February 07, 2004

Freedom Benchmarking

Does the rankings of economic freedom from the Fraser Institute and Heritage Foundation/Wall Street Journal point in the same direction? Here is a simple scatterplot I did of one index against another. Click on the thumbnail for a big popup.

As can be seen there is a lot of correlation (0.85). While the ranking order could be changed quite a bit by using one index over the other, the overall estimates appears to be quite consistent. There are no real outliers in the data.

(And where is Sweden? It is hidden by El Salvador, just above Bahrain)

The Heritage index is composed of several factors, and it is interesting to plot the correlations between them and the Fraser index. Below is a correlation matrix plot, where the color of each square denotes how much one factor correlates with another. The hot colors show the strong correlations, the bluish the weakest (or even negative).

[Technical notes: I used the 2002 data, and negated the Fraser index so that it points in the right direction. ]

There is a big group of strongly correlated factors in the corner: respect for property rights, no unnecessary regulation and absence of black markets are good predictors for economic freedom (cause and effect is of course variable; in a free economy there is little competitive advantage for a black market, while less regulation on the other hand implies economic freedom). Another conclusion is that both indices have roughly the same correlations with the factors, which suggests that they have some validity. It is interesting to note (but hard to see) that the Fraser index correlates best of all the other factors with the entire Heritage index: the combination of factors is a better predictor than each in isolation.

Plotting GDP against freedom shows a nice curve:

Having a more free economy correlates with more GDP. Another obvious fact that needs to be stated again and again.

OK, but what about political freedom? I used Freedom House's ratings for civil liberties and political freedom, and plotted the average of them against the Heritage index.

[The small height differences between countries are just a display trick. Since the FH index either is an integer or a half integer there was a great deal of crowding of the text, so I jittered the positions upwards and downwards by +-0.1.]

This scatterplot has some fun aspects. We have a dense cluster of very politically free western countries at the lower left with some of the "well-behaved" South American countries like Chile and Uraguay. Then there is a wide sigmoidal band leading up to the Axis of Evil. Some notable outliers are Saudi Arabia, Bahrain and the Arab Emirate - oil is good for business but bad for democracy. And Singapore is doing its best cyberpunk imitation. Among the 'nice guys' Estonia is notable and should really fix its civil liberties. On the other side of the sigmoid we have Suriname as a surprisingly democratic but economically unfree country (probably because of the focus on Bauxite and the governments economic troubles). But on average, the trend is that political freedom and economical freedom goes hand in hand. The correlation is 0.65 - not bad (if this had been psychology :-).

This kind of indices are of course subjective and prone to biases of various kinds. Still, they seem to provide a reasonably good aggregate sketch of the state of different nations. They don't tell us in themselves why a nation is as it is, but it shows many of the commonalities. The next step in analysis is to look at how they change in time. Does political freedom often cause economical freedom, or vice versa? How does economic freedom changes lead to GDP changes? Lots of fun things to explore with a spreadsheet or Matlab for the armchair economist.

Posted by Anders at February 7, 2004 03:04 AM

An interesting thing is that the scatterplot showing freedom & GDP suggests that there is little difference in GDP between completely unfree (5) states and somewhat unfree (3,5) states. What does this mean? Perhaps the use of having some unregulated sectors is minimal if you still have some part of the economy which is completely regulated, and thus hinders the economy in total?

Posted by: Richard at February 7, 2004 03:17 PM

I did some experimentation, and I think it is mostly because GDP is so unequal; there is little room for variation at the bottom. If you plot the logarithm of GDP instead the diagram forms a rough line (correlation 0.66), indivating that the effect of freedom on GDP really seems to be an exponential increase.

Also, some of the true tyrranies like North Korea doesn't have GDP estimates in my dataset, so there may be a bias by the missing values.

Still, there are some oddities in the data. Libya seems to be too rich and have a too high life expectancy given its repression (official figures?). Belarus is probably living off its former industrialisation, and Iran seems to be a bit like Libya in the diagram.

I think the core idea of certain unregulated sectors allowing greater GDP than freedom holds, just look at Saudi Arabia. But very small economies are strongly affected by single industries and outside investment, so they are far less predictable than big economies.

Posted by: Anders at February 7, 2004 08:16 PM

Nice work, Anders. Would you mind listing the tools you used? It'd also prove convient if you posted links to the data, instead of just to the websites of the source organizations.

Posted by: Jay Dugger at February 8, 2004 06:06 PM

Thanks Jay, I have added them to the next post (as well as some other plots to delight and confuse).

Posted by: Anders at February 10, 2004 08:05 PM