Have We Been Here Before?

Like many people working in development, I’ve been affected by a strain of aid angst in the last few years, and have blogged about this in a previous incarnation.

Aid’s internal crisis is gathering steam: Dambisa Moyo is the centre of a great deal of attention; Bill Easterly has been mud-wrestling with Jeffrey Sachs; and in relative sotto, others such as Yash Tandon have been more virulent in their criticisms, with deeper flaws in their analysis. The problems in Moyo’s Dead Aid analysis have been autopsied sufficiently, but the central premise retains power: aid has had significant unintended consequences, and has achieved relatively little against most macro-indicators of development, especially in Africa.

Historically, aid is a relatively recent phenomenon. In fact, if we acknowledge the profound structural, motivational and political differences between the goals and methods of the Marshall Plan and other efforts of economic generation and regeneration that have followed wars, aid in its current form is still in its infancy as a component of historical processes of development. As a result, some of the most interesting writing on the process of development assumes no aid at all.  One such example (here greatly abridged and simplified) is particularly instructive. Indeed, it gives us a strong sense of what the alternatives to aid are, given that it barely considers it to be a possibility.

In 1954, Michal Kalecki wrote a paper entitled ‘The Problem of Financing Economic Development’. Kalecki was a Marxist, which may put off some readers, but this is incidental to many of the insights he raises in his analysis. Put simply, his central concern is how the rapid increase in investment required to generate and sustain an increase in the productive capacity of an economy can be financed without causing undue pressure on inflation or real wages, and without causing other unintended social or economic consequences. He does this through a model of the economy which examines the production of consumption goods and investment goods, through the investment, consumption, savings, taxes and trading behaviour of capitalists, workers and small proprietors. It’s this approach that demonstrates his Marxism; however, his concern with macroeconomic stability in the face of stimuli to demand and supply reflects a very modern sensibility.

The central challenge in an economy that does not receive international capital flows (aid, loans or direct investment) is that to develop, the economy must demonstrate an increase in productivity and production of mass industrial consumption goods (i.e. through investment) as well as in agriculture, near-simultaneously. Failing this, one or more of several problems may occur, chief among which are the dangers of inflationary spirals, under-utilised capacity, locally concentrated unemployment and restrained effective demand.

Kalecki goes on to show that international flows may relieve these pressures on the economy. Essentially less savings will be required for the same amount of investment to occur, and the import of capital will either act to increase in the supply of goods or reduce the demand for local goods fuelled by domestic investment. Either on the supply side or the demand side, inflationary pressures decrease, while investment continues to occur at a similar rate.

However, by excluding international capital flows from his initial analysis, Kalecki makes a powerful point that should be far more central to the analysis of the aid critics than it is. Essentially, the problems of rapid development are of a structural nature: the effect on inflation, unemployment, real wages, and demand patterns of any rapid drive to investment and development depend on the sectoral distribution of investment and of the labour force, the ownership and market structures of production in different sectors and the trading patterns extant in the economy.

Thus, rapid investment must usually be accompanied by profound structural changes to the economy and socio-polity (insofar as labour and ownership are determined not just by economic influences), or negative effects must be minimised through appeal to some form of external inflow. Most aid critics narrowly focus on these inflows, trying to find an appropriate and accessible form of international capital is not aid.

Kalecki has much to say about this, as well. He considered various forms of international capital flows for their merits in reducing the economic pressures of development.

  • Aid is dismissed as a viable form. No strictly economic difficulties would arise; however, the political and non-economic strings associated with grants may ‘adversely affect the whole course of development’.
  • Direct investments are also laced with difficulty. Though dividends on shares respond to economic situations better than interest on loans, Kalecki is concerned that ‘direct investment frequently takes place in certain branches of the economy, such as the production of raw materials for export, which may not be in line with a reasonable plan for the development of the resources of a country.’ It is not beyond the realms of rational thought to worry that China’s African presence is headed in this direction.
  • Foreign loans on a commercial basis are preferred by Kalecki. They lack the potential for distortion of the economy that other modes of financing have, but he rightly points out that interest rates may be prohibitively high, and they can be difficult to access. Moyo suggests some ways around this, but most depend on significant Government improvements. Thus the poorest-performing countries, most in need of an economic stimulus, will find it hardest to access it.

Ultimately, Kalecki makes a final, ingenious, suggestion for financing development investment: a situation in which ‘investment goods from abroad are obtained on loan, the repayment and interest on which take the form of future exports of specific commodities produced in the under-developed country in question’. This approach requires a lender with an underutilized productive capacity in investment goods production and a desire for future commodities better produced elsewhere. Ingenious though it is, the likelihood of it being tested on a large enough scale to make an impact is relatively slim.

Now, I don’t make claims that this analysis is flawless, but there are serious lessons for aid critics here. At a very basic level, the paper maintains a central focus on the need for structural changes in the economy – not simply liberalisation or greater state control, but a change in the patterns of ownership and the fundamentals of production. With these changes, the need for aid, foreign direct investment or for loans is dampened. This is a message we must not drop. I take issue with aid cheerleaders calling for more, more, more: but how different is calling for ever greater access to foreign loans or direct investment without the requisite changes to the socio-economic structure? Kalecki’s world without aid demonstrates that the problems of economic development are not rooted in what volume or form inflows come – the reforms that yield the biggest gains are independent of how investment is financed. As Kalecki concludes,

The solution to the problem must be based on economic policies embracing the whole process of development.

Not just the financing of it.

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