ECONOMIC FREEDOM AND ECONOMIC GROWTH

Relationship Between Economic Freedom and Economic Growth: A Literature

Review
This paper studies the relationship between economic freedom and economic growth.
To this end, we first discuss what economic freedom is and how it is measured. Institutions
can limit or enhance individual economic freedom. Differences in institutions between
countries can therefore result in different levels of economic freedom for the citizens of these
countries. Various authors have endeavored to map the institutions they consider determinant
of economic freedom. These authors concluded that by using one single indicator for
economic freedom much information is lost and they suggested that several principal
components be used as measures of aspects of economic freedom.
The second paragraph investigates whether a statistical association exists between the
overall economic freedom indicator and economic growth. A positive association between the
level of economic freedom and economic growth has been found in some empirical studies.
Absence of studies that fail to report a positive association between economic freedom and
economic growth may not be taken as proof of the existence of such an association.
It may be possible, though, to distinguish components of economic freedom that have
an association with economic growth. The third paragraph investigates whether such
components have been identified. Ayal and Karras (1998) investigated which components of
economic freedom contributed to economic growth. Carlsson (2002) investigated which
components of economic freedom were associated with economic growth and Justesen
investigated the causal relationship between economic freedom and economic growth.
The fourth paragraph investigates what is known about the causality between
economic freedom and economic growth. Dawson (2003) and Justesen (2008) both studied
the causal relationship between economic freedom and its subcomponents on the one hand
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and the long-run economic outcomes of investment and economic growth on the other using
Granger causality tests. Faria and Montesinos (2009) used an instrumental variables approach
in order to establish the causal relationship between an overall economic freedom indicator
and economic growth.
We end with investigating which mechanisms underly a causal relationship between
economic freedom and economic growth. Surprisingly, there is hardly any attention in the
literature for the mechanisms underlying a potential causal relationship between economic
freedom and growth. (359 words)

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Conclusion
What is economic freedom and how is it measured? Economic freedom seems to relate
to people having their private property rights respected and protected and the lack of obstacles
to voluntary exchange. The extent to which a countrys institutions contribute to economic
freedom is measured by overall economic freedom indicators comprising of several
components. Economic freedom is not a one-dimensional concept, so expressing a countrys
economic freedom in one single number does not capture the multifaceted character of the
concept of economic freedom.
Does a statistical association exist between the overall economic freedom indicator
and economic growth? The evidence is not quite conclusive as to the existence of an
association between the level of an overall economic freedom indicator and economic growth.
Some studies find a positive association, some fail to find such an association, there is
publication bias in the literature, results may hinge crucially on the inclusion or exclusion of
the least free countries, and a meta-analysis included too many different studies to be decisive
in this matter.
It may be possible, though, to distinguish components of economic freedom that have
an association with economic growth. Have such components been identified? The available
evidence is far from conclusive. Each study that addressed the question which components of
economic freedom are associated with economic growth singled out different components;
results were never corroborated. So it is still unclear which, if any, component of economic
freedom is associated with economic growth.
What is known about the causality between economic freedom and economic growth?
Studies that specifically investigated this causality issue strongly suggest that economic
freedom causes economic growth rather than the other way around. There is only consensus
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about the causal effect of an overall economic freedom indicator, not about any of its
components.
Which mechanisms underly a causal relationship between economic freedom and
economic growth? Little is know about the mechanisms linking economic freedom and
economic growth, as not much attention has been paid to theory-building in this area. Only
indirect effects on economic growth through capital accumulation and increases in factor
productivity have been established. (347 words)

Jan Kreumer (4033833)