U.S. Falls out of the Index of Economic Freedom's Top 10

WASHINGTON, JAN. 4, 2005—For the first time ever, the United States does not rank among the world’s 10 freest economies in the Index of Economic Freedom, published annually by The Heritage Foundation and The Wall Street Journal.

The United States’ score in the 2005 Index, did not change from 2004. But improvements in the economies of Chile, Australia and Iceland enabled all three to surpass the United States, leaving it in a tie for 12th with Switzerland and out of the top 10 for the first time in the 11-year history of the Index.

“The United States is resting on its laurels while innovative countries around the world are changing their approaches and reducing their roadblocks,” said Marc Miles, a co-editor of the book, along with Ed Feulner and Mary Anastasia O’Grady. “The U.S. is eating the dust of countries that have thrown off the 20th-century shackles of big government spending and massive federal programs.”

As in previous years, the Index ratings reflect an analysis of 50 different economic variables, grouped into 10 categories: banking and finance; capital flows and foreign investment; monetary policy; fiscal burden of government; trade policy; wages and prices; government intervention in the economy; property rights; regulation; and informal (or black) market activity. Countries are rated one to five in each category, one being the best and five the worst. These ratings are then averaged to produce the overall Index score. Worldwide, the scores of 86 countries improved, the scores of 57 declined and the scores of 12 are unchanged from last year’s Index The United States recorded an overall score of 1.85 for the second consecutive year, making it one of 17 countries rated as having “free” economies. Another 56 countries finished between 2.0 and 3.0 and are considered “mostly free,” 70 finished between 3.0 and 4.0 and received a “mostly unfree” rating, and 12 were considered “repressed.”

With top scores in property rights, banking/finance and monetary policy, the United States is still a vibrant and dynamic economy, the editors note. But a 4.0 rating in fiscal burden of government, which ranks worse than all but 30 countries in the survey, held it back. This reflects poor scores in the area of taxation. The U.S. corporate tax rate ranks 112th out of the 155 countries scored, and its top individual tax rate ranks an only somewhat better 82nd. The fiscal burden rating also reflects the fact that federal spending has reached levels not seen since World War II and now costs the average household more than $20,000 per year. This is the 11th consecutive year The Heritage Foundation and The Wall Street Journal have published the Index. Marc Miles is director of Heritage’s Center for International Trade and Economics, Ed Feulner is Heritage’s president, and Mary O’Grady edits the “Americas” column and is a senior editorial page writer at the Journal.

Print versions of the 2005 Index of Economic Freedom (414 pp., $24.95) can be ordered by calling 1-800-975-8625 and are available in English or Spanish. Additionally, the full text, along with all charts and graphs, will be available via the Internet at heritage.org/index.

US Summary

The U.S. Constitution provides strong protections for private property, and the vibrancy and dynamism of the U.S. economy are testimony to these constitutionally protected economic liberties. In the post–World War II period, the United States generally took a strong leadership position in expanding global trade through lower tariff barriers. In the 1980s, economic growth reflected deregulation and tax cuts. In the 1990s, a stable monetary policy and a wave of technological innovation, buttressed by strong protection of intellectual property rights, continued the growth trend. The 2001 recession that interrupted the trend is over, and the economy is again strong with improving job growth. The Administration of George W. Bush has continued America’s leadership role in free trade with signed free trade agreements with both Singapore and Chile, approved agreements with Australia and Morocco, pending agreements with Bahrain and Central America, and ongoing negotiations with other countries throughout the world. Government spending, however, expands without constraints. The massive farm subsidies of 2002 were followed by the massive Medicare prescription entitlement of 2003. Increased regulatory laws in the securities field have raised compliance costs in capital markets, forcing some firms simply to buy back their stock and retreat from public markets. Anti-dumping trade barriers are growing, and inflation rose following the steep plunge in the dollar. In short, the United States, while still a vibrant country, is at a crossroads: It will either continue to be a leader in economic freedom or idly watch other countries pass it by. The United States’ overall score is unchanged this year.

Trade Policy

Score:2.0

The World Bank reports that the United States’ weighted average tariff rate in 2002 (the most recent year for which World Bank data are available) was 2.6 percent. According to the Economist Intelligence Unit, the government imposes non-tariff barriers, including quotas, tariff rate import quotas, anti-dumping provisions, countervailing duties, and licensing requirements, on a number of goods.

Fiscal Burden

Score:4.0

The United States’ top federal income tax rate is 35 percent. The top corporate tax rate is 35 percent. Government expenditures as a share of GDP increased less in 2003 (0.4 percentage point to 35.9 percent) than they did in 2002 (0.7 percentage point). On net, the United States’ fiscal burden of government score is unchanged this year.

Government Intervention

Score:2.0

Based on data from the Organisation for Economic Co-operation and Development, the government consumed 15.5 percent of GDP in 2003. In 2002, according to the International Monetary Fund, the United States received 3.04 percent of its total revenues from state-owned enterprises and government ownership of property.

Monetary Policy

Score:1.0

From 1994 to 2003, the United States’ weighted average annual rate of inflation was 2.19 percent.

