Why do some countries prosper and grow rich while others do not?
According to the great moral philosopher Adam Smith, the key to prosperity is freedom -- economic freedom.
People produce more when they have economic freedom to go into business and occupations of their own choosing, when they can reap profit (and suffer losses) from their activities, when they can save and invest in productive projects, and when they are free to trade with each other. Economic freedom opens up the path to prosperity.
Of course freedom is also valuable in itself. Restrictions on the freedom to choose and engage in voluntary exchange deny human beings something they value -- something that is integral to their humanity.
Yet, the idea, that economic freedom and prosperity are mutually reinforcing, or even compatible, is increasingly being questioned. Indeed, during the last federal election over 60 per cent of the electorate voted for political parties which promised to reduce economic freedom in the belief that that would bring prosperity. Of course, the critics are also concerned that freedom brings with it greater social inequities.
Despite its pivotal role, the notion of economic freedom has received surprisingly little systematic attention.
To address this gap, the Fraser Institute in Canada, with the assistance of 53 other similar organisations from around the world, has published the Economic Freedom of the World Report 1998 -- the fourth such report.
The Report rates the performance of 119 countries. The ratings are done on the basis of 25 factors including freedom to trade, freedom to keep one's earnings and the freedom to own and use property.
The Report, once again, found that Hong Kong had the freest economy in 1998. Singapore, New Zealand, the United States and the United Kingdom round out the top five.
Australia was tied for eighth place along with Canada, Panama and Ireland. At the other end of the spectrum, Myanmar, Guinea-Bissau, Congo, Rwanda and Romania were the world's least free. Africa remains the least free -- and the least prosperous -- continent.
Interestingly, the biggest improvers came from outside the usual ranks. The Dominican Republic lead the improvers list followed by Hungary, Ireland, Mauritius Panama, Philippines Poland and Portugal. Malaysia and Indonesia were among the countries with the largest falls in the freedom ranking from 1990 to 1997 -- a period which preceded their recent economic woes.
Australia's economic freedom rating has registered steady improvement during the last decade. Its ranking has risen to it present ranking of eighth from twenty-fourth in 1975.
Several factors have contributed to the improvement in Australia's rating. Tariffs have been reduced and other trade barriers relaxed. The size of the trade sector has doubled. Inflation has, during the last seven years, been relatively low and stable. Government share of total consumption has declined. The top marginal tax rate on personal income has been reduced.
Australia shines in terms of having the most open currency markets, the least controls on interest rates, low government ownership of banks, and the best legal structure and property rights measured in terms of the risks of expropriation and contract violations (though if land rights issues were included the rating may have been different).
The Report shows a robust positive relationship between the change in economic freedom and the growth of GDP. The top 20% most economically free countries had an average per capita GDP $US18,142 and an average GDP growth rate of 1.8 per cent over the last seven years. As freedom declined so did GDP per capita and GDP growth rate. The bottom 20 per cent least economically free countries had an average per capita GDP of just $US1,538 and an average growth rate of -2.1 per cent.
Research conducted using the index found that the level of economic freedom explained about 65 per cent of the variation in national income. Indeed, the same research found that a 10 per cent increase in economic freedom can be expected to bring about an increase in GDP per capita of between 7 and 14 per cent.
Contrary to concern's of the critics, the evidence shows that economic freedom tends to re-inforce social cohesion rather than damage it. Research undertaken by Winton Bates using the index found that low-income earners tend to be relatively better off in countries with high levels of economic freedom. More importantly, there appears to be a strong, positive relationship between level of economic freedom and the share of benefits flowing to low income groups. For example, in the most economically free countries, families in the lowest 20 per cent of income distribution experienced income growth of over twice the national average. In other words, economic freedom tends to empower the poor to help themselves.
The 1998 Economic Freedom Report provides powerful evidence that Adam Smith was right more than 200 years ago. There is a strong link between freedom, prosperity and social cohesion.
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