Economic Development Strategies for the New Economy

In the New Economy, the ticket to faster and broader income growth is innovation. The New Economy puts a premium on what Nobel Laureate economist Douglas North calls “adaptive efficiency,” which refers to the ability of institutions to innovate, continuously learn, and productively change. As markets fragment, technology accelerates, and competition comes from unexpected places, learning, creativity, and adaptation have become the principal sources of competitive advantage in many industries. Enabling constant innovation needs to become the goal of all organizations committed to prospering. Similarly, the goal for states must be to foster innovation and adaptation—in infrastructure, in institutions, and on the part of individuals.

These efforts need to be proactive and designed for the long-term. States need to challenge all economic sectors and institutions, including their own institutions of government, to become cultures of innovation. The consequences for any state that does not respond to this challenge are low productivity, stagnant living standards, and reduced opportunity for its citizens.

Innovation and change mean uncertainty and disruption. But it is becoming increasingly clear that dynamism is critical to growth. (You can’t have upward mobility if no one is on the move.) The more churning in a state, in terms of new business start-ups and existing business failures, the faster the state’s rate of economic growth. In fact, of all of the indicators in this report, churn is the second-most-strongly correlated with state employment growth (behind jobs in gazelle companies). This means that states need to promote change and innovation, not retard it.

In this New Economy, traditional rationales and goals for economic development need to give way to new ones. With the national unemployment rate at a 30-year low of around 4 percent, and the highest unemployment rate of any individual state at 6.6 percent (West Virginia), job creation is at least temporarily no longer job one.
The challenge now is to create a progressive economic policy framework that will encourage a new era of higher per-capita income growth, while promoting and enabling a broad-based prosperity that produces the widest possible winners’ circle.

Despite recent strong gains (over 2 percent per year for the last two years), productivity and per-capita income growth have each barely exceeded 1 percent per year over the last 25 years—their lowest levels in a half century.28 Moreover, income growth has been unequal: while well-paying jobs increased by 20 percent in the last 10 years, moderate wage jobs did not grow, and low-wage jobs grew 10 percent. In addition, growth has been geographically uneven in many states, with innovation-oriented, knowledge jobs concentrating in a few metropolitan areas, while other areas often languish. The recent strong productivity gains and wage growth across all income groups are welcome news, but states need to ensure that the trend continues well into the 21st century.

To achieve these new goals, states will need to overhaul their familiar approaches to economic development. In the old economy, fixed assets, financing, and labor were the principle sources of competitive advantage for firms. That’s why states focused on physical infrastructure for factories, gap financing for big industrial projects, and marketing and incentives to attract industry. But following a low cost, industrial recruitment strategy—cutting taxes and services in hopes of making a state attractive to companies—is no longer the path to raising wages and quality of life.

In the New Economy, states need to shift their focus from “hunting and gathering” (industrial recruitment) to “gardening” (promoting growth from within).

Tomorrow’s jobs will come from fast-growing entrepreneurial firms, and not from the small number of business relocations. States that ignore entrepreneurial growth in favor of expensive zero-sum industrial recruitment will do so at their own peril. A case in point is Iowa, which in the early 1980s chose not to provide a loan and business assistance to Ted Waitt, a twenty-something fledgling entrepreneur seeking to start a new firm, since his was not a large firm nor a big industrial recruitment prospect. Waitt, who had an idea of selling computers by mail order, stayed in the same metropolitan area, but went just across the state border to South Dakota, which was more than happy to help him grow his company. Today, that company, Gateway, is one of the largest employers in South Dakota.

Unfortunately, many states continue to pursue Industrial Age economic development strategies that seek to attract out-of-state investments through corporate tax subsidies, abatements, and assurances of low labor costs. To make matters even worse, many states subsidize companies that pay very low wages. These strategies are increasingly out of touch with the factors that constitute success in the New Economy: good public education, an R&D infrastructure, availability of job-specific skills training, quality of life, quality government, and innovative economic development efforts. This is not to say that fiscal discipline should not be a cornerstone of government in the New Economy. But low costs with a poor quality of life are not the tickets to success.

