Tuesday, July 10, 2012

The Fallacy of Foreign Aid

THE ADVOCATES OF FOREIGN AID BELIEVE THAT IT helps not only the country that gets it but the country that gives it. They believe, therefore, that it promotes worldwide “economic growth.” They are mistaken in these assumptions.

I should make clear at the beginning that when I refer here to foreign aid I mean government-to-government aid. Still more specifically, I mean government-to-government “economic” aid. I am not considering here intergovernmental military aid extended either in wartime or peacetime. The justification of military aid will depend, in each case, only partly on economic considerations, and mainly on a complex set of political and military factors.

It ought to be clear, to begin with, that foreign aid retards the economic growth and the capital development of the country that grants it. If it is fully paid for out of taxes at the time it is granted, it puts an additional tax burden on industry and reduces incentives at the same time that it takes funds that would otherwise have gone into new domestic investment. If it is not fully paid for, but financed out of budget deficits, it brings all the evils of inflation. It leads to rising prices and costs. It leads to deficits in the balance of payments, to a loss of gold, and to loss of confidence in the soundness of the currency unit. In either case foreign aid must set back the donor country’s capital development.

All the consequences just described have occurred in the United States. In the 23 years ending June 30,1968, American foreign aid—grants, loans, and interest—reached the stupendous total of $171 billion. As the public debt increased from $259 billion at the end of fiscal 1945 to $359 billion in 1968, this means that $100 billion of this foreign aid was in effect paid for by borrowing and by inflating the currency, and $71 billion by added taxation. Without the foreign aid handouts we could have avoided both the inflation and the added taxation. We could have avoided both the cumulative deficit of $30 billion in the balance of payments and the loss of $10 billion gold in those years. Today, American “liberals” are talking about all the billions we ought or will need to spend to extend and improve our roads and highways, to improve and increase our housing and to rehabilitate our blighted cities, to combat air pollution and water pollution, to bring more water to the cities and to turn salt water into fresh. The $171 billion that went into foreign aid would have covered practically all the improvements in this direction that most of these “liberals” are demanding.

The Pump-Priming Argument
We sometimes hear it said by American advocates of foreign aid (and we very frequently hear it said by many of the foreign recipients of our aid, and always by the Communists) that the United States has got great economic advantages out of its foreign aid program. We desperately need “outlets” and “new markets” for our “surplus.” We must give part of our goods away, or give foreigners the dollars with which to buy them, to keep our factories going and to maintain full employment. This program was even necessary, according to the Communists, to “postpone the inevitable collapse” of capitalism.

It should not be necessary to point out that this whole argument is unmitigated nonsense. If it were true that we could create prosperity and full employment by making goods to give away, then we would not have to give them to foreign countries. We could accomplish the same result by making the goods to dump into the sea. Or, far better, our government could give the money or the goods to our own poor.

It ought to be clear even to the feeblest intelligence that nobody can get rich by giving his goods away or making more goods to give away. What seems to confuse some otherwise clearheaded people when this proposition is applied to a nation rather than an individual is that it is possible for particular firms and persons within the nation to profit by such a transaction at the expense of the rest. The firms, for example, that are engaged in making the exported foreign aid commodities are paid for them by the aid-receiving country or by the United States Government. But the latter gets the money, in turn, from the American taxpayers. The taxpayers are poorer by the amount taken. If they had been allowed to keep it, they would have used it themselves to buy the goods they wanted. True, these would not have been precisely the same goods as those that were made and exported through the foreign aid program. But they would have supplied just as much employment. And Americans, rather than foreigners, would have got what was made by this employment.

Buying Friends
“Yes,” it may be conceded, “all of this may be true; but let us not look at the matter so selfishly, or at least not so nearsightedly. Think of the great blessings that we have brought to the aid-receiving countries, and think of the long-run political and other intangible gains to the United States. We have prevented the aid-receiving countries from going Communist, and the continuance of our aid is necessary to continue to keep them from going Communist. We have made the recipient countries our grateful allies and friends, and the continuance of our foreign aid is necessary to continue to keep them our grateful allies and friends.”

First, let us look at these alleged intangible gains to the United States. We are here admittedly in the realm of opinion, in the realm of might-have-beens and might-be’s, where proof either way is hardly possible. But there is no convincing evidence that any of our aid-recipients that have not gone Communist would have done so if they had not got our economic aid. Communist Party membership in aid-receiving France and Italy did not fall off; in fact it has shown a tendency to increase in both countries with increasing prosperity. And Cuba, the one country in the Western Hemisphere that has gone Communist, did so in 1959 in spite of having shared freely in our foreign aid in the preceding twelve years. Cuba had been favored by us, in fact, beyond all other countries in sugar import quotas and other indirect forms of economic help.

