This seminal Handbook provides a comprehensive overview of contemporary research on economic freedom, using multidiscipl
109 21 4MB
English Pages 438 [439] Year 2024
Table of contents :
Front Matter
Copyright
Contents
Contributors
Acknowledgments
1. Introduction to the Handbook of Research on Economic Freedom
PART I The Concept and Measurement of Economic Freedom
2. The creation of the Economic Freedom of the World index
3. Economic Freedom of the World in the universe of measuring institutions
PART II Economic Freedom in the World
4. Economic freedom, 1950–2020
5. Economic freedom in economic history
PART III Economic Freedom in the History of Economic Thought
6. Adam Smith and economic freedom
7. Economic freedom in the Freiburg and Austrian schools
PART IV Determinants of Economic Freedom
8. Religion and economic freedom
9 The effects of crises on economic freedom and market-oriented reforms: a survey
10. Democracy and economic freedom
11. Government ideology and economic freedom: new empirical evidence
12. Immigration and economic freedom
13. Deep determinants of economic freedom
PART V Consequences of Economic Freedom
14. The impact of economic freedom on economic growth
15. Economic freedom and inequality: a survey of the empirical literature
16. Economic freedom and happiness: on moderation and mediation
17. Entrepreneurship and economic freedom
18. The influence of the market economy and economic freedom on culture
19. Economic freedom and gender
20. Economic freedom and populism
21. Economic freedom and human rights: a survey
22. Economic freedom and the economic effects of crises
23. Economic freedom and environmental performance
24. Economic freedom, peace and violent conflict
25. The impact of economic freedom on corruption and the shadow economy
PART VI The Philosophy of Economic Freedom
26. Economic freedom and social justice
27. Freedom and flourishing
Index
HANDBOOK OF RESEARCH ON ECONOMIC FREEDOM
In memory of James D. Gwartney for making research on economic freedom possible and for providing extraordinary personal inspiration
Handbook of Research on Economic Freedom Edited by
Niclas Berggren Associate Professor of Economics, Research Institute of Industrial Economics (IFN), Sweden, and Department of Managerial Economics, Prague University of Economics and Business, Czechia
Cheltenham, UK • Northampton, MA, USA
© Niclas Berggren 2024
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2024930479 This book is available electronically in the Economics subject collection http://dx.doi.org/10.4337/9781802206159
ISBN 978 1 80220 614 2 (cased) ISBN 978 1 80220 615 9 (eBook)
EEP BoX
Contents
List of contributorsvii Acknowledgmentsix 1
Introduction to the Handbook of Research on Economic Freedom1 Niclas Berggren
PART I
THE CONCEPT AND MEASUREMENT OF ECONOMIC FREEDOM
2
The creation of the Economic Freedom of the World index James D. Gwartney and Robert A. Lawson
16
3
Economic Freedom of the World in the universe of measuring institutions Ryan H. Murphy
31
PART II
ECONOMIC FREEDOM IN THE WORLD
4
Economic freedom, 1950–2020 Ryan H. Murphy
47
5
Economic freedom in economic history Vincent J. Geloso and Gregory W. Caskey
59
PART III ECONOMIC FREEDOM IN THE HISTORY OF ECONOMIC THOUGHT 6
Adam Smith and economic freedom Maria Pia Paganelli
74
7
Economic freedom in the Freiburg and Austrian schools Gerhard Wegner
85
PART IV DETERMINANTS OF ECONOMIC FREEDOM 8
Religion and economic freedom André Azevedo Alves and Inês Gregório
9
The effects of crises on economic freedom and market-oriented reforms: a survey Hans Pitlik
10
Democracy and economic freedom Abishek Choutagunta and Jerg Gutmann
133
11
Government ideology and economic freedom: new empirical evidence Klaus Gründler, Armin Hackenberger and Niklas Potrafke
144
v
101
117
vi Handbook of research on economic freedom 12
Immigration and economic freedom Alexandre Padilla
159
13
Deep determinants of economic freedom Ola Olsson
173
PART V
CONSEQUENCES OF ECONOMIC FREEDOM
14
The impact of economic freedom on economic growth Jakob de Haan and Jan-Egbert Sturm
189
15
Economic freedom and inequality: a survey of the empirical literature Daniel L. Bennett
208
16
Economic freedom and happiness: on moderation and mediation Johan Graafland
225
17
Entrepreneurship and economic freedom Per L. Bylund, Peter G. Klein and Matthew McCaffrey
242
18
The influence of the market economy and economic freedom on culture Eelke de Jong
259
19
Economic freedom and gender Rosemarie Fike
273
20
Economic freedom and populism Andreas Bergh and Anders Kärnä
297
21
Economic freedom and human rights: a survey Christian Bjørnskov
315
22
Economic freedom and the economic effects of crises Jamie Bologna Pavlik
330
23
Economic freedom and environmental performance Jonas Grafström
343
24
Economic freedom, peace and violent conflict Tim Krieger and Daniel Meierrieks
357
25
The impact of economic freedom on corruption and the shadow economy Peter Graeff
372
PART VI THE PHILOSOPHY OF ECONOMIC FREEDOM 26
Economic freedom and social justice Nick Cowen
388
27
Freedom and flourishing Douglas J. Den Uyl and Douglas B. Rasmussen
402
Index415
Contributors
André Azevedo Alves, Universidade Católica Portuguesa, Portugal, and St. Mary’s University, UK. Daniel L. Bennett, Department of Management & Entrepreneurship, College of Business, University of Louisville, USA. Niclas Berggren, Research Institute of Industrial Economics (IFN), Sweden, and Department of Managerial Economics, Prague University of Economics and Business, Czechia. Andreas Bergh, Lund University and Research Institute of Industrial Economics (IFN), Sweden. Christian Bjørnskov, Department of Economics, Aarhus University, Denmark, and Research Institute of Industrial Economics (IFN), Sweden. Jamie Bologna Pavlik, Department of Agricultural and Applied Economics, Texas Tech University, USA. Per L. Bylund, Oklahoma State University, USA. Gregory W. Caskey, Baker School of Business, The Citadel, USA. Abishek Choutagunta, University of Hamburg, Germany. Nick Cowen, School of Social and Political Sciences, University of Lincoln, UK. Jakob de Haan, University of Groningen, The Netherlands, and CESifo, Germany. Eelke de Jong, Radboud University Nijmegen, The Netherlands. Douglas J. Den Uyl, Liberty Fund, USA. Rosemarie Fike, Texas Christian University, USA. Vincent J. Geloso, Department of Economics, George Mason University, USA. Johan Graafland, Tilburg University, The Netherlands. Peter Graeff, Christian-Albrechts University, Germany. Jonas Grafström, The Ratio Institute, Sweden. Inês Gregório, Universidade Católica Portuguesa, Portugal. Klaus Gründler, ifo Institute, LMU Munich and CESifo, Germany. Jerg Gutmann, University of Hamburg, University of Freiburg and CESifo, Germany. James D. Gwartney, was in the Department of Economics, Florida State University, USA. Armin Hackenberger, ifo Institute and LMU Munich, Germany. vii
viii Handbook of research on economic freedom Anders Kärnä, Örebro University and Research Institute of Industrial Economics (IFN), Sweden. Peter G. Klein, Baylor University, USA. Tim Krieger, University of Freiburg and CESifo, Germany. Robert A. Lawson, Southern Methodist University, USA. Matthew McCaffrey, University of Manchester, UK. Daniel Meierrieks, WZB Berlin, Germany. Ryan H. Murphy, Southern Methodist University, USA. Ola Olsson, School of Business, Economics and Law, University of Gothenburg, Sweden. Alexandre Padilla, Metropolitan State University of Denver, USA. Maria Pia Paganelli, Trinity University, USA. Hans Pitlik, Austrian Institute of Economic Research (WIFO), Austria. Niklas Potrafke, ifo Institute, LMU Munich and CESifo, Germany. Douglas B. Rasmussen, St. John’s University, USA. Jan-Egbert Sturm, KOF Swiss Economic Institute, ETH Zurich, Switzerland, and CESifo, Germany. Gerhard Wegner, University of Erfurt, Germany.
Acknowledgments
The Editor of this Handbook, Niclas Berggren, wants to thank Alexandra O’Connell at Edward Elgar Publishing for enabling this book to be written, Christian Bjørnskov at Aarhus University for providing moral and intellectual support and Magnus Henrekson at the Research Institute of Industrial Economics (IFN) for valuable advice and mentorship. This publication was made possible through the support to Niclas Berggren of Grant 62065 from the John Templeton Foundation. The opinions expressed in this publication are those of the authors and do not necessarily reflect the views of the John Templeton Foundation.
ix
1. Introduction to the Handbook of Research on Economic Freedom Niclas Berggren
INTRODUCTION The market economy has become the predominant economic system in the world. Admittedly, it takes many forms, primarily depending on the role the state takes in relation to it.1 In some instances, the state is quite absent from economic life, aside from providing a set of rules within which ‘spontaneous’ economic processes take place. In other cases, the state has developed symbiotic relations with the business sector, which may entail restrained competition due to entry barriers, regulation and strong market power for certain corporations.2 Another type of relation to the state exists in advanced welfare states, which are often quite market-oriented – in combination with a high level of social spending (and accompanying high tax ratios). One may also point at authoritarian market economies, where the political system is non-democratic but where market mechanisms are applied to a large degree and where market outcomes, in terms of income and wealth and their unequal distribution, are regularly accepted by those in power. Even though the type of market economy varies, there is, with very few exceptions, no country in the world today that has opted for another way of organizing its economy. There is no denying, then, that the market economy is an astounding success, in terms of having been allowed relatively free, and increasingly free, rein in most countries in recent decades. Still, it remains controversial – just as it was when it emerged in connection with international trade on a large scale in the 15th century onwards, during the Industrial Revolution in the 18th and 19th centuries, and when it continued to develop across Europe after that. Indeed, Marx and Engels (2010 [1848], p. 16) were adamant not to equate the spread of the market-economic system with approval of the outcomes of that system: The bourgeoisie, by the rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all, even the most barbarian, nations into civilization. The cheap prices of commodities are the heavy artillery with which it batters down all Chinese walls, with which it forces the barbarians’ intensely obstinate hatred of foreigners to capitulate. It compels all nations, on pain of extinction, to adopt the bourgeois mode of production; it compels them to
1 Cf. Hall and Soskice (2001), who make a distinction between liberal market economies and coordinated market economies, and Milanovic (2019, p. 5), who contrasts liberal meritocratic capitalism with state-led political, or authoritarian, capitalism. 2 Zingales (2009) contrasts a ‘pro-business’ and a ‘pro-market’ approach to the market economy: ‘Capitalism calls not only for freedom of enterprise, but for rules and policies that allow for freedom of entry, that facilitate access to financial resources for newcomers, and that maintain a level playing field among competitors. … Most lobbying is pro-business, in the sense that it promotes the interests of existing businesses, not pro-market in the sense of fostering truly free and open competition’ (emphasis in original), cf. Rajan and Zingales (2003). A similar distinction was made by Hayek (1948, ch. 6), in his discussion of ‘free enterprise’ and competitive order.
1
2 Handbook of research on economic freedom introduce what it calls civilization into their midst, i.e., to become bourgeois themselves. In one word, it creates a world after its own image.
The economic system Marx and Engels inspired – a socialist planned economy with public ownership of the means of production – has been tried by now, throughout much of the 20th century – and it failed. Today’s critics of the market economy are mostly not advocating a return to such a system but want, through various types of political action, to limit freedom for economic actors in various ways while retaining basic features of the market economy. The critics appreciate the wealth-creating aspects of markets but wish to stifle various outcomes they believe are associated with them, such as inequality, exploitation, crises, social conflict and environmental degradation. But (relatively) free markets have their defenders as well, arguing that they are better than more politically constrained, or ‘crony-capitalist’, market-oriented systems to generate long-term wealth and freedom of choice, but perhaps also social, cultural and environmental benefits. Who is right and who is wrong? What are the consequences of a system of markets? In public debate, pro- and anti-market positions have too often been defended on ideological or emotive grounds. Luckily, and in contrast, there is by now a great deal of research that addresses what markets do and do not do, and what they result and do not result in. This is, not least, the result of new data in recent decades. For instance, Lawson (2022) reports that there are more than 1,300 peer-reviewed journal articles citing the Economic Freedom of the World index. A first purpose of this book is to present a state-of-the-art, up-to-date overview of peer-reviewed research on the consequences of economic freedom – which is the overarching term used to denote the degree to which an economy is market-oriented in its key institutions and policies. This kind of overview should be informative for scholars doing work on economic systems, economic institutions and economic policies. Through the chapters of this book, they can easily get a grasp on the relevant studies that already exist. It should also be useful for policymakers who wish to pursue evidence-based reforms, since the research can indicate what will happen when market-related institutions and policies are changed. If the degree to which economies are market-oriented is an important matter, by having various consequences people care about, a natural follow-up question is: what determines the degree of economic freedom in a country? A second purpose of this book is therefore to present a state-of-the-art, up-to-date overview of peer-reviewed research on the causes of economic freedom. This should be of interest to scholars interested in the political economy of reform – what enables and what stymies attempts to change the rules and policies that shape an economic system? Likewise, it should be of practical relevance for policymakers contemplating either increases or decreases of economic freedom. How – under what conditions – can such changes most easily be achieved? Thus far, I have focused on causes and consequences of economic freedom, basically within a consequentialist framework (Sinnott-Armstrong 2022), the idea being that what matters, ultimately, for our evaluation of the market-orientation of economic systems is their consequences. A prime example of such an approach is utilitarianism. A consequentialist focus, whether utilitarian or not, can be motivated philosophically, but also questioned. Some normative approaches to assessing economic systems are deontological in character – what matters is not whether, say, a market economy produces wealth or a certain degree of wealth inequality but whether it conforms to some principle or set of principles. An example would be a libertarian who adheres to natural rights, such as a right to private property; another example
Introduction 3 would be a Rawlsian, who is interested in whether economic freedom is socially just or not as perceived in the original position; a third example would be someone embracing virtue ethics, in the Aristotelean tradition, and who evaluates economic systems in relation to how it contributes to human flourishing. In order to shed broader light on ways to think about economic freedom and its normative status, a third purpose of this volume is to present a few takes on economic freedom from philosophy. Furthermore, there are a couple of contributions from the history of economic thought. The idea is to situate the notion of economic freedom in the writings of Adam Smith, on the one hand, and in the so-called Freiburg and Austrian schools of economic thought, on the other hand. Thereby, one hopefully gains a richer understanding, through extended reasoning and through connections to a rich body of economic and philosophical literature in the European intellectual tradition, of why economic freedom is thought to be valuable, but also why certain limitations thereof might be considered desirable.
THE CONCEPT OF ECONOMIC FREEDOM Thus far, I have written as if key terms are clearly defined. But as is the case with many concepts that describe principles or overarching systems, it is not easy to pinpoint exactly what economic freedom is. The task is not made easier by what was pointed out above, namely, that market economies come in different forms. Still, if we define economic freedom as the degree to which an economy is market-oriented, the conceptual task becomes one of defining the market-orientation of an economy. I propose that an economy is market-oriented, and thus economically free, if most of its resources, including property, are privately owned and controlled; if there is a right to enter voluntary contractual relations with others (also across borders); and if the government intervenes little, through regulation and taxation, aside from upholding the rule of law.3 One can imagine this as a continuous variable. This definition relies heavily on legal rules, or formal institutions, defined by North (1991, p. 97) as ‘the humanly devised constraints that structure political, economic and social interaction’. Economic freedom is thus an institutional concept, denoting, in a sense, a legally guaranteed free sphere of action. Within this sphere, economic action – be it innovation, investments, employing, buying, selling or something else – can (relatively) freely take place. But that freedom hinges on certain constraints being enforced, e.g., that one cannot violate general legal rules, hinder others who act within the sphere or infringe on their right to own property and enter into contracts with others. However, one is free to enter a market and to compete with incumbents in that market. As the free sphere of action is further curtailed, primarily by political decisions, the market-orientation of an economy is reduced. There are, of course, many competing definitions, but in many cases they are compatible with my (explicitly institutional) suggestion. Let me mention two. Milanovic (2019, p. 2) proposes this definition: ‘production organized for profit using legally free wage labor and mostly privately owned capital, with decentralized coordination’. Hayek (1976, ch. 10) uses the term ‘catallaxy’, or market order, in contrast to ‘economy’, since the latter term implies a single order of ends. The market order is ‘the special kind of spontaneous order produced by the market through people acting within the rules of the law of property, tort and contract’ (p. 109). We see that Hayek stresses the institutional framework of markets as a prerequisite for the market process, building on voluntary interaction to satisfy individual ends and resulting in order. 3
4 Handbook of research on economic freedom The institutions constituting economic freedom is one thing – the actual market process, and the outcomes it generates, another. Economic freedom is best seen as an application of negative freedom, in the sense of Berlin (1969), which means that it does not entail the supplication of resources to bring about certain outcomes but only the freedom to try to make certain outcomes come about. One implication is that the same level of economic freedom in different places can generate different outcomes. The same level of freedom does not imply the same ability or willingness to act, not least because the surrounding society can be different in other dimensions that are important for the outcomes that eventually materialize. For example, education levels may very well differ, and a setting with high economic freedom is probably more likely to generate high economic growth if education levels are high. Another example relates to what Douglass North called ‘informal institutions’, most notably the cultural features of a society. If people are more trusting in one setting with the same level of economic freedom as another setting with lower trust, it is likely that the economic outcomes will be ‘better’ in the former setting (since trust as such has been shown to relate to consequences desired by many, such as higher economic growth). In other words, there may be moderating factors of these and many other kinds that influence how economic freedom translates into various outcomes. Lastly, it may be worth pointing out that to a social scientist qua social scientist, the term economic freedom, or the market-orientation of an economic system, is a positive and not a normative concept. It does not, for this reason, matter if the people involved in producing data on economic freedom happen to strive for economic freedom or not. One simply takes the level of economic freedom as an object of study, and either tries to locate its determinants or its consequences, but one can do so whether one, on a personal level, dislikes or likes economic freedom.
MEASURES OF ECONOMIC FREEDOM The virtues and vices of the market economy have, as indicated not least by the quote from Marx and Engels above, been debated for centuries (cf. Hirschman 1982). It has mainly had its friends on the right-hand side of the political spectrum, stressing its contribution to economic development, civilized habits and peace and its compatibility with negative freedom (itself valued greatly on the right). Conversely, those on the left-hand side have tended to stress the downsides of the market economy and problematize it, pointing at its undermining of social cohesion through exploitation and the generation of inequalities, at its weakening of electoral democracy and its tendency to ruin the environment for the sake of the enrichment of a few. However, until the 1990s, there was no distinct measure of the degree to which an economy was market-oriented, and thus, much of the debate was based on theoretical reasoning and anecdotal, case-oriented, qualitative empirical evidence – if evidence played a role at all. Of course, there is nothing inherently wrong in pursuing that kind of analysis, which can be seen as a starting point that may generate testable hypotheses for people who are engaged in basic economic and political issues. Yet, I think it fair to say that systematic, quantitative empirical evidence on issues relating to market economies was lacking and sorely needed. The absence of such evidence plausibly emboldened both sides of the left-right political divide in holding on to their ideologically derived beliefs, as there was no easy way to ascertain which claims were correct. In contrast, the scientific approach is well described by Buchanan (2001, p. 157):
Introduction 5 [S]cience is the process through which individual beliefs about reality are continually corrected, and a process within which individuals are brought into agreement about that which is, at least in the provisional filing cabinet, relatively absolute absolutes … The social function of ‘science’, the activity of the specialists, is that of shutting off dialogue and discourse, of resolving conflicts among competing explanations of physical reality, and of allowing provisional truths to be put to everyday usage, at least until more acceptable alternatives emerge.
This understanding of the role of science stresses the provisional nature of knowledge: anything considered true at some point in time may be reassessed and rejected as new findings emerge. When it comes to evaluations of the market economy, long-held ‘truths’ may need to be updated, in certain cases more than once. But for this to be possible, data are needed. In the 1990s, two indices measuring economic freedom saw the light of day: the Economic Freedom of the World index (Gwartney et al. 2022) and the Index of Economic Freedom (Miller et al. 2020). These measures enabled – and continue to enable – scholars to undertake empirical analyses of the causes and consequences of economic freedom.4 The indices build on published data, which means that there are a lot of variables in other datasets – e.g., the Worldwide Governance Indicators, the Varieties of Democracy dataset, the International Country Risk Guide – that constitute indicators of various aspects of economic freedom. The unique thing about the economic-freedom indices is that they attempt to capture the overall market-orientation of the economic system by a certain combination of variables, based on a conceptual interpretation of the notion of economic freedom. To exemplify with the Economic Freedom of the World index, which is the most widely used indicator in the academic literature, it consists of five areas, which are motivated as follows (Gwartney et al. 2022, p. v): Area 1: Size of Government As government spending, taxation, and government-controlled enterprises increase, government decision-making is substituted for individual choice and economic freedom is reduced. Area 2: Legal System and Property Rights Protection of persons and their rightfully acquired property is a central element of both economic freedom and civil society. Indeed, it is the most important function of government. Area 3: Sound Money 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. Area 4: Freedom to Trade Internationally Freedom to exchange—in its broadest sense, buying, selling, making contracts, and so on—is essential to economic freedom, which is reduced when freedom to exchange does not include businesses and individuals in other nations. Area 5: Regulation 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.
Each area is rated from 0 to 10, and the overall index is the average of the five area ratings. The areas in turn consist of subareas, which in turn are constructed on the basis of over 40 I would especially like to highlight the heroic efforts of Professor James D. Gwartney in producing the Economic Freedom of the World index (which I do at greater length in Berggren 2014). Gwartney (2009) and Gwartney and Lawson (2024), in this Handbook, detail how that index came to be. 4
6 Handbook of research on economic freedom individual variables, which likewise have a rating between 0 and 10 and where the area ratings are the averages of the ratings of the underlying variables. The index is available for 165 countries for every five years between 1970 and 2000, and yearly after that. Obviously, this forms a cross-country dataset that is very useful for research. Most of the chapters of this Handbook refer to research using it. See Murphy (2024a) for a discussion of this index and related measures and Murphy (2024b) for a descriptive presentation of economic freedom using this index, both in this volume.
CAUSES AND CONSEQUENCES OF ECONOMIC FREEDOM With the emergence, in the mid-1990s, of datasets measuring (aspects of) economic freedom came a flow of new research studies. Some tried to identify explanations of why the degree of market-orientation differs between countries and why it changes over time, while others explored how variations in the degree of market-orientation affected a range of outcomes. This Handbook aims, through most of its chapters, to summarize and analyze this research literature by proposed causes or by proposed consequences and, also, to identify opportunities for new research (both in terms of improvements in the methods used and in terms of new and innovative research questions). Already, Lawson et al. (2020), Hall and Lawson (2014) and Lawson (2022) have accounted for studies using the Economic Freedom of the World index to identify determinants and effects of economic freedom.5 As shown in these overviews of the literature, there are hundreds of studies, but it is in the nature of the article format that the studies can only be described very summarily. This Handbook provides more depth in having separate chapters on various determinants and effects, and it covers more years of publications, but like the two articles, it aims to present the literature as complete as possible as a guide both to the scholars working on related topics in the future and to policymakers.
CHALLENGES AND COMPLICATIONS Before providing a brief summary of all the chapters, it should be recognized that there are potential problems with the line of research covered in this book. Most such potential problems pertain to cross-country studies in general, but some are particular to economic-freedom research. They are of course discussed in many of the chapters but let me mention a few general issues. First, the construction of an index is, to some extent, arbitrary. This problem concerns, among other things, variable selection, the method of transforming numerical values to a common scale and the method of aggregation (cf. Gründler and Krieger 2022). When it comes to variable selection, contested issues are, for example, whether the size of government should be conceptualized as necessarily reducing economic freedom and whether outcomes (rather than institutions or policies), such as monetary stability, should be seen as instances of economic freedom. When it comes to aggregation, there are different views, e.g., regarding whether one should use simple averages or more intricate weighting schemes, perhaps based
5
There are two earlier reviews of consequences as well, Berggren (2003) and de Haan et al. (2006).
Introduction 7 on principle components analysis. On matters like these, reasonable people can reach different conclusions, but one thing to note is that any researcher can easily change the indices, since all data and weights are published openly. This includes using only parts of an index if someone thinks this better reflects the concept of economic freedom. Second, some people think of the indices as normative, as statements of what is desirable. One indication of this may be that both major indices are published by market-friendly think tanks (the Fraser Institute and the Heritage Foundation). While this is a possible interpretation, Paldam (2003) in my view rightly opines that even if the publishers have certain normative commitments, they know they have scrutinizing eyes upon them, prompting them to be conscientious in putting the indices together in an honest and transparent way. In the case of the Economic Freedom of the World index, it has been constructed and is constantly updated by academic experts, which further indicates credibility. The indices can just as well be used by market skeptics who want to investigate possible negative outcomes of economic freedom – or, indeed, by value-neutral researchers who simply want to find ‘things’ out. Third, when looking at empirical relationships between economic freedom and other variables, we are far from a solid understanding of the complete causal structure. While we can find indications of a relationship between various ‘determinants’ and economic freedom, and between economic freedom and various ‘outcomes’, there may be other non-included and, in some cases unobservable, factors that drive these relationships. There are mediators and moderators that often provide a richer understanding of simple relationships. Likewise, there may be reverse causality, blurring the notions of determinants and outcomes. Observational data of the kind exemplified by economic-freedom indices are not ideally suited to sort out endogeneity concerns. There are, however, attempts at reducing this problem, e.g., through the epidemiological method, synthetic controls, matching methods, event studies, natural experiments or instrumental variables – but these approaches are often difficult to apply and are missing from many studies. Thus, findings should in many cases not be interpreted causally. It is arguably in this methodological area that future research can improve the credibility of the empirical findings involving economic freedom that have been produced thus far the most. This being said, there is great value in the studies that have been produced up to now. This volume aims, not at presenting an overview of ‘perfect’ studies, but at presenting sufficiently good studies that can inform both policy decisions and future – less imperfect and topic-wise expanded – research. But as always, research should not be digested or be applied uncritically.
THE CHAPTERS The chapters of this book have been sorted into six sections, and I will finish this introduction by presenting brief summaries of each chapter by section.6 Part I: The Concept and Measurement of Economic Freedom Chapter 2, ‘The creation of the Economic Freedom of the World index’, is written by James D. Gwartney and Robert A. Lawson. The chapter describes how the Economic Freedom of the 6 It bears noting that all chapters have been peer-reviewed and revised on the basis of detailed reports.
8 Handbook of research on economic freedom World index came into existence. The index measures the extent to which the institutions and policies of various countries are coordinated through personal choice, voluntary exchange, open markets and clearly defined and enforced property rights. The authors also describe how the index has changed over the years. The current index uses 42 different variables grouped into five major areas to provide a measure of economic freedom for 165 countries. The authors argue that the index makes it possible for researchers to analyze cross-country differences in economic freedom and to study its consequences for economic and other outcomes. Chapter 3, ‘Economic Freedom of the World in the universe of measuring institutions’ by Ryan H. Murphy, situates the Economic Freedom of the World index among other measures of institutional quality. He points out that there are other measures of economic freedom, which are constructed differently, and which focus on other points in time or subregions within countries. There is, moreover, an overlap between the Economic Freedom of the World index and other measures of institutional quality that are different conceptually, such as globalization, the rule of law, the business environment, and even certain (maximalist measures of democracy. He contends there is sufficient depth in the available data to test hypotheses concerning economic freedom and institutional quality in a variety of nuanced ways. Part II: Economic Freedom in the World Chapter 4, ‘Economic freedom, 1950–2020’ by Ryan H. Murphy, presents the most extensive worldwide economic freedom data from 1950 to 2020 presently available. It does so by chain-linking data at the country level to account for the compositional bias of which countries happen to have data available in a given year. In the absence of this correction, the extent of liberalization (i.e., increases in economic freedom) is understated. This exercise is repeated for the years 1950–2020 to assess different regions of the world and for 1970–2020 to assess different areas of economic freedom. Globally, liberalizations persisted overall up through 2019. Chapter 5 is entitled ‘Economic freedom in economic history’ and is written by Vincent J. Geloso and Gregory W. Caskey. They provide an overview of key scholarly contributions that build upon the role of economic freedom in economic history. Contributions that set forth cultural, institutional, and technological frameworks to account for change in economic history are highlighted. Moreover, the limits of institutional explanations are discussed, not least in light of competing theories of what contributed to economic freedom and growth. A central message of the chapter is that the concept of ‘positive economic liberty’ – the guarantee of access to markets that allow people to control their own existence - has been heretofore underappreciated in the literature in economic history. Part III: Economic Freedom in the History of Economic Thought This section contains Chapter 6, ‘Adam Smith and economic freedom’, by Maria Pia Paganelli, and Chapter 7, ‘Economic freedom in the Freiburg and Austrian schools’, by Gerhard Wegner. These two chapters describe some key thinkers involved in developing conceptions of economic freedom and theories of how economic freedom is crucial for a dynamic and growing economy. Paganelli argues that there are good reasons to associate economic freedom with Adam Smith. Not least, he is critical of limitations of the market process introduced as the result of interest-group influence. Still, he is not an advocate of laissez faire. Paganelli points
Introduction 9 out that Smith accepts limitations on individual freedom if the wellbeing of the majority of the population requires it. Wegner explains in what ways economic freedom plays a decisive role in both the Freiburg school and the Austrian school, highlighting especially the contributions of Walter Eucken and F. A. Hayek. While the Freiburg school refers to Kant’s moral philosophy and links the theory to German economic history, the Austrian school, in its Hayekian form, presents an evolutionary account of the process of civilization. Yet, both schools reach similar policy conclusions, having specific ideas about the limits of government action. The Freiburg school stresses the importance of a competitive order that ensures economic opportunities and challenges. This may in some cases entail limitations on private economic power. Part IV: Determinants of Economic Freedom In Chapter 8, André Azevedo Alves and Inês Gregório write about ‘Religion and economic freedom’. They discuss how the main religious doctrines and other associated philosophical and religious factors influence opinions and perceptions about the market economy and how they may affect economic freedom. They focus on the religious doctrines of Judaism, Christianity, Islam, Hinduism and Buddhism in order to understand how their teachings relate to the concepts and institutions of the market economy. They finish with a broad characterization of the religious character of countries with high and low economic freedom, providing suggestive links. In Chapter 9, ‘The effects of crises on economic freedom and market-oriented reforms: A survey’, Hans Pitlik addresses the important question of how economic crises affect the institutional environment. The chapter begins with a theoretical discussion of the link between crises and subsequent market-oriented reforms. Consulting the empirical evidence, Pitlik considers the idea of a direct positive impact of crises on economic liberalization over-simplified. Just as the theoretical analyses point at mixed and inconclusive effects of crises, the empirical evidence does so, too. Chapter 10 is called ‘Democracy and economic freedom’, with Abishek Choutagunta and Jerg Gutmann as its authors. The chapter provides an overview of the literature studying the relationship between democracy and economic freedom. In particular, they engage with the seminal study on this topic and provide updated evidence. The results are less robust than in the original study, but the overall picture is one of a positive influence of democracy on economic freedom, at least in non-OECD countries. In Chapter 11, Klaus Gründler, Armin Hackenberger and Niklas Potrafke write about ‘Government ideology and economic freedom: New empirical evidence’. Their contribution is a review of studies of how government ideology affects economic freedom. They provide new empirical evidence using the latest set of available data for the period 2000–2020. The findings reveal that economic freedom is lower under governments with left-leaning economic beliefs – but only if such governments have a populist character. Chapter 12, ‘Immigration and economic freedom’, is by Alexandre Padilla. He looks at two questions. First, he reviews the literature testing whether countries or regions that are more economically free attract immigrants. Second, he provides an overview of research investigating whether countries that receive immigrants see their economic freedom scores improve or decline. The literature indicates that migrants value economic freedom. They tend to move to countries with higher levels of economic freedom than their home countries, and there are no
10 Handbook of research on economic freedom indications of economically significant declines in economic freedom in countries or regions that receive them. The last text of this section is Chapter 13, in which Ola Olsson presents research on ‘Deep determinants of economic freedom’. He traces the origin of economic freedom to hunter-gatherers. They were highly mobile, had no property rights to land and used exit as the main strategy for conflict resolution. Around 11,000 years ago, sedentary agriculture became an established form of production, which meant that physical capital accumulation increased and that property rights emerged. While this increased economic freedom in one sense, it can also be seen as having reduced it by entailing restrictions to mobility, greater interdependence and the emergence of powerful elites that extracted tributes. In an empirical exercise, Olsson shows that basic geographic and climatic factors such as elevation and temperature still explain almost half of the contemporary cross-country variation in economic freedom. Part V: Consequences of Economic Freedom In Chapter 14, ‘The impact of economic freedom on economic growth’, Jakob de Haan and Jan-Egbert Sturm offer a review of studies on the relationship between economic freedom and economic growth. While they find that most studies report a direct positive relationship between economic freedom and growth, much of the literature faces problems such as the potential endogeneity of economic freedom and problematic specifications of the growth models. As a point of worry, they remark that several methodologies that have been suggested to deal with shortcomings of traditional cross-country and panel growth models have hardly been applied thus far. This creates opportunities for further research. Chapter 15, ‘Economic freedom and inequality: A survey of the empirical literature’, is written by Daniel L. Bennett. He provides a systematic overview of the empirical literature examining the link between economic freedom and inequality. He concludes that the empirical evidence is mixed. While it indicates a negative relationship between economic freedom and economic inequality when comparing countries or regions, the findings are less conclusive in studies that look at variation within countries or regions. He points out that the distributional impact of economic freedom may be conditional on other factors such as, for example, economic development, political regime type or the level of economic freedom. In Chapter 16, ‘Economic freedom and happiness: On moderation and mediation’, Johan Graafland surveys the literature on the relationship between economic freedom and happiness (mostly measured as life satisfaction). He finds fairly clear results in favor of a positive relationship between economic freedom and happiness, most supported for the rule of law and least supported for the size of government and regulation. Graafland identifies several moderators that affect the relationship between economic freedom and happiness, such as income, religion, national culture, pro-market preferences and quality of government, while finding that mediation is relatively unexplored. The few studies available have identified satisfaction with public goods, income, trust, income inequality and job perspectives as mediating factors. As a way forward, he proposes more research on moderating and mediating factors, and on trying to establish causality. Chapter 17, ‘Entrepreneurship and economic freedom’, is written by Per L. Bylund, Peter G. Klein and Matthew McCaffrey. They begin by presenting their view of what entrepreneurship is, what its social and economic significance consists of and how it relates to economic freedom. They contrast their view with several other theoretical accounts of the relationship
Introduction 11 between entrepreneurship and economic freedom. They then continue with an overview of the empirical evidence on economic freedom and entrepreneurship, where most studies find a positive association, but they also point out several limitations and pitfalls that future research should address. In Chapter 18, Eelke de Jong presents research on ‘The influence of the market economy and economic freedom on culture’. The chapter is an overview of empirical research on the effects of a market society on culture, in the form of values, social attitudes and norms of behavior. De Jong finds that the institutions of free markets, especially the rule of law, tend to have a positive influence on civic virtues, trust and tolerance. The influence is stronger in rich, Western countries than elsewhere. However, establishing the exact causal path appears difficult and remains a challenge. Chapter 19, ‘Economic freedom and gender’ by Rosemarie Fike, explores the relationship between the market orientation of economies and the standing and welfare of women. The main question asked is: do markets oppress women or help them flourish? The chapter introduces a gender-adjusted measure of economic freedom, discusses theoretical arguments about the effects of markets on the lives of women and presents some empirical evidence to help shed light on the issue; this evidence is also compared with related empirical findings in the economics literature. Chapter 20 is on ‘Economic freedom and populism’ and is written by Andreas Bergh and Anders Kärnä. The starting point is the success of populist politicians and the oft-heard argument that free markets are to blame. Market critics assert that trade and competition destroy jobs and cause social tensions in society, or fear of such outcomes, which in turn makes many people supportive of the ‘easy solutions’ proposed by populists. However, in their review of the literature, they find little support that economic freedom causes populism, except for trade with China, which seems to generate populism. Complementing the literature by analyzing panel data on populist voting in European countries, Bergh and Kärnä find that economic freedom correlates negatively with right-wing populism and is uncorrelated with left-wing populism. Moreover, there are indications that populist politicians decrease economic freedom. In Chapter 21, ‘Economic freedom and human rights: A survey’, Christian Bjørnskov provides an overview of the literature associating economic freedom with de facto respect of human rights. There are 38 published papers that explore the association, using different measures and methods. Thirty papers document positive effects and only two find negative effects. Bjørnskov concludes that the empirical literature supports the existence of a positive association between economic freedom and respect for human rights, even though methodological challenges remain, not least with regard to causality. Chapter 22, ‘Economic freedom and the economic effects of crises’ is by Jamie Bologna Pavlik. She asks how economic freedom affects the negative economic fallout associated with a variety of crisis types (e.g., pandemics, financial crises and natural disasters). A key hypothesis is that economic freedom creates an environment that is conducive to entrepreneurial behavior, which gives individuals the flexibility necessary to react to crisis situations in a relatively successful way. The chapter reviews the existing literature on this topic and offers some preliminary evidence concerning the economic impact of Covid-19. In Chapter 23, ‘Economic freedom and environmental performance’, Jonas Grafström looks at the relationship between economic freedom and various environmental outcomes. His analysis relies on comparing countries’ standing in the Environmental Performance Index with two indices of economic freedom. Whether economic freedom is good or bad for the environment
12 Handbook of research on economic freedom depends on how it affects incentives, productive efforts and effective resource use. Greater economic freedom can thus both harm and help the environment. The empirical findings suggest, however, that in the economically freest countries, the environment is significantly better and has been improving more than in the less free countries during the last decade. Tim Krieger and Daniel Meierrieks have written Chapter 24, ‘Economic freedom, peace and violent conflict’. They analyze the literature on how economic freedom and violent conflict relate to each other. They consider theories of how economic freedom, in its various manifestations, affect violent conflicts, from terrorism to war. The theories are then confronted with the existing empirical findings. The authors find empirical support for pro-market institutions contributing to external and internal peace and stability beyond mere economic gains. However, they also point out shortcomings of the existing literature and identify potential avenues of future research. In Chapter 25, ‘The impact of economic freedom on corruption and the shadow economy’, Peter Graeff begins by presenting basic tenets of a theoretical framework for considering the impact of economic freedom on corruption and dealings in the shadow economy. The general prediction is that economic freedom reduces incentives for such activities. In an overview of the empirical literature, Graeff finds support for the theoretical prediction, but only when overall indices of economic freedom are applied. Opposite effects sometimes appear for various subcomponents of economic freedom, and when changing the time horizon. Part VI: The Philosophy of Economic Freedom In Chapter 26, Nick Cowen writes about ‘Economic freedom and social justice’. He notes that many ethicists and social scientists are critical of the processes and outcomes they think appear under economic freedom. He considers classical liberal responses to the claims of social justice and concludes that they have not been very successful in rebutting the expressed concerns relating to inequality. Instead, by developing an argument based on insights from classical political economy, he presents a richer account of the socializing role of economic freedom. Rather than dismissing social justice, this perspective justifies the inclusion of economic freedom within broader frameworks of institutions, rights and duties – not least in its Rawlsian form. Last but by no means least, we have chapter 27, ‘Freedom and flourishing’ by Douglas J. Den Uyl and Douglas B. Rasmussen. They start by affirming the conclusion of Deirdre McCloskey, that the West grew rich because of the emancipation of human ingenuity made possible by the development of liberalism. They develop the argument further by adding that the ‘enrichment’ has a strong moral dimension related to the neo-Aristotelian account of human flourishing that the authors have developed. They show that flourishing under freedom has many entrepreneurial features similar to those found in creating wealth. Part of the argument is that a political-legal order that enforces basic, negative rights, of which economic freedom can be seen as a subset, protects the possibility of self-direction and allows for the development of moral responsibility and in turn human flourishing.
Introduction 13
LOOKING FORWARD This is the only handbook covering research on economic freedom. The first comprehensive measures appeared in the 1990s, and since then a rich body of research has appeared. There is arguably great value in providing an overview of the key results so far. This overview should be inspiring to scholars interested in basic questions about the market economy and what it entails – it enables them to relate to what has already been done and to creatively consider ways of expanding the research frontier, both topic- and methodology-wise. It should also be useful knowledge for people active in public-policy work, as many findings speak to political decisions on the size of government, the quality of legal systems, monetary policy, trade policy and regulation.
REFERENCES Berggren, N. (2003). The benefits of economic freedom: A survey. Independent Review 8(2): 193–211. Berggren, N. (2014). The soft side of economic freedom. Annual Proceedings of the Wealth and Well-Being of Nations 6: 43–66. Berlin, I. (1969). Two concepts of liberty. In: Four Essays on Liberty, 118–172. Oxford: Oxford University Press. Buchanan, J.M. (2001). The potential for tyranny in politics as science. In: Moral Science and Moral Order: The Collected Works of James M. Buchanan, Volume XVII (eds. G. Brennan, H. Kliemt and R.D. Tollison), 153–170. Indianapolis, IN: Liberty Fund. de Haan, J., Lundström, S. and Sturm, J.-E. (2006). Market-oriented institutions and policies and economic growth: A critical survey. Journal of Economic Surveys 20(2): 157–191. Gründler, K. and Krieger, T. (2022). Should we care (more) about data aggregation? European Economic Review 142(February): 104010. Gwartney, J.D. (2009). Institutions, economic freedom and cross-country differences in performance. Southern Economic Journal 75(4): 937–956. Gwartney, J.D. and Lawson, R.A. (2024). The creation of the Economic Freedom of the World index. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 16–30. Cheltenham: Edward Elgar Publishing. Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Hall, J.C. and Lawson, R.A. (2014). Economic freedom of the world: An accounting of the literature. Contemporary Economic Policy 32(1): 1–19. Hall, P.A. and Soskice, D. (2001). Varieties of Capitalism: The Institutional Foundations of Comparative Advantage. Oxford: Oxford University Press. Hayek, F.A. (1948). ‘Free’ enterprise and competitive order. In: Individualism and Economic Order, 107–118. Chicago: University of Chicago Press. Hayek, F.A. (1976). Law, Legislation and Liberty: The Mirage of Social Justice. London: Routledge. Hirschman, A.O. (1982). Rival interpretations of market society: Civilizing, destructive or feeble? Journal of Economic Literature 20(4): 1463–1484. Lawson, R.A. (2022). Economic freedom in the literature: What is it good (bad) for? In: Economic Freedom of the World: 2022 Annual Report (eds. J.D. Gwartney, R.A. Lawson, J.C. Hall and R.H. Murphy), 187–200. Vancouver: Fraser Institute. Lawson, R.A., Murphy, R.H. and Powell, B.W. (2020). The determinants of economic freedom: A survey. Contemporary Economic Policy 38(4): 622–642. Marx, K. and Engels, F. (2010 [1848]). The Manifesto of the Communist Party. Marxists Internet Archive. https://www.marxists.org/archive/marx/works/download/pdf/Manifesto.pdf (accessed 5 October 2022).
14 Handbook of research on economic freedom Milanovic, B. (2019). Capitalism, Alone: The Future of the System that Runs the World. Cambridge, MA: Harvard University Press. Miller, T., Kim, A.B., Roberts, J.M. and Tyrrell, P. (2020). 2020 Index of Economic Freedom. Washington, DC: Heritage Foundation. Murphy, R.H. (2024a). Economic Freedom of the World in the universe of measuring institutions. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 31–45. Cheltenham: Edward Elgar Publishing. Murphy, R.H. (2024b). Economic freedom, 1950–2020. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 47–58. Cheltenham: Edward Elgar Publishing. North, D.C. (1991). Institutions. Journal of Economic Perspectives 5(1): 97–112. Paldam, M. (2003). The economic freedom of Asian tigers: An essay on controversy. European Journal of Political Economy 19(3): 453–477. Rajan, R. and Zingales, L. (2003). Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity. New York: Crown Publishing Group. Sinnott-Armstrong, W. (2022). Consequentialism. Entry, Stanford Encyclopedia of Philosophy. https:// plato.stanford.edu/archives/win2022/entries/consequentialism (accessed 6 October 2022). Zingales, L. (2009). Capitalism after the crisis. National Affairs 53(1): 22–35.
PART I THE CONCEPT AND MEASUREMENT OF ECONOMIC FREEDOM
2. The creation of the Economic Freedom of the World index James D. Gwartney and Robert A. Lawson
INTRODUCTION The first edition of the Fraser Institute’s Economic Freedom of the World (EFW) index was published in 1996 (Gwartney et al. 1996), and revised editions have been published annually since then. The purpose of the EFW index is to measure the degree to which the institutions and policies of countries are consistent with economic freedom and to track changes in economic freedom through time. The index has been used in numerous studies (see Lawson et al. 2020, and Lawson 2022) and has influenced public policy debates throughout the world. The objective of this chapter is to document the history of the creation and the evolutionary development of the EFW index. First, the historical background, events, and nature of the EFW project will be outlined in detail. Second, the creation and composition of the initial EFW index published in 1996 will be described. Finally, the evolutionary development and modifications of the index since the initial publication will be discussed.
HISTORY OF THE EFW PROJECT The origins of the EFW project go back to the 1984 general meeting of the Mont Pelerin Society (MPS) held in Cambridge, UK.1 Understandably, George Orwell’s famous dystopic novel, 1984, was a key topic of discussion at the meeting. A panel session was organized on the topic, ‘Was George Orwell right?’ This session featured a paper by Paul Johnson, one of the world’s leading historians, entitled, ‘1984: A false alarm.’ Johnson argued that the world had not evolved in the manner projected by Orwell. We were not living in a totalitarian Big Brother era, and if anything, political liberalism and democracy seemed to be on the rise. China was beginning to move away from the horrors of the Great Leap Forward and Cultural Revolution, and even the Soviet Union was hinting at liberalizations that would come a couple of years later in the form of perestroika and glasnost. Michael Walker, the founder and executive director of the Fraser Institute, was asked to comment on Johnson’s paper. Walker argued that while political liberalism may be on the rise, economic control in the form of taxation, industrial planning, trade protectionism, wage-price controls, and other regulations were stifling the actions of individuals and entrepreneurs in a manner similar to the projections of Orwell. Furthermore, there is a relationship between
The Mont Pelerin Society is a prestigious society of classical liberals founded by F.A. Hayek in the aftermath of World War II. MPS hosts meetings where members and their guests can discuss and debate the issues of the day. 1
16
The creation of the Economic Freedom of the World index 17 economic freedom and political freedom that hangs in the balance. Stressing this point, Walker quoted a key passage from Milton Friedman’s Capitalism and Freedom (1962, p. 9), Historical evidence speaks with a single voice on the relation between political freedom and a free market. I know of no example in time or place of a society that has been marked by a large measure of political freedom, and that has not also used something comparable to a free market to organize the bulk of economic activity.
This triggered a heated debate concerning whether economic freedom was gaining or losing ground. Disagreement was widespread and neither side presented much in the way of empirical evidence. This convinced Michael Walker that economic freedom needed to be more carefully defined and measured. If even committed classical liberals like those attending Mont Pelerin Society meetings were unable to distinguish between political and economic freedom and determine whether economic freedom was increasing or decreasing, someone needed to figure out how to measure it and track changes through time. Walker convinced Milton and Rose Friedman to join him in hosting a series of conferences with the objective to define and measure economic freedom for a large set of countries. The Liberty Fund, a foundation located in Indianapolis, Indiana, agreed to arrange for the necessary funding. Eventually, six conferences were held during 1986–1993. The participation of the Friedmans in this project was of crucial importance. This made it possible for the small Liberty Fund conferences, typically involving about 15 participants, to attract some of the world’s best minds to the project. In addition to Walker, the Friedmans, and the eventual authors of the index, the conferences involved approximately 60 scholars, including luminaries such as Armen Alchian, Peter Bauer, Edward Hudgins, Gary Becker, Ed Crane, Arthur Denzau, David Friedman, John Goodman, Arnold Harberger, Henri Lepage, Assar Lindbeck, Ronald Jones, Tibor Machan, Henry Manne, Richard McKenzie, Charles Murray, Douglass North, William Niskanen, Svetozar Pejovich, Alvin Rabushka, Richard Rahn, Alan Stockman, Sally Pipes, Gerald Scully, Richard Stroup, and Gordon Tullock. The first meeting was held October 5–8, 1986 in Napa Valley, California. Selected papers and transcripts of the discussions were later published in a volume edited by Walker (1988). Milton Friedman suggested that a representative from Freedom House be invited to make a presentation at this meeting. Freedom House had been producing cross-country indexes of political rights and civil liberties for many years and thus had considerable experience in the construction of freedom-related indexes. Moreover, the 1982 Freedom House annual report (Gastil 1982) included a section, on an experimental basis, providing ratings for economic freedom (Wright 1982). Raymond Gastil, then the President of Freedom House and Lindsay Wright, an economist working for the organization, presented a paper on their concept of economic freedom. The Gastil and Wright (1988) viewpoint reflected the Freedom House perspective that democratic political procedures and civil liberties are the most important aspects of economic freedom. Progressive taxation and income transfers are entirely consistent with economic liberty, they contended, so long as they are approved by democratic majorities. A spirited discussion and debate occurred with regard to whether economic freedom was properly understood in the context of individual rights (the position held by most of the conference participants) or whether economic freedom was a collective right that was ‘hardly separable from political freedom,’ which was the Freedom House view (Gastil 1985, p. 170). Walker (1996, p. 2) summarized the views of most of the conference participants in the following manner:
18 Handbook of research on economic freedom Several of the participants in this first conference, including myself, Walter Block, and Alvin Rabushka, believed that the Freedom House approach trivialized and distorted economic freedom, making it dependent on the political process. We came away even more convinced that development of a sound measure of economic freedom was a vitally important project.
Walker felt that a series of follow-up symposia was needed to explore the weaknesses of the Freedom House approach and to develop a measure of economic freedom based on classical liberal principles. The Liberty Fund agreed to finance five additional conferences with the objective of clearly defining economic freedom and developing a measure for a large set of countries. The second meeting was held in Vancouver in July of 1988. The papers and proceedings of this second meeting were later published in a volume edited by Block (1991). The highlight of the 1988 meeting was a paper presented by Alvin Rabushka focusing on how economic freedom should be defined and analyzing how it might be measured (Walker 1996). Building on the work of John Locke and Adam Smith, Rabushka examined the attributes of economic freedom and policies consistent with that freedom. He was highly critical of the collective rights approach of Freedom House presented at the first meeting. Rabushka stressed that economic freedom is present when individuals are permitted to choose for themselves and that collective action that interferes with their choices is still a violation of economic freedom. Private property and rule of law provide the institutional foundation for economic freedom. He applied the concept of economic freedom to five basic areas – taxation, public spending, economic regulation of business and labor, money, and foreign trade – and outlined some ideas about how it might be measured in each of these areas. After the presentation of the Rabushka paper and accompanying discussion, it was clear that the Freedom House conceptual approach did not provide a fruitful path to the development of a sound measure of economic freedom. Freedom House itself did eventually release an economic freedom index of its own (Messick 1996). In this volume, it appears that they had adopted a somewhat more individual-rights viewpoint compared with the one presented earlier. Even so, Freedom House could not bring itself to include government spending and/ or taxation in its index. In any case, Freedom House’s economic freedom index was published only once, and its interest in the topic appears to have waned. The 1988 meeting also featured a paper by Zane Spindler and Laurie Still (1991) seeking to develop an empirical measure of economic freedom based on individual rights. Spindler and Still considered a list of 21 items and attempted to evaluate the consistency of each of the factors with economic freedom for 148 countries. Their list of factors included items such as privatization, import restrictions, taxes, tariffs and non-tariff barriers, and price controls. Unfortunately, data were unavailable for many of the factors. Of the 21 items included in their index, the average country had just 6.5 data points; the most any country had was 13 and some countries had only 1. Obviously, the limited data coverage and large variation in the variables used from country to country weakened the trustworthiness of the index. Furthermore, some of the items on their list, such as ‘infrastructure,’ were more closely related to economic development rather than economic freedom. During the discussion of this paper, participants were asked to prepare a list of factors that they thought should be included in a measurement of economic freedom. This list provided direction for the future development of a more reliable index. James Gwartney’s involvement with the EFW project began with his participation in the 1988 meeting. He later recalled reading the letter inviting him to participate in a Liberty fund conference focusing on how to measure economic freedom (Gwartney 2009). Reading this
The creation of the Economic Freedom of the World index 19 part of the letter, his immediate thought was this is a harebrained idea. How could anyone measure something as complex and multi-dimensional as economic freedom? Gwartney then noticed that the invitation was from Milton Friedman, and thus he immediately fired back his acceptance. As Gwartney reflected on this meeting, he was impressed with the cooperative spirit as some of the world’s leading minds sought to develop a really important measurement tool. Virtually all participants perceived they were involved in an important project. There was even discussion of the parallel between this project and the development of national income accounts in the 1920s. Like economic freedom, measurement of national income was also complex and multidimensional. Initial measurement efforts were imperfect, and debate continues with regard to precisely how various items should be handled. Nonetheless, development of a measure of national income was one of the most important economic breakthroughs of the 20th century. Perhaps, this would also be the case for the development of a sound measure of economic freedom (Gwartney 2009). A third meeting in this series of Liberty Fund/Fraser Institute symposia was held in Banff, Alberta in 1989 and was followed soon thereafter with a fourth meeting held at Sea Ranch, California in 1990. The papers and discussions from these two meetings were later published in a single volume by the Fraser Institute (Easton and Walker 1992). The Banff meeting featured a paper by Gerald Scully and Daniel Slottje (1992), which represented the first fully-fledged effort to develop an empirical measure of economic freedom based on the principles outlined by Alvin Rabushka at the second meeting. This work was an outgrowth of Scully’s earlier interest in constitutional rules and economic growth (Scully 1992). Using 15 ‘liberty indicators,’ such as the flexibility of exchange rates, conscription, and a variety of other variables mostly related to civil liberties, Scully and Slottje developed a measure of economic freedom for 144 countries. They spent a lot of time discussing the details related to alternative ways of weighting the variables included in their index, an exercise that foreshadowed issues the EFW index would also confront. The Scully and Slottje paper was later published in the symposium proceedings, but they first published a version of it in Public Choice, making theirs the first economic freedom index published outside of the Liberty Fund/Fraser symposium proceedings (Scully and Slottje 1991). Although Scully continued to work in the field, he eventually dropped his own index and used the EFW index in his research (e.g., Scully 2002). During the first two conferences of the series, there was considerable debate about the nature and conceptualization of economic freedom. At the Banff meeting, however, a consensus crystalized. There was widespread agreement that self-ownership and freedom of individuals to choose for themselves constitute the foundation of economic freedom. Individuals are economically free when they can choose how to use their time, talents, and resources as long as their actions do not harm the person or property of another party. Use of violence, theft, fraud, and physical invasions are not permissible; but otherwise, economically free individuals are free to choose for themselves, trade with others, and compete as they see fit (Walker 1996). This concept of economic freedom is closely related to the presence of protective rights, that is, rights that provide individuals with a shield against others who would invade and/or take what does not belong to them. Since they are non-aggression or ‘negative’ rights, all citizens can simultaneously possess them. Some argue that individuals have invasive rights or what some call ‘positive’ rights to things such as food, housing, medical services, or a minimal income level. Such rights imply that some individuals have a right to demand that others
20 Handbook of research on economic freedom provide these things to them. For example, if Paul has a positive right to housing, this logically implies that Paul has a right to force Peter and others to provide the housing. But in a negative rights context, Paul has no right to the labor of Peter or any other individual because Peter owns himself. No one has a right to the time, talents, and resources of others. Put another way, individuals and groups do not have a right to demand that others provide things to them. Thus, invasive rights are inconsistent with economic freedom. The Banff meeting also featured a set of papers outlining variables needed to develop a measure of economic freedom in labor markets, international trade, and money of stable value. While these papers provided details on the measurement of economic freedom in each of these areas, data limitations restricted their application. One of the papers indicated roughly 100 variables that would be needed to develop a sound measure of economic freedom in labor markets. Unfortunately, only six or seven of the specified variables could be obtained for as many as a dozen countries. Following this presentation, Gwartney and Block concluded that it would be more fruitful to focus on a smaller set of variables that could be actually obtained for a large set of countries. As they shared this view with conference participants, Gwartney recalls that Friedman responded, ‘I agree and you should do so and present your findings at the next meeting.’ Upon his return to Tallahassee, Gwartney enlisted the assistance of his graduate student, Robert Lawson, to begin the construction of a new index. The fourth meeting was held in Sea Ranch, California in 1990, and this meeting featured the first presentation by Gwartney et al. (1992) of what would eventually evolve into the EFW index. The index provided ratings for 79 countries based on 11 variables grouped into four major categories (see Box 2.1). The variables were objective and available for a fairly large number of countries from published external sources.
BOX 2.1 COMPONENTS AND SUB-COMPONENTS OF THE INITIAL INDEX CONSTRUCTED BY GWARTNEY, BLOCK, AND LAWSON IN 1990 I.
Money and Prices a. Standard deviation of the annual growth rate of the money supply (last five years) b. Standard deviation of the annual inflation rate (last five years) II. Size of Government a. Total government expenditures as a percent of GNP b. Nonfinancial central government enterprises i. Total number ii. Government enterprises in designated industries c. Portion of economy subject to price controls III. Takings and Discriminatory Taxation a. Transfers and subsidies as a percent of GNP b. Top marginal tax rate (and income threshold at which it applies) c. Conscripts per 1,000 population IV. Restrain of International Trade a. Taxes on international trade as a percent of exports and imports b. Actual size of the trade sector compared to the expected size
The creation of the Economic Freedom of the World index 21 The Sea Ranch meeting also featured an interesting experiment on an alternative approach. At the beginning of the session, Milton and Rose Friedman asked the 23 participants to rank order the perceived economic freedom of 11 countries with which all participants would be familiar. The 11 countries included in this survey were: Australia, Chile, France, Germany, Hong Kong, India, Israel, Japan, Sweden, the United Kingdom, and the United States. The Friedmans tabulated the rankings during the evening and presented the results the following day. This simple survey and analysis enhanced the confidence in the Gwartney, Block, and Lawson approach. While there were some differences, the Gwartney, Block, and Lawson ratings of the 11 countries were highly correlated with the rankings derived by the survey approach. In 1991, a fifth meeting of the series was held in Monterey, California (Walker 1996) without the participation of Gwartney and Lawson. This meeting focused on a series of papers based on the survey approach to creating an index. Groups of respondents in Asia, Latin America, Africa, Europe and North America were asked to rank countries in their region as well as countries outside their region which were common to all of the lists. In this way it was hoped that an integrated picture might emerge of the economic freedom rankings of the countries examined. While this experiment generated some interesting results, it also highlighted a number of problems. The respondents did not possess enough information about a broad set of countries. Even knowledgeable people living in a given region generally possessed detailed knowledge for only one or two countries in their region. In the end, the conference did not generate a set of coherent ratings that seemed credible. Later an actual survey was sent to Mont Pelerin Society members all over the world, who presumably would have closely related ideas regarding the concept and meaning of economic freedom. While the results from this survey were more consistent, it was felt that the more objective, data-driven approach previously presented by Gwartney, Block and Lawson would lead to a more desirable outcome. The sixth and final symposium in the series was held in Sonoma, California in 1993. This meeting focused on an expanded and updated version of the Gwartney, Block and Lawson measure. Several suggestions for improvement were advanced and alternative methods of weighting the variables considered. After this meeting, Michael Walker and the Fraser Institute decided it was time to move toward a final publication. Gwartney developed serious problems with his eyesight shortly after the 1993 meeting, which would eventually result in his total blindness; this caused a several-year delay in the publication process. In the interim, the Heritage Foundation released its own Index of Economic Freedom in 1995 which was published mere months before the EFW index. Edward Hudgins had been a representative from the Heritage Foundation at both the Banff and Sea Ranch meetings. See Miller et al. (2022) for the most recent Heritage index.
STRUCTURE OF THE INITIAL EFW INDEX The Fraser Institute released the initial Economic Freedom of the World: 1975–1995 (Gwartney et al. 1996) to considerable fanfare receiving attention even from The Economist (Anonymous 1996) magazine. The publication contained an introduction by Michael Walker describing much of the historical background outlined above and a foreword by Milton Friedman. Throughout the development phase of the index, Milton Friedman constantly reminded participants that we were developing a scientific measure. To the fullest extent possible, it should
22 Handbook of research on economic freedom be based on objective quantifiable data and transparent procedures. The subjective views of the researchers should not influence the rating of any country. Thus, the data used to derive ratings were objective data obtained from external sources. The goal was the development of an index that others, regardless of their political orientation, could replicate. As shown in Box 2.2, the initial EFW index was based on 17 components organized into four major areas. Based on the actual data, each component was assigned a gradation rating ranging from zero representing the least free to ten representing the freest. The component ratings were aggregated to derive the area ratings and finally the area ratings aggregated to derive an overall summary rating. Data were available to calculate the index for 102 nations for 1975, 1980, 1985, 1990, and 1993–1995. This made it possible to not only observe cross-country differences in economic freedom, but for the first time, to track country changes through time. As the availability of data expanded through the years, the EFW index has become more comprehensive, and changes have been made in the structure, the types of data used, and the methods of aggregation.
BOX 2.2 COMPONENTS AND SUB-COMPONENTS OF THE FIRST EFW REPORT IN 1996 I.
Money and Inflation (protection of money as a store of value and medium of exchange) a. Average annual growth rate of the money supply during the last five years minus the potential growth rate of real GDP b. Standard deviation of the annual inflation rate during the last five years c. Freedom of citizens to own a foreign currency bank account domestically d. Freedom of citizens to maintain a bank account abroad II. Government Operations and Regulations (freedom to decide what is produced and consumed) a. Government general consumption expenditures as a percent of GDP b. The role and presence of government-operated businesses c. The extent that businesses are free to set their own prices d. Freedom of private businesses and cooperatives to compete in markets e. Equality of citizens under the law and access of citizens to a nondiscriminatory judiciary f. Freedom from government regulations and policies that cause negative real interest rates III. Takings and Discriminatory Taxation (freedom to keep what you earn) a. Transfers and subsidies as a percent of GDP b. Top marginal tax rate (and income threshold at which it applies) c. The use of conscripts to obtain military personnel IV. Restraints on International Exchange a. Taxes on international trade as a percent of exports plus imports b. Difference between the official exchange rate and the black market rate c. Actual size of the trade sector compared to the expected size d. Restrictions on the freedom of citizens to engage in capital transactions with foreigners
The creation of the Economic Freedom of the World index 23 The Economic Freedom Network From the beginning, the EFW Index has been produced and published by the Fraser Institute in Canada and is co-published by an Economic Freedom Network (EFN) of private think tanks and institutes, each of which receives copyright permissions within its country. Currently, there are EFN members in 90 different countries. EFW members include the Cato Institute (USA), the Hong Kong Center for Economic Research, the Institute of Economic Affairs (UK), the Liberales Institut (Germany), The Free Market Foundation (South Africa), and Timbro (Sweden). Each year before final publication, the EFW index authors send preliminary data to the members of the EFN for their review. They are asked to comment on the data for their country and in rare cases correct the data when a credible local source conflicts with the international sources. In addition, the EFN holds an annual meeting, hosted by one of the member groups, to discuss the EFW index in more detail. At these meetings, invited guests make presentations and participate in panel discussions. Importantly, the annual EFN meeting also provides the authors with the opportunity to share and discuss ideas for improvements in the index with a broad set of scholars and practitioners who have been involved with the project through the years. The open collaborative spirit of those first six Liberty Fund colloquia remains alive at these annual EFN meetings.
CHANGES IN THE INDEX THROUGH TIME In the foreword to the initial EFW publication (Gwartney et al. 1996, p. vii), Milton Friedman (1996) wrote: Freedom is a big word, and economic freedom not much smaller. To talk about economic freedom is easy; to measure it, to make fine distinctions, assign numbers to its attributes, and combine them into one overall magnitude – that is a very different and much more difficult task, as we found out when we started on this quest some thirteen years ago (see Michael Walker's introduction). James Gwartney, Robert Lawson, and Walter Block deserve great credit for having brought this quest to so satisfactory a temporary conclusion – I say temporary because this study of economic freedom for more than 100 countries provides a cornucopia for students of the relation between economic freedom, political freedom, and civil freedom, and for further explorations of the relation between economic freedom and the level and rate of economic growth. The resulting studies will surely make revised editions necessary, both to bring the indexes of economic freedom up to date and to incorporate the additional understanding that will be generated.
As Friedman correctly indicated, the EFW index was a work in progress. Subsequent changes would be necessary to improve the accuracy and comprehensiveness of the measure. The following provides a review of the major changes in the index since the initial publication. Structural Changes to the Index As previously mentioned, objective variables such as government consumption as a share of total consumption were strongly preferred to variables reflecting subjective views. While it was possible to develop a set of objective variables for the measurement of economic freedom
24 Handbook of research on economic freedom in the areas of size of government, access to sound money, and openness of international exchange, this was not the case in the legal system and regulatory areas. Nonetheless, institutions and policies in these areas exert a major impact on economic freedom. In the end, it was decided that survey data would be needed to provide information on the consistency of institutions and policies with economic freedom in the legal and regulatory areas. Prior to the 2002 report, the EFW index mainly used data from the International Country Risk Guide (ICRG) to measure cross-country differences in the legal structure area (PRS Group, various years). Beginning in the early 2000s, the World Economic Forum’s Executive Opinion Survey, which formed the basis for its Global Competitiveness Report (GCR) ratings, included information on the independence of the judiciary, impartiality of courts, and hiring and firing practices (World Economic Forum, various years). The GCR also included several variables that addressed regulatory restraints, particularly those limiting freedom to contract and compete in business activities and labor markets. Beginning with the 2002 annual report, survey variables from the GCR were incorporated into the legal and regulatory areas of the index. Like the other variables in the index, the survey variables were derived from an external source. Although the data were subjective, the subjective views of the authors still did not exert an impact on the rating of any country. This is a critical ingredient of the index that has been and will continue to be maintained. The 2002 annual report (Gwartney and Lawson 2002) also reorganized the components into five major areas: (1) Size of Government, (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. This basic organizational structure of the areas in the index is still maintained. In 2007, the availability of the Doing Business Indicators of the World Bank presented another opportunity to increase the comprehensiveness of the EFW index. Using a team of professionals around the globe, World Bank staff derived data on the required time and money costs across countries when engaging in various business activities such as starting a new business, clearing imports or exports through customs, hiring and dismissing employees, collecting an uncontested debt, and making tax payments. The methodology of the World Bank involved estimating the regulatory compliance cost incurred in each country when undertaking specific generic business activities. These data along with the survey data from the Global Competitiveness Report substantially increased the coverage of various indicators of economic freedom in the legal and regulatory areas of the EFW index.2 In 2020, the EFW index began to augment various components and sub-components using selected variables from the Varieties of Democracy (V-Dem Institute, various years) database, and as a result the data coverage prior to 2000, especially in Area 2, has been greatly enhanced. The 2007 annual report contained 42 different variables (components and sub-components), up from 25 in 1998–1999, 17 in the initial 1996 report, and 11 in the first prototype index (Gwartney and Lawson 2007). The 42 variables were grouped into the five major areas of the index. With only minor changes, this structure is still present in the latest annual report. See Box 2.3 for the listing of the components in each of the five areas of the index in the 2022 report. The World Bank recently announced the discontinuation of the Doing Business project over alleged improprieties in the calculations related to several countries including China. Simeon Djankov (2022) is currently exploring the opportunity to revive the project with another institutional home. 2
The creation of the Economic Freedom of the World index 25 Each annual report contains an appendix, ‘Explanatory notes and data sources,’ indicating the source of the raw data for each component and how the data are transformed to the zero to ten scale. This allows reviewers to understand how the ratings for each component are derived. Because the derivation of data takes time and only data from external sources are used, there is a two-year lag between the year of the annual report and the year used to derive the index. For example, the 2022 annual report provides the EFW index based on data from 2020.
BOX 2.3 COMPONENTS AND SUB-COMPONENTS OF 2022 EFW INDEX I.
Size of Government a. Government consumption b. Transfers and subsides c. Government investment d. Top marginal tax rate i. Top marginal income tax rate ii. Top marginal income and payroll tax rate II. Legal System and Property Rights a. Judicial independence b. Impartial courts c. Protection of property rights d. Military interference in the rule of law and politics e. Integrity of the legal system f. Legal enforcement of contract g. Regulatory costs of the sale of real property h. Reliability of police III. Sound Money a. Money growth b. Standard deviation of inflation c. Inflation: most recent year d. Freedom to own foreign currency bank accounts IV. Freedom to Trade Internationally a. Tariffs i. Revenue from trade taxes (% of trade sector) ii. Mean tariff rate iii. Standard deviation of tariff rates b. Regulatory trade barriers i. Non-tariff trade barriers ii. Compliance costs of importing and exporting c. Black market exchange rates d. Controls on the movement of capital and people i. Financial openness ii. Capital controls iii. Freedom of foreigners to visit V. Regulation
26 Handbook of research on economic freedom a.
Credit market regulation i. Ownership of banks ii. Private sector credit iii. Interest rate controls/negative real interest rates b. Labor market regulations i. Hiring regulation and minimum wage ii. Hiring and firing regulations iii. Centralized collective bargaining iv. Hours regulations v. Mandated cost of worker dismissal vi. Conscription c. Business regulations i. Administrative requirements ii. Bureaucracy costs iii. Starting a business iv. Impartial public administration v. Licensing restrictions vi. Cost of tax compliance
Adjustment for Differences in the Legal Rights of Women Relative to Men The 2017 report incorporated an adjustment of the legal structure area rating for cross-country differences in the legal rights of women relative to men. While the legal rights of men and women are similar or identical in many countries, and most economic policies affect women and men equally (e.g., inflation and tariffs), this is not always the case especially when it comes to legal matters. The World Bank provides data on the legal rights of women relative to men for a large number of countries on women’s freedom to move outside of the home, open a bank account, engage in employment, operate a business, own property, and inherit assets, among others. These data were used to adjust country ratings in the legal area. Failure to make this adjustment results in an upward bias of the ratings for economic freedom in countries that restrict the legal rights of women. Since the World Bank data on gender disparities are available historically all the way back to 1970, it was possible to adjust the earlier EFW ratings as well. This adjustment both improved the accuracy and expanded the comprehensiveness of the EFW index. Rosemarie Fike conducted detailed research on this topic and assisted us with the adjustment in the legal area. See Fike (2017) for details. Aggregation Methods and Weighting of Components How should the components be aggregated and used to calculate area and summary ratings? There is no single answer to this question. Economic theory provides direction regarding elements that should be grouped together within the areas of the index, but it does not indicate how each component should be weighted. It would be nice if the components of economic freedom were independent of each other and a statistical tool such as regression analysis could be used to derive an appropriate weight for each component. However, the components are
The creation of the Economic Freedom of the World index 27 often interrelated, and even if they were independent, the number of observations would limit the use of statistical techniques to derive weights. The initial 1996 EFW report derived area and summary ratings based on three alternative weighting methods: equal weights, survey information, and correlation with level of income. The next few reports used principal component analysis to assign the component weights (within each area) and the area weights (for the summary rating). These alternative weighting systems did not generally exert much impact on the overall ranking of countries. Starting with the 2002 Report, the index switched to using simple averages to create the component, area, and summary index scores. There were two practical reasons underlying this decision. First, it was easily understandable and easier to compute. Complex statistical weighting procedures are difficult for the media, policymakers, and ordinary citizens to comprehend. Thus, use of a simple averaging technique was consistent with our goal of transparency. Second, there is reason to believe that the components of economic freedom work together like a team. Put another way, they may be linked like the wheels, motor, transmission, drive shaft, and frame of a car. Which of these components is most important for the operation of the car? The question cannot be easily answered because the parts work together. If any of these key parts break down, the car is immobile. We think institutional quality may be much the same. If any of the key parts are absent, the overall effectiveness is undermined. Just as it is a bundle of interrelated parts underlying the operation of an automobile, there is reason to believe that there is a bundle of interrelated components underlying the operation of economic freedom. As the result of these two considerations, we organize the elements of the index in a manner that seems sensible to us, but we make no attempt to weight the components in any special way when deriving either area or summary ratings. Of course, the component and area ratings are available to researchers and if they believe that an alternative weighting procedure is more appropriate for their purposes, we have always encouraged them to employ it. In fact, a cottage industry of alternative weighting schemes for the EFW index has emerged. Heckelman and Stroup (2000) experimented with different aggregation schemes based on growth regressions, to which Sturm et al. (2003) responded offering their own preferred weighting method. Balliew et al. (2020) explored the use of geometric means instead of arithmetic means. Along similar lines, Bolen and Sobel (2020) suggest that countries with higher standard deviations of the area ratings grow less rapidly over time, ceteris paribus, echoing the EFW authors’ teamwork argument. Comparability Across Time As the availability of data through time has increased, the number of countries included in the index has expanded. The initial 1996 Index included 102 countries. By 2002, the annual report covered 123 countries, and that figure has jumped to 165 in the most recent report (Gwartney et al. 2022). More importantly, the EFW index has also become more comprehensive through time. The number and composition of the components and sub-components for many countries vary across time. Given these changes in the structure of the index, how can comparability across time be achieved? Our initial solution was to adopt a chain-linked procedure similar to that used by government statisticians when there are changes in the basket of goods included in the construction of price indexes to track inflation. When new goods are added (or old goods subtracted) to the
28 Handbook of research on economic freedom basket, the statisticians will base changes in the price index only on changes in the prices of goods that are common from one year’s basket to the next. If we add, say, bananas to a price index basket that had previously contained only apples and oranges, the only effect of this addition would be to adjust the price index based on changes in the price of bananas this year to next. In essence, the price level of bananas would not matter, only changes in the price of bananas would matter. If the following year, avocados were added, then similarly, the price index would adjust upward or downward based on changes in the price of avocados. The 2002 EFW index was the first to present a chain-linked EFW index (now called the EFW Panel Dataset) using the 2000 value as the ‘base year.’ The 2000 rating was taken as the base, and then the scores for the areas and the overall index were adjusted upward or downward in the years before and after based only on changes in the ratings for the underlying variables common to adjacent data years. One downside to this approach was that you could only construct a chain-linked score for those countries with ratings in the 2000 base year. As time went on, additional countries were added to the EFW index, but they could not be included in the chain-linked version of the index without a rating in 2000. Beginning with the 2022 report, the base year was set as the most recent year, and the chain-linking procedure was performed going backward in time from that most recent year. This means that the EFW Panel Dataset can include the same list of countries as the regular index. It should be noted that the EFW Panel Dataset contains area and summary ratings only for those years in which the country received a regular EFW index rating. Because some data for earlier years may have been updated or corrected, researchers are always encouraged to use the data from the most recent annual report to assure the most reliable figures.
CONCLUSION Those intensely involved with the EFW project set out to develop to the fullest extent possible a comprehensive and accurate measure of economic freedom. We believed that this measure would make it possible for researchers to investigate more directly a large number of unsettled questions. Consider the following questions. Are the poor often left behind in more economically free economies? Is income inequality greater in countries with more economic freedom? How does economic freedom impact environmental quality? Are economically free countries more or less likely to become involved in wars? Are people living in economically free countries more or less happy than those residing in countries that are less economically free? Can a country maintain a high degree of political freedom without relying on something like a market economy to allocate goods and resources? These are vitally important questions. Without a measure of economic freedom, it would be impossible to address them in a scholarly manner. From the outset, those of us involved in the EFW project sought to move questions like these away from opinions, biases, and heated arguments toward scholarly empirical analysis. The more than 1,300 peer-reviewed journal articles that have cited the EFW index (Lawson 2022) provide ample evidence of the success of the EFW index in affecting the academic conversation. Scholarly debate about the EFW index itself is ongoing as evidenced by the spirited exchange of papers by Hanson (2003) and Heckelman (2005); the vigorous debate between about the proper specification to be employed in growth regressions among de Haan et al.
The creation of the Economic Freedom of the World index 29 (2006), Lawson (2006), de Haan and Sturm (2006), Lawson and Cole (2007), and de Haan and Sturm (2007); and the debate about the appropriateness of including government spending in the EFW index between Ott (2018, 2022) and Murphy (2022a, 2022b). Regrettably, sober analyses such as these play only a small role in popular and political discussions about economic freedom. Clearly, there is much room for improvement in these areas.
REFERENCES Anonymous (1996). Economic freedom: Of liberty, and prosperity. The Economist (13 January) Balliew, S., Mathews, T. and Hall, J. (2020). Measuring economic freedom: An alternative functional specification and subsequent rating. Applied Economics 52(14): 1582–1591. Block, W. (ed.) (1991). Economic Freedom: Toward a Theory of Measurement: Proceedings of an International Symposium. Vancouver: Fraser Institute. Bolen, J.B. and Sobel, R.S. (2020). Does balance among the areas of institutional quality matter for economic growth? Southern Economic Journal 86(4): 1418–1445. de Haan, J., Lundström, S. and Sturm, J.-E. (2006). Market-oriented institutions and policies and economic growth: A critical survey. Journal of Economic Surveys 20(2): 157–181. de Haan, J. and Sturm, J.-E. (2006). How to handle economic freedom: Reply to Lawson. Econ Journal Watch 3(3): 407–411. de Haan, J. and Sturm, J.-E. (2007). Handling economic freedom in growth regressions: A reply to Cole and Lawson. Econ Journal Watch 4(1): 79–82. Djankov, S. (2022). Doing Business 2.0: A better guide for policy makers. In: Economic Freedom of the World: 2022 Annual Report (eds. J.D. Gwartney, R.A. Lawson, J. Hall and R.H. Murphy), 201–214. Vancouver: Fraser Institute. Easton, S. and Walker, M. (eds.) (1992). Rating Global Economic Freedom. Vancouver: Fraser Institute. Fike, R. (2017). Adjusting for gender disparity in economic freedom and why it matters. In: Economic Freedom of the World: 2017 Annual Report (eds. J.D. Gwartney, R.A. Lawson and J. Hall), 189–212. Vancouver: Fraser Institute. Friedman, M. (1962). Capitalism and Freedom. Chicago: University of Chicago Press. Friedman, M. (1996). Foreword. In: Economic Freedom of the World: 1975–1995 (eds. J.D. Gwartney, R.A. Lawson and W. Block), vii–viii. Vancouver: Fraser Institute. Gastil, R. (ed.) (1982). Freedom in the World: Political Rights and Civil Liberties 1982. Westport, CT: Greenwood Press. Gastil, R. (ed.) (1985). Freedom in the World: Political Rights and Civil Liberties 1984–1985. Westport, CT: Greenwood Press. Gastil, R. and Wright, L. (1988). The state of the world economic and political freedom. In: Freedom, Democracy, and Economic Welfare: Proceedings of an International Symposium (ed. M. Walker), 85–120. Vancouver: Fraser Institute. Gwartney, J.D. (2009). Institutions, economic freedom, and cross-country differences in performance. Southern Economic Journal 75(4): 937–956. Gwartney, J.D., Block, W. and Lawson, R.A. (1992). Measuring economic freedom. In: Rating Global Economic Freedom (eds. S. Easton and M. Walker), 153–228. Vancouver: Fraser Institute. Gwartney, J.D. and Lawson, R.A. (2002). Economic Freedom of the World: 2002 Annual Report. Vancouver: Fraser Institute. Gwartney, J.D. and Lawson, R.A. (2007). Economic Freedom of the World: 2007 Annual Report. Vancouver: Fraser Institute. Gwartney, J.D, Lawson, R.A. and Block, W. (1996). Economic Freedom of the World: 1975–1995. Vancouver: Fraser Institute. Gwartney, J.D., Lawson, R.A., Hall, J. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Hanson, J. (2003). Proxies in the new political economy: Caveat emptor. Economic Inquiry 41(4): 639–646.
30 Handbook of research on economic freedom Heckelman, J. (2005). Proxies for economic freedom: A critique of the Hanson critique. Southern Economic Journal 72(2): 492–501. Heckelman, J. and Stroup, M. (2000). Which economic freedoms contribute to growth? Kyklos 5(3): 527–544. Lawson, R.A. (2006). On testing the connection between economic freedom and growth. Econ Journal Watch 3(3): 398–406. Lawson, R.A. (2022). Economic freedom in the literature: What is it good (bad) for? In: Economic Freedom of the World: 2022 Annual Report (eds. Gwartney, J.D., Lawson, R.A., Hall, J. and Murphy, R.H.), 187–200. Vancouver: Fraser Institute. Lawson, R.A. and Cole, J. (2007). Handling economic freedom in growth regressions: Suggestions for clarification. Econ Journal Watch 4(1): 71–78. Lawson, R.A., Murphy, R.H. and Powell, B. (2020). The determinants of economic freedom: A survey. Contemporary Economic Policy 38(4): 622–642. Messick, R. (ed.) (1996). World Survey of Economic Freedom: 1995–1996: A Freedom House Study. New Brunswick, CT: Freedom House/Transaction Publishers. Miller, T., Kim, A. and Roberts, J. (2022). 2022 Index of Economic Freedom. Washington, DC: Heritage Foundation. Murphy, R.H. (2022a). On whether the size of government belongs in economic freedom indexes. Econ Journal Watch 19(1): 47–57. Murphy, R.H. (2022b). Freedom stands: A rejoinder to Ott. Econ Journal Watch 19(2): 242–246. Ott, J. (2018). Measuring economic freedom: Better without size of government. Social Indicators Research 135(2): 479–498. Ott, J. (2022). Leave size of government out of the measurement of economic freedom: Put quality of government in. Econ Journal Watch 19(1): 58–64. PRS Group (various years). International Country Risk Guide. Liverpool, NY: The PRS Group. Scully, G. (1992). Constitutional Environments and Economic Growth. Princeton, NJ: Princeton University Press. Scully, G. (2002). Economic freedom, government policy, and the trade-off between equity and economic growth. Public Choice 113(1–2): 77–96. Scully, G. and Slottje, D. (1991). Ranking economic liberty across countries. Public Choice 69(2): 121–152. Scully, G and Slottje, D. (1992). Measuring economic liberty. In: Rating Global Economic Freedom (eds. S. Easton and M. Walker), 255–279. Vancouver: Fraser Institute Spindler, Z. and Still, L. (1991). Economic freedom ratings. In: Economic Freedom: Toward a Theory of Measurement: Proceedings of an International Symposium (ed. W. Block), 135–175. Vancouver: Fraser Institute. Sturm, J.-E., Leertouwer, E. and de Haan, J. (2003). Which economic freedoms contribute to growth: A comment. Kyklos 55(3): 403–416. V-Dem Institute (various years). Varieties of Democracy. Gothenburg, Sweden: V-Dem Institute. Walker, M. (ed.) (1988). Freedom, Democracy, and Economic Welfare: Proceedings of an International Symposium. Vancouver: Fraser Institute. Walker, M. (1996). Introduction: The historical development of the economic freedom index. In: Economic Freedom of the World: 1975–1995 (eds. J.D. Gwartney, R.A. Lawson and W. Block), 1–7. Vancouver: Fraser Institute. World Economic Forum (various years). Global Competitiveness Report. Davos, Switzerland: World Economic Forum. Wright, L. (1982). A comparative survey of economic freedom. In: Freedom in the World (ed. R. Gastil), 51–90. Westport, CT: Greenwood Press.
3. Economic Freedom of the World in the universe of measuring institutions Ryan H. Murphy
INTRODUCTION Economic Freedom of the World (EFW) is a widely used index measuring economic freedom that first appeared in 1996, but it did not emerge without certain predecessors. In this chapter, I will place EFW in context of many other measures of institutions, in rough chronological order. There are several other indexes of economic freedom, some of which are direct competitors for EFW, and some of which are meant to achieve different purposes, such as making comparisons across regions of a single country. Others that I will discuss are conceptually adjacent to economic freedom, such as the quality of the business environment, or the strength of the rule of law. What will become apparent is how interconnected and overlapping the literature on the measurement of institutions is, and this point may not be obvious even to many regular users of these kinds of data.
EARLY QUANTIFICATIONS OF INSTITUTIONS The comparison of institutions across countries dates back centuries. Of course, we could comfortably point to Adam Smith’s (1981 [1776]) The Wealth of Nations as our intellectual starting point. But the quantitative comparison of countries using statistical methods dates much more recently. One early example is Seymour Martin Lipset’s (1959) systematic analysis of the causes of democracy across countries. The theory that emerged from his analysis – that a certain level of wealth would be needed for a country to attain durable democracy – became known as the Modernization Hypothesis and remains widely discussed today. Another starting point for the quantitative literature is the remarkably ahead-of-its-time work, Society, Politics, and Economic Development, by Irma Adelman and C. Taft Morris (1967), which made use of regression analysis at a point in time when such exercises were logistically challenging. The Polity data series was developed in the 1960s and the current version of the series, Polity5, spans from 1800 to the present for a large number of countries, reporting the autocratic and democratic elements of each (Marshall 2020). Autocracy and democracy are individually scored on a zero-to-ten scale, and the combination of the two scores (i.e., ‘autocracy’ is subtracted from ‘democracy’) is the ‘Polity’ rating for the country, with the latter running from –10 to +10. This rating is very commonly used today to assess democracy by country, although the methodology has its critics.1 A subset of the Polity data measures ‘executive The dataset was used to ‘show’ that countries with middling scores in Polity (around zero) were also those most prone to conflict. It was determined that this was caused by measures of conflict being embedded in the Polity data itself, and such a research design was nonsensical. See Vreeland (2008). 1
31
32 Handbook of research on economic freedom constraint,’ which is the extent to which the executive branch of government is constrained by another governing body such as a legislature. ‘Executive constraint’ isn’t closely related to economic freedom,2 but it is one of the most important variables used in the literature for assessing the importance of institutions (see, for example, Glaeser et al. 2004). What is now known as the Freedom in the World index – that is, not Economic Freedom of the World – was published first in 1973 by Raymond Gastil; early papers using this data will often refer to it as ‘the Gastil index’ (Repucci and Slipowitz 2021).3 The current version of the index measures two dimensions of institutional quality – political freedom and civil liberties. ‘Political freedom’ is a measure of democracy, while ‘civil liberties’ are freedoms such as the freedom of speech, the freedom of association, and freedom of religion. The historical data going back to 1972 report high-level aggregate assessments of political freedom and civil liberties on a 1–7 scale, where higher values correspond to less freedom. Simply adding the data together offers a reasonable stand-in for measuring ‘liberal political institutions.’ There is somewhat more detailed data on the ratings since 2003, and raw data underlying the ratings are available for the years from 2013–present. For most purposes, the high-level, aggregated data are more useful, however.
MEASURING ECONOMIC FREEDOM As time went on, it became more recognized that measuring economic freedom would itself be desirable too. Crude measures of economic freedom by country prior to this often involved simply looking at government consumption as a share of total consumption,4 which is a poor measure to use on its own. As far as I am aware, historically, the first measure of ‘economic freedom’ is actually reported by Freedom House in the 1980s, almost in passing. They do not define the concept as modern indexes do, but rather as a mélange of freedom to own property, freedom of association, freedom of movement, and freedom of information. Alongside their economic freedom measure is their assessment of each country’s ‘economic system.’ ‘Economic system,’ which assessed the degree of capitalism versus socialism, is closer to what we now think of as ‘economic freedom’ itself. These old classifications of economic systems are sometimes referred to as Gastil–Wright classifications (see Wright 1982). Freedom House would later return to the topic with the World Survey of Economic Freedom 1995–1996 (Messick 1996). While the definition of economic freedom used by Freedom House would come closer to the classical liberal5 one than did the one in earlier reports, it still did not quite match the modern definition (most notably with respect to labor unions). The
More recently, Blattman (2022) discusses recent reductions in the score of the United States which have strained the credibility of the project. 2 Executive constraint is sometimes used as a stand-in for the rule of law. 3 Freedom in the World actually has its origins in the 1950s with a predecessor known as the Balance Sheet of Freedom. 4 For example, see Bollen (1979). 5 By ‘classical liberal,’ what is meant are ‘laissez-faire’ institutions and policies, in conjunction with the quality of a narrow set of public goods. These institutions and policies were widely considered a source of economic development, and whether they are is a scientific question. The definition of ‘economic freedom’ in Wright (1982) had little relationship to any obvious scientific hypothesis, and was therefore far less useful.
Economic Freedom of the World in the universe of measuring institutions 33 report apparently did not persist following its initial publication, but it was cited rather prominently in the literature in the years that followed (e.g., Hall and Jones 1999, Sala-i-Martín 1997). Aside from the assessments of Freedom House, a series of meetings took place during the 1980s involving, among others, recipients of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel such as Milton Friedman and Douglass North, on the best way to go about measuring country-level economic freedom. The first of these indexes developed during the meetings was a method created primarily by Gerald Scully, and was later published in the journal Public Choice (Scully and Slottje 1991; Scully 1992). While Scully’s index was a success, the author did not pursue updating it, while other projects moved forward. That leaves the two active projects measuring economic freedom – the Fraser Institute’s Economic Freedom of the World (Gwartney et al. 2022) and the Heritage Foundation’s Index of Economic Freedom (Miller et al. 2020). Economic Freedom of the World is the primary focus of this Handbook, and I am a co-author of the index.6 A few things differentiate EFW and Heritage. EFW contains data once every five years from 1970–2000 and yearly since. Heritage contains yearly data from 1995 to present. EFW identifies its data sources cleanly; Heritage does this to some extent, but it is still opaque on several of its measures – for instance, what informs its ‘financial freedom’ area. Heritage includes a government integrity (a measure of corruption) area; EFW does not. Heritage covers a larger number of countries. Finally, the Index of Economic Freedom receives more coverage in the popular press, while Economic Freedom of the World appears more frequently in the scholarly literature. Before proceeding, I wish to follow this summary of economic freedom indexes with two notes in their history. La Porta et al. (2004) examine the effects of judicial independence on a series of variables, four of which constitute something akin to a makeshift index of economic freedom. These are the property rights index from the Index of Economic Freedom, the number of steps it takes to open a business, an index of employment laws, and government ownership of banks. The data on the number of steps to open a business and government ownership of banks directly evolved into data sources that would become used in EFW, and the index of employment laws is closely related to EFW component 5B (labor market regulation). The property rights index from the Index of Economic Freedom is roughly analogous to Area 2 in EFW (quality of the legal system and property rights). However, conceptual interpretations have shifted somewhat since the publication of La Porta et al. (2004), and judicial independence itself is now thought of as what defines, at least in part, the quality of the legal system (and property rights) itself; it would thus be odd to use judicial independence to explain what is essentially Area 2 in EFW. La Porta et al. (2004) is a well-known and influential paper, and it is worthwhile remembering that it more or less developed its own set of economic freedom indicators. The second note is that the Millennium Challenge Corporation, one of the levers of US foreign aid disbursement, uses a set of eight measure of economic freedom while determining which countries to send aid to (Millennium Challenge Corporation 2021, pp. 14–15). The eight measures are a mixture of third-party sources and are in some ways similar to how Economic Freedom of the World is constructed, and they directly use the ‘trade policy’ component of Heritage’s Index of Economic Freedom. As far as I know, that this index is embedded as 6 For more on this index, especially see two other chapters in this Handbook: Gwartney and Lawson (2024) and Murphy (2024).
34 Handbook of research on economic freedom deeply in the operations of the United States government is something that is little known even among scholars studying economic freedom.
MEASURES ADJACENT TO ECONOMIC FREEDOM As the demand for more and better data proceeded, scholars elsewhere began measuring concepts closely related to economic freedom. In a paper by Jeffrey Sachs and Andrew Warner (1995), the authors identify the year in which countries became ‘open economies,’ that is, when they ceased socialism or autarky, and entered the global economy. As nearly all countries would be classified as ‘open’ today, clearly there is a great deal of variation as to what can constitute an ‘open’ economy. Yet given how thin data are for most countries when you look back more than a few decades, this exercise is invaluable. For instance, Greece opened its economy in 1959, Ireland in 1966, and India in 1994. The United States is classified as opening in 1950 or earlier, as is Switzerland. Another blunt measure used on occasion is the classifications by Janos Kornai (1992) as to whether a country was at one point truly communist; Sachs and Warner use Kornai’s classification to inform their own assessment of open economies. The classifications by Sachs and Warner were subsequently refined and extended by Wacziarg and Welch (2008). Also seeing use in the 1990s, first prominently in the work of Stephen Knack and Phillip Keefer (1995), is a measure of expropriation risk (the risk of the state expropriating your property) from the International Country Risk Guide (ICRG). These data remain in common use, continue to be updated, and are available starting in 1984. Expropriation risk is an incomplete measure of capitalism, and its use can be viewed as an intermediate step between economic liberalism and the generic level of institutional quality. Two other elements of ICRG are actually currently in current use in the construction of EFW: their measure of the rule of law and their measure of political interference by the military and the police. Another concept related to economic freedom is globalization. The crude (but simple) way to measure globalization is to calculate trade openness, defined as imports plus exports as a percentage of GDP. One is not measuring policy here, except indirectly, and this measure is biased in favor of small countries, as large countries are more capable of efficiently trading within their internal markets. The more sophisticated way to measure globalization currently is the KOF Globalization Index (Dreher 2006; Gygli et al. 2019), which measures economic globalization (a mixture of policies pertaining to trade and financial openness), social globalization (a variety of other social indicators such as migration rates and television access) and political globalization. These are available both as de jure and de facto measures. Both trade openness and the KOF Globalization Index present options to scholars if they are closer to the research question at hand. Around the turn of the millennium, the infrastructure for measuring institutions progressed rapidly, first with the Worldwide Governance Indicators from the World Bank, with data available beginning in 1996 (Kaufmann et al. 2008). These indicators encompass six dimensions of institutional quality, with some amount of overlap with economic freedom, and their contents constituted the mainstream consensus of the academic literature of the time. These dimensions are ‘voice and accountability’ (a measure of democracy and civil rights), ‘political stability and the absence of violence,’ ‘government effectiveness,’ ‘regulatory quality,’ ‘rule of law,’ and ‘control of corruption.’ (It is worth noting that ‘regulatory quality’ largely means
Economic Freedom of the World in the universe of measuring institutions 35 a deregulated business climate, although it does include variables on a robust antitrust policy as well.) These aggregates are constructed using a pastiche of variables from third parties, and while the World Bank does give a list of them, it is not clear how they are used for any given country on any given year. Still, the average of the six dimensions of Worldwide Governance Indicators is probably the best measure we have out there if we wish to obtain a generic measure of institutional quality.7 A more offbeat measure of institutions was developed by Christopher Clague and his colleagues in a paper (Clague et al. 1999) published in the Journal of Economic Growth. This measure, called contract-intensive money, is the ratio of the currency held in banks to the total money supply. The public’s willingness to keep money in banks is a sign of the government’s willingness and ability to enforce contracts and provide the institutional conditions needed for prosperity. Contract enforcement is needed to be assured that money lent to banks is safe, and banks will only lend that money back out if they themselves can enforce contracts. Furthermore, holding and using currency are most important in black markets. While contract-intensive money may appear to be a circuitous means of assessing institutional quality, it can be calculated with only two pieces of data and appears to work reasonably well. It is still sometimes used today. In 2002, Simeon Djankov and his co-authors (Djankov et al. 2002) published an article in the Quarterly Journal of Economics that led to the creation of the Doing Business Report, published until very recently by the World Bank (2020). A corruption scandal internal to the report took place, with China jockeying for higher rankings, and individuals at the highest levels of the World Bank playing along. This resulted in the project being cancelled (World Bank 2022). The future of the project has been discussed most recently in Djankov (2022). The report was unique of its type by gathering ‘hard’ data on the number of procedures and the financial cost of things businesses must do, such as dealing with a construction permit or registering property. This contrasts with many other such rankings, which often rely on expert opinion or surveys. Doing Business captured a mix of variables that fall under the umbrella of economic freedom (e.g., how many barriers governments put in the way of starting a business) and those that are not (e.g., how difficult it is get electricity). As such, it was best thought of in the aggregate as how conducive a country was to commerce than it was thought of as economic freedom. EFW has used several variables from Doing Business, namely for contract enforcement, the cost of registering property, the cost of importing and exporting, the minimum wage, hours regulations, mandated costs of dismissing employees, the ease of starting a business, licensing restrictions, and costs of tax compliance. An attempt at replicating the methodology of Doing Business at the level of US states, Canadian provinces, and Mexican states has also been recently undertaken and published in 2019; as of 2021 the project is in its third edition (Center for the Study of Economic Liberty 2021). It is possible that resources that were used in the Doing Business Report ultimately become allocated to a related project, the World Bank’s Enterprise Surveys, which encapsulates many of the same topics, but is survey-based; this also means it measures de facto business conditions, whereas the Doing Business Report was de jure. At the present time, the surveys are taken very sporadically and it is unclear that operationalizing them for measuring eco Others have experimented with using a subset of the indicators. A recent prominent example is Pritchett (2022), who combines government effectiveness, rule of law, regulatory quality, and control of corruption. 7
36 Handbook of research on economic freedom nomic freedom would be practical. Another alternative to Doing Business is the Economist Intelligence Unit’s (EIU) Market Indicators & Forecasts, as it has a lot of overlap with the Doing Business Report, but its country coverage is much smaller and it is not free to access. Also from the World Bank, there is the Country Policy and Institutional Assessment (CPIA), which is calculated annually for 73 low-income countries from 2005 to present. Sixteen criteria are grouped into one of four headings – economic management, structural policies, policies for social inclusion and equity, and public sector management and institutions. For economic freedom, the most important piece of the 16 is CPIA’s measure of ‘property rights and rule-based governance,’ and it is now used to supplement other data in the legal system and property rights area of Economic Freedom of the World. CPIA is less well-known than many of the other measures found here because of its focus on lower-income countries, but that makes it all the more useful because such countries are also those for which data are most difficult to find otherwise. In 2004, the World Economic Forum launched the Global Competitiveness Report (Schwab 2019), which is similar to the Doing Business report, but broader in nature. Some commentators, e.g., Krugman (1994), have objected to the use of the phrase ‘competitiveness’ when it is taken to mean that countries compete in the same sense that two firms in the same industry compete – which is false. Optics aside, the report catalogs numerous factors which impact each country’s economic performance. It categorizes each of the variables into one of 12 ‘pillars’ in the report, which include some elements of economic freedom. The current build of EFW uses Global Competitiveness Report data on judicial independence, impartial courts, the protection of property rights, the reliability of the police, non-tariff trade barriers, hiring and firing regulations, centralized collective bargaining, and administrative requirements from governments for businesses. There have been delays to the production of new data from the Global Competitiveness Report since the onset of Covid-19, but there has not been any direct indication that it will not pick back up in the future, as it is a key publication for the World Economic Forum. The Bertelsmann Stiftung Transformation Index (BTI) measures the paths of developing and transition economies in creating effective market and democratic institutions (Donner et al. 2022). It reports data on many dimensions of institutions, with variables related to economic freedom sprinkled throughout the index. But it must be used with caution. First, the data are limited both in the nature of countries scored (limited to only the countries that are not at the institutional frontier) and temporally (it only dates back to 2006). Second, the index indiscriminately includes some measures of outcomes, not institutions, such as the development of the banking system. Third, even when they include measures of institutions and policies related to economic freedom, they may score the policy in the ‘wrong’ direction, as they do with antitrust. So, even though they score an area called ‘market economy’ and a component of it is ‘organization of the market and competition,’ neither of them can really stand in for economic freedom unless one adjusts the data. Still, the BTI sometimes has data on institutions and policies where others do not. Personally, I think the BTI is a useful means of operationalizing ‘inclusive institutions’ in the sense of Acemoglu and Robinson (2012), although choosing it limits the countries that you are able to use.8
8 The European Bank for Reconstruction and Development (2023) also produces assessments similar to BTI, but they are far more limited in scope, evaluating 38 countries in or surrounding Europe.
