There are many reasons why unemployment can vary across states. Unemployment varies across demographic groups—younger people and black people have higher unemployment rates than older people and white people, respectively. As a result, demographic differences across states can be associated with interstate variation in unemployment.
Likewise, there can be state-specific effects that lead to unemployment differences. For example, part of Nevada’s high unemployment rate is likely a hangover from the housing bust in Las Vegas. On the other hand, the oil and gas boom in North Dakota has pushed down that state’s unemployment rate.
It is also possible that the variation in labor market conditions across states is partly attributable to differences in economic freedom. This is the question we examine in a paper that will appear in this October’s Contemporary Economic Policy.
Economic freedom means that workers and entrepreneurs can engage in mutually beneficial dealings without interference from high taxes, big government, and heavy regulation of labor markets. Conveniently, the Fraser Institute’s Economic Freedom of North America (EFNA) reports provide an annual index of economic freedom for each state dating back to 1981. Each state is rated on a scale from 1 to 10, with a higher EFNA rating indicating more economic freedom.
Before turning to a summary of our paper’s statistical analysis, consider Figure 1, which depicts each state’s EFNA rating and its unemployment rate. (The data are for 2010, the most recent year the economic freedom index is available.) As the plotted line indicates, there is a strong negative relationship between economic freedom and unemployment. That the fit is somewhat noisy, rather than being tightly clustered around the plotted line, is not surprising because this simple plot does not control for any of the other factors that might affect unemployment rates.