Economic Freedom of the World 2013 Annual ReportThe index published in Economic Freedom of the World measures the degree to whichthe policies and institutions of countries are supportive of economic freedom. Thecornerstones of economic freedom are personal choice, voluntary exchange, freedomto compete, and security of privately owned property. Forty-two variables areused to construct a summary index and to measure the degree of economic freedomin five broad areas:1 Size of Government;2 Legal System and Property Rights;3 Sound Money;4 Freedom to Trade Internationally;5 Regulation.Since our first publication in 1996, numerous studies have used the data publishedin Economic Freedom of the World to examine the impact of economic freedomon investment, economic growth, income levels, and poverty rates. Virtuallywithout exception, these studies have found that countries with institutions andpolicies more consistent with economic freedom have higher investment rates,more rapid economic growth, higher income levels, and a more rapid reductionin poverty rates.The EFW index now covers 152 countries and territories. Data are available forapproximately 100 nations and territories back to 1980, and many back to 1970.This data set makes it possible for scholars to analyze the impact of both cross-countrydifferences in economic freedom and changes in that freedom across a three-decadetime frame.Frazer InstituteFI_b100f5a6-4c6d-11e2-8135-c0ec52c8e326James GwartneyAuthorRobert LawsonAuthor Joshua HallAuthorCountriesCountries included -- There are 152 countries included in this year’s index, up from 144 last year. Thenew countries added to the index (with data for both 2010 and 2011) are BruneiDarussalam, Cape Verde, The Gambia, Lebanon, Suriname, Swaziland, Tajikistan,Timor-Leste, and Yemen. Because of the civil war and the unreliability of the datasince 2011, the rating for Syria has been temporarily suspended, though historicaldata are included in Chapter 2: Country Data Tables.To measure the degree to which the policies and institutions of countries are supportive of economic freedom.Economic FreedomThe cornerstones of economic freedom are personal choice, voluntary exchange, freedom to compete, and security of privately owned property.Personal ChoiceVoluntary ExchangeFreedom to CompeteSecurity of Privately Owned PropertySize of GovernmentMeasure the degree to which a country relies on personal choice and markets rather than government budgets and political decision-making.Area 1The four components of Area 1 indicate the extent to which countries rely on thepolitical process to allocate resources and goods and services. When governmentspending increases relative to spending by individuals, households, and businesses, government decision-making is substituted for personal choice and economic freedom is reduced. The first two components address this issue. Government consumption as a share of total consumption (1A) and transfers and subsidies as a share of GDP (1B) are indicators of the size of government. When government consumptionis a larger share of the total, political choice is substituted for personal choice.Similarly, when governments tax some people in order to provide transfers to others, they reduce the freedom of individuals to keep what they earn.The third component (1C) in this area measures the extent to which countriesuse private investment and enterprises rather than government investment andfirms to direct resources. Governments and state-owned enterprises play by rulesthat are different from those to which private enterprises are subject. They are notdependent on consumers for their revenue or on investors for capital. They oftenoperate in protected markets. Thus, economic freedom is reduced as governmententerprises produce a larger share of total output. The fourth component (1D) is based on (1Di) the top marginal income tax rate and (1Dii) the top marginal income and payroll tax rate and the income threshold at which these rates begin to apply. These two sub-components are averaged to calculate the top marginal tax rate (1D). High marginal tax rates that apply at relatively low income levels are also indicative of reliance upon government. Such rates deny individuals the fruits of their labor. Thus, countries with high marginal tax rates and low income thresholds are rated lower...Taken together, the four components of Area 1 measure the degree to whicha country relies on personal choice and markets rather than government budgetsand political decision-making. Therefore, countries with low levels of governmentspending as a share of the total, a smaller government enterprise sector, and lowermarginal tax rates earn the highest ratings in this area.Government Consumption1ATransfers and subsidies1B Government enterprises and investment1C Top marginal income tax rate1Di Top marginal income and payroll tax rate1Dii Top marginal tax rate1DSize of Government1 Legal System & Property RightsProtect persons and their rightfully acquired property. Area 2Protection of persons and their rightfully acquired property is a central elementof economic freedom and a civil society. Indeed, it is the most important functionof government. Area 