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Correlation Between Economic Freedom and Income

I was recently reading the Index of Economic Freedom World Rankings developed by the Heritage Foundation which is a measure of the economic freedom and opportunity in countries. In 1776, economist Adam Smith, in his influential work, The Wealth of Nations, formulated a theory that when institutions and governments protect the economic liberty of individuals, greater prosperity results for all.

Today that theory has been measured and proven, as you can see in the chart below. In red is plotted the economic freedom score of 157 countries, and in blue is plotted the GDP per capita in those same countries. As you can see, the greater the economic freedom in a country, the greater the economic prosperity of its people.

Gross domestic product (GDP) is a primary indicator of wealth and economic prosperity; it represents the total dollar value of all goods and services produced by the country and is divided by the population (per capita) to adjust for population size difference.

What is Economic Freedom?
Economic freedom is defined as the right to control one’s own labor and property. “In an economically free society, individuals are free to work, produce, consume, and invest in any way they please, with that freedom both protected by the state and unconstrained by the state. In economically free societies, governments allow labor, capital and goods to move freely, and refrain from coercion or constraint of liberty beyond the extent necessary to protect and maintain liberty itself.” (See http://www.heritage.org/Index/FAQ.aspx)

The economic freedom score is determined based on each countries performance in 10 areas:

  • Business Freedom: the ability to start, operate, and close a business. Takes into account the overall burden of regulation, as well as the efficiency of government in the regulatory process.
  • Trade Freedom: the absence of tariffs and other barriers that affect the import and export of goods and services.
  • Fiscal Freedom: the burden of government taxes both on individuals and corporations, as well as the overall amount of taxes as a percentage of GDP.
  • Government Size: the level of government expenditures as a percentage of GDP. Includes government expenditures on all levels federal, state, and local.
  • Monetary Freedom: price stability including an assessment of inflation and price controls. Price stability without government intervention is the ideal state for the free market.
  • Investment Freedom: the free flow of investment capital (foreign investment as well as internal capital flows) in order to determine its overall investment climate.
  • Financial Freedom: the extent of government regulation of banks and other financial services; the difficulty of opening and operating financial services firms; and government influence on the allocation of credit.
  • Property Rights: the ability of individuals to accumulate private property; the degree to which a country’s laws protect private property rights and to which its government enforces those laws. It also assesses the likelihood that private property will be expropriated and the ability of individuals and businesses to enforce contracts.
  • Freedom from Corruption: Corruption erodes economic freedom by introducing insecurity and uncertainty into economic relationships. The score for this component is derived from Transparency International’s Corruption Perceptions Index.
  • Labor Freedom: the legal and regulatory framework of a country’s labor market. It considers regulations on minimum wages, laws inhibiting layoffs, severance requirements, and measurable regulatory burdens on hiring, hours, etc.
  • (see Methodology for the 10 Economic Freedoms)

    Conclusion
    As shown in the graph above, there is empirical evidence that economic freedom, as defined by the ten factors above, leads to economic prosperity. Despite that, there are still many doubters, particularly in the moderate and left-leaning political philosophies. With the so-called stimulus bill, our president, most in his party, and some in the opposition party, are currently engaged in one of the largest expansions of government in our country’s history. This expansion of government brings with it a reduction of economic freedom, and consequently the economic prosperity of all will be diminished. Thus this stimulus package, passed in the name of helping people, will in fact hurt the economic fortunes of individuals and businesses in our country.


    Economic Freedom scores taken from the Heritage Foundation
    http://www.heritage.org/Index/Ranking.aspx

    GDP per capita by country was taken from Wikipedia:
    http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)_per_capita

    2008 Recession Is Official

    After nearly of a year of unofficial pronouncements of the country’s recession (see, for example, NPR: Official Or Not, Consumers Sense A Recession), media outlets across the country, earlier this month, announced that the recession is now official (see, for example, NPR: Recession Is Official).

    So what’s the difference between an official and an unofficial recession? Unofficially, a recession could be classified as any “period of general economic decline.” Officially, a recession is a decline in “GDP for six months (two consecutive quarters) or longer.” (see recession definition at BusinessDictionary.com).

    So all this talk of recession and GDP (Gross Domestic Product) growth got me thinking I should look at the data (see chart below), analyze it and see if I can find anything insightful. Here’s what I found:

  • There seems to be no correlation between GDP growth and the political party in the White House. (Which is unfortunate, for me, because I really like Republican economic policy platform of lower taxes, etc. much better than the Democrats.)
  • Economic down turns during an election year generally means the incumbent party in the White House will lose. This happened in 2008, 2000, 1992, and 1980. (Please note that I do not consider the president to be ‘Economist and Chief’, though that seems to be how the American people treat him.)
  • Average quarterly GDP growth, over the past 60 years, has been right at 3%.
  • The economic data does seems somewhat cyclical, with recessions hitting every 8 to 12 years.


    Sources:
    –Quarterly Growth in real GDP at annual rates, Percent
    http://www.economagic.com/em-cgi/data.exe/var/rgdp-qtrchg
    –“The current administration has compiled the worst economic record in 50 years.” -Bill Clinton, 1992, http://www.ibiblio.org/nii/econ-posit.html