In 2000, the United States ranked second in the world for economic freedom
Today it sits at 14th
In 2000, the United States ranked second in the world for economic freedom. Today it sits at fourteenth. Most Americans have no idea this happened.
That drop might sound like trivia. A number on a chart. Academic bookkeeping. But here’s what makes it interesting: that same decline correlates with roughly 740,000 fewer new businesses being launched in America each year. Not cumulatively. Annually. Every single year for over a decade.
This isn’t speculation. The data comes from a collection of essays published by the Fraser Institute and the Mercatus Center at George Mason University, edited by Donald Boudreaux. The contributors include economists from NYU, The Citadel, Southern Methodist University, and various research institutions. What they found deserves more attention than it has received.
Let me explain what they uncovered and why it matters.
Start with a simple question. Why do some countries prosper while others remain poor? For decades, economists pointed to capital accumulation, labor, and technology. Save more, invest more, adopt better machines, and growth follows. The models were elegant. They were also incomplete.
Liya Palagashvili of NYU opens the collection by noting what these models failed to explain. Why don’t people in poor countries save? Why do they use technology less efficiently? Why don’t workers invest in their own development? The traditional models treated these behaviors as inputs into a formula but never asked what shaped the behaviors themselves.
The answer, as it turns out, is institutions. The rules of the game.
Here’s what that means in practice. In Tanzania, pledging your car as collateral for a business loan takes 297 days. In the semi-autonomous region of Zanzibar, such pledges don’t exist at all. Hernando de Soto documented this reality across the developing world. People own homes and cars but cannot use them to finance new ventures because the property rights systems are too weak, informal, or corrupt to support such transactions. The entrepreneurial spirit exists. The legal infrastructure to channel it productively does not.
Now consider the opposite end of the spectrum. The three countries with the highest economic freedom scores according to the 2014 Economic Freedom of the World index were Hong Kong, Singapore, and New Zealand. They averaged 17.1 new business ventures per 1,000 working-age people. The three lowest-scoring countries in the dataset, Democratic Republic of the Congo, Algeria, and Argentina, managed 0.249 new ventures per 1,000 people. That’s roughly one new business for every 4,000 adults.
The gap is not explained by cultural differences in entrepreneurial spirit. Russell Sobel of The Citadel makes this point forcefully. Every society contains creative, innovative individuals. The question is what they do with their talents. In countries with secure property rights, impartial courts, and limited government interference, these people start businesses. In countries without such institutions, they become lobbyists, rent-seekers, or worse.
William Baumol called this distinction productive versus unproductive entrepreneurship. The entrepreneur who invents a better mousetrap and sells it for profit is productive. The entrepreneur who hires lobbyists to secure government subsidies or files frivolous lawsuits to extract settlements is unproductive. Both activities require creativity, energy, and business acumen. Only one creates wealth. The other merely redistributes it, often destroying value in the process.
Sobel extended Baumol’s framework with data from US states. He constructed an index of net entrepreneurial productivity that accounts for both business creation and rent-seeking behavior. States with higher economic freedom scores showed not only more business formation but also less unproductive activity. The creative energies of their populations were channeled into wealth creation rather than wealth extraction.
This brings us to the uncomfortable part of the story. The United States.
The Economic Freedom of the World index measures five broad areas. Size of government. Legal system and property rights. Sound money. Freedom to trade internationally. And regulation. Each area is scored on a scale of zero to ten, with ten being the freest.
In 2000, the United States scored 8.65 overall. By 2012, that score had dropped to 7.81. The decline wasn’t uniform across all areas. The most dramatic deterioration occurred in legal system and property rights, where the US rating fell from 9.23 to 7.02. The specific component measuring protection of property rights dropped from 9.10 to 6.95.
To put this in perspective, Canada actually improved its property rights score over the same period, moving from 7.98 to 8.39. The United Kingdom experienced only a slight decline. The American collapse stands out.
What happened?
Roger Meiners and Andrew Morriss examine this question by focusing on the rule of law. The concept refers to governance by predictable rules that don’t depend on the whims of whoever happens to hold power at any given moment. This predictability matters enormously for entrepreneurs because business ventures often require long-term planning and investment. Nobody builds a factory if they expect the government to seize it next year. Nobody signs a twenty-year lease if courts might reinterpret the contract whenever political winds shift.
Meiners and Morriss document erosion of the rule of law through a series of government interventions. The auto bailouts treated senior bondholders differently than established bankruptcy law prescribed. Regulatory agencies expanded their authority through creative interpretations of existing statutes. The legal environment became less predictable, which means riskier for entrepreneurs.
