New growth theorist Paul Romer is into city-states. He sees them as a mechanism for accelerating Third World development and lifting rural populations out of poverty. It’s an intriguing, if complicated, idea. Michael Perelman posts Stewart Brand’s (of Whole Earth Catalog fame) synopsis (tip-of-the-hat to Mark Thoma for the pointer).

[D]eveloping countries could invite instant Hong Kongs – new cities in new locations run by experienced governments such as Canada or Finland. They would enrich the country where they are built as special economic zones while also rewarding the distant government that makes the investment of building the new city state and installing a set of fair and productive rules.  Over time, as with Hong Kong, the new city is turned over to the host country.

Living through the current economic downturn, none of us take economic prosperity for granted anymore. We’re aware now, more than ever, of how important it is to cultivate the things that contribute to long-run economic growth and sustained prosperity as well as to regulate and cope with those which can come to jeopardize that prosperity.

Economists mainly agree that there are two things that power long-run economic growth. Thanks to the Nobel-prize winning work of Robert Solow, we know that technology is one. Human capital is another. Detailed empirical studies by Harvard’s Robert Barro and others show the connection between human capital and economic growth.

But what about class – does it matter? Using data from the International Labour Organization, Charlotta Mellander developed class profiles for nations of the world. The graphs below show the relationship between two main classes – the creative class and the working class – and two common measures of economic growth - gross domestic product (GDP) per capita and total factor productivity (TFP).

The results could not be more striking.

The creative class is strongly related to both GDP per capita and total factor productivity. In preliminary statistical analysis conducted by Mellander, the creative class effect was even stronger than that from the well-established human capital measure.

Now look at the graphs for the working class. Societies with large concentrations of the working class have lower levels of GDP per capita and total factor productivity.

Source of all graphics: Martin Prosperity Institute

David Crane says innovation, not creativity, is the key to the future:

The big question in looking to Ontario’s future has to be: How do we create the climate for innovation that will lead to new industries and jobs based on new goods and services we can sell the rest of the world? This is where the report falls short.

Its focus on expanding the size of the so-called “creative class” runs into the law of diminishing returns, the same law that spells out the limits on physical capital accumulation.

While computers represented a big gain initially for the economy when they were first introduced, at some point additional computers had no value unless they were much better than the original computers.

Likewise, growth in the number of people with university degrees can bolster the economy, but at some point there is little need for an additional graduate if there is no job for him or her.

Unless there are new or expanding industries to hire these new graduates, simply increasing the supply doesn’t do much.

First off, let me say that while I am a big admirer of Crane’s writing, he’s dead wrong here. We are not just calling for more creative class jobs, but for increasing the creativity content of all jobs – service as well as manufacturing and agriculture too.  And that creativity does not spring from anywhere, but from real places that engender it and create the ecosystem to utilize it and put it to work.

A core focus of our work at the MPI is about why and how it is not enough to increase supply of creative work, but to build demand for it.  That too occurs in places. That is why we have to build new infrastructure and break with the old housing-auto-industrial complex (making housing and cars cheaper) to free up demand for the products and services of more creative work.  Our colleague Chris Kennedy and his collaborators have made a fundamental contribution here, and my recent Atlantic essay and a good portion of our ongoing MPI work picks up this challenge.

Crane then brings in a big gun, Stanford economist Paul Romer, to bolster his argument

In other words, as economist Paul Romer has emphasized in his work on innovation and economic growth, an economy cannot grow simply by accumulating more of the same.

Romer, who was a key figure in the economic growth program of the Canadian Institute for Advanced Research, argued many years ago that “the increases in standards of living that we achieved in the last century were possible only because of the discoveries and innovation that let new physical capital and new human capital be put to work in high return activities.” So for him, “the most important job for economic policy is to create an institutional environment that supports technological change.”

In fact, Romer has argued, the nations that “are most successful in creating institutions that foster discovery and innovation will be the worldwide technological leaders.”

Innovation has to include greater investment by both government and business. A recent study by the Information Technology and Innovation Foundation in Washington found that there has been a dramatic increase in the number of innovations in the U.S. that are federally funded.

In other words, government plays a crucial role in fