How States Grow: Old Vs New Economy

1. How States Grow:Old Vs New Economy Soji Adelaja, Yohannes Hailu, Mark Wyckoff and Eric Bailey Presented at the 2008 World Congress on National Accounts and Economic Performance Measures for Nations May 15, 2008 Washington, D.C.

2. Background • Depending on a country’s stage of economic development, the policies and institutional arrangements needed to bring about growth are now widely understood and increasingly being applied. • Globalization, emergence of the New Economy and resulting mobility of talent, venture capital and new innovative technology pose new challenges in understanding optimal growth strategies, particularly in the context of the domestic economy. • New growth levers are emerging, the impacts of which are not well understood. • While growth accounting included traditional growth determinants in explaining growth, New Economy advocates suggest a whole new set of factors (eg. talent, green infrastructure, venture capital, patient capital, cultural assets, and other quality of life amenities). • How we measure economic performance depends on whether we can capture the drivers of new growth.

3. What Drives Economic Growth?Theories of Economic Growth • Adam Smith – Nature and Causes of the Wealth of Nations • Division of labor and specialization. • Laissez-faire – minimal government interference. • Functional legal system. • Think about Russia. • David Ricardo – International Trade and Growth • The concept of diminishing returns • Growth based on international trade rooted in comparative advantage. • Think about India.

4. What Drives Economic Growth?Theories of Economic Growth • Neo-Classical Growth Models • These models emphasize the role of capital accumulation • Solow-Swan model – output is produced by capital and labor, where labor and capital productivity determines growth, given an exogenous technical progress (measured by Solow residual or TFP) • Model expanded by considering the role of technological progress and human capital in explaining differences in growth across countries and in accounting for growth. • Think about Mexico. • Endogenous Growth Models • These models relaxed some earlier assumptions about economic growth and endoenized technological progress in growth accounting • R&D (ideas) based endogeneous growth models identify innovation as the driver of long-term economic growth • For instance, Eaton and Kortum (1996) identified that more than 50% of productivity growth in OECD countries is due to innovations in the U.S., Germany and Japan. • Getting there.

5. What Drives Economic Growth?Theories of Economic Growth • Evolutionary Growth Theories: • Technological progress is a long-lasting adjustment process • Growth theory need to be conceptualized from broader firm capabilities than just human capital and R&D investments. • Institutional framework under which growth happens is important consideration. • Getting near. • Sources of Economic Growth – Other Ideas • Labor force expansion; Entrepreneurship. • Capital stock; Government policies. • Almost there. • Observation • Economic knowledge about growth was based on the concept of comparative advantage. • In an era of globalization where tangible new assets are mobile, and traditional assets are increasingly irrelevant, are these models relevant?

6. What Drives Economic Growth?Theories of Economic Growth • Implications to Growth Accounting • Determination of the sources of economic growth is an important factor in determining how such growth will be measured. • Growth accounting depends on how growth happens, and how growth happens changes overtime depending on the structure of the emerging economy.

7. Largest publicly traded company is in Beijing, not New York. The biggest refinery is being constructed in India, not the Gulf of Mexico. The largest investment fund on the planet is in Abu Dhabi, not London. The biggest movie industry is Bollywood, no longer Hollywood. The largest casino is in Macao, which overtook Las Vegas in gambling revenues last year. In the most recent rankings, only two of the world's ten richest people are American, but ten years ago, the United States would have serenely topped almost every one of these categories. In 2006 and 2007, 124 countries grew their economies at over 4 percent a year. That includes more than 30 countries in Africa. The share of people living on $1 a day has plummeted from 40 percent in 1981 to 18 percent in 2004 and is estimated to drop to 12 percent by 2015. Poverty is falling in countries that house 80 percent of the world's population. Foreign students and immigrants account for almost 50 percent of all science researchers in the U.S. In 2006 they received 40 percent of all PhDs. By 2010, 75 percent of all science PhDs in this country will be awarded to foreign students. Recent Trends Source: News Week - May 12, 2008.

8. The New Economy Proposition • Drivers of New Economy Growth: • Talent attraction. • Venture capital attraction. • Entrepreneurial culture. • Information technology. • Quality of Life. • Green Infrastructure. • Etc. • New Economy Drivers in a Global Context • Barriers still exist between nations due to immigration rules, risk aversion, and the fixity of green infrastructure assets. • New Economy Drivers in a Domestic Context • Mobility of New Economy drivers suggests a whole new capacity to aggregate critical new economy assets for economic advantage.

