What is Economic Development?

 Defining Economic Development

Economic development is fundamentally about enhancing the factors of productive capacity - land, labor, capital, and technology  - of a national, state or local economy.  By using its resources and powers to reduce the risks and costs which could prohibit investment, the public sector often has been responsible for setting the stage for employment-generating investment by the private sector.

The public sector generally seeks to increase incomes, the number of jobs, and the productivity of resources in regions, states, counties, cities, towns, and neighborhoods.  Its tools and strategies have often been effective in enhancing a community's:

However, there can be trade-offs between economic development's goals of job creation and wealth generation.  Increasing productivity, for instance, may eliminate some types of jobs in the short-run.

There is lively debate within the field about the differing goals for place-based development strategies and also about whether place-based or people-based is best.  Value differences, contending ideological positions, and varied theories of how economic development occurs and how it should be practiced are presented in the following section.

Economic Development Theories

Economic development encompasses a wide range of concerns.  To most economists, economic development is an issue of more economic growth.  To many business leaders, economic development simply involves the wise application of public policy that will increase U.S. competitiveness.  To those who think that government should more actively direct the economy, economic development is a code phrase for industrial policy.  To environmentalists, economic development should be sustainable development that harmonizes natural and social systems.  To labor leaders, it is a vehicle for increasing wages, benefits, basic education, and worker training.  To community-based leaders and professionals, economic development is a way to strengthen inner city and rural economies in order to reduce poverty and inequality.  To public officials at state and local levels, economic development embodies the range of job creation programs broadened since the 1980s in response to the decline of federal domestic assistance.

Theories of economic development abound. Varying in basic, fundamental ways, they make different behavioral assumptions, use different concepts and categories, explain the development process differently, and suggest different policies. The theories used by economic developers determine, either explicitly or implicitly, how these developers understand economic development, the questions they ask about the process, the information they collect to analyze development, and the development strategies they pursue. Ultimately, theoretical insights influence how successful economic developers are in promoting local competitiveness.

To apply a theory successfully, the economic developer must understand its language.  The major theories of economic development are each summarized in terms of five fundamental elements.

Economic Base Theory
The basic categories of economic base theory are the industrial sectors of the regional economy assigned to either the basic sector or the non-basic sector. The definition of local economic development is equivalent to the rate of local economic growth measured in terms of changes in the local levels of output, income, or employment.  The essential dynamic of the theory is the response of the basic sector to external demand for local exports, which, in turn, stimulates local growth.  The economic base multiplier transmits change in output, income, and employment from the basic sector to the entire regional economy.  The theory's major strengths are: (1) its popularity as a basis for understanding economic development in North America; and (2) its simplicity as a theory or tool for prediction.  Its major weakness is its in-adequacy as a theory for understanding economic development, especially in the long term.  Economic base theory strongly supports attracting industry through recruitment and place marketing.

Staple Theory
Staple theory identifies industrial sectors as its basic categories.  It defines economic development as sustained growth over the long term.  The essential dynamic is the external investment in, and demand for, the export staple that leads to the successful production and marketing of the export staple in world markets. The theory's major strengths are its historical relevance to North American economic development and its emphasis on understanding the region's economic history.  Its major weakness is that it describes, more than explains, the development process. Staple theory provides a general strategy of development by recognizing the connections of the economic base to the political superstructure. Economic developers should continue to build on and improve the export staple as long as it remains competitive in the larger economic system.  The idea is to "stick to one's knitting," since strengthening the existing specialization may be more sensible than attempting to diversify the economic base.  Eventually, footloose economic activities (that is, those not closely tied to specific resources, inputs, or markets) will be attracted to the area if its market achieves sufficient size or if it offers urbanization economies that can be exploited by other exporters.

Sector Theory
Sector theory uses three aggregate sectors as basic categories.  The level of development depends on sectoral diversity, emphasizing a prominent tertiary sector, and labor productivity.  The essential dynamic involves the income elasticity of demand and labor productivity of primary and secondary sectors: as incomes rise, the demand for income-elastic products grows; output increases as labor released from primary and secondary sectors is employed in tertiary sectors. Although sector theory is attractive because it can be applied and tested empirically, the primary, secondary, and tertiary categories are too crude to be useful in practice.  The overriding application is the need to attend to industries producing income-elastic commodities in order to achieve sustained growth.

