The Index of Economic Freedom focuses on four key aspects of the economic environment over which governments typically exercise policy control:
- Rule of law,
- Government size,
- Regulatory efficiency, and
- Market openness.
In assessing conditions in these four categories, the Index measures 12 specific components of economic freedom, each of which is graded on a scale from 0 to 100. Scores on these 12 components of economic freedom, which are calculated from a number of sub-variables, are equally weighted and averaged to produce an overall economic freedom score for each economy.
The following sections provide detailed descriptions of the formulas and methodology used to compute the scores for each of the 12 components of economic freedom.
RULE OF LAW
Property Rights
The property rights component assesses the extent to which a country’s legal framework allows individuals to accumulate private property freely, secured by clear laws that the government enforces effectively. Relying on a mix of survey data and independent assessments, it provides a quantifiable measure of the degree to which a country’s laws protect private property rights and the extent to which those laws are respected. It also assesses the likelihood that private property will be expropriated by the state.
The more effective the legal protection of property, the higher a country’s score will be. Similarly, the greater the chances of government expropriation of property, the lower a country’s score will be.
The score for this component is derived by averaging scores for the following five sub-factors, all of which are weighted equally:
Physical property rights,
Intellectual property rights,
Strength of investor protection,
Risk of expropriation, and
Quality of land administration.
Each of these sub-factors is derived from numerical data sets that are normalized for comparative purposes using the following equation:
Sub-factor Score i = 100 x (Sub-factorMax–Sub-factori)/(Sub-factorMax–Sub-factorMin)
where Sub-factori represents the original data for country i; Sub-factorMax and Sub-factorMin represent the upper and lower bounds for the corresponding data set; and Sub-factor Score i represents the computed sub-factor score for country i.
For a few countries, comparable data were not available for every sub-factor. In those cases, a score was computed for the missing sub-factor based on the relative percentile ranking of that country on the other sub-factors.
Sources. The Index relies on the following sources for assessing property rights: World Economic Forum, World Competitiveness Report; World Bank, Doing Business; and Credendo Group, Country Risk Assessment.
Judicial Effectiveness
Well-functioning legal frameworks are essential for protecting the rights of all citizens against unlawful acts by others, including by governments and powerful private parties. Judicial effectiveness requires efficient and fair judicial systems to ensure that laws are fully respected, with appropriate legal actions taken against violations. The score for the judicial effectiveness component is derived by averaging scores for the following three sub-factors, all of which are weighted equally:
Judicial independence,
Quality of the judicial process, and
Likelihood of obtaining favorable judicial decisions.
Each of these sub-factors is derived from numerical data sets that are normalized for comparative purposes using the following equation:
Sub-factor Score i = 100 x (Sub-factorMax–Sub-factori)/(Sub-factorMax–Sub-factorMin)
where Sub-factori represents the original data for country i; Sub-factorMax and Sub-factorMin represent the upper and lower bounds for the corresponding data set; and Sub-factor Score i represents the computed sub-factor score for country i.
For a few countries, comparable data were not available for every sub-factor. In each of these cases, a score was computed for the missing sub-factor based on the country’s relative percentile ranking on the other sub-factors.
Sources. The Index relies on the following sources for assessing judicial effectiveness: World Economic Forum, World Competitiveness Report, and World Bank, Doing Business.
Government Integrity
Corruption erodes economic freedom by introducing insecurity and coercion into economic relations. Of greatest concern is the systemic corruption of government institutions and decision-making by such practices as bribery, extortion, nepotism, cronyism, patronage, embezzlement, and graft. The lack of government integrity caused by such practices reduces economic vitality by increasing costs and shifting resources into unproductive lobbying activities.
The score for this component is derived by averaging scores for the following six sub-factors, all of which are weighted equally:
Public trust in politicians,
Irregular payments and bribes,
Transparency of government policymaking,
Absence of corruption,
Perceptions of corruption, and
Governmental and civil service transparency.
Each of these sub-factors is derived from numerical data sets that are normalized for comparative purposes using the following equation:
Sub-factor Score i = 100 x (Sub-factorMax–Sub-factori)/(Sub-factorMax–Sub-factorMin)
where Sub-factori represents the original data for country i; Sub-factorMax and Sub-factorMin represent the upper and lower bounds for the corresponding data set; and Sub-factor Score i represents the computed sub-factor score for country i.
For a few countries, comparable data were not available for every sub-factor. In each of these cases, a score was computed for the missing sub-factor based on the country’s relative percentile ranking on the other sub-factors.
