Every year, the Wall Street Journal and Heritage Foundation bring out a book called The Index of Economic Freedom, the centerpiece of which is an index ranking countries by the extent of freedom in 10 economic dimensions. Not all will agree with this definition of freedom: Janis Joplin declared, famously, that freedom’s just another word for nothing left to lose. But the index does provide a rough and ready measure of controls and tax rates.
The authors claim, as always, that the index proves that laissez faire is the proven path to prosperity. The freest economies have a per capita income of $ 29,219, more than twice that of the “most free” category and more than four times that of the “mostly unfree” category. That is a major broad-brush lesson.
Yet the authors exaggerate grossly in claiming that “misery has a cure, and its name is economic freedom.” The index itself shows that the fastest growing countries are (and have long been) mostly unfree.
China, the miracle economy of the last two decades, ranks 112 out of 155 rated countries. It has moved up 16 places in 2005. Yet its low position after 25 years of Dengist reform shows that relative unfreedom can produce the fastest growth rate in history.
Vietnam enjoyed average GNP growth of 7.9% in 1990-2000, the second highest in the world. This sterling performer comes 137th .
The countries of the sub-continent have done well in recent years, growing at 5-7%, yet come in “mostly unfree” category. India has been growing at around 6% annually. Sri Lanka and Bangladesh have achieved around 5% annually. Pakistan is back to 5-6% growth after a difficult time in the 1990s. Yet the index ranks Sri Lanka at 79, India at 112, Pakistan and 133 and Bangladesh at 141 (second last among the mostly unfree countries).
So, this part of the Index could be used by left-wingers to claim that prosperity lies in being mostly unfree! That, of course, would be an equally unwarranted conclusion. Hong Kong and Singapore continue to be at the top of the list. These are developing countries that have become the richest in the world. They have done so by creating open economies with low taxation and strong property rights. This is the most devastating possible demolition of the left-wing argument that an economic freedom is a trap set by white imperialists to dominate the world. o too is the fact is that a splinter of the former Soviet Union, Estonia, has shot up into fourth position (it has zero tax on reinvested FDI profits).
The Index also drives home the point that the USA is not exactly the land of the Free, having slipped from 5th position in 1998 to 12th today. Its corporate tax is high by world standards, and it ranks112 in this respect.
That can we make of this very mixed bag of messages? Mainly that the world is a complex place where there are many paths to success and failure. Economic freedom by itself does not tell you enough. Hong Kong is top of the list, but public spending accounts for half its housing and most of its education, and a good chunk of its infrastructure. Its tax rates are very low mainly because the government owns most of the land and makes millions through land sales. Singapore has focused on attracting foreign investment, and the biggest locally-owned companies are public sector giants providing infrastructure very efficiently. These two most free countries actually run on the basis of excellent public-private sector partnerships, not pure laissez faire.
The Index shows that economic freedom matters hugely in the long run, and that all successful countries becoming more free. But the process need not be radical. You can go down the radical Estonia path or the gradualist Vietnam path, and both can produce good results. Ultimately, specific institutions and mind-sets in each country matter more than simple IMF-World Bank rules. No index or formula can capture the complexities that determine success.
Third, the political economy of small countries seems very different from that of large ones. Small countries know they cannot aim for self-sufficiency or create national champions behind protectionist barriers. They tend to be countries where lobbies for trade, banking and shipping are more powerful than for industry, and this facilitates an open economy. They see foreign investment as a fertilizer for growth, not an instrument of foreign domination.
So it is no surprise that the six freest economies (as measured by the Index) are all small countries–Hong Kong, Singapore, Luxemburg, Estonia, Ireland and New Zealand. By contrast, large countries tend to have industrial and agricultural lobbies equating protectionism with patriotism. Their internal trade greatly exceeds external trade, so they entertain delusions about self sufficiency (forget developing economies, several US Presidents have talked nonsense about independence from OPEC in energy).The mind-set created by such institutions makes it impossible to move rapidly towards economic freedom.
The most successful ones are moving gradually towards freedom. But a quantum jump to the top of the Index is politically impossible, and not essential either. For success, the direction of economic freedom seems more important than its absolute level. We need not (and cannot) become clones of Singapore or Estonia.
Index of Economic Freedom: 2005
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The ten dimensions are trade policy, fiscal burden, government intervention, monetary policy, foreign investment, banking and finance, wages and prices, property rights, regulation, and informal markets.