Friday, February 24, 2012

How Low Will We Go?: Long Term Perspectives on a Flailing Economy

How Low Will We Go?: Long Term Perspectives on a Flailing Economy
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College SD

11:30 am, Friday, 24 February 2012, CJ Callaway’s Event Center (69th and Minnesota)

Nine days ago, at the Augustana Academy for Seniors, I delivered a speech called “Little Business on the Prairie: Exploring How Entrepreneurs Keep South Dakota’s Economy Vibrant.” That speech, which like this one is posted on my personal blog called finance history and policy dot blogspot dot com, that’s finance history and policy dot blogspot dot com, was about South Dakota’s economy and was much more upbeat than today’s pessimistic talk, which is about the national economic outlook. I fear that the national economy will remain in a funk – a period of no to slow growth – for a decade or more, perhaps, like Lenore, for evermore. That’s from Edgar Allan Poe’s poem “The Raven,” by the way. To invoke Poe once more, this time his place of death, I fear the entire U.S. economy will soon resemble that of Baltimore in the HBO Series The Wire – very po’ indeed. Seriously, barring a major natural catastrophe or war, the odds of America degenerating into third world-like poverty is slim but without major political reforms I think our economy is likely to slip into the same superpower retirement community inhabited by Persia, Rome, the Mongols, the Mayans, Holland, England, Japan, and so many other has beens.
The United States is the third most populous nation in the world behind China and India and has almost a 100 million more people than number four Indonesia, so it is going to remain an important player on the world stage for a long time to come. But if it continues down its current path it will not long remain the most important one, economically, politically, or militarily.
South Dakota may benefit from these changes, at least in relative terms, due to its entrepreneurial culture and pro-business economic climate. As you may know, famed economist Arthur Laffer and the American Legislative Exchange Council recently ranked South Dakota second, behind Utah, in overall economic outlook. South Dakota ranked first, of all U.S. states and Canadian provinces, in the Fraser Institute’s economic freedom index and the state has for seven years in a row ranked number one in the Small Business and Entrepreneurship Council’s small business survival index, well ahead of runners up Nevada and Texas. But no state can soar too far above the others without attracting enough people and capital to bring it back into orbit around the national economy. In other words, if the overall U.S. economy stagnates, so too will that of each of the states, at least eventually. The American Dream will die first but what consolation will that be when South Dakota’s Reverie follows it gently into that good night? That’s not Poe, by the way, and enough with the po-etry for today.
One particularly troubling sign that the state and national economies are stagnating is the recent rise in what was traditionally called sharp business practices. It’s not as apparent here in Sioux Falls as elsewhere but even our burgeoning little metropolis has its share of shysters. Several kiosks in the mall, the big one, have been selling shoddy quote unquote No Way products because there is no way the vendors will refund your money and no way the products should have been sold in the first place. And at least one major local car dealer is getting a reputation for overcharging for repairs. Well, overcharging even more than it used to. What is troubling is that those and other businesses engaging in sharp practices must not envision a more prosperous future on the horizon. They are trying to get as much as they can today even though they must know that if they persist in scamming their customers they will not be around tomorrow. As a business strategy that only makes sense if they are on the verge of bankruptcy or believe that the economy is.
Please keep in mind that I am not predicting that national economic stagnation must occur. There is nothing inevitable about it that I can see. Rather, America’s, and hence ultimately South Dakota’s, economic future hinges on its policies, which are ultimately a function of its politics. If numerous people argue persuasively that the economy will remain in a funk they may change public sentiments and politicians’ agendas enough to drive implementation of reforms that will break the funk and hence the nation’s relative economic slide. If that comes to pass, historians, decades hence, will chide and deride the pessimists not realizing that their vocal lamentations indirectly saved the nation’s economy, just as the wails of George Washington and Alexander Hamilton in the 1780s initiated the reforms that launched America on its modern growth trajectory a decade later.
I’d like nothing better than to regale you with a three hour lecture explaining how Hamilton et al turned an unstable, bankrupt, economic backwater into a major nation in a single lifetime. But if you are really that interested you could pick up my One Nation Under Debt, which is really reasonably priced on Amazon right now. Suffice it to say here that the U.S. implemented constitutions at the national and state levels that protected people’s lives, liberties, and properties without dipping very deeply into their pockets or intruding much into their day-to-day lives. Confidence in government led directly to the financial and corporation revolutions that made possible the agricultural, transportation, and industrial revolutions that transformed the continent into the most productive in history to date.
Reforms are necessary again today because current policies are clearly not working. The economy is showing few signs of growth in the short term, faces a major conundrum in the intermediate term, and the most important long term driver of growth, confidence in government, has disintegrated in recent years. If the economy does soar anytime soon, be on the lookout for yet another speculative bubble at the heart of it and signs of the financial cataclysm that must inevitably follow. Please allow me to explain the reasoning behind those claims in some detail.
Nobody can predict short run movements in the economy consistently and with precision but consensus economic forecasts are often quite accurate and go well beyond stock prices, which you may have noticed have been up recently. Just like they were in 1929 and 1999. The VIX, a stock market volatility index, is just a quarter of the level it was during the crisis of 2008, in fact at almost exactly the same level it was before the financial manure hit the fan that year. So it is difficult for me to rest easy simply because the VIX is low, or because the stock market is up.
Certainly watch the VIX and the equities markets -- the Dow, the S&P, and the Russell 2000 -- but don’t be a lemming. There are numerous other, more important economic indicators out there. In our 2011 book, The Wall Street Journal Guide to the 50 Economic Indicators That Really Matter, Simon Constable and I show that even lay investors can peer a few months into the future with some confidence by carefully studying the clues that the economy is constantly creating about its current condition and direction. Most of those clues or indicators are still showing signs of weakness and even the economy’s few bright spots could be, perversely enough, signs of its shaky condition. To call a turn in the economy, many forecasters like to see the so-called three Ps: pronounced, persistent, and pervasive movements in the data. Pronounced means large, persistent means a trend, not a random bounce, and pervasive means not limited to just a few indicators. Right now, the economy has zero Ps.
Let’s overview the short-term outlook in more detail:
1.    GDP growth in 2011 was positive but still anemic. That means each person on average produced a little bit more than they did in 2010 but not by much. Some forecasts for 2012 are more optimistic but others are pessimistic and hardly anyone expects breakout growth. The headline for the Philadelphia Fed’s most recent survey of professional forecasters is quote Forecasters Predict Lower Growth and Higher Unemployment in 2012 and 2013. unquote
2.    Unemployment has decreased of late, job growth is up, and new jobless claims are down. Unemployment, however, is still above 8 percent nationally and is likely to remain higher than optimal throughout the rest of the year. That means continued weak demand for consumer durables, more mortgage defaults, and continued stress on government budgets.
3.    The Federal Open Market Committee’s promise to keep the Federal funds rate, its overnight interbank interest rate target, at almost zero for the foreseeable future suggests that the Federal Reserve and many investors remain pessimistic about the economy’s growth prospects this year. It also means that fears of future inflation and asset bubbles loom large.
4.    The Federal Reserve’s January Beige book, its summary of current economic conditions, pointed to modest improvements in manufacturing and retail but also noted continued problems in financial services and real estate.
5.    Consumer confidence grew steadily last Fall but has recently weakened again. Consumer spending was sluggish in December despite early claims to the contrary. Investor confidence also declined recently, mostly due to uncertainty about Europe. Small business confidence indicators are up, but only slightly. Business inventories are slowly building but remain lean.
