Road to Prosperity: Economic Freedom


In this article the author analyses differences in methodologies of evaluating economic freedom, presents Lithuania’s rankings among other countries and discusses discernable trends that the world is likely to be following.

Why do some countries flourish and others languish? What is the formula for economic prosperity and growth? What has to be done so that people and companies earn more? These questions troubled economists who tried to unriddle the secret of enrichment. Back in the middle of the last century, economic theorists proved that only the reign of the market creates the best prerequisites for the growth of peoples’ economic welfare.
However, theory is not always convincing; ordinary people, and sometimes politicians, want “harder,” practical, evidence. Fortunately, today we have as many as three surveys, counting over a decade, which prove practically a direct link between economic freedom and economic welfare. Reports on economic freedom are conducted by the U.S.A. Heritage Foundation, the Freedom House and Canada’s Fraser Institute. The latter has published the most recent annual report on “Economic Freedom in the World.”
On methodology
The Fraser Institute has been conducting freedom studies since 1986 in 123 countries, together with similar organizations (the Lithuanian Free Market Institute in Lithuania). In conducting them, third-party statistical data has been used to help ensure objectivity. The development of the methodology for the report was led by Nobel Prize winner Milton Friedman. Today, M. Friedman sees the freedom index as a roadmap to building prosperous and democratic nations. “Freeing people economically unleashes individual drive and initiative and puts a nation on the road to economic growth,” he says. Empirical data confirms an old economic truth – economic freedom is the foundation for the creation of peoples’ welfare.
The freedom index measures economic freedom in five key areas – size of government: taxes, expenditures and enterprises; legal structure and security of property rights; access to sound money; freedom to exchange with foreigners; and regulation of credit, labour and business. In total, 21 components are incorporated into the final integrated index, which decides the country’s ranking. The most recent report publishes the 2001 freedom ratings.
Lithuania in the world
According to the Fraser report, in 2001, Lithuania received a rating of 6.2 and was ranked 69th together with Cyprus, Mexico and Tanzania. The neighbouring Baltic States have outscored Lithuania in freedom ratings: Latvia was ranked 51st, and Estonia – 16th. Neighbouring Poland is lagging behind and was ranked 77th. Compared to the last report, the amount of freedom in Lithuania has changed very insignificantly, however, Lithuania dropped from 68th to 69th position.
But if we were to look at the report by the Heritage Foundation, we would see a slightly different arrangement of the Baltic States. Estonia, an unquestionable leader in the Heritage index, ranked 6th, while Lithuania, ranked 29th, outran Latvia, ranked 33rd. Both indexes agree that Hong Kong leads the freedom index, with Singapore ranking 2nd.
Where Lithuania lags behind and what are the future perspectives?
In which of the said five areas is Lithuania leading, in which is it lagging behind and why?
In the Fraser report, Lithuania received the least amount of points (meaning that there is least freedom) in the area of labour regulation. This area focuses on the impact of the minimum wage, flexibility in hiring and firing, a share of labour force whose wages are set by centralised collective bargaining, and other labour regulations. Flexibility in hiring and firing received a particularly low rating, which, despite being liberalized by a new labour code effectual form 2003, still remains quite rigid. Even if there is hope that in light of the new labour code the rating might go up next year, a decision to increase the minimum wage from 430 to 450 litas will undoubtedly pull the rating down.
A significant number of people in Lithuania receive a minimum wage. This is an indicator that it is not that minimum, but rather “average.” A decision to raise the minimum wage was likely driven by plans to increase budget revenues, rather than was a result of changed market conditions. C
ompared to the neighbouring Baltic States, Lithuania received a particularly small amount of points for the monetary policy pursued. Having an analogous monetary system to that of Estonia – the currency board, and for the past ten years enjoying a stable national currency, Litas, Lithuania received a rating of only 7.5, while both Estonia and Latvia got a rating of 8.8. This part of the report casts somewhat doubts on its methodology. It measures the growth of money supply, which indicates the level of government intervention in the money market; however, with the existence of the currency board this measurement has a completely different meaning. In the instance of a pegged currency, the growth of money supply is stimulated not by the central bank, but, for the most part, by investments. The currency board renders the central bank harmless, almost unable to influence the monetary policy. Therefore, different measurement criteria should be applied to countries with strict currency board systems. In the area of monetary policy, Lithuania indeed has a potential to better its rating if the methodology was improved. However, it should not be forgotten that in such a case a change in ratings in the freedom index would not mean an increase in freedom and welfare.
According to the Fraser index, Lithuania enjoys the most freedom in the area of exchange with foreigners; the amount of freedom was evaluated with 7.8 points. Indeed, Lithuania has abolished most import and export restrictions, has concluded free trade agreements with 31 countries, which include important trade partners. The tariffs of customs duties applied in Lithuania are comparatively low; they amount, on average, to 2.5 percent (and to 12.5 percent for agricultural products). Integration into the EU will somewhat correct these figures. The average tariff of customs duties (conventional customs) will go up to 4.5 percent, and to 14.4 percent for agricultural products. Besides, it is noteworthy, that the extent of non-tariff barriers, measured by the Fraser’s freedom index, is increasing. So in the future the amount of freedom to exchange with foreigners will shrink.
The world – in shackles?
What does the globe look like in progress? Is humanity striving for more economic freedom, or is apt to give it up, agreeing in turn to lose part of well-being? And even though no one calculates the freedom index of the world, the trend can be discerned by looking at individual countries. The freedom indexes are falling in all countries, even in the leading ones – Hong Kong and Singapore. Once rated the highest, 9 points, Hong Kong received only 8.6 points. No country has ever had absolute freedom – a rating of 10 points. Countries are becoming more similar, but, most sadly, they settle not for freedom, but for the restraints thereof. The lesson of economic prosperity is yet to be learned.