Economic Freedom and Economic Growth: Pennsylvania and South Dakota
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana University, Sioux Falls, S.D.
For the Pennsylvania Economics Association Conference in Kutztown, Pa., 30 May – 1 June 2019
NOTA BENE: I've been blogging extensively for the AIER, partly in support of my new book, Financial Exclusion, which you can (should?) buy here: https://www.amazon.com/gp/product/B07SC4CBDD.
My AIER blog list page is here: https://www.aier.org/staff/robert-e-wright.
Paper and slides:
Pennsylvania and South Dakota are not as dissimilar as they might at first seem. While South Dakota is physically bigger (76K vs. 45K square miles) and flatter, both states share the same basic rectangular shape and, more importantly, they both have metropoles at either end, Philadelphia and Sioux Falls in the east and Pittsburgh and Rapid City in the west, and a capital on a major river in the middle, Pierre on the Missouri and Harrisburg on the Susquehanna. Euroamerican Pennsylvania is also two centuries older (c. 1680) than Euroamerican South Dakota (c. 1860), which helps to explain its much higher population (13 vs. .9 million) and population density (285 vs. 11 people per square mile).
Per capita income is also higher in Pennsylvania ($51K vs. $48K) but its economic freedom score is somewhat lower (7.2 vs. 8.0). This is interesting because many people believe, on the basis of natural experiments like East and West Germany and North and South Korea, that economic freedom causes economic growth. Take that as you may, the two variables are incontestably highly correlated. Why, then, does South Dakota not have a higher per capita income than Pennsylvania?
Three major hypotheses come to mind. The first is that what really matters for growth is something other than economic freedom. In other words, South Dakota suffers from some problem or problems that Pennsylvania does not.
The second hypothesis is that specific types of freedom are more important to growth than the overall freedom score and that Pennsylvania is freer than South Dakota in those specific growth areas.
The third hypothesis is that the reported economic freedom scores are incorrect and Pennsylvania is economically freer, or South Dakota is economically less free, than measured.
I find little support for the first two hypotheses but a compelling story in support of the third, specifically the proposition that South Dakota’s freedom score, or its population, should be adjusted downward.
Numerous studies show a very high level of correlation between economic freedom and per capita income. Parsing out causation is harder but it does make sense that places with lower taxes, fewer regulations, more fiscal responsibility, less onerous and expensive entry barriers, and so forth would create more incentives for people to work harder and smarter and hence lead to higher income growth. The best causal evidence comes from natural experiments at the national level. So, for example, Korea and Germany were divided for exogenous reasons and one part endowed with relatively more economic freedom than the other part. As predicted, the freer parts, South Korea and West Germany, did much better economically than their relatively unfree counterparts.
But there is no such conclusive proof that economic freedom causes growth at the state level, so we should explore the possibility that something other than economic freedom might explain South Dakota’s relatively lower income. I cannot find anything, however, that makes sense, at least when the facts about both states are known. For instance, sometimes people intuit that South Dakota suffers because of its location, its size, its lack of fossil fuel production, its supposed reliance on agriculture, or its lack of diversity, finance, tourism, or education. These are all wrong and some are even silly.
For example, South Dakota happens to be in the exact center of the continent. Its average distance to all the inland markets is therefore shorter than Pennsylvania’s. Consider, for example, the average travel distance from Sioux Falls to New York (1,361 miles), Chicago (573), Houston (1,083), and Los Angeles (1,640), 1,164 miles, compared to Philadelphia (94 miles; 759 miles; 1,549 miles; 2,711 miles), which is 1,278 miles.
Size per se can’t matter. Many of the world’s richest countries, like Iceland and Monaco, are small. The population of South Dakota is about the same as that of my former home county, Montgomery, an affluent set of suburbs and exurbs just north of Philadelphia.
