Keating: Indexing Economic Freedom

February 22, 2013


Economic literacy is increasingly important. Philosophers, linguists and journalists have been conversant with the Gross Domestic Product, the Dow, unemployment statistics and prime interest rates for some time now. Since 1996, however, the Economic Freedom of the World (EFW) Index, published jointly by the Fraser and CATO Institutes, is the new indicator on the block.

References to the EFW are increasingly found in business and economic reports. The index uses 42 variables to construct a summary index in five broad areas: size of government, legal system and property rights, sound money, freedom to trade internationally and regulation.

The framers of the EFW Index value personal choice, voluntary market exchange, ease of entry into markets, and protection of persons and property as ingredients of economic freedom. Some analysts believe that changes in economic freedom in the short run are related to long-term economic prosperity. If so, it is unfortunate that policy responses to economic crises, such as the Great Recession, often tend to reduce economic freedom. Consumption by government, income transfers and marginal tax rates are among variables used to assess size of government. When government spending is large relative to total spending, government decision-making is substituted for personal choice, reducing economic freedom. Judicial independence, impartial courts, protection of property rights and the reliability of police are used in the index to develop a legal system and property-rights measure. No attempt is made to weight components in any special way; however, primary sources for each variable are made fully available. Inflation distorts relative prices, alters the terms of long-term contracts and renders it virtually impossible for households and firms to make future plans. Therefore, the sound money component of the EFW Index includes money growth, changes in inflation and the freedom to own foreign-currency bank accounts. Freedom to trade internationally contributes to our modern living standards. Tariffs, trade barriers and controls on the movement of money, capital and people are used to assess trade freedom.Regulation of credit and labor markets, with business activities, inhibits economic freedom. To score well on this component of the EFW Index, countries must allow markets to determine prices and refrain from regulatory practices that retard business entry and increase production costs.The EFW Index is not without its detractors — those who believe that the index is ideologically driven and those who think that the index is not associated with economic growth and well-being.

Imitation is sincere flattery, though, and similar measures for the health of a society, ranging from economic indicators to social ones, such as inequality and crime, are being developed. The cover article of The Economist  (Feb. 2, 2013) included such an index that illustrated the experience of Nordic countries. It showed that Sweden, Denmark, Finland and Norway continue to pride themselves on the generosity of welfare programs but, in general, are moving slowly in the direction of choice and competition and away from paternalism and government planning.

Maryann O. Keating, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation who lives in South Bend, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell, 2009.


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This table from The Economist  (Feb. 2, 2013) highlights the experience of Nordic countries, which continue to pride themselves on the generosity of their welfare programs. Nevertheless, since 1990, Sweden, Denmark, Finland and Norway have been moving slowly in the direction of choice and competition and away from paternalism and government planning.



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