Foreign Aid and the World Bank

Sanjay Paul
March 1997

(A slightly revised version of this article appeared as "Foreign Aid Can Benefit Domestic Development" in Business Forum, Green Bay Press-Gazette, March 29, 1997.)

       There is a general presumption in certain quarters that rapid economic growth in other countries is somehow detrimental to our standard of living. This feeling was especially pronounced in the late 1980s when a slew of horripilatory articles and books stoked fears about Japanese domination of the global economy -- and the concomitant decline of the United States.

       Such tomes have become rarer now. While the U.S. economy has since chugged along robustly, the Japanese economy has been mired in a protracted recession for the last six years. But far from crowing over this "victory" over Japan, the Clinton administration is increasingly concerned about the anemic state of the Japanese economy.

       Why is Japan's economic lethargy, and more generally poor performance in other countries, a source of concern to the United States?

       Because it will eventually crimp growth in the United States. An economic slowdown in other countries will result in fewer purchases of U.S. goods and services. As the exports of American-made cars, machine tools and movies fall, the affected industries will be forced to reduce their output. Accordingly, employment will fall -- and the seeds of a slowdown in the U.S. economy would have been planted.

       A vigorous global economy, on the other hand, is conducive to lively growth at home. Increased foreign demand will spur U.S. exports, leading to higher gross domestic product and improved standard of living in the U.S.

       The merits of this argument are clear from the experience in Western Europe following World War II. Besides causing untold suffering to millions of human beings, the war had decimated vast swathes of production facilities in Europe. The labor force, the capital stock -- the resources needed for production in any economy -- lay in complete disarray. The future beckoned grimly.

       Look at Western Europe now. Germany, France, England, Italy -- all teem with great prosperity. How did these countries rise, Phoenix-like from the ashes of World War II, to become the doughty economic powers of today?

       There were more than a few forces at work. Among them: an indefatigable human spirit, democratic institutions, economic policies designed to harness the power of free markets while providing safety nets for those less fortunate -- and the Marshall Plan.

       The Marshall Plan of 1948 provided U.S. funds to Europe for financing their most pressing needs -- food, infrastructure, imports (from the U.S.) and the like. This infusion of foreign aid, arguably, has been of paramount importance in laying the foundation for Western Europe's subsequent recovery.

       Along with Western Europe's economic revival, the U.S. too enjoyed a surge in prosperity. The 1950s and 60s witnessed dramatic improvements in U.S. productivity and living standards for its citizens. There were gains in political stability as well -- the linkages of trade and investment bound the U.S. and European countries inextricably together leading to greater cooperation on several fronts.

       It is difficult to find critics of the Marshall Plan today. Yet, the virtues of foreign aid are still largely ignored.

       Critics of foreign aid argue that aid to developing countries is used improperly -- that it is spent on projects that offer meager returns ("white elephants") or, worse, it ends up in the Swiss bank accounts of tinpot dictators.

       Unfortunately, there is a great deal of merit to the above arguments. Large dollops of foreign aid have indeed been squandered -- both by the recipients of aid and those who give it. Too often, foreign aid is a rubric employed by developed countries to disguise sales of weapons and military technology to developing countries. That such "assistance" fails to promote economic development is hardly surprising.

       Multilateral institutions engaged in dispensing aid are not immune from criticism either. Consider the World Bank, which makes loans at below-market interest rates to low-income countries through funds provided by taxpayers in developed countries. Critics of the World Bank say that it has often financed expensive capital-intensive projects in low-income countries with negligible impact on the lives of millions of poor in those countries.

       In a speech given recently at St. Norbert College, Mr. Matthew F. McHugh, Counselor to the President of the World Bank, admitted that mistakes have been made in the past. But, he said, a greater appreciation for market forces and sound macroeconomic policy is causing a change in the World Bank's focus. While it still continues to finance long-term projects, the Bank now encourages recipient countries to adopt policies that provide macroeconomic stability (lower inflation, smaller budget deficits), promot e private enterprise (selling off state-owned industries), and invest in human capital (education and health).

       These are heartening developments. A judicious use of foreign aid can do wonders for economic development (recall the Marshall Plan). Not only will the recipient country gain from it, so will the developed countries. As low-income countries begin to grow rapidly, so will their appetite for foreign goods -- leading to increased exports for the developed countries. Furthermore, higher incomes in the developing country will mitigate the attractiveness of migration to developed countries; accordingly, immigration levels in developed countries will fall. Economic development also provides a political benefit: Since higher incomes are usually accompanied by a growing middle class with a healthy appetite for civil liberties, economic development will result in the emergence of democratic institutions thus fostering greater political stability in developing countries.

       Mr. McHugh's visit to Green Bay was prompted in large measure by the desire to inform the public about the World Bank -- and engender public support for the U.S.'s financial commitment to the World Bank. He has a persuasive case.

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