A Dysfunctional Federalism

State governments continue to claim they have both the responsibility for economic growth and the power to produce economic change outcomes that are in the best interests of their constituents as reflected in this statement from the National Governors Association:

“As the principal stewards of their states’ economic success, governors recognize that the global marketplace presents both challenges and opportunities and that states must address both to ensure their continued competitiveness.”[1]

Consistent with this image, state governments routinely invest substantial tax dollars in a range of activities intended to promote business growth, create jobs, and increase incomes.  They build and maintain business related infrastructure, train and educate workers, offer tax breaks and direct subsidies to corporations to entice them to make new investments or to discourage them from withdrawing investments, advertise in other states and nations, and send delegations abroad to lure foreign corporations to invest in their states.  By one estimate, states and localities spent an estimated $50 billion per year at the beginning of this decade on tax incentives.[2]  As of 2002, states spent approximately $190 million on international programs (excluding investment incentives) and maintained an estimated 240 overseas offices, up from only four in 1980.[3]

And yet, state governments clearly do not have the powers required to back up the governors’ claim to be the principle stewards of their states’ economic success.  And the objective evidence strongly suggests that their efforts to fulfill that role are wasted.

The Myth of State Economies

“In other words, if we think of state borders as physical barriers, do we also irrationally imagine that these borders protect us in some way? …

The idea was that the dark line would reinforce the biased notion that borders are impermeable—and that states are therefore meaningful categories to rely on for decision making. …

As reported in October in the online version of the journal Psychological Science, when the radioactive waste was being stored in neighboring Nevada, residents of Salt Lake City perceived much greater risk of contamination if the border was a light, dotted line. In their minds, that light, sketchy border minimized the distinction between Utah and Nevada—and thus increased their perception of risk. The thick, dark border offered psych­ological protection from radioactivity.”[4]

The use of the term “state economy”, and even more to the point, terms like “Michigan economy” and “Nevada economy” by economists, economic policy experts, and policy makers has the same psychological effect as drawing a dark border around a state.  These semantic practices reinforce a perceptual idea about the geopolitical boundaries that can be drawn around economic activities that is untenable.

Whether we map the distribution of clusters of production sectors (e.g., grain production, coal mining) around the world, or map densities of commercial and financial flows among peoples of the world, or map production supply chains (stretching from extraction of raw materials to assembly of the final product), the resulting map will not create economic boundaries that coincide with a map of U.S. state boundaries.

A state economy is nothing more than an artifact of geopolitical decisions made long ago.  Like the mix of bird species in a state, the mix of economic activities and relationships in a state is little more than an arbitrary consequence of the intersection between where a state boundary was drawn and where particular economic activities and relationships later developed.  Economic activities and relationships in a state come and go, but state boundaries almost always stay put.

There is now one expanding global economy in which geopolitical boundaries, even the boundaries of nation-states, have a very limited and diminishing relationship to the global distribution of economic activities and relationships.  State economies exist only in our minds so they can only be managed by state governments in our minds.

The Myth of State Power over Economic Activities

In the 1886 case of Santa Clara County v. Southern Pacific Railroad, the U.S. Supreme Court heard a case in which the attorneys for the Southern Pacific Railroad argued that the corporation was a person within the intent of the due process protection for persons written into the 14th Amendment to the U.S. Constitution.[5]   The following statement by Chief Justice Waite, made during the hearing and in the court reporter’s notes but not part of the Court’s published decision, ended up becoming reaffirmed in future court cases as constitutional law:

“The Court does not wish to hear argument on the question whether the provision in the Fourteenth Amendment to the Constitution which forbids a state to deny to any person within its jurisdiction the equal protection of the laws applies to these corporations. We are all of opinion that it does.”

Provisions of the U.S. Constitution regarding federal authority over interstate commerce and relations with foreign powers, along with the above interpretation of the 14th Amendment, and the many other court decisions rendered over the last two centuries with regard to economic matters, have effectively stripped states of the power to promote the general welfare within their boundaries through the use of economic development policies.

Globalization has compounded the Constitutional powerlessness of state governments over economic matters.  In the context of global competition among hundreds of competing cities, provinces, states, and nations, a government must have the powers of a true nation-state to effectively promote domestic economic growth.  U.S. states, however, cannot control the flow of capital and goods across their borders; they cannot regulate the economic relations between their citizens and the citizens of foreign countries.  They have neither the constitutional authority to sign trade and investment agreements nor the international standing and military power to enforce them.

Evidence that State Economic Development Efforts are Wasted

The economic development agencies of state governments claim that they are successful, but outside studies generally do not support their claims.  Two examples:

• Ambrosius, Margery Marzahn, The Effectiveness of State Economic Development Policies: A Time-Series Analysis, The Western Political Quarterly, Vol. 42, No. 3 (Sep., 1989), pp. 283-300.
• Lynch, Robert G., The Impact of State Tax Policy on Economic Growth, Presentation before the Maryland Business Tax reform Commission, May 4, 2010. Available online.)

It is also worth noting that recent books and articles on the global economic crisis and the Great Recession in the U.S. hardly mention state governments.  In about the only political consensus we can find these days, economists, policy experts, business leaders, and politicians all put the spotlight on federal policy.  Were state governments able to act as powerfully in the world economy as the governors claim, this would surely not be the case.  States would be called upon to make a significant contribution to returning the U.S. to prosperity.

Dysfunctional Federalism

The untenable claim by state governors that they are the principle stewards of their states’ economic success is rooted in a dysfunctional system of federalism.  Over the last two centuries, virtually every social, economic, political, and geopolitical fact that informed the writing of the U.S. Constitution has disappeared.  During those two centuries, as new facts displaced old facts, the system of federalism was changed.  But the process of change, an accumulation of ad hoc legislation and court decisions, and the outcome of the Civil War, did not produce a rational division of responsibilities and powers between states and the federal government appropriate to the times in which we live.  Instead, it produced an awkwardly contradictory and constitutionally ambiguous, and thus tendentious, division of responsibilities and powers.  It produced a dysfunctional federalism.

The dysfunction has been evident for decades, but only in the last decade, particularly since the onset of the Great Recession, has it become truly debilitating.  It permits and encourages jurisdictional fights that damage the fabric of the nation and wasteful spending on unproductive state and local economic development efforts.  From the perspective of the U.S. nation as a whole, the outcome is debilitating policy incoherence.

We have not yet paid the full price for abiding this system.