The Measurement and Importance of Economic Freedom

The Economic Freedom of the World 2019 annual report, published by the Canadian Fraser Institute and a network of independent research institutes in more than 90 countries, was recently released. The authors of the report are James Gwartney, Florida State University; Robert A. Lawson and Ryan Murphy of Southern Methodist University; and Joshua Hall, West Virginia University.

The Economic Freedom of the World (EFW) index provides a comprehensive measure of the consistency of a country’s institutions and policies with economic freedom. It is an outgrowth of a series of conferences hosted by Milton and Rose Friedman and Michael Walker  during 1986-1994. In addition to the Friedmans, several of the world’s leading economists including Douglass North, Gary Becker, Peter Bauer, William Niskanen, and Gordon Tullock contributed to the development of the EFW measure.

The cornerstones of economic freedom are personal choice, voluntary exchange, open markets, and clearly defined and enforced property rights. In order to achieve a high EFW rating, a country must do some things, but refrain from others. Governments enhance economic freedom when they provide an infrastructure for voluntary exchange, and protect individuals and their property from aggressors. In this regard, the legal system is particularly important. The country’s legal institutions must protect the person and property of all individuals from the aggressive acts of others and enforce contracts in an even-handed manner. Access must also be provided to money of sound value. But governments must also refrain from actions that restrict personal choice, interfere with voluntary exchange, and limit entry into markets.  Further, economic freedom is reduced when taxes, government expenditures, and regulations are substituted for personal choice, voluntary exchange, and market coordination. Essentially, the EFW index is a measure  of the  degree to which countries rely on decentralized open markets rather than centralized political decision-making to allocate goods and resources.

The index measures the degree of economic freedom present in five major areas: [1] Size of Government, [2] Legal System and Property Rights, [3] Sound Money, [4] Freedom to Trade Internationally, and [5] Regulation of credit, labor, and business. In total, the index incorporates 43 distinct variables. Further, the legal rights of women differ from those of men in many countries . In order to account for this factor, data from the World Bank was used to construct a gender disparity index. In turn, this index was used to adjust the legal structure country ratings for differences between men and women in legal rights related to economic freedom.

Each  of the 43 variables are placed on a scale from 0 to 10 that reflects the distribution of the underlying data.  These data are used to derive component ratings  which are averaged to derive the rating for each of the five major areas.  Finally, the ratings for the five areas are averaged to derive a summary rating for each country. The EFW data are currently available for 162 countries. Time series data are available for 102 countries back to 1980. The latest ratings are based on data for 2017.

As in recent years, Hong Kong and Singapore had the highest 2017 summary ratings. The following countries ranked three through ten: New Zealand, Switzerland, United States, Ireland, United Kingdom, Canada, Australia, and Mauritius.

The rankings of some other major countries are Japan (17th), Germany (20th), Italy (46th), France (50th), Mexico (76th), Russia (85th), India (79th), China (113th), and Brazil (120th).

The 10 lowest-rated countries are: Iraq, Republic of Congo, Egypt, Syria, Democratic Republic of Congo, Angola, Algeria, Sudan, Libya, and lastly Venezuela. Interestingly, the five countries with the lowest EFW ratings all derive a substantial share of their national income from oil exports.

Why is the measurement of economic freedom important? For many years, economists and others have debated how market economies performed compared to those that rely more heavily on government intervention and political allocation. Without a measure of economic freedom, empirical analysis of this issue is impossible. The EFW data across countries and time facilitates scholarly analysis of how differences in economic institutions and policies impact the performance of economies.

There is strong evidence that freer economies perform better than those that are less free.  Measured in 2011 dollars, countries in the top quartile of economic freedom had an average per-capita GDP of $36,770 in 2017, compared to $6,140 for nations in the bottom quartile. Similarly, life expectancy is 79.5 years in the top quartile of countries compared to 64.4 years in the bottom quartile.

Since the initial publication of the Economic Freedom of the World report in 1996, numerous scholarly studies have used the data to examine the impact of economic freedom on investment, economic growth, income levels, and poverty rates. Virtually without exception, these studies have found that countries with institutions and policies more consistent with economic freedom have higher investment rates, more rapid economic growth, higher income levels, and a more rapid reduction in poverty rates.

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Dr. James D. Gwartney holds the Gus A. Stavros Eminent Scholar Chair, directs the Stavros Center for the Advancement of Free Enterprise and Economic Education and is a Professor of Economics. 

The featured image is from cnsnews.com

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