Economists and policy-makers seem to have a blind spot when thinking about how the economy functions and what determines success. Analytical frameworks and government policies consistently neglect the role of space and geography in favour of national averages and sectoral 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, capable public institutions, reliable infrastructure, and proximity to markets and suppliers. But just how important are these factors compared with the particular mix of local industries and macro-economic conditions?
In a recent paper we unpacked the economic performance of different provinces in South Africa to diagnose the significance of local factors and sectoral conditions. This is helpful in understanding why some provinces consistently outperform others. And what might be done to help lagging regions improve their competitiveness.
The starting point is to recognise the systemic differences in the size and performance of South Africa’s nine provinces:
Production is highly uneven across the country. The province of Gauteng generates a third of national GDP - more than double the output of the next province - but with less than 1.5% of the land. According to South African Revenue Service, individual taxpayers from Gauteng contribute 47% of the national total for this revenue source. Yet they only constitute 25.8% of the country’s population.
Some provinces are more productive than others. The Gauteng and Western Cape economies expanded at an average rate of almost 3% per annum between 1995 and 2018. This was a third faster than the rest of the country.
There is growing divergence between the largest and smallest provinces. Over the last two decades the share of national GDP in the three largest economies (Gauteng, KwaZulu-Natal and the Western Cape) 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 lies behind the growing divergence between the best and worst performing regions? And what underpins the continuing growth and prosperity of Gauteng?
Unpacking uneven development
The performance of provinces is often attributed to their industrial structure: the problem with lagging regions is said to be their dependence on lagging sectors. Hence, the challenge for provinces such as Mpumalanga and the North West is their reliance on mining and related heavy industries because of rising energy costs and volatile commodity prices.
The usual policy prescription is to find the means to diversify and industrialise.
Yet industrialisation is unrealistic for many small towns. Bigger 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 eco-system need to be carefully considered as opposed to generic plans that gain little local traction.
There are several reasons why economies develop 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 road, rail and harbours, as well as public utilities and municipal services.
The skills and capabilities of the local workforce, including basic education and tertiary institutions.
The quality of local institutions, including municipal leadership and technical competence. Also the efficacy of community-based organisations, business councils, industry associations and trade unions.
These differences can be important, especially as the effects are cumulative and mutually reinforcing over time. There are potent implications for policy from this thinking.
Here are some examples.
To accelerate growth within the Eastern Cape, would it be best to incentivise key industries, such as the automotive sector? Or would public resources be better spent on improving the operating environment for a variety of businesses, such as through upgrading the infrastructure?
A third possibility could be to boost the quality and supply of particular skills that are in high demand by local firms.
It is difficult for policymakers to disentangle the multiple factors and forces underpinning regional growth and to pinpoint those with most potential to accelerate development. A sensible place to start is to disaggregate variables associated with national conditions from the distinctive circumstances prevailing within each region.
Shift-share analysis is a common technique for this purpose. This separates out the change in output for a region into three main components:
growth arising from national industry trends (known as the industry-mix effect),
growth arising from cross-cutting productivity (known as the region effect), and
growth related to industry-specific locational advantages (known as the industry-place interaction effect).
Our results demonstrate that national industry trends explain not more than half of the growth performance of provinces.
For instance, in Gauteng, a favourable industry-mix worked together with positive place-based factors to give it a significant growth advantage compared to the rest of the country. By contrast, the Eastern Cape was hamstrung by poor local productivity despite an advantageous industry composition. The Free State had the worst of both industry and regional factors and so was at a significant disadvantage.
In every case, regional factors were fundamental in explaining provincial economic outcomes.
It is vital that national growth plans pay careful attention to the unique features of each region if they are to succeed. One implication for policymakers is that targeting growth sectors cannot be the sole focus of industrial policy.
The findings call for more detailed analysis of the core features of each province to help them navigate structural change. This includes the performance of the metro economies. A more devolved approach to national economic policy could build on the strengths of every region.
The national economy is hamstrung if only some regions manage to grow.
This article was first published by Econ3x3 under the heading, Place matters: National prosperity depends on every region performing better.