This is the third and last part in my trilogy on private consumption (see part one and two). It explains how private-consumption data can be used to evaluate a state’s economy. We already know how we can relate private, disposable income and consumption, and thereby get an idea of how prosperous - or poor - a state is. We also know that the pattern of private consumption is relevant for the success or failure of certain types of tax reform.
The question in today’s piece is: what can changes in consumption patterns tell us about the direction of a state’s economy?
We will use Wyoming as an example, the reason being that the state has undergone a shift in its economy, from prosperous to perilous. This shift offers a good case study for the role that private consumption can play in “signaling” state economic trends.
Wyoming is the least populated state in the union, with less than 600,000 residents spread out over a square 450 miles long and 350 miles wide. There are no major urban areas; the largest city is Cheyenne of 60,000. The economy has, for the better part of a half century, been critically dependent on the extraction of natural resources. Coal has dominated the minerals industry, followed by oil, natural gas and a host of other natural resources.
The dependency on the minerals industry has grown over the years, especially for the state government. During years with high energy prices and strong global demand, the state of Wyoming raked in severance tax revenue to the tune of $1 billion per year. On top of that, large parts of the state’s sales and gross receipts taxes have been dependent on a thriving natural-resources industry.
With the global recession and subsequent decline in energy prices things changed dramatically for the Wyoming economy. In one year the state has lost almost one in six jobs in the minerals industry - well-paying jobs often paying more than twice the average earnings for non-minerals private-sector jobs.
With this in mind, let us look at consumption in Wyoming and its changes over an extended period of time.
To begin with, Wyoming has seen a decline in consumption out of personal disposable income. This is a sign of either of two things: consumers are getting much wealthier, or they are increasingly worried about the future and prefer to increase saving than to maintain a high level of consumption.
Which explanation is the likely one? The red function in Figure 1 shows the gradual decline in the percentage of consumption out of disposable income (measured along the left axis). The blue function (measured along the right axis) shows growth in per-capita personal income:
Clearly, starting somewhere around 2006 the growth rate in per-capita personal income weakened. It was still growing, but the declining growth rate shows that the decline in consumption out of disposable income can be explained by weakening income growth.
At least for the latter half of the time period illustrated here. What explains the decline in the earlier period is a different story.
When income growth weakens, comes to a stop or even turns negative, consumers grow increasingly cautious about the future. They reduce spending on luxury and comfort items and concentrate on outlays for essential items.
The effect of the downshift in disposable-income growth on private consumption is visible in the growth rates for consumption for the two time periods discussed here:
We can draw two conclusions from our observations of consumer spending. The first is that it will have repercussions for the economy in general, with business getting tighter across the economy. As it turned out, Wyoming did experience a deeper recession than any other state, with the worst GDP growth record of all 50 states in 2009-2011.
The second conclusion is based on a comparison of Wyoming consumption data to national data. The drop in consumer spending was sharper in Wyoming than in the country in general: U.S. consumer spending fell by about two thirds of the decline in Wyoming. This means that the drop in personal, disposable income was related at least in part to domestic factors.
We have already mentioned the drop in minerals activity, which coincided with the Great Recession. However, since we are discussing disposable income it is always advisable to look at tax policy. Figure 2 explains:
The solid dark blue function represents growth in per-capita disposable income. For every $100 of disposable income a Wyomingite had in 1998, he had $250 in 2012. The red dashed line represents the growth in total taxes, while the dashed light-blue and yellow functions represent, respectively, growth in state and local taxes.
Local taxes grew faster than disposable income, while state taxes grew more slowly. The balance between the two turned out in favor of the consumer for the earlier part of the period observed, but somewhere around 2006 the growth rate in total taxes picked up. It matched and then exceeded disposable-income growth.
Together with a general economic downturn, this shift in the growth rate of taxes helps explain why Wyomingites saw a shift for the worse in their disposable incomes after 2006. Again, we have a relationship between policy making and people’s income and spending, a relationship that is often ignored when state legislators consider whether to raise taxes or not.
The duo of variables, disposable income and private consumption, is a useful tool in measuring several aspects of a state’s economy. Most importantly, of course, is what it says about the prosperity of private citizens, but as explained here it can also inform a range of legislative decisions.
Sven R. Larson is an economist and Member of the Council of Scholars with Compact for America. He has a blog called America’s Fiscal Future and he recently published "Robbing the Millennials: How We Looted Our Kids' Future and the New Handshake We Owe Them"