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Governments behaving badly… We’ve all seen it. Get a bunch of libertarians from around the world together, and each seems to take perverse pride in proving that her own government is the worst of all. How can we quantify governments’ badness?

On the economic side, we might look to the Economic Freedom of the World index. The Economist has come up with a clever new one: the DOG factor (“discount for obnoxious governments”). It’s the deviation of the price-to-earnings ratio in the domestic market from global standard valuations. Some governments score very high indeed on the DOG factor:

Iran, like Russia a target of Western sanctions, trades on a p/e of just 5.6 and has a total stockmarket value of $131 billion; were it to be rated on a par with the average emerging market, its market value would be $292 billion, so its DOG factor is $161 billion or 55%.

Argentina’s government has manipulated its inflation rate, defaulted on its debt back in 2001 and, thanks to the legal battle that ensued, may do so again in a few days’ time. Its stockmarket trades on a price-earnings ratio of 6.1. As a result, its total value is $56 billion, rather than the $115 billion it might have commanded (a DOG factor of 51%). After its hyperinflationary episode last decade, Zimbabwe’s rating has recovered a bit, although it still lags the emerging-market average.

Someone oughta run a correlation between DOG factor and economic freedom score. I bet there’d be a strong one.

Bonus question: How could you calculate DOG factor equivalents for American states?

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In his 1982 book, The Rise and Decline of Nations, economist Mancur Olson argued that over time, stable societies accumulate “distributive coalitions,” narrow special-interest organizations that complexify social life and burden the economy with overregulation and opaque forms of wealth redistribution. The notion that distributive coalitions are more often bad than good for economic performance, at least when they are not sufficiently “encompassing” to internalize the costs of inefficient redistribution, is pretty well accepted, but Olson’s thesis that political stability and the passage of time are the most important determinants of the number and power of distributive coalitions has been more controversial. One of the chapters of his book is an empirical test of the hypothesis on the 50 states. Olson finds that states settled earlier have higher rates of unionization and lower growth rates (in the 1960s and 1970s), except the former Confederate states, which “benefit” from the disruptive legacies of the Civil War and Reconstruction.

I am skeptical of Olson’s explanation for the growth of distributive coalitions, but his research does contain a kernel of truth. States that industrialized (note) early often show up on the bottom of economic freedom indices and usually have lower-than-average growth rates even today. Why is that?

To answer the question, we have look back at the social context of 19th century industrialization. The U.S. started out as an overwhelmingly rural, farming country. Industrialization populated the cities. Industrialization advanced first in those parts of the country that were unfit for export agriculture, benefited from high tariff walls on manufactures, and had a policy of free labor: southern New England, New York, and New Jersey. However, resource discoveries in the West also brought urban growth to California.

In 1900, the most urbanized states, by far, were Rhode Island (88.3%) and Massachusetts (86.0%). Then came New York (72.9%), New Jersey (70.6%), and Connecticut (59.9%). Pennsylvania (54.7%), Illinois (54.3%), and California (52.3%) were not far behind Connecticut. All of these states, with the possible exception of Pennsylvania, are now recognized as “deep-blue,” solidly Democratic states. Most of these states were relatively free for industry in the early 20th century, but they also boasted the strongest labor unions and most severe class conflict. These highly urban states became “proletarianized,” leading today to a strong concentration of Democratic votes in their metropolitan centers, according to Jonathan Rodden and other scholars.

As late as 1957, New Jersey was an example of a low-tax business haven. State and local taxes from all sources as a percentage of personal income stood at just 6.3% in New Jersey that year. Delaware had the lowest tax collections in the country, at 4.6% of income. States at the high end included Vermont (9.1%), which pioneered the state income tax, North (9.7%) and South Dakota (9.0%), and Oregon (9.0%). These states remained rural for a long time in part because prairie populism and Yankee progressivism yielded fiscal and regulatory policies that deterred investment. The South’s repression of blacks through Jim Crow kept their institutions “extractive,” to use Acemoglu and Robinson’s term, and their comparative development level low.

Nowadays, urbanization does not tend to produce proletarianization. Not many Americans are employed in manufacturing any more, nor are many private-sector workers covered by collective bargaining agreements. Thus, economic freedom has lost its self-undermining character. In the 1800s and early 1900s, economic freedom fostered industrialization, which brought on proletarianization, which led to a pro-regulatory public ideology, which then led to reversals in economic freedom. Now, late industrializers are not necessarily becoming less economically free. Indeed, there is a slight, positive correlation between present-day state urbanization rate and the Ruger-Sorens measure of economic freedom, controlling for left-right ideology.

States like California and New York are living off the accumulated capital of past economic freedom. Now that the political tide has turned decisively against economic freedom in those states, they are shedding people and jobs and growing more slowly than the rest of the country. Places like the Dakotas, Carolinas, Oklahoma, and Texas, which have reversed their anti-market policies of the past, represent America’s dynamic economic future.

