Pathways to economic prosperity: Theoretical, methodological, and evidential considerations

Contextualizing the “freedom leads to prosperity” hypothesis 

This paper provides an overview of the diverse ways in which scholars have sought to account for differing levels of economic prosperity in order to place the freedom and prosperity hypothesis in a broader historical-empirical and theoretical context. The first section provides an overview of the most prominent theoretical models of economic growth and economic development. The second section surveys a variety of accounts of why different countries enjoy different levels of economic prosperity today. The third section provides a hyper-stylized history of successful cases of state-led (rather than market-oriented) and institutions-focused economic development in order to shed light on the question of how—in the context of the freedom-leads-to-prosperity hypothesis—ostensibly “Unfree” countries were able become relatively prosperous. The last section discusses the theoretical, conceptual, and methodological implications of the preceding discussion for broadly institutionalist explanations of national economic prosperity. 

Some countries are more prosperous than others 

Some countries are more economically prosperous than others, if economic prosperity is narrowly defined in terms of per capita income. Differences in economic prosperity are the consequence of differing per capita economic growth rates over an extended time horizon. Economic growth is a multi-causal phenomenon, meaning it is influenced by a variety of factors. Different levels of long-term economic growth have been variously attributed to political, financial, economic, social, cultural, institutional, geographic, and demographic factors—to mention just a few—or any combination thereof. It is an empirical question whether and to what extent these factors have explanatory power. Answering empirical questions by necessity involves crucial decisions in terms of methodology. 

Historically, countries have experienced different levels of economic growth and development. Beginning in the middle of the eighteenth century, the industrial revolution propelled England and later northwest Europe and then North America, to relative economic prosperity. Japan’s rapid economic ascent following the Meiji Restoration and East Asia’s even more rapid rise during the last quarter of the twentieth and the first quarter of the twenty-first century are other examples of successful economic development. 

There is little consensus among researchers as to what best explains differences in economic prosperity. At risk of over-simplification, economists seek to understand the under-lying mechanics of economic growth and development and seek to identify ways to activate these mechanisms. Economic historians and political economists are equally, if not more interested in the non-economic factors affecting prosperity in order to explain why some countries managed to pursue successful pro-growth policies while others did not. This often includes “exogenous” factors, such as geography, the availability of natural resources, and so on. These two approaches are not necessarily incompatible. Assuming economists identify the economic mechanism (or mechanisms) necessary to generate sustained economic growth, the question as to why some countries have succeeded in activating it (or them) and what structural factors may have constrained or facilitated their activation are related, yet analytically separate questions. 

Frequently, answers differ because the questions differ. Explaining, for example, why the industrial revolution of the eighteenth century occurred at all, why it occurred in Britain rather than in China, or why some countries were subsequently able to replicate Britain’s economic success (while others were not) may elicit very different answers.1Robert Allen, “Why Was the Industrial Revolution British?,” VoxEU and the Centre for Economic Policy Research (CEPR), May 15, 2009,​british; Kenneth Pomeranz, The Great Divergence: China, Europe, and the Making of the Modern World Economy (Princeton: Princeton University Press, 2000); Jonathan Daly, Historians Debate the Rise of the West (London: Routledge, 2014). Similarly, the answer as to why a low-income country is able to sustain economic growth may differ from the answer to what supports superior economic growth in a technologically advanced economy. Assuming that the same factors affect economic growth equally across all countries and at all times is just that: an assumption. This is worth bearing in mind when seeking to explain the relative economic success of countries, and especially when providing policy recommendations. 

The causal importance of a particular factor or set of factors, such as economic, legal, and political freedom, may vary depending on a country’s characteristics, such as its level of development, political stability or socioeconomic structures, the level of international economic integration, or the availability of technology. In methodological terms, it is difficult-to-impossible to control for all these potentially relevant factors. In a low-income country, expanding the physical capital stock (characterized by high marginal productivity) may have a greater impact on economic growth than in a high-income country with a large capital stock (and rapidly diminishing capital productivity). Smart policies, such as those that support innovation, may be more important in the latter case, while such policies may be less impactful, or less necessary, in countries that seek to catch up economically by adopting existing technologies. As will be shown in greater detail below, this is often discussed in the context of so-called “latecomers” (countries that are, relatively, economically and technologically backward) and advanced economies (operating near the so-called “technological frontier”) In technologically advanced economies, economic growth is primarily driven by innovation and technological progress. In less advanced economies, it is driven by extensive (rather than intensive) capital accumulation and the incorporation of “off-the-shelf” technologies into the production process.2Thomas Philippon, The Great Reversal: How America Gave Up on Free Markets (Cambridge: Harvard University Press, 2019). Different factors may account for economic growth at different levels of economic development. More on this later. 

Economic models of economic development 

The standard economic growth model, the so-called Solow–Swan model, sees long-run economic growth as the consequence of capital accumulation, labor force growth and productivity increases (or technological progress). In this model, economic growth is exogenous. A high level of per capita income is a reflection of a large physical capital stock as well as the efficiency with which the factors of production are deployed. Technology is exogenous. Successful countries rely on a virtuous cycle of increased investment, accelerating economic growth, rising incomes and increasing savings, which in turn helps sustain high levels of investment, and so on. It discounts the importance of economic policy and what economists call “endogenous factors,” namely factors that are conducive to furthering innovation, creating knowledge, and enhancing human capital, including the quality of public policies.3Paul M. Romer, “The Origins of Endogenous Growth,” Journal of Economic Perspectives 8, no. 1 (winter 1994), 3–22.

