Economic freedom is the ability of individuals to own private property and use it as they see best, so long as they don’t commit violence or fraud against others. Economic freedom and secure private property rights are critical to economic development. We must be confident that we’ll be able to reap the rewards from what we produce for there to be an incentive to be productive. Accordingly, Lawson, Murphy, and Powell (2020) note: “A large literature has found positive associations between economic freedom and income, growth, and a variety of other desirable outcomes” (622).
In this article, I’ll use the Fraser Institute’s “Economic Freedom of the World” index to analyze how Armenia has fared regarding economic freedom in recent history, present the most fundamental argument why economic freedom is essential to a prosperous society and analyze Armenia’s transition out of socialism in light of this argument.
Economic Freedom in Armenia
For a country that was part of the totalitarian, socialist Soviet Union for 70 years, Armenia has performed quite well in terms of economic freedom, at least from 2004. The Fraser Institute has data on Armenia’s economic freedom from 2004 to 2019, and throughout this period Armenia’s score has been steady, averaging roughly 7.74 out of 10 for this period.
The Fraser Institute’s imperfect but useful index “has been cited in hundreds of academic articles” (Hall and Lawson, 2014, 1) and is calculated by taking a simple average of scores for five areas of freedom: size of government, legal system and property rights, sound money, freedom to trade internationally and regulation.
Compared to its neighbors, Armenia scored considerably higher than Azerbaijan, Turkey and Iran for every year from 2004 to 2019 but ranked somewhat lower than Georgia for most years. Compared to a selection of other landlocked post-Soviet countries, Armenia outperformed every one of these countries for every year from 2004 to 2019. However, there is much room for improvement, as we would expect for a country that only 30 years ago escaped from the backwardness and repression of the Soviet Union. With the proper culture and leadership, we could reach the level of economic freedom (and wealth) historically enjoyed in Switzerland, New Zealand and Singapore.
Armenia’s overall economic freedom score has been consistently strong, always ranking in the top quartile of the world. Proponents of economic freedom argue that economic freedom spurs growth, and the data in Armenia’s case bear out this relationship. So much so, in fact, that Armenia was donned “The Caucasian Tiger” in a book published in 2007 by the World Bank, due to Armenia’s “stellar growth record.” The vast majority of this growth took place under President Robert Kocharyan’s administration, which spanned from 1998 to 2008. Since independence in 1991, Armenia’s GDP (adjusted for purchasing power parity) exploded from about $9 billion to over $39 billion in 2020, more than quadrupling.
Armenia has had solid economic freedom for all years that data is available, always ranking in the top quartile globally, but still has much room to improve. This overall strong economic freedom has not surprisingly been accompanied by a multiplication of GDP since independence from the Soviet Union. The question remains, what is it about economic freedom, if anything, 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 problem, explained 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 of achieving them: land, labor and capital, are limited. In advanced economies with billions of different ways of combining our various stores of copper, lumber, labor, farmland, etc., how can we determine how best to use our scarce resources to fulfill our wants?
There are countless things we could produce and countless different ways of producing given outputs. Houses could be made with hardwood floors rather than linoleum floors, but that would mean having less wood for building furniture, for example. Thus, 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 desires?
In a market economy, the answer is the information contained within prices. Individuals 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 profit and loss calculations based on the prices of their outputs, minus the prices of their inputs on the market. The difference of total revenue from production and total cost of production is profit.
By pursuing the most profitable path possible in production plans, entrepreneurs, in simply pursuing their own self-interest, are guided not to use society’s scarce supply of, say, steel, to build a tractor factory in Alaverdi, when society more urgently needs that steel to build a machine tools plant in Gyumri.
If society more urgently needs a machine tools plant 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 of the expected costs and revenues of these two production plans are weighed against one another, one is more profitable than the other.
Contrariwise, in a socialist economy, there is no private property, there is no voluntary exchange of capital goods, and consequently, there are no market prices that reflect the preferences of consumers. Thus, economic calculation is impossible under socialism, and decisions about resource allocation must instead be made via political means, rather than economic means.
Politics replaces economization. The will of the few central planners replaces the preferences of the millions of people who engage in exchange every day. And these central planners, who are confronted with billions of competing possible ways to allocate society’s scarce resources, but have no market prices to guide them, are in Mises’ words, left “groping in the dark.”
The Calculation Problem in Mixed Economies
It’s critical to note that it’s not just socialist economies that suffer from the calculation problem. Mixed economies, where there are elements of the free market combined with government intervention, suffer from the calculation problem to the extent that and in those spheres where economic activity is funded by taxation, rather than voluntary exchange. Economist Murray Rothbard called these “islands of calculational chaos.”
When we voluntarily buy milk at the store, this communicates, through demonstrated preference, consumers’ desire to buy milk in certain quantities at certain prices, as opposed to the other goods that this money could have been spent on. This allows farmers to gauge in advance how much milk to produce, and, depending on the prices, whether they should adjust their plans to produce more cows for milk, more chickens for eggs, or some altogether different course of action.
However, when the government raises money through the involuntary means of taxation, this does not communicate consumer demand for any particular quantity of a given good or service. Rather, it indicates that taxpayers demand to not be prosecuted for tax evasion.
Another benefit of lowering taxes and allowing people to make decisions for themselves based on prices, instead of having the state tax and spend based on political decision-making, is that the government never even has the opportunity to engage in corruption with money that never passes through its hands.
The Soviet Transition
The misallocation of scarce resources under socialism’s “groping in the dark” without the guiding light of market prices was perhaps the biggest reason why it was so economically painful when the Soviet Union fell apart and the former Soviet republics abruptly transitioned to more market-oriented economies.
It’s akin to someone who’s been living underground for 70 years finally finding their way to the surface and being exposed to sunlight. It’s good that this unfortunate person has finally found their way above ground, but the transition to the light (prices) will initially burn their eyes.
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 of land Z was not optimal in satisfying the needs of society, compared to the other possible uses of the resources that were expended on that factory. Instead, society more urgently needed a factory producing good A, using production process B, in location C.
Naturally, the transition process was painful, with workplaces closing, people losing their jobs and production temporarily falling, until the economy was fundamentally restructured according to market prices, as opposed to the dead hand of Soviet central planners.
Armed with the insights of economic science, and in particular Mises’ economic calculation problem, the path to prosperity for Armenia is significantly clearer. The market economy must be strengthened by protecting private property from both government and private predation, and by keeping government spending, taxes, and regulation to a minimum, in order to allow resources to be guided by the light and information provided by market prices, rather than political expediency.
Gor Mkrtchian
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