Opinion & Commentary
Tried and true way to economic growth
The Heritage Foundation in Washington has just published its economic freedom ratings for 2002, with Australia ranking in 14th position – that is, behind the economic high fliers who set world-best institutional standards, but well ahead of the interventionist and sclerotic welfare states of western Europe.
But the Heritage report, as well as work done by the Fraser Institute in Canada, does something much more important than publishing league tables on the quality of property rights and non-interventionism. It adds convincing evidence to a new theory of economic growth, namely that ‘it is the traffic rules, the institutions, stupid, that make for poverty or prosperity!’.
The same conclusion emerges from weighty new empirical research by two American researchers, Richard Roll of the University of California and John Talbot. All this has forceful implications for economic policy.
Their research has shown that 85% of all differences between the poorest and richest societies - ranging from US$440 ($853.98) in Sierra Leone to more than US$41,000 ($79,500) in Luxembourg – can be explained by differences in the protection of private property, civil liberties, political and press freedom, as well as the absence of black markets, discriminatory regulations, inflation and barriers to free trade. This observation holds true between countries and over time. Liberal economic reforms and the assertion of basic economic freedom have invariably boosted economic growth, as well as high employment, the reduction in poverty and improvements on many other social fronts.
Postwar economic reforms in Germany and Japan, subsequent improvements in economic freedom in East Asia, even the People’s Republic of China, and more recent reforms in countries such as Australia have been rewarded by economic prosperity.
Only economists who disregard institutions could call these episodes ‘economic miracles’, i.e. outcomes that cannot be rationally explained. Interest groups which seek and extract political favours, parliaments and judges that grant them, and politicians that distribute opportunistic hand-outs have to be seen as the main enemies of broad-based prosperity.
The research confirms what common sense and some economic theories have asserted all along. Prosperity, and all its benefits, depend on the division of labour and the effectiveness of coordinating millions of specialised producers. If these are made to compete, time and again, and can do so with trust in simple, reliably enforced ‘traffic rules’, they will be a genuine knowledge nation and offer bountiful economic opportunity: growth and high employment for most.
The good news to emerge from these insights is that the institutions - the rules of human coordination - are man-made and therefore can be altered by people of good will.
The new growth theory has numerous powerful policy implications, which are now being absorbed in Washington and some other capitals, though not yet in the traditional policy establishments of industry departments, international organisations and many parts of the third world, let alone in most universities.
One policy consequence of the insight that poverty is the result of insecure institutions and discrimination, now contributes to the decline in foreign aid. Countries that have implemented competitive markets and protect private property cannot be their mismanaged brothers’ keepers forever. Calls by the likes of Malcolm Fraser for unlimited compassion, irrespective of behaviour and effort on the part of poor nations, are therefore falling increasingly on deaf ears. Aid is being concentrated on short-term emergencies after catastrophes and is channelled away from avid aid claimants, as for example our lovable South Pacific neighbours who keep violating the most basic economic and other liberties. With crony preferentialism, foreign trade interventionism, expropriation and wide-spread market distortions, even copious aid will have no effect on alleviating poverty and extending life spans.
The implication for national policy makers and the World Bank is to make foreign aid conditional on institutional reform. With economic reforms that implement high standards of economic freedom, a good investment climate will be ensured and “the investment dollars will magically appear”, as Roll and Talbot put it, so that aid becomes superfluous.
Another policy implication of the new growth theory has to do with the fact that prosperity is not driven by what many economists have asserted, for example a high investment rate, high R&D spending or a big share of foreign trade. These are proximate causes of growth. They beg the immediate question: Why are investment, R&D or international trade high in some countries, but not in others? The real and deeper reasons lie with secure property rights, the freedom of contract and the equality of all – the well-connected and newcomers alike - before the law. Government policies that promote investment or research and development by artificial means, target superficial symptoms and induce a waste of resources on lousy projects. What is worse, they introduce favouritism and detract from the equality of all before the law.
Over time, governments thus erode genuine economic freedom and weaken the spontaneous growth potential. The Australian government should not favour research and development spending by big firms over other costs that producers incur. The mercantilistic promotion of exports and the maintenance of the costly Austrade bureaucracy, which the Productivity Commission has rightly lambasted for its ineffectiveness, aim tax dollars at tokenism and detract from basic freedom and equality.
The research by the Heritage Foundation, the Fraser Institute and a rapidly growing network of researchers that look at the fundamental institutions of economic freedom and genuine economic reforms, is rapidly changing the policy scene overseas.
It will eventually trickle down to Canberra and State capitals. The question is: with what cultural time lag? And will the electorate accept the lessons?
About the Author:
Wolfgang Kasper is a Senior Fellow at the Centre for Independent Studies.
