What do we know about the causes of regional growth? Part 3 ECON 4480 State and Local Economies 1

Reasons for Growth We now have three reasons why growth rates can vary among regions: – Technical progress may differ between regions. – The growth of capital stock may vary between regions. – The growth of the labor force may vary between regions. 2

Reasons for Growth An implication of the neoclassical model is that capital and labor will move to the regions offering the highest rates of return. This is known as interregional factor migration. ( a factor is a factor of production such as labor or capital). If capital and labor are mobile, producers will seek the most profitable locations for new capital investments, and labor will move to regions that have high wages. 3

Neoclassical Model 4 Output growth Growth of capital stock Growth of labor force Technical progress Capital inflow Local capital spending by residents Net inmigration of workers Natural population growth Inflow of technical knowledge Local R&D, education Rate of return relative to other regions Wage rate relative to other regions Birth and death rate

Reasons for Growth Which regions are predicted to grow fastest? The neoclassical model predicts that regions with a high capital/labor ratio have high wages and a low yield on capital investment. For these regions, capital will flow out and labor will flow in. What will happen to output? If capital outflow is faster than labor inflow, output will decline. 5

Reasons for Growth On the other hand, what if a region has a low capital/labor ratio? Productivity will be low and therefore wages will be low. In these regions, a small increase in capital will have a large effect on output. The yield on capital investment is high. For these regions, capital will flow in and labor will flow out. What happens to output? If capital inflow is faster than labor outflow, output will rise. 6

Factor Migration Does capital move faster than labor in practice? The fact is that capital is much more mobile between regions than is labor. Capital can easily flow to regions with higher growth rates. Labor mobility is much slower to respond to higher wages because of home ownership, regional preferences, family ties, and so on. It is certain that capital will move much faster than labor. 7

Testing the Theory Tests of neoclassical growth theory at the regional level are few and far between: Borts and Stein (1964) – divided states into low-wage states and high-wage states. – The model predicts that labor will move from low- wage to high-wage states. – The model was not confirmed by the evidence for the study period

Testing the Theory Hulten and Schwab (1984) – Estimate the importance of technical progress, capital stock growth and labor growth for the growth of output using nine regions in the U.S. – Hulten and Schwab found that most of the regional growth differences can be attributed to differences in labor force growth and to a smaller degree capital stock growth differences. – Technical progress showed little difference between regions. 9

Testing the Theory Labor was relatively mobile during the period. Technical progress was distributed relatively evenly across regions. 10 Sources of output growth for US regions (Hulten & Schwab) Output growth Capital stock growth Labor force growth Other factors Snowbelt regions Sunbelt regions Note: Other factors includes technical change Output growth due to…

Testing the Theory The neoclassical model predicts that, with mobile labor and capital, incomes in low-wage regions will rise as capital flows in, and incomes in high-wage regions will decline as capital flows out. In other words, the theory predicts that incomes among regions will tend to move closer to each other, or converge, over a long time period. 11

Convergence for Real Output per Capita? 12 Regions in the NW and SE quadrants are moving towards (converging) to the national average output per capita. Regions in the NE and SW quadrants are moving away. Converging

Conclusions The original neoclassical growth model offers some important insights into the reasons for regional variations, but the model has serious weaknesses. – Mobility of capital and labor is assumed by the model. While capital is mobile, labor is not. – Evidence of the model’s prediction of convergence among regions is somewhat convincing. 13