Freedom Generates Prosperity

Trade and Economics - January 2, 2022

Since 1996, a group of economists have sought to survey economic freedom all over the world…

It was in August 1983 at the Mont Pelerin Society regional meeting in Vancouver. One day, I shared a table at lunch with, amongst others, Professor Harold Demsetz of the University of California in Los Angeles, UCLA. I was young and waxing enthusiastically about freedom. Demsetz, a thoughtful, soft-spoken economist, challenged me: ‘What is freedom? I don’t understand what we are talking about unless it can be measured.’ I was slightly taken aback. With my background in philosophy and history, I had never thought of freedom as in any way measurable. But I quickly realised that Demsetz had a point. We should have a rough idea of how to measure freedom in different societies, at least in order to determine what counts for more or less of it at any given time. Indeed, in the 1980s and 1990s a group of economists under the leadership of Nobel Laureate Milton Friedman, his wife Rose, Dr. Michael Walker of the Fraser Institute in Vancouver and Professor James Gwartney, the author of a widely used economics textbook, began to construct an Index of Economic Freedom, publishing their first report in 1996. Since then, Gwartney and his associates, Robert Lawson, Joshua Hall, and Ryan Murphy, have worked tirelessly on improving the Index. The latest report was published in September 2021, with data from 2019.

How is the Index Composed?

Gwartney and his associates measure economic freedom in five areas, size of government, legal systems and property rights, sound money, freedom to trade internationally, and regulation. In the first area, it is assumed that an increase in government spending, taxation, and the size of government-controlled enterprises leads to the substitution of government decision-making for individual choice and to a reduction in economic freedom. In the second area, what is seen to matter is the protection of persons and their rightfully acquired property, a central element of both economic freedom and civil society, indeed the most important function of government. In the third area, it is recognised that inflation erodes the value of rightfully earned wages and savings. Sound money is thus essential to protect property rights. When inflation is not only high but also volatile, it becomes difficult for individuals to plan for the future and thus use economic freedom effectively. In the fourth area, what is measured is the freedom to exchange, in its broadest sense, buying, selling, making contracts, and so on. It is regarded as essential to economic freedom, which is reduced when the freedom to exchange does not include businesses and individuals in other nations. In the fifth area, it is emphasised that governments not only use a number of tools to limit the right to exchange internationally: they may also impose onerous regulations that limit the right to exchange, gain credit, hire or work for whom you wish, or freely operate your business. Altogether, forty-two data points in those five areas are used to construct the index. To the utmost extent possible, the data come from publicly accessible sources, such as the World Bank and statistical bureaus, not from subjective estimates.

In the 2021 report, 165 jurisdictions were surveyed. It turned out that Hong Kong had in 2019 the freest economy in the world, with Singapore coming second. The authors noted however that economic freedom in Hong Kong was likely to decline in the near future as a result of measures undertaken by the Chinese Communist Party. The two former British colonies, Hong Kong and Singapore, were followed by New Zealand, Switzerland, Georgia, the United States, Ireland, Lithuania, Australia, and Denmark, in that order. Notably, the freest economies are mostly those of small countries, with the exception of the United States which is however a federation of fifty small states. There is a systemic reason for this, I believe: small states need open borders if they are to benefit from the division of labour between nations. They are therefore likely to allow and indeed encourage free trade. The United Kingdom is number 12 on the Index, Finland number 21, Iceland number 23, and Norway and Sweden are tied at number 37. The case of Iceland is striking. She saw a steady increase in economic freedom from 1990 to 2005, as a comprehensive programme of liberalisation, stabilisation and deregulation was implemented by David Oddsson, Prime Minister in 1991–2004. After the 2008 bank collapse the economy became much unfreer, under a radical left-wing government which was however voted out in 2013. In 2010, the Icelandic economy had sunk to number 98 on the Index of Economic Freedom! Since 2013, Iceland has been slowly climbing up the list. The unfreest economies in the world are in the Central African Republic, the Democratic Republic of Congo, Syria, the Republic of Congo, Iran, Zimbabwe, Algeria, Libya, Sudan, and, lastly, Venezuela. Neither North Korea nor Cuba are included in the survey, for obvious reasons.

