Last month the Heritage Foundation released the 2010 Index of Economic Freedom. Every year, a similar index is also issued by the Fraser Institute to compare countries across the globe. These rankings are not without consequences. For example, one criterion used by the recently formed Millennium Challenge Corporation for its Millennium Challenge Account (MCA) is freedom as estimated by Freedom House. Similarly, foreign investors rely on these indices to at least screen prospective destinations for their funds. I consider these indices valid in terms of the parameters employed but want to question their reliability to measure freedom across structurally different economies and polities.
My scepticism is based on these arguments. In developing countries, a large portion of the economy is informal, and thus figures on the size of the government relative to the private sector, a key variable used by all indices, may not be equally meaningful. Moreover, in poor countries, political freedom may be valued less than in richer countries – thus cultural preferences and valuations should be accounted for. Also in most developing economies, corruption would interact as a confounding variable and distort interpretations. For example, these indices measure ease of doing business in terms of number of days required or spent in opening or closing a business. In a pervasively corrupt government, the number of days is a function of access to specific officials, something that may not be reflected in the statistics. Finally, these indices rely on the principle of aggregation, which in principle is valid. However, if the underlying data is hugely skewed (for instance, physical conditions at sub-national levels vary a great deal), then aggregation can be quite misleading. For these and other reasons, it could be argued that the indicators should be adjusted according to the specific circumstances of the country concerned. This would hopefully produce a more consistent measure of freedom, which would in turn provide more accurate guidance for both policy and business interventions.