Tuesday, January 22, 2008


In a mutual cooperation, Heritage Foundation and Wall Street Journal issued a new 2008 Index of Economic Freedom (link). The index measures the level of economic freedom in the world, emphasizing the degree of economic liberty in each country. Some countries, such as Montenegro, Serbia and Iraq, remained unranked subject to incomplete information about the areas reflecting the level of economic freedom. By a methodological definition (link), the economic freedom is a material autonomy in relation to the state and organized groups. An individual is free who can secure and protect his human resources, labor and private property. Economic freedom involves several sub-levels such as freedom to invest, freedom to start a business, freedom to choose, freedom to trade, freedom from corruption, freedom from government, fiscal freedom and the protection of private property rights nevertheless. Higher the value of each component, higher the level of economic freedom.

The Meaning of Economic Freedom

Innumerable empirical investigation has confirmed a positive correlation between economic freedom and sustainable economic performance. Gwartney, Lawson and Holcombe (1999) have explored the relationship between economic and economic growth (link). They concluded that an environment with a high degree of economic freedom is essential to sustainable growth performance. As an ingredient of general prosperity, high level of economic freedom is impossible without a firm role of institutions whose aim is to protect private property from expropriation and to enforce the rule of law. Institutions are defined as the rules of the game and interaction between individuals. Institutions are a set of formal and informal rules that define the scope and shape of behavioral limit in private contracts. Inevitably, the aim of institutions is to minimize the transaction cost through codified arrangements and the respect for individual liberty and a limited role of government. The pursuit of institutions to minimize the transaction cost is, of course, essential to sustainable economic performance. Douglass North, the father of new institutional economics once wrote:

"The inability of societies to develop effective, low-cost enforcement of contracts is the most important source of both historical stagnation and contemporary underdevelopment in the third world."

Source: Douglass North; Institutions, Institutional Change and Economic Performance, Cambridge University Press, 1990 (link)

The quality of the business environment regarding creativity, innovation, financial markets and free exchange, is a set of components that determine the rank of economic freedom in a particular country. By the logic of the common sense, economic freedom is a necessity for both human and political freedom. Economic control is not only the control of economic transactions. It is the control of the means for all individual ends. And whoever has the control over the means must also determine which values will rate higher and which ends shall be served. The following relationship has been succinctly explained by Friedrich August von Hayek who once wrote:

"Even striving for equality by means of a direct economy can result only in an officially enforced inequality - an authoritarian determination of the status of each individual in the new hierarchical order"
-- Friedrich August von Hayek

Top 10 - The Champions of Economic Liberty

In this year's index, economic freedom in only seven nations was distributed as free. The distribution of economic freedom is officially shaped in six different categories. Again, Hong Kong remained the freest economy in the world, scoring very high on each component of economic liberty. In the group of free economies there are also Singapore, Ireland, Australia, United States, New Zealand and Canada. Those countries scored very high in monetary freedom, business freedom, private property rights, labor freedom and financial freedom. Among top 10 there are three countries left: Chile, Switzerland and United Kingdom. Sound regulatory environment, efficient judicial system, deregulated product markets, liberalized financial sector and low exchange costs reflect the ranking of countries among top 10. Among them, only Chile is a middle-income country but economic reforms in the past decade such as the privatization of the pension system boosted growth performance of the Chilean economy and contributed to Chile's high score in economic freedom. In 2008, the overall economic freedom of the world has not increased, but some countries progressed dramatically well while some other countries diverged. For example, Mauritius and Denmark performed a continued improvement from previous ranking while Russia's ranking decreased substantially.

Economic freedom in Nordic countries

The proponents of the so-called Nordic model argue that it is possible to combine sound economic performance and an unlimited welfare state. At this stage, they cite the example of Nordic countries. It is somewhat of a paradox to speak of the Nordic countries as they notably differ in several aspects. Therefore, it is actually impossible to speak about the Nordic model in general. Nordic countries score very well in the area of the quality of the business environment, having created one of the freest business areas in the world. Nordic countries also score very well on freedom to trade internationally, open investment environment, non-existent corruption, flexible financial environment, and independent judiciary. But Nordic tigers score quite badly in the areas of fiscal burden and government size. However, each Nordic countries has its own features. Iceland has been very successful in tax reform, entrepreneurship and competitiveness, Denmark has reformed its labor market towards far greater flexibility, Finland is known for the highly rated elementary and secondary education system, Sweden pioneered voucher system and the privatization of health-care and pension funds. Norway, the least free Nordic country, is known for rich natural resources, enabling both generous welfare system and impeding structural environment.

Slovenia - Subalpine Jail

This year's rank of Slovenia in terms of economic freedom has not improved substantially. Officially, economic freedom in Slovenia improved by 0,4 percentage point reflecting a cautous approach to pro-growth economic reforms. However, Slovenia is ranked as 75th freest economy in the world. A growing number of former communist countries has overtaken Slovenia such as Albania, Macedonia, Romania, Bulgaria. Even Lebanon has surpassed Slovenia. The country scored well on trade freedom and monetary freedom. Poor quality of the business environment reflects the overburden and failure of the regulatory environment. Slovenia lacks the privatization of banking and insurance sector. Also, the judicial system lacks the independence from political influence and it is known for substantial court delays, inefficient staff and slow procedures. Halted privatization programs have been a wish of political aim to control particular sectors of the economy. In addition, minor tax reform slightly cut tax rates on productive behavior. However, tax rates remained steeply progressive and high. Public spending has not increased substantially but the level of public spending is still very high accounting for 47,2 percent of the GDP in recent year.

Trade Unions as Means of Coercion

The most significant obstacle to higher level of economic freedom is Slovenia's highly regulated and rigid labor market that hinders productivity growth and job opportunities. Without a radical deregulation of the labor market, productivity growth could slow substantially. Flexibility is a key feature of the labor market, brining generous effect on labor supply. In fact, the power of labor unions is the greatest obstacle to the strength of economic freedom in Slovenia.

Rok SPRUK is an economist.

Copyright 2008 by Rok SPRUK

No comments: