Commentary

The Keys to Economic Freedom and Prosperity

Modern economic growth is mainly about brain power and sound policy. Investment capital and entrepreneurial talent will flow toward economies with low taxes, secure property rights, sound money and sensible regulatory policies. In contrast, when these factors are absent, people will find more attractive environments elsewhere.

Nations prosper when they provide a climate that encourages their citizens, often in cooperation with foreigners, to discover and adopt better ways of doing things.

The recently released “2001 Economic Freedom of the World” annual report, published by a worldwide network of more than 50 institutes, examines the degree to which a country’s institutions and policies adhere to principles of economic freedom. The report uses data on the size of government, price stability, trade openness, the quality of legal structures, and other variables to develop a summary index of economic freedom. The index measures the ability of citizens in 123 countries to choose for themselves, engage in market activities, and keep what they earn.

This year’s report also grades 58 countries on a more comprehensive index that captures the effect of regulation and more accurately pinpoints the strengths and weaknesses of each country. As was the case for the regular index, Hong Kong and Singapore ranked first and second respectively. The two city-state economies were followed by the United States, New Zealand, United Kingdom, Ireland, Canada and Switzerland. Chile (tied with Germany for 16th) was the highest ranked Latin American economy. The rankings of other large economies included France (36th), India (46th), China (52nd) and Brazil (55th).

Western European countries generally ranked high in all areas except size of government and labor market regulation. Of the 58 countries graded, only two Western European countries (Ireland and Iceland) scored in the top 20 for size of government. Belgium, France, Austria, Sweden, Norway, Denmark, Italy and Spain all received low ratings in this area.

The situation was much the same for labor market regulation. France and Germany were the two lowest rated countries. All of the 10 countries with the most restrictive labor regulations were Western European. The United Kingdom, Switzerland, Iceland and Ireland were the only Western European countries ranking in the upper half of the 58 in this area.

A legal system that protects property rights and enforces contracts in an even-handed way is central to economic freedom and progress. So too is the freedom to compete in business. Almost all of the countries with the weakest legal systems and most highly regulated business sectors were either Latin American or former socialist countries. The 10 lowest rated countries in the legal area were Peru, Indonesia, Ecuador, Venezuela, Ukraine, Russia, Bolivia, Mexico, Colombia and El Salvador. The 10 with the most restrictive business regulations were Russia, Venezuela, Ukraine, Mexico, El Salvador, Bulgaria, Bolivia, Indonesia, Argentina and Colombia.

The point should not be missed: Inadequate legal systems and restrictive regulations are stifling economic progress throughout much of Latin America and among the former socialist countries.

With regard to strengths and weaknesses, Mexico stands out. The good news is that during the last two decades, Mexico moved from one of the least to one of the most open economies in the world. In the trade openness area, Mexico ranks 17th , just below the U.K. and above France and the United States. Today, international trade is 64 percent of the Mexican economy, up from 23 percent in 1985. The bad news is that Mexico still has a long way to go before it qualifies as a liberal economy. Its area rankings for quality of legal system (52nd), access to sound money (49th), banking and finance (46th), and regulation of business (53rd) were all poor.

Prosperity depends on getting the institutional and policy environment right. Nations that adopt policies inconsistent with economic freedom will stifle innovation and drive potential investors to more favorable environments. Their economies will stagnate and their citizens will continue in poverty.

James Gwartney and Robert Lawson are co-authors of “Economic Freedom of the World,” an annual report published by the Cato Institute in the United States, Fraser Institute in Canada and a worldwide network of 50 other institutes.