Supply-Based Regional Growth Analysis

1. Supply-Based Regional Growth Analysis Chapter 8 1

2. Solow (1956) Swan (1956) • Y = f(K, L, ) • Y, K, and L are the levels of output, capital, and labor • K and L are equally productive everywhere • Constant returns to scale • Level of technical progress, , is available everywhere • Rate of return to capital=interest rate • MPL = wage in the perfectly competitive market 2

3. Solow (1956) Swan (1956) • Growth occurs • When amount of resources increase • Technology shifts the production function upward • Spatial misallocation of resources is corrected (spatial mismatch) • “Technology” is measured as the residual after explaining growth due to other production factors. (between 1929 and 1982: > 33%) 3

4. Production function 4

5. Neoclassical wage equilibration via capital migration 5

6. Neoclassical wage equilibration via labor migration 6

7. Catch-up • Low-wage regions would see a faster increase in growth rates and wage rates than higher-wage areas. • Free trade and migration should induce low-income regions to catch up and converge with high-income areas. • Restricted trade and migration should result in diverging economies. 7

8. Convergence: a reality? • Few empirical studies have established a convergence process. • Santa Clara County, California, average annual wage per job was $69,288 (2004) • Garfield Co., (eastern Montana) lower land prices and an average wage $17,012 (2004) 8

9. Convergence: a reality? • In neoclassical growth theory, differences in per capita income and growth rates across regions cannot persist without market interference • If it works for countries: what about states? Counties? Cities? Census tracts? Households? 9

10. Solow Residual • Amount of growth that is not explained by the quantity of inputs (the residual of the regression equation) is a measure of technological innovation. • Knowledge and ideas are never generated. They show up instantly everywhere like manna from heaven. 10

11. Solow Residual • No learning curve needed, but … • Workers can neither modify nor recreate the existing technology • Agglomeration economies, technological spillovers, or entrepreneurial ability have no role in growth. 11

12. Role of Government • Neoclassical theory often masks a moral requirement that low-income areas should grow faster. • Taxes should be levied on the developed regions and used to assist growth in low-income areas. • But, taxes reduce employment in developed regions. • Spending crowds out private sector. 12

13. Endogenous Growth theory • Romer’s (1986): Output = f(Capital, Labor, and Knowledge). • Modifies Solow/Swan growth model. • Diminishing marginal productivities for capital and labor; but the marginal product of knowledge is increasing. • Once we have a certain stock of knowledge, doubling inputs devoted to research does not double the amount of new knowledge. 13

14. Endogenous Growth theory • But: • There is no automatic equilibrating mechanism that requires low-income areas to grow faster than developed areas. • Convergence is not necessary. • Growth in some regions can be slower than in others or even stagnant. • Growth is a function of: externalities, increasing (or constant) returns to scale, decreasing returns to producing new knowledge. 14

15. Endogenous Growth theory • Input and output markets are not necessarily perfectly competitive. • Most endogenous growth models assume some form of production based on: • Technology and innovation, • Unskilled and skilled labor, • Physical capital • Infrastructure and public services. 15

16. Technology and innovation • Labor can flow from unskilled to skilled markets, with a time lag. • Investments in human capital mean constant learning. • Physical capital incorporates the latest technology. 16

17. Infrastructure • Physical infrastructure • Provision and maintenance of utilities, roads, highways, bridges, mail, telecommunications. • Social infrastructure • Existence and respect for property rights as well as nonobstructive bureaucracies. 17

18. Government • Provide and maintain infrastructure • Enforce property rights. 18

19. Technology • The saving force. How? • Deskilling of jobs (process innovations ) • Requires higher skills (product innovations ) • Employment could (simultaneously) increase, decrease, or remain stable if firms adapt newest technology 19

20. Innovation • Using knowledge to invent and introduce a new product, process, or service into the marketplace. • Classification: • the ratio of its spending on research and development to its total sales, or • the industry’s ratio of research and development employment to total employment. • Firms that innovate grow faster • innovations cause more rapid growth or • the faster-growing firms have a greater ability to innovate 20

21. Knowledge, Innovation, and Technological Progress • The more that is known, the easier it is to invent and discover even more. • engineering and chemistry • Highly innovative regions increase the technological gap. • Imitation and diffusion reduce technology gaps 21

22. Public goods • Nonrivalry: several people can use the same good simultaneously. Nonexcludability: it is difficult to prohibit people from using the good. • Romer (1996): Technology is a set of ideas combined with “physical things” and used in production. • An idea (knowledge) is a nonrival good, but the physical things are rival goods. 22

23. Dual continuum showing Pure Private and Pure public goods 23

24. A Firm’s Investment in Private R&D • Expected rate of return on research and development • Has to be at least equal to the expected rate of return of another project 24

25. How Does Knowledge Spill Over • Knowledge is exchanged among people in the same industry (localization economies), or • Among industries in geographic proximity (urbanization economies). • By sharing inputs, backward linkages facilitate innovation in decreasing the cost of using new ideas. 25

26. Geographic concentration? • Perroux (1950) no. Input suppliers need not even be on the same continent to be influential: hard to create policy • Boudeville (1966) spatial proximity and agglomeration economies are fundamental for innovation. • But innovators, research institutions, and a highly trained workforce must all interact to maintain a viable, dependable network. 26

