The Reality of R.I. Economy

The Providence Journal Commentary Section
December 2009

Recently, Scott Wolf of Grow Smart Rhode Island wrote an interesting article (“Misleading business climate rankings, 11/5) where he raised the question of whether Rhode Island’s consistently poor performances in fifty-state business climate comparisons not only demoralizes us, but may possibly doom us to unsatisfactory future economic performance if improving our state’s business climate becomes the main focus of policy.

Have such rankings been a primary focus of economic development here? While I believe they should be one of our primary focuses, I can’t imagine anyone alleging that they have been. In the last budget, for example, not only did the legislature cast aside virtually all of the tax change recommendations put forward by the Governor and his tax study group that would have materially benefited our state in fifty-state comparisons, they made capital gains ordinary income in a state with very high marginal tax rates. Can anyone meaningfully conclude that our state has done a great deal to improve other deficiencies in its tax and cost structure regarding fees, regulations, electricity cost, and problems with the skills of our state’s labor force? According to Mr. Wolf, this is a moot issue; such changes really don’t matter.

 Mr. Wolf hypothesizes that the criteria judged to be relevant to economic success in these surveys are in reality largely irrelevant. He cites as empirical evidence the fact that several current state economic performance metrics are not necessarily nor obviously correlated with survey rankings for states that score the highest in these surveys. He expects the conclusions of his analysis to be “jaw-dropping” to persons like me who believe that business conditions do matter a great deal for our state’s future economic progress.
There is indeed a jaw-dropping element in Mr. Wolf’s analysis: the inappropriateness of the methodology he uses. In restricting his analysis exclusively to recent values of his performance metrics, Mr. Wolf commits a fairly common empirical analysis error – he overlooks the critical relationship between the time period used and results obtained. By focusing exclusively on current values, a time period when all of the states he considers are mired in recessions, there is far too much “noise” in his data to arrive at any meaningful conclusions about the fundamental relationship between rankings and economic performance. A more appropriate approach would have been to view state economic performance over far longer period, one that includes both recoveries and recessions. Although I doubt he purposely selected his sample strategically, focusing exclusively on a single period, a recession, to evaluate long-term performance is precisely what someone attempting to “rig” the results in the negative would have done.

This is not to say that I disagree with everything Mr. Wolf said about fifty-state comparisons. I have written numerous articles in these pages over the years discussing how these surveys are by their nature little more than elegant exercises in adding apples and oranges. The weights assigned to various indictors are generally arbitrary, to be sure, and not, as Mr. Wolf correctly ascertained, correlated with long-term measures of state economic success. But, regardless of whether or not we like them, in the computer age, these surveys have become potentially important (low cost) sources of information that companies use in their location decisions.

This brings us to another question raised by Mr. Wolf: will these low rankings somehow doom our state to unsatisfactory economic performance? In raising this question, Mr. Wolf very clearly confuses cause and effect: the effect of highly ineffective economic leadership here over the past decade is a business climate that consistently produces unsatisfactory business survey rankings. Simple correlation analysis doesn’t and can’t change that.

What about the academic literature which generally concludes that differences in tax rates among states don’t significantly impact economic success? For the vast majority of states this is correct, as they possess business structure characteristics that are fairly or reasonably similar. These studies, which attempt to model mean performance, often find Rhode Island to be an “outlier,” several standard deviations from the mean (regression line). In other words, the “standard” models of economic performance based on taxation measures don’t work all that well for Rhode Island. Viewing Rhode Island’s tax and cost structure in its entirety, taxes and costs do matter here, more so than most other states, even though as Mr. Wolf correctly notes, there are relatively small groups, such as tech persons, for whom this is not much of an issue. Because that group is not necessarily affected, it is valid to conclude that the same must be true for small business and manufacturers here, both of which comprise far greater portions of our state’s economy?

I respect and admire Grow Smart Rhode Island and I endorse many of the recommendations they make. But those recommendations pertain to the long term. What about the short-term and the fact that the world is not linear? In a well managed state, the short-term would transition easily and logically into the long-term. But this is Rhode Island. The likely success of a number of the measures proposed by Grow Smart Rhode Island will be less than they presume based on how far we have allowed our state’s economy to fall and many of the negatives of our present business climate that Mr. Wolf appears all too ready to dismiss.

 
by Leonard Lardaro