The Administration's Proposal

The Bush Administration is asking for $1.3 billion in fiscal year (FY) 2004, rising to $5 billion in FY 2006, for countries with a proven track record of adopting policies conducive and complementary to long-term economic growth and prosperity. The Administration has identified three policy areas--good governance, investment in health and education, and promoting economic freedom--and 16 performance indicators that measure these areas. (See text box, "MCA Criteria.")

To qualify for the MCA, a country must score above the median2 for half of the indicators in each policy area--that is, it must pass three of the six performance indicators that measure good governance, two of the four that measure investment in people, and three of the six that measure economic freedom. The Bush Administration also has determined that countries must pass the "control of corruption" indicator to qualify.

Although the "control of corruption" indicator is important, the "rule of law" indicator is a better fail-safe because weak rule of law allows corruption to continue unpunished. Addressing the rule of law, therefore, would help address the issue of corruption. In addition, strong rule of law has been shown to be a key component in long-term economic growth and prosperity.3

In terms of income requirements, only countries with a per capita income less than $1,435 will be considered during the first two years of the MCA.4 In the third year, countries with a per capita income between $1,435 and $2,975 will also be considered. The median scores for each income group will be computed separately.

Focusing MCA resources on countries with good policies is appropriate; based on World Bank analysis, which has found that development assistance programs spur growth only in countries with sound policies and institutions, it is clear that aid is far less effective in bad policy environments and can actually be counterproductive.5 Other World Bank studies have demonstrated that open markets and economic liberalization provide the fastest, most reliable path to growth and prosperity.

A 2002 study, Globalization, Growth, and Poverty: Building an Inclusive World Economy found that "globalized" developing countries (nations where trade as a percentage of GDP is high) achieved an annual average growth rate of 5 percent in per capita income during the 1990s. In less globalized developing countries, the "aggregate growth rate was actually negative in the 1990s."6 Contrary to claims raised by anti-globalization activists, World Bank analysis also found that globalization helps the poor as much as the rich and improves labor and environmental standards in the long run.7

The Index of Economic Freedom, published annually by The Heritage Foundation and The Wall Street Journal, confirms these studies.8 As the Index shows, free countries on average have a per capita income twice that of mostly free countries, and mostly free countries have a per capita income more than three times that of mostly unfree and repressed countries. This relationship exists because countries that promote economic freedom provide an environment that facilitates trade and encourages entrepreneurial activity, which in turn generates economic growth.

How to improve the MCA

The basic framework for the Millennium Challenge Account is sound, but Congress can improve its administration and prevent the recurrence of past failures in development assistance. Specifically, Congress should:

• Ensure that eligibility for the MCA is determined solely according to a country's performance in the 16 indicators identified by the Administration. Using the indicators to establish eligibility encourages prospective recipients to increase their efforts to improve in the 16 indicators identified by the Administration as contributing to development. For this incentive to be effective, countries must be able to determine what improvements must be made to qualify for MCA assistance.

  The effectiveness of the MCA will only be undermined if the Millennium Challenge Corporation (MCC) or its Board of Directors is permitted to approve MCA assistance to countries that do not qualify for that assistance based on their performance. As more political subjectivity is inserted into MCA eligibility, there is less incentive for countries to improve. Similarly, Congress should resist the temptation either to earmark specific amounts for specific countries or regions or to attach requirements in addition to the 16 indicators identified by the Administration for MCA eligibility, as these will dilute the MCA's objectivity and effectiveness.

  Therefore, the sole criterion for MCA eligibility should be a country's performance in the established indicators. Politically motivated assistance, to the extent it is deemed necessary, should be made through other assistance programs.

• Use eligibility to maintain constant pressure on MCA countries to improve. Eligibility for the MCA should not be static. Instead, it should require improvements by recalculating the median value annually to take improvement into account and incrementally raise the bar for eligibility. However, countries must be able to tell what is necessary to qualify in the upcoming year in order to undertake appropriate measures to improve.

