most free 2nd quartile 3rd quartile least free...trust in french society and the functioning of its...

The European Union – Catalyst for Economic Freedom?Selected Essays

by Steffen Hentrich, Emmanuel Martin, Danko Tarabar and Andrew Young

Dokumentation

Most Free

2nd Quartile

3rd Quartile

Least Free

Publisher

Friedrich Naumann Foundation for FreedomInternational Political DialogueDialogue Programme Brussels71 Avenue de Cortenbergh1000 Bruxelles, Belgium

Edited by Julie Cantalou and Caroline Margaux Haury

Overall ProductionCOMDOK GmbH

Map Economic Freedom in Europe:Bill Ray. Copyright © The Fraser Institute, 2014

December 2014

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THE EuROPEAN uNION – CATAlYST FOR ECONOMIC FREEDOM?Selected Essays

by Steffen Hentrich, Emmanuel Martin, Danko Tarabar and Andrew Young

The European Union – Catalyst for Economic Freedom? 3

Table of Contents

Preface 5Hans H. Stein, Director Regional Office European Institutions and North America, Friedrich Naumann Foundation for Freedom

Fred McMahon, Michael Walker Chair of Economic Freedom Research, The Fraser Institute

Economic Freedom in the European Union – 10 A Country-by-Country OverviewSteffen Hentrich, liberal Institute, Friedrich Naumann Foundation for Freedom

Does the European Union Promote Convergence in Economic Freedoms? 25Danko Tarabar and Andrew T. Young, West Virginia university

France: Economic Freedom at the Mercy of a Dysfunctional Democracy 35Emmanuel Martin, Director at the Institute for Economic Studies – Europe, Paris

Biographies of the authors 48

Impressions World Economic Freedom Conference 2014 50

4 The European Union – Catalyst for Economic Freedom?


Preface

by Hans H. Stein, Director Regional Office European Institutions and North America, Friedrich Naumann Foundation for Freedom

The Economic Freedom of the World Report 2014 was launched in Brussels on 7 October at an event organized by the Friedrich Naumann Foundation for Freedom and the Fraser Institute. Olli Rehn, Vice-President of the Eu-ropean Parliament, insisted on the importance of kee-ping up the reform process in the Eu and its member states in order to improve Europe’s competitiveness and ultimately its wealth. In his view, the biggest challenge for the Eu will be to “reform its economic and social model without giving up the social market economy on which the Eu is based”.

Although most Eu member states rank within the top 40 out of 151 countries in the Economic Freedom in the World Index, many countries still perform poorly on economic freedom in Europe. It is striking that between the highest ranking Eu member state in the Index 2014, Finland on rank 10, and the lowest, Slovenia on rank 105, the gap in economic freedom remains big within the Eu. Scandinavi-an countries, although well-known for their large welfare states, are in the lead with regard to economic freedom, while most progress in economic freedom in the Eu has been achieved in new member states. For the first time, the Friedrich Naumann Foundation for Freedom publishes a detailed analysis of the state of economic freedom in Europe and asks the question of the European union’s im-pact on economic freedom in its member states.

This collection of papers attempts to give insight into the close interlinkage bet-ween institutions and economic freedom, both at the European as well as the country level.

Steffen Hentrich’s article offers a broad overview of the state of economic free-dom in the Eu and provides data analysis of the various policy areas and attempts at assessing the Eu’s impact on economic freedom in each of these areas. Even if the Eu member states, with the notable exception of Finland, do not belong to the top-10-group of the Economic Freedom in the World Index, most Eu countries qualify for the freest quartile of the index. Over the years, economic and political


integration in the European union has been influential for economic freedom in Europe. Steffen Hentrich attempts to answer the question if the Eu has contri-buted to convergence in economic freedom through harmonization of economic and political institutions.

Andrew T. Young and Danko Tarabar’s contribution studies economic freedom in 42 European countries and estimates the relationship between Eu membership and the increase in economic freedom on the one hand and the level of conver-gence with the top countries in economic freedom on the other hand. The authors find that while economic freedom levels have increased meaningfully throughout Europe in the period 1970-2010 and the level of dispersion of economic freedom across European countries has decreased, these trends are difficult to attribute to the Eu as an institutional body.

In his case study on France, Emannuel Martin discusses the interlinkage between what he calls the “dysfunctional” institutional framework and the lack of eco-nomic freedom in France. In his view, the measure of a nation’s economic free-dom is a good proxy for its institutional quality. He concludes by underlining the importance of thorough reforms instead of mere make-up reforms to increase transparency and accountability, which in turn should overall increase the levels of economic freedom.


Preface

by Fred McMahon, Michael Walker Chair of Economic Freedom Research, The Fraser Institute

The question of whether European union membership increases or decreases economic freedom has vexed for decades. The question can be rephrased into a more common form: Does the Eu promote good or bad po-licy. Economic freedom can, on the whole, be taken as equivalent to good policy since, as the authors in this volume note, it has been shown to be associated with a number of good outcomes.

The question has taken on added urgency with the on-set of the financial crisis. Further urgency is added to the question by growth of Eu-skepticism, which could

conceivably lead the united Kingdom out of the union. Complaints against the Eu are usually based on populist appeals to nationalism and the loss of sove-reignty but, particularly in Britain, they are also tied to policy concerns: that Eu rules, regulations, and red-tape are tying down the economy, in effect reducing economic freedom.

The standard economist answer to the question – does the Eu reduce economic freedom – is “no” and “yes”. (No wonder economists infuriate the public and po-licy makers.)

The “yes” applies to new member states. These nations typically start with very low levels of economic freedom. Eu requirements may not be “best-in-class” eco-nomic freedom solutions, but they are typically a lot better than what is found in Eu candidate countries.

The “no” applies to countries with above-average aspirations to economic free-dom. So many in Britain complain about over-Eu-regulation, particularly in the all-important labor market. These regulations can stop willing-workers from accepting jobs from willing-employers, reducing economic freedom, growth, prosperity, and employment.


Of course, it can be no other way in any organization with rule-enforcing powers. For any given variable, the average the organization strikes will be below the level of the highest members and above the level of the lowest members.

Thus this collection of essays, which explores the magnitude and direction of Eu influence, is extremely valuable. The Friedrich Naumann Foundation for Freedom (FNF) and the editors should be congratulated for producing this timely and im-portant volume. It is based on the proceedings of the Economic Freedom of the World Network Meeting held in Brussels this year, sponsored and organized by FNF in cooperation with Canada’s Fraser Institute, the publisher of the Economic Freedom of the World: Annual Report and other economic freedom related re-ports.

Steffen Hentrich in “Economic Freedom in the European union – A brief Country-by-Country Overview” explores the Eu’s overall record and examines the approach of individual countries. He notes that the Eu has many positive features—opening Europe to competition and increasing trade and the movement of capital and people, all of which boosts economic freedom independent of other rules impo-sed by the Eu. Harmonization in and of itself also increases economic freedom by removing market frictions. But, of course, this positive effect on economic free-dom can be overwhelmed if it is accompanied by whole new books of regulations which reduce economic freedom.

All in all, he concludes that the Eu has caused convergence in economic freedom across member states but this returns us to the “yes” and “no” answer. “The con-vergence of economic freedom ratings across Eu member states clearly reflects the harmonization of economic and political institutions across Europe. At best this stabilizes economic freedom and prevents member countries to step out of line and practice more interventionist policies. At worst it turns out to be an im-pediment to implement market reforms, to limit government intervention and reduce public spending in individual countries.”

Andrew T. Young and Danko Tarabar in their econometric study, “Does the European union Promote Convergence in Economic Freedoms?” argue that a priori the Eu should promote economic freedom by removing barriers between countries and thus promoting competition to improve economic policy or be left behind. “One would expect that jurisdictional competition, all else equal, leads governments to adopt policies and institutions that raise their EFW scores.”


like Hentrich they find a convergence in European scores but they “find no signi-ficant relationship between Eu and these convergence measures; no evidence that the European union enhances jurisdictional competition and leads to a tighter distribution of economic freedom scores.”

They also find an increase in economic freedom among Eu members but again don’t find evidence the Eu itself is responsible for this improvement. “However, from the data it is difficult to attribute these trends to jurisdictional competition fostered by the Eu. One possibility is that the reforms associated with a country’s accession period are more meaningful contributors to economic freedom than actual membership.”

I took a quick, back-of-the-envelope look at this and found supporting evidence. Post-communist states that joined the Eu had significant increases in economic freedom. The average score in 1985 was 4.1, rising to 7.3 in 2012. However, vir-tually all of this increase happened by 2004, when the score was 7.1. The largest tranche of post-communist states entered the Eu in 2004.

Emmanuel Martin, in “France: Economic Freedom at the Mercy of a Dysfunctional Democracy”, explores how a country can dodge good policy despite the compe-titive pressures to improve. He focuses on institutions, particularly the level of trust in French society and the functioning of its democracy.