Sources. The Index relies on the following sources for assessing government integrity: World Economic Forum, World Competitiveness Report; World Justice Project, Rule of Law Index; Transparency International, Corruption Perceptions Index; and TRACE International, The Trace Matrix.
Government Size
Tax Burden
Tax burden is a composite measure that reflects marginal tax rates on both personal and corporate income and the overall level of taxation (including direct and indirect taxes imposed by all levels of government) as a percentage of gross domestic product (GDP). The component score is derived from three quantitative sub-factors:
The top marginal tax rate on individual income,
The top marginal tax rate on corporate income, and
The total tax burden as a percentage of GDP.
Each of these numerical variables is weighted equally as one-third of the component score. This equal weighting allows a country to achieve a score as high as 67 based on two of the factors even if it receives a score of 0 on the third.
Tax burden scores are calculated with a quadratic cost function to reflect the diminishing revenue returns from very high rates of taxation. The data for each sub-factor are converted to a 100-point scale using the following equation:
Tax Burdenij = 100 – α (Factorij)2
where Tax Burdenij represents the tax burden in country i for factor j; Factorij represents the value (a percentage expressed on a scale of 0 to 100) in country i for factor j; and α is a coefficient set equal to 0.03. The minimum score for each sub-factor is zero, which is not represented in the printed equation but was used because it means that no single high tax burden will make the other two sub-factors irrelevant.
As an example, in the 2018 Index, Mauritius has a flat rate of 15 percent for both individual and corporate tax rates, which yields a score of 93.3 for each of those two factors. Mauritius’s overall tax burden as a portion of GDP is 21.2 percent, yielding a score of 86.5 for that factor. When the three factors are averaged together, Mauritius’s overall tax burden score becomes 91.
Sources. The Index relies on the following sources for information on tax rate data, in order of priority: Deloitte, International Tax and Business Guide Highlights; International Monetary Fund, Staff Country Report, “Selected Issues and Statistical Appendix,” and Staff Country Report, “Article IV Consultation”; PricewaterhouseCoopers, Worldwide Tax Summaries; countries’ investment agencies; other government authorities (embassy confirmations and/or the country’s treasury or tax authority); and Economist Intelligence Unit, Country Commerce and Country Finance.
For information on tax burden as a percentage of GDP, the primary sources are Organisation for Economic Co-operation and Development data; Eurostat, Government Finance Statistics data; African Development Bank and Organisation for Economic Co-operation and Development, African Economic Outlook; International Monetary Fund, Staff Country Report, “Selected Issues,” and Staff Country Report, “Article IV Consultation”; Asian Development Bank, Key Indicators for Asia and the Pacific; United Nations Economic Commission for Latin America, Economic Survey of Latin America and the Caribbean; and individual contacts from government agencies and multinational organizations such as the IMF and the World Bank.
Government Spending
The government spending component captures the burden imposed by government expenditures, which includes consumption by the state and all transfer payments related to various entitlement programs.
No attempt has been made to identify an optimal level of government spending. The ideal level will vary from country to country, depending on factors that range from culture to geography to level of economic development. At some point, however, government spending becomes an unavoidable burden as growth in the size and scope of the public sector leads inevitably to misallocation of resources and loss of economic efficiency. Volumes of research have shown that excessive government spending that causes chronic budget deficits and the accumulation of public debt is one of the most serious drags on economic dynamism.
The Index methodology treats zero government spending as the benchmark. As a result, underdeveloped countries, particularly those with little government capacity, may receive artificially high scores. However, such governments, which can provide few if any public goods, are likely to receive low scores on some of the other components of economic freedom (such as property rights, financial freedom, and investment freedom) that measure aspects of government effectiveness.
Government spending has a major impact on economic freedom, but it is just one of many important components. The scale for scoring government spending is nonlinear, which means that government spending that is close to zero is lightly penalized, while levels of government spending that exceed 30 percent of GDP lead to much worse scores in a quadratic fashion (for example, doubling spending yields four times less freedom). Only extraordinarily large levels of government spending (for example, over 58 percent of GDP) receive a score of zero.
The equation used for computing a country’s government spending score is:
GEi = 100 – α (Expendituresi)2
where GEi represents the government expenditure score in country i; Expendituresi represents the average total government spending at all levels as a percentage of GDP for the most recent three years; and α is a coefficient to control for variation among scores (set at 0.03). The minimum component score is zero.
In most cases, the Index uses general government expenditure data that include all levels of government such as federal, state, and local. In cases where data on general government spending are not available, data on central government expenditures are used instead.
