Still Not as Good as You Think

A serious look at our economy dispels the political hype that Minnesota is a ‘blue state that works.’

Money isn’t everything, but a strong and growing economy is vital for many of the things we take for granted living in Minnesota. Without high incomes, we would struggle to cope with the harsh winter weather or support the vibrant cultural life we take pride in. Nor would we be able to fund services such as education and policing.

Indeed, Minnesota’s economy is often touted as a poster child for “Blue State” policies of high taxes and government spending and extensive regulation. To assess the truth of such panegyrics, in 2016 the Center of the American Experiment commissioned Dr. Joseph Kennedy to take an in depth look at Minnesota’s economy. The results were released in a report, “Minnesota’s Economy: Mediocre Performance Threatens the State’s Future.”

This year we have looked at the data again. We have another year of data to analyze and, more importantly, we apply a framework of economic growth theory to look at the prospects for Minnesota’s economic future. After plundering our thesaurus, this time around we find that Minnesota’s economic performance is lackluster.

Economic growth

Minnesotans take great pride in their state’s economy, and quite rightly. It provides them with one of the highest standards of living in the country. Between 1965 and 1997, the state’s annual growth rate of real GDP—the amount of goods and services produced in an economy adjusted for inflation—was 3.1 percent, slightly above the national average of 2.9 percent.

In recent years, this has not been the case. Since 2000, the state’s real GDP grew at a rate below the national average and is now 2.5 percent lower than it would be if it had matched it. This cannot be attributed to “convergence,” in which incomes in poorer areas grow faster than those in richer ones. Recent academic work by Peter Ganong of the University of Chicago and Daniel Shoag of Harvard shows that, over the period covered by our report, no such convergence has been taking place in the United States.

We see a similar story when we look within the state. Among the 15 Metropolitan Statistical Areas (MSAs) with the largest GDP in 2016, the Twin Cities rank 12th on real GDP growth since 2000. Mankato and Rochester show the strongest growth since 2000. But, when growth in Minnesota’s MSAs is compared with that in the MSAs in the four neighboring states (30 in all), only Mankato makes it into the top 10. Notably, Iowa has three of the top ten fastest growing MSAs in that group.

Once again, this cannot be blamed on convergence. A recent study by Elisa Giannone of Princeton finds that, during the period covered by our report, convergence has declined in cities too. It should also be noted that some of the MSAs the Twin Cities have outperformed include Chicago and Detroit, which have well-documented, structural problems. The Twin Cities should not be content simply to outperform them.

Productivity

Perhaps most worrying is Minnesota’s poor record on productivity. This is an absolutely vital economic variable which we return to throughout the report. Increased productivity is the bedrock of improved standards of living. As the economist Paul Krugman has said, “Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

So, it is a concern that on one common measure of productivity, GDP per employee, Minnesotan workers produce 8.2 percent less than the national average. Of course, this measure can be skewed by part time workers who count the same as full time ones but generally produce less. It also masks the variation between different sectors. So, to take some of this into account, we can look at GDP per hour worked in both the goods producing and service producing industries, for which data goes back to 2007. Sadly, we see the same story. Minnesotan workers lag the national average in goods production by 5.5 percent and in services by 7.6 percent.

The trends in these numbers are also a concern. True, productivity growth has been sluggish at the national level since the financial crisis. But Minnesota now consistently lags the national average on real GDP per worker by more than it did in the early 2000s. On real GDP per hour worked in goods production, Minnesota has flat lined like the rest of the country since 2010. In services production, however, while the national level of real GDP per hour worked is about where it was in 2010, in Minnesota it is lower. This is a particular source of concern as this is where many of the state’s new jobs have been found in recent years.

Incomes

It is often pointed out that incomes in Minnesota are high relative to the national average. It is true that Minnesota’s average level of Personal Income (a measure of income received from wages, capital, and transfers), $52,117, ranks 14th in the country.

But even here, the picture is not as good as it first appears. Since 2000, Personal Income growth in Minnesota has matched the national average buthas been slower than in 31 other states. With growth in disposable Personal Income—that left after taxes—Minnesota lagged 30 states between 2000 and 2016, but was a little behind the national average. Once again, the points about “convergence” apply.

Furthermore, what growth there has been has been in Personal Income has come in large part from an increase in transfer income, such as Social Security. This accounted for 47 percent of all Personal Income growth since 2000. Indeed, over that period transfer income in Minnesota grew by 69.1 percent while the national figure was 59.9 percent.

This is unsustainable. Income received in return for performing labor or renting out capital is good, from an economic perspective. It is received in return for producing goods or services, and the production of goods and services is what GDP measures. More of this means higher GDP. Transfer income, by contrast, is not received in return for productive activity. For the transfer of income to take place, the income must first be generated by the productive economic activities of labor and capital. These transfers may be deemed necessary, but it is a worrying sign, both nationally and at the state level, that they comprise an ever growing share of American incomes.

Jobs

Minnesota enjoys a low unemployment rate. During 2016, its unemployment rate of 3.9 percent was comfortably below the national average of 4.7 percent. Its Labor Force Participation rate—the share of the workforce in work or looking for work —remains above the national average. The state has a lower share of households with no or one worker than the national rate, and a higher share with two, three, or more workers.

But, again, a deeper look at the data reveals cause for concern. Between 2000 and 2016, Minnesota ranked 28th out of 50 states and the District of Columbia on job creation. It lagged the national average rate.

