Consequences of Economic Freedom

Daniel Bennett, PhD, studies the consequences of economic freedom, or the degree to which a nation or subnational region’s institutions and policies support free enterprise. To achieve a high economic freedom score, the institutional environment must provide secure protection of private property, evenhanded enforcement of contracts, and a stable monetary regime. It should also exhibit low levels of distortionary taxation and regulation and rely primarily on markets rather than the political process to allocate goods and resources. Countries such as New Zealand, Switzerland, the U.S., and Denmark rate very high in terms of economic freedom. Meanwhile, countries such as Iran, Zimbabwe, Sudan, and Venezuela rates very low.

Bennett’s research interests were motivated by the popular narrative that the capitalist economic system is responsible for rising, unsustainable levels of inequality. Seeking to better understand the validity of this narrative, he identified two major issues.

First, according to his Empirical Economics study, the theoretical relationship between economic freedom and inequality is ambiguous, and previous cross-country studies have reached mixed conclusions. Particularly, the study highlights the sensitivity of previous findings to the sample of countries and period used, suggesting that the statistical relationship between the two variables is indeterminate. One reason for inconclusive findings may be that researchers tend to look at changes over time, but institutions tend to change slowly over time and inequality can be structural, meaning that it persists over long periods of time because of non-market mechanisms such as, e.g., colonization, slavery, and land distributions by the state that create a distribution of income in favor of the politically favored elite. 

In a Journal of Institutional Economics study, Bennett finds that nations that historically developed stronger property rights institutions because of geographic conditions more favorable for small-scale farming (relative to large-scale plantation farming) today exhibit less structural inequality. For example, historical geographic conditions favored the emergence of weak property rights institutions in countries such as South Africa and Honduras, which today have very high levels of structural inequality. Meanwhile, the conditions were much more favorable for the emergence of strong property rights in countries such as Germany and Denmark, which today exhibit low levels of structural inequality.

In the context of the U.S. states, Bennett provides evidence in a Journal of Regional Analysis & Policy study that increases in freedom may lead to higher inequality in states with low levels of freedom (e.g., New York, California, West Virginia), but this effect diminishes at moderate levels of freedom, becoming negative at high levels (e.g., New Hampshire, Texas, Florida).

A second issue with the capitalism-inequality narrative is that the proposed solutions typically involve greater government intervention in the economy, which reduces economic freedom and may, in turn, restrict some of its benefits. For example, Bennett finds in this World Development study of former European colonies that countries in which the historical settlement conditions were more favorable for the emergence of economic freedom (e.g., U.S., Hong Kong, Canada) are today much more prosperous economically than countries with poor settlement conditions (e.g., Pakistan, Cameroon, Uganda). He also finds, in this Contemporary Economic Policy study, that there is less happiness inequality (as measured by the standard deviation of individual life satisfaction) in countries with greater economic freedom, and that individuals living in more economically free nations perceive greater control over their lives, according to the finding of this European Journal of Political Economy study.

Bennett’s recent research focuses on how economic freedom influences entrepreneurship and innovation. This Small Business Economics study demonstrates that more economically free U.S. cities exhibit higher rates of new business creation (e.g., Miami, Austin, Tampa, Dallas, Houston) than less economically free cities (e.g., Buffalo, Sacramento, Cleveland, Louisville). He also finds (in this SBE paper) that the most innovative countries in the world tend to have high levels of both economic freedom and cultural individualism (e.g., U.S., Australia); however, the combination of high levels of freedom and low levels of individualism (e.g., Hong Kong, Singapore) is better for innovation than vice versa (e.g., Argentina, South Africa). In a recent Journal of International Business Studies article, Bennett examines how populism, particularly the left-wing variety, deters individuals from pursuing entrepreneurship by creating uncertainty about the future stability of the free enterprise system.