The Millennium Challenge Account and Foreign Assistance: Transformation or More Confusion?

Lael Brainard
Lael Brainard National Economic Advisor - National Economic Council

March 1, 2003

On March 22, 2002, President Bush announced a plan to increase U.S. bilateral development aid starting in 2004, reaching an added $5 billion a year by 2006. The full increase in funding—nearly twice the size of existing U.S. bilateral development assistance programs—would set up a Millennium Challenge Account (MCA) to promote growth in reform-oriented developing countries. Nations receiving the aid would have to meet eligibility criteria involving good government, economic freedom, and investment in health and education.

The MCA presents an enticing opportunity to transform U.S. development policy toward the world’s poorest countries. With allocations based solely on economic performance and governance, the MCA would be the closest to a development purist’s blueprint for aid that the United States has ever attempted. Its clear criteria and substantial sums of money offered on enticing terms could create incentives for governments to improve economic policies and governance while helping strong performers sustain growth and improve investment climates. It could also force greater clarity of roles and missions among the many U.S. programs for developing nations. But the proposal is not without risk. The administration must take care not to add to the confusion of overlapping U.S. foreign assistance agencies. It must offer a clear-eyed vision of how the MCA fits alongside existing U.S. programs for developing nations, especially the Agency for International Development (AID), the 7,000-strong agency established in 1961 to promote “sustainable development.” It must also squarely address the tension between foreign policy and development goals that chronically afflicts U.S. foreign assistance.

Serving Two Masters

The tension between development and foreign policy is particularly acute because the MCA is being crafted at a time when national security has returned to the nation’s consciousness to an extent not seen since the Cold War. Indeed, the MCA was announced in the context of the war against terrorism, just months after the tragedy of September 11. President Bush explicitly cited the antiterrorism rationale in announcing the MCA: “We fight against poverty because hope is an answer to terror.”

More often than not, U.S. foreign assistance programs have failed because development and foreign policy objectives have pulled in different directions. It makes little sense to expect aid dollars that are allocated according to geopolitical criteria to promote growth and development. Aid allocated according to the logic of the Cold War has often been lost to corruption, waste, or diversion—as in Zaire, Liberia, Sudan, and Somalia. Billions were poured into Egypt after the Camp David peace accords without producing durable economic or political modernization.

It is important to distinguish between the principles guiding the allocation of aid among countries and the purposes on which aid is spent. Strictly speaking, for assistance to have the greatest development impact it must not only be spent on economic development but also be allocated on the basis of development worthiness. Most of what is considered “economic assistance” in the U.S. budget goes to countries based on political considerations, even though the money itself is used for economic purposes. Only about a third of U.S. bilateral economic assistance is now allocated among countries based on development priority—and of that, much is based not on performance but on assessed needs as well as U.S. political and economic objectives. In principle, pure development assistance should be allocated to the investments with the highest marginal value, determined by the extent of need (or the marginal social value) and the recipient country’s policy environment. The Millennium Challenge Account would try to isolate the highest potential investments by targeting only the best-performing poor countries.

The theory animating the MCA appears akin to a takeoff model, where foreign assistance plays a catalytic role at a critical stage, helping a country with good policies to attract investment and trade that enable it to graduate from the program rather quickly. Most development experts expect this process to take decades, rather than a few years. Nonetheless, many outside observers support the emphasis on strong policy environments and hope the focus on the best performers will win political support over time.

Critical Design Elements

As of the end of 2002, the Bush administration had developed details on some but by no means all elements of the MCA’s design. The Millennium Challenge Corporation will be a new government entity overseen by a board composed of cabinet officials and chaired by the secretary of state. It will have a staff of roughly 100 on limited-term appointments.

In the first two years only countries with per capita incomes below $1,435, the internationally recognized income threshold for “low-income” countries, will be allowed to apply. In the third year the pool will expand to include countries with incomes up to $2,975—the World Bank cutoff for lower-middle-income countries. The enlarged pool, which brings such strategically significant countries as Jordan, Egypt, and South Africa into the tent, could give MCA decisionmaking a political tilt.

