Index of economic freedom

The Index of Economic freedom compiled by the Heritage Foundation and Wall Street Journal has come out with its 2006 index of economic freedom. It again claims that the higher the rating the better the economic performance (measured by per capita incomes). But it uses a composite un-weighted index of several indicators. Some of these indicators such as business freedom (meaning how free entrepreneurs are to start a business), property rights, trade freedom, investment freedom and freedom from corruption are clearly correlated to economic growth. However, size of government (tax levels and progressiveness and levels of government expenditures) is not correlated with growth. Nor is labour freedom (restrictions on wages, hours and on hiring and firing) a strong predictor of economic growth once a certain level of freedom has been attained. But the Heritage Foundation insists on weighting all the indicators equally. Its main rationale is that it is interested in liberty â not just economics. Fair enough but disappointing to an economists

My aim here is not to revive the earlier debate I started in an earlier posting a few weeks ago on hard liberalism versus economic liberalism. My aim is to point out one stark fact. The compilers of the Index of Economic Freedom have Australia as number three in the freedom league â just below Hong Kong and Singapore. And the main reason is that we have an extraordinary high rating for labour freedom. Australia here is ranked higher than USA or UK or New Zealand.

This does not surprise me as many OECD publications rated Australia as a âvery light❠labour market regulator even before WorkChoices. But surely Coalition politicians and right wing commentators must stop arguing that we still have a highly regulated labour market.

For example, Peter Saunders, from the Center for Independent Studies, is quoted in The Australian yesterday as saying that âlooking around at other Western countries, we still have one of the most regulated labour marketsâ. As a generalization, this is quite incorrect. It is true that, by international standards, Australia still has a high statutory minimum wage relative to median earnings (although that ratio is shrinking every year). But when one looks at overall worker protection regulation, including unfair dismissals and access to trade unions for example, we are leaders in the freedom league. Even short term immigrant flows are being liberalized.

So letâs have no more of these claims that we are still over-regulated as far as labour markets are concerned.

27 thoughts on “Index of economic freedom

  1. Fred,

    Could you point me to a simple econometric analysis of the relationship between economic performance and the components of freedom. I imagine that with a decade or so of data across a range of countries with a range of freedon indices, one could do a nice illustrative regression that might interest…..an MBA class.

  2. Perhaps Mr Saunders means that Australia’s new industrial dispensation concentrates too much on positive repressive measures, allowed employers to abolish awards at their leisure, and didn’t do what the elegantly simple NZ legislation did.
    Or perhaps it still doesn’t display the rigorously liberal and economically robust approach that the ex-slavery states in the US display to er ‘labour relations’ as some call it.
    In any case it is as well to know that enough is never enough, and that we can expect endless bleating from Mr Saunders and his clients just so long as people resist the notion that his clients are entitled to exepct the welfare system (aka PAYE taxpayers) to pay their labour costs.

  3. CIS actually held a seminar on the Heritage Index when it was first released and both I and Alex Robson from ANU spent a lot of time explaining why Heritage have the ‘labour freedom’ measure hopelessly wrong! They rely on the World Bank’s “Doing Business” survey which looks only at statutory regulation and concludes Australia is lightly regulated. But our regulatory system (even after Work Choices) does not rely on statutes. For example, we have no statutory minimum wage. Rather, the Fair Pay Commission lays down minimum wages. But the absence of a statute doesn’t mean we don’t regulate wages – we just do it in a different way which is generally much more detailed and intrusive than a general law based system. Other international researchers who understand our system better have Australia scoring much worse than the Heritage/World Bank would have you believe – e.g. a research paper by Botero which the World Bank actually references measures ‘regulation of labor’ in 85 countries and gives Australia a score of 0.35 on employment law, which is below the global average (countries like North Korea and Zimbabwe tend to push the average score up!) but shows we are a lot more regulated than New Zealand (0.16), USA (0.22) and UK (0.28) – yet Heritage has us beating all these countries on its index. The World Bank makes lots of errors which get carried over into the Heritage index – e.g. it seems unaware that we still have unfair dismissal laws for bigger companies in Australia, and it says redundancy is “costless” when in fact many agreements contain firm severance pay entitlements.
    Basically, Heritage don’t understand the Australian system, and their measure is hopelessly wrong. At the CIS seminar, the guy from Heritage acknowledged these criticisms and promised to take them into account when the next Index is compiled. Fred really shouldn’t get so excited on the basis of such shoddy data.

  4. Peter, why are severence pay entitlements a restriction on freedom? If you object to these, then surely you must also object to severence payments that are built into telecommunications contracts, rent contracts and the like?

  5. To add to Peter’s comment, the Heritage calculations were actually made before Work Choices was enacted and it is clear that they did not understand the award system. As to Damien’s point, I don’t think Peter is saying that at all. He was just using that as an illustration of the Index’s misunderstanding of how things work/worked here. Of course a labour contract with severance payments, or extra holidays or whatever, is a contract and, if freely entered into, then there’s no question of it being a restriction on freedom.

  6. The issue of switching costs is an interesting one, nonetheless. While the parties to contract are free to enter into it ex ante, by doing so they reduce their freedom to exit it ex post. If a person’s preferences are not time consistent, this raises some difficult issues in terms of how their welfare should be evaluated.

