September 29, 2012 — Thomas Anderson

A significant portion of my political debates involve discussing the effects of libertarian-style economic freedom on a country’s well-being. This type of debate includes two major components: quantifying economic freedom and quantifying a country’s well-being. Measuring these quantities alone is a challenge in itself, but in order to really make an argument regarding their effects on each other, they must be measured independently, without having one measure create bias in the other. When looking at just one country’s policies and well-being, any number of historical events with any number of interpretations can be invoked to suggest that any of these measures are outliers. As an example, just think about how many different explanations there are regarding the causes of the 2007 global financial meltdown. Each different ideological group will adhere religiously to their own explanation, and reject all others. In order to get past all of these political games, we need to find a way to look at every country at once, averaging out the effects of historical anomalies and coincidences. Only if we find a way to do this, can we truly evaluate the general effects of economic freedom on the well-being of countries without politically biased interpretations of events getting in the way. I believe that I have found a set of indices that makes this possible.

I. The Indices

I’ve often referred to the Heritage Index of Economic Freedom, which tries to quantify how “economically free” a country is. Their index is compiled from a purely capitalist perspective, which may lead those who operate from a socialist perspective to reject their ordering as a measure of “true freedom.” However, what we can say is that their index is a great measure of how closely the policies of various countries adhere to the capitalist libertarian vision of economic freedom. This excludes any direct description of non-economic personal freedoms. Their scoring system is broken down into 10 categories:

1. Rule of Law

-Property Rights: The extent to which a country’s laws protect the right of individuals to acquire and keep private property.

-Freedom from Corruption: The extent to which a country’s people perceive their government to be free from corruption.

2. Limited Government

-Fiscal Freedom: A measure of how low the tax burden is upon the people.

-Government Spending: A measure of how little of the GDP the government spends.

3. Regulatory Efficiency

-Business Freedom: A measure of how easy it is to start, operate, and close a business in the country’s regulatory framework.

-Labor Freedom: A measure of the absence of regulations on employers’ hiring, use, and firing of employees.

-Monetary Freedom: A measure of the stability of prices, and the absence of government control of prices.

4. Open Markets

-Trade Freedom: A measure of the absence of tariffs, and other government-imposed barriers to international trade.

-Investment Freedom: A measure of how little the government controls investment activities, and the flow of investment resources.

-Financial Freedom: A measure of the independence of banks from government control.

Again, I’d like to emphasize that I’m not asking anyone to assume that these measures are an objective way of measuring freedom. The Heritage Foundation’s index is clearly a measure of how closely a country’s policies adhere to a minarchist libertarian’s view of economic freedom. The higher a country’s score on the index, the more that country’s economic laws and governmental activities follow the libertarian view of individual liberty, avoiding government activism, socialism, technocracy, and other forms of centralization of economic control. It is this description that I will be referring to when I talk about economic freedom throughout the remainder of this series. According to this description, Hong Kong has the world’s most economic freedom with a score of 89.9, and the United States is down at #10 with a score of 76.3. The country with the least economic freedom (that’s fully ranked and scored)1 is Zimbabwe.

So what effects do these policies have on a country’s well-being? A socialist or progressive or technocrat would argue that these policies would destroy a country by making the poor poorer and the rich richer, destroying a country’s foundations. They say that Hong Kong and Singapore can only prosper with such policies because they’re so small, making them outliers. But a libertarian or conservative or capitalist would disagree, saying that these forms of economic freedom allow for the investment, competition, and innovation that make a country grow and prosper. So how do we resolve these differences and ferret out the effects on a country’s well-being of the economic policies originating from these two different perspectives?

Well, I found another index out there which takes an entirely different approach to ranking countries. The Fund for Peace Failed States Index tries to quantify the extent to which a country has failed and collapsed based purely on symptomatic observation of the conditions people live in under the various governments of the world. Their mission is humanitarian rather than ideological, so their scoring system is based purely on an observation of the components of a failed state (things that nobody wants to end up with), and the extent to which each country has experienced those symptoms. Their scores are also broken down into a number of categories:

1. Social Indicators

-Demographic Pressures: The extent to which a population suffers from hazards beyond their own immediate control, such as natural disasters, scarcity, and environmental degradation.