Rather than simply trying to cut costs, pass out incentives, or react to each new economic gyration, states should instead invest in the foundation areas for growth in the New Economy. A progressive, innovation-oriented state policy framework for this New Economy should rest on five pillars: 1) Co-investment in the skills of the workforce; 2) Co-investment in an infrastructure for innovation; 3) Reinvention—and digitization—state and local governments; 4) Foster the growth of the digital economy, and 5) Foster civic collaboration.

Co-invest in the Skills of the Workforce

Lack of progress in education is cause for concern. Nationwide, K-12 performance has simply failed to keep up with the pressing need for a skilled workforce—in spite of continued increases in spending.29 And industry has cut back its expenditures on training.30 States need to adopt policies to ensure that American companies have the skilled workers they need to be productive, while simultaneously ensuring that American workers have the skills they need to navigate, adapt, and prosper in the New Economy. States can do several things to improve K-12 performance and foster skills of the workforce:

Hold all students to high standards. Standards-based K-12 reform is already bearing fruit in many states. States that have adopted rigorous standards and are assessing progress against them have seen significant increases in school performance, especially among underprivileged students. Particularly noteworthy are Kentucky, North Carolina, and Texas, which have all made considerable progress as a result of standards-based reform. High standards and meaningful assessments mean real accountability for school systems, administrators, teachers, and students.

Adopt sensible public school choice policies. Charter schools, inter-district public school choice, and open enrollment are all tools that states are using to stimulate competition, give parents options, and raise the quality of public schools. There are charter school laws on the books in 34 states and the District of Columbia, and more than 1,100 charter schools are in operation nationwide. Public school choice—with real and meaningful choices for parents—is critical to improving schools.

Overhaul antiquated K-12 public school funding systems. Public school choice and high standards will be meaningless if resource allocation isn’t modernized. The reliance on the property tax to fund schools results in gross inequities between affluent and impoverished communities, and is particularly inequitable to rural areas. Currently, 17 states have school finance litigation in their courts and are wrestling with changing their finance structures. In addition, eight states, including Texas, Arizona, and Arkansas, have overhauled their systems in the past three years. Money alone will not solve educational problems; however, neither will a lack of resources. In addition, outmoded funding systems hamstring charter schools and efforts to increase public school choice.

Provide incentives for the creation of math and science charter high schools specifically focused on serving disadvantaged students. K-12 education needs to give students the math and science skills they need to succeed in the New Economy. In the last 15 years, states such as North Carolina and Illinois have established math and science magnet high schools, but these schools have generally not focused on disadvantaged students. If states are to encourage students—including minority students—that have not traditionally gone into science and engineering fields, they need to target their efforts.

Co-invest in industry-led regional skills alliances. A number of states, including Pennsylvania, Rhode Island, and Wisconsin, are shifting the focus of workforce training efforts to support industry-led skills alliances. For example, as part of the Wisconsin Regional Training Partnership, a number of metal-working firms, in conjunction with the AFL-CIO, used an abandoned mill building to set up a teaching factory to train workers with needed skills. In order to jump start and add to the scale of these efforts, the Progressive Policy Institute has proposed that the federal government provide matching funds for industry-led regional skills alliances (RSAs). Bipartisan legislation has been introduced in Congress, and as part of the Administration’s “Life-Long Learning” agenda, Vice President Gore recently announced a proposal to commit up to $60 million in the FY 2000 budget to promote RSAs.31 States should play active roles in the creation and co-funding of these alliances.

Rationalize programs funded under the 1998 Workforce Investment Partnership Act to create one-stop shops for all employment and training services. The Act gives states significant authority to craft comprehensive workforce development systems. But states must make these programs as user-friendly as possible. States should consolidate the welfare-to-work systems now being created so they do not end up with two separate bureaucracies focused on training disadvantaged workers. States should also take advantage of the authority granted in the Act to provide training and re-employment vouchers to individuals in need of services, and the vouchers should be coupled with “consumer report cards” to track the performance of training providers.

