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WEEKLY LETTER

November 25, 1988

Why Do Regions Grow?
It is obvious even to the most casual observer
that different regions grow at different rates.
Sometimes the reasons are clear, such as the
tendency of Alaska's economy to follow trends in
oil prices. Likewise, changes in technology or
even national and international politics may
cause dramatic changes in growth patterns.
OPEC's cohesion and the accompanying higher
oil prices accounted for Alaska's most recent
boom period. The advent of economical air conditioning undoubtedly played a role in Arizona's
rapid rise during the past twenty years. These
types of events cause bursts of rapid growth.
But after these growth spurts are over, why do
some areas continue to prosper while others
stagnate or decline? In many cases, the reasons
for differences among states' growth rates are not
as clear. Why is Nevada booming now, while Arizona's growth rate is slowing? This Letter explores
some of the possible explanations for differences
in regions' growth rates. The most important factors seem to be industrial mix and access to
labor, raw materials, and markets. The business
environment created by taxes and public spending tends to have a much smaller effect.

Industry mix
One of the most obvious and compelling reasons
that regions' growth rates differ is differences in
their dependence on growing and shrinking industries. For example, states with defenseoriented economies performed quite well
through most of the 1980s, as federal spending
for weapons systems and military supplies rose.
For example, California received 23 percent of
the nation's defense contract awards in 1984.
Thus, it is not surprising that California's employment growth averaged 2.5 percent per year
between 1980 and 1987, compared with average
growth of 1.8 percent nationally.
In contrast, regions that depend heavily on industries that are shrinking tend to perform poorly.
The fates of Alaska and Texas, which together account for half of
oil production, provide
particularly vivid examples. In the two years fol-

u.s.

lowing the oil price plunge of early 1986,
employment fell 7.6 percent in Alaska and 2.3
percent in Texas. In addition, sharp declines in
property values in both states caused problems
for local financial institutions.
From these examples, one might conclude that a
region's growth rate can be projected from forecasts of growth for specific industries, weighted
by each industry's importance to that region. In
practice, however, this approach would not be effective. The apparel industry provides an
example. Growth in the apparel industry nationwide was virtually nonexistent during the 1970s
and 1980s. In fact, employment actually fell by
6.8 percent between 1975 and 1985.
The industry mix approach would lead one to
conclude that states where the apparel industry
is important should have experienced slower .
growth. In the Northeast, the traditional center of
the:ndustry, appare'l industry employment did
fall by 21.3 percent between 1975 and 1985.
However, quite the opposite occurred in the
Southeastern states, where apparel actually accounts for a greater proportion of total
employment. In these states, the number of workers in the apparel industry grew by 10.3 percent
during those same years!
There are countless other examples of industries
that have fared poorly in one region and at the
same time have grown at a robust pace in other
regions. Thus, although industry mix does explain some of the observed differences among
regions, other factors clearly also playa role.

Business environment
One such factor may be differences in the "business climates" among regions. According to this
view, some regions are receptive to new businesses, and offer them favorable operating
environments, while other \lreas have features
that businesses find less attractive.
This argument has some appeal. For example, a
city that has easy access to a large market is

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likely to be an attractive location for many types
of enterprises. A port, a railroad or major highway running through town, or an airport that is
equipped to handle large cargo planes, can be
an important asset for a firm that needs to transport supplies and finished products from one
place to another. By the same token, anup-to~
date telecoll1municationsinfrastructure can be
crucial for a financial company that seeks to
service its accounts from a distance.
But one business environment may be attractive
to some firms and not tootheTs. This is why the
published "business climate" rankings differ so
much from each other. Different rankings place
emphasis on different characteristics, some of
which are attractive to some types of firms, and
others of which are attractive to others.
Consider, for example, two manufacturing industries, aerospace and apparel. These industries are
very different from each other, and consequently
have very different needs. An aerospace firm
would want to locate its plant in an area that
has an adequate supply of highly-skilled and
mechanically-trained workers,as well as highly
educated engineers. A good educational system
also would be important to such a firm because
it ensures a future supply of well-educated
workers. Production would be impossible withouthighly trained workers, and since production
is relatively capital intensive,other issues, including taxes and labor and land costs, would be
relatively less important.
Apparel manufacturing, in contrast, is highly labor intensive. Consequently, the cost of labor is a
critical consideration for anyone seeking to set
up an apparel manufacturing plant. A highlyskilled local work force is less critical than a
work force that will work for low wages. Because
profit margins are narrow, low land costs and low
taxes also would be advantageous for apparel
manufacturers.

