Endogenous economic freedom and the wealth of nations: evidence from a panel of countries, 1996–2011

Abstract

Indexes of economic freedom measure the degree to which the policies and institutions of countries are supportive of economic freedom. The authors find a considerable scope for improvement in Index of Economic Freedom, created by Heritage Foundation, since not all components of index have equal effect on economic well-being. Contrary to Heritage methodology the authors tackle the aggregation bias and highlight that each index component contributes differently to the level of economic freedom and subsequently to the level of income per capita. The level of fiscal freedom and monetary freedom exert the strongest influence on the overall index of economic freedom. Authors present the new endogenous cross-country ranking of 135 countries from Instrumental Variable-Two Stage Least Squares (IV-2SLS) empirical specification which removes the inconsistencies arising from the arbitrary assumption of the equivalent effect of each component on the overall index and, hence, the level of real income per capita.

Keywords:

• institutional framework
• economic freedom
• endogenous index of economic freedom
• economic prosperity

JEL Classification::

• O40
• O50
• C23

Notes

¹ Cf. Table A1, Appendix for a detailed explanation of each component of the overall index of economic freedom.