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Article Excerpt
Abstract
The Economic Freedom Index of North America measures the impact of governmental institutions. The literature finds that economic freedom leads to higher incomes. Economic freedom is a geographically defined benefit, the value of which will be capitalized into real estate values. We hypothesize that more economic freedom should lead to higher home prices, ceteris paribus. Our findings support our hypothesis. Through a variety of direct and indirect effects, economic freedom influences the quality of life. States that are more economically free are more attractive places to live, and the benefits accruing to more economic freedom are capitalized into home prices.
I. Introduction
Higher values of the Economic Freedom Index of North America (Karabegovic, Samida, Schlegel, and McMahon, 2003), an index measuring a constellation of government policies (hereafter the freedom index) has been linked to higher income (Karabegovic, Samida, Schlegel, and McMahon, 2003; Karabegovic and McMahon, 2005), more business venturing and entrepreneurship (Campbell and Rogers, 2007; Kreft and Sobel, 2005), and population in-flow (Ashby, 2007). The freedom index measures the impacts of governmental institutions, which largely stop at a state's borders. Thus a state's policies and institutions consistent with economic freedom constitute a geographical benefit. The value of geographically defined benefits will be capitalized into home prices. We hypothesize that more economic freedom should lead to higher home prices, ceteris paribus.
Gwartney and Lawson (2002), Farr, Lord, and Wolfenbarger (1998), Gwartney, Lawson, and Holcombe (1999), Cole (2003), and Powell (2003) emphasize how economic freedom promotes economic prosperity and growth around the world. Kreft (2003), Kreft and Sobel (2005), and Wang (2005) apply the Economic Freedom Index of North America to questions of income, income growth, and entrepreneurship, while Ashby (2007) applies the index to migration patterns. In general, these and other papers find that pro-freedom national/state institutions are causally related to income growth, entrepreneurship, and immigration. Entrepreneurship and migration are associated with economic development (Mora and Davila, 2006; Acs and Storey, 2004). Higher income is associated with lower crime rates and diminished public corruption (Glaeser and Saks, 2006). Growing and increasingly affluent populations will put upward pressure on home prices. In addition to these indirect influences on home prices, people may value also value economic freedom intrinsically. Such notional value (as opposed to instrumental value) of freedom is also expected to exert upward pressure on home values.
Using the New Institutional analytical framework (North, 1981; Hayek, 1960), institutional choices lead to economic and social outcomes. Causality runs from institutions and policies to outcomes, rather than the other way around. While governments cannot select a vector of economic shocks, they can select policies; governments can select whether to embrace economic freedom. Thus, economic freedom (institutional choice) yields higher incomes, greater entrepreneurship, lower crime rates, and less corruption, as well as notional value. One way in which residents will capitalize these value streams accruing to a locale's freedom is through housing appreciation.
Accordingly, we estimate models of housing price change. Our primary measure for home price change is the Office of Federal Housing Enterprise Oversight's (OFHEO) House Price Index (HPI). Our findings support our hypothesis; namely, that states with more economic freedom experience greater housing values, ceteris paribus. Through a variety of direct and indirect effects, the political policies and institutions summarized in the freedom index influence the quality of life in their respective states. States that are more economically free are more attractive places to live. Stipulating that the supply of housing is not perfectly elastic in the short run, the benefits accruing to more economic freedom are capitalized into home prices.
II. Literature Review
The literature review is divided into two subsections. The first subsection describes the literature on the freedom indices with an explanation of how the Economic Freedom Index of North America is constructed and how it is used in this study. The second subsection provides an overview of relevant literature on housing prices with an explanation of the index used in this study.
1. Economic Freedom of North America
Freedom indexes of the world have established themselves as fixtures in the social sciences literature, especially in the economic growth literature (see, for example, recent work by Atukeren, 2005; Berggren and Jordahl, 2005; and Gwartney, Lawson and Clark, 2005). Researchers have used these indices or their constituent components as regressors to explain income or income growth rates. At root, this literature concerns the relationship between "institutions" and their impact on observed economic outcomes (e.g., North, 1981). While governments cannot select a vector of economic shocks, they can select policies. Thus, the literature argues that primary causality runs from institutions to policies and then to income,...
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