View Paper

LINDSEY GIFFIN
Economic Freedom and Its Impact on Standard of Living
(Under the Direction of DR. DAVID B. MUSTARD)
1. INTRODUCTION:
The disparate economic conditions of developed and developing nations have made
foreign aid centrally important in today’s global economy. There is widespread debate
concerning the effectiveness of financial aid to developing countries. Every year developed
countries devote over $50 billion in aid to improve the standard of living in developing countries
(Godoy 2002). Unfortunately this approach to aid does not induce institutional change and
provides only a short-term solution to a fraction of citizens; the per capita income of a majority
of the recipient countries of aid has actually dropped since receiving the funds (Eiras 2004).
Years of futilely sending funds to developing countries without conditioning on the economic
policies of the government has subsidized the poor governance of many nations and trapped their
citizens in poverty (Fuelner 2004). A longer-term, more inclusive solution is needed. The key is
not sending aid so that the government can provide for the citizens but rather opening up markets
so that the citizens can provide for themselves. A nation needs to change its fundamental
institutions to induce economic growth and improve the standard of living.
In January 2004 the Bush administration introduced a promising new approach to foreign
aid, the Millennium Challenge Account. This fund will support only governments that have
initiated “growth-promoting governance and economic policies” (Powell 2004). Aid is
conditional on the degree to which countries rule justly, invest in their citizens, and most
importantly, promote economic freedom. Conditioning aid on improving economic freedom
could be a substantial step toward alleviating the poverty that plagues billions. Kim Holmes
1
(2004) states “economic freedom is…as essential to economic growth as elections are to
democracy.”
Economic freedom measures the ability to conduct commerce in an environment where
property rights are secured and there is minimal governmental interference (Gwartney and
Lawson 2002). Past research shows a causal link between increased economic freedom and
economic growth. This study examines whether increased economic freedom also improves
standards of living. Economic freedom considers five aspects of a nation’s economic
institutions: minimal government, secure property rights, access to sound money, freedom to
trade internationally, and regulation of business, credit, and labor. Rather than study the effects
of improved economic freedom in aggregate, it is important to investigate the effects of each
individual aspect before advising change.
Using empirical evidence from over 120 countries and over 20 years, this study examines
the effects of each of the different aspects of economic freedom on a variety of standard of living
variables, including measures of education, health, and access to modern technology. The
analysis reveals that more secure property rights, more freedom to trade internationally, and less
regulation of business, credit, and labor increase standard-of-living measures. However. a
smaller government decreases the standard of living in all but one measure. Additionally. a
sound legal system and secure property rights have the largest impact on improving the lives of a
nation’s citizens. Using the results of this study and previous research, developed nations can
construct effective foreign aid initiatives that improve the lives of citizens in developing nations
by enhancing economic freedom.
Section 2 explores the previous research relating economic freedom and growth
prospects. Section 3 lays out the regression model, a detailed description of the data used, and a
2
predictive theory. The regression results and analysis follow in section 4, and finally concluding
remarks sum up the findings.
2. REVIEW OF LITERATURE:
Economic freedom allows individuals and firms to voluntarily exchange and produces
mutually beneficial outcomes. In 1776, Adam Smith, a moral philosopher who is regarded by
many as the father of economics, proposed that economic freedom causes economic growth and
“the wealth of nations.” Many policymakers agreed with Smith’s premise and implemented
policies consistent with this theory, until a series of events in the early part of the twentieth
century, including two world wars and the Great Depression, changed the dominant theory of
economic growth to one that called for active government intervention and increased
protectionism; examples include wage and price controls and extensive regulation. However,
there has been a recent trend back towards more free markets, as real-life experiments exhibited
the prosperity of market-driven South Korea and West Germany compared to the devastation of
centrally planned North Korea and East Germany. Additionally the fall of the communist Soviet
Union demonstrated that government could not distribute resources more efficiently than the
market. The pendulum of thinking has once again swung back toward the side of economic
freedom (Holcombe 1998).
Because the present time is characterized by global integration, it is more important than
ever that developing countries understand how to take advantage of this global economic growth
and translate it into increased standards of living for its citizens. Ian Vasquez (2002) asserts that
“globalization holds the most promise for developing countries with respect to economic growth,
poverty reduction, and the reversal of global inequality.” He suggests that developing countries
follow the lead of historical examples such as Europe, which improved living standards threefold
3
in the nineteenth century, and the United States, which quadrupled them in this same period.
Consistent with the institutional theory of growth (Gwartney and Lawson 2002), Vasquez (2002)
contends that the West’s advancement and economic growth was not by luck, but by an
environment that provided individuals and organizations freedom and incentives through
protection of property rights.
