Tag Archives: EFW

Does economic freedom matter among wealthy countries?

In response to my last post, alert Neighborhood Effects reader Shane Phillips writes:

Are there charts like these that just compare the nations in the top quintile? It’s good to know that economic freedom leads to these positive outcomes, but knowing the difference between the Central African Republic, for example, and the US doesn’t really tell me as much as the US vs other modern, developed countries would.

This is a great question and the answer is yes, there has been some attempt to examine these relationships in a sub-set of wealthier countries. One area in which this has been done is in the literature looking at the effect of government size on economic growth. Government size, remember, is just one aspect of economic freedom (in the EFW, the other components are “legal system and property rights,” “sound money,” “freedom to trade internationally,” and “regulation”).

Speaking broadly, most economists who have looked at this, tend to approach the question with the following theoretical relationship in mind:

government size and growth in theory

In other words, at low levels of government spending, additional spending may be able to increase growth by financing things like property protection and public goods. But at higher levels of government spending, marginal increases in government size detract from growth as taxes become more distortionary and as government becomes less effective.

Andreas Bergh and Magnus Henrekson have a very nice survey of this literature. The whole study is worth a read, but one of the more important findings is that while the relationship is fairly ambiguous when all countries are included, it is less-so when you look at the sub-sample of wealthy countries:

The literature on the relationship between the size of government and economic growth is full of seemingly contradictory findings. This conflict is largely explained by variations in definitions and the countries studied. An alternative approach—of limiting the focus to studies of the relationship in rich countries, measuring government size as total taxes or total expenditure relative to GDP and relying on panel data estimations with variation over time—reveals a more consistent picture. The most recent studies find a significant negative correlation: An increase in government size by 10 percentage points is associated with a 0.5 to 1 percent lower annual growth rate.

To me this suggests that the theoretical prediction may not be far from the mark. It’s interesting to note, by the way, that government size is generally negatively correlated with other aspects of economic freedom. So the freer, more-developed countries are often the ones with the largest public sectors. This helps explain why the relationship isn’t consistent across a larger sample: some of the countries with the smallest size governments are also those with the most regulation, the most barriers to trade, etc.

What about economic freedom more broadly defined? Has this been studied among the subset of relatively wealthy and relatively economically-free countries? I’m unaware of any formal studies, but as it turns out I’ve done some simple correlations myself. In the chart below, I graph economic freedom along with per capita GDP in OECD countries. The relationship is positive and statistically significant, though I’d caution that it is a small sample size and I have no control variables.

economic freedom and per capita GDP in OECDOne nice thing about focusing on the subset of OECD countries is that doing so allows me to examine the relationship between economic freedom and median income (which isn’t readily available for non-OECD countries). Per capita measures are problematic because they are sensitive to outliers. A handful of super-wealthy people in the U.S. or Luxembourg may give the false impression that everyone is wealthy. The median, however, doesn’t have this problem because it is unaffected by the levels at the extremes of the sample. Here the relationship is in terms of median income:

economic freedom and median income in oecdAs before, the same caveat applies: This is statistically significant; but it is a small sample and I have no control variables.

Why are there no libertarian countries?

In a recent article in Salon, Michael Lind posed a question:

Why are there no libertarian countries? If libertarians are correct in claiming that they understand how best to organize a modern society, how is it that not a single country in the world in the early twenty-first century is organized along libertarian lines?

He (or more likely his editors) called it the “question libertarians just can’t answer.” The headline of E.J. Dionne’s piece in praise of Lind’s article was more direct, calling the question “Libertarianism’s Achilles’ heel.”

Before addressing the substance of the question, it is worth noting that Lind seems to have misunderstood a central tenet of libertarian thinking: Few libertarians claim to have any superior knowledge of how to organize society. More often, libertarians come to their world view precisely because they think that no one could know how to plan the affairs of others.

Setting this aside, though, is the absence of a purely or even mostly-libertarian state proof that libertarian goals are unworthy? I don’t see how. No one thinks that the existence of poverty makes charity an unworthy goal. Why should the existence of widespread government intervention in private affairs make individual freedom an unworthy goal?

The key here is to appreciate the distinction between an optimal position and an equilibrium position. Optimality—whether it is defined as Pareto efficiency or justice as fairness—is a normative description of the degree to which we think a condition is ideal. Equilibrium, on the other hand, is a positive description of the way we think the world will actually turn out.

