peter bauer’s legacy of liberty - cato institute · peter bauer’s legacy of liberty by ... i...

1000 Massachusetts Avenue, N.W.Washington, D.C. 20001

www.cato.org

Peter Bauer’sLegacy of

Liberty

byJames A. Dorn

“There are few things that are moreimportant than to honor those people whohave promoted liberty around the world,and Peter deserved that prize. A friend of

mine for 50 years, he was alwaysconsistent and persistent in presenting ideas that were unpopular but correct.”

—Milton Friedmanon the inaugural Milton Friedman Prize forAdvancing Liberty, awarded posthumously

to Peter Bauer, May 9, 2002

“Peter Bauer is in a class of his own as anoutstanding economist. The originality,

force, and extensive bearing of his writingshave been quite astonishing. He is

a real pioneer of modern developmenteconomics. He is a profound theorist

of the process of change that transformsa subsistence or near-subsistence

economy into an exchange economy.”—Amartya Sen

“Bauer is not a mere Scrooge who says‘Bah! Humbug!’ to the poor. On the

contrary, his vision of the world accordsfar more respect to the less-developed

regions and peoples than doesthe conventional viewpoint.”

—Thomas Sowell

72214_CATO_Covers.pmd 9/20/02, 8:41 AM2-3

1A HERO OF THE MARKET REVOLUTIONThe death of Peter Bauer on May 2, 2002, at 86years old, marked the passing of a great econo-mist and a hero of the market revolution that hasbeen sweeping the globe. In recognition of his pio-neering work in development economics and hislifelong commitment to the principles of a freesociety, Bauer was named the first recipient of theMilton Friedman Prize for Advancing Liberty, a$500,000 prize awarded every two years by theCato Institute. Bauer was awarded the prize post-humously on May 9, at the Cato Institute’s 25thanniversary celebration. At that ceremony, MiltonFriedman expressed his admiration for Bauer withthese words: “There are few things that are moreimportant than to honor those people who havepromoted liberty around the world, and Peterdeserved that prize. A friend of mine for 50 years,he was always consistent and persistent in pre-senting ideas that were unpopular but correct.”

“He was always consistent and persistent inpresenting ideas that were unpopular butcorrect.”

For years Bauer fought against so-calleddevelopment experts who saw comprehensivecentral planning, protectionism, and foreign aidas prerequisites for economic advance. The col-lapse of communism in Soviet Bloc countries in1989 and in the USSR in 1991, and the end of cen-tral planning in those countries as well as in Chinaand other developing countries, were the defin-ing moments of the 20th century from a market-liberal perspective. Those events, in particular,have vindicated Bauer’s lifework.

Pieter Tamas Bauer was born in Budapeston November 6, 1915. He attended the famousScholae Piae and then went on to study law atBudapest University. In 1934, he embarked for

James A. Dorn is vice president for academic affairs at theCato Institute and professor of economics at Towson Uni-versity in Maryland. He is the coeditor of The Revolution inDevelopment Economics. The author gratefully acknowledgesa grant from the Earhart Foundation to help prepare this es-say for publication.

72214_CATO_Pages_text.pmd 8/27/02, 12:06 PM1

2England and was admitted to Gonville and CaiusCollege, Cambridge, where he studied econom-ics and graduated in 1937. Bauer then returned toHungary to complete his law degree and serve inthe military. In 1939, he left to take a job in Lon-don with Guthrie & Company, a merchant housethat conducted business in the Far East. Bauerbegan his academic career in 1943 at London Uni-versity, where he was first a research fellow andthen, in 1947, a reader in agricultural economics.He moved on to teach at Cambridge Universityin 1948 and remained there until 1960. The re-mainder of his distinguished academic career wasspent as a professor at the London School of Eco-nomics. In 1982, he was made a life peer with theappropriate title Lord Bauer of Market Ward. Hewas a fellow of the British Academy and a mem-ber of the Mont Pélerin Society.1

THE END AND CRITERION OFDEVELOPMENT: EXTENDINGINDIVIDUAL CHOICEFor Bauer, the essence of development is the ex-pansion of individual choices, and the role of thestate is to protect life, liberty, and property so thatindividuals can pursue their own goals and de-sires. Limited government, not central planning,was his mantra. Accordingly, in 1957, Bauer wrotein Economic Analysis and Policy in UnderdevelopedCountries:

I regard the extension of the range ofchoice, that is, an increase in the rangeof effective alternatives open to people,as the principal objective and criterionof economic development; and I judgea measure principally by its probableeffects on the range of alternativesopen to individuals. . . . The acceptanceof this objective means that I attach sig-nificance, meaning, and value to indi-vidual acts of choice and valuation,including the individual time prefer-ence between the present and the fu-ture [Bauer 1957: 113].

1For a useful biographical sketch of Bauer, see Harris (2002).Basil Yamey (1987) presents an excellent overview of Bauer ’swork.


3He went on to say, “My position is much influ-enced by my dislike of policies or measures whichare likely to increase man’s power over man, thatis, to increase the control of groups or individualsover their fellow men.”

“I regard the extension of the range ofchoice . . . as the principal objective and cri-terion of economic development.”

Bauer ’s view of economic development as aprocess consistent with, and dependent on, pri-vate property and freedom of contract placed himfirmly in the tradition of the great classical liber-als. His adherence to the principles of free tradeand free people reflected his deep respect for thedignity, rationality, and capabilities of poor peoplearound the world.

