How States Grow:How States Grow: Old Vs New EconomyOld Vs New Economy

Soji Adelaja, Yohannes Hailu, Mark Wyckoff and Soji Adelaja, Yohannes Hailu, Mark Wyckoff and Eric BaileyEric Bailey

Presented at the 2008 World Congress on Presented at the 2008 World Congress on National Accounts and Economic Performance National Accounts and Economic Performance

Measures for NationsMeasures for Nations

May 15, 2008May 15, 2008

Washington, D.C.Washington, D.C.

BackgroundBackground• Depending on a country’s stage of economic Depending on a country’s stage of economic

development, the policies and institutional development, the policies and institutional arrangements needed to bring about growth are now arrangements needed to bring about growth are now widely understood and increasingly being applied.widely understood and increasingly being applied.

• Globalization, emergence of the New Economy and Globalization, emergence of the New Economy and resulting mobility of talent, venture capital and new resulting mobility of talent, venture capital and new innovative technology pose new challenges in innovative technology pose new challenges in understanding optimal growth strategies, particularly understanding optimal growth strategies, particularly in the context of the domestic economy.in the context of the domestic economy.

• New growth levers are emerging, the impacts of which New growth levers are emerging, the impacts of which are not well understood.are not well understood.

• While growth accounting included traditional growth While growth accounting included traditional growth determinants in explaining growth, New Economy determinants in explaining growth, New Economy advocates suggest a whole new set of factors (eg. advocates suggest a whole new set of factors (eg. talent, green infrastructure, venture capital, patient talent, green infrastructure, venture capital, patient capital, cultural assets, and other quality of life capital, cultural assets, and other quality of life amenities). amenities).

• How we measure economic performance depends on How we measure economic performance depends on whether we can capture the drivers of new growth.whether we can capture the drivers of new growth.

What Drives Economic Growth?What Drives Economic Growth?Theories of Economic GrowthTheories of Economic Growth

• Adam Smith – Nature and Causes of the Wealth Adam Smith – Nature and Causes of the Wealth of Nationsof Nations

• Division of labor and specialization.Division of labor and specialization.• Laissez-faire – minimal government interference.Laissez-faire – minimal government interference.• Functional legal system.Functional legal system.• Think about Russia.Think about Russia.

• David Ricardo – International Trade and GrowthDavid Ricardo – International Trade and Growth• The concept of diminishing returnsThe concept of diminishing returns• Growth based on international trade rooted in Growth based on international trade rooted in

comparative advantage.comparative advantage.• Think about India.Think about India.

What Drives Economic Growth?What Drives Economic Growth?Theories of Economic GrowthTheories of Economic Growth

• Neo-Classical Growth ModelsNeo-Classical Growth Models• These models emphasize the role of capital accumulationThese models emphasize the role of capital accumulation• Solow-Swan model – output is produced by capital and labor, Solow-Swan model – output is produced by capital and labor,

where labor and capital productivity determines growth, where labor and capital productivity determines growth, given an exogenous technical progress (measured by Solow given an exogenous technical progress (measured by Solow residual or TFP)residual or TFP)

• Model expanded by considering the role of technological Model expanded by considering the role of technological progress and human capital in explaining differences in progress and human capital in explaining differences in growth across countries and in accounting for growth.growth across countries and in accounting for growth.

• Think about Mexico.Think about Mexico.

• Endogenous Growth ModelsEndogenous Growth Models• These models relaxed some earlier assumptions about These models relaxed some earlier assumptions about

economic growth and endoenized technological progress in economic growth and endoenized technological progress in growth accountinggrowth accounting

• R&D (ideas) based endogeneous growth models identify R&D (ideas) based endogeneous growth models identify innovation as the driver of long-term economic growth innovation as the driver of long-term economic growth

• For instance, Eaton and Kortum (1996) identified that more For instance, Eaton and Kortum (1996) identified that more than 50% of productivity growth in OECD countries is due to than 50% of productivity growth in OECD countries is due to innovations in the U.S., Germany and Japan.innovations in the U.S., Germany and Japan.

• Getting there.Getting there.

