Index of countries' regulatory frameworks and institutions
- an analysis of how international comparisons can be used and interpreted
There is a consensus today that a country’s institutions – its rules of play – are of crucial importance for its economic development. Attempts are therefore being made to measure the quality of countries’ regulatory frameworks and institutions by drawing up various types of index that are among other things used as benchmarks in international comparisons and as bases for the economic debate.
The index can be said to measure different dimensions of the conditions of enterprise, the existence of regulations and the degree of market economy; in other words the business climate in a broad sense. Growth Analysis was commissioned by the government to continue and deepen its analysis of the following indexes in 2013: The Economic Freedom of the World index (EFW), developed by the Fraser Institute, the World Bank’s Cost-of-Doing-Business index (CDB) and the OECD’s indicators of product market regulations (PMR) and employment protection legislation (EPL).
The present study focuses on what the indexes measure, what they cover, the weighting of different dimensions, and their reliability and quality. The aim of the study is to discuss how the indexes should be interpreted and to what extent international comparisons of this kind can be used as bases and guidance for drawing up the national growth policy. Sweden’s position, or ranking, in the indexes listed above over time is also studied, the aim of the analysis being to identify Sweden’s areas of strength and improvement potential and if possible try to trace development to measures or reforms carried out over the past two decades.
International indexes constitute a valuable basis for policy shaping
The composite indexes dealt with in the report are considered to be the most reliable and well developed measures of the degree of market economy, the quality of a country’s institutions, the existence of economic regulation and various dimensions of the conditions for enterprise. They are all to a great extent based on transparent, fact-based, comparable measures and therefore constitute a valuable foundation for setting priorities and delimiting the focus of the work done on growth-promoting reforms at national level. Measuring progress on structural reforms is crucial to being able to formulate policy recommendations.
When using the indexes, it is recommended that it is not sufficient to merely study the overall, total appraisals provided by the indicators. Various underlying dimensions or sub-indicators should also be analysed. As regards the CDB, ranking should be avoided since it does not say anything about the distance between the ranked countries. It is therefore more useful to look at the percentage distance to the top-ranked country (distance to frontier). Nor should too much importance be attached to minor differences or changes since these are difficult phenomena to capture.
It is also worth noting that all the indexes use the same weighting as regards included components or sub-indicators when weighed together into the overall index. The exception is the LMR indicator, where the weighting is based on the sub-indicators’ relative importance when companies decide to employ or dismiss personnel.
Ultimately, it is not possible to say that any of the indexes are better or more reliable than the others. They illustrate different aspects and all have their own merits. The EFW index is the broadest and describes the degree of economic freedom in an economy. It comprises regulation, free trade, institutional framework conditions such as protection of rights of ownership and the legal system’s independence, macro-economic indicators and the size of the state. The OECD’s PMR indicator measures the extent to which regulation promotes or inhibits competition. The indicator has been developed and is now integrated with, among other things, indicators of certain service industries, which gives it greater coverage. It thereby also illustrates the fact that differences in development over time and between countries is to a great degree dependent on sector-specific forms of regulation. The OECD’s LMR indicator is the most comprehensive indicator of labour market regulation. The World Bank’s CDB index measures costs and the regulatory burden for a medium-size limited liability company over its entire life cycle from start-up to liquidation. It is thus slightly narrower but uses a well developed methodology. In conclusion it should be emphasised that the correlation between the different indexes is high, even though their structures and what they measure differ.
The review of the various indexes shows that Sweden has implemented several structural reforms and is in a very good position in most respects. As earlier structural reforms are considered to have been successful in many respects, Sweden can continue with further reforms, given the goals of higher growth and increased employment. These ambitions and other goals may conflict, but the present report has its starting point in the indexes listed above that identify areas that are considered to be of importance for economic growth.
The reforms have meant that economic freedom as measured using the EFW index has increased significantly over time. Two areas of strength in Sweden are in particular the legal system and sound money. The improvement in the latter area can be largely attributed to the introduction of inflation targets and a norm for price stability in 1993. The area of regulation in the EFW index has improved significantly between 1995 and 2011 and Sweden was ranked tenth in this dimension in 2011. It is in particular in the area of labour market regulation that improvements have taken place. Sweden has by tradition a good position as regards the area of free trade. The fifth area, and the one that is largely responsible for lowering Sweden’s overall ranking, is the size of the state. High marginal tax rates on income from work in an international comparison (56% and 67% when payroll taxes are included) contribute to a low value in this area.
According to the OECD’s PMR indicator Sweden has low barriers to entrepreneurship in comparison with other OECD countries. Regarding the service sectors (the retail trade and professional services), Sweden has the least regulation of all OECD countries. Like most OECD countries, Sweden has low barriers to trade and direct investments. Between 1998 and 2008, Sweden’s development has meant a liberalisation in 13 out of the total of 18 dimensions. The number of publicly owned companies and the extent of direct state control of companies, however, have increased since 1998.
According to the OECD’s LMR indicator, security of employment for temporary employees was very strict until 1990, but the rules governing time-limited employment have been gradually relaxed since then. Two reforms of importance to this development are that staffing companies were permitted as of 1993 and that the possibility for so-called general employment on a temporary basis was introduced in 2007. The stringency concerning security of employment for permanent employees, on the other hand, has remained largely unchanged over the period.
The international comparisons tell us quite clearly that Sweden’s areas for improvement are principally high marginal tax rates on income from work, public ownership of companies particularly in the network sectors, and strict regulation of permanent employment. Regarding the costs involved in running a company, the greatest improvement potential can be found in the areas of investor protection, financing, contracts, liquidation (insolvency), and the administrative burden of the tax system, where the distance to frontier is approximately 20 percentage points or more. This is in spite of the improvements such as the restoration of the preferential right reform and strengthened protection for prioritised creditors in 2009 and strengthened protection for minority interests in 2010. There is on the other hand relatively light regulatory burden in the other five dimensions. One recommendation concerning regulatory reform is therefore that the focus should be more on areas where the distance to the top-ranked country is greatest. If improvements are made in the first five dimensions, this may at the same time have greater impact on the overall index since the scope for improvement is greater, even if the goal is effective and expedient rules rather than top ranking in the index.