Growth Pole Theory
Growth pole theory treats industries as the basic unit of analysis, one that exists in an abstract economic space. Economic development is the structural change caused by the growth of new propulsive industries.  Propulsive industries are the poles of growth, which represent the essential dynamic of the theory.  Growth poles first initiate, then diffuse, development.  Growth pole theory attempts to be a general theory of the initiation and diffusion of development based on François Perroux's domination effect. Although insights drawn from the theory are useful, it has failed as a general theory of development.  Growth center strategies are based on this theory. Also summarized in the table are the growth theories of Gunnar Myrdal and Albert Hirschman, which are consonant with Perroux's theory.

Neoclassical Growth Theory
The basic categories of neoclassical growth theory are sectors or regions that comprise the macro economy.  Economic development is defined as an increase in the rate of economic growth, measured in terms of changes in output or income per capita. The theory has two essential dynamics. One, in aggregate models, the rate of saving that supports investment and capital formation drives the growth process. Two, in regional models, factor prices--specifically, the relative returns on investment and relative wage rates--stimulate factor flows that result in regional growth.  Growth theory suggests that economic developers respect the free market and do what is necessary to support the efficient allocation of resources and the operation of the price mechanism.  The simplest growth models imply that economic developers are unnecessary, but more complex formulations would support various economic development activities.

Interregional Trade Theory
The basic categories of interregional trade theory are prices and quantities of commodities and factors of production, just as in microeconomics.  The implicit definition of development is economic growth that leads to greater consumer welfare.  The essential dynamic is the price mechanism (price-quantity effects) operating to eliminate price differentials and establish equilibrium prices (the terms of trade). The theory has two unique strengths. First, consumer welfare (increases in aggregate consumption benefits), not job creation, is the goal of development. Second, the price/cost-based theory is extremely precise, yet its precision is achieved with numerous restrictive assumptions and largely by ignoring the dynamics of development.  Economists use growth theory and trade theory to advocate less government intervention and freer international trade, more open regions, and, in general, more competitive markets.  The theories provide strong support for local infrastructure development, improvement in government efficiency, and other measures that could increase local productivity and lower input costs for all producers.  Local developers, on the other hand, often ignore the implications of growth and trade theory and instead support protectionist measures and growth strategies that do not always improve the economic well-being of local consumers.

Product-Cycle Theory
Product-cycle theory treats the developmental age of the product as its basic category.  Products are classified as new, mature, or standardized.  At any point in time, the space economy can be divided into regions where new products tend to arise and regions devoted to the production of standardized commodities.  The essential dynamic of product-cycle theory is new product development, which is one form of innovation.  From locations where new product innovation takes place, the product is eventually standardized and diffused to other locations in the space economy.  The process stimulates economic growth and development in both types of locations, but the character of development is different in each. These differences help explain why levels of development vary from place to place, and why differences can persist. The economic developer who wants to apply product-cycle theory in its most literal form must try to identify and work with manufacturing companies that can create new products.  Alternatively, the developer may be able to mobilize the resources needed to improve the local business infrastructure in ways that would support new product development.

Entrepreneurship Theories
The basic category of economic development is the entrepreneurial function as embodied in the entrepreneur. Development proceeds as changes in firms and industries result in more resilient, diverse local economies.  The essential dynamic driving the development process is innovation. Innovation is conceptualized variously in different theories as new combinations, improvisation, or creative risk taking.  To its credit, entrepreneurship theory is mediated theory; people make development happen.  This strength, however, leads to the weakness that entrepreneurship theory is not easy to apply consistently.  The most general application is to support an industrial environment or ecology favorable to entrepreneurs.

