Large inflows of foreign aid change local politics for the worse and undercut the institutions needed to foster long-run growth

See Gates Foundation Should Credit Market Reforms for Poverty Reduction by Daniel Press of CEI.

"Last week, the Bill and Melinda Gates Foundation released its annual letter, celebrating its investments in the developing world. Following their typical upbeat style, this year’s letter served as a thank-you note to their friend and fellow philanthropist, Warren Buffett. Buffett, who has donated a substantial portion of his fortune to the Foundation over the years, recently wrote a letter asking what humanitarian return there has been on his investment. The Gates Foundation provided this summary of its report back:

It’s a story about the stunning gains the poorest people in the world have made over the last 25 years. This incredible progress has been made possible not only by the generosity of Warren and other philanthropists, the charitable giving of individuals across the world, and the efforts of the poor on their own behalf—but also by the huge contributions made by donor nations, which account for the vast majority of global health and development funding.

Our letter is being released amid dramatic political transitions in these countries, including new leadership in the United States and the United Kingdom. We hope this story will remind everyone why foreign aid should remain a priority—because by lifting up the poorest, we express the highest values of our nations.

In part, the Foundation is spot on. The world’s poorest have indeed made “stunning gains” over the past few decades. Extreme poverty has fallen by some 80 percent since 1970, while child mortality has also seen dramatic improvements. What they get wrong, however, is the cause of all of this. The letter’s emphasis on government development aid as the source of this progress is misplaced, and masks a controversial legacy.

Between 1962 and 2012, world governments contributed almost $4 trillion of their taxpayers’ money to aid programs. For some recipient nations, this accounts for as much as 44 percent of their GDP. While international development experts have been predicting that such incredible charity would end poverty as we know it, it has been shown to have had little effect on the recipient countries’ economic growth. In some African nations, among the largest recipients of aid, there is even a negative relationship. Zambia is one such sad example. Former World Bank economist William Easterly found that if Zambia had received its aid funding between 1960 and the early 1990s as investment dollars instead, it could have had a per capita GDP of around $20,000. Instead, an average Zambian in the early 1990s lived off of just $500 per year – less than in 1960.

The reason behind the aid-development model’s monumental failures are clear – aid corrupts the incentives required for nations to develop. With the promise of large aid checks, African governments have transferred their attention from domestic economic development towards courting foreign donors. This has created generous budgets for unaccountable governments, who would rather reap in aid money than begin the tedious task of reform. Without such free-market reforms, long-term prosperity is unlikely. As economist and Nobel laureate Angus Deaton has written, “large inflows of foreign aid change local politics for the worse and undercut the institutions needed to foster long-run growth.”

It is well established by now that countries that embrace free-market reforms, including liberalized trade, reduced regulation, and secure property rights, tend to grow faster than others. Indeed, the unprecedented decline in world poverty in the last few decades has coincided with a significant increase in global economic freedom. The collapse of the Soviet Union, the opening up of India and China, and the spread of globalization have all helped spur the recent explosion in economic freedom.
The comparison of capitalist South Korea with socialist Ghana is especially compelling. Since the 1960s, South Korea’s embrace of foreign investment, liberalized trade, and strong property rights led to an over 2,000 percent increase in income, reaching $38,571 per capita. Ghana’s socialist experiment, on the other hand, led to a meager 83 percent rise in per capita incomes, reaching $4,495. This was while Ghana was receiving massive amounts of aid and South Korea received relatively little.  The “efforts of the poor” that have followed free-market reforms have created wealth and fostered robust economic growth. That the people of the developing world are creating their own development through embracing markets is the real cause for celebration.

The Gates Foundation should give greater credit to the proven economic reforms that have spurred development throughout the world. They crafted their annual letter to reassure Mr. Buffett of the effectiveness of his charity. But if he was looking for better return, I’d bet on free markets for the developing world."