He shows that lack of trust – something necessary for economic freedom and in turn generated by economic freedom – in France inhibits the growth of economic freedom. “The traditional anti-market mentality in France is very much correlated to its national tendency to mistrust. Mistrust is a very good soil for anti-market and anti-competition programs and regulations.” In other words, this creates a vicious cycle: lack of trust weakens economic freedom and lack of economic free-dom weakens trust.

He also shows how the institutions of government in France cut lines of accoun-tability and centralize decision-making, including an ironically highly centralized campaign to de-centralize.

As noted earlier, competition between countries in the Eu should force better po-licy since those that maintain bad policy will be left behind. Martin shows us how a dysfunctional political system can cause nations to make the perverse choice of maintaining bad policy and thus being left behind. This is perhaps a key reason the Eu has not lived up to its potential to improve policy.


Economic Freedom in the European Union – A Country-by-Country Overview

Steffen Hentrich, Liberal Institute, Friedrich Naumann Foundation for Freedom, Berlin

The European union has been an ambitious project from its beginning. In the aftermath of the Second World War the European Economic Community was created to foster economic cooperation. Economic trade and interdependence should stimulate economic development and avoid conflict. Today the Eu has developed from an economic union into almost a comprehensive political union covering nearly all areas of political decision making. The European single market is the Eu’s main economic driver. It has opened Europe to competition, created new jobs and enabled businesses and citizens to benefit from economic specialization and economies of scale. Today, free trade of goods, services, capital and the free movement of people between member countries is commonplace.

Binding agreements between the growing number of member states has led to a harmonization of economic and political institutions across Europe. In most are-as of political decision making, Eu member states cannot avoid the influence of Eu legislation. Nevertheless, there are still institutional differences between the member states. This also affects the degree of economic freedom across Europe. Economic freedom is a well acknowledged driver of economic development and wealth. Since the first publication of the Economic Freedom of the World Index (EFWI) in 1996, a growing amount of economic research has documented the im-portance of economic freedom for economic growth and development. Even poli-tical rights and civil liberties are positively correlated with economic freedom.

There are still big differences in economic freedom between the Eu member states: Finland ranks 10th in the Economic Freedom Index 2014, while Slovenia ranks 105th. How is it possible that within a common market and regulatory fra-mework such differences still exist? What is the state of economic freedom in Eu member states? What institutional differences influence the divergence of economic freedom in the Eu? To answer these questions it is necessary to look for similarities and differences of economic institutions between the Eu mem-ber states. The following paper presents data from the Economic Freedom of the World report 2014 to give a short overview of the state and development of eco-nomic freedom in the European union. It shows not only the overall ratings for


Eu countries but also the ratings for the different areas of the Index. In addition, it compares the economic freedom ratings between the Eu15 member states (Eu member states before the Eastern enlargement round in 2004) and other deve-loped countries (OECD). Whenever appropriate, new Eu member state ratings are considered separately.

Economic Freedom in the European Union

With regards to economic freedom there are significant differences between member states. While Finland ranks 10th in this year’s report, Slovenia shares the 105th rank with Sierra leone. Yet, most Eu member countries are in the first and second quartile of the EFW Summary Index. Only Italy, Greece and Slovenia are in the third quartile of the index. No Eu member state is in the fourth, the least free, quartile of the EFW Index. While most Eu15 countries are in the highest quartile of the economic freedom index, new member states concentrate in the second and third quartile. Nevertheless the differences in the ratings between Eu countries are comparatively small. Finland gets 7.84 index points out of ten, Slovenia 6.57 (Figure 1).

For comparison, Hong Kong leads the global ranking with 8.98 index points, Ve-nezuela ranks last with a summary rating of 3.89 index points. Figure 2 shows the comparatively small range of Eu28 country rankings. Ratings of former Eu15 countries are even less different than ratings of the new member states.


Figure 1: Summary Economic Freedom Ratings for 2012: European Union

Note: The different shades of gray mark the relative position of Eu countries in the global ran-king (quartiles).

Source: Fraser Institute, Economic Freedom of the World: 2014 Annual Report.

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Figure 2: Economic Freedom Summary Index 2012, EU28 countries, EU15 countries and new EU member countries

Note: A Box-Whisker-Plot is used to show the distribution of a dataset. The box highlights the middle half of all data points and is split by the median value. The whiskers mark the highest and the lowest value.

Source: Fraser Institute, Economic Freedom of the World: 2014 Annual Report.

What causes the differences in ratings between the Eu member states? Figures 3a to 3e show the area ratings of Eu member states for 2012. While the diver-gences in areas 1 (size of government), 2 (legal system & property rights) and 5 (regulation of credit, labor and business) are comparatively high, in areas 3 (sound money) and 4 (freedom to trade internationally) ratings do not vary much. The latter areas are those where European legislation has effectively taken over the role of country specific legislation.

In the European Monetary union member states have to comply with a group of monetary and fiscal policies before being able to adopt the Euro. Within the sin-

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7,0 6,8

6,4 6,1

5,9 5,8 5,8 5,7 5,7 5,7 5,7 5,7

5,4 5,3

5,3 5,2

4,9 4,9

4,6 4,6

4,2 4,1

4,0 3,9

3,7 3,6

0 1 2 3 4 5 6 7 8 9 10

RomaniaLithuaniaBulgaria

CyprusSlovak Rep

GreeceEstoniaPolandMalta

Czech Rep.Latvia

HungarySpain

PortugalGermany

CroatiaUnited Kingdom

IrelandAustriaFinland

SloveniaDenmark

FranceItaly

LuxembourgBelgiumSweden

Netherlands

a) Area 1: Size of Government

8,9 8,2 8,2 8,2

8,0 8,0 7,9 7,9

7,8 7,2

7,2 7,2

7,1 6,9

6,7 6,5 6,4

6,4 6,4

6,1 6,1

6,1 5,9

5,7 5,6

5,6 5,4

5,0

0 1 2 3 4 5 6 7 8 9 10

FinlandLuxembourg

SwedenNetherlands

AustriaDenmarkGermany

IrelandUnited Kingdom

EstoniaMalta

FranceBelgiumPortugal

SpainLatvia

CyprusLithuania

PolandHungarySlovenia

Czech Rep.Italy

CroatiaSlovak Rep

RomaniaGreece

Bulgaria

b) Area 2: Legal System & Property Rights

9,8 9,7 9,7 9,7 9,7 9,7 9,7 9,6 9,6 9,6 9,6 9,6 9,5 9,5 9,5 9,5 9,5 9,5 9,5 9,5 9,4 9,4

9,4 9,3

9,0 8,9 8,8

8,2

0 1 2 3 4 5 6 7 8 9 10

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SwedenPortugal

IrelandItaly

FranceBelgium

DenmarkGreeceCroatiaPolandAustria

NetherlandsHungary

CyprusSlovak Rep

GermanyMalta

BulgariaCzech Rep.

FinlandRomania

LuxembourgLatvia

LithuaniaEstonia

Slovenia

c) Area 3: Sound Money

7,4 7,1

7,0 6,8

6,4 6,1

5,9 5,8 5,8 5,7 5,7 5,7 5,7 5,7

5,4 5,3

5,3 5,2

4,9 4,9

4,6 4,6

4,2 4,1

4,0 3,9

3,7 3,6

0 1 2 3 4 5 6 7 8 9 10


CyprusSlovak Rep


Czech Rep.Latvia

HungarySpain

PortugalGermany



SloveniaDenmark

FranceItaly


Netherlands


8,9 8,2 8,2 8,2

8,0 8,0 7,9 7,9

7,8 7,2

7,2 7,2

7,1 6,9

6,7 6,5 6,4

6,4 6,4

6,1 6,1

6,1 5,9

5,7 5,6

5,6 5,4

5,0

0 1 2 3 4 5 6 7 8 9 10

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SwedenNetherlands



EstoniaMalta


SpainLatvia

CyprusLithuania


Czech Rep.Italy

CroatiaSlovak Rep

RomaniaGreece

Bulgaria


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9,4 9,3

9,0 8,9 8,8

8,2

0 1 2 3 4 5 6 7 8 9 10

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IrelandItaly

FranceBelgium


NetherlandsHungary

CyprusSlovak Rep

GermanyMalta

BulgariaCzech Rep.

