November 6, 2014 | Special Report on Economic Freedom
The Heritage Foundation has been tracking and ranking trade freedom around the world since 1995. The rankings have consistently shown a correlation between trade freedom and improved lives. The latest rankings, reported in the forthcoming 2015 Index of Economic Freedom, once again confirm this connection. This report describes why trade is important to people around the world and provides options for advancing free trade.
Bryan Riley is Jay Van Andel Senior Analyst in Trade Policy in the Center for Trade and Economics, of the Institute for Economic Freedom and Opportunity, at The Heritage Foundation. Ambassador Terry Miller is Director of the Center for Trade and Economics and the Center for Data Analysis, of the Institute for Economic Freedom and Opportunity, and Mark A. Kolokotrones Fellow in Economic Freedom at The Heritage Foundation.
The latest rankings of trade freedom around the world, developed by The Heritage Foundation and The Wall Street Journal in the forthcoming 2015 Index of Economic Freedom, once again demonstrate that citizens of countries that embrace free trade are better off than those in countries that do not. The data continue to show a strong correlation between trade freedom and a variety of positive indicators, including economic prosperity, low poverty rates, and clean environments. Worldwide, the average trade freedom score improved from 74.8 to 75.3 out of a maximum score of 100.
The volume of world trade in goods and services plummeted during the global recession, but trade measured in U.S. dollars has rebounded to historically high levels. Since the creation of the World Trade Organization (WTO), global exports have increased by 364 percent, nearly two-and-a-half times more than world gross domestic product (GDP). The WTO predicts that global trade will grow by 4 percent in 2015.
U.S. trade volume has also increased. Total U.S. exports and imports exceeded $5 trillion for the first time in 2013.
A comparison of economic performance and trade scores in the 2015 Index of Economic Freedom demonstrates the importance of trade freedom to prosperity and well-being. Countries with the most trade freedom have higher per capita incomes, lower incidences of hunger in their populations, and cleaner environments.
Since World War II, international trade agreements have been a successful tool for reducing barriers to global commerce. In 1947, the average tariff rate in industrial countries was about 40 percent. Today, the average worldwide tariff rate is less than 3 percent. As Heritage Foundation economist Joe Cobb pointed out 20 years ago when Congress was debating the implementing legislation for the Uruguay Round trade pact, these agreements also promote freedom and individual sovereignty:
The most populist and democratic institution ever to evolve in human society is the free market, with strong protections for private property rights, and the freedom of average people to buy whatever they think is best for their families—regardless of the economic nostrums of protectionists.
Major reductions in trade barriers took place under the auspices of the General Agreement on Tariffs and Trade (GATT), culminating in the creation of the WTO. However, progress toward multilateral trade liberalization has stalled since then.
From 1947 to 1994, a new round of global trade negotiations was held on average about every six years. The longest gap between agreements was 15 years. It has now been 20 years since the creation of the WTO and conclusion of the Uruguay Round, the last comprehensive global trade agreement.
Although progress toward global trade agreements, including the WTO’s Doha Round, has stalled, use of regional and bilateral free trade agreements to reduce trade barriers has filled the void. Over 200 of these agreements have taken effect since the WTO was created, and dozens more are being negotiated. In addition, many countries have unilaterally reduced trade barriers.
Several ongoing global initiatives promise to lower trade barriers even further. Those initiatives include the Trade Facilitation Agreement, Trade in Services Agreement (TISA), Continental Free Trade Area (CFTA) for Africa, Trans-Pacific Partnership (TPP), and the Transatlantic Trade and Investment Partnership (TTIP).
Trade Facilitation Agreement. In December 2013, WTO members finalized negotiations of the Trade Facilitation Agreement. This agreement encourages measures such as using common customs standards, facilitating electronic payment, publishing trade procedures, customs cooperation, and using a “single window” for trade documents.
As The Heritage Foundation recently noted, cutting red tape at border crossings and improving customs and border procedures would be extremely beneficial. The Peterson Institute for International Economics estimates that trade facilitation could boost global GDP by $960 billion.
Regrettably, India has blocked implementation of the agreement. Whether this trade deal will ever be implemented remains to be seen.
Trade in Services Agreement. In 2013, countries representing a majority of the world’s services market launched the TISA. Trade in services includes international commerce in transportation, travel, communications services, construction, insurance, banking, and computer services. Services exports account for about one-fifth of all global exports. Yet numerous barriers interfere with the free flow of trade in services, including:
Service industries account for about 75 percent of the U.S. and European Union (EU) economies.
