Why Do Some States Face Steep Borrowing Costs?

One of the interesting—and alarming—developments in state finance over the last few years is the spread between borrowing costs among the states. Unsurprisingly, the borrowing costs of all states jumped during the financial crisis and recession. But as the (anemic) recovery began, the borrowing costs of many states eased while those of some states like California and Illinois remained high.

A paper by Daniel Nadler and Sounman Hong of the Harvard Kennedy School offers one explanation:

Political-institutional factors—such as the political composition of state legislatures, and interstate variations in public sector labor environments, such as union strength, and collective bargaining rights—can explain a significant proportion of interstate variation in bankruptcy risk. We find that, controlling for multiple economic variables, states with weaker unions, weaker collective bargaining rights, and fewer Democratic state legislators pay less in borrowing costs absolutely, and less in borrowing costs at similar levels of unexpected budget deficits, than do states with stronger unions and a higher proportion of Democrats.

As this summary puts it:

According to the study, a 20 percentage point difference in the share of the public-sector workforce that is unionized is associated with an additional increase in state borrowing costs of 40.4 basis points.