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The Relationship Between Political and Economic Freedom Reconsidered
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Granger-Causality Clive Granger proposes the following definition of causality: This definition, in the econometric literature referred to as Granger-causality, has been extensively applied in econometrics because it has the advantage, as it has been emphasized by Granger himself, to be operational.
We now perform tests for Granger-causal relationships between economic freedom and growth using several different equations. The first group of equations are used to test for unilateral Granger causality of the level of economic growth, that is, they allow for tests to determine if economic freedom Granger-causes economic growth.
The number of lagged values K and J is chosen by the investigator. If equation 2for example, makes a significant contribution to the explanation of growth over and above equation 1this would mean that prior levels of EF1 are significantly related to the current level of economic growth, leading us to the conclusion that EF1 Granger-causes growth same applies for all other equations. Symmetrically, the next group of equations are used to test for unilateral Granger causality of economic freedom, that is, they allow for tests to determine if economic growth Granger-causes economic freedom.
Finally, we shall also analyze and compare the results from the unilateral tests shown in equations 1 through For example, if EF1 is shown to Granger-cause growth using results from the first two equations and growth is shown to Granger-cause EF using the information provided in equations 23 and 44the conclusion would be that the two are bilaterally related or jointly determined.
Similar information can also be drawn for other possible bilateral relationships shown in the specified equations. Dummy variables for all countries were included when estimating each of the specified regression equations to help control for country-specific information.
This is necessary because our data set includes a limited number of time-series observations from a large number of countries and when these are pooled to capture and exploit the time-series properties of all countries together in an effort to explore for causal relationships, there is a risk that cross- country differences may be so significant as to overwhelm any time-series information that is available in the data, biasing the results and providing an inaccurate picture of any "true'' relationship that may exist among the variables being studied.
The ordinary least-squares parameter estimates for equations to test if Granger causality does run unilaterally from economic freedom to growth are shown in Tables 6. A priori, it is expected that, if a significant relationship is found to exist among any of the variables being studied, it should be positive. We begin with specification i which ignores all economic freedom terms and estimates a simple regression of growth on its lagged value growtht Because of conditional convergence, current economic growth is has a negative and statistically significant relationship with lagged growth.
When we also include a twice lagged variable of economic growth, both coefficients appear to be negative and significant results not shown. In specifications ii - xix of Table 6we successively include in the regression almost every one of the twenty-one sub-components of the economic freedom index some of them have not been tested due to lack of data availability. Firstly, we find that the estimated coefficients and statistical significance of growtht-1 are robust to the inclusion of the new variables.
Second, the estimated coefficients that are statistically significant have the expected sign positive.
In particular, the empirical results enable us to identify which components of economic freedom past values have had statistically significant positive effects on current rate of growth, when one controls for the lagged growth.
Firstly, all F-statistics are statistically significant at 99 percent level. On the other hand, the t-statistics are only significant for government consumption area1apublic investment area1cgrowth of money supply area3arecent inflation area3cfreedom to trade internationally area4regulation on credit market area5a and on business market area5c. That is, the rate of economic growth should be higher in the future in countries where, ceteris paribus, government consumption expenditure is kept low, investment is primarily made by private agents, growth of money supply is kept near to the growth of per capita income, recent inflation is low, people are free to trade with the rest of the world and credit and business markets are deregulated.
All sub-areas under 2 - Legal Structure and Security of Property Rights have not been tested due to missing data same applies for area 4b.
The relationship between economic freedom, political freedom and economic growth
We do test the coefficient for area 2 as a whole, but it fails to be significant at 95 percent. This result could come to us as a shock as we would suppose that a sound legal structure and good protection of property rights should spur growth on a large scale. Unfortunately, given the methodology used in this study, the limited amount of available data is not sufficient to adequately explore for that possibility.
And even if there was more data available, the difficulty to measure accurately legal institutional framework would represent an extra obstacle for the objective measurement of that area of economic freedom. On Table 7we find the ordinary least-squares parameter estimates for equations to test if economic growth Granger-causes economic freedom.
