Economic Freedom of the World Annual Report James Gwartney, Robert Lawson, & Joshua Hall with Scott L. Baier, Christian Bjørnskov, Matthew Clance, Alice M. Crisp, Axel Dreher, Gerald P. Dwyer, Nicolai J. Foss, and Kai Gehring Most Free 2nd Quartile 3rd Quartile Least Free 2012 Economic Freedom of the World 2012 Annual Report James Gwartney Robert Lawson Joshua Hall Florida State University Southern Methodist University Beloit College with Sco L. Baier Christian Bjørnskov Mahew Clance Alice M. Crisp Clemson University Aarhus University Clemson University Florida State University Axel Dreher Gerald P. Dwyer Nicolai J. Foss Kai Gehring Heidelberg University University of Carlos III Copenhagen Business School University of Göingen & Norwegian School of Economics & Business Administration  Fraser Institute ©2012 • www.fraserinstitute.org • www.freetheworld.com Copyright ©2012 by the Fraser Institute. All rights reserved. No part of this book may be reproduced in any manner whatsoever without wrien permission except in the case of brief quotations embodied in critical articles and reviews. e authors of this book have worked independently and opinions expressed by them are, therefore, their own and do not necessarily reect the opinions of the supporters, trustees, or sta of the Fraser Institute. is publication in no way implies that the Fraser Institute, its trustees, or sta are in favor of, or oppose the passage of, any bill; or that they support or oppose any particular political party or candidate. Published in cooperation with the Economic Freedom Network Editing, design, and typeseing by Lindsey omas Martin Cover design by Bill Ray Printed and bound in Canada Data available to researchers e full data set, including all of the data published in this report as well as data omied due to limited space, can be downloaded for free at <http://www.freetheworld.com>. e data le available there con- tains the most up-to-date and accurate data for the Economic Freedom of the World index. Some vari- able names and data sources have evolved over the years since the rst publication in 1996; users should consult earlier editions of Economic Freedom of the World for details regarding sources and descriptions for those years. All editions of the report are available in PDF and can be downloaded for free from <http://www.freetheworld.com/datasets_e fw.html>. However, users are always strongly encouraged to use the data from this most recent data le as updates and corrections, even to earlier years’ data, do occur. Users doing long-term or longitudinal studies are encouraged to use the chain-linked index as it is the most consistent through time. If you have diculty downloading the data, please contact Fred McMahon via e-mail to < freetheworld@fraserinstitute.org>. If you have technical questions about the data itself, please contact Robert Lawson via e-mail to <robert.a.lawson@gmail.com>. Please cite the data set as: Authors: James Gwartney, Robert Lawson, and Joshua Hall Title: 2012 Economic Freedom Dataset, published in Economic Freedom of the World: 2012 Annual Report Publisher: Fraser Institute Year: 2012 URL: <http://www.freetheworld.com/datasets_e fw.html> Cite this publication Authors: James Gwartney, Robert Lawson, and Joshua Hall Title: Economic Freedom of the World: 2012 Annual Report Publisher: Fraser Institute Date of publication: 2012 Digital copy available from <www.fraserinstitute.org> and <www.freetheworld.com> Publishing history See page 309 for a list of all volumes of Economic Freedom of the World and associated publications. Cataloguing Information Gwartney, James D. Economic freedom of the world … annual report / James D. Gwartney. Annual. Description based on: 1997 2012 issue by James Gwartney, Robert Lawson, and Joshua Hall, with Sco L. Baier, Christian Bjørnskov, Mahew Clance, Alice M. Crisp, Axel Dreher, Gerald P. Dwyer, Nicolai J. Foss, and Kai Gehring. Issued also online. ISSN 1482-471X; ISBN 978-0-88975-258-0 (2012 edition). 1. Economic history 1990- Periodicals. 2. Economic indicators Periodicals. I. Fraser Institute (Vancouver, B.C.) II. Title www.freetheworld.com • www.fraserinstitute.org • Fraser Institute ©2012 Table of Contents Executive Summary / v Chapter 1 Economic Freedom of the World in 2010 / 1 Chapter 2 Country Data Tables / 27 Chapter 3 Institutions and Economic, Political, and Civil Liberty in Latin America / 173 by Alice M. Crisp and James Gwartney Chapter 4 Banking Crises and Economic Freedom / 201 by Sco L. Baier, Mahew Clance, and Gerald P. Dwyer Chapter 5 Does Aid Buy (Economic) Freedom? / 219 by Axel Dreher and Kai Gehring Chapter 6 How Institutions of Liberty Promote Entrepreneurship and Growth / 247 by Christian Bjørnskov and Nicolai J. Foss Appendix Explanatory Notes and Data Sources / 271 About the Authors / 285 About the Contributors / 286 Acknowledgments / 288 e Economic Freedom Network / 289 Fraser Institute ©2012 • www.fraserinstitute.org • www.freetheworld.com Economic Freedom of the World: 2012 Annual Report • v www.freetheworld.com  •  www.fraserinstitute.org  •  Fraser Institute ©2012 Executive Summary Economic Freedom of the World e index published in Economic Freedom of the World measures the degree to which the policies and institutions of countries are supportive of economic freedom. e cornerstones of economic freedom are personal choice, voluntary exchange, free- dom to compete, and security of privately owned property. Forty-two variables are used to construct a summary index and to measure the degree of economic freedom in ve broad areas:  Size of Government;  Legal System and Property Rights;  Sound Money;  Freedom to Trade Internationally;  Regulation. An important anniversary is year is the  anniversary of Milton Friedman’s birth. Milton Friedman was the godfather of Economic Freedom of the World. He believed that, if economic free- dom could be measured with greater accuracy, it would be possible to isolate its impact on the performance of economies and other factors of interest. is led to the Economic Freedom of the World project, headed by Milton and Rose Friedman and Michael Walker, then executive director of the Fraser Institute. Since our rst publication in , numerous studies have used data from Economic Freedom of the World to examine the impact of economic freedom on investment, economic growth, income levels, and poverty rates. Virtually without exception, these studies have found that countries with institutions and policies more consistent with economic freedom have higher investment rates, more rapid economic growth, higher income levels, and more rapid reductions in poverty rates. Economic freedom from around the world • In the chain-linked index, average economic freedom rose from . (out of ) in  to . in . It then fell for two consecutive years, resulting in a score of . in  but has risen slightly to . in , the most recent year available. It appears that responses to the economic crisis have reduced economic freedom in the short term and perhaps prosperity over the long term, but the upward movement this year is encouraging. vi • Economic Freedom of the World: 2012 Annual Report Fraser Institute ©2012 • www.fraserinstitute.org • www.freetheworld.com • In this year’s index, Hong Kong retains the highest rating for economic freedom, . out of . e other top  nations are: Singapore, .; New Zealand, .; Switzerland, .; Australia, .; Canada, .; Bahrain, .; Mauritius, .; Finland, .; and Chile, .. • e rankings (and scores) of other large economies in this year’s index are the United Kingdom,  (.); the United States,  (.); Japan,  (.); Germany,  (.); France,  (.); Italy,  (.); Mexico, , (.); Russia,  (.); Brazil,  (.); China,  (.); and India,  (.). • e scores of the boom ten nations in this year’s index are: Venezuela, .; Myanmar, .; Zimbabwe, .; Republic of the Congo, .; Angola, .; Democratic Republic of the Congo, .; Guinea-Bissau, .; Algeria, .; Chad, .; and, tied for  worst, Mozambique and Burundi, .. • e United States, long considered the standard bearer for economic freedom among large industrial nations, has experienced a substantial decline in economic freedom during the past decade. From  to , the United States was generally rated the third freest economy in the world, ranking behind only Hong Kong and Singapore. Aer increasing steadily during the period from  to , the chain- linked EFW rating of the United States fell from . in  to . in  and . in . e chain-linked ranking of the United States has fallen precipitously from second in  to eighth in  and  th in  (unadjusted ranking of  th ). Nations that are economically free out-perform non-free nations in indicators of well-being • Nations in the top quartile of economic freedom had an average per-capita GDP of $, in , compared to $, for boom quartile nations in  current international dollars (Exhibit 1.7). • In the top quartile, the average income of the poorest % was $,, com- pared to $, in the boom in  current international dollars (Exhibit 1.10). Interestingly, the average income of the poorest % in the most economically free nations is more than twice the overall average income in the least free nations. • Life expectancy is . years in the top quartile compared to . years in the boom quartile (Exhibit 1.11). • Political and civil liberties are considerably higher in economically free nations than in unfree nations (Exhibit 1.12). Chapter 1: Economic Freedom of the World in 2010 e authors of the report, James Gwartney (Florida State University), Robert Lawson (Southern Methodist University), and Joshua Hall (Beloit College) pro- vide an overview of the report and discuss why economic freedom is important. ey also consider the key factors underlying the decline in economic freedom of the United States since . Economic Freedom of the World: 2012 Annual Report • vii www.freetheworld.com  •  www.fraserinstitute.org  •  Fraser Institute ©2012 Chapter 2: Country Data Tables Detailed historical information is provided for each of the  countries and ter- ritories in the index. Chapter 3: Institutions and Economic, Political, and Civil Liberty in Latin America In this chapter, Alice M. Crisp and James Gwartney take a closer look at the eco- nomic, political, and civil institutions of  Latin American countries. ese insti- tutions are interrelated and they work as a combination to inuence economic performance. To a large degree, researchers know the bundle of economic insti- tutions and policies that lead to economic growth and prosperity. But economic institutions are an outgrowth of the political process. Similarly, civil liberties inu- ence the public discourse and thereby have an impact on both economic and politi- cal decision-making. e quality of economic and political institutions is generally related. In Latin America, ve countriesChile, Peru, Panama, Trinidad & Tobago, and Uruguayrank in the top eight in both economic and political institutional quality. Similarly, six countriesVenezuela, Ecuador, Haiti, Bolivia, Guyana, and Hondurasrank in the boom eight in both the economic and political catego- ries. e chapter provides detailed information on the strengths and weaknesses and changes in the institutional quality of Latin American countries during the past two decades. Chapter 4: Banking Crises and Economic Freedom Sco L. Baier, Mahew Clance, and Gerald P. Dwyer examine the connection between banking crises and measures of economic freedom from Economic Freedom of the World: 2011 Annual Report. ey nd that higher economic free- dommore personal choice, freedom of exchange, and protection of private propertyis associated with a lower probability of a banking crisis. is is con- trary to conventional wisdom that nancial “deregulation” contributes to nancial and banking crises. is nding appears in estimates from both a linear prob- ability and a probit model and is also unaected by inclusion of the growth of real Gross Domestic Product (GDP), deposit insurance, time or country dummy variables, or the level of real GDP. e authors also nd that economic freedom falls aer a nancial crisis. Chapter 5: Does Aid Buy (Economic) Freedom? In this chapter, Axel Dreher and Kai Gehring survey the literature investigating the eects of development aid on economic freedom. e authors discuss the theoreti- cal channels by which development aid can aect freedom and review the existing empirical literature. Overall, this literature does not establish a nal answer to the question of whether aid works. However, multilateral aid seems to be more eec- tive in increasing freedom than bilateral aid, and aid disbursed in the period aer the Cold War seems to be more eective as well. is highlights the importance of changes in the prevailing aid paradigm over time when analyzing the eectiveness of aid. Moreover, the authors stress that a unied framework is required to con- clusively investigate the eect of aid on freedom, including a common sample and method of estimation, common control variables, and changing one parameter of the empirical setup at a time rather than all of them together. viii  •  Economic Freedom of the World: 2012 Annual Report Fraser Institute ©2012 • www.fraserinstitute.org • www.freetheworld.com Chapter 6: How Institutions of Liberty Promote Entrepreneurship and Growth Christian Bjørnskov and Nicolai J. Foss report on previous research on the links between institutions of freedom, entrepreneurship, and economic growth and add some new ndings. Specically, they discuss how economic policy and institutional design aect entrepreneurship, and how entrepreneurship in turn aects total fac- tor productivity. In a panel of 25 developed countries observed between 1980 and 2005, they nd that government size and sound money positively aect entrepre- neurial activity while legal quality does so negatively. Further evidence shows that both entrepreneurship and legal quality exert a positive impact on productivity. e main eects of improvements to economic freedom are mediated through entrepre- neurship and are substantial. Data available to researchers e full data set, including all of the data published in this report as well as data omit- ted due to limited space, can be downloaded for free at < http://www.freetheworld.com>. e data le available there contains the most up-to-date and accurate data for the Economic Freedom of the World index. Some variable names and data sources have evolved over the years since the rst publication in 1996; users should consult earlier editions of Economic Freedom of the World for details regarding sources and descriptions for those years. All editions of the report are available in PDF and can be downloaded for free at < http://www.freetheworld.com>. However, users are always strongly encouraged to use the data from this most recent data le as updates and corrections, even to earlier years’ data, do occur. Users doing long-term or longitu- dinal studies are encouraged to use the chain-linked index as it is the most consis- tent through time. If you have diculty downloading the data, please contact Fred McMahon via e-mail to < freetheworld@fraserinstitute.org>. If you have technical questions about the data itself, please contact Robert Lawson via e-mail to < robert.a.lawson@gmail.com>. Please cite the data set as: Authors James Gwartney, Robert Lawson, and Joshua Hall Title 2012 Economic Freedom Dataset, published in Economic Freedom of the World: 2012 Annual Report Publisher Fraser Institute Year 2012 URL <http://www.freetheworld.com/datasets_efw.html>. [...]