FinlandRomania

LuxembourgLatvia

LithuaniaEstonia

Slovenia


7,4 7,1

7,0 6,8

6,4 6,1

5,9 5,8 5,8 5,7 5,7 5,7 5,7 5,7

5,4 5,3

5,3 5,2

4,9 4,9

4,6 4,6

4,2 4,1

4,0 3,9

3,7 3,6

0 1 2 3 4 5 6 7 8 9 10


CyprusSlovak Rep


Czech Rep.Latvia

HungarySpain

PortugalGermany



SloveniaDenmark

FranceItaly


Netherlands


8,9 8,2 8,2 8,2

8,0 8,0 7,9 7,9

7,8 7,2

7,2 7,2

7,1 6,9

6,7 6,5 6,4

6,4 6,4

6,1 6,1

6,1 5,9

5,7 5,6

5,6 5,4

5,0

0 1 2 3 4 5 6 7 8 9 10

FinlandLuxembourg

SwedenNetherlands



EstoniaMalta


SpainLatvia

CyprusLithuania


Czech Rep.Italy

CroatiaSlovak Rep

RomaniaGreece

Bulgaria


9,8 9,7 9,7 9,7 9,7 9,7 9,7 9,6 9,6 9,6 9,6 9,6 9,5 9,5 9,5 9,5 9,5 9,5 9,5 9,5 9,4 9,4

9,4 9,3

9,0 8,9 8,8

8,2

0 1 2 3 4 5 6 7 8 9 10

United KingdomSpain

SwedenPortugal

IrelandItaly

FranceBelgium


NetherlandsHungary

CyprusSlovak Rep

GermanyMalta

BulgariaCzech Rep.

FinlandRomania

LuxembourgLatvia

LithuaniaEstonia

Slovenia


Figure 3a-e: Economic freedom area ratings 2012, EU28 member statesSource: Fraser Institute, Economic Freedom of the World: 2014 Annual Report.


7,4 7,1

7,0 6,8

6,4 6,1

5,9 5,8 5,8 5,7 5,7 5,7 5,7 5,7

5,4 5,3

5,3 5,2

4,9 4,9

4,6 4,6

4,2 4,1

4,0 3,9

3,7 3,6

0 1 2 3 4 5 6 7 8 9 10


CyprusSlovak Rep


Czech Rep.Latvia

HungarySpain

PortugalGermany



SloveniaDenmark

FranceItaly


Netherlands


8,9 8,2 8,2 8,2

8,0 8,0 7,9 7,9

7,8 7,2

7,2 7,2

7,1 6,9

6,7 6,5 6,4

6,4 6,4

6,1 6,1

6,1 5,9

5,7 5,6

5,6 5,4

5,0

0 1 2 3 4 5 6 7 8 9 10

FinlandLuxembourg

SwedenNetherlands



EstoniaMalta


SpainLatvia

CyprusLithuania


Czech Rep.Italy

CroatiaSlovak Rep

RomaniaGreece

Bulgaria


9,8 9,7 9,7 9,7 9,7 9,7 9,7 9,6 9,6 9,6 9,6 9,6 9,5 9,5 9,5 9,5 9,5 9,5 9,5 9,5 9,4 9,4

9,4 9,3

9,0 8,9 8,8

8,2

0 1 2 3 4 5 6 7 8 9 10

United KingdomSpain

SwedenPortugal

IrelandItaly

FranceBelgium


NetherlandsHungary

CyprusSlovak Rep

GermanyMalta

BulgariaCzech Rep.

FinlandRomania

LuxembourgLatvia

LithuaniaEstonia

Slovenia


8,7 8,6

8,5 8,4

8,2 8,2

8,1 8,1 8,1 8,0

8,0 7,9 7,9 7,9 7,9

7,8 7,8 7,8 7,7

7,7 7,7 7,6 7,6 7,6 7,6 7,6

7,4 7,4

0 1 2 3 4 5 6 7 8 9 10


NetherlandsFinlandEstonia

DenmarkLuxembourg

MaltaLatvia

BelgiumFrance

Czech Rep.PortugalSweden

Slovak RepGermany

AustriaRomania

SpainCroatiaCyprus

HungaryItaly

LithuaniaGreece

BulgariaSlovenia

Poland

d) Area 4: Freedom to trade internationally

7,9 7,9 7,9

7,8 7,8

7,7 7,7 7,7

7,6 7,6 7,6 7,6 7,5 7,5 7,5 7,5

7,4 7,3 7,3

7,1 7,1

7,1 7,0

6,8 6,7

6,6 6,5

5,7

0 1 2 3 4 5 6 7 8 9

BulgariaSweden

DenmarkEstonia

LithuaniaCzech Rep.

RomaniaBelgium

United KingdomMalta

FinlandLatvia

IrelandNetherlands

HungaryPoland

LuxembourgItaly

Slovak RepGermany

AustriaFranceCroatiaCyprus

PortugalSpain

SloveniaGreece

e) Area 5: Regulation


gle market the four freedoms apply and people, goods, services and money can move around the Eu as freely as they do within a single country. Regarding trade relations with non-Eu countries the European union is responsible for the trade policy of its member countries. Based on the Eu Treaties no individual member government can enter bilateral trade agreements with non-Eu trade partners. Therefore Eu member states practice similar trade policies. More divergence in other areas reflects more leeway in Eu member state legislation, most pronounced in the divergences in areas 1 and 2, but also in area 5.

Figure 4 shows the distribution of ratings for all 28 Eu member countries for all five areas. In areas 1 (size of government ) and 2 (legal system and property rights) the highest and lowest ratings differ and the countries scatter more around the median value than in areas 3, 4 and 5. Here the ratings of the majority of the Eu member countries resemble each other and they are almost identical in the case of monetary policy.

8,7 8,6

8,5 8,4

8,2 8,2

8,1 8,1 8,1 8,0

8,0 7,9 7,9 7,9 7,9

7,8 7,8 7,8 7,7

7,7 7,7 7,6 7,6 7,6 7,6 7,6

7,4 7,4

0 1 2 3 4 5 6 7 8 9 10


NetherlandsFinlandEstonia

DenmarkLuxembourg

MaltaLatvia

BelgiumFrance

Czech Rep.PortugalSweden

Slovak RepGermany

AustriaRomania

SpainCroatiaCyprus

HungaryItaly

LithuaniaGreece

BulgariaSlovenia

Poland

d) Area 4: Freedom to trade internationally

7,9 7,9 7,9

7,8 7,8

7,7 7,7 7,7

7,6 7,6 7,6 7,6 7,5 7,5 7,5 7,5

7,4 7,3 7,3

7,1 7,1

7,1 7,0

6,8 6,7

6,6 6,5

5,7

0 1 2 3 4 5 6 7 8 9

BulgariaSweden

DenmarkEstonia

LithuaniaCzech Rep.

RomaniaBelgium

United KingdomMalta

FinlandLatvia

IrelandNetherlands

HungaryPoland

LuxembourgItaly

Slovak RepGermany

AustriaFranceCroatiaCyprus

PortugalSpain

SloveniaGreece

e) Area 5: Regulation


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Figure 4a-c: Economic Freedom Summary Index 2012, EU28, EU 15 and new EU member countriesSource: Fraser Institute, Economic Freedom of the World: 2014 Annual Report.

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looking at the differences between Eu15 members and new member states (Figures 4b and 4c) it is obvious that the distribution of ratings between both groups differs only in some areas. The size of government (area 1) tends to be smaller in new member states. In contrast the legal system and the protection of property rights (area 2) are less developed. In areas 3 and 4 new member states also tend to be a little less free than Eu15 members. Regarding the regulation of the capital market, the labor market and business, new member states tend to be freer than Eu15 member states.

A comparison between economic freedom of Eu members and Top-10-Countries in the EFW-Ranking shows that Eu member states are on average economically less free. The only exception is monetary policy. A remarkably large difference can be seen in area 1 where the mean rating differs almost two points between Eu members and the Top-10-Countries (table 1). Notably different is also the mean rating in areas 2 and areas 5. Eu member states seem to be characterized by bigger government, a weaker legal system, less secure property rights and more regulation than countries in the Top-10-Group.


Table 1: Economic Freedom Area Ratings for Top-10-Countries and EU28 member states

Country Area 1 Size of Go-vernment

Area 2Legal System and Property Rights

Area 3Sound Money

Area 4Freedom to Trade Internatio-nally

Area 5Regulation of Credit, Labor and Business

Eu28

Mean

Maximum

Minimum

5,4

7,4

3,6

6,9

8,9

5,0

9,4

9,8

8,2

7,9

8,7

7,4

7,3

7,9

5,7

Top-10

Mean

Maximum

Minimum

7,3

9,4

4,9

7,8

8,9

6,5

9,2

9,7

8,4

8,2

9,4

7,2

8,1

9,0

7,2

Source: Fraser Institute, Economic Freedom of the World: 2014 Annual Report, own calculations.

looking at the relationship between economic freedom and income per capita in the Eu, figure 5a shows a positive but weak relation for Eu28 member states as well as Eu15 member states (figure 5b). For the new member states the picture is even less clear, illustrating a slightly negative correlation between per capita income and economic freedom (figure 5c). While the least free country in the European union, Slovenia, has the third highest per capita income of all new Eu member states, Romania, the second poorest country, has a rating about one index point higher. Given the relatively small divergence of economic freedom between the Eu members, other factors like population size, economic structure, infrastructure or even geography similarly affect income differences across the European union. Numerous studies have analyzed this relationship in detail, whi-le controlling for other factors. They have found that countries with higher and improving economic freedom generally achieve higher levels of per-capita GDP (see Hall and lawson, 2014).


Figure 5 a-c: Economic Freedom and income per capita for the EU member states

Note: GDP per Capita, (PPP constant 2011 uS$), 2012, line depicts linear trend function.

