© The Corporation for Enterprise Development

Making the Grade: The 1988 Development Report Card for the States

Executive Summary

1988 will be remembered as a year of races. Presidential races. Winter Olympic races. Summer Olympic races. But the most important race of all has already been underway for several years: the 50 American states, along with the developed and developing nations of the world, are in a race for the economic future—a race for leadership and dominance in the global economic marketplace. In the past, the United States was always the odds-on-favorite, but that is no longer the case. Today, the competition is stiffer, the field is wide open, and the stakes are higher than they have ever been before.

The Challenge of Adding Value

Given the cost advantage Third World competitors hold, it has be come clear that American businesses have to win by making things better, not cheaper. Under the new rules of global economic competition, businesses win by innovating constantly — by repeatedly creating and improving new products and services, penetrating new markets — in short, by adding value. It is characteristic of creating incremental increases in value — of competing on the basis of quality, innovation, services to customers, production flexibility, and astute marketing—that best defines the businesses that are succeeding in today's economy, not whether they are big or small, old or new.

Value-Adding Partnerships

This same characteristic—a commitment to adding value—is what distinguishes the states that are the leaders in the 1988 Development Report Card for the States. The high scoring states in CfED's second annual study, which grades every state on four indexes that together comprise a state's "economic climate," are making conscious, incremental investments to improve their ability to support and assist businesses in the race for the economic future.

In short, the states that have committed themselves to adding value to their economies—to long-term investments in the skills of their workforce, the quality of their education system, the condition of their infrastructure, the accessibility of financial capital, the quality of their research institutions, the viabilities of their communities, both urban and rural, and the quality of the environment—have become active partners with business in the challenge of building economic competitiveness. Where these partnerships are strong, economic strength has followed.

Taking the Measure of State Economics

Taking the measure of the competitors in this economic race is no mean feat. Each state is different and every business has different requirements for growth. How can we identify a state with an economic climate capable of supporting business development—that is, a state where all the actors are doing their part to meet the challenge of adding value? Four questions help us spot the leaders and frame the four indexes in the Development Report Card:

• How well is the state's economy performing?

• How vital are the businesses in the state?

• What is the stat's capacity for continued growth?

• What policies has the state established to support business growth, expand opportunity, and add value to its economy?

The Big Picture: The Summary Results

The Leaders

Connecticut, Massachusetts, Maryland, New Jersey, Vermont

The states in the Northeastern "megalopolis"the heavily urbanized and developed stretch of the East Coast from Maryland to Maine — continues to set the pace in the nation's race to the economic future, just as they did last year. Employment and income continue to rise, businesses continue to grow, and the states themselves are continuing to invest in future growth, not content to "coast." This year, five of the six states that earned nothing less than a B on the Report Card are from this booming area. Minnesota is the only state from outside the region with the same high marks.

The Contenders

California. Delaware, Maine, Pennsylvania, Virginia. Washington, Wisconsin

The next tier of states includes those with only one grade below an A or a B. Some of these states in the second tier are among the up-and-coming states in the nation, while others are long-term economic stalwarts working hard to address the challenges of a changing economy.

The Pack

The twenty-five states found in the pack—each earning C's or worse in at least two of the Indexes — come in several different varieties:

Arkansas, Florida, Indiana, Michigan, New York, North Carolina, Ohio, South Carolina, West Virginia

Most encouraging are a handful of states found mostly in the Industrial Midwest and the New South that are generally lagging behind the top states in economic performance, but have established policies and investment commitments to turn their economies around. These states—all of which earn an A or B in the Policy Index—could very well be the new challengers in the years to come.

New Hampshire, Rhode Island

Also in the pack are states which are best described as coasting. These states tend to have well-performing economies but weak foundations. They lag other states in policies and investments in capacity-building needed to power their own growth. Most prominent here are New Hampshire and Rhode Island which largely benefit from their proximity to the robust Boston metropolitan area.

Arizona, Colorado, Georgia, Hawaii, Illinois, Missouri, Utah

A notch below these coasting states are several that display average or slightly better economic performance, but average to weak efforts in development policies.

