The Process of Growth

How we grow

The economic growth is defined by two distinctly different processes. As previously noted, we have used the following basic definition to define economic growth as “an increase in the capacity of an economy to produce goods and services, compared from one period of time to another” (Investopedia, N.D). However, the factors that drive these distinct processes are different and it depends on where your economy is in its development trajectory.

The first growth process is catch-up growth. Catch up growth occurs in developing nations when exogenous (outside) knowledge and technologies are applied to build better roads, schools, and hospitals etc. closing development gaps. As underdeveloped nations start with less capital, their productivity is substantially boosted, rapidly driving up productivity by replicating methods of production, technologies, and institutions used in developed economies. As a result catch-up growth can lead to growth rates as high as 5-10 per cent as seen by China and South Korea over the last few decades. (Sachs, 2015).

The second growth process is endogenous growth. Endogenous growth refers to the “economic advancement that emerges from the internal workings of the economy (Sachs, 2015).” Endogenous growth requires nations to have skilled workers, be technology leaders and their business need to have the capabilities to develop new and sustain competitive advantages. Endogenous growth therefore comes from innovation of new machinery, techniques and industries; and a must in order to belong to the developed world.

The process of endogenous growth is sometimes also referred to as “a process of increasing returns to scale or chain reaction economy” as allows for spill-overs that continue to stimulate further and combine innovations (Sachs, 2015). Acemouglu and Robinson (2012) go further in their definition to suggest endogenous growth also is about having the capabilities to transform and respond the “wide spread creative destruction” which is associated with innovation. As endogenous growth is not about adoption but creation, it is harder and slower process at around 1-2 per cent growth in GDP a year (Sachs, 2015).

Why it matters

Making the distinction between the two growth process matters because it requires different institutions[1] in that catch-up growth is about adoption and endogenous growth is about innovation (Acemouglu and Robinson, 2012; Sachs, 2015). And economic developers are not always conscious of this in their interventions.

Catch up-growth requires governments to have a stronger role in stimulating growth directly. Governments of developing nations need to quickly develop infrastructure, advance human capital outcomes and attract investment which are considered a prerequisite for endogenous growth.

While the role of government in stimulating endogenous growth more about enabling the private sector to innovate and be competitive. Government role is more about regulatory reform that enables structural change, advanced workforce development such as STEM programs and R&D.

[1] A  nations cultural, norms and regulative elements

Achieving Even Growth – in Western Australia and anywhere else

Cities play a new economic role in the global economy, becoming economic territories in their own right. Urbanisation is a defining phenomenon of this century, and today, more than half the world’s people live in cities (World Bank Group, 2009). It is an economic force known as ‘agglomeration’ that drives urbanisation, and therefore, offers a platform to study how place growth and competitiveness occurs.

Economic agglomeration occurs when firms are attracted to a place to take advantage of the specialisation and scale and skilled workforces are attracted to the diverse employment opportunities and social offerings that a city offers. This relationship between firms and skilled workforces creates new ideas (innovation) and new businesses (through spill overs of ideas) that enable productivity gains, the creation of new jobs and increases income for its citizens (World Bank Group, 2015). Thus cities become a powerful force in driving economic development.

Agglomeration refers to a dynamic system where firms and people are drawn to co-locate close to one another, and as a result, these places become more productive, driving long-run growth. There are two main sources of agglomeration: urbanisation economies and localisation economies (Maynard, 2017).

Urbanisation economies refers to benefits that firms in a number of different industries receive from population and infrastructure clustering. Specifically economies of scale that can be gained from by being located close to one another. An example of this is a shopping centre (Maynard, 2017).

Localisation economies refers to the benefits that firms in the same industry gain from being located close together. These include labour pooling and knowledge spill overs. An example of this is an industrial cluster such as silicon valley (Maynard, 2017).

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Is it time, do we need a new industrial strategy?

The merits of industrial policy have been long debated; with it’s of success less discernible. As a result, for a long period there governments have had no appetite to return to a purposeful industrial policy – that is, until now.

Earlier this year, the United Kingdom (UK) Government released a new Industrial Strategy green paper and it brings new thinking. There are modernisations to the strategy, in that, it is innovation and technology focused, business-led, focuses on cluster, is integrated with other policy objectives and aims to achieve wider societal goals such as equality through economic development. However, the biggest innovation is that its sectorial approach is administered at the place level. In other words, the strategy aims to develop sectorial policies that take into consideration the specific advantages and needs of places and their industries (The Conversation, 2017).

This renewed focus isn’t being driven just by the UK, the United States and other institutions such as the European Commission, OECD, World Bank, and the Centre for Cities are beginning to focus on industrial policy once again. So what is driving this renewed focus on industrial policy, what lessons are there to be had and should we be paying attention?

Industrial policy is defined by the World Bank Group ( 2016) and the DCED (N.D) as “government efforts to alter industrial structure to promote productivity-based growth” and notes that industrial policy has been “used to support or protect sectors expected to offer better prospects for economic growth or societal welfare” (2016).  Kroes (2006) provides a more contemporary definition as “one which frames the structural conditions necessary to ensure economic success in a globalising economy”.

 The History of Industrial Policy

The history of industrial policy stems back to the days of protectionism and governments trying to create industries. Giuale (2014) notes that policies from the 1950-1980s treated industrial as “infants – in need of all kinds of support until they could survive on their own.” Public servants would pick industries based on their ability to create jobs, to attempt import substitution, to support flagging industries or where it was believed future growth opportunities. Governments provided these industries tax breaks, discounted credit, subsided utilities, government contracts and even capital injections when they became uncompetitive (Giuale, 2014). It has been argued that this period of industrial policy led to outcomes worse than market failures with few winners and the observation that public servants are not capable of picking winners (Giuale, 2014; World Bank Group, 2016).

The 1980-1990s focused more on export, privatisation, de-regulation and de-industrialisation of sectors. Eventually, industrial policy fell out of favour with governments from the 2000’s onwards, with a horizontal approach preferred. Instead industry support was broad-based, focusing on the business environment, innovation and competitive forces rather than sectors (Aiginger, 2014; The Conversation, 2017; World Bank Group, 2016).  On occasions, some sectors were supported more where horizontal policies were found to not be specific enough or where instruments had an unintended impact (Aiginger, 2014).  However, no industry has ever succeeded without some backing from its government.

The Resurgence

Since the 2008 financial crisis, there has been a renewed push for “industry-oriented ‘integrated’ policies (Aiginger, 2014). The financial crisis highlighted that there was an imbalance in many developed economies with the financial sector making up a larger proportion than it should. This is because the financial sector is not a driver of innovation or export growth in itself (such as manufacturing and agriculture industrial sector) and therefore, it reaches a point in which growth of the sector does not correlate to economic growth (Aiginger, 2014, University of Bath, 2013; World Bank Group, 2016).

Although public policy cannot fully anticipate market demands and cycles, there is a role for governments to enable structural change through stakeholder collaboration on innovation and market development, pre-competitive investments in infrastructure and skills; and support structural change to achieve societies long term goals (i.e inclusiveness, environmental sustainability and job creation) (Aiginger, 2014; Altenburg et al, 2016). Evidence has shown that industrial policies that have focused on innovation, skills, technology development of sectors and promoted positive externalities have been more successful in achieving productivity improvements and societies long term goals (Aiginger, 2014; University of Bath, 2013; World Bank Group, 2016). Leading some to call for a reformed industrial agenda and argue that it provides “proper recipe for real economic growth and structural transformation” (World Bank Group, 2016).

Lessons from industrial policy

There have been many evaluations of industrial policy and there is now a deeper understanding of how industries grow and the types of government instruments that are more effective.  The following is a summary of a few recent evaluations that have informed the new UK Industrial Strategy and perhaps, provide a platform for our own industrial policies:

