Economic Freedom: Essential Principles

• Essential Principles
• History
• Estonia
• Kenya
• Cuba
• Resources
• Study Questions

Introduction

A Migrant Mother and her Children during the Great Depression

Although there are no international covenants clearly guaranteeing economic freedom as there are with political and civil rights, few political theorists today doubt the connection between a free or market-based economy, broadly defined, and a free political system. In the late 18th and 19th centuries, political and economic liberalism were intertwined philosophies that heralded the expansion of both individual liberty and property ownership, the two characteristics that have generally marked the rise and success of democracies. Yet the strict interpretation of economic liberalism also became associated with economic license, large disparities in income, and catastrophes like the Great Depression of the 1930s. In Europe and the United States, social democratic parties responded by adopting more egalitarian policies and establishing components of a welfare state, even while generally accepting the basic foundations of a market economy. In the last 30 years, conservative parties in countries with major world economies (including the United States, the United Kingdom, Italy, and France) reintroduced classical economic liberalism as the guiding philosophy, but without eliminating the central institutions of the welfare state.

What in fact constitutes economic freedom? What degree of economic freedom is needed for democracy to flourish?

...few political theorists today doubt the connection between a free or market-based economy, broadly defined, and a free political system.

History

For most of human history, there has been little economic freedom as most political scientists or political economists would define it today. Even the ancient states of democratic Athens and republican Rome, many of whose citizens owned property and engaged in trading, were still largely aristocratic societies that depended on slaves for the operation of their farms and industries. Indeed, until the advent of political and economic liberalism, most people in most societies were legally or informally bound to an owner, employer, or ruler, often as slaves, who were considered a form of property; serfs, who were tied to agricultural land and owed their lord obligatory labor or rent, but usually enjoyed some customary rights; or indentured servants, whose freedom was restored after a fixed period of time.

The most famous document establishing constitutional limits on monarchy and guaranteeing such feudal property rights was the Magna Carta...

In many countries, all property and economic rights were theoretically distributed by the monarch, who was considered to possess the realm's whole wealth and territory. The land could be divided according to his or her will and was usually given to barons who were expected to raise military forces when called upon. This gave rise to hereditary landowning aristocracies, some of which became less dependent upon the monarch and more assertive of their own rights and privileges. The most famous document establishing constitutional limits on monarchy and guaranteeing such feudal property rights was the Magna Carta, signed by England's King John in 1215 at the insistence of his nobles. Towns and cities also enjoyed special rights as distinct units under the feudal system, and their merchants and artisans—known in France as the bourgeoisie, or townsmen—often organized themselves into collective entities to hold wealth, conduct business, or defend rights in common. These were known as corporations, since in legal terms they were considered a single person (corpus is Latin for body). Monarchs recognized such entities by granting charters of incorporation and began to encourage groups of merchants to undertake risky or expensive enterprises, like oceanic trade or the foundation of overseas colonies, that would benefit the kingdom. Among the most famous of these were the respective East India Companies of Great Britain and the Netherlands, which founded colonies and sought to monopolize trade with parts of Asia between the 17th and 19th centuries. Another group with a royal charter, the London Company, founded the first permanent English settlement in North America, Jamestown, in 1607.

The formation of chartered trading companies was a key component of mercantilism, the dominant economic system in much of Europe from the 16th to the 18th century. According to mercantilist theory, a nation's wealth depended on the acquisition of gold and silver through increased exports and internal self-sufficiency. This required protectionist policies to safeguard a country's domestic industries, and colonial expansion to secure exclusive sources of raw materials and captive markets for export products. By encouraging domestic and overseas commerce, manufacturing, the accumulation of wealth, and the development of large and uniform national economies, mercantilism set the stage for the emergence of a new form of political economy based on the largely unfettered operation of markets.

Adam Smith

Just as John Locke's Two Treatises of Government had a revolutionary influence on political philosophy by establishing the principles of self-governance (see "Consent of the Governed"), Adam Smith's The Wealth of Nations, published nearly a century later in 1776, had a seminal effect on the field of economics by laying out new principles based on individual liberty.

