2014 Index of Economic Freedom

Methodology

The Index of Economic Freedom focuses on four key aspects of the economic environment over which governments typically exercise some policy control:

  • Rule of law,
  • Government size,
  • Regulatory efficiency, and
  • Market openness.

To provide as comprehensive a picture as possible of conditions in these four categories, the Index measures 10 specific components of economic freedom, each of which is graded on a scale from 0 to 100. Scores on these 10 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 10 components of economic freedom.

RULE OF LAW

Property Rights

The property rights component is a qualitative assessment of the extent to which a country’s legal framework allows individuals to freely accumulate private property, secured by clear laws that are enforced effectively by the government. It measures 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 and analyzes the independence of the judiciary, the existence of corruption within the judiciary, and the ability of individuals and businesses to enforce contracts.

The more effective the legal protection of property, the higher a country’s score; similarly, the greater the chances of government expropriation of property or the less independent the judiciary, the lower a country’s score.

Each country’s property rights score is assessed according to the following criteria:

  • 100—Private property is guaranteed by the government. The court system enforces contracts efficiently and quickly. The justice system punishes those who unlawfully confiscate private property. There is no corruption or expropriation.
  • 90—Private property is guaranteed by the government. The court system enforces contracts efficiently. The justice system punishes those who unlawfully confiscate private property. Corruption is nearly nonexistent, and expropriation is highly unlikely.
  • 80—Private property is guaranteed by the government. The court system enforces contracts efficiently but with some delays. Corruption is minimal, and expropriation is highly unlikely.
  • 70—Private property is guaranteed by the government. The court system is subject to delays and is lax in enforcing contracts. Corruption is possible but rare, and expropriation is unlikely.
  • 60—Enforcement of property rights is lax and subject to delays. Corruption is possible but rare, and the judiciary may be influenced by other branches of government. Expropriation is unlikely.
  • 50—The court system is inefficient and subject to delays. Corruption may be present, and the judiciary may be influenced by other branches of government. Expropriation is possible but rare.
  • 40—The court system is highly inefficient, and delays are so long that they deter the use of the court system. Corruption is present, and the judiciary is influenced by other branches of government. Expropriation is possible.
  • 30—Property ownership is weakly protected. The court system is highly inefficient. Corruption is extensive, and the judiciary is strongly influenced by other branches of government. Expropriation is possible.
  • 20—Private property is weakly protected. The court system is so inefficient and corrupt that outside settlement and arbitration is the norm. Property rights are difficult to enforce. Judicial corruption is extensive. Expropriation is common.
  • 10—Private property is rarely protected, and almost all property belongs to the state. The country is in such chaos (for example, because of ongoing war) that protection of property is almost impossible to enforce. The judiciary is so corrupt that property is not protected effectively. Expropriation is common.
  • 0—Private property is outlawed, and all property belongs to the state. People do not have the right to sue others and do not have access to the courts. Corruption is endemic.

An intermediate score such as 75 or 45 may be assigned to countries whose property rights fall between two adjacent categories.

Sources. Unless otherwise noted, the Index relies on the following sources for information on property rights, in order of priority: Economist Intelligence Unit, Country Commerce, 2010–2013; U.S. Department of Commerce, Country Commercial Guide, 2010–2013; U.S. Department of State, Country Reports on Human Rights Practices, 2010–2012; and various news and magazine articles.

Freedom from Corruption

Corruption erodes economic freedom by introducing insecurity and uncertainty into economic relations. It also reduces economic vitality by increasing costs and shifting resources into unproductive activities.

The score for this component is derived primarily from Transparency International’s Corruption Perceptions Index (CPI), which measures the level of perceived corruption in 176 countries.

Transparency International revised its CPI methodology in 2012 and now reports CPI scores on a 0–100 scale in which a score of 100 indicates very little perceived corruption. Transparency International has indicated that country scores computed with its new methodology are not directly comparable to its scores for previous years. The Index has therefore adjusted its methodological use of CPI data in order to maintain as much comparability as possible between current freedom from corruption scores and scores from prior years. A two-step approach has been used.

