Peter Bauer and the Foreign Aid Bankruptcy

(Theory and Politics of Foreign Aid)

Submitted by: Meha Lodha on 31st May 2010
University of Wroclaw

Table of Contents

Introduction......................................................................................................................1
1.0 Peter Bauer.................................................................................................................3
2.1 Poverty and Foreign Aid............................................................................................4
2.2 Population Control and Foreign Aid..........................................................................5
2.3 The Big Push Model and Foreign Aid.......................................................................7
Does Foreign Aid lead to Economic Development?........................................................8
Conclusion.......................................................................................................................9
Bibliography..................................................................................................................10

Introduction

Foreign aid, in general, refers to aid (money, goods, services) granted or received
in the international context. Foreign aid in relation to economic development can be
understood well when the scope is narrowed down to development aid and official
development assistance.

Development aid can be defined as “that part of foreign aid whose purpose is to
contribute to human welfare and development in poor countries”.1

According to the Organization for Economic Cooperation and Development,

Official Development Assistance can be defined as, “Flows of official financing
administered with the promotion of the economic development and welfare of developing
countries as the main objective, and which are concessional in character with a grant

1
R.Ridell, Does Foreign Aid Really Work?, Chapter 2, Oxford University Press, 2007
element of at least 25 percent (using a fixed 10 percent rate of discount). By convention,
ODA flows comprise contributions of donor government agencies, at all levels, to
developing countries (“bilateral ODA”) and to multilateral institutions.”2

The words to be watched out for in both the definitions are “development in poor
countries” and “promotion of the economic development and welfare of developing
countries” respectively. This brings us to the imminent question – does foreign aid really
contribute to the economic development of poor/under developed/developing/third world
countries (countries of the “south”).

A classic example of aid having worked for economic development is the

Marshall Plan, when Europe emerged as a phoenix from the ashes using the aid provided
by the United States after World War II. Postmodern times have also seen development
in many parts of Asia and Latin America though many parts of Africa are still severely
underdeveloped in spite of the countries from the West regularly pumping aid.

But on the other hand, some groups in recipient countries have viewed foreign aid
suspiciously as nothing more than a tool of influence of donor countries. For example,
critics of the International Monetary Fund (IMF) allege that the required structural
adjustments (to be eligible to receive foreign aid) are too politically difficult and too
rigorous and that the debts incurred through IMF loans help to create poverty, as capital
that could have been invested instead was channeled into debt repayment. In general,
opponents of the way that foreign aid programs have operated charge that foreign aid has
been dominated by corporate interests, has created an unreasonable debt burden on
developing countries, and has forced countries to avoid using strategies that might protect
their economies from the open market.3

2
OECD Glossary of Statistical Terms http://stats.oecd.org/glossary/detail.asp?ID=6043 Accessed Date: 28th
May 2010
3
Foreign Aid: Criticsm – Britannica Online Encyclopaedia
http://www.britannica.com/EBchecked/topic/213344/foreign-aid/256256/Criticism Accessed Date: 28th
May 2010
 From the perspective of under-developed countries, development economist, Peter
Bauer, probably has been the best known critic of foreign aid. This essay focuses on three
of the cases for foreign aid that Peter Bauer refuted to show that the very concept of
foreign aid as a means of putting the under-developed world on a steady path of
development is intellectually “bankrupt”. These four arguments are:
1. Third World countries are trapped in a vicious circle of poverty that can be broken
only by foreign aid from the more prosperous industrial nations of the world.
2. Population growth is a hindrance to economic development and Foreign aid
should be aimed at controlling the population growth of the developing world.
3. Aid money should be poured by donor countries into projects as this can assure
economic development.

The later part of the essay focuses on the question – Does foreign aid really lead
to economic development? – by showing the results of two separate studies conducted in
the years 2000 and 2003 respectively by economists Craig Burnside and David Dollar;
and William Easterly, Ross Levine, and David Roodman.

The conclusion states that Peter Bauer refuted the three above mentioned
arguments much before research studies began to show that foreign aid does not
necessarily lead to economic development of the developing countries.