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One of the regular Pileus bloggers asked me to elaborate on a claim I made briefly in my earlier discussion of BHL. I had said “there is an intra-libertarian debate [that it is useful to have about philosophical justification: is a system of individual rights ultimately justified because it accrues the best results for the poor, or is it justified for some other reason(s), and has the beneficial characteristic of accruing the best results for the poor?” and suggested I thought it was the latter. The idea that the social order can only be justified if it brings about the best results for the worst off, which is a prominent feature of Rawlsian welfare-state liberalism, has been employed as a rationale for classical-liberal non-redistributionist policies. I certanily like the irony that the chief heuristic of redistributionist theory undermines redistributionist institutions. And, as I said in the orginal post, I appreciate the positive outreach effects of noting that free market policies help everyone prosper, especially the poor. But I am hesitant to agree that the Rawslian principle is why we should have free markets. For one thing, I think we should have free markets for the same reason I think we should be free generally. I do not differentiate “civil liberty” and “economic liberty.” The latter is simply the manifestation-in-transactions of the former. Without the freedom to transact, my “freedom to choose” is pretty superficial. Rawls himself argues that we must have a system of equal freedom to choose and believe and think and speak – rights that cannot be trumped by social utility. It is only trading and acquiring rights that he says can be interfered with. But as Nozick demonstrated, you cannot interfere with transactional freedom without simultaneously interfering with freedom of choice. There are not two kinds of liberty, civil and economic, there’s just liberty (although there are of course different contexts in which we talk about liberty). And I think liberty is a necessary component of human flourishing. Humans cannot achieve virtue and happiness by coercion. “Rights” should be understood as a way to secure the possibility of self-directed activity in the social setting. The social order is thus justified if it is one which protects individual rights, and unjustified otherwise. That is the why of classical liberalism. The fact that classical liberalism and free markets help the poor better than redistributive statism is a great thing, both intrinsically and in terms of explaining its virtues to others. But the justification must be something else, something universal. Put it another way: if everyone were wealthy, would individual rights no longer be important? Of course not.

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My sometime coauthor William Ruger has a piece in The American Conservative on Luigi Zingales’ A Capitalism for the People. He compares Zingales to early Chicago School economist Henry Simons in his willingness to consider unconventional remedies to crony capitalism, lack of competition, and “bigness” more generally:

Fast forward to today, and we see another Chicago economist, Luigi Zingales, confronting another economic crisis and likewise trying to put capitalism back on the right path in his book, A Capitalism for the People. The similarities between Simons and Zingales do not stop there. In fact, Zingales’s philippic against the early 21st century’s economic and political trends—including growing income inequality—and in favor of competition over monopoly frequently calls to mind the older Chicago tradition that Simons represented in A Positive Program.

Unlike his predecessor’s, Zingales’s reform measures are far more consistent with the tenets of a free society. In recognizing the danger of bigness—especially big business tied to big government—while hoping to meet the threat with greater respect for markets and freedom, Zingales fuses many of the best parts of the “old” and “new” Chicago Schools.

Some of his policy recommendations seem a bit contrived or poorly thought through, but others are genuinely interesting:

Zingales focuses on education as an antidote to the increasing inequality that accompanies globalization. Unfortunately, as he points out, “perhaps the most destructive cronyism that uses lobbying to extract money from the American people in exchange for a product that doesn’t meet their real needs is in the public school system.” Sounding a lot like his fellow Chicagoan, Zingales repeats Milton Friedman’s argument for publically funded school vouchers as a means to increase equality of opportunity. He adds the twist that there should be “higher-value vouchers for people who start from less privileged conditions” and “match-specific vouchers” to incentivize good schools to “rescue poorer-performing students at risk.” To allow individuals to take risks and invest in themselves “when the consequences of failure are very harsh,” Zingales also supports a safety net of forgiving bankruptcy laws, unemployment insurance, and job retraining.

Zingales wants to reinvent antitrust, with regulators focusing not just on the economic advantages of mergers but the political consequences that arise from large corporate combinations. Where the political results would likely be “welfare-reducing,” Zingales would have the government prevent such mergers or limit the lobbying those corporations can engage in. As he admits, “This would be a radical departure from the status quo”—indeed, one reminiscent of Simons’s anti-monopoly program. Further steps he recommends to revive a competitive market include better balancing our patent and copyright regime, empowering shareholders in corporate governance (even by quotas), and enacting progressive taxation on corporate lobbying.

He supports a number of other critical institutional reforms to the tax and finance system: simplifying corporate taxes, ending expiring tax provisions, applying legal rules to the government (which creates them in the first place), instituting a reward system for whistleblowers, and increasing data transparency through disclosure requirements. Financial regulation, he says, should be parceled out to three agencies, each responsible for meeting only one key goal: price stability, protection against fraud and abuse, and system stability. Zingales disapproves of using the tax system for “massive” redistribution of wealth and income. Instead, he favors Pigouvian taxes (which “correct distorted incentives”), such as levies on lobbying or on potentially destabilizing short-term debt.

