Economic Freedom Matters a Lot More for Economic Development than You Think!

Abstract

The literature connecting economic freedom indexes to income levels and growth generally points in the direction of a positive association. In this paper, we argue that this finding is a highly conservative one as the data is heavily biased against finding any effects. The bias emerges as a result of the tendency of dictatorial regimes to overstate their GDP level. Dictatorships also tend to have lower scores of economic freedom. This downwardly biases any estimations of the relation between income and economic freedom. In this paper, we use recent corrections to GDP numbers – based on nighttime light intensity – to estimate the bias. We find that the true effects of economic freedom and its components on income levels are between 1.1 and 1.33 times greater than commonly estimated. For economic growth, the bias is far smaller and only appears to be relevant for some individual components such as size of government and property rights.

Keywords: Economic Freedom, Economic Growth, Dictatorship, Development