Economic Freedom and Poverty

By Mohamed Ilham B Mohamed Salleh
Raffles Institution (Junior College), Singapore

When William Easterly published his research, comparing the impact of foreign
aid and increased economic freedom on the long term economic circumstances
of countries, critics condemned his implication that aid mechanisms were largely
failures in their present form and derided the need for more market capitalism
(Lawson, 2002). Yet, further analysis of the relationship between economic
freedom and poverty rates did reveal much empirical evidence indicating that the
poorer agents in freer market systems enjoyed substantially higher living
conditions than those in centrally planned economies (Gwartney & Norton, 2008).
Part of the reason, it seems, lies in the increases in overall welfare of a country’s
residents due to freedom in the economy. Therefore, reforms that seek to
liberalize markets in the less developed countries should lead to a decline in
impoverishment levels. While government intervention may still contribute to
poverty reduction through establishment of basic economic security and a
meritocratic environment, the need for a free economy should form the more
crucial aim of such stratagem.

The reason for poverty, a term associated with the low-income bracket and
deficiency of many basic needs (Gwartney & Norton, 2008), stems from the basic
problem of scarcity in economic theory. Since there are limited factors of
production and unlimited wants, the poor are those who get the least of the
national output from economic activity. It is the role of any economic system is to
allocate these scarce resources between their alternative uses, and to do it well.
The free economy, with its markets, uses the price mechanism to do this,
emphasizing pursuit of self-interest as the main driving force behind decisions.
Economic agents may also own private properties and have freedom of choice
as well as enterprise. When properly working, these markets are also
characterized by their low barriers to entry due to high competition and the
absence of externalities. Here, the effectiveness of market liberalization in easing
poverty levels is assessed from a macroeconomic viewpoint, mainly looking at
areas of fiscal, monetary and supply-side policy (Areas 1, 3, 5 in report) albeit
with welfare economics when needed.

The most prominent way in which a free market economy may moderate poverty
levels is through sustained economic growth throughout a country. Such growth
entails an increase in productive capacity in the economy. A general explanation
for observed trends of rapid growth after opening up of economies, such as in
Singapore or Hong Kong, is that the free market economy eliminates heavy
bureaucratic costs, including social obstacles such as corruption, that are needed
to allocate resources otherwise. The automatic nature of the price mechanism is
one in which prices reflect the types of goods in demand and amount of
resources required for their production. Markets tend to a dynamic equilibrium
where quantity demanded is equal to that supplied. Hence, manual methods of
addressing resource allocation issues including price controls and output quotas,
and their administrative costs of maintaining a healthy budget and information
collection, are not necessary in the free economy, leading to less wasteful use of
resources which may be redirected to useful output.

Through facilitation of free trade, there is more exchange between buyers and
sellers in free economies. They swap products they make for those they have
less comparative advantage in, and thus their terms of trade must be mutually
beneficial. In a free market, this will stop only when people get worse off when
they trade, in Pareto optimality. Thus, the skills of the poorest segments of
society are more transferrable in a free economy, as more people may need their
services, increasing their income levels.

Another reason for economic expansions in free market economies is actual
growth due to the high efficiency of price mechanism in allocating resources. As
there is much competition in the free market, firms have an incentive to lower
prices, and will want to maintain their profit-maximizing goals. Thus, their total
costs must be kept low, and firms will necessarily lower costs until they are
productively efficient. Firms also lower prices to be competitive until their price for their last unit is equal to the marginal cost of that unit. Thus firms reduce their unemployment or underemployment of resources in an economy as the more
efficient the firms are, the more profits they will get. This leads to actual growth in the economy, with Aggregate Demand rising as more factors of production may
now be employed. Thus the economy now provides for more people and poverty
may be alleviated.

Evidence of this relationship is abundant in literature concerning poverty
reduction. For example, Botswana, with increased government investment,
enterprise and spending, had a reduced GDP growth rate from 2005-2008
(Grube, 2009). Governments too, have their own objectives of maximizing
electorate wishes, and may be influenced by political lobbies. Likewise, they do
not have full information of consumer demand and may have time lags in
implementing policies. As such, countries which have done away with excess
government interference, such as Ghana, have reaped the benefits of higher
economic growth, and through it, increases in standards of living. Mauritius too,
has had less than 10% below the poverty line since diversifying and privatizing
important industries.

