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Posts Tagged ‘Economic Freedom’

I’m in Vancouver, Canada, for the biennial meeting of the World Taxpayers Associations.

I gave a speech on why tax competition is a valuable force to constrain the greed of the political class, but warned the audience that high-tax governments and international bureaucracies are using financial protectionism to coerce low-tax jurisdictions into weakening their good policies.

But regular readers know that I pontificate far too often on that topic, so today’s column is instead about a presentation by Michael Walker, who was the founding Executive Director at Canada’s Fraser Institute.

Michael’s great contribution to the world was the creation of the Economic Freedom of the World Index, which he developed working with scholars such as Milton Friedman.

I’ve cited the EFW Index many times, particularly to bemoan how America’s score has deteriorated during the Bush-Obama years.

Today, though, we’re going to look at global trends in economic freedom, using some of the slides from Michael’s presentation. And the good news, as you can see from the green line in this first chart, is that there was a significant increase in economic freedom between 1980 and 2010.

EFW Economic Freedom(1)

The blue line, by the way, shows how much nations differed. A higher blue line means more variation (in other words, some nations with very good scores and some with very bad scores), while a lower blue lines means that nations are converging.

To really understand what’s happening, however, it’s important to look at the component parts of the EFW Index. As I wrote back in 2012:

…a country’s economic performance is governed by a wide range of policies.

Indeed, the research suggests that there are five big factors that determine prosperity, and they’re all equally important.

Rule of law and property rights

Sound money

Fiscal policy

Trade policy

Regulatory policy

So let’s look at what’s been happening in each of these areas. Keep in mind, as we look at the following charts, that 10 is the best score.

We’ll start with fiscal policy. As you can see, policy was moving in the wrong direction from 1970 to 1985, then we got two decades of pro-growth changes, but now policy is again trending in the wrong direction.

EFW Size of Government

We’re still better off than we were 30 years ago, but I’m afraid scores will continue to decline because tax rates are now heading in the wrong direction and the burden of government spending is rising in many nations.

Now let’s look at the regulatory data. The trend may not be dramatic, but it is positive. The green line is gradually rising, showing that governments are easing red tape and reducing intervention.

EFW Regulation

Moreover, there’s no sign that policy is moving in the wrong direction, at least on a global basis.

Shifting to trade, we have perhaps the biggest success story in global economic policy. Between 1980 and 200, there was a dramatic increase in the freedom to trade.

EFW Free Trade

We also see some progress on monetary policy, both in that it stopped moving in the wrong direction in 1975 and then moved in the right direction beginning in 1995.

EFW Sound Money

Though I confess some skepticism about this measure. Central banks have created a lot of problems with excess liquidity, but they generally escape blame so long as easy-money policies don’t result in higher consumer prices.

This brings us to our final category. Property rights and the rule of law are very important for market economies, but unfortunately we’ve seen no long-run improvement in these key measures. Positive change between 1975 and 1995 is offset by movement in the wrong direction at other times.

EFW Rule of Law

Indeed, if we look at this next chart, which measures the distribution of scores for each category in 2010, you’ll see that nations get their lowest scores on rule of law and property rights.

EFW Five Factors

This aggregate data, while very useful, does not tell the entire story. If you look at various regions, you’ll discover that “first world” nations tend to get decent scores on rule of law and property rights while developing nations get poor scores.

Indeed, this is why the blue line in the rule of law/property rights chart is so much higher than it is for other categories. Simply stated, this is one area where there hasn’t been much convergence.

Which is a big reason why many developing nations are economic laggards, even if they get reasonably good scores in other categories.

Here’s a final chart that emphasizes that point. It shows nations that get the best scores on the size of government (left column), but then shows that many of them get very poor scores for rule of law and property rights (right column).

The fiscal burden of government is very low in nations such as Lebanon and Bangladesh, for instance, but these jurisdictions don’t attract a lot of investment or enjoy much growth because government fails to provide the right environment.

