Researchers use rich labor and tax data from Sweden to track workers and study impacts of new businesses

When Amazon opened the bidding for its second headquarters, more than 200 towns and cities in North America jumped at the opportunity to host the online giant and its 50,000 jobs. As some debate the true economic value of such a deal, new research at Harvard's Center for International Development (CID) shows it can be vital to help regions transform their economies and diversify into new economic activities.

It's widely believed that regions require a strong entrepreneurial culture to reinvent themselves. In this model, structural transformation is home-grown and dependent on local entrepreneurs that are willing to try new development paths. However, in a paper recently published in Economic Geography, CID researchers Frank Neffke and Matté Hartog, along with colleagues in the Netherlands and Sweden, challenge this view. They argue that, although local entrepreneurs play some role in helping a region diversify into new activities, many simply imitate activities already present in the region. The most transformative impulses actually come from outsiders who provide the local economy with experience, knowhow and networks from elsewhere.

We talked to the researchers about their findings and what they mean for local policymakers who want to bring about structural change to their region.

Structural Change in Sweden

1 in 20 establishments founded by non-local firms lead to a new industry in a region

for local firms, this share is just 1 in 50

Can you define structural change?

FN: There is a lot of turnover in the precise industries that are present in a region. However, structural change is not simply a change in the mix of industries found in a region, but rather a change in the underlying capability base that sustains these industries. This distinction is very important. For instance, when a region shifts its focus from car manufacturing to motorcycle manufacturing, or from car manufacturing to medicines, in both cases the region’s industry mix changes. However, clearly the latter change is of a different quality: whereas making motorcycles does not require radically different capabilities than making cars, producing medicines does. Therefore, whereas both types of regional diversification would represent “industrial change,” only the latter constitutes “structural change.”

MH: The question then is how to quantify structural change. What we argue in the paper is that what matters is whether a region’s labor force will need to acquire new skills. That is, whereas cars and motorcycles require similar skills and knowhow, to make medicines workers need completely different skills. This suggests that we can measure the degree to which a new industry transforms a region by looking at how unrelated it is in terms of human capital requirements to the activities that are already present in the region. For this, we need to figure which industries require similar skills.

What was your methodology?

MH: We used official tax registry data from 1994-2010 for the entire population of Sweden. This data set, provided by Statistics Sweden, allowed us to “follow” all workers in Sweden as they changed jobs, so we could see the industries willing to hire each other’s workers. If two industries can easily exchange workers, this suggests that they require similar skills. With this in mind, we defined a measure of inter-industry relatedness from millions of job switches between industries, where industries that exchange abnormally many workers are said to be skill-related. Going back to our measure of structural change, we can now ask which type of economic agents introduce activities in an economy that would require workers who have skills that are not yet common in the region.

Your research defies a widely-spread notion that entrepreneurship is the main way to generate structural change. Could you elaborate?

MH: Structural change of local economies is often associated with entrepreneurs coming up with new ideas that mark new growth paths. We find that, entrepreneurs indeed tend to explore many more new and unrelated activities in a local economy than the new subsidiaries of expanding firms.

However, this picture changes when looking at where these entrepreneurs and expanding firms came from. Local entrepreneurs and firms tend to be relatively conservative and set up activities that are closely related to those currently thriving in the region. However, entrepreneurs and firms that come to the region from elsewhere tend to bring along new and unrelated activities. As such, they help the region transform and renew its economy. This highlights that it is often necessary to bring in new knowledge from outside the system to spur structural change, which highlights the importance of mobility of entrepreneurs (migration) and firms (investments from outside the region) and the knowledge they bring.

FN: Something to take into account is that, whereas entrepreneurs often fail in activities that are not well embedded in the local economy, the subsidiaries of existing firms do not. A possible explanation is that subsidiaries can draw upon the experience and knowhow of their parent firm, whereas entrepreneurs are “on their own.” Hence, whereas entrepreneurs are often lauded by policymakers for bringing in new ideas, they typically lack the resources and connections to help these ideas get rooted. That would explain why, in the long run, it is not entrepreneurs from outside the region but rather new establishments of existing, nonlocal firms – such as Amazon opening a new headquarters - that set in motion long-lasting change.

In the paper you mention that, as firms, regions must adapt to changes in the economic environment. Can you mention a few ways in which regions have successfully done so?

FN: Malmö, in Sweden, is a good example. Historically a manufacturing center, the city suffered when its manufacturing base, and in particular its shipyards, collapsed in the 1980s and early 1990s. However, after Sweden's financial crises of the early 1990s, the city successfully reinvented itself and became host to a number of modern, knowledge-based manufacturing and services activities. In contrast, many peripheral regions never recovered from their own structural declines.

Abandoned Industrial Plant in Malmo, Sweden

What would be the main takeaways from your research to a local policymaker?

MH: First of all, fostering entrepreneurship is no silver bullet to spurring structural transformation. Instead, structural change depends on the economy’s openness to attract new firms and entrepreneurs and transfer knowhow and technologies from elsewhere.

FN: In addition, our framework allows to objectively measure and visualize a region's economic transformation. The tools we produce in the paper can be used by policymakers as diagnostic tools to get a bird’s eye perspective of the capability base of a region and its opportunities for growth and diversification. Particularly, they can determine the fit between the economic activities potential investors could bring to the region and the region's existing portfolio. This would help assess whether such investors would reinforce the region’s current capabilities, gently nudge them onto a new trajectory or lead to radical transformation. Although it is up to policymakers themselves to decide how desirable these options are and whether or not to intervene, understanding how they may affect a region’s long-term development path should be of great value in itself.

Related links

CID's Growth Lab

More research on Structural Transformation/Diversification