The Economic Freedom Index (EFI) works on the presumption that the best situation is where every individual has the freedom to work, invest, spend, move, own property, produce, etc, with few impediments. Governments need to create an environment that allows all this to happen by not just helping individuals but also keeping out of the way. The EFI looks at four broad factors covering 10 attributes which are evaluated to arrive at the final score. Indias score is 55.7 in 2014, and the silver lining is that it has increased from 45.1 in 1995. The earlier ranks do not quite matter as the number of countries in the set kept changing depending on the availability of data. Hong Kong leads with a score of 90.
The four broad areas are rule of law, limited government, regulatory efficiency and open markets. Out of the 10 parameters that have been evaluated, India was mostly free in 3 attributes, moderately free in 2, mostly unfree in 1 and repressed in 4. Generally speaking, this is not a good showing at all.
In the rule of law category, the EFI looks at property rights and corruption. We are at the borderline of property rights with a score of 50, which has not changed for the last 20 years or so. The issue that has been pointed out is that the protection provided to preservation of such rights is weak as the judicial system, though independent, is susceptible to prolonged processes which are expensive and also subject to political pressure. On corruption, we have always scored low and the best was 35 in 2009, against a present score of 31.5. One can hope that with this issue of governance coming up strongly in our polity, improvement could be expected in the next few years.
The second area relates to limited government where both government spending and taxation (fiscal freedom) are considered. The scores are 77.8 and 79.4, respectively, which is not bad on a relative scale too. However, government spending had scored a high of 90.6 in 1999. Quite clearly, a progressively higher deficit run by the government through spending has militated against the space to individuals.
The regulatory efficiency category is interesting, which covers business, labour and monetary freedom. The low score in business freedom (37.7) follows the World Bank Doing Business view given the challenges any entrepreneur faces. We do not do too badly when it comes to labour freedom with a score of 74 which comes under the mostly free classification. Conditions are easier and there are exit options open for labour. But monetary freedom is low at 65.5 and has come down from a high of 77.2 in 2007. The high persistence of inflation comes in the way of efficient use of monetary tools by the central bank and this has been the case in India where an inflationary environment has made things tough for RBI.
The fourth category, open markets, is where trade, investment and financial freedoms are evaluated. In terms of trade, we do not do too badly, scoring 65.6. In fact, compared to a decade back, when the score was 23.6, there has been more than doubling of the effort here. Investment freedom remains low and here the EFI looks more closely at the FDI rules, where India is not considered to be too open. For domestic investment too, the environment is not hospitable and overlaps with the business freedom index. The investment freedom score was 50.8 in 2006 and it has been downhill since then. FDI has been increasing in the country; but this index would say that if we were more open to such investment, the flows would have been larger which would have benefited growth.
Last, India is again low on financial freedom, and this is more a regulatory and policy issue. With the government controlling the larger part of the financial system and having several pre-emptions under the umbrella of affirmative lending, the flexibility to operate and become more efficient is hindered considerably.
The EFI is, most certainly, a wake-up call for the government to look at the faultlines and address them. These indicators comprise the economic and business environment, which has to be tuned to the requirements of accelerated growth. Almost all these indicators are within the confines of our legislative bodies and there is a pressing need to bring in the right policy framework to revive investment.
Todays economic plight is symbolic of our shortcomings in all these aspects. When we talk of policy inaction and impediments to do business, which also involves corruption, it is a grievance of almost the whole of India Inc. The limited fiscal space we have is due to high deficits and, given that we talk a lot on inflation but do little about addressing the problems, the monetary freedom level too is low. RBIs latest group report on inclusive banking, which talks of more priority sector lending combined with the criteria of forcing banks to open branches in unbaked areas for new bank licenses, would actually bring down the level of financial freedom further.
Since it is agreed by almost everybody that opening up the reforms and reducing controls helped the country to move out of the stagnant equilibrium path, it is evident that we need to do it all over again to move away from this state of almost unfree as per the Heritage Foundation. Doing so, by addressing these five issues where we are sub-optimal, is the way ahead.
The author is chief economist, CARE Ratings. Views are personal