May 6, 1994

May 6, 1994 | Backgrounder on Federal Budget

The Index of Economic Freedom: A Tool For Real Reform of ForeignAid

(Archived document, may contain errors)

986 May 6,1994 THE INDEX OF ECONOMIC FREEDOM A TOOL FOR REALREFURM OFFOREIGN AID INTRODUCTION The U.S. foreign aid program badly needs a major overhaul. Its guiding legislation, the For eign Assistance Act of 1961 (FAA is burdened with 33 objectives. The nee d to consider goals as diverse as promoting urban development and improving a recipient countrys human rights practices leaves the U.S. foreign aid program unfocused. The FAA also restricts the Presidents flexibility in dispensing foreign aid. An important tool of foreign policy, foreign aid is best allocated by the President, and not by Congress, which doles out funds to its favor ite countries and programs. Moreover, the U.S. Agency for International Development (AID the lead agency for coordinating and i m plementing U.S. bilateral economic assistance, is inef ficient and wasteful. In fact, before taking charge of AID, incoming Administrator Brian At wood called the agency a disaster. Representative John Kasich of Ohio expressed a com mon congressional sent i ment last June when he ded AID broken Foreign aid is supposed to be a tool for advancing American interests abroad. But it is a tool worn down by repeated misuse. Most of the countries receiving U.S. development aid have made little economic progress. Thi s has been the case with Zaire, for example, which has received some $1.2 billion in development aid from the U.S. since 19

64. Zaire today is in chaos, experiencing decline instead of economic growth. Rather than helping poor countries U.S. aid has often discouraged economic development by propping up governments pursuing ruinous statist economic policies.This certainly has been the case with Brazil, Peru, and Su dan, which have received collectively $5.5 billion in development aid since 1946.

The Clinton Administration recognizes the need to reform U.S. foreign aid. It has unveiled a foreign aid reform proposal which it claims will advance American interests in todays world. Unfortunately, the centerpiece of this effort, the Peace, Prosperity, and Democr a cy Act of 1994 (PPDA), fails to address the fbndamental problems facing U.S. foreign aid. In fact the changes proposed by the PPDA 8~e merely cosmetic, promising much but delivering little disguising an attachment to the status quo behind the seductive rh etoric of reform 1 2 Doug J. Swanson, Fmigo aid agency has a long history of waste. New adminim pldm to battle Ww, Thc Dallcrs Morning News, August 8,1993, p. 1A.

Congmmimd Recod June 16.1993, p. H3629.

The Administrations proposal indeed perpetuates many of the same policies that have been so ineffective over the past 33 yeah. For example, it will guarahtee that development aid con tinues to flow to countries with econo& policies that preclude my chance of development.

The Clinton plan institutionalizes the concept of sustainable development, or statecontrol led economic management undertaken in .the name of objectives such as protecting the envi ronment. While doing little to encourage economic development this concept will foster a de structive mindset of entitlement and dependency among developing countries as sustainable development put into practice in the developing world would work against economic growth Rooted in the Cold War, the current foreign aid fiameworkis rotting. A dramatic new ap proach t o U.S. foreign aid could promote economic development abroad and serve the inter ests of American taxpayers and foreign aid recipients alike To do this, foreign aid must ad vance clearly identifiable national interests, and when intended to promote econom i c develop ment be conditioned on free market reforms and progress toward establishing a market econ omy Thus a U.S. foreign aid refom package should J Establish the Index of Economic Freedom as the prime determinant in allocating development aid among rec i pient countries Using the Index, a quantitative measure of economic freedom, to allocate development assistance would ensure that U.S. aid helps countries that want to make the transition to free markets. Otherwise, aid will only prop up non-reforming eco n omies that refuse to grow and prosper despite the in flux of billions of dollars of aid J Reduce foreign aid. Clinton Administration foreign aid spending, a planned $14.6 bil lion in 1995, would throw taxpayers dollars at problems over which the U.S. has l it tle or no influence. In Kenya, for example, the U.S. plans on spending some $15 mil lion in 1995 to promote economic growth, despite the fact that the Kenyan govern ment for years has been dragging its feet in implementing desperately needed eco nomic r eforms. It makes no sense to spend money on these kinds of programs. With a budget deficit of some $223 billion this year, the Clinton foreign aid spending pro posal should be cut by at least $1 billion this year J Eliminate the Agency for International D e velopment. The Clinton Administration wants to reinvent this agency, which is renowned for its inefficiency and mismanage ment. But several credible and bipartisan studies have recommended doing away with it altogether? The Administrations proposal appear s to be driven by the bureau cratic survival instinct. In reforming Americas foreign aid program, AIDS responsi bilities should be reassigned to the State Department, eliminating this unnecessary government agency 3 These include the Hamilton-Gilman Task F o rce Report (1989) and the Residents Commission on the Management of AID hgrams (1992 2 J Grant the President more flexibility in using aid as an instrument of foreign policy, Aid can be used to promote economic development and serve American political and se curity interests abroad. However, this is not being done. Congessionalmicmmanage ment has hamstrung the U.S. foreign aid program, rendering it largely incapable of re sponding to opportunities where it might make a difference J Reject the concept of su s tainable development. AID Administrator Brian Atwood has stated what sustainable development signifies: broad-based, economic growth which protects the environment, enhances hum& capabilities, upholds democratic values and improves the quality of life for the cumnt generation while preserving that opportunity for future generations. While proposed as a new guiding philoso phy of the revamped American foreign aid program, the concept of sustainable devel opment promises nothing but increased government cont r ol of economic activity This outcome will be the exact opposite of the free market development the Clinton Administration claims to champion. Real sustainable development is occurring in places like Taiwan and Hong Kong, where economic growth depends on n either for eign aid nor the environmental watchdogs at AID and the World Bank THE U.S. FOREIGN AID PROGRAM: A RECORD OF FAILURE The U.S. will spend approximately $13.4 billion in total foreign aid in 19

94. Spending for bilateral economic development aid t o specific countries is $2.4 billion. Aid given through such multilateral institutions as the World Bank and the Inter-American Development Bank to tals $1.9 billion. Bilateral U.S. aid for the former Soviet Union is approximately $900 million.