This somewhat mirrors the distinction between liberal-institutionalist and state-interventionist theories of economic development. Broadly liberal accounts of economic development emphasize the role of private economic agents, functioning markets, and private-sector investment, while statist or “development state” accounts highlight the role played by public-sector policies, particularly in the presence of market failures or in areas where social returns exceed private returns.4Ha-Joon Chang, Kicking Away the Ladder: Development in Historical Perspective (London: Anthem, 2002) Liberal accounts attribute economic development to self-interested economic agents acting in the context of political and economic stability and freedom, the rule of law, and market competition. In this respect, the nineteenth-century “nightwatchman” state, which guarantees economic stability and provides political stability, and the so-called Washington consensus, with its emphasis on market reform and curtailing the role of the state, are variations of a theme. 

By contrast, many development economists see the state as playing an important role in economic development that goes beyond the provision of legal, economic, and political freedom and stability. The “big push model” is fairly representative of this literature. Models, like Rostow’s “linear stages of growth model,” emphasize the need for governments to stimulate “economic take-off” through large, up-front, government-financed infrastructure investment.5W. W. Rostow, “The Stages of Economic Growth,” The Economic History Review 12, no. 1 (1959), 1–16. Starting from a low level of income, putting a country on a path of sustained economic growth requires large, catalytic, government-financed infrastructure investment to lower transaction costs and make (some) markets economically viable, thus overcoming market failure.  

Many of these models emphasize the existence of market failures and coordination costs as well as the ability of the state to help overcome them. For example, a private firm may want to produce tires. But this requires a large up-front investment. This only makes economic sense if there is sufficient demand for tires from a car manufacturer. The car manufacturer faces the same problem. The government can then step in to help overcome the coordination problem by supporting investment or guaranteeing demand, ultimately assuming financial risks to reduce economic and financial uncertainty for private economic agents. Related to the coordination problem and market failure is the notion that the social returns of government-supported investment may exceed the economic returns of private investment. As the private sector will not make the socially optimal level of investment because of its inability to internalize profits, the government has an important role in supporting investment and thereby supporting economic development.  

Another prominent model sees economic development as a process whereby increased agricultural productivity allows rural workers to move into more capital-intensive industries in urban areas. The so-called “dual-sector Lewis model” posits the transfer of surplus labor in the agricultural sector to the higher-productivity, capital-intensive industrial sector, thereby promoting industrialization, productivity, and development.6W. Arthur Lewis, “Economic Development with Unlimited Supplies of Labour,” The Manchester School 22, no. 2 (1954), 139–91. For a critical perspective, Douglas Gollin, “The Lewis Model: A 60-Year Retrospective,” Journal of Economic Perspective 28, no. 3 (summer 2014), 71–88 Here again, it is easy to see how government has a role to play in terms of providing adequate infrastructure to support urbanization, for example. This is perhaps best illustrated by the contrast between Latin America’s favelas and China’s more successful urbanization, supported in part by controls of rural–urban migration in the latter case. 

Liberal economists point to government failure (or economic inefficiencies caused by government intervention)—often but not always in the context of rent-seeking interests that weaken a government’s ability to pursue a successful long-term economic development policy—as a major explanation for the lack of economic growth. In this vision, significant government intervention in the economy is bound to fail because private interests capture policies and influence them to their benefit, at the expense of long-term economic growth. In other words, the importance of market failure versus government failure underpins different visions of the role played by market-oriented versus state-interventionist policies in fostering economic growth and development. 

Economic models, as opposed to political-economic accounts, do not typically consider political-economic institutions, socio-cultural attitudes, or other exogenous factors to play a role in economic development. Instead, they seek to identify the basic economic mechanism that allows countries to generate sustained economic growth and raise income levels. Endogenous growth models do allow for the incorporation of factors other than capital accumulation, labor force growth, and techno-logical progress, but often do so in rather abstract ways. Meanwhile, political-economic accounts often focus on factors, such as social attitudes or geography, that are hypothesized to be more or less conducive to successful economic development, even if the basic underlying growth mechanism in terms of a self-reinforcing “economic growth/investment” cycle is generally assumed to be the same. In other words, political-economic accounts are more concerned with the question of what factors or policies help activate the mechanism necessary to generate sustained economic growth.  

So far for theory; now a data point. Whether economists have misidentified relevant mechanisms, or political economists have failed to identify the relevant factors, or countries have been unable or unwilling to implement growth-enhancing policies and reforms, economic development policies have generated disappointing outcomes. According to the World Bank, of the 101 middle-income economies in 1960 only thirteen had become high-income economies by 2008 (including Hong Kong, Japan, Korea, Singapore, and Taiwan). Some analysts have taken this to mean that “despite the best efforts of generations of economists, the deep mechanisms of persistent economic growth remain elusive.”7Abhijit V. Banerjee and Esther Duflo, Good Economics for Hard Times (New York: Public Affairs, 2019), 207. But this may be too defeatist. Countries may not have reached high-income status, but per capita income in many (but not all) of the world’s economies has increased, whether they have “caught up” with high-income economies or not. According to the World Bank, China, Romania, and Ethiopia have seen their per capita income (in international dollars at purchasing power exchange rates) quadruple over the past twenty years. Surely, this must count as a success, whether or not they are classified by the World Bank as high-income countries. 

Geography, climate, institutions and economic prosperity  

Even if one accepts that economic well-being comes about as a consequence of capital accumulation and productivity growth, regardless of what role, if any, the government has to play in this process, it is a fact that some countries have higher per capita income levels than others. Some countries have obviously been more successful than others. This has been variously attributed to structural factors, such as geography, or discretionary actions, such as good policies. Again, capital accumulation (and productivity growth) is the basic underlying mechanism that paves the path to prosperity. But both endogenous and exogenous factors can be conceptualized as being more or less conducive to this mechanism being activated. 