The two can be one and the same, as when economists predict that the outcome in a competitive market will be efficient. But the two needn’t be the same.

And in fact, a long list of libertarians and libertarian-leaning thinkers seem to have believed that liberty is emphatically not a stable equilibrium. Perhaps the most famous statement to this effect is Thomas Jefferson’s lament that “The natural progress of things is for liberty to yield, & government to gain ground.” More recently, in his introduction to Capitalism and Freedom, Friedman averred that “Freedom is a rare and delicate plant.”

Perhaps these statements can be dismissed as rhetorical flourishes. But formal public choice models quite often predict sub-optimal political equilibria. And libertarians frequently cite these models in support of their limited government perspective. So, like a great deal of progressives, it turns out that libertarians seem to think that “what is” is not optimal and that we should strive for, well, progress.

Much of the rest of Lind’s piece is dedicated to Mauritius, a small economically-free island nation off the coast of Africa. Mauritius often ranks high in economic freedom while, Lind notes, it has comparatively high infant mortality and comparatively low literacy rates. From this sample of one, he concludes:

Libertarians seem to have persuaded themselves that there is no significant trade-off between less government and more national insecurity, more crime, more illiteracy and more infant and maternal mortality, among other things

This is not the way social science–or any science–should be done. Do you know someone who regularly exercises yet seems to struggle with a weight problem? If so, this is hardly a reason to conclude that limited exercise is statistically significantly related to excess weight. It might be an indication of a broader relationship. But wouldn’t you want to gather more data and examine it in light of your existing theories?

Fortunately, economic freedom indices such as the Economic Freedom of the World Index (EFW) by Gwartney, Lawson, and Hall, have permitted researchers to do just that. And as it happens, each of the “trade-offs” that Lind names has been examined. Let’s take each in turn:

  • National insecurity and economic freedom: David Steinberg and Stephen Saideman examined the relationship between government involvement in the economy and ethnic violence in a 2008 article published in International Studies Quarterly.  In their words, “Our theory of insecurity predicts that free market economies reduce violent ethnic conflict by reducing fear and insecurity. We present statistical analyses, using data from the Minorities at Risk project and the Index of Economic Freedom, showing that government involvement in the economy increases ethnic rebellion. Our results suggest that the overall size of the public sector is less important than government interference with the market allocation mechanism.”
  • Crime and economic freedom: Edward Stringham and John Levendis explored the relationship between economic freedom and homicide in their chapter in the 2010 EFW. They found economic freedom and homicide to be negatively correlated. Here is Figure 6.1:

economic freedom and homicide, 2010 EFW

  • Illiteracy and economic freedom: A number of authors have looked at the relationship between economic freedom and literacy, often focusing on male/female inequality in literacy. In her 2006 study in Independent Review, for example, Michelle Fram Cohen used a Gender Empowerment Index that included disparities in female and male literacy, life expectancy, and income.  She found economic freedom was positively related to the female empowerment index. Michael Stroup also looked at this relationship in his 2007 article in the Journal of Economic Behavior and Organization. He, too, found a positive association between economic freedom and female literacy (he also found economic freedom was positively associated with life expectancy, fertility, and contraception use by women). Then there is this chart in the 2011 EFW (click on the chart to make it larger):

economic freedom and literacy, 2011 EFW

  • Infant mortality and economic freedom: This relationship was charted in the 2007 EFW:

economic freedom and infant mortality, 2007 EFW

  • Maternal mortality and economic freedom: Stroup visited this question in his chapter in the 2011 EFW. Here is the chart, which also shows the relationship between economic freedom and adolescent fertility:

economic freedom and maternal mortality

For an overview of the entire literature, check out Lawson and Hall’s recent article in Contemporary Economic Policy (here is a non-gated working paper version). They reviewed 198 articles using the EFW as an independent variable. In their words:

Over two-thirds of these studies found economic freedom to correspond to a “good” outcome such as faster growth, better living standards, more happiness, etc. Less than 4% [MM: 8 articles] of the sample found economic freedom to be associated with a “bad” outcome such as increased income inequality. The balance of evidence is overwhelming that economic freedom corresponds with a wide variety of positive outcomes with almost no negative tradeoffs.

———

Update:

Here is Jonah Goldberg’s response to Lind. Many others have had excellent responses as well.