Economic Support Funds (ESF a form of economic aid given to advance U.S. political and security interests (as opposed to promoting economic development), amounts to $2.4 billion.

Direct military aid will be $3.2 billion this year ceive $3 billion and Egypt $2.1 billion in ESF and military aid. The U.S. has given Israel about $21 billion in economic aid and $34 billion in military aid since 19

46. Over this time Washington has given Egypt about $22 billion in economic aid and $17 billion in military aid.

Such high levels of spending would not have come about had it not been for the rise of eco nomic development theory in the 1960s. At that time, many Western governments and their academic advisers came to believe that the state had to take the lead in mobilizing re s ources and directing economic development in theThird World. Thus their foreign aid programs often supported the nationalization of industries, high levels of individual taxation, the estab lishment of state monopolies, high trade barriers to protect home industries, and heavy restric tions on the private sector of the economy Israel and Egypt are by far the largest recipients of U.S. foreign aid. This year, Israel will re 4 Statement of the Honorable J. Brian Atwood, Administrator, Agency for Internationa l Development, Before the Senate Committee on Foreign Relations, Subcommittee on International Economic Policy, Oceans and Environment, February 9, 1994, p. 11 3 Major Recipients' of US. Foreign Assstance 3000 2500 2000 I500 lo00 Kx 0 Millions of Dollars A 1 Source: Congresional Resear& Service. I In Tanzania, for example, AID provided financial support and technical assistance to forced rural collectivization efforts! A cause ckZ2bre of Western donors, Tanzania became one of the most heavily aided countrie s in the developing world, having received some $13 billion in development aid since 19

61. Today Tanzania is the world's Second poorest country. Tanza nia's per capita GNP is approximately $120.

India is another country that has pursued a disastrous and largely Westem-sponsored statist development strategy. Despite some recent attempts at economic liberalization, India still has one of the world's most heavily stateantrolled economies. After near ly 45 years of state planned economic development, India's per capita GNP remains around $3

30. This ranks In dia behind Haiti, with its $370 per capita GNP. India has received an estimated $55 billion in foreign aid since 195 1, more than any other developing nation since the end of World War II.

The lack of economic progress in Tanzania and India is not unique. Many developing coun tries find themselves worse off .today economically than 30 years ago, despite billions of dol lars of foreign aid. This is particularly true throughout Africa, a continent where economic growth has been crushed under the heavy boot of the state. Tragically, despite massive infu 6 5 6 See Thomas P. Sheehy Tanzania's Travails: Lessons in Improving American Aid to the Third Worl d Heritage Foundation Bocrtgrowrdcr No. 866, November 14,1991, for an ovemiew of the destructive role AID played in Tanzania See'Ihomas P. Sheehy, "Too Much to Hope For? An African Success Story The Wall Street Journal Europe, February 23,1994, p. 8, for a recent assessment of theTanzanian reform effort 4 sions of foreign aid, countries in Africa are poorer today than they were at the begin ning of the continent's independence era in the late 1950s and early 1960s Factors other than misguided economic polic i es have contributed to economic stagnation in the developing world. Widespread corruption also is responsible. Leaders intent on enriching themselves at their countries' expense is a common occurrence in countries receiving vast amounts of foreign aid. Ad ding to the misery have been widespread civil war and ethnic un rest, which have retarded economic development in Africa in particular.

This dismal legacy of aid-dependent .economic stagnation should be contrasted with the re cord of countries that have pursued largely open and market-oriented development strategies.

The two best examples are the Republic of China on Taiwan and the Republic of Korea. Their tremendous ecmomic success came about only when they adopted free market-oriented devel opment strategies.

The economic development of Chile also demonstrates the perverse effect of foreign aid.

Over the last several years Chile has had one of the fastest growing economies in the world.

Its GDP growth has averaged 7.3 percent per year since 19

88. Thi s growth has dramatically improved the lives of the Chilean pple, reducing the infant mortality rate from 78 to 17 per 1,OOO births between 1970 and 1991 and raising life expectancy from 64 years to 72 years be tween 1970 and 19908 All of these improvemen t s, however, came only after the Chilean gov ernment of General August0 Pinochet was almost completely cut off from foreign aid after his 1973 coup d'etat stagnating economically. In 1973, Salvador Allende's last as president, GDP shrank 5.6 per cent. As w i th many Latin American countries, the government controlled a large part of Chile's economy, an estimated 75 percent of the GDP. By 1990, this had changed dramati cally. The Chilean government controlled about 25 percent of the economy after Pinochet's pr ivatization program was largely complete. It is almost certain that Pinochet would not have taken the political risk of his free market reforms had he been able to depend on foreign aid?

Chile, however, is not the only example of economic growth taking off after a cutoff of for eign aid. The impressive economic performance of Taiwan began only after large-scale eco nomic aid from the U.S. was discontinued. Taiwan moved away from protectionist trade poli cies-thus beginning its economic miracle-only when it was clear that U.S. aid would be cut in the mid-1960s.'o Hong Kong and Singapore, other Asian success stories, received only negligible amounts of aid.

