“California Dreaming”

Mike Kimel at Angry Bear writes: California v. Red States, What Causes Growth, and the Great Stagnation

Introduction:

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

In the conclusion:

This post has several takeaways:

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

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

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

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

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

From (1) (2) and (3) the clear implication is that the red states grew more because they had the fastest increases in government spending.

But then (4) comes along and says that State and Local spending as a share of total spending has remained relatively constant. What I gather is that the states where overall spending grew more are the states which also had the highest real growth rates. After all, government is one of the components of spending and if the economy grows government spending grows with it. But that doesn´t mean (unless the share of government was increasing) that government spending is driving growth.

The chart below begins with the “Great Moderation”.

Kimel_1

In North Dakota government spending share has fallen considerably in the last few years. If North Dakota is growing more than California (in fact more than all the states in the sample) it is because private spending is more than offsetting the fall in government spending as a share of the economy. And that´s oil!

In several states more recently the share of government spending has increased to the upper bound in the sample. In California it has gone above the sample peak. In Colorado and Texas, on the other hand it has remained close to the lower bound in the sample.

Nominal spending (NGDP) at the state level is determined fundamentally by the conduct of national monetary policy (much like in the individual Eurozone countries). The panel shows how close to trend nominal spending has remained. That is measured by the NGDP Gap, the percent difference between actual spending and the trend level of spending. Note that there´s a close correspondence between the “gap” and the rate of unemployment.

Kimel_2

North Dakota is in a league of its own:

Kimel_3

If monetary policy is the same for all states, why should the spending gap and the correspondence of the gap with unemployment differ widely? Local factors that affect both the gap and unemployment may be important. One such factor is researched in this just released NBER paper: “UNEMPLOYMENT BENEFITS AND UNEMPLOYMENT IN THE GREAT RECESSION: THE ROLE OF MACRO EFFECTS”. In their conclusion they write:

One motivation for increasing unemployment benefit durations during the Great Recession, in addition to helping unemployed workers smooth their consumption, is to increase employment through its stimulative effect on local demand. Although we cannot do full justice to evaluating this effect given the methodology on which our analysis relies, our results nevertheless offer some insights. To the extent that the unemployed spend a significant fraction of their income in their home counties (in a form of e.g., rent payments or service purchases), the corresponding part of the stimulative effect is fully captured by our analysis.

Indeed, we find that border counties with longer benefit durations have much higher unemployment, despite the potential beneficial effects of spending. …We find, however, that an increase in unemployment due to benefit extensions is similar in magnitude to the decline of employment. Thus, the total effect on spending is ambiguous as extending benefits increase spending by the unemployed but at the same time decrease spending as fewer people are employed. The potential offsetting effect of lower employment due to higher benefits was also recognized by policymakers but considered – based on the micro studies discussed above – to be quantitatively very small. Our results of a sizeable macro effect leads us to expect that the stimulative effect of higher spending by the unemployed is largely offset by the dramatic negative effect on employment from the general equilibrium effect of benefit expansion on vacancy creation.

Note Mike Kimel graciously made his spreadsheet available

2 thoughts on ““California Dreaming”

  1. “But that doesn´t mean (unless the share of government was increasing) that government spending is driving growth.”

    Leaving aside your comments about North Dakota, I believe that sentence is where we parted company. But don’t forget the post you reference also showed that for most states, state & local spending tended to be most heavily correlated with state gdp four and five years out. Additionally, for all states in the sample, the Federal gov’t’s spending was most heavily correlated with state gdp four or five years out. Given that, unless I’m missing something, one of the following three options must be true:

    a. government spending is either an important driver of growth
    b. the government (at the state, local, and federal levels) is a good predictor of the state of the economy four and five years out, and it adjusts its spending in any given year to be some desired proportion of the state’s economy four and five years out
    c. coincidence

    I think we can all agree that option b is preposterous. That leaves options a and c. Correlation does not imply causality but for what little it is worth, I don’t believe this is a coincidence.

  2. Interesting post, Marcus. I like to take somebody’s statement (as you take Mike Kimel’s) and look at it in graphs, as you do here. Satisfying to see claims validated, or not. Also, in my experience, Kimel does some really good spreadsheets. For me, that’s an added bonus of your post.

    From the NBER paper:
    We find, however, that an increase in unemployment due to benefit extensions is similar in magnitude to the decline of employment. Thus, the total effect on spending is ambiguous…

    Out of context, maybe I misunderstand. But it seems to me the NBER paper is relying on the notion that the increase in unemployment is somehow the fault of people who simply STAYED on unemployment. But those people cannot account for the increase; OTHER people, people who were working, but lost jobs, account for both the decline of employment and the increase of unemployment.

    I don’t misunderstand. They refer to the “effect of benefit expansion on vacancy creation” as if “increasing unemployment benefit durations” created the vacancies. Doesn’t make any sense to me, even when you bold it.

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