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What is Economic Freedom and What Can it Say About Prosperity?

by Matt Mitchell on May 24, 2011

in Economic Policy

My post in the NYT’s Room for Debate blog elicited a good number of comments and questions. So today I thought I might elaborate on the most-important of these questions: What exactly is economic freedom and what do we know about the way it affects prosperity?

First, its impact. The economists Chris Doucouliagos and Mehmet Ali Ulubqasoglu recently reviewed 45 studies examining the freedom-growth relationship. They concluded:

[R]egardless of the sample of countries, the measure of economic freedom and the level of aggregation, there is a solid finding of a direct positive association between economic freedom and economic growth.

Studies also find that economic freedom tends to be associated with a whole host of other factors that humans tend to value such as:

  • Higher income levels: Faria and Montesinos (2009) Dawson (1998), De Haan and Siermann (1998), De Haan and Sturm (2000), Cole (2003), Gwartney et al. (2004) and Weede (2006);
  • Lower poverty levels: Norton (2003);
  • Less volatility in the business cycle: Dawson (2010);
  • Better environmental outcomes: Norton (1998), ch. 2);

even:

  • Fewer homicides: Stringham and Levendis (2010); and 
  • Greater levels of reported happiness: Ovaska and Takashima (2006)

But what is economic freedom?

The concept is quite old, dating back to well-before Adam Smith. For his part, he called it “a system of natural liberty” and gave us a view of what he meant by it when he wrote:

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.

This, however, is still pretty vague.

So in the last quarter-century, a number of economists have focused on defining and—importantly—measuring economic freedom. There are now a number indices of economic freedom at both the national and sub-national levels. Among academics, the most-widely cited of these is the Economic Freedom of the World index, the latest of which is authored by Professors James Gwartney, Joshua Hall, and Robert Lawson. This index grew out of a series of conferences initiated by (Nobel Laureate) Milton Friedman and the Fraser Institute’s Michael Walker in the mid-1980s to early 1990s. Other attendees included economic luminaries such as “Lord Peter Bauer, Gary Becker, Douglass North, Armen Alchian, Arnold Harberger, Alvin Rabushka, Walter Block, Gordon Tullock, and Sir Alan Walters” (a number of whom have either won Nobel prizes in own their right or are likely to in the years that come). Out of these conferences, a consensus began to emerge that the four cornerstones of economic freedom were:

  • Personal choice,
  • Voluntary exchange coordinated by markets,
  • Freedom to enter and compete in markets, and
  • Protection of persons and their property from aggression by others.

From these conceptual cornerstones, the authors of the index began to gather data with an eye toward objectively measuring the degree to which the laws of different nations permit (or don’t) the exercise of economic freedom. Their index includes factors such as government consumption spending as a share of total consumption, top marginal income tax rates, the degree of judicial independence, growth in the money supply, taxes on international trade, and regulation of private sector credit (among 17 other components). The index now covers more than 140 countries, with data on many going back to 1970. And now there are literally hundreds of peer-reviewed articles that are based on this index or one of many others like it.

Since the publication of this index, a number of others have gotten in on the game. There are now indices that measure freedom at the sub-national level, the most-recent of which is Sorens and Ruger’s Freedom in the 50 States, published by Mercatus (the next addition of which is coming out soon). 

As I have recently noted, these state level indices suggest that economic freedom is a powerful predictor of prosperity.

So that, in a nutshell, is economic freedom.

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