Road show: the rock star and the treasury secretary demonstrate the limits to aid - Columns - Brief Article

Reason, August, 2002 by Mike Lynch

THE RECENT AFRICAN poverty safari of U2 frontman Bono and Treasury Secretary Paul O'Neill taught the world many things. Chief among the lessons: Publicity stunts still work.

True, the Odd Couple comparisons, all that starched shirt vs. blue wrap-around sunglasses stuff, quickly grew tired. But the stunt had its uses, including starting a discussion about the efficacy of foreign aid, the causes of poverty in Africa, and the effect American domestic policy has on the poor abroad.

Many people believe that a simple recipe produces wealth. Take a bit of capital, add labor, and stir. Bake at 350 degrees for a year or so, and out pops an increase in goods people both want and are able to consume. In this view, poor countries merely need a supply of missing ingredients, usually the capital, which can be provided by wealthy countries with dough to burn. The favorite example is the Marshall Plan. "You still find people my parents' age in Europe who talk about the Marshall Plan," Bono told Time. "Can we do something that people will be proud of in generations?"

The Marshall Plan, however, is more a model of successful public relations than of successful economic aid. Tyler Cowen, an economist at George Mason University, has studied the postwar economic performance of the plan's purported beneficiaries and found a tenuous relationship between aid and economic growth. Some countries, such as Germany, France, and Belgium, were already growing before the aid arrived. Others, such as Austria, only started growing only after it was trickling off.

The Marshall Plan stunted growth in important ways. For every dollar in U.S. aid that a European government received, it had to spend a dollar of its own currency. This sucked money out of the private sector and increased state planning and control over the economy. Other aid conditions distorted trade and punished exporters. In at least one country, Greece, the aid increased corruption. "The so-called dollar shortage was not the critical problem facing Europe at the time," writes Cowen. "Bad economic policy was the true culprit."

The Marshall Plan was a screaming success, however, when compared to development aid to African countries. In Africa as in Europe, the cause of economic problems is bad government policy. For evidence, examine World Bank insider William Easterly's masterful book, The Elusive Quest for Growth (2001).

Easterly has both an exceptional understanding of academic theory and the scars from trying to apply it over many years. The leading lights of the development aid industry, he reports, don't know much about economic growth. To this day, they use a Soviet-inspired growth model that was acknowledged as useless by one of its own developers way back in 1957. (Its chief virtue is that it always tells them to spend more money.) More to the point, they systematically refuse to accept what they do know: that what's missing in developing countries is not something that wealthy donors can easily bestow, such as a wad of cash or a boatload of high-tech equipment. What's missing are the institutions that make economic activity possible.

Easterly stresses that structural incentives matter. When people can benefit from investing in the future, they do so. Where investment is likely to be destroyed by corrupt governments, they don't.

One might think that this would be a nearly universally accepted view, especially in a profession supposedly based on the insight that people rationally pursue their self-interest. Certainly, it isn't a fresh idea. The recently deceased economist Peter Bauer trumpeted it for years. Bauer spent the early years of his professional life in Malaysia and West Africa, where he saw both the entrepreneurial productivity of local farmers and the deadening effects of government policies.

"Where people's abilities, motivations and social and political institutions are favorable, material progress will occur," Bauer wrote in 1972. "Where these basic determinants are unfavorable, development will not occur, even with aid."

Yet this hasn't been the standard view among development economists, who practice a discipline that owes its very existence to the aid it champions. "We must recognize that there are few, if any, truly universal principles or 'laws' of economics governing economic relationships that are immutable at all times and in all places," the economist Michael P. Todaro writes in the 1997 textbook Economic Development.

In this view, the key is government planning: "A larger government role and some degree of coordinated economic decision making directed toward transforming the economy are usually viewed as essential components of development economics."

Which brings us back to the starting point of both Easterly's book and Bono and O'Neill's tour: Ghana, where the fruits of "coordinated economic decision making" are on dismal display. Easterly opens The Elusive Questfor Growth in 1957, the year the country gained independence from Britain, a separation that left the former colony with new roads, health clinics, and schools.