It is true that South Dakota does not produce fossil fuels. If you think it does, you have it confused with North Dakota, the oil fields of which do nothing for South Dakota’s economy according to a careful study by the Minneapolis Fed. South Dakota gets much of its electricity from hydro plants along the Missouri River and, like most states, imports gasoline, but mixes it with home grown, and unsubsidized, ethanol.
South Dakota is, however, not dependent on agriculture. Not even its farmers and ranchers are, as most learned in the 1980s that it is important to diversify into financial assets, town jobs, and hunting leases. Agriculture represents only about 6 percent of state GDP, much more than Pennsylvania’s .5%, but much less than the FIRE industry (finance, insurance, and real estate) in either place. In fact, South Dakota is much more reliant on FIRE (26% of GDP) than Pennsylvania (19% of GDP) is!
And tourism is much bigger in South Dakota, where it accounts for 6.4 percent of employment versus only 3.9 percent in Pennsylvania.
The population of South Dakota is not as diverse as that of Pennsylvania by some measures but the metropoles, particularly Sioux Falls, are amazingly diverse, and in diverse ways. There are more straight up Africans in Sioux Falls than African-Americans, for example. Most are Christians relocated from Ethiopia and Somalia by Lutheran Social Services. South Dakota has actually elected two people of Lebanese descent, one Democrat and one Republican, to the U.S. Senate!
And, contrary to stereotypes based on inputs (teacher salaries) instead of outputs (student learning), South Dakotans are not appreciably dumber than Pennsylvanians. In 2013, for example, South Dakota high school seniors scored 4th highest in the country in mathematics. That same year, though, they stumbled in reading, coming in only 5th nationally, a mere 20 places ahead of Pennsylvania.
The second hypothesis also fails under close scrutiny as South Dakota’s economic freedom score in all three major areas of government spending, taxes, and labor market freedom are superior to those of Pennsylvania and have been since 1981, with only the very slight and very recent exception of labor market freedom, which is Pennsylvania’s freest area since the demise of private sector unions in steel and coal. Meanwhile, South Dakota slipped in the labor freedom category by enacting a state minimum wage above the federal one and indexing it to inflation.
That leaves us with the third hypothesis, that economic freedom is lower in South Dakota than reported, or rather that the population that enjoys a freedom score of 8.0 is some 80,000 people lower than reported. These are not due to measurement errors per se but rather to counting people living on Indian Reservations. South Dakota has 8 Indian Reservations and the 3 huge ones located west of the Missouri River, to wit the Cheyenne River, Rosebud, and Pine Ridge reservations, are desperately poor. Their denizens basically live under socialism and hence have very little economic freedom. The Bureau of Indian Affairs is a central planner run amok and Indian Health Services is socialized medicine at its worst. Most damning of all, Reservation Indians have little access to decent financing because the land tenure system on the Reservations is completely different from that of the rest of the country and the criminal justice system is even more farcical. Any way you slice it, Indian Reservations, which have per capita incomes of $10,000 or so, drag down the state averages. Remove the three poorest counties in the state, which are perennially among the poorest in the nation, Ziebach, Todd, and Oglala Lakota, from the state’s income statistics and South Dakota’s per capita income exceeds that of Pennsylvania by almost $3,000, an appropriate figure given the state’s higher economic freedom score.
Conversely, if that thought is too jarring for a Pennsylvania audience, we need to lower South Dakota’s economic freedom score to account for the fact that a large percentage of its population subsists at a level of economic freedom at best half that of the rest of the state. In that case, Pennsylvania has a higher per capita income than South Dakota but is also more economically free, on average.
If the issue of the dearth of economic freedom in Indian Country interests you, I supply many more details in my 2015 book, Little Business on the Prairie, which is a history and policy analysis of entrepreneurship in South Dakota from 10,000 BC to the present. You can buy a copy when you visit South Dakota’s Badlands, Mount Rushmore, or Crazy Horse monuments or just want to hunt dinosaurs. If a trip to South Dakota is not on your bucket list, though, you can pick up a copy on Amazon.