Economic Freedom of the World in the universe of measuring institutions 37 Finally, appearing in the early aughties was Varieties of Capitalism, a book-length work by David Soskice and Peter Hall (2001). The book compares liberal market economies – essentially, the United Kingdom and its English-language offshoots – and coordinated market economies, found in Northern Europe. The book describes each as a means of a country being successful, but the groups of countries are successful in different ways. Coordinated market economies are more union-based and collaborative, whereas liberal market economies are more dynamic and innovative. Varieties of Capitalism is very well-known in disciplines such as political science, but it has seen relatively little mention among scholars working on economic freedom,9 this is despite it undeniably being another important conceptual distinction for the study of economic freedom.10
MOST RECENT DEVELOPMENTS There are four additional relatively recent indexes measuring concepts adjacent to economic freedom that are well worth mentioning. The first of these is the Rule of Law Index produced by the World Justice Project (2021; cf. Botero and Ponce 2011). It conceptualizes the rule of law in terms of four principles: accountability, just laws, open government, and accessible and impartial dispute resolution. The index has significant institutional support and conducts surveys using a series of questions for each of the principles, with data running from 2012 to present, for 128 countries in its most recent iteration. The second is a measure of judicial independence from Drew Linzer and Jeffrey Staton (2015). This measure combines various concepts adjacent to judicial independence in order to develop a data set capturing the concept, in its current iteration back to 1900. Among the eight variables the authors use are four data sources we have already discussed: executive constraint from Polity, the measure of law and order from the International Country Risk Guide, contract-intensive money, and judicial independence from the Global Competitiveness Report. Another recent development is the Varieties of Democracy (‘V-Dem’) index, which covers 1789 to present for 202 countries (Coppedge et al. 2022). There have been lengthy disputes about the measurement of democracy and whether, for example, it should be reduced to the basic political structures (‘are people allowed to vote?’) or something deeper (Dahl 1971; Bollen 1990). V-Dem circumvents many of these disputes by offering five different conceptualizations of democracy: electoral democracy, liberal democracy, participatory democracy, deliberative democracy, and egalitarian democracy. In order to do so, it consults with panels of experts to construct what is frankly a preposterous quantity of data which underlies their conceptualizations of democracy. For almost any political institution – or any institution at all, really – V-Dem is a place to look. It is so comprehensive, in fact, that time was taken to assess by country and by year how much of the economy was owned by the government. Data attempting to assess this question hadn’t really existed yet outside of estimates for a few dozen countries. Needless to say, V-dem constructing and cataloguing these data was immensely helpful for the project of meas9 See Tarko and Safner (2022) as an exception, who have put economic freedom data to the claims of Varieties of Capitalism. 10 This distinction has sometimes appeared, of course, in the literature and what is adjacent to it. See, for instance, Acemoglu et al. (2012) and Huskinson and Lawson (2014).
38 Handbook of research on economic freedom uring economic freedom. In time for the 2019 report, we added their data on state ownership of the economy to Economic Freedom of the World in the size of government area. We also used several of their variables to further refine our coverage in the legal system and property rights area (as well as to one small piece of the regulation area). Staton and Linzer also now use V-Dem data as well for assessing judicial independence along with their previous variables. Alesina et al. (2020) present a database of reforms for 90 countries from 1973–2014 (the ‘Structural Reforms Database’). These ‘reforms’ are largely, though not uniformly, liberalizations. The areas assessed by the authors are trade, external and internal finance, product market regulation, and labor market regulation. Some of the data in the database are presently unique to it (especially with respect to product market regulation). And although some of the ‘reforms’ are not proper liberalizations, the summary index combining their measures of trade and regulation conceptually approaches economic freedom. One other major development is the Human Freedom Index (Vásquez et al. 2022), published by the Cato Institute. This index offers a more comprehensive view of freedom by including data on economic freedom, personal freedom, and safety and security. Economic Freedom of the World is used to provide the areas of economic freedom, while the other measures are informed by the standards and practices on EFW. Of the other data sources already discussed in this chapter, it makes use of data from Freedom in the World, Worldwide Governance Indicators, the Rule of Law index, and V-Dem, along with many others that were not covered. Not all freedom is economic freedom, and if you wish to assess how a country’s institutional environment is supportive of overall human freedom, the Human Freedom Index is what to use. (I am one of the authors of the Human Freedom Index.)
MEASURES OF ECONOMIC FREEDOM IN OTHER TIMES AND PLACES As the millennium turned, we also saw the development of indexes of economic freedom that extended beyond comparisons across countries in the modern era. The Fraser Institute created a sister index for Economic Freedom of the World, the Economic Freedom of North America (EFNA) index (Karabegovic et al. 2003; Stansel et al. 2021), which allows for a direct comparison of economic freedom between US states, Canadian provinces, and, in its current form, the Mexican states. In order to ensure consistent comparisons across the regions, and the possibility of measuring a lengthy set of years, the areas in the index are limited to three: government spending, taxation, and labor market regulation. Besides that, the ‘rules’ and look of EFNA are nearly identical to EFW. As a result of the limits placed on the number of variables it includes, however, the index is available yearly going all the way back to 1981. Technically speaking, more years are available for EFNA than EFW because EFW is available only in five-year increments prior to 2000. Murphy (2020) has provided recommendations for how property rights data could be incorporated into EFNA and how EFNA should be rebalanced, but these recommendations have not been implemented. An index competing with EFNA is Freedom in the 50 States, published by the Cato Institute (Ruger and Sorens 2021). Half of the index is personal freedom, as opposed to economic freedom, but in the data files its measure of economic freedom can be accessed quite readily. Its approach differs radically from EFNA, casting a wide net and gathering regulatory and other data that are not only denser than EFNA, but also denser than the scope of EFW. It also
Economic Freedom of the World in the universe of measuring institutions 39 weights the data differently depending on how important it is, which differs drastically from EFNA and EFW, where weights are equal.11 Finally, the data are only updated periodically, although the data themselves are available yearly from 2000–2019. Dean Stansel, now the first author of Economic Freedom of North America, decided to take everything a step further by measuring economic freedom at the local level, namely across US metropolitan statistical areas (MSAs) (Stansel 2019). An MSA is, essentially, a city and its surrounding suburbs and exurbs, which together constitute a coherent regional economy. Using the Census of Governments, a data set produced by the Census Bureau once every five years (the ‘2s’ and the ‘7s’), it ranks 382 of these areas on the five-year increments from 1972 to 2012 in its current build, with many of the freest regions appearing in Texas, Florida, and Virginia, and the least free regions in California and New York. Notably, however, there are states which contain MSAs from both the first and third quartile (including Texas) and from the fourth and second quartile (including California), which indicates the index is measuring something above and beyond what is already understood using the state-level measure. The project is ongoing and was most recently published by the Reason Foundation. A more recent development has been the attempt to trace economic freedom further back in time than 1970. One such successful effort, by Leandro Prados De La Escosura (2016), is an index by decade from 1850 to present for 21 countries. As of now, this is the only quantitative measure of economic freedom which reaches that far back in time. Elsewhere, Robert Lawson and I (Lawson and Murphy 2019; see also Murphy and Lawson 2018) constructed economic freedom data for 1950, 1955, 1960, and 1965 while matching the methodology of EFW as closely as we could. Using this slightly looser methodology, we were able to get a rating for 111 countries in 1950 and even more than that for more recent years, although this rating may not be as high quality as the main index. The data are not ‘official,’ but are available on a separate tab of the public Microsoft Excel workbook kept online on the Fraser Institute’s website. Other estimates have been developed for measuring economic freedom subnationally for countries besides the United States, Canada, and Mexico. One, developed by Vladimir Fernandes Maciel and his co-authors (Maciel et al. 2019), assesses the relative economic freedom of states within Brazil from 2003 to 2016, while another, developed by Dennis Coates and Irina Mirkina (2021), assesses the relative economic freedom of 83 regions of Russia from 1992 to 2018. Both of these attempts replicate the methodology of Economic Freedom of North America and its relatively narrow set of variables. Other attempts to measure subnational economic freedom include ones for India (Debroy et al. 2013), Italy (Ronca and Guggiola 2004), Argentina (Leonardi et al. 2019), Australia (Institute of Public Affairs 2014), and Germany (Fuest et al. 2015; Spruk and Kešeljević 2018).12 Several of these measures of subnational economic freedom were evaluated systematically by Sobel (2021).
The argument for not putting weights on such an index is that it invalidates the in-sample p-values of any observed relationship, and imperils external validity due to overfitting. 12 While several of these studies have their limits, I offer caution concerning Spruk and Kešeljević (2018), which include two outcome variables (the business start-up rate and the shadow economy) as measures of economic freedom. 11
40 Handbook of research on economic freedom
SUMMARY AND CONCLUSIONS A summary of the existent measures of economic freedom can be found in Table 3.1, and a summary of the various quantitative assessments of institutions adjacent to the measure of economic freedom can be found in Table 3.2. Table 3.1
Economic freedom datasets
Variable
What it measures
Coverage
Commentary
Worldwide economic freedom
Up to 165 countries,
The current author is
1970–present
a co-author
Up to 177 countries,
The primary alternative data
1995–present
source for economic freedom
Current worldwide indexes Economic Freedom of the World Index of Economic Freedom
Worldwide economic freedom
Former worldwide measures or indexes World Survey of Economic
Worldwide economic freedom
82 countries, 1995 only
Freedom (Freedom House)
Less well-defined theoretical conception of economic freedom
Scully and Slottje (1991)
Worldwide economic freedom
144 countries, from roughly
Very loose conception of
the late 1980s
economic freedom, with several measures of civil liberties included
Gastil–Wright Classification
Classification of degree of
166 countries, early-mid
Classification of degree of
of Economic Systems
capitalism versus socialism,
1980s
capitalism is close to what is now called economic freedom
plus ‘economic freedom’ Kornai (1992)
List of historically communist
Comprehensive list
Available online
states Regularly updated subnational measures of economic freedom Economic Freedom of North
Ratings of US and Mexican
US and Canada:1981–present; Versions of the index that
America
states and Canadian provinces
Mexico: 2003–present
measure (a) state policy only and (b) state and national policy occurring within the state; state-level policy measure is fiscal policy and labor regulations only
Freedom in the 50 States
State-level economic and
2000–present
Kitchen sink approach to data selection
personal freedom data for the United States Metropolitan Area Economic
Economic freedom of US
Freedom Index
Metropolitan Statistical Areas
1972–2012 (every five years)
Economic Freedom of North America methodology
Economic Freedom of the World in the universe of measuring institutions 41 Table 3.2
Measures of not-exactly economic freedom
Variable
What it measures
Coverage
Updated?
Notes
Sachs and Warner
The year each country
134 countries
No
Useful for studying 20th century; see
(1995)
open itself to world
also Wacziarg and Welch (2008)
markets Trade openness
(Exports + imports) /
As many as you can get
GDP; a simple measure
trade data for
Yes
A blunt instrument, but can be interpreted as practical, de facto experience with global markets
of globalization KOF Globalization
Policies and other
215 countries and
Index
indicators concerning
territories
Yes
Includes indicators of economic, social, and political globalization; features both a de jure and a de facto
globalization
version Worldwide
Six major dimensions
200+ countries, goes
Governance
of institutional quality
back to 1996 for some
Yes
Average the six gets you a general measure of institutions; can average subsets of them to answer different
Indicators
questions Contract-intensive
Contract enforcement
As many as you can get
money
and property rights
money data for
Doing Business
Ease of doing business
Up to 190 countries,
Report
across countries
2003–2019
Yes
A proxy variable
No(?)
Mixture of regulatory measures and others; de jure measure; project shut down because of concerns about corruption at World Bank
Enterprise surveys
Variety of questions for
Spotty
Yes
Some de facto regulation, at least according to the respondents
businesses, including some on regulation CPIA Property
The presence of
Developing countries,
Rights and
government structures
2005–present
Rule-based
enforcing property
Governance
rights and contracts
Global
‘Competitiveness,’
Up to 141 countries,
Competitiveness
inclusive of regulatory
2004–2019
Report
characteristics
Bertelsmann
General institutional
137 countries,
Transformation
development
2004–present
Yes
Can be used to supplement other measures, as it rates countries that are often unrated elsewhere (is used this way in EFW)
Yes(?)
Was not updated 2020–2022, likely for reasons related to Covid-19, but it is not entirely clear.
Yes
Countries that are not or were not at the institutional frontier only
Index International Country Assessment of various
141 countries, as far
Risk Guide
back as 1984
risks by country,
Yes
One of the original measures of institutions; it does cost money to access
including data on the rule of law and contracts Rule of Law Index
Survey-based measure
139 countries,
of the rule of law
2012–present
Varieties of
Measures not just
202 countries,
Democracy
democracy but almost
1789–present
Yes
The most comprehensive assessment of the rule of law, but limited time dimension
any legal or political institution you can think of
Yes
Some countries have yearly rule of law data from 1789–present. The data can be cumbersome to use
42 Handbook of research on economic freedom Variable
What it measures
Coverage
Updated?
Notes
Structural Reforms
Measures of reforms to
90 countries, 1973–2014
Unclear
Some unique data, but not all of its
Database
trade, finance, product
components are liberalizations
markets, and labor markets Linzer and Staton
Statistical
202 countries,
(2015)
agglomeration of
1900–2015
Likely?
Agglomeration of many ‘latent’ measures, some of which appear in this table
measures of judicial independence EIU Market
Expert ratings on
60 countries,
Indicators &
a variety of regulations
1981–present
Forecasts
and market institutions
Human Freedom
Combination of
165 countries,
Index
Economic Freedom of
2008–present
Yes
It costs money, and is currently limited to countries where there is market demand for ratings
Yes
Comprehensive measure of negative freedom (includes civil liberties
the World with personal
but excludes direct measures of
freedom data
democracy)
While new challenges have appeared from the perspective of the generation and acquisition of data, especially the cancellation of the Doing Business Report, knowledge of the measurement of institutions has improved dramatically since the post-war era. At that point in time, we had little more than classifications of democracies. Today, we have measures of economic freedom going further back in time, and at the level of metropolitan areas in the US, and state or provincial data now for a handful of countries. We also have dense data on a number of concepts similar but not identical to economic freedom, such as globalization or property rights governance. It was only a few years ago that we did not think we would ever have data on government ownership of the economy, but the Varieties of Democracy project decided to start producing it, seemingly almost incidentally. I have not discussed the large variety of measures of institutions because I wish to dissuade you from using Economic Freedom of the World in your assessment of institutions. But sometimes you will wish to ask, am I observing economic freedom or is the hypothesis consistent with both economic freedom and generic institutional quality? Then maybe you should use the average of Worldwide Governance Indicators. Or do you need to distinguish economic freedom and limited government in the political sense? Then one should check Polity 5’s executive constraint. It is important to understand how these measures interrelate – as I have tried to convey, there is much more overlap between the datasets than one may realize – and how they can be used to ask subtly different research questions. Far from the days when we thought of government consumption as a useful proxy for marketization or when Sachs and Warner (1995) cobbled together something resembling what constitutes an open economy, we have a variety of rather robust means of assessing our research questions.
Economic Freedom of the World in the universe of measuring institutions 43
REFERENCES Acemoglu, D. and Robinson, J.A. (2012). Why Nations Fail: The Origins of Power, Prosperity, and Poverty. New York: Crown Business. Acemoglu, D., Robinson, J.A. and Verdier, T. (2012). Can’t we all be more like Scandinavians? Asymmetric growth and institutions in an interdependent world. Working Paper No. 18441, National Bureau of Economic Research, Cambridge, MA. Adelman, I. and Morris, C.T. (1967). Society, Politics, and Economic Development. Baltimore: Johns Hopkins Press. Alesina, A., Furceri, D., Ostry, J., Papageorgiou, C. and Quinn, D. (2020). Structural reforms and elections: Evidence from a world-wide new dataset. Working Paper No. 26720, National Bureau of Economic Research, Cambridge, MA. Blattman, C. (2022). Is America on the brink of civil war? Such predictions are overblown and dangerous. USA Today (3 July). Bollen, K.A. (1979). Political democracy and the timing of development. American Sociological Review 44(4): 572–587. Bollen, K.A. (1990). Political democracy: Conceptual and measurement traps. Studies in Comparative International Development 25(1): 7–24. Botero, J.C. and Alejandro Ponce, A. (2011). Measuring the rule of law. Working Paper No. 1, The World Justice Project, Washington, DC Center for the Study of Economic Liberty (2021). Doing Business North America. Tempe, AZ: Center for the Study of Economic Liberty. Clague, C., Keefer, P., Knack, S. and Olson, M. (1999). Contract-intensive money: Contract enforcement, property rights, and economic performance. Journal of Economic Growth 4(2): 185–211. Coates, D. and Mirkina, I. (2021). Economic freedom of the Russian Federation. Journal of Regional Analysis & Policy 51(1): 14–26. Coppedge, M., Gerring, J., Knutsen, C.H., Lindberg, S.I., Teorell, J., Altman, D., Bernhard, M., Fish, M.S., Glynn, A., Hicken, A., Luhrmann, A., Marquardt, K.L., McMann, K., Paxton, P., Pemstein, D., Seim, B., Sigman, R., Skaaning, S.-E., Staton, J., Wilson, S., Cornell, A., Alizada, N., Gastaldi, L., Gjerløw, H., Hindle, G., Ilchenko, N., Maxwell, L., Mechkova, V., Medzihorsky, J., von Römer, J., Sundström, A., Tzelgov, E., Wang, Y.-T., Wig, T. and Ziblatt. D. (2022). V-Dem dataset v12. V-Dem Institute, University of Gothenburg. Dahl, R.A. (1971). Polyarchy: Participation and Opposition. New Haven, CT: Yale University Press. De La Escosura, L. (2016). Economic freedom in the long run: Evidence from OECD countries. Economic History Review 69(2): 435–468. Debroy, B., Bhandari, L. and Aiyar, S.S.A. (2013). Economic Freedom of the States of India 2013. Washington, DC: Cato Institute. Djankov, S. (2022). Doing Business 2.0: A better guide for policy makers. In: Economic Freedom of the World (eds. J.D. Gwartney, R.A. Lawson, J.C. Hall and R.H. Murphy), 201–213. Vancouver: Fraser Institute. Djankov, S., La Porta, R. López-de-Silanes, F. and Shleifer, A. (2002). The regulation of entry. Quarterly Journal of Economics 117(1): 1–37. Donner, S., Hartmann, H., Harterich, C., Steinkamp, S., Sikk, A., Volkel, J., Spengler, H.-J., Thiery, P., Basedau, M., Heyl, C., Schmidt, S., Renner, J., Croissant, A. and Trinn C. (2022). BTI 2022: Codebook for Country Assessments. Gutersloh: Bertelsmann Stiftung. Dreher, A. (2006). Does globalization affect growth? Evidence from a new index of globalization. Applied Economics 38(10): 1091–1110. European Bank for Reconstruction and Development (2023). How we assess transition impact. Web page. https://www.ebrd.com/what-we-do/economic-research-and-data/transition-impact.html (accessed 10 January 2023). Fuest, C., Bertenrath, R. and Welter, P. (2015). Wirtschaftliche Freiheit in den deutschen Bundeslandern. Postdam: Friedrich Naumann Foundation for Freedom. Glaeser, E.L., La Porta, R., Lopez-de-Silanes, F., and Shleifer, A. (2004). Do institutions cause growth? Journal of Economic Growth 9(3): 271–303.
44 Handbook of research on economic freedom Gygli, S., Haelg, F., Potrafke, N. and Sturm, J.-E. (2019). The KOF Globalisation Index: Revisited. Review of International Organizations 14(2): 543–574. Gwartney, J.D. and Lawson, R.A. (2024). The creation of the Economic Freedom of the World index. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 16–30. Cheltenham: Edward Elgar Publishing. Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World; 2022 Annual Report. Vancouver: Fraser Institute. Hall, R.E. and Jones, C.I. (1999). Why do some countries produce so much more output per worker than others? Quarterly Journal of Economics 114(1): 83–116. Huskinson, T. and Lawson, R.A. (2014). Clusters of economic freedom. Applied Economic Letters 21(15): 1070–1074. Institute of Public Affairs. (2014). Economic Freedom Index 2013. Melbourne: Institute of Public Affairs. Karabegovic, A., Samida, D., Schegel, C.M. and McMahon, F. (2003). North American economic freedom: An index of 10 Canadian provinces and 50 US states. European Journal of Political Economy 19(3): 431–452. Kaufmann, D., Kraay, A. and Mastruzzi, M. (2008). Governance Matters VII: Aggregate and individual governance indicators, 1996–2007. Working Paper No. 4654, World Bank, Washington, DC Knack, S. and Keefer, P. (1995). Institutions and economic performance: Cross-country tests using alternative institutional measures. Economics & Politics 7(3): 207–227. Kornai, J. (1992). The Socialist System: The Political Economy of Communism. Princeton, NJ: Princeton University Press. Dataset at: http://www.kornai-janos.hu/Kornai2016-Background-material-1.pdf (accessed 21 January 2023). Krugman, P. (1994). Competitiveness: A dangerous obsession. Foreign Affairs 73(2): 28–44. La Porta, R., López-de-Silanes, F., Pop-Eleches, C. and Shleifer, A. (2004). Judicial checks and balances. Journal of Political Economy 112(2): 445–470. Lawson, R.A. and Murphy, R.H. (2019). Economic freedom of the world in the 1950s and 1960s. In: Economic Freedom of the World: 2019 Annual Edition (eds. J.D. Gwartney, R.A. Lawson, J.C. Hall and R.H. Murphy), 189–198. Vancouver: Fraser Institute. Leonardi, A., Mandolesi, A. and Bongovanni, J. (2019). Indice de Desempeno Provencial 2019. Rosario: Fundacion Libertad. Linzer, D.A. and Staton, J.K. (2015). A global measure of judicial independence, 1948–2012. Journal of Law and Courts 3(2): 223–256. Lipset, S.M. (1959). Some social requisites of democracy: Economic development and political legitimacy. American Political Science Review 53(1): 69–105. Maciel, V.F., Ruiz de Gamboa, U.M., Portillo, J.A. and Ghizellini, M. (2019). Brazilian states’ economic freedom index: Applying Fraser’s methodology for 2003–2016 data. Quarterly Journal of Austrian Economics 22(3): 428–452. Marshall, M.G. (2020). Polity5: Political Regime Characteristics and Transitions, 1800–2018. Vienna, VA: Center for Systemic Peace. Messick, R. (1996). World Survey of Economic Freedom. Piscataway, NJ: Transaction Publishers Miller, T., Kim, A.B., Roberts, J.M. and Tyrrell, P. (2020). 2020 Index of Economic Freedom. Washington, DC: Heritage Foundation. Millennium Challenge Corporation. (2021). Report on the criteria and methodology for determining the eligibility of candidate countries for millennium challenge account assistance for fiscal year 2022. Washington, DC: Millennium Challenge Corporation. Murphy, R.H. (2020). The quality of legal systems and property rights by state: A ranking and their implications for economic freedom. Journal of Regional Analysis & Policy 50(1): 29–45. Murphy, R.H. (2024). Economic freedom, 1950–2020. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 47–58. Cheltenham: Edward Elgar Publishing. Murphy, R.H. and Lawson, R.A. (2018). Extending the Economic Freedom of the World index to the Cold War era. Cato Journal 38(1): 265–284. Pritchett, L. (2022). National development delivers: And how! And how? Economic Modelling 107(February): 105717.
Economic Freedom of the World in the universe of measuring institutions 45 Repucci, S. and Slipowitz, A. (2021). Freedom in the World 2020: Democracy Under Siege. Washington, DC: Freedom House. Ronca, G. and Guggiola, G. (2004). Misurare la Liberta Economica nel Mondo, in Europa, in Italia. Milan: Guerini e Associati. Ruger, W. and Sorens, J. (2021). Freedom in the 50 States. Washington, DC: The Cato Institute. Sachs, J. and Warner, A. (1995). Economic reform and the process of global integration. Brookings Papers on Economic Activity 1: 1–118. Sala-i-Martín, X.X. (1997). I just ran two million regressions. American Economic Review 87(2): 178–183. Schwab, K. (2019). The Global Competitiveness Report 2019. Geneva: World Economic Forum. Scully, G.W. (1992). Constitutional Environments and Economic Growth. Princeton, NJ: Princeton University Press. Scully, G.W. and Slottje, D.J. (1991). Ranking economic liberty across countries. Public Choice 69(2): 121–152. Smith, A. (1981 [1776]). An Inquiry into the Nature and Causes of the Wealth of Nations. Indianapolis, IN: Liberty Classics. Sobel, R.S. (2021). The Determinants of Subnational Economic Freedom: An Analysis of Data for Seven Countries with Implications for Optimal Jurisdiction Size. Vancouver: Fraser Institute. Soskice, D. and Hall, P.A. (2001). Varieties of Capitalism: The Institutional Foundations of Comparative Advantage. Oxford: Oxford University Press. Spruk, R. and Kešeljević, A. (2018). Economic freedom and growth across German districts. Journal of Institutional Economics 14(4): 739–765. Stansel. D. (2019). US Metropolitan Area Economic Freedom Index. Los Angeles: Reason Foundation. Stansel, D., Torra, J. and McMahon, F. (2021). Economic Freedom of North America 2021. Vancouver: Fraser Institute. Tarko, V. and Safner, R. (2022). International regulatory diversity over 50 years: Political entrepreneurship within fiscal constraints. Public Choice 193(1): 79–108. Vásquez, I., McMahon, F., Murphy, R.H. and Schneider, G.S. (2022). The Human Freedom Index 2022: A Global Measure of Personal, Civil, and Economic Freedom. Washington, DC: Cato Institute. Vreeland, J.R. (2008). The effect of political regime on civil war: Unpacking anocracy. Journal of Conflict Resolution 52(3): 401–425. Wacziarg, R. and Welch, K.H. (2008). Trade liberalization and growth: New evidence. World Bank Economic Review 22(2): 187–231. World Bank (2020). Doing Business 2020. Washington, DC: World Bank. World Bank (2022). The Development Effectiveness of the Use of Doing Business Indicators, Fiscal Years 2010–2020. Independent Evaluation Group. Washington, DC: World Bank. World Justice Project (2021). Rule of Law Index 2021. Washington, DC: World Justice Project. Wright, L. (1982). A comparative study of economic freedom. In: Freedom in the World (ed. R. Gastil), 51–90. Westport: Greenwood Press.
PART II ECONOMIC FREEDOM IN THE WORLD
4. Economic freedom, 1950–2020 Ryan H. Murphy
INTRODUCTION What is the recorded history of measured economic freedom? Certainly, among countries with an unfortunate history with communism, there is more freedom today than for much of the previous century. But it’s a little less clear if the question is posed concerning the United States or Western Europe. On the one hand, there are widespread narratives about ever-expanding welfare states and ever-growing pages of regulation dictated by unaccountable bureaucrats. On the other hand, certain industries have been either privatized or deregulated, inflation has (or had) come down, and income tax rates are not what they once were. And many countries outside the Western world have chosen to modernize their institutions, which in part means opening themselves to global markets. Narratives can be optimistic, as in Yergin and Stanislaw (1998), or pessimistic, as in Boudreaux (2015). The purpose of this chapter is to provide firmer grounding on what the basic facts are about the evolution of economic freedom in the postwar era. Worldwide, is there less economic freedom, or more? Which dimensions of economic freedom have seen improvement, and which have not? And in which ways do regions of the world differ? An initial exploration of these questions also may function as a natural companion to later chapters of this volume. This chapter takes quantitative estimates of economic freedom and answers each of these questions in a systematic manner. The main scholarly innovation is making an adjustment to the data that accounts for the changing identity of which countries have enough data to receive economic freedom ratings. When these changes in country composition are taken into account, the trends in economic freedom are more pronounced and positive. In the section that follows, prior to exploring results, we will first describe the technical aspects of the analysis in greater detail.
TECHNICAL PRELIMINARIES In the Economic Freedom of the World (EFW) dataset, data are available for individual countries every five years from 1970 to 2000, and yearly from 2000 to 2020. EFW compiles data on the size of government, the quality of the legal system and property rights, sound money, the freedom to trade internationally, and regulation, with countries scored from zero to ten. In the most recent year (2020), scores were available for 165 countries. In addition to the primary EFW dataset, however, there is supplementary data which measure economic freedom in 1950, 1955, 1960, and 1965 (Murphy and Lawson 2018; Lawson and Murphy 2019); data were identified going back to 1950 for four of the five areas of economic freedom (insufficient data were available to score the regulation area). For size of government, data were assembled for government consumption and government capital share; for the legal system and property 47
48 Handbook of research on economic freedom rights, there are data on judicial independence, the impartiality of courts, the protection of property rights, the integrity of the legal system, and the impartiality of public administration (plus an adjustment for disparate treatment by gender); for sound money, there are data on average inflation, the standard deviation of inflation, and restrictions on foreign currency; and for the freedom to trade internationally, there are data on trade openness,1 import duties, and capital controls. While the resulting index is not as high quality as the main Economic Freedom of the World index, at the high levels of aggregation we are operating with, it can be blended with the main data set to give a complete picture for 70 years from 1950–2020.2 Before assembling seventy years of data and analyzing its trends, however, we must address certain concerns about individual countries. One is that there is no consistency within countries for what variables will even be available across time. If country composition is not considered, a country’s score may artificially ‘jump’ from one year to another not because of any change in policy, but because of the value of a variable that happened to become available at that date. The main index addresses this issue by employing a method of ‘chain-linking.’ Most well-known in its application to measuring inflation, chain-linking works by ignoring a piece of data (in the case of inflation, a new product in the market) the first year it appears. It then only looks at changes in the new data over time to make use of the information contained in the data. This adjustment has been available online alongside the main EFW index for those who want to have a more accurate sense of the time series of individual countries. Chain-linking is also likely more accurate for most formal applications, such as when using panel methods. However, if we are looking at overall economic freedom for a group of countries, there are also heterogeneities across years with respect to which countries receive a score. Suppose it is the case that countries with more economic freedom tend to receive scores beginning in an earlier year (such as 1970), and countries that are added to the index later (like 2011) tend to have lower scores. This is indeed the case; for unsurprising reasons, the factors which determine a country’s economic freedom, a country’s wealth, and the quality of a country’s data collection are all interrelated. Data first appear where institutional quality is higher. Therefore, when assessing global trends, chain-linking does not adjust for heterogeneity in the countries covered by the index over time, and if new countries are added only after they have undergone some market liberal reforms, then the trend in economic freedom over time will appear less pronounced than it should be. We can address the problem, however, by chain-linking across countries that make up whichever group that we are interested in looking at. So, for instance, if a country is first ranked in 2001, it will not be used to score 2001. The chain-linking procedure will first consider it when assessing the world trend in 2002.
TOTAL WORLDWIDE ECONOMIC FREEDOM Figure 4.1 presents global economic freedom from 1950–2020 with data chain-linking both within and across countries. Global economic freedom rises between 1955 and 1960 (this might reflect the reintegration of Europe into the global economic system), but it is otherwise essentially flat from 1950–1985. It then skyrockets as the ‘neoliberal’ or ‘Washington consensus’ reforms escape the United States and the United Kingdom into the rest of the world
1 2
This variable is a dichotomous measure found in Sachs and Warner (1995). The data have also been ‘spliced’ together with the main dataset through regression.
Economic freedom, 1950–2020 49 (much as described in Yergin and Stanislaw 1998), and continues rising until the mid-2000s, when it declines in conjunction with the global financial crisis. The rise of global economic freedom then recommences, only to be reversed by COVID-19 in the most recent year we have available, 2020.
Figure 4.1
Global economic freedom, 1950–2020
Although it looks like a small blip, the observed decline in 2020 is the greatest year-to-year decline over a single year timespan we have on record, and in all likelihood updated and revised data will increase the magnitude of the decline. Two of the most important datasets for the construction of the Economic Freedom of World index, the Global Competitiveness Report and the Doing Business report, have not been updated (and in the case of Doing Business, it is far from clear it will return in any form). We can say with some confidence that ‘true’ global decline in economic freedom in 2020 is larger than what is conveyed in this figure.3 Additionally, inflation did not really begin hitting world economies until 2021, which means that 2021 will show a still further decline associated with COVID-19, and 2022 will presumably show further declines coinciding with the energy shock. And while political commentators are apt to associate liberalizations with ‘shock therapy’ foisted on societies against their will in the midst of crises (Klein 2007; cf. Berggren and Bjørnskov 2019), the continued broad trends upward observable up through 2019 are consist3 There have been efforts to quantify the novel regulatory actions that took place in 2020 and 2021 as limitations to economic freedom (Miozzi and Powell 2023), but the index as it is constructed, especially once the delayed data are finally reported, seems to be capable of accounting for much of the decline without the need for ad hoc adjustments.
50 Handbook of research on economic freedom ent with findings elsewhere on the patterns of economic liberalization in practice: sizeable, lasting liberalizations are gradual and occur over many years (as in Sobel 2017; cf. Lawson et al. 2019). What is key is to avoid periods of crisis where it may all be given back.4 It may have been too much to expect the continued rapid pace of liberalization that was taking place from 1985–2000, but there persisted a continued upswing in the global data after, impeded first by the financial crisis and then by COVID-19.
WORLDWIDE ECONOMIC FREEDOM BY AREA We can also consider global trends for the individual areas of economic freedom. The five areas each appear in Figure 4.2. Because of weaker data coverage for the individual areas in the 1950–1965 data – ratings for individual areas by country, though not for economic freedom as a whole, are not particularly credible – we will only look at the trends since 1970.
Figure 4.2
Global economic freedom by area, 1970–2020
The Size of Government For Area 1, we observe a decline in scores from 1970 to 1985 (i.e., growing size of government), only for the scores to rocket upwards (i.e., shrinking size of governments) through 2000. The data then pause only to continue increasing until the onset of the Great Recession. Subsequently, the data actually began recovering back to its previous high, until another collapse in conjunction with COVID-19. The bulk of the literature on economic freedom and different forms of crises tend to show that they cause less economic freedom, not more. See the two chapters from this volume, Bologna Pavlik (2024) and Pitlik (2024), for more on this literature. 4
Economic freedom, 1950–2020 51 Two further points concerning the global trends in the size of government are worth making. The first is that although the era of sweeping reforms to government spending likely ended in conjunction with the Great Recession, the size of government relative to the size of the economy diminishes so long as economic growth takes place: even when spending on the welfare state and entitlements is linked to inflation, the spending is not automatically linked to overall growth in the economy. In other words, merely stopping new programs from coming online is a way to automatically sunset the size of government. The second point is that, although Western and Northern Europe likely were successful in rearranging the deckchairs of the welfare state in the 1990s in such a way that made their welfare states sustainable,5 there is empirical evidence that there is only so much more spending that these governments can do while maintaining a certain level of economic performance (Bergh and Henrekson 2011; Karceski and Kiser 2020); in other words, the countries of Western and Northern Europe cannot really drag the world average score down much further without stultifying their economies. The Quality of the Legal System and Property Rights Also in Figure 4.2, the quality of the legal system and property rights shows slow, steady movements up from 1970 onwards. Such a sustained improvement may be more controversial than it first appears. Area 2 is the most clearly ‘institutional’ of the measures in EFW, and recent claims from those such as Andrews et al. (2017, pp. 17–24) have been that either the worldwide development of core institutions has ceased, or that these institutions are improving at an imperceptibly slow rate. What we observe in Figure 4.2 is steady improvement for the world overall of just over a full point (from 4.34 to 5.36). This improvement corresponds to just under two-thirds of a standard deviation when expressed in terms of the 2019 data. Although the rate of change has slowed, it does not appear that it has ceased (subject to likely COVID-19-related revisions). Chain-linking is especially important here: a simple average of the countries that were scored, rather than chain-linking, cuts the observed increase in half (the first period is 4.82 instead of 4.34) because of the bias over which countries appear in the data set when.6 Sound Money When measuring the worldwide trend for sound money, we again observe the world hitting its nadir in 1975, with only modest improvements in the 1980s, as countries throughout the world continued to see themselves rocked by periodic hyperinflations. Reform became rapid in 1995, and these reforms persisted up to 2019. This pattern in the data lines up historically with the worldwide trend of adopting independent central banks. There is some COVID-19-associated decline in 2020 in Area 3, but there is bound to be a further decline due to rising inflation in 2021 and 2022.
Cf. Bergh (2020). The pattern is not why Andrews et al. (2017) found virtually no change in the countries they study, because they keep a consistent list of countries across time. It is more likely that they only observe tiny changes because of the abridged time period they cover, which at the earliest begins in 1996 and ends in 2013. One of their data sources does not begin until 2006. 5 6
52 Handbook of research on economic freedom Freedom to Trade Internationally Results concerning free trade, however, are among the less reassuring findings. While trade agreements persisted, the rapid increase in free trade was essentially stopped in its tracks following the 1999 protests in connection with the meeting of the World Trade Organization in Seattle, with some separate role likely played by the political responses to 9/11. And by the time the War on Terror and the Great Recession had played out, populism had already taken sway: the liberalization of trade essentially ceased following the year 2000. It is perhaps fortunate that we do not observe actual declines in free trade until 2020; the most recent decline reflects the imposition of visa requirements and border lockdowns (these constitute a very small component of the index, but there was a large, nearly universal decline worldwide), as opposed to new barriers to free trade in goods or financial markets. Regulation Finally, for regulation, reforms take off in 1985 and persist through 2010. Liberalization appears to have ceased since then, although technically the highest global score on record was in 2019. The score for 2020 is also likely to be subject to significant revision. These numbers still do not contain any changes in response to, for example, the changes in business people’s evaluation of the regulatory burden in conjunction with COVID-19. While we can only speculate, it would be not be surprising if their views on regulatory burdens had changed dramatically for the worse. Summary of Areas of Economic Freedom A summary of these results is found in Table 4.1, where chain-linked 1970, 2019, and 2020 data are found (plus chain-linked 1950 data for the main index). The 1970 and 2019 data were then differenced (with the expectation that 2019 is a better picture of the underlying institutions than 2020) and divided by the standard deviation of the 2019 data, such that the increases in the areas of economic freedom can be seen in terms of how countries vary across the world. Freedom to trade internationally has seen the largest increase (1.80 standard deviations), followed by regulation (1.43), sound money (1.11), the size of government (0.83), and the legal system and property rights (0.63). The arcs of all areas were roughly the same, although the timing of the liberalizations differed slightly, as did the post-Great Recession/pre-COVID trajectory of each area.
ECONOMIC FREEDOM OF PARTICULAR GROUPS OF COUNTRIES An alternative approach to the data is to chain-link groups of countries together. I will provide a few rather obvious groupings of countries and report their time series back to 1950. First, I will consider various groupings of ‘frontier’ Western countries: the OECD, the G7, Western,
Economic freedom, 1950–2020 53 Table 4.1 EFW
Chain-linked worldwide data of economic freedom and its areas 1950
1970
2019
2020
Change
Change/standard
(1970–2019)
deviation (2019)
4.99
5.33
6.89
6.75
1.56
1.57
Size of government
–
5.85
6.77
6.60
0.92
0.83
Legal system and
–
4.34
5.31
5.36
0.97
0.63
property rights Sound money
–
6.60
8.33
8.24
1.73
1.11
Freedom to trade
–
4.39
7.03
6.62
2.64
1.80
–
5.42
7.03
6.93
1.61
1.43
internationally Regulation
Note: The individual areas of economic freedom are not sufficiently well measured to trust trends for the years 1950–1965, but there are sufficient data to consider its overall trend.
Northern, and Southern Europe, and the offshoots of Britain.7 These appear as Figure 4.3. While the level of economic freedom differs across these different groupings, the contours of the pattern that they follow is striking, even given that there is significant overlap in the countries included using the different definitions. While the main story is the unified pattern of the economic freedom of wealthy countries since 1950, it is worth noting that the British offshoots and the G7 were in lockstep until 1975 or 1980, and the G7 diverged towards the OECD and Europe afterwards. Suppose, instead, we want to focus on the transition from communism in a systematic way. We make use of the Kornai (1992) definition of communism to determine which countries were actually under communism at some point in the twentieth century.8 Given Kornai’s list and given which countries have EFW scores (e.g., no North Korea or Cuba), we are left with the following group, using modern day names of the regions in question: Albania, Angola, Armenia, Azerbaijan, Belarus, Benin, Bosnia and Herzegovina, Bulgaria, Cambodia, China, Republic of Congo, Croatia, Czechia, Estonia, Ethiopia, Georgia, Hungary, Kazakhstan, Laos, Latvia, Lithuania, Moldova, Mongolia, Montenegro, Mozambique, Nicaragua, North Macedonia, Poland, Russia, Serbia, Slovakia, Slovenia, Tajikistan, Ukraine, Vietnam. Results using this group of countries chain-linked together – along with four other groups of countries we will discuss shortly – are found in Figure 4.4.
7 The ‘OECD’ definition is the current definition of the OECD: Australia, Austria, Belgium, Canada, Chile, Colombia, Costa Rica, Czechia, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Israel, Italy, Japan, South Korea, Latvia, Lithuania, Luxembourg, Mexico, The Netherlands, New Zealand, Norway, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States. ‘Europe’ is Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, Malta, The Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, and the United Kingdom. The offshoots of Britain are Australia, Canada, Ireland, New Zealand, the United Kingdom itself, and the United States. 8 Kornai is generally viewed as an authority on the topic of socialism. In Kornai (2016, p. 553), he notes the three primary characteristics of the socialist system (of nine total) are that (1) the ruling political group enforces public property and bureaucratic coordination, (2) property is dominated by state ownership and (3) society is coordinated via bureaucracy.
54 Handbook of research on economic freedom
Figure 4.3
Economic freedom of groups of economically advanced countries
While there was a discrete jump for many countries circa the fall of the Soviet Union, there were some periods for some countries before 1991 that were less oppressive than others, and not all countries immediately liberalized their economies when they were given the political freedom to do so. What result appears here should not be read as a single collective event of liberalization, but the general path of countries that we can authoritatively (i.e., per Kornai) say fell under communism at some point in their recent history. What we observe is more or less a random set of disturbances set around a very low initial level of economic freedom of around 4.0, and then rapid reforms that commenced in 1990. While the reforms have since slowed, there have been no indication that they have actually stopped, as can be observed in Figure 4.4. The steady, ongoing nature of the reforms contradicts claims of a general failure among the transition economies (e.g., Fukuyama 2004, pp. 1–57), although there are obvious specific examples of autocratic or weak states among those that were previously communist. Figure 4.4 also presents the global trends for some of the major geographic areas of the world, although they are not exhaustive of every country on the planet. The first of these is historical economic freedom in Sub-Saharan Africa.9 In the earliest periods, we do not observe Sub-Saharan Africa to have all that much more economic freedom than even the historically communist countries. Liberalization begins in earnest in the mid-1990s, and it persisted until petering out in the most recent years. That leaves Sub-Saharan Africa with far more economic Data were applied from the countries of Angola, Benin, Botswana, Burkina Faso, Burundi, Cabo Verde, Cameron, Central African Republic, Chad, Democratic Republic of the Congo, Republic of the Congo, Comoros, Cote D’Ivoire, Djibouti, Eswatini, Ethiopia, Gabon, The Gambia, Ghana, Guinea, Lesotho, Kenya, Liberia, Madagascar, Mali, Niger, Nigeria, Rwanda, Senegal, Seychelles, Sierra Leone, Somalia, South Africa, Sudan, Tanzania, Togo, Uganda, Zambia, and Zimbabwe. 9
Economic freedom, 1950–2020 55
Note: All data originate with Gwartney et al. (2022).
Figure 4.4
Economic freedom by country grouping
freedom than it possessed before liberalization, but it remains behind levels of economic freedom elsewhere. The next geographic area we will consider is the Middle East and North Africa (MENA).10 The pattern is again somewhat similar to the other liberalizations worldwide. Economic freedom begins at a somewhat higher level than Sub-Saharan Africa or the historically communist countries. Reform takes off in the early 1990s, but it ceases altogether in conjunction with the financial crisis (peaking in 2007). Economic freedom subsequently fell back to the level of where it was around 2000, and to where Sub-Saharan Africa is today. MENA is an example of actual backpedaling of reforms even before COVID-19, in contrast to other groupings of countries, where we mostly have seen slowing or stagnating reforms. From what the data indicate, the Arab Spring clearly failed to lead to the expansion of economic freedom that people hoped. It is in Asia-Pacific (i.e., East Asia, South Asia, Southeast Asia, and Oceania11), the next geographic area, where we see the most reform, and the most sustained reform, with reform Data were applied from the countries of Algeria, Bahrain, Djibouti, Egypt, Iran, Iraq, Israel, Jordan, Kuwait, Lebanon, Libya, Morocco, Qatar, Saudi Arabia, Sudan, Syria, Tunisia, United Arab Emirates, and Yemen. 11 Data were applied from the countries of Australia, Bangladesh, Brunei, Cambodia, China, Fiji, Hong Kong, India, Indonesia, Japan, South Korea, Laos, Malaysia, Mongolia, Myanmar, Nepal, New 10
56 Handbook of research on economic freedom continuing almost continuously since 1975 (excepting a period during the late 1990s and early 2000s, perhaps because of the 1997 Asian Financial Crisis). Economic freedom began at low levels similar to other groupings of countries above, and now has a score of around seven, approaching that of Europe and the OECD. Yet the countries included here are very diverse in terms of geopolitics, culture, and economic development; they also represent more than half of the world’s population. The final group of countries we will consider is Latin America.12 The level of economic freedom begins at a level somewhat higher than most of the world in the 1950s, but it collapses in the 25 years following 1960, as populist governments, of both left and right-wing varieties, took power throughout the region. Reforms begin in 1985, but essentially cease in 2000. The level of economic freedom in Latin America is somewhat lower than Asia-Pacific, but what is most notable is how little improved economic freedom is in Latin America relative to where they stood in 1950. Summary of Groups of Countries Table 4.2 compares the improvements of each grouping of countries from 1950 to 2020. In rank order, historically communist countries have improved their economic freedom the most (3.05 standard deviations), followed by Sub-Saharan Africa (2.10), Asia-Pacific (1.66), Europe (1.49), MENA (1.22), and Latin America (0.87). Although Europe remains first of the six groups in both 1950 and 2020, Latin American falls from second to fourth, the historically communist rise from last to third, and Asia-Pacific rises from fourth to second. In both the 2019 and 2020 data, it is the Middle East and North Africa that rank lowest in economic freedom, not Sub-Saharan Africa. Europe appears alongside the other country groups in Figure 4.4 to facilitate the comparison of their trajectories. Table 4.2
Chain-linked economic freedom of different groups of countries, ranked by improvement in economic freedom, 1950–2020
1950
1970
2000
2019
2020
Change
Change/standard
(1950– 2020)
deviation (2020)
Historically communist
3.85
4.70
5.88
7.05
6.89
3.04
3.05
Sub-Saharan Africa
4.05
4.69
5.49
6.22
6.15
2.09
2.10
Asia-Pacific
5.32
5.52
6.60
7.09
6.98
1.66
1.66
Europe
6.03
6.42
7.81
7.80
7.56
1.53
1.53
Middle East and North
4.87
5.22
6.11
6.13
6.08
1.21
1.22
5.75
5.73
6.78
6.79
6.61
0.86
0.87
Africa Latin America
Note: Communism as defined by Kornai (1992).
Zealand, Pakistan, Papua New Guinea, The Philippines, Singapore, Sri Lanka, Taiwan, Thailand, Timor-Leste, and Vietnam. 12 Data were applied from the countries of Argentina, Belize, Bolivia, Brazil, Costa Rica, Chile, Colombia, the Dominican Republic, Ecuador, Guatemala, Guyana, Haiti, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Suriname, Uruguay, and Venezuela.
Economic freedom, 1950–2020 57
CONCLUSION Trends in economic freedom are far more unified than one may expect. The timing of the beginning and later stagnation of economic liberalization was common throughout the world, including the countries exiting communism. While we observe economic freedom to be mostly stagnant from 1950 to 1985 (as opposed to declining), the simplistic, popular narrative by Yergin and Stanislaw (1998) is, more or less, supported by the data. The ascendant pessimism that took hold in conjunction with the Great Recession, however, is not supported by the data. On the one hand, the general trend in the most recent two decades has been that of stagnation – likely in part the result of the 1999 protests of the World Trade Organization, as well as the various responses to 9/11 – as opposed to decline. On the other hand, most years saw small, steady improvements, with two disasters, namely the global financial crisis of the late 2000s and COVID-19 beginning in 2020, along the way causing economic freedom to decline sharply in the short term. The pattern observed is entirely consistent with the observations of Sobel (2017), where freedom is built with boring, slow policy improvements but can be quickly lost in conjunction with crises. Although EFW data for 2020 are now nominally available, the data were not completely updated, largely because of the delays or cancellations of the Global Competitiveness Report and Doing Business. Even though the year-to-year decline from 2019 to 2020 was unprecedented, revisions may result in even larger declines. Will economic freedom rebound after COVID-19 like it did, more or less, after the financial crisis, or is this the beginning of a long-run reversal in the trend? Only time will tell. The size of government may revert quickly to where it was, but sound money worldwide is almost certainly in decline. The prospect of a return to mercantile trade wars, or even more military conflict like we see in Ukraine, remain existential threats to economic freedom. Longer-run trends do warrant pessimism for the Middle East and North Africa (MENA). Even before COVID-19, economic freedom had not merely stagnated, as in the case of the rest of the world, but actually declined notably. The economic freedom of this region is now below Sub-Saharan Africa. Needless to say, the politics of MENA are complicated, but the region’s active move away from economic freedom may be the most understudied question among the recent trends in economic freedom.
REFERENCES Andrews, M., Pritchett, L. and Woolcock, M. (2017). Building State Capability: Evidence, Analysis, Action. New York: Oxford University Press. Berggren, N. and Bjørnskov, C. (2019). Do voters dislike liberalizing reforms? New evidence using data on satisfaction with democracy. Journal of Institutional Economics 15(4): 631–648. Bergh, A. (2020). Hayekian welfare states: Explaining the coexistence of economic freedom and gig government. Journal of Institutional Economics 16(1): 1–12. Bergh, A. and Henrekson, M. (2011). Government size and growth: A survey and interpretation of the evidence. Journal of Economic Surveys 25(5): 872–897. Bologna Pavlik, J. (2024). Economic freedom and the economic effects of crises. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 330–342. Cheltenham: Edward Elgar Publishing. Boudreaux, D. (ed.) (2015). What America’s Decline in Economic Freedom Means for Entrepreneurship and Prosperity. Vancouver: Fraser Institute.
58 Handbook of research on economic freedom Fukuyama, F. (2004). State Building: Governance and World Order in the Twenty-First Century. London: Profile Books. Gwartney, J.D., Lawson, R.A., Hall, J. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Karceski, S.M. and Kiser, E. (2020). Is there a limit to the size of the state? The scope conditions of Wagner’s Law. Journal of Institutional Economics 16(2): 217–232. Klein, N. (2007). The Shock Doctrine: The Rise of Disaster Capitalism. New York: Henry Holt and Company. Kornai, J. (1992). The Socialist System: The Political Economy of Communism. Princeton, NJ: Princeton University Press. Kornai, J. (2016). The system paradigm revisited: Clarification and additions in light of experiences in the post-socialist region. Acta Oeconomica 66(4): 547–596. Lawson, R., Grier, K. and Absher, S. (2019). You say you want a (rose) revolution? The effects of Georgia’s 2004 market reforms. Economics of Transition and Institutional Change 27(1): 301–323. Lawson, R.A. and Murphy, R.H. (2019). Economic freedom of the world in the 1950s and 1960s. In: Economic Freedom of the World: 2019 Annual Report (eds. J.D. Gwartney, R.A. Lawson, J. Hall and R.H. Murphy), 189–198. Vancouver: Fraser Institute. Miozzi, V. and Powell, B. (2023). Measuring economic freedom during the COVID-19 pandemic. Journal of Institutional Economics 19(2): 229–250. Murphy, R.H. and Lawson, R.A. (2018). Extending the Economic Freedom of the World index to the Cold War era. Cato Journal 38(1): 265–284. Pitlik, H. (2024). The effects of crises on economic freedom and market-oriented reforms. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 117–132. Cheltenham: Edward Elgar Publishing. Sachs, J. and Warner, A. (1995). Economic reform and the process of global integration. Brookings Papers on Economic Activity 1: 1–95. Sobel, R.S. (2017). The rise and decline of nations: The dynamic properties of institutional reform. Journal of Institutional Economics 13(3): 549–574. Yergin, D. and Stanislaw, J. (1998). The Commanding Heights: The Battle for the World Economy. New York: Touchstone.
5. Economic freedom in economic history Vincent J. Geloso and Gregory W. Caskey
INTRODUCTION On the relationship between economic freedom and political freedom, Milton Friedman (1962, p. 9) famously wrote, Historical evidence speaks with a single voice on the relation between political freedom and a free market. I know of no example in time or place of a society that has been marked by a large measure of political freedom, and that has not also used something comparable to a free market to organize the bulk of economic activity.
While claims such as this, emphasizing the import of economic freedom in economic history were manifestly true to many at the time, the empirical strength of such claims rested primarily upon anecdotal and/or limited case studies.1 This was because scholars in this area faced a lack of historical data with which to systematically assess such claims. Recognizing this, Friedman argued that much work was needed to ‘bring the indexes of economic freedom up to date’ to begin to address this task (Block et al. 1996). In this chapter, we provide an overview of the contributions that theoretically connected ‘economic freedom’ to historical development. In doing so, we follow the definition of economic freedom as described in the Fraser Institute’s Economic Freedom of the World report, namely: The cornerstones of economic freedom are personal choice, voluntary exchange, open markets, and clearly defined and enforced property rights. Individuals are economically free when they are permitted to choose for themselves and engage in voluntary transactions as long as they do not harm the person or property of others. (Gwartney et al. 2022, p. 1)
While researchers for years lacked a consistent index with which to reliably measure economic freedom and its effects upon economic outcomes until the mid-1990s, a number of scholars who recognized the importance of economic freedom in economic development nonetheless relied upon notions of economic freedom in developing their frameworks in economic history. We present the key contributions in this area, including institutional frameworks (North 1981, 1990) as well as technological explanations (Rosenberg 1972, 1982; Mokyr 1992) and cultural explanations (McCloskey 2006, 2010, 2016).
1 Prior to the advent of synthetic control methods that allow for quasi-causal inferences to be made (Abadie et al. 2010; Gilchrist et al. 2023), such case studies were generally taken very lightly as the choice of counterfactuals was immensely arbitrary unless there was a clear accident of history acting to create a decent setup for causal claims. An example of this is the use of South and North Korea during the 1970s and 1980s as an illustration for the benefits of economic freedom (given how large the gap in economic policy was, this was an easy and obvious example).
59
60 Handbook of research on economic freedom Additionally, we outline the key contributions in the realm of providing an empirical basis with which to analyze economic freedom over time, including the Fraser Institute’s Economic Freedom of the World (EFW) report (Gwartney et al. 2022), as well as the Historical Index of Economic Liberty (HIEL) (Prados de la Escosura 2016a). In doing so, we draw connections between the seminal contributions in economic history noted above and the empirical mechanisms that researchers can now more accurately assess given access to indices such as EFW. Despite the lack of formal data, conceptions of economic freedom nonetheless resided in the background of the seminal works of economic history on the structures and institutions underlying economic development. We highlight these key contributions that raised important questions and supplied answers of deep relevance to questions of economic freedom. Finally, we argue that the concept of ‘positive economic liberty’ presents an excellent analytical framework for advancing research in the area of identifying advances in economic freedom in economic history. As defined by Taylor (1985), positive liberty refers to ‘the ability to fulfill my purposes’ (p. 229) while negative liberty is ‘the independence of the individual from interference by others’ (p. 211). While our modern indices do well in providing data to assess how relatively free from intrusion (i.e., ‘negative liberty’) individuals throughout the world are, this approach is distinct from questions regarding the ‘positive’ economic liberties (or, the ability of individuals to more effectively fulfill their commercial and entrepreneurial purpose) of people living centuries ago. In this regard, we argue that renewed focus upon identifying episodes in history in which individuals experienced increases in positive economic freedoms – such as gaining more freedom to start businesses, keep larger percentages of profits, and participate in broader degrees of market activity – would yield important insights for researchers in economic freedom. In the section that follows, we conduct a survey of those contributions in economic history linked with economic freedom-like concepts.
SEEING ECONOMIC FREEDOM IN ECONOMIC HISTORY In this section, we conduct a survey of the seminal frameworks in economic history and their connection to modern conceptions of economic freedom. Each of these contributions was concerned with the key question in economics, namely: what causes economic growth? Given that these analyses lacked the benefit of access to a formalized EFW, we highlight the relevance of economic freedom in the context of the questions raised and arguments set forth in these frameworks. We focus here on including explanations for growth focused on culture, institutions, and technology. In doing so, we acknowledge that these factors do not exist independently of one another.2 Institutions Douglass North regarded it as the primary task of the economic historian, ‘to explain the structure and performance of economies through time’ (North 1981, p. 3). Holding aside the cultural values and preferences of people over time, North investigated the causes and effects of the evolution of humanly-devised institutions. For instance, North (1988, pp. 7–8) wrote, 2 Koyama and Rubin (2022) emphasize this point in their recent treatment when comparing geographic, cultural, institutional, and demographic explanations for the wealth of nations.
Economic freedom in economic history 61 The evolution of government from its medieval, Mafia-like character to that embodying modern legal institutions and instruments is a major part of the history of freedom. It is a part that tends to be obscured or ignored because of the myopic vision of many economists, who persist in modeling government as nothing more than a gigantic form of theft and income redistribution.
Such explanations have yielded large influence in scholarly work, including examining China’s transition to a market economy (Qian and Roland 1998), the emergence of federalism (Qian and Weingast 1997), the Glorious Revolution (North and Weingast 1989), and societal structures (North et al. 2009). North’s ideas regarding institutions, which he defined as ‘the rules of the game in a society’ and ‘the humanly devised constraints that shape human interaction’ (North 1990, p. 4), have clear implications for the study of economic freedom in economic history. In particular, those institutions promoting growth are ones consistent with economic freedom. Take property rights institutions, for instance. Where rulers are incentivized to produce institutional arrangements that are wealth-creating, it is because they are offered rewards for protecting property rights (one of the components that enter modern economic freedom indexes). This point is made clearly in Violence and Social Orders (North et al. 2009). The book sets forth a framework comparing ‘natural’ and ‘open access’ societies, arguing that the degree to which individuals can enjoy increasing degrees of prosperity is conditional upon the political institutions – in particular, the degree of coercion associated with those institutions – existing in a given society. From here, a framework is developed for how societies transition from natural orders (whereby powerful elites enjoy rents that are restricted to most in society) to open access orders (whereby market principles such as competition and free economic and political entry are the basis for social organization – things that translate broadly as ‘economic freedom’). As Bates (2010) points out, whereas the former system is prone to devolve into violence when hit with some shock to the political equilibrium, the latter is more adaptive as there are competing power centers in society. In other words, ‘economic freedom’ creates resilience. The notion of an ‘open-access’ society is present in North’s earlier work on the Industrial Revolution. Of this, North (1981, p. 172) argued that the First … Economic Revolution was the inflection change in the supply curve of new knowledge, rather than the clustering of a set of innovations … nothing automatic about a society’s ability to realize this productive potential since its realization involves a basic restructuring of property rights.
Within a ‘natural’ society, shocks to the system – such as a reordering of property rights due to increased productive capabilities – are likely to result in violence and unrest initiated by powerful elites desirous of preserving their rents. In contrast, Bates (2010) writes that such deviations are less consequential within open societies, particularly because the military exists as an entity that is distinct from politics in such societies. Related is North’s work on constitutions and constraints. Of the Glorious Revolution in 1688, North and Weingast (1989) argue that new institutions – particularly the development of representative Parliament governing alongside the Crown as well as an independent judiciary – were the basis for economic growth in Britain. The development of these institutions, they argue, permits governments to ‘not merely establish the relevant set of rights, but must make a credible commitment to them’ (p. 803). The authors point to the success following the
62 Handbook of research on economic freedom Glorious Revolution in terms of thriving capital markets as evidence for the theory that institutional change in this manner credibly signaled that property rights would be upheld in Britain.3 Culture Next, we draw attention to explanations that rely upon culture and cultural change as engines for development, highlighting their connection to notions of economic freedom. In her well-known trilogy, Deirdre McCloskey (2006, 2010, 2016) argues that the phenomenal rise of living standards beginning in the mid-nineteenth century should be focused upon the entrepreneurial process, particularly as espoused by Israel Kirzner (1973). In his seminal work, Kirzner drew sharp focus on the conditions that allow individuals to discover profit opportunities. A departure from the notion that economists should primarily be concerned with the study of equilibrium, Kirzner argued that economists should concern themselves with the study of the ‘series of systematic changes in the interconnected network of market decisions’ that permit entrepreneurs to discover profit opportunities (Kirzner 1973, p. 10). In the Kirznerian framework, it is ‘alertness’ – the process by which individuals discover information through market interactions – that propels the entrepreneur to act upon previously unnoticed opportunities. Importantly, prices change in the marketplace as a byproduct of entrepreneurial action. Alertness to arbitrage opportunities is the engine of both productivity-enhancing investment as well as consumer welfare-enhancing innovation. It is this conception of the market process – particularly Kirznerian alertness – that forms McCloskey’s theoretical underpinnings.4 For instance, she argues that the dignity accorded to those individuals who – through entrepreneurial alertness – acted to enhance societal standards of living played a substantial role in the rise of the West. ‘[M]otivated by dignity and enabled by liberty’, McCloskey (2010, p. 20) argues that the approbation of others encouraged such individuals to press onward in their entrepreneurial endeavors. Characterizing this broad change in the rhetoric regarding the dignity of business, McCloskey argues, ‘once breeding ideas were set free in the seventeenth century they created more and more opportunities for Kirznerian alertness … the opportunities were alertly taken up’ (McCloskey 2011, p. 50). This virtuous cycle – a feedback loop between entrepreneurial alertness and an increase in the dignity afforded to entrepreneurial activity – is at the core of McCloskey’s explanation for the steep increase in standards of living since the 1800s.5 In this respect, we see a reinforcing mechanism at work: cultural change (i.e., the newfound dignity afforded to business people) contributed to increasing degrees of economic freedom, and economic freedom (in this case, the productive activities of alert entrepreneurs) contributed to ongoing cultural change. Another important and related line of scholarship is that of Joel Mokyr. While Mokyr’s earlier work emphasizes the role of technological and scientific progress as the engine of growth (Mokyr 1992), his more recent works focus upon the role that culture and institu-
Related is the work of Weingast (1995) and Qian and Weingast (1997). In contrast to McCloskey, Geloso (2015) argues that a focus upon social networks – and their information-generating properties that bolster the functioning of markets – is a more valuable route forward for market process scholarship than a narrow focus upon the role of the entrepreneur. 5 In reference to the dignity hypothesis, Williamson (2012, p. 767) argues ‘this implies that dignity is a direct cause of growth, not a proximate cause ... a change in the way people talked about markets, ideas, prudence, entrepreneurs, and innovation lead to the change in economic progress.’ 3 4
Economic freedom in economic history 63 tions play in giving rise to the new ideas and innovation that came about with the Industrial Revolution (Mokyr 2005, 2009, 2011). Central to Mokyr’s argument is what he refers to as ‘emergence of a belief in the usefulness of progress’, as it marked ‘a turning point when intellectuals started to conceive of knowledge as cumulative’ (Mokyr 2016).6 For Mokyr, the onset of these loosened cultural and institutional constraints heightened returns for investment in productivity-enhancing technologies.7 In Gifts of Athena, Mokyr (2011) laid out a theoretical foundation for why societies resist innovation and the new technologies thereof. First, powerful incumbents – fearing a threat to their power with the loss of the status quo – have strong incentives to quell technological change that threatening their existing economic rents. Second, technological innovation sparks concerns about the unintended political, economic, and social consequences they may set in motion. Such changes may yield additional costs to people who were not party to the development and adoption of the innovation. These motives, writes Mokyr, ‘often merge and create powerful forces that use political power and persuasion to thwart innovations’ (Mokyr 2017, p. 968). Underlying these arguments is the notion that technological progress – far from following a neat, linear historical trajectory – is, and has long been, a political process. With this in mind, the history of economic growth is in some sense a horse race between technological progress and the fears and anxieties of people that can be channeled to thwart progress (Mokyr et al. 2015). A different strand of Mokyr’s research focuses upon the role of political fragmentation (i.e., a large number of states) in promoting economic development (Mokyr 2016). Fragmentation in this respect allowed the conditions in which those with heterodox ideas could flourish. Entrepreneurs, scientific innovators, and political or religious ideologues – whose ideas and actions could land them on the wrong side of existing stakeholders – could exit their present state for another in the onset of the suppression of their efforts. This difference is at the core of what Mokyr argues set apart Europe from other highly technologically advanced societies, such as the Qing Dynasty of China and the Mughal Empire of South Asia. While these empires had similar degrees of scientific advancement to what was achieved in Europe by the early eighteenth century, they functioned as unitary empires, not allowing space for those with heterodox ideas to flourish (Mokyr 2016, pp. 167–170). Relative to other technologically advanced states, the polities of Europe benefited from an ‘integrated market for ideas’, allowing it ‘to benefit from the obvious economies of scale associated with intellectual activity’ (Mokyr 2016, p. 170). While many scholars have argued that political fragmentation was central to the rise of Europe, Mark Koyama notes that what sets Mokyr’s argument apart is its specificity, particularly in pointing to not merely decentralization, but rather ‘the combination of cultural unity with political fragmentation and competition’ (Koyama 2018). Technology As North (1994) acknowledged in his Nobel Prize acceptance speech, Nathan Rosenberg made significant contributions towards the understanding of technological change through time and See also Mokyr and Nye (2007). Important examples of Mokyr’s cultural-institutional story can be found in a series of recent works that pertain to technological adoption and tinkering that are crucial to productivity improvements (Kelly et al. 2014, 2023; Kelly and Ó Gráda 2016; Maw et al. 2021). 6 7
64 Handbook of research on economic freedom the contribution of this process to economic development (Rosenberg 1972, 1982; Rosenberg and Birdzell 1986; Mowery and Rosenberg 1999). In what has been dubbed the ‘Rosenberg– Birdzell hypothesis’, a central argument of Rosenberg’s is that innovation and technological change has its roots in economic competition and in independent political units (Rosenberg and Birdzell 1986), a claim supported by Mokyr and others. That is, technological innovation was able to occur within the context of a loosening of political and religious controls. In these cases, institutional changes that increased economic freedom (specifically through improvements in property rights protections and the regulatory environment, to use EFW terminology) resulted in technological progress. Rosenberg placed a strong emphasis upon the understanding of technological change as occurring within particular institutional contexts. ‘Technological change and scientific innovation’, writes Rosenberg (1982, p. 22), ‘are responses to underlying economic variables.’ Recognizing the endogeneity to such processes around the world, Rosenberg (1982, p. 23) wrote, ‘Additional knowledge of new production possibilities is not costless, nor is the rate and direction of technological change exogenous.’ Rather, Rosenberg argued that technological change should be understood as path-dependent phenomena, as technological trajectories of the past ‘leave a profound imprint upon the present’ (Rosenberg 1982, p. 17). In these terms, those societies that enjoyed a ‘path-dependent’ trajectory of productive technological change and innovation were those that were more economically free than other societies. Similarly, Mokyr (2011) places a sharp emphasis upon the institutional context within which technological change takes place, particularly political economy considerations. Writing of the considerable overlap between the battles against free trade and technological progress, Mokyr (2011, p. 261) writes, ‘... free trade and an open economy are by far the best guarantees that an economy will be induced to employ best-practice techniques, just as protection is the best way of keeping out threatening foreign techniques.’ Here, technological progress and institutional context promoting free trade and expanding markets are inextricably intertwined. A great deal of cliometric research has been devoted to theorizing about the causes and consequences of the British Industrial Revolution. In his seminal paper, Temin (1997) conducted a horserace between the two primary competing views of what accounted for the Industrial Revolution, including broad changes in the British economy and society, as opposed to the result of technological change that was confined to only a few industries. While the former emphasizes the effects of a ‘wave of gadgets’ (Ashton 1948) that spread throughout the British economy and which helped produce the widespread technological progress that we observed in the Industrial Revolution, the latter argues that it was technological progress, specifically in the cotton and iron industries, that propelled the Industrial Revolution (Harley 1982; Crafts 1985; Harley and Crafts 2000).
MEASURING ECONOMIC FREEDOM EFW and HIEL The inception of the Fraser Institute’s Economic Freedom of the World (EFW) index provided scholars of economics and economic history with a dataset to test their propositions about the causes and effects of economic freedom (Gwartney et al. 2022). As Hall and Lawson (2014, p. 1) put it, the EFW index is designed ‘to measure the consistency of a nation’s policies and
Economic freedom in economic history 65 institutions with economic freedom.’ The subcomponents that form the EFW are proxies for the foundations of economic freedom, including personal choice, voluntary exchange, freedom to enter markets and compete, and security of the person and privately owned property (Gwartney et al. 2022, p. v). The five subcomponents – which include 42 externally sourced data points – cover the size of government, legal system and property rights, sound money, freedom to trade internationally, and regulation.8 In 2017, a Gender Legal Rights Adjustment was added to the EFW, measuring the extent to which men and women possess the same degree of economic freedom within countries. At its core, the EFW ‘... measures the degree to which the policies and institutions of countries are supportive of economic freedom’ (Gwartney et al. 2022, p. v). Since the inception of the EFW index, hundreds of academic articles have utilized EFW as a key variable of interest. As Hall and Lawson (2014) found in their survey of this literature, over two-thirds of the studies deploying economic freedom as an independent variable found economic freedom to be positively correlated with outcomes such as faster economic growth, higher living standards, greater levels of reported happiness, and more. Additionally, of the 198 papers analyzed by Hall and Lawson (2014, p. 8) only eight yielded significant negative results associated with economic freedom. Recently, Lawson updated these numbers and found even more signs that economic freedom was generally a positive force over more than 500 surveyed articles (Lawson 2022). As such, a large empirical literature has come about demonstrating the robust association between economic freedom and the wealth of nations (Berggren 2003).9 For instance, Gorodnichenko and Roland (2017) argue that individualism, as defined by a cultural trait emphasizing personal freedom and achievement, has a dynamic, positive effect on innovation and economic growth. This occurs in no small part due to awards associated with social status through personal accomplishments, discoveries, innovations, success in business, artistic prowess, or humanitarian efforts. While individualism and economic freedom are not the same thing, the institutional arrangements that characterize economically free societies are those that are likely to more effectively channel individualism into productive economic outcomes (Cai et al. 2022, p. 869). Although EFW has provided the basis for great advancement in empirical research on economic freedom, EFW data only go back to 1970. While EFW provides an excellent resource for contemporary analysis of economic history, the lack of pre-1970 data places bounds upon the external validity of inferences drawn from contemporary analyses with respect to questions of the past.10 To address this limitation, Prados de la Escosura (2016a) developed the Historical Index of Economic Liberty (HIEL) to provide a longer-run view of the dimensions and effects of economic freedom for today’s highly developed nations. The HIEL covers the 21 countries included in the Organization for Economic Co-operation and Development (OECD) over the period of 1850–2007 prior to its 1994 enlargement. The HIEL approach differs from the EFW in its focus upon ‘positive’ economic freedom – the
8 As Gwartney et al. (2022) clarify, the EFW is built upon sources such as the International Monetary Fund, World Bank, and World Economic Forum that provide data for a large number of countries. 9 See also Guiso et al. (2003), Faria and Montesinos (2009), and de Soysa and Fjelde (2010). 10 On this, Prados de la Escosura (2016b) argues, ‘The lack of a long-run perspective reduces the value of its lessons and policy implications, with the risk of identifying what it is specific to the recent past, with empirical regularities that apply across space and time.’
66 Handbook of research on economic freedom guarantee of access to markets that allow people to control their own existence – as opposed to ‘negative’ freedom, which involves a lack of interference or coercion by others (Berlin 1969). While both of these approaches are related to questions of economic freedom, an opportunity exists for researchers to identify instances or periods in economic history where there have been expansions in positive economic freedoms. These include, for instance, the ability to more effectively enjoy residual-claimant status over profits or the ability to participate in broader sectors of economic activity than a previous period. An example of this approach is captured with the Historical Index of Human Development (Prados de la Escosura 2013, 2015). Building off of the work of Desai (1991, p. 356), Prados de la Escosura (2015, p. 221) argues that human development (or the ability for individuals to more effectively develop their personal potential as they see fit) can be depicted as ‘positive freedom’. For researchers interested in economic freedom in economic history, this would involve examining scenarios where, due to some change in the relevant incentives and constraints, individuals were more effectively able to fulfill their commercial and entrepreneurial purposes. The HIEL represents an important advance. As Prados de la Escosura (2016a, p. 435) notes, ‘[e]conomic liberty expanded over the last century-and-a-half, reaching more than two-thirds of its possible maximum. However, its evolution has been far from linear.’ As noted, the HIEL is distinct in its methodological approach as a metric of economic freedom insofar as it is focused upon ‘positive’ economic freedoms, such as the evolution of institutions that permitted greater degrees of freedom of choice for people across economic, political, and social domains. Methodologically, the HIEL approach involves examining the shortfall of economic freedom in a country relative to its estimated upper bound of economic freedom, with improvement measured as the proportion of the maximum possible freedom (Prados de la Escosura 2016a). Despite this distinction, there remains overlap between the HIEL and EFW indices. For instance, framed in the context of positive economic liberty, Prados de la Escosura (2016a, p. 435) argues that ‘improved property rights provided the main contribution to the long-run advancement of economic liberty.’ Likewise, considering EFW’s focus upon freedom from intrusion within its five subcomponents, one is ‘security of the person and privately owned property’. This is in contrast to other indices that focus on identifying the extent to which ‘negative’ freedoms are present across locales as the basis for measuring economic freedom. Prados de la Escosura (2016a, p. 436) writes, A country will be depicted as economically free insofar as privately owned property is securely protected, contracts enforced, prices stable, barriers to trade small, and resources mainly allocated through the market. Assessing the consistency of a nation’s institutions and policies with these requisites is the purpose of any index of economic freedom.
At present, only a handful of articles have relied on the HIEL dataset. Most of these are produced by one of the authors of the present chapter (Candela and Geloso 2021; Geloso and Bologna Pavlik 2021; Geloso et al. 2022; Siklos 2022). These articles point in the same direction as the survey produced by Lawson (2022), in that they all suggest positive associations. The problem is that these are few in numbers and greater use of the HIEL dataset would be welcomed.
Economic freedom in economic history 67 The Role of Economic Freedom in Economic History Each of the aforementioned institutional, technological, and cultural frameworks to varying degrees rely upon EFW-related or adjacent explanations. This is not to diminish the significance of these arguments. Rather, it is to draw attention to the mechanisms of economic freedom as an underrated factor in economic history research. As Hall and Lawson (2014, p. 1) write, the EFW’s concept of economic freedom resides ‘... within the classical liberal tradition that emphasizes the importance of private property, rule of law, free trade, sound money, and a limited role for government.’ Of this, Friedman pointed out, the construction of EFW was not required for many to associate a close relation between economic freedom and the level and rate of economic growth. Rather it provided an objective set of data to more deeply explore the essential connections with respect to this relationship (Gwartney et al. 2022). Cultural explanations for changes in economic development/economic growth are important, but they rely upon an institutional environment through which changing cultural values could flow. Of course, there is endogeneity here, as it may be that those societies where market-oriented, individualistic cultures developed were places with institutions that were conducive to such developments (Williamson 2012; Choi and Storr 2019; Cai et al. 2022). In these societies, Kirzernerian entrepreneurs were alerted to entrepreneurial opportunities but also possessed the freedom to act upon that alertness. Related is the notion set forth by Mokyr (2016), whereby fragmentation permitted the conditions for entrepreneurs of heterodox religious or political orientations to flourish. This mechanism is closely related to four of the five EFW sub-components, including size of government, legal system and property rights, freedom to trade internationally, and regulation. That is, even the possibility of exit for such individuals presupposes some degree of economic freedom for individuals finding themselves on the wrong side of existing individuals and institutions of power. As Mokyr (2011) points out, battles over technological change and free trade have had and will continue to have significant implications for economic history. One such implication, he writes, is that ‘technological progress in a society is by and a large a temporary and vulnerable process, with many powerful enemies with a vested interest in the status quo or an aversion to change continuously threatening it’ (Mokyr 2011, p. 221). By consequence, Mokyr points out that technological change – the type that transforms living standards, which we know individuals are capable of – is rare relative to stasis and the status quo. Another implication, writes Mokyr (2011, p. 221), is that ‘most underdeveloped countries cannot take technology transfer for granted’, as such efforts are likely to run into barriers set up by existing stakeholders. This mechanism, which is also addressed by North et al. (2009), speaks directly to the insights of the EFW index. That is, we would expect that societies whereby powerful elites prevent competitive processes from being set forth are ones that score low in EFW sub-components such as private property rights, the rule of law, and free trade. Conversely, societies that are characterized by a great deal of economic dynamism and innovation are likely the opposite, scoring relatively highly in these components.
68 Handbook of research on economic freedom
WAYS FORWARD: ‘POSITIVE ECONOMIC LIBERTY’ Prados de la Escosura (2016a) has persuasively argued that greater focus is needed upon identifying ‘positive economic liberty’ in economic history. In this regard, we argue that further explorations in the realm of identifying and analyzing developments of positive economic freedoms would be of great value for future research in economic history. As Geloso (2018, p. 21) argues, ‘[h]istory has become a tool with which to resolve ongoing debates between economists as it allows them to extend their data in to the past. The idea is that great datasets going back decades or centuries may unlock the big questions.’ In this respect, a large opportunity exists for researchers interested in economic freedom and economic history to push this project back even further. In addition to the opportunities for expanding the historical time horizon of such data, an equally substantial opportunity exists to expand the geographic scope of such an index to include the great societies of East, Central, and South Asia, along with the Middle East, Africa, South America, and Oceania. While this no doubt presents a steep challenge for researchers, should an expanded historical and geographic Index of Positive Economic Liberty be developed, this would be a significant advance for scholarly research in this area, as it would add onto the excellent work of the HIEL to ‘[examine] the shortfall of economic freedom in a country relative to its estimated upper bound of economic freedom ...’ (Prados de la Escosura 2016a, p. 440). For example, related to the argument that political freedom came about in Greece upon the emergence of additional market freedom (Friedman 1962, p. 9), it would be highly valuable to dig down into such instances and many more that represented positive advances in economic liberty for people. While some of these differences are of a semantic nature, we argue there’s more distinctions to unearth in this area. A modern analogue through which this takes place is the onset of ‘permissionless innovation’ (Munger 2018) or ‘evasive entrepreneurship’ (Elert and Henrekson 2016). Both of these concepts make it clear that, even when economic freedom is restricted in some sense, creative entrepreneurs nonetheless continue to have strong incentives to innovate to provide valuable goods and services to people. Changes in this area are now ubiquitous in modern commercial life, particularly by way of innovations in the sharing economy. This phenomenon – whereby broad changes in economic life are brought about by technological innovation before governments had a chance to intervene or alter its course – is not a new one. In the Mokyrian framework, the onset of permissionless innovation represents an example where technological progress happened in such a way that powerful enemies with a vested interest in quelling such developments were unable to effectively respond to.
CONCLUSION In this chapter, we’ve highlighted the key contributions that directly or indirectly built upon the role of economic freedom in economic history. In particular, we’ve provided an overview of various frameworks, including institutional, and technological, and cultural accounts for change in economic history. We’ve placed these contributions in the context of the Economic Freedom of the World index (Gwartney et al. 2022), as well as the Historical Index of Economic Liberty (Prados de la Escosura 2016a). Finally, we’ve argued that the concept of
Economic freedom in economic history 69 ‘positive economic liberty’ has been heretofore underappreciated in the literature on economic freedom in economic history. As Friedman (1962, p. 9) pointed out, it is difficult to appreciate increases in positive economic freedom, particularly if one already resides in a relatively free society: Because we live in a largely free society, we tend to forget how limited is the span of time and the part of the globe for which there has even been anything like political freedom: the typical state of mankind is tyranny, servitude, and misery. … Political freedom in this instance clearly came along with the free market and the development of capitalist institutions. So also did political freedom in the golden age of Greece and in the early days of the Roman era. History suggests only that capitalism is a necessary condition for political freedom.
For researchers interested in economic freedom in economic history, a number of questions remain that are worthy of examination. One is the relationship between state capacity and economic freedom. That is, while high-capacity states can effectively provide public goods that benefit the citizenry and promote productive exchange, such states necessarily – to varying degrees – utilize reductions in freedom in bringing about enhanced capacity. As Geloso and Salter (2020) point out, we do not observe societies lacking state capacity with high economic performance. As such, they argue that state capacity serves as a survivability condition for economic prosperity, not a causal condition of it. Likewise, other fruitful projects ahead would be to identify examples of advances in positive liberty in economic history, including improvements in residual claimant status for entrepreneurs, the ability for consumers to interact with a greater set of producers, or the right for business owners to operate in certain segments of the economy that they were previously blocked from participating in. What were the changes in the relevant incentives and constraints that brought such changes about? These questions are of particular interest for researchers interested in economic freedom and economic history.
REFERENCES Abadie, A., Diamond, A. and Hainmueller, J. (2010). Synthetic control methods for comparative case studies: Estimating the effect of California’s tobacco control program. Journal of the American Statistical Association 105(490): 493–505. Ashton, T.S. (1948). The Industrial Revolution 1760–1830. Oxford: Oxford University Press. Bates, R. (2010). Review of: Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History. Journal of Economic Literature 48(3): 752–756. Berggren, N. (2003). The benefits of economic freedom: A survey. Independent Review 8(2): 193–211. Berlin, I. (1969). Four Essays on Liberty. Oxford: Oxford University Press. Block, W., Gwartney, J.D. and Lawson, R.A. (1996). Economic Freedom of the World: 1975–1995. Vancouver: Fraser Institute. Cai, M., Caskey, G.W., Cowen, N., Murtazashvili, I., Murtazashvili, J.B. and Salahodjaev, R. (2022). Individualism, economic freedom, and charitable giving. Journal of Economic Behavior & Organization 200(August): 868–884. Candela, R.A. and Geloso, V.J. (2021). Economic freedom, pandemics, and robust political economy. Southern Economic Journal 87(3): 1250–1266. Choi, S.G., and Storr, V.H. (2019). A culture of rent seeking. Public Choice 181(1): 101–126. Crafts, N.F. (1985). British Economic Growth During the Industrial Revolution. Oxford: Clarendon Press. de Soysa, I., and Fjelde, H. (2010). Is the hidden hand an iron fist? Capitalism and civil peace, 1970–2005. Journal of Peace Research 47(3): 287–298.
70 Handbook of research on economic freedom Desai, M. (1991). Human development: Concepts and measurement. European Economic Review 35(2–3): 350–357. Elert, N., and Henrekson, M. (2015). Evasive entrepreneurship. Small Business Economics 47(1): 95–113. Faria, H.J. and Montesinos, H.M. (2009). Does economic freedom cause prosperity? An IV approach. Public Choice 141(1): 103–127. Friedman, M. (1962). Capitalism and Freedom. Chicago: University of Chicago Press. Geloso, V.J. (2015). Deirdre McCloskey, Kirznerian growth and the role of social networks. Economic Affairs 35(3): 453–463. Geloso, V.J. (2018). Economics, economic history and historical data. In: An Economist’s Guide to Economic History (eds. M. Blum and C.L. Colvin), 21–29. Cham: Palgrave Macmillan. Geloso, V.J., and Bologna Pavlik, J. (2021). Economic freedom and the economic consequences of the 1918 pandemic. Contemporary Economic Policy 39(2): 255–263. Geloso, V.J., and Salter, A.W. (2020). State capacity and economic development: Causal mechanism or correlative filter? Journal of Economic Behavior & Organization 170(February): 372–385. Geloso, V.J., Hyde, K. and Murtazashvili, I. (2022). Pandemics, economic freedom, and institutional tradeoffs. European Journal of Law and Economics 54(1): 37–61. Gilchrist, D., Emery, T., Garoupa, N. and Spruk, R. (2023). Synthetic control method: A tool for comparative case studies in economic history. Journal of Economic Surveys 37(2): 409–445. Gorodnichenko, Y. and Roland, G. (2017). Culture, institutions, and the wealth of nations. Review of Economics and Statistics 99(3): 402–416. Guiso, L., Sapienza, P. and Zingales, L. (2003). People’s opium? Religion and economic attitudes. Journal of Monetary Economics 50(1): 225–282. Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Hall, J.C., and Lawson, R.A. (2014). Economic freedom of the world: An accounting of the literature. Contemporary Economic Policy 32(1): 1–19. Harley, C.K. (1982). British industrialization before 1841: Evidence of slower growth during the industrial revolution. Journal of Economic History 135(42): 267–289. Harley, C.K., and Crafts, N.F. (2000). Simulating the two views of the British industrial revolution. Journal of Economic History 60(3): 819–841. Kelly, M., Mokyr, J. and Ó Gráda, C. (2014). Precocious albion: A new interpretation of the British industrial revolution. Annual Review of Economics 6(1): 363–389. Kelly, M., Mokyr, J. and Ó Gráda, C. (2023). The mechanics of the industrial revolution. Journal of Political Economy 131(1): 59–94. Kelly, M. and Ó Gráda, C. (2016). Adam Smith, watch prices, and the industrial revolution. Quarterly Journal of Economics 131(4): 1727–1752. Kirzner, I.M. (1973). Competition and Entrepreneurship. Chicago: University of Chicago Press. Koyama, M. (2018). Review of: A Culture of Growth: The Origins of the Modern Economy. Independent Review 22(3): 451–456. Koyama, M. and Rubin, J. (2022). How the World Became Rich: The Historical Origins of Economic Growth. Cambridge: Polity Press. Lawson, R.A. (2022). Economic freedom in the literature: What is it good (bad) for? In: Economic Freedom of the World: 2022 Annual Report (eds. J.D. Gwartney, R.A. Lawson, J.C. Hall and R.H. Murphy), 187–200. Vancouver: Fraser Institute. Maw, P., Solar, P., Kane, A. and Lyons, J.S. (2021). After the great inventions: Technological change in UK cotton spinning, 1780–1835. Economic History Review 75(1): 22–55. McCloskey, D.N. (2006). The Bourgeois Virtues: Ethics for an Age of Commerce. Chicago: University of Chicago Press. McCloskey, D.N. (2010). Bourgeois Dignity: Why Economics Can’t Explain the Modern World. Chicago: University of Chicago Press. McCloskey, D.N. (2011). A Kirznerian economic history of the modern world. In: The Annual Proceedings of the Wealth and Well-Being of Nations 2011–2011 (ed. Emily Chamlee-Wright), 45–64. Beloit, WI: Beloit College Press.
Economic freedom in economic history 71 McCloskey, D.N. (2016). Bourgeois Equality: How Ideas, Not Capital or Institutions, Enriched the World. Chicago: University of Chicago Press. Mokyr, J. (1992). The Lever of Riches: Technological Creativity and Economic Progress. Oxford: Oxford University Press. Mokyr, J. (2005). The intellectual origins of modern economic growth. Journal of Economic History 65(2): 285–351. Mokyr, J. (2009). The Enlightened Economy: An Economic History of Britain, 1700–1850. New Haven, CT: Yale University Press. Mokyr, J. (2011). The Gifts of Athena. Princeton, NJ: Princeton University Press. Mokyr, J. (2016). Progress isn’t natural. The Atlantic. https://www.theatlantic.com/business/archive/ 2016/11/progress-isnt-natural-mokyr/507740/ (accessed 31 March 2023). Mokyr, J. (2017). Review of: Innovation and Its Enemies: Why People Resist New Technologies. Journal of Economic History 77(3): 968–970. Mokyr, J., and Nye, J.V.C. (2007). Distributional coalitions, the industrial revolution, and the origins of economic growth in Britain. Southern Economic Journal 74(1): 50–70. Mokyr, J., Vickers, C. and Ziebarth, N.L. (2015). The history of technological anxiety and the future of economic growth: Is this time different? Journal of Economic Perspectives 29(3): 31–50. Mowery, D.C. and Rosenberg, N. (1999). Paths of Innovation: Technological Change in 20th-Century America. Cambridge: Cambridge University Press. Munger, M.C. (2018). Tomorrow 3.0: Transaction Costs and the Sharing Economy. Cambridge: Cambridge University Press. North, D.C. (1981). Structure and Change in Economic History. New York: W.W. Norton and Company. North, D.C. (1988). Institutions, economic growth and freedom: An historical introduction. In: Freedom Democracy and Economic Welfare: Proceedings of an International Symposium (ed. M.A. Walker), 3–25. Vancouver: Fraser Institute. North, D.C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press. North, D.C. (1994). Economic performance through time. American Economic Review 84(3): 359–368 . North, D.C., Wallis, J.J. and Weingast, B.R. (2009). Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History. Cambridge: Cambridge University Press. North, D.C. and Weingast, B.R. (1989). Constitutions and commitment: The evolution of institutions governing public choice in seventeenth-century England. Journal of Economic History 49(4): 803–832. Prados de la Escosura, L. (2013). Human development in Africa: A long-run perspective. Explorations in Economic History 50(2): 179–204. Prados de la Escosura, L. (2015). World human development: 1870–2007. Review of Income and Wealth 61(2): 220–247. Prados de la Escosura, L. (2016a). Economic freedom in the long run: Evidence from OECD countries (1850–2007). Economic History Review 69(2): 435–468. Prados de la Escosura, L. (2016b). Economic liberty in the long run: Evidence from OECD countries. Blog post. https://ehes.org/2014/04/28/economic-liberty-in-the-long-run-evidence-from-oecd -countries/(accessed 13 March 2023). Qian, Y. and Roland, G. (1998). Federalism and the soft budget constraint. American Economic Review 88(5): 1143–1162. Qian, Y. and Weingast, B.R. (1997). Federalism as a commitment to reserving market incentives. Journal of Economic Perspectives 11(4): 83–92. Rosenberg, N. (1972). Factors affecting the diffusion of technology. Explorations in Economic History 10(1): 3–33. Rosenberg, N. (1982). Inside the Black Box: Technology and Economics. Cambridge: Cambridge University Press. Rosenberg, N. and Birdzell, L. (1986). How the West Grew Rich: The Economic Transformation of the Industrial World. New York: Basic books. Siklos, P.L. (2022). Did the great influenza of 1918–1920 trigger a reversal of the first era of globalization? International Economics and Economic Policy 19(3): 459–490.
72 Handbook of research on economic freedom Taylor, C. (1985). What’s wrong with negative liberty? In: Philosophy and the Human Sciences: Philosophical Papers, Vol. 2, 211–229. Cambridge: Cambridge University Press. Temin, P. (1997). Two views of the British industrial revolution. Journal of Economic History 57(1): 63–82. Weingast, B.R. (1995). The economic role of political institutions: Market-preserving federalism and economic development. Journal of Law, Economics, & Organization 11(1): 1–31. Williamson, C.R. (2012). Dignity and development. Journal of Socio-Economics 41(6): 763–771.
