Big government is good for economic freedom

by John Quiggin on July 24, 2004

Over at Marginal Revolution, Alex Tabarrok recently presented a graph showing a positive correlation between UN measures of gender development and the Fraser Institute’s Economic Freedom Index. Of course, Alex presented the usual caveats about causation and correlation, but he concluded “at a minimum the graph indicates that capitalism and gender development are compatible contrary to many radicals”

This prompted me to check out how the Economic Freedom index was calculated. The relevant data is all in a spreadsheet, and shows that the index is computed from about 20 components, all rated as scores out of 10, the first of which is general government consumption spending as a percentage of total consumption. Since the Fraser Institute assumes that government consumption is bad for economic freedom, the score out of 10 is negatively correlated with the raw data.

Looking back at Alex’s post, I thought it likely that high levels of government expenditure would be positively rather than negatively correlated with gender development, which raised the obvious question of the correlation between government consumption expenditure and economic freedom (as defined by the Fraser Institute index). Computing correlations, I found that, although it enters the index negatively, government consumption expenditure has a strong positive correlation (0.42) with economic freedom as estimated by the Fraser Institute. Conversely, the GCE component of the index is negatively correlated (0.43) with the index as a whole. By contrast, items like the absence of labour market controls were weakly correlated with the aggregate index.

It immediately struck me that this could be the basis of some snarky pointscoring. But on reflection, I thought that it would be more useful to look seriously at the issues raised by this result.

First, it’s necessary to explain the results. A large slab of the index consists of things like the absence of military interference in the rule of law. There’s also an entire section of the index devoted to sound money (low and stable inflation). These are both features characteristically provided by strong democratic governments, and not by weak ones, regardless of whether they are interventionist or laissez-faire. It seems pretty clear that a principal components analysis would show a dominant component associated with the characteristics of developed mixed economies, characteristics that include high levels of public expenditure, combined with relatively light-handed forms of government intervention in the private sector, compared to those characteristic of weak governments in less developed countries.

This is scarcely surprising. State capacity tends to rise with income, so in wealthy countries the state can achieve more, with less obtrusive use of power, than in poor countries. It is strong and not weak states that produce economic freedom.

The same principles that lead to support for separation of powers within the state with clearly defined roles for the judiciary, legislature and executive (including the military!), also yield support for a mixed economy against the alternatives of comprehensive central planning and unfettered corporate power. The mixed economy produces more economic freedom for the average person than does the minimal state. Despite its own presumption to the contrary, the Fraser Institute’s analysis supports this conclusion.

{ 15 comments }

1

dsquared 07.24.04 at 12:15 pm

My third ever CT post addressed similar questions wih respect to a different “Index of Economic Freedom” and came up with similar conclusions.

2

slolernr 07.24.04 at 4:16 pm

See also Peter Lindert, Growing Public, Cambridge UP. Like you and the FI (inadvertently) he finds that assumptions about the cost/drag of guvmint are ill-founded, because they’re based on bad assumptions about the structure and effects of welfare policies.

3

eudoxis 07.24.04 at 4:57 pm

Note that “big government” in the Fraser Institute report consists of 3 components: 1) general government consumption spending, 2) transfers and subsidies, and 3) enterprises and investment. The Quiggin “big government” includes only the first. What happens if you take the inverse of all three? Also, high taxes seem related.

4

Mike Huben 07.24.04 at 6:36 pm

6 years ago, I debated IEF’s at a pre-blog site called Suite 101 with Bryan Johnson (an author of the Heritage Foundation/WSJ IEF.)

I slapped together a web page of resources and criticisms at:
http://world.std.com/~mhuben/ief.html
It was never really meant to be public, but had some good criticisms.

One thing to remember about the several IEFs that various conservative and libertarian thinktanks have created is that for a brief period siz years ago they WERE touted as guidebooks for economic development: to the point that a fair amount of legislation based on them was introduced into the US Congress. Fortunately, that went nowhere. At the time I said they were (like the Laffer Curve) propaganda and not science. I’m a layman, but I backed that up with a simple survey of 6 recent economic development textbooks, none of which referenced IEFs.

5

Dave 07.24.04 at 7:04 pm

Let me propose a different interpretation – one I don’t necessarily agree with, but which may be valid:

Size of government may be correlated with other indicators, such as a stable currency, but it is in countries which manage to maximize those other indicators while minimizing the size of government where there is the most “economic freedom”.

This could be similar to inflation vs. unemployment – it is possible to have high inflation and low unemployment or low inflation and high unemployment, but it is even better if both are low.

6

Bob McGrew 07.24.04 at 8:25 pm

The mixed economy produces more economic freedom for the average person than does the minimal state.

If I understand correctly, this isn’t what your argument says. The argument says (correctly) that economic freedom tends to be correlated strongly with government expenditure, because both are correlated with being a developed nation.

But it’s unclear where the comparison to unfettered capitalism comes from, since undeveloped nations are hardly bastions of unfettered capitalism either. In fact, one major problem of weak states is that they can’t offer the rights-protecting guarantees of the minimal state (or, alternatively, that they are captured by elites who use them to perpetuate their dominance.)

7

Tom DC/VA 07.25.04 at 12:57 am

Ah, good, another stick to beat the market fundamentalists with.

Really, though, that strong states produce the greatest economic freedom should be accepted wisdom by now. Clearly, complete state planning (Soviet Union) does not work well. Just as clearly, complete chaos (Congo, Afghanistan) works far less well. Somewhere in between (USA, Singapore, Hong Kong, and even France) works quite well by any current or historical standard. That leaves (or should leave) the debate confined to the question of how much regulation, both for an economy as a whole and for specific markets.

