The Great Twentieth-Century Foreign-Aid Hoax

The Marshall Plan is going down in history as the great savior of a war-devastated Europe. The history books are wrong.

The Marshall Plan revitalized postwar Western Europe, contained Soviet expansion, stopped the spread of communism, helped preserve the European capitalist tradition, powered tremendous economic growth, and helped save the US economy from a postwar depression. Or so conventional wisdom would have it. Winston Churchill once referred to the Marshall Plan as "the most unsordid act in all of history." Few American policies have been treated so reverently by historians.

The Marshall Plan is more than a historical event—it has become a modern myth. As such, it may be mostly true or mostly false, but it exercises a powerful hold over reality. And the perceived success of the Marshall Plan has influenced American foreign-aid policy since the late 1940s. Nearly all of the US foreign-assistance programs of the 1940s and 1950s, for instance, were conceived with the Marshall Plan in mind. Since the late 1940s, many Latin American leaders have called for a "Marshall Plan for Latin America." President Ronald Reagan's Caribbean Basin Initiative bears the stamp of Marshall Plan influence, and a more comprehensive aid plan for Latin America has been advocated by the Reagan administration. On March 5, 1983, then–US Ambassador to the United Nations Jeane Kirkpatrick said that "Washington should initiate a major economic aid program for Central America similar to the Marshall Plan in Europe after World War II."

Perhaps even more important than the plan's impact on any particular political attitude has been its influence on the general perception of the US role in the world as a supplier of foreign aid. Before the 1940s, foreign aid was not a continuing issue in American politics. Since the 1940s, nearly everyone seems to believe that foreign aid can work and that it is up to America to produce the successful formula. The Marshall Plan then is wheeled out as an example of successful foreign aid. While it has become fashionable to admit the Marshall Plan experience cannot be directly applied to the problems of Third World nations, there is still an implicit presumption that the plan is somehow indirectly relevant. The success of the Marshall Plan is never questioned; the only issue is how to remodel the blueprint in order to suit the needs of the developing world.

The historical reality of the Marshall Plan does not match the popular myths. As such, serious questions about foreign aid are raised. For if the most highly acclaimed foreign-aid program of this century—if not of all Western history—was at most a limited success, then foreign aid as a concept should be critically reexamined.

The genesis of the Marshall Plan is to be found in Secretary of State George Marshall's famous speech at Harvard University on June 5, 1947, in which Marshall alluded to a comprehensive aid program to spur Europe's recovery. Marshall noted that "Our policy is directed not against any country or doctrine but against hunger, poverty, desperation, and chaos."

The details of the Marshall Plan—also known as the European Recovery Program (ERP)—were fleshed out the following year in a series of Allied meetings. The concurrent Greek and Turkish crises and the Truman Doctrine influenced the plan. The ERP became the keystone of American policy toward Europe. Not only would European recovery be encouraged and Soviet influence limited, but the economic resuscitation of Germany would be made possible in a manner acceptable to the other Allied nations.

America offered Marshall Plan aid to all European nations except Spain, but the Soviet Union and Eastern bloc nations refused to participate for reasons that remain somewhat unclear. On April 2, 1948, Congress passed the Economic Cooperation Act, implementing the Marshall Plan. The bill outlined a four-year, $1.7-billion system of grants for European nations to buy US products—amounting to aid of unprecedented scope. Assistance was officially given to promote industrial and agricultural production, attain and maintain internal financial stability, and stimulate trade within Europe and with the outside world. The Economic Cooperation Administration (ECA) was created to oversee and direct the aid program.

Four decades later, the Marshall Plan is a study in mythology.

Myth No. 1: The Marshall Plan was a significant factor in West European postwar recovery. Although the Marshall Plan has received a tremendous amount of publicity, its actual financial impact was quite small. At no time did Marshall Plan aid ever exceed 5 percent of the gross national product of the recipient nations. And the assistance totals were minuscule compared to the growth that occurred in the 1950s.

More important, the so-called dollar shortage was not the critical problem facing Europe at the time; bad economic policy was the true culprit. In nearly every country occupied by Germany during the war, the stringent system of Nazi economic controls was continued even after the country was liberated. And in each case, rapid economic growth occurred only after the controls were lifted and sound economic policy established. This happened irrespective of the timing and extent of Marshall Plan aid. The restoration of liberal regimes, relative monetary and fiscal stability, business confidence, a general willingness to support the postwar rebuilding effort, and economic integration of the continent were the primary factors behind the resurgence of the European economies. These factors were not always encouraged by the plan. In fact, those countries receiving relatively large amounts of aid per capita, such as Greece and Austria, did not recover economically until US assistance was winding down. Meanwhile, Germany, France, and Italy began their recovery before receiving Marshall Plan funds.