PART III ECONOMIC FREEDOM IN THE HISTORY OF ECONOMIC THOUGHT
6. Adam Smith and economic freedom Maria Pia Paganelli
Some time ago, a colleague asked me where in Adam Smith’s work she could find the use of the expression ‘Laissez Faire’ because she could not find it. It did not occur to her that she could not find it because it is not there. It was pretty much engrained in her that Smith used the expression and was a promoter of Laissez Faire. But despite some popular beliefs, Adam Smith never used the term Laissez Faire, nor did he support it, even if he favored a great deal of economic freedom. One can think of economic freedom as a spectrum, with Laissez Faire at one extreme of it. Smith was on this spectrum, but never reached its end. The French Physiocrats coined and used the expression Laissez Faire Laissez Passer. Smith never used it. Smith was often associated with the Physiocrats, correctly or not, given his trip to France escorting the young Duke of Buccleuch in his Grand Tour of Europe (Alcouffe and Massot-Bordenave 2020). The alleged influence of the Physiocrats over Smith reached the point of being considered the cause of the so-called Das Adam Smith Problem. The Problem, as presented by German scholars associated with the Historical school at the end of the 19th century, was that Smith wrote The Theory of Moral Sentiments (Smith 1982 [1759]) first, praising benevolence, and then the Physiocrats made him change his mind so that when he wrote The Wealth of Nations (Smith 1981 [1776]), he praised self-interest instead (Montes 2003). That Smith had an inconsistency problem as presented in the traditional Das Adam Smith Problem is considered a dead horse in the literature by now (Paganelli 2008). However, that Smith was not a supporter of Laissez Faire should not be a surprise, given his critical treatment of it in Book IV of The Wealth of Nations, and given some explicit commentaries about his rejection of Physiocracy by some of his earlier editors (Berkowitz 2018). Yet, historians of economics of the caliber of Jacob Viner (1927) and George Stigler (1971) seemed puzzled about Smith’s rejection of a zero-government intervention attitude, probably because they wished to bring the weight of Smith in support of their own positions (Kennedy 2009; Liu 2022). Smith criticized the Physiocrats for their misconceived notion that manufacturers and merchants, unlike agricultural labor, are unproductive, but of particular relevance here, he took on their Laissez Faire positions and their excessive focus on perfect liberty. For Smith, a system can be well-functioning even if not perfect. And indeed, if one waits for perfection, one will never do much. After all, we live relatively well even if we do not follow the strictest diet and even if our eyesight is not perfectly sharp. In a sense, we can think of Smith’s understanding of economic freedom as a spectrum, more than an on-off switch. Laissez Faire, being at one of the extremes of the spectrum with its perfect liberty, seems like a kind of dogmatic ideology favoring a beautiful and perfect system, which unfortunately, focusing on perfection, does not always take reality into consideration. The system of Physiocracy is indeed a system, after all, for Smith. Smith bundles the analysis of the physiocratic system under the same umbrella as the mercantile system, in Book IV of the Wealth of Nations. But Physiocracy, differently from the mercantile system, seems to be driven by a genuine love of system, like the one Smith describes for the ‘man of system’. 74
Adam Smith and economic freedom 75 Furthermore, differently from the mercantile system, attempts to implement physiocratic ideas in practice were rare and of very limited consequences. The ‘man of system’, as Smith describes him in The Theory of Moral Sentiments, is a person with a vision and enamored with that vision. So much so that in trying to implement it in practice, he forgets that the real people are not like pieces on a chessboard that can be moved at will. They are real human beings with their own will, which may or may not coincide with the will attributed to them by the ‘man of system’. And when the two diverge, instability problems emerge. For Smith, the human condition is much more complex and diverse than a one-size-fits-all system or than a perfect system. Context matters; circumstances matter; historical conditions matter; intentions matter; consequences matter. Smith’s approach is much more flexible and malleable, less perfectionist if you will, than the one endorsing Laissez Faire. Under some circumstances economic freedom is welcome; under different circumstances it is not. It depends. For sure, though, economic freedom is strictly preferred to policies that favor special interest groups and harm the majority of society. The criticisms Smith offers against the mercantile system are thus very different from the ones offered against the agricultural system. While the Physiocrats may be driven by a genuine sense of system, a sense of systematization of the knowledge of the economy so as to form a beautiful and coherent model, the mercantilists are driven by self-interest and greed. Self-interest here is in its 18th century meaning: acting in one’s interest disregarding the presence and the well-being of others. Smith violently attacks it, to adopt a sentence with which Smith himself in correspondence describes his Wealth of Nations (‘a violent attack against the commercial system of Britain’). Self-interest differs from interest. One appeals to the butcher’s, brewer’s, and baker’s interest to get one’s dinner, Smith tells us, not to their self-interest. Smith actually uses the term self-interest only once, to refer to the deleterious self-interest of the Church. The distinction between interest and self-interest is subtle but important. Mercantilists are not ‘men of system’ since they do not seem to necessarily be enamored with the beauty of their system – but for Smith, they are much more dangerous than that. They are people willing and able to distort the common perception of the economy and of society, to capture the powers of the state, and to sacrifice the ‘blood and treasure’ of their fellow-citizens to enrich themselves (Paganelli 2023). The problem with the lack of economic freedom for Smith is thus not necessarily its presence or its absence per se, but the socially harmful consequences of the misuses of state power to benefit some at the expense of others. Smith (in)famously welcomes explicit violations of personal liberty, and he explicitly recognizes it as such. ‘Party walls’, i.e., legally mandated partitions between houses that prevent the spread of fire from house to house, are necessary even if they are violations of natural liberty. The transmission of fire from house to house was a major devastating problem that cities with wooden houses and oil lamps had; often a fire would lead to the burning down of the whole city. Mandating ‘party walls’ was an attempt to alleviate the problem. And Smith endorses it open-armed: But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as of the most despotical. The obligation of building party walls, in order to prevent the commu-
76 Handbook of research on economic freedom nication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed. (WN II.ii.941)
The banking regulations he is referring to in the sentence above included the ban on small denomination notes, which in Smith’s account are like a ‘party wall’, a violation of natural liberty but a necessary one. Small denomination notes were a market response to the lack of small coins, with which working poor would be paid (Sargent and Velde 2003). For Smith, if small denomination notes are allowed, their users are exposed to the high risk of personal ruin. The users of small denomination notes tend to be the working poor. The issuers of small denomination notes can be ‘beggarly bankers’, not necessarily the most reliable ones. If they go bankrupt, which they will, in Smith’s account, the working poor will face catastrophic consequences. So even if both parties voluntarily use and welcome small denomination notes, they should be banned for the good of preventing a major evil among the weakest of society. Smith also wanted to ban the option clause, for the same reason. The option clause was a voluntary clause of delayed conversion of banknotes, usable in case of illiquidity problems of a bank. It was welcomed by both bankers and holders of banknotes, as it guaranteed payment, with interest, even if later in time. But for Smith this ‘party wall’ is needed because it reduces the incentives of a bank to over-issue and thus prevent the greater evil to society of general instability caused by multiple over-issuing institutions. Such practices could more easily cause bank runs, and thus bankruptcies and turmoil (or the opposite effect – instability – that the ban of the option clause caused, see Goodspeed 2016). The justification of usury laws, which Smith also supports, runs on the same motive. In the absence of usury laws, the incentives are such that interest rates would increase, because of an adverse selection problem. With high interest rates, only the riskier projects would be financed, and the riskier the project, the higher the interest rate to compensate for the higher risk, the riskier the projects seeking financing, and so on. This comes at the expense of the prudent enterprises, which will have trouble financing. Productive resources would thus be diverted and wasted into unachievable projects and society would be worse off because it will be harder, if not impossible, to finance productive, prudent investments (Leloup 2000; Paganelli 2003). So even if economic freedom is hereby limited, that limitation is well-justified. The list of limits of economic freedom dictated by the general well-being of society (or of the majority of the people in it (Levy 1995)) include, among others, the Navigation Act and the subsidies for the production of military supplies, such as British sail-cloth and British gunpowder. This is because, for Smith, national defense is more important than economic freedom and the opulence that usually comes with it. The defense of Britain depends on its number of sailors and ships, in Smith’s account. The Act of Navigation is thus justifiable even if it is an encroachment of economic freedom. The Act forbids foreign ships from bringing foreign goods to Britain while allowing them to export British goods. But arriving in Britain with an empty cargo is not economically feasible for any kind of vessel, which means that the Act of Navigation de facto grants the monopoly of the British trade to British ships. But those British ships and sailors can come in handy to the British navy in case of war. Ergo Smith’s acceptance of the trade monopoly established with the Act of Navigation. 1 I use the standard referencing system here and throughout the rest of the paper. Wealth of Nations: WN Book.Chapter.Paragraph.
Adam Smith and economic freedom 77 Smith is also willing to limit economic freedom through the imposition of some taxes, in some specific circumstances. For example, taxing foreign goods when there are taxes on the same goods produced domestically can be justified. Without the tax on foreign goods, the producers of the domestic taxed goods would suffer unfairly from the foreign competition. This tax on foreign goods would equalize domestic and foreign goods, allowing them to compete on a fair ground. Why one should not abolish the tax on domestic goods, rather than imposing a tax on the same foreign goods, remains unanswered. That said, what is not justifiable for Smith is to extend these taxes on the necessaries of life and on all kinds of other foreign goods. Taxing the imports of necessities such as soap, salt, leather, or candles, would increase domestic labor costs, and therefore the price of all commodities, and that is not justifiable. For Smith, a tax on necessities is a sort of magic wand that figuratively, not literally obviously, transforms good soil and a good climate into poor soil and a bad climate. And if the tax is too high it becomes equivalent to the ‘curse’ of ‘barrenness of the earth and inclemency of the heavens’. Note that in Smith’s time, and in the decades following his death, his work was often consulted as a source of fiscal wisdom to reform obsolete or malfunctioning tax systems (Astigarraga and Zabalza 2022). Smith is willing to sacrifice economic freedom to taxation of foreign goods also in additional circumstances. But note again that these are not general prescriptions but case-by-case analyses. Should we sacrifice economic freedom and penalize consumers of foreign goods with taxation on foreign goods? It depends. If another country is taxing our goods, retaliation may be appropriate if it eventually induces foreigners to repeal their tax. If there is a domestic industry that grew with protections, should we sacrifice economic freedom by slowing the opening to free imports to avoid disorders which may arise from the loss of many jobs when competition is introduced? It depends, for Smith, and this is a difficult case to evaluate. It needs a case-by-case analysis of the local circumstances. In theory, it should be done slowly and with a lot of notice. Yet, at the end of each war, thousands of sailors come home and need to find a job. They do it without problems. Similarly, displaced workmen should be able to find different employment. After all, the capital of the country remains the same, so the demand for labor should remain the same too, just in different occupations. What makes the difference? The level of economic freedom of the country. If there is enough freedom of employment and of movement, both of people and of capital, then the adjustment will be easier and faster and potentially without disorders. But with strict labor restrictions, such as apprenticeships and the Poor Laws, problems are more likely to emerge. For Smith, the abolition of apprenticeships and the Poor Laws should thus be a priority. Indeed, Smith’s acceptance of the limitations of economic freedom stop drastically at restrictions that do not benefit society but only some specific groups at the expense of others. His analysis of the labor market is telling. Mandatory apprenticeships is part of these condemnable restrictions. Smith also condemns the Poor Laws and enslaved labor. Mandatory apprenticeships are labor market regulations which are a violation of economic freedom, but are not ‘party walls’: they benefit a small group of people at the expense of the majority of the population, rather than benefiting the majority. They should be eliminated. Apprenticeships are ‘a manifest encroachment of just liberty’. Each man’s ‘most sacred and inviolable’ property is his labor. Property of labor is the foundation of all property. Limiting people’s employment is therefore a ‘plain violation of the most sacred property’. Economic freedom is here necessary both for promoting efficiency but also for assuring justice.
78 Handbook of research on economic freedom Mandatory apprenticeship is indeed an attempt to reduce competition by regulating the number of apprentices (usually one or two) and the number of years they have to serve (usually seven). They are officially justified as necessary training to guarantee high quality products. But the employer is the best judge of the quality of the work done, because his interest is at stake. Furthermore, for Smith, apprenticeships teach idleness, not industriousness, since there is no reward for working. Industriousness would be better taught if the trainee would be paid by the piece and had to pay for spoiled materials. For Smith, apprenticeships are thus ‘altogether unnecessary’ but, without them, the masters would have to pay wages for seven years, so the masters favor them. Without them, the apprentices would also eventually lose out since their work is easy to learn, and without barriers to entry they would have to face more competition and lower wages when the training is over, so the trainees also favor them. Without them, everybody else would be better off, because they could have cheaper goods, so Smith condemns them. For Smith, the real sources of quality and discipline in a profession are the consumers: competition is the greatest discipline and quality controller. It is not by accident that, despite favoring all the ‘party walls’ in the banking system, Smith adamantly favors competition among banks of issue as the strongest source of financial stability. Just like it is not by accident that for Smith good transportation counts among the greatest improvements in society. Good transportation introduces rival commodities in old markets and it also opens new markets. Monopolies, which would be de facto present if transportation is limited, would more easily break down. And monopolies are for Smith the greatest enemy of good management: only competition forces management to be good ‘for the sake of self-defence’, meaning that if they want to survive in a competitive environment, they will have to manage their resources well; they have to be disciplined and offer quality products, or their competitors will force them to go out of business. Furthermore, good transportation allows for the markets to extend. The division of labor is limited by the extent of the market. This means that good transportation allows for greater division of labor and thus greater productivity and greater economic growth. Freedom of movement of labor is thus part of those economic freedoms that Smith sees as fundamental for a healthy economy. Limitations of movement of labor not just across professions but also across locations are not ‘party walls’ but laws that are deleterious to society. The Poor Laws satisfy the self-interest of the few at the expense of the most vulnerable of society. They ought to be condemned and are indeed condemned, in Smith’s analysis. The Poor Laws are laws to discourage or prevent the free circulation of the poor. In England before the 16th century, the charity of monasteries would support the poor. When monasteries were forced to close, the poor had no support. Parishes now had to provide for their poor. The incentives for each parish were to send their poor away and not to receive any. The Poor Laws emerged in the attempt to regulate the parishes’ relief of the poor. But, in practice, they made it impossible for a poor person to move: ‘it is more difficult for a poor man to cross to the next parish than to change country’, Smith declares. The consequences include that labor cannot move from the parishes where it is abundant to the parishes where it is scarcer. Smith’s judgment is lapidary: ‘it is an evident violation of natural liberty and justice’. It is a ‘cruel oppression’. And like apprenticeship and the Poor Laws, enslaved labor is also morally and economically anathema for Smith. All workers, free or enslaved, respond to incentives, like everybody else. ‘It is better to play for nothing than to work for nothing’ says the proverb, according to Smith.
Adam Smith and economic freedom 79 So when workers are paid a fixed minimum amount, regardless of performance, they will work the minimum necessary, be they artisans or college professors. When their pay is linked to performance, on the other hand, they can work so much as to make themselves exhausted and sick. Enslaved workers have no rights to acquire property, being themselves property. For Smith, enslaved labor is therefore the most expensive kind of labor in existence because enslaved workers, unable to acquire property, will ‘eat as much as they can and work as little as possible’. If they work a bit more than mere subsistence it is because that labor is ‘squeezed out of [them] by violence only’ (WN III.ii.9). The North American Quakers freed their slaves only because they were few and the cultivation of corn did not generate enough revenue to support that expense. Only sugar and tobacco can afford slaves because of their extreme profits. As shown above, for Smith a person’s ‘most sacred and inviolable’ property is his labor (WN I.x.c.12). Property of labor is the foundation of all property. Limiting their employment is therefore a ‘plain violation of the most sacred property’. Enslaving labor is thus the strongest of these violations. In this case, Smith condemns the violation of economic freedom (and the ‘plain violation of the most sacred property’) on a different ground than the accusations he made against apprenticeship and the Poor Laws. Economic freedom here is unjustly violated because of the ‘love to domineer’ some people think it is humiliating to have to persuade those whom they consider inferiors (WN III.ii.10; see also Peart and Levy 2005 and Easterly 2021). The love of domineering generates enslaved labor, and enslaved labor is not, by definition, free labor. And Smith strongly condemns it. The limitations of economic freedom in the labor market, which are driven by self-interest proper, be it the greediness for higher profits or wages, the unwillingness to help who is in need, or the love of domination, are thus far from being justifiable ‘party walls’. They curtail productivity as they decrease the incentive to work, let alone to innovate. What allows for economic improvement? For Smith, the economic success of a country lays exclusively in ‘the security of laws, that each man can enjoy the fruits of his labor’. Smith, who is usually very cautious and qualifies his statements, here drops all hesitations: [The security of laws] is alone sufficient to make any country flourish, notwithstanding … other absurd regulations of commerce …. The natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security, is so powerful a principle that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions with which the folly of human laws too often incumbers its operations; though the effects of these obstructions is always more or less either to encroach upon its freedom, or to diminish its security. (WN IV.v.b.43)
This is most likely one of the reasons why Smith is often perceived as a champion of economic freedom. But it is an economic freedom that is far from Laissez Faire, let alone ‘anarcho-capitalism’. It is an economic freedom guaranteed by the security of the law. It is an economic freedom guaranteed by the security of the laws that treat all people equally and do not benefit some at the expense of others. It is an economic freedom that goes hand in hand with ‘order and good government’. It is never a perfect freedom, but it is a freedom that allows the human desire to better one’s condition to overcome natural and artificial obstacles. Europe, with a series of lucky accidents, managed to create enough space for this freedom to emerge. The British North American colonies too were blessed with the freedom and security
80 Handbook of research on economic freedom of the British constitution, according to Smith. Both experienced a sustainable and healthy growth. In Europe, the barbaric invasions caused people to flee the countryside in search of security. Land was consolidated in the hands of a few. The lords rivaled the king in power. Farmers, oppressed with servitude, if they had a little capital, hid it and then ran away from the lords into towns. Towns would give them protection. The king granted privileges to towns to weaken the power of the lords. And in this way, both people and capital ran into cities, ‘the only sanctuary in which it could be secured to the person who acquitted it’. Free-burghs emerged and secured themselves some or complete independence. Their subsistence came from trade. This trade created and was supported by expanding islands of freedom and that ‘order and good government’ ignited a virtuous spiral of growth. The ancient policies of Europe were instead preventing economic freedom and were unfavorable to improvement: they prohibited the exportation of corn, restrained inland commerce, and gave privileges to fairs and markets, thus limiting competition. Smith’s analysis of the origins and consequences of the prohibition of the exportation of corn is telling of the problems of restrictions to economic freedom that are not ‘party walls’, restrictions that benefit only a few at the expense of the many. Wars and bad weather caused scarcity of corn and its high prices. If the government ordered selling corn at a ‘reasonable price’, either too little corn came to market, causing famine; or too much corn came to market, selling out soon, also causing famine. Thus, government policies of price control were the source of famine. Yet, people believed that it is the avarice of corn merchants that causes famine. So corn merchants became the object of hatred and indignation. They could even be in danger of ruin, having their magazine plundered or destroyed by violence. The ancient policies of Europe encouraged this hatred toward corn merchants, believing it would be cheaper to buy corn from farmers directly rather than through corn dealers, and called for the elimination of the middlemen. Now farmers were forced to be corn merchants. But as corn merchants, they could not sell any cheaper than any other corn merchants. In addition, they now needed to use their capital in different ways. Forcing farmers to be corn merchants is a violation of natural liberty and thus unjust, Smith tells us. Not surprisingly, it is also inefficient. For Smith, the law ought always to trust people with the care of their interest because with their local knowledge they generally are better judges of it than the legislator. Smith also explains that when scarcity is real, it is better to spread the inconvenience over time. It is in the interest of the merchant to do so, and to do so as smoothly as possible. Nobody has the same interest, the same knowledge, and the same ability as the corn merchant. This is why corn trade ought to be left free. Yet the Corn Laws were present despite their negative consequences on society. Why? For Smith, the corn exporters and importers were the ones behind this deleterious limitation of competition and freedom of trade. Corn producers were too many and too dispersed to effectively collude. Domestic corn merchants face all sort of unjustified attacks to have any political grip. Importing and exporting corn merchants are the ones that benefit from corn trade regulations. They are few in number, concentrated in town, so they can collude easily, conspiring against the public on how to increase their prices. And indeed the ‘clamor and sophistry’ of merchants are such as to be able to persuade the majority of people that they need to pay higher prices for their products. They manage to persuade people that ‘the private interest of a part of society is the general interest of the whole’.
Adam Smith and economic freedom 81 For Smith, colonial traders used the same ‘clamor and sophistry’ to convince the public that the colonial markets should be monopolized. And in particular, that the North American colonies should not be competitors in manufacturing production. But to prohibit them from making all they can from their own produce or from using their capital the way they think most advantageous is a manifest violation of the most sacred right of mankind, Smith again tells us. The interest of the colonies is sacrificed to the interest of the merchants. And yet, despite this monopoly, Great Britain was not as illiberal with colonies as other empires. With the exception of foreign trade, the colonies managed their own affairs, handled their own assembly of representatives, which kept the executive power in check. Colonists felt secure. As long as one obeyed the law, one had nothing to fear from the resentment of the government or of the civil and military officer. In addition to this security, colonists could easily acquire land because in the colonies there was no primogeniture. Smith identifies the law of primogeniture in Europe as a major reason for slow growth. Estates are too large. It is difficult to know how to improve them. Not enough land can go on the market, leading to monopoly prices. Buying land thus is the most unprofitable use of small capital. It is done because of the security that the land gives once one retires. In the North American colonies on the other hand, there was freedom in the land market. And colonials could easily purchase it, enjoying the feeling of being ‘master, and independent of all the world’. The British North American colonies thus enjoyed an unprecedented economic growth which is witnessed by their rate of population growth: their population seems to have doubled every 25 years. In Europe, the population doubled every 500 years instead (Levy 1978). But in Smith’s account, Britain is the only country that gives so much security to its colonies. Spain, Portugal, and France have a more absolute government. There may be more freedom in the capital city because the sovereign keeps the inferior officers in check. But in the colonies, away from the sovereign’s sight, the inferior officers can become tyrants. It may thus not be an accident that it is only for Britain that the colony trade overcomes the damages its monopoly causes. Britain has comparatively more freedom of trade and, most importantly, it has an equal and impartial administration of justice, where the rights of the meanest subject are as respected as the rights of the greatest. This allows every person to safely have the fruits of their labor, which is the greatest and most effective way to increase and improve industry. Things are different in Spain and Portugal. Their irregular and partial administration of justice protects the rich and powerful debtors from the injured creditors, decreasing, if not eliminating, the incentives to produce. There, the damages of monopoly are more than the benefits of trade. Yet again, economic freedom for Smith needs to be combined with equality before the law and security of these laws. Given the economic freedom and the security of the laws the British North American colonies have, according to Smith, they will soon become the most prosperous country in the world. Within a century or so, Smith predicts, they will surpass Britain in wealth and productivity. It is in Britain’s interest to let them go and become their best trading partner, or to incorporate them in the Union, rather than trying to keep them as colonies. The colonies will not accept it, will fight the best of the possible motherlands, and will win their independence (WN IV.vii.c). For Smith, the British Empire is after all just a dream of Empire. It is an Empire not of shopkeepers but an Empire created and governed by shopkeepers (WN IV.vii.c.63). It is created to offer captured consumers for those domestic producers and traders who have enough power
82 Handbook of research on economic freedom to influence the parliament, to the point of even intimidating the legislature. Their system, the mercantile system, is a perverse apparatus of limitations of economic freedom that are driven by successful special interest groups who have captured state power to their own benefits at the expense of society. So, for example, Smith tells us that a bounty is a subsidy given when trade would not happen without it. The perversity of the logic is that a subsidized trade is an unprofitable trade. It would not take place without subsidies: if it were a profitable trade, it would not need subsidies. The reasons used to justify subsidies are the very reasons for which they should not be given. Similarly, monopolies are perversely useless, if the goods are done more cheaply at home, or hurtful, if it costs more to make them than to buy them. Take the cattle trade, for example. If trade in cattle was free, so few would be imported anyway, because the transport of live cattle is so expensive, especially by sea, that it would make little difference. Cattle is indeed possibly the only good that is more expensive to transport by sea than by land. Even the freest importation of salted meats would make little difference because it is also bulky and expensive to transport, and the quality of the salted meat is so much less than fresh meat that it is not a real competitor. So we would not see much change in the prices of butchers’ meat. Some may claim that protections are useful because they may help some industries to develop faster than otherwise. But protections cannot increase the industry of society. The industry of society can increase only as capital increases; and capital increases only as saving increases. The immediate effect is actually a decrease in revenue. Take the wine market, for example. Given the gloomy weather of Scotland, Scotland is not among the best producers of wines. The wine industry does not grow that fast there. It does not grow at all, actually. But protecting wine production in Scotland to develop that industry faster would be ludicrous. And yet monopolies abound. That is because merchants and manufacturers of finer manufactures are the greatest special interest behind them, in Smith’s account. Lower transport costs make it easier to export finer manufactures than cattle. Indeed, if there were free imports of manufactures, some home producers would suffer a lot. Some may even go to ruin. Which simply means that their capital is now inefficiently used and will eventually find different and more productive employment. Cartelized merchants and manufacturers are thus perversely and dangerously clever in fooling those who believe that limits of economic freedom are beneficial to the country. This is not a wonderful system with which the ‘man of system’ is enamored. These limitations of economic freedom are far from being ‘party walls’. They are the opposite. They are limitations that are hurtful for society. Merchants and manufacturers who are able to successfully cartelize and affect the legislature pervert what commerce is and ought to be. Smith believes that commerce is and ought to be ‘a bond of union and friendship’ among nations. The wealth of one’s neighbor may be dangerous in war but it is beneficial in trade. A rich man, after all, is a better customer than a poor one. Amsterdam is a perfect example that open ports enrich cities and towns, they do not ruin them. But the ‘passionate confidence of interested falsehood’ of merchants is such that they make every nation look with envy upon the prosperity of other countries. The manufactures of rich nations are claimed to be dangerous rivals, even if this competition is beneficial to the majority of the people. They make the neighbors become necessarily enemies, and their wealth and power inflame violence and ‘discord and animosity’.
Adam Smith and economic freedom 83 Smith believes there are things that have remedies and things that do not. The universal violence and injustice of rulers has no remedy. The ‘mean rapacity’ and the monopolizing spirit of merchants also has no remedy. But it can be and it ought to be prevented from disturbing the tranquility of society. Merchants are not and ought not to be the rulers of mankind. The state should try to avoid being captured by them. In this case, economic freedom should thus prevail. Adam Smith thus does not embrace Laissez Faire, but he is also very wary of state interventions driven by special interest groups. While suggesting that economic freedom may bring benefits to society, he also suggests that some government interventions, when genuinely motivated to prevent harm to most, should be welcomed. His positions do not seem dogmatic. Future avenues of research may explore if and how his positions relate to consequentialist arguments made by later economists or how they differ from natural rights defenses of economic freedom.
REFERENCES Alcouffe, A. and Massot-Bordenave, P. (2020). Adam Smith in Toulouse and Occitania: The Unknown Years. Cham: Palgrave Macmillan. Astigarraga, J. and Zabalza, J. (eds.) (2022). Adam Smith and the Wealth of Nations in Spain: A History of Reception, Dissemination and Application, 1777–1840. Abingdon: Routledge. Berkowitz, B.D. (2018). Playfair: The True Story of the British Secret Agent Who Changed How We See the World. Fairfax, VA: George Mason University Press. Easterly, W. (2021). Progress by consent: Adam Smith as development economist. Review of Austrian Economics 34(2): 179–201. Goodspeed, T.B. (2016). Legislating Instability: Adam Smith, Free Banking, and the Financial Crisis of 1772. Cambridge, MA: Harvard University Press. Kennedy, G. (2009). Adam Smith and the invisible hand: From metaphor to myth. Econ Journal Watch 6(2): 239–263. Leloup, S. (2000). Pour en finir avec l’usure: L’enjeu de la controverse entre Adam Smith et Jeremy Bentham. [Smith and Bentham on usury laws: The terms of the debate.] Revue Economique 51(4): 913–936. Levy, D.M. (1978). Some normative aspects of the Malthusian controversy. History of Political Economy 10(2): 271–285. Levy, D.M. (1995). A partial spectator in The Wealth of Nations: A robust Utilitarianism. European Journal of the History of Economic Thought 2(2): 299–326. Liu, G.M. (2022). Adam Smith’s America. Princeton, NJ: Princeton University Press. Montes, L. (2003). Das Adam Smith problem: Its origins, the stages of the current debate, and one implication for our understanding of sympathy. Journal of the History of Economic Thought 25(1): 63–90. Paganelli, M.P. (2003). In medio stat virtus: An alternative view of usury in Adam Smith’s Thinking. History of Political Economy 35(1): 21–48. Paganelli, M.P. (2008). The Adam Smith problem in reverse: Self-interest in The Wealth of Nations and The Theory of Moral Sentiments. History of Political Economy 40(2): 365–382. Paganelli, M.P. (2023). Adam Smith and the morality of political economy: A public choice reading. In: Interpreting Adam Smith: Critical Essays (ed. P. Sagar), 111–123. Cambridge: Cambridge University Press. Peart, S. and Levy, D.M. (2005). The ‘Vanity of the Philosopher’: From Equality to Hierarchy in Post-Classical Economics. Ann Arbor, MI: University of Michigan Press. Sargent, T.J. and Velde, F.R. (2003). The Big Problem of Small Change. Princeton, NJ: Princeton University Press. Smith, A. (1981 [1776]). An Inquiry into the Nature and Causes of the Wealth of Nations. Indianapolis, IN: Liberty Classics.
84 Handbook of research on economic freedom Smith, A. (1982 [1759]). The Theory of Moral Sentiments. Indianapolis, IN: Liberty Classics. Stigler, G.J. (1971). Smith’s travels on the ship of state. History of Political Economy 3(2): 265–277. Viner, J. (1927). Adam Smith and laissez faire. Journal of Political Economy 35(2): 198–232.
7. Economic freedom in the Freiburg and Austrian schools Gerhard Wegner
INTRODUCTION The Freiburg school and the Austrian school have placed the role of economic freedom for the prosperity of a society at the heart of their economic analysis. They have, on the one hand, renewed the classical liberalism of Adam Smith and his analysis of the system of natural liberty and, on the other hand, broadened and deepened the understanding of the meaning of economic freedom. Both schools, and in this they differ from standard economics, have brought economic freedom back into economic theory as a category of analysis and furnished new justifications for its economy-wide significance. In this respect, the study of economic freedom in these strands of thought goes beyond a history of economic thought. The great interest that the Freiburg school and the Austrian school attached to economic freedom is due to a historical background: both schools faced economic policies in their countries that pursued policy goals in manifold interventionist and freedom-restricting ways. The Freiburg school criticized the economic policy of the Weimar Republic, the Austrian school the interventionism in post-WWI Austria. Both schools, in turn, were confronted with fundamental alternatives of economic order that were debated or in practice after the First World War, among them the Bolshevik planned economy of the Soviet model, variants of democratic socialism, a corporative model of order, or even Italian and later German fascism. These various anti-liberal models of order played a similar role for the Freiburg and Austrian schools as the counter-model of mercantilism had played for Adam Smith. The Freiburg school – here synonymous with Ordoliberalism – emerged as a distinctly German tradition of liberal thought that developed in critical discourse with the historical school after the Great War. The major representatives were Alexander Rüstow, Wilhelm Röpke, Hans Großmann-Doerth, Franz Böhm, Leonhard Miksch and, above all, Walter Eucken. A compilation of their most important contributions can be found in Goldschmidt and Wohlgemuth (2008a). The Freiburg school develops the concept of an institutional framework (a makeshift translation for Ordnungsrahmen) for the market economy, in which market participants trade by free agreement. Hence, the institutional protection of economic freedom plays a central role. In contrast to Ordoliberalism, the Austrian school emerged decades earlier and renewed economic theory in various ways. Of great significance is Carl Menger’s theory of marginal utility and Böhm-Bawerk’s theory of interest and capital (Böhm-Bawerk 1956 [1883]; Menger 1976 [1871]). The preoccupation with economic freedom, however, occurred only after the First World War. Here again, Mises and especially Hayek play a central role. Therefore, we will only deal with this later branch of the Austrian school, which has devoted itself in detail to the analysis of freedom. The theoretical background and, in particular, the genealogy of the two schools of liberalism differ significantly. They originate from contrasting strands of economic thinking, that is, from 85
86 Handbook of research on economic freedom the historical school on the one hand and from Carl Menger’s marginal utility school on the other; in the legendary methodological dispute (Methodenstreit), the opposing views on the role of deductive theorizing and inductive epistemology based on thorough historical research clashed (Menger 1985 [1883]). Although Ordoliberalism had distanced itself from the historical school and turned to modern economic market theory, it retained in its thinking the historical, sociological dimension of the historical school. The Austrian school, in turn, originated with Menger as pure theory, but since Hayek and Mises it has broadened its perspective to include sociological and historical aspects (Boettke and Storr 2002). Despite a different theoretical heritage, both schools arrive at very similar insights regarding the role of freedom and the proper relationship between the state and the economy. Both schools consider the state indispensable for a market economy and reject anarchism as an alternative.1 However, they intend a distinct separation between the state and the economic sphere. In this way, they argue for liberal economic policy and demand that government activity be based on liberal principles. Even democratically elected parliaments should be bound by rules when choosing their policy goals and instruments. Both schools take the position that the state should not only grant economic freedom but also protect it. Consequently, they cannot be content with deriving economic policy recommendations. Rather, they must reflect on the institutional arrangements by which a political order can effectively guarantee economic freedom. In both schools, these considerations are aimed at the democratic constitutional state. This state owns the ‘monopoly of legitimate coercive power’ (Weber 1972 [1922], pp. 39–30), which is, however, limited in its scope and extension by the rule of law; the latter goes beyond a purely formal sense and means what German jurisprudence calls the ‘substantive rule of law’ (Sommermann 2012, pp. 97–108). Undemocratic alternatives to the political order that restrict political freedom or civil society are out of the question for both schools, even though critics of neoliberalism occasionally make this reproach. However, the two schools differ in assessing economic power. Ordoliberalism focuses on this issue, which is why this topic requires special consideration, in particular since economic power is interpreted as a challenge to economic freedom. In addition, later contributions following the Ordoliberal tradition considered the choice of national civil codes as part of economic freedom. These issues acquired practical relevance for strategies of European economic integration in the EU. In the following, we first explain what is meant by economic freedom. We introduce this term without reference to the schools; nevertheless, it is essentially based on them. Subsequently, we discuss the modes of justification for economic freedom for Ordoliberalism and the Austrian school separately. In the final subsection we delineate how both schools have been converging in the German debate and contribute to policy issues.
THE CONCEPT OF FREEDOM By freedom we are generally referring to general freedom under a legal norm. Beneficiaries of economic freedom are all natural persons or corporate bodies that are free to choose their economic objectives.
1
The anarchist branch of Austrian theory deviates from this; see below.
Economic freedom in the Freiburg and Austrian schools 87 The concept of freedom used here is closely related to Kant’s philosophy of law that he developed in critical discussion with Rousseau (Kant 1965 [1785], pp. 71–74). Citizens are free to choose their economic actions, for instance, how to use their property, as long as they do not violate the rights of others. This corresponds roughly to the legal norm of all civil codes that protect economic freedom. The concept of freedom protects economic subjects from unlawful interference by other subjects or state authorities, but does not establish a subjective right to a material endowment in order to exercise these rights in practice (Berlin 1969, pp. 122–124). Importantly, the use of economic freedom must not infringe the rights of third parties. A negative impact on others, which may take the form of ‘creative destruction’, must therefore be distinguished from the violation of rights (Schumpeter 2003 [1943], pp. 81–86). Economic freedom as a legal principle thus corresponds to the duty to tolerate undesirable effects of the exercise of freedom by other market participants. Therefore, the provision of economic freedom always requires the determination of the limits of private autonomy. By subsuming these limits under a principle of law, however, they remain beyond the power of arbitrary or spontaneous determination by state authorities. Economic freedom as a universal right is not conditional on any quid pro quo on the part of economic agents, e.g., support for the government or the ruling party (the latter is often the case in authoritarian political systems that grant entrepreneurial freedom only conditionally and as a privilege). If the government violates the law, the right to economic freedom can be sued for if necessary. Such a lawsuit can succeed only if the courts apply the law independently of the government. It follows that the separation of powers, especially the independence of the judiciary, is a necessary condition for economic freedom. Both Ordoliberalism and the Austrian school envisaged such a political order to ensure economic freedom. Economic freedom refers to all conceivable activities of economic life. These include (a) the acquisition of movable and immovable property (private property), (b) the free use and disposal of acquired property, (c) the conclusion of contracts with other persons or organizations (freedom of contract), (d) the choice of occupation and the offering of work for remuneration (freedom of occupation, free disposal of labor), (e) the taking up of an entrepreneurial activity for the production and sale of goods and services (freedom of trade), (f) the free choice of the location of economic activity (freedom of establishment), (g) the contractual association with other persons for the establishment of an association or an enterprise (freedom of association). To these fundamental freedoms others may be added, such as the right to claim ownership of the result of a creative activity. In principle, these economic freedoms require protection by a legal system, which is itself national law. It is in line with the liberal tradition to allow part of these fundamental freedoms to apply across borders as well. The aspects of economic freedom referred to are negative in nature, as they only protect against illegal interference by the state or by other persons. Some state interference or reservations of permission for economic freedom remain possible. Such restrictions, however, must always be oriented towards the protection of general freedom, i.e., the freedom which finds its limits in the freedom of fellow citizens. Since the holder of these rights is only prohibited from infringing the rights of others, everything else remains permitted, including the creative search for new opportunities for their use. Rights are by their nature purely formal and leave open whether the individual is materially or subjectively able to make use of them. For instance, despite freedom of occupation, individuals may not be able to find an occupation that meets their aspiration, as social and material restrictions can be decisive for the actual exercise of rights.
88 Handbook of research on economic freedom Economic freedom serves its bearers (i.e., all members of society with legal capacity) to achieve economic advantage through individual efforts. However, market participants may also seek profits by preventing others (competitors or customers) from taking advantage of preferable offers. Suppliers with market power can exploit a monopoly position in order to retain customers or to enter into cartel agreements. It remains to be examined whether this constitutes an abuse of economic freedom to the detriment of others. If necessary, a restriction on economic freedom is called for in order to reinstate universal freedom. The Freiburg school undertakes many efforts to address the abuse of economic freedom. The theoretical challenge is to define such abuse in a way that avoids arbitrary assessment of market outcomes and remains compatible with the concept of universal freedom.
ECONOMIC FREEDOM IN THE FREIBURG SCHOOL Of the representatives of Ordoliberalism, Walter Eucken, Franz Böhm and Hans Grossmann-Doerth taught at the University of Freiburg; the latter two were legal scholars, while Walter Eucken and Wilhelm Röpke (who taught in Geneva) were economists. A hallmark of the Freiburg school is the combination of economics and jurisprudence. This combination contributed significantly to the practical importance of the Freiburg school after the Second World War in West Germany. The lasting impact also extends to the economic policy of the European Union (Brunnermeier et al. 2016, pp. 61–67). Ordoliberalism overlaps with the concept of the ‘Social Market Economy’, with which it is often equated. However, the latter is more oriented towards policymaking, which must also deal with issues such as income policy or business cycle policy. Alfred Müller-Armack, the founder of the ‘Social Market Economy’, attempts to build a bridge between Ordoliberalism and the practical problems faced by policymakers (Müller-Armack 1976). This makes the ‘Social Market Economy’ more eclectic (Goldschmidt and Wohlgemuth 2008b). The first and probably most important practitioner of the ‘Social Market Economy’, Economics Minister Ludwig Erhard, advocated and promoted this conception. In practice, however, he tended to adhere to Ordoliberalism and Eucken’s agenda. Walter Eucken develops the theoretical foundation of the Freiburg school in the Grundsätze der Wirtschaftspolitik (published posthumously in 1952), which represents the most important document of the Freiburg school (Eucken 2004 [1952]). The Grundlagen der Nationalökonomie, first published during the National Socialist era, can be understood as a theoretical preliminary study to the Grundsätze (Eucken 2021 [1947]). Grossman-Doerth was involved in the practical implementation of the market economy in 1948, which involved price liberalization and abandonment of the wartime economy. In continuation of classical liberalism, the Freiburg school develops a theory of the market economy and its institutional prerequisites. It discusses the planned economy as a counter-model of the market economy in detail, whereby it included experiences with the war economy under National Socialism. The Freiburg school, however, is not content with emphasizing the advantages of prices over quantity management in a planned economy. Its concern is the elaboration of a coherent framework for practical economic policy. This includes the identification of essential goals and maxims of economic policy as well as the description of the necessary legal framework. In this way, the Freiburg School combines theoretical insights of economics with practical requirements of institutional implementation.
Economic freedom in the Freiburg and Austrian schools 89 A novel theoretical concept introduced by the Freiburg school is the term ‘economic constitution’ (Wirtschaftsverfassung). Rather than using this term neutrally as a description of the comprehensive set of institutions under which all economic activities take place, the Freiburg school refers to the ‘economic constitution’ as the set of specific institutions that are required to ensure the conditions for economic growth and prosperity. Ordoliberalism thereby refers to the conception of classical liberalism. According to a statement by Franz Böhm, who coined the term ‘economic constitution’, the theoretical agenda entails translating Adam Smith’s theory into the language of law (Böhm 1964 [1933], p. ix). This normative task ultimately turns out to be a matter of positive theory as well, since it is amenable to theoretical and empirical verification and validation. Aligning the legal framework with the notion of a well-functioning economic order is at the heart of Ordoliberal thought. The economic constitution, thus, has the task to anchor economic freedom institutionally. The rationale for this not only lays in economic motives. Against the background of major social disruptions in the first half of the twentieth century, Ordoliberalism always viewed itself as a social philosophy that sought to design a humane social order. Eucken explicitly refers to Kant and regards the free economic order as an imperative of practical reason (Eucken 2004 [1952], pp. 176–179). According to Kant, moral action presupposes inalienable freedom; and Eucken follows Kant that indivisible freedom includes the economy in order to bring forth what Kant calls ‘civic state’ (bürgerlicher Zustand). Eucken also rejects benevolent paternalism, which Kant once called the ‘greatest despotism conceivable’, on moral grounds alone (Kant 1992 [1793], p. 22). For the Freiburg school, then, freedom always represents both a moral intrinsic value and a means of increasing economic prosperity.2 This nexus between Immanuel Kant and Adam Smith has a certain tradition in German political economy and is renewed by the Freiburg school (Deecke 2015). Ordoliberalism places a special emphasis on living conditions of workers (‘Soziale Frage’), which attests to the still continuing influence of the German historical school. Workers’ freedom should not be exhausted in the freedom to conclude labor contracts. In organizations, ‘personal claims to rule workers’ and ‘social pressure’ create dependencies that are incompatible with a liberal order (Eucken 2004 [1952], pp. 320–324). However, Eucken rejects collectivization of the means of production as a solution, since such a state monopoly would only exacerbate workers’ dependence. Instead, he recommends a formal governance structure to transform personal hierarchical dependencies into legal relations. Eucken is also open to workplace co-determination, while he strictly rejects supra-firm co-determination by union councils (Eucken 2004 [1952], p. 320). Local demand monopolies of firms in the labor market can reinforce personal dependencies and constrain the freedom of employees (Eucken 2004 [1952], p. 187). If competition cannot disempower dominant market positions, the personal rule of employers over employees intensifies. Even though Eucken welcomes countervailing power through unions in principle, he points to the possible restriction of freedom through collective bargaining agreements. This ambivalence also characterizes Eucken’s position on social policy, to which he is basically sympathetic. In particular, Eucken supports worker protection legislation. However, he also draws attention to the restriction of freedom when the employee becomes completely dependent on a state bureaucracy (Eucken 2004 [1952], pp. 187–188). 2 Ordoliberals took a more critical stance towards Smith’s evolutionary understanding of morality, which is why they saw Christian values as indispensable; see Horn (2019).
90 Handbook of research on economic freedom In his Grundsätze der Wirtschaftspolitik, Eucken outlines the guidelines of a liberal competitive order, thereby distinguishing constituent and regulatory principles. In the first place, he mentions the primacy of monetary policy with the goal of a stable currency as a prerequisite for any rational economic calculation. Eucken refers to the period since the beginning of the First World War, which was characterized by continuous inflation, culminating in hyperinflation in 1923. Since prices generally do not rise proportionally, hyperinflation distorts rational economic calculation (Eucken 2004 [1952], p. 256). When no currency existed at all after the Second World War, the barter economy and the use of money substitutes (cigarettes) plunged large segments of the population into existential hardship. On the question of the institutional implementation of a stable currency, however, Eucken remains rather vague. He does not mention institutional considerations of central bank independence, but only states that the central bank should be committed only to the goal of a stable currency. Unlike Röpke, who prefers the gold standard, Eucken considers a commodity reserve currency without committing himself on this issue (Röpke 1959 [1945], pp. 16–17; Eucken 2004 [1952], pp. 262–264). Eucken continues with further constituent principles. Economic policy should guarantee open markets. In foreign economic policy, free trade is desirable; if tariffs are introduced, they should be moderate. Eucken rejects quantitative import restrictions because they eliminate prices as an indicator of scarcity. In the domestic economy, open markets require a limited use of patents, since they enable monopolies beyond the necessary extent. In general, private economic power is to be limited. As further constituting principles, Eucken refers to private property, freedom of contract, the principle of private liability, and – which is a special feature of the Freiburg school – the principle of constancy in economic policy. Eucken justifies these principles with the primacy of competition in the allocation of scarce resources. He refrains from referring to a formal economic model. The decisive factor is always the idea of general freedom as a prerequisite for competition. In this sense, Eucken defines private property as power of disposal with simultaneous ‘powerlessness to restrict the power of disposal and freedom of other owners to the detriment of the collective’ (Eucken 2004 [1952], p. 274). In justifying property, freedom of contract and liability, Eucken repeatedly refers to the dysfunctionality of the planned economy, which prevents the adjustment of economic plans to changing data. Eucken also rejects state ownership of the means of production in specific economic sectors. Since the state is responsible for the competitive order by controlling cartels and monopolies, it must retain its autonomy. As the arbiter of the competitive order, it must not become an actor having its own economic interests. Eucken lists the principle of private liability in his Grundsätze as a matter of course that does not require further explanation. In particular, Röpke describes the combination of private property and liability as a channel through which both individuals and firms acquire competencies to deal with the uncertainty of markets through ownership (Röpke 1979, pp. 297–336). Hayek agrees with this view when he devotes an entire chapter in his Constitution of Liberty in which he strongly defends the connection between freedom and responsibility (Hayek 1960, pp. 71–84). The principle of ‘constancy in economic policy’ is a distinctive feature of the Freiburg school. It saw the short-temperedness and volatility of economic policy in the Weimar Republic as a major cause of the ongoing economic crisis (whereby a close commitment to the immanent rules of democratic politics was seen as being responsible). According to Eucken (2004 [1952], p. 288), ‘[t]he nervous restlessness of economic policy, which today often discards what was valid yesterday, creates great uncertainty and – together with distorted price
Economic freedom in the Freiburg and Austrian schools 91 relations – prevents many investments. The atmosphere of trust is lacking’. He thereby views short-lived, experimental economic policies – including monetary, trade and tax policies – as one reason why amortization periods for private investment had shortened dramatically as compared with the period before the First World War.3 Above all, the constantly shifting trade policies among the Western industrialized nations had done serious damage to world trade. According to Röpke, moderate long-term trade restrictions only in the form of tariffs are the lesser evil as long as these trade policies are stable and predictable (Röpke 1959 [1945], pp. 155–163). According to the Freiburg school, stability and predictability of economic policy have an intrinsic value and can compensate to some extent for the loss of other components of economic freedom. Characteristically, the Freiburg school takes an empirical, experience-based approach to identifying economic principles. Experience with economic policy relates primarily to German economic history since 1800 and includes the economic policy of the Weimar Republic, the National Socialist wartime economy, and finally the economic policy of the occupying powers after 1945. Whereas the Weimar Republic was already characterized by manifold interventions, exchange controls, state intervention in wage policy or tolerated cartels and monopoly formation, under National Socialism economic freedom was almost completely sacrificed to a coercive planned economy. In many respects, the anti-liberal economic policy was maintained by the Western occupying powers until the currency reform of 1948, which led to severe underprovision and malnutrition of the population, as Eucken reports (Caldwell and Klausinger 2022, pp. 666–667). The Freiburg school derives its model of order essentially from a comparison of these four economic epochs. It rejects from the outset the unfree economic order under National Socialism and the wartime economy as well as the early post-war order. Instead, Ordoliberals – as liberals in Europe as a whole – oriented themselves in many respects to the comparatively successful economic order before the First World War, which was characterized by low government spending and moderate free trade among the major trading nations. From these ‘natural experiments’, the Freiburg school derives its conception of a viable liberal economic constitution that provides the framework for practical economic policy. For Eucken, these principles enjoy constitutional status for economic policy. They are supplemented by ‘regulating principles’, which stabilize the order and correct its temporary results. They include competition policy, which we will discuss in a moment, as well as income policy and regulatory intervention in the narrower sense. In the case of income policy, Eucken generally favors a moderate, progressive income tax, but draws attention to the incentive problem associated with extensive progressiveness of tax rates. The source of the general increase in prosperity is and remains the rise in productivity in the economy, which in turn is driven by competition. In Ordoliberal thinking, competition is of paramount importance. Regulations in the narrower sense are justified to prevent negative externalities or to pursue high objectives of protection, such as health protection. In this context, Eucken does not share the view that the absence of any regulation yields the highest freedom. Drawing on the experience of the Weimar Republic, the Freiburg school concluded that the control of economic power was the imperative of the times. Not only does the power of the state have to be limited, but also private economic power in the form of cartels or monopolies. 3 For an analysis of the change of the economic order in Germany after the Great War, see Wegner (2020).
92 Handbook of research on economic freedom Competition is in itself an instrument for disempowering economic power when innovators put competitive pressure on incumbents. However, suppliers with market power can escape this control. In particular, Franz Böhm, a legal scholar and specialist of commercial law, systematically addresses the problem of private economic power, providing the theoretical basis for competition policy in post-war antitrust law in West Germany (Böhm 1960 [1928]). Franz Böhm completed his habilitation thesis in Freiburg under Walter Eucken’s supervision. Since Böhm most thoroughly penetrated the problem of economic power and Eucken relied substantially on him, a sketchy description of Franz Böhm’s position is in order. For Böhm, economically dominant market positions such as monopolies are unproblematic as long as they are based on competitive advantages. Power positions become an issue when competitors or the demand side are prevented from entering into exchange with each other through deliberate measures. ‘This ability, as an inferior supplier, to prevent or penalize the partner from accepting better offers is the essence of economic power’ (Böhm 1960 [1928], p. 32). In the exercise of economic power at the expense of third parties, the Freiburg school sees a loss of general economic freedom. According to Franz Böhm, the legitimacy for state action to curtail economic power arises from the following: the introduction of general freedom in economic relations (abolition of guilds, abolition of regalia and privileges, and simultaneous introduction of freedom of trade) resulted from state legislation.4 However, this legal introduction of economic freedom had the purpose of establishing an ‘anarchic economic order’ in the sense of Adam Smith (unlike Marx, Böhm uses this term in an affirmative sense). The legislator only empowered market participants to regulate their own economic relations, not to change the economic order at their own discretion. When market participants with market power abolish the ‘anarchic’ economic order, they are acting outside their authority. This gives the state the right to restore a competitive order and to restrict market power through legislation. Eucken puts it succinctly: ‘Freedom of contract may not be granted for the purpose of concluding contracts that restrict or eliminate freedom of contract’ (Eucken 2004 [1952], p. 278). Competition policy, however, is to be limited to restoring general economic freedom. It should not be directed at the design of market outcomes or market structures. On this issue, the Freiburg school positioned itself clearly against representatives of the Harvard school of antitrust (Hoppmann 1975 [1967]). Moreover, competition policy should not pursue or be combined with industrial policy objectives, but should adopt a rule-based approach. Since the Freiburg school consisted not only of economists but also of legal scholars, the principle of per se rules also found its way into the jurisprudence and influenced German as well as European antitrust legislation. In 1957, the German Bundestag passed the Act against Restraints of Competition, which was significantly promoted by the Ordoliberal Minister Ludwig Erhard. From an Ordoliberal perspective, the extent of economic freedom in any economy would also have to be assessed from the viewpoint of effective competition policy.
Böhm refers primarily to the German economic history of capitalism, when economic freedom was successively enacted from 1808 to the 1860s through the state abolition of monopolies and exchange constraints. 4
Economic freedom in the Freiburg and Austrian schools 93
ECONOMIC FREEDOM IN THE AUSTRIAN SCHOOL The Austrian school did not systematically analyze freedom in economics before the First World War. For Carl Menger, Friedrich von Wieser or Eugen von Böhm-Bawerk, economic freedom was sufficiently in place, so that a closer analysis proved unnecessary. Just as for the Freiburg school, the historical background played a decisive role for the new subject of economic freedom among the economists of the Austrian school. The Austrian economy also fell into a serious crisis after the First World War, which was characterized by production slumps and high inflation. Moreover, the dissolution of the Habsburg Empire was accompanied by a fragmentation of the trade region, which was decisively exacerbated by the protectionist trade policies of the successor states of the Habsburg Empire. Austrian economic policy reacted to this crisis mainly with interventionist measures, overriding the market mechanism in many areas (e.g., the housing market). As in Germany – and everywhere in the Western world – liberalism was losing influence in science and politics in Austria. Capitalism itself was perceived as the cause of the economic crisis, leading academic circles to recommend socialism or hybrids between socialism and capitalism as a solution. This prompted Ludwig von Mises to write a comprehensive critique of the economic and social model of socialism (Mises 1932). By revealing the serious effects of socialism and interventionism on the coping with economic scarcity, Mises builds a case for economic freedom ex negativo (Mises 2011 [1929], 1932). Mises’s student Friedrich August von Hayek took up this critique of socialism and opposed political concepts that sought to overcome capitalism (Caldwell and Klausinger 2022, pp. 143–146). In several decades of research, Hayek renewed classical liberalism and analyzed the role of freedom in the evolution of societies. He spread his ideas in the Anglo-Saxon world where the Austrian school found its new home. For twentieth-century liberalism, the significance of Hayek’s analysis can hardly be overestimated. It also provides the theoretical background for current approaches in empirical research to measure economic freedom within countries. Therefore, Hayek’s analysis deserves a closer look. Hayek initially opposes a specific conceptualization of economic freedom. In contrast to later representatives of the Austrian school such as Israel Kirzner, who is primarily interested in the entrepreneur as an actor in the competitive order, Hayek does not limit the concept of freedom to a specific economic sphere of activity (Hayek 1960, p. 35; Kirzner 1973). He understands freedom fundamentally as indivisible freedom of action, which can always have an economic aspect, even if this is not of central importance for the actor. Hayek leaves open which economic role the market actor plays, be it as consumer, investor, entrepreneur or employee. Referring to classical liberalism, Hayek interprets freedom as the absence of coercion (Hayek 1960, pp. 11–21; Berlin 1969, pp. 121–122), irrespective of whether individuals make use of their freedom or are subjectively capable of doing so. By the same token, the negative concept of freedom avoids a connotation with prosperity (Hayek 1960, p. 18). In the Constitution of Liberty, Hayek does not yet explicitly refer to Kant – this occurs in Law, Legislation and Liberty – but he nevertheless understands freedom as general freedom under the law. A legal order is thus the prerequisite for general freedom. Selectively granted freedoms do not count as freedom for him, but are merely privileges that can be revoked. For empirical measures of economic freedom in autocratic regimes, this means that even temporarily high levels of certain economic freedoms cannot be considered universal freedom because of their
94 Handbook of research on economic freedom dependence on political discretion. This likely holds for all countries that lack the separation of powers and independent courts. A distinctive feature of Hayek’s analysis is the connection between freedom and progress in a society based on the division of labor. This goes hand in hand with the division of knowledge and thus assumes a lack of general knowledge about what prosperity is and how it can be achieved (Hayek 1937).5 Wealth creation therefore can only occur through a competitive process of discovery. The outcome of this trial-and-error process is unknown in advance. In his defense of freedom, Hayek draws directly on the tradition of Adam Smith’s classical liberalism, according to which an individual’s use of freedom is productive for others, i.e., generates a positive externality (the opposite idea is found in Hobbes, who views an individual’s use of freedom as a potential threat to others). The increase in the standard of living occurs through innovations that are tried out by individuals and offered in markets. A reference to Schumpeter’s theory of innovation is highly suggestive, but missing in Hayek’s elaboration. Hayek thus justifies freedom in light of its collective benefit: What is important is not what freedom I personally would like to exercise but what freedom some person may need in order to do things beneficial to society. This freedom we can assure to the unknown person only by giving it to all. (Hayek 1960, p. 32)
Unlike the Freiburg school, there is no moral justification of freedom as a prerequisite for the use of practical reason. Nevertheless, Hayek, as Mill, understands freedom as a medium of social civilization in the sense of a ‘further development’ of humanity without a known telos. Hayek emphasizes the openness of this evolutionary process, which he describes as an ‘advance into the unknown’. The negativity of economic rights corresponds to the innovativeness of the spontaneous order and plays an instrumental role. Since the result turns out to be a novel solution, it defies an end-state benchmark. One of his most famous statements is: ‘Freedom granted only when it is known beforehand that its effects will be beneficial is not freedom’ (Hayek 1960, p. 31). He acknowledges that freedom can be abused, such as for the production of ‘foolish things’. Nevertheless, he assigns a beneficial effect to general freedom: ‘Our faith in freedom does not rest on the foreseeable results in particular circumstances but on the belief that it will, on balance, release more forces for the good than for the bad’ (Hayek 1960, p. 31, emphasis added). This Hayekian defense of universal freedom suggests the objection that a petitio principii might exist (Wegner 2012, p. 134): how can the benefit of freedom be asserted in advance if the outcome of the use of freedom is by definition unknown? If one were to characterize the outcome of competition as desirable because it results from the use of freedom, this would be tantamount to an is-ought fallacy or evolutionary market positivism, whose shorthand would be: because freedom does exist, it should exist. Hayek counters this justifiable objection by identifying universal freedom not only as a medium for experimentation with new ‘useful things’. Rather, it also becomes an institutional condition for rejecting inferior offers or patterns of allocation. A single innovator faces competition from others, and all together may fail if the demand side does not follow suit. Continuing Hayek’s argument, Streit describes competition as a control agency, which in turn presupposes freedom of choice on the demand side (Streit 1991, pp. 38–42). In this way, competition itself becomes an endogenous measure
5
See also the contributions in Hayek (1948).
Economic freedom in the Freiburg and Austrian schools 95 of prosperity. Whether this is consistent with some external measure of human well-being remains an open question and may even be unlikely. General freedom as a precondition for competition can only ensure that the endogenous standard of comparison itself becomes subject to self-correction and revision. General freedom does not guarantee a perfect economic order, but only the review of its results. It is this process which makes an order based on freedom appealing. By applying this evolutionary understanding of welfare, the Austrian school distances itself from neoclassical welfare economics and even from the neoclassical understanding of the allocation of scarce resources to given ends as the epitome of economics (Robbins 1945 (1935]). There is no external observer or ‘ideal socialist planner’ to determine an optimal end state of the economy. The process of experimentation in competition becomes preferable to any end state: ‘Which goods are scarce, however, or which things are goods, or how scarce or valuable they are, is precisely one of the conditions that competition should discover’ (Hayek 2002, p. 13). In his approach, freedom becomes an economic resource. The link between general freedom and progress reflects Mill’s rationale for general freedom: Further development of society is only possible through freedom, while temporary inferior solutions are also rejected through freedom of choice (Mill 2001 [1859], pp. 18–52; Mill 2006 [1870], pp. 794–796). This is what makes classical liberalism so emphatic. While Mill sees experimentation with the new, including new ideas, as endangered by the human tendency to conformism, Hayek’s optimism about progress, less so than that of Mises, is tempered by ambivalent experiences with industrialization. Urbanization, urban sprawl, structural crises (e.g., in the rural economy) also represent problems of modernity for Hayek. In The Constitution of Liberty, Hayek does not question the necessity of an economic policy beyond the minimal state. He does, however, criticize the tendency of democratic economic policy to overestimate its ability to design the future. Instead, he discusses possibilities of an adaptive economic policy that supports the structural change of the spontaneous order, preferring indirect interventions to political ‘constructivism’: If the quickest way to a now visible solution becomes the only permissible one and all alternative experimentation is precluded, and if what now seems the best method of satisfying a need is made the sole starting point for all future development, we may perhaps reach our present goal sooner, but we shall probably at the same time prevent the emergence of more effective alternative solutions. (Hayek 1960, p. 260)
This approach to economic policy does not rule out state intervention, but it emphasizes liberal skepticism about state monopolies. From this perspective, Hayek discusses the institutions of the modern welfare state, which had replaced earlier visions of socialism. He discusses a variety of areas of economic policy, including agricultural policy, housing policy, social security institutions, and the progressive tax rate. Only rarely does he reject these policies outright. One exception is distributive justice, which aims at a just distribution of income in society. Since the distribution of income results primarily from the use of freedom, any attempt to ‘fine-tune’ just earnings must violate general freedom (Hayek 1998 [1976], pp. 62–100). In other respects, he points to potential disincentives for, for example, private saving, investment, and risk-taking that are often ignored as side effects. He discusses alternatives that leave more options to the target groups by avoiding a state monopoly. In doing so, he combines his abstract theoretical argumentation with political issues to illustrate that liberal alternatives to
96 Handbook of research on economic freedom the bureaucracy of the welfare state exist and are capable of opening up innovation competition and capital investment. These are the essential elements of Hayek’s conception of freedom. Despite skepticism about the possible abuse of state power, Hayek acknowledges the necessity of the ‘state’s monopoly of legitimate coercive power’ (Weber) to guarantee freedom, and he also accepts the necessity of economic policy. Hayek is an evolutionary economist, not an anarchist. The branch of the Austrian school that is particularly critical of the state, as represented by Murray Rothbard and Hans-Hermann Hoppe, leaves the Hayekian framework (Rothbard 1962; Hoppe 1987). Nevertheless, Austrian economists who follow Hayek continue to argue about the scope and extent of liberal economic policy.
THE CONVERGENCE OF THE FREIBURG AND AUSTRIAN SCHOOLS The Freiburg school and the Austrian school arrive at similar economic policy conclusions from different theoretical approaches (Kolev 2015). Both schools see the increase in productivity through competition as the essential cause of prosperity; general freedom is referred to as an institutional prerequisite. The elaboration of competition policy as a framework condition is what makes the Freiburg school special. The later representatives of the Freiburg school oppose the instrumentalization of competition policy for industrial policy; they invoke a rule-based approach to safeguard general freedom. In Germany, the two schools have increasingly merged since the 1970s. In particular, Hayek’s evolutionary understanding of the market has found great resonance among the followers of the Freiburg school. Eucken’s theoretical alignment with the general equilibrium theory was thus abandoned. Since both schools understand freedom as indivisible, the question of a systematic relationship between economic and political order also arises. In this context, Eucken takes issue with Schumpeter’s view that a coercive economy can exist in an order that protects personal and cultural freedom (Eucken 2004 [1952], pp. 127–133). He considers this impossible against the background of the experience with Bolshevism. The idea that one can compensate for the freedom-threatening effect of central planning of the economic process by expanding free orders in the political, legal, and cultural spheres is thus a fundamental error. Centrally controlled orders of the economy and free orders of the state, of law, of education must come into conflict with each other. (Eucken 2004 [1952], p. 133)
In other words, it is no accident that politically free societies do not sustain a coercive economy. Hayek shares this view. This argument also excludes, in principle, the combination of competitive economic order and autocracy. Eucken writes: ‘The guiding principles in the economy should harmonize from the outset with the principles of other orders – e.g., the state’ (Eucken 2004 [1952], p. 133). As a prerequisite for a free economic order, Eucken mentions not only the rule of law, but also ‘cultural freedom’ and ‘freedom in education’. It is difficult to conceive how an autocracy can guarantee this cultural diversity in the long run. With Hayek, the situation is more complex in that some political commentaries, e.g., on the Chilean military dictatorship, gave the impression of a positive evaluation of autocracy in the event of the implementation of the rule of law (Caldwell and Montes 2015). Separating
Economic freedom in the Freiburg and Austrian schools 97 theoretical considerations from everyday political commentaries, his remarks from the seventh chapter of The Constitution of Liberty are relevant. Although, there, Hayek also dissociates the rule of law from democracy, his further discussion ends with a connection between the two. ‘It is always valid … that democracy is an important safeguard of individual liberty’ (Hayek 1960, pp. 107–108). Likewise, he states that ‘there is widespread consensus that … the case for democracy and the case for freedom of speech and discussion are inseparable’ (Hayek 1960, p. 109). Overall, Hayek’s understanding of democracy is deeply influenced by nineteenth-century liberalism, which understood democracy primarily as a competition of ideas and opinions and as a process of selection of the best. In the mass democracy of the twentieth century, Hayek sees at least a potential threat to freedom. He believes, however, that ‘democracy is not yet freedom ... but democracy is more likely to create freedom than other forms of government’ (Hayek 1960, p. 108). Generally, in a democracy, personal freedom needs a constitutional anchor.6 The reflections on European integration are another result of the alliance between the Freiburg school and the Austrian school. Hayek had already addressed this issue before the war and discussed how the restriction of competition by national legislators in the form of subsidies and regulations could be curbed (Hayek 1948, pp. 255–272). Expanding on the idea of competition as a process of discovery, German economists following Hayek’s ideas propose a freedom-enhancing form of European integration (Streit and Mussler 1994; Streit and Kiwit 2001). In line with liberal skepticism of the state, they develop a concept that prevents the concentration of power in the form of a supranational legislative monopoly. In addition to the basic economic freedom guaranteed by the EU as subjective rights (free movement of goods, persons, services and capital), they demand further individual freedom to freely choose commercial and corporate law for cross-border transactions or investments. Thus, market participants would not be bound by the commercial law of their own national legislator, but could establish companies in their country according to the law of another European member state. Legislation would remain the sole responsibility of the state, but the state would no longer act as a monopolist vis-à-vis market participants. In this way, legal systems could compete with each other, which would tend to discourage groups from capturing the legislature for the benefit of their own. These ideas are not just theory, but find partial support in European treaties and also in the European Court of Justice. This is just one recent example of how the ‘Freiburg–Austrian school’ is looking for solutions to counter the concentration of state power through rules that promote freedom. Both the Freiburg and Austrian schools arguably provide the most thorough analysis of the role of freedom in economics that is available to date. The combination of philosophical considerations rooted in the Kantian and Scottish schools of the Enlightenment and evolutionary thinking coupled with economic expertise is unique. It still provides a multi-faceted intellectual resource for exploring the implications of economic freedom on societal progress.
6 The democratic legitimacy problem of Hayek’s policy recommendations and possible solutions are analyzed in Wegner (2009).
98 Handbook of research on economic freedom
REFERENCES Berlin, I. (1969). Two concepts of liberty. In: Four Essays on Liberty (ed. I. Berlin), 118–172. Oxford: Oxford University Press. Boettke, P.J. and Storr, V.H. (2002). Society and economy in Weber, Mises and Hayek. American Journal of Economics and Sociology 61(1): 161–191. Böhm, F. (1964 [1933]). Wettbewerb und Monopolkampf: Eine Untersuchung zur Frage des wirtschaftlichen Kampfrechts und zur Frage der rechtlichen Struktur der geltenden Wirtschaftsordnung. Berlin: Carl Heymann. Böhm, F. (1960 [1928]). Das Problem der privaten Macht. In: Reden und Schriften über die Ordnung einer freien Gesellschaft, einer freien Wirtschaft und über die Wiedergutmachung (ed. E.-J. Mestmäcker), 25–45. Karlsruhe: C.F. Müller. Böhm-Bawerk, E. (1956 [1883]). Capital and Interest. A Critical History of Economic Theory. South Holland, IL: Libertarian Press. Brunnermeier, M., James, H. and Landau, J.-P. (2016). The Euro and the Battle of Ideas. Princeton, NJ: Princeton University Press. Caldwell, B. and Klausinger, H.-J. (2022). Hayek: A Life: 1899–1950. Chicago: University of Chicago Press. Caldwell, B. and Montes, L. (2015). Friedrich Hayek and his visits to Chile. Review of Austrian Economics 28(3): 261–309. Deecke, K. (2015). ‘Staatswirtschaft vom Himmel herabgeholt’: Konzeptionen liberaler Wirtschaftspolitik in Universität und Verwaltung 1785–1845. Frankfurt am Main: Klostermann. Eucken, W. (2004 [1952]). Grundsätze der Wirtschaftspolitik, Tübingen: Mohr. Eucken, W. (2021 [1947]). Die Grundlagen der Nationalökonomie, Nordersted: BoD. Goldschmidt, N. and Wohlgemuth, M. (2008a). Grundtexte zur Freiburger Tradition der Ordnungsökonomik. Tübingen: Mohr. Goldschmidt, N. and Wohlgemuth, M. (2008b). Social market economy: Origins, meanings and interpretations. Constitutional Political Economy 19(3): 261–276. Hayek, F. A. (1937). Economics and knowledge. Economica 4(13): 33–54. Hayek, F.A. (1948). Individualism and Economic Order. Chicago: University of Chicago Press. Hayek, F.A. (1960). The Constitution of Liberty. Chicago: University of Chicago Press. Hayek, F.A. (1998 [1973, 1976, 1979]). Law, Legislation and Liberty: A New Statement of the Liberal Principles of Justice and Political Economy. London: Routledge. Hayek, F.A. (2002). Competition as a discovery procedure. Quarterly Journal of Austrian Economics 5(3): 9–23. Hoppe, H.-H. (1987). Eigentum, Anarchie und Staat. Studien zur Theorie des Kapitalismus. Opladen: Westdeutscher Verlag. Hoppmann, E. (1975 [1967]). Wettbewerb als Norm der Wettbewerbspolitik. In: Wettbewerbstheorie (ed. K. Herdzina), 230–243. Köln: Kiepenheuer und Witsch. Horn, K. (2019). The difficult relationship between historical Ordoliberalism and Adam Smith. Freiburger Diskussionspapiere zur Ordnungsökonomik No. 19/03, University of Freiburg. Kant, I. (1965 [1785]). Grundlegung zur Metaphysik der Sitten. Hamburg: Meiner. Kant, I. (1992 [1793]). Über den Gemeinspruch: Das mag in der Theorie richtig sein, taugt aber nicht für die Praxis. Hamburg: Meiner. Kirzner, I. (1973). Competition and Entrepreneurship. Chicago: University of Chicago Press. Kolev, S. (2015). Ordoliberalism and the Austrian school. In: The Oxford Handbook of Austrian Economics (eds. P.J. Boettke and C.J. Coyne), 419–444. Oxford: Oxford University Press. Menger, C. (1976 [1871]). Principles of Economics. New York: New York University Press. Menger, C. (1985 [1883]. Investigations into the Method of the Social Sciences with Special Reference to Economics. New York: New York University Press. Mill, J. S. (2001 [1859]). On Liberty. Ontario: Batoche Books. Mill, J.S. (2006 [1870]). Principles of Political Economy with Some of Their Applications to Social Philosophy. Indianapolis, IN: Liberty Fund. Mises, L. von (2011 [1929]). A Critique of Interventionism. Auburn, AL: Ludwig von Mises Institute. Mises, L. von (1932). Die Gemeinwirtschaft. Untersuchungen über den Sozialismus. Jena: Fischer.
Economic freedom in the Freiburg and Austrian schools 99 Müller-Armack, A. (1976). Wirtschaftsordnung und Wirtschaftspolitik. Studien und Konzepte zur Sozialen Marktwirtschaft und zur europäischen Integration. Bern: Haupt. Robbins, L. (1945 [1935]). An Essay on the Nature and Significance of Economic Science. London: MacMillan. Röpke, W. (1959 [1945]). International Order and Economic Integration. Dordrecht: Reidel. Röpke, W. (1979). Civitas Humana: Grundfragen der Gesellschafts- und Wirtschaftsreform. Bern und Stuttgart: Haupt. Rothbard, M. (1962). Man, Economy and State. New York: Van Nostrand Press. Schumpeter, J.A. (2003 [1943]). Capitalism, Socialism and Democracy. London: Routledge. Sommermann, K.-P. (2012). Art. 20 Abs. 3 GG und das Rechtsstaatsprinzip. In: Das Bonner Grundgesetz (eds. H. von Mangoldt, F. Klein and C. Starck), 97–108. München: Beck. Streit, M.E. (1991). Theorie der Wirtschaftspolitik. Düsseldorf: Werner. Streit, M.E. and Kiwit, D. (2001). Zur Theorie des Systemwettbewerbs. In: Jenaer Beiträge zur Institutionenökonomie und Wirtschaftspolitik (ed. M.E. Streit), 328–363. Baden-Baden: Nomos. Streit, M.E. and Mussler, W. (1994). The economic constitution of the European community: From Rome to Maastricht. Constitutional Political Economy 5(3): 319–353. Weber, M. (1972 [1922]). Wirtschaft und Gesellschaft. Grundriss der verstehenden Soziologie. Tübingen: Mohr. Wegner, G. (2009). Substantive versus procedural liberalism: Exploring a dilemma of contemporary economic liberalism. Journal of Institutional and Theoretical Economics 165(3): 535–557. Wegner, G. (2012). Ökonomischer Liberalismus als Politische Theorie: Befund, Kritik, Rekonstruktion. Tübingen: Mohr. Wegner, G. (2020). Reassessing the dependence of capitalism on democracy: The case of Imperial Germany and the Weimar Republic. Journal of Institutional Economics 16(3): 337–354.
PART IV DETERMINANTS OF ECONOMIC FREEDOM
8. Religion and economic freedom André Azevedo Alves and Inês Gregório
INTRODUCTION It is very difficult to think about human societies without religion. Despite the general trends towards secularization that we have been witnessing for the past century in several regions of the world, religion continues to be a central element for many people’s lives and continues to be ‘arguably one of the most important social phenomena’ (Berggren and Bjørnskov 2013, p. 161). As with other social and cultural factors, religion has the capacity to influence world affairs and, more precisely, to have an impact on development, in its political, economic, or social dimensions. When starting any theoretical discussion involving religion and economic affairs, it is inevitable to think about Max Weber and his classic The Protestant Ethic and the Spirit of Capitalism (Weber 2002 [1905]), where he argued in favour of a causal link between both factors, with religion offering a psychological and mental framework that enabled the prosperous emergence of free enterprise and modern capitalism. However, Guiso et al. (2002) remind us that, in 1844, Marx had already coined the expression ‘religion is the people’s opium’ to refer to the idea that religion is simply a reflection of human life created by men to distort reality and an instrument for the ruling classes to control the masses. Most recently, many contemporary authors have been concerned about the potential relationships between religion and economic development, economic growth, economic openness, amongst others. In this chapter, our main purpose is to discuss how the main religious doctrines and other associated philosophical and religious factors influence opinions and perceptions about the market economy and how they may affect economic freedom. We start by analysing five religious doctrines – Judaism, Christianity, Islam, Hinduism, and Buddhism – in order to understand how their teachings relate to the concepts and institutions of the market economy. We then address how practices emerging from these teachings can influence not only the working of the market economy, but also the perceptions people have about their role in the economy and the proper role of government. Moreover, we provide a brief overview of empirical studies relating religion to economic freedom, as well as an overview of the economic freedom scores of countries relating to their dominant religions. But before proceeding and aiming at clarifying not only our argument but also to limit it, it is worth understanding how the concept of economic freedom is going to be used: 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. (Berggren 2003, p. 194)
101
102 Handbook of research on economic freedom
THE MAIN RELIGIOUS DOCTRINES AND THE MARKET ECONOMY The concept of religion is very complex and not easily defined. We will follow a proposal made by Helble (2007) that uses the definition given by Encyclopedia Britannica, combining three fundamental ideas. Religion implies a relation between a person and God, gods, or spirits; its main element is worship, but it is also composed of other elements such as a proposal of moral conduct and an active participation in religious practices and institutions; and it can only exist within human interaction. So, ‘the believer has a personal relation to God or Gods, but at the same time he or she is not religious on his or her own, but in interaction with other adherents’ (Helble 2007, p. 387). Moreover, it is also important to clarify that this chapter considers the influence of religion in human societies as twofold: directly, in the adherence to established precepts (an example of this in the economic sphere would be religious teachings on usury); and indirectly, in the definition of moral aspects, cultural and social norms or other customs and traditions (such as, for example, fostering a culture in which respect for contractual arrangements is valued even if religious teachings may not in themselves contain specific stipulations of contractual compliance in the economic sphere). We believe it is this indirect influence of religion that justifies its importance as a social phenomenon even in those countries where most of the population considers itself ‘not religious’ and does not engage in any religious practice. Human societies do not exist in a vacuum, and social norms are always the product of the influence of many factors, including religious traditions, beliefs, practices, or behaviours. As an example of this indirect influence, Becker and Woessmann (2009) found that Protestant societies, for insisting on instruction for reading the Bible, ended up contributing importantly to the development of literacy and of human capital, two fundamental elements for economic prosperity. But what is so unique about religion that gives it this capacity of influencing every aspect of daily life and of driving social change? McCleary and Barro (2006) call it ‘salvific merit’ – the idea that the actions performed by an individual during her lifetime will determine her fate after death. So, because virtually all main religious doctrines incorporate some notion of salvation, this will motivate individuals to behave more decently to avoid punishment in the afterlife. In terms of economic efficiency, ‘beliefs in these compensators can raise productivity by fostering individual traits such as honesty, work ethic and thrift’ (McCleary and Barro 2006, p. 51).1 These motivators may come from the original written messages left by the different religious founders, the subsequent doctrine developed by theologians and religious authorities or from the application of those messages in religious daily practices. The existence of these two sources of influence, which are especially evident in the case of some religions, are important to bear in mind because: These religious teachings [which affect people’s attitudes towards the economic system] do not necessarily reflect the authentic message contained in the sacred texts. They simply represent the way certain religious beliefs became crystallized over time and the way they are taught and transmitted from one generation to the next. (Guiso et al. 2002, p. 230)
1 McCleary and Barro (2006) also mention that, in certain contexts, there is also the possibility of this idea of salvation fostering anti-social actions and leading to violence.
Religion and economic freedom 103 First, we will look at the sacred teachings provided by each of the main religious doctrines, and after that will we pay attention to the practical implications of these teachings. Judaism Judaism is one of the oldest religious doctrines in the world. Its origin can be traced back to 538 bce in the Middle East, and at its core is the Torah, the Hebrew Bible that contains the five first sacred texts that set out the Jewish law (Helble 2007). Irimie (2013) identifies the five main principles that laid the foundations for Jewish economic theory and that align with the present view of the market economy: ● First, the idea expressed in the Genesis creation narrative according to which man and woman were created in the image of God, being active collaborators in completing the process of creation (Genesis 1:26). ● Second, the notion contained in the book of Exodus that an expressed command of God requires the protection of private property and the prohibition of theft and of coveting another’s possessions (Exodus 2:15–17). ● Third, the principle referring to the accumulation of wealth as a sign of virtue and not of vice, because it allows men to dedicate more time to the religious study and to donate; ‘in this regard the founders of the Jewish were an eloquent example, Abraham, Isaac and Jacob were men of means, and Old Testament stories point out this fact’ (Irimie 2013, p. 73). ● Fourth, the obligation set out in Deuteronomy according to which the poor and the needy must be considered and offered help (Deuteronomy 15:10). ● Fifth, the recognition in the first book of Samuel that a centralized government must be avoided for bearing too many risks, including taking over the resources of the society and using them for the benefit of one individual or a very restricted group (1 Samuel 8:10–18). There are nevertheless some other elements that appear to clash with the contemporary concept of market economy. One of the most common examples is the problem of interest. For Jews, the prohibition of interest was a matter of social protection, because ‘when the poor borrowed due to a desperate situation, he should not be further burdened with an additional interest’ (Leviticus 25:35–37; cf. Irimie 2013, p. 78).2 Additionally, some authors further explore the assistance that is due to the needy and the poor to raise attention to the possibility of this being more than a recommendation of moral behaviour. According to Conway (2017, p. 245), ‘the welfare provision mandated in the Hebrew Bible should be regarded as required public provision rather than a commendatory private, voluntary charitable giving’. Judaism thus helps ‘market activities and patterns of consumption [to] operate within a God given morality’ (Tarami 1997, p. 45). And despite recognizing that these activities may result
2 With Jewish law being interpreted as applying to loans from Jews to other Jews, and Christians facing a generic prohibition on charging interest, this prohibition was eased and many Jews came to be employed in moneylending. This, in turn, often led to unpopularity of Jewish communities and to denunciations of the evils of ‘Jewish usury’. Wood (2002, p. 167) clarifies: ‘… [The Jews] were not subject to the jurisdiction of the Church. They were also not subject to qualms of conscience, for there seemed to be clear sanction for their activities in Deuteronomy 23.19–20, which forbade the Jews to lend at usury to their fellow Jews, but allowed that “unto a stranger thou mayest lend upon usury”. The “stranger” in this case was the Gentile’.
104 Handbook of research on economic freedom in less time to dedicate to religious acts or in exacerbated material desires, the Jewish framework for economic affairs is based on teachings that encourage trade, while simultaneously promoting an ethical behaviour in that context. Christianity With little more than 2,000 years, Christianity is the religious doctrine with the highest number of adherents in the world (Helble 2007). The scriptures that sustain the main Christian beliefs are gathered in the Bible that includes the Old Testament and the New Testament. A greater emphasis is put on the latter, especially on the Gospels that consist of an account of the life of Jesus by his closest apostles. Given that the Jewish Torah is part of the Old Testament, Christianity’s economic principles also emerge from the idea that God is the creator of the world, and that man was made in his image to actively participate in his creation. For this reason, through work man was allowed to acquire private property and to take advantage of material goods (2 Thessalonians 3:9–13). However, the moral risks of accumulating possessions are not forgotten and, to avoid neglecting spiritual life and falling for the sin of greed, these material goods are to be wisely used following two conditions: considering that ‘the first aim of both property and work and any economic activity consist in obtaining the means of subsistence … [and that] who has enough or too much has to care for the needs of the neighbour’ (Luke 3:10; cf. Wojciechowski 2014, p. 402). In what concerns economic activity, the Christian scriptures are also clear about the right to be paid for the work done (2 Timothy 2:6) and even admit differences in the income paid for different efforts employed in different tasks, if it is shared with those who are in need (2 Corinthians 8:13–15). Another example that may represent the importance given in the Christian belief to hard work and entrepreneurship is the Parable of the Talents in Matthew (25:14–30) or of the Pounds in Luke (19:11–27). According to the narrative, a prince once called his servants, gave them some money, asked them to use it to earn more money and then left on a journey. Upon his return, he called the servants again: the first two servants had doubled the money they had received, but the third servant had kept the money hidden and had not multiplied it. The prince was not satisfied with the third servant, took from him the money he had received and had him punished. Taking this prince to be God and the money to be the world he created for us, this parable may be interpreted as a sign to not waste the opportunities given by God and to take care of the gifts received, to invest our labour in them and to get good results. This parable also sheds light on interest, for the prince criticized the third servant for hiding the money, when he should have put it in the bank so that it could at least have generated interest (Matthew 25:27; Luke 19:23). So, the scriptures are not so assertive in forbidding the charging of an additional amount when money is lent, even though general advice is given about the importance of compassion when lending money to those in need, for this to be an act of charity instead of greed. To sum up, Biblical teachings here analysed: … condemn theft, greed, egoism but without a negation of the value of material goods. Multiplying them by means of property, work, and business has a good aim satisfying legitimate human needs. A person who works and honestly increases his or her wealth through business can be praised. Producing (creating) material goods is not less important than distributing them. (Wojciechowski 2014, p. 407)
Religion and economic freedom 105 These teachings have then been confirmed by Christian scholars throughout the centuries. One of the most influential accounts was given by St. Thomas Aquinas, whose work touched upon different aspects of economic theory. According to him, markets play a very important role in society and money should be seen as a legitimate means of exchange. So, trade and business were to be pursued freely if two conditions were respected: ‘that the exchange is voluntary and at a just price’ (Helble 2007, p. 391).3 When the Reformation started in the 15th and 16th centuries, the differences between the old Roman Catholic tradition and the new Protestant denominations began to emerge. From the Catholic side, the work of the late scholastics – particularly those of the School of Salamanca – combined the Thomistic framework with ‘a more elaborate understanding of the functioning of market economies and the role of prices with a greater practical scepticism about government intervention in general and price controls in particular’ (Alves and Gregório 2021, p. 221).4 From the Protestant side, the prominent reformist leader Martin Luther ‘raised the profile of work immensely and work became an intrinsically positive activity that was pleasing to God’ (Kahl 2005, p. 102) and that, together with a stronger division of labour and roles in society, encouraged a sense of entrepreneurship, with individuals creating businesses and investing money to foster those businesses. A few centuries before the Reformation, the Great Schism between West and East had already given origin to the Eastern Orthodox Christian Church. According to Makrides (2019, p. 25), the Orthodox Church is characterized by a mystical and otherworldly-orientation and its main basic features include: the lack of tension between church and state and the subjection of the former to the latter; a traditionalist work ethic, coupled with a religious legitimation aimed at safeguarding the existing status quo; sociopolitical centralism and limited structural differentiation; the overwhelming significance of the community or of the broader kin group; the lack of individual innovative endeavours; and the absence of major conflicts between religious, state and social actors.
Therefore, Orthodox monastics are recognized by their renunciation of all things that were not necessary for human life and by their practices of poverty and of alienation from material things (Taivans 2022). Nonetheless, there are also examples of Orthodox communities successfully engaging in trade and businesses, which are reflected in today’s ‘Orthodox mercantile diasporas involved in various commercial networks or family businesses’ (Makrides 2019, p. 30). This openness to market activities and to economic undertakings is also highlighted by Nikolas Gvosdev (2010), who recalls that the Sacred Bishops’ Council of the Russian Orthodox Church in 2000 adopted a document entitled ‘Bases of the Social Concept’, laying out the official position regarding economic issues in the following lines: workers should enjoy the fruits of their labour; workers should take care of those unable to earn their living; property is a gift of God and should be used for the benefit of people. The Eastern Orthodox Church thus recognizes the right to own property but also emphasizes the need for social responsibility, avoiding individualism and selfishness.5
3 For a more detailed analysis of the concept of just price from a Christian perspective, see also Alves and Gregório (2021). 4 See also Chafuen (2003), Elegido (2009) and Alves and Moreira (2013a,b). 5 Gvosdev (2010) also recalls an intervention of the Metropolitan Kirill in the European Council of Religious Leaders in Oslo where he stated that the Eastern Christian civilization is based on ‘indisputable priority of the spiritual over the material, of self-denial and self-restriction over the aspiration of earthly
106 Handbook of research on economic freedom Islam Islam is the youngest of the five religious doctrines considered in this chapter. Its central figure is the Prophet Mohammed, its main text is the Quran and its teachings have an impact on virtually all dimensions of life and are enacted in the Sharia, the ultimate legal authority for Islamic communities. Maybe because the Prophet Mohammed himself was a merchant, there are in the Quran ‘over 1,400 of 6,226 verses referring to economic issues’ (Helble 2007, p. 392). The Islamic doctrine incites Muslim people to work, to engage in trade and to obtain wealth and acquire property through labour and through legal profiting activities: Islam teaches that the gain which anyone may make in life depends on his work. nobody has a right to live on the labour of others without performing any useful work himself. Likewise, ownership is the fruit of labour, in which a man applies his labour to natural resources and they consequently become his property. (Malik 2016, p. 9)
As with other religious doctrines, however, wealth is to be acquired within certain moral limits and individuals should abstain from lying, wasting or being greedy (Al-Baqarah 2:188). Additionally, the needs of the poor are not to be forgotten and the payment of zakat, a form of tax, is seen as a way to ‘purify one’s soul from greed, selfishness and ego, as well leads to increase in material welfare in this world and prosperous life in the Hereafter’ (Malik 2016, p. 16). The topic of property is also extensively addressed in the Quran, based on the idea of God as the creator of the world and man as his ‘viceregent’, who received Earth as a temporary gift as a sign of God’s bounty (Al-Hajj 22:65). A particularity of the Quran is that these property rights are also considered for women (An-Nisa 4:7,32), ‘a concept in which most nation deprived their female population of at the time of revelation, in al-Qur’an, it is highly respected and is equally sacred as men’s in Islam’ (Malik 2016, p. 7). The main Islamic text also refers to the subject of interest, riba, leaving a serious warning: those who insist on charging interest will be punished on Judgment Day (Al-Baqarah 2:275). This punishment emerges from the concerns with the risk of greediness caused by excessive consumption and accumulation of wealth, which also justifies the stipulation that ‘money by itself should not create money’ (Sait and Lim 2006, p. 12). Notwithstanding the teachings of the Prophet Mohammed, many authors argue that there are important differences between the messages written in the Quran and the economic practices implemented by Islamic countries for the operation of a market economy.6 According to Facchini (2010, p. 118), ‘in the Muslim world there is no difference between religion and state’ – the impact of this unity combined with the positive and divine character of the Sharia law is a topic to which we will return later in this chapter.
success, of common interests over private ones, of the faithfulness to the truth and ideals over worldly benefits and earthly wellbeing’, in contrast to the Western world where ‘the structure of the society as a whole is arranged in a way to ensure the maximum possible realization of the individual rights and freedoms’. 6 An important element here is the waqf, an endowment generally used for charitable and religious purposes, which can be traced back to the Ottoman empire. Authors argue that the waqf system failed to evolve with time and to address modern concerns and ended up perpetuating institutional stagnation (Kuran 2004, pp. 71–72).
Religion and economic freedom 107 Hinduism Hinduism is a polytheistic religion that emerged during the first millennium bce in India, where it is still mostly based. Because it does not have a known founder nor a founding event, Hinduism is embedded with a ‘relentless self-transcendence’, comprising a mere ‘aspect of the awareness of eternity and consequent indifference to history’ (Saran 1963, p. 90). Deep-rooted in the spiritual traditions of India, Hinduism is considered a way of life that provides a code of conduct to be followed by all to assure the welfare of humanity. This code of conduct is dharma and includes five different elements: ahmisa, non-violence; satya, truthfulness; astheya, not acquiring unjust wealth; souchem, purity of mind and action; indreyanigraha, control of senses. Hence, the goal of every individual life is ‘to confirm dharma while acquiring wealth (artha) and enjoying desires (kama) and to reject wealth and desires which are contrary to dharma’ (Rao 1998, p. 233). Although in theory Hinduism leaves space for enjoyment and for accumulation of wealth, the real structure of the Hindu society poses many challenges to this pursuit of dharma.7 On the one hand, there is a strict hierarchical system of castes, to which belonging is seen as a result of actions performed in the previous life; on the other hand, it lacks an egalitarian character and women are considered a lower rebirth than men. Both these characteristics determine important conditions in life, such as the type of education received and the type of job one can have, therefore playing a significant role in ‘limiting people’s life-chances and opportunities for development, as well as the realization of equal human rights’ (Tomalin 2009, p. 23). These inherent characteristics of the Hindu society combined with a more ingrained denial of the passage of time and with the positions of some of its most charismatic leaders – Gandhi was strongly against industrialization and capitalism – pose a real challenge to the presence of a market economy within a Hindu context. Buddhism Buddhism was founded in India, around 525 bce, by Siddhartha Gautama. Being a very flexible system of beliefs, it is generally assumed that ‘Buddhism does not include explicit guidelines for economic behaviour …, [but] the social ethic of Buddha touches several times on economic issues’ (Helble 2007, p. 390). Buddha is said to have had a personal relation with the topic of economic affairs, for he himself had taught economic ethics and had reflected upon the importance of engaging in economic activity and creating wealth. In this regard, important moral considerations are to be considered, ‘one of which is the ideal of “right livelihood”, in the sense that one’s means of livelihood are honest and are not causing suffering for others’ (Brox and Williams-Oerberg 2017, p. 506).8 7 Tomalin stresses the difficulty in extracting Hindu views from religious texts because empirical or ethnographic research must be valued and considered. And ‘this gulf between the lived and the textual tradition reflects a distinction between so-called “village”, “popular” or “vernacular” Hinduism and “Brahmanical Hinduism”. Whereas the former relates to what most people actually do, the latter relates to a version of Hinduism that focuses upon the Sanskrit texts … and the beliefs and practices of the priestly Brahmin caste’ (Tomalin 2009, p. 6). 8 As an example, Buddhist monks ‘were allowed to keep money, sell donations given them to profit, lend out money, and collect interest as long as profits went to the Buddha, dharma, and sangha, even
108 Handbook of research on economic freedom Concerning its spiritual principles, Buddhism is established on ‘The Four Noble Truths’: suffering exists; suffering has causes; we can stop causes of suffering; the path of mindful living shows how to do this. And Schumacher (1973), a prominent author in the field of Buddhist economics, claims that when this framework is transferred into an economic context, a more simple and moderate life emerges: ‘instead of one-sidedly maximizing consumption and seeing gross national product as a proxy for happiness, we should minimize needs, strive for simplicity, and avoid violence’ (Lennerfors 2014, p. 72). Also, Buddhism places a great emphasis on the idea of interdependence: the human species is considered just another element of a great system and therefore is not supposed to dominate it, as it happens in other religion doctrines. In Buddhism, domination is replaced by sustainability.9 Hence, although some advantages of business and wealth are recognized, Buddhism still holds that ‘every increase in wants leads to a decrease in happiness and vice versa’ and that ‘development, which has physical and mental dimensions, does not start with goods rather people their education, organisation, and discipline’ (Uprety 1996, pp. 120–121). In fact, instead of promoting market economy as currently understood, Buddhist scholars believe this tradition has ‘a critical potential to become a real future for capitalism’ and should aim at ‘inspiring the creation of an economically and ecologically sustainable future’ (Lennerfors 2014, pp. 67–68). Summing up, this section has presented the main teachings about economics and economic activities that can be found in the sacred texts or in the wider doctrines by theologians and other religious authorities of the five religions examined. Evidently, this analysis does not fully account for all religious doctrines or religious traditions of the world; however, these were chosen considering they are the most influential in today’s world and the most representative of the world population. We will now turn to the practical implications of these teachings and to their impact in terms of social and economic organization.
IMPLICATIONS FOR ECONOMIC FREEDOM In this section, we explore the existence of a relationship between the religious doctrines examined above and the degree of economic freedom of selected countries, both overall and in three specific areas. It is important to note that this analysis can of course only suggest possible patterns of association rather than establish causality since many other relevant variables are related with economic freedom. But before that, and to contextualize and complement the argument made by us in this chapter, a brief and non-exhaustive review of selected important econometric studies that have looked at (some aspect of) religion and (some aspect of) economic freedom should be made: ● Berggren and Bjørnskov (2013) develop a cross-country regression analysis including 112 countries and find that religiosity is negatively related with property rights and the rule of though economic activities for personal profit continued to be proscribed’ (Brox and Williams-Oerberg 2017, p. 506). 9 ‘Life should be perceived as an inextricable web in which nothing can claim separate of static experience. Humans form an integral part of this system, but are not supposed to dominate nature (unlike the claims of Christianity). The resources should therefore be used according to the principles of sustainability and provision of all species’ (Helble 2007, p. 390).
Religion and economic freedom 109 law. Taking religiosity as ‘the share of people in a country for which religion is important in daily life’ (Berggren and Bjørnskov 2013, p. 161), the authors analyse how this dimension impacts the quality of formal institutions, namely property rights and the rule of law, and conclude that ‘the larger the share for which religion is an important part of daily life, the weaker the rule of law and the protection of property rights’ (Berggren and Bjørnskov 2013, pp. 172–173). Among other reasons, the authors suggest this might be explained by some inherent characteristics of virtually all religion traditions, which include their tendency to be anti-materialistic, to appeal to redistribution from richer to poorer groups in society, to believe justice will only be made in the afterlife and to prefer the order provided by the rules emerging from the sacred texts and defined by religious authorities, rather than by formal institutions. These results were found to hold only in democracies and not in autocratic regimes. ● Hillman and Potrafke (2018) investigate the impact of religion in economic freedom with a cross-sectional data set that includes 137 countries averaged over the period 2001–2010 and conclude that economic freedom is associated with Protestantism, is not associated with Islam, and with Catholicism is somewhere in between. The empirical estimates made by the authors show that ‘economic freedom is positively associated with Protestantism (r = .27) and negatively associated with Islam (r = –.21). For Catholicism, the correlation is close to 0 (r = –.06). Regarding the relation between religiosity and economic freedom, the results align with those of Berggren and Bjørnskov (2013) and indicate that ‘on average, where religiosity is high, economic freedom is low’ (Hillman and Potrafke 2018, p. 253). ● de Soysa (2019) focuses his analysis on the relation between Islam and free-market capitalism and finds a positive association between the two. Using the Economic Freedom Index by Fraser Institute, the author concludes that Muslim countries show positive correlations with all areas of the index, except for ‘legal security and property rights’, while Protestant countries base their positive correlation with economic freedom in the areas of legal security and property rights, negatively correlating with small government and freedom to trade. ● Abellán (2023) uses data from the World Values Survey (1995–2020) and the European Values Study (1999–2020) to understand differences in attitudes between Catholics, Protestants and Muslims towards work, the market economy and other socio-political ethic elements. Despite recognizing that these may be only partial correlations, the author finds that ‘Protestants have no higher pro-work or pro-market attitudes than Catholics or Muslims. On the contrary, Muslims attach more importance to work than Protestants’.
