Angus Deaton, the Scottish economist who was just awarded the prestigious Nobel Memorial Prize in Economic Prize, is a noted critic of the notion that foreign aid can help poor countries grow their way out of poverty. Defenders of foreign aid have been quick to point out that one could support foreign aid for other reasons, e.g., to help meet the basic health needs of the world’s poorest countries, and they’re right in this regard. If our goal is to alleviate the suffering associated with entrenched poverty, aid can do a great deal of good. Where defenders of foreign aid go wrong, however, is to suggest that it can promote development, if by development we mean a steady increase in productive potential that is the only lasting solution to the ravages of poverty.
To understand why foreign aid, or government-to-government transfers, to use the economist P.T. Bauer’s term of choice, has such a poor track record of spurring development in this sense, I recommend Nicholas Eubank’s 2012 essay on “Taxation, Political Accountability, and Foreign Aid: Lessons from Somaliland.” Drawing on the history of early modern Europe, Eubank observes that modern, representative states first emerged when autocratic governments found that to survive intense inter-state military competition, they needed to secure tax revenue from their subjects. But their subjects were only willing to consent to high levels of taxation in exchange for greater political accountability, a process that scholars have dubbed “revenue-bargaining.” The result is that autocratic governments were forced to become less autocratic, as their only alternative was to face military defeat. Imagine if this process were somehow short-circuited — if autocratic governments had some source of revenue other than taxes raised on domestic production, like aid from some distant foreign government. In that case, the autocratic government in question would have no need to surrender its power, or to increase its legitimacy by, say, fighting corruption and embracing transparency. Transfers from some other government would finance, directly or indirectly, the state’s repressive apparatus and its various military objectives, and the subjects of the state in question would have little choice but to grin and bear it.
To illustrate that this revenue-bargaining dynamic can be found in a modern setting, Eubank points to Somaliland, a country that declared its independence from Somalia in the wake of Somalia’s descent into civil war in the early 1990s, yet which has never been internationally recognized. Because Somaliland is not recognized by the world’s rich market democracies, it receives virtually no government-to-government transfers. Moreover, Somaliland is bereft of so-called “point-source natural resources,” like oil wells or diamond mines, that a government could exploit by controlling a relatively small patch of territory. Somaliland’s government has thus been forced to bargain with Somaliland’s citizens to get the tax revenue it needs to survive. Though good statistics on Somaliland are hard to come by, the limited evidence we do have suggests that the country has fared reasonably well, considering the challenges it faces. More to the point, Somaliland is one of the most democratic countries in sub-Saharan Africa. Having accountable political institutions is not an economic panacea in itself, to be sure. But I’d suggest that Somalilanders are far better off with these institutions than they would be without them, and that these institutions can serve as a solid foundation for future economic development. That is no small thing.