RULE OF LAW

Property Rights

The property rights component assesses the extent to which a country’s legal framework allows individuals to acquire, hold, and utilize private property, secured by clear laws that the government enforces efectively. Relying on a mix of survey data and independent assessments, it provides a quantifiable measure of the degree to which a country’s laws protect private property rights and the extent to which those laws are respected. It also assesses the likelihood that private property will be expropriated by the state.

The more efective the legal protection of property, the higher a country’s score will be. Similarly, the greater the chances of government expropriation of property, the lower a country’s score will be.

The score for this component is derived by averaging scores for the following five sub-factors, all of which are weighted equally:

Physical property rights,

Intellectual property rights,

Strength of investor protection,

Risk of expropriation, and

Quality of land administration.

Each of these sub-factors is derived from numerical data sets that are normalized for comparative purposes using the following equation:

Sub-factor Score _i = 100 x (Sub-factorMax–Sub-factori)/(Sub-factorMax–Sub-factorMin)

where Sub-factori represents the original data for country i;

Sub-factorMax and Sub-factorMin represent the upper and lower bounds for the corresponding data set; and

Sub-factor Score i represents the computed sub-factor score for country i.

For a few countries, comparable data were not available for every sub-factor. In those cases, a score was computed for the missing sub-factor based on the relative percentile ranking of that country on the other sub-factors.

Sources. The Index relies on the following sources in assessing property rights: World Economic Forum, World Competitiveness Report; World Bank, Doing Business; and Credendo Group, Country Risk Assessment.

 

Judicial Efectiveness

Well-functioning legal frameworks are essential for protecting the rights of all citizens against unlawful acts by others, including governments and powerful private parties. Judicial efectiveness requires efcient and fair judicial systems to ensure that laws are fully respected and appropriate legal actions are taken against violations. The score for the judicial efectiveness component is derived by averaging scores for the following three sub-factors, all of which are weighted equally:

Judicial independence,

Quality of the judicial process, and

Favoritism in decisions of government ofcials.

Each of these sub-factors is derived from numerical data sets that are normalized for comparative purposes using the following equation:

Sub-factor Score _i = 100 x (Sub-factorMax–Sub-factori)/(Sub-factorMax–Sub-factorMin)

where Sub-factori represents the original data for country i;

Sub-factorMax and Sub-factorMin represent the upper and lower bounds for the corresponding data set;

Sub-factor Score i represents the computed sub-factor score for country i. For a few countries, comparable data were not available for every sub-factor.

In each of these cases, a score was computed for the missing sub-factor based on the country’s relative percentile ranking on the other sub-factors.

Sources. The Index relies on the following sources in assessing judicial efectiveness: World Economic Forum, World Competitiveness Report, and World Bank, Doing Business.

Government Integrity

Corruption erodes economic freedom by introducing insecurity and coercion into economic relations. Of greatest concern is the systemic corruption of government institutions and decision-making by such practices as bribery, extortion, nepotism, cronyism, patronage, embezzlement, and graft. The lack of government integrity caused by such practices reduces public trust and economic vitality by increasing the costs of economic activity.

The score for this component is derived by averaging scores for the following six sub-factors, all of which are weighted equally:

Public trust in politicians,

Irregular payments and bribes,

Transparency of government policymaking,

Absence of corruption,

Perceptions of corruption, and

Governmental and civil service transparency.

Each of these sub-factors is derived from numerical data sets that are normalized for comparative purposes using the following equation:

Sub-factor Score i = 100 x (Sub-factorMax–Sub-factori)/(Sub-factorMax–Sub-factorMin)

where Sub-factori represents the original data for country i;

Sub-factorMax and Sub-factorMin represent the upper and lower bounds for the corresponding data set; and

Sub-factor Score i represents the computed sub-factor score for country i.

For a few countries, comparable data were not available for every sub-factor. In each of these cases, a score was computed for the missing sub-factor based on the country’s relative percentile ranking on the other sub-factors.

Sources. The Index relies on the following sources in assessing government integrity: World Economic Forum, World Competitiveness Report; World Justice Project, Rule of Law Index; Transparency International, Corruption Perceptions Index; and TRACE International, The Trace Matrix.

