All Commentary
Friday, September 22, 2017

Economic Freedom Is the Best Weapon Against Poverty

Poverty is really about a shortage of rights and freedoms and the institutions that emerge as a result.

Over the past few decades, hundreds of millions of people have risen out of poverty to grow into a powerful global middle class. This unprecedented rise is overwhelmingly the result of embracing greater economic freedom.

Economic freedom enshrines personal choice, voluntary exchange, and protection of private property. It is development from the bottom up by individuals, not top down by governments.

Economic Freedom in the Developing World

Over the years, economic freedom has proven to be an incredibly robust prediction of how prosperous countries are, or will become. The Fraser Institute has found that more economically free countries have higher levels of income, more rapid economic growth, and a greater reduction in poverty rates. For example, in 2015, nations in the top quartile of Fraser’s economic freedom had an average adjusted per capita GDP of over $40,000, compared to around $5,000 for bottom quartile nations.

Free market reforms have ushered in prosperity for millions of the world’s poor. The rise of China and India is further proof. After the partial freeing of markets—China after 1978 and India after 1991—they started growing exponentially, at 7 to 12 percent, up from around 2 percent. While neither country is close to being entirely economically free, even their modest improvements have led to the greatest reduction in absolute poverty the world has ever seen.

Free market reforms have ushered in prosperity for millions of the world’s poor. But can governments and international organizations really plan a market economy from the top down?

The short answer is, “No.” Free institutions cannot be designed from the top down and they cannot be bribed into existence by foreign aid.

Trillions of dollars of development aid have been transferred over the last 60 years, yet the results have been dismal. Economists have often found that foreign aid has no influence on economic growth whatsoever, while some have found that it even has a negative influence.

This is because, as former World Bank economist William Easterly has argued, it’s not about getting the right people or the right plan to solve poverty from the top down. Poverty is really about a shortage of rights and freedoms and the institutions that emerge as a result.

The Power of Laisse-Faire and Private Property

Market institutions are best formed when governments take a hands-off approach. A great example of this has been the rise of mobile money in Kenya.

Just over 10 years ago, the telecom company Safaricom launched M-Pesa, a mobile money service in Kenya that allows users to send and receive digital payments. In 2015, Safaricom reported that M-Pesa payments accounted for around 44 percent of the country’s GDP with over 25 million accounts.

This shadow economy is a natural response to the stifling restrictions that governments have placed upon businesses and entrepreneurs. The key to M-Pesa’s success was that Kenya’s regulatory environment was relatively accommodating. Whereas banks and financial institutions are heavily regulated, M-Pesa, as a telecom service, was exempt from many burdensome regulations. The lack of access to finance in Kenya was solved through “permissionless innovation.”

But this isn’t the situation across most industries in Africa. One of the greatest problems on the continent is informal economies—where businesses operate outside of a country’s legal framework—accounting for some 50 to 80 percent of GDP.

This shadow economy is a natural response to the stifling restrictions that governments have placed upon businesses and entrepreneurs, forcing people out of the formal economy. The World Bank’s most recent Ease of Doing Business report deemed Africa the most difficult region in the world for starting a business.

Another factor is the lack of secure property rights. Nations with the strongest private property protections have per capita incomes five times higher than those with only moderate protections. Without formal land titles, individuals struggle to gain finance, start businesses, or access the justice system.

African nations have some of the least secure property rights in the world. If individuals and businesses do not have formal titles to their land or other property, how can they be integrated into the formal economy?

How We Can Help

African nations—not foreign governments—need to implement free-market reforms. But that doesn’t mean there’s nothing Western countries can do to help. There are many barriers—detrimental to both themselves and developing nations—that they can bring down.

Embrace free trade and capital flows. One of the most substantial barriers to African agricultural development is Western farm subsidies. According to Oxfam, some 10 million people in Western Africa who rely on cotton exports lose up to $250 million a year from Western subsidies. This is just the tip of the iceberg when it comes to farm subsidies, and it is low-hanging fruit that would benefit both the most and least developed economies.

Liberalize immigration. Immigrants are a fantastic resource for the American economy, but they are also a fantastic opportunity for the immigrants’ countries themselves. Liberalizing visa and work requirements will help develop the human capital of immigrants that will then benefit their home nations upon return.

Stop destructive interventions. Western nations should stop trying to socially engineer outcomes through development aid. It is a textbook example of good intentions leading to unintended consequences. But perhaps the greatest problem is that it has encouraged a political framework in direct opposition to the kind of economic freedom required for development. Any program that contributes to planning development from the top down prevents countries from embracing economic freedom. They should be strongly rethought.

Economic freedom is the single greatest driver of prosperity. Since the fall of communism and the rise of China and India, this has become undoubtedly clear. If Western governments and developing nations wish to spur development and create a world free of poverty, it is essential to embrace economic freedom.

This article is adapted from a speech delivered to the Foreign Service Institute at the United States Department of State on August 29, 2017. The full contents of the presentation can be found here.

  • Daniel Press is a policy analyst at the Competitive Enterprise Institute, where he focuses on financial regulation, international development and trade.