Source: Fraser Institute, Economic Freedom of the World, 2014 Annual Report, World Bank, World Development Indicators.

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Economic Freedom in the Europe Union over the years

On average, the world is economically freer today than it was three decades ago (figure 6a). Today, more than 75 percent of the 101 countries with continuous ratings since 1980 have a higher degree of economic freedom than the top 25 percent in 1980. Most of the increase took place during the 1980s and 1990s. In principle this also applies to the European union.

Figure 6b shows the distribution of the chain-linked economic freedom ratings for the Eu15 member countries since 1980. In 2012, all Eu15 member states were within the range of the countries listed in the top quartile in 1980. After 2005 the ascent of the median rating of economic freedom in the European union as well as in other developed OECD countries came to a halt and declined (figure 7b and c). Most non-Eu OECD countries are freer than Eu15 countries but the coun-try ratings are generally more dispersed. In addition the decrease of the median of economic freedom ratings in reaction to the global recession in 2008-09 was more distinct in non-Eu OECD countries.

Since then the median of economic freedom ratings in non-Eu OECD Countries slightly increased while the erosion of economic freedom in the Eu seems to per-sist. The convergence of the economic freedom ratings over the years is surely

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the result of the institutional integration of Eu member states. For the new Eu member states the accession to the Eu went along with more economic freedom (figure 6d). After 2005, the economic freedom median increased only slightly. To-day more than 75 percent of the new Eu members are economically freer than the freest quartile before the accession to the Eu.

Figure 6 a-c: Economic freedom chain-linked summary ratings from 1980 to 2012

Note: Croatia is not included because it joint the Eu in 2013Source: Fraser Institute, Economic Freedom of the World, 2014 Annual Report, World Bank, World

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Conclusion

Over the years, economic and political integration in the European union has been influential for economic freedom in Europe. Despite the increasing centrali-zation of political decision making and shrinking political independence of the Eu member states in legislative matters, they still maintain an above average level of economic freedom. Even if the Eu member states, with the exception of Fin-land, do not belong to the Top-10-group of the Economic Freedom of the World Index 2014, most Eu countries qualify for the top quartile of the Index. Most Eu countries as well as other developed countries suffered a noticeable loss in eco-nomic freedom after the global recession in 2008-09. Governments across the globe reacted to the crisis with more public spending, expansive monetary poli-cy and stricter business regulation. In contrast to other developed countries the creeping erosion of economic freedom in the Eu seems to continue. The conver-gence of economic freedom ratings across Eu member states clearly reflects the harmonization of economic and political institutions across Europe. At best this stabilizes economic freedom and prevents member countries to step out of line and practice more interventionist policies. At worst it turns out to be an impedi-ment to implement market reforms, to limit government intervention and reduce public spending in individual countries.

Literature

Gwartney, James, Robert lawson, and Joshua Hall (2014). Economic Freedom of the World, 2014 Annual Report. Fraser Institute.

Hall, Joshua, and Robert lawson (2014): Economic Freedom of the World: An Accounting of the literature. Contemporary Economic Policy 32, 1: 1-19. http://onlinelibrary.wiley.com/doi/10.1111/coep.12010/abstract.


Does the European Union Promote Convergence in Economic Freedoms?

Danko Tarabar and Andrew T. Young, West Virginia University

Introduction

In 1958 the Treaty of Rome established the European Economic Community (EEC), or what later became known under the Treaty of Maastricht in 1993 as the European union (Eu). Initially the EEC included only 6 countries (Belgium, France, Italy, luxembourg, the Netherlands, and West Germany). Today, the Eu consist of 28 member states.

The underlying goal of the EEC and, in turn, the Eu is to create a common market amongst its members. As part of an economic union, Eu countries share a customs union and a uniform trade policy. Goods, capital, and individuals can move freely across borders within the Eu. And as part of a political union members work through shared institutions such as the European Council, the Council of Ministers, the European Commission and the European Parliament to collectively set policy.

Given the high level of integration amongst Eu members, jurisdictional competiti-on along independent policy margins may be particularly effective. Tiebout (1956) showed that jurisdictional competition tends to lead towards efficient policy en-vironments, and that tendency is only limited to the extent that individual go-vernments can extract rents from fixed factors (Epple and Zelenitz, 1981). Highly integrated markets and the mobility of capital and labor work to minimize this limitation on the tendency towards more efficient policy environments.

Many economists suggest that an environment of economic freedom is conducive to good economic outcomes (e.g., Gwartney, lawson, and Holcombe, 1999). In par-ticular, numerous studies have reported a positive relationship between the Fraser Institute’s Economic Freedom of the World (EFW) index and economic outcomes in cross country samples. These outcomes include income levels and growth rates, life expectancies, and measures of subjective well-being. (See Hall and lawson (2013) for a recent survey of these studies.) One would expect that jurisdictional competition, all else equal, leads governments to adopt policies and institutions that raise their EFW scores. In this paper we explore whether or not Eu member-ship leads to increases in and/or convergence across European EFW scores.


In addition to jurisdictional competition, Eu membership is awarded to those Euro-pean countries that meet the Copenhagen Criteria, which stipulate the conditions of accession. These conditions necessitate the existence of democracy and rule of law, a functional market economy able to compete in the common Eu market, and the capacity to adhere to Eu obligations and policies (e.g., the common monetary policy of the Eurozone). The very criteria for Eu membership, then, to some extent set a new member on a path towards greater economic (and political) freedom.

We study an unbalanced panel of up to 42 European countries and relate Eu mem-bership to changes in EFW scores over 5-year intervals (1970-1975; 1975-1980; ...; 2005-2010). We report that Eu membership is associated, all else equal, with an increase in the 5-year change in a country’s EFW score of about 0.174 points. (The EFW index is on a scale of 0 to 10 with 10 being most free; the standard deviation in our sample is about 1.091.) This is a modest (though statistically significant) effect and is consistent with results reported by Hall and lawson (2011).

Alternatively, we also relate Eu membership at the beginning of a 5-year period to the gap between a country’s end-of-period EFW score and the highest EFW in the sample. We find no statistically significant relationship between Eu membership and convergence in economic freedom levels. Taken together, our results suggest that Eu-based jurisdictional competition has modest to no discernable effects on the cross-country distribution of economic freedom in Europe.

Data

The dependent variables in our study are the change in the EFW score (FREE-DOM) over a 5-year interval (FREEDOM – FREEDOM(-1)) and two measures of convergence in economic freedom scores. The first measure of convergence that we examine is:

CONVERGE_1 = (FREEDOM – FREEDOM(-1))/(LEADER(-1) – FREEDOM(-1)).

The above is the change in a country’s freedom as a percentage of the initial gap between the leader country’s EFW score (lEADER) and its own EFW score. The second measure that we consider is:

CONVERGE_2 = (LEADER – FREEDOM)/(LEADER(-1) – FREEDOM(-1)).

This second measure is defined, for a 5-year period, as the end-of-period gap re-lative to the initial gap.


The EFW annual report ranks countries according to their degree of economic free-dom, which broadly implies the “freedom of personal choice, voluntary exchange, freedom to compete, and security of privately owned property.” The report uses 42 variables to examine five different dimensions of economic freedom, which all weigh equally in constructing the overall economic freedom index. These dimen-sions are: (1) size of government, (2) legal system and property rights, (3) access to sound money, (4) freedom to trade internationally, and (5) the degree of regu-lation in the economy. In Europe (and around the world) the leaders in economic freedom have traditionally been smaller states: luxembourg, Switzerland, and Ireland, with EFW scores ranking anywhere from 8.01 to 8.63 depending on the year of observation.

In our analysis we also control for outcome measures often thought to be corre-lated with admission criteria. In particular we control for (i) initial EFW scores, (ii) real GDP per capita growth, (iii) the Polity IV index, (iv) (natural log of) population size, (v) NATO membership dummy, and (vi) Eu membership dummy. All regressions also include country fixed effects and either a linear time trend or time period dummies. See table 1 for a summary statistics of regression variables.

Table 1. Regression variables summary statistics, 1970-2010.

Variable No. of Mean Std. Dev. C.O.V. Min Max Observations

FREEDOM 270 6.687 1.091 0.163 3.030 8.630

log(POP) 401 15.723 1.466 0.093 12.228 18.814

PC_RGDP growth 279 0.110 .233 2.076 -94.1% 211.8%

DEMOC 383 3.801 7.428 1.954 -9 10

NATO 305 0.501 .500 .998 0 1

Eu 304 0.421 .494 1.173 0 1

The Polity IV Project (Marshall, Gurr, and Jaggers 2013) ranks the governing aut-hority spectrum according to a regime’s “competitiveness of political participation, regulation of participation, openness and competitiveness of executive recruitment, and constraints on the chief executive.” It is a composite measure of democracy set on a scale from -10 (hereditary monarchy) to +10 (consolidated democracy),


with higher scores denoting more democratic regimes. A high Polity IV score is thus likely associated with the adherence of the political criterion of accession.

