John Hood John Locke Foundation
January 15, 2014
Are you ready for some good news?
For 20 years, the Wall Street Journal and the Washington-based Heritage Foundation have produced international indexes of economic freedom. Countries that adopt fiscal restraint and free trade, protect the rights of contract and property ownership, and avoid excessive taxes or regulations earn high scores on the index. Countries where governments abuse their power earn low scores.
According to the latest study, the average amount of economic freedom is higher today than at any time in the past two decades. Hundreds of millions of people live in countries in Latin America, Eastern Europe, Africa, and Asia that have liberalized their economies over the past 20 years. That’s one reason why global poverty has experienced one of the largest declines in human history during the period.
Not every country has gotten freer, of course. Some countries such as North Korea and Iran have remained repressed during the entire period. Others that previously had high or improving scores on the index are now experiencing backslides. The bad news is that the United States is one of them. Once a reliable leader of the pack, we have now fallen out of the top 10 countries in economic freedom, thanks to fiscal recklessness, recent increases in tax and regulatory burdens, and other encroachments on free enterprise.
While Washington (maybe) gets its act together, state and local governments will have to take the lead in helping to reverse the trend. As it happens, there are economic freedom indexes for states as well as for countries. North Carolina ranks in the middle of the pack according to some of the indexes, and a bit better than that on others. Recent decisions in Raleigh to reform and reduce taxes while reining in counterproductive regulation will help. In the coming years, lawmakers need to protect these gains in economic freedom and build on them.
Why? Because even at the state level, there is compelling evidence linking economic freedom to measures of economic progress such as job creation, business starts, and income growth.
Last year, I conducted a literature survey of all recent studies published in academic or professional journals that examined the relationship between government policies and state economic performance. From 1992 to 2013, there were 31 studies of economic freedom indexes. In 24 of them (77 percent), higher economic-freedom scores were associated with higher economic performance after adjusting for other factors. In the remaining seven studies, there was no statistically significant relationship. Not a single study found that higher economic freedom — which primarily means lower taxes, spending, and regulatory burdens — was statistically associated with lower economic growth.
A 2012 paper in the International Journal of Economics and Finance, for example, found that states with higher economic freedom tend to attract higher levels of investment from foreign firms, which then leads to more economic growth. A 2007 study in the Southern Economic Journal found that states attract another form of valuable capital, people, to the extent they embrace economic freedom.
And a 2013 paper in Contemporary Economic Policy found that higher state rankings on the Fraser Institute’s Economic Freedom of North America index was associated with lower unemployment and higher labor-force participation. “Our findings have clear implications for policymakers,” the study’s authors concluded. “Adopting policies that increase economic freedom by one point in the EFNA index would reduce the unemployment rate by as much as 1.3 percentage points” while increasing “the labor force participation rate by up to 1.9 percentage points and the employment-population ratio by as much as 2.3 percentage points.”
The argument here is not for anarchism. When governments perform their core services efficiently and effectively, economies benefit. Moreover, America still outranks most countries in the world in economic freedom, while North Carolina is hardly California when it comes to limitations on free enterprise. But by making wise fiscal and regulatory decisions, we can expand both freedom and prosperity.
Or so say two decades of social science and practical experience.
Hood is president of the John Locke Foundation. For more information, visit www.johnlocke.org.