2009 Index of Economic Freedom

Quick Facts

Population:

• 0.1 million

GDP (PPP):

• $0.5 billion
• 1.3% growth
• 2.2% 5-year compound annual growth
• $5405 per capita

Unemployment:

• 13.0%

Inflation (CPI):

• 5.9%

FDI Inflow:

• $10.5 million

The 2009 Index is the first to assess Tonga’s level of economic freedom. The country’s economic freedom score is 54.1, making its economy the 126th freest in the Index. Tonga is ranked 26th out of 41 countries in the Asia–Pacific region, and its overall score is below the world average.

Tonga's economy remains dependent on overseas remittances, which account for more than 20 percent of GDP, outweighing income from tourism, agricultural exports, and other economic activities. The poor business environment has contributed significantly to Tonga's low level of productivity and economic growth despite the country's workforce, which is considered the best educated among the Pacific Island nations.

Tonga's public sector continues to play a dominant role in economic activity, crowding out the private sector. The government is the most prominent source of employment. Despite several reform measures that include broad-based tax reform in late 2007, Tonga's legal and regulatory framework remains weak. Frequent policy changes and opaque commercial regulations increase uncertainty and raise the overall cost of business activity. Protection of property rights is weak, and corruption remains a serious problem.

Background Back to the top

The Kingdom of Tonga is the South Pacific's last Polynesian monarchy. Some 100,000 people are spread across 48 of its 171 islands. Tonga has been independent since 1970. Its politics are dominated by the royal family, hereditary nobles, and a small number of other landholders. There are no political parties. More than half of the population lives abroad, and the economy is heavily dependent on their remittances. Agriculture is the principal productive sector of the economy.

Business Freedom 79.0 Back to the top

The overall freedom to start, operate, and close a business is respected under Tonga's regulatory environment. Starting a business takes an average of 25 days, compared to the world average of 38 days. Obtaining a business license requires less than the world average of 18 procedures. Closing a business is time-consuming and costly.

Trade Freedom 56.0 Back to the top

Tonga's weighted average tariff rate was 17 percent in 2006. Tonga has made progress in liberalizing its trade regime, but import restrictions, import taxes, import certification requirements, and inadequate infrastructure add to the cost of trade. Ten points were deducted from Tonga's trade freedom score to account for non-tariff barriers.

Fiscal Freedom 82.5 Back to the top

A comprehensive tax reform package implemented in late 2007 resulted in consolidation of the corporate tax and simplification of the overall system. The top income tax rate was raised to 20 percent, and the top corporate tax rate is 25 percent. Other taxes include a value-added tax (VAT) and a vehicle tax. In the most recent year, overall tax revenue as a percentage of GDP was 27.0 percent.

Government Size 58.0 Back to the top

Total government expenditures, including consumption and transfer payments, are high. In the most recent year, government spending equaled 37.4 percent of GDP.

Monetary Freedom68.9 Back to the top

Inflation is relatively high, averaging 6.5 percent between 2005 and 2007. The government influences prices of petroleum products and other commodities through regulations. The ruling family and other Tongan nobles control other key prices through their ownership of most enterprises and utilities. Fifteen points were deducted from Tonga's monetary freedom score to adjust for measures that distort domestic prices.

Investment Freedom40.0 Back to the top

Foreign investors are restricted by law from doing business in certain sectors and must be approved by the government. The government allows full ownership by a foreign investor in cases where manufacturing activities are using imported raw materials for export or the investments are too large for local investors; however, the government encourages joint ventures. Bureaucracy is generally transparent and efficient. To conserve foreign exchange, the National Reserve Bank of Tonga exercises some control of foreign receipts and payments. The repatriation of funds, including dividends, profits, capital gains, interest on capital and loan repayment, and salaries, faces some restrictions. Land may be leased but not owned.

Financial Freedom20.0 Back to the top

Tonga's small financial sector remains underdeveloped and dominated by banking. There are three commercial banks operating in the country, and financing is generally available to domestic as well as foreign investors without restrictions. However, the relatively high costs of credit and limited access to financing impede more dynamic entrepreneurial activity. A considerable portion of the island's population is outside of the formal banking sector. The National Reserve Bank of Tonga oversees banking, and the government-owned Tonga Development Bank finances many development projects. Capital markets are undeveloped.

Property Rights20.0 Back to the top

Tonga has a fairly efficient legal system based on British common law. The judiciary is independent and conducts generally fair public trials, although all judges are appointed by the monarch. Property rights are uncertain. The constitution mandates that an 8.25-acre plot of communally owned land be given to each male at age 16, but there is not enough land available to fulfill that mandate for the rapidly growing population, and this is a source of dissension. Tonga has legislation protecting intellectual property rights, but enforcement of IPR laws is weak. Counterfeit and pirated products are widely available on the local market.

Freedom From Corruption17.0 Back to the top

Corruption is perceived as rampant. Tonga ranks 175th out of 179 countries in Transparency International's Corruption Perceptions Index for 2007. Although the law provides criminal penalties for official corruption, government officials sometimes engage in corrupt practices with impunity. In a high-profile case in 2006, the Speaker of the Tongan Parliament was convicted and fined for bribery. Another minister has been accused of misappropriating public funds. Government preferences appear to benefit businesses associated with members of the royal family.

Labor Freedom99.4 Back to the top

Tonga's flexible labor regulations facilitate employment and productivity growth. The non-salary cost of employing a worker is low, and dismissing a redundant employee is not costly. However, the formal labor market is not fully developed.