If economic development is to be maximized,then freedom must be maximized, which meanscoercion must be minimized. To do so the powersof government must be limited to the protection ofpersons and property. People will then be free tochoose and expand their options provided theyrespect the equal rights of others. The rules of thegame were important to Bauer because theyhelped define the choice set open to individuals.Long before it became fashionable Bauer appliedproperty rights theory and public choice to thefield of development economics.

The spontaneous market order is consistentwith freedom. Any increase in the scope of mar-ket exchange naturally increases the effectiverange of individual choices. Likewise, any restric-tion of economic freedom reduces the effectiverange of alternatives open to individuals and hin-ders development, as envisioned by Bauer. Boththe rich and the poor benefit from economic free-dom. When law safeguards private propertyrights, people will specialize in ownership and riskbearing, markets will flourish, and voluntarytrades will be mutually beneficial.

In his essay “Market Order and State Plan-ning,” Bauer (1984: 25) wrote,

The market order minimizes the powerof individuals and groups forcibly to


4restrict the choices of other people.Forcible restriction of the choice of oth-ers is what coercion means. Possessionof wealth does not by itself confer suchpower on the rich. Indeed, in modernmarket economies the rich, especiallythe very rich, usually owe their pros-perity to activities which have widenedthe choices of their fellow men, includ-ing those of the poor.

“The market order minimizes the power ofindividuals and groups forcibly to restrictthe choices of other people.”

For Bauer, the poor benefit from the freedom tochoose whom to work for and where, as opposedto a centrally planned economy where workershave no such freedom. Power in the hands of gov-ernment officials is more dangerous than moneyin the hands of rich people. Restricting capitalflows and travel also harms the poor. That is whyBauer (1984: 26–27) emphasizes that “in the ThirdWorld, as in the West, the extension of opportuni-ties presented by the market has been and is ofcritical significance for the poor”; “poverty is notthe same as unfreedom in the sense of being sub-ject to coercion by others”; and “a market order isa necessary condition of personal freedom.”

Bauer ’s focus is on the process of develop-ment, as measured by the extent of economic free-dom, not on the growth of national income. Thetwo, of course, are related, but there are impor-tant differences. A centrally planned economy mayhave a high rate of economic growth (ignoringmeasurement problems), but people are not freeto choose; oppressive government narrowly lim-its their range of effective alternatives. That as-pect of development must not be ignored,according to Bauer (1957: 125–26).

In sum, what really matters to Bauer is free-dom of choice, including the choice about howmuch to save and to invest: “The right of somepeople to force others to develop is not self-evi-dent, particularly when a widening of the rangeof choice, of access to alternatives, is regarded as


5the principal benefit of economic development”(Bauer 1957: 122).

“The right of some people to force others todevelop is not self-evident.”

If people are to be free to choose, their prop-erty rights must be protected by law. Bauer placeda great deal of emphasis on the primacy of prop-erty in a market-liberal order and in the develop-ment process. The movement from subsistence toexchange requires a legal system that providessecure property titles, enforces contracts, and ad-judicates disputes fairly and efficiently. It was clearto Bauer that restrictions on private ownershiperode not only economic freedom but also personalfreedom.

In his study of the Malayan rubber industryin 1948, Bauer criticized the restrictive practicesof the colonial government that preventedsmallholders (small-scale growers) from acquir-ing land. He saw the refusal to alienate land forrubber planting as particularly harmful to thesmallholder and socially disruptive:

Rubber production is an industrywhere apart from statutory restriction,the small man was until recently in aposition to start on his own and to se-cure a decent and independent income,with the possibility of rising to higherlevels; until the ban on new plantingand on the alienation of land for rub-ber planting, estate labourers often roseto the position of medium orsmallholders through the developmentof a rubber holding. But for the almostuninterrupted statutory restriction ofthe last quarter of a century, therewould today be fewer landlesslabourers in Malaya and many moreowners of small plantations. Thiswould conduce to social stability of thecountry. The present policy of support-ing production based on large alienlabour forces and of preventing the ex-tension of individual ownership of land


6is directly fostering the growth of ex-tremist political movements [Bauer1948a: 87].2

At a time when most development “experts” werecalling for anti-market, state-led developmentpolicies, Bauer was certainly ahead of his time inseeing the importance of economic freedom—es-pecially private property rights—as a key deter-minant of economic development as well aspersonal liberty.

“Preventing the extension of individualownership of land is directly fostering thegrowth of extremist political movements.”

THE CHIMERA OF STATE-LEDDEVELOPMENTState-led development policy is an impossible orfoolish fantasy, a chimera. Once governmentpower is extended beyond its legitimate boundsof protecting persons and property, freedom willlose ground; the alternatives open to individualswill be considerably restricted compared to a lib-eral constitutional order based on limited govern-ment and private property rights. What mattersfor Bauer (1957: 113) is “the process by which de-velopment is promoted”: a spontaneous free-mar-ket process that enlarges individual choice is thetrue meaning of development; a coercive, state-led development policy that denies individualsthe freedom to make their own choices is pseudodevelopment.

Given his view of what the end and crite-rion of economic development should be, Bauerreacted strongly to those who favored centralplanning. He dissected the case for planning andexposed the fallacies of those development expertswho argued that the poor were incapable of lift-ing themselves out of poverty because of marketfailures.

