The Process of Creating a State Economic Ranking is More Art Than Science, According to Kauffman Foundation Article

Much-touted entrepreneurship indexes are highly subjective and should not guide policy

(KANSAS CITY, Mo.) Sept. 11, 2013 – State economic rankings, though popular with think tanks, policymakers, media and even some academics, cannot be taken at face value, according to this article published online today by the Journal of Applied Research in Economic Development.

The article, titled "How Can I Create My Favorite State Ranking?" and written by Ewing Marion Kauffman Foundation researchers, points out that such rankings typically are subjective and provide little meaningful information, despite their pervasiveness.

"Often, these rankings are plagued by lack of clarity about what is being measured or whether the ranking accurately assesses what it claims to measure," said Kauffman senior scholar Yasuyuki Motoyama, Ph.D., who wrote the article with Jared Konczal, a senior analyst. "Further, the connection between these indexes and actual economic growth and performance at the state level is ambiguous, at best."

For example, the Small Business and Entrepreneurship Council's Small Business Survival Index – one of more than a dozen state rankings touted across the country – is based on factors such as taxes, health care costs, minimum wage level and the presence of right-to-work laws. However, this measures government costs without factoring in benefits generated by government, such as infrastructure and small business development centers.

The authors point out that Kauffman Foundation research has been used as the basis for ranking states, most notably on the rate of entrepreneurial activity, formalized in the Kauffman Index of Entrepreneurial Activity. This is an index based on data from the U.S. Census Bureau and Bureau of Labor Statistics, and it has never intended to be used to claim that one state or another is "better" for entrepreneurs.

Forthcoming Kauffman research, the article says, shows that many rankings fail even to correlate with company owners' business climate perceptions. Further, the proliferation of state rankings can lead policymakers and economic development consultants to misuse them, either celebrating a conveniently positive ranking or initiating efforts to address a poor ranking, when neither action is based on valid economic indicators.

The authors conducted a series of exercises to demonstrate how such rankings can be manipulated. The exercises were based on eight state-level indicators related to innovation and entrepreneurship:

  • Self-employment rate
  • Kauffman Index of Entrepreneurial Activity
  • Business startup rate
  • Ratio of science and engineering bachelor degree holders to the total population
  • Patents per science and engineering workforce
  • Venture capital investment over Gross State Product
  • Research and development expenditures
  • Number of high-growth Inc. 500 firms  

The indicators were chosen because they typically are used to measure entrepreneurship and innovation, two vital indicators for every state's economic health. But after employing several analyses, the researchers found that most of the eight indicators were only modestly correlated, if at all.

To prove the point, the authors invite readers to create their own state rankings. Demonstrating that rankings can be developed in ways that favor any given state, the Kauffman researchers created a simulation analysis with randomly generated weights, which revealed that, among 1,000 different scenarios, five states were eligible to be No. 1, 16 were eligible for the Top Five and 22 could be ranked in the Top 10.

The subjectivity and limitations of state economic rankings led to four observations, according to the article:

  • Policymakers should not rely on a single indicator to gauge economic conditions.
  • Aggregating indicators does not provide solutions because indicators are highly variable.
  • Policymakers should not focus on improving their states' rankings because the rankings lack meaning.
  • Rather, they should employ a scorecard approach, which does not create a normative, quantified measure, but descriptively assesses various conditions of each state.    

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