But over the past two years, the Tar Heel state has lost its luster. Its unemployment rate, consistently well below the national average, is now one of the nation's highest, at 6.3%. Plant shutdowns are proliferating. The state's triple-A bond rating, long trumpeted by governors as a symbol of a rock-solid state, was downgraded in August by Moody's Investors Service.

What went wrong? For starters, the state's industrial base was hit with a one-two punch. First, the recession hit North Carolina harder than many other states due to its heavy reliance on manufacturing, which boomed during the economic expansion then crashed during the past two years, hammering a host of telecommunications and information-technology producers that had flocked to the state. Manufacturers were also slammed by a wave of imports that flooded into the U.S. market, causing more damage to the state's already weakening textile and furniture industries. In other words, the recession both accelerated North Carolina's Old Economy layoffs and ultimately creamed its two principal New Economy replacements.

Most noteworthy, though, North Carolina got nailed in part because it was caught doing exactly the right things for the long-term health of its economy: boosting K-12 education, a weak link in its schools, while moving from lower-skill to higher-skill industries. To be sure, it's that ironic twist that gives the state its best hope for recovery.

For other states, North Carolina's stumble is a sobering lesson in how quickly seemingly strong state economies can sour, particularly when they're in the midst of a transition. "As an economic structure is shifting, you're exposed to events you've not been exposed to in the past," says Ross DeVol, director of regional and demographic studies at think tank Milken Institute in Santa Monica, Calif. "You can get blindsided."

Few people know this better than North Carolina Gov. Mike Easley. By Gov. Easley's eighth day in office in January 2001, he was forced to declare a fiscal emergency, freezing state spending and withholding money due local governments, to cope with a growing budget shortfall that ultimately topped $1.5 billion, more than 10% of the state budget.

WHEN IT WAS FLUSH with cash thanks to soaring tax revenue from capital-gains and other sources in the late '90s, the state spent freely on popular initiatives such as early-childhood education and teacher-pay raises. The efforts paid off with higher test scores and reduced teacher turnover. But the spending also helped to break the state budget because rather than paying for new programs with new revenue, legislators counted on continued inflated tax revenue. Like their counterparts in many states, they then compounded the problem by lowering taxes -- by a total of $1.5 billion.

The area around Hickory, N.C., was caught in the eye of what local economic-development chief Scott Millar calls "the perfect storm." Three fiber-optic and coaxial cable makers, which expanded rapidly in the late '90s and diversified the area's industrial mix of furniture and textile firms, have laid off about 3,000 of 8,000 workers since early 2001 amid a world-wide fiber-optic glut, worsening rather than buffering the recession's pain for Hickory. In less than two years, the area's jobless rate surged to 9.4% from 1.5% -- rivaling California's Silicon Valley as the region with the sharpest rise in the nation. "North Carolina proved to be less diversified than it thought," says Robert Kurtter, an analyst at Moody's.

STATE LEADERS ADMIT they were shocked by the suddenness of the decline, but vigorously defend their strategy. "I don't know exactly how long it will take, but we will come back because North Carolina made very wise investments," says former Gov. Jim Hunt, who championed the education spending and industry diversification in the '90s.

North Carolina's new strategy is a variation on the old. "My mantra is no cuts in education," says Gov. Easley. With laid-off workers swelling enrollment by 10% for the year ended June 30, the community-college system is one of the few agencies not to have its budget slashed. The state also has a different key-industry target: the still-growing biotechnology sector. An $85 million fund that includes money for venture capital and training to assist biotech firms was announced in August by a foundation created by the state to help counties hurt by the declining tobacco industry.

Can North Carolina return to its pre-eminence? Most observers think so, provided its leaders don't stray from long-term investments in education and stay alert for more economic curve balls. "It's easy to get discouraged after we sailed through two previous recessions as if they didn't exist," says Lanty Smith, a Greensboro, N.C., investment and merchant banker who in the 1980s was president of Burlington Industries Inc., a onetime textile giant now in bankruptcy proceedings. "We've got some work to do, but I like our prospects better than most of the rest of the country."