As for gaining grateful allies or even friends, there is no evidence that our $11 billion of lend-lease to Russia in World War II endeared us to the Russian leaders; that our aid to Poland, Yugoslavia, Indonesia, and Egypt turned Gomulka, Tito, Sukarno, or Nasser into dependable allies; that it has made France, or India, Mexico, Chile, Laos, Cambodia, Bolivia, Peru, Ghana, Panama, Algeria, and scores of other nations that have got our aid, into our grateful friends.

On the other hand, there is good reason to suspect that our aid has often had the opposite effect. Countries have found that whenever they look as if they are in danger of going Communist they get more American aid. This veiled threat becomes a recognized way of extorting more aid. And the leaders of governments getting our aid find it necessary to insult and denounce the United States to prove to their own followers that they are “independent” and not the “puppets” of “American imperialism.” It is nearly always the United States embassies and information offices that periodically get rocks thrown through their windows, not the embassies of countries that have never given a cent.

Humanitarian Motives
“Still,” it may be (and is) objected, “to mention any of these things is to take a shortsighted and selfish point of view. We should give foreign aid for purely humanitarian reasons. This will enable the poor nations to conquer their poverty, which they cannot do without our help. And when they have done so, we will have the reward of the charitable deed itself. Whether the recipients are grateful to us or not, our generosity will redound in the long run to our own self-interest. A world half rich and half poor is an unsafe world; it breeds envy, hatred, and war. A fully prosperous world is a world of peace and good will. Rich nations are obviously better customers than poor nations. As the underdeveloped nations develop, American foreign trade and prosperity must also increase.”

The final part of this argument is beyond dispute. It is to America’s long-run interest that all other countries should be rich and productive, good customers, and good sources of supply. What is wrong with the argument is the assumption that government-to-government aid is the way to bring about this desired consummation.

The quickest and surest way to production, prosperity, and economic growth is through private enterprise. The best way for governments to encourage private enterprise is to establish justice, to enforce contracts, to insure domestic peace and tranquility, to protect private property, and to secure the blessings of liberty, including economic liberty—which means to stop putting obstacles in the way of private enterprise. If every man is free to earn and to keep the fruits of his labor, his incentives to work and to save, to invent and invest, to launch new ventures, to try to build a better mousetrap than his neighbor, will be maximized. The effort of each will bring the prosperity of all.

Under such a system more and more citizens will acquire the capital to lend and invest, and will have the maximum inducement to lend and invest at home. Very quickly more and more foreigners will also notice the investment opportunities in (let us call it) Libertania, and their money will come in to speed its development. They will place their funds where they promise to earn the highest returns consonant with safety. This means that the funds will go, if the investments are wisely chosen, where they are most productive. They will go where they will produce the goods and services most wanted by productive Libertanians or by foreigners. In the latter case they will produce the maximum exports, or “foreign exchange,” either to pay off the investment or to pay for the import of the foreign goods most needed.

The surest way for a poor nation to stay poor, on the other hand, is to harass, hobble, and straitjacket private enterprise or to discourage or destroy it by subsidized government competition, oppressive taxation, or outright expropriation.

Socialism versus Capitalism
Now government-to-government aid rests on socialistic assumptions and promotes socialism and stagnation, whereas private foreign investment rests on capitalistic assumptions and promotes private enterprise and maximum economic growth.

The egalitarian and socialistic assumptions underlying government-to-government aid are clear. Its main assumption is that the quickest way to “social” justice and progress is to take from the rich and give to the poor, to seize from Peter and give to Paul. The donor government seizes the aid money from its supposedly overrich taxpayers; it gives it to the receiving nation on the assumption that the latter “needs” the money—not on the assumption that it will make the most productive use of the money.
From the very beginning government-to-government aid has been on the horns of this dilemma. If on the one hand it is made without conditions, the funds are squandered and dissipated and fail to accomplish their purpose. But if the donor government attempts to impose conditions, its attempt is immediately resented. It is called “interfering in the internal affairs” of the recipient nation, which demands “aid without strings.”

In the more than twenty expensive years that the foreign aid program has been in effect, American officials have swung uncertainly from one horn of this dilemma to the other—imposing conditions, dropping them when criticized, silently watching the aid funds being misused, then trying to impose conditions again. But recently American officials seemed bent on following the worst possible policy—that of imposing conditions, but exactly the wrong conditions.