In the eye of the beholder
These examples suggest that, although virtually
all firms are interested in the characteristics of a
region's labor force, the list of "desirable" characteristics varies depending on the production
process. Morevover, other factors, including land
costs, taxes, and public spending, are more important for some producers than they are for
others.

These differences explain much of the wide disagreemeent among rankings of business climate.
Some rankings place the greatest weight on
costs. According to these rankings, the best
places to locate are those with low labor and
land costs, and low taxes. Other rankings place
greaterweight on the education and skill levels
of workers, and on amenities which might make
the location a desirable place in which to live.
Theserankings suggest that the best places to locate have educated work forces, well developed
educational systems, and cultural and natural attributes that attract educated residents, even
though such areas also tend to have higher labor
and land costs, and high taxes. Thus, these two
sets of priorities lead to rankings that are diametrically opposed to each other!
Economists who have studied the effects of taxes
and government spending on business location
decisions generally have found that these factors
have little effect on the location decisions of
firms. This is particularly true at the state level.
There are too many other, more important differences among states.. However, taxes and
government spending patterns may be significant
when firms are deciding among competing jurisdictions within a single metropolitan area, since
land and labor costs vary less among such jurisdictions.
In general, however, these considerations suggest
that there is no such thing as an ideal business
cI imate. The characteristics that are attractive to
some firms frequently are the same characteristics that deter others. In fact, Professor Skoro of
Boise State University has compared regional
economic projections based on various published business climate rankings with projections
based only on the region's past economic growth.
Skoro found that past growth yielded better forecasts than did any of the published business
climate rankings.
This suggests that localities can have only a limited impact on the attractiveness of their
locations to firms. They can spend tax dollars
wisely, and minimize waste. A region with a well
developed school system and a highly educated
work force would do well to focus its recruiting
efforts on industries that seek these characteristics. In contrast, a region with a relatively
unskilled work force might be more successful if
it concentrated on attracting firms for which low

costs are advantageous. Thus, the most effective
economic development policies are likely to be
those that focus on taking advantage of what the
region already has to offer, rather than attempting
to change the economic base of the area.

regional economic growth is population growth,
but it is not always clear whether the population
movements cause economic growth, or whether
economic growth attracts population growth. In
most cases, it probably works both ways.

National economic growth

It makes sense, for example, that a state experiencing rapid population growth would have a
fast-growing economy. The economy of Arizona
during the mid-1980s provides a vivid example of
rapid economic growth associated with inmigration. As population grows, demand grows.
Construction activity booms as demand for housing grows. In addition, the need to provide
services to the larger population stimulates
growth in such enterprises as grocery stores, restaurants, gas stations, and laundromats.

Another factor that affects economic growth in
virtually all regions is the condition of the national economy. Regions tend to grow when the
nation as a whole is growing. There are exceptions, such as Alaska, which has boom-bust
cycles that seem to be completely Urlcorrelated
with national cycles. Although most states' economies are associated with the nation's, the way in
which that association manifests itself varies considerably from state to state.
One important difference is in the extent of
"comovement."ln essence, this describes the
extent to which knowing about the national
economy. provides information about the regional
economy. A state with "high comovement" is
one that follows the nation fairly closely. California is a good example ofa high comovement
state. That is, knowing that the national economy
is experiencing a boom suggests that California
probably is experiencing a boom as well. At the
other end of the spectrum are "low comovement" states, such as Alaska. Even knowing
exactly what is happening in the national economy does not provide a good picture of the
condition of Alaska's economy. Most states fall
between these two extremes, depending on the
diversity and industry mix of their economies.

Population movements
Another factor that frequently is associated with

At the same time, a growing economy tends to
attract migrants. During the oil boom years, people flocked to Texas and Alaska in search of jobs.
Until recently, Arizona's rapidly growing economy provided a strong magnet for further inmigrants.

Many factors
This discussion suggests that many factors help to
determine why some regions grow more rapidly
than others do. Technological change, industrial
mix, access to transportation and markets, and
the health of the surrounding economy are all
important. Compared to these factors, government efforts to make a particular location more
attractive to business generally are relatively
unimportant.

Carolyn Sherwood-Call
Economist

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Barbara Bennett) or to the author.... Free copies of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco 94120. Phone (415) 974-2246.

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