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Backgrounder #1153 on Trade and Economic Freedom

January 26, 1998

The International Responsibility and Self Sufficiency Act

By

The U.S. foreign aid program was created to promote economic development in less-developed countries, to achieve U.S. foreign policy and security interests abroad, and to open overseas markets to American exports. Since 1945, the United States has spent nearly $500 billion (more than $1 trillion in constant 1995 dollars)1 to achieve these goals. Yet this sizable investment has generated few success stories. Instead, the record demonstrates that many countries receiving U.S. development assistance are no better off today, after decades of economic assistance, than before receiving this aid.

For this reason, ever since the Agency for International Development (AID) was created to oversee the disbursement of America's foreign aid dollars, the foreign aid program has been a subject of controversy. Numerous government audits and reports have recommended that this wasteful program be curtailed or eliminated.2 This criticism has led to attempts to revamp AID's focus, but these generally have failed, and both the Administration and Congress have chosen instead to increase foreign aid spending over the years.

When Congress reconvenes this month, it will have another opportunity to scrutinize the foreign aid program. Because economic development assistance has failed to help recipients and discourages them from adopting better economic policies, Representative Gerald Solomon (R-NY) will introduce the International Responsibility and Self Sufficiency Act. This Act offers Congress a structured method for evaluating, prioritizing, and eventually phasing out ineffective foreign economic aid. It targets economic development assistance and clearly defines what constitutes such assistance. Only programs listed in the Act's "definitions" would be affected by its provisions; programs not listed-such as aid to Israel or Egypt, military or security assistance, disaster relief, or the National Endowment for Democracy and similar democracy-building programs-would be exempt.

According to the bill's findings, economic freedom is the single most important factor in a country's ability to develop sustainable levels of economic growth. Since governments often place restraints on that freedom, it is possible to measure and quantify those restraints and develop an objective method for evaluating the effectiveness of economic aid. The bill's findings concur with Heritage Foundation studies over the past four years: Most long-term recipients of U.S. economic development assistance have not improved their economies.3 Furthermore, they often do not support U.S. foreign policy goals and vote against the United States on issues before the United Nations. Finally, they impose some of the highest barriers to U.S. exports.

Faced with such unsatisfactory results, this legislation is designed to give Washington policymakers an efficient methodology for overhauling foreign aid. It proposes a structured method for evaluating development assistance on an annual basis and achieving some of the recommendations made in the U.S. government's own audits. It allows Congress to phase out ineffective development assistance over a five-year period so recipient countries can implement steps to prepare for the elimination of aid. And it gives Congress a way to make sure developing countries will not become even more dependent on an international welfare system that has prevented more than promoted sustainable economic development. By using this methodology, Congress would send notice to all aid recipients that they, like long-term recipients of welfare in the United States, will soon be on their own in the global economy.

The International Responsibility and Self Sufficiency Act should promote a debate in Congress on the merits of U.S. foreign aid and the effectiveness of AID. It would give legislators the ability to eliminate most economic development assistance in an efficient and justifiable manner, and it would help aid recipients become more responsible for their economic policies.

Establishing an Annual Index
to Measure Economic Freedom

Foreign aid has failed to achieve its original objectives. As summarized in the International Responsibility and Self Sufficiency Act,

United States foreign assistance has failed to help other countries.... [Of the] 67 countries [that] have received foreign assistance from the United States for more than 35 years...37 countries have economies that grew by less than 1.0 percent per year since receiving such foreign assistance. These countries are no better off economically than before receiving such foreign assistance. Of these 37 countries, 19 actually are poorer than they were before receiving United States foreign assistance.4

To overhaul the foreign aid program, Section 3 of the Act would phase out most economic development assistance over a five-year period. To this end, the U.S. Department of State would be required to evaluate and grade, on an annual basis, a recipient country's level of economic freedom according to a specific set of criteria, and to submit its findings to Congress. Congress would use this report to determine how rapidly to phase out development assistance. Specifically, the bill would:

  • Establish an "index" to measure objectively a country's level of economic freedom each year, with each country to be ranked as "free," "mostly free," "mostly unfree," or "repressed";

  • Allow Congress to establish the time frame for phasing out development assistance based on these rankings; and

  • Direct U.S. representatives to international organizations to oppose contributions by those organizations to countries which, having scored poorly on the State Department index, are ineligible for U.S. development assistance. If the organization proceeded to provide economic assistance to these countries, the Secretary of the Treasury would be required to withhold the amount necessary to support the loans or grants that went to those countries during the previous fiscal year.

Measuring Economic Freedom

Section 3 of the International Responsibility and Self Sufficiency Act requires the Secretary of State to "establish an index of economic freedom for the purposes of evaluating on an annual basis the level of economic freedom of countries receiving United States development assistance."5 The Secretary of State would evaluate the laws, policies, and practices of a recipient country that most contribute to or detract from its level of economic freedom, and would submit a report to Congress annually. As sources of data for this analysis, the State Department would be authorized to use only its own Country Reports on Economic Policy and Trade Practices and the Country Commercial Guides published by the U.S. Department of Commerce.

