How the West was Lost?

This article was published on, July 17, 2004.

According to a new report, economic freedom across the world is growing. Economic liberalization in Central and Eastern Europe in particular is on the upswing. Unfortunately, the same cannot be said about most of the countries of the pre-enlargement European Union. Should the trend of growing competitiveness and improving business environments in post-communist countries continue, companies and capital will shift from West to East. Erosion of the Western tax base should then prompt competitive tax cutting in the West. And that’s good news for Europe’s over-taxed citizens.

This year’s report, called Economic Freedom of the World: 2004 Annual Report and published July 15 by the Economic Freedom Network, measures 38 separate variables, including the burden of taxes and labor and business regulation, the strength of private property rights, freedom to trade with foreigners, and access to sound money to produce an estimate of economic freedom in a specific country.

Based on 30 years of available data, the authors - economists James Gwartney and Robert Lawson — were able to establish a strong correlation between economic freedom and economic growth. Between 1993 and 2002, for example, countries in the most economically free quintile grew at a rate of 2.4 percent per year. Countries in the least economically free quintile contracted by 0.5 percent per year. Similarly, the 2002 per capita income in the most economically free quintile was $26,106, while per capita income in the least economically free quintile was only $2,828.

In 2004, 123 countries throughout the world were ranked relative to one another and rated on a 1 to 10 scale of economic freedom, with 0 denoting the least free and 10 denoting the freest economy. In 2004, Hong Kong remained the freest economy in the world. It was followed by Singapore. Sharing third place were New Zealand, Switzerland, and the freest EU economy, the United Kingdom. The least free EU economy was Slovenia in 74th place. In 44th place, France continued to be the least free pre-enlargement EU economy.

The European economy that has over the course of the year achieved the most rapid improvement was Slovakia, which jumped 26 places (from 77 to 51). Lithuania improved its ranking by 25 places (from 69 to 44). Other significant improvements were achieved by Poland (from 77 to 61), Latvia (from 51 to 36) and Hungary (from 35 to 22). In 2004, Estonia remained the freest economy of the former communist bloc, having jumped from 16th to 11th place in the world. Some EU countries, including Ireland, Netherlands, Denmark, Austria, Germany, Portugal and Italy saw some marginal erosion of their rankings.

An un-weighted average for the 15 members of the pre-enlargement EU showed no change over last year. The “old” 15 members retained their 2003 ranking of 20.9 and rating of 7.4. The eight countries of Central and Eastern Europe that joined the EU on May 1, 2004, improved their performance considerably. Over the course of the year, the new members improved their average ranking from 54.6 to 42.5 and their average rating from 6.5 to 6.9.

Looking at the level of economic freedom in Europe between 2000 and 2004, it is evident that the “new” EU countries are catching up with the “old.” The average ranking of the old EU members declined from 19 in 2000 to 20.9 in 2004. The average ranking of the new members from Central and Eastern Europe increased from 62.8 to 42.5. Their average rating rose from 6.6 to 6.9. The rating for the old 15 EU members, however, fell from 8.2 in 2000 to 7.4 in 2004.

European economic freedom 2000-2004

Liberalization in Eastern Europe could increase internal competition in Europe and the competitiveness of European companies overseas. However, care needs to be taken to prevent politicians and special interests in Western Europe, which fear the growing competitiveness of the East, from harming Eastern efforts to liberalize. The minimum corporate tax rate, currently favoured by France and Germany, should be strenuously opposed. Moreover, the new EU members should reject the European Constitution. Increased centralization of economic decision-making in Brussels may prevent the increase in economic freedom in the East, which is needed if the new EU members are also to become prosperous.

Marian L. Tupy is assistant director of the Project on Global Economic Libertyat the Cato Institute.