The German economic recovery is the most miraculous example of European postwar economic growth and the most frequently cited example of a Marshall Plan success. Thus, it deserves a closer look.

American aid never exceeded 5 percent of West Germany's GNP, even in 1948–49, at the height of ECA assistance. At the same time, Allied occupation costs and reparations absorbed from 11 to 15 percent of West Germany's GNP. The US government's policies, therefore, caused German resource problems rather than cured them. The net economic transfers out of West Germany loom even larger because throughout the mid-1950s Bonn repaid half of its ECA aid.

The West German suffering during this period resulted primarily from ill-conceived economic policies, not plant dismantlings and reparations. The Allied Control Commission (ACC) continued the Nazi system of economic controls, involving not only price controls and production quotas but also conscription of resources, including labor. The ACC raised taxes by an average of 50 percent. Rent controls seriously exacerbated the housing shortage that had resulted from wartime bombing of German cities and the influx of over five million refugees from East Germany.

In 1945–46, Germany was allowed no foreign trade, a prohibition that was only gradually relaxed. Although most of the German populace was consuming food at a rate just slightly above the starvation level, the Allies forced Germany to refuse numerous barter deals, like food for coal and steel, offered by other European nations. In addition, the ACC limited West German industrial output to levels ranging from 10 to 70 percent of those in the mid-1980s. Until mid-1948, the German economy hobbled along at a near-subsistence level, sustained only by black markets and private scavenging.

West Germany's upturn really began on June 20, 1948, when the Allies instituted currency reform, effectively "tenthing" the money supply; that is, bringing the money supply to one-tenth its initial level. The old Reichsmark became a Deutschemark in one of the most drastic deflations ever. The average German's standard of living shot up within hours of the currency reform as people became fully willing to accept currency in return for goods and services.

Less than one month later, Ludwig Erhard, German economic director of Bizonia (the postwar American-British occupation zone), pushed the German economy further onto the right track. One Sunday, when everyone else had left their offices, Erhard defied orders and issued an edict abolishing most of the Allied economic controls. When Erhard was called on the carpet the next day, legend has it that the following dialogue took place:

One US Army colonel demanded:"How dare you relax our rationing system when there is a widespread food shortage?"

Erhard replied: "But Herr Oberst, I have not relaxed rationing; I have abolished it! Henceforth, the only rationing ticket the people will need will be the deutschemark. And they will work hard to get these deutschemarks, just wait and see…"

General Lucius Clay: "Herr Erhard, my advisors tell me you are making a terrible mistake."

Erhard: "Don't listen to them, General, my advisors tell me the same."

Erhard's free-market philosophy worked well. Monthly production indices rose at rates that exceeded many later yearly increases. The West German economic miracle was underway. Several months later, Marshall Plan aid began to arrive.

Myth No. 2: The Marshall Plan encouraged the development of free enterprise and sound economic policy. Proponents of the Marshall Plan have argued that American economic influence pushed Western Europe in the direction of free trade and a market economy. Leftist critics of the Marshall Plan, such as Joyce and Gabriel Kolko, have helped cement this myth by alleging that the ECA "forced" capitalism upon an otherwise recalcitrant Europe.

The truth is that those directing postwar US foreign economic policy had strong interventionist sympathies; when faced with any problem, their instinct was to seek a government solution. Furthermore, the very structure of the Marshall Plan encouraged state planning. Harry Bayard Price, author of the definitive The Marshall Plan and its Meaning, observed:

"Administration of the aid program influenced governments in many cases to increase economic planning and controls. To demonstrate their economic needs and how they proposed to bring about recovery, they expanded the apparatus for central supervision of their economies."

US aid, for instance, is widely regarded as a driving force behind economic centralism in France. Richard Kuisel has noted that "the United States supplied the first [Monnet] plan with equipment and materials, credits, and its expansionist economic philosophy.…even the idea of how a planning unit should function owed much to Anglo-American advice."

