Tag Archives: Ireland

Economic Freedom In Decline

Today, the Fraser Institute released the 2011 version of the Economic Freedom of the World report. Authored by James Gwartney of Florida State University, Robert Lawson of Southern Methodist University, and Joshua Hall of Beloit College, the index is an annual measure of economic freedom. Drawing on 42 data points gathered from each of 141 countries, it assigns each nation an economic freedom score. The score reflects the degree to which citizens in the nation enjoy economic freedom as characterized by “personal choice, voluntary exchange coordinated by markets, freedom to enter and compete in markets, and protection of persons and their property from aggression by others.”

Chapter 3 of the new report features an essay by Jean-Pierre Chauffour, lead economist of the World Bank’s Middle East and North Africa Region. In Figure 3.1, reproduced below, Chauffour shows the relationship between economic freedom and the log of per capita income (adjusting for purchasing power parity).

But economic freedom seems to be about more than just per capita income. Readers of Neighborhood Effects know that scores of peer-reviewed studies have examined the relationship between economic freedom and all sorts of measures of well being. The overwhelming evidence is that economic freedom is positively related to things humans like (per capita income of the poor, life expectancy, access to clean water, etc.) and negative related to things humans don’t like (poverty, child labor, etc.). Some of the most sophisticated studies have even tried to disentangle cause and effect.

So where do we stand? The data are lagged, so this year’s report now calculates economic freedom through 2009. There are some bright spots. For example:

The chain-linked summary ratings of Uganda, Zambia, Nicaragua, Albania, and Peru have improved by three or more points since 1990.

There is also some bad news:

 ….In contrast, the summary ratings of Venezuela, Zimbabwe, United States, and Malaysia fell by eight tenths of a point or more between 1990 and 2009, causing their rankings to slip.

In fact, those countries that slipped the most since 2000 were: Argentina, Iceland, Ireland, the United States, and Venezuela.

To see just how far the U.S. has fallen, consider the graph below. The first phase shows the U.S. (chain-linked) economic freedom score from 1970 through 2000. It is slow and steady progress the whole way. The second phase shows the U.S. score from 2000 onward. It is a dramatic and precipitous drop. Notice, by the way, that the ascendant periods lasts through three presidents of two different parties. The descent also seems to have persisted irrespective of the party in office. It seems that the policies that impact economic freedom are not strongly related to partisanship.

Mercatus has its own state-level measure of economic freedom, developed by Jason Sorens of the University of Buffalo (SUNY) and William Ruger of Texas State University.

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Addendum: Here is Arnold Kling on the report. Here is David Henderson. Here is Mark Steyn. Here is Robert Lawson.

Can a reduction in government spending stimulate the economy?

This, of course, is quite relevant given the latest news. To help find the answer, I consulted my graduate macroeconomics text. There, on pp. 546-7, I found this passage:

[A] small reduction in current government purchases could signal large future reductions, and therefore cause consumption to rise by more than the fall in government purchases.

Surprisingly, these possibilities are more than just theoretical curiosities. Giavazzi and Pagano (1990) show that fiscal reform packages in Denmark and Ireland in the 1980s caused consumption booms, and they argue that effects operating through expectations were the reason. Similarly, Alesina and Perotti (1997) show that deficit reductions coming from cuts in government employment and transfers are much more likely to be maintained than reductions coming from tax increases, and that, consistent with the importance of expectations, the first type of deficit reduction is often expansionary while the second type usually is not.

I did my graduate work at George Mason, so you may be thinking that this is some free-market fundamental text. It is actually David Romer’s Advanced Macroeconomics (David, of course, is the husband of President Obama’s former CEA chair, Christina Romer).

Since Mr. Romer wrote the passage above (the second edition was published in 2000), the case for expansionary spending cuts has, if anything, strengthened. Consider this 2010 piece by Harvard’s Alberto Alesina. He finds:

[N]ot all fiscal adjustments cause recessions. Countries that have made spending adjustments to reduce their deficits have made large, credible, and decisive cuts. Even in the very short run, many reductions of budget deficits, even sharp ones, have been followed immediately by sustained growth rather than recessions.