Selection of recipients will be based on scores on 16 data indicators grouped in three broad areas: governing justly, investing in people, and economic performance. A country must score above the median on half of the indicators in each area to qualify—and must also score above the median on controlling corruption. Although the approach is as objective as one is likely to find in the realm of policy, in practice it can produce some surprising outcomes. A dry run undertaken by Steve Radelet, for example, finds that both China and Egypt would qualify for MCA aid despite China’s severe human rights deficiencies and Egypt’s history of wasted aid. Such anomalies will leave a big role for subjective judgment, which could also lead toward greater geopolitical bias, especially given the administration’s decisions to make the secretary of state head of the board of directors and to include wealthier—and more politically salient—countries in the third year. The emphasis placed by the MCA on virtue relative to need is starkly evident in that eligible countries are home to only 12.8 percent of the population of sub-Saharan Africa, the poorest region of the world.

The types of programs eligible for MCA aid still await definition. When first announcing the MCA, President Bush offered only broad-brush guidance about the programs it would fund: basic health, education, and poverty alleviation. Support for all these programs is broad not only in the administration and Congress but internationally. Although environmental and energy programs have garnered support at the international level and among some members of Congress, they do not appear to have many advocates within the administration, which has emphasized an interest in private-sector development and infrastructure investment—although AID has long since exited that troubled field.

Finally, the MCA proposal rests heavily on country ownership and accountability. In accord with a growing international consensus that development investments perform better the more they are formulated by the beneficiary government in the context of integrated development strategies, governments that meet the selection criteria would submit funding proposals of their own choosing, rather than be guided by U.S. consultants. The projects, once begun, would be rigorously monitored. Specialists familiar with the messy realities of development projects worry, however, about the limited capacity of poor-country governments to design and implement acceptable grant proposals. They also wonder whether an agency with a staff of 100 can effectively administer and monitor $5 billion in grants each year. The implied level of assistance disbursed per staff member is $50 million, more than 10 times the per-staff level typically disbursed by bilateral aid agencies.

What about AID?

Every administration for the past 30 years has tried to reform AID. The Bush administration has instead decided to design around it. Although development experts advocated creating the Millennium Challenge Corporation as an autonomous entity within AID, the administration established it as an independent corporation overseen by the State Department.

Far from rendering AID irrelevant, the decision to make the MCC an independent corporation has placed AID squarely in the spotlight. If the proposal is to transform U.S. development policy, it must articulate a clear division of labor among the MCC, AID, and other programs for developing nations.

The MCC would likely operate initially in countries that now account for one quarter of the economic assistance administered by AID. One could imagine a variety of scenarios regarding MCC and AID coordination within these countries. At one end of the spectrum, MCC qualification could mean that AID would pack its bags and move elsewhere. Or MCC could fund the top priorities of the local government, while AID maintained programs in areas of high priority to the United States, such as child survival and health and HIV/AIDs. Or responsibilities could be divided according to the different budget authorities of the two agencies, with AID limited to nonrecurring expenses such as teacher training and technical assistance, while the MCA specialized in capital expenditures, such as school buildings, and recurring costs, such as teacher salaries. Or over time, AID might continue to focus on social sectors, while the MCA became more focused on the private sector.

But most of these divisions entail problems that tend to blur the sharp identification of the MCA with the best performers. And from a practical standpoint, the administration has not yet determined what would happen to AID mission staff in those countries where the MCA was likely to operate. Certainly, it would be wasteful to duplicate staff. But if AID staff assisted with the preparatory work and contracting and helped monitor and evaluate MCC programs, it would suggest a troubling misalignment of AID staff incentives and responsibilities and heavy MCC dependence on AID.

For near-miss countries that failed to qualify for the MCA by virtue of one or two indicators, it is not yet clear which agency would take lead responsibility. This question is important because it is in precisely such countries that the promise of vastly increased foreign assistance could be catalytic in strengthening the policy environment. For near-miss countries, limited funding to address weak areas could be made available through the MCA but managed through AID on the presumption that greater oversight and involvement would be entailed than for normal MCA grants.

