• Heritage Action
  • More
Backgrounder #1617 on Trade and Economic Freedom

December 18, 2002

Trade Promotes Prosperity and Security

By and

The Bush Administration has formulated a comprehensive national security strategy that links national defense, security, and economic policies.2 The goal is to extend the peace and ensure political stability around the world.

After the Cold War, "the U.S. promotion of democracy and American values worldwide, facilitated by communication advances, was linked to free trade, American economic prosperity, global stability, and thereby U.S. national security."3 The Administration's recent white paper elaborates on this concept, identifying "free markets and free trade" as key to a secure America and a major component of the national security strategy.4

Economists have long recognized that free markets and free trade are the source of economic prosperity; but as President Bush has noted, democracy and economic openness are also "the best foundations for domestic stability and international order."5 The fact is that allies and trading partners are more likely to resolve differences than to resort to armed conflict. "For example," write Edward Mansfield of the University of Pennsylvania and Jon Pevehouse of the University of Wisconsin, "in a seminal study on this topic, Solomon W. Polachek (1980) analyzed 30 pairs of countries from 1958 to 1967 and found that higher levels of trade dampen conflict."6 Mansfield and Pevehouse also show that trade agreements dampen conflict because such hostilities threaten the very economic benefits that states expect to achieve and are achieving from the agreements.7 The free exchange of goods builds wealth and prosperity for all concerned.

Congress should heed these findings and adopt the Administration's vision of a national security strategy that extends the peace by promoting political and economic freedom around the world. Specifically, Congress should:

  • Ratify the free trade agreements (FTAs) with Singapore and Chile when they are signed and transmitted to Congress by the President.
    Singapore is an important trading partner, a destination for U.S. foreign investment, and a key ally. Chile is a beacon of political and economic freedom in a troubled region. Congress should also support negotiations initiated recently with Morocco, the Southern African Customs Union, Central America, and Australia.

  • Reinforce the linkage between foreign aid and economic reform in recipient countries by supporting the Millennium Challenge Accounts (MCAs) proposed by the Administration.
    This initiative would direct aid money specifically to countries that implement policies that encourage economic freedom.

Additionally, Congress and the Administration should supplement these reforms by encouraging the World Bank and International Monetary Fund (IMF) to re-evaluate their aid eligibility criteria. Despite vast amounts of assistance, developing countries continue to struggle to achieve economic growth.

ADVANCING SECURITY BY EXTENDING ECONOMIC FREEDOM

It is fitting that economic freedom be included as part of the national security strategy. A strong economy undergirds a strong national defense, and the strong U.S. economy is one source of the military strength of the United States. The national security strategy also argues, however, that the economic strength of other friendly countries will enhance U.S. security.

Economic freedom sustains economic growth and wealth creation. Free markets foster the spirit of entrepreneurship and innovation that creates new products and jobs. This creative economic process in turn generates higher incomes, savings and wealth creation, and economic development in nations.

According to the Office of the U.S. Trade Representative, for instance, the North American Free Trade Agreement and the Uruguay Round together "generate annual benefits of $1,300-$2,000 for the average American family of four."8 Such benefits equal more than $100 per month and would greatly assist struggling families throughout the world. According to a World Bank study, "growth generally does benefit the poor as much as everyone else, so that the growth-enhancing policies of good rule of law, fiscal discipline, and openness to international trade should be at the center of successful poverty reduction strategies."9

Chapter VI of the Administration's national security strategy describes the process succinctly: "Ignite a New Era of Global Economic Growth Through Free Markets and Free Trade." Specifically:

A strong world economy enhances our national security by advancing prosperity and freedom in the rest of the world. Economic growth supported by free trade and free markets creates new jobs and higher incomes. It allows people to lift their lives out of poverty, spurs economic and legal reform, and the fight against corruption, and it reinforces the habits of liberty.10

MEASURING ECONOMIC FREEDOM

The difference between poverty and prosperity is economic freedom. That relationship is well-documented in the annual Index of Economic Freedom, which measures economic freedom in 161 countries and is co-published by The Heritage Foundation and The Wall Street Journal. Each country is scored on a scale of 1 to 5, with 1 being the highest. The scores are broken into four categories: free, mostly free, mostly unfree, and repressed.