1.0 Peter Bauer

Lord Peter Thomas Bauer (1915 – 2002) was a development economist who
championed the political economy of classical liberalism for developing societies.4 Born
in Budapest, Hungary and trained in Cambridge, UK, Peter Bauer was a Professor at the
London School of Economics from 1960 to 1983.5 His specialty was the economics of

4
Machan, Tibor; Downtrodden lives bettered by freedom? Sun, The (Yuma, AZ); 08/05/2006
5
Peter Thomas Bauer http://homepage.newschool.edu/het//profiles/bauer.htm Accessed May 26th 2010
under developed countries. In the last two decades of his life, he was Lord Peter Bauer,
courtesy of the former British Prime Minister, Margaret Thatcher.6

From 1948 to 2000, Peter Bauer wrote books that challenged the prevailing
development orthodoxy, including the myth that poverty is self-perpetuating.7 He is
remembered today for his studies on the working of markets in low-income countries, for
his trenchant analysis of the shortcomings of “development planning” and for his
devastating critique on the modern worldwide convention of “foreign aid”.8

Peter Bauer is perhaps best known as a persistent and articulate critic of foreign
aid, who since 1972 saw it as not only failing to speed up, but actually hurting economic
development. He started his criticism when foreign aid to the developing world was only
getting underway, and never wavered. He defined foreign aid as “a transfer of resources
from the taxpayer of a donor country to the government of a recipient country.”9

2.1 Poverty and Foreign Aid

The dominant orthodoxy in development economics was that the Third World
countries were trapped in a vicious circle of poverty that could be broken only by
massive foreign aid from the more prosperous industrial nations of the world.

Peter Bauer refuted that vision by pointing out that “Before 1886, there was not
one cocoa tree in British West Africa. By the 1930s, there were millions of acres of cocoa
there, all owned and operated by Africans.” According to Peter Bauer, the Third World
people were just as capable of responding to the incentives of a market economy as
anyone else. Peter Bauer was also of the opinion that if poverty was a trap from which

6
Sowell, Thomas; RIP Peter Bauer, who refused to buy the argument that one cannot escape poverty,
Enterprise/Salt Lake City; 5/13/2002, Vol. 31 Issue 47, p34, 1/2p
7
The CATO Institute: Peter Bauer http://www.cato.org/special/friedman/bauer/index.html Accessed Date:
26th May 2010
8
Eberstadt, Nicholas; Rethinking the population problem, Public Interest; Spring2005, Issue 159, p139-
151, 13p
9
Shleifer, Andrei; Peter Bauer and the Failure of Foreign Aid, Cato Journal, vol. 29 no. 3, Fall 2009
there was no escape, we would all still be living in the Stone Age, since all countries
were once as poor as the Third World nations are today.10

According to what Peter Bauer stated in his book, From Subsistence to Exchange
and Other Essays (2000), development aid is not necessary to rescue poor societies from
a vicious circle of poverty. Indeed it is far more likely to keep them in that state. It
promotes dependence on others. It encourages the idea that emergence from poverty
depends on external donations rather than on people’s own efforts, motivation,
arrangements, and institutions.

An IMF 2005 working paper titled, “Does Foreign Aid Reduce Poverty?
Empirical Evidence from Nongovernmental and Bilateral Aid” by Nadia Masud and
Boriana Yontcheva, was aimed at verifying if foreign aid has a positive impact on two
human development indicators (infant mortality and adult literacy) whose improvement is
part of the Millennium Development Goals. The results of this paper show that official
bilateral aid is not very effective in reducing infant mortality, that there is hardly any
impact of foreign aid on illiteracy and that foreign aid reduces government efforts in
achieving developmental goals.

2.2 Population Control and Foreign Aid

International donor agencies - the International Monetary Fund, World Bank,

United Nations Fund for Population Activities (UNFPA), United States Agency for
International Development (USAID), United Nations Development Programme (UNDP)
-- have all identified population growth as one of the main factors for underdevelopment,
and have channelled billions of dollars into population control. One of the World Bank's
activities has been to pressure national governments into prioritising population control
policies and then providing loans and credits for implementing them.11
10
Sowell, Thomas; RIP Peter Bauer, who refused to buy the argument that one cannot escape poverty,
Enterprise/Salt Lake City; 5/13/2002, Vol. 31 Issue 47, p34, 1/2p
11
http://infochangeindia.org/200704056302/Population/Population-Puzzle/Manufacturing-consent-for-
Third-World-population-control.html Accessed Date: 29th May 2010
 Family planning and birth control have been part of foreign aid programs for
many decades now. US assistance to developing countries like Peru, Zimbabwe has
focused on, among other areas, family planning.

By the late 1970s and early 1980s, a worldwide network of activist anti-natal
organizations—including private foundations, bilateral foreign aid agencies, multilateral
institutions like the United Nations family and the World Bank, and a host of recipient
groups the world over—were making the case that rapid population growth was having
deleterious, or even disastrous, effects in low income areas, and perhaps even on the
world as a whole. Poverty, unemployment, hunger, and social strife were just some of the
afflictions the "population explosion" was said to be visiting on a hapless planet. Robert
McNamara, then-president of the World Bank, insisted that "the threat of unmanageable
population pressures is very much like the threat of nuclear war," and identified what he
termed "rampant population growth" as "the greatest single obstacle to the economic and
social advancement of the peoples in the underdeveloped world.12

Peter Bauer was an opponent of the overpopulation thesis (though it was one of
the key dogmas of development economics)13, recognizing that the poor like the rich
should have the right to choose the number of children they have, that many developing
countries are under-populated, and that population growth will anyhow slow down once
the poor become richer14.

