The Failure of Foreign Aid: The Case of Zambia

1. The New Comparative Political EconomyPeter J. BoettkeHayek Visiting FellowLondon School of Economics18 October 2004

2. The Failure of Foreign Aid:The Case of Zambia • If the 2 billion of aid had worked as the investment gap theory predicted, the per capita income would be $20,000, not the $600it actually is Source: Easterly, “The Five Myths of Third World Development”

3. 3.0% 60 Growth Loans (right (left axis) 55 axis) 2.5% 50 2.0% 45 1.5% 40 IMF/World Bank Adjustment Loans per Year 35 1.0% 30 0.5% 25 0.0% 20 -0.5% 15 60s 70s 80s 90s IMF/World Bank Adjustment with Growth did not work out as the theory would predict… Per capita growth Source: Easterly, “The Five Myths of Third World Development”

4. Comparative Political Economy in the Literature • Old Comparative • Focus on the theory of optimal planning and the empirics of growth • Bridge • Focus on property rights • Austrians, Barzel, Kornai • Shleifer • Focus on legal origins, political regimes, regulatory enforcement mechanisms and entrepreneurship • Strength: Focus on given institutional possibilities and the trade-offs that exist in policing predation at the public and private level • Weakness: forces us to limit our analysis to within institutional choice, rather than between institutional choice

5. The Transition Experience • Three distinct moments: • Getting the Prices right • Getting the Institutions right • Getting the Culture right • If sequentially timed, rather than simultaneous, policies will fight against each other • The entire intellectual tool-kit, not just policy advice, that was developed to fit the Keynesian-Market socialist approach must be jettisoned from the development aid agenda

6. Empirics & Assessment • Ineffectiveness of traditional techniques • de facto vs. de jure • Importance of the unofficial economy • See Besançon • Shortcomings of standard data analysis • “It is not that we have to stop asking so many questions about economic growth. We just have to stop expecting the international data to give us all the answers.” (Mankiw, 1995, 307) • Ethnography unbound • Participant observer • Personal Interviews • Surveys

7. Importance of the Unofficial Economy… ‘The Soviet economy is the subject of a considerable volume of scholarly work which occupies numerous study centers in Europe and the United States and which provides material for a vast literature and various academic journals. But those born in the Soviet Union or those who approach Soviet society through history, literature, travel or through listening to what the émigrés have to say, find that they cannot recognize what the economists describe. There seems to be an unbridgeable gap between this system, conceived through measurements and figures, and the other system, without measurements or figures, which they have come to know through intuition and their own actual experience. It is an astonishing feature of the world of Soviet affairs that a certain kind of economic approach to Soviet reality, no matter how well-informed, honest and sophisticated, is met with such absolute skepticism and total disbelief by those who have a different approach that they do not even want to offer any criticism – it being impossible to know where to begin’ (Alain Besançon, 1980, 143).

8. Empirics & Assessment (cont’d) • Assessment of economic activities within an economy focuses not on the macroeconomic data, but on the microeconomic structure of investment and enterprise • Increased capital investment is the key • Credible institutions in the realms of politics, law, economics, finance, and society are necessary • Development assistance will not be effective if it crowds out indigenous efforts to provide social services • The development aid project is one of building an institutional infrastructure that allows the human mind to flourish

9. Policy Implications • The focus of our efforts in development assistance should be at the level of the institutional infrastructure • Engineering mentality has to be abandoned completely • Focus on cultivating economic development by aiding the establishment of the institutional conditions conducive to growth • An understanding of indigenous institutions and their ‘stickiness’ • Regression theorem generalized • Long-run policies • General: Privatization, price liberalization, low inflation, fiscal responsibility, low levels of taxation and regulations, and open international trade • Entrepreneurship: micro-environment and its impact • Providing theoretical content to de Soto, and empirical content to Kirzner