Skip to main content
SpringerLink
Log in

Economic freedom and growth. Which policies matter the most?

  • Original Paper
  • Published:
Constitutional Political Economy Aims and scope Submit manuscript

Abstract

Empirical studies provide evidence that economic freedom, as measured by the Economic Freedom of the World Index, is related to economic growth. None the less, identifying which aspects of economic freedom are more conducive to growth has proven difficult, due to multicollinearity among the index areas. A possible explanation is that certain countries score high in all areas, whereas others tend do bad in all of them, simply because the former are more freedom-friendly than the latter. However, it is also true that each country presents a combination of freedoms, and restrictions to freedom, at the level of the individual indicators that make up each area. If some regularity exists with respect to these combinations, empirical detection of the most popular policy combinations would alleviate the collinearity problem, when assessing growth effects. Our article explores this possibility by means of cluster analysis, which we conduct at the individual indicator level. We show that multicollinearity can indeed be reduced in this way and identify policy packages that seem to be more conducive to economic growth than others. Results further indicate that certain policy packages may have only a short-term effect on growth, whereas others seem to have an enduring one.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Similar content being viewed by others

Notes

  1. Along with different collaborators, Gwartney and Lawson (2001, 2002), Gwartney et al. (1996) have successively added more variables to their index and changed the areas a number of times. For a historical overview, Heckelman and Stroup (2005), as well as de Haan et al. (2006) offer a detailed and critical discussion on the past and present versions. According to the latter, some of the EFW versions are quite different when measured by rank correlation coefficients, reflecting the underlying changes that have been made in the index. Consequently, when comparing results from different studies on the relation between the EFW Index and growth rates, one has to consider carefully which version the authors are eventually using in each study, since this could make a substantial difference.

  2. In what follows we dispense with the bulky literature focused on the growth effects of the size of the public sector, written outside the framework of the economic freedom indices. On this, see Bergh and Henrekson (2011) as well as Coll (forthcoming).

  3. Other authors have resorted to theory in order to rearrange the EFW Index and, typically, to purge it from some of its components. Thus, de Haan and Sturm (2000) resorted to definitions by North (1981) to differentiate between variables that measure rules from those that measure outcomes. On these grounds, they purged the EFW Index from tax rates, government consumption variables and conscription, to produce their own version of the Index. A similar move in this same direction was recently made by Kapás and Czeglédi (2008), who also purge the EFW Index of certain variables. These authors let themselves be guided by a concept of economic freedom as defined by Hayek (1960), regrouping the EFW Index into freedom related variables, policy variables, and other variables.

  4. De Haan and Siermann (1998), de Haan and Sturm (2000), like Sturm et al. (2002) only find the period increase to exert a positive impact on growth rates. Dawson (1998), Weede and Kämpf (2002), Pitlik (2002), and Doucouliagos and Ulubasoglu (2006) maintain that the increase in economic freedom is the principal cause of GDP growth, but they also find the relationship between the economic freedom level and growth to be positive and significant. Finally, Easton and Walker (1997), like Heckelman and Stroup (2000), Ali and Crain (2001, 2002), Cole (2003), Gwartney et al. (2004), and Weede (2006) encounter the level of economic freedom to be the main cause of growth, even though the increase in economic freedom also has a positive effect.

  5. The idea that the full effect cannot be immediately felt is appealing, and those contributions that use cross sectional analysis currently take periods of 5 years or more as their time units. The use of such long periods somewhat alleviate the need of estimating time lags, but the fact remains that we still don’t know how long does it take for the effects of changes in economic freedom to operate. According to Chong and Calderón (2000) or Gwartney et al. (2004, 2006), these effects are highest after 10 years or so. However, this conclusion is entirely based on the sizes of lagged coefficients, which may be influenced by other factors.

