What Happens to Economic Freedom?
1. THE DECLINE OF EUROPE
For more than one hundred years, or since the beginning of the First World War, Europe has been in decline. Before that, the great powers of Europe dominated the world. Although the United States is located outside of Europe, one may regard it as a ‘daughter society’ of Europe, because so much of its population is descended from European immigrants and settlers. By contrast, Japan is a truly non-European power, but has transformed itself according to European models in scientific education, technology, law, and government. Before the First World War, government interference in the economy remained limited. Government mostly accounted for about 10 per cent of GDP, and nowhere for more than 17 per cent.11 Vito Tanzi and Ludger Schuknecht, Public Spending in the 20th Century. A Global Perspective
(Cambridge: Cambridge University Press, 2000). Property rights of people and enterprises were respected. In spite of protectionist inclinations, there was a great deal of free trade. Before the establishment of generous welfare states, migration raised few problems. There was considerable economic freedom.
The bloodbath of the Great War precipitated two additional catastrophes: first, the Russian Revolution, which rapidly led to the collectivization of the economy and the repression of individual liberty; second, the treaty of Versailles, and related treaties including that of Trianon, which did nothing for reconciliation, but contributed to the rise of Hitler and thereby to the next war and the Holocaust. With the benefit of hindsight one may consider these ‘peace treaties’ as armistices because similar groups of nations fought each other in both world wars. Around one hundred million Europeans lost their lives because of the world wars or communist and Nazi tyranny.22 Rudolph J. Rummel, Death by Government (New Brunswick, NJ: Transaction Publishers, 1994). Economic freedom was massively reduced in all belligerent nations. Moreover, the global economic crises and the resulting New Deal in the US instigated a major expansion of government and thereby reduced economic freedom even in the US, the citadel of capitalism. The retreat of economic freedom was most easily visible in Europe, where it was lost east of the Iron Curtain dividing Europe.
The war had impoverished most of Europe. The result of communism was that poverty could not be overcome rapidly east of the Iron Curtain. A lack of economic freedom and poverty are nevertheless compatible with military power. An American strategic thinker once estimated that the USSR was about five times as effective as the US in transforming economic power into military power.33 Edward N. Luttwak, The Grand Strategy of the Soviet Union (New York, NY: St. Martin’s Press,
1983). At the end of the Second World War, Germany had lost its great power status. Britain and France became permanent members of the United Nations Security Council, but never again came even close to possessing the same power as the US or the USSR, the ‘superpowers’. From a power politics point of view, Europe was divided into an American and a Soviet sphere of influence.
2. A POST-WAR REVIVAL OF ECONOMIC FREEDOM
In spite of the New Deal and the subsequent war economy, the US economy remained much freer than the economies of the Western European nations. As important as the military protection provided by the Americans or their Marshall Plan aid was the intellectual impact of America on Europe. West Germany was much more open to American economic thought than France, and it benefitted from this openness. US policies resulted in the restoration of free trade. Given their economic might after the Second World War and the global role of their currency, the Americans did not need to insist on reciprocity in making economic concessions. They could easily afford to provide an example in eliminating barriers to trade. After the Second World War, Western Europe (and Japan) enjoyed the opportunity to exploit the advantages of backwardness.44 In a simple regression model of economic growth, about half of the cross-national variance is
explained by three variables: advantages of backwardness, human capital formation, and economic
freedom. Moreover, the advantages of backwardness themselves are largely an external effect of
the economic freedom of freer and richer countries elsewhere, because poorer and less developed
countries benefit from the model and markets which more advanced countries provide them with.
See Erich Weede, ‘Economic Freedom and Development: New Calculations and Interpretations’,
CATO Journal, 26/3 (2006), 511–524. These countries could grow faster than America, and close some of the gap in living standards. Thirty years after the war the worst wounds had been healed, and living standards and incomes in the more advanced European countries were at about 70 per cent of American standards.
Transatlantic cooperation in defence, economic success in Western Europe, and persistent scarcity in the planned economies undermined the confidence of ruling communist elites. When Reagan reinforced the arms race and decided to establish a missile defence system which, if successful, might undermine Soviet secondstrike capability, Gorbachev responded with policies of economic and political reform. The reforms failed. The Warsaw Pact as well as the Soviet Union collapsed and fragmented. The West had won the Cold War.