110 Handbook of research on economic freedom
Economic Freedom in Countries Based on their Main Religion We proceed by selecting the countries that represent each of the main religious doctrines for the purpose of this analysis. As such, we take the G20 forum and the 20 countries with the highest GDP per capita in the world10 and try to identify the religious doctrine that played a more determinant role in the origin and evolution of each country. Table 8.1 reflects our proposal. Table 8.1
Countries identified with religions
Religious doctrine
Countries
Judaism
Israel
Christianity – Catholicism Christianity – Protestantism
Argentina, Austria, Brazil, Belgium, France, Italy, Mexico, and Ireland Denmark, Finland, Iceland, Norway, Sweden, New Zealand, United Kingdom, and United States
Christianity – Orthodox
Greece, Russia
Islam
Indonesia, Qatar, Saudi Arabia, Turkey
Hinduism
India, Nepal
Buddhism
China, Hong Kong, Japan, Singapore, South Korea
Christianity – mixed
Australia, Canada, Germany, Netherlands, South Africa, and Switzerland
Additionally, we created a ‘Christianity – mixed’ category to include those countries in which there is a clear Christian influence but where the predominant denomination is not so perceptible. Also, to avoid having only one country representing one religion, we considered two extra countries for the cases of Orthodox Christianity and Hinduism where the influence of the respective religious doctrine is undeniable, despite not matching the chosen criteria. For the case of Judaism, considering the high concentration of adherents in the same country, we decided not to add any other country. For this set of countries, we present, in Table 8.2, their economic freedom scores using data from the Economic Freedom of the World index by the Fraser Institute for 2020 (Gwartney et al. 2022), as well as their scores for three areas of economic freedom: legal system and property rights, government size and regulation. Scores can range from 0 to 10.11 By analysing the table, it is possible to identify several patterns: ● On average, Protestant countries rank the highest in terms of overall score of economic freedom, as well as in the areas of legal system and property rights and of regulation. Countries with other Christian traditions – Catholic or mixed – also rank relatively well in
For the 20 countries with the highest GDP per capita in the world, and for representativity, we considered only those with a population higher than 5 million inhabitants. 11 The index measures economic freedom in five areas: (1) size of government; (2) legal system and property rights; (3) sound money; (4) freedom to trade internationally; and (5) regulation. A larger size of government and more regulation lower the score (for more details, see Gwartney et al. 2022). This chapter looks only at areas 1, 2 and 5, as we expect them to have the greatest impact on economic freedom. Nonetheless, the overall score in Table 8.2 refers to the average of the five areas. 10
Religion and economic freedom 111 Table 8.2
Level of economic freedom by country based on their main religion
Country
Overall
Legal system
score
and property
Government size
Regulation
rights Judaism
Israel
7.35
6.12
6.26
7.14
Christianity
AVERAGE
6.98
6.50
5.85
6.86
– Catholicism
Argentina
4.87
4.80
6.48
5.49
Austria
7.56
8.39
4.93
7.20
Brazil
6.33
5.16
6.61
4.46
Belgium
7.37
7.52
4.32
7.75
France
7.33
7.19
4.92
7.2
Ireland
7.86
7.74
6.17
8.14
Italy
7.40
6.51
5.3
7.66
Mexico
7.12
4.72
8.08
7.00
Christianity
AVERAGE
7.82
8.30
5.48
7.85
– Protestantism
Denmark
8.09
8.66
5.24
8.43
Finland
7.64
8.70
4.71
7.72
Iceland
7.73
8.51
5.74
7.08
Norway
7.58
8.57
4.72
7.65
Sweden
7.56
7.93
4.43
7.67
New Zealand
8.27
8.72
6.29
8.57
United Kingdom
7.71
7.75
5.93
7.58
United States
7.97
7.56
6.79
8.11
AVERAGE
6.72
5.56
5.28
6.33
Greece
6.81
5.98
4.85
6.01
Russia
6.62
5.13
5.7
6.65
AVERAGE
6.84
5.50
6.27
6.69
Indonesia
7.09
4.90
7.91
6.46
Qatar
6.99
5.43
5.94
7.43
Saudi Arabia
6.78
6.81
4.71
6.99
Turkey
6.48
4.84
6.52
5.88
AVERAGE
6.63
5.32
7.76
6.92
India
6.72
5.57
7.52
6.49
Nepal
6.54
5.07
8.00
7.34
AVERAGE
7.72
7.05
6.48
7.85
China
6.27
5.12
4.97
6.24
Hong Kong
8.59
7.50
8.24
8.84
Japan
7.82
7.71
5.65
8.12
Singapore
8.48
8.29
7.18
8.72
South Korea
7.42
6.65
6.34
7.32
AVERAGE
7.70
7.86
5.99
7.76
Australia
8.04
8.34
6.09
8.27
Canada
7.81
8.02
5.82
7.96
Germany
7.65
7.75
5.64
7.66
The Netherlands
7.75
8.35
4.86
7.78
South Africa
6.55
5.95
5.99
6.78
Switzerland
8.37
8.74
7.52
8.10
Christianity – Orthodox
Islam
Hinduism
Buddhism
Christianity – mixed
112 Handbook of research on economic freedom
● ●
● ● ●
●
terms of economic freedom, with average overall scores ranging between 7 and 8 points. Countries with a Christian-Orthodox tradition are an exception, where overall scores of economic freedom do not reach 7 points on average. When comparing Catholic and Protestant countries, Protestantism is associated with relatively higher overall scores of economic freedom, while Catholicism is associated with relatively lower overall scores, particularly in Latin America. When considered individually, the highest overall scores of economic freedom can be found in two countries with a Buddhist tradition, Hong Kong and Singapore, with scores above 8 points. However, this finding should be interpreted with care considering these are very specific polities where arguably other factors may be regarded as playing a more critical role than religion in the degree of economic freedom. The lowest overall scores of economic freedom can be found in countries with a Christian-Orthodox and Hindu traditions. Within Islam, Indonesia and Qatar perform better in terms of economic freedom than the other countries analysed. In terms of legal system and property rights, countries with an Islamic and Hindu tradition tend to have lower scores in this area when compared with the other two areas of the index, while countries with a Christian tradition tend to have the highest scores in these areas when compared with the other two areas of the index. Regarding the Christian-mixed category, Australia and Switzerland rank on average above 8 points, suggesting they are closer to the Protestant group, while Canada, Germany, the Netherlands and South Africa have scores that resemble other Catholic countries more.
Which Religion Is at the Base of the Freest World Economies? Next, we use the Economic Freedom of the World index from the Fraser Institute and three reference years – 1990, 2005, 2020 – for each of which we show the 20 countries with the highest economic freedom and their dominant religion. Table 8.3 shows the results. The following patterns emerge from the table: ● The country that ranks first in the three reference years has a Buddhist tradition, as well as the country that ranks second in two reference years. ● The presence of countries with a Christian tradition in the ranking is dominant for the three reference years – on average 16 countries out of the 20 biggest world economies. ● Between Catholic and Protestant countries, Protestantism appears to have a greater positive correlation with economic freedom than Catholicism. ● The presence of countries with a Christian-Orthodox tradition in the ranking of the biggest world economies appears to be increasing – from 0 to 1 between 1990 and 2005 and from 1 to 4 between 2005 and 2020. This finding must be interpreted considering political developments in Eastern Europe since 1990. ● The presence of countries with Islamic and Hindu traditions is rather erratic.
Religion and economic freedom 113 Table 8.3
Freest world economies by religion
1990
2005
2020
Country
Religion
Country
Religion
Country
Religion
1
Hong Kong
Buddhism
Hong Kong
Buddhism
Hong Kong
Buddhism
2
United States
Christianity
Singapore
Buddhism
Singapore
Buddhism
Christianity
Switzerland
– Protestantism 3
Switzerland
Christianity
United States
– mixed 4
Singapore
Buddhism
– Protestantism Switzerland
Christianity – mixed
Christianity – mixed
New Zealand
Christianity – Protestantism
5 6
United
Christianity
Kingdom
– Protestantism
Canada
Christianity
United Kingdom New Zealand
– mixed 7
Australia
Christianity
Christianity
Denmark
– Protestantism Christianity
– Protestantism Australia
- Protestantism Ireland
– mixed
Christianity
Christianity Christianity – mixed
United States
- Catholicism
Christianity – Protestantism
8
Japan
Buddhism
Canada
Christianity - mixed
Estonia
Christianity
9
Luxembourg
Christianity
Australia
Christianity – mixed
Mauritius
Hinduism
Christianity
Ireland
Christianity
– Orthodox – Catholicism 10
New Zealand
Christianity
Denmark
– Protestantism 11
Germany
Christianity
– Protestantism Iceland
– mixed 12
Netherlands
Christianity
Christianity
– Catholicism Armenia
– Protestantism
Christianity – Orthodox
Japan
Buddhism
Japan
Estonia
Christianity – Orthodox Lithuania
Buddhism
– mixed 13
Denmark
Christianity – Protestantism
14
Belgium
Christianity
Finland
– Catholicism 15
Finland
Christianity
Norway
Christianity
Christianity
Canada
– Protestantism Chile
– Protestantism 16
Christianity
Austria
Christianity
– Catholicism
Panama
Christianity
Christianity – mixed
Latvia
Austria
Christianity
Czech Republic
Malaysia
Islam
– Catholicism Spain
Christianity
Netherlands
– Catholicism Norway
Christianity
France
Christianity – Catholicism
Germany
Christianity – mixed
Christianity – Catholicism Christianity – mixed
Romania
- Protestantism 20
Christianity – Protestantism
– Catholicism 19
Christianity – Orthodox
Netherlands
– Catholicism 18
Christianity – mixed
Georgia
– Protestantism 17
Christianity – Catholicism
Christianity – Orthodox
Iceland
Christianity – Protestantism
CONCLUSIONS Development in world affairs, either in its political, economic, or social dimensions, is the result of the influence and impact of many and diverse factors and circumstances. In this chapter, we looked at religion as one of ‘the most important social phenomena’, powerful enough to determine the course of prosperity of human societies. Without forgetting that reli-
114 Handbook of research on economic freedom gion does not exist in a vacuum and that it interplays with many other important factors, we analysed the primary economic implications of the five main religious doctrines, taken both from their original sacred texts and from the consequent wider teachings and doctrines developed by theologians and other religious authorities. After that, we aimed at identifying patterns and tendencies in the concrete data set that was built according to the methodology explained. Our main results suggest that there may be a pattern of greater prevalence of Christianity in the countries that enjoy a greater level of economic freedom, with a slight advantage of Protestantism but without evident contrast with Catholicism. Therefore, the thesis originally advanced by Max Weber if not contradicted by these findings is at least attenuated by them. It is true that the way these teachings are practically adopted and the predisposition to engage in some economic activities or the spirit with which certain economic goals are pursued varies between the different Christian denominations. However, it also appears that, despite the separation brought by the Reformation, the general support for the basic principles of a market economy as advanced by the scriptures was not abandoned in Christian beliefs and practices, although support does seem somewhat stronger in countries of a Protestant Christian tradition than in others. Contrasting our analysis with the papers cited before, it is mostly in line with findings by Abellán (2023) that Protestantism, Catholicism and Islam do not appear to have significant practical differences concerning attitudes towards the market economy – and less so with the more Weberian findings of Hillman and Potrafke (2018). It is also compatible with the positive association between Islam and free-market capitalism suggested by de Soysa (2019). Our analysis does not focus on religiosity as such and thus it is not possible to contrast it with the findings by Berggren and Bjørnskov (2013). Finally, it is also important to note that teachings in sacred texts and actual practice often vary. In a way this is unavoidable because any text requires interpretation, which will naturally evolve over time and be influenced by specific circumstances and by prevailing intellectual trends. A more fine-tuned and detailed analysis trying to make sense of the distinction between theoretical religious teachings and actual legal and economic practices falls outside the scope of this chapter but would be an interesting and promising path for future research. Likewise, we see scope for further econometric work that tries to disentangle causal effects.
REFERENCES Abellán, M. (2023). Catholics, Protestants and Muslims: Similar work ethics, different social and political ethics. Journal of Comparative Economics 51(3): 778–815. Alves, A.A. and Gregório, I. (2021). Price controls and market economies. In: Christianity and Market Regulation: An Introduction (eds. D.A. Crane and S. Gregg), 213–232. Cambridge: Cambridge University Press. Alves, A.A. and Moreira J.M. (2013a). The Salamanca School. New York: Bloomsbury. Alves, A.A. and Moreira J.M. (2013b). Business ethics in the School of Salamanca. In: Handbook of the Philosophical Foundations of Business Ethics (ed. Christoph Luetge), 207–225. Heidelberg: Springer. Becker, S.O. and Woessmann, L. (2009). Was Weber wrong? A human capital theory of Protestant economic history. Quarterly Journal of Economics 124(2): 531–596. Berggren, N. (2003). The benefits of economic freedom: A survey. Independent Review 8(2): 193–211. Berggren, N. and Bjørnskov, C. (2013). Does religiosity promote property rights and the rule of law? Journal of Institutional Economics 9(2): 161–185.
Religion and economic freedom 115 Brox, T. and Williams-Oerberg, E.L. (2017). Buddhism, business, and economics. In: The Oxford Handbook of Contemporary Buddhism (ed. M. Jerryson), 504–517. Oxford: Oxford University Press. Chafuen, A. (2003). Faith and Liberty: The Economic Thought of the Late Scholastics. Lanham, MD: Lexington Books. Conway, D. (2017). Judaism and liberalism: Israel’s economic problem with its Haredim. Economic Affairs 37(2): 240–253. de Soysa, I. (2019). Is Islam compatible with free-market capitalism? An empirical analysis, 1970–2010. Politics and Religion 12(2): 227–256. Elegido, J.M. (2009). The just price: Three insights from the Salamanca school. Journal of Business Ethics 90(1): 29–46. Facchini, F. (2010). Religion, law and development: Islam and Christianity – why is it in Occident and not in the Orient that man invented the institutions of freedom? European Journal of Law and Economics 29(1): 103–129. Guiso, L., Sapienza, P. and Zingales, L. (2002). People’s opium? Religion and economic attitudes. Journal of Monetary Economics 50(1): 225–282. Gvosdev, N.K. (2010). An Orthodox look at liberty and economics in Russia. Interview. https://www .acton.org/pub/religion-liberty/volume-14-number-4/orthodox-look-liberty-and-economics-russia (accessed 14 December 2022). Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2021 Annual Report. Vancouver: Fraser Institute. Helble, M. (2007). Is God good for trade? Kyklos 60(3): 385–413. Hillman, A.L. and Potrafke, N. (2018). Economic freedom and religion: An empirical investigation. Public Finance Review 46(2): 249–275. Irimie, A. (2013). Influences of Judaism in economy. Review of Economic Studies and Research Virgil Madgearu 6(2): 71–80. Kahl, S. (2005). The religious roots of modern poverty policy: Catholic, Lutheran, and Reformed Protestant traditions compared. Religion and Society 46(1): 91–126. Kuran, T. (2004). Why the Middle East is economically underdeveloped: Historical mechanisms of institutional stagnation. Journal of Economic Perspectives 18(3): 71–90. Lennerfors, T.T. (2014). A Buddhist future for capitalism? Revising Buddhist economics for the era of light capitalism. Futures 68(April): 67–75. Makrides, V.N. (2019). Orthodox Christianity and economic development: A critical overview. Archives de sciences sociales des religions 185(January–March): 23–43. Malik, M. (2016). A special case study on religion & property rights: Property rights from an Islamic perspective. Report. http://irep.iium.edu.my/51878/ (accessed 12 November 2022). McCleary, R. and Barro, R.J. (2006). Religion and economy. Journal of Economic Perspectives 20(2): 49–72. Rao, K.S.S. (1998). Hinduism and the new economic policy. International Review of Sociology 8(2): 233–238. Sait, S., and Lim, H. (2006). Land, Law and Islam: Property and Human Rights in the Muslim World. London: Zed Books. Saran, A.K. (1963). Hinduism and economic development in India. Archives de sociologie des religions 8(15): 87–94. Schumacher, E.F. (1973). Small Is Beautiful: Economics as if People Mattered. London: Blond & Briggs. Taivans, L.G. (2022). Between Oriental orthodoxy and European modernity: Georgian Orthodox Church, market economy, and social message. Occasional Papers on Religion in Eastern Europe 42(6): 77–94. Tomalin, E. (2009). Hinduism and international development: Religions and development background paper. Religions and Development Working Paper No. 19-2009, Department for International Development, University of Birmingham. Tarami, M. (1997). The challenge of wealth: Jewish business ethics. Business Ethics Quarterly 7(2): 45–56.
116 Handbook of research on economic freedom Uprety, P.R. (1996). The economics of Buddhism: An alternative model for community development. Contributions to Nepalese Studies 23(1): 119–124. Weber, M. (2002 [1905]). The Protestant Ethic and the Spirit of Capitalism. New York: Penguin. Wojciechowski, M. (2014). Economy and business in the Bible. In: The Bible and Economics (ed. György Benyik), 403–413. Szeged: JATEPress. Wood, D. (2002). Medieval Economic Thought. Cambridge: Cambridge University Press.
9. The effects of crises on economic freedom and market-oriented reforms: a survey Hans Pitlik
THE UNRESOLVED PUZZLE: WHY AND WHEN DO REFORMS HAPPEN? Thanks to a growing body of research in the field of political economy, we have gained a better understanding of why governments often deviate from economic freedom and how policies that are detrimental to prosperity, growth, and overall well-being can persist for long periods of time (e.g., North 1990; Acemoglu and Robinson 2008). Implementation of reforms is hindered by conflicts of interest among organized groups, voters, bureaucratic resistance, and motivations of policymakers seeking re-election. However, if the substantial benefits of economic liberalization (de Haan and Sturm 2024) cannot account for a change in policy, why do we occasionally observe reforms that increase economic freedom despite the fact that they may harm powerful vested interests? A prominent idea is that crises may help overcome political obstacles and trigger reforms promoting economic freedom. The Crisis Hypothesis expresses the notion that economic conditions must deteriorate substantially to facilitate change. From a normative standpoint, it can even be argued that crises may be considered desirable if they ultimately lead to improved policies and stimulate higher economic growth (Drazen and Grilli 1993; Cavallo and Cavallo 2010). Political activist Naomi Klein (2007) takes the argument almost to the level of a neoliberal conspiracy, by suggesting that governments deliberately create political or economic crises to cultivate an environment where voters are more inclined to accept otherwise intolerable liberalization policies. This chapter reviews the theoretical and empirical links between poor economic performance and liberalization. The ultimate query is whether or not, or under what circumstances, adoption of policies inducing more economic freedom is facilitated by crises. The concept of economic freedom is comprehensive and refers to the overall quality of the institutional environment governing voluntary transactions in economic markets (cf. Murphy 2024). Property rights protected by a well-functioning and impartial legal system are essential to this institutional quality, but also various aspects of limited government interference in private market interactions, including low public spending and taxation, limited regulation of product and factor markets, freedom to trade internationally, and availability of sound and stable money. Economic reform encompasses a comprehensive array of policy measures aimed at enhancing the quality of the institutional framework governing economic markets. These measures often involve actions such as the consolidation of public finances, monetary disinflation, trade liberalization, and the deregulation of market transactions. Therefore, when discussing the potential effects of crises on reform, it is crucial to consider a broad spectrum of policy 117
118 Handbook of research on economic freedom changes that align with market-friendly principles and contribute, at least partially, to the advancement of economic freedom.
CRISES CAN STIMULATE MARKET-ORIENTED REFORM The Basic Hypothesis According to the fundamental proposition of the Crisis Hypothesis, a very poor economic performance is supposed to stimulate subsequent market-friendly policy changes. Although the precise origin of this idea is uncertain and there are conceptual ambiguities regarding the theoretical and empirical identification of a crisis, by the early 2000s the idea that a sudden deterioration of economic conditions can serve as a catalyst for reforms leading to increased economic freedom had almost achieved the status of ‘conventional wisdom’ (Drazen and Easterly 2001). This perception was certainly shaped by the observation of instances where liberalization and macroeconomic stabilization measures were implemented following severe economic hardships in various regions around the world during the 20th century. The relevant literature summarized in the following sub-sections identifies various pathways through which a crisis can trigger liberalizing reforms. These approaches should be viewed as complementary explanations rather than being mutually exclusive substitutes for one another. The models share a common understanding that a significant and swift deterioration of economic conditions modifies the considerations of relevant political and economic actors, making the option of reform suddenly viable. A negative shock, often referred to as a crisis, disrupts prevailing anti-reform alliances, alters political equilibria, and motivates policymakers to embrace reform initiatives. The perspectives examined in the subsequent subsections aim to elucidate why politicians in normal times often do not advocate for liberalizing reforms that would benefit a majority of voters, even if it means that special interests would suffer losses, and how crises mobilize support for previously unattainable policy changes. Pathological Learning Fundamental beliefs directed against economic deregulation and in favor of state intervention among many segments of society are often deeply rooted (e.g., Alesina et al. 2015; Pitlik and Rode 2017). Ideological convictions play an even more important role for preference formation than economic self-interest and socio-economic characteristics (Duval et al. 2022). Crises can change our perception of how the world works by stimulating ‘pathological learning’ (Freytag and Renaud 2007; Dunlop and Radaelli 2020). By revealing an extreme policy failure, a major deterioration of the status quo pushes actors into a predisposition to adapt beliefs, convincing policymakers and voters of the inferiority of hitherto chosen interventionist strategies. Eventually political entrepreneurs will search for alternatives, pick up new ideas and produce change (Rodrik 2014). The idea of pathological learning has its merits but its association with crisis remains somewhat tautological. As Rodrik (1996, pp. 26–27) puts it: ‘Reform naturally becomes an issue only when current policies are perceived not to be working. A crisis is just an extreme instance of policy failure. That policy reform should follow crisis, then, is no more surprising
The effects of crises on economic freedom and market-oriented reforms 119 than smoke following fire.’ The puzzle is, why are reforms substantially delayed although the benefits of a policy change are obvious, and why do reforms occur in times of crisis? Political Myopia and Transition Costs of Reform Although long-term benefits may be substantial, a temporary decline of production or increasing unemployment are almost inevitable by-products of structural reforms, monetary stabilization, or fiscal retrenchment. Reforms are frequently disruptive and painful in the short run, while in the long term, liberalization will lay the ground for efficiency and prosperity (e.g., Blanchard and Giavazzi 2003; Alesina et al. 2020). Experiences of former communist systems also revealed that transition to market economies was associated with significant up-front cost of adjustment to new rules and regulations (e.g., Iwasaki and Kumo 2019). Facing substantial initial costs, incumbent governments may tend to avoid reform due to concerns of electoral defeat. Liberalization proves to be good politics, albeit with a notable caveat: the benefits of reforms take a considerable amount of time to materialize, rendering the relationship between policy success and political advantage unexploitable for aspiring reformers. Reform-minded governments cannot be sure to stay in power when facing elections during the transition phase and political rivals may reap all the reform benefits. Incumbents who can rationally expect that they will be in power for a longer period of time, may be better suited to initiate reforms, as they can reap the economic and electoral benefits. Political myopia could be attributed to electoral terms with short-sighted and uninformed voters (Nordhaus 1975). But why would rational voters not support reform policies when they anticipate that losses are only temporary? First, the formation of rational expectations in fundamental policy reforms is considerably more challenging. Moreover, voter myopia can still be considered rational in instances where information problems persist (Bonfiglioli and Gancia 2013), or when governments cannot credibly commit to adhere to reform pledges (Leblanc et al. 2000). Calculations may change during a profound crisis when the status quo becomes increasingly unsustainable. In such circumstances, governments are more inclined to embrace the risks of temporary hardships during the transition period. Short-term costs associated with bold policy reforms appear relatively smaller and more manageable in the midst of a deep recession, even if transition costs might be high. This is corroborated by a prominent idea in behavioral economics that people avoid risky choices when anticipating gains but are more prone to risky options when they find themselves in the domain of losses (Kahneman and Tversky 1979). Loss aversion deters reforms if people perceive a mediocre but stable status quo as a reference point. Governments and voters support risky reforms if they consider themselves to face a deep crisis and the status quo becomes unacceptable (Weyland 1998; Vis and van Kersbergen 2007). Yet, costs of economic adjustment to far-reaching liberalization will politically be easier to tolerate during good times (Bean 1998). Opposition against reform will be weaker, and governments might thus be more willing to launch reforms during an economic upswing. From this perspective, favorable economic conditions give reforming governments the time and more resources to compensate potential losers.
120 Handbook of research on economic freedom Uncertainty about Distributional Consequences of Reforms Dewatripont and Roland (1995) and Fernandez and Rodrik (1991) address uncertainty about the distributional consequences of a market-oriented policy change as an impediment to liberalization. The Fernandez–Rodrik story is related to trade liberalization but can be applied to other types of market-oriented reform. Its main idea is that ex post outcomes of reform are known to be beneficial for a voter majority, but ex ante it is unknown who will gain and who will not. If a substantial fraction of the population is uncertain whether they will benefit or lose, the expected pay-off from policy liberalization may well be negative for a majority of voters, causing a systematic bias against change. Although its overall gains are positive, a beneficial reform may be rejected ex ante. Labán and Sturzenegger (1994) demonstrate in a similar framework that a crisis impacts positively on the willingness to accept distributional uncertainty from fiscal adjustment, if the stream of benefits pertaining to status quo policies is becoming ever more negative. Eventually, the voter segments most affected by a crisis agree to a policy change that they rejected beforehand. The extreme welfare loss that each actor suffers during a crisis dwarfs losses associated with an unfavorable distribution of the burden of reform (Drazen and Grilli 1993). Bargaining over Reform as a War of Attrition Deep crises can reduce political opposition to liberalization by lowering payoffs of reform obstruction. The war of attrition model of Alesina and Drazen (1991) summarizes this idea in a dynamic game of chicken between two groups over the distribution of stabilization costs. Both groups have veto rights in the reform decision. To reduce its own share of reform cost, each group blocks a beneficial policy change, expecting the other group to give in earlier. At some point in time, however, one group finds it too costly to further negotiate with the prospect of having to bear smaller reform burdens and agrees to pay a higher fraction of the costs. The quintessence of the model is that only the passage of time reveals which opponent is weaker due to high waiting costs. In this setting, a progressive worsening of the economic situation increases the costs of postponing reforms, and eventually one party concedes when it is cheaper to accept a higher share of stabilization costs than to prolong obstruction.
DO CRISES ALWAYS FAVOR ECONOMIC LIBERALIZATION? Crises create both a window of opportunity and a sense of urgency for facilitating extraordinary institutional change. Yet, while crises can play a critical role in stimulating economic freedom, they are neither a necessary nor a sufficient condition for liberalization (Williamson and Haggard 1994). In this section, we examine briefly why fast economic deterioration may serve as a catalyst for market-oriented reform only under certain conditions, or may even completely fail to do so. The Conditioning Role of Political Institutions A major conditioning factor for the success of liberalization attempts in a crisis is the nature of the political system. Reform capacity is often linked to political regime types. On the one
The effects of crises on economic freedom and market-oriented reforms 121 hand, economic freedom seems to be compatible with different political institutions to varying degrees (cf. Rode and Gwartney 2012; Choutagunta and Gutmann 2024). On the other hand, the constitutional setting of a country will probably shape the pace and direction of a government’s crisis response. Implementation of reforms depends on a complex interplay of institutional factors and not solely on unsustainable economic conditions. Following a popular belief, political authorities unconstrained by checks and balances are more decisive when it comes to making far-reaching choices. ‘Strong governments’ do not depend on compliance of veto players, such as coalition partners or reform-opposing vested interests, or – in case of autocratic regimes – on electoral majorities. Hence, economic liberalization is supposedly more difficult with fragmented decision-making and numerous veto actors who have the means to block reforms (‘t Hart et al. 1993; Cox and McCubbins 2001). The strong government hypothesis claims that, confronted with a crisis, fewer executive constraints and centralized decision-making allow faster reform implementation, whereas in consensus systems with multiple veto actors, transformation of interventionist policies towards more economic freedom is delayed or even infeasible. Although formally not equipped with veto powers, government bureaucracy can play an outstanding role diluting market-oriented policy change. In general, members of public administration benefit from heavier government spending and regulation and are therefore supposed to clash with certain aspects of economic liberalization (Rattsø and Sørensen 2004). Even if reform-minded governments aim at spending cuts or at an elimination of business-strangling regulatory rules as a crisis response, the implementation of complex and ambitious reform packages requires expertise and cooperation of the bureaucracy. Periods of far-reaching reform needs may be exactly the times when civil servants are politically most important but are in fierce opposition to reform, as they have much to lose from a policy change (Asatryan et al. 2017). The view that autocratic regimes, or democratic political systems with few veto points, are superior in implementing market-oriented reforms is yet not unchallenged. In a dynamic perspective, a major source of reform stalemate is lack of government credibility in carrying out reform promises. Models in the previous section assume implicitly that transfer schemes to pay off losers from liberalization cannot be implemented because winners are unable to commit credibly to not defect on a compensation agreement (Dixit and Londregan 1995; Rodrik 2014). From this perspective, reforms will be adapted with higher probability if consensus-building democratic mechanisms are established, and actors are believed to stick to their compensation promises (Jain and Mukand 2003; Pitlik 2008). In autocracies or in democratic systems with weak credibility-enhancing institutions, the struggle over the distribution of the costs and benefits from reform could be paralyzing, because there is more at stake for winners and losers from reforms. Rules of democratic participation, constraints on executive action, and checks and balances may then be good for reform, as they foster peaceful conflict resolution, increase accountability of rulers and credibility of political promises in times of crisis (Rodrik 1999). Do Crises Motivate Economic Populism Instead of Liberalization? Crises may also facilitate the exact opposite of liberalization, i.e., a deterioration of economic freedom. In his seminal book, Crisis and Leviathan, Higgs (1987) claims that major national crises in the United States triggered expansions of federal government rather than leading to
122 Handbook of research on economic freedom more economic freedom. When the crisis is over, a ratchet-effect applies and the government does not return to its pre-crisis levels of intervention, spending and taxation. Higgs argues that during a severe economic crisis, popular beliefs in the efficiency of markets weaken and therefore voter demand for government intervention spreads. This contention is quite close to ‘learning-from-mistakes’ considerations. Crises foster policy change, but do not necessarily trigger change towards economic freedom. Shocks may have different effects, depending on whether they occur in an economically free or unfree system. If an economic downturn is attributed to failures of market-oriented policies, it seems natural to assume that restrictions of economic freedom are suggested to improve matters. Crises promote structural reforms, if (and only if?) existing regulations are recognized to be, at least partially, responsible for economic deterioration. Accordingly, crises should bring about more interventionist policies and economic populism instead of economic freedom when perceived hardships are associated with liberalized markets. The Financial Crisis starting in 2007 is a case in point, as its origin and deeper causes are still disputed. Stiglitz (2009) endorses the claim that the crisis was induced and prolonged by too lax financial regulations. Claessens et al. (2010) and Rose and Spiegel (2012) put forward that economic and financial turmoil were most probably instigated by multiple factors and cannot be attributed simply to market or government failure; under-regulation of financial markets may have played a role as well as over-regulation. Economic narratives about the nature and sources of a crisis probably matter for which course of action will be supported by voters and taken by governments. Political partisanship of the incumbent government can be crucial in determining the direction of reform responses (Gründler et al. 2024), and policy responses to crises will partly depend on government ideological orientation and world views (Galasso 2014; Bjørnskov and Rode 2019).
EMPIRICAL EVIDENCE Particularly in the 1970s, 1980s, and 1990s governments in many countries that experienced negative growth, high inflation, unemployment, mounting public debt or severe balance of payment troubles, rushed to different types of market-oriented reforms. This stimulated not only theoretical ideas linking economic crises to liberalization, but also numerous studies testing the Crisis Hypothesis. Among the first to search for systematic empirical evidence, Drazen and Easterly (2001) performed a statistical analysis, concluding that deep inflation crises and extreme black-market premiums are associated with reforms, but current account deficits or budget deficits are not. A crisis may lead to reform and improvement when policy measures are clear and easy to implement. In the aftermath of the Great Recession of 2008, the tide seemed to have turned. Reform fatigue impacted many countries when their economies emerged from the financial crisis. The research challenge was now to explain the absence of liberalizing reforms despite deep economic and financial crises (Drazen 2010). Understandably, more recent empirical analyses focused strongly on the effects of financial crises on economic freedom.
The effects of crises on economic freedom and market-oriented reforms 123 Country Studies Detailed country studies, which mainly cover reform episodes between the 1970s and early 1990s revealed in many instances a close connection of economic crises and subsequent liberalizing reforms across the world (e.g., Williamson 1994). Brown (2016) refers to studies of 24 countries and regions that witnessed substantial increases of economic freedom from 1980–2005, as measured by major improvements in the Economic Freedom of the World-index of the Fraser Institute (Gwartney et al. 2022). In all but one case in his sample, liberalization occurred amid an economic crisis. Although crises were directly connected to institutional reform episodes, the nature of crises varied from long but moderate downturns to an accelerating decline in post-socialist transition countries, or severe disruptions in long-stagnating developing countries. Examining a broad set of potential driving factors, Brown finds economic crises to be the single most important element associated with subsequently enhanced economic freedom. Yet, many other countries, Brown acknowledges, experienced deep crises over the period under consideration without undertaking significant reforms. Ambiguous Results of Econometric Studies Quantitative studies of crises and reform typically examine time-series variation in a cross-country sample, regressing the level or change of an indicator of economic freedom (or one of its sub-components) on an indicator for crises plus further explanatory covariates. Accordingly, panel econometrics is (still) the workhorse in empirical tests of drivers of liberalization. A few contributions center on the link of economic crises and comprehensive measures of overall economic liberalization (e.g., Pitlik and Wirth 2003; Lora and Olivera 2004; de Haan et al. 2009; Fidrmuc and Tichit 2013; Stocker 2016; March et al. 2017; Murphy and Smith 2018). A greater number of studies scrutinize specific aspects of market-oriented policies and institutions. Research considers the role of economic crises for privatization (e.g., Campos and Horváth 2012; Galasso 2014), trade liberalization (Brooks and Kurtz 2007; Campos et al. 2010; Ballard-Rosa et al. 2018), financial sector regulation (e.g., Abiad and Mody 2005; Agnello et al. 2015; Hlaing and Kakanika 2018; Saka et al. 2021), regulation of labor and product markets (e.g., Bjørnskov and Rode 2019; Gokmen et al. 2021; Alesina et al. 2020; Duval et al. 2021), macroeconomic stabilization and fiscal retrenchment (e.g., Alesina et al. 2006; Lavigne 2011; Giesenow et al. 2020), or the connection of crises with efficiency-enhancing internal reforms of the public administration (Hugh-Jones 2014; Asatryan et al. 2017; Randma-Liiv and Kickert 2017). While case studies of liberalization episodes often confirm the notion that economic freedom can be facilitated by economic crises, quantitative evidence is much more mixed, loaded with caveats, and often contradictory. It is hardly possible to discuss the dozens of relevant econometric assessments of the effect of crises on (aspects of) economic liberalization in brief. Mahmalat and Curran (2018) provide a comprehensive survey of relevant studies. A recent review of studies on determinants of economic freedom by Lawson et al. (2020) covers crises as a potentially major driver of the creation of a market-friendly environment. In the following we highlight results of selected studies in order to demonstrate the range of outcomes.
124 Handbook of research on economic freedom A vast number of econometric studies find empirical support for some versions of the Crisis Hypothesis. A bad growth performance appears to have stimulated market-oriented reforms in many instances.1 Pitlik and Wirth (2003) use the idea that good times may be better suited to adopt structural reform policies but that crises generate stronger incentives to do so. In a worldwide sample, they find that a moderate economic downturn is correlated with lower levels of reform, whereas significant liberalization can be observed during profound growth crises and even in the absence of a growth crisis. Lora and Olivera (2004) notice for a Latin America sample, that crises between 1985 and 1995 made market-oriented change more feasible. Fidrmuc and Tichit (2013) examine post-communist countries and find that the severity of crises spurred the pace of economic liberalization. A more nuanced view is provided by papers that consider the effects of crises conditional on political constraints. Pitlik (2008) reports that comprehensive reform as a crisis response depends on the political regime type. While democratic systems undertake liberalization efforts in a crisis, autocracies tend to reform significantly less during growth crises (cf. Andersson 2016).2 Galasso (2014) shows that fractionalized governments find it more difficult to agree on reform in good times but are effective in producing structural reform during crises. Alesina et al. (2006) observe that stabilizations more likely occur in times of crises but that necessary reforms are delayed in fragmented and polarized political systems. Campos et al. (2010) find political crises to be more important for labor market and trade liberalization than economic crises. Still other contributions find no crisis effects on economic freedom, and some studies even imply that crises are associated with subsequent declines in economic freedom. Murphy and Smith (2018) notice that negative nominal GDP growth shocks are followed by reductions in economic freedom, five years, ten years, and fifteen years following the crisis period. A study by de Haan et al. (2009) suggests that crises are associated with reductions in most areas of economic freedom, both in the short and in the long term. Quite a few studies observe a missing or even a statistically significant negative relationship between financial crises and liberalization. Abiad and Mody (2005) were among the first to investigate the effects of crises on financial liberalization. Their analysis suggests that different types of crises possibly have different effects: while balance-of-payments crises spur reforms, banking crises cause setbacks of liberalization (cf. Campos and Horváth 2012). Stocker (2016) finds that financial crises coincide with decreases in economic freedom, only an external debt crisis weakly relates to economic liberalization. Missing reform progress may be caused by a general pattern of increasing economic polarization after financial crises, generating political gridlock and reform reversals (Mian et al. 2014). Agnello et al. (2015), on the other hand, maintain that recessions and external debt crises are the main triggers of financial, banking and trade reforms, whereas banking crises drive financial deregulation. Young and Bologna (2016) consider several types of financial crises (banking, sovereign debt, currency, inflation crises) in a panel of 70 countries during 1966–2010 and focus on effects on three sub-areas of economic freedom, security of property
Alesina et al. (2020) observe that most structural reforms are implemented during recessions, which has proven counterproductive for electoral chances of reforming governments. This suggests that reforms are almost ‘imposed’ by recessions or crises. 2 Mody and Saravia (2008) find that institutional checks that impose constraints on executives were associated with more rapid reform program negotiation with the IMF. 1
The effects of crises on economic freedom and market-oriented reforms 125 rights, freedom to trade internationally, and government regulation. Results are sobering, as estimates are statistically insignificant or show no robust correlation. Gokmen et al. (2021) report evidence of a negative relationship between occurrence of financial crises and adoption of different types of market-oriented structural reforms, including trade liberalization, banking, or network industries. In non-democratic regimes financial crises push towards less market-oriented policies, while in democracies the crisis impact is less clear. This result appears to be driven in part by growing anti-market attitudes in the population during crises. Saka et al. (2021) focus on financial regulation and provide strong evidence against the Crisis Hypothesis in the wake of financial crises. Employing difference-in-differences analysis in a panel dataset of 94 countries over the period 1973 to 2015, their results point to an increase of government interventions on financial markets as a crisis response, predominantly in democratic settings. Do Crises Promote Populism? Historical analysis reveals that when the cause of financial crises is perceived to be liberalization, governments impose new regulations and reverse the process of previous financial liberalization (Dagher 2018). Guiso et al. (2019) demonstrate that anti-establishment parties are likely to gain electoral support when governing parties fail to manage economic shocks. Both left-wing and right-wing populists frequently back policies in sharp contrast to principles of economic freedom (Rode and Revuelta 2015). In line with that finding, Guriev and Papaioannou (2022) show that a rise of economic and political populism took place during and shortly after the 2008–2009 global financial turmoil. If crises lift ideologically extreme parties in office, this may explain a more interventionist policy stance. However, Stankov (2018) finds declines in income per capita are not associated with higher support of economic populists. Some Extensions and Variations of the Theme Crises may be home-grown and reflect failure of domestic policies, or they may have external sources transmitted from abroad. If economic deterioration has its main roots in domestic policies, one can expect a policy change to help overcome the crisis. However, if a crisis is caused instead by bad policies abroad, incentives to initiate reforms at home may be weak. Waelti (2015) indeed provides evidence that financial reform adaptation depends on the origin of the financial crisis. Another aspect often neglected in empirical analyses is that the likelihood of a crisis depends crucially on the quality of institutional environment and government regulations in place. Economic freedom is associated with economic flexibility and protects countries more effectively from deep growth crises than intense regulation (Bjørnskov 2016; Geloso and Bologna Pavlik 2021; Bologna Pavlik 2024).3 Allowing for possible endogeneity between regulatory provisions and macroeconomic conditions in a two-step Heckman-selection procedure for a sample of 61 countries over the period 1975 to 2005, Hlaing and Kakinaka (2018) find that financial crises promote financial 3 Marchionne et al. (2022) find a hump-shape association as financial instability is lower in either loosely or stringently regulated countries.
126 Handbook of research on economic freedom liberalization. However, they do not observe that financial crises also encourage prudential regulation which may be an essential ingredient for higher financial market stability. Banking crises are frequently caused by a weak and volatile macroeconomic environment that is itself rooted in lack of economic freedom. Hence a banking crisis may promote more comprehensive reforms to reduce risks in the banking sector. Supporting this idea, Andersson (2016) observes that only banking crises coupled with a GDP growth crisis cause broad institutional reform efforts aimed at improving the macroeconomic environment. Hence, not all banking crises have the potential to promote comprehensive reforms. What Explains the Inconsistency of Empirical Results? Ambiguous and contradictory findings of empirical research are nothing new in social science, to be sure. Fully concise explanations of the origins for such diversity of results are still missing, and the fact that there is not a single unified theoretical framework linking crises and reforms makes empirical tests difficult. Nevertheless, some general points can be made, even though empirical strategies differ in the underlying definition of reform and economic liberalization, country sample, and time period under consideration. If ideas are driving forces of institutional change, the dominance of certain economic narratives at certain times will channel the direction of the institutional change (Polanyi-Levitt 2012; Rodrik 2014). When market-orientation is out of fashion, one should not expect to observe economic liberalization in general. According to Campos and Horváth (2012), one of the most significant reasons for divergent findings is the presence of measurement issues. Quantifying economic liberalization consistently across countries and over time can be particularly challenging. When examining the crisis hypothesis through empirical tests, a common approach is to measure the intensity of reforms by assessing the improvements in an index that reflects economic freedom over time.4 Besides general criticism regarding the operationalization of economic freedom, this implies that only sustained reforms are recorded unless one considers rather short time windows. Reforms initiated as a crisis response may subsequently be withdrawn and do not show up in the data. Moreover, indicators used to identify reforms always include judgements about what change can be classified as a significant, as opposed to a minor policy action, or even only measurement error (Duval et al. 2021). Methodological challenges also pertain to measurement, definition, and identification of crises. In theoretical papers, crises are modeled as dwindling income or utility losses by players in reform games, but the whole conjecture is rather unspecific regarding the distinct nature of a crisis. One strand of literature relies on extraordinary crisis-laden economic or political events. The systemic financial crisis database (Laeven and Valencia 2020) and Reinhart and Rogoff’s (2014) data have become standard information on financial sector crises across the world. In other papers, crises are operationalized by a sharp deterioration of country-level (macroeconomic) performance indicators, such as GDP growth, unemployment, inflation, or current
Early studies (Drazen and Easterly 2001) even use economic outcomes as indicators for successful reform. However, when measuring reform, it is at least advisable to employ policy indicators that are directly under the control of the government. 4
The effects of crises on economic freedom and market-oriented reforms 127 account balance, to name a few. A severe crisis is defined as a very poor outcome as compared with some reference level, e.g., relative to other countries and/or time periods. Real (per capita) GDP growth is the indicator of choice in many studies. There are good reasons for that, as events such as financial crises, or other economic shocks from high inflation, balance-of-payment deterioration, etc., are in the end often – though not always5 – related to national income. Provided that low growth is caused by a lack of economic freedom, it is also an adequate indicator of policy failure. In any case, crises are commonly identified using thresholds, i.e., when an indicator of bad performance exceeds some level arbitrarily defined by the researcher.6 Mahmalat and Curran (2018) argue that what really drives reform incentives and liberalization pressure are perceptions of the economic situation. Perceptions and expectations differ over time and across countries, shaped by economic-historical paths and experiences. Some countries probably never face a ‘crisis’ according to some fixed threshold because their performance is never as bad as in other countries.7 But that does not mean that people never perceive a crisis from their perspective. Empirical identification of crises is far from being a trivial exercise, and it may be advisable for researchers to demonstrate the robustness of their results. An important step in this direction has been made recently by Duval et al. (2021). The authors argue that the political economy approaches linking crises and reform are not yet settled enough. Theory and related empirical work have identified too many channels and conditioning variables that potentially shape the strength and the direction of the crisis-reform nexus. Model selection and specification therefore becomes crucial. In the face of enormous model uncertainty, Duval et al. (2021) propose to employ Bayesian averaging of maximum likelihood estimates to test and identify robustness of a whole set of different economic and political drivers of liberalization. Employing a new dataset of labor and product market reforms covering advanced economies over four decades, Duval et al. (2021) also increase homogeneity of the country sample and thus probably improve the comparability of crisis perceptions among the political actors. Testing a large list of potential correlates of reforms simultaneously, the authors find the crisis-liberalization nexus to be economically significant and robust. Other potential covariates are only weakly associated or even unrelated to labor and product markets liberalization.
WHERE DO WE STAND NOW? The theoretical literature has produced a vast array of explanations of why deep economic and financial crises may help overcome political resistance against reforms and trigger change. Numerous empirical contributions devoted to testing the Crisis Hypothesis arrive at inconclusive and contradictory results. Crises can promote policy change, but its direction is not always clear. When an economic model has proven to be inefficient, it is natural for politicians and
5 Research by Dwyer et al. (2013) illustrates that a non-negligible fraction of banking crises was not associated with a GDP decline. 6 Depth and duration are at least two important dimensions in that respect (Bjørnskov 2016). 7 One might consider the definition of reference groups, consisting of a subset of the entire sample. But who are the peers: countries with similar development status, geographical neighbors, or politically aligned countries?
128 Handbook of research on economic freedom voters to desire a change, which can vary across economic and political systems, depending on the initial situation. In a socialist environment, a financial crisis may lead to a greater inclination towards market-friendly reforms. On the other hand, in capitalist economies, the response to a crisis may lean towards opposite measures (Abramitzky et al. 2023). As of today, it seems that the mechanisms underlying the formulation of the Crisis Hypothesis are still not fully understood and are much more complex than presumed. Ideas and dominating narratives are crucial, but political systems matter too. The path of institutional change towards economic liberalization is shaped by a large set of conditioning political and economic factors to be explored in empirical research. Economic crises can even in theory cause a wide variety of policy responses. Future empirical research must be better suited to test the precise narrative and the political mechanisms that are associated with the notion that crises promote economic freedom. Addressing endogeneity and reverse causality issues of political and economic institutions and crisis-type developments with advanced econometric methods or natural experiments is more common (e.g., Hlaing and Kakanika 2018; Saka et al. 2021; Abramitzky et al. 2023), but remains tricky and will also depend on the specific research question and data availability.
REFERENCES Abiad, A. and Mody, A. (2005). Financial reform: What shakes it? What shapes it? American Economic Review 95(1): 66−88. Abramitzky, R., Ben-Porath, N., Lavy, V. and Palgi, M. (2023). Financial crisis in a socialist setting: Impact on political behavior, social trust, and economic values. Working Paper No. w30918, National Bureau of Economic Research, Cambridge, MA. Acemoglu, D. and Robinson, J.A. (2008). Persistence of power, elites and institutions. American Economic Review 98(1): 267−293. Agnello, L., Castro, V., Jalles, J.T. and Sousa, R.M. (2015). What determines the likelihood of structural reforms? European Journal of Political Economy 37(March): 129−145. Alesina, A., Algan, Y., Cahuc, P. and Giuliano, P. (2015). Family values and the regulation of labor. Journal of the European Economic Association 13(4): 599−630. Alesina, A., Ardagna, S. and Trebbi, F. (2006). Who adjusts and when? The political economy of reforms. IMF Staff Papers 53(1): 1−29. Alesina, A. and Drazen, A. (1991). Why are stabilizations delayed? American Economic Review 81(5): 1170−1188. Alesina, A.F., Furceri, D., Ostry, J.D., Papageorgiou, C. and Quinn, D.P. (2020). Structural reforms and elections: Evidence from a world-wide new dataset. Working Paper No. w26720, National Bureau of Economic Research, Cambridge, MA. Andersson, F.N. (2016). A blessing in disguise? Banking crises and institutional change. World Development 83(July): 135−147. Asatryan, Z., Heinemann, F. and Pitlik, H. (2017). Reforming the public administration: The role of crisis and the power of bureaucracy. European Journal of Political Economy 48(June): 128−143. Ballard-Rosa, C., Carnegie, A. and Gaikwad, N. (2018). Economic crises and trade policy competition. British Journal of Political Science 48(3): 713−748. Bean, C. (1998). The interaction of aggregate-demand policies and labor market reform. Swedish Economic Policy Review 5(2): 353−382. Bjørnskov, C. (2016). Economic freedom and economic crises. European Journal of Political Economy 45(December): 11−23. Bjørnskov, C. and Rode, M. (2019). Crisis, ideology and interventionist policy ratchets. Political Studies 67(4): 815−833.
The effects of crises on economic freedom and market-oriented reforms 129 Blanchard, O. and Giavazzi, F. (2003). Macroeconomic effects of regulation and deregulation in goods and labor markets. Quarterly Journal of Economics 118(3): 879−907. Bologna Pavlik, J. (2024). Economic freedom and the economic effects of crises. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 330–342. Cheltenham: Edward Elgar Publishing. Bonfiglioli, A. and Gancia, G. (2013). Uncertainty, electoral incentives and political myopia. Economic Journal 123(568): 373−400. Brooks, S.M. and Kurtz, M.J. (2007). Capital, trade and the political economies of reform. American Journal of Political Science 51(4): 703−720. Brown, M. (2016). Identifying drivers of economic reform: A case studies approach. Journal of Private Enterprise 31(1): 1−19. Campos, N.F. and Horváth, R. (2012). Reform redux: Measurement, determinants and growth implications. European Journal of Political Economy 28(2): 227−237. Campos, N.F., Hsiao, C. and Nugent, J.B. (2010). Crises, what crises? New evidence on the relative roles of political and economic crises in begetting reforms. Journal of Development Studies 46(10): 1670–1691. Cavallo, A.F. and Cavallo, E.A. (2010). Are crises good for long term economic growth? The role of political institutions. Journal of Macroeconomics 32(3): 838–857. Choutagunta, A. and Gutmann, J. (2024). Democracy and economic freedom. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 133–143. Cheltenham: Edward Elgar Publishing. Claessens, S., Dell’Ariccia, G., Igan, D. and Laeven, L. (2010). Cross–country experiences and policy implications from the global financial crisis. Economic Policy 25(62): 267–293. Cox, G.W. and McCubbins, M.D. (2001). The institutional determinants of economic policy outcomes. In: Presidents, Parliaments and Policy (eds. S. Haggard and M.D. McCubbins), 21–63. Cambridge: Cambridge University Press. Dagher, J. (2018). Regulatory cycles: Revisiting the political economy of financial crises. Working Paper No. 18/8, International Monetary Fund, Washington, DC. de Haan, J. and Sturm, J.-E. (2024). The impact of economic freedom on economic growth. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 187–207. Cheltenham: Edward Elgar Publishing. de Haan, J., Sturm, J.-E. and Zandberg, E. (2009). The impact of financial and economic crises on economic freedom. In: Economic Freedom of the World: 2009 Annual Report (eds. J.D. Gwartney, R.A. Lawson and J.C. Hall), 25–36. Vancouver: Fraser Institute. Dewatripont, M. and Roland, G. (1995). The design of reform packages under uncertainty. American Economic Review 85(5): 1207–1223. Dixit, A. and Londregan, J. (1995). Redistributive politics and economic efficiency. American Political Science Review 89(4): 856–866. Drazen, A. (2010). Financial market crisis, financial market reform: Why hasn’t reform followed crisis? ECFIN Economic Briefs 6: 12–16. Drazen, A. and Easterly, W. (2001). Do crises induce reform? Simple empirical tests of conventional wisdom. Economics and Politics 13(2): 129–157. Drazen, A. and Grilli, V. (1993). The benefit of crisis for economic reforms. American Economic Review 83(3): 588–608. Dunlop, C.A. and Radaelli, C.M. (2020). The lessons of policy learning: Types, triggers, hindrances and pathologies. In: A Modern Guide to Public Policy (eds. G. Capano M. and Holwett), 222–241. Cheltenham: Edward Elgar Publishing. Duval, M.R.A., Ji, Y., Papageorgiou, M.C., Shibata, M.I. and Spilimbergo, M.A. (2022). Preferences for reforms: Endowments vs. beliefs. Working Paper No. 17088, International Monetary Fund, Washington, D.C. Duval, R., Furceri, D. and Miethe, J. (2021). Robust political economy correlates of major product and labor market reforms in advanced economies: Evidence from BAMLE for logit models. Journal of Applied Econometrics 36(1): 98–124. Dwyer, G.P., Devereux, J., Baier, S. and Tamura, R. (2013). Recessions, growth and banking crises. Journal of International Money and Finance 38(November): 18–40. Fernandez, R. and Rodrik, D. (1991). Resistance to reform: Status quo bias in the presence of individual-specific uncertainty. American Economic Review 81(5): 1146–1155.
130 Handbook of research on economic freedom Fidrmuc, J. and Tichit, A. (2013). How I learned to stop worrying and love the crisis. Economic Systems 37(4): 542–554. Freytag, A. and Renaud, S. (2007). From short-term to long-term orientation: Political economy of the policy reform process. Journal of Evolutionary Economics 17(4): 433–449. Galasso, V. (2014). The role of political partisanship during economic crises. Public Choice 158(1): 143–165. Geloso, V. and Bologna Pavlik, J. (2021). Economic freedom and the economic consequences of the 1918 pandemic. Contemporary Economic Policy 39(2): 255–263. Giesenow, F.M., de Wit, J. and de Haan, J. (2020). The political and institutional determinants of fiscal adjustments and expansions: Evidence for a large set of countries. European Journal of Political Economy 64(September): 101911. Gokmen, G., Nannicini, T., Gaetano Onorato, M. and Papageorgiou, C. (2021). Policies in hard times: Assessing the impact of financial crises on structural reforms. Economic Journal 131(638): 2529–2552. Gründler, K., Hackenberger, A. and Potrafke, N. (2024). Economic freedom, government ideology and populism: New empirical evidence. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 144–158. Cheltenham: Edward Elgar Publishing. Guiso, L., Herrera, H., Morelli, M. and Sonno, T. (2019). Global crises and populism: The role of Eurozone institutions. Economic Policy 34(97): 95–139. Guriev, S. and Papaioannou, E. (2022). The political economy of populism. Journal of Economic Literature 60(3): 753–832. Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Higgs, R. (1987). Crisis and Leviathan. Oxford: Oxford University Press. Hlaing, S.W. and Kakinaka, M. (2018). Financial crisis and financial policy reform: Crisis origins and policy dimensions. European Journal of Political Economy 55(December): 224–243. Hugh-Jones, D. (2014). Why do crises go to waste? Fiscal austerity and public service reform. Public Choice 158(1): 209–220. Iwasaki, I. and Kumo, K. (2019). J-curve in transition economies: A large meta-analysis of the determinants of output changes. Comparative Economic Studies 61(1): 149–191. Jain, S. and Mukand, S.W. (2003). Redistributive promises and the adoption of economic reform. American Economic Review 93(1): 256–264. Kahneman, D. and Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica 47(2): 263–292. Klein, N. (2007). The Shock Doctrine: The Rise of Disaster Capitalism. London: Macmillan. Labán, R. and Sturzenegger, F. (1994). Distributional conflict, financial adaptation and delayed stabilizations. Economics & Politics 6(3): 257–276. Laeven, L. and Valencia, F. (2020). Systemic banking crises database II. IMF Economic Review 68(2): 307–361. Lavigne, R. (2011). The political and institutional determinants of fiscal adjustment: Entering and exiting fiscal distress. European Journal of Political Economy 27(1): 17–35. Lawson, R.A., Murphy, R.H. and Powell, B.W. (2020). The determinants of economic freedom: A survey. Contemporary Economic Policy 38(4): 622–642. Leblanc, W., Snyder, Jr., J.M. and Tripathi, M. (2000). Majority-rule bargaining and the underprovision of public investment goods. Journal of Public Economics 75(1): 21–47. Lora, E. and Olivera, M. (2004). What makes reforms likely: Political economy determinants of reforms in Latin America. Journal of Applied Economics 7(1): 99–135. Mahmalat, M. and Curran, D. (2018). Do crises induce reform? A critical review of conception, methodology and empirical evidence of the ‘crisis hypothesis’. Journal of Economic Surveys 32(3): 613–648. March, R.J., Lyford, C. and Powell, B.W. (2017). Causes and barriers to increases in economic freedom. International Review of Economics 64(1): 248–267. Marchionne, F., Pisicoli, B. and Fratianni, M. (2022). Regulation, financial crises and liberalization traps. Journal of Financial Stability 63(December): 101060. Mian, A., Sufi, A. and Trebbi, F. (2014). Resolving debt overhang: Political constraints in the aftermath of financial crises. American Economic Journal: Macroeconomics 6(2): 1–28.
The effects of crises on economic freedom and market-oriented reforms 131 Mody, A. and Saravia, D. (2008). From crisis to IMF-supported program: Does democracy impede the speed required by financial markets? Working Paper No. 08/276, International Monetary Fund, Washington, DC. Murphy, R.H. (2024). Economic Freedom of the World in the universe of measuring institutions. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 31–45. Cheltenham: Edward Elgar Publishing. Murphy, R.H. and Smith, T.L. (2018). Aggregate demand shortfalls and economic freedom. Review of Austrian Economics 31(1): 111–122. Nordhaus, W.D. (1975). The political business cycle. Review of Economic Studies 42(2): 169–190. North, D.C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press. Pitlik, H. (2008). The impact of growth performance and political regime type on economic policy liberalization. Kyklos 61(2): 258–278. Pitlik, H. and Rode, M. (2017). Individualistic values, institutional trust and interventionist attitudes. Journal of Institutional Economics 13(3): 575–598. Pitlik, H. and Wirth, S. (2003). Do crises promote the extent of economic liberalization? An empirical test. European Journal of Political Economy 19(3): 565–581. Polanyi-Levitt, K. (2012). The power of ideas: Keynes, Hayek, and Polanyi. International Journal of Political Economy 41(4): 5–15. Randma-Liiv, T. and Kickert, W. (2017). The impact of the fiscal crisis on public administration reforms: Comparison of 14 European countries. Journal of Comparative Policy Analysis: Research and Practice 19(2): 155–172. Rattsø, J. and Sørensen, R.J. (2004). Public employees as swing voters: Empirical evidence on opposition to public reform. Public Choice 119(3): 281–310. Reinhart, C.M., and Rogoff, K.S. (2014). This time is different: A panoramic view of eight centuries of financial crises. Annals of Economics and Finance 15(2): 1065–1188. Rode, M. and Gwartney, J.D. (2012). Does democratization facilitate economic liberalization? European Journal of Political Economy 28(4): 607–619. Rode, M. and Revuelta, J. (2015). The wild bunch! An empirical note on populism and economic institutions. Economics of Governance 16(1): 73–96. Rodrik, D. (1996). Understanding economic policy reform. Journal of Economic Literature 34(1): 9–41. Rodrik, D. (1999). Where did all the growth go? External shocks, social conflict and growth collapses. Journal of Economic Growth 4(4): 385–412. Rodrik, D. (2014). When ideas trump interests: Preferences, worldviews and policy innovations. Journal of Economic Perspectives 28(1): 189–208. Rose, A.K. and Spiegel, M.M. (2012). Cross-country causes and consequences of the 2008 crisis: Early warning. Japan and the World Economy 24(1): 1–16. Saka, O., De Grauwe, P. and Ji, Y. (2021). Financial policymaking after crises: Public vs. private interests. Working Paper No. 9131, CESifo, Munich. Stankov, P. (2018). The political economy of populism: An empirical investigation. Comparative Economic Studies 60(2): 230–253. Stiglitz, J.E. (2009). The anatomy of a murder: Who killed America’s economy? Critical Review 21(2–3): 329–339. Stocker, M.L. (2016). Crisis facilitates policy change, not liberalization. Journal of Financial Economic Policy 8(2): 87–103. ‘t Hart, P., Rosenthal, U. and Kouzmin, A. (1993). Crisis decision making: The centralization thesis revisited. Administration & Society 25(1): 12–45. Vis, B. and van Kersbergen, K. (2007). Why and how do political actors pursue risky reforms? Journal of Theoretical Politics 19(2): 153–172. Waelti, S. (2015). Financial crisis begets financial reform? The origin of the crisis matters. European Journal of Political Economy 40(December): 1–15. Weyland, K. (1998). The political fate of market reform in Latin America, Africa and Eastern Europe. International Studies Quarterly 42(4): 645–673. Williamson, J. (ed.) (1994). The Political Economy of Policy Reform. Washington, DC: Institute for International Economics.
132 Handbook of research on economic freedom Williamson, J. and Haggard, S. (1994). The political conditions for economic reform. In: The Political Economy of Policy Reform (ed. J. Williamson), 525–596. Washington, DC: Institute for International Economics. Young, A.T. and Bologna, J. (2016). Crises and government: Some empirical evidence. Contemporary Economic Policy 34(2): 234–249.
10. Democracy and economic freedom Abishek Choutagunta and Jerg Gutmann
INTRODUCTION Institutions govern almost all interactions in modern-day societies, be they economic, political, or social. Institutional economics tries to understand the causes and consequences of these various institutions. Here, we are interested in how different institutions are related to each other. More specifically, we are reviewing the literature on how the most basic political institutions, those creating political accountability via free and fair elections, are linked to economic institutions that are supposed to contribute to a society’s economic prosperity by protecting individuals’ economic freedom. An economically free society has two key features. First, and most importantly, it has well-defined and enforced property rights. Second, its members can freely conclude contracts and rely on the government to enforce all lawful contracts. Ideally, the combination of these two factors results in a free market that efficiently allocates resources. Economic freedom can be defined as a set of rights that give individuals the freedom to choose between economic transactions without excessive regulatory constraints and unlawful coercion by others (Gwartney and Lawson 2003). Therefore, economic freedom is a characterization of the degree to which an economy is a market economy (Berggren 2003). Economic freedom is distinct from other freedoms that may be enjoyed independently, or not, even if there exist complementarities between these freedoms. Political freedom and civil liberties can be understood as two elements of ‘personal freedom’, which together with economic freedom forms the overarching concept of ‘human freedom’ (see, for example, Vásquez and Porčnik 2019; and Berggren and Gutmann 2020). Institutions can be defined as commonly known rules that are used to structure recurrent interactions and come with a sanction mechanism (Voigt 2013; Gutmann and Voigt 2023). Political institutions, which constrain collective decision-making and collective action in the political sphere, can be distinguished from economic institutions that regulate exchange among private actors (Acemoglu et al. 2005). Here, we are interested in the effect of democracy, which can be understood as a bundle of institutions that ensures the accountability of politicians to the citizens via competitive elections, on economic freedom, which is safeguarded by institutions that facilitate free economic transactions by protecting property rights and enforcing private contracts.1 One reason why it might be important to understand whether democracy is conducive to economic freedom is that the latter is linked more clearly to economic growth (Blume and Voigt 2007). Theoretically, democracy can influence economic freedom in two ways. First, it can change the policies politicians want to implement in equilibrium. This preference-based view is, for This chapter is limited to the effect of democracy on economic freedom. For a broader exposition of the relationship between democracy and economic freedom, see, for example, Giavazzi and Tabellini (2005), Lawson and Clark (2010), and Bjørnskov (2018). 1
133
134 Handbook of research on economic freedom example, taken by Amin and Djankov (2014), Giuliano et al. (2013), and de Vanssay et al. (2005), who posit that since democratic politics can be described by the median voter theorem, politicians should promote economic freedom to increase the welfare of large parts of society, especially the middle class. However, the electorate in a democracy may not always favor economic freedom, either because they do not understand its efficiency-enhancing effects (Fernandez and Rodrik 1991; Fidrmuc 2003) or because they prefer short-term redistribution and regulation in their favor over any longer-term efficiency gains from economic freedom (Meltzer and Richard 1981). Second, democracy may affect the ability to implement economic reforms, i.e., to transition from one set of economic policies to another. Some authors in this strand of literature argue that democratic governments enjoy greater legitimacy and can thus implement economic reforms more easily (Dethier et al. 1999; Giuliano et al. 2013). However, autocrats may also not experience any relevant political costs and could thus expand economic freedoms more decisively than democrats in order to maximize future political rents (Clague et al. 1996; Pitlik 2008). In this chapter, we replicate the empirical approach used by de Haan and Sturm (2003) to test whether democracy influences subsequent changes in economic freedom in a country. Consistent with the results of de Haan and Sturm (2003), we find that increases in economic freedom between 1975 and 2020 can be explained by a country’s initial (1975) level of democracy in a sample of 102 countries. In other words, better democratic institutions appear to be associated with more economic freedom in the years to come, although this result is not entirely robust to using alternative democracy indicators. The remainder of this chapter is structured as follows. The next section discusses the empirical literature around democracy and economic freedom. The third section describes our empirical method, the underlying dataset that we use, and briefly discusses the results of the replication exercise. The fourths section concludes.
LITERATURE SURVEY The relationship between democracy and economic freedom has been explored in numerous publications. Lawson et al. (2020) cite 20 relevant studies in their survey on the use of Gwartney et al.’s (1996) Economic Freedom of the World (EFW) indicators. These studies either examine the relationship between democracy and economic freedom or at least use an indicator of democracy to explain a country’s level of economic freedom in the context of another research question. Lawson et al. note that while no studies point to a negative relationship, there are a number of studies that find no statistically significant association. Only a ‘slim majority’ found democracy to be positively and significantly related to economic freedom. Lawson et al. (2020) arrive at this conclusion by making a slightly vague distinction between the effect of democracy and that of political freedom.2 Since they find that there is over-
Note that Lawson et al. do not follow a distinction between two established concepts of democracy, namely, electoral and liberal democracy. They also do not provide exact definitions of democracy and political freedom. The distinction rather seems to follow the use of particular indicators produced by different organizations. Therefore, it remains unclear what kind of political systems their differentiated discussion of the literature is supposed to reflect. 2
Democracy and economic freedom 135 whelming empirical evidence that political rights, human rights, and civil liberties positively influence economic freedom, the evidence for a positive effect of democracy is strengthened if one does not distinguish democracy from political rights and civil liberties. In this study, we do not make this distinction and consider democracy to be a bundle of institutions that ensure effective majority decision-making. The seminal study of the effect of democracy on economic freedom is de Haan and Sturm (2003). They analyze data on developing countries covering the period 1975–1995 and show that a more positive trend in economic freedom can be explained by a country’s higher initial level of democracy. They use an array of robustness checks (different indicators of democracy, removal of outliers, and a different estimation technique) to demonstrate the robustness of this relationship. In a similar vein, de Vanssay et al. (2005) show how checks and balances contribute to higher economic freedom, whereas members of the executive that are beholden to special interests contribute to lower economic freedom scores.3 Murphy (2022) re-examines the findings of de Vanssay et al. (2005) for an extended sample period of 1975–2019 and finds no robust relationship between economic freedom and democracy. Pitlik (2008) links economic growth and democratic political institutions to the implementation of economic liberalization reforms. He defines an increase in the EFW index over a five-year period as a liberalization episode. Pitlik’s (2008) results demonstrate that democracies are more successful at expanding economic freedom than autocracies. During periods of poor economic growth, only democratic regimes tend to use the window of opportunity to implement economic reforms.4 Meanwhile, Krieger and Meierrieks (2016) show that moving from a semi-democracy to a full democracy is associated with an increase in EFW scores in a sample of 96 countries between 1971 and 2010. They also show that the ‘sound money’ and ‘international trade’ components of the EFW index drive this effect. Lundström (2005) suggests that democracy has a conditional effect on economic freedom. She examines the effect of democracy on the different sub-indicators of economic freedom in a sample of developing countries and finds that democracy affects only some dimensions of economic freedom. Her results indicate that democracy has a positive effect – in the sense of more economic freedom – on ‘government operations and regulation’ and ‘restraints on international exchange’, but no effect on ‘money and inflation’ and ‘discriminatory taxation’. Rode and Gwartney (2012) show that the effect of democratization on economic freedom changes over the years after the transition. They observe that while economic freedom in a country increases after its transition from autocracy to democracy, the rapid expansion of economic freedom tends to be short-lived. Newly transitioned democracies enjoy relatively high growth of economic freedom for the first five to ten years, but over time these gains in economic freedoms recede. These results are further bolstered by Murphy’s (2018) study, which finds that democracy has a positive effect on economic freedom only in the short run.
3 De Vanssay et al. (2005) study the following constitutional and political traits: the parliamentary form of government, military chief executives, term limits, whether the executive represents special interests (i.e., if the party of the executive is a rural, religious, regional, or nationalist party), and whether one party controls both the executive and the legislature. 4 See the literature survey of the effects of crises on economic freedom and market-oriented reforms by Pitlik (2024) in this Handbook.
136 Handbook of research on economic freedom While the studies cited above use some version of the EFW index, first published by Gwartney et al. (1996), to measure economic freedom, other studies rely on alternative indicators. Giuliano et al. (2013) examine the effect of democracy on economic liberalization reforms using sectoral regulation indices that they construct for 150 countries spanning 45 years between 1960 and 2004. Regulatory activities in six sectors are considered: financial, capital and banking sectors, product markets, agriculture, and trade. Giuliano et al. find that democracy facilitates liberalization in the majority of these sectors. Amin and Djankov (2014) construct a binary indicator of whether a country implemented one or more regulatory reforms in a year according to the World Bank’s Ease of Doing Business index. Their results indicate that the probability of economic liberalization reforms is significantly higher in democracies. Using an indicator of economic freedom derived from Coppedge et al.’s (2022) V-Dem database, Krieger (2022) shows that the quality of ‘economic institutions’ improves as countries democratize.5 In summary, the studies discussed above generally indicate a positive relationship between democratic institutions and economic freedom. However, it is also worth noting that the estimated effect of democratic institutions on economic freedom varies depending on the indicators used, the time period considered, and the countries in the sample. In light of these considerations, this chapter aims to revisit and further examine the relationship between democracy and economic freedom by utilizing updated indicators and a longer time-series than the one considered in a seminal study, thereby providing a more comprehensive understanding of the relationship.
REPLICATING AND EXTENDING DE HAAN AND STURM (2003) With over 300 citations, de Haan and Sturm (2003) have produced the most influential study in this literature. Here, we reproduce their empirical analysis based on contemporary data for the same as well as for a significantly extended time period. Our replication is, thus, not an exercise in validating whether the original study was executed carefully or whether its results remain unaffected by reasonable changes, for example with respect to its model specification. Instead, we are asking whether the same study based on today’s improved and extended data would yield the same conclusions. De Haan and Sturm (2003) study the time period 1975–1995 and estimate linear regression models with robust standard errors based on the following cross-sectional estimation equation (10.1): ∆ EFW i,1975−95 = α + β × EFW i,1975 + δ × Democracy i,1975 + ξ × Xi + ϵi
(10.1)
De Haan and Sturm (2003) indicate that their sample comprises only developing countries, but they do not specify how these are defined. Thus, we limit our sample to all countries that were not members of the OECD by 1975. Data on ‘economic freedom’ comes from Gwartney et al.’s (2022) EFW index. The EFW index scores (on a scale from 0 to 10) the level of economic Krieger’s (2022) composite index includes five V-Dem indicators: protection of property rights, effective access to justice, judicial independence, transparent laws with predictable enforcement, and rigorous and impartial public administration. 5
Democracy and economic freedom 137 freedom across 24 components in five key domains: size of government, legal system and security of property rights, sound money, freedom to trade internationally, and regulation. The component scores are averaged to derive the overall rating for each country-year. The original dependent variable computed by de Haan and Sturm (2003) measures the difference between economic freedom in 1995 and in 1975. As an extension, we construct the same dependent variable for the period 1975–2020 to see if the original relationship would hold over an even longer period of time. Gaps in the EFW index time series are filled by linear interpolation. We replicate the four main regression tables in the original study by de Haan and Sturm (2003) using three of the four original indicators to measure democracy. First, we rely on the two so-called Gastil indices of ‘political rights’ and ‘civil liberties’, which are still produced by Freedom House (2022). The Gastil indices are measured on a scale from 1 to 7 where lower values indicate more political rights or civil liberties.6 The scores are given by country analysts and expert advisors. Moreover, we use Freedom House’s classification of whether a country is ‘free’ (as opposed to partly free or not free), based on these indices. Finally, instead of the fourth indicator used by de Haan and Sturm (2003), a long outdated binary indicator of democracy by Gasiorowski (1996), we produce a similar indicator based on the binary democracy classification by Bjørnskov and Rode (2020). This indicator measures the share of the observed years between 1961 and 1992 in which a country is classified as an ‘electoral democracy’ by Bjørnskov and Rode’s (2020) dummy variable ‘democracy’.7 Since the original coding by Gasiorowski (1996) did not follow a transparent coding rule, it is difficult to evaluate how similar the two binary democracy indicators are conceptually. However, Gasiorowski’s definition of democracy appears to be broader than the minimalist definition of electoral democracy used by Bjørnskov and Rode (2020). Note that there is a weak conceptual overlap between economic freedom and one of our democracy indicators. The Gastil index of civil liberties includes a measure of the rule of law, which is also measured as part of one dimension of the EFW index. Following de Haan and Sturm (2003), all models include ‘initial economic freedom’ and an additional vector of control variables X that accounts for omitted causes of changes in economic freedom. Our data on ‘aid’ and ‘trade’, respectively measured as a share of GDP, come from the World Bank’s (2022) World development indicators. A dummy variable for ‘East Asia’ follows the regional classification of the United Nations. An indicator for a country’s ‘Spanish colonial origin’ comes from Teorell (2010). Data on PPP-adjusted ‘income per capita’ and its ‘growth rate’ come from version 10.01 of the Penn World Table by Feenstra et al. (2015). Only our measure of ‘political instability’ deviates from that employed by de Haan and Sturm (2003). We use the average of two conflict scores created by the Center for Systemic Peace to measure civil and international conflict (Marshall 2019). This indicator captures more forms of political instability than merely assassinations and revolutions and should thus be superior to the original control variable. All control variables are measured over
Political-rights scores are based on three subcategories: electoral process, political pluralism and participation, and functioning of the government. Civil-liberties scores cover four subcategories: freedom of expression and belief, rights of association and organization, rule of law, and personal autonomy and individual rights. 7 Bjørnskov and Rode (2020) code country-years as democratic based on whether elections are conducted, whether legislative and executive offices are contestable, and whether there has previously been a peaceful transition of power post-election. 6
138 Handbook of research on economic freedom the same time periods as in the original study. Table 10.1 provides summary statistics of our dependent and independent variables. Table 10.1
Descriptive statistics N
Mean
Standard
Minimum
Maximum
deviation Economic freedom 1975–1995, difference
102
0.84
0.88
–1.80
3.64
Economic freedom 1975–2020, difference
102
1.61
1.16
–3.20
3.98
Civil liberties 1975
96
4.70
1.66
1
7
Political rights 1975
96
5.05
1.87
1
7
Free 1975
96
0.18
0.38
0
1
Electoral democracy 1961–1992, average
102
0.24
0.34
0.00
1.00
Initial economic freedom 1975
102
4.92
1.07
2.99
9.15
Income per capita 1975
97
8.22
1.00
6.35
12.36
Aid 1971–1975, average
81
0.04
0.05
0.00
0.21
Trade 1970–1990, average
87
66.55
45.93
12.48
321.45
East Asia
102
0.04
0.20
0
1
Spanish colonial origin
102
0.17
0.37
0
1
Growth rate 1960–1975
81
0.59
0.67
–0.29
2.57
Political instability 1960–1974, average
93
0.26
0.50
0.00
2.63
Tables 10.2–10.5 show the results of our replication of Tables 1 to 4 in de Haan and Sturm (2003). To save space, we include control variables in groups instead of one by one. Models (1) to (5) in each table correspond to the original models. Model (6) uses an analogous dependent variable, but it is constructed based on changes in economic freedom between 1975 and 2020. Note that our sample size is larger than that of de Haan and Sturm (2003) since the databases have been updated. De Haan and Sturm (2003) report regression models based on 53 to 68 countries. Our model estimates are based on 64 to 102 countries. Table 10.2
Change in economic freedom, Gastil civil liberties index
(1)
(2)
(3)
(4)
(5)
(6)
1975–1995
1975–1995
1975–1995
1975–1995
1975–1995
1975–2020
–0.155**
–0.149**
–0.139*
–0.138**
–0.153*
–0.147*
(0.054)
(0.053)
(0.056)
(0.049)
(0.058)
(0.071)
–0.390***
–0.461***
–0.592***
–0.691***
–0.780***
–1.003***
(0.112)
(0.121)
(0.133)
(0.131)
(0.145)
(0.154)
0.189*
–0.133
–0.169
–0.318
–0.236
(0.075)
(0.116)
(0.116)
(0.176)
(0.216)
–7.306**
–5.250*
–6.608**
–1.898
(2.752)
(2.466)
(2.411)
(2.827)
0.007***
0.010***
0.014***
0.011***
(0.002)
(0.002)
(0.002)
(0.003)
East Asia
1.703***
2.203***
1.823***
(0.192)
(0.400)
(0.364)
Spanish colonial origin
0.737**
0.907**
0.555*
(0.266)
(0.262)
(0.260)
Civil liberties 1975 Economic freedom 1975 Income per capita 1975 Aid 1971–1975 Trade 1970–1990
Growth rate 1960–1975
–0.131
–0.130
(0.182)
(0.195)
Democracy and economic freedom 139
(1)
(2)
(3)
(4)
(5)
(6)
1975–1995
1975–1995
1975–1995
1975–1995
1975–1995
1975–2020
0.332
0.463**
(0.217)
(0.171)
Political instability 1960–1974 Observations R-squared
96
93
72
72
64
64
0.163
0.203
0.308
0.426
0.504
0.542
Note: OLS regression coefficients, robust standard errors in parentheses. The dependent variable is the change in economic freedom between 1975 and 1995 (models 1 to 5) or the change in economic freedom between 1975 and 2020 (model 6). Note that the Gastil index of civil liberties is coded such that lower values indicate more civil liberties. *p < 0.05, **p < 0.01, ***p < 0.001.
Table 10.3
Change in economic freedom, Gastil political rights index
(1)
(2)
(3)
(4)
(5)
(6)
1975–1995
1975–1995
1975–1995
1975–1995
1975–1995
1975–2020
–0.153**
–0.140**
–0.108*
–0.109*
–0.123*
–0.036
(0.046)
(0.046)
(0.051)
(0.044)
(0.054)
(0.069)
–0.387***
–0.445***
–0.556***
–0.660***
–0.748***
–0.939***
(0.101)
(0.110)
(0.126)
(0.124)
(0.139)
(0.158)
0.167*
–0.141
–0.180
–0.335
–0.221
(0.074)
(0.117)
(0.118)
(0.183)
(0.221)
–7.611**
–5.414*
–6.869**
–2.612
(2.752)
(2.472)
(2.391)
(2.996)
0.007***
0.010***
0.013***
0.011***
(0.002)
(0.002)
(0.003)
(0.003)
East Asia
1.502***
2.042***
1.590***
(0.162)
(0.439)
(0.424)
Spanish colonial origin
0.788**
0.965***
0.614*
(0.265)
(0.256)
(0.271)
Political rights 1975 Economic freedom 1975 Income per capita 1975 Aid 1971–1975 Trade 1970–1990
Growth rate 1960–1975 Political instability 1960–1974 Observations R-squared
–0.163
–0.138
(0.200)
(0.232)
0.314
0.466*
(0.215)
(0.201)
96
93
72
72
64
64
0.184
0.215
0.303
0.424
0.505
0.517
Note: OLS regression coefficients, robust standard errors in parentheses. The dependent variable is the change in economic freedom between 1975 and 1995 (models 1 to 5) or the change in economic freedom between 1975 and 2020 (model 6). Note that the Gastil index of political rights is coded such that lower values indicate more political rights. *p < 0.05, **p < 0.01, ***p < 0.001.
Table 10.2 reports results consistent with those in de Haan and Sturm (2003), as more civil liberties in 1975 (note that lower values in the Freedom House scale indicate more democracy) are associated with improvements in economic freedom between 1975 and 1995. This result is virtually unchanged when we try to explain changes in economic freedom until 2020. Table 10.3 uses an indicator of political rights and the results for the 1975 to 1995 period are again consistent with those produced by de Haan and Sturm (2003). However, the model fails to adequately predict changes in economic freedom up until 2020.
140 Handbook of research on economic freedom Table 10.4
Change in economic freedom, Freedom House dummy
(1)
(2)
(3)
(4)
(5)
(6)
1975–1995
1975–1995
1975–1995
1975–1995
1975–1995
1975–2020
Free 1961–1992
0.413
0.365
0.224
0.238
0.247
0.097
(0.209)
(0.208)
(0.203)
(0.218)
(0.265)
(0.366)
–0.328**
–0.406***
–0.536***
–0.641***
–0.723***
–0.934***
(0.097)
(0.111)
(0.129)
(0.129)
(0.143)
(0.143)
0.205*
–0.109
–0.148
–0.294
–0.210
(0.079)
(0.118)
(0.115)
(0.186)
(0.225)
–8.298**
–6.113*
–7.620**
–2.835
(2.845)
(2.549)
(2.501)
(2.905)
0.007***
0.010***
0.013***
0.011***
(0.002)
(0.002)
(0.003)
(0.003)
East Asia
1.504***
1.989***
1.581***
(0.169)
(0.465)
(0.438)
Spanish colonial origin
0.788**
0.964***
0.613*
(0.265)
(0.264)
(0.269)
Economic freedom 1975 Income per capita 1975 Aid 1971–1975 Trade 1970–1990
Growth rate 1960–1975 Political instability 1960–1974 Observations R-squared
–0.135
–0.131
(0.213)
(0.238)
0.354
0.479*
(0.221)
(0.191)
96
93
72
72
64
64
0.125
0.166
0.270
0.392
0.472
0.515
Note: OLS regression coefficients, robust standard errors in parentheses. The dependent variable is the change in economic freedom between 1975 and 1995 (models 1 to 5) or the change in economic freedom between 1975 and 2020 (model 6). Note that the binary democracy indicator reflects whether a country is classified as politically free. *p < 0.05, **p < 0.01, ***p < 0.001.
Whereas the results in Tables 10.2 and 10.3 support the robustness of the original findings, those in Table 10.5 suggest that these results are not robust to the inclusion of all control variables. The results in Table 10.4 are even statistically insignificant throughout all model specifications. Overall, our replication and extension of the seminal study by de Haan and Sturm (2003) draws a similar picture as the original results, but it is also consistent with more recent studies that fail to find consistent and robust evidence for a positive relationship between democracy and economic freedom (see especially the survey by Lawson et al. 2020). The results are strongest for indicators of political rights and weakest for a crude dummy variable indicating whether countries were free in 1975. This suggests that while there are good reasons to believe that democracy may be conducive to improvements in economic freedom, additional evidence is still needed to fully understand this relationship. Table 10.5
Change in economic freedom, Bjørnskov and Rode
(1)
(2)
(3)
(4)
(5)
(6)
1975–1995
1975–1995
1975–1995
1975–1995
1975–1995
1975–2020
0.834**
0.774**
0.716**
0.539*
0.591
0.518
(0.249)
(0.258)
(0.266)
(0.240)
(0.351)
(0.515)
–0.309***
–0.354***
–0.519***
–0.636***
–0.702***
–0.928***
(0.084)
(0.096)
(0.118)
(0.124)
(0.145)
(0.161)
Electoral democracy 1961–1992 Economic freedom 1975
Democracy and economic freedom 141
(1)
(2)
(3)
(4)
(5)
(6)
1975–1995
1975–1995
1975–1995
1975–1995
1975–1995
1975–2020
Income per capita 1975
0.142*
–0.157
–0.163
–0.322
–0.237
(0.070)
(0.117)
(0.121)
(0.175)
(0.213)
–7.265**
–5.575*
–7.204**
–2.496
(2.674)
(2.489)
(2.396)
(2.847)
0.008***
0.010***
0.013***
0.011***
(0.002)
(0.002)
(0.003)
(0.003)
1.221***
1.955***
1.584***
(0.305)
(0.403)
(0.365)
0.640*
0.772**
0.442
(0.250)
(0.271)
(0.263)
Aid 1971–1975 Trade 1970–1990 East Asia Spanish colonial origin Growth rate 1960–1975 Political instability 1960–1974 Observations R-squared
–0.154
–0.150
(0.191)
(0.204)
0.262
0.403
(0.234)
(0.221)
102
97
73
73
64
64
0.206
0.225
0.330
0.415
0.489
0.529
Note: OLS regression coefficients, robust standard errors in parentheses. The dependent variable is the change in economic freedom between 1975 and 1995 (models 1 to 5) or the change in economic freedom between 1975 and 2020 (model 6). Note that the binary democracy indicator reflects whether a country is an electoral democracy. *p < 0.05, **p < 0.01, ***p < 0.001.
CONCLUSION A review of the literature on democracy and economic freedom suggests that the empirical evidence from previous studies supports a positive effect of democracy on economic freedom, but not all studies find such a robust relationship. Replicating the seminal study by de Haan and Sturm (2003), we can largely confirm their findings, with the exception of estimates based on a crude dummy variable indicating whether countries were free in 1975. We conclude that the evidence at this time is strong enough to support a positive effect of democracy on economic freedom, but that future studies may still improve our understanding of this non-trivial empirical relationship. Proponents of economic freedom can see our results as encouraging in the sense that promoting democracy may be one way to also increase economic freedom. At the same time, critics of economic freedom should take notice that economic freedom does not seem to be something forced on societies by powerful elites, but it is countries where politicians are accountable to the majority of the population that choose to adopt policies and institutional changes that further economic freedom.
REFERENCES Acemoglu, D., Robinson, J.A. and Johnson, S. (2005). Institutions as a fundamental cause of long-run growth. In: Handbook of Economic Growth (eds. P. Aghion and S.N. Durlauf), 386–472. Amsterdam: North Holland. Amin, M. and Djankov, S. (2014). Democratic institutions and regulatory reforms. Journal of Comparative Economics 42(4): 839–854.
142 Handbook of research on economic freedom Berggren, N. (2003). The benefits of economic freedom: A survey. Independent Review 8(2): 193–210. Berggren, N. and Gutmann, J. (2020). Securing personal freedom through institutions: The role of electoral democracy and judicial independence. European Journal of Law and Economics 49(2): 165–186. Bjørnskov, C. (2018). The Hayek–Friedman hypothesis on the press: Is there an association between economic freedom and press freedom? Journal of Institutional Economics 14(4): 617–638. Bjørnskov, C. and Rode, M. (2020). Regime types and regime change: A new dataset on democracy, coups, and political institutions. Review of International Organizations 15(2): 531–551. Blume, L. and Voigt, S. (2007). The economic effects of human rights. Kyklos 60(4): 509–538. Clague, C., Keefer, P., Knack, S. and Olson, M. (1996). Property and contract rights in autocracies and democracies. Journal of Economic Growth 1(2): 243–276. Coppedge, M., Gerring, J., Knutsen, C.H., Lindberg, S.I., Teorell, J., Alizada, N., Altman, D., Bernhard, M., Cornell, A., Fish, M.S., Gastaldi, L., Gjerløw, H., Glynn, A., Grahn, S., Hicken, A., Hindle, G., Ilchenko, N., Kinzelbach, K., Krusell, J., Marquardt, K.L., McMann, K., Mechkova, V., Medzihorsky, J., Paxton, P., Pemstein, D., Pernes, J., Ryden, O., von Römer, J., Seim, B., Sigman, R., Skaaning, S.-E., Staton, J., Sundström, A., Tzelgov, E., Wang, Y., Wig, T., Wilson S. and Ziblatt, D. (2022). V-Dem country-year dataset v12, Varieties of Democracy (V-Dem) Project, University of Gothenburg. de Haan, J. and Sturm, J.-E. (2003). Does more democracy lead to greater economic freedom? New evidence for developing countries. European Journal of Political Economy 19(3): 547–563. de Vanssay, X., Hildebrand, V. and Spindler, Z. A. (2005). Constitutional foundations of economic freedom: A time-series cross-section analysis. Constitutional Political Economy 16(4): 327–346. Dethier, J.-J., Ghanem, H. and Zoli, E. (1999). Does democracy facilitate the economic transition? An empirical study of Central and Eastern Europe and the former Soviet Union. Policy Research Working Paper No. 2194, World Bank, Washington, DC. Feenstra, R.C., Inklaar, R. and Timmer, M.P. (2015). The next generation of the Penn world table. American Economic Review 105(10): 3150–3182. Fernandez, R. and Rodrik, D. (1991). Resistance to reform: Status quo bias in the presence of individual-specific uncertainty. American Economic Review 81(5): 1146–1155. Fidrmuc, J. (2003). Economic reform, democracy and growth during post-communist transition. European Journal of Political Economy 19(3): 583–604. Freedom House (2022). Freedom in the World 2022: The Global Expansion of Authoritarian Rule. Washington, DC: Freedom House. Gasiorowski, M.J. (1996). An overview of the political regime change dataset. Comparative Political Studies 29(4): 469–483. Giavazzi, F. and Tabellini, G. (2005). Economic and political liberalizations. Journal of Monetary Economics 52(7): 1297–1330. Giuliano, P., Mishra, P. and Spilimbergo, A. (2013). Democracy and reforms: Evidence from a new dataset. American Economic Journal: Macroeconomics 5(4): 179–204. Gutmann, J. and Voigt, S. (2023). Conceptualization and measurement of institutions. In: Routledge Handbook of Comparative Economic Systems (eds. B. Dallago and S. Casagrande), 241–255. London: Routledge. Gwartney, J.D., Block, W. and Lawson, R.A. (eds) (1996). Economic Freedom of the World: 1975–1995. Vancouver: Fraser Institute. Gwartney, J.D. and Lawson, R.A. (2003). The concept and measurement of economic freedom. European Journal of Political Economy 19(3): 405–430. Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Krieger, T. (2022). Democracy and the quality of economic institutions: Theory and evidence. Public Choice 192(3–4): 357–376. Krieger, T. and Meierrieks, D. (2016). Political capitalism: The interaction between income inequality, economic freedom and democracy. European Journal of Political Economy 45(December): 115–132. Lawson, R.A. and Clark, J.R. (2010). Examining the Hayek–Friedman hypothesis on economic and political freedom. Journal of Economic Behavior & Organization 74(3): 230–239. Lawson, R.A., Murphy, R.H. and Powell B.W. (2020). The determinants of economic freedom: A survey. Contemporary Economic Policy 38(4): 622–642.
Democracy and economic freedom 143 Lundström, S. (2005). The effect of democracy on different categories of economic freedom. European Journal of Political Economy 21(4): 967–980. Marshall, M.G. (2019). Major episodes of political violence (MEPV) and conflict regions, 1946–2018. Database. Center for Systemic Peace, Vienna, VA. Meltzer, A.H. and Richard, S.F. (1981). A rational theory of the size of government. Journal of Political Economy 89(5): 914–927. Murphy, R.H. (2018). Imperfect democracy and economic freedom. Journal of Public Finance and Public Choice 33(2): 197–224. Murphy, R.H. (2022). The constitution of ambiguity: The effects of constitutions on economic freedom. Economic Affairs 42(2): 240–258. Pitlik, H. (2008). The impact of growth performance and political regime type on economic policy liberalization. Kyklos 61(2): 258–278. Pitlik, H. (2024). The effects of crises on economic freedom and market-oriented reforms: A survey. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 117–132. Cheltenham: Edward Elgar Publishing. Rode, M. and Gwartney, J.D. (2012). Does democratization facilitate economic liberalization? European Journal of Political Economy 28(4): 607–619. Teorell, J. (2010). Determinants of Democratization: Explaining Regime Change in the World, 1972–2006. Cambridge: Cambridge University Press. Vásquez, I. and Porčnik, T. (2019). The Human Freedom Index 2019: A Global Measurement of Personal, Civil, and Economic Freedom. Washington, DC: Cato Institute. Voigt, S. (2013). How (not) to measure institutions. Journal of Institutional Economics 9(1): 1–26. World Bank (2022). World development indicators. Database. World Bank, Washington, DC.
11. Government ideology and economic freedom: new empirical evidence Klaus Gründler, Armin Hackenberger and Niklas Potrafke
INTRODUCTION Government ideology has been shown to influence a large set of economic policies and outcomes. Ideologies typically cover a wide range of beliefs, including, for instance, ideas on what should be the best form of government (e.g., autocracy or democracy) or the best economic system (e.g., capitalism or socialism). The economics literature mainly focuses on beliefs about the functioning of the economy, and often distinguishes parties into camps depending on their members’ – broadly defined – preferences for public service (e.g., Pickering and Rockey 2011). Governments that advocate a large size and scope of government are usually defined to have ‘leftwing’ ideology. A large size and scope of government includes, for example, redistributive taxes and transfers, generous public expenditure schemes and strict regulation of labor and product markets. At the other end of the political spectrum are parties with strong beliefs in free markets, which typically prefer a smaller size of government and fewer regulations (‘rightwing’ ideology). While political parties often have clear-cut ex ante beliefs about economic policies, an important question is whether policymaking in practice takes different forms among parties with different ideologies. In this chapter, we use the most recent and comprehensive data collection on economic freedom of the Fraser Institute, providing new empirical evidence on the consequences of government ideology for policymaking based on a sample of 101 countries observed between 2000 and 2020. Our measure for policymaking is economic freedom, which encompasses many important aspects of economic policy, including the design of fiscal policies and the regulation of markets. We provide three main results. The first main result is that government ideology impacts economic freedom. Our results show that economic freedom is lower under governments with leftwing ideology than under governments with rightwing ideology. This result is statistically significant at the 1 percent level when we compare means of economic freedom conditional on government ideology over time and it re-appears in econometric models that account for time-invariant confounding factors via fixed effects for countries. Our second main result is that the relation between government ideology and economic freedom vanishes once we specify two-way fixed effects models that account for time-invariant heterogeneity across countries and year-specific shocks and trends. These specifications exploit within-country variation, measuring how economic freedom changes in an individual country once there was a change in government, e.g., from a leftwing to a rightwing government. A possible explanation of these results is that there is heterogeneity in the groups of governments with leftwing and rightwing ideology, and that the negative impact on economic freedom is initiated only by a specific subset of governments. 144
Government ideology and economic freedom 145 Our third main result is that populism is the missing dimension to explain the nexus between government ideology and economic freedom (see also Rode and Revuelta 2015, and Celico and Rode 2023). While populism in politics has a long history, there was an unprecedented rise in populism during the past decades, which gained pace since the mid-2010s (Funke et al. 2020 report that 25 percent of the governments in their sample were classified as populist in 2018). An empirical regularity reported in prior studies is that populist leaders tend to use expansionary fiscal policies that create a short-lived economic boom, but unsustainable macroeconomic policies ultimately end in economic crises. These policies are what Dornbusch and Edwards (1991) call the ‘self-destructive feature’ of populism. What follows from these observations is that the anti-establishment rhetoric of and economic policies under populist politicians are likely to also deteriorate economic freedom. Populism often goes hand in hand with extreme government ideologies at both ends of the spectrum, and may hence influence the relationship between ideology and economic freedom. Distinguishing between populist leftwing government and non-populist parties with leftwing ideology, we provide evidence on how populism relates to the nexus between government ideology and economic freedom: for non-populist governments, economic freedom of rightwing and leftwing parties is almost comparable. There are, however, major differences between populist leftwing governments and governments with other ideologies. The data show that economic freedom is much lower in populist leftwing governments than under any other form of government. Consistent with these summary statistics, our results demonstrate that the negative effect of leftwing ideology is driven by leftwing populists in power. Our chapter consists of three main parts. We start by a discussion of the theory of how government ideology influences economic policies and outcomes, what the fundamental building blocks of individual party ideologies are, and how they are related to government ideology and economic freedom. In the second part, we survey the empirical literature on the effects of government ideology on the design of economic freedom. Finally, the third part includes our new empirical evidence on the association between government ideology and economic freedom.
BACKGROUND Partisan Theories and the Role of Government Ideology The partisan theories describe how government ideology influences economic policies and outcomes (Hibbs 1977; Chappell and Keech 1986; Alesina 1987).1 Under the classical partisan approach, the economy is modelled by a Phillips curve which describes a negative relationship between unemployment and inflation. Governments choose a specific point on the Phillips curve by implementing fiscal and monetary policies. If unemployment is caused by cyclical factors, expansionary fiscal and monetary policies give rise to decreasing unemployment and increasing inflation. Leftwing governments typically choose a combination of inflation and unemployment that put greater weight on employment, and hence implement more expansionary fiscal and monetary policies than rightwing governments. Clearly, governments only design monetary policies when central banks depend on governments’ directives. When 1 On surveys of the empirical literature on partisan politics see, for example, Schmidt (1996), Potrafke (2017, 2018) and Wenzelburger and Zohlnhöfer (2022).
