Commentary

There’s Power In Economic Liberty

By James D. Gwartney and Robert A. Lawson
This article appeared in Investor’s Business Daily, September 9. 2005.

The latest Economic Freedom of the World report, released today, confirms yet again what happens when the state moves aside and allows the private sector to perform. Consider the successes in Ireland, Iceland and New Zealand, which have undergone dramatic changes in freeing their economies since the 1980s. Published by a network of private “think tanks” in more than 60 countries, the report uses 38 different components to rate the institutions and policies of 127 countries on a 10-point scale.

Essentially, the ratings reflect the degree to which countries rely on voluntary exchange and markets rather than taxes, government spending and regulations to allocate goods and resources.

As the rankings above indicate, Hong Kong is still the world’s freest economy. Singapore ranks second, while New Zealand, Switzerland and the U.S. are tied for third.

The United Kingdom, Canada, and Ireland occupy the next three spots.

The rankings of the world’s largest economies include Germany 19th, Japan 30th, France 38th, Italy 54th, Mexico 59th, India 66th, China 86th and Russia 115th.

The world is substantially different than it was a quarter of a century ago when Margaret Thatcher and Ronald Reagan were first elected as heads of their respective governments.

Compared to 1980, marginal tax rates are lower, international trade is freer and monetary policy is more stable. This shows up in the economic freedom measure. Of the 102 countries with ratings in both 1980 and 2003, only for recorded less economic freedom in 2003 than in 1980.

Does economic freedom make a difference? A substantial body of scholarly research indicates that it does. Countries that are economically free tend to grow more rapidly and achieve higher levels of income than those that are less free.

Benefits Accrue

The experiences of Ireland, New Zealand and Iceland illustrate the importance of economic freedom.

In the mid-1980s all these countries were characterized by large and growing governments, high taxes and substantial restraints on international trade.

In 1985, Ireland’s economic freedom rating was 6.2, New Zealand’s was 5.9 and the rating for Iceland was 4.9.

Between 1985 and 1995, however, each of these countries moved substantially toward economic freedom and their ratings increased accordingly.

Today, each of the three ranks among the world’s freest economic. And they have reaped substantial benefits.

During the last dozen years, the growth rate of per capita GDP of each of these countries has been more than double the rate of the 1980s. In recent years, the unemployment rates of Ireland and New Zealand have been about 5%, less than half the rate of most European countries.

And Iceland’s unemployment rate is even lower, a minuscule 2.6%.

Estonia also vividly illustrates the power and potency of economic freedom. In this year’s index, it ranks 9th (ties with Australia, Luxembourg, and the United Arab Emirates).

Thus, it is the freest of the former Soviet bloc countries.

A decade ago, inflation in Estonia was over 1,000%, the economy was declining, unemployment was over 30% and 95% of the enterprises were owned by the government.

But Estonia moved quickly. Government enterprises were privatized, a flat rate tax was adopted, government spending was sliced and trade barriers were eliminated. In the short space of eight years, Estonia’s economic freedom rating rose from 5.3 to 7.8 on the 10-point EFW scale.

Learn The Lesson

Today, inflation is 2.5%, Estonia’s economy is growing at an annual rate in excess of 6% and unemployment is low.

Modern economic growth is primarily about investment, innovation and discovering better ways of doing things. Without economic freedom, the growth process is stifled.

This is a lesson that all countries, both the rich and poor, need to take seriously and act accordingly.

Gwartney is Gus A. Stavros professor of economics at Florida State University.
Lawson is professor of economics and George H. Moor chairman at Capital University. They are the co-authors of Economic Freedom of the World Annual Report, published in the U.S. by the Cato Institute.