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Sri Lanka’s declining Economic Freedom – a flashback to 2014

Credit - Fraser Institute

The 2016 Economic Freedom Report provides a flashback into Sri Lanka’s economy in 2014 & a chance to compare it with the changes made thereafter.

On the 15th of September the Fraser Institute released it’s Economic Freedom of the World – 2016 Annual Report, which envisages to measure the degree to which the policies and institutions of countries are supportive of economic freedom” using the EFW Index. Sri Lanka was ranked 111 out of 159 countries and territories included in the 2016 report. The island nation gained a rating of 6.28 out of 10; a rating has been steadily dropping since an all time high in 2011.

The above statement may raise the eyebrows of some of our readers – How can the rating continue to regress when other indicators like the Global Peace Index and the Human Capital Index have shown improvement following the change in Government in 2015? The catch is that the 2016 Index actually reports on developments in the year 2014, and nothing after, thus making the data already “outdated”, if not for other countries then at least for Sri Lanka. Therefore, it is indeed important to keep this in mind when analyzing the report.

How is Economic Freedom measured?

According to the report, economic freedom is present when economic activity is coordinated by personal choice, voluntary exchange, open markets, and clearly defined and enforced property rights. The EFW index envisages to identify how closely institutions and policies of a country correspond with the idealized structure of limited government, where the government protects property rights and arranges for the provision of a limited set of “public goods” such as national defense and access to money of sound value, but little beyond these core functions. Thus, clearly this Index fully supports Laissez-faire policies, and thus ranks countries based on this.

The Fraser Institute uses 42 variable in five broad areas to construct the Index. The five broad areas are;

ef1

Each of the 42 variables (component and sub-component) is standardized to carry a score ranging from 0-10. When sub-components are present, the sub-component ratings are averaged to derive the component rating. The component ratings within each area are then averaged to derive ratings for each of the five areas. The ratings for the five areas are then averaged to derive the final composite score for each country.

Also important to note is that the report provides two different ratings. The first rating is based on (raw) averaging method mentioned in the previous paragraph. The second is that in order to be able to analyze the data year-on-year and ensure compatibility across time, similar to what is done when calculating the GDP, the data has been chain-linked (using 2000 as the base year).

As a result of this we get two ratings; unadjusted and the chain-linked ratings. Thus, it is important to use the unadjusted rating when comparing countries within a particular year, but switch to the chain-linked ratings when analyzing the changes of a country as well as cross-country comparisons (relative rankings) across time. Chain-linked ratings are available for 123 countries. The chain-linked methodology means that a country’s rating will change across time periods only when there is a change in ratings for components present during adjacent years.

What happened in 2014?

In 2014 the best performers were Hong Kong, Singapore and New Zealand, while the country that ranked the worst were the Republic of Congo, Libya and Venezuela.

Furthermore the report made the following conclusions;

  1. Nations with higher per-capita GDP performed better on the Index.
  2. High-income industrial economies generally rank quite high for Areas 2-4, but their ratings were lower in Areas 1 and 5.
  3. In developing nations a small fiscal size of government is insufficient to ensure economic freedom, and that fulfillment of other areas is also required.
  4. Life expectancy was higher in countries that performed better on the Index.
  5. Political and civil liberties are considerably higher in economically free nations than in un-free nations.

Sri Lanka on the Index?

As mentioned, Sri Lanka was ranked 111, and got an overall unadjusted rating of 6.52. Sri Lanka performed better than India (6.50, 112), Bangladesh (6.35, 121) and Pakistan (6.01, 133), while Nepal and Bhutan performed better scoring 6.54 (108) and 7.07 (75) respectively. We can also see that the unadjusted rating has been deteriorating from being at an all time high of 6.65 in 2011 (Refer to the Excel spreadsheet for more details). And while it is important to compare Sri Lanka’s performance in relation to other countries, I believe what is more important is to compare Sri Lanka against itself.

Thus it maybe best to compare the chain-linked ratings for Sri Lanka as they would provide a more accurate picture of the changes in Sri Lanka over time. Sri Lanka was ranked 95 (out of 123) based on its chain-linked rating, and we can also see that there has been a deterioration of Sri Lanka’s rating falling from 6.40 in 2011 to 6.28 in 2014. If we look into each of the five Areas, the following year-on-year changes can be observed;
ef2

From the above we can see that only Area 2 had a significant improvement in 2014. Area 1 and Area 4 significantly deteriorated, with the Freedom to Trade Internationally Areas dropping by 0.48 points. As a result, the overall rating of Sri Lanka dropped in 2014. Thus, the government is justified in pursuing multiple Free Trade Agreements with India, China, Singapore and trade concessions from the EU and USA. If successful, these measures could improve this ranking in the subsequent reports.

Area 1, Size of Government, is obviously an area Sri Lanka struggles with due to its oversized public sector workforce and massive influence of the state in the economy via State Owned Enterprises (SOEs). With the current government intent on divesting its shares in certain entities like Hilton, Lanka Hospitals and selling a major stake of SriLankan Airlines, this could improve over time. But then again our politicians cannot afford to loose too many SOEs, which they can use to bribe voters through promises of government jobs.

However, we can see that Sri Lanka’s year-on-year chain-linked ranking have been relatively stable. The reason for this is because on average the countries ranked around Sri Lanka, also had a drop in their ratings, thus resulting in only a change on one position when compared to 2013.

Improvements since 2014?

As stated in the introduction, this data is reflective of that in 2014, and if we recall, most likely the ratings would reflect the realities of Sri Lanka during that time. It would indeed be interesting to see if the ratings of 2015 do improve. And if they do, it maybe possible to prove that there is a correlation between the improvement of Sri Lanka on various indices and the change of Government in January 2015. But one one must keep in mind that the structural reforms that are being taken by the current government will take time to take effect, even those FTAs. After all Rome might burn down in a few days, but it took years to build it.

Yet, there is one important caveat to this Index – and that is the fact that it fully supports Laissez-faire policies and considered welfare state policies in negative light. This can been seen by the relatively low rankings for the developed welfare-states such as Iceland (76), Sweden (39), and Denmark (21).

We must realise that sometimes, gaining the best “score” on an international index may not be the optimal result. Thus, while it is indeed advantageous for Sri Lanka to improve its ranking on the Index, it is important to keep in mind that it should not be done at the expense of Sri Lanka’s, albeit sometimes limited, social welfare structure and assistance provided for the lower economic strata, and thereby be able to justify being a Socialist Democratic Republic.

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