For the 2003 edition of the Index, countries with free economies had, on average, a real per capita GDP almost eight times that of economies in the bottom two categories. Indeed, the real per capita GDP of the free economies was more than twice that of mostly free economies. This second category contains many comparatively wealthy economies of the developed world, so the relationship between the top two freedom categories is compelling: Economic freedom fosters growth over time.11

The Bush Administration has identified seven key policies to generate higher productivity and economic growth. These seven policies correspond to six of the 10 factors utilized in computing the economic freedom scores in the Index of Economic Freedom. The policies are:

  1. Pro-growth legal and regulatory policies to encourage business investment, innovation, and entrepreneurial activity;
  2. Tax policies--particularly low marginal rates--that improve incentives for work and investment;
  3. Rule of law and intolerance of corruption so that people are confident that they will enjoy the fruits of their economic endeavors;
  4. Strong financial systems that allow the most efficient use of capital;
  5. Sound fiscal policies to support business activity;
  6. Investments in health and education that improve the well-being and skills of the labor force and population as a whole; and
  7. Free trade that provides new avenues for growth and fosters the diffusion of technology and ideas that increase productivity and opportunity.12

Exchange or trade in goods is the basis of all economic activity, whether domestic or international.13 It is a basic economic principle that both parties to voluntary trade gain from the exchange; each party emerges from the transaction better off. The case for free trade is not only economic, however, but also moral.

The concept of "free trade" arose as a moral principle before it became a pillar of economics. If you can make something that others value, you should be able to sell it to them; if others make something that you value, you should be able to buy it. This is real freedom--the freedom for a person, or a nation, to make a living.14

ECONOMIC GROWTH VS. TERRORISM

As President Bush recognizes, "freedom is the non-negotiable demand of human dignity; the birthright of every person--in every civilization."15 The defense of free markets thus provides a moral as well as pragmatic basis for U.S. foreign policy.

Free markets offer the option of prosperity over poverty and provide opportunities for the world's poorest to advance. None benefit more from an open trading environment than the citizens of developing countries. As noted by New Zealand's Mike Moore, the former head of World Trade Organization, "Free trade is the best hope of the worst off."16

It is wrong to attribute terrorism to poverty. If poverty itself caused terrorism, "sub-Saharan Africa would be the greatest exporter. Fifteen of nineteen September 11 hijackers, moreover, came from oil rich and relatively prosperous Saudi Arabia, while two more were middle class boys from Lebanon and Egypt."17 At the same time, however, the conditions that perpetuate poverty also generate terrorism: "Lack of economic freedom fuels the resentment, desperation, and hopelessness that terrorist organizations utilize to recruit new members and muster support for their activities."18

According to U.S. Trade Representative Robert Zoellick,

The offensive against terrorism requires fresh thinking about how to tackle the global challenges of poverty and privation. To be sure, the source of terrorism is not poverty; to believe that is an insult to people all over the world who struggle daily to overcome hardships. Terrorism's roots lie in a deep evil and fanatic ideologies. But there is no doubt that societies that fragment, that are poor, that have no sense of hope, become fertile grounds in which terrorists can burrow. So all of us have a stake in development and democracy.19

To be successful in the long run, the war on terrorism must be accompanied by a strategy to extend the fruits of economic development to the regions of the world that harbor terrorism. The Middle East surely ranks at the top of regions of concern: "If the war on terrorism is not to become a long-running clash of civilizations, America must combine military victory over terrorism's sponsors with an effort to bring progress to the Islamic world."20

Extending freedom thus becomes an imperative for long-term success against terrorism. As a result, freedom, progress, prosperity, and security are linked together in the national security strategy, the economic aspect of which has two principal components: trade and aid.