2In his first book, The Rubber Industry, Bauer (1948b: 348) ar-gued, “In order to make new planting feasible, there mustalso be liberal alienation (and on easy terms) of land. . . .Particular attention should be given to the encouragementof small ownership.”


7The Appeal of Central PlanningUnder central economic planning, governmentdecision-making replaces private decision-mak-ing. For that reason, says Bauer (1978: 185), “Plan-ning . . . has obvious appeal to politicians,administrators, and intellectuals, since it createspositions of power that members of these groupsexpect to fill, with resulting political, emotional,and financial advantages.” Moreover, planningappeals to people because they wrongly perceivethe market system as “irrational and confused”while planning appears to be “based on method,reason, and science.” The third reason Bauer givesfor the appeal of planning is its link “to the all-embracing messianic creed of Marxism-Leninism.”

The idea that socialist planners can solve theproblem of poverty better than the free marketwas generally accepted in the Third Word, untilrecently. And it was mostly Western developmentexperts who spread that idea. In 1957, Paul A.Baran, a respected economist at Stanford Univer-sity, wrote, “The establishment of a socialistplanned economy is an essential, indeed indis-pensable, condition for the attainment of economicand social progress in underdeveloped countries”(Baran 1957: 261). One year earlier, GunnarMyrdal had written, “The special advisers to un-derdeveloped countries who have taken the timeand trouble to acquaint themselves with the prob-lem . . . all recommend central planning as thefirst condition of progress” (Myrdal 1956a: 201).That socialist mentality and the vision of state-led development were so ingrained that as late as1985, after years of failure, Indian Prime MinisterRajiv Gandhi could write,

While there is a problem of collecting,coordinating, sorting out and analyz-ing the tremendous amount of infor-mation needed for developmentalplanning at the national level, the so-lution perhaps lies in improving thetools of collection and analysis of dataand not in abandoning the planningeffort itself.3

3Quoted from a letter the prime minister sent to Cato Insti-tute president Edward H. Crane, after Gandhi had receiveda copy of Don Lavoie’s (1985) book, National Economic Plan-ning: What Is Left?


8Today, even the World Bank (1997: 1–2) ad-

mits that the notion that “good advisers and tech-nical experts would formulate good policies,which good governments would then implementfor the good of society” was naive. “Governmentsembarked on fanciful schemes. Private investors,lacking confidence in public policies or in thesteadfastness of leaders, held back. Powerful rul-ers acted arbitrarily. Corruption became endemic.Development faltered, and poverty endured”—exactly as Bauer had predicted.

The notion that “good advisers and techni-cal experts would formulate good policies,which good governments would thenimplement for the good of society” wasnaive.

Central Planning and FreedomCentral planning extends the power of the stateby making government the overseer dictating ev-ery aspect of economic life. When people haveonly one employer, no property rights, no privatemarkets to trade in, no investment choices, andfree trade is a crime, there is little room for hu-man development. All economic decisions becomepoliticized and corruption becomes common-place. As Bauer (1976: 84), noted, “By continuingand extending state control over the lives of thepopulation, central planning reinforces the sub-jection of the individual to authority. Such a de-velopment discourages self-reliance, personalprovision for the future, sustained curiosity, andan experimental turn of mind.”

The goal of development planners was notmerely to control the economy but to controlpeople and remake society. Indeed, Bauer (1976:188) tells us that Myrdal’s main thesis was that“personal conduct and social attitudes are to berestructured in the interest, or at least the declaredinterest, of higher per capita incomes.” The poorwere not to be trusted with freedom: they were


9assumed to be indifferent toward the future andunresponsive to market prices. Thus, for their owngood, they would have to be treated as pawns inthe hands of the enlightened planners. That anti-market mentality disturbed Bauer. He did not seethe poor as “lifeless bricks, to be moved about bysome master builder” (Bauer 1984: 5). The poorare not indifferent to their future or unresponsiveto market incentives. Given freedom and respon-sibility, poor people are fully capable of movingthemselves and their families out of poverty.

The Anti-Market Mentality of Development ExpertsThe mantra of development experts was that therewas a “vicious circle of poverty” from which thepoor could not escape except with the help of cen-tral planners and external aid. Compulsory sav-ing, protectionist trade policies, marketing boards,state-directed production and investment, andgovernment-to-government transfers were thenorm. Bauer (2000: 6) argued otherwise: “To havemoney is the result of economic achievement, notits precondition. . . . Indeed, if the notion of thevicious circle of poverty were valid, mankindwould still be living in the Old Stone Age.”

“If the notion of the vicious circle of povertywere valid, mankind would still be living inthe Old Stone Age.”

Bauer ’s experience in Malaya (now Malay-sia), in the late 1940s, and in West Africa led himto recognize the importance of individual effortby small landowners and traders in moving fromsubsistence to a higher standard of living. As hewrote in The Development Frontier:

A developed infrastructure was not aprecondition for the emergence of themajor cash crops of Southeast Asia andWest Africa. As has often been the caseelsewhere, the facilities known as in-frastructure were developed as theeconomy expanded. . . . What hap-pened was in very large measure theresult of the individual voluntary re-


10sponses of millions of people to emerg-ing or expanding opportunities createdlargely by external contacts andbrought to their notice in a variety ofways, primarily through the operationof the market. These developmentswere made possible by firm but lim-ited government, without large expen-ditures of public funds and without thereceipt of large external subventions[Bauer 1991: 190–91].Bauer was among the first to clearly see that

the real plight of underdeveloped countries is notmarket failure but government failure—that is, thefailure of government to protect property rights,enforce contracts, and leave markets alone:

The literature of market failure hasbeen used largely as a collection ofsticks with which to beat the marketsystem. The critics who propose replac-ing the market system by political de-cisions rarely address themselves tosuch crucial matters as the concentra-tion of economic power in politicalhands, the implications of restriction ofchoice, the objectives of politicians andadministrators, and the quality andextent of knowledge in a society andof its methods of transmission [Bauer1984: 30].

