The economic freedom debate

The evidence for economic freedom to boost growth and prosperity for the wider population is overwhelmingly positive

The notion of economic freedom (EF) has been almost central to macroeconomic theory around the world originating from the likes of Adam Smith, Friedrich Hayek and more recently Milton Friedman among others. While these policies have been pioneered by stellar economists, they have also been applied to many other countries around the world especially in the growth driven emerging markets. In the Economic Freedom of the World: 2017 Annual report, by Fraser Institute, economic freedom  is quantified into a common index over a long time frame enabling us to understand the evolution of the same. Not only would this provide a perspective on India’s global standing, it would also provide some perspective on what can be done to boost trade in the short and medium term.
 
The evidence for EF to boost growth and prosperity for the wider population is overwhelmingly positive. The per capita incomes of countries in the “most free” quartile ($42,583) are almost seven times as high as the countries in the “least free” quartile and almost twice that of countries in the second-highest quartile. Other macroeconomic and welfare indicators seem to suggest that more freedom means better prospects for prosperity overall.
 
The EF index measures the degree to which the policies and institutions of countries are supportive of EF by assessing data points present in five major areas: [1] Size of government, [2] legal system and property rights, [3] sound money, [4] freedom to trade internationally, and [5] regulation of credit, labour, and business. In the index, India’s ranking over the years has been interesting, to say the least. In 2015 rankings, India is 95th while Russia lags in 110th and China in 112th place respectively. India is also ranked below Mexico, Italy, Germany. While these observations give us more impetus to improve the EF, one also ponders the impact of EF on our macroeconomic indicators.
 
The CATO Institute rankings show a significant dip from 2005 till 2014 and then show a marginal improvement after that until 2015. On the other hand, economic growth for India has been the highest in this same period. The average GDP per capita income has almost doubled during the same time period. In addition, the overall GDP growth rate had an average growth rate of 7.53 during the same period. The question one asks is: Is the EF index, as defined by CATO, reflective of the broader growth story? How much of EF contributes to the economic growth?
 
The answer to this question still remains a yes because of two important points. (In fact, it points out that if there was more EF, perhaps the growth would have been much higher.) One, if we look at one of the key growth drivers in the peak growth era of the mid-2000s, it has been international trade. The amount of international trade was increasing from the mid-1980s all the way till 2011 and peaked in the 2005-2010 period. The GDP boom in the first decade of the 21st century was largely driven by the increase in international trade — note that I make a distinction between FDI and international trade; the former is a negligent part of our GDP (less than 2 per cent) when compared to trade as a whole.
 
World Bank data shows that trade (as a per cent of GDP) has been reducing from 2011 downwards. Historical records indicate that trade indeed has played a role in driving the growth numbers higher. The second point is on the CATO EF index itself. CATO’s index components, plotted over time, show that the “government”, “sound money” and “regulation” parameters have been significantly improving over the years. The two big drags, as one would call it, on the economy have been “freedom to trade internationally” and the “legal system and property rights” parameters.  While the former is a long-term process involved with key legislative outcomes (such as the land acquisition bill and judicial reforms), the latter is something that the government can definitely do something about. The government could do three key things to boost international trade and in turn the GDP of the country as a whole.
 
First, having invested so much political and social capital in GST, the government would be prudent to focus on boosting trade through championing it as the “transparency solution” to India’s shady and often ineffective tax processes. For example, the electronics sector in India has been largely overshadowed by China and other Asean countries due to its complicated multi-state regulatory structures and non-transparent tax system. Second, it could address some of the indirect costs due to bureaucratic delays and infrastructure management at the country’s ports. For example, a CII and Maersk study states that 10 per cent reduction in these costs can boost India’s competitiveness and contribute additional revenues of up to $5.5 billion. Third, it could boost competitiveness and make optimum use of it in bilateral trade negotiations. India’s significant progress in the international rating agency and organisation’s assessments should be the perfect catalyst to boost bilateral negotiations and accelerate international trade. It would be prudent that we focus on international bilateral agreements to boost our trade share of the GDP in total.
 
In retrospect, one has to understand the importance of economic freedom in our economic narrative. While there have to be buffers in place, it is imperative that trade movement between Indian businesses and the outside world is accelerated. The Fraser Institute’s report might be a wake-up call for us to make even more efforts to accelerate the process of creating more opportunities for trade to flourish. One hopes that the government looks into it and accelerates its initiatives in this regard.

The writer is a macroeconomist. Views are personal.