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A new paper in the Quarterly Journal of Economics (working version here) finds that the combination of intelligence and a willingness to break the rules as a youth is associated with a greater tendency to operate a high-earning incorporated business as an adult i.e. be an entrepreneur.

Previous work examining entrepreneurship that categorizes all self-employed persons as entrepreneurs has often found that entrepreneurs earn less than similar salaried workers. But this contradicts the important role entrepreneurs are presumed to play in generating economic growth. As the authors of the new QJE paper remark:

“If the self-employed are a good proxy for risk-taking, growth-creating entrepreneurs, it is puzzling that their human capital traits are similar to those of salaried workers and that they earn less.”

So instead of looking at the self-employed as one group, the authors separate them into two groups: those who operate unincorporated businesses and those who operate incorporated businesses. They argue that incorporation is important for risk-taking entrepreneurs due to the limited liability and separate legal identity it provides, and they find that those who choose incorporation are more likely to engage in tasks that require creativity, analytical flexibility and complex interpersonal communications; all tasks that are closely identified with the concept of entrepreneurship.

People who operate unincorporated businesses, on the other hand, are more likely to engage in activities that require high levels of hand, eye and foot coordination, such as landscaping or truck driving.

Once the self-employed are separated into incorporated and unincorporated, the puzzling finding of entrepreneurs earning less than similar salaried workers disappears. The statistics in the table below taken from the paper show that on average incorporated business owners (last column) earn more, work more hours, have more years of schooling and are more likely to be a college graduate than both unincorporated business owners and salaried workers based on two different data sets (Current Population Survey (CPS) and National Longitudinal Survey of Youth (NLSY)).

(click table to enlarge)

The authors then examine the individual characteristics of incorporated and unincorporated business owners. They find that people with high self-esteem, a strong sense of controlling one’s future, high Armed Forces Qualifications Test scores (AFQT)—which is a measure of intelligence and trainability—and a greater propensity for engaging in illicit activity as a youth are more likely to be incorporated self-employed.

Moreover, it’s the combination of intelligence and risk-taking that turns a young person into a high-earning owner of an incorporated business. As the authors state, “The mixture of high learning aptitude and disruptive, “break-the-rules” behavior is tightly linked with entrepreneurship.”

These findings fit nicely with some notable recent examples of entrepreneurship—Uber and Airbnb. Both companies are regularly sued for violating state and local ordinances, but this hasn’t stopped them from becoming popular providers of transportation and short-term housing.

If the founders of Uber and Airbnb always obtained approval before operating the companies would be hindered by all sorts of special interests, including taxi commissions, hotel industry groups and nosy neighbors. Seeking everyone’s approval—including the government’s—before operating likely would have meant never getting off the ground and the companies know this. It’s interesting to see evidence that many other, less well-known entrepreneurs share a similar willingness to violate the rules if necessary in order to provide their goods and services to customers.

Recently I wrote about the decline in the U.S. prime-age male labor force participation (LFP) rate and discussed some of the factors that may have caused it. One of the demand-side factors that many people think played a role is the decline in manufacturing employment in the United States.

Manufacturing has typically been a male-dominated industry, especially for males with less formal education, but increases in automation and productivity have resulted in fewer manufacturing jobs in the United States over time. As manufacturing jobs disappeared, the story goes, so did a lot of economic opportunities for working-age men. The result has been men leaving the labor force.

However, the same decline in manufacturing employment occurred in other countries as well, yet many of them experienced much smaller declines in their prime-age male LFP rates. The table below shows the percent of employment in manufacturing in 1990 and 2012 for 10 OECD countries, as well as their 25 to 54 male LFP rates in 1990 and 2012. The manufacturing data come from the FRED website and the LFP data are from the OECD data site. The ten countries included here were chosen based on data availability and I think they provide a sample that can be reasonably compared to the United States.

country 25-54 LFP rate, manuf table

As shown in the table, all of the countries experienced a decline in manufacturing employment and labor force participation over this time period. Thus America was not unique in this regard.