Continental Free Trade Area for Africa. The African Union represents nearly every country on the continent. In 2012, the African Union Summit approved a plan to create the CFTA for Africa by 2017. According to the Action Plan for Boosting Intra-Africa trade:
Trade is widely accepted as an important engine of economic growth and development. There are many regions and countries of the world that have been able to lift their peoples from poverty to prosperity through trade. Although the African economy is characterized by a relatively high degree of openness, with the ratio of exports and imports to GDP amounting to 55.7% in 2009, trade has not served as a potent instrument for the achievement of rapid and sustainable economic growth and development for many of the countries. As a consequence, Africa remains the most aid-dependent continent of the world, unable to eliminate poverty through trade.
Potential benefits identified by the African Union include improved food security through reductions in agricultural protectionism, increased competitiveness, and reduced reliance on foreign aid. Negotiations are scheduled to begin in 2015.
Trans-Pacific Partnership. The TPP is a set of trade and investment negotiations among the United States, Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam.
The TPP is intended to be a “gold standard” agreement that will be open to additional parties, eventually becoming the core of a free trade area for the Asia–Pacific. According to a TPP statement:
A final Trans-Pacific Partnership agreement must reflect our common vision to establish a comprehensive, next-generation model for addressing both new and traditional trade and investment issues, supporting the creation and retention of jobs and promoting economic development in our countries. The deepest and broadest possible liberalization of trade and investment will ensure the greatest benefits for countries’ large and small manufacturers, service providers, farmers, and ranchers, as well as workers, innovators, investors, and consumers.
A high-quality TPP agreement that meets these goals and is open to additional countries would provide a tremendous boost to global trade freedom.
Transatlantic Trade and Investment Partnership. In February 2013, President Barack Obama called for a free trade agreement between the United States and the EU during his State of the Union address. This proposed agreement is now known as the Transatlantic Trade and Investment Partnership. A TTIP agreement that reduces barriers to trade and investment between the United States and the EU, thereby empowering individuals on both continents, would boost trade freedom. To be successful, negotiators need to resist efforts to create new regulatory barriers to trade under the guise of “harmonization.”
In addition to these and other trade agreements, all countries have the opportunity to reduce trade barriers on their own and reap the benefits, including increased foreign investment and faster economic growth.
With the growth in value chains (described below), more countries should recognize the benefits of unilateral tariff cuts.
In the past, many countries embraced a misguided mercantilist view of trade: exports good, imports bad. This theory is especially damaging in today’s global economy, which increasingly relies on global value chains. Today, it is rare for a product traded on the global market to be made entirely in one country. Trade analysts generally understand that the modern global economy has changed how people should think about trade:
Examples of how traditional trade statistics can be misleading include:
In 2013, a World Economic Forum study concluded that reducing barriers to global supply chains could increase global GDP by up to six times more than eliminating all tariffs. As the Heritage Foundation has observed, “Promoting free trade should not just be about exports. Imports are a vital part of the U.S. economy, creating valuable jobs in some of our most innovative sectors.” This is especially evident when businesses import the intermediate goods they need to make competitive products.
Governments interested in higher economic growth, less hunger, and better environmental quality should reduce trade barriers. Options for boosting trade freedom include:
Surveys suggest that people would welcome leadership on these issues. According to a recent Pew Research survey conducted in 44 countries, a median of 81 percent of people believe trade is good. A 2014 survey by the Chicago Council for Public Affairs found strong support for international commerce in the United States. According to that survey, 65 percent of Americans believe “globalization, especially the increasing connections of our economy with others around the world, is mostly good for the United States.”
The 2015 Index of Economic Freedom shows that people who live in countries with low trade barriers are better off than those who live in countries with high trade barriers. Reducing those barriers—whether unilaterally, bilaterally, or multilaterally through regional trade agreements, comprehensive global agreements, or sector-specific negotiations—is a proven recipe for prosperity.
The trade freedom scores reported in this paper are based on two variables: trade-weighted average tariff rates 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 basic calculation of the score using the equation:
Trade Freedomi = (Tariffmax – Tariffi) / (Tariffmax – Tariffmin) x 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, and the upper bound was set as a score of 50. NTBi, 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:
Both qualitative and quantitative data are used to determine the extent of NTBs in a country’s trade policy regime. Restrictive rules that hinder trade vary widely, and their overlapping and shifting nature makes gauging their complexity difficult. The categories of NTBs considered in the trade freedom penalty include:
As an example, Brazil received a trade freedom score of 69.6. By itself, Brazil’s weighted average tariff of 7.7 percent would have yielded a score of 84.6, but the existence of NTBs in Brazil reduced its score by 15 points.
Gathering data on tariffs to make a consistent cross-country comparison can be 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 trade policy, the authors use the World Bank’s most recently reported weighted average tariff rate for a country. If another reliable source reported more updated information on a country’s tariff rate, the authors note this fact and may review the grading if strong evidence indicates that the most recently reported weighted average tariff rate is outdated.