EFW Size of Government vs Rule of Law Challenge

All of which shows why Hong Kong, Singapore, and Switzerland deserve special praise. They have strong rule of law and property rights while simultaneously maintaining reasonable limits on the fiscal burden of the public sector. No wonder they are ranked first, second, and fourth in overall economic freedom.

And it’s worth noting that a few other nations deserve honorable mention for getting good fiscal policy scores while doing a decent job on the rule of law and property rights, specifically Bahamas (#39), Chile (#11), Mauritius (#6), and United Arab Emirates (#5).

By the way, the United States only got a 6.4 for size of government and a 7.1 for rule of law and property rights. No wonder America is only #17 in the overall rankings.

Back in 2000, when the United States ranked #3, we got a 7.0 for size of government and a 9.2 for rule of law and property rights.

So now you now know why I complain so much about Bush and Obama. And you especially know why I’m so concerned about the erosion of the rule of law under Obama.

P.S. A Spanish academic has developed some fascinating historical data on non-fiscal economic freedom, which is very helpful in understanding how the western world has managed to remain somewhat prosperous even though the fiscal burden of government increased dramatically in the 20th Century.

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In the pre-World War I era, the fiscal burden of government was very modest in North America and Western Europe.

Total government spending consumed only about 10 percent of economic output, historical-size-of-govtmost nations were free from the plague of the income tax, and the value-added tax hadn’t even been invented.

Today, by contrast, every major nation has an onerous income tax and the VAT is ubiquitous. These punitive tax systems exist largely because – on average –  the burden of government spending now consumes more than 40 percent of GDP.

To be blunt, fiscal policy has moved dramatically in the wrong direction over the past 100-plus years. And thanks to demographic change and poorly designed entitlement programs, things are going to get much worse according to BIS, OECD, and IMF projections.

Long-Run GDPWhile these numbers, both past and future, are a bit depressing, they also present a challenge to advocates of small government. If taxes and spending are bad for growth, why did the United States (and other nations in the Western world) enjoy considerable prosperity all through the 20th Century?

I sometimes get asked this question after speeches or panel discussions on fiscal policy. In some cases, the person making the inquiry is genuinely curious. In other cases, it’s a leftist asking a “gotcha” question.

I’ve generally had two responses.

1. The European fiscal crisis shows that the chickens have finally come home to roost. More specifically, the private economy can withstand a lot of bad policy, but there is a tipping point at which big government leads to massive societal damage.

2. Bad fiscal policy has been offset by good reforms in other areas. More specifically, I explain that there are five major policy factors that determine economic performance and I assert that bad developments in fiscal policy have been offset by improvements in trade policy, regulatory policy, monetary policy, and rule of law/property rights.

I think the first response is reasonably effective. It’s hard for statists to deny that big government has created a fiscal and economic nightmare in many European nations.

But I’ve never been satisfied with the second response because I haven’t had the necessary data to prove my assertion.

However, thanks to Professor Leandro Prados de la Escosura in Madrid, that’s no longer the case. He’s put together some fascinating data measuring economic freedom in North America and Western Europe from 1850-present. And since he doesn’t include fiscal policy, we can see the degree to which there have been improvements in other areas that might offset the rising burden of taxes and spending.

Here’s one of his charts, which shows the growth of economic freedom over time. For obvious reasons, he doesn’t include the periods surrounding World War I and World War II, but those gaps don’t make much of a difference. You can clearly see that non-fiscal economic freedom has improved significantly over the past 150-plus years.

Economic Freedom 1850-2007

Most of the improvement took place in two stages, before 1910 and after 1980.

It’s also worth noting that things got much worse during the 1930s, so it appears the developed world suffered from the same bad policies that Hoover and FDR were imposing in the United States.

Indeed, here’s another chart, which highlights various periods and shows which policies were moving in the right direction or wrong direction.

Economic Freedom Changes 1850-2007

As you can see, the West enjoyed the biggest improvements between 1850-1880 and after 1980 (let’s give thanks to Reagan and Thatcher).

There also were modest improvements in 1880-1910 and 1950-1960. But there was a big drop in freedom between the World War I and World War II, and you can also see policy stagnation in the 1960s and 1970s.

