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Chapter 17
Institutions, Policies, and Cross-Country Differences in
Income and Growth
OUTLINE
I. How Large are the Income Differences Across Countries?
A. Purchasing power parity comparisons indicate that the per person income in wealthy
countries such as the United States, Ireland, and Norway is about fifty times the income
II. How Do Growth Rates Vary Across Countries?
A. The fastest growing countries in the world are LDCs although other LDCs are doing
very poorly.
B. The growth picture of LDCs is clearly one of diversity.
III. Economic Freedom as a Measure of Sound Institutions
A. Economists since the time of Adam Smith have generally argued that freer economies
are likely to be more productive.
B. Economic freedom is complex and very difficult to measure.
C. Measure of economic freedom developed by Fraser Institute indicates consistency of
the legal structure and policies with secure property, monetary stability, free trade, and
reliance on markets.
IV. Institutions, Policies, and Economic Performance
A. Countries with more economic freedom, as measured by the Freedom Index in 1990-
2009 also had both a higher average per capita GDP in 2009 and more rapid average
growth rates during 1990-2009.
V. Economic Freedom, Institutions, and Investment
A. Even though wages are lower and capital less abundant in low-income countries, both
private investment rates in countries with less economic freedom.
B. The productivity of investment is lower in countries with less economic freedom.
VI. Is Institutional Change Possible?
A. Countries that have substantially improved the quality of their institutions in recent
decades have registered impressive growth rates.
1. Ireland, Botswana, Chile, Estonia, and even China are examples.
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VII. The Declining Economic Freedom of the United States
A. The Economic Freedom of the United States
1. During the 1980-2000 period the U.S. had the 3rd highest economic freedom rating,
ranking behind only Hong Kong and Singapore.
3. The U.S. ranking has slipped from 3rd to 17th in 2011.
B. Implications of the Decline in the U.S. EFW Rating
1. Between 2000 and 2010 the U.S. rating fell by almost a full point. While a one unit
2. The following elements contributed to the decline in the US EFW rating: higher levels
of government spending, a reduction in the quality of the legal environment, higher non–
VII. Rich and Poor Nations Revisited
A. Countries with low per capital income in 1990 dominate the list of both (1) those that
have grown most rapidly and (2) those that have regressed and experience falling
incomes since 1990.
B. When low-income economies have sound institutions, they can grow rapidly because:
1. they can merely copy or emulate technologies and business practices that have been
IX. Economic Rules and Political Decision Making
A. Economic institutions and policies will reflect political choices.
1. The political environment often conflicts with the adoption of sound economic
policy.
OBJECTIVES
We discuss the size of the current economic gap among nations. The text points out the income
differences across countries are huge. However, the fastest growing countries are less developed
countries. The chapter next points out of measuring income differences among countries are
presented.
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The chapter next analyzes the role of economic freedom in determining economic growth.
More economic freedom is present when people are permitted to choose for themselves, trade freely
with others in both domestic and international markets, and live in an environment where property
IMPORTANT POINTS AND TEACHING SUGGESTIONS
2. Review Exhibits 4 and 5, which show that countries with more economic freedom tend to have
3. Review Exhibit 7 which show that countries with more economic freedom tend to have higher
investment levels and more productive investment.
HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS
3. -growing economies during the past two decades were
4. In order to make a high score on the EFW index, a country must rely extensively on markets,
7. According to the Economic Freedom of the World measure, the economic freedom of the
162 Chapter 17/ Institutions, Policies, and Cross-Country Differences in Income and Growth