Executive Summary
With the publication of this edition, The Heritage Foundation/Wall Street Journal Index of Economic Freedom marks its 13th anniversary. The idea of producing a user-friendly "index of economic freedom" as a tool for policymakers and investors was first discussed at The Heritage Foundation in the late 1980s. The goal then, as it is today, was to develop a systematic, empirical measurement of economic freedom in countries throughout the world. To this end, the decision was made to establish a set of objective economic criteria that, since the inaugural edition in 1995, have been used to study and grade various countries for the annual publication of the Index of Economic Freedom.
Economic theory dating back to the publication of Adam Smith's The Wealth of Nations in 1776 em-phasizes the lesson that basic institutions that protect the liberty of individuals to pursue their own eco-nomic interests result in greater prosperity for the larger society. Perhaps the idea of freedom is too sophis-ticated, as popular support for it constantly erodes before the onslaught of populism, whether democratic or autocratic. Yet modern scholars of political economy are rediscovering the centrality of "free institutions" as fundamental ingredients for rapid long-term growth. In other words, the techniques may be new, but they reaffirm classic truths. The objective of the Index is to catalog those economic institutions in a quantitative and rigorous manner.
Yet the Index is more than a simple ranking based on economic theory and empirical study. It also iden-tifies the variables that comprise economic freedom and analyzes the interaction of freedom with wealth.
The 2007 Index of Economic Freedom measures 157 countries across 10 specific factors of economic freedom, which are listed below. Chapter 3 explains these factors in detail. High scores approaching 100 represent higher levels of freedom. The higher the score on a factor, the lower the level of government in-terference in the economy.
The 10 Economic Freedoms
- Business Freedom
- Trade Freedom
- Fiscal Freedom
- Freedom from Government
- Monetary Freedom
- Investment Freedom
- Financial Freedom
- Property Rights
- Freedom from Corruption
- Labor Freedom
Highlights from the 2007 Index
Global economic freedom holds steady, but there is much room for improvement. The average economic freedom score is 60.6 percent, the second highest level since the Index began in 1995 and down by 0.3 percentage point from last year. Each region has experienced an increase in economic freedom dur-ing the past decade.
Former British colonies in Asia lead the world in economic freedom. Hong Kong has the highest level of economic freedom for the 13th straight year. Singapore remains close, ranked second in the world, and Australia is ranked third freest economy in the world, which means that the Asia–Pacific region is home to the top three economies.
Twelve of the top 20 freest economies are European. A majority of the freest economies are in Europe, led by the United Kingdom, Ireland, Luxembourg, and Switzerland. Only five are in the Asia–Pacific region. The remaining three are from the Americas: the United States, Canada, and Chile.
The methodology for measuring economic freedom is significantly upgraded. The new methodol-ogy uses a scale of 0–100 rather than the 1–5 brackets of previous years when assessing the 10 component economic freedoms, which means that the new overall scores are more refined and therefore more accurate. Second, a new labor freedom factor has been added, and entrepreneurship is being emphasized in the busi-ness freedom factor. Both of these new categories are based on data that became available from the World Bank only recently. This attention to detail benefits some countries and punishes others, and readers may note some dramatic changes in rankings. The methodology has been vetted with a new academic advisory board and should better reflect the details of each country's economic policies. In order to compare country performances from past years accurately, scores and rankings for all previous years dating back to 1995 have been adjusted to reflect the new methodology.
Economic freedom is strongly related to good economic performance. The world's freest countries have twice the average per capita income of the second quintile of countries and over five times the average income of the fifth quintile of countries. The freest economies also have lower rates of unemployment and lower inflation. These relationships hold across each quintile, meaning that every quintile of less free econo-mies has worse average rates of inflation and unemployment than the preceding quintile has.
The top 20 countries have held relatively steady. Even though the methodology used for rating eco-nomic freedom has been revised with this edition of the Index, the composition and order of the top 20 economies have hardly changed at all. Japan and Belgium moved into the top group (compared to the old methodology, not compared to 2006 scores using the new methodology), whereas Austria and Sweden fell to lower positions.
