Co-authored by Natasha Srdoc, co-founder, Adriatic Institute for Public Policy and International Leaders Summit, Becky Norton-Dunlop, vice president of The Heritage Foundation and former director of the White House Cabinet Office during President Ronald Reagan and Dr. Stefan Gehrold, head of European Office Brussels, Konrad Adenauer Foundation
The topics of strengthening the transatlantic partnership and advancing economic freedom were brought to the forefront, when we gathered in Brussels at a dinner event of the Konrad Adenauer Foundation in December 2014. At this meeting, leading politicians from Brussels as well as elected members of Germany's national parliament reviewed the trends highlighted by 'The Index of Economic Freedom' which was co-published by The Heritage Foundation and The Wall Street Journal.
The discussed analysis included both selected EU member states such as Estonia or Germany and non-EU member states such as Switzerland, Ukraine and the United States. Recognizable trends appeared when comparing Western democracies to former communist countries. On the one hand Eastern European countries generally achieved higher scores in fiscal freedom due to the implementation of low flat tax pro-growth policies. Western European countries except Italy but including Estonia, on the other hand, scored much higher in the rule of law category, which encompasses protection of property rights and freedom from corruption.
Results of the Analysis
The annual 'Index of Economic Freedom' report rates countries around the world by assessing ten categories of economic freedom. The Index has proven to be a useful tool for investors, the respective nations' economic reformers, policymakers, academics, journalists, teachers, scholars and voters.
The authors of the 'Index of Economic Freedom' clarified that "The highest forms of economic freedom should provide an absolute right of property ownership, full freedom of movement for labor, capital and goods, and an absolute absence of coercion or constraint of economic activity beyond that which is necessary for the protection and maintenance of liberty itself."
When analyzing economic freedom, the authors observe the critical relationship between individuals and the government. "In general, state action or government control that interferes with individual autonomy limits economic freedom." The 'Index of Economic Freedom' demonstrates that a higher level of economic freedom leads to higher GDP per capita, higher living standard, reduces poverty, leads to more education opportunities, better health care, improves environmental performance, and promotes effective and democratic governance.
Decades of experience and research in economic development and transition economies provide a clear template of principles needed to achieve higher levels of economic growth. The 'Index of Economic Freedom' classifies these principles in four broad categories over which governments typically exercise some policy control: (a) rule of law, (b) government size, (c) regulatory efficiency and (d) open markets.
These categories incorporate 10 specific components of economic freedom. Each economy rated in the 'Index of Economic Freedom' receives an overall economic freedom score based on the weighted average of 10 economic freedoms, each graded on a scale from 0 to 100, with 100 being the best. The ten economic freedoms, which are equally weighted, are: Property rights, freedom from corruption, fiscal freedom, government spending, business freedom, labor freedom, monetary freedom, trade freedom, investment freedom and financial freedom.
The world's top-5 performing economies in the 2015 'Index of Economic Freedom' are: Hong Kong, Singapore, New Zealand, Australia and Switzerland. Three European countries were rated among the top ten: Switzerland (5th), Estonia (8th) and Ireland (9th). With a score of 80.5 points, Switzerland is the only European country whose economy is rated as "free".
2015 Index of Economic Freedom Findings for Germany
The country achieved an overall score of 73.8 in the 2015 'Index of Economic Freedom', making it a "mostly free" economy. By improving its overall score by 0.4 points year-on-year, Germany moved from 8th to 7th place in Europe's region and from 18th to 16th place in the world ranking.
Germany's improved scores of labor freedom (+4.8), government spending (+1.9), monetary freedom (+0.7), and trade freedom (+0.2) outweighed worsened scores of freedom from corruption (-2.1), business freedom (-1.7), and fiscal freedom (-0.4).
Out of ten categories of economic freedom Germany is rated as economically "free" in five areas: property rights, business freedom, monetary freedom, trade freedom and investment freedom.
Germany achieved its lowest scores in the category of government spending, which is rated as "repressed", and in labor freedom, which is rated as "mostly unfree" and is on the verge of the "repressed" category. Although rated as "moderately free", Germany's fiscal freedom places the country in the 168th place out of 178 countries ranked globally. This shows that Germany is lagging significantly behind in pursuing a pro-growth tax policy.
In order to increase economic freedom for its citizens, Germany needs to reduce government spending, introduce more flexibility in the labor market, significantly lower its top marginal personal income tax rate and decrease the overall tax burden for its citizens.
Germany's government budget surplus which - according to Destatis - totaled €18 billion ($20.4 billion) in 2014, provides space for Germany to reduce top corporate and personal income tax rates and thus, generate higher economic growth. As incomes rise, this would lead to nominally higher tax revenues, yet lower tax burden.
Encouraging Economic Freedom in South East Europe
Since Germany is Europe's largest economy, the most significant net contributor to the EU budget, and an export-driven economy, it is in its best interest to encourage economic freedom in other EU member states as well as in those aspiring to join the European Union.
This conclusion becomes even more significant as European countries with the lowest levels of economic freedom, such as Greece, received significant German taxpayer aid (€93 billion euro in guarantees). The recent member state Croatia is also heavily dependent on EU taxpayer's aid. Therefore, advancing economic freedom in candidate countries would benefit EU member state taxpayers as well as citizens of accession nations.
In better understanding the corruption in the region, a study by Washington, DC-based Global Financial Integrity reveals that over $111.6 billion in illicit financial outflows via crime, corruption and tax evasion left the Balkans during 2001-2010 and was sent to financial institutions in Austria, Liechtenstein and beyond. The amount of illicit financial outflows equals in the case of Montenegro for example 138% of its GDP while the new EU member state Croatia features illicit financial outflow of 25% of its GDP.
Europe's south is known for high government expenditures, opaque public finances and found "repressed" in the Index's categories of freedom from corruption and property rights. These countries can learn from Estonia's transformation led by Mart Laar and Slovakia's reforms pursued by Dzurinda's government. Estonia and Slovakia significantly increased economic freedom for their citizens. Member states with a well-functioning judiciary and administration should continue their assistance and support principled reformers in their quest to establish the rule of law.
Rather than continuing to transfer taxpayer money to weak rule of law states, donor countries should help advance economic freedom across the region.
All 10 categories of economic freedom are within the domain of government policy. The combination of legislative framework and government policies can be pursued to increase economic freedom of each country's citizens. According to the methodology of the 'Index of Economic Freedom' a country can be categorized as completely "free", if the following conditions are fulfilled:
- Establish an independent judiciary and the rule of law in order to protect property rights.
- Shine a bright light on corrupt practices and then eliminate them.
- Reduce taxes.
- Cut government spending.
- Simplify the process to register, operate and close a business.
- Offer a labor market based on a flexible regulatory framework.
- Maintain price stability through low inflation and allow market pricing to prevail.
- Eliminate tariffs and non-tariff barriers.
- Enable domestic and foreign actors to invest in all sectors without barriers.
- Enable greater competition of the financial sector and encourage capital market development by minimizing governmental interferences.
One of the most important prerequisites for achieving higher level of each of the ten economic freedoms is the rule of law. The law has to apply in the same way to all citizens at all times. No individual, no organization and no company should be favored. Furthermore, corruption has to be punished.
The Index illustrates that it is essential to create opportunities for all and favoritism for none. If one succeeds in increasing economic freedom, it will also alleviate significant brain drain. Therefore, advancing economic freedom is a worthy goal for political leaders.