Growth theories and their application to the beloved country

Governing the market?

Even so, the 20th century has produced enough evidence to make possible general statements about the conditions under which economic development is most (and least) likely to take place. Controlled laboratory experiments may rarely be feasible when humans are involved, but the course of history has produced massive de facto experiments, at enormous cost to those who were involved without their consent, but which have produced fairly conclusive evidence about how economies grow. This of course refers to the so-called socialist experiment, the most massive venture in social engineering in history, and also the most resounding failure.

        When in 1917 the Bolsheviks seized power in Russia they could count on plenty of sympathy and support in the capitalist countries of Western Europe. It was only a major punctuation in an intellectual trend which held that the market was incapable of achieving certain objectives. Throughout most of the 20th century the state tended to encroach on the territory of the market. The authors of a recent account of “the battle between government and the marketplace”, have succinctly summarised the course of events and the reasons why it happened as it did: The state’s “victories were propelled by revolution and two world wars, by the Great Depression, by the ambitions of politicians and governments. It was also powered by the demands of the public in the industrial democracies for greater security, by the drive for progress and improved living conditions in developing countries – and by the quest for justice and fairness. Behind all this was the conviction that markets went to excesses, that they could readily fail, that there were too many needs and services they could not deliver, that the risks and the human and social costs were too high and the potential for abuse too great” (Yergin and Stanislaw, p.11).

        The trend has been reversed. It had to wait till the end of the 20th century, but the turning-back of the interventionist tide appears decisive, so much so that debate about the relative merits of socialism and capitalism comes across as proof of intellectual backwardness and plain ignorance of facts which can no longer be denied.

Analysis and insight – and some data

Believers in free markets had of course “known” for a long time that economic freedom was more conducive to economic prosperity than planning and state ownership. But intuitively plausible as this may have seemed, there was no general agreement about how economic freedom should be defined and measured. And there was also a lack of data which applied across enough countries over long enough time periods to show the close links between economic freedom and economic growth.

        These gaps have now very substantially been filled. Within half a decade the results of scholarly research have been coming in at a steady pace; they have shown that liberty and prosperity keep close company. The pioneering effort wasEconomic Freedom of the World: 1975-1995 by James Gwartney, Robert Lawson and Walter Block. Co-published in 1996 by 11 economic institutes around the world, the study was the outcome of a series of six conferences sponsored by the Fraser Institute of Vancouver and the Liberty Fund of Indianapolis between 1986 and 1993. The 62 conference participants included some of the world’s top economists, including three winners of the Nobel Prize.

        On the basis of its examination of 102 countries over a 20-year period, the study compiled an index which measured ways in which governments restrict economic freedom. The index had 17 components, which shows that economic freedom is a many-sided thing. It is not simply reflected by the amount of public spending relative to GDP, or by the degree of state ownership of industry. These do enter the index, but it also includes price controls, industrial regulation, exchange controls, the level and impact of marginal tax rates, the level and variability of inflation, subsidies and transfers between citizens as a share of GDP, and the presence of conscription. They come down to some broad questions. Does government protect the money in your pocket from eroding in value through inflation? To what degree does government decide what should be produced and consumed? To what extent does government take from you to give to others? How free are you to enter into dealings with foreigners?

        The authors of the study rated the 102 countries on each of the components on a scale of 0-10. Zero meant complete unfreedom relating to the measure involved, and 10 amounted to total freedom. Once the ratings had been obtained, the authors had to decide what weight to apply to each. For instance, did strict exchange controls matter more for economic freedom than high marginal tax rates? As it was unlikely that they all mattered equally, the authors of the study decided to rely on a survey of the views of the 62 economists who attended the six conferences between 1986 and 1993.

        The findings of the study were emphatic. They showed that countries with the most economic freedom grew most rapidly over the 20-year period, ie, at an average of 3.3% per annum per capita GDP. So rapid growth was reflected in higher income levels. By the same token, countries with the lowest level of economic freedom achieved in 1994 the lowest level of GDP, viz. $1 650 per capita in 1985 dollars.

        As the authors put it: “There were no exceptions – every nation that significantly improved its rating also achieved solid economic growth. On the other hand, economies that moved away from economic freedom were characterised by sluggish growth and decline”.

Author: Henry Kenney – This article is an extract from FMF Monograph 31 "Growth theories and their application to the beloved country" and may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Free Market Foundation.



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