  6. A possible solution to this problem is estimating the effects of economic freedom on investment, although this leads to the next problem of formulating a proper equation for investment. Evidence is mixed up to date: While de Haan and Siermann (1998) claim that investment is not related to their indicator of economic freedom, Gwartney et al. (2004, 2006), Dawson (2006), Justesen (2008), and Aixalá and Fabro (2009) state that economic freedom has a positive influence on the investment rate. Gwartney et al. (2004, 2006) have tried to estimate the total growth effect (i.e., direct plus indirect) of economic freedom, but further research seems to be necessary to clarify this issue.

  7. Total GDP in constant (year: 2000) US$. Source: The World Bank.

  8. The idea that inspired such an attempt was that a country with a higher total GDP also has greater power in the world economy. Furthermore, it is possible that economically powerful countries create a model that other nations might want to imitate, in order to be economically successful themselves. Therefore, the global influence exercised by countries with a higher total GDP on what is defined as economic freedom should be greater.

  9. Even authors that heavily criticize the theories of Lynn and Vanhanen (2002) on the heritability of intelligence agree that a correlation between their average national IQ estimates and GDP per capita exists (Whetzel and McDaniel 2006). Hunt and Wittmann (2008) conclude that although the Lynn and Vanhanen data set contains questionable points, their empirical conclusion, that there is a strong statistical relationship between GDP per capita and IQ, is correct.

  10. In addition, we have run another eight sets of analogous regressions, where we have split the whole period into 5 year sub-periods with no time overlap whatsoever. The results do not change and therefore support our standpoint. For reasons of space, these are not shown, but they are available from the authors upon request.

  11. These results are not shown for reasons of space, but they are available from the authors upon request.

  12. The list comprises, among others, Kormendi and Meguire (1985), Grier and Tullock (1989), de la Fuente (1997), Angelopoulos and Philippopoulos (2007), and Coll (forthcoming).

References

  • Aixalá, J., & Fabro, G. (2009). Economic freedom, civil liberties, political rights and growth: A causality analysis. Spanish Economic Review, 11, 165–178.

    Article  Google Scholar 

  • Alesina, A., Devleeschauwer, A., Easterly, W., Kurlat, S., & Wacziarg, R. (2003). Fractionalization. Journal of Economic Growth, 8, 155–194.

    Article  Google Scholar 

  • Ali, A. M., & Crain, W. M. (2001). Political regimes, economic freedom, institutions, and growth. Journal of Public Finance and Public Choice, 19, 3–21.

    Google Scholar 

  • Ali, A. M., & Crain, W. M. (2002). Institutional distortions, economic freedom, and growth. Cato Journal, 21, 415–426.

    Google Scholar 

  • Angelopoulos, K., & Philippopoulos, A. (2007). The growth effects of fiscal policy in Greece 1960–2000. Public Choice, 131, 157–175.

    Article  Google Scholar 

  • Atlas Narodov, Mira. (1964). Moscow: Miklukho-Maklai Ethnological Institute at the Department of Geodesey and Cartography of the State Geological Committee of the Soviet Union.

  • Ayal, E. B., & Karras, G. (1998). Components of economic freedom and growth. The Journal of Developing Areas, 32, 327–338.

    Google Scholar 

  • Barro, R. J. (1991). Economic growth in a cross section of countries. The Quaterly Journal of Economics, 106(2), 407–443.

    Article  Google Scholar 

  • Belsley, D. A., Kuh, E., & Welsch, R. E. (1980). Regression diagnostics: Identifying influential data and sources of collinearity. New York: Wiley.

    Book  Google Scholar 

  • Berggren, N. (2003). The benefits of economic freedom. A Survey. The Independent Review, 8, 193–211.

    Google Scholar 

  • Berggren, N., & Jordahl, H. (2005). Does free trade really reduce growth? Further testing using the economic freedom index. Public Choice, 122, 99–114.

    Article  Google Scholar 

  • Bergh, A., & Henrekson, M. (2011). Government size and growth: A survey and interpretation of the evidence. Journal of Economic Surveys, 25(5), 872–897. First published online 07 June 2011.

