Do free markets and social progress go together?

Let's go beyond "crude" GDP and see how economic freedom stacks up against SPI (social progress index)

Those sceptical of capitalism tend to dismiss evidence, either causal or correlational, of economic freedom being tightly connected to GDP per capita. They say GDP is a crude measure that might mean something to those worshipping money and material wealth but is meaningless as a true measure of social wellbeing or progress.

That’s quite a problematic line of reasoning because GDP actually tends to do quite well in tracking a bunch of key social metrics everyone cares about. But let’s take the critics at their word. What if we swap the ostensibly crude GDP measure for a better one? How does capitalism fare then?

The social progress index is a composite score that measures “the real-life outcomes experienced by people across a wide range of social and environmental indicators”. It explicitly excludes indicators of economic performance. It combines three broad dimensions: basic needs, foundations of wellbeing, and opportunity. More specific indicators include nutrition and medical care, housing, safety, child stunting, education, environmental quality, equal opportunities, and so on.

So, is there any connection between economic freedom and the social progress index?

Yes, countries with freer markets rank much higher on the social progress index. The relationship is very strong and almost linear, although not quite so. There are countries, such as Venezuela, Argentina, and Iran, that are not economically free but have much more social progress than a perfectly linear trend would predict. For the vast majority of countries, though, the relationship is quite simple.

But economic freedom refers to a bunch of social institutions and processes. Which are the ones that really statistically matter for social progress? Perhaps surprisingly, it’s only those aspects of economic freedom that have to do with legal institutions (the rule of law and property rights) and freedom of international trade (low tariffs and open markets in general). How big the government is, and the amount of regulation, don’t seem to matter either way. Libertarians should take note.

Table 1: OLS regressions

Okay, so countries with better legal institutions, protected private property, and globalized, open trade exhibit a higher level of social progress. Moving up by only one point on the legal system/property dimension (0–10 scale) means being around 6 points higher on the social progress index (0–100 scale). With freedom of trade, the coefficient is around 2.4, so a 1-point increase translates to 2.4-point increase in social progress.

Obviously, no causation can be inferred from such simple bivariate comparisons. Economically free countries tend to also be more culturally individualistic, richer, and more politically free or democratic, so it could be that these characteristics (not economic freedom itself) are bringing them social progress. The relationship is confounded.

So, let’s control for these cultural, economic, and political confounders. Once we do so (see Table 1 above), statistical significance on all of the economic freedom variables vanishes. It seems that it’s mostly democracy and wealth that are doing the heavy lifting with respect to social progress.

But even if economic freedom doesn’t directly bring social progress, isn’t it a key cause of increased wealth in societies? And if so, might it indirectly contribute to social progress via generating wealth, which then unleashes progress?

A simple mediation exercise suggests this is the case. Legal institutions/property rights and freedom of international trade are positively associated with GDP per capita, which is positively associated with social progress. The “total effect” sizes on these two aspects of economic freedom are, in standardized terms, 0.51 and 0.15, respectively. Substantively speaking, the former is very large, the latter small-to-modest. Small government and deregulation are irrelevant, though.

Table 2: Mediation analysis (total relationship shown: direct + indirect)

Again, causality cannot be inferred here, because even though confounding (omitted-variable bias) is reduced through the use of controls, there might be some leftover confounding from yet other societal differences. Moreover, the arrow of causality can point in either direction. Perhaps it’s not economic freedom → wealth → social progress but instead social progress → wealth → economic freedom. That is, societies might progress for some reasons, then become wealthier due to all of the social progress, which subsequently causes people to demand open economic institutions, such as property rights and freedom of trade.

Theoretically, it’s highly unlikely that causality would go only in one or the other direction. But we know from more rigorous studies that economic freedom definitely, at least in part, causes wealth (not just vice versa). To the extent that it does, my mediated correlations here echo a causal relationship.

However we spin it, it’s clearly the case that (some aspects of) economic freedom, wealth, and social progress go hand in hand. That’s a fact many don’t like hearing. At the same time, small government and deregulation are at best useless as far as progress is concerned…