Epilogue: A 120-Year Perspective

PART 5:

Francis Fukuyama has argued that "the worldwide liberal revolution" which he sees as being now in progress represents the prolongation of a centuries-old tendency which can be expected to continue.  He writes:

... the growth of liberal democracy, together with its companion, economic liberalism, has been the most remarkable macropolitical phenomenon of the last four hundred years ... the current liberal revolution ... constitutes further evidence that there is a fundamental process at work that dictates a common evolutionary pattern for all human societies -- in short, something like a Universal History of mankind in the direction of liberal democracy.  The existence of peaks and troughs in this development is undeniable.  But ... Cycles and discontinuities in themselves are not incompatible with a history that is directional and universal. ... ⁽¹²⁰⁾

This view of the past may be valid for liberal democracy, but does not at all apply to its "companion".  For one thing, the time-frame of 400 years does not fit.  On the one hand, the story of economic freedom goes a long way back, much further than four centuries.  Thus Hayek maintains, in relation to the history of Rome, that "The classical period was ... a period of complete economic freedom, to which Rome largely owed its prosperity and peace", while Sir John Hicks traced the origins of what he termed the Mercantile Economy to the emergence of the city state as a trading entity. ⁽¹²¹⁾  On the other hand, economic liberalism as a doctrine, a coherent way of thinking about economic and political systems with a broad programme to go with it, goes back only some two centuries and a half.  To quote Lionel Robbins:

Only in the middle of the eighteenth century did men begin to conceive of a world in which privilege to restrict should itself be restricted and in which the disposition of resources should obey, not the demands of producers for monopoly, but the demands of consumers for wealth. ⁽¹²²⁾

A CENTURY-LONG RETREAT

Over this 250 years as a whole, contrary to Fukuyama's thesis, there has been no consistent trend to economic liberalism.  True, there was clearly such a tendency, over a growing number of countries, from the latter part of the 18th century onwards;  but from the late 19th century this direction of change was reversed.  Liberalism began on balance to lose ground, and was increasingly and explicitly rejected.  Although there is no conspicuous and dramatic turning point, 1880 can be taken as an approximate watershed year;  and as was seen in Part 1 above, the recent trend away from interventionism in economic systems can be dated, again approximately, from the close of the 1970s.  Over the whole of the intervening century, on balance, economic systems, and in some respects economic ideas also, moved away from liberal norms and practice.  This was not a matter of "cycles and discontinuities", to use Fukuyama's terms.  Before the present trend set in, and even allowing for exceptions and for some notable positive developments after 1945, economic liberalism had been in decline for a century.  This makes recent events the more remarkable;  and in looking ahead, it is worth examining the main features of past decline and present recovery, with a view to distinguishing those recent changes that may be temporary or reversible from those that appear more permanent and likely to be taken further.

In viewing the past 120 years, the two world wars emerge as landmark events.  Hence there are three main phases to consider:  1880-1914;  1914-45;  and the period since the Second World War.  Within the latter, the last 20 years form a distinct sub-period in which a long-continuing downward trend in the fortunes of economic liberalism has been reversed.

The main aspects and features of liberal decline after 1880 are all to be seen before the First World War.  Three in particular are to be noted, both because they involved a clear break with liberalism and because they were woven together to make up a rival and increasingly influential view of the world.

The first of these comprises policies towards international trade.  During the decades before the First World War, an increasing number of countries in Europe, together with Canada and later followed by Australia, New Zealand and Japan, moved to establish protective tariffs -- thus joining the US and Russia, which had never adopted free trade.  By later standards, almost all the protective systems of mid-1914 were moderate;  and on balance, and despite them, closer international economic integration went ahead during this whole period.  All the same, free trade had been generally discarded as a guiding principle. ⁽¹²³⁾

The second area is that of foreign and colonial policies.  Not surprisingly, governments across the world had never been strongly influenced by Cobdenite liberal ways of viewing national interests and international relations, except -- for a period only, from roughly 1860 to 1880 -- in the context of treaties providing for free trade;  and from the 1890s, as David Fieldhouse has noted, imperialism acquired a more purposive and systematic character:  "European statesmen and public opinion began to assume that each state must stake its claims overseas or see national interests go by default." ⁽¹²⁴⁾  In some cases, as in French practice and in the programme put forward in Britain by Joseph Chamberlain, such notions were linked to preferential tariff systems and ideas of imperial strategic self-reliance in a world of great-power rivalries.  Tariff protection and imperial preferences were viewed not just as instruments for shielding and encouraging particular industries or ventures, but also as leading elements in national self-assertion and defence.