-Refugees and Internally Displaced Persons (IDPs): The magnitude of the problems associated with populations being removed from their homes, creating refugees.

-Group Grievance: The extent of tension between different factional groups (racial, ethnic, religious, etc.), in the form of discrimination or violence.

-Human Flight and Brain Drain: A measure of the net emigration of the populace, especially the emigration of educated individuals.

2. Economic Indicators

-Uneven Economic Development: The extent of disparities and inequality in income, wealth, and economic opportunities among different groups.

-Poverty and Economic Decline: A measure of how severely a country suffers from economic recession, inflation, high public debt, unemployment, and other indicators of economic decline.

3. Political and Military Indicators

-State Legitimacy: The extent to which a government fails to represent its citizens through corruption, power struggles, or disenfranchising votes.

-Public Services: A measure of the effectiveness and prevalence of the infrastructure that most governments provide as public services, including police, fire, communications, transportation services, and others.

-Human Rights and Rule of Law: The extent to which a government violates human rights through deprivation of civil liberties, arbitrary exercise of the law, or cruel and disproportionate punishment.

-Security Apparatus: The level of militarized internal conflict, and the number of fatalities that result.

-Factionalized Elites: A measure of political entrenchment, brinksmanship, and other tactics that make real political change impossible.

-External Intervention: The extent to which a country has failed to meet its international obligations, leading to foreign intervention in their affairs.

The Failed State Index does not measure policy. It directly measures reports of how far a country has progressed towards failure, in terms of establishing a stable legal framework, protecting the people, and ensuring their prosperity. With such a comprehensive description of the factors involved in the collapse of a country, this index acts as an appropriate measure of a country’s well-being. Somalia gains the #1 spot in state failure, with a score of 114.9, while Finland comes in last place at #177 (in the game where you want to lose) with a score of 20.0. The United States sits at #159, with a failure score of 34.8.

II. Correlations in the Overall Rankings and Scores



In the Heritage Index of Economic Freedom, we have a good measure of how extensively countries adhere to the policies of libertarian-style economic freedom, and in the Failed State Index, we have a direct measure of various conditions that describe the well-being of countries. So if we can find any correlations between these two scoring systems, then we can determine the extent to which certain policies may create the conditions of a failed state. Though we must be careful not to say that correlation necessarily implies causation, we can certainly say that the stronger the correlation, the more closely a policy is related to the condition.

To elaborate, there are three scenarios that may be implied by a generalized correlation between a policy and a condition:

1. The policy caused the condition.

2. The condition leads countries to adopt this policy.

3. Some external factor leads both to the condition and the adoption of a policy.

No country is absolutely bound to legislate policy based on the conditions it experiences. In other words, while a policy can directly cause a condition, a condition can only indirectly cause a policy to be implemented, by exerting pressure on whatever legislative process a country uses. Thus, we would necessarily see stronger correlations in scenario #1 than in scenarios #2 and #3. Hence, we can say that the stronger the correlation observed, the more likely it is that the policy directly causes the condition, rather than any indirect relationship occurring between the policy and the condition. Using this standard, we can distinguish relationships that describe the direct effects of a policy from other types of relationships that may pop up.

With this evaluation standard in mind, I’ve plotted every available2 country on a graph comparing their Failed State rankings to their Economic Freedom rankings (Figure 1).

As can be seen in Figure 1, there definitely is some sort of correlation between economic freedom ranking and state failure ranking. A linear fit can be applied to the data with an R-squared value of 0.55 and a slope of -0.731. This is a fairly strong, negative correlation, indicating there is indeed a relationship between these two rankings. Based on this data, we cannot be 100% certain that every component of economic freedom prevents state failure, but we can at least say that economic freedom clearly is not the cause of state failure.