Alaska, Iowa, Kansas, Montana, New Mexico, Texas

Finally, in the pack are a number of states hard hit by recent economic shocks, that are beginning to put policies in place but can do more.

The Trailing States

Alabama, Idaho, Kentucky, Louisiana, Mississippi, Nebraska, Nevada, Oklahoma, South Dakota, North Dakota, Tennessee, Wyoming

Bringing up the rear are states with three grades of D or F or states with at least two grades of D or F and no grade above a C. These include several rural states — remote from centers of economic activity, mainly dependent upon energy development and other commodity industries, and in the case of the Southern states, still trying to overcome a legacy of poverty. These rural states tend to have little value-added in their economies. Several of the rural energy and commodity-producing states have essentially colonial economies: They export raw materials and import finished goods. While commodity prices were high these states thrived. But when the prices collapsed, they were left unprepared for the challenge of rebuilding and diversifying.

What ties these trailing states together is an absence of either the kinds of investments in future development capacity needed to get them through these difficult times or, for many, the kind of development policies which would help them out of their current predicament. Many of these states held similar rankings last year and appear to have made little progress in the race to the future.

Common Themes

One of the most illuminating results of the Report Card is how frequently state scores correlate across Indexes. States in the lead tend to lead on every Index, and frequently in each subindex as well. At the opposite extreme, states that trail the pack tend to do so across the board.

Perhaps the most encouraging overall finding is how aggressively the states facing the most severe challenges of economic restructuring (and in the Southeast, of persistent poverty) are taking control of their own economic destinies. Four of the ten A's in policy were earned by the Midwestern states of Michigan, Ohio, Indiana, and Wisconsin as they respond to the sharp challenges of restructuring in manufacturing. The honor grades earned by South Carolina, North Carolina, Arkansas and Florida are even more encouraging. Their assaults on the joint legacies of poverty and underinvestment promise rapid advances toward parity with the more developed states in the nation.

More sobering, however, is the extent to which economic disparities—between metropolitan areas and rural regions, between vibrant suburbs and distressed urban neighborhoods, between whites and minorities, and men and women—continue to offset the advances achieved by many states. The standings of states like California, New York and Georgia, among others, would be higher were it not for these disparities.

Finally, we note that the rural states that depend on energy and commodity production face a potentially long period of stagnation before lasting improvements in their economies are likely. A quick increase in oil or commodity prices or reduction in the dollar may lift their economic spirits, but an apparent shortage of strategic development policies and a history of underinvestment in the building blocks of economics indicate that they are poorly prepared to face the long-term economic challenges of the future.

Index One: The Performance Index

Rationale

As each of the nation's 50 states race toward increased global economic competitiveness, the Performance Index provides us with a kind of statistical glance over the shoulder at where we've just been. It is a progress report which asks: "How are we doing?" and "Are we on the right track?" It doesn't tell us much about the future. It doesn't tell us who will do well in the race to the future. But it does tell us how we are doing now, and that's a start.

This year, The Performance Index has four subindexes:

• Employment: the extant to which the economy is providing jobs for those who want them.

• Earnings and Job Quality: how people are compensated for the work they do.

• Equity: the extent to which the opportunity to work is widely shared.

Findings

The 1988 Performance Index findings underscore the most basic point about America's economy: that most of the action is in the Northeast.

All six of the New England states earn A's in the performance index, as the ripple effect of the booming Boston metropolitan economy continues to spread outward. Continuing the trend we noted last year, all but one of the states in the Northeast "megalopolis"—the rapidly urbanizing and growing region from Virginia to Maine— receive A or B. With complex, diversified economies and strong information and technology industries, these states are hot, as anyone who has tried to buy a home in this region knows only too well. The lone exception, New York, is close behind with a high C, its solid performance in earnings held back by the persistence of poverty conditions and relatively moderate employment gains.

"Split level" economies—booming metropolitan areas bordered by languishing rural or non-metropolitan areas, or burdened by the persistence of poverty amid economic growth—characterize a number of states this year, including North Carolina, Georgia and Arizona, among others.

As was the case last year, the nation's older industrial states—Michigan, Ohio and Illinois, for example—continue to struggle to overcome the unemployment created by major structural economic change occurring in the last decade, even though, as we will see later, many of them are leading on other indexes.

