November 30, 1999

November 30, 1999 | Commentary on Foreign Aid and Development

Expanding Economic Freedom

Why do some countries prosper while others do not? It's a question as old as Adam Smith's "The Wealth of Nations," and it's what we at The Heritage Foundation and The Wall Street Journal try to answer every year in the "Index of Economic Freedom," a country-by-country survey of economic freedom around the world.

The central finding of the Index is clear: Countries with the most economic freedom have higher rates of long-term economic growth and more prosperity than those with less economic freedom. By that measure, the 2000 edition of the Index contains good news: More countries expanded economic freedom during the past year (57) than curtailed it (34).

While countries that restrict economic liberty still outnumber those that allow it, governments in almost every region of the world have enacted policies that give their citizens a higher level of economic freedom and, over the long term, higher economic growth.

Perhaps surprisingly, the United States does not have the world's freest economy. We come in fourth place, behind Hong Kong, Singapore and New Zealand. Although it is now back under the control of Mainland China, Hong Kong -- with its non-existent trade barriers, strong protection of property rights, and 17 percent top marginal income tax rate -- is a model of economic freedom.

Other countries one would expect to do well on the Index because they have a track record of prosperity -- such as Germany, France and Sweden -- are actually further down the list. These countries will pay a price for imposing restrictions on economic freedom. Indeed, there is some evidence they already have, as unemployment rates in much of Western Europe hover above 10 percent.

The exceptions in Western Europe are Great Britain and Ireland, which are two of only 10 countries with economies rated "free" on the Index. This underscores another finding of the Index: that countries operating under a strong tradition of Anglo-American capitalism, with its emphasis on a well-functioning legal system and secure property rights, tend to outperform countries with electoral freedom but no "rule of law." Luxembourg and Switzerland, while not part of the Anglo-Saxon world per se, still hew to the Anglo model.

"People ... tend to undertake hard work and investments only if they have a reasonable probability of enjoying the fruits of their efforts," Harvard economics professor Robert Barro writes in the 2000 Index. "Thus, if property rights are insecure ... people tend to work less and invest little." Which explains why countries with British roots, such as the United States, Canada and Australia, tend to rank high, while Russia and most former Soviet states rank low.

Although several former communist countries improved last year -- led by Estonia, in 22nd place globally -- nearly all are rated "mostly unfree." Many have instituted capitalist reforms since the Cold War, but lacking economic freedom and the rule of law, they struggle with high levels of corruption. Free elections alone will do little to erase the effects of seven decades of central planning.

For years, U.S. foreign policy has promoted democracy around the globe as the best way to ensure economic prosperity. But according to Barro, a country's form of government is not the overriding factor for economic freedom that many U.S. officials assume it to be. Otherwise, a democracy such as Russia would rank higher than 122nd, and a monarchy such as Bahrain would rank lower than fourth.

The Index also demonstrates that low inflation can play a critical role in creating economic growth. This is certainly the case in Latin America, where more than a dozen countries from Mexico to Chile have expanded economic freedom for the third year in a row, again making this region the world's "most improved." Lower inflation helped El Salvador, the "Hong Kong of Latin America," tie with Chile for 11th place globally. Argentina, where inflation dropped from 3,000 percent in 1989 to less than 1 percent in 1998, is 17th. Brazil (110th) and Venezuela (94th) are crippled by inflation rates topping 45 percent.

Although Mexico saw its Index score rise in 1999, it remains "mostly unfree." Trade with its NAFTA partners has increased, but Mexico raised tariff rates last year and suffers from high levels of official corruption. As trade between the United States and Latin America climbs over the next several years, Mexico might find itself more of an obstacle than a conduit to the free flow of trade.

The Index proves that economic growth is no accident but the result of economic freedom. Without it, no country can bridge the gap from poverty to prosperity.

Gerald P. O'Driscoll, a former Federal Reserve vice president and co-editor of the 2000 "Index of Economic Freedom," is a senior fellow in economic policy at The Heritage Foundation. Copies of the Index can be ordered by calling 1-800-975-8625.

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