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- See also: Index of Economic Freedom
The annual survey Economic Freedom of the World is an indicator which attempts to measure the degree of economic freedom, using a definition for this similar to laissez-faire capitalism, in the world's nations. This indicator has been used in many peer-reviewed studies which have found many beneficial effects of more economic freedom.[1][2] There are various criticisms, for example that the important part of economic freedom may be efficient rule of law and functioning property rights, rather than low taxes and a small state.
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History
Nobel Laureate Milton Friedman and Michael Walker of the Fraser Institute hosted a series of conferences from 1986 to 1994. The goal was to create a clear definition of economic freedom and a method for measuring it. Eventually this resulted in the first report on worldwide economic freedom, Economic Freedom of the World. Later the Heritage Foundation and the Wall Street Journal created another similar index, the Index of Economic Freedom.
Methodology
The participants in the conferences reached a consensus that the cornerstones of economic freedom are:
- Personal choice rather than collective choice,
- Voluntary exchange coordinated by markets rather than allocation via the political process,
- Freedom to enter and compete in markets, and
- Protection of persons and their property from aggression by others.
The 2005 report states "When the functions of the minimal state—protection of people and their property from the actions of aggressors, enforcement of contracts, and provision of the limited set of public goods like roads, flood control projects, and money of stable value—are performed well, but the government does little else, a country’s rating on the EFW summary index will be high. Correspondingly, as government expenditures increase and regulations expand, a country’s rating will decline."
In practice, the index measures:
- Size of Government: Expenditures, Taxes, and Enterprises
- Legal Structure and Security of Property Rights
- Access to Sound Money
- Freedom to Trade Internationally
- Regulation of Credit, Labor, and Business
The report uses 38 distinct variables, from for example the World Bank, to measure this. Some examples: tax rates, degree of juridical independence, inflation rates, costs of importing, and regulated prices. Each of the 5 areas above is given equal weight in the final score.
Research
Hundreds of peer-reviewed articles have used the index. It have been used in, for example, economic research, political science, and environmental research.[3][4]
Economic freedom has been shown to correlate strongly with higher average income per person, higher income of the poorest 10%, higher life expectancy, higher literacy, lower infant mortality, higher access to water sources and less corruption. The share of income in percent going to the poorest 10% is the same for both more and less economically free countries.[5]
The people living in the top one-fifth of the most free countries enjoy an average income of $23,450 and a growth rate in the 1990s of 2.56 percent per year; in contrast, the bottom one-fifth in the rankings had an average income of just $2,556 and a -0.85 percent growth rate in the 1990s. The poorest 10 percent of the population have an average income of just $728 in the least free countries compared with over $7,000 in the most free countries. The life expectancy of people living in the most free nations is 20 years longer than for people in the least free countries[6].
Higher economic freedom, as measured by both the Heritage and the Fraser indices, correlates strongly with higher self-reported happiness.1
Higher economic freedom is extremely significant in preventing wars. Economic freedom is around 54 times more effective than democracy (as measured by Democracy Score) in diminishing violent conflict.2
Regarding environmental health, studies have found no or a positive effect. More important may be the Kuznets curve. Many, but not all, environmental health indicators, such as water and air pollution, show an inverted U-shape: in the beginning of economic development, little weight is given to environmental concerns, raising pollution along with industrialization. After a threshold, when basic physical needs are met and there are funds available, interest in a clean environment rises, reversing the trend.[7]
One question has been what sub-components are responsible for economic growth. Functioning property rights, low corruption, and low inflation may be particularly important. Regarding the size of government and free trade there is much conflicting evidence.
An overview of research can be found here [8], including studies showing that more economic freedom is the cause of beneficial effects. It also states that Economic Freedom of the World has been used in most of the academic research, partly because Index of Economic Freedom only goes back to 1995 and because it uses more subjective variables.
