The Trade-And-Aid Myth

Paul Wolfowitz, the new President of the World Bank just visted Bangladesh yesterday. Setting aside his notorious involvement in gone-awry Iraq war, his few observations on the prospect of achieving 8 percent GDP in Bangladesh but only if Bangladeshi government takes sincere initiatives reducing endemic corruption hit the mark. Here are a few extracts of Mr. Wolfowitz's comment:

"I am absolutely convinced that you have the same great human resources here that your big neighbour in the west has. You have wonderful, talented people. But the problem of corruption is a big drag on your economy. Big power projects unfortunately are one of the principal targets for corruption," he cited as an example. This sector needs reform, he pointed out, adding, "We are not imposing harsh conditions... We are just saying we invest in your country and we need some assurance that the investment would go to help the poor people." Wolfowitz said the WB's future aid for projects including those in the power sector would depend on reducing corruption, because "we cannot commit money unless we are convinced it is going to be spent in the right way." [The Daily Star, August 22, 2005]

Compare Mr. Wolfowitz's comment with Professor Dani Rodrik's article published in Tom Paine a few weeks ago. He provides a few practical examples where the progress of nations toward more economic success came through their own efforts, including curbing corruptions and crimes, whereas in nations where even having the richest and the most powerful country in the world as the neighbor and getting the most favored trading partner treatment is no guarantee to achieve similar economic success.

"Development should focus not on trade and aid, but on improving the policy environment in poor countries." How would they do it? Perhaps witholding any material and immaterial support from the corrupt regimes around the world could do the trick. And of course, steering away the powerful nations' own corrupted corporations from meddling into the corrupting process itself could be the final nail on the coffin. The memory of the energy Minister of Bangladesh who resigned in June of this year for getting an expensive car from an oil exploration company is still too raw to forget for many. Bangladesh or other poor nations cannot solve these widespread corruption processes alone, these have to be done in coordinated fashion, from East to West, North to South, without prejudice.

Regards,
Sohel

The Trade-And-Aid Myth

Dani Rodrik

Dani Rodrik is Professor of Political Economy, John F. Kennedy School of Government, Harvard University.

Trade and aid have become international buzzwords. More aid (including debt relief) and greater access to rich countries’ markets for poor countries’ products now appears to be at the top of the global agenda. Indeed, the debate nowadays is not about what to do, but how much to do, and how fast.

Lost in all this are the clear lessons of the last five decades of economic development. Foremost among these is that economic development is largely in the hands of poor nations themselves. Countries that have done well in the recent past have done so through their own efforts. Aid and market access have rarely played a critical role.

Consider a developing country that has free and preferential market access to its largest neighbor, which also happens to be the world’s most powerful economy. Suppose, in addition, that this country is able to send millions of its citizens to work across the border, receives a huge volume of inward investment, and is totally integrated into international production chains. Moreover, the country’s banking system is supported by its rich neighbor’s demonstrated willingness to act as a lender of last resort. Globalization does not get much better than this, right?

Now consider a second country. This one faces a trade embargo in the world’s largest market, receives neither foreign aid nor any other kind of assistance from the West, is excluded from international organizations like the World Trade Organization, and is prevented from borrowing from the International Monetary Fund and the World Bank. If these external disadvantages are not debilitating enough, this economy also maintains its own high barriers on international trade (in the form of state trading, import tariffs, and quantitative restrictions).

As the reader may have guessed, these are real countries: Mexico and Vietnam. Mexico shares a 2,000-mile long border with the United States, which provides not only privileged market access in goods and labor, but also a claim to the resources of the U.S. Treasury (as became apparent during the 1995 peso crisis).

By contrast, America maintained a trade embargo against Vietnam until 1994, established diplomatic relations only in 1995, and did not provide most-favored nation treatment to Vietnamese imports for years after that. Vietnam still remains outside the WTO.

Now consider their economic performance. Since the North American Free Trade Agreement (NAFTA) was signed in December 1992, Mexico’s economy has grown at an average annual rate of barely over one percent in per capita terms. This is not only far below the rates of Asia’s economic superstars; it is also a fraction of Mexico’s own growth performance during the decades that preceded the debt crisis of 1982 (3.6 percent per year between 1960 and 1981).

Vietnam, however, grew at an annual rate of 5.6 percent per capita between the onset of its economic reforms in 1988 and the establishment of diplomatic relations with the United States in 1995, and has continued to grow at a rapid 4.5 percent pace since then. Vietnam witnessed a dramatic fall in poverty, while in Mexico real wages fell. Both countries experienced sharp increases in international trade and foreign investment, but the pictures are utterly different where it counts most: rising standards of living, particularly for the poor.

What these examples show is that domestic efforts trump everything else in determining a country’s economic fortunes. All the opportunities that the U.S. market presented to Mexico could not offset the consequences of policy mistakes at home, especially the failure to reverse the real appreciation of the peso’s exchange rate and the inability to extend the productivity gains achieved in a narrow range of export activities to the rest of the economy.

What matters most is whether a country adopts the right growth strategy. With none of Mexico’s advantages, Vietnam pursued a strategy that focused on diversifying its economy and enhancing the productive capacity of domestic suppliers.

Broader post-war experience supports the conclusion that domestic policies are what matter most. South Korea took off in the early 1960’s not when foreign aid was at its apex, but when it was being phased out. Taiwan did not receive foreign aid or preferential market access. China and India, today’s two economic superstars, have prospered largely through sui generis reform efforts.

It is tempting to ascribe the rare African successes—Botswana and Mauritius—to foreign demand for their exports (diamonds and garments, respectively), but that story goes only so far. Obviously, both countries would be considerably poorer without access to foreign markets. But, as in other cases of successful development, what distinguishes them is not the external advantages they possess, but their ability to exploit these advantages.

Witness the mess that other countries made of their natural-resource endowments. The word “diamond” hardly conjures images of peace and prosperity in Sierra Leone. Similarly, few of the export processing zones proliferating around the world have delivered the results observed in Mauritius.

None of this absolves rich countries of their responsibility to help. They can make the world less hospitable for corrupt dictators—for example, by greater sharing of financial information and by not recognizing the international contracts that they sign. Similarly, increasing the number of poor-country workers allowed to work in rich countries, and providing greater scope for growth-oriented policies by relaxing WTO rules and conditionality from the United States, would produce greater long-term development impact.

It is far from clear that expanding market access and boosting aid are the most productive use of valuable political capital in the North. Development should focus not on trade and aid, but on improving the policy environment in poor countries.