Sources. The Index relies on the following sources for information on government intervention in the economy, in order of priority: Organisation for Economic Co-operation and Development data; Eurostat data; African Development Bank and Organisation for Economic Co-operation and Development, African Economic Outlook; International Monetary Fund, Staff Country Report, “Selected Issues and Statistical Appendix,” Staff Country Report, “Article IV Consultation,” and World Economic Outlook Database; Asian Development Bank, Key Indicators for Asia and the Pacific; African Development Bank, The ADB Statistics Pocketbook; official government publications of each country; and United Nations Economic Commission for Latin America, Economic Survey of Latin America and the Caribbean.
Fiscal Health
Widening deficits and a growing debt burden, both of which are caused by poor government budget management, lead to the erosion of a country’s overall fiscal health. Deteriorating fiscal health, in turn, is associated with macroeconomic instability and economic uncertainty.
Debt is an accumulation of budget deficits over time. In theory, debt financing of public spending could make a positive contribution to productive investment and ultimately to economic growth. However, mounting public debt driven by persistent budget deficits, particularly spending that merely boosts government consumption or transfer payments, often undermines overall productivity growth and leads ultimately to economic stagnation rather than growth.
The score for the fiscal health component is based on two sub-factors, which are weighted as follows in calculating the overall component score:
Average deficits as a percentage of GDP for the most recent three years (80 percent of score) and
Debt as a percentage of GDP (20 percent of score).
The equation used for computing a country’s fiscal health score is:
Sub-factor Scorei = 100 – α (Sub-factori)2
where Sub-factor Scorei represents the deficit or debt score in country i; Sub-factori represents the factor value as a portion of GDP; and α is a coefficient to control for variation among scores (set at 2 for deficit and 0.01 for debt). The minimum sub-factor score is zero.
In most cases, the Index uses general government deficit and debt data that include all levels of government such as federal, state, and local. In cases where such general government data are not available, data on central government expenditures are used instead.
Sources. The Index relies on the following sources for information on government intervention in the economy, in order of priority: International Monetary Fund, World Economic Outlook Database, Staff Country Report, “Selected Issues and Statistical Appendix,” and Staff Country Report, “Article IV Consultation”; Asian Development Bank, Key Indicators for Asia and the Pacific; African Development Bank, The ADB Statistics Pocketbook; Economist Intelligence Unit, Data Tool; and official government publications of each country.
REGULATORY EFFICIENCY
Business Freedom
The business freedom component measures the extent to which the regulatory and infrastructure environments constrain the efficient operation of businesses. The quantitative score is derived from an array of factors that affect the ease of starting, operating, and closing a business.
The business freedom score for each country is a number between 0 and 100, with 100 indicating the freest business environment. The score is based on 13 sub-factors, all of which are weighted equally, using data from the World Bank’s Doing Business report:
Starting a business—procedures (number);
Starting a business—time (days);
Starting a business—cost (% of income per capita);
Starting a business—minimum capital (% of income per capita);
Obtaining a license—procedures (number);
Obtaining a license—time (days);
Obtaining a license—cost (% of income per capita);
Closing a business—time (years);
Closing a business—cost (% of estate);
Closing a business—recovery rate (cents on the dollar);
Getting electricity—procedures (number);
Getting electricity—time (days); and
Getting electricity—cost (% of income per capita).
Each of these sub-factors is converted to a scale of 0 to 100, after which the average of the converted values is computed. The result represents the country’s business freedom score in comparison to the business freedom scores of other countries.
Each sub-factor is converted to a scale of 0 to 100 using the following equation:
Sub-factor Scorei = 50 x (Sub-factoraverage/Sub-factori )
which is based on the ratio of the country data for each sub-factor relative to the world average, multiplied by 50. For example, on average worldwide, it takes 21 days to start a business. Israel’s 12 days to start a business is a sub-factor value that is better than the average, resulting in a ratio of 1.75. That ratio multiplied by 50 equals the final sub-factor score of 87.5.
For the five countries that are not covered by the World Bank’s Doing Business report, business freedom is scored by analyzing business regulations based on qualitative information from reliable and internationally recognized sources.
Sources. The Index relies on the following sources in determining business freedom scores, in order of priority: World Bank, Doing Business; Economist Intelligence Unit, Country Commerce; U.S. Department of Commerce, Country Commercial Guide; and official government publications of each country.
Labor Freedom
The labor freedom component is a quantitative measure that considers various aspects of the legal and regulatory framework of a country’s labor market, including regulations concerning minimum wages, laws inhibiting layoffs, severance requirements, and measurable regulatory restraints on hiring and hours worked, plus the labor force participation rate as an indicative measure of employment opportunities in the labor market.