First, the Index converts the raw CPI data to maintain approximately the same range of scores achieved in the previous Index, using the following equation:

CORRUPTIONxi = ((10–CPIx)/(10–95)) * 100

where CORRUPTIONxi represents an initially converted current-year corruption score for country x, CPIx represents Transparency International’s CPI score for country x, and 10 and 95 represent the previous minimum and maximum values achieved on the Index’s freedom from corruption score.

Second, in computing the final 2014 Index freedom from corruption scores, each country’s initially converted corruption score is averaged with its corruption scores from the previous two Index editions (2013 and 2012) so that year-to-year score incompatibility introduced by Transparency International’s new methodology is further reduced. Nonetheless, the reader is urged to use caution in comparing the 2014 Index’s corruption scores with the previous edition’s corruption scores.

For countries that are not covered in the CPI, the freedom from corruption score is determined by using the qualitative information from internationally recognized and reliable sources.1 This procedure considers the extent to which corruption prevails in a country. As with scores derived from Transparency International data, these scores are averaged with corruption scores from the previous two editions of the Index.

Sources. Unless otherwise noted, the Index relies on the following sources for information on informal market activities, in order of priority: Transparency International, Corruption Perceptions Index, 2010–2012; U.S. Department of Commerce, Country Commercial Guide, 2010–2013; Economist Intelligence Unit, Country Commerce, 2010–2013; Office of the U.S. Trade Representative, 2013 National Trade Estimate Report on Foreign Trade Barriers; and official government publications of each country.

GOVERNMENT SIZE

Fiscal Freedom

The fiscal freedom component is a composite measure of the burden of taxes that reflects both marginal tax rates and the overall level of taxation, including direct and indirect taxes imposed by all levels of government, as a percentage of GDP. The component score is derived from three quantitative 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.

Fiscal freedom scores are calculated with a quadratic cost function to reflect the diminishing revenue returns from very high rates of taxation. The data for each factor are converted to a 100-point scale using the following equation:

Fiscal Freedomij = 100 – α (Factorij)2

where Fiscal Freedomij represents the fiscal freedom 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 factor is zero, which is not represented in the printed equation but was utilized because it means that no single high tax burden will make the other two factors irrelevant.

As an example, in the 2014 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 the two factors. Mauritius’s overall tax burden as a portion of GDP is 18.3 percent, yielding a tax burden factor score of 90.0. When the three factors are averaged together, Mauritius’s overall fiscal freedom score becomes 92.2.

Sources. Unless otherwise noted, the Index relies on the following sources for information on taxation, 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,” 2010–2013; PricewaterhouseCoopers, Worldwide Tax Summaries, 2010–2013; 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, 2010–2013.

For information on tax burden as a percentage of GDP, the primary sources (in order of priority) were 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 2013; International Monetary Fund, Staff Country Report, “Selected Issues,” and Staff Country Report, “Article IV Consultation,” 2010–2013; Asian Development Bank, Key Indicators for Asia and the Pacific, 2010–2013; and individual contacts from government agencies and multinational organizations such as the IMF and 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 ranging from culture to geography to level of economic development. However, government spending becomes an unavoidable burden at some point as government grows in scope and size, resulting in both 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. Underdeveloped countries, particularly those with little government capacity, may receive artificially high scores as a result. 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 non-linear, 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 total amount of government spending at all levels as a portion of GDP (between 0 and 100); 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. Unless otherwise noted, 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 2013; International Monetary Fund, Staff Country Report, “Selected Issues and Statistical Appendix,” Staff Country Report, “Article IV Consultation,” 2010–2013, and World Economic Outlook Database 2012; Asian Development Bank, Key Indicators for Asia and the Pacific, 2010–2013; African Development Bank, The ADB Statistics Pocketbook 2013; official government publications of each country; and United Nations Economic Commission for Latin America, Economic Survey of Latin America and the Caribbean, 2010–2013.

