Financial Times

Economic Freedom: Sri Lanka leads in South Asia
By Muttukrishna Sarvananthan (Research Fellow, International Centre for Ethnic Studies, Colombo, Sri Lanka.)
According to Gwartney and Lawson (2003: 5) "the key ingredients of economic freedom are personal choice, voluntary exchange, freedom to compete, and protection of person and property". A country's adherence to such economic freedom is measured by the Economic Freedom of the World (EFW) index developed by the Fraser Institute based in Vancouver, Canada. The EFW index is based on 38 variables (including 18 survey-based variables derived from the International Country Risk Guide and the Global Competitiveness Report) and was available for 123 countries in 2001, the latest available year. The EFW index has a scale of 0 to 10 - zero depicting no economic freedom at all and 10 depicting highest economic freedom.

The EFW index is subdivided into 5 major components: (i) Size of Government: public expenditures, taxes and public enterprises; (ii) Legal Structure and Security of Property Rights; (iii) Access to Sound Money; (iv) Freedom to Exchange with Foreigners; and (v) Regulation of Credit, Labour and Business. Further, the 'Size of Government' is subdivided into 5 components; 'Legal Structure and Security of Property Rights' is subdivided into 5 components; 'Access to Sound Money' is subdivided into 4 components; 'Freedom to Exchange with Foreigners' is subdivided into 9 components; and 'Regulation of Credit, Labour and Business' is subdivided into 15 components (Gwartney and Lawson, 2003: 6-10). Hence, altogether 38 variables compose the EFW index.

In 2001 the top ten countries in terms of economic freedom were Hong Kong (8.6), Singapore (8.5), United States (8.3), New Zealand (8.2), United Kingdom (8.2), Canada (8.1), Australia (8.0), Ireland (8.0), Switzerland (8.0) and Netherlands (7.8). The bottom ten countries were Myanmar (3.8), Democratic Republic of Congo (3.9), Zimbabwe (4.0), Algeria (4.2), Guinea-Bissau (4.4), Republic of Congo (4.5), Ukraine (4.6), Romania (4.7), Malawi (4.8) and Central African Republic (4.9) (Gwartney and Lawson, 2003: 11). The world average economic freedom rating was 6.4 in 2001 (Table 1).

There also seems to be a positive correlation between economic freedom and economic growth, per capita income, life expectancy, income inequality, literacy rate, access to safe sanitation facilities and safe water (see Gwartney and Lawson, 2003: 20-21, 35).

Freedom indices
In South Asia economic freedom indices are available for the largest five countries, viz. India, Pakistan, Bangladesh, Nepal and Sri Lanka. Sri Lanka had the highest economic freedom rating in South Asia (6.3) during 2001, the latest year for which data is available. This may not be surprising because of the fact that Sri Lanka was the first country in South Asia to open up its economy in 1977. But, in 1980 Nepal (5.7) and India (5.2) had higher ratings than Sri Lanka (4.9). In 1985 and 1990 Nepal (5.3) had higher ratings than Sri Lanka (5.1 & 5.0 respectively). Nevertheless, since 1995 Sri Lanka (6.1, 6.1 & 6.3) has had the highest ratings though in 2000 India (6.1) and Sri Lanka (6.1) had equal rating. Yet economic freedom in Sri Lanka during 2000 and 2001 (6.1 & 6.3 respectively) were slightly less than the world average of 6.3 and 6.4 respectively (Table 1).

Sri Lanka had a very restrictive and inward looking economy between 1970 and 1977. Unfortunately the economic freedom index of Sri Lanka for 1970 and 1975 are unavailable. It would have been certainly far below the 1980 rating because of nationalisation of the plantation sector, price and exchange controls resulting in parallel markets for commodities and foreign currencies, high import tariff rates and high income, property and wealth taxes, inter alia.

Although economic freedom rating for 1970 and 1975 are unavailable data for certain components of the economic freedom index are available. For example, for 1970 some sub-components of the 'Size of Government', 'Access to Sound Money' and 'Freedom to Exchange with Foreigners' are available while for 1975 in addition to the foregoing some sub-components of the 'Regulation of Credit, Labour and Business' are available (see Gwartney and Lawson, 2003: 142).

