The Economics of Poverty Traps and Big Pushes

We have just seen the promise and the pitfalls of policies to foster local economic growth by increasing the supply of skilled workers in a city. The alternative approach is to try to increase the demand for labor by attracting employers. This often amounts to offering targeted incentives to innovative companies to locate in a struggling community, in the hope of forming a cluster that in the long run becomes self-sustaining. Once a successful industrial cluster is under way, it tends to strengthen over time. Its labor market and the market for specialized business services become even thicker, and its knowledge spillovers become even stronger. The difficult part, of course, is jump-starting the cluster.

In 2005, Ping Wang was facing a similar problem. He had been chairman of the economics department at Washington University in St. Louis for only a few months, but he quickly realized that the department was in trouble. Wash U. offers an excellent undergraduate program, ranked just below the Ivy League schools, and attracts smart students from all over the country. Unlike its Ivy League competitors, however, Wash U. has never been particularly strong in economics. When Wang became chairman, the department had been stuck for years near the lower part of academic rankings. It simply did not have many professors actively engaged in research.

 For a university, there is much to be gained from a strong economics department. Economics tends to be a popular major, because it offers good career prospects. Unlike many other academic fields, economics matters to people outside academia, and economists’ research is often cited in newspapers and television. While academic economists’ salaries are considerably higher than, say, those of physicists or biologists, economists are cheap for universities, since they do not need expensive labs or sophisticated scientific instruments.

The problem with transforming a sleepy, third-rate economics department into a top-notch research powerhouse, Wang quickly realized, was that academics are kind of like high-tech companies: they tend to be productive and innovative when they are surrounded by smart colleagues with whom they can exchange ideas. Left alone, they tend to stagnate. Thus departments that are already strong tend to become stronger over time, because the presence of productive researchers is attractive to other productive researchers, and departments that are weak tend to get weaker for the same reason. No good academic wants to be the first to move to a weak department. It is not just about prestige; it is about actual productivity.

Economists who study developing countries call this situation a poverty trap. Wang realized that there was only one way to break out of this trap: he needed a “big push” strategy. What he did was unprecedented. He called up two academic stars at other universities and made them an offer they simply could not refuse: a yearly salary in the vicinity of $600,000. The gamble paid off. The two stars quit their jobs at more prestigious universities and moved to St. Louis. Now that the department had two stars, other economists began to find the place attractive and accepted Wang’s offers there, albeit at normal salaries. As more good economists went there, the department became even more attractive. Wash U. jumped in the rankings. Wang had broken out of the poverty trap. Unfortunately, this positive feedback loop broke down in 2008, when the financial crisis severely diminished Wash U.’s endowment and forced the department to scale back its hiring.

 In essence, a city stuck in a poverty trap faces the same challenge. It is trapped by its past. The only way to move a city from a bad equilibrium to a good one is with a big push: a coordinated policy that breaks the impasse and simultaneously brings skilled workers, employers, and specialized business services to a new location. Only the government can initiate these big-push policies, because only the government has the ability to coordinate the individual actors—the workers and employers—to get the agglomeration process going. The idea is to provide public subsidies for those who are willing to move first but then stop the subsidies after the process becomes self-sustaining, in much the same way that Wash U. was willing to overpay the first two people hired but not later ones. The benefits of big-push policies are potentially huge, because declining communities can, in principle, be brought back to life.

But the track record of these policies is mixed. To succeed, the push needs to be really big. It also needs to be decisive and sustained, and, most important, the subsidies must target the right beneficiaries. As the story of Wash U. shows, the cost can be high and the success only temporary.

 The first and most important big push ever attempted in the history of the United States was the Tennessee Valley Authority (TVA), created in the midst of the Great Depression to lift a desperately poor region out of poverty. According to Franklin Roosevelt—never prone to understatement—the program was intended to modernize the regional economy by “touching and giving life to all forms of human concerns.” In practice, this meant investing in large-scale infrastructure programs, particularly electricity-generating dams, whose power was used to electrify the region and boost local productivity; an extensive network of new roads; a 650-mile navigation canal; schools; and flood control systems. A smaller portion of the funds was devoted to malaria prevention, reforestation, educational programs, and health clinics. The scale of the program was enormous, far beyond anything attempted before or since. Between 1933 and 1958, $30 billion from U.S. taxpayers poured into the region. At the program’s peak, in 1950, the annual federal subsidy to the region was $625 per household. After 1958 the federal government began to scale back its investment, and the TVA became a largely self-sustaining entity.

