Economic Freedom by the Numbers

Description

What’s the evidence that economic freedom is beneficial for society? Prof. Antony Davies shows charts of the free market’s effects on unemployment, inequality, poverty, and even child labor.

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ANTONY DAVIES: Economists are interested in how people behave when their unlimited desires collide with their limited abilities. We focus a lot on how people go about making decisions and what those decisions are. Here, you could imagine, not just amongst economists but amongst people at large, two schools of thought. One school of thought says that decision-making should be more centralized, that is, the government should be making decisions and imposing those decisions on people. The argument that people often make is that, look, if you leave them to themselves, people will consolidate power, they’ll stifle competition, they’ll exploit each other, and because of that, when decisions need to be made, they should be made centrally by a government that makes the decision for everyone.
Then there’s another group of people who say, “No. Decisions should be made individually, because if you leave people alone, they will disseminate power, they’ll promote competition, they’ll create and disseminate wealth.” This school of thought says that decision-making should be left at the individual level. People should be free to make whatever decisions they want for themselves, and the role of government should be restricted to preventing people from harming each other but otherwise leaving them alone.
What’s interesting is that as we think about these two schools of thought, should decision-making be more centralized or should decision-making be left to individuals, we can look at different societies that have employed different types of decision-making and ask what’s happened. Now we’ll be using here what’s called the Economic Freedom Index. This comes from the Fraser Institute, and the Fraser Institute looks at all sorts of things such as how much government spending is there in a society; how much transfer is going on, that is, the government taking money from one group of people and giving it to another; how much regulation is there; how much rule of law is there; are people protected from other people coming and harming them?
The more a society falls into the individual decision-making category, the higher it ranks on the Economic Freedom Index. The more it falls into the centralized decision-making category, the lower it scores on economic freedom. Basically, economic freedom boils down to two things, one, individuals making decisions for themselves and two, the government taking the role of protecting people from others imposing harm on them.
Let’s look at the United States. We’ll take the 50 states and divide them into two groups. In each year, we’ll have the 25 U.S. states in which decision-making was done in a more centralized manner compared to the other states and the 25 states in which decision-making was done in a more individual manner compared to the other states. All the years available, 1984 through 2014, in every one of these years, each of these states appears in every single year in this more centralized decision-making category. These states, in every year, 1984 through 2014, appear in the group of states in which decisions are made in a more individual basis.
Now that’s about half of the states. The other half of the states are here, and they go back and forth. California, for example, moves back and forth eight times between these two groups over these range of years. In each year, we’ve got 25 states in the more centralized decision-making category, we have 25 states in more individual decision-making category, and we understand as the years go by, these states move back and forth.
Let’s start by looking at outcomes. Let’s talk about people’s income. We’ll look at median household income here, and what I’m showing you are a bunch of years. We’ll start with 1984. This is median household income adjusted for inflation. The blue bar shows you the median household income amongst those 25 states in which decision-making is done in a more centralized manner, and in 1984, those states exhibited a median household income of $56,600. In that same year, 1984, the states in which decision-making was done in a more individual fashion, those states exhibited a median household income of slightly more, 56,900. This is 1984.
In 1985, median household incomes fell, adjusted for inflation, but you can see the same pattern. The median household income amongst the 25 states in which decision-making was done more centrally is 54,900. The median household income amongst states in which decision-making was done in a more individual basis is slightly higher at 55,100. That’s 1984 and 1985.
Now in 1986, the pattern reverses. In the states that make decisions in a more centralized manner exhibit higher median household incomes. The states that make decisions in a more individual manner exhibit lower household income. In 1987, the pattern reverses again, and now the states that make decisions in a more individual manner have higher household incomes. We can continue this comparison for all the years, and when we do, we find the following. Of all of these years, 75% of the time, the states that allow people to make more decisions for themselves exhibited higher household income than the states in which the governments made more decisions for people.
Now there’s a good counterargument to this, and the counterargument is this. Well, you’re looking at median household income, but that can mask the effects of unemployment. For example, suppose we have two societies. In this society, I’ve got 10 workers, each earning $50,000. In this society, I’ve got nine workers earning nothing, and one worker earning half a million dollars. In both societies, the average income is $50,000, and yet, there’s a marked difference in unemployment. The unemployment in this first society is zero. The unemployment in the second society is 90%.
Maybe it’s the case that this household-income data that we’re looking at is masking something. Let’s look at unemployment, same kind of comparison. This is 1981. The data go back a little further here. You can see the states that made more decisions for people, in a more centralized manner, had almost the same, slightly higher unemployment than the states that allowed people to make more decisions for themselves.
In 1982, states that exhibited more centralized decision-making had significantly higher unemployment than the states that allowed more individual decision-making. We can continue this for all of the years, and what you will find is that in every single year, with the exception of those five, states that allowed people to make more decisions for themselves exhibited lower unemployment rates than did the states that made decisions for others. In fact, if you take the difference in these unemployment rates and convert them into human beings, you find the difference is about 600,000 jobs. Said another way, if over this period, the more centralized decision-making states exhibited the same unemployment rate as the more individual decision-making states, we would have seen 600,000 more jobs throughout the country.
There’s a good counter-argument which says that unemployment data ignore the chronically jobless. Let me show you how this works. Let’s suppose we have a labor force of five million people, and of these five million people, 4.7 are employed and 300,000 are unemployed. When we calculate the unemployment rate, we take the number of unemployed people, 300,000, and we divide it by the labor force of five million, so here we have a 6% unemployment rate.