The World Bank produces the most comprehensive and consistent information on weighted average applied tariff rates. When the weighted average applied tariff rate is not available, the authors use the country’s average applied tariff rate. When the country’s average applied tariff rate is not available, the authors use the weighted average or the simple average of most-favored-nation (MFN) tariff rates. In the very few cases in which data on duties and customs revenues are not available, the authors use international trade tax data instead.
In all cases, the authors clarify the type of data used and the different sources for those data in the corresponding write-up for the trade policy factor. When none of this information is available, the authors simply analyze the overall tariff structure and estimate an effective tariff rate.
The trade freedom scores for 2015 are based on data for the period covering the second half of 2013 through the first half of 2014. To the extent possible, the information is current as of June 30, 2014. Any changes in law effective after that date have no positive or negative impact on the 2015 trade freedom scores.
Finally, unless otherwise noted, the authors use the following sources to determine scores for trade policy, in order of priority:
 See Appendix A.
 The 2015 Index of Economic Freedom will be published in January 2015. The trade freedom scores, which account for 10 percent of a country’s overall economic freedom score, were released early at the request of the Millennium Challenge Corporation, which uses them as part of its criteria for determining countries’ eligibility for grants.
 World Bank, “Trade (% of GDP),” http://data.worldbank.org/indicator/NE.TRD.GNFS.ZS (accessed October 9, 2014).
 Press release, “WTO Lowers Forecast After Sub-Par Trade Growth in First Half of 2014,” World Trade Organization, September 23, 2014, http://www.wto.org/english/news_e/pres14_e/pr722_e.htm (accessed October 9, 2014).
 U.S. Department of Commerce, Bureau of Economic Analysis, “International Data,” Table 1.1, http://www.bea.gov/iTable/iTable.cfm?ReqID=62&step=1#reqid=62&step=2&isuri=1&6210=1 (accessed October 9, 2014).
 Douglas A. Irwin, “International Trade Agreements,” in David R. Henderson, ed., The Concise Encyclopedia of Economics, 2nd ed. (Indianapolis: Liberty Fund, 2008), http://www.econlib.org/library/Enc/InternationalTradeAgreements.html (accessed August 1, 2014), and World Bank, “Tariff Rate, Applied, Weighted Mean, All Products (%),” http://data.worldbank.org/indicator/TM.TAX.MRCH.WM.AR.ZS (accessed October 1, 2014).
 Joe Cobb, “The Real Threat to U.S. Sovereignty,” Heritage Foundation Lecture No. 497, August 1, 1994, http://www.heritage.org/research/lecture/hl497nbsp-the-real-threat-to-us-sovereignty.
 Office of the U.S. Trade Representative, “Saving Money, Growing Trade, Raising Incomes Worldwide: The New WTO Trade Facilitation Agreement,” December 2013, http://www.ustr.gov/about-us/press-office/fact-sheets/2013/December/WTO-Trade-Facilitation-Agreement (accessed October 9, 2014).
 Ryan Olson, “Obama Should Push Modi on Trade Facilitation,” Heritage Foundation Issue Brief No. 4279, September 25, 2014, http://www.heritage.org/research/reports/2014/09/obama-should-push-modi-on-trade-facilitation (accessed October 9, 2014).
 Gary Hufbauer and Jeffrey Schott, “Payoff from the World Trade Agenda 2013,” Peterson Institute for International Economics, June 14, 2013, http://www.iie.com/publications/papers/hufbauer-schott20130614ppt.pdf (accessed October 9, 2014).
 Eric Bellman and Peter Kenny, “India Blocks WTO Agreement to Ease Trade Rules,” The Wall Street Journal, July 27, 2014, http://online.wsj.com/articles/india-blocks-wto-agreement-to-ease-trade-rules-1406471335 (accessed October 9, 2014).
 Coalition of Services Industries, “Why America Needs a New Trade in Services Agreement,” December 2013, https://servicescoalition.org/images/TiSA_Background.pdf (accessed October 9, 2014).
 Reuters, “U.S. Says Basic Outline in Place for Int’l Services Trade Deal,” June 18, 2014, http://www.reuters.com/article/2014/06/18/usa-trade-services-idUSL2N0OY0M020140618 (accessed October 9, 2014).
 African Union, “Action Plan for Boosting Intra-African Trade,” http://www.au.int/en/sites/default/files/Action%20Plan%20for%20boosting%20intra-African%20trade%20F-English.pdf (accessed October 9, 2014).
 Assembly of the African Union, “Boosting Intra-African Trade,” Assembly of the African Union, January 29–30, 2012, http://ti.au.int/en/sites/default/files/Boosting%20IAT%20Assembly%20AU%202%20%28XVIII%29%20English.pdf (accessed October 9, 2014).
 Press release, “Experts Discuss the Establishment of the Continental Free Trade Area,” African Union, April 7, 2014, http://ti.au.int/en/sites/default/files/cfta%20-%20Press%20release%20Englishbcc%20%282%29.pdf (accessed October 9, 2014).
