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January 19, 2012, Thursday

Measuring economic freedom around the world and in Turkey

In the precarious and uneven recovery from the worst global financial and economic crisis in decades, the expanding role of governments in combating it has become increasingly controversial from the perspective of economic freedom.

Amid the crisis, many people lost much of their faith in private enterprise and free markets, which they accuse of being reckless risk-takers and having uncontrolled greed. Scared of another global depression, they urged their governments to bail out troubled financial institutions. They also pressured their governments to jump-start the economy by increasing public expenditures, which would swell budget deficits and public debt. The US and many other governments readily obliged, as they directly and indirectly intervened in their macro and micro economies, often haphazardly and opaquely, with dubious outcomes.

Although governments have an indispensable role in a well-functioning capitalist economy to set and enforce the rules of the game as well as provide public goods, any government action, especially if coerced, to mitigate a crisis has costs as well as benefits. One such cost is the danger that as governments, through ad hoc and myopic quick fixes, excessively intervene in and exert overbearing control over the economy, they will curtail economic freedom. Less economic freedom will discourage the entrepreneurship, competition and innovation that have proven to be essential for rapid economic growth and rising prosperity.

How do we define economic freedom, how can we measure it, and why is it essential for growth and prosperity? Two annual reports, “Economic Freedom of the World” (EFW) by the Fraser Institute in Canada and the “Index of Economic Freedom” (IEF) by the Heritage Foundation-Wall Street Journal in the US, have tackled these questions. The latest EFW survey was published last September. I will focus on the better known 2012 IEF report, in its 18th year, released last week, which defines economic freedom as the fundamental right of individuals to control their labor and property. Economically free individuals can “work, produce, consume and invest in any way they choose under a rule of law, with their freedom at once both protected and respected by the state.” The 483-page report emphasizes individual empowerment, equitable treatment, and promotion of competition as the basic principles of economic freedom.

The report, based on data for the second half of 2010 and first half of 2011, ranks 179 countries according to 10 specific factors under four headings: (1) Rule of law (property rights and freedom from corruption); (2) Limited government (fiscal freedom and government spending); (3) Regulatory efficiency (business freedom, labor freedom and monetary freedom); and (4) Open markets (trade freedom, investment freedom and financial freedom). Each factor is graded from 0 to 100, and the scores for the 10 factors are averaged to get the overall IEF for each country. The closer is the IEF to 100, the greater the degree of economic freedom. The freer countries have higher per capita incomes. They also achieve lower rates of poverty, unemployment and inflation as well as higher rates of innovation, entrepreneurship and economic growth.

The report classifies 179 countries into five quintiles according to their overall IEF scores: Free (80-100) with five countries, Mostly Free (70-79.9) with 23 countries, Moderately Free (60-69.9) with 62 countries, Mostly Unfree (50-59.9) with 60 countries, and Repressed (0-49.9) with 29 countries. The top 10-ranked countries in 2012 IEF are: Hong Kong (89.9), Singapore (87.5), Australia (83.1), New Zealand (82.1), Switzerland (81.1), Canada (79.9), Chile (78.3), Mauritius (77.0), Ireland (76.9) and the US (76.3). The 10th ranked US has seen its overall score drop steadily since 2007, when it ranked fourth. That is due to its deteriorating scores for government spending, freedom from corruption and investment freedom, reflecting the extraordinary and intrusive government interventions in the US economy during the global crisis. Turkey is ranked 73rd globally and 34th among 43 European countries.

In 2012 IEF, 75 countries had higher, 90 had lower, and 14 had unchanged scores compared to 2011 IEF. Of the 75 economies with higher scores 73 were developing or emerging economies. The world average IEF score, which had registered modest but steady increases before the outbreak of the global crisis in 2008, decreased from 59.7 in 2011 to 59.5 in 2012. Turkey's score also dropped, from 64.2 to 62.5, due to alleged “explosive growth” in government spending as a percentage of gross domestic product (GDP). The reason for that “explosive growth” finding is the implausible increase in government spending as a percentage of GDP from 23.4 percent in 2011 IEF to 37.2 percent in 2012 IEF. But the Turkish government data do not show such an “explosive growth,” raising doubts about Turkey's 2012 IEF score. The data, which show that total government spending as a percentage of GDP rose from 34.6 percent in 2008 to 40.1 percent in 2009 but dropped to 38.4 percent in 2010 and 37.4 percent in 2011, suggest that the 2012 IEF score should have been higher.

If we take the data underlying the 18 IEF reports at face value, Turkey's IEF score, above the world average since 2008, climbed during 2005-2011, catapulting Turkey from the “Mostly Unfree” status to the “Moderately Free” status since 2009, a remarkable achievement.

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