146 Handbook of research on economic freedom central banks are independent, governments have means to influence monetary policies by, for example, appointing politically aligned members of the central bank council.2 The main motivation for a particular combination of inflation and employment on the Phillips curve chosen by leftwing and rightwing governments is to gratify the needs of their constituencies. Leftwing governments have been described to gratify the needs of blue-collar workers. Rightwing governments, on the other hand, put greater weight on the needs of white-collar workers and entrepreneurs. The reason for this focus is that both constituencies care more about either employment or inflation. Blue-collar workers are usually assumed to be more concerned about the threat of becoming unemployed than white-collar workers and entrepreneurs. White-collar workers often have higher education levels than blue-color workers and better fallback positions. Constituencies of rightwing parties, in turn, are often wealthier than voters with leftwing ideology and depend to a larger extent on capital income.3 Hence, rightwing political parties have strong incentives to keep price increases at moderate levels. The partisan theories have been developed for two-party systems as being present, for example, in the United States or (for a long time) in the United Kingdom. The theories have been tested, however, also for economic policies and outcomes in countries with multi-party systems such as Germany or Sweden, because political parties in these countries have long belonged to political camps that can be classified as leftwing and rightwing. In recent years, however, party systems have changed in many industrialized countries. New political parties such as Green parties and populist parties have entered the political arena. ‘Populism’ in the political economy literature is often defined to classify leaders who separates the society into two groups, channeling a conflict between ‘the true people’ and ‘the elite’. How Green and populist politicians in power have influenced economic policies and outcomes has been examined in empirical studies. For example, the first Green-led government in the German states did not change macroeconomic policies according to the predictions of the classical partisan theories. It did promote, however, wind energy to a smaller extent than a synthetic counterfactual government (Potrafke and Wüthrich 2020). Populist rightwing mayors in the Austrian state of Carinthia increased polarization within society (Doerr et al. 2021). How populism affects economic freedom is discussed by Bergh and Kärnä (2024) in this volume. Leftwing and rightwing governments also regulate labor and product markets in different manners. For example, leftwing governments may advocate stricter employment protection and more generous unemployment benefits than rightwing governments. They may also want to have network industries such as gas, electricity, telecommunication, railways and airlines to be controlled by the governments. Rightwing governments, by contrast, prefer network industries to be deregulated and privatized (Potrafke 2010). The concept of economic freedom integrates many fields of economic policies, including fiscal and monetary policies as well as the regulation of markets (e.g., Berggren 2003). The economic freedom indices aggregate several important aspects of economic policymaking into a unidimensional score that very broadly reflects the economic viewpoints of a government.
On ideology-induced monetary policies see, for example, Belke and Potrafke (2012), Giesenow and de Haan (2019), Binder (2021) and Cahan et al. (2021). 3 Clearly, low-income citizens are also harmed by inflation. They spend, for example, a large share of their income on consumption. 2
Government ideology and economic freedom 147 It is therefore a well-suited measure of economic policy to investigate how leftwing and rightwing governments implement economic policies and influence economic outcomes. Previous Evidence on Government Ideology and Economic Freedom The effects of government ideology on economic freedom have been examined at the national and subnational level. The results show that government ideology has influenced economic freedom at the national level (Crampton 2002; Jäger 2017; Murphy 2019; Castro and Martins 2021a, b). Rightwing governments have been shown to be more active in promoting economic freedom than leftwing governments. The relationship between government ideology and economic freedom is quite pronounced and has been shown to be present based on data until the year 2017. In emerging countries, rightwing governments promoted economic freedom in a more rigorous way than rightwing governments in established industrialized countries. Populist left-wing governments decreased economic freedom to a large extent (Castro and Martins 2021a). Political institutions affected the nexus between government ideology and economic freedom: rightwing governments in democracies strongly increased economic freedom (Castro and Martins 2021b). Prior studies also showed that the individual attributes of economic freedom are associated differently with party ideology. When focusing on components of economic freedom that give rise to political polarization and that are under the discretion of national governments, such as size of government, ideology-induced effects are even stronger than when considering the overall indices as such (Jäger 2017). In the US states, overall economic freedom has hardly been more pronounced under Republican than Democratic governors and state governments (Bjørnskov and Potrafke 2013). Republican-controlled states had lower taxes than states ruled by Democrats (Gu et al. 2017). In the Canadian provinces, rightwing governments provided more labor market freedom than leftwing governments (Bjørnskov and Potrafke 2012). For the German states, there is evidence that rightwing state governments led to generally higher levels of economic freedom than leftwing governments (Potrafke 2013). This effect is driven by the West German states. In the East German states, government ideology was not correlated with economic freedom, a result that is likely to be based on the lack of an established democratic party system in East Germany.
NEW EMPIRICAL EVIDENCE: GOVERNMENT IDEOLOGY AND ECONOMIC FREEDOM Revisiting the Link between Government Ideology and Economic Freedom with New Data The previous evidence on the link between government ideology and economic freedom is based on empirical estimates that consider the period until the year 2017. There have been several major trends in politics that impacted both government ideology and the degree of economic freedom. Starting in the mid-2010s, there has been a stark increase in populist parties and governments, ultimately leading to a major change in the political landscapes (e.g., Funke et al. 2020). The British Brexit and the election of Donald Trump as US president, both taking place in 2016, are major examples of changing political landscapes, but populists have been
148 Handbook of research on economic freedom on the rise also in other countries, including Germany, Finland, Italy, Brazil, and Russia. At the same time, intensified competition with China and other countries, the Russian invasion of Crimea in 2014, and the rise of the Far-East led to the resurrection of competition between systems. Against the backdrop of these developments that are unparalleled in the younger history of many countries, a key question is whether the evidence on the ideology-freedom nexus still persists. Relatedly, the economic views of populist leaders are remarkably different from the position of traditional leftwing and rightwing parties. An important question is, therefore, whether the rise of populism has impacted the relationship between ideology and economic freedom. Data Economic freedom We use the Economic Freedom of the World index compiled by the Fraser Institute to quantify a nations’ degree of economic freedom. The index aggregates 42 individual attributes of economic freedom and distinguishes between five categories of economic freedom: (i) size of government, (ii) legal system and property rights, (iii) sound money, (iv) freedom to trade internationally and (v) regulation. The index is available for 165 countries at a yearly base from 2000 to 2020 and ranges from 0 (lowest) to 10 (highest economic freedom). See, for example, Gwartney et al. (2022) for details. Government ideology Measuring government ideology is straightforward for OECD countries with traditional and established political parties (e.g., Bjørnskov 2005, 2008, and Potrafke 2009, 2017), but it is quite difficult for developing countries. When samples include both developed and developing countries, scholars often use data from the Database of Political Institutions (Cruz et al. 2021), which considers the ideology of the chief executive. For this analysis, we will focus on rightwing (conservative, Christian democratic) and leftwing (communist, socialist, social democratic) parties. Government ideologies are usually difficult to compare across countries, particularly when the sample includes many countries. For example, the German Social Democrats (SPD) are very different from many socialist parties in Latin America, and the National Front from France differs in many dimensions from traditional conservative parties in Europe. Coding of government ideology therefore primarily focuses on changes within countries, with systematical cross-national differences in the political landscape being absorbed by fixed effects in empirical specifications. Sample Joint availability of data allows us to measure economic freedom and political ideology for 101 countries over a time span of 21 years. Around 53 percent of country-year observations are coded as rightwing, and about 47 percent as leftwing.4 Our final sample includes 1,444 country-year observations. Examples of rightwing heads of governments include George W. 4 The entire dataset on economic freedom contains more than 150 countries. Of these roughly 3,000 country-year observations, 23 percent are coded as rightwing, 26 percent as leftwing, around 8 percent have a ‘center’ ideology, and the remaining 43 percent are unidentified. After excluding the latter two categories, 1,444 country-year observations from 101 countries remain.
Government ideology and economic freedom 149 Bush and Donald Trump in the United States or Hungary’s Viktor Orbán. Leftwing heads of state were, for example, Barack Obama in the United States or Evo Morales in Bolivia. Populism Following Funke et al. (2020), we understand a populist to be a leader who separates the society into two groups, channeling a conflict between ‘the true people’ and ‘the elite’. Populists present themselves to be fighting for the people against said establishment. Funke et al. (2020) surveyed 770 pieces of literature on populism and used these to classify country-year observations for 60 countries up to the year 2018 as either populist or non-populist. We use their data to identify 729 of our country-year observations as either populist or non-populist, on top of differentiating them by leftwing and rightwing. Economic Freedom and Government Ideology at a Glance We first provide correlational evidence on the relationship between economic freedom and government ideology by comparing the mean levels of economic freedom under leftwing and rightwing heads of government. The results, presented in Figure 11.1, point to pronounced empirical regularities: between 2000 and 2020, the mean level of the overall economic freedom index was 7.3 under rightwing and 6.8 under leftwing governments. The result of a t-test shows that the difference in measured economic freedom is statistically significant at the 1 percent level. The comparison of group means between governments with leftwing and rightwing ideology masks the great degree of heterogeneity in our sample, both over time and within a given year. Figure 11.2 takes a closer look at the plurality of country-year observations for rightwing and leftwing governments in our sample. Panel A of the figure plots the distribution of economic freedom scores for each year separately for rightwing (full line, diamonds) and leftwing (dashed line, circles) governments. The lines show the development of means for both groups over time. At the beginning of the 21st century, we observe little differences in economic freedom between leftwing and rightwing governments. Since then, however, the two camps diverged, mostly driven by an increase in the average economic freedom of rightwing governments, which increased steadily since the turn of the millennium. The divergence reached its maximum during the mid-2010s and flattened at the end of the sample period. Over the entire period, economic freedom, on average, stagnated under leftwing governments. Looking at the distribution of economic freedom scores reveals great heterogeneity across countries, but also points to a number of distinct empirical patterns: while there are many leftwing-ruled and rightwing-ruled countries at the top of the economic freedom distribution in each year, the observations at the bottom of the distribution are almost exclusively composed of leftwing governments. Populist parties have enjoyed a great deal of electoral success during the 2010s. Panel B of Figure 11.2 therefore distinguishes between populist (dashed lines) and non-populist (full lines) parties. Excluding populist from non-populist governments fundamentally changes the empirical patterns, uncovering two new sets of stylized facts: First, the lower score of economic freedom in leftwing-ruled countries is almost exclusively driven by leftwing-populists, but there is a (much smaller) gap also persisting between non-populist governments. Second, we also observe stark differences between populist governments. While economic freedom
150 Handbook of research on economic freedom
Note: The figure shows the differences in means of the economic freedom index of the Fraser Institute between governments with leftwing and governments with rightwing ideologies in 101 countries, 2000–2020. A t-test reveals that the unconditional differences in means are statistically significant at the 1 percent level.
Figure 11.1
Mean comparison of economic freedom levels, leftwing versus rightwing governments
deteriorates under leftwing-populists, rightwing populism, on average, goes hand in hand with more market-oriented policies. There is, however, also large heterogeneity in the group of rightwing populist governments, illustrated by the strong dispersion of the economic freedom distribution. Cross-country Evidence Estimation strategy The unconditional comparison of means in Figures 11.1 and 11.2 are informative, but the relationship between government ideology and economic freedom may be confounded by factors that simultaneously correlate with both ideology and economic freedom. There may also be time-specific shocks and trends that impact the relationship between ideology and economic freedom. We account for these factors by using panel data techniques to portray the correlation between government ideology and economic freedom conditional on fixed country and fixed period effects. Doing so exploits within-country variation, that is, it measures how economic freedom changed on average when government ideology changed in an individual country. The empirical model is specified as follows: EF Iit = β LEF Tit + γ Ii + δ Tt + ε it
(11.1)
Government ideology and economic freedom 151 where the index of economic freedom EFI of country i in year t is related to a dummy indicating whether country i was governed by a leftwing chief executive (LEFT = 1) as opposed to a rightwing head of state (LEFT = 0). We account for all time-invariant country-specific factors that may impact economic freedom and government ideology (e.g., cultural norms, political history, geography, dominant national schools of thought, Socialist legacy, etc.) by including a full set of country-specific dummy variables. We also condition our estimates on trends and period-specific shocks by including fixed effects for all periods in our sample. The idiosyncratic error εit absorbs all time-varying country-specific shocks. We estimate equation (11.1) by Ordinary Least Squares (OLS) and specify standard errors that are robust to arbitrary heteroskedasticity. Main results Table 11.1 presents our main results, gradually developing the full specification described in equation (11.1). Column (1) reports results from a parsimonious model that relates the economic freedom (EF) index to the dummy variable of leftwing ideology. The estimated coefficient on the leftwing government dummy shows that leftwing governments’ economic freedom index is 0.5 units lower than economic freedom under rightwing governments, a difference that is statistically significant on all conventional significance levels. The estimated parameter is economically sizable: a difference of 0.5 units corresponds to 0.5/0.88 = 0.6 standard deviations of the economic freedom index, pointing to large differences in economic freedom across government ideologies. In column (2), we include fixed effects for all periods in the sample to capture general trends in economic freedom and global shocks in our sample. Doing so yields little changes in
152 Handbook of research on economic freedom
Note: Panel A shows the distribution (dots) and mean across countries (line) over time, by the ideology of the executive of each country. Diamonds or a full line stand for rightwing, circles or a dashed line stand for leftwing ideology. The plot is based on 1,444 county-year observations from 101 countries for 2000–2020. Panel B further highlights populist leaders. For comparison, the non-populist mean economic freedom index is displayed with full lines, the populist mean with dashed lines. The plot is based on 729 country-year observations from 59 countries for 2000–2018.
Figure 11.2
Distribution of economic freedom per ideological camp and development of group means over time. Panel A (previous page): Distribution of economic freedom and group means over time, by government ideology. Panel B (above): Distribution of economic freedom and group means over time, by government ideology and populism
the empirical results. The parameter estimate retains its negative sign in column (3) when we account for time-invariant country fixed effects, but the difference between leftwing and rightwing governments in these models is not statistically distinguishable from zero. The parameter estimate is positive and lacks statistical significance in column (4) when we include both year fixed effects and country fixed effects. Results for the subcategories of economic freedom The economic freedom index of the Fraser Institute consists of five subcategories, which refer to different aspects of economic freedom, with varying discretions of governments to alter these categories. We next examine whether the main results are driven by a particular sub-category of economic freedom, re-estimating the empirical models specified in Table 11.1 for each sub-category. Figure 11.3 presents results from the parsimonious model that measures unconditional correlations between government ideology and economic freedom (‘parsimonious’) and the comprehensive model that includes a full set of fixed effects for countries and years (‘comprehensive’). The results are in line with the benchmark estimates. For each
Government ideology and economic freedom 153 Table 11.1
Main results, government ideology and economic freedom
(1)
(2)
(3)
(4)
EF Index
EF Index
EF Index
EF Index
Ideology (1 = Left)
–0.512***
–0.515***
–0.002
0.006
(0.044)
(0.044)
(0.019)
(0.019) Yes
Year FE
–
Yes
–
Country FE
–
–
Yes
Yes
Observations
1,444
1,444
1,444
1,444
Adjusted R2
0.083
0.080
0.918
0.930
Note: The table shows the results of the estimations of the (conditional) correlation between the political ideology of a country’s executive and economic freedom as measured by the Fraser Institute’s Economic Freedom of the World index. ‘Left’ is a dummy indicating whether a country’s executive was coded as leftwing in a given year. ‘Year FE’ and ‘Country FE’ denote fixed effects for years and countries, respectively. Estimations are based on a sample of 1444 country-year observations from 101 countries spanning from 2000 to 2020. Standard errors are adjusted to arbitrary heteroskedasticity and are reported in parentheses. Asterisks denote conventional significance levels: *p < 0.1, **p < 0.05, ***p < 0.01.
Note: The figure shows re-estimates of our baseline models using the five subcategories of the economic freedom index constructed by the Fraser Institute. The empirical models are specified identically to the benchmark results in Table 11.1. ‘Parsimonious model’ refers to the model reported in column (1) of Table 11.1, showing unconditional correlations between government ideology and economic freedom, while ‘comprehensive model’ refers to the model reported in column (4) of Table 11.1, showing results from the fully specified model that also includes fixed effects for countries and years. The sample comprises 101 countries, 2000–2020.
Figure 11.3
Government ideology and economic freedom, sub-categories of economic freedom
154 Handbook of research on economic freedom category, we observe a negative correlation between leftwing ideology and economic freedom that is statistically significant at the 1 percent level. Once we condition on fixed effects for countries, however, this relationship disappears. Interpretation and discussion of the results Taken together, the results reported in Table 11.1 and Figure 11.3 imply that, from 2000 to 2020, there is a negative correlation between leftwing ideology of the government and economic freedom. The results from a two-way fixed effects model suggest, however, that the differences in economic freedom were driven to a large extent by country-specific characteristics. A related explanation is that there is heterogeneity also within the groups of leftwing and rightwing governments. When only a specific subset of observations in the group of leftwing governments initiates a decline in economic freedom, the results would be confounded by ‘false positives’, as the within-estimator treats all observations that are coded as ‘left-wing’ identically. Against the backdrop of the unprecedented rise in populism during the past decades, we hypothesize that populism may be the missing link between government ideology and economic freedom. Put differently, we hypothesize that only left-wing populist parties trigger a change in economic freedom, whereas left-wing governments that are not led by populist leaders do not differ from their right-wing counterparts. The Role of Populism We argue that populism is another important ideological dimension governing over measured economic freedom, complementing the traditional separation between ‘leftwing’ and ‘rightwing’. This assumption is plausible given the fundamental differences in worldviews that result in pronounced differences in economic freedom between populist and non-populist governments (Panel B of Figure 11.2). Following Funke et al. (2020), we understand a populist to be a leader who separates the society into two groups, channeling a conflict between ‘the true people’ and ‘the elite’. Populists present themselves to be fighting for the people against said establishment. Funke et al. (2020) surveyed 770 pieces of literature on populism and used these to classify country-year observations for 60 countries up to the year 2018 as either populist or non-populist. We rely on their data to identify 729 of our country-year observations as either populist or non-populist, on top of differentiating them by leftwing and rightwing. To account for populism, we augment our empirical specification by a dummy variable indicating whether country iat time twas governed by a populist: EF Iit = β LEF Tit + θPO Pit + φ (LEF Tit × PO Pit ) + γ Ii + δ Tt + ε it
(11.2)
where PO Pit is our measure of populism. The main coefficient of interest, φ, measures the impact of the interaction term between leftwing ideology and populism. Main results for populism The results conditional on populist parties are reported in Table 11.2. The table replicates the model specification used for the baseline results reported in Table 11.1. The main finding is that economic freedom is lower under leftwing populists than under any other government ideology. The estimated parameters of the interaction term between leftwing government ideology and being populist are statistically significant at the 1 percent level in columns (1) to (4).
Government ideology and economic freedom 155 Table 11.2
Government ideology and economic freedom, results conditional on populism
(1)
(2)
(3)
(4)
EF Index
EF Index
EF Index
EF Index
Ideology (1 = left)
–0.188***
–0.163***
0.002
0.023
(0.054)
(0.054)
(0.019)
(0.019)
Populist
–0.111*
–0.143**
0.173**
0.122*
(0.064)
(0.068)
(0.081)
(0.070)
–0.718***
–0.790***
–0.364***
–0.406***
(0.117)
(0.120)
(0.108)
(0.110)
Year FE
–
Yes
–
Yes
Country FE
–
–
Yes
Yes
Observations
729
729
729
729
Adjusted R2
0.147
0.163
0.890
0.903
Left×Populist
Note: The table shows the results of the estimations of the (conditional) correlation between the political ideology of a country’s executive and economic freedom and economic freedom as measured by the Fraser Institute’s Economic Freedom of the World index. ‘Left’ (‘Populist’) is a dummy indicating whether a country’s executive was coded as leftwing (populist) in a given year. ‘Left×Populist’ gives the two dummies’ interaction term, only taking the value 1 for leftwing-populist country-year observations. ‘Year FE’ and ‘Country FE’ denote fixed effects for years and countries, respectively. Estimations are based on a sample of 729 country-year observations from 59 countries spanning from 2000 to 2018. Standard errors are adjusted to arbitrary heteroskedasticity and are reported in parentheses. Asterisks denote conventional significance levels: *p < 0.1, **p < 0.05, ***p < 0.01.
First, we focus on the parsimonious model specifications, displayed in columns (1) and (2). In line with our baseline findings reported in Table 11.1, the association between leftwing ideology and lower economic freedom is economically and statistically significant. The parameter estimates of the government ideology variables in Table 11.2 are, however, smaller than in Table 11.1. The difference in economic freedom between non-populist governments is much smaller than the difference between all (populist and non-populist) governments. On average, the difference between a non-populist rightwing and a populist rightwing government is negative, and of about the same size as the difference between non-populist rightwing and non-populist leftwing governments, and less than a quarter of one standard deviation in economic freedom. Leftwing, populist governments, however, are associated with much lower levels of economic freedom, as illustrated by the interaction term’s coefficient of –0.718 and –0.79. In expectation terms, a leftwing, populist country’s economic freedom index is about one unit lower than the one of a non-populist, rightwing country. In columns (3) and (4), we extend the empirical specification by accounting for cross-country heterogeneity. Augmenting the model by fixed effects, we observe no statistically significant difference in economic freedom between non-populist leftwing and rightwing governments. Rightwing populist governments are even associated with higher levels of economic freedom, on average, than their non-populist counterparts. The main result of Table 11.2 is that the negative association between government ideology and economic freedom is driven by leftwing populist governments. Results for the subcategories of economic freedom We examine whether the results are driven by individual subcategories of economic freedom that are associated with the worldviews of leftwing populists. In Figure 11.4, we present re-estimates of our baseline results for populism, reporting unconditional correlations (‘par-
156 Handbook of research on economic freedom
Note: The figure shows re-estimates of our baseline models using the five subcategories of the economic freedom index constructed by the Fraser Institute. The empirical models are specified identically to the benchmark results in Table 1. ‘Parsimonious model’ refers to the model reported in column (1) of Table 11.1, showing unconditional correlations between government ideology and economic freedom, while ‘comprehensive model’ refers to the model reported in column (4) of Table 11.1, showing results from the fully specified model that also includes fixed effects for countries and years. The sample comprises 59 countries, 2000–2018.
Figure 11.4
Government ideology and economic freedom, subcategories of economic freedom
simonious’) and a fully specified model that includes fixed effects for countries and years (‘comprehensive’). The results show that the effect of leftwing populism mainly materialized through protectionist policies and a decline in sound money. We observe somewhat weaker effects for regulation policies.
CONCLUSION Government ideology is an important predictor of economic freedom. Previous studies have shown that economic freedom was lower under leftwing than rightwing governments. We use the most recent economic freedom data for the period 2000–2020 and re-examine the nexus between government ideology and economic freedom. Doing so is interesting because party systems have changed in many countries since the last studies on the topic have been conducted. New political parties such as the Greens and populist parties have entered the political arena and enjoyed electoral success. We find that economic freedom was still lower under leftwing than rightwing governments when using the most recent data, a result that is strong when comparing economic freedom across countries but that lacks statistical significance when considering fixed country effects in an econometric model. Our results show that populism is the missing dimension that links government ideology to economic freedom: populist leftwing governments had significantly lower economic freedom than governments with other ideologies. A prime example is
Government ideology and economic freedom 157 Argentina where the populist leftwing Kirchner-governments pushed back economic freedom to a large extent. Future research should arrive at causal effects on how government ideology influences economic freedom. Identification strategies may include regression-discontinuity designs (RDD) that exploit tight vote margins of incumbent governments. Difference-in-differences (DiD) and synthetic control (SC) models should be used to examine interesting case studies when exogenous variation gave rise to changes in governments. Clearly, RDD, DiD and SC models help to produce internally valid estimates. We will need many well executed, internally valid studies to make inferences about how government ideology influences economic freedom.
REFERENCES Alesina, A. (1987). Macroeconomic policy in a two-party system as a repeated game. Quarterly Journal of Economics 102(3): 651–678. Belke, A. and Potrafke, N. (2012). Does government ideology matter in monetary policy? A panel data analysis for OECD countries. Journal of International Money and Finance 31(5): 1126–1139. Berggren, N. (2003). The benefits of economic freedom: A survey. Independent Review 8(2): 193–211. Bergh, A. and Kärnä, A. (2024). Economic freedom and populism. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 297–314. Cheltenham: Edward Elgar Publishing. Bjørnskov, C. (2005). Does political ideology affect economic growth? Public Choice 123(1–2): 133–146. Bjørnskov, C. (2008). The growth–inequality association: Government ideology matters. Journal of Development Economics 87(2): 300–308. Bjørnskov, C. and Potrafke, N. (2012). Political ideology and economic freedom across Canadian provinces. Eastern Economic Journal 38(2): 143–166. Bjørnskov, C. and Potrafke, N. (2013). The size and scope of government in the U.S. states: Does party ideology matter? International Tax and Public Finance 20(4): 687–714. Binder, C.C. (2021). Political pressure on central banks. Journal of Money, Credit and Banking 53(4): 715–744. Cahan, D., Doerr, L. and Potrafke, N. (2021). Government ideology and monetary policy in OECD countries. Public Choice 181(3): 215–238. Castro, V. and Martins, R. (2021a). Government ideology and economic freedom. Journal of Comparative Economics 49(1): 73–91. Castro, V. and Martins, R. (2021b). Economic liberalization, political regimes and ideology. Kyklos 74(2): 463–487. Celico, A. and Rode, M. (2023). Populism, majority rule, and economic freedom. In: Economic Freedom of the World: 2023 Annual Report (ed. J.D. Gwartney, R.A. Lawson and R.H. Murphy), 189–205. Vancouver: Fraser Institute. Chappell, H.W. and Keech, W.R. (1986). Party differences in macroeconomic policies and outcomes. American Economic Review 76(2): 71–74. Crampton, E. (2002). You get what you vote for: Electoral determinants of economic freedom. Journal of Private Enterprise 18(1): 32–56. Cruz, C., Keefer, P. and Scartascini, C. (2021). Database of political institutions 2020. Inter-American Development Bank, Washington, DC. Doerr, L., Potrafke, N. and Roesel, F. (2021). Populists in power. Working Paper No. 9336, CESifo, Munich. Dornbusch, R. and Edwards, S. (1991). The macroeconomics of populism. In: The Macroeconomics of Populism in Latin America (eds. R. Dornbusch and S. Edwards), 7–13. Chicago: University of Chicago Press. Funke, M., Schularick, M. and Trebesch, C. (2020). Populist leaders and the economy. Discussion Paper No. 15405, CEPR, London.
158 Handbook of research on economic freedom Giesenow, F.M. and de Haan, J. (2019). The influence of government ideology on monetary policy: New cross-country evidence based on dynamic heterogeneous panels. Economics & Politics 31(2): 261–239. Gu, J., Compton. R.A., Giedeman, D.C., and Hoover, G.A. (2017). A note on economic freedom and political ideology. Applied Economics Letters 24(13): 928–931. Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Hibbs, D.A. (1977). Political parties and macroeconomic policy. American Political Science Review 71(4): 1467–1487. Jäger, K. (2017). Economic freedom in the early 21st century: Government ideology still matters. Kyklos 70(2): 256–277. Murphy, R.H. (2019). The long-run effect of government ideology on economic freedom. Economic Affairs 39(1): 101–114. Pickering, A. and Rockey, J. (2011). Ideology and the growth of government. Review of Economics and Statistics 93(3), 907–919. Potrafke, N. (2009). Did globalization restrict partisan politics? An empirical evaluation of social expenditures in a panel of OECD countries. Public Choice 140(1): 105–124. Potrafke, N. (2010). Does government ideology influence deregulation of product markets? Empirical evidence from OECD countries. Public Choice 143(1): 135–155. Potrafke, N. (2013). Economic freedom and government ideology across the German states. Regional Studies 47(3): 433–449. Potrafke, N. (2017). Partisan politics: Empirical evidence from OECD panel studies. Journal of Comparative Economics 45(4): 712–750. Potrafke, N. (2018). Government ideology and economic policy-making in the United States: A survey. Public Choice 174(1): 145–207. Potrafke, N. and Wüthrich, K. (2020). Green governments. Working Paper No. 8726, CESifo, Munich. Rode, M. and Revuelta, J. (2015). The Wild Bunch! An empirical note on populism and economic institutions. Economics of Governance 16(1): 73–96. Schmidt, M.G. (1996). When parties matter: A review of the possibilities and limits of partisan influence on public policy. European Journal of Political Research 30(2): 155–183. Wenzelburger, G. and Zohlnhöfer, R. (2022). Bringing agency back into the study of partisan politics: A note on recent developments in the literature on party politics. Party Politics 27(5): 1055–1065.
12. Immigration and economic freedom Alexandre Padilla
INTRODUCTION This chapter investigates the relationship between immigration and economic freedom and asks the following question: do immigrants value economic freedom? To answer this question, this chapter reviews two strands of the economic literature investigating the relationship between immigration and economic freedom. The first strand examines whether immigrants tend to move to countries and regions that are more economically free. The second strand studies whether countries that receive immigrants, particularly those coming from countries with (much) lower levels of economic freedom, experience a subsequent improvement or decline in their economic freedom scores. It is essential to investigate the extent to which immigrants value economic freedom as studies suggest that economic systems that foster greater economic freedom result in increased levels of economic growth, income, and human development indicators. There is evidence from several studies indicating that regions and countries with such economic institutions typically experience favorable economic and social outcomes, as highlighted by Hall and Lawson (2014) and Lawson (2022). If immigrants do not value economic freedom, there is a risk that immigration, particularly from countries with low levels of economic freedom, could lead to a decline in economic freedom in the host countries. This, in turn, could erase the gains in economic and human development that these countries have achieved by promoting greater levels of economic freedom. Moreover, if a lack of economic freedom is not what drives people to emigrate, it is unlikely that mass emigration would provide incentives for origin countries to adopt economic institutions that promote greater levels of economic freedom. As a result, these countries may miss out on opportunities for economic growth and improvements in human development indicators. The question of whether immigrants value economic freedom is central to an ongoing debate among economists studying immigration. Some, such as Clemens (2011), argue that current immigration restrictions are excessively high, causing missed opportunities for significant global economic gains from trade. However, others, such as Collier (2013) and Borjas (2014, 2015, 2016), contend that these potential gains are overestimated. They argue that large-scale migration from countries with poor economic institutions may result in the importation of those institutions into the host country, displacing the existing ‘good’ institutions and leading to the re-creation of the poor economic conditions the immigrants left behind.1 If Borjas is correct in his assertion that immigrants bring their home countries’ institutions with 1 Other examples of economists who argue that immigration restrictions are inefficiently high and generate global economic deadweight losses are: Hamilton and Whalley (1984), Moses and Letnes (2004), Walmsley and Winters (2005), Benhabib and Jovanovic (2012), Kennan (2013), di Giovanni et al. (2015), and Docquier et al. (2015).
159
160 Handbook of research on economic freedom them, immigrants from poor countries may import institutions that impede economic freedom and negate any gains from increasing economic freedom. Not only would examining whether migrants consider economic freedom, at home and abroad, when deciding to migrate, and whether economic freedom declines following the arrival of immigrants, particularly those from countries with lower levels of economic freedom, allow us to provide an answer to the question as to whether immigrants value economic freedom. It could also challenge Borjas’s hypothesis that immigrants from low-economic-freedom countries will import such institutions. If migrants do not value economic freedom, why would they leave their home countries in the first place? It is unlikely that migrants would seek to implement in their host countries the institutions that drove them to leave their home countries. Alternatively, if immigrants do not take economic freedom into account when deciding to immigrate, they may attempt to transplant their home countries’ institutions, which could be detrimental to economic freedom in the host country. Hence, examining whether economic freedom declines following the arrival of immigrants, especially those from countries with lower levels of economic freedom, can still provide insights into the extent to which immigrants value economic freedom.2
ECONOMIC FREEDOM, WHAT IS IT GOOD FOR? Standard economic theory assumes that people seek to maximize their utility. This implies that people decide to emigrate if the expected utility of living abroad (after accounting for the costs of migration) is greater than the expected utility of staying in their home country. If people do not migrate, it means that the marginal cost of migrating is at least equal to its marginal benefit (Ashby 2010, p. 51; Geis et al. 2013, p. 825). Although utility cannot be directly measured, people’s decisions can reveal some of their preferences. In the case of migration, analyzing what distinguishes immigrants’ destination countries from their origin countries can help identify their preferences. Economic freedom has been identified as a potential factor that influences migration decisions, and a large body of literature has examined its role in these decisions. Before we discuss the literature on the link between immigration and economic freedom, let us briefly consider the literature on the effects of economic freedom on various socio-economic outcomes. If economic freedom has positive effects, it could explain why migrants choose to leave their home countries with limited economic freedom and move to countries with higher levels of economic freedom. By doing so, they can reap the benefits of economic freedom. In line with the model of revealed preferences, their decision to move to countries with more economic freedom indicates a preference for such conditions. A large literature has been investigating ‘whether economic freedom yields positive or negative outcomes’ (Lawson 2022, p. 187).3 Hall and Lawson (2014, p. 1) review 402 original
Immigrants could still be attached to their home countries’ institutions even if they are inconsistent with the promotion of economic freedom, if immigrants do not fully comprehend the link between economic freedom and the quality of their life. 3 Readers of the Handbook of Research on Economic Freedom may want to read Part V of the Handbook on the consequences of economic freedom for a more comprehensive review of the literature 2
Immigration and economic freedom 161 papers published between 1996 and 2011 that use the Economic Freedom of the World (EFW) index as an independent variable and find that over two-thirds of these studies found economic freedom to correspond to a ‘good’ outcome such as faster growth, better living standards, more happiness, etc. Less than 4% of the sample found economic freedom to be associated with a ‘bad’ outcome such as increased income inequality. The balance of evidence is overwhelming that economic freedom corresponds with a wide variety of positive outcomes with almost no negative tradeoffs.
Lawson (2022, p. 188) reviews an additional 811 empirical papers published between 2011 and 2022. Out of the 811 papers, 721 empirical papers used economic freedom as an independent variable to determine its impact on some socio-economic outcomes.4 Lawson (2022, p. 192) finds that out of the ‘721 empirical papers, slightly more than half (50.6%, n = 365) of the papers were deemed to be good in that the EFW index variable was positively correlated with a good outcome.’ Not surprisingly, ‘the EFW index variables were quite positively related to the more “economic” variables, such as growth, income, investment, labor, and trade’ (Lawson 2022, p. 195). For example, about two-thirds of the papers find a positive relationship between EFW and growth in GDP per capita; and over 70 percent of the papers find a positive relationship between EFW and GDP per capita, output per worker, or total factor productivity (Lawson 2022, p. 196). Lawson also finds that the relationship between EFW and entrepreneurship is positive in over 60 percent of the papers. In almost 60 percent of the papers, the relationship between EFW and investment is also positive. Although more than 10 percent of studies have found a negative relationship between economic freedom and, for example, environmental outcomes, human rights, social development, and inequality, most studies still document a positive correlation between these outcomes and economic freedom (Lawson 2022, pp. 195–196).
DO IMMIGRANTS VALUE ECONOMIC FREEDOM? While the literature suggests that economic freedom typically leads to positive socio-economic outcomes, it is not clear whether migrants value economic freedom or its associated benefits. However, by examining where people choose to move, we can get insights into their preferences. By studying how economic freedom at home and abroad affects migration decisions, we can gain insights into what factors influence these decisions. Should I Stay or Should I Go? Does Economic Freedom Matter to Emigrants? Using the 2007 EFW report, Ashby (2010) is first to examine whether more economic freedom is attractive to immigrants by analyzing a cross-section of bilateral migration stocks for 58 countries as well as migration flows to OECD countries from 2001 to 2006. Instead of and, more particularly, de Haan and Sturm (2024) on economic freedom and economic growth and Bjørnskov (2024) on economic freedom and human rights. 4 The 90 remaining empirical papers using the EFW index have economic freedom as the dependent variable to determine the factors that lead to an increase or decrease in economic freedom. See Lawson et al. (2020) for a survey of that literature.
162 Handbook of research on economic freedom focusing exclusively on whether origin countries’ lack of economic freedom is a push factor or whether destination countries’ level of economic freedom is a pull factor, Ashby looks at relative economic freedom between the economic freedom of destination countries and the economic freedom of origin countries to assess whether more economic freedom attracts immigrants. His results show that relatively more economic freedom and political freedom is attractive to immigrants (Ashby 2010, p. 60). However, Ashby (2010, p. 60) also finds that ‘political freedom appears to have a significant impact only when economic freedom or income are excluded and only provides evidence of indirect benefits’ (emphasis in original). Nejad and Young (2016) build on Ashby (2010) and investigate emigrant self-selection according to institutional quality using up to 3,566 observations on bilateral migration flows from 77 countries from 1990 to 2000. They ask whether economic and political freedoms of potential destinations relative to origins are significant determinants of migration decisions. They also ask whether potential immigrants’ education level matters when looking at factors motivating them to move. Like Ashby (2010), they find that economic freedom is a powerful draw for potential immigrants, both college-educated and not. They also show that potential immigrants are attracted to destinations with sounder currencies, less burdensome regulations, and stronger property rights and legal systems (Nejad and Young 2016, p. 80). They also find that the quality of the legal and property rights systems has the most pull effect regardless of the educational attainments of immigrants. The differences they find between skilled and unskilled immigrants when it comes to out-migration decisions come down to per capita income gap and costs of migration resulting from distance. For skilled immigrants, the greater the income gap between origin and destination countries, the more likely they are to emigrate because the returns to human capital are greater (Nejad and Young 2016, p. 79). Distance between destination and origin countries is a proxy for the costs of migration. Therefore, given that the returns of immigration are greater for college-educated immigrants than they are for unskilled immigrants, it is not surprising that that college-educated immigrants are more likely to bear those costs than unskilled immigrants because the returns to immigration for skilled immigrants are more likely to outweigh those costs than they are for unskilled immigrants (Nejad and Young, 2016, pp. 79–80). Instead of investigating whether greater economic freedom is a pull factor, Meierrieks and Renner (2017) investigate whether the lack of economic freedom at home is a push factor for potential migrants from 91 emerging countries to the 20 most attractive OECD destination countries from 1980 to 2010. Their results show that increases in economic freedom at home discourages immigration by high-skilled workers but not low-skilled ones (Meierrieks and Renner 2017, pp. 992–993). This result does not suggest that low-skilled immigrants do not account for the lack of economic freedom when deciding to emigrate but rather they do not necessarily appreciate how improvements in economic freedom improve their well-being. In addition, Meierrieks and Renner (2017, p. 997) find that high-skilled migrants deciding to emigrate particularly value the increased economic security (in the form of more secure property rights and less redistribution) that greater economic freedom provides. Finally, Arif disentangles the pull and push effects of economic, political, and social institutions on migration. His results show that economic freedom exercises the strongest pull and push effects compared with political and social institutions. Consistent with previous research, Arif (2020, p. 1701) also shows that college-educated migrants are more aware of the quality of economic, political, and social institutions at destination countries, while unskilled migrants are more sensitive to social institutions in their home countries.
Immigration and economic freedom 163 Do Immigrants Value Economic Freedom in Their Host Countries? The literature on migration determinants suggests that economic freedom is a significant factor for emigrants when deciding to migrate from source to destination countries. Additionally, studies show that skilled immigrants tend to place more value on greater economic freedom compared with unskilled immigrants, possibly due to their better understanding of the link between economic freedom and the returns on their human capital. On the other hand, unskilled immigrants seem to leave because they do not like their home country’s institutions. However, given that economic freedom is highly correlated with income levels, it makes it challenging to know whether immigrants leave because their home country’s economic freedom is too low or because of the potential for higher earnings abroad, not least since they may not know that higher earnings abroad is highly correlated with the destination countries’ level of economic freedom. While immigrants seem to gravitate toward countries with more economic freedom, it does not necessarily indicate that they recognize the benefits of economic freedom. This raises an important question: is it possible that these immigrants are still attached to their home countries’ institutions, even though these institutions do not promote economic freedom and may be largely responsible for their countries’ present predicaments? As a result, could they attempt to substitute their home countries’ institutions with those of the destination countries? This is the argument that Borjas (2014, 2015, 2016) and Collier (2013) advance. Borjas (2015, p. 968) develops a model where immigrants contribute to institutional change in their new countries in various degrees. The degree to which immigrants import their home countries’ institutions ranges from 0 to 1, where 1 means that ‘the immigrants “import” the entire set of institutions and norms’ that led to their home countries’ poor economic performance, totally overtaking host countries’ institutions (Borjas 2015, p. 968). According to Borjas’s simulation, as soon as the factor by which immigrants import their home countries’ ‘bad’ institutions exceeds 0.75 (0.5 when one accounts for migration costs), the negative externalities associated with importing those ‘bad’ institutions turn the global gains in trillions of dollars associated with lowering immigration restrictions into losses (Borjas 2015, p. 969). More importantly, and this is what is at the heart of Borjas’s critique of the literature arguing in favor of liberalizing international labor mobility, as soon as more than 50 percent of the institutions from the home countries of the immigrants are imported, the change in income per capita for natives in receiving countries, after paying out the salaries of immigrants, turns negative (Borjas 2015, p. 972).5 Borjas does not discuss the channels through which immigrants import their home countries’ bad institutions and substitute them for the host countries’ good institutions. In their study, Padilla and Cachanosky (2023) identify three channels through which immigrants would import their home countries’ institutions: (1) voting and lobbying; (2) vertical transmission of institutional preferences to their descendants who can then vote and lobby; and (3) horizontal transmission by transferring institutional preferences onto natives through long-lasting contact resulting from intermarriage and residential integration (Giuliano and Tabellini 2021). 5 Borjas (2014, pp. 969–970) acknowledges that his exercise, which calculates the net benefits or costs of mass immigration accounting for the degree by which immigrants import their home countries’ institutions, is just a simulation. However, he does not provide any empirical evidence to support his simulation.
164 Handbook of research on economic freedom Since Borjas criticized the literature supporting the relaxation of immigration restrictions, economists have tested his model by examining whether the arrival of immigrants from regions or countries with lower levels of economic freedom led to a decline in economic freedom in host countries with initially higher levels. Clark et al. (2015) are the first to examine a cross-section of 110 countries from 1990 to 2011. They examine whether countries hosting higher shares of immigrants in 1990 experienced a decline in their EFW scores up until 2011. Their results are inconsistent with Borjas’s conclusions and are statistically and economically significant. First, their results show that a greater share of immigrants in the population in 1990 is correlated with a higher level of economic freedom in 2011. Second, using the results from the literature estimating the impact of economic freedom on economic growth and using their estimate that a one standard-deviation larger immigrant stock increases economic freedom by 0.34 points, Clark et al. (2015) estimate that such an increase in the immigrant stock would generate almost a half percentage point higher long-run annual growth rate. Cross-country studies face a challenge in identifying the effects of immigration on economic freedom, given the significant historical, cultural, economic, political, legal, and ethnic heterogeneity among countries. Other factors could also explain variations in economic freedom. To address this issue, one approach is to focus on a country where regions or states have some autonomy in implementing their own economic policies or institutions. This can help determine whether institutional changes occur following the arrival of immigrants and whether the nature of those changes varies depending on the immigrants’ region of origin or the level of institutional quality in their home countries. In the United States, states have some degree of autonomy in terms of implementing their own economic policies. Therefore, examining whether states with more immigrants or more immigrants coming from countries with much lower levels of economic freedom experience a decline in their economic freedom represents a unique opportunity to examine the institutional impact of immigrants while mitigating the heterogeneity problems that cross-country studies face. Padilla and Cachanosky (2018, 2023) and Padilla et al. (2020) attempt to examine immigrants’ impact on US economic freedom at the state level using the Fraser Institute’s Economic Freedom of North America (EFNA) report (Stansel et al. 2016; Stansel et al. 2022). Their analysis investigates the relationship between immigration and the EFNA scores for each US state from 1980 through 2010 using panel data at 10-year intervals and over a 30-year period. Given the relative heterogeneity of the US immigrant population, they disaggregate immigration data in various ways to test whether states with a higher (change in the) share of immigrant population experience a subsequent decline of their EFNA scores. The results are consistent across their papers whether they disaggregate immigrants accounting for their naturalization status, according to their educational attainments, or whether immigrants come from countries that are one, two, three or more standard deviations below the US EFW score. When people immigrate to the United States even from countries with less economic freedom, they do not dampen economic freedom in their destination states whether they examine the relationship 10 years later or over a 30-year period. More importantly, the results, whether
Immigration and economic freedom 165 positive or negative, are not economically significant even if in a few instances they are statistically significant.6 Tuszynski and Stansel (2020) improve on Padilla and Cachanosky (2018). They examine whether immigrants’ continent of origin matters when investigating immigrants’ impact on US states’ economic freedom scores as measured by the 2017 EFNA report (Stansel et al. 2017). Tuszynski and Stansel (2020) find that the relationship between immigration and economic freedom is negative and statistically significant at the 5 percent and 1 percent levels for immigrants from Asia and North America, respectively, in area 3, labor market freedom. For immigrants from Africa, the relationship is positive and statistically significant at the 5 percent level. In area 1, government spending, they find that the only statistically significant relationships come from immigrants from Asia (negative and statistically significant at the 5 percent level) and North America (negative and statistically significant at the 10 percent level). While the relationships between immigrants from these regions and these areas of economic freedom are negative and statistically significant, the impact associated with these negative coefficients is not significant from an economic viewpoint. Using fixed-effects difference-in-differences regressions, Tuszynski and Stansel (2020) find that the only statistically significant relationships come from immigrants from Asia in the area of taxes and from immigrants from North America in the area of labor market freedom. Those relationships are negative and statistically significant at the 1 percent level. Again, the magnitude of these effects is not economically significant. A critique that applies to most studies examining immigrants’ impact on the economic freedom of receiving countries or states is that most countries or states have not experienced mass immigration. Therefore, it is difficult to assess whether immigrants coming in mass from a country with a very low level of economic freedom to another country with a higher level of economic freedom would lead to a decline of the receiving country’s economic freedom. Using the synthetic control method, Powell et al. (2017) are the first to analyze whether mass immigration from a group of countries, those of the former Soviet Union, with very low levels of economic freedom, led to a decline of economic freedom in the country receiving them, Israel.7 The authors’ findings are contrary to what Borjas’s model predicts. Despite
6 As discussed in Padilla and Cachanosky (2023, p. 492), the EFW (Gwartney et al. 2022) and EFNA (Stansel et al. 2021) reports do not calculate economic freedom the same way, as the EFW areas of legal system and property rights, sound money, and freedom to trade internationally are more likely to apply to country-level than to state-level policies. Therefore, using the EFW scores to group immigrants according to how far below the US immigrants’ home countries score, might amount to compare apples with oranges. To alleviate this issue, before grouping immigrants according to how far below their home countries are the USA, Padilla and Cachanosky (2023) recalculate countries’ economic freedom scores focusing on the ratings these countries receive in the EFW report for size of government (area 1), which approximates areas 1 and 2 in the EFNA report and labor market regulations (area 5B), which approximates area 3 of the EFNA. 7 The synthetic control method was first developed by Abadie and Gardeazabal (2003). Within the context of the institutional impact of mass immigration, the intuition behind the method is to create a synthetic unit, that is, a counterfactual unit (for example, a ‘synthetic Israel’) that is a statistically alternative version of the treated unit that ‘behaved’ like the treated unit (the real Israel) before mass immigration occurred but did not experience mass immigration. Comparing the trend of the synthetic unit with the one of the treated unit (the Israel that experienced mass immigration), before and after mass immigration takes place, allows one to identify whether mass immigration actually did cause the institutional change observed post-immigration in the treated unit.
166 Handbook of research on economic freedom receiving immigrants from a block of countries with a very low economic freedom score, Israel’s economic freedom improved significantly; Israel’s country ranking in terms of economic freedom score improved by 47 places (Powell et al. 2017, p. 94). These Jewish immigrants, by virtue of Israel’s Law of Return, were immediately granted the right to vote and participate in the political process. Rather than deteriorate, ‘Israel’s economic institutions made great strides in the direction toward greater economic freedom and away from socialism while the immigrants influenced the political process’ (Powell et al. 2017, p. 94). Israel’s level of economic freedom went from ‘15% below the global average in economic freedom to 12% above average’ (Powell et al. 2017, p. 94). However, it is worth noting that most immigrants to Israel from the former Soviet Union were skilled workers, and nearly a third were scientific academic workers (Powell et al. 2017, p. 87). Although they came from countries with an institutional environment inconsistent with the promotion of economic freedom, these immigrants were more likely to ‘think like economists’ and more likely to appreciate the importance of a high-quality economic institutional environment to promote long-run economic growth – which would be reflected in their votes (Caplan 2001). The immigrants’ backgrounds, in part, could explain why their influx boosted Israel’s economic freedom as opposed to deteriorating it, as Borjas’s model would predict. In addition, while it is true that Israel’s EFW score was higher than that of the Soviet Union, Israel’s EFW score was also rather low. Israel has been ranked in the fourth quartile of the EFW report since the 1970s. In terms of standard deviations, Israel’s average EFW score over the period 1970–2000 was almost three standard deviations below that of the United States, while Israel’s average EFW score over the same period was barely four-fifths of a standard deviation above that of the Russian Federation. Therefore, while Powell et al. (2017) show that mass immigration to Israel did not deteriorate Israel’s economic institutions, it does not address whether mass immigration could have deteriorated Israel’s economic institutions (measured in terms of its economic freedom score) if Israel had had an economic freedom score comparable with the United States. Nowrasteh et al. (2020), within the context of Jordan, study how mass immigration affects countries with weak institutions. Also using the synthetic control method, they show that mass migration to Jordan of Kuwaiti–Palestinian refugees from the first Gulf War in 1990–1991 had significant and long-lasting positive effects on Jordanian economic institutions. They use economic freedom from the 2017 EFW report (Gwartney et al. 2017) as a proxy for the quality of Jordanian economic institutions. Again, Nowrasteh et al. (2020) show that mass immigration did not deteriorate further the economic freedom of the country that received them. It should be noted that the Kuwaiti–Palestinian refugees were not allowed to work in the public sector and were not entitled to receive any government benefits. As a result, these refugees were eager to enter the private sector workforce and to start their own firms (Nowrasteh et al. 2020, p. 13). The refugees started firms in the construction, retail, financial, commercial, and industrial sectors (Nowrasteh et al. 2020, p. 545). Therefore, it should not be surprising that they supported economic policies that would result in greater levels of economic freedom in Jordan, joining other Palestinian workers and business owners who also dominated the private sector and who were also excluded from the public sector and from receiving any government benefits. One can wonder whether mass immigration of Kuwaiti–Palestinian refugees would have had turned out different if they had been allowed to work in the public sector and/ or to receive government benefits.
Immigration and economic freedom 167 At the US state level, Yao et al. (2021) use difference-in-differences regressions and the synthetic control method to investigate whether the 1986 Immigration Reform and Control Act (IRCA) that mass-legalized undocumented immigrants had negative effects on the quality of state-level economic institutions as measured through the 2018 EFNA report (Stansel et al. 2018). They find that the 1986 IRCA may have led to some temporary increase in government spending relative to income. However, in the long run, the 1986 IRCA had no effects on the US states’ economic freedom scores, as measured by the EFNA report. They conclude that the amnesty of undocumented immigrants did not lead to a decrease in productivity in the United States, buttressing arguments that relaxed migration barriers lead to greater global economic efficiency. Finally, Yao et al. (2022) investigate the fiscal effects of the mass arrival of Cuban refugees in the city of Miami in 1980. Their analysis uses the synthetic control method to analyze whether, without such mass immigration of refugees who came from a country with abysmal economic institutions, Miami’s fiscal situation would have been better or worse. To evaluate the fiscal impact of mass immigration into Miami, Yao et al. (2022) use Stansel’s (2019) Economic Freedom in US Metropolitan Areas along with a variety of other measures of fiscal health. Their results show that the Mariel Boatlift had virtually no effects on government spending on consumption, transfers and subsidies, nor on insurance and retirement payments. They also do not find any effects on sales tax revenues and property and other tax revenues. Yao et al. (2022, p. 323) do recognize that one reason they find no causal effect from the Mariel Boatlift is that the city of Miami received financial aid from the federal government and the state of Florida.
DISCUSSION AND CONCLUDING REMARKS When reviewing the literature on immigration and economic freedom, we identified two strands of the literature. The first strand examines whether economic freedom appears to be a determinant factor behind people’s decision to live abroad. The second strand investigates whether immigrants coming from countries with (much) lower levels of economic freedom dampen economic freedom in destination countries. Putting together this literature, we can interpret it as studying whether migrants value economic freedom. In the context of immigration, if economic freedom matters to them, people are more likely to move to countries with institutions that promote economic freedom and less likely to leave in the first place if their home countries’ institutions promote economic freedom. At the same time, if people value economic freedom, they are less likely to support institutions that are antithetical to economic freedom even if they come from countries with institutions that are inconsistent with the promotion of economic freedom. Our review of the literature indicates that migrants value economic freedom. They tend to move to countries with higher levels of economic freedom than their home countries. Furthermore, we do not observe any economically significant decline in economic freedom in countries or regions that receive them following their arrival, neither in the short run nor in the long run. It is important to note that this literature does not attempt to test whether all people value economic freedom. Rather, it attempts to test whether a subset of people, migrants, put some value on economic freedom when deciding to migrate. It is also important to note that when
168 Handbook of research on economic freedom disaggregating migrant populations between college and non-college-educated migrants, depending on how the model is specified, economic freedom or one of its subcomponents appears to matter more for college-educated than non-college-educated migrants.8 However, that it matters less for some does not imply that it does not matter at all. Furthermore, the literature shows that migrants are attracted to countries with sounder currencies, less burdensome regulations, and stronger property rights and legal systems. Given that these subcomponents of the EFW index are likely to have the most impact on the returns to human capital, it should not be surprising that the literature also finds that the per capita income gap between the origin and destination countries is a crucial factor in determining where migrants relocate.9 A question arises from that observation. Even if both economic freedom and income gaps are significant determinants of migration, we cannot ignore that both are highly correlated with each other since countries with higher levels of economic freedom also exhibit higher levels of income (Faria and Montesinos 2009). Therefore, while the literature shows that economic freedom is a significant determinant of migration, one can ask whether it is the perspective of earning a (much) higher income in destination countries that truly exercises that pull factor, compared with there being more economic freedom as such. In addition, we should not ignore that most of these studies do not show causality or absence of causality, regardless of whether they test if economic freedom is a significant determinant of migration or whether they test if we observe a subsequent decline in economic freedom in regions or states that receive immigrants from countries or regions with very low economic freedom scores. What these studies, whether they use gravity models or dynamic panel data models, merely establish is whether we observe statistically and sometimes economically significant relationships between immigrants and economic freedom. This is also why studies relying on the synthetic control method and other quasi-experimental methods are quite promising. Unlike most traditional regression analysis, they can identify whether immigration has a causal impact on economic freedom. These studies show that countries or regions that have experienced mass immigration from countries that have poor economic freedom levels saw an increase in economic freedom that would not have occurred had mass immigration not taken place. While studies using quasi-experimental methods such as the synthetic control method are able to uncover the causal effects or non-effects of mass immigration, these studies cannot disentangle the part of the effect that comes from immigrants and the part of the effect that comes from the natives. The increase in economic freedom observed after mass immigration could be due to a shift in the preferences of the natives. Specifically, if the natives perceive that immigrants would be the primary beneficiaries of institutions such as the welfare state, which are deemed inconsistent with economic freedom, they may withdraw their support for these institutions. This shift may occur regardless of the accuracy of the perceptions or whether
Even when disaggregating immigrants in subgroups such as college- and non-college-educated immigrants, we are still looking at average measures. Even among college-educated immigrants, we cannot say that all college-educated immigrants value economic freedom. A casual look at the college-educated population and their policy views clearly shows that not all college-educated immigrants value economic freedom, at least not according to how it is typically defined in the EFW reports and by economists in general. 9 See also Ortega and Peri (2013). 8
Immigration and economic freedom 169 they are influenced by stereotypes. This is also why some of these studies rely on narratives to provide context and to explain why mass immigration caused an increase in economic freedom and whether the increase in economic freedom was driven by immigrants, natives, or a little bit of both.10 Overall, the literature suggests that migrants value economic freedom. However, some aspects of the relationship between immigration and economic freedom have not been extensively studied, leaving important questions and research avenues still open. First, further research is needed to fully understand the relationship between emigration and economic freedom in home countries. Does mass emigration lead to institutional change toward promoting economic freedom in home countries? For example, Docquier et al. (2016, p. 222) show that ‘openness to migration (measured by the total emigration rate) contributes to improve institutional quality (as measured by standard indicators of democracy and economic freedom) in the migrants’ origin countries.’ Their results are robust regardless of the specifications (OLS, pooled OLS, two-stage least squares or system GMM) and identification strategies they use. However, this study lacks an analysis of the channels through which institutional change is occurring. For instance, does the institutional change occur through remittances? Some research suggests that remittances can promote democratization in some autocracies (Escribà-Folch et al. 2015). Alternatively, could institutional change be occurring through social remittances, which refer to ‘the ideas, behaviors, identities, and social capital that flow from receiving-to-sending-country communities’ (Levitt 1998, p. 927)? Further research is necessary to identify the specific channels through which emigrants can drive institutional change in their home countries. In summary, to better understand the impact of emigration on economic freedom in home countries, future research should explore both the direction and extent of institutional change, as well as the specific channels through which such change occurs. When disaggregating immigrant population and examining the relationship with economic freedom, the literature tends to distinguish according to immigrants’ educational attainment or between the economic freedom score of immigrants’ origin countries. However, there are three possible areas that this literature has not yet investigated to any large extent: female immigration, descendants of immigrants, and refugees and asylum seekers. The determinants of female migration remain a topic of interest in migration research. One potential determinant is economic freedom, as it may attract female migrants seeking to capitalize on their human capital. However, recent studies by Fike (2016, 2017) reveal that, while economic freedom scores have risen in many countries, gains have not been distributed equally across genders. This suggests that the benefits associated with economic freedom may not be shared equally across genders. Given this, we might consider the economic freedom gap between origin and destination countries as a factor influencing female migration. The question then arises as to whether women take into account the distribution of economic freedom gains across genders, or only consider the absolute gap in economic freedom levels. Likewise, in examining the relationship between immigrants and economic freedom, relatively little attention has been devoted to the descendants of immigrants. By examining the long-run differences, studies on the connection between immigration and economic freedom 10 As we discussed earlier, a channel through which immigrants can affect institutions is by transferring horizontally their institutional preferences to natives through long-lasting contact.
170 Handbook of research on economic freedom can provide insight into the potential long-term effects of immigration on economic freedom in destination countries or regions (Padilla and Cachanosky 2023). However, such research has not focused on the attitudes toward economic freedom of immigrants’ descendants, including those born in their home countries versus those born in destination countries. For example, Moriconi et al. (2022) examine the voting behavior of second-generation immigrants in European countries between 2001 and 2017 and find that, compared with observationally identical natives, second-generation immigrants exhibit a significant left bias. They also find that ‘second-generation migrants support policies for redistribution, education, and social welfare, but they do not exhibit party affiliation or ideological belonging’ (Moriconi et al. 2022, p. 19). Similarly, Giavazzi et al. (2019) study the speed of convergence (or lack thereof) toward the prevailing norm of a range of values and beliefs of different generations of descendants from European and Mexican immigrants to the United States. They find a lower degree of convergence to the prevailing norm for values and beliefs regarding politics and redistribution and a higher degree of convergence for attitudes toward cooperation. They conclude that a higher degree of convergence appears to characterize attitudes for which the benefits of assimilation are likely to be greater; instead, attitudes that are either characterized by lower benefits or for which direct transmission within the family to be more important and effective show slower convergence. (Giavazzi et al. 2019, p. 149)
Given the findings of the literature on the benefits of economic freedom, the findings of the literature on the role of economic freedom as a determinant of migration, and the findings by Giavazzi et al. (2019), it seems that another venue of research would be to investigate immigrants’ descendants’ attitudes toward economic freedom. Do they converge toward the prevailing norm of immigrants’ countries of origin? Do immigrants transmit to their descendants’ attitudes toward economic freedom converging toward the prevailing norm in destination countries because they recognize the benefits of economic freedom? Although asylum seekers and refugees are technically immigrants, their decision to emigrate is often driven by factors other than economics, such as the risk of persecution in their home country. Nonetheless, it would be valuable to explore the relationship between refugees and economic freedom. For instance, do refugees consider the economic freedom of the countries they seek to enter when fleeing their own country? Do they recognize the benefits of economic freedom? Moreover, do natives react differently to refugees, and how does this affect economic freedom in countries that host them? Nowrasteh et al. (2020) shed light on some of these questions by studying Kuwaiti–Palestinian refugees in Jordan. However, Jordan’s institutions were not conducive to economic freedom. It would be interesting to investigate the impact of the mass arrival of refugees in a country with a high level of economic freedom. To summarize, it is worth reiterating that while additional research utilizing disaggregated data and quasi-experimental approaches, such as the synthetic control method and difference-in-differences, is necessary, the current literature on immigration and economic freedom indicates that immigrants tend to gravitate towards nations with institutional frameworks that align with the advancement of economic freedom due to the various beneficial consequences it produces. Consequently, as the research suggests, immigrants are unlikely to endorse institutional changes that oppose economic freedom.
Immigration and economic freedom 171
REFERENCES Abadie, A. and Gardeazabal, J. (2003). The economic costs of conflict: A case study of the Basque Country. American Economic Review 93(1): 113–132. Arif, I. (2020). The determinants of international migration: Unbundling the role of economic, political and social institutions. World Economy 43(6): 1699–1729. Ashby, N.J. (2010). Freedom and international migration. Southern Economic Journal 77(1): 49–62. Benhabib, J. and Jovanovic, B. (2012). Optimal migration: A world perspective. International Economic Review 53(2): 321–348. Bjørnskov, C. (2024). Economic freedom and human rights: A survey. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 315–329. Cheltenham: Edward Elgar Publishing. Borjas, G.J. (2014). Immigration Economics. Cambridge: Cambridge University Press. Borjas, G.J. (2015). Immigration and globalization: A review essay. Journal of Economic Literature 53(4): 961–974. Borjas, G.J. (2016). We Wanted Workers. New York: W.W. Norton and Company. Caplan, B. (2001). What makes people think like economists? Evidence on economic cognition from the Survey of Americans and Economists on the Economy. Journal of Law and Economics 44(2): 395–426. Clark, J.R., Lawson, R.A., Nowrasteh, A., Powell, B.W., and Murphy, R.H. (2015). Does immigration impact institutions? Public Choice 163(3–4): 321–335. Clemens, M.A. (2011). Economics and emigration: Trillion-dollar bills on the sidewalk? Journal of Economic Perspectives 25(3): 83–106. Collier, P. (2013). Exodus: How Migration is Changing Our World. Oxford: Oxford University Press. de Haan, J. and Sturm, J.-E. (2024). The impact of economic freedom on economic growth. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 189–207. Cheltenham: Edward Elgar Publishing. Di Giovanni, J., Levchenko, A.A. and Ortega, F. (2015). A global view of cross-border migration. Journal of the European Economic Association 13(1): 168–202. Docquier, F., Machado, J. and Sekkat, K. (2015). Efficiency gains from liberalizing labor mobility. Scandinavian Journal of Economics 117(2): 303–346. Docquier, F., Lodigiani, E., Rapoport, H. and Schiff, M. (2016). Emigration and democracy. Journal of Development Economics 120(May): 209–223. Escribà-Folch, A., Meseguer, C. and Wright, J. (2015). Remittances and democratization. International Studies Quarterly 59(3): 571–586. Faria, H.J. and Montesinos, H.M. (2009). Does economic freedom cause prosperity? An IV approach. Public Choice 141(1–2): 103–127. Fike, R. (2016). Gender disparity in legal rights and its effect on economic freedom. In: Economic Freedom of the World: 2016 Annual Report (eds. J.D. Gwartney, R.A. Lawson and J. Hall), pp. 189–211. Vancouver: Fraser Institute. Fike, R. (2017). Adjusting for gender disparity in economic freedom and why it matters. In: Economic Freedom of the World: 2017 Annual Report (eds. J.D. Gwartney, R.A. Lawson and J. Hall), pp. 189–2011. Vancouver: Fraser Institute. Geis, W., Uebelmesser, S. and Werding, M. (2013). How do migrants choose their destination countries? An analysis of institutional determinants. Review of International Economics 21(5): 825–840. Giavazzi, F., Petkov, I. and Schiantarelli, F. (2019). Culture: Persistence and evolution. Journal of Economic Growth 24(2): 117–154. Giuliano, P. and Tabellini, M. (2021). The seeds of ideology: Historical immigration and political preferences in the United States. Working Paper No. 20–118, Harvard Business School, Harvard University. Gwartney, J.D., Lawson, R.A. and Hall, J. (2017). Economic Freedom of the World: 2017 Annual Report. Vancouver: Fraser Institute. Gwartney, J.D., Lawson, R.A., Hall, J. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Hall, J. and Lawson, R.A. (2014). Economic freedom of the world: An accounting of the literature. Contemporary Economic Policy 32(1): 1–19.
172 Handbook of research on economic freedom Hamilton, B. and Whalley, J. (1984). Efficiency and distributional implications of global restrictions on labour mobility: Calculations and policy implications. Journal of Development Economics 14(1): 61–75. Kennan, J. (2013). Open borders. Review of Economic Dynamics 16(2): L1–L13. Lawson, R.A. (2022). Economic freedom in the literature: What is it good (bad) for? In: Economic Freedom of the World: 2022 Annual Report (eds. J.D. Gwartney, R.A. Lawson, J. Hall and R.H. Murphy), pp. 187–199. Vancouver: Fraser Institute. Lawson, R.A., Murphy, R.H. and Powell, B.W. (2020). The determinants of economic freedom: A survey. Contemporary Economic Policy 38(4): 622–642. Levitt, P. (1998). Social remittances: Migration driven local-level forms of cultural diffusion. International Migration Review 32(4): 926–948. Meierrieks, D. and Renner, L. (2017). Stymied ambition: Does a lack of economic freedom lead to migration? Journal of Population Economics 30(3): 977–1005. Moriconi, S., Peri, G. and Turati, R. (2022). Are immigrants more left-leaning than natives? Working Paper No. 30523, National Bureau of Economic Research, Cambridge, MA. Moses, J.W. and Letnes, B. (2004). The economic costs to international labor restrictions: Revisiting the empirical discussion. World Development 32(10): 1609–1626. Nejad, M. and Young, A.T. (2016). Want freedom, will travel: Emigrant self-selection according to institutional quality. European Journal of Political Economy 45(Supplement, December): 71–84. Nowrasteh, A., Forrester, A.C. and Blondin, C. (2020). How mass immigration affects countries with weak economic institutions: A natural experiment in Jordan. World Bank Review 34(2): 533–549. Ortega, F. and Peri, G. (2013). The effect of income and immigration policies on international migration. Migration Studies 1(1): 47–74. Padilla, A. and Cachanosky, N. (2018). The Grecian horse: Does immigration lead to the deterioration of American institutions? Public Choice 174(3–4): 351–405. Padilla, A. and Cachanosky, N. (2023). Immigration and economic freedom of the US states: Does the institutional quality of immigrants’ origin countries matter? Journal of Contemporary Economic Policy 41(3): 489–512. Padilla, A. Cachanosky, N. and Beck, J. (2020). Immigration and economic freedom: Does education matter? Journal of Private Enterprise 35(1): 29–57. Powell, B.W., Clark, J.R. and Nowrasteh, A. (2017). Does mass immigration destroy institutions? 1990s Israel as a natural experiment. Journal of Economic Behavior & Organization 141(September): 83–95. Stansel, D. (2019). Economic freedom in US metropolitan areas. Journal of Regional Analysis and Policy 49(1): 40–48. Stansel, D., Torra, J. and McMahon, F. (2016). Economic Freedom of North America 2016. Vancouver: Fraser Institute Stansel, D., Torra, J. and McMahon, F. (2017). Economic Freedom of North America 2017. Vancouver: Fraser Institute. Stansel, D., Torra, J. and McMahon, F. (2018). Economic Freedom of North America 2018. Vancouver: Fraser Institute. Stansel, D., Torra, J. and McMahon, F. (2021). Economic Freedom of North America 2021. Vancouver: Fraser Institute. Stansel, D., Torra, J., McMahon, F. and Carrión-Tavárez, Á. (2022). Economic Freedom of North America 2022. Vancouver: Fraser Institute. Tuszynski, M. and Stansel, D. (2020). Immigration and state institutions: Does region of origin matter? Cato Journal 40(3): 625–664. Walmsley, T.L. and Winters, L. (2005). Relaxing the restrictions on the temporary movement of natural persons: A simulation analysis. Journal of Economic Integration 20(4): 688–726. Yao, L., Bolen, J.B. and Williamson, C.R. (2021). The effect of mass legalization on US state‑level institutions: Evidence from the Immigration Reform and Control Act. Public Choice 189(3–4): 427–463. Yao, L., Bolen, J.B. and Williamson, C.R. (2022). Are economic arguments against immigration missing the boat? The fiscal effects of the Mariel Boatlift. Southern Economic Journal 89(2): 305–325.
13. Deep determinants of economic freedom1 Ola Olsson
INTRODUCTION Levels of economic freedom display a great degree of variation across contemporary countries. Many of these differences are characterized by substantial persistence, sometimes being traced to environmental, climatic and geographical conditions prevailing hundreds or thousands of years ago (Diamond 1997; Olsson and Hibbs 2005; Fincher and Thornhill 2013). How did these original conditions push societies onto distinct paths that they would then sometimes follow throughout history until the present day? In this chapter, I review the literature on the deep determinants of contemporary variations in levels of economic freedom (as defined below). I argue that although many institutional configurations across countries and regions have an element of randomness, appearing like mutations due to historical shocks and thriving for a while in an otherwise inhospitable environment, much of the variation in levels of economic freedom can be understood as the outcome of institutional adaptations to the specific geographical and climatic conditions prevailing in specific places during different times. During most of history, the particular institutions (including those favoring economic freedom) that are in place are simply those that have prevailed after millennia of evolutionary competition over resources between initially small (and later very large) groups of humans. In this sense, I will not view economic freedom as a natural terminal station in human development but merely as one type of institutional configuration in a universe of many other potential configurations. My focus will be on understanding how deep environmental determinants, such as geography and climate, have shaped the particular institutional adaptations that favored the emergence of economic freedom. My analysis starts with forager societies that have inhabited the earth during most of the history of Homo sapiens. I will then analyze the prevalence of economic freedom in early agricultural societies where the first states typically emerged a few thousand years later. Lastly, I will provide a brief empirical analysis, displaying a typical cross-country regression specification, where different components of economic freedom are regressed on deep environmental variables and some proxies for intermediate historical developments such as the timing of the rise of agriculture, the emergence of states, and the historical prevalence of infectious disease. Given the objective to review deep-rooted historical factors, my definition of economic freedom will center on ‘positive freedoms’, such as the existence of effective and broadly distributed private property rights to goods, immaterial assets, and factors of production, as well as the individual’s freedom to take economic actions, such as producing, consuming, and exchanging goods freely, and freedom of choice of partners and residence, according to I am grateful for helpful comments from the editor, an anonymous reviewer, and from participants at the special seminar on Handbook chapters at the Southern Economic Association in Fort Lauderdale, Florida, November 2022. 1
173
174 Handbook of research on economic freedom individual needs and preferences. I will also discuss ‘negative freedoms’ such as freedom from migration restrictions and various kinds of coercion by autocratic rulers. I consider economic freedom to be strong in a society if property rights are de facto (or effectively) enforced, either informally through norms and customs or formally through courts and the rule of law. Furthermore, such rights are only meaningful if they are relatively widely distributed, or inclusive in character (Acemoglu et al. 2005). In recent history, exchange has been carried out in free markets where monetary prices and measurable quantities are determined by supply and demand. However, what I will refer to as exchange here also encompasses the more complicated patterns of reciprocal exchange among foraging and early farming societies where the transfer of a desirable good from one person to another might be accompanied by an informal future obligation to reciprocate in kind with, for instance, an exchange-specific service or act of loyalty. Apart from exchange, other key economic actions that characterize economic freedom include contracting, freedom to organize in commercial associations, freedom to form households with a partner of one’s own choice, and freedom to move and live wherever the individual prefers. The literature on economic freedom is inevitably closely related to the very extensive writings on the importance of institutions for economic development. This tradition was pioneered by North and Thomas (1977), North (1990), Acemoglu et al. (2001) and others and has been extensively surveyed elsewhere, for instance in Acemoglu et al. (2005). Although variables such as private property rights have a central place in both traditions, I will try to stick to the research that focuses explicitly on economic freedom as the ultimate dependent variable of interest, rather than economic growth, as in the institutions literature. The empirical literature on deep determinants of economic freedom has recently been exhaustively reviewed by, for instance, Lawson et al. (2020). For readers interested in a systematic review of empirical results, I refer to that paper. Compared with the existing literature, my review will have a novel focus by studying the deep roots of contemporary economic freedom from institutions among hunter-gatherer groups, early agricultural communities and the first states.
ECONOMIC FREEDOM AMONG FORAGERS According to recent research, the history of our species (H. sapiens) dates back at least 300,000 years (Hublin et al. 2017). During most of this time, modern humans lived as foraging hunter-gatherers in Africa. From around 80,000 years ago, humans moved out of Africa and dispersed into the Arabian peninsula and then towards South and East Asia (70,000 years ago), Australia (65,000 years ago), Europe (45,000 years ago), and North America (15,000 years ago). In the section below, I will describe the determinants of variations in economic freedom among foraging societies that roamed the earth during at least 96 percent of our history. I will argue that this is relevant also for understanding how contemporary institutions and patterns of economic freedom have emerged. In order to meet their basic needs of caloric intake, shelter and security, humans have, throughout history, been able to exploit at least five factors of production: Human capital (including one’s own cognitive skills, physical strength, energy, character, etc.), physical capital (tools, dwellings, weapons, draft animals, land, etc.), social capital (kinship ties, exchange networks, norms, institutions), technological knowledge (ideas related to efficient
Deep determinants of economic freedom 175 production), and the natural environment (Olsson 2024). As I will show, economic freedom can, in a basic sense, be characterized by the nature of human exploitation of these five factors of production. Our understanding of prehistorical hunter-gatherers relies to a great extent on observations of contemporary forager groups. In general, such cultures display a great deal of variation across the world as a result of their adaptation to extremely diverse natural environments, ranging from tropical rain forests in Africa to Arctic conditions in Greenland. Some of the main differences concern the basic strategy for subsistence food production, which can be characterized by hunting animals, gathering terrestrial fruits, plants, and tubers, or aquatic fishing-related activities, including collecting mussels and killing seals (Olsson 2024). Despite this great variance in living conditions, some clear patterns regarding economic freedom are still discernible. In general, two key features of the economies of foraging hunter-gatherers are their relatively low population density (compared with farmers) and their high degree of residential mobility. Hunter-gatherer groups often live in residential multi-household groups of at least 25–30 individuals that sometimes during the year gather in larger units, and then disperse again. For instance, the Semang of the Malay peninsula change residence 26 times a year, moving on average 11.3 km (Kelly 2013). The often described !Kung hunter-gatherers of the Kalahari tend to live in smaller camps spread out on the dry savannah when their main source of calories (mangongo nuts) are ripe. During the dry season, they gather in larger camps near a water resource and conduct ceremonies, exchange information, and other investments in social capital (Lee 1979; Johnson and Earle 2000). The low population density and the high degree of mobility among such groups are generally believed to be similar to conditions that prevailed for most hunter-gatherer groups during prehistory. In terms of economic freedom, there are several implications worth noting from this kind of economic behavior. First, individuals tend to have informal private property rights to physical capital such as digging sticks, axes, and spears, but not to land. Although there is usually some degree of territoriality in the sense that hunter-gatherer bands recognize certain areas as their homeland, they generally do not stake out ownership or claim unique rights to specific parcels of land (Kelly 2013). The inevitable high mobility among many hunter-gatherers naturally implied that the stock of physical capital within households needed to be relatively small since all tools and belongings had to be carried along or dispensed with upon departure. There were some but no substantial investments in niche construction or land-related capital, such as the clearing of fields or the nurturing of a garden of fruit trees. Neither were there large investments in permanent residential structures such as stone floors. An accumulation of stocks of resources was simply not feasible until groups settled down and became sedentary farmers. Private property rights to physical capital were thus necessarily limited among hunter-gatherers. Second, large game hunted by groups of men are usually shared within the multi-household group, including women and children, according to different conventions and are not considered to be owned by any particular individual. This was rational for several reasons, for instance because meat typically needed to be consumed at once and since the sharing of a temporary abundance of meat was a kind of social insurance mechanism that created obligations for reciprocation in times of need later. The traditions surrounding the hunting and often joint consumption of meat around campfires are further believed to have important implications for the human development of social capital and even brain capacity (Dunbar 1998; Henrich 2016).
176 Handbook of research on economic freedom Third, there was generally a seemingly free reciprocal exchange of goods within and among groups. Such trade was often surrounded by strong social conventions in the sense that a gift from one agent to another typically gave rise to an obligation to reciprocate at some time in the future. In case of failure to do so, there were no big chiefs or courts to punish individuals, but shame and contempt often served as very efficient enforcement mechanisms (Kelly 2013). Evidence of conscious exchange of valuable minerals that were purposefully mined, dates back at least 200,000 years when a group located in Rift Valley, south of Lake Turkana in Kenya, were part of a far-reaching network of obsidian trade (Blegen 2017). Fourth, and very importantly, when conflicts arose within highly mobile low-population-density groups, they were usually ultimately resolved through fission, i.e., individuals or families simply chose an exit option and moved to another group or place when discord or violence among members threatened to affect the survival of the group. This exit option also implied that no strongman or elite could aim to dominate other individuals or subgroups since they could just take off if some leader showed too autocratic tendencies. The exit potential for individuals or sub-groups naturally varied across environments and, as we shall see, the leaders of groups would later attempt to mitigate the fission tendencies within groups by creating institutions and social capital that tied groups together. Very often, such developments reduced economic freedom, as defined here. This latter, deep human impulse of fission as a method of conflict resolution, also common among our ape relatives, was arguably hampered during periods of climatic downturns. Just like many hunter-gatherer groups gathered around a water hole in the dry season, groups had no choice but to congregate in fertile refugia in periods of cold and dry climate. In an initial phase, population density must then have increased, which caused an increased competition over resources, drastically reduced the exit options, and presumably forced groups to adopt new norms and institutions adapted to the changed situation (Olsson 2024).
AGRICULTURAL PRODUCTION AND EARLY STATES From around 11,000 years ago, the first signs emerged that certain sedentary communities had started relying on plants and animals that had become domesticated, i.e., their physical morphology and genetic constitution had started to alter so that they transformed into new kinds of species that were adapted to human needs and that no longer had the capacity to survive in the wild (Larson et al. 2014). In the process, humans had also created new agricultural niches that in many ways also domesticated the surrounding habitat where fields, orchards, and grazing grounds replaced untouched forests and wetlands. As I will argue below, this revolutionary change in human food production also implied that humans in many ways domesticated themselves into a new kind of agricultural H. sapiens that soon became completely reliant on a few domesticated species and who gradually weeded out the deep forager instinct of constantly moving and solving conflicts through fission.2 The emergence of permanent farming villages had several fundamental effects on various aspects of what we now refer to as economic freedom. Sedentism implied that individuals had strong incentives to accumulate both physical capital and food resources. From the archaeo2 See for instance Henrich (2016), Scott (2017) and Ho et al. (2022) for discussions about human self-domestication.
Deep determinants of economic freedom 177 logical record, it is evident that the amount of physical capital per household greatly increased as people invested in permanent and more robust dwellings, food production tools such as flint sickles and primitive ploughs, and, not least, in stocks of domesticated animals such as goats, sheep, pigs, cattle, buffalo, llama, and dogs, and in carefully managed agricultural fields. Already before full domestication, we know that granaries were constructed in the Levant to store grains (Kuijt and Finlayson 2009). Arguably, investments in this kind of capital and the saving of food output would not have taken place unless institutional innovations such as property rights had been created, as argued among others by economists North and Thomas (1977) and Bowles and Choi (2019). Some of the early farming villages in Southwest Asia and Anatolia such as Abu Hureyra, Jericho, and Catalhöyuk, would soon grow to become large sites of 10–15 hectares with a population close to 10,000 people at a time. In Catalhöyuk, almost identical houses were built on top of each other with ancestors buried beneath the floors (Larsen et al. 2019). This has been interpreted as a way of establishing ‘facts on the ground’ or de facto property rights to a lineage or clan.3 It might be argued that the emergence of property rights to physical capital thus implied an increase in economic freedom, as we define it, for the farmers of the early Neolithic. Although property rights to land-related capital implied more freedom for individuals than in a situation where they cultivated the land as serfs under a landlord, it is not entirely clear that such rights actually implied greater freedom compared with the subsistence strategy of foragers. The latter had no property rights but were still free to pursue whatever food resources they preferred.4 Furthermore, the investments and defense required of a household’s residence and plots implied that many farmers were stuck where they were and therefore had a substantially lower mobility and de facto freedom to move and exit to another location than the typical hunter-gatherers. In the permanent farming villages, women typically had more children than among foragers. Certain later agricultural technologies, such as the use of ox-drawn ploughs from the fourth millennium bce in Europe and Southwest Asia, required extensive upper body strength, which is believed to have changed the division of labor so that women were primarily confined to food preparation and child rearing close to home, which further reduced their mobility and possibly permanently contributed to more unequal gender norms (Boserup 1970; Alesina et al. 2013). There are also strong indications that the early farmers in general had to work more hours a week under more difficult circumstances and that the overcrowded settlements made them more prone to disease (Sahlins 1972; Cohen and Crane-Kramer 2007). In addition, the substantial investments in land-related capital and the usually very transparent harvests of crops implied that powerful chiefs, and later kings, had strong incentives and good opportunities to seize farmer capital and output through taxation or appropriation by force (Scott 2017; Mayshar et al. 2022). On balance, the transition to a sedentary agriculture made possible the emergence of private property rights in the early farming villages, which might
3 See Anderson and Hill (2004) for an account of how property rights evolved in the frontier of the American West. 4 The question of whether a transition from hunting and gathering to agriculture and formal institutions of private ownership implied an improvement in terms of economic freedom has been extensively discussed in political discourses at least since the writings of Hobbes, Locke, and Rousseau. Whereas Hobbes and Locke believed that man could not really have a secure existence without a strong central authority that upheld laws and rights, Rousseau claimed that there would be no conflict over property without rights in the ‘state of nature.’
178 Handbook of research on economic freedom be considered to have contributed to a stronger economic freedom, whereas a reduced spatial mobility and a greater risk of appropriation implied a lower economic freedom. Despite many hurdles and significant costs, many farmers still chose to leave the crowded old core regions of agriculture and migrate to new lands. Judging by more contemporary patterns, it seems likely these colonizations were primarily driven by disenfranchised young males without extensive physical or land-related capital. Such colonization movements often happened in waves of a few hundred years of frantic pioneer spirit, whereupon momentum slowed down and a period of stagnation set in. The organization of colonizer villages in the agricultural frontier was very different from that in Anatolian megasite settlements such as Catalhöyuk from where the agricultural colonizer movement ultimately originated. Frontier settlements, cleared from surrounding European forests, featured characteristic longhouses rather than the dug-in houses built on top of each other in Catalhöyuk, and accommodated several households or lineages at a time. This residential pattern signaled a population in pioneer mode (Shennan 2018), perhaps even with a similar culture as in later pioneer movements such as the colonization of western United States (Bazzi et al. 2020). In Olsson and Paik (2016), we further argue that the archaeological record, as well as evidence from more recent migration episodes and the contemporary distribution of norms, strongly suggest that the people who chose to leave the large and overcrowded farming settlements in Southwest Asia tended to value the freedom to move and had a stronger individualistic culture than those who stayed behind. In social psychology, individualistic norms are described as involving a strong belief in the individual’s own capacity and agency, a focus on the individual rather than the family, and egalitarian social norms. Collectivistic norms, on the other hand, are characterized by a low belief in the individual’s own capacity and a strong belief in fate, prioritizing the family before the needs and preferences of the individual, and norms towards obedience to traditional authority (Triandis 1995). The people who stayed behind in the old core areas of agriculture, on the other hand, most likely held collectivistic norms and a high acceptance of sharing, packed together in almost identical dwellings and accepting the rules laid down by someone else (Olsson and Paik 2016). Life in the crowded farming villages changed human conditions in so many ways. The accumulation of people, capital and food resources soon attracted the attention of nomadic groups still roaming the countryside nearby. We know from later in history, for instance from China, Egypt and Mesopotamia, that sedentary communities often were the object of attacks from nomadic ‘barbarians’ who sometimes violently tried to appropriate the resources of the large settlements. This must also have happened to the early farming communities that initially were likely tiny but densely populated colonies in an environment still dominated by foragers. The prevalence of such hostility exacerbated the need to construct fortifications and the organization of a defensive military capacity. When the hunter-gatherers had disappeared from the old core areas, communities could not resist the temptation of raiding each other for valuable commodities or for prestige. This pattern would later become very common among, for instance, the Mesopotamian and Mayan city states. The implication of the strong intergroup competition was that the large farming communities in the agricultural core areas soon adopted military institutions that would strengthen tendencies towards collectivism. Recent research has emphasized that key differences in farming technologies, for instance regarding the physical character of the planting, nurturing, and harvesting of crops, had a substantial impact on cultural norms. First, the old irrigation theory associated with Wittfogel (1957), and later corroborated by Bentzen et al. (2016), contends that irrigation requires
Deep determinants of economic freedom 179 large-scale collective action, which can only be effectively organized by an autocratic state. The need for irrigation should, according to this logic, not be conducive to individual freedom.5 A second central aspect concerned the transparency of food production, for instance determined by the predictability of rainfall or the flooding of rivers. In Southern Mesopotamia and in Egypt, the flooding of rivers was relatively easy to observe and exploit for taxation by a ruler but less so in rain-fed Northern Mesopotamia, where no state emerged until later. Yet another factor was the degree to which the dominant cultivated plants were cultivated above or below ground. Tubers such as potatoes were less transparent and not easily stored, whereas cereals were readily observable, easy to store and easy to appropriate by a king or an elite (Mayshar et al. 2022). A third theory argues that there is a key difference between rice production on irrigated paddies and rain-fed wheat fields in the sense that the cultivation of rice is functionally interdependent of many farmers cooperating. Along these lines, Talhelm et al. (2014) developed the rice theory of cultural norms, arguing that cultures that were heavily dependent on rice should therefore be more collectivistic. In an experimental study on students from typical wheat and rice areas in China, Talhelm et al. (2014) indeed found evidence of large contemporary differences in cultural attitudes supporting the predictions of the rice theory. Apart from defense considerations and the technology of subsistence food production, Olsson and Paik (2016) argue that also a third factor contributed to the collectivism of the agricultural core areas: the prevalence of infectious disease. The large and unhealthy agricultural settlements, where people and animals shared quarters, attracted rats, fleas, and mosquitos, provided the ideal breeding ground for the mutation and spread of lethal viruses (Scott 2017). As argued convincingly by Fincher and Thornhill (2013) in their parasite-stress theory of values, a high prevalence of infectious disease is often associated with collectivistic norms. Several recent works in the literature have suggested that there might exist a universal tradeoff between economic freedom and public measures to contain infectious disease (Troesken 2015; Geloso et al. 2022; Furton 2023; Koyama 2023). Disease outbreaks favored isolation within settlements and a general mistrust of strangers and members of out-groups. All these behaviors are typical for collectivist communities. In sparsely populated peripheral areas, such issues were less of a problem and hence did not enhance collectivist tendencies. Collectivist norms recognize property rights but focus on the rights of the family, lineage or group, whereas individualistic norms emphasize the rights of individuals. Collectivistic family norms further strongly circumscribe an individual’s freedom of economic activity. In a collectivist world, sons follow in the footsteps of fathers, and women marry whoever their parents think is best suited for them. In this sense, collectivistic cultural norms are strongly associated with low levels of economic freedom. Using data on historical infectious disease prevalence from Murray and Schaller (2010), Nikolaev and Salahodjaev (2017) demonstrate that there is a strong empirical link from historical disease exposure, a collectivist culture, and low levels of economic freedom. What I referred to as a self-domestication of humans from their forager past, is thus closely associated with the emergence of collectivist norms and both probably displayed a great deal of variation across the world with the strongest collectivist norms in the old agricultural core areas. The existence of collectivist norms helps us explain the next revolution in the human 5 See also Ostrom (1990) for a rather different view of this collective action problem in water management.
180 Handbook of research on economic freedom socioeconomic career: the rise of states. In a recent quantitative study of the origins and later development of states, Borcan et al. (2018) map the development of all contemporary states, starting from Uruk (in contemporary Iraq) around 3400 bce up until 2000 ce. In a follow-up paper, Borcan et al. (2021) demonstrate that the emergence of states is a sequential development that generally follows a few thousand years after the transition to agriculture. Sedentary farming in large village settlements provided the breeding grounds for collectivist culture, stratified societies, economic inequality, and the emergence of an elite from which paramount chiefs transformed into kings. The early states of antiquity typically had in common a capacity to extract some kind of tribute or taxation from the people in the state, either in the form of agricultural output or in the form of corvée labor. In Egypt, for instance, the massive pyramids of the Old Kingdom are believed to have been built by locally organized groups of corvée labor. The freedom of individual farmers to freely exploit his or her own labor and capital, was severely circumscribed. As argued by Allen (1997) and Mayoral and Olsson (2022), these strong constraints against individual freedom in Egypt were to a great extent a function of the environmental circumscription of the Egyptian state along the Nile, which during extensive periods prohibited the exit option of oppressed populations. As originally envisaged by Carneiro (1970), a situation where a fertile core area was surrounded by an inhospitable hinterland, implied that an elite had a stronger capacity to dominate and exploit their own population who were trapped, as in a social cage (Allen 1997). A number of papers in the literature develop the argument and explore empirically the hypothesis that an early history of agriculture and states should have persistent effects even on contemporary institutions and levels of economic development (Bockstette et al. 2002; Olsson and Hibbs 2005; Putterman and Weil 2010; Galor and Özak 2016). Although this literature is too large to review here, it has an indirect relevance for our understanding of economic freedom. I will return to some of the predictions from these works in the empirical section. Yet another related theory contends that the geographical extent of the state or polity also mattered for economic freedom. The argument proposes that large states have economies of scale in coercion but also that preference heterogeneity should increase with distance and consequently breed discontent among peripheral groups (Friedman 1977; Alesina and Spolaore 1997). Olsson and Hansson (2011) demonstrate that there is a negative empirical relationship between contemporary country size and the strength of the rule of law.
DEEP ROOTS OF ECONOMIC FREEDOM: AN EMPIRICAL ANALYSIS In the sections above, I reviewed the literature on the deep determinants of economic freedom. In this section, I will provide a rudimentary empirical regression analysis of fundamental covariates of economic freedom that are directly related to the discussion above. Similar or tangential analyses have been presented elsewhere so I make no strong claims of originality below. The simple proposed causal chain can be summarized as: Underlying environmental factors (Xi) ==> Intermediate historical variables (time since agricultural transition, the emergence of states, prevalence of infectious diseases) (Hi) ==> Contemporary economic freedom (Fi)
Deep determinants of economic freedom 181 I argue that, in most cases, underlying environmental factors Xi have an indirect impact through some intermediate historical development or variable Hi, which in turn has a direct effect on contemporary freedom. For instance, it seems likely that a factor such as a country’s distance to the equator (in absolute latitude degrees) might have a negative effect on the prevalence of certain infectious diseases, which in turn affect the institutional choices of societies. However, there are no obvious reasons to believe that a location far from the equator has a direct causal impact on economic freedom. With other environmental factors such as distance to a coast or river, the proximity to water might have facilitated trade and the escape of oppositional individuals or groups both historically and contemporaneously, implying that distance to water might have had both a direct and an indirect effect on economic freedom. The proposed simple model above forms the basis of the main cross-country empirical equation that I estimate: Fi = αi + βi Xi + γ Hi + ε i
(13.1)
In this equation, Fi is our measure of economic freedom (composite and disaggregated scores 1–100 for 2022 (from Heritage Foundation 2022) and from the Fraser Institute (Gwartney et al. 2022), ranging from 0–10) in country i, αi is a constant, Xi are fundamental geographical and climatic factors that are typically included (distance to equator, average distance to a coast or river, average temperature, precipitation, elevation above sea level, and soil suitability to agriculture),6 Hi are variables capturing intermediate historical developments, and εi is an error term. In Table 13.1, Hi includes Time since agricultural transition (in thousands of years), a country’s aggregated experience of State history (1 percent depreciation of older index values), and the Historical prevalence of infectious disease (normalized index). The latter variable is an index capturing the historical prevalence of seven infectious diseases. The first two variables are from Borcan et al. (2018), whereas the latter variable is taken from Murray and Schaller (2010). I certainly do not suggest that these three intermediate variables form an exhaustive list of potential mechanisms, but I would argue that they are the variables that most directly relate to the discussion in the sections above. Furthermore, there are no reasons to be concerned about reverse causality since both Xi and Hi are historically determined variables, whereas the outcome variable captures levels of economic freedom observed in 2020–2022. In Table 13.1, I start by analyzing the reduced-form impact of fundamental geographical and climatic factors Xi on Fi by omitting Hi. In the table, the dependent variables are different composite and selected disaggregated measures of contemporary economic freedom from the Heritage Foundation in columns (1)–(7) and from the Fraser Institute in columns (8–12), using a sample of 137 countries with available data. The results for the composite indices are shown in columns (1) and (8).7 The included disaggregated measures are selected to be in line with the definition of economic freedom above and, for instance, exclude the size of government as an indicator of freedom.8 The three aspects in columns (2)–(4) are Property rights, Judicial effectiveness, and Government integrity, which all belong to the so-called Rule of law category in the Heritage See for instance Borcan et al. (2018). The Pearson correlation between the two composite indices is 0.88. 8 See for instance Ott (2018) for arguments against including the size of government in an index of economic freedom. 6 7
(0.016)
–2.837
(3.499)
Soil suitability
(0.299)
0.53
137
(6.726)
–3.265
(0.035)
0.009
(0.593)
–1.502**
(0.003)
–0.010***
(0.004)
–0.018***
0.44
137
(8.488)
–10.808
(0.045)
0.036
(0.692)
–1.503**
(0.004)
–0.009**
(0.005)
–0.021***
(0.333)
0.200
effect.
Judicial
(3)
0.53
137
(6.671)
–14.301**
(0.036)
0.027
(0.571)
–1.351**
(0.003)
–0.006*
(0.004)
–0.018***
(0.289)
0.267
integrity
Gov.
(4)
0.58
137
(4.750)
–0.579
(0.025)
0.041*
(0.363)
–0.894**
(0.002)
–0.003
(0.002)
–0.011***
(0.187)
0.288
freedom
Business
(5)
0.17
137
(3.556)
–1.613
(0.020)
0.001
(0.280)
–0.718**
(0.001)
–0.003**
(0.002)
–0.004*
(0.145)
–0.143
freedom
Labor
(6)
0.38
137
(2.835)
0.777
(0.018)
0.060***
(0.230)
0.067
(0.002)
0.000
(0.002)
–0.002
(0.120)
0.461***
freedom
Trade
(7)
0.37
137
(0.242)
0.420*
(0.002)
0.003**
(0.025)
–0.052**
(0.000)
–0.000
(0.000)
–0.000**
(0.013)
0.005
Fraser score
(8)
0.54
137
(0.411)
–0.360
(0.003)
0.004
(0.042)
–0.123***
(0.000)
–0.000
(0.000)
–0.001***
(0.022)
0.010
property
Legal and
(9)
0.18
137
(0.461)
0.198
(0.003)
0.005*
(0.048)
–0.066
(0.000)
–0.000
(0.000)
–0.000
(0.024)
0.008
money
Sound
(10)
Components of Fraser Institute in 2020 (11)
0.23
137
(0.318)
0.441
(0.002)
0.001
(0.024)
–0.050**
(0.000)
–0.000
(0.000)
–0.000
(0.013)
0.001
Regulation
(12)
0.36
137
(0.397)
0.690*
(0.002)
0.003
(0.039)
–0.085**
(0.000)
–0.000
(0.000)
–0.001***
(0.021)
0.001
freedom
Trade
Note: The dependent variable in column (1) is the composite index of economic freedom in 2022 from the Heritage Foundation (2022) and subcomponents of the same index in columns (2)–(7). The dependent variable in column (8) is the composite index of economic freedom in 2020 from the Fraser Institute (Gwartney et al. 2022) and subcomponents of the same index in columns (9)–(12). The sample contains 137 countries. The estimator is OLS, robust standard errors in parentheses. See text for explanations about included variables.
