1997 Index of economic freedom
Edited by: Kim R Holmes, Bryan T Johnson & Melanie Kirkpatrick
Publishers: The Heritage Foundation Price: Rs 700 (approx) ($19.97)
Theories abound about the origin and cause of economic development. The findings of this study, based on a constructed freedom index, are conclusive: countries with greater economic freedom have higher growth rate than those with less independence. Undoubtedly, economic growth does depend upon economic freedom. But the index is not an adequate indicator of the paths taken to development. Economic history of the countries with high growth rates today show that freedom is often the result rather than the cause of development.

The authors define "Index of economic freedom" based on 10 quantitative parameters: tariff rates, taxation, government share of output, inflation, limits on foreign investment, banking restrictions, wage and price controls, property rights, general business regulation and the extent of the black market. All these indicate an open market economy. Thus, all the essays edited in this volume claim that open market economies with minimal government intervention develop faster than partially-closed economies with the government playing an important role. Does economic history really provide any statistical clue to whether, as the book says, there is a statistically significant relationship between the rankings in the 1997 index and levels of economic growth since 1976? The answer is a plain `no'.

If one examines the method of calculating the 1997 index of freedom it is surprising the constituent variables are assigned single score without realising that these may vary to a great extent between countries. They should have been indexed over a scale of 0 and 1. In the case of high growth economies, like China and Japan, the State played an important role.

The State nurtured them during the high growth period and developed institutions to ensure transition to an open economy. Even the World Bank has realised that market failure is widespread the over, more so in developing economies. It calls for an effective State to aid markets so that the economy can ride the correct path to development. The index of freedom surprisingly advocates the monetarist point of view that money supply should expand in relation to the levels of real output. But what did China do? It increased money supply at a rate of 20 per cent annually, which undervalued its currency and made China export-competitive. The high rate of economic growth and a moderate rate of inflation of about three per cent was the end result. Countries where money supply was curtailed did help to kill inflation rate, but this led to cooling off of the economy and in some cases stagflation. This is what is happening today in India also.

To conclude the bill misses the point that while propagating economic freedom one cannot ignore the levels of development each economy is passing through. Developing countries today have rigid and imperfect capital, product and labour markets. Their regulatory system and mechanism for enforcing contract are all underdeveloped. It is here that the State has to play an effective role. It is only when the desired level of development has been brought about, the economy is ready for freedom. Freedom is the effect rather than the cause of development.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.