The State Department's analysis would grade countries on a scale of 1 to 5, with 1 the best possible score and 5 the worst, for each of the following ten specific economic factors:

1. Trade policies, including average tariff rates, the existence of significant non-tariff barriers, and corruption within the customs service.

2. Taxation policies, such as top income tax rate, the tax rate for the average income level, the top corporate tax rate, and the existence of other major forms of taxes.

3. Government intervention in the economy, including government consumption as a percentage of the economy, the extent to which the government owns businesses and industry, and the portion of the economy's output that is produced by government.

4. Monetary policies and the average inflation rate for the most recent ten-year period.

5. Capital flows and foreign investment laws, including laws allowing 100 percent foreign ownership of businesses; restrictions on industries and companies receiving foreign investment; performance requirements for foreign companies; whether foreigners can own land, foreign and domestic companies are treated equally under the law, and foreign companies can repatriate their earnings; and the ability of foreign companies to receive local financing.

6. Banking policies, including an analysis of the extent to which government owns any banks; the ability of foreign banks to open branches and subsidiaries; the level of government influence over the allocation of credit; the ability of banks to operate free of government regulations, such as in deposit insurance; and the freedom of banks to offer all types of financial services, such as the buying and selling of real estate, securities, and insurance policies.

7. Wage and price control policies, including the freedom of businesses to set their own wages and prices without government influence, the existence and extent of government price-setting for any products, and the existence of government subsidies to businesses.

8. Property rights and the rule of law, including the extent to which the legal system is free from government influence, the existence of a commercial code defining contracts, the willingness to allow foreign arbitration of contract disputes, the ability of the government to expropriate property, the level of corruption in the judiciary, the existence of major delays in receiving judicial decisions, and the existence of laws protecting private property.

9. Regulation policies, including the government's requirement of a license to operate a business; how easily such a license can be obtained; the level of corruption within the bureaucracy; the ability of the government to force businesses to subscribe to benefits such as established work weeks, paid vacations, and maternity leave; the existence of regulations forcing businesses to subscribe to strict environmental, consumer safety, and worker health regulations; the existence of regulations that impose burdens on business; and the extent of that burden.

10. The state of the black market, including the extent of black market activity in such industries as labor, transportation, agriculture, manufacturing, services, pirated intellectual property, and smuggling.

These ten factor scores would be averaged to establish a country's overall economic freedom score, ranging from 1.00 to 5.00. Based on this overall score, each country would be ranked as follows: "free" if the scores fall between 1.00 and 1.99; "mostly free" for scores that fall between 2.00 and 2.99; "mostly unfree" for scores between 3.00 and 3.99; and "repressed" for scores of 4.00 and higher.

This method of grading recipient countries is vital to the goal of making countries accountable for progress in attaining economic freedom. It details the factors to be measured and the specific sources for the data the State Department would use to analyze a country's level of economic freedom. Furthermore, it lists the specific criteria that should be included in analyzing a country according to those factors. These explicit directions preclude, to the greatest extent possible, any misrepresentation or underreporting of actual economic conditions in recipient countries.

Attempts in past years to require that AID report on economic freedom in such detail have failed, largely because the language in the congressional request was overly vague and the request placed AID in a difficult position. AID, by its very nature, is the biggest proponent of foreign aid; it therefore should not be asked to produce a report that could be used to abolish some of its own programs. The index proposed in the International Responsibility and Self Sufficiency Act would remove AID from this conflict of interest by requiring that the State Department produce the report.

Phasing Out Development Assistance

Section 4 of the Act requires the President to submit a ranking for countries requesting development assistance based on the report prepared by the State Department. It also establishes the criteria by which a country's aid would be phased out. For example, countries ranked "free" would not receive development assistance after fiscal year 1999; "mostly free" countries would not receive aid after FY 2001; "mostly unfree" countries would not receive aid after FY 2003; and "repressed" countries would not receive assistance after FY 1999.

Because the sponsors recognize that some recipients of foreign aid probably will move between these categories during the phase-out period, the bill allows for special consideration in these cases. For example, countries moving from "mostly free" to "repressed" would not receive aid after the year in which the determination was made because of their regressive performance. Countries moving from "mostly unfree" to "repressed" also would not receive aid following the year in which the determination was made, since continuing that aid would reward them for policies that caused them to regress. Those moving from "repressed" to "free" would not receive assistance because they no longer need it. However, countries moving from "repressed" to "mostly unfree" or "mostly free" could receive either two or four more years of aid, in addition to aid in FY 1999, provided they remained at that level.

Other movement between categories, however, would not affect the length of time a country might receive aid. Thus, countries would receive aid for the time specified by their first ranking. It is the sense of the bill's authors that countries receiving a score of "free" would have prosperous economies, and therefore would not need U.S. economic development assistance. "Repressed" countries, on the other hand, probably would have centrally planned economies and governments that are hostile to free-market economic policies. Having done little to help their economies become more prosperous, they could not be expected to use continued assistance to institute the necessary reforms in the future.

