New Report – The United States’ Sharp Drop in Economic Freedom Since 2000 Driven by “Decline in Rule of Law”

The increased use of eminent domain to transfer property to powerful political interests, the ramifications of the wars on terrorism and drugs, and the violation of the property rights of bondholders in the auto-bailout case have weakened the tradition of strong adherence to the rule of law in United States. We believe these factors have contributed to the sharp decline in the rating for the legal-system area.

To a large degree, the United States has experienced a significant move away from rule of law and toward a highly regulated, politicized, and heavily policed state.

– From the Cato/Fraser Institute’s recent report: Economic Freedom of the World in 2012

Every year, Cato and Canada’s Fraser Institute publish a report titled Economic Freedom of the World (EFW), in which they rank countries across the globe based on their economic freedom. The latest report was just released and it covers 2012 data for 152 countries. The methodology for the index is based on five major areas in which the countries are ranked. These are are listed below along with a brief summary:

1) Size of Government
The four components of Area 1 indicate the extent to which countries rely on the political process to allocate resources and goods and services. When government spending increases relative to spending by individuals, households, and businesses, government decision-making is substituted for personal choice and economic freedom is reduced.

2) Legal System and Property Rights
Protection of persons and their rightfully acquired property is a central element of economic freedom and a civil society. Indeed, it is the most important function of government. Area 2 focuses on this issue. The key ingredients of a legal system consistent with economic freedom are rule of law, security of property rights, an independent and unbiased judiciary, and impartial and effective enforcement of the law.

Countries with major deficiencies in this area are unlikely to prosper regardless of their policies in the other four areas.

Remember that line for later, it is extremely important.

3) Sound Money
Sound money is essential to protect property rights and, thus, economic freedom. Inflation erodes the value of property held in monetary instruments. When governments finance their expenditures by creating money, in effect, they are expropriating the property and violating the economic freedom of their citizens.

The important thing is that individuals have access to sound money: who provides it makes little difference.

4) Freedom to Trade Internationally
In our modern world of high technology and low costs for communication and transportation, freedom of exchange across national boundaries is a key ingredient of economic freedom. Many goods and services are now either produced abroad or contain resources supplied from abroad. Voluntary exchange is a positive-sum activity: both trading partners gain and the pursuit of the gain provides the motivation for the exchange. Thus, freedom to trade internationally also contributes substantially to our modern living standards.

5) Regulation
When regulations restrict entry into markets and interfere with the freedom to engage in voluntary exchange, they reduce economic freedom. The fifth area of the index focuses on regulatory restraints.

Using the report’s historical data, the clearest trend with regard to the United States is that the country’s economic freedom has plummeted since the year 2000. Specifically, throughout most of the period from 1980-2000, the U.S. ranked as the world’s 3rd freest economy in the world, just behind Hong Kong and Singapore. By 2005, the ranking had fallen to 9th, and has since fallen further. Its rank in 2010, 2011 and 2012, was 15th, 16th and 14th, respectively. What is shows it that while the U.S. has remained steady over the past three years, there has been a clear and significant drop since the start of the millennium. The report blames this largely on a decline in the rule of law. It notes that:

What accounts for the US decline? While US ratings and rankings have fallen in all five areas of the EFW index, the reductions have been largest in the Legal System and Protection of Property Rights (Area 2), Freedom to Trade Internationally (Area 4), and Regulation (Area 5). The plunge in Area 2 has been huge. In 2000, the 9.23 rating of the United States was the 9th highest in the world. But by 2012, the area rating had plummeted to 6.99, placing it 36th worldwide.

While it is difficult to pinpoint the precise reason for the decline in Area 2, the increased use of eminent domain to transfer property to powerful political interests, the ramifications of the wars on terrorism and drugs, and the violation of the property rights of bondholders in the auto-bailout case have weakened the tradition of strong adherence to the rule of law in United States. We believe these factors have contributed to the sharp decline in the rating for the legal-system area.

Expanded use of regulation has also been an important contributing factor to the declining ratings of the United States. During the past decade, non-tariff trade barriers, restrictions on foreign investment, and business regulation have all grown extensively. The expanded use of regulation in the United States has resulted in sharp rating reductions for components such as independence of the judiciary, impartiality of the courts, and regulatory favoritism. To a large degree, the United States has experienced a significant move away from rule of law and toward a highly regulated, politicized, and heavily policed state.

The above paragraphs will be of particular interest to long time readers of Liberty Blitzkrieg, since I have often expressed the view that of all the systemic issues plaguing the nation today, none is more societally and economically destructive as the erosion of the rule of law. In the recent post, Lois Lerner’s Revenge: Anti-Obamacare Filmmaker is Hit with IRS Audit, I noted the following:

There are many systemic reasons why America continues to circle the toilet bowl toward a full fledged oligarchic Banana Republic. I’ve spent the last couple of years highlighting many of them here on these pages. Nevertheless, all of them pale in comparison with the disappearance of the rule of law. When the rule of law ceases to apply to the rich and powerful, a society ends up suffocating within a culture of theft, an endless stream of cronyism and criminality.

Also, recall that earlier in this post I highlighted that the Cato/Fraser report noted: “Countries with major deficiencies in this area [rule of law] are unlikely to prosper regardless of their policies in the other four areas.” 

So where does this leave us going forward? In my opinion, the U.S. is living on borrowed time. The entrepreneurial spirit is still very much alive, and a lot of innovative things are happening in the tech area, but other than that, the U.S. economy looks very much like a third word oligarchy. From my perspective, we need to reinstate the rule of law at once. The bad actors amongst the rich and powerful will continue to feast relentlessly on the productive parts of the economy so long as they they are never held accountable for their crimes. Simply put: The rule of law must be restored immediately.

If we fail to do so, the 99.9% will continue to feel it economically. As the Cato report notes:

The decline in the summary rating between 2000 and 2012 on the 10-point scale of the index may not sound like much, but scholarly work on this topic indicates that a one-point decline in the EFW rating is associated with a reduction in the long-term growth of GDP of between 1.0 and 1.5 percentage points annually (Gwartney, Holcombe, and Lawson, 2006). This implies that, unless policies undermining economic freedom are reversed, the future annual growth of the U.S. economy will be only about half its historic average of 3%.

But it won’t only hurt our financial well being. It will also result in a continued loss of our civil liberties. See the following chart:

When it comes to the restoration of the rule of law, there is simply no time to waste.

To read the full Cato/Fraser report, go here.

In Liberty,
Michael Krieger

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