Freedom & growth: No Siamese twins

HOW dependent is prosperity on economic freedom? The Heritage Foundation and Wall Street Journal compile annually an Economic Freedom Index.

This is based on 50 different economic variables grouped into 10 categories — banking and finance, capital flows and foreign investment, fiscal burden, trade policy, wages and prices, government intervention, property rights, regulation, and black market activity.

The results for 2003 are paradoxical, and do not vindicate either the extreme right or extreme left.

1. India is mostly unfree. Of the 156 countries ranked, India occupies joint 119th position, and is categorised as “mostly unfree.” It is rated rock bottom in trade policy (high import tariffs), and rated very poor in regard to the fiscal deficit, banking restrictions, government regulations and the black market.

When economic reform began in 1991, many Indian leftists accused the government of liberalising much too fast. Well, a decade later, the verdict is that India remains mostly unfree. I have long complained that we have had only half-baked reform. According to the Economic Freedom Index, I exaggerate; we have no more than quarter-baked reform.

2. India is freer than China. People who think China has run far ahead of us are in for a shock. China occupies 127th position in the rankings, well below India. In many ways China is indeed more free than India, especially in its special economic zones, but it has a myriad of constraints elsewhere. Virtually all the companies listed in the Shanghai stock exchange are government companies. China’s banking system is even more controlled and more bankrupt than our own.

3. The fastest growing countries are mostly unfree. The Heritage Foundation claims that economic freedom equals prosperity. It says per capita income averages $3,400 in the “mostly unfree” category, $12,569 in the “mostly free”, and $26,855 in the “free” category, comprising ten rich countries. However, a closer look at the rankings dispels the notion of a simple correlation.

Three of the fastest-growing countries in the world — China, India and Vietnam — are way down in the rankings, at positions 119, 127 and 135 respectively.

In all three, economic liberalisation has played a major role in producing rapid growth. All three have become front-runners in the race for growth despite a heavy burden of remaining controls. There is more to growth than absence of controls.

Other countries occupying joint 119th position with India include Ethiopia, Bangladesh, Turkey, Venezuela and Zambia. The Economic Freedom Index may show that in some statistical sense all these countries are equally unfree, but certainly all are not equally prosperous, nor do they grow equally fast.

4. Many relatively free countries are relatively slow growers. Some of the countries listed high up in the index of freedom have not enjoyed rapid growth. The Czech Republic averaged just 0.9% annual GDP growth in 1990-2000, yet is ranked 35th, jointly with Japan and ahead of France (40th). Armenia averaged a decline in GDP of 1.9% annually in that decade, yet occupies 44th position jointly with Hungary (1.5% growth). Jamaica (56th position) has averaged only 0.5% growth.

5. The economic travails of the former Soviet Union were not due to excessive economic freedom. From being a superpower, the countries comprising the former Soviet Union crashed in economic terms in the 1990s, and some have barely got back to their 1990 levels of income.

Many critics have blamed this on an excessively rapid pace of economic liberalisation. But the Index of Economic Freedom reveals a very different picture.

Ukraine ranks 131st, Russia 135th, Tajikistan 143th, Turkmenistan 146th, Uzbekistan 149th and Belarus 151st. Whatever else you might say about the follies and policies of Russia and other members of the ex-Soviet Union, excessive freedom has simply not been the problem.

The disaster economies are all notably unfree, notwithstanding the freeing of most prices and privatisation of some companies.

6. The fastest growing parts of the former Soviet Union are the most free. The notably fast-growing fragments of the former superpower are the three Baltic states. Of these Estonia occupies 6th position in the Freedom Index, Lithuania 29th and Latvia 33rd.

Remember that these were swallowed up by the Soviet Union as recently as World War II, and so retained an institutional memory of markets, which helped greatly when they opened up in the 1990s. This, alas, was not true of the Soviet heartland, where the revolution of 1917 wiped out all institutional knowledge and traditions of markets for eight decades before the fall of communism.

Like the Baltic states, the communist countries of Eastern Europe were also bludgeoned into the Soviet orbit as recently as World War II, and so retained an institutional memory of markets. They too managed the transition to capitalism much better. Clearly, institutions and history matter.

The conclusion: there are no easy or simple links between economic freedom and growth. Some kinds of government intervention (complex and corrupt controls and procedures) can greatly slow down growth, but other interventions (universal education, good infrastructure, good governance) are essential for growth. Merely being an open economy (like some African sluggards) is not good enough: you need institutions that facilitate entrepreneurship and dynamism. The experience of China, India and Vietnam shows that the direction of liberalisation seems far more important than its absolute level.

Above all, it seems that many very different paths can lead to success. So much depends on local traditions and history that no single blueprint will succeed everywhere, and freedom to experiment and innovate seems to be vital. India has been well served by its historical mercantile traditions, by the diversity of regimes in different states that allows for experimentation. And it has benefited from the right direction in policy, no matter that this is only quarter-baked.