What’s happening to American prosperity?

Your humble blogger has been an "advisor" to the Legatum Prosperity Index for a few years now. They released their 2012 rankings today, and according to Bloomberg, the results ain’t good for the United States:

The U.S. slid from the top ten most prosperous nations for the first time in a league table which ranked three Scandinavian nations the best for wealth and wellbeing. The U.S. fell to 12th position from 10th in the Legatum Institute’s annual prosperity index amid increased doubts about the health of its economy and ability of politicians. Norway, Denmark and Sweden declared the most prosperous in the index, published in London today. With the presidential election just a week away, the research group said the standing of the U.S. economy has deteriorated to beneath that of 19 rivals. The report also showed that respect for the government has fallen, fewer Americans perceive working hard gets you ahead, while companies face higher startup costs and the export of high-technology products is dropping. “As the U.S. struggles to reclaim the building blocks of the American Dream, now is a good time to consider who is best placed to lead the country back to prosperity and compete with the more agile countries,” Jeffrey Gedmin, the Legatum Institute’s president and chief executive officer, said in a statement (emphasis added).

In the Wall Street Journal, Gedmin and Prosperity Index program director Nathan Gamester push on this message a bit harder in an op-ed:

Earlier this month the Obama administration received good news: U.S. unemployment seems finally to be coming down. This week, however, the news is not so good. In fresh data on economic prosperity from countries around the world, the U.S. has fallen out of the Top 10 for the first time ever. If elections were decided by data, today’s findings would spell trouble for President Obama. The 2012 Legatum Prosperity Index captures not simply the quarterly or annual ups and downs of the national economy, but rather long-term underlying components of national prosperity. Our findings suggest that the American Dream is in jeopardy. The first problem is well-known. America has saddled itself with crippling debt and soaring entitlement spending. Couple these with projections of low growth—and possibly even another recession—and a bleak picture emerges. It seems that even parts of Old Europe, the euro crisis notwithstanding, can teach America a thing or two. Norway, Denmark and Sweden top our rankings this year. Once upon a time the Scandinavians were world champions in big government and social spending. But bloated welfare states have been brought to heel in recent years. There has been deregulation and privatization: The Swedes even privatized air traffic control. Today Denmark has one of the most flexible labor markets in the world. (emphasis added)

So, the subtext seems pretty clear: U.S. prosperity is declining because of staggering debt and a bloated public sector, in contrast to those newly laissez-faire Scandinavians. You can guess which presidential camdidate is better-placed to reward entrepreneurship.

This has prompted some gnashing of tweets teeth about the future of the United States. Now, having looked at the numbers, I share some of this anxiety. There is a powerful grain of truth to Gedmin and Gamester’s assertions. But there are a few other grains of truth that should be sprinkled about before reaching any conclusions:

GRAIN OF TRUTH #1: The U.S. didn’t really fall too far in the rankings — it went from 10th place last year to 12th this year. That’s partly because Luxembourg got added to the index in the interim and it did better than the United States in the rankings. It’s not great, but it’s not an exaggerated decline either.

GRAIN OF TRUTH #2: High levels of debt ain’t what’s holding the United States back in these rankings. Japan has a much higher debt-to-GDP ratio, but its economic performance ranked eight places higher than the U.S. There are other factors at work here.

GRAIN OF TRUTH #3: If you burrow into the report itself (.pdf), you find that the primary reason for the drop in the U.S. ranking was a fall in the "Entrepreneurship and Opportunity" score. The primary driver for this? "This fall is driven by a decline in the number of US citizens who believe that hard work will get them ahead and a decrease in ICT exports (p. 10)."

Now this leads to an interesting question: what drives the decline in the belief that hard work will get one ahead in life? Legatum explains that on p. 38:

Low business start-up costs and a positive perception of a country’s entrepreneurial environment contribute to improving citizens’ economic prospects and overall wellbeing. The sub-index also evaluates a country’s ability to commercialise innovation and measures the technological and communication infrastructure that is often essential to successful commercial endeavours. It further provides a snapshot of access to opportunity by tracking inequality and by asking citizens whether they believe their society to be meritocratic. (emphasis added)

And now we get to the nub of it. The decline in America’s prosperity score is partly a function of the weak economy — but it’s primarily a function of citizen perceptions of their ability to get ahead. Government barriers to entrepreneurial activity would certainly depress those perceptions, but so would very high levels of inequality (moderate levels of inequality are a different animal altogether). The more unequal a society is, the less that ordinary citizens feel that their own efforts will yield commensurate rewards. And in the past few years, the data shows that the United States has become increasingly unequal.

So, if Gedmin and Gamester are correct that Americans should use this report to think about which presidential candidate would be poised to improve American prosperity, you have to ask yourself which candidate is more likely to improve Americans’ belief that their society rewards hard work and effort. And I don’t think the answer is as clear cut as they think it is.

What do you think?