|Why "Economic Freedom" Is Just Another Way of Saying "Headed for a Cliff"
By John Miller, Dollars and Sense
In "Capitalism in Crisis," his May op-ed in the Wall Street Journal,
U.S. Court of Appeals judge and archconservative legal scholar Richard
Posner argued that "a capitalist economy, while immensely dynamic and
productive, is not inherently stable." Posner, the long-time
cheerleader for deregulation, added, quite sensibly, "we may need more
regulation of banking to reduce its inherent riskiness."
That may seem like a no-brainer to you and me, right there in the
middle of the road with yellow lines and dead armadillos, as Jim
Hightower is fond of saying. But Journal readers were having none of
it. They wrote in to set Judge Posner straight. "It is not free
markets that fail, but government-controlled ones," protested one
And why wouldn’t they protest? The Journal has repeatedly told readers
that "economic freedom" is "the real key to development." And each
January the Journal tries to elevate that claim to a scientific truth
by publishing a summary of the "Index of Economic Freedom," an annual
report put out by the Heritage Foundation, Washington’s foremost
right-wing think tank. But Heritage’s index turns out to be a
barometer of corporate and entrepreneurial freedom from accountability
rather than a guide to which countries are giving people more control
over their economic lives and over the institutions that govern them.
This January was no different. "The 2009 Index provides strong
evidence that the countries that maintain the freest economies do the
best job promoting prosperity for all citizens," proclaimed this
year’s editorial, "Freedom is Still the Winning Formula." But with
economies across the globe in recession, the virtues of free markets
are a harder sell this year. That is not lost on Journal editor Paul
Gigot, who wrote the foreword to this year’s report. Gigot allows that
"ostensibly free-market policymakers in the U.S. lost their monetary
policy discipline, and we are now paying a terrible price." Still,
Gigot maintains that "the Index of Economic Freedom exists to
chronicle how steep that price will be and to point the way back to
What the Heritage report fails to mention is this: while the global
economy is in recession, many of the star performers in the Economic
Freedom Index are tanking. Fully one-half of the ten hardest-hit
economies in the world are among the 30 "free" and "mostly free"
economies at the top of the Index’s ranking of 179 countries.
Here’s the damage, according to the IMF. Singapore, the Southeast
Asian trading center and perennial #2 in the Index, will suffer a
10.0% drop in output this year. Number 4 Ireland, the so-called Celtic
tiger, has seen its rapid export-led growth give way to an 8.0% drop
in output. The foreign-direct- investment-favored Baltic states of
Estonia (#13) and Lithuania (#30) will each endure a 10.0% loss of
output this year. Finally, the economy of Iceland (#14), the loosely
regulated European banking center, will contract 10.6% in 2009.
As a group, the Index’s 30 most "free" economies will contract 4.1% in
2009. All of the other groups in the Index ("moderately free," "mostly
unfree," and "repressed" economies) will muddle through 2009 with a
much smaller loss of output or with moderate growth. The 67 "mostly
unfree" countries in the Index will post the fastest growth rate for
the year, 2.3%.
So it seems that if the Index of Economic Freedom can be trusted, then
Judge Posner was not so far off the mark when he described capitalism
as dynamic but "not inherently stable." That wouldn’t be so bad, one
Journal reader pointed out in a letter: "Economic recessions are the
cost we pay for our economic freedom and economic prosperity is the
benefit. We’ve had many more years of the latter than the former."
Not to Be Trusted
But the Index of Economic Freedom cannot and should not be trusted.
How free or unfree an economy is according to the Index seems to have
little do with how quickly it grows. For instance, economist Jeffery
Sachs found "no correlation" between a country’s ranking in the Index
and its per capita growth rates from 1995 to 2003. Also, this year’s
report cites North America as the "freest" world region, but it logged
the slowest average growth over the last five years, 2.7% per year.
The Asia-Pacific region, rated "less free" than every other region
except Sub-Saharan Africa, posted the fastest average growth over the
last five years, 7.8% a year. That region includes India, China, and
Vietnam, among the world’s fastest growing economies, which ranked
123, 132, and 145 respectively and were all classified as "mostly
unfree." And there are plenty of relatively slow growers among the
countries high up in the Index, including Switzerland (#9).
The Heritage Foundation folks who edited the Index objected to Sachs’
criticisms; their claim, they say, is that growth is tied to changes
in economic freedom, not the level of economic freedom. But even that
claim doesn’t hold up. Economic journalist Doug Henwood found that a
rising index ranking from 1997 to 2003 could explain no more than 10%
of GDP growth.
But even more fundamental flaws with the Index render any claim about
the relationship between prosperity and Heritage’s version of
"economic freedom" questionable. Consider just two of the ten
components used to rank countries: fiscal freedom and government size.
Fiscal freedom (what we might call the
"hell-if-I’m-going-to-pay-for-government" index) relies on the top
personal and corporate income tax brackets as two of its three
measures of the tax burden. These are decidedly flawed measures.
Besides ignoring the burden of other taxes, singling out these tax
rates doesn’t get at effective income tax rates, that is, how much of
a taxpayer’s total income goes to paying these taxes. For example, on
paper U.S. corporate tax rates are higher than those in Europe. But
nearly one-half of U.S. corporate profits go untaxed. The effective
rate of taxation on U.S. corporate profits currently stands at 15%,
far below the top official rate of 35%. And relative to GDP, U.S.
corporate income taxes are no more than half those of other OECD
Their third measure of fiscal freedom, government tax revenues
relative to GDP, bears little relationship to economic growth. After
an exhaustive review, economist Joel Selmrod, former member of the
Reagan Treasury Department, concludes that the literature reveals "no
consensus" about the relationship between the level of taxation and
The Index’s treatment of government size, which relies exclusively on
the level of government spending relative to GDP, is just as flawed.
First, "richer countries do not tax and spend less" than poorer
countries, reports economist Peter Lindhert. Beyond that, this measure
does not take into account how the government uses its money. Social
spending programs—public education, child care and parental support,
and public health programs—can make people more productive and promote
economic growth. That lesson is not lost on Hong Kong (#1) or
Singapore (#2). Both provide universal access to health care, despite
the small size of their governments.
The size-of-government index also misses the mark because it fails to
account for industrial policy. This is a serious mistake, because it
overestimates the degree to which some of the fastest growing
economies of the last few decades, such as Taiwan and South Korea,
relied on the market and underestimates the positive role that
government played in directing economic development in those countries
by guiding investment and protecting infant industries.
Beyond all that, the Index says nothing about political freedom.
Consider once again the two city-states, Hong Kong and Singapore,
which top their list of free countries. Both are only "partially free"
according to Freedom House, which the editors have called "the
Michelin Guide to democracy’s development." Hong Kong is still without
direct elections for its legislators or its chief executive, and
proposed internal security laws threaten press and academic freedom as
well as political dissent. In Singapore, freedom of the press and
rights to demonstrate are limited, films, TV and the like are
censored, and preventive detention is legal.
So it seems that the Index of Economic Freedom in practice tells us
little about the cost of abandoning free market policies and offers
little proof that government intervention into the economy would
either retard economic growth or contract political freedom. In
actuality, this rather objective-looking index is a slip-shod measure
that would seem to have no other purpose than to sell the neoliberal
policies that brought on the current crisis, and to stand in the way
of policies that might correct the crisis.
© 2009 Dollars and Sense All rights reserved.