The Other Olympics

What do the United States and the United Kingdom have in common, economically, with Argentina, Pakistan, Uganda, Venezuela, Greece and North Korea?  Answer: they have all become less free over the past 20 years.

I am writing this note a bit later in the month than I normally do and will ascribe the delay to Olympic Fever.  Well, perhaps that’s an exaggeration, but I have to admit that I find something compelling about watching men and women fly down a hill, unprotected, at speeds greater than I than I am allowed on the freeway.  However, now that the athletic competition is over, I can turn my attention to the more important global competition, the Economic Olympics.

Every day of every year, companies and individuals compete economically.  Most are looking to enhance their own quality of life.  Some do better than others.  Some do worse.  Some of the outcome is due to the effort put forth.  Some of the outcome is due to the skills of the competing parties.  And some is due to the environment in which they operate.  It is the last of these that I look at in this month’s post.

About 15 years ago, I first came across the Wall Street Journal and Heritage Foundation’s annual Index of Economic Freedom and was immediately hooked.  This year’s release marks the 20^th anniversary of the index.  The concept of Economic Freedom and the construction of the index made intuitive sense to me.  As described by the authors, Economic Freedom is a condition where individuals are free to work, produce, consume, and invest in any way they please. It also describes a situation where governments allow labor, capital and goods to move freely, and where they refrain from the coercion or constraint of liberty.  In measuring economic freedom, the Index analyzes countries’ commitment to the rule of law, principles of limited government, regulatory efficiency, and open markets – what they refer to as the “four pillars”.

Each pillar is comprised of two to three sub-categories which themselves are comprised of a variety of quantitative and qualitative measures.  The four pillars and the ten sub-categories are:

• The Rule of Law (property rights, freedom from corruption);
• Limited Government (fiscal freedom, government spending);
• Regulatory Efficiency (business freedom, labor freedom, monetary freedom); and
• Open Markets (trade freedom, investment freedom, financial freedom).

Each of the ten economic freedoms within these categories is graded on a scale of 0 to 100. A country’s overall score is derived by averaging these ten economic freedoms, with equal weight being given to each (http://www.heritage.org/index/about).

This year, 186 countries were included in the study and 179 received scores.  While the difference in ranks should not be taken as a precise measure of guaranteed success (really, what is the difference between a score of 73.2 and 76.1?), countries can more easily be delineated into one of five broad classifications: Free (currently 6 countries), Mostly Free (28), Moderately Free (56), Mostly Unfree (61) and Repressed (27).  In addition to the broad classifications, I have always been interested in how countries have moved within the rankings.  I would find more comfort starting a business in a country, for example, that moved from 100 to 60, than in one that fell from 20 to 40.

This year, only six countries are considered truly Free.  They are (in order) Hong Kong, Singapore, Australia, Switzerland, New Zealand and Canada.  Hong Kong has remained the most free country since the inception of the study.  On the other hand, the United States’ score has now fallen in each of the past seven years; and while it was ranked as high as number five just six years ago, it is currently number 12.  The country, though, still remains Mostly Free.

With that in mind, I look to summarize the winners and losers over the past 20 years.  During this time, the general level of global economic freedom has increased, though it has not been consistent over time or across countries.  In addition, the size of the scored universe has increased meaning many countries have fallen in the rankings simply because new countries have entered, even though absolute scores may have increased. It is also harder to move up in the rankings when you already have a high freedom score and rank and it is easier to improve when you have a low rank and score.  With all these moving parts in mind, I have looked at winners and losers in a couple of different ways.  Note that this specific analysis of the data has not been endorsed by the authors and is mine entirely.  I would direct you to their complete study to see their conclusions.  That said, allow me to present my winners and losers.

The Winners

Only five countries moved up in the rankings during both the periods 1995 – 2004 and 2004 – 2014.  They are Bulgaria, Canada, Chile, Hungary and Sweden. In all of these cases, the absolute scores improved in both periods.  I consider these countries all Gold Medalists.

If, instead, I measure winners and rank countries by percentage improvement in score over the full period (and then eliminate any whose scores declined in the most recent 10-year period or which are not currently considered Moderately Free or better) I am left with 21 names – Romania, Albania, Poland, Bulgaria, Botswana, Hungary, Madagascar, Sweden, Peru, Malta, Ghana, Canada, Uruguay, Australia, Chile, Jordan, the Slovak Republic, the Philippines, Mexico, Singapore and Hong Kong.  All are interesting and comprise my Silver and Bronze Medalist lists.

The Losers

A much larger group of countries fell in the rankings during both periods, though as mentioned earlier, in many cases a fall in the absolute rank was due to an expansion of the number of countries scored in the study (up from 101 in 1995 to 155 in 2004 to 178 today).  Excluding those whose absolute score today is higher than it was in 1995, we are left with 27 countries who lost ground during both periods (the bolded countries are the larger and more investible).  They are Argentina, Belize, Costa Rica, Ecuador, El Salvador, France, Greece, Guatemala, Guinea, Italy, Morocco, North Korea, Oman, Pakistan, Panama, Sierra Leone, Sri Lanka, Swaziland, Thailand, The Bahamas, Tunisia, Uganda, the Ukraine, the United Kingdom, the United States, Venezuela and Zimbabwe. 

A smaller list of eight countries saw raw scores decline in both periods.  They were Argentina, Ecuador, Greece, Guinea, Panama, Venezuela and Thailand.  Of these, only Thailand and Panama remain in the Mostly Free category.  These are consistently bad players.

The countries whose score declined by the greatest percentage (and by at least 10%) over the past ten years include North Korea, Bolivia, Venezuela, the Central African Republic, Argentina, Turkmenistan, Equatorial Guinea, Cuba, Chad, Mauritania, Algeria, Trinidad and Tobago, Ecuador and Belize – on nobody’s list of economic paragons and, for the most part, not investible countries. 

Of the larger and more liquid countries, deterioration in Freedom scores of at least 5% over the past ten years were seen in Brazil, the Ukraine, South Africa, Greece, Ireland, Italy and Egypt.  Of these seven countries, only Ireland (solidly) and Italy (though just barely) remain in the Mostly Free category.  This should be disconcerting to those looking to start businesses or those who have large operations in these countries.

Economic Freedom scores are not, by themselves, an investment strategy.  Instead, they can be used as a risk measure and as a caution for companies with large investments in the less free regions.  Also they should serve as a wake up call for policy makers not in the Free or Mostly Free categories, or in those countries not moving up quickly from the lower ranks.