What aid can't do: reply to Ranis.

• Author: Skarbek, David B.
• Position: Gustav Ranis - Essay

Gustav Ranis addresses our recent article in this journal where we argued that foreign aid is unable to solve the economic problem and thus unable to make poor countries rich (Skarbek and Leeson 2009). The following quotations from his article summarize his main objections to our argument:

Instead of the MCC's [Millennium Challenge Corporation's] present grants-for-projects approach, favored by Easterly and Skarbek and Leeson, policy-based program lending or grants should be relied upon.

Skarbek and Leeson are ready to throw the baby out with the bath water. While foreign aid as presently practiced is admittedly flawed, there is no reason not to encourage at least this promising new window [a modified MCC] as a potentially valuable component of our long-term foreign policy arsenal [Ranis 2011].

We have two replies to Ranis's remarks. First, while we cannot speak for William Easterly, we can speak for ourselves. And we can say unequivocally that neither of us favors a grants-for-projects approach to foreign aid. Second, we question the ability of a modified MCC to address the plight of poor people in developing countries.

The Problem with a Grants-for-Projects Approach

The thrust of our original paper which asked the simple question "What can aid do?"--was that no foreign aid initiative can solve the economic problem societies must solve to climb from poverty. That problem requires identifying the resource allocation that maximizes resources' value to society. Grants for projects do not help us identify this. They are an example of what aid can do--increase a predetermined output by devoting more resources to its production--not what aid must do to make poor countries rich, which is to solve the economic problem stated above. Whether developed countries should use aid to increase a predetermined output by devoting more resources to its production is a normative question. Our original argument analyzed a positive one.

Markets solve the economic problem required to make poor countries rich. But markets require a system of private property rights. Developing countries lack such a system. That is why they are undeveloped.

If the major impediment to developing countries adopting a system of private property rights were a lack of finances, aid could contribute to relieving poverty indirectly by financing the creation of such a system--assuming that all relevant parties had the incentive to use it for the purpose. But we doubt that is the ease. As...