Rethink Local Economic Development…Again

In 1990, Michael Porter, a Harvard University Business School Professor, published The Competitive Advantage of Nations, an examination of how prosperity is created and maintained in the modern global economy. This book shaped how national policy was established across the world. Despite its age, this publication is a must read for any local government looking to create wealth and grow a sustainable local economy for the future.

While this well-known work did create a major shift in economic development across the world, it has not found its way into the hands of a majority of rural communities, it seems. Rather than discuss each and every concept Porter puts forth in this publication, there are two basic concepts in particular that should “hit home” for many rural local government entities striving to increase the economic well-being of their community.

First, a move away from solely utilizing the “tactical” approach of development and instead emphasizing a “strategic” method is a sure-fire way to spur new ideas and techniques to revitalize a fading business sector. The table below illustrates the central characteristics of each development method:

TACTICAL_001

Too often rural economic development is focused solely on chasing. A never-ending quest to find and “steal” that big industry or business and bring it into town. Efforts can be made to achieve this goal, because in reality, if achieved, this endeavor can have an enormous positive impact on a local economy very quickly. Nevertheless, achieving sustainable development occurs when we think “strategically” rather than “tactically”. It takes constant collaboration among both the public and private sectors of an entire region to achieve sustainable growth, this becomes even more necessary for rural communities. The strategic method also necessitates us to focus more on how we can grow what we have, rather than just search for the next big business. Big business attraction can create fantastic newspaper headlines, but rarely does aid in sustainable development on its own.

Similarly, concept two follows this discussion through the description of three stages of business competitive advantage. The stages are as follows:

  1. Factor-Driven Stage – In this state competitive advantage is based exclusively on the endowments of labor and natural resources of the community. This stage on supports businesses providing relatively low-wage.
  2. Investment-Driven Stage – This stage can be identified when efficiency in producing standard products and services become the source of competitive advantage. The economy is focused and concentrated on manufacturing and on outsourced service exports. These economies do achieve higher wages than the first stage, but are very susceptible to financial crises’ and external, sector-specific demand shocks.
  3. Innovation-Driven Stage – This final stage can be described as an economy that has the ability to produce original and/or other innovative products and services with the most advanced technological methods. The business environment is such that multiple sectors and clusters have deep roots in the community, growing and building with and from one another. Companies also tend to compete globally rather than regionally or state-wide and develop their own unique strategies for intelligent investment, growing with and alongside technology innovation, as well as having the capacity to innovate within.

After reading and thinking for a few minutes about each one of these stages, it will become quite obvious to those individuals who understand basic economics, which stage your particular community currently sits. In rural areas of the nation and State of Illinois Stage 1 economies are quite common, Stage 2 economies may occur in one or two communities per county, and Stage 3 economies may only appear once or twice regionally. However, while this may be the case generally, it does not have to be the rule.

Any community of any size can create a “Innovation-Driven” economy. The biggest mistake that a community can make is try to 100% mimic the stages of success a neighboring community followed. While a collaboration on strategy may be appropriate, the makeup and progression of the growth will differ. One community may have a location advantage, another a labor advantage, and even yet another with a community college. The essential piece of the puzzle is finding your community’s unique advantage and continually feeding this advantage until blossoming. An additional article that may help trigger ideas related to this discussion is “The Economy of Creativity”.

For more information from the Harvard Business School, please go to their website by clicking Harvard Business School

If you are interested in putting Michael Porter’s The Competitive Advantage of Nations on your bookshelf, you can find it here:

 

What’s dragging down the Illinois Economy?

Illinois is home to a well-documented people problem. The state’s population has been shrinking for four consecutive years, and its labor force is declining as well. At the same time, Illinois’ economy is lagging the nation in terms of growth.

Analyzing the component parts of economic growth shows how these two unfortunate realities are connected. And how state and local tax hikes in Illinois are making things worse.

Illinois’ slow growth

Analyzing economic growth in Illinois requires deconstructing the state’s growth in real gross domestic product into its primary contributions: labor inputs and labor productivity. The production process transforms labor, capital and technology into output (real GDP). That means if Illinoisans work fewer hours, or more Illinoisans leave the state or retire earlier over time, labor input in the production process will grow more slowly or even shrink. Declining labor input can easily cancel out any improvement in productivity growth, leaving real GDP growth unchanged or even lower than before.

Labor productivity growth and employment growth declined in Illinois relative to other U.S. states.