2 focuses on this issue. The key ingredients of a legal systemconsistent with economic freedom are rule of law, security of property rights, anindependent and unbiased judiciary, and impartial and effective enforcement ofthe law. The nine components in this area are indicators of how effectively the protective functions of government are performed. These components are from three primary sources: the International Country Risk Guide, the Global Competitiveness Report, and the World Bank’s Doing Business project.Security of property rights, protected by the rule of law, provides the foundationfor both economic freedom and the efficient operation of markets. Freedomto exchange, for example, is meaningless if individuals do not have secure rights toproperty, including the fruits of their labor. When individuals and businesses lackconfidence that contracts will be enforced and the fruits of their productive effortsprotected, their incentive to engage in productive activity is eroded. Perhaps morethan any other area, this area is essential for the efficient allocation of resources.Countries with major deficiencies in this area are unlikely to prosper regardless oftheir policies in the other four areas.Judicial independence2AImpartial courts2B Protection of property rights2CMilitary interference in rule of law and politics2D Integrity of the legal system2E Legal enforcement of contracts2F Regulatory restrictions on the sale of real property2G Reliability of police2H Business costs of crime2I Legal Structure and Property Rights2 Sound MoneyArea 3Money oils the wheels of exchange. An absence of sound money undermines gains from trade. As Milton Friedman informed us long ago, inflation is a monetary phenomenon, caused by too much money chasing too few goods. High rates of monetary growth invariably lead to inflation. Similarly, when the rate of inflation increases, it also tends to become more volatile. High and volatile rates of inflation distort relative prices, alter the fundamental terms of long-term contracts, and make it virtually impossible for individuals and businesses to plan sensibly for the future. Sound money is essential to protect property rights and, thus, economic freedom. Inflation erodes the value of property held in monetary instruments. When governments finance their expenditures by creating money, in effect, they are expropriating the property and violating the economic freedom of their citizens.The important thing is that individuals have access to sound money: who providesit makes little difference. Thus, in addition to data on a country’s inflation andits government’s monetary policy, it is important to consider how difficult it is touse alternative, more credible, currencies. If bankers can offer saving and checkingaccounts in other currencies or if citizens can open foreign bank accounts, thenaccess to sound money is increased and economic freedom expanded.There are four components to the EFW index in Area 3. All of them are objectiveand relatively easy to obtain and all have been included in the earlier editionsof the index. The first three are designed to measure the consistency of monetarypolicy (or institutions) with long-term price stability. Component 3D is designed tomeasure the ease with which other currencies can be used via domestic and foreign bank accounts. In order to earn a high rating in this area, a country must follow policies and adopt institutions that lead to low (and stable) rates of inflation and avoid regulations that limit the ability to use alternative currencies.Money growth3AStandard deviation of inflation3B Inflation: Most recent year3C Freedom to own foreign currency bank accounts3D Sound Money3 TradeFreedom to trade internationallyArea 4In our modern world of high technology and low costs for communication andtransportation, freedom of exchange across national boundaries is a key ingredientof economic freedom. Many goods and services are now either produced abroador contain resources supplied from abroad. Voluntary exchange is a positive-sumactivity: both trading partners gain and the pursuit of the gain provides the motivation for the exchange. Thus, freedom to trade internationally also contributes substantially to our modern living standards. At the urging of protectionist critics and special-interest groups, virtually all countries adopt trade restrictions of various types. Tariffs and quotas are obvious examples of roadblocks that limit international trade. Because they reduce the convertibility of currencies, controls on the exchange rate also hinder international trade. The volume of trade is also reduced if the passage of goods through customs is onerous and time consuming. Sometimes these delays are the result of administrative inefficiency while in other instances they reflect the actions of corrupt officials seeking to extract bribes. In both cases, economic freedom is reduced. The components in this area are designed to measure a wide variety of restraints that affect international exchange: tariffs, quotas, hidden administrative restraints, and controls on exchange rates and capital. In order to get a high rating in this area, a country must have low