2017 Index of Economic Freedom: Trade and Prosperity at Risk

Ambassador Terry Miller

 

Director, Center for Data Analysis and the Center for Trade and Economics and Mark A. Kolokotrones Fellow in Economic Freedom

Ambassador Terry Miller focuses on research into how free markets and international trade foster economic growth around the world.

 

The latest rankings of trade freedom around the world, developed by The Heritage Foundation in the forthcoming 2017 Index of Economic Freedom,[1] once again demonstrate that citizens of countries that embrace trade freedom are better off than those in countries that do not. The data continue to show a strong correlation between trade freedom and a variety of positive indicators, including economic prosperity, low poverty rates, and clean environments.
Worldwide, the average trade freedom score improved just barely over the past year, from 75.6 to 75.9 out of a maximum score of 100. The improvement was due to a small decline in average tariff rates among the countries measured.

Why Trade Freedom Matters

A comparison of economic performance and trade scores in the 2017 Index of Economic Freedom demonstrates the importance of trade freedom to prosperity and well-being. Countries with the most trade freedom have higher per capita incomes, lower incidences of hunger in their populations, and cleaner environments.



Boosting Trade and Economic Freedom. Since World War II, government barriers to global commerce have been reduced significantly. Today, the average worldwide tariff rate is less than 3 percent. The average world tariff rate has fallen by one-third since the turn of the century alone.[2] Sixteen countries have an average tariff rate of 1 percent or less.
These countries with low tariffs and few non-tariff barriers benefit from stronger economic growth. But more open trade policies do not just promote economic growth, they encourage freedom—including protection of property rights and the freedom of average people to buy what they think is best for their families, regardless of attempts by special interest groups to restrict that freedom.
But not all countries have embraced openness to trade. Double-digit tariff rates are applied in 34 countries, and even countries with low average tariff rates often have high tariff peaks for some items. In the United States, for example, the average tariff rate is just 1.4 percent, but pickup trucks face a prohibitive 25 percent tariff, and many types of clothing are subject to double-digit tariffs.[3]
Threats to Trade. The volume of U.S. and world trade in goods and services plummeted during the global recession, declining by roughly 20 percent between 2008 and 2009. From 2009 to 2014, U.S. and world trade volume increased by around 50 percent, followed by a 10 percent drop in world trade volume in 2015, along with a 4 percent decline in U.S. trade volume. The World Trade Organization (WTO) predicts an increase in global trade of just 1.7 percent in 2016.[4]
The recent stagnation in global trade volume and anti-trade rhetoric is cause for concern in many quarters. Consider the following observations:

• International Monetary Fund (IMF): “The slowdown in trade growth since 2012 is largely because of weak growth, but also fewer trade deals and a recent uptick in protectionism.”[5]
• Peterson Institute for International Economics: “[T]he absence of liberalization and the eruption of micro-protection have been major contributors to weak trade and investment performance.”[6]
• WTO Director-General Roberto Azevêdo: “Out of the more than 2,800 trade-restrictive measures recorded…since October 2008, only 25 per cent have been removed. In the current environment, a rise in trade restrictions is the last thing the global economy needs.”[7]
• Center for Economic and Policy Research: “Between 1 January and 31 October 2015, a total of 539 measures were taken by governments worldwide that harmed foreign traders, investors, workers, or owners of intellectual property. In no previous year have we found so many trade distortions so quickly.”[8]

 

Trade Is for Everyone

There is no doubt that free trade is popular among economists and CEOs. A panel of economic experts was recently asked to respond to the following proposition: “Adding new or higher import duties on products such as air conditioners, cars, and cookies—to encourage producers to make them in the US—would be a good idea.” All of the respondents either “disagreed” or “strongly disagreed.”[9]
According to the Business Roundtable, an association of chief executive officers of leading U.S. companies, “Expanding international trade is essential to higher economic growth and creating new jobs.”[10]
But support for trade is not limited to economists and CEOs. Despite the relatively weak economy and an increase in anti-trade rhetoric, most Americans remain open to the idea of expanding trade:

• According to a February 2016 Gallup Poll, 58 percent of Americans view trade as more of an opportunity for the U.S. economy than a threat, versus just 34 percent who viewed trade as more of a threat than an opportunity.[11]
• According to a June 2016 survey from the Chicago Council on Global Affairs, 59 percent of Americans believe international trade is good for the U.S. economy.[12]
• A July 2016 NBC News/Wall Street Journal poll found 55 percent of Americans believe trade with foreign countries is good and just 38 percent believe it is bad.[13]
• The Heritage Foundation’s American Perceptions Initiative asked, “Which is more important: allowing free trade so companies can buy the inputs they need at a lower cost, low-income families can buy clothing at more affordable prices, and the economy can create new jobs, or allowing Congress to protect some politically connected industries from low-priced imports?” Just 9 percent of Americans chose protectionism.[14]

Freedom to Trade Is a Populist Policy

The idea behind freedom to trade is simple: People are better off when they decide for themselves how to spend their money than when politicians or bureaucrats decide for them. This is hardly an elitist point of view.
The 2017 Index of Economic Freedom shows that people who live in countries with low trade barriers are better off than those who live in countries with high trade barriers. Reducing those barriers remains a proven recipe for prosperity. Governments interested in higher economic growth, less hunger, and better environmental quality should promote freedom, not pander to special interests who want to restrict it.
—Bryan Riley is Jay Van Andel Senior Analyst in Trade Policy in the Center for Trade and Economics, of the Institute for Economic Freedom and Opportunity, at The Heritage Foundation. Ambassador Terry Miller is Director of the Center for Trade and Economics and the Center for Data Analysis, of the Institute for Economic Freedom and Opportunity, as well as Mark A. Kolokotrones Fellow in Economic Freedom, at The Heritage Foundation.

