South Africa and its declining level of economic freedom

Recently the Wall Street Journal and the Heritage Foundation released the 14th edition of their annual publication that documents the level and variation of economic freedom across the globe. Given the current uncertainties facing the South African economy the index provides a resolute light at the end of the tunnel. Throughout the duration of the publication’s 14-year history the index has repeatedly demonstrated that greater economic freedom unambiguously leads to greater prosperity.

The 2008 Index of Economic Freedom covers 162 countries and uses 10 specific factors to empirically test the countries’ degree of economic freedom. The 10 variables used are, Business freedom, Trade freedom, Fiscal freedom, Government size, Monetary freedom, Investment freedom, Financial freedom, Property rights, Freedom from corruption, and Labour freedom.

The report notes, “A systematic analysis of the 10 freedoms has demonstrated again this year that economic freedom is the key to creating an environment that allows a virtuous cycle of entrepreneurship, innovation, and sustained economic growth”. The index shows that economies with higher levels of economic freedom enjoy higher living standards.

Indeed, countries in the top quintile, representing the freest economies in the index, enjoy gross domestic product (GDP) per capita’s of USD 28,217 on average. Compare this to the least free economies that fall into the bottom quintile of the index, and have GDP per capita’s of USD 4,205 on average. The report notes that the lesson from the index is simple, “Economic failure is a predictable consequence of economic repression. Countries that reflect the desires of their people for better lives will adopt economic freedom and countries that repress their people for political reasons will cause economic suffocation.”

Freer economies enjoy less unemployment. The freest economies in the world have unemployment rates of 5.9 per cent on average. In contrast the least free economies in the world have unemployment rates of 19.6 per cent on average. Inflation also increases as economic freedom declines. On average, the freest economies in the world enjoy inflation rates of 2.9 per cent whereas the least free economies have inflation rates of 44 per cent.

The report notes that the overall global economic score is 60.3 per cent, which is essentially the same as last year. But, since the inception of the index in 1995, the overall level of economic freedom in the world has increased by 2.6 percentage points. Hong Kong is again the freest economy in the world for the 14th straight year. Singapore retains its position as the second freest economy followed by Ireland in third position.

The index shows that of the top twenty freest economies in the world, half of them are European. Five of the top twenty are from the Asian region and three are from the Americas. Sub-Saharan Africa has one lone country in the top twenty, namely Mauritius. The small island economy is the second most improved country in this year’s index, with an economic freedom rating of 72.3 per cent, giving it a rank of 18th up from number 34 last year.

Mauritius continues to be a beacon of light for Africa, showing the growth potential of other African economies if only they adopted freer policies. Mauritius scores above the global average by 10 percentage points or more in 6 of the variables namely: investment freedom, property rights, business freedom, freedom from corruption, fiscal freedom and government size.

Sub-Saharan Africa remains the least free region in the world, occupying roughly half of the bottom twenty positions. South Africa’s overall level of economic freedom declined slightly (0.2 percentage points) leading to a movement down the rankings from 55th position in last year’s index to 57th, with a freedom rating of 63.2 per cent. This score places South Africa in the ‘moderately free’ category. South Africa is the 4th freest economy in the sub-Saharan African region with Mauritius, Botswana and Uganda all receiving higher honours.

When compared against the world average, South Africa falls down in the areas of labour freedoms and fiscal freedoms. South Africa’s labour laws provide people who are employed with a high degree of security at the expense of the unemployed. The unemployed are prevented from gaining work experience while their productivity is not high enough to justify the wages that the law compels employers to pay them.

South Africa’s top marginal tax rate at 40 per cent is one of the highest in the world and our labour market policies are among the most stringent. High marginal tax rates reduce the incentives of entrepreneurs to risk their capital and sacrifice their time and energy to earn higher incomes. High marginal tax rates also interfere with the ability of individuals to pursue their goals and result in lower after-tax incomes for workers and therefore smaller disposable incomes. Less disposable income means less saving; less saving means less capital formation; less capital formation means lower labour productivity, and lower labour productivity means lower real wages.

In the past South Africa has made significant changes that have increased its level of economic freedom but more recent changes are threatening some of the progress it has made. This can only have deleterious consequences for its economy and the lesson should be clear – if South Africa wants to grow and increase the standard of living of all its citizens, it needs to embrace economic freedom.

Author: Jasson Urbach is an economist with the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.

FMF Feature Article/ 29 January 2008