Aside from individual historical examples of successful market economies,
comprehensive empirical studies also support the theory that increased freedom leads to
economic growth. The most widely regarded study is the Fraser Institute’s Economic Freedom of
the World (EFW). After indexing the economic freedom of over 120 different countries, the
study charts a variety of factors of the different EFW index quintiles. The study finds that
increased economic freedom is correlated with higher per-capita income, economic growth, life
expectancy, income level of the poorest 10%, adult literacy, access to treated water, and political
rights and civil liberties. On the other hand, it is correlated with lower infant mortality,
percentage of children in the labor force, and corruption (Gwartney and Lawson 2002).
In addition to empirical evidence, theoretical constructs show how economic freedom
increases economic growth. Douglass North (1990) asserts institutions determine, in large part,
the incentives of economy participants. When institutions promote the production of increased,
valuable output, they promote economic growth. Niclas Berggren (2003) determines (or another
synonym of “asserts”) several reasons why countries that are economically free promote a
number of growth-enhancing incentives:
They promote a high return on productive efforts through low taxation, an independent
legal system, and the protection of private property; they enable talent to be allocated
where it generates the highest value; they foster a dynamic, experimentally organized
economy in which a large amount of business trial and error can take place and in which
competition between different actors occurs because regulation and government
4
enterprises are few;…and they promote the flow of trade and capital investment to where
preference satisfaction and returns are the highest.
Most research looks at the effects of economic freedom in aggregate. It is important,
however, not to generalize the effects of different aspects of economically free institutions.
Fredrik Carlsson and Susanna Lundstrom (2002) studied the specific aspects of economic
freedom that contribute to economic growth. They found that, although in aggregate a larger
economic freedom index (as measured by an average EFW index from 1975-1995) led to
economic growth, two categories, size of government and freedom to trade with foreigners, were
negatively related to GDP growth. Also they found monetary policy and price stability to have
an insignificant effect on economic growth. Unfortunately, the paper does not offer further
theoretical support for these findings.
Another area of research with regard to economic freedom and economic growth is
establishing the causal link of freedom to growth. Manuel Vega-Gordilla and Jose Alvarez-Arce
(2003) conducted a causality study examining the relationships between economic freedom,
political freedom, and economic growth. The results showed that economic and political
freedom enhanced economic growth. However, the effect of economic freedom was nearly
double that of political freedom. More importantly the study did not find that economic growth
was a predictor of economic freedom; this demonstrates that economic freedom causes growth
and not vice versa.
3. EMPIRICAL MODEL, DATA, AND THEORY:
To analyze the impact of changes in economic freedom on standards of living, I estimate
the following regression for each of eight measures of standard of living:
Yit = α + β EFit + δ Xit + τT t + ε it
5
The dependent variable is the standard of living measure, Yit, corresponding to country, i,
and year, t. The term EFit is a vector of four economic freedom variables. The term Xit
represents a vector of control variables including GDP per capita and GDP growth per capita.
The term T t is vector of year fixed effects. By controlling for time fixed effects, I net out the
effect that the passage of time and external environmental events have on the dependent
variable.1 ε it is the error term that accounts for all other unobserved factors affecting the standard
of living measure.
To measure economic freedom, I used the Fraser Economic Freedom of the World
Report. This publication is the collaborative work of the Fraser Institute and members of the
Economic Freedom Network. Data on economic freedom in 123 countries are reported for every
five years dating back to 1970 and for 2001 and 2002. Another highly regarded measure of
economic freedom published by the Heritage Foundation and The Wall Street Journal entitled
the Index of Economic Freedom, is also widely used in research. However, because this index
has data dating back only to 1995 it does not capture the significant, recent changes in economic
freedom in Eastern Europe brought about by the collapse of the Soviet Union. Therefore, the
Fraser report was a better resource for this paper.
The Economic Freedom of the World Annual Report is broken down into five major
categories and then further into numerous sub-components. Each sub-component is scored on a
ten-point scale, with ten being the most economically free, and these ratings are averaged for
each major category (Gwartney and Lawson 2002). I use this category average for four of the
1
To solve the problem of perfect multicollinearity it is necessary to exclude one of the years. I excluded y1980
from the equation.
6
five major categories of economic freedom2, which include size of government, legal structure
and security of property rights, freedom to trade internationally, and regulation of credit, labor,
and business. This study is expected to show that as people are granted more freedom to conduct
economic activities, they allocate their resources in more productive ways to increase economic
growth and the standard of living. A description of the components included in each measure of
economic freedom follows.
