Practical analysis for investment professionals
13 March 2018

Red States, Blue States: Two Economies, One Nation

As economists and investors, we treat the United States as one country and one economy and the eurozone as a conglomerate of many countries with a common currency.

There are good reasons for this: The United States is not just a currency union and a single market but also a fiscal union with a uniform legal system.

But the differences among the various US states can be striking. Some time ago, I spoke with a friend about the gulf in living standards between prosperous areas in California or on the East Coast and much poorer sections in the Deep South. Since we had had too much beer, we decided to calculate the gaps in living standards among the various states and correlate them with the results of the presidential election of 2016.

After all, according to the media narrative, it was the forgotten men and women in the Rust Belt and the Midwest who swung the balance in the 2016 presidential election.

The American Human Development Index (AHDI) allows for a state-by-state assessment of critical factors like income, education, and health. When we calculated the average AHDI for the red states — those won by Donald Trump — it was much lower than the average AHDI for blue states. In fact, by way of international comparisons, the blue states won by Hillary Clinton have a human development index similar to the Netherlands, while the red states have an AHDI that resembles Russia’s.

Now, before you start writing hate mail or troll me on Twitter, know that I am not making a value judgment here. Red states are neither inferior nor superior to blue states. Both have their very own idiosyncratic challenges.

Red and blue states are very different — economically speaking.

This is where a recent study by David C. Parsley and Helen Popper comes in. The duo investigated the differences between red and blue states much more thoroughly than my friend and I did over a couple of beers.

So what did they find?

Red and blue states vary so much in their economic trajectories that they may as well be two distinct countries within the United States.

First, blue states have enjoyed higher economic growth rates on average than red states since the Great Recession. Since the mid-2000s, the business cycle of blue states has increasingly diverged from that of their red counterparts.

The average disparity in GDP growth between red states and blue states has hovered around 3.5% since the recession ended. For comparison, a previous study of 20 developed nations found an average GDP convergence among them of only 1.75%.

Differences in GDP growth also lead to differences in household income and household consumption — i.e., in living standards. Luckily, there are several transfer mechanisms that mitigate these gaps in GDP growth so that consumption shortfalls in red states amount to only about one-fifth of the growth deficits.

But Parsley and Popper found that red states and blue states smooth these consumption variations in very different ways.

Capital markets are the great leveler.

Capital markets are the most important tool to mitigate consumption gaps from one year to the next and from one state to another. Capital markets ease about 43% of idiosyncratic state risks. In a sense, capital markets render an important service often overlooked in the public debate: They reduce income inequality among the states.

But once capital markets are accounted for, further crucial differences emerge. The second most critical tool to smooth consumption in red states is fiscal transfers. Blue states, on the whole, contribute more tax revenue to federal coffers than they receive in return. So in aggregate, the federal government transfers wealth from the blue states to the red states.

Blue staters, on the other hand, ease the consumption gap by saving more and purchasing durable goods. Of course, poorer households often cannot save and thus must rely on fiscal transfers, so this red state-blue state gap might just be the result of wealth disparities between the two cohorts.

Whatever the cause, the study demonstrates that the current polarization in US politics is misguided and counterproductive. Economically speaking, the red states benefit from the blue states through government redistribution and transfers of capital from blue state savers to red state investments via capital markets.

Blue states benefit from red states, on the other hand, which fuel their higher growth and higher income with attractive investment opportunities as well as cheaper labor and lower prices.

The current political polarization is undermining not only the sense of unity among the American people, but also the future economic growth of the country as a whole.