By the way, I wonder what we would see if we had data from 2007-2014. Based on the statist policies of Bush and Obama, as well as bad policy in other major nations such as France and Japan, it’s quite likely that the line would be heading in the wrong direction.

But I’m digressing. Let’s get back to the main topic.

The moral of the story is that we’ve been lucky. Bad fiscal policy has been offset by better policy in other areas. We’re suffering from bigger government, but at least we’ve moved in the direction of free markets.

That being said, we may now be in an era when bad fiscal policy augments bad policy in other areas.

For further information, this video explains the components of economic success.

P.S. I’ve written before that government bureaucrats don’t work as hard as folks employed in the economy’s productive sector.

Well, that’s becoming official policy in some parts of Sweden.

A section of employees of the municipality of Gothenburg will now work an hour less a day… The measure is being self-consciously conceived of as an experiment, with a group of municipal employees working fewer hours and a control group working regular hours – all on the same pay. …Mats Pilhem, the city’s Left-wing deputy mayor, told The Local Sweden that he hoped “staff members would take fewer sick days and feel better mentally and physically after working shorter days”.

Heck, if you want fewer sick days, just tell them they never have to show up for work. And I’m sure they’ll “feel better mentally and physically” with that schedule.

I’m also amused by this passage from the article.

Anna Coote, Head of Social Policy at the New Economics Foundation, a UK-based think tank, welcomed the proposals. “Shorter working hours create a more committed and stable workforce,” Ms Coote told The Telegraph.

Gee, what a surprise. If you overpay a group of people and tell them they can spend more time at home, they’ll be very anxious to keep those jobs.

Sounds like a great deal…unless you’re a taxpayer.

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One of the reasons why this blog is called International Liberty is that the world is a laboratory, with some nations (such as France) showing why statism is a mistake, other jurisdictions (such as Hong Kong) showing that freedom is a key to prosperity, and other countries (such as Sweden) having good and bad features.

It’s time to include Chile in the list of nations with generally good policies. That nation’s transition from statism and dictatorship to freedom and prosperity must rank as one of the most positive developments over the past 30 years.

Here’s some of what I wrote with Julia Morriss for the Daily Caller. Let’s start with the bad news.

Thirty years ago, Chile was a basket case. A socialist government in the 1970s had crippled the economy and destabilized society, leading to civil unrest and a military coup. Given the dismal situation, it’s no surprise that Chile’s economy was moribund and other Latin American countries, such as Mexico, Venezuela, and Argentina, had about twice as much per-capita economic output.

Realizing that change was necessary, the nation began to adopt pro-market reforms. Many people in the policy world are at least vaguely familiar with the system of personal retirement accounts that was introduced in the early 1980s, but we explain in the article that pension reform was just the beginning.

Let’s look at how Chile became the Latin Tiger. Pension reform is the best-known economic reform in Chile. Ever since the early 1980s, workers have been allowed to put 10 percent of their income into a personal retirement account. This system, implemented by José Piñera, has been remarkably successful, reducing the burden of taxes and spending and increasing saving and investment, while also producing a 50-100 percent increase in retirement benefits. Chile is now a nation of capitalists. But it takes a lot more than entitlement reform, however impressive, to turn a nation into an economic success story. What made Chile special was across-the-board economic liberalization.

We then show the data (on a scale of 1-10) from the Fraser Institute’s Economic Freedom of the World, which confirm significant pro-market reforms in just about all facets of economic policy over the past three decades.

But have these reforms made a difference for the Chilean people? The answer seems to be a firm yes.

This has meant good things for all segments of the population. The number of people below the poverty line dropped from 40 percent to 20 percent between 1985 and 1997 and then to 15.1 percent in 2009. Public debt is now under 10 percent of GDP and after 1983 GDP grew an average of 4.6 percent per year. But growth isn’t a random event. Chile has prospered because the burden of government has declined. Chile is now ranked number one for freedom in its region and number seven in the world, even ahead of the United States.

But I think the most important piece of evidence (building on the powerful comparison in this chart) is in the second table we included with the article.

