The Trade-and-Aid Myth

Dani Rodrik

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 WTO, and is prevented from borrowing from the IMF 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 US 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 NAFTA was signed in December 1992, Mexico’s economy has grown at an average annual rate of barely over 1% 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% per year between 1960 and 1981).

Vietnam, however, grew at an annual rate of 5.6% per capita between the onset of its economic reforms in 1988 and the establishment of diplomatic relations with the US in 1995, and has continued to grow at a rapid 4.5% 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 US 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 US, 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.