Now, suppose that a hundred thousand of these people had been unemployed for so long they had become what we call discouraged. That is, they would like to have jobs, but they’ve gone for such a long period of time of being rejected repeatedly that they just give up looking. They give up looking not because they don’t want jobs but because they think there’s just no point in looking for a job.
When workers become discouraged, they move out of the unemployment category and they become what we call non-employed. These hundred thousand workers, when they give up looking for jobs, we no longer count them as unemployed. In fact, we no longer count them as part of the labor force at all. They’re a third category, non-employed workers.
Now we can go back and recalculate the unemployment rate, and the unemployment rate, of course, is the number of unemployed divided by the labor force, and look at what’s happened. Our unemployment rate has dropped to 4.1%. Now go back and compare these two scenarios. Here, 100,000 of my workers have become discouraged and left the labor force. My unemployment rate because of that drops from 6% to 4.1%, but look at the two scenarios.
In the two scenarios, there are the same number of people working, 4.7 million, 4.7 million. In other words, as workers become discouraged, we stop counting them as unemployed, and the unemployment rate appears to fall, even though it’s possible that the same number of people are employed as were employed before. Really, what we want to do here is get our heads around perhaps poverty instead of unemployment, because what really matters isn’t whether you have a job. It’s whether you can eat.
Let’s look at the poverty numbers and again compare states in which decision-making is more centralized to states in which decision-making is done in a more individual basis. What you see for all the years available, 1981 through 2014, in every single year, with the exception of these three, the poverty rate in the states that allowed people to make more decisions for themselves was lower than in the states in which government made more decisions for the people. If you convert the difference in poverty rates to human beings, the difference is three million people. In other words, if over this period the centralized decision-making states had the same low poverty rate that the individual decision-making states had, there would have been three million fewer Americans living in poverty.
A good counterargument to this is that poverty rates can mask the effects of inequality. Let’s talk about inequality for a moment. Now economists measure this with something called the Gini coefficient. The Gini coefficient ranges from zero to one, where zero is perfect equality, everyone is the same, and one is perfect inequality, one person has all the income and everybody else has nothing. There’s less data available for inequality among the states, but I’ll show you everything that’s readily available. As you look at this picture, down means more equality. Up means more inequality. Down is good. Up is bad.
Again, let’s compare the centralized decision-making states to the individual decision-making states. If you do that, you find an interesting pattern. In every single year, inequality amongst the states that allow people to make more decisions for themselves is actually lower than it is amongst the states in which the government makes more decisions for them.
We’ve seen income, we’ve seen unemployment, we’ve seen poverty, we’ve seen inequality. In every instance, the states in which people are free to make more decisions for themselves show better outcomes. Maybe it’s the case that there’s something weird about Americans. Americans enjoy being entrepreneurial. We generally don’t like people telling us what to do. Maybe there’s some other reason particular to Americans that causes freedom to work better here than it might elsewhere.
A good way to address this is to perform the same comparison we just performed amongst the states amongst the various countries of the world. Here, we’ll look at roughly 130 reporting countries, and let’s start by looking at poverty rates. If we take all the countries of the world and divide them into two groups, those in which decision-making is done in a more centralized manner and those in which decision-making is done in a more individual manner, what we find is that the poverty rate amongst these countries that allow more individual decision-making is significantly less. The same phenomenon we observed with the states.
Now you might argue, yes, but what we’re getting here is what’s called the rich-country effect. The rich-country effect says, well, look, rich countries of course have less poverty. They’re rich. Also, if you’re a rich country, you have the leisure to be concerned with things like individual decision-making, economic freedom. You’re not worried about where your next meal is coming from. Maybe what we’re seeing here is simply a fact that rich countries coincidentally tend to enjoy more individual decision-making.
The way to answer that is to look at the poorest countries. I’m going to show you now the poorest 20% of countries in the world. I’m going to take the poorest 20% of countries and divide them into two groups, the poor countries in which decision-making is done in a more centralized manner and the poor countries in which decision-making is done in a more individual manner. What you observe is, again, the same phenomenon. Now the poverty rates are astronomical. They’re above 30% in both cases, and yet, despite that, the poor countries in which decision-making is done in a more individual basis enjoy a lower poverty rate than the countries in which decision-making is done in a more centralized manner.
What about inequality? Same thing that we saw amongst the states, less pronounced perhaps, but the same direction. Countries in which the government makes more decisions for people tend to exhibit more inequality than do countries in which decision-making is more individual. It’s not just income inequality. It’s also gender inequality. This is measured by the United Nations, and it asks questions like to what extent are women’s quality of life, educational opportunities, health care different than those of men within each country.
What we find is amongst countries in which individuals are allowed to make more decisions for themselves, gender inequality is actually lower. Child labor rates exhibit the same pattern. In countries in which the government makes more decisions for the people, these are principally poor countries, but the child labor rates you see are markedly higher.
What’s the conclusions? We look at all this. We’ve looked across countries, across states, across time and we see repeatedly societies with more economic freedom enjoy less unemployment, higher incomes, less poverty, less income inequality, less gender inequality, and lower child labor rates. All of that seems to go with more economic freedom, more individual decision-making, but people are selfish, and if you leave them alone, they’re going to act in a selfish manner.
That’s what individual decision-making is going to give us, and that’s true. More freedom means a greater ability to exploit people. It means a greater ability to harm others. It means a greater ability to despoil the environment. All of this comes with the ability to act more freely, but also with the ability to act more freely, people have a greater ability to cooperate. They have a greater ability to help each other and they have a greater ability to protect the environment. This also comes with more economic freedom. This suggests, then, the appropriate role of government in society is to prevent people from harming each other, but otherwise leave them alone.