6.    Consumer credit recently jumped $20 billion, way above the consensus forecast. Some of the news here is good – about $5 and a half billion went to new car sales, which are showing a little life, probably because people like me are finding it too expensive to keep our old clunkers running. But the rest of the news is bad – people are running up their credit card balances again. That means that many of the little glimmers of hope we have seen recently may be the result of people running deeper into debt prior to bankruptcy. Our bankruptcy laws give people big incentives to do that now, you know.
7.    Nonfarm productivity is at its lowest levels since 2008.
8.    At just over 4 percent, Mortgage Rates are still a major bargoooon but Mortgage Applications are down over 3 percent. Existing Home Sales are up but only because Home Prices continue to erode. Nationwide, in January alone the median price fell 4.6 percent and the average price fell 4 percent. There are a few signs, like the recent improvement in the National Association of Home Builders’ housing market index, that a bottom nears. Inventories of Homes for Sale are down to 6.1 months, its lowest level since the crisis. Until housing prices actually regain some lost ground, however, more foreclosures and economically damaging lawsuits are in the offing.
9.    Manufacturing is pretty strong, but largely because of last year’s earthquake in Japan and the weakness of the dollar, which has boosted exports for the third year in a row. If the dollar continues its recent uptick, manufacturing will probably hit the skids again.
10.           The Non-Manufacturing index surged in January but it did the same thing a year ago before declining yet again.
11.           Construction is finally showing signs of life but it is coming off extremely low levels of activity.
12.           Gasoline demand is at its lowest levels since the financial crisis and of late demand for natural gas has been lower than expected, even adjusting for the mild winter.
13.           The Philadelphia Fed’s Aruoba-Diebold-Scotti Business Conditions Index is slightly above zero but flatter than a prairie meadow.
14.           The coverage of retail sales has been kind of humorous. When the weather is bad, analysts claim that sales are down because people stayed home. When the weather is good, the same analysts say that sales are down because people don’t need to buy winter clothes, emergency supplies, and so forth. How about sales are down because people don’t have much money and their credit cards are all maxed out? In any event, December’s numbers have been revised downward and January’s numbers were weaker than expected.
15.           Last but not least, zombies still stalk the land. No, I’m not referring to the human flesh craving monsters that roam AMC every Sunday night at 8 Central, I’m talking about banks that are economically dead, that are technically bankrupt -- due in part to an ever growing inventory of foreclosed homes of dubious value -- but that remain on regulatory life support. Such banks, we learned during the S&L Crisis, will often take big risks to try to get their balance sheets back into the black. A few will succeed but most will not, further straining the financial system and the government’s elaborate but strained bailout net.
Zombie banks also cloud the horizon in the intermediate term because their existence increases what economists call asymmetric information. Banks don’t know which of their brethren they can trust and borrowers don’t know if they were turned down for a loan because they are a bad credit risk or because their bank is brain dead. Zombie banks can be overly litigious too. Instead of rationally settling debts caused by the continued gloom in the housing sector, they sue, and sue, and sue so some executive can book a quote unquote profit when a judgment is obtained. That’s a great boon for banks’ lawyers but destroys the credit of Americans with good incomes who pay their bills but who can’t get above water on their mortgages or who had to relocate because of a new job, a growing family, or the deterioration of their neighborhood due to all of the crackhead-infested, boarded-up houses that have not so mysteriously appeared in it over the past few years.
As the housing crisis grinds into yet another year, such frivolous lawsuits are growing in number and overall economic drag but policymakers are reluctant to address the problem in a significant way. A few weeks ago, for example, the government settled with five big banks accused of abusive foreclosure practices for a mere $25 billion. Homeowners helped by the legislation will receive around $2,000 each sometime in the next three years. A writer Forbes, not exactly a leftwing business periodical, called that sum a quote unquote spit in the bucket. The editors at equally radical Bloomberg agreed that quote the settlement amount is a pittance. Unquote A hundred, hundred fifty years ago any bank that systematically presented fake evidence to courts would have been liquidated, their directors sued into poverty, and their executives jailed.
Intermediate term growth prospects are also clouded by the possibility of inflation. If the economy ever heats up, the Fed will have to raise interest rates aggressively to stop the general price level from rising rapidly or another asset bubble from forming and that may stop the economy in its tracks. If the Fed doesn’t boost rates fast enough, the economy could suffer from a bout of stagflation, or high inflation, high unemployment, and low growth, similar to the 1970s. A decade ago, when confidence in the Fed’s ability to fine tune the economy was at its apex, the seriousness of the Fed’s conundrum would have been downplayed. Today, few would estimate the probability that the Fed can engineer a robust, low inflation expansion at much above one in three. That’s a big reason why gold is way up. The price of gold is off its highs but the precious yellow stuff is still up over 25 percent on the year and over 150 percent over five years ago. Investors buy gold when they fear inflation, perceive high levels of policy uncertainty, and/or foresee a period of civil unrest.
Civil unrest is not an impossibility because long term growth prospects are extremely weak. Anybody remember the 1960s? I don’t because I wasn’t born until the tail end but I heard the family stories about grandma Wright sitting on the front porch with a loaded side by side while rioters looted and burned stores just a few blocks away. And of course I’ve studied the history. A few more years of economic despair for our young adults and another round of bank bailouts, especially one widely perceived to have been caused by European fiscal profligacy, and it could be 1967-68 all over again. Hell hath no fury like someone with high expectations scorned. And while large scale rioting might help the manufacturers of riot gear, tear gas, billy clubs, and so forth, it is not good for the economy. The 1960s riots contributed mightily to the quote unquote malaise of the 1970s, which was just Jimmy Carter’s hokey term for the economy’s astonishingly low rate of productivity growth in that dreadful decade.
Economic growth is not about, and never has been about, jobs per se. Good jobs are a result of economic growth, not a cause of it. Economic growth is about efficiency, about producing the same quantity and quality of goods from less input: fewer hours worked, less energy wasted, fewer raw materials consumed. That means that prosperity is ultimately built on driving people into new lines of work and capital into new industries. The first factory operatives and miners were farmers made obsolete by improved agricultural techniques and tools, the agricultural revolution unleashed by the national and state constitutions and Hamilton’s financial reforms that I mentioned earlier. Likewise, today’s modern service economy is built upon the brains of the sons and daughters of factory workers, people no longer needed to build stuff due to sundry innovations in production techniques from Ford’s assembly line to robotics to just-in-time inventory systems.
So, again, what matters for long term growth is efficiency, doing more with less. Businesses and industries become more efficient only when people have incentives to work harder and smarter. The incentives are the main thing, not the particular technologies that they spawned. Americans invented, improved, or commercialized cotton gins, steamships, telegraphs, light bulbs, automobiles, mainframe computers, personal computers, the Internet, and literally millions of lesser inventions and innovations because they believed that they would be fairly rewarded for doing so. Americans were no smarter than other peoples – we’re just a genetic hodge podge and cultural stew of them anyway – but since the ratification of the Constitution we’ve been among the best compensated for enhancing efficiency.
Incentives to work harder and smarter, the long range drivers of the American economic miracle, are, however, deteriorating along with the Constitution. We seem determined to teach our children that the way ahead is to cultivate cozy relationships with government officials, create shoddy but clever products, foist them off on unsuspecting dupes, reap millions, and then take refuge in government bailouts and incompetence.
