Capitalism and Free Trade:Untried Tools of Economic Development

Three concepts that are given a great deal of lip service these days are capitalism, free trade, and economic development. Despite all the discussion, however, the three are rarely connected in any meaningful sense. The result has been disastrous. Fifty years of so-called economic development and foreign aid have led to economic repression and a decline in living standards in many “developing” nations.

Two fundamental goals underlie any attempt at economic development. First, foreign assistance is intended to increase the economic and social well-being of those receiving aid. Concurrently, foreign aid is meant to increase the economic and social well-being of the donor population by creating new trading partners and greater global wealth.

The idea of economic development and foreign aid are not new. It can be argued that the history of mankind is a history of economic development. The first humans that ventured from their immediate surroundings were in search of more bountiful and prosperous sources of food. In a sense, these early explorers were reaching out to the larger world in an attempt to improve their economic situation.

The conquests of early empires were attempts to improve the wealth and well-being of the citizens of those empires. The spread of Christianity (both peaceful and through the Crusades) can be viewed as attempts to improve the existence of far-off peoples by introducing them to the one true God. (The spread of any religion may be interpreted in such a moral-development light.) Voyages to the New World, early colonialism, and mercantilism were all attempts to reach out to foreign lands to improve the prosperity of a specific group of individuals. Most recently, unilateral aid and multilateral assistance through global organizations such as the World Bank and International Monetary Fund (IMF), have been attempts to increase the economic well-being of poor nations with the ultimate goal of increasing global prosperity.

Whether or not historic attempts at development are viewed as having been successful or not, it is evident that foreign assistance of the past 50 years has been a complete and utter failure. To quote a recent task force created by President Clinton, “…despite decades of foreign assistance, most of Africa and parts of Latin America, Asia, and the Middle East are economically worse off today than they were 20 years ago.” I could not say it better myself.

Take the case of India. The United States alone has poured more than $55 billion into India over the past 52 years. Despite this tremendous investment, the Gross Domestic Product per capita, a standard measure of economic well-being, has increased on average by only 1.4 percent per year, from $217 in 1965 to $425 in 1995. Today more than 40 percent of Indians live below the poverty level and nearly 50 percent of economic activity takes place on the black market.

But India is a success story compared to Haiti. The United States has given Haiti more than $1 billion in direct aid over the past thirty years. The result? Per capita GDP has actually decreased in inflation-adjusted terms, from $360 in 1965 to just $231 in 1995. In other words despite 53 years of foreign aid, the economic well-being of the average Haitian has decreased by some 36 percent.

India and Haiti are not isolated failures. Throughout the developing world, nations have absorbed billions of dollars in aid and “economic capital” without improving the well-being of their populations. And the reasons economic development efforts of the past 50 years have failed are not isolated. They are systemic. Three reasons for failure can be identified:

Economic development and foreign aid of the past 50 years has been government centered and government driven. Until very recently, most foreign aid was given as cash from the government of one nation to that of another. As such, foreign aid is ripe for corruption both within the donor government and the recipient government. Moreover, and more pervasive, is that government by definition is a bureaucracy and therefore subject to all the shortcomings of a bureaucratic system, including the fact that decisions are made thousands of miles from the point of impact and that they have a natural disposition to the status quo even in the face of continual failure.

Economic development of the past 50 years has been central-plan driven. Many foreign aid programs are reminiscent of Soviet-style, five-year plans that were (and remain) unresponsive to technological progress and changing circumstances. The problem with centrally-planned foreign assistance is that it is impossible for a single person or single government agency to understand the intricacies of another nation’s entire economy. Only individuals responding to localized knowledge can make the best decisions for themselves.

Foreign aid ignores the causes and attacks the symptoms of economic problems. For example, the availability of multilateral aid often depends on a country’s ability to reduce its government deficit. However, the level of government taxation and spending is more important to economic development than government debt. In addition, most foreign aid programs of the past 50 years have assumed that developing nations simply lack the economic capital to prosper. The result of this thinking is that billions of dollars are pumped into a country’s economy. But as Lord P.T. Bauer wrote in 1987, “Lack of money is not the cause of poverty, it is poverty” and to have money is the “result of economic achievement not its precondition.” The lack of capital is a symptom of underdevelopment not a cause.

All of these failures can be summed up in the simple statement that individuals, not benign government agencies, make decisions, and individuals serving within the government lack the knowledge to make decisions for the entire economy of a country. This was one of the many lessons taught by Nobel laureate economist F.A. Hayek. As Hayek and others have realized, the only path to economic prosperity is to allow individuals, acting within a secure system of private property rights, to make their own economic decisions. In other words, the only route to true and enduring economic development is through the introduction of capitalism and the practice of free trade.

Capitalism and free trade (grouped together under the umbrella of free markets) work for the exact same reasons that government-centered aid fails. Free markets are not government centered, free markets are not centrally planned, and free markets reinforce the root causes of economic prosperity and allow the results to follow naturally.

Despite the dominance of government-centered foreign aid, we have witnessed pockets of free market-based development and the record in these cases is encouraging. Perhaps the most striking example is Taiwan. Despite virtually no U.S. foreign aid, Taiwan has managed to increase their per capita GDP by 983 percent over the past 30 years, from $833 in 1965 to $9,020 in 1995. Taiwan accomplished this tremendous growth by embracing capitalism and practicing free trade. In other words, by taking the opposite tact as Haiti over the past 30 years, the average Taiwanese today enjoys a living standard 45 times that of the average Haitian.

There are other examples of capitalism and free trade working to enrich populations where government programs have failed. Chile, Australia, and Britain have all managed to replace their doomed public pension systems with privately-oriented retirement savings plans, much to the economic benefit of ordinary workers. African elephants and those populations dependent on their survival have benefited from private ownership of the herds. In the United States tenants of publicly-assisted housing projects have benefited from gaining an ownership right in their homes.

The lesson is that where government-controlled aid and economic-development attempts have failed, capitalism and free trade have succeeded. Policy makers should end the destructive practice of foreign aid, help foreign nations privatize their state-owned assets, and end repressive government habits such as trade barriers and regulation. In the place of these old tricks, developing nations should keep taxes low, keep trade open, enforce private ownership, and allow civil institutions to flourish. These measures will take time to work, especially given the past 50 years of destructive activity, but they are the only route to real and sustainable economic development.

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