Economic Freedom of the World - 2016 Annual Repot.

Note: This is a copy/paste from The Fraser Institute’s Economic Freedom of the World - 2016 Annual Repot.

Link to EFW Appendix (full description of variables)

Data Bib:

Authors: James Gwartney, Robert Lawson, and Joshua Hall
Title: 2016 Economic Freedom Dataset, published in Economic Freedom of the World: 2016 Annual Report
Publisher: Fraser Institute
Year: 2016
URL: www.freetheworld.com/datasets_efw.html>

EFW publication Bib:

Authors: James Gwartney, Robert Lawson, and Joshua Hall
Title: Economic Freedom of the World: 2016 Annual Report Publisher: Fraser Institute
Date of publication: 2016
Digital copy available from: www.fraserinstitute.org and www.freetheworld.com

Economic Freedom of the World

The index published in Economic Freedom of the World measures the degree to which the policies and institutions of countries are supportive of economic freedom. The cornerstones of economic freedom are personal choice, voluntary exchange, freedom to enter markets and compete, and security of the person and privately owned property. Forty-two data points are used to construct a summary index and to measure the degree of economic freedom in five broad areas:

  1. size of government: expenditures, taxes, and enterprises
    • A. Government consumption
    • B. Transfers and subsidies
    • C. Government enterprises and investment
    • D. Top marginal tax rate
        1. Top marginal income tax rate
        1. Top marginal income and payroll tax rate
  2. legal structure and security of property rights
    • A. Judicial independence
    • B. Impartial courts
    • C. Protection of property rights
    • D. Military interference in rule of law and politics
    • E. Integrity of the legal system
    • F. Legal enforcement of contracts
    • G. Regulatory costs of the sale of real property
    • H. Reliability of police
    • I. Business costs of crime
  3. access to sound money
    • A. Money growth
    • B. Standard deviation of inflation
    • C. Inflation: most recent year
    • D. Freedom to own foreign currency bank accounts
  4. freedom to trade internationally
    • A. Tariffs
        1. Revenue from trade taxes (% of trade sector)
        1. Mean tari rate
        1. Standard deviation of tari rates
    • B. Regulatory trade barriers
        1. Non-tari trade barriers
        1. Compliance costs of importing and exporting
    • C. Black-market exchange rates
    • D. Controls of the movement of capital and people
        1. Foreign ownership / investment restrictions
        1. Capital controls
        1. Freedom of foreigners to visit
  5. regulation of credit, labor, and business
    • A. Credit market regulations
        1. Ownership of banks
        1. Private sector credit
        1. Interest rate controls / negative real interest rates
    • B. Labor market regulations
        1. Hiring regulations and minimum wage
        1. Hiring and firing regulations
        1. Centralized collective bargaining
        1. Hours regulations
        1. Mandated cost of worker dismissal
        1. Conscription
    • C. Business regulations
        1. Administrative requirements
        1. Bureaucracy costs
        1. Starting a business
        1. Extra payments / bribes / favoritism
        1. Licensing restrictions
        1. Cost of tax compliance
1. Size of Government

The four components of Area 1 indicate the extent to which countries rely on the political process to allocate resources and goods and services. When government spending increases relative to spending by individuals, households, and businesses, political 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 consumption is 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 countries use private investment and enterprises rather than government investment and firms to direct resources. Governments and state-owned enterprises play by rules that are diferent from those to which private enterprises are subject. They are not dependent on consumers for their revenue or on investors for capital. They often operate in protected markets. Thus, economic freedom is reduced as government enterprises 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 which a country relies on personal choice and markets rather than government budgets and political decision-making. Therefore, countries with low levels of government spending as a share of the total, a smaller government enterprise sector, and lower marginal tax rates earn the highest ratings in this area.

3. Sound Money

Money oils the wheels of exchange. An absence of sound money undermines gains from trade. As Milton Friedman informed us long ago, in ation is a monetary phenomenon, caused by too much money chasing too few goods. High rates of monetary growth lead to in ation. 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 provides it makes little difference. Thus, in addition to data on a country’s rate of inflation and its government’s monetary policy, it is important to consider how difficult it is to use alternative, more credible, currencies. If bankers can offer saving and checking accounts in other currencies or if citizens can open foreign bank accounts, then access to sound money is increased and economic freedom expanded.

There are four components to the EFW index in Area 3. All of them are objective and relatively easy to obtain. The first three are designed to measure the consistency of monetary policy (or institutions) with long-term price stability. Component 3D is designed to measure 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.

4. Freedom to Trade Internationally

In our modern world of high technology and low costs for communication and transportation, freedom of exchange across national boundaries is a key ingredient of economic freedom. Many goods and services are now either produced abroad or contain resources supplied from abroad. Voluntary exchange is a positive-sum activity: 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 the movement of 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.

5. Regulation

When regulations restrict entry into markets and interfere with the freedom to engage in voluntary exchange, they reduce economic freedom. The fifth area of the index focuses on regulatory restraints that limit the freedom of exchange in credit, labor, and product markets. The first component (5A) reflects conditions in the domestic credit market. One sub-component provides evidence on the extent to which 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 for 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 of employees and employers. Among the more prominent are minimum wages, dismissal regulations, centralized wage setting, extension of union contracts to non-participating parties, and conscription. Labor-market regulations (component 5B) is designed to measure the extent to which these restraints upon economic freedom are present. In order to earn high marks in the component rating regulation of the labor market, a country must allow market forces to determine wages and establish the 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 are designed to identify the extent to which regulations and bureaucratic procedures restrain entry and reduce competition. In order to score high in this portion of the index, countries must allow markets to determine prices and refrain from regulatory activities that retard entry into business and increase the cost of producing products. They also must refrain from “playing favorites”, that is, from using their power to extract financial payments and reward some businesses at the expense of others.



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