Economic freedom is the ability of individuals to own private property and use it as they see fit, as long as they do not commit violence or fraud against others. Economic freedom and security of private property rights are essential to economic development. We need to be confident that we can reap the rewards of what we produce for there to be an incentive to be productive. As a result, Lawson, Murphy and Powell (2020) note: “An extensive literature has found positive associations between economic freedom and income, growth, and a variety of other desirable outcomes” (622).
In this article, I will use the Fraser Institute’s “Economic Freedom of the World” index to analyze how Armenia has fared on economic freedom in recent history, present the most fundamental argument as to why economic freedom is essential to a prosperous society and analyze Armenia’s transition. of socialism in the light of this argument.
Economic freedom in Armenia
For a country that was part of the totalitarian and socialist Soviet Union for 70 years, Armenia has done fairly well in terms of economic freedom, at least as of 2004. The Fraser Institute has data on Armenia’s economic freedom from 2004 to 2019, and throughout this period. period, Armenia’s score has been stable, averaging around 7.74 out of 10 for that period.
The Fraser Institute’s imperfect but useful index “has been cited in hundreds of academic papers” (Hall and Lawson, 2014, 1) and is calculated taking a simple average of scores for five freedom domains: size of government, legal system and property rights, sound money, freedom to trade internationally, and regulation.
Compared to its neighbours, Armenia scored considerably higher than Azerbaijan, Turkey and Iran for each year from 2004 to 2019, but slightly worse than Georgia in most years. Compared to a selection of other post-Soviet landlocked countries, Armenia outperformed each of these countries for each year from 2004 to 2019. However, there is plenty of room for improvement, as one would expect for a country that only 30 years ago escaped backwardness and the repression of the Soviet Union. With the right culture and leadership, we could achieve the level of economic freedom (and wealth) historically enjoyed Switzerland, New Zealand and Singapore.
Armenia’s overall economic freedom score has always been high, consistently ranking in the top quartile of the world. Proponents of economic freedom argue that economic freedom stimulates growth and that Data in the case of Armenia confirm this relationship. So much so, in fact, that Armenia has donned “the Caucasian tiger” in a book published in 2007 by the World Bank, due to Armenia’s “exceptional growth record”. The vast majority of this growth took place during the administration of President Robert Kocharyan, which spanned from 1998 to 2008. Since independence in 1991, Armenia’s GDP (adjusted for power parity of purchase) has exploded from around $9 billion to over $39 billion in 2020, more than quadrupling. .
Armenia has enjoyed strong economic freedom in all the years data is available, still ranking in the top quartile globally, but still has a long way to go. This strong global economic freedom has unsurprisingly been accompanied by a multiplication of GDP since independence from the Soviet Union. The question remains, what about the economic freedom, if any, that is so essential to prosperity?
The economic calculation problem of socialism
The most fundamental reason why the market economy is so essential to prosperity is the economic calculation problemexplained by Ludwig von Mises in his 1920 book Economic Calculation in the Socialist Commonwealth. Human beings live in a world of scarcity. Our desires are unlimited, but our means to realize them: land, labor and capital, are limited. In advanced economies with billions of different ways to combine our various stocks of copper, timber, labor, farmland, etc., how do we determine the best way to use our scarce resources to meet our needs?
There are countless things we could produce and countless manners to produce given outputs. Homes could be built with hardwood floors rather than linoleum floors, but that would mean having less wood for building furniture, for example. So, with billions of potential ways to use our scarce resources, how do we know what to produce, and how to produce it, to best satisfy humanity’s needs and wants?
In a market economy, the answer is the information contained in prices. People with private property voluntarily decide to engage in exchanges, and from these exchanges we can see the prices paid for various goods and services. These prices contain information about the relative supply and demand of different goods and services. Entrepreneurs then engage in arithmetic calculations of profit and loss based on the prices of their products minus the market prices of their inputs. The difference between the total revenue from production and the total cost of production is the profit.
Pursuing the most profitable route possible in production plans, entrepreneurs, simply pursuing their own interests, are guided not to use society’s scarce supply of, say, steel to build a tractor factory in Alaverdi, when society needs it more urgently. steel to build a machine tool factory in Gyumri.
If the company has a more urgent need for a machine tool factory in Gyumri than a tractor factory in Alaverdi, this will be communicated to the entrepreneur trying to decide between these options in the fact that when all costs and revenues expected from these two production plans are weighed against each other, one is more profitable than the other.
On the contrary, in a socialist economy there is no private property, there is no voluntary exchange of capital goods, and therefore there are no market prices which reflect consumer preferences. Thus, economic calculation is impossible under socialism, and decisions about the allocation of resources must instead be made by political means, rather than economic means.
Politics replaces economization. The will of the few central planners supersedes the preferences of the millions of people who trade every day. And those central planners, who are faced with billions of possible competing ways to allocate society’s scarce resources, but who have no market price to guide them, are, in Mises’ words, left “to grope in the dark”.
The calculation problem in mixed economies
It is essential to note that it is not only socialist economies that suffer from the calculation problem. Mixed economies, where there are free market elements combined with government intervention, suffer from the problem of calculation to the extent and in the spheres where economic activity is financed by taxation, rather than by voluntary exchanges . Economist Murray Rothbard called these “islands of computational chaos”.
When we voluntarily buy milk from the store, it communicates, through a demonstrated preference, consumers’ desire to buy milk in certain quantities at certain prices, as opposed to other goods on which that money might have been spent. This allows farmers to assess in advance how much milk to produce and, depending on prices, whether they need to adjust their plans to produce more cows for milk, more chickens for eggs or a line of totally different behavior.
However, when government raises funds through involuntary means of taxation, it does not communicate consumer demand for a particular quantity of a given good or service. Rather, it indicates that taxpayers are demanding not to be prosecuted for tax evasion.
Another advantage of lowering taxes and allowing people to make their own decisions based on prices, instead of the state taxing and spending based on political decision-making, is that the government does not have never even the power opportunity engage in corruption with money that never passes through his hands.
The Soviet transition
The misallocation of scarce resources under “groping in the dark” socialism without the guiding light of market prices was perhaps the main reason why it was so economically painful when the Soviet Union collapsed. collapsed and the former Soviet republics abruptly transitioned to more market-oriented economies. .
It’s like someone who’s been living underground for 70 years is finally finding their way to the surface and being exposed to sunlight. It’s good that this unfortunate has finally found his way above ground, but the step into the light (the prices) will burn his eyes first.
Once the former Soviet economy was exposed to market prices, it became clear that the political decision to build a factory producing good X using production process Y on plot Z was not optimal to satisfy the society’s needs, compared to the other possible uses of the resources that have been spent on this factory. Instead, society had a more urgent need for a factory producing good A, using production process B, at location C.
Understandably, the transition process was painful, with workplace closures, job losses and a temporary drop in production, until the economy was fundamentally restructured according to market prices, for opposition to the dead hand of the Soviet central planners.
Armed with the knowledge of economics, and in particular that of Mises economic calculation problem, Armenia’s path to prosperity is much clearer. The market economy must be strengthened by protecting private property from governmental and private predation, and by keeping public spending, taxes and regulation to a minimum, in order to allow resources to be guided by light and information. provided by market prices, rather than political expediency.