Economic Freedom V.S.Economic Freedom V.S. Real GDP growth, or other Real GDP growth, or other

indicators of economic indicators of economic outcomeoutcome

04015304 Choi Kit Ying 04015304 Choi Kit Ying 04015290 Wong Kim On04015290 Wong Kim On 04013786 Lam King Nin04013786 Lam King Nin 04010140 Chan Hing Kwok04010140 Chan Hing Kwok

IntroductionIntroduction

To evaluate the economic To evaluate the economic performance among different performance among different countries, a lot of economic indicator countries, a lot of economic indicator are usedare used

For example, level of output, static For example, level of output, static efficiency, dynamic efficiency, dynamic efficiency……….etcefficiency……….etc

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

Economic freedom indexEconomic freedom index

The goal for this index is to develop a The goal for this index is to develop a systematic, empirical measurement systematic, empirical measurement of economic freedom in countries of economic freedom in countries throughout the world.throughout the world.

The Index is a careful theoretical The Index is a careful theoretical analysis of the factors that most analysis of the factors that most influence the institutional setting of influence the institutional setting of economic growth. economic growth.

MethodologyMethodology

Total 157 countries are gradedTotal 157 countries are graded Due to economic or political instability , a Due to economic or political instability , a

few countries were not ranked few countries were not ranked 1.1. Democratic Republic of the CongoDemocratic Republic of the Congo 2.2. IraqIraq 3.3. Papua New GuineaPapua New Guinea 4.4. SamoaSamoa 5.5. Serbia and MontenegroSerbia and Montenegro 6.6. SomaliaSomalia 7.7. SudanSudan

10 broad factors 10 broad factors

1.1. Trade policy Trade policy 2.2. Fiscal burden of government Fiscal burden of government 3.3. Government intervention in the economy Government intervention in the economy 4.4. Monetary policy Monetary policy 5.5. Capital flows and foreign investment Capital flows and foreign investment 6.6. Banking and finance Banking and finance 7.7. Wages and prices Wages and prices 8.8. Property rights Property rights 9.9. Regulation Regulation 10.10. Informal market activity Informal market activity

WeighingWeighing

All factors are weighted equally All factors are weighted equally Each factor is graded according to a unique scEach factor is graded according to a unique sc

aleale The scales run from 1 to 5 The scales run from 1 to 5

overall score based on the simple average of toverall score based on the simple average of the 10 individual factor scoreshe 10 individual factor scores

The most conductive

The least conductive

1 5

4 broad categories of economic 4 broad categories of economic freedomfreedom

categoriescategories FreeFree Mostly Mostly FreeFree

Mostly UnfrMostly Unfreeee

RepressedRepressed

average average overall overall scorescore

1.99 1.99

or lessor less2.00 2.00

to 2.99to 2.993.00 3.00

to 3.99to 3.994.00 4.00

or or higherhigher

Latest rating

Trade policyTrade policy

The degree government hinders The degree government hinders access to and the free flow of access to and the free flow of foreign commerce foreign commerce

affect the ability of individuals to affect the ability of individuals to pursue their economic goals pursue their economic goals

Components :Components :1.1. weighted average tariff rate weighted average tariff rate 2.2. non-tariff barriers (e.g. import quotas, non-tariff barriers (e.g. import quotas,

licensing requirements)licensing requirements)

3.3. corruption within the customs servicecorruption within the customs service

Fiscal burden of governmentFiscal burden of government

Government expenditures increases, Government expenditures increases, the level of economic freedom in a the level of economic freedom in a society reduces, vice versasociety reduces, vice versa

Expenditure is financed-by taxation Expenditure is financed-by taxation

resources are diverted from the resources are diverted from the potentially more productive private potentially more productive private sectorsector

expenditures reflect the total fiscal expenditures reflect the total fiscal burdenburden

Components :Components :1.1. Top marginal income tax rate Top marginal income tax rate 2.2. Top marginal corporate tax rate Top marginal corporate tax rate 3.3. Year-to-year change in government exYear-to-year change in government ex

penditures as a share of GDP penditures as a share of GDP *double weight on the top corporate *double weight on the top corporate

tax rate tax rate

Government intervention in the Government intervention in the economyeconomy

Measures government's direct use of scMeasures government's direct use of scarce resources for its own purposes anarce resources for its own purposes and government’s control over resourced government’s control over resources through ownerships through ownership

