For
the first time in the 11 years that the Heritage Foundation
and The Wall Street Journal have been publishing the
Index of Economic Freedom, the U.S. has dropped out
of the top 10 freest economies in the world. . Policy
makers who pay lip service to fighting poverty would
do well to grasp the link between economic freedom
and prosperity. This year the Index finds that the
freest economies have a per-capita income of $29,219,
more than twice that of the "mostly free"
at $12,839, and more than four times that of the "mostly
unfree." Put simply, misery has a cure and its
name is economic freedom. -Wall Street Journal op-ed
by Mary Anastasia O'Grady, January 4, 2005.
I must be confused. I somehow thought that an Economic
Freedom Index would showcase countries that are reducing
the democratic deficits of the global economy by giving
people more control over their economic lives and
the institutions that govern them. In the hands of
the Wall Street Journal and the Heritage Foundation,
Washington's foremost right-wing think tank, however,
an economic freedom index merely measures corporate
and entrepreneurial freedom from accountability. Upon
examination, the index turns out to be a poor barometer
of either freedom more broadly construed or of prosperity.
The index does not even pretend that its definition
of economic freedom has anything to do with political
freedom. Take the two city-states, Hong Kong and Singapore,
which top the index's list of free countries. Both
are only "partially free" according to Freedom
in the World, an annual country-by-country assessment
published by the nonpartisan think tank Freedom House,
which the Journal's editors themselves have called
"the Michelin Guide to democracy's development."
Hong Kong is still without direct elections for its
legislature or its chief executive, and a proposed
internal security law threatens press and academic
freedom as well as political dissent. In Singapore,
freedom of the press and the right to demonstrate
are limited; films, TV, and other media are censored;
preventive detention is legal; and you can do jail
time for littering.
Moving further down the list of "free" countries,
the rankings are no better correlated with any ordinary
definition of "freedom," as economic journalist
Robert Kuttner pointed out when the index was first
published in 1997. For instance, Bahrain (#20), where
the king holds an effective veto over parliament and
freedom of expression is limited, ranks higher than
Norway (#29), whose comprehensive social insurance
and strong environmental regulation drag down its
score. Likewise, Kuwait, an emirship no one would
term free or democratic, is tied (at #54) with Costa
Rica, long the most vigorous democracy in Latin America.
These results are not surprising, however, given the
index's premise: the less a government intervenes
in the economy, the higher its freedom ranking. Specifically,
the index breaks "economic freedom" down
into 10 components: trade policy; fiscal burden of
government; level of government intervention; monetary
policy; financial liberalization; banking and finance
policies; labor market policies; enforcement of property
rights; business, labor, and environmental regulations;
and size of the black market. In other words, minimum-wage
laws, environmental regulations, or requirements for
transparency in corporate accounting make a country
less free, whereas low business taxes, harsh debtor
laws, and little or no regulation of occupational
health and safety make a country more free.
Consider that the index docks the United States' ranking
for passing Sarbanes-Oxley, a law that seeks to improve
corporate accounting practices and to make CEOs responsible
for their corporations' profit reports. The segment
of the U.S. population whose economic freedom this
law erodes is tiny, but it's obviously that segment-not
workers and not even shareholders-whose freedom counts
for the folks at the Journal and at Heritage.
The rather objective-looking list that results from
assessing the 10 components ranks 155 countries from
freest (Hong Kong and Singapore) to most repressive
(Burma and North Korea). The index then becomes a
tool its authors can use to hammer home their message:
economic freedom (as they define it) brings prosperity.
As they point out, "the freest economies have
a per-capita income more than twice that of the 'mostly
free' and more than four times that of the 'mostly
unfree.'"
Not so fast. For one thing, the index's creators used
some oddball methods that compromise its linkage of
prosperity to economic freedom.
