2012-04-25

The fallacy of cheap foreign aid

I watched the video to Sarah McLachlan's World on Fire - a nice, likeable song. The video makes claims such as the following:
  • "$150,000 could make a difference to over 1,000,000 people"
  • "$200 [pays for a] Production Assistant in LA for 1 day, or 100 children's school fees for 1 term in Ethiopia"
  • "$10,200 = 2 hours of film stock, or 6 wells built in 6 different countries"
I will trust Sarah McLachlan that these claims are technically correct - "the best kind of correct".

The problem with these statements is that they stop being correct when applied at a meaningful scale.

I would hazard a guess that a well would cost a lot more than $1,700 to build, if you build it in the US.

In the US, $2 is obviously not enough to pay for a child's school fees for one term, regardless of how poor the quality.

The reason these costs are "lower" in places like Ethiopia is not because it takes less work to do them. In fact, building a well, or providing education, may well require more work in Ethiopia, than it does in the US.

The reason the costs seem "lower" is that the US dollar has tremendous purchasing power there. However, the only reason the US dollar has such purchasing power is because they have access to few of them.

When you send a gift of US dollars to a person to Ethiopia, you are blessing that person with a token of exchange, which they can use to obtain services from other people in Ethiopia; they can command local work that would otherwise be used for something else.

When you send an Ethiopian 10 US dollars, you are not, somehow, magically, sending to that country assistance that would be worth $10,000 in the US. You are only sending foreign aid that's worth those same $10. However, because US dollars in Ethiopia are scarce, the recipient can use them to command the local economy to redirect local goods and services disproportionately to him, instead of to people who would otherwise receive them. He can outcompete other local people with his 10 US dollars.

What would happen, then, if every person in North America and Europe sent 10 US dollars to Ethiopia?

If that happened, Ethiopia would be flooded with about $10 billion US dollars, which is about 1/3 of their recent annual GDP.

With such an infusion of US dollars, the local value of a USD would plummet. Ethiopia has 83 million people; assuming no immigration, the work force available locally would remain the same. If the US dollars were distributed across the population uniformly, expenses like school fees would jump in price radically. The country as a whole would be able to use the money to import $10 billion worth of material goods. But those $10 billion wouldn't buy a single bit more imported goods than they can buy in the US or Europe.

Arguments like in Sarah McLachlan's video are a fallacy, because the only reason $2 pays for 1 term of schooling in Ethiopia is because scarce US dollars act as an economic lever which redirects consumption from one set of poor people to another set of poor people.

On balance, sending them $2 isn't help in any way substantially greater than what $2 would buy in a developed country.

If we wanted to help all of them, it would cost us dearly. It cannot be done cheaply in any way. The world population is over 7 billion, and the world GDP is $63 trillion. If we distributed that equally to every person, everyone would get USD 750 per month. If this money was spread globally, a dollar wouldn't buy a single iota more elsewhere, than it does in the US.