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April 4, 2014

Using the Index of Economic Freedom: A Practical Guide

By

Abstract

This report is a practical guide for using the Index of Economic Freedom—the invaluable annual measure of economic (and hence political) freedom around the world. Published jointly by The Heritage Foundation and The Wall Street Journal, and celebrating its 20th anniversary in 2014, the ideas behind the Index are fundamental and enduring, applicable to many of the decisions that researchers and policymakers must make. This guide provides over 20 ways how people—whether policymakers, business owners, or interested individuals—can learn from and use the Index for advocacy, policy analysis, education, market analysis, investment promotion, academic research, and entrepreneurship. 

In 2014, the Index of Economic Freedom, co-published by The Wall Street Journal and The Heritage Foundation, celebrates its 20th anniversary. For two decades, the Index, by cataloguing economic policy developments of the globe, has served as a beacon for people around the world who recognize enhanced economic liberty and individual opportunity as the surest path to greater prosperity.

The Index has also been a practical guide for students, professors, educators, investors, government officials, think tank researchers, and advocacy groups across the world. Its timely and accurate research has become a significant source of information for experts in government policy, education, and market research, influencing leaders across the globe.

There is even more that the Index can do. This report is a practical guide to help individuals use the Index in their everyday lives, particularly as they struggle to enhance and defend their own economic freedom. The ideas behind the Index are fundamental and enduring, applicable to many of the decisions that researchers and policymakers must make. This guide provides over 20 ways how the Index can be used and built upon in advocacy, policy analysis, education, market analysis, investment promotion, academic research, and entrepreneurship. As the Index moves into its next decade, the publishers’ goal is to make it as useful and relevant as possible.

Advocacy

At the heart of the Index of Economic freedom is a desire to promote the ideals of liberty and economic empowerment throughout the world. Ordinary people at the grassroots level are constantly on the front lines promoting and defending the principles of economic freedom. The Index is a vital tool for those who want to mold a better livelihood for themselves, and better society in general, through advocacy. In 2014, no country in the Index received a perfect score, either overall or in any factor. This leaves plenty of ammunition for advocates of economic freedom to promote their causes. Those interested in advocating for increased levels of economic freedom in their country should consider:

  • Creating a scorecard for politicians. Politicians should be held accountable for their votes for and against the principles of economic freedom. One way to hold government representatives accountable is by tracking and recording their legislative record on economic freedom.[1]This could include tracking votes, bills introduced, bills sponsored, and other metrics. A grade could then be assigned based on the lawmaker’s record on economic freedom issues.
  • Organizing and promoting economic freedom in your local community. Meet with local members of your community and discuss the principles of economic freedom and how they can be applied to your city, state, or country. Sometimes the most powerful movements start in the smallest ways. Promoting economic freedom and educating others in your community is vital for spreading the word about the benefits of economic freedom. Contact The Heritage Foundation for access to Index materials to distribute in your community.[2]
  • Contacting your representatives. Hold your representatives accountable to the principles of economic freedom by educating them about its benefits. Be vocal about legislation that is not consistent with the principles of economic freedom by writing letters, making phone calls, and setting up meetings with your local and national lawmakers.
  • Distributing the Index of Economic Freedom. Perhaps the most valuable way to spread the word about the Index is by distributing the Index itself, as well Index highlights, books, and other Heritage research in the local community. Visit The Heritage Foundation’s online store to purchase a copy of the Index,[3] or contact The Heritage Foundation directly for resources on spreading economic freedom.

