South Africa improves to 85th on economic freedom rankings

The Economic Freedom of the World: 2012 Annual Report identifies for us several important factors that the South African government can act on now to improve economic growth and progress. Refinements in the Economic Freedom of the World (EFW) index have increased the reliability of the data as well as their relevance to South African conditions. This better enables us to focus attention on those factors most in need of correction.

Two new factors might seem all too obvious to South Africans. “Reliability of police” is one of the lowest scoring factors. Clearly, the maintenance of order and the rule of law, which requires the protection of people and their private property, is essential for the preservation of all other freedoms. This is related to another index factor, the business costs of crime, which also scores poorly and places South Africa at a competitive disadvantage.

The factor with the lowest score, capital controls, might be the easiest to correct. Of the thirteen specific capital controls recorded by the International Monetary Fund, the 2010 report listed South Africa as imposing twelve of them. Given that such controls are most likely to fail to achieve any goal suitable for public statement, a timetable for the systematic removal of such controls would bring assured benefits.

Higher levels of unemployment are associated with lower levels of economic freedom. Although South Africa's overall EFW index this year is slightly higher than in last year's report, it is still lower than its peak of ten years ago. Freedom from labour market regulations is also below its peak. Specifically, a lack of flexibility in hiring and firing of workers as well as a ponderously restrictive system of centralised collective bargaining raises the cost of labour and reduces productivity. However well-intended these controls might be, they discourage employment and contribute to labour strife.

Two other areas where South Africa scores poorly are in the legal enforcement of contracts and the regulatory compliance costs associated with the administrative requirements placed on businesses. A legal environment that cannot assure the enforcement of contracts will be a low-trust environment that necessarily raises the costs of doing business and limits the range of activities likely to be undertaken. Business activity is further discouraged when the time and resources of individuals and businesses are diverted from production into the compliance with regulations.

South Africa's EFW scores are pulled down further by two related factors: “government consumption” and “government enterprises and investment.” Government expenditures take up almost a third of South Africa's annual gross domestic product (GDP) and necessarily require a source of funding, which always comes from individuals in the private sector. These funds are raised through taxation (of individuals, their activities, and their businesses) and through the imposition of user fees or, more flexibly, through borrowing.     Whichever way the funding is raised, as government grows in size, it reduces the freedom of individuals to spend and invest.

Certainly those government expenditures and activities are intended to provide benefits to taxpayers and other residents. But as the size of government grows, the return on each rand spent or invested tends to diminish while the burden on individuals tends to grow. South Africa's low EFW index score in this area (size of government) suggests that it is well beyond the point of diminishing returns. Although certain interest groups would resist, and no doubt demand compensation, it would still be in the national interest to reduce the magnitude and scope of government expenditures.

The existence of state-owned enterprises also reduces the scope for private activities. Even when the intention is to operate such enterprises on a commercial basis, taxpayer funding and the unavoidable politicisation of their governance will set these companies apart from their private competitors, if such competitors are allowed. The visible advantage of government financing merely hides the full cost of the burden that is transferred to taxpayers and to competitors. We lose the informational benefits of participation in the private capital markets. Taxpayers and customers would be better served when state-owned enterprises are privatised and their industries deregulated.

The EFW component on which South Africa scores highest is in the provision of sound money. But on this component, 79 other countries score higher. Control of the rand money supply has improved steadily over time and price inflation has remained within, or close to, its target range. The score will improve when the inflation target range is brought down and when South Africans have greater freedom to own foreign-currency bank accounts.

In this year's overall EFW rankings, South Africa has improved slightly over last year, moving up to 85th place. But the trend over the past 10 years has been downward in both the index and the ranking. It should be remembered that the loss of economic freedom has real consequences.

In positive terms, increased economic freedom is associated with higher economic growth and development, improved standards of living, and greater levels of peaceful cooperation.

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