137
0.034**
Precipitation
0.43
(0.262)
R2
–0.585**
Temperature
Countries
(0.002)
–0.004***
(0.002)
–0.006***
Elevation
or river
Distance to coast
(0.130)
rights
score
0.132
Absolute distance
to equator
Property
Heritage
0.207
(2)
(1)
Components of Heritage Foundation in 2022
Dependent variable:
Deep determinants of selective subcomponents of the Heritage Foundation and the Fraser Institute measures of contemporary economic freedom
Table 13.1
182 Handbook of research on economic freedom
Deep determinants of economic freedom 183 Foundation (2022), which are in turn similar to the Fraser measure of Legal system and property rights in column (9). These subcomponents are intended to capture (negative) freedom from corrupt practices such as bribery, nepotism, patronage, embezzlement, and graft and are more or less identical to measures of institutional quality in other parts of the literature. In general, Distance to coast or river has a strong negative relationship with the dependent variables in columns (2)–(5), (9) and (11). In addition, Temperature has a consistently negative and often significant estimate. For instance, a one standard deviation increase in temperature (8.4°C) is associated with a 4.9 unit decrease in the economic freedom index in column (1). The estimates for Absolute latitude, Elevation, Precipitation and Soil suitability are usually measured with less precision, in particular when the Fraser measures are dependent variables. It is somewhat striking that in columns (2)–(5) and (9), our environmental and geographical determinants can explain 44–58 percent of the cross-country variation in the subcomponents of economic freedom. Labor freedom and Sound money are the outcome variables that are least well explained by geography. Table 13.2 focuses on the estimates of the three proposed intermediate variables in Hi while also controlling for the geographical variables in Xi in every other column. In the table, I only report the estimates of Distance to coast or river and Temperature which were most often significant in Table 13.1. The dependent variable is the composite indices of economic freedom from the Heritage Foundation in columns (1)–(6) and from the Fraser Institute in columns (7)–(12). In columns (1)–(2) and (7)–(8), the intermediate variable is Time since agricultural transition, measured in millennia. The estimate is insignificant in columns (1) and (7) and negative and significant at the 5 percent level in columns (2) and (8). The estimate –0.91 in column (2) implies that a one standard deviation increase in years since agricultural transition (2.43) is associated with a fall in the freedom index of about 2.21, which is a quite modest effect considering that the mean is 60. Still, if anything, it appears that a long history of agriculture has a small negative influence on contemporary economic freedom. In columns (3)–(4) and (9)–(10), the main explanatory variable is the State history index (1 percent depreciation of previous periods) from Borcan et al. (2018). The index measures the total experience of states within a contemporary country’s borders from 3500 bce to 2000 ce with a value close to 1 indicating a maximum state experience and vice versa. I include a non-linear specification since it was demonstrated in Borcan et al. (2018) that the relationship between state history and levels of economic development displayed an inverted U-shape so that intermediate levels of state history were associated with the highest levels of GDP per capita. The estimates of the linear and squared state history also indicate a clear inverted U-shape with the highest levels of economic freedom enjoyed by countries with an intermediate experience of state history. The implied freedom-maximizing level of state history from the parameters in column (4) is around 0.23, equivalent to the level of Norway. My interpretation is that whereas a too short state history often implies that state institutions and capacities are too weak to guarantee economic freedom, a very long experience of state history means that institutions tend to become extractive and authoritarian, which is also detrimental for economic freedom. In columns (7)–(8) and (11)–(12), I revisit the parasite-stress hypothesis of Fincher and Thornhill (2013) and analyze whether a history of a high prevalence of infectious diseases is associated with less economic freedom. Once again, an additional intermediate link proposed by the literature is a culture of either collectivist or individualistic norms where collectivist, authoritarian norms are hypothesized to be more common in high disease-prevalence environ-
142
0.00
Countries
R2
0.44
133
60.0 0.10
150
60.0
N
(29.76)
0.46
137
60.0
Y
(0.266)
–0.543**
(0.002)
–0.007***
(21.45)
–59.69***
(14.66)
27.79*
(6)
0.24
173
60.0
N
(1.096)
–9.190***
0.44
137
60.0
Y
(0.258)
–0.509*
(0.002)
–0.005***
(1.934)
–3.971**
Historical disease
(5)
(8)
0.00
144
6.74
N
(0.033)
–0.003
0.39
135
6.74
Y
(0.024)
–0.041*
(0.000)
–0.000**
(0.037)
–0.077**
Time since agriculture
(7)
Fraser Institute (10)
0.12
149
6.74
N
(2.15)
–10.30***
(1.319)
5.59***
0.41
137
6.74
Y
(0.023)
–0.046**
(0.000)
–0.000**
(1.94)
–5.84***
(1.281)
2.83**
State history
(9)
(12)
0.31
161
6.74
N
(0.080)
–0.791***
0.41
137
6.74
Y
(0.023)
–0.039*
(0.000)
–0.000
(0.161)
–0.548***
Historical disease
(11)
Note: The dependent variable in columns (1)–(6) is the composite score for economic freedom in 2022 from the Heritage Foundation (2022). The dependent variable in columns (7)–(12) is the composite score for economic freedom in 2020 from the Fraser Institute (2022). The estimates of three intermediate historical variables are displayed in the table, together with the coefficients for Distance to coast or river and Temperature. Four additional geographical controls are included in all even-numbered columns. The estimator is OLS, robust standard errors in parentheses. See text for explanations about included variables.
60.0
Mean dep. var.
Y
(0.253)
N
Geo controls
(0.002)
–0.496*
Temperature
–0.006***
Distance to coast
Historical disease
–122.88***
(17.86)
State history sq.
(0.397) 67.86***
(0.385)
(4)
State history
(3)
State history
–0.910**
0.129
Time since
agriculture
Time since agriculture
(2)
(1)
Heritage Foundation
Dependent variable: Economic freedom
Effect of intermediate historical developments on contemporary economic freedom
Table 13.2
184 Handbook of research on economic freedom
Deep determinants of economic freedom 185 ments. The results in the table appear to corroborate this hypothesis. The estimate is negative and significant at least at the 5 percent level in all columns, and disease prevalence explains almost 31 percent of the variation in column (11). Using the slope coefficient in column (12), where we include all geographical controls, a one standard deviation increase in disease prevalence (0.62) is associated with a 0.34 unit lower level of economic freedom. This marginal impact is relatively modest considering that the mean of the dependent variable is 6.74. One main takeaway from this very basic empirical analysis is that the standard fixed geographical and environmental factors alone can account for around half of the variation in levels of economic freedom. Adding intermediate variables does not contribute with a lot of extra explanatory power. Does this mean that environmental factors primarily have a direct effect on economic freedom? I would say that a great deal of the effect above is probably indirect after all but that it runs through historical intermediate developments that we have not identified in this brief overview. Promising candidates for further intermediate variable analysis from the broader literature include origins of legal traditions (Glaeser and Shleifer 2002), religion (Becker and Woessman 2009), and historical conflict intensity (Dincecco et al. 2021). In general, I believe the future empirical literature on economic freedom would benefit from further efforts to come up with more innovative research designs, perhaps by exploiting natural experiments or other quasi-random exogenous sources of variation, as well as lab-in-the-field and regular lab experiments.
CONCLUDING REMARKS In this chapter, I have reviewed the literature on the deep determinants of economic freedom, starting with the recorded experience from historical and contemporary low population density hunter-gatherer groups where exit was always the primary method of conflict resolution and where the need to be mobile precluded the accumulation of physical capital and extensive niche construction. I showed that the situation was very different in the early agricultural villages where sedentary farmers developed permanent settlements with extensive investments, property rights, social stratification and public goods that often required large-scale collective action. Lastly, in the empirical analysis of deep determinants of economic freedom, I demonstrated that basic environmental and climatic variables such as distance to coast or river and temperature can explain almost half of the cross-country variation in different aspects of economic freedom.
REFERENCES Acemoglu, D., Johnson, S. and Robinson, J.A. (2001). The colonial origins of comparative development: An empirical investigation. American Economic Review 91(5): 1369–1401. Acemoglu, D., Johnson, S. and Robinson, J. (2005). Institutions as a fundamental cause of long-run growth. In: Handbook of Economic Growth, volume 1B (eds. P. Aghion and S.N. Durlauf), 385–472. Amsterdam: Elsevier. Alesina, A., Giuliano, P. and Nunn, N. (2013). On the origins of gender roles: Women and the plough. Quarterly Journal of Economics 128(2): 469–530. Alesina, A. and Spolaore, E. (1997). On the number and size of nations. Quarterly Journal of Economics 125(4): 1627–1682.
186 Handbook of research on economic freedom Allen, R.C. (1997). Agriculture and the origins of the state in ancient Egypt. Explorations in Economic History 34(2): 135–154. Anderson, T. and Hill, P. (2004). The Not so Wild, Wild West: Property Rights on the Frontier. Stanford, CA: Stanford University Press. Bazzi, S., Fiszbein, M. and Gebresilasse, M. (2020). Frontier culture: The roots and persistence of ‘rugged individualism’ in the United States. Econometrica 88(6): 2329–2368. Becker, S.O. and Woessman, L. (2009). Was Weber wrong? A human capital theory of Protestant economic history. Quarterly Journal of Economics 124(2): 531–596. Bentzen, J., Kaarsen, N. and Wingender, A.M. (2016). Irrigation and autocracy. Journal of the European Economic Association 15(1): 1–53. Blegen, N. (2017). The earliest long-distance obsidian transport: Evidence from the ~200 ka Middle Stone Age Sibilo School Road Site, Baringo, Kenya. Journal of Human Evolution 103(February): 1–19. Bockstette, V., Chanda, A. and Putterman, L. (2002). States and markets: The advantage of an early start. Journal of Economic Growth 7(4): 347–369. Borcan, O., Olsson, O. and Putterman, L. (2018). State history and economic development: Evidence from six millennia. Journal of Economic Growth 23(1): 1–40. Borcan, O., Olsson, O. and Putterman, L. (2021). Agricultural transition and first state presence. Explorations in Economic History 82(October): 101404. Boserup, E. (1970). Woman’s Role in Economic Development. London: George Allen and Unwin. Bowles, S. and Choi, J.K. (2019). The Neolithic agriculture revolution and the origins of private property. Journal of Political Economy 127(5): 2186–2228. Carneiro, P. (1970). A theory of the origin of the state. Science 169(3947): 733–738. Cohen, M.N. and Crane-Kramer, M.M. (eds.) (2007). Ancient Health: Skeletal Indicators of Agricultural and Economic Intensification. Gainesville, FL: University Press of Florida. Diamond, J. (1997). Guns, Germs and Steel: The Fates of Human Societies. New York: Norton. Dincecco, M., Fenske, J., Menon, A. and Mukherjee, S. (2021). Pre-colonial warfare and long-run development in India. Economic Journal 132(643): 981–1010. Dunbar, R. (1998). The social brain hypothesis. Evolutionary Anthropology 6(5): 178–190. Fincher, R. and Thornhill, T. (2013). The Parasite-Stress Theory of Values and Sociality. Cham: Springer. Friedman, D. (1977). A theory of the shape and size of nations. Journal of Political Economy 85(1): 59–77. Furton, G. (2023). The pox of politics: Troesken’s tradeoff reexamined. Public Choice 195(4): 169–191. Galor, O. and Özak, O. (2016). The agricultural origins of time preference. American Economic Review 106(10): 3064–3103. Geloso, V., Hyde, K. and Murtazashvili, I. (2022). Pandemics, economic freedom, and institutional trade-offs. European Journal of Law and Economics 54(5): 37–61. Glaeser, E. and Shleifer, A. (2002). Legal origins. Quarterly Journal of Economics 117(4): 1193–1229. Gwartney, J.D., Lawson, R.A., Hall, J.C., Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Henrich, J. (2016). The Secret of Our Success. Princeton, NJ: Princeton University Press. Heritage Foundation (2022). 2022 Index of Economic Freedom. Washington, DC: Heritage Foundation. Ho, H.-A., Martinsson, P. and Olsson, O. (2022). The origins of cultural divergence: Evidence from Vietnam. Journal of Economic Growth 27(1): 45–89. Hublin, J.J., Ben-Ncer, A., Bailey, S.E., Freidline, S.E., Neubauer, S., Skinner, M.M., Bergmann, I., Le Cabec, A., Benazzi, S., Harvati, K. and Gunz, P. (2017). New fossils from Jebel Irhoud, Morocco and the pan-African origin of Homo sapiens. Nature, 546(7657), 289–292. Johnson, A.W. and Earle, T. (2000). The Evolution of Human Societies: From Foraging Group to Agrarian States. Stanford, CA: Stanford University Press. Kelly, R. (2013). The Lifeways of Hunter-Gatherers: The Foraging Spectrum. Cambridge: Cambridge University Press. Koyama, M. (2023). Epidemic disease and the state: Is there a tradeoff between public health and liberty? Public Choice 195(1–2): 145–167.
Deep determinants of economic freedom 187 Kuijt, I. and Finlayson, B. (2009). Evidence for food storage and predomestication granaries 11,000 years ago in the Jordan Valley. PNAS 106(27): 10966–10970. Larson, G., Piperno, D.R., Allaby, R.G. and Fuller, D.Q. (2014). Current perspective and the future of domestication studies. PNAS 111(17): 6139–6146. Larsen, C.S., Knusel, C.J., Haddow, S.D. and Glencross, B. (2019). Bioarchaeology of Neolithic Çatalhöyuk reveals fundamental transitions in health, mobility, and lifestyle in early farmers. PNAS 116(26): 12615–12623. Lawson, R.A., Murphy, R.H. and Powell, B.W. (2020). The determinants of economic freedom: A survey. Contemporary Economic Policy 38(4): 622–642. Lee, R. (1979). The !Kung San: Men, Women and Work in a Foraging Society. Cambridge: Cambridge University Press. Mayoral, L. and Olsson, O. (2022). Floods, droughts and environmental circumscription in early states: The case of ancient Egypt. Mimeo, University of Gothenburg. Mayshar, J., Moav, O. and Pascali, L. (2022). The origin of the state: Land productivity or appropriability? Journal of Political Economy 130(4), 1091–1144. Murray, D.R. and Schaller, M. (2010). Historical prevalence of infectious diseases within 230 geopolitical regions: A tool for investigating origins of culture. Journal of Cross-Cultural Psychology 41(1): 99–108. Nikolaev, B. and R. Salahodjaev (2017). Historical prevalence of infectious disease, cultural values, and the origin of economic institutions. Kyklos 70(1): 97–128. North, D.C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press. North, D.C. and Thomas, R.P. (1977). The first economic revolution. Economic History Review 30(2): 229–241. Olsson, O. (2024). Paleoeconomics: Climate Change and Economic Development in Prehistory. London: Palgrave MacMillan. Olsson, O. and Hansson, G. (2011). Country size and the rule of law: Resuscitating Montesquieu. European Economic Review 55(5): 613–629. Olsson, O. and Hibbs, D.A. (2005). Biogeography and long-run economic development. European Economic Review 49(4): 909–938. Olsson, O. and Paik, C. (2016). Origins of cultural divergence: Evidence from the Neolithic revolution. Journal of Development Economics 122(September): 197–213. Ostrom, E. (1990). Governing the Commons: The Evolution of Institutions for Collective Action. Cambridge: Cambridge University Press. Ott, J. (2018). Measuring economic freedom: Better without size of government. Social Indicators Research 135(2): 479–498. Putterman, L. and Weil, D. (2010). Post-1500 population flows and the long-run determinants of economic growth and inequality. Quarterly Journal of Economics 125(4): 1627–1682. Sahlins, M. (1972). Stone Age Economics. Chicago: Aldine. Scott, J.C. (2017). Against the Grain: A Deep History of Our Earliest States New Haven, CT: Yale University Press. Shennan, S. (2018). The First Farmers of Europe: An Evolutionary Perspective. Cambridge: Cambridge University Press. Talhelm, T., Zhang, X., Oishi, S., Shimin, C., Duan, D., Lan, X. and Kitayama, S. (2014). Large-scale psychological differences within China explained by rice versus wheat agriculture. Science 344(6184): 603–608. Triandis, H.C. (1995). Individualism and Collectivism. Oxford: Westview Press. Troesken, W. (2015). The Pox of Liberty: How the Constitution Left Americans Rich, Free, and Prone to Infection. Chicago: University of Chicago Press. Wittfogel, K. (1957). Oriental Despotism: A Comparative Study of Total Power. New Haven, CT: Yale University Press.
PART V CONSEQUENCES OF ECONOMIC FREEDOM
14. The impact of economic freedom on economic growth1 Jakob de Haan and Jan-Egbert Sturm
INTRODUCTION Economists have for some time recognized that institutions play an important role in explaining the economic performance of nations. Some even argue that institutional differences are the key driver of cross-country differences in economic development (see the contributions in de Haan 2019). According to North (1990, p. 3), institutions ‘are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interactions.’ Glaeser et al. (2004, p. 275) argue that there are two key elements in this definition: institutions are constraints, and these constraints need to be reasonably durable. In this sense, institutions (the rules) are different from policies (the game): ‘constitutions or electoral rules are good examples of institutions, but good policies chosen by dictators who have a free hand are not.’ No doubt, the critique raised by Glaeser et al. (2004) that many proxies for institutional quality refer to outcomes rather than enduring constraints applies to economic freedom (EF) measures as well. Several components of the EF indices refer to policies. Still, both institutions and policies may matter (IMF 2003). This chapter reviews studies on the relation between economic freedom and economic growth. The chapter is structured as follows. The next section discusses the empirical methods used to analyze this relation. The ensuing section provides an overview of the studies that we are aware of, updating the survey by de Haan et al. (2006). The final section discusses what we can learn from this research and offers some promising ways to analyze the relation between EF and economic growth.
MODELLING CHOICES Most studies use the EF index of the Fraser Institute, which measures the degree of economic freedom present in five major areas: Size of Government, Legal System and Property Rights, Sound Money, Freedom to Trade Internationally, and Regulation of Credit, Labor, and Business.2 Whereas the level of the index gives empirical substance to the concept of economic freedom, the change in the EF index resembles the institutional and policy reform
We like to thank Joppe de Bruin for excellent research assistance and the editor for useful feedback on a previous version of this chapter. 2 See Murphy (2024) for details. Another index is provided by the Heritage Foundation. Although both EF indices are fairly similar, there are also some important differences; see Ram (2014) for a further discussion. 1
189
190 Handbook of research on economic freedom required by international organizations like the IMF and the World Bank when they provide financial support to member countries (de Haan et al. 2006; Grier and Grier 2021). Several studies examine the relation between subcomponents of the EF index and economic growth. Lawson (2006, p. 401) argues, however, that this is like asking what the most important ingredient is in a cherry pie. Is it the cherries? The sugar? The flour? The shortening? If you fail to include any of those ingredients, you will not bake a cherry pie. In reality all the ingredients work together. … We can parse EF out into various parts, ingredients if you will, but it is conceptually difficult to say which is most important.
If the subcomponents of EF are included in the same regression, there is a serious multicollinearity problem, as many of the component parts of the index are highly correlated with other parts. Many studies use Barro-type cross-section or panel growth models where the dependent variable is the growth rate of GDP per capita over a particular period. Alternatively, a few studies employ GDP per capita as left-hand side variable, in line with studies such as Acemoglu et al. (2001), where the EF index is used as an indicator of institutional quality which is, in a first-stage regression, related to circumstances at the time of colonization. Although cross-country growth regressions have been very popular for some time, they face several problems. First, there is the issue of which variables should be included apart from initial income and the ‘standard’ drivers of long-term growth, such as investment and human capital. There is a tremendous number of potential variables that have been suggested to affect long-term growth. This problem of model uncertainty is, of course, not unique to the EF-growth literature (Sturm and de Haan 2001). Several methods have been proposed to deal with it, like extreme bounds analysis (EBA), be it in the form as originally proposed by Leamer (1983) or variants thereof as suggested by Levine and Renelt (1992) and by Sala-i-Martin (1997). More recently, the Bayesian Averaging of Classical Estimates (BACE) approach has been proposed (Doppelhofer et al. 2004); it has also been used in the literature on the growth effects of EF (cf. Bergh and Karlsson 2010). Second, several older cross-country studies included both the initial level and the change in the EF index. As shown by de Haan et al. (2006), this yields a highly problematic specification as it is equivalent to a specification with the levels of EF at the start and at the end of the sample. In addition, a few more recent studies include both the initial level and change of the EF index in cross-country growth models (cf. Campbell and Snyder 2012; Wiseman 2017). Lawson and Murphy (2018) even run some kind of horse race between a model that includes only the change in the index and one that includes the initial level and the change. Third, the direction of causality is not clear in cross-country regressions (Justesen 2008). That is, does economic freedom cause economic growth or does economic growth affect economic freedom? Cross-country studies can establish a possible correlation between EF and growth, but in the absence of valid instrumental variables, pure cross-country studies are not particularly well-suited for investigating causality; after all, correlation does not establish causality. Attempts have been made to endogenize EF (there is a large literature examining the drivers of (changes in) economic freedom, surveyed in Lawson et al. 2020), but most studies surveyed in the next section treat EF as an exogenous variable. More recent studies use panel data techniques in estimating growth models. However, in principle, these studies suffer from the same shortcoming as cross-country studies. It is
The impact of economic freedom on economic growth 191 thus not surprising that panel studies add tests, such as the Granger causality test, to identify causality (Justesen 2008). Useful as these tests are, it should be noted that establishing Granger-causality is not the same as establishing economic causality. Studies using the level of GDP per capita as a left-hand side variable often employ an instrumental variable (IV) approach. Faria and Montesinos (2009) use instruments frequently employed in this line of literature (such as legal origin, latitude, ethnolinguistic fractionalization, settler mortality rates and population density in 1500), and judicial independence and constitutional review. Faria et al. (2016) use genetic diversity, i.e., the probability that two randomly selected individuals from the relevant population differ genetically from one another, as instrument for EF (and their other proxies for institutional quality). The main instrument used by Bennett et al. (2017) in their model, which aims to explain the level of real GDP per capita in 2010 for a set of 60 countries, is population density in 1500. Several recent studies, as summarized in the third section, focus on the impact of economic freedom on economic growth in a particular country. Although some time series econometric estimators can be used for this purpose, in general, single-country studies face the problem of a limited number of observations and lack of variability.
OVERVIEW OF EMPIRICAL RESEARCH Table 14A.1 provides an overview of empirical studies published after the survey by de Haan et al. (2006), thereby updating their Table 5. The studies are presented in chronological order. To find these studies, we used Google Scholar, which provides information on papers citing de Haan and Sturm (2000), de Haan et al. (2006), and Doucouliagos and Ulubasoglu (2006). However, many of the citing studies were not analyzing the impact of EF on economic growth and were therefore not considered further. Next, the reference list of studies found, which focus on the relation between EF and growth, was subsequently checked. This yielded a few more studies. Table 14A.1 reports the reported results for the impact of EF on economic growth, but note that this relation may not be the focus of all papers summarized. Most studies summarized in Table 14A.1 use data for sets of countries or (sometimes) single countries and the level of EF. In general, these studies report a positive association between EF and economic growth. A few studies focus on changes in EF. A subset of studies employs EF data for US states as published by the Fraser Institute (Karabegovic et al. 2003), including Compton et al. (2011) and Wiseman (2017). Other studies take even lower levels of government as the basis for analysis, such as Bologna et al. (2016), who use data for 381 US metropolitan areas to examine direct and indirect effects of economic freedom on growth and income levels, and Spruk and Kešeljević (2018), who employ data for 407 German districts over 1995–2010. Whereas most studies focus on the unconditional impact of EF (or changes therein) on economic growth, it is possible that the impact of EF on growth is conditioned by some other variable, such as the stage of development (Xu and Li 2008) or entrepreneurship (Bjørnskov and Foss 2012). Likewise, the impact of other drivers of economic growth may be conditioned by EF. There is some evidence for this. For instance, Azman-Saini et al. (2010) report that the impact of FDI on growth is contingent on the level of EF. Likewise, Ketteni and Kottaridi (2019) find that labor market flexibility stimulates the FDI effect on growth. Williamson and Mathers (2011)
192 Handbook of research on economic freedom report that culture affects growth but only if economic freedom is low. One possible explanation for this finding is that when institutions such as private property rights are not formally enforced, individuals may rely on informal norms. Of course, the effect of economic freedom on economic growth may also be conditioned by other factors. This issue has received scant attention. Recently, Graafland and de Jong (2022) examined the conditioning effect of culture. Using Hofstede’s six dimensions of national culture in a sample of 67 countries covering the 1970–2019 period, these authors report that in all regressions economic freedom has a positive influence on economic development. At the same time, the cultural dimension Long Term Orientation increases the effect of economic freedom on income per capita, whereas Uncertainty Avoidance weakens the positive relation between economic freedom and income per capita. Economic freedom may also have an indirect effect on growth, by affecting determinants of economic growth. One obvious variable that is generally included in growth regression is investment. But economic freedom may also affect investment in human capital, as shown by Feldmann (2017). It is quite remarkable that most studies summarized in Table 14A.1 do not examine such indirect effects. An exception is Fabro and Aixalá (2012), who find that EF has a Granger-causal impact on investment in human and physical capital. Likewise, there is an extensive line of research on the impact of natural resource endowments on economic growth, often concluding that countries with a lot of natural resources have a weak economic growth performance (‘natural resource curse’). A few papers (such as Kim and Lin 2007) suggest that economic freedom may reduce this curse.
CONCLUSION: WHAT DOES RESEARCH ON THE EF-GROWTH NEXUS TELL US? Doucouliagos and Ulubasoglu (2006, p. 78) concluded that ‘regardless of the sample of countries, the measure of economic freedom and the level of aggregation, there is a solid finding of a direct positive relation between economic freedom and growth.’ As shown in Table 14A.1, most studies that have been published since then, confirm these conclusions. Since we wrote our previous survey on the literature examining the impact of economic freedom on economic growth, a lot of studies have been published. The left-hand-side of Figure 14.1 shows the respective publication years of the studies summarized in Table 14A.1. It highlights that in the years after the financial crisis there was a peak, but also in more recent years studies analyzing the relation between EF and economic growth have been published. Still, in our view, many studies surveyed here suffer from problems that we already identified in our earlier review, such as the potential endogeneity of EF and wrong specifications of the growth model used. Apart from studies analyzing the conditioning effects of economic freedom on other drivers of economic growth, and those analyzing the conditioning effect of other factors (such as generalized trust and other aspects of culture) on the impact of economic freedom on growth, most of the literature surveyed here does not offer major new insights. What is even more worrisome is that several methodologies that have been suggested to deal with shortcomings of traditional cross-country and panel growth models have hardly been applied. By now, it would have been possible, for instance, following Hausman et al. (2005) and Jong-A-Pin and de Haan (2011), to examine whether growth accelerations or decelerations are proceeded by changes in economic freedom, which would have provided more convincing
The impact of economic freedom on economic growth 193
Note: The dotted line in the top graph shows a fitted fifth-order polynomial trend line. The h-indices are extracted from https://www.scimagojr.com/journalrank.php.
Figure 14.1
Histograms summarizing publication years and journal quality of papers surveyed in Table 14A.1
194 Handbook of research on economic freedom evidence for a link between EF and economic development. Likewise, given the availability of a reasonable number of annual observations, it is remarkable that none of the studies surveyed employs Local Projections as proposed by Jordà (2005). de Haan and Wiese (2022) employ this method to analyze the impact of product and labor market reform on economic growth in a sample of OECD countries. It is also remarkable that studies do not carefully distinguish between the policy and institutional components of the EF index of the Fraser Institute, even though that would be pretty straightforward to do. The only paper going in this direction is Aisen and Veiga (2013), who, apart from the total index, consider the second component of the Fraser Institute index separately. This component captures the institutional-quality dimension of the index. Finally, the impact of the literature discussed here on studies on the impact of institutions on economic development is remarkably low. As shown by the right-hand-side panel of Figure 14.1, we have not found papers published in top-tier journals. The highest ranked journal, as measured by the respective h-index, in which two papers mentioned in Table 14A.1 have been published is World Development.3 With some distance this is followed by publications in the International Business Review, Applied Economics, the European Journal of Political Economy, the Journal of Comparative Economics, Public Choice, and Economic Modelling. At the lower end, we have hardly cited journals such as the Journal of Private Enterprise and the Journal of Risk and Financial Management. Referring to the index of the Heritage Foundation, Auer (2013, p. 182), argues that its limited use may reflect that it ‘is somewhat ideology-based (for example lower government spending is automatically associated with better institutional outcomes).’ Although institutions providing EF measures indeed have a clear pro-free-market position, that is not a good reason to ignore insights from the literature surveyed in this chapter, nor valid grounds for not using EF measures as proxies for institutional quality and economic policies. Referring to the index of the Fraser Institute, and despite their critique of it, de Haan et al. (2006, p. 182) concluded: ‘that the index is both reliable and useful.’ Indeed, as Bennet et al. (2017, p. 504) put it, Previous studies examining the impact of institutions on comparative economic development mainly rely on a unidimensional measure of institutions such as constraints on the executive, risk of expropriation, or the rule of law, but Acemoglu and Johnson (2005) suggest that there are a broad cluster of institutions that are mutually reinforcing for the development process. The EFW index … is constructed to provide a comprehensive measure of the degree to which a nation’s economic institutions and policies reflect the protection of private property, free trade, market allocation, and minimal policy-induced price distortions.
REFERENCES Acemoglu, D., Johnson, S. and Robinson, J.A. (2001). The colonial origins of comparative development: An empirical investigation. American Economic Review 91(5): 1369–1401. Acemoglu, D. and Johnson, S. (2005). Unbundling institutions. Journal of Political Economy 133(5): 949–995.
3 The h-index is defined as the maximum value of h such that a journal has published at least h papers that have each been cited at least h times. Three studies surveyed in Table 14A.1 are not included in this graph. Bjørnskov and Foss (2012) has been published as a book chapter, while two publications appeared in journals without an h-index (Gorlach and le Roux 2015 and Kabir and Alam 2021).
The impact of economic freedom on economic growth 195 Acquah, E., Carbonari, L., Farcomeni, A. and Trovato, G. (2023). Institutions and economic development: New measurements and evidence. Empirical Economics 65(4): 1693–1728. Acikgoz, B., Amoa, A. and Yilmazer, M. (2014). Economic freedom and growth: A panel cointegration approach. Panoeconomicus 63(5): 541–562. Aisen, A. and Veiga, F.J. (2013). How does political instability affect economic growth? European Journal of Political Economy 29(March): 151–167. Aixalá, J. and Fabro, G. (2009). Economic freedom, civil liberties, political rights and growth: A causality analysis. Spanish Economic Review 11(3): 165–178. Alexandre, F., Bação, P. and Veiga, F.J. (2022). The political economy of productivity growth. European Journal of Political Economy 75(December): 102185. Al-Gasaymeh, A., Almahadin, H.A., Alshurideh, M., Al-Zoubi, N.A. and Alzoubi, H.M. (2020). The role of economic freedom in economic growth: Evidence from the MENA region. International Journal of Innovation, Creativity and Change 13(10): 759–774. Auer, R.A. (2013). Geography, institutions, and the making of comparative development. Journal of Economic Growth 18(2): 179–215. Azman-Saini, W.N.W., Baharumshah, A.Z. and Law, S.H. (2010). Foreign direct investment, economic freedom and economic growth: International evidence. Economic Modelling 27(5): 1079–1089. Bennett, D.L., Faria, H.J., Gwartney, J.D. and Morales, D.R. (2017). Economic institutions and comparative economic development: A post-colonial perspective. World Development 96(August): 503–519. Bergh, A. and Karlsson, M. (2010). Government size and growth: Accounting for economic freedom and globalization. Public Choice 142(1): 195–213. Bjørnskov, C. (2017). Growth, inequality, and economic freedom: Evidence from the U.S. states. Contemporary Economic Policy 35(3): 518–531. Bjørnskov, C. and Foss, N.J. (2012). How institutions of liberty promote entrepreneurship and growth. In: Economic Freedom of the World: 2012 Annual Report (eds. J.D. Gwartney, R.A. Lawson and J. Hall), 247–270. Vancouver: Fraser Institute. Bjørnskov, C. and Foss, N.J. (2013). How strategic entrepreneurship and the institutional context drive economic growth. Strategic Entrepreneurship Journal 7(1): 50–69. Bologna, J., Young, A.T. and Lacombe, D.J (2016). A spatial analysis of incomes and institutional quality: Evidence from U.S. metropolitan areas. Journal of Institutional Economics 12(1): 191–216. Campbell, N.D. and Snyder, T.J. (2012). Economic growth, economic freedom, and the resource curse. Journal of Private Enterprise 28(1): 23–46. Cebula, R.J. (2010). Impact of trade freedom on per capita real GDP growth among OECD nations: Recent panel data evidence. Applied Economics Letters 17(17): 1687–1690. Cebula, R.J. (2011). Economic growth, ten forms of economic freedom, and political stability: An empirical study using panel data, 2003–2007. Journal of Private Enterprise 26(2): 61–81. Cebula, R.J. (2013). Which economic freedoms influence per capita real income? Applied Economics Letters 20(4): 368–372. Cebula, R.J. and Clark, J.R. (2014). The effects of economic freedom, regulatory quality and taxation on the level of per capita real income: A preliminary analysis for OECD nations and non-G8 OECD nations. Applied Economics 46(31): 3836–3848. Cebula, R.J., Clark, J.R. and Mixon, F.G. (2012). The impact of economic freedom on per capita real GDP: A study of OECD nations. Journal of Regional Analysis and Policy 43(1): 34–41. Ciftci, C. and Durusu-Ciftci, D. (2022). Economic freedom, foreign direct investment, and economic growth: The role of sub-components of freedom. Journal of International Trade & Economic Development 31(2): 233–254. Compton, R.A., Giedeman, D.C. and Hoover, G.A. (2011). Panel evidence on economic freedom and growth in the United States. European Journal of Political Economy 27(3): 423–435. Dawson, J.W. (2015). The empirical volatility-growth relationship: Is economic freedom the missing link? Journal of Private Enterprise 30(2): 61–82. de Haan, J. (ed.) (2019). Institutions and Economic Development. Cheltenham: Edward Elgar. de Haan, J. and Sturm, J.-E. (2000). On the relationship between economic freedom and economic growth. European Journal of Political Economy 16(2): 215–241. de Haan, J. and Wiese, R. (2022). The impact of product and labor market reform on growth: Evidence for OECD countries based on local projections. Journal of Applied Econometrics 37(4): 746–770.
196 Handbook of research on economic freedom de Haan, J., Lundström, S. and Sturm, J.-E. (2006). Market-oriented institutions and policies and economic growth: A critical survey. Journal of Economic Surveys 20(2): 157–191. Dima, B., Dima, S. and Lobont, O. (2013). New empirical evidence of the linkages between governance and economic output in the European Union. Journal of Economic Policy Reform 16(1): 68–89. Dkhili, H. and Dhiab, L.B. (2018). The relationship between economic freedom and FDI versus economic growth: Evidence from the GCC countries. Journal of Risk Financial Management 11(4): 81. Doucouliagos, H. and Ulubasoglu, M.A. (2006). Economic freedom and economic growth: Does specification make a difference? European Journal of Political Economy 22(1): 60–81. Doppelhofer, G., Miller, R.I. and Sala-i-Martin, X. (2004). Determinants of long-term growth: A Bayesian Averaging of Classical Estimates (BACE) approach. American Economic Review 94(4): 813–835. Erdal, F. and Yenipazarli, A. (2013). Which economic freedoms contribute income per capita? Are results sensitive to the indicators and the estimation methods? Emerging Markets Finance and Trade 49(sup5): 130–147. Fabro, G. and Aixalá, J. (2012). Direct and indirect effects of economic and political freedom on economic growth. Journal of Economic Issues 46(4): 1059–1080. Farhadi, M., Islam, M.R. and Moslehi, S. (2015). Economic freedom and productivity growth in resource-rich economies. World Development, 72(August): 109–126. Faria, H.J. and Montesinos, H.M. (2009). Does economic freedom cause prosperity? An IV approach. Public Choice 141(1–2): 103–127. Faria, H.J., Montesinos, H.M., Morales, D.R. and Navarro, C.E. (2016). Unbundling the roles of human capital and institutions in economic development. European Journal of Political Economy 45(suppl.): 108–128. Feldmann, H. (2017). Economic freedom and human capital investment. Journal of Institutional Economics 13(2): 421–445. Flachaire, E., García-Peñalosa, C. and Konte, M. (2014). Political versus economic institutions in the growth process. Journal of Comparative Economics 42(1): 212–229. Foley, M. and Clark, J.R. (2016). Economic freedom and real income. Journal of Regional Analysis and Policy 46(1): 52–59. Glaeser, E., La Porta, R., Lopes-de-Silanes, F. and Shleifer, A. (2004). Do institutions cause growth? Journal of Economic Growth 9(3): 271–303. Gorlach, V.I. and le Roux, P. (2015). The impact of economic freedom on economic growth in the SADC: An individual component analysis. Studies in Economics and Econometrics 39(2): 41–63. Graafland, J. (2020). Contingencies in the relationship between economic freedom and human development: The role of generalized trust. Journal of Institutional Economics 16(3): 271–286. Graafland, J. and de Jong, E. (2022). The moderating role of culture on the benefits of economic freedom: Cross-country analysis. Journal of Comparative Economics 50(1): 280–292. Grier, K.B. and Grier, R.M. (2021). The Washington consensus works: Causal effects of reform, 1970–2015. Journal of Comparative Economics 49(1): 59–72. Hall, J.C., Lacombe, D.J. and Shaughnessy, T.M. (2019). Economic freedom and income levels across U.S. states: A spatial panel data analysis. Contemporary Economic Policy 37(1): 40–49. Hall, J.C., Levendis, J. and Scarcioffolo, A.R. (2020). The efficient corruption hypothesis and the dynamics between economic freedom, corruption, and national income. Journal of Developing Areas 54(3): 161–175. Hall, J.C., Sobel, R.S. and Crowley, G.R. (2010). Institutions, capital, and growth. Southern Economic Journal 77(2): 385–405. Hausmann, R., Pritchett, L. and Rodrik, D. (2005). Growth accelerations. Journal of Economic Growth 10(4): 303–329. Heckelman, J.C. and Knack, S. (2009). Aid, economic freedom, and growth. Contemporary Economic Policy 27(1): 46–53. Hussain, M.E. and Haque, M. (2016). Impact of economic freedom on the growth rate: A panel data analysis. Economies 4(2): 5. IMF (2003). Growth and Institutions. In: World Economic Outlook (April), 95–128. Washington, D.C.: International Monetary Fund.
The impact of economic freedom on economic growth 197 Jordà, Ò. (2005). Estimation and inference of impulse responses by local projections. American Economic Review 95(1): 161–182. Jong-A-Pin, R. and de Haan, J. (2011). Political regime change, economic liberalization and growth accelerations. Public Choice 146(1): 93–115. Justesen, M.K. (2008). The effect of economic freedom on growth revisited: New evidence on causality from a panel of countries 1970–1999. European Journal of Political Economy 24(3): 642–660. Kabir, M.A. and Alam, N. (2021). The efficacy of democracy and freedom in fostering economic growth. Emerging Economy Studies 7(1): 76–93. Kacprzyk, A. (2016). Economic freedom-growth nexus in European Union countries. Applied Economics Letters 23(7): 494–497. Karabegovic, A., Samida, D., Schlegel, C.M. and McMahon, F. (2003). North American economic freedom: An index of 10 Canadian provinces and 50 U.S. states. European Journal of Political Economy 19(3): 431–452. Kešeljević, A. and Spruk, R. (2013a). Endogenous economic freedom and the wealth of nations: Evidence from a panel of countries, 1996–2011. Applied Economics 45(28): 3952–3962. Kešeljević, A. and Spruk, R. (2013b). Global distribution and dynamics of economic freedom: Non-parametric approach. Economic Modelling 33(July): 560–571. Ketteni, E. and Kottaridi, C. (2019). The impact of regulations on the FDI-growth nexus within the institution-based view: A nonlinear specification with varying coefficients. International Business Review 28(3): 415–427. Kim, D.-H. and Lin, S.-C. (2017). Natural resources and economic development: New panel evidence. Environmental and Resource Economics 66(2): 363–391 Lawson, R.A. (2006). On testing the connection between economic freedom and growth: A comment on de Haan, Lundström, and Sturm. Econ Journal Watch 3(3): 398–406. Lawson, R.A. and Murphy, R.H. (2018). Economic freedom and growth specification debate: A retrospective. Applied Economics Letters 25(15): 1038–1040. Lawson, R.A., Murphy, R.H. and Powell, B.W. (2020). The determinants of economic freedom: A survey. Contemporary Economic Policy 38(4): 622–642. Leamer, E.E. (1983). Let’s take the con out of econometrics. American Economic Review 73(1): 31–43. Levine, R. and Renelt, D. (1992). A sensitivity analysis of cross-country growth regressions. American Economic Review 82(4): 942–963. Murphy, R.H. (2024). Economic Freedom of the World in the universe of measuring institutions. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 31–45. Cheltenham: Edward Elgar Publishing. North, D.C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge: Cambridge University Press. Pääkkönen, J. (2010). Economic freedom as driver of growth in transition. Economic Systems 34(4): 469–479. Panahi, H., Assadzadeh, A. and Refaei, R. (2014). Economic freedom and economic growth in MENA countries. Asian Economic and Financial Review 4(1): 105–116. Pattanaik, F. and Nayak, N.C. (2014). Economic freedom and economic growth in India: What is the empirical relationship? Economic Change and Restructuring 47(4): 275–298. Peev, E. and Mueller, D.C. (2012). Democracy, economic freedom and growth in transition economies. Kyklos 65(3): 371–407. Próchniak, M. and Witkowski, B. (2014). The application of Bayesian Model Averaging in assessing the impact of the regulatory framework on economic growth. Baltic Journal of Economics 14(1–2): 159–180. Ram, R. (2014). Measuring economic freedom: A comparison of two major sources. Applied Economics Letters 21(12): 852–856. Rode, M. and Coll, S. (2012). Economic freedom and growth: Which policies matter the most? Constitutional Political Economy 23(2): 95–133. Sala-i-Martin, X. (1997). I just ran two million regressions. American Economic Review 87(2): 178–183. Santiago, R., Fuinhas, J.A. and Marques, A.C. (2020). The impact of globalization and economic freedom on economic growth: The case of the Latin America and Caribbean countries. Economic Change and Restructuring 53(1): 61–85.
198 Handbook of research on economic freedom Silberberger, M. and Königer, J. (2016). Regulation, trade and economic growth. Economic Systems 40(2): 308–322. Spruk, R. and Kešeljević, A. (2018). Economic freedom and growth across German districts. Journal of Institutional Economics 14(4): 739–765. Sturm, J.-E. and de Haan, J. (2001). How robust is the relationship between economic freedom and economic growth? Applied Economics 33(7): 839–844. Williamson, C.R. and Mathers, R.L. (2011). Economic freedom, culture, and growth. Public Choice 148(3–4): 313–335. Wiseman, T. (2017). Economic freedom and growth in U.S. state-level market incomes at the top and bottom. Contemporary Economic Policy 35(1): 93–112. Wu, C. (2011). Economic freedom, economic growth, and China. Chinese Economy 44(5): 104–119. Xu, Z. and Li, H. (2008). Political freedom, economic freedom, and income convergence: Do stages of economic development matter? Public Choice 135(3–4): 183–205. Young, A.T. and Sheehan, K.M. (2014). Foreign aid, institutional quality, and growth. European Journal of Political Economy 36(December): 195–208. Zghidi, N., Sghaier, I.M. and Abida, Z. (2016). Does economic freedom enhance the impact of foreign direct investment on economic growth in North African countries? A panel data analysis. African Development Review 28(1): 64–74. Zghidi, N., Sghaier, I.M. and Abida, Z. (2018). Remittances, institutions, and economic growth in North African countries. Journal of Knowledge Economy 9(3): 804–821. Zhang, F., Hall, J.C. and Yao, F. (2018). Does economic freedom affect the production frontier? A semiparametric approach with panel data. Economic Inquiry 56(2): 1380–1395.
FI
Xu and Li
components
and Knack
(2009)
FI and five
FI
Heckelman
(2009)
Montesinos
Faria and
Fabro (2009)
Aixalá and
FI
components
(2008)
(2008)
EF measure
FI and five
Study
Lagged change
Initial level
(separately)
Level and change
Level
(separately)
Level and change
Level/change EF
Sample
in PPP
National income per capita
rate of GDP per capita
GDP per capita and growth
capita
Growth of real GDP per
sample each year
capita real income in the
income to the highest per
country’s per capita real
countries
47 aid-recipient
54–99 countries
187 countries
1990–2000
1980–2000
(5-year periods)
1976–2000
(5-year periods)
1970–2003
ln[S/1–S], where S is 104 countries
Period 1970–1999 (5-year periods)
35–72 countries
capita
Growth of real GDP per
Dependent variable
Granger-cause growth but this
biased-corrected FE VAR
all components.
in levels and first differences. levels and first
all components, they are jointly insignificant.
positive effect on growth; components
(weighted by country size)
growth.
negative effect on
have positive or
stage regression. When considering Cross-section; WLS
included in second GDP per capita. EF index has
Positive impact
No controls
capital investment growth (both in differences).
physical and human between EF and
EF also affects causal relation
Bilateral
is greater for OECD convergence.
countries.
EF on convergence of EF on income
Positive effect
on growth and
Cross-section; IV
causality tests; GMM
Panel model; Granger
Panel model; FE; OLS
Positive effect of
investment.
change of EF
causality tests; panel
does not hold for
Comments EF also affects
Conclusions Level and
Panel model; Granger
Method
Overview of recent empirical studies on the relation between economic freedom and growth
Justesen
Table 14A.1
APPENDIX
The impact of economic freedom on economic growth 199
Sample
Period
1970–2005
1970–1995 and
(5-year periods)
1976–2004
FI for US states
and components
(2011)
components
HF and
Compton et al.
Cebula (2011)
Government
(2010)
Institute
Quality of
FI
Pääkkönen
(2010)
Hall et al.
components)
HF (4
over 5-year periods
1988–2005
1980–2000
50 US states
1981–2004
OECD countries 2003–2007
countries
worker Log real GDP per capita
25 transition
96 countries
Growth of real GDP per
worker
Real output growth per
Average and change GSP growth rate
Level
Level
Level
(OECD)
30 countries
2005–2007
Real GDP per capita (log)
countries
Average annual GDP growth 29 high-income
85 countries
Cebula (2010)
Level
Level
Dependent variable Log real GDP per capita
(5-year periods)
components
Karlsson
Level/change EF
Level
(2010)
FI and
Bergh and
et al. (2010)
EF measure
FI
Study
Azman-Saini
Method
Conclusions
Comments
growth while government size has
in explaining growth according to BACE model.
on growth; mixed and components.
results for level
positive impact GMM
Change has
on growth.
positive impact
components have
7/10 EF
Positive impact.
quality.
of institutional
certain level
on growth after
positive impact
only have
Capital increases
are included EF components.
included jointly.
Components
investments.
effect of EF and
Negative interaction
simultaneously.
in regressions
components is increasing in
periods; FE; OLS,
Panel using 5-year
and TSLS
Panel regressions; OLS
GMM
Panel regressions;
Cross-section; OLS
OLS
Economic growth Different EF
a negative effect.
associated with
unimportant
BACE; OLS
Panel FE regressions;
is positively
EF index
EF. Freedom to trade
effect of FDI and
Positive interaction
Panel model; FE and
Panel model; FE; GMM Positive effect.
200 Handbook of research on economic freedom
FI and
components
FI
Bjørnskov and
Foss (2012)
Campbell and
capita
components
(2012)
(separately)
Growth of real GDP per
FI and
Rode and Coll
Level and change
capita
Mueller (2012)
Level
Growth of real GDP per
Growth of real GDP per
HF components
Level
Real GDP per capita
capita
Growth of real GDP per
Total factor productivity
Peev and
FI
Fabro and
Level
change
and jointly with)
Level (separately
Level
capita
of HF
(2012)
Cross-section; OLS
Change has
1995–2007
(5-year periods)
1980–2005
68 countries
countries
24 transition
79 countries
1990–2007
2000–2008 and
1994–2007
(5-year periods)
1976–2005
OECD countries 2002–2006
104 countries
25 countries
Cross-section; OLS
Panel model; FE; OLS
weighted TSLS
Panel model; SEM;
Panel; FE; OLS
Cross-section; OLS
TSLS
Panel model; IV; OLS,
Endogeneity
included jointly.
All components
interaction effects.
No model with
Comments
identify components of EF. components are significant.
cluster analysis to but only some
The authors use association
Positive
all components.
of some but not
significant impact checked via SEM.
Positive and
investment.
and stimulates
impact on growth
EF has positive
positive impact.
components have
7/10 EF
included jointly.
impact when
have significant
Change and level
growth.
productivity
promote
components
Some
level.
in contrast to
1995–2008
Conclusions Positive impact.
jointly)
183 countries
(5-year periods)
Method Panel model; FE; OLS
positive impact,
Growth of real GDP
Period 1970–2004
(separately and
Level and change
countries
capita
Sample 26–128
Dependent variable Growth of real GDP per
Aixalá (2012)
Components
Cebula et al.
Snyder (2012)
HF
Wu (2011)
(2011)
and Mathers
Level/change EF
Level and change
EF measure
FI
Study
Williamson
The impact of economic freedom on economic growth 201
components
HF
HF and FI
Foss (2013)
Cebula (2013)
Dima et al.
similar to FI and
components
HF and
components
Yenipazarli
(2013)
Kešeljević and
Spruk (2013a,
components)
HF but modified
(2014)
Cebula and
Clark (2014)
HF (2
Acikgoz et al.
b)
Own measure
Erdal and
(2013)
capita Total factor productivity
FI and
Veiga (2013)
Level
Level
Level
Change
Level
Level
Level
Dependent variable
Real GDP per capita
Log of real GDP per capita
Log of real GDP per capita
Real GDP per unit of labor
capita (log)
Gross national income per
Level per capita real income
Growth of real GDP per
Bjørnskov and
Level/change EF
Level
EF measure
FI
Study
Aisen and
Sample
Period
2003–2006
(5-year periods)
1980–2005
(5-year periods)
1960–2004
Method
Conclusions
are added. components.
1993–2011
Panel FE; OLS
Panel regressions; OLS
Panel FE; OLS, TSLS
Positive effect.
positive effect.
freedom have
and business
Fiscal freedom
significant.
components are
but not all
Positive effect
components.
unlike several
significant effect,
cointegration; OLS; ML has positive and
robustness check.
EF is used as income. Aggregate index
governance quality. between EF and
Main focus on
used. No controls in 7/10 EF Positive relation
components are
is increasing
(annual data)
1996–2011
Lagged values
Comments
income per capita of some EF
Level of real
growth.
productivity
promote
components
Some
ARDL and Johansen
system-GMM
Panel FE regressions;
OLS
Panel FE regressions;
TSLS
Panel model; OLS,
Panel model; FE; GMM Positive effect.
1970–2006
OECD countries 2003–2007
105 countries
135 countries
Turkey
(5-year periods)
27 EU countries 2000–2010
countries
30 OECD
25 countries
169 countries
202 Handbook of research on economic freedom
Level/change EF
Dependent variable
Sample
measured in the EF index. Model for components does not include controls.
components, except for legal structure and property rights. Positive effect.
components
Roux (2015)
Metropolitan EF
index
Bologna et al.
(2016)
(separately)
FI and
Level
Level (log)
capita income
Level and growth of real per
Nominal GDP (log)
exist between EF components. EF index is included as first lag.
Granger-causes growth. Index and all five components are
and Granger causality tests; pooled OLS; LSDV; system-GMM
Durbin model; OLS and ML areas
to growth. Positive effect.
positively related
reduced by EF. Causal links EF Panel FE regressions
2002–2005/2011 Cross-section; Spatial
2000–2009
natural resources
Negative effect of significant.
Panel model; FE; GMM EF is not
metropolitan
381 US
(SADC)
13 countries
(5-year periods)
1970–2010
change are included.
Gorlach and le
productivity
63–99 countries
effect.
components
Growth in total factor
both level and have positive
(2015)
Level
TSLS
Cross-section; OLS,
FI and
1980–2009
Farhadi et al.
capita
Growth of real GDP per
components
Level and change
included) are never
(2015)
TSLS
Positive effect.
effect.
have positive
GMM Panel model; FE; OLS,
Level and change
Panel model; BMA;
OLS
Panel model; pooled;
Components (jointly
while this is also
effects of
significant. 99 countries
(5-year periods)
1970–2010
government size,
growth. Positive
estimator
In some regressions
Level and change
116 countries
control for
effect EF on
regressions; unknown
FI and
capita
Growth of real GDP per
10-year periods)
(overlapping
1970–2010
2004–2010
Subperiods of
Comments Models include
Conclusions Positive overall
Method Panel RE and FE
Dawson
components
Sheehan
Level
Period 2000–2009
(2014)
FI and
Young and
(2014)
capita
(separately)
components
Witkowski
111 countries
India
capita Growth of real GDP per
Level and change
states
FI and
Nayak (2014)
Próchniak and
20 states in
Level
EF in Indian
Growth of state GDP per
13 countries
Pattanaik and
Real GDP per capita (MENA)
Level
(2014)
EF measure
FI
Study
Panahi et al.
The impact of economic freedom on economic growth 203
countries
30 OECD
79 countries
2013–2015 and
2003–2010
(5-year periods)
1975–2005
2010
per capita in
capita
(5-year periods)
component of FI
and Königer
106 countries
(5-year periods) Growth of real GDP per
28 EU countries 1985–2009 1970–2009
Level
Log of real GDP per capita
components
Level
and 57 countries 2004–2014
Regulation
FI and
Kacprzyk
and 5-year average)
(2016)
components
Haque (2016)
186 countries
Silberberger
HF index and
Hussain and
(2016)
growth that is larger for
estimation and FE-IV.
Panel FE and RE
Panel FE regressions
institutions on
models; RE/FE
Positive effect.
Positive relation.
regime.
low-democracy
of economic
mixture regression
Positive impact
regressions; finite
Panel FE and RE
TSLS
Conclusions Positive impact.
Method Cross-section; IV;
and fiscal freedom
Business freedom
Comments
an explanatory countries); OLS
Panel model; FE; GMM Positive impact.
Panel model; FE; GMM Positive impact.
the rank of EF as and cross section (186
some models.
simultaneously in
included
and components
variable. Index
performed using model (both datasets)
Regressions are also
as controls.
variables are added
Replacement
from the index.
Growth of real GDP (annual
Real per capita income
capita
Growth of real GDP per
Period Level of GDP
are removed
Level
Sample
index) and FI
components are
Clark (2016)
Dependent variable Real GDP per capita in 2010 56–66 countries
used to construct
HF (8/10
Foley and
Level
Level
Flachaire et al.
(2014)
1985–2010)
FI
Level/change EF
Level (average
(2016)
EF measure
FI
Study
Faria et al.
204 Handbook of research on economic freedom
Level/change EF
Dependent variable
America
HF and
components
FI
(2017)
Dkhili and
Dhiab (2018)
Lawson and
America
(2019)
capita
Durbin model; ML
Panel model; spatial
indirect effects.
but positive
No direct effect
production frontier; ML inefficiencies. US states
(5-year periods) Log of real state GDP per
1981–2012
Change
(2018)
EF reduces
Hall et al.
110 countries
is high.
pronounced if EF
Effect of
change are included.
both level and
In some regressions
level of EF jointly.
remittances more
Panel model; stochastic
EF of North
Positive impact.
Panel model; FE; GMM Positive impact.
regressions; OLS
Cross-section
Positive impact.
Positive impact.
Positive impact.
economic growth.
positively to
contributes
countries
1980–2012
1995–2010
inequality most.
Uses change and
the effect of
it that income inequality
appears to moderate
more likely is
Government size
high.
stronger if EF is
North-African
Four
Germany
407 districts in
regressions; OLS
Comments Effect of FDI is
level of EF, the
The higher the
Positive impact.
1990–2010
Log of real GDP per capita
FI
Growth of real GDP per
GDP per capita
Growth and level of real
1995–2004
Panel model; FE; OLS,
estimator
model; unknown
Cross-section
capita
115 countries
1995–2017
(3-year periods)
Panel; FE and spatial
GLS
1979–2011
Panel FE regressions;
1981–2011
Cross-section; TSLS
(5-year periods)
1985–2010
(5-year periods)
Growth of real GDP per
Five countries
US states
50 US states
60 countries
countries
North-African
Conclusions
Method Panel model; FE; GMM Positive impact.
Period 1980–2013
GMM
Zhang et al.
Level
Sample Four
capita
Growth of real GDP per
capita
Level
Level
jointly)
(separately and
Level and change
Level
income
(2018)
Zghidi et al.
FI
authors
Kešeljević
(2018)
Index created by
Spruk and
Murphy (2018)
EF of North
Wiseman
Growth of real market
America (three
(2017)
Level and change
in 2010 Growth of personal income
1985–2010)
Level
EF of North
(2017)
Bjørnskov
components)
Log real GDP per capita
Level (average
FI, HF
Bennett et al.
Growth of real GDP per capita
Level
(2016)
EF measure
FI
Study
Zghidi et al.
The impact of economic freedom on economic growth 205
Period
components)
FI
Graafland
HF
Santiago et al.
(2020)
(2020)
FI
Hall et al.
(2020)
Level
Change
Level
capita
Growth of real GDP per
Real GDP per capita
income)
and components (incl.
Human Development Index
globalization are jointly included.
on long-run growth. estimator
countries
included.
consumption)
(electric power
Dubious control
EF and Negative impact
generalized trust.
Driscoll-Kraay
estimator
Positive effect.
developed
1995–2015
Panel; VAR; unknown
conditioned by
Effect is positively
simultaneously.
are added
All components
monetary policy.
freedom, and
spending, business
Panel; ARDL; FE;
24 least
2002–2013
(5-year periods)
countries 136 countries
Panel; FE and RE; OLS Positive effect.
corruption,
1990–2015
freedom from positive effect.
29 OECD
property rights,
components have
government
components:
in growth. All
system-GMM
(MENA)
enhancing role
Considered
are not investigated.
et al. (2020)
EF plays an
13 countries
HF (five
Al-Gasaymeh
Panel FE regressions;
of FDI on growth. Direct effects EF
local least squares 2010–2018
interacted with FDI.
stimulates effect
model; system-GMM,
Growth in GDP
components are
Labor flexibility
smooth coefficient
Level
regulation. These
FDI on growth.
and semiparametric
Kottaridi developed)
Comments Labor and credit
Conclusions Positive effect of
Method Panel FE regressions
developing, 31
capita
Sample 66 countries (35 2000–2015
Dependent variable Growth in real GDP per
(2019)
Level/change EF
Level
EF measure
FI
Study
Ketteni and
206 Handbook of research on economic freedom
HF and
components
Ciftci and
Durusu-Ciftci
Level/change EF
(5-year periods)
Method
score method
Generalized propensity
Panel; RE; OLS
causality; SUR
Panel; Granger
Panel; FE; OLS; GMM
Panel; FE; GLS
Panel; matching; OLS
Conclusions
included simultaneously. in low- and countries.
middle-income
components effect notably
Different
culture.
two dimensions of
conditioned by
Effect is
Comments
(non-linear)
Positive
Positive effect.
are very mixed.
for components
countries; results
effect in only few
EF has positive
Positive effect.
Positive effect.
capita.
on GDP per
positive impact
Reform has
Note: ARDL= Autoregressive Distributed Lag; BACE= Bayesian Averaging of Classical Estimates; BMA = Bayesian Model Averaging; FE= Fixed Effects; FI = Fraser Institute; GLS = Generalized Least Squares; GMM = Generalized Method of Moments; HF = Heritage Foundation; IV = Instrumental Variables; LSDV = Least Squares Dummy Variable; ML = Maximum Likelihood; OLS = Ordinary Least Squares; RE= Random Effects; SEM = Simultaneous Equations Model; SUR = Seemingly Unrelated Regressions; TSLS = Two Stage Least Squares; VAR = Vector Autoregression; WLS = Weighted Least Squares.
growth rate)
components
(2023)
80 countries
1970–2019
1995–2019
(5-year periods)
1990–2018
1950–2007 and
2006–2018
1980–2015
GDP per capita (level and
67 countries
18 countries
64–83 countries
115 countries
Period 1970–2015
FI and
GNI per capita
capita
Growth in real GDP per
Growth in productivity
Log of real GDP per capita
Sample 141 countries
Acquah et al.
Level
Dependent variable Real per capita GDP
(5-year periods)
Level
Level
Level
Level
Jumps in index
de Jong (2022)
Graafland and
FI
components
(2022)
FI and
al. (2022)
FI
Alexandre et
Alam (2021)
Kabir and
Grier (2021)
EF measure
FI
Study
Grier and
The impact of economic freedom on economic growth 207
15. Economic freedom and inequality: a survey of the empirical literature Daniel L. Bennett
INTRODUCTION Inequality is a pressing concern, acknowledged by scholars, leaders, and organizations globally. Former US President Obama referred to rising inequality as ‘the defining challenge of our time,’ and reducing inequality is a sustainable development goal of the United Nations. To tackle this challenge, understanding its drivers is crucial. Free market capitalism is a common culprit for rising inequality. Pope Francis, for example, described capitalism as a system of ‘exclusion and inequality,’ and Hugo Chávez labeled it as ‘the realm of injustice and a tyranny of the richest against the poorest.’ Meanwhile, Piketty (2014, p. 1) characterizes capitalism as a system that ‘generates arbitrary and unsustainable inequality.’ Critics of capitalism, often adopting a Marxian perspective, view capitalists as resource owners who exploit labor for personal gain (Young and Lawson 2014). However, institutions securing private property rights, facilitating market exchanges, and enforcing contracts – central to capitalism – are integral to economic freedom (Gwartney and Lawson 2003, Hodgson 2015). If we conceptualize capitalism as economic freedom, the critical view implies that it leads to significant inequality, primarily due to the division between resource owners and workers. Nevertheless, Young and Lawson (2014), analyzing the relationship between economic freedom (measured by the Economic Freedom of the World (EFW) index) and labor’s share of national income across 93 countries from 1970 to 2009, find a positive association between economic freedom and labor’s share. While their results challenge the Marxian perspective, they don’t fully explain how economic freedom influences the distribution of resources in capitalist societies, a concern for many. Therefore, understanding the relationship between economic freedom and inequality is crucial for establishing the link between capitalism and inequality, as well as informing policy measures to reduce disparities. Although economic freedom has been empirically linked to positive socio-economic outcomes such as economic growth, foreign direct investment, life expectancy, entrepreneurship, innovation, and psychological well-being, studies examining its relationship with income inequality have yielded mixed results (Bennett and Nikolaev 2017a; Lawson 2022). This chapter surveys the literature on economic freedom and inequality, focusing on empirical studies in peer-reviewed journals listed in the Social Sciences Citation Index (SSCI) that employ multidimensional measures of economic freedom. Additionally, studies investigating specific aspects of economic freedom such as private property rights, regulation, and privatization are discussed. While most studies focus on economic inequality, there is an emerging body of research examining the relationship between economic freedom and other types of inequalities such as happiness, health and gender and racial disparities. These studies are also discussed. Next, I describe the methodology used for the literature review. 208
Economic freedom and inequality: a survey of the empirical literature 209
METHODOLOGY To provide a comprehensive survey of existing literature on economic freedom and inequality, I conducted a systematic search. Specifically, I searched for and reviewed studies published in peer-reviewed journals listed in the SSCI using two phrase Boolean combinations of author-listed keywords from the following two sets: (1) ‘deregulation’, ‘economic freedom’, ‘economic liberalization’, ‘free market’, ‘liberalization’, ‘market liberalization’, ‘market reform’, ‘private property rights’, ‘privatization’, ‘pro market institutions’, or ‘regulation’; and (2) ‘income distribution’, ‘income share’, ‘inequality’, or ‘mobility’. To ensure that the SSCI search did not omit any relevant peer-reviewed journal articles, I supplemented it with a search of Google Scholar for the same keywords. After cleansing the data to remove duplicates, the search yielded nearly 750 unique manuscripts that were examined for inclusion in this review. Because this review is focused on empirical studies, conceptual and/or theoretical articles were not included. I also excluded studies focused on fiscal, monetary, or international trade policy because there exist well-established literatures for these areas. I also excluded from the review studies published in non-English journals and studies concerned with corruption, globalization, and governance because these institutional constructs are conceptually distinct from economic freedom. For interested reviewers, Table 15.1 summarizes key theoretical considerations for the relationship between economic freedom and inequality by area of economic freedom, as conceptualized by Gwartney and Lawson (2003) in development of the Economic Freedom of the World Index, a widely used measure of economic freedom in academic studies that has been cited in more than 1,300 peer-reviewed journal articles (Lawson 2022). After omitting articles outside the scope of the review, 58 articles remained that are included in the survey. While economics journals account for most of the publications, business, public policy, political science, and social science journals also published some of this research.
COUNTRY-LEVEL EVIDENCE Because the seminal articles on economic freedom and inequality are cross-country comparative studies, I first review the cross-country empirical evidence on the relationship between economic freedom and economic inequality. Before delving into this literature, I first present as Figure 15.1 a snapshot of the relationship between economic freedom and the net (post tax and transfer) income Gini coefficient, with both measures representing the mean country-level value over the period 2010–2020.1 As depicted, inequality is higher in countries with less economic freedom. However, this relationship is purely cross-sectional and does not control for other potential confounding factors or how changes in economic freedom influence changes in
The Gini coefficient is a one-dimensional measure of inequality based on the Lorenz curve that captures the overall distribution of a resource such as income or consumption within a population. It ranges from zero (each unit has equal share) to one (one unit controls 100 percent). 1
210 Handbook of research on economic freedom inequality. Empirical studies account for these factors using a variety of multivariate regression methods.2 Table 15.1 Economic freedom
Theoretical considerations Description
Theoretical considerations
Expected
Extent which resources,
● A larger welfare state, characterized by redistributive
Ambiguous
goods, and services are
tax-and-transfer policies, may reduce inequality by
area Size of government
relationship
allocated through personal choice and markets relative to political processes.
reducing disparities and increasing access to education. ● Government consumption spending, investment, and state-owned enterprises may create greater incentives for unproductive entrepreneurship and reallocate resources regressively.
Legal institutions
Protection of persons
● Promote competitive markets and reduce barriers to
and property rights
and their property and
entry and investment, providing greater economic
evenhanded enforcement of
opportunity that acts to reduce market disparities.
Negative
contracts. Sound money
Absence of high and volatile ● Unsound monetary practices can exacerbate inequality rates of inflation.
Negative
because high income earners and the wealthy are better positioned to protect and leverage their assets for arbitrage opportunities.
International trade
Absence of trade barriers
freedom
that distort exchange across national borders.
● In less developed countries, trade barriers restrict
Ambiguous
opportunities for unskilled workers, increasing inequality. ● In developed countries, trade liberalization may reduce economic opportunities for unskilled workers, leading to greater inequality.
Regulatory freedom
Freedom from regulations that hinder entry, competition, and exchange in domestic credit, labor, and product markets.
● Some regulations protect consumers and workers,
Ambiguous
promoting economic opportunities and reducing inequality. ● Regulations may also act as entry barriers, protecting specific firms or industries and limiting competition, thus increasing inequality.
Note: Economic freedom areas and descriptions were adopted from Gwartney and Lawson (2003). Theoretical considerations were adopted from Bennett and Nikolaev (2017a).
Economic Freedom and Gini-based Measures of Inequality Berggren (1999) provides the first study to empirically analyze the relationship between economic freedom and income inequality. Utilizing an early version of the Economic Freedom of the World index (EFW), which was comprised of four major areas, to examine the relationship between economic freedom and income inequality as measured by Gini coefficients, Berggren analyzes the relationship for a cross-section of 66 nations. Berggren’s OLS results indicate 2 Cross-sectional regression methods such as ordinary least squares (OLS) and two-stage least squares (2SLS) are based on between-country variation, while longitudinal regression methods such as fixed effects (FE), random effects (RE), and generalized method of moments (GMM) are based on within-country variation over time.
Economic freedom and inequality: a survey of the empirical literature 211
Note: Both measures reflect country-level mean over the period 2010–2020. Inequality data are from Standardized World Income Inequality Database 9.4 (Solt 2020). Economic Freedom data are from Economic Freedom of the World Index (Gwartney et al. 2022).
Figure 15.1
Income inequality versus economic freedom
that the level of EFW in 1985 and the ten-year change in EFW over the period 1975–1985 are associated with higher and lower income inequality in 1985, respectively. Although paving the way for other scholars to explore this important relationship, Berggren’s study has been criticized for using non-comparable measures of inequality (Scully 2002)3 and misinterpreting the short-run and long-run effects of a distributed lag model (Carter 2007).4 Scully (2002) provides the second economic freedom-inequality study. Using a nine-variable economic freedom index and accounting for the non-comparability of Gini measures by including dummy variables for each type of measure, Scully utilizes 2SLS to estimate the direct effect of economic freedom on inequality as well as its indirect effect via its positive effect of economic growth. For a sample of 26 mostly developed nations over the period 1975–1990, Scully found that economic freedom has a negative direct and total effect on inequality, but the indirect effect through the growth channel is positive. Scully’s identification strategy, however, is problematic because the exclusion restriction for the instrumental variable (i.e., growth of physical capital and government spending) is likely not satisfied (Bennett and Nikolaev 2017a). Following the seminal studies by Berggren (1999) and Scully (2002), many of the studies in this literature employ a multi-dimensional economic freedom index and a Gini-based measure of income inequality to empirically analyze the relationship. These studies, which are summarized in Table 15.2, utilize a variety of datasets, samples, and econometric methods. 3 The measures differ on several dimensions such as: monetary income versus expenditures; person versus household-based; and net versus gross income. 4 Mathematically, the reduced-form equation given by Yt = α + β1 EF0 + β2 ∆ EF + e , where
∆ EF = EF1 − EF0 , is equivalent to Yt = α + (β1 − β2 ) E F0 + β2 E F1 + e (de Haan et al. 2006).
212 Handbook of research on economic freedom Some of the studies find a positive relationship between economic freedom and inequality (Pérez-Moreno and Angulo-Guerrero 2016; Kwon 2018; Karakotsios et al. 2020), while others observe a negative relationship (Clark and Lawson 2008; Apergis and Cooray 2017). Several studies, however, do not report a robust statistically significant relationship at the 5 percent level (Bergh and Nilsson 2010; Sturm and de Haan 2015; Yay et al. 2016). Conditional Effects Some authors contend that the relationship between economic freedom and inequality is conditional on some other factor. For example, several studies consider whether the effect of economic freedom on inequality is conditional on the level of inequality. The results, however, have been mixed. Carter (2007) theorizes the existence of a U-shaped economic freedom-inequality relationship such that economic freedom is negatively associated with inequality at low levels of freedom and positive at higher levels. Carter examines and finds evidence supporting this hypothesis using FE regression for a sample of 39 high- and middle-income countries over the period 1980–2000. Two other studies provide additional evidence of a cross-country U-shaped economic freedom-inequality relationship (Yılmaz et al. 2022; de Soysa and Vadlamannati 2023); however, a replication study by Bennett and Nikolaev (2017a) suggests that this quadratic relationship is not empirically generalizable. Furthermore, Apergis and Cooray (2017), who use panel cointegration methods to examine the long-run relationship between economic freedom and net income inequality for 138 countries over the period 1960–2010, find that although the long-run relationship is negative,5 there may be a threshold level of economic freedom below which the relationship is positive. They estimate the threshold level of economic freedom to be slightly above the mean of their sample. Their results hold for each of the five major areas of the EFW index and are robust to various measures of inequality and an alternative measure of economic freedom that omits transfers and subsidies (Sturm and de Haan 2015). Furthermore, several studies argue that the relationship between economic freedom and inequality is moderated by other factors. Ahmad (2017), for example, suggests that the relationship is conditional on the political regime type. Using difference GMM for an unbalanced sample of 103 countries over the period 1970–2014, Ahmad argues for and finds some evidence of a positive relationship between economic freedom and income inequality that is attenuated in countries with a democratic political regime. Unfortunately, Ahmad’s results are neither conceptually nor empirically generalizable, as additional tests reveal that they are sensitive to the estimator employed, measurement of key constructs, and choice of control variables. In a study focused on 35 Asian economies over the period 2000–2018, Huynh (forthcoming) suggests that the relationship between economic freedom and inequality is conditional on the level of economic development. Huynh finds that economic freedom is associated with higher levels of gross income inequality at low levels of development (≈1/3 standard deviation below the sample mean) but is associated with less inequality at higher levels of development. 5 Similarly, Szczepaniak et al. (2022) study the effect of economic freedom on household consumption inequality in Indonesia over the period 1999–2019 using an autoregressive distributed lag error correction model, reporting a negative long-run relationship between economic freedom and consumption inequality.
Economic freedom and inequality: a survey of the empirical literature 213 Table 15.2 Empirical cross-country economic freedom and Gini-based inequality studies Author(s) Berggren (1999)
Number of
Sample
countries
period
66
1985
Method(s)
Inequality
Finding
Notes
(–)
Include level and change
measure(s) OLS
Income Gini; income share ratios
of EF, which should be interpreted as distributed lag model. Did not report marginal effects for decomposition results, so statistical significance and direction unknown. Multiple income concepts.
Scully (2002)
26
1975–1990
2SLS, 3SLS
Income Gini
(–)
Net direct and total effect. Positive effect via economic growth. Multiple income concepts.
Carter (2007)
39
1980–2000
FE
Income Gini
U-shaped
Multiple income concepts.
Clark and Lawson
66
1980–2002
OLS
Gini
(–)
Did not specify net or gross
78
1970–2005
FE, SGMM
Net income Gini
n/s
(2008) Bergh and Nilsson
income.
(2010)
EF, trade freedom and regulatory freedom positive in FE specifications.
Sturm and de Haan 108
1971–2010
FE
Gross income Gini
n/s
(2015)
Exclude government size and sound money from EF measure.
Pérez-Moreno and
28
2000–2010
POLS, FE, RE, Unspecified SGMM
Angulo-Guerrero (2016)
(+)
Some results sensitive to
income Gini; 80/20
measure of inequality and
income ratio
estimator. European nations only.
Yay et al. (2016)
90
1970–2005
SGMM
Theil industrial
n/s
pay inequality Ahmad (2017)
103
1970–2014
FE, SGMM
Net income Gini
Results sensitive to country sample.
n/s
Effects buffered in democratic regime.
Apergi and Cooray 138
1960–2010
(2017)
Panel
Net income Gini;
cointegration
gross income Gini;
FE, SGMM
Net income Gini;
(–)
n/s
Results sensitive to
Theil index Bennett and
91
1970–2010
Nikolaev (2017a)
inequality measure, sample,
gross income Gini;
and period.
consumption Gini Kwon (2018)
20
1988–2009
OLS, FE,
Gross income Gini
(+)
2SLS Karakotsios et al.
Indirect effect via positive effect on financialization
58
1995–2016
PMG
Net income Gini
(+)
137
2000–2018
FE
Net income Gini
U-shaped
(2020) Yılmaz et al. (2022)
214 Handbook of research on economic freedom Author(s) de Soysa and
Number of
Sample
countries
period
128
1990–2017
Method(s)
Inequality
Finding
FE, SGMM
Net income Gini
(+)
Results sensitive to estimator. Some evidence
Vadlamannati
of U-shaped relationship.
(2021) Huynh
Notes
measure(s)
35
2000–2018
FE, SGMM
Gross income Gini
(+)
Effect buffered by GDP.
(forthcoming)
Note: The table summarizes results from cross-country studies examining the relationship between overall economic freedom and Gini-based measures of inequality. (+) and (–) denote a positive or negative significant relationship at 5 percent significance or better, while n/s denotes statistical insignificance at 5 percent level. EF = economic freedom; FE = fixed effects ordinary least squares; OLS = ordinary lease squares; RE = random effects ordinary least squares; POLS = pooled ordinary least squares; PMG = pooled mean group; SGMM = system generalized method of moments; 2SLS = two-stage least squares; 3SLS = three-stage least squares.
Meanwhile, in a study of 20 developing nations over the period 1988–2009, Kwon (2018) finds that economic freedom does not have a direct effect on income inequality, but it does indirectly increase inequality by promoting greater financial development. Economic Freedom and Income Shares As evidenced by the above review of the cross-country evidence, the empirical relationship between economic freedom and Gini-based measures of inequality is very mixed. As demonstrated by Bennett and Nikolaev (2017a), who perform a rigorous replication of the well-cited Bergh and Nilsson (2010) and Carter (2007) studies, cross-country studies in this literature are often sensitive to the country sample, time period, and choice of measures of economic freedom and inequality, potentially explaining the mixed findings. Additionally, Bergh and Bjørnskov (2021, p. 171) suggest that the Gini coefficient is an inappropriate measure of inequality for understanding how economic freedom influences inequality, noting that: a robust association between economic freedom and a unidimensional metric of income inequality such as the Gini coefficient is unlikely to exist if economic freedom relates differently with income growth at different parts of the income distribution. For example, economic freedom could plausibly lead to disproportionally higher incomes at the top of the distribution by increasing the returns to capital or certain skills, while simultaneously favoring low-income earners by lowering barriers to entry and promoting competition. If that is the case, increased economic freedom will change the shape of the Lorenz curve … with ambiguous consequences for the Gini coefficient.
Following this logic, several recent studies employ new data from the Global Consumption and Income Project, which provides historical consumption and income data by decile for 133 countries, to derive income growth and/or income shares as an alternative way to assess the distributional effects of economic freedom. Saccone (2021), for instance, examines how economic freedom influences the income shares by decile for a sample of 76 countries over the period 1980–2014. Results from Saccone’s RE estimates suggest that economic freedom is negatively associated with the income shares of the lower eight deciles, but positively associated with the top two deciles, suggesting that economic freedom is associated with greater inequality. Migheli and Saccone (2023) find somewhat contradictory results using FE estimation for a sample of 70 countries. They observe that economic freedom is positively associated with the income share of the top decile and negatively associated with the income shares of
Economic freedom and inequality: a survey of the empirical literature 215 the middle and upper middle segments of the distribution, but it has no effect on the income shares of the lowest deciles. Dean and Lawson (2021) replicate Saccone’s (2021) findings using more recent data, but also show that while economic freedom may decrease the share of income accruing to the bottom 80 percent of the distribution, it is positively associated with a higher absolute level of income for all income groups, with the largest income growth occurring at the bottom of the distribution. In a related study, Bergh and Bjørnskov (2021) decompose the EFW index into three components to separately analyze the effect of institutions (i.e., property rights and rule of law), policy (i.e., monetary, trade, and regulation), and limited government on income growth by quintile. Their FE results, based on a sample of 145 countries over the period 1975–2015, suggest that institutions and policy freedom are positively associated with income growth for all quintiles, and that limited government is positively associated with income growth for all quintiles in democracies but not autocracies. Although these studies are more about growth than inequality, they suggest that while economic freedom may make some groups relatively better off than others, which is what a measure of inequality assesses, it may improve the economic conditions of all groups. Contextualizing their findings, Dean and Lawson (2021, p. 106) describe how the choice for the world’s relatively poor may be between having a larger share of a smaller pie with less to eat (under conditions of less economic freedom) versus having a smaller share of a larger pie with more to eat (under conditions of more economic freedom).
However, Kwon and Salcido (2019) observe in a study of 15 developing nations over the period 1970–2010 that economic liberalization – measured by a custom index using data from EFW and the KOF globalization and financial reforms datasets – is positively associated with the long-run growth of income for the top 0.1 percent of the distribution, but does not have a robust relationship with income growth of the top 1 percent, top 10 percent, or bottom 90 percent of the distribution, suggesting that the economic liberalization only benefits the super-rich. Meanwhile, Prinz (2016) examines the relationship between economic freedom and the number of billionaires, as measured by Forbes’ 2016 billionaires list, for a large sample of 178 countries. Prinz’s OLS results reveal that none of the areas of the Heritage Foundation Index of Economic Freedom is associated with the number of billionaires. Similar to studies employing Gini coefficients as the measure of inequality, studies utilizing income quintile data appear also to be sensitive to the country sample, measure, and methodology. Callais and Young (2023) emphasize ‘that the choice of econometric model is of first-order importance’ and employ matching methods to address concerns of endogeneity in their analysis of 117 countries over the period 1970–2015. By matching countries that experienced a large change in economic freedom (i.e., treatment) to comparable countries that did not experience much change in economic freedom (i.e., control), they are able to estimate the causal effect (i.e., average treatment on the treated) of changes in economic freedom on changes in various measures of inequality. Their findings indicate that substantial increases in economic freedom are associated with higher income levels across all deciles, marginal decreases in the income share of the upper-middle class, and a slight increase in overall income inequality as measured by the Gini coefficient. In summary, they assert that increasing economic freedom benefits all income groups, albeit with a modest advantage for the top income groups.
216 Handbook of research on economic freedom
SUBNATIONAL EVIDENCE Numerous studies examine the relationship between economic freedom and inequality at the subnational level. Ashby and Sobel (2008) employ state-level data from the Fraser Institute’s Economic Freedom of North America (EFNA) dataset to assess the relationship between economic freedom and net income share by quintile. Their OLS estimates suggest that changes in EFNA between 1981–1982 and 2001–2003 are associated with higher income shares for the lowest quintile but have no effect on the income shares of the middle and highest quintile. They also observe a negative relationship between economic freedom and the highest-to-lowest income quintile ratio, suggesting that increases in freedom are associated with less inequality. However, their econometric models can be re-interpreted as a distributed lag model, which suggests that that initial and contemporary levels of economic freedom are positively and negatively associated with contemporary inequality (Bennett and Vedder 2013). In their study of the US states over the period 1974–2004, Bennett and Vedder (2013) propose and find evidence of a Kuznets style economic freedom-inequality curve using FE regression. At low levels of economic freedom, increases in freedom are associated with higher income inequality. At higher levels of economic freedom, however, the positive inequality effect diminishes, turning negative at levels above 7.3, which is slightly above the sample mean. Employing a panel error correction model, Apergis et al. (2014) examine the long-run relationship between economic freedom and income inequality for the US states over the period 1981–2004. They show that, consistent with the country-level findings of Apergis and Coorey (2017), state-level freedom is associated with less inequality in the long-run. However, they also provide evidence of bi-directional causality – higher levels of inequality lead to less economic freedom, which in turn leads to greater inequality, pointing to a potential vicious inequality–lower freedom cycle. However, Onafowora and Owoye (2017) do not find a significant relationship between economic freedom and income inequality in their analysis that extends to 2011. Several other studies employ EFNA data to examine the relationship between economic freedom and various measures of inequality. Compton et al. (2014), for instance, examine the relationship between EFNA and mean income growth by quintile from 1981 to 2004 using system GMM. Their findings indicate that economic freedom is positively associated with mean household income growth and growth of quintiles 2–5 but is unrelated to income growth of the lowest decile. Wiseman (2017) utilizes the ratio of the top 10 percent to bottom 90 percent of the income distribution as a measure of inequality and employs FE regression. Wiseman’s findings point towards a negative relationship between economic freedom and inequality that is greater in low-income relative to high-income states. Lastly, Bennett (2016), in the only study pooling subnational data for US states and Canadian provinces, observes a positive association between subnational economic freedom and inequality, as measured by gross income Gini, over the period 1980–2010.
DISAGGREGATING ECONOMIC FREEDOM Economic freedom encompasses a range of interconnected institutions and policies that promote voluntary market exchange (Bennett et al. 2017). While Gwartney et al. (2022) express concerns about disaggregation, arguing for the interdependence of different aspects
Economic freedom and inequality: a survey of the empirical literature 217 of economic freedom in facilitating economic functioning and resource distribution, academic studies have increasingly adopted the practice of disaggregating economic freedom indices to explore potential heterogeneous effects (Lawson 2022). This trend extends to research on economic freedom and inequality, yielding diverse findings. Most studies find that the individual components of economic freedom do not significantly determine economic inequality at the 5 percent level (Bergh and Nilsson 2010; Pérez-Moreno and Angulo-Guerrero 2016; Yay et al. 2016; Ahmad 2017; Bennett and Nikolaev 2017a), although Apergis and Cooray (2017) report a robust negative long-term relationship between each of the five areas of the EFW index and income inequality. A large volume of studies also focuses on the relationship between a specific aspect of economic freedom and inequality. I exclude the extensive body of literature that examines the distributional effects of specific dimensions of economic freedom such as financial liberalization (Ni and Liu, 2019), fiscal policy (Clemens et al. 2015), monetary policy (Colciago et al. 2019), and trade liberalization (Pavcnik 2017). Instead, I focus on studies that offer fresh insights into how relatively understudied aspects of economic freedom, including property rights, non-financial regulation, and privatization reforms, influence inequality. Private Property Rights and Inequality Several studies examine the relationship between private property rights, an essential feature of economic freedom, and inequality. Bennett and Nikolaev (2016) build on the Engerman-Sokoloff hypothesis to theorize that a nation’s historical factor endowments influence the development of property rights institutions, which in turn have a long-lasting effect on economic inequality. They argue that countries with factor endowments more favorable for large-scale family enterprises develop weaker private property rights institutions, perpetuating higher economic inequality. They find empirical support for the durable negative effect of property rights institutions on structural inequality using a 2SLS approach for a sample of 98 countries. Two additional studies utilize longitudinal data to examine the link between property rights and income inequality within countries. Ouattara and Standaert (2020) employ threshold panel regression to examine how property rights influence income inequality for a sample of 189 countries over the period 1994–2014. They find that property rights are positively associated with higher inequality in less democratic countries, but the relationship is negative for more democratic nations. However, it is important to note that their results are sensitive to the measurement of inequality and property rights. Non-Financial Regulation and Inequality A large body of literature examines the effects of financial regulation on inequality (Ni and Liu 2019), so I do not review such studies here. However, relatively fewer studies examine the link between non-financial regulation and inequality, so I review this nascent body of evidence. In cross-country longitudinal studies, the impact of regulation on inequality has yielded mixed results, depending on the type of regulation analyzed. Calderón and Chong (2009) find that greater labor market regulation is associated with lower overall inequality for a sample of 65 nations over the period 1970–2000. They also observe that more labor market regulation is associated with a higher income share for the bottom 20 percent but a lower share for the top
218 Handbook of research on economic freedom 20 percent, thus decreasing inequality. Adams and Atsu (2015) discover a positive relationship between regulatory freedom and inequality for a sample of 72 developing countries in Latin America and Asia over the period 2000–2011. Analyzing the regulatory index’s subcomponents, they observe that the positive link between regulatory freedom and inequality holds for business and labor regulatory freedom, while credit market regulation has no effect on inequality. However, Chambers et al. (2019) find that regulatory barriers to entry, such as licenses and fees, are associated with greater inequality for a panel of 115 countries over the period 2004–2016. Their study reveals that higher entry barriers lead to an increased income share for the top 10 percent, exacerbating overall inequality. Cooke et al. (2021) focus on a specific regulatory entry reform in Portugal, which reduces the time to start a new formal business to a single day. Using detailed employer–employee linked administrative data, they find that this deregulation results in a reduction of firm hierarchy layers, ultimately reducing wage inequality within firms by flattening pay dispersion within firms. Several recent US studies examine the relationship between regulation and inequality in the US using a novel regulatory dataset from the QuantGov project. Chambers and O’Reilly (2022) use the state-level FRASE dataset, which combines industry-specific federal regulatory restrictions with state economic data to assess the relative effect of regulation on each state’s economy, to examine the relationship between regulatory burden and income inequality across 50 states from 1997 to 2015. Their results reveal that a greater regulatory burden is positively associated with income inequality. Notably, they also observe a positive association between labor market freedom (EFNA area 3) and inequality, consistent with cross-country evidence. Mulholland (2019), using industry-level data from the RegData database, shows that wage inequality within occupations is higher in heavily regulated industries in the United States between 2002 and 2014. Bailey et al. (2019) use industry-level RegData to explore how the regulatory burden affects wages by occupation. Their findings suggest that wages tend to be lower in occupations within heavily regulated industries, with more pronounced negative effects for lower-income workers, indicating regressive effects of regulation. Privatization and Inequality Several studies examine how privatization reforms have influenced inequality. Using the World Bank Privatization Database, Ceriani et al. (2022) find a negative relationship between privatization reforms and income inequality in a sample of 62 low and middle-income nations from 1998 to 2008, with the negative effect stronger in democratic nations. Peña-Miguel and Cuadrado-Ballesteros (2018), using the Privatization Barometer dataset, observe no significant relationship between privatization and overall income inequality in a sample of 22 European nations from 2004 to 2013, but privatization is associated with a greater income share for the top 20 percent of the distribution. Case studies offer valuable insights into the distributional effects of private property reforms. Walder and He (2014) find that housing privatization in China resulted in significant wealth gains for individuals in privileged occupations, widening the wealth gap compared with private entrepreneurs and blue-collar workers. However, non-housing wealth generated by entrepreneurs helped mitigate the wealth gap.
Economic freedom and inequality: a survey of the empirical literature 219
EMERGING STREAMS OF RESEARCH While the economic freedom literature predominantly emphasizes income inequality, scholars have also examined its impact on various other types of societal inequalities. Next, I describe several emerging streams of economic freedom research, including happiness, health, and gender and racial inequality. Happiness Inequality Several studies have investigated the relationship between economic freedom and the distribution of happiness. The results are mixed with respect to overall freedom, but two studies identify a negative link between private property rights and happiness inequality. Ovaska and Takashima (2010) conduct a cross-sectional study of 72 countries in the 1990s and find that economic freedom is negatively associated with life satisfaction inequality but has no significant relationship with happiness inequality. Examining a sample of 92 countries from 1981 to 2012, Bennett and Nikolaev (2017b) find a negative relationship between economic freedom and happiness inequality. Their results remain robust across various measures of happiness inequality and estimation methods. Further analysis by Bennett and Nikolaev reveals that the negative association between economic freedom and happiness inequality is driven by the areas of sound money and property rights within the EFW index. In line with these findings, Bjørnskov and Ming-Chang (2015) use happiness responses from the World Values Survey and create four happiness categories: misery, moderately dissatisfied, moderately satisfied, and happy. They find that private property rights are positively associated with the proportion of people reporting happiness, while negatively associated with the share reporting misery, suggestive of a negative relationship between property rights and happiness inequality. Gender and Racial Inequality Scholars have begun exploring the relationship between economic freedom and racial and/or gender inequality, providing valuable insights that highlight the nuanced effects of economic freedom on disparities in pay, managerial representation, and board representation. Several studies suggest that economic liberalization has reduced gender pay inequality in China. Maurer-Fazio and Hughes (2002) investigate the impact of labor market liberalization in China on such inequality. They find that the gender wage gap and the proportion of the gap unexplained by observed characteristics are largest in the most liberalized sectors (e.g., joint ventures), smaller in the collective sector, and smallest in the least liberalized sector (e.g., government). However, the decline in relative pay for women in the most liberalized sector is offset by a larger absolute increase in earnings, resulting in the highest relative median female earnings on the male income distribution in that sector. Ng (2007) examines different phases of economic liberalization in China and their effect on gender pay differentials, finding that gender pay differentials were reduced during the early-stage reform but increased in subsequent reform periods. Ng also observes higher growth in the unexplained gender pay differential in eastern regions of China that implemented stronger market-oriented reforms. Hoover et al. (2015) investigates the impact of state-level economic freedom on the income gap between Black and White households from 1980 to 2014. Their findings reveal that economic freedom is associated with higher median gross incomes for White households but has
220 Handbook of research on economic freedom no effect on the median gross income for Black households. Additionally, they report a negative association between economic freedom and the Black-to-White income ratio, suggesting a positive link between economic freedom and racial inequality. In a subsequent study, Hoover et al. (2018) provide further evidence, showing that economic freedom is positively associated with higher median net incomes for both White and Black households, with larger effects observed for the former. Zhang (2022) examines the impact of state bans on public sector affirmative action on the racial composition of firm managers in the private sector. Analyzing data from 11,311 firms and 34,353 establishments in the United States between 1985 and 2015, Zhang finds that firms in states implementing such bans experience slower growth in Black manager representation, particularly among Black female managers. The study also investigates the political ideology of firm CEOs, revealing that the negative effects of state affirmative action bans on Black manager representation are more pronounced in firms led by conservative CEOs. Lee et al. (2022) explore the relationship between economic freedom in a firm’s state headquarters and the gender and ethnic diversity of firm board members. Analyzing data on corporate board membership for 3,111 publicly traded US firms from 1996 to 2015, they find a negative association between economic freedom and both gender and minority board diversity. The results hold across different measures of economic freedom and various estimation methods. Health Inequality Several studies also examine the relationship between economic freedom and health inequality, and collectively suggest that economic freedom is associated with less healthcare inequality. de Soysa and Vadlamannati (2021) conduct a cross-country comparative study involving 149 countries from 1970 to 2015. Their research reveals a negative relationship between economic freedom and inequality in access to healthcare. Notably, their analysis does not identify meaningful differences in this relationship based on regime type (democratic or non-democratic). In a cross-sectional study of 42 developing countries, Amate-Fortes et al. (2016) uncover that economic freedom is associated with less inequality in child health mortality using various indicators such as the ratio of infant mortality rates across different wealth percentiles and maternal education levels. Hall et al. (2018) utilize propensity score matching methods to study the association between state-level economic freedom, self-reported health status, and race. Their findings indicate that economic freedom is associated with lower overall health levels, but states with greater economic freedom exhibit a smaller racial gap in health status.
DISCUSSION As noted in the introduction to this chapter, capitalism is often criticized for generating unsustainable economic inequalities. If we conceptualize capitalism as economic freedom, those holding such a view believe that there exists a positive relationship between economic freedom and inequality. Yet, the empirical evidence surveyed in this chapter suggests the relationship is considerably more complicated, with the choice of sample, measures, and methodology often influencing the results (Bennett and Nikolaev 2017a; Callais and Young 2023). As suggested by numerous studies, the distributional impact of changes in economic freedom may be con-
Economic freedom and inequality: a survey of the empirical literature 221 ditional on other factors such as, for example, economic development, political regime type, or the level of economic freedom. Thus, further exploration of potential moderating factors is needed to advance our understanding of how economic freedom influences economic inequality. Additional studies that examine the distributional consequences of understudied aspects of economic freedom using novel data sources would also advance knowledge of the economic freedom–inequality relationship. Research on economic freedom and inequality has expanded to encompass various dimensions of inequality. Initial findings suggest that economic freedom is associated with a more equal distribution of happiness and reduced healthcare inequality. It also influences racial and gender disparities, with heterogenous effects across subgroups. Although not covered in this survey, studies on equality of opportunity indicate that economic freedom is linked to greater equity in education, health, and justice (de Soysa and Vadlamannati 2021), as well as higher socio-economic mobility (Boudreaux 2014; Dean and Geloso 2022; Callais and Geloso 2023). However, economic liberalization may negatively impact intergenerational social mobility in transition economies (Gugushvili 2017). These emerging research areas, supported by advancements in data analytics and multilevel methods, offer ample opportunities for scholars to contribute to the understanding of the relationship between economic freedom and inequality.
REFERENCES Adams, S. and Atsu, F. (2015). Assessing the distributional effects of regulation in developing countries. Journal of Policy Modeling 37(5): 713–725. Ahmad, M. (2017). Economic freedom and income inequality: Does political regime matter? Economies 5(2): Article 2. Amate-Fortes, I., Guarnido-Rueda, A. and Molina-Morales, A. (2016). Determinants of child health inequalities in developing countries: A new perspective. Society 53(6): 641–646. Apergis, N. and Cooray, A. (2017). Economic freedom and income inequality: Evidence from a panel of global economies: A linear and a non-linear long-run analysis. The Manchester School 85(1): 88–105. Apergis, N., Dincer, O. and Payne, J.E. (2014). Economic freedom and income inequality revisited: Evidence from a panel error correction model. Contemporary Economic Policy 32(1): 67–75. Ashby, N.J. and Sobel, R.S. (2008). Income inequality and economic freedom in the US states. Public Choice 134(3–4), 329–346. Bailey, J.B., Thomas, D.W. and Anderson, J.R. (2019). Regressive effects of regulation on wages. Public Choice 180(1–2): 91–103. Bennett, D.L. (2016). Subnational economic freedom and performance in the United States and Canada. Cato Journal 36(1): 165–185. Bennett, D.L., Faria, H.J., Gwartney, J.D. and Morales, D.R. (2017). Economic institutions and comparative economic development: A post-colonial perspective. World Development 96(August): 503–519. Bennett, D.L. and Nikolaev, B. (2016). Factor endowments, the rule of law and structural inequality. Journal of Institutional Economics 12(4): 773–795. Bennett, D.L. and Nikolaev, B. (2017a). On the ambiguous economic freedom-inequality relationship. Empirical Economics 53(2): 717–754. Bennett, D.L. and Nikolaev, B. (2017b). Economic freedom and happiness inequality: Friends or foes? Contemporary Economic Policy 35(2): 373–391. Bennett, D.L. and Vedder, R.K. (2013). A dynamic analysis of economic freedom and income inequality in the 50 US states: Empirical evidence of a parabolic relationship. Journal of Regional Analysis and Policy 43(1): 42–55. Berggren, N. (1999). Economic freedom and equality: Friends or foes? Public Choice 100(3–4): 203–223.
