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.
[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.
[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.”