In Peter Bauer’s 1981 book, Equality, the Third World and Economic Delusion
there is an essay titled "The Population Explosion: Myths and Realities." begins by
reviewing some obvious but often neglected facts about poverty and development in the
modern era. Many areas of the world—Western Europe and North America—had risen to
prosperity despite rapid, or even exceptionally rapid, rates of population increase. Some

12
Eberstadt, Nicholas; Rethinking the population problem, Public Interest; Spring2005, Issue 159, p139-
151, 13p
13
Sowell, Thomas; RIP Peter Bauer, who refused to buy the argument that one cannot escape poverty,
Enterprise/Salt Lake City; 5/13/2002, Vol. 31 Issue 47, p34, 1/2p
14
Shleifer, Andrei; Peter Bauer and the Failure of Foreign Aid, Cato Journal, vol. 29 no. 3, Fall 2009
of these newly affluent locales, moreover, had achieved their wealth despite not only
dramatic increases in population, but a manifest scarcity of, arable land and a lack of
other "natural" resources (Japan or Hong Kong).

Conversely, Peter Bauer reminded his readers, dreadful poverty could be seen
today in many parts of the modern world where land and other resources have been
abundant, and where population density has been and is quite low (large parts of Central
Africa, among other places). In Bauer’s words, “The predictions of doom through
population growth rest on the idea that economic achievement, progress and welfare all
depend primarily on natural resources, supplemented by physical capital. This Malthusian
notion is then supplemented by the very non-Malthusian idea that, people in LDCs (less
developed countries) have no will of their own and are simply passive victims of external
forces: in the absence of Western-dictated pressures, people in the less developed world
procreate heedless of consequences.”

2.3 The Big Push Model and Foreign Aid

During the post-World War II era, the intellectual support for many of the policy
recommendations for how to allocate aid in order to stimulate economic development
was based on the “big push model”.

According to the Big Push Model, (developed by Rosenstein-Rodan in 1943,

formalized by Murphy, Shleifer, and Vishny in 1989) what keeps countries behind is
insufficient investment across sectors of the economy and in infrastructure. To the extent
that foreign aid supplies investment capital, it jump starts economic growth, and initiates
a virtuous cycle whereby investment generates income and thus raises the economic
return to further investment.

With regards to the “investment fetish” (the conception that capital and
investment was both the driving engine and the limiting constraint in the process of
modern economic growth), Peter Bauer said, “The volume of investible funds is in any
case a minor factor in economic development. Much capital formation forms more
closely analogous to consumer durables than to instruments for increasing production and
promoting further economic growth. It is unwarranted, further, to assume that the
governments of the LDCs (least developed countries) in question would use investible
funds more wisely if they did not have to use them to provide for an expanding
population. The investment record of many Third World governments has been
deplorable.”15

Peter Bauer relentlessly criticized the big push model. He argued that foreign aid
providers do not know which investments are appropriate for a developing economy, so
aid money is poured into bad projects (also known as white elephants), which not only
fail to encourage economic growth, but divert scarce human and other resources away
from productive uses. The limited institutional and human capabilities of a country are
wasted on unproductive rather than productive activities. Aid destroys economic
incentives, leads to misallocation of scarce resources, and so not only fails to jump start,
but actually undermines growth.16

Peter Bauer also wrote that “It is more meaningful to say that capital is created in
the process of development, rather than that development is a function of capital. 17

Does Foreign Aid lead to Economic Development?

In 2000, two World Bank economists, Craig Burnside and David Dollar, relying
on a panel data set of 56 countries over six 4-year periods (beginning with 1970–73 and
ending with 1990–93), used regression analysis techniques to examine the relationship
between national economic growth, national economic policy, and foreign aid received.

15
Eberstadt, Nicholas; Rethinking the population problem, Public Interest; Spring2005, Issue 159, p139-
151, 13p
16
Shleifer, Andrei; Peter Bauer and the Failure of Foreign Aid, Cato Journal, vol. 29 no. 3, Fall 2009
17
Dorn, James A. ECONOMIC DEVELOPMENT AND FREEDOM: THE LEGACY OF PETER
BAUER, CATO Journal; Fall2002, Vol. 22 Issue 2, p355, 17p
 Their two principal findings were (1) the estimated coefficient of aid is negative
but not statistically significant, and (2) the estimated coefficient of the aid-policy
interaction term is positive and significantly different from zero. From these two results,
they concluded: “We find that aid has a positive impact on growth in developing
countries with good fiscal, monetary, and trade policies, but has little effect in the
presence of poor policies.”

