Foreign Aid: Why It Will Never Work

After a detour into British politics in my last post, I’m now back on topic. The topic, this time, is foreign aid. This is a debate that has been largely absent from the election campaign (for understandable reasons as people are more worried about themselves). The only times foreign aid has become an issue in the campaign has been when it’s been a part of a bigger issue: Recently, Republicans have been on the offensive about cutting aid to countries like Egypt and Libya, due to the recent attacks against US embassies.

That, however, ignores the real issue: Foreign aid isn’t working – and it will never work. I’m not the first person to talk about this subject, and I think most conservatives agree that foreign aid as it currently works is highly inefficient and does absolutely nothing to help the people it is supposed to help. Foreign aid does more to pad the pockets of already-rich often undemocratically elected leaders than it does to help those who are actually in need. So far (almost) everyone agrees. But why is this so? If we can answer that question, we can also answer the next question: Can foreign aid ever work, or is it a flawed concept altogether?

The answer is a (for those who’ve followed my blogging) familiar concept: A conflict of interest. You see, no-one actually wants Africa or the other third-world countries to succeed. We want them to stay alive – or rather, we’d feel too horrible about not helping them to stay alive – but we don’t actually want them to stabilize and develop. The reason why we don’t want that can be summarized in one single word: China.

What does China have to do with all of this? Those of you who are older than me may remember that China used to be a communist country (today’s economic system may best be described as corporatist), and a very poor one at that. China is in fact the only country that was poorer the year 1979, than it was in the year 1000. One millenia of growth wiped out by only 30 years of communism! This has changed now, and China can no longer be classified as a third world country. While far from rich, China has managed to grow impressively in the past decades, and has established itself as a global competitor to the US. In particular, China has managed to industrialize faster than I’m pretty sure any country in history ever did.

And that’s the problem: China’s success stems from its ability to attract US (and European) companies. By offering low salaries, an almost unlimited workforce (with a strong work ethic at that), few or non-existant regulations and low taxes, China has convinced many American manufacturers about the wisdom of outsourcing. This has led to calls for protectionist policies against China; even many conservatives claim that competing against low-wage countries is “unfair” and that we need to “level the playing ground” by raising tariffs against such countries.

Such claims are economic nonsense. One of the very first discoveries in economics was that free trade is wonderful, and you’ll have a hard time finding a single economist today who doubts this.

However, voters, not economists, decide government policy. And voters tend to think about the short term: Sure, outsourcing may be great for everyone (yes, including the US) in the long term, but what about today? The short-term losses scare people away from fully endorsing free trade with everyone, everywhere.

Here’s an interesting question for everyone to ponder though: Why don’t we hear very much about companies outsourcing to Africa? Think about it, and you’ll realize that Africa has very much the same things China have: Low taxes, no regulations, low wages (even lower than China’s). So why outsource to China, but not Africa?

Here’s the thing: The foreign aid that the western world gives to Africa is intentionally badly designed to make sure that Africa can never get put of poverty. Because, if they did, companies would soon start outsourcing factories to Africa as well. We’d be creating a new China, and we don’t want that, so we’d rather keep the Africans in poverty. I know this is a controversial conclusion, but look at how badly the foreign aid is spent today, and you’ll realize there is no way this is an accident: We don’t actually want to help Africa. It’s tough enough dealing with companies outsourcing to China; we don’t need another low-wage, low-regulated competitor.

If Africa could only get some political stability (we could help them with that), maybe some help with law enforcement (yep, we could help them with that too) and infrastructure (again, we could if we wanted to), Africa could easily become the next economic “tiger”. However, if the African countries were to become tiger economies, that would be the last nail in the coffin for American and European manufacturing. The manufacturers who haven’t already left for China would leave for Africa, creating (temporary) high unemployment in important swing states like Ohio and Michigan.

We want to help Africa, because we’re good people. But we also don’t want to make any sacrifices (not even short-term sacrifices), because we’re also selfish people. This is a conflict of interest: The solution to this dilemma is to “help without helping” by giving inefficient foreign aid.

But how can we feel good about helping, when the help isn’t doing anything? How can this satisfy our altruistic needs? I don’t know, but it starts early: Remember how your mom used to tell you to eat your vegetables, telling you to “think of all the starving kids in Africa who would love to eat the vegetables you want to throw away”? Of course, while there are plenty of good reasons to eat vegetables, this isn’t one of them: Even if you eat your vegetables, the starving kids in Africa will be just as starving when you’re finished. What you indirectly tell your kids when you tell them these kinds of things is that giving up luxuries is a good thing, even if people who don’t have those things (ie vegetables to eat) won’t actually be helped. We’re essentially teaching kids altruistic self-flagellation. You should care about other people, and therefore you should hurt yourself. Even when it doesn’t help the people you are supposed to care about.

