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.