Tuesday, May 4, 2010

Economic freedom and the wealth of nations

Today, I would like to present the impact of GDP per capita on economic freedom across the world in 2010. Economic freedom is a measure of country's freedom to invest, consume, work and produce in any way pleased. It is also a measure of state's protection of private property rights under the rule of law. In the graph, I compared the GDP per capita (PPP-adjusted) in international dollars and economic freedom score from Index of Economic Freedom. The index ranges from 0 to 100; where higher number indicates higher level of economic freedom.

As you can see, higher GDP per capita is associated with more economic freedom. I found that if GDP per capita increases by 1000 USD, economic freedom score, on average, improves by 0.6 percentage points, all other remaining constant. In addition, 48.03 percent of the variation in economic freedom is explained by the variability of GDP per capita.

Economic freedom is an essential determinant of economic development. The lack of institutions of private property, rule of law and contract enforcement is the main source of economic underdevelopment and contemporary stagnation in the third world.

It is not natural disasters and the lack of humanitarian aid that keeps Haiti poor but the absence of economic freedom which has lead to widespread corruption in judiciary, business and politics, and to the diversion of investment out of the country. Haiti's economic freedom index (50.8) is among lowest in the sample of 50 countries.

The least economically free countries are Venezuela (37.1), Libya (40.2), Belarus (48.7) and Russia (50.3). The best performing countries in economic freedom are Australia (82.6), New Zealand (82.1), Ireland (81.3) and Switzerland (81.1).

Economic freedom and GDP per capita in 50 countries

Source: Heritage Foundation, IMF (2010)


  1. This comment has been removed by the author.

  2. A very interesting post. Of course there's a positive relatiosnhip between economic freedom and GDP per capita but the relationship can become loose when different countries are sampled in such as Singapore and Hong Kong. The level of economic freedom in Western Europe is relatively high but it is, at the same time, restrained by high government spending, restrictive tax rates and highly regulated labor markets. These countries, at the same time, enjoy superior advantage in the rule of law and independence of judiciary. I would prefer to put Rodrik's argument of the quality of institutions ahead of GDP per capita as the explanatory variable of economic freedom. As you can see from the sample, the highest advantage in economic freedom is attributed to Anglosaxon countries with robust rule of law and high-quality indicators of institutional governance. These indicators contemplate output indicators such as labor market regulation. On the other hand, countries with Continental legal origin tend to score high on the rule of law but the performance of Continental Europe is hindered by high government spending. I haven't yet conducted empirical analyses on these relationships but I there is an inevitable and undoubtful assumption that "capture theory" is a sufficient predictor of economic freedom, controlling for government spending since reductions in government spending are locked by interest groups and, hence, economic freedom advancement is impossible, reflecting elitistic fine-tuning of fiscal policy. On the other hand, Dani Rodrik found that the share of income earners in top 1% of income distribution is negatively related to economic growth in developing countries.

    A very good piece of analysis. I liked it.