Aid, Trade, Development: The Bauer Legacy

Dr. Razeen Sally

June 2002

What makes poor countries “develop” into rich ones? What keeps them “underdeveloped”? Does aid work? Is it more important than trade? These questions were the lifelong preoccupation of Peter Bauer, the LSE and Cambridge economist who died last month. Was Lord Bauer (who was ennobled by Mrs. Thatcher in the 1980s) right on development?

For much of the post-war period, development economics had an anti-market, statist bent. The conventional wisdom held that poor countries were beset by huge market failures, particularly a structural gap between investment needs and low rates of domestic saving. Foreign aid was essential to bridge that gap; and it was used to buttress command economy-style planning, state-led industrialisation, nationalisation and protectionism.

Peter Bauer was a lone dissident voice. In blunt, trenchant language, he rejected socialist planning and recalled the older classical economic virtues of markets and prices as the drivers of economic growth and poverty reduction. Bauer, more than anyone else, must be credited with changing expert thinking on the economics of development – in academia, international organisations, national donors, and, not least, in developing countries.

Bauer is, above all, a classical economist in the tradition of Adam Smith, not a modern, narrowly specialised, technically dazzling neoclassical economist. His basic economic principles are those of The Wealth of Nations: government should protect the security of property and persons, but otherwise allow “natural liberty” – the freedom to produce, exchange and consume according to market prices – free rein. Private enterprise and unimpeded trade, investment and migration in ever-widening markets, not state intervention, are the engines of development.

Moreover, Bauer, like Smith, does his political economy bottom-up, closely observing reality at ground level, with a fine sensibility for history, culture and institutions. Not for him the misuse of formal quantitative models in post-war economics, with the concomitant disregard of historical processes and institutional conditions. The young Bauer, it should be recalled, cut his teeth on meticulous pre-independence studies of the rubber industry in Malaya and cocoa production in the Gold Coast (now Ghana). These studies alerted him to the role of small-scale peasant crop growers and traders, especially how, with the right structures and incentives, they could be entrepreneurial and plan for the long-term. His general conclusion was that a combination of light, limited government and the exercise of natural liberty by entrepreneurs big and small, foreign and local, allowed large parts of the developing world to prosper.

To Bauer, trade, not foreign aid, is the handmaiden of development. In the colonial period, particularly through the mediation of the British Empire, extensive and diversified commercial contacts with the West enabled great improvements in the economic well-being of less developed countries – most spectacularly so in the entrepôts of Hong Kong and Singapore. At the other extreme, parts of the world with relatively little contact with the West remained stuck in poverty and misery.

Bauer’s classical liberal insights on trade accord with the recent evidence. Developing countries and now countries in transition with liberal trade policies grow faster and drag more of their people out of poverty than countries which remain protectionist. This is one essential difference between East Asia, Eastern Europe and some Latin American countries, on the one hand, and South Asia, the Middle East, the ex-Soviet Union and most of Africa, on the other.

Bauer’s most controversial writings are on the economics – and politics – of aid. His views apropos can be summed up in this typically blunt sentence: “government-to-government transfers ….are an excellent method for transferring money from poor people in rich countries to rich people in poor countries.”

Ultimately, aid fails miserably due to its corrupting psychology and politics. It inculcates the belief that development comes from outside and not through sustained domestic effort. It focuses energies on distributing the spoils of politics rather than on productive wealth-creation. It allows venal elites to extract funds through beggary or blackmail – much of it ending up in their pockets or distributed as largesse to political supporters – while perpetuating highly damaging policies at home. Aid thus delays rather than promotes much-needed policy reforms.

Bauer was right: aid has failed. Countries on a drip-feed of aid, e.g. sub-Saharan African countries where aid constitutes over 10 per cent of GNP, remain the poorest in the world. Countries with some success in combating poverty, such as India and to a much greater extent China, depend little on aid (less than 1 per cent of GNP in both countries).

Has Bauer won the debate on aid? Not quite. The argument gaining currency today is that more aid is needed and that it does work, providing it goes to countries with a track record of sound market-oriented policies and not to those unable to deliver effective, sustained policy reforms. This is the thrust of the Zedillo Report for the UN, which recommends a doubling of aid to $100bn annually; of the recent UN Monterrey Declaration; and of President Mbeki’s new initiative on aid-and-development for Africa.

In economic terms, there is perhaps a case for increased aid in support of market-promoting reforms in the world’s poorest countries – although this is not nearly as important as trade liberalisation in developing and developed countries. However, Bauer’s siren voice on the inherent politics and psychology of aid should make one exceedingly sceptical of grand aid-expanding initiatives. Most aid still goes to corrupt, criminal governments. National and international aid bureaucracies, in alliance with assorted consultants, academics and NGOs, have a vested interest in the aid business, mostly with little regard to policy results. Rather than showering more manna on the aid circus, wouldn’t it be better to restructure the existing $50bn of annual aid so that it goes to deserving countries with improving policies?

Lord Bauer wanted to be remembered not so much for original theories and insights but for clarity of thought and moral courage. Swimming vigorously against the intellectual tides of his time, he repeated the enduring verities of Adam Smith and applied them to the post-war developing world. “Let us be free from cant” was his motto; and he was fond of this quote from Pascal: “Let us labour at thinking clearly. Herein lies the source of moral conduct.” This is indeed how Lord Bauer, a true child of the Scottish Enlightenment, should be remembered.

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