This thinking follows us through life; just think about all the meaningless internet activism that doesn’t change anything. You “like” a facebook page, and you feel like you’ve done the good deed of the day, even though liking a page never have and never will change anything. “Oh come on, I made a sacrifice, I gave up minutes of my time to like the page and I even wrote a supporting comment on the wall!” – Yes, but that doesn’t change anything. Happiness is not a zero-sum game: Just because you make a sacrifice (making yourself less happy) doesn’t mean someone else gets more happy.

This may sound like a conspiracy theory, but it’s not. I’m not saying that some evil geniuses are secretly planning on keeping Africa poor forever; I’m just saying no-one really has any motivation to design a good foreign aid policy. And when you lack motivation to do well, you do badly – at least in politics.

Now, I know a lot of readers are going to take issue with the whole “outsourcing is good for the US” thing, so let me explain what I mean: Standard economic theory tells us that a good X should be produced by whichever country can produce good X most efficiently. They can then trade with a country that’s not as good at producing good X, but on the other hand are more efficient when it comes to producing good Y. Every country has its advantages and disadvantages – some things can’t be produced in the US at a reasonable cost.

So far, most people agree. A concept that is harder to grasp is that the economy is dynamic, and so what goods you should produce can change over time. “We used to have toy manufacturing in the US when I was a kid, why can’t we have it now?” is a common question that I’m going to try and answer.

Basically, the economy is driven by what consumers want, not what producers want. You may not like losing your job at the toy factory where you used to work, but you do like getting cheap clothes at the store. Well, guess why you can afford so many more clothing items than when you were a kid? You guessed it: Production has moved to outside the US. Back when a strong majority of Americans didn’t have a college degree, and Americans were still willing to work for relatively low salaries, and there was no China or Japan to compete with, toy manufacturing in the US made sense. When communism effectively fell in China, in 1979, it was kind of like as if a new, super-cheap shop opened up next door to the other shop you used to go to. Suddenly, shopping in the old, expensive shop made less sense than it did just the day before the new cheap shop opened.

OK, so it makes sense for consumers to buy some chinese-made goods rather than goods made in America – but how is this good for America? It’s good for America in two ways:

1) When a piece of clothing costs $10 rather than$20, that means more money is left over to spend on other American goods. Also, this means consumption as a whole goes up, raising our standard of living. But, most importantly:

2) When workers aren’t tied up in manufacturing, this means more people available to work in R&D. The more people work in R&D, the more technological improvements you get – and technological improvements is what drives long-term growth. It’s actually the only thing that drives long-term growth (per capita). Essentially, outsourcing can help us raise our long-term growth rate/”steady state”. Of course, this can be a painful process for those who lose their jobs – but in the long run, it’s none the less a good thing.

But back to foreign aid: What do I mean by saying it can never work? Sure it could work if we only got a little bit less selfish and accepted that the US as of today shouldn’t be a manufacturing nation? It’s not that simple. You see, the reason why people don’t accept outsourcing is because they value the short-term losses more than the long-term gains. This is due to something called “discount rates” – a phenomena that isn’t a bad thing in itself by any means. It just means that when we choose between getting something now, and getting something later, we discount the “later” option. Let me give you an example:

If your annual discount rate is 10 %, and you get to choose between receiving 100 dollars now, or 105 dollars in a year, then you will choose 100 dollars now because 105/1.10 = 95.45 = less than 100. If you get to choose between 100 dollars now, or 120 dollars in two years, you will still choose 100 dollars today because 120/(1.10)^2 (1.10 squared) is less than 100. Whether or not you will accept giving up X amount of money today to get Y amount of money in the future depends entirely on your discount rate. If you have a low discount rate, that means you value the future a lot compared to the present, while if you have a high discount rate, you don’t. Americans have a pretty high discount rate, and as of now, we don’t know how to lower it. There is economic research being done in this area of course, but we still don’t have a clue how to convince someone to care about the future.

As long as there are swing states that depend on foreign aid not working, it will never work.

Finally, just to put the last nail in the coffin: Foreign aid decreases the amount individuals otherwise give to charity. You see, “giving” in economics is really just another good. You give for the same reason you buy other products and services: To increase your total amount of happiness (in economics we call it utility). And here’s the tricky thing: The more you buy of a good, the less happiness you get for each additional unit. If you’ve already had one portion of a food, then the next portion won’t make you as happy as the first one did, because you’re not as hungry as you were when you had the first one. This applies to charity as well: If you’ve already donated 10 % of your salary, the next 10 % you donate is not going to make you as happy as the first 10 % did.

This is a problem when we use taxpayer dollars for foreign aid: Many people will simply feel that they’ve already done their part; they pay taxes, and the state donates to charity for them so they don’t have to. So, when Save the Children comes knocking on their door, they can turn them down without feeling too bad; they’ve already donated through the IRS, haven’t they? Of course, Save the Children is like 10 times as efficient as the federal government when it comes to providing aid, but this doesn’t matter in the context. They don’t get enough extra happiness from giving to private charities, now that they give through the government – even though the money they give through the government isn’t going to help anyone.