This approach to economic development is based on the intuitive notion that public monies can jump-start a local economy trapped in poverty. But critics on both the right and the left have lambasted such initiatives, either as big government overreach or top-down control of local communities. In an influential 1984 article in the New York Review of Books, the progressive urban thinker Jane Jacobs wrote a scathing critique of big-push policies, including the TVA, arguing that it is an unnatural way to foster local economies and concluding that “in practice, they work miserably.”

How can we assess these place-based policies in a rigorous way? The real test is not whether they create jobs during the push. The fact that an inflow of money temporarily increases economic activity in an area is hardly a sign that the money was well spent. Instead we need to look at whether the publicly financed seed can eventually generate a privately supported cluster that is large enough to become self-sustaining. The idea is that the government-provided investment carries the local economy past the tipping point but not any further. At that point the forces of agglomeration take over, continuing to attract businesses and workers well after the subsidies end.

 My colleague Pat Kline and I conducted a careful study of the TVA initiative and found that the program was successful in generating an industrial revolution in an area that had been largely rural up to that point. During the big-push years of 1933 to 1958, manufacturing jobs in the region grew much faster than they did in the rest of the country, as companies found the cheap electricity and easy transportation attractive. Manufacturing jobs kept growing faster after the federal subsidies dried up. Even in 2000, more than forty years after the end of the federal transfers, manufacturing jobs in the region were growing faster than those in comparable parts of the South, although the effect is now slowing down and will probably disappear soon. While the program was successful in moving the region from a low-productivity sector (agriculture) to a high-productivity sector (manufacturing), it did not succeed in raising local wages in any significant way. The reason is simple: as more and more jobs were created, more and more workers moved there from the rest of the South to take advantage of improved economic conditions. This increase in the supply of labor effectively offset the increase in demand.

The fundamental challenge with policies such as the TVA is that for them to be successful, local policymakers must be able to pick promising companies to invest in. They need to be a little like venture capitalists. In this sense, FDR had it easy. When manufacturing was the engine of job growth and prosperity depended on infrastructure and cheap energy, the recipe for development was obvious. The level of industrial development in the Tennessee Valley was so low that it did not matter too much whether an aluminum smelter, a steel factory, or a chemical factory opened its doors. But today the most important determinant of success for local communities is human capital, and making the right call is much harder. Should a county spend all its money attracting a new nanotech lab, or should it go for Amazon’s latest computer farm? A solar-panel R&D facility or a biotech lab? Even professional venture capitalists have a hard time predicting which industries and companies will succeed. For mayors of struggling municipalities, this challenge can prove insurmountable.

 Indeed, looking at the map of America’s major innovation clusters, it is hard to find an example of one that was spawned by a big push. No local politician set out to create Silicon Valley. And we have seen in the cases of Seattle, Boston, San Diego, and Los Angeles, the success of an original anchor company was typically the seed that grew into a high-tech cluster.

The same is true for smaller, more specialized clusters, arguably a more realistic goal for struggling communities. Consider Portland, Oregon; Boise; and Kansas City, three small high-tech hubs anchored by semiconductors, general high tech, and animal health and nutrition science, respectively. Although small, these are dynamic centers: Portland and Boise produce almost as many patents per capita as Boston. None of these hubs were planned. The opening of Intel’s semiconductor facility in 1976 jump-started Portland’s high-tech sector. The seed for Boise was planted in 1973, when Hewlett-Packard moved its printer division there. Life science R&D in Kansas City can be traced back to the 1950s, when Ewing Marion Kauffman started his pharmaceutical lab. As pointed out in a recent Brookings Institution study, little of the high-tech presence in these cities resulted from aggressive recruitment of companies by local governments.

 Other parts of the world have seen some success. Ireland used a deliberate big-push policy to build up human-capital-intensive sectors that previously did not exist. Through aggressive tax incentives and other enticements, it created important clusters in high tech and finance, although the country’s recent financial crisis throws into question the sustainability of such policies. Israel’s high-tech cluster, one of the most dynamic in the world, is highly dependent on the country’s military. Although the Israeli government did not set out to create a local high-tech sector, its need for innovative defense technologies and specialized human capital indirectly fostered a private sector that later became globally competitive.

Perhaps the clearest example of big-push success is Taiwan, which transformed its rural economy into an advanced one with a dynamic innovation sector through a large-scale policy of government-sponsored research in the 1960s and 1970s. The program succeeded in bringing top Chinese scientists back from the United States and establishing a cluster of publicly supported R&D that eventually became thick enough to sustain private companies. This is one of those rare instances in which policymakers turned out to be good venture capitalists. While they did bet on several failed technologies, they also bet on semiconductors very early on. Semiconductors quickly became the core of Taiwan’s high-tech sector and arguably one of its engines of prosperity. More recently, Taiwan’s high-tech cluster has been embracing newer technologies, including life sciences. But Taiwan might just be the exception that proves the rule.