Seven quantitative sub-factors are equally weighted, with each counted as one-seventh of the labor freedom component:
Ratio of minimum wage to the average value added per worker,
Hindrance to hiring additional workers,
Rigidity of hours,
Difficulty of firing redundant employees,
Legally mandated notice period,
Mandatory severance pay, and
Labor force participation rate.
In constructing the labor freedom score, each of the seven sub-factors is converted to a scale of 0 to 100 based on the following equation:
Sub-factor Scorei = 50 x (Sub-factoraverage/Sub-factori)
where country i data are calculated relative to the world average and then multiplied by 50. The seven sub-factor scores are then averaged for each country, yielding a labor freedom score in comparison to other countries.
The simple average of the converted values for the seven sub-factors is computed to obtain the country’s overall labor freedom score.
For the five countries that are not covered by the World Bank’s Doing Business report, the labor freedom component is scored by looking at labor market flexibility based on qualitative information from other reliable and internationally recognized sources.
Sources. The Index relies on the following sources for data on labor freedom, in order of priority: World Bank, Doing Business; International Labour Organization, Statistics and Databases; World Bank, World Development Indicators; Economist Intelligence Unit, Country Commerce; U.S. Department of Commerce, Country Commercial Guide; and official government publications of each country.
Monetary Freedom
Monetary freedom combines a measure of price stability with an assessment of price controls. Both inflation and price controls distort market activity. Price stability without microeconomic intervention is the ideal state for the free market.
The score for the monetary freedom component is based on two sub-factors:
The weighted average inflation rate for the most recent three years and
Price controls.
The weighted average inflation rate for the most recent three years serves as the primary input into an equation that generates the base score for monetary freedom. The extent of price controls is then assessed as a penalty deduction of up to 20 points from the base score. The two equations used to convert inflation rates into the final monetary freedom score are:
Weighted Avg. Inflationi = θ1 Inflationit + θ2Inflationit–1 + θ3 Inflationit–2
Monetary Freedomi = 100 – α √Weighted Avg. Inflationi – PC penaltyi
where θ1 through θ3 (thetas 1–3) represent three numbers that sum to 1 and are exponentially smaller in sequence (in this case, values of 0.665, 0.245, and 0.090, respectively); Inflationit is the absolute value of the annual inflation rate in country i during year t as measured by the Consumer Price Index; α represents a coefficient that stabilizes the variance of scores; and the price control (PC) penalty is an assigned value of 0–20 penalty points based on the extent of price controls.
The convex (square root) functional form was chosen to create separation among countries with low inflation rates. A concave functional form would essentially treat all hyperinflations as equally bad, whether they were 100 percent price increases annually or 100,000 percent, whereas the square root provides much more gradation. The α coefficient is set to equal 6.333, which converts a 10 percent inflation rate into a freedom score of 80.0 and a 2 percent inflation rate into a score of 91.0.
Sources. The Index relies on the following sources for data on monetary policy, in order of priority: International Monetary Fund, International Financial Statistics Online; International Monetary Fund, World Economic Outlook and Staff Country Report, “Article IV Consultation”; Economist Intelligence Unit, ViewsWire and Data Tool; various World Bank country reports; various news and magazine articles; and official government publications of each country.
OPEN MARKETS
Trade Freedom
Trade freedom is a composite measure of the extent of tariff and nontariff barriers that affect imports and exports of goods and services. The trade freedom score is based on two inputs:
The trade-weighted average tariff rate and
Nontariff barriers (NTBs).
Different imports entering a country can (and often do) face different tariffs. The weighted average tariff uses weights for each tariff based on the share of imports for each good. Weighted average tariffs are a purely quantitative measure and account for the calculation of the base trade freedom score using the following equation:
Trade Freedomi = 100(Tariffmax–Tariffi)/(Tariffmax–Tariffmin) – NTBi
where Trade Freedomi represents the trade freedom in country i; Tariffmax and Tariffmin represent the upper and lower bounds for tariff rates (%); and Tariffi represents the weighted average tariff rate (%) in country i. The minimum tariff is naturally zero percent, and the upper bound was set as 50 percent. An NTB penalty is then subtracted from the base score. The penalty of 5, 10, 15, or 20 points is assigned according to the following scale:
20—NTBs are used extensively across many goods and services and/or act to impede a significant amount of international trade.
15—NTBs are widespread across many goods and services and/or act to impede a majority of potential international trade.
10—NTBs are used to protect certain goods and services and impede some international trade.
5—NTBs are uncommon, protecting few goods and services, and/or have a very limited impact on international trade.
0—NTBs are not used to limit international trade.