In 2003, Burnside and Dollar’s conclusion were challenged by economists

William Easterly, Ross Levine, and David Roodman. They used the exact same
regression specification as Burnside and Dollar, but expanded the set of observations to
include data that were not available to Burnside and Dollar. They were able to augment
Burnside and Dollar’s 56-country sample with 6 additional countries and one additional
4-year period (1994–97).

Using their expanded data set, they found that the aid-policy interaction term is
not significantly different from zero, indicating no support for Burnside and Dollar’s
conclusion that in a good policy environment foreign aid has a positive effect on
economic growth. The study went one step further: empirical evidence suggested that
foreign aid has a negative growth effect even where economic policy is sound.18

Conclusion

Most of Peter Bauer’s written works (including arguments against the competence
of foreign aid) were published before 2000 and it is only in recent years that the
effectiveness of foreign aid has come into limelight and question. The incompetence and
the very busted idea of foreign aid has been quite evident in recent years.

18
Brumm, Harold J.; AID,POLICIES, AND GROWTH: BAUER WAS RIGHT, CATO Journal; Fall 2003,
Vol. 23 Issue 2, p167-174, 8p, 2 Charts
 Peter Bauer proclaimed well ahead in time that foreign aid is not an effective
instrument in reducing poverty, population growth is not an impediment to economic
development and that foreign aid interfering with the investment in under developed
nations can be a detriment to economic development.

The notion that foreign aid can help alleviate poverty has been proved wrong by
the continuing dismal economic status of most of the African continent which has
received more than $580 billion of aid since 1960.19

Economies of countries with burgeoning populations like China, India and Brazil
are being watched out for. There have been studies and discussions to show the
possibility that China and India will dominate the 21st century global economy (video
lecture by award winning Professor Lee Branstetter of Carnegie Mellon University,
USA).

The reasons why aid hasn’t always worked is that aid money suffers from the
trickle down effect and wasteful administrative and consumption spending and has made
Government agencies, incharge of “effectively” using aid, hotbeds of corruption. The
very blueprint of foreign aid needs to be redesigned and alternate approaches need to be
explored.

Bibliography

• Machan, Tibor; Downtrodden lives bettered by freedom? Sun, The (Yuma, AZ);
08/05/2006
• Sowell, Thomas; RIP Peter Bauer, who refused to buy the argument that one
cannot escape poverty, Enterprise/Salt Lake City; 5/13/2002, Vol. 31 Issue 47,
p34, 1/2p

19
http://unctad.org/en/docs/gdsafrica20061_en.pdf Accessed Date: 29th May 2010
• Eberstadt, Nicholas; Rethinking the population problem, Public Interest;
Spring2005, Issue 159, p139-151, 13p
• Shleifer, Andrei; Peter Bauer and the Failure of Foreign Aid, Cato Journal, vol. 29
no. 3, Fall 2009
• Dorn, James A. ECONOMIC DEVELOPMENT AND FREEDOM: THE
LEGACY OF PETER BAUER, CATO Journal; Fall2002, Vol. 22 Issue 2, p355,
17p
• Brumm, Harold J.; AID,POLICIES, AND GROWTH: BAUER WAS RIGHT,
CATO Journal; Fall 2003, Vol. 23 Issue 2, p167-174, 8p, 2 Charts
• Economic Development in Africa
http://unctad.org/en/docs/gdsafrica20061_en.pdf Accessed Date: 29th May 2010
• OECD Glossary of Statistical Terms http://stats.oecd.org/glossary/detail.asp?
ID=6043 Accessed Date: 28th May 2010
• Foreign Aid: Criticsm – Britannica Online Encyclopaedia
http://www.britannica.com/EBchecked/topic/213344/foreign-
aid/256256/Criticism Accessed Date: 28th May 2010
• Peter Thomas Bauer http://homepage.newschool.edu/het//profiles/bauer.htm
Accessed May 26th 2010
• The CATO Institute: Peter Bauer
http://www.cato.org/special/friedman/bauer/index.html Accessed Date: 26th May
2010
• Manufacturing consent for Third World population control
http://infochangeindia.org/200704056302/Population/Population-
Puzzle/Manufacturing-consent-for-Third-World-population-control.html
Accessed Date: 29th May 2010