Economic Freedom in Uncertain Times

S ince the second half of 2008, the world economy has been undergoing a period of uncertainty and slowing economic growth. While some proclaimed the death of capitalism, the free market system has, in fact, demonstrated an impressive level of resilience during 2009 and now shows vital signs of an economic upturn. Policy choices made at this critical juncture of the global recovery will unquestionably shape the growth trajectory for the world economy in the years ahead. Countries on Diverging Paths The financial crisis and recession that afflicted the world economy in 2008 and 2009 resulted in, and may even have been caused by, significant reductions in economic freedom in a number of countries around the world. At the same time, many other countries have held firm on the path to greater economic freedom and the greater prosperity that it brings. After five years in which economic freedom had shown modest but steady advances throughout the world, the 2010 Index has measured a small decline—one- tenth of a point (0.1 point)—in the world average economic freedom score.1 The recession of 2008-2009 was the first major worldwide economic disruption of the age of globalization. Economically free countries are typically more open and engaged with the world economy than their more repressive counterparts. Many of the most economically free were among the first to feel the effects of the crisis, which spread through the financial system. Those that are most open to trade, and particularly those that are most dependent on export-oriented growth, were among the most vulnerable to economic downturns in other countries. On the other hand, the economically free countries, which over the years have grown faster and accumulated more wealth than their repressed counterparts, were in a better position to withstand a temporary downturn. The economically free have more durable and transparent economic institutions, more diversified economies, and more flexibility in responding to a crisis. Thus, we would expect to see less harmful permanent impact from the crisis and recession in the economically free countries. We also would expect to see faster and more pronounced recovery from the negative effects that do occur. The 2010 Index of Economic Freedom is based on data reflecting conditions from July 2008 through June 2009 (and sometimes earlier years when later data are not available). Thus, the effects of the recession and the policies through which governments have tried to respond are not fully captured in the rankings. Indeed, the full effect of some of the policies undertaken by governments, such as the inflationary impact of expansionary monetary policy and various governments' stimulus programs, may not show up for several years. Diverging eConomiC FreeDom sCores Many countries, despite the economic difficulties they may be experiencing, have held true to the principles of economic freedom and have continued to adopt measures to liberalize and deregulate economic activity. Eighty- one countries—almost half of all those ranked in the Index —showed improvements in their overall economic freedom scores this year. Regrettably, the levels of economic freedom in 90 other countries, as measured in the 2010 Index , have declined. Many of the countries whose scores have dropped have responded to the economic crisis with policy moves that, whether intended or not, add up to a fundamental assault on economic freedom. In the United States, for example, policies or proposals have included more intrusive regulations, government takeovers of businesses, government subsidies and bailouts of private firms, loose monetary policy, tax increases, and protectionist measures to reduce trade. (See "Can Trade Protectionism Save Jobs?") Interventionist measures that harm economic freedom are detrimental to economic growth, with effects that in some cases will show up immediately, and sometimes after a delay, but in all cases can endure for years to come. Though bailouts and subsidies may provide short-term relief for some chosen firms, the impact on the overall economy quickly turns negative as governments have to finance spending through increased taxation, borrowing that crowds out private investment, or monetary expansion that fuels inflation,download