3. LEARNING FROM HISTORY
People try to learn from history. They do not necessarily succeed. Given the sequence of catastrophes in the first part of the twentieth century—remember the hundred million or so victims of war and tyranny in Europe—they arrived at the sensible idea of ‘no more wars’. While the avoidance of war between East and West was the consequence of nuclear arsenals capable of destroying all of humanity, the idea of peace was combined with the idea of unifying Europe. Beginning with the European Coal and Steel Community, the unification ideal led to the European Union, which comprised 28 members before Brexit. By the mutual acceptance of product standards, the lowering of barriers to trade, and the single market, European unification promoted economic freedom within Europe. Since economic freedom reinforces prosperity and growth,55 Erich Weede, ‘Wirtschaftliche Freiheit. Hintergrundbedingungen, Auswirkungen und
Gefährdungen’, Wirtschaftspolitische Blätter, 61/3–4 (2014), 443–455. and prosperity comes close to being a prerequisite of democracy, European unification also led to democracy as well as the capitalist peace within Europe.66 Erich Weede, ‘The Expansion of Economic Freedom and the Capitalist Peace’, in William R.
Thompson, ed., The Oxford Encyclopedia of Empirical International Relations Theory (Oxford: Oxford
University Press, 2018), 820–836. In spite of Brexit, one should still remember that Margaret Thatcher, a strong believer in economic freedom, did promote the single market. Since the EU has contributed to prosperity, peace, and democracy in Europe, many members of the European elite believe that Europe has successfully learnt from its history.
4. FORGETTING THE ROOTS OF THE EUROPEAN MIRACLE
Unfortunately, this is only a half truth. European history did not begin with the First World War. If one asks why European or Western civilization could overcome mass poverty which characterized the great Asian civilizations, then the short answer is that we owe it to European disunity. In contrast to the great Asian civilizations where huge territories were subject to the rule of dynasties that lasted centuries, Europe always consisted of a great number of principalities, autonomous cities, kingdoms, or states. Attempts to unify all of Europe by force failed. Competition between polities forced rulers to concede and respect the property rights of their subjects, including merchants, artisans, peasants, and later manufacturers, long before democracy was established.77 Eric L. Jones, The European Miracle (Cambridge: Cambridge University Press, 1981); Deirdre
Nansen McCloskey, Bourgeois Dignity (Chicago: Chicago University Press, 2015); Erich Weede,
Asien und der Westen (Baden-Baden: Nomos, 2000). Rulers who strove above all to accumulate more wealth than their neighbours and were less inclined to respect the economic freedom of producers suffered the consequences of a weakening tax base in their country. Territorial fragmentation meant that no ruler exercised unchecked power. This territorial separation of powers preceded the functional separation of legislative, executive, and judicial branches.
The existence of multiple polities within Europe had the additional benefit of limiting the impact of unavoidable human error. Political fragmentation made it impossible to enforce misguided policies everywhere in Europe. The benefit of competing polities and policies, of observable differences in success or failure, seems to have been better understood in Switzerland than in Brussels, where the administration of the EU regards centralization and integration as always better than competition between European nations in searching for the best responses to arising challenges. European disunity was mixed or beneficial in terms of its impact on property rights and economic freedom, but simultaneously made European states more prone to conflict than was the case among other great civilizations.
5. ECONOMIC FREEDOM AT RISK
‘More Europe’ should not be the goal. Instead we should attempt to preserve the positive impact of competition between polities on economic freedom and democracy, and on the secure property rights of enterprises, as well as on individual liberty, and simultaneously to put an end to internecine wars on the continent. The integration of markets which the EU has largely achieved is also an instrument in the service of this endeavour. By contrast, political integration and centralization invariably increases the risk of misguided policies imposed on huge territories, as demonstrated by communist central planning.88 Why a planned economy cannot work well has been known since shortly after the 1917 Russian
Revolution. See Ludwig von Mises, Die Gemeinwirtschaft (Stuttgart: Lucius et Lucius, 2007, first
printed 1922); Friedrich August von Hayek, ‘The Use of Knowledge in Society’, American Economic
Review, 35/4 (1945), 519–530.
