Cause for concern

Accounting for Minnesota’s relative growth slowdown

The problem

What matters for economic welfare is per capita income. This is a general measure of welfare, telling us how much per person is available to be consumed, invested, or put to some other use. If we want to increase economic welfare, we should pursue policies that increase per capita income. Given its importance, Minnesota’s recent record on per capita GDP growth is concerning. Minnesota has long been able to boast a level of per capita GDP above that of the United States generally, a “premium” for living in the state. As recently as 2014, this premium was $4,669, or $18,676 for a family of four. Since 2014, however, it has fallen every year and was down to just $435 in 2023. In quarterly data, the premium disappeared completely in the first half of 2024.

This premium has disappeared because in every year since 2014, Minnesota’s per capita GDP growth has been slower than that of the United States generally. Only Wisconsin can match this record. While Minnesota’s rate of per capita GDP growth increased from an average of 0.8 percent annually from 2008 to 2014 to 1.1 percent from 2014 to 2023, the rate for the United States increased from 0.6 percent to 1.9 percent. This wasn’t driven by a handful of high-performing states. The ranking of Minnesota’s mean, real per capita GDP growth among the 50 states fell from 17th in 2008-2014 to 37th in 2014-2023.

What accounts for Minnesota’s relative slowdown? To answer this, we need to examine the components of real per capita GDP growth.

Per capita economic growth comes from three sources. These are an increase in the amount of labor provided by a given population, growth of capital per worker (the tools those workers have to work with), and Total Factor Productivity (TFP — “the way inputs to the production process are transformed into output”). These three sources can be labeled “human capital,” “physical capital,” and “TFP.” Determining how a country or state is performing with regard to these sources is vital for identifying policies that will boost real per capita GDP growth. Policies that increase employment or skills raise human capital, policies that stimulate increased capital investment elevate the amount of physical capital, and policies that spur increased innovation and entrepreneurship catalyze TFP growth.

In our new report “Accounting for Growth: Measuring the sources of per capita economic growth at the state level,” we use a technique called “growth accounting” to break down the observed rate of change in real per capita GDP into the shares derived from changes in human capital, physical capital, or TFP, and identify the sources of Minnesota’s relative growth slowdown.

The investigation

From 2008-2014 to 2014-2023, the average rate of per capita GDP growth in Minnesota increased by 0.3 percentage points. An increase in the average, weighted per capita growth rate of human capital accounted for 0.2 percentage points. An increase in the growth rate of physical capital per capita (weighted) accounted for the rest, but a decline in the growth rate of TFP offset some of this.

Human capital

Our estimates of human capital are derived from the number of people employed, the average number of hours each worker works annually, the average skills each worker derives from their education, and the average skills each worker derives from their experience. From 2008-2014 to 2014-2023, the unweighted rate of change of human capital per capita rose from an average decline of -0.4 percent annually to an increase of 0.4 percent — an increase of 0.8 percentage points.

Experience

An improvement in the rate of growth of the average level of human capital arising from experience per capita accounted for half of this, or 0.4 percentage points; an average annual decline of -0.4 percent in 2008-2014 became 0.0 percent in 2014-2023.

The stock of human capital arising from experience per capita can change if either total employment, the average stock per worker, or the population changes (a negative sign in the equation). From 2008-2014 to 2014-2023, there was no increase in the average annual growth rate of employment, but an increase in the growth rate of experience per worker (0.2 percentage points, from a decline of -0.3 percent to -0.1 percent) and a decline in the rate of population growth (0.2 percentage points) drove an overall improvement.

Why might per worker human capital arising from experience fall, and why might that fall slowly, as we see in Minnesota? Our measure of human capital per worker has it increasing up to and including the category “Total, 35 to 44 years”; after that, it declines in each category as workers become set in their ways and their experience becomes a negative factor. An increasing share of the workforce over 45 years old would lead to a lower average level of human capital arising from experience.

