Tag Archives: North America

More labor market freedom means more labor force participation

The U.S. labor force participation (LFP) rate has yet to bounce back to its pre-recession level. Some of the decline is due to retiring baby-boomers but even the prime-age LFP rate, which only counts people age 25 – 54 and thus less affected by retirement, has not recovered.

Economists and government officials are concerned about the weak recovery in labor force participation. A high LFP rate is usually a sign of a strong economy—people are either working or optimistic about their chances of finding a job. A low LFP rate is often a sign of little economic opportunity or disappointment with the employment options available.

The U.S. is a large, diverse country so the national LFP rate obscures substantial state variation in LFP rates. The figure below shows the age 16 and up LFP rates for the 50 states and the U.S. as a whole (black bar) in 2014. (data)

2014-state-lfp-rates

The rates range from a high of 72.6% in North Dakota to a low of 53.1% in West Virginia. The U.S. rate was 62.9%. Several of the states with relatively low rates are in the south, including Mississippi, Alabama and Arkansas. Florida and Arizona also had relatively low labor force participation, which is not surprising considering their reputations as retirement destinations.

There are several reasons why some states have more labor force participation than others. Demographics is one: states with a higher percentage of people over age 65 and between 16 and 22 will have lower rates on average since people in these age groups are often retired or in school full time. States also have different economies made up of different industries and at any given time some industries are thriving while others are struggling.

Federal and state regulation also play a role. Federal regulation disparately impacts different states because of the different industrial compositions of state economies. For example, states with large energy industries tend to be more affected by federal regulation than other states.

States also tax and regulate their labor markets differently. States have different occupational licensing standards, different minimum wages and different levels of payroll and income taxes among other things. Each of these things alters the incentive for businesses to hire or for people to join the labor market and thus affects states’ LFP rates.

We can see the relationship between labor market freedom and labor force participation in the figure below. The figure shows the relationship between the Economic Freedom of North America’s 2013 labor market freedom score (x-axis) and the 2014 labor force participation rate for each state (y-axis).

lab-mkt-freed-and-lfp-rate

As shown in the figure there is a positive relationship—more labor market freedom is associated with a higher LFP rate on average. States with lower freedom scores such as Mississippi, Kentucky and Alabama also had low LFP rates while states with higher freedom scores such as North Dakota, South Dakota and Virginia had higher LFP rates.

This is not an all-else-equal analysis and other variables—such as demographics and industry composition which I mentioned earlier—also play a role. That being said, state officials concerned about their state’s labor market should think about what they can do to increase labor market freedom—and economic freedom more broadly—in their state.

Economically Free States see 30 Percent Faster Job Growth

In my last post, I mentioned a couple of business climate indices. There is a new paper by Jed Kolko, David Neumark, and Marisol Cuellar Mejia which examines these types of indices in depth. They find that states with high rankings in economic freedom indices tend to have faster job growth, greater wage growth, and greater growth in gross state product.

There are a lot of indexes out there that attempt to rank states in terms of their business climates and the results of their rankings often conflict. As the authors write:

[A]cross all 50 states, every state but one ranks in the top 20 in at least one index, and every state ranks in the bottom half in at least one index.

However, it turns out that when you dig deeper, the indices can be grouped into two general categories and there is actually a lot of consistency within these categories.

Economic Freedom Indices:

The first category examines what the authors call “taxes and costs” and what I might call economic freedom. It includes factors such as the cost of doing business, the size of government, tax rates and tax burden, regulation, litigation, and welfare and transfer payments. The following five indices tend to capture these types of factors:

The economic freedom component of the Freedom in the 50 States Index by Sorens and Ruger would almost certainly fall into this category too, but since the authors focused on indices that have been around for several years, they do not include it.

Productivity and Quality of Life:

The second group of indices tends to measure what the authors call “productivity or quality of life.” These indices include measures of quality of life; equity; employment, earnings and job quality; business incubation; human capital; infrastructure; and technology, knowledge jobs, and digital economy. It appears to me that a number of the indices in this group focus on outcomes (are there a lot of “knowledge jobs in the state”?) while others in this group focus on policy inputs aimed at improving the quality of life (has the government invested in business incubation and human capital?). The indices that tend to fall into this category include:

  • The State New Economy Index by the Progressive Policy Institute, the Information, Technology and Innovation Foundation, and the Kauffman Foundation,
  • The Development Report Card for the States—Performance by the Corporation for Enterprise Development,
  • The Development Report Card for the States—Development Capacity, also by the Corporation for Enterprise Development,
  • The Development Report Card for the States—Business Vitality, also by the Corporation for Enterprise Development, and
  • The State Competitiveness Index by the Beacon Hill Institute.

The distinction isn’t always clear cut and I’d note that the Beacon Hill State Competitiveness Index, for one, also seems to capture a lot of economic freedom-type factors. The authors categorize an eleventh index, the Fiscal Policy Report Card on the Nation’s Governors by the Cato Institute, as falling somewhere between these two broad groups.