A. The Size of Government
The size of government variable measures the extent to which economies are run by the
market or by the government. The smaller the relative government size, the higher EFW rating a
country receives for this measure; the measure is an inverse relationship. The larger the
government the larger share of the economy it will control, interfering with individual choice and
hindering the economic freedom of its citizens. Additionally, the relative size of transfers and
subsidies are measured; the more transfers and subsidies a government imposes, the less it
protects people’s rights to keep what they own. Government enterprise and investment is the
third sub-component making up the size of government variable. The more goods and services
are produced by the government rather than the private sector, the less of a role market forces
play in the economy. Finally the top marginal tax rate rounds out the measure of size of
government. As citizens are taxed more they lose their rights to keep what they earn and decide
for themselves how they should allocate their resources (Gwartney and Lawson 2002). When
government size is reduced, and smaller transfers, subsidies, and taxes enable people to keep
more of their money, the standard of living goes up. However, there may be some instances
when, due to the communal nature of certain goods and services, a smaller, more economically
2
I exclude one category, sound money, for both theoretical and empirical reasons. Theoretically, access to sound
money is the measure most indirectly tied with standard-of-living variables. Empirically, other research has shown
it to have little effect on the outcomes of interest (Carlsson and Lundstrom 2002).
7
free government size could actually decrease standard of living (Roll 2004). Examples of such
public goods include education, national defense, and environmental protection (Carlsson and
Lundstrom 2002).
B. Legal Structure and Security of Property Rights
The base of a successful economy is the assurance that the fruits of one’s labor will be
protected and contracts will be enforced. Components that make up the legal structure and
security of property rights category are judicial independence, impartial courts, protection of
intellectual property, military interference, and integrity of the legal system. As it is difficult to
measure these objectively, and quantitatively, the ratings for this category are based upon two
surveys, The International Country Risk Guide and The Global Competitiveness Report. Secure
property rights play an integral part in economic freedom; without it freedom to conduct
commerce is difficult, as people will not transact without assurance that the legal system will
protect what they earn (Gwartney and Lawson 2002). The standard of living increases when
property rights are enforced through a secure legal system because people have incentives to
work and create wealth. Additionally, the exchanges that private property rights facilitate
communicate very valuable information, for example prices, allowing participants to make
economically sound decisions concerning allocation of resources.
C. Freedom to Trade Internationally
True economic freedom is not only the ability to conduct commerce domestically but also
the freedom to transact internationally. The freedom of a country to trade internationally is
measured by the taxes on exports and imports in the form of tariffs, both overt and hidden trade
barriers, the actual size of the trade sector relative to its expected size, the official versus the
8
black market exchange rate, and the government-imposed restrictions on capital markets. The
data reflected in the ratings for this category are a combination of survey data from the Global
Competitiveness Report and quantitative, objective measures. The higher the costs to trade
internationally due to protective, restrictive trade policies and interference in foreign capital
markets the less economically free a country is (Gwartney and Lawson 2002). Lower trade
barriers and an environment conducive to trade allow countries to benefit from mutual gains and
efficiently allocate resources to their most productive uses, increasing consumption possibilities
for these nations and their citizens.
D. Regulation of Credit, Labor, and Business
The final category of economic freedom used in my study is regulation of credit, labor,
and business. Like the measure of government size, this measure is also inversely related to the
amount of regulation. The less regulation of the economy, the higher EFW rating the country
receives. The more regulation a government imposes the less market forces are allowed to work
to drive the economy to the most mutually beneficial outcomes. Freedom from regulation in the
credit industry requires that private banks supply credit to those who desire it at marketdetermined interest rates. A free labor market creates an environment with incentives to work
hard such as low unemployment benefits and flexible labor laws. Finally it is important that
business activities be free from regulation. Prices should be market determined, and barriers to
entry and other regulations should be low or nonexistent, allowing competitive practices to create
efficient markets. Since the effects of many regulations cannot be concretely measured, almost
two-thirds of the ratings in this category are based on survey data (Gwartney and Lawson 2002).
It is anticipated that as regulation on business, credit, and labor markets decreases, standard of
9
living will increase because individuals and organizations are enabled to work unhindered,
eliminating the economic waste produced by bureaucracy and prohibitive standards.
The World Bank’s 2003 World Development Indicators provided data for measures of
economic well-being and standard of living. This is the World Bank’s annual report of
development around the globe. The study encompasses 208 countries and reports over five
hundred indices annually from 1960 to 2001. To account for overall differences in the economic
status of the countries on the standard of living, I incorporated GDP per capita and annual
percentage GDP growth per capita as control variables in my study. GDP per capita measures
the gross domestic product of a country divided by its mid-year population in constant 1995 US
dollars. The percentage annual growth rate of GDP per capita is based on constant local currency
of the respective country (World Bank 2003). Unlike many studies that use GDP and GDP
growth as the dependent variables regressed onto economic freedom indices, I incorporate these
as additional independent variables to net out their effects on the standard of living.
