The Heritage Foundation

Executive Summary #1602 on Trade, Economic Freedom

October 18, 2002

October 18, 2002 | Executive Summary on Trade, Economic Freedom

Executive Summary: The Millennium Challenge Account: Linking Aid with Economic Freedom

President George W. Bush announced the formation of the Millennium Challenge Account (MCA) during the United Nations Financing for Development Conference in Monterrey, Mexico, in March 2002. The MCA will attempt to address the failure of current U.S. development assistance programs to meet their stated goals. Most recipients of U.S. development aid are poorer now than they were before first receiving that aid. According to the Organisation for Economic Co-operation and Development, the United States provided $167 billion to 156 developing countries from 1980 to 2000. But for the 97 for which reliable economic data for that period are available, the World Bank reports that median per capita gross domestic product (GDP) declined from $1,076 in 1980 to $994 in 2000.

Recognizing this problem, President Bush specified that the MCA would be "above and beyond existing aid" and, for the first time, would be distributed only to developing countries that "govern justly, invest in their people and encourage economic freedom." The MCA will not replace existing development assistance programs or subtract from their budgets. In fact, President Bush allocated an additional $5 billion, phased in over a three-year period: a $1.7 billion increase in fiscal year (FY) 2004, $3.3 billion in FY 2005, and the full $5 billion in FY 2006 to fund the MCA. As a separate and distinct entity, the MCA is essentially an experimental program that attempts to learn from past mistakes and explore new strategies to improve the effectiveness of future development aid programs.

The President's three broad criteria that recipients must meet to qualify for MCA assistance--good governance, investment in health and education, and sound economic policies--are consistent with the findings of numerous studies that show that good policies, not aid, are the primary drivers of development. At best, foreign development assistance will accelerate the economic growth that results from sound policies and good governance.

While the President laid out a broad framework for the MCA, much work remains to be done to flesh out the details if the MCA is to succeed where previous development efforts have failed. The Bush Administration must first determine which developing countries could receive this funding. A good starting point is the World Bank's International Development Association (IDA) program, which provides concessional loans to 79 of the poorest developing countries that do not qualify to borrow from the International Bank for Reconstruction and Development.

The primary requisite for MCA funds, however, should be progress toward reform, not merely poverty. Therefore, other developing countries not poor enough to be in the IDA, like Botswana, Guatemala, and Peru, also should be considered. Rather than the mere disbursement of development assistance, the goal is to maximize the effectiveness of development assistance.

For the MCA to be an effective catalyst for development, it must encourage economic freedom--the most reliable and consistent determinant of economic growth, which in turn alleviates poverty. Furthermore, policies that promote economic freedom support good governance and increase per capita income that provides the environment and resources necessary to improve health and education standards. Countries with higher per capita income can afford to invest in schools, hospitals, better sanitation, and a clean water supply. That is why richer countries have longer life expectancy, higher literacy rates, lower incidence of child labor, access to safe drinking water, and better air quality.

Therefore, the MCA should allocate resources to developing countries that have made demonstrable progress in adopting policies that advance economic freedom. The Administration should develop an objective measure of economic policies that permits comparison between possible aid recipients and monitor their progress over time. A model for this measure is the Index of Economic Freedom, published annually by the Heritage Foundation and The Wall Street Journal. Since its inception in 1995, the Index has shown consistently that the freer the economy, the higher its real per capita GDP. The Index measures economic freedom by analyzing 50 economic indicators and grouping them into 10 independent factors:

  1. Trade Policy --the degree to which government hinders the free flow of goods and services.
  2. Fiscal Burden of Government --the burden a government imposes on its citizens through taxes and government spending.
  3. Government Intervention in the Economy --the government's direct use and control over resources.
  4. Monetary Policy --the average rate of inflation over a 10-year period.
  5. Capital Flows and Foreign Investment --how the free flow of foreign and domestic capital is restricted.
  6. Banking and Finance --the regulations imposed on banks and other financial institutions.
  7. Wages and Prices --the extent to which a government allows the market to set wages and prices.
  8. Property Rights --the extent to which the government protects private property and how safe private property is from expropriation.
  9. Regulation --the degree to which the government imposes regulations that are burdensome to business.
  10. Black Market --the pervasiveness of the market for illegal goods and services, capturing the effects of government interventions not measured elsewhere.

Of the 79 IDA-eligible countries, Armenia, Bolivia, and Cambodia are a few examples of economies that the Index determined to be "mostly free" and therefore most capable of maximizing development assistance to accelerate economic growth. The transparency of such objective analysis would assure potential aid recipients that development is the sole goal of the MCA and that its eligibility would be based principally on sustained policy improvement over time rather than on political considerations unrelated to economic growth.

Sara J. Fitzgerald is a Policy Analyst in the Center for International Trade and Economics, at The Heritage Foundation.

About the Author

Sara J. Fitzgerald Policy Analyst
Center for Trade and Economics (CTE)