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That Center of the American Experiment report on the Minnesota economy? It’s politics, not economics

Minnesota’s slower growth has an explanation in economic theory — and it’s got nothing to do with taxes or regulation.

Minnesota will continue to be rich — it just won’t have as big of a lead over other states as it does now.
MinnPost photo by Peter Callaghan

Last week, the Center of the American Experiment issued what it called a “groundbreaking paper” on the Minnesota economy, “Minnesota’s Economy: Mediocre Performance Threatens the State’s Future.” Their conclusion is stark:

Are Minnesota’s blue-state policies responsible for its economic underperformance? There is no question Minnesota’s higher tax and regulatory burdens add to the cost of doing business. In recent years, Minnesota has increased these burdens while a number of other states, such as North Carolina, Indiana and Tennessee, have taken serious steps to reduce them. Without any other obvious weak points—beyond the inescapable realities of the state’s northern locale—Minnesota’s tax and regulatory burdens are among the only suspects at the scene of Minnesota’s mediocre economic performance.

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Though it looks like a research paper, with 30 figures, 5 tables, and a page of footnotes in tiny print, the report is actually an advocacy document more akin to a 40-page op-ed than an academic study. In particular, the conclusion (that Minnesota must lower taxes and reduce regulatory burdens) is the starting point, with evidence marshalled to support that end. This is in line with the Center’s stated goal of formulating policies “that emphasize free enterprise, limited government, personal responsibility and government accountability.”

The research literature on economic growth and standards of living across states is much more nuanced than the Center’s paper lets on. In particular, average growth does not mean Minnesota’s performance is mediocre; rather, average growth is exactly what economic theory predicts for a high-income state like Minnesota.

The Center makes the following argument:

  1. Minnesota is growing at average or below average rates, depending on the measure chosen.
  2. There are three reasons why states grow at average or below average rates:
    • Poor ranking on social indicators such as education levels, health measures, and labor force participation.
    • High taxes
    • Burdensome levels of regulation

    Minnesota ranks high in social indicators, so it must be high taxes and regulations that lead to the state’s “mediocre performance.”

There are two problems with the Center’s argument: First, their assertions about taxes and regulation are not borne out by scholarly research, and second, they are missing a critical reason for slower growth that scholars across the political spectrum agree on.

Little correlation between taxes, regulation and growth

An enormous amount of academic work has been done over the past 30 years on the sources of economic growth across countries, states, and regions; yet the Center takes no account of it at all.

This is too bad, since we’ve learned an enormous amount about why some states grow rapidly while others don’t. Among the findings are:

  • There is no hard and fast relationship between taxes and economic growth. Some scholars read the literature as showing that taxes strongly affect growth while others contend that the same group of studies show no relationship.
  • There is no hard and fast relationship between regulations and economic growth. A nice recent illustration of this is here, where Menzie Chinn of the University of Wisconsin-Madison updates his annual look at the relationship between state-level growth and the American Legislative Exchange Council (ALEC) Economic Outlook Ranking.

Poor get richer, rich stay rich

However, there is a relationship between a state’s level of income and its growth rate. Specifically, research has shown time and again that states which start out with low levels of income per person grow faster than states that begin with higher levels of income per person. This phenomenon is known as income convergence, and shows up across countries, regions, provinces, prefectures, and states. (Robert Barro, a Harvard professor and fellow at the Hoover Institution, is the leading scholar in this area.)

A clear implication of income convergence is that high-income states, like Minnesota, tend to have below-average growth rates. That is, high income states don’t run away from the pack; instead, through movements of people, capital, and ideas, low income states catch up to the high income states by growing faster — but not forever.

For example, Figures 6 and 7 in the Center’s report show that South Dakota grew significantly faster than Minnesota from 2000 to 2015. In 2000, income per person in South Dakota was $ 36,110 (in 2009 dollars) while Minnesota’s was $48,055. By 2015 South Dakotans had almost reached Minnesota’s 2000 level, hitting $ 47,460. In the meantime, Minnesotans saw their per capita income continue to rise, to $54,431.

Yes, South Dakota grew twice as fast as Minnesota (1.8 percent per year versus 0.8 percent per year), and could catch up to Minnesota by 2028 if these growth rates stayed the same. However, another implication of the income convergence literature is that a state like South Dakota will see its growth rate slow as it gets closer to the leaders. Meanwhile, Minnesota will continue to be rich — it just won’t have as big of a lead over other states as it does now.

Other states to follow?

Finally, is Minnesota falling behind? Should we follow the examples of North Carolina, Indiana and Tennessee? Let’s take at income per capita, relative to the national average, for Minnesota versus these three states:

Real GDP per person, 2000–2015
Per capita real GDP in chained 2009 dollars, as ratio of U.S. average.

Minnesota, after losing ground in the 2000s, regained its 8 percent lead on the national average while North Carolina, Tennessee, and Indiana continued to lag behind. Perhaps the effects of their new tax and regulatory policies will show up in the years to come, but as of 2015 they have a long way to go to catch up to Minnesota.

Keeping our edge

How Can Minnesota Stay Above Average?” is the title of a talk I’ve been giving since 2009 (and wrote about in a couple of MinnPost columns here and here.) Terry Fitzgerald, an economist at the Federal Reserve Bank of Minneapolis, first studied this  topic back in 2003. I am happy that the Center of the American Experiment agrees that this is an important question to investigate and has joined the hunt for answers.

I hope that in the future, rather than starting with policy prescriptions, the Center will first look at the evidence, formulate hypotheses about Minnesota’s growth performance based on economic theory, and then test these hypotheses against the data. We can then have a fruitful conversation about a variety of policies that could boost Minnesota’s growth rate.