by Daniel J. Mitchell
The main argument in favor of foreign aid is that rich countries can and should help poor countries become more prosperous. And plenty of politicians are following that approach. According to the latest data from the Organization for Economic Cooperation and Development, donor governments gave away more than $220 billion last year. But advocates of foreign aid say that’s not enough. The folks at the United Nations assert that rich countries should double their foreign aid budgets.
Skeptics of aid have a different perspective. They explain that foreign aid is not successful and that increasing aid budgets would be throwing good money after bad. They argue that foreign aid is wrong in theory since it focuses on giving money to governments rather than the pro-market policy reforms that would boost growth. And they argue that foreign aid has failed the real-world test since countries receiving large transfers have not climbed out of poverty.
For those who care about evidence, the skeptics have a stronger argument. Not only is there no evidence that foreign aid has ever turned a poor country into a rich country; it is much more likely that foreign aid undermines economic development by giving politicians in recipient nations an excuse to delay or avoid needed reforms. For instance, the latest report from the United Nations’ Economic and Social Council shows that developing nations are regressing rather than progressing in meeting development goals.
The World Bank has a comprehensive database showing how much foreign aid various jurisdictions have received since 1960. It shows that poor nations have received $4 trillion over the past six-plus decades, a staggering sum of money. If government-to-government transfers were good for prosperity, the nations that have received the most aid should show very strong results. Yet those countries are still mired in poverty. Politicians in recipient nations have become rich, but the people have remained poor.
Incidentally, the US Agency for International Development claims that South Korea and Taiwan show that foreign aid can be successful. Yet a report from the Cato Institute noted that “those countries began to take off economically only after massive US aid was cut off.”
Let’s look at Moldova and Romania for an apples-to-apples case study, since the two countries are next to each other and share a common ancestry. Moldova is an economic laggard. It is the poorest nation in Europe other than Kosovo and war-ravaged Ukraine, with per capita economic output lower than nations such as Libya, Ecuador, and Botswana. The country has experienced very little real (inflation-adjusted) growth since breaking free from the Soviet Union about three decades ago.
Romania also was very poor when it was part of the Soviet Empire. Yet look at what has happened to per capita GDP in Romania over the past three decades. As shown in the chart, Romanians’ living standards have dramatically increased, while Moldovans’ have remained stagnant:
What accounts for the vastly different economic outcomes in Moldova and Romania? The answer in large part is that there are significant differences in economic policy. Romania has shifted toward capitalism, while Moldova is plagued by statism.
According to the Fraser Institute’s Economic Freedom of the World report, Moldova is ranked #57 while Romania is ranked #27. The Heritage Foundation’s Index of Economic Freedom also shows Romania with significantly better economic policy than Moldova. Except both countries rank lower with Heritage than with Fraser, with Romania coming in at a mediocre #51 and Moldova trailing with a dismal #99.
Now let’s bring foreign aid into the analysis. According to the World Bank data, Moldova has received more than $7.8 billion of aid over the past three decades (one of the world’s biggest recipients on a per capita basis). Romania, however, has only received $5.6 billion. And since Romania has 19 million people compared to Moldova’s 2.5 million, per capita handouts to Moldova have been immensely larger.
Yet has all that aid helped Moldova grow faster than Romania? No.
Has all that aid helped Moldova keep pace with Romania? No.
In all likelihood, the handouts to Moldova have probably led to less growth. Why? Because politicians have less incentive to fix problems when they can simply put their hands out for freebies.
By the way, there is no reason to think that European Union membership is responsible for Romania’s comparatively strong performance. EU membership (phased in between 2004–2007) did not alter the nation’s long-run growth rate.
To conclude, government-to-government aid could play a productive role if there was conditionality. If the United States government and other aid agencies around the world made aid contingent on big improvements in economic policy, that would result in more prosperity for Moldova. Sadly, donor governments are tragically uninterested in imposing good conditions on aid. And recipient governments only care about keeping the aid spigots open so that politicians and senior bureaucrats can pocket a big share of the loot.
This column summarizes some of the findings from a recently published study.
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Daniel J. Mitchell is a Washington-based economist who specializes in fiscal policy, particularly tax reform, international tax competition, and the economic burden of government spending. He also serves on the editorial board of the Cayman Financial Review.
