Competition among Governments Is Important for Economic Freedom

Think about where you live. Why did you choose to live there? Is it near your job? Low taxes? Good schools? Nice roads and sidewalks? Perhaps all of these factors played a role in your decision. There are nearly 36,000 municipal or town governments in America, and each offers a different mix of government goods and services depending in part on the preferences of residents and local officials. The large amount of choices helps us find a city that is right for us, and in a new study, economists Brad Hobbs, Dean Stansel, and I find that more choices are also associated with more economic freedom.

In an influential article, economist Charles Tiebout reasoned that the existence of many local governments enables each of us to choose the one that best matches our preferences for government goods and services. The old real estate yarn “location, location, location” includes the fact that people without children may prefer a city with lower taxes and lower quality schools, while some parents prefer to pay more taxes in a city with better schools. Tiebout’s analysis was the inspiration for the term “voting with your feet”—the idea that people often move to the locality they like best rather than try to change things by voting in elections.

In their 1980 book “The Power to Tax,” economists Geoffrey Brennan and James Buchanan take Tiebout’s idea a little further. They argue that because people can vote with their feet, government behavior is constrained. If a city raises taxes but doesn’t use the money to improve services people will leave for a better-managed city.

More generally, the threat of exit by people, firms, and entrepreneurs creates competition among governments that limits governments’ ability to exploit its citizens. Brennan and Buchanan’s conjecture became known as the Leviathan hypothesis. It posits that the more governments there are to choose from, the harder it will be for any single government to exploit its citizens.

To test this, my coauthors and I use a unique measure of economic freedom constructed for U.S. metropolitan areas, where more economic freedom means less government exploitation. Other studies have found that this measure of local economic freedom is associated with faster per capita income growth, more entrepreneurial activity, and lower borrowing costs via better bond ratings.

In our analysis, we find that more local governments per square mile—a statistic that captures the ease of moving between jurisdictions—is associated with more metropolitan area economic freedom. However, the strength of this relationship varies by region. The relationship is strongest in metropolitan areas in the Northeast and Midwest regions of the country and weakest in the South.

Some of the regional variation is likely due to historical factors. Economist William Fischel argues that because of rainfall patterns and historical race-based segregation, local government power is more concentrated in county governments in the West and the South than it is in the denser Northeast and Midwest regions.

In the relatively flat North where rain is plentiful, population densities in the 19th and 20th centuries were high enough to warrant forming many local governments. The city or village government had most of the power, and county governments, which are the states’ local administrative units, played a relatively minor role. As the urban population spread out in the mid-20th century, the small rural towns in the North became suburbs, each with its own distinct local government.

In more arid and mountainous western areas such as Arizona, Nevada, Utah and Colorado, populations were more scattered. To achieve economies of scale in the provision of government goods and services (school districts, fire districts, and so on) with such sparse populations, local government had to cover more area. Thus, the larger county, not a smaller local government, became more influential in local governance in these areas.

The South is similar to the arid West because of racial segregation. “Separate but equal” government services required local government jurisdictions to cover a wide area in order to be economical. To maintain black-white segregation, more power was allocated to the state and the state’s local administrative unit, the county. Because of this history, local government in the South is more like the arid West than the North, despite the South’s having terrain and rainfall similar to the North.

When government power is concentrated at the county level, it is harder for towns and municipalities in the same county, and thus the same metro area, to differentiate themselves and compete with one another for residents. This helps explain the stronger results in the more competitive Northeast and Midwest.

Critics of competition between local governments emphasize the costs of duplicating local services, such as police and fire protection, and the difficulty of getting local governments to agree on large projects that would supposedly benefit the entire region, such as large infrastructure projects. Having one metropolitan-level government, they argue, would decrease costs and streamline the decision-making process.

One overarching metropolitan government created to maximize a region’s welfare at the lowest cost might sound great, but how do we ensure that it does its job? Experience shows us that the best way to ensure that any provider stays responsive to its customers is through competition. Consumers compete against other consumers (think about the last house you bid on) and producers compete against other producers (think about Google and Apple).

Competition among firms leads to the duplication of products and services (UPS and FedEx, Old Spice and Speed Stick), but it also forces firms to pay attention to what their customers want. If they don’t, their customers will find a new provider. It’s reasonable to think that similar competitive forces are required to keep governments responsive to their constituents.

This is not to say that some amount of metropolitan-level government, perhaps to oversee large infrastructure projects, is not worthwhile. But we must also consider competition’s ability to discipline local governments and increase economic freedom when discussing the pros and cons of government consolidation.