Even the World Bank has tacitly admitted the true relationship between foreign aid and eco nomic develo pment. A long-time, consistent champion of increased development aid spend In 1970, Chile was the world's second largest recipient of foreign aid per capita. It was also 7 SeeThomas P. Sheehy Beyond Dependence and Poverty: Rethinking US. Aid to Africa," H e ritage Foundation Backgruunder No. 947, June 25,1993, for an account of how foreign aid has contributed to Africa's economic decline 8 World Development Repurt 1993: Investing in Heulth Published for the World Bank (Oxford: Oxford University Ress 1993 p. 2 93 9 For an excellent overview of Pinochet's ref- odyssey, see Angel0 Codevilla Is Pinochet the'Model Foreign AjJdrs, NovemberAkcember 1993 10 Melvyn B. Knruss. Develupment Without Aid: Gruwth, Poverty and Govemment (New York McGraw-Hill, 1983 p 160 5 ing , the World Bank nevertheless fails even to mention the role of foreign aid in East Asias economic take-off in a recently released study of the Asian Tigers.

Clearly, foreign aid is not required for development; more often than not it is a hindrance Free m arket economic policies are the prerequisite to development success In a 1993 report on development aid to Africa, AID itself acknowledges that much of the investment financed by USAID and other donors between 1960 and 1980 has disappeared without a trace This realization has led many Western donors to drop their strong sup port for.statist.economic development policies. By the earlyto ad-l980s, the U.S. and other donors began to encourage and sometimes even demand that recipient countries undertake econom ic policy changes as a condition for receiving continued aid. Besides economic liber alization, the U.S. and other donors have begun to demand the establishment of democracy as a condition for aid.

Attaching strings to foreign aid has not been welcomed by many recipients, particularly de veloping countries that view conditionality as an infringement on their sovereignty. Condition ality also challenges the so-called right to aid, as expressed in the Report of the World Com mission on the Environment and De v elopments 1987 report Our Common Future (also known as the Brundtland Report).13 Opposition to conditionality also stems from the fact that governments throughout the developing world have a stake in the status quo; the eco nomic and democratic liberaliza tion refonns being pushed by donors threaten the power of the entrenched elites who control the government and economy of many developing world countries.

During the presidencies of Ronald Reagan and George Bush, the US. emphasized condi tionality, attempting to use aid as a lever to press for economic liberalization. This trend inten sified with the end of the Cold War. For example Zaire today has been alm ost completely shut off from U.S. development and military aid because its autocratic President Mobuto Sese Seko refuses to sanction a democratic transition and economic liberalization.

The World Bank and the International Monetary Fund 0 have taken the le ad in setting the criteria for economic conditionality, functioning together as the coordinating body for na tional donors, including the U.S. Indeed, a seal of approval from these two international fi nancial institutions has become virtually a prerequis i te for receiving significant amounts of de velopment aid. The World Bank provides structural adjustment loans to assist countries un dergoing economic reform. These loans, many times at concessional interest rates, often are directed at liberalizing key s e ctors of an economy, such as agriculture or manufacturing. A country failing to abide by the terms of its structural adjustment agreement runs the risk of having its access to World Bank and IMF funds cut off. At least in theory, though not often in pract i ce, national donors who pledge support for an economic restructuring program will stop or significantly reduce aid to non-performing countries 11 The Eart Asian Miracle: Economic Gnnvth and Public Policy A World Bank Policy Research Report, Published for t he World Bank (Oxford: Oxford University hs, 1993 12 Africa: Growth Renewed Hope Rekindled: A Report on the Performance of the Development Fund for Africa 1988-1992, U.S. Agency for International Development, 1993, p. 17 13 Oxford University Press, 1987 6 The World Bank and IMF record of promoting economic growth is modest at best. In Af rica, where virtually every country has an World Bank or IMF program in place, the World Bank claims that countries pursuing fair or adequate macroeconoqic policies have d o ne bet ter than those with poor or very poor policies. But the economic growth in those countries has been low; the avera e annual GDP per capita growth rate has been only 0.4 percent be tween 1987 and 1991 economic refonn programs worldwide concluded bet w een the multilateral financial institu tions anhrkstrbcturing countriesbreak down l5 This does not stop the World Bank and the IMF from returning to do business as usual, however. For example, the governments of Kenya and Nigeria each have broken their ec o nomic agreements with the IMF and World Bank several tiines over the last few years. Nevertheless, there is always a second chance. The Kenyan and Nigerian governments have merely once agzh agreed to abide by the economic conditionality of the IMF and the World Bank. Thus the aid .is flowing back to these countries.

However, it is doubtful that a country would generate sustained economic growth even if it adhered rigorously to the demands of the IMF or World Bank. These institutions have long track records of subsidizing failed statist economic policies. Therefore, they are not in a good position to promote free market reforms. Czech Prime Minister Vaclav Klaus, moreover, has complained publicly that the IMF and World Bank are staffed with people with a st atist out look. l6 Klaus also has noted that IMF and World Bank aid is wrong and counterproductive.

This aid, states Klaus, is not taken seriously, neither by the donors nor recipients. They are misused, misdirected. They simply disappear. They are very of ten counterproductive. They prolong the moment when the necessary domestic changes have to be implemented.

The Chileans undertook major economic reforms without any input from the IMF and the World Bank. Their success was mainly the result of a single-min ded focus on shrinking the size of the states role in the economy-something which is lacking in the multinational finan cial institutions.

