Hardly a day goes by when I don’t speak with someone about their area’s growing or shrinking economy. Much of the time my conversations are with business people or with folks who think about the economic vitality of a region much like that of a business. One difficult part of every such conversation involves explaining how economists think about growth, and how much it differs from the way a business thinks about its own growth. 

Business people are typically good at business. They think about costs, market demand, advertising, reputation, competitiveness and attracting capital for expansions. These are all elements of a thriving business that often color both the conversation and thinking about a region’s economy. It is typical for economic developers to use the language of business when talking about a state or city. However, the way economists think about economic growth in a city or state is vastly different. In truth, none of these business terms or the ideas that underlie them have any place in really understanding how regional economies grow or stagnate. Let me explain.

The dominant way economists think about economic growth is a simple one. The size of a region’s economy is almost wholly determined by very few simple factors. In maybe the simplest framework, only the number of people and the dollar value of physical capital, like machinery, buildings and roads, determine the size of a region’s economy. This formulation dates back to the late 1950s and won an early Nobel prize in economics, and remains a powerful way to think about the issue. 

To illustrate this in Indiana, I used new data on county-level gross domestic product (the size of each county’s economy) from 2001 to 2015. In this basic model, more than 90 percent of the difference in GDP between Indiana counties was explained solely by the number of people and the gross assessed value of all property in the county. 

The implications of this are many. At the very least, it means that all the other ‘businessy’ stuff that communities try to do can explain less than 10 percent of the difference between the best- and worst-performing counties in our state. But, the economic model can do even more. 

If we add a simple measure of human capital to the model, such as the share of adults with a college diploma, we are left with maybe 8 percent of the difference between counties unexplained by these three simple data points; number of people, the assessed value of capital and the share of adults with a college degree. This small modification of this statistical model causes the overall value of people on a local economy to increase and the value of capital to decrease. When we include education, we find that a 1.0 percent increase in people has about twice the benefit on the local economy, as does a 1.0 percent increase in physical capital (machinery, equipment and the like). Of course, our policies almost wholly ignore that result, but that is for another column. 

This year’s Nobel Prize in economics rewarded research on human capital and economic growth. My favorite insight from this work is that education not only makes people more productive, but it actually makes machinery more productive. Both of these effects have a single source, but two very different and highly beneficial effects. 

There are other insights to these approaches, such as the fact that wages are heavily determined by the skills of those who live and work around you, making places with a higher share of more educated citizens better for everyone. Research into economic growth is not isolated to these broad issues. There is important work on corruption, governance, climate, culture, health and other factors. However, all this research focuses on how these individual factors influence the productivity of capital or people. That is, this research focuses on explaining the factors that influence more than 90 percent of regional differences in growth, not the less than 10 percent. 

In contrast, the ‘businessy’ ideas about a local economy just don’t survive close scrutiny. Local reputation, advertising, local competitiveness turn out to be empty ideas. Even the most thoughtful issues around growth, such as local tax rates, are by themselves useless concepts. But, everyone already knows that, right? Taxes in fast growing Boston or San Francisco dwarf those of any Rustbelt town. Unless you contrast taxes (a business cost) with the quality of local public services (a business benefit) you understand absolutely nothing useful about either. 

Now, by all means, you can worry about your community’s reputation, or solely about tax rates or the ‘competitiveness of a region,’ whatever that might be. You can worry about the weather as well. What unifies all these worries is that you can do nothing about them that helps your local economy. Ultimately, what matters for local economies are the fundamentals that cause educated workers to live in your communities. At least that is what economic research has been steadily concluding over the past half century.