Where We Stand: Our Principles On A Free Market Economic Development Strategy

While there are legitimate reasons for the United States to support existing humanitarian and military assistance programs, the case for continuing economic assistance programs that are not contingent on good policies is weak.

Since World War II, the United States has provided more economic assistance to the world than any other country. However, despite massive handouts, poor nations have failed to develop. The United States disbursed nearly $259 billion (in 1995 dollars) in development assistance between 1980 and 2001, yet most recipient-country citizens are no better off today in terms of per capita gross domestic product (GDP) than they were decades ago. In fact, some are poorer. Of the 77 countries that received economic assistance between 1980 and 2001 equivalent to at least 1 percent of their 2001 GDP and for which per capita GDP data are available: Thirty-three experienced a decline in real per capita GDP; fifteen experienced negligible real growth (less than 1 percent compound annual growth) in per capita GDP; and only 29 experienced real compound annual growth in per capita GDP exceeding 1 percent. Of these 29 countries, only eight experienced growth greater than 3 percent.

Development assistance provided through international financial institutions like the World Bank has done no better. Among the 75 net recipients of World Bank assistance between 1980 and 2002 for which GDP per capita data are available: Thirty-seven experienced a decline in real per capita GDP; fifteen experienced negligible real growth in real per capita GDP; and only 23 experienced real compound annual growth in per capita GDP exceeding 1 percent. Of these 23 countries, only seven experienced growth greater than 3 percent.

This failure to elicit economic growth has been a tragedy for most poor citizens of recipient nations. A low-income country with a per capita income of less than $1 per day (such as Burkina Faso or the Central African Republic) requires a per capita real compound growth of approximately 5 percent for 15 years to reach the World Bank–defined level of lower-middle-income status (per capita income of $746). To reach upper-middle-income status (per capita income of $2,976) would require per capita real compound growth of over 5.5 percent for 40 years. Instead, Burkina Faso and the Central African Republic have experienced real growth in per capita GDP of 1.34 percent and –1.03 percent, respectively, since 1980.

The 2004 Index of Economic Freedom confirms a strong positive relationship between economic freedom and per capita gross domestic product. Moreover, average GDP growth rates increase as a country’s economic freedom score improves, as measured in the Index.

Why have these countries failed to develop despite receiving billions in economic assistance? It is because development assistance has focused on the symptoms (poverty) rather than the causes (policies). Evidence from the 2004 Index of Economic Freedom illustrates that free countries have a per capita income twice that of mostly free countries and that mostly free countries have a per capita income more than three times that of mostly unfree and repressed countries. Countries that maintain policies that promote economic freedom provide an environment that facilitates trade and encourages entrepreneurial activity, which in turn generates economic growth.

The economic futures of developing countries lie predominantly in their own hands through the policies that they choose to adopt and implement. Higher per capita GDP requires policies that are most likely to achieve that result: economic freedom and the rule of law. Economic assistance can further growth in countries with good economic policies and institutions—countries that embrace economic freedom and the rule of law—but it cannot replace good policies.

It is past time for the U.S. to end traditional development assistance in favor of promoting policies that have a proven relationship with economic growth. Decades of foreign aid have failed to lift recipients out of poverty. The few examples of successful development indicate that the keys are good economic policy and a strong rule of law—not foreign assistance. The U.S. should recognize the failure of development assistance and adopt a new development strategy based on economic freedom.

U.S. support for economic assistance should be restricted to those programs that foster positive outcomes for development, such as President George W. Bush’s Millennium Challenge Account. Development assistance programs in which the money is disbursed based on poverty alone, without regard to policies, should be ended.

Congress should eliminate USAID, which has a poor record of generating development among its recipients. In its place, the Department of State and the Department of Defense should fund and administer all U.S. military and security assistance, as well as disaster relief, in a manner that satisfies the national security interests of the United States.

The MCA represents a fundamental shift in development assistance. It provides assistance only to countries that have a proven record and are likely to adopt policies that are complementary to and conducive to economic growth. Compared to traditional foreign aid, the MCA should be a far more effective means of providing assistance and of leading poor nations to adopt policies that can encourage economic growth and development with or without foreign assistance.

The IMF has a poor record of preventing financial crises. In fact, it has contributed to many financial crises through poor policy advice and lending practices. As noted by former IMF chief economist Kenneth Rogoff:

“In a nutshell, the Fund’s current resources of $150 billion seem like enough to cause moral-hazard problems (that is, to induce excessive borrowing) without being enough to deal with a really deep global financial crisis. The Fund is just too politicised to be a consistently effective lender of last resort, and if its financial structure is not changed, there are always going to be Argentinas.”

The IMF has had a counterproductive impact on the international financial system and should be eliminated. Rogoff recommends that the IMF continue to provide technical advice and coordination of the international financial system. Such a restricted role would not require billions of dollars in resources and could be performed by a much smaller organization. If its advice proves sound, countries would pay for its services.

The World Bank has been unsuccessful in helping countries to develop.At best, it should provide resources to countries that lack access to private capital markets, but through pro-market policies that eventually gain access to international financial markets. However, most World Bank funds do not currently go to such countries. As noted by Rogoff:

“The Bank should be reduced to its defensible aid core: that is, to its International Development Assistance (IDA) window. And IDA funds should become 100% outright grants, rather than 70% as they are now.”

These are among the recommendations made by the Meltzer Commission, which proposed increasing the grant element of World Bank assistance, focusing on the poorest nations, and requiring independent audits of World Bank projects to ensure that they meet their stated goals.

Free trade is critical to increasing living standards in the U.S. and its trade partners. The United States should continue to promote free trade worldwide as a strategy to open markets and bring prosperity. A key component is for developed nations to reduce trade barriers to developing nations. While developed countries maintain low average trade barriers, their highest trade barriers tend to apply to developing countries’ exports, such as textiles and agriculture products. Similarly, many developed countries provide large subsidies for agricultural production, creating indirect trade barriers. Such barriers should be eliminated to encourage development through free markets.