Many economic development leaders and elected officials think of their state or city like it’s a business.
They approach economic development policies trying to make their place competitive by offering tax incentives or direct subsidies. They also anguish over image, trying to market their community as if it were a product or service.
This approach sounds reasonable, it’s easy to explain, and it has been a universal failure.
Indiana is a cheap place to hire workers (aside from stunningly high health care costs), it’s well located on major transportation arteries, and it has arguably the lowest business tax and regulatory burden in the nation. If Indiana were a business, we should be booming.
Instead, our economy has lagged the nation since World War II, with the last two decades offering the worst relative economic performance to the nation on record.
To rub salt in those wounds, we also lag behind states that cable TV pundits like to make jokes about, such as California and New York. Both states have crushed Indiana’s growth for decades. Just last year, California grew 51% faster than Indiana, and New York grew 65% faster.
Adjusting for inflation, the average Hoosier makes less today than the typical Californian did in 2005 or New Yorker in 2006. That translates to Hoosier per capita income differences of more than $20,000 per year with California and $11,000 with New York.
So how does the business analogy compare?
Tax rates in California and New York are much higher than in Indiana, although higher health care prices offset much of that benefit. Land is more expensive in California and New York, as are construction costs. The regulatory environment on business is breathtakingly more onerous in California and New York.
Yet, Indiana is losing people to California and New York. For every 10 Hoosiers who move to California, six Californians move to Indiana. And, for every 10 Hoosiers who move to New York, three New Yorkers move to Indiana.
It’s still fun to poke fun at Californians and New Yorkers, but it is delusional to believe Indiana possesses some economic magic they lack. Something else is going on, and just exactly what that is becomes painfully obvious when you understand the way economists view economic growth.
The modern economic explanation for regional growth differences dates to the 1950s. At the time, the profession pondered the differences in wealth across much of the world as we entered a rapid period of de-colonization. The idea that best explained the world was one in which capital — productive machinery and equipment — flowed from rich to poor places in search of a higher rate of return.
This idea, which was expressed as a mathematical model, garnered a Nobel prize for Robert Solow. His theory argued that, at the margin, an extra truck or lathe or bridge offered a higher rate of return in a poor, capital-starved region. It was a time of real optimism about world poverty.
But by the late 1970s, the key prediction of this model, that poor places would grow faster than rich places, failed to materialize. Instead, rich places got richer, while poor places tended to stagnate. Infusions of capital to poor countries in Africa and Asia have not yielded the expected growth. It was a deep puzzle.
In the 1980s, different groups of researchers added a measure called “human capital” to that model. By human capital, they meant education, skills and better health. In practice, the only things we could measure to put into this equation was the educational attainment of the population.
This simple addition yielded surprisingly good predictions. Today, variations on that approach explain most of the differences in standards of living, worker productivity and economic growth rates between continents, nations, states and counties.
To put it as plainly as possible: Educational attainment alone is now a more powerful predictor of a region’s economic success than everything else combined. For a developed nation like us, there are two key elements of education that drive growth differences.
Not surprisingly, the first is the ability to educate the existing citizens of a region. Places that do well educating their own citizens tend to do very well economically. The reason is simple. Education tends to make workers more productive.
Of course, this isn’t universally true — as any faculty meeting will amply demonstrate — but on average it is the case. This higher productivity of the individual worker results in both higher initial wages and a lifetime of wage growth.
It is obviously true that college graduates outearn non-college graduates. But that is only part of the explanation.
If you are a high school graduate, living in a city or state with a high share of college graduates also provides a significant wage increase. Simply moving Indiana from our current 41st rank to the national average of educational attainment would be equivalent to a 5.3% pay increase for the typical Hoosier high school graduate.
The reason for this observed boost in wages is simply that these less well-educated workers are more likely to be in environments with more productive workers. It also means that there are fewer poorly educated workers surrounding you. This combination makes well-educated places a leading destination for people who have not graduated from college.
The second reason education tends to benefit a region so dramatically is that a strong educational system is a magnet for educated people. Net migration in the U.S. is almost exclusively from poorly educated counties to highly educated counties.
Even the highly publicized movement of Californians to Texas is dominated by people moving from poorly educated parts of California to Austin, Dallas and Houston, where 60%, 45% and 33% of adults hold a bachelor’s degree or higher. The California county with the biggest migration losses has only 22.5% of its adults with a bachelor’s degree.
The Midwest has lagged behind the nation in growth for four decades, all the while embracing an economic development strategy from the 1950s and ’60s that showed no evidence of success even then. In recent decades, almost every Midwest state has doubled down on that strategy, with deeply troubled projects like Foxconn and the LEAP district.
These failed business attraction strategies occur at the same time we see deep cuts to funding for education, particularly higher education. If a diabolical Bond villain were to craft a set of policies that ensured long-term economic decline in a developed country, it would come in two parts. First, spend enormous sums of money on business incentives that offer a false narrative of economic vibrancy, then cut education spending.
Welcome to the Midwest, circa 2024.
Michael J. Hicks is the director of the Center for Business and Economic Research and the George and Frances Ball Distinguished Professor of Economics in the Miller College of Business at Ball State University.