222 Handbook of research on economic freedom Bergh, A. and Bjørnskov, C. (2021). Does economic freedom boost growth for everyone? Kyklos 74(2): 170–186. Bergh, A. and Nilsson, T. (2010). Do liberalization and globalization increase income inequality? European Journal of Political Economy 26(4): 488–505. Bjørnskov, C. and Ming-Chang, T. (2015). How do institutions affect happiness and misery? A tale of two tails. Comparative Sociology 14(3): 353–385. Boudreaux, C.J. (2014). Jumping off of the Great Gatsby curve: How institutions facilitate entrepreneurship and intergenerational mobility. Journal of Institutional Economics 10(2): 231–255. Calderón, C. and Chong, A. (2009). Labor market institutions and income inequality: An empirical exploration. Public Choice 138(1–2): 65–81. Callais, J.T. and Geloso, V. (2023). Intergenerational income mobility and economic freedom. Southern Economic Journal 89(3): 732–753. Callais, J.T. and Young, A.T. (2023). A rising tide that lifts all boats: An analysis of economic freedom and inequality using matching methods. Journal of Comparative Economics 51(3): 744–777. Carter, J.R. (2007). An empirical note on economic freedom and income inequality. Public Choice 130(1–2): 163–177. Ceriani, L., Scabrosetti, S. and Scervini, F. (2022). Inequality, privatization, and democratic institutions in developing countries. Revista Hacienda Pública Española 240(1): 95–124. Chambers, D., McLaughlin, P.A. and Stanley, L. (2019). Barriers to prosperity: The harmful impact of entry regulations on income inequality. Public Choice 180(1): 165–190. Chambers, D. and O’Reilly, C. (2022). Regulation and income inequality in the United States. European Journal of Political Economy 72(March): 102101. Clark, J.R. and Lawson, R.A. (2008). The impact of economic growth, tax policy and economic freedom on income inequality. Journal of Private Enterprise 24(1): 23–31. Clemens, M.A., De Mooij, R.A., Gupta, S. and Keen, M. (2015). Inequality and Fiscal Policy. Washington, DC: International Monetary Fund. Colciago, A., Samarina, A. and de Haan, J. (2019). Central bank policies and income and wealth inequality: A survey. Journal of Economic Surveys 33(4): 1199–1231. Compton, R.A., Giedeman, DC and Hoover, G.A. (2014). A distributional analysis of the benefits of economic freedom. European Journal of Political Economy 33(March): 121–133. Cooke, D., Fernandes, A.P. and Ferreira, P. (2021). Entry deregulation, firm organization, and wage inequality. International Journal of Industrial Organization 77(June): 102763. de Haan, J., Lundström, S. and Sturm, J.-E. (2006). Market-oriented institutions and policies and economic growth: A critical survey. Journal of Economic Surveys 20(2): 157–191. de Soysa, I., and Vadlamannati, K. C. (2021). Does free-market capitalism drive unequal access to health? An empirical analysis, 1970–2015. Global Public Health 16(12): 1904–1921. de Soysa, I. and Vadlamannati, K.C. (2023). Free market capitalism and societal inequities: Assessing the effects of economic freedom on income inequality and the equity of access to opportunity, 1990–2017. International Political Science Review 44(4): 471–491. Dean, J. and Geloso, V. (2022). Economic freedom improves income mobility: Evidence from Canadian provinces, 1982–2018. Journal of Institutional Economics 18(5): 807–826. Dean, J., and Lawson, R.A. (2021). Who gains from economic freedom? A panel analysis on decile income levels. Economics and Business Letters 10(2): 102–106. Gugushvili, A. (2017). Political democracy, economic liberalization, and macro-sociological models of intergenerational mobility. Social Science Research 66(August): 58–81. Gwartney, J.D. and Lawson, R.A. (2003). The concept and measurement of economic freedom. European Journal of Political Economy 19(3): 405–430. Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Hall, J.C., Humphreys, B.R. and Ruseski, J.E. (2018). Economic freedom, race, and health disparities: Evidence from US states. Public Finance Review 46(2): 276–300. Hodgson, G.M. (2015). Conceptualizing Capitalism: Institutions, Evolution, Future. Chicago: University of Chicago Press. Hoover, G.A., Compton, R.A. and Giedeman, DC (2015). The impact of economic freedom on the black/ white income gap. American Economic Review 105(5): 587–592.
Economic freedom and inequality: a survey of the empirical literature 223 Hoover, G.A., Compton, R.A. and Giedeman, DC (2018). More on the impact of economic freedom on the black/white income gap. Public Finance Review 46(2): 205–223. Huynh, C.M. (forthcoming). Economic freedom, economic development and income inequality in Asia: An analysis from the Kuznets curve perspective. Journal of the Asia Pacific Economy. Karakotsios, A., Katrakilidis, C., Dimitriadis, D. and Christoforidis, T. (2020). Examining the relationship between income inequality, taxation and economic freedom: A panel cointegration approach. Economics and Business Letters 9(3): 206–215. Kwon, R. (2018). How do neoliberal policies affect income inequality? Exploring the link between liberalization, finance, and inequality. Sociological Forum 33(3): 643–665. Kwon, R. and Salcido, B. (2019). Does a rising tide lift all boats? Liberalization and real incomes in advanced industrial societies. Social Science Research 79(March): 127–140. Lawson, R.A. (2022). Economic freedom in the literature: What is it good (bad) for? In: Economic Freedom of the World: 2022 Annual Report (eds. J.D. Gwartney, R.A. Lawson, J.C. Hall and R.H. Murphy), 187–200. Vancouver: Fraser Institute. Lee, S.M., Bazel-Shoham, O., Tarba, S.Y. and Shoham, A. (2022). The effect of economic freedom on board diversity. Journal of Business Research 149(October): 833–849. Maurer-Fazio, M. and Hughes, J. (2002). The effects of market liberalization on the relative earnings of Chinese women. Journal of Comparative Economics 30(4): 709–731. Migheli, M. and Saccone, D. (2023). Some new evidence on economic freedom and income distribution. Applied Economics 55(27): 3154–3169. Mulholland, S.E. (2019). Stratification by regulation: Are bootleggers and Baptists biased? Public Choice 180(1): 105–130. Ng, Y.C. (2007). Gender earnings differentials and regional economic development in urban China, 1988–1997. Review of Income and Wealth 53(1): 148–166. Ni, N. and Liu, Y. (2019). Financial liberalization and income inequality: A meta-analysis based on cross-country studies. China Economic Review 56(August): 101306. Onafowora, O. and Owoye, O. (2017). A panel vector autoregression analysis of income inequality dynamics in each of the 50 states of USA. International Journal of Social Economics 44(6): 797–815. Ouattara, B. and Standaert, S. (2020). Property rights revisited. European Journal of Political Economy 64(September): 101895. Ovaska, T. and Takashima, R. (2010). Does a rising tide lift all the boats? Explaining the national inequality of happiness. Journal of Economic Issues 44(1): 205–224. Pavcnik, N. (2017). The impact of trade on inequality in developing countries. Working Paper No. 23878, National Bureau of Economic Research. Peña-Miguel, N. and Cuadrado-Ballesteros, B. (2018). The role of governance in privatisation reforms: A European analysis. Scottish Journal of Political Economy 65(5): 479–500. Pérez-Moreno, S. and Angulo-Guerrero, M.J. (2016). Does economic freedom increase income inequality? Evidence from the EU countries. Journal of Economic Policy Reform 19(4): 327–347. Piketty, T. (2014). Capital in the Twenty-First Century. Cambridge, MA: Harvard University Press. Prinz, A. (2016). Do capitalistic institutions breed billionaires? Empirical Economics 51(4): 1319–1332. Saccone, D. (2021). Who gains from economic freedom? A panel analysis on decile income shares. Applied Economics Letters 28(8): 646–649. Scully, G.W. (2002). Economic freedom, government policy and the trade-off between equity and economic growth. Public Choice 113(1–2): 77–96. Solt, F. (2020). Measuring income inequality across countries and over time: The Standardized World Income Inequality Database. Social Science Quarterly 101(3): 1183–1199. Sturm, J.-E. and de Haan, J. (2015). Income inequality, capitalism, and ethno-linguistic fractionalization. American Economic Review 105(5): 593–597. Szczepaniak, M., Geise, A. and Bariyah, N. (2022). Impact of institutional determinants on income inequalities in Indonesia during the Era Reformasi. Journal of Asian Economics 82(October): 101526. Walder, A.G. and He, X. (2014). Public housing into private assets: Wealth creation in urban China. Social Science Research 46(July): 85–99. Wiseman, T. (2017). Economic freedom and growth in US state-level market incomes at the top and bottom. Contemporary Economic Policy 35(1): 93–112.
224 Handbook of research on economic freedom Yay, G., Taştan, H. and Oktayer, A. (2016). Globalization, economic freedom, and wage inequality: A panel data analysis. Panoeconomicus 63(5): 581–601. Yılmaz, I., Balkan, M.M. and Tağ, M.N. (2022). Income inequality and economic freedom: The 2000s. Journal of Applied and Theoretical Social Science 4(4): Article 4. Young, A.T. and Lawson, R.A. (2014). Capitalism and labor shares: A cross-country panel study. European Journal of Political Economy 33(March): 20–36. Zhang, L. (2022). Regulatory spillover and workplace racial inequality. Administrative Science Quarterly 67(3): 595–629.
16. Economic freedom and happiness: on moderation and mediation Johan Graafland
INTRODUCTION Since the late twentieth century, the focus of economic research has shifted from traditional economic measures, such as the Gross Domestic Product, to more subjective measures of well-being. This shift has been motivated by the fact that for humans, well-being is a more relatable measure since it also captures the less tangible aspects of welfare. Since then, researchers have been trying to understand what the sources of well-being are and how they can be stimulated (Bjørnskov et al. 2010). Of all the economic factors studied, such as income inequality, unemployment, and inflation, one strand of the literature is of special interest to us in this chapter: that which studies the effect of economic freedom on happiness. The concept of economic freedom relates to the degree of personal choice, voluntary exchange, freedom of competition, and protection of privately owned property afforded by society (Gwartney and Lawson 2003). The literature distinguishes five different subdimensions of economic freedom: a small size of government and tax freedom, quality of the legal system and property rights, sound money, freedom to trade internationally, and freedom from government regulation of labor, product and capital markets (Gwartney et al. 2008). The aim of this chapter is to provide a literature overview of empirical research into the relationship between economic freedom and happiness and to identify topics for future research. We build on a previous recent literature overview by Berggren and Bjørnskov (2020) and extend this study in two ways. First, we focus on possible moderators that strengthen or weaken the relationship between economic freedom and happiness. This increases our understanding of the conditions under which economic freedom will contribute more or less to happiness. Second, we describe which factors have been found to mediate the relationship between economic freedom and happiness. This provides insight into the channels through which economic freedom affects happiness. In brief, moderation models clarify when and to what extent and mediation models highlight how economic freedom affects happiness. At the end of the chapter, we sketch some possibilities for future research on moderation and mediation in the relationship between economic freedom and happiness.
ECONOMIC FREEDOM AND HAPPINESS In our overview, we use the concept of economic freedom as introduced in Berggren (2024). Most research uses the data of the Fraser Institute. An alternative is the economic freedom index of the Heritage Foundation. Research that used both indicators often found similar results (e.g., Graafland and Compen 2015 and Graafland and Lous 2018). Happiness is often used interchangeably with life satisfaction. Both are subjective well-being (SWB) measures 225
226 Handbook of research on economic freedom and refer to an overall evaluation of life. Whereas life satisfaction provides a comprehensive appraisal of life as it is in comparison to how life should be (Veenhoven 2000) and is a more reflective measure, happiness is a more instantaneous measure of SWB. In this chapter, we will, in general, collectively refer to all SWB measures as ‘happiness’ but still indicate the precise measures used when specific studies are described. In a recent study, Berggren and Bjørnskov (2020) presented a literature overview of studies on the relationship between institutions and happiness. Economic freedom is one of the three types of institutions they researched, besides political and legal institutions. Table 16.1 presents a condensed overview of their results (extended by some other recent studies). In this table I focus on two aspects: the type of indicator of economic freedom researched, and – which is a novelty of this chapter – variables that moderate the relationship between economic freedom and happiness.1 For the overall index of economic freedom, there is almost unambiguous support for a positive relationship between economic freedom and happiness. However, whether economic freedom causally affects happiness is less certain. As argued by Rode et al. (2013), reverse causality from life satisfaction to economic freedom cannot be theoretically excluded, as life satisfaction may foster social capital, which may be supportive to the quality of formal institutions. Esaiasson et al. (2020) provided some support for reverse causality as they found that citizens use their happiness as a criterion for deciding whether to support government policies. Most research reported in Table 16.1 did not test for causality. However, the few studies that did, such as Rode (2013) (who used geographic and linguistic variables as instruments for economic freedom) and Jackson (2017) (who employed system generalized method of moments, which uses past observations in levels and differences to generate a set of instrumental variables), support a positive causal effect from economic freedom on happiness. Rode (2013) also tested the reverse relationship from life satisfaction on economic freedom directly, using annual per capita consumption of spirits as an instrumental variable for life satisfaction, and did not find evidence of reverse causality. However, this conclusion is challenged by a result of Spruk and Kešeljević (2016). On the one hand, they found that economic freedom causally positively affects happiness across space in a cross-country model (using national culture as instrumental variable), which would support the results of Rode (2013) and Jackson (2017). On the other hand, using a longitudinal panel, they found that happiness is negatively related to economic freedom over time at the national level. The authors did not provide an explanation for this intriguing result, but if this result were to be supported by other research, it has important policy implications as it casts doubt on the favorable happiness effects of increasing economic freedom in a national context. To obtain a more detailed understanding of the reasons for a positive relationship between economic freedom and happiness, we consider research on each of the five subdimensions of economic freedom. Since (small) size of government, quality of the legal system, sound money, freedom to trade internationally (trade freedom for short), and freedom from government regulation refer to very different aspects of economic freedom, it is possible that their influence on life satisfaction may vary (Graafland and Compen 2015). This is supported by Table 16.1 that shows that for some subdimensions of economic freedom, the positive rela I have not included the recent and growing literature on the effects of government regulations in response to COVID-19. This literature is still developing and concerns the very specific situation of a pandemic, which created huge externalities that called for active government regulation. 1
Economic freedom and happiness: on moderation and mediation 227 tionship with happiness or life satisfaction is not robust. For example, for (small) government size, some studies found a positive and some a negative relationship between economic freedom and happiness, whereas other studies found no significant relationship. The ambiguity of these findings thus do not provide a clear guidance in judging the empirical relevance of two opposite views on the effects of a large government, i.e., the welfare state view that a large government increases happiness by securing social and economic safety, and the neoliberal perspective that views it as a wasteful spender that negatively affects happiness (Kim and Kim 2012; Graafland and Verbruggen 2022). Also, for freedom from government regulation the relationship is ambiguous. Whereas several studies found that freedom from regulation increases happiness, for the labor market, most studies found that freedom from regulation decreases happiness. Furthermore, Wang et al. (2021) estimated that mandatory air pollution disclosure exerted a significantly positive impact on happiness, mainly by reducing air pollution, whereas Xu et al. (2022) found that environmental regulation can diminish the negative impact of air pollution on happiness. The strongest support for a positive relationship is found for the subdimension of rule of law. Also, for sound money and trade freedom, the relationship with happiness tends to be positive, although some studies did find a negative relationship. Lin et al. (2017) showed, however, that besides the positive effect of globalization on a country’s happiness, there is a negative indirect effect on neighboring countries by changing a country’s relative position. Finally, it should be noted that most research reporting detailed results for the subdimensions of economic freedom did not estimate their influence on happiness simultaneously, but rather separately (as in Rode 2013 and Gehring 2013, and in all studies that focus on one subdimension of economic freedom only). Since the five subdimensions correlate (except small size of government), testing them simultaneously may lead to multicollinearity. However, when testing them separately, the test result for each single subdimension may partly represent the influence of other subdimensions with which it is correlated. As a result, the estimated coefficients for each subdimension, when estimated separately, may be inflated.
MODERATION The variety in the relationship between economic freedom and happiness is not only noticeable from the different results for its five subdimensions, but it is also apparent from the importance of moderating factors. Moderation models allow the strength of the effect of an independent variable on a dependent variable to vary with the level of a third variable, the so-called moderator (relation d1 in Figure 16.1). Dependent on the strength of the moderation coefficient and the values of the moderator, the effect of the independent variable on the dependent variable can be positive, negative or nihil. Moderation models thus clarify the condition under which an independent variable affects a dependent variable. Moderation can be estimated by including the interaction between (or multiplication of) the independent variable and the moderator as an explanatory variable. Another way of identifying moderators is by testing the robustness of a relationship for subsamples for different values of the moderator. Frey (2020) noted that research into institutional conditions and under what circumstances they affect happiness, has so far rarely been undertaken. Still, Table 16.1 identifies various types of moderators in the relationship between economic freedom and happiness, including
Yes
LS LS H LS
Graafland (2020a)
Gropper et al. (2013)
Jackson (2017)
Nadeem et al. (2019)
LC
LS
Obydenkova and Salahodjaev (2017)
Bjørnskov et al. (2008b)
consumption
LS LS
Rode (2013)
Bjørnskov et al. (2008a)
H H+LS
Perovic and Golem (2010)
Ram (2009)
LS LC
Nadeem et al. (2019)
Ott (2010a,b; 2011)
Yes
LS LS
Kim and Kim (2012)
H+LS LS
Gehring (2013)
Hessami (2010)
Knoll and Pitlik (2016)
LS
Flavin et al. (2014)
Yes
LS
H
Yes
Bjørnskov et al. (2007)
Veenhoven (2000)
Yes
LS H
Rode (2013)
Spruk and Kešeljević (2016)
H+LS LS
Ovaska and Takashima (2006)
Rode et al. (2013)
LS EW
Nikolaev (2014)
Nikolaev and Bennett (2017)
– government
Small government
H+LS H+LS
Evrensel (2018)
Gehring (2013)
H+LS LS
Bavetta and Navarra (2011)
Evrensel (2015)
freedom
Negative
Positive
Positive
Insignificant
Insignificant
Negative
Positive
Positive
Positive/negative
Insignificant
Negative
Intelligence
Decentralization
Policy orientation, Income groups
Quality of government
Income group
Government size
effectiveness
Capability to choose Type of expenditure, policy orientation, government
Insignificant for rich countries Cross versus within-country
Positive
Insignificant for middle-income countries
Long-term orientation
Prefer private ownership companies
Religion
Moderation by
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Positive
variables
variable
Overall economic
Use of instrumental Main result
Dependent
Study
Studies on the relationship between economic freedom and happiness
Independent variable
Table 16.1
228 Handbook of research on economic freedom
LS LS
H
Tsai (2009)
Yi and Sun (2021)
H
H+LS
LS LS
Nikolaev (2015)
Rode (2013)
LS
Ma and Chen (2020)
Nadeem et al. (2019)
LC LC
Kumari et al. (2021)
Lin et al. (2017)
LS
H+LS
H
Gehring (2013)
Hessami (2011)
Bjørnskov et al. (2008a)
Dluhosch and Horgos (2013)
LS
Sanfey and Teksoz (2007)
Afia and Harbi (2017)
Trade freedom
LS LS
Nikolaev (2015)
Rode (2013)
LC LS
Kumari et al. (2021)
LS H+LS
Di Tella et al. (2001)
Gehring (2013)
Nadeem et al. (2019)
LS LS
Rode et al. (2013)
Blanchflower et al. (2014)
Sound money
Yes
LS LS
Nadeem et al. (2019)
Nikolaev (2015)
H H+LS
Fereidouni et al. (2013)
Gehring (2013)
LS LS
Bjørnskov et al. (2010)
Bjørnskov (2014)
Rule of law
LC
H
Jackson (2017)
Oishi et al. (2012)
– taxation
– marginal tax
LC H+LS
O’Connor (2017)
Pacek and Radcliff (2008)
protection
Positive
Positive
Positive
Negative
Positive
Inverted U shape
Positive/negative
Positive
Positive
Insignificant
Positive
Positive
Positive
Negative
Positive
Positive
Negative
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Positive
Negative
Positive
Negative
Negative
variables
variable
– social
Use of instrumental Main result
Dependent
Study
Independent variable
Insignificant for rich countries
Inequality
Insignificant for rich countries
Insignificant for rich countries
Insignificant for rich countries
Insignificant for poor countries
Insignificant for poor countries
Insignificant for poor countries
Stronger in economic crisis
Type of measure small government
Moderation by
Economic freedom and happiness: on moderation and mediation 229
H H
Nikolaev (2015)
Wang et al. (2021)
Xu et al. (2022)
Gehring (2013)
–business
–credit market
LS
Positive
Positive
Negative
Negative
Positive
Negative
Negative
Insignificant
Negative
Negative
Negative
Negative
Negative
Negative
Insignificant
Positive
Positive
Positive
Note: EW = emotional well-being, H = happiness, LS = life satisfaction, LC = life evaluation with Cantril ladder scale.
H+LS
LS
LS
Ochsen and Welch (2012)
Radcliff (2013)
H+LS H
Hevenstone (2011)
Jackson (2017)
LS+CL LS
Flavin et al. (2019)
Hamermesh et al. (2017)
LS LS
Carr and Chung (2014)
Flavin et al. (2014)
LS LC
Rode (2013)
Boarini et al. (2013)
–labor market
LS LS
Knoll et al. (2013)
Nadeem et al. (2019)
LS H+LS
Bjørnskov (2014)
Gehring (2013)
regulation
variables
variable
Freedom from
Use of instrumental Main result
Dependent
Study
Independent variable
Income group
Employment insecurity
Insignificant for rich countries
Market orientation
Stronger in economic crisis
Moderation by
230 Handbook of research on economic freedom
Economic freedom and happiness: on moderation and mediation 231
Figure 16.1
Moderation, mediation and moderated mediation
culture (religion, long-term orientation, preference for private ownership, political ideology); income level; and quality of government and type of government expenditure. Research using culture as moderator includes Evrensel (2015) who found that economic freedom increases happiness in mainly Christian countries. For countries that are mainly Muslim and Buddhist/Hindu, economic freedom decreases happiness. Furthermore, Graafland (2020a) found that the cultural dimension of long-term orientation positively moderates the relationship between economic freedom and happiness. The intuition is that the effect of economic freedom depends on how people make use of their freedom. If people and companies lack long-term orientation, they will be disinclined to engage in future-oriented behaviors that stimulate their welfare in the long-term, such as investing in the future and delaying individual or collective gratification. In short-term oriented countries, more economic freedom may therefore decrease rather than increase their happiness. In addition, political ideology influences the strength of the effect of economic freedom on happiness. Bjørnskov et al. (2008a) found that the marginal effects of low government consumption are higher for right-wing than for left-wing voters. Finally, Knoll et al. (2013) estimated that trade freedom particularly benefits people who are opposed to market-oriented policies. This is a somewhat counterintuitive finding, which contradicts other studies, such as Gehring (2013), who found that a positive attitude towards market economy, measured by people’s preference of private ownership over companies, increases the positive effect of economic freedom. Besides culture, income level can also moderate the effect of economic freedom on happiness. For example, Knoll and Pitlik (2016) estimated that (small) government size has neither positive nor negative effects for the happiness of low-income groups.2 Happiness was only reduced for high-income households when spending was increased. For rule of law, half of the studies reported that its positive effect on happiness is only significant for rich countries. In contrast, trade freedom has been found to increase happiness particularly in poor countries. Based on these results, it seems that the positive relationship between economic freedom and happiness for rich countries is mostly driven by the rule of law and for poor countries by trade freedom. The conclusion of Wright (2000), who found that once a developed country attains a certain level of standard of living, globalization will not increase the happiness of people, thus seems still valid. Finally, Flavin et al. (2019) found that the positive happiness effects of labor market regulations are the largest among individuals with lower incomes.
2
Knoll and Pitlik (2016) used instruments for income, but not for government size.
232 Handbook of research on economic freedom A third type of moderator concerns quality of the government and type of government expenditure. For example, Ott (2010a, b, 2011) found that the effect of the size of government on happiness depends on the quality of the government. Decreasing the size of the government raises happiness if the quality of the government is low, but decreases it when the quality of government is high.3 Bjørnskov et al. (2007) found that the positive effect of a small government is moderated by government effectiveness and type of government expenditure.4 The positive effect is not supported for government subsidies and transfers and capital expenditure. Furthermore, Bjørnskov et al. (2008b) found that the positive effect of government consumption on life satisfaction decreases with decentralization of government revenue and expenditure. Lastly, Oishi et al. (2012) found that progressive taxation is associated with increased levels of happiness. However, they did not find any relationship with average tax rates and government spending. Moderation may also stem from non-linearity in the relationship between economic freedom and happiness, as this means that the effect of economic freedom on happiness is contingent on the level of economic freedom itself. An example is Hessami (2010) who found an inversely U-shaped relationship between public sector size and people’s happiness, suggesting that happiness initially increases when government size increases, and decreases beyond a certain, optimal, level of government size. Furthermore, Ma and Chen (2020) estimated that the relationship between free trade and happiness has an inverted U shape, indicating that the level of trade openness influences its relationship with happiness. Lastly, we found studies with several other moderators. For example, for government regulation Bjørnskov (2014) identified a positive moderation effect by a dummy for economic crisis, suggesting that freedom from regulation is particularly relevant in preventing loss in happiness in times of economic crisis. For freedom from regulation of labor markets, Carr and Chung (2014) showed that active public interventions in the labor market particularly increases the happiness of people who face employment insecurity. Furthermore, Obydenkova and Salahodjaev (2017) found that government size increases happiness least in countries with lower levels of cognitive abilities. The rationale of this effect is that high general intelligence is associated with efficient bureaucracies, for example because an intelligent electorate provides a check on fraudulent and incompetent bureaucrats. Veenhoven (2000) found that the relationship between economic freedom and happiness is strongest in nations where the capability to choose is lowest. The intuition of this result is, however, unclear because capability to choose implies that opportunities are acknowledged and acted upon. One would therefore expect an opposite finding. Finally, Ma and Chen (2020) showed that the effect of trade freedom on happiness is negatively moderated by income equality.
Many other studies have confirmed that quality of government has a positive effect on happiness. See, for example, Helliwell et al. (2018), who measured quality of government by government effectiveness, regulatory quality, rule of law, and the control of corruption from the World Bank’s Worldwide Governance Indicators (WGI) project. 4 They used the share of the population having access to media and modern communication devices, a dummy for civil law systems, and the absolute deviation from parity of the ratio of investment prices to the general price level as instruments for government spending. 3
Economic freedom and happiness: on moderation and mediation 233 Table 16.2
Mediation studies of relationship between economic freedom and happiness
Study
Independent variable
Mediator
Result mediation
Oishi et al. (2012)
Fiscal freedom
Satisfaction with
Negative
public goods Graafland and Compen (2015)
Size government
Trust
Negative
Rule of law
Trust
Positive
Rule of law
Income per capita
Positive
Sound money
Income per capita
Positive
Graafland and Lous (2018)
Fiscal freedom
Income inequality
Negative
Sound money
Income inequality
Positive
Trade freedom
Income inequality
Negative
Freedom from
Income inequality
Negative
regulation Oishi et al. (2018)
Fiscal freedom
Income inequality
Negative
Income inequality
Fairness and trust
Negative
Luecke and Knabe (2020)
Freedom from labor regulation
Risk of job loss
Positive
Freedom from labor regulation
Perceived employability
Positive
Graafland (2023a)
Economic freedom
Individual autonomy
Positive
Sound money
Individual autonomy
Positive
Trade freedom
Individual autonomy
Positive
MEDIATION Whereas a considerable amount of attention has been dedicated to investigating the relationship between economic freedom and happiness, the mediating factors of this relationship remain relatively unexplored. Mediation models give insight into how an independent variable affects the dependent variable by changing an intermediate variable, the so-called mediator. In the context of this chapter, the mediation model consists of three relations (see Figure 16.1). Relation (a) explains how the mediator is affected by economic freedom, and relation (b) explains how happiness is affected by the mediator. Relation (c) depicts a possible direct effect of economic freedom on happiness that is not mediated by the mediator. The mediation effect (also called indirect effect) is defined as the multiplication of relation (a) and (b). If the direct effect is insignificant and the indirect effect is significant, the model exhibits so-call full mediation. Scanning the literature, we found six studies that identified mediators in the relationship between (subdimensions of) economic freedom and happiness. First, Oishi et al. (2012) researched the role of satisfaction with public goods as a mediator in the relationship between progressive taxation and happiness. Progressive taxation is negatively related to fiscal freedom (which is a part of a small size of government). They found that citizen’s satisfaction with public and common goods, such as education, health care, good affordable housing, air and water quality, and public transportations, fully mediated the association between progressive taxation and the happiness of nations. Their results indicate that the quality of public goods rather than progressive taxation policy contributes to a happy society. A weak point of this research is, however, that the theoretical reason for progressive taxation causing higher satisfaction with public goods remains unclear. Graafland and Compen (2015) researched two other mediators: generalized trust and income per capita. Trust has been found to be dependent on economic freedom (Berggren
234 Handbook of research on economic freedom and Jordahl 2006), whereas other research has shown it to be an important driver of happiness (Bjørnskov et al. 2010; Oishi et al. 2011). Income per capita has also been found to be positively affected by economic freedom (Justesen 2008; Cebula 2013), whereas the evidence that income per capita raises happiness is more ambiguous. Graafland and Compen (2015) tested the mediating role of trust and income per capita for all five subdimensions of economic freedom simultaneously. They found that trust significantly negatively mediates the effect of a small size of government and that trust and income per capita positively mediates the effect of rule of law on happiness. Income per capita also positively mediates the effect of sound money on happiness. Graafland and Lous (2018) hypothesized that income inequality may mediate the relationship between various subdimensions of economic freedom and happiness. Research has shown that income inequality can be linked to happiness (Oshio and Kobayashi 2010; Verme 2011; Lous and Graafland 2022) as well as to various factors that affect happiness, e.g., health (Sturm and Gresenz 2002), quality of the social environment (Helliwell et al. 2009), homicide (Elgar and Aitken 2011), social dysfunctioning (Wilkinson and Pickett 2010), social security (Mau et al. 2012), trust (Oshi et al. 2011; Barone and Mocetti 2016), and rent-seeking (Stiglitz 2012). Previous research has also indicated that economic freedom and its subdimensions may affect income inequality (Albanesi 2002; Stiglitz 2012).5 Using a panel of OECD countries, Graafland and Lous (2018) found that income inequality significantly negatively mediates the influence of fiscal freedom (which partly covers size of government), trade freedom, and freedom from regulation on happiness, and significantly positively mediates the effect of sound money on happiness. Using data from the Heritage Foundation the positive mediation effect of sound money is not significant. Instead, income inequality is found to significantly mediate a positive relationship between rule of law and happiness. Whereas both income inequality and trust have been shown to mediate the relationship between economic freedom and happiness, research has shown that these two variables also relate to each other, as income inequality may crowd out trust (Graafland and Lous 2019). This is nicely illustrated by Oishi et al. (2018). Using a multilevel mediation model, they showed that progressive taxation (which is negatively related to tax freedom) decreases income inequality at the national level, and that income inequality in turn lowers perceived fairness and trust. Perceived fairness and trust are positively related to happiness at the individual level. When they left out perceived fairness and trust, they estimated that income inequality decreases happiness. Combining these findings with those of Graafland and Compen (2015) and Graafland and Lous (2018, 2019) explains why a small government size may have an adverse effect on happiness, namely by fiscal freedom causing more income inequality and lower trust.6 Fifth, Luecke and Knabe (2020) focused on one aspect of regulation of the labor market, namely employment protection regulations. They proposed risk of job loss and perceived employability as mediators for the relationship between employment protection and happi-
For an overview of research on the relationship between economic freedom and inequality, see Bennett (2024). 6 Helliwell et al. (2021) also argued that trust and income inequality mediate the relationship between government and happiness. However, they did not consider the size of the government, but quality of government. 5
Economic freedom and happiness: on moderation and mediation 235 ness.7 In the empirical analysis, they distinguished two types of workers: permanent workers and fixed-term workers. They found that stricter employment protection is negatively related to the employability for both types of workers. For job loss, they did not find a significant relationship with employment protection for permanent workers, but for fixed-term workers job loss increases with employment protection. As job loss (employability) is found to decrease (increase) happiness, the results imply that employment protection has a negative effect on the happiness of both groups. For both types of workers, only the indirect effect of employment protection on happiness through job loss and employability is significant, while the direct effect is insignificant, indicating full mediation. Finally, Graafland (2023a) found that individual autonomy, or individual freedom of choice, mediates the relationship between economic freedom and life satisfaction. This result supports the argument of Adam Smith that commercial society fostered the liberty and security of individuals and that, after all, it is individual autonomy, instead of wealth, that brings people happiness. In line with previous research by Steckermeier (2021), Graafland (2023a) found that individual autonomy increases life satisfaction more than any other variable. Individual autonomy, in turn, was found to be positively related to economic freedom, which is in line with research by Nikolaev and Bennett (2016) and Pitlik and Rode (2016). The indirect effect of economic freedom on life satisfaction through individual autonomy is significant and explains 18 percent of the total relationship between economic freedom and life satisfaction. Testing for the five subdimensions of economic freedom separately, the mediation effect is only significant for sound money and freedom to trade. Furthermore, Graafland (2023b) found that the strength of the relationship between individual autonomy and life satisfaction increases with individualism, one of Hofstede’s dimensions of national culture. This result implies that the indirect effect of economic freedom on life satisfaction is greater in countries with an individualistic rather than a collectivistic culture.
FUTURE RESEARCH The preceding section illustrates that mediation analysis of the relationship between economic freedom and happiness is still in its infancy. There are many opportunities for extending this research in the future. A starting point is provided by the subjects of the various chapters in Part IV of this volume on the consequences of economic freedom, because these factors are in turn likely to affect happiness. Obvious candidates are entrepreneurship, effects of crisis, and the environment. For example, whereas economic freedom has been found to foster entrepreneurship (Bjørnskov and Foss 2008; Murphy et al. 2020), entrepreneurship has been found to increase happiness (Benz and Frey 2008; Murphy et al. 2020). This suggests that entrepreneurship mediates the relationship between economic freedom and happiness. Examples of other mediators that may explain the relationship between economic freedom and happiness are various indicators of the quality-of-life index of the OECD, such as housing, jobs, education, civic engagement, health, safety, and work-life balance. As argued and empirically shown by Graafland (2020a), these indicators are positively related to economic Besides, they tested for two moderators, unemployment rate and share of fixed-term workers, in the relationship between employment protection regulations and the two mediators. This type of model is a so-called moderated mediation model. 7
236 Handbook of research on economic freedom freedom, except work–life balance, which is significantly negatively related to economic freedom (whereas community is not significantly affected). It is likely that happiness, in turn, is positively related to these various aspects of quality of life. For example, Stryzhak (2020) found that education is positively related to economic freedom and that education makes persons happier, not only because the life of educated people is longer, but also more interesting and informative. Another factor that may mediate the relationship between economic freedom and happiness is civic virtues. Civic virtues can be defined as ‘those social norms, ethical commitments, and other-regarding preferences that facilitate the workings of the institutions advocated by liberals’ (Bowles 2011, p. 50). Classical virtue ethics and empirical research showed that civic virtues increase happiness (Graafland 2022). How economic freedom affects civic virtues is, however, ambiguous. Whereas the so-called doux commerce thesis states that free market institutions have a favorable influence on civic virtues, the so-called self-destruction thesis states that free market institutions are inimical to the civic virtues (Hirschman 1982; Fourcade and Healy 2007; Storr and Choi 2019). Although this debate on free market institutions and civic virtues is very relevant to policymakers, empirical evidence on these opposing propositions is still scarce. Recent research by Schilpzand and de Jong (2023) and by Graafland (2023b) indicate some support for the doux commerce thesis. Schilpzand and de Jong found a positive effect of market exposure (measured by the number of employed and unemployed persons in a region as a percentage of the region’s total population) on civic morality. Graafland identified a positive relationship between rule of law and civic virtues and found that civic virtues, in turn, increase happiness, directly as well as indirectly by stimulating trust. Future work could also focus on moderation or so-called moderated mediation, in which a moderator affects the strength of the relationship between the independent variable and mediator(s) or between the mediator and dependent variable (arrows d2 and d3 in Figure 16.1, respectively). To illustrate, Graafland and de Jong (2022) found that the relationship between economic freedom and income per capita is negatively moderated by uncertainty avoidance and positively moderated by long-term orientation. This model could be extended to a moderated mediation model as income per capita has been found to increase happiness. Similarly, Graafland (2020b) found that generalized trust moderates the relationship between economic freedom and the human development index. As subindicators of the human development index, such as income per capita and education, may affect happiness, this suggests another moderated mediation model with trust as moderator.
CONCLUSIONS Our literature overview has shown that there is ample support of a positive relationship between the overall index of economic freedom and happiness. However, whether economic freedom causally affects happiness is less certain. The relationship between economic freedom and happiness varies per subdimension of economic freedom. Whereas rule of law, sound money, and trade freedom are mostly found to be positively related to happiness, for a small government size and freedom from regulation many studies also found a negative relationship. For rich countries the positive relationship between economic freedom and happiness is mostly driven by the rule of law subdimension, and for poor countries by the trade freedom subdimension of economic freedom.
Economic freedom and happiness: on moderation and mediation 237 Our literature overview also identified a set of variables that moderate the relationship between economic freedom, or one of its subdimensions, and happiness, including culture, income level, and quality of government. Research into mediating factors in the relationship between economic freedom and happiness is, however, relatively scarce. We found six studies identifying satisfaction with public goods, income, trust, income inequality, job perspectives, and individual autonomy as mediating factors. Mediation analysis is important because it gives insight into why economic freedom may affect happiness. To gain further insight into which conditions and through what channels economic freedom affects happiness, future research should focus on other mediating and moderating factors.
REFERENCES Afia, N.B. and Harbi, S. (2017). Empirical analysis of the relationship between military endeavor, economic growth and happiness. Journal of Economic Development 42(2): 51–66. Albanesi, S. (2002). Inflation and inequality. Discussion Paper No. 3470, Centre for Economic Policy Research, London. Barone, G. and Mocetti, S. (2016). Inequality and trust: New evidence from panel data. Economic Inquiry 54(2): 794–809. Bavetta, S. and Navarra, P. (2011). Economic freedom and the pursuit of happiness. In: 2011 Index of Economic Freedom (eds. T. Miller and K.R. Holmes), 61–68. Washington, DC: Heritage Foundation. Bennett, D.L. (2024). Economic freedom and inequality: A survey of the empirical literature. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 208–224. Cheltenham: Edward Elgar Publishing. Benz, M. and Frey, B.S. (2008). The value of doing what you like: Evidence from the self-employed in 23 countries. Journal of Economic Behavior & Organization 68(3): 445–455. Berggren, N. (2024). Introduction to the Handbook of Research on Economic Freedom. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 1–14. Cheltenham: Edward Elgar Publishing. Berggren, N. and Jordahl, H. (2006). Free to trust: Economic freedom and social capital. Kyklos 59(2): 141–169. Berggren, N. and Bjørnskov, C. (2020). Institutions and life satisfaction. In: Handbook of Labor, Human Resources and Population Economics (ed. K. F. Zimmermann), 1–48. Cham: Springer. Bjørnskov, C. (2014). Do economic reforms alleviate SWB losses of economic crises? Journal of Happiness Studies 15(1): 163–182. Bjørnskov, C. and Foss, N.J. (2008). Economic freedom and entrepreneurial activity: Some cross-country evidence. Public Choice 134(3): 307–328. Bjørnskov, C., Dreher, A. and Fischer, J.A.V. (2007). The bigger the better? Evidence of the effect of government size on life satisfaction around the world. Public Choice 130(3–4): 267–292. Bjørnskov, C., Dreher, A. and Fischer, J.A.V. (2008a). Cross-country determinants of life satisfaction: Exploring different determinants across groups in society. Social Choice and Welfare 30(1): 119–173. Bjørnskov, C., Dreher, A. and Fischer, J.A.V. (2008b). On decentralization and life satisfaction. Economics Letters 99(1): 147–151. Bjørnskov, C., Dreher, A. and Fischer, J.A.V. (2010). Formal institutions and SWB: Revisiting the cross-country evidence. European Journal of Political Economy 26(4): 419–430. Blanchflower, D.G., Bell, D.N.F., Montagnoli, A. and Moro, M. (2014). The happiness trade-off between unemployment and inflation. Journal of Money, Credit and Banking 46(S2): 117–141. Boarini, R., Comola, M., de Keulenaer, F., Manchin, R. and Smith, C. (2013). Can governments boost people’s sense of well-being? The impact of selected labor market and health policies on life satisfaction. Social Indicators Research 114(1): 105–120. Bowles, S. (2011). Is liberal society a parasite on tradition? Philosophy & Public Affairs 39(1): 46–81. Carr, E. and Chung, H. (2014). Employment insecurity and life satisfaction: The moderating influence of labor market policies across Europe. Journal of European Social Policy 24(4): 383–389.
238 Handbook of research on economic freedom Cebula, R.J. (2013). Which economic freedoms influence per capita real income? Applied Economics Letters 20(4): 368–372. Di Tella, R., MacCulloch, R.J. and Oswald, A.J. (2001). Preferences over inflation and unemployment: Evidence from surveys of happiness. American Economic Review 91(1): 335–341. Dluhosch, B. and Horgos, D. (2013). Trading up the happiness ladder. Social Indicators Research 113(3): 973–990. Elgar, F. and Aitken, N. (2011). Income inequality, trust and homicide in 33 countries. European Journal of Public Health 21(2): 241–246. Esaiasson, P., Dahlberg, S. and Kokkonen, A. (2020). In pursuit of happiness: Life satisfaction drives political support. European Journal of Political Research 59(3): 25–44. Evrensel, A.Y. (2015). Happiness, economic freedom and culture. Applied Economics Letters 22(9): 683–687. Evrensel, A.Y. (2018). Contradictory effects of religiosity on subjective well-being. Cogent Economics and Finance 6(1): 1525115. Fereidouni, H.G., Najdi, Y. and Amiri, R.E. (2013). Do governance factors matter for happiness in the MENA region? International Journal of Social Economics 40(12): 1028–1040. Flavin, P., Pacek, A.C. and Radcliff, B. (2014). Assessing the impact of the size and scope of government on human well-being. Social Forces 92(4): 1241–1258. Flavin, P., Pacek, A.C. and Radcliff, B. (2019). Labor market regulation and SWB in low-income countries. European Journal of Political Research 58(4): 1088–1107. Fourcade, M. and Healy, K. (2007). Moral views of market society. Annual Review of Sociology 33(August): 285–311. Frey, B.S. (2020). What are the opportunities for future happiness research? International Review of Economics 67(1):5–12. Gehring, K. (2013). Who benefits from economic freedom? Unraveling the effect of economic freedom on SWB. World Development 50(C): 74–90. Graafland, J. (2020a). When does economic freedom promote well-being? On the moderating role of long-term orientation. Social Indicators Research 149(1): 127–153. Graafland J. (2020b). Contingencies in the relationship between economic freedom and human development: The role of generalized trust. Journal of Institutional Economics 16(3): 271–286. Graafland, J. (2022). Ethics and Economics: An Introduction to Free Markets, Equality and Happiness. London: Routledge. Graafland, J. (2023a). Economic freedom and life satisfaction: A moderated mediation model with individual autonomy and national culture. European Journal of Political Economy 79(September): 102448. Graafland, J. (2023b). On rule of law, civic virtues, trust, and happiness. Applied Research Quality Life 18(4): 1799–1824. Graafland, J. and Compen, B. (2015). Economic freedom and life satisfaction: Mediation by income per capita and generalized trust. Journal of Happiness Studies 16(3): 789–810. Graafland, J. and Lous, B. (2018). Economic freedom, income inequality and life satisfaction in OECD countries. Journal of Happiness Studies 19(7): 2071–2093. Graafland, J. and Lous, B. (2019). Income inequality, life satisfaction inequality and trust: A cross-country panel analysis. Journal of Happiness Studies 20(6): 1717–1737. Graafland, J. and de Jong, E. (2022). The moderating role of culture on the benefits of economic freedom: Cross-country analysis. Journal of Comparative Economics 50(1): 280–292. Graafland, J. and Verbruggen, H. (2022). Free-market, perfect market and welfare state perspectives on ‘good’ markets: An empirical test. Applied Research in Quality of Life 17(2): 1113–1136. Gropper, D.M., Lawson, R.A. and Thorne, Jr., J.T. (2013). Economic freedom and happiness. Cato Journal 31(2): 237–255. Gwartney, J.D. and Lawson, R.A. (2003). The concept and measurement of economic freedom. European Journal of Political Economy 19(3): 405–430. Gwartney, J.D., Lawson, R.A. and Norton, S. (2008). Economic Freedom of the World: 2008 Annual Report. Vancouver: The Fraser Institute. Hamermesh, D.S., Kawaguchi, D. and Lee, J. (2017). Does labor legislation benefit workers? Well-being after an hours reduction. Journal of the Japanese and International Economies 44(C): 1–12.
Economic freedom and happiness: on moderation and mediation 239 Helliwell, J.F., Barrington-Leigh, C.P., Harris, A. and Huang, H. (2009). International evidence on the social context of well-being. Working Paper No. 14720, National Bureau of Economic Research, Cambridge, MA. Helliwell, J.F., Huang, H., Grover, S. and Wang, S. (2018). Empirical linkages between good governance and national wellbeing. Journal of Comparative Economics 46(4): 1332–1346. Helliwell, J.F., Huang, H. and Wang, S. (2021). Happiness and the quality of government. In: The Oxford Handbook of the Quality of Government (eds. A. Bågenholm, M. Bauhr, M. Grimes and B. Rothstein), 601–619. Oxford: Oxford University Press. Hessami, Z. (2010). The size and composition of government spending in Europe and its impact on well-being. Kyklos 63(3): 346–382. Hessami, Z. (2011). Globalization’s winners and losers: Evidence from life satisfaction data, 1975–2001. Economics Letters 112(3): 250–253. Hevenstone, D. (2011). Flexicurity, happiness and satisfaction. International Journal of Sociology 41(3): 7–45. Hirschman, A.O. (1982). Rival interpretations of market society: Civilizing, destructive or feeble? Journal of Economic Literature 20(4): 1463–1484. Jackson, J. (2017). Free to be happy: Economic freedom and happiness in US states. Journal of Happiness Studies 18(4): 1207–1229. Justesen, M.K. (2008). The effect of economic freedom on growth revisited: New evidence on causality from a panel of countries 1970–1999. European Journal of Political Economy 24(3): 642–660. Kim, S. and Kim, D. (2012). Does government make people happy? Exploring new research directions for government’s roles in happiness. Journal of Happiness Studies 13(5): 875–899. Knoll, B. and Pitlik, H. (2016). Who benefits from big government? A life satisfaction approach. Empirica 43(3): 533–557. Knoll, B., Pitlik, H. and Rode, M. (2013). A note on the impact of economic regulation on life satisfaction. Applied Economics Letters 20(9): 916–920. Kumari, N., Sahu, N.C. and Kumar, P. (2021). Does globalization lead to happiness? Experience from Asian lower-middle income countries using pooled mean group (PMG) model. In: Critical Perspective on Emerging Economies: An International Assessment (eds. A.K. Mishra, V. Arunachalam and D. Patnaik), 1–16. Cham: Springer. Lin, C.H.A., Lahiri, S. and Hsu, C.P. (2017). Happiness and globalization: A spatial econometric approach. Journal of Happiness Studies 18(6): 1841–1857. Lous, B. and Graafland, J. (2022). Who becomes unhappy when income inequality increases? Applied Research in Quality of Life 17(1): 299–316. Luecke, C. and Knabe, A. (2020). How much does others’ protection matter? Employment protection, future labor market prospects and well-being. Oxford Economic Papers 72(3): 893–914. Ma, Y. and Chen, D. (2020). Openness, rural-urban inequality, and happiness in China. Economic Systems 44(4): 100834. Mau, S., Mewes, J. and Schöneck, N.N. (2012). What determines subjective socio-economic insecurity? Context and class in comparative perspective. Socio-Economic Review 10(4): 655–682. Murphy, R.H., Tuszynski, M. and Jackson, J. (2020). Some dynamics of socioeconomic relationships: Well-being, social capital, economic freedom, economic growth, and entrepreneurship. American Journal of Entrepreneurship 13(1): Article 1. Nadeem, M., Jun, Y., Tian, Y., Hussain, Z. and Yousuf, M. (2019). Happiness flight with institutional capabilities: Evidence of the effects of economic freedom on SWB in developing countries. Journal of Applied Economic Sciences 14(3): 907–922. Nikolaev, B. (2014). Economic freedom and quality of life: Evidence from the OECD’s Your Better Life Index. Journal of Private Enterprise 29(Fall): 61–96. Nikolaev, B. (2015). Economic freedom and SWB. In: Economic Behavior, Economic Freedom and Entrepreneurship (eds. R.J. Cebula, J.C. Hall, F.G. Mixon, Jr. and J.E. Payne), 178–192. Cheltenham: Edward Elgar Publishing. Nikolaev, B. and Bennett, D.L. (2016). Give me liberty and give me control: Economic freedom, control perceptions and the paradox of choice. European Journal of Political Economy 45(1): 39–52. Nikolaev, B. and Bennett, D.L. (2017). Economic freedom and emotional well-being. Journal of Regional Analysis and Policy 47(1): 88–99.
240 Handbook of research on economic freedom O’Connor, K.J. (2017). Happiness and welfare-state policy around the world. Review of Behavioral Economics 4(4): 397–420. Obydenkova, A.V. and Salahodjaev, R. (2017). Government size, intelligence and life satisfaction. Intelligence 61(March–April): 85–91. Ochsen, C. and Welsch, H. (2012). Who benefits from labor-market institutions? Evidence from surveys of life satisfaction. Journal of Economic Psychology 33(1): 112–124. Oshio, T. and Kobayashi, M. (2010). Income inequality, perceived happiness, and self-rated health: Evidence from nationwide surveys in Japan. Social Science & Medicine 70(9): 1358–1366. Oishi, S., Kesebir, S. and Diener, E. (2011). Income inequality and happiness. Psychological Science 22(9): 1095–1100. Oishi, S., Schimmack, U. and Diener, E. (2012). Progressive taxation and the SWB of nations. Psychological Science 23(1): 86–92. Oishi, S., Kushlev, K. and Schimmack, U. (2018). Progressive taxation, income inequality and happiness. American Psychologist 73(2): 157–168. Ott, J. (2010a). Good governance and happiness in nations: Technical quality precedes democracy and quality beats size. Journal of Happiness Studies 11(3): 353–368. Ott, J. (2010b). Greater happiness for a greater number: Some non-controversial options for governments. Journal of Happiness Studies 11(5): 631–647. Ott, J. (2011). Government and happiness in 130 nations: Good governance fosters higher level and more equality of happiness. Social Indicators Research 102(1): 3–22. Ovaska, T. and Takashima, R. (2006). Economic policy and the level of self-perceived well-being: an international comparison. Journal of Socio-Economics 35(2): 308–325. Pacek, A.C. and Radcliff, B. (2008). Welfare policy and SWB across nations: An individual-level assessment. Social Indicators Research 89(1): 179–191. Perovic, L.M. and Golem, S. (2010). Investigating macroeconomic determinants of happiness in transition countries: How important is government expenditure? Eastern European Economics 48(4): 59–75. Pitlik, H. and Rode, M. (2016). Free to choose? Economic freedom, relative income and life control perceptions. International Journal of Well-Being 6(1): 81–100. Radcliff, B. (2013). Labor unions and economic regulation. In: The Political Economy of Human Happiness: How Voters’ Choices Determine the Quality of Life (ed. B. Radcliff), 142–158. Cambridge: Cambridge University Press. Ram, R. (2009). Government spending and happiness of the population: Additional evidence from large cross-country samples. Public Choice 138(3): 483–490. Rode, M. (2013). Do good institutions make citizens happy, or do happy citizens build better institutions? Journal of Happiness Studies 14(5); 1479–1505. Rode, M., Knoll, B. and Pitlik, H. (2013). Economic freedom, democracy and life satisfaction. In: Economic Freedom of the World: 2013 Annual Report (eds. J.D. Gwartney, R.A. Lawson and J.C. Hall), 215–233. Vancouver: Fraser Institute. Sanfey, P. and Teksoz, U. (2007). Does transition make you happy? Economics of Transition 15(4): 707–731. Schilpzand, A. and de Jong, E. (2023). Do market societies undermine civic morality? An empirical investigation into market societies and civic morality across the globe. Journal of Economic Behavior & Organization 208(April): 39–60. Spruk, R. and Kešeljević, A. (2016). Institutional origins of SWB: Estimating the effects of economic freedom on national happiness. Journal of Happiness Studies 17(2): 659–712. Steckermeier, L.C. (2021). The value of autonomy for the good life: An empirical investigation of autonomy and life satisfaction in Europe. Social Indicators Research 154(1): 693–723. Stiglitz, J.E. (2012). The Price of Inequality: How Today’s Divided Society Endangers Our Future. London: Penguin Books. Storr, V.H. and Choi, G.S. (2019). Do Markets Corrupt our Morals? Cham: Palgrave Macmillan. Stryzhak, O. (2020). The relationship between education, income, economic freedom and happiness. SHS Web of Conferences 75(2): 03004.
Economic freedom and happiness: on moderation and mediation 241 Sturm, R. and Gresenz, C. (2002). Relations of income inequality and family income to chronic medical conditions and mental health disorders: National survey in USA. British Medical Journal 324(7328): 20–23. Tsai, M.C. (2009). Market openness, transition economies and subjective wellbeing. Journal of Happiness 10(5): 523–539. Veenhoven, R. (2000). Freedom and happiness: A comparative study in 46 nations in the early 1990s. In: Culture and Subjective Well-Being (eds. E. Diener and E.M. Suh), 257–288. Cambridge, MA: MIT Press. Verme, P. (2011). Life satisfaction and income inequality. Review of Income and Wealth 57(1): 111–137. Wang, J., Wang, Y., Sun, C. and Chen, X. (2021). Does mandatory air quality information disclosure raise happiness? Evidence from China. Energy Economics 94(11): 105094. Wilkinson, R. and Pickett, K. (2010). The Spirit Level: Why Equality Is Better for Everyone. London: Penguin Books. Wright, R. (2000). Will globalization make you happy? Foreign Policy 120(September): 54–64. Xu, F., Luo, X.L., and Zhou, D. (2022). Air pollution, residents’ happiness, and environmental regulation: Evidence from China. Environmental Science and Pollution Research 29(September): 64665–64679. Yi, Z. and Sun, C. (2021). Import trade liberalization and individual happiness: Evidence from Chinese General Social Survey 2010–2015. Applied Economics 53(56): 6535–6553.
17. Entrepreneurship and economic freedom Per L. Bylund, Peter G. Klein and Matthew McCaffrey
INTRODUCTION Entrepreneurship scholars have long recognized the crucial role of the institutional environment in fostering entrepreneurship and economic growth (Baumol 1990; Foss and Klein 2010; Pacheco et al. 2010; Bjørnskov and Foss 2016; Terjesen et al. 2016; Dilli et al. 2018). Economic freedom, or the right to engage in economic activity free of government restriction, has been at the center of this research agenda. It is a necessary condition for entrepreneurship because decisions about creating, expanding, liquidating, or otherwise managing business ventures require individual agency; likewise, economic freedom means little if it does not include the freedom to start or run a company. However, the relationship between entrepreneurship and economic freedom is not always simple. There are many conceptions of entrepreneurship and competing theories of what entrepreneurs do and the role they play in the economy. Entrepreneurship is a complex phenomenon under most definitions because it usually involves change, sometimes throughout entire economies. And because entrepreneurship takes place within specific institutional settings that affect entrepreneurial motivations, actions, and outcomes, there are many interactions to consider across different levels of analysis. Contemporary work on this question is the result of centuries of discussion and debate about the role of entrepreneurs in the social order. It includes theory and empirics developed through dedicated entrepreneurship research as well as insights from economics, sociology, psychology, management studies, and other disciplines. In this chapter, we will survey some of the key trends and major contributions to the study of entrepreneurship and economic freedom and point out some of its achievements and pitfalls.
DEFINING ENTREPRENEURSHIP The definition of entrepreneurship is a subject of endless debate among researchers. For the purposes of this chapter though, entrepreneurship is defined as judgmental decision-making about the use of scarce resources in the face of uncertainty (Foss and Klein 2012; Foss, Klein, and McCaffrey 2019a). This approach dates back at least as far as Richard Cantillon, and was further developed by Carl Menger, Frank Fetter, Frank Knight, and Ludwig von Mises. Today it is known as the ‘judgment-based approach’ (JBA) to entrepreneurship (Klein and McCaffrey 2022). In the JBA, the social role of entrepreneurship is to provide satisfaction of the most urgent wants of consumers. This is done by making good judgments about how best to use society’s scarce resources to produce goods and services that, when available, are of value to the public. Most importantly, entrepreneurs make decisions about how best to use heterogeneous capital assets in production. The great challenge facing entrepreneurs in making these choices, 242
Entrepreneurship and economic freedom 243 however, is uncertainty about the process, primarily about future market conditions (Knight 1921; Mises 1998 [1949]). Any kind of entrepreneurial action takes time, which means the future outcome is unknown at the moment of decision. Uncertainty means entrepreneurs can make mistakes and waste resources. This in turn gives rise to profit and loss: good judgments yield profits that signal consumer satisfaction, while losses reveal dissatisfaction and the need to allocate resources differently. The profit-and-loss system is ultimately an endless process of sorting successful from unsuccessful entrepreneurial investments. Importantly, entrepreneurship in this sense does not exist in an institutional vacuum; quite the contrary – some institutions facilitate effective judgments, others do not (Foss, Klein, and Bjørnskov 2019). Examples of the former are ‘the security of private property against all encroachments, and sound money’ (Salerno 1990, p. 69). These are interrelated: property is necessary for production and making investments, which are in turn assessed and evaluated using money prices, which together form the system of market prices entrepreneurs use to reckon returns. It is consequently no coincidence that property rights and sound money are key metrics in the measurement of economic freedom (see below). The most important aspect of the institutional environment is a system of money prices, without which entrepreneurs cannot make calculations about the future value of their decisions, and whether they will ultimately be profitable. It is also important that they are market prices determined by entrepreneurs competitively bidding for resources. Any disruption or distortion of the price system, which means prices no longer represent the expected valuations of consumers, carries heavy costs for entrepreneurs, who are forced to reckon using faulty tools. This, as we explain below, is a crucial aspect of the relationship between entrepreneurship and economic freedom, because attacks on economic freedom inevitably distort prices and therefore undermine entrepreneurs’ ability to use scarce resources to improve the welfare of consumers. By way of analogy, an entrepreneur without access to real market prices is just as ‘blind’ in her undertakings as an architect or builder without reliable measures or a consistent yardstick. Note that the discussion above does not assume the entrepreneur is motivated by purely financial considerations. Indeed, evidence suggests that entrepreneurial objectives are multidimensional, including, besides material gains, the desire for autonomy and independence, the value of pursuing one’s idiosyncratic vision, protection for the family name, attempting to improve society, and so on (Stephan et al. 2015). Even in these cases though, the entrepreneur requires physical and financial capital and must write and enforce contracts, rely on monetary exchange, and use profit-and-loss metrics as a (perhaps partial) indicator of performance.
CONCEPTS OF ENTREPRENEURSHIP AND ECONOMIC FREEDOM A challenge in interpreting research on the relationship between economic freedom – and institutions more generally – and entrepreneurship is that entrepreneurship is conceived in many different ways, including self-employment or new venture formation and more abstract notions of thinking or acting, such as alertness, innovativeness, and judgment.
244 Handbook of research on economic freedom Occupational Choice and New Venture Creation If entrepreneurship is conceived as self-employment – the choice to become one’s own boss, as opposed to working for a firm as employee – then economic freedom represents institutions and policies that affect the ability of individuals to work in their chosen occupation. These would include the tax treatment of self-employment earnings compared with wage income (Bruce and Mohsin 2006), labor-market interventions that encourage or impede job mobility, ‘safety net’ programs such as health insurance and how these are tied to employment status (Hombert et al. 2020), idiosyncratic industry-specific regulations that make it difficult to switch occupations (Gohmann 2012), as well as regulations affecting vocational training, business education, and other support systems. While some of the empirical literature examines the effects of institutions and policies on self-employment, many studies describe economic freedom in more general terms while using occupational choice as the measure of entrepreneurial activity, even without drawing direct links between policies and self-employment (e.g., Bjørnskov and Foss 2008). Entrepreneurship can also be studied at the firm level instead of the individual level; here the focus is on the formation and growth of new ventures (e.g., Story 1982; Stam and Wennberg 2009; Bennett 2021a, 2021b). Economic freedom affects business formation and expansion via several channels, including the difficulty of registering or licensing new firms, regulations that support or impede resource acquisition, intellectual property protections, accounting rules on valuation of private equity, and regulations on acquisitions. Entrepreneurial Alertness The classic analyses of entrepreneurship tend to focus on more abstract conceptualizations (Klein, 2008) from which much of the literature on economic freedom and entrepreneurship starts. For example, Israel Kirzner advances a view of economic freedom based on his theory of entrepreneurial alertness. Under economic freedom, entrepreneurs tend to be alert to price discrepancies in the market – they discover opportunities for arbitrage – which leads to a better adjustment of supply and demand to existing conditions, and, eventually, to a market-clearing equilibrium (Kirzner 1973). However, a lack of economic freedom disrupts entrepreneurs’ ability to perceive profit opportunities, and thus leads to a suboptimal outcome where markets are unable to clear properly or to maximize consumer welfare (Kirzner 1982, 1984, 1985). In practice, this happens because of significant regulation or other restrictions in the marketplace. Of course, economists have long recognized that regulation can seriously reduce entrepreneurial activity by destroying the incentive to produce. However, Kirzner’s view is different: he analyzes the effects of policy through ‘entrepreneurial incentives’ (Kirzner 1985, pp. 28–29). Regulations create an unconscious ‘block’ that prevents entrepreneurs from perceiving opportunities: [D]irect controls by government on prices, quantities, or qualities of output production or input employment may unintentionally block activities which have, as yet, not been specifically envisaged by anyone. Where these blocked activities turn out to be entrepreneurially profitable activities (perhaps as a result of unforeseen changes in data), the likelihood of their being discovered is then sharply diminished. (Kirzner 1982, p. 6)
Entrepreneurship and economic freedom 245 Entrepreneurial incentives thus operate on an unconscious level as profitable opportunities appear to entrepreneurs spontaneously. In fact, Kirzner’s theory explicitly excludes search activities from entrepreneurship, which is limited to the quality of being alert to opportunities that already exist (e.g., Kirzner 2019). Kirzner exemplifies bad policy with a tax on entrepreneurial profits, which can ‘succeed only in removing from potential entrepreneurs all incentive for paying attention to anything but the already known’ (Kirzner 1985, p. 111). Entrepreneurs are thus incentivized under economic freedom to ‘pay attention’ to the unknown (though how this happens unconsciously, as Kirzner asserts, remains a mystery). Freedom is of fundamental importance to entrepreneurs because profits are not earned (as when a worker earns a wage). In Kirzner’s theory, profit requires little if any action or investment (see, for example, Rothbard 1974) – profit is merely the outcome of entrepreneurial alertness, itself an uncaused precondition for profitable error-correction (Kirzner 1978). Thus, Kirzner (2019) argues, we need an expanded, or even separate, theory to pass ethical judgment on entrepreneurial profit. Kirzner’s basic claim that entrepreneurs tend to notice opportunities that are in their interest to notice has been subjected to significant criticism (e.g., Hülsmann 1997; Foss and Klein 2010; Evans and Friedman 2011; McCaffrey 2014; Bylund 2021). His further arguments about the effects of regulation are open to similar objections (McCaffrey 2015). Essentially, if there is no ‘tendency’ for profitable opportunities to be noticed, it stands to reason that unprofitable opportunities do not necessarily tend to go unnoticed. If an entrepreneur is unaware of an opportunity, how can changing the value of that opportunity make it more or less likely to be discovered? Kirzner also argues that one reason economically unfree societies fail is that they lack entrepreneurial incentives, which are abolished through public ownership of the means of production (Kirzner 1982). However, if this is correct, the case for more central planning and control of the economy is strengthened: It is true in a trivial sense that entrepreneurs can be defined as those who are ‘alert to profit opportunities,’ but we wonder why agents of the central planning board could not be equally alert. The real issue is not alertness, but the magical property that Kirzner attributes to those who are alert: the property of thereby finding what they are looking for (a profit opportunity) and knowing what to do about it. If mere alertness – activated by ‘the profit motive’ … – were all it took to produce the requisite knowledge, one could incentivize central planners with the same motive or an even stronger one, such as the death penalty. (Evans and Friedman 2011, pp. 85–86)
A final objection to Kirzner’s theory of entrepreneurship and economic freedom is that it focuses only on the way regulation blocks or destroys entrepreneurial opportunities. Yet there is another possibility: regulation can also create opportunities, especially for ‘unproductive’ or ‘destructive’ entrepreneurship. This point is explored in the next subsection. Entrepreneurial Innovation Ever since the work of Joseph Schumpeter (1934 [1911]), the concept of entrepreneurship has become associated with innovation. In fact, today, entrepreneurship is practically defined as innovative or creative activity. In this branch of research, the problem of economic freedom becomes one of examining exactly how such freedom affects both the quantity and the distribution of innovative behavior.
246 Handbook of research on economic freedom William Baumol pioneered this research agenda. The main thrust of his contribution is the insight that institutions influence not just the amount of entrepreneurship (innovation) in society, but also its distribution among various productive, unproductive, and destructive activities (Baumol 1990). Productive entrepreneurship is any innovative activity that improves societal well-being, whereas unproductive or destructive entrepreneurship redistributes or actively destroys wealth and welfare (e.g., organized crime, rent-seeking). Institutions, or the ‘rules of the game,’ determine the relative payoffs to these different types of innovation. Entrepreneurs respond to these incentives, so if the rewards to unproductive rent-seeking or organized crime are greater than those to satisfying consumers, entrepreneurship gravitates toward unproductive innovation. There is empirical support for Baumol’s thesis (e.g., Sobel 2008), but recent work has also expanded the typology. Baumol’s view acknowledges only the ways that entrepreneurs abide by the rules embodied in institutions, but they can also evade or alter them. Such actions can be highly innovative and disruptive both economically and institutionally (e.g., Elert and Henrekson 2016). In addition, entrepreneurs can abide, alter, or evade in either productive or unproductive ways, giving a total of six options. The institutional setting, by imposing significant restrictions or rules-based burdens or causing institutional uncertainty (Bylund and McCaffrey 2017), can also force entrepreneurs to exit the market altogether. The crucial question about economic freedom is how free or unfree institutions encourage or discourage innovation, and whether they distribute innovative activities in ways that are beneficial or harmful to society at large. This question is more complex than establishing the direct link between the degree of freedom offered by formal institutions (such as laws) and entrepreneurship (e.g., Gwartney et al. 1999). Formal institutions are only part of the institutional framework within which entrepreneurship is undertaken (e.g., Williamson 2000). Mediating and moderating factors, including informal institutions, play a role as well. A literature on entrepreneurship in different cultural and religious settings establishes that there are such effects and that they, sometimes, significantly affect entrepreneurial outcomes (e.g., Nabisaalu and Bylund 2021).1 The Judgment-based Approach to Economic Freedom: Ownership, Prices, and Incentives Much of the empirical research on entrepreneurship and economic freedom adopts a narrow view of entrepreneurship out of expediency: specific events such as startup foundings, patent applications, new product launches, and so on, are much more amenable to measurement than broader conceptions. Yet these kinds of activities capture only a few specific aspects of entrepreneurs’ decision processes. The JBA, which is based on a broader view of entrepreneurship, allows for such metrics, and many others, which is why we use it as an umbrella concept.
1 Informal institutions are broader and less observable than formal institutions, but they matter greatly for understanding the relationship between entrepreneurship and economic freedom. For example, informal institutions such as corruption are often the result of weak formal institutions or institutional voids. And like formal institutions, entrepreneurs are challenged by, and can respond to, informal institutions. Some work even suggests the informal institutions ‘dominate’ formal ones (Eesley et al. 2018).
Entrepreneurship and economic freedom 247 Entrepreneurship-as-judgment incorporates most conventional arguments about incentives and public policy. Insecure property rights, taxation, regulation, legal protections against competition, and other limits to economic freedom alter the perceived costs and benefits of different investment decisions. Entrepreneurs do their best to judge exactly how costs and benefits change, and often alter their expectations and behavior as a result. For example, when taxation becomes too burdensome, or regulations make a particular production process infeasible, or antitrust law prevents a company from growing, entrepreneurs adjust their forecasts of future profitability. They make conscious decisions to abide, alter, evade, or exit (Bylund and McCaffrey 2017) based on their understanding of the future. More fundamentally, a lack of economic freedom undermines vital conditions of the market process upon which entrepreneurs rely, especially the price system. Prices are crucial for entrepreneurs in estimating the costs and revenues of their ventures. They establish relative valuations of the factors of production. Entrepreneurs choose based on the relative prices of inputs and expected selling prices of outputs. Existing prices are determined by entrepreneurs’ bidding and continuously adapt as new entrepreneurs enter and incumbents exit. Consequently, market prices for the means of production reflect entrepreneurs’ collective valuations.2 Barriers to economic freedom alter the set of feasible entrepreneurial decisions and produce different prices than would obtain under conditions of free exchange. This fundamentally changes or ‘distorts’ the entrepreneurial process and its outcomes. One example is price controls, which proscribe exchanges outside specific price ranges. Price ceilings such as rent controls cause shortages of housing and prevent markets from clearing. This carries important implications for entrepreneurs as the entrepreneurial judgment of building owners about how best to use their property is overridden by a regulatory authority. Entrepreneurs and consumers are no longer allowed to negotiate a mutually agreeable price, and the price that does obtain fails to reflect prevailing conditions of supply and demand for housing. In such cases, the judgments of elected officials or appointed bureaucrats – non-owners who lack the incentives or specific knowledge associated with ownership (Foss et al. 2021) – is substituted for that of entrepreneurs. Another example is interest rates, which are market prices for time. They can become distorted through monetary policy (Newman and Sieroń 2022), usually through excessive credit expansion that lowers them below the level that would otherwise have obtained. The effect is similar to price controls: entrepreneurs’ vital tool for forecasting fails to reflect conditions of supply and demand in the time market. This in turn leads to resources being misallocated intertemporally, just as rent controls lead to the misallocation of housing. A third and related form of price distortion is inflation. Inflation is often described as a general rise in prices but is better understood as a fall in the purchasing power of money due to an increase in the supply of money (Earle 2021). Viewed in this light, inflation also carries special significance for entrepreneurs. Prices do not adjust instantly and evenly: they change to different degrees and at different times (Mises 1998 [1949], pp. 535–583; Blaug 1996, pp. 20–22). Variations in the money supply therefore profoundly influence the structure of rel-
This argument (see, for example, Hayek 1948; Rothbard 1962; Kirzner 1973; Mises 1998 [1949]) does not assume perfectly competitive general equilibrium prices in order for the price mechanism to effectively allocate resources. From the perspective of contemporary welfare economics, price ‘distortions’ resulting from market imperfections would also have to be considered in evaluating the efficacy of any economic system. 2
248 Handbook of research on economic freedom ative prices. When this structure changes independently from changes in resource availability, new entrepreneurial errors are made. Errors are often ‘clustered’ in particular industries, such as natural resource extraction, construction, or mortgage lending (Rothbard 2000 [1963]). If clusters grow large enough, they can result in larger economic crises. Changes in the purchasing power of money affect the real economy and the real distribution of resources. Deceptive prices are most devastating in conditions of rapid inflation or hyperinflation, when economic calculation breaks down (e.g., Bresciani-Turroni 1937; Earle 2021). These problems are exacerbated by the fact that entrepreneurship is a continuous process of decision-making (Casson and Wadeson 2007; McMullen and Dimov 2013; Bylund et al. 2023). Over time these errors in judgment compound, leading to misallocation of resources and welfare losses for consumers and entrepreneurs. Under weak institutions, government interventions tend to accumulate. Mises (1929) showed that policies that manipulate the price system inevitably hurt the very people they are intended to help. However, it is politically inexpedient to abandon these regulations. To counteract their negative effects then, a new round of regulations is introduced. Yet these too create unintended consequences that must also be mitigated by a new round of interventions. Thus, regulations accumulate, and economic freedom diminishes, especially for entrepreneurs, who are deprived of both the right to make decisions and seek profits and the fundamental means for economic calculation. Lastly, entrepreneurs are part of a larger ‘ecosystem’ of actors and economic functions. One approach lists financial, labor-market, educational, and inter-firm institutions as key examples (Dilli et al. 2018). Others frame them in terms of a ‘collaborative innovation bloc’ consisting of ‘entrepreneurs, early- and later-stage-financiers, key personnel, and customers’ (Elert and Henrekson 2019, p. 295; Foss, Klein and McCaffrey 2019b). Economic freedom matters greatly for each of these other groups as well; for example, capital controls undermine the international trade component of economic freedom and prevent entrepreneurs from obtaining crucial financial resources. Entrepreneurship can be seriously curtailed even if it is not directly or explicitly regulated.
EMPIRICAL FINDINGS There is a growing empirical literature that applies the above-mentioned concepts of entrepreneurship and economic freedom. Studies in this literature typically employ proxies for institutions and policies associated with economic freedom. The most prominent example is the Fraser Institute’s Economic Freedom of the World (EFW) index, which includes country-level data from a broad sample of countries going back to 1970.3 Similar measures have also been constructed for US states (e.g., Ruger and Sorens 2021). The Fraser Institute index has mainly been used to explain productivity and economic growth but has also become increasingly popular in the literature on the institutional environment for entrepreneurship (Bjørnskov and Foss 2016; Su et al. 2017). Most studies find positive relationships between economic freedom and new firm formation, self-employment rates, innovation, and other indicators of entrepreneurial activity. Evidence exists as well for 3 See Gwartney and Lawson (2024) and Murphy (2024) in this volume for a detailed account of this index.
Entrepreneurship and economic freedom 249 the positive effects of sound money, minimal regulation, limited taxation, and free trade on entrepreneurship, most often measured as self-employment (e.g., Nyström 2008; Levie and Autio 2011; Zhu and Zhu 2017). There are thus many connections between economic freedom and entrepreneurship (Bennett and Nikolaev 2019). The results of examining individual components of the EFW index are not consistent, however. Some cross-country evidence shows that while the size of government is negatively related to entrepreneurship and the existence of sound money is positively related, other components of economic freedom had no significant relationship (Bjørnskov and Foss 2008). Other work finds that opportunity-driven entrepreneurship is positively associated with property rights, while necessity-driven entrepreneurship is positively associated with fiscal freedom and monetary freedom (McMullen et al. 2008). Still other research shows no connection between sound money or the quality of the legal system and growth driven by entrepreneurship but that entrepreneurs are best able to increase total factor productivity under conditions of greater government power over economic activity (Bjørnskov and Foss 2013). Nevertheless, larger government is also associated with lower levels of nascent and realized entrepreneurship, although the quality of the legal system only influences entrepreneurship in its later stages. In general, institutions tend mainly to influence those stages (Bjørnskov et al. 2022). The literature generally acknowledges that more government control over economic affairs leads to less entrepreneurship, but, in light of Baumol’s theory discussed above, increasingly recognizes the complexity of institutions. The first direct test of Baumol’s theory was a cross-sectional study of 40 countries that revealed a negative correlation between entrepreneurs’ pursuit of high-growth (i.e., job-creating) activities and a country’s level of corruption, and provided further evidence that institutions influence the allocation of entrepreneurial talent among productive and unproductive ventures (Bowen and DeClercq 2008).4 Cross-sectional data from 48 US States likewise link institutional quality with productive entrepreneurship (Sobel 2008). These insights have since been extended within and between countries, and across a range of institutional settings. Aidis et al. (2008) showed that Russia’s institutions have a negative impact on the number of start-ups as well as the number of business owners, and tend to favor politically-connected ‘insiders’ over innovative ‘outsiders.’ Likewise, poor public policies in Brazil led to destructive entrepreneurship, particularly when policy sought to increase traditional economic indicators (Hall et al. 2012). Other US evidence has shown that corruption reallocates resources to unproductive capital projects at the expense of more productive investments in other industries (Boudreaux et al. 2018). In addition to the choice between productive and unproductive activities, Levie and Autio (2008) also found that institutional conditions are an important determinant of the choice between entrepreneurial and non-entrepreneurial activity. And Stenholm et al. (2013) found country-level evidence of how institutions influence both the rate and type of entrepreneurial activity. Entrepreneurial behavior is also shaped by ‘institutional voids’ in which formal institutions either fail to support market transactions or are absent altogether (e.g., Mair et al. 2012). In these cases, traditional market entrepreneurship becomes difficult or impossible due to excessively high transaction costs or uncertainties. Such voids can exist in both formal and informal institutions and can affect entrepreneurs’ objectives as well as the forms of entre4 The relation between economic freedom and corruption is complex and requires special discussion. See Graeff (2024) in this volume.
250 Handbook of research on economic freedom preneurial activity they pursue (Webb et al. 2020). It can also encourage the development of second-best institutions that entrepreneurs use to fill an institutional void or otherwise change the institutional setting itself (Rodrik 2008; Douhan and Henrekson 2010). More recent work along these lines has emphasized that entrepreneurs do not only or always passively respond to institutions ‒ they can also affect them as institutional entrepreneurs, as mentioned above (Elert and Henrekson 2016). The institutional voids literature shows that entrepreneurs with little economic freedom have more options than simply closing up shop or accepting lower returns, declining new investment opportunities, etc. Entrepreneurs can interact with the institutional environment by abiding by it, evading it, or even altering it. Importantly, this means that a lack of economic freedom can be reversed if it creates difficult or intolerable conditions for entrepreneurs, who then work to improve existing institutions or create new ones in which they can more comfortably engage in socially productive behavior. Institutions also influence various socio-cognitive traits that are antecedents to action such as opportunity recognition, entrepreneurial self-efficacy, and fear of failure (Boudreaux, Bennett, et al. 2023). Each of these influences opportunity entrepreneurship (the first two positively, the last negatively), but with differing degrees: in general, the more economic freedom, the greater the influences (Boudreaux et al. 2019). Dutta and Sobel (2021) likewise show that entrepreneurs’ fear of failure is less significant when economic freedom is greater, because they perceive more alternative opportunities. Along similar lines, Bennett and Nikolaev (2021) find that individualistic cultural values (informal institutions) and economic freedom (formal institutions) enable each other, such that one cannot grow indefinitely without the other, and the most innovative countries tend to feature large amounts of both. Institutional quality, including increasing economic freedom, is associated with the choice to be self-employed (Gohmann 2012) and influences how entrepreneurs choose to launch new ventures. In the Asia-Pacific region, for example, high-quality institutions encourage formal entrepreneurship while lower-quality encourages informal entrepreneurship (Autio and Fu 2015). In Dau and Cuervo-Cazurra (2014), liberal economic policies appear to positively influence formal and informal entrepreneurship. Stronger government was also associated with formal entrepreneurship, but had a stronger negative impact on informal entrepreneurship, indicating a net negative effect on entrepreneurial activity. Some work finds that more economic freedom increases formal but decreases informal entrepreneurship (Saunoris and Sajny 2017), but others find that a large shadow economy can become institutionally embedded such that entrepreneurial entry again increases as new frameworks of rules emerge (Estrin and Mickiewicz 2012). All told, the question of economic freedom and formal and informal entrepreneurship remains controversial. There is also a growing literature on international entrepreneurship. Audretsch and Fiedler (2022) find that small increases in economic freedom can produce disproportionate increases in entrepreneurial activity, even in markets lacking significant freedom. The difference between countries’ levels of economic freedom influences how entrepreneurs establish ventures abroad and their ownership strategies for doing so (Arslan et al. 2015). Along these lines, the internationalization of some Latin American SMEs is associated with improvements in the size and regulatory power of government, but not with freedom to trade or property rights (Felzensztein et al. 2022). Increased economic freedom also allows foreign direct investment to increase opportunity-driven entrepreneurship while decreasing necessity-driven entrepreneurship (Afi et al. 2022). There is also research examining how entrepreneurs cope in more
Entrepreneurship and economic freedom 251 extreme circumstances. For instance, following a natural disaster, foreign aid can be positively associated with entrepreneurial activity, but only in countries with high-quality governments (Boudreaux, Jha and Escaleras 2023). In the United States, economic freedom is strongly associated with job creation, while the lack of freedom is associated with job destruction (Barnatchez and Lester 2017). In US metropolitan areas there is a positive relation of economic freedom for job and firm creation, but no effect on the destruction of jobs or firms (Bennett 2021a). The underlying institutional factors that are positively and negatively associated with job and firm creation are more heterogeneous and nuanced, however (Bennett 2021b). One common theme in this literature is that few labor market regulations or disruptions are associated with business creation and the pursuit of opportunities (e.g., McMullen et al. 2008; Cumming and Li 2013; Zhu and Zhu 2017).
LIMITATIONS Despite significant progress, the literature on institutions, entrepreneurship, and economic growth suffers from several problems, including that it: narrowly identifies entrepreneurship with start-ups and self-employment; does not theorize many potentially relevant inter-level links and mechanisms; and suffers from sample limitations, omitted variable biases, causality issues, and response heterogeneity. (Bjørnskov and Foss 2016, p. 292)
This literature, like all empirical studies of entrepreneurship at the aggregate level, suffers from challenges of definition and measurement, making them hard to compare consistently across industries, regions, or nations. Papers such as McMullen et al. (2008) combine economic freedom data with survey-based entrepreneurship indicators from the Global Entrepreneurship Monitor that distinguish between ‘opportunity’ entrepreneurship (new venture formation or small business ownership designed to create and capture value) and ‘necessity’ entrepreneurship (undertaken by those who believe they have few alternatives). They find that opportunity-motivated entrepreneurship is positively associated with property rights protection while necessity-motivated entrepreneurship is associated with efficient monetary and fiscal policy, suggesting that economic freedom affects entrepreneurs with different motivations and in different circumstances in distinct ways. A broader measurement challenge is that observable indicators of entrepreneurial behavior such as self-employment or startup activity do not correspond precisely to the abstract functions of alertness, innovativeness, or judgment. This is also one reason empirical work in entrepreneurship is often associated with innovation, which is easier to capture quantitatively using various proxies (e.g., the number of patent applications). While we can interpret cases and examples of successful and unsuccessful entrepreneurship in terms of alertness or judgment, theoretically or empirically, it is not obvious how these could be captured in a large-sample quantitative study.5
5 More detailed examinations are facilitated by individual-level panel data from sources such as the Panel Study of Entrepreneurial Dynamics, the Global Entrepreneurship Monitor, and registries maintained by Nordic countries, along with advances in multilevel modelling (e.g., Boudreaux et al. 2019; Boudreaux, Bennett, et al. 2023). While these datasets include cognitive factors such as self-efficacy,
252 Handbook of research on economic freedom The quantitative literature also suffers from challenges associated with causal inference. Most studies use cross-sectional or panel data in which economic freedom, like other parts of the institutional environment, can be plausibly interpreted as exogenous to the individual entrepreneur, though some elements (regulation, tax policy) may be endogenous responses to the level of economic activity, including the quality and quantity of entrepreneurship. Another issue, discussed by Foss and Klein (2010), is that functions such as alertness and judgment take place in any environment, regardless of institutional quality. Under economic freedom, these activities are channeled into value-creating economic activities. Where economic freedom is absent, actors still exercise alertness and judgment, if only to avoid burdensome regulation, protect their property from expropriation, engage in lobbying or bribery or other forms or predation (Baumol 1990), or otherwise attempt to navigate a dysfunctional economic environment. What does it mean to have ‘more’ or ‘less’ entrepreneurship under these conditions? A related problem is the formal support of entrepreneurship, primarily through government policy, by offering targeted subsidies (e.g., Lerner 2009), instituting incubators (e.g., Kolympiris and Klein 2017), etc. Such measures are intended to boost entrepreneurship and thereby economic growth (Wennekers and Thurik 1999) by lowering the threshold or protecting startups from early failure. The measurable outcomes are mixed (Dvouletý et al. 2021), but also raise important questions about the nature and frequency of entrepreneurship. For example, it is possible that subsidies generate ‘too much’ entrepreneurship, which may be distortive and not necessarily beneficial. Subsidies also distort because they help cover costs and therefore incentivize some entrepreneurship at the expense of other types or in different industries. How entrepreneurs respond to specific added incentives is not obvious (Wood et al. 2016), which makes such measures unpredictable. While some claim that the government has a responsibility to support inventions and innovations to generate entrepreneurship and economic growth (Mazzucato, 2011), there is little evidence for a positive role of state intervention (Wennberg and Sandström 2022). Public actors, unlike entrepreneurs, specialize in acquiring and exercising political power – a very different set of competences from those exercised by entrepreneurs competing in a market economy (Murtinu et al. 2022). This raises questions regarding the nature of entrepreneurship with respect to the structure of the market. It is not merely the case that regulations hamper entrepreneurship but also that policy is used in the opposite way: to engender or boost it, generally or for specific types. At the same time, entrepreneurship is not only subject to the existing institutions but also affects them and can, through disruptive innovation (Elert and Henrekson 2016) or political entrepreneurship (McCaffrey and Salerno 2011), change the institutional setting (Bylund and McCaffrey 2017).
fear of failure, and beliefs about future opportunities, they do not capture more abstract notions of alertness or judgment.
Entrepreneurship and economic freedom 253
CONCLUSION There is a relationship between entrepreneurship and economic freedom, but the exact nature of it is contested, and much work remains to unpack its nuances. We will suggest some avenues for future work to help develop our understanding of this relationship. Classical contributions on entrepreneurship and economic freedom tended to assume that economic freedom is a precondition for, or an important component of, productive entrepreneurship. This is undoubtedly true for most productive economic activity, as recognized by economists such as Mises. Entrepreneurs cannot perform their economic function of satisfying consumers under high taxation, regulation, and other restrictions on their ability to produce and exchange. Likewise, capital and labor must be able to move freely for entrepreneurs to be able to direct them effectively in production. This straightforward approach provides a persistent stream of opportunities for new historical and empirical research. However, Baumol (1990) expanded this fundamental view by noting that institutions can sometimes divert entrepreneurs into unproductive and destructive activities that are more remunerative than serving consumers in the marketplace. More recent studies have added layers of complexity to his initial observation, but these too have yet to be fully teased out, and there remain valuable opportunities for theoretical and empirical work. Another important area that has largely been overlooked in the literature concerns the role and effects of the price system on entrepreneurial behavior. Studies have attempted to explicate the relationship between the institutional setting (or specific institutions) and entrepreneurship (and entrepreneurial outcomes), but the link is assumed to be direct. However, entrepreneurs plan and make decisions based on the system of market prices and what the prices represent. With a distorted or imperfect price system, entrepreneurs struggle to appraise future market conditions and direct production in response. This highlights some deeper aspects of economic freedom, especially the importance of sound money that can be used to express market prices. Although measures of economic freedom traditionally include estimates of monetary freedom or stability, these are not usually integrated into an understanding of how entrepreneurs use money prices in their calculations. More attention to this issue, and to related questions such as how entrepreneurs appraise specific prices such as interest rates (Engelhardt 2012), would be welcome. Another issue is entrepreneurial decision-making about the limits of the firm. Entrepreneurs are constantly negotiating the size and structure of their companies (Klein 1996), choices that also depend on reliable prices. When prices are distorted by regulation, monetary instability, etc., firm size and structure can change in unsustainable ways. This happens most notably in the boom phase of the business cycle, but can occur under more mundane conditions as well, such as when firms receive subsidies or are subject to high taxation. It is worth investigating how limitations on economic freedom influence entrepreneurs’ decisions to increase or decrease firm size, and how they encourage entrepreneurs to change the internal management structure of their companies. Much more work is needed then to analyze and understand the price system as a mediating framework or conduit between the institutional setting and entrepreneurial action. Economic freedom is crucial here because it allows for exchange and meaningful prices, and properly serves (or, when distorted, undermines) entrepreneurs’ economic calculations and their ability to create value for consumers. The empirically established effects of economic freedom on entrepreneurship (and vice versa) happen through the workings of the price system (e.g.,
254 Handbook of research on economic freedom Hayek 1945). We expect that much of the relationship between economic freedom and entrepreneurship can be better understood through its varied effects on such money prices. Finally, there are a variety of technical problems relating to definition, measurement, causal inference, and so on that continue to create problems in the empirical literature. The need to resolve these more specific issues will keep quantitative researchers busy for decades to come.
REFERENCES Afi, H., Boubaker, S. and Omri, A. (2022). Do foreign investment and economic freedom matter for behavioral entrepreneurship? Comparing opportunity versus necessity entrepreneurs. Technological Forecasting and Social Change 181(August): 121761. Aidis, R., Estrin, S. and Mickiewicz, T. (2008). Institutions and entrepreneurship development in Russia: A comparative perspective. Journal of Business Venturing 23(6): 656–672. Arslan, A., Tarba, S.Y. and Larimo, J. (2015). FDI entry strategies and the impacts of economic freedom distance: Evidence from Nordic FDIs in transitional periphery of CIS and SEE. International Business Review 24(6): 997–1008. Audretsch, D.B. and Fiedler, A. (2022). The Vietnamese entrepreneurship paradox: How can entrepreneurs thrive without political and economic freedom? Journal of Technology Transfer 47(4): 1179–1197. Autio, E. and Fu, K. (2015). Economic and political institutions and entry into formal and informal entrepreneurship. Asia Pacific Journal of Management 32(1): 67–94. Barnatchez, K. and Lester, R. (2017). The relationship between economic freedom and economic dynamism. Contemporary Economic Policy 35(2): 358–372. Baumol, W.J. (1990). Entrepreneurship: Productive, unproductive, and destructive. Journal of Political Economy 98(5): 893–919. Bennett, D.L. (2021a). Local economic freedom and creative destruction in America. Small Business Economics 56(1): 333–353. Bennett, D.L. (2021b). Local institutional heterogeneity and firm dynamism: Decomposing the metropolitan economic freedom index. Small Business Economics 57(1): 493–511. Bennett, D.L. and Nikolaev, B.N. (2019). Economic freedom, public policy, and entrepreneurship. In: Economic Freedom of the World: 2019 Annual Report (eds. J.D. Gwartney, R.A. Lawson, J.C. Hall and R.H. Murphy), 199–224. Vancouver: Fraser Institute. Bennett, D.L. and Nikolaev, B.N. (2021). Individualism, pro-market institutions, and national innovation. Small Business Economics 57(4): 2085–2106. Bjørnskov, C. and Foss, N.J. (2008). Economic freedom and entrepreneurial activity: Some cross-country evidence. Public Choice 134(3–4): 307–328. Bjørnskov, C. and Foss, N.J. (2013). How strategic entrepreneurship and the institutional context drive economic growth. Strategic Entrepreneurship Journal 7(1): 50–69. Bjørnskov, C. and Foss, N.J. (2016). Institutions, entrepreneurship, and economic growth: What do we know and what do we still need to know? Academy of Management Perspectives 30(3): 292–315. Bjørnskov, C., Foss, N.J. and Xu, T. J. (2022). The role of institutions in the early entrepreneurial process. Industrial and Corporate Change 31(4): 905–933. Blaug, M. (1996). Economic Theory in Retrospect. Cambridge: Cambridge University Press. Boudreaux, C.J., Bennett, D.L., Lucas, D.S. and Nikolaev, B.N. (2023). Taking mental models seriously: Institutions, entrepreneurship and the mediating role of socio-cognitive traits. Small Business Economics 61(2): 465–493. Boudreaux, C.J., Jha, A. and Escaleras, M. (2023). Weathering the storm: How foreign aid and institutions affect entrepreneurship activity following natural disasters. Entrepreneurship Theory and Practice 46(6): 1843–1868. Boudreaux, C.J., Nikolaev, B.N. and Holcombe, R.G. (2018). Corruption and destructive entrepreneurship. Small Business Economics 51(1): 181–202. Boudreaux, C.J., Nikolaev, B.N. and Klein, P.G. (2019). Socio-cognitive traits and entrepreneurship: The moderating role of economic institutions. Journal of Business Venturing 34(1): 178–196.
Entrepreneurship and economic freedom 255 Bowen, H.P. and De Clercq, D. (2008). Institutional context and the allocation of entrepreneurial effort. Journal of International Business Studies 39(4): 747–767. Bresciani-Turroni, C. (1937). The Economics of Inflation. London: George Allen & Unwin. Bruce, D. and Mohsin, M. (2006). Tax policy and entrepreneurship: New time series evidence. Small Business Economics 26(5): 409–425. Bylund, P.L. (2021). The Austrian free enterprise ethic: A Mengerian comment on Kirzner (2019). Review of Austrian Economics 34(4): 495–501. Bylund, P.L., and McCaffrey, M. (2017). A theory of entrepreneurship and institutional uncertainty. Journal of Business Venturing 32(5): 461–475. Bylund, P.L., Packard, M.D. and Rapp, D.J. (2023). From static to processual analysis: How insights from Austrian economics can advance research on public policy and entrepreneurship. Journal of Entrepreneurship and Public Policy 12(1): 32–48. Casson, M. and Wadeson, N. (2007). The discovery of opportunities: Extending the economic theory of the entrepreneur. Small Business Economics 28(4): 285–300. Cumming, D. and Li, D. (2013). Public policy, entrepreneurship, and venture capital in the United States. Journal of Corporate Finance 23(December): 345–367. Dau, L.A. and Cuervo-Cazurra, A. (2014). To formalize or not to formalize: Entrepreneurship and pro-market institutions. Journal of Business Venturing 29(5): 668–686. Dilli, S., Elert, N. and Herrmann, A.M. (2018). Varieties of entrepreneurship: Exploring the institutional foundations of different entrepreneurship types through ‘Varieties-of-Capitalism’ arguments. Small Business Economics 51(2): 293–320. Douhan, R. and Henrekson, M. (2010). Entrepreneurship and second-best institutions: Going beyond Baumol’s typology. Journal of Evolutionary Economics 20(4): 629–643. Dutta, N. and Sobel, R.S. (2021). Entrepreneurship, fear of failure, and economic policy. European Journal of Political Economy 66(January): 101954. Dvouletý, O., Srhoj, S. and Pantea, S. (2021). Public SME grants and firm performance in European Union: A systematic review of empirical evidence. Small Business Economics 57(1): 243–263. Earle, P.C. (2021). A virtual Weimar: Hyperinflation in Diablo III. In: The Invisible Hand in Virtual Worlds: The Economic Order of Video Games (ed. M. McCaffrey), 133–151. Cambridge: Cambridge University Press. Eesley, C.E., Eberhart, R.N., Skousen, B.R. and Cheng, J.L.C. (2018). Institutions and entrepreneurial activity: The interactive influence of misaligned formal and informal institutions. Strategy Science 3(2): 393–407. Elert, N. and Henrekson, M. (2016). Evasive entrepreneurship. Small Business Economics 47(1): 95–113. Elert, N. and Henrekson, M. (2019). The collaborative innovation bloc: A new mission for Austrian economics. Review of Austrian Economics 32(4): 295–320. Engelhardt, L. (2012). Expansionary monetary policy and decreasing entrepreneurial quality. Quarterly Journal of Austrian Economics 15(2): 172–194. Estrin, S. and Mickiewicz, T. (2012). Shadow economy and entrepreneurial entry. Review of Development Economics 16(4): 559–578. Evans, A.J. and Friedman, J. (2011). ‘Search’ vs. ‘browse’: A theory of error grounded in radical (not rational) ignorance. Critical Review 23(1–2): 73–104. Felzensztein, C., Saridakis, G., Idris, B. and Elizondo, G.P. (2022). Do economic freedom, business experience, and firm size affect internationalization speed? Evidence from small firms in Chile, Colombia, and Peru. Journal of International Entrepreneurship 20(1): 115–156. Foss, N.J. and Klein, P.G. (2010). Alertness, action, and the antecedents of entrepreneurship. Journal of Private Enterprise 25(2): 145–164. Foss, N.J. and Klein, P.G. (2012). Organizing Entrepreneurial Judgment: A New Approach to the Firm. Cambridge: Cambridge University Press. Foss, N.J. Klein, P.G. and Bjørnskov, C. (2019). The context of entrepreneurial judgment: Organizations, markets, and institutions. Journal of Management Studies 56(6): 1197–1213. Foss, N.J., Klein, P.G., Lien, L.B., Zellweger, T. and Zenger, T. (2021). Ownership competence. Strategic Management Journal 42(2): 302–328. Foss, N.J., Klein, P.G. and McCaffrey, M. (2019a). Austrian Perspectives on Entrepreneurship, Strategy, and Organization. Cambridge: Cambridge University Press.