Besides economic reform considerations made in tandem with the IMF and World Bank the U.S. looks at other factors in allocating development aid. Criteria include a countrys pro gress toward democracy and lawful governance, need as determined by social indicators environmental policies, and respect for human rights. Political and security calculations are also made, par t icularly with military aid and economic support funds. In fact, the State Depart ment, and not AID, takes the lead on decisions concerning the allocation of ESF, the bulk of which is given to Israel and Egypt l Moreover, these countries routinely ignore t h e World Banks advice. In fact, over half of all 14 Adjusiment in Africa: Reforms. Results, and the Road Ahead, A World Bank Policy Research Report (Oxford: Oxford University Press, 1994 p 6. IS Joan M. Nelson and Stephanie J. Eglington, Global Goals, Cont e ntious Means: Issues OfMdtiple Aid Conditionalify, Policy Essay No. 10 (Washington: Overseas Development Council, 1993 p. 42. 16 Melanie S. Tammen, Time to Retire the World Bank and the International Monetary Fund, in Mar&et Liberalism (Washington. D.C.: T he Cat0 Institute, 1993 p. 31 1. 17 Vaclav Klaus, Interplay of Political and Economic Reform Measures in theTransfomation of Postcommunist Countries. Heritage Lecture No. 470, October 15,1993. 18 Angel0 Codevilla, Is Pinochet the Model? Foreign Affairs No v embcr/December 1993 7 This mix of often competing foreign aid objectives has had the effect of discounting the im portance of a recipients economicpolicies. Some in Congress have begun to question this policy. Representative David Obey (D-WI for example, n oted during a 1993 congressional hearing that For a number of years, people have looked at the Egyptian problem as being a black hole, and I think there is more than a little concern about the ability of the Israeli Gov ernment to get its own economic hou s e in order At the same hearing, Assistant Secretary of State for Near Eastern and South Asian Affairs Edward P. Dierejian stated: The Egyptian economy remains dominated by large, inefficient public sector monopolies, the activities of private businessmen: r emain heavilymMrkted and the regulatory. environment remains ex tremely ~ncertain Indeed, Israel and Egypt both have statist economies in desperate need of liberalization. Nevertheless, these two countries will receive 5.1 billion in U.S. aid in 1995 Cong r essional Entanglement Most people agree that U.S. foreign aid legislation needs to be reformed. The Foreign Assis tance Act of 1961 has been amended over 70 times, and it has 33 different objectives. The Hamilton-Gilman Task Force Report, a 1989 report by Representatives Lee Hamilton

-IN and Benjamin Gilman (R-NY), now chairman and ranking minority member of the House For eign Affairs Committee, concluded that the U.S. foreign assistance program is hamstrung by too many conflicting objectives.

This repor t also found that the U.S. foreign aid program suffers from too many legislative earmarks. Earmarks have the effect of establishing additional aid priorities. In 1993, approxi mately 57 percent of development aid, 84 percent of ESF, and 96 percent of mili tary aid was earmarked for specific countries or sectors.

Congressional micromanagement of U.S. foreign aid has its unsavory side as well. Andrew Natsios, a former AID assistant administrator, reported last August that it was not uncommon for him to be sum moned into congressional offices and berated because congressional friends had lost out on AID contracts.p 20 21 The September 1993 Report of the Task Force To Reform A.I.D. and the International Af fairs Budget (the so-called Wharton Report) summed up th e difficulties brought about by the FAA and congressional earmarking: AID is not equipped to carry out its mission effectively.

The agency is burdened by process, its problems stemming from an unfocused mandate, over regulation, inflexibility due to earmar king, and poor ~nanagement Clearly, AID is a trou bled agency 19 Elaine Sciolino. Clinton Challenged on Share of U.S. Aid Going to Israel and Egypt, The New York Times, March 9 1993, p. A9 20 House Foreign Affairs Committee, Report of theTask Force on For e ign Assistance to the Committee on Foreign Affairs Washington, D.C US. Government Printing Office. February 1,1989 p.vii 21 Preventive Diplomacy: Revitalizing A.I.D. and Foreign Assistunce for the Post-Cold War Em. Report of the Tmk Force To Reform 111, D . and the International Affairs Budget, September 1993, p. 28 22 Swanson, op. cit 23 Preventive Diplomacy, p. 1 1 1 8 AID Under Stress Established in 1961 as an autonomous agency under the State Department, the Agency for International Development, with it s 3,800 professional staff members, will administer almost 7.5 billion in forei aid in 19

95. Yet AID is acknowledged to be a dispirited and poorly managed agency This fact led incoming AID Administrator Brian Atwood to volunteer AID as a reinvention lab f or Vice President Al Gores task force to.reinvent the federal AID has launched a-reorganization.plan intended to .simplify organizational arrange ments, eliminate redundancies, and configure organizational units appropriately in order to cany out our work more efficiently. AID also is revamping its financial manage ment and procurement systems, which will strengthen enforcement of procurement in tegrity statutes.26 Moreover, AIDS Quality Control Council established an Internal Regulatory Committee to carry out a 50 percent regulatory reduction plan. There is plenty of regulation to be reduced. AID currently has an unbelievable 37 procedural handbooks REINVENTING FOREIGN AID THE CLINTON ADMINISTRATION APPROACH The Clinton Administrations plan to reform forei gn aid is contained in its Peace Prosperity, and Democracy Act of 19

94. This proposed legislation, it is said, will launch the US. foreign aid program into a new post-Cold War era of promoting sustainable de velopment.

In fact, the Clinton Administration foreign aid plan promises only to waste more money on ineffective programs. Its central fault is that it avoids what should be the prime focus of US. foreign aid reform: encouraging self-generated economic growth by promoting free market transitions.

The Clinton Administration proposes an overall foreign aid spending level of $14.6 billion for 1995, to be allocated according to the outline in its Peace, Prosperity, and De mocracy Act of 19

94. The PPDA has five major categories: Sustainable Developmen t Building Democracy, Promoting Peace, Providing Humanitarian Assistance, and Promoting GrowthThroughTrade and Investment. Despite the new categories, the character and spending levels for U.S. foreign aid programs for 1995 would not differ significantly f rom the past. While the Export-Import Bank and environmental and popu lation control programs would receive more funding, food aid programs would be cut slightly. Assistance for Israel and Egypt would remain constant 24 Christopher Madison, Agency in Agon y, National Journal, November 21,1992, notes AID has been beset by constant criticism from Congress, slack management, rock-bottom morale and deep internal uncertainty about its status.