But when changes in both variables are plotted on the same graph, the story that the decline in manufacturing employment caused the drop in male LFP rate doesn’t really hold up.

country 25-54 LFP rate, manuf scatter plot

The percentage point change in manufacturing employment is across the top on the x-axis and the percentage point change in the prime-age male LFP rate is on the y-axis. As shown in the graph the relationship between the two is negative in this sample, and the change in manufacturing employment explains almost 36% of the variation in LFP rate declines (the coefficient on the decline in manufacturing employment is -0.322 and the p-value is 0.08).

In other words, the countries that experienced the biggest drops in manufacturing employment experienced the smallest drops in their LFP rate, which is the opposite of what we would expect if the decline in manufacturing employment played a big role in the decline of the LFP rate across countries.

Of course, correlation does not mean causation and I find it hard to believe that declines in manufacturing employment actually improved LFP rates, all else equal. But I also think the less manufacturing, less labor force participation story is too simple, and this data supports that view.

America and Italy experienced similar declines in their male LFP rates but neither experienced the largest declines in manufacturing employment over this time period. What else is going on in America that caused its LFP decline to more closely resemble Italy’s than that of Canada, Australia and the UK, which are more similar to America along many dimensions?

Whatever the exact reasons are, it appears that American working-age males responded differently to the decline in manufacturing employment over the last 20 + years than similar males in similar countries. This could be due to our higher incarceration rate, the way our social safety net is constructed, differences between education systems, the strength of the economy overall or a number of other factors. But attributing the bulk of the blame to the decline of manufacturing employment doesn’t seem appropriate.

The steady disappearance of prime-age males (age 25-54) from the labor force has been occurring for decades and has recently become popular in policy circles. The prime-age male labor force participation rate began falling in the 1950s, and since January 1980 the percent of prime-age males not in the labor force has increased from 5.5% to 12.3%. In fact, since the economy started recovering from our latest recession in June 2009 the rate has increased by 1.3 percentage points.

The 12.3% of prime-age males not in the labor force nationwide masks substantial variation at the state level. The figure below shows the percentage of prime-age males not in the labor force—neither working nor looking for a job—by state in 2016 according to data from the Current Population Survey.

25-54 males NILF by state 2016

The lowest percentage was in Wyoming, where only 6.3% of prime males were out of the labor force. On the other end of the spectrum, over 20% of prime males were out of the labor force in West Virginia and Mississippi, a shocking number. Remember, prime-age males are generally not of school age and too young to retire, so the fact that one out of every five is not working or even looking for a job in some states is hard to fathom.

Several researchers have investigated the absence of these men from the labor force and there is some agreement on the cause. First, demand side factors play a role. The decline of manufacturing, traditionally a male dominated industry, reduced the demand for their labor. In a state like West Virginia, the decline of coal mining—another male dominated industry—has contributed as well.

Some of the most recent decline is due to less educated men dropping out as the demand for their skills continues to fall. Geographic mobility has also declined, so even when an adjacent state has a stronger labor market according to the figure above—for example West Virginia and Maryland—people aren’t moving to take advantage of it.

Of course, people lose jobs all the time yet most find another one. Moreover, if someone isn’t working, how do they support themselves? The long-term increase in female labor force participation has allowed some men to rely on their spouse for income. Other family members and friends may also help. There is also evidence that men are increasingly relying on government aid, such as disability insurance, to support themselves.

These last two reasons, relying on a family member’s income or government aid, are supply-side reasons, since they affect a person’s willingness to accept a job rather than the demand for a person’s labor. A report by Obama’s Council of Economic Advisors argued that supply-side reasons were only a small part of the decline in the prime-age male labor force participation rate and that the lack of demand was the real culprit:

“Reductions in labor supply—in other words, prime-age men choosing not to work for a given set of labor market conditions—explain relatively little of the long-run trend…In contrast, reductions in the demand for labor, especially for lower-skilled men, appear to be an important component of the decline in prime-age male labor force participation.”

