Global economic freedom is declining, impacting countries’ abilities to grow their economies. Examining the link between economic freedom and prosperity.
Global economic freedom is on the decline: That could be a quick summary of the report published by the Heritage Foundation that keeps track of global economic freedom. The pandemic has caused governments across the world to take control of their economies. The war in Ukraine will also lead to countries backsliding their economic freedom. Why is economic freedom important?
What is key to economic growth and prosperity? Even today, the Washington consensus is held to be the best policy recommendation for economic development. The Washington Consensus is a set of 10 economic policy recommendations for developing countries that were promoted by Washington-based institutions such as the IMF, the World Bank, and the U.S. Treasury in the 80s and 90s. These include fiscal discipline, public expenditure priorities, tax reform, financial and trade liberalization, privatization, deregulation, FDI encouragement, property rights, and fighting corruption.
These recommendations have been implemented in several countries and have worked well. However, it also has its limitations, as the example of China, which grew without fully embracing the Washington Consensus, shows. On top of that, we have cases like Argentina, which
embraced some of the measures but did not follow up on others. In the case of Argentina, it did not follow the principle of fiscal discipline ( Baumol et.al 2007).
In addition to the policy recommendations, I would like to examine the role of economic freedom. Although there are many factors, there exists a strong link between economic freedom and economic prosperity.
First, let us examine the meaning of economic freedom. The Heritage Foundation has made a comprehensive list ranking countries based on economic freedom. They used 12 indicators to rank countries. These 12 indicators are property rights, judicial effectiveness, government integrity, tax burden, government spending, fiscal health, business freedom, labor freedom, monetary freedom, trade freedom, investment, and financial freedom (Miller et al., 2022). Of course, we can extend this list to include more variables, as the list is non-exhaustive. However, it provides a good framework for examining economic freedom.
Here are the top 25 ranked countries when it comes to economic freedom:
Unsurprisingly, all these countries also have high GDP Per Capita. When we examine the GDP per capita of these countries, we see that they are all in the top brackets. For example, the World Bank estimates that Singapore has a GDP per capita of 72,794 USD. Switzerland has a GDP per capita of 91,992 USD, while Ireland has a GDP per capita of approximately 100,000 USD. In fact, all the top 25 countries have extremely high GDP per capita. These countries have diversified their economies. Oil-rich Gulf countries may have higher GDP per capita, but their economies are not diversified as much as Western European and North American countries. Nor do they come to the top when it comes to economic freedom. With economic freedom comes the chance to diversify the economy and escape the Dutch disease. The Dutch disease occurs when an economy is overly reliant on one sector to provide for the economy. The term Dutch Disease was coined when a substantial oil deposit was discovered in the North Sea in 1959. The country loses its competitive advantage in other sectors, and depends on one sector to drive its economy. This happens because the domestic currency appreciates owing to the discovery of new resources, and the economy may take time to recover.
We can also notice that these countries on top of the list are also industrialised economies which now rely heavily on the tertiary sector to drive growth. I categorize these countries as reaching Stage 5 of the Rostow model. In his 1960 book,Stages of Economic Growth :A nnon-Communist manifesto ttheorized that economic growth occurs in five stages. These 5 stages are:
Stage 1: Traditional society with limited technology. The primary sector is the dominant sector in this society.
Stage 2: Pre-conditions for takeoff, including commercial exploitation of agriculture and minerals. There is an increase in population during this period. Agricultural output has also increased. Then we have the period of transition to stage 3.
Stage 3 : Take off, during this stage, manufacturing becomes dominant and powerful. This was the phase of the Industrial Revolution. The secondary sector gains prominence during this phase. Then we move onto the developed stage or stage 4.
Stage 4: Drive to maturity: This is the stage in which the country now specializes in a few industries. They use modern technology and move on to Fordism, where specialization takes place. Then we have the 5th and last stage for the Rostow model.
Stage 5: High mass consumption: In this stage, labor is substituted by capital. The tertiary sector becomes the dominant sector. There is also a medical revolution which happens in this stage.
According to this model, most countries on top of the freedom index list would fall in Stage 5. As we will soon notice, things are a bit different for countries which do not score well in the freedom index.
Now, let us look at the other extreme to see if there is indeed a link between economic freedom and prosperity. Below are countries at the bottom of the rank.
|168||Central African Republic||45.7|
These countries are in the repressed category (Miller et al., 2022). North Korea is shown at the bottom of the table. In the case of North Korea, the World Bank does not maintain a statistic. This is because the data were unreliable and difficult to collect. The United Nations estimate that North Korea’s GDP per capita is approximately 600 USD. Most of the countries in the low rung of the index have extremely low GDP per capita and are under authoritarian rulers. Sudan, for example, has a GDP per capita less than 1000 USD. Venezuela only has around 3000 USD. However, this country had a GDP per capita of more than 13000 USD a decade earlier. Its ranking in the economic freedom index has been on a freefall in the last couple of years, along with its collapse in living standards. Its potential for economic recovery is also compromised, as long as the current authoritarian leader is in charge and fails to diversify its economy.
Most countries on this list do not have developed economic infrastructure. Most of these countries still depend on the primary sector to drive economic growth and activity. According to the Rostow model, most countries are still in stage 2, 3 or 4. A notable exception is China, which has a relatively good economic standing but ranks poorly in terms of economic freedom.
In this index, it is also interesting to note that there is a link between political freedom and economic freedom, although not to a large extent. Iran and China for example would rank very low in any political index. It is also ranked low in terms of the economic freedom indices. Can we have economic freedom without political freedom? This question is to be considered and debated.
One of the most important factors for economic growth is the role played by how free a country is. You will only start a new business or industry if you are allowed to freely operate in the market, and some countries that rank lowest in terms of GDP per capita are still higher placed than other dictatorships. For example, Burundi and South Sudan have the lowest GDP per capita in the world, but they are a bit higher in ranking than Cuba and Zimbabwe, which have higher GDP per capita.
However, this relationship is clear. There are no countries with high economic freedom, but very low economic prosperity. Most countries with high economic freedom are in stage 5 of the Rostow model. On the other hand, there is no country with very low economic freedom and high economic prosperity. The only country that might be considered an exception is China. China was ranked 158th in the economic freedom index. At the same time, China is a middle-income country with a GDP per capita of approximately 13,000 USD. However, China’s growth story is unique, and it is difficult to apply to other countries.
The question to be further examined is whether a country can grow without ensuring proper economic freedom for its citizens and businesspeople. Ensuring proper economic reforms and having economic freedom seem to help a country launch its economic success story. Successful countries do not rely heavily on the government to drive economic growth, and this is something we ought to learn from them – hopefully, before we lose our wealth.
Miller, T., Kim, A. B., & Roberts, J. M. (2022). 2022 INDEX OF ECONOMIC FREEDOM. Retrieved from https://www.heritage.org/index/pdf/2022/book/2022_IndexOfEconomicFreedom_FINAL.pdf
Baumol, W. J., Litan, R. E., & Schramm, C. J. (2007). Good capitalism, bad capitalism, and the economics of growth and prosperity. Yale University Press. https://data.worldbank.org/indicator/NY.GDP.PCAP.CD
What Is The Dutch Disease? Origin of Term and Examples (investopedia.com)
Rostow, W. W., & Rostow, W. W. (1990). The stages of economic growth: A non-communist manifesto. Cambridge university press.
- Adithyan Puthen VeettilAdithyan Puthen Veettil holds a Bachelor’s in economics and is a student doing his master’s in international studies at the Diplomatic Academy, Vienna. Adithyan is spring intern 2023 at the Austrian Economic center.