ECONOMIC FREEDOM AND LABOR MARKET CONDITIONS: EVIDENCE FROM THE STATES

I. INTRODUCTION Labor market conditions are one of the most politically salient dimensions of public policy. For example, the change in the unemployment rate is strongly related to presidential election outcomes (Fair 1978). That such a relationship exists is not particularly surprising--people out of work or anxious about being able to find or retain a job are, ceteris paribus, probably less inclined to think existing policies should be continued. Beyond the electoral fortunes of politicians, U.S. labor market conditions are especially prominent in current public discourse because unemployment reached levels not seen for three decades during the sharp recession of 2007-2009 and has receded only lethargically. The attention placed on national labor market aggregates, however, obscures the disparate labor conditions that exist across states. For example, in December 2012 (the most recent month available at the time of writing), state unemployment rates ranged from 3.2% in North Dakota to 10.2% in Nevada and Rhode Island. This variation in labor market conditions across states is the topic of our article. We posit that the variation in labor market conditions across states is related to interstate differences in economic freedom. There are a number of channels through which economic freedom might be associated with labor market outcomes. The most direct is through labor market regulations. For example, there is an extensive, although not unanimous, literature finding a negative relationship between the minimum wage and employment (Neumark and Wascher 2007). Consistent with the possibility that labor market regulations stifle labor market outcomes, Garrett and Rhine (2011) find that less labor market regulation (as well as more economic freedom in general) is associated with higher rates of employment growth among U.S. states over the period 1980-2005. Beyond a direct link between labor market regulation and employment conditions, there are other channels through which economic freedom might also be associated with favorable labor market outcomes. There is an extensive literature 'finding that economic freedom is positively related to economic growth (Dawson 2003; Doucouliagos and Ulubasoglu 2006; Gwartney, Lawson, and Holcombe 1999; Heller 2009). Increases in economic output presumably increase the demand for labor (and other inputs) unless the entire increase in output arises solely from productivity gains. Entrepreneurship is another channel through which economic freedom might foster robust labor market outcomes. Using different measures of new firm creation, Kreft and Sobel (2005), Campbell, Rogers, and Heriot (2007-2008), and Campbell and Rogers (2007) find that economic freedom is positively related to interstate differences in new firm formation. If such entrepreneurial activity leads to job creation, then there would be a positive relationship between economic freedom and favorable labor market outcomes. Another channel through which economic freedom could be associated with more favorable labor market outcomes is net immigration. Ashby (2007) finds that economic freedom is positively related to net immigration among U.S. states. If the decision to migrate is based, at least in part, on seeking out better labor market possibilities then net immigration would be related to job creation in states attracting immigrants. In addition to the theoretical reasons why interstate variation in economic freedom should be associated with cross-state differences in unemployment and other labor market outcomes, extensive international comparisons support such a conclusion. Cross-country studies by Feldmann (2006, 2007, 2010) find that economic freedom is associated with lower unemployment. Our article extends this line of research to the U.S. states. II. EMPIRICAL FRAMEWORK We use annual state-level data to examine state labor market conditions over the period 1981-2009. …