Question

Do you think if there seems to be a correlation between economic freedom and economic growth? Summarize your findings.

Answer 1

The relationship between economic freedom and economic growth has always been frequently discussed in the economic literature. Economic freedom is often believed to enhance economic growth, which in turn creates more economic freedom.

For over a hundred years, the economic world has been engaged in a great intellectual debate. On one side of this debate have been those philosophers and economists (Like Adam Smith) who advocate an economic system based on private property and free markets—or what one might call economic freedom. The key ingredients of economic freedom are personal choice, voluntary exchange, freedom to compete in markets, and protection of person and property. Institutions and policies are consistent with economic freedom when they allow voluntary exchange and protect individuals and their property.

On the other side of this debate are people hostile to economic freedom who instead argue for an economic system characterized by centralized economic planning and state control of the means of production. Advocates of an expanded role for the state include Jean-Jacques Rousseau and Karl Marx and such twentieth-century advocates as John Kenneth Galbraith. These scholars argue that free markets lead to monopolies, chronic economic crises, income inequality, and increasing degradation of the poor, and that centralized political control of people’s economic lives avoids these problems of the marketplace. They deem economic life simply too important to be left up to the decentralized decisions of individuals.

In the early twentieth century, state control grew as communism and fascism spread. In the United States, the New Deal significantly expanded the role of the state in people’s economic lives. In the late 1970s and early 1980s, economic freedom staged a comeback, with deregulation, privatization, and tax cuts. Of course, the major increase in economic freedom came with the fall of the Soviet Union. Today, the advocates of freedom dominate the debate.

Substantial evidence has informed the debate. Indeed, the stark differences in the standards of living of people in economically freer systems compared with those in less-free systems have become more and more obvious: North versus South Korea, East versus West Germany, Estonia versus Finland, and Cubans living in Miami versus Cubans living in Cuba are examples. In each case, people in the freer economy have better lives, in virtually every way, than their counterparts in the less-free economies.

Measuring Economic Freedom

Organization such as the Fraser Institute, as well as individual scholars, published “economic freedom indexes” attempting to quantify economic freedom. Using data from the World Bank, International Monetary Fund, Global Competitiveness Report, International Country Risk Guide, and others, the report rates countries on a zero-to-ten scale. Higher scores indicate greater economic freedom. The overall index is based on ratings in five broad areas.

Size of government. To get high ratings in this area, governments must tax and spend modestly, and marginal tax rates must be relatively low.

sound money is a measure of how much the government refrains from abusing its monopoly power. To get high ratings here, a country’s inflation must be low and stable, and the government must permit people to own currencies of other nations.

Property rights and rule of law. This area measures the consistency of a country’s legal system with the protection of property, enforcement of contracts, and evenhanded application of the law.

International trade. Countries that refrain from enacting protectionist tariffs, quotas, and capital controls get higher ratings in this area.

Regulation. Regulations such as interest-rate controls (usury laws), restrictions on bank ownership by foreigners, minimum wages, military conscription, business licensing, and price controls are included. Such controls and regulations violate the principles of economic freedom.

Some countries, such as Hong Kong, Singapore, and the United States, consistently registered high ratings throughout the 1980s and 1990s. Germany’s economic freedom rating has also been quite steady. Among developed countries we also have seen some big reformers. Ireland, U.K. and New Zealand has been the gainer. The world’s two largest economies by population, India and China, both have low ratings. While their current ratings are still low by world standards, these improvements in economic freedom have been quite substantial; both countries’ economies are growing rapidly as a result.

Among the former Soviet and centrally planned economies, some have succeeded greatly in increasing economic freedom. Estonia now ranks thirteenth in the world, having instituted nearly complete free trade, a stable monetary policy, and considerable fiscal restraint. In 1995, it was ranked eighty-first.

While there is no clear evidence that economic freedom creates greater income inequality, there is clear evidence that lowest-income people in freer countries are better off than their counterparts in less free countries.

As time goes on, these measures of economic freedom will improve and our understanding of the relationship between private property and free markets and economic performance will similarly improve. But in the great debate between economic freedom and political planning, the evidence is increasingly clear. Economic freedom leads to better economic results.