Economic freedom in the world

The Foundation has promoted the rigorous study of the levels of economic freedom prevailing in numerous countries around the world and has supported the development of the Historical Index of Economic Freedom (HIEL) developed by Professor Leandro Prados de la Escosura. This space collects the results for 21 countries in this Index and offers useful tools of analysis for teachers, researchers and people interested in the comparative study of the levels of economic freedom and its components in the world, such as editors of the series and systems of comparison and presentation of data.

Economic freedom is a negative freedom, defined as the absence of interference or coercion in the economic decisions of the individual. Personal choice, voluntary exchange, access to markets and the protection of individuals and their property are its constituent elements.

The Historical Index of Economic Freedom (ICE) is inspired by and adapts from a long term perspective the Economic Freedom of the World Index (EFW) of the Fraser Institute (Gwartney et al., 2022). A detailed explanation of the calculation procedures can be found on this website. A discussion of the concept and an analysis of preliminary results can be found in Prados de la Escosura (2016).

Technical information:

A country can be considered economically free to the extent that people and their property are protected, contracts are enforced, prices are stable, barriers to trade are low and resources are primarily allocated in the market. The purpose of an index of economic freedom is to test the consistency between a country's institutions and policies and these requirements.

A distinction can be made between four dimensions of economic freedom: the legal system and property rights, the value of money, the opening y regulation.

For each dimension of economic freedom, an index has been calculated on the basis of different indicators consistent in space and time.

When the value of an indicator is inversely related to the degree of economic freedom, it has been transformed into an index by the expression:

I_ij = 10 (V_MAX -V_ij) / (V_MAX- V_MIN)

In which V_ij represents the value of the country indicator i in the year jwhile V_MAX y V_MINare its maximum and minimum values.

Alternatively, when the value of the indicator is directly related to the degree of economic freedom, the expression used is as follows:

I_ij = 10 (V_IJ -V_MIN) / (V_MAX- V_MIN)

Thus, the resulting index of economic freedom always varies between 0 (minimum) and 10 (maximum).

The period under consideration is that of the expansion and development of modern capitalism, from the emergence of free trade and laissez faire in the mid-19th century to the present.

Rule of law, security of property rights, judicial independence and impartiality of the courts are prerequisites for a legal structure consistent with the principles of economic freedom.

Among the possible indicators, the following have been chosen:

Judicial independence
Impartial courts
Integrity of the legal system
Enforcement of contracts

An aggregate index has been obtained as the unweighted arithmetic mean of these four sub-indices.

A credible and efficient monetary system is essential to protect economic freedom and its main contribution is to provide price stability. Inflation erodes the value of property held in monetary instruments. Moreover, high and volatile inflation rates distort relative prices and disrupt long-term contracts.

The indicators chosen to assess the consistency of monetary policy and institutions with price stability include the following:

Inflation rate
Standard deviation of inflation (as a measure of volatility).
Differential growth in the quantity of money

The difference between the average annual growth of the money supply over the past 5 years and the average annual growth of real GDP over the past 10 years. Its rationale is that high rates of money supply growth lead to inflation.

The aggregate index is obtained by taking the unweighted arithmetic mean of these three sub-indices.

Free trade represents a key dimension of economic freedom in that it provides individuals with the widest choice of goods and services and facilitates their specialisation according to comparative advantage.

In order to assess economic freedom in international trade, it is necessary to analyse a wide range of restrictions, including tariffs, the exchange rate and capital controls. Three indicators have been considered:

Tariffs. Weighted nominal protection measured as the ratio of total customs revenue to the total value of exports and imports.
Factor mobility. Combines capital and labour mobility indices.
Black market prize measured as the difference, in logarithms, between the official exchange rate and the parallel (black market) exchange rate (from 1946).

The aggregate index results from the unweighted arithmetic average of the three sub-indices.

Regulation of economic activities can restrict market freedom by interfering with the decision of individuals to engage in voluntary exchanges. Three types of regulation have been distinguished:

Credit market regulation. It consists of two indicators:

Interest rate control: whose long-term evolution can be approximated by the short-term real interest rate (the nominal rate minus the inflation rate).
The ratio of the budget balance to GDP: Provides an indicator of the risk of "push-out" effect (crowding out).

The aggregate index has been obtained as the unweighted arithmetic mean of these two indices.

Labour market regulation

Laws and regulations affecting wages and working conditions can restrict negative economic freedom by constraining or reducing labour market flexibility. Three indicators have been chosen:

Freedom of movement within the country's borders
Freedom from forced labour
Protective employment legislation. An index of employment protection legislation (EPL) as an indicator of labour market regulation for the post-1950 period.

The aggregate index of regulatory freedom is the unweighted arithmetic mean of the three sub-indices.

Business regulation

Impartial public administration

The aggregate index has been obtained as the unweighted arithmetic mean of the three indices.

Table 1: Dimensions of the Historical Index of Economic Freedom (HIEL) and its components

Legal structure and property rights	Value for money	International trade	Regulation
Judicial independence	Inflation rate	Nominal weighted protection	Credit market regulation
Impartial courts	Inflation variability	Factor mobility	Labour market regulation
Integrity of the legal system	Money growth differential	Black market prize (from 1950)	Business regulation
Enforcement of contracts

The indices for each dimension (property rights, value of money, international openness, regulation) are then combined by an unweighted arithmetic mean into a historical index of economic freedom (HIEL), which ranges from 0 to 10.

HIEL = (ILE _{property rights} + ILE _money + ILE _opening + ILE _regulation) / 4

How much has economic freedom increased? Since the index has upper and lower bounds (it varies between 0 and 10), the use of conventional measures to summarise its evolution, such as its percentage change or the logarithmic rate of change, is inadequate, since the increases that are achieved for low initial values of the index cannot be achieved when the initial values are high. It is therefore preferable to consider the absolute difference in economic freedom with respect to the upper bound (10) at the initial point considered, and then calculate the relative reduction in that difference over a given period. Thus, the increase in economic freedom is measured as a proportion of the maximum possible increase.

For example, for the average (not weighted by population) of OECD countries, the initial gap or deficit with respect to the upper limit (10) was, in 1850/54, 3.48 points. Between 1850/54 and 2016/20 it narrowed to 1.36 points. The reduction in the initial gap has therefore been 61 per cent [(3.48-1.36)/3.48 = 0.611].

However, the relative initial gap reduction approach is not additive. Thus, the sum of the reduction of the initial gap for two consecutive periods, 1850-1814 and 1914-1950 is not identical to the reduction of the initial gap between 1850 and 1950.

Bibliographical references

Gwartney, J.D., R.A. Lawson and J.H. Hall (2022), Economic Freedom of the World: 2022 Annual ReportVancouver: Fraser Institute.

Prados de la Escosura, L. (2023), Economic Freedom in RetrospectEHES Working Paper 236

Prados de la Escosura, L. (2016), Economic Freedom in the Long Run: Evidence from OECD Countries (1850-2007), Economic History Review 69 (2): 435-468