Many Americans now believe that they live in a very sophisticated kleptocracy. More obvious, more brutal kleptocracies, like Saddam’s Iraq, Fidel’s Cuba, Kim’s North Korea, Mao’s China, or Muammar’s Libya, to name just a few, remained extremely poor because nobody had any incentive to work harder or smarter for fear that they would lose their property or even their lives. Despite the passage late last year of the National Defense Authorization Act, legislation that allows the military to detain U.S. citizens on American soil indefinitely and without trial, most Americans are not yet worried about government-issued jack boots kicking in their doors late at night so they continue to go to work and school. But increasing numbers of them do perceive that income inequality is rising and civil liberties are weakening. They sense that the rich and politically powerful are more equal than the rest, so real wages are likely to flat line even as taxes increase. Life is still pretty good – as a conservative think tank recently pointed out, most Americans own things like TVs and refrigerators. But many people sense that conditions are not likely to improve no matter what actions they, as individuals, undertake, a fear effectively exploited in a recent TV commercial where a grandfather wonders aloud if his grandson will ever be able to own a big house like his. One of our hoariest and most useful myths, that of Horatio Alger and the self-made person, has passed into history and with it the innovations that would have reinvigorated our moribund economy.
A weak economy does not bode well for Obama’s re-election this Fall, which will sadden the Democrats in the room – both of you – and encourage the Republicans. But more and more Americans seem to be coming to the view that the nation’s economic trajectory does not rest on which party controls the White House, Congress, or even the entire government. Both major parties and the federal bureaucracy appear to be in Washington to help themselves, not to promote a vision of the greater good, however defined. That is why Congress’s approval rating is now 10 percent, lower than pornography, lower than polygamy, and even, I suspect, lower than polygamist pornography. The sense that politicians and government bureaucrats are in it for themselves is also why not one, not two, but three apostate political factions, the Tea Party, Ron Paul, and Occupy Wall Street, flourish.
Members of each of those factions know that the status quo is rife with serious problems but for ideological reasons focus their wrath too narrowly. Tea Party folks are riveted on government budgets. Taxes, deficits, and government expenditures are certainly important issues – some of you may know that I called for the creation of the Tea Party, albeit with a less stupid name, in a Los Angeles Times op ed way back in March 2008 – but as the movement evolved, entirely without my involvement I should add, it became partisan and ideological. Budget reform has proven intractable because members of both parties, as well as government employees of course, have incentives to borrow and spend. Instead of becoming the independent party opposed to both existing parties that I called for, the Tea Party allowed itself to be co-opted by the Republicans.
Members of the Occupy movement -- which by the way I can’t be blamed for in any way, shape, or form -- fixate on the influence of the rich, the now infamous one percent, on government policies. The uber-wealthy do seem to have undue influence, and gained still more in recent years thanks to the proliferation of SuperPACs and SCOTUS’s seriously flawed Citizens United decision. Seriously, I mean seriously flawed. As in laughable were it not so tragic. Unfortunately, the Occupiers are also too partisan, blaming rich Republicans for the power they wield instead of blaming a system that gives the wealthy members of both parties, and even of other countries, too much of a say in American electoral politics.
Ron Paul is nominally a Republican but he is not going to win the Republican primary. His numbers in the polls and primaries held to date, however, have been remarkable, about twice what he polled four years ago. More than 1 in 10 American voters throughout the country believe the federal government has taken its wars, monetary policies, and civil liberties restrictions too far. But like the Tea Party, Paul and his disciples place too much blame on the government per se and not enough on manipulation of the government by powerful special interest groups. Paul insists on auditing the Federal Reserve directly, for example, rather than auditing its owners and clients, the commercial banks that it has, unsurprisingly, been bailing out the last three plus years.
The differences between these three groups are deep and heartfelt. Occupiers love to bash Paul and vice versa. Ditto Tea Partiers and Occupiers. And of course most Tea Partiers blanche at Paul’s stand on defense, the so-called wars on drugs and terror, and a number of social issues. There is a chance, however, that the three groups could coalesce under a single, neo-progressive banner. A century ago, Progressives, a motley crew of Republicans, Democrats, and Populists ranging from Theodore Roosevelt to William Jennings Bryan, sought to purify all levels of government by fighting corruption and inefficiency with a variety of reforms, the most important and lasting of which were electoral. It was the Progressives who revitalized American democracy by pushing the secret ballot, initiative, referendum, recall, direct primaries, direct election of U.S. Senators, and women’s suffrage. Progressives, believe it or not, were major players in South Dakota’s political scene a century ago and could become so again.
The neo-progressive movement that I have in mind would not espouse specific economic policies – it would immediately splinter if it did -- but would instead work to reinvigorate American democracy beginning, perhaps, with campaign finance reform. Citizens United must be overturned, Super PACs obliterated, and the power of political party machines over candidate selection reduced if not eliminated. Initiative, referendum, and recall need to be extended to the federal government in intelligent -- which is to say more Dakotan than Californian -- ways. And if that doesn’t work to restore the public’s confidence in their national government, more radical reforms – like random selection of legislators -- must be contemplated, debated, and tested.
But what if such reforms lead to the implementation of the wrong economic policies, ones that injure long-term growth prospects? Frankly, I do not think that is possible. First, it may very well be the case that economic policies are not “right” or “wrong” per se but rather that any policy widely perceived as legitimate will turn out to be growth-inducing because it will establish known rules that will be widely followed. Rationing and price controls, for example, largely worked during World War II but flopped in 1971 because the public saw the wartime measures as necessary but easily saw through Tricky Dick Nixon’s New Economic Plan. If this view is correct, the problem with Obamacare, Social Security, the recent bailouts, and the like is not their intrinsic characteristics but the fact that many Americans see them as illegitimately enacted and continued, as de facto unconstitutional whether the Supreme Court rules it so or not.
Second, it seems unlikely that a well-functioning democracy – something the neo-progressives could help the nation to re-create -- replete with diverse economic interests would allow one group to exploit another to any significant degree, much as Madison argued in Federalist Number 10. If that is the case, a quote unquote wrong policy would quickly be corrected. If a policy benefitted no one, repeal would be easy. If it benefitted a minority interest, the expropriated majority would soon overturn it. Policies that injured the overall economy but benefitted a majority would be rare but difficult to dislodge if not checked by the Senate or a presidential veto before their implementation. Overall, though, there is little to fear from quote unquote wrong policies. What we need to worry about is what we now have in spades, illegitimate and unconstitutional policies that benefit small special interest groups at the expense of taxpayers and hence overall economic health.
A neo-progressive small d democratic movement might also be able to coalesce around corporate governance reform. Stockholders have long since lost control of the corporations they nominally own to executives, which to a first order approximation is why executives get paid so much. In my book Corporation Nation: Rise and Demise of the American Economic Juggernaut, forthcoming from the University of Pennsylvania Press late this year or early next, I describe several reform proposals that would return control to stockholders and hence make corporations less likely to take on excessive but executive bonus enhancing risks. Occupiers could see those reforms as “regulations,” and hence good, while followers of Paul and the Tea Party could see them as property rights protections, and hence something they should support. A side benefit of corporate governance reform is that returning control to stockholders would also likely limit corporate politicking, just as it did in the nineteenth century. Corporations will still lobby for special perks for themselves but won’t find it cost effective to back candidates for ideological reasons.
Finally, a neo-progressive movement might reduce America’s economic malaise by directly reforming its emerging kleptocracy. The disparate parts of the movement could be brought together simply by recognizing that both governments and corporations can and do steal from the American people. Governments steal from taxpayers whenever they allow inefficiencies like Amtrak or the Post Office to persist and whenever they allow markets to become or stay uncompetitive, views already held by some Tea Party and Paul followers. Corporations steal from consumers whenever they engage in uncompetitive practices or obtain special favors such as bailouts, views already held by Occupiers and some of Paul’s followers. Unlike members of the current factions, neo-progressives would recognize that they cannot hope to reform the government or big businesses but rather that both must be brought to heel through the concerted efforts of everyone who recognizes the damage that kleptocracy can, has, and will continue to inflict on the economy by diminishing Americans’ incentives to work hard and smart.