Increase scholarships for students attending public or private technical schools. A number of states have introduced legislation to address businesses’ needs for more technically skilled workers by having the state pick up the students’ tab for community college tuition and technical training. Governors in at least 16 states have proposed establishing, increasing, or expanding scholarship programs this year. For example, a bill introduced in the Michigan Senate would provide a $300 state tax credit to cover the balance of a student’s Michigan community college tuition that is not covered by the federal Hope Scholarship tax credit. The state tax credit would be available to all students from two-parent households with incomes under $100,000 and single-parent families with less than $50,000 in annual income. In Delaware, the House Education Committee unanimously approved a bill that would allow any Delaware student who graduates from a public or private high school with at least a 3.0 grade point average to attend the Delaware Technical and Community College free for two years. Students must be accepted and enrolled as a technology student.

Co-invest in an Infrastructure for Innovation

Innovation drives growth in the New Economy. Two-thirds of per-capita economic growth stems from technological innovation. While states that score well on innovation indicators actually showed lower rates of job growth between 1991 and 1996 (there is an overall correlation of -0.15 for the 50 states), they scored much higher on rates of growth in per-capita income (a correlation of 0.24). In other words, the higher the score on innovation capacity, the faster the incomes of the residents went up. As a result, if states want to boost the incomes of their residents, embracing technological innovation is a key path. And technology jobs are not just in Silicon Valley. In fact, the fastest growing high-tech areas of the country are places like Lancaster, Pennsylvania, and Boise, Idaho.

Invest in higher education, particularly in science and engineering. The United States is not educating enough scientists and engineers, particularly computer scientists and technical engineers. The number of students receiving bachelor of science degrees in engineering has fallen to a 17-year low. Between 1986 and 1998, they declined by 19.8 percent, while the overall number of students receiving bachelor’s degrees increased by nearly 20 percent. Not only do investments in engineering and science programs produce the type of knowledge-based workforce that states need in order to prosper, but strong science and engineering departments are critical to fostering industry/university partnerships and commercializing technology.

Boost efforts to link industry, universities, and government laboratories. All 50 states invest in initiatives to foster collaborative R&D (through research “centers of excellence,” for example). But state investments in these initiatives have increased little in the last 10 years as states have pursued more expensive—and often dubious—industrial recruitment incentives.

Boost R&D tax credits, or create them if they don’t exist. In 1996, 35 states offered an R&D tax credit, but most were modest, averaging less than 5 percent. At 22.5 percent, Rhode Island has the highest rate in the nation. Studies show
that the R&D tax credit is an effective way of stimulating private-sector R&D.32

Support the commercialization of innovation. Increasingly, states are focusing not just on fostering the development of new technologies, but on helping businesses to grow by commercializing the technologies (developing, producing, and marketing new products). States such as Oklahoma, Kansas, Florida, and North Dakota have all recently developed initiatives such as commercialization centers or technology business assistance programs to help entrepreneurs commercialize technology.

Encourage “co-opetition.” Competition for market position has been increasing, but so has the frequency of collaboration among competitors. In fact, management expert Peter Drucker and others have suggested that the organizational dynamic of networks, partnerships, and collaborative ventures is a main organizing principle in the New Economy. This kind of coopetition, as Harvard business professor Michael Porter and others have shown, is often regional (for example, optics in Rochester, Minnesota; furniture in Tupelo, Mississippi; hosiery in western North Carolina; and information technology in Silicon Valley). As Berkeley professor AnnaLee Saxenian notes in Regional Advantage: A Study of Boston’s Route 128 and Silicon Valley, “Innovation is a collective process as well as an individual one.”33 States should support all kinds of collaborative partnerships and networks by reorienting their economic development and training programs to support regional industrial clusters. For example, Rhode Island’s Samuel Slater Innovation Fund provides matching funds to industry clusters focused on improving their competitive position.

Promote Innovation- and Customer-Oriented Government

States with the most innovative, customer-oriented institutions (businesses, non-profits, and governments alike) will be the winners in the New Economy. But current government organization in most states has been borrowed from the mass production, hierarchical model, tending to produce many (if not more) of the same rigidities, inefficiencies, quality problems, and customer dissatisfaction that plague similarly structured businesses.34 If Industrial Age state governments do not transform into Information Age governments, they will impede rather than advance progress.

