Reading David Dollar’s article (“Eyes Wide Open,” Spring 2003) made me feel as if I were in the company of an alert old English sheepdog. Like so many establishment economists, Dollar was trying to see and indeed thought he was seeing everything in his purview, but actually he was seeing only a small fraction of what was staring him straight in the face.

What Dollar did see is that foreign aid over the past two decades largely failed to make a dent in the growing income differentials between the world’s wealthiest and poorest states. His only clear exceptions were China and India. While correct, Dollar neglected to observe that rapidly growing China and India, from the beginning, received exceptionally low levels of per capita foreign aid compared to the world’s other poor countries. Thus, while Dollar saw the past lack of success of foreign aid to poor countries, he displayed a sheepdog-like blind-spot regarding the possible perversity of such aid.

Dollar has, of course, sometimes thought about this possible perversity. This undoubtable fact raises a second similarity between old English sheepdogs and economists. Again because the eyes of a typical old English sheepdog are covered by fur, an outside observer has to rely on quite indirect evidence to determine what the dog is really thinking. Is the dog feeling aggressive or benevolent? The fact that Dollar, a leading World Bank economist, is ignoring existing evidence on the perverse nature of foreign aid to the world’s poorest countries preliminarily shows that his underlying, doubtlessly subconscious, intentions are more self-serving than society-serving.

Dollar is suggesting either advice-accompanied unconditional grants or a new, more custom-tailored form of conditional grants. Unconditional grants to very poor countries are a disaster. The supported leaders rationally pocket such grants and work to make their countries poorer in order to qualify for even larger grants in the future. Moreover, increasing the profit to leadership in these countries increases the temptation to acquire leadership and thereby increases the extent of civil war and repression, the costs of which are perversely born by the intended beneficiaries.

Dollar’s proposal for new, more custom-tailored, conditionality stems from his assertion that modern studies suggest the importance of institutions (including local institutional persistence and regional particularism) and financial assistance for constructing social overhead capital. However, influential development economists writing 20 years ago largely shared the same view.  Although Dollar is appropriately negative concerning the establishment-economics-inspired conditionality that has increasingly dominated the past two decades, he displays no understanding of the reasons behind its economically disastrous nature.  His argument reveals no substantial insight that economists did not have 20 years ago. There is simply no wisdom in sending developing countries back to their dangerous sheepdog tailors for a more customized fit. It would be far more promising to change tailors altogether.

One salient fact that establishment economists have traditionally overlooked regarding economic development is their own failure to generate a Pareto-relevant explanation of what makes some economies so much poorer than others. A market failure that Dollar emphasizes is “weak property rights.” This traditionally emphasized variable apparently means high transaction costs. But then why have high-legal-cost countries like Great Britain and the United States been the world’s richest two countries over the past two centuries? In any case, such a development theory, while perhaps relevant to legal reformers, would have no policy implications for economics. While it is common for development economists to recommend public support for investment projects that would be profitable but for the existence of high transaction costs, a likely reason the externally unadvised government would avoid supporting such projects is that these transaction costs would probably remain high even if the project were supported by the government. Peculiarly absent from the standard theories of underdevelopment are extremely low-level laissez-faire equilibria for a given legal system, Pareto-relevant underdevelopment traps that can be eliminated with specific economic policies.

A second salient fact traditionally overlooked by economists is that virtually all of the world’s wealthiest states are private-property-constrained democracies. Viewing democracy as a system of negotiation between conflicting special interest groups that generates mixed-economy compromises among these interest groups, this salient fact has been true since the beginning of recorded history. Before economists can plausibly claim to know how to improve upon the mixed-economy compromises of these societies, they must first understand the economic problems that these non-economist-run polities are solving. Doing so entails the introduction of complex externalities, monopolies, collective goods, protection costs, and transaction costs that simply do not exist in standard economic models. As in my recent book with Hickson, entitled Ideology and the Evolution of Vital Institutions: Guilds, the Gold Standard and Modern International Cooperation (Kluwer, 2001), the poverty-creating market imperfections must be identified and integrated into economic theory before economists can honestly expect to contribute to the reform of less successful states.

The only obvious way to explain establishment economists’ professional blind-spot with respect to the systematically unmatched success of certain democracies is to acknowledge that economists are basically substitutes for democracies in generating legislation. Given the narrow range of policy alternatives that economists traditionally address, economists would make themselves superfluous if they systematically acknowledged the remarkable legislative efficiency of some democracies. The above pair of establishment economic blind-spots are intimately related. The laissez-faire underdevelopment traps overlooked in the first blind-spot can be systematically eliminated only by an effective democracy, a democracy whose legislatures are pragmatically responsive to special interests and whose bureaucracy is ethically dedicated to dutifully executing the state’s apparently irrational legislation. What eliminates underdevelopment traps and related market failures in a private property system is effective democracy.

While economists historically have been too narrowly self-interested to admit this theoretical and empirical fact, most outsiders have come to recognize it. Economists can play a critically important role in the world, but that role is not to preach free trade. Like an unfriendly old English sheepdog, we economists would profit from reform and might come to be appreciated for the beneficial services we can provide our society.