Provincial Economic Freedom in Canada 1981-1998

by Faisal Arman, Dexter Samida, and Michael Walker

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The Relationship between Economic Freedom and Provincial Well-Being

A recent article in the American Economic Review examines the relationship between economic freedom and economic growth in a cross-section of 59 countries (Easton and Walker 1997). The study found that the level of economic freedom exerted a separate influence on economic growth, even when the level of technology, the level of education of the workforce, and the amount of investment in machinery and equipment and other capital goods were taken into account. The implication is that economic freedom is a separate driver of economic growth and development. The publications in The Fraser Institute's series, Economic Freedom of the World--a collaboration of institutes in 53 countries--also show a clear relationship between economic freedom and both the level of per-capita GDP and its rate of growth.

The calculation of the Index of Provincial Economic Freedom makes possible for the first time the investigation of the relationship between economic freedom and other economic variables in a Canadian national context. In order to test this relationship, we first of all correlated the per-capita GDP of each province over the period from 1981 to 1996 with the index of economic freedom outcome for that province in each of those years. The result of this correlation is presented in figure 1.

In assessing this scatter, the reader should bear in mind that the components of the index are unrelated statistically to provincial gross domestic product and there is, therefore, no particular statistical reason to expect a correlation between the level of economic freedom and per-capita GDP. To the extent that a relationship exists, therefore, it seems that there is a link between economic freedom and economic welfare. As we report in exhibit 2, 68 percent of the variation in per-capita GDP amongst the provinces over that period is explained by variations in provincial economic freedom. Given all of the influences that are exerted on GDP over this period of time, this is an extraordinarily tight statistical relationship and suggests a strong link between economic freedom and economic welfare.

In order to isolate many of the economic factors that influence all of the provinces over the period since 1981--world wide recessions, global changes in interest rates and that sort of thing--we have calculated the relative rates of economic freedom and the relative standard of living in each of the provinces, as measured by relative per-capita GDP. Figure 2 displays the relationship between relative per-capita GDP and relative provincial economic freedom. As can be seen, there appears to be an even tighter relationship in the relative magnitudes. The second equation in exhibit 2 finds that variations between the provinces in their relative degree of economic freedom explains 65 percent of the variation of the per-capita GDP of the provinces from the average of the other provinces.

Click Here to View Figure 1

In other words, this relative relationship measures the extent to which differences between the level of economic freedom in a particular province and the level of economic freedom in the average of the other nine provinces are reflected in differences between the per-capita GDP in that province and the average per-capita GDP of the other nine provinces. In keeping with the results found in the international studies, the relationship in figures 1 and 2 and in exhibit 2 indicate that those provinces that pursue policies restricting economic freedom bear the consequence of lower levels of per-capita income in absolute terms and lower levels of per-capita income relative to the other provinces. Provinces that have relatively lower levels of economic freedom seem to be relatively more susceptible to disruptions in the level of economic activity than those provinces that have relatively higher levels of economic freedom.

Click Here to View Figure 2

Click Here to View Figure 3

From the equations in exhibit 2, it is possible to calculate more precisely the relationship between the level of economic freedom and the level of per-capita GDP in a province. Equation 1 relates the level of per-capita GDP to the level of economic freedom. The equation indicates that an increase of one ranking point in the level of economic freedom will produce a $2433 increase in the level of per-capita income in that province. In the provincial analyses that follow, we have indicated the extent to which per-capita incomes in each of the provinces could have been boosted by moving the level of economic freedom in the province closer to that of the top performing provinces.

We also explicitly examine the relationship between changes in economic freedom and changes in the level of per-capital GDP. The results of a test of this relationship are presented in exhibit 3. Here we find that change in per-capita GDP is significantly related to change in provincial economic freedom and that change in relative per-capita GDP is significantly related to change in relative provincial economic freedom.

Figure 3 illustrates how economic freedom has changed over time in each of the provinces. It presents an index that measures each of the provincial economic freedom ratings relative to the 1981 average of the economic freedom ratings in all of the provinces. So a level of 1 in the chart would indicate that the province's level of economic freedom was the same as the average level in 1981. A level of 2 would indicate that the level of economic freedom in the province was twice as high as the average level in 1981, whereas a figure of 0.5 would indicate that the level of economic freedom was one-half the level of the average of the provinces in 1981.

As can be readily seen from the chart, the early 1980s were characterized by a generally declining level of economic freedom. This was followed by something of a rebound at the latter part of the 1980s.

• Alberta followed a similar trend even while it had a relatively high level of economic freedom throughout the measurement period. Alberta's economic freedom was at its lowest level in 1985, growing from there and eventually surpassing its initial value.
• Ontario's decline in the early 1980s was modest and was followed by a rebound in 1989. From 1989 until 1994, the figure shows economic freedom declining in Ontario with a recovery starting after 1994.
• Saskatchewan's economic freedom declined from 1981 to 1993, even dipping below the 1981 average level of economic freedom. Saskatchewan's recovery since 1993 has been more gradual than its decline and thus the province has not equaled its initial 1981 level.
• British Columbia moved contrary to the general trend in the early 1980s and increased its level of economic freedom, peaking in 1989, and declining since then. While British Columbia started the measurement period with a relatively high level of economic freedom, in 1993 economic freedom in this province fell below the 1981 average level of economic freedom.
• Figure 3 shows that Manitoba's economic freedom gradually declined, reaching its low point in 1993 when it moved below the 1981 average level of economic freedom. Manitoba's economic freedom has increased since 1993 and, in the 1998 estimate, reached the 1981 average level of economic freedom.
• Prince Edward Island began the measurement period below the 1981 average level of economic freedom but its economic freedom has been increasing since then, with a minor setback in 1993. By the 1998 estimate, Prince Edward Island had surpassed a number of other provinces that had started the measurement period with much higher economic freedom.
• New Brunswick's level of economic freedom has been moving erratically. From 1981 to 1985 economic freedom declined, jumped up in 1989, and again declined to its lowest point in 1993. Since 1993, economic freedom has been increasing in New Brunswick.
• Nova Scotia increased its level of economic freedom for most of the measurement period except from 1989 to 1993, when there was a decline in economic freedom. For most of the measurement period, except 1989, Nova Scotia has been below the 1981 average level of economic freedom.
• While Quebec has consistently had a relatively lower level of economic freedom than other provinces, it approached the 1981 average level of economic freedom in 1989. This was followed by a decline in 1993 and then a general stability in its level of economic freedom.
• Newfoundland's level of economic freedom peaked in 1989 before declining in 1993 and from 1994 onwards. Newfoundland's level of economic freedom has been consistently lower than every other province during the measurement period.

Figures 4, 5, and 6 give a graphical overview of the economic freedom ratings for the provinces over the measurement period. In the next chapter we provide a province-by-province account of economic freedom and economic performance.

Click Here to View Figure 4

Click Here to View Figure 5

Click Here to View Figure 6

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Last Modified: Wednesday, October 20, 1999.