Old, managerial, command-and-control models don’t work anymore in business, and they don’t work in government either.35 Developing customer-oriented government is important not just because it cuts costs, but also because it improves the quality of life in a state. And both are critical because states’ ability to retain and attract highly educated and skilled “knowledge workers” will help shape competitive success. In order to grow or attract the kinds of knowledge-based industries driving economic growth today, a state must first be attractive to these mobile, well-educated, knowledge workers.

Be on the forefront of providing government services online. The motto “online, not in line” should guide state efforts to use digital technologies. Digital government efforts simultaneously cut costs and improve services. For example, Massachusetts residents receive a $5 rebate when they renew their drivers’ licences online because of the cost savings and efficiency gains for the Department of Motor Vehicles. But a large share of state government functions can be conducted online. Every state’s Department of Administration should conduct a study of significant business-to-government or citizen-to-government interactions and assess the potential for conducting those transactions electronically.

Foster the Transformation to a Digital Economy

As the Internet has mushroomed and the cost of computing and telecommunications technologies continues to plummet, a digital economy is beginning to emerge in the United States, with a significant share of business and government transactions starting to be conducted through digital electronic means. The U.S. Internet economy was recently estimated to have generated some $300 billion in revenue and to have supported over a million jobs in 1998.36 But if the digital economy is to reach its full potential, government regulatory, tax, and procurement policies must be aimed first at not hindering and then, where possible, at proactively fostering this transformation.

While the digital economy will be driven by the private sector, there are a number of things states can do to foster its growth:

Work together to establish a uniform legal framework to encourage electronic commerce. Since the Internet knows no borders, it would be counterproductive for individual states to create legislation affecting the Internet in isolation. Of particular concern are issues like spam (unsolicited commercial e-mail), business and professional licensing (for doctors, for example), and taxation. Another important issue is the use of digital signatures, which allow individuals to authenticate themselves online. (There are currently more than 20 states with some kind of digital signature law on the books or pending.) All of this legislation should be consistent with model legislation created by the National Commission on Uniform State Laws so that all states sign onto the same policy framework. Otherwise, the risk is a digital-era Tower of Babel with 50 different sets of laws dictating how companies sell goods or provide services over the Net. It is true that states have historically enjoyed a degree of autonomous authority over such matters of commerce, but if they do not coordinate and establish a common framework for governing digital commerce, affected industries will rightly go to Washington to press for federal preemption. One way or another, the Internet will acquire uniform rules.

Ensure that laws and regulations do not harm the growth of the digital economy and the Internet. One of the first things states can do is examine their existing laws and regulations and amend any that discriminate against electronic commerce. But it will be just as important going forward to avoid creating new laws that will place a drag on the Internet economy. For example, states should not tax the use of the Internet itself—for example, by imposing taxes on the fees consumers pay to Internet Service Providers to access the Internet. In 1998, over 800 bills related to the Internet were introduced in the states, and over 500 have been introduced so far in 1999. Some of these bills are carefully crafted and well thought out, but many are not. Some Internet-related state legislation can be particularly counterproductive. For example:

• A proposed bill in New Jersey would let individuals sue their Internet Service Providers (ISPs) for unsolicited commercial E-mail that other individuals or companies transmit over the ISP’s network.

• Tennessee is considering legislation that would make ISPs liable for blocking access to specific web sites that post sexually-explicit content not suitable for minors. The fact that most ISPs have customers in multiple states, and sometimes even countries, means that they would have to find some way to block some sites for some customers, and others for other customers.

The costs and confusion resulting from these types of laws can be significant. Moreover, both measures would turn ISPs into Internet cops.

States need to resist pressures from businesses and interest groups threatened by the Internet. These groups must not be allowed to use the power of government to protect themselves against economic change that benefits all consumers. Among recent examples:

• The Unauthorized Practice of Law Committee in Texas recently won a ruling that could lead to a ban on the sale of Quicken Family Lawyer, a software package that lets consumers create legal forms such as wills and simple contracts without the help of a lawyer.

• Wine distributors in many states have lobbied successfully for rulings making it illegal—a felony in some states—to buy wine over the Internet. In contrast, some states have made it legal to sell wine provided the buyers pay the sales tax and show proof of age when the item is delivered.

• In Washington, university faculty have protested against distance learning online. More recently, the American Federation of Teachers began running ads opposing distance learning.

