a dynamic non-linear analysis

Abstract

We analyze the effect of economic freedom, or the absence of economic regulation, on GDP growth. The theory presented combines two opposing views on the effect of regulation on growth. The theory suggests that the relationship is non-linear and that an optimal level of regulation may vary with the level of develop­ment. Therefore, we analyze the empirical relation using a flexible dynamic panel data model with fixed effects. The results show that the effect of regulation on growth is indeed non-linear and depends on income. For low-income countries, there is little effect of changing regulation. For highly regulated middle-income countries, deregulation can increase growth, but only up to a point. For high-income countries, deregulation leads to higher growth. Holding regulation constant, there is catch-up growth with a maximum at an intermediate income level.

Keywords: Catch-up growth, economic freedom, economic regulation, fixed effects, GMM, specification tests.

JEL classification: C23, D70, H11, O40.