California v. Red States, What Causes Growth, and the Great Stagnation

by Mike Kimel

California v. Red States, What Causes Growth, and the Great Stagnation

Lately there has been a small cottage industry of California v. Texas comparisons, with California getting the apparent short end of the stick.  Heavily regulated, high tax, big gubmint California is the past, and free wheeling low tax small government Texas is the future, and among the pieces of evidence is people moving out of California and into Texas.  California has been the punching bag as long as I can remember.  Texas usually plays the role of the victor, but every so often another state is put up as the shining paragon.  Over the years I’ve seen California get the negative comparison treatment relative to Colorado (mostly in the 1980s), North Carolina (mostly in the 1990s), Tennessee (a few times over the decades), and even (lately) North Dakota.

The graph below shows the indexed real state GDP for each of these states using state GDP and deflator data from the Bureau of Economic Analysis (www.bea.gov).  Figures go back to 1963:

Figure 1.

It’s fairly obvious where the story comes from.  California’s growth has looked anemic, at least relative to Colorado, North Carolina and Texas. So far the standard narrative fits the data.

The BEA’s data helpfully breaks out components of the GDP by line.  One such line is the state and local spending’s contribution to GDP.  The BEA also provides a deflator for that spending. Here’s indexed real state and local spending looks like:

Figure 2.

As the graph shows, the growth in state and local government spending in the socialist republic of California has exploded relative to the other states, thus explaining the anemic California’s anemic growth.  Wait, no, that’s not what the graph shows at all.  Colorado, North Carolina, and Texas, the three states which grew faster than California, all also had much faster increases in the growth rate in state and local government spending.   In general, except for the period in which the resource boom in North Dakota in the last few years, a casual look at the graphs indicates that the indexed state and local spending moves proportionally to the indexed state GDP.

This suggests one of three things:

1. Wealth effect: as state GDP rises, people demand (and pay for) proportionally more services

2. Government spending multiplier effect: as state and local spending increases, that creates a proportional increase in state GDP

3.  Government spending is unrelated to State and local GDP, and what we see in the two graphs is a coincidence.

So let’s see if we can narrow down the likelihood of each of these options.  The table below shows the correlation between real state and local spending and real state gdp, allowing each variable to lead the other by up to five years:

Figure 3.

The indexed real state and local government spending seems to lead the indexed real gdp by about four or more years for most states except North Carolina, which suggests state and local government spending actually affects economic growth.  Infrastructure matters.

That might also indicate that states and local governments might have an incentive to increase their spending over time, which is not we actually see.  As the graph below shows, the State and Local Spending as a percentage of State GDP seems to be fairly consistent across the states and across the decades.

Figure 4.

What about Federal government spending?  Here’s what the real indexed Federal government spending within each state looks like:

Figure 5.

Texas, Colorado, and North Carolina, the states in our sample with the fastest growth over the past four decades, have also been the states with the biggest increases in real Federal government spending.  And as the table below shows, Federal spending in a state seems to leads the state of the economy by four years or more:

Figure 6.

But that also implies bad news:

Figure 7.

As the graph above show, Federal spending, which tends to lead the economic condition of states in our sample by four or more years, held more or less steady until the early 1970s, and then began declining.  The pull back in federal government corresponds to what Tyler Cowen called the period of Great Stagnation.  Coincidence?  Only in a world like this one, where people don’t pay attention to data. Of course, on this planet, growth is slower than it should be and people are poorer.

This post has several takeaways:

1. In the last four decades, economic growth has been faster in some red states like Texas, North Carolina and Colorado than in California

2. In the states in our sample, government spending (state, local and federal) tends to lead the economic conditions by four or more years.

3. States with the fastest economic growth (Texas, Colorado, North Carolina) also tended to have the fastest increases in government spending.

4.  State and local spending as a share of the economy has held more or less constant over the last four decades.

5.  Federal government spending as a share of the economy has been declining.

—

Note. If anyone wants a copy of my spreadsheet, drop me a line at my first name (mike) period my last name (kimel) at gmail period com.