... Joshua Hall Title 2012 Economic Freedom Dataset, published in Economic Freedom of the World: 2012 Annual Report Publisher Network Economic Freedom Year 2012 URL Published work using research ratings from Economic Freedom of the World A list of published papers that have used the economic freedom ratings from Economic Freedom of the World is available... of the World: 2012 Annual Report; World Bank, World Development Indicators 2011 Income Share (%) unrelated to economic freedom 2.75% 2.56% 2.37% 2.26% 2.0 1.5 1.0 0.5 0.0 Least Free Third Second Most Free Economic Freedom Quartile www.freetheworld.com  •  www.fraserinstitute.org  •  Fraser Institute 2012 24  •  Economic Freedom of the World: 2012 Annual Report The amount of income, as opposed to the. .. Freedom House (2011) Freedom in the World 2011: The Authoritarian Challenge to Democracy www.freetheworld.com  •  www.fraserinstitute.org  •  Fraser Institute 2012 26  •  Economic Freedom of the World: 2012 Annual Report Data available to researchers The full... Fraser Institute 2012 •  www.fraserinstitute.org  •  www.freetheworld.com 10.00 (1) Economic Freedom of the World in 2010  •  15 The Chain-Linked Summary Index The data published in Economic Freedom of the World are available for many countries back to 1970 Through time, the index has become more comprehensive and the available data more complete As a result, the number and composition of the components... Chapter 1 Economic Freedom of the World in 2010 This year is the 100th anniversary of Milton Friedman’s birth Milton Friedman was the godfather of the Economic Freedom of the World (EFW) project He believed that, if economic freedom could be measured with greater accuracy, this would make it possible for researchers to identify its impact on economic performance with greater clarity This has been the case... measurement of economic freedom is an essential element of scholarly research on these vitally important topics The Economic Freedom of the World index for 2010 The construction of the index published in Economic Freedom of the World is based on three important methodological principles First, objective components are always preferred to those that involve surveys or value judgments Given the multidimensional... www.freetheworld.com Economic Freedom of the World in 2010  •  7 trade The volume of trade is also reduced if the passage of goods through customs is onerous and time consuming Sometimes these delays are the result of administrative inefficiency while in other instances they reflect the actions of corrupt officials seeking to extract bribes In both cases, economic freedom is reduced The components in... www.freetheworld.com  •  www.fraserinstitute.org  •  Fraser Institute 2012 22  •  Economic Freedom of the World: 2012 Annual Report Economic freedom and human progress As is customary, this chapter concludes with some graphs illustrating simple relationships between economic freedom and various other indicators of human and political progress (Exhibits 1.7–1.12, pp 22–24) The graphs use the average of the. .. areas for future research Fraser Institute 2012 •  www.fraserinstitute.org  •  www.freetheworld.com Economic Freedom of the World in 2010  •  23 Exhibit 1.7: Economic Freedom and Income per Capita, 2010 40,000 freedom have substantially higher 35,000 per-capita incomes Sources: Fraser Institute, Economic Freedom of the World: 2012 Annual Report; World Bank, World Development Indicators 2011 GDP per... This has led to debate about how the ordering of economic and political reforms influence performance and why reforms occur in some countries, but not others The New Institutional Economics highlights the importance of the Economic Freedom of the World project The EFW data set provides the most comprehensive measure of the degree to which countries rely on markets rather than political decision-making . Summary Economic Freedom of the World e index published in Economic Freedom of the World measures the degree to which the policies and institutions of countries. rather than all of them together. viii  •  Economic Freedom of the World: 2012 Annual Report Fraser Institute 2012 • www.fraserinstitute.org • www.freetheworld.com Chapter