Does economic freedom cause prosperity? An IV approach

Abstract

A positive, statistical and economic significant relation between growth, income level and the Economic Freedom of the World (EFW) index has been amply documented. Most analyses, however, use OLS methods which, in the presence of endogenous variables do not establish causality and produce biased and inconsistent estimates. This paper uncovers the exogenous component of EFW using IV methods and finds a robust channel from economic freedom to prosperity. The findings, including instrument validity tests, support the importance of policies and institutions for development and warrants policy advice aimed at increasing economic freedom to foster prosperity. [PUBLICATION ABSTRACT]