What do we know about the causes of regional growth? Part 2

1. What do we know about the causes of regional growth?Part 2 ECON 4480 State and Local Economies

2. Neoclassical Theory • Case 2: growth with technical change • Now we introduce technical change, adding more realism. • To simplify, regard technical change as a separate element; this technical progress is a given, determined outside the model. Call technical progress A. • Now the growth equation is: • Y = f( A, K, L). • Now, growth in productivity depends not only on capital deepening but also technical change.

3. Technical change Productivity (Y/L) Y/L = f(A2,K/L) Y/L = f(A1,K/L) Y/L2 Y/L1 • Productivity rises for a given K/L because of technical progress. • Even if both capital and labor do not grow, productivity can grow if there is technical progress. K/L Capital per worker (K/L)

4. Reasons for Growth • We now have three reasons why growth rates can vary among regions: • Technical progress may differ between regions. • The growth of capital stock may vary between regions. • The growth of the labor force may vary between regions.

5. Endogenous Technical Progress • Further advances in neoclassical growth theory sought to explain the determinants of technical progress instead of simply assuming it is given. • Bringing technical progress into the model means we are making it endogenous instead of exogenous. • Technical progress can be thought to depend on: • The number of workers involved in the knowledge production industry, and • The existing stock of knowledge.

6. Neoclassical Model Output growth Growth of capital stock Technical progress Growth of labor force Natural population growth Net inmigration of workers Labor in knowledge production Stock of knowledge Local capital spending by residents Capital inflow Birth and death rate Wage rate relative to other regions Rate of return relative to other regions

7. Endogenous Technical Progress Workers in the knowledge production industry Higher education and private-sector research and entrepreneurship Technical progress Feedback of technical progress to the stock of knowledge Stock of Knowledge

8. Endogenous Technical Progress • Education and entrepreneurship are thought to be the primary sources of innovation, new techniques, and new ideas. • Technical progress grows as long as labor supply for the knowledge industry grows. • The faster the supply of labor in the knowledge industry grows, the faster technical progress grows, and the faster output per worker can grow.

9. Technology catch-up • New ideas and technology (ways of doing things) travels rapidly across regions. • Regions that have a long way to catch up technologically will experience a larger boost in technical progress than will regions that are already advanced. • Regions with low technical progress will benefit from catch up as long as the proper incentives and institutions are in place.

10. Extending the neoclassical growth model • Recent research also recognizes the role of human capital as pertains to technical progress. • Human capital refers to the level of education, training, skill, and experience of our workforce. • Human capital is important in two ways: • The stock of human capital determines a region’s ability to absorb and use new technology. As technology is widely shared, a region with a highly skilled workforce is more able to benefit from the technology. • The stock of human capital is also very important for a region’s ability to generate technical progress on its own.

11. Extending the neoclassical growth model • But investing more resources in human capital or physical capital is not enough to generate and sustain technical progress. • A region must also possess the appropriate institutional environment for technical progress: • Collective learning process in which many persons interact and exchange ideas and information • In such environments, knowledge moves quickly, generating many more new ideas. • More new ideas lead to more technical progress, additional labor productivity, and a higher standard of living.

12. Technical Progress and the Institutional Environment Institutional environment Workers in the knowledge production industry Higher education and private-sector research and entrepreneurship Technical progress Feedback of technical progress to the stock of knowledge Stock of Knowledge

13. Extending the neoclassical growth model • The most effective institutional environments are those that bring together large numbers of highly educated people. This is an example of agglomeration. • Consequently, regional differences in technical progress can occur because the institutional environment differs among regions. • Adding highly educated people to a region creates substantial benefits. Rauch (1993) estimates that an extra year of education raises labor productivity for a region by 3 percent.

14. Extending the neoclassical growth model • Emphasis on human capital has led economists to think about technical progress occurring in two ways: • Embodied technical progress: technology that is an integral part of new capital goods; regions can generate technical progress by purchasing technology embodied in capital goods. • Disembodied technical progress: independent of capital stock; produced in knowledge-rich, highly creative environments; occurs in research and development and high-level service activities (such as medical). Regions that can do this can generate their own technical progress.

15. Extending the neoclassical growth model • These extensions of the neoclassical model allow us to explain why regional growth differences persist in the long run: • The primary reason for regional growth differences is that some regions are more able to generate their own technical progress.

16. Extending the neoclassical growth model • Knowledge-rich regions that have a conducive institutional environment will create their own technical change (disembodied technology), giving them a large advantage. • Less well endowed regions (with knowledge) will focus more on obtaining technology by purchasing from other regions (embodied technology).

17. Conclusions • Economists have long investigated the causes of regional productivity growth and growth of economic welfare. • Explaining regional differences in the growth of per capita income is of particular interest to policymakers. • The neoclassical growth model, focusing on supply-side factors, is one approach.

18. Conclusions • The original neoclassical growth model offers some important insights into the reasons for regional variations, but the model has serious weaknesses. • Mobility of capital and labor is assumed by the model. While capital is mobile, labor is not. • Evidence of the model’s prediction of convergence among regions is weak at best.

19. Conclusions • An important strength of the neoclassical model is the attention given to technical progress. • Extensions to the neoclassical model bring technical progress into the model. • Technical progress is thought to depend on the level of human capital, entrepreneurship, and institutional environment.

20. Conclusions • Regions that are able to generate their own technical progress (i.e., produce disembodied technology) will achieve more growth in the long-run than regions that acquire technology from other regions (embodied technology).