    Google Scholar 

  • Carlsson, F., & Lundström, S. (2002). Economic freedom and growth: Decomposing the effects. Public Choice, 112, 335–344.

    Article  Google Scholar 

  • Chong, A., & Calderón, C. (2000). Causality and feedback between institutional measures and economic growth. Economics and Politics, 12, 69–81.

    Article  Google Scholar 

  • Cole, J. H. (2003). The contribution of economic freedom to world economic growth, 1980–99. Cato Journal, 23, 189–198.

    Google Scholar 

  • Coll, S. (forthcoming). Leviathans in the mist. Is there too much government in OECD countries? Cato Journal.

  • Coyne, C. J., & Sobel, R. S. (2010). How are institutions related? Economic Freedom of the World: 2010 Annual Report, 163–174.

  • Dawson, J. W. (1998). Institutions, investment, and growth: New cross-country and panel data evidence. Economic Inquiry, 36, 479–495.

    Article  Google Scholar 

  • Dawson, J. W. (2003). Causality in the freedom growth relationship. European Journal of Political Economy, 19, 479–495.

    Article  Google Scholar 

  • Dawson, J. W. (2006). Regulation, investment, and growth across countries. Cato Journal, 26, 489–509.

    Google Scholar 

  • De Haan, J., Lundström, S., & Sturm, J. E. (2006). Market-oriented institutions and policies and economic growth: A critical survey. Journal of Economic Surveys, 20, 157–191.

    Article  Google Scholar 

  • De Haan, J., & Siermann, C. L. J. (1998). Further evidence on the relationship between economic freedom and economic growth. Public Choice, 95, 363–380.

    Article  Google Scholar 

  • De Haan, J., & Sturm, J. E. (2000). On the relationship between economic freedom and economic growth. European Journal of Political Economy, 16, 215–241.

    Article  Google Scholar 

  • de la Fuente, A. (1997). Fiscal policy and growth in the OECD. London: Centre for Economic Research Discussion paper nº. 1755.

    Google Scholar 

  • Doucouliagos, C., & Ulubasoglu, M. (2006). Economic freedom and economic growth: what difference does specification make? European Journal of Political Economy, 22, 60–81.

    Article  Google Scholar 

  • Easton, S. T., & Walker, M. A. (1997). Income, growth, and economic freedom. The American Economic Review, 87, 328–332.

    Google Scholar 

  • Fox, J. (1991). Regression diagnostics. London: Sage Publications.

    Google Scholar 

  • Friedman, M. (1962). Capitalism and freedom. Chicago: Chicago University Press.

    Google Scholar 

  • Gallup, J. L., Sachs, J. D., & Mellinger, A. D. (1999). Geography and economic development. CID Working Paper No. 1.

  • Grier, K. B., & Tullock, G. (1989). An empirical analysis of cross-national economic growth, 1951–80. Journal of Monetary Economics, 24, 259–276.

    Article  Google Scholar 

  • Gwartney, J., Hall, J., & Lawson, R. (2010). Economic freedom of the world. 2009 annual report. Vancouver: The Fraser Institute.

  • Gwartney, J., Holcombe, R. G., & Lawson, R. (2004). Economic freedom, institutional quality, and cross-country differences in income and growth. Cato Journal, 24, 205–233.

    Google Scholar 

  • Gwartney, J., Holcombe, R. G., & Lawson, R. (2006). Institutions and the impact of investment on growth. Kyklos, 59, 255–273.

    Article  Google Scholar 

  • Gwartney, J., & Lawson, R. (2001). Economic freedom of the world. 2001 annual report. Vancouver: The Fraser Institute.

  • Gwartney, J., & Lawson, R. (2002). Economic freedom of the world. 2002 annual report. Vancouver: The Fraser Institute.

  • Gwartney, J., Lawson, R., & Block, W. (1996). Economic freedom in the world, 1975–1995. Vancouver: The Fraser Institute.

