We’ve learned a lot about development and prosperity during the last decade. Most important, we have learned that institutions and policies make a big difference. Countries that establish institutions and follow policies consistent with economic freedom grow, prosper, and achieve high levels of income. Those that do not, stagnate at low income levels.
The Economic Freedom of the World (EFW) index makes it possible for researchers to directly analyze this issue. In order to achieve a high EFW rating countries must do some things and refrain from others. They must provide monetary arrangements that make it possible for their citizens to have access to sound money; a monetary unit that is easily convertible and widely accepted throughout the world. They must also provide a legal system that protects individuals and their property from potential aggressors and enforces contracts in an evenhanded manner. But they must also keep taxes low, rely on markets and avoid price controls of all types, and refrain from regulatory actions that restrict trade and retard entry into markets.
Without exception, the countries with the highest per capita income levels have registered high EFW ratings during the last several decades. For example, nine of the ten countries with the highest per capita income levels in the world are ranked in the top 13 among the 123 countries rated in our most recent EFW index. The 10th (Norway) ranked 26th among the 123.
The economically free countries also grow more rapidly. We broke the countries of the EFW project into those with EFW ratings of more than 7.0, between 5 and 7, and those with ratings of less than 5.0. Those in the top group grew at an annual rate of 2.8 percent during 1980-2000, compared to 1.4 percent for the middle group, and 0.1 percent for the countries with the least economic freedom.
The more economically free countries also attracted more investment. During the 1980s and 1990s, private investment comprised 18 percent of GDP in the more economically free economies, compared to approximately nine percent of GDP for the economies with less economic freedom. Foreign direct investment, almost all of which is private, was a whopping 45 times more per worker in the economically free group than was the case for the less free group. Not only was the investment rate higher in economically free countries, so too was the productivity of that investment. Our analysis indicates that the productivity of investment during 1980-2000 was approximately 70 percent higher for the economically free group than the group with the least amount of economic freedom.
Can small countries like the Bahamas achieve high levels of per capita income? Clearly, the answer is “yes.” Among the 123 countries included in the EFW projects, seven of the 10 countries with the highest income levels had populations of less than 10 million. Luxembourg, Ireland, Iceland, Denmark, Austria, Singapore, and Hong Kong provide examples of economies with relatively small populations that have achieved rapid growth and high levels of income. All of these economies had high EFW ratings and their international trade sectors in particular are quite open. These are the examples that the Bahamas should emulate.
If the Bahamas had been as economically free as Ireland, for example, during the last two decades, our analysis indicates that its per capita GDP would be approximately twice the current figure. If the Bahamas wants to become more prosperous, it must become more economically free.
(James Gwartney is a professor of economics and holder of the Gus A Stavros Eminent Scholar Chair at Florida State University.)