Progress is universal across all continents. Across the five regions, Europe is clearly the most free us-ing an unweighted average (67.5 percent), followed at some distance by the Americas (62.3 percent). The other three regions fall below the world average: Asia–Pacific (59.1 percent), Middle East/North Africa (57.2 percent), and sub-Saharan Africa (54.7 percent). However, trends in freedom are mirrored closely across all regions. The main distinguishing feature of the regions is that Asia–Pacific countries have the highest variance, which means that there is a much wider gap between the heights of freedom in some economies and the lows in others that is nearly twice as variable as the norm.
Of the 157 countries graded numerically in the 2007 Index, only seven have very high freedom scores of 80 percent or more,1making them what we categorize as "free" economies. Another 23 are in the 70 percent range, placing them in the "mostly free" category. This means that less than one-fifth of all countries have economic freedom scores higher than 70 percent. The bulk of countries—107 economies—have freedom scores of 50 percent–70 percent. Half are "moderately free" (scores of 60 percent–70 percent), and half are "mostly unfree" (scores of 50 percent–60 percent). Only 20 countries have "repressed economies" with scores below 50 percent.
The typical country has an economy that is 60.6 percent free, down slightly from 60.9 percent in 2006. This decline is caused primarily by monetary freedom scores, which are 2.6 percentage points lower on average due to slightly more extensive price controls and a mild increase in inflation. Even so, the past scores for these two years produced the overall highest scores ever recorded in the Index, so the overall trend continues to be positive. As noted, although the methodology used for measuring freedom was revised this year, previous scores were also revised to be consistent across time.2
Among specific economies during the past year, the scores of 65 countries are now higher, and the scores of 92 countries are worse.
The variation in freedom among all of these countries declined again for the sixth year in a row, and the standard deviation among scores now stands at 11.4, down one-tenth of a percentage point from last year and down two full points since 1996.3
The Impact of Economic Freedom
There is a clear relationship between economic freedom and numerous other cross-country variables, the most prominent being the strong relationship between the level of freedom and the level of prosperity in a given country. Previous editions of the Index have confirmed the tangible benefits of living in freer socie-ties. Not only is a higher level of economic freedom clearly associated with a higher level of per capita gross domestic product, but those higher GDP growth rates seem to create a virtuous cycle, triggering fur-ther improvements in economic freedom. Our 13 years of Index data strongly suggest that countries that increase their levels of freedom experience faster growth rates.
Chart 4 shows a strong relationship between the level of economic freedom in 2007 and the logarithmic value of the most recent data for per capita GDP using 157 countries as data points.
Charts 5–8 illustrate four different relationships using a quintile framework. The top quintile of coun-tries is composed of those that are ranked from 1 to 31 globally (Hong Kong to the Czech Republic), and each subsequent quintile includes the next group of countries. Quintiles are not the same as categorical groups (free, mostly free, etc.) and are used here because each quintile is comparable based on the same number of countries.
Chart 5 shows that four of five quintiles have roughly equal populations, but the fourth quintile alone contains half of the world's population. This is due to the presence of China and India together. This fact suggests that when China and India further open their economies to globalization so that internal economic freedoms are strengthened, the rise in global prosperity is poised for very large increases.
Chart 6 is another look at the relationship between economic freedom and average per capita incomes. The quintiles with higher economic freedom have dramatically higher incomes per person.
Charts 7 and 8 show that unemployment rates are higher for each quintile of lower economic freedom. Likewise, inflation rates rise on average as economic freedom declines.
he lesson from these charts is simple. Economic repression is a sad consequence of other events. Countries that are able to reflect the desires of their people for better lives will adopt economic freedom, and countries that repress their people for political reasons will cause economic suffering.
In other words, the claim that the suspension of economic freedom is done for the good of the people is no longer tenable.
