Fraser Institute’s Economic Freedom of the World

The Economic Freedom of the World survey by Gwartney and Lawson focuses on fewer topics (38 components in total), measuring the degree to which the policies and institutions of countries are supportive of economic freedom. This survey has the longest history of those reviewed in this study, starting in 1970. Reports were produced every five years until 2000, and then yearly. After 1997 components were added with the inclusion of survey data from the ”International Country Risk Guide” and the WEF survey, in order to incorporate legal structure and regulatory elements more fully. The overall indicator in 2003 (the latest year available) was decomposed into 5 areas (New Zealand’s rank is in brackets beside each area):

1. The size of government: expenditures, taxes, and enterprises (33^rd).

2. Legal structure and protection of property rights (8^th).

3. Access to sound money (28^th).

4. Freedom to trade internationally (20^th).

5. Regulation of Credit, Labour and Business (4^th).

The components of areas 4 and 5 (those relevant for the comparison of regulatory practices) are set out in Figure 3 below. For the sub-factors in area 5, New Zealand ranked 2^nd for credit market regulations, 38^th for labour market regulations, and 4^th for business regulations. For the ‘Regulatory Trade Barriers’ sub-factor in area 4, New Zealand ranked 5^th in 2003. Both the regulatory components of area 4 and most of the data which makes up the sub-factors in area 5 are obtained from the WEF and IMD surveys.

Figure 3 - Decomposition of the Fraser Institute's Area 4 and Area 5

Heritage Foundation, Index of Economic Freedom

The ‘Index of Economic Freedom’ published by The Heritage Foundation and the Wall Street Journal, defines economic freedom as “the absence of government coercion or constraint on the production, distribution or consumption of goods and services beyond the extent necessary for citizens to protect and maintain liberty”. The Heritage Foundation aims to construct a systematic, empirical measure of economic freedom according to this definition. To this end they have grouped 50 variables into the 10 categories listed below. The Index covers 161 countries and has been produced annually since 1995. In 2004, New Zealand ranked 9^th equal with Australia on the overall Index of Economic Freedom, down from 5^th in 2003. The 10 categories, along with New Zealand’s rank in 2004 in brackets beside each factor, are:

1. Trade policy (39^th equal)

2. Fiscal burden of government (101^st equal)

3. Government intervention in the economy (11^th equal)

4. Monetary policy (1^st equal)

5. Capital flows and foreign investment (13^th equal)

6. Banking and finance (1^st equal)

7. Wages and prices (2^nd equal)

8. Property rights (1^st equal)

9. Regulation (4^th equal)

10. Informal market activity (1^st equal)

Even though all of the 50 variables were studied, not all of them were given an individual score or specific mention in the text. Therefore while we can compare each of the 10 factors across countries and study what the factors comprise, we cannot compare the individual components of each factor across countries. For example, the first factor labelled ‘Trade policy’ comprises three variables: ‘Weighted average tariff rate’, ‘Non-tariff barriers’, and ‘Corruption in the customs service’. No data or scores are provided on these three variables. The factor is given a score of 1 if the weighted average tariff rate is less than or equal to 4%, while a score of 5 is given if the weighted average tariff rate is greater than 19%. If non-tariff barriers exist “in sufficient quantity”, or if there is ample evidence of corruption, a country’s score on this factor based solely on the weighted average tariff rate receives an additional point on the scale.

For the ‘Government intervention’ factor, the total score is derived as the average of the scores assigned to the level of government consumption (as a percentage of GDP), and to the level of the share of government revenues from state-owned enterprises and property.

For factor 5 (‘Capital flows and foreign investment’), countries were assigned a score of 1 if they met the following criteria:

• open and impartial treatment of foreign investment;
• accessible foreign investment code;
• almost no restrictions on foreign investments except for fields related to national security; and
• no restrictions on capital transactions.

A score of 5 means that the government actively seeks to prevent foreign investment and to prohibit all capital flows, and there is widespread corruption. New Zealand’s score on this factor is 1 point worse than the previous year, dropping from a score of 1 to 2.

Factor 6 (‘Banking and Finance’) assesses the openness of a country’s banking and financial system. The authors score this factor by determining specifically whether foreign banks and financial services firms are able to operate freely, how difficult it is to open domestic banks and other financial services firms, how heavily regulated the financial system is, how great the presence of state-owned banks is, whether the government influences the allocation of credit, and whether banks are free to provide customers with insurance and invest in securities (and vice versa). New Zealand ranked 1^st equal on this factor in 2004.

The ‘Wages and prices’ factor is scored by the extent to which a government allows the market to set wages and prices. Specifically, this factor looks at which products have prices set by the government and whether the government has a minimum wage policy or otherwise influences wages.

For the ‘Regulation’ factor, the authors take into consideration the following variables:

• Licensing requirements to operate a business
• Ease of obtaining a business license
• Corruption within the bureaucracy[8]
• Labour regulations, such as established workweeks, paid vacations, and parental leave
• Environmental, consumer safety, and worker health regulations
• Regulations that impose a burden on business

A score of 1 is assigned to a country if:

• all existing regulations are straightforward and applied uniformly to all businesses;
• regulations are not much of a burden for business; and
• corruption is nearly nonexistent.

To obtain a score of 5 on this factor, a country must: have a government which impedes the creation of new businesses; have corruption which is widespread; and have regulations applied randomly.

Thus one difference between this Index and those previously discussed is that the authors explicitly also look at how regulations are imposed. That is, are they imposed uniformly or haphazardly? The argument here is that even if two countries notionally have the same set of regulations, they may still impose different regulatory burdens in practice. If one of them applies its regulations evenly and transparently, it lowers the regulatory burden as businesses can more easily make long-term plans. If the other country applies the same regulations inconsistently, it raises the regulatory burden on businesses by creating an unpredictable business environment.

In the discussion of New Zealand’s score on the ‘Regulation’ factor (New Zealand had a score of 2.0 in 2004 to give it a rank of 4^th equal), the authors suggest that the three-layered regulatory system involving national, regional, and local authorities created by the Resource Management Act, has resulted in an inconsistent system in which each of the country’s 83 different local authorities interprets the law in its own way and accusations of environmental violations can be filed on a broad-ranging basis. The authors go on to say that “efforts to fine-tune this act to make it less burdensome have met with only marginal results”.

Finally, the ‘Informal market’ factor takes into account the fact that informal markets are the direct result of some kind of government intervention in the market place. An informal market activity is one that the government has taxed heavily, regulated in a burdensome manner, or simply outlawed in the past. This factor captures effects of government interventions that are not fully measured elsewhere. New Zealand was ranked 1^st equal on this factor in 2004.

The “cash economy” and the “black market” are responses to regulation that highlight the ambiguity of the idea of the impact of regulation. On the one hand, informal markets are welfare-enhancing for those directly involved: voluntary participants gain from trade. On the other hand, informal markets might not always be welfare-enhancing from society’s point of view. The existence of these markets in defiance of regulation generates enforcement costs, risk, externalities and whatever ills the regulations are designed to avert.