Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Industrial Diversity, Growth, and Volatility in the Seven States of the Tenth District

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Industrial Diversity, Growth, and Volatility in the Seven States of the Tenth District

Article excerpt

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State and local officials have long sought to diversify the mix of industries in their regions, hoping to reduce short-term volatility in their communities' economic growth rates and potentially boost overall long-term growth. Economic theory predicts that, just as diversifying an investment portfolio can help reduce risk, the diversification of industries in a given region can help reduce volatility in growth rates. The theory is that regions specializing heavily in only one or two industries will be tied closely to the fate of those industries, a condition that may lead to large swings in employment growth and wage growth. If instead employment is spread across many industries, then when one industry stumbles, others may still fuel the region's overall economic performance and mitigate volatility in its growth rates.

While theory suggests diversity reduces volatility, views are mixed on how industrial diversity affects long-term growth. According to one view, even if diversity does offer the benefit of reduced volatility, it might be detrimental to a region's growth prospects over time. Communities with diverse industries may be unable to achieve as much growth as more specialized communities because the latter can benefit from knowledge spillovers among firms within the same industry. A contrary view is that economic growth is maximized when numerous, differing industries are in proximity, allowing the cross-pollination of knowledge and skills among them.

A close examination of the evidence can help policymakers determine whether industrial diversity poses a tradeoff, providing increased stability but at the cost of slower growth, or whether it can offer the best of both worlds: increased stability and faster growth. The case of the seven-state region examined here-the Tenth District of the U.S. Federal Reserve System-sheds light on this policy debate. The analysis shows that counties with greater industrial diversity did see greater economic stability. However, differences in industrial diversity had no significant impact on overall growth, neither increasing nor restraining the growth rates for employment or wages.

Section I sets out a method for measuring industrial diversity, describes the Tenth District's industrial mix, and shows how it has shifted over time. Sections II and III, respectively, estimate the impact of industrial diversity on volatility and growth, in each case also examining the results after controlling for the effects of two key industries in the region: agriculture and energy. Section IV summarizes the two conclusions that emerge from the analysis. First, industrial diversification can benefit a community by promoting stability, without adversely affecting economic growth. Greater stability is an important benefit in and of itself, helping individuals and local governments plan for the future and avoid the disruptions inherent in volatile conditions. Second, diversification is not a driver of growth. Officials who want to promote growth may need to apply other approaches to the task.

I. EXAMINING INDUSTRIAL DIVERSITY: THE CASE OF THE TENTH DISTRICT

This section describes the landscape of industrial diversity across the Tenth District, first introducing a measure of diversity that reflects how workers in a given area-in this case, in each county of the Tenth District-are distributed among different industries.1 The measure varies considerably across the nearly 500 counties of the District, revealing widely differing levels of industrial diversification. Some counties specialize heavily in the energy and agricultural sectors, while others feature varying degrees of specialization and diversification among other industries.

Measuring industrial diversity

Researchers use a variety of methods to measure industrial diversity. They have calculated diversity at different geographic levels, ranging from states and metropolitan areas to commuter areas and counties. …

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