So there you have it. Leading economic indicators show few signs that the U.S. economy will pick up soon, intermediate-term growth prospects are clouded by the specters of asset bubbles, zombie banks, and runaway inflation, and long-term growth prospects remain dim due to levels of political and business corruption unseen since the Progressive era a century ago. If Paulites, Tea Partiers, and Occupiers can concentrate on common ground, however, they could implement reforms that would restore Americans’ faith in their government and give them reasons to work hard and smart once again. Without the restoration of such incentives, the U.S. economy will continue to stagnate, eventually dragging down even the vibrant economy of the Northern Plains. The nation will probably remain comfortably affluent but will slip relative to Brazil, China, India, and other large up and comers and inequalities of income and influence will grow, how far nobody knows. Beyond that, I dare not speculate.

Wednesday, February 15, 2012

Little Business on the Prairie: Exploring How Entrepreneurs Keep South Dakota’s Economy Vibrant

Little Business on the Prairie: Exploring How Entrepreneurs Keep South Dakota’s Economy Vibrant
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College SD

10:45 am, Wednesday, 15 February 2012, 3-in-1 Room, Morrison Commons

In 9 days, at the Augustana Thought Leader Forum, I will be delivering a speech called “How Low Will We Go? Long Term Perspectives on a Flailing Economy.” That speech, which like this one will be posted on my personal blog called finance history and policy dot blogspot dot com, that’s finance history and policy dot blogspot dot com, is about the national economy and will be a downer. Today’s talk is about South Dakota’s economy and is much more upbeat. South Dakota is part of an economic district, the Federal Reserves’s Ninth, that is expected to grow only moderately in 2012, but faster than most of the rest of the nation for the fourth year in a row. Simply because, as I fear, the national economy remains in a long term funk – a decade or more of no to slow growth – does not mean that South Dakota cannot continue to do well economically, in relative if not absolute terms, for a long while.
You probably already know that South Dakota’s economy is better than most. But just how much better is it? And how much better can it become?
As of December 2011, the most recent reliable state by state data available, the state’s unemployment rate was, at 4.2 percent, the third lowest in the nation behind North Dakota, which in case you haven’t heard is experiencing an energy boom of Albertan proportions. South Dakota barely lost the second slot to Nebraska and was well ahead of fourth place, shared by New Hampshire and Vermont at 5.1 percent. In Mississippi, Rhode Island, California, Nevada, and, ironically enough, Washington DC, the unemployment rate was still in double digits. The national average was 8.5 percent that month, twice that of the Mount Rushmore State. If Federal Reserve forecasters are correct, by the end of this year employment levels in South Dakota will return to pre-crisis levels.
South Dakota’s population is not growing quite as fast as the national average, 7.9 percent compared to 9.7 percent between the last two decennial censuses, but that the state is growing at all given the hollowing out of many agricultural communities is amazing enough, and largely attributable to the 24 percent growth of Sioux Falls and the 14 percent growth of Rapid City, not to mention the prodigious growth of some of their suburbs. Brandon’s population doubled between 2000 and 2010, for example, and out west Box Elder’s population soared almost 175 percent.
Despite being home to five of the nation’s seven poorest counties, South Dakota’s median income in 2010 was over $48,000, just $2,500, or 5 percent, below the national median. In 1980, by contrast, South Dakota’s per capita income was $7,800, 18 percent below the national average of $9,500. Income inequality in South Dakota is remarkably low. It’s tied with Wisconsin for the lowest in the country with a Gini coefficient of 33.[i] The Gini coefficient, in case you aren’t familiar, is a statistical measure of inequality bounded by 0, or perfect equality, and 100, or perfect inequality. A Gini of 33 is a bit higher than some Western European nations but lower, and hence more equal, than others, like Britain or Estonia. The U.S. figure is over 46 at this point. In other words, South Dakota’s quote unquote 1 percent is more like 5 or 10 percent.
Despite, or perhaps because of, its relative equality of incomes, South Dakota’s economic performance for the decade 1999 to 2009 was ranked eleventh in the nation in a recent study by Arthur Laffer, the economist that brought us the famous Laffer tax rate slash revenue tradeoff curve, and two economists associated with the American Legislative Exchange Council. Those same three economists also ranked South Dakota second, behind Utah, in overall economic outlook.[ii] The U.S. Chamber of Commerce lists South Dakota as the fourth best growth performer in the last ten years behind energy-rich Alaska and North Dakota and jackalope-rich Wyoming. The Chamber also lists South Dakota second only to Tennessee in terms of taxes and regulations, second in transportation, and fifth in overall infrastructure.[iii]
Some attribute South Dakota’s economic strength to federal agricultural subsidies. The state does rank ninth in the nation in that category, its farmers having received over 9.6 billion dollars between 1995 and 2010. But these days the federal government doles out money to numerous other groups as well, and not as lavishly in the Mount Rushmore State as elsewhere. In 2008, South Dakota received almost 1.3 billion dollars in all forms of federal assistance, or just shy of 1,600 bucks per person, making it only the 21st highest federal aid recipient in per capita terms, and a far cry short of Alaska’s 2,600, Vermont’s 2,800, or Washington DC’s whopping almost 4,700 dollars per person in federal aid.[iv] In aggregate, South Dakota residents do receive more in federal expenditures than they pay in taxes but, thanks to federal government budget deficits, that is true in the vast majority of other states and nationally too.
Why, then, is South Dakota’s economy so strong relative to that of the nation?
First, major non-agricultural sectors stopped deteriorating in 2009 and 2010 and rebounded in 2011. The financial services sector, which accounts for about 20 percent of the state’s total economic output, began growing again. Manufacturing and trade, which combined account for another 25 percent of state output, expanded strongly off their post-crisis lows.[v] Tourism rebounded in 2010, with visitor spending topping $1 billion for the first time, as many Americans still suffering from the soft economy thought it more prudent to vacation by driving West than by flying to Europe or the Caribbean.[vi]
Second, demand for agricultural products, which accounts for about 10 percent of the state’s economic output, has been strong. Corn prices are now at about 5 dollars and 50 cents per bushel, off their almost 7 dollar high in August 2011, but up from the 2 to 3 dollars common before 2007. Soybeans are projected at 11 plus bucks per bushel this year, up from 10 in 2008-9, and wheat should be over 7, up from under 5 in 2009-10. Livestock prices are up too. The same sows that went for 25 or 30 dollars in 2000 sold for almost 60 in 2011. Choice slaughter lambs that went for 80 or so in April 2000 sold for 190 dollars in April of last year.[vii] Choice steers will go for 120 to 128 this year, up from 83 and a quarter in 2008-9. Unsurprisingly, the price of agricultural land has increased from 15 to 20 percent since 2006.[viii]
Third, despite the rising price of agricultural land, South Dakota did not experience the housing bubble and subsequent bust on anything like the scale suffered nationally, where median housing prices increased from about $150,000 in 2000 to $250,000 in late 2006, an increase of 67 percent, before falling back 16 percent to about $210,000 by the end of 2011. The median home price in South Dakota, by contrast, was just shy of $80,000 in 2000, and in 2010 was just over $122,000, an increase of about 50 percent. Home prices in South Dakota have slipped slightly in the past year but are still up 4.26 percent over the last 5 years, ranking it fifth in the nation behind four of its neighbors, North Dakota, Wyoming, Iowa, and Nebraska, in terms of housing price appreciation.