Components :Components :1.1. Government consumption as a percentGovernment consumption as a percent

age of GDP age of GDP 2.2. Size of the state-owned sector Size of the state-owned sector 3.3. the state of privatization programs the state of privatization programs

Monetary policyMonetary policy

Stable monetary policy Stable monetary policy can rely on market prices for the can rely on market prices for the

foreseeable future foreseeable future longer-term plans are easier to longer-term plans are easier to

makemake individuals enjoy greater economic individuals enjoy greater economic

freedom freedom There is no singularly accepted theory There is no singularly accepted theory

of the right monetary institutions for a of the right monetary institutions for a free society nowfree society now

Most monetary theorists support for loMost monetary theorists support for low or zero inflation w or zero inflation

Components :Components :1.1. weighted average annual rate of inflatiweighted average annual rate of inflati

on of the past 10 years on of the past 10 years

Capital flows and foreign Capital flows and foreign investmentinvestment

Restrictions on foreign investment limit Restrictions on foreign investment limit the inflow of capital and thus hamper the inflow of capital and thus hamper economic freedom, vice versaeconomic freedom, vice versa

Components :Components :1.1. foreign investment code foreign investment code 2.2. restrictions on access to foreign exchange restrictions on access to foreign exchange 3.3. restrictions on payments, transfers, and capital restrictions on payments, transfers, and capital

transactions transactions 4.4. Equal treatment under the law for both foreign Equal treatment under the law for both foreign

& domestic companies& domestic companies5.5. Foreign ownership of landForeign ownership of land6.6. Availability of local financing for foreign Availability of local financing for foreign

companiescompanies

Banking and financeBanking and finance Banks provide the essential financial Banks provide the essential financial

services that facilitate economic growth services that facilitate economic growth heavy bank regulation, the less free they heavy bank regulation, the less free they

are to engage in these activities are to engage in these activities restricts economic freedom restricts economic freedom Components :Components :1.1. Government regulationsGovernment regulations2.2. Government ownership of financial InstitutionsGovernment ownership of financial Institutions3.3. Restrictions on the ability of foreign banks to Restrictions on the ability of foreign banks to

open branches & subsidiariesopen branches & subsidiaries4.4. Government influence over the allocation of Government influence over the allocation of

creditcredit

Wages and pricesWages and prices

If prices are determined freely If prices are determined freely

allocate resources to their highest allocate resources to their highest use use

Governments mandate wage and Governments mandate wage and price controlsprice controls

inhibit information, restrict economic inhibit information, restrict economic activity activity

lower level of economic freedom lower level of economic freedom

Components :Components :

1.1. Degree of freedom to set pricesDegree of freedom to set prices

2.2. Minimum wage lawsMinimum wage laws

3.3. Government price controlsGovernment price controls

4.4. Government subsidies to business Government subsidies to business that affect pricesthat affect prices

Property rights Property rights

Examines …Examines …

1.1. the extent to which the government protects the extent to which the government protects private property by enforcing the laws private property by enforcing the laws

2.2. how safe private property is from how safe private property is from expropriation. expropriation.

Secure property rights give citizens the Secure property rights give citizens the confidence to undertake commercial confidence to undertake commercial activities freely activities freely

less protection private property receives, less protection private property receives, lower level of economic freedom lower level of economic freedom

Components :Components :

1.1. Independence of the judiciary Independence of the judiciary

2.2. Delays in receiving judicial Delays in receiving judicial decisionsdecisions

3.3. Corruption within the judiciaryCorruption within the judiciary

4.4. Government expropriation of Government expropriation of propertyproperty

5.5. Commercial code defining contractsCommercial code defining contracts

RegulationsRegulations

Measures how easy or difficult it is to Measures how easy or difficult it is to open and operate a business open and operate a business

Most important Regulations are Most important Regulations are associated with licensing new associated with licensing new companies and businessescompanies and businesses