Chile’s per-capita GDP has increased by about 130 percent, while other major Latin American nations have experienced much more modest growth (or, in the tragic case of Venezuela, almost no growth).

Perhaps not as impressive as the performance of Hong Kong and Singapore, but that’s to be expected since they regularly rank as the world’s two most pro-market jurisdictions.

But that’s not to take the limelight away from Chile. That nation’s reforms are impressive – particularly considering the grim developments of the 1970s. So our takeaway is rather obvious.

The lesson from Chile is that free markets and small government are a recipe for prosperity. The key for other developing nations is to figure out how to achieve these benefits without first suffering through a period of socialist tyranny and military dictatorship.

Heck, if other developing nations learn the right lessons from Chile, maybe we can even educate policy makers in America about the benefits of restraining Leviathan.

P.S. One thing that Julia and I forgot to include in the article is that Chile has reformed its education system with vouchers, similar to the good reforms in Sweden and the Netherlands.

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Johnny Munkhammar is a member of the Swedish Parliament and a committed supporter of economic liberalization. He has a column in the Wall Street Journal Europe that does a great job of explaining how Sweden became rich when it was a small-government, pro-market nation. He then notes that his country veered off track in the 1970s and 1980s, but is now heading back in the right direction. I’ll have more analysis below these excerpts, but it is especially impressive that Sweden is ahead of America on key reforms such as Social Security personal accounts and school choice.

Sweden is not socialist. According to the World Values Survey and other similar studies, Sweden combines one of the highest degrees of individualism in the world, solid trust in well-functioning institutions, and a high degree of social cohesion. Among the 160 countries studied in the Index of Economic Freedom, Sweden ranks 21st, and is one of the few countries that increased its economic freedoms during the financial crisis. …Sweden wasn’t always so free. But Sweden’s socialism lasted only for a couple of decades, roughly during the 1970s and 1980s. And as it happens, these decades mark the only break in the modern Swedish success story. …The Swedish tax burden was lower than the European average throughout these successful 60 years, and lower even than in the U.S. Only in 1950 did Sweden’s tax burden rise to 20% of GDP, though that remained comparatively low. …The 1970s were a decade of radical government intervention in society and in markets, during which Sweden doubled its overall tax burden, socialized a slew of industries, re-regulated its markets, expanded its public systems, and shuttered its borders. In 1970, Sweden had the world’s fourth-highest GDP per capita. By 1990, it had fallen 13 positions. In those 20 years, real wages in Sweden increased by only one percentage point. …By the late 1980s, though, Sweden had started de-regulating its markets once again, decreased its marginal tax rates, and opted for a sound-money, low-inflation policy. In the early 1990s, the pace quickened, and most markets except for labor and housing were liberalized. The state sold its shares in a number of companies, granted independence to its central bank, and introduced school vouchers that improved choice and competition in education. Stockholm slashed public pensions and introduced private retirement schemes, keeping the system demographically sustainable. These decisive economic liberalizations, and not socialism, are what laid the foundations for Sweden’s success over the last 15 years. …Today, the state’s total tax take comes to 45% of GDP, from 56% ten years ago. Meanwhile, unemployment benefits, sick leave and early retirement plans have all been streamlined to encourage work. The number of people receiving such welfare—which soared during the socialist decades—has fallen by 150,000 since 2006, a main reason for Sweden’s remarkably sound public finances.

Sweden still has a public sector that is far too big, but the damage caused by bloated government is at least partially offset by very good policy in other areas. Sweden is actually slightly more free market than the United States on non-fiscal measures in the Economic Freedom of the World index. Here’s a chart comparing Sweden and the United States. But I also included a few other nations for purposes of comparison. You can see Switzerland, the U.S., Sweden, and the United Kingdom all have similar scores for economic freedom if the burden of taxation and government spending is removed from the mix. But things change dramatically when taxes and spending are added to the formula. Switzerland is ranked 4th overall because of a decent fiscal system, ahead of the United States (6th) and United Kingdom (10th). while Sweden falls all the way to 37th place.