To measure the standard of living I chose eight variables encompassing a range of
different aspects of well-being. Incompleteness of data prohibited me from using a number of
measures that could have more accurately depicted the standard of living in the respective
countries, such as poverty headcounts, unemployment rates, improved water sources, and
education levels of labor force. Using the most complete data possible, I chose literacy rate,3
percentage gross school enrollment in primary, secondary, and tertiary schools, immunization
rate, life expectancy at birth, abundance of telephone mainlines, and electricity production. The
literacy rate measures the percentage of citizens over fifteen years old who can read and write on
a simple base level. Percentage gross school enrollment in primary, secondary, and tertiary
3
To maintain uniformity is the interpretation of the coefficient estimate, I converted reported illiteracy rate into
literacy rate. Therefore a positive coefficient estimate is interpreted as more economic freedom and growth
contribute to a higher standard of living as measured by literacy.
10
schools is a ratio of the total school enrollment to the total number of children in the population
that correspond to the official age group of the respective school level. The United Nations
Educational, Scientific, and Cultural Organization provides all these education data.
The immunization rate is measured as the percent of children under the age of one who
received one dose of vaccine for the measles as reported by the World Health Organization.
Additionally, total years of life expectancy at birth indicate the health of a nation.
To measure citizens’ access to modern technology I looked at the number of telephone
mainlines, or lines connecting an individual’s telephone to the public telephone network, per one
thousand people. This information is provided by the International Telecommunications Union.
Additionally, the number of kilowatt hours of electricity produced in a country as provided by
the International Energy Agency reflects the modernity of a nation.4 I examine education,
health, and technology-related measures to get a broader picture of the standard of living in each
country.
My study evaluated all countries included in both the World Bank and Fraser data sets;
since Fraser was the smaller data set, it was the main determinate of the countries selected. Only
two of those included in the Fraser set were not included in the World Bank data;5 consequently,
my study contains repeated cross sections of 121 countries6 in 1980, 1985, 1990, 1995, 2000, and
2001. By incorporating a span of over 20 years, I capture the effects of changes in economic
freedom rather than simply differences in static scores across countries. Only measures from
every five years are studied because the Fraser data set only reports measures for every five years
up until 2001. I chose 1980 as the start date for my study because 1980 marks the start of the
4
To convert this measure to one that can be used in comparisons across countries of different populations, I divided
it by population to get electricity production per capita.
5
South Korea and Taiwan were included in the Fraser data set but not the World Bank data set.
6
See the Appendix for all the countries contained in the sample.
11
current wave of globalization. Unlike the previous wave of globalization between 1950 and 1980
that integrated developed nations into a global market, the present wave has also integrated
developing nations into this market (Collier and Dollar 2002). Additionally this start date allows
me to capture the dramatic changes in economic freedom in Eastern Europe in the late 1980’s
and early 1990’s brought about by the fall of the Soviet Union. The effects of increased
economic freedom on standard of living can be seen most overtly in these nations.
4. RESULTS:
A. Educational Outcomes
Table 1, found in the appendix, provides the results of the regression for educational
outcomes. Varying degrees of economic freedom have substantial effects on education rates. For
every one-point increase in the rating of freedom to trade, the literacy rate increases by
approximately 3.2 percentage points. Increased property rights have effects similar in scale to
those of free trade on educational variables. The literacy rate is predicted to increase by 2.7
percentage points for every one-point increase in the legal structure and security of property
rights rating. Government size, however, does not have a statistically significant effect on
literacy rate. The final measure of economic freedom, regulation of credit, labor, and business,
has no statistically significant effect on literacy either. As would be intuitively predicted, the
level of GDP per capita has both a statistically and economically significant effect on the literacy
rate of a nation. For every one-thousand-dollar increase in GDP per capita literacy increases by
one percentage point. GDP growth per capita, however, does not have a statistically significant
effect on literacy.
Similar to free trade’s effect on literacy, a one-point increase in this measure increases
primary-school enrollment by 2.38 percentage points. Unlike the other educational measures,
12
increased property rights do not have a statistically significant effect on primary-school
enrollment in this study. On the other hand, the government size measure has a statistically
significant but negative effect on school enrollment. As government size decreases, primaryschool enrollment decreases by 1.09 percentage points. As regulation of credit, labor and
business decreases, primary-school enrollment increases by 1.8 percentage points. An increase
in the growth of GDP per capita by one percentage point raises enrollment by .70 percentage
points, but GDP per capita alone does not have a statistically significant effect on primary school
enrollment.