Influence and trends
The above has had "at least some indirect effects" on economic policy in some nations. In Russia it influenced President Vladimir Putin, after he won the 2000 election, to adopt a flat tax and restructure the very high marginal payroll taxes that were causing massive tax evasion. Supporters argue that this has contributed to the strong economic growth in Russia in recent years. On the other hand, Russia still scores very low in both indices and the high oil prices have helped Russia's economy. Flat taxes have also been instituted in Latvia, Estonia, and Slovakia, and are discussed in several other nations. Iceland has cut several of its taxes, with advocates for this using the economic freedom model. A related index for Chinese provinces is followed by both Chinese scholars and policy makers. There is also a network of institutions in 59 different nations that use the index to promote free market ideas.[9].
Economic Freedom of the World 2005 states that the world economic freedom score has grown considerably in recent decades. The average score has increased from 5.17 in 1985 to 6.4 in the most recent available year. Of the nations in 1985, 95 nations increased their score, seven saw a decline, and six were unchanged.
Criticism
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One criticism may be that this is simply a list of wealthy nations. However, economic wealth or high living standards are not used when scoring the nations. As noted above, proponents argue that there is evidence that one important explanation for the high wealth and living standards in these nations are that they have had high economic freedom in the past. Thus, while today Japan is much more wealthy than Estonia, since Estonia has a higher economic freedom, it may well be that in the future Estonia's economic wealth and living standards will grow faster than Japan's.
Another criticism is that for example China, and more generally several other developing nations, have high growth rates but relatively low economic freedom. However, developing nations should generally have higher growth rates than developed nations, since, for example, they are catching up and do not need to research new technologies initially. China started with very high poverty and very low economic freedom. "To be sure, China's economic freedom measures just 54 percent in 2007. But 30 years ago in 1977, the measure would have been near zero. By quietly setting aside Maoist dogma in 1978, the introduction of property rights for small farmers by Deng Xiaopeng initiated a revolution in economic freedom. As Milton Friedman anticipated, this small infusion had dramatic and positive effects. Within a few years, the Communist Party was promoting the slogan 'It is glorious to be rich.' Looking back, China's economic freedom has grown by 1 or 2 percentage points every year for 30 years, and the economy grew along with it: a growth-growth relationship." Chinese growth may slow if the reforms do not continue.[10]
The independent research does not necessarily support all of the ideals of laissez-faire. For example, when examining the effects of subcomponents of the index, any positive effect that a low level of taxes might have is much more disputed than the importance of rule of law, lack of political corruption, low inflation, and functioning property rights. Some of the highest ranking countries in the Index, for example Iceland (# 5), Denmark (# 8), Finland (# 12) and Sweden (# 19) are widely recognized as having some of the world's most extensive welfare states, which are strongly opposed by advocates of laissez-faire.
Additionally, critics of the view of Hong Kong as a laissez-faire capitalist state (ranked #1 in the Index of Economic Freedom) point out several flaws in this view of this region's economy. It is argued that the government has intervened to create economic institutions such as the Hong Kong Stock Market and has been involved in massive public works and extensive social welfare spending. All land in Hong Kong is owned by the government and leased to private users. By restricting the sale of land leases, the Hong Kong government keeps the price of land at what some would say are artificially high prices and this allows the government to support public spending with a low tax rate.[11]
Research using the Ease of Doing Business Index suggests that the effect of business regulations is more important than government consumption.[12] The Global Competitiveness Report looks at several other factors that also affect economic growth such as infrastructure, health, and education.
The World Bank is a strong supporter of the importance of economic growth for reducing poverty. However, the World Bank does not believe that laissez-faire policies, if they allow large inequalities of wealth to develop, are an effective way to achieve this goal. It argues that an overview of many studies shows that:
- Growth is fundamental for poverty reduction, and in principle growth as such does not seem to affect inequality.
- Growth accompanied by a more egalitarian distribution of wealth is better than growth alone.
- High initial income inequality is a brake on poverty reduction.
- Poverty itself is also likely to be a barrier for poverty reduction; and wealth inequality seems to predict lower future growth rates.[13]
Current ratings
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Economic Freedom of the World
A summary of the current index, published in 2008. (The 2007 full dataset is available at the Free the World website.)
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