Unsurprisingly, mortgage default and foreclosure rates in South Dakota are much lower than elsewhere. In the first quarter of 2010, just over 5 percent of South Dakotans’ mortgages were delinquent, the third lowest rate in the nation after Alaska and North Dakota and much lower than the 15 to 25 percent rate recorded in states like Michigan, California, Arizona, Nevada, and Florida. In December 2011, South Dakota suffered just 1 foreclosure for every 7,168 housing units, compared to 1 in 360 in Florida, 1 in 346 in Michigan, 1 in 254 in California, and 1 in every 177 housing units in Nevada. We could almost change South Dakota’s nickname to “The Land That the Housing Bubble and Bust Forgot.”
          The fourth and arguably most important factor in the state’s economic success is its favorable business environment. According to the Tax Foundation, South Dakota this year ranks second behind only Wyoming in terms of favorable tax climate for business. Its state-by-state index measures corporate, individual income, sales, unemployment insurance, and property taxes.[ix] According to the Fraser Institute, in 2011 South Dakota was, with a score of 8.1 on a scale of 0 to 10, the most economically free of all U.S. states and Canadian provinces. Numero uno. Most importantly, perhaps, South Dakota has for seven years in a row[x] ranked number one in the Small Business and Entrepreneurship Council’s small business survival index, well ahead of runners up Nevada and Texas.[xi] The state is, in other words, a haven for, and incubator of, entrepreneurs. And that is, for the most part, a very important aspect of the state’s relative economic strength.
The relationship between entrepreneurship and economic growth is not clear cut, mostly due to the ambiguity of the concept of entrepreneurship. Some people define the term narrowly, including in it only successful inventors or major business innovators. You know, the Eli Whitneys, Thomas Edisons, Bill Gateses, and Steve Jobses of the world. Others go to the opposite extreme and label any self-employed individual an entrepreneur. That is what Scott Shane does in his controversial book, The Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By, to paint entrepreneurs as bunch of middle aged losers who couldn’t keep real jobs.
I try to take a more nuanced view of the matter by making economist Will Baumol’s distinction between innovative and replicative entrepreneurs and historian Burton Folsom’s distinction between value creating and rent-seeking businesses. Rent seekers try to get something for nothing. They reach into other people’s pockets for their profits, sometimes by outright stealing it but more often by turning the government into their protector or bill collector. Think the construction contractors behind the infamous Bridge to Nowhere in Alaska or the ones who built that airport in the middle of rural, mountainous western Pennsylvania. The one with two half-empty commercial flights per day. Think about the recent automaker and financial institution bailouts or other forms of so-called corporate welfare. Since they do not create anything new of value, rent seeking entrepreneurs actually hurt the economy by reducing incentives for Folsomian value-creating entrepreneurs. Why work hard and smart just so some thief or politically-connected chump can take it from you?
Folsom’s value-creating entrepreneur produces economic goods, material things or services that people want to buy, the very heart of economic prosperity. They might do so through what Baumol calls innovative or replicative means. In other words, they might create a new technology, like wireless networking protocols, or a new gadget, like an I-pad. Or they might develop a new service, like home grocery delivery or Facebook. Or they might envision a new management technique such as just in time inventory control. Innovators are, in other words, the classic ideal of the entrepreneur.
The success of individual endeavors is not, for Baumol or myself, a prime consideration, the willingness and ability of entrepreneurs to innovate is the key to their importance. The environment, which is to say the market, will select the best ideas and jettison the rest. Failure is an important part of the process because we want to test as many feasible ideas against reality – the market -- as possible. Many innovative ideas die but are quickly recycled into new ventures, some of which will transform our lives for the better. Failed ideas may also reappear decades later and thrive in the new economic environment. Credit cards and fax machines, both of which debuted in the nineteenth century but did not hit it big until the twentieth, are prime examples.
The other type of entrepreneur, the replicative one, is the unsung hero of entrepreneurship. Replicative entrepreneurs push existing goods into new markets, be those markets geographical, as when a new restaurant opens in Sioux Falls or Mitchell, or cultural, as when an existing product like an automobile tire is used for new purposes, or a new demographic, like bald men, begins to see the merits of a hoary good like shampoo.
Most people do not consider replicative entrepreneurs as important as innovative ones but that is only because replicative entrepreneurs make contributions that are more difficult for casual observers to see. Adding a new restaurant in Sioux Falls increases competition and hence lowers price and/or increases the quality offered by all the restaurants in the market. The new restaurant may fail but it may also thrive and drive a marginal competitor into a new line of business. That’s bad for the marginal restaurateur, but good for diners and for overall economic efficiency.
Replicative entrepreneurship can also keep the unemployment rate low and thus minimize the negative social and economic effects of high unemployment on communities, including stress on government budgets, increased housing vacancies, more crime and suicides, and so forth. Scott Shane, the Illusions of Entrepreneurship author who I mentioned earlier, delights in pointing out that replicative entrepreneurs earn less per hour on average than people with identical human capital traits – experience and education – who are employed by others. But that claim reminds me of the old canard that there are three types of lies: white lies, damn lies, and statistics. What Shane misses is that it is better, for both the business owner and society, to be a replicative entrepreneur than to be unemployed, whether the cause of unemployment is cyclical, structural, or due to discrimination. The January 2012 Minneapolis Fedgazette, for example, quotes Patrick Boulay of New Business Minnesota, a networking organization for small businesses, to the effect that many unemployed people in their 50s are starting businesses QUOTE because they don’t think they have a chance at another job UNQUOTE due to their age.
And of course there is more to life than money. Many people enjoy the autonomy of being their own boss and are willing to earn a little less, or work a little longer, for the privilege. Not that I necessarily buy into Shane’s statistics. One of the many benefits of self-employment is self-scheduling and pacing. The self-employed, for example, can more easily tradeoff between work length and intensity. The former can be measured fairly easily, the latter only with great difficulty. And some of us would rather work from 10 am to 8 pm than from 8 am to 5 pm.
Culture certainly plays some role in South Dakotans’ penchant for entrepreneurship. It is much easier to fathom starting your own business if your parent, sibling, grandparent, or friend did so, even if their business venture ended quickly as so many do. But more importantly, researchers have show that innovation breeds more innovation. At its root, entrepreneurship is about discovery and acting upon unexploited profit opportunities. Exploitation of one opportunity often creates new ones. Without smart phones, for example, we wouldn’t have the ten gazillion apps we have to run on them. Sorry, wrong crowd. How about this? Without MacIver, there would be no MacGruber??? … Without automobiles there would be no intermittent speed windshield wipers? [Wave hands.]
But the most important cause of entrepreneurial intensity is overall government economic policy. I’ve already given you the latest stats on that. What I want to do now is to provide some historical context for the state government’s long standing and deep-seated encouragement of innovative and replicative value-adding entrepreneurship. Climatic, geographical, and geological deficiencies have long challenged South Dakota’s economic viability by rendering it thinly populated and highly dependent -- directly or indirectly -- upon agriculture.[xii] From territorial times to the present, the state’s government has periodically responded to those challenges by attempting to render the state as amenable to business interests as possible. South Dakota was a leading “right to work” or anti-union state by the 1940s, a position that it maintains to this day. In the 1980s, the state, led by Republican governor Bill Janklow, abolished usury laws in a successful bid to attract credit card companies and other lenders. Big corporations like Sears and Gateway and flotillas of smaller companies flocked to the state, especially its southeastern cities, to take advantage of the state’s low-tax, lightly-regulated business environment.
