Another look at Minnesota’s underperforming economy

Minnesota’s economy has clearly underperformed the national average in recent years. A 2008 Minnesota 2020 report demonstrated that from 2002 to 2007, Minnesota’s employment growth and median household income fell relative to other states, while our unemployment rate rose. In addition, growth in Minnesota’s Gross Domestic Product (GDP) lagged significantly behind the national average.

There is disagreement over the cause of Minnesota’s economic slump. Minnesota 2020 has posited that the state’s waning economic performance is due in part to public disinvestment during the era of “no new taxes.” In absolute terms and relative to other states, real per capita public revenues and expenditures in Minnesota have declined significantly since 2002.

However, there are other competing explanations for Minnesota’s economic deterioration. For example, it has been argued that at least a portion of Minnesota’s slumping performance relative to other states since 2002 is due to strong growth in the defense sector; as the argument goes, because defense is a relatively small share of Minnesota’s economy, Minnesota was not well situated to benefit from growth in defense spending so Minnesota’s economic growth has lagged behind the rest of the nation.

In addition to growth in defense spending, there are other factors that could explain Minnesota’s relatively low GDP growth since 2002. For example, energy-producing states experienced rapid GDP growth because of increasing energy prices. Energy production contributes less to GDP in Minnesota than in the nation as a whole. Thus, escalating energy prices buoyed GDP growth more nationally than in Minnesota.

The home-construction slump
Another factor that could contribute to Minnesota’s relatively poor economic performance relative to the rest of the nation is the slump in new home construction, which was detrimental to the forestry and wood-products industries. Insofar as these industries are a significant component of Minnesota’s economy, the slump in new home construction could explain some portion of Minnesota’s low GDP growth relative to the rest of the nation.

Finally, the airline industry has fallen on hard times since 2002. The air transportation industry is a larger component of GDP in Minnesota than nationally; thus, the slump in this industry has hit Minnesota harder than most other states and thereby could also help to explain Minnesota’s low GDP growth in comparison to the rest of the nation.

It is difficult to quantify with precision the impact of these trends upon national and Minnesota GDP growth. However, using data from the U.S. Bureau of Economic Analysis (BEA) it is possible to compare Minnesota and U.S. total GDP growth to “adjusted GDP” growth after factoring out the following categories: national defense, oil and gas extraction and mining support activities, petroleum and coal products manufacturing, forestry (this category also includes “fishing and related activities,” which are lumped together with forestry in BEA data), wood products manufacturing, and air transportation. GDP growth was adjusted for inflation using the GDP price index from the BEA.

Analysis extended through 2007
The information presented below is an update of research originally presented in 2008. The 2008 research examined GDP growth from 2002 to 2006; the information below will extend the analysis through 2007.

The graph below compares real Minnesota and U.S. total GDP and “adjusted GDP” growth from 2002 to 2007. During this period, Minnesota total real GDP growth lagged 4.1 percent behind the national average. After factoring out national defense, energy extraction and manufacturing, forestry and wood product manufacturing, and air transportation, Minnesota “adjusted GDP” growth was still 2.3 percent below the national average.

Based on this analysis, it is clear that trends in national defense, energy, wood products, and air transportation contributed to Minnesota’s low GDP growth relative to the rest of the nation from 2002 to 2007. However, even after factoring out the impact of these categories, over half of the gap between Minnesota and the rest of the nation in terms of GDP growth remains. In other words, it appears as if trends in defense spending, energy, and the other categories described above explain some — but not all, or even most — of Minnesota’s lackluster GDP growth.

Furthermore, this analysis probably overstates the degree to which Minnesota’s below average GDP growth can be attributed to trends in defense spending. BEA data does not separate out the portion of GDP attributable to national defense for individual states. Thus, for purposes of this analysis, it was assumed that the increase in national defense spending contributed nothing to Minnesota GDP growth from 2002 to 2007, which is probably not the case. As a result of the inability to quantify the national defense share of Minnesota GDP, this analysis overstates the extent to which Minnesota’s below average GDP growth is the result of growth in defense spending.

The economic improvement in Minnesota relative to others states that was promised by proponents of “no new tax” tax policies has not materialized. In fact, the opposite has occurred: Minnesota’s economic performance has deteriorated relative to other states. Minnesota 2020’s 2008 analysis of this issue concluded that:

The extent to which anti-tax advocates can blame external factors for Minnesota’s slumping economic performance is limited. Even after adjusting for these external forces in a way that likely overstates their impact, Minnesota’s GDP growth is still considerably below the U.S. average. In short, “no new tax” proponents are running out of excuses.

Nothing in this updated analysis gives any reason for altering this conclusion.

No surprise in Minnesota’s performance
Minnesota’s deteriorating economic performance relative to the rest of the nation during the “no new tax” era should not come as a surprise. Since 2002, Minnesota’s current spending on public education has dropped below the national average and the real revenue needed to pay for public services has declined. It is foolhardy to expect prosperity to result from a policy that shortchanges important long-term public investments.

It is time to reject a policy that peremptorily dismisses the option of revenue increases as part of the solution to addressing the challenges posed by Minnesota’s huge $7.4 billion deficit and dwindling public resources. In dealing with these problems, all options need to be on the table.

Jeff Van Wychen is a fiscal policy fellow at Minnesota 2020. This piece is reprinted from the organization’s website.