For a start, geography and climate may help account for pronounced income differences.8John Luke Gallup, Jeffrey D. Sachs, and Andrew D. Mellinger, “Geography and Economic Development,” International Regional Science Review August 22, no. 2 (August 1999), 179–232; John W. McArthur and Jeffrey D. Sachs, “Institutions and Geography: Comment on Acemoglu, Johnson and Robinson (2000)” (working paper 8114, NBER, 2001); Daron Acemoglu, Simon Johnson, and James A. Robinson, “Reversal of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution,” Quarterly Journal of Economics 117, no. 4 (November 2002), 1231–94; Dani Rodrik, Arvind Subramanian, and Francesco Trebbi, “Institutions Rule: The Primacy of Institutions Over Geography and Integration in Economic Development,” Journal of Economic Growth 9, no. 2 (2004), 131–65; Jeffrey D. Sachs, “Institutions Don’t Rule: Direct Effects of Geography on Per Capita Income” (working paper 9490, NBER, 2003); Jeffrey D. Sachs and Andrew M. Warner, “Natural Resource Abundance and Economic Growth” (working paper 5398, NBER, 1995). Coincidence or not, most high per capita income countries are located in moderate climate zones in North America, Europe, and East Asia. Landlocked countries are typically less prosperous than countries with access to seaborne trade. The climate may create more or less favorable conditions for economic development, and it may affect the prevalence of disease agents (like malaria); indirectly, it may affect health conditions, the productivity of the workforce and the ability to generate agricultural surpluses and thereby a country’s ability to support population growth and urbanization—all other things being equal.9William Easterly and Ross Levine, “Tropics, Germs and Crops: How Endowments Influence Economic Development,” Journal of Monetary Economics 50, no. 1 (January 2003), 3–39; William Easterly and Ross Levine, “Africa’s Growth Tragedy: Policies and Ethnic Divisions,” Quarterly Journal of Economics 112, no. 4 (November 1997), 1203–50. Such factors do not represent insurmountable obstacles, as in many instances public policies can help overcome them.10Amartya Sen, Poverty and Famines: An Essay on Entitlement and Depriv-ation (Oxford: Oxford University Press, 1983). But unfavorable starting conditions—or “factor endowment”—can help explain the relative economic backwardness of certain countries and regions. 

Geographic features also affect the availability of fertile, arable land, the availability of natural resources, the existence of navigable rivers, and access to seaborne trade. Countries with access to navigable rivers or seaborne trade have easier access to international commerce and face lower transportation and transaction costs, allowing for greater internal and international market integration and economies of scale—all other things being equal. In Russia, many rivers run south-to-north and flow into the Arctic. In Western Europe, rivers crisscross the continent and flow into ice-free waters, allowing for lower transportation costs and facilitating market integration. Again, much of course depends on policies. For instance, an extensive coastline and access to overseas markets are of little use if policies prohibit trade, as they did in pre-Meiji Japan; and a lack of navigable rivers can to some extent be overcome by building railways. Similarly, malaria was once rampant in parts of Southern Europe until public policies helped eliminate it.11It is, of course, important to demonstrate why and how these policies come about. See Stefan Dercon, Gambling on Development: Why Some Countries Win and Others Lose (London: C. Hurst, 2022). But the fact that some of these structural impediments can be overcome by policies does not mean they do not have an effect on long-term economic prosperity or affect the historical trajectory of an economy’s development. 

Source: World Bank.

Climatic conditions and geographic circumstances may also interact with economic development in complex (non-linear) and complicated (multi-causal) ways (which are difficult to model statistically). Some path-dependent historical accounts—accounts where previous conditions strongly affect subsequent outcomes—attribute North America’s economic success to the prevalence of a settler colonialism (New England), while the climatic and agricultural conditions in the American South, the Caribbean, parts of South America, and especially Sub-Saharan Africa led to the emergence of an extractive, exploitative type of colonialism, centered around slave-based agriculture or the extraction of mineral resources.12James Mahoney, Colonialism and Postcolonial Development: Spanish America in Comparative Perspective (Cambridge: Cambridge University Press, 2010); Daron Acemoglu, Simon Johnson, and James A. Robinson, “The Colonial Origins of Comparative Development: An Empir-ical Investigation,” American Economic Review 91, no. 5 (December 2001), 1369–1401; Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer, “The Economic Consequences of Legal Origins,” Journal of Economic Literature 46, no. 2 (2008), 285–332. This, in turn, favored the emergence of business-friendly and liberal-democratic institutions in the case of settler colonialism and non-liberal, non-market institutions benefiting a narrow elite, in the case of extractive colonialism. Similarly, slave-holding economies were far less likely to move toward democratic governance and leant toward exploitation by conservative ruling elites with little to no interest in economic modernization. Research shows that regions with low settler mortality two centuries ago benefit from business-friendly institutions and higher per capita income today.13Acemoglu et al., “The Colonial Origins . . .”. Path dependency may not foreclose certain historical trajectories, but it may make it less likely that countries end up on them. This goes to show that economic development can be regarded as a function of a country’s institutional evolution, but this evolution itself owed much to exogenous climatic and agricultural conditions and, ultimately, its history. 

Similarly, different types of legal regimes related to different colonial histories (British common law versus French Napoleonic code) have been hypothesized to have affected the subsequent economic development of postcolonial regimes in Africa. And different economic and political regimes have given rise to wildly different levels of economic prosperity, as geographically adjacent cities across the US–Mexican border, or East and West Germany during the Cold War, or North and South Korea today, suggest.14Douglass C. North, William Summerhill, and Barry R. Weingast, “Order, Disorder and Economic Change: Latin America vs. North America” in Governing for Prosperity, ed. Bruce Bueno de Mesquita and Hilton L. Root (New Haven: Yale University Press, 1999). But even here, the reasons for such pronounced differences are more multi-faceted, including not just institutions but also access to internal and foreign markets, the provision of economic aid, and so on. 

