Economic Freedom Reduces Poverty: The Canadian Experience

Economic Note showing that fewer regulations and lower taxes can alleviate persistent poverty and improve poverty resistance

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Poverty study concludes Quebec should imitate Alberta (Western Standard, May 26, 2024) Un fardeau fiscal et réglementaire plus souple aiderait à réduire la pauvreté (Le Journal de Montréal, May 30, 2024) Lower Taxes, Flexible Regulation Could Have Prevented 140K Poverty Cases in Quebec: Report (The Epoch Times, June 4, 2024)	Interview (in French) with Vincent Geloso (Richard Martineau, QUB Radio, May 30, 2024)

This Economic Note was prepared by James Dean, assistant professor of economics at Western Carolina University (Cullowhee, North Carolina), and Vincent Geloso, assistant professor of economics at George Mason University (Fairfax, Virginia), and Senior Economist at the MEI. The MEI’s Taxation Series aims to shine a light on the fiscal policies of governments and to study their effect on economic growth and the standard of living of citizens.

The experience of poverty can be crippling. Health issues incurred during a spell of poverty may have long-lasting effects. Children born into poverty tend to suffer educational setbacks that often result in lower incomes and inferior health outcomes in later life. Beyond these direct effects, poverty is frequently accompanied by a form of social exclusion whereby participation in both civil society and democratic activities is reduced. The cumulative effect of these factors can severely limit individuals’ ability to improve their circumstances, affecting not just their own lives, but potentially the lives of future generations as well.(1)

Discussion of policy designed to remedy poverty generally focuses on the redistributive measures that governments can implement. Less frequently discussed is the role of pro-market policies that enhance the economic freedom of the poor (i.e., protection of property rights, limited regulation, open trade, low taxes, and low government spending). The present study highlights new research that demonstrates the importance of economic freedom in alleviating poverty.

Economic Freedom and Persistent Poverty

There is a wide body of literature that emphasizes how economic freedom promotes economic growth and development in general.(2) Because it generates economic growth, we may reasonably expect economic freedom to reduce poverty as well, and this is confirmed by the small subset of this literature which has been dedicated to analysis of the distribution of the fruits of economic growth with respect to socio-economic status. It turns out that economically freer societies enjoy greater income gains for all groups and thus tend to have lower poverty rates into the bargain.(3)

It turns out that economically freer societies enjoy greater income gains for all groups.

But this existing literature is unable to address some of the issues that we normally care about when we talk about poverty, more specifically, those aspects that relate to the “dynamics of poverty.” In general, it would be helpful to know whether and to what extent the poor are persistently poor.(4) Can these individuals exit poverty or are they trapped in it forever? If they do manage to escape, do they then linger near the poverty line, forever vulnerable to small economic shocks that could push them back under? Persistent poverty often leaves lasting scars, but economic precarity may have long-term effects of its own.

This issue is directly tied to our understanding of the importance of economic freedom. After all, we want to know whether removing barriers to entrepreneurship facilitates the climb out of poverty; whether the deregulation of certain services reduces the cost of living so as to increase real incomes; whether lowering taxes encourages the acquisition of skills while rewarding effort and savings; whether the deregulation of professions allows people to change sectors more easily, etc. Exactly how economic freedom allows people to escape poverty is what really matters. So what is the empirical evidence in this regard?

The Canadian Experience

There is a paucity of continuous international data tracking the dynamics of poverty (duration of poverty spells, rates of exit from poverty, rates of entry into poverty and so on). Fortunately, there exists an intranational database that allows us to consider these statistics for Canadian provinces as far back as 1992.

Statistics Canada compiles extensive data regarding “low-income status”—a term that can be understood as synonymous with “poverty.” This includes the rates of entry and exit from low-income status for tax filers each year, and the persistence of low-income status among tax filers over rolling eight-year windows.(5) The rates of entry and exit are measured over a full-year period so as to indicate, for example, whether a given person entered/exited within the year 2020. The data for persistence tracks the same individuals for an eight-year period. For example, one group is tracked from January 1, 2010 to December 31, 2017, another from January 1, 2011 to December 31, 2018, and so on.