Other researchers, however, are less convinced. For example, AEI’s Nicholas Eberstadt thinks that supply-side factors play a larger role than the CEA acknowledges and he discusses these in his book Men Without Work. One piece of evidence he notes is the different not-in-labor-force (NILF) rates of native born and foreign born prime-age males: Since one would think that structural demand shocks would affect both native and foreign-born alike, the difference indicates that some other factor may be at work.

In the figure below, I subtract the foreign born not-in-labor-force rate from the native born rate by state. A positive number means that native prime-age males are less likely to be in the labor force than foreign-born prime age males. (Note: Foreign born only means a person was born in a country other than the U.S.: It does not mean that the person is not a citizen at the time the data was collected.)

25-54 native, foreign NILF diff

As shown in the figure, natives are less likely to be in the labor force (positive bar) in 34 of the 51 areas (DC included). For example, in Texas the percent of native prime-age men not in the labor force is 12.9% and the percentage of foreign-born not in the labor force is 5.9%, a 7 percentage point gap, which is what’s displayed in the figure above.

The difference in the NILF rate between the two groups is also striking when broken down by education, as shown in the next figure.

25-54 native, foreign males NILF by educ

In 2016, natives with less than a high school degree were four times more likely to be out of the labor force than foreign born, while natives with a high school degree were twice as likely to be out of the labor force. The NILF rates for some college or a bachelor’s or more are similar.

Mr. Eberstadt attributes some of this difference to the increase in incarceration rates since the 1970s. The U.S. imprisons a higher percentage of its population than almost any other country and it is very difficult to find a job with an arrest record or a conviction.

There aren’t much data combining employment and criminal history so it is hard to know exactly how much of a role crime plays in the difference between the NILF rates by education. Mr. Eberstadt provides some evidence in his book that shows that men with an arrest or conviction are much more likely to be out of the labor force than similar men without, but it is not perfectly comparable to the usual BLS data. That being said, it is reasonable to think that the mass incarceration of native prime-age males, primarily those with little formal education, has created a large group of unemployable, and thus unemployed, men.

Is incarceration a supply or demand side issue? On one hand, people with a criminal record are not really in demand, so in that sense it’s a demand issue. On the other hand, crime is a choice in many instances—people may choose a life of crime over other, non-criminal professions because it pays a higher wage than other available options or it somehow provides them with a more fulfilling life (e.g. Tony Soprano). In this sense crime and any subsequent incarceration is the result of a supply-side choice. Drug use that results in incarceration could also be thought of this way. I will let the reader decide which is more relevant to the NILF rates of prime-age males.

Criminal justice reform in the sense of fewer arrests and incarcerations would likely improve the prime-age male LFP rate, but the results would take years to show up in the data since such reforms don’t help the many men who have already served their time and want to work but are unable to find a job. Reforms that make it easier for convicted felons to find work would offer more immediate help, and there has been some efforts in this area. How successful they will be remains to be seen.

Other state reforms such as less occupational licensing would make it easier for people— including those with criminal convictions—to enter certain professions. There are also several ideas floating around that would make it easier for people to move to areas with better labor markets, such as making it easier to transfer unemployment benefits across state lines.

More economic growth would alleviate much of the demand side issues, and tax reform and reducing regulation would help on this front.

But has something fundamentally changed the way some men view work? Would some, especially the younger ones, rather just live with their parents and play video games, as economist Erik Hurst argues? For those wanting to learn more about this issue, Mr. Eberstadt’s book is a good place to start.

Alaska is facing another budget deficit this year – one of $3 billion – and many are skeptical that the process of closing this gap will be without hassle. The state faces declining oil prices and thinning reserves, forcing state legislators to rethink their previous budgeting strategies and to consider checking their spending appetites. This shouldn’t be a surprise to state legislators though – the budget process during the past two years ended in gridlock because of similar problems. And these issues have translated into credit downgrades from the three major credit agencies, each reflecting concern about the state’s trajectory if no significant improvements are made.