In 1965 President Johnson announced that our future foreign aid would go to those countries “willing not only to talk about basic social change but who will act immediately on these reforms.” But what our aid officials appeared to have in mind by “basic social change” was to ask of the countries that receive our grants, not that they give guarantees of the security of property, the integrity of their currencies, abstention from crippling government controls, and encouragement to free markets and free enterprise, but that they move in the direction of government planning, the paternalistic state, the redistribution of land, and other share-the-wealth schemes.

Land Reform Measures
The so-called “land reform” that our government officials often demanded meant destroying existing large-scale agricultural enterprises, dividing land into plots too small for efficient or economic cultivation, turning them over to untried managers, undermining the principles of private property, and opening a Pandora’s box of still more radical demands.

Socialism and welfare programs lead to huge chronic government deficits and runaway inflation. This is what has happened in Latin America. In the ten years to the end of 1968 the currency of the Argentine lost 93 per cent of its purchasing power; the currency of Chile lost 89 per cent; of Brazil 98 per cent. The practical consequence of this is the expropriation of wealth on a tremendous scale.
Yet a United States senator, recently demanding “land reform” and ignoring this history, made it a charge against the rich in these aid-receiving nations that they do not “invest in their own economies” but place their funds abroad. What he failed to ask himself is why the nationals of some of these countries have been sending their funds abroad or putting them in numbered accounts in Switzerland. In most cases, he would have found that it was not only because no attractive private investment opportunities were open to them at home (because of burdensome controls, oppressive taxes, or government competition), but because they feared the wiping out of their savings by rapid depreciation of their home currencies, or even the outright confiscation of their visible wealth.

The Benefits?
In the last 23 years foreign aid has made American taxpayers $171 billion poorer, but it has not made the recipients anything like that much richer. How much good has it actually done them? The question is difficult to answer in quantitative terms, because foreign aid has often been a relatively minor factor out of the scores of factors affecting their economies.

But the advocates of foreign aid have had no trouble in giving glib and confident answers to the question. Where, as in Western Europe and Japan, our aid has been followed by dramatic recovery, the recovery has been attributed wholly to the aid (though just as dramatic recoveries occurred in war-torn nations after World War I when there was no aid program). But where our aid has not been followed by recovery, or where recipient nations find themselves in even deeper economic crises than they were before our aid began, the aid advocates have simply said that obviously our aid was not “adequate.” This argument is being used very widely today to urge us to plunge into an even more colossal aid program.

A careful country-by-country study, however, shows pretty clearly that in recent years wherever a country (such as West Germany) has reformed its currency, kept it sound, and adhered in the main to the principles of free enterprise, it has enjoyed a miraculous recovery and growth. But where a country (such as India) has chosen government planning, has adopted grandiose socialistic “five-year plans” arbitrarily directing production into the wrong lines, has expanded its currency but kept it for many years overvalued through exchange controls, and has put all sorts of restrictions and harassments in the way of private enterprise and private initiative, it has sunk into chronic crises or famine in spite of billions of dollars in generous foreign aid.

As Charles B. Shuman, president of the American Farm Bureau Federation, recently put it, the one common denominator in virtually all the hungry nations has been “their devotion to a socialist political-economic system—a government-managed economy. The world does not need to starve if the underdeveloped areas can be induced to accept a market price system, the incentive method of capital formation—competitive capitalism.”

Our conclusion is that government-to-government foreign aid, as it exists at present, is a deterrent, not a spur, to world economic prosperity, and even to the economic progress of the underdeveloped recipients themselves.

Wasteful Projects
This is true partly because of the very nature of foreign aid. By providing easy outside help without cost, it often fails to encourage self-help and responsibility. Moreover, government-to-government economic help almost inevitably goes to government projects, which frequently means socialized projects, such as grandiose government steel mills or power dams.

It is true that there are many economic services, such as streets and roads, water supply, harbors, and sanitary measures, that are usually undertaken by governments even in the most “capitalistic” countries, yet which form an essential basis and part of the process and structure of all production. Foreign as well as domestic funds may legitimately go to governments for such purposes. Yet intergovernmental aid is likely to channel a disproportionate amount of funds even into such projects. If governments had to depend more on domestic or foreign private investors for these funds, less extravagant projects of this nature would be embarked upon. Private investors, for example, might lend more freely for toll roads and bridges, and similar projects that promised to be self-liquidating, than for those that yielded no monetary return. As a result, the recipient government’s planners would make more effort to put their roads and bridges where the prospective use and traffic would prove heavy enough to justify the outlay.
In addition to the conditions in the very nature of government-to-government aid that make it on net balance a deterrent rather than a spur to private enterprise and higher production, there is the attitude of many American aid officials, who insisted that underdeveloped nations should not get more aid unless they adopted “land reform,” planning, and other socialistic measures—the very measures that tend to retard economic recovery.