In The Wealth of Nations, Smith argued that mercantilism ignored the true nature of wealth, which was best attained through open competition and the interaction of supply and demand rather than the enforcement of monopolies and the excessive accumulation of gold and silver. Individuals pursuing their own self-interest created competition, which helped to keep prices close to the cost of production and encouraged growth. Mercantilism's protectionist system, according to Smith, raised certain prices artificially and benefited a small group to the detriment of all, while the accumulation of bullion simply led to inflation. Smith advocated laissez-faire ("allow to do"), meaning the limitation of government intervention in the economy, so that the mechanisms of competition and the market could operate without hindrance. The government should restrict itself, he argued, to providing law and order, protecting private property, and certain other important functions.

Smith spoke to the needs of an emerging class of manufacturers, traders, property owners, and other beneficiaries of an evolving economy. His impact has been enduring. The Wealth of Nations remains the basis for free-market theory, and Smith's views have had wide and continuing influence over government policy and the platforms of political parties.

In most countries, the abolition of serfdom and slavery coincided with major advances in economic growth and the development of democracy.

Starting in the late 18th century, there has been a clear connection between the increase in economic freedom (reducing government controls and expanding property rights) and the expansion of political freedom. While the free-market economy or capitalism emerged in a time when serfdom and slavery were still being practiced, they ultimately proved incompatible. In most countries, the abolition of serfdom and slavery coincided with major advances in economic growth and the development of democracy. Capitalism, however, also entailed new forms of labor exploitation. Drawing in part upon the masses of people displaced from the countryside by more efficient farming, industrialists were able to pay low wages and maintain poor working conditions. In market terms, the labor supply exceeded demand, making individual workers cheap and expendable. The rise of labor unions, beginning in the early to middle 19th century, gave workers more bargaining power and helped to increase pay, alleviate poor working conditions, and expand political representation. But severe treatment of workers remains common in many countries, reflecting an ongoing tension between free-market principles and freedom of association in most democracies (see "Freedom of Association".

In general, it can be said that two rival sets of economic principles and policies have dominated the political debate in democracies for more than 150 years. One is social democracy, which favors government intervention, and the other is liberalism, favoring laissez-faire. In the last 60 years, parties representing both political trends have come to accept the basic elements of a free-market or free-enterprise economy as well as those of a state welfare system. They have alternated in power and adjusted their policies according to what citizens want or need at a particular time (lower taxation to stimulate business, for example, or state intervention to alleviate poverty). During the Great Depression and post–World War II periods, the social democratic parties in Europe and the United States instituted policies to spread wealth more evenly and foster economic growth through government programs. These parties also tended to place greater emphasis on regulations to protect the environment and the consumer than on what might be termed economic freedom or business interests. In the last 25 to 30 years, economically or "classically" liberal parties (often dubbed "conservative" in U.S. political jargon, which commonly uses "liberal" to refer to the social democratic Left) and their policies have enjoyed more success in the major world economies, including the United States. They have replaced government intervention with lower taxes, reduced regulation, and free-trade initiatives.

The broadest ideological challenge to economic freedom— and freedom generally— was communism...

The broadest ideological challenge to economic freedom—and freedom generally—was communism, first adopted by a government when the Bolsheviks took power in Russia in 1917. Like social democracy, communism drew inspiration from German theorist Karl Marx's critique of capitalism in the mid–19th century. But unlike social democracy, whose leaders and thinkers sought gradual reforms within a liberal democratic political system and rejected Marx's revolutionary and historically determinist theories, communism used Marxist ideology to advocate violent tactics and the establishment of a totalitarian political system. In economic terms, that meant seizing and collectivizing all property, placing it under the state's central control, and directing every economic act through state planning. Millions of people died in the process of collectivizing all farmland in the Soviet Union, China, and other Communist countries; millions more found themselves caught in the huge forced-labor system constructed to help carry out the state's economic plan and punish its critics. Dissidents often likened life under Communist regimes to slavery.

Karl Marx

Communist systems produced chronic shortages and widespread deprivation, while democratic countries saw remarkable growth and abundance in the decades after World War II. Over time, the Soviet Communist system decayed economically and collapsed politically in the face of competition from its democratic and capitalist rivals. Chinese Communist leaders, however, prevented the collapse of their regime by creating a hybrid system of authoritarian capitalism, loosening some economic controls while maintaining a political dictatorship. The remaining handful of unreformed Communist states—such as North Korea and Cuba (see below)—have sunk to extreme poverty.