The third main element is domestic.  Over this same period, national governments increasingly assumed responsibility for (1) redistributing income and wealth through public finance, (2) the establishment of nation-wide schemes for pensions and social insurance of various kinds, (3) the financing, and increasingly the provision, of education and health services, and in many cases (4) the closer regulation of labour markets.  How far the underlying aims of these often related initiatives represented a break with economic liberalism, rather than a legitimate reinterpretation and reshaping of it to meet changing conditions and new possibilities, is to some extent debatable:  as noted above, there are -- and were -- different schools of thought within the liberal camp, particularly with respect to redistribution through public finance.  But the extent of centralisation and state provision in the various expenditure programmes, and the limits thus placed on competition and freedom of choice and initiative, typically went much further than was consistent with the principle of limited government.  As Hayek noted in relation to Bismarck's initiative in Germany in the 1880s, which created the first centrally-sponsored social insurance system:

... individuals were not merely required to make provision against those risks which, if they did not, the state would have to provide for, but were compelled to obtain this protection through a unitary organisation run by the government ... Social insurance ... from the beginning meant not merely compulsory insurance but compulsory membership in a unitary organisation controlled by the state. ⁽¹²⁵⁾

Almost everywhere, centralisation within such schemes, as also in health and education, brought with it an undermining of the existing voluntary organisations and charities, a narrowing of options, and the creation of whole new categories of people who were servants of the state.

Thus even by 1914 the notion had become widely accepted, not just among socialists, that economic liberalism was an outdated creed.  Official policies naturally reflected this, and these policies were not made by socialist parties which up to then had nowhere won office.  It was in fact the conservative nationalist framework of thinking, and governments that reflected it, which provided an increasingly accepted alternative to liberalism, particularly in the imperial Germany of 1871-1918 whose influence on world events proved decisive.  This alternative combined collectivist social policies, tariff protection, and a conception of national interest as being served by military power, assertiveness, and the possession or control of trade routes and territory.  Its influence and appeal were not confined to parties and movements of the right.

The First World War itself, and still more its consequences, brought a whole series of setbacks to the liberal cause.  As an immediate result, a fully state-directed economic system emerged in what was to become the USSR, while everywhere the wartime experience of government direction increased the tendency to accept regulation as normal, and reinforced the sense and conviction that the natural trend of events was towards a larger economic role for the state.  Even in the 1920s, tariff rates were typically increased, while new tariff systems came into existence as a result of the emergence of newly-created national states.  Then, with the advent and deepening of the Great Depression, the international trade and payments system was shattered.  Virtually every country raised tariffs, while alongside them import quotas became a standard instrument of policy.  Exchange controls were widely adopted and international flows of long-term investment fell away.  Between 1929 and 1932 the volume of world exports declined by more than one-quarter, while in value terms the fall was over 60 per cent. ⁽¹²⁶⁾  Everywhere the relatively free movement of people across national borders, which had been largely preserved up to 1914, was replaced by highly restrictive immigration régimes.  The whole notion of a predominantly laissez-faire capitalist economy was discredited by the onset and persistence of mass unemployment, the more so since no such trend had appeared in the Soviet Union.  Just as later in the 1970s, governments everywhere reacted to unforeseen problems and crises with a range of interventionist measures, domestic and external.  Under the impact of events, economic thinking moved towards a more activist conception of the role of governments.  By the end of the inter-war period it was widely accepted that liberalism was finished, driven from the stage by the march of events.  A good illustration is the valedictory judgement made by an eminent (and liberal) economic historian, Eli Heckscher, writing in the early 1930s, that:

mercantilism gave way to liberalism which, after a period of dominance which represented a very short time in world history, gave way in its turn to newer systems. ⁽¹²⁷⁾

