Economic Freedom: Its Measurement and Importance
Free Economies Are More Prosperous
FEBRUARY 01, 1997 by JAMES D. GWARTNEY
Dr. Gwartney is professor of economics at Florida State University. More information about the index can be found in Economic Freedom of the World: 1975-1995 (Washington, D.C.: Cato Institute, 1996).
Since the time of Adam Smith, economists have generally argued that individuals will be more productive when they are economically free. Thus one would expect market economies to grow more rapidly and be more prosperous than those that are politically organized and centrally planned. Without a reasonable measure of economic freedom, however, how can one tell if this is true?
Beginning more than a decade ago, the Fraser Institute of Vancouver, British Columbia, spearheaded a drive to develop a sound measurement of economic freedom. They organized a series of conferences that focused on this topic. Input was solicited from several of the world’s leading economists, including Nobel laureates Milton Friedman, Gary Becker, and Douglass North. As the result of our participation in these conferences, Robert Lawson, Walter Block, and I developed an index of economic freedom.
The central elements of economic freedom are personal choice, freedom of exchange, and protection of private property. Our index contains 17 variables designed to measure the degree that these elements are present in various countries. The index is subdivided into four major areas: money and inflation, government operations, takings, and international trade. The components of the index are objective variables derived from regularly published data. For example, the components in the money and inflation area are: (a) the variability of the inflation rate during the last five years, (b) expansion in the money supply (adjusted for long-term growth of output), and (c) the freedom of citizens to maintain and use alternative currencies. In essence, the components of our index identify the degree to which the policies and institutions of a country are consistent with sound money, reliance on markets, protection of private property, and freedom of international exchange.
We compiled the data for each of the components and used it to derive a summary index rating for 102 countries in 1975, 1980, 1985, 1990, and 1993-1995. The economy of Hong Kong was the highest rated in the world in 1993-1995, a spot that it also achieved during each of the earlier rating years. The rest of the top ten during 1993-1995 were, in order, New Zealand, Singapore, the United States, Switzerland, United Kingdom, Canada, Ireland, Australia, and Japan. The countries with the least economic freedom during 1993-1995 were Zaire, Iran, Algeria, Syria, Nicaragua, Brazil, Burundi, Romania, Uganda, and Zambia.
In many ways, the change in a country’s rating is more interesting than the rating at a point in time. Economic theory indicates that economic freedom will enhance the gains from trade, specialization, and entrepreneurship. Therefore, countries with large increases in the index should achieve above-average growth rates.
The accompanying chart presents data on the growth rates of the ten countries with the largest increases in economic freedom between 1975 and 1990. The identical data are also presented for the ten countries with the largest declines. The per capita GDP of the ten countries that registered the most improvement grew at an average annual rate of 2.7 percent between 1980 and 1994. All of the countries that moved toward economic freedom achieved positive growth rates of per capita GDP. In contrast, the countries with the largest reductions in freedom experienced an average decline in per capita GDP of one percent per year. Only two of these countries were able to achieve positive rates of economic growth.
The components of the economic freedom index are all indicators of institutional structure and economic policy. None of them is a proxy for either growth or level of income. Thus, there is nothing inherent in the organization of the data that would explain the strong positive relationship between increases in economic freedom and growth. The relationship could just as well have been negative or random. The fact that it was positive is strong evidence that Adam Smith was right—free economies are more prosperous.
1. James Gwartney, Robert Lawson, and Walter Block, Economic Freedom of the World: 1975-1995 (Washington, D.C.: Cato Institute, 1996). The book was co-published by the Fraser Institute in Canada and nine other institutes around the world.