Growing a State's Economy: The Arizona-New Mexico Case Study

Preface - AO Editors' Note

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By Matt E. Ryan, Ph.D.
Assistant Professor of Economics
Duquesne University

I. Introduction

   While many politicians disagree on the means, not one candidate running for public office would assume a platform against the desirable ends of “growing the economy.” The outcomes associated with an expanding economy are numerous, and not related strictly to the income they earn. Better health outcomes, more choices as a consumer, and an expanded set of personal and professional opportunities are just a few of the reasons that voters care about growing the economy.

    This analysis looks at the recent economic history of two neighboring states, Arizona and New Mexico, and tells the story of two different means to achieving the end of economic growth. New Mexico focused more on the public sector as a source of economic growth; in contrast, Arizona focused more on markets and the private sector as the engine of wealth generation.

    As a result of this fundamental difference in mindset towards the role of the government in the economy, Arizona’s economy grew from 1.45 times the size of New Mexico’s in 1963 to over 3.11 times its size in 2008—a staggering separation over less than half a century.

    When economists talk about economic growth, oftentimes the metric used is gross domestic product per capita, or GDP per capita (or within the United States, gross state product per capita, or GSP per capita). Countries or states with larger populations will have larger GDPs, all else equal, due to the simple fact that larger populations will produce more goods and services. In order to capture more accurately the economic well-being of an area, it makes sense to consider the number of people in an economy.

    GDP per capita simply takes the total output of a nation’s economy (GDP) and divides it by its population. Switzerland, widely considered one of the richest countries in the world, has a GDP per capita of roughly $42,000. By comparison, Russia—by no means as rich Switzerland—has a GDP per capita around $16,000 (CIA World Factbook). Due to differences in population, though, the Russian economy is over seven times the size of Swiss economy. Sometimes looking solely at the size of the economy can be misleading.

    However, despite Arizona’s advantage over New Mexico in terms of gross state product per capita, the focus of this study will be on the overall size of the economy. Why? Because it is the exact focus of legislators and policy makers to increase the size of the economy.

    Political rhetoric emphasizes more jobs, more companies, more output—just more, independent of population. In fact, growing economies will experience increases in population due to immigration that will lessen, statistically, the influence of a growing economy on the per capita metric.

    The experience of Arizona and New Mexico highlight this effect perfectly. Arizona experienced a massive growth in population over the second half of the 20th century. In 1960, Arizona had 1.3 million people, yet by 2000 had over 5 million residents. No decade passed in which Arizona experienced less than 35% population growth over the preceding ten years. By comparison, New Mexico had about 950,000 residents in 1960, and grew to only 1.8 million people in 2000. New Mexico experienced no decade of population growth greater than 30%.

    Arizona’s continued edge over New Mexico in GDP per capita fails to account for—in fact, hides—the remarkable differences in population growth between the two states, and implies astonishing growth in the overall size of the Arizona economy relative to the New Mexico economy, as mentioned above (U.S. Census Bureau).

II. Arizona vs. New Mexico: The Last 50 Years 


Source: U.S. Department of Commerce, Bureau of Economic Analysis, Regional Economic Analysis Division

Source: U.S. Department of Commerce, Bureau of Economic Analysis, Regional Economic Analysis Division

    In national terms, Arizona and New Mexico’s economy looked very similar in 1963. Arizona’s economy was 33rd largest in the United States at $24.7 billion, in today’s dollars, with New Mexico’s right behind it at 36th largest with an output of nearly $17.0 billion, also in 2008 dollars. Moreover, neither economy had a natural advantage to growth over the other. Both economies experience similar climate and have similar terrain. Neither has an inherent geographical advantage in trade or migratory issues. Further, both have similar histories with regards to culture—specifically, Native American and Hispanic—should that play a role in long-term economic development.

    While the impact of natural differences such as these across areas is debatable as to its exact nature (even its propensity to help or harm an economy), there can be no discernable impact due to the remarkably common features shared by both of the states.

