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When Innovation Overrides Basic Economics in Driving Industrial Growth

July 28, 2010 By Aaron Sinner, Undergraduate Research Fellow

With its reputation as a higher-tax state with a strong workforce, Minnesota would be wise to pay attention to an economic concept called "path-dependence," a theory in which location of origin determines an industry's long-term geographic center of operation, not the "invisible hand" of market economics as it would appear on paper. Understanding path-dependence and the role it can play in making Minnesota a national leader is a key to future economic success.


Path-dependence's basic idea is that a region's slight start-up advantage can make events unfold along a certain path that reinforces itself as it goes. As American economist and Nobel laureate Paul Krugman wrote, "If there is one single area of economics in which path dependency is unmistakable, it is in economic geography-the location of production in space. The long shadow cast by history over location is apparent at all scales, from smallest to largest-from the cluster of costume jewelry firms in Providence to the concentration of 60 million people in the Northeast corridor."

For example, if a business in a burgeoning industry suddenly takes off, then companies that sell supplies for that industry will attempt to locate near the booming business. This will induce further businesses in that industry to relocate or start up in that area, and create a talent pool for the industry in the same location, until the region becomes the central hub for the industry regardless of whether it is best suited for it.  As Atul Gawande reports, "This entrenches local advantages that lead other firms producing similar goods to set up business in the same area-even if prices, taxes, and competition are stiffer."

What this means for Minnesota is, if we can get a leg up in a budding industry, we could come to dominate that industry for decades to come. A clear historical example is Minnesota's "Medical Alley," which stretches from Duluth through the Twin Cities down to Rochester. University of Saint Thomas Professor Michael P. Moore wrote in 1992, "This $7 billion industry is Minnesota's leading employer and is still growing faster than any other." Our state's history with medical device manufacturing, and the broader medical field as a whole, was jump-started when Medtronic invented the first battery-powered pacemaker in 1957. Today, Minnesota's top five manufacturers alone account for $22 billion in sales. The industry as a whole employs 30,000 Minnesotans, according to DEED.

Medical technology growth went hand-in-hand with the University of Minnesota's Department of Surgery-the U of M's educated worker base provided an incentive for Medtronic and others to be founded in the area, and the medical companies provided an incentive for the U of M to keep its medical programs strong. As the industry prospers, companies that specialize in anything from electronics to plastic molding can also do well in Minnesota.

Professor Brian Buhr, head of the University of Minnesota's Department of Applied Economics, sees other potential industries that have benefited from path-dependence. "You have to ask yourself, 'Why are we the number one turkey-producing state?'" he says. His answer: individuals were raising turkeys in plenty of states, including Minnesota, until the 1940's and 1950's, when a disease began to ravage turkey populations across the country. But Minnesota winters killed off the disease, leaving turkeys here unaffected. This gave Minnesota an advantage in turkey-raising that continues to this day.

Buhr also points to Minnesota's strength in the livestock and flour milling industries as showing some characteristics of path-dependence. "The river system was the key thing here," he says, in establishing the industries in the first place. But even today, when these industries don't depend nearly as strongly on river systems, the livestock and flour milling industries remain strong.

Nothing about the medical equipment, turkey, livestock, or flour milling industries makes them uniquely well-suited for modern Minnesota, yet through a combination of natural resources, public investment, private innovation, and in some cases sheer luck, our state was able to gain early advantages that have led Minnesota to become a major base of operations for all of them. Path-dependence turned our head-starts into broad leads.

Yet the medical device industry has a particular lesson for Minnesota: Moore says that in recent years, changing incentives in Minnesota have caused many smaller start-ups in the medical device field to struggle as venture capitalists move to Ohio, where the state offers more support to the industry. "Minnesota could certainly help with some early stage grants," he says, that would fill the "gap in funding" as projects move from university research to commercial ventures. Both Ohio and Wisconsin have funds to help fill this gap, and Minnesota would be wise to also create such a fund. The conclusion seems obvious: to maintain our advantages, we must provide a combination of public and private support, especially when this combination is what entrenched an industry in Minnesota in the first place.

As we work to shore up support for those industries where we are already a leader, Minnesotans should also look for fledgling fields in which we can become future leaders. One particular field that deserves our attention is that of alternative energy. Likely to be a break-out industry in the coming years, Minnesota is well-positioned to jump ahead of other states early on. As Minnesota 2020 has detailed, Minneapolis and Duluth rank among the top cities nationwide in solar power rooftop potential, and our recent report provides an excellent roadmap for how Minnesota can start down this path.

Minnesota is well-poised to jump out in front in the alternative energy industry so long as we make doing so a priority. As path-dependence teaches, the advantage to an early lead could have huge ramifications for decades to come.

 

photo credit: Chad Johnson, creative commons

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