How to Help Poor Countries

Nancy Birdsall, Dani Rodrik, and Arvind Subramanian

From Foreign Affairs, July/August 2005

Summary:  Increasing aid and market access for poor countries makes sense but will not do that much good. Wealthy nations should also push other measures that could be far more rewarding, such as giving the poor more control over economic policy, financing new development-friendly technologies, and opening labor markets.

Nancy Birdsall is President of the Center for Global Development in Washington, D.C. Dani Rodrik is Professor of International Political Economy at Harvard's John F. Kennedy School of Government. Arvind Subramanian is Division Chief in the Research Department of the International Monetary Fund. The views expressed here are their own and not those of their respective institutions.

Almost all successful cases of development in the last 50 years have been based on creative -- and often heterodox -- policy innovations. South Korea and Taiwan, for example, combined their outward trade orientations with unorthodox policies: export subsidies, directed credit, patent and copyright infringements, domestic-content requirements on local production, high levels of tariff and nontariff barriers, public ownership of large segments of banking and industry, and restrictions on capital flows, including direct foreign investment. Since the late 1970s, China has also followed a highly unorthodox two-track strategy, violating practically every rule in the book -- including, most notably, securing private property rights. India, which raised its economic growth rate in the early 1980s, remained a highly protected economy well into the 1990s. Even Chile -- Latin America's apparently "orthodox" standout that managed to achieve both growth and democracy -- violated conventional wisdom by subsidizing its nascent export industries and taxing capital inflows.

Conversely, countries that have adhered more strictly to the orthodox structural reform agenda -- most notably in Latin America -- have fared less well. Since the mid-1980s, virtually all Latin American countries have opened and deregulated their economies, privatized their public enterprises, and allowed unrestricted access to foreign capital. Yet they have grown at a fraction of the pace of the heterodox reformers and have been strongly buffeted by macroeconomic instability.

The contrasting experiences of eastern Asia, China, and India suggest that the secret of poverty-reducing growth lies in creating business opportunities for domestic investors, including the poor, through institutional innovations that are tailored to local political and institutional realities. Ignoring these realities carries the risk that pro-poor policies, even when they are part of apparently sound and well-intentioned IMF and World Bank programs, will be captured by local elites.

Wealthy nations and international development organizations thus should not operate as if the right policies and institutional arrangements are the same across time and space. Yet current WTO rules on subsidies, foreign investment, and patents preclude some of the policy choices made, for example, by South Korea and Taiwan in the past, when rules under the WTO's predecessor, the General Agreement on Tariffs and Trade, were more permissive. What is more, new WTO members typically confront demands to conform their trade and industrial policies to standards that go well beyond existing WTO agreements. The new Basle II international banking standards, better fitted to banks in industrialized nations, risk making it more difficult for banks in developing countries to compete.

To be sure, not all internationally imposed economic discipline is harmful. The principle of transparency, enshrined in international trade agreements and many global financial codes, is fully consistent with policy independence, as long as governments are provided leeway with respect to actual policy content. A well-functioning international economic system does need rules. But international rules should regulate the interface between different policies and institutional regimes, not erase them.

There are signs of change in the rich world's attitude. Some donors, notably the United Kingdom and the United States, the latter with its Millennium Challenge Account, are moving away from attaching explicit, heavy conditions to their grants and loans and are instead screening applicants early to ensure that assistance will be reasonably well spent. The World Bank and other organizations are designing programs with countries in which resources are disbursed not in exchange for policy reform but on the basis of pre-agreed benchmarks of progress -- be it reduced inflation, more children finishing primary school, or more completed external audits of government accounts. These changes deserve to be reinforced.

Rich countries also harm their developing counterparts in other ways, most notably with their emissions of greenhouse gases. According to the growing scientific consensus, the costs of climate change will disproportionately burden developing countries. Estimates of these costs, including reduced water availability and agricultural productivity, vary from 4 to 22 percent of poor countries' incomes. Rich nations must quickly lead the way in enacting measures beyond the Kyoto Protocol. A market-based system of tradable emissions rights offers a great opportunity to combine efficiency with equitable treatment for developing countries. Poor nations would be allotted enough emissions to ensure future growth -- the same right that the industrial countries have enjoyed for centuries. Market-based trading would guarantee that pollution would be cut where costs are lowest, ensuring maximum efficiency: if costs are lower in India than in the United States, for example, the United States could pay India to pollute less, and India would be financially better off in doing so.

POSITIVE STEPS

Wealthy nations can also take positive steps to directly benefit developing countries -- specifically, by taking action against corrupt leaders, assisting research and development, and enhancing global labor mobility.