Illinois' economic growth lagging the nation

These results highlight that Illinois’ low population growth (including negative population growth since 2014) and declining labor force are mostly responsible for the decline in the growth rate of civilian employment. It is also obvious that Illinois would have grown faster than the rest of the U.S. economy if the state’s workforce had grown on par with the rest of the U.S. economy.

What’s behind sluggish employment growth?

Growth accounting deconstructs the growth rate of an economy’s total output into that which is due to increases in the contributing amount of the factors used in production – capital and labor – and that which cannot be accounted for by observable changes in factor utilization.

An analysis of Illinois’ expansions suggests that the growth rate of the capital stock (the crucial ingredient that makes labor more productive) has declined much more than the decline in labor. The state has experienced a serious decline in investment, and that is causing weaker wage growth. As a result, fewer people want to live and work in Illinois, fueling a decline in the growth rate of employment.

From 2010-2015, private nondurable goods consumption and government spending in Illinois increased to 70 percent of the real economy, compared with only 67 percent during the 1992-2000 economic expansion. Although the growth in all factors declined relative to the 1992-2000 expansion, declining growth in the capital stock was the main culprit. The slowdown in the growth rate of the capital stock is consistent with a decline in investment.

Weak growth in capital stock is behind Illinois' weak expansion

The large decline in the growth rate of Total Factor Productivity is common to most U.S. states. However, a larger decline in investment expenditures is the chief culprit in explaining why Illinois is experiencing its weakest economic expansion in the post-World War II era.

Tax hikes likely reduced investment in Illinois

In 2011, then-Gov. Pat Quinn praised the decision of state lawmakers to raise the individual income tax rate by 66 percent as necessary to address the state’s “fiscal emergency.” The plan raised the individual income tax rate to 5 percent from 3 percent, and raised the corporate tax rate to 7 percent from 4.8 percent. The tax hikes placed Illinois among the top four states in the United States for highest state corporate income taxes, and among the top four in the industrialized world for the highest combined national-local corporate income taxes.

In 2017, two years after the partial sunset of the 2011 tax hikes, the Democratic majority in the Illinois General Assembly, along with a group of Republican state representatives and one Republican state senator, broke the state’s two-year budget deadlock by overriding Gov. Bruce Rauner’s veto of a hike of individual and corporate income taxes. The Illinois income tax rate for individuals went up to 4.95 percent from 3.75 percent, which, added to an increase in the corporate rate, resulted in a $5 billion hike.

Income tax revenues are expected to increase, but at what cost? Although economists are divided as to whether tax cuts always stimulate economic activity, they agree unanimously that tax hikes lead to significant reductions in income and employment. Experts also agree that tax cuts enacted in periods of low or negative economic growth boost real GDP.

Not surprisingly, the share of income attributed to capital in Illinois – investment income – declined, according to Bureau of Economic Analysis data. Lower after-tax returns to investment reduce investment flows, thus slowing the growth of the capital stock and ultimately reducing real wage growth. A real wage decline has negative implications for employment growth and real GDP growth. Even with a highly educated workforce – as Illinois enjoys in the Chicago metro area, for example – a sharp reduction in the after-tax value of employment opportunities and Illinoisans’ purchasing power will fuel Illinois’ outmigration crisis.

The economic impact of tax and spending policy is not trivial. On one hand, higher income taxes penalize labor and capital income, therefore discouraging investments in productive capital. This reduction in productive capital causes labor to become less productive, thus causing the real wage to decrease. Declining real wages have a negative effect on labor supply. On the other handa lower after-tax income raises the need to work, save and invest in order to maintain the same living standard.

The first effect lowers economic activity – economists refer to it as the substitution effect – while the second effect raises activity through the income effect. The impact of the tax hike depends on which of these effects dominates the other in magnitude. Essentially, good tax policy implies a tax change that minimizes any reduction in the size of the tax base.

As evidenced by a decline in investment and employment growth, the 2011 income tax hikes were not good tax policy. And there’s little reason to think the 2017 tax hikes won’t have the same effect as Illinoisans look ahead to 2018.

The right policy prescriptions in Illinois should aim to stimulate investment. Policies that lower the cost of doing business and lower barriers to entry into the marketplace would result in higher demand for capital, thus making investment in Illinois more attractive. Illinois will not diverge from its path of poor growth until lawmakers realize the failures of recent tax hikes, and opt for more economic growth instead.

 

Source: Illinois Policy