Economic freedom of the world index Chan Wing Kiu 05009634 Cheng Yee Ling 05009642 Wong Chi Ki 05015049 Yim Kei Yan 05015626
What is Economic Freedom The key ingredients of economic freedom are : Personal choice Voluntary exchange coordinated by markets Freedom to enter and compete in markets Protection of persons and their property from aggression by other
Economic Freedom of the World Project Objective: find a way to measure economic freedom and explore the connection between it and other variables 20 year project Led by Professor Milton Friedman, Rose Friedman and Michael Walker of The Fraser Institute Involved 60 of the world ’ s top scholars
Components of The Economic Freedom of the World Index 1) Size of government :expenditures,taxes and enterprise 2) Legal Structure and Security of Property Rights 3) Soundness of Money 4) Freedom to trade internationally 5) Regulation of business, labor and capital markets Based entirely on objective or third party data for 130 countries
Each component and sub-component is placed on a scale from 0 to 10 that reflects the distribution of the underlying data. The component ratings within each area are averaged to derive ratings for each of the five areas. In turn, rating is the average of the five area ratings.
1 ) Size of government and taxation A ) General government consumption spending as a percentage of total consumption B )Transfers and subsidies as a percentage of GDP C) Government enterprises and investment as a share of total investment
D )Top marginal tax rate (and income threshold at which it applies) i) Top marginal income tax rate (and income threshold at which it applies) Ii) Top marginal income and payroll tax rate (and income threshold at which the top marginal income-tax rate applies)
Size of Government and the Top 10 Source: The Fraser Institute.
Legal Structure and Security of Property Rights A ) Judicial independence—the judiciary is independent and not subject to interference by the government or parties in disputes B) Impartial courts—a trusted legal framework exists for private businesses to challenge the legality of government actions or regulation C) Protection of intellectual property D) Military interference in rule of law and the political process E) Integrity of the legal system
Legal System and Property Rights and the Top 10 Source: The Fraser Institute.
Access to Sound Money A) Average annual growth of the money supply in the last five years minus average annual growth of real GDP in the last ten years B) Standard inflation variability in the last five years C) Recent inflation rate D) Freedom to own foreign currency bank accounts domestically and abroad
Sound Money and the Top 10 Source: The Fraser Institute.
Freedom to Trade Internationally A) Taxes on international trade i) Revenue from taxes on international trade as a percentage of exports plus imports ii) Mean tariff rate iii) Standard deviation of tariff rates B) Regulatory trade barriers i) Non-tariff trade barriers ii) Compliance cost of importing and exporting C) Actual size of trade sector compared to expected size
Freedom to Trade Internationally and the Top 10 D) Difference between official exchange rate and black-market rate E) International capital market controls i) Foreign ownership / investment restrictions ii) Restrictions on the freedom of citizens to engage in capital market exchange with foreigners —index of capital controls among 13 IMF categories
Freedom to Trade Internationally and the Top 10 Source: The Fraser Institute.
Regulation of Credit, Labor, and Business A) Credit market regulations i) Ownership of banks—percentage of deposits held in privately owned banks ii) Competition—domestic banks face competition from foreign banks iii) Extension of credit—percentage of credit extended to private sector
Regulation of Credit, Labor, and Business iv) Avoidance of interest rate controls and regulations that lead to negative real interest rates v) Interest rate controls—interest rate controls on bank deposits and/or loans are freely determined by the market
Regulation of Credit, Labor, and Business B) Labor market regulations i) Impact of minimum wage ii) Hiring and firing practices—hiring and firing practices of companies are determined by private contract iii) Share of labor force whose wages are set by centralized collective bargaining
Regulation of Credit, Labor, and Business iv) Unemployment benefits—the unemployment benefits system preserves the incentive to work v) Use of conscripts to obtain military personnel
Regulation of Credit, Labor, and Business C Business regulations i) Price controls—extent to which businesses are free to set their own prices ii) Burden of regulation iii) Time with government bureaucracy—senior management spends a substantial amount of time dealing with government bureaucracy
Regulation of Credit, Labor, and Business iv) Starting a new business—starting a new business is generally easy V) Irregular payments—irregular, additional payments connected with import and export permits, business licenses, exchange controls, tax assessments, police protection, or loan applications are very rare
Regulations and the Top 10 Source: The Fraser Institute.
2006 Overall Economic Freedom Index and the Top 10 Source: The Fraser Institute.
Why is Economic Freedom Important? Economic freedom is fundamental human right, without them there can be no political freedom or civil freedoms They are a prerequisite for growth and development They are a prerequisite for broader human development
Economic Freedom in the World, 2002 and per-Capita Income Economic freedom of the world 2002 Log per capital income, 2002
Per Capita Income and Economic Freedom QuartileLeast Free …………… Most Free Sources: The Fraser Institute; The World Bank, World Development Indicators CD-ROM, 2005.
Growth in Real GDP Per Capita and Economic Freedom QuartileLeast Free ……………..….. Most Free Sources: The Fraser Institute; The World Bank, World Development Indicators CD-ROM, 2005.
How do economic freedom related to economic development? Why do planners fail so badly? In a world of great uncertainty and unpredictability, economic freedom succeeds for the following reasons.
Reasons for the successful of economic freedom 1. Economic freedom fosters competition and weeds out the many failures. 2. Economic freedom give rise of market mechanism.
Reasons for the successful of economic freedom 3. Economic freedom ruthlessly reallocates resources away from what is failing towards what is succeeding. 4. Economic freedom makes it possible to increase the scale of a successful activity rapidly and by a huge magnitude.
Reasons for the successful of economic freedom 5. Economic freedom makes possible sophisticated contracts that allow individuals and firms to deal with uncertainty.
Correlation between EFI and unemployment 1. Size of Government: 1) High tax ( low economic freedom) ->low incentive to work -> high unemployment rate 2) Large proportion of transfer payment ->Low incentive to work -> high unemployment rate
Correlation between EFI and unemployment 2. Legal Structure and Security of Property Right 1) Well PPR increase confidence to invest fruit of labor is protected reduce Unemployment 2) Good legal structure -> reduce uncertainty ->encourage investment -> low unemployment rate
Correlation between EFI and unemployment 3. Access to Sound Money 1)Sound money is essential to PPR -> reduce uncertainty -> encourage investment -> low unemployment rate 2)inflation distort relative price alter the fundamental term of long term contract difficult for future planning erode the value of property held in monetary instrument
Correlation between EFI and unemployment 4. Freedom to trade internationally 1)High degree of freedom to trade -> well development of export sector -> well development of domestic production -> low unemployment rate
Correlation between EFI and unemployment 5. Regulation of credit, labor and business 1)credit example: limiting no. of banks lower the ability for banks to loan lower investment -> higher unemployment rate 2)labor example: Minimum wages exists of unemployment Better way- let market determines labor wages
Correlation between EFI and unemployment 5. Regulation of credit, labor and business 3)business burden of regulation lower the incentives for investment lower the ease to enter market high unemployment rate
Economic Freedom and UnemploymentLeast Free ……………..….. Most Free Sources: The Fraser Institute; The World Bank, World Development Indicators CD-ROM, 2005.
Conclusion economic freedom is not easy to achieve principles such as private property, freedom of choice of occupation, protection against state expropriation, freedom of entry and competition in markets, prices determined by markets are difficult to implement the principles in practice