Much has been written recently on the efficacy of foreign aid for economic development. Before we can make sense whether foreign aid is affective in assisting less developed countries experience sustainable economic development, we need to understand what are the sources of prosperity to begin with. Only after we grasp what causes prosperity can we then evaluate whether foreign aid assists, hinders, or has no impact on the process of economic expansion and development.
Even before we do that, however, it is helpful to remind ourselves that for the bulk of human history, poverty was the norm for the masses. Mass prosperity is a relatively recent phenomenon. Therefore before we ask why some societies are poor, we should investigate why any societies are prosperous.
As I explain in the culminating chapter of Foundations of Economics, economic theory has much to tell us about how societies become prosperous. Economics identifies three sources of economic progress: the division of labor, capital accumulation, and entrepreneurship. Today I want to focus on the division of labor. It is so important that in Human Action (p. 157), Ludwig von Mises referred to the division of labor and the human cooperation inherent to it as “the fundamental social phenomenon.” The division of labor is socially fundamental in two senses. It has been with us since the beginning of human history and it is the driving force for the forming of societies. In the book of Ezekiel, for example we find a list of 37 different goods that were brought to the commercial center Tyre from 23 different cities or regions.
The division of labor contributes to prosperity, because people are more productive when they specialize in doing those tasks at which they are relatively most efficient. Instead of every person producing every good that he consumes himself, all of us are more productive if we specialize in producing those goods for which we are the low cost producer. This division of labor results in more total output and more goods available for society to consume using the same quantity of resources.
There are many reasons for this. God has created mankind with unequal abilities in human labors. He has also providentially distributed natural resources unequally over the earth. Capital goods are also unequally distributed. Different people have different quantities and kinds of tools, buildings, and machines with which to work. Because different people possess different human abilities, natural resources, and capital goods, they tend to be relatively more productive at certain tasks and relatively less productive at other tasks. These differences and the ability to produce more in certain lines of production create an incentive to specialize in production.
Given the differences in labor abilities resource and capital goods endowments, people find it in their interest to specialize in making those goods at which they are relatively better at producing. As everyone specializes in producing goods they can make at the lowest cost compared to anyone else, the total output of all members of society increases. As people exchange their output with others who have participated in the division of labor, they are also able to consume more than they could without the division of labor.
We can only benefit from the division of labor, however, if we can exchange what we produce. Voluntary exchange is necessary to open the door to the division of labor, because only the possibility for exchange allows us to produce goods for the market and not for merely our own use. If no exchange took place, everything each of us wants to consume would have to be made personally. By allowing for the development of the division of labor, exchange helps bring about economic progress, which allows for an increasing number of people to have dominion over the earth, not by killing or robbing one another, but by peaceful, mutually beneficial voluntary trade.