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6 UNIVERSITY OF BOTSWANA LAW JOURNAL DECEMBER 2010 development, then no country could have developed to begin with. Then there are also many recent examples of countries, such as South Korea and Taiwan, which began to develop only after they stopped receiving large-scale economic aid. 12 Moreover, examination of the relevant data also undercuts the theory that foreign aid is necessary for economic development. Recent studies have taken to task conventional foreign aid wisdom, as represented by the “Financing Gap” approach. Developed by World Bank economists, the “Financing Gap” approach assumes that the amount of economic growth a country experiences is proportional to the level of investment. 13 Thus, if poor countries are not investing enough to achieve a target output, foreign aid could make up for the shortfall, ensuring enough investment for economic growth. Experience has failed to validate the assumptions of the “Financing Gap” approach. A number of empirical studies show that there is no statistical correlation between economic growth and official levels of investment. 14 This finding implies that foreign aid for investment is not a sufficient condition for economic growth. Furthermore, in countries where economic growth has occurred, only six percent had increased the amount of investment by the amount required according to the finance gap models. This casts serious doubts on any simplistic model relating economic growth to investment. 15 Additionally, dozens of econometric studies on the relationship between foreign aid and economic growth reveal no conclusive evidence that the level of aid is correlated with the amount of growth in recipient countries. 16 B. Why Aid is Ineffective and Harms its Recipients Studies of economic data and statistics have resoundingly shown that foreign aid has not brought about the expected economic growth in recipient countries. One must now ask, why hasn't foreign aid worked? Indeed, can foreign aid work, within the constructs of economic reasoning? A vast body of literature tells us no, and for the following reasons. First, foreign aid handouts are not subject to the “market test” of profit and loss, thus they are wasted rather than being put to productive use. Second, foreign aid creates “perverse incentives,” 12 M. Krauss, Development without Aid (New Press, 1983) p. 190. 13 See W. Easterly, The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics (MIT Press, 2001) pp. 28-37. 14 Ibid., 39-42; M. Blomstom et al., Is Fixed Investment the Key to Economic Growth?, 111 Quarterly Journal of Economics 269 (1996). 15 See Easterly, note 13 above, p. 40. This isn’t to say that investment in capital isn’t crucial for economic development. What is important is the right kind of investment, which government aid programs lack the knowledge and incentive to provide. Easterly goes too far in rejecting the importance of investment altogether. 16 A number of recent studies have found that aid fails to systematically improve growth rates. See P. Boone, Politics and the Effectiveness of Foreign Aid, 40 European Economic Review 289 (1996); I. Vasquez, Official Assistance, Economic Freedom, and Policy Change: Is Foreign Aid Like Campagne?, 18 Cato Journal 275 (1998); T. Ovaska, The Failure of Development Aid, 23 Cato Journal 175 (2003).
FOREIGN AID, THE RULE OF LAW AND ECONOMIC DEVELOPMENT IN AFRICA 7 entirely antithetical to economic growth and development, amongst those who receive it. Finally, foreign aid, by subsidizing corrupt regimes, empowers dictators and begets increased corruption and repression of the poor masses it aims to help. Despite its noble intentions, foreign aid is doomed to failure for these systemic reasons, which shall now be examined in further detail. Foreign Aid Lacks Market Signals Under market capitalism, entrepreneurs evaluate possible investment projects on the basis projected return- “i.e.”, will the investment be profitable? 17 Entrepreneurs stake their own funds, or borrowed funds for which they are ultimately liable, on these investments, thus they have strong incentive to “get it right,” “i.e.” to avoid bad investments that won't pay off. Of course, entrepreneurs can and do fail in this regard; they frequently lose money in what turn out to be unprofitable investments and face the prospect of going out of business. Entrepreneurs who repeatedly fail will ultimately lose their funding, whether it be their own money, bank credit, or shareholders' equity. In general, successful entrepreneurs, those who do the best job of satisfying consumers and thereby winning their business, are rewarded with profits, and unsuccessful entrepreneurs, who waste resources, are “fired” by the consumers. In contrast, the bureaucrats and government officials responsible for “investing” foreign aid dollars face no such market test, and hence have no such incentive to make the best investment choices. 18 As long time aid practitioner Thomas Dichter has noted: “Whereas a large corporation cannot lose money forever without facing some consequences, the aid industry has gone on for 60 years with hardly anything to show for the two trillion dollars it has spent (something it does not really bother to deny), and yet it is still very much in business.” 19 The primary incentive of World Bank bureaucrats is to spend as much money as possible, not to ensure it is effectively spent. Consequently, billions of dollars have been siphoned into inefficient, and unproductive, and capital-intensive projects such as the construction of damns, oil refineries, airports, and crop-storage depots. 20 Many of these projects are unsustainable, and have to be abandoned. A 2000 report found that 73 percent of the projects undertaken in Africa that year by the World Bank were not even 17 For a more detailed explanation of the entrepreneur’s role in the market economy, see I. Kirzner, Competition and Entrepreneurship (University of Chicago Press, 1973). 18 For an explanation of the different incentives that private and public decision makers face, see L. V. Mises, Bureaucracy (Yale University Press, 1944). 19 T. Dichter, Time to Stop Fooling Ourselves about Foreign Aid: A Practitioner’s View, Cato Institute Foreign Policy Briefing No 86 (2005). 20 See D. Osterfeld, note 9 above, p, 150; G. B. N. Ayittey, Aid For Black Elephants: How Foreign Assistance Has Failed Africa, in D. Bandow & I. Vasquez ed., Perpetuating Poverty (Cato Institute, 1994).
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