For every relevant sub-area of the EFN index separately again, sub-areas under area 2 and 5b have not been testedwe begin with specification i which ignores all economic growth terms and estimates a simple regression of freedom on its lagged value areat All coefficients but two are statistically significant.
Then, in specification ii we include a lagged variable of economic growth growtht-1 to check if we can improve the predictability of current level of economic freedom when including information based on past growth.
Results show that, after controlling for past economic freedom, past growth is positively correlated with Standard inflation variability in the last five years and negatively correlated with Transfers and subsidies as a percentage of GDP, Top marginal tax rate, Freedom to trade internationally and taxes on international trade. These results indicate that economic growth, although enhanced by freer economic environments, act as an obstacle for further expansions of economic freedom.
The components of economic freedom, income and growth: an empirical analysis
Economic expansion seems to Granger-cause a more than proportional raise on government transfers and subsidies and on tax rate. We do not have a clear insight on why this should be, but we do suspect that it is related to the idea that governments might tend to try to correct the bad side of a perhaps unfair economic growth by transferring resources to low-income fractions of the population that are not enjoying the benefits from this growth.
This could also explain higher top marginal tax rate, because governments worried about equality would try to take larger portions of income from the wealthy to raise fund for higher transfers and subsidies. This could be particular true for social-democrat nations. The results also tell us that past economic growth is related to current loss of freedom to trade internationally. This finding goes against our intuition that fast-growing countries would seek to open their economy trying to have access to larger markets, because of their also growing competitiveness and productivity.
On the other hand, we should consider the possibility that economic growth strengthens the power of some pressure groups, and these groups could on their turn exercise their lobby power in order to annulate international competition. Finally, the only sub-area of economic freedom that appears to have bilateral relationship with growth is the freedom to trade internationally.
While more open economies appear to show higher rates of economic expansion, growth tends to minimize this effect by negatively influencing the extent to which countries are free to trade with others.
Countries with more economic freedom attract more investment and achieve greater productivity from their resources. As a result, they grow more rapidly and achieve higher income levels.
Does economic freedom lead or lag economic growth? evidence from Bangladesh
In contrast, countries stagnate when their institutions stifle trade and erode the incentive to engage in productive activities. Provision of institutions supportive of economic freedom is the key to the growth process. Countries with low initial levels of income, in particular, are able to grow rapidly and move up the income ladder when their policies are supportive of economic freedom. The results reported above are very supportive of the proposition that economic freedom enhances growth both via increasing total factor productivity and via enhancing capital accumulation.
We expect this finding to be neither surprising nor controversial.
- The relationship between economic freedom, political freedom and economic growth
What we consider to be the primary contribution of this paper to the literature is the identification of the sub-components of economic freedom which are shown to be statistically significantly correlated with growth. These are i small government consumption, ii low transfer and subsidies, iii public sector responding for a low share of total investments, iv independent judiciary, v impartial and reliable courts, vi protected intellectual property, vii no military interference in the political process, viii money growth kept close to real GDP growth, ix low standard inflation variability in the last five years x low recent inflation levels, xi small and clear trade barriers, xii official exchange rate near black-market rate, xiii less regulated credit market and xiv less regulated business markets.
We believe these findings are more useful than results which rely on aggregate or composite indices of economic freedom. While earlier research has shown economic freedom "as a whole" to be statistically significantly correlated with growth, our results show that this may be due to the effects of only some of the underlying components of economic freedom.
An additional benefit of our analysis is that it can be used to offer more specific policy suggestions. Instead of much of the existing literature's vague recommendation of "enhancing economic freedom," our results have identified particular elements, cultivation of which is likely to promote capital accumulation and growth. Still, however, a number of unresolved questions remain. For example, we are surprised that some of the variables such as the marginal tax rate and foreign capital control were not statistically significant.
We suspect that this may reflect lack of identification power rather than the absence of an economic effect, but future research is necessary to address these questions more appropriately. Components of economic freedom and growth: Journal of Developing Areas 32, p. Economic freedom and equality: Income, growth, and economic freedom.
Economic freedom and the quality of life. Constitutional Political Economy, 10, p.