Conditions for Private Investment
If our aid program were now tapered off, and the underdeveloped nations had to seek foreign private capital for their more rapid development, the case would be far different. Foreign private investors would want to see quite different reforms. They would want assurance (perhaps in some cases even guarantees) against nationalization or expropriation, against government-owned competition, against discriminatory laws, against price controls, against burdensome social security legislation, against import license difficulties on essential materials, against currency exchange restrictions, against oppressive taxes, and against a constantly depreciating currency. They would probably also want guarantees that they could always repatriate their capital and profits.

Foreign private investors would not demand the active cooperation or an enthusiastic welcome by the government of the host country, but this would certainly influence their decision considerably. In fact, foreign private investors, unless the would-be borrowers came to them, would not demand any conditions at all. They would place their funds where the deterrents and discouragements were fewest and the opportunities most inviting.

What the anti-capitalistic mentality seems incapable of understanding is that the very steps necessary to create the most attractive climate for foreign investment would also create the most attractive climate for domestic investment. The nationals of an underdeveloped country, instead of sending their money abroad for better returns or sheer safekeeping, would start investing it in enterprise at home. And this domestic investment and reinvestment would begin to make foreign investment less and less urgent.
It is unlikely that reforms in the direction of free enterprise will be made by most socialistic and control-minded countries as long as they can get intergovernmental aid without making these reforms. So a tapering off or phasing out of the American aid program will probably be necessary before a private foreign investment program is launched in sufficient volume.

A More Hopeful Alternative
I should like to renew here a suggestion for an interim program which I put forward in National Review of May 6, 1961: that from now on out, economic foreign aid be continued solely in the form of loans rather than grants. These would be hard loans, repayable in dollars. They would bear interest at the same rate that our own government was obliged to pay for loans of equal maturity. They would be repayable over not more than 25 to 30 years, like a mortgage. Like a mortgage, they would preferably be repayable, principal and interest, in equal monthly or quarterly installments, beginning immediately after the loan was made.

Such loans would not be urged on any country. The would-be borrowers would have to apply for them. They would be entitled to borrow annually, say, any amount up to the amount they had previously been receiving from us in grants or combined loans and grants.

All these requirements would be written into law by Congress. Congress would also write into law the conditions of eligibility for such loans. Among such conditions might be the following: The borrowing government would have to refrain from any additional socialization or nationalization of industry, or any further expropriation or seizure of capital, domestic or foreign. It would undertake to balance its budget, beginning, say, in the first full fiscal year after receiving the loan. It would undertake to halt inflation. The borrowing government, for example, might agree not to increase the quantity of money by more than 5 per cent in any one year, and not to force its central bank to buy or discount any increased amount of the government’s own securities. The borrowing government might be required to dismantle any exchange controls. In brief, the borrowing country and government would be obliged to move toward the conditions that would be necessary to attract private domestic or foreign capital.

Anticipated Consequences
My guess is that the mere requirement for repayment of principal and interest, to begin immediately, would in itself probably reduce applications for aid to about a third of the amounts we now pay out. The other conditions of eligibility would probably cut the applications to a sixth or a tenth of these amounts. For the borrowing governments would have to think twice about the advisability of projects for which they would have to start paying themselves. Projects would tend to be reduced to those that were self-liquidating, i. e., demonstrably economic.

The borrowing nations could not complain that we were trying to interfere in or to dictate their domestic economic policies. These would merely be the conditions of eligibility for loans. The borrowing nations would be neither forced nor urged to borrow from us. The American administrators of the foreign loan program would not be authorized either to dictate or remove any conditions or to discriminate among borrowers. In any case, their discretion should be very narrowly circumscribed.

The benefits of such a program would be many and obvious. It would immediately cut down drastically the outflow of American funds in foreign aid. Most of the aid that we granted through such loans would be repaid with interest. We would not be courting foreign favor. The would-be borrowers would have to come to us, openly. We would cease, immediately, to subsidize and expand foreign socialism.

I should make it clear that I am not proposing such a program for its own sake, but as a purely transitional measure to phase out our existing foreign-aid program with the least possible disturbance, disruption, or recrimination. This scaled-down lending program might run for, say, a maximum of three years. At the end of that time it could easily be terminated. For meanwhile the borrowing governments, and particularly private enterprises in their respective countries, would have created an attractive climate, and would have become attractive media, for both domestic and foreign private investment.
In such a revitalized capitalistic climate, the improvement in world economic conditions might even become spectacular.

Man vs. The Welfare State

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