the black-market exchange rate, and the extent of international capital market controls. Regulation of credit, labor and business measures credit market regulations, labor market regulations, and business regulations. The EF index is constructed if the data is available on at least three out of the four areas of economic freedom; otherwise we marked the data as missing.

The index of entitlement rights _(ER)_ is computed from the fifth area of the Fraser Institute’s Economic Freedom of the World. It is a rough proxy to measure the inclination of government to expand the scope of their activities in providing goods, services and entitlements. It includes the general government consumption spending as a percentage of total consumption, transfers and subsidies as a percentage of GDP, government enterprises and investment, and top marginal tax rate. Because this measure is both broad and limited, it necessarily hides a lot of heterogeneity, especially regarding the quality of public expenditures and other forms of government intervention. In particular, among small governments, the index cannot distinguish between failed states and more effective states. Among larger governments, the index cannot differentiate efficient welfare states from ineffective and wasteful rent-seeking states. Yet, the index aims at capturing the overall characteristic that governments with large public spending, transfers and subsidies, numerous government enterprises, and high marginal tax rates are generally prone to provide various forms of entitlements (e.g., entitlement to healthcare, education, pension; entitlement to free or highly subsidized food, water, energy, and other goods and services; entitlement to public housing, rent controls, or publicly-guaranteed mortgage; entitlement to public employment, minimum wage; entitlement to be protected from foreign and domestic competition through bans, quotas, and other various limits to entry). The value of the index has been reversed so that the higher levels represent larger governments and by extension more extensive provisions of ERs.

The index of civil and political rights _(CPR)_ is computed as the simple average of Freedom House’s Civil Rights (CR) and Political Liberties (PL) indices.<sup>16</sup> Civil rights indicates whether citizens are able to participate freely in the political process, including the right to vote for distinct alternative in legitimate lections, compete for public office, join political parties and organizations, as well as elect representatives that have a distinct impact on public policies and are accountable to the public. Political liberties allow for freedom of expression and belief, association and organization rights, rule of law and personal autonomy. The indices has been reversed as compared to the original Freedom House indices, so that the higher the level of index the higher the level of freedom. Because the indexes of civil rights and political liberties are highly correlated,<sup>17</sup> we create a joint index of civil and political rights (CPR).

A number of control variables are used to depict exogenous factors, such as geography, landlockedness, and remoteness. To control for geography, we use the data from Gallup, Sachs and Mellinger (1998) on the extent of land located in the geographical tropics. To control for landlockedness, we also use the data from Gallup, Sachs and Mellinger (1998) on the proportion of the country’s populations living within 100 km of the coastline or ocean-navigable river. To control for remoteness, we include a measure of the average distance to the world markets in line with the work of Redding and Venables

> 16 <u>http://www.freedomhouse.org/template.cfm?page=594</u> 17 The Spearman rank correlation between the two indices over the period of 1970-2007 amounts to 0.93.

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