Proxies for economic freedom: a critique of the Hanson critique

Southern Economic Journal, Oct, 2005 by Jac C. Heckelman

1. Introduction

Economic freedom indicators have become quite popular recently as a useful tool to quantify the relationship between a country's institutional structure and its promise for prosperity. Recent surveys include those by Berggren (2003), Mueller (2003, chapter 22), and Holcombe (2001). The most prominent indicators, denoted in the order of how extensively they have been used in empirical studies, are those developed by the Fraser Institute, the Heritage Foundation, and Freedom House. Recently, Hanson (2003) has criticized these types of studies on a number of grounds. Hanson expresses concern that these various proxies for the institutional environment have been adopted unquestioned and that they have been considered interchangeable despite having been developed independently by divergent agencies. In particular, he notes that Freedom House uses different criteria than Fraser or Heritage in developing its economic freedom rankings. Although several scholars have shown the three sets of rankings to be highly correlated, Hanson considers this to be problematic. He then presents bivariate regressions to test the relationship of freedom ranking to national wealth and argues that the results cannot be trusted, calling them "statistical nonsense" (p. 640).

Although the purpose of Hanson's study was a larger concern, namely what he regards as an unreliable reliance on econometric regression analyses that engage in false correlation and corroboration tests, he uses the economic freedom literature as his foil. Although there may be a useful cautionary tale here in general, by focusing on a single economic freedom study (specifically, Hanke and Walters 1997) as his whipping boy and failing to mention any others, Hanson's criticism may be interpreted as denigrating the empirical economic freedom literature in its entirety. Thus, it is useful to closely scrutinize his criticisms of this particular study, and the economic freedom literature more generally, to assess their accuracy. Although published only recently, Hanson's article has already garnered a lot of attention. In a simple search on the Internet, I found several working papers already citing his article. It would appear, therefore, that a thorough review of Hanson's study is in order.

Each of the next three sections considers Hanson's arguments in order. These can be summarized as follows. First, Hanson argues that empiricists working with the various economic freedom indicators fail to adequately distinguish between these different proxies. Second, Hanson notes that the economic freedom indicators may suffer from endogeneity to GDP in their construction, and also in empirical applications in which they are used in cross-country regressions to explain variations in GDP. Finally, Hanson presents a series of bivariate regressions between the Fraser index and GDP that he claims refutes any connection by focusing on the differences in the estimates over time. Most of these arguments are shown to be of questionable legitimacy and/or apply only to a select few empirical studies rather than to the literature as a whole.

2. Incompatibility of the Different Economic Freedom Measures

Hanson believes that the Freedom House indicators are fundamentally different from those developed by Fraser and Heritage. Although Hanson agrees with the standard interpretation in the literature that Fraser and Heritage are strictly measures of institutional support for the free market, he suggests that an alternative label for the Freedom House index would be "Liberal Values Index." Hanson believes, "It is troubling, in any case, that measures that differ so strikingly with one another are often taken to measure the same thing" (p. 642). Hanson seems to indicate that the tendency is for most researchers to treat these measures equivalently. In practice, however, it is rare for empirical researchers to use Freedom House or Heritage instead of, or even in addition to, the Fraser index. This may be because of researchers' belief in the superiority of the Fraser index, but some have conjectured that reliance on Fraser is simply because it is the only one of the three constructed for years prior to 1995 (De Haan 2003; Berggren 2003). Either way, the relevance of Hanson's criticism to the general literature is questionable. Given that the Freedom House scores, unlike Fraser or Heritage, have never been updated, they are unlikely to be of much use in the future either, rendering the whole point moot.

The argument itself, in addition to being somewhat irrelevant to the literature, can be questioned. If someone were interested in using Freedom House scores as a proxy for economic freedom, Hanson's argument should not by itself alter this inclination, because it is not clear that the various measures are indeed at odds with each other as Hanson concludes. The seeming incompatibility appears because, as Hanson points out, Freedom House includes policies supporting the rights to organize and protecting rights of women and minorities, which are not directly considered by Fraser or Heritage. Hanson's mistake is that he seemingly conflates activist government policies with the absence of official governmental barriers.