India’s economic freedom plunge

For a government so devoted to rankings and ratings, India dropping 20 places to 143 in the 2017 Index of Economic Freedom must have been a bummer. If Prime Minister Narendra Modi felt it worthwhile to approvingly cite India’s 19-place improvement in the World Bank’s Logistics Performance Index, surely such a dramatic fall in economic freedom should send alarm bells ringing?

Compiled by the conservative Washington DC-based Heritage Foundation, the Index of Economic Freedom has an unambiguous free-market tilt. It ranks countries based on 12 factors:

Screen Shot 2017-02-19 at 2.12.21 PM.png

And on the face of it, India seems to have taken quite a hit:

Screen Shot 2017-02-19 at 1.37.20 PM.png

But the jittery libertarians can relax. India’s dip in the index is the result of a methodological change, not a big deterioration in economic freedom. Low scores in two new variables – “judicial effectiveness” and “fiscal health” – pushed India’s 2017 ranking down the list. If we compare 2017 with previous years on a like-for-like basis, India stands at 121, pretty much the same. The bad news? India has shown no improvement either, so Acche Din are as distant as ever.

Now you might say that these indices are arbitrary, opaque or irrelevant, and you would have a point. Heritage doesn’t tell us how individual scores are calculated, and only five of the 12 variables are drawn from concrete data, as opposed to more subjective surveys by the World Economic Forum, the World Bank, Transparency International etc. The way the index is calculated, modest changes in one or two variables can send a country up or down five to 10 places.

Since many of these appear to be subjective measures (e.g. “property rights”, “judicial effectiveness”, “government integrity”), small rank changes could simply reflect random measurement error. Furthermore, it’s debatable whether saying that India ranks three spots higher than Brazil under “property rights” is truly meaningful.

There are conceptual issues too. If you give Sudan, Sierra Leone and the Democratic Republic of Congo top billing under “government spending” and code the welfare states of Finland, France and Denmark as low in this case, are you not implausibly suggesting that weak government capacity produces prosperity?

More broadly, a 2012 paper by economists Aleksander Kešeljević and Rok Spruk finds that country rankings can change once you account for endogeneity – the fact that richer countries will already tend to be freer economically – as well as for how various components of the index affect prosperity differently (e.g. fiscal and monetary variables have a bigger impact than rule-of-law variables).

Screen Shot 2017-02-19 at 12.15.06 PM.png

The point is, there’s no need to get hung up on such indices. They can be a periodic reminder of how far there is to go to liberalise the Indian economy, but they are also constrained by a specific ideological perspective. No one in India seriously disputes that it’s desirable to make it easier for firms to do business, but reasonable people can disgree whether the Mahatma Gandhi National Rural Employment Guarantee Act enhances or limits economic freedom.

And think about demonetisation. If it were to reduce corruption in a sustainable way (count me as a sceptic), it would certainly contribute to economic freedom. But it has also imposed a tax on all holders of currency (i.e. everyone), devastated India’s informal sector and facilitated Raid Raj by all-powerful income tax authorities. The irony is that India may be holding its position as far as the Heritage Foundation is concerned, but its economic freedom is moving in reverse gear.