Kentucky’s Economy: Structural Problems and Solutions

Former Presidential advisor Herb Stein once said, “Unsustainable trends tend to come to [an] end”. In other words, ignoring reality doesn’t change reality. That’s why it is important to use this economic recession to ask the “big” questions. What structural problems exist in Kentucky’s economy that impede economic growth? What can be done to fix said structural problems?

The Pew Center on the States recently published a report entitled “Beyond California” in which they rank each state’s economic situation based both on the depth of its current recession and the long term structural issues of each state’s public finances. According to these rankings, Kentucky finished 11th worst among states. Kentucky’s poor score largely reflects Kentucky’s unwillingness to address long term structural problems with its state budget. These structural problems include high levels of debt, massive unfunded liability in its state pension systems, high levels of taxes and spending, misdirected government spending, and a burdensome regulatory system. Left unchecked, these factors will drag down Kentucky’s economic recovery and negatively impact both current residents and future generations.

In 2009, state government spending accounted for 23.3% of Kentucky’s gross state product, making Kentucky the ninth highest government spending state, relative to income, in the country. The Commonwealth needs to determine what the goals of its government spending are. Is the goal to build roads and provide education, or is it to redistribute income? Investing in human and physical infrastructure can grow the state economy. Redistributing income still spends money, but doesn’t provide growth and can actually limit it. Kentucky ranks 8th highest amongst states in welfare spending as a percentage of gross state product.

When you compare state vs. local spending, Kentucky’s spending is one of the most concentrated of any state in the union. The primary reason for concentration at the state level is to enable income redistributions from the wealthier parts of Kentucky to the poorer areas. As spending decisions are best made by people who benefit from the spending, Kentucky would benefit from shifting much of its spending from the state level to the local level.

Kentucky could also lower spending at the state and local levels and stimulate growth by eliminating existing prevailing wage laws. Such action would allow the state to not only increase infrastructure, but to do so at a lower price. The resulting money saved could then be used to pay down existing state debt.

The state should also examine its spending on its health and pension plans for state workers. At last count, the state had $26 billion of unfunded liabilities in its pension system. As of 2007, Kentucky’s pension system was at 70.3% of funded liability, or 11th worst among states according to Standard and Poors. Liability is most easily managed in a defined contribution plan. Going forward, the state could benefit from moving employees to defined contribution plans rather than defined benefit retirement plans.

As unfunded liability has risen, so too has spending on state employee health care. A recent study by the Kentucky Chamber of Commerce noted that spending on employee health care has risen by over 174% since 2000 – a rate five times faster than economic growth during this period. That is an unsustainable trend. Economic reality dictates that health care costs for state employees and retires need to be shared with said employees and retirees.

In terms of the Pacific Research Center’s ranking of each state’s level of economic freedom, the state of Kentucky ranks only 40th. One of the largest factors restricting economic freedom in Kentucky is their refusal to enact right-to-work legislation. Government policies that require certificates of need or closed shop laws that inhibit peoples’ right to work reduce economic freedom and make it difficult to attract new industries to the state. Right-to-work states have grown faster in the last decade than closed shop states.

The state should also look at how other states have improved educational outcomes. For example, numerous studies have demonstrated the effectiveness of charter schools in improving educational performance both for those students who attend charter schools and for those students who stay behind in their own public schools. Kentucky is one of only a few states that don’t allow charter schools.

In order for economic recovery to occur in Kentucky, the state needs to find ways to spend less, get more for the money they do spend, free the state from burdensome regulations that limit wealth creation, and pay down state debt; all without increasing the tax burden on Kentucky businesses and citizens. At 9.4%, the Kentucky state tax burden is already in the highest half of states as measured by total tax burden. Although the needed changes would not be easy, they are necessary for Kentucky’s economy to grow to its fullest potential.

What lies ahead for Kentucky’s economic future? Only time will tell, but we would be foolish to continue on our current path and yet expect different results. Unless Kentucky state politicians enact meaningful economic reforms, we can expect that Kentucky, which already ranks 42nd in per capita gross state product, will only fall further behind.

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