The property rights component assesses the extent to which a country's legal framework allows individuals to acquire, hold, and utilize private property and the extent to which these rights are secured by applicable 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 level of state expropriation of private property. The more effective the legal protection of property is, the higher a country's score will be, and the greater the chances of government expropriation of property are, the lower a country's score will be.

The score for this component is derived by averaging scores for three equally weighted sub-factors:

• Risk of expropriation,
• Respect for intellectual property rights, and
• Quality of contract enforcement, property rights, and law enforcement.

Sources: The Index relies on the most recent available versions of the following sources in assessing property rights: Credendo, Country Risk and Insights; U.S. Chamber of Commerce, Global Innovation Policy Center, International IP Index; and World Bank, Worldwide Governance Indicators.

Properly functioning legal frameworks are essential for protecting the rights of all citizens against unlawful acts by others, including governments and powerful private parties. Judicial effectiveness requires efficient and fair judicial systems to ensure that laws are fully respected and appropriate legal actions are taken against violations.

The score for the judicial effectiveness component is derived by averaging scores for three equally weighted sub-factors:

• Judicial independence,
• Quality of the judicial process, and
• Perceptions of the quality of public services and the independence of the civil service.

Sources: The Index relies on the most recent available versions of the following sources in assessing judicial effectiveness: Freedom House, Freedom in the World, and World Bank, Worldwide Governance Indicators.

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 that such practices cause reduces public trust and economic vitality by increasing the costs of economic activity.

The score for this component is derived by averaging scores for three equally weighted sub-factors:

• Perceptions of corruption,
• Bribery risk, and
• Control of corruption including “capture” of the state by elites and private interests.

Sources: The Index relies on the most recent versions of the following sources in assessing government integrity: Transparency International, Corruption Perceptions Index; TRACE International, Trace Bribery Risk Matrix®; and World Bank, Worldwide Governance Indicators.

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 equally weighted 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.

Sources: The Index relies on the most recent available data from the following sources for information on tax rates, in order of priority: KPMG International; Deloitte, Tax Guides and 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; and other government authorities (embassy confirmations and/or the country’s treasury or tax authority).

For information on the tax burden as a percentage of GDP, the primary sources are World Bank, World Development Indicators; Organisation for Economic Co-operation and Development data; Eurostat, Government Finance Statistics; African Development Bank Group, African Economic Outlook; International Monetary Fund, Government Finance Statistics (GFS) database, Staff Country Report, “Selected Issues,” and Staff Country Report, “Article IV Consultation”; Asian Development Bank, Key Indicators for Asia and the Pacific; and United Nations Economic Commission for Latin America, Economic Survey of Latin America and the Caribbean.

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.

The Index does not 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 public sector’s size and scope leads inevitably to misallocation of resources and loss of economic efficiency. As volumes of research have shown, 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—especially those with little government capacity—may receive artificially high scores. However, such governments can provide few if any public goods and will probably 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 spending that is close to zero is lightly penalized and spending that exceeds 30 percent of GDP leads to much worse scores in a quadratic fashion (for example, twice as much spending yields four times less freedom). Only extraordinarily high levels of government spending (for example, more than 58 percent of GDP) receive a score of zero.

Sources: The Index relies on the most recent versions of 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 Group, 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, AfDB Statistics Pocketbook; official government publications of each country; and United Nations Economic Commission for Latin America, Economic Survey of Latin America and the Caribbean.

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, and deteriorating fiscal health 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 contribute to productive investment and ultimately to economic growth. However, mounting public debt driven by persistent budget deficits—and especially by 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).

For most countries, the Index uses general government deficit and debt data for all levels of government, from national to local. In cases where such general government data are not available, data on central government expenditures are used.

For several countries, particularly developing countries, statistics related to budget balance as a percentage of GDP are subject to frequent revisions by such data sources as the IMF.

Sources: The Index relies on the most recent available versions of 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, AfDB Statistics Pocketbook; and official government publications of each country.

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
• A qualitative evaluation of nontariff barriers (NTBs).

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 hard to measure. The types of NTBs considered in our scoring include:

• Quantity restrictions: import quotas; export limitations; voluntary export restraints; import‐export embargoes and bans; countertrade; etc.
• 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.
• In addition, where possible, we consider and report the number of nontariff measures in force as calculated by the World Trade Organization (WTO).

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 a country’s most recently reported most favored nation (MFN) trade-weighted average tariff rate from our primary source.

The most comprehensive and consistent information on MFN trade-weighted average tariff rates is published by the WTO. When the MFN trade-weighted average applied tariff rate is not available, the Index uses the country’s simple average of MFN tariff rates; when the country’s simple average MFN tariff rate is not available, the weighted average or the simple average of applied tariff rates is used. In the very few cases for which tariff rates are not available from the WTO or the World Bank, data on international trade taxes or an estimated effective tariff rate are used.

Sources: The Index relies on the most recent versions of the following sources in determining scores for trade policy, in order of priority: World Trade Organization, World Tariff Profiles; 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; U.S. Department of Commerce, Country Commercial Guide; and official government publications of each country.

In an economically free country, there would be no constraints on the flow of investment capital. Individuals and firms would be able 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 Index’s investment freedom component.

In practice, however, most countries impose 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 are deducted from the ideal score of 100 for each of the restrictions 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 scores for the few governments that impose so many restrictions that they total more than 100 points in deductions are set at zero.

• Investment Restrictions
• National treatment of foreign investment
• Foreign investment code
• Restrictions on land ownership
• Sectoral investment restrictions
• Expropriation of investments without fair compensation
• Foreign exchange controls
• Capital controls

As many as 20 additional points may be deducted for security problems, a lack of basic investment infrastructure, or other government policies that inject a considerable degree of uncertainty and indirectly burden the investment process and limit investment freedom.

Sources: The Index relies on the most recent versions of 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; 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 is both an indicator of banking efficiency and 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; 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; and foreign financial institutions operate freely and are treated the same as domestic institutions.

To assess the overall level of financial freedom that ensures easy and effective access to financing opportunities for people and businesses in a country’s economy, the Index takes account of 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.

Sources: The Index relies on the most recent versions of the following sources for data on banking and finance, in order of priority: International Monetary Fund, Staff Country Report, “Selected Issues,” and Staff Country Report, “Article IV Consultation”; Organisation for Economic Co-operation and Development, Economic Surveys; 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.