    There may well be very good reasons for including such a switching cost into contracts, such as the need to deter opportunistic behaviour by one party after the other party has incurred an up front cost. However, switching costs might also be used to deter entry. As such, they may have some implications for the level of competition in a market. This probably requires that the market be imperfectly competitive to begin with, since consumers would be unlikely to agree to such a switching cost if they had a better alterative. In effect, the switching cost in this case would be designed to enhance existing barriers to entry by other firms.

  7. It seems to me a lot depends on whose freedom is being measured. One of the ironic things about the ‘liberalising’ aspect of so-called Workchoices is that it prohibits certain choices – even where an employer and employee (or group of them) wish to do so. From what I keep hearing, whilst it strenghtens employer freedom vis a vis employees, it can still be very bureaucratic in its requirements in respect of what government requires. There were comments in Crikey just today from someone from the Motor Trades Association, amongst others, in a piece called “workchoices strngling business with red tape”

  8. I am not equipped to get into a technical discussion of the merits or otherwise of the Heritage Foundation data (I work from home without any resources). I am surprised the Wall Street Journal has associated itself with a

  9. Fred,

    I would have thought that the minimum wage is one of the most important parameters of labour market regulation – and certainly more important as it rises to being an outlier – as ours is. So I’m with the righties on this.

    On the Wall St Journal I disagree with you too, but I’m not with the righties. Judging from it’s editorials and op eds it is a right wing rag. There’s no other major newspaper that I simply rule out reading unless pointed there by someone I trust. Of course I’m not saying it doesn’t still have some good articles or even op eds, but it’s a joke as far as its editorial policy is concerned.

  10. Fred, there’s nothing technical at all about Peter’s comments. The Heritage data (which is partly based on World Bank data) is fine as it goes *given its assumptions* but the problem with these overseas studies is they don’t capture what is in effect the quasi-legislation (or whatever the right technical term is) which accounts for the bulk of our IR laws. So if you only want to compare statutory regulation between countries it works fine but is basically misleading, rather than ‘shoddy’. As for the OECD data as you point out yourself it only captures one variable of labour market regulation.

  11. Nicholas, there is huge scope for downward labour cost flexibility under the new Howard regime. So, despite our high minimum wage, we ought to rank well even on that freedom criterion.

  12. Given my past experience with the Heritage index, I would scrutinise any use of its data that appeared in an article submitted for Policy. I don’t recall it being cited in the last 3 years in which I have been editor again.

  13. Jason, it was Peter Saunders who used the word ‘shoddy’ to describe the Heritage data (Andrew called it ‘rubbish’). I merely picked up the language.

    Andrew, is your journal ‘Policy’ disowning Fraser as well as Heritage data? If so, it thins out much of the right wing economic literature on the relatioship between economic freedom (in the broadest sense) and per capita growth which Policy has greatly relied on in the past (although not recently).

  14. If you have a look at the World Economic Forum data, I think you’ll find that Australia does not score well on Labour Markets. I’ve got some 1999 data (at home) where Australia ranked 27/44 on the impact labour reguations have on business. (Hong Kong is one, Singapore two … the US is ninth). By OECD standards Australia has a good rank, in 1999 4/21. But this reflects the social democrat notion where workers have a right to work and employers the duty to employ. As we more to the more sensible notion of workers have the duty to work and employers the right to employ I expect our World Economic Forum ranking will improve.

  15. “But this reflects the social democrat notion where workers have a right to work and employers the duty to employ. As we move to the more sensible notion of workers have the duty to work and employers the right to employ I expect our World Economic Forum ranking will improve.”

    I don’t think I’ve seen the contrast between the two positions stated so simply and elegantly before. I’ll cite this formulation in future.

  16. Any data on how economic growth and GDP is shared around among those dutiful employees and entitled employers? Maybe we could do a graph of relative shares of output over time? Or perhaps not. I mean, the duty of employees is to produce, and employers have the right to determine the amount of product they are entitled to. After all, it wouldn’t do to have the trickled on, dispute the amount that gets pissed on them would it.

  17. Fred – I am no expert on these indexes, but as with any source I have found to be seriously wrong in the past I would be very cautious about using it in the future (that’s not to say I wouldn’t, but I would subject it to extra scrutiny to satisfy myself that it was accurate). I’ve had no experience either way with the Fraser Institute economic freedom data.

  18. The Bush Administration is one admirer of the Heritage Foundation’s Index
    of Economic Freedom. The Index is used (among other indices) to determine eligibility for grants by the Millennium
    Challenge Corporation
    , a US-Govt. funded outfit which gives grants
    under agreements (called “compacts”) to a number of LDCs and transition
    economies “to reduce global poverty through the promotion of sustainable
    economic growth”. Indices of Civil Liberties and of Political Rights
    come from Freedom House (on whose Board sit Wolfowitz, Rumsfeld and
    Brzezinski, among others). Other indices are taken from other
    organisations.

  19. Sinclair, Sinclair, Sinclair… workers don’t have a “duty” to work. Both workers and employers have the freedom to join any contract they like. Once they’ve joined the contract they both have the duty to live up to the requirements of that contract.

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