Institutions and Policies of Economic Freedom: Different Effects on Income and Growth

Abstract: The aim of this paper is to provide some additional results concerning how and why economic freedom enhances growth and/or long-run income. Our hypothesis, based on the theory of entrepreneurship, is that institutions and policies of economic freedom may have different effects and work through different channels. We first present the theoretical arguments, then we empirically investigate the effects of institutions and policies of economic freedom on growth and long-run income. To do this, we categorize the components of the Economic Freedom of the World (EFW) index as institutions and policy variables and apply both Acemoglu et al.’s (2001) and Mankiw et al.’s (1992) modeling strategies in our cross-country regression analyses. The major finding is that institutions and policies of economic freedom have different effects on long-run income/growth both in terms of their size and working mechanisms. While the institutions of economic freedom have a positive significant effect both on long-run income and growth, and this effect has a direct and an indirect channel as well, monetary policy takes effect only during the catch-up process and this effect is direct, and fiscal policy does not have a significant impact.