More here.

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Classical Liberalism and the Austrian School is the latest collection of essays from Ralph Raico, published by the Ludwig von Mises Institute. Ralph was kind enough to send me a print copy.

The introductory, eponymous essay concerns the relationship between Austrianism as an economic methodology and classical liberalism as a political program or ideology. Raico disputes Mises’ contention that Austrian methodology (methodological individualism) is clearly separate from the normative claims of classical liberalism (2-3). Raico builds a persuasive case that Austrianism as traditionally understood is indeed naturally related to classical liberalism; however, I would argue that this implication is not entirely to the credit of traditional Austrianism.

First, let us take methodological individualism. Modern neoclassical economics is as thoroughly methodologically individualist as Austrianism ever was. But note that both neoclassical and Austrian economists depart from methodological individualism when convenient to do so, for instance when deploying the firm as a rational actor. The firm is a collective entity. Robert Nozick in Anarchy, State, and Utopia has a brilliant insight into when methodological individualism “might go wrong” (22):

If there is a filter that filters out (destroys) all non-P Q’s, then the explanation of why all Q’s are P’s (fit the pattern P) will refer to this filter. For each particular Q, there may be an explanation for why it is P, how it came to be P, what maintains it as P. But the explanation of why all Q’s are P will not be the conjunction of these individual explanations, even though these are all the Q’s there are, for that is part of what is to be explained… The methodological individualist position requires that there be no basic (unreduced) social filtering processes.

The filtering process for the firm is profit maximization. We can know that firms try to maximize profit even if we do not have a good explanation for why each individual firm tries to maximize profit, or why individuals have chosen so to organize themselves. The answers to the latter question were developed by Coase and Williamson, by the way (Chicagoites, not Austrians, though fully taken on board by contemporary Austrians).

Second, (more…)

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Which public policies make an economy better for business? One way to answer this question is to ask businesspeople. Two recent surveys ask businesspeople to rank the American states on their friendliness toward business.

Now, libertarians often remind us that friendliness toward business is not the same as friendliness toward markets. Indeed, libertarians believe that many of their favored policies, such as abolishing trade protection, corporate welfare, and regulations that privilege big business, will redound to the benefit of workers and small business owners. What’s so interesting about these two surveys is that they are of different types of business owners: CEOs of large companies and small businesspeople. The first survey was conducted by Chief Executive magazine and the second by thumbtack.com in partnership with the Kauffman Foundation. By relating respondents’ views about the friendliness of their states to those states’ actual policies, we can see where big and small businesses agree and disagree about which policies are most important for their success.

My first step was to draw out of these survey data those numbers that relate specifically to different states’ policy environments, as opposed to other aspects of the economic climate. From the CEO survey, therefore, I took the taxation/regulation score given for each state (higher is better). From the small business survey, I took the “Regulations” component grades. Unfortunately, the small business survey does not include raw scores for each state, so I simply quantified the grades as follows: A+ = 0, A = 1, A- = 2, and so on, up to F = 11. The small business survey only covers 45 states, but for these states, the correlation between CEO and small business scores was -0.76. Since higher is better in the CEO survey and lower is better in the small business survey, that high correlation indicates a surprising degree of agreement between large and small businesses about states’ friendliness toward their businesses.

Nevertheless, there may remain some important differences in which policies large and small businesses prioritize. To get a handle on this question, (more…)

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There is an interesting NYT piece by Adam Davidson on Edward Conard, former Bain partner and author of a forthcoming book entitled Unintended Consequences: Why Everything You’ve Been Told About the Economy Is Wrong. Here is one excerpt from a fascinating article:

A central problem with the U.S. economy, he [Conard] told me, is finding a way to get more people to look for solutions despite these terrible odds of success. Conard’s solution is simple. Society benefits if the successful risk takers get a lot of money. For proof, he looks to the market. At a nearby table we saw three young people with plaid shirts and floppy hair. For all we know, they may have been plotting the next generation’s Twitter, but Conard felt sure they were merely lounging on the sidelines. “What are they doing, sitting here, having a coffee at 2:30?” he asked. “I’m sure those guys are college-educated.” Conard, who occasionally flashed a mean streak during our talks, started calling the group “art-history majors,” his derisive term for pretty much anyone who was lucky enough to be born with the talent and opportunity to join the risk-taking, innovation-hunting mechanism but who chose instead a less competitive life. In Conard’s mind, this includes, surprisingly, people like lawyers, who opt for stable professions that don’t maximize their wealth-creating potential. He said the only way to persuade these “art-history majors” to join the fiercely competitive economic mechanism is to tempt them with extraordinary payoffs.

Conard seems to minimize the importance of transfer-seeking behavior in shaping the economy–a point that is nicely developed by Davidson. Any reactions?

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