Flexible Production Theories
Flexible production theories focus on production regimes and related methods of industrial organization as basic categories. The regional development implications of customized, batch, and long-run (or "Fordist") production regimes--as well as outsourcing practices, supplier relations, and processes of vertical integration and disintegration--are the principal concerns. Development is not just quantitative growth but also qualitative change in industrial mix, firm structure, and sources of competitiveness (for example, from least-cost or price-focused competition to that based on innovation, product differentiation, and niche marketing). More recent research has focused on the impact of flexible production on labor practices, compensation, and power relations between large and small firms.  The key variable or relationship (essential dynamic) that drives flexible production theories are changes in the nature of demand that require firms to become more agile; standardized, least-cost production is considered less and less viable as consumer tastes in industrialized countries become more sophisticated and global competition intensifies.  Firms adapt to this new environment by adopting flexible production technologies, managing supplier relationships, and utilizing interfirm networks for information sharing and joint problem solving. Among the principal strengths of the theory are a focus on rich, complex production dynamics within firms, between firms, and between firms and labor. Weaknesses are related to the strengths in that the focus on specific micro relations means that implications for regional aggregates are often neglected.  In terms of application, the theory informs industry cluster strategies, buyer-supplier networking initiatives, technology transfer programs, small-firm programs, and some types of worker ownership and labor management policies applied at the community level.

*Malizia, Emil E. and Edward J. Feser. 1999. Understanding Local Economic Development. New Brunswick, NJ: Center for Urban Policy Research, Rutgers University.

Economic Development vs. Economic Growth

Economists Peter Bearse and Roger Vaughan write that:

According to this view, economic development and economic growth are not necessarily the same thing. First, development is both a prerequisite to and a result of growth. Development, moreover, is prior to growth in the sense that growth cannot continue long without the sort of innovations and structural changes noted above. But growth, in turn, will drive new changes in the economy, causing new products and firms to be created as well as countless small incremental innovations. Together, these advances allow an economy to increase its productivity, thereby enabling the production of more outputs with fewer inputs over the long haul. Environmental critics and sustainable development advocates, furthermore, often point out that development does not have to imply some types of growth. An economy, for instance, can be developing, but not growing by certain indicators. Indeed, the measure of productivity should not be solely monetary; it should also represent and shed light on how effectively scarce natural resources are being used and how well pollution is being reduced or prevented. ¹

Definitions That Address Equity and Sustainability

Economic development policymakers and practitioners who are concerned about economically disadvantaged and depressed communities highlight some different issues when they define economic development. Community economic development or CED typically has five goals:

The first objective is shared by other more conventional economic and business development strategies. But the last four distinguish community economic development from many traditional approaches and are especially important for both low-income and working class communities. The practice of CED also has a strong institution-building dimension, involving the creation and strengthening of economic organizations controlled or owned by residents of the area where these institutions are located. These might include business firms, industrial parks, banks, credit unions, cooperatives, community development corporations, and mutual housing associations. Lastly, there is an implicit anti-poverty mission implied in this definition, given the goal of creating more family-wage jobs.

The following economic development definition goes further on issues of fairness, environmental compatibility, and quality of life. The Corporation for Enterprise Development has argued that economic development should help to achieve a more widely shared and sustainable quality of life. This overall definition may be broken down into three elements:

Obviously, this conception of economic development adds to the debate about the means and ends of development policy. Many economic developers see their job solely as one that concerns employment generation and income growth. They believe that they have little influence on other objectives and are not responsive to constituencies that are most concerned with issues of equity and environmental conservation.

But an increasing number of voices contends that economic development policies must pass the tests suggested by the last few definitions: Are the policies, programs, and practices generating a higher standard of living and more and better jobs? Are programs becoming more accountable, cost-effective, and user-friendly? Are they expanding opportunities for all Americans? And are they becoming more compatible with conserving our environmental assets and promoting a higher quality of life?

Why Is Economic Development Important

Economic development in the U.S. is a big deal. To start, many argue that economic development is necessary for sustaining the competitiveness of the United States economy and raising overall productivity and incomes. Second, additional development can help maintain a high level of employment and job quality for all Americans. Third, it can help to create the jobs necessary for providing middle-class opportunities for the jobless and working poor. Fourth, it can provide the earnings needed to make further investments in education, government services, amenities, infrastructure, and quality of life.