If regulations applies evenly and If regulations applies evenly and transparently transparently

regulatory burden lowersregulatory burden lowers

Components :Components :1.1. Degree of corruption in government Degree of corruption in government 2.2. Licensing requirements to operate a Licensing requirements to operate a

businessbusiness3.3. Labor regulationsLabor regulations4.4. Environmental, consumer safety, & Environmental, consumer safety, &

worker health regulationsworker health regulations5.5. Extent to which regulations impose Extent to which regulations impose

a burden on business a burden on business

Informal market Informal market

A government regulation or restriction A government regulation or restriction in one area may create an informal in one area may create an informal marketmarket

Captures the effects of government Captures the effects of government interventions that are not always fully interventions that are not always fully measured elsewheremeasured elsewhere

Reflects restrictions, taxes, or Reflects restrictions, taxes, or imperfections in the private market imperfections in the private market

larger the informal market, the lower larger the informal market, the lower the country's level of economic freedomthe country's level of economic freedom

Components :Components :

1.1. Mainly relies on Transparency Mainly relies on Transparency International's Corruption International's Corruption Perceptions Index (CPI)Perceptions Index (CPI)

2.2. SmugglingSmuggling

3.3. Piracy of intellectual property in Piracy of intellectual property in the informal marketthe informal market

Economic Freedom Economic Freedom VS. VS.

Real GDP GrowthReal GDP Growth

Real GDPReal GDP Real GDP = Nominal GDP – Inflation Real GDP = Nominal GDP – Inflation

raterate

Real GDP measures the value of output Real GDP measures the value of output in two or more different years by in two or more different years by valuing the goods and services valuing the goods and services adjusted for inflation. adjusted for inflation.

For year over year For year over year GDP growthGDP growth, "real , "real GDP" is usually used as it gives a more GDP" is usually used as it gives a more accurate view of the economy.accurate view of the economy.

Economic Freedom Economic Freedom VS. VS.

Real GDP GrowthReal GDP Growth Generally, real GDP is positively Generally, real GDP is positively

related to the economic freedomrelated to the economic freedom A free economy can allocate the A free economy can allocate the

resource more efficientresource more efficient if prices are determined freely,if prices are determined freely, resources go to their most productive resources go to their most productive

useuse

Better protection of private Better protection of private property, Increase incentive of property, Increase incentive of productionproduction

More free capital flows and More free capital flows and foreign investment can boost the foreign investment can boost the GDPGDP

China is a good examChina is a good exampleple

Since the reform periSince the reform period, the market is mood, the market is more open and the GDP re open and the GDP growth is increase growth is increase

China

0.00

5000.00

10000.00

15000.00

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

China

The more Economic The more Economic Freedom , the Freedom , the more Real GDP more Real GDP Growth?Growth?

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

Economic Freedom Economic Freedom VS. VS.

Gini CoeffecientGini Coeffecient

Gini coefficientGini coefficient It is usually used to measure income inequalitIt is usually used to measure income inequalit

y, but can be used to measure any form of uney, but can be used to measure any form of uneven distribution. ven distribution.

Using the Gini can help quantify differences in Using the Gini can help quantify differences in welfare and compensation policies and philoswelfare and compensation policies and philosophies. ophies.

The Gini coefficient is a number between 0 anThe Gini coefficient is a number between 0 and 1, where 0 corresponds with perfect equality d 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 c(where everyone has the same income) and 1 corresponds with perfect inequality (where one orresponds with perfect inequality (where one person has all the income, and everyone else hperson has all the income, and everyone else has zero income). as zero income).

Gini coefficientGini coefficient

China

Iran

South Korea

Hong Kong

September 2005

Hong Kong is the champion in economic Hong Kong is the champion in economic freedomfreedom

However, its Gini coefficient is the higheHowever, its Gini coefficient is the highest compare with other developed countrst compare with other developed countriesies

0.525 in 20010.525 in 2001

The welfare is low in Hong Kong,so the fiscal bThe welfare is low in Hong Kong,so the fiscal burden of Hong Kong is lowurden of Hong Kong is low

Compare with Sweden ,its welfare is high(scorCompare with Sweden ,its welfare is high(scored 3.6 at the category of Fiscal burden), so Swed 3.6 at the category of Fiscal burden), so Sweden have low gini coefficient. Although Swededen have low gini coefficient. Although Sweden will loss some degree of freedom due to higen will loss some degree of freedom due to higher welfareher welfare

More free, better living standard of people?More free, better living standard of people?

