Business cycles have long captured the interest of economists, and
these transient fluctuations typically garner a great deal of attention
from the media and policymakers as well. But over the last 15 years,
many economists have turned their attention away from short-term cycles
and focused instead on long-term growth trends. This new focus has
been driven, in part, by the observation that even small differences
in long-term growth rates lead to huge differences in standards of
living over time, disparities that far exceed the impact of transitory
For example, Nobel Laureate Robert Lucas, a University of Chicago
economist, has pointed out that while South Korea and the Philippines
had similar per capita incomes in 1960, the superior growth of South
Korea over the following 28 years (6.2 percent per year vs. 1.8 percent)
resulted in Korean incomes being three times larger than the incomes
in the Philippines by 1988. While this example is especially striking,
a general observation from the growth literature is that differences
in long-term growth rates have a much larger impact on the level of
income over time than do typical business cycle fluctuations.
Current research on economic growth and on business cycle fluctuations
most often focuses on nations, but this article employs tools from
both research fields to examine the performance of a state economy,
Minnesota's. And by following Minnesota's progress over the past 70
years, it draws insights that may prove valuable to economists and
policymakers in other states, as well.
The study of state business cycles is hardly new. In fact, more than
20 years ago, Federal Reserve Bank of Minneapolis economists Robert
Litterman and Richard Todd studied Minnesota business cycles in a
Quarterly Review article titled, "As
the Nation's Economy Goes, So Goes Minnesota's".
The current article begins by updating Litterman and Todd's analysis,
and while additional facts are uncovered, their basic conclusion still
holds true: The state economy fluctuates closely with the national
Careful studies of long-term growth in individual states are less
common, but the economic implications are arguably more important.
After the analysis of Minnesota business cycles, this article therefore
turns to an analysis of the state's long-term growth. The discussion
here centers on an important, but underappreciated, fact about the
Minnesota economy: Over the past 70 years, Minnesota's per capita
income has slightly, but steadily, outgrown U.S. per capita income.
To understand why this fact is so important, consider the following.
Minnesota per capita income in 1929 was 14 percent below the national
figure. By 2001, state per capita income had risen to 8 percent above
U.S. per capita income. Had Minnesota's economy grown at the same
pace as the nation's economy over the past 70 years, its current per
capita income would be 21 percent lower than it is today. So while
the recent recession has been traumatic for Minnesotans who have lost
their jobs, the 1 percent decrease in real per capita income statewide
from the start of the recession in the first quarter of 2001 to the
fourth quarter of 2001 is small in comparison with those long-run
gains enjoyed by Minnesota's populationboth in absolute terms
and relative to the national averagebetween 1929 and 2001. The
second part of this article examines this long-term increase in Minnesota's
relative income and helps illuminate the sources of that increase.
But first, the state business cycle is examined.
Defining business cycles
To compare Minnesota business cycles with national business cycles,
as well as business cycles in other states, a measure of economic
activity and a clear definition of business cycles are needed. The
measure of economic activity used here is real earned income, which
includes all wage and salary earnings, plus proprietor's income. This
is a broad measure of activity that encompasses all sectors of the
economy. The data have been adjusted for inflation, and all variables
are measured in 1996 dollars.
Following modern business cycle theory, business cycles are defined
as the fluctuations in earned income around the long-run trend. Figure
1 illustrates the basic idea of this definition for the U.S. economy.
The top panel shows U.S. earned income and a smooth trend line drawn
through the data. The percent deviations between the actual data and
the trend line are shown in the bottom panel, and are defined to be
the business cycle. The same procedure is used to define the business
cycle for each state economy.
This definition of business cycles has several appealing features.
The business cycles for each state and for the nation are measured
independently of each other; states do not always suffer downturns
with the national cycle. Business cycles are measured in percentage
terms, which allows for a more meaningful comparison of cycles between
big and small states, and between individual states and the nation.
And finally, the volatility and timing of business cycles can be easily
There is a visible relationship between this measure of the national
business cycle and the more widely known business cycle dating of
peaks and troughs announced by the National Bureau of Economic Research.
NBER recessions are indicated in the bottom panel of Figure 1 by shaded
areas. Generally speaking, NBER recessions correspond to intervals
in which the business cycle line falls from above trend to below trend.
However, some periods of decline in the business cycle line are not
associated with NBER recessions, such as the decline during the mid-1990s.