Preventive Diplomacy found that AID is an ineffectively managed agency . p. 27 25 Atwood announced this step at his April 29,1993, conhnation hearing before the Senate Foreign Relations Committee 26 U.SA.1.D. Congressional Presentation, Fiscal Year 1995, p. 4 9 Sustainable Development Title I of the Clinton Administrations P P DA is entitled Susknable Development This term is not defined in the act, but aims at broad-based, economic growth that reduces hunger and poverty, protects the environment, enhances human capabilities, upholds democratic val ues, and improves the uality o f life for current generations while preiserving that opportunity for future generation Close to $5 billion in sustainable development funds has been re quested for 1995 Although sustainable development is only one of the five major titles of the PPDA, AI D Administrator Brian Atwood has called it the philosophical basis of the Administrations en tire foreign aid reform effort. Hence its designation as Title I. Promoting sustainable develop ment also has been incorporated by AID as its single overarching go al.

The concept of sustainable development came out of the World Commission on the Envi ronment and Developments 1987 Brundtland Report?8 The Brundtland Report also speaks of all peoples right to development. Sustainable development since 1987 has gained C UT rency, and was an important theme of the 1992 United Nations-sponsored Earth Summit held in Rio. Some of the proposals accepted in Rio envision expanded official transfers of wealth from the West to the developing world for a variety of purposes, inclu d ing protection of the environment and more effective population control, two main pillars of sustainable de velopment. 29 Growth Under Fire It was once generally assumed that economic growth was the best way to assure improve ments in environmental qualit y . But this assumption is being challenged by advocates of the concept of sustainable development. One development study explains: Formerly, we felt that concern with the global environment could be addressed by successful economic develop ment. Now, we ar e beginning to understand we can attain develo ment only by protecting the global environment and by balancing population and resources.

This balancing of resources, however, is a euphemism for heavy state intervention in the economy, which leads to econom ic stagnation. In pursuit of environmental quality, the ineffi cient state sector would be reinforced by the official transfer of resources from developed to developing nations. In short, sustainable development implicitly rejects economic growth pro duce d by the private sector as the main goal of Western foreign aid. Instead it is based on the premise of government economic control. This premie exists in spite of the fact that free mar ket economies are far better than governments at fostering both econom i c development and environmental protection SO 27 H.R. 3765,103d Congress, 2d Session. p. 1 1 28 World Commission on Environment and Development, Oxford University Press, 1987 29 kter Bauer, Development Aid End It or Mend It, Occasional Paper Number 43, In t ernational Center for Economic Growth, San Francisco, CA. p. 2 30 Ralph H. Smuckler and Robert J. Berg with David F. Gordon, New Challenges, New Opportunities: U.S. cooperation for International Growth and Development in the 199Os, Michigan State Universi t y. Center for Advanced Study of International Development, August 1988, p. 3 10 STARTING OVER: A NEW APPROACH TO U.S. FOREIGN AD While the Clinton Administrations Peace, Prosperity, and Development Act of 1994 pur ports to reinvent foreign aid, it amounts to little more than tinkering with a failed program.

Worse, by embodying the concept of sustainable development as its principal philosophy, it guarantees that U.S. foreign aid will continue to be little more than an international welfare program, doling out taxpayer dollars with little to show in return.

The fact is that there is little the U.S. government can do to create economic growth in for eign countfies. The key to worldwide economic-development is furthering an open intern tional economic system that fosters .trade. Some countries will participate, others will not. At best, foreign aid can be used to encourage the types of free-market economic reforms that are needed to enter the world economic system. What has worked for such diverse success sto ries as Taiwan, Chile, and democratic Poland can work for the entire developing world.

To avoid wasting the American taxpayers money, the U.S. foreign aid progrm should be revamped to ensure that its marginal contribution supports economic reform, growth, and prosperity. To reform foreign aid, the Clinton Administration should d Establish the Index of Economic Freedom as the prime determinant in There is a stark contrast between the tremendous economic progress made by those coun tries that have pursued fr e e market-oriented development strategies and the economic stagna tion of those that have established statist economies. The lesson for the U.S. is clear: develop ment aid should be given only to those countries that are making progress toward establishing free market economies. These countries are the only real candidates for sustained economic growth. Yet while the U.S. has made some progress in this ma, it has not come far enough.

The U.S. foreign aid program needs to establish the Index of Economic Freedom -a quantita tive measure of economic freedom-as the prime determinant in allocating development aid among countries.

It was a concern over economic progress that led the Presidents Commission on the Man agement of AID Programs (1992) to recommend that AID concentrate its development aid on nations which promote private sector economic growth. In its final report, the Commissions Chairman, George M. Ferris, Jr urged AID to establish an Index of Economic Freedom for the purpose of allocating development aid among countries?

The Index of Economic Freedom is a means of gauging a countrys commitment to free market economic growth. The Index takes into account numerous factors, including 1) Private Property Rights. Does a govemment expropriate property? Are there restrictions on what citizens can own? Is there an independent judiciary to protect a citizens prop erty against both other citizens and the government 2) The Si of the State Sector. What percentage of the gross domestic product is controlled by the state 3) Taxation. How high are the top rates and at what income levels do they become effective allocating development aid among recipient countries 31 p. 20 11 Private Banking and Financial Institutions. Is private banking allowed? Does the govern ment c ontrol banking and give preferential access to funds to privileged elites? Do gov ernment policies prevent small, private cooperative banks from being established Regulation. How difficult is it to secure a business license? What sort of red tape do entre preneurs face? What regulations favor established businesses at the expense of oew comers?

Wages and Prices. Are wages and prices set by the voluntary mutual transactions of indi aiduals in he market or by government bureaucrats?

Trade. How high are tariff levels? What value of imports are controlled by quotas or other trade restrictions?

Capitel dows and Investments. Does the government restrict foreign investment? Are there limits on repatriating capital or profits?