The availability of abundant natural resources, sometimes called the “resource curse,” may be more likely to lead to the emergence of autocratic “rentier economies.” Natural resources can often be more easily controlled by a government. This creates greater incentives to gain political control of these resources than it does in economies relying on manufacturing, market competition, and technological innovation.15Stephen Haber and Victor Menaldo, “Do Natural Resources Fuel Authoritarianism? A Reappraisal of the Resource Curse,” American Political Science Review, 105, no. 1 (February 2011), 1–26; Michael Lewin Ross, “Does Oil Hinder Democracy?,” World Politics 53, no. 3 (April 2001), 2001 Abundant, easy-to-control natural resources may also lead to greater corruption and nepotism, which are detrimental to economic development. It may even crowd out human capital formation, as rent-seeking, as opposed to market-oriented economies, may be more prevalent, lowering the economic returns to education. As the benefits of controlling resources are greater than in non-resource economies, countries with abundant resources may also experience higher-intensity political conflict and civil strife.16Axel Dreher and Merle Kreibaum, “Weapons of Choice: The Effect of Natural Resources on Terror and Insurgencies,” Journal of Peace Research 53, no. 4 (July 2016), 539–53. 

In addition to geography, climate, and natural resources, demographic factors, such as population density or population age, may be more or less conducive to economic growth and innovation.17David E. Bloom, David Canning, and Jaypee Sevilla, “Economic Growth and the Demographic Transition” (working paper 8685, NBER, 2001); David E. Bloom, Jeffrey D. Sachs, Paul Collier, and Christopher Udry, “Geography, Demography and Economic Growth in Africa,” Brookings Papers on Economic Activity 1998, no. 2 (1998), 207–95; David E. Bloom and Jeffrey G. Williamson, “Demographic Transitions and Economic Miracles in Emerging Asia,” World Bank Economic Review 12 no. 3 (September 1998), 419–55. A higher population density has also been identified as being conducive to technological innovation.18Michael Kremer, “Population Growth and Technological Change: One Million B.C. to 1990,” Quarterly Journal of Economics 108 no. 3 (August 1993), 681–716. Leaving aside the impact of rapid demographic change on political and social stability (e.g., a “youth bulge”) and its indirect effect on economic growth, demographic change can affect aggregate savings behavior and the cost of investment. A falling dependency ratio, that is, the ratio of people of non-working to working age, allows an economy to generate greater savings than a country with an increasing dependency ratio, all other things being equal. The one-child policy, for example, may in part help explain the dramatic increase in savings and investment—and economic growth—in China since its introduction in 1980. As always, whether favorable demographic trends affect economic growth will in part be affected by public policies. For example, the population must want to save, and high inflation may deter it from doing so. Many factors, most prominently policies, affect savings behavior, and policies themselves are likely to be a function of monetary stability, political stability, and so on.  

Importantly, political and economic stability is almost universally regarded as being conducive to economic prosperity. Easterly and Levine, for example, demonstrate in the case of Africa how a high degree of ethnic diversity is correlated with low education levels, inadequate infrastructure, and underdeveloped financial systems.19Easterly and Levine, “Africa’s Growth Tragedy …”. Foreign or civil wars, high levels of domestic crime, and recurrent financial and economic crises constrain economic growth, as they render investment decisions riskier and require higher returns, if the risk can be quantified at all.20International Monetary Fund, “The Economic Consequences of Conflict in Sub-Saharan Africa,” (working paper 2020/221, IMF, 2020) And these factors may condition each other and translate into a negative feedback loop, which can make it difficult to model statistically. 

Following Max Weber’s work on the Protestant work ethic, some scholars have sought to demonstrate that socio-cultural values, such as achievement orientation versus post-materialist values and the implications of this in attitudes toward economic prosperity, can explain differences in economic growth. But, leaving aside the fact that cultural attitudes can be difficult to quantify, scholars have wrestled with the direction of causality (as they do in so many other cases).21Jim Granato, Ronald Inglehart, and David Leblang, “The Effect of Cultural Values on Economic Development: Theory, Hypotheses, and Some Empirical Tests,” American Journal of Political Science 40, no. 3 (August 1996), 607–31. Similarly, the impact of religion, and especially monotheistic religion, has been hypothesized to systemically impact economic growth due to the hypothesized link between organized religion, political power, beliefs, and human capital development, particularly in terms of the Protestant Reformation.22Jared Rubin, Ludger Woessmann, and Sascha O. Becker, “Recent insights on the role of religion in economic history,” VoxEU and the Centre for Economic Policy Research (CEPR), July 12, 2020, Related explanatory approaches focus on the socio-historical trajectory and economic history of a country determining discount rates and hence savings behavior.23Eduardo Gianetti, O Valor de Amanhã (São Paulo: Companhia das Letras, 2012). Even more controversially, differential demographic growth among different social groups has been credited with paving the way for Britain’s industrialization.24Gregory Clark, A Farewell to Alms: A Brief Economic History of the World (Princeton: Princeton University Press, 2007). 

Last but certainly not least, most economists regard institutions as affecting growth and prosperity. Institutions, for example, have been seen as the cause of the differential economic performance of Rhenish stakeholder—as opposed short-term US-style shareholder—capitalism.25Christian Marx and Morten Reitmayer, eds., Rhenish Capitalism: New Insights from a Business History Perspective (London: Routledge, 2022) They have been identified as explaining macroeconomic stability or the relative success of Keynesian economic policies—to name just two examples.26Fritz Scharpf, Crisis and Choice in European Social Democracy (Ithaca: Cornell University Press, 1991). Conceptually, economic freedom, political freedom, and the rule of law are seen as being conducive to economic prosperity, as they lower transaction costs and limit economic risk. Sound regulation and predictable institutions are widely seen as enhancing economic competition, investment efficiency, and innovation by limiting rent-seeking opportunities and the emergence of non-competitive economic structures.  