Is there data to back this up? While I don’t know about any studies asking this specific question, diminishing marginal utility is a well-proven concept, and the rest of what I said follows from this. If you accept diminishing marginal utility, you have to accept tha above paragraph. However, it should be noted that Americans donate several times as much to charity as Swedes (Sweden has a massive welfare state and so the state takes care of most of the charity on behalf of the people).

But what about foreign aid “success stories”? The most commonly cited example of successful foreign aid is the Marshall plan, a plan put together by the US in order to save Europe from starving to death after World War II (thanks guys!). The problem is that the situation in Europe after World War II doesn’t even slightly resemble the situation in Africa today. Even after WWII, most European countries had relatively strong institutions (law enforcement, courts etc), the exception being Germany. But Germany still had a relatively educated workforce with a strong work ethic – something that certainly helps (and something most African countries don’t have). Also, the US has a huge incentive in providing the Marshall plan and do it as efficiently as possible: Without help, Europe was almost certain to be sucked into Soviet communism. This was also before outsourcing became a thing, so no-one worried about it yet.

It’s time we stop kidding ourselves about foreign aid. The government will never be properly motivated to do foreign aid the right way, so let’s leave it to the people who are: The thousands of volunteers in private charity organizations who selflessly give up their time and money to help the less fortunate in other countries. They are more motivated and more efficient than any government bureaucrat will ever be. Economics proves it; reality shows it.

Thanks for reading.

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  • Shane Vander Hart

    Good post. I agree that the concept of government-driven foreign aid is ineffective. However recent tragedies have shown that Americans in particular have responded well to crisis via NGOs – we saw in after the Tsunami in SE Asia, after the Haitian earthquake and even at home after Hurricane Katrina hit New Orleans.

  • Anita Morrill

    Two thoughts here: First, economic aid (handing out money or commodities) and relief work (doctors volunteering services) are largely ineffective because of the lack of security in Africa. Either the items get stolen or the aid workers are kidnapped/shot, etc. However, security cannot develop independently of (ahead or behind) industry. They have to evolve together at similar rates before you will see permanent change.
    Secondly, what about the AIDS relief done by Fmr. President Bush? Worth it? Not worth it? Why?

    • Shane Vander Hart

      Not worth it, not when we continue to run up debt. The crisis needed to be addressed, and he could have used the bully pulpit to do so, but let NGOs do what they do best. World Vision, Compassion and others are doing excellent work there.

    • John Gustavsson

      Aids relief, like Shane said, can best be done by NGOs. If you can’t properly motivate yourself to do a good job, then let someone else do the job.

  • Emmanuel Igwe

    I largely disagree with you on several points, John and my contrary opinions would be presented in an order of significance from the main body to the supporting structure of your blog.

    Firstly, the notion that foreign aid isn’t working and probably never will is unsagacious, with all due respect. This statement clearly avoids the distinction between the private donor of any fashion and a government/ international donor scheme as a representative of private individuals. It somewhat exposes the rest of my critiques of your article. For instance, the idea that foreign aid is and never will work is a mockery on the people that actually perform this act as a gesture of goodwill. However, when this idea is applied to a governmental aid scheme, then the answer that aid (especially foreign) may be designed to keep “third-world countries” at a stagnant growth rate may not be too far-fetched after-all.

    My second critique is formed by a definition of poverty traps (i.e. why aid is important) thus making way for me to define my reasons for the failure of a vast amount of aid schemes of any sort. If aid is designed to eliminate poverty, then the important question to be asked relates to the existence of poverty traps. Let’s examine the criteria that defines a poverty trap.

    Development economics would suggest two criteria that establishes the existence of a poverty trap for any individual classified as within the international measurements of poverty. The first one is that poverty traps exist when there are hindrances that suppress the rate of wealth or income growth for people with barely any investment capital. However, when there is a potential for a faster growth amongst the poor with a steady-state solution being reached as wealth and income increases, then there is no poverty trap, hereby defining the other criterion.

    By highlighting these criteria, we begin to understand why governments, international and private aid donors mostly get it wrong in terms of their aid programmes. In my view, the reasons for aid inefficiency isn’t simply because developed countries are afraid of “the rise of the rest” but because of three fundamental factors: (a) Rigidity of aid schemes towards change or development; (b) An ignorance of where a poverty trap may exist or not thus leading to allocative inefficiencies of cataclysmic proportions (e.g. constant supply of fertiliser to a local farmer of fertile land where all he may have needed was just a one-time supply); and (c) A clash of ideologies (especially between the West and the Rest of the world) that leads to further communication mishaps thus creating the big mess that could exist.

    The third major critique refers to your constant focus on Africa as though it were the only aim of international aid. As a matter of fact, aid of charitable sorts and otherwise, flow from all ends to all ends of the world. Was it not in November of 2011, when the Portuguese government asked Angola (its so-called “colonial servants) for a bail-out from its economic turmoil?

    I believe in a partnership of governments and volunteering agencies with the aim of poverty reduction amongst other quagmires aid aims to annihilate. But I agree that the government and NGOs need to revamp their structures to accommodate for the demanding tasks that are entrenched in the provision of aid.