May 8, 2002 | News Releases on Foreign Aid and Development

Foreign Aid Should Follow Free-Market Reforms, Analysts Say

WASHINGTON, May 8, 2002-President Bush is right to insist that any increases in U.S. foreign aid go to countries that agree to open their economies, but more needs to be done to ensure this money isn't squandered, a new Heritage Foundation paper says.

To that end, President Bush should stress the benefits of economic freedom and administer the aid as grants rather than loans, say Brett Schaefer, Heritage's Jay Kingham fellow in international regulatory affairs, and Aaron Schavey, a policy analyst in the think tank's Center for International Trade and Economics.

President Bush has proposed adding $10 billion to America's foreign aid package over the next three years. He would put the money into a "Millennium Challenge Account" that would disburse money only to nations that show they're working to root out corruption, raise health and education standards and promote economic freedom.

How this progress will be measured has yet to be ironed out, but the success of the concept is vital to promoting growth in the Third World, Schaefer and Schavey say. America has spent more than $500 billion over the last 50 years on foreign assistance, yet standards of living have fallen in many Third World countries during that time. Zambia, for instance, has received more than $1 billion in foreign aid since 1964, yet its per capita income has dropped from $664 then to $338 in 1999.

"To achieve growth, countries must embrace economic freedom," the Heritage analysts say. "The ones that do tend to have much higher per-capita incomes. Conversely, countries that lack economic freedom do not experience sustained growth-and therefore cannot afford to clean their environment or raise labor standards-no matter how much assistance they receive."

Lower tariffs, smaller barriers to foreign investment, and limited regulatory burdens account for as much as 80 percent of the difference in per-capita income between rich and poor countries, the analysts say, citing the work of UCLA economists Richard Roll and John Talbott. Of perhaps greater importance, they write, is that property rights be respected and that contracts be honored and enforced by an independent judiciary.

The notion of disbursing foreign aid as grants rather than as loans embraces a recommendation made by the International Financial Institution Advisory Commission (known as the Meltzer Commission). The commission urged countries to stop making loans that later crush their recipients under impossible debt-and instead give them grants conditional on adopting economic policies likely to bring fiscal success.

"The president should use the Millennium Challenge Account as a prototype for this proposal to demonstrate that performance-based grants not only are possible but probably more effective than conventional aid in raising standards of living and stimulating economic growth," Schaefer and Schavey say.

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