You probably know more about those recent episodes than I do as a carpetbagger from back East who first landed here in Sioux Falls just two years and ten months ago. You may not remember, however, that some of the state government’s economic development efforts flopped. In 1984, for example, the Federal Reserve strangled South Dakota’s attempt to circumvent federal restrictions against banks selling insurance. And a much earlier and at best modestly successful attempt by South Dakota to expand its tax base by chartermongering has been largely forgotten, even by scholars, so I intend to spend some time on it here this morning.
Around 1900, South Dakota became a chartermonger, or in other words a state that tried to induce out-of-state corporations to charter in it even though most would have no significant physical presence in the state. A Delaware if you will. The effort fell short because most quality incorporators -- entrepreneurs starting new corporations from scratch or executives of existing businesses that sought new charters -- did not believe that the state’s low fees and relatively lax enforcement of its corporate laws adequately compensated them for the uncertainty inherent in South Dakota’s relatively immature and volatile political and judicial systems.
Beginning almost immediately after ratification of the U.S. Constitution in 1788, substantial numbers of American entrepreneurs sought to charter -- or in other words to legally incorporate -- their businesses in order to obtain corporate privileges like perpetual succession and limited liability. Initially, most charters were special pieces of legislation specific to the business being incorporated. Obtaining special charters was sometimes an exercise in politics and hence expensive and time consuming. Late in the antebellum period, an increasing number of states passed general incorporation laws that rendered the chartering process cheaper, quicker, and less uncertain. The general incorporation movement quickened after the Civil War but incorporation by special charter did not disappear altogether except in those states, like South Dakota, that banned special charters in their constitutions.
Prior to the Civil War, U.S. corporations almost invariably received charters from the state or states in which they conducted their primary operations. In the decades following the war, however, national economic integration and the 1869 U.S. Supreme Court decision in Paul v. Virginia, which forbid states to exclude corporations chartered in other states, necessitated new arrangements. While smaller, more local concerns continued to charter in their main state of domicile because the benefits of incorporating elsewhere rarely exceeded the costs, larger, interstate corporations increasingly chartered in just one state, the one that offered them the most valuable charters on net, and did business in other states under “trust” agreements, as holding companies, or as so-called “foreign” corporations.
Unlinking place of business from state of incorporation created regulatory arbitrage opportunities for companies eager to find the best combination of charter fees, taxes, regulatory environment, and court system available. Early in the twentieth century, South Dakota joined Delaware, Maine, New Jersey, New York, Washington, D.C., and West Virginia in a competition to attract the most corporate chartering activity. New Jersey was the first to the interstate game, in the 1880s. In the last decade of the nineteenth century, aided by corporate attorney James Brooks Dill, it again liberalized its corporate laws. Most importantly, perhaps, it allowed the formation of corporations that did nothing but own the stock of other companies regardless of their place of business. In other words, it invented the holding company. In 1913, after New Jersey’s domestic economy had grown large and strong enough to stand on its own, antitrust measures that soured interstate corporations passed at the behest of Woodrow Wilson, the state’s former governor and the nation’s new president. Many corporations reacted by fleeing to Delaware, which had positioned itself as heir apparent by copying and somewhat liberalizing New Jersey’s corporate laws, adopting its legal precedents in toto, and then offering the whole package at half of New Jersey’s price. Delaware still controls the market, with relative newcomer Nevada a distant second.
South Dakota is not currently a serious competitor in the chartermongering game and has not been for decades. For a few years early in the twentieth century, however, it was able to induce significant numbers of corporations to charter in it, and hence pay it fees and taxes, during a crucial period in the state’s development.
From outposts like Sioux Falls and Yankton established in the 1860s and 1870s in the extreme eastern and southern parts of what would become the state of South Dakota in 1889, farmers of wheat and other small grains spread northward toward glacial lakes like Thompson and Big Stone and westward toward the Missouri River. Aided by sufficient, well-timed rainfall, the east river half of South Dakota grew quickly from 1879 until 1886. In 1887, however, a drought that would last until 1896 began. The years 1889 and 1894 were particularly dry. In 1892, $10,000 of federal money was expended in Pierre on rainmaking experiments. They failed, of course, but irrigation with water from underground aquifers provided costly and temporary relief to a few farmers in the James River Valley. During the drought, wheat yields on un-irrigated land plummeted to just one bushel per acre, necessitating infusions of government seed grain and, in 1894, a state tax moratorium. Many farmers responded by replacing grain monoculture with a system of mixed farming, with more emphasis on livestock, that made them less susceptible to bouts of dry weather. By the late 1890s, South Dakota was more dairy land than wheat belt, though some 3.8 million acres remained devoted to wheat in 1900 and there were still some fields devoted to wheat over a century later.
The state government also responded to the risks posed by fluctuations in the region’s precipitation cycle. Officials realized that corporate chartering fees were immune to regional climatic challenges and already by the early 1890s had learned firsthand that the state’s first large interstate corporations, its building and loan associations -- an early type of mortgage lender -- could increase tax revenues. If businesses could be induced to charter in South Dakota, even if they never operated there, some state services could be funded by out-of-staters, as officials knew was the case in New Jersey. South Dakota lawyers also recognized the bounty that could be theirs if the state could attract significant interstate corporate chartering activity.
Well before 1900, corporate law in each state was broadly identical. Charters provided businesses with the same general corporate powers, limited liability was widespread, and one vote per share voting rules had become the norm. Corporate laws, however, varied greatly from state to state in details important to incorporators. By the late nineteenth century, corporation law was in a state of flux due to the Great Merger Movement, the amalgamation of thousands of smaller businesses into large industrial trusts with significant market power, and due to Progressive notions that big businesses should be made less injurious and more useful. Most states toughened their corporation laws by QUOTE placing restrictions on the commencement of business by a company … imposing liabilities on directors with respect to debts, undue preferences, etc. and requiring the corporation to file [financial] statements. UNQUOTE In an attempt to capitalize on the unsettled conditions, South Dakota took the opposite tack. In 1901 it came forward with a proposition that a contemporary corporate attorney claimed QUOTE will grant to a corporation everything that it will ask, and for a consideration so minute as to be scarcely worth mentioning. UNQUOTE  In addition to lax laws, the state also rendered fees fairer and service speedier.
South Dakota’s corporation laws were more lax in their enforcement than they looked on paper. True, most types of companies could incorporate in perpetuity and begin business immediately after filing and before raising any equity capital and non-residents could own and control domestic corporations without restriction. But the state’s laws also endeavored to:
ONE: protect citizens and consumers by:
reserving the right to QUOTE alter, revise or annul any charter … whenever it may be injurious to the citizens of this state UNQUOTE
and forbidding QUOTE the making of contracts and combinations for the purpose of controlling, limiting or regulating the production of any article or commodity, or the market price thereof, or to restrict free competition in its production or sale. UNQUOTE
South Dakota’s corporate laws also sought to:
TWO: protect creditors and stockholders by requiring:
the annual publication of corporate balance sheets, making the state one of only about a dozen states to require such public disclosure at that time; and that certain account and record books be maintained and open to the inspection of stockholders.
The laws also tried to:
THREE: protect minority stockholder interests via:
by-laws approved by a majority of shares and made publicly available; cumulative voting rights; prohibitions against corporations engaging in activities outside those specified in their charters; prohibitions against stock watering, the practice of issuing shares for other than QUOTE money, labor done, or money or property actually received UNQUOTE; restrictions against excessive leverage or in other words over borrowing; and prohibitions against paying dividends out of capital stock or any other source except actual profits.
Weak enforcement effectively emasculated such strictures but the laws were on the books and hence were potential causes of trouble should the state legislature change hands or the state bureaucracy change its mind.