For instance, according to the index, the fiscal burden
of the Swedish and Danish welfare states is smaller
than that of the United States, even though U.S. government
spending is more than 20 percentage points lower relative
to Gross Domestic Product (GDP, or the size of the
economy). This bizarre result comes about because
the index uses the change in government spending,
not its actual level, to calculate fiscal burden.
To measure the tax side of a country's fiscal burden,
the index uses the top rate of the personal and corporate
income taxes-and that's equally misleading. Besides
ignoring the burden of other taxes, these two figures
don't get at effective tax rates, which also depend
on what share of corporate profits and personal income
is actually taxed. On paper, U.S. corporate tax rates
are higher than those in Europe, as the Journal is
quick to point out. But nearly half of U.S. corporate
profits go untaxed. The average rate of taxation on
U.S. corporate profits currently stands at 15%, far
below the top corporate tax rate of 35%. And relative
to GDP, U.S. corporate income taxes are no more than
half those of other OECD countries.
The index's treatment of government intervention is
flawed as well, for it fails to count industrial policy
as a form of intervention. This is a serious mistake:
it means that the index overestimates the degree to
which some of the fastest growing economies of the
last few decades, such as in Taiwan Province of China
and South Korea, relied on the market and underestimates
the positive role that government played in directing
economic development in those countries by guiding
investment and protecting infant industries.
The treatment of informal markets is downright strange.
The index considers a large informal sector to indicate
less economic freedom because government restrictions
must have driven that economic activity underground.
(Of course, you could take the opposite view: since
the informal sector is for the most part unregulated,
countries with larger informal sectors are, by the
index's definition, more free!) But this way of looking
at it biases the index. Developing countries tend
to have large informal sectors while developed economies
usually have small informal sectors. That means the
index systematically lowers the economic freedom index
of developing countries while boosting the scores
of developed countries, thus artificially correlating
income levels with economic freedom. Even right-wing
economist Stefan Karlsson of the libertarian Ludwig
Von Mises Institute has criticized the index on this
point. Thanks in part to this
bias, Estonia, Chile, and Bahrain are the only middle-income
countries to make it into the top 20.
Whatever the biases in the index do to cement a tight
relationship between economic freedom and income,
they can't produce a tight correlation between economic
freedom and growth. The fastest-growing countries
are mostly unfree. Take China, India, and Vietnam,
three of the fastest-growing countries in the world.
They are way down in the rankings, at #112, #118,
and #137 respectively. While all three countries have
adopted market reforms in recent years that have improved
their standing in the index, their trade policies
and regulations remain "repressive." And
there are plenty of relatively slow growers among
the countries high up in the index, including Estonia
(#4), the Journal's poster child for economic freedom.
How free or unfree a country is according to the index
seems to have little to do with how quickly it grows.
An "Economic Freedom Index" that tells us
little about economic growth or political freedom
is a slipshod measure that would seem to have no other
purpose other than to sell the neoliberal policies
that stand in the way of most people gaining control
over their economic lives and obtaining genuine economic
freedom in today's global economy.
Resources
Mary Anastasia O'Grady, "Hail Estonia!"
Wall Street Journal, 1/4/05; The 2005 Index of Economic
Freedom (Heritage Foundation, 2005); "Malaysia
climbs up economic freedom index," The Star Online,
1/25/05; "Freedom & Growth: No Siamese twins,"
The Economic Times, 5/27/02; Robert Kuttner, "A
Weird Set of Values," The American Prospect,12/7/97;
Stefan M. I. Karlsson, "The Failings of the Economic
Freedom Index," (Ludwig Von Mises Institute,
1/21/05); "Freedom in the World 2005: Civic Power
and Electoral Politics," (Freedom House, 2005)
http://www.freedomhouse.org/research/survey2005.htm
* John
Miller teaches economics at Wheaton College and is
a member of theDollars & Sense collective.
This article was originally published
in Dollars & Sense magazine, the magazine of economic
justice; http://www.dollarsandsense.org/
June 8, 2005.
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