    Nonetheless, the picture of the two economies changed drastically by 2008. Arizona’s economy swelled to $216.5 billion, 20th largest in the United States. By comparison, New Mexico’s economy grew only to $66 billion, and actually retreated one spot in comparison to the rest of country to the 37th largest economy in the country.

    Clearly, in light of the similarities between the two states, there must be a significant driving force pushing Arizona forward and restraining New Mexico. The answer lies in the utilization of markets in generating wealth.

III. Small Changes, Large Outcomes 

    Economies have a large amount of inertia; it is difficult to affect changes upon an economy so as to generate large-scale differences in outcomes in a short period of time. This reality is a function both of the nature of economies as well as the nature of the political process. By in large, changes to the policy structure within which individuals operate do not change violently; taxes rarely triple over any substantive range, and regulations typically do not shift from non-existent to onerous overnight. As a result, many policy makers operate in a world of marginal changes to their policy environment, not ground breaking ones.

    Fortunately for legislators, small changes in policy can yield sizeable outcomes in the long run. One general rule of thumb to follow is the “Rule of 70.” Anything subjected to a growth rate—economies, bank accounts—will roughly double in size according to the following ratio:
Years needed to double = 70 ÷ Annual Growth Rate.

    Due to compounding growth, even small changes in growth rates have very significant impact on long-run expansion. Consider two economies, A and B, subjected to two different growth rates, 3% and 5%, respectively. Economy A, at its annual 3% growth rate, will double in size roughly every 23, or 70/3, years. Economy B, however, growing at 5% annually, will double in size roughly every 14, or 70/5, years.

    A modest difference in growth rates between the two economies—only two percentage points—yields a difference in the time required to double of nearly a decade. In fact, Economy B can double itself nearly twice in the time it takes Economy A to double itself once.

     The story of Economy A and Economy B is not entirely removed from the story of Arizona and New Mexico. Holding constant the value of the dollar, Arizona’s economy by 2008 had grown to over 10 times its size in 1963, translating to an average annual rate of about 5.3%. New Mexico’s economy, on the other hand, grew to a size by 2008 that was less than 5 times its original size, growing at an average annual of approximately 3.5%. Despite the modest difference in average annual growth rates—a bit less than 2%—Arizona’s performance, relative to New Mexico’s, is astounding.

     That such small changes in growth rates can have such remarkable impacts is a godsend for policymakers. The task of securing long-run prosperity appears daunting, especially in policy-poor environments. But while large-scale changes can bring about much needed change, they need not be the only path to wealth. Marginal, continual changes in the right direction can lead to nontrivial outcomes.

    Since small changes are the norm for state policy makers, as mentioned above, the question moves to what small changes to incorporate. Arizona’s path to prosperity yields a perfect roadmap for any legislator looking to improve their state’s economy.

IV. Private Sector vs. Public Sector Growth 
 

Source: U.S. Department of Commerce, Bureau of Economic Analysis, Regional Economic Analysis Division

     Arizona’s vast economic expansion can be traced to one overarching theme: reliance on the private sector. Figure 2 provides a snapshot of Arizona’s emphasis on private industry relative to New Mexico. The value on the y-axis is the difference between Arizona and New Mexico with respect to the percentage of each economy devoted to private sector activity.

    For example, the value for the first year on the graph, 1963, is about 2.5%. This value means that for every 100 dollars generated in gross state product, Arizona’s economic output would consist of roughly two and a half dollars more from the private sector as compared to New Mexico. Positive values denote a greater reliance on the private sector to generate economic output; indeed, for every year since 1963 except one (1982), private industry has driven economic activity in Arizona to a greater extent than in New Mexico.

    The same issue of small differences playing a large role is applicable here as well. Despite both economies containing private sectors responsible for over three-quarters of the state’s economic activity for the duration of the time period in this analysis, the small yet distinct separation led to a marked difference in long-run economic outcomes.

