It is a relatively uncontroversial result, confirmed by a number of econometric studies, that economic freedom has a positive effect on incomes (GDP per capita). An econometric study to appear in the European Journal of Political Economy, “Revisiting the Relationship Between Economic Freedom and Development to Account for Statistical Deception by Autocratic Regimes,” argues that the relationship is biased downward by dictatorial regimes because their GDP figures are overestimated. Such regimes restrict economic freedom and have an interest in hiding the consequences from their subjects. Moreover, the constraints a dictatorial regime faces are much reduced by the absence of a free press and of periodical elections that could remove him.
The authors of the paper are Vincent Geloso, an assistant professor of economics at George Mason University, and two Ph.D. candidates at Middle Tennessee State University, Sean Alvarez and Macy Scheck. Vincent Geloso is a young professor and mounting star who has published economic studies of great interest in many areas. [Editor’s note: You may wish to read Geloso’s lead essay in this Liberty Matters Forum, Did the American Colonies Pay Too High a Cost for Revolution?]
The authors measure economic freedom mainly with the Fraser Institute’s Economic Freedom of the World index. As for estimating the gap between officially reported GDP figures and the true ones, they adjust the former by using the nighttime light intensity observed by satellites (following the research of economist Luis Martinez). The idea is straightforward: there should be a correlation between a country’s average wealth (proxied by GDP per capita) and its night lighting; the poorer a country, the darker you expect it to be at night. Pictures of the extreme cases of North Korea and South Korea are one case in point. Geloso et al. use data of more than 110 countries over two decades. By comparing the coefficients representing the impact of economic freedom on GDP and growth in the equations using both reported GDP and adjusted GDP, they obtain an estimate of how the lies of dictatorial regimes falsely boost reported prosperity. Quoting from the conclusion of the accepted version of their article:
For income levels between 1992 and 2013, we find that the true effect of economic freedom is between 1.1 and 1.62 times larger than estimations based on manipulated GDP numbers. … we do find signs that the association between income growth and changes in economic freedom is being modestly understated.
Our results are consistent with findings that dictatorships are generally unable to sustain high levels of economic development and that they are not noticeably better at securing faster economic growth.
These very plausible results, I suggest, raise two related questions. First, falsifying GDP figures while keeping them minimally credible is not as easy as it seems. When the figures are provided to international organizations such as the World Bank, the false numbers need to be consistent and appear to respect the demanding and internationally recognized methodology of national accounting. Second, why doesn’t the World Bank audit national accounts data more carefully? I suspect the answer is that, like the International Monetary Fund and other intergovernmental organizations, the World Bank is dependent on its member governments and the latter’s politicians. In other words, I hypothesize that intergovernmental organizations are too political and their bureaucracies of economists not independent enough.
READER COMMENTS
Kevin
Jun 25 2024 at 5:14pm
I completely agree that economic freedom is a crucial factor for economic growth and the wealth of a nation’s citizens.
If one compares indices of economic freedom with per capita GDP in terms of purchasing power parity, the trend seems clear.
My question is this: why does the correlation between economic freedom and per capita GDP p.p.p. within each U.S. state, not correlate as strongly as it seems to among the relative wealth of nations?
Craig
Jun 25 2024 at 7:10pm
I’d suggest that the laws of economics are not quite the laws of physics. If you were to suggest to me that FL is more free than NY, I would agree with you, but the stats are clear that NY’s per capita gross state product is obviously much higher. I would suggest that other factors matter as well and ultimately NY would be wealthier still if it were freer and FL would be that much poorer if it emulated NY.
Kevin
Jun 25 2024 at 7:16pm
I agree. I was just curious as to whether or not anyone had any specific reasons for why that might be.
Pierre Lemieux
Jun 26 2024 at 11:45am
Kevin: One factor not to forget is that free trade within the United States. Also remember that state GDP is, like GDP in general, a “resident,” not “national,” concept (https://www.bea.gov/sites/default/files/methodologies/0417_GDP_by_State_Methodology.pdf). A company fiscally resident in California has all its profits (plus its labor costs, considered as labor’s production) counted in California’s GDP, even if most of its business (sales and purchases) is done in other states where it may freely sell and from which it may freely purchase.
steve
Jun 26 2024 at 3:13pm
I think there are credible examples where nations have experienced a lot of growth while remaining pretty authoritarian by eliminating/decreasing corruption and crime, especially if we are talking about catch up growth. Also, for whatever reason our best universities are in areas that some would not consider as having the freest markets. It gives those areas a resource advantage.
Steve
Kevin
Jun 27 2024 at 2:43pm
Thanks for the great explanation. I really appreciate it!
Robert EV
Jun 28 2024 at 1:10pm
A general Economic Freedom score from the Cato Institute puts FL above NY, but it might be worth looking into the individual sub-scores. They can’t all have equal weight when it comes to GDP.
Looking at the scores I’m guessing would be most pertinent to an employee or employee-owner:
In terms of Occupational Freedom, NY is ranked much freer than FL: http://www.freedominthe50states.org/occupational
Health Insurance they are tied: http://www.freedominthe50states.org/health-insurance
Labor market FL is much freer than NY: https://www.freedominthe50states.org/labor
Matthias
Jun 25 2024 at 8:18pm
The correlation between dictatorship and poverty is easy enough to see.