This is what we see in Minnesota. From 1999 to 2018, the share of Minnesota’s workforce aged 45 or older rose by 10.6 percentage points, from 34.8 percent to 45.4 percent, and human capital arising from experience per worker fell by 5.8 percent as a result. Since 2018, however, the share of Minnesota’s workforce aged 45 or older fell to 41.7 percent and human capital arising from experience per worker rose by 0.9 percent. Minnesota’s improved rate of change for human capital arising from experience is a result of its workforce getting younger, on average, since 2018, thanks to increases in the employment ratios of age groups under 55 and declines in those above. Other states did better, however, and Minnesota’s ranking on this measure fell from 4th out of 50 states in 2008-2014 to 45th in 2014-2023.

Employment

An improvement in the rate of change of the share of the population employed accounted for another 0.2 percentage points; an average annual decline of -0.1 percent in 2008-2014 became growth of 0.1 percent in 2014-2023.

But even as this rate improved, its ranking sank, from 2nd out of 50 states in 2008-2014 to 43rd in 2014-2023. This may be largely because Minnesota already has one of the highest employment ratios in the United States. Its average ratio across the years 2008 to 2014 — 51.7 percent — ranked 7th out of 50 states and across the years 2015 to 2023, its ratio — 52.3 percent — ranked 3rd. Given its relatively high employment ratio, there is less potential for Minnesota to generate faster per capita GDP growth by increasing it than in most other states, so a relatively low growth ranking is unsurprising as other states catch up.

This is not to say that there is no scope at all, however. As a share of the civilian non-institutional population, Minnesota’s employment ratio peaked at 72.9 percent in 1998 but had fallen by 6.5 percentage points to 66.4 percent in 2023. While this is often attributed to the aging of the workforce, the steepest falls in employment ratios among age groups since 2000 are found among those aged 16-19 and 20-24, down 5.3 and 6.0 percentage points respectively. If the employment ratios among these younger groups could be raised back to their levels of 2000, 37,000 more young Minnesotans would be employed, and per capita GDP would be higher.

Education

An increase in the growth rate of the average worker’s human capital arising from education accounted for another 0.1 percentage point; the average annual growth rate rose from 0.1 percent in 2008-2014 to 0.2 percent in 2014-2023. The stock of human capital arising from education per capita can change if total employment, the average stock per worker, or the population changes. From 2008-2014 to 2014-2023, there was no increase in the average annual growth rate of employment or in the average stock per worker, but a decline in the rate of population growth (0.2 percentage points, from 0.7 percent annually to 0.5 percent) drove an overall improvement, as it is a negative sign in the equation.

Again, even as this rate improved, its ranking sank, from 3rd out of 50 states in 2008-2014 to 42nd in 2014-2023. This might be because this source of growth is tapped out. In 2023, for example, 72.8 percent of Minnesota’s workforce was educated beyond a regular high school diploma, GED, or alternative credential, the second highest share in the United States. It might not be possible to increase this much further. The key question is whether the 20.7 percent of Minnesota’s 2023 workforce that had a regular high school diploma, GED, or alternative credentials are more skilled than the 22.2 percent of the state’s 2014 workforce who were similarly educated.

Physical capital

The (unweighted) average per capita growth rate for physical capital in Minnesota rose from 1.0 percent annually in 2008-2014 to 1.3 percent in 2014-2023. What accounts for this?

As our measure of human capital has four components, growth in our measure of physical capital can be broken down between the 19 North American Industry Classification System (NAICS) two-digit industries.