    Google Scholar 

  • Hall, R. E., & Jones, C. I. (1996). The productivity of Nations. NBER Working Paper No. 5812.

  • Hanushek, E. A., & Woessmann, L. (2008). The role of cognitive skills in economic development. Journal of Economic Literature, 46(3), 607–688.

    Article  Google Scholar 

  • Hayek, F. A. (1960). The constitution of liberty. Chicago: The University of Chicago Press.

    Google Scholar 

  • Heckelman, J. C., & Stroup, M. D. (2000). Which economic freedoms contribute to growth? Kyklos, 53, 527–544.

    Article  Google Scholar 

  • Heckelman, J. C., & Stroup, M. D. (2005). A comparison of aggregation methods for measures of economic freedom. European Journal of Political Economy, 21, 953–956.

    Article  Google Scholar 

  • Hunt, E., & Wittmann, W. (2008). National intelligence and national prosperity. Intelligence, 36, 1–9.

    Article  Google Scholar 

  • Jones, G., & Schneider, W. J. (2006). Intelligence, human capital, and economic growth: A bayesian averaging of classical estimates (BACE) approach. Journal of Economic Growth, 11, 71–93.

    Article  Google Scholar 

  • Justesen, M. G. (2008). The effect of economic freedom on growth revisited: New evidence on causality from a panel of countries 1970–1999. European Journal of Political Economy, 24, 642–660.

    Google Scholar 

  • Kapás, J., & Czeglédi, P. (2008). Economic freedom in terms of kinds of government actions: An empirical investigation. The International Society for New Institutional Economics (ISNIE), 12th Annual Conference, University of Toronto.

  • Klein, L. R. (1962). An introduction to econometrics. Englewood Cliffs: Prentice-Hall.

    Google Scholar 

  • Kormendi, R. C., & Meguire, P. G. (1985). Macroeconomic determinants of growth. Cross-country evidence. Journal of Monetary Economics, 16, 141–163.

    Article  Google Scholar 

  • Leschke, M. (2000). Constitutional choice and prosperity: A factor analysis. Constitutional Political Economy, 11, 265–279.

    Article  Google Scholar 

  • Lopez, J. H. (2004). Pro-poor growth: a review of what we know (and of what we don’t). The World Bank. PREM Poverty Group.

  • Lynn, R., & Vanhanen, T. (2002). IQ and the wealth of Nations. Westport, Connecticut, London: Praeger.

    Google Scholar 

  • Manly, B. F. J. (1989). Multivariate statistical methods. A primer. New York, London: Chapman and Hall.

    Google Scholar 

  • North, D. C. (1981). Structure and change in economic history. New York: Norton & Co.

    Google Scholar 

  • North, D. C., & Thomas, R. P. (1973). The rise of the Western World. A new economic history. Cambridge, London, New York, New Rochelle, Melbourne, Sydney: Cambridge University Press.

    Book  Google Scholar 

  • Pitlik, H. (2002). The path of liberalization and economic growth. Kyklos, 55, 57–80.

    Article  Google Scholar 

  • Rindermann, H., & Thomson, J. (2011). Cognitive capitalism: The effect of cognitive ability on wealth, as mediated through scientific achievement and economic freedom. Psychological Science, 22, 754–763.

    Article  Google Scholar 

  • Romer, P. M. (1990). Endogenous technological change. Journal of Political Economy, 98, 71–102.

    Article  Google Scholar 

  • Romesburg, H. C. (1984). Cluster analysis for researchers. Belmont, CA: Lifetime Learning Publication.

    Google Scholar 

  • Sachs, J. D. (2001). Tropical underdevelopment. NBER Working Paper No. W8119.

  • Sachs, J. D., & Warner, A. M. (1995). Natural resource abundance and economic growth. NBER Working Paper No. 5398.