Even the clearest structure, where the MCA operates in high-capacity countries and AID in low-capacity countries, has some anomalous implications. If AID is left with three core missions—humanitarian assistance, transition assistance for post-conflict countries, and social assistance in poorly performing states—more of its programs will be directly related to foreign policy than ever before. And in principle, the MCA’s mission should be relatively free of foreign policy considerations. Yet the administration’s proposal would give the State Department the lead role on the board overseeing the MCA, while doing nothing to strengthen State’s input into AID decisionmaking.

Important questions also involve coordination among U.S. development programs more generally. Most obviously, the more the MCA moves in the direction of funding infrastructure and enterprise funds, the more it raises questions about overlap with the Overseas Private Investment Corporation, the Export-Import Bank, and the Trade and Development Agency. And U.S. development assistance will not achieve maximal efficiency and impact unless it is part of a coherent approach across all U.S. development programs, such as debt relief, trade preferences, and the credit-rating process. Creating another independent agency with its own idiosyncratic conditions threatens to add to the confusion. A strong mechanism to force interagency coherence would bring greater clarity, as would moving toward a single hierarchy of eligibility criteria over time, so that the best-performing poor nations would automatically qualify for the most flexible terms on trade access, debt treatment, development assistance, and export and investment programs. Unfortunately, the obstacles are high, including jurisdiction problems across agencies within the executive branch and across committees in the legislative branch.

Congressional Oversight

For the MCA to succeed, Congress must be a committed partner. But the MCA will win the necessary trust of Congress only if its design contains adequate self-executing safeguards.

Many of AID’s inefficiencies stem from its interpretation of requirements imposed by Congress in the budget process. AID shoulders a heavy burden of congressional earmarks—requirements setting aside specific portions of its budget for purposes such as child survival and health programs. It is also subject to numerous policy directives—274 at last count. Asked for the single best way to improve their performance, most AID employees would opt for “notwithstanding authority”—the kind of flexibility that allows the Office of Foreign Disaster Assistance to move money rapidly to newly identified needs. Notwithstanding authority makes it possible to bypass time-consuming contracting requirements and procurement regulations that often seem focused on economic stimulus in the United States, rather than in the beneficiary nation.

But to ask for such congressional self-restraint, the administration must put forward a design that builds in comparable self-restraint—for instance, self-executing safeguards against misuse of funds. The combination of transparent, rigorous selection criteria, limiting eligibility to the best performers, and strong accountability through continuous monitoring and periodic evaluations moves in this direction, but may not be enough.

It may also be hard to craft such a procedural deal because congressional oversight on foreign assistance is highly unpredictable. Although most congressional programs are reauthorized every one to five years, the mammoth Foreign Assistance Act of 1961 has not been reauthorized since 1986. The handful of new assistance programs authorized since then has come through piecemeal legislation; attempts at more systematic overhaul have failed. The problems with congressional oversight have numerous explanations, including the perception that foreign aid votes never win favors for members of Congress. Deep ideological differences also exist between key members on the foreign relations oversight committees. Because appropriations bills must be voted each year, much of the oversight normally assumed by the congressional authorizing committees has instead fallen to the appropriators, contributing to the proliferation of funding restrictions.

The administration would have the best chances of winning greater flexibility for the MCA by showing appropriate deference to the authorizing committees. Settling for a piecemeal approach would help the MCA’s chance of passage, even though amending the Foreign Assistance Act itself would better clarify the complementary mission of AID.

Promise and Pitfalls

The proposed creation of a $5 billion annual fund to promote growth in reform-oriented developing countries holds tremendous promise, but the pitfalls—not least the deteriorating U.S. budget outlook—abound. The task of winning Congress’s approval of MCA funding is itself sobering. And if the administration gets past that hurdle, others remain. If the selection process is overlaid with a geopolitical screen, if the MCA adds to the confusion surrounding AID’s mission, or if the MCA design does not contain adequate self-executing safeguards, the MCA will fall short. And the negative repercussions could be great. A failed MCC would quickly become yet another example of wasted aid, and the most expensive, and could undermine political support for foreign assistance for decades to come. With this in mind, it is extremely important to get it right the first time.