Old Post: On Economic Growth vs. Economic Development

[Originally posted December 2005]

Picture this scene: two toddlers fidgeting at the kitchen table, each with a piece of cake before them. They look at the now-empty cake tin and, realizing they are partaking of the last two pieces, begin to eye their own piece and that of their sibling’s. Immediately, they begin to complain – “His piece is bigger!” “No, hers is!” – oblivious to the fact that another cake is baking in the oven. Forks flying, they desperately try to steal bites from each other. The older sibling ends up with a little more than the younger, most of the cake has now crumbled to the floor, and neither will be enjoying the freshly baked cake now because of their misdeeds.

This is what passes for urban economic development nowadays: politicians and localities stealing “bites” from each other, with most of the “crumbs” landing on the floor. When agencies are asked about their economic development strategies, they respond with words like “attraction” and “retention.” New Jersey tried to woo CIGNA to its side of the river, while Philadelphia hustled to keep Comcast downtown, all in the name of “economic development.” But while we fight over pieces of the cake, who’s trying to figure out how to make more cake?

Maybe we should focus less on economic development, in which all too often we settle for political interventions to redistribute existing resources, and more on economic growth, which Princeton University defines as “steady growth in the productive capacity of the economy.” Increased productivity leads to all sorts of good things, just as partaking in a freshly baked cake is much better than fighting over an increasingly crumbly cake. As explained by Robert Litan and Alice Rivlin in their book, Beyond the Dotcoms, increased productivity means higher profits, which can lead to one of two things: higher wages or lower prices. In both cases, our purchasing power increases, and we can therefore enjoy a higher standard of living.

Economic development without economic growth does not lead to increased productivity and often leads to decreased productivity. Just as fighting over cake sometimes leaves you with crumbs on the floor, fighting over businesses and jobs costs time and money, not to mention the adjustment costs that are incurred if those businesses and jobs relocate. No matter to our politicians: what counts is that we have more businesses than our neighboring locality, that we were able to close the deal, and that we were able to create new jobs for our citizens. Only we didn’t really create new jobs, we just relocated existing ones. It all seems a wee bit childish.

So how do we achieve economic growth? And how do we get our politicians to quit fighting like toddlers and calling it economic development? As for the first question, the answer lies in stimulating innovation, which usually happens via technology, entrepreneurship, and education. The US Bureau of Economic Analysis tracks national productive output by a measure called Gross Domestic Product (GDP). On the expense side, GDP is the sum of consumption, investment, government purchases, and net exports. On the income side, GDP is the sum of compensation, taxes, corporate profits, and capital costs. No matter which side of GDP you are looking at, you’ll increase that number not by moving businesses, activities, and jobs around, but by creating new businesses, activities, and jobs, or upgrading the ones that already exist.

That’s where innovation comes in. For example, Litan and Rivlin speak of the Internet’s ability to drive down transaction costs, increase efficiency in managing value chains, and improve market competition by increasing the number of buyers and sellers and the transparency of prices and information. They estimate the Internet will account for a $125 to $250 billion impact on GDP over a five-year period, adding a ¼ to a ½ percent to GDP.

The Arkansas Science and Technology Authority understands the importance of investing in the kind of innovation that will stimulate economic growth and not just economic development. In a 2003 study entitled “The Keys to Growth in the New Economy: Investing in Discovery, Engineering, and Entrepreneurship,” John Ahlen and Mark Diggs stress the creation of new firms as a vital component in a multi-dimensional approach to economic growth.

Finally, both Litan and Rivlin as well as Ahlen and Diggs highlight education as an effective way to achieve economic growth. Litan and Rivlin use the phrase, “human investment,” while Ahlen and Diggs speak of “maximizing the potential of individuals through education.”

So innovation through technology, entrepreneurship, and education is the gateway to economic growth. But how do we get the politicians to help? An important but underrated answer is to quit fighting. Just as Mother won’t give a new cake to two warring toddlers, economic growth doesn’t happen as easily where politicians are refusing to collaborate. Secondly, politicians can certainly do things to stimulate technology, entrepreneurship, and education, although I am loath to hold government responsible for responding nimbly and accurately to market trends.

Finally, economic development and economic growth are not totally unrelated. In a 1998 study, the Center for Policy Initiatives found that the lower the level of urban poverty in a region, the more robust its economic growth, inferring that efforts to reduce economic inequality can and do lead to improved regional economic performance.

So there is a role for the politicians to play: make sure the cake gets divvied up somewhat fairly, create welcoming climates for innovation via technology, entrepreneurship, and education to take place, and don’t fight too much with your sibling politicians. It sounds like a piece of cake.

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