Finally, the bottom of the overall Performance rankings is dominated by rural Southern and Western states. Many of these states have poorly diversified economies heavily dependent upon energy production (coal, oil and gas), mining and, to a lesser extent, agriculture. Others have a history of chronic poverty and have concentrated on hitching their fortunes to recruitment strategies designed to attract footloose branch plants through overgenerous tax breaks and other incentives. Many of these companies have since moved overseas to even lower production cost environments, leaving the states that lavished incentives on them unprepared to generate their own sources of economic growth.

Index Two: The Business Vitality Index

Rationale

The standings of each state competitor in the economic race to the future depend, to a significant degree, on the inherent vitality of the businesses in that state. Businesses create jobs. Businesses create income. And often, businesses spawn and attract other businesses. Their ability to create, produce and sell products and services that are valued in national and international markets—value that can be turned into jobs, wages and profits—determines much about the economic future of the states in which they are located.

How can we tell if state economies have businesses that meet the test of vitality? As we begin to understand more clearly the dynamics of state economies, there is mounting evidence that vital businesses, and vital state economies conform to four basic principles:

• Long-term economic vitality depends on the ability of businesses to initiate, adapt to, and take advantage of rapid change.

• The principal source of economic vitality in any state is local businesses and entrepreneurs, not businesses attracted from other states or nations.

• Industrial diversity is crucial to long-term economic vitality.

• The vitality of businesses in a state largely depends upon the extent to which they invest in themselves — in the products and services they produce, in their employees, and in their physical plant.

Using these four principles as a base, this index gauges the vitality of businesses within each state by using three subindexes:

• Competitiveness of Existing Businesses: how well the state's businesses are doing and the extent to which they are investing in themselves.

• Entrepreneurial Energy: examines the level of entrepreneurial activity in the state.

• Structural Diversity: measures the diversity of industrial activity in a state's economy in recent years.

Findings

If a state does well in the Performance Index, then we should expect it to do well on the Business Vitality Index as well . Similarly, a (state) that which does poorly on one should also do poorly on the other. And to a large extent, that is what has happened. Of the ten states receiving A's in the Vitality Index, six receive A's in the Performance Index as well — Delaware, Maine, Maryland, New Hampshire, New Jersey, and Vermont. Moreover, all but six of the states earning D's or F's in this Index score a C or worse in the Performance Index. For the states in the middle of the Vitality Index there is no strong pattern.

The overall standings in this Index show significant differences from last year. Part of this change is due to shifts in the economic situation in each of the states — energy states are down, for example, and states with pockets of rapid growth are up. But another cause of these changes is the Index itself. The Business Vitality Index is very different this year. It measures more aspects of the vitality of businesses in a state economy and it measures some of the same things as last year more sensitively. The overall effect seems to be a moderating of the extremes, as one might expect: the high fliers are not quite as high and the trailing states, in most instances, are not as far behind.

The states at the top tend to have economies that are both developed (diverse and competitive in national and international markets) and vibrant (full of new and growing businesses). In addition, all but six of the states earning A's or B's are east of the Mississippi. Most of the states at the bottom of the list tend to have economies deeply dependent on natural resource development and agriculture, including Iowa, Mississippi, Nebraska, Louisiana, Oklahoma, South Dakota and Wyoming. Several others are older industrial states still struggling to overcome the effects of structural change, including Illinois, Ohio, Wisconsin and Pennsylvania.

The Capacity Index

Rational

In the race to the economic future, some of the competitors have a distinct advantage: they are in better condition. Investments have been made to ensure that they were well prepared at the start and that they are well nourished throughout.

There are four kinds of economic conditioning or capacity-building investments in which states and their political subdivisions are principally involved that we measure in this Index.

• Subindex One: Human Resource Capacity: the range of educational skills in the workforce.

• Subindex Two: Technological Resource Capacity: the pool of potential innovators and research dollars in the state.

• Subindex Three: Financial Resource Capacity: the level of financial resources and aggressiveness of financial institutions in a state.

• Subindex Four: Physical Infrastructure and Amenity Resource Capacity: creating and maintaining physical infrastructure and quality of life amenity resources.