We determine the extent of NTBs in a country’s trade policy regime using both qualitative and quantitative information. Restrictive rules that hinder trade vary widely, and their overlapping and shifting nature makes their complexity difficult to gauge. The categories of NTBs considered in our penalty include:
Quantity restrictions—import quotas; export limitations; voluntary export restraints; import–export embargoes and bans; countertrade; etc.
Price restrictions—antidumping duties; countervailing duties; border tax adjustments; variable levies/tariff rate quotas.
Regulatory restrictions—licensing; domestic content and mixing requirements; sanitary and phytosanitary standards (SPSs); safety and industrial standards regulations; packaging, labeling, and trademark regulations; advertising and media regulations.
Customs restrictions—advance deposit requirements; customs valuation procedures; customs classification procedures; customs clearance procedures.
Direct government intervention—subsidies and other aid; government industrial policies; government-financed research and other technology policies; competition policies; government procurement policies; state trading, government monopolies, and exclusive franchises.
As an example, China received a trade freedom score of 73.2. By itself, China’s trade-weighted average tariff of 3.4 percent would have yielded a score of 93.2, but the existence of NTBs in China reduced its score by 20 points.
Gathering tariff statistics to make a consistent cross-country comparison is a challenging task. Unlike data on inflation, for instance, some countries do not report their weighted average tariff rate or simple average tariff rate every year.
To preserve consistency in grading the trade freedom component, the Index uses the most recently reported weighted average tariff rate for a country from our primary source. If another reliable source reports more updated information on the country’s tariff rate, this fact is noted, and the grading of this component may be reviewed if there is strong evidence that the most recently reported weighted average tariff rate is outdated.
The most comprehensive and consistent information on weighted average applied tariff rates is published by the World Bank. When the weighted average applied tariff rate is not available, the Index uses the country’s average applied tariff rate; and when the country’s average applied tariff rate is not available, the weighted average or the simple average of most favored nation (MFN) tariff rates is used. In the very few cases where data on duties and customs revenues are not available, data on international trade taxes or an estimated effective tariff rate are used instead. In all cases, an effort is made to clarify the type of data used in the corresponding write-up for the trade freedom component.
Sources. The Index relies on the following sources to determine scores for trade policy, in order of priority: World Bank, World Development Indicators; World Trade Organization, Trade Policy Review; Office of the U.S. Trade Representative, National Trade Estimate Report on Foreign Trade Barriers; World Bank, Doing Business; U.S. Department of Commerce, Country Commercial Guide; Economist Intelligence Unit, Country Commerce; World Economic Forum, The Global Enabling Trade Report; and official government publications of each country.
Investment Freedom
In an economically free country, there would be no constraints on the flow of investment capital. Individuals and firms would be allowed to move their resources into and out of specific activities, both internally and across the country’s borders, without restriction. Such an ideal country would receive a score of 100 on the investment freedom component of the Index.
In practice, however, most countries have a variety of restrictions on investment. Some have different rules for foreign and domestic investment. Some restrict access to foreign exchange. Some impose restrictions on payments, transfers, and capital transactions. In some, certain industries are closed to foreign investment.
The Index evaluates a variety of regulatory restrictions that typically are imposed on investment. Points, as indicated below, are deducted from the ideal score of 100 for each of the restrictions found in a country’s investment regime. It is not necessary for a government to impose all of the listed restrictions at the maximum level to eliminate investment freedom. The few governments that impose so many restrictions that they total more than 100 points in deductions have had their scores set at zero.
Investment Restrictions
National treatment of foreign investment
No national treatment, prescreening 25 points deducted
Some national treatment, some prescreening 15 points deducted
Some national treatment or prescreening 5 points deducted
Foreign investment code
No transparency and burdensome bureaucracy 20 points deducted
Inefficient policy implementation and bureaucracy 10 points deducted
Some investment laws and practices nontransparent
or inefficiently implemented 5 points deducted
Restrictions on land ownership
All real estate purchases restricted 15 points deducted
No foreign purchases of real estate 10 points deducted
Some restrictions on purchases of real estate 5 points deducted
Sectoral investment restrictions
Multiple sectors restricted 20 points deducted
Few sectors restricted 10 points deducted
One or two sectors restricted 5 points deducted
Expropriation of investments without fair compensation
Common with no legal recourse 25 points deducted
Common with some legal recourse 15 points deducted
Uncommon but occurs 5 points deducted
Foreign exchange controls
No access by foreigners or residents 25 points deducted
Access available but heavily restricted 15 points deducted
Access available with few restrictions 5 points deducted
Capital controls
No repatriation of profits; all transactions require
government approval 25 points deducted
Inward and outward capital movements require
approval and face some restrictions 15 points deducted
Most transfers approved with some restrictions 5 points deducted
Up to an additional 20 points may be deducted for security problems, a lack of basic investment infrastructure, or other government policies that indirectly burden the investment process and limit investment freedom.
