Ever freer union? Economic freedom and the EU

The debate about the effects of EU membership on a country’s policy environment is ongoing and not new. On the left, the EU is often presented as a “neoliberal” project aimed at implementing free trade and liberalising markets. Conversely, sceptics on the right argue that it is a socialist, bureaucratic and centralising project. These two opposing views recently came to the fore during the Brexit referendum: prior to the vote, some of the “Bremainers” argued that the economic consequences of leaving the EU would be “catastrophic”, while the proponents of a Brexit argued that the UK “would be able to compete far more effectively in the world market place without EU regulations”.

What will happen to the UK is for the future to show. Meanwhile, we try to address this issue on the basis of an index, provided by the Fraser Institute and published in the “Economic Freedom of the World: 2015 Annual Report”, which consists of five different areas describing economic freedom.

What is economic freedom?

According to the Fraser Institute’s definition, economic freedom is achieved when stable judicial and governmental institutions exist, but government interference in markets and decision-making is minimal. The Institute’s index of economic freedom is the most commonly used measure within academia in this regard. In previous papers, economic freedom has been shown to be positively associated with GDP growth, higher levels of GDP, higher quality of life, and tolerance towards sexual minorities.

The Economic Freedom of the World Index is published by the Fraser Institute with assistance from liberal think tanks around the world. Countries are rated on a scale from zero to ten in five different areas which are compiled to produce the average overall rating of economic freedom. [1]

Figure 1 shows the evolution of average economic freedom in time for the 28 member of the EU It is clear that not only former socialist dictatorships have liberalised their economies – the trend is positive for both groups. Though slightly negative since its peak around the year 2000, there is a considerable increase during the last 40 years.

Ever freer union - Figure 1

What is the relationship between EU membership and economic freedom?

In all model specifications, EU membership is found to have a positive association with economic freedom: in some versions of the model the average increase in economic freedom from EU membership is more than one unit, which, on a scale from zero to ten, is a substantial effect. One should also bear in mind that the estimated effect of the EU only picks up changes in economic freedom that occur after joining the EU, while possible changes occurring prior to the actual membership are ignored (for instance, a country has to adapt its laws during the screening process).

Figure 2. Estimated effect of membership in the EU, estimated using member countries that joined between 1981 and 2007. Source: own calculations.

ever-freer-union-figure-2Figure 3. Estimated effect of membership in the EU, estimated using member countries that joined between 1973 and 2007. Source: own calculations

ever-freer-union-figure-3

Looking at the estimated effect of EU membership on the different areas in Table 1, one can see that EU membership is positively related to all areas of economic freedom. The largest estimated effect is on the area of Sound Money, the high score indicating that the domestic currency is relatively stable and that citizens are free to own foreign currency bank accounts. The positive association of EU membership with Freedom to Trade Internationally suggests that the EU’s efforts to remove trade obstructions both within and outside the Union through bi- and multilateral agreements have been effective.

The results for Size of Government and Regulation contrast with the eurosceptic claim that the EU is a large and inefficient bureaucratic body: they rather suggest that member countries on average have lowered their top marginal tax rate and that government spending as a share of GDP has decreased, and that the average regulatory burden has decreased. These results, combined, could indicate that the EU has fostered healthy institutional competition between Member States and decreased the bureaucratic burden.

Table 1. Estimated effect of EU membership for economic freedom and different areas of the index.

Areas Estimated effect
Economic Freedom (all areas) 0.71*
Size of Government 0.46*
Legal System and Property Rights 0.24
Sound Money 1.39*
Freedom to Trade Internationally 0.98*
Regulation 0.59*

The index is measured on a scale from zero to ten. Source: own calculations.* Statistically significant estimate

What might have caused countries to liberalise?

Since only the association between EU membership and developments in economic freedom has been studied, it is only possible to speculate about what specifically caused countries to implement more liberal policies. It may be that decision makers in Brussels through law-making force countries to implement policies that would have been difficult for domestic decision-makers to implement; for instance, a populist politician who would have subsidised a struggling firm might now be prevented by EU law.

Nobel laureate James Buchanan, moreover, argued that European cooperation could foster institutional competition between the member states, in that countries “would be unable to depart significantly from overall efficiency standards in their taxing, spending, and regulatory politics” since they otherwise would face an outflow of citizens and companies.

Conclusions

The discussion regarding the effect of being a European Union Member State will likely exist for as long as the Union does. Overall, our findings suggest that countries tend to become economically freer after joining the EU, reinforcing free trade with member nations and fostering lower taxes and more flexible labour markets – results that are in stark contrast to assertions that the EU is just a regulatory machine. The European Union may not be perfect, but it seems to have made Europe more economically liberal. As the countries of Central and Eastern Europe strive to achieve higher growth and quality of life, EU membership might prove an important step in the right direction.

 

[1] The index is published annually and the most recent year for which there is data is 2013. Until 2000, however, the index was only published every five years. It is primarily based on official data available to the public, such as tax revenue as a share of GDP, customs duties and public expenditures. The methodology for compiling the ratings is published together with the “Economic Freedom of the World: 2015 Annual Report”.

[2] For many countries in Central and Eastern Europe there is no data until the 1990’s – for instance the Baltic countries were part of the Soviet Union until 1991 – so we divided the 28 members in two groups.

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