The Heritage Foundation has published the 2012 Economic Freedom Index and the results make for interesting reading. For the first time the scores for Chile are higher than both the UK and the US. Chile is placed 7th this year on 78.3 overall points while the US are ranked 10th with 76.3. The UK did not make it into the top 10, sitting in 14th place on 74.1 points. But what does it all mean?
The Economic Freedom Index is an attempt to provide a measurement of economic freedom that is comparable between diverse countries of the world. There are 10 indices nested within four categories:
- Rule of law (property rights, freedom from corruption)
- Limited government (fiscal freedom, government spending)
- Regulatory efficiency (business freedom, labour freedom, monetary freedom)
- Open markets (trade freedom, investment freedom, financial freedom).
The ten indicators for Chile this year are illustrated in the figure below:
This indicator refers to the ease with which businesses can start up and get running, without undue interference from the state. For example, in some countries (e.g. Hong Kong) setting up a licence to run a business can be achieved very quickly by completing a single form. In others, however, the process can be long-winded, taking days or weeks with numerous encounters with bureaucratic officials.
Trade freedom means that an economy is open to imports from around the world and that individuals within a nation can be part of an international marketplace (buying and selling). Trade Freedom is often restricted by taxes and tariffs, therefore the indicator is in part defined by the lack of government involvement in international markets.
This measure captures the extent of freedom allowed by government to businesses and individuals to keep and spend their income as they wish. Control comes not only in the form of income tax and other taxation but also through government debt which must ultimately be paid by individuals through further taxation.
Excessive government spending on projects is thought to ‘crowd out’ the private sector, who could have otherwise have benefitted (and paid tax) from projects, whether they be public works providing infrastructure or funding research. Furthermore, it is argued that isolation from the private sector may increase bureacracy and waste, and reduce efficiency.
Monetary Freedom concerns the government’s monetary policy in terms of inflation and stability. It is thought that low inflation is preferred along with an independent central bank. With low inflation, investments and savings can be made more confidently. In addition, inflationary prices act as an invisible tax stealing wealth.
When investment is free and open, domestic and international entrepreneurial opportunites are increased, raising the likilihood of job creation and economic expansion. In theory, such investment should benefit society at large and not just individuals.
Financial Freedom refers to the freedom given by the state to banking and financial services. Regulation that goes beyond transparency and honesty is likely to reduce efficiency and limit competition. For example, if government intervenes in the stock market, capital prices can be biased distorting the true market-driven value of products.
Acquiring property and wealth is thought to be central to a healthy market economy. Property rights (including intellectual property) that are secure and protected by law allow individuals to be confident in saving, making long-term plans and engage in entrepreneurial activity.
Freedom from Corruption
This indicator is defined as ‘dishonesty or decay’, or more fully, “a distortion by which individuals are able to gain personally at the expense of the whole.” Specific examples of political corruption include: bribery, extortion, nepotism, cronyism, patronage, embezzlement and graft (profiting from public funds).
By Labour Freedom the Index means the ability of individals to work as much as the want and of businesses to contract labour freely and to dismiss redundant workers when they are not required. It is suggested that trade unions may either incease freedom or an impediment to “efficient functioning” or labour markets but that with more freedom comes lower unemployment rates.
In other words it is a ‘capitalism index’. The extent to which free markets operate in a country and how flexible governments are towards international investors and entrepreneurs. While investment in a country from overseas may benefit society at large due to job creation and increased revenue from taxation, it is unclear whether or not all will benefit from such freedoms. If workers are unprotected by unions and left open to the prospect of redundancy or forced onto short-term contract work, then as consumers, savers and investors in the property market and particpants in entrepreneurial activity, confidence is likely to be low and therefore such stabilising action will be low. Similarly, with Government spending, although there is evidence that through competition and the drive for profit, private companies often outperform their public sector counterparts, increased profit may not be the ultimate driver for a country; relying solely on such a motivation could be short-sighted. It may not even make economic sense. A case in point is copper mining in Chile. Although private mining tends to be more efficient than public, public ownership brings with it the benefit of keeping 100% of the profit in the coffers, rather than income from taxation only. Clearly, indicators such as Freedom from Corruption can be universally beneficial. Business Freedom also makes a lot of sense, as bureaucratic red-tape can tie up potential investors that could bring innnovation and job creation to a nation. While economic freedom is desirable in open and free societies, it should be granted primarily with the benefit of individuals within the country itself (particularly the poor and vulnerable) firmly in mind and not at their expense. So while the high scores achieved by Chile in economic freedom are encouraging, it will be sad to see a rampant form of capitalism undo the country’s fabric…