The results on secondary-school enrollment vary somewhat from those on primary-school
enrollment. A one-point increase in a country’s free trade measure increases secondary-school
enrollment by 2.52 percentage points. Unlike primary-school enrollment, secondary-school
enrollment is positively and statistically significantly affected by more secure property rights.
An increase of the property rights variable increases enrollment by over 3.6 percentage points.
Government size once again has a negative effect on school enrollment that is both economically
and statistically significant. Conversely, regulation of credit, labor, and business affects
secondary-school enrollment on the same scale but in the opposite direction. A one-point
increase in the regulation rating of a nation increases secondary-school enrollment by 3.8
percentage points. As for the control variables, every thousand-dollar increase in GDP per
capita increases secondary-school enrollment by 1.16 percentage points; however, GDP growth
per capita has no statistically significant effect.
Unlike all the other educational measures, free trade does not have a statistically
significant effect on tertiary-school enrollment. More secure property rights do have a positive
and significant effect on tertiary-school enrollment with an estimated coefficient of 3.66.
13
Consistent with the other levels of schooling, an increase in the rating of government size has a
negative effect on enrollment. Reduction of regulation of credit, labor and business increases
tertiary school enrollment by about 1.8 percentage points. Also for every thousand dollar
increase in GDP, tertiary-school enrollment goes up by .5 percentage points. Once again GDP
growth per capita is statistically insignificant.
In summary, the effects of increased economic freedom are largely as anticipated. The
more economic freedom a nation has, the higher its education rates. The only exception is the
negative effect that a decrease in government size has on school enrollment; however, upon
further study, these results make sense. In past research, government expenditure has been
positively correlated with wealth. Although too much government interference can be a
hindrance to developed economies, a threshold of government involvement is necessary to
establish the basic infrastructure of society, especially concerning public goods such as
transportation and education systems (Roll 2004). As government size decreases, the number of
public schools and educational resources would also decrease, decreasing total school
enrollment.
B. Health Outcomes
Table 2 in the appendix shows the effects of economic freedom on the health of a country
as measured by immunization rate and life expectancy at birth. As countries obtain more
freedom to trade internationally, as measured by a one-rating-point increase, the immunization
rate increases by almost two percentage points, which is statistically significant to the ninety-five
percent confidence level. The effects of increased property rights are also statistically significant
for immunization, where a one-point increase leads to an immunization rate of four percentage
points higher. The size of government and regulation of credit, labor, and business measures
14
have no significant impact on the immunization rate of the nation. GDP per capita has a
statistically significant but economically small effect on the immunization rate. Oddly, as GDP
per capita increases by one thousand dollars the immunization rate decreases by .18 percentage
points; although this effect is very small, it is still counterintuitive. Finally as GDP per capita
growth increases by one percent, the immunization rate increases by one-third of a percentage
point.
Freedom to trade internationally also positively affects life expectancy at birth. As the
measure increases by one point, life expectancy increases by about one and a half years. Like the
estimate of free trade on immunization, this estimate is also statistically significant to the ninetyfive percent confidence level. Similar to the effect of increased freedom to trade, increased
property rights lead to about a one-and-a-half-year addition to life expectancy for the citizens of
the country. A decrease in the size of government also leads to a significant increase in life
expectancy of .8 years. Regulation of credit, labor, and business is the only variable that has no
statistically significant effect on life expectancy. Increased GDP per capita does have a
statistically significant, positive effect on life expectancy but the effect is small; as GDP per
capita increases by one thousand dollars, life expectancy increases by .3 years. Similarly, life
expectancy increases by about one-third of a year, as GDP per capita growth increases by one
percent.
Property rights have the most significant positive effect on health variables. I theorize
that a contributing factor to this relationship is the intellectual property protection component of
this measure. Alex Rosenberg states, “A market economy without patent rights will not provide
the optimum amount of welfare” (2003). Due to exorbitant research and development costs,
pharmaceutical companies incur high fixed costs to initially produce a drug but low marginal
15
costs to produce additional doses. Often pharmaceutical companies will make these drugs
available to developing nations at reduced prices in an attempt to recover a small portion of the
fixed cost; it is a win-win situation for both the company and developing nations (Tabarrok
2000). However, if nations do not respect the intellectual property of the companies, they will
ignore the needs of these nations and shift their research and investment to other concerns. Put
simply, by honoring patent rights countries are not only improving their access to current lifesaving drugs but also are providing incentives for the creation of drugs beneficial to them in the
future (Rosenberg 2003).