What Drives Economic Growth?What Drives Economic Growth?Theories of Economic GrowthTheories of Economic Growth

• Evolutionary Growth Theories:Evolutionary Growth Theories:• Technological progress is a long-lasting adjustment Technological progress is a long-lasting adjustment

processprocess• Growth theory need to be conceptualized from broader Growth theory need to be conceptualized from broader

firm capabilities than just human capital and R&D firm capabilities than just human capital and R&D investments.investments.

• Institutional framework under which growth happens is Institutional framework under which growth happens is important consideration.important consideration.

• Getting near.Getting near.• Sources of Economic Growth – Other IdeasSources of Economic Growth – Other Ideas

• Labor force expansion; Entrepreneurship.Labor force expansion; Entrepreneurship.• Capital stock; Government policies.Capital stock; Government policies.• Almost there.Almost there.

• ObservationObservation• Economic knowledge about growth was based on the Economic knowledge about growth was based on the

concept of comparative advantage. concept of comparative advantage. • In an era of globalization where tangible new assets are In an era of globalization where tangible new assets are

mobile, and traditional assets are increasingly irrelevant, mobile, and traditional assets are increasingly irrelevant, are these models relevant?are these models relevant?

What Drives Economic Growth?What Drives Economic Growth?Theories of Economic GrowthTheories of Economic Growth

• Implications to Growth AccountingImplications to Growth Accounting

• Determination of the sources of economic Determination of the sources of economic growth is an important factor in determining growth is an important factor in determining how such growth will be measured.how such growth will be measured.

• Growth accounting depends on how growth Growth accounting depends on how growth happens, and how growth happens changes happens, and how growth happens changes overtime depending on the structure of the overtime depending on the structure of the emerging economy.emerging economy.

Recent TrendsRecent Trends• Largest publicly traded company is in Beijing, not Largest publicly traded company is in Beijing, not

New York.New York.• The biggest refinery is being constructed in India, The biggest refinery is being constructed in India,

not the Gulf of Mexico.not the Gulf of Mexico.• The largest investment fund on the planet is in Abu The largest investment fund on the planet is in Abu

Dhabi, not London. Dhabi, not London. • The biggest movie industry is Bollywood, no longer The biggest movie industry is Bollywood, no longer

Hollywood. Hollywood. • The largest casino is in Macao, which overtook Las The largest casino is in Macao, which overtook Las

Vegas in gambling revenues last year. Vegas in gambling revenues last year. • In the most recent rankings, only two of the world's In the most recent rankings, only two of the world's

ten richest people are American, but ten years ago, ten richest people are American, but ten years ago, the United States would have serenely topped almost the United States would have serenely topped almost every one of these categories. every one of these categories.

• In 2006 and 2007, 124 countries grew their In 2006 and 2007, 124 countries grew their economies at over 4 percent a year. That includes economies at over 4 percent a year. That includes more than 30 countries in Africa. more than 30 countries in Africa.

Source: News Week - May 12, 2008.

• The share of people living on $1 a day has The share of people living on $1 a day has plummeted from 40 percent in 1981 to 18 plummeted from 40 percent in 1981 to 18 percent in 2004 and is estimated to drop to 12 percent in 2004 and is estimated to drop to 12 percent by 2015. Poverty is falling in countries percent by 2015. Poverty is falling in countries that house 80 percent of the world's population. that house 80 percent of the world's population.

• Foreign students and immigrants account for Foreign students and immigrants account for almost 50 percent of all science researchers in almost 50 percent of all science researchers in the U.S. In 2006 they received 40 percent of all the U.S. In 2006 they received 40 percent of all PhDs. By 2010, 75 percent of all science PhDs in PhDs. By 2010, 75 percent of all science PhDs in this country will be awarded to foreign students. this country will be awarded to foreign students.

The New Economy PropositionThe New Economy Proposition• Drivers of New Economy GrowthDrivers of New Economy Growth::

• Talent attraction.Talent attraction.• Venture capital attraction.Venture capital attraction.• Entrepreneurial culture.Entrepreneurial culture.• Information technology.Information technology.• Quality of Life.Quality of Life.• Green Infrastructure.Green Infrastructure.• Etc.Etc.

