Economic Freedom V.S. Real GDP growth, or other indicators of economic outcome Choi Kit Ying Choi Kit Ying Wong Kim On Wong Kim On Lam King Nin Lam King Nin Chan Hing Kwok Chan Hing Kwok

Introduction

To evaluate the economic performance among different countries, a lot of economic indicator are used To evaluate the economic performance among different countries, a lot of economic indicator are used For example, level of output, static efficiency, dynamic efficiency ……….etc For example, level of output, static efficiency, dynamic efficiency ……….etc

One of them is the index of economic freedom announced by the Heritage Foundation (a unique institution public policy research organization, founded in 1973) One of them is the index of economic freedom announced by the Heritage Foundation (a unique institution public policy research organization, founded in 1973)

Economic freedom index The goal for this index is to develop a systematic, empirical measurement of economic freedom in countries throughout the world. The goal for this index is to develop a systematic, empirical measurement of economic freedom in countries throughout the world. The Index is a careful theoretical analysis of the factors that most influence the institutional setting of economic growth. The Index is a careful theoretical analysis of the factors that most influence the institutional setting of economic growth.

Methodology

Total 157 countries are graded Total 157 countries are graded Due to economic or political instability, a few countries were not ranked Due to economic or political instability, a few countries were not ranked 1. Democratic Republic of the Congo Democratic Republic of the Congo Democratic Republic of the Congo 2. Iraq Iraq 3. Papua New Guinea Papua New Guinea Papua New Guinea 4. Samoa Samoa 5. Serbia and Montenegro Serbia and Montenegro Serbia and Montenegro 6. Somalia Somalia 7. Sudan Sudan

10 broad factors 1. Trade policy 2. Fiscal burden of government 3. Government intervention in the economy 4. Monetary policy 5. Capital flows and foreign investment 6. Banking and finance 7. Wages and prices 8. Property rights 9. Regulation 10. Informal market activity

Weighing All factors are weighted equally All factors are weighted equally Each factor is graded according to a unique scale Each factor is graded according to a unique scale The scales run from 1 to 5 The scales run from 1 to 5 overall score based on the simple average of the 10 individual factor scores overall score based on the simple average of the 10 individual factor scores The most conductive The least conductive 1 5

4 broad categories of economic freedom categoriesFree Mostly Free Mostly Unfree Repressed average overall score 1.99 or less 2.00 to to or higher Latest rating

Trade policy The degree government hinders access to and the free flow of foreign commerce The degree government hinders access to and the free flow of foreign commerce affect the ability of individuals to pursue their economic goals affect the ability of individuals to pursue their economic goals Components : Components : 1. weighted average tariff rate 2. non-tariff barriers (e.g. import quotas, licensing requirements) 3. corruption within the customs service

Fiscal burden of government Government expenditures increases, the level of economic freedom in a society reduces, vice versa Government expenditures increases, the level of economic freedom in a society reduces, vice versa Expenditure is financed-by taxation Expenditure is financed-by taxation resources are diverted from the potentially more productive private sector resources are diverted from the potentially more productive private sector expenditures reflect the total fiscal burden expenditures reflect the total fiscal burden

Components : Components : 1. Top marginal income tax rate 2. Top marginal corporate tax rate 3. Year-to-year change in government expenditures as a share of GDP *double weight on the top corporate tax rate

Government intervention in the economy Measures government's direct use of scarce resources for its own purposes and government ’ s control over resources through ownership Measures government's direct use of scarce resources for its own purposes and government ’ s control over resources through ownership Components : Components : 1. Government consumption as a percentage of GDP 2. Size of the state-owned sector 3. the state of privatization programs

Monetary policy Stable monetary policy Stable monetary policy can rely on market prices for the foreseeable future can rely on market prices for the foreseeable future longer-term plans are easier to make longer-term plans are easier to make individuals enjoy greater economic freedom individuals enjoy greater economic freedom There is no singularly accepted theory of the right monetary institutions for a free society now There is no singularly accepted theory of the right monetary institutions for a free society now

Most monetary theorists support for low or zero inflation Most monetary theorists support for low or zero inflation Components : Components : 1. weighted average annual rate of inflation of the past 10 years