256 Handbook of research on economic freedom Foss, N.J., Klein, P.G. and McCaffrey, M. (2019b). The entrepreneurship scholar plays with blocs: Collaborative innovation or collaborative judgment? Review of Austrian Economics 32(4): 321–330. Gohmann, S.F. (2012). Institutions, latent entrepreneurship, and self–employment: An international comparison. Entrepreneurship Theory and Practice 36(2): 295–321. Graeff, P. (2024). The impact of economic freedom on corruption and the shadow economy. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 372–386. Cheltenham: Edward Elgar Publishing. Gwartney, J.D. and Lawson, R.A. (2024). The creation of the Economic Freedom of the World index. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 16–30. Cheltenham: Edward Elgar Publishing. Gwartney, J.D., Lawson, R.A. and Holcombe, R.G. (1999). Economic freedom and the environment for economic growth. Journal of Institutional and Theoretical Economics 155(4): 643–663. Hall, J., Matos, S., Sheehan, L. and Silvestre, B. (2012). Entrepreneurship and innovation at the base of the pyramid: A recipe for inclusive growth or social exclusion? Journal of Management Studies 49(4): 785–812. Hayek, F.A. (1945). The use of knowledge in society. American Economic Review 35(4): 519–530. Hayek, F. A. (1948). Individualism and Economic Order. Chicago: University of Chicago Press. Hombert, J., Schoar, A., Sraer, D. and Thesmar, D. (2020). Can unemployment insurance spur entrepreneurial activity? Evidence from France. Journal of Finance 75(3): 1247–1285. Hülsmann, J.G. (1997). Knowledge, judgment, and the use of property. Review of Austrian Economics 10(1): 23–48. Kirzner, I.M. (1973). Competition and Entrepreneurship. Chicago: University of Chicago Press. Kirzner, I.M. (1978). Economics and error. In: New Directions in Austrian Economics (ed. L.M. Spadaro), 57–76. Kansas City, MO: Sheed Andrews and McMeel. Kirzner, I.M. (1982). Competition, regulation, and the market process: An ‘Austrian’ perspective. Cato Policy Analysis No. 18, Cato Institute, Washington, DC. Kirzner, I.M. (1984). Incentives for discovery. Economic Affairs 4(2): 3–4. Kirzner, I.M. (1985). Discovery and the Capitalist Process. Chicago: University of Chicago Press. Kirzner, I.M. (2019). The ethics of pure entrepreneurship: An Austrian economics perspective. Review of Austrian Economics 32(2): 89–99. Klein, P.G. (1996). Economic calculation and the limits of organization. Review of Austrian Economics 9(2): 3–28. Klein, P.G. (2008). Opportunity discovery, entrepreneurial action and economic organization. Strategic Entrepreneurship Journal 2(3): 175–190. Klein, P.G. and McCaffrey, M. (2022). Entrepreneurial judgment. In: A Modern Guide to Austrian Economics (ed. Per Bylund), 64–83. Cheltenham: Edward Elgar Publishing. Knight, F.H. (1921). Risk, Uncertainty and Profit. Boston: Houghton Mifflin. Kolympiris, C. and Klein, P.G. (2017). The effects of academic incubators on university innovation. Strategic Entrepreneurship Journal 11(2): 145–170. Lerner, J. (2009). Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed – and What to Do About It. Princeton, NJ: Princeton University Press. Levie, J. and Autio, E. (2008). A theoretical grounding and test of the GEM model. Small Business Economics 31(3): 235–263. Levie, J. and Autio, E. (2011). Regulatory burden, rule of law, and entry of strategic entrepreneurs: An international panel study. Journal of Management Studies 48(6): 1392–1419. Mair, J., Martí, I. and Ventresca, M.J. (2012). Building inclusive markets in rural Bangladesh: How intermediaries work institutional voids. Academy of Management Journal 55(4): 819–850. Mazzucato, M. (2011). The Entrepreneurial State: Debunking Public vs. Private Sector Myths. London: Demos. McCaffrey, M. (2014). On the theory of entrepreneurial incentives and alertness. Entrepreneurship Theory and Practice 38(4): 891–911. McCaffrey, M. (2015). Economic policy and entrepreneurship: Alertness or judgment? In: The Next Generation of Austrian Economics: Essays in Honor of Joseph T. Salerno (eds. P.L. Bylund and D. Howden), 183–199. Auburn, AL: Ludwig von Mises Institute.
Entrepreneurship and economic freedom 257 McCaffrey, M. and Salerno, J.T. (2011). A theory of political entrepreneurship. Modern Economy 2(4): 552–560. McMullen, J.S., Bagby, D.R. and Palich, L.E. (2008). Economic freedom and the motivation to engage in entrepreneurial action. Entrepreneurship Theory and Practice 32(5): 875–895. McMullen, J.S. and Dimov, D. (2013). Time and the entrepreneurial journey: The problems and promise of studying entrepreneurship as a process. Journal of Management Studies 50(8): 1481–1512. Mises, L. von (1929). Kritik des Interventionismus: Untersuchungen zur Wirtschaftspolitik und Wirtschaftsideologie der Gegenwart. Jena: Gustav Fischer. Mises, L. von (1998 [1949]). Human Action: A Treatise on Economics. Auburn, AL: Ludwig von Mises Institute. Murphy, R.H. (2024). Economic Freedom of the World in the universe of measuring institutions. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 31–45. Cheltenham: Edward Elgar Publishing. Murtinu, S., Foss, N.J. and Klein, P.G. (2022). The entrepreneurial state: An ownership competence perspective. In: Questioning the Entrepreneurial State: Status-Quo, Pitfalls, and the Need for Credible Innovation Policy (eds. K. Wennberg and C. Sandström), 57–75. Cham: Springer. Nabisaalu, J.K. and Bylund, P.L. (2021). Knight, financial institutions, and entrepreneurship in developing economies. Journal of Institutional Economics 17(6): 989–1003. Newman, J.R. and Sieroń, A. (2022). Austrian business cycle theory. In: A Modern Guide to Austrian Economics (ed. P.L. Bylund), 257–282. Cheltenham: Edward Elgar Publishing. Nyström, K. (2008). The institutions of economic freedom and entrepreneurship: Evidence from panel data. Public Choice 136(3–4): 269–282. Pacheco, D.F., York, J.G., Dean, T.J. and Sarasvathy, S.D. (2010). The coevolution of institutional entrepreneurship: A tale of two theories. Journal of Management 36(4): 974–1010. Rodrik, D. (2008). Second-best institutions. American Economic Review 98(2): 100–104. Rothbard, M.N. (1962). Man, Economy, and State: A Treatise on Economic Principles. Princeton, NJ: Van Nostrand. Rothbard, M.N. (1974). Review of Competition and Entrepreneurship. Journal of Economic Literature 12(3): 902–904. Rothbard, M. N. (2000 [1963]). America’s Great Depression. Auburn, AL: Ludwig von Mises Institute. Ruger, W.P. and Sorens, J. (2021). Freedom in the 50 States. Washington, DC: Cato Institute. Salerno, J.T. (1990). Postscript: Why a socialist economy is ‘impossible’. In: Economic Calculation in the Socialist Commonwealth (L. von Mises), 49–69. Auburn, AL: Ludwig von Mises Institute. Saunoris, J.W. and Sajny, A. (2017). Entrepreneurship and economic freedom: Cross-country evidence from formal and informal sectors. Entrepreneurship & Regional Development 29(3–4): 292–316. Schumpeter, J.A. (1934 [1911]). The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. Cambridge, MA: Harvard University Press. Sobel, R.S. (2008). Testing Baumol: Institutional quality and the productivity of entrepreneurship. Journal of Business Venturing 23(6): 641–655. Stam, E. and Wennberg, K. (2009). The roles of R&D in new firm growth. Small Business Economics 33(1): 77–89. Stenholm, P., Acs, Z.J. and Wuebker, R. (2013). Exploring country-level institutional arrangements on the rate and type of entrepreneurial activity. Journal of Business Venturing 28(1): 176–193. Stephan, U., Hart, M. and Drews, C.C. (2015). Understanding motivations for entrepreneurship: A review of recent research evidence. Enterprise Research Centre Rapid Assessment Paper, Aston University, Birmingham, UK. Story, D.J. (1982). Entrepreneurship and the New Firm. London: Routledge. Su, J., Zhai, Q. and Karlsson, T. (2017). Beyond red tape and fools: Institutional theory in entrepreneurship research, 1992–2014. Entrepreneurship Theory and Practice 41(4): 505–531. Terjesen, S., Hessels, J. and Li, D. (2016). Comparative international entrepreneurship: A review and research agenda. Journal of Management 42(1): 299–344. Webb, J.W., Khoury, T.A. and Hitt, M.A. (2020). The influence of formal and informal institutional voids on entrepreneurship. Entrepreneurship Theory and Practice 44(3): 504–526. Wennberg, K. and Sandström, C. (2022). Questioning the Entrepreneurial State: Status-Quo, Pitfalls, and the Need for Credible Innovation Policy. Cham: Springer.
258 Handbook of research on economic freedom Wennekers, S. and Thurik, R. (1999). Linking entrepreneurship and economic growth. Small Business Economics 13(1): 27–56. Williamson, O.E. (2000). The new institutional economics: Taking stock, looking ahead. Journal of Economic Literature 38(3): 595–613. Wood, M.S., Bylund, P.L. and Bradley, S.W. (2016). The influence of tax and regulatory policies on entrepreneurs’ opportunity evaluation decisions. Management Decision 54(5): 1160–1182. Zhu, H. and Zhu, S.X. (2017). Corporate innovation and economic freedom: Cross-country comparisons. Quarterly Review of Economics and Finance 63(February): 50–65.
18. The influence of the market economy and economic freedom on culture1 Eelke de Jong
INTRODUCTION Economic activities can be organized and coordinated in various ways, which differ in the role played by the government, people’s networks and individuals themselves. In a centrally planned economy, the government determines the prices and often also the quantities produced. In a network economy, a dominant role is played by people’s networks: extended family, occupational organization, etc. Individuals and their preferences and decisions are central in a free market economy. In such an economy the government’s role is restricted to guaranteeing property rights by means of an impartial judiciary system. In practice, in many countries all three coordination mechanisms are in place and the countries differ in the degree they make use of each of these mechanisms (see de Jong 2022). In a free market economy, the government sets the legal rules but neither the government nor any other group prescribes the individuals’ preferences and decisions. The academic literature about the free market started in the 18th century and immediately discussed the pros and cons of a free market society for people’s morality. Would people misuse their freedom at the expense of others (Hobbes) and would they become so selfish that their concern for the common good would diminish (i.e., Hirschman 1982)? This dilution of morality would be critical because it would undermine the population’s moral obligations that, in turn, are necessary for the proper functioning of a society based on markets. In this discussion markets are a means of distributing production factors and final products and services. At times markets are also used to provide services traditionally provided by family and neighbors, such as childcare and care for the elderly. Such cases provoke even more a debate on the moral limits of markets (Sandel 2012). Others (Rand et al. 1967; McCloskey 2010) argue that market activities stimulate moral behavior in their participants because commerce teaches – even requires – people to behave well. Individuals can only participate in markets when there is, in the words of Adam Smith, mutual sympathy: recognition and empathy for other (anonymous) parties with whom one deals. This discussion illustrates that the market is a controversial distribution mechanism. A market economy needs certain values; to work well, it must be embedded in a market-friendly culture. In its turn the market economy stimulates certain values that might enhance its functioning but could also undermine it. In this chapter we discuss the empirical literature examining how the market economy influences culture in the sense of the dominant norms and values of a population. Markets, economic freedom and culture refer to nationwide phenomena. Hence, we consider the literature on the effects of a market society and do not consider discussions 1 I thank Niclas Berggren, Jakob de Haan and an anonymous reviewer for their comments on a previous version of this chapter.
259
260 Handbook of research on economic freedom confined to whether a market-type arrangement is the best solution for a particular problem, for example, whether a fee has to be paid for blood donation or a fine for collecting children too late from a daycare center. The market process is considered to exist of two elements: institutions, such as laws protecting property rights; and the market process (see Figure 18.1). These two elements are expected to influence each other (arrows a in Figure 18.1). Institutions and policies that are in place for a long time can ingrain a certain habit and thus change values (see Bowles 1998, and arrow b in Figure 18.1). The market process consists of interactions between participants. The participants’ dominant experiences can have a lasting effect on their values (arrow c in Figure 18.1). The studies discussed investigate whether one or both of these market features influence values. Under values, we list the topics to be discussed in the next sections. Of course, the market also influences income per capita, income inequality and wealth inequality, which might also affect values. Studies investigating these relationships are not considered in this chapter but by de Haan and Sturm (2024) and Bennett (2024) in this Handbook. Unless stated otherwise, the intensity of the market is measured by the score of the Economic Freedom of the World index published by the Fraser Institute (Gwartney et al. 2022). This index contains five subindices: (1) small size of the government; (2) rule of law (protection of property rights, enforcement of contracts); (3) sound monetary policy; (4) freedom to exchange goods and services internationally; and (5) no government regulatory restraints on credit, labor and product markets. The higher the score the more the economy is assumed to reflect a market economy.
Figure 18.1
The causal relationships between markets and values
In a free market economy, individuals are free to participate in a transaction without any further obligation than to fulfill the agreements made as part of the transaction. The buyer pays the price and the seller delivers the goods or services and obtains the money the two agreed upon. No further implicit or explicit obligation is attached to this transaction. As a consequence, both parties are free to select another partner, if they want, to make a similar transaction in the future. According to some, this high level of disconnectedness of people in a market economy
The influence of the market economy and economic freedom on culture 261 undermines other-regarding behavior, also known as civic virtues. A related issue is whether people help those in need – whether markets are conducive to charity and trust in unknown others. Minorities have a vulnerable position in every society. Is this less so in a market society, where group pressure might be less because every individual can decide for him- or herself? Yet, the large role of the individual might lead to too much focus on oneself instead of the group (individualism) and maybe too high a level of self-attribution.2 After presenting research findings on these matters, the chapter ends with conclusions and a discussion, including some ideas for further research. This chapter summarizes the research on the causal effect of markets and economic freedom on values. However, often authors argue that values are necessary preconditions for markets to work, so that causality is assumed to run from values to market institutions. We therefore start our discussion with some notions on causality.
CAUSALITY The debate on whether values are a prerequisite for the well-functioning of markets or if markets influence values is quite old. Weber (2001 [1930]) is assumed to argue that values determine economic outcomes.3 His arguments are echoed in the modern literature by Oliver Williamson (2000), arguing that formal institutions are embedded in values. The hypothesis that values are determining institutions and practices is also known as the Hierarchy of Institutions Hypothesis. Karl Marx is the most important representative of the opposite hypothesis, namely that material conditions, which include markets and laws, influence values. A similar causal direction can be found in Inglehart’s work on post-materialism. He argues that post-materialism ‘denotes a set of goals that are emphasized after people have attained material security, and because they have attained material security’ (Inglehart 1997, p. 35, emphasis in original). The claim about the causal direction can be studied by means of logical reasoning (philosophy), historical studies over a long period, experiments, and empirical studies. Instrumental variables (IV) regressions form the standard procedure in empirical studies to validate a certain causal pattern. Finding valid instrumental variables appears, however, to be difficult, in particular when it comes to such a broad issue as the extent to which markets causally influence the dominant values in a society. Then the instrumental variable has to have a very significant effect on the variable representing the market and no effect (orthogonal to the disturbance term) on the value under study. Moreover, a weak instrumental variable makes the estimator more imprecise than an Ordinary Least Squares (OLS) estimator (see Angrist and Pischke 2009, ch. 4), which needs to be taken into account. In any case, as Deaton (2010) argues, it is not relevant whether the market influences the values but why it does so. So, ideally,
2 Self-attribution refers to the cognitive phenomenon by which people attribute failures to situational factors and successes to personal characteristics. 3 Although this is indeed the dominant argument in Weber’s main text, he certainly doesn’t exclude the opposite direction of causality, as might be clear from the following quote: ‘[I]t is, of course, not my aim to substitute for a one-sided materialistic an equally one-sided spiritualistic causal interpretation of culture and of history. Each is equally possible ...’ (Weber 2001 [1930], p. 125).
262 Handbook of research on economic freedom instrumental variables regressions inform us about the mechanism behind the influence of the market on values. In order to solve the causality issue, some researchers suggest using experiments. In these experiments, participants act under conditions that are suggested to reflect the non-market conditions and those that are supposed to reflect a market phenomenon. The differences in their attitudes and actions under these two types of circumstances are then assumed to reflect the influence of markets. These experiments are confined to a particular aspect of a market economy: change in information, for example. In addition, the respondents are members of a small group, who know that they are being observed. These characteristics make them less appropriate for studying nationwide phenomena such as free markets, morals and values.4 The empirical studies to be discussed in the next sections are based on large datasets covering great parts of societies. If panel data are used then the within-estimator is the OLS estimator in a regression on deviations from country means (see Verbeek 2004, p. 350). Hence, in a regression with a morality item as the dependent variable and market intensity as one of the explanatory variables, the within-estimator estimates whether an observation higher than the mean of market intensity is associated with a positive or negative influence on morality. Although this is not a measure of causality in the strict sense, it suggests at least a positive relationship over time within the same unit of analysis. The between-estimator estimates whether, on average, units with a higher level of market activity are associated with higher or lower levels of morality. Presenting the means for market versus non-markets societies, as is done by Storr and Choi (2019), is the simplest version of the between-estimator. In all cases no strict argument for causality can be established. More certainty about the causal path can be found if one regresses the change in the cultural value on the lagged change in the measure of market intensity. Then at least the change in market intensity precedes the change in values. One is even more certain of the causal direction if the reverse regression, of the change in values in previous periods explaining the change in market intensity, finds an insignificant coefficient for the change of values. Some call this a kind of Granger causality test.
OTHER-REGARDING BEHAVIOR Civic Virtues The effect of free markets on civic virtues is the subject of a controversial and long-standing debate. Civic virtues are ‘those social norms, ethical commitments, and other-regarding preferences that facilitate the workings of the institutions advocated by liberals’ (Bowles 2011, p. 50), where ‘institutions advocated by liberals’ refers to free market institutions. Examples of these ‘bourgeois’ virtues are voluntarily paying taxes and contributing to public goods, respect for private property, honesty, and fair treatment. Adam Smith already states that ‘whenever commerce is introduced into any country, probity and punctuality always accompany it’ (Smith 1982 [1762, 1763], §17). In our times McCloskey (2010) argues that the increasing dominance of bourgeois virtues contributed to economic growth during the Industrial Revolution. The 4 See also Bowles and Polania-Reyes (2012, p. 401) for some critical remarks on the external validity of experiments.
The influence of the market economy and economic freedom on culture 263 hypothesis that trade leads to virtues is known as the doux commerce hypothesis. Others have argued that a market economy will undermine this crucial willingness to act in favor of the public good. Bowles (2011) calls this tendency of the market economy, ‘parasitic liberalism’, which corresponds to Hirschman’s (1982) self-destruction thesis. Empirical tests of the doux commerce versus parasitic liberalism hypotheses are scarce. Exceptions are three recent studies, namely Storr and Choi (2019), Graafland (2023) and Schilpzand and de Jong (2023). All three studies measure civic virtues by indicators from the illegal dishonesty domain of the Morally Debatable Behaviors Scale (Katz et al. 1994). These items are answers to questions on whether unethical actions, such as claiming government benefits to which you are not entitled or accepting a bribe, are 1 (always justifiable) up to 10 (never justifiable). The questions used in each study are listed in Table 18.1. Table 18.1
Studies of the effect of markets on civic virtues
Study
Items of civic virtues
Measure of market economy
Storr and Choi (2019)
avoiding a fare in public transport
Binary
cheating on taxes stealing property accepting a bribe Graafland (2023)
cheating on taxes
Subindex legal system and property rights
accepting a bribe
of EFW index
claiming government benefits Schilpzand and de Jong (2023)
cheating on taxes
Economic activity rate
claiming government benefits
EFW index and its subindices
avoiding a fare in public transport
Storr and Choi (2019, Figure 5.5) show for each item the average score of respondents in market societies versus those in nonmarket societies. Respondents in market economies appear to find these actions less acceptable than those in nonmarket societies. The other two studies use the average of the items listed in Table 18.1 as the measure for civic virtues. Graafland focuses on the rule of law as measured by the second subindex of the Economic Freedom of the World (EFW) index and finds that a higher quality of the legal system reduces the acceptance of unethical behavior.5 Similar results are reported by Schilpzand and de Jong (2023) for the EFW index. In their within-regression, the term is quadratic, indicating a positive but declining influence of the EFW indicator on civic morality. Moreover, a more detailed regression reveals that the positive effect of the EFW index is, in particular, significant in a sample restricted to Western countries. They also perform an analysis at the regional (within-country) level. Then they use economic activity as a measure of market influences.6 Due to data restrictions, only European countries are included in the analysis. Once again, Schilpzand and de
Graafland (2023) estimates the between-estimator and lags the EFW by five years in order to reduce the influence of reverse causality. Schilpzand and de Jong (2023) estimate the within-estimator and do not use lags. 6 The economic activity rate is the number of employed and unemployed persons in a region as a percentage of the region’s total population. The rate will be high in a region where many tasks, such as for example daycare for children, are performed by market parties instead of relatives and neighbors. It reflects the salience of a market society. 5
264 Handbook of research on economic freedom Jong (2023) find a positive relation between economic activity and the aversion to unethical behavior. The positive influence disappears when a measure of fairness is included. This result suggests that the market has a positive influence on civic virtues as long as the market process is regarded as delivering fair results. Charity Charity is another form of other-regarding behavior. Storr and Choi (2019) provide evidence on the behavior of very rich persons and the results of surveys collected by Gallup and published by the Charities Aid Foundation. They note that in market economies very rich persons often bundle large shares of their wealth in a charity foundation. Examples are Andrew Carnegie, Bill and Melinda Gates and Mark Zuckerberg and his wife Priscilla Chan (Storr and Choi 2019, pp. 164–165). These nonprofit foundations are exempt from paying taxes or pay taxes at a reduced rate. Consequently, one can argue that tax planning instead of charity plays a role. Donations by non-rich people are often also deductible from taxes, so that again motives related to tax reduction and to charity can both play a role. In addition, empirical research reveals that within a society, persons of lower social status show more attention to others and greater sensitivity to others’ welfare than people from higher social classes (Piff and Robinson 2017). As a result, those from lower social classes tend to give higher donations as a percentage of income. Andreoni (2006, Table 2) reports a U-shaped curve for American households. The middle classes donate the lowest percentage of their income, and the lowest income class donates the highest share of their income. Experimental research suggests that this type of prosocial behavior of lower classes can be attributed to a higher sensitivity to the needs of others (Piff et al. 2010). The difference with members of higher social classes disappears if the latter are experimentally induced to feel compassion (Piff et al. 2010), which illustrates that the higher social classes are not per se less prosocial but just do not know the needs of the poor. Gsottbauer et al. (2022) confirm that the higher social classes are not per se less social. In some experiments the rich tend to cheat more than the poor, and high-income participants consider it more likely that participants cheat and also believe that people cheat to a larger degree than do low-income participants (Gsottbauer et al. 2022, Figure 5, p. 2407). However, these differences are not statistically significant. Hoffman (2011) even finds a positive correlation between a person’s income and the probability to save a Jew during the Second World War. The previous results suggest that altruism is determined by the ability to help and the awareness of the needs of others. The results provided by Piff et al. and Gsottbauer at al. are derived from data regarding inhabitants from the same developed countries: respectively, the United States of America and Germany. If the suggested explanatory factors are universal then one would expect that, in poor countries, which are often non-market societies, charity is motivated by compassion for the needy, whereas in the rich market societies, the ability to help might be more important. Consequently, helping others is expected to be found in both types of countries. This is indeed what Storr and Choi (2019, pp. 166–167) report for the top 10 countries in the 2017 World Giving Index. This index shows whether respondents volunteered, donated money, or helped a stranger in the past month. The top three countries are non-market economies, namely Myanmar, Indonesia and Kenya. Six countries out of the top ten are market economies. If one restricts prosocial behavior to donations to charity, then
The influence of the market economy and economic freedom on culture 265 the percentage of persons who donate is about twice as large for market societies than for non-market societies. In conclusion, a market economy often leads to a higher income, which enlarges the ability to donate to those in need, but might reduce the awareness and sensitivity for the needs of the poor, so that on balance helping the poor can be found in both market and non-market societies.
TRUST The literature distinguishes between different types of trust. Particularized trust refers to the expectation of a partner’s reliability with respect to his or her obligations, predictability of behavior and fairness in actions and negotiations while faced with the possibility to behave opportunistically (Zaheer et al. 1998). This type of trust is formed through repeated interactions between the persons and organizations concerned (the market process in Figure 18.1). Many typologies of particularized trust have been developed, depending on the basis of trust (knowledge versus identification), the strength of the trust (fragile versus resilient), etc. (see, among others, Das and Teng 2001). Generalized or social trust refers to trust in unknown others. In empirical studies, trust in unknown others is measured by the percentage of respondents who positively answer the question ‘Generally speaking, would you say most people can be trusted, or that you cannot be too careful in dealing with other people’.7 Institutional trust refers to trust in state institutions, such as the judiciary, the police and parliament, which can be expected to be a positive function of their fairness and effectiveness (Sønderskov and Dinesen 2016, p. 181). A first indication that generalized trust is determined by other mechanisms than particularized trust is provided by Storr and Choi (2019, p. 180). They present scores for market societies and non-market societies on survey questions asking for the respondents’ trust in family members, neighbors, known associates, people met for the first time, and strangers. Respondents from market societies score higher on all questions. However, the differences in scores between respondents from market versus non-market societies on the first four questions is small, in particular when it comes to family and neighbors. A large difference is, however, reported for the question whether one trusts strangers: 42 percent (market societies) versus 19 percent (nonmarket societies). Some studies of the influence of generalized trust on economic growth also investigate the determinants of trust (Knack and Keefer 1997; Zak and Knack 2001). Trust appears to be positively related to constraints on the executive and to an independent judiciary system (Knack and Keefer 1997). Similar findings are reported by Zak and Knack (2001) for an index of investor rights, an index of property rights and the Transparency International Index of perceptions of corruption. Beugelsdijk (2006) performs a principal components analysis on trust and measures of formal and informal institutions. He finds that trust scores are high on 7 This question is from the World Values Survey and is widely used and criticized. An important element of the criticism is the ambiguous content of ‘most people can be trusted’ versus ‘you cannot be too careful in dealing with other people’. For more discussion on this issue, see Beugelsdijk (2006, notes 1, 2).
266 Handbook of research on economic freedom the principal component that also includes measures of institutional strength as used by the two previously mentioned studies. From this, he concludes that a country’s score on generalized trust is a proxy for the quality of its institutions. We trust each other because we know that in case of conflicts we can rely on independent judges. The studies mentioned so far do not claim a causal direction, although Beugelsdijk tends to reason in favor of the hypothesis that good quality of institutions leads to trust. Berggren and Jordahl (2006) investigate the influence of EFW index and its subindices on trust and use an IV approach to find evidence of a causal direction. Ordinary Least Squares (OLS) regressions for a broad group of countries show that the EFW index, and the subindices legal structure and security of property rights, sound money, and regulation of credit, labor and business, have a significant positive influence on trust. Splitting the group of countries in OECD and non-OECD counties reveals that legal structure and security of property rights is an important determinant of trust within the group of OECD countries. The other two indices – sound money and regulation – explain the differences within the group of non-OECD countries. Dummies for legal origin are used as instrumental variables for legal structure and security of property right. These instruments appear to be weak. The IV regressions result in less significant coefficients than the corresponding OLS regressions. Still some coefficients are significant. However, the first stage results signify weak instruments, so that once again we have to conclude that the causal direction is hard to identify econometrically. An experimental study confirms the causal effect of an impartial enforcement system on cooperation and trust (Cassar et al. 2014). Similar results are found by Sønderskov and Dinesen (2016) using longitudinal data of Danish respondents over a time span of up to 18 years. The respondents are asked questions about social trust and institutional trust. The authors use individual fixed effects and lag institutional trust in regressions explaining social trust and vice versa. Lagged perception of institutional trust appears to significantly influence social trust, whereas the reverse regression does not deliver strong results.
ATTITUDES TOWARDS MINORITIES: TOLERANCE In the previous section we have discussed the attitude (trust) towards others, where it is unknown who the others are or to which group they belong. In reality, many different groups of people inhabit a country. These groups differ with respect to, for example, ethnicity, race, religion, and the way of life. Respect for diversity and openness to members of different groups is often found to stimulate innovation and growth (Bove and Elia 2017; Audretsch et al. 2018). Consequently, it is of economic importance to investigate the relation between economic freedom and the level of tolerance. Economic freedom can influence tolerance in different ways. One channel is through the market process: the interaction between individuals (Berggren and Nilsson 2013). First, as with trust, the positive experiences in the marketplace might lead to a positive view of others and thus also of those from other groups. Second, people might realize that they need others to foster their own interests and view other people on the basis of their competence instead of race or ethnicity. Third, the market process might transform the society from one with many small groups, each with a lot of internal pressure to conform to group norms, into a large one where pressures to adhere to norms of a particular group are less.
The influence of the market economy and economic freedom on culture 267 People might also be more tolerant if they fear less threat from minorities. This threat might be less if the judicial system is efficient and property rights are well protected. The perceived threat is also reduced if all members are treated equally and no particular group obtains a favorable position. In addition, good economic conditions such as income per capita and sound economic policy might increase the acceptance of minorities. In a series of papers, Berggren and Nilsson (2013, 2014, 2016, 2021) study various of these channels for different types of tolerance. In order to tackle reverse causality, they use instrumental variables or lagged changes. In the latter case, they explain the change in tolerance by the change in economic freedom during an earlier period. Table 18.2 summarizes the effects that appeared to be significant. The authors also performed various instrumental variables regressions and reported the results which they thought to be significant in their papers. However, according to the criteria set by Angrist and Pischke (2009, pp. 212–213), the instruments used are very weak: the F statistic is smaller than 10. I therefore decided not to report the instrumental variables regressions in Table 18.2. Table 18.2
Significant effects found in studies on economic freedom and tolerance Tolerance towards
Measure
Homosexuals
Race
Economic
+
+
freedom
+ +
Atheists
Communists
Jews
+ (kids) +
+
property rights
+
+
+
+
+
+
2013
First diff.
2013
First diff.
2016
OLS
2014
+ (kids)
OLS
2013
+ (av.)
First diff.
2016
OLS
2014
OLS bil.
2021
OLS
2021
+ + +
OLS
+ (av.)
+
Sound money
Study
– (kids)
+ Legal system and
Method General
+ (kids)
+ +
OLS
2013
First diff.
2013
OLS
2014
+
OLS bil.
2021
Freedom to trade
-
OLS bil.
2021
internationally
-
OLS
2021
OLS
2013
Regulation
+ (kids)
Note: av. = average; first diff. = first differences; kids = a measure of tolerance where people indicate if they think it is important for children to learn tolerance; OLS = Ordinary Least Squares; OLS bil. = an OLS regression with only one subindex of the EFW as the explanatory variable and the control variables.
Economic freedom appears to increase tolerance towards homosexuals, people of a different race, atheists and communists (Table 18.2, first rows). Note that the results with respect to atheists and communists hold in a sample of American respondents. Investigations into the effects of the subindexes of the Economic Freedom of the World index reveal that the legal structure and protection of property rights is important for tolerance towards all groups.
268 Handbook of research on economic freedom Apparently, people tolerate minorities if they feel themselves well protected. For the US sample, Berggren and Nilsson (2016, p. 65) use the Fraser Institute’s Economic Freedom of North America index and find that a decrease in the top marginal rate of income-tax increases tolerance towards homosexuals, atheists and communists. One can interpret this finding as evidence of an increase in tolerance if respondents feel that the tax system has become fairer in the sense that groups are treated alike. Sound money has a positive effect on the tolerance towards homosexuals and the share of persons who find that children should be taught tolerance (Table 18.2, row sound money). The effect on whether to teach children tolerance depends on the estimation method used. It is positive in the cross-sectional OLS regressions but negative when first differences are used. The positive effect of sound money on tolerance indicates that people are more tolerant if their economic circumstances allow it. Finally, it appears that freedom to trade internationally has a negative effect on the acceptance of Jews, whereas it does not have an effect on the tolerance towards the other groups. This might reflect the perception of respondents that Jews are prominent in international finance and trade. Consequently, free trade is assumed to favor Jews as they are well positioned to take advantage of the possibilities resulting from free trade. Respondents seem to regard freedom in international trade as a measure that unfairly increases the privilege of this minority so that regulations enabling international trade lead to antisemitism.8 The effects reported above are direct effects. One can imagine that under certain circumstances the effects are larger or smaller. Berggren and Nilsson (2014) find that the positive effect of economic freedom on the tolerance of homosexuality is larger if trust is high. This larger effect when trust is high holds for economic freedom in general, small government, and sound money. Berggren and Nilsson (2016) perform the Granger type causality test described in the section on causality. Except for one case, the influence of the change in tolerance on the change of economic freedom is insignificant. This suggests a causal direction from economic freedom towards tolerance.
INDIVIDUALISM AND SELF-ATTRIBUTION Many authors have argued that market societies need a certain set of values, such as individualism. Henrich (2020) describes how rules set by the Christian Church have undermined the extended family and thus increased individualism, which might have led to market societies. We do not discuss this literature as it concerns the causal direction opposite to the theme of this chapter. However, the causality can also go the other way: people who are used to living in a market society might acquire certain features that persons living in a more centrally governed society do not acquire. Pejovich (2003, p. 351), for example, notes that ‘while the capitalist culture puts a premium on performance, risk taking and the freedom to choose, the old ethos in Central and East European favors the equality of results and social welfare programs’. This process In their study on antisemitism, Berggren and Nilsson find similar results when they replace legal system and protection of property rights by the rule of law indicator developed by Gutmann and Voigt (2018) and freedom to trade internationally by the KOF Globalization Index of Gygli et al. (2019). 8
The influence of the market economy and economic freedom on culture 269 will be reinforced by the values parents and teachers transmit to children. Compared with more hierarchical societies, in a market society participants have more freedom to choose the way they want to organize their lives. Success and failures can to a greater degree be credited to the persons’ own decisions and efforts, which is also known as self-attribution (see also Bowles 1998, p. 97). Self-attribution can stimulate people to take the initiative and perform tasks. An important initiative concerns inventing a new product or procedure. In accordance with this idea, Bennett and Nikolaev (2021) find that at the country level the degree of innovation is positively related to Individualism. Moreover, pro-market institutions stimulate innovation. This effect is even larger in individualistic societies, so that individualism enhances the effect of pro-market institutions. In an individualistic society a person can attribute his or her good deeds, for example, to his or her own actions. Moreover, in such a society people are more open to unknown others, which expands the circle of sympathy. Both factors might explain the higher level of charity in countries scoring high on individualism (Cai et al. 2022). The downside of self-attribution can be that actors ascribe success to their own efforts only, whereas in reality the circumstances or the facilities offered by the government also play a role. This results in an attribution bias or overconfidence. Chui et al. (2010) argue that these biases are related to the individualism index of Hofstede (2001) and apply these ideas to financial markets and investment strategies. They find that individualism is correlated with high trading volumes and high volatility, which supports the idea that investors in more individualistic cultures tend to be more overconfident. Since market societies are characterized by high levels of individualism, this would imply that a market society can stimulate overconfidence.
CONCLUSION AND DISCUSSION This chapter discussed the literature on the influence of a market society on culture in the sense of dominant values. We explicitly referred to market societies as an all-encompassing phenomenon that has to be compared with other society-wide ways of organizing economic activities, such as centrally planned economies and network economies. This choice excludes the discussion of aspects of markets in isolation, such as the pros and cons of financial incentives for blood donation. Our interest is in the effect of markets on persistent trends in values in the majority of a population. Consequently, we have to consider the market as a phenomenon that can have an influence on all members of a society. Two aspects of a market are distinguished: (a) the rules and regulation and the (b) the market process. Many empirical studies make use of the Economic Freedom of the World index of the Fraser Institute as a measure for rules and regulation. Higher values on this index refer to freer markets. This index appears to be positively related to civic virtues, trust, and tolerance. The subindex on protection of property rights and the enforcement of contracts appears to be of particular relevance. Econometrically, open borders are correlated with higher levels of antisemitism, which could indicate that the respondents feel that open borders favor the Jews disproportionally. The effects of market regulation on various items of culture appear to be higher and more significant in a sample of Western rich countries than in non-Western countries. The influence of the market process, the interaction between those who are involved in transactions, can be of relevance for bilateral trust and self-attribution. However, such evidence is much harder to find than for the legal indicators. It could reflect the fact that better
270 Handbook of research on economic freedom quantitative measures of legal rules are available than for the intensity of interaction between market participants, so that the effects of the former are more easily found in empirical studies. More in-depth studies could shed some light at the mechanisms at work and the relevance of people’s treatment of each other in the marketplace. In this chapter we have focused on the influence of the market itself: its institutions and the working of the market process. We did not deal with the economic consequences of a market such as high levels of per capita income or more or less inequality in income and wealth. It could be that the results found can at least partly be ascribed to these outcomes of markets. Causality is another difficulty we came across. The evolution of institutions and culture is a complex historical process in which causality can go both ways. We questioned the appropriateness of instrumental variables regressions for finding the causal pattern. Moreover, the results reported in the literature discussed appeared to be based on weak instruments, which sheds doubts on their econometric validity. The Granger type of causality regressions seem to us to be more promising. A detailed account of the evolution of institutions and values over time might be even more valuable. Given the slow speed of the processes concerned, such a study will depend on the availability of appropriate data over a long time span. Finally, we suggest some avenues for future research not covered in this chapter. As Pejovich (2003, p. 351), notes ‘the capitalist culture puts a premium on performance, risk taking and the freedom to choose’. Individualism covers freedom to choose. However, as far as we know no study considers the influence from a (non)-market economy on the degree of risk taking, or uncertainty acceptance. In the case of risk, the distribution function is known, whereas under uncertainty no distribution of outcomes is available. The acceptance or rejection of hierarchy is another factor that might be related to a market economy. In theory a free market is associated with an egalitarian society, whereas a centrally planned economy is expected to be hierarchical. A hierarchical society expects different roles and associated values for different social economic classes. Is this indeed the case? De Jong and Schilpzand (2022) provide some information for three different types of market economies. It would be of interest to study more systematically the relation between free markets and the attitude towards hierarchy for a wider group of countries.
REFERENCES Andreoni, J. (2006). Philanthropy. In: Handbook of the Economics of Giving, Reciprocity, and Altruism: Applications, Volume 2 (eds. S.-C. Kolm and J.M. Ythier), 1201–1269. Amsterdam: North-Holland. Angrist, J.D. and Pischke J.-S. (2009). Mostly Harmless Econometrics: An Empiricist’s Companion. Princeton, NJ: Princeton University Press. Audretsch, D.B., Seitz, S. and Rouch, K.M. (2018) Tolerance and innovation: The role of institutional and social trust. Eurasian Business Review 8(7): 71–92. Bennett, D.L. (2024). Economic freedom and inequality: A survey of the empirical literature. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 208–224. Cheltenham: Edward Elgar Publishing. Bennett, D.L. and Nikolaev, B. (2021) Individualism, pro-market institutions, and national innovation. Small Business Economics 57(4): 2085–2106. Berggren, N. and Jordahl, H. (2006). Free to trust: Economic freedom and social capital. Kyklos 59(2): 141–169. Berggren, N. and Nilsson, T. (2013). Does economic freedom foster tolerance? Kyklos 66(2): 177–207. Berggren, N. and Nilsson, T. (2014). Market institutions bring tolerance, especially where there is social trust. Applied Economics Letters 21(17): 1234–1237.
The influence of the market economy and economic freedom on culture 271 Berggren, N. and Nilsson, T. (2016). Tolerance in the United States: Does economic freedom transform racial, religious, political and sexual attitudes? European Journal of Political Economy 45(December): 53–70. Berggren, N. and Nilsson, T. (2021). Economic freedom and antisemitism. Journal of Institutional Economics 17(2): 289–304. Beugelsdijk, S. (2006). A note on the theory and measurement of trust in explaining differences in economic growth. Cambridge Journal of Economics 30(3): 371–387. Bove, V. and Elia, L. (2017). Migration, diversity and economic growth. World Development 89(January): 227–239. Bowles, S. (1998). Endogenous preferences: The cultural consequences of markets and other economic institutions. Journal of Economic Literature 36(1): 75–111. Bowles, S. (2011). Is liberal society a parasite on tradition? Philosophy & Public Affairs 39(1): 46–81. Bowles, S. and Polania-Reyes, S. (2012). Economic incentives and social preferences: Substitutes or complements? Journal of Economic Literature 50(2): 368–425. Cai, M., Caskey, G.W., Cowen, N., Murtazashvili, I., Murtazashvili, J.B. and Salahodjaeve, R. (2022). Individualism, economic freedom, and charitable giving. Journal of Economic Behavior & Organization 200(August): 868–884. Cassar, A., d’Adda, G. and Grosjean, P. (2014) Institutional quality, culture, and norms of cooperation: Evidence from behavioral field experiments. Journal of Law and Economics 57(August): 821–863. Chui, A.C.W., Titman S. and John Wei, K.C. (2010). Individualism and momentum around the world. Journal of Finance 65(1): 361–392. Das, T.K and Teng, B.S. (2001). Trust, control and risk in strategic alliances: An integrated framework. Organizational Studies 22(2): 251–283. Deaton, A. (2010). Instruments, randomization, and learning about development. Journal of Economic Literature 48(2): 424–455. de Haan, J. and Sturm, J.-E. (2024). The impact of economic freedom on economic growth. In: Handbook of Research on Economic Freedom (ed. N. Berggren), 189–207. Cheltenham: Edward Elgar Publishing. de Jong, E. (ed.) (2022). Economic Ideas, Policy and National Culture: A Comparison of Three Market Economies. London: Routledge. de Jong, E. and Schilpzand, A. (2022). National culture in the three types of market economies. In: Economic Ideas, Policy and National Culture: A Comparison of Three Market Economies: (ed. E. de Jong), 15–32. London: Routledge. Graafland, J.J. (2023). On rule of law, civic virtues, trust, and happiness. Applied Research in Quality of Life 18(4): 1799–1824. Gsottbauer, E., Müller, D., Müller, S., Trautmann, S.T. and Zudenkova, G. (2022). Social class and (un) ethical behavior: Causal and correlation evidence. Economic Journal 132(647): 2392–2411. Gutmann, J. and Voigt, S. (2018). The rule of law: Measurement and deep roots. European Journal of Political Economy 54(September): 68–82. Gwartney, J.D., Lawson, R.A., Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Gygli, S., Haelg, F., Potrafke, N. and Sturm, J.-E. (2019). The KOF globalization index: Revisited. Review of International Organizations 14(3): 543–574. Henrich, J. (2020). The WEIRDEST People in the World: How the West Became Psychologically Peculiar and Particularly Prosperous. London: Allen Lane. Hirschman, A.O. (1982). Rival interpretations of market society: Civilizing, destructive, or feeble? Journal of Economic Literature 20(4): 1463–1484. Hoffman, M. (2011). Does higher income make you more altruistic? Evidence from the Holocaust. Review of Economics and Statistics 93(3): 876–887. Hofstede, G. (2001) Culture’s Consequences; Comparing Values, Behaviors, Institutions and Organizations across Nations. Beverly Hills, CA: Sage Publications. Inglehart, R. (1997). Modernization and Postmodernization: Cultural, Economic and Political Change in 43 Societies. Princeton, NJ: Princeton University Press. Katz, R.C., Santman, J. and Lonero, P. (1994). Findings on the revised morally debatable behaviors scale. Journal of Psychology 128(1): 15–21.
272 Handbook of research on economic freedom Knack, S. and Keefer, P. (1997). Does social capital have an economic payoff? A cross-country investigation. Quarterly Journal of Economics 112(4): 1251–1288. McCloskey, D.N. (2010). The Bourgeois Virtues: Ethics for an Age of Commerce. Chicago: University of Chicago Press. Pejovich, S. (2003). Understanding the transaction costs of transition: It’s the culture stupid. Review of Austrian Economics 16(4): 347–361. Piff, P.K. and Robinson, A.R. (2017). Social class and prosocial behavior: Current evidence, caveats, and questions. Current Opinion on Psychology 18(December): 6–10. Piff, P.K., Kraus, M.W., Côté, S., Cheng, B.H. and Keltner, D. (2010). Having less, giving more: The influence of social class on prosocial behavior. Journal of Personality and Social Psychology 99(5): 771–784. Rand, A., Branden, N., Greenspan, A. and Hessen, R. (1967). Capitalism: The Unknown Ideal. New York: Signet. Sandel, M.J. (2012). What Money Can’t Buy: The Moral Limits of Markets. New York: Farrar, Straus and Giroux. Schilpzand, A. and de Jong, E. (2023). Do market societies undermine civic morality? An empirical investigation into market societies and civic morality across the globe. Journal of Economic Behavior and Organization 208(April): 39–60. Smith, A. (1982 [1762, 1763]). Lectures on Jurisprudence. Indianapolis, IN: Liberty Fund. Sønderskov, K.M. and Dinesen, P.T. (2016). Trusting the state, trusting each other? The effect of institutional trust on social trust. Political Behavior 38(1): 179–202. Storr, V.H. and Choi, G.S. (2019). Do Markets Corrupt Our Morals? London: Palgrave Macmillan. Verbeek, M. (2004). A Guide to Modern Econometrics. Chichester: John Wiley & Sons. Weber, M. (2001 [1930]). The Protestant Ethic and the Spirit of Capitalism. London: Routledge. Williamson, O.E. (2000). The new institutional economics: Taking stock, looking ahead. Journal of Economic Literature 38(3): 595–613. Zaheer, A., McEvily, B and Perrone, V. (1998). Does trust matter? Exploring the effects of interorganisational and interpersonal trust on performance. Organisation Science 9(2): 141–159. Zak, P.J. and Knack, S. (2001) Trust and growth. Economic Journal 111(470): 295–321.
19. Economic freedom and gender Rosemarie Fike
INTRODUCTION One question that has been recently growing in interest amongst institutional scholars is what impact economic freedom has on historically marginalized groups, such as women. To feminists, the topic of economic freedom can be a divisive one. Left-leaning feminist narratives tend to blame free market systems for exploiting women and reinforcing social norms that designate women as inferior to men. Feminist proponents of economic freedom tend to highlight the ways in which economic rights offer women meaningful ways to improve their lives. The relationship between economic freedom and women’s well-being is undoubtedly complex. On the one hand, economic freedom can provide opportunities for women to participate in the economy and achieve financial independence, which can enhance their status and empower them to make important life choices. In countries with high levels of economic freedom, women may have more opportunities to start businesses, access credit, and participate in the labor force. On the other hand, economic freedom alone does not guarantee gender equality, and in some cases, economic freedom may exacerbate existing gender disparities. This may be particularly true in places where women face discrimination or social and cultural barriers that prevent them from fully participating in the economy. With the development of new sources of data that capture the gender differences in economic laws and the gender differences in development outcomes, coupled with innovations in the way economic freedom is measured, a new and exciting avenue for research has emerged in understanding the impact of economic freedom on women’s lives. This chapter explores that relationship to address the question: do markets oppress women or help them flourish? It first defines the measure of economic freedom being utilized in this analysis. Next, it presents some theoretical arguments about the benefits that markets provide for women that proponents of economic freedom have made since the Enlightenment. It then explores several feminist critiques of free markets and highlights the ways in which markets reinforce structures that subjugate women. The chapter then examines some empirical evidence to help shed light on this debate and compares those results with the related empirical evidence in the economics literature. It concludes with a discussion of some relevant policy questions and potential directions for additional research.
WHAT IS ECONOMIC FREEDOM? Economic freedom refers to a system of rules that enables individuals to have greater control over the course of their own lives. It protects their right to own, transform, and trade property as they see fit. It allows people to pursue the occupation that best aligns with their personal preferences and plans. It protects their right to open a bank account, enter contracts, and move freely within, and outside of, their country. 273
274 Handbook of research on economic freedom The Fraser Institute’s Economic Freedom of the World Annual Report provides the measure of economic freedom being used in this analysis (Gwartney et al. 2022). The Economic Freedom of the World (EFW) index captures the extent to which individuals living in a particular country are free to engage in economic activity without interference from the state. There are five areas of economic freedom measured in the EFW index: size of government; legal system and property rights; sound monetary policy; freedom to trade internationally; and regulation of credit, labor and business. Within each category, several different variables are used to assess a country’s relative freedom. These individual components are aggregated into an index that assigns each country a score on a scale of 0–10. Higher values indicate a society has a greater degree of economic freedom and economic activity is dictated largely by decentralized market forces, while lower values indicate a greater degree of central planning and state control over market interactions. In 2017, the EFW index began to account for gender differences in formal laws and regulations that exist in many countries (Fike 2016).1 For example, if a country with low tax rates for businesses has laws such that only men are permitted to register a business or enter into contractual agreements, then only 50 percent of the population benefits from the low tax rates. In such cases, the EFW index scores would be adjusted downward. Measures of economic freedom that do not account for gender differences in the law, however, will overstate the level of economic freedom. For our analysis of economic freedom and gender, it is important to use a measure that is nuanced enough to account for existing gender disparity under the law.
WHY MIGHT ECONOMIC FREEDOM HELP PROMOTE WOMEN’S WELLBEING? The idea that economic freedom has benefits for women is not a new argument. Classical liberal scholars have long argued that economic freedom can improve the plight of women and other marginalized groups. Intuitively, how might that work? Expanding the scope of the market through economic freedom ought to increase opportunities to gain from trade. Coupled with competition, this expansion of the market should encourage entrepreneurs to find ways to increase production efficiency by furthering the division of labor, increasing specialization, and investing more heavily in the use of dedicated capital goods. Increased trade and division of labor ought to generate wealth and improve living standards. With higher living standards comes a greater demand for goods and services. This raises the demand for labor (of both males and females), which ought to improve labor market outcomes for women. In addition, increases in living standards bring about improvements in health and the ability to afford to invest more heavily in developing human capital. Increased specialization of labor increases incentives for individuals to make those human investments. If true, 1 The gender adjustment factor is constructed using data from the World Bank’s Women, Business, and the Law annual report (World Bank 2022a). There are 17 questions in that report that explicitly pertain to women’s economic rights from a negative rights perspective. A country earns a score of ‘0’ if there are gender-specific laws that place additional restrictions on women’s economic choices and earns a ‘1’ if there are no existing barriers that are specific to women. The adjustment factor is a simple average of those 17 dummy variables. Area 2 of the EFW index is then adjusted using the following equation: Gender adjusted area 2 = [(Area 2)(1+gender disparity score)]/2. After that, the adjusted area 2 score is averaged together with the scores across the other four areas to arrive at a gender adjusted EFW index.
Economic freedom and gender 275 then greater economic freedom should be associated with better labor market, health, and education outcomes for women. Early Feminist Support for Economic Freedom Early feminists, such as Mary Wollstonecraft (1792), argued in favor of granting women the same rights to own property, seek employment, and engage in voluntary market transactions that men enjoyed. To her, these rights were a necessary step to securing women’s material wellbeing and bringing about social and political equality. In ‘The subjection of women’ (2018 [1869]), John Stuart Mill similarly argued that the social and legal subordination of women violates their fundamental human rights and acts a barrier to human progress. He called for the elimination of all forms of discrimination and prejudice against women, including economic discrimination, and advocated for women to have the same rights and opportunities as men, including the right to own property, earn a living, and participate fully in economic and social life. Mill further believed that greater economic freedom and equality for women would benefit society, not just women. First, women’s participation in economic life would increase overall productivity and economic growth. In addition to these material benefits, Mill thought men would benefit from having more equal, authentic, and fulfilling relationships with women, instead of relationships strained by the economic and social inequality that allowed men to be ‘petty tyrants’ in their own homes. There is evidence supporting Mill’s prediction that all of society benefits when women are granted economic rights. Several scholars (Doepke and Tertilt 2009; Fernández 2014) argue that men benefited from the elimination coverture laws because it improved the education and opportunities available to their daughters. Others have identified the more widespread social benefits that result from women’s increased economic participation. For example, Cuberes and Teignier (2016) estimate that there are significant opportunity costs of imposing formal and informal restrictions on women’s economic rights. They find that OECD countries with minimal restrictions forego 15 percent of per capita GDP each year while countries with more severe restrictions forego upwards of 35 percent each year. Finally, Hazan et al. (2019) found that the removal of coverture laws in the United States led to an increase in the supply of credit, changes in the structure of household portfolios, and shifted labor toward more capital-intensive non-agricultural sectors. In their view, these changes deepened the complexity of the financial markets in the United States, laying the groundwork for extensive industrialization. Additionally, it is important to acknowledge the work of female classical liberal scholars, such as Rose Wilder Lane, Isabel Paterson, and Ayn Rand, who staunchly defended economic freedom and individualism on more general grounds beyond their purported ability to achieve feminist goals. These scholars forged impressive careers during a time when women’s participation in those academic circles was rare (Burns 2015). The Doux Commerce Thesis: Classical Liberal Support for Economic Freedom The idea that the market process is one that could offer social benefits, such as improvements in the status and treatment of women, is not unique to early feminists. Since the 18th century Enlightenment, scholars such as Voltaire (2009 [1733]), Hume (2007 [1739]), Montesquieu
276 Handbook of research on economic freedom (1977 [1748]), Smith (1981 [1776]), and Say (2001 [1803]) have posited that market forces have a civilizing effect on the manners and dispositions of their participants. This position is known as the doux commerce thesis. To succeed in the market, one must cultivate bourgeois virtues which include prudence, temperance, courage, and justice (McCloskey 2006). Business owners must keep the promises they make in their contracts with suppliers and customers. They must refrain from cheating their current customers to maintain a reputation that allows them to attract future customers. They must pay attention to what potential customers need and desire and be willing to take risks finding ways to deliver it to them. Market participants are also encouraged to refrain from discussing controversial or offensive topics, lest it affect their business. Voltaire (2009 [1733]) marveled how members of different religious groups are able to regularly make peaceful exchanges with people they might be inclined to disparage in other contexts. The division of labor and trade helps foster mutual dependence and social cooperation, tying the fate of one person (or nation) to that of another. Through commerce, people do not just trade goods and services, but they also exchange ideas and values. Trade can even help diffuse technological and scientific knowledge. Recent scholars have examined the validity of this thesis. Their work shows that markets make people more tolerant of others who are different (Berggren and Nilsson 2013), markets are associated with less materialistic attitudes (Teague et al. 2020), and more moral behavior overall (Storr and Choi 2019). Gehring (2013) finds that societies characterized by economic freedom tend to experience higher wellbeing, which might also make market participants more tolerant. Harris et al. (2023) argue that markets humanize people, identifying a positive empirical relationship between market interactions and moral sentiments. Finally, Berggren and Nilsson (2021) highlight the complex nature of economic freedom and tolerance by showing that different aspects of economic freedom have opposing effects on antisemitic sentiments. Additional Support for Economic Freedom Other notable economists have also identified ways in which economic freedom could improve women’s lives. Becker (1957) argues that market competition discourages discriminatory behavior through the price mechanism and the profit/loss motive. To Becker, discrimination arises when individuals or firms are willing to incur a cost for their own prejudice. His model shows that in a competitive market, discriminatory firms are at a disadvantage compared with non-discriminatory firms, since they would be hiring and promoting based on irrelevant characteristics such as race, gender, or religion, rather than skills and capabilities. This leads to lower profits for discriminatory firms, which are then pushed out of the market by their non-discriminatory competitors. If sexist employers do not start to behave as if they do not possess discriminatory preferences, their businesses will fail. As a result, the demand for women’s labor will increase, and with it, so will wages.2
Becker offers an important caveat: if customers themselves possess discriminatory preferences, employers who hire members of the discriminated against group may lose more in revenue through lost customers than they save on production costs. However, this is only likely to be the case in a closed economy where the customers do not come from other societies with other preferences. Free international trade reduces the chances that challenging discrimination would be costly to the employer. 2
Economic freedom and gender 277 In Development as Freedom, Amartya Sen (1999) argues that markets provide women with access to income, employment, and resources, which can increase their bargaining power within households and society. This helps reduce gender-based inequality and increase women’s participation in economic and social life. Interestingly, Sen’s work also acknowledges that markets alone cannot ensure gender equality. He acknowledges that broader social and political factors (such as cultural norms, legal frameworks and social institutions) can act as barriers to women’s opportunities and capabilities (Sen 2003). For women to fully reap the benefits of markets, it is necessary to address these barriers. Sen’s work also calls attention to the complicated interrelationships between various measures of women’s wellbeing. For example, a more extensive educational background will put women in a better position to succeed in the labor market. Having more opportunities in the labor market ought to raise the cost of having children. Building on Sen’s work, Murthi et al. (1995) and Dreze and Murthi (2001) empirically demonstrate that improvements in women’s literacy rates are associated with lower fertility rates, lower child mortality rates and higher rates of women’s participation in the labor market. One last and often overlooked benefit of economic freedom for women is that it enables financial independence, which improves their negotiating position in many important ways. They will have a greater say in household bargaining situations allowing them to influence how household resources are used (Becker 1974). Additionally, a financially dependent woman may feel morally obligated to consent to certain arrangements, such as engaging in sexual behavior with their spouse, whereas having an independent source of income could empower women to make different choices (Zelizer 2005).
WHY MIGHT ECONOMIC FREEDOM HARM WOMEN? One of the more common criticisms of market-based economic institutions is that the competitive market process systematically exploits certain groups of people to benefit those who hold more power. Marx (1993 [1867]) argued that laborers are exploited by their employers. Eric Williams (1944) argued that market economies could not have existed without the large-scale accumulation of capital that resulted from exploiting the labor of enslaved populations. More recent work by Beckert (2014) contends that markets require the exploitation of marginalized groups in order to function and develop. Scholars focused on issues of gender equality make similar claims. Feminist critiques of markets focus on the idea that markets are not gender-neutral constructs but are entangled in a web of gendered beliefs and practices (Nussbaum 2000; Folbre 2006; and Holmstrom in Cudd and Holmstrom 2011). For example, the unpaid caring labor provided in large part by women across the world is what enables others to fully participate in the formal market process. Since time is scarce, the more time women spend providing this unpaid labor, the less time they can spend participating in the formal labor market. This leaves women at a competitive disadvantage. Nussbaum believes that the market-driven approach to gender equality is flawed because it tends to treat women as mere economic actors, ignoring the broader social and cultural factors that shape their experiences and opportunities. She argues that women’s participation in markets is often constrained by informal social and cultural norms that limit their access to
278 Handbook of research on economic freedom education, job training, and other resources, and that these norms must be addressed in order to achieve gender equality (Nussbaum 1999). Nussbaum (2011) further argues that markets reward traditionally masculine traits and characteristics, such as competition, over feminine traits, such as empathy and compassion. As such, markets tend to place a higher value on work that aligns with these masculine traits. As a result, the formal and informal care work performed by women, such as childcare and housework, is undervalued in the market economy, leading to economic inequality between men and women. Folbre (1994, 2001) also argues that the gendered division of labor, which assigns men to paid work and women to unpaid care work, is reinforced by the market system in that it prioritizes individual self-interest over collective wellbeing. Several scholars have also criticized Becker’s (1957) theory that competition weeds out discrimination. Bergmann (1974) points out that while it may be true that discriminatory firms would be at a competitive disadvantage in a perfectly competitive market, real-world markets are often far from perfectly competitive, with imperfect information, unequal bargaining power, and other barriers that can prevent the full realization of market forces. As a result, gender discrimination can persist even when the market is highly competitive. Moreover, England (1992) points out that Becker’s theory assumes that the costs of discrimination are borne solely by the discriminator, but the costs are often borne by the victims. Consequently, gender discrimination can lead to a perpetuation of gender-wage disparities and reduced representation of women in leadership positions.
EXPLORING THE EMPIRICAL EVIDENCE What does the real-world, empirical evidence suggest about the impact economic freedom has on women’s lives? Since theoretical arguments regarding the impact markets have on women’s lives cut in both directions, examining the empirical evidence is an important first step in answering that question. Using data obtained from the World Bank Development Indicators (World Bank 2022b) and World Values Survey (Inglehart et al. 2020), this chapter examines the relationship between economic freedom and labor market outcomes, educational outcomes, health outcomes, and gender norms.3 Where possible, the outcome for women is compared with the outcome for men. Correlations can tell us whether economic freedom is associated with better or worse outcomes for women, however, it is not enough to fully understand the entangled relationship between economic freedom and women’s wellbeing. To get at that more complicated question, each set of correlations is followed by a discussion of the empirical evidence found in the relevant economics literature.4
3 With the exception of the gender norms data, all outcome variables reflect the year 2020. The World Values Survey collects data in waves, so the year of data differs for each country. 4 See Stroup (2008, 2011) and Fike (2017, 2019, 2020, 2023) for similar empirical exercises that depict relationships that are consistent with what is presented here.
Economic freedom and gender 279 Economic Freedom and Women’s Labor Market Outcomes Labor force participation rate Figure 19.1 depicts the labor force participation rate of those women and men aged 15 and older. The labor force participation rate for women is the highest in countries where economic freedom prevails (53.6 percent) and is the lowest in countries with the most severe restrictions on economic freedom (44.6 percent). While in all cases, the participation rate for men is higher than that of women across all categories of economic freedom, in the least free economies, the difference between men and women’s labor force participation rates is 25.0 percentage points, and that gap narrows to 15.1 percentage points when looking at the most free economies.
Figure 19.1
Labor force participation rate (percent of population aged 15 and up)
Female percentage of total labor force Females as a percentage of the total labor force also increases along with the level of economic freedom. Figure 19.2 indicates that in the most free economies, 44.5 percent of the labor force is female, while in the least free economies women make up only 37.6 percent of the total labor force, a difference of 6.9 percentage points. In other words, the female proportion of the labor force in economically free countries is about 18 percent higher on average than in economically unfree countries. Wage and salaried workers The next figure, Figure 19.3, examines the percentage of the working population that works under a contract that entitles them to payment that is not contingent upon generating revenue for the unit for which they are employed. Workers with a wage or salary contract have a stream of income that is less vulnerable than those working without contracts. In the least free economies, only 38.3 percent of employed women and 43.2 percent of employed men were
280 Handbook of research on economic freedom working under contracts. In the most free economies, the percentage of workers with contracts increases to 83.6 percent of employed women and 78.7 percent of employed men.
Figure 19.2
Female percentage of total labor force
Figure 19.3
Wage and salaried workers (percent of employed population)
Women, Business, and the Law index scores The Women, Business, and the Law index is generated by the World Bank (2022a), and it captures the extent to which laws and regulations actively encourage women’s participation
Economic freedom and gender 281 in the economy through examining rules that govern the mobility of workers, marriage laws, the ways assets are owned and inherited, rules regarding retirement pensions, and even the presence of anti-discrimination laws and family-friendly labor policies. Scores closer to 100 suggest that society has ample opportunities for women to flourish economically and lower scores indicate the existence of legal and regulatory hurdles to women engaging in formal employment. Figure 19.4 indicates that the most economically free countries have an average Women, Business, and the Law score of 89.0 while in the least free countries, it is only 63.7. Countries that embrace a general policy of economic freedom are less likely to have gender-specific barriers to participating in the economy.5
Figure 19.4
Women, Business, and the Law index scores (scale 1–100)
Share of labor force with advanced education Greater economic freedom is also correlated with a more educated labor force. This makes sense, as the scope of the market expands and labor becomes more specialized, there are higher rewards to building human capital. This relationship is depicted in Figure 19.5. In the least free economies, only 53.7 percent of the female labor force has training beyond secondary schooling, compared with 77.3 percent for males. In the most free economies, the percentage of the female labor force with advanced education increases to 77.0 percent, a difference of 23.3 percentage points (over 43 percent). For men, the difference is less pronounced, but there is an increase to 82.3 percent. The education gender gap also narrows as economic freedom increases.
5
The version of the EFW index used in Figure 19.4 is not adjusted for gender disparity.
282 Handbook of research on economic freedom
Figure 19.5
Share of labor force with advanced education (percent of population aged 15 and up)
Account ownership at a financial institution or mobile-money service provider The final measure of labor market wellbeing is depicted in Figure 19.6, the percentage of the adult population with their own account at a financial institution. This captures the degree to which individuals have financial independence. In the least free economies, only 32.7 percent of women and 43.6 percent of men have bank accounts. Account ownership is far more prevalent in the most economically free countries with 82.8 percent of women and 85.6 percent of men owning an account. For women, the rate of ownership more than doubles when moving from the least free economies to the most free. The empirical evidence on labor market performance Across all six measures of labor market performance examined above, women fare better as economic freedom increases. These results are suggestive, not definitive. Additional research is necessary to address causality concerns. The empirical evidence in the existing literature is mixed. Most research focuses on the gender-wage gap. Hazarika and Otero (2004) find that the trade liberalization that came with NAFTA reduced the gender wage gap in Mexico, while Berik et al. (2004) demonstrate that increased competition from international trade exacerbated gender wage discrimination in Taiwan and South Korea. Zweimuller et al. (2008) show that increased economic freedom has a strong, negative impact on the gender wage gap. Oostendorp (2009) argues that the economic development resulting from globalization reduces the gender wage gap, as does greater trade and foreign direct investment. Yahmed (2012) show that trade openness reduced the gender wage gap for unskilled workers but increased it for workers with higher levels of human capital. Gaddis and Pieters (2017) find no evidence that trade liberalization increases labor market participation for men or women but show that it did cause the gender gap between men and women’s participation and employment rates to narrow slightly. On the other hand, Hall et
Economic freedom and gender 283
Figure 19.6
Account ownership at a financial institution or mobile-money service provider (percent of population aged 15 and up)
al. (2020) offer additional evidence that certain aspects of economic freedom, lower minimum wages and smaller government, result in higher gender wage gaps. Outside of the gender wage gap, Meyer (2006) shows that trade liberalization had a slight positive impact on women’s labor market participation, but that effect was more pronounced in middle- and higher-income countries than in low-income nations. Additional work by Feldmann (2007) provides evidence that economic freedom substantially reduces unemployment rates, especially for women and younger workers. Islam et al. (2019) find laws that do not grant women the same economic rights as men discourage women’s participation in the workforce and hurts their chances of working in management or owning their own business. In a joint report by the World Bank and World Trade Organization (2020), trade is demonstrated to have a positive impact on employment and wages for women. Increased trade generates better jobs and lowers the costs of production. One caveat is that the positive benefits for women will not occur if there are substantial barriers (formal or informal) to their economic participation. Hyland et al. (2020) echoes these results. Finally, regarding financial independence, Gaddis et al. (2022) show that in countries with more gender-equal property rights regimes, women are more likely to own property. While most of the evidence suggests that economic freedom improves women’s labor market outcomes, what might explain the existence of contrary results? Sauré and Zoabi’s (2014) model shows that if market liberalization increases demand for labor in female intensive sectors more than it does in male intensive sectors, then gender gaps will narrow, and women’s participation will increase but that this is only true if male and female labor are imperfect substitutes. If that is not true, then we may see men migrating into female intensive sectors causing the gender wage gap to increase and women to drop out of the labor force. Mukhopadhyay’s (2015) model predicts that a reduction in import tariffs (i.e., movement toward economic freedom) may narrow the gender wage gap and raise female labor force
284 Handbook of research on economic freedom participation, but it may also increase foreign capital inflows which could offset those effects. In short, the relationship between economic freedom and labor market outcomes is a complex one. The embedded nature of the economy in a broader institutional context that includes gender norms and other market characteristics can interact with movements toward economic freedom in a way that mitigates the benefits that women experience relative to men. One limitation of the existing literature is that it largely focuses on the international trade aspect of economic freedom, not on economic freedom’s other dimensions. Things such as the security of property rights, the extent to which the government is a major player in the market, or the legal barriers on people’s ability to pursue the occupation of their choosing are not typically included as an explanatory variable of interest. Thus, there is considerable room for scholars interested in economic freedom to contribute to this conversation. Economic Freedom and Women’s Health Outcomes Life expectancy at birth As shown in Figure 19.7, in economically free economies, women are expected to live to be 82.2 years and men are expected to live 77.0 years. However, in the least free economies, the life expectancy is only 68.6 years for women 64.3 years for men. This means that women living in the most free economies can expect to live on average, about 13.6 years longer than their counterparts living in economically unfree economies. That represents a significant improvement in wellbeing.
Figure 19.7
Life expectancy at birth (years)
Prevalence of undernourishment The percentage of the total population that is undernourished gives us an idea of the extent to which people can have enough to eat to meet their daily needs. Lack of nourishment hinders our ability to grow, learn, work, and enjoy our lives. As shown in Figure 19.8, in the least free
Economic freedom and gender 285 economies, 18.0 percent of the population is undernourished compared with only 3.9 percent of the population in the most free societies.
Figure 19.8
Prevalence of undernourishment (percentage of total population)
Child mortality rate One of the worst misfortunes that could possibly befall a family is the death of a child. This is far less likely to occur in economically free societies. The relationship between child mortality rates and economic freedom is depicted in Figure 19.9. In the least economically free countries, child mortality rates for females are 46.8 deaths per 1,000 births compared with only 5.5 deaths in the most economically free economies. For male children, the mortality rate is 54.8 deaths per 1,000 births in the least free countries, and only 6.6 deaths in the freest economies. Lifetime risk of maternal death Women are also less likely to die during childbirth in economically free societies. Figure 19.10 shows the relationship between economic freedom and the lifetime risk of maternal death, i.e., the probability that a woman will, at some point, die as a result of pregnancy. For women living in the least free economies, the probability of maternal death is 1.7 percent (one out of every 58.8 women) while it’s 0.037 percent (one out of every 2,702.7 women) in the freest countries. Given these odds, is likely that most people living in the least economically free societies know at least one person who has died from maternal causes. Adolescent fertility rate Figure 19.11 shows the relationship between economic freedom and adolescent fertility rates. The adolescent fertility rate refers to the number of babies born for every 1,000 adolescent girls (aged 15–19). We expect there to be a greater demand for labor present in economically free societies and with that a higher rate of return to developing one’s human capital. As such, the opportunity cost of having a child at a young age should be higher in economically free
286 Handbook of research on economic freedom societies than in economically unfree societies. The data are consistent with this, as the adolescent fertility rate is 18.8 births per 1,000 adolescents in the most free economies, while that number is 77.2 in the least free.
Figure 19.9
Child mortality rate (deaths per 1,000 live births)
Figure 19.10 Lifetime risk of maternal death (percent)
Economic freedom and gender 287
Figure 19.11 Adolescent fertility rate (births per 1,000 women aged 15–19) The empirical evidence on women’s health outcomes Once again, the relationships depicted in this section show a correlation between economic freedom and superior health outcomes for women (and men). The mechanism through which economic freedom impacts health is likely through the channel of economic development. These claims are suggestive and additional research is required to determine both causality and the channels through which economic freedom operates. These results are echoed in the related literature. Esposto and Zaleski (1999) were among the first to find that economic freedom increases life expectancy. These results are corroborated by Lawson et al. (2016), who show that economic freedom increases life expectancy for both men and women, despite being associated with higher BMIs for men in developing nations. Puaschunder (2018) finds that greater economic freedom is associated with lower fertility rates. Naanwaab’s (2018) work shows that an increase in economic freedom tends to reduce infant and maternal mortality rates, but these effects are most pronounced for the poorest countries. Kouton et al. (2021) demonstrate that economic freedom has a positive impact on health outcomes, in general, by acting as a necessary mechanism to improve information and communication technology diffusion. Lastly, in a study of African countries, Sharma (2020) provides evidence that greater economic freedom reduces mortality rates and increases life expectancy.6
6 One stark omission from this literature is the investigation of the impact of economic freedom on health practices, such as female genital mutilation. The Cato Institute’s Human Freedom Index (Vásquez et al. 2022) does include female genital mutilation as a variable, but the question of the impact of economic institutions on the prevalence of this practice is unexplored.
288 Handbook of research on economic freedom Economic Freedom and Women’s Educational Outcomes Primary school enrollment rates Figure 19.12 shows the average enrollment rates for primary school for each of our economic freedom quartiles. In the least free economies, 81.2 percent of girls and 81.4 percent of boys were enrolled in primary school. In the freest economies, 94.4 percent of girls and 94.2 percent of boys were enrolled in primary school.
Figure 19.12 Adjusted net primary school enrollment rates (percent of primary school aged children) Completion of lower secondary education Figure 19.13 depicts the relationship between economic freedom and completion rates for lower secondary education. In the least free economies, only 25.5 percent of women and 33.3 percent of men completed lower-secondary schooling, a gender gap of 7.8 percentage points. In societies where economic freedom reigns, secondary completion rates are much higher: in the most free economies, 85.5 percent for women and 87.7 percent for men, a much smaller gender gap of only 2.2 percentage points. Intuitively, it makes little sense for the average person to obtain higher levels of education when economic freedom, and the opportunities it creates, are absent. Completion of post-secondary education Finally, Figure 19.14 shows the correlation between economic freedom and the completion rates for post-secondary education. The difference between the least free and most free economies is even more pronounced than it was previously. In the least free economies, only 7.4 percent of women and 11.3 percent of men obtain formal training beyond their secondary schooling. In the most economically free economies, however, 40.8 percent of women and
Economic freedom and gender 289 37.1 percent of men make such investments in their human capital. The post-secondary completion rate for women is about five times higher in the freest countries than it is in the least free countries. Notably, in less free economies the completion rates for men are higher than women, but at higher levels of economic freedom, the opposite is true.
Figure 19.13 Completion of lower secondary education (percent of population aged 25 and up)
Figure 19.14 Completion of post-secondary education (percent of population aged 25 and up)
290 Handbook of research on economic freedom The empirical evidence on women’s educational outcomes In an economically free society, the returns to obtaining human capital ought to be higher. The empirical relationship between economic freedom and measures of educational enrollment and attainment at the primary, secondary, and post-secondary levels seem to bear this out, given the same caveats about causality as above. There is little research exploring the relationship between economic freedom and women’s education specifically, but what does exist is consistent with the results above. Heath and Jayachandran (2018) show that increased labor force participation rates of women led to a rise in girls’ education. Nikolaev (2014) finds that greater economic freedom is associated with higher levels of overall educational attainment, more years spent in education, and better performance on student skill assessments. A historical case study by Geddes et al. (2012) demonstrates that when women’s economic rights were expanded when US states began to overturn coverture laws, the educational enrollment rates of women increased, especially those aged 15–19 years. Finally, Feldmann (2017) examines the relationship between economic freedom and human capital investments and provides evidence that economic freedom raises secondary enrollment rates, both in general, and for women specifically. Economic Freedom and Gender Norms Since one of the major criticisms of markets is that they reinforce patriarchal social norms, it is important to empirically test that claim. The World Values Survey (WVS) provides a set of qualitative data regarding a variety of social views. Following the lead of Alesina et al. (2013), we use several questions from this survey to get a sense of a society’s overarching gender norms and then examine how those norms vary depending on the level of economic freedom that is present. Specifically, there are three questions measuring social views regarding whether men should be prioritized over women when it comes to employment, education, and political leadership opportunities. The larger the proportion of the population that agrees with the statement, the lower a country’s score for that particular measure of gender norms. The more people disagree, or strongly disagree with the statement (i.e., there is less of a male preference), the higher the norms score. WVS question 1: When jobs are scarce, jobs are more important for men than women Survey respondents were asked whether they agree or disagree with the statement ‘when jobs are scarce, jobs are more important for men than women.’ In Figure 19.15, the average score for this gender norms question is depicted for each of our economic freedom quartiles. In the freest countries, the average score for this question is 0.63, while it is only 0.35 in the least free economies. This indicates that in economically free societies social norms are less likely to prioritize men over women when it comes to jobs.7 WVS question 2: Men make better political leaders than women Figure 19.16 depicts the average score countries received when survey respondents were asked whether they agree or disagree with the statement ‘men make better political leaders than women.’ In the most free countries, the average score for this question is 0.60, while it is 7 The version of the EFW index used in Figures 19.15–19.17 is also not adjusted for gender disparity.
Economic freedom and gender 291 only 0.41 in the least free economies. This suggests that in economically free societies, social attitudes are more open to women being political leaders than they are in unfree societies.
Figure 19.15 When jobs are scarce, jobs are more important for men than women
Figure 19.16 Men make better political leaders than women
WVS question 3: University is more important for men than it is for women Finally, respondents were asked whether they agree or disagree with the statement ‘university is more important for men than it is for women.’ The average score for each economic freedom
292 Handbook of research on economic freedom quartile is depicted in Figure 19.17. In the freest economies, the average score for this question is 0.73 while it is only 0.60 in the least free. This means that people in economically unfree societies are more inclined to believe that investments in higher education are more important for their sons than their daughters.
Figure 19.17 University is more important for men than it is for women The empirical evidence on gender norms Taking these results together, we have some additional support for the doux commerce thesis. That is, people living in economically free countries are less likely to think men ought to take priority over women in employment, leadership, and education opportunities. It also seems to be the case that people, in general, are more accepting of women going to university than they are of women being political leaders. This seems inconsistent with the view that markets harm women, and institutional arrangements that embrace economic freedom also reinforce traditional, patriarchal gender norms. Unfortunately, there are no existing empirical studies specifically examining the relationship between economic freedom and gender norms. However, Heyat’s (2006) work shows that globalization helped alter gender norms in Azerbaijan, making people more accepting of women working in public-facing jobs, wearing trousers, smoking in public, and patronizing restaurants, bars, and nightclubs. Potrafke and Ursprung’s (2012) cross-country analysis demonstrates that globalization alters social institutions in a way that reduces female subjugation. Further, Lemke’s (2016) work on the role that interjurisdictional competition had on women gaining property rights in the United States shows that pressure from firms wishing to hire women in textile factories played a major role in women acquiring property rights in the northeastern part of the country. Further, employers invested significant time and energy
Economic freedom and gender 293 in helping reduce the social stigma associated with women working outside their homes.8 Similarly, the data presented here suggest that higher levels of economic freedom are associated with greater tolerance of women taking on roles that challenge traditional gender norms.
CONCLUDING THOUGHTS This chapter explores both the theoretical arguments and empirical evidence regarding the impact that economic freedom has on women’s lives. The available empirical evidence largely suggests that women fare better in absolute terms under a system of economic freedom than they do under more centrally planned economic systems. In many instances, the data presented here also show that gender gaps in performance narrow as economic freedom increases. Women living in more economically free societies have better labor market outcomes than their counterparts living in unfree places. They have higher rates of labor market participation, they are more likely to have a formal wage or salary contract, they have a more advanced skill set, and they are more likely to have access to their own account at a financial institution. In economically free societies, women and their children are healthier than those living in economically unfree countries. They live longer and are less likely to be undernourished. Child mortality rates are lower, and women are much less likely to die due to maternal causes. In addition, adolescent fertility rates are much lower in free societies. Women living in economically free societies also have higher rates of educational attainment at every single level of schooling than women living in economically unfree societies. They are more likely to enroll in primary schooling, complete lower-secondary schooling, and obtain post-secondary training. Finally, economic freedom also seems to be associated with gender norms that are more tolerant of women taking on less traditional roles in society. That is, societies that are economically free are less likely to have a demonstrated preference that males should take precedence over females when it comes to employment, education, and political leadership opportunities. The policy implications of the information presented here are potentially significant. Proponents of gender equity push for policies that restrict economic freedom such as gender quotas for corporate boards, mandatory paid maternity leave, and other state-led efforts. If economic freedom provides meaningful benefits for women’s wellbeing, then we may want to proceed with caution and rethink strategies that restrict economic rights in the name of pursuing gender equality. Going forward, researchers should take steps to address causality concerns regarding the relationships described in this chapter and to explore the mechanisms through which economic freedom improves women’s lives. Additionally, quantitative empirical exercises alone are insufficient to truly understand the ways in which economic freedom alters (or fails to alter) women’s choices in meaningful ways. There is much room for field work to be conducted, especially in regions of the world that are experiencing significant changes in the economic rights of women, such as Saudi Arabia and the United Arab Emirates, both of which have taken steps to increase women’s economic rights since 2018 (Fike 2023). While this chapter Additionally, the studies referenced in the doux commerce section above suggests that greater economic freedom generates more tolerant attitudes toward others and acceptance of those who are different from oneself. 8
294 Handbook of research on economic freedom demonstrates that markets improve women’s lives in absolute terms, the relative performance of men and women is of particular interest to many people. The relationship between economic freedom and gender gaps in performance should also be investigated further. Lastly, research presented in this chapter provides some reason to be optimistic about the effect that economic freedom might have on other marginalized groups. As new data become available, scholars ought to extend the work done in the area of economic freedom and women’s wellbeing to examine the impact of economic freedom on the rights and wellbeing of racial and ethnic minority groups, religious minorities, the gay and transgender communities, and more.
REFERENCES Alesina, A., Giuliano, P. and Nunn, N. (2013). On the origins of gender roles: Women and the plough. Quarterly Journal of Economics 128(2): 469–530. Becker, G.S. (1957). The Economics of Discrimination. Chicago: University of Chicago Press. Becker, G.S. (1974). A theory of social interactions. Journal of Political Economy 82(6): 1063–1093. Beckert, S. (2014). Empire of Cotton: A Global History. New York: Alfred A. Knopf. Berggren, N. and Nilsson, T. (2013). Does economic freedom foster tolerance? Kyklos 66(2): 177–207. Berggren, N. and Nilsson, T. (2021). Economic freedom and antisemitism. Journal of Institutional Economics 17(2): 289–304. Bergmann, B.R. (1974). Occupational segregation, wages and profits when employers discriminate by race or sex. Eastern Economic Journal 1(2): 103–110. Berik G., Rodgers Y. and Zveglich J. (2004). International trade and gender wage discrimination: Evidence from East Asia. Review of Development Economics 8(2): 237–254. Burns, J. (2015). The three ‘furies’ of libertarianism: Rose Wilder Lane, Isabel Paterson, and Ayn Rand. Journal of American History 102(3): 746–774. Cuberes, D. and Teignier, M. (2016). Aggregate effects of gender gaps in the labor market: A quantitative estimate. Journal of Human Capital 10(1): 1–32. Cudd, A. and Holmstrom, N. (2011). Capitalism, For and Against: A Feminist Debate. Cambridge: Cambridge University Press. Doepke, M. and Tertilt, M. (2009). Women’s liberation: What’s in it for men? Quarterly Journal of Economics 124(4): 1541–1591. Dreze, J. and Murthi, M. (2001). Fertility, education, and development. Evidence from India. Population and Development Review 27(1): 33–63. England, P. (1992). Comparable Worth: Theories and Evidence. London: Routledge Esposto, A.G. and Zaleski, P.A. (1999). Economic freedom and the quality of life: An empirical analysis. Constitutional Political Economy 10(2): 185–197. Feldmann, H. (2007). Economic freedom and unemployment around the world. Southern Economic Journal 74(1): 158–176. Feldmann, H. (2017). Economic freedom and human capital investment. Journal of Institutional Economics 13(2): 421–445. Fernández, R. (2014). Women’s rights and development. Journal of Economic Growth 19(1): 37–80. Fike, R. (2016). Gender disparity in legal rights and its effect on economic freedom. In: Economic Freedom of the World: 2016 Annual Report (eds. J.D. Gwartney, R.A. Lawson and J.C. Hall), 189–211. Vancouver: Fraser Institute. Fike, R. (2017). Women and Progress 2017 Report: The Impact of Economic Freedom and Women’s Well-being. Vancouver: Fraser Institute. Fike, R. (2019). Women and Progress 2019 Report: Gender Disparity under the Law and Women’s Well-Being. Vancouver: Fraser Institute. Fike, R. (2020). Women and Progress 2020 Report: Women’s Economic Rights: What’s Changed and Why Does It Matter? Vancouver: Fraser Institute.
Economic freedom and gender 295 Fike, R. (2023). Women and Progress 2023 Report: Moving Closer to Gender Equality? Vancouver: Fraser Institute. Folbre, N. (1994). Who Pays for the Kids? Gender and the Structures of Constraint. London: Routledge. Folbre, N. (2001). The Invisible Heart: Economics and Family Values. New York: The New Press. Folbre, N. (2006). Measuring care: Gender, empowerment, and the care economy. Journal of Human Development 7(2): 183–199. Gaddis, I. and Pieters, J. (2017). The gendered labor market impacts of trade liberalization. Journal of Human Resources 52(2): 457–490. Gaddis, I., Lahoti, R. and Swaminathan, H. (2022). Women’s legal rights and gender gaps in property ownership in developing countries. Population and Development Review 48(2): 331–377. Geddes, R., Lueck, D. and Tennyson, S. (2012). Human capital accumulation and the expansion of women’s economic rights. Journal of Law and Economics 55(4): 839–867. Gehring, K. (2013). Who benefits from economic freedom? Unravelling the effect of economic freedom on subjective well-being. World Development 50(October): 74–90. Gwartney, J.D., Lawson, R.A. Hall, J.C. and Murphy, R.H. (2022). Economic Freedom of the World: 2022 Annual Report. Vancouver: Fraser Institute. Hall, J.C., Ross, A. and Bologna Pavlik, J. (2020). Laissez-faire economic policy in a world where gender income gaps exist: Helping or hurting? Journal of Economics, Race, and Policy 3(2): 144–158. Harris, C., Myers, A. and Kaiser, A. (2023). The humanizing effect of market interaction. Journal of Economic Behavior & Organization 205(January): 489–507. Heath, R. and Jayachandran, S. (2018). The causes and consequences of increased female education and labor force participation in developing countries. In: The Oxford Handbook of Women and the Economy (eds. S.L. Averett, L.M. Argys and S.D. Hoffman), 345–368. Oxford: Oxford University Press. Hazan, M., Weiss, D. and Zoabi, H. (2019). Women’s liberation as a financial innovation. Journal of Finance 74(6): 2915–2956. Hazarika, G. and Otero, R. (2004). Foreign trade and the gender earnings differential in urban Mexico. Journal of Economic Integration 19(2): 353–373. Heyat, F. (2006). Globalization and changing gender norms in Azerbaijan. International Feminist Journal of Politics 8(3): 394–412. Hume, D. (2007 [1739]). A Treatise of Human Nature. Oxford: Clarendon Press. Hyland, M., Djankov, S. and Goldberg, P.K. (2020). Gendered laws and women in the workforce. American Economic Review: Insights 2(4): 475–490. Inglehart, R., Haerpfer, C., Moreno, A., Welzel, C., Kizilova, K., Diez-Medrano J., Lagos, M., Norris, P., Ponarin, E. and Puranen, B. (2020). World Values Survey. All rounds – country-pooled datafile. Madrid and Vienna: JD Systems Institute & WVSA Secretariat. Islam, A., Muzi, S. and Amin, M. (2019). Unequal laws and the disempowerment of women in the labor market: Evidence from firm-level data. Journal of Development Studies 55(5): 822–844. Kouton, J., Betila, R.R. and Lawin, M. (2021). The impact of ICT development on health outcomes in Africa: Does economic freedom matter? Journal of the Knowledge Economy 12(4): 1830–1869. Lawson, R.A., Murphy, R.H. and Williamson, C.R. (2016). The relationship between income, economic freedom, and BMI. Public Health 134(May): 18–25. Lemke, J. (2016). Interjurisdictional competition and the married women’s property acts. Public Choice 166(3): 291–313. Marx, K. (1993 [1867]). Capital: A Critique of Political Economy. London: Penguin. McCloskey, D.N. (2006). The Bourgeoisie Virtues: Ethics for an Age of Commerce. Chicago: University of Chicago Press. Meyer, L.B. (2006). Trade liberalization and women’s integration into national labor markets: A cross-country analysis. Social Indicators Research 75(1): 83–121. Mill, J.S. (2018 [1869]). The subjection of women. In: J.S. Mill ‘On Liberty’ and Other Writings (ed. S. Collini), 117–217. Cambridge: Cambridge University Press. Montesquieu, C.-L. de Secondat (1977 [1748]). The Spirit of the Laws. Berkeley, CA: University of California Press. Mukhopadhyay, U. (2015). Trade liberalization and gender inequality in the labor market: A theoretical approach. Urban and Regional Development Studies 27(1): 68–87.
296 Handbook of research on economic freedom Murthi, M., Guio, A.C. and Dreze, J. (1995). Mortality, fertility, and gender bias in India: A district level analysis. Population and Development Review 21(4): 745–782. Naanwaab, C. (2018). Does economic freedom promote human development? New evidence from a cross-national study. Journal of Developing Areas 52(3): 183–198. Nikolaev, B. (2014). Economic freedom and quality of life: Evidence from the OECD’s Your Better Life Index. Journal of Private Enterprise 29(3): 61–96. Nussbaum, M.C. (1999). Sex and Social Justice. Oxford: Oxford University Press. Nussbaum, M.C. (2000). Women and Human Development: The Capabilities Approach. Cambridge: Cambridge University Press. Nussbaum, M.C. (2011). Creating Capabilities: The Human Development Approach. Cambridge, MA: Harvard University Press. Oostendorp, R.H. (2009). Globalization and the gender wage gap. World Bank Economic Review 23(1): 141–161. Potrafke, N. and Ursprung, H.W. (2012). Globalization and gender equality in the course of development. European Journal of Political Economy 28(4): 399–413. Puaschunder, J.M. (2018). Capitalism crowding out fertility. Proceedings of the 10th International RAIS Conference on Social Sciences and Humanities/Advances in Social Science, Education and Humanities Research 211: 138–141. Sauré, P. and Zoabi, H. (2014). International trade, the gender wage gap and female labor force participation. Journal of Development Economics 111(November): 17–33. Say, J.-B. (2001 [1803]). A Treatise on Political Economy. London: Routledge. Sen, A. (1999). Development as Freedom. Oxford: Oxford University Press. Sen, A. (2003). Development as capability expansion. In: Readings in Human Development: Concepts, Measures and Policies for a Development Paradigm (eds. S. Fukuda-Parr and A.K. Shiva Kumar), 3–16. Oxford: Oxford University Press. Smith, A. (1981 [1776]). An Inquiry into the Nature and Causes of the Wealth of Nations. Indianapolis, IN: Liberty Fund. Sharma, A. (2020). Does economic freedom improve health outcomes in Sub–Saharan Africa? International Journal of Social Economics 47(2): 1633–1649. Storr, V.H. and Choi, G.S. (2019). Do Markets Corrupt Our Morals? Cham: Palgrave Macmillan. Stroup, M.D. (2008). Separating the influence of capitalism and democracy on women’s well-being. Journal of Economic Behavior & Organization 67(3–4): 560–572. Stroup, M.D. (2011). Does economic freedom promote women’s well-being? In: Economic Freedom of the 2011 Annual Report (eds. J.D. Gwartney, R.A. Lawson and J.C. Hall), 179–190. Vancouver: Fraser Institute. Teague, M., Storr, V.H. and Fike, R. (2020). Economic freedom and materialism: An empirical analysis. Constitutional Political Economy 31(1): 1–44. Vásquez, I., McMahon, F., Murphy, R.H. and Schneider, G.S. (2022). The Human Freedom Index 2022: A Global Measurement of Personal, Civil, and Economic Freedom. Washington, DC: Cato Institute. Voltaire (2009 [1733]). Letters Concerning the English Nation. Oxford: Oxford University Press. Williams, E. (1944). Capitalism and Slavery. Chapel Hill, NC: University of North Carolina Press. Wollstonecraft, M. (1792). A Vindication of the Rights of Woman. London: J. Johnson. World Bank (2022a). Women, Business and the Law: Time Series. Washington, DC: World Bank. World Bank (2022b). World Development Indicators: Annual Report. Washington, DC: World Bank. World Bank and World Trade Organization (2020). Women and Trade: The Role of Trade in Promoting Gender Equality. Washington, DC: World Bank. Yahmed, S. B. (2012). Gender wage gaps across skills and trade openness. Working Paper No. 32, Aix-Marseille School of Economics. Zelizer, V. (2005). The Purchase of Intimacy. Princeton, NJ: Princeton University Press. Zweimuller, M., Winter-Ebmer, R. and Weichselboume, D. (2008). Market orientation and gender wage gaps: An international survey. Kyklos 61(4): 615–635.
20. Economic freedom and populism Andreas Bergh and Anders Kärnä
INTRODUCTION Economic freedom is a characteristic of a political entity and its institutions and policies. Typically, the political entity is a country, though measures of economic freedom at local and regional levels also exist. Consequently, the relationship between economic freedom and populism can be thought of as a relationship between country level characteristics (economic freedom) and an individual characteristic (populist attitudes), or as a relationship between two country level characteristics (economic freedom and the populist vote share). Much has been written about populism, particularly in recent years, as populist parties and candidates have gained popularity in several countries (see, for example, Levitsky and Ziblatt 2018; Norris and Inglehart 2019; Applebaum 2021). The literature on economic freedom and populism is, however, small. In fact, a Web of Science search in peer-reviewed journals for papers that include both ‘economic freedom’ and ‘populism’ in the title results in no hits. The approach taken in this chapter is therefore to structure the discussion around populism and the five areas of economic freedom included in the Economic Freedom of the World index (henceforth the EFW index) produced by the Fraser Institute (discussed in detail in Gwartney and Lawson (2024) and Murphy (2024a, b) in this Handbook). We complement this approach using the survey by Guriev and Papaioannou (2022), who synthesize the literature on the recent rise of populism. In doing so, they discuss some aspects that are related to economic freedom, namely the role of cross-border trade and austerity measures after the 2008–2009 global financial crisis. We also provide a basic empirical analysis of how right-wing and left-wing populism (as defined by Heinö 2016) correlate with the various dimensions of economic freedom. The rise of populism around the world has been swift and synchronized. It is easy to point to examples of what most would agree are examples of populist success around the world. In 2010, we saw the rise of the Tea Party movement in the United States, Viktor Orbán took power in Hungary, and the right-wing populist Sweden Democrats entered parliament in Sweden, a country that had long seemed spared populist electoral success. In July 2011, the Phak Phuea Thai (PPT, ‘For Thais Party’) won a landslide victory in Thailand. In 2014, populists did well in the European Parliament elections. In 2015, the Polish Law and Justice Party came to power. Populism may possibly have peaked in 2016 with Brexit and the election of Donald Trump in the United States, but it did not end there. In 2017, Front National leader Le Pen advanced to the second round of the French presidential election, and the far-right Alternative for Germany (AfD) party won seats in the German parliament for the first time. In 2018, the so-called yellow vests movement in France began weekly protests against the high cost of living, economic inequality and taxes on the working class and the middle class. The list is far from complete. But what exactly do these diverse parties and movements have in common? 297
298 Handbook of research on economic freedom As noted by Rode and Revuelta (2015), the populist label has been applied to a broad spectrum of political actors including Mahmoud Ahmadinejad, former president of Iran, Silvio Berlusconi, former prime minister of Italy, Hugo Chávez, late president of Venezuela, and George W. Bush, former president of the United States. To this list we can now add another former president of the United States, Donald Trump. It seems safe to say that the term ‘populist’ is used broadly, loosely, and pejoratively. Can populism be given a precise definition? The early academic literature failed to do so, partly because some early studies focused on differences between parties and movements that all resided under the populist label, rather than describing what (if anything) they had in common (cf. Canovan 1981). Discussing if Hugo Chávez should be considered to be populist, Hawkins (2009) identified four different approaches to defining populism: the structural view (which focuses on the social origins of regimes); the economic view (sometimes labelled economic populism) based on shortsighted policies that neglect concerns about inflation and deficits; the political-institutional view (which focuses on the presence of a charismatic leader that often creates hostility towards a group of outsiders); and finally the discursive view (which identifies populism as set of ideas, where the good is represented by the will of the people who struggle against the conspiring elites, who have managed to subvert the will of the people). A longstanding debate in populism research concerns whether populists are left-wing, right-wing, neither or both. According to Weyland (2001), the appearance of right-wing populism has seriously challenged structural and economic definitions, because these definitions take socioeconomic traits to be an integral part of the concept, thereby excluding other forms of poli