Italian leaders sought market solutions for some of their economic problems but were actively hindered by ECA administrators. The Americans in charge of the ECA in Italy continually expressed concern about the Italian government's "excessive" attention to balancing budgets and controlling monetary expansion. US advisors urged Italy to undertake a coordinated public investment program. In 1949–50, American officials finished a study of the Italian economy without mentioning stringent migration controls across municipalities and rent controls, perhaps Italy's two worst pieces of economic legislation.

State intervention was built into the Marshall Plan in other ways as well. Example: for every dollar that the ECA gave a foreign government, that government had to set aside an equivalent amount of domestic currency to be used for public works, public investments, and similar state projects. As a result, every US dollar sent to a foreign government caused that government to take another from its own private sector.

The Marshall Plan also subsidized the extensive postwar monetary and fiscal policies that caused enormous problems for many West European governments. Government-to-government transfers make it easier for governments to live beyond their means and to postpone needed belt-tightening. In the case of France, ECA appropriations allowed Paris to continue expending resources to retain France's colonial empire. Nearly all of the Marshall Plan aid to France in 1949–50 was offset by French military expenditures in territories abroad, primarily Indochina. In fact, foreign assistance always effectively subsidizes the most objectionable practices of the recipient government. Earmarking the funds does no good. If the money is sent, say, for bread, the old "bread funds" will be shifted to the objectionable activity.

An oft-cited Marshall Plan benefit is that it increased trade contacts between members of the Atlantic community. While there is truth to this, the Marshall Plan disrupted other trade relationships. For instance, on March 11, 1949, the New York Times reported that "United States tractor exporters with the support of ECA missions are successfully persuading the French and other Western governments not to shift purchases from United States products to Italian."

More significantly, Marshall Plan exports of tobacco, primarily to West Germany, seriously damaged the Greek tobacco industry. Prior to the war, tobacco accounted for 50 percent of all Greek export earnings and was a critical source of foreign exchange. By 1947, Greek tobacco sales had fallen to 35 percent of their prewar level, but still amounted to the respectable figure of 17,300 tons per year. In its first year, the Marshall Plan funded the export of 40,000 tons of American tobacco to Europe. Greek tobacco exports fell to 2,500 tons a year and never recovered. Turkey, Rhodesia, and Algeria also found their tobacco exports diminished by ECA allocations.

The Marshall Plan significantly affected the volume of trade between East and West Europe as well. All of the countries participating in the Marshall Plan were required to accept American export-licensing regulations regarding Eastern Europe. Among other things, this meant that "military related" items could not be sold to the East bloc. "Military related" was defined in such a manner as to include most machinery, chemicals, medicines, and even typewriters.

The experience of Greece, where American advisors exercised considerable control over the economy, further demonstrates the Marshall Plan's problematic influence on European economic policy. In addition to its civil war, Greece was burdened with an economy paralyzed by a rigid system of economic controls and concomitant corruption and lawlessness. Throughout the late 1940s and early 1950s, the Greek economy was wracked by huge import and foreign-exchange scandals resulting from government restraints on trade. Yet the American members of the Greek Foreign Trade Administration pushed for tighter price and exchange controls instead of a move toward freer markets.

As more American aid was funneled through the Greek government, graft and corruption increased. Major scandals were being uncovered monthly. It was only in 1953 that Greece began to recover—the year when US aid was cut to $25 million. This was the first postwar year when the Greek government balanced its budget. Few partisans of the Marshall Plan remind us that the American experiment in Greece was originally dubbed the "mini-Marshall Plan" because it was considered a microcosm of a larger effort.

Myth No. 3: The operation of the Marshall Plan was not strongly influenced by domestic US special interests. While it is commonly acknowledged that such foreign-trade and investment programs as the Export-Import Bank and the Commodity Credit Corporation often serve the interests of particular US businesses and banks, the Marshall Plan usually has been considered beyond reproach. Both popular and scholarly opinion depict the Marshall Plan as a nearly ideal pluralistic and humanitarian foreign-aid program whose aims were not corrupted by the operation of pressure groups and special interests. However, reality is entirely different.

The very conception of the Marshall Plan implied that it was partially designed to serve special business interests. Before the ECA went into operation, a sizable share of US aid was administered through the United Nations. The UN did not stipulate, of course, that US-provided dollars be used to purchase American goods, nor did it earmark specific commodities to be purchased. In contrast, all of the aid channeled through the ECA was linked to purchases of particular US goods and services. In this regard, the Marshall Plan subsidized some US businesses at the expense of the American taxpayer.