The emergence of efficiency- and growth-enhancing economic institutions has in turn been linked to liberal-democratic institutions, the underlying rationale being that “economic institutions encouraging economic growth emerge when political institutions allocate power to groups with interests in broad-based property rights enforcement, when they create effective constraints on power-holders, and when there are relatively few rents to be captured by powerholders.”27Daron Acemoglu, Simon Johnson, and James Robinson, “Institutions as the Fundamental Cause of Long-Run Growth” (working paper 10481, NBER, 2004). In the context of such economic institutions, self-interested economic agents are free to pursue their economic interests, which, thanks to J.S. Mill’s “invisible hand,” will lead to the pursuit of enlightened self-interest, efficient capital allocation and long-run economic growth. 

The above discussion does not constitute a comprehensive survey of the economic development and growth literature. The literature is vast. Rather, it is meant to provide a flavor of what other factors have been hypothesized, or empirically found, to be conducive to long-run economic prosperity. If nothing else, the survey suggests that there are theoretical grounds for assuming that a whole range of factors has the potential to affect the long-term economic development of a country, and that these factors often interact in a variety of complicated and sometimes complex ways. This raises the question, discussed in more detail below, of whether any surgical policy intervention can be effective, given the large number of complicated and interrelated background conditions that impact the effectiveness of such interventions. 

Nevertheless, institutions feature prominently in many explanatory approaches to economic growth and development. In addition to geography, demographics, climatic conditions, and political stability, many economists and political economists see the quality of policies as crucial in terms of economic success. If economic prosperity is best explained by past levels of investment, then the question necessarily arises: Are there policies, tied to varying domestic political-institutional arrangements, that have proven more or less conducive to long-term economic growth? 

Liberal versus state developmentalist accounts of economic development 

An important debate in the literature on economic development has focused on the role of the state. Politically, this debate—more or less helpfully—is sometimes cast in terms of “Beijing consensus” versus “Washington consensus.” The Beijing consensus represents politically authoritarian state-led development policies accom-panied by a hefty dose of state intervention, while the Washington consensus puts the emphasis on institutions and policies that limit state intervention and foster the free play of market forces. The liberal strand of scholarship ascribes economic growth and development to a broadly market-oriented economic system, where private economic agents are free to pursue their economic interests and where the government’s role is limited to providing political stability and underwriting the rule of law. This classical-liberal strand of scholarship has come in for criticism from the “developmental state” literature, which emphasizes the benefits of an interventionist state in furthering economic development.  

Much of this scholarly debate is related to the notion of “latecomers” in development economics.28Alexander Gerschenkron, Economic Backwardness in Historical Perspective (Cambridge: Harvard University Press, 1962). The main features of “economic backwardness” are: banks or the state channel capital to strategic sectors; a focus on production rather than consumption; an emphasis on capital- rather than labor-intensive production; a reliance on borrowed rather than indigenous technologies; a reliance on productivity growth; and a modest contribution of the agricultural sector to economic growth. This economic strategy was pursued in countries such as Imperial Germany or early Soviet Russia. In practice, the latecomer and certainly the “developmentalist” models are also often thought to include interventionist governments that subsidize and allocate credit in line with developmental preferences (as opposed to market-based credit allocation), pursue a strategic trade policy (as opposed to trade liberalization), as well as extensive industrial policies (aimed at “picking winners”), large-scale infrastructure investment, and public spending on education (as opposed to market-led development and private-sector investment and spending).29Dani Rodrik, “Industrial Policy: Don’t Ask Why, Ask How,” Middle East Development Journal 1, no. 1 (2009), 1–29; Dani Rodrik, One Economics, Many Recipes: Globalization, Institutions and Economic Growth (Princeton: Princeton University Press, 2007).  

The “developmental state” literature emphasizes the importance of interventionist government policies relative to that of market-oriented policies, at least in the initial stages of economic development.30Meredith Woo-Cummings, ed., The Developmental State (Ithaca: Cornell University Press, 1999); Stephan Haggard, Pathways from the Periphery: The Politics of Growth in the Newly Industrializing Countries (Ithaca: Cornell University Press, 1990); Charles Harvie and Hyun-Hee Lee, “Export-Led Industrialization and Growth: Korea’s Economic Miracle 1962-89,” Australian Economic History Journal 43, no. 3 (2003), 256–86; Atul Kohli, State-Directed Development: Political Power and Industrialization in the Global Periphery (Cambridge: Cambridge University Press, 2004); Byung-Kook Kim and Ezra F. Vogel, eds., The Park Chung Hee Era: The Transformation of South Korea (Cambridge: Harvard University Press, 2011) Historically, such policies have not always been successful, but when they were successful, they were very successful. (Market failure may exist, but so does government failure.) South Korea and China come to mind as examples of very successful state intervention. In the case of Japan, Chalmers Johnson has shown how a politically insulated bureaucracy capable of avoiding capture by rent-seeking interests very successfully guided the country’s post-war economic development.31Chalmers Johnson, MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925-1975 (Stanford: Stanford University Press, 1982). Other features of developmental state-driven development include political stability and economic instability, as well as (often) capital controls and a highly controlled exchange rate, which, importantly, allows for an export-driven industrialization strategy, flanked by strategic investment not just in infrastructure but also education. 

