Countries which rank high on economic freedom indices consistently outperform less free economies

Adam Smith, in his 1776 masterpiece, ‘An Inquiry into the Nature and Causes of the Wealth of Nations’, observed that for a nation to prosper, little else is required than to provide individuals with economic freedom. If economic freedom is provided, the rest of the requisites will be brought upon by the natural course of things.
On the other hand, for decades, democracy has also been accepted as the ultimate political system capable of bringing prosperity to a nation. Many have assumed that democratic governance leads to economic success because of its promise of free and fair elections, equal representation and civil and political liberties.
However, democracy cannot guarantee economic progress in the absence of economic freedom, which is characterised by the ability of individuals to make their own economic decisions, own property and participate in the voluntary exchange of goods and services. This is not to say that we should not strive for a democratic political system, but when it comes to economic development and prosperity, economic freedom plays a far more critical role than democracy.
So, what is economic freedom? It is the ability of individuals and firms to engage in economic activities without much ado from the government. Protection of property rights, rule of law, regulatory quality and efficiency, freedom to trade and fiscal responsibility are the fundamental tenets of economic freedom. Countries ensuring economic freedom tend to rank high in entrepreneurship and innovation, have a thriving private sector, and a robust legal framework that upholds contracts and protects property rights.
Democracy, on the other hand, is a system of governance that gives the masses political power to choose their rulers through regular, free, and fair elections. Basic tenets of democracy include civil liberties such as freedom of speech and association, the right to vote, and an independent judiciary. While democracy is an essential component of political freedom, it does not necessarily guarantee policies and institutions that ensure economic freedom.
Empirical evidence has consistently shown that there is a strong causal relationship between economic freedom and economic growth. Countries which rank high on economic freedom indices, such as the Heritage Foundation’s Index of Economic Freedom or the Fraser Institute’s Economic Freedom of the World Index, consistently outperform less free economies in terms of economic growth and prosperity.
Take, for example, the cases of Hong Kong and Singapore: these two economies, despite not being full-fledged democracies, have consistently shown remarkable economic growth and become high-income countries because they are among the most economically free countries in the world.
Furthermore, India is considered the world’s largest democracy. India has faced persistent economic challenges because it was too slow to reform the colonial-era economic and administrative system, which was full of bureaucratic inefficiencies, excessive regulations, and corruption. Only in recent years has India started experiencing rapid economic growth when it began to introduce market reforms and economic liberalisation, leading to more economic freedom.
Economic freedom enables people to innovate and succeed so that their profits can motivate them when starting new ventures. The regulatory costs are low, and property rights are secure in this context, implying that firms are in a better position to seize new opportunities and engage in risk-taking, which creates new employment in the economy.
On their part, political liberal democracies that involve enormous state interferences in the economic system, either through taxation or excessive bureaucracies and policies, may hamper creativity or restrict business openings.
Moreover, countries with a higher level of economic freedom have smaller governments, which take fewer taxes and have fewer market operation regulations. If governments make it their priority to sustain the rule of law and property rights and make sure that markets are fair and competitive, they stimulate growth.
On the other hand, democracies with large public sectors, too many welfare programmes, and high government consumption are less efficient, rife with corruption and slow-growing.
The polarisation of the two Koreas offers the best example of harbingers of armed confrontation underlining this point. Though North Korea does not allow any freedom of economy, South Korea has opened the gates to a free economic system. Today, South Korea has a highly developed economy, while in North Korea, famine and crises are still rampant.
Representative leaders are usually forced to implement policies that will positively address current short-term political power advantages at the cost of long-run economic stability. For instance, politicians from democratic countries are tempted to encourage subsidies, social welfare programmes or protectionism measures in order to win support from the electorate, even though these have negative effects on growth and development.Comparatively, countries that support economic liberty usually have policies favouring economic growth and development.
The Greek economic meltdown in the late 2000s is a good example. Greece’s democratic government made the mistake of spending too much on social welfare programmes, which led to its insolvency. This demand to meet voters’ immediate economic expectations weakened the stability of the economy.
Even though democracy is arguably one of the best political systems that provides civil liberties and representation in the political systems of the world, it does not guarantee economic development. Though it may sometimes go hand in hand with development, economic freedom is the driving factor behind the engine of prosperity.
The writer holds a PhD from Lee Kuan School of Public Policy, NUS Singapore, and currently teaches at the University of Kotli Azad Jammu and Kashmir
Published in Dawn, The Business and Finance Weekly, October 28th, 2024