Population size can have an impact on the Eu integration process because the larger the potential entrant the higher the costs of absorption into the Eu com-mon market. Population is measured in millions of people. Real per capita income is measured in constant 2005 u.S. dollars. The data on income and population is gathered from the World Bank’s World Development Indicators.

We obtain NATO and Eu membership data from the organizations’ respective of-ficial websites. All but four traditionally neutral Eu countries (Sweden, Austria, Ireland, and Finland) are also NATO members. While membership in NATO is not a formal criterion for joining Eu, a vast majority of entrants became a part of NATO before joining the ranks of Eu. The Eu puts a strong emphasis on the stra-tegic partnership between the two organizations, and joining NATO serves as an important signal for Eu administrators that the potential entrant has reached a certain level of political and economic stability.

Some caveats are in order. The political landscape of the European continent has much changed between 1970 and 2010, which warranted our special attention in constructing our dataset. For instance, the former Soviet republics inherit the uSSR‘s Polity IV index in the period 1970-1990. Soviet satellite states, however, do not. Similarly, the former Yugoslav republics inherit the Socialist Federal Re-public of Yugoslavia‘s Polity IV index for observations 1970-1990. The EFW and World Bank classify Germany and West Germany as one country (“Germany”) from 1970 onward. The Polity IV data for the country mimics those of West Germany through 1990, and Germany’s between 1990 and 2010.

Results

Table 2 reports some summary statistics for European EFW scores within each of the time periods that constitute our sample. The number of countries scored by the Fraser Institute has increased over time, such that the number of countries for which EFW scores are available increases from one time period to the next, and from 19 in 1970 to 44 in 2010. That being said, one notes that the average EFW score has been, in general, increasing. The maximum score recorded across European countries has not changed much (8.01 in 1970 versus 8.31 in 2010) while, alternatively, the minimum score has rose markedly (from 3.65 in 1970 versus 5.90 in 2010).


Table 2. European Economic Freedom of the World index summary statistics, 1970-2010.

Year Countries Mean Std. Dev. C.O.V. Min Max

1970 19 6.578 1.025 0.156 3.65 8.01

1975 20 5.940 1.099 0.185 3.80 8.48

1980 22 6.131 1.081 0.176 3.72 8.05

1985 25 6.167 1.113 0.180 3.70 8.39

1990 26 6.438 1.280 0.199 3.54 8.21

1995 35 6.372 1.347 0.211 3.03 8.26

2000 35 6.999 0.964 0.138 5.15 8.63

2005 44 7.248 0.640 0.088 5.81 8.37

2010 44 7.235 0.492 0.068 5.90 8.31

Notes: maximum EFW scores were Ireland (1995), luxembourg (1970, 1975, 1980, 1985), and Switzerland (1990, 2000, 2005, 2010).

The rising minimum score with a relatively constant maximum score might sug-gest that the distribution of EFW scores has been tightening from 1970 to 2010. The standard deviations and coefficients of variation support this suggestion. The standard deviation of European EFW scores was 1.025 in 1970 and had decreased to 0.492 by 2010. Since the average was rising over the 1970-2010 period, the coefficient of variation fell more markedly (from 0.156 in 1970 to 0.068 in 2010). The picture across Europe is one of a distribution of economic freedom tightening around an increasing mean. This characterization is still apt while looking only at the 1990-2010 period when over 25 countries are observed for each year.

In table 3 we report the results of OlS regressions of changes in economic free-dom (FREEDOM – FREEDOM(-1)) on various controls and either a time trend (co-lumns 1 and 2) or period dummy variables. In all regressions country fixed effects are included. The control variable of interest is the dummy variable which takes a value of 1 if a country is in the Eu; 0 otherwise (Eu). The column 1 regression in-cludes the initial level of economic freedom, the initial (log) population level, and the growth rate of real GDP per capita as additional controls. The Eu coefficient


estimate is positive and statistically significant at the 10 percent level. When the initial level of the Polity IV score (DEMOC) and the NATO dummy variable (NATO) are added (column 2) the Eu coefficient estimate increases from 0.155 to 0.206 and becomes statistically significant at the 5 percent level. Results are largely unchanged when the time trend is replaced by period dummy variables (point estimate = 0.174; statistically significant at the 5 percent level). The R2 for this last specification is the largest (0.653) so we will treat this as our preferred set of results. Based on those results, being part of the European union leads to in-creases in a country’s EFW scores by an additional 0.174 points over 5 years. The standard deviation of EFW scores across our entire sample is 1.091 so this is a very modest effect. Indeed, it would take over 30 years for the cumulative effect to equal that standard deviation value.

In table 4 we consider two measures on convergence in cross-country freedom scores, both based on country EFW scores relative to that of the leader (i.e., highest EFW score) country in a given time period. If the Eu enhances jurisdic-tional competition, then we expect that a country’s membership will increase its CONVERGE_1 and decrease CONVERGE_2 (as it is defined at the end-of-period gap relative to the initial gap).

Across the board, however, we find no significant relationship between Eu and these convergence measures; no evidence that the European union enhances ju-risdictional competition and leads to a tighter distribution of economic freedom scores. Of course, as table 2 evidences, there has been a tightening of the distri-bution of EFW scores across Europe during the 1970-2010 period. Based on the data, however, it is difficult to attribute this to the economic and political inte-gration that characterizes the European union.


Table 3. Fixed effects OLS regressions of changes in economic freedom on European Union membership.

Dependent Variable FREEDOM – FREEDOM(-1) (1) (2) (3)

Eu(-1) 0.155* 0.206** 0.174**

(0.083) (0.091) (0.082)

FREEDOM(-1) -0.686*** -0.694*** -0.606*** (0.076) (0.068) (0.102)

log(POP(-1)) 0.660 0.555 0.290 (0.546) (0.546) (0.597)

log(PC_RGDP)- log(PC_RGDP(-1)) 1.706*** (0.402) (0.379) 1.806*** (0.291) 1.492***

DEMOC(-1) 0.044*** 0.039*** (0.010) (0.011)

NATO(-1) -0.102 0.009 (0.116) (0.132)

TIME_TREND 0.196*** 0.165*** (0.057) (0.051)

F-stat. (Country Effects) 1.935*** 1.844*** 1.270

Period Dummies No No Yes

Countries 42 39 39

Observations 219 204 204

R2 0.337 0.453 0.653

Notes: *, **, and *** denote, respectively, significance at the 10, 5, and 1 percent levels. Standard errors are in parentheses and are clustered by countries. Fixed period effects and fixed country effects are included in all regressions unless explicitly noted otherwise.


Table 4. Fixed effects OLS regressions of economic freedom convergence ratios on European Union membership.

Dependent Variable CONVERGE_1 CONVERGE_2 (1) (2) (3) (4) (5) (6)

Eu(-1) 0.191 0.090 -0.004 -0.157 -0.019 0.009 (0.278) (0.189) (0.109) (0.315) (0.240) (0.109)

FREEDOM(-1) -0.647*** -0.686*** -0.460** 0.786*** 0.854*** 0.640*** (0.143) (0.177) (0.185) (0.221) (0.265) (0.235)

log(POP(-1)) -0.147 0.347 -0.215 0.605 0.072 0.335 (0.910) (1.137) (1.370) (1.124) (1.292) (1.460)

log(PC_RGDP)- log 2.826** 2.868*** 2.343*** -2.621*** -2.74*** -1.893**(PC_RGDP(-1)) (1.147) (1.046) (0.780) (0.780) (0.683) (0.886

DEMOC(-1) 0.001 -0.006 0.005 0.008 (0.022) (0.019) (0.026) (0.023)

NATO(-1) 0.317 0.492** -0.504* -0.449* (0.222) (0.202) (0.262) (0.262)

TIME_TREND 0.250* -0.350* (0.150) (0.180)

F-stat. (Country Effects) 1.185 1.142 0.819 0.932 0.968 0.754

Period Dummies No No Yes No No Yes

Countries 42 39 39 42 39 39

Observations 211 196 196 211 196 196

R2 0.287 0.299 0.347 0.340 0.360 0.436

Notes: *, **, and *** denote, respectively, significance at the 10, 5, and 1 percent levels. Standard errors are in parentheses and are clustered by countries. Fixed period effects and fixed coun-try effects are included in all regressions unless explicitly noted otherwise. CONVERGE_1 is defined as (FREEDOM – FREEDOM(-1))/(LEADER(-1) – FREEDOM(-1)) where lEADER is the highest EFW country score in a given period. CONVERGE_2 is defined as (LEADER – FREEDOM)/(LEADER(-1) – FREEDOM(-1)).


Conclusions

Economic freedom has been positively linked to higher income levels and growth rates, longer life expectancy, and subjective perceptions of well-being. One bene-fit of the economic and political integration associated with the European union, then, may be the promotion of jurisdictional competition leading to policy reforms than increase economic freedom in individual members and lead to convergence in freedom levels across members.