Or consider this 2010 piece by David Henderson. It focuses on the Canadian experience of cutting spending in the 1990s. He writes:

Canada was able to escape from chronic deficits and trimmed its debt from nearly 70 percent of GDP to 29 percent of GDP, all without sacrificing growth.

What’s more, “There were six to seven dollars in budget cuts for every dollar of tax increases.”

Or consider another piece, also by Henderson, focusing on post-WWII spending cuts in the U.S. He writes:

In the four years from peak World War II spending in 1944 to 1948, the U.S. government cut spending by $72 billion—a 75-percent reduction. It brought federal spending down from a peak of 44 percent of gross national product (GNP) in 1944 to only 8.9 percent in 1948.

The post-WWII U.S. economy is widely regarded to have been quite healthy. This, of course, confounded Keynesians like Paul Samuelson who had predicted that war demobilization would lead to the “greatest period of unemployment and industrial dislocation which any economy has ever faced.” (emphasis original)

Or try this 2010 piece by Goldman Sachs economists Ben Broadbent and Kevin Daly. They report:

In a review of every major fiscal correction in the OECD since 1975, we find that decisive budgetary adjustments that have focused on reducing government expenditure have (i) been successful in correcting fiscal imbalances; (ii) typically boosted growth; and (iii) resulted in significant bond and equity market outperformance. Tax-driven fiscal adjustments, by contrast, typically fail to correct fiscal imbalances and are damaging for growth.

In contrast, some people are pointing to a new IMF report that claims “fiscal consolidation typically reduces output and raises unemployment in the short term.” But as Alberto Alesina argues, the IMF findings are not all that different from his own. Critically, the IMF agrees that “tax increases are much worse for the economy than spending cuts.” Moreover, the IMF agrees that “after a few years, even large (but spending based) fiscal adjustments create growth for the economy.”

To me, the evidence suggests that Obama’s Deficit Commission chairs are on the right track in emphasizing 75 percent spending cuts relative to 25 percent revenue increases.

Is California’s Debt a Greek Tragedy?

James Surowiekci writing at The New Yorker considers whether there is good reason to think California’s fiscal plight puts it on course for a Greek-style collapse. Greece is not the only EU nation in trouble. Add in Portugal, Ireland, Italy and Spain to the massive debt club (a.k.a the PIIGS), with debt levels at 60% of GDP in 2008-2009. By contrast the most fiscally troubled states of California, New York, New Jersey and Illinois had debt-to-GDP ratios of 15% during the same period.

Surowiecki suggests this may be reason to breathe a little easier. The biggest debtor nations in the EU owe three times as much relative to GDP as do their high-debt counterparts in the US. Plus, the states can count on a federal bailout.

Yet, neither of these thoughts are entirely comforting.

First, states have underestimated their pension obligations by threefold. Official reports estimate New Jersey’s unfunded pension obligations at $45 billion. Using more reasonable discount rates to estimate New Jersey’s pension obligation reveals an unfunded liability of $137.9 billion, or 261% of total state debt. That’s before adding in Other Post-Retirement Benefits (OPEB) and health care for public sector workers.

Secondly, a half century of  intergovernmental infusions from D.C. in the form of transfers,Medicaid, and stabilization money hasn’t kept the states afloat. Quite the contrary the erosion of fiscal federalism has meant a loss of states’ control over spending and policy.

The FY 2009 stimulus has been as effective as a shot of morphine. States have now spent their education money to expand spending and avoid cuts. Fast forward to FY 2010. Revenues haven’t recovered. Pension obligations loom larger and those “saved and created” jobs are now in search of funds.

Factor in the growth in Social Security, Medicare, health care spending, and annual deficits projected to average $1 trillion over the next  decade and America 2030 looks alot worse than Greece 2010.