To quell incorporators’ fears that the government of a new, distant, lightly populated state would be unable to process large numbers of charters, South Dakota, like other chartermongers, established a service corporation to conduct the business of processing large quantities of incorporation paperwork quickly and efficiently. In numerous advertisements published in 1902, the South Dakota Secretary of State boasted that 95 percent of applications were approved QUOTE within ten hours after the application is received here. UNQUOTE
The state also restructured its fees. Through 1902, it charged $10 for examining, filing, and recording business charters regardless of the applicant company’s capitalization. In a 1902 missive to the governor, South Dakota Secretary of State O. C. Berg argued that the fee structure was QUOTE inadequate and unjust UNQUOTE because small, local corporations paid the same as large, interstate corporations that QUOTE with few if any exceptions, never transact a dollar’s worth of business within this state, nor bring any property into the state that can be assessed for taxation. UNQUOTE
Berg, who had been born and trained for business in Norway, suggested implementing a graduated charter fee. In addition to appearing to be fairer to small corporations, a graduated fee schedule was likely to increase overall revenues because larger corporations could easily afford to pay the higher levies. The legislature therefore moved on Berg’s suggestion when it came into session in early 1903. After some revisions in the Senate, the bill passed easily, 41 to 4. It also sailed through the House, 83 to 4. The law, as enacted in March 1903, created a graduated charter fee schedule: $10 for corporations capitalized at less than $25,000, $15 for corporations capitalized up to $100,000, $20 up to $500,000, $25 up to $1 million, and $40 for corporations capitalized over $1 million. By the end of the decade, the fees had been raised a few dollars each but they remained inconsequential to large corporations. A South Dakota charter for a company capitalized at $50 million, one wag noted, QUOTE cost somewhat less than the charge of an average tailor for an ordinary suit of clothes. UNQUOTE
Until at least the outbreak of World War I, South Dakota charged the lowest incorporation fees of any state, including Delaware, and its cost advantage increased with company size. Its annual franchise taxes were, at zero, also the lowest available, again especially for larger corporations. The state also had one of, if not the, lowest overall tax burdens for businesses as well.
Thanks to its low fees and speedy service, increasing numbers of corporations began chartering in South Dakota. Through the 1890s, the state chartered just a few hundred corporations each year. In fiscal 1902, however, that number soared to almost 2,000 before falling back to about 1,000 per year. For a few years, then, South Dakota lagged only New Jersey and New York in terms of corporate chartering, and was well ahead of Delaware and a nose in front of Maine. Revenues from business chartering and related corporate activity also increased markedly, from less than $7,000 in fiscal 1899 to over $25,000 in fiscal 1903, but remained a far cry shy of the $3 million or so that New Jersey raked in each year over that span.
Exactly how many interstate corporations each state was able to attract cannot be determined with precision because they were not differentiated in state records. Many corporations chartered in New York, for example, operated solely in the Empire State or were headquartered there and operated elsewhere through sales agents. Similarly, some of the corporations chartered in South Dakota were purely domestic ones that simply had no reason to charter elsewhere. The Argus-Leader Company chartered in Sioux Falls in August 1905 and capitalized at $40,000, for example, was undoubtedly the company that published the newspaper of the same name and city. Clearly, however, a large portion of the corporations chartered in South Dakota in the early twentieth century were interstate ones that had decided to avail themselves of the state’s low fees, quick processing, and lax enforcement of corporate law. For example, the Crystal Bullfrog Mining Company, capitalized at $1 million in Pierre, was actually located in Nevada.
In the end, however, South Dakota’s success at chartermongering was more absolute than relative. Although its chartermongering activities generated revenue for the state government, South Dakota never came close to dethroning New Jersey or Delaware as the nation’s business corporation center. When deciding where to charter, businessmen and their corporate counsel took numerous factors into consideration. While South Dakota scored high marks with its low chartering fees and corporate taxes, it did less well when it came to perceptions about the quality of its corporate laws, courts, and political stability. While New Jersey was considered stable and predictable, South Dakota was thought of as wild and untried, a significant liability when trying to attract staid corporations.
Victory in the competition for corporate charters was neither a “race to the bottom,” as some scholars have argued, nor a “race to the top” as others have claimed. Corporations did not all flock to, or flee from, states with the weakest corporation laws. Instead, incorporators of quality companies looked for middle ground, states that were neither too harsh like Massachusetts, nor too soft, like West Virginia, Arizona, and South Dakota, all of which developed reputations for laxity that made QUOTE investors look with distrust on any corporation which operates under one of their charters. UNQUOTE West Virginia had the laxest laws and hence was, as one contemporary put it, QUOTE a snug harbor for roaming and piratical companies and the Mecca of irresponsible corporations. UNQUOTE Because investors were wary of West Virginia corporations, good corporations had to steer clear of it lest they fall into discredit by association. Warned one contemporary, QUOTE the mere fact that a corporation is organized in Arizona, South Dakota, or the District of Columbia, is sufficient to put experienced investors on their guard and renders the sale of corporate securities difficult. UNQUOTE Some South Dakota officials, like O. C. Berg, did not want to be compared to pirates -- or, perhaps more appropriately, Vikings -- but for the most part their calls for tighter enforcement went unheeded, dooming any chance the state had to capture a larger share of the interstate charter market. In 1913, the state finally passed securities regulations requiring merit review by a newly instituted state securities commission. The law, however, did more to protect banking interests than investors and contemporaries found some of the commission’s rulings QUOTE UNQUOTE radical.
In the competition with other states for charters, South Dakota faced several other major challenges as well. Regardless of where they were chartered, most big and hence litigious businesses were headquartered on the East Coast and hence naturally considered New Jersey (and later Delaware) a cheaper, closer, safer, and overall more attractive alternative to South Dakota, and especially its capital Pierre, a tiny place at the end of the railroad line that after an initial burst of growth had stagnated. In 1902, before economists at Harvard and in the Yale Law Journal, an influential corporate attorney questioned the efficacy of having QUOTE the rights of a Boston stockholder in a South Dakota organization determined by the judge of the South Dakota courts interpreting the statutes of South Dakota. UNQUOTE To many Americans, South Dakota was an almost foreign place, a frigid, unforgiving land strewn with bison and peopled, where inhabited at all, by listless and wildly individualistic pioneers, drunken savages, itinerant cowboys, and larger than life characters like Boone May, Wild Bill Hickok, and Calamity Jane, who considered Eastern corporate types a QUOTE weaker class of people than themselves. UNQUOTE
Contemporaries also considered New Jersey’s and Delaware’s business case law precedents superior to those of other states, including newcomer South Dakota, where errors of omission abounded and errors of commission were not unknown. As late as 1902, South Dakota still had no statutory provision or court decision that explicitly allowed corporations to issue short term promissory notes, no explicit power to issue preferred stock, and no laws regarding the merger of corporations  -- except railroads -- chartered in different states. In 1902 its corporate law still contained numerous QUOTE apparent conflicting provisions, UNQUOTE a state of affairs that hardly inspired confidence. In 1903, a South Dakota court made what the Harvard Law Review believed to be an incorrect decision in an important corporate law case, further undermining the state’s credibility with potential incorporators. Two years later, a South Dakota judge caused a minor ruckus when he decided that contracts made with out-of-state corporations that had not complied with the letter of the state’s regulations -- paying a fee, filing copies of incorporation documents, and appointing an agent -- were entirely void.