The Index of Economic Freedom should weigh government consumption as a percentage of gross domestic product (GDP The correlation between government consumption and eco nomic growth is dramatic. For example, in 1975 sub-Sahara Africa, government consumptio n as a ratio of GDP was 14 percent while in the countries of East Asia and the Pacific it was slightly over 8 percent Today, the East Asia and Pacific region is undergoing an economic boom.

The Index of Economic Freedom is not an untested idea. Development and the Narionral Zn teres U.S. Economic Assistance into the 21st Century, released in 1989 by then-AID Admin istrator Alan Woods, proposed such an index to evaluate AID programs; it was called then an Economic Opportunity Index. The Woods Report noted t h at AID economists had made a pre liminary effort at developing a policy matrix that permitted comparisons of overall economic policy in specific developing countries over time. Their 42-country survey was based on coun try specific rankings of several fac t ors, including property rights, official corruption, effective ness of legal remedies to enforce contracts, the extent of directed credit, the incentive effect of marginal taxation, foreign exchange controls, and the size of the black market. Not surpris ingly, the Economic Opportunity Index found that countries with more free market-oriented policies have had, on average, better rates of economic growth than more statist-oriented economies.

A recently released World Bank study of Africa also presents a va riation of the Index, and demonstrates once again that government intervention hinders economic growth.34 The World Bank determined the level of market intervention by gauging the degree to which various gov ernments allowed for competition in the pricing , purchasing, and exporting of major agricul tural export commodities. Its analysis shows a strong correlation between positive economic growth and limited government intervention into the examined African economies.

Using the Index of Economic Freedom to determine where the U.S. should supply develop ment aid will enable Washington to distance itself from the destructive games being played be tween the IMF and the World Bank and their aid recipients. Currently, most of the IMF/World 33 32 A4wtment in Afri c a: Reforms. Results, and the Road Ahead, p. 24 33 Development and the Natwnal Interest, p. 52 34 A&stment in Afiica, p. 6 12 Bank economic restructuring programs break down. They are consequently renegotiated on terms more favorable to recipients This har dly engenders the respectful partnership be tween donors and recipients, much-touted within the international development community.

Applying the Index would give the U.S. a criterion other than a recipient countrys standing with the IMF and World Bank by which to judge its commitment to free market economic re form.

A truly respectful partnership between foreign aid donors and developing countries will ex ist only when donors get serious about economic reform and are prepared to invest their re sources el sewhere if necessary. Under these Circumstances, countries would be encouraged to compete for aid by making market reforms, and not by making promises that get broken.

Such a climate would better approximate the type of market relationships in the world e con omy. The status quo of loose to nonexistent conditionality only breeds contempt for Western donors and creates a misguided and ultimately self-destructive sense of entitlement. The Index of Economic Freedom would reduce U.S. complicity in this wastefu l and damaging charade.

The World Bank itself all but admits the irrelevance of its structural adjustment lending games. Its 1993 World Development Report noted: Some of the most dramatic adjustment reforms took place without adjustment lending (as in Chil e and Viet Nam), and some coun tries that received adjustment loans did little or nothing to pursue reforms (for example, Tanza nia and Zambia).35 Chile and Vietnam are increasingly granting their citizens economic free dom and, as expected, they are seei n g rapid economic growth. Vietnam had GDP growth of 8 percent last year and Chiles is expected to be 5 percent this year. The U.S. would lose little by avoiding this deceptive structural adjustment game and by using the Index as a guide for al locating dev elopment aid.

While the measure of economic freedom a country grants to its citizens should be the prime determinant in allocating U.S. development aid, this consideration should also play a part in the allocation of Economic Support Funds (ESF ESF are pro vided to countries for reasons that go beyond economic development or humanitarian assistance. Israel and Egypt are the major recipients of ESF.

Support for the statist and inefficient economies of Israel and Egypt may be necessary for political reasons, but it makes little economic sense and only prolongs long overdue economic reform and fosters long-term instability?6 An Index of Economic Freedom score should at least be calculated for recipients of ESF aid. The rationale for military and emergency huma ni tarian aid should be determined apart from the Index.

In countries burdened by a non-reforming statist government, continued foreign aid gener ally focuses on basic human needs. Nutrition, basic education, and health programs have ac tually been the maj or priority of U.S. development aid since the passage of the 1973 Mutual Development and Cooperation Act in 19

73. Yet, this is humanitarian aid, not development aid. While the US. should continue providing humanitarian aid in emergencies, it should be re cognized as such, with no pretenses that it is contributing to economic development. As shown in Chile, the best basic human needs program is market-driven economic growth 35 World Development Report 1993: Investing in Health, p. 45 36 See Odd Shenkar, Fr o m Beijing to Jerusalem: pitfalls of a Hybrid Economy, Jausalem, Institute for Advanced Strategic and Political Studies, April 1994, for an excellent overview of needed refonns of the Israeli economy 13 I hstituting the Index of Economic Freedom would brin g the additional benefit of re-estab lishing the original premise of fomb aid: that it should be transitional. President John E Kennedy spoke of seeing US. development aid recipients "take off" into lf:~ufficiency Yet despite billions spent on overseas aid , the U.S. is no closer to Kehedy's ideal. The Index of Economic Freedom would communicate to other countries that the U.S. will help them es tablish the sole known means of generating prosperity-the free ma J Reduce foreign aid The fokign aid budget shoul d not escape federal budget cuts. Indeed, it is difficult to jus tify the Clinton Administration spending some $14.6 billion on foreign aid in 1995 when the federal deficit will be some $223 billion this year. Because of this deficit, taxes will be raised by 260 billion over five years. The high level of foreign aid spending is all the more indefen sible given that the Administration plans nearly 150 billion in cuts from the defense budget over the next five years.