Capital flows and foreign investment Restrictions on foreign investment limit the inflow of capital and thus hamper economic freedom, vice versa Restrictions on foreign investment limit the inflow of capital and thus hamper economic freedom, vice versa Components : Components : 1. foreign investment code 2. restrictions on access to foreign exchange 3. restrictions on payments, transfers, and capital transactions 4. Equal treatment under the law for both foreign & domestic companies 5. Foreign ownership of land 6. Availability of local financing for foreign companies

Banking and finance Banks provide the essential financial services that facilitate economic growth Banks provide the essential financial services that facilitate economic growth heavy bank regulation, the less free they are to engage in these activities heavy bank regulation, the less free they are to engage in these activities restricts economic freedom restricts economic freedom Components : Components : 1. Government regulations 2. Government ownership of financial Institutions 3. Restrictions on the ability of foreign banks to open branches & subsidiaries 4. Government influence over the allocation of credit

Wages and prices If prices are determined freely If prices are determined freely allocate resources to their highest use allocate resources to their highest use Governments mandate wage and price controls Governments mandate wage and price controls inhibit information, restrict economic activity inhibit information, restrict economic activity lower level of economic freedom lower level of economic freedom

Components : Components : 1. Degree of freedom to set prices 2. Minimum wage laws 3. Government price controls 4. Government subsidies to business that affect prices

Property rights Examines … Examines … 1. the extent to which the government protects private property by enforcing the laws 2. how safe private property is from expropriation. Secure property rights give citizens the confidence to undertake commercial activities freely Secure property rights give citizens the confidence to undertake commercial activities freely less protection private property receives, lower level of economic freedom less protection private property receives, lower level of economic freedom

Components : Components : 1. Independence of the judiciary 2. Delays in receiving judicial decisions 3. Corruption within the judiciary 4. Government expropriation of property 5. Commercial code defining contracts

Regulations Measures how easy or difficult it is to open and operate a business Measures how easy or difficult it is to open and operate a business Most important Regulations are associated with licensing new companies and businesses Most important Regulations are associated with licensing new companies and businesses If regulations applies evenly and transparently If regulations applies evenly and transparently regulatory burden lowers regulatory burden lowers

Components : Components : 1. Degree of corruption in government 2. Licensing requirements to operate a business 3. Labor regulations 4. Environmental, consumer safety, & worker health regulations 5. Extent to which regulations impose a burden on business

Informal market A government regulation or restriction in one area may create an informal market A government regulation or restriction in one area may create an informal market Captures the effects of government interventions that are not always fully measured elsewhere Captures the effects of government interventions that are not always fully measured elsewhere Reflects restrictions, taxes, or imperfections in the private market Reflects restrictions, taxes, or imperfections in the private market larger the informal market, the lower the country's level of economic freedom larger the informal market, the lower the country's level of economic freedom

Components : Components : 1. Mainly relies on Transparency International's Corruption Perceptions Index (CPI) 2. Smuggling 3. Piracy of intellectual property in the informal market

Economic Freedom VS. Real GDP Growth

Real GDP Real GDP = Nominal GDP – Inflation rate Real GDP = Nominal GDP – Inflation rate Real GDP measures the value of output in two or more different years by valuing the goods and services adjusted for inflation. Real GDP measures the value of output in two or more different years by valuing the goods and services adjusted for inflation. For year over year GDP growth, "real GDP" is usually used as it gives a more accurate view of the economy. For year over year GDP growth, "real GDP" is usually used as it gives a more accurate view of the economy.

Economic Freedom VS. Real GDP Growth Generally, real GDP is positively related to the economic freedom Generally, real GDP is positively related to the economic freedom A free economy can allocate the resource more efficient A free economy can allocate the resource more efficient if prices are determined freely, if prices are determined freely,  resources go to their most productive use

Better protection of private property, Increase incentive of production Better protection of private property, Increase incentive of production More free capital flows and foreign investment can boost the GDP More free capital flows and foreign investment can boost the GDP

China is a good example China is a good example Since the reform period, the market is more open and the GDP growth is increase Since the reform period, the market is more open and the GDP growth is increase

The more Economic Freedom, the more Real GDP Growth?

Improving economic freedom will raise real GDP growth rate, but not the only factor.