This developmentalist account is not completely at odds with the liberal-institutionalist literature. But at a minimum, the former puts far greater emphasis on government intervention, and less on the market and concomitant political, legal, and economic freedom. One would think that the debate has been settled by now. But neither side in the debate has conceded. The evidence appears consistent with either explanatory approach, at least in the eyes of their defenders. The World Bank saw Asia’s economic success as the consequence of market-oriented reform,32World Bank, The East Asian Miracle: Economic Growth and Public Policy (Oxford: Oxford University Press, 1993). while developmentalist critics emphasized the importance of government intervention.33Robert Wade, Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization (Princeton: Princeton University Press, 1990). This may simply be a methodological problem: too many variables and too few cases. 

What “deviant cases” have to say about freedom and prosperity 

Some of the most successful examples of economic development over the past half-century were countries whose economic growth accelerated under illiberal political and broadly state-interventionist economic regimes. The so-called “East Asian miracle,” referring to the rapid economic rise of South Korea, Taiwan, and China, among others, largely took place under authoritarian regimes and in the context of interventionist economic policies, at least in the case of South Korea and China. On their face, these examples point to causality running from economic modernization to political freedom and democratization, rather than from political freedom to economic prosperity. More importantly, they suggest that political liberalization is not, at least not initially, a necessary precondition for sustained growth acceleration. Conversely, some important countries, such as India, have long been characterized by political and legal freedom, but have remained economically much less prosperous. India has only recently started to experience a tangible growth acceleration. This is why, according to the “freedom leads to prosperity” hypothesis, these countries are considered to be outliers, or “deviant cases.” What insights, if any, can be gleaned from these important deviant cases for the liberal approach to economic development? 

In China, economic growth took off in the late seventies in the wake of the first steps toward greater economic liberalization, including reforms of so-called township and village enterprises (TVEs) as well as the selective opening of the Chinese economy to foreign investment. TVE reform effectively created private markets, in a partial shift away from a centrally planned economy. The second stage of reform saw significant privatization of state-owned industries as well as the lifting of price controls, again strengthening private markets. The third stage involved China joining the World Trade Organization, preceded by further—largely market- and trade-oriented—economic reform, which increased the competitive pressure faced by the Chinese economy. To this day, political rights remain very restricted and the rule of law and its enforceability are somewhat limited. But (until recently) economic freedom and the role of markets and private enterprise continued to expand. 

If nothing else, this is suggestive of the fact that partial, gradual economic liberalization contributed to China’s economic development over the past four decades. This hyper-stylized description suggests that in the case of China political and legal freedom were not prerequisites for rapid economic development, at least not initially, when levels of per capita income were very low. It also suggests that developmentalist policies geared toward generating savings and investment (including financial repression), combined with gradual, liberalizing reform aimed at furthering private enterprise and competitive markets, contributed to high and sustained economic growth. It is, of course, impossible to say if more radical transformation would have translated into even faster economic growth. Finally, it remains to be seen whether China can manage to become a high-income country without further reform of its legal and political regime, and do so without relying more rather than less on private enterprise and markets, particularly given that it is facing the so-called middle-income trap.34Barry Eichengreen, Donghyun Park, and Kwanho Shin, “When Fast Growing Economies Slow Down: International Evidence and Implications for China,” Asian Economic Papers 11, no. 1 (2012), 42–87. 

Source: World Bank.

South Korea’s “economic takeoff” also took place in the context of non-democratic politics. As in China, it was characterized by extensive (if arguably less extensive than in China) government intervention. Central economic planning was never a core feature of the South Korean economy. But the government channeled cheap savings toward strategic industries, pursued selective and strategic trade liberalization, supported infrastructure investment, and kept labor demands at bay. Economic freedom was never quite as restricted as in China, nor was the role of state-owned enterprises nearly as prominent as in China. But chaebols (Korean conglomerates) maintained very close and privileged ties with the government and operated in less-than-competitive markets domestically, even if the government ensured that they were faced with foreign trade competition. The government did rely on firms, especially chaebols, in its pursuit of economic development. South Korean economic growth took off in the context of a heavy-handed, strategic, but ultimately successful economic policy. Economic reform began in the early sixties and generated rapid economic growth, although political liberalization would not follow until the mid-nineties. Again, all of this can only be suggestive. It is impossible to say what would have happened if South Korea had become a democracy in the early seventies. But as far as the evidence goes, it is suggestive of reverse causality in terms of economic modernization leading to economic prosperity leading to political liberalization and democratization. 

It is worth contrasting the experience of China and South Korea with that of India. Any contrast or comparison can only be suggestive, given the hyper-stylization of the models and a highly selective, if theoretically interesting, sample selection. Throughout the sixties, seventies and eighties, India was characterized by the so-called “Hindu rate of growth.” India was a democracy, characterized by the rule of law, but also by extensive economic restrictions. It is likely that these restrictions were the main reason for India’s poor economic performance, even though adverse demographic development may also have weighed on growth. Gradual economic reforms, or rather policy changes, arrived in fits and starts, beginning in the mid-eighties and including IMF-supervised partial trade liberalization in the early nineties, and preceded the gradual acceleration of economic growth. One can certainly debate the significance of economic liberalization in terms of growth. As always, an evaluation of the counterfactual will need to remain somewhat speculative but it seems reasonably clear that a significant degree of political and legal freedom were, by themselves, insufficient to push India onto a high-growth trajectory. Economic liberalization does seem to have had an effect, or at least it preceded accelerating economic growth.35Arvind Panagariya, India: The Emerging Giant (New York: Oxford University Press, 2008). 

