income. For example, the countries in the bottom quartile of economic freedom have average incomes only one-fifth as high as countries in the top quartile of economic freedom, based on analyses in the Economic Freedom of the World report.39
Policies that promote economic freedom also improve development indicators such as longevity, access to safe drinking water, level of corruption, and higher incomes for the poorest members of society. For example, countries in the bottom quartile of economic freedom have average incomes for the poorest 10 percent that are less than one-tenth as high as the similar poorest group in the countries in the top quartile.40
The developing countries that have liberalized their economies and achieved sustained growth have done far more to reduce poverty and improve living standards than those dependent on foreign aid. Nobel laureate Deaton found:
Even in good environments, aid compromises institutions, it contaminates local politics, and it undermines democracy. If poverty and underdevelopment are primarily consequences of poor institutions, then by weakening those institutions or stunting their development, large aid flows do exactly the opposite of what they are intended to do. It is hardly surprising then that, in spite of the direct effects of aid that are often positive, the record of aid shows no evidence of any overall beneficial effect.41
In the end, a country’s progress depends almost entirely on its domestic policies and institutions, not on outside factors such as foreign aid. As William Easterly suggested, aid distracts from what really matters, “such as the role of political and economic freedom in achieving development.”42 Policymakers should recognize that foreign aid has not caused the worldwide shift toward markets and growth, and that increased foreign aid would do more harm than good.
Ian Vásquez is the director of the Cato Institute’s Center for Global Liberty and Prosperity. His articles have appeared in newspapers throughout the United States and Latin America, and he is a columnist at El Comercio (Peru). Vásquez has appeared on CNBC, NBC, C-SPAN, CNN, Telemundo, Univisión, and Canadian Television, as well as National Public Radio and Voice of America, discussing foreign policy and development issues. He received his bachelor’s degree from Northwestern University and his master’s degree from the School of Advanced International Studies at Johns Hopkins University. He is the co-author of The Human Freedom Index, editor of Global Fortune: The Stumble and Rise of World Capitalism and coeditor of Perpetuating Poverty: The World Bank, the IMF and the Developing World. He has testified numerous times in the U.S. Congress on economic development issues.
1 Organization for Economic Cooperation and Development, http://data.oecd.org/oda/net-oda.htm.
2 Organization for Economic Cooperation and Development, http://data.oecd.org/oda/net-oda.htm.
3 Organization for Economic Cooperation and Development, http://data.oecd.org/oda/net-oda.htm.
4 Al Kamen and Thomas W. Lippman, “Task Force Favors Restructuring and Refocusing Troubled AID,” Washington Post, July 3, 1993.
5 Cited in Ian Vasquez, “Foreign Aid and Economic Development,” Cato Handbook for Policymakers, Cato Institute, 2017.
6 The “Meltzer Commission” was the International Financial Institution Advisory Commission, “Report to the U.S. Congress and the Department of the Treasury,” March 8, 2000.
7 Partnerships for Development (Washington: World Bank, 2000), p. 97.
8 Ibid., p. 82.
9 Paul Collier, “The Failure of Conditionality,” in C. Gwin and J.M. Nelson, eds., Perspectives on Aid and Development (Washington: Overseas Development Council, 1997), p. 51.
10 Shyam J. Kamath, “Foreign Aid and India’s Leviathan State,” in Doug Bandow and Ian Vásquez, eds., Perpetuating Poverty: the World Bank, the IMF, and the Developing World (Washington: Cato Institute, 1994), p. 218-220.
11 Angus Deaton, The Great Escape: Health, Wealth, and the Origins of Inequality (Princeton: Princeton University Press, 2013), p. 294.
12 Stephen Knack, “Aid Dependence and the Quality of Governance: Cross-Country Empirical Tests,” Southern Economic Journal 68, vol. 2 (2001): 310-329.