Policy Analysis

Economic freedom should be a guiding principle for policymakers and their staff as they shape the laws and institutions of society. The Index is a helpful guide for anyone interested in seeing which policies are succeeding, and which are failing, in promoting economic freedom. In addition, the Index and its complementary data[4]are a helpful barometer by which policymakers can measure the progress of building effective and efficient institutions and programs. Using Index analysis and data is also useful for measuring and benchmarking economic and institutional impacts, as laws and policies are implemented. For example, since 2004, the U.S. Millennium Challenge Corporation (MCC) has used the Index to determine whether countries should qualify for U.S. foreign assistance.[5] Policymakers who want to improve the efficacy of their efforts to promote prosperity by ensuring consistency with the principles of economic freedom can:

  • Develop economic reforms based on the Ten Economic Freedoms. The Index of Economic Freedom is based on 10 factors ranked on a numeric scale from zero to 100. With easy-to-read graphics on each country page, policymakers considering economic reforms may find significant opportunities for improving economic performance in those factors in which they score the lowest. These factors may indicate significant binding constraints on economic growth and prosperity. In addition, each country page presents in-depth justification for each factor score, allowing individuals to identify specific reforms to undertake.
  • Use the Index for research and analysis. The Index is not only a key statistical tool for measuring economic and other freedoms, but also an objective and detailed research publication for reference and analysis on public policies throughout the world. Each Index country page includes justification and analysis of policies related to each category of freedom. In addition, country pages provide detailed background knowledge, including a history and key macroeconomic data. This information is important for policymakers interested in developing reform and researching aspects of the economy in their country and others. 
  • Incorporate the Index in policy review and implementation. In the past, the Index has been essential in measuring policy outcomes from government agencies and private groups. Following the MCC as an example, U.S. and international policymakers can use the Index more frequently to monitor policy objectives and outcomes. This could include linking foreign policy objectives to economic freedom indicators and targeting the success of economic reform implementation to Index scores.
  • Create an economic freedom agenda in their country. Each year, experts at The Heritage Foundation update the “Global Agenda for Economic Freedom.” This report lays out key areas for reform that are consistent with the principle of economic freedom. It is a useful resource for policymakers around the globe who want to implement economic freedom policies in their countries.

Education

Understanding the principles of economic freedom and their importance in building more prosperous societies is a key lesson for students around the world. More often than not, students are not taught the historical connection between economic freedom and prosperity. According to the Council for Economic Education, only 22 states in the U.S. require economics courses in high school. In addition, the National Council for Economic Education (NCEE) finds that high school students’ knowledge of economic concepts is exceptionally low. In a 24-question quiz on economics and financial literacy conducted by the NCEE, the average American high school student scored 53 percent, a failing grade.[6] These results indicate that high school students are largely ignorant of economics and economic freedom in general. For educators, the Index is an educational tool that can been used as a framework for teaching students about economics and economic freedom.

Develop Curriculum. The principles of economic freedom include property rights, freedom from corruption, fiscal freedom, control of government spending, business freedom, labor freedom, monetary freedom, trade freedom, investment freedom, and financial freedom. Each of these fundamentals is a lesson in itself. Separately or as a whole, the principles of economic freedom can be molded and shaped into a variety of lesson plans and curricula, ranging from business courses to law and economics. A comprehensive course on economic freedom may include the following seven lessons:

  • Lesson 1: Philosophical Fundamentals of Economic Freedom. Students will learn the intellectual and philosophical foundations of economic freedom. This could include the works of Adam Smith, David Ricardo, Friedrich Hayek, and Milton Freidman. More advanced students can study the theoretical economic basis of the Index, including macroeconomics, new institutional economics, monetarism, and trade theory.
  • Lesson 2: Rule of Law. Students will learn how property rights and corruption affect the efficiency of markets. Student will be able to demonstrate an understanding of the incentives that underpin a society based on private property. Students will analyze the proliferation of rent-seeking and crony capitalism as it pertains to the increasing size of government.
  • Lesson 3: Government Size. Students will understand the effect that taxes and government spending have on individuals and entrepreneurs. This could include the negative incentives from excessive taxation, as well as the crowding out effect. More advanced students can study the different tax regimes and the difference between good and bad government spending.   
  • Lesson 4: Regulatory Efficiency. Students will understand the effects that government regulations have on the functioning of markets. Students should demonstrate knowledge of inflation, the interaction between businesses and regulators, and the importance of the freedom to work. Educators can use anecdotal evidence with which students are familiar to make the subject more relatable. For example, educators could relate business freedom and licensing to the frustration of going to the Department of Motor Vehicles to get a driver’s license. 
  • Lesson 5: Open Markets. Students will understand the benefits of trade, including absolute and comparative advantage. Students should also understand the effects that tariffs have on the goods they buy.
  • Lesson 6: Student Reforms. Students should learn about the economic freedom and historical background of an assigned country, using the Index and outside material as sources. Students should then identify that country’s weakest factor and explain why it scored badly on that point. Lastly, teachers should encourage students, whether separately or in groups, to develop ideas for reforms based on the Index of Economic Freedom.   
  • Lesson 7: Country and Regional Comparative Analysis. Students should choose one rich country and one poor country. Students should conduct a comparative analysis of each country, highlighting where the two economies have succeeded and failed based on the principles of economic freedom. The students should then answer the question “Why are some countries rich and others poor?” using the Index as a resource. 

