The Paul Collier School of Economic Development Goes Rambo?

[Today we happily welcome a guest post from one of our perspicacious interns, Charles Johnson.]

Dr. Kane's blog post about Easterly and the U.S. Army has gotten me thinking about how the military's Keynesian, supply side approach might fall short. 

Aside from Dr. Kane's paper, there's considerable evidence that security can help an economy recover. A paper out of Claremont McKenna and the U.S. Military Academy used the Law of One Price and examined a basket of 255 goods across Iraqi society to get a sense of whether or not the surge worked at reducing price disparities and hence promoting economic growth. Here's what they found, via (the sadly defunct) Odd Numbers blog.

1. The dispersion of prices in Iraq has been roughly twice the level of price disparities in the United States or Japan. 
2.  Regions with the largest U.S. military presence, which presumably brings greater security, saw the least amount of price dispersion. 
3.  And most importantly, price dispersion fell by about 11 percent after the surge started in February 2007, but picked up again after the surge ended in November, though at a slower pace.  

But where does one draw the line between security and costly occupations? 

Paul Collier, a development scholar out of Oxford, believes that U.N. peacekeeping forces can do best, but only if they are given ten years or more worth of money from the international donors. (Let's leave out, for the moment, the tremendous sexual abuse of children by peacekeeping troops overseas.)

Collier is a subscriber to the young male theory of violence and so he favors spending lots on infrastructure and getting the young men jobs so that they don't go killing each other, which sounds familiar when compared to what's been going on in Iraq. Collier says that it is foolish to expect conflict-emerging nations to compete on the international stage because they rarely have a comparative advantage. 

In this TED Talk at the State Department, Collier explains that post-conflict reconstruction is so very difficult and that donors should give money so to keep the state apparatus on life support. What's needed, he argues, is Accountants Without Borders, that tracks the money from donors and makes sure that it's all allocated properly. But Collier, just as in his book The Bottom Billion is foggy on when taxation should kick in and when aid money should exit, an essential component of becoming a responsible, modern state. To his credit, he mentions that it's foolhardy for local governments to finance the unfunded liabilities of a growing state, so, instead, he wants donor governments to finance it. 

Collier implores policymakers to be patient, something which policymakers are notoriously reluctant to be. Most Western governments don't last for 10 years and an open-ended commitment to post-conflict reconstruction "budget support" might be seen as a blank check. Worse yet, as Dambisa Moyo, herself a student of Colier's at both Harvard and Oxford, notes in her book, Dead Aid, there becomes little case for government when your government doesn't provide any public services. (See her interview with Peter Robinson at Uncommon Knowledge.) What Africa needs, she argues, is a reverse of the Boston tea party: Taxation and Representation. Otherwise, it should just elect aid agencies if they are to provide the public goods. 

Despite the clearly better track record of U.S. occupations and economic growth, I'm hesistant about efforts such as the U.S.-development enterprise fund.

It seems to be dead from its inception for much the same reason that much of the aid money is destined for waste. Bill Easterly is right to pan it for being a kind of social engineering. Put simply, how would the U.S. government (and the Congress which designs the program) know what's best for Iraqi market needs? (Heaven help the Iraqi industries that seek to compete with congressionally-connected U.S. firms!)

Advocates point to the USAID involvement in Eastern Europe post-Berlin wall, but here granting that Eastern Europe made the transition to a market economy due to USAID enterprise funds grants too much. One of the few countries that triumphed in the most communist era, was tiny Estonia that ignored much of the wisdom of from USAID and the IMF. Its Prime Minister, Mart Laar, credits Milton Friedman's book, Free to Choose, with much of the genesis of the reforms success. He claimed that it was the one book on economics he had ever read. Laar instituted a flat tax, repealed protectionist policies, and his economy took off and ushered in the flat tax revolution that's sweeping the world.

One of those countries that now has a flat tax is Iraq. Iraq's economy, erstwhile run by the big government-Keynesian Baathists, is now doing quite well for itself. Its 45% tax rate that sought to soak the rich has been reduced to a 15% flat tax. Its currency continues to appreciate favorably. Its oil revenue and surplus grew in 2008, according to GAO. Why doesn't Iraq use this money to fund an enterprise or sovereign wealth fund? Why must the U.S. Congress pick winners and losers in Iraqi entrepreneurial ventures? 

 

Critics could take comfort that the $250 million proposed for an American-backed Iraqi investment is a drop in the bucket in the larger market for enterprise-capital inflows into emerging-market. But they might take heart in these figures, provided by Roy C. Smith's "Enterprise Capital in Emerging Markets" in The Independent Review: 

 

Total enterprise capital raised or deployed in emerging-market economies increased from $517 billion in 2001 to $1.57 trillion in 2006. These essentially private transactions greatly exceed sovereign-government financing totals for the years indicated. . . . 

Enterprise-capital inflow into emerging-market economies has tripled in the past six years, and wherever it has gone, it has had an important effect on economic growth. Indeed, as shown by the experience of Russia, India, and China, the ability to attract relatively large quantities of capital for private investment has made possible exceptional economic-growth rates, despite the many difficulties and imperfections in these countries’ investment climates.

Enterprise capital now appears to be far more effective in generating growth in developing countries than foreign aid and loans from multinational development agencies or from individual countries’ robust government- allocated national economic development efforts, which for nearly fifty years were regarded as the world’s best solutions for ending poverty and distress in theThird World. These “solutions,” however, did little to generate the rates of economic growth needed in the Third World o alleviate the poverty and distress.

Easterly and others have pointed out how aid money can tend to crowd out foreign investment. Perhaps the best thing the U.S. could do with respect to Iraq's economy is leave well enough alone and let the security and capital inflows do their magic. 

--Charles Johnson

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