C. Technology Outcomes
As shown in table 3 in the appendix, with the exception of government size, increased
economic freedom increases citizens’ access to modern technology as measured by availability
of telephone lines and production of electricity. An increase of one point on the free trade index
is correlated with nearly six additional telephone lines per one thousand people. Increased
property rights have the largest impact on telephone lines; a one-point increase in the index leads
to an additional 24 telephone lines (per one thousand people). Similar to the results of
government size on school enrollment, this regression finds government size to have a
statistically significant negative effect on telephone lines. As the size of government decreases,
the number of telephone lines per one thousand people decreases by nearly 9. Regulation has a
very similar impact on telephone access in the opposite direction. As government regulation
decreases, telephone lines increase by about 9 per one thousand people. As is expected, the
higher the GDP per capita, the more accessibility to telephone lines. For every one-thousanddollar increase in GDP per capita, telephone lines increase by about 12 per one thousand people.
GDP growth does not have a statistically significant effect on telephone lines.
16
Free trade’s effect on electricity production is not statistically significant. Similar to
telephone lines, increased property rights have the largest impact on electricity production; a
one-point increase in the property rights rating leads to an additional 516 kilowatt hours of
electricity produced per capita. Again government size has a statistically significant negative
effect on electricity. As the size of government decreases, electricity produced drops by 325
kilowatt hours per person. As the amount of government regulation decreases, electricity
production increases by 344 kilowatt hours per capita. Again, the higher the GDP per capita, the
more electricity a nation produces. Electricity production goes up by about 209 kilowatt hours
per person, for every one-thousand-dollar increase in GDP per capita. Finally, GDP growth does
not have a statistically significant effect on electricity production either.
5. CONCLUSION:
Table 4 in the appendix contains a summary of the results of this study. The theory that
increased economic freedom leads to a higher standard of living holds in relation to property
rights, freedom to trade internationally, and regulation of business, credit, and labor. As
countries permit more free trade, the standard of living rises in all measures but tertiary-school
enrollment and electricity production. As countries establish a more secure legal system and
protection of property rights, all variables but primary-school enrollment are positively affected.
Less regulation of business, credit, and labor also improve the quality of life, but it does not have
a significant effect on literacy or health variables. However, increased economic freedom as
measured by a decrease in government size actually has a negative effect on all standard-ofliving variables in which it is statistically significant except for life expectancy. This likely
results from the fact that there are certain welfare-improving public goods government provides
that the free market does not.
17
A secure legal system and protection of property rights prove to have the most dramatic
effects on standard of living. Hernando de Soto (2004) describes the rule of law as the “bedrock”
of capitalism and the property system as “the hidden architecture that organizes the market
economy.” Without property rights and a system to enforce them, capital, the fuel of a market
economy, cannot be created. Secure property rights, upheld contracts, and impartially enforced
laws are critical factors in attracting investment, fostering private ownership, and allowing
mutually beneficial exchange (DeSoto 2004). An empirical study showed that countries with an
average economic freedom rating of seven or above for legal structure and security of property
rights experienced an average GDP growth rate of 2.5% per capita from 1980 to 2000 compared
with an average growth rate of .33% for those countries with a average legal rating less than four
(Gwartney and Lawson 2002).
This study, along with previous research in the field, provides evidence that in a majority
of aspects, increased economic freedom improves the lives of citizens in the country where it is
implemented. With today’s rapid improvements in technology and communications and the
increased globalization of commerce, the potential for economic growth is tremendous.
Economically free institutions are needed to take advantage of this growth. A recent article in
the Wall Street Journal stated the findings of this paper concisely: “Put simply, misery has a cure
and its name is economic freedom” (O’Grady 2004). It is important, however, not to make
generalizations concerning economic freedom as a whole so that the most precise information
can be disseminated to developing countries to assist them in achieving higher standards of
living.
This information has important public policy implications. How should developed
nations allocate resources to best promote the quality of life of citizens in developing nations?
18
There is currently widespread debate concerning whether aid induces economic growth or if it
tends to breed corruption and inhibit economic reforms (Tupy 2004). Craig Burnside and David
Dollar (1997) conclude that the fiscal, monetary and trade policies of a nation are key
determinants of the effectiveness of development aid in enhancing growth. The growing
evidence that strong property rights, freedom to trade, and freedom from regulation promote
many broad measures of wellbeing can be used by developed nations to construct more effective
foreign aid initiatives. Reliant on the link established in this study between improvements in
economic freedom of nations and a rise in their standard of living, foreign aid conditional on
nations establishing free economic institutions is an effective means of reducing poverty.