    Societies always have, and always will, encounter the fundamental problem of scarce resources. The larger question, however, is how to organize economic activity in light of this scarcity. Solutions span a spectrum of more government-focused, centrally-planned options to more market-oriented, disparate ones. A focus on the private sector is an emphasis on the latter.

    As history has shown, and economic theory has proven, relying on the market to answer the fundamental allocation question of economics leads to superior economic outcomes and many-fold advantages in wealth and human well-being.

    A more market-oriented economy holds a distinct advantage over a more public-sector-oriented economy in its ability to coordinate economic activity. Oftentimes, “coordination” in any context implies a top-down oversight of activity. The nature of an economy and the individuals that comprise it, however, make such a top-down effort impossible to execute with any degree of success. Instead, coordination within a market system comes from open, unencumbered competition between market participants in light of a well-functioning price system.

    When individuals are free to earn income for themselves and obtain those goods they desire through voluntary transactions, markets direct goods towards those who value them the most. Instead of manually aggregating all of the relevant production specifics for every industry and every individual’s individual preferences, as would be needed to effectively allocate resources in a top-down scenario, prices play the role of aggregating information and allowing individuals to act for themselves in light of the preferences of others.

    Beyond questions of the ability of a public sector to direct resources towards their most valued uses are issues of a more expansive public sector dissolving the link between individuals’ actions and outcomes for society. One large reason why capitalism works so effectively as a economic system is that the market process translates personal self-interest into societal well-being.

    Individuals making themselves better off through voluntary transactions make everyone better off. Since self-interest is natural, capitalism provides the foundation in which society prospers by virtue of its members pursuing their own ends. Involving the public sector in the economic process, however, forces a wedge between this connection of individual self-interest and societal well-being.

    Whereas a market-based economic system generates a positive relationship between, these two factors, no such relationship exists in a public-sector based economic system. In fact, pursuing one’s self-interest oftentimes generates a negative effect on societal well-being. Instead of pursuing self-interest through a market system and providing value to society by doing so, individuals also have the opportunity to pursue their self-interest through the political process. The political process does not generate value for society as voluntary trade does; in fact, losses to society are often the result of transfers of wealth, lobbying, interest groups and the like. Ultimately, states that focus more on the public sector translate more individual economic activity into losses for society than states that focus more on the competitive market.

V. Conclusion 

     This analysis takes a brief look at the recent economic history of Arizona and New Mexico and discerns one important aspect of the difference in economic performance of the last fifty years: The degree to which each state utilized the private sector as an engine of economic growth. Arizona’s economy relied more upon market activity, whereby New Mexico had a larger reliance on the public sector within its economy.

    As expected, areas that rely on markets grow faster and generate wealthier areas over time, and the Arizona/New Mexico dynamic is the perfect example. From a beginning ratio of 1.45-to-1, the Arizona economy, relative to New Mexico, grew to over three times the size of its neighbor in less than 50 years.

    By comparison, if New Mexico had experienced the growth that Arizona had, and vice versa, over the same time span, the New Mexico economy would be nearly 50% larger than the Arizona economy. Small differences in growth rates have staggering results over the long run, and indeed, modest differences in an economy’s reliance on the private sector generate marked discrepancies in an economy’s level of wealth and a society’s level of well-being.

     The results point to the immediate policy prescription of minimizing the footprint of the public sector on any state’s economic activity—even if only marginally. Reducing public outlays, minimizing tax burdens and cutting regulation all play a direct role in shifting the focus away from the public sector and into private sector. By doing so, states’ economies can grow faster and its residents can more quickly reap the benefits of increased wealth.
 

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Matt Ryan holds a Ph.D. in economics and is an assistant professor of economics at Duquesne University and recieved much of his academic training in the western United States..  Cllick here to read Ryan's opinion piece in the Arizona Daily Star suggesting that Arizona's economic recovery is dependent on private growth rather than new taxes.