For more from Joachim Klement, CFA, don’t miss Risk Profiling and Tolerance: Insights for the Private Wealth Manager, published by the CFA Institute Research Foundation.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/filo

About the Author(s)
Joachim Klement, CFA

Joachim Klement, CFA, is Head of Investment Research at Fidante Capital and a trustee of the CFA Institute Research Foundation. Previously, he was CIO at Wellershoff & Partners Ltd., and before that, head of the UBS Wealth Management Strategic Research team and head of equity strategy for UBS Wealth Management. Klement studied mathematics and physics at the Swiss Federal Institute of Technology (ETH), Zurich, Switzerland and Madrid, Spain, and graduated with a master’s degree in mathematics. In addition, he holds a master’s degree in economics and finance.

13 thoughts on “Red States, Blue States: Two Economies, One Nation”

  1. Chuck T says:

    Illinois must be an anomaly. My pitiful state had a real GDP CAGR of .5 from 2006-2016 compared to the nations real GDP CAGR of 1.2. I find it ironic that a lot of my friends are trying to leave here and relocate to a red state, like AZ, TN, and TX. Times they are a changin.

  2. Timothy Carne says:

    An additional reason for the disparity which was not referenced in this article is the dramatically large percentage of government expenditures that are spent within 25 miles of Washington DC. Maryland (my home) as well as Virginia reap huge economic benefits from this lucky geography. If the capital were Des Moines Iowa I hardly think Maryland or Virginia would be anywhere near the top of the GDP list.

    1. Joachim Klement says:

      Absolutely correct 🙂

  3. Joe Smit says:

    This article doesn’t address the fact there are Repub voters in blue states and vice versa. We have exit poll data showing how people voted by income and education levels, which are the only proxies we need to determine who’s contributing what.

    Nate Silver at 538 also noted Trump voters in the primaries made 20% more income than Hillary or Bernie voters.

  4. Robert Derse says:

    It would be interesting to see this data analyzed by smaller geographic areas such as census tracts or counties or zip codes. Perhaps the more meaningful comparisons are urban versus suburban versus rural.

  5. Omry says:

    I’m sorry..

    But I honestly think you are mistaken.

    1.growth is alk and well.

    But personally.. I think the disparity is more that Blue States had falled more in the recession than the Red States.

    Thus had more room to grow.

    And I doubt much taxes pas Californias State Government to reach anyone else.

  6. Laura warren says:

    This assessment seems to really have missed the big picture by coming at things from the wrong angle. It seems to be that the most expensive states to live in are the blue states. The blue states have lower income but higher costs of living and it is clear that they are monitarily eliminating mediocraty, sick, disabled and the elderly. Because there is no way to live there on soctal services or retirement, or the average salary. Which is said to be around $75,000. But you’d be hard pressed to earn that salary, so I don’t know where you’d get that average from. Never the less, it doesn’t come close to being enough.

  7. Steve Rogers says:

    I must have missed the part on the benefits of Red States to the Blue ones. How exactly do they benefit us and can you quantify it?

    1. Jason Mitchell says:

      Steve Rogers I think he was saying that blue state investors create businesses in red states for cheaper labor and lower overhead which creates jobs for the red and income for the blue as well….. but I could be totally off because it wasn’t clear to me either

  8. Mark says:

    I wonder how well California would get along without Silicon Valley? I often hear the resident say these things but if we were to remove the one area that actually produces California would be a sinking ship.

    https://www.google.com/amp/s/techcrunch.com/2014/02/05/what-happens-to-california-if-silicon-valley-became-a-state-in-7-graphs/amp/

  9. TCM says:

    While your premise, “economically speaking, the red states benefit from the blue states through government redistribution and transfers of capital from blue state savers to red state investments via capital markets”, as derived from the study, may be true, your conclusion that the study manifestly “demonstrates that the current polarization in US politics is misguided and counterproductive” is a profound twist and extension of logic, a mangled bridge too far. You might as well have just written, “Let them eat brioche,” and been done with it.

  10. Robert Eggleston says:

    Home prices tend to much higher in blue states than in red states. The higher rent or mortgage payment basically uses up all of the extra income people make there. Consequently people move to the red states despite the lower average wages. Look at population growth rates. On average the red states are growing much faster.

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