Upper Midwest Is Enjoying Sudden Renaissance of Economic Freedom

Published December 1, 2008

In news that has come as something of a surprise to economy watchers, the South is no longer the U.S. region offering the most promising trend toward economic freedom.

The new champ is the Upper Midwest—places such as South Dakota, which tops the latest U.S. Economic Freedom Index, issued by the Pacific Research Institute and Forbes magazine.

The index uses 143 variables organized into five sectors—fiscal, regulatory, judicial, government size, and welfare spending—to determine how much of a threat state government policies pose to the economic freedom of businesses and individuals.

The higher a state’s taxes, the heavier its regulation, the more activist its judges, the larger its welfare budget, and the more bloated its spending, the less economic freedom its residents have, the report observes.

‘Perfect Example’

“While southern states still tend to be above the median, the conventional wisdom is that the South is much more pro-business in its government policies than it really turns out to be when you look at it,” Lawrence J. McQuillan, the index’s lead author, said.

Instead, the report found many upper-Midwest states are making the largest strides toward increasing economic freedom and attracting an influx of capital, people, and businesses.

For example, South Dakota—which doesn’t tax corporate or personal income, personal property, business inventories, or inheritances—jumped 14 spots since 2004, when the index was last published. The state has the second-most business-friendly tax climate, according to the Tax Foundation’s 2009 Business Tax Climate Index.

“South Dakota is a perfect example that other states can focus on and learn from,” McQuillan said. “Other states can learn how to structure a tax code that’s very business-friendly and that encourages businesses and new people to move in.”

The state is becoming a magnet for technology firms and small manufacturing businesses, McQuillan said.

Catching Up

While other states in the region still rank behind many southern states, they are quickly catching up. Wisconsin, for example, trailed Virginia, Georgia, Arkansas, Alabama, and South Carolina in this latest index, but the Badger State’s leap of 20 places from its spot in the previous index was the largest in the nation. Minnesota and Illinois jumped 18 and 19 places, respectively.

But even the states making strides in the overall amount of economic freedom enjoyed by their citizens trail far behind in some sectors in the index. For example, while Wisconsin ranks ninth in the government-size sector, only one state ranked lower in the fiscal sector.

Still, what’s happening in the Upper Midwest is nothing short of an economic freedom renaissance, spurred largely by the pressure one state’s fiscal reforms put on neighboring states to improve or lose people and capital, McQuillan said.

McQuillan points to Minnesota Gov. Tim Pawlenty’s (R) effort to improve the business climate in his state.

“He’s putting pressure on other states to follow along or be left in the dust,” McQuillan said. “It’s a good kind of competitive environment.”

Migration Gaps

One of the exceptions to the economic resurgence in the region is Michigan, which ranked 34th in the latest economic freedom index, down seven spots from its place in the 2004 edition.

Michigan trails only Rhode Island in outbound migration, according to Michael LaFaive, fiscal policy director of the Mackinac Center for Public Policy, a think tank based in Michigan. Migration rates are a function of relative economic opportunity, LaFaive said.

“Why would people leave behind everything they know and go and spend a fortune moving to a location that has equal, if not fewer, opportunities than the state where they currently reside?” LaFaive said. “And it’s not only a financial move; it’s also a psychological move—they have to part with their culture.”

The economically freest states are growing much faster than those with the least freedom, the study notes. According to McQuillan’s index, net in-migration for the 20 economically freest states between 2003 and 2007 was 27.36 people per 1,000. The migration rates were only 1.17 people per 1,000 people in the most economically oppressed states. Thus Americans are “voting with their feet,” as economist Charles Tiebout described it.

Political Consequences

Low migration rates can eventually lead to a reduction in the number of representatives the state sends to Congress—which can translate into a loss of power and federal dollars.

Like California, which ranked No. 49 in McQuillan’s report, Michigan is poised to lose a seat in Congress after the next census.

“We already get back less money from the federal government than we send,” LaFaive said. “Losing a congressional seat … will mean less power and the likelihood that we will have less money for our roads.”

Guide for Recovery

However, McQuillan notes, the research provided by the index can be a guide for recovery even in Michigan.

“If Michigan improved its economic freedom by just one slot—if it went from No. 43 to No. 42—it would mean a net increase of about 10,000 people,” McQuillan said. “That’s [an influx of] badly needed consumers, investors, workers, and entrepreneurs.”

Jim Waters ([email protected]) is director of policy and communications at the Bluegrass Institute for Public Policy Solutions in Bowling Green, Kentucky.

For more information …

The U.S. Economic Freedom Index 2008 Report, Pacific Research Institute and Forbes magazine: http://special.pacificresearch.org/pub/sab/entrep/2008/Economic_Freedom/