“The literature of market failure has beenused largely as a collection of sticks withwhich to beat the market system.”

The politicization of economic life, the lossof freedom, and the damage done to civil societyunder comprehensive economic planning are nowwell known. That is why attention is finally shift-ing from the model of state-led development tothe nature of institutions and the role of govern-ment in fostering the spontaneous market process.As the World Bank (1997: 1) noted, “State-led in-tervention emphasized market failures and ac-corded the state a central role in correcting them.But the institutional assumptions implicit in this


11world view were, as we all realize today, too sim-plistic.”

Bauer (1978: 184) points to “the belief thateconomic controls are necessary to shield peoplefrom the risks of the market, especially price fluc-tuations of export crops” as “another source ofhostility to the market.” To reduce that risk, manyless developed countries (LDCs) in Asia and Af-rica set up state monopolies with the exclusiveright to buy crops for export. Farmers were paidbelow-market prices for their crops and the stateexport monopolies captured the profits. The re-sulting tax on farmers’ incomes “retarded the ex-pansion of the exchange economy and restrictedthe volume of private saving, thus inhibiting theemergence of a local capitalist class.” Instead ofreducing risks for farmers, the controls actuallyincreased risk by politicizing life:

State controls have not secured stabil-ity in any meaningful sense for thefarmers or other economic agents sub-ject to them. Both controls and the con-sequent politicization of life involvehazards more severe and less predict-able than those of the markets. Afterall, if agricultural prices fluctuate, it ispossible for producers (or for that mat-ter, governments) to set aside reserves.No such protection is available againstthe withdrawal of a trading license, theconfiscation of income or property, ordeportation [Bauer 1978: 185].Those who criticize the market for its im-

perfections fail to consider “that market partici-pants are people. Human beings and theirarrangements cannot be faultless” (Bauer 1984:29). The implicit assumption of market pessimistsis that people in government are somehow betterthan people in the market order. Yet, as Bauerwarns, those in government have the power to co-erce, something that market participants lack: “Inrecent years, detractors of the market order havemade much of instances of political pressure, orof fraud by market participants. Would it makefor a better society if more people with such hab-its were in the government sector and thus pos-sessed the coercive power which goes with it?”


12Some people criticize the market order for

failing to bring about sufficiently fast materialprogress. However, Bauer (1984: 29) emphasizes:

It is not a defect of the market that itdoes not guarantee material progress,let alone contentment or happiness. Itis a corollary of voluntary arrange-ments that they permit people to re-main materially unambitious or toconsider the cost of economic improve-ment excessive if that is what theywish. The market order permits themto do their own thing, to use contem-porary jargon.Perhaps the loudest criticism of the market

has been that it leads to inequality in the distribu-tion of income and wealth. Bauer addressed thatcriticism head-on. First, he distinguished between“inequality” and “differences,” with the latter thepreferred term since it is more analytical and lessemotive. People differ with respect to their abili-ties and their character and conduct; those differ-ences result in differences in income and wealth.Second, in a market order, one becomes rich byserving the needs of others—that is, by satisfyingconsumers’ preferences. Those individuals whoput resources to higher valued uses will do betterthan those who do not.

Third, there are two ways to achieve higherincomes: by force or by voluntary exchange. Themarket order rests on equality under the law andlimited government; using the government tobring about forced transfers violates private prop-erty rights and attenuates economic freedom. Jus-tice, properly understood, requires limitedgovernment, not a redistributive state. Critics ofthe market outcome thus turn justice on its head.It is not successful entrepreneurs in Western mar-ket economies who exploit the poor in the ThirdWorld, but rather their own corrupt governments.4

Because the attempt by governments to re-move income differences (“inequality”) necessar-ily involves the use of force, Bauer (1981: 8) saw“an underlying contradiction in egalitarianism inopen societies.” Indeed,

4For an exchange between Bauer and Amartya Sen on egali-tarianism, see New York Review of Books (1982).


13In an open and free society, politicalaction which deliberately aimed tominimize, or even remove, economicdifferences (i.e. differences in incomeand wealth) would entail such exten-sive coercion that the society wouldcease to be open and free. The success-ful pursuit of the unholy grail of eco-nomic equality would exchange thepromised reduction or removal of dif-ferences in income and wealth formuch greater actual inequality ofpower between rulers and subjects.Dictating equality of outcome not only de-

stroys freedom, by discriminating against indi-viduals or groups who are successful, but alsodestroys the wealth-creating properties of thecompetitive market process—a process that restson the sanctity of private ownership and freedomof contract. Bauer, like the great 18th century clas-sical liberals, recognized the important linkagebetween the institutional or property rights frame-work and the process of wealth creation. Criticsof the market who ignore that linkage disregardreality.

“Economic performance depends on per-sonal, cultural, and political factors, onpeople’s aptitudes, motivations, and socialand political institutions.”