  The Administration's suggested eligibility criteria--exceeding the median in half the factors in each of the three categories of indicators (three of six indicators in ruling justly, including corruption; two of four indicators in investing in people; and three of six indicators in economic freedom)--will likely use the most recent data available to determine eligibility. To make eligibility predictable for potential recipients, the median should be calculated using indicator values from two years prior to the year for which eligibility is being determined.

  For instance, if 2003 data are used to compute the median of all potential MCA recipients in 2004, Country X has no way to change policy by the time the data become available at year end. However, if eligibility for 2004 is based on 2002 data, Country X will know that the median is, for example, 5 percent of GDP and can pass a health budget for 2003 to surpass the median for that indicator. This gives potential recipients the ability to adopt policy changes to meet criteria while putting pressure on countries to improve their policies in reaction to rising medians.

• Make it difficult, but not impossible, to change MCA indicators. Making substantial improvement in the indicators may require significant reform that will not bear immediate fruit. Therefore, potential recipients must be reasonably certain that the criteria will not change in midstream after they undertake such reform. Moreover, frequent manipulation of the criteria could arouse suspicions that eligibility is subject to political manipulation rather than based on objective analysis of performance. Therefore, once established, the MCA indicators should be difficult to change.

  The 16 performance indicators proposed by the Administration have the strength of being widely available for eligible countries, easy to measure, updated relatively frequently, and largely objective. However, new and better indicators may be formulated in time. To ensure use of the best indicators available while preserving the fairness and transparency of the MCA, performance indicators should be changed only when justified by empirical evidence and with the approval of Congress.

• Require annual independent assessments of the MCA's success in meeting its goals. The reports should evaluate the success rates of MCA-funded projects and determine the contribution that the MCA has made to increased growth and development in recipient countries.
• Create a sunset provision that terminates authority for the MCA if it does not prove more effective than past development efforts. The strongest argument for the MCA is that it is an alternative approach to existing development assistance, which has proven largely ineffective at increasing economic growth and prosperity. There is no need for two development assistance programs that are equally ineffective. Therefore, authorization for the MCA should sunset after a period sufficient to measure its effectiveness in accomplishing its stated goals: strengthening the rule of law and reducing corruption; increasing economic freedom, growth, and prosperity; and improving health and education in recipient countries.

  Reauthorization should be permitted only by a majority vote of the House and Senate finding that the MCA has been more successful than traditional development assistance. The basis for this evaluation should be a 10-year review by Congress, based on annual reports, that provides:

• The specific objectives of the MCA program, both for each recipient country and for individual projects funded fully or partially by the MCA, and an independent assessment of the extent to which those objectives were achieved;
• Data on the status of all MCA recipient countries according to the 16 eligibility criteria when first evaluated by the MCC, the improvement in those criteria made over the first 10 years of the MCA, and an estimate of how much of that improvement can be directly attributed to MCA efforts and projects; and
• Data on the status of all MCA-eligible countries according to the 16 eligibility criteria when first evaluated by the MCC, the improvement in those criteria made over the first 10 years of the MCA, and an estimate of how much of that improvement can be directly attributed to efforts to achieve and maintain MCA eligibility.

If the MCA proves more successful than traditional development assistance, it should be promoted as a model for development assistance in the multilateral development banks and for other major bilateral donors. Moreover, traditional development assistance should be directed into the MCA to improve the effectiveness of America's development efforts. If the MCA is not successful, it does not deserve to continue and should be allowed to expire.

Conclusion

The Millennium Challenge Account represents a fundamental shift in development assistance because it would provide assistance only to countries with a proven record of adopting policies that are complementary and conducive to economic growth. To preserve the integrity of this approach, Congress should hold the MCA to high standards of performance that are independently verified, insulate the program's eligibility criteria from political priorities that would undermine the programs, focus on economic growth and development, and insert a sunset provision in the legislation to focus the institution on results.

Brett D. Schaefer is Jay Kingham Fellow in International Regulatory Affairs in the Center for International Trade and Economics, and Paolo Pasicolan is a Policy Analyst in the Asian Studies Center, at The Heritage Foundation.