Into this scene, as a further and calamitous element of disintegration, came the Nazi régime in Germany, and with it the harnessing of what soon became the strongest military power in the world to Hitler's conception of a national destiny to be realised through war, conquest, the confiscation of vast territories, and the establishment of a master race.  This belongs in our story, not just because it made a second European war virtually inevitable, but because it represented an extension and fulfilment, carried it is true to the point of utter insanity, of the related notions which had so gained ground even before 1914 -- the submergence of individual goals into those of the nation, the collectivist view of the state's role, responsibilities and powers to act, and the idea of conquest as the key to realising not only national security and prosperity but also, and more fundamentally, the task assigned by history to the nation and those belonging to it.

In a less extreme and irrational form, much the same notions underlay the evolution of Japanese imperial and foreign policy in the decade or so before Pearl Harbour.  The plan which took shape for a "Co-Prosperity Sphere" has obvious affinities with earlier notions, in Britain and Germany especially, of imperial self-sufficiency and the control of strategic overseas territories as a necessary basis for a country's security and influence in the world, and hence (it was assumed) for prosperity also.  It is not just military-dominated Realpolitik that accounts for Japanese official policies in these years, but also a more widely held conception of national interests, and of the means to pursuing them, which was profoundly collectivist and anti-liberal, and where the possibility of sustained economic progress within a free and open economy was not so much rejected as scarcely recognised.  There are few starker and more fateful instances in history of the continuing influence on political leaders of pre-economic conceptions of the world.

As a result of the Second World War, the immediate frontal attack on liberalism, political and economic, was repelled, and before long fully-functioning democratic systems and relatively free market economies were established in both Germany and Japan -- indeed, the German economic reforms of the late 1940s were a landmark event in the history of economic liberalism.  At the same time, this war, like its predecessor, contributed both to extending central control over the economy and to reinforcing the idea that this was still the natural trend of events.  Further, an early momentous consequence of the war was the establishment of communism and state-directed economies in Central and Eastern Europe, while before long the same had happened in China and North Vietnam.  For the non-communist world, the summary history from the early post-war years to the late 1970s is set out in Part 1 above:  briefly, it records (1) a mixed story for the core OECD countries, with liberalism gaining ground on balance from 1945 to 1973, but with some retreat over the next few years, and (2) for the developing countries as a group, though with exceptions, a general trend towards interventionism.  For the world as a whole over this period, and taking account of all three groups of countries, it is the counter-liberal tendencies that on balance prevail.

HAS THE CLIMATE OF OPINION REALLY CHANGED?

This survey of history might suggest a darker view of the prospects for economic liberalism than was initially sketched above, since within it these last two decades emerge as a relatively short and possibly unrepresentative phase, following a century-long broadly unfavourable trend.  To judge this, it is helpful to look at the three main heads of anti-liberal thinking and practice just identified -- protectionism, nationalism and collectivism -- and to see how far, in relation to each, the liberal alternative has made gains which could well be lasting.  Here much depends on an assessment of how far underlying attitudes have changed and are changing.

In relation to this movement of attitudes, there is some difference between the external and internal dimensions of policy.  With respect to international transactions, including capital flows as well as trade, there has been continuing and extensive liberalisation in a process which has spread in recent years from the core OECD countries to much of the rest of the world.  For the OECD group this trend, despite the many limitations, qualifications and exceptions that have attended it, goes back half a century to the resolutions and agreements of the early post-war years:  it is not just a recent change of course.  For the non-OECD countries involved, old assumptions have been set aside in response to what have appeared as the lessons of past decades, and this may well prove to be a lasting change.  In both groups, and even taking into account the impact of the recent financial crises, there is an established momentum of liberalisation which, in part because of the continuing effects of the revolution in communications, seems likely to be maintained.  True, there is another side to the picture.  Trade interventionism in a variety of forms is to be found still in pretty well every country and trading entity;  the ideas of traditional mercantilism remain widely influential;  there is considerable distrust, especially though not only in many developing countries, of the idea of closer international economic integration;  and there exists now a substantial risk that trade will be distorted by damaging new provisions relating to employment conditions and environmental standards.  Further, and as noted above, the idea of full freedom of capital flows has now become more widely questioned, at any rate for non-OECD economies.  All the same, a relatively open and non-interventionist world trade and investment system has almost certainly come to stay.  Indeed, it is now possible to imagine, for the first time since June 1914, the reestablishment of a liberal international economic order extending to all cross-border flows except those of people.