Independently of European integration, there exists another long-term threat to economic freedom. For decades, the size of government and its impact on the economy has expanded. Government expenditure rises even faster than government revenue. Except for the gap between revenue and expenditure, social transfers are the most rapidly growing element. Many Western European welfare states are characterized by government expenditures close to 50 per cent of GDP, government debt close to or even above 100 per cent of GDP, and social transfers close to 30 per cent of GDP.99 Vito Tanzi, Government versus Markets (Cambridge: Cambridge University Press, 2011); Vito Tanzi,
Dollars, Euros and Debt (Basingstoke, Hampshire: Palgrave Macmillan 2013). In practice, the goal of social justice seems to require overburdening the next generation with public debt. Even if social justice is a must for a humane society, it is difficult to justify the overburdening of future generations to such a degree.
The impact of taxes and transfers on incentives generates problems. Those who work hard and achieve a great deal earn a large amount of money. However, they are then effectively punished by progressive taxation. Those who achieve little and earn little are rewarded by transfers. In the long run, this self-reinforcing process necessarily undermines readiness to work hard. Moreover, does it still pay for parents to nurture discipline and ambition in children if wages for some jobs are quite similar to the transfer payments one gets without doing anything useful for others? There must be some relationship between the small gap between transfers and modest earnings for unskilled work on the one hand, and the miserable atmosphere at many European schools on the other.
So long as generous welfare states are not a global phenomenon, they generate the wrong incentives for migration. If you work hard and earn a lot in, say, Germany, you may feel an incentive to emigrate. In America or Switzerland, your tax bill would be lower. If you are a sub-Saharan or Arab migrant, you might get more in transfer payments in Germany than you could reasonably hope to make at home by hard work. Moreover, poor migrants who go to a rich country where they do not master the language cannot avoid suffering a devaluation of whatever human capital they possessed at home.
If one evaluates the development of the EU, success predominates until the establishment of the single market. Failure predominates since the introduction of the euro.1010 Thilo Sarrazin, Europa braucht den Euro nicht (München: DVA, 2012); Hans-Werner Sinn, Die
wundersame Geldvermehrung (Freiburg: Herder, 2021). At first, Southern Europe benefitted from falling interest rates. Then a crisis followed. The eurozone could be kept together only by zero interest rates as well as by huge credits provided by target imbalances or rapidly established special funds. Whether the Northern credit suppliers will ever receive their money back is uncertain because of the still-rising debt levels of Southern crisis countries. The burden on Northern taxpayers and savers, however, did not prevent hard times and extreme rates of youth unemployment in Southern Europe. With the benefit of hindsight, the establishment of a common currency for economies as different as those of Germany and Greece should be judged as an error resulting in a negative sum game where little has been gained and much has been lost.
Many economists had warned against a premature currency union. Did it ever seem plausible that countries which had repeatedly devalued their currencies in the past in order to regain competitiveness could do without this instrument in future? Was it wise to simultaneously aim at the irreversibility of the euro and to commit to ‘no bail-out’? Since 2021, the EU has also distributed money from a recovery fund without any payback obligation to countries which have been hit hard by the pandemic. Thus, the EU proceeds to become a community of debt and income transfers between nations. This raises three issues: are those member states believed to be robust and strong, like Germany, as resourceful as some want to believe? Before the pandemic, German government debt was about 60 per cent of GDP. If one were to add public commitments regarding pensions and health care, then government debt would easily amount to double GDP. Given the rapid greying of most European societies, one should ask whether national welfare states which devour up to one third of GDP should be complemented by another level of organized redistribution? Is it affordable? The additional demand for public resources as well as the accompanying expansion of the European administration risks further reducing economic freedom and thereby overburdening the capabilities of even the strongest European economies.
Misguided European decision-making also prevails in asylum and migration policy. After the Second World War, refugee and asylum rights were restricted to other Europeans. Rights for protection were extended to people from other civilizations only later. From a human rights point of view the earlier restriction was never justified. Implicitly, however, the earlier restriction took into account the relative ease of integrating migrants into host societies. Obviously, the integration of other Europeans is much easier—say of Poles in Germany or Portuguese in France— than the integration of Muslims. Since refugees and asylum-seekers have rights in host societies, and since the abuse of their rights does not always lead to expulsion, even in cases of murder or terrorism, rights of asylum and refuge have resulted in a situation where migrants from poor countries can choose their destination at will and enjoy welfare for long periods of time. In fact, migrants’ rights to refuge or asylum constitute a third level of the welfare state. Not only compatriots or fellow Europeans, but everyone who is poor and desperate has a chance to live at taxpayers’ expense in rich EU countries, if they can successfully get there.