Wayne Crews tackles the regulatory burden from another angle. He estimates that federal regulations cost the average American household $14,976 annually, or roughly one quarter of before-tax income. That figure doesn’t include state and local regulations. It doesn’t capture the businesses that were never started because the compliance costs made them unviable. It measures only the direct burden on existing economic activity.
The numbers are staggering but abstract. The mechanism deserves attention.
Regulations function as a fixed cost. Building a handicapped ramp costs the same whether you’re a small restaurant or a national chain. Installing pollution control equipment requires similar expertise regardless of your firm’s size. For large corporations with in-house legal and compliance departments, these requirements represent a nuisance. For entrepreneurs launching startups, they represent potential death.
Peter Calcagno and Sobel examined this effect empirically. As regulatory levels grow, they disproportionately harm firms with fewer than five employees. The entrepreneurial sector shrinks. The gap between established corporations and new entrants widens.
There’s also an opportunity cost that rarely gets discussed. Every hour a bank executive spends dealing with regulators is an hour not spent on customer service, product development, or employee training. As John Allison documented, the post-2008 explosion of financial regulation forced senior bank personnel to devote substantially more time to compliance and substantially less time to actual banking.
Some readers will object at this point. Regulations exist for reasons. Consumer protection. Environmental protection. Financial stability. Worker safety. Are these not legitimate government functions?
The contributors don’t dispute that some regulation serves valid purposes. Their argument is narrower. The cumulative burden of regulation has grown dramatically without corresponding improvements in the outcomes regulation supposedly ensures. Countries with heavier regulatory burdens don’t consistently show better pollution outcomes, health outcomes, or product quality. What they do show is higher corruption and larger unofficial economies, as documented by Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer.
The 2014 Doing Business report from the World Bank found that starting a business in the United States requires on average six procedures and 5.6 days, costing 1.2 percent of income per capita. In Canada, the same process ranks second in the world for ease. American entrepreneurs face more friction than their Canadian counterparts despite operating in a supposedly more capitalist economy.
But wait. Didn’t the United States recover from the 2008 financial crisis? Aren’t stock markets at record highs? Isn’t unemployment low? Why does any of this matter?
The Kauffman Foundation provides one answer. Despite the recovery, the rate of new business creation in America has been flat or falling for decades. Population grew, but per-capita entrepreneurship didn’t keep pace. The State of Entrepreneurship Report called this trend troubling for the long-term health of the economy.
Ryan Decker, John Haltiwanger, Ron Jarmin, and Javier Miranda reached similar conclusions. Business dynamism has declined over recent decades. The firm startup rate keeps falling. The number of young firms operating in the economy keeps shrinking. This decline contributed disproportionately to employment weakness between 2006 and 2009.
Here’s what makes these findings particularly concerning. The sources of American prosperity haven’t disappeared. The country still has world-class universities, deep capital markets, a culture that celebrates entrepreneurial success, and an enormous consumer market. The human capital and the entrepreneurial spirit remain abundant. What changed is the institutional environment in which that capital and spirit operate.
Randy Holcombe of Florida State University developed a framework for understanding how entrepreneurial environments evolve. When entrepreneurs successfully exploit profit opportunities, they don’t just create wealth for themselves. They alter the economic landscape in ways that create new profit opportunities for others. Innovation breeds innovation. Discovery enables further discovery.
This process explains why prosperity tends to cluster. Silicon Valley didn’t produce one successful tech company and stop. It produced an ecosystem where successful entrepreneurs mentor the next generation, where suppliers and talent concentrate, where investors develop expertise in evaluating opportunities, where the whole becomes far greater than the sum of its parts.
But the same logic works in reverse. When institutions make productive entrepreneurship less rewarding relative to unproductive entrepreneurship, creative individuals shift their energies accordingly. More lobbyists. Fewer engineers. More lawyers filing dubious lawsuits. Fewer inventors filing patents. The ecosystem that breeds prosperity starts breeding rent-seeking instead.
Deirdre McCloskey calls this the Bourgeois Revaluation. In the 18th century, attitudes toward commerce and entrepreneurs shifted in Northwestern Europe. Business became respectable. Commercial success became honorable. This cultural change, McCloskey argues, was essential to the subsequent explosion of growth that created the modern world.
Her point cuts both ways. If cultural attitudes toward entrepreneurship matter for prosperity, then the erosion of institutional support for entrepreneurship threatens prosperity. Not immediately. Not dramatically. But persistently, relentlessly, cumulatively.
