It is very easy to read all the wrong conclusions from the latest Index of Economic Freedom, which ranks 157 countries according to the freedom they offer their citizens to truck, barter and trade. The Heritage Foundation, a free market think tank in the US, and The Wall Street Journal (Mint published the index on Page 21 on Wednesday) publish the index every year.
Hong Kong, Singapore and Ireland top the charts. However, the world’s two most dynamic economies—India and China—are among the stragglers at the back of the line. India’s rank is 115. China is even worse, at 126.
So, what’s all this fuss about economic freedom all about?
The Heritage Foundation website says that the economic freedom index “documents the link between economic opportunity and prosperity.” The obvious conclusion from the latest index is that the lack of economic freedom in India and China does not seem to have affected their ability to grow at spectacular rates. But look at another obvious correlation.
The world’s most free economies are also likely to be among its richest. There are very few poor or lower middle-income countries in the top 25. Similarly, the poorest countries have the least economic freedom. For example, the countries in the top quintile have an average per capita income of $28,217 while those in the fourth quintile (which includes India and China) have a per capita income of $3,790.
It could also be spuriously argued that countries can afford economic freedom only after they reach a certain degree of prosperity; till then, the state has to drive economic affairs. This is patently untrue. India and China started hurtling towards prosperity only after their respective governments unfettered their economies to some extent.
The Indian and Chinese economies have expanded rapidly despite the relative lack of economic freedom because they are emerging out of a centuries-long trap of low productivity and low incomes. These two countries have been positioned well below the global production possibility frontier. So, they have been able to close the gap with a minimal of economic reform and globalization. But as they catch up with countries that are currently more productive and richer, both India and China will have to learn to be more productive and innovate if they are to stay in the game. This cannot happen in a controlled economy. Japan’s sclerotic economy is proof of the fact that long-term growth comes from economic freedom rather than from state-led development.
Let’s stick to the Indian case from now on. Over the past decade and a half, despite many false starts, the Indian economy has got a lot of its macroeconomics in place. Taxes are moderate. Protective tariff walls are lower. Most licensing has been consigned to the rubbish bin. There has been far less progress on the microeconomic front. Companies still struggle with a corrupt inspector raj. The freedom to start and close down a business is severely restricted. Labour laws are an incentive to employ fewer people and use more capital instead.
These are the really big issues that need to be tackled in the years ahead. In an essay written to go with the new economic freedom index, Carl J. Schramm, CEO of the Kaufmann Foundation, brings in the concept of economic fluidity. He says that economic freedom reflects the amount of fluidity in the institutional, organizational and individual elements of an economy. Such fluidity “allows the mixing of ideas and generation of innovation.”
India needs a more fluid economic structure, which will allow its entrepreneurs to take risks and innovate. While macroeconomic freedom has considerably improved since 1991, there is still a lot of work to be done at the micro level.
That will allow India to move from a Keynesian to a Schumpeterian mindset.
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