 

GOVERNMENT SIZE

Tax Burden

Tax burden is a composite measure that reflects marginal tax rates on both personal and corporate income and the overall level of taxation (including direct and indirect taxes imposed by all levels of government) as a percentage of gross domestic product (GDP).

The component score is derived from three quantitative sub-factors:

The top marginal tax rate on individual income,

The top marginal tax rate on corporate income, and

The total tax burden as a percentage of GDP.

Each of these numerical variables is weighted equally as one-third of the component score. This equal weighting allows a country to achieve a score as high as 67 based on two of the factors even if it receives a score of 0 on the third.

Tax burden scores are calculated with a quadratic cost function to reflect the diminishing revenue returns from very high rates of taxation. The data for each sub-factor are converted to a 100-point scale using the following equation:

Tax Burdenij = 100 – α (Factorij)² 

where Tax Burdenij represents the tax burden in country i for factor j;

Factorij represents the value (a percentage expressed on a scale of 0 to 100) in country i for factor j;

α is a coefcient set equal to 0.03.

Sources. The Index relies on the following sources for information on tax rate data, in order of priority: Deloitte, International Tax and Business Guide Highlights; International Monetary Fund, Staf Country Report, “Selected Issues and Statistical Appendix,” and Staf Country Report, “Article IV Consultation”; PricewaterhouseCoopers, Worldwide Tax Summaries; countries’ investment agencies; other government authorities (embassy confirmations and/or the country’s treasury or tax authority); and Economist Intelligence Unit, Country Commerce and Country Finance.

For information on tax burden as a percentage of GDP, the primary sources are Organisation for Economic Co-operation and Development data; Eurostat, Government Finance Statistics data; African Development Bank and Organisation for Economic Co-operation and Development, African Economic Outlook; International Monetary Fund, Staf Country Report, “Selected Issues,” and Staf Country Report, “Article IV Consultation”; Asian Development Bank, Key Indicators for Asia and the Pacific; United Nations Economic Commission for Latin America, Economic Survey of Latin America and the Caribbean; and individual contacts from government agencies and multinational organizations such as the IMF and the World Bank.

 

Government Spending

No attempt has been made to identify an optimal level of government spending. The ideal level will vary from country to country, depending on factors that range from culture to geography to level of economic development. At some point, however, government spending becomes an unavoidable burden as growth in the size and scope of the public sector leads inevitably to misallocation of resources and loss of economic efciency. Volumes of research have shown that excessive government spending that causes chronic budget deficits and the accumulation of public debt is one of the most serious drags on economic dynamism. Government spending has a major impact on economic freedom, but it is just one of many important components.

The scale for scoring government spending is nonlinear, which means that government spending that is close to zero is lightly penalized, while government spending that exceeds 30 percent of GDP leads to much worse scores in a quadratic fashion (for example, doubling spending yields four times less freedom

The equation used to compute a country’s government spending score is:

GEi = 100 – α (Expenditures_i )²

where GEi represents the government expenditure score in country i;

Expendituresi represents the average total government spending at all levels as a percentage of GDP for the most recent three years;

and α is a coefcient to control for variation among scores (set at 0.03).

Sources. The Index relies on the following sources for information on government intervention in the economy, in order of priority: Organisation for Economic Co-operation and Development data; Eurostat data; African Development Bank and Organisation for Economic Co-operation and Development, African Economic Outlook; International Monetary Fund, Staf Country Report, “Selected Issues and Statistical Appendix,” Staf Country Report, “Article IV Consultation,” and World Economic Outlook Database; Asian Development Bank, Key Indicators for Asia and the Pacific; African Development Bank, The ADB Statistics Pocketbook; ofcial government publications of each country; and United Nations Economic Commission for Latin America, Economic Survey of Latin America and the Caribbean.

 

Fiscal Health

Widening deficits and a growing debt burden, both of which are caused by poor government budget management, lead to the erosion of a country’s overall fiscal health. Deteriorating fiscal health, in turn, is associated with macroeconomic instability and economic uncertainty. In theory, debt financing of public spending could make a positive contribution to productive investment and ultimately to economic growth. However, mounting public debt driven by persistent budget deficits, particularly spending that merely boosts government consumption or transfer payments, often undermines overall productivity growth and leads ultimately to economic stagnation rather than growth.

