This post is by Claudia Williamson, a post-doctoral fellow at DRI.
This is a central question of The Aid Trap, by Columbia professors R. Glen Hubbard and William Duggan. Instead of supporting development, the authors argue, aid creates additional hurdles. While aid ‘crowds out or corrupts the business sector,’ we remain caught in an aid trap because business doesn’t pull at the heartstrings the way charity does.
The first half of the book documents the historical roots of prosperity and poverty. While people in today’s rich countries rose out of poverty as it became easier to do business, bad institutions and policies in poor countries have created perverse business incentives (for example: it takes 361 days and costs seven times the average per capita income to go through the seventeen procedures required for a firm in Mozambique to get the government licenses it needs to operate). Not only does aid support bad policies and the government that created them, but by decreasing the reliance on taxes for funding aid removes incentives for reform. Why become a less corrupt, more business-friendly government when aid makes it unnecessary?
Aid stifles the private sector by hindering local entrepreneurship, decreasing reliance on market transactions and trade. It is often more profitable to work for an aid agency or a NGO than to start a business. Locals get squeezed out of business when an aid agency shows up, so instead of competing with aid agencies most try and join them. Why buy grain from the local farmer when a NGO is giving it away for free?
The second half of the book describes Hubbard and Duggan’s proposed alternative, a modern “Marshall Plan” that would support business directly without channeling money to governments or through NGOs. An independent agency would loan money to local businesses, and these loans would be repaid not to the agency but to those local governments that have agreed to reform the business sector and spend the money on public infrastructure.
The Aid Trap’s focus on private markets and the need for change in the business environment is a laudatory move in the right direction for helping the world’s poor. But the authors’ new Marshall Plan raises some obvious questions
As the authors acknowledge, post-war Europe is very different than most poor countries today. Reconstruction is completely different than building from scratch. Most European countries had a healthy private sector before the war, implying that many of the barriers to business in today’s poor countries were absent. Removing these barriers is part of the new Marshall Plan, but transforming bad institutions into good ones remains elusive. And if such barriers were removed, wouldn’t private financing find it profitable to provide loans as we see in India or China, possibly making the new Marshall Plan unnecessary?
Despite this, the book as a whole is a great description of the current gridlock in the aid debate, and a creative attempt to get out of it.