The Cato Institute's 2007 annual report on Economic Freedom of the World has just been published. The report measures "economic freedom" based on the following:
- Size of Government: Expenditures, Taxes, and Enterprises
- Legal Structure and Security of Property Rights
- Access to Sound Money
- Freedom to Trade Internationally
- Regulation of Credit, Labor, and Business.
The report is full of interesting data, but has to be handled with care. In fact, I look forward to the report every year because it gives me plenty of new evidence to play with (many of which run counter to the conclusions that the report's authors want to draw).
Here is a predictable chart, which shows that richer countries have more "economic freedom."
No surprise here.
And here is one that shows that the relationship between economic growth and Cato's index of economic freedom rates is--well, leaving out the basket cases (the bottom quartile), there is no determinate relationship.
How do we make sense of this?
I don't think we should be surprised. What the second picture reveals is the tremendous variance in economic performance among countries that pass a minimum threshold of market-orientedness. In these countries, the pursuit of ever freer markets is rarely the most appropriate government strategy. The binding constraint often lies elsewhere, and may involve more government rather than less.
A good example is El Salvador, a country that is second only to Chile in Cato's rankings of economic freedom in Latin America. (Please don't get me started on Chile's industrial policies again...) The Salvadoran economy is totally privatized, has free trade and free finance, and is dollarized. Yet it has languished in low-growth hell, and would have been in even worse dire straits if it did not receive a huge amount of remittances from Salvadorans in the U.S.
El Salvador is a prime example of the "build-it-and-they-will-come" fallacy: all you need to do is to get the basics right, and then markets will do the rest. (The analogy is Larry Summers'.) All successful countries have instead required their governments to crowd in private economic activity through inducements of various kinds. Ricardo Hausmann and I make the specific case for El Salvador here.