 The White House, “Trans-Pacific Partnership Leaders Statement,” October 8, 2013, http://www.whitehouse.gov/the-press-office/2013/10/08/trans-pacific-partnership-leaders-statement (accessed October 9, 2014).
 Richard Baldwin, “Unilateral Tariff Liberalisation,” Centre for Trade and Economic Integration Working Paper, April 2011, http://graduateinstitute.ch/webdav/site/ctei/shared/CTEI/working_papers/CTEI-2011-04.pdf (accessed April 18, 2013).
 Pierre-Louis Vézina, “Race-to-the-Bottom Tariff Cutting,” Graduate Institute of International and Development Studies Working Paper No. 12/2010, July 2010, http://repec.graduateinstitute.ch/pdfs/Working_papers/HEIDWP12-2010.pdf (accessed April 18, 2013).
 International Bank for Reconstruction and Development and World Bank, “Global Economic Prospects: Trade Regionalism, and Development,” 2005, http://siteresources.worldbank.org/INTGEP2005/Resources/gep2005.pdf (accessed April 19, 2013).
 Moises Naim, “The Free-Trade Paradox,” Foreign Policy, August 17, 2007, http://www.foreignpolicy.com/articles/2007/08/16/the_free_trade_paradox (accessed October 17, 2014).
 William M. Powers, “The Value of Value Added: Measuring Global Engagement with Gross and Value-Added Trade,” U.S. International Trade Commission, Office of Economics Working Paper No. 2012-11A, November 2012, p. 1, http://www.usitc.gov/publications/332/working_papers/EC201211A.pdf (accessed October 9, 2014).
 Organisation for Economic Co-operation and Development and World Trade Organization, “Trade in Value-Added: Concepts, Methodologies and Challenges,” p. 1, http://www.oecd.org/sti/ind/49894138.pdf (accessed October 9, 2014).
 World Trade Organization, “Globalization of Industrial Production Chains and Measurement of Trade in Value Added,” conference proceedings, October 2010, p. 3, http://www.wto.org/english/res_e/booksp_e/act_conf_e.pdf (accessed October 9, 2014).
 Organisation for Economic Co-operation and Development, “Interconnected Economies: Benefiting from Global Value Chains,” 2013, p. 25, http://www.oecd.org/sti/ind/interconnected-economies-GVCs-synthesis.pdf (accessed October 9, 2014).
 Kenneth L. Kraemer, Greg Linden, and Jason Dedrick, “Capturing Value in Global Networks: Apple’s iPad and iPhone,” July 2011, p. 7, http://pcic.merage.uci.edu/papers/2011/value_ipad_iphone.pdf (accessed October 9, 2014).
 Galina Hale and Bart Hobijn, “The U.S. Content of ‘Made in China,’” Federal Reserve Bank of San Francisco Economic Letter, August 8, 2011, http://www.frbsf.org/economic-research/publications/economic-letter/2011/august/us-made-in-china/ (accessed October 9, 2014).
 Susan B. Hester, “Analyzing the Value Chain for Apparel Designed in the United States and Manufactured Overseas,” Moongate Associates, p. 1, http://tppapparelcoalition.org/uploads/021313_Moongate_Assoc_Global_Value_Chain_Report.pdf (accessed October 9, 2014).
 News release, “Report: Reducing Supply Chain Barriers Could Increase Global GDP up to Six Times More Than Removing All Import Tariffs,” World Economic Forum, January 23, 2013, http://www.weforum.org/news/report-reducing-supply-chain-barriers-could-increase-global-gdp-six-times-more-removing-all-imp (accessed October 9, 2014).
 Ryan Olson, “Mr. President, Don’t Forget: Imports Create Jobs, Too,” The Daily Signal, February 20, 2013, http://dailysignal.com/2013/02/20/mr-president-dont-forget-imports-create-jobs-too/ (accessed October 9, 2014).
 Pew Research Center, Spring 2014 Global Attitudes Survey, Q27, http://www.pewglobal.org/2014/09/16/faith-and-skepticism-about-trade-foreign-investment/trade-09/ (accessed October 9, 2014).
 Dina Smeltz and Ivo Daalder, “Foreign Policy in the Age of Retrenchment,” Chicago Council on Global Affairs, p. 37, http://www.thechicagocouncil.org/UserFiles/File/Task%20Force%20Reports/2014_CCS_Report.pdf (accessed October 9, 2014).
 The MFN tariff rate is the “normal” non-discriminatory tariff charged on imports. In commercial diplomacy, exporters seek MFN treatment—that is, the promise that they will be treated as well as the most favored exporter. The MFN rule requires that the concession be extended to all other members of the World Trade Organization. MFN is now referred to as permanent normal trade relations (PNTR).