Market Analysis

One of the central tenants of the Index is its emphasis on promoting competitiveness through the principles of economic freedom. As global markets expand and become more interconnected, businesses are increasingly looking for resources to help identify competitive and profitable opportunities both in the United States and overseas. The Index is an important tool for meeting this need. Drawing from a team of researchers, economists, and area specialists at The Heritage Foundation, the Index includes objective measurements, historical background, and policy analysis of 186 economies throughout the world. This detailed research can be used as an important resource for businesses and investors conducting market analysis. Potential applications include:      

  • Conducting political risk analysis. Included in each country page is a historical background that provides the political and historical context for the Index’s analysis and conclusions. This information, as well as key macroeconomic statistics, complement the 10 economic freedoms and provide readers with timely, objective information on the potential political risk of the country in question. This information can be used as an important reference for business leaders and investors as they seek to enter markets throughout the world.
  • Tracking economic reform. Pro-market economic reforms are essential to improving a country’s competitiveness and score in the Index of Economic Freedom. Perhaps one of the most important insights for businesses is that they operate not merely in an economy, but in a political economy. The Index is an unparalleled tool for tracking these political economies. Reforms that affect economic freedom and business functions are tracked on the country pages under the four aspects of economic freedom—(1) rule of law, (2) government size, (3) regulatory efficiency, and (4) market openness. This information provides vital insights into major reform agendas in countries throughout the world, as well as their policy outcomes.
  • Understanding regional competitiveness. The proliferation of regional supply chains and trading networks makes understanding regional competitiveness important for any investor. The Index is a helpful tool for identifying and analyzing competitive markets, both amongst and within geographical regions. Chapter 1 of the 2014 Index of Economic Freedom provides in-depth analysis of global and regional patterns of economic freedom, allowing readers to easily identify good policy and increased competitiveness across the globe. In addition, The Heritage Foundation’s color-coded, interactive “Heat Map” on the Index website is an easy to use the tool for quickly identifying regions of high economic freedom.[7]

Investment Promotion

Increasingly, countries across the globe are vying and competing for limited investment dollars. Attracting investment is key to growth and instituting good public policies, including economic freedom, and is vital for any country looking to improve its attractiveness on the international stage. In recent years, branding has become a crucial factor for marketing countries to global investors. Countries have turned to investment promotion and industrial development agencies to promote their economies. As a measure of economic freedom and competitiveness, the Index can help countries market themselves. In recent years, the Cyprus Investment Promotion Agency (CIPA) and Industrial Development Agency of Ireland (IDA Ireland) have both publically promoted their countries success in the Index.[8][9] Countries that would like to follow Cyprus’s and Ireland’s lead should consider:

  • Collaborating with The Heritage Foundation on an Index launch. Each year the launch of the Index of Economic Freedom is an exciting time for tracking the progress over the previous year. For some countries, the Index launch is a time for celebration as they move toward greater economic freedom. Promoting the success of one’s country on an investment or government website is an opportunity to show investors the attractiveness of your economy. Each January, The Heritage Foundation releases the annual edition of the Index of Economic Freedom. Heritage and its experts are available to provide press releases and expert commentary on a country’s progress toward economic freedom. 
  • Promoting their progress on your investment promotion website. Investment authorities regularly boast about good investment grades from Standard & Poor’s and Moody’s. Similarly, economic freedom is something to boast about, too. Promoting positive progress toward economic freedom on a country’s investment website is highly attractive to investors and observers and indicates a commitment to reform and good public policy.