Countries moving from "repressed" to "mostly free" would receive aid for slightly fewer years than those moving from "repressed" to "mostly unfree." The reason: The latter group would need a longer period of time to adjust to the loss of foreign aid, since they would not yet have established the policies that could help them receive a better ranking. They would be more likely to become "repressed" again. Continuing aid for a longer period of time could discourage them from sliding back to policies that kept their economies "repressed" in the past.

The bill also includes provisions for dealing with new or successor countries that come into existence between fiscal years 1999 and 2002. U.S. development assistance would be given for the first year after a country's establishment as a new or successor country. Countries that came into existence after 2002 would not be eligible for assistance.

Section 4, therefore, establishes conditions for continuing or phasing out U.S. economic aid. The fact that assistance to countries that move from "repressed" to "mostly unfree" would be extended demonstrates the intent that these countries be given time to plan for the cessation of development assistance. This policy would send a strong signal to governments of countries in which freedom is regularly repressed.

An International Perspective

Section 5 of the International Responsibility and Self Sufficiency Act includes strong provisions that would affect U.S. participation in such multilateral financial institutions as the World Bank and the International Monetary Fund (IMF). Specifically, the bill would:

  • Require the Secretary of the Treasury to instruct U.S. executive directors of international financial institutions to vote against giving international assistance to countries ranked ineligible for U.S. aid under Section 4 (this would not apply to disaster assistance);

  • Allow the United States to withhold from its own dues or contributions to those organizations an amount equal to the assistance they provided to any country ineligible for U.S. development assistance; and

  • Recommend that international financial institutions establish an index of economic freedom similar to the one proposed in the bill, and implement a similar phase-out period for their assistance based on that index.

This section makes it clear that other forms of U.S. foreign aid must be taken into consideration if the Act is to have its full effect. For example, since foreign aid is given also through such vehicles as the World Bank and the IMF, the money the U.S. contributes to those organizations could be given to countries that are ineligible for U.S. economic assistance based on the bill's index. The World Bank, the IMF, and sister organizations like the Inter-American Development Bank and the Asian Development Bank do not have their own indices to determine which countries would benefit from aid. This legislation offers Congress a way to recover American tax dollars that have been given to countries that score poorly on its index and are therefore ineligible for U.S. aid under its provisions.

Conclusion

Since 1945, the United States has committed nearly $500 billion to support its foreign aid objectives, but government reports and audits have questioned the effectiveness of this program in achieving its goals. Consequently, ever since the Agency for International Development began disbursing development assistance in the mid-1960s, there have been many attempts to overhaul the program. But these attempts have failed.

Those who are undecided about the effectiveness of foreign aid should find the International Responsibility and Self Sufficiency Act illuminating. U.S. development assistance has not accomplished its goals of encouraging economic development in less-developed countries and promoting U.S. foreign policy and security interests abroad. The record shows that most recipients of foreign aid are no better off today, after years of development assistance, than they were before. Claims by proponents of foreign aid that its main goal is to prevent poor countries from becoming poorer simply are not accurate. Moreover, while one of the goals of foreign aid is to help developing countries grow and prosper, this goal can be achieved without development assistance.

Policymakers will soon consider this new legislation that is designed to encourage less-developed countries to adopt the kinds of economic policies that lead to economic prosperity. The International Responsibility and Self Sufficiency Act offers Congress a systematic methodology for phasing out most economic development assistance over five years, with very few exceptions. Unless Congress uses this opportunity to scrutinize and evaluate foreign aid and abolish elements of the program that do not work, it will continue to waste billions of taxpayer dollars on a program that helps to assure that most of the world's poor will remain impoverished.

Endnotes

1 According to data in the Historical Tables of the 1998 Budget of the United States Government, total budget outlays for foreign aid since 1945 approach $500 billion. The Congressional Research Service has estimated that the amount could be as high as $2 trillion, not adjusted for inflation; see report, The Foreign Relations Revitalization Act of 1995, Committee on Foreign Relations, U.S. Senate, 104th Cong., 1st Sess., June 9, 1995, p. 12.

2 See, for example, Development and the National Interest: U.S. Economic Assistance into the 21st Century, Report by the Administrator of the Agency for International Development, Washington, D.C., 1989; Report of the Task Force on Foreign Assistance, report to the Committee on International Relations, U.S. House of Representatives, February 1, 1989; State 2000, A New Model for Managing Foreign Affairs, U.S. Department of State, Washington, D.C., 1992; and various audits by the U.S. General Accounting Office and AID Office of Inspector General.

3 Bryan T. Johnson, Kim R. Holmes, and Melanie Kirkpatrick, 1998 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones & Company, Inc., 1998), and previous editions.

4 Discussion Draft, The International Responsibility Act of 1998, U.S. House of Representatives, 105th Cong., 1st Sess., December 15, 1997, p. 3.

5 Ibid., Section 3, p. 6. 

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