Government efforts to control the ability of individuals and businesses to exchange goods and services freely across borders have once again intensified during the past year. The Heritage Foundation’s forthcoming 2022 Index of Economic Freedom finds that the global average of countries’ trade-freedom scores has declined from 70.9 to 69.5 on the Index’s 0-to-100 trade-freedom scale. This is the fourth straight year that the global average has dropped.
Trade freedom declined in 98 of the 177 countries ranked in the Index. Scores improved in only 37 countries and were unchanged in 42 countries. The U.S. score declined by more than five points to 75.2. China, by contrast, gained two points to achieve a new score of 73.2.
Basics of Trade Freedom
Trade freedom measures the degree to which individuals and businesses are able to buy from and sell to people and businesses around the world free from government intervention. Governments typically implement trade barriers to control the flow of imports, most often in an attempt to insulate domestic producers from foreign competition. They also occasionally restrict exports. Barriers to trade freedom include tariffs (taxes on imports) as well as nontariff barriers. Nontariff barriers are varied and can range from quotas to trade-distorting subsidies and regulations. In recent years, the ability of governments to achieve their trade policy goals through protectionist measures has eroded as the lines of domestic and foreign-made products are increasingly blurred due to the rapid growth of international supply chains as well as the shift to services and digital trade.
The benefits of greater trade freedom are well documented. For example, countries with greater trade freedom tend to have much higher income per capita, better food security, more political stability, and healthier natural environments. (See Chart 1.) It is abundantly clear that when a country’s government gets out of the way and allows individuals to make unimpeded trading decisions that are best for themselves, their families, and their companies, people thrive.
The Index’s lower trade-freedom scores this year are a reflection of some governments’ concerns about trade balances that show more imports than exports. Officials reason that restrictions on imports can boost domestic manufacturing and increase gross domestic product (GDP). There is scant support in economic theory for such reasoning. The empirical evidence from the United States is that higher imports, not exports, correlate most closely with faster growth in GDP. While some of this correlation no doubt reflects higher consumption of imports caused by increases in wealth, it is also true that a significant percentage of imports are so-called intermediate goods used by U.S. firms in their manufacturing processes. Imports are thus an input into higher GDP.
In any case, the measurement of a country’s trade balances with other countries says nothing about the quality or value of the individual trades involved, each of which is made by people or firms for their own benefit. Countries, as such, do not trade with one another. It is businesses and individuals that are trading, with thousands of individual transactions every day. Government intervention based on the simple summing of those transactions is misguided, at best, and likely to do far more harm than good. Indeed, the bar is, or at least should be, very high for governments trying to explain how the sum of myriad individual transactions, each of which is judged to be beneficial by its participants, can result in societal harm justifying some intervention.
The Heritage Foundation’s Index of Economic Freedom has demonstrated for more than 27 years that individuals around the world benefit from liberalized trade policies that reduce or do away with protectionist barriers. The benefits of more open trade policies are vast and far-reaching. Government restrictions on trade, if any, should be narrow and carefully targeted.
The Importance of the World Trade Organization in Advancing Trade Freedom
Governments have often found that it is easiest to dismantle trade barriers in the context of international negotiations or as a result of commitments made in multilateral or bilateral trade agreements. The keystone of the international system of such agreements and negotiations is the World Trade Organization (WTO), and it is probably no coincidence that the recent decline in world trade freedom has occurred at a time when the WTO has been in crisis, with its dispute resolution system virtually inoperable.
Many member nations feel that the WTO is lacking in certain areas, especially in its ability to curtail what many regard as abusive or unethical trading or subsidy practices by China. It is vital that such nations and transnational organizations, especially the United States and the European Union, work together strategically and practically to reform the over 25-year-old institution to improve its effectiveness in resolving disputes between members and to ensure that bad actors with anti-free-market trade practices are not supported.
Countries with Notable Trade-Freedom Developments This Year
The United States. This year, the United States has its worst nontariff trade barrier score ever. The poor U.S. showing was driven in large part by agricultural subsidies. As described by Inside U.S. Trade:
The United States this week reported that its total aggregate measurement of support—a category of trade-distorting agricultural subsidies—in the 2019–2020 marketing year was the highest ever recorded and just shy of the $19.1 billion limit set by World Trade Organization rules.