These hyper-stylized accounts of economic development in apparently “deviant” cases of both types— “Unfree” countries (in the terminology of the Freedom and Prosperity Indexes) experiencing high and sustained economic growth, and one “Free” country experiencing low economic growth—suggest that, at least in these instances and with no claim to generalizability, the relationship between freedom and prosperity is not as straightforward as might be expected. The cases were of course explicitly chosen because they do not conform to the expectation that extensive political or even legal freedom is a necessary precondition for high and sustained economic growth. But all three cases suggest that economic liberalization, or an increase in economic freedom, may have played a crucial role in accelerating economic growth. The case of India also suggests that even extensive political and legal freedom is insufficient to accelerate economic growth if economic freedom is restricted. The cases of China and South Korea also suggest that economic growth can be turbocharged through smart economic, including interventionist, policies. But it is also worth noting that these policies were flanked by gradual domestic and external liberalization and a shift toward “more market.” More detailed historical case studies are required to evaluate this conclusion. 

Methodological and conceptual implications 

The preceding sections have shown several things: (a) a large number of different factors has been invoked to explain different levels of prosperity; (b) scholarly opinion differs with respect to the (relative) importance of the factors bringing about prosperity; and (c) continued disagreement exists between liberal economists emphasizing the role of institutions and markets, and state-developmentalists emphasizing the role of interventionist, strategic developmental policies. 

The Atlantic Council’s Freedom and Prosperity Indexes posit a relationship between political, economic, and legal freedom, embedded in institutions, and prosperity, broadly defined. It is concerned with the causal effect of economic, legal, and political freedom on prosperity. Methodological choices are front and center in terms of assessing this relationship and generating policy recommendations. Statistical studies can never decisively establish a causal relationship. As statistician Richard Berk puts it: “Credible causal inferences cannot be made from a regression analysis alone. . . . A good overall fit does not demonstrate that a causal model is correct. . . . There are no regression diagnostics through which causal effects can be demonstrated. There are no specification tests through which causal effects can be demonstrated.”36Richard A. Berk, Regression Analysis: A Constructive Critique (Thousand Oaks: Sage, 2004). Even the strongest statistical study design will not prove causation. True, but statistical studies, if well designed, can go some way to suggesting causation.  

As for cross-country growth regressions, Banerjee and Duflo note that “[t]here is always going to be a million ways to do cross-country comparisons, depending on exactly which brave assumptions one is willing to swallow.”37Banerjee and Duflo, Good Economics for Hard Times, 59. They explain: “The game is to use data to predict growth, based on everything from education and investment to corruption and inequality, culture and religion, the distance to the sea or to the equator. The idea was to find what in a country’s policies could help predict (and hopefully affect) its economic growth. But that literature eventually hit a brick wall,” for “everything at the country level is a product of something else.” Or again, “both countries and country policies differ in so many that in effect we are trying to explain growth with more factors than the number of countries, including many we may not have thought of or cannot measure.”38Banerjee and Duflo, Good Economics for Hard Times, 181–82. Meta-studies suggest that the results of cross-country regression exercises are not very robust, with the exception of the relationship between the investment-to-GDP ratio and economic growth.39Ross Levine and David Renelt, “A Sensitivity Analysis of Cross Country Growth Regressions,” American Economic Review, 82, no. 4 (September 1992), 942–63. Empirically, it is also a fact that economic growth rates often change drastically from decade to decade without much apparent change in policies or reform.40William Easterly, The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics (Cambridge: MIT Press, 2001). The bottom line is that the level of investment appears to explain the level of economic growth quite well, but that there is no clear sense as to what (best) explains investment levels. 

A purely quantitative analysis, probing the link between freedom/institutions and prosperity, faces epistemic limitations.  

  1. Large-N, quantitative studies may provide support for the hypothesized relationship, suggesting the extent to which freedom/institutions affect prosperity—on average. What the researcher would like to know just as much though is the extent to which a specific institutional reform will affect economic growth in a particular case. This is related to another methodological problem.  
  1. Statistical studies cannot control for all relevant factors. But a failure to control for relevant “background” conditions generates biased estimates of the effects of policy changes and reform. Moreover, omitting important causal factors will lead to biased results.  
  1. Estimating the effect of individual factors is challenging. After all, some changes may have highly non-linear effects in the context of specific background conditions, while having no or much more limited effects under a different constellation. Average effects can only ever be so helpful. The estimates derived from statistical studies therefore depend greatly on model specification and the theoretical assumptions underpinning it.  
  1. If statistical models fail to address the issue of the direction of causality—namely whether greater freedom or institutional reform leads to (or precedes) greater prosperity (or vice versa)—it is obviously not warranted to interpret the results one way or the other. Qualitative, historical studies find it much easier to address this issue.  
  1. Statistical studies should therefore be complemented by case studies, to move beyond correlation and to allow for a greater appreciation of potential causal complexity and multiple causation, as well as the direction of causality.  

Qualitative, small-N studies or case studies are better suited to fully explaining differences in prosperity (effects). Statistical studies focus on what is called the “effects of causes,” while qualitative studies focus on the “causes of effects.” Qualitative studies are better suited to account for “complex” causation (wherein a large number of factors contributes to prosperity) and “multiple” causation (wherein the same phenomena can be induced by different causes or different combinations of causes). If combined with process tracing, this allows the researcher to address the issue of the direction of causality more readily and explore the potential existence of confounding and omitted variables and differing structural background conditions. Compared to statistical studies, with their focus on correlation, such an approach also allows for a better understanding of the trajectories of change. The drawback is that small-N studies do not allow for a broader generalization beyond the cases analyzed, and the carefully examined cases may not generate a pattern. Nevertheless, insights from historical case studies will help sensitize researchers to interaction effects and a greater appreciation of context. They should also serve as reminders not to read too much into, or be overconfident about, the results of statistical analyses. 

Economic growth: It’s complicated! 