Economic Freedom: Escape from Poverty

It is widely recognised that in the last two decades of the twentieth century, the era of Hayek and Friedman, and of Thatcher and Reagan, economic freedom in the world grew significantly. It is perhaps less well known that in the first two decades of the twenty-first century, economic freedom continued to grow. Between 2000 and 2019, the average economic-freedom rating increased to 7.04 from 6.61. What is really remarkable however is the comparison between different economies. In the report, the economies surveyed are divided into four groups, the freest quartile, the next-freest one, the next-unfreest one, and the unfreest one. One comparison between these quartiles is in terms of income. The differences are staggering. Nations in the freest quartile had an average per-capita GDP of $50,619 in 2019, compared to $5,911 for nations in the bottom quartile (PPP constant 2017, international$). Another comparison, in terms of poverty, is even more telling. In the freest quartile, the average income of the poorest 10 per cent was $14,400, compared to $1,549 in the unfreest quartile. Interestingly, the average income of the poorest 10 per cent in the economically freest nations was more than twice the average per-capita income in the unfreest nations. Moreover, in the freest quartile, 0.9 per cent of the population experienced extreme poverty (US$1.90 a day) compared to 34.1 per cent in the unfreest quartile. Yet another remarkable fact is that life expectancy was 81.1 years in the freest quartile compared to 65.9 years in the unfreest quartile. Again, literacy was 95.1 per cent among men and 94.1 per cent among women in the freest nations but only 64.7 per cent and 59.7 per cent respectively in the unfreest nations.

As a political philosopher, I find these data highly relevant. Demsetz certainly had a point in our discussion almost forty years ago. One of the most-acclaimed philosophers of the twentieth century, Harvard Professor John Rawls, in 1971 presented a theory of justice according to which income distribution in a just society had to be such that the conditions of the worst off would be as good as they could possibly be. This was called the ‘maximin’ rule: it was about maximising the minimum. Rawls argued that this was a rule which enlightened, self-interested but risk-averse people would adopt under a ‘veil of ignorance’, where they would not know in which income group they would themselves end up. The only justification for income inequality was, Rawls said, if it benefitted the poor. There are many flaws in Rawls’ theory, as I (and many others) have pointed out, but it certainly leads to an important question: What kind of economy is likely to offer the worst off the best opportunities? The comparison between the quartiles suggests an answer which is intellectually satisfying because it is systemic rather than anecdotal: Economic freedom offers the worst off the best opportunites to escape poverty. It is an intriguing and important fact that the average income of the poorest 10 per cent in the economically freest nations turns out to be more than twice the average per-capita income in the unfreest nations. In short, capitalism—by which I mean a system of private property, free trade, and limited government—passes with flying colours Rawls’ test for a just income distribution. It is not surprising that ordinary people try to get from Cuba to Florida, or from China to Hong Kong, or from Venezuela to almost any other country in the world.

Human Freedom

Although a strong connection thus can be established between freedom and prosperity, it need not be a one-way causal connection. It is not enough to increase economic freedom and then wait expectantly for general prosperity to follow. Economic growth depends on many variables, including institutions and conventions which will usually only develop slowly. Under normal circumstances, economic freedom may be a necessary condition of prosperity, but it is not, at least in the short run, a sufficient condition. Also, there is more to a good life than economic freedom, as the sad example of Hong Kong shows. Man lives not by bread alone. Therefore, experts at two think tanks, Fraser in Canada and Cato in the United States, have constructed the Index of Human Freedom where they build upon the detailed and meticulous work done by Gwartney and his associates, while they broaden the scope and include political and intellectual freedoms. That is a story for another time.