ON THE DETERMINANTS OF ECONOMICDEVELOPMENTAfter studying a number of LDCs, Bauer con-cluded that economic development depends oninstitutions, culture, and conduct, not on planning,large-scale state investment, or natural resources:

Economic performance depends onpersonal, cultural, and political factors,on people’s aptitudes, motivations,and social and political institutions.Where these are favorable, capital willbe generated locally or attracted fromabroad, and if land is scarce, food will


14be obtained by intensive farming or byexporting other goods [Bauer 2000: 29].A large and growing population is not a det-

riment to economic progress, nor is a high popu-lation density, provided the institutional settingis favorable to freedom and responsibility. Thus,for Bauer, “Economic achievement and progressdepend on people’s conduct, not on their num-bers.” He criticized the use of national incomeper capita as a measure of personal welfare since“it ignores satisfaction people derive from hav-ing children or from living longer. . . . Ironically,the birth of a child is registered as a reduction innational income per head, while the birth of a calfshows up as an improvement” (Bauer 2000: 30–31).

“Economic achievement and progressdepend on people’s conduct, not on theirnumbers.”

The Investment Fetish and Compulsory SavingBauer was especially critical of the argument,widely accepted by development experts, thatlarge-scale government investment is necessaryto alleviate poverty. First, investment itself is onlyone factor influencing economic growth:

It is misleading to think of investmentas the only or the principal determi-nant of development. Other factors andinfluences, such as institutional andpolitical forces, the qualities and atti-tudes of the population, and the sup-ply of complementary resources, areoften equally important or even moreimportant. . . . It is more meaningful tosay that capital is created in the pro-cess of development, rather than thatdevelopment is a function of capital[Bauer 1957: 119].Second, when the state uses taxes and other

measures to reduce private consumption, peoplecan be made worse off: private investment is re-duced, hence restricting the growth of the marketsector; and compulsory saving reduces individual


15freedom. It is wrong, says Bauer, to regard “thetotal proceeds of compulsory saving . . . as a netaddition to resources.” There is a cost involved,namely, the forgone net income that could havebeen created if those same funds had been directedto private capital formation. Moreover, “Taxationfor development [i.e., compulsory saving] nor-mally falls on activities in the exchange sector, andis very likely to take forms which will retard theenlargement of production for wider exchange.”Finally, state-directed investment and compulsorysaving have a negative impact on freedom: theytypically lead to “a great inequality in the distri-bution of power within the country,” which “im-plies a restriction in the range of alternatives ofthose over whom the power is exercised” (Bauer1957: 116–17, 124). In response to the notion that“enforced austerity is . . . necessary for a prom-ised increase in output,” Bauer (1981: 254) replies,“What right have the rulers to coerce their sub-jects for this purpose?” 5

“It is more meaningful to say that capital iscreated in the process of development,rather than that development is a functionof capital.”

Third, state-directed investment is notori-ously inefficient because it is guided by political,not economic, considerations. The so-called in-vestment fetish of development experts resultedin numerous large-scale projects that were monu-ments for the ruling elite at the expense of the poor(Bauer 1981: chap. 14). Moreover, the lack of pri-vate property rights in those investments led tomismanagement and poor maintenance. One needonly look at the wasteland of the former SovietUnion and its client countries.

To think that the poor are incapable of sav-ing and investing for the future is to ignore thelessons of history, argues Bauer. The smallholders

5Nobel laureate economist Gunnar Myrdal (1956b: 64) arguedin his Cairo lectures: “There is no other road to economicdevelopment than a forcible rise of the part of the nationalincome which is withheld from consumption and devotedto investments, and this implies a policy of utmost austerity.”


16in Malaya and the small-scale traders in West Af-rica clearly had the foresight and the incentive toforgo current consumption in order to plant crops(rubber trees in Malaya and cocoa trees in BritishWest Africa) that required several years beforethey were ready to be harvested for sale on themarket (Bauer 1948a, 1948b, 1954). No coercionwas necessary.

In sum, “Emergence from poverty . . . doesnot require large-scale capital formation. It re-quires changes in attitudes and mores adverse tomaterial improvement, readiness to produce forthe market instead of for subsistence, and thepursuit of appropriate government policies. Muchof capital formation is not a pre-condition of ma-terial advance but its concomitant” (Bauer 1981:248). Those changes are best brought about bymoving toward an open society and a liberal tradepolicy, not by government coercion, protection-ism, and foreign aid.

“Contacts through traders and trade areprime agents in the spread of new ideas,modes of behavior, and methods ofproduction.”

The Dynamic Gains from TradeBauer criticized conventional development econo-mists for neglecting the role of traders in the tran-sition from subsistence to an exchange economy.Internal trade, in particular, is an important sourceof growth for LDCs, as Bauer found in his studyof West African trade. The emergence of a mer-chant class—a class of small traders and shop-keepers—helps “to create commercial institutionsand practices and to raise the level of human capi-tal” (Bauer 2000: 4). Small-scale traders provideboth marketing services and credit to their cus-tomers. Such credit provision is the last link in along chain beginning with large financial institu-tions in the world capital markets. Accordingly,“There is . . . a process of bulk-breaking in the fi-nancial market; and the farmer in the hinterlandhas access indirectly to the world capital market”(Bauer 2000: 10). Experts who were wedded to the


17idea that only large-scale capital investment couldend poverty in LDCs neglected those informallinks and small-scale capital projects.