Sources. The Index relies on the following sources for data on capital flows and foreign investment, in order of priority: official government publications of each country; U.S. Department of State, Investment Climate Statements; Economist Intelligence Unit, Country Commerce; Office of the U.S. Trade Representative, National Trade Estimate Report on Foreign Trade Barriers; World Bank, Investing Across Borders; Organisation for Economic Co-operation and Development, Services Trade Restrictiveness Index; and U.S. Department of Commerce, Country Commercial Guide.
Financial Freedom
Financial freedom is an indicator of banking efficiency as well as a measure of independence from government control and interference in the financial sector. State ownership of banks and other financial institutions such as insurers and capital markets reduces competition and generally lowers the level of access to credit.
In an ideal banking and financing environment characterized by a minimum level of government interference, independent central bank supervision and regulation of financial institutions are limited to enforcing contractual obligations and preventing fraud. Credit is allocated on market terms, and the government does not own financial institutions. Financial institutions provide various types of financial services to individuals and companies. Banks are free to extend credit, accept deposits, and conduct operations in foreign currencies. Foreign financial institutions operate freely and are treated the same as domestic institutions.
The Index scores an economy’s financial freedom by looking at five broad areas:
The extent of government regulation of financial services,
The degree of state intervention in banks and other financial firms through direct and indirect ownership,
Government influence on the allocation of credit,
The extent of financial and capital market development, and
Openness to foreign competition.
These five areas are considered to assess an economy’s overall level of financial freedom that ensures easy and effective access to financing opportunities for people and businesses in the economy. An overall score on a scale of 0 to 100 is given to an economy’s financial freedom through deductions from the ideal score of 100.
90—Minimal government interference. Regulation of financial institutions is minimal but may extend beyond enforcing contractual obligations and preventing fraud.
80—Nominal government interference. Government ownership of financial institutions is a small share of overall sector assets. Financial institutions face almost no restrictions on their ability to offer financial services.
70—Limited government interference. Credit allocation is influenced by the government, and private allocation of credit faces almost no restrictions. Government ownership of financial institutions is sizeable. Foreign financial institutions are subject to few restrictions.
60—Moderate government interference. Banking and financial regulations are somewhat burdensome. The government exercises ownership and control of financial institutions with a significant share of overall sector assets. The ability of financial institutions to offer financial services is subject to some restrictions.
50—Considerable government interference. Credit allocation is significantly influenced by the government, and private allocation of credit faces significant barriers. The ability of financial institutions to offer financial services is subject to significant restrictions. Foreign financial institutions are subject to some restrictions.
40—Strong government interference. The central bank is subject to government influence, its supervision of financial institutions is heavy-handed, and its ability to enforce contracts and prevent fraud is weak. The government exercises active ownership and control of financial institutions with a large minority share of overall sector assets.
30—Extensive government interference. Credit allocation is influenced extensively by the government. The government owns or controls a majority of financial institutions or is in a dominant position. Financial institutions are heavily restricted, and bank formation faces significant barriers. Foreign financial institutions are subject to significant restrictions.
20—Heavy government interference. The central bank is not independent, and its supervision of financial institutions is repressive. Foreign financial institutions are discouraged or highly constrained.
10—Near-repressive. Credit allocation is controlled by the government. Bank formation is restricted. Foreign financial institutions are prohibited.
0—Repressive. Supervision and regulation are designed to prevent private financial institutions from functioning. Private financial institutions are nonexistent.
Sources. The Index relies on the following sources for data on banking and finance, in order of priority: Economist Intelligence Unit, Country Commerce and Country Finance; International Monetary Fund, Staff Country Report, “Selected Issues,” and Staff Country Report, “Article IV Consultation”; Organisation for Economic Co-operation and Development, Economic Survey; official government publications of each country; U.S. Department of Commerce, Country Commercial Guide; Office of the U.S. Trade Representative, National Trade Estimate Report on Foreign Trade Barriers; U.S. Department of State, Investment Climate Statements; World Bank, World Development Indicators; and various news and magazine articles on banking and finance.
General Methodological Parameters
Period of Study. For the current Index of Economic Freedom, scores are generally based on data for the period covering the second half of 2016 through the first half of 2017. To the extent possible, the information considered for each variable was current as of June 30, 2017. It is important to understand, however, that some component scores are based on historical information. For example, the monetary freedom component uses a three-year weighted average rate of inflation from January 1, 2014, through December 31, 2016.