12. Implications to Domestic Growth Accounting • Old Economy: Q = (K, L, M, N). • New Economy: Q = (K, L, M, N | V, T, E, P). Q = (K, L, M, N | V, T, E, P). >90% >90%

13. Population Growth Prosperity Companies & Employers Manufacturing Jobs Old Economy Talented Knowledge Workers Prosperity Population Growth Knowledge Jobs Amenities QOL New Economy New Economy Proposition • Old Economy • Old Industrial Complexes are people magnets. • Strategies focused on attracting industry. • Strategies focused on cheap land, willing workers, raw materials, low taxes, etc. Low Cost Location • New Economy • Great places are talent magnets. • Talented create jobs. • Strategies focused on attracting talented people. • Strategies focused on attractive tolerant places with great social, natural, entrepreneurial, creative and intellectual capital. • Talent is the currency of the “New Economy”.

14. Preliminary Evidence onDrivers of Growth • LPI conducted a study to test the share of Old and New Economy factors in the growth of state population, employment and wage using a regional science framework. • Determinants of population, employment and wage growth between 2000 and 2005 are modeled as seemingly unrelated regression of three equations.

15. Endogenous: Population Employment Wage Demographic Factors: % of Pop. foreign born (NE) % urban Pop. (NE) Population density (OE) Economic Factors: Per capita income (OE) Unemployment rate (OE) Housing value (OE) GSP per capita (OE) Value of exports (OE) % high school completion and above (OE) New Economy Factors: Milken state tech. index (NE) # of patents (NE) Broadband connections (NE) R&D expenditure (NE) IT jobs (NE) Creative industry jobs (NE) Energy cost (NE) # of women and minority owned businesses (NE) Urban mass transit (NE) % Bachelor’s degree and above (NE) Green Infrastructure Factors: Green Plan Capacity Index (NE) Expenditure on green infrastructure (NE) Forest acres; Park acres (NE) Coastline miles (NE) Violent crimes (OE) Identified Variables

16. Rankings Demographic Variables= population density, % foreign born, % urban, % minority.Economic Variables = wage, PCI, unemployment, GSP per capita, housing value.New Economy Variables= broadband connections, minority firms, R&D expenditure, energy costs, patents, Milken tech index.Green Infrastructure Variables= miles of shores, Green Plan Capacity Index, acres of forest and state parks, expenditure on green infrastructure.

17. Mean Rank and Performance

18. Empirical Findings • Change in population equation: • Model performance – R-squared is 0.91. • Drivers of population change are: • State per capita income (+) • Amenities (Green Plan Capacity Index) (+) • % foreign born (+) • Urban mass transit (-) • Regional dummies: WSC (+), ESC (+), SA(+) • Share of New Economy Drivers: • Using R-squared decomposition, the share of New Economy factors that determine population change (minority population, air quality, other amenities, Milken tech index, Green Plan Capacity Index) is estimated at 97%.

19. Empirical Findings • Change in employment equation: • Model performance – R-squared is 0.83. • Drivers of employment change are: • Educational attainment (+) • Amenities (Green Plan Capacity Index (+), state parks (+)) • Housing value (-) • % urban population (+) • Regional dummies: MT (+), PAC (+), ESC (+), SA (+) • Share of New Economy Drivers: • Using R-squared decomposition, the share of New Economy factors that determine employment change (patents, broadband connection, minority owned firms, higher education, amenities, % urban population) is estimated at 63%.

20. Empirical Findings • Change in wage equation: • Model performance – R-squared is 0.88. • Drivers of wage change are: • # of IT jobs (+) • Broadband connections (+) • Educational attainment (+) • Amenities (green infrastructure) (+) • Crime (-) • Regional dummies: PAC (+), MA (+) • Share of New Economy Drivers: • Using R-squared decomposition, the share of New Economy factors that determine wage changes (% minority, IT jobs, broadband connections, minority firms, % creative industry jobs, expenditure on green infrastructure, higher education) is estimated at 87%.

21. Implications to Economic Performance Measurements • The dominance of New Economy factors in driving growth is increasingly becoming an economic reality. • This poses numerous implications to the way we measure productivity and growth: • What is the productivity contribution of talent? • What is the productivity and growth contribution of venture capital? • What is the productivity and growth contribution of green infrastructure assets? • How do we measure these variables to account for their role in determining growth and productivity? • Understanding and accounting for the role of New Economy factors in determining growth and productivity could potentially add to the accuracy of economic performance measures. • As we worry about national growth accounting, we should worry about domestic growth accounting.

22. Thank you!