REGULATORY EFFICIENCY

Business Freedom

Business freedom is an overall indicator of the efficiency of government regulation of business. The quantitative score is derived from an array of measurements of 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 10 factors, all 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);2
  • Obtaining a license—time (days);
  • Obtaining a license—cost (% of income per capita);
  • Closing a business—time (years);
  • Closing a business—cost (% of estate); and
  • Closing a business—recovery rate (cents on the dollar).3

Each of these 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 other countries. Even if a country requires the highest number of procedures for starting a business, which yields a score of zero in that factor, it could still receive a score as high as 90 based on scores in the other nine factors. Singapore, for instance, receives scores of 100 in nine of these 10 factors, but the 11 licensing procedures required by the government equate to a score of 68.2 for that factor, giving Singapore an overall business freedom score of 96.8.

Each factor is converted to a scale of 0 to 100 using the following equation:

Factor Scorei = 50 factoraverage/factori

which is based on the ratio of the country data for each factor relative to the world average, multiplied by 50. For example, on average worldwide, it takes 15 procedures to get necessary licenses. Canada’s 11 licensing procedures are a factor value better than the average, resulting in a ratio of 1.15. That ratio multiplied by 50 equals the final factor score of 68.2.

For the six 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.4

Sources. Unless otherwise noted, the Index relies on the following sources in determining business freedom scores, in order of priority: World Bank, Doing Business 2014; Economist Intelligence Unit, Country Commerce, 2010–2013; U.S. Department of Commerce, Country Commercial Guide, 2010–2013; 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.

Six quantitative factors are equally weighted, with each counted as one-sixth of the labor freedom component:5

  • 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, and
  • Mandatory severance pay.

Based on data collected in connection with the World Bank’s Doing Business report, these factors specifically examine labor regulations that affect “the hiring and redundancy of workers and the rigidity of working hours.”6

In constructing the labor freedom score, each of the six factors is converted to a scale of 0 to 100 based on the following equation:

Factor Scorei = 50 x factoraverage/factori

where country i data are calculated relative to the world average and then multiplied by 50.

The simple average of the converted values for the six factors is computed for the country’s overall labor freedom score. Even if a country had the worst rigidity of hours in the world with a zero score for that factor, it could still get a score as high as 83.3 based on the other five factors.

For the six countries that are not covered by the World Bank’s Doing Business report, the labor freedom component is scored by looking into labor market flexibility based on qualitative information from other reliable and internationally recognized sources.7

Sources. Unless otherwise noted, the Index relies on the following sources for data on labor freedom, in order of priority: World Bank, Doing Business 2014; Economist Intelligence Unit, Country Commerce, 2010–2013; U.S. Department of Commerce, Country Commercial Guide, 2010–2013; 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 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. Unless otherwise noted, 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, 2013; Economist Intelligence Unit, ViewsWire; and official government publications of each country.

OPEN MARKETS

Trade Freedom

Trade freedom is a composite measure of the extent of tariff and non-tariff 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
  • Non-tariff 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 = (((Tariffmax–Tariffi)/(Tariffmax–Tariffmin)) * 100) – 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 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.
  • Investment restrictions—exchange and other financial controls.
  • Customs restrictions—advance deposit requirements; customs valuation procedures; customs classification procedures; customs clearance procedures.
  • Direct government intervention—subsidies and other aid; government industrial policy and regional development measures; government-financed research and other technology policies; national taxes and social insurance; competition policies; immigration policies; government procurement policies; state trading, government monopolies, and exclusive franchises.

As an example, Botswana received a trade freedom score of 79.7. By itself, Botswana’s weighted average tariff of 5.2 percent would have yielded a score of 89.7, but the existence of NTBs in Botswana reduced its score by 10 points.

Gathering tariff statistics to make a consistent cross-country comparison is a challenging task. Unlike data on inflation, for instance, countries do not report their weighted average tariff rate or simple average tariff rate every year; in some cases, the most recent year for which a country reported its tariff data could be as far back as 2007.

