Business dynamics and economic performance in the Midwest: A look at the new Innovation 2.0.

• Author: Slaper, Timothy

The Indiana Business Research Center recently launched Innovation 2.0. It is a rich compilation of a broad array of measures of innovation at the county, metropolitan statistical area (MSA) and economic development district levels nationwide. What follows is something of a case study for how a researcher might use the Innovation 2.0 data.

Inside Innovation 2.0

Innovation 2.0 provides a robust set of relevant measures of innovation and regional competitiveness that are constructed based on research pertaining to the forces and prerequisites of competitiveness and performance. The importance of clusters to regional economic growth has been well-documented elsewhere. The regional competitive model that is advocated here focuses on the regional character of internally generated (i.e., internal to the region) growth through innovation and entrepreneurship. Put differently, fresh ideas and a propensity to take chances provide a fertile seedbed for innovation and a foundation to create new economic opportunities.

Innovation 2.0 is a web-based tool, available at www.statsamerica.org/ii2, for regional economic development practitioners to identify the innovation-based strengths and weaknesses of a regional economy. Many of the measures used gauge the foundational elements that are currently in place in the region for future, innovation-driven economic growth. Some of the measures gauge the degree to which the region is attractive to new talent and firms that may also enhance the regional economy, but those same measures of attractiveness are also measures for retaining current talent and firms.

Certain regional characteristics, in other words, work like gravity, keeping objects on the ground and pulling objects to the ground. It is hoped, therefore, that Innovation 2.0 is not primarily used to try to attract outside firms, resources and talent, but is used to identify indigenous sources of innovation and ways to fortify those sources. Encouraging homegrown entrepreneurs with personal commitments to the region, for example, is preferred over attracting talent with minimal personal investment in the region.

The index measure that is a key component of Innovation 2.0 is admittedly not perfect. Researchers have noted the pitfalls with creating indexes. For example, using indexes can result in a loss of variability and explanatory power through the grouping of data. This is something we will attempt to address later in the article as we evaluate which regional characteristics are better equipped to explain MSA performance in the Midwest.

Imperfections aside, the Innovation Index version 2.0 presents a state-of-the-art measure of county and regional innovation capacity and performance. This index can serve as a valuable tool for policymakers and practitioners to quickly evaluate innovative capacity and potential. Economic development practitioners not only get a quick snapshot of how their region is doing in terms of innovation with the headline index, but they also have the ability to drill down and get dirty in the data to gain a better understanding about their regions strengths and weaknesses.

It is not surprising that developing data-driven regional development strategies requires data. The Innovation 2.0 project consolidates data from multiple public sources. The vast majority of the data items used in the Innovation Index are county-based and are available for download by county, MSA and other official statistical areas. The website currently aggregates the index components in an equal, unprejudiced manner. That is, the data are assembled thematically and with no judgment calls regarding what measures are the most relevant in terms of measuring innovation capacity.

The next step for the IBRC researchers is to conduct empirical analysis. This article is part of that next step, something of a case study in how a researcher or an economic development practitioner can use the Innovation 2.0 data to determine which factors are the most important in driving regional innovation and economic performance.

The "headline" index--the one, high-level summary index--is comprised of five major categorical indexes organized thematically. Those five major indexes are built up from several core indexes that are built up from numerous measures.

One of the new features in this version of the index is that users may also include the optional social capital index in the calculation of the overall index.

An additional state context category is displayed as part of the data output. It is for reference only and not included in the calculation of the overall index because many regions, official or user-defined, cross state boundaries. It includes measures that are important but not available at the county level.

View measures by category

* Human Capital & Knowledge Creation

* Business Dynamics

* Business Profile

* Employment & Productivity

* Economic Well-Being

* Social Capital

* State Context

The set of measures that comprise Innovation 2.0 is expansive (see sidebar), so we selected just a dozen or so measures of business dynamics and regional characteristics to see how they relate to important measures of regional economic and innovation performance in order to keep the analysis and presentation manageable. For this analysis, we trimmed the number of regions to those MSAs in the Midwest, so we could focus on Indiana and neighboring states.

What follows is a discussion of the measures we used in this analysis and the motivation for including them in Innovation 2.0. The measures are categorized as either an input to innovation that may explain the performance, or an output that is an outcome of innovative activities.

Input measures

Inputs are those factors, influences or conditions that promote innovation and create knowledge. Input measures for Innovation 2.0 are categorized into two thematic categories: human capital and knowledge creation and business dynamics.

Human capital and knowledge creation are critical and typically explain much of why some regions prosper and others do not. But it is because education and knowledge building are the standard, default variables, that we decided to focus on regional business dynamics for the purpose of this analysis.

Business dynamics (in the form of entry and exit) is the mechanism by which outdated ideas and industry practices are replaced by new and potentially revolutionary ones. This process of creative destruction--a term and concept introduced by the economist Joseph Schumpeter--is the hallmark of a thriving and dynamic economy. This dynamic is at the heart of competition creating new industries, invigorating old ones and relegating inefficient practices to the pages of history. As such, exit and entry drive the growth and prosperity of individual firms, as well as the economy at large. This is a central focus of research in both economics and management.

In particular, an expanding body of research focuses on the geographic dimension of entry and exit, the effect on the formation and growth of firms, and the associated implications for local and national economies. As older, inefficient and marginally productive capital is destroyed, new, efficient and productive capital is created. This implies that productivity variability is likely linked closely to job reallocation, as workers matched with unproductive capital lose their jobs and new, more productive couplings of labor and capital are made.

Table 1 shows all the variables, and the data sources, that we investigated. Using averages of multiple years reduced the cyclical effects of the Great Recession and smoothed the sometimes erratic nature of patent and FDI data. For more information on the measures, the source data and the Innovation Index 2.0 calculations, please see the report, "Driving Regional Innovation: The Innovation Index 2.0." (1)

Establishment formation and dynamics

Some researchers have emphasized technological and knowledge requirements that have changed, or even destroyed, the economic viability of a region's industries, firms and jobs. But then again, these changes also present the opportunity to create new industries, firms and jobs. Labor churn improves productivity. Labor churn is an indicator that members of the workforce are bettering their employment situation. That is, workers move to more desirable and higher-wage jobs. In the same way, churn--whether measured by new businesses being established or by existing businesses expanding their workforce--provides an indicator that the region is undergoing positive economic change.

There are also churn measures that focus on employment, not establishment, counts.

In recent decades, the U.S. economy has shown secular declines in employment and business dynamics. This decline in dynamism has...