Politics 2000

You’ve heard a lot about the recent banking crises, ranging from AIG to Freddie Mac and Fannie Mae. You’ve likely heard CNN declare the economy “Issue #1.” Both national tickets are trying to claim a superior economic plan because polls consistently say Americans are most concerned about pocketbook issues this election.

America is based in freedom. One may start his or her own business or start low on the socioeconomic ladder and climb rung after rung unless he or she is a success beyond the wildest dreams. Such a vision is not a possibility in much of the world. The newest annual report from professors James Gwartney of Florida State University and Robert Lawson of Auburn University–Economic Freedom of the World–shows the U.S. has slipped a bit this decade from its lofty standard. I talked with Dr. Lawson about the report and his thoughts on current economic issues that will influence November’s election. My questions are in italic. Dr. Lawson’s responses are in bold. I thank him for his time and assistance.

Would you tell me about your background? What got you interested in studying the economic freedom of most of the world’s nations?

I just took a position as a professor at Auburn University, but for the previous 12 years, I was a professor at Capital University in Columbus Ohio. I got interested in this topic in graduate school at Florida State University while studying under the report’s co-author Jim Gwartney.

Adam Smith’s Wealth of Nations was about why some nations are wealthy and some are not. This question is still the big question in economics. Smith thought economic freedom (he called it a “system of natural liberty”) was important for prosperity. Until this report came along we didn’t have any way to emprically examine this idea in a systematic way. Now we do.

What does the Economic Freedom of the World report measure?

We create an index, based on a zero-to-ten scale, that attempts to gauge how consistent a country’s policies and institutions are with economic freedom, which we define to include freedom to trade, individual choice in markets, low taxes and regulations, private property, etc. We rely on data from external sources such as the World Bank, IMF, World Economic Forum, etc. The current report uses 42 components, grouped into five different areas, to rate 141 countries. Ratings are also available for many countries as far back as 1970.

Where can I read the report?

The entire report, as well as all of the data, are available on our website: http://www.freetheworld.com. You can buy the report as well. The Cato Institute has it on sale here: http://www.cato.org/pubs/efw/.

The U.S. is eighth in the world and has a score of eight on a ten-point scale. That seems good, although not as good as 2000.

Yes, in 2000 the U.S. scored 2nd but has been falling since then.

Hong Kong, Canada, Singapore and Chile are among the nations ranked ahead of the U.S. Why?

In Hong Kong and Singapore’s case, the answer is that taxes and to an extent regulations are much lower than in the U.S. They are also the most free trade nations on earth. Canada, Chile and the others are more like the U.S. in many ways and the differences are really quite small. I wouldn’t make too big of a deal out of such small differences. These are all mostly market-oriented economies — though not necessarily free market economies.

What factors caused the rating declines this decade? Can the next president reverse them?

The biggest reason is that the U.S. ratings in the “legal and property rights” area have fallen by over 2 full points (on the 0-10 scale). The underlying data are mostly from surveys so it’s hard to tell exactly what the cause is, but we speculate that property rights are not considered as secure in the U.S. now because of various policy changes associated with the war on terrorism and perhaps the Kelo decision. To the extent that the war on terrorism is a cause, and we cannot be sure that it is, this does seem to fall within the domain of executive power, so yes, it seems like the next president could reverse this trend.

I can’t imagine the U.S. score improved this year with the bailouts of Freddie Mac and Fannie Mae, the collapse of Bear Stearns and Merrill Lynch and the government takeover of AIG. What are your thoughts of the American banking industry?

Unfortunately, there is a long lag in getting all the data reported for the 141 countries we cover, so the ratings in the most recent report reflect the year 2006. Thus, the recent troubles are not reflected yet.

I do worry that this crisis is going to be used by some to justify more regulations on housing and financial markets. I tend to see the current policies and regulations as being a big part of the problem. Various subsidies for home ownership like tax deductible mortgage interest and FHA loans along with government programs like the Community Reinvestment Act contributed to putting people into homes with too high loan to equity ratios. Deposit insurance and the belief, apparently correct, that the government will insulate everyone, from individual homeowners to large financial institutions, from losses has fueled even greater risk taking. I fear we haven’t seen the end of this and these bailouts are only going to encourage more risk taking in the future.

Does the American trade deficit harm its economic freedom?

No. Not at all. I don’t think the trade deficit matters at all for economic freedom. If people living in America want to purchase more goods and services from people living in other countries, then they should be free to do so. The flip side of the equation is that if people living in other countries want to invest in U.S. assets instead of buying U.S.-made goods and services then they should be free to do so.

I also see no reason to worry in the slightest about the trade deficit in terms of economics. It really is just an accounting identity that has no meaning economically.

What can people who want more economic freedom do?

Move to Hong Kong! Seriously, I don’t know. Ultimately people get the economic system they vote for. The problem is that neither political party is all that committed to allowing more economic freedom.

Of Barack Obama and John McCain, who is likely to do more to boost freedom?

I really don’t know. I think the question should be “who is likely to do the least damage to economic freedom.” Both appear to want higher taxes and regulations though perhaps in different ways. I suppose that on paper, John McCain is more friendly to economic freedom; he is certainly more favorable toward free trade. But that’s just on paper. Bill Clinton was certainly no great advocate for economic freedom, but during his tenure, we got freer trade, smaller government spending as a share of GDP, and welfare reform. G.W. Bush talked a lot about economic freedom, but it has been falling under his watch.

What should Congress do to improve freedom? What about the states?

Congress could reduce spending and taxes including tariffs. It could cut quotas for products like sugar and subsidies for products like corn. Serious reform needs to be done to rein in entitlement spending under Social Security, Medicare, and Medicaid. These programs are great threats to our freedom in the future. None of this is going to happen, but that’s what they could do. The states, which account for about 1/3 of all taxes, have a big role to play. The regulation of many business and occupations is largely still handled by the states. One of our components measures occupational licensing, which is pretty much exclusively a state issue. From an economic freedom point of view, no one should be required to get the government’s permission to enter any occupation.

What else should I know about the report?

I would only add that nothing in the report necessarily says we should have more economic freedom. The report only creates a measurement of economic freedom. Whether we should have more or less is a secondary, though important, issue. However, having this report will hopefully inform us all about how societies that allow more economic freedom perform compared with those that restrict economic freedom.

The research that has been done is pretty convincing to me in showing that more economic freedom results in higher national incomes and growth rates, and is associated with many desirable social outcomes including more equality, longer life expectancy, better environmental quality, etc. If this is true, then maybe the report offers some support for creating more economic freedom, but this is not really what the report is about.

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