Overall, we can generate a total of 11 variables regarding the experience of poverty in Canada: the average length of a poverty spell, the share of population that experience zero years in poverty, the share of population that experience the full eight years in poverty, the entry rate, the exit rate, and the respective probabilities of exit after 1, 2, 3, 4, 5, and 6 years in poverty.(6) All of these variables are available from 1992 until today.(7)

If Quebec had possessed Alberta’s level of economic freedom, the rate of extremely persistent poverty would have been almost halved.

Because this data can be broken down by province, it can also be matched against the Economic Freedom of North America (EFNA) report produced by the Fraser Institute. The EFNA ranks economic freedom on a scale from zero to ten (worst to best) and is composed of three metrics: i) level of government spending by type; ii) level of taxation; and iii) labour market regulation.(8)

In our work, we have combined these two datasets and tested the importance of economic freedom for each of the 11 statistics relating to poverty in Canadian provinces over the period from 1992 to today.(9) With the addition of a number of relevant economic control variables to keep all else equal,(10) we tested whether the EFNA predicts normatively superior outcomes with regard to poverty statistics.(11)

The relationship between economic freedom and poverty statistics is such that we could not find any instance in which more economic freedom hurt the poor.(12) Conversely, when we use the aggregate index we find cases in which economic freedom helps the poor and achieves statistical significance (see Table 1 for the first five poverty statistics listed above). When we look at the components for labour market regulations and levels of taxation, we find that fewer regulations and lower taxes always reduce poverty.

One useful way to visualize the importance of these results is to imagine what would happen to poverty indicators in the province with the lowest economic freedom if it somehow became as free as the freest province. Over the period from 1992 to 2020, the provinces that qualify are Quebec and Alberta, respectively. In the last rolling window (2013 to 2020), Quebec’s score on the EFNA index was 4.44 points (out of 10) below Alberta’s. The result is depicted in Figure 1 in which “Freer Quebec” is Quebec if it were as economically free as Alberta.

If Quebec had possessed Alberta’s level of economic freedom, the rate of extremely persistent poverty (i.e., eight years spent in poverty) would have been 2.3% over the rolling window from 2013 to 2020. This means that Quebec’s actual rate of 4.4% (223,440 individuals) during that period would have been almost halved, pulling close to 107,000 individuals out of extremely persistent poverty.

Government introduces numerous hurdles that prevent people escaping the poverty trap.

A similar exercise can be conducted using the rate of poverty resistance (i.e., zero years in poverty during the period). Had they enjoyed the same levels of economic freedom as Albertans, 77.2% of Quebecers would have experienced no poverty spells between 2013 and 2020. Contrasted with the actual rate of 74.4%, we can see that an additional 2.8% of Quebecers would have been spared the experience of poverty. This is close to a quarter of the annual poverty rate across the period, implying that some 140,000 more individuals would have avoided poverty altogether from 2013 to 2020.

Deregulate Occupational Licensing and Housing to Empower the Poor

The usual focus on giving money to the poor has distracted us from an important alternative. Government introduces numerous hurdles that prevent people escaping the poverty trap. Removing these hurdles, i.e., increasing economic freedom, would empower the poor in ways that require little to no expenditure by government. Three examples should suffice to show how.

• First, Canadian provinces (Quebec included) have created a wide array of occupational licensing regulations—a particularly regressive set of policies since they limit the ability of individuals to access new occupations (and not just highly-skilled ones).(13)
• Second, multiple governments in Canada (provincial, federal, municipal) create barriers to competition, e.g., state monopolies and restrictions on non-Canadian market participants, such that between 25.2% and 35.1% of the Canadian economy is shielded from competition.(14) These barriers to competition depress real wages by increasing the cost of living and slowing down productivity growth (which pushes up wages).
• Third, housing regulations that limit construction in cities tend to be highly regressive. Cities have the potential to offer great chances for upward mobility because they offer more (and more remunerative) employment opportunities,(15) but by increasing house prices and rents, housing regulations prevent people from accessing these opportunities.(16) Compounding this is the fact that rent represents a larger fraction of the budgets of the poor; this amplifies the regressivity of these housing regulations.(17) By reducing rental prices, the removal of housing regulations would increase access to opportunities as well as reducing the cost of living for the poor.

Policy reforms on these three fronts would be easy moves for governments seeking to alleviate persistent poverty and prevent the scars of poverty from materializing in the first place. Even modest steps in this direction could make a substantial difference for the poor in Quebec and across Canada.