Comparing business cycles: some bad news
The Minnesota and U.S. business cycles show a striking similarity
(Figure 2), somewhat surprising given that the Minnesota economy constitutes
less than 2 percent of the national economy. Clearly, the Minnesota
cycle has closely tracked the national cycle over the 20 years since
the Litterman-Todd analysis. The Minnesota cycle is somewhat more
volatile than the national cycle, though the excess volatility appears
to have lessened in recent years.
The fact that the Minnesota economy fluctuates so closely with the
U.S. economy is not unusual. It is true for most states, despite large
differences in their economies. In 40 of the 50 states, over half
the variability in each state economy is directly associated with
fluctuations in the national economy.
Compared with other state economies over this period, the Minnesota
business cycle is more volatile; indeed, it ranks as the 14th most
volatile state. While this may seem disturbing for Minnesota, it is
only part of the story and is, in fact, rather misleading.
Composition and stability: bad news turns better
Why is the Minnesota economy so volatile, and is it becoming more
or less so? To answer these questions, it is useful to look at the
individual sectors of the state economy more closely because different
sectors of the economy fluctuate very differently. For example, the
farm, manufacturing and construction sectors tend to be relatively
volatile, while the services and government sectors are relatively
stable. The overall volatility of a state economy can therefore be
strongly influenced by the relative size of its various sectors.
Litterman and Todd reported 20 years ago that the sectoral composition
of Minnesota's economy was quite similar to the nation's. That continues
to hold true, as the compositions of the two economies have evolved
quite similarly over time.
But a prominent distinction between Minnesota and the nation historically
has been the relatively large size of Minnesota's farm sector. Today,
however, this difference has disappeared. Since 1960, the farm share
has fallen from roughly 5 percent to 1 percent in the U.S. economy,
and from almost 10 percent to 1 percent in the Minnesota economy.
What makes the decline in Minnesota's farm share especially noteworthy
is that farm sector earnings are extremely volatile, and that volatility
largely accounts for the relatively high volatility in the state economy
described earlier. Figure 3 illustrates the nonfarm business cycles
in Minnesota and the United States. With farm earnings excluded, Minnesota's
business cycle has had the same volatility as the U.S. cycle and less
volatility than most state business cycles, ranking as the 37th most
volatile state rather than the 14th.
Furthermore, the declining farm sector share also helps explain the
declining excess volatility of Minnesota's business cycle. Since Minnesota's
farm sector is likely to remain small, Minnesota's future volatility
will be determined primarily by its nonfarm economygood news
in light of its relative stability over the past 40 years.
A primary strength of Minnesota's nonfarm economy is its diversity.
This diversity contributes to its stability. It is interesting to
note that most individual sectors of the state's economy are more
volatile than the nonfarm economy as a whole, but the sectors' fluctuations
do not all coincide. By blending a wide range of economic activities,
the Minnesota economy is more stable, in much the same way that a
well-diversified stock portfolio reduces risk.
Also, as with a stock portfolio, there is something of a trade-off
between risk and reward for a state economy. Several relatively volatile
sectors, such as the manufacturing, and finance, insurance and real
estate sectors, have relatively high average wages, while low-volatility
sectors such as the services and government sectors have low average
wages. So another benefit of Minnesota's diverse economy is that it
can reap some of the reward in high wages that relatively volatile
sectors offer, without greatly decreasing its stability.
Long-run trends: even better news
While the study of business cycles remains of interest, many economists
have turned more of their attention toward long-term economic growth.
The reason lies in a simple, yet powerful insight: Small differences
in growth rates that persist for long periods lead to large differences
in the level of economic activity and standards of living, differences
that dwarf the effect of minor, short-term deviations from the long-run
Consider two neighboring hypothetical economies, A and B, that have
the same per capita income today. Suppose economy A grows at an average
annual rate of 4 percent, while economy B grows at 2 percent. Under
this scenario, residents of economy A will have double the income
of their poor neighbors after 35 years. The residents of economy B
will have little sympathy if economy A then suffers a recession in
which its residents' average income declines by a relatively trivial
2 percent, since economy A residents will still be 98 percent richer.
Since 1929, U.S. real per capita personal income has risen almost
fivefold (Figure 4), and Minnesota income levels have increased similarly.*
However, a closer inspection reveals that Minnesota income started
below national income and finished above it. Since 1929, real U.S.
per capita income has grown at an annual rate of 2.23 percent, while
Minnesota per capita income rose 2.56 percent annually. Although this
difference is small on an annual basis, the cumulative effect over
70 years is substantial. While U.S. income rose almost 500 percent
over the entire period, Minnesota income grew more than 600 percent.