 

When Taxpayer Dollars Are Used to Advocate for More…Taxpayer Dollars

Back in 2010, I noted that government spending can beget further spending. I cited research by Russell Sobel and George Crowley which shows that when the federal government transfers money to the states (as the stimulus bill did), the states tend to increase their own future taxes after the federal money goes away. They found that for every $1.00 the feds send to the states, states increase their own future taxes between $0.33 and $0.42.

Image by scottchan

It recently came to my attention, however, that little-noticed aspects of the 2009 Stimulus and the 2010 Affordable Care Act go even further: they fund advocacy on behalf of further state and local government spending.

Here is the story:

The stimulus bill set aside $650 million for the Department of Health and Human Services to spend on “evidence-based clinical and community-based prevention and wellness strategies.” The idea was to encourage state and local governments to adopt policies that get people to stop smoking, to eat better, and to get exercise.

HHS used the money to create a new grant program called Communities Putting Prevention to Work (CPPW). According to the CPPW website, it features “a strong emphasis on policy and environmental change at both the state and local levels.” (emphasis added).

Grants can go to local governments or to non-profits. You can see a list of approved grantee strategies here. Many of the strategies seem to be regulatory in scope (e.g. media and advertising bans for cigarettes, bans on branded promotional items, etc.). A number are also focused on getting state and local governments to spend more money. For example, they suggest efforts to get money for “hard-hitting counter-advertising” against tobacco. Or for “safe, attractive accessible places for activity” such as “recreation facilities, [and] enhance[d] bicycling and walking infrastructure.” They also call for “Reduced price[s] for park/facility use” (which, of course, means increased taxpayer support).

Interestingly, the Affordable Care Act doubled down on these activities. “Phase Two Funding” for CPPW was buried in the ACA.

It seems more than a little unseemly to have federal taxpayers bankroll an advocacy campaign like this. How would progressives feel if federal tax dollars were spent on a campaign to get state governments to cut taxes and regulations? Or how about a taxpayer-financed campaign to promote awareness of the Economic Freedom of the World index or the Freedom in the 50 States Index? Studies suggest, by the way, that economic freedom is associated with improved health outcomes (see Exhibit 1.16 of the EFW on p. 24). So maybe such a campaign would qualify for a grant under the program?

“Where are the jobs from the Bush tax cuts?”

So asked Senator Franken (D-MN) in a press conference this week.

It is a good question.  From 1981 through 2000, real GDP grew at an average annual rate of 3.3 percent.  But from 2001 to 2008 (even before the Great Recession began), real GDP grew at only 2.1 percent per year.  Why did growth seem to slow after the Bush tax cuts?  There are a number of different plausible answers.  I’ll take a stab at two:

1.  Yes, all things being equal, some people believe that a deficit-financed tax cut should improve the economy.  But all things were not equal in the 2000s.  In just about every aspect other than taxes, economic policy in the 2000s moved in an anti-market direction.  One could cite monetary policy as John Taylor does.  One could cite regulatory policy as Mark and Nicole Crain do.  One could cite trade policy.  One could cite the increased reliance on counter-cyclical stimulus efforts (there were 4 such packages during the Bush years).  Lastly, one could cite the large increases in spending that attended two wars, the prescription-drug benefit, the farm bill, and other policies.  Indeed, according to the broadest measure of economic freedom over time, the “chain-linked” EFW score by Gwartney, Lawson and Hall, U.S. economic freedom steadily improved up until around 2000, whereupon it precipitously fell:

2.  Another reply might be: we didn’t have a tax cut.  By this I mean that a tax cut without a spending cut is not a tax cut; it is a tax deferral.  When I wrote earlier that some people believe that a deficit-financed tax cut will improve the economy, I linked to John Maynard Keynes.  This is because Keynesian models predict deficit-financed tax cuts will spur economic growth (they also predict that deficit-financed spending increases will spur growth).  But there are other schools of thought.  One theory holds that if uber-rational, forward-looking consumers know that Deficits Are Future Taxes (Professor Mike Munger uses the helpful acronym “DAFT”), then they will save for those taxes today, which means that they won’t spend, completely offsetting whatever government spending that the deficits pay for.  But as I’ve explained in a previous post, you don’t need to believe in such an extreme model of human rationality to arrive at the conclusion that deficit-financed taxes will fail to spur growth.  This is because deficits lower the nation’s capital stock, which over the medium-to-long-run also harms economic growth (see the link for more details).

The bottom line: Though he almost certainly didn’t intend it this way, Senator Franken’s observation that the Bush years were not massive growth years actually bolsters the case for both spending cuts AND tax cuts.