Many potential incorporators also questioned the stability and predictability of the state’s political system, a matter of prime importance to businessmen who wanted QUOTE to know where they stand at all times and do not care to be confronted with sudden legislative enactments or with unexpected court decisions. UNQUOTE South Dakota became the first state to adopt initiative and referendum and hence seemed radically democratic to many Easterners. Like many other western states, it had a reputation for harboring anti-corporate sentiments so strong that they sometimes led to what the Sioux Falls Argus Leader called corporation lynching, which it defined as the machinations of QUOTE those who fight corporations simply because they are corporations and of demagogues who do it for the special purpose of winning popular applause. UNQUOTE In 1908, for example, South Dakota followed several other Midwestern and western states by imposing low railway passenger rates. Foreign immigrants – mostly Scandinavians and Germans who composed up to a third of the state’s population in the late nineteenth century -- rendered the state more politically heterogeneous and left-wing than it would later become.
In fact, Populists and Progressives were potent forces in early South Dakota politics. Populist James H. Kyle, for example, served the state in the U.S. Senate from 1891 until his death in 1901. In 1896, Fusion, which is to say Populist and Democrat, candidate Andrew E. Lee was elected governor on the coattails of Democratic presidential candidate William Jennings Bryan, who denizens of Sioux Falls exuberantly pulled in a carriage through the streets of the city. In May 1900, Sioux Falls hosted the National Populist Convention and large audiences attended Bryan rallies in Aberdeen, Mitchell, and Yankton in late September. Despite last minute predictions to the contrary, the state went for McKinley and replaced a Democratic incumbent Senator with a Republican. By 1904, however, the Republican party was having a difficult time staying united in several Midwestern states, including South Dakota, because, as a contemporary pundit put it, QUOTE the progressives and conservatives are too far apart, not alone upon personalities, but on the vital questions of the hour, UNQUOTE the most important of which was the so-called corporation, trust, or railroad question. By 1912, South Dakota progressives were speaking openly of forming their own third party.
Early South Dakotans were known for bashing politicians, like Coe I. Crawford, thought to represent the interests of large corporations. By the early 1900s, Crawford himself had joined the Progressives opposed to corporate influence in government. He was elected governor on the Republican ticket in 1906 and during his two-year term (1907-1908), Progressives made noises about prohibiting corporations from making political contributions, banning corporate employees from public office, and implementing other reforms considered detrimental to corporate interests. Ever since, the typical South Dakotan voter and politician has expressed almost as much distrust of big business as of big government, both of which they perceive as threats to their agrarian traditions.
In the end, then, chartering in South Dakota appealed mostly to local companies and a relatively thin crust of more speculative companies active across state lines that sought to minimize charter and franchise fees and taxes. The revenue that such corporations provided the state treasury was very real but the overall impact on the state’s economic development was minimal because few established any significant physical presence in the state. The later efforts of Janklow and others to induce actual investment in the state were much more lasting and important. I have no reason to doubt that Pierre will continue to seek out ways to attract businesses to the state and to encourage value-creating entrepreneurship.
          That does not mean, however, that the state’s economic future is assured. What future challenges might the state economy face? Well, agricultural prices could decline in real terms. They probably will at some point but who knows when or how quickly. A bigger threat, I think, is that the state will lose some or all of its federal funding, and I don’t mean just its agricultural subsidies. In one scenario, Washington finally gets around to some serious fiscal reforms and slices away at smaller states like South Dakota, which has those two beautiful U.S. Senators but only one junior member in the House of Representatives. In another, much more frightening scenario, the federal government’s finances implode and every state’s federal gravy train makes its final stop. Such a fiscal catastrophe would undoubtedly induce a recession that would hurt not only ag prices but also tourism, including Black Hills and Badlands excursions, hours spent at Deadwood gaming tables, pheasant hunting bookings, and goose and walleye outings on the Missouri. While resident sportsmen like myself would be thrilled at a reduction of what I’ll call -- only half tongue in cheek -- foreign competition, numerous hotels, restaurants, and gas stops would suffer to the point of cutting back on staff if not going under outright.
What is the chance of a fiscal crisis in Washington? Can’t say for sure. If I could I would be in Chicago or Manhattan right now, making the appropriate trades with nine zeroes at the end. The chance of a meltdown is certainly higher today than it was before 9/11, when the government actually ran a few surpluses. Remember them good old days? And the chance of a federal fiscal crisis is much higher now than it was before the massive bailouts that followed the financial crisis of 2008. TARP and the auto bailout, it turns out, were only minor sideshows that hid the real bailout, massive purchases of so-called toxic assets by the Federal Reserve. The Fed has been buying bad assets from banks with reserves, or deposits at the Fed, which it then pays interest on to the banks. That is why banks haven’t increased their lending even in the face of higher profitability and that, in turn, is why inflation has not been a major problem yet. But the nature of the Fed’s bailout is also why the economy remains as soft as a fresh cow pie. If the economy begins to heal, banks will lend their excess reserves to businesses and consumers but that will put upward pressure on prices and wages that could easily get out of control if the Fed doesn’t raise interest rates. In other words, stagflation, a period of high inflation and low economic growth associated with the economic malaise of the 1970s, could return with a vengeance, especially if the Iranians manage to disrupt the flow of oil through the Strait of Hormuz as they have been threatening to do.
Another cost of the Fed’s bailout activity is that it, and the rest of the government, are now clearly in the pockets of big business, especially the large, complex financial institutions that caused the financial crisis in the first place with their use and abuse of credit default swaps, collateralized mortgage obligations, and the other multifarious tools of excess risk taking. And that realization has made many Americans very, very angry, angry enough to camp out in urban parks and college campuses last fall until pepper spray and cold weather bade them leave. But the so-called Occupy Movement continues in new forms and may become a political and economic force in this election year.
For better or worse, South Dakota is still part of the United States so South Dakotans must worry about what is going on in Washington and even state capitals across the nation because if we learned nothing else from the 2008 crisis and subsequent recession, it is that the state’s economy is unlikely to soar while the national economy plummets. But entrepreneurial South Dakotans should look upon this troubled period as an opportunity. You are all probably well aware at this point that the Chinese character for “crisis” is a combination of the characters for “danger” and “opportunity.” Augustana College has contractually barred me from engaging in entrepreneurial pursuits directly, but if I were a South Dakotan entrepreneur I would be asking myself how I could profit from the repeal or significant revision of federal regulations like Obamacare, Dodd-Frank, and drug control; military, education, and postal spending reductions; high levels of inflation; and even rampant civil disorder in major cities.
It seems unlikely that South Dakota will have to set up refugee camps for displaced citizens from Shy Town, STL, or KC-MO but, ironically given the chartermongering episode I just related, the state could become a haven for businesses that need political, social, or economic stability in order to thrive. I can almost see the pitch now: The Wild West is no more, welcome to the Mild West, where you can call your U.S. Senators John and Tim when you see them at the barbershop, where your children can grow up safe and sound, and your business can compete nationally and internationally, even, nay especially, in these troubled times.
Thank you!


[i] Branko Milanovic, The Haves and the Have-Nots: A Brief and Idiosyncratic History of Global Inequality (New York: Basic Books, 2011), 178.
[ii] Arthur B. Laffer, Stephen Moore, and Jonathan Williams, Rich States, Poor States: ALEC-Laffer State Economic Competitiveness Index 4th ed. (2011), 11, 17, 48, 90.
[iii] U.S. Chamber of Commerce and the National Chamber Foundation, Enterprising States: Recovery and Renewal for the 21st Century (2011) , 16, 20, 25, 108.
[v] BEA interactive table tools.
[x] “South Dakota is Friendliest State for Small Business, Again,” Argus Leader (December 12, 2011).
[xii] This section is based upon a forthcoming book chapter tentatively titled “Chartermongering by South Dakota in the Early Twentieth Century.”