Mainstream development theory over-looked the dynamic gains from trade liberaliza-tion: “Contacts through traders and trade areprime agents in the spread of new ideas, modesof behavior, and methods of production. Externalcommercial contacts often first suggest the possi-bility of change, including economic improve-ment” (Bauer 2000: 8). The availability of Westerngoods provides an incentive for people in LDCsto work hard, to save, and to invest in order toafford the newly available luxury goods: “It is noaccident that throughout the Third World the mostadvanced regions are those with most Westerncommercial contacts; and, conversely, the mostbackward and poorest are those with few suchcontacts” (Bauer 2000: 5).

Countries that isolate themselves from thebenefits of the international division of labor paya high price: “The absence of trading links withthe outside world and lack of reserve stocks turnmisfortune, such as bad weather, into disaster;belt-tightening becomes starvation. . . . There is acore of truth in the jibe that the weather tends tobe bad in centrally controlled economies” (Bauer2000: 7–8).

“It is no accident that throughout the ThirdWorld the most advanced regions are thosewith most Western commercial contacts.”

By opening internal and external markets tocompetition, governments can provide a soundbasis for material progress. The problem is thatentrenched interests in many Third World coun-tries wish to maintain the status quo. Breaking upgovernment monopolies and liberalizing tradewould help the poor but injure politically power-ful groups, so change is difficult. Protectionist poli-cies retard economic growth and thus Third Worldgovernments turn to external aid as an alterna-tive source of helping the poor. Bauer saw thatapproach as a dangerous detour and a dead end.The poor are doubly harmed: first by the anti-


18competitive effects of state monopolies and tar-iffs and second by the corrupting influence of gov-ernment-to-government transfers.

FOREIGN AID AND THE POLITICIZATIONOF ECONOMIC LIFEWhile trade increases the range of alternatives tothe poor, foreign aid makes them more dependenton government and politicizes economic life. Of-ficial aid is better seen as a subsidy to corrupt gov-ernments, argued Bauer, than a benefit to the poor.In his view, foreign aid is neither necessary norsufficient for economic development—and is aptto be detrimental (Bauer 1976: 95–136). Thosetechnocrats who argue that LDCs cannot growwithout outside help and that poverty is self-per-petuating neglect the fact that “to have money isthe result of economic achievement, not its pre-condition. That this is so is plain from the veryexistence of developed countries, all of whichoriginally must have been underdeveloped andyet progressed without external donations” (Bauer2000: 6).

“The concept of the Third World and thepolicy of official aid are inseparable. Theone would not exist without the other.”

History shows that external subsidies politi-cize economic life and delay real reform.6 Bauerrecognized that, in making the transition from planto market in former communist countries, it is es-sential to create a market-friendly institutionalinfrastructure. Instead of making people in the

6Foreign aid has been a dismal failure because economic lib-erty, not economic aid, is the key ingredient in fostering ma-terial advance. Bauer made that point repeatedly and recentstudies support his long-held views. Bryan Johnson and Tho-mas Sheehy (1996: 2) found that “of the 34 long-term recipi-ents of U.S. foreign aid ranked by the Index [of Economic Freedom]as lacking economic freedom, 26 are no better off than theywere over three decades ago.” Ian Vásquez examined 73countries over the 1971–95 period and found no positive cor-relation between aid and economic growth. In fact, there wasa slight negative correlation. He also found that for a groupof 20 countries whose economic freedom ranking was con-stant or declined over the 1985–90 period, 19 of those coun-tries had received increased aid as a percentage of GDP(Vásquez 1998: 276, 279).


19East dependent on government aid, Western gov-ernments should demonstrate their own adher-ence to the market-liberal order by openingmarkets to the East and liberalizing trade relations(Bauer 1998).

“Official aid is, in practice, an importantanti-market force.”

Foreign aid has often been used to enhancethe wealth of Third World rulers and to supporttheir political ambitions rather than to promotethe long-run economic health and independenceof individuals in the LDCs. Such aid has also ben-efited domestic producers in the donor countries.For those and related reasons, Bauer (1984: 40)argued that without foreign aid there would beno Third World: “The concept of the Third Worldand the policy of official aid are inseparable. Theone would not exist without the other. . . . Thus,the Third World is a political and not an economicconcept.”

Bauer viewed government-to-governmenttransfers—i.e., official foreign aid—“as an inde-pendent source of hostility to the market.” ThirdWorld leaders have an incentive to use externalaid to gain greater control of economic life: “Sincethe aid is given to governments, it strengthens theposition of and enlarges the state sector as com-pared to the private sector.” Moreover, Bauer ar-gued that foreign aid “provokes and exacerbatespolitical tension, which again arouses hostility tothe market, especially in multiracial societies.”Hence, for Bauer, “official aid is, in practice, animportant anti-market force” (Bauer 1978: 182–83).

Today the emphasis is on linking foreign aidto market liberalization. But if aid is neither nec-essary nor sufficient for economic development,the current case for government-to-governmenttransfers is suspect. Private capital markets arefully capable of supplying sufficient funds for eco-nomic development, provided those funds areused productively and profitably in the ThirdWorld.


20THE FUTURE OF MARKET LIBERALISMThe massive failure of central planning means thatit is no longer a major threat to the market order.The real danger to market liberalism is the ideathat the inequality of income and wealth requirescorrective government action and that the West isresponsible or guilty for Third World poverty (Bauer1981: chap. 4). Indeed, it is widely believed thatsocial justice requires greater equality in the dis-tribution of income and wealth, which implies thatsignificant differences in income and wealth (asdetermined by some arbitrary social norm) aredue to “exploitation, oppression, discriminationor improper privilege; and politically organizedredistribution is desirable” (Bauer 1984: 73). Such“legitimization of envy” is a major threat to anopen society, in Bauer ’s view.