Equal Weight. In the Index of Economic Freedom, the 12 components of economic freedom are weighted equally so that the overall score will not be biased toward any one component or policy direction. It is clear that the 12 economic freedoms interact, but the exact mechanisms of this interaction are not clearly definable: Is a minimum threshold for each one essential? Is it possible for one to maximize if others are minimized? Are they dependent or exclusive, complements or supplements?
These are valid questions, but they are beyond the scope of our fundamental mission. The purpose of the Index is to reflect the economic and entrepreneurial environment in every country studied in as balanced a way as possible. The Index has never been designed specifically to explain economic growth or any other dependent variable; that is ably done by researchers elsewhere. The raw data for each component are provided so that others can study, weight, and integrate as they see fit.
Using the Most Currently Available Information. Analyzing economic freedom annually enables the Index to include the most recent information as it becomes available country by country. A data cutoff date is used so that all countries are treated fairly. As described above, the period of study for the current year’s Index considers all information as of the last day of June of the previous year (in this case, June 30, 2017). Any new legislative changes or policy actions effective after that date have no positive or negative impact on scores or rankings.
Defining the Country Pages “Quick Facts”
Each country page includes “Quick Facts,” a statistical profile including the country’s main economic and demographic indicators. In order to facilitate comparisons among countries, the GDP and GDP per capita figures in the “Quick Facts” section have been adjusted to reflect purchasing power parity (PPP). Caution should be used in interpreting changes in these figures over time, as PPP conversion rates are subject to regular revision by the International Monetary Fund and the World Bank. In order to provide accurate estimates of annual and five-year GDP growth rates, these figures have been calculated using constant U.S. dollars for the most recent available years. Exact definitions and sources for each category of data reported are as follows:
Population: 2016 data from International Monetary Fund, World Economic Outlook Database, April 2017. For some countries, other sources include the country’s statistical agency and/or central bank.
GDP: Gross domestic product (total production of goods and services) adjusted to reflect purchasing power parity. The primary source is International Monetary Fund, World Economic Outlook Database, April 2017. The secondary source for GDP data is Economist Intelligence Unit, Data Tool. Other sources include a country’s statistical agency and/or central bank.
GDP growth rate: The annual percentage growth rate of real GDP derived from constant currency units. Annual percent changes are year-on-year. The primary source is International Monetary Fund, World Economic Outlook Database, April 2017. Secondary sources include World Bank, World Development Indicators Online; Economist Intelligence Unit, Data Tool; and a country’s statistical agency and/or central bank.
GDP five-year average annual growth: The average growth rate measured over a specified period of time. The five-year annual growth rate is measured using data from 2012 to 2016, based on real GDP growth rates. The primary source is International Monetary Fund, World Economic Outlook Database, April 2017. Secondary sources are World Bank, World Development Indicators Online, and Economist Intelligence Unit, Data Tool.
GDP per capita: Gross domestic product (adjusted for PPP) divided by total population. The sources for these data are International Monetary Fund, World Economic Outlook Database, April 2017; World Bank, World Development Indicators Online; U.S. Central Intelligence Agency, The World Factbook 2017; and a country’s statistical agency and/or central bank.
Unemployment rate: A measure of the portion of the workforce that is not employed but is actively seeking work. Data are from International Labour Organization, World Employment Social Outlook: Trends 2017.
Inflation: The annual percent change in consumer prices as measured for 2016 (or the most recent available year). The primary source for 2016 data is International Monetary Fund, World Economic Outlook Database, April 2017. Secondary sources are Economist Intelligence Unit, Data Tool; Asian Development Bank, Asian Development Outlook 2017; and a country’s statistical agency and/or central bank.
Foreign direct investment (FDI) inward flow: The total annual inward flow of FDI in current 2016 U.S. dollars, reported in millions. FDI flows are defined as investments that acquire a lasting management interest (10 percent or more of voting stock) in a local enterprise by an investor operating in another country. Such investment is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments and both short-term and long-term international loans. Data are from United Nations Conference on Trade and Development, World Investment Report 2017.
Public debt: Gross government debt as a percentage of GDP, which indicates the cumulative total of all government borrowings less repayments that are denominated in a country’s currency. Public debt is different from external debt, which reflects the foreign currency liabilities of both the private and public sectors and must be financed out of foreign exchange earnings. The primary sources for 2016 data are International Monetary Fund, World Economic Outlook Database, April 2017; International Monetary Fund, Article IV Consultation Staff Reports, 2013–2017; and a country’s statistical agency.
