Issue 1, 2015. February-March



An Overview of the 2014 Heritage Foundation Index

Ketevan Khorava, Grant Thornton

Index of Economic Freedom

Determining the specific level of economic liberalization of different countries' economies has recently arisen as necessary and an important value for investors, politicians and others.

The American thinktank Heritage Foundation, in collaboration with the Wall Street Journal, has developed a unified Index of Economic Freedom that examines countries in the context of 50 different parameters, which are grouped into 10 major categories: 1) TradeFreedom; 2) Fiscal Freedom; 3) Government Spending; 4) Monetary Freedom; 5) Investment Freedom; 6) Financial Freedom; 7) Labor Freedom; 8) Property Rights; 9) Freedom from Corruption; and 10) Business Freedom. The index is an overall score, which is derived by averaging equally weighted scores in each of the foregoing categories. Based on its average score, each country falls within one of five degrees of economic freedom: 1) Free (80-100); 2) Mostly Free (70.0-79.9); 3) Moderately Free (60.0-69.9); 4) Mostly Unfree (50.0-59.9); 5) Repressed (0-49.9), which clearly conveys information about a country's freedom.

Moving Ahead or Falling Behind?

In 2014, the Heritage Foundation published an analysis of 186 economies throughout the world - a report that sent a clear signal for post-Soviet countries about their progress.

For example, results from the South Caucasus and Eastern Europe show that countries, where there are significant institutional reforms and where the government is creating a favorable environment for investment, are more effectively transitioning to modern, mobile economies compared to those struggling to implement reforms.

As for post-Soviet countries, the clear leader is Estonia, which is ranked 11th in the world and is included in the list of countries having "Mostly Free" economies.

Estonia's high score reflects years of reforms, including the country's linear income tax reform, which has contributed to the rapid growth of the economy.Estonia "linear income tax" experience was so successful that other countries - Lithuania, Latvia and then Russia - copied it in 2001. Ukraine and Georgia also introduced flat income taxesin 2004, as did Slovakia and Romania in 2005.

Georgia's scores reflect the country's mixed success at reforms; it scores higher than its neighbors, but still has room for improvement.

The country is ranked 22nd in the 2014 index. Georgia's highest score is for labor freedom at 91.2. The country also received high marks for business freedom, 87.8, which is an important indicator for investors.

Georgia's score is based on its easy business-incorporation policy, which allows entrepreneurs to register a business with just two procedures in two days. There is no minimum capital requirement. Completing licensing requirements typically take just two months to complete.

The country also boasts several other advantages, like flexible working hours, that have helped its score.

Unfortunately Georgia has low scores in Property rights, at 40.0 and Freedom from Corruption at 42.8. But ranked between Luxembourg and Sweden, Georgia's score earned accolades from officials. The country improved in several areas, like business freedom and monetary freedom - and its overall score was higher than the 2013 ranking, continuing its trend of year on year improvement

Regional Trends

Interesting trends are also observed in Georgia's neighboring countries: Armenia is ranked 41st; Azerbaijan is in the 81st position, and Turkey is ranked 64th.

The improvement of Azerbaijan's ranking is due to the state's policy to promote trade, encourage investments and establish a moderate tax system. The report found, however, that the country needs institutional and systemic reforms for property rights (the country scored 20), as well as anti-corruption measures (the country scored 22.7).

Turkey's ranking was an improvement over past years. But the report makes it clear that despite reforms implemented in recent years, the government still interferes in the economy, and dynamic entrepreneurial activity requires liberalization of regulations and taxes.

According to the 2014 data of the Heritage Foundation, Russia ranked 140 out of 186 countries of the world due to issues concerning property rights and corruption.

Economic Lessons

The Economic Freedom index can be used as a guide for Georgia as it choose the best road to economic growth. Georgia should use the reports published by the Heritage Foundation and the annual edition of the Wall Street Journal on the Index of Economic Freedom to assess reforms aimed at improving economic freedom that are planned for each year.

If one analyzes Georgia's score for Economic freedom for 2014, one sees that itsoverall score is 0.4 point higher than 2013, with improvements in six of the ten categories of economic freedom, including government spending, investment freedom and monetary freedom.

"Georgia is ranked 12th out of 43 countries in the Europe region and its score is well above the regional average," the report noted.

Over the 19 years that Georgia has been included in the Index, its economic freedom has advanced over 28 points, the third best of any country.

"The impressive growth of Georgia's economic freedom has been propelled by broad-based score improvements in such critical areas as regulatory efficiency and market openness," the report stated.

From a "repressed" economy almost 19 years ago, Georgia has gradually advanced to the ranks of the economically "mostly free," achieving its highest score ever in the 2014 Index.

But there is still more to do. The report's authors found that "deeper institutional reforms to eradicate lingering corruption and increase judicial independence are critical to ensuring greater economic freedom in Georgia." Dynamic positive changes occurred with Georgia's with property freedom score from years 2007 to 2013, but unfortunatelynow Georgia's property freedom score is 5 points lower than last year.

If one assumes that property freedom is one of the determinant factors for investment, then one will come to see a certain corelation between the two: FDI as a percentage of the national GDP has also decreased since 2011.

The Index of Economic Freedom is proof that economic growth is not an isolated event, but rather a consequence of economic freedom. Without it, no country can overcome poverty andfurther itsdevelopment - a lesson the Georgian government should take to heart as it continues the country's reform policy.