Foreign Investment

Score:2.0

The United States welcomes foreign investment. Foreign and domestic enterprises are treated equally under the law, foreign investors are not required to register with or seek approval from the federal government, and there are no local content requirements or ownership restrictions on most industries. According to the Economist Intelligence Unit, however, “Foreign investments face restrictions in banking, mining, defence contracting, certain energy-related industries, fishing, shipping, communications and aviation.” The government also restricts foreign acquisitions that threaten to impair national security. Restrictions on financial transactions with Cuba and Cuban nationals, Burma, Iran, Iraq, Sudan, the Taliban, specified terrorist groups, and specified drug traffickers are strict and enforced. There are no controls or requirements on current transfers, access to foreign exchange, or repatriation of profits. Purchase of real estate is unrestricted on a national level, although purchase of agricultural land by foreign nationals or companies with at least 10 percent foreign ownership must be reported to the U.S. Department of Agriculture; some states impose restrictions on purchases of land and other types of investments by foreign companies.

Banking and Finance

Score:1.0

Federal and state governments share regulatory responsibility for banks. In recent years, there has been substantial deregulation of banking. Reform of the Glass–Steagall Act and the 1956 Bank Holding Company Act in 1999 eliminated barriers to entry into U.S. financial markets and removed prohibitions against the purchase of banks by insurance and securities companies. This has facilitated both the creation of universal financial services companies and the competitiveness of U.S. banking, as well as further consolidation of the financial services industry, enabling U.S. firms to compete more effectively in global markets. A troubling development during the 1990s was the growing nationalization of mortgage risk through the growth of government-sponsored enterprises focused on housing finance. However, the overall trend in financial services is toward more competition and continued product innovation. The Economist Intelligence Unit reports that the number of banking institutions has fallen from 14,300 in 1984 to 7,930 banks today. Foreign banking and securities firms generally compete on an equal footing with domestic firms.

Wages and Prices

Score:2.0

Overall, the market sets wages and prices. According to the Economist Intelligence Unit, “Price controls apply to some regulated monopolies in the United States (like utilities and the postal service), and certain states and localities control residential rents. The most recent imposition of price restrictions was approved in May 2002, when the state legislature of Hawaii approved price caps on petrol prices, which have historically been higher than in any other US state.” The federal government continues to influence prices on some goods and services by purchasing excess production and manipulating prices through subsidies to companies like Amtrak. The government also influences prices of some dairy products by subsidizing dairy farmers. Under the Farm Security and Rural Investment Act of 2002, agricultural spending and subsidies will rise by more than 80 percent (from $100 billion to $180 billion) over the next 10 years, with subsidies for corn, soybeans, wheat, rice, and cotton increasing by 70 percent. While these subsidy amounts are immense, so is the U.S. agricultural sector (and the economy in general, of which agriculture accounts for only 2 percent), and this reduces the overall impact of agricultural subsidies on prices. The federal government imposes a minimum wage.

Property Rights

Score:1.0

The United States does very well in most measures of property rights protection, including an independent judiciary, a sound commercial code and other laws for the resolution of property disputes between private parties, and the recognition of foreign arbitration and court rulings. However, the concerns outlined in recent years linger. Uncompensated government expropriations of property remain highly unlikely, but local governments’ abuse of eminent domain power with the seizure of private land (with some compensation) and its transfer to another party for a non-public or quasi-public use has become more common—despite some successful legal challenges to that practice. An even more serious problem is that governments at all levels impose numerous regulatory and land-use controls that diminish the value and enjoyment of private property. Examples include extensive “growth controls”; unreasonable zoning hurdles; facility permitting regimes; and far-reaching environmental, wetlands, and habitat restrictions on the use and development of real estate. Thus, the protections for private property are undermined by a vast bureaucracy that has the power to interfere substantially with many property rights. The level of protection for property in the United States will depend eventually on whether the courts and legislative bodies place clear limits on bureaucratic power or require cost-effective remedies for property owners whose rights have been affected. The Supreme Court’s performance in such government “takings” cases has been decidedly mixed in recent years. The past year was a disappointment, with the Court declining to hear any important case, including three cases challenging the constitutional scope of the national wetlands regulations.

Regulation

Score:2.0

Establishing a business is easy. “Through a fairly simple procedure,” reports the Economist Intelligence Unit, a firm “can then set up offices, plants or other permanent establishments under the corporation laws of other states…. Firms may choose a location on the basis of which state’s laws offer greater flexibility.” The U.S. labor market is one of the world’s most flexible. Regulations are applied evenly and consistently. However, many regulations—for example, the Americans with Disabilities Act, various civil rights regulations, environmental laws, health and product safety standards, and food and drug labeling requirements—although well-intentioned, can be onerous. According to the Financial Times, a recent survey reveals that the new regulations for corporate governance under the 2002 Sarbanes–Oxley Act increase companies’ “average cost of being public…[by] 130 percent….” Electronic commerce is minimally regulated. By global standards, the level of regulation in the United States is low.

Informal Market

Score:1.5

Transparency International’s 2003 score for the United States is 7.5. Therefore, the United States’ informal market score is 1.5 this year.

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