The score for the fiscal health component is based on two sub-factors, which are weighted as follows in calculating the overall component score:

Average deficits as a percentage of GDP for the most recent three years (80 percent of score)

Debt as a percentage of GDP (20 percent of score).

The equation used to compute a country’s fiscal health score is:

Sub-factor Score_i = 100 – α (Sub-factori )²

where Sub-factor Scorei represents the deficit or debt score in country i;

Sub-factori represents the factor value as a portion of GDP;

α is a coefcient to control for variation among scores (set at 2 for deficit and 0.01 for debt).

Sources. The Index relies on the following sources for information on government intervention in the economy, in order of priority: International Monetary Fund, World Economic Outlook Database, Staf Country Report, “Selected Issues and Statistical Appendix,” and Staf Country Report, “Article IV Consultation”; Asian Development Bank, Key Indicators for Asia and the Pacific; African Development Bank, The ADB Statistics Pocketbook; Economist Intelligence Unit, Data Tool; and ofcial government publications of each country.

 

Business Freedom

The business freedom component measures the extent to which the regulatory and infrastructure environments constrain the efcient operation of businesses. The quantitative score is derived from an array of factors that afect the ease of starting, operating, and closing a business. The business freedom score for each country is a number between 0 and 100, with 100 indicating the freest business environment. The score is based on 13 sub-factors, all of which are weighted equally, using data from the World Bank’s Doing Business report:

Starting a business—procedures (number);

Starting a business—time (days);

 Starting a business—cost (% of income per capita);

Starting a business—minimum capital (% of income per capita);

Obtaining a license—procedures (number);

Obtaining a license—time (days);

Obtaining a license—cost (% of income per capita);

Closing a business—time (years);

Closing a business—cost (% of estate);

Closing a business—recovery rate (cents on the dollar);

Getting electricity—procedures (number);

Getting electricity—time (days);

Getting electricity—cost (% of income per capita).

Each sub-factor is converted to a scale of 0 to 100 using the following equation:

Sub-factor Score_i = 50 x (Sub-factoraverage/Sub-factor_i )

which is based on the ratio of the country data for each sub-factor relative to the world average.

 Sources. The Index relies on the following sources in determining business freedom scores, in order of priority: World Bank, Doing Business; Economist Intelligence Unit, Country Commerce; U.S. Department of Commerce, Country Commercial Guide; and ofcial government publications of each country.

Labor Freedom

The labor freedom component is a quantitative measure that considers various aspects of the legal and regulatory framework of a country’s labor market, including regulations concerning minimum wages, laws inhibiting layofs, severance requirements, and measurable regulatory restraints on hiring and hours worked, plus the labor force participation rate as an indicative measure of employment opportunities in the labor market.

Seven quantitative sub-factors are equally weighted, with each sub-factor counted as one-seventh of the labor freedom component:

Ratio of minimum wage to the average value added per worker,

Hindrance to hiring additional workers,

Rigidity of hours,

 Difculty of firing redundant employees,

Legally mandated notice period,

Mandatory severance pay,

Labor force participation rate.

In constructing the labor freedom score, each of the seven sub-factors is converted to a scale of 0 to 100 based on the following equation:

Sub-factor Score_i = 50 x (Sub-factoraverage/Sub-factori )

The seven sub-factor scores are then averaged for each country, yielding a labor freedom score in comparison to other countries.

Sources. The Index relies on the following sources for data on labor freedom, in order of priority: World Bank, Doing Business; International Labour Organization, Statistics and Databases; World Bank, World Development Indicators; Economist Intelligence Unit, Country Commerce; U.S. Department of Commerce, Country Commercial Guide; and ofcial government publications of each country.

 

Monetary Freedom

Monetary freedom combines a measure of price stability with an assessment of price controls. Both inflation and price controls distort market activity. Price stability without microeconomic intervention is the ideal state for the free market.

The score for the monetary freedom component is based on two sub-factors:

The weighted average inflation rate for the most recent three years and

Price controls.