NCPA - National Center for Policy Analysis

What Is Necessary For Economic Growth?

July 18, 2001

The World Bank has virtually nothing to show for its 50-year effort to alleviate poverty in the developing world. Indeed, most people living in poor countries have seen their living standards decline for decades.

When the World Bank and the International Monetary Fund were established after World War II, the dominant theory said economic growth was a function of capital, meaning goods-producing plant and equipment, or "machinery." All one needed to do, it was thought, was to increase investment and growth would follow. Foreign aid would provide the capital missing from underdeveloped nations.

As economist William Easterly shows in "The Elusive Quest for Growth" this policy didn't work because of diminishing returns. Giving a seamstress with no equipment a sewing machine will increase her productivity a lot. But giving her another one will not, because she can only work on one machine at a time. Although some capital is necessary for growth, simply giving capital to those without it -- i.e., foreign aid -- is unlikely to stimulate growth.

It is technology and the worker's knowledge of how to use it that really creates the growth, as Easterly shows, not the machinery per se.

For example, Bangladesh became a world leader in textile production because a Korean company invited 130 Bangladeshi workers to learn its production methods, in return for a percentage of the profits in future enterprises. Almost all of the workers went on to establish successful textile companies of their own.

Foreign aid, like welfare, Easterly complains, tends to reward bad behavior and thus actually retards growth. A "tough love" solution -- cutting off nations that don't shape up, rewarding those that do -- would work better.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, "The Hazards of Throwing Money at the Problem," review of William Easterly, "The Elusive Quest for Growth" (MIT, 2001), Wall Street Journal, July 18, 2001.


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