Academic Research

The Index of Economic Freedom has its roots in academia. Indeed, it was Nobel Laureate Milton Freidman who first professed the need for a way to measure and monitor economic freedom around the world. Since then, the Index has been featured in numerous pieces of empirical and theoretical academic research from respected research institutions such as Wake Forest University, the University of Akron, and Illinois State University in the U.S., and the University of Vienna and Queen’s University abroad. Data driven and fact based, the Index is a useful qualitative and quantitative tool for academics and college students interested in studying the impacts that economic freedom has on economies and societies. Not only does the Index provide quantitative rankings and scores of all its factors across the 20 years history of the publication, each edition also provides important and reliable macroeconomic data as well as journal articles that contribute to academic literature. Academics and students can use the Index to:

  • Conduct quantitative analysis of the global economy. With over 20 years’ worth of data, the Index of Economic Freedom and its website database contain thousands of data points that can contribute to statistical and econometric analysis. In 2014 alone, the Index authors collected over 7,000 data points, and immeasurable qualitative research information. This information can be used to contribute to the growing academic literature on economic freedom over the past two decades. Index data can easily be accessed in the appendices of each edition, as well as through an easy-to-use website database.[10] Data include not only individual factor scores and rankings, but also macroeconomic data, including unemployment rates, gross domestic product (GDP), foreign direct investment (FDI) flows, and debt levels. All data are collected from impartial third-party sources, such as the World Bank, the International Monetary Fund, and the World Trade Organization.
  • Conduct background research. Not only does the Index offer quantitative information for academic researchers, it also provides detailed background and reference material on nearly every economy in the world. Each country page is packed with information on the countries’ recent social, economic, and political history authored by The Heritage Foundation’s foreign policy experts. In addition, the country page offers background information on each aspect of economic freedom: rule of law, government size, regulatory efficiency, and open markets. This includes up-to-date information and analysis of public policies, reforms, regulatory changes, and business environments. This information can be helpful for conducting background research and in-depth policy analysis.
  • Reference important macroeconomic data points. One of the most valuable pieces of Index data is the macroeconomic dataset that The Heritage Foundation researchers use to rank and score economies. With over 2,000 new data points added each year, this information covers important macroeconomic statistics, including tariff rates, income and corporate tax rates, population, GDP and GDP per capita, unemployment rates, inflation rates, FDI inflows, government expenditures, and tax burdens. Instead of searching through databases at multiple institutions, researchers can access this data for analysis at one central location: the Index of Economic Freedom’s website.
  • Learn about recent empirical and theoretical studies on economic freedom. Each edition of the Index of Economic Freedom includes work from scholars on the subjects of economic freedom and free markets. This year, the 2014 Index of Economic Freedom includes contributions on the morality of capitalism by John Tomasi of Brown University, and a study of conditional cash transfers in Bolivia by Sergio Daga of the Bolivian think tank Populi. Past editions of the Index have included works by noted Harvard University economist Robert Barro and Heritage scholars such as Derek Scissors and Tim Kane. These works can be easily accessed on the Index website, and contribute to a growing academic literature on economic freedom.[11]For current researchers, the data lays an important intellectual foundation for further free market studies.