All this economic growth tends to decrease destitution in a nation’s population, by
allowing more people access to higher material living standards and qualities of
life. The dilemma of the problem of scarcity becomes less acute (M Roberts,
2003) as on average, people may afford essential healthcare services and
education, thus reducing the deficiencies of the poor. A rapidly growing economy
can also afford to be more generous to the disadvantaged, as the poor can now
be made better off without the richer being worse off due to increases in overall
income levels. Since 1981, 500 million people have been lifted out of poverty in
China due to rapid economic growth (Lardy, 2002). Although this redistribution
may necessarily require government intervention in the form of a tax structure,
the cause of the growth was primarily a free economy, as elaborated above.
Therefore, reforms may enable governments to decrease the poverty rate. A
critical example of why reforms are needed can be shown in Zimbabwe, which
among other things, raised its money supply, leading to hyperinflation and an
unstable currency. Uncertainty resulted in withdrawing of foreign direct
investment, economic recession, and eventually widespread famine and disease
due to poverty. Since the use of other currencies (small step to reform),
investment may reenter as the climate becomes more stable, although this is
affected heavily by lack of business confidence in the tattered country.
Zambia’s privatization of copper mines (Grube, 2009) since 2006, has also lead
to surges in economic growth patterns, due to private firms seeking to increase
their revenue. Loosening of business regulations has also contributed to the
increase in productivity, leading to lower prices for the copper-refining industry
there and more output for trade, especially with China. Since there is wider share
of ownership, more people have greater stakes in the economy and thus there is
economic growth and decreased poverty. A newly floating exchange rate also
allows for devaluation of its currency to correct its balance of payments deficit
incurred by heavy debt. This allows capital reinvestment to return (Fundanga,
2006).

Detractors might argue that economic growth spurred on by free markets will be
unevenly distributed. However, data from Adams (2003) shows that economic
growth does not affect inequality much, thus results of growth often are spread to
even the poorest sectors. Yet, larger businesses and unions may gain more at
the expense of the others and thus relative poverty may still remain, although
absolutely, it will decrease. Other strategies that are often cited often fail to
recognize this in calling for increased regulation – the poor have more income in
free and rich nations than in unfree ones (Lawson, 2002).
Moreover, time lags are an important concern here. It will take a long time to
realize benefits of growth and lowered poverty. There may be hope in some
countries that once economic growth sets in, a high multiplier and accelerator
may increase the potential of these economies to offset implementation time
costs.

There is also the evident need for intervention when there are monopolies or
oligopolies in poverty-stricken countries. Supernormal profits may not be used
efficiently for research and development purposes and it is often the more
established firms that often tend to increase in size and power, which can lead to
increases in inequality, after deregulation. Governments also need to correct for
inefficiencies which limit the extent of macroeconomic growth through lump sum
taxes on goods and those associated with negative externalities, such as
pollution which disproportionately affects the more defenseless poor.
As Easterly (2001) had mentioned, poor nations do grow faster than rich ones
once economic freedom has been planted. Although there is a need for some
form of mixed economy dependent on the unique circumstances of the nation,
the economic activities should primarily be based on a free market framework to
reap benefits listed here. With increases in living standards, opening of
economies is definitely an effective way to down hardship.


Works cited
Adams, R. (Ed.). (2003). Economic growth, inequality, and poverty : findings from
a new data set. In REPEC (1st ed., Washington, D.C.: World Bank.
Easterly, W (2001, Dec). Think Again: Debt Relief. Retrieved June 1, 2009, from
Foreign Policy Magazine Web site:
http://plato.acadiau.ca/COURSES/POLS/Grieve/Debt%20relief%20easterl
y.html
Fundanga, C. M. (2007, Nov). Central bank independence - A Zambian
perspective. Retrieved June 1, 2009, from Bis Web site:
http://www.bis.org/review/r071123e.pdf
Grube, Laura (2008). Economic Freedom: Key to Poverty Reduction. Retrieved
June 1, 2009, from African Executive Web site:
http://www.africanexecutive.com/modules/magazine/articles.php?article=3
641 Lardy, Nicholas R., 2002.
Lawson, R (2002, Jul 3). Economic Freedom Needed To Alleviate Poverty
Around The World. Retrieved June 1, 2009, from CATO institute Web site:
http://www.cato.org/pub_display.php?pub_id=3512
Lardy, N R (2002, Apr 29). The Economic Future of China. Retrieved June 1,
2009, from Asia society Web site:
http://www.asiasociety.org/speeches/lardy.html