Wednesday, April 23, 2008

What is Foreign Aid About?

Surprisingly, William Baumol and his coauthors of Good Capitalism, Bad Capitalism, and the Economics of Growth and Prosperity seem to misunderstand the purposes of foreign assistance to developing nations. Their book, of course, focuses on policies to promote economic growth, and that is the main theme of the chapter on policies to promote growth in developing countries.

That chapter makes important and I think accurate points. While the book recommends that developed nations combine a vibrant small business sector for the creation of new technologies and business models with a strong large business sector to adopt, perfect and commercialize those innovations, it recognizes that developing nations that are not at the technological frontier can best progress by innovation based on imitation and commercialization based on low labor costs. It also recognizes that countries face serious problems in the transition from effective policies to catch up and reach the technological frontier and competing actively at that frontier. Indeed, the book recognizes that the distribution of income in Africa and Latin America is such that the vested interests may be more interested in maintaining their privileged economic and political positions than in general economic growth, and that they have the power to do so.

The authors, however, seem to believe that the purpose of so called "development assistance" is to promote increases in average per capita income. They point out, correctly, that econometric studies do not confirm that foreign aid results in economic growth. Actually, I don't think donor nations are very interested in taxing their citizens to promote increases in average per capita income in other countries far away. Foreign aid during the Cold War (and even today) was more likely to reflect political objectives (supporting allies, supporting former colonies, buying influence) than interests in creating more income to be badly distributed in Africa or Latin America. In fact foreign aid is more often focused on alleviating the worst aspects of poverty, and in fact over the last few decades countries receiving foreign aid have often greatly improved health status of their citizens and extended educational opportunities to their children.

Perhaps the authors underestimate the impact of war, conflict , tribalism, and natural disasters in constraining long term economic growth in developing nations, as well as the negative impact of geography in some countries.

Don't get me wrong. I am very much enjoying the book and find it very useful. The book only addresses foreign aid in one short section in one chapter.

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