Provincial Economic Freedom in Canada 1981-1998

by Faisal Arman, Dexter Samida, and Michael Walker

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Executive Summary

Economic freedom is vital to the well-being of all Canadians. Those provinces that liberate their economies receive dividends for their efforts in the form of higher rates of growth and higher levels of income per capita. When provincial governments restrict economic freedom, growth is dampened and income per capita declines relative to economically free jurisdictions.

In its simplest form, economic freedom involves the freedom to make choices, freedom of exchange, and protection of private property. Any major impediment to the exercise of these rights as a result of intervention by government is a violation of economic freedom. The freest of economies will operate with a minimal amount of government interference, relying upon personal choice and markets to answer basic economic questions such as what is to be produced, how much is to be produced, and for whom production is intended.

Provincial Economic Freedom in Canada tracks provincial economic freedom from 1981 to the present. It is a reliable indicator of economic freedom across the Canadian provinces and, since it is based on objective components, can be updated regularly in order to track future changes in economic freedom. There are 11 components grouped into four major areas: I. Government Operations and Regulations; II. Takings and Discriminatory Taxation; III. Interprovincial Trade; IV. Labour Market Regulations. After the data for each of these components were assembled, each province received a grade from zero through 10 for each component based on an objective rating scale.

Each component's grade was then weighted based on a system derived from the system used in the first two editions of Economic Freedom of the World (Gwartney, Lawson, and Block 1996; Gwartney and Lawson 1997). The weights used in Economic Freedom of the World were based on a survey of the participants in the Fraser Institute--Liberty Fund Symposia Series (see page 14; Gwartney and Lawson 1997: 7). The weights for components taken directly from the Economic Freedom of the World were modified for use with the Canadian provinces, which are subject to political and economic conditions different from those at work in international states. Weights for components created specifically for Provincial Economic Freedom in Canada, 1981-1998 were calculated based on their assumed contribution to provincial economic freedom as compared to other items already included. These weights were then adjusted until they equalled one hundred. (See Exhibit 1).

Economic Freedom and Economic Growth

This study also investigates the relationships between economic freedom and other economic variables. Economic theory suggests that some minimal level of economic freedom is necessary to spark economic growth and bring a nation or province an increased standard of living. Many economists and public-policy analysts disagree, however, about whether restrictions upon economic freedom beyond this level systematically reduce or increase economic welfare This is fundamentally a question about the size and role of government.

Statistical analysis done for this study clearly demonstrates that economic freedom as measured by the index of provincial economic freedom is positively related to provincial per-capita gross domestic product (GDP). Provinces that have pursued restrictive policies have suffered economically, while those that have fostered increased economic freedom have benefited. Moving up a single point in the index of provincial economic freedom adds an additional $2,433 to provincial per-capita GDP. When comparisons are made between relative freedom and relative economic well-being, the relationship is even more striking. This occurs because investment and labour tends to flow to areas with the best opportunities.

This study also shows that greater provincial economic freedom spurs increased economic growth. Due to random shocks affecting the entire Canadian economy, this relationship tends to fluctuate from year to year. In order to minimize the effect of these shocks upon our results, the relationship between relative changes in economic freedom and relative changes in provincial per-capita GDP was also investigated. This relationship was also statistically significant and a large portion of the relative variation in per-capita GDP is explained simply by the relative variation in economic freedom.

Most provinces had declines in economic freedom in the early 1980s due to an expansion of government; an increase in economic freedom appeared around 1989 as governments generally tried to reduce consumption and lower personal tax rates. The least economically free provinces tended to have modest increases in economic freedom throughout the measurement period but in all cases these provinces remained below the average level of economic freedom. This is unfortunate as the least free provinces are also Canada's poorest provinces. Restraining market activity in these provinces imposes costs on those who can least afford them. The statistical models developed in this study suggest that the cost to jurisdictions that are less economically free than Alberta is in the range of $6,000 to almost $13,000 per person per year.

Economic Freedom: Provincial Ratings

The provinces of Alberta and Ontario have the greatest economic freedom in Canada. Alberta and Ontario have maintained first and second place respectively throughout the period of measurement, except in 1985 and 1989 when Ontario took first place. Since 1993, Alberta has ranked first or second in each of the four major areas of the index and has had particular success in reducing personal and corporate tax rates. Since 1993, Ontario has been struggling to maintain a distant second position, with Prince Edward Island positioned to overtake it. Ontario's best ranking is in the Government Operations area of the index, due to the government's reduction of its consumption relative to that in other provinces.

At the other end of spectrum, Newfoundland has been the least economically free province in Canada throughout the period under study. New Brunswick and Quebec also consistently achieved low ratings from 1986 to 1996. In recent years, Newfoundland has placed in either second last or last place in each of the four major areas of the index. Areas of particularly poor performance include government consumption, and transfers and subsidies. Quebec's low ranking is due to a large number of transfers and subsidies and considerable business regulation. New Brunswick's low overall ranking was due to a very poor showing in the Government Operations and Interprovincial Trade areas of the index.

Click Here to View Figure A: 1998 Estimate of Provincial Economic Freedom

Changes in Economic Freedom in the Provinces

Prince Edward Island has shown the greatest improvement in the freedom rankings. In 1981, Prince Edward Island was the sixth freest province in Canada. From 1989 through to 1996, Prince Edward Island made modest gains in economic freedom by reducing government consumption as a percentage of GDP, and the annual minimum wage as a percentage of per-capita GDP, moving from a rating of 4.8 in 1989 to 5.4 in the 1998 estimate. The result of these changes was an improvement to third place.

British Columbia showed the greatest drop in economic freedom. From 1981 to 1994, it was able to maintain its standing among the five most economically free provinces; from 1985 to 1993, it was ranked the third freest province. However, as a result of changes in its policies after 1994, including an increase in government consumption as a percentage of GDP, a rise in the annual minimum wage as a percentage of per-capita GDP, and an increase in personal and corporate taxes, British Columbia tumbled to sixth place in 1995 and to eighth position in the 1998 estimate.

Manitoba showed a modest loss of economic freedom, dropping from 5.5 in 1981 to 5.0 in the 1998 estimate. This was due to a drop in its ratings for categories (I) Government Operations and Regulations and (II) Takings and Discriminatory Taxation. Nevertheless, Manitoba maintained its ranking as the fifth freest jurisdiction.

Saskatchewan's economic freedom has fluctuated greatly, losing ground from 1981 to 1993 and then gaining ground relative to other provinces from 1994 to 1996. These fluctuations were caused by a lack of fiscal restraint until recent years and the retention of a large government-enterprise sector. In the 1998 estimate, Saskatchewan was the fourth most economically free province.

Nova Scotia ranked eighth freest province in 1981 and seventh freest province in 1985. It was the fourth freest province in 1989 and fluctuated between sixth and seventh freest for the rest of the measurement period. The increase in ratings in 1989 was due to reduced government consumption, a lower top marginal tax rate, and a reduced minimum wage, while the subsequent decline was the result of lower scores in (I) Government Operations and Regulations and (II) Takings and Discriminatory Taxation of this index.

For a complete listing of the ratings of each province, please see pages 38 to 40.

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