Economic freedom and migration flows between U.S. States.

• Author: Ashby, Nathan J.
• Position: Author abstract

1. Introduction

   Tiebout (1956) provided the foundation for analyzing the effects of local government policy differentials on migration. As long as consumers are fully mobile and informed, restrictions to employment opportunities are low, and public services provide no externalities or diseconomies between communities, consumers convey their preferences through migration or "voting with their feet." Hayek (1945) addressed the idea that local governments are more capable of making better decisions than federal officials due to a greater access to knowledge concerning the needs of their localities.

   Weingast (1995) contended that these two arguments do not completely describe the benefits of federalism, where federalism is defined as a separation of power between different levels of government. In addition to creating jurisdictional competition as suggested by Tiebout, federalism can create incentives for political officials to promote markets, which enhance total utility (Qian and Weingast 1997). When there is sufficient separation of authority in economic matters between the federal and local governments, this is known as market-preserving federalism. If a country meets the standards as a market-preserving federation, migration is likely to result in more efficient policies that result in greater well-being of individuals in the long run.

   As there is no natural tendency for firm leadership to respond to the demands of shareholders (Coase 1937), there is no reason to assert that political officials efficiently respond to the welfare needs of constituents. Effective government institutions align the incentives of officials to the will of the citizens similar to the manner in which institutions of firms can induce an effective response to the well-being of shareholders. Federalism is one such institution. If individuals are free to migrate between jurisdictions, this serves as a check on government intrusion in economic matters. As Friedman (1962) put it, "If I do not like what my state does, I can move to another." In a market-preserving federation, states face a hard budget constraint in that they have no ability to print currency and little ability to borrow or rely on higher levels of government. If local governments maintain autonomous power in economic matters separate from the higher jurisdiction, they have little incentive to bail out inefficient economic projects or seize wealth from efficient industries. This forces local government to weigh the benefits versus the costs of such actions since they might drive economically significant labor and capital to neighboring localities. When local governments systematically receive economic assistance from higher levels of government, this violates the principle of market-preserving federalism endangering the sustainability of markets and opportunities for efficient utility maximization through migration.

   The study of federalism entails important policy implications for enhancing the welfare of individuals and obtaining more efficient economic outcomes. Weingast (1995) demonstrated that the relative federalistic nature of China's government compared to Russia has led to economic benefits that have far exceeded its former counterpart in communism. This being the case, Holcombe (1994) suggested that constitutional rules limiting authority at the national level are more important than at the local level due to the relative immobility of individuals. It is conjectured that any policies that limit the authority of the national government on economic matters will sustain market-preservation and create incentives for political officials to align themselves with the welfare of their constituencies. The question to be addressed in this paper is whether or not individuals in aggregate react in the manner suggested by Weingast and others. In other words, this analysis determines whether individuals in aggregate migrate toward states with higher economic freedom and estimates the marginal impact of policies that contribute to economic freedom.

   This paper is divided into four parts. Section 2 provides further discussion of economic freedom and market-preserving federalism and a brief review of migration theory. Section 3 explains the contribution of this analysis to prior literature and the model that will be tested in this study. In particular, this paper analyzes the effects of economic freedom on the migration behavior of individuals in the lower 48 states. The Economic Freedom of North America Index (2005) is decomposed into its major components to analyze the impact that these measures have on migration flows between states. Spatial methods are used in this analysis. Spatial models take into account spatial dependence and heterogeneity between observations that are not detected by the standard distance variables included in gravity models. Porojan (2001) utilized spatial methods to analyze trade flows between the European Union and potential members using a modified gravity model. Other than the aforementioned study, spatial econometrics has been greatly underutilized in migration research (Cushing and Poot 2004). Section 4 consists of an analysis of the empirical results and gives a detailed interpretation. Section 5 concludes the paper with summary remarks and a discussion of policy implications.

2. A Review of the Literature

   Economic Freedom and Market-Preserving Fiscal Federalism

   Friedman (1962) postulated that economic freedom is important for two reasons. First, it is an end in itself. Second, it is a "necessary but not sufficient" condition toward obtaining and maintaining political freedom. Economic freedom may include measurements of freedom from coercive property and income taxation to the extent of government control over the private sector to the liberty to work at the occupation and remuneration of one's choosing and buy or sell goods at prices determined independent of the government. In addition to these reasons, market institutions induce political officials to react to the preferences of the private citizens (Weingast 1995; Qian and Weingast 1997).

   Riker (1964) provided two qualifications for a government to be considered a federation. First, there must be a hierarchy of governments that has at least two levels with a demarcated scope of authority. Second, the autonomy of each level must be institutionalized in a manner that makes the restrictions of federalism self-enforcing. Weingast (1995) further defined a market-preserving federation as one in which the subnational government possesses primary regulatory authority in economic matters, has no trade barriers, and faces a hard budget constraint. According to this definition, Weingast postulated that the United States acted under this type of system during the nineteenth century until the 1930s. Although the contemporary United States does not qualify according to Weingast's definition, it is one of the more federalistic nations. The more economic authority is decentralized, the more efficient the economic outcome will be through migration.

   The indexes of economic freedom are often used to measure the extent to which economic systems rely on free markets. Numerous studies have evaluated the relationship between economic freedom and measurements of well-being, such as income, life expectancy, and/or education at the international and national level. However, one could also assert that the propensity to migrate is also a function of individuals seeking to maximize utility through revealed preference. This paper analyzes the impact of government policy that enhances economic freedom on gross migration flows in the lower 48 U.S. states.

   Several studies have been conducted analyzing the effect of economic freedom on measurements of well-being such as income, poverty, and human development measurements. Many of these have been cross-national analyses using either the Economic Freedom of the World Index published by Gwartney, Lawson, and Gartzke (2005) through the Fraser Institute or that by Miles et al. (2006) of the Heritage Foundation. Most find a significant positive relationship between these measures and quality of life. A positive link to economic freedom has been made with higher incomes per capita and economic growth (Islam 1996; Ali 1997; Easton and Walker 1997; Ayal and Karras 1998; De Haan and Sierman 1998). Farr, Lord, and Wolfenbarger (1998) and Gwartney, Lawson, and Holcombe (1999) demonstrated that causality runs in the direction from economic freedom to economic growth and not vice versa. Since there is some disagreement as to the use of income or income growth as legitimate measurements of well-being, numerous studies exist that have demonstrated that economic freedom is associated with higher human development, lower poverty, higher literacy rates, and other positive aspects of quality of life (Grubel 1998; Norton 1998; Esposto and Zaleski 1999). In addition, Adkins, Moomaw, and Savvides (2002), using panel data, demonstrated that institutions that promote economic freedom lead to higher technical efficiency. Hanson's (2003)

   recent criticism of the findings of studies that demonstrate the positive effects of economic freedom and institutions has received much attention. However, Heckelman (2005) argued that the criticisms provided by Hanson were not made on a thorough analysis of the literature, and that there are flaws to the analysis.

   Recently, similar data were constructed by Karabegovic, McMahon, and Mitchell (2005) of the Fraser Institute that measure economic freedom in U.S. states as well as in Canadian provinces. (1) Using these data, the authors demonstrated that higher average scores of economic freedom are significantly associated with higher average incomes and income growth rates in the North American region. The data were provided at both a national and subnational level. The national data measured the extent to which economic freedom was restricted at all levels...