Essential Principles

Economic freedom, like political freedom, has many definitions. As noted above, these are often tied to a political viewpoint or ideology. While Adam Smith's The Wealth of Nations wove the ideas of political and economic liberalism together, the most famous free-market theorists, such as Milton Friedman, Friedrich Hayek, and Ludwig von Mises, generally ignore Smith's broader theories and focus on his advocacy of laissez-faire, taking the principle of the free market as something like an absolute dictum. Thus, any state intervention in the economy—including such widely adopted policies as a minimum wage, environmental controls, or collective bargaining via labor unions—is considered to be a harmful infringement on economic freedom, even if Smith himself might have allowed it (Smith, for example, supported the right of workers to form unions). Hayek and Mises go so far as to say that any such intervention constitutes a step toward communism and tyrannical "serfdom."

The Heritage Foundation, a conservative think tank, conducts an annual survey of economic freedom that defines such freedom in stark terms:

The highest form of economic freedom provides an absolute right of property ownership, fully realized freedoms of movement for labor, capital, and goods, and an absolute absence of coercion or constraint of economic liberty beyond the extent necessary for citizens to protect and maintain liberty itself. In other words, individuals are free to work, produce, consume, and invest in any way they please, and that freedom is both protected by the state and unconstrained by the state.

This compelling statement, taken literally, appears to argue that any state action beyond basic functions like law and order violates economic freedom. Of course, while most democratic governments routinely violate the standard above, as well as the general concept of a completely free market, they still fall within the more complex definition of freedom used by Freedom House. Perhaps, then, some broader principles should be applied.

The 20th-century confrontation between democracy and Communist dictatorship points to the profound importance of both economic and political freedom. Under communism, state control over property and all aspects of the economy was not simply an alternative economic model but an essential component in a larger totalitarian system. The state's economic tyranny further reduced the realm of individual freedom and helped prevent the rise of an alternative to Communist political power.

Drawing on this experience and its contrast with democratic societies, economist Ezra Solomon, a former member of the U.S. president's Council of Economic Advisers, proposed a different way of thinking about economic freedom, reconnecting it to its political roots. In his essay "The Economy in a Free Society," he writes:

[A] free economy is most suitable to a free polity for it allows the broadest scope of liberty in the free exchange of goods and services between individuals and groups... Private property and free markets do limit the power of the state by diffusing its control over the economic lives of its citizens. Individual liberty in making economic decisions limits the power of the state to control the political lives of the citizenry.

Thus, property rights and individual freedom in economic decision making are a necessary bulwark against both the tyranny of the state and the economic power of privileged elites. To the extent that state intervention endangers that bulwark, it might be considered a violation of economic freedom. But if a lack of state involvement allowed the unhindered actions of privileged elites to threaten individual freedom, that too would violate the principles of economic freedom. Democracies have found that they must balance state intervention and economic freedom, and they have allowed voters to decide when that balance requires adjustment or correction.

...property rights and individual freedom in economic decision making are a necessary bulwark against both the tyranny of the state and the economic power of privileged elites.

Conclusion

In the last 25 years, principles of economic freedom have generally advanced together with those of democracy and political freedom. In some cases economic liberalism followed the rise of political liberalism, while in others economic liberalism has spearheaded political change. In all countries, basic concepts of economic freedom as defined by Ezra Solomon above—lack of interference in individual decision making and the ability of free markets to diffuse state power—played a key role in political transitions. Another economic aspect of democratic transition was described by the renowned American sociologist Seymour Martin Lipset, who determined that economic development, modernization, and a rise in the middle class helped increase people's expectations for both economic improvement and political freedom (see Resources).

The connection between economic freedom and democracy is made clearer by a comparison of economic and political conditions. Of the 49 countries that received the top rankings in Freedom House's Freedom in the World 2007 survey (scores of 1 for both political rights and civil liberties), 40 were also listed in the United Nations Development Program's 2006 Human Development Index; 35 of those were among the index's top 50 countries. Similarly, 37 of the 49 were listed in the Heritage Foundation's 2007 Index of Economic Freedom, and 32 of those were ranked in the top 50. By contrast, lack of freedom and economic deprivation commonly go together. Although there are exceptions, the citizens of the world's worst dictatorships generally live in poor economic conditions.