James d. Gwartney

The Importance of Institutions and Policies

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Video:
Economic Freedom Index
How much do institutions and policies matter? To answer this question, we need a way
of comparing the institutions and policies of different countries. Since the mid-1980s, the
Fraser Institute of Vancouver, Canada, along with a number of partners, has reported a cross-
country index of economic freedom called the “Economic Freedom of the World (EFW)”
index. Now published by a worldwide network of institutes, this index measures the extent to
which a country’s institutions and policies are consistent with economic freedom. It captures
size of government, the legal system and property rights, sound money, freedom to trade, and
the regulatory environment. The index incorporates 42 separate components and provides
ratings for approximately 160 countries, some going as far back as 1980 and others added as
data becomes available.
In many ways, the EFW index reflects the elements outlined in previous sections of this
book. To achieve a high EFW rating, a country must provide secure protection of privately
owned property, evenhanded enforcement of contracts, and a stable monetary environment. It
also must keep taxes low, refrain from creating barriers to both domestic and international
trade, and rely more fully on markets rather than government expenditures and regulations to
allocate goods and resources. If these institutional and policy factors really do affect economic
performance, countries with persistently high EFW ratings should do much better than those
with persistently low ratings.
Exhibit 12 presents data on 2017 per capita income and its recent growth for the ten
countries with the highest and lowest EFW ratings in 2016. The countries with the highest
ratings are not surprising, except for Georgia and Mauritius, where the effect of recent
economic reforms is clearly evident. At the bottom of the rankings is Venezuela. Under the
Chavez/Maduro government, what was once the most prosperous country in South America
has become a clear example of the disastrous failure of communist/socialist economic
planning. Countries exhibiting the most economic freedom have an average 2017 per capita
income of $56,749, almost seven times the average for the least-free countries.

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As can also be seen in Exhibit 12, economically free countries have consistently
positive growth rates. The least-free countries exhibit a wide variety of growth experiences.
Some, during periods of stability and starting from a low growth rate, grow strongly, but others
with especially bad policies, even shrink over time. The average annual growth rate of the top
group was 3.7 percent, compared to -0.4 percent for the bottom group.

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