• State professional licensing requirements that do not recognize licenses from other states limit the practice of tele-medicine and other kinds of online professional services.

In these and other cases, entrenched business and professional interests have raised barriers against new forms of commerce, and in so doing have effectively raised prices and reduced access for residents in their state. States that facilitate this sort of entrenched resistance are only impeding progress for themselves and the nation.

Encourage faster deployment of broadband telecommunications technologies. The lack of high bandwidth telecommunications capacity, especially to the home, is a barrier to progress in the Information Age. State telecommunication regulations need to remove barriers to market-led investments in broadband infrastructure. One thing states can do to ensure this is avoid applying the existing telephone universal service regulations to the Internet and broadband telecommunications. Applying this old economic framework would likely have the unintended effect of slowing down the deployment of these technologies.

Support Internet access at public facilities. At least for the next several years, most Americans will not have Internet access at home. Yet, public access is currently limited. For example, only half of American libraries (47.9 percent) offer Internet access, while only 9.2 percent offer access in all their local branches. Ensuring that places like libraries, schools, community centers, employment centers, and other public agencies (particularly those in lower income areas) provide sufficient free access to the Internet will enable all individuals to access these technologies.

Actively encourage widespread use of digital signatures. Individuals must be able to verify their identity online if there is ever to be a truly robust digital economy. Digital signatures are an important part of the solution. But institutions cannot begin offering services that will require digital signatures (such as online loan applications by banks) until a large number of citizens actually have digital signatures. And yet a large number of people will not have digital signatures until they need them for electronic transactions. States could play the critical role of solving this “chicken or egg” conundrum by enabling their Departments of Motor Vehicles to begin issuing digital signature certificates to all citizens who choose to apply for them. This is a similar to the function DMVs already perform by issuing drivers’ licenses and state ID cards. Unlike in those cases, however, DMVs should not monopolize the process; citizens should also be able to obtain digital certificates from private sector sources.37

Foster Civic Collaboration

In the New Economy, “an infrastructure for collaboration” is a key component of success. As Harvard Business School Professor Rosabeth Moss Kantor writes in her book World Class, “Politics involves battles over distribution: who gets which slices of the pie. A community’s social infrastructure, in contrast, offers the prospect for expanding the pie. Yet, the social infrastructure (for collaboration) is too often neglected, allowing the area to remain fragmented and balkanized.”38

This social capital—the ability of people to work together for a common purpose in groups and organizations—is a characteristic of successful regional economies around the world, from Silicon Valley in California to the Emilia Romanga region in central Italy. These places have begun to work collectively and to see their competition as coming not from another part of the state, but from outside the state or region.

For example, Silicon Valley was so concerned that a growing
“culture of blame” was inhibiting collective problem solving that the region created a partnership of business, government, and
community-based organizations called “Joint Venture Silicon Valley” to collectively address issues standing in the way of the area’s future progress. Numerous other regions and states, including San Diego, Pittsburgh, Kansas, Indiana, and Rhode Island, have also developed similar public-private councils to foster economic and community development.

In the New Economy, the successful states and regions are the ones with the most effective collaborative networks that craft and implement innovative solutions to public policy questions, placing the public interest above a narrow interest in maintaining the status quo.

Form economic policy councils that bring together key leaders in business, government, labor, civic groups, and higher education to provide in-depth analysis of the economy, develop creative economic strategies, and build widespread consensus for action.

Foster sub-state regional collaborative efforts that bring all the parties to the table to collectively develop and implement economic strategies for their regions.

Summary

The New Economy is here to stay—there’s no going back. It brings enormous potential for the growth of state economies, but also introduces challenges. If states do not invest in a knowledge infrastructure—world class education, training, and technology—companies will not have the skilled workers and cutting edge tools needed to grow and create well-paying jobs. If states erect barriers to the growth of the Internet and the digital economy instead of facilitating it, the real incomes of their residents will ultimately suffer from lost growth potential. And if Industrial Age state governments do not transform themselves into Information Age governments, they will impede, rather than advance growth. Simply put, states that meet the challenges of the New Economy—focusing on innovation, learning, and constant adaption-will be the ones that succeed and prosper.

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