Establishing causation is a bit harder: how do we exclude that freedom isn’t just one of those normal goods people buy more of as they get richer? Or how do we exclude that it’s just a third factor causing both?
Jon Murphy
Jun 25 2024 at 9:11pm
That’s a good question. Causality is always difficult to tease out, but I think there are factors that help us:
-When we see countries that were relatively liberal (or liberalizing) who fall into dictatorship and regress in terms of economic growth, such as Argentina in the 1900s and China now, it provides evidence of causality.
-When we see countries with very similar starting points but vastly different results, such as East and West Germany and North and South Korea, it helps us tease out causality
-When we see countries who undergo rapid liberalization achieve strong economic growth after, such as Sweden, Poland (really vast swaths of former Soviet states), it provides strong evidence of causality.
-When we see efforts of deliberate planning aimed at ending poverty, like foreign aid, fail, while liberalization succeeds, I think that is strong evidence of causality.
Could there be a third factor? Yes. Indeed, there likely is: liberalization without institutional reform and buy-in does not work. There needs to be the “bourgeois virtues” as well. And we certainly have much more to learn.
Craig
Jun 26 2024 at 3:24pm
“When we see countries with very similar starting points but vastly different results, such as East and West Germany and North and South Korea, it helps us tease out causality”
These two are the quintessential examples, I think. The other one I like is the difference between the agricultural production in the former Soviet Union on the private plots of land versus the collectivist farms.
Pierre Lemieux
Jun 26 2024 at 11:53am
Matthias: Alvarez, Geloso, and Scheck recognize that they have only established causation but note that their results complement other econometric studies that find causation. (There are econometric techniques that can rule out mere correlation.)
Peter
Jun 25 2024 at 10:11pm
I might argue that economic freedom is a first world luxury, i.e. “all things equal” but they aren’t.
I’d make the counterpoint was “authoritarian” Russia under Putin 2005 economical better that free market liberty loving Russia 1995? Would anyone argue with a straight face a Somalia dictator would could get control of the country would economically be better than the existing failed state? And I’d argue you are going to need a dictatorship to get out of that mess, how’s democracy and an internal western liberal revolution working out for them? Saudi does pretty good for an absolute monarchy as does Brunei. You quote South Korea but forget for most of S. Korea’s economic miracle it was a military dictatorship. Singapore did pretty good as a dictatorship and most would argue authoritarian America has did better than a more economically liberal past America.
I.e. sure if you took France and installed Kim Jung Il it might do worse economically that it is now but I don’t know if Somalia would.
Jon Murphy
Jun 26 2024 at 8:47am
I’m not sure your examples really support the argument you’re trying to make. Russia and Somalia are more cases of moving from one form of lawlessness to another.
(Your third example, of South Korea, is incorrect. The revival of South Korea didn’t really take off until the end of the military dictatorship and the move toward liberalization)
Monte
Jun 26 2024 at 12:08am
The evidence is clear. Dictatorships often sacrifice current generations in the hope of generating future economic prosperity. The problem is that this continually leads to even more sacrifices.
Some key findings of the 2024 Index of Economic Freedom:
The standard of living, measured by incomes per capita, is much higher in economically freer countries. Countries rated “free,” “mostly free,” or “moderately free” in the 2024 Index generate incomes that are more than double the average levels in other countries and more than three times higher than the incomes of people living in economically “repressed” countries.
As documented once again in the 2024 Index, economic freedom also correlates significantly with overall well-being, which includes such factors as health, education, the environment, innovation, societal progress, and democratic governance
Especially notable is the continuing decline within the “mostly free” category of the United States, whose score plummeted to 70.1, its lowest level ever in the 30-year history of the Index. The U.S. is now the world’s 25th freest economy. The major causative factor in the erosion of America’s economic freedom is excessive government spending, which has resulted in mounting deficit and debt burdens.
Richard W Fulmer
Jun 26 2024 at 2:16pm
GDP figures from countries with command economies are problematic not just because of lying. Some of what is produced at the whim of those in power is useless. The USSR, for example, failed to produce spare parts for farm tractors. As a result, many tractors ended up being canibalized for their parts.
Mactoul
Jun 26 2024 at 10:48pm
Are these correlation weighed by the country population?
A China or an India is 100x a mid-sized European country and not weighing in this factor would distort the correlation significantly.
The past 30 years economic growth in China, and to a lesser extent in India and other developing countries, should have also put paid to any simplistic association between economic growth and freedom indices
But enough plausible arguments were found to hand-wave away any objections to the dogma that economic freedom alone is the determinant of prosperity.
Pierre Lemieux
Jun 29 2024 at 4:49pm
Mactoul: I can’t see how your weighing proposal makes sense. If we wanted to verify if countries where people eat more fat record more heart-disease deaths, it would make no sense to “weigh” the results by the size of the population (or the size of the mountains). Geloso et al. do include the level of urbanization among their control variables. (Perhaps urbanization is what you were wondering about.) Moreover, their specifications for the level of GDP per capita do include dummy-variables for “time-invariant unobserved heterogeneity at the country level that may have affected GDP per capita.” Although econometrics is not my strong point, this seems to make sense.
