Measuring the economic performance of regions: creative destruction and economic dynamism.

• Author: Slaper, Timothy F.
• Position: Cover story

What drives the economic performance of a region or state, and how do we measure it? This article is first in a series that will explore how well Indiana's economic performance compares to other states in the union and what forces may account for that performance.

Concern over global competitiveness, industrial restructuring and slowing productivity growth has led to great interest in how these factors interrelate. 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. This process, this "creative destruction," a term and concept introduced by the economist Joseph Schumpeter early last century, is the hallmark of a thriving and dynamic economy. The premise is that the incessant turbulence of an economy in motion can explain patterns of economic growth and change. As new products, process and production technologies, and organizational forms emerge and new markets are created, underlying dynamics disturb the previous steady state and stimulate the emergence of new, more competitive conditions.

The appeal of labor churn was highlighted in a recent InContext article. (1) A major takeaway from the article is that 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.

For this reason, labor churn is an important indicator in the annual "State of the New Economy" report. (2) The Global Innovation Index also includes a measure for new business density. (3) The Bureau of Labor Statistics is also in the game with its "Entrepreneurship and the U.S. Economy" analysis that uses data tracking establishment births. (4)

Business dynamics in the form of entry and exit is the mechanism by which outdated ideas and industry practices are replaced by new and potentially revolutionary ones.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 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, and 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.

Localized employment churn registered as job creation and destruction dynamics can account for variations in regional productivity, job creation and changes in the standard of living. Research suggests that employment turnover and replacement dynamics have a large and significantly positive effect on regional productivity growth independent of a variety of industrial restructuring processes that may occur at the same time.

Employment churn effects do not always exert a uniform influence on regional productivity performances, however. As the industrial belt turned to rust throughout the 1980s until the mid-1990s, job creation and destruction dynamics often canceled each other out as regions underwent industrial restructuring. Since the mid-1990s, however, the positive effects on regional productivity growth have been strong.

This article provides an investigation motivated by micro-level research on firm-level entry and exit, expansion and contraction. 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.

Churn can also signal entrepreneurial activity. The greater portion of establishments that are births, or the significance of employment gains due to new business formation, points to people taking risks to start businesses. It also measures, to a large degree, the adaptability of a region in responding to economic stress. Workers may lose their jobs due to competitive pressure from the next state or overseas. A flexible, resilient workforce would "adapt" rather than "die." The region would set forth to seize new business opportunities rather than hoping that an outside force--for example, an inbound relocating company--will provide their next paycheck.

A comparison of cross-sectional employment at two points in time enables the calculation of net employment growth: How many more or fewer jobs exist at the latter time period compared to the earlier time period? Thinking about how...