In this paper we have studied a panel of 42 European countries and estimated the relationships between Eu membership and (a) changes in a country’s eco-nomic freedom and (b) the rate at which a country’s freedom level converges to that of the leader country. In the case of the former, we find that Eu membership is associated, all else equal, with an increase in the 5-year change in a country’s EFW score of about 0.174 points. (The EFW index is on a scale of 0 to 10 with 10 being most free; the standard deviation in our sample is about 1.091.) This is a small effect. In the case of convergence rates, we find no statistically significant effects at all.

As a matter of fact, economic freedom levels have increased meaningfully throughout Europe during the 1970-2010 time period. Also, the dispersion of freedom levels across European countries has decreased. However, from the data it is difficult to attribute these trends to jurisdictional competition fostered by the Eu. One possibility is that the reforms associated with a country’s accession period are more meaningful contributors to economic freedom than actual mem-bership. In this case, our results are encouraging to the extent that we find mo-dest gains, and certainly no backslide, in economic freedom once Eu membership has been acquired.

Literature

Epple, D., Zelenitz, A. 1981. The implications of competition among jurisdictions. Journal of Political Economy 89, 1197-1217.

Gwartney, J. D., lawson, R., Holcombe, R. G. 1999. Economic freedom and the environment for economic growth. Journal of Institutional and Theoretical Eco-nomics 155, 643-663.

Hall, J. C., lawson, R. A. 2011. The European union and economic freedom. Global Economy Journal 11, 1-14.


Hall, J. C., lawson, R. A. 2013. Economic freedom of the world: an accounting of the literature. Contemporary Economic Policy 32, 1-19.

Tiebout, C. M. 1956. A pure theory of local expenditures. Journal of Political Economy 64, 416-424


France: Economic Freedom at the Mercy of a Dysfunctional Democracy

Emmanuel Martin, Director at the Institute for Economic Studies – Europe, Paris

1. Introduction

1.1. “Institutional quality” and economic freedom

Economists, back to Turgot and Adam Smith up to the institutional school today, have pointed at the role of institutions and the institutional framework for eco-nomic development and growth. Growth of economic activities evolves very much in an organic way, with industries arising from specialization and then develo-ping, giving rise to more specialized activities and so on. The movement of this growth is entrepreneur-driven and requires some form of coordination for the vast competitive division of labor and knowledge underpinning it to actually operate. Coordination itself pre-supposes the resolution of two major problems of human interaction: the problem of information and the problem of incentives.

The recognition that good institutional frameworks should provide the incentives and information-generating channels for people to engage in productive activi-ties and specialize – and thus generate growth – is a major message of sound economic analysis. Policy-making should thus be largely devoted to the search of “institutional quality” to provide such a framework. Grasping such “institutional quality” is not an easy task though, especially given different cultural and histo-rical political backgrounds.

The Economic Freedom of the World Index is probably the best measure of insti-tutional quality in this context. It gives social scientists and policy-makers an overview of the institutional strengths and weaknesses of a country, their evolu-tion through time and comparative performance with other nations. It provides the keys for understanding the level of – or lack of – prosperity in each nation, and consequently points at the opportunities for improvement of the institutio-nal framework.


1.2. “Institutional quality”: the case of France

The index is a very good indicator of the current situation in France for exam-ple. In 2012 the country lost 18 places in the ranking, from 40th out of 152 to 58th. The main drives for this ranking are the “Size of government” component, at 114th and “Regulation” component, at 74th, on which we shall focus in the va-rious sections.

The idea in this paper is to give a more contextualized, less-quantifiable, explana-tion of the lack of economic freedom in France, by analyzing some of its “in depth” institutional infrastructure: the political, administrative and social models. The argument is that France’s “dysfunctional democracy” (to use a loose expression) produces mechanisms that very often go against economic freedom.

using the adjective “dysfunctional” here probably sounds like another French-bashing slogan. Indeed, the trend has become fashionable lately. The French Prime-Minister even said it was unbearable. Yet, is it undeserved? True, the coun-try enjoys a privileged location in Europe, with an efficient infrastructure and so-mewhat productive human capital. However, as many entrepreneurs can testify, France has become quite off-putting for creative people.

There are several ways in which the French democracy has become dysfunctio-nal – consequently leading to less economic freedom. Accountability of political power is lacking, with a direct effect on over-spending and production of complex rules: a bicephalous executive, a weak Parliament and an untamed administration are important causes of these symptoms. Add to this a complex, often opaque, decentralization process initiated in the 1980’s. Then, the French “social model”, praised like a national treasure, is actually very problematic for economic free-dom and prosperity (but also for the very thing it is supposed to promote: what the French call “solidarity”). Mr Hollande recently launched “pro-business” and “simplification” reforms: will these change the trend?

2. The Grande Nation drifting away

France was described as “the time-bomb at the heart of Europe” by The Econo-mist in late 2012. The characterization was probably not that excessive, especially with hindsight.

At the time, the government undertook a policy of “recovery in justice” that was in fact a policy of semi-austerity: increased taxes and no reduction in public spending.


As predicted by many analysts, it only made the situation worse. This was also a time when new announcements were made regularly, especially about taxation, thus constantly changing the rules of the game. The political and policy fine- tuning” of an obviously amateurish government had devastating effects in terms of “regime uncertainty” on entrepreneurship – and thus on wealth-creation.

In two years, France’s unemployment lines increased by half a million. The official category A numbers are about 3,7 million. All categories represent 5,4 million. 23 percent of the youth is still plagued with unemployment. The famous announce-ments on the soon-to-come “inversion of the unemployment curve”, which had been a promise of François Hollande, ended as a political nightmare for him - and as a very real one for millions.

Economic growth, which was also announced to be just around the corner, has been very sluggish. And without the right incentives for entrepreneurs, one hardly sees how it cannot be so. There seems to have been a lack of understanding that growth – economically sustainable growth that is – is actually generated by en-trepreneurs. Any policy that goes against the incentives of entrepreneurs will go against growth. That many of them are actually fleeing the country should not be a surprise to anyone. A survey by Ifop and Deloitte in November 2014 noted that 27 percent of the young people are ready to try their chance abroad, vs. 13 percent two years ago.

Government spending is now flirting with a staggering 57 percent of Gross Dome-stic Product (GDP). Half of it is related to “social spending”. Official public debt is now at 95 percent of GDP, having just reached the symbolic level of € 2 trillion. Such levels exert a crowding-out effect on the private sector, whilst the latter is the only source of economically sustainable growth. Deficits targets have been systematically postponed since 2009. This year the public deficit will reach 4,4 percent, creating palpable tensions with Brussels and Berlin.

Yet it would be wrong to blame this government for all of France’s economic woes. The former government of Nicolas Sarkzoy is also largely to blame. The “reformer”, so-called “liberal” President, soon turned into a zealous Keynesian. He increased public spending from 52 to 56 percent of GDP. Debt went from 64 to 88 percent of GDP, adding an extra € 600 billion on the shoulders of the future tax payers. Many of the “reforms” of Mr Sarkozy ended up being either more costly or entren-ching vested interests even more (Cahuc & Zylberberg, 2010). They probably had less to do with substance than with the promotion of the political prestige of an “over-communicating” President.


But as, will be argued here, neither Mr Sarkozy nor Mr Hollande are sole respon-sible for the situation. “It’s the system, stupid” one is tempted to say. A glance at the “system” should indeed show how reforms in favor of economic freedom can only been achieved through a radical change of the “deep institutional” level of the country. Otherwise, it would only amount to cosmetics.

3. Public spending: Where is the French Parliament?

The Parliament is probably the most important institution in the “democratic con-tract”. Its duty is not only to vote laws but first of all, to control the government and the administration, and especially to control their spending. It is supposed to represent not just the “citizens”, but also the citizens as tax payers. Its role is thus to carefully scrutinize budgets, proposed and actual, and to help correct trends of mismanagement of “other people’s money” (Martin 2014). It should push for more transparency, more accountability and better governance of such money. In this respect, the French Parliament is quite disappointing. Clearly, it is a weak institution. What are the reasons for this state of affairs in the country of the 1789 Revolution?

France’s constitution of 1958, though firstly drafted in 1946, re-emerged at a very special time, when the Fourth Republic’s constant government instability ended in a final crisis and was designed for one man, General de Gaulle. Instead of a regime in which the Parliament was strong but ineffective given constantly changing coa-litions (the Fourth Republic), the Fifth Republic offered a strong executive. Despite its label as parliamentary regime, it has a strong presidential component. We thus find an “organic defect in the constitution of the Fifth Republic: it is a hybrid of the parliamentary system and the presidential system” (Revel 1993: 22). Except in – rare – times of cohabition between a President and an opposition Parliament, the country is ruled by some sort of “Presidentocracy” (ibid.: 15).