The new high is the result of a spike in farm subsidies provided by the Trump administration to counteract the retaliatory tariffs China imposed on U.S. agricultural products as the U.S. escalated its duties on China to eventually cover $370 billion worth of goods. The Trump administration provided farmers with $12 billion in 2018 and a $16 billion aid package in 2019 to help them bear the brunt of the retaliatory tariffs.
The situation shows how one form of trade barrier, U.S. tariffs on China in this case, can lead to another trade barrier being raised (retaliatory tariffs by China on the U.S.) to still another (massive subsidies to farmers as the trade war escalates). It creates stifling costs for businesses and consumers, slowing down the pace of trade, and costing jobs and salaries when businesses must bear the brunt of higher tariffs and nontariff barriers to trade, or customers switch the products they buy based on trade barriers imposed by governments.
China. China implemented a free trade agreement with Mauritius, the economically freest sub-Saharan African nation according to the 2021 Index of Economic Freedom. The pact is China’s 16th preferential trade agreement. China also lowered its trade-weighted average tariff rate by a full point, to 3.4 percent. As a result, its trade-freedom score increased from 71.2 in the 2021 Index to 73.2 in the upcoming 2022 Index.
Kiribati. As the U.S. and many other countries have imposed higher tariffs on their people, the coral atolls nation of Kiribati has improved its trade freedom by lowering its trade-weighted average tariff rate to 0.0. As a result, Kiribati’s trade-freedom score jumped from 23.8 in the 2021 Index of Economic Freedom to 80.0 in the upcoming 2022 Index. The previously high import duties (tariffs) in Kiribati have been replaced by valued-added taxes and excise taxes, which are thought to be more efficient and less economically debilitating sources of revenue.
In order to further improve its trade-freedom score, Kiribati will have to do away with some of its nontariff trade barriers, while keeping its average weighted tariff rate at zero.
Each year, the Index of Economic Freedom shows that economies and people are better off when trade is free and open. The correlations between free and open trade and healthy natural environments, higher gross national income, political tranquility, and greater food security are undeniable. To improve their trade-freedom scores, countries should first and foremost lower their domestic barriers to trade by eliminating tariffs and nontariff barriers. Eliminating tariffs gives the greatest boost to trade freedom, but entering into free trade agreements with other countries can also lower barriers. It is crucial, however, that these agreements truly promote free trade rather than just manage trade flows through burdensome regulations that have little or nothing to do with individual and business freedom. Countries must also remain dedicated to their WTO commitments while they seek reform of the organization.
Patrick Tyrrell is Research Coordinator in the Margaret Thatcher Center for Freedom, of the Kathryn and Shelby Cullom Davis Institute for National Security and Foreign Policy. Ambassador Terry Miller is Visiting Fellow for Economic Freedom in the Davis Institute, at The Heritage Foundation.
Appendix A: Methodology
Trade freedom is a composite measure of the extent of tariff and nontariff barriers that affect imports and exports of goods and services. The Index of Economic Freedom’s trade-freedom score is based on two inputs:
- The trade-weighted average tariff rate, and
- A qualitative evaluation of nontariff 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 = 100(Tariffmax–Tariffi)/(Tariffmax–Tariffmin) – 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 at 50 percent.
The extent of NTBs in a country’s trade policy regime is determined 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 types of NTBs considered in Index scoring include:
Quantity restrictions: such as import quotas, export limitations, voluntary export restraints; import–export embargoes and bans, and countertrade measures;
Regulatory restrictions: licensing; domestic-content and mixing requirements; sanitary and phytosanitary standards (SPSs); safety and industrial-standards regulations; packaging, labeling, and trademark regulations; and advertising and media regulations.
Customs restrictions: advance-deposit requirements, customs-valuation procedures, customs-classification procedures, and 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; government monopolies, and exclusive franchises.
In addition, where possible, the Index considers and reports the number of nontariff measures in force as calculated by the World Trade Organization (WTO).
As an example, Kiribati received a trade-freedom score of 80.0. By itself, Kiribati’s trade-weighted average tariff of 0.0 percent would have yielded a score of 100, but the evaluation of NTBs in Kiribati resulted in a 20-point deduction from that score.
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 the most recently reported most favored nation (MFN) trade-weighted average tariff rate for a country from our primary sources.
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 where 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 instead.