Wednesday, August 05, 2009

Determinants of economic growth II

Earlier this week I wrote about various factors that promote economic vitality, contrasting unemployment rates in states with a more interventionist approach against those that lean more towards a free market philosophy. The Free Exchange blog, however, notes the role played by geography:
Morever (sic), the recession as exerienced (sic) at state levels doesn't lend itself to easy analysis through a left-right lens. Yes, "blue" areas of the country have been among the hardest hit by the downturn. The Midwest has been in or near recession for years now, and the West Coast has been beset by a triple blow: a housing crash, a deep manufacturing downturn, and an implosion in trade with Asia. But left-leaning areas of the country have also been among the most resilient. The Northeast corridor of the country, stretching from Washington to Boston, has enjoyed below average unemployment rates (and that despite the bloodletting on Wall Street) and seems prepared to lead the national economy out of recession.

Meanwhile, redder states like South Carolina are suffering from extremely high unemployment rates, and other sunbelt metropolitan areas like Atlanta and Phoenix have not had the benign housing crash that Texas has had. And where red states have performed well, that success is frequently due to factors that aren't easily replicable, like resource wealth.
Matthew Yglesias similarly downplays the impact of policy in determining economic growth, endorsing the Free Exchange view that other factors such as geography play a more significant role.

Two quick thoughts:
  • The red-blue divide doesn't interest me as much as policy differences and the impact of economic freedom on growth. Using political parties as a proxy for this strikes me as problematic given that Republicans aren't always averse to government interventions in the economy.
  • The statement that the BosWash corridor has lower than average unemployment rates is not as informative as the blogger thinks. After all, a majority of states -- 34 -- have unemployment rates lower than the national average, due to a few states like Michigan that push the average up. It's the same principle as Bill Gates walking into a bar and suddenly the average income of the place makes everyone rich.
But the overall point about geography is well taken and one I have made myself. Coastal California is always going to be a desirable place to live while Fargo probably isn't going to become an economic powerhouse no matter what policies the city or state implement. Factors such as natural resources, access to the ocean and even climate will all play a role.

With this in mind I decided to compare states with similar geography but contrasting economic approaches to try to get a better sense for the impact of policy and make more "apples to apples" comparisons. The pairings I decided to look at are Arizona vs. New Mexico, New Hampshire vs. Vermont and Alabama vs. Mississippi. Unemployment rates are based on an average of the July unemployment numbers for 2000 through 2008 and the June unemployment numbers for 2009 with Bureau of Labor Statistics data. GDP data is from wikipedia while economic freedom rankings are from the Mercatus Center.

Economic freedom ranking: 11
Average unemployment rate: 5.11
GDP per capita: $32,833

New Mexico
Economic freedom ranking: 43
Average unemployment rate: 5.37
GDP per capita: $30,706

Economic freedom ranking: 10
Average unemployment rate: 5.25
GDP per capita: $27,695

Economic freedom ranking: 30
Average unemployment rate: 6.78
GDP per capita: $24,518

New Hampshire
Economic freedom ranking: 2
Average unemployment rate: 4.07
GDP per capita: $36,616

Economic freedom ranking: 45
Average unemployment rate: 4.05
GDP per capita: $31,780

In every single case the state with the greater economic freedom has either a comparable or superior unemployment rate and per capita GDP of at least $2,000 more than its neighbor.


Paradigm Shifter said...

This makes for an even better statistical analysis for me this week. I can test both regional and economic freedom on a statistical basis to see which factors are significant AND what the relative effect of each is. Nice post, Colin!

Ben said...

New Hampshire is an interesting case. From what I recall when my parents lived in Nashua, the population was heavily weighted to the south eastern portion of the state and a very large number of those people worked in Massachusetts, in the technology sector, and earned high wages there. It'd be interesting to see how many people worked in Massachusetts and how much they earned in comparison to those that lived and worked in New Hampshire.

Colin said...

Two points:

1. Remember that we are measuring per capita GDP and not income, which aren't the same. Nevertheless the point is taken that well paid workers will drive up the overall average.

2. The reason that people choose to work in MA while living in NH can in large part be attributed to the lack of an income tax in NH (no sales tax either). So the fact that NH's low tax policy is succeeding in attracting workers to the state shouldn't be held against it -- indeed, it can be seen as further proof that such policies contribute to economic vitality.

Ben said...

I'm not holding it against New Hampshire, and you're right the lack of taxation certainly attracts people to live in New Hampshire. But New Hampshire's proximity to Massachusetts and the high wages there make it possible to work in one state and live tax-free in another, and for huge numbers of people from Massachusetts driving to southern New Hampshire to go shopping at the Pheasant Lane Mall. I'm not sure that, were every state to adopt New Hampshire's model, the model would bear out success.

Colin said...

Fair. Further, I should note that NH has access to the ocean -- Portsmouth -- while Vermont does not.

Paradigm Shifter said...

A similar analysis, although statistical in nature, can be found here. It tends to find Colin's original post on GDP to be correct, but the picture is murkier on unemployment.