  • Sala-i-Martin, X. (1997). I just ran two million regressions. The American Economic Review, 87, 178–183.

    Google Scholar 

  • Sala-i-Martin, X. (2006). The world distribution of income: Falling poverty and… convergence, period. The Quarterly Journal of Economics, 121, 351–397.

    Article  Google Scholar 

  • Sala-i-Martin, X. (2007). Global Inequality fades as the global economy grows. 2007 Index of Economic Freedom. The Heritage Foundation and Wall Street Journal.

  • Solow, R. (1956). A contribution to the theory of economic growth. Quarterly Journal of Economics, 70, 65–94.

    Article  Google Scholar 

  • Sturm, J. E., Leertouwer, E., & de Haan, J. (2002). Which economic freedoms contribute to growth? A comment. Kyklos, 55, 403–416.

    Article  Google Scholar 

  • Weede, E. (2006). Economic freedom and development: New calculations and interpretations. Cato Journal, 26, 511–524.

    Google Scholar 

  • Weede, E., & Kämpf, S. (2002). The impact of intelligence and institutional improvements on economic growth. Kyklos, 55, 361–380.

    Article  Google Scholar 

  • Whetzel, D. L., & McDaniel, M. (2006). Prediction of national wealth. Intelligence, 34, 449–458.

    Article  Google Scholar 

Download references

Acknowledgments

The authors thank the following persons for having made helpful comments: Niclas Berggren, Judith Clifton, Sven-Olov Daunfeldt, Daniel Díaz, Marcos Fernández-Gutierrez, Kevin Grier, James Gwartney, Santiago Lago, Felix Meier zu Selhausen, Julio Revuelta, Carmen Trueba and Erich Weede, as well as three anonymous referees. Preliminary versions of this paper were presented at the following conferences: The 2010 Annual Meeting of the Public Choice Society in Monterey, CA, the 2010 Annual Meeting of the European Public Choice Society in Izmir, Turkey, and the 2010 Annual Conference of the International Society for New Institutional Economics in Stirling, UK. Martin Rode would also like to thank the Spanish Ministry of Education for financial support in the framework of an FPU scholarship.

Author information

Authors and Affiliations

  1. Department of Economics, University of Cantabria, Av. de Los Castros s./n., 39005, Santander, Spain

    Martin Rode & Sebastian Coll

  2. Department of Economics, Florida State University, Tallahassee, FL, 32306, USA

    Martin Rode

Authors
  1. Martin Rode
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Sebastian Coll
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Sebastian Coll.

Appendix

Appendix

Country list for regression

Albania

Japan

Argentina

Jordan

Australia

Kenya

Austria

Korea, Rep.

Bangladesh

Latvia

Belgium

Lithuania

Bolivia

Mexico

Botswana

Netherlands

Brazil

New Zealand

Bulgaria

Nicaragua

Canada

Norway

Chile

Pakistan

Colombia

Panama

Costa Rica

Paraguay

Croatia

Peru

Czech Rep.

Philippines

Denmark

Poland

Dominican Rep.

Portugal

Ecuador

Romania

Estonia

Russia

Finland

Singapore

France

Slovak Rep

Germany

Slovenia

Greece

South Africa

Honduras

Spain

Hong Kong

Sweden

Hungary

Switzerland

Iceland

Thailand

India

Tunisia

Indonesia

Turkey

Ireland

United Kingdom

Israel

United States

Italy

Uruguay

Jamaica

Venezuela

See Tables 11 and 12.

Table 11 Estimation results for the EFW Index areas (initial level)
Full size table
Table 12 Estimation results for the new clusters (initial level)
Full size table

Rights and permissions

Reprints and permissions

About this article

Cite this article

Rode, M., Coll, S. Economic freedom and growth. Which policies matter the most?. Const Polit Econ 23, 95–133 (2012). https://doi.org/10.1007/s10602-011-9116-x

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10602-011-9116-x

Keywords

JEL Classification

Search

Navigation