13 Raghuram G. Rajan and Arvind Subramanian, “Aid and Growth: What Does the Cross-Country Evidence Really Show?” National Bureau of Economic Research Working Paper no. 11513, August 2005.
15 Ernest H. Preeg, Neither Fish nor Fowl: U.S. Economic Aid to the Philippines for Noneconomic Objectives (Washington: The Center for Strategic and International Studies, 1991), p. 17.
16 Assessing Aid: What Works, What Doesn’t, and Why (Washington: World Bank, 1998), p. 49.
17 Craig Burnside and David Dollar, “Aid, Policies, and Growth,” World Bank, Policy Research Working Paper no. 1777, June 1997, p. 4.
18 Ian Goldin, Halsey Rogers, and Nicholas Stern, “The Role and Effectiveness of Development Assistance: Lessons from World Bank,” in A Case for Aid: Building a Consensus for Development Assistance(Washington: World Bank, 2002), p. 31.
19 Ibid., p. 43.
20 Stephen Knack, “Aid Dependence and the Quality of Governance: Cross-Country Empirical Tests,” Southern Economic Journal 68, vol. 2 (2001): 312.
21 Paul Collier, “The Failure of Conditionality,” in C. Gwin and J.M. Nelson, eds., Perspectives on Aid and Development (Washington: Overseas Development Council, 1997), p. 57.
22 Gustav Ranis, “On Fast-Disbursing Policy-Based Loans,” Center for Strategic and International Studies Task Force on Multilateral Development Banks, July 1996, p. 6.
24 Raghuram G. Rajan and Arvind Subramanian, “Aid and Growth: What Does the Cross-Country Evidence Really Show?” National Bureau of Economic Research Working Paper no. 11513, August 2005.
25 Peter T. Bauer, Equality, the Third World, and Economic Delusion(Cambridge, MA: Harvard University Press, 1981), p. 122.
26 World Bank, World Development Indicators Online, http://publications.worldbank.org/WDI.
27 Assessing Aid: What Works, What Doesn’t, and Why (Washington: World Bank, 1998), p. 51.
28 William Easterly, “How Did Heavily Indebted Poor Countries Become Heavily Indebted? Reviewing Two Decades of Debt Relief,” World Development 30, no. 10 (October 2002): 1677-1696.
30 International Monetary Fund, www.imf.org/external/pubs/ft/weo/2015/02/weodata/download.aspx.
31 Michael Maren, “Nongovernmental Organizations and International Development Bureaucracies,” in Ted Galen Carpenter, ed. Delusions of Grandeur: the United Nations and Global Intervention (Washington: Cato Institute, 1997), p. 229.
32 Ian Vasquez, “Foreign Aid and Economic Development,” Cato Handbook for Policymakers, Cato Institute, 2017.
33 Ibid., p. 236.
34 Andrew Natsios, “Reorganizing U.S. Development Assistance: For Better or Worse? A Debate,” Center for Global Development, March 17, 2006, p. 15.
35 Jonathan Morduch, “The Microfinance Promise,” Journal of Economic Literature XXXVII (December 1999): 1571.
36 Ibid., p. 1610.
37 David Roodman, Due Diligence: An Impertinent Inquiry into Microfinance (Baltimore, MD: Brookings Institution Press, 2012).
38 Ian Vasquez, “Foreign Aid and Economic Development,” Cato Handbook for Policymakers, Cato Institute, 2017.
39 James Gwartney, Robert Lawson, and Joshua Hall, Economic Freedom of the World: 2015 Annual Report (Vancouver: Fraser Institute, 2015), p. 23.
40 James Gwartney, Robert Lawson, and Joshua Hall, Economic Freedom of the World: 2015 Annual Report (Vancouver: Fraser Institute, 2015), p. 23.
41 Angus Deaton, The Great Escape: Health, Wealth, and the Origins of Inequality (Princeton: Princeton University Press, 2013), p. 305.
42 William Easterly, “The Aid Debate Is Over,” Reason.com, January 2014.