“Legitimization of envy” is a major threat toan open society.

Equality properly understood as equalityunder the law, whereby just rules provide equalprotection to persons and property, is one of thebasic principles of a market-liberal order and isfully compatible with individual freedom. WhatBauer is against is not the use of force to safeguardproperty rights but rather the use of governmentpower to take private property without theowner ’s consent for the sake of achieving somepolitically determined equality in the distributionof income and wealth. The further a countrymoves along the path of the redistributive or wel-fare state, the greater the inequality of power thatwill result as political decisions trump marketdecisions.7

If individuals believe that the West’s wealthis the result of exploiting the Third World’s re-sources and that trade makes the rich grow richerat the expense of the poor, then further interna-

7Bauer points out the confusion in thinking that differencesin wealth naturally imply differences in power, in the senseof “the ability of some individuals to control others.” In real-ity, “freedom from control or dictation is a function of accessto independent alternatives, and not of equality of wealth orincomes conventionally measured” (Bauer 1957: 125, n. 21).


21tional pressure will be put on Western govern-ments to exploit the rich, in the name of social jus-tice. When that mentality prevails, constitutionaldemocracy, limited government, and the sponta-neous market order will give way to crudemajoritarianism and market socialism. That pro-cess is apparent today in the growth of the pater-nalistic state and the anti-globalization movement.

Bauer (1984: 35) clearly understood that “re-placement of market processes by political deci-sions provides power, influence, jobs and moneyfor politicians and civil servants.” The challengeis to limit the power of government by a “consti-tution of liberty,” as Hayek (1960) used the term,so that people are free to choose. To do so, how-ever, there must be an ethos of liberty in society.Bauer ’s persistence and courage in defending theprinciples of a free society need to be continuedtoday if market liberalism is to survive and flour-ish in the 21st century. The first step is to recog-nize the need for clear thinking. As Bauer (1984:37) noted, “In spite of its productivity, the marketorder may well go under unless its participantsand supporters have the clarity of thought andthe will and courage to work for its survival.”Bauer (1984: 89) was fond of saying, “There isprofound truth in Pascal’s maxim that workinghard to think clearly is the beginning of moralconduct.” When he was ennobled in 1982, LordBauer chose the motto “Let us be free from cant”for his coat of arms.

“There is profound truth in Pascal’s maximthat working hard to think clearly is thebeginning of moral conduct.”

Bauer’s legacy is that through his persistenceand clarity of thought he helped us better under-stand the forces that shape economic develop-ment, especially the institutions of privateproperty, stable money, free trade, and limitedgovernment—all of which underpin the market-liberal order. His “dissent on development,” inwhich he almost single-handedly overturned thestate-led development model, guarantees that he


22will be remembered as one of the 20th century’sgreatest champions of freedom.

REFERENCESBaran, P. A. (1957) The Political Economy of Growth. New

York: Monthly Review Press.Bauer, P. T. (1948a) Report on a Visit to the Rubber Grow-

ing Smallholdings of Malaya, July–September 1946. Lon-don: His Majesty’s Stationery Office.

_______ (1948b) The Rubber Industry: A Study in Compe-tition and Monopoly. London: Longmans, Green andCo. for the London School of Economics.

_______ (1954) West African Trade: A Study of Competi-tion, Oligopoly and Monopoly in a Changing Economy.Cambridge: Cambridge University Press.

_______ (1957) Economic Analysis and Policy in Under-developed Countries. Durham, N.C.: Duke UniversityPress.

_______ (1976) Dissent on Development. Revised ed.Cambridge, Mass.: Harvard University Press.

_______ (1978) “Hostility to the Market in Less-Devel-oped Countries.” In K. Brunner (ed.) The First Worldand the Third World: Essays on the New InternationalEconomic Order, 169–89. Rochester, N.Y.: Universityof Rochester Policy Center Publications.

_______ (1981) Equality, the Third World, and EconomicDelusion. Cambridge, Mass.: Harvard UniversityPress.

_______ (1984) Reality and Rhetoric: Studies in the Eco-nomics of Development. Cambridge, Mass.: HarvardUniversity Press.

_______ (1991) The Development Frontier: Essays in Ap-plied Economics. Cambridge, Mass.: Harvard Univer-sity Press.

_______ (1998) “Western Subsidies and Eastern Re-form.” In J. A. Dorn, S. H. Hanke, and A. A. Walters(eds.) The Revolution in Development Economics, 239–50. Washington: Cato Institute.

_______ (2000) From Subsistence to Exchange and OtherEssays. Princeton, N.J.: Princeton University Press.

Dorn, J. A.; Hanke, S. H.; and Walters, A. A., eds. (1998)The Revolution in Development Economics. Washing-ton: Cato Institute.

Gandhi, R. (1985) Letter to Edward H. Crane, 26 No-vember.

Harris, R. (2002) “Powerful Economic Analyst withControversial Views.” Financial Times, 6 May: 6.

Hayek, F. A. (1960) The Constitution of Liberty. Chicago:University of Chicago Press.

Johnson, B. T., and Sheehy, T. P. (1996) 1996 Index ofEconomic Freedom. Washington: Heritage Foundation.