Denmark gets very high marks for non-fiscal freedom, so it only drops to 14th in the overall rating because of its bloated welfare state. Hong Kong and Singapore, meanwhile, rank 1st and 2nd in the world because of strong ratings on non-fiscal factors and they also manage to limit the fiscal burden of government.

Last but not least, many of Johnny’s points are included in this Center for Freedom and Prosperity video.

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I touched a raw nerve with my post about Fidel Castro admitting that the Cuban model is a failure. Matthew Yglesias and Brad DeLong both attacked me. DeLong’s post was nothing more than a link to the Yglesias post with a snarky comment about “why can’t we have better think tanks?” Yglesias, to his credit, tried to explain his objections.

This leads Daniel Mitchell to post the following chart which he deems “a good illustration of the human cost of excessive government.”…this mostly illustrates the difficulty of having a rational conversation with Cato Institute employees about economic policy in the developed world. Cuba is poor, but it’s much richer than Somalia. Is Somalia’s poor performance an illustration of the human costs of inadequate taxation? Or maybe we can act like reasonable people and note that these illustrations of the cost of Communist dictatorship and anarchy have little bearing on the optimal location on the Korea-Sweden axis of mixed economies?

I’m actually not sure what argument Yglesias is making, but I think he assumed I was focusing only on fiscal policy when I commented about Cuba’s failure being “a good illustration of the human cost of excessive government.” At least I think this is what he means, because he then tries to use Somalia as an example of limited government, solely because the government there is so dysfunctional that it is unable to maintain a working tax system.

Regardless of what he’s really trying to say, my post was about the consequences of excessive government, not just the consequences of excessive government spending. I’m not a fan of high taxes and wasteful spending, to be sure, but fiscal policy is only one of many policies that influence economic performance. Indeed, according to both Economic Freedom of the World and Index of Economic Freedom, taxes and spending are only 20 percent of a nation’s grade. So nations such as Sweden and Denmark are ranked very high because the adverse impact of their fiscal policies is more than offset by their very laissez-faire policies in just about all other areas. Likewise, many nations in the developing world have modest fiscal burdens, but their overall scores are low because they get poor grades on variables such as monetary policy, regulation, trade, rule of law, and property rights.

So, yes, Cuba is an example of “the human cost of excessive government.” And so is Somalia.

Sweden and Denmark, meanwhile, are both good and bad examples. Optimists can cite them as great examples of the benefits of laissez-faire markets. Pessimists can cite them as unfortunate examples of bloated public sectors.

P.S. Castro has since tried to recant, claiming he was misquoted. He’s finding out, though, that it’s not easy putting toothpaste back in the tube.

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 Some of my posts spark debate between Bush supporters and Clinton fans, particularly on my Facebook page. I hate to burst anyone’s bubble, but Clinton wins that contest hands down. I’m only talking about economic issues, to be sure, so I’m not looking to trigger any discussions about foreign policy or abortion.

Regarding economic issues, perhaps the key thing to understand is that there are many factors which determine economic freedom (which, of course, is related to growth and prosperity). Some people look at a high-profile issue such as taxes, and are tempted to rank Bush higher because he cut taxes in 2001 and 2003, whereas Clinton increased taxes in 1993 (he also cut taxes in 1997, but not as much as he raised them four years earlier).

But while Bush had a better record on taxes, he had a much worse record on spending. And as I wrote in the Washington Examiner a couple of years ago, Bush’s record in other areas was more statist than Clinton’s (and I was writing before the bailouts).

Perhaps the best way of showing the difference between Bush and Clinton is to examine the Economic Freedom of the World annual rankings. Not all the years are available, but the image below clearly shows that economic freedom rose during the Clinton years and fell during the Bush years.

I’m no great fan of Bill Clinton, and I’ll be the first to admit that many of the good things that happened under Clinton were the result of a GOP Congress (in the good old days before they were corrupted by compassionate conservatism). But also keep in mind that Clinton signed into law almost all of the good policies that were enacted during his reign. Likewise, Bush signed into law almost all of the bad policies that were enacted during his reign. If I’m choosing between the economic policies that were implemented by the previous two Presidents, the answer is obvious.

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