The original Marshall Plan legislation, for instance, required that at least half of all US-financed ECA goods be shipped in vessels of American registry with American insurance. Even Paul Hoffman, head of the ECA, admitted that this stipulation cost "millions of dollars," because American vessels were not always the cheapest available.

The Virginia tobacco manufacturers were particularly influential at the ECA. In the early years of the Marshall Plan, Europe was desperate for farm equipment and had put in a number of urgent requests for tractors and other kinds of farm machinery. Yet, as of June 30, 1949, the ECA had shipped only $40 million of farm equipment while managing to send $111 million (or 40,000 tons) worth of tobacco. Meanwhile, in 1948, per capita ECA exports of dried fruit to the Bizonia zone were two-and-one-half times the US per-capita consumption of dried fruit. The same year, more than 175 million pounds of expensive, inferior-quality spaghetti were shipped to Italy. This period also saw the shipment of 65,000 trucks to Europe, despite the dreadful condition of Western Europe's roads and the serious gas shortage.

The influence of special interests was described by Colonel Andrews, Chief of Food Procurement for the US Army Civilian Supply Program in Germany. He noted that because the United States was producing more peanuts than could be profitably sold in domestic markets, the Department of Agriculture was pushing peanut sales for Marshall Plan funds. The result: hundreds of millions of pounds of peanuts were shipped to Western Europe instead of the lard that Andrews had requested.

American oil companies also benefited from the Marshall Plan. Washington discouraged the use of coal and the building of independent oil refineries in Western Europe and encouraged the importation of American oil from the Mideast. As a result, oil shipments were an important feature of the Marshall Plan, accounting for 11 percent of ECA shipments. Not coincidentally, earlier US policies had strongly encouraged American oil companies to expand Mideast production.

When US companies started selling Mideast oil through the ECA, it was sold at the higher price of Texas Gulf oil—plus the transport cost of shipping oil from the Texas Gulf across the Atlantic. For more than two years, the average price of oil sold to Western Europe fluctuated between $3.50 and $4.00 a barrel. This figure was well over the cost of production. The same Mideast oil was being shipped back to the Americas in increasing quantities at a lower price than it was sold for in Europe. If the Europeans tried to buy their oil elsewhere—and some did—they would lose the ECA subsidy that picked up the entire bill.

Myth No. 4: American postwar foreign economic policy was one of free trade and the "Open Door" The Marshall Plan was directed at solving an important problem—the so-called dollar shortage of Western Europe. Yet this problem could have been alleviated far more efficiently by reducing the trade barriers between the United States and Western Europe.

At the time, only 55 percent of US imports were duty-free, and most of the tariffs were not trivial in size. On manufactured items the tariff ranged as high as 30 to 40 percent. On knives with folding blades the tariff hit 184 percent. Tariffs on minerals and raw materials were slightly lower on average, but still reached 39.5 percent on mercury, 41.3 percent on tungsten, and 33 percent on fluorspar.

The US government estimated that a complete suspension of tariffs in 1950 alone would have increased annual imports anywhere from $673 million to $1.4 billion. With the exception of Japan, almost all of the increase would have come from Marshall Plan countries, particularly Great Britain and its large but troubled textile industry.

Contrary to popular belief, US trade policy was dominated by restrictive,bilateral trading agreements, not "open door" multilateralism. This counteracted much of the American attempt to restore European prosperity.

It is a truism that perceptions of history influence ideas about the present and the future. The series of myths that have sprung up around the Marshall Plan have given rise to a virtually identical series of myths around foreign policy today. Proponents of foreign aid almost always argue that US assistance spurs foreign economic growth, encourages sound and free-market economic policies, and is in the long-run best interests of the American economy. At the same time, they often overlook US barriers to trade, such as tariffs and quotas, in the search for a rational development policy.

Policymakers and aid proponents should no longer view the Marshall Plan as an unqualified success. Its effects on postwar Europe were, at best, mixed. The basic problem with foreign aid is that economic growth is not a creature of central planning and direction. Growth is the result of individual initiative and enterprise within a sound legal and economic framework. Government can only supply the framework. Anything more will result in the well-known problems of central or socialist planning: the impossibility of rational economic calculation, the creation of perverse incentives, and the stifling of entrepreneurial initiative. Foreign-aid programs always will be plagued by such problems.

Tyler Cowen is pursuing graduate studies in economics at Harvard University. This article is adapted from a chapter in U.S. Aid to the Developing World, edited by Doug Bandow. Copyright © 1985 by the Heritage Foundation.