Local economic freedom and creative destruction in America

Abstract

Economic freedom facilitates the market selection mechanism that enables the Schumpeterian creative destruction process. I develop a framework depicting how economic freedom, which reduces entry barriers and transaction costs, acts as an external enabler that facilitates the creation of firms and jobs. It also facilitates the market correction device, potentially serving as a disabling force to allow firm and job destruction. Using a novel metropolitan statistical area–level dataset, I investigate empirically the role of local economic freedom on dynamism for a sample of nearly 300 U.S. cities over the period 1972–2012. My results confirm that economic freedom is positively associated with firm and job creation, but it has no effect on firm and job destruction.

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Fig. 1

Notes

  1. 1.

    Bologna and Jamie (2014) is the only previous study that I am aware of to examine the relationship between economic freedom and entrepreneurial activity at the local level. My analysis differs in several respects. First, Bologna’s study utilized preliminary MSA-level economic freedom data (Stansel 2013) that was only available for a single year, 2002. My study is, to the best of my knowledge, the first to employ the recently developed longitudinal Metropolitan Economic Freedom Index (Stansel 2019). Second, Bologna employed cross-sectional spatial econometrics methods, whereas I use panel data econometrics methods to exploit within-region variance over time. Third, Bologna considered the impact of local economic freedom on establishment entry and self-employment, whereas I consider the effect of local economic freedom on both the firm entry and exit rates, as well as the job creation and destruction rates. Lastly, Bologna found evidence of a positive and significant indirect spillover effect, but no direct effect, of the level of economic freedom on her measures of entrepreneurial activity, whereas I find evidence of a direct and significant effect of local economic freedom on my measure of entrepreneurship, the firm entry rate.

  2. 2.

    As a supplement to the analysis, however, I also separately examine the effects of economic freedom on job creation by new firm entry and expansion by incumbent firms, as well as on job destruction by incumbent firm exits and contractions. These results are presented in Appendix Table B3.

  3. 3.

    As an example, the firm entry rate assigned to 1997 is the average annual number of firms created over the period 1997–2001 relative to the total number of firms in 1997. Note that the BDS data series ends in 2014, so the numerator for the measures mapped to 2012 represent the average values over the 3 years spanning 2012–2014.

  4. 4.

    In results not reported for space, I ran the Hausman (1978) specification test to determine whether a fixed-effects (FE) or random-effects (RE) estimator is more appropriate for each dynamism indicator using the most complete model (see model 7 in Tables 1, 2, 3, and 4). Under the null hypothesis, both the FE and RE estimators are assumed consistent and the RE estimator is more efficient. The Wu-Hausman test statistic, which has a χ2 distribution, is used to test the null hypothesis. If the null is rejected (i.e., p value ≤0.05), then the FE estimator is preferred because it is assumed consistent and the test suggests that the RE estimator is inconsistent (Wooldridge 2010). For all dynamism indicators, the p value of the test statistics is 0.000, suggesting that the null be rejected.

  5. 5.

    See footnote 1 for a detailed explanation on how the current study differs from Bologna and Jamie (2014).

  6. 6.

    Given that the OECD countries are among the most economically developed in the world, the context of the two studies differs considerably. This may explain the qualitatively opposite results obtained in the two studies with respect to the effect of economic freedom on necessity entrepreneurship.

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Bennett, D.L. Local economic freedom and creative destruction in America. Small Bus Econ 56, 333–353 (2021). https://doi.org/10.1007/s11187-019-00222-0

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Keywords

  • Creative destruction
  • Dynamism
  • Economic freedom
  • Entrepreneurial ecosystems
  • External enablers
  • Firm entry
  • Firm exit
  • Public policy
  • Regional entrepreneurship
  • Institutions

JEL classification

  • H32
  • H71
  • J08
  • L26
  • L53
  • M13
  • O43
  • P10
  • R11
  • R50