Tuesday, November 6, 2018

Economic Freedom, Part 3

The attempt to develop a rigorous, quantitative measure of economic freedom may strike some as a presumptuous undertaking.  The effort requires agreement on the conceptual dimensions of economic freedom, the indicators or data that fit or reflect each of the several dimensions of economic freedom, and the generation of a number (or numbers) that sums up all of the different dimensions, thereby permitting comparative ratings on the degree of economic freedom that exists both in the aggregate for each of the different dimensions of economic life in every country in the world at any point in time.  This post summarizes the initial effort.  I encourage you to read the full text of defining economic freedom and some possible measures, which appears in Chapter 4, Economic Freedom:  Toward a Theory of Economic Measurement (pages 87-108).  It lays a foundation for subsequent efforts to refine the conceptual elements of economic freedom, identify data requirements, and develop quantitative measures.  The ultimate objective is an annual report or yearbook, which has been produced annually by the Fraser Institute since 1996, rating economic freedom in every country around the globe, thereby upgrading the initial Freedom House Rating prepared by Zane Spindler and Laurie Still (Chapter 5, pages 135-171).

In Chapter 4 I tried to offer a preliminary definition, a check list, or a recipe of economic freedom ingredients.  I tried to identify the fewest number of dimensions that would be self-contained, consistent, and coherent.  Obviously, you could break them into many more.  This same set of seven dimensions could be subdivided into 10, 20, 25, or 30, as the case may be.  I compromised in the trade-off to produce something that is both meaningful and simple.

Some of the seven dimensions represent notions about individuals and others aggregate notions about the whole society.  For example, the schedule of marginal rates affects an individual’s decision to work, save, and invest, while an average tax burden may affect the society as a whole.

A second way to slice through these seven categories is in terms of institutions or rules and policies or incentives.  The first two, private property and the rule of law, I regard as institutional framework rules.  The others are public policies that governments undertake which have an effect on people’s capacity to do things economically and make them more or less free.

Two Institutions

My taxonomy is guided by philosophical considerations.  One cannot proceed without talking about private property.  A second area connected to private property is the rule of law.  In one community the rules are clear and one can expect fair and impartial treatment, and in the other the laws seem whimsical and decision making appears capricious.  The rule of law can enhance economic freedom through a written code, an independent judiciary, the structure of the legal codes, what kind of legal code it is, rights of appeal, and so on.

Five Categories of State Intervention

The first area of state intervention I examine is taxation.  Taxation can encompass high taxation, low taxation, the structure of taxes, composition of taxes, visible versus invisible taxes, rates of tax, whether taxes are used to redistribute income and wealth, taxes versus user fees to finance public services, and a broad-based proportional low tax scheme that promotes or enhances economic freedom as opposed to a loophole-ridden selective system with high rates on some kinds of economic activities and no rates on others.

A second area is public spending, the counterpart of taxation.  For centuries, the principle of balanced budgets regulated budget policy.  For the past 75 years, budget deficits have become a way of life in most advanced and developing countries. Until 1929, public spending in the U.S. consumed 10% of GDP.  Since then it has tripled.  The amount of spending, how it is spent, the amount of interest paid on a large and growing public debt, and the growing welfare state all have an impact on economic freedom, the ability of individuals to exercise responsibility for their own affairs.  What kind of spending enhances economic freedom and which doesn’t?

A third area is regulation of business and labor.  Regulatory agencies have dramatically increased in number and scope since 1960.  For business, important aspects of economic freedom include legal formalities required to set up a business should be few and inexpensive, free entry and exit into any line of production, absence or presence of monopoly practices that benefit specific firms or industries, and free movement of prices to equate supply and demand in the market place.  Other regulations are designed to control externalities such as air and water pollution, impose safety requirements on food, drugs, transportation carriers, the production of other goods and services that affect public health and safety, job safety inspections, equal employment opportunity enforcement, consumer product safety standards, and energy restrictions.  However, regulations can entail large expenditures to comply, or they can be imposed in a least-cost, minimally-interventionist manner.  How they are imposed affects both efficiency and economic freedom.

Labor regulations entail the rights of workers, choice of occupation, freedom to travel at home and abroad, unions (right to strike, compulsory payment of union dues, membership requirements), sick leave, vacation time, fringe benefits, hours of work, workmen’s compensation ordinances, pension fund requirements, and other measures.  All of these impact the economic freedom of workers and the overall labor market, raising the cost of production and reducing employment.

A fourth area is money.  The following policies, practices, and institutions, among others, should be examined to investigate a link between monetary policy and economic freedom:

The legal right of non-governmental entities to issue private currency;
The absence of legal tender laws;
The right to buy (free of sales and other taxes), own, and exchange gold (silver) coins;
An accurate description of the monetary system;
The successful conduct of monetary policy in terms of price stability and steady growth;
Convertibility of currency (into goods and services and other currencies);
Free inward and outward movement of capital;
Competition within banking and financial services sectors; and
Monetary policy rules.

The final area is foreign trade.  Free trade maximizes both efficiency and economic freedom.  It enables individuals to buy and sell freely on world markets, selling products at the highest possible price and purchasing goods and services at the lowest possible price and giving individuals the widest possible choice of consumer goods.  Free trade also permits specialization, division of labor, and the principle of comparative advantage to work to the benefit of individuals and firms in each country.

Those socialist and developing countries that pursued policies of self-reliance, self-sufficiency, import substitution, protectionism, and other inward-looking policies resulted in dismal records of economic performance and curtailed economic freedom.  Those that pursued policies in a milieu of free trade flourished.

Free trade means an absence of tariffs, non-tariff barriers, capital controls, restrictions on direct foreign investment, and government controlled marketing boards that fix the price of imports to consumers and exports to producers.

Summary

In the interests of parsimony here, I encourage you to read the full text of my paper and the subsequent discussion with the conference participants.

The measurement of economic freedom has been refined and improved since the Napa Valley Conference held in Vancouver in July 1988, both for the Fraser Institute Annual Report and the follow-on Heritage Foundation/Wall Street Journal Index.  I hope you will review the Fraser Institute Annual Report published in conjunction with the Cato Institute.

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