Lane Kenworthy, The Good Society
September 2016

Economic freedom is the ability of people to engage in economic pursuits — producing, selling, and buying goods, services, and labor — as they choose. What is the role of economic freedom in a good society? How do we measure it? What is the relationship between economic freedom and economic affluence? Is a big government compatible with economic freedom?

Skip to:

• The role of economic freedom in a good society
• Measuring economic freedom
• Negative and positive liberty
• Affluence and economic freedom
• Government and economic freedom in rich nations

THE ROLE OF ECONOMIC FREEDOM IN A GOOD SOCIETY

Economic liberty often is promoted as a means to other valuable ends. Milton Friedman, one of economic liberty’s most forceful advocates, argued that it is key to economic growth, rising living standards, and political liberty.¹

Others rest the case for economic liberty on its intrinsic value. Amartya Sen, for instance, argues that the ability to pursue economic choices is one of the most important elements of human capability. We should value it as an end in itself, rather than solely or mainly as a means to other ends.²

Is individual liberty paramount? Few people think it should trump all other considerations. Virtually everyone supports government paternalism in the form of property protection, traffic lights, and food safety regulations, to mention just a few examples. And many people support public social programs. Once basic needs are met, people tend to want more security, greater opportunity, and enhanced fairness. They are willing to allocate some of their present and future income to guarantee these things, and they are willing to allow government to take on that task. Government social programs thus tend to expand in size and scope as nations grow richer.³

MEASURING ECONOMIC FREEDOM

The Heritage Foundation and the Wall Street Journal have created an economic freedom index that identifies ten dimensions of economic freedom, which can be grouped into three categories.⁴

Good government

• Secure property rights. Individuals are permitted to buy and sell property, and to profit from doing so. Privately-owned property is protected by law from theft and expropriation. Voluntary contracts are enforced. And some types of innovations are protected by copyright or patents.
• Low corruption. Bribery, extortion, nepotism, cronyism, patronage, embezzlement, graft, and other types of corruption impede pursuit of economic activity and exchange. Transparency, an effective legal regime, and strong norms help to limit corruption.
• Stable currency and market-determined prices (“monetary freedom”). High inflation reduces economic actors’ ability to plan for the future. Government wage or price controls interfere with the freedom of firms and workers to buy and sell as they choose.

Light regulation of economic activity⁵

• Ability to establish and run an enterprise (“business freedom”). Regulations (licensing requirements, safety rules, and others), subsidies to existing firms, and implicit guarantees of government bailout can impede the creation of new firms and the freedom of firms to operate as they choose.
• Ability to hire and fire employees and determine work hours and work conditions (“labor freedom”). Here impediments include rules governing hiring and work hours and restrictions on firing and working conditions. These restrictions may come from government or from collective bargaining with unions.
• Ability to import and export (“trade freedom”). The freedom to buy and sell should apply not only to goods and services produced domestically but also to those from abroad. Tariffs, quotas, and other restrictions impede this capability.
• Investment freedom. Governments and other economic actors sometimes place restrictions on the movement of capital. Some limits are needed to protect consumers and safeguard the financial system, but extensive restrictions impinge on the liberty of investors and of potential recipients of investment.
• Financial freedom. Equity markets and other financial markets require some regulation, particularly to ensure transparency and, again, to safeguard the stability and continuation of the financial system and the broader economy. But excessive intervention unnecessarily reduces choice.

Low taxes and government spending

• Low taxes (“fiscal freedom”). Taxes reduce individuals’ and firms’ ability to use their income and wealth as they choose.
• Low government spending. Government expenditures on goods, services, and transfers can crowd out opportunities for private enterprise.

NEGATIVE AND POSITIVE LIBERTY

Isaiah Berlin, in his essay “Two Concepts of Liberty,” famously distinguished between negative freedom and positive freedom.⁶ Negative freedom refers to the absence of restrictions on choice. Positive freedom refers to people’s capability to choose and act. Securing positive economic freedom may require reduction of negative freedom. For instance, establishment and enforcement of property rights reduces negative economic liberty. But that reduction is more than offset by the fact that property rights expand people’s capability to produce, buy, and sell. The same is true of bankruptcy laws, patent protection, public schooling, provision of infrastructure, and many other institutions.

There is no universal law that can tell us whether a particular institution or government policy will contract or expand economic freedom overall. We have to weigh the evidence on a case-by-case basis.

AFFLUENCE AND ECONOMIC FREEDOM

Economic freedom and economic affluence tend to go hand in hand, as freedom is likely to be conducive to economic growth and affluence is likely to promote greater economic freedom. Figure 1 shows per capita gross domestic product (GDP) and overall economic freedom as of 2016 in the 177 countries for which data are available. The positive correlation between the two is clear.

At the same time, it’s unlikely that the correlation is linear. For instance, economic affluence might boost economic freedom only once a certain threshold of affluence (GDP per capita) has been reached. Similarly, increases in economic freedom might not do much to boost economic growth until a country reaches a particular freedom threshold.⁷

It’s also possible that there is little impact once countries have reached a high level of affluence and/or freedom. Of particular interest here is the question of whether differences in freedom matter for economic growth in rich nations. Figure 2, which shows growth of GDP per capita over the period 1979 to 2007 by economic freedom, suggests no effect across 21 affluent democracies.

GOVERNMENT AND ECONOMIC FREEDOM IN RICH NATIONS

We might expect that in the world’s rich countries the three types of economic freedom would go together. But perhaps not. Affluent nations surely are more likely to have good government, but they may also tend to have high taxes and government spending, since as people get richer they tend to be willing to pay more for insurance and fairness. Furthermore, public insurance and regulation may be alternative routes to goals such as economic security and fairness; countries might opt for one or the other, rather than both.

Figure 3 shows country scores for good government on the horizontal axis and for light regulation on the vertical axis. Here we see a positive correlation. Rich countries with good government tend to use a comparatively light regulatory touch (upper-right corner), whereas those that do less well at securing the preconditions for economic freedom tend to regulate more heavily (lower-left corner).

Figure 4 has good government on the horizontal axis with low taxes and government spending on the vertical. Here we observe no correlation. Some countries with good government also have low taxes and public expenditures — Switzerland, Australia, and Canada, for example. But other good-government nations, such as Denmark, Sweden, and Finland, have high taxes and spending.

Figure 5 has light regulation on the horizontal axis and low taxes and spending on the vertical. Once again we see no correlation. Australia, Canada, and Switzerland are emblematic of a consistently high-liberty approach; they have modest regulation of economic activity and low taxes and government expenditures. But Denmark, and to a lesser extent Sweden, Belgium, the Netherlands, and a few others, feature light regulation coupled with heavy taxation and high public spending.

Denmark, in the lower-right corner of figure 5, is a particularly striking case. It has the least regulation among the 21 countries and the highest taxes and public spending. In this approach, sometimes referred to as “flexicurity,” government takes money from citizens and spends it to enhance economic security, opportunity, and fairness. In doing so, it reduces the freedom of individuals and firms to use their income as they please.⁸ Government also sets basic standards for worker and consumer protections, but for the most part it doesn’t tell economic actors how to meet those standards. The aim is to maximize individuals’ opportunities and to provide security for those who fail while impinging as little as possible on competition and flexibility. Economic freedom is abridged in one important respect, but is kept at a high level in another.⁹