Subnational Economic Freedom and Performance in the United States and Canada

During his illustrious career spanning more than half a century, Richard Vedder has tirelessly advocated for limited government and free enterprise. Much of his scholarship has focused on examining how fiscal and labor market policies consistent with the principles of economic freedom are associated with economic and social benefits such as stronger economic performance (Vedder 1981, 1990), lower unemployment (Vedder and Gallaway 1996, 1997), and poverty alleviation (Vedder and Gallaway 2002). Vedder has also examined the impact of government policy on income inequality (Vedder 2006; Vedder and Gallaway 1986, 1999; Vedder, Gallaway, and Sollars 1988), an area that he and I have collaborated to study (Bennett and Vedder 2013, 2015). Thus, Vedder's scholarship has contributed to our understanding of the impact that economic freedom exerts on economic outcomes. Vedder's research has primarily examined the effects of individual policies such as the structure of taxation and barriers in the labor market, but a mounting body of academic research links aggregate measures of economic freedom to a variety of positive economic, political, and social outcomes. Hall and Lawson (2014) and Hall, Stansel, and Tarabar (2016) provide recent surveys of this literature. This article builds on my previous work with Vedder and contributes to the growing body of research on the effects of economic freedom by examining the relationship between subnational economic freedom and various measures of economic performance for a panel of U.S. states and Canadian provinces over the period 1980-2010. Existing theory and empirical evidence suggest that economic freedom is positively associated with economic development and labor market outcomes, which the evidence presented here further corroborates, but the relationship between economic freedom and inequality is not well understood. It is important to examine how economic freedom affects inequality because income inequality has been heralded as the defining challenge of our time by influential public figures and economists. Free-market capitalism is often blamed for rising inequality, and the prescribed solution is typically freedom-reducing government interventions. Pope Francis (2013: 48), for instance, describes market capitalism as a system of exclusion and inequality that is unjust at its roots. Paul Krugman (2013) points to U.S. financial deregulation and entitlement reform as factors in driving higher U.S. income disparities. President Barack Obama has repeatedly expressed a desire to raise the federal minimum wage and increase the progressivity of the income tax structure as means to stem the tide of rising inequality. Thomas Piketty (2014: 1) argues that without corrective political intervention, capitalist economies inevitably produce rates of return on capital that exceed the growth rates of income and output, a process that automatically generates arbitrary and unsustainable inequalities. While free-market capitalism is heralded as the villainous perpetrator of inequality, existing theory and evidence on the relationship between economic freedom and inequality is largely inconclusive (Bennett and Nikolaev 2015b). By necessity, institutional and policy reforms intended to reduce inequality through government intervention reduce economic freedom, potentially undermining the other positive effects associated with economic freedom such as economic development and improved employment opportunities, both of which enhance economic well-being. The results presented here suggest that subnational economic freedom is associated with higher levels of income per capita, lower rates of unemployment, and higher income inequality across subnational economies in the United States and Canada. Methodology and Data This article utilizes panel data from the 50 U.S. states and 10 Canadian provinces over the period 1980-2010 to estimate (lie partial effects of subnational economic freedom on measures of macroeconomic performance, including income per capita, the unemployment rate, and relative income inequality. …

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