Regulation, investment, and growth across countries.

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Regulation, investment, and growth across countries.

Numerous studies have explored the relationship between economic freedom and long-run economic growth across countries. (1) One particular aspect of economic freedom that has received relatively little attention in the empirical growth literature, however, is the extent of government regulation. Determining the impact of regulation on cross-country economic performance has been virtually impossible because of the inherent difficulties in measuring the scope of regulation across countries. While a few studies investigate various aspects of specific regulations, none are able to assess the importance of a comprehensive measure of regulation on long-run economic performance in a large sample of countries. (2)

Fortunately, the recent availability of data on the scope of regulation across countries now makes such a study possible. Recent releases of the Fraser Institute's Economic Freedom of the World annual report include data on the regulatory environment in a large number of countries. Beginning with the 2002 release, the report's economic freedom of the world (EFW) index includes regulation as one of its five major areas. (3) Within this area of the index, there are as many as 15 components covering credit market, labor market, and business regulations for which cross-country data are available. Table 1 lists these underlying components as found in Gwartney and Lawson (2005). (4)

There are no well-developed theories of how regulation should affect long-run economic performance. However, it is reasonable to think that regulation may affect an economic agent's ability to engage in voluntary exchange and the efficiency with which resources are used in an economy. Thus, we might expect that the level of regulation in a country is related to indicators of long-run economic performance such as the level of investment or per capita income growth. The line of reasoning here is similar to that relating the more broadly defined concept of economic freedom to long-run performance. Note that this discussion does not presume that the effect of regulation is either positive or negative--this is ultimately an empirical issue. As such, the analysis below will follow the same approach as has been used in the empirical growth literature where the impact of economic freedom has been addressed. The results will show whether or not regulation has economic implications beyond those related to economic freedom more generally...

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