The fact that the executive power is bicephalous is not without serious issues either. The Prime minister is appointed by the President - not the Parliament. The Prime minister plays the role of a “fuse” in case the political situation turns bad. The result is that when things go well the President can be praised, and when things go sour, the Prime minister is blamed. This is the perfect recipe for lack of accountability and goes against the logic of democracy. And as Revel noted such a system does not even promote the supposed “efficiency” that it is often thought of enabling. Worse, by institutionalizing the lack of accountability it instils a men-tality of “I spend, therefore I am” (ibid.: 103), a mentality that is duplicated at the head of each of the layers of the French government.


In the face of this hypertrophy of the executive and of its spendthrift tendencies what is the Parliament doing? Despite “reforms” over decades, the French Par-liament remains an organ without strong power. It is not protecting economic freedom.

Besides its actual dwarfing by the constitution, the French Parliament does not have the means to control spending. There are parliamentary commissions of course. But unfortunately, the possibility for Members of Parliament to cumulate mandates in the various layers of the government is a serious obstacle to an effective Parlia-ment. Indeed, its “special reporters” are very often at the same time mayor or pre-sident of region for example and thus can only dedicate a limited amount of their time to researching the issues. They are probably not even competent in auditing such and such fields. They only have a few administrators to rely on, sometimes not even one full time. And they have to audit billions of euros of spending. It is simply impossible for them to do their job. (Mathieu, 2008: 118-120)

Also, the fact that the MPs control the administration with the help of people from the administration is problematic: it is an obvious conflict of interest. This conflict of interest is even greater when one looks at the sociology of the Parlia-ment: during recent legislatures, half of the MPs could either be civil servants or come from the public sector. It is hard to think that these people are not biased when they have to control their colleagues.

A solution would be to use the services of private audit companies. But this has been consistently refused by the honourable members of the venerable institu-tion, when one MP would suggest the idea (Mathieu, 2008: 118-120). (It can be done but should remain an exception)

Here the role of the French audit office is quite telling. The Cour des Comptes pro-duces very good reports on many subjects related to public finances and policies. But its mission is to inform the public about the conformity of public spending with the law, not to directly reform the administration. Of course at the same time it makes recommendations, but they are not constraining in any way. And those recommendations cannot be “too political” otherwise the administrati-on knows how to answer by recalling that “such reforms will have an uncertain outcome” – a diplomatic way to mean “strike” (IREF, 2014)… Then, the Cour is a body outside Parliament and its magistrates do not want to be an instrument of the Parliament. The result is that its reports are gathering dust on some obscure shelves in an obscure office…


One is of course left with the impression of a gigantic missed opportunity to use its work efficiently within Parliament to reform the country. unfortunately, the separation between a body with the power to control (the Parliament) from a body with the means to control (the Cour des comptes) insures that inefficiency in public spending remains…

The Parliament is thus a good place to understand how accountability in French politics is a mirage – an important explanation in the country’s level of econo-mic freedom.

4. French administration and decentralization: anti-democratic

The French administration is well known for its culture of opacity and complexity. It seems to have a life of its own, away from any form of coercion from the part of either the legislative or the executive. It should be added in the list of tradi-tional powers. Even a Minister cannot “touch” it without losing her mind or her seat (Verdié-Molinier 2013: 29-41).

The complexity of the administration has made it look like a spaghetti bowl, a big ball of wool from which “pulling a thread” usually leads to unintended conse-quences. Interconnections and complementarities between services and admini-strations have helped ensure that any reform would turn into a headache. When reform is finally possible, subtle bureaucratic mechanisms of adaptation can end up torpedoing the initial goals of the reform.

For example, France has about 37,000 municipalities, which accounts for 40 percent of all municipalities in the European union. Given this huge number of “communes,” it was decided to incite them to regroup in order to cut costs: that is the “inter-communality” process launched in 1960’s. Except their number re-mained the same. What the process did was to add an extra layer of government: “inter-communalité”. New staff was hired. New spending was decided. Costs were not cut overall.

Another problem is the number of civil servants. About 5 million, but exactly how many, we’re not sure – which gives an idea of the level efficiency of the admi-nistration.

A report in 2009 by the Cour des Comptes showed that the number of French civil servants grew by 36 % between 1980 and 2008 – twice the rate of job growth in the rest of the economy. The decentralization launched in the 1980s led to a 71 %


increase in local government headcounts. unfortunately there was no correspon-ding decrease in central government: the number of its civil servants increased by 14 % during the same period.

Decentralization à la française has been a lesson not to follow. It started with a good idea: France was too centralized and it needed more local flexibility and adaptation to local circumstances, and certainly more local democracy. unfortu-nately, the decentralization process, paradoxically, operated in a very centralized fashion, leading to unintended consequences.

Exactly as at the national level, local democracy requires accountability to function efficiently. unfortunateley, from 1982 onwards, when France began to increase the layers of sub-national government administration, decentralization opened the door for local politicians and administration to escape accountability.

First, by adding complexity. The struture of the French administration looks like a millefeuille cake, layered with the commune, the syndicate of communes, inter-communalities, sub-regional councils, regional councils and then the central ad-ministration (and then Brussels…). Though some of the decentralized layers have clear missions, most can engage in various areas of policy, thanks to a “general clause of competence,” from unemployment to development, instead of having strict administrative specializations and differentiation. Some regions thus create their own “embassies” abroad for example… Such duplication is costly.

Secondly, financing for projects also runs across layers of government: in such a system no one is accountable for public spending at various levels. None of these layers enjoy fiscal autonomy: despite a recent drop in endowments from the cen-tral government, sub-national “collectivités” still receive nearly a third of their funding from the central government, rather than directly from local taxpayers. Of course, using “other people’s money” to finance local political demands is not the best incentive to carefully manage finances. For too many French voters, someone else will always pay for their local politicians’ promises – and very often there have been many promises to “buy the local electorate”. The crucial link bet-ween citizens’ taxes and the services they receive from their local governments is broken. This general lack of accountability minimizes pressure on officials to control spending.

Decentralization has in fact turned into a new sort of “local corporatism” where the interests of local bureaucracy can be in harmony with those of the local poli-ty, as in the regional and departmental councils. Worse, as the “general clause of


competence” has enabled local governments to increase their interventionism in the economy, they have made a whole part of the local private economy depen-dent on public money, from NGOs to businesses. local cronysm fed with a lot of “other people’s money” now represents vested interests constituting an effective coalition to “defend their share of the cake”.

local democracy can be stimulated by federalism, which is a bottom-up process respecting the subsidiarity principle and thus maximizing accountability and taming public spending through the institutional competition it generates. Provided it is more generally embedded in a framework of rule of law, it is thus very much promoting economic freedom. French decentralization is nothing of the sort. It is a top-down process, without real local autonomy or institutional competition. It produces a lack of accountability and yet another possibility to live off other people’s money, pushing for more spending, and leading to a sort of “corporatism” that is in fact very similar to that produced by France’s social model.

5. France’s “social” model: anti-social, anti-economic

In their enlightening book on “mistrust” in France, Algan & Cahuc (2007: 42-78) follow the steps of Tocqueville, Peyrefitte or Fukuyama on the origins of the lack of trust in some societies, and its consequences on economic efficiency and ability to reform. By taking Algan & Cahuc analysis to its logical conclusion, one can only bemoan that the French social model is not only anti-social, but anti-economic. Much of the lack of economic freedom in the country is actually linked to this so-called social model.

The French social model is conservative (as opposed to social-democratic or libe-ral). And conservative social models are typically associated with corporatism and dirigisme or statism. “Corporatism, the granting of social rights on the basis of status and occupation, has institutionalized the segmentation of social relations. It creates an entanglement of measures specific to each status, and promotes rent-seeking and maintains mutual suspicion. Statism, which consists in regulating all economic and social domains in fine details, ends up emptying “social dialogue” of its content, hinders competition and promotes corruption”. (ibid.: 42).

The centralization of power through strong statism, combined with strong corpo-ratism means that most social spending will be channeled through government or public bureaucracy – instead of simply remaining at each corporation’s level. Such welfare models in which social rights are centrally granted according to status or political favors, are very much unequal (with various public pension systems


granting very different benefits for instance). A paradox in the country of Liberté, Égalité, Fraternité… Such a system has multiple negative effects and initiates a vicious circle which is crucial to understand, as it generates some of the psycho-logical roots then accounting for the lack of economic freedom.

As it institutes a permanent competition to receive the favours of the Prince, such a system generates mutual suspicion, envy, defiance and mistrust, thereby eroding social capital (France has been labelled “the mistrust society” by Algan & Cahuc). This in turn has ripple effects.

Voluntary institutions of civil society, which form a crucial aspect of “horizontal” democracy and which should constitute its social fabric, are simply bypassed or neutralized: their existence is confined to a vertical relation with the government. Because of the inability to voluntary financing of horizontal relations, this “third sector” is largely subsidized, adding to public spending. The sizable number of people working in that sector then represents constituencies having an interest in increasing public spending – reducing economic freedom.

In a “society of mistrust” what the French call “social dialogue” becomes nearly impossible. This is extremely important for labour market relations when negot-iations need to be made. These transaction costs also reduce economic freedom.