Despite these issues, residents have not been complaining, at least not until recently. Every fall, some earnings from Alaska’s Permanent Fund get distributed out to citizens – averaging about $1,100 per year since 1982. Last summer, Governor Walker used a partial veto to reduce the next dividend from $2,052 to $1,022. Although politically unpopular, these checks may be subject to even more cuts as a result of the current budget crisis.

The careful reader might notice that Alaska topped the list of the most fiscally healthy states in a 2016 Mercatus report that ranks the states according to their fiscal condition (using fiscal year 2014 data). For a state experiencing so much budget trouble, how could it be ranked so highly?

The short answer is that Alaska’s budget is incredibly unique.

On the one hand, the state has large amounts of cash, but on the other, it has large amounts of debt. Alaska’s cash levels are what secured its position in our ranking last year. Although holding onto cash is generally a good thing for state governments, there appears to be diminishing returns to doing so, especially if there is some structural reason that makes funds hard to access for paying off debt or for improving public services. It is yet to be seen how these factors will affect Alaska’s ranking in the next edition of our report.

Another reason why Alaska appeared to be doing well in our 2016 report is that the state’s problems – primarily spending growth and unsustainable revenue sources – are still catching up to them. Alaska has relied primarily on oil tax revenues and has funneled much of this revenue into restricted permanent trusts that cannot be accessed for general spending. When the Alaska Permanent Fund was created in the 1980s, oil prices were high and production was booming, so legislators didn’t really expect for this problem to occur. The state is now starting to experience the backlash of this lack of foresight.

The first figure below shows Alaska’s revenue and expenditure trends, drawing from the state’s Comprehensive Annual Financial Reports (CAFRs). At first look, you’ll see that revenues have generally outpaced spending, but not consistently. The state broke even in 2003 and revenues steadily outpaced expenditures until peaking at $1,266 billion in 2007. Revenues fell to an all-time low of $241 billion following the recession of 2008 and then fluctuated up and down before falling drastically again in fiscal year 2015.

alaska-revenues-exp4.5.17

The ups and downs of Alaska’s revenues reflect the extremely volatile nature of tax revenues, rents, and royalties that are generated from oil production. Rents and royalties make up 21 percent of Alaska’s total revenues and oil taxes 6 percent – these two combined actually come closer to 90 percent of the actual discretionary budget. Alaska has no personal income tax or sales tax, so there isn’t much room for other sources to make up for struggling revenues when oil prices decline.

Another major revenue source for the state are federal grants, at 32 percent of total revenues. Federal transfers are not exactly “free lunches” for state governments. Not only do they get funded by taxpayers, but they come with other costs as well. There is research that finds that as a state becomes more reliant on federal revenues, they tend to become less efficient, spending more and taxing more for the same level of services. For Alaska, this is especially concerning as it receives more federal dollars than any other state in per capita terms.

Federal transfers as an income stream have been more steady for Alaska than its oil revenues, but not necessarily more accessible. Federal funds are usually restricted for use for federal programs and therefore their use for balancing the budget is limited.

A revenue structure made up of volatile income streams and hard-to-access funds is enough by itself to make balancing the budget difficult. But Alaska’s expenditures also present cause for concern as they have been growing steadily, about 10 percent on average each year since 2002, compared with private sector growth of 6 percent.

In fiscal year 2015, education was the biggest spending category, at 28% of total expenditures. This was followed by health and human services (21%), transportation (11%), general government (10%), the Alaska Permanent Fund Dividend (9%), public protection (6%), and universities (5%). Spending for natural resources, development, and law and justice were all less than 5 percent.

The next figure illustrates the state’s biggest drivers of spending growth since 2002. Education and general government spending have grown the most significantly over the past several years. Alaska Permanent Fund spending has been the most variable, reflecting the cyclical nature of underlying oil market trends. Both transportation and health and human services have increased steadily since 2002, with the latter growing more significantly the past several years as a result of Medicaid expansion.

alaska-spendinggrowth4.5.17

Alaska’s spending is significantly higher than other states relative to its resource base. Spending as a proportion of state personal income was 31 percent in fiscal year 2015, much higher than the national average of 13 percent. A high level of spending, all else equal, isn’t necessarily a bad thing if you have the revenues to support it, but as we see from this year’s budget deficit, that isn’t the case for Alaska. The state is spending beyond the capacity of residents to pay for current service levels.

