By Matt Kelly
Defining freedom can be a difficult endeavor, yet the ability to compare relative economic and social liberties among countries is of significant importance for economic research. With that aim in mind, Florida State University professor and DeVoe Moore scholar James Gwartney and Robert Lawson of Southern Methodist University, have compiled the Economic Freedom of the World Index since 1996. The authors admit that quantifying an abstract idea like freedom has its limitations, but the index has greatly enhanced academic understanding of the relationship between liberty and economic performance.
The Economic Freedom of the World (EFW) Index is made up of 42 distinct variables, which can be grouped into 5 basic categories: (1) size of government in terms of expenditures, taxes, and enterprises, (2) legal structure and security of property rights, (3) access to sound money, (4) freedom to trade internationally, and (5) regulation of credit, labor, and business. Variables include the length of time needed to start a business, restrictions on international trade, government spending levels, military interference in economic and civil matters, inflation, and a host of other factors. These values are added up to compute a country’s ranking on the EFW index.
Hong Kong and Singapore are tied for the top 2012 ranking, while the United States has lagged behind in recent years (and is currently ranked 12th). The 2014 report attributes the relatively poor performance by the U.S. to “the increased use of eminent domain to transfer property to powerful political interests, the ramifications of the wars on terrorism and drugs, and the violation of the property rights of bondholders in the auto-bailout case have weakened the tradition of strong adherence to the rule of law in United States.” These are worrying trends for the U.S., the overall growth in economic freedom across the globe is also something to celebrate. Measured on a 10-point scale, the overall average has risen from 5.32 in 1980 to 6.84 in 2012.
A higher EFW ranking is associated with greater social well-being. For instance, the average income for a country’s poorest 10% of its population reached $11,610 for countries in the top quartile of the EFW. In contrast, the bottom quartile (25%) in the least free countries earned an average of $1,358 (dollar figures are calculated using purchasing power parity and in constant 2011 US$). Perhaps most strikingly, life expectancy is 79.9 years in the top quartile of the EFW compared to 63.2 years in the bottom quartile.
Numerous academic studies have used EFW data to explain how economic performance is affected by government institutions. A 2006 paper by Gwartney, Holcombe, and Lawson indicates that a one-point decline in the EFW rating is associated with a reduction in the long-term GDP growth of between 1.0 and 1.5 percentage points annually.
Others have used it to explain the relative successes of reform and revolutionary movements throughout the world, as with a more recent paper by Fred McMahon on the Arab Spring. Although a period of “phony reform” during the late 20th century nocently discredited the idea of free markets for many in the Middle East, the region’s average EFW rating ticked upward slightly in 2012. Though many cards are stacked against them (violence, clientelist governments, sectarianism), the higher EFW is a positive sign.
Gwartney and Lawson maintain that their EFW index doesn’t encompass everything there is to know about economic growth, which is also influenced by demographics, innovation, and access to natural resources among other factors. Yet, their index and the research inspired by it suggests government institutions matter tremendously. The index provides valuable insight into the nature and characteristics of market-oriented economies and those dominated by government regulation and planning.