An economist is someone who looks at something that works in practice and wonders if it will work in theory.  At least that is what former president Ronald Reagan is reputed to have said once, no doubt to the amusement of his audience. 

There is little doubt that those of us in the dismal science spend a lot of time trying to reconcile what we see with our own eyes with the theory that we all grew up with.  But it’s not just an empty exercise.  Explaining the facts of economic growth with theoretical models helps us predict the future, and quite possibly change it.

Indiana has packaged itself for decades as a reasonably low-cost place to do business.  Land is cheap here, housing is affordable, and wage rates for many occupations are below the national average.  For companies interested in lowering their costs, our state would seem ideal.  And for workers, our low cost of living makes our lower wages go a lot farther than the dollar amounts themselves would suggest.

Yet growth in the state economy, especially in the regions outside Indianapolis, has been much slower in the last two decades than elsewhere in the country.  While areas with spectacularly high costs of living, like Boston, Washington D.C., and Silicon Valley continue to grow and develop at a blistering pace, we’ve largely remained on the sidelines, hawking our low-cost marketing pitch to deaf ears.

The clear message is that there’s a lot more to profitability than simply cost.  Indeed, the implications of some new theories of regional growth, or what has come to be known as economic geography, is that the costs that we can easily see and measure are almost irrelevant.

Consider, for example, the financial services industry.  In the year 1999, the average worker in the banking, insurance, and real estate industries in Indiana made an annual salary of $31,850.  That’s almost $8,000 less than the average U.S. worker in the same industries, who made $39,564 a year in 1999.  And in east central Indiana, those industries paid just $22,560 to their workers on average, barely more than half the national average.

So is the message to all the Chase Manhattan, Wells Fargo, and Bank of America’s of the world to close their doors and move their operations to Indiana, or even, to Muncie?  Probably not.  For one thing, such a move would greatly increase the distance between them and their major customers.  And, internet technology notwithstanding, increased distance means increased costs.

Then there is the supplier chain to consider.  Financial institutions are heavy users of all kinds of services – legal, informational, and technical.  Many of those needs are quite specialized – and less likely to be found in a historically manufacturing-based economy like ours.  And they are even less likely to be found in a relatively tiny economy like Muncie.  Access to the infinite variety of services banks can buy in a large urban area, like Chicago or New York, more than makes up for the higher rents and wages they pay.

Boasting about costs to companies with specialized needs becomes a waste of time.  Areas with developed networks that can supply a wider spectrum of labor and other specialized services have advantages that more than compensate for their higher wages and rents.

It’s not an altogether harsh message for Indiana.  After all, our access to markets and the tremendous variability and specialization in labor and the industrial base throughout the state keeps even more Indiana manufacturing jobs from disappearing offshore to lower wage countries than is already the case.  But when it comes to selling ourselves as a place for companies outside our traditional scope to operate, it makes the bar a little higher.