These are the building blocks of state economies. How well-developed they are, and how they are used, will have a lot to do with future economic performance and the attractiveness of the state to new economic development.

In the last decade, various crises—in infrastructure, environment, public education, adult literacy, technology development and commercialization, among others—have precipitate significant increases in investments in these building blocks in many states. But despite this progress, many of our international competitors are still in better condition. Compared to other advanced industrial economies, for example, our labor force has lower literacy rates, poor math and science skills and higher school dropout rates. Moreover, we invest less in civilian R&D.

Findings

The clear message of the state standings in the Capacity Index, perhaps even clearer than last year, is that if you want an economy that performs well and that produces jobs and income that are widely shared, a long-term commitment to investing in the basic foundations of the economy—an educated workforce, basic research, physical infrastructure and amenities, and financial capital—is essential.

In fact, virtually the only states at the top of the Performance Index that are not also at the top of the Capacity Index are states which owe the lion's share of their booming economies to spillover effects from Massachusetts, the state that most embodies that commitment.

What's more, the states that score well in the Capacity Index—such as Massachusetts, Maryland, Connecticut and New Jersey—are likely to continue to hold their leads. Having made significant investments for the future, these states are ensuring that their success is no "flash in the pan.

In the second tier of this Index are several states that have a good record of commitment to capacity-building and more recent rebuilding, but that either have been faced with massive economic restructuring (New York, Wisconsin, Ohio and Michigan, for example) or are currently living through a cyclical transition (Oregon and Texas, for example).

At least one state — New Mexico performs reasonably well on the Capacity Index thanks largely to the national research labs it hosts. But it may never be able to translate these assets into economic performance due to the limitations of its workforce and the fact that much of the research is top secret and therefore difficult to commercialize.

At the opposite end of this Index, the picture is just as clear. All of the states receiving F's are rural Southern or Appalachian states — Arkansas, Kentucky, Mississippi and West Virginia. other states rating poorly in capacity are either highly rural or in the Southeast, or both. With very few exceptions, the relationship between capacity and performance is direct. Virtually all of the low Capacity states economies are performing poorly (Maine, Indiana and Nevada are the exceptions). The reasons are the same for all of them: a legacy of low educational attainment levels, limited technological and research capacity, modest or minimal capital markets, and a history of inadequate investments in physical infrastructure. Thanks to the work of Southern leaders and institutions like the Southern Growth Policies Board, the tide is beginning to turn in the Southeast, though it may be a while before the payoff is widely visible. On the other hand, there is little evidence of a similar consistent commitment in the rural Western and Plains states at the bottom of this list.

Index Four: The Policy Index

Rationale

There is no finish line in the race to the economic future. Like the horizon, the goal advances ahead of us even as we approach it. It's probably just as well: our economy is changing so quickly these days that it is hard enough just ensuring that you are on the right track. "Competitiveness," therefore, is determined not. by whether one wins or loses, but how well one plays the game. And while their resources are limited, each state has the power to improve its competitive position in the race.

That's exactly what many of them are doing. One by one, states are focusing on creating economic environments that encourage the expansion of existing businesses within their own borders. If these initiatives are attractive to businesses elsewhere, so much the better.

This new focus demonstrates a much clearer understanding by state officials about the role public actors play in our private marketplace economy. It used to be said that: "The government which governs best, governs least." Today, as it becomes clearer that there is a direct relationship between public investments in capacity-building and the vitality of private industry, a more appropriate perspective is that: "The government which governs best, governs thoughtfully."

As the pace of economic change has quickened and the challenge of economic development has become more complex, businesses and state governments have found that they need each other more than they once thought. In a world of global economic competition, accelerating product cycles, rapid spread of technologies and expansionist foreign industrial strategies, success often can be achieved only by joint action.

Given these new realities, states recently have created a remarkable array of economic development policy innovations, often with the direct participation of businesses. They have created university and business R&D partnerships, established new business incubators, chartered public venture capital funds, streamlined tax and regulatory programs and provided comprehensive international trade assistance services, among other things. And, having recognized that a skilled workforce is the key to competitiveness, they have upgraded investments in public elementary, secondary, and higher education, as well as in a wide range of adult skill enhancement initiatives, from basic literacy to problem-solving, dependability and other personal skills. Finally, they have acted to bring those left behind by changes in our economy back into the mainstream through a variety of programs ranging from distressed community business development to self-employment programs for the disadvantaged.