Though Sri Lanka tops in economic freedom within South Asia it lags behind Southeast Asian countries barring Indonesia (Gwartney and Lawson, 2003: 11). Sri Lanka's top position in South Asia in terms of economic freedom is buttressed by the facts that it has the highest economic growth rate, per capita income, life expectancy, literacy rate, access to safe sanitation facilities and safe water in South Asia (Mahbub ul Haq Human Development Centre, 2003: 228-231).

In terms of the ranking of economic freedom indices Sri Lanka was in the 70th position in 1980. That improved to 64th position in 2001 (out of 123 countries). Sri Lanka's position fluctuated between the lowest 74th (in 1990) to highest 57th (in 1995) during the period 1980 and 2001 (Table 2). Economic freedom index of Sri Lanka is unavailable for 1970 and 1975. However, as argued above it would have been lower than that in 1980.

As a corollary to the top position in terms of economic freedom rating Sri Lanka was at the top in terms of ranking of countries according to the degree of economic freedom within South Asia in 2001. However, in 1980 Nepal and India were well ahead of Sri Lanka and in 1985 and 1990 only Nepal was ahead of Sri Lanka. Since 1995 Sri Lanka had the best ranking (jointly with India in 2000) (Table 2).

Again, Southeast Asian countries (barring Indonesia) were ahead of Sri Lanka during 2001 (Gwartney and Lawson, 2003: 11). The comparison of economic freedom rankings overtime may be misleading because the number of countries incorporated in the exercise has been growing. For 1970 only 53 countries were rated, which increased to 70 countries for 1975, 102 countries for 1980, 109 countries for 1985, 113 countries for 1990 and 123 countries for 1995, 2000 & 2001.

Whilst the number of countries incorporated in the exercise increased Sri Lanka's position improved, which means Sri Lanka had fared much better than the rankings in Table 2 would show. For example, in 1980 Sri Lanka was in the 70th position out of 102 countries but in 2001 it was in the 64th position out of 123 countries. That means, in 2001, Sri Lanka's position improved by more than six places (than reflected in Table 2).

It is important to note that the ratings and rankings of each component and sub-components differ from the aggregate ratings/rankings given in Tables 1 & 2. That is, though overall Sri Lanka seems to top in economic freedom within South Asia since 1995 in certain components and sub-components of the index it lags behind some other South Asian countries (see Gwartney and Lawson, 2003: 46, 91, 115, 123&142).

Economic liberalisation
Sri Lanka was the trendsetter in economic liberalisation and reform in the South Asian region having embarked on opening up its economy in 1977. After the first wave of economic liberalisation throughout the 1980s Sri Lanka embarked on a second wave of economic liberalisation beginning 1990. The positive results of this second wave of liberalisation are reflected in the economic freedom index, which increased from 5.0 in 1990 to 6.1 in 1995.

In Sri Lanka economic liberalisation was by and large mistakenly equated with trade liberalisation. That is, the liberalisation of the external trade sector was not matched by reduction in the size and role of the state. This has, for example, resulted in double-digit budget deficits for the first time since independence during the post-1977 period.

These budget deficits in turn have made the total public debt greater than the GDP of the country in many years during the liberalisation period. Ironically the size of the public sector doubled between 1978 and 2000. In 1978 there were 600,000 public sector employees that increased to 1.2 million in 2000. Further, even after a quarter century of economic liberalisation more than 60% of the total bank deposits are with the state banks. Moreover, the labour laws in the country are still very restrictive for entrepreneurship. Though Sri Lanka remains the most open economy in South Asia further reforms need to be undertaken in order to remove the structural and institutional impediments to economic freedom such as the foregoing ones.

Though the overall economic freedom index of Sri Lanka is fairly positive its performances in some of the sub-components of 'Legal Structure and Security of Property Rights' (military interference, integrity of legal system and protection of intellectual property), 'Freedom to Exchange with Foreigners' (restrictions on foreign capital transactions, hidden import barriers and costs of importing) and 'Regulation of Credit, Labour & Business' (time spent with government bureaucracy, price controls, impact of minimum wage, flexibility of hiring and firing and private ownership of banks) are lagging behind (Gwartney and Lawson, 2003: 142).

Further, the changes in the ratings of some of the components of the economic freedom index from one year to another are suspect. For example, Sri Lanka received 7.2 rating for 'time spent with government bureaucracy' in 2000 which declined to 4.0 in 2001. Likewise, for 'flexibility in hiring and firing' Sri Lanka received a rating of 2.9 in 2000 which jumped to 4.6 in 2001. Further, the rating for 'impartial courts' rose from 5.0 in 2000 to 6.1 in 2001. Moreover, the rating for 'protection of intellectual property' jumped from 3.5 in 2000 to 5.0 in 2001. The foregoing changes in ratings between 2000 and 2001 appear to be doubtful because there do not seem to be any considerable improvement in any of these factors in just one year. Besides the quality of the underlying statistical data on which the economic freedom index is based is wanting.