The change in attitudes here has gone together with a profound -- though incomplete and not fully explicit -- recasting of the assumptions underlying foreign policies and the conduct of international relations.  Three main factors have been at work here.  First is the restoration and spread of liberal democratic régimes and institutions.  This has restricted the possibilities for assertive nationalism, since there is good reason to think that "modern democracies do not go to war with one another", and that "The slow growth of stable democracy will gradually extend the area in which nations do not need to fear being conquered or destroyed". ⁽¹²⁸⁾  The transformation of the relationship between France and Germany since 1945 is a conspicuous instance of how the world has changed in this respect.  Second, the growth and spread of prosperity since the Second World War has made it evident as never before that the key to a better material life is not to be found in the acquisition and control of foreign or colonial territory:  in this, Cobden has at last begun to come into his own.  Third, the collapse of communism has meant that for the first time since the revolution of 1917 the foreign policy of Russia is not based on the unwavering assumption of permanent hostility towards, and on the part of, the Western capitalist countries.  All this has not only strengthened the prospects for peace, which itself is favourable to economic liberalism;  it has also further undermined the ideas and assumptions of collectivist nationalism and raison d'état, and thus done much to remove from the scene what had always been a powerful anti-liberal influence.

When it comes to domestic policies, the record of change looks rather different and the prospects more uncertain.  On the one hand, there are a number of respects in which underlying attitudes and assumptions have changed significantly and the change could well prove lasting.  Across the world, this can be seen in the acceptance and spread of privatisation and "marketisation" -- through the transfer of ownership from public to private hands, the contracting out of the provision of public services, and (though this remains more difficult) the raising or introduction of charges for these.  In the core OECD countries, the widespread resistance to higher taxes, and concern about their effects, has meant that attempts to limit public expenditure are now an established feature of government policies.  Elsewhere in the world, among the sizeable minority of non-reforming countries, there is a good chance that the further spread of democracy will lead to the establishment or restoration of basic economic freedoms, as well as to greater openness to trade and investment, in the countries affected.  In every country, the combined effect of modern communications and the cross-border liberalisation that has already occurred has been to make people aware as never before of wider economic possibilities and opportunities, and hence more resistant to forms of regulation, internal as well as external, which would close them off.  This tendency can be expected to continue.

Perhaps more than on the external side, however, there are qualifications to be made to this story of economic reforms and of support for liberalisation.  In the core OECD countries in particular, public expenditure ratios for the most part remain at high and close to record levels.  In almost every country, labour markets are still closely regulated;  free schooling, most social services, and often the supply of health services continue to be dominated by state monopoly provision;  and the permeation of economic life by political influences is even now largely accepted or endorsed.  All this reflects a strong continuity of anti-liberal ideas, assumptions and attitudes, as well as -- and arguably more than -- the combination of successful lobbying by interest groups and self-directed preoccupations on the part of political leaders.  In most if not all countries, including those which have recently emerged from communist systems, there remains a surprising degree of belief in the capacity and duty of central governments to manage national economies in detail, and to bring to pass a wide range of specific outcomes without noticeable cost to individual freedom or the effective working of the system.  The obverse of this attitude, as noted already, is a general distrust of markets and non-regulated processes.  In relation to the recent and prospective success of liberal democracy, Fukuyama argues convincingly that authoritarian régimes have lost legitimacy in the world of today:  almost everywhere, their claims to acceptance and support are now dismissed as fraudulent.  Broadly speaking, and despite the collapse of communism, no such decisive loss of perceived legitimacy has yet occurred with respect to the economic role and pretensions of the modern state.