• New Economy Drivers in a Global ContextNew Economy Drivers in a Global Context• Barriers still exist between nations due to immigration rules, Barriers still exist between nations due to immigration rules,

risk aversion, and the fixity of green infrastructure assets. risk aversion, and the fixity of green infrastructure assets. • New Economy Drivers in a Domestic ContextNew Economy Drivers in a Domestic Context

• Mobility of New Economy drivers suggests a whole new Mobility of New Economy drivers suggests a whole new capacity to aggregate critical new economy assets for capacity to aggregate critical new economy assets for economic advantage.economic advantage.

Implications to Domestic Growth Implications to Domestic Growth AccountingAccounting

• Old Economy:Old Economy:

Q = (K, L, M, N).Q = (K, L, M, N).• New Economy:New Economy:

Q = (K, L, M, N | Q = (K, L, M, N | V, T, E, PV, T, E, P).).

Q = (K, L, M, N | Q = (K, L, M, N | V, T, E, V, T, E, PP).).

>90%

>90%

New Economy PropositionNew Economy Proposition

Low Cost Location

Companies & Employers

Manufacturing Jobs

Population Growth

Prosperity

Old Economy

Amenities QOL

Talented Knowledge

Workers

Knowledge Jobs

Population Growth

Prosperity

New Economy

New Economy•Great places are talent Great places are talent magnets.magnets.•Talented create jobs.Talented create jobs.•Strategies focused on Strategies focused on attracting talented people.attracting talented people.•Strategies focused on Strategies focused on attractive tolerant places attractive tolerant places with great social, natural, with great social, natural, entrepreneurial, creative entrepreneurial, creative and intellectual capital.and intellectual capital.

Old Economy•Old Industrial Complexes Old Industrial Complexes are people magnets.are people magnets.•Strategies focused on Strategies focused on attracting industry.attracting industry.•Strategies focused on Strategies focused on cheap land, willing cheap land, willing workers, raw materials, low workers, raw materials, low taxes, etc.taxes, etc.

•Talent is the currency of the “New Economy”.

Preliminary Evidence onPreliminary Evidence onDrivers of GrowthDrivers of Growth

• LPI conducted a study to test the share of Old LPI conducted a study to test the share of Old and New Economy factors in the growth of state and New Economy factors in the growth of state population, employment and wage using a population, employment and wage using a regional science framework.regional science framework.

• Determinants of population, employment and Determinants of population, employment and wage growth between 2000 and 2005 are wage growth between 2000 and 2005 are modeled as seemingly unrelated regression of modeled as seemingly unrelated regression of three equations.three equations.

Identified VariablesIdentified Variables• Endogenous:Endogenous:

• PopulationPopulation• EmploymentEmployment• WageWage

• Demographic Factors:Demographic Factors:• % of Pop. foreign born (NE)% of Pop. foreign born (NE)• % urban Pop. (NE)% urban Pop. (NE)• Population density (OE)Population density (OE)

Economic Factors:Economic Factors:• Per capita income (OE)Per capita income (OE)• Unemployment rate (OE)Unemployment rate (OE)• Housing value (OE)Housing value (OE)• GSP per capita (OE)GSP per capita (OE)• Value of exports (OE)Value of exports (OE)• % high school completion and % high school completion and

above (OE)above (OE)

• New Economy Factors:New Economy Factors:• Milken state tech. index (NE)Milken state tech. index (NE)• # of patents (NE)# of patents (NE)• Broadband connections (NE)Broadband connections (NE)• R&D expenditure (NE)R&D expenditure (NE)• IT jobs (NE)IT jobs (NE)• Creative industry jobs (NE)Creative industry jobs (NE)• Energy cost (NE)Energy cost (NE)• # of women and minority owned # of women and minority owned

businesses (NE)businesses (NE)• Urban mass transit (NE)Urban mass transit (NE)• % Bachelor’s degree and above % Bachelor’s degree and above

(NE)(NE)

• Green Infrastructure Factors:Green Infrastructure Factors:• Green Plan Capacity Index (NE)Green Plan Capacity Index (NE)• Expenditure on green Expenditure on green

infrastructure (NE)infrastructure (NE)• Forest acres; Park acres (NE)Forest acres; Park acres (NE)• Coastline miles (NE)Coastline miles (NE)• Violent crimes (OE)Violent crimes (OE)

RankingsRankings

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.

