"Economic Freedom?" Professor, Your Bias Is Showing

The September 16, 2015 guest editorial in the Courier-Journal was titled, “Economic freedom report shows U.S. lagging.” The column was written by Professor Stephan Gohmann, the director of the new John H. Schnatter Center for Free Enterprise at the University of Louisville. Knowing that the Schnatter Center also receives funding from the Koch family, I took the headline and the accompanying article with a healthy dose of skepticism. Read on to see why.

Besides heading up the Schnatter Center, Professor Gohmann is the BB&T Distinguished Professor of Free Enterprise at the University of Louisville. He may be best known for teaching a BB&T-sponsored course entitled the “Moral Foundations of Capitalism” in which books by Ayn Rand are prominently featured as a condition of the chair endowment.

In his C-J guest editorial, Professor Gohman lamented that in the latest “Economic Freedom Report” the U.S. had declined from a second-place ranking in 2000 to a #16 ranking in 2015 (out of 123 countries for which there was complete data). The editorial continued, “If this were the Olympics, Americans would be aghast. Economic freedom has a much larger effect on Americans than the bravado we get from bringing home lots of Olympic medals.” The editorial ended with a familiar stilted comparison to a socialist country. “The U.S. has a choice. Do we want more economic freedom and better lives, or less economic freedom and diminished lifestyles more like Venezuela? I think the answer is clear — greater economic freedom.”

I was intrigued to note that economic freedom was supposedly decreasing at the same time that economic inequality is increasing in the United States. As an academic, I know that it is often wise to track back to the original documents to tease out apparent paradoxes and ideological cant. I thus began an exploration of the “Economic Freedom of the World” report and its touted “Economic Freedom” index. The report was available online from Simon Fraser University and was accompanied by press releases as well as a spreadsheet of the data for the index going back through 1970.

The Economic Freedom index is composed of the following five components: 1) size of government and taxation, 2) property rights and the rule of law (e.g., low corruption), 3) sound money, 4) international trade and tariffs , and 5) level of regulation of business, labor and financial markets. The report also disclosed that University of Chicago economist and noted neo-liberal Milton Friedman had developed the index. Moreover, the report was said to be a collaborative effort by more than 60 economists and economic researchers from around the world.

I began by examining changes in each component of the “Economic Freedom Index” over time. Three of the components of the index had remained pretty stable since the year 2000: the size of government; regulation of business, labor, and financial markets; and sound money. If economic freedom is declining in the U.S., it is not because of these components.

It was these very components, however, that Professor Gohman highlighted as examples of declining economic freedom in the U.S. “When governments reduce economic freedom, everyday people lose out. For example, when the EPA issues rules that drive up the cost of coal, Kentucky coal miners lose their jobs. When the federal government increases taxes, Kentuckians have less money to spend on those things that make their lives better.” Of course, there are the little complications to Professor Gohmann’s thesis that EPA rules are not the main cause of coal’s decline, and that federal taxes have decreased for the vast majority of citizens since 2000.

I then looked at the components that did decline, and found that the declines were confined to the areas of Private Property/Rule of Law, and Trade Regulation and Tariffs. In looking at the trend of the private property/rule of law index the “decline” mostly coincided with the 2005 Supreme Court decision of Kelo versus New London. In that decision the court ruled that a city could expropriate land from one private property owner and transfer that land to another property owner for the purpose of promoting the overall economic development of a community. As both the political right and left deplored this decision, there is little controversy here.

The decline in trade regulations and tariffs seemed a bit more elusive. At this point I went back to the press release that was issued along with the report and found this summary sentence, “A weakened rule of law, the so-called wars on terrorism and drugs, and a confused regulatory environment have helped erode economic freedom in the United States.” As the “War on Terror” has involved multiple levels of disruption of trade, plus financial controls and intrusions on economic and personal privacy, this decline in “economic freedom” is not particularly controversial from a progressive point of view either.

Clearly Professor Gohmann had presented a rather skewed interpretation of the data. There was, however, a much bigger point to make — the index itself is ideologically skewed and internally contradictory. I returned to the first component of the index: the size of government. I already knew that the size of government would generally be negatively correlated with the economic well-being of a country, not positively correlated as Professor Gohmann was implying. I identified the countries with the largest and smallest public sectors on the size of government index. I then consulted the 2014 World Bank ranking of countries by per capita income and produced the following Table.

Table 1:

The only surprise in the chart is the magnitude of the differences. The size of the state and taxation is a general feature of prosperous nations and certainly not the reverse. From a simple methodological standpoint, the “Economic Freedom Index” is a very flawed metric. The size-of-government component is negatively correlated with the other 4 scales. In other words, the size-of-government part of the index artificially deflates the range of variability of the countries on the index.

One can see in this simple chart that a small governmental sector is a strong correlate of economic backwardness; it is definitely not positively correlated with economic development. Of the five indexes making up the overall economic freedom index, the United States scored lower on this index than the other 4 indexes. As you can see, however, we are mostly in good company. How could some of the brightest economic minds in the world create such an internally flawed index and seriously promote it? Well, never underestimate the power of wishful thinking driven by an ideological agenda:

• Joshua Hall (report co-author) heads up the Center for Free Enterprise at WVU, funded by the Koch Foundation.
• James Gwartney (report co-author) is head of the Stavros Center for the Advancement of Free Enterprise at Florida State, another school receiving a grant from the Koch Brothers to teach their version of economics.
• Robert Lawson (report co-author) is the director of the O’Neill Center for Markets and Freedom, and has lectured for the Koch Foundation and had his work funded by them.
• The Fraser Institute (source of the report) has also been funded by various Koch foundations and gifts.

The final point to be made is that most people in advanced democratic societies see very considerable advantage in managing some of their most important needs collectively via public expenditures (e.g., defense, health care, public safety, education, transportation, old age pensions). In most of these areas, the consensus in mature economies is that, in fact, public sector expenditures are more efficient for some purposes (e.g., administrative costs of social security compared to individual retirement accounts). Citizens generally want effective and accountable governmental services, not merely a smaller government. We are proud citizens of a democratic polity and not merely atomized consumers maximizing individual utility. We still want a government of the people, by the people, and for the people to address the general welfare as we see fit.

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* The outliers of Hong Kong and China deserve an additional bit of explanation. Hong Kong is a small state within China and does not carry a national defense burden hence we might expect its public sector to be smaller. China, on the other hand, still carries a substantial state enterprise sector as the legacy of Communism and its armed forces are large and widely involved in the economy.