  • Macro policies shortfalls: Neo-liberal policies implemented since the 1980s (i.e. de-regulation, privatisation and reduced government role) have facilitated the growth and power of a few multinational corporates and the ability for a few company to destabilise the economy (University of Bath, 2013). While the London School of Economics (LSE) Growth Commission (2017) notes that monetary, fiscal and competition policy have gaps governments can do more to stimulate sustainable competition and economic growth;
  • Picking Winners: Industrial policy should benefit everyone and not favour individual firms i.e. “pick winners”. Policies that enable firms to gain power and dominate the market locally (multinational national corporations) “can lead to situations where public interest may not met and enable hollowing out of the sector, tax avoidance and lower wages (Aiginger, 2014; University of Bath, 2013). Governments should only take specific firm level interventions when the long term success of an industry or a place is in distressed i.e. significant job losses, recessions (Aiginger, 2014);
  • Locked-in: Industrial policies are “necessary to prevent locked-in situations” where industry continues to pursue conservative strategies or develop backward ‘dirty’ products because that was what had previously worked or considered the norm (Aiginger, 2014). That is because “development is fundamentally about structural change: it involves producing new goods with new technologies and transferring resources from traditional activities to these new ones” (Dani Rodrik, 2007);
  • Co-operation: Industrial policy should enable an environment of co-operation between government and the private sector that facilitates cross-sectoral spill-overs that extend beyond financial gains (Aiginger, 2014). Industrial policy should be relatively business led and provide a framework to develop new comparative advantages through collaboration and competition between firms, with links with institutions (such as universities and research institutes) within and relationships outside regions to develop global markets and enable knowledge spill overs across sectors (Aiginger, 2014; University of Bath, 2013);
  • Place-based: Industrial policies appear to be best “tailored at regional and local levels (in particular, cities) to promote regional re-generation, nurture and exploit cluster dynamics” (Centre for Cities, 2017; University of Bath, 2013). That is, industrial policy “needs to take a place-based perspective” and look to enhance the existing strengths, address growth constraints and strengthen agglomeration forces (Centre for Cities, 2017);
  • Skills, knowledge and technology: Industrial policy has traditionally focused on sectors, however it is the “skills profile” of a locations business base that enables knowledge and technology development and therefore has a more important bearing on a place and its economic performance (Centre for Cities, 2017);
  • Export Driven: Export businesses enable economic growth as they tend to be higher skilled, driving up productivity and brining wealth into the community which flows on to create jobs in the local sectors such as shops, cafes and doctors (Centre for Cities, 2017). Export business also prefer city locations due to their ability to access “knowledge and ideas, deep pools of workers, and markets and suppliers” (Centre for Cities, 2017); and
  • Integrated: Industrial policy should be integrated and forward-looking. Innovation is a key driver of economic growth and structural change. Therefore industrial policy should be “merged with innovation policy” and delivered through a systematic approach that aligns with other policies such as environmental sustainability, competition and education (Aiginger, 2014, Centre for Cities; 2017; LSE Growth Commission, 2017).  Figure 1 provides a systemic view of integrated industrial and innovation policy.

Australia may not have as much of a reliance on the financial sector; however our sectors are rapidly losing competitiveness, while other places lack economic diversity. So is it time we reviewed our approach to supporting business, the type of development we aim to achieve and the way we support places and their firms to compete. Do we need a new industrial strategy like the UK?

You can also find out more information on the Centre for Cities, 10 ideas for a successful place-based industrial strategy here.

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Aiginger, K. (2014) Industrial Policy for a sustainable growth path. European Union, Welfare Wealth Work. P.g.10

Giugale, M. (2014) Economic Development: What Everyone Needs to Know. Oxford University Press: New York.

Economic Development vs Economic Growth

While I have called this blog “Growth Economics”, economic development is the higher order concept to economic growth. This is because economic development moves beyond the growth of Gross domestic Product (GDP) to include improvements across many areas of a complex system and can encompasses economic, social and environmental outcomes.

I would therefore like to cover economic development and how is it measured as the first blog. Essentially the purpose of this blog is to act a learning journal; and to capture and share all of the fantastic things that I read and learn regarding economic growth and development theory and practice. Later I will explore other factors have an impact, direct or indirect economic development.

Economic growth is narrow concept of the two and generally refers to the growth of economic output from one period to the next. Economic growth is usually measured by a country’s GDP “the monetary value of all the finished goods and services produced within a country’s borders in a specific time period” (Investopdedia, N.D). However, there are various problems with applying a narrow view of growth and using GDP the primary indicator. This is because as growth becomes quantifiable in terms of current market prices and only the value of the final good or service is measured leading to many shortcomings (Hans Economics, 2012).

For example, GDP does not:

  • measure inputs, intermediaries or good and services that pass through unofficial markets;
  • consider whether the good or services is in demand, of high value or innovative (thereby replacing old products);
  • GDP does not measure non-market activities that benefit society as a whole such as raising a child, leisure time or public-sector services and government spending (e.g education and health);
  • discount economic activities that do not directly raise the wealth of individual (e.g defence spending), production that leads to negative externalities or where production is increased are produced in response to a negative situation such as a cyclone (Investopedia, N.Da); and
  • measure individual wealth, the distribution of wealth or the long-run impact of wealth generation (Sachs, 2015).

Economic development is a much broader concept that is concerned about the standard of living and the wellbeing of individuals, as well as the prosperity and future potential of the whole system. The IEDC (N.D) describes economic development “as a process that influences growth and restructuring of an economy to enhance the economic wellbeing of a community.” The World Bank Group (2017) refers local economic development as the “economic capacity of a local area to improve its economic future and the quality of life for all. It is a process by which public, business and nongovernmental sector partners work collectively to create better conditions for economic growth and employment generation”.

The pathway to economic development involves many different ingredients and will be different for different communities and therefore each community must address different factors according to their advantages, constraints and barriers. Amongst many others, economic development moves beyond simple indicators such as GDP to include: how well income is distributed (Gini coefficient); participation rates; environmental sustainability; political stability and good governance; how well educated and healthy people are; innovation rates; and how happy people are.

For a more comprehensive list of indicators, the World Bank Group have a comprehensive list on their site here.