AN ACHIEVEMENT AND ITS LIMITS

When viewed in the perspective of the last 120 years, the recent clear improvement in the fortunes of economic liberalism appears as more impressive and more fundamental, and yet at the same time more surprising.  The fact that a century-long decline has been so clearly reversed, with a large and growing majority of countries around the world taking the path of economic reform, is remarkable in itself;  and in the light of history, it is apparent that the significance of what has happened goes well beyond a listing of specific reforms and changes of course in policies.  There have been profound shifts in attitudes and working assumptions.  From the late 19th century for many decades, national economic policies, internal and external, were strongly influenced, if not dominated, by the two leading and mutually reinforcing constituents of anti-liberal thinking and practice -- that is, economic nationalism, joined with a belief in the need for central direction of economic systems, or at any rate for a continuing expansion of state ownership and state initiative.  Both of these twin guiding principles have lost authority and support:  it is they, rather than the liberal view of the world, which now increasingly appear as outdated and inadequate.  Few predicted before the event that the climate of opinion would evolve in this way.

It would be wrong, however, to conclude from this change, and from the recent progress of economic reform, that liberalism as such has triumphed or is in course of doing so, still less that such an outcome is historically natural or inevitable.  As we have seen, the liberalisation of these past two decades, and the change in attitudes which it has both reflected and helped to promote, have not been mainly due to, and have not brought about, a general endorsement of economic liberalism as such.  Today as earlier, the ideas which enter into the liberal blueprint, despite the gains they have made within the extended professional milieu, have only limited support elsewhere:  it is a telling fact that they do not even now provide the basis, in any country of the world, for a political movement or party that has to be taken seriously in the competition for office and power.  In effect, public opinion and political leaders across the world have come to accept some of the leading practical conclusions that liberalism points to, while remaining indifferent to, or distrustful of, the way of thinking from which these conclusions are derived.

There is little sign that this situation is about to change.  On the positive side (from a liberal viewpoint), a general reversal of the main recent market-oriented reforms does not now seem probable in any leading country, while there are reasons for thinking that the pressures and incentives arising both from events and problem situations and from further technical progress will continue on balance to favour the liberal cause, as they have over the past two decades.  At the same time, however, the various anti-liberal influences described above are likely everywhere to remain both strong and pervasive, and it is possible that in many countries they will gain at least temporary strength from untoward developments, economic and political, which cannot now be clearly foreseen, or from reactions to what are seen as the adverse consequences of liberalisation and closer international economic integration.  Even aside from such possibilities of retreat, the further extension of market-oriented reforms to those areas of policy which have so far remained relatively unaffected by liberalisation is very much in question.  Despite their substantial improvement over these past two decades, which appears all the more notable when seen in historical perspective, the fortunes of economic liberalism during the opening decades of the new century remain clouded and in doubt.

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ENDNOTES

120.  Francis Fukuyama, The End of History and the Last Man, New York:  Avon Books, 1993, p. 48.

121.  Hayek, The Constitution of Liberty, op. cit., p. 107;  John Hicks, A Theory of Economic History, Oxford:  Clarendon Press, 1969.

122.  Lionel Robbins, Economic Planning and International Order, London:  Macmillan, 1937, p. 233.

123.  Yergin and Stanislaw assert, misleadingly, that "the late nineteenth-century world" was "a world of expanding economic opportunity and ever-diminishing barriers to travel and trade" (The Commanding Heights, op. cit., p. 16).  Though the international economic system of June 1914 was a liberal one, arguably more so than that of today, barriers to trade notably increased from 1879 onwards, while restrictions on free migration also began to appear.

124.  David Fieldhouse, Economics and Empire, London:  Weidenfeld and Nicolson, 1973, p. 463.

125.  Hayek, The Constitution of Liberty, op. cit., p. 287.

126.  These estimates are from Maddison, Monitoring the World Economy, op. cit., pp. 238-39.

127.  Heckscher, Mercantilism, op. cit., Vol. 2, p. 339.

128.  Max Singer and Aaron Wildavsky, The Real World Order:  Zones of Peace/ Zones of Turmoil, Chatham, NJ:  Chatham House Publishers Inc., 1993, pp. 3 and 4.