As Algan & Cahuc note, the fact that the minimum wage in France is decided by the government (centralization and statism, again) leaves out any serious role for trade unions on the labour market, as politicians usurp their major task. The crisis of unionism is real. Employee union membership represents only 8 percent of the workforce, and mostly in the public sector. This very low unionisation rate contrasts with the wide powers that the few unions enjoy as official “social part-ners”, not only in social negotiations but also in the management of a host of social security institutions and their billions of euros. Because unions do not have to live on the membership fees of their members, they are partly financed by tax payers’ or companies’ money. Going on strike on other people’s money is always easier: such incentives do not promote a culture of negotiation, but a culture of conflict much more prone to general strikes that can take the country or a region’s infrastructure in hostage.

Trust is like lubricant in the gears of a market economy. It reduces transaction co-sts. Mistrust is always quite problematic for the acceptance of a market economy. Markets suppose contracts and thus to a certain extent, the ability to trust other parties. The traditional anti-market mentality in France is very much correlated


to its national tendency to mistrust. Mistrust is a very good soil for anti-market and anti-competition programs and regulations. Protectionism and colbertism have indeed been an ideological tradition in French politics, and a main drive for the country’s bloated regulation. Again, this is not good news for economic freedom.

Finally, this combination of individual and corporatist selfishness and mistrust is a huge obstacle when a country needs to reform itself. If citizens are not able to sit around a table to discuss priorities, or if any corporation will block the country if its privileges are affected, indeed reforming will be hard. We probably have here an explanation of the mechanisms behind why “France is too proud to reform” - as a famous American investor recently noted.

France’s social model is thus not only anti-social, promoting the exact opposite of the cherished value of solidarity, i-e corporatist selfishness, but it is also anti-economic. It generates values opposite to economic freedom and vested interests against reform towards more economic freedom.

6. Hollande’s “pro-business” turn: good news for economic freedom?

Growth needs entrepreneurs. This seems to have been partly understood since the President and his various governments slightly changed their tactics lately, in order to reinstall confidence from the part of businesses. But is this a real turn in favor of economic freedom?

unfortunately, the first strategy consisted in new complex redistribution measures designed to reduce harm made to businesses (such as the Tax Credit for Compe-titiveness and Employment – CICE in French), by compensating for the increase in taxes. Such measures are still very much technocratic in their implementation (making it complicated for small businesses), and, more profoundly, still rely on a misunderstanding of why businesses employ people: an entrepreneur does not create jobs “in counterpart” for less taxes, he or she creates jobs because enough services are demanded to make hiring people profitable.

Then the President turned to the complexity of norms. No less than 400 000 norms are said to exist in France, many of which are simply an unnecessary nuisance to business life. According to the Organisation for Economic Cooperation and Deve-lopment (OECD) these administrative burdens would cost between 60 billion to 80 billion euros (3 or 4 percent of GDP). The place of the ‘burden of government regulation’ for businesses in the World Economic Forum’s 2014 - 2015 competi-


tiveness report is quite significant from this point of view: France is ranked 121st out of 144 countries.

The French government finally realized the vast potential of opportunities for growth that is available in a simplification of the life of businesses, especially in their relations with the French administration. In the spring of 2013 Mr Hollan-de thus launched the idea of a “simplification shock”, in order to get rid of these growth killing norms. unfortunately, after one and a half year, only 100 simpli-fications have been suggested. The government promised savings of € 11 billion. Many analysts doubt the magnitude of the figure: the French think tank IFRAP estimates the savings at € 2 billion.

Interestingly, one important measure designed to simplify the life of citizens con-flicts with transparency. It is the simplification of the pay slip. Given the multitude of welfare agencies to which the French have to pay social contributions, the pay slip has become illegible for someone without a training in accountancy. But the simplification ended not in reducing the number of those various contributions for businesses to process but simply hiding the lines on the pay slip for the wage earner. This obviously obscures the real cost of social security for citizens. Not to mention that a new contribution was added in the process…

Besides, as often in France, it would be “too simple to make things too simple”. Thus, it turns out that concomitantly, new measures will be enforced in 2015 to introduce a “hardness account” for workers exposed to certain hardships at work. The idea is that such workers can accumulate points to use for training, part-time work or early retirement. Yet such a system increases red tape, calculations are complex and will no doubt generate conflicts and new claims.

One thus wonders whether the “simplification shock” is not another communication exercise, to reassure a tired French constituency, but also Brussels and markets. A genuine simplification would be more seriously restructuring and downsizing the complex bureaucracy. Clémenceau was famous for saying that “France is a fertile land: one sows civil servants and grows taxes”. And one should add “regulations” and “red tape”. The bigger the number of bureaucrats, the more complex the divi-sion of labor in the bureaucracy and the more complex its rules. The overstaffing of all layers of government has created a “business of complication” that is very hard to clear now.

To this regard, the recent decision to “clarify” the missions of the various layers of government in the decentralized structure is good news but can only be im-


plemented if the number of civil servants and bureaucrats is downsized. Mr Hol-lande also proposed to halve the number of regions by merging them. But will the number of regional staff be downsized too? This was not clear.

Thus one should not be too optimistic about the “simplification shock” and its ability to promote the kind of economic freedom that France badly needs today.

7. Conclusion

The measure of a nation’s economic freedom is a good proxy for its institutional quality. Here we wanted to give a more historical, cultural and sociological context to the numbers behind the levels of economic freedom in France. The lesson is that a nation is a complex “institutional order” and that the surfacing of indica-tors related to economic freedom very often relate to more “in depth” institutio-nal path dependence. The political, administrative and social models of a country end up with through its evolutionary historical process very much determine to which extent it will enjoy certain levels of economic freedom.

using the French case, we could see to what extent economic freedom can be affected by such models, reminding how things like trust can be both explained by political and social models and then, in turn, explaining a lot of dysfunctional aspects. Yet, to a large degree, all this amounts to how other people’s money” is spent. Governments, parliaments, and unions tend to clash with economic free-dom when they can safely mismanage “other people’s money”. Such dysfunctio-nal democracies have problems at promoting economic freedom. From this point of view, more transparent, accountable democracies should overall increase their levels of economic freedom.

France is often perceived as a nation proud to give lessons. At least, here are les-sons not lo follow from it.


Literature

Algan, Yann & Pierre Cahuc (2007) La société de défiance, Comment le modèle social français s’autodétruit, CEPREMAP, Éditions Rue d’ulm.

Bramoullé, Gérard (2006) Finances et Liberté Locales, librairie de l’université d’Aix-en-Provence.

Cahuc, Pierre & André Zylberberg (2010) Les réformes ratées du president Sarkozy, Champs actuel, Flammarion.

Deloitte/Ifop (2014) “l’humeur des jeunes diplômés 2014”, available on www.deloitterecute.fr

IREF (2104) “les rapports de la Cour des comptes: Beaucoup de bruit pour rien”, October 24, www.irefeurope.org

Martin, Emmanuel (2014) L’argent des autres, les Belles lettres.

Mathieu Alain (2008) Le modèle anti-social français, Éditions du cri.

Revel, jean-François (1993) L’absolutisme inefficace ou Contre le présidentialisme à la française. Press Pocket, Agora.

The Economist (2012) “The time-bomb at the heart of Europe”, November.

Verdié-Molinié Agnès (2013) 60 milliards d’économies! Albin Michel.


Biographies of the authors

Steffen Hentrich is a research fellow at the Liberal Institute of the Friedrich Naumann Foundation for Freedom in Berlin. He studied economics and political science at the Berlin university of Technology. At the Liberal Institute he deals with issues relating to property rights, environmental protection and energy policy. His articles on environmental and energy policy have been published in scientific journals including: Climate Policy, Marine Policy, Zeitschrift für umweltpolitik und umwelt-recht as well as in magazines, newspapers and popular weblogs.

Emmanuel Martin is Director of the Institute for Econo-mic Studies – Europe. He also moderates seminars for the Atlas Economic Research Foundation and for the Friedrich Naumann Foundation for Freedom. He is an expert for Geopolitical Information Service. He has written dozens of Opeds republished in the francophone world, in Europe and the uSA. Martin holds a PhD in economics and is the author of “l’argent des autres“ (“Other people’s money”) recently released in France.

Danko Tarabar is a native of Belgrade, Serbia, and a Ph D candidate in economics at West Virginia university. He specializes in trade, development, and monetary econo-mics and focuses his research on the interplay of formal and informal institutions and economic growth in deve-loping and transition economies.


Andrew Young is associate professor of economics at West Virginia university and co-director of the Center for Free Enterprise in the WVu College of Business and Economics. His research is concerned with the role of institutions in the processes of economic growth and development. His work has been published in, among other places, the Review of Economics and Statistics, the Jour-nal of Money, Credit and Banking, and the Journal of law, Economics and Organization. Professor Young received his PhD in economics from Emory university.


Impressions from the World Economic Freedom Conference 2014

Held in Brussels, 5-7 October 2014

most free 2nd quartile 3rd quartile least free...trust in french society and the functioning of its...

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