South Africa should strive for greater economic freedom

The next Economic Freedom of the World annual report is soon to be released and will reveal whether SA has improved its overall level of economic freedom. Some factors will improve the rating and others are likely to reduce it.

The index published in Economic Freedom of the World measures the degree to which the policies and institutions of countries are supportive of economic freedom. The foundations of economic freedom are personal choice, voluntary exchange, freedom to compete and security of privately owned property. One of the key objectives in compiling the EFW index is to establish whether relationships exist between economic freedom and economic growth and wealth. The findings in the report unambiguously support the fact that economic freedom is strongly related to prosperity and growth; countries that are economically free tend to grow faster and be more prosperous.

Research in the 2004 report found that economically free nations attract nearly $11,000 (R73, 590) of investment per worker, twelve times more than the $847 (R5,666) investment per worker in unfree economies. Moreover, the productivity of investment is 70 per cent greater in economically free nations than in unfree nations. Nations in the top fifth of the economic freedom index have an average per capita income of $26,100 (R174,609) compared to $2,800 (R18,732) for nations in the bottom fifth. Furthermore, in nations scoring in the top fifth, the average income of the poorest 10 per cent of the population was $6,877 (R46,007) compared to just $823 (R5,506) in the least free nations. This shows that economic freedom benefits everyone. Both poor and rich get richer together.

Adam Smith, Milton Friedman, and Friedrich Hayek all maintained that freedom of exchange and market co-ordination provide the fuel for economic progress. Without exchange and entrepreneurial activity, co-ordinated through markets, modern living standards would be impossible. Indeed, this notion is supported by a brief look at the countries that have been at the top of the economic freedom ratings over the past few years. In the 2004 report Hong Kong received a rating of, 8.7 out of 10, closely followed by Singapore at 8.6. New Zealand, Switzerland, the United Kingdom, and the United States tied for third with ratings of 8.2. The other top 10 nations are Australia, Canada, Ireland, and Luxembourg. The majority of these countries appear in the top ten of the United Nations Human Development index and all rank amongst the top 25. Economic freedom is common to all these nations, ensuring not only high standards of living for their people through high economic growth rates but also all the other positive benefits of human development.

SA was ranked 44th on the index last year, sharing this ranking with France, Lithuania, Malta, Peru and Uruguay. Labour market regulation was one of SA’s most problematic areas. Comparing our unemployment rate with those of countries that shared our economic freedom ranking, we find that SA fares badly. Our unemployment rate is 26.2% while that of France is 8.9%, Lithuania 13.8%, Malta 7.0%, Peru 8.7% and Uruguay 17.2%. Minimum wages and lack of flexibility in hiring and firing give us a low economic freedom rating in this area.

An unintended consequence of SA’s labour laws, which were adopted to provide job security for the employed, is that they prevent people who want to work from negotiating their own terms with potential employers. Higher labour costs and minimum wages reduce the employment opportunities of unemployed people with few skills who would typically otherwise find employment in small and micro enterprises. The unemployed are prevented from gaining work experience while their productivity is not high enough to justify the wages employers would be compelled to pay them, leaving them in a most unenviable position. Without experience they can’t get jobs and without jobs they can’t get experience.

Unemployed South Africans would clearly benefit considerably from greater flexibility at the lower end of the labour market. In a labour surplus economy like SA’s, where there are large numbers of semi-skilled and unskilled workers, the jobless need an increase in the demand for labour more than anything else. They need to have employers offering them jobs that will allow them to get onto the first rung of the employment ladder. A survey among the unemployed is certain to reveal that many people would be prepared to work for lower wages and under less favourable conditions than are currently required by the labour laws.

SA is already in the top 40% of economically free countries and is reaping the benefit in the form of sound economic growth. However, even higher levels of economic growth could be achieved if the government freed up the economy even further. Improved economic freedom ratings, closer to 10 than the current quoted ratings, could be achieved by instituting reforms in the following areas: reduce government consumption expenditure (4.8), dispose of government enterprises (4.0), reduce top marginal tax rates (4.5), reduce crime (3.3), remove restrictions on foreign capital transactions (0.8), reduce the effect of minimum wages (4.6), increase flexibility in hiring and firing (2.2), reduce the negative consequences of collective bargaining (4.7) and remove price controls (3.2).

SA is poised to move either way. Government is under pressure from some quarters to increase intervention in business and reduce economic freedom. On the other hand there are signs that influential members of government are all too well aware of the potential negative consequences of adopting the type of ‘command economy’ policies that were pursued by the apartheid government. Authoritarian government gave us twenty years of a shrinking economy. SA cannot afford another similar period of stagnation. Rapid growth in a flourishing economy is essential and the route to achieve that desirable end is through increased economic freedom.

Author: Jasson Urbach is an economic researcher at 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 Free Market Foundation.

FMF Feature Article/ 19 July 2005