Since the fall of the Berlin Wall 20 years ago, the performance of market economies has been a powerful theme in assessing the health of societies around the world. But free enterprise has come under attack with the global economic crisis, the perceived threat of climate change, and a broader concern--most recently promoted by French President Nicolas Sarkozy--that growth alone does not indicate prosperity.
And at first glance, this year's Prosperity Index, published yesterday by the Legatum Institute, seems to provide evidence that capitalism is in trouble. The index aims to be a holistic measure of societal well-being, measuring not only things like economic freedom and property rights but also factors such as education, health, and good governance. The Institute found that four of the five most prosperous countries are democracies of Northern Europe: Finland, Sweden, Denmark and Norway--all well-known as high-tax, social welfare states. And while the U.S. and U.K. rank ninth and 12th respectively, France, Germany and Spain are not far behind. Fourteen of the top 20 countries are European. So does that mean capitalism needs to be reigned in as many of its critics consider? Far from it.
Consider the Wall Street Journal/Heritage Foundation Index of Economic Freedom, which measures the key factors in political and economic freedom, such as strength of democratic checks and balances, protection of property rights, enforcement of contracts, ease of starting a business, and of hiring and firing staff. Due to their strongly capitalist systems, Hong Kong and Singapore score very highly in the WSJ index. Their lower personal freedoms and scores on interpersonal trust and community engagement drag them down to 18th and 23rd respectively on the Prosperity Index. Similarly, the top performers of Northern Europe do not do as well in the WSJ Index as they do in the Prosperity Index, since their economic fundamentals are not stellar.
Many people--especially Americans--think of wealth as the basis of health and happiness, too. In other words, market economies with good economic fundamentals drive us to more fulfilling lives. Europeans often counter that a narrow pecuniary viewpoint gives a distorted picture of the human experience. Worse yet, it can lead to the tyranny of materialism. Who is right?
A statistical analysis of both indexes shows that economic prosperity and more holistic indicators overlap significantly, but not completely. It's no coincidence that the Prosperity Index calls its economic and democracy sub-indexes the drivers of wealth, and implicitly, prosperity. If one strips out the three main economic sub-indexes from the Prosperity Index, one can compile a ranking from the six remaining sub-indexes that have more to do with quality of life than economic growth. Using statistical techniques, one can test how much of the WSJ Index explains the Prosperity Index's broader well-being indicators. The relationship is statistically significant, with just under two thirds of Legatum's well-being indicators explained by economic and political freedom.
While free enterprise is not the only important factor explaining national differences in well-being, it probably does explain most of it. This means subverting the mechanisms of free enterprise would not just lead to lower economic growth but also lower social scores. The fact that the Nordic countries do so well in the Prosperity Index has largely to do with the fact that apart from their welfare policies, they also encourage entrepreneurship, free trade, and have stable monetary policies--even as they employ strong rhetoric against capitalism. Finland, Sweden and Denmark all score higher than Switzerland and nearly all of their southern European counterparts on their capacity to commercialize innovation, through factors such as business start-up procedures, business registration rates, and royalties on patents. All of this drives dynamic entrepreneurship, and spurs people to innovate and take risks, as they are more reassured that good ideas will pay off.
U.S. policy makers would do well to note this fact as they contemplate more "European" policies. And as the West contemplates ever tighter regulations on how and where money can be spent, lent and invested, their leaders should remember that economic and political liberty--while not the whole story--play a key role in prosperity. They are the engine driving much of what makes life worthwhile.
Arthur C. Brooks is the president of AEI. Ryan Streeter is a senior fellow at the Legatum Institute.