Another way to see the relative gain in Minnesota's income over time
is to look at state per capita income as a percent of the U.S. average.
Minnesota's income has steadily increased relative to average U.S.
income for the last 70-plus years (Figure 5). The long-run trend is
quite consistent, though there were large but temporary variations
from the general trend during the Great Depression and during World
War II and its aftermath. In 1929, Minnesota per capita income was
86 percent of the national average. It surpassed the U.S. figure in
the early 1970s and continued to climb to 108 percent of U.S. income
in 2001. Put in today's dollars, if Minnesota average income were
still 86 percent of the U.S. average, state income would be almost
$7,000 per person lower.
A closer look at trends
What accounts for Minnesota's superior growth over the past 70 years?
A definitive answer is beyond the scope of this article, but looking
a little more closely at the data provides some insights.
First, there is an important distinction between the growth in Minnesota
income from 1929 through the late 1950s and the growth from the late
1950s to the present. In the earlier period, years in which Minnesota
income was catching up to the national average, the growth was associated
with a general convergence in state per capita income levels across
the country. That is, poor states were generally growing more rapidly
than rich states, so that the difference between per capita income
in rich and poor states narrowed substantially.
Minnesota's ranking among states in terms of per capita income averaged
around 25th from 1929 to 1959, with some small, short-lived variations.
So while Minnesota's income rose notably as a percent of the U.S.
average during this period, its relative position among states was
unchanged. This does not explain Minnesota's relative growth during
this period, but it does suggest that the state's growth was part
of a nationwide phenomenon, and not something unique to Minnesota.
This situation changed after the 1950s. Minnesota's per capita income
ranking began climbing during the 1960s, rising to 17th by the late
1970s, and reaching the top 10 during the latter half of the 1990s.
In 2001, Minnesota stood eighth. Between 1959 and 2001, Minnesota's
annual per capita income growth rate of 2.76 percent outpaced 38 of
the 50 states, and only five states grew at rates above 2.90 percent.
Furthermore, Minnesota's per capita income growth since the late
1950s was not a regional phenomenon. Prior to the 1960s, Minnesota
income grew at roughly the same pace as average per capita income
in the Plains states (Iowa, Kansas, Minnesota, Missouri, Nebraska,
North Dakota and South Dakota) and in the Great Lakes states (Illinois,
Indiana, Michigan, Ohio and Wisconsin) (Figure 6). The Great Lakes
states had higher average incomes, but similar growth. Starting in
the 1960s, Minnesota income began to rise more quickly than the average
in both regions.
So Minnesota's per capita income growth over the past 40 years was
unique, and thus more interesting. Analysis of the different components
of personal income reveals that most of the state's relative gain
was driven by an increase in per capita labor earnings, with income
from capital holdings (dividends, interest income and rental income)
contributing to a lesser extent. The third component, transfer payments
(primarily comprising government payments for retirement and disability
insurance benefits, medical payments and income maintenance benefits),
had a detrimental effect on the state's relative income, as Minnesota's
share of total transfer payments fell over this period.
Since labor earnings per capita is the primary source of Minnesota's
relative growth, tracking down the source of this growth should be
informative. First, note that an increase in labor earnings per capita
can result from higher earnings per worker and/or more workers per
capita. As it turns out, both factors have been influential in Minnesota.
Some of Minnesota's relative gain in per capita income was due to
an increase in the fraction of Minnesotans employed. Minnesota currently
has one of the highest employment-to-population ratios of any state
in the country. Furthermore, the increase in the fraction of Minnesotans
working has been substantial. The percent of all Minnesotans employed
increased from about 41 percent in 1970 to 54 percent in 2000. But
what is important for Minnesota's relative gain is that the fraction
of Minnesotans employed rose faster than the national figure, which
increased from roughly 39 percent to 48 percent over the same period.