Perhaps most concerning, given the importance of productivity, is where these jobs have been found. Figure 1 shows the Gross Value Added (GVA) associated with the average job in various occupational categories as well as the percentage increase or decrease in those jobs since 2000. Mining & Logging, for example, generated $447,603 per job in 2016 and Information generated $319,596. But, in the previous 16 years, Minnesota lost 23.5 percent of its jobs in Mining & Logging and 26.9 percent of those in Information. In contrast, the fastest growing occupations, Health Care and Educational Services, have a relatively low GVA per job. Health Care jobs, for example, generate an average of $88,761 of GVA annually, but jobs there have increased by 60.8 percent since 2000. Educational Services jobs generate an average of $58,239 of GVA annually, and employment in that sector has risen by 61.2 percent over the period. This is undoubtedly part of the state’s productivity problem.

The Prospects for Minnesota’s Economic Future 

This takes us from 2000 to 2016. But what might the future hold?

The sources of GDP per capita growth

GDP per-capita income is what matters for the well-being of individuals. This is GDP divided by the number of people in that economy. Its growth rate is the sum of the growth rates of 1) labor force participation, 2) capital per worker, and 3) productivity. We can look at the prospects for each of these to see where Minnesota’s economy might be heading.

Minnesota’s labor force

A higher share of people working will mean more GDP to be divided among the population. So, a high Labor Force Participation Rate helps per capita GDP growth.

The outlook on labor force participation is poor. Minnesota faces the demographic challenge common to the west of an aging population. Its Labor Force Participation Rate will fall as Baby Boomers retire. From a current level of 69.1 percent, the Minnesota Demographic Center projects that it will fall to 64.6 percent in 2035.

With a smaller share of Minnesotans working, there will be less GDP to divide among the population. This will lead to falling GDP per capita unless the remaining workers can become more productive. Minnesota’s state economist, Laura Kalambokidis, made this point at a conference at the Federal Reserve Bank of Minneapolis recently. It takes us back, once again, to the importance of productivity.

One thing that will help is for Minnesota to retain and attract productive workers. Immigration is often mooted as the solution to aging populations and declining rates of Labor Force Participation. But this will only be the case if the workers who come in are more productive than the average of workers already here. If they are, they will increase GDP by more than they increase the capita, increasing GDP per capita. If they are less productive, however, they will increase the capita by more than the GDP and reduce GDP per capita.

Sadly, the evidence suggests that Minnesota is doing a bad job of attracting and retaining productive American workers. Using income as a proxy for productivity, Census Bureau evidence shows that, between 2011 and 2015, Minnesota saw a net inflow of residents with annual incomes below $25,000, and a net outflow of residents in every income category above that. Neither of these is simply “snow birds” heading to warmer climates. Over the same period, Minnesota suffered a net domestic out-migration in every single age category, with Under 26 being the third worst.

What drives this? Minnesota’s high taxes play a part. As a share of state income, state-local taxes are higher in Minnesota than in all but seven other states. Our top rate of income tax is the fourth highest in the country. Significantly, it is not just “the rich” who are taxed heavily. Minnesota’s lowest income tax rate is higher than the highest rate in 23 other states.

Capital per worker

If a worker is given tools to work with he or she will, up to a certain point, be able to produce more. One farmer can cut more corn with a scythe than with his or her bare hands. Increases in capital per worker can make those workers more productive.

Unfortunately, data for capital per worker at the state level is very hard
to come by, but is driven by returns on investment, which are primarily affected by tax rates. The most recent academic estimates by Cal State’s Steven Yamarik are six years old and cover the period 1990 to 2007.

Here again, Minnesota’s taxes are not conducive to continued economic growth at past rates. The Tax Foundation ranks the state 46th out of 50 for its business tax climate. Our corporate taxes are more complex than in many other states. We impose a deduction schedule for natural resources on top of the federal one, and we are one of only eight states to have an Alternative Minimum Tax on corporations. Our corporate income tax rate is the third highest in the country. On top of the federal rate, this gives Minnesota one of the highest rates of corporate taxation in the western world.

We see some of the effects of this in Minnesota’s poor record of attracting venture capital. In 2015, the average American worker had $391 of venturecapital behind them. In Minnesota,
the figure was just $108. This, in turn, shows up in our relatively low rate of new business creation. In 2000, these made up 43 percent of American businesses and 41 percent in Minnesota. By 2014, these figures had slumped to 34 percent and 30 percent.

Total Factor Productivity

The key to growth lies not so much in adding new labor and capital inputs, but in increasing the quality of these inputs— educating workers, swapping a combine harvester for a scythe—and the skill with which they are combined: entrepreneurship. Economists group these together in the category “Total Factor Productivity” (TFP), and this is where the real engines of economic growth are to be found.

IMF research into economic growth among the states suggests that growth in TFP is driven by research and development spending and educational attainment. As a share of state GDP, in 2014 Minnesota’s spending on research and development, 2.5 percent, was in line with the national average, and our state has the fourth best record in America for patents per million people, with 885.

Education has long been one of Minnesota’s strong points. Compared to the national averages, our state compares favourably on a range of educational outcomes, though our mediocre performance on AP scores should be noted. An educated workforce should be an economic bonus in the future if education remains the focus of teaching, and not political indoctrination.

Minnesota can do better

Looking to the future, Minnesota will face economic challenges. The state’s relatively well-educated workforce will be a definite asset if academic standards are maintained. But Minnesota also faces some headwinds that could hinder future growth. As Baby Boomers retire, the state’s labor force will shrink, providing a drag on growth for perhaps the next two decades. An increasing share of seniors will need workers in productive jobs to support them and the growing number of workers who will be required in low productivity sectors such as health care. Yet, the high rate of corporate tax will deter the investment needed to make workers more productive. And Minnesota lags the rest of the nation in Research & Development spending.

Minnesota has some historic advantages, but prosperity should not be taken for granted. Minnesotans and their policymakers will have to make their state more competitive to assure Minnesota’s future prosperity.