Commonly Used Abbreviations
CARICOM: Caribbean Community and Common Market, composed of Antigua and Barbuda, the Bahamas, Barbados, Belize, Dominica, Grenada, Guyana, Haiti, Jamaica, Montserrat, Saint Lucia, Saint Kitts and Nevis, Saint Vincent and the Grenadines, Suriname, and Trinidad and Tobago.
ECOWAS: Economic Community of West African States, economic union of 15 West African countries including Benin, Burkina Faso, Cabo Verde, Côte d’Ivoire, The Gambia, Ghana, Guinea, Guinea–Bissau, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone, and Togo.
EU: European Union, consisting of Austria, Belgium, Bulgaria, Cyprus, Croatia, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, and Sweden.
GCC: Gulf Cooperation Council, political and military alliance of six Middle Eastern countries including Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.
IMF: International Monetary Fund, established in 1945 to help stabilize countries during crises; now includes 188 member countries.
OECD: Organisation for Economic Co-operation and Development, an international organization of developed countries, founded in 1948; now includes 34 member countries.
OECS: Organization of Eastern Caribbean States, self-described as an “International Inter-governmental Organisation dedicated to economic harmonisation and integration, protection of human and legal rights, and the encouragement of good governance among independent and non-independent countries in the Eastern Caribbean,” consisting of Antigua and Barbuda, Commonwealth of Dominica, Grenada, Montserrat, the Federation of St. Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, the British Virgin Islands, Anguilla, and Martinique.
OPEC: Organization of Petroleum Exporting Countries, self-described as an “intergovernmental organization of 14 oil-exporting developing nations that coordinates and unifies the petroleum policies of its Member Countries,” which include Algeria, Angola, Ecuador, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.
WTO: World Trade Organization, founded in 1995 as the central organization dealing with the rules of trade between nations and based on signed agreements among member countries. As of November 2017, there were 164 member economies.
ENDNOTES:
1. The maximum sub-factor score of 100 is assigned to balanced budgets or budget surpluses.
2. Obtaining a license indicates the necessary procedures, time, and cost involved in getting construction permits.
3. Infrastructure services such as roads, water, and power supplies are critical to an economy’s overall business climate. Among the key infrastructures, according to a recent World Bank study, securing electricity connection is often considered the most important aspect of facilitating private business. In an effort to measure business freedom more comprehensively, the 2016 Index adopted three sub-factors related to “getting electricity.” Although the overall impact of this methodological refinement is minimal, the reader is urged to exercise caution in comparing business freedom scores over time.
4. The five countries that are not covered by the World Bank’s Doing Business study are Cuba, North Korea, Libya, Macau, and Turkmenistan.
5. The assessment of labor freedom dates from the 2005 Index because of the limited availability of quantitative data before that time. In the 2016 Index, the labor freedom measurement added labor force participation rates to its sub-factors. According to the International Labour Organization, the labor force participation rate is defined as “a measure of the proportion of a country’s working-age population that engages actively in the labour market, either by working or looking for work; it provides an indication of the size of the supply of labour available to engage in the production of goods and services, relative to the population at working age.” See “KILM 1. Labour Force Participation Rate,” in International Labour Organization, Key Indicators of the Labour Market, Eighth Edition (Geneva: International Labour Office, 2014), p. 29, http://kilm.ilo.org/2011/download/kilmcompleteEN.pdf. In light of the labor freedom assessment’s being refined with the addition of labor force participation rates, the reader is urged to use caution in comparing labor freedom scores over time.
6. The first six sub-factors specifically examine labor regulations that affect “the hiring and redundancy of workers and the rigidity of working hours.” For more detailed information on the data, see “Employing Workers,” in World Bank, Doing Business,
http://www.doingbusiness.org/MethodologySurveys/EmployingWorkers.aspx. Reporting only raw data, the Doing Business 2011 study discontinued all of the sub-indices of “Employing Workers”: the difficulty of hiring index, the rigidity of hours index, and the difficulty of redundancy index. For the labor freedom component of the 2014 Index, the three indices were reconstructed by Index authors according to the methodology used previously by the Doing Business study.
7. See note 4, supra.
8. MFN is now referred to as permanent normal trade relations (PNTR).
9. Given the fact that the Index is published several months after the cutoff date for evaluation, more recent economic events cannot be factored into the scores. In the past editions, however, such occurrences have been uncommon. The impact of policy changes and macroeconomic statistics available since the second half of 2017 has not affected the rankings for the 2018 Index but almost certainly will show up in scores for the next edition.
