Improving the measurement of economic freedom by replacing government size with government effectiveness

The Fraser Institute’s Economic Freedom of the World index and the Heritage Foundation’s Index of Economic Freedom allow researchers to empirically test the hypothesis that greater economic freedom leads to higher economic growth. Government size is a component of both indices. A larger government size reduces a country’s economic freedom score while a smaller government size increases a country’s score. This study challenges the practice of treating government size as a factor that is inversely proportional to economic freedom. The study finds (1) the economic freedom indices better estimate GDP per capita if the government size component is removed, (2) government size is the only index component that, when excluded, materially improves the predictive power of the indices to estimate GDP per capita, and (3) modifying the published indices to replace government size (as a negative indicator) with government effectiveness (as a positive indicator) produces indices that are better estimators of economic growth. The author argues that a larger government size cannot itself be considered a curtailment of freedom without consideration of how tax revenues are spent, which is partially captured in the government effectiveness measure.