Economic Freedom is good for the State, too

Ron Knecht

(Ron Knecht & Geoffrey Lawrence) – The freedom of individuals to take a job, quit a job, start a business, or close a business at will is an essential part of America.  When Thomas Jefferson wrote that we have a God-given right to “the pursuit of happiness,” this is a big part of what he meant.  Unlike the European legacy of being chained to the family occupation, Americans are free to decide how and what work we do for a living, plus when and where.

With the widest array of economic and occupational freedom in the world history, Americans quickly showed how industrious individuals become when their creativity is allowed to run wild.  Within a relatively short time, the U.S. became the world’s wealthiest nation.

In recent decades, however, the rapid accumulation of red tape and taxes on businesses and individuals has eroded the dynamism of our economy and led to a major long-term slow-down in economic growth and opportunity.  Government officials invent meritorious sounding reasons we should heavily regulate people’s ability to offer interior design services or even African hair braiding.  Today, laws exist that prohibit an unskilled worker from taking a job if the agreed-upon wage falls below an arbitrary and legislatively determined threshold — even if no other job is available to that person.

In some states, more than half the fruits of a person’s labor can be taken via income-based taxes before that person gets paid.

The largest consumer in the world is not Warren Buffett, Walmart or any private entity, but the U.S. federal government.

These are conditions Jefferson certainly never envisioned when he declared our natural right to the pursuit of happiness.

It turns out, however, that even governments benefit from the economic freedom of their people, despite all the excuses they can invent for taking it away.  This probably comes as little surprise to the most educated Americans, because a rising tide lifts all boats and economic growth means more revenues for government, too.

A series of recent academic papers, though, have looked explicitly at the impact of economic freedom on key government financial health indicators like state bond ratings.  These are important signals because they reflect the confidence that investors have in the growth prospects of individual states.  To a large extent, the broad policies adopted in each state provide the framework upon which to judge these growth prospects.

As one paper in the latest edition of a major economics journal puts it, “Government inhibits the economic freedom of individuals under its oversight by erecting barriers to efficient exchange between individuals, by confiscating property through taxation, and by increasing its presence in the market as a major buyer of goods and services.  Economic freedom is enhanced when governments protect property rights and enforce the rule of law.”

That study ran a series of statistical analyses and found: “The economic effect of freedom is…as important [to bond ratings] as increases in other commonly used economic control variables, such as income per capita and decreases in unemployment. This suggests that state policymakers who indicate a willingness to reduce the government’s share of economic activity, reduce the tax burden, and allow for freer labor markets are more likely to see their state’s bond rating rise and financing burdens fall.”

In fact, the analysis shows that each of those three subcomponents of economic freedom is individually as important to bond ratings as a state’s unemployment rate.  Thus, when a state enjoys economic freedom, investors are confident in its ability to pay its bills over the long term, even if it confronts short-term challenges.  Importantly, higher bond ratings mean low-interest rates for state and local governments.

These studies are consistent with many others.  A recent study of the effect of public-sector collective bargaining laws found that states that impose a compulsory requirement on cities and counties to negotiate toward union contracts also experience lower bond ratings and higher financing costs.  Investors simply have more confidence in states where the rule is laissez-faire.

Of course, Jefferson knew all this long before there were ever economics journals.  He didn’t need complicated econometric analyses to plainly see that economic freedom benefits human beings.  We suspect that’s true for many of our readers, too.

Ron Knecht is Nevada State Controller.