A higher fraction of people working does not account for all of Minnesota's
rise, however. Earnings per worker also increased relative to the
national figure. But the increase in earnings does not necessarily
reflect higher wages within individual sectors. For example, earnings
per worker could have risen as workers left low-paying jobs in the
farm sector and found higher-paying jobs in other sectors, such as
manufacturing. However, nonfarm earnings per worker also rose during
this period, suggesting that a shrinking farm sector is not the entire
Finally, economic theory identifies labor productivity growth, or
growth in output per worker, as a fundamental driving force for long-term
increases in labor earnings per worker. Productivity growth is also
viewed as critical for sustained long-term growth, since the fraction
of Minnesotans working cannot rise indefinitely. So an interesting
question is whether the gain in labor earnings per worker was associated
with a gain in the relative productivity of Minnesota's workforce.
A first look at the data indicates that Minnesota's labor productivity
did increase faster than the nation's. Since 1977, the productivity
of the Minnesota workforce relative to the U.S. average, as measured
by gross state product per worker in both, increased noticeably during
both the 1980s and 1990s. (Data prior to 1977 are not readily available
The relative increase in labor productivity, labor earnings and
employment per capita all suggest that there may have also been a
rise in the relative human capital, or skills, of Minnesota residents.
This section examines whether the human capital of Minnesota's residents
increased faster over the past 50 years than did the nation's, on
average, using education as a crude proxy for human capital.
Education levels have increased dramatically throughout the country
over the past 50 years. If education is to play a role in the explanation
for Minnesota's incomes rising faster than the nation's as a whole,
it must be that education levels have risen more rapidly in Minnesota's
population. There is some evidence that this is the case.
In 2000, Minnesota ranked seventh among the states in the percent
of residents 25 years and over with at least a bachelor's degree (31.2
percent compared to 25.6 percent in the nation), and third in the
percent of residents with a high school degree (90.8 percent vs. 84.1
percent for the nation).
Earlier in the century, however, the education level of Minnesota's
population was not especially impressive relative to the country as
a whole. For example, in 1950, the percent of Minnesotans aged 25
and over with four or more years of college was 5.6 percent, the same
as the national figure. The fraction of the population with four or
more years of high school was also much closer to the national average
in 1950 (34.7 percent in Minnesota vs. 33.4 percent for the United
States). Finally, the median duration of schooling in 1950 for Minnesotans
was nine years, lower than the national figure of 9.3 years. Minnesota's
reputation as having an educated populace apparently was being established
during the same period that Minnesota's per capita income was beginning
to surpass the national average.
Care should be taken in drawing inferences from this observation
on education. A good educational system does not itself guarantee
a highly educated population and strong economic growth. North Dakota
has one of the highest high school graduation rates in the country,
as well as one of the nation's highest percent of students continuing
on to college. Yet the state ranks relatively low nationally in the
percent of its adult population with a college degree, and the state's
per capita income ranked 37th in 2001. Many of North Dakota's educated
young people leave the state. Obviously, there is an important interplay
between an education system that supplies educated people and a state
economy with enough jobs that demand those educational skills. It
is difficult to disentangle the effects of the labor market's two
This article has examined the performance of the Minnesota economy
using the tools and techniques commonly employed by economists studying
national phenomena, such as the large disparity in income growth rates
across countries. Sticking with this parallel, and with the Minnesota
economy in mind, it seems natural to ask what the literature on economic
growth has found regarding explanations for the differences in growth
Not surprisingly, identifying the specific causes behind the differences
in growth rates across countries has proven difficult. But progress
has been made. Differences in productivity across countries have been
identified as a critical factor, and government policies can affect
productivity significantly. Government subsidies to failing or inefficient
firms, for example, may preserve jobs in the short-run, but delay
the transition to more efficient production practices that enhance
economic growth and long-term job creation. Tax policies have also
been found to have a large impact on national incomes. Still other
research concludes that the incentives to accumulate human capital
are a crucial part of the explanation for cross-country income growth
Which of these factors, or perhaps others, best explain the steady
increase in Minnesota's income per capita over the past 70 years is
an important question for state policymakers to address. Business
cycle fluctuations will almost surely continue to dominate the public's
attention, making it easy to overlook important long-run trends and
tempting policymakers to focus on cyclical, short-term economic forces
and policies. While it will continue to be important to mitigate the
hardship of recessions, the future prosperity of the Minnesota economy
depends upon understanding the long-term economic forces and policies
that have gotten us to where we are today.
income is a more comprehensive measure of income than the earned income
data used in the previous section. In addition to income from labor
services, it includes income derived from capital holdings (dividends,
interest and rent) and transfer payments by governments and businesses.
Only earned income data are available by sectors, and sectoral data
provided key insights in the business cycle analysis.