Virginia, along with the rest of the country, is clawing its way out of a major recession that began in late 2007 following the bursting of the nationwide housing bubble.

Despite the looming prospect of a reduction in federal spending and many simmering problems around the world, the state's economy today is well situated for a healthier future, according to a report by University of Virginia economist Bill Shobe in the current issue of The Virginia News Letter, published by the Weldon Cooper Center for Public Service at the University of Virginia.

But achieving and maintaining Virginia's economic health will require thoughtful guidance by state policymakers, Shobe writes, because Virginia faces a federal spending cut that could be greater as a share of its total economy than in almost any other state.

Shobe warns, "It is now likely that both the military and nonmilitary components of federal spending will not just decelerate, but will fall in absolute terms." In his view, some combination of spending cuts and increased revenues will almost certainly be part of the national effort to bring future growth in the federal debt down to manageable levels.

The portion of economic activity in Virginia tied to federal spending has been growing for a long time, largely as a result of military-related spending, and has been accelerating in recent years, he writes. By 2010, the federal-spending portion of the state's economic activity rose to 32 percent, compared to an average of about 22 percent for the country as a whole.

Wages for federal civilian and military personnel and military procurement spending make up most of the big wedge between Virginia and the rest of the country, Shobe writes. While no one can predict the full extent or types of cuts, "the details aren't likely to be pretty from Virginia's point of view," he wrote.

Shobe's team at the Cooper Center modeled the economic effects of a sudden 30 percent drop in federal government employment in Virginia. Following a difficult period of adjustment, there is a silver lining; Labor becomes relatively more valuable to the economy, so as the adjustment unfolds, the workers who remain have a lower rate of unemployment and higher purchasing power than before the drop in federal jobs. Results like these reinforce the need for careful attention to how the economy adjusts to changes in public policy.

In recent decades, Virginia's economy has tended to perform better than the national economy, with lower spikes in unemployment during recessions and faster growth in income during expansions, writes Shobe, who is also a professor of public policy in the Frank Batten School of Leadership and Public Policy. During the recent recession, the national unemployment rate rose from 4.4 percent to 10 percent, but Virginia's unemployment rate peaked at 7.3 percent before starting to fall.

The housing market in Virginia has also fared better than for the nation as a whole. The rate of new construction fell to record lows here as elsewhere, but, for most of the state, housing prices did not experience as dramatic a rise during the boom as in other parts of the country. In fact, Northern Virginia has remained one of the healthier urban housing markets in the country, Shobe says.

Shobe advocates strengthening three "three core wealth-creating activities," broad areas for Virginia and other state governments to increase economic well-being and productivity.

The first is bolstering public education at all levels, not only to increase labor productivity, but also because it fosters leadership and civic engagement.

Second is promoting entrepreneurship, "the mysterious process through which creative individuals generate increased value by finding ways to provide better goods and services to people at a better price."

The third area Shobe says needs strengthening is "the efficient provision of public goods" – functions and infrastructure that are more efficiently provided by government rather than competitive markets. Among these are environmental quality, new basic scientific knowledge, enforcing property rights, and public safety.

"Government attention to education, entrepreneurship and the efficient provision of public goods will do considerably more for citizens of the state than any direct efforts to change the balance of trade with other states and with the world. The ultimate goal should be to make your human capital and your civic institutions so attractive that firms will be willing to pay a bonus to locate here rather than vice versa."

About The Virginia News Letter

The Virginia News Letter, issued six to eight times per year, is devoted to Virginia public policy issues. Authors are drawn from the Cooper Center, elsewhere at the University of Virginia, other public and private higher education institutions in Virginia, and non-academic experts in the state. Each issue features an article by a different author.