Eeconomists and policy makers seem to have a blind spot when thinking about how the economy works and what determines success. Analytical frameworks and government policies systematically neglect the role of space and geography in favor of national averages and sector plans. Yet growing evidence from around the world shows the importance of place and location for productivity, growth and development.
Intuitively, it is obvious that economic progress depends on the quality of local skills, competent public institutions, reliable infrastructure and proximity to markets and suppliers. But how important are these factors relative to the particular combination of local industries and macro-economic conditions?
In one recent article we analyzed the economic performance of different provinces in South Africa to diagnose the importance of local factors and sectoral conditions. This is helpful in understanding why some provinces consistently perform better than others. And what could be done to help lagging regions improve their competitiveness.
The starting point is to recognize the systemic differences in the size and performance of South Africa’s nine provinces:
Production is very uneven across the country. The province of Gauteng generates a third of the national GDP – more than double the production of the neighboring province – but with less than 1.5% of the land. According to the South African Revenue Authority, individual taxpayers in Gauteng contribute 47% of the national total for this source of income. Yet they constitute only 25.8% of the country’s population.
Some provinces are more productive than others. The economies of Gauteng and the Western Cape grew at an average rate of almost 3% per year between 1995 and 2018. This was a third faster than the rest of the country.
There is a growing divergence between the larger and smaller provinces. Over the past two decades, the share of national GDP in the three largest economies (Gauteng, KwaZulu-Natal and Western Cape) has increased, while the share in the three smallest (North West, Free State and Northern Cape) contracted. Spatial inequalities have been further amplified by the COVID-19 pandemic.
What’s behind the growing divergence between top and bottom performing regions? And what underpins Gauteng’s continued growth and prosperity?
Unpacking uneven development
The performance of provinces is often attributed to their industrial structure: the problem of lagging regions is their dependence on lagging sectors. Therefore, the challenge for provinces such as Mpumalanga and the North West is their reliance on mining and related heavy industries due to rising energy costs and price volatility. raw material.
The usual policy prescription is to find ways to diversify and industrialize.
Yet industrialization is unrealistic for many small towns. Larger agglomerations have many advantages that make them more likely to benefit from spatially blind national industrial policies. The unique strengths and limitations of each local ecosystem should be carefully considered as opposed to generic plans that gain little local traction.
There are several reasons why economies grow unevenly between places, including:
- The industrial structure and whether it is dominated by relatively dynamic or stagnant clusters of firms and their suppliers.
- Natural resource endowments, including mineral reserves, soil quality and rainfall.
- The quality of physical infrastructure, such as roads, railways and ports, as well as utilities and municipal services.
- The skills and capacities of the local workforce, including basic education and higher education institutions.
- The quality of local institutions, including municipal leadership and technical competence. Also the effectiveness of community organizations, business councils, industry associations and trade unions.
These differences can be significant, especially since the effects are cumulative and mutually reinforcing over time. There are powerful policy implications of this thinking.
Here are some examples.
To accelerate growth in the Eastern Cape, would it be better to incentivize key industries, such as the automotive sector? Or would public resources be better spent on improving the operating environment for a variety of businesses, for example by upgrading infrastructure?
A third possibility could be to improve the quality and supply of particular skills that are in high demand by local businesses.
It is difficult for policymakers to disentangle the multiple factors and forces underpinning regional growth and identify those that have the most potential to accelerate development. A good starting point is to separate the variables associated with national conditions from the particular circumstances prevailing in each region.
Shift-Share Analysis is a common technique for this purpose. This separates a region’s variation in production into three main components:
- growth resulting from national industry trends (known as the industry composition effect),
- growth resulting from cross-sectional productivity (known as the region effect), and
- growth linked to industry-specific location advantages (known as the industry-location interaction effect).
Our results show that national industry trends explain no more than half of the provinces’ growth performance.
For example, in Gauteng, a favorable industrial mix has combined with positive local factors to give it a significant growth advantage over the rest of the country. In contrast, the Eastern Cape was crippled by low local productivity despite an advantageous industrial composition. The Free State had the worst of the industrial and regional factors and was therefore at a considerable disadvantage.
In all cases, regional factors played a fundamental role in explaining provincial economic performance.
To be successful, it is essential that national growth plans pay particular attention to the unique characteristics of each region. One implication for policy makers is that targeting growth sectors cannot be the sole objective of industrial policy.
The results call for a more detailed analysis of the main characteristics of each province to help them navigate structural change. This includes the performance of metropolitan economies. A more decentralized approach to national economic policy could build on the strengths of each region.
The national economy is paralyzed if only certain regions manage to develop.
This article was first published by Eco3x3 under the title, Place Matters: National Prosperity Depends on How Each Region Performs.