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 World Bank publishes the most comprehensive and consistent information on weighted average applied tariff rates. 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.8 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. Unless otherwise noted, the Index relies on the following sources to determine scores for trade policy, in order of priority: World Bank, World Development Indicators 2013; World Trade Organization, Trade Policy Review, 1995–2013; Office of the U.S. Trade Representative, 2013 National Trade Estimate Report on Foreign Trade Barriers; World Bank, Doing Business 2012 and Doing Business 2013; U.S. Department of Commerce, Country Commercial Guide, 2009–2013; Economist Intelligence Unit, Country Commerce, 2010–2013; World Bank, Data on Trade and Import Barriers: Trends in Average Applied Tariff Rates in Developing and Industrial Countries, 1981–2010; 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 are typically 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 effectively eliminate investment freedom. Those 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 non-transparent
    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. Unless otherwise noted, 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; Economist Intelligence Unit, Country Commerce, 2010–2013; Office of the U.S. Trade Representative, 2013 National Trade Estimate Report on Foreign Trade Barriers; and U.S. Department of Commerce, Country Commercial Guide, 2010–2013.

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 where a minimum level of government interference exists, 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 into the following 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,
  • The extent of financial and capital market development,
  • Government influence on the allocation of credit, 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.

  • 100—Negligible government interference.
  • 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—Significant government interference. The central bank is not fully independent, and its supervision and regulation of financial institutions are somewhat burdensome. The government exercises active 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 extensively influenced 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. Private financial institutions are nonexistent.

Sources. Unless otherwise noted, the Index relies on the following sources for data on banking and finance, in order of priority: Economist Intelligence Unit, Country Commerce and Industry Report Financial Services, 2010–2013; International Monetary Fund, Staff Country Report, “Selected Issues,” and Staff Country Report, “Article IV Consultation,” 2010–2013; Organisation for Economic Co-operation and Development, Economic Survey; official government publications of each country; U.S. Department of Commerce, Country Commercial Guide, 2010–2013; Office of the U.S. Trade Representative, 2013 National Trade Estimate Report on Foreign Trade Barriers; U.S. Department of State, Investment Climate Statements, 2010–2013; World Bank, World Development Indicators 2013; and various news and magazine articles on banking and finance.

General Methodological Issues

Period of Study. For the current Index of Economic Freedom, scores are generally based on data for the period covering the second half of 2012 through the first half of 2013. To the extent possible, the information considered for each variable was current as of June 30, 2013. 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, 2010, to December 31, 2012.

Equal Weight. In the Index of Economic Freedom, the 10 components of economic freedom are equally weighted so that the overall score will not be biased toward any one component or policy direction. It is clear that the 10 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, 2013). Any new legislative changes or policy actions effective after that date have no positive or negative impact on scores or rankings.9

  1. ^The following countries are not covered by the 2012 CPI: Belize, Fiji, Kiribati, Macau, Micronesia, Maldives, Samoa, Solomon Islands, Tonga, and Vanuatu.
  2. ^Obtaining a license indicates necessary procedures, time, and cost in getting construction permits.
  3. ^The recovery rate is a function of time and cost. However, the business freedom component uses all three sub-variables to emphasize closing a business, starting a business, and dealing with licenses equally.
  4. ^The four countries that are not covered by the World Bank’s Doing Business study are Cuba, North Korea, Macau, and Turkmenistan. The methodology for business freedom dates from the 2006 Index because of the limited availability of quantitative data before that date. For the 1995 through 2005 editions, we used a subjective assessment with a score of 1–5. Those earlier scores have been converted by means of a simple formula to make them comparable. Top scores were converted to 100, the next best to 85, and so on. This conversion formula is different from the one used for other subjective factors, but it is unique because those other factors are not bridging to a new, data-driven methodology.
  5. ^The labor freedom assessment in the 2009 Index expanded its factors to six from the four used in previous editions. This refinement was applied equally to past editions’ labor freedom scores to maintain consistency. The assessment of labor freedom dates from the 2005 Index because of the limited availability of quantitative data before that time.
  6. ^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.
  8. ^MFN is now referred to as permanent normal trade relations (PNTR).
  9. ^Occasionally, because 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, such occurrences have been uncommon and isolated to one region of the world. The Asian financial crisis, for example, erupted at the end of 1997 just as the 1998 Index was going to print. The policy changes in response to that crisis, therefore, were not considered in that year’s scoring, but they were included in the next year’s scores. Similarly, this year, the impact of government policies and more recently available macroeconomic statistics since the second half of 2013 have not affected the rankings for the 2014 Index but almost certainly will show up in scores for the next edition.

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