The contributors to this collection offer various prescriptions. More jurisdictional competition. Federal systems that allow states to experiment with different approaches. Regulatory reform that subjects new rules to rigorous cost-benefit analysis. Judicial independence that prevents political manipulation of property rights.
Whether these prescriptions are feasible is a separate question. What the data establish is that the problem exists, that it’s measurable, and that its consequences are substantial.
Seven hundred forty thousand businesses per year that didn’t happen. Millions of jobs that weren’t created. Innovations that weren’t developed. Products that weren’t invented. Services that weren’t provided. This is what a 0.91-point decline in an economic freedom index actually means when translated into real-world outcomes.
The entrepreneurs who would have started those businesses still exist. They’re still creative, still ambitious, still looking for ways to get ahead. They’ve just been redirected. Some became compliance officers. Some became lobbyists. Some became consultants helping established corporations navigate the regulatory maze. Some simply gave up and took corporate jobs.
The energy didn’t disappear. It was rechanneled into activities that don’t create new wealth, don’t disrupt established industries, don’t deliver the creative destruction that makes economies grow.
Frédéric Bastiat made this observation in 1850. Man can derive life and enjoyment from labor, by applying his faculties to create things of value. Or he can derive life and enjoyment from plunder, by seizing what others have created. When plunder becomes easier than production, plunder prevails.
Friedrich Hayek said something similar a century later. The proportion of people prepared to try new possibilities is more or less the same everywhere. What differs is whether prevailing institutions allow them to do so or prevent them.
The evidence suggests that American institutions have shifted, gradually but measurably, toward prevention. Property rights less secure. Courts less predictable. Regulations more burdensome. Entry barriers higher. The fundamentals of economic freedom eroded.
This erosion didn’t happen through dramatic policy changes that sparked national debate. It happened through accumulation. A new regulation here. An expanded interpretation of an existing law there. A court decision that weakened contract enforcement. A bailout that treated creditors unequally. Each individual change was small. The cumulative effect was large.
Understanding this pattern matters because reversing it requires addressing the accumulation, not any single policy. There’s no magic bullet, no simple fix, no one law to repeal that would restore what has been lost. The solution, if there is one, involves the slow, difficult work of institutional reform across multiple dimensions.
Whether that work will happen is beyond the scope of what data can tell us. What the data can tell us is that the current trajectory leads somewhere specific. Somewhere with less entrepreneurship, less dynamism, less growth, and less prosperity than the alternative.
The United States went from second place to fourteenth in economic freedom. Most Americans didn’t notice. Perhaps they should.
Sources
Boudreaux, Donald J., ed. What America’s Decline in Economic Freedom Means for Entrepreneurship and Prosperity. Fraser Institute and Mercatus Center at George Mason University, 2015.
Palagashvili, Liya. “Entrepreneurship, Institutions, and Economic Prosperity.” Chapter 1.
Sobel, Russell S. “Economic Freedom and Entrepreneurship.” Chapter 2.
Lawson, Robert A. “Economic Freedom in the United States and Other Countries.” Chapter 3.
Meiners, Roger, and Andrew P. Morriss. “Special Interests, Competition, and the Rule of Law.” Chapter 4.
Crews, Clyde Wayne Jr. “One Nation, Ungovernable? Confronting the Modern Regulatory State.” Chapter 5.
Additional sources referenced within the volume include: Gwartney, James, Robert Lawson, and Joshua Hall. Economic Freedom of the World: 2014 Annual Report. Fraser Institute, 2014. Baumol, William J. “Entrepreneurship: Productive, Unproductive, and Destructive.” Journal of Political Economy 98 (1990). Holcombe, Randall D. “Entrepreneurship and Economic Growth.” Quarterly Journal of Austrian Economics 1, no. 2 (1998). McCloskey, Deirdre N. Bourgeois Dignity: Why Economics Can’t Explain the Modern World. University of Chicago Press, 2010. de Soto, Hernando. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. Basic Books, 2000. Decker, Ryan, John Haltiwanger, Ron Jarmin, and Javier Miranda. “The Role of Entrepreneurship in US Job Creation and Economic Dynamism.” Journal of Economic Perspectives 28, no. 3 (2014). Kirzner, Israel M. Competition and Entrepreneurship. University of Chicago Press, 1973. Schumpeter, Joseph A. Capitalism, Socialism and Democracy. Harper & Brothers, 1942.