Economic Freedom Economic Freedom VS. VS.

Unemployment rateUnemployment rate

Unemployment RateUnemployment Rateunemployment rate of 2004

02468

1012

SouthKorea

China HongKong

Iran

unemployment rate of2004

Economic freedom is negatively related Economic freedom is negatively related to the unemployment rateto the unemployment rate

More foreign investment More foreign investment more labour demandmore labour demand lower unemployment rate lower unemployment rate

In the category of In the category of Fiscal burden of Fiscal burden of government , more government , more unemployment unemployment benefit and other welfare, the benefit and other welfare, the economic freedom is lowereconomic freedom is lower

Working incentive is lower and Working incentive is lower and unemployment rate will be higherunemployment rate will be higher

Overall, unemployment rate will be Overall, unemployment rate will be low if the score which in low if the score which in Index of Index of Economic FreedomEconomic Freedom is low. is low.

Exceptional case: Under the central Exceptional case: Under the central planning system, there is no planning system, there is no unemployment unemployment

The problem about The problem about accuracy of these accuracy of these

indicatorindicator

We get the basic knowledge of these We get the basic knowledge of these economic indicators and their economic indicators and their correlationcorrelation

Do they reflect the reality situation?Do they reflect the reality situation? We discovered some problems about We discovered some problems about

the calculation of these indexthe calculation of these index

About category: wages and prices About category: wages and prices

It only considers the direct wage It only considers the direct wage control by the government.control by the government.

Ignores the other factors which control Ignores the other factors which control the wages. For example, union the wages. For example, union

The score of Sweden, Finland and The score of Sweden, Finland and Denmark at this category are 2Denmark at this category are 2

We think these countries should not We think these countries should not get such good score at this categoryget such good score at this category

The strong union power in these The strong union power in these control the wage of the marketcontrol the wage of the market

They are often given direct and They are often given direct and indirect financial support from the indirect financial support from the governmentgovernment

Are they free??Are they free??

About the category: Informal About the category: Informal market market

As the Heritage foundation argued: it As the Heritage foundation argued: it is a kind of indirect measurement of is a kind of indirect measurement of how freedom is restricted within the how freedom is restricted within the formal marketformal market

If the formal market is free, people If the formal market is free, people have no incentive to engage at have no incentive to engage at informal marketinformal market

However, in our point of view, the size of However, in our point of view, the size of informal market is not highly correlated informal market is not highly correlated with economic freedomwith economic freedom

The efficiency and attitude of the governThe efficiency and attitude of the government in cracking down on the informal sment in cracking down on the informal sector is more importantector is more important

For example: tax evasion of third world cFor example: tax evasion of third world countries with low tax rates v.s Scandinavountries with low tax rates v.s Scandinavia with high tax ratesia with high tax rates

Imagine the consequence if Hong Kong Imagine the consequence if Hong Kong Customs and Excise Department do notCustoms and Excise Department do nothinghing

So, this category should not weight as saSo, this category should not weight as same as other categoriesme as other categories

About real GDP growth rateAbout real GDP growth rate

Very often, the growth rate is higher Very often, the growth rate is higher in developing countriesin developing countries

the development of advanced the development of advanced countries is relatively slowcountries is relatively slow

Many inefficient investment are Many inefficient investment are counted in the GDPcounted in the GDP

For example, the large number of For example, the large number of empty building and low utilization empty building and low utilization highway in Chinahighway in China

Also, the GDP reported by the Also, the GDP reported by the countries their own is not accuratecountries their own is not accurate

This is the end of the This is the end of the presentation.presentation.

~Thank you very much~~Thank you very much~

Question and Answer Question and Answer SessionSession