But all this has been clear for a while. Why are all the debates still so absolutist?

8

Roger Hurwitz 07.25.04 at 2:15 am

here’s some anecdotal data that relates gender, economic freedom, big government and conservative attitudes:
according to census data, in the 1950’s, over 100,000 women of color in the Washington DC area were employed as domestic help. By 1980, following three decades of expansion of the US federal government, this figure had shrunk to near zero. Presumably most women of color who might otherwise be domestic were now had government jobs. I don’t believe that white southern
Congressmen and their staffs have ever forgiven the Democrats for making good help so hard to find.

9

John Quiggin 07.25.04 at 2:47 am

DD, looking back at your post, I think we may be dealing with the same index and, as you say, drawing much the same conclusions. The CT hivemind (© SDB) strikes again!

10

John Humphreys 07.25.04 at 3:31 am

Freedom leads to prosperity, prosperity leads to democracy, democracy leads to larger government…

There is an outstanding and worthwhile question that follows – what does big government lead to? Schumpeter (who was writing about such things even before Quiggin) suggested that the end result would be socialism and stagnation.

Some say we’ve reached about the right level (social democrats like most CTers I imagine), some say we’ve gone to far (that would be the liberal democrats like me) and some say we haven’t gone far enough (bob brown et al). That’s all fine as a contemporary political debate. But there is another fun question – is there any inevitable (or at least likely) historical trend?

Basically – will social democracy fail? If so – why? And what will replace it?

11

Anon Again 07.25.04 at 5:19 am

But is big government good for academic freedom?

quoting:

Going Broke by Degree: Why College Costs Too Much

Richard Vedder, AEI Press

June 2004
Economist Richard Vedder wrote, and the American Enterprise Institute Press has just published, this fine book-length analysis of college costs, the reasons they have risen so much, and what can be done about it. In a nutshell, he finds U.S. colleges and universities deeply inefficient and unproductive places that pass along most of these weaknesses to their clients (and taxpayers) via rising tuitions and appropriations. He suggests a number of possible remedies, every one of which will outrage the mandarins of American higher education but almost all of which deserve respectful attention from state and federal policy makers. He examines both tuition-related issues and the (mixed and not entirely persuasive) case for public subsidies. “A good case can be made,” Vedder writes, “that governments should largely get out of the higher education business, ending state subsidies and tax advantages for private donations. Moreover, the evidence is strong that massive governmental infusions of funds, along with tax-sheltered private contributions, have contributed to the cost explosion in higher education.” Though higher ed is not Gadfly’s usual beat, this is an important book that should have been written a decade ago and that Congress ought take very seriously when, next year, it starts afresh to renew the Higher Education Act. It weighs in at 260 pages, the list price is $25, the ISBN is 0844741973, and you can obtain additional information by clicking here.

12

John Quiggin 07.25.04 at 5:24 am

Critics of publicly-financed higher education in Australia and the UK make almost exactly the opposite claim, namely that public financing is responsible for the chronic underfunding of the system.

13

Anthony 07.25.04 at 8:09 am

John Quiggin – the American experience and the British/Australian experience are not necessarily contradictory. In all three countries, public funding has prevented any sort of change which might increase economic efficiency, and has sometimes allowed increased inefficiency. In the US, which does not have a national health system, education is the most sacred of budgetary sacred cows, and this universities are lavishly funded – more than enough to cover for their inefficent performance. In Britain and Australia, when the budget crunch comes, as it inevitably does, National Health has priority over universities, and so the universities are in reduced circumstances. However, the universities receive enough funding, with enough strings attached, that it’s nearly impossible for them to make the sorts of radical changes which would allow them to use their meager allotments more efficiently, without risking being driven into penury. Here in California, we may be reaching this point, with k-12 education replacing National Health as the more sacred cow.

14

Peter Levine 07.26.04 at 3:03 pm

Here’s a possible (partial) explanation of why active government might correlate positively with economic freedom. The more a government taxes and regulates the economy, the stronger civil society becomes. (“Civil society” means the array of nonprofit, non-governmental associations.) In turn, civil society is a bulwark of freedom, because associations prevent abuses of state power and teach people to be skilled and active citizens.

My information is out of date, but in 1990-91, in a sample of 23 developed and democratic countries, there were strong positive correlations between the average number of associations people belonged to (according to the World Values Survey) and (a) the government’s share of GDP; (b) the Heritage Foundation’s index of taxation; and (c) the Heritage Foundation’s index of government intervention. Robert Putnam also found positive correlations between the size of countries’ governments and (a) trust and (b) group membership: see Bowling Alone (the book), p. 281. And Henry Milner has found a powerful positive relationship between the size of government and adults’ political skills and knowledge.

Putnam argues that the very large differences in associational membership and trust among U.S. states cannot be explained by the size of state governments. That’s because the level of taxation vanishes in regression models constructed to explain social capital. However, it’s unmistakable that states like Minnesota, with a tradition of strong and good government, have three times as much “social capital” as states like Mississippi and Louisiana, where government is smaller, poorer, but often more oppressive.

15

Decnavda 07.27.04 at 7:31 pm

I have commented before on the empirical problem this poses for (right-)libertarians. Libertarianism is dedicated to three main pillars:
1. Increasing social freedoms.
2. Increasing ecconomic freedoms.
3. Reducing government spending.
In the past 30 years, social freedoms have increased, eccomonic freedoms have increased, and government spending has increased. This tends to lead libertarians to either be optimists, by focusing on 1 and 2, or pessimists by focusing on 3. What it should lead to is a reevaluation of the premise that increased government spending is incompatible with social and ecconomic freedoms.

Comments on this entry are closed.