This study could be improved with future research. Further examination into different
forms of the model could reveal more information concerning the link between economic
freedom and standard of living; each category of economic freedom is uniquely related to the
dependent variables. By augmenting these findings with additional standard-of-living variables,
one could gain a better insight into economic freedom’s effects on the total welfare of citizens.
Finally, a more expansive study over a longer period would allow one to hold time as well as
country fixed effects constant. By controlling for differences across countries, more of the
variation in the dependent variables could be explained, and one could gain a more precise
picture of the true effects of changes in economic freedom.
19
APPENDIX
Table 1: Economic Freedom Variables’ Effect on Educational Outcomes
Variable
Literacy Rate
Primary-School
Enrollment
Secondary-School
Enrollment
Tertiary-School
Enrollment
3.20**
2.38**
2.52**
0.778
(0.79)
(0.78)
(0.89)
(0.57)
2.71**
0.87
3.66**
2.34**
(0.73)
(0.77)
(0.87)
(0.56)
0.062
-1.09*
-3.44**
-1.26**
(0.63)
(0.63)
(0.72)
(0.47)
8.66
1.80*
3.81**
1.77**
(1.07)
(1.08)
(1.24)
(0.81)
GDP per Capita
0.95**
-0.17
1.16**
0.50**
(thousands)
(0.20)
(0.12)
(0.14)
(0.09)
GDP Growth per
Capita
0.20
0.70**
0.28
-0.12
(0.19)
(0.20)
(0.23)
(0.15)
Year Fixed Effects
Yes
Yes
Yes
Yes
Adjusted R2
0.31
0.10
0.59
0.48
Number of
Observations
486
469
455
435
Economic Freedom
Variables
Free Trade
Property Rights
Government Size
Regulation
Control Variables
Notes:
1. Standard errors are in parentheses
2. ** and * denote significance at .05 and .10 levels respectively
20
Table 2: Economic Freedom Variables’ Effect on Health Outcomes
Variable
Immunization
Rate
Life Expectancy
1.94**
1.58**
(0.72)
(0.32)
4.01**
1.55**
(0.68)
(0.31)
-0.23
0.81**
(0.58)
(0.25)
0.34
-0.40
(0.98)
(0.45)
GDP per Capita
-0.18*
0.33**
(thousands)
(0.11)
(0.05)
GDP Growth per
Capita
0.33*
0.23**
(0.19)
(0.85)
Year Fixed Effects
Yes
Yes
Adjusted R2
0.42
0.45
Number of
Observations
552
616
Economic Freedom
Variables
Free Trade
Property Rights
Government Size
Regulation
Control Variables
Notes:
1. Standard errors are in parentheses
2. ** and * denote significance at .05 and .10 levels respectively
21
Table 3: Economic Freedom Variables’ Effect on Technology Outcomes
Variable
Telephone
Electricity per
capita
5.76*
-28.97
(3.21)
(154.61)
24.10**
515.82**
(3.06)
(143.68)
-8.75**
-325.21**
(2.52)
(119.17)
8.58*
344.27*
(4.44)
(211.30)
GDP per Capita
12.11**
208.82**
(thousands)
(0.48)
(23.32)
GDP Growth per
Capita
0.91
-54.05
(0.83)
(42.39)
Year Fixed Effects
Yes
Yes
Adjusted R2
0.84
0.50
Number of
Observations
611
434
Economic Freedom
Variables
Free Trade
Property Rights
Government Size
Regulation
Control Variables
Notes:
1. Standard errors are in parentheses
2. ** and * denote significance at .05 and .10 levels respectively
22
Table 4: Summary of Effects of Economic Freedom Measures on Standard of Living
Measures
Variables
Literacy
Free Trade
+
Property Rights
+
Government Size
0
Regulation
0
Primary-School
Enrollment
+
0
-
+
Secondary-School
Enrollment
+
+
-
+
Tertiary-School
Enrollment
0
+
-
+
Immunization
+
+
0
0
Life Expectancy
+
+
+
0
Telephone
+
+
-
+
Electricity
0
+
-
+
23
121 Countries Included in Study:
Albania
Algeria
Argentina
Australia
Austria
Bahamas, The
Bahrain
Bangladesh
Barbados
Belgium
Belize
Benin
Bolivia
Botswana
Brazil
Bulgaria
Burundi
Cameroon
Canada
Central African
Republic
Chad
Chile
China
Colombia
Congo, Dem. Rep.
Congo, Rep.
Costa Rica
Cote d'Ivoire
Croatia
Cyprus
Czech Republic
Denmark
Dominican Republic
Ecuador
Egypt, Arab Rep.