The authors examined the degree to which these indices predicted job growth, wages, and Gross State Product (controlling for other factors that might influence economic growth, including weather and historical industry mix). They found that the quality of life indices generally do a poor job of predicting these positive economic outcomes. In contrast, the economic freedom (aka “low taxes and few regulatory costs”) indices are strong predictors of job growth, wages, and GSP. In particular, the authors found “the corporate income tax structure and base matter for wage and GSP growth, though not necessarily for employment growth.” furthermore, the relationship, “does not appear to be driven by the top marginal tax rate, but rather by other factors such as the simplicity of corporate taxation…” They also found that greater welfare and transfer payment spending was associated with slower economic growth (they have reason to dismiss most concerns about reverse causality; but I’ll leave that to the reader to investigate).

The two indices with the best record for predicting economic progress were the Economic Freedom of North America index by Fraser (“the strongest and most robust evidence”) and the State Business Tax Climate by the Tax Foundation. Looking at the Fraser index, they found that moving a state from the 40th to the 10th place in terms of economic freedom “would increase the rate of growth of employment by 0.317 percentage point.” Given that the mean employment growth rate is 1.15 percent, this amounts to about 30 percent faster employment growth.

Lastly, the authors found that “footloose” industries such as manufacturing that are less-tied to the geography of the state tend to be more responsive to the policies captured by these indices.

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Update: I have fixed a broken link to the article.  Thanks to alert readers! 

Oregon’s Millionaire’s Tax Doesn’t Pan Out

To close its $3.8 billion FY 2010- FY 2011 projected budget gap, Oregon has relied on an evaporating stimulus, budget cuts of roughly 9 percent and tax increases. The state’s income tax was raised with a new top rate of 11 percent. However the tax on the richest two percent of residents hasn’t performed as expected. Last year the new tax rate brought in $180 million. This year collections dropped to $130 million. The Wall Street Journal writes this shouldn’t be suprising. A full quarter of “rich tax filers seem to have gone missing.” it’s likely millionaires will be looking for other places to domicile. The tax applies to stocks and capital which means Oregon has “virtually the highest capital gains tax in North America.”

Conflicting Trends in Urban Development

In 1970, the first Business Improvement Area was instituted in Toronto, Ontario, and the concept has since  spread throughout North America and the world. In the United States, these organizations are most commonly known as Business Improvement Districts (BIDs), and they are collectives of neighboring business people who work together to maintain their public spaces at a higher level than their municipalities would.

BIDs have been highly successful in many areas of the United States, including New York, Los Angeles, and Washington, because they allow businesses to pay for specific services that are beneficial to their immediate vicinities rather than providing these services through an unpopular and inefficient tax levied at the city or state level. Business owners may elect to use allocate this funding to market their neighborhoods, provide street clean-up or security beyond the level offered by their municipality, or enact improvements to storefronts and building facades.

In parts of the Midwest, the trend is developing into organizations known as Special Improvement Districts, allowing both residents and businesses to participate in neighborhood governance. A Crain’s Cleveland Business article explains:

These groups are encouraged by the success of the downtown Cleveland SID, which was created in 2005. The SID, which is operated by the Downtown Cleveland Alliance, has gotten high marks for a program it calls “Clean & Safe” that has put a team of “ambassadors” in yellow shirts on downtown streets. They scour sidewalks, water plants, provide directions to pedestrians and keep an eye out for any bad behavior.

The downtown group also sponsors special events designed to bring people downtown and markets downtown as a tourist destination.

Property owners agreed to a special assessment that raises about $3 million a year for the program.

The SID concept is effective because the taxing authority is devolved to the lowest possible level, the neighborhood. This direct democracy allows for the fees collected to be spent as desired by those who pay them. Obviously the demand for various services varies across different neighborhoods’ organizations. Additionally, those who pay SID fees are likely to closely monitor how they are spent, rendering it unlikely that the money will be spent wastefully or lost to corruption.

As this grassroots concept is gaining momentum at the local level, a new White House initiative, the Office of Urban Affairs, is taking a top-down approach to urban issues. The purpose of this new office is to promote the administration’s urban policy agenda, heavily influenced by the ideas promoted by the Brookings Institution’s Metropolitan Policy Program, in municipalities across the country.

A Washington Post article explains that some critics of the program believe that urban issues should be handled at the local level, varying with the diverse challenges and opportunities that face different cities across the country:

“Cities improved dramatically in periods when the federal government backed off the most,” said Fred Siegel, a history professor at the Cooper Union who served as an adviser to former New York mayor Rudolph W. Giuliani (R).

Undoubtedly, research institutions have valuable insights to offer neighborhood and municipal leaders in the fields of transportation, land use, and community development. However, a one-size-fits-all approach to implementing these ideas in urbanities across the country is impractical and will be weighted down with many layers of bureaucratic inefficiencies. Rather, BIDs, SIDs, and city governments should have the freedom to select the policies that are most practical and efficient for their localities.