Economic Freedom, Institutional Quality, And Cross-Country Differences in Income and Growth‪.‬

In the past few decades, the issues in the literature on economic growth have broadened from the development of general theories of growth, largely based on Solow (1956), toward an examination of why there are differences in growth rates across countries, and why some countries continue to grow while others stagnate at low levels of income. This study takes an institutional approach and uses a recently developed measure of institutional quality, the Economic Freedom of the World (EFW) index (Gwartney and Lawson 2003) to examine the issue of cross-country differences in income levels and growth rates. The emphasis on the importance of institutions to economic prosperity goes back at least to Adam Smith (1776), and has been found in the more recent work of Olson (1982), Scully (1988), North (1990), Barro (1996), Barro and Sala-i-Martin (1995), Landes (1998), Hall and Jones (1999), and Acemoglu, Johnson, and Robinson (2001). Despite this interest in institutions, much work on economic growth treats institutions peripherally if at all. One challenge to the institutional approach is to find a way to quantify the quality of institutions. The EFW index used here is a measure of institutional quality and, to the extent that higher EFW ratings lead to more rapid growth and higher income levels, it provides insight into the characteristics of an environment conducive to prosperity. The results show that better institutions lead to higher income, and that institutional improvements result in higher rates of economic growth.