Economic Freedom and Growth

Josh Hall,

Release Date
February 10, 2011


Free Markets and Capitalism

Economics professor Josh Hall describes how greater economic freedom leads to higher incomes and more economic development over time. When governments allow citizens the freedom to trade, own property, create businesses, and contract with others, the income of average citizens grows over time. This effect can be observed internationally when comparing countries, as well as domestically when comparing states in the US.

Economic Freedom and Growth
Why are some places rich and others poor? Why are some big cities bright, and others dark? These are some of the most important and enduring puzzles in the history of economics. Adam Smith saw these same contrasts in 1776, and asked the same questions in his book, The Wealth of Nations. For Smith, the source of these differences was simple: economic freedom.
In his own words, “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice.” Was Smith right that a limited government that keeps the peace and administers justice is all we need for prosperity? How would we know?
The “Economic Freedom of the World” report measures how a country’s policies are consistent with personal choice, private property, and voluntary exchange—the economic system that Adam Smith advocated. We can use these measures to rank a country’s economic freedom and then see how freedom is related to growth. Let’s take these rankings and separate the counties into four groups, from the least free to the most free. The countries with the lowest economic freedom have the lowest GDP per capita, but the freest countries enjoy a standard of living over eight times higher.
If you think that these results are skewed by factors like geography or culture, let’s look at the Korean peninsula. North and South Korea have similar culture, geography, and natural resources. Now, let’s look at the peninsula at night. What happened? In 1953, Korea separated. The South chose greater economic freedom while the North eliminated nearly every form of individual liberty. Sixty years later, average income in South Korea is 10 times higher than in the North.
Now, let’s look a little closer to home. Maryland versus West Virginia. According to the reports“The Economic Freedom of North America,” Maryland is the 18th freest state, while West Virginia is 40th. Why? The West Virginia tax code makes it difficult for businesses to operate. For example, the buildings you see in this photo, on the Maryland side, those belong to a company that was originally founded in West Virginia. It moved across the border so its taxes and costs would be lower, allowing it to grow, create more jobs, and increase prosperity. This happens all over the state, and these differences in prosperity are measurable. The result is that per-capita incomes are over $10,000 higher in Maryland than in West Virginia.
Clearly, they should have followed Adam Smith’s advice. He got it right. Individual freedom in economic life leads to economic progress. So if you care about growth and prosperity, you can’t ignore the importance of economic freedom.