Economic growth and development are multi-causal, complicated, and sometimes complex social phenomena, as the review of the literature on geography, disease agents, or types of colonialism suggests. Different countries seem to have taken different paths toward prosperity (nineteenth-century Britain versus today’s China, for instance). The survey of the literature suggests that policies matter, or can matter. It also suggests that institutions matter, or can matter. It also suggests that “exogenous” structural factors, such as geography or climate, may have an effect. But there is disagreement as to which factors matter, how much they matter, and under what circumstances. This is not helped by the fact that institutions and policies are closely intertwined. Statistical and qualitative analysis can only advance our confidence in the importance of the various factors so much. The available evidence suggests that it is helpful to think of various factors interacting to generate sustained economic growth, including and especially policies and institutions. At the same time, it is worth acknowledging that institutions do not function in a vacuum, isolated from existing social, economic, political, and maybe even socio-cultural realities (background conditions). Nor do policies, whose implementation is very much dependent on institutions. Moreover, even if quantitative research managed to overcome additional challenges, such as sample selection, mismeasurement, misspecification, complexity, and non-linearity,41Simon Commander and Zlatko Nikoloski, “Institutions and Economic Performance: What Can Be Explained?,” Review of Economics and Institutions 2, no. 2 (2011). history would counsel against construing the relationship between freedom/institutions and prosperity in an overly simplistic or deterministic way. All of this should caution against a “one-size-fits-all” approach in terms of policy advice. 

A purely quantitative analysis will also have little to say about the right sequencing of reform, or which policy measures should be prioritized. Statistical analysis will almost inevitably translate into one-size-fits-all policy advice. This should be avoided, or at least tempered, given methodological limitations, lack of unambiguous empirical results, multiple causation and complex interaction effects. Institutions as well as policies interact with other factors in complicated, sometimes complex ways, unlikely to be fully captured by a statistical model. Moreover, institutions are embedded in a country’s broader historical-cultural context and their proper and effective functioning is dependent on a government’s willingness and ability to uphold them. Institutions are embedded in a country’s social context, which affects the way they function as well as their effect on economic outcomes. And institutional strengthening is often a long-term process. The effects of institutional reform are contextual. How quickly and efficiently institutional reform translates into high-quality, growth-enhancing policies will depend on context. Some countries reform their institutions and move onto a higher-growth path (e.g., Eastern European transition countries).42Daron Acemoglu and James Robinson, “The Role of Institutions in Growth and Development,” Review of Economics and Institutions 1, no. 2 (2010). Others reform their institutions along similar lines and do not experience faster economic growth (e.g., Mexico). Yet others manage to generate rapid economic growth despite limiting reform to economic institutions alone (e.g., China).  

However, accepting that we can never be one hundred percent confident about the effects of proposed reform measures does not mean that we do not have any grounds at all for being somewhat confident that market-oriented institutional reform, or the pursuit of high-quality public policies aimed at mobilizing savings and investment, or building infrastructure, or supporting human capital, are conducive to sustained economic growth. At a bare minimum, the evidence strongly suggests that any measure that manages to increase investment on a sustained basis supports long-term economic growth.  

Another reason to think about the effectiveness of institutional and policy reform measures in a context-sensitive way is that a laundry list of reform fails to tell policymakers which reform they should prioritize. It is desirable to identify the so-called “most binding constraint,” namely the factor holding back economic growth the most and whose removal generates the greatest return in terms of economic growth.Ricardo Hausman, Bailey Klinger, and Rodrigo Wagner, “Doing Growth Diagnostics in Practice: A ‘Mindbook’” (working paper no. 177, CID, 2008); 43Ricardo Hausmann, Dani Rodrik, and Andrés Velasco, “Growth Diagnostics” (Boston: The John F. Kennedy School of Government, 2005). Prioritizing measures that address this constraint is desirable economically. It is also desirable politically, given that governments typically have limited amounts of political capital at their disposal as well as a limited technocratic capacity to formulate and implement reform. In light of methodological challenges, ambiguous empirical results, and the need to provide case-specific policy advice, it is difficult to disagree with Ricardo Haussmann et al.: 

Trying to come up with an identical growth strategy for all countries, regardless of their circumstances, is unlikely to prove productive. Growth strategies are likely to differ according to domestic opportunities and constraints. There are of course some general, abstract principles such as property rights, the rule of law, market-oriented incentives, sound money, and sustainable public finances which are desirable everywhere. But turning these general principles into operational policies requires considerable knowledge of local specificities.44Hausmann, Rodrik, and Velasco, “Growth Diagnostics.” 

Prosperity is the outcome of sustained investment and economic growth. The evidence also suggests that economic prosperity is best conceived of as a multi-causal phenomenon.45Dani Rodrik, One Economics, Many Recipes: Globalization, Institutions and Economic Growth (Princeton: Princeton University Press, 2007). Many factors contribute to prosperity. Institutions and markets matter. But so do public policies. So do political and economic stability. It is not one factor that generates lasting economic growth. It is a combination of factors. For individual reform measures to be successful, they need to take context into account in both their design and implementation.  

Institutional reform, allowing for market-based competition and efficient capital allocation, may help one to achieve prosperity, provided one can sidestep market failures. State interventionist policies may also get one there, provided one can avoid government failure. The available evidence suggests that there are different paths leading to economic prosperity. Countries can be nudged onto these paths by different types of reform, depending on circumstances. At a minimum, measures need to increase investment on a sustained basis. This may not be very helpful but it is the most certain thing that we can infer from the evidence. This is one more reason why one-size-fits-all policy should be resisted and causal complexity and multiple causation taken seriously when offering policy advice in the real world. 

Markus Jaeger is an adjunct associate professor of international and public affairs at Columbia University. 

Image: A farmer arranges mangoes after the yield dropped because of high temperature, in Ismailia, Egypt, August 18, 2023. REUTERS/Mohamed Abd El Ghany