Growth in the per capita physical capital stock in the Real Estate and Rental and Leasing sector was $314 from 2008 to 2014 and $12,707 between 2014 and 2023. While it accounted for three percent of total growth in Minnesota’s per capita physical capital stock in the former period, this rose to 58.7 percent in the latter. The increase in the mean rate of growth in this sector — by 1.8 percentage points from 2008-2014 to 2014-2023 — is not the largest, but this sector accounts for the greatest share, by far, of Minnesota’s physical capital stock: 44.1 percent in 2008 and 41.7 percent in 2014. This is not unusual. From 2008 to 2023, this sector accounted for an average of 43.4 percent of the total physical capital stock of the United States. This increased growth rate in such a major sector was the primary driver of the increased overall growth rate in Minnesota’s per capita stock of physical capital between the two periods 2008-2014 and 2014-2023.

But the ranking of Minnesota’s per capita physical capital growth fell from 24th out of 50 states in 2008-2014 to 37th in 2014-2023. What accounts for this?

The ranking of the growth rate in Minnesota’s per capita stock of physical capital fell in 12 of the 19 NAICS industries between the periods 2008-2014 and 2014-2023, including Manufacturing, Information, Health Care and Social Assistance, Utilities, and Finance and Insurance — which, between them, accounted for the 2nd, 3rd, 4th, 5th, and 6th largest average shares of the state’s total capital stock between 2008 and 2023. In seven of these industries, their growth rankings fell while their rate of growth accelerated; per capita growth rates of physical capital improved in Minnesota, but not by as much as in other states. In four industries, both the ranking and the rate of growth declined. One of these was Manufacturing, in which the average annual rate of growth of per capita physical capital fell by 2.7 percentage points, from growth of 2.5 percent in 2008-2014 to a decline of -0.2 percent in 2014-2023. Manufacturing accounts for the second largest share of Minnesota’s total physical capital stock, an average of 13.7 percent in 2008-2023. To understand how important the decline in the growth of physical capital per capita in this sector is, we multiply the percentage point change in each industry’s growth rates by their average share of Minnesota’s total capital physical capital stock. For Manufacturing, this “index” is -0.4, the largest in magnitude after Real Estate and Rental and Leasing and the main drag on the state’s rate of per capita physical capital growth between the two periods.

Our method of calculating the physical capital stocks in each state uses the GDP of each industry in each state as a share of the GDP of the industry for the United States as a whole to apportion the overall physical capital stock of the United States in each industry to each industry in each state. It follows that a decline in Minnesota’s per capita physical capital stock in the Manufacturing sector could come from either a decline in the per capita physical capital stock in that sector for the United States generally, or a decline in Minnesota’s share of national output in that sector.

The decline in Minnesota’s per capita physical capital stock in the Manufacturing sector was not the result of a decline at the national level. The national growth rate of the per capita physical capital stock in Manufacturing was largely unchanged between the two periods 2008-2014 and 2014-2023 — 1.5 percent and 1.6 percent respectively — but in Minnesota, it slumped from a rate of 2.5 percent annual growth in 2008-2014 to an annual rate of decline of -0.2 percent in 2014-2023.

This must mean that the per capita decline in Minnesota’s stock of physical capital in the Manufacturing sector in 2014-2023 was driven by a decline in the state’s share of the national output in that industry. Indeed, the state’s share of national Manufacturing GDP reached a post-1998 peak of 2.3 percent in 2014 but has since dropped to 2.0 percent in 2023. Neither was it the case that Minnesota’s share fell because of faster growth in the nation’s Manufacturing output; while Manufacturing output per capita for the United States increased by 4.7 percent from 2014 to 2023, in Minnesota, it declined by 6.5 percent.

Conclusion

Some sources of per capita GDP growth are subject to certain limits: the employment ratio and hours worked, for example, cannot exceed 100 percent or 24 per day. The same goes for education. No more than 100 percent of people can have college degrees. With its high rankings on these measures, Minnesota probably cannot draw much faster GDP per capita growth from them.

This shifts the focus to physical capital and TFP, entrepreneurship, and innovation. This is the approach Minnesota must take for faster per capita growth, yet for physical capital, our growth accounting finds that we are falling behind other states, and for TFP, we are declining. This is where Minnesota’s policymakers must look if we are to see per capita incomes rising up the ranks again.