Tools for Entrepreneurs

Opening up a business is difficult and risky. When coupled with high taxes, inefficient regulations, corruption, and financial risk, the barriers to becoming a successful entrepreneur can often be impossibly high. Sometimes these risks are difficult to track, and not abundantly clear. The Index can provide a solution to this asymmetry by serving as a transparent, easy-to-understand analytical tool to help entrepreneurs understand the risks of starting a business in their own country. Each of the Index’s four aspects—rule of law, government size, regulatory efficiency, and open markets—affect the operation of business and the ability of entrepreneurs to start and maintain profitable enterprises. As a result, entrepreneurs can use the Index as an important source to:

  • Understand the risks facing their businesses. High taxes and tariffs, inflation, excessive steps to obtain a business license, and unclear and arbitrary enforcement of property rights are all important risks facing businesses around the globe. The Index compiles these factors in a single source so that entrepreneurs can conveniently learn about the issues that they will face before filing their first tax return or heading to the business registrar.
  • Lobby lawmakers for increased economic freedom. In many countries, business communities are the most vocal and persistent advocates of economic freedom. As a result, they have the opportunity to promote economic freedom in national capitals around the world. As mentioned above, the Index can be used as an effective tool for tracking the public policy priorities of lawmakers and holding them accountable for the policies that either discourage, or encourage, entrepreneurship in their societies.
  • Track how public policy will affect their bottom line. Every action by lawmakers affects a business’s bottom line in some way. The Index of Economic Freedom helps to track these effects by measuring the ability of individuals and entrepreneurs to expand their businesses, and profits, without undue government intervention. Each freedom contains key insights into public policy developments of that respective country, allowing entrepreneurs to track the policies that directly affect them and their employees.

Go Forth

Going into its 21st year, the Index has the potential to be a vital tool for a large constituency, from investors to students to policymakers and beyond. This guide is a useful starting point for the next generation of individuals who wish to use and apply the principles of economic freedom in their lives. Using the Index, individuals can improve their businesses, advocate good public policies, educate their children and, most important, help build a society where freedom, opportunity, prosperity, and civil society flourish.

—Ryan Olson is a Research Assistant in the Center for International Trade and Economics at The Heritage Foundation.

Show references in this report

[1]See Heritage Action’s “Scorecard,” http://www.heritageactionscorecard.com

[2]For contact information, please see Terry Miller, Kim R. Holmes, and Anthony B. Kim, 2014 Index of Economic Freedom (Washington, DC: The Heritage Foundation and Dow Jones & Company, Inc., 2014), “About the Index,” http://www.heritage.org/index/about.

[3]To purchase the 2014 Index, please visit Shop Heritage, http://shop.heritage.org/.

[4]2014 Index of Economic Freedom, “Explore the Data,” http:// www.heritage.org/index/explore.

[5]Millennium Challenge Corporation, “Guide to the MCC Indicators and the Selection Process for Fiscal Year 2014,” September 2013, http://www.mcc.gov/documents/reports/reference-2013001142401-fy14-guide-to-the-indicators.pdf (accessed February 7, 2014).

[6]National Council for Economic Education, “What American Teens & Adults Know About Economics,” April 26, 2005, http://www.councilforeconed.org/cel/WhatAmericansKnowAboutEconomics_042605-3.pdf (accessed February 7, 2014).

[7]To view the 2014 Index of Economic Freedom “Heat Map,” go to http://www.heritage.org/index/heatmap.

[8]Cyprus Investment Promotion Agency, “2013 Index of Economic Freedom,” March 2013, http://www.investcyprus.org.cy/easyconsole.cfm/id/462 (accessed January 7, 2014).

[9]IDA Ireland, “Ireland Ranks First in Europe in 2010 Index of Economic Freedom,” January 22, 2010, http://www.idaireland.com/news-media/featured-news/ireland-ranks-first-in-eu/ (accessed January 7, 2014).

[10]To view the appendices to the 2014 Index, see 2014 Index of Economic Freedom, “Downloads,” http://www.heritage.org/index/download.

[11]To download scholarly contributions to the 2014 Index, see 2014 Index of Economic Freedom,“Downloads,” http://www.heritage.org/index/download.

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