January 28, 2010 | Commentary on Economic Freedom, Index of Economic Freedom, Economy

Greater Freedom the Answer to Economic Woes

The United States no longer ranks among the world's free economies. For the first time in its 16-year history, the "Index of Economic Freedom" (published by the Heritage Foundation and the Wall Street Journal) grades our economy as only "mostly free."

For Americans who haven't suffered job-loss or pay cuts in the last two years, "mostly free" may feel little different from "free." But for the nearly 20 million who lack work or the millions more who find themselves earning a lot less, this news can help answer the question, "Why me?"

Numerous studies show that nations create more jobs and more prosperity the more they free their economies. The connection is especially important for poor people. New research from the National Bureau of Economic Research shows -- over the last 40 years -- a strong connection between the worldwide march toward greater economic freedom and the massive reduction in poverty. Since 1970, global poverty has dropped 80 percent.

But when economic freedom is repressed, the climb out of poverty is much more difficult. The U.S. decline to "mostly free" status means our economy offers less opportunity for job seekers -- especially those lacking career experience.

The U.S. needs to add about 125,000 net new jobs each month just to keep up with high school and college graduates entering the work force and those looking to re-enter after raising a family or retraining for a new career. When average job creation falls below this level, the unemployment rate usually rises.

America's Index score declined in six of the 10 factors used to calculate the economy's overall level of freedom. Here's what declined, and why:

1. Government spending: Massive increases in overall government spending dropped the score for this component to 58 on a 100 point scale. Increases in government spending withdraw capital from the job-creating private sector. In 2009 alone, spending grew by 20 percent over previous year levels, an astounding increase in government's "weight" on the economy.

2. Monetary freedom: Aggressive government intervention in major sectors of the economy -- housing, financial and automotive -- greatly distorted prices. This only encourages inefficient economic behaviors. For example, the bailout of Chrysler and GM kept these firms from undergoing needed reorganization and liquidation. Instead, capital and labor were squandered on propping up business models and products rejected by the buying public. This leaves prices artificially high. The monetary freedom score tumbled to 78.1 from 84.

3. Financial freedom: Interventions in financial markets also keep the economy from operating at optimal levels. This past year saw the feds take over many key financial firms and take unprecedented (in this country) steps to control private business decisions, such as fair compensation for executives. The financial freedom score dropped 10 points, to 70.

4. Property rights: The sanctity of contracts -- particularly an individual's right to own property -- is central to economic freedom. Those rights were significantly undermined by the federal takeover of financial and automobile companies. The feds ran roughshod over shareholder rights, instead granting sweetheart deals to unions and other power players. The score in this category fell by 5 points.

5. Investment freedom: The freedom to invest one's property stems directly from the enjoyment of property rights. Restrict that freedom, and growth rates fall below their potential. Unfortunately, the federal government tightened restrictions limiting the ability of foreign investors to invest in U.S. firms.

6. Fiscal freedom: Much of the developed world continued to reduce tax rates on personal and business income. The United States fell further behind by doing nothing. Today our corporate income tax rates are the highest in the world (after adding in state profits taxes). Our personal income tax rates are increasingly uncompetitive. High tax rates restrict economic growth by discouraging investment in new business ventures and the creation of new, labor-saving goods. While the U.S. score in this category didn't fall, many of our key economic competitors did better.

The U.S. economy is righting itself from the most severe recession since the 1930s. But it's doing so at a glacial pace. Public policies that reduce the free use of personal property and retard the entrepreneurial risk-taking only lengthen the recovery process.

Those paying the heaviest price for this sluggishness are the millions of unemployed Americans waiting for the recovery to blossom, and the millions more who hope to regain economic ground lost over the last two years. Government policies that erode our economic freedom won't spark the desired recovery. They will only delay it, and prolong the human suffering.

William W. Beach is director of the Heritage Foundation's Center for Data Analysis.

About the Author

William W. Beach Director, Center for Data Analysis and Lazof Family Fellow
Center for Data Analysis

First Appeared in The Washington Times