Modeling Economic Output and Economic Growth with respect to Economic Freedom A COMPARATIVE STUDY OF DEVELOPING AND DEVELOPED COUNTRIES
Background to thesis
The governing dynamics behind the output of an economy (GDP) is subject to constant debate in economics. What makes an economy prosper and why are some countries more prosperous than others? Alongside the debate, extensive theoretical and empirical research has tried to answer this question.
The original neoclassical growth model from economists Solow (1956) and Swan (1956) suggest that the GDP of poor countries will – under the right conditions – grow faster than the GDP of rich countries, which is why the starting level of income must be of importance to economic growth. The models did not provide a satisfying explanation for why productivity was lower in poorer countries, but it laid the foundation for empirical research on the subject.
Extensions from economists Romer et al. (1992) provided a model that took human capital in account for explaining why productivity was lower in developing countries. Further extensions from Hall & Jones (1999) suggested that social infrastructure also should be included in the model in order to describe the environment in which agents ultimately produce economic output. Within the term social infrastructure there are defining measures such as rule of law, property rights and freedom of contract – all measures of economic freedom.
The relationship between economic freedom and economic growth has been examined by researchers with varying results. Notably, De Haan & Sturm (2000), used cross-sectional data from 80 countries over years 1975-1990 and found that there was a significant positive correlation between economic growth and changes in economic freedom – but not between economic growth and the level of economic freedom. Other researchers such as Scully (2002) and Dawson (2002) found a significant positive correlation between the level of economic freedom and economic growth.
As mentioned above, most papers have examined the relationship between GDP/capita growth and economic freedom on a cross-country sample, which arguably signifies short- term growth (Hall & Jones, 1995). This paper aims to further expand the knowledge on long-term economic growth by examining the GDP/capita level of 50 countries (of which 25 are developing and 25 developed) in relation to their respective level of economic freedom, using more recent data from year 2000 to 2013 – as well as the short-term growth by studying the GDP/capita growth rate. Furthermore, this paper will examine what impact economic freedom has within the sample groups of developed and developing countries.