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Foreign Aid, Help or Hindrance? Part 2

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What about the argument that aid at least helps countries that are helping themselves? The Brookings Institute and World Bank researchers repair to this final redoubt, but even here there is reason for skepticism. In his preface to the latest Heritage Foundation report, President Edwin Feulner argues that one of the most important conclusions of the report “is a resounding condemnation of foreign aid. It demonstrates that countries with free economies generally don’t need U.S. development assistance, because their economies are growing and prospering.”

Indeed, there is little doubt that success begets success. Today private capital flows, particularly investment, account for 80 percent of net long-term financial transfers. The CSIS report worried that private capital flows (mostly investment) — $244 billion worth last year, up $60 billion, or 32.3 percent, from the year before, far more than total assistance levels — have been concentrated in a dozen developing states, which collected nearly three-fourths of the proceeds, but that merely demonstrates the power of the private marketplace to reward good policies.

Moreover, however well-intentioned, aid to even the best of governments risks reducing the incentive to reform. Moving toward a free market is a continuing process for most Third World states, and foreign infusions reduce the penalty paid for dumb economic policies. Certainly in the major cases — China, India, Russia — there is no evidence that Western assistance played any role in their reform processes. Indeed, the West has subsidized foreign governments irrespective of their economic policies.

Are there a few cases that remain where well-administered aid might speed up the development process? It seems doubtful, but even if so, to use that as the justification for America’s expansive foreign-aid program demonstrates just how far the debate has shifted. The fact that there might be some benefit in some limited cases is hardly adequate justification for a program that has spent, in current dollars, more than $1 trillion since World War II. If speeding up growth that would otherwise occur was a good reason for foreign aid, the United States should be a recipient.

Reducing and more selectively appropriating aid would, at most, simply minimize the loss. True, with more countries moving towards free markets — though with no thanks to foreign aid, as Bernside and Dollar admit (see “Foreign Aid, Help or Hindrance? Part I,” February 1998 Freedom Daily) — some advocates contend that there are now more nations in which aid can play a truly beneficial role. What is the likelihood that Congress and the aid bureaucracy will choose well? Harvard’s Jeffrey Sachs calls for “a carefully designed program,” “a better focused foreign aid program,” and one “limited in duration” accompanied by “a plan to phase it out.” He is obviously living in an ivory tower, not Washington. Nor will reinvention of U.S. AID, as touted by administrator Brian Atwood, or more extensive bureaucratic reorganizations of the sort favored by Senate Foreign Relations Committee Chairman Jesse Helms (R.-N.C.), make any real difference.

Indeed, consider the rush to bail out Indonesia, South Korea, and Thailand. First it was Mexico, which the United States aided three years ago. The reason, explained the administration, was that Mexico was unique. Its economy was intimately tied to that of America — the two nations had only recently inked the NAFTA trade accord — and refugees might flood across the border if prosperity were not restored. America’s southern neighbor could not be allowed to fail.

The argument was never convincing — the slump in an economy a tenth the size of America’s in no way threatened U.S. prosperity — but at least the contention had some surface plausibility. And there was only one Mexico. No other developing state could make a similar claim to U.S. aid.

Then came Indonesia, whose trade with America is negligible. And South Korea, which has benefited from huge U.S. military subsidies for decades. Indeed, the U.S. already spends about $15 billion annually to defend the Republic of Korea, as much as South Korea spends to protect itself. Next on the list of possible candidates for bailouts are Brazil, Japan, and Russia. Explained Treasury Secretary Robert Rubin: “Financial stability around the world is critical to the national security and economic interests of the United States.” Well, perhaps, but the financial stability of every nation around the globe?

These countries are in trouble not because of, say, sunspots, but because of their own policies. For instance, Indonesia has been liberalizing, but its economy remains bedeviled by inefficient monopolies, insolvent banks, harmful trade barriers, wasteful food subsidies, and political favoritism. Being a relative, or being married to a relative, of President Suharto is the surest way to wealth. “The Suharto crowd,” notes Holman Jenkins of the Wall Street Journal, “has laid its hand on every good thing the country has to offer, making themselves impossibly rich and, also, just impossible.”