Economic Freedom VS. Gini Coeffecient

Gini coefficient It is usually used to measure income inequality, but can be used to measure any form of uneven distribution. It is usually used to measure income inequality, but can be used to measure any form of uneven distribution. Using the Gini can help quantify differences in welfare and compensation policies and philosophies. Using the Gini can help quantify differences in welfare and compensation policies and philosophies. The Gini coefficient is a number between 0 and 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 corresponds with perfect inequality (where one person has all the income, and everyone else has zero income). The Gini coefficient is a number between 0 and 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 corresponds with perfect inequality (where one person has all the income, and everyone else has zero income).

Gini coefficient China Iran South Korea Hong Kong September 2005

Hong Kong is the champion in economic freedom Hong Kong is the champion in economic freedom However, its Gini coefficient is the highest compare with other developed countries However, its Gini coefficient is the highest compare with other developed countries in in 2001

The welfare is low in Hong Kong,so the fiscal burden of Hong Kong is low The welfare is low in Hong Kong,so the fiscal burden of Hong Kong is low Compare with Sweden,its welfare is high(scored 3.6 at the category of Fiscal burden), so Sweden have low gini coefficient. Although Sweden will loss some degree of freedom due to higher welfare Compare with Sweden,its welfare is high(scored 3.6 at the category of Fiscal burden), so Sweden have low gini coefficient. Although Sweden will loss some degree of freedom due to higher welfare More free, better living standard of people? More free, better living standard of people?

Economic Freedom VS. Unemployment rate

Unemployment Rate

Economic freedom is negatively related to the unemployment rate Economic freedom is negatively related to the unemployment rate More foreign investment More foreign investment more labour demand more labour demand lower unemployment rate lower unemployment rate

In the category of Fiscal burden of government, more unemployment benefit and other welfare, the economic freedom is lower In the category of Fiscal burden of government, more unemployment benefit and other welfare, the economic freedom is lower Working incentive is lower and unemployment rate will be higher Working incentive is lower and unemployment rate will be higher

Overall, unemployment rate will be low if the score which in Index of Economic Freedom is low. Overall, unemployment rate will be low if the score which in Index of Economic Freedom is low. Exceptional case: Under the central planning system, there is no unemployment Exceptional case: Under the central planning system, there is no unemployment

The problem about accuracy of these indicator

We get the basic knowledge of these economic indicators and their correlation We get the basic knowledge of these economic indicators and their correlation Do they reflect the reality situation? Do they reflect the reality situation? We discovered some problems about the calculation of these index We discovered some problems about the calculation of these index

About category: wages and prices It only considers the direct wage control by the government. It only considers the direct wage control by the government. Ignores the other factors which control the wages. For example, union Ignores the other factors which control the wages. For example, union The score of Sweden, Finland and Denmark at this category are 2 The score of Sweden, Finland and Denmark at this category are 2 We think these countries should not get such good score at this category We think these countries should not get such good score at this category

The strong union power in these control the wage of the market The strong union power in these control the wage of the market They are often given direct and indirect financial support from the government They are often given direct and indirect financial support from the government Are they free?? Are they free??

About the category: Informal market As the Heritage foundation argued: it is a kind of indirect measurement of how freedom is restricted within the formal market As the Heritage foundation argued: it is a kind of indirect measurement of how freedom is restricted within the formal market If the formal market is free, people have no incentive to engage at informal market If the formal market is free, people have no incentive to engage at informal market

However, in our point of view, the size of informal market is not highly correlated with economic freedom However, in our point of view, the size of informal market is not highly correlated with economic freedom The efficiency and attitude of the government in cracking down on the informal sector is more important The efficiency and attitude of the government in cracking down on the informal sector is more important

For example: tax evasion of third world countries with low tax rates v.s Scandinavia with high tax rates For example: tax evasion of third world countries with low tax rates v.s Scandinavia with high tax rates Imagine the consequence if Hong Kong Customs and Excise Department do nothing Imagine the consequence if Hong Kong Customs and Excise Department do nothing So, this category should not weight as same as other categories So, this category should not weight as same as other categories

About real GDP growth rate Very often, the growth rate is higher in developing countries Very often, the growth rate is higher in developing countries the development of advanced countries is relatively slow the development of advanced countries is relatively slow Many inefficient investment are counted in the GDP Many inefficient investment are counted in the GDP

For example, the large number of empty building and low utilization highway in China For example, the large number of empty building and low utilization highway in China Also, the GDP reported by the countries their own is not accurate Also, the GDP reported by the countries their own is not accurate

This is the end of the presentation. ~Thank you very much~ Question and Answer Session