The Policy Index is designed to capture these innovations. They fall into two broad categories: development preconditions and strategic development initiatives. The first group includes those responsibilities of government which strengthen the basic foundation for economic activity:

• Subindex One: Improving Governance and Regulation

• Subindex Two: Creating a Stable and Equitable Tax and Fiscal Environment

• Subindex Three: Investing in Education

• Subindex Four: Investing in Infrastructure and Amenities

The second group includes those cutting-edge strategies—many of them partnerships with private industry—that help states, and the businesses in them, compete in today's economy:

• Subindex Five: Mobilizing Capital

• Subindex Six: Promoting new enterprises and Strengthening Existing Businesses

• Subindex Seven: Investing in Disadvantaged Individuals and Communities

• Subindex Eight: Agricultural Development (This subindex is for information only, and is not included in calculating the final Policy index grade, because it is not applicable to all states.)

The number and variety of these initiatives have risen sharply, even in just the last year. The decision to include individual state initiatives in any of these categories was guided by several key questions: Can the initiative have significant impact on the state's economy? Is the initiative targeted at an important barrier or opportunity for growth? Given the limits of state resources, and the need for partnerships with private actors, is the initiative likely to leverage significant private investment? Is it likely to enhance the equitable distribution of economic opportunity? Does it empower communities and individuals to improve their own economic conditions? Is it politically pragmatic and administratively feasible? In a sense, however, perfect accuracy is unnecessary here. What we are trying to gauge is the relative level of effort: Is a state doing most of things within its power to increase the competitiveness and attractiveness of its economy? Some of the things? Very few of them?

What if a state does all the things we list in the Policy Index—will it be successful? Will its economy boom? We make no such claim. Government is but one player in any economy, and not the most important one at that. Its resources are small and its role is limited. But the evidence is unequivocal that, however small, this role is also crucial:

• State governments can, by their own actions, create the environment in which businesses can grow, economies can expand, and opportunity can be widely shared. Just as clearly, by their inaction, states can render their economies lifeless and uncompetitive.

Findings

As expected, among the states earning honor grades of A's or B's in the Policy Index are many of the Northeast states that also lead the nation in economic performance — Connecticut, Maine, Massachusetts, Maryland, New Jersey and Vermont. These states have made a strong commitment to public investments and public-private partnerships that will strengthen their capacity to generate future growth and position them to remain leaders in the economic race to the future.

But perhaps the most interesting finding is that a number of industrial Midwest and New South states with troubled economies in recent years are also among the states earning A's and B's in the Policy Index. These states include Indiana, Michigan, Ohio, Arkansas, South Carolina and West Virginia. They symbolize that famous adage: "when the going gets tough, the tough get going."

There is another pattern in the Policy Index findings as well: a number of states whose economies are booming have weal foundations and are doing poorly in the Policy Index. These states are "coasting." Their current success is largely due to "being in the right place at the right time" and their future prospects for powering their own growth do not seem bright. Most prominent examples of such coasting states are Rhode Island and New Hampshire.

Finally, as with last year, among the states with the farthest to go in economic development policy initiatives tend to be the thinly-populated. Plains and Mountain states—including South Dakota, North Dakota, Idaho, Nebraska, and Wyoming. Heavily dependent upon energy and other commodity prices, these states have been content in the past to take whatever the cycles give them: to "boom" with the good times and go "bust" in the bad times. Joining these Plains and Mountain states at the bottom of the Policy Index are several Southern states slow to take charge of their own futures and aggressively work to build their own economies—most notably, Alabama, Tennessee, Georgia, Louisiana and Oklahoma.

And in the end, that is the message of the Policy Index: that states can gain a measure of control over their own economic destinies. Resources may be limited, but imagination is not.

Reprinted with permission

The Corporation for Enterprise Development
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© Copyright 1989
Institute for domestic Tranquility