The third level of the welfare state can be quite expensive, much more than the development aid provided by rich countries for poor ones. It has been estimated that the one million migrants admitted by Germany in 2015 have cost at least 450 billion euros since their arrival. My personal estimate would be about twice as high, as a result of greater pessimism about migrant integration in the labour market.1111 Hans-Werner Sinn, ‘So kann es nicht weiter gehen’, ifo-Schnelldienst, 4 (2016), 3–6; Bernd
Raffelhüschen and Stefan Moog, ‘Zur fiskalischen Dividende der Flüchtlingskrise. Eine
Generationenbilanz’, ifo-Schnelldienst, 4 (2016), 24–29. Background information about the human
capital impact on prosperity and growth can be found in Garett Jones, Hive Mind. How Your
Nation’s IQ Matters So Much More Than Your Own (Stanford, CA: Stanford University Press, 2016);
Heiner Rindermann, Cognitive Capitalism. Human Capital and the Well-Being of Nations (Cambridge:
Cambridge University Press, 2018). For further analysis of mass migration, see Erich Weede, ‘Mass
Immigration: Cost or Benefit?’, Hungarian Review, 6/6 (November 2015), 8–17. Since rich and poor countries differ in the kind and quality of education and training on offer, as well as in the needs of their labour markets, most migrants coming from poor countries must be unqualified or insufficiently qualified. Since welfare payments in France, Germany, or Sweden may easily top median incomes in the poorest countries, availability of welfare at European levels must exert an extremely strong attractive force on migration from Muslim or African countries.
Europe should not complement indebted and greying welfare states with a global community of redistribution and transfers, with greater incentives to incur debt because those who have spared their taxpayers may hope to shift some of the burden onto taxpayers elsewhere. Does responsible budgeting become more likely if it is punished by transfer regulations? What Europe needs is more competition between governments at the local, regional, and national levels, more individual and enterprise responsibility, and less government interference, i.e. more economic freedom. Although the EU can justifiably claim some successes in its competition and market-opening policies,1212 Thomas Philippon, The Great Reversal. How America Gave Up on Free Markets (Cambridge, MA:
Belknap, Harvard University Press, 2021). it suffers from an inclination to limit policy competition between governments in general and tax competition in particular. The more the EU constrains tax competition, the more it becomes a union of governments that want to escape popular control by delegating ever more decisions to Brussels, which wants to deny easily available exit options to high achievers and tax payers. It is thus an often overlooked fact that Europe could economically and technologically overtake other civilizations because of policy competition and political constraints arising out of the existence of a multitude of states which are small compared to huge Asian empires. Since European principalities and states had to compete for financial and human capital, their governments had to respect private property rights even before democracy began to spread.
As EU politicians have already demonstrated that they cannot handle affairs without running up huge debts, the Swiss example of referenda should be considered. It is doubtful whether the euro could have been established on the basis of a referendum, or whether a referendum would have ratified the rescue packages. The question of whether voters really want an indebted transfer community, which might also become an inflationary community, would thus have become inescapable. The higher a state’s public debt level, the more attractive it appears, to some politicians at least, to inflate much of the debt mountain away. That is why Nobel laureate Friedrich August von Hayek called for the denationalization of money.1313 Friedrich August Hayek, Denationalisation of Money (London: Institute of Economic Affairs, 1976). If this were ever achieved, it might become a most effective debt brake. As long as we leave the inflation option to politicians, they will try to apply it modestly, but may ultimately lose control. Once we arrive at a fully established community of transfers, debt, and common liability, our politicians might no longer see any alternative to inflating away at least some of the debt, and to do so repeatedly.
Although it is governments and their policies, rather than free markets, which are responsible for the approximately one hundred million European victims of war and tyranny in the twentieth century, with the bigger states and the great powers having more responsibility for this than the smaller states, the only thing we Europeans seem to have learnt from history is to seek salvation in size and centralization. We try to strengthen the EU in order to overcome the risk of future fratricide. We forget that Europe managed to overcome mass poverty because of limited government and economic freedom. We forget that economic cooperation and free trade between nations might conciliate interstate political relations even without a centralized administration in Brussels. We also forget that past catastrophes arose not only from tyranny and moral torpor, but also from a deficit in analysis about the likely consequences of actions.