PROMOTING FREE TRADE

In August 2002, Congress passed trade promotion authority (TPA) and President Bush signed the bill into law. The bipartisan effort in Congress to give the President authority to negotiate "up or down" trade deals was an important first step toward implementing a comprehensive trade strategy. It was also a model for how Congress can work with the Administration to implement its broader national security strategy.

Countries that trade with each other are less likely to engage in actions that would disrupt economic opportunity. Many trade agreements create a forum for the settlement of disputes, thereby reducing tension among the parties to the agreement. While the benefits of engaging in trade agreements to foster diplomacy between countries are clear, they also extend to reinforcing existing relationships. The U.S. Trade Representative is currently completing negotiations for an FTA with Singapore and has recently finished negotiations with Chile. Completing these agreements is an important element of a trade agenda.

Singapore has been an important ally in the war on terrorism. "On its home front," as a recent Heritage Foundation study notes, "Singapore's efforts against terrorists are broad and comprehensive. As early as September 2001, the Singapore government had established an inter-ministerial taskforce on anti-terrorism."21 Singapore has arrested a number of terrorists with links to al-Qaeda. It also has the region's largest dock, which was designed specifically to host American aircraft carriers.

Congress should support the Administration's pursuit of other bilateral trade agreements, following up on Chile and Singapore. The Administration has already announced its intention to pursue an FTA with Morocco, one of the first Islamic countries to support the U.S. war on terrorism. Under King Mohammed VI, Morocco has been pursuing economic and political reforms. A bilateral trade agreement with Morocco would both encourage the reform process and reward an important regional ally. It also would directly address the need to bring economic progress to the Islamic world.

Similarly, the Administration has announced its intention to pursue regional trade agreements with Central America and the Southern African Customs Union. Each of these agreements, if concluded, would send strong messages of hope to regions that are lagging in economic development but many of whose political leaders are pursuing economic liberalization measures.

The national security strategy also mentions negotiating a free trade agreement with Australia, a solid partner in the war against terrorism. Just a few weeks after September 11, Australia committed 1,550 soldiers to support the international coalition against terrorism. Beyond its troops, Australia supplied equipment including tanker aircraft, P-3 long-range maritime aircraft, and an amphibious command ship.22

The partnership between the United States and Australia is nothing new; the two nations fought side-by-side in every major war in the 20th century.23 Negotiating a free trade agreement with Australia would reinforce this strong alliance and lower the barriers that now exist between the two countries.

ECONOMIC AID

Many Americans have taken a jaundiced view of foreign aid, and for good reason. Most recipients of U.S. economic aid are less well off today than they were before first receiving assistance. Between 1980 and 2000, the taxpayers of the United States provided $167 billion to 156 developing countries. There are reliable data for only 97 of these countries. For those 97, the World Bank reports that median per capita GDP declined from $1,076 in 1980 to $994 in 2000.24

Development experts have been increasingly inclined to criticize the effectiveness of aid. The Bush Administration has called it "a failed strategy." According to Harvard Professor George Lodge, "at times foreign aid has even worsened the plight of the poor, by sustaining the corrupt or otherwise inefficient governments that caused their misery in the first place."25

To rectify this situation, the Administration has presented a vision and a bold program for expanding the circle of development, which it terms "a moral imperative."26 The core of this vision is the Millennium Challenge Account.

To qualify for MCA assistance, recipients would have to demonstrate good governance, investment in health and education, and sound economic policies. In the past, much aid has been given without these specific prerequisites attached. Under the President's initiative, however, instead of merely promising reform to receive assistance, countries would be required to demonstrate concrete reform in order to qualify.

The Administration has also set an ambitious goal for aid: doubling the size of the world's poorest economies within a decade. To double their real per capita GDP, the poor countries will have to achieve a compound annual growth rate of at least 7.2 percent over a decade. The experience of the countries for which data are available on the World Bank's World Development Indicators shows the difficulty of achieving this goal within one 10-year period. (See Table 1.)