Mean Rank and PerformanceMean Rank and Performance

Income mean Rank Relationship

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

0.00 5.00 10.00 15.00 20.00 25.00 30.00 35.00 40.00

Mean Rank

PCI

Mean Rank

Linear (MeanRank)

Empirical FindingsEmpirical Findings• Change in population equation:Change in population equation:

• Model performance – R-squared is 0.91.Model performance – R-squared is 0.91.• Drivers of population change are:Drivers of population change are:

• State per capita income (+)State per capita income (+)• Amenities (Green Plan Capacity Index) (+)Amenities (Green Plan Capacity Index) (+)• % foreign born (+)% foreign born (+)• Urban mass transit (-)Urban mass transit (-)• Regional dummies: WSC (+), ESC (+), SA(+)Regional dummies: WSC (+), ESC (+), SA(+)

• Share of New Economy Drivers:Share of New Economy Drivers:• Using R-squared decomposition, the share of New Using R-squared decomposition, the share of New

Economy factors that determine population change Economy factors that determine population change (minority population, air quality, other amenities, Milken (minority population, air quality, other amenities, Milken tech index, Green Plan Capacity Index) is estimated at tech index, Green Plan Capacity Index) is estimated at 97%.97%.

Empirical FindingsEmpirical Findings• Change in employment equation:Change in employment equation:

Model performance – R-squared is 0.83.Model performance – R-squared is 0.83. Drivers of employment change are:Drivers of employment change are:

• Educational attainment (+)Educational attainment (+)• Amenities (Green Plan Capacity Index (+), state parks (+))Amenities (Green Plan Capacity Index (+), state parks (+))• Housing value (-)Housing value (-)• % urban population (+)% urban population (+)• Regional dummies: MT (+), PAC (+), ESC (+), SA (+)Regional dummies: MT (+), PAC (+), ESC (+), SA (+)

Share of New Economy Drivers:Share of New Economy Drivers:• Using R-squared decomposition, the share of New Using R-squared decomposition, the share of New

Economy factors that determine employment change Economy factors that determine employment change (patents, broadband connection, minority owned firms, (patents, broadband connection, minority owned firms, higher education, amenities, % urban population) is higher education, amenities, % urban population) is estimated at 63%.estimated at 63%.

Empirical FindingsEmpirical Findings• Change in wage equation:Change in wage equation:

Model performance – R-squared is 0.88.Model performance – R-squared is 0.88. Drivers of wage change are:Drivers of wage change are:

• # of IT jobs (+)# of IT jobs (+)• Broadband connections (+)Broadband connections (+)• Educational attainment (+)Educational attainment (+)• Amenities (green infrastructure) (+)Amenities (green infrastructure) (+)• Crime (-)Crime (-)• Regional dummies: PAC (+), MA (+)Regional dummies: PAC (+), MA (+)

Share of New Economy Drivers:Share of New Economy Drivers:• Using R-squared decomposition, the share of New Using R-squared decomposition, the share of New

Economy factors that determine wage changes (% Economy factors that determine wage changes (% minority, IT jobs, broadband connections, minority minority, IT jobs, broadband connections, minority firms, % creative industry jobs, expenditure on green firms, % creative industry jobs, expenditure on green infrastructure, higher education) is estimated at 87%.infrastructure, higher education) is estimated at 87%.

Implications to Economic Implications to Economic Performance MeasurementsPerformance Measurements

• The dominance of New Economy factors in driving The dominance of New Economy factors in driving growth is increasingly becoming an economic reality.growth is increasingly becoming an economic reality.

• This poses numerous implications to the way we This poses numerous implications to the way we measure productivity and growth:measure productivity and growth:

• What is the productivity contribution of talent?What is the productivity contribution of talent?• What is the productivity and growth contribution of What is the productivity and growth contribution of

venture capital?venture capital?• What is the productivity and growth contribution of What is the productivity and growth contribution of

green infrastructure assets?green infrastructure assets?• How do we measure these variables to account for their How do we measure these variables to account for their

role in determining growth and productivity?role in determining growth and productivity?• Understanding and accounting for the role of New Understanding and accounting for the role of New

Economy factors in determining growth and Economy factors in determining growth and productivity could potentially add to the accuracy of productivity could potentially add to the accuracy of economic performance measures.economic performance measures.

• As we worry about national growth accounting, we As we worry about national growth accounting, we should worry about domestic growth accounting.should worry about domestic growth accounting.

Thank you!Thank you!