ECONOMIC FREEDOM PAYS OFF; JUST LOOK AT CANADA

Saturday, March 6, 2004

Hooray! Finally there's one of those state rankings where Colorado comes top in the nation, and it's a desirable one, too. I mean by that both that it's an index of economic freedom, which is a good thing to have more of, and also that it has been constructed with great care to avoid the methodological traps so many such rankings rush into.

And not to be too parochial about it, the results hold important lessons for all state legislatures: Prosperity originates in freedom. Remember, the full title of Adam Smith's revolutionary book is An Inquiry into the Nature and Causes of the Wealth of Nations. It works for states and provinces too.

The practice of computing an index of economic freedom for nations is well established. The Fraser Institute, which has its main office in Vancouver, B.C., began a series of such reports about 20 years ago. More recently, it has joined up with the National Center for Policy Analysis, based in Dallas, for a similar report, "Economic Freedom in North America," covering the United States and Canada.

Considering only policies at the state and local levels, not federal government policies, Colorado is first among 50 states and 10 provinces, tied with Delaware, South Dakota and Tennessee.

Taking all levels of government into account, Colorado is second, behind Delaware. The difference is that the amount of money collected by the federal government in a state usually differs from the amount of money spent by the federal government in a state.

That transfer of funds is far more extensive in Canada, with the startling result that only Alberta earns a place in the respectable middle, while the other provinces occupy nine of the bottom 10 places, along with chronically depressed West Virginia. In wealth, Ontario -- "normally considered Canada's industrial heartland," is poorer than all of the states except West Virginia and Missisippi.

"Canada's fiscal federalism," the report explains, "transfers money from rich provinces to poor ones," and since economic freedom encourages economic growth, it "in effect transfers money from relatively free provinces to relatively unfree provinces." That in turn creates perverse incentives for politicians, since if they limit economic growth they get more money from the government in Ottawa and they control that money.

Stronger private economic growth, on the other hand, benefits other people and reduces politicians' power and influence.

Fewer measures of economic freedom are available to test the differences between states than between nations, but the ones selected are plausible, and perhaps more important, the way they are implemented has been refined over the years during which the national rankings have been compiled.

The measures fall into three areas, each of which carries equal weight in the rankings, and within each area each measure is weighted equally. One could argue that the weightings should be different, but only on subjective grounds, and anyway, the data have been tested for a variety of different weightings, and the outcomes change very little.

The areas are:

* "Size of government," which includes general consumption expenditures by government as a percentage of gross domestic product, and transfers and subsidies as a percentage of GDP;

* "Takings and discriminatory taxation," which includes total governments' revenue from their own sources as a percentage of GDP; top marginal income tax rate and the income threshold at which it applies; indirect tax revenue as a percentage of GDP and sales taxes collected as a percentage of GDP;

* "Labor market freedom," which includes minimum wage legislation; government employment as a percentage of total state or provincial employment; occupational licensing, and union density.

Does it matter? Yes, indeed. Average per capita income for the bottom quintile on the all-government scale is about $21,000; in the top quintile, it is almost $37,000. There are exceptions -- the plot of economic freedom against income is quite scattered -- but the correlation is clear. In fact the correlation between growth of income and increases in freedom is even stronger, which is important because states often change their economic policies significantly when they change administrations, and the results are evident quickly enough to be significant even on politicians' time scales.

Ten states, including Colorado, have been consistently in the top third for two decades, 1981-2001. During that time, the U.S. per capita income went up by 34 percent; in those top-rated states, it went up 43 percent. In the bottom third, it went up only 17 percent.

True, the last couple of years have been rough in Colorado. But they could have been much, much worse.