To find cuts, the Administration need look no further than the Congressional Budget OMice 0 The CBO, as part of its fifteenth annual report on possible deficit reduction plans, has looked at the Administration's spending plans and cites possible cuts in d e velopment aid that would save $330 million in 1995 and $1.9 billion over a five-year period. The CBO notes that this option would allow AID to focus on more attainable goals in those countries most likely to benefit from U.S. development aid. The CBO also cites $120 million in possible cuts in se curity assistance for 1995 and $2.1 billion in total security aid cuts through 19

99. And the CBO identifies a $510 million cut in the 1993Jwdget of the Export-Import Bank, which subsi dizes credit for foreign buyers of U.S. goods.

Proponents of incmsed development aid often criticize proposals to cut foreign aid. They are quick to point out that the U.S. spends a low percentage of its GDP on foreign aid, some 0.23 percent, when compand to other developed countrie s.4 These fips disregard the esti mated $12 billion a year given to overseas development efforts by the American private sec tor!1 Moreover, while the governments of Sweden and the Netherlands may spend more per capita in foreign aid, these countries have led the international campaign for the kinds of sta tist economic policies that have devastated Tanzania and other developing countries. The US should take the lead in rejecting their failed approach. Reducing overall levels of assistance would be one way of doing so 38 37 Development and the Notional fntemt, p. 18 38 For a full discussion of the Clinton Administration's defense policy, see LewrenceT. Di Rita et ul Thumbs Down to the Bonom-Up Review Heritage Foundation Buckgmunder No. 957, September 24,199 3; Baker Spring Clinton's Defense Budget Falls Far Short Heritage Foundation Btackgmunder Updute No. 217, March 15,1994; John Luddy A National Security Agenda for the New Secretary of Defense Haitage Foundation kkgmder Up&e No. 214.

February 10,1994 39 Red ucmg the -it: Spending and Revenue Options, A Report to the Senate and House Committees on the Budget Congressional Budget Office, March 1994, pp. 97-104 40 Larry Q. Newels Foreign Aid Clinton Adminidon Policy and Budget Rehn Ropods," Congressional Resear c h Service Issue Brief, Updated January 28,1994, p. 6 41 Development and the National Intemt, p. 61 14 J Eliminate the Agency f0.r International Development AID is the lead agency for coordinating and implementing U.S. bilateral economic aid. It is also in the word of its Administrator, Brian Atwood, a disaster, a dispirited and poorly man aged agency suffering low-morale, despite having spent $1 14 billion .in development aid since its creation in 19

61. Indeed, AID has become a much-publicized reinvention lab for the Clinton Administrations federal government overhaul of fourteen separate management studies within the last eight years In short, AID has been under continuous reinvention and study with no appreciable results.

The 1989 Hamilton-GhanTask Forc e Report noted that %e most effective way to re move bureaucratic cobwebs and take up a new mandate is to create a new entity to administer and allocate economic assistance. The report recommended that AID be replaced with a new institutional entity!2 The Presidents Commission on the Management of AID Programs and numerous other studies have recommended that AID be fully integrated into the State Depart menL Merging AID into the State Department would not be a difficult organizational task. Doing so would o ffer improved economies of scale. Desk officers and administrative functions and overseas activities, for example, could be consolidated4 Why, for example, should there be an expert on Zambia at both the State Department and AID, when both spend most of t h eir time considering the U.S. assistance program? The same is true of having both AID and State Department economic officers on the ground in the same countries. If foreign aid is to be re invented, AID cannot be the agency to do so. AID is part of the pr o blem, not the solution Yet AID has undergone four major management reorganizations, and has been the subject 43 J Grant the President more flexibility in using aid as an instrument of The President is charged in the constitution with conducting U.S. forei g n policy. Aid is a tool of foreign policy, but current U.S. foreign aid legislation makes it all but impossible for the President to use that tool with any flexibility. Moreover, too much U.S. foreign aid is ear- marked by Congress for specific sectom and countries. For example, Congresss 1994 foreign aid appropriation bill requires that $1 million be spent for the Micro and Small Enterprise De velopment Such congressional micro-management results in rigid and ineffective budgets and programs. New foreign assistance legislation aimed at promoting economic free dom and allowing the President the flexibility to achieve this goal is long overdue.

Strict legislative control over foreign aid is unique to the U.S. The appropriations legAa tion of other donor coun tries largely avoids earmarking specific amounts for countries and programs. In Japan, an extreme example, the Diet does not even pass foreign aid legislation even though the Japanese government spent $1 1 billion in official development aid in 1991 forei g n policy 42 p.vii 44 Thc Pasants Commission on the Management qfA.1.D. Pmgmms: Critical Underlying Issues Furthrr Analysis, Decemba 22,1994, p. 36 45 Many gray or shadow emnarks m written into the report accompanYing congressional appropriation bills for f oreign aid.While not technically law, these recommendations and suggestioas are de facto earmarks 43 p. 12 15 Congressional power over U.S. foreign aid is the result of disillusionment with the Vietnam War. By 1966, Vietnam alone wasreceiving over 43 perc e nt of AIDS development grants After the recognition that the $7 billion U.S. economic aid effort in Vietnam.had been waste ful and largely irrelevant to bettering Vietnamese lives, significant congressional restrictions were added to the US. foreign aid p rogram! It is time to move beyond the lessons of this era. This congressional stranglehold has doomed the U.S. foreign aid effort to failure.

The Clinton Administrations Peace, Prosperity, and Democracy Act of 1994 would in crease executive flexibility in managing the US. foreignaid program. The PPDA eliminates countxy specific%akiiarlcs and i&iciiohs. But it retiins several prohibitions against aiding countries that are communist or hum rights violators. The PPDA grants the President broad authority to wa i ve these prohibitions when the national intemst requires it Congress should not issue the President a foreign aid carte blanche. But neither should it continue its current micromanagement. A more constructive approach would be for Congress to .hold the Pr esident responsible for achieving tangible results in the countries it aids and cut ting overall aid levels if those results are not satisfactory.