27. Collaboration • Innovative milieu,industrial district, technopole, science park • Goal: Recreate Silicon Valley. • Milieu: industrial culture that promotes collective learning • Knowledge must be acquired, maintained, and reproduced. • “Creative forgetting” allows technical change to progress. 27

28. Human Capital and Technical Change • Improvements in productivity come from • Advances in physical technology integrated in newer capital, • Increases in the stock of knowledge bridge building, and • Incorporation of human capital in individual workers. • Brooklyn Bridge took 14 years (1869-1883) • Verrazano-Narrows Bridge: 5 years (1959-1964) 28

29. Brooklyn Bridge 29

30. Verrazano–Narrows Bridge 30

31. Human Capital • Theodore Schultz (1963) • Health care, *education, job search time, job search costs (newspapers, agencies, moving), on–the–job training (learning -by-doing), job tenure. 31

32. Measures of Formal Education • Enrollment rates proportion of school age children enrolled in school at the beginning of the academic year. • Should predict the future stock of human capital. • Does not account for students who leave or choose not to work after graduation. 32

33. Measures of Formal Education • Literacy rate represents a basic level of human capital acquired by individuals at a point in time. • How to effectively test? • For the US, in 18% of the households English is not the primary language • Proficiency in the primary language of a region increases productivity and potential earnings (statistically significant). 33

34. Measures of Formal Education • Average educational attainment • Assumes workers with the same level of education possess the same skills. (All Master’s degrees create the same skills.) • Murphy, Shleifer, and Vishny (1991): A 10% increase in the average educational attainment leads to an average 8% increase in a state’s aggregate output. 34

35. Rates of Return to an Investment in Education • 80% for elementary school in low-income countries to - 3% for some grad degrees • Quality preschool: 7% and 16%. • Bachelor’s degree at 8% • Graduate degree 7% to 12% (average) • Society’s RoR: individuals do not consider the positive externalities  they underinvest 35

36. Education • Learn cognitive skills. • Self-reliance and dynamism • More patient toward bureaucracies • Comply more with organizational rules, Easier to train. • Employers use to screen workers. Signals ability, achievement, motivation, and ethnic/social origin. 36

37. Social capital • Network of informal social relations, family and community connections, common values, and respect for norms • Encourages information spillovers • Becomes an informal safety net 37

38. Social capital • Includes all elements necessary to determine how the community shapes its own destiny • How to adapt to a climate and a community, • The workings of local networks • The identification of the true decision maker • Social capital produces positive and negative effects on a community. • Reciprocity is expected. The more “social debts” a person holds, the more social capital is available. (influence) • “Old-boy networks,” intolerance against “outsiders” limit knowledge dissemination. 38

39. Social Mindset and Growth • Easterlin (1981) (Economic historian) • Colonialism, absolute monarchy, the Roman Catholic Church, and Islamic fundamentalism deter mass schooling and the free circulation of ideas. • Protestantism and Humanism scientific progress, pure reason, and the conviction that humanity is master of its own destiny positively influence economic growth. 39

40. Social mindset • Incomes in poorer regions cannot converge if they lack human capital, and if they are resigned that this is their fate. • More productive individuals need to work with other high-skilled workers. • An insufficient market for skilled labor creates a brain drain. 40

41. Role of Capital • Tangible, physical capital • Increasing “plant” means expanding existing firms or attracting new ones. • Attracting new firms implies technological investment— • New capital embodies new technology (Arrow’s (1962) vintage model of capital) 41

42. Types of depreciation • Physical depreciation, (wear and tear). • Obsolescence. • Reduced demand for outmoded product. 42

43. Theory of creative destruction • Schumpeter’s (1962) • Innovating entrepreneurs lead the most important firms. • Competitive, dynamic environment, relentless innovation, they continuously create disequilibrium. 43

44. Theory of creative destruction • New technologies are superimposed on the top of past technology, and combined with the most avant-garde technologies. • Future technologies threaten economic profits (rents) created by current research. 44

45. Theory of creative destruction • The temptation to curtail future research to protect a process of production creates a no-growth trap. • No research, no innovations. • Economy stagnates. • Entrepreneurs decide what innovations to adapt 45

46. Firm Births • Urbanization and localization economies • Presence of small, specialized firms • Persistently high unemployment rates (unemployment desperation.) (high probability these won’t survive) 46

47. Innovation and firm size • Old mass-production “Fordist” firms (rust belt) less likely to innovate • Internal labor markets—few new ideas • Innovating employees leave or succumb to corporate mindset • Out-dated plant and equipment • Original location may no longer be cost minimizing • Unions set a regional minimum wage so that start-ups cannot successfully bid for workers. 47

48. Innovation and firm size • The existence of many small manufacturing firms means the social structure fosters an entrepreneurial spirit and facilitates start-ups • Small businesses outperform large ones in industries dominated by technical change 48

49. Foreign Direct Investment • “Foreign” means ownership by investors based outside the country or anyone from outside a locality owning local capital • Two ways it takes place: • Parent firm builds an entirely new branch in the area (Greenfield investment), or • Parent firm acquires existing facilities. 49

50. Foreign Direct Investment • Two theories • Internalization theory, a parent firm invests in foreign assets instead of assets in its own region when the host region offers an advantage not available in the home region. (Greenfield investments) • Network theory, a parent firm tries to acquire complementary assets by expanding their networks. (Purchase existing plant) 50