What should Alaska do?

This is a complicated situation so the answer isn’t simple or easy. The Alaska government website provides a Microsoft Excel model that allows you to try and provide your own set of solutions to balance the budget. After tinkering with the state provided numbers, it becomes clear that it is impossible to balance the deficit without some combination of spending cuts and changes to revenues or the Permanent Fund dividend.

On the revenue side, Alaska could improve by diversifying their income stream and/or broadening the tax base. Primarily taxing one group – in this case the oil industry – is inequitable and economically inefficient. Broadening the base would cause taxes to fall on all citizens more evenly and be less distortive to economic growth. Doing so would also smooth revenue production, making it more predictable and reliable for legislators.

When it comes to spending, it is understandably very difficult to decide what areas of the budget to cut, but a good place to start is to at least slow its growth. The best way to do this is by changing the institutional structure surrounding the political, legislative, and budgeting processes. One example would be improving Alaska’s tax and expenditure limit (TEL), as my colleague Matthew Mitchell recommends in his recent testimony. The state could also look into item-reduction vetoes and strict balanced-budget requirements, among other institutional reforms.

Ultimately, whatever steps Alaska’s legislators take to balance the budget this year will be painful. Hopefully the solution won’t involve ignoring the role that the institutional environment has played in getting them here. A narrow tax base reliant on volatile revenue sources, restricted funds, and growing spending are all factors that have led many to think that Alaska is and always will be “different.” But what constitutes sound public financial management is the same regardless of state. Although Alaska’s situation is unique, their susceptibility to fiscal stress absent any changes is not.

Mutant Capitalism rears its ugly head in Arlington

March 23, 2017

Confectionery-giant Nestlé plans to move its U.S. headquarters from California to 1812 North Moore in the Rosslyn area of Arlington in the next few years. This should be great news for the people of Arlington—a world-famous company has decided that Arlington County is the best place to be in the U.S. This must be due […]

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Government Spending and Economic Growth in Nebraska since 1997

March 10, 2017

Mercatus recently released a study that examines Nebraska’s budget, budgetary rules and economy. As the study points out, Nebraska, like many other states, consistently faces budgeting problems. State officials are confronted by a variety of competing interests looking for more state funding—schools, health services and public pensions to name a few—and attempts to placate each […]

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An Overview of the Virginia State Budget and Economy

March 6, 2017

By Adam Millsap and Thomas Savidge Virginia’s economy has steadily grown over time in spite of expenditures outpacing revenues each year since 2007. However, economic growth within the state is not evenly distributed geographically. We examine Virginia’s revenue and expenditure trends, highlighting the sources of Virginia’s revenue and where it spends money. Then we discuss […]

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Innovation and economic growth in the early 20th century and lessons for today

February 22, 2017

Economic growth is vital for improving our lives and the primary long-run determinant of economic growth is innovation. More innovation means better products, more choices for consumers and a higher standard of living. Worldwide, hundreds of millions of people have been lifted out of poverty due to the economic growth that has occurred in many […]

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Why Do We Get So Much Regulation?

February 17, 2017

Over the past 60 or 70 years, levels of regulation in the United States have been on the rise by almost any measure. As evidence, in the year 1950 there were only 9,745 pages in the US Code of Federal Regulations. Today that number is over 178,000 pages. There is less information about regulation at […]

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High-speed rail: is this year different?

February 8, 2017

Many U.S. cities are racing to develop high speed rail systems that shorten commute times and develop the economy for residents. These trains are able to reach speeds over 124 mph, sometimes even as high as 374 mph as in the case of Japan’s record-breaking trains. Despite this potential, American cities haven’t quite had the […]

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