Economists have developed three competing explanations, or theories, to explain differences in economic growth between regions. Over the past several decades, economic development policy in Indiana has coalesced around one of these theories. Sadly, it is the one theory that has shown the least ability to predict growth, or in other words, the wrong model.
The three theories are human capital, quality of life and agglomerations.
The human capital explanation for growth is pretty simple. Places — counties, metropolitan areas or states — grow because of educated people. This idea has best been argued by Harvard University economist Ed Glaeser, an urbanist and conservative. His influential paper, “The Rise of the Skilled City,” makes the argument with data (see www.nber.org/papers/w10191).
I’ve riffed off Glaeser’s work in several columns (see https://commentaries.cberdata.org/tag/15). Perhaps the best example I have is that counties with above-average shares of college graduates generated all of the nation’s net economic growth, and then some, since 1970 as less-educated counties contracted (see https://commentaries.cberdata.org/1308/the-birth-and-death-of-rustbelt-cities). Most of that growth took place in the top 100 counties — out of 3,143.
That theory works well, but it doesn’t explain how educated people got to those counties.
For that, we need another theory, best attached to a 1982 study by economist Jennifer Roback. Her work demonstrated that households were attracted to amenities, and they were willing to pay more for a house and take a pay cut to live in a place with robust attractions. This theory is quality of life.
My work on this issue with colleagues Amanda Weinstein and Emily Wornell measured quality of life down to the county level for the first time. Our research demonstrated that quality of life explains about half the population growth and more than half of employment growth in the U.S. since 1970.
Putting these two ideas together paints a rich picture of long-term prosperity in the U.S. Places that start out with a high share of educated workers likely have a prosperous future. Places that can grow their educated share do even better. These results hold across time and place, rural and urban, and across almost every type of geography and state (see https://link.springer.com/article/10.1007/s00168-022-01155-5 and www.brookings.edu/articles/improving-quality-of-life-not-just-business-is-the-best-path-to-midwestern-rejuvenation).
Indiana policymakers certainly talk about education and quality of life. And we’ve had some important policies that offered quality of life improvements, including the Regional Cities Initiative and READI Grants (https://journals.sagepub.com/doi/10.1177 /08912424241237507). But, these investments of a few hundred million dollars are tiny compared to the nearly $2 billion we spend each year chasing development using the third theory.
Agglomerations is the technical term for the magic that happens when businesses cluster in a certain area. It is a staple of the newest theories surrounding regional growth that earned Paul Krugman a Nobel prize (see www.nobelprize.org/prizes/economic-sciences/2008/krugman/lecture). The idea is simple. Businesses that locate close to one another inadvertently share innovation and skills. They may do so through formal cooperation, by hiring one another’s staff or just by having people from the same trade hang out at a bar or go to church together.
The agglomerations idea is more than a century old, but Krugman made it much more powerful by identifying the sources of some growth associated with it. Much of Indiana’s economic development policy that focuses on attracting key businesses, attracting capital and focusing on forward and backward supply chain linkages is, perhaps unwittingly, drawn from Krugman’s research.
The agglomerations model is a particularly strong theory in predicting growth in the developing world, but it explains only a tiny share of economic growth in postwar America.
As an analogy, suppose you wanted a drug that could make you healthier — say, to lose weight. One drug worked between five and seven times better than another drug and cost less. Which would you choose?
Well, we’ve chosen the expensive, ineffective drug.
If the agglomerations theory was right, the Midwest — Indiana, Michigan, Illinois, Ohio and Wisconsin — would have populations two or three times the current levels. Detroit, Toledo, Waukesha and Muncie would all have double or triple their current populations and GDP, and be among the richest places in America. Meanwhile, Phoenix, Atlanta, Tampa, Miami, Denver, Boston, Charlotte, Houston, Dallas and Austin would be piddling little towns, half their current sizes or smaller.
Indiana has doubled down on the agglomerations policies, especially over the past eight years. These are increased tax incentives, particularly on business capital for selected industries. Normally, direct business incentives for selected industrial sectors are part of economic development policies. The LEAP District is all of this badness in one place.
To pay for these, and double down on agglomerations, you would cut state taxes, especially on businesses. You might eliminate property taxes and worry little about education or funding livable attractive communities.
That’s precisely what Indiana does.
The right policies for human capital would first promote educational attainment, from pre-K through college, and pay for it. Instead, we’ve cut spending on this for 15 years. Smart quality-of-life policies unleash local governments to become unique places of their own creation. We do the exact opposite, as Senate Enrolled Act 1 will make abundantly clear in the years to come.
The remarkable failure of economic development policies offers a unique opportunity to learn and retool our state for the next half-century. The only way this will happen is if a broad swath of Hoosiers demand change.
It isn’t enough to condemn the LEAP district or re-tool the Indiana Economic Development Corp. The entirety of the business attraction model has failed Hoosiers (see www.iastatedigitalpress.com/rreg/article/id/18245).
If the human capital and quality of life theories are right, the Midwest would be a half-century into a century-long period of economic decline. The only thriving places across the Midwest would be a few cities that were not industrial centers in 1950 — like Indianapolis or Columbus, Ohio.
At the same time, we’d see rapid economic growth in sunbelt cities, across Texas, Tennessee and North Carolina. The area from Richmond, Virginia, to Boston would be one vast urbanized area. The human capital and quality of life theory also predicts the rise of Denver and Boulder, Boise and other places that were largely economic unknowns in 1950.
Which theories do you think work better? That isn’t a real question, of course; the real question is how would we change policies to better promote growth?
