Does Economic freedom enhance firm investment? Theory and evidence from North America

Using a generalized Q model of investment, this paper studies the impact of economic freedom on corporate investment, in presence of financing constraints. The theoretical predictions of the model are tested on a large and heterogeneous sample of non-financial US firms over the period 2000-2016. Consistently with the model’s predictions, empirical results show that: 1) economic freedom enhances firm investment; 2) the sensitivity of investment to the firm internal funds is mitigated by the presence of economic freedom; 4) the negative effect of financing constraints on firm investment is mitigated by the presence of economic freedom; 8) all these effects are strong and robust for the Economic freedom index and most of its counterparts. Our findings are in line with the finance literature view according to which the development of financial institutions and quality of enforcement of the law help busting the economic growth.