Global economic freedom has declined over the past year according to the 2012 Index of Economic Freedom. The tension between government control and the free market has heightened around the world, particularly in developed countries. Eroding hard-earned gains in economic freedom in years past, the mounting burden of reckless government spending in many cases has overwhelmed gains in economic freedom achieved in other policy areas.
The 2012 Index, the 18th edition, analyzes economic policy developments in 184 countries since the second half of 2010. Somalia, though not formally graded, returns to the Index for the first time since the 2001 Index. Countries are graded and ranked on 10 measures of economic freedom that evaluate the rule of law, the intrusiveness of government, regulatory efficiency, and the openness of markets.
Highlights from the 2012 Index
Rapid expansion of government, more than any market factor, appears to be responsible for flagging economic dynamism. Government spending has not only failed to arrest the economic crisis, but also—in many countries—seems to be prolonging it. The big-government approach has led to bloated public debt, turning an economic slowdown into a fiscal crisis with economic stagnation fueling long-term unemployment. For governments that increasingly are constrained by budget deficits and rising debt, the disconnect between past promises and the capability to fulfill them, and between financial assets and liabilities, has become difficult to ignore. A fundamental rethinking of the social contract, the basic and proper relationship between government and citizen, has become not just an academic exercise, but a political debate that in some countries has spilled into the streets.
The steady progress in global economic freedom documented by the Index until 2008 has not resumed. The global average economic freedom score in the 2012 Index is 59.5, a 0.2 point decline from last year and matching the second lowest level in the past 10 years. (See Chart 1.) Renewed economic uncertainty and stagnation caused by the sovereign debt turmoil in some key developed economies have battered world economic progress. Unquestionably, the policy choices made at this juncture—which involve the overriding question of whether there will be more freedom or less—will be vital in determining levels of future prosperity.
Chile and Mauritius advanced into the top 10 in the rankings in the 2012 Index, reflecting notable advances in their economic freedom scores. Chile is returning to the top 10, where it last appeared in 2010. For Mauritius, it is the first time in the top 10 and the first time ever that a Sub-Saharan African country has been so highly ranked. Ireland and the U.S. lost ground, slipping to the 9th and the 10th spots, respectively. Despite its high regulatory efficiency and strong rule of law, Denmark fell out of the top 10 altogether because of huge government spending equivalent to almost 60 percent of total domestic output and a high corresponding tax burden. Bahrain dropped from the top 10 as a result of worsening scores for corruption, property rights, and government spending.
Every region continues to be represented by at least one of the top 20 freest economies. Nine of these elite economies are in Europe, led by Switzerland, Ireland, and Denmark. Six are in the Asia–Pacific region. Replacing Japan, Taiwan has joined the top 20 as the world’s 18th freest economy. Canada and the U.S. represent North America. The other regions are represented by one country each: Chile (South and Central America/Caribbean region); Mauritius (Sub-Saharan Africa region); and Bahrain (Middle East and North Africa region).
The scores of 75 economies improved, but 90 countries lost economic freedom, and 14 showed no change. Of the 75 economies whose scores improved, 73 are considered developing or emerging countries. Many are in the Asia–Pacific, Sub-Saharan Africa, and South and Central America/Caribbean regions. Australia and Iceland are the only two developed countries that recorded score improvements in the 2012 Index, partly due to their efforts to bring government spending under control.
Economic freedom continued to advance in the Sub-Saharan Africa and Asia–Pacific regions. Led by Guinea–Bissau, Rwanda, Liberia, and Zimbabwe, Sub-Saharan African had the largest gains on average in the Index. In the Asia–Pacific region, Mongolia, Kazakhstan, and Taiwan led the way in enhancing economic freedom.
