A Free and Prosperous New Year

January 6, 2005 • Commentary

The sun rises in 2005 on the freest and most prosperous world in history.

According to Economic Freedom of the World: 2004 Annual Report, the average economic freedom rating for 123 countries rose from 5.1 in 1980 to 6.5 in 2002, on a scale from 1 to 10, with 10 representing full economic freedom. China showed a particularly strong move in the direction of economic freedom, moving from 3.8 in 1980 to 5.7 in 2002 (down slightly from 5.9 in 2000). But other countries also moved toward economic freedom, notably Australia, Chile, El Salvador, India, Ireland, Mauritius, New Zealand, and Uganda.

Hong Kong was rated the freest economy in the world, but it declined slightly from 9.1 in 1995 to 8.7 in 2002.

The authors of the report, published by the Fraser Institute in Vancouver, pointed to several ways in which economic freedom has grown:

  • The use of extremely high marginal tax rates fell sharply. In 2002, not a single country imposed a 60 percent marginal tax rate on personal income; in 1980, 49 did so.
  • Exchange‐​rate controls were liberalized substantially. In 2002, there were only four countries with black‐​market exchange rate premiums of 25 percent or more compared to 36 countries in 1980.
  • Tariffs were reduced. In 2002, the mean tariff rate was 10.4 percent compared to 26.1 percent in 1980.
  • Controls on both capital markets and interest rates were relaxed.

Over the past 25 years, several factors have contributed to the growth in economic freedom. The collapse of the Soviet Union allowed Russia and its former colonies to give their citizens more freedom. Ronald Reagan and Margaret Thatcher challenged the concept of ever‐​bigger government and showed that tax cuts and privatization can create prosperity. The spread of world trade — often called “globalization” — brought more countries into the world economy and gave their citizens more comfortable lives.

All those trends should continue. On Ronald Reagan’s 93rd birthday last February, China’s deputy finance minister Lou Jiwei told the Wall Street Journal that China would cut tax rates. “It’s a lot like Reaganomics,” Lou said. “We feel that only through simplifying things and lowering tax rates will revenue collection become more efficient.”

Countries compete more than ever to attract businesses, investors, and citizens. High tax rates, capital controls, and excessive regulation drive investors away, so many countries have been trying to cut taxes and regulation. “Tax competition” helps protect taxpayers from their own governments.

But there are powerful forces that resist the call for less government. The European Union started as a free‐​trade area — it was first known as the Common Market — but today it is largely a giant cartel for high taxes. Its leaders try to “harmonize” tax rates by pressuring member countries with low taxes to raise them.

President Vladimir Putin has been tightening restrictions on press freedom in Russia and also moving to reverse some of the post‐​Soviet industrial privatization. The arrest of Yukos CEO Mikhail Khodorkovsky and the renationalization of part of Yukos serve as a powerful warning to other Russian executives and to international investors.

Africa and the Arab world still have not tasted much economic freedom. Despite the Bush administration’s promise to bring democracy and free enterprise to Iraq, progress in Arab countries looks likely to be very slow.

The Bush years have been a mixed bag for economic freedom in the United States. Tax rates have been cut, but government spending has soared — a combination that can’t go on forever. Since his reelection, President Bush has promised to let American workers invest their Social Security taxes in private retirement accounts. If Congress goes along, that would be the biggest boost for economic freedom in many decades.

Hong Kong is in a curious position: It is the freest economy in the world, but it is now part of a country run by the Communist Party. Although China’s economy is getting more free, Beijing is exerting more control over Hong Kong. That creates great risks for both freedom and prosperity in Hong Kong.

We must not forget the real importance of economic freedom. Besides the value of freedom itself, economic freedom leads to economic growth. And growth is not just an abstract concept. It means that women have running water, rather than having to carry water from a well that may be miles away. It means enough food for children. It means medical care and dramatically lower rates of infant mortality.

The hurricanes that devastated Haiti earlier this year and the Asian tsunamis last week both reminded us of the real costs of poverty. It is the lack of wealth that forced so many people to live in homes that could be easily destroyed by hurricanes and tsunamis. Economic freedom means more wealth for the whole society, which means better‐​built homes and better warning systems in case of disaster.

For those of us who want the poorest people in the world to have better lives, the challenge is to continue the spread of globalization, resist tax cartels, and give more people more opportunity to own stocks, bonds, and other real assets.

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