Moreover, economic development policy matters. Federal, state, and local governments spend billions of dollars in its name. So, development policy choices affect taxpayers' pocketbooks. What's more, evidence suggests that many development programs actually work and do achieve the goals listed above. ²

Economic development issues have a way of dominating most policy debates in state legislatures and city councils. Its prominence is due in part to citizens' tendency to evaluate public officials' success by how well their state or local economy is faring. If jobs are being generated, incomes are growing, and high profile companies are being attracted or retained, then a politician's tenure is likely to be extended. If not, he or she may become history.

But there is another important twist on the significance of economic development. Almost every major state and local policy debate, whether it involves taxation, welfare, environmental regulations, or workforce healthy and safety, quickly becomes a debate over economic development. Indeed, most new social and regulatory policies are fought on the grounds that they will harm the area's business climate and cause private investment to dry up. Similarly, education reform and adult retraining are promoted for their potential impact on economic growth.

What Do Economic Developers Do?

During the last thirty-plus years, the field of economic development has changed significantly. Once an ad hoc art and practice, it is gradually becoming more of a science, an industry and a profession. Today, the field has its own journals and trade associations. It is taught in universities and colleges. Certificates are awarded to those who undergo appropriate training. Regional, national, and international conferences are held from Frankfurt, Germany, to Raleigh, North Carolina.

Many lay people mistakenly believe that economic development is simply a hands-on profession. The economic developer promotes sites, visits existing industries, runs a revolving loan fund, and so forth. But this is only the field's external face.

Economic development activities and outcomes are also shaped by public policies. Funding for infrastructure, tax and regulatory policies, new workforce training grants, and countless other examples influence the environment for investment and commerce. Called "business climate," this contested term refers to the extent to which the political and policy environments of a particular state or locality, compared with other jurisdictions, are seen to be supportive or burdensome to businesses. The implication is that any area whose business climate is not "competitive" will be shunned by the corporate sector and will find it difficult to attract or grow new firms and the jobs they provide.

The business climate is affected by both major cost factors (e.g., land, labor, taxes, regulations) and non-cost factors (e.g., quality of life, attitudes toward business). Government has a big impact on business climate (and hence, economic development practice), for it is that combination of services provided by the public sector, such as education, infrastructure, taxation, and regulation, which creates the context within which companies operate. Moreover, government delivers other direct programs to companies in the form of grants, low interest loans, debt insurance mechanisms, and business advisory services.

There is no complete roster of all who are involved in this field, but here are some indicators of its size.

Once it was virtually synonymous with business recruitment efforts; now it has broadened its boundaries. Today's economic development involves initiatives ranging from improving local amenities (e.g., building a museum and aquarium) to reforming the K-12 educational system, from retaining existing businesses to fostering minority ownership of business enterprises.

Indeed, a recent trade association publication that surveyed economic developers found them in general agreement that:

Yet, in many respects the challenge is the same. Economic developers invest to build up their location and promote their assets and opportunities to prospective investors, both inside and outside the community. ⁴

Endnotes

¹Roger Vaughan and Peter Bearse, "Federal Economic Development Programs: A Framework for Design and Evaluation," in Robert Friedman and William Schweke (editors), Expanding the Opportunity to Produce: Revitalising The American Economy Through New Enterprise Development (Washington: DC, 1981), 309. back to text

²For strong examples , see Timothy Bartik, Who Benefits From State and Local Economic Development Policies?; Michael Luger and Harvey Goldstein,Technologyin the Garden; Avis Vidal, Rebuilding Communities: A National Study of Urban Community Development Corporations; and Richard Bingham and Robert Mier (editors), Dilemmas of Urban Economic Development.

³American Economic Development Council, Economic Development in Today's Economy: A Toolbox Publication from AEDC, 1998, pp.12,15.

⁴Obviously, if a treaty like the MAI is enacted, it will significantly affect business climate issues and policies and make it more difficult for local citizens to have development policies reflect some of their deeply-held values, if acting on these values entails "discriminating" in favor of local interests or particular investors and industries.