Monte
Jun 27 2024 at 12:18pm
It would be imprudent to argue that economic freedom alone is the sole determinant of prosperity. However, it is instrumental for promoting it. But economic freedom must be accompanied by institutional integrity (rule of law, property rights, fair trade, etc.). And there are examples of authoritarian regimes that have experienced significant near and intermediate-term economic growth. However, history demonstrates that dictatorships are more prone to economic stagnation in the long term.
Jim Glass
Jun 28 2024 at 3:26am
It’s best not to confuse economic freedom and political freedom, i.e. voting democracy. E.g., Singapore is world #1 in economic freedom as per Heritage’s 2024 Index of Economic Freedom. But it is a one-party state, ranked 122 of 198 and rated only “partly free” in Freedom House’s World Index of Political Freedom.
As to economic freedom, Nobelist Douglass North quantified the huge increase seen in the number of ‘organizations free of the control of the central government’ in economies that achieve advanced first-world status. These may be local governments, businesses, unions, banks, non-profits, churches, schools and universities, social clubs, retirement funds, homeowners associations, whatever. In 2000, nations with over $20,000 per capita income ($37,000 today) had 83% of the world’s total of such organizations against 17% of world population … those with income from $5,000 to $20,000 had 10% versus 24% of population … those with income under $5,000 had 7% versus 59% of population. [See Violence and Social Orders.]
As to political freedom in the form of voting democracy, things are not at all so clear. Voters are always massively “rationally ignorant” of economics and align up on many causes that run counter to sound economics even in first-world liberal democracies (price and rent controls, NIMBYism, protectionism, etc., etc.) In lesser developed countries voting democracy can be overwhelmed by corruption, nepotism, racism, regionalism, nationalism, social grievances, and all kinds of tribalism figurative and literal — putting economic development into reverse. Fairly counted election results produced Mussolini, Adolph, Putin, Mugabe, and many more. (“New authoritarian regimes are always very popular” — historian Richard Evans reviewing the 1930s.) Less catastrophically, groups may continuously vote subsidies and protections for themselves at others’ costs, democratically turning their country into Argentina.
India and China are an interesting contrast. Starting from about the same point and time they adopted similar (on their face) economic development policies, but China’s economy rocketed upward while India’s didn’t. Why? This analysis finds that the biggest cause is that India’s elected regional and local governments remained largely under the sway of all the problems above (plus the caste system) in ways that blocked development. As one specific example, the central governments of both China and India recruited investment by foreigners. In China, under the marching orders of the CCP, the local government leaders had the deal-closing papers ready to sign when the western investors got off the plane, literally. But in India the elected local politicians had final power over foreign investment, and consistently frustrated it in response to the local interests they represented. Thus, China received a flood of foreign investment and India didn’t. (There’s much more, listen to the whole thing.)
I’m not the biggest fan of the CCP, but one must give the devil it’s due. Prof. Devesh Kapur is quoted above as saying India’s dysfunctional local governments are the result of it being a “premature democracy”, having adopted democracy before it was developed enough to do so. (Americans may think of Iraq and Afghanistan.) In such cases an authoritarian regime that follows sensible policies may outperform dysfunctional democracy.
Back to North: He noted the above but said to achieve first-tier economic status authoritarian regimes eventually must choose to cede power to all the “independent organizations” and turn democratic. (South Korea, etc.) Or they can choose to keep their power and stifle the independent organizations — as the CCP is doing today amid its Leninist turn –, and enjoy a future of economic stagnation or worse in the ‘middle income trap’.
So we get back to political freedom and democracy being necessary for first-tier economic freedom and development, and thus very highly correlated with it. But as to whether it is a cause or result of first-tier economic development, eh, not so clear. It’s certainly no guarantee of it.
Though Singapore’s GDP per capita is in the top-5 or top-10 of the world, depending what numbers you use, one-party state and all. Proving …
V L Elliott
Jun 29 2024 at 9:01pm
Good article but “freedom”, while necessary and I most assuredly agree, is not enough. I will fall back on the Philadelphia debates of the mid-1770s among the founders of the United States of America to choose, instead, “liberty”. I suggest that to them liberty included freedom but went further. To me in their discussions — using my own words here — liberty meant/means the range of choices available to individuals over which each individual can responsibly exercise their freedom to choose. The wider the range of available choice, specifically here including economic as well as political choices, the more choices people can make. Among those choices are the option(s) to seek gain by placing at risk resources they own or for which they are responsible. These entrepreneurial choices, when successful, re-allocate resources from less to more efficient uses and so can lead to overall growth. This line of argument opens links to collective action and to the stability/instability of system and order. Freedom? Of course and with emphasis! But don’t stop there because there is a great deal that is relevant which can be seen, perhaps more clearly, on the longer and wider road which I believe the idea or context of liberty can provide. Again, good article.
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