tariffs, easy clearance and efficient administration of customs, a freely convertible currency, and few controls on the movement of physical and human capital.Revenue from trade taxes (% of trade sector)4AiMean tariff rate4Aii Standard deviation of tariff rates4Aiii Tariffs4ANon-tariff trade barriers4Bi Compliance costs of importing and exporting4Bii Regulatory trade barriers4B Black market exchange rates4C Foreign ownership/investment restrictions4Di Capital controls4Dii Freedom of foreigners to visit4Diii Controls of the movement of capital and people4D Freedom to trade internationally4 RegulationArea 5When regulations restrict entry into markets and interfere with the freedom toengage in voluntary exchange, they reduce economic freedom. The fifth area of theindex focuses on regulatory restraints that limit the freedom of exchange in credit,labor, and product markets. The first component (5A) reflects conditions in thedomestic credit market. One sub-component provides evidence on the extent towhich the banking industry is privately owned. The final two sub-components indicate the extent to which credit is supplied to the private sector and whether controls on interest rates interfere with the market in credit. Countries that use a private banking system to allocate credit to private parties and refrain from controlling interest rates receive higher ratings for this regulatory component.Many types of labor-market regulations infringe on the economic freedom ofemployees and employers. Among the more prominent are minimum wages, dismissal regulations, centralized wage setting, extension of union contracts to nonparticipating parties, and conscription. The labor-market component (5B) isdesigned to measure the extent to which these restraints upon economic freedomare present. In order to earn high marks in the component rating regulation of thelabor market, a country must allow market forces to determine wages and establishthe conditions of hiring and firing, and refrain from the use of conscription.Like the regulation of credit and labor markets, the regulation of business activities(component 5C) inhibits economic freedom. The sub-components of 5C aredesigned to identify the extent to which regulations and bureaucratic procedures restrain entry and reduce competition. In order to score high in this portion of theindex, countries and territories must allow markets to determine prices and refrainfrom regulatory activities that retard entry into business and increase the cost ofproducing products. They also must refrain from “playing favorites”, that is, fromusing their power to extract financial payments and reward some businesses at theexpense of others.Ownership of banks5Ai Private sector credit5Aii Interest rate controls/negative real interest rates)5Aiii Credit market regulations5A Hiring regulations and minimum wage5Bi Hiring and firing regulations5Bii Centralized collective bargaining5Biii Hours Regulations5Biv Mandated cost of worker dismissal5Bv Conscription5Bvi Labor market regulations5B Administrative requirements5Ci Bureaucracy costs5Cii Starting a business5Ciii Extra payments/bribes/favoritism5Civ Licensing restrictions5Cv Cost of tax compliance5Cvi Business regulations5C Regulation5 SUMMARY INDEXConstruction of Area and Summary ratings -- Theory provides us with some direction regarding elements that should be includedin the five areas and the summary index, but it does not indicate what weightsshould be attached to the components within the areas or among the areas in theconstruction of the summary index. It would be nice if these factors were independent of each other and a weight could be attached to each of them. In the past, we investigated several methods of weighting the various components, including principle component analysis and a survey of economists. We have also invited others to use their own weighting structure if they believe that it is preferable. Our experience indicates that the summary index is not very sensitive to alternative weighting methods. Furthermore, there is reason to question whether the areas (and components) are independent or work together like the wheels, motor, transmission, driveshaft, and frame of a car. Just as it is these interconnected parts that provide the mobility of an automobile, it may be the combination of interrelated factors that brings about economic freedom. Which is more important for the mobility of an automobile: the motor, wheels, or transmission? The question cannot be easily answered because the parts work together. If any of these key parts break down, the car is immobile.Institutional quality may be much the same. If any of the key parts are absent, theoverall effectiveness is undermined.As the result of these two considerations, we organize the elements of the indexin a manner that seems sensible to us but we make no attempt to weight the components in any special way when deriving either area or summary ratings. Of course, the component and sub-component data are available to researchers who would like to consider alternative weighting schemes and we encourage them to do so.2013-09-28http://www.freetheworld.com/release.htmlOwenAmburOwen.Ambur@verizon.net