Because of the high R-squared value, there must be at least some influence from economic freedom that prevents state failure. No nation with less economic freedom than Slovenia (Economic Freedom rank #69) has managed to avoid failure better than Italy or Argentina (tied Failed State rank #145). Additionally, no nation with more economic freedom than Jordan (Economic Freedom rank #30) has ended up failing worse than Cyprus (Failed State rank #119). For every 10 ranks a country drops in economic freedom, you can expect them to go up about 7 ranks in state failure. Interestingly, between 2008 and 2012, the US has dropped 5 ranks in economic freedom, and gone up 2 ranks in state failure, whereas the linear fit would predict an increase in failed state status of 3 or 4 ranks. The predictive power there is not bad, though not perfectly accurate.

One source of error in predicting the trends a country will follow is the fact that each ranking is a measure relative to every other country, rather than an absolute measure. So, if a country is improving or worsening their economic freedom or state failure, they may remain at the same rank if the countries surrounding them in the ranking are moving in the same direction. To account for this error, we can plot the countries based on their absolute Economic Freedom and Failed State scores, rather than their rankings (Figure 2).

Even if we look at the raw scores, there still appears to be a correlation. With a linear fit, the R-squared value is about the same, at 0.53, and the slope is -1.54. The data appears better grouped, but the similar R-squared value comes as a result of some bias in the residuals. Instead of a linear fit, a sigmoid might fit better (Figure 3).

Indeed, a sigmoid curve fits the data comparing freedom and failure scores far better, with an R-squared value of 0.61. The correlation is apparently very negative, with a loss in 15 freedom points translating into a gain of over 40 state failure points in the steepest part of the curve. No country with a freedom score higher than 76 has a failure score higher than 45. Additionally, no country with a freedom score lower than 48 has a failure score lower than 67. With such a reliable negative relationship between economic freedom and state failure, this now appears to be a strong enough correlation to establish causation.

If a country’s freedom score drops below 76, they will end up in severe danger of rapidly climbing in state failure score. Countries with an economic freedom score as low as 70 already span nearly the entire spectrum of state failure, including failure scores from 20 to 85. Ominously, the United States currently has a freedom score of 76.3, putting this country right at the edge of the cliff of rapid state failure. Perhaps this observation relates to the general perception that the U.S. is headed towards decline. The curve fit predicts the U.S. state failure score to be about 34.96, and the actual state failure score is 34.8. The U.S. economic freedom score has dropped more than 4 points over the last 4 years, increasing its failed state score from 32.8 (predicted: 30.3). So far, this correlative model is very accurately predicting the trajectory of the United States as it abandons policies of economic freedom, putting this country on pace to be worse off than Spain by the end of a second Obama term, worse off than Greece and Kuwait within 10 years, worse off than Cuba, Mexico, and Vietnam within just 15 years, worse off than Israel and Madagascar in 20 years, and putting us among the worst failed states in the world within just 25 years.

I would hope that Americans would remember their heritage of liberty and stop this decline before we get far enough along to consider ourselves equal to any of the above-mentioned countries in well-being. But before this decline can be prevented, Americans need to recognize how great of an effect economic liberty has on our lives. We cannot continue to function as a successful, developed nation if we continue electing politicians who publicly disparage the principles of liberty, equating economic freedom with an attack on the poor. As the data presented here shows, it simply is not true that economic freedom creates poor social conditions, and in fact, the opposite appears to be true. If we favor the principles and policies of economic freedom, we will gain prosperity as a country. Australia (89.1, 23.2), New Zealand (82.1, 25.6), and Switzerland (81.1, 23.3) appear to have learned this lesson, so why can’t we?

I will be continuing this analysis in Part 2 of the series, with an analysis of how the subcategories of Heritage’s Economic Freedom measures correlate with State Failure.

Footnotes

1. North Korea is included in the ranking, but is not fully scored. Afghanistan, Iraq, Liechtenstein, Sudan, and Somalia are not ranked due to the difficulty of obtaining reliable data.

2. Countries were excluded if and only if data was not available from one of the two indices.