Measuring social capital

Indicators Aotearoa New Zealand (IANZ) has released a list of all the indicators they are considering to be used to measure wellbeing in New Zealand. This list might be said to contain too many indicators to be useful, but if you’re going to have a bath you might as well have a big bath. 

In this article we suggest an addition to the indicators for Social Capital: economic freedom. We highlight the importance of economic freedom and suggest a source of data.

Social capital is the norms, values, and institutions that underpin society

The concept of Social Capital according to Treasury is the “norms and values that underpin society”. This description fits quite neatly into our (economists) conception of institutions such as property rights, taxation, and The State etc. 

The indicators for Social Capital arrived at by IANZ are a good start, but are the least well developed in terms of breadth. We contend that a reasonable addition to these indicators could be a measure of economic freedom.

Economic freedom is necessary for wellbeing. A pleasant surprise is that economists have had a good concept of wellbeing for a long time. In Theory and History Ludwig von Mises paraphrased Eugen Böhm-Bawerk as describing wellbeing as “…not refer[ing] only to concerns commonly called egoistic but comprehends everything that appears to an individual as desirable and worthy of being aimed at (erstrebenswert).”¹

Economic freedom allows individuals to strive for the ends they believe are desirable. It is also a necessary condition to the development of the division of labour which allows for the production of the means to achieve those ends.²

Measuring economic freedom

A specific measure of economic freedom that has already been developed by a reputable organisation is the Index of Economic Freedom by The Heritage Foundation.³ New Zealand is currently ranked 3rd on this index, behind Hong Kong and Singapore. Australia is 5th and the US is 12th.

We can see the influence of high economic freedom on another common wellbeing measure – the GDP per capita - in the following chart. ⁴ We see that greater economic freedom is associated with higher GDP per capita (PPP) in 2019. We emphasise that economic freedom is the component of wellbeing to be strived for and measured, but we show that it has positive flow on effects for the narrow wellbeing measure of GDP per capita (PPP).

Indicators can be broad or specific

In terms of adding some measures to the overall wellbeing indicators measurement framework one option is to use just the overall index score. A second option is to pick a few components which are of particular interest. An important one is property rights. This is important because well-defined and protected property rights allow the division of labour to develop and extend. It should be emphasised that the concept of property rights includes one’s ownership of one’s body and one’s labour. So, even those people who have little physical assets have (inalienable) rights in their own body and labour. Without defined and protected property rights one cannot accumulate wealth or produce much more than bare subsistence for fear that it might be confiscated.⁵

In countries where we see the division of labour break down (such as modern day Venezuela) what we often see preceding that is a wholesale violation of property rights across the economy. Conversely, in countries where we see the development of protection for property rights (such as China post reforms) we see the division of labour continually extend and widespread human flourishing.

Other specific components that could be used as indicators by themselves include labour freedom, business freedom, and the tax burden.