One area of foreign aid in which the Presidents flexibility is particularly important is secu rity assistance . Consistent with his role as the commander in chief, the President can use lim ited amounts of foreign aid to further post-Cold War objectives such as the counter-prolSera tion of chemical, biological, and nuclear weapons. Foreign aid can also be used to retrain the military forces in the newly emerging democracies in Central and Easkm Europe.

For example Congress has authorized nearly $1 billion to assist in the dismantling of the nuclear arsenal of the former Soviet Union. At the same time, the Pentagon is expected to as sist the armed forces of the former Warsaw Pact prepare their military forces for participation in NATOs Partnership for Peace PFP) plan. The PFP is the fmt step toward expanded NATO membership for important Central European countries s uch Poland and the Czech Republic. Joint training exercises with NATO and headquarters staff officer assignments am two important elements of this gram, which is expected to cost as much as $30 million a year for the next several years.

Funds for these hig h priority national security programs come directly out of the Pentagon budget, which has been reduced disproportionately to the rest of government spending.The Clinton Administration intends to reduce defense spending by nearly $150 billion over five yea r s. Given their cmnt rate of growth, domestic entitlement programs will increase by nearly 40 percent during the same period. Under these conditions, it is no longer acceptable to place the burden of post-Cold War security assistance objectives on the Pent a gon, which must use every dollar available to modernize weapons and equipment and to sustain the force struc me 8.O 46 Thc Presidents Codswn on the Management 0flLI.D. Pmgrrrms: Critical Underlyinglssues Further Analysir, p 9. 47 See Nick Ebustadt, Ibe Pe r version of Foreign Aid, Commcnrory, June 1985, pp. 19-33 48 For a full discussion of the Partnership for Peace, see LamceT. Di Rita, Beyond the Partnership for Peace, Heritage Foundation Brrckgmrcnder No. 957, January 7,1994 16 Countries receiving securit y assistance would score higher on the Index of Economic Free dom than many recipients of traditional development assistance. Many of the new democra cies in Central and Eastern Europe have embarked on aggressive free market reform pro grams as they emerge from decades of statist centrally planned economies. Providing addi tional assistance to these countries in the form of military education and training, for example would be consistent with the overall objectives of a revamped foreign aid program focused o n rewarding the transition to free markets. The President should be given the authority to do that free of congressional over-management, without having to sacrifice Americas own mili tary readinessin&e.process J Reject the concept of sustainable developm ent.

AID Administrator Brian Atwood has called sustainable development, which is Title I of the Peace, Prosperity, and Democracy Act, the guiding philosophy of the Clinton Administra tions foreign aid reform effort. Yet this concept is vague. Promoting fre e market-generated economic growth should be the primary goal of the U.S. foreign aid program.

Sustainable development, while vaguely defined by the Clinton Administration, implies more government control and regulation of resources. It is thus hostile to the free market!9 Advocates of sustainable development prescribe the same type of statist policies that the de velopment community claims it is encouraging developing countries to abandon. Private prop erty rights (and the liability laws that assign indi v idual responsibility for pollution) are the best protector of the environment, not socialism. Those countries with the highest levels of state control of the economy consistently have produced the most damaging environment problems, whether they be air po llution in Eastern Europe or the devastation of agricultural lands in Zimbabwe.

Another disturbing premise of sustainable development is the notion that developing coun tries have special rights or entitlements from the developing world. The World Commission on the Environment and Developments Ow Common Future report, a chief source f or the sustainable development doctrine, speaks of all peoples right to development. This devel opment, of course, should come through foreign aid. The U.N.s International Covenant on Economic, Social and Cultural Rights outlines the rights to adequate fo od, clothing and hous ing.50 AID Administrator Brian Atwood himself has declared that free and uncontested ac cess to a range of family planning methods and services is a fundamental human right.

This philosophy of rights is dubious at best. Developing cou ntries have no special claim on industrialized ones. They deserve to be treated equally and with respect, but the industrialized world has neither the money nor the obligation to fulfill the rights cited by Atwood and others.

The concept of sustainable de velopment is unsound in theory and practice. There should be one goal of the U.S. foreign aid effort: promoting transitions to free markets. The Index of Economic Freedom is the best philosophical and practical basis for achieving this goal 49 See Thomas J . DiLorenzo, The Mirage of Sustainable Development, Contemporary Issue Series 56, Center for the Study of American Business, January 1993 50 The International Bill of Rights (New York: United Nations, 1993 p. 10 51 John M. Goshko, Planned Parenthood Gets A ID Grant, The Washington Post, November 23,1993. p. A12 17 CONCLUSION The U.S. foreign aid program needs a major overhaul. Unfortunately; the Clinton Admini strations reform plans make cosmetic changes while furthering the philosophy of sustain able devel opment, which has little to do with promoting economic growth, which is the pre requisite to development.

The Clinton foreign aid reform plan also lacks a commitment to the idea that foreign aid shouldbe temporary. It is also overreaching, promising to rem ake the world with admittedly liihited resources;Phe~limitsitsDf such utopian visions of remaking the world were demon strated in the debacle of Somalia. Millions of dollars of aid were poured into Somalia, and still the country descended into anarchy In f act, foreign aid set the stage for the chaos in So malia by enticing a power grab by rival leaders to wrest control of the government and for eign aid pot. The Clinton Administration appears to have little understanding of this foreign aid dynamic. nomic g rowth and development. Instead of dependence, foreign aid should be premised on the idea of freedom. The Clinton Administration should recognize the dangers of foreign aid and use the Index of Economic Freedom to identify which countries are making the tr a nsition to a free market. Applying the Index in this way will help produce the economic growth that is necessary to promote democracy, clean up the environment, and increase American exports all goals of Clintons foreign aid plan Foreign aid weakens thrif t, industry, and self-reliance-the values that are essential for eco Thomas P. Sheehy Jay Kingham Fellow in International Regulatory Affairs Jason Keramidas contributed to this study 18

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