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ANNEX

MEASURING ECONOMIC FREEDOM AND ASSESSING ITS BENEFITS ⁽¹⁾

The Economic Freedom of the World Project, some of the recent results of which are drawn on in Part 2 above, has been sponsored by a network of research institutes across the world, including the Institute of Economic Affairs, under the leadership of the Fraser Institute of Vancouver, Canada.  The main research has been carried out at Florida State University, under the direction of James Gwartney.  From its early days, Milton Friedman has been a sponsor of, and adviser to, the project.  The main output is the set of economic freedom ratings for a growing number of countries across the world over the period from 1975 onwards, but the results are also used to explore the relationship between the extent of freedom and both the level of GDP per head and its rate of growth in the countries covered:  an underlying theme, therefore, is the relation between economic freedom and economic performance.

Derivation of the Index of Economic Freedom

The ratings for each country are arrived at by judging its performance under a set of 17 attributes which, when combined, make up an index of economic freedom:  each attribute is assigned a weight, and each country's overall freedom rating is the weighted average of its 17 individual ratings.  The attributes are grouped under four headings, namely:

• "Money and inflation" (total weight, 15.7 out of 100), which covers the rate of growth of the money supply, recent inflation rates, and the freedom of citizens to hold foreign currency and to bank abroad.
• "Government operations and regulations" (total weight, 34.6), which covers the share of government consumption in total consumption, the significance of public enterprises, the extent of price controls, freedom of businesses to compete, legal equality and access to a "non-discriminatory judiciary", and freedom from regulations that cause real interest rates to be negative.
• "Takings and discriminatory taxation" (total weight, 27.2), which covers transfers and subsidies in relation to GDP, top marginal tax rates and their thresholds, and whether or not there is military conscription.
• "Restraints on international exchange" (total weight, 22.5), which covers the level of taxes on international trade, the difference between the official and the black market exchange rates, the actual size of the trade sector as compared with what might be expected, and the extent of official restrictions on overseas capital transfers.

In arriving at the rating for a particular country in a particular year, there are unavoidably problems as to (1) the reliability of the published data relating to each of the listed attributes, (2) the mapping of the data into ratings on the scale of zero to 10, as well as (3) the choice of weights for each attribute and the ratings attached to it.  So far as I can judge, the project has made a good selection and use of relevant sources, while the choice of procedures under (2) and (3) has been thoroughly considered.  Hence the results, in terms of the ratings and their changes over time, are of considerable interest.  At the same time, there are limitations not only to the figures themselves, but also to even the most soundly based and best conducted statistical exercise of this kind.  Further, and inevitably, there is room for debate as to the significance of what comes out of the study.

Limitations of the Results

There are various limitations and weaknesses to be found in the index in its present form.  Not surprisingly, one of these relates to coverage, which though broad is still incomplete.  In particular, no indicators have as yet been included relating to the changing balance between freedom and regulation in labour markets;  work is now under way to make good this omission.  A further gap, not easy to fill, relates to economy-wide regulation in such areas as occupational health and safety and the environment.  A specific weakness, which arises from the project's exclusive focus on individual countries, is that the present freedom ratings take no account of the existence of the European Union.  Hence a country such as Belgium has been given the maximum rating for its liberal trade régime, despite the fact that Belgium's trade régime has long been that of the EU which (to put it mildly) contains significant non-liberal features.  More generally, issues of accuracy and interpretation arise concerning the results that are shown for particular countries.  In Australia, for instance, the evolution of the freedom ratings bears surprisingly little correspondence with what most observers would regard as the changing balance within official policies:  the main advances are assigned to the period of the Fraser government in 1975-80, whereas it was the succeeding Labor government, from the end of 1983 to the beginning of the 1990s, which took the decisive steps towards a less regulated and more open economy.  Such doubts and queries as to accuracy, relevance and completeness are to be expected in what are still the early stages of such an ambitious venture in comparative economic history.

