Peter Bauer
From Subsistence To Exchange And Other Essays
The process by which the case for official aid has come to be regarded as self-evident has been gradual. From about the 1950s to about the 1970s advocates of this policy often still found it necessary to put forward arguments or justifications, some of which still frequently surface in discussions on this subject.
Much the most persistent argument for these subsidies has always been that without external donations poor countries cannot emerge from poverty. Since about the late 1970s another argument has become prominent, namely that the subsidies are required to improve the condition of the poorest peoples in the Third World. External subsidies were deemed indispensable for the progress of poor countries because they could not themselves generate the capital required for their advance. This argument, popularised as the vicious circle of poverty and stagnation, was the central theme of development economics from the 1940s to the 1970s. It is still often heard, notably in the context of official assistance to postcommunist governments. This argument was endorsed by for instance Nobel Laureates Gunnar Myrdal and Paul Samuelson. The latter formulated it concisely: 'They (the backward nations) cannot get their heads above water because their production is so low that they can spare nothing for capital formation by which the standard of living could be raised.'
In reality, throughout the world and throughout history, countless individuals, families, groups, communities, and countries have emerged from poverty to prosperity without donations and often did so within a few years or decades. Immigrant communities such as those of Southeast Asia and North America are familiar examples. The hypothesis is also disproved by the existence of developed countries, all of which started poor and developed without subsidies. If external subsidies were indispensable for economic advance, mankind would still be living in the Old Stone Age. The world is a closed system that has never received subsidies from outside itself.
Recent examples of emergence from backwardness and poverty in a few decades without subsidies are readily observable in what is nowadays called the Third World. Since about the 1860s large parts of the underdeveloped world, such as Southeast Asia, West Africa, and Latin America, were transformed in a few decades without subsidies.
There is a distinct model behind the hypothesis of the vicious circle: the growth of income depends on investment; investment depends on saving; saving depends on income. The model pivots on the notion that the low level of income itself prevents the investment required to raise it, hence a zero or negligible rate of economic growth. The model is refuted by obvious reality. If an hypothesis conflicts with empirical evidence, especially if it does so on a massive scale, as in this case, this means that either the variables specified are unimportant or they do not interact in the manner postulated. Both these defects apply in this instance.
The volume of investible funds is not a critical independent determinant of economic advance. If it were, millions of people could not have advanced from poverty to prosperity within a few years.
Much research by leading scholars, including Nobel Laureate Simon Kuznets, has confirmed that capital formation was a minor factor in the progress of the West since the eighteenth century, a period particularly congenial to productive investment. And these findings refer to capital formation and not simply to the volume of investible funds.
Poor people can generate or secure sufficient funds to start on the road to progress if they are motivated to improve their material condition and are not inhibited by government policy or lack of public security. They can save modest amounts even from small incomes to make possible direct investment in agriculture, small-scale trading, the purchase of simple tools and equipment, and for many other purposes.
One general feature of the early stages of economic progress is the replacement of subsistence production by market production for wider exchange. This process is accompanied by certain types of capital formation, important categories of which are incompletely recorded in statistics or altogether unrecorded. This applies to the establishment, extension, and improvement of agricultural properties, for instance the planting of cocoa or rubber trees in plantations on small holdings where the output is collected and distributed by traders. These categories of capital formation are indispensable for the advance from subsistence production. They usually do not require monetary savings or investment, which explains why they often escape statistical record. My experiences in West Africa and Southeast Asia, in which I studied the cocoa industry and the rubber industry, have alerted me to the significance of such categories of capital formation.
What has to be remembered and emphasised is that having capital is the result of successful economic performance, not its precondition. Economic Performance depends on personal, cultural, and political factors, on people's aptitudes, attitudes, motivations, and social and political institutions. Where these are favourable, capital will be generated locally or attracted from abroad.
