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New study shows that increasing economic freedom leads to lower poverty rates

In the pre-COVID period, Americans saw large gains in income and also drops in poverty. This was all thanks to a strong economy that facilitated larger than normal returns across all income groups. And this growth was in part due to factors that characterized this period like deregulation and lower taxes.

This is generally well in accordance with economic theory; lower taxes and less regulation reduce the overall cost of doing business. This makes it more profitable for individuals and businesses to engage in economically productive activities. Therefore individuals become more likely to engage in individual startups and small enterprises. And businesses may make more investments in things like research and innovation, and physical capital. All these activities drive up productivity up and raise incomes.

Economic Freedom

What the issue of taxes and regulation boils down to is that of economic freedom. Taxes and regulation are generally some of the two factors that are included in the analysis of the umbrella term “economic freedom”. The Heritage Foundation, for instance, defines economic freedom as a “fundamental right of every human to control his or her own labor and property”. And to that, it adds,

In an economically free society, individuals are free to work, produce, consume, and invest in any way they please. In economically free societies, governments allow labor, capital, and goods to move freely, and refrain from coercion or constraint of liberty beyond the extent necessary to protect and maintain liberty itself.

Therefore any factor, including the level of tax and regulatory burden, that makes it unnecessarily harder for individuals to work, produce, consume, or invest in any way they please, that country has little economic freedom. And the opposite is true.

Economic Freedom and Poverty

A lot of studies exist showing a positive relationship between economic growth and the level of economic freedom. And just recently a study by Colin Doran and Thomas Stratmann has come out bearing witness to this same theme. The study, which quantifies the relationship between poverty and economic freedom finds that increasing levels of freedom are associated with lower levels of poverty.  The results of the study are described below;

Over the span of 20 years (1995-2015), Doran and Stratmann measured the correlation between components of the Heritage Foundation’s Index of Economic Freedom as applied to three different income thresholds; $1.90 a day, $3.20 a day, and $5.50 a day (at 2011 purchasing power parity). To test the theory that increasing economic freedom in a country leads to lower poverty rates worldwide, the experiment’s data is drawn from 151 countries and over 1,000 observations.

By studying how involved each government is in the economic marketplace, Doran and Stratmann concluded that a country’s market, public policy, integrity, and regulatory efficiency can help bring down poverty rates. For example, public policy that is associated with increasing the country’s integrity or government transparency, i.e. policy that reduces corruption and political bribery, correlate with lower poverty rates. According to their research, “a 10% increase in a country’s government integrity score is correlated with a 0.8% to 1.6% reduction in poverty rate depending on the poverty threshold used” (The Relationship between Economic Freedom and Poverty Rates: Cross Country Evidence).

Policies that lead to more freedom in the market also show a statistical negative correlation with poverty. Thus, “lower non-tariff barriers and lower tariff rates” lead to lower poverty levels in all three income thresholds. Furthermore, reductions in certain government controls of the financial industry are associated with lower poverty rates because banks are more free to extend credit and accept deposits (The Relationship Between Economic Freedom and Poverty Rates: Cross Country Evidence).

The positive relationship between economic freedom and economic growth is largely established by ample evidence. However, research also suggests that crises present opportunities for governments to expand their reach, socially and economically, and stay that way. The coronavirus pandemic has certainly presented that opportunity.

Therefore, at a critical time like this, it is important to champion freedom in all its forms. As evidence continues to show, people when left to their own devices will do more to develop better themselves, than can be achieved by government action. And this is an especially important time to remember that.