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Executive Memorandum #915 on Trade and Economic Freedom

February 25, 2004

MCA: Rewarding Open Markets

By and

In a new approach to foreign aid, Congress has approved $1 billion for the Millennium Challenge Account (MCA) for fiscal year 2004. President Bush has stated that the MCA will "reward nations that have more open markets." To accomplish the President's goal, the Millennium Challenge Corporation (MCC) should focus on each candidate country's progress toward more open markets. The Heritage Foundation's Index of Economic Freedom tracks precisely such progress.

Using the Index as a guide, the MCC could identify which candidate countries have been working hardest toward President Bush's goal. The Index measures economic freedom by examining 10 factors: trade policy, fiscal burden of government, government intervention in the economy, monetary policy, capital flows and foreign investment, banking and finance, wages and prices, property rights, regulation, and informal market activity. As the Index of Economic Freedom has demonstrated for the past 10 years, countries that open their markets have higher GDP per capita. (See Chart 1.)

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The MCC recently designated 63 countries as potential recipients of MCA grants. Table 1 shows the performance of the 49 of these 63 countries that are covered by the Index. Using Index data, the table divides the 49 countries into quartiles based on the improvement in their levels of economic freedom over the past four years. Within each quartile, countries are listed according to degree of improvement, in descending order: Countries in the first quartile are progressing fastest toward economic freedom and would therefore benefit most from the MCA. Conversely, countries in the fourth quartile have improved the least and, measured against the President's goal, are the least deserving of MCA grants.

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These two groups have strikingly different experiences in escaping poverty. The countries in the top quartile have slightly more than six times as much GDP growth over the past 10 years as those in the bottom quartile. Consistent with the President's mission, they are likely to move beyond their current dependence on aid.

For instance, Cape Verde's level of economic freedom has steadily increased since 2000, directly contributing to Cape Verde's achieving a higher rate of economic growth than most other countries in the table. The government plans to continue this progress by privatizing the remaining state-owned companies, reducing the corporate income tax rate, and implementing other measures. On the other hand, Bolivia has failed to move steadily toward economic prosperity. As the table demonstrates, Bolivia's poor record in economic freedom is associated with plummeting economic growth.

When selecting the countries to receive MCA grants this year, the MCC Board should look no further than the top of this table. The countries chosen this year will set a standard for years to come. Economics, not politics, should determine how the MCA carries out its mission.

Sara J. Fitzgerald is a Trade Policy Analyst and Anthony B. Kim is a Research Assistant in the Center for International Trade and Economics at The Heritage Foundation.

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