Jonathan Barazzutti

There are a near infinite number of possible policy debates that could occur about every minute detail of how an economy should be run. While these debates are necessary, they present a challenge as the finite amount of knowledge that anyone has inhibits them from having definitive answers to what the optimal policy should be.

That is why at some point we need broad-level heuristics when we think about economic policy, or any policy for that matter. One great example of this is the concept of economic freedom. Economic freedom looks at the degree to which a country’s economy runs on free market principles and the protection of private property. Both the Heritage Foundation in the United States and the Fraser Institute in Canada have indices that attempt to measure how economically free countries are around the world. With this quantification of relatively abstract principles, it becomes possible to empirically study the effect of economic freedom on a variety of outcomes that we would consider valuable. And many empirical studies have been done utilizing these measures.

In 2013, the economists Joshua Hall and Robert Lawson conducted a literature review of 198 studies using the index as an independent variable in an empirical study. They found that over two-thirds of the studies examined found economic freedom to correspond to a “good” outcome, and less than 4 percent found it to correspond to a “bad” outcome. The 4 percent marked as corresponding to a bad outcome generally either suggested that economic freedom was associated with increased inequality, or indicated that regulations in some contexts can help reduce caloric intake or obesity. However, the overwhelming majority of studies found economic freedom to be associated with good outcomes, and many of the findings in the 4 percent are contradicted by the broader literature.

In fact, a more recent quantitative literature review by Lawson and other colleagues found that if anything, research overall suggests that higher economic freedom reduces inequality. However, due to significant heterogeneity in the results, the researchers concluded that economic freedom probably had zero net effect on inequality. The evidence suggesting that pro-market policies are overall associated with good outcomes with few to no tradeoffs is staggering.

Breaking it down by outcomes, on the macroeconomic side economic freedom is associated with higher economic growth, increased innovation, lower unemployment, higher labor force participation and employment-population ratios, and lower debt risk. On the welfare economics side, economic freedom is associated with lower poverty and increased social mobility. Regarding quality of life indicators, economic freedom is associated with greater happiness, higher subjective well-being, longer life expectancy, and greater health, education, and disease prevention. Finally, regarding civil society measures, economic freedom is associated with less government corruption and greater political freedom.

While all of this speaks spectacularly for economic freedom, it must be noted that this is an assessment of economic freedom in general, and thus will mask significant variation between different policies or factors that go into economic freedom. It is clear from this research that an extreme degree of government control over the economy through a mix of centralized planning, heavy regulation, and state ownership would lead to adverse outcomes. However, that doesn’t mean that every instance of government involvement in the economy is necessarily negative.

For example, I think there’s still a case to be made for making primary education universal and especially making healthcare universal, both aims which would require some level of state involvement in the economy. Similarly, there is still room for some degree of social spending. As I’ve argued in my article “On the Optimization of Social Services”, some forms of social spending would actually pay for themselves and thus generate positive economic growth. Other social spending beyond that can be valuable if it reduces poverty, although care must be taken to ensure that it is not excessive.

Another example where government intervention may be valuable is in the context of large-scale pollution issues. Economic freedom, while often being able to deal with localized pollution problems, cannot address pollution issues present at a global scale, such as CO2 emissions. When the consequences of pollution are not immediately felt by a local community, markets left to their own devices have no incentive to internalize the externality, and collective action problems inhibit any private agent from trying to address it.

A final example is quantitative easing done to support recovery during recessions, a policy measure that has been found to boost economic growth. While the extremely high debt-to-GDP ratios seen in countries like Canada are probably harmful in the long-run, having a budget deficit during recessions and a budget surplus during expansions would help to stabilize the economy during times of crisis while balancing the budget in the long-run. Most budget deficits today appear to be run irrespective of current macroeconomic conditions within the country, and thus risk stunting growth in the long run. Still, some deficits can serve positive purposes depending on the context.

While the relationship isn’t absolute, the evidence on economic freedom strongly suggests that extreme government control over the economy is detrimental, even if some level of regulation can be positive. It thus demonstrates that economic systems such as state-planned socialism would ultimately do more harm than good. Research on economic freedom can’t tell us exactly how to manage our economy, but it serves as a useful heuristic for when policy might be heading in a good direction, and when it might not be.