Tag Archives: Professors James Gwartney

Economic Freedom, Growth, and What Might Have Been

Economists are obsessed with growth. And for good reason. Greater wealth doesn’t just buy us nicer vacations and fancier gadgets. It also buys longer life spans, better nutrition, and lower infant mortality. It buys more time with family, and less time at work. It buys greater self-reported happiness. And as Harvard economist Benjamin Friedman has argued, wealth even seems to make us better people:

Economic growth—meaning a rising standard of living for the clear majority of citizens—more often than not fosters greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy.

For much of my lifetime, brisk economic growth was the norm in the United States. From 1983 to 2000, annual growth in real (that is, inflation-adjusted) GDP averaged 3.67 percent. During this period, the U.S. experienced only one (short and mild) recession in the early ‘90s. The era was known among macroeconomists as the “great moderation.”

But starting around the turn of the millennium, things changed. Instead of averaging 3.67 percent growth, the U.S. economy grew at less than half that rate, 1.78 percent on average. To see the effect of this deceleration, consider the chart below (data are from the BEA). The blue line shows actual GDP growth (as measured in billions of chained 2009 dollars).

The red line shows what might have happened if we’d continued to grow at the 3.67 percent rate which prevailed for the two previous decades. At this rate, the economy would have been 30 percent larger in 2015 than it actually was.

This assumes that the Great Recession never happened. So to see what would have happened to GDP if the Great Recession had still occurred but if growth had resumed (as it has in every other post-WWII recession), I calculated a second hypothetical growth path. The green line shows the hypothetical path of GDP had the economy still gone through the Great Recession but then resumed its normal 3.67 percent rate of growth from 2010 onward. Under this scenario, the economy would have been fully 8 percent larger in 2015 than it actually was.

screen-shot-2016-09-16-at-11-31-02-am

(Click to enlarge)

So what happened to growth? One answer is economic freedom—or a lack thereof. Just yesterday, the Fraser Institute released its annual Economic Freedom of the World report. Authored by Professors James Gwartney of Florida State University, Robert Lawson of Southern Methodist University, and Joshua Hall of West Virginia University, the report assesses the degree to which people are free to exchange goods and services with one another without interference. As Adam Smith might have put it, it measures the degree to which we live under “a system of natural liberty.”

As the chart below shows, economic freedom was on the steady rise before 2000. This coincided with modest deregulation of a few industries under Carter and Reagan, tax cuts under Reagan and Clinton, free trade deals, and restrained growth in the size of government. But from 2000 onward, U.S. economic freedom has been in precipitous decline. This coincides with major new financial regulations under both Bush II and Obama, significant growth in government spending, and a steady erosion in measures of the rule of law.

screen-shot-2016-09-16-at-11-33-15-am

(Click to enlarge)

As I’ve noted before, the research on economic freedom is quite extensive (nearly 200 peer-reviewed academic studies use economic freedom as an explanatory variable). Moreover, meta-studies of that literature find “there is a solid finding of a direct positive association between economic freedom and economic growth.”

Perhaps the two charts have something to do with one another?

 

 

What is Economic Freedom and What Can it Say About Prosperity?

My post in the NYT’s Room for Debate blog elicited a good number of comments and questions. So today I thought I might elaborate on the most-important of these questions: What exactly is economic freedom and what do we know about the way it affects prosperity?

First, its impact. The economists Chris Doucouliagos and Mehmet Ali Ulubqasoglu recently reviewed 45 studies examining the freedom-growth relationship. They concluded:

[R]egardless of the sample of countries, the measure of economic freedom and the level of aggregation, there is a solid finding of a direct positive association between economic freedom and economic growth.

Studies also find that economic freedom tends to be associated with a whole host of other factors that humans tend to value such as:

  • Higher income levels: Faria and Montesinos (2009) Dawson (1998), De Haan and Siermann (1998), De Haan and Sturm (2000), Cole (2003), Gwartney et al. (2004) and Weede (2006);
  • Lower poverty levels: Norton (2003);
  • Less volatility in the business cycle: Dawson (2010);
  • Better environmental outcomes: Norton (1998), ch. 2);

even:

  • Fewer homicides: Stringham and Levendis (2010); and 
  • Greater levels of reported happiness: Ovaska and Takashima (2006)

But what is economic freedom?

The concept is quite old, dating back to well-before Adam Smith. For his part, he called it “a system of natural liberty” and gave us a view of what he meant by it when he wrote:

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.

This, however, is still pretty vague.

So in the last quarter-century, a number of economists have focused on defining and—importantly—measuring economic freedom. There are now a number indices of economic freedom at both the national and sub-national levels. Among academics, the most-widely cited of these is the Economic Freedom of the World index, the latest of which is authored by Professors James Gwartney, Joshua Hall, and Robert Lawson. This index grew out of a series of conferences initiated by (Nobel Laureate) Milton Friedman and the Fraser Institute’s Michael Walker in the mid-1980s to early 1990s. Other attendees included economic luminaries such as “Lord Peter Bauer, Gary Becker, Douglass North, Armen Alchian, Arnold Harberger, Alvin Rabushka, Walter Block, Gordon Tullock, and Sir Alan Walters” (a number of whom have either won Nobel prizes in own their right or are likely to in the years that come). Out of these conferences, a consensus began to emerge that the four cornerstones of economic freedom were:

  • 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.

From these conceptual cornerstones, the authors of the index began to gather data with an eye toward objectively measuring the degree to which the laws of different nations permit (or don’t) the exercise of economic freedom. Their index includes factors such as government consumption spending as a share of total consumption, top marginal income tax rates, the degree of judicial independence, growth in the money supply, taxes on international trade, and regulation of private sector credit (among 17 other components). The index now covers more than 140 countries, with data on many going back to 1970. And now there are literally hundreds of peer-reviewed articles that are based on this index or one of many others like it.

Since the publication of this index, a number of others have gotten in on the game. There are now indices that measure freedom at the sub-national level, the most-recent of which is Sorens and Ruger’s Freedom in the 50 States, published by Mercatus (the next addition of which is coming out soon). 

As I have recently noted, these state level indices suggest that economic freedom is a powerful predictor of prosperity.

So that, in a nutshell, is economic freedom.