More broadly, there are aspects of the evolution of economic policies, and of the changing balance between liberalism and interventionism, which are not fully captured in statistical series or indicators, however well chosen and assembled.  Thus turning points may be critical even though their short-term measurable results are limited:  among other instances, this is true for the Australian case just mentioned, and it may likewise prove true of India in 1991.  In the case of the former Soviet Union, as noted above in the main text, the various indicators that show restricted progress up to now do not reveal, or even hint at, the momentous fact that a new epoch has begun.  Further, an exclusive focus on the measurable dimensions of economic freedom risks giving a distorted picture because the political dimension is not taken into account:  as Sir Samuel Brittan has rightly said, "there are subtle links between political repression and the reality of economic freedom itself, difficult to put into any index". ⁽²⁾  The high ratings given here for a country such as Singapore may not be fully comparable with those for more open political systems.

The Connection between Economic Freedom and Economic Performance

In the first major report from the project, Economic Freedom of the World, 1975-95, a special chapter is devoted to a cross-country comparative analysis of the relation between the freedom ratings and the success of economic systems as shown by levels of GDP per head and rates of change in it over time:  both changes within countries and differences across them are taken into account in the analysis.  The evidence from the country data for this 20-year period is marshalled so as to bring out three results which appear as firmly established:  first, countries with higher freedom ratings have higher levels of GDP per head;  second, the countries with high freedom ratings had higher rates of growth of GDP per head in the period, as compared with those with low ratings where these rates were generally low and often negative;  and third, increases in the ratings were characteristically followed by increases in the rates of growth of GDP per head.

These conclusions are not surprising, and the broad connection between economic freedom and prosperity emerges even more strikingly if one goes beyond the study, to take into account evidence which extends further than the 20 years or so which it covers.  Between 1945 and 1990 something remarkably close to a controlled country-wide experiment took place, which has thrown into clear relief some of the necessary conditions for good economic performance.  In two adjacent economies, quite different economic and political systems were established at the end of the Second World War, and maintained thereafter, where previously there had been only one.  At the time when the separation occurred, both countries were in much the same difficult, almost desperate, situation.  They shared a common language, a common history, and a common culture and social structure, yet by historical accident they now took separate and contrasted paths.  For the next 45 years the two economies evolved on different lines, largely in isolation from one another since one of the governments effectively closed off all interactions between them.  Their comparative performance was strikingly and consistently divergent, so much so that eventually the less successful system ceased to be viable and merged with the other.

These two contrasted political and economic systems, of course, belonged respectively to West and East Germany.  One could scarcely imagine a more conclusive demonstration of the superiority of a largely market-led system over a state-directed one.  A similar contrast, equally telling, is to be found in East Asia, as between South and North Korea.

This, however, leaves open the question of whether and to what extent, within the set of countries which have market-based economic systems, growth rates of productivity and output per head are closely linked to the prevailing balance between liberalism and interventionism and to changes in this balance.  To my mind, it is clear that other influences, understandably not considered in the Economic Freedom of the World project, may have to be taken into account.

One instance of this is the comparative performance of the British and Japanese economies in the decades after the Second World War.  Between 1950 and 1973, on Angus Maddison's figures, the average annual growth rate of GDP per head in Britain was 2.4 per cent, as compared with 8.0 per cent in Japan.  Admittedly, this huge gap becomes narrower if one takes instead the respective estimated rates of growth of labour productivity, as measured by GDP per hour worked:  for Britain this is 3.1 per cent per annum, as compared with 7.7 per cent for Japan.  However, the difference is still very large, so large that it cannot mainly be explained in terms of the "catch-up factor", which enters in because of the low Japanese starting-point in 1950.

Why was the Japanese economic performance in these years so strikingly better than the British?  One widely-accepted explanation is that well-devised official industrial policies, originating in and carried through by the famous MITI (Ministry of International Trade and Industry), were the main single factor:  Japan is seen as offering a model of a planned market economy and a "developmental state".  On this view, so far from it being greater economic freedom that made the difference, it was to the contrary judicious central guidance, of a kind which was lacking in Britain but available in Japan, and which entailed a degree of departure from liberal norms.  Even if one rejects this interpretation of history, as I would myself, ⁽³⁾ it is hard to see that the main difference between the two economies is to be found in the prevailing extent of economic freedom or its comparative evolution, with the Japanese system closer to the liberal blueprint.  It is true that nationalisation was carried a good deal further in Britain than in Japan after the Second World War, and that the public expenditure ratio was consistently higher.  On the other hand, while both began the period as highly protectionist, it was the UK that did more to liberalise its trade as time went on;  Japanese agricultural protection was much higher throughout;  and foreign direct investment was virtually precluded in Japan while the British investment régime was consistently liberal.  Both countries maintained tight exchange control régimes.  Comparing the two economies, it is hard to see how the striking contrast in performance could be explained in terms of differences, or divergent changes, in an index of economic freedom:  it seems clear that other influences were dominant.

