The worldwide collapse of socialism has revolutionized the theory of economic development. Formerly, most academic economists, as well as those in the CIA, believed that growth was fueled by high rates of investment, access to cheap natural resources, the ability to absorb the latest technology, and, most important, a central plan to insure against the "anarchy of the market."
The economic irrationality that resulted from this approach has discredited it. Today, economists stress the value of free economic institutions. When one compares economic success as measured by the rise in living standards, countries fare better with lower levels of taxation and tariffs, less government regulation, a stable monetary policy, a freer banking system, free flow of domestic and foreign capital, and strong protections for private property.
NOBEL INFLUENCE. Douglas North, whose work stresses the importance of institutions, recently won the Nobel prize in economics. His influence is reflected in two recent books. One is my own, The Capitalist Revolution in Latin America, published in March by Oxford University Press. The other is the Heritage Foundation's 1997 Index of Economic Freedom.
My co-author, Karen LaFollette Araujo, and I discovered that the more successful Latin American countries have shifted away from what economists call rent-seeking (rewards from government-dispensed privileges and protections from competition) to profit-seeking (rewards from risking capital in the market). Chile is the best example. Its government consumes only 9% of gross domestic product compared with 35% in the U.S. (including state and local). This low rate was achieved by privatizing the state social security and national health systems and by permitting private education and public utilities.
Economists acknowledge that government uses resources less efficiently than the private sector and, therefore, the larger the government the greater the economy's loss of efficiency. We found another reason why the size of government matters. The larger the state presence, the more the economy is characterized by rent-seeking.
Government draws seekers after privilege like a magnet. The bigger the magnet, the greater the distortion of economic incentives, as people find that success depends more on access to government than on efficient market behavior.
Heritage's index bears this out. The most successful economies have the most economic freedom. Hong Kong has the best ranking, and its economic success is legendary. Singapore has the second-best ranking. The U.S. and Switzerland are tied for fifth, followed by Britain (thanks to Margaret Thatcher's reforms) and Taiwan. Interestingly, the Czech Republic has a better ranking than Japan or any other Continental European country.
Heritage's effort to explain economic success in terms of the freedom of economic institutions is an important undertaking. Any index has subjective elements, and Heritage's would probably benefit from some changes in emphasis and weighting. Chile's ranking, for example, is marred by black-market pirating of computer software and pharmaceuticals and by the presence of a state lending agency. These are undesirable but hardly seem to offset the small percentage of GDP taken by government.
FEUDAL BUTTONS. In my view, the most important indication of economic freedom is the tax burden. In the U.S., successful, hard-working people face a combined state, local, and federal marginal tax rate of 50% or more, and they routinely hand over one-third or more of their annual incomes to tax authorities. It is stretching things to describe people as free when they do not own the product of their own labor.
My first article as a scholar was published in a journal of classical and medieval studies. It caused a sensation and was republished for many years in widely-used textbooks. In researching the subject, I had occasion to survey the tax rates faced by medieval serfs. They varied over time and place but tended not to exceed one-third of the serfs' labor. There was a good reason for this. The productivity of labor was low, and a man who owed more than one-third of his labor to government could not survive. As he had nothing to lose, he would revolt and kill the tax collectors. Thanks to capitalism, labor productivity today is high, and we do not dwell on the implications of successful Americans having no more ownership rights to their own labor than did medieval serfs. Maybe we should.