Institute for Research in Economic and Fiscal issues

IREF Europe - Institute for Research in Economic and Fiscal issues

Fiscal competition
and economic freedom


Economic Freedom: Remedy against Corruption

During the next months the Olympic Games will take place in Brazil. As was already the case during the Football World Championships 2014, we will see many reports about the widespread corruption in this country. Unfortunately, far less attention will be paid to how underdeveloped economic freedom is in Brazil. This is the case despite the fact that internationally corruption and economic bondage have a tendency to go hand in hand.
In countries with particularly high levels of corruption people are also facing strong economic restrictions. The opposite is the case for countries with high levels of transparency. Here people are enjoying economic freedom. It is true that there are countries where people are economically free but corruption is still a huge issue. However, there are no countries which offer little to no economic freedom and at the same time low corruption. Although a free economy does not appear to guarantee low levels of corruption it is still necessary to lay the ground to eradicate corruption and foster economic growth.

Corruption bad, Economic Freedom good

There is plenty of empirical evidence for the negative consequences arising from corruption. Corruption has a negative impact not only on GDP and economic growth but also on the volume of investments as well as life expectancy in a country. The contributions to the empirical literature draw a unitary, but not very surprising picture. Corruption is therefore not desirable.
While corruption is hampering growth, empirical evidence suggests that economic freedom leads to a positive development of economic growth and the GDP of a country. The more people are able to decide on the usage of resources independently from the state, the more productively they will be used. Economic freedom is therefore desirable.

More economic freedom, less corruption
In the wake of these results it comes to no surprise that corruption tends to be less common in countries with higher levels of economic freedom.

The Corruption Perception Index published by Transparency International has prevailed as parameter for the degree of abuse of power of bureaucrats, politicians and other officials assigned with community tasks. The index measures the perceived corruption of the public sector within a country’s population. A higher Corruption Perception Index indicates that corruption is less of a problem.
The Economic Freedom Index published by the Fraser Institute has on its part established itself as gauge for economic freedom. The higher its value, the more extensive the economic freedom in the country. The value for the economic freedom given by the Economic Freedom Index is higher the (1) less influential the state is, the (2) more reliable the justice system and property rights are, the (3) more stable the country’s currency is, the (4) easier cross-border trade can be carried out, and the (5) less restricting state regulations are. The thus measured economic freedom is the highest when state interference is limited to protecting its citizens and their property rights as well as to providing a few public goods.

Economic freedom no guarantor against corruption
Those countries with the lowest economic freedom are also haunted by far-fetched corruption while countries with little issues with corruption show high levels of economic freedom.
However, there are countries which have relatively high levels of economic freedom, but where corruption is still a big issue. This is particularly true for the group of countries around Cambodia, which in terms of economic freedom is doing as well as Sweden, however, perceived corruption in the public sector is substantially higher. Nevertheless, there is no country with weak economic freedom where corruption is not a serious problem.
These observations fit the hypothesis Milton Friedman published in 1962 which says that economic freedom is a necessary but not a sufficient condition for political freedom, hence, political freedom is not possible without economic freedom. The absence of corruption can be understood as an element of political freedom. The fact that no country can be found where economic freedom is weak and corruption is not a big issue, is supporting Friedman’s thesis that a country cannot have political freedom as long as it the state that primarily decides how resources are to be used.

Economic Freedom: Remedy for Corruption
Despite pronounced economic freedom being only a necessary condition and no guarantee for less corruption, there are in general clear indications that more economic freedom leads to a decrease in corruption. Possible exceptions confirm the rule. For rich and developed countries recent results show that a stronger influence of the state – statement (1) in the list above – does not necessarily mean more corruption. Additionally, other results imply stricter regulations in poor countries – statement (5) in the list above – can reduce corruption.
However, together with the available empirical studies, the presented data leads to the conclusion, that only in countries with high levels of economic freedom corruption opportunities for state representatives can be almost eliminated. Therefore, everyone who wishes for less corruption should also argue for more economic freedom – positive effects on growth would be a welcome side effect.

This article is a translation of an original piece published on our German site and available at http://de.irefeurope.org/Wirtschaftliche-Freiheit-Mittel-gegen-Korruption,a1160

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