Economic Freedom and Real Income

Abstract

(ProQuest: ... denotes formulae omitted.)1.IntroductionIn a recent Special Issue of this Journal, the topic of economic freedom and the economic ramifications and measures thereof were studied by a number of authors.1 These studies were those by Hall (2013), Stansel (2013), Ashby, Bueno, and Martinez (2013), Cebula, Clark, and Mixon (2013), Bennett and Vedder (2013), Belasen and Hafer (2013), and Mulholland and Hernandez-Julian (2013). In the spirit of these studies, the present study focuses on providing updated insights into a particular potential impact of higher economic freedom levels, namely, higher real income levels. Although the existing literature in fact does to some extent focus on the effect of higher levels of economic freedom on real income levels, this is not the primary focus of the majority of the related literature. By contrast, then, this study exclusively investigates the hypothesis that higher levels of overall economic freedom in an economy promote a higher level of economic activity and hence yield higher levels of per capita real income (GDP) in that economy, ceteris paribus.Where this present study principally differs from the existing related literature is three-fold. First, although focusing on the overall Heritage Foundation (2013) economic freedom index, the present study deconstructs that overall index to create an eight-component rather than ten-component measure; for reasons provided below, fiscal freedom and business freedom are deleted from the overall measure. Second, in the pursuit of a broader perspective and to compensate for the deletion of fiscal freedom and business freedom, this study also investigates two additional, complementary hypotheses: (1) the higher the taxation level relative to GDP, the lower the per capita real income level; and (2) quality regulation leads to a higher per capita real income level. Third, in order to provide a broad and diverse context for the empirical analysis of these joint hypotheses, we focus on the member nations of the OECD, consisting of 30 nations in the early years of this century and of 34 nations as of 2010.2This study investigates whether international/ interregional per capita real income differentials are a function of different levels of economic freedom, differential tax burdens, and differentials in the quality of government regulation.3 The study period runs from 2003-2010.2.FrameworkPer capita real income, RPCINC, is an economic variable that parallels, in principle, what have been the foci of most of the more recent related studies on macroeconomic growth. Per capita income is made comparable across nations by purchasing-powerparity adjustments. Given the emphasis in this study on the role of economic freedom in determining per capita real income and hence international differentials thereof, the most fundamental hypothesis of this study is that per capita real income depends positively upon economic freedom in each of its various studied forms, ceteris paribus. In addition, per capita real income is hypothesized to be a negative function of the tax burden as a percent of GDP, TAX, because higher tax burdens reduce disposable income and limit the ability to purchase new goods and services and thereby reduce/restrict the level of economic activity. In addition, per capita real income is hypothesized to be an increasing function of regulatory quality, REGQ, since better quality regulation interferes less with the market-based economy. Per capita real income is also hypothesized to be influenced by political stability as well as economic variables (OTHER).Thus, the model is:... (1)RPCINCjt is the level of the purchasing-power-parity adjusted per capita real income (GDP) in OECD nation j in year t; FREEnjt refers to the value of the economic freedom measure (index) n in nation j in year t (n=8 in each of the primary estimations, as explained below); TAXjt is the ratio of all taxes in nation j to the GDP level within nation j in year t, expressed as percent; REGQjt refers to the role played by government in the economy under the rubric of regulations and in fact is an index that measures the overall quality of those regulations in nation/region j in year t; STABjt is an index that measures the degree of political stability in each nation/region j in year t; and OTHERjt refers to economic control variables in nation j in year t. …