El Salvador
Estonia
Fiji
Finland
France
Gabon
Germany
Ghana
Greece
Guatemala
Guinea-Bissau
Guyana
Haiti
Honduras
Hong Kong, China
Hungary
Kuwait
Latvia
Lithuania
Luxembourg
Madagascar
Malawi
Malaysia
Mali
Malta
Mauritius
Mexico
Morocco
Myanmar
Namibia
Nepal
Netherlands
New Zealand
Nicaragua
Niger
Nigeria
Russian Federation
Rwanda
Senegal
Sierra Leone
Singapore
Slovak Republic
Slovenia
South Africa
Spain
Sri Lanka
Sweden
Switzerland
Syrian Arab Republic
Tanzania
Thailand
Togo
Trinidad and Tobago
Tunisia
Turkey
Uganda
Iceland
India
Indonesia
Iran, Islamic Rep.
Ireland
Israel
Italy
Jamaica
Japan
Jordan
Kenya
Norway
Oman
Pakistan
Panama
Papua New Guinea
Paraguay
Peru
Philippines
Poland
Portugal
Romania
Ukraine
United Arab Emirates
United Kingdom
United States
Uruguay
Venezuela, RB
Zambia
Zimbabwe
24
References
Berggren, Niclas. 2003. The Benefits of Economic Freedom: A Survey. The
Independent Review 8, no. 2: 193-211.
Burnside, Craig, and David Dollar. 1997. Aid, Policies and Growth. World Bank Policy
Research. http://econ.worldbank.org/docs/320.pdf
Carlsson, Fredrik, and Susanna Lundstrom. 2002. Economic Freedom and Growth:
Decomposing the Effects. Public Choice 112: 335-44
Collier, Paul, and David Dollar. 2002. Globalization, Growth, and Poverty: Building an
Inclusive World Economy. Washington, D.C.: World Bank.
De Soto, Hernando. 2004. Law and Property Outside the West: A Few New Ideas About
Fighting Poverty. The Road to Prosperity: The 21st Century Approach to
Economic Development. Washington D.C.: Heritage Books.
Eiras, Ana Isabel. 2004. Why Economic Freedom, Not Aid, Is the Answer to Poverty.
The Road to Prosperity: The 21st Century Approach to Economic Development.
Washington D.C.: Heritage Books.
Feulner, Edwin J. 2004. Preface. The Road to Prosperity: The 21st Century Approach to
Economic Development. Washington D.C.: Heritage Books.
Godoy, Julio. 2002. New Report Reveals a Drop in Aid to Developing Countries. The
Inter-Press Service. 17 May. http://www.globalpolicy.org/finance/docs/2002/0517
aid.htm.
Gwartney, James G., and Robert A. Lawson. 2002. Economic Freedom of the World
2002 Annual Report. Vancouver: Fraser Institute.
25
Holcombe, Randall G. 1998. Economic Freedom and Economic Growth. The Freeman,
February 1998.
Holmes, Kim R. 2004. Promoting Economic Freedom at the United Nations. The
Heritage Foundation, Lecture # 823, 24 February 2004.
North, Douglass C. 1990. Institutions, Institutional Change, and Economic Performance.
Cambridge, U.K.: Cambridge University Press.
O’Grady, Mary Anastasia. 2005. Hail Estonia. The Wall Street Journal, 4 Jan. 2005,
A12. http://online.wsj.com.
Powell, Colin. 2004. MCC Board Meeting Minutes, 2 February 2004.
www.mca.gov/Documents/board_transcript_020204.html.
Roll, Richard. 2004. Economic and Political Freedom: The Keys to Development. The Road to
Prosperity: The 21st Century Approach to Economic Development. Washington D.C.:
Heritage Books.
Rosenberg, Alex. 2003. The Priority of Intellectual Property Rights. Fraser Forum,
Feb. 2003. http://www.fraserinstitute.ca/admin/books/chapterfiles/The%
20Priority%20of%20Intellectual%20Property%20Rights-Rosenberg.pdf#.
Tabarrok, Alexander. 2000. Drug Price Controls: A “Cure” Worse Than the Disease.
Patriot News, 22 May 2004. http://www.independent.org/newsroom/article.
asp?id=159.
Tupy, Marian. Aiding the Absurd. Tech Central Station, 18 February 2004.
http://www.cato.org/research/articles/tupy-040218.html.
Vasquez, Ian. 2002. Globalization and the Poor. The Independent Review 7, no.2:
197-206.
26
Vega-Gordilla, Manuel, and Jose L. Alvarez-Arce. 2003. Economic Growth and
Freedom: A Causality Study. Cato Journal 23, no. 2:199-215.
World Bank. 2003. 2003 World Development Indicators [on CD-Rom]. Washington,
D.C.: World Bank.
27