23Lavoie, D. (1985) National Economic Planning: What Is

Left? Cambridge, Mass.: Ballinger.Myrdal, G. (1956a) An International Economy: Problems

and Prospects. New York: Harper._______ (1956b) Development and Underdevelopment.

Cairo: National Bank of Egypt.New York Review of Books (1982) “’Just Deserts’: An Ex-

change” [between P. T. Bauer and Amartya Sen], 10June: 43.

Vásquez, I. (1998) “Official Assistance, Economic Free-dom, and Policy Change: Is Foreign Aid Like Cham-pagne?” Cato Journal 18 (2): 275–86.

World Bank (1997) World Development Report 1997: TheState in a Changing World. New York: Oxford Uni-versity Press for the World Bank.

Yamey, B. S. (1987) “Peter Bauer: Economist andScholar.” Cato Journal 7 (1): 21–27.


About the Institute

Founded in 1977, the Cato Institute is a publicpolicy research foundation dedicated to

broadening the parameters of policy debate toallow consideration of more options that are con-sistent with the traditional American principles oflimited government, individual liberty, andpeace. To that end, the Institute strives to achievegreater involvement of the intelligent, concernedlay public in questions of policy and the properrole of government.

The Institute is named for Cato’s Letters, lib-ertarian pamphlets that were widely read in theAmerican Colonies in the early 18th century andplayed a major role in laying the philosophicalfoundation for the American Revolution.

Despite the achievement of the nation’sFounders, today virtually no aspect of life is freefrom government encroachment. A pervasiveintolerance for individual rights is shown bygovernment’s arbitrary intrusions into privateeco-nomic transactions and its disregard for civilliberties.

To counter that trend, the Cato Instituteundertakes an extensive publications programthat addresses the complete spectrum of policyissues. Books, monographs, and shorter studiesare commissioned to examine the federal budget,Social Security, regulation, military spending,international trade, and myraid other issues.Major policy conferences are held throughout theyear, from which papers are published thriceyearly in the Cato Journal. The Institute also pub-lishes the quarterly magazine Regulation.

In order to maintain its independence, theCato Institute accepts no government funding.Contributions are received from foundations, cor-porations, and individuals, and other revenue isgenerated from the sale of publications. TheInstitute is a nonprofit, tax-exempt educationalfoundation under Section 501(c)3 of the InternalRevenue Code.

72214_CATO_Pages_text.pmd 9/12/02, 10:26 AM27

Cato Sponsors Program

To broaden its base of financial support andexpand the dissemination of its policy studies,

the Cato Institute maintains a Sponsors Program,through which individuals can make tax-deductibleannual contributions ranging from $50 to $24,999.More than 20,000 individuals have participated in theprogram. In addition to receiving bimonthly reportson the Institute’s activities and various of itspublications (depending on the level of support),Sponsors are encouraged to exchange ideas for policystudies and program activities with the Cato staff.

“Cato’s conferences have performed a real serviceby promoting consideration of a range of possiblepolicies that have generally been simply ruled outof court by the conventional establishment.”

—Milton Friedman, Nobel laureate

�Benefactors ($5,000–$24,999) receive all Catopublications and invitations to all major events,including the annual Benefactor Summit resortretreat, featuring internationally renowned speakersand senior Institute staff.

�Patrons ($1,000–$4,999) receive Regulation magazine,the Cato Journal, all books, and the Policy Analysisand Policy Briefing studies. Also sent are Cato PolicyReport, bimonthly memos from Institute president EdCrane, and invitations to all major events.

�Sustaining ($500–$999) Sponsors receive Regulationmagazine, all Policy Analysis and Policy Briefingstudies, Cato Policy Report, and the bimonthly memoon Cato activities.

�Basic ($100–$499) Sponsors receive selectednumbers in the Policy Analysis and Policy Briefingseries, Cato Policy Report, and the bimonthly memoon Cato activities.

�Introductory ($50) A 50% discount on Basic Spon-sorship, available only to first-time supporters of theInstitute.

Cato Institute1000 Massachusetts Avenue, N.W.

Washington, D.C. 20001www.cato.org

72214_CATO_Pages_text.pmd 9/12/02, 10:26 AM28

1000 Massachusetts Avenue, N.W.Washington, D.C. 20001

www.cato.org

Peter Bauer’sLegacy of

Liberty

byJames A. Dorn

“There are few things that are moreimportant than to honor those people whohave promoted liberty around the world,and Peter deserved that prize. A friend of

mine for 50 years, he was alwaysconsistent and persistent in presenting ideas that were unpopular but correct.”

—Milton Friedmanon the inaugural Milton Friedman Prize forAdvancing Liberty, awarded posthumously

to Peter Bauer, May 9, 2002

“Peter Bauer is in a class of his own as anoutstanding economist. The originality,

force, and extensive bearing of his writingshave been quite astonishing. He is

a real pioneer of modern developmenteconomics. He is a profound theorist

of the process of change that transformsa subsistence or near-subsistence

economy into an exchange economy.”—Amartya Sen

“Bauer is not a mere Scrooge who says‘Bah! Humbug!’ to the poor. On the

contrary, his vision of the world accordsfar more respect to the less-developed

regions and peoples than doesthe conventional viewpoint.”

—Thomas Sowell

72214_CATO_Covers.pmd 9/20/02, 8:41 AM2-3

peter bauer’s legacy of liberty - cato institute · peter bauer’s legacy of liberty by ... i...

Documents