Other historical episodes point to a similar conclusion.  For example, the general and surprisingly abrupt falling away of rates of productivity growth in virtually all the core OECD countries, as between the "golden age" of 1950-73 and the past quarter of a century, cannot readily be explained in terms of a shift towards interventionism, even though elements of this are arguably part of the story.  A more specific and more recent comparison is between the economies of New Zealand and Ireland.  Since the reform process was set under way in New Zealand in mid-1984, liberalisation has been taken further there than in Ireland, and on most reckonings the New Zealand economy would now show up as the freer of the two:  both these conclusions emerge from the respective figures in Table 3 (above, pp. 20-21).  But if we compare 1984 with 1997, GDP per head in New Zealand appears as having increased by only some 10 per cent, as compared with over 90 per cent for Ireland. ⁽⁴⁾  It seems obvious that this remarkable divergence between the two countries cannot be chiefly explained with reference to the comparative extent of economic freedom or differences in the recent progress of liberalisation.

It is in fact doubly misleading to present economic freedoms as providing uniquely the master-key to economic progress.  For one thing, and as just noted, this may not fit well the facts of particular historical episodes or situations.  But in any case, these freedoms are to be valued for their own sake:  they are ends as well as means.  That there may be other influences as well on economic performance, and hence other means of improving it, does not weaken the case for trying to secure and maintain them.

The qualifications just made do not put in question the broad conclusions of the Economic Freedom of the World studies.  The connection between economic freedom and prosperity is real, and these past few decades have indeed provided strong confirmatory evidence of it.  What is more, the connection appears as closer and more pervasive if one takes account also of aspects of material well-being which are not reflected in national accounts statistics.  For instance, the freeing or extension of retail opening hours, which has gone ahead in many previously regulated core OECD countries, has brought improvements in welfare, possibly substantial, which do not show up in series for GDP per head;  and similar gains have been still greater in former communist countries where rationing and queues were pervasive under the old system.  Again, the case against anti-discrimination laws is that they preclude a host of mutually beneficial deals and arrangements:  as Richard Epstein has put it in the context of New Zealand, "every single characteristic regarded as irrelevant under the Human Rights Act 1993 may in some settings be absolutely critical for the intelligent deployment of resources". ⁽⁵⁾  The benefits from such an improved deployment, which extend to consumers also, would go well beyond what would be picked up in the series for GDP.  It is because the gains arising from free choice, free contract and private initiative are varied, pervasive and widely diffused that the link with prosperity is so direct.

ENDNOTES

1.  This Annex draws on a review article of mine on the first main report of the Economic Freedom of the World Project, Economic Freedom of the World, 1975-95.  (Richard Wood, "Measuring Economic Freedom and Assessing Its Benefits", Agenda, Vol. 4, No. 2, 1997.)

2.  Financial Times, 12 June 1997.

3.  Reasons for doubting that the effects of Japanese governments' post-war industrial policies were significant and positive are set out in Ramesh Ponnuru, The Mystery of Japanese Growth, London:  Centre for Policy Studies, 1994.  In any case, British governments, regardless of party allegiance, pursued systematic activist industrial policies of various kinds right through these years and later.

4.  GDP figures are from OECD sources.  Admittedly, this may not be the most appropriate comparison:  because inward direct foreign investment has been so important in Ireland, and exceptionally low corporation taxes are in place for many of the firms involved, GNP per head, rather than GDP, might well be a better indication of performance.  But such an adjustment would still leave a wide gap between the two countries.

5.  Richard Epstein, Human Rights and Anti-discrimination Legislation, Wellington:  New Zealand Business Roundtable, 1996, p. 14.