Moreover, though as per the economic freedom index Sri Lanka enjoys considerable economic freedom (as is evident in Table 1) in reality a large chunk of the population has been deprived of economic freedom due to the civil war in the past twenty years. The secessionist struggle in the North and East Province of the country has resulted in severe erosion of economic freedom, inter alia. A devastating economic embargo imposed on the North and East Province since 1990 has seriously hampered productive activities (see Sarvananthan, 2003). This economic embargo included essential food commodities, medicines and agricultural inputs such as fertilisers, pesticides and fuel as well. Besides, arbitrary and extra legal taxes imposed by various rebel groups also impinged on the economic freedom of the masses in the North and East Province.

The Government of Sri Lanka unilaterally lifted the economic embargo in January 2002 prior to the signing of an indefinite ceasefire agreement with the Liberation Tigers of Tamil Eelam (LTTE) in February 2002. However, arbitrary and extra legal taxes imposed by the LTTE rebels have become further entrenched and widespread during the past 18 months. Though with the lifting of the economic embargo economic freedom of the people of the North and East Province has been restored to a considerable extent various rebel taxes impinge on economic freedom (see Sarvananthan, 2003b).

LTTE interference
In addition to extra legal taxes the farmers and fisherpersons in the North and East Province are faced with a monopsony (single buyer), which is the LTTE. After the ceasefire agreement agricultural and fishing activities have received a tremendous boost in rebel held territories. However, the rebels purchase farm and fish produce at a fixed (below market) price and transport to Colombo to sell at a higher price. Thus the rebels have taken away the freedom of the producers to market their own produce. This restriction imposed by the rebels even during peacetime impinges on the economic freedom of the people in the North and East Province.

In these circumstances fairly high economic freedom ratings received by Sri Lanka throughout the 1990s seem doubtful. Thus, the non-incorporation of the taking away of economic freedom by state and non-state actors in the theatres of civil war appears to be a major deficiency in the economic freedom index of Sri Lanka. Similarly the economic freedom index may overlook intra-country disparities in economic freedom in other civil war-torn countries and even federal states (where different tax regimes, size of government, regulations, etc, may prevail).

Some mechanism has to be found to take on board the intra-country disparities in economic freedom, as in the case of Sri Lanka, in the compilation of such index. For example, an index for the war-torn regions and another for the rest of the country can be compiled and then the average of the two could become the country index.
Access to correct and truthful information is sine qua non for the effective functioning of an open market economy and to this end a vibrant free media is a must.

There appears to be a positive correlation between freedom of the media (both print and electronic) and economic development. A recent World Bank study has highlighted the positive correlation between free media and economic development in several countries both developed and developing (World Bank, 2002). In the case of Sri Lanka considerable state-ownership of both print and electronic media has a debilitating effect on economic development and empowerment by way of spreading false and misleading information to the masses. Further, the Tamil language newspapers (both national and North and East-based) are coerced and/or bribed to toe the line of the LTTE seriously jeopardising the political and economic freedom of the masses in the North and East region. In short the Tamil language newspapers (national and regional) have become mouthpieces of the LTTE shunning any alternative views or opinions.

Hence, a rating for freedom of the media should be incorporated in the economic freedom index. An organisation such as the Article 19, which monitors media freedom globally, may have a dataset that can be used in the EFW index. Here again intra-country differences should be captured.

The economic freedom index is little known in Sri Lanka and hence rarely used in policy dialogue. There is a dearth of awareness about the economic freedom index among bureaucrats and the academia. However, there is some knowledge about the index among the business community, especially within the chambers of commerce and industry. In this background a campaign to create awareness about the economic freedom index among the bureaucracy, academia, business community and the general public is a long felt need.

In sum, though the economic freedom index is a valuable measure it needs to be modified to incorporate intra-country differences and include additional criteria as they become relevant and necessary. Thus the economic freedom index should keep on evolving diachronically. (through time). (This paper was presented at the Economic Freedom Network Asia workshop held in Jaipur, India in September. The views expressed here are those of the author and not of the ICES.)

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