At the beginning of the First World War, leaders in Paris and Berlin imagined an early occupation of the enemy’s capital, instead of the murderous and indecisive trench warfare to come. Hitler hoped his ‘Reich’ would last a thousand years, instead of twelve. The communists believed that nations could grow affluent by central planning instead of economic freedom, but achieved only persistently low standards of living. In contemporary European debates there is too much moralizing, but not enough analysis of the likely consequences of political actions.
- 11 Vito Tanzi and Ludger Schuknecht, Public Spending in the 20th Century. A Global Perspective
(Cambridge: Cambridge University Press, 2000). - 22 Rudolph J. Rummel, Death by Government (New Brunswick, NJ: Transaction Publishers, 1994).
- 33 Edward N. Luttwak, The Grand Strategy of the Soviet Union (New York, NY: St. Martin’s Press,
1983). - 44 In a simple regression model of economic growth, about half of the cross-national variance is
explained by three variables: advantages of backwardness, human capital formation, and economic
freedom. Moreover, the advantages of backwardness themselves are largely an external effect of
the economic freedom of freer and richer countries elsewhere, because poorer and less developed
countries benefit from the model and markets which more advanced countries provide them with.
See Erich Weede, ‘Economic Freedom and Development: New Calculations and Interpretations’,
CATO Journal, 26/3 (2006), 511–524. - 55 Erich Weede, ‘Wirtschaftliche Freiheit. Hintergrundbedingungen, Auswirkungen und
Gefährdungen’, Wirtschaftspolitische Blätter, 61/3–4 (2014), 443–455. - 66 Erich Weede, ‘The Expansion of Economic Freedom and the Capitalist Peace’, in William R.
Thompson, ed., The Oxford Encyclopedia of Empirical International Relations Theory (Oxford: Oxford
University Press, 2018), 820–836. - 77 Eric L. Jones, The European Miracle (Cambridge: Cambridge University Press, 1981); Deirdre
Nansen McCloskey, Bourgeois Dignity (Chicago: Chicago University Press, 2015); Erich Weede,
Asien und der Westen (Baden-Baden: Nomos, 2000). - 88 Why a planned economy cannot work well has been known since shortly after the 1917 Russian
Revolution. See Ludwig von Mises, Die Gemeinwirtschaft (Stuttgart: Lucius et Lucius, 2007, first
printed 1922); Friedrich August von Hayek, ‘The Use of Knowledge in Society’, American Economic
Review, 35/4 (1945), 519–530. - 99 Vito Tanzi, Government versus Markets (Cambridge: Cambridge University Press, 2011); Vito Tanzi,
Dollars, Euros and Debt (Basingstoke, Hampshire: Palgrave Macmillan 2013). - 1010 Thilo Sarrazin, Europa braucht den Euro nicht (München: DVA, 2012); Hans-Werner Sinn, Die
wundersame Geldvermehrung (Freiburg: Herder, 2021). - 1111 Hans-Werner Sinn, ‘So kann es nicht weiter gehen’, ifo-Schnelldienst, 4 (2016), 3–6; Bernd
Raffelhüschen and Stefan Moog, ‘Zur fiskalischen Dividende der Flüchtlingskrise. Eine
Generationenbilanz’, ifo-Schnelldienst, 4 (2016), 24–29. Background information about the human
capital impact on prosperity and growth can be found in Garett Jones, Hive Mind. How Your
Nation’s IQ Matters So Much More Than Your Own (Stanford, CA: Stanford University Press, 2016);
Heiner Rindermann, Cognitive Capitalism. Human Capital and the Well-Being of Nations (Cambridge:
Cambridge University Press, 2018). For further analysis of mass migration, see Erich Weede, ‘Mass
Immigration: Cost or Benefit?’, Hungarian Review, 6/6 (November 2015), 8–17. - 1212 Thomas Philippon, The Great Reversal. How America Gave Up on Free Markets (Cambridge, MA:
Belknap, Harvard University Press, 2021). - 1313 Friedrich August Hayek, Denationalisation of Money (London: Institute of Economic Affairs, 1976).