Four Asia–Pacific economies and Switzerland earned designation as truly “free” economies for the 2012 Index. Each achieved a score above 80 on the grading scale. Hong Kong successfully defended its status as the world’s freest economy for a remarkable 18th year in a row. Singapore remains the world’s second freest economy and closed the gap with Hong Kong a bit as a result of advances in financial freedom. Australia, New Zealand, and Switzerland maintained their previous standings of 3rd, 4th, and 5th, respectively. These five free economies’ relative strength is no accident. Their continuing commitment to rule of law, limited government, regulatory efficiency, and open markets has been the source of impressive resilience during uncertain economic times.
Greater Economic Freedom: The Imperative for Growth and Progress
The overarching objective of economic policies must be to create an environment that provides the best chance for sustained economic growth, rising incomes, and improvements in overall well-being. The broad consensus, supported by volumes of research, is that vibrant and lasting economic growth is achievable only when governments adopt economic policies that increase individual choice and opportunity, empowering and encouraging entrepreneurship.
The Index results, when compared with data about changes in economic and social conditions in societies around the world, provide strong empirical evidence that the free-market system remains not only viable—with the value of its core features such as private property rights, openness, and flexibility almost unquestioned—but uniquely able to promote economic dynamism and long-term prosperity.
The positive relationship between economic freedom and prosperity has been confirmed yet again in the 2012 Index. GDP per capita is much higher in countries with greater economic freedom. Chart 2 shows a strong positive relationship between the level of economic freedom and GDP per capita.
While much of the world has progressed toward greater economic freedom and higher prosperity in recent decades, a significant proportion of the world’s population lives in countries where economic freedom and opportunity are restrained. As seen in Chart 3, almost three-quarters of the world’s people live in countries that are “mostly unfree” or “repressed” (economic freedom scores of less than 60). Much of that 75 percent comes from just two countries, India and China.
Higher economic freedom is strongly correlated with successful elimination of poverty. Chart 4 shows that poverty intensity, as measured by the United Nations’ new Multidimensional Poverty Index that assesses the nature and intensity of poverty at the individual level in education, health outcomes, and standard of living, is much lower on average in countries with greater economic freedom.
Advancing economic freedom is vital to lifting people to greater prosperity. Not only is a higher level of economic freedom clearly associated with a higher level of per capita income, but countries’ improvements in economic freedom also increase their income growth rates, speeding economic and social progress. (See Chart 5.)
Chart 6 illustrates the impressive progress of Mauritius, the first Sub-Saharan African country to rank in the Index’s top 10. For comparison, its changes in GDP growth and economic freedom are contrasted with those of the United Kingdom, from which Mauritius became independent in 1968.
Economic freedom is highly correlated with entrepreneurial activity that creates new jobs and increases opportunities and choices for individuals in advancing their own well-being. (See Chart 7.)
The proven path to revitalizing economic growth is to advance economic freedom by promoting policies that generate a virtuous cycle of innovation, job creation, productivity growth, and higher living standards that in turn helps to create the social and economic resilience that sustains and empowers individuals in a rapidly evolving economic environment. As shown in Chart 8, economic freedom is positively linked to innovation.
The need to improve, or in some cases restore, economic freedom is stronger than ever. The challenge is to preserve past gains in economic freedom and to ensure that reform agendas focus on generating greater economic freedom, not less.
With global economic recovery far from secure, many countries are at a critical juncture, Policy decisions will be difficult, and the pressure for government intervention to favor politically powerful interests can be severe. Trade freedom and financial freedom are particularly threatened around the world, and the push for ever greater regulation in fields such as resource usage or labor relations is unabated.
The fundamental principles emphasized in the Index of Economic Freedom—the empowerment of individuals, equitable treatment for all, and the promotion of competition—can provide a good guide. Policies can be judged on whether they reinvigorate entrepreneurial dynamism or perpetuate static patterns of production and employment, whether they promote openness or protectionism.
Ultimately, the choice is a simple one: for or against economic freedom itself. The Index provides powerful evidence that the path to greater freedom is also the path to greater prosperity.