Poverty, Free Trade and Economic Growth

First Published: 2001-11-19

Dr. Peter Maynard, president of the Bahamian Bar Association, recently commented on the dilemma facing small island countries in the proposed Free Trade Area of the Americas. This article will deal with his economic judgments and not with the specifics of the Draft Agreement dated July 3, 2001.

Dr. Maynard sees world poverty as a threat to mankind equal to that posed by terrorism. Furthermore, he believes that —

1. Economic growth alone will not empower the people, insulate them against arbitrary crises and shocks nor end their “voicelessness, powerlessness and hopelessness.”

2. Small island states lack sufficient economies of scale in transportation, markets, etc., and are prone to natural and ecological disasters.

3. Multinational corporations are a source of greed.

4. “Free trade was our colonial past.” and that colonial past will return with the expanding economic empires of the future.

5. International development banks impose harmful conditions in making new loans and canceling and rescheduling old loans.

He concludes that the island states under the FTAA will become “neo-colonies” by 2005.

The starting point and panaceas.

Yes…world poverty is a startling reality. About 900 million people in Western Europe, North America, and parts of the Pacific Rim find prosperity, while 5 billion people live in poor nations and 1.2 billion live in extreme poverty. More over, “the growth rate of Gross Domestic Product (GDP) per capita of the typical poor country was zero between 1980 and 1998.”

Fortunately, the world has a 50-year record of trying to create sustained economic growth in less developed countries. Mr. William Easterly, a Senior Advisor for the Development Research Group of the World Bank, analyzes this record in “The Elusive Quest for Growth” published this year by MIT Press. This book should be viewed, in part, as an audit of the development record of the World Bank.

The starting point of the author is the exact opposite of Dr. Maynard. To Mr. Easterly improvement in hunger, mortality, and poverty is directly related to and not independent of economic growth. “Poverty is not just low GDP; it is dying babies, starving children, and oppression of women and the downtrodden. The well-being of the next generation in poor countries depends on whether our quest to make poor countries rich is successful.”

The author then examines the development panaceas used in the past by the international development banks and wealthy donor countries. Two are discussed below:

1.) “Foreign Public Aid for Investment” was the policy used immediately after World War II. The development banks and donor countries, impressed with the forced savings, investment and production record of Russia in World War II, financed major large-scale investments in dams, roads and factories in poor countries. They were believed to be the “necessary investments” that would trigger growth in both output and savings.

For example, in the 1950s foreign aid to Ghana financed road building, a railroad, the Akosombo Dam, an aluminum smelter and the expectation of economic growth of 7% per year. The real disaster is that “today Ghanaians are about as poor as in the 1950s. In virtually all cases Foreign Public Aid for Investments… promoted consumption and not increased domestic saving and investment.”

2.) Another panacea was investment in education. But…Easterly concludes, “Education is worth little more than hula hoops to a society that wants to grow. Critical is determining what the educated people do with their skills. In an economy with extensive government intervention, the activity with the highest returns to skills might be lobbying the government for favors. The government creates profit opportunities by its interventions…

“In an economy with many government interventions, skilled people opt for activities that redistribute income rather than activities that create growth. According to the author, one somewhat whimsical piece of evidence that supports this story is that economies with lots of lawyers grow more slowly than those with lots of engineers.”

Government.

Mr. Easterley observed, “Bad governments as well as bad luck can kill growth. Because becoming rich—that is, growth—is so sensitive to the incentive to lower present consumption in return for higher future income, anything that mucks up that incentive will affect growth. The prime suspect for mucking up incentives is government. Any government action that taxes future income implicitly or explicitly will lower the incentive to invest in the future. Things like high inflation, high black market premiums, negative real interest rates, high budget deficits, restrictions on free trade, and poor public services create poor incentives for growth. We have evidence that these government policies lower growth.”

Corruption.

“The urge to steal everything not bolted to the floor is the most obvious growth-killing incentive that government officials face. Requiring private businesspeople to pay bribes is a direct tax on production, and so we would expect it to lower growth…

“The International Credit Risk Guide surveys businesspeople on their perception of corruption in countries around the world on a rating between 0 (most corrupt) and 6 (least corrupt). In 1990, the countries that distinguished themselves with a 0 for exceptional graft in the line of duty were the Bahamas, Bangladesh, Indonesia, Liberia, Paraguay, and Zaire.

“The data show that corruption and growth are inversely related…nobody wants to invest in a corrupt economy, and nobody wants to do all the other things that make for a growing economy”

Polarized peoples.

“The fundamental difference between redistributionist and development governments is social polarization. Societies divided into factions fight over division of the spoils; societies unified by a common culture and a strong middle class create a consensus for growth—growth that includes the poor.”

The Bahamas, growth and free trade.

Mr. Easterly makes extensive reference to countries as Ghana, the Ivory Coast, India and Bangladesh but refers to the Bahamas only once. Among his poor countries of the world and the forty-two small countries in Dr. Maynard’s list of African-Caribbean-Pacific states, the Bahamas is certainly one of the most prosperous.

Between 1993 and 2000 Bahamian GDP grew at an average of 1.6% when adjusted for both inflation and population growth and by 4% in the last two years. In addition, there was an important redistribution of income in favor of the “working classes.” The lower 60% of then population got a bigger slice of the bigger economic pie. This good performance came after more than a decade of stagnation.

The reality is that the relative prosperity of the Bahamas has been based on a number of often-cited factors: its geographical location, tourism resources, stable macroeconomic policies and favorable incentives toward investment in the early years of the FNM administration.

Factors that are overlooked are corruption, redistribution of income policies and free trade.

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