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WebMemo #914 on Trade and Economic Freedom

November 14, 2005

Unconditional Debt Relief Is a Big Mistake

By

As the Senate attempts to clear its docket of unfinished bills, the chamber's Leadership seeks to bring S. 1320, the Multilateral Debt Relief Act of 2005, to a vote. The bill's sponsors believe that heavily indebted poor countries (HIPCs) bear too huge a debt burden to spark growth and leave poverty behind while paying back their multilateral lenders. Their bill would relieve debt and provide more resources for future aid programs. Experience, however, shows that debt relief and aid alone will not put countries on the path to prosperity. The Senate should instead focus on promoting good government, the rule of law, and economic freedom-the real keys to growth.

 

Introduced in June 2005 by Senators Mike DeWine (R-OH), Rick Santorum (R-PA), Russ Feingold (D-WI), Dick Lugar (R-IN), and Barack Obama (D-IL), S. 1320 authorizes the Secretary of Treasury "to instruct the United States Executive Director of each international financial institutions [IFIs]…to reach an agreement among shareholders [of such IFIs] to permanently cancel 100 percent of the debts owed to each such institution by any eligible country." In addition, the bill would "compensate" the IFIs, such as the World Bank and the International Monetary Fund, for the debt payments that they will forgo. With this compensation, the IFIs will have the resources to hand over more money to poor countries and to achieve the UN's Millennium Development Goals.

 

This approach sends two problematic signals. First, it implies that the United States pardons mismanagement, dictatorship, and corruption-the circumstances that led many countries to pile up their debt. Second, the compensation provision indicates that the U.S. will continue to fund poor countries' governments regardless of whether government corruption and bad policies are to blame for their poverty.

 

As the bill's proponents argue, freed from the burden of debt, the leaders of the HIPCs would face a tremendous opportunity to set their countries on the path of growth. But will they seize this opportunity? History suggests that they will not.

 

Experience shows that economic freedom, good government, and the rule of law are the three basic elements that lead to economic growth and development. According to The Heritage Foundation/The Wall Street Journal 2005 Index of Economic Freedom, of the 18 countries (Benin, Bolivia, Burkina Faso, Ethiopia, Ghana, Guyana, Honduras, Madagascar, Mali, Mauritania, Mozambique, Nicaragua, Niger, Rwanda, Senegal, Tanzania, Uganda, and Zambia) that would immediately qualify for debt relief, few have economies that could take advantage of it. Most of these countries provide little protection of property rights and little domestic security, while permitting high levels of corruption and state intervention in the economy. Thirteen have "mostly unfree" economies (that is, there are significant barriers to entrepreneurship and other economic activities), and only 5 have "mostly free" economies. Some of these countries, such as Bolivia, are currently in political turmoil, and others, such as Niger, Rwanda, and Tanzania, are virtual dictatorships.

 

It is not their debts, but these countries' anti-market policies that are retarding growth. Corrupt and authoritarian leaders will use the clean debt slate as an opportunity to run up debt again, for their own ends. With the promise of unconditional relief, kleptocrats would have no incentive to improve their behavior. 

 

Permanently reducing poverty requires more potent medicine. Debt relief should be used as an incentive for reform. The United States should be a leader in promoting good governance by rewarding countries for implementing sound policies. A better approach to improving the poorest countries' growth prospects would be to advocate assistance only to countries that have a proven record of governing justly, investing in their people, and fostering economic freedom.

 

The United States already has a program that encourages such behavior, the Millennium Challenge Account. The Senate would do well to model any debt relief initiatives on it.

 

Ana Isabel Eiras is Senior Policy Analyst for International Economics in the Center for International Trade and Economics at The Heritage Foundation.

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