Appendix B: Methodology

The trade freedom scores reported in this Backgrounder are based on two variables: trade-weighted average tariff rates and non-tariff barriers (NTBs).
Different imports entering a country can, and often do, face different tariffs. The weighted average tariff uses weights for each tariff based on the share of imports for each good. Weighted average tariffs are a purely quantitative measure and account for the basic calculation of the score using the equation:
Trade Freedomi = (Tariffmax – Tariffi) / (Tariffmax – Tariffmin) x 100 – NTBi
where Trade Freedomi represents the trade freedom in country i, Tariffmax and Tariffmin represent the upper and lower bounds for tariff rates, and Tariffi represents the weighted average tariff rate in country i. The minimum tariff is naturally zero, and the upper bound was set as a score of 50. NTBi, an NTB penalty, is then subtracted from the base score. The penalty of 5, 10, 15, or 20 points is assigned according to the following scale:

• Penalty of 20. NTBs are used extensively across many goods and services or impede a significant amount of international trade.
• Penalty of 15. NTBs are widespread across many goods and services or impede a majority of potential international trade.
• Penalty of 10. NTBs are used to protect certain goods and services or impede some international trade.
• Penalty of 5. NTBs are uncommon, protecting few goods and services, with very limited impact on international trade.
• No penalty. NTBs are not used to limit international trade.

Both qualitative and quantitative data are used to determine the extent of NTBs in a country’s trade policy regime. Restrictive rules that hinder trade vary widely, and their overlapping and shifting nature makes gauging their complexity difficult. The categories of NTBs considered in the trade freedom penalty include:

• Quantity restrictions. These include import quotas, export limitations, voluntary export restraints, import/export embargoes and bans, and countertrade measures.
• Price restrictions. These include antidumping duties, countervailing duties, border tax adjustments, and variable levies and tariff rate quotas.
• Regulatory restrictions. These include licensing; domestic content and mixing requirements; sanitary and phytosanitary standards; safety and industrial standards regulations; packaging, labeling, and trademark regulations; and advertising and media regulations.
• Customs restrictions. These include advance deposit requirements, customs valuation procedures, customs classification procedures, and customs clearance procedures.
• Direct government intervention. These include subsidies and other aids; government industrial policy and regional development measures; government-financed research and other technology policies; national taxes and social insurance; competition policies; immigration policies; state trading, government monopolies, and exclusive franchises; and government procurement policies.

As an example: Brazil received a trade freedom score of 69.4. By itself, Brazil’s weighted average tariff of 7.8 percent would have yielded a score of 84.4, but the existence of NTBs in Brazil reduced its score by 15 points.
Gathering data on tariffs to make a consistent cross-country comparison can be a challenging task. Unlike data on inflation, for instance, some countries do not report their weighted average tariff rate or simple average tariff rate every year. To preserve consistency in grading trade policy, the authors use the World Bank’s most recently reported weighted average tariff rate for a country. If another reliable source reported more updated information on a country’s tariff rate, the authors note this fact and may review the grading if strong evidence indicates that the most recently reported weighted average tariff rate is outdated.
The World Bank produces the most comprehensive and consistent information on weighted average applied tariff rates. When the weighted average applied tariff rate is not available, the authors use the country’s average applied tariff rate. When the country’s average applied tariff rate is not available, the authors use the weighted average or the simple average of most-favored-nation (MFN) tariff rates. In the very few cases in which data on duties and customs revenues are not available, the authors use international trade tax data instead.
In all cases, the authors clarify the type of data used and the different sources for those data in the corresponding write-up for the trade policy factor. When none of this information is available, the authors simply analyze the overall tariff structure and estimate an effective tariff rate.
The trade freedom scores for 2017 are based on data for the period covering the second half of 2015 through the first half of 2016. To the extent possible, the information is current as of June 30, 2016. Any changes in law effective after that date have no positive or negative impact on the 2017 trade freedom scores.
Finally, unless otherwise noted, the authors use the following sources to determine scores for trade policy, in order of priority:

1. The World Bank, World Development Indicators 2016.
2. The World Trade Organization, Trade Policy Review, 1995–2016.
3. Office of the U.S. Trade Representative, 2016 National Trade Estimate Report on Foreign Trade Barriers.
4. The World Bank, Doing Business 2015 and Doing Business 2016.
5. U.S. Department of Commerce and U.S. Department of State, Country Commercial Guide, 2011–2016.
6. Economist Intelligence Unit, Country Commerce, 2016.
7. World Economic Forum, The Global Enabling Trade Report 2014.
8. Official government publications of each country.