The Diminished Role of Aid

September 24, 1997 • Commentary
This article appeared in the Journal of Commerce.

The World Bank, at this week’s meeting in Hong Kong, will attempt to explain what it and other development banks will do in the increasingly market‐​oriented global economy.

The bank faces scrutiny by observers around the world and across the political spectrum who are trying to determine what role, if any, it should play.

One of the organizations to study just that was the Center for Strategic and International Studies. Its special task force was made up of representatives from big business, think tanks, development banks and non‐​governmental organizations. In its just‐​released report, the CSIS panel grappled with many of the problems — ranging from poor project performance and outdated missions to lack of accountability and openness — that have plagued the multilateral development banks.

The tone of the report is striking. The members express caution, rather than enthusiasm, about the ability of the development banks to accomplish many of their ambitious and noteworthy goals. The task force points out that lending will do little good, and will likely be counterproductive, if the overall policies of a country are inimical to growth. In general, economic progress requires a market‐​oriented policy environment, according to the report.

The development banks themselves frequently make the same point, but, as the task force says, they often continue to lend to governments regardless of their economic policies. Other areas of general consensus include concern about the banks’ unnecessary secrecy and empty promises of reform.

Troublesome, however, is the recommendation for the continuation, or even expansion of the development banks’ support for private ventures and free‐​market reforms in borrower countries.

Private capital flows now dwarf official aid flows to the developing world. The report acknowledges that those flows and market‐​oriented development strategies suggest a declining role for the multilateral development banks. But it warns that only about a dozen developing countries receive the bulk of that private capital. That is precisely as it should be.

Economic freedom, not misnamed foreign aid, is the answer to international poverty.

Nations that have done the most to reform have succeeded in attracting voluntary, private money, while those that have been unwilling to change — like most of the sub‐​Saharan states — have failed to attract capital. Clearly, the ability to attract capital is determined by the type of policies and institutions a country embraces, not by outside aid.

Despite that evidence, some task force members call for an increased role of the development banks in guaranteeing or lending directly to private‐​sector projects. But subsidizing or publicly guaranteeing private investment schemes is an inappropriate way of promoting free market.

Such support for the private sector relieves the host governments of the need to create an investment environment that would genuinely attract foreign capital. In the worst‐​case scenario, overreliance on development bank guarantees — which are determined more by political than by market considerations — could exacerbate the developing‐​countries’ external debt problem.

The private sector’s proven ability to finance and operate development projects traditionally undertaken by governments has led the task force to suggest that multilateral banks move away from financing such projects. Instead, they should concentrate on technical assistance in setting up regulatory frameworks and agencies to oversee environmental reform, a task far more complex than the relatively simple physical infrastructure projects on which the banks have such a poor track record.

Moreover, the report doesn’t suggest what model — United States, Western European, or Japanese — the banks should impose on developing countries. Given the crisis of the regulatory welfare state in the developed world, recommending any of those models would not be particularly prudent, especially given the ongoing public debate in the United States over whether national regulatory agencies should continue to exist.

In any case, the development banks’ problems go beyond the practical. Their approach, which continues to view official outside aid and advice as essential for economic growth, is fundamentally flawed. The experience of nations that have prospered without foreign aid provides ample proof of that.

By recognizing that the multilateral development banks are becoming less relevant in today’s world, the task force has advanced the debate over foreign aid.

The United States should stop funding the banks and encourage the other industrialized countries to do likewise. Instead, the Western nations should promote international development by lifting trade barriers. Economic freedom, not misnamed foreign aid, is the answer to international poverty.

About the Authors
Ian Vásquez

Vice President for International Studies and Director, Center for Global Liberty and Prosperity