The Benefits of Economic Freedom: A Survey
Berggren, Niclas, Independent Review
The absence of economic growth implies the continued existence of poverty and hardship. The International Monetary Fund (IMF 2001) and others now perceive the prospects for global economic growth to be relatively weak.
Neoclassical economic theory explains economic growth as a function of changes in four factors--capital, labor, human capital, and technology (Romer 1990)--but the question remains: Which economic policies are most favorable to growth? A new line of research on economic freedom answers as Adam Smith did long ago. "Economic freedom" means the degree to which a market economy is in place, where the central components are voluntary exchange, free competition, and protection of persons and property (Gwartney and Lawson 2002, 5). The goal is to characterize the institutional structure and central parts of economic policy.
Economic freedom may constitute an explanatory factor for growth and the distribution of income. In econometric analysis, economic freedom is thus an independent variable. However, economic freedom may also be affected by other variables and thereby constitute a dependent variable, possibly influenced by factors such as political freedom, wealth, or democracy. (1)
The most ambitious attempt to quantify economic freedom is the Economic Freedom Index (EFI) reported annually in Economic Freedom of the World (Gwartney and Lawson 2002). (2) Since 1996, data updated yearly have been published, and the data now cover the years 1970, 1975, 1980, 1985, 1990, 1995, and 2000. These data have begun to be used in scholarly research, which has contributed to increasing our knowledge of the importance of economic freedom.
Another such index is published by the Heritage Foundation in cooperation with the Wall Street Journal (O'Driscoll, Holmes, and O'Grady 2002). (3) This index and the EFI are similar in their overall implications, but because the EFI has been used more extensively in academic contexts (in part because the other index goes back only to 1995 and uses more subjective variables), (4) it is the focus of this article, which surveys the recent literature in the field.
The Concept of Economic Freedom
Economic freedom is a composite that attempts to characterize the degree to which an economy is a market economy--that is, the degree to which it entails the possibility of entering into voluntary contracts within the framework of a stable and predictable rule of law that upholds contracts and protects private property, with a limited degree of interventionism in the form of government ownership, regulations, and taxes. (5) Economic freedom is distinct from political freedom (participation in the political process on equal conditions, actual competition for political power, and free and fair elections) and from civil freedom (protection against unreasonable visitations, access to fair trials, freedom of assembly, freedom of religion, and freedom of speech).
The EFI is a means of measuring the degree of economic freedom by including thirty-seven components divided into five groups in an index for the years 1970 (54 countries), 1975 (83 countries), 1980 (105 countries), 1985 (111 countries), 1990 (113 countries), 1995 (123 countries), and 2000 (123 countries). The five groups are (1) size of government: expenditures, taxes, and enterprises; (2) legal structure and security of property rights; (3) access to sound money; (4) freedom to exchange with foreigners; and (5) regulation of credit, labor, and business. (6) Each component is measured from 0 ("no economic freedom") to 10 ("full economic freedom"). The index is calculated using arithmetic averages. It should be noted that the components of the EFI, as well as weighting schemes, have changed in the various editions that have been published. Hence, when comparing studies, one needs to be careful to clarify which editions one uses.
Table 1 presents the EFI values in 2000 for a number of countries, as well as the percentage change of the index since 1970. …