Indeed, Indonesia is a prime example of what the National Review ‘s Richard Brookhiser meant when he observed that “Asian capitalism, to the degree that it is different from plain old capitalism, is weaker, bleeding money to the politically connected, cushioning the powerful from their business blunders.” This is exactly how the South Korean and Thai economies worked. They relied enough on market forces to generate growth, but widespread state preferences for the politically powerful created an artificial bubble waiting to be burst.

After the bubbles did burst — currencies crashed, raising the price of imports, and foreign exchange reserves plummeted, raising questions about repayment of foreign loans — the countries adopted policy reforms. But only after the bubbles burst. It was economic failure, not loans from the IMF and the United States that forced the governments to act.

Unfortunately, however, the bailout packages will reduce the respective governments’ incentive to reform by relieving the pain of financial failure. Economist Mari Pangestu warns of Indonesia, “There are still some untouchables among banks and their customers, and you can’t do anything with the untouchables.” The regime certainly won’t do anything about them — particularly the boondoggle aerospace and auto programs — unless forced to do so.

Yet today Indonesia and its fellow borrowers are likely to do only the minimum necessary to receive aid. Were the countries simply left to their own devices, they would have to adopt all of the reforms necessary to recondition their economies and reassure foreign investors, who tend to be more careful with their own cash than are international aid bureaucrats with tax monies from industrialized states.

Now that Washington has intervened again and again, what nation cannot expect help? So much for Sachs’s idea of “a carefully designed program,” “a better focused foreign aid program,” and one “limited in duration” accompanied by “a plan to phase it out.” There are more potential problems throughout Asia, including the two largest economies, Japan and China. Economists forecast lower growth throughout Latin America, where Brazil and Mexico look particularly shaky. Then there’s Russia. How stable will the U.S. economy be if Washington continually underwrites economic failure around the globe?

This proclivity to intervene creates a danger of what economists call “moral hazard.” The expectation of a subsidy encourages people to behave irresponsibly, as it did many owners of federally insured savings and loans. International aid has similar effects. Warns economist Allan Meltzer, “Banks and financial institutions can now act safe in the knowledge that the IMF will provide a safety net to protect them from some, or even most, of their losses.”

Of course, if U.S. taxpayers are lucky, Indonesia, South Korea, and who knows who else won’t need their money, and if they do, like Mexico, they will repay their loans. But even such a best case won’t be costless, since credit isn’t free. When Washington channels billions of dollars to authoritarian kleptocracies — or even genuine democracies — it diverts resources from other uses, such as investment by entrepreneurs of their own money in America. We will never know how much we have lost in order to promote “stability” in other nations.

Foreign aid has failed. Whereas advocates once claimed that foreign transfers could move developing states into the industrialized world, an increasing number of supporters now acknowledge that the only case in which it might work is where countries have already adopted market reforms. But in those cases it is not needed. If Congress can’t kill off this program, after 50 years of failure, then what can it kill?

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    Doug Bandow is vice president of policy at Citizen Outreach, the Cobden Fellow in International Economics at the Institute for Policy Innovation, a senior fellow at the Cato Institute, and serves as adjunct scholar for The Future of Freedom Foundation. He is a former special assistant to President Reagan; he is also a graduate of Stanford Law School and a member of the California and D.C. bars. BOOKS BY DOUG BANDOW: Leviathan Unchained: Washington’s Bipartisan Big Government Consensus (forthcoming) Tripwire : Korea and U.S. Foreign Policy in a Changed World (1996) Perpetuating Poverty : The World Bank, the Imf, and the Developing World (1994) The Politics of Envy : Statism As Theology (1994) The U.S.-South Korean Alliance : Time for a Change (1992) The Politics of Plunder : Misgovernment in Washington (1990) Beyond Good Intentions : A Biblical View of Politics (1988)