Economic Freedom Index Biased Towards Rich Countries

Over the past few years, it has been interesting to see the United States slowly lose its top spot in the Index of Economic Freedom. In 1995 the United States was in 4th place, behind Hong Kong, Singapore and UK. In 2010 the United States is in 8th place, behind Australia, New Zealand, Ireland, Switzerland and Canada but no longer behind the United Kingdom, which fell to 11th place. This change is mostly due to other countries improving, although the United States has fallen from a score of 90 on corruption to 73 in 2010.

 
However, when I dug deeper into the methodology I encountered an anomaly. The index adjusts many of the costs to per capita income or some other metric. This makes sense in one sense, as requiring a year's salary to start a business in a poor country is much worse than needing a few thousand dollars somewhere in the developed world. However, the side effect of this type of measurement is that the United States rates more highly in Business Freedom than other countries partially because of its baseline.  Fiscal Freedom and Government Spending are measured the same way. As Greg Mankiw has pointed out, the taxes paid per person in the United States are very comparable to other countries in the developed world, it is merely the rate that is lower.
 
The United States is still one of the most free economies in the world, but people who follow these indices should realize that this is partially because the United States is rich to begin with. Poorer countries that try to mimic its policies will be seen as far less rich than the United States.
 
Edit: It looks like some countries were missing in 1995. In the 1996 data that I am using New Zealand and Switzerland were both added to the index, pushing the United States back to 5th place (It was ahead of the UK by 1996).

About

I studied Bioengineering at the University of California at San Diego. While there I served as a trustee on the investment committee of the UCSD Student Foundation, a group that manages an endowment to fund scholarships. While in college I applied my interest in finance and economics by working as a summer associate at Clarium Capital Management, working part time my senior year, and joining full time when I graduated in 2006, staying there through August 2010. I am currently working as a portfolio manager at another global macro hedge-fund in the Presidio (And blogging about more directly market related ideas at their restricted blog). I’ve been focusing on quantitative finance, currencies, commodities, the interplay between finance and politics, demography and other long term trends.

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