Only a few select countries have achieved this level of performance, and fewer still have replicated it a second time. It may be that the wiser course would be to set a less ambitious goal. As Table 2 demonstrates, achieving a 5 percent growth rate over 14 years is a much more attainable and reasonable goal for most countries.

Without policies that support economic freedom, expansive growth is not achievable. Policies that encourage such freedom are found in the criteria used for the Index of Economic Freedom.

  • Trade policy
    Policies that encourage the free flow of goods and services and do not hinder this flow with high tariffs and non-tariff barriers.

  • Fiscal burden of government
    Low tax rates and low government expenditures as a percentage of GDP.

  • Government intervention in the economy
    Low government consumption as a percentage of the economy and little state ownership.

  • Monetary policy
    A policy of low inflation, which facilitates market pricing.

  • Capital flows and foreign investment
    Policies that allow foreign ownership of business and property and do not hinder such activities with burdensome restrictions and/or regulations.

  • Banking and finance
    Policies that allow companies to offer all types of financial services, such as insurance and securities, and impose a low regulatory burden on such activities.

  • Wages and prices
    Freedom for the market to set prices and wages.

  • Property rights
    Policies that protect private property, purge corruption in the judiciary, thwart government expropriation of property, define commercial products, and allow judicial decisions to be made in a timely manner.

  • Regulation
    Regulations that do not hinder entrepreneurs from starting a business and do not impose a burden on existing business.

  • Black market
    "Black markets are the direct result of some kind of government intervention in the marketplace. A black market activity is one that the government has taxed heavily, regulated in a burdensome manner, or simply outlawed in the past."27

Policies that allow the market and the individual entrepreneur to thrive will lift individuals and entire economies out of poverty. As the evidence in the Index of Economic Freedom clearly indicates, countries that choose economic freedom will experience greater per capita income growth. In the words of Mike Moore, "Those countries that have liberalized have done the best, and we ought to say so."28

Poverty is often blamed on a lack of foreign assistance, but the history of foreign aid demonstrates otherwise. Many of the countries repeatedly given assistance by the World Bank and the International Monetary Fund continue to remain poor. While much has been given to these countries, economic freedom has not been required. The Administration and Congress should encourage the World Bank and IMF to require countries to implement economic reform before receiving assistance. Without such reform, assistance will merely fall on infertile ground and wither away.

TRADE AND AID TOGETHER INCREASE GROWTH

Poverty does not cause terrorism, but those living in a repressed country with little opportunity are clearly more likely to join such groups. Tying aid to reform will encourage countries to implement economic freedom and in turn create opportunities for the world's poor. Negotiating free trade agreements will strengthen alliances between the other parties and the United States and expand opportunities for both parties. Congress should push such policies in two ways:

  • Ratify the free trade agreements with Singapore and Chile when they are signed and transmitted to Congress by the President.
    Singapore is an important trading partner, a destination for U.S. foreign investment, and a key ally. Chile is a beacon of political and economic freedom in a troubled region. Congress should also support negotiations initiated recently with Morocco, the Southern African Customs Union, Central America, and Australia.

  • Reinforce the linkage between foreign aid and economic reform in recipient countries by supporting the Millennium Challenge Accounts proposed by the Administration.
    This initiative would direct aid money specifically to countries that implement policies that encourage economic freedom.

Additionally, Congress and the Administration should supplement these reforms by exerting their influence to advance reform within the World Bank and IMF, including a re-evaluation of their aid eligibility criteria.

CONCLUSION

The Bush Administration has formulated a comprehensive national security strategy that links national defense, security, and economic policies. The mission is nothing less than to extend the peace and ensure political stability throughout the post-Cold War world.

Promoting trade generates not only higher rates of economic growth, but also stronger alliances around the world. Both of these results reinforce U.S. national security and advance U.S. foreign policy interests. The interests of our allies, and indeed all peoples around the world, would benefit from implementing this strategy. Congress should therefore support the Administration's implementation of its strategic vision.

Dr. Gerald P. O'Driscoll, Jr., is former Director of, and Sara J. Fitzgerald is a Trade Policy Analyst in, the Center for International Trade and Economics at The Heritage Foundation.


1. The authors wish to thank Anthony Kim for his valuable research assistance and Brett Schaefer for his insightful comments.

2. The White House, The National Security Strategy of the United States of America, September 2002. Cited hereafter as National Security Strategy.

3. David Jablonsky, "The State of the National Security State," Parameters: U.S. Army War College Quarterly, Winter 2002-03,

4. National Security Strategy, p. 23.

5. President George W. Bush, Letter of Introduction to National Security Strategy.

6. Edward D. Mansfield and Jon C. Pevehouse, "Institutions, Interdependence, and International Conflict," paper prepared for the 2001 American Political Science Association Annual Meeting, San Francisco, California, August 30-September 2, 2001.

7. Ibid.

9. David Dollar and Aart Kraay, "Growth Is Good for the Poor," World Bank, March 2001, at /static/reportimages/DD3DA7CA88BCC43D3714B247E92B6C3C.pdf.

10. National Security Strategy, p. 17.

11. For a recent, comprehensive analysis of the sources of economic development, see Richard Roll and John Talbott, "Why Many Developing Countries Just Aren't," Working Paper 19-01, Los Angeles, The Anderson School at UCLA, November 2001.

12. National Security Strategy, p. 17.

13. Armen A. Alchian and William R. Allen, Exchange and Production: Theory in Use (Belmont, Cal.: Wadsworth Publishing Company, Inc., 1969), pp. 39-53 and 209.

14. National Security Strategy, p. 18.

15. Bush, Letter of Introduction to National Security Strategy.

16. The Honorable Mike Moore, quoted in "Moore's Code," New Zealand Herald, August 31, 2002.

17. Robert L. Pollock, Chapter 3, "In the Middle East, Arbitrary Government Feeds Rage," in Gerald P. O'Driscoll, Jr., Edwin J. Feulner, and Mary Anastasia O'Grady, 2003 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones & Co., Inc., 2003), p. 30.

18. Brett D. Schaefer, "Expand Economic Freedom to Counter Terrorism," Heritage Foundation Backgrounder No. 1508, December 6, 2001, p. 1.

19. Robert B. Zoellick, "Free Trade, Free People," The Wall Street Journal, November 4, 2002.

20. Pollock, "In the Middle East, Arbitrary Government Feeds Rage," p. 30.

21. Dana R. Dillon and Sara J. Fitzgerald, "Why the United States Should Complete the Bilateral Free Trade Agreement with Singapore," Heritage Foundation Executive Memorandum No. 810, April 12, 2002.

23. Ibid.

24. GDP data and per capita GDP data from World Bank, World Development Indicators 2002.

25. George C. Lodge, "The Corporate Key: Using Big Business to Fight Global Poverty," Foreign Affairs, July 2002.

26. National Security Strategy, p. 21.

27. William W. Beach and Gerald P. O'Driscoll, Jr., Chapter 5, "Explaining the Factors of the Index of Economic Freedom," in O'Driscoll, Feulner, and O'Grady, 2003 Index of Economic Freedom, p. 66.

28. "Moore's Code," New Zealand Herald, August 31, 2002.

Heritage's daily Morning Bell e-mail keeps you updated on the ongoing policy battles in Washington and around the country.


The subscription is free and delivers you the latest conservative policy perspectives on the news each weekday--straight from Heritage experts.


The Morning Bell is your daily wake-up call offering a fresh, conservative analysis of the news.


More than 450,000 Americans rely on Heritage's Morning Bell to stay up to date on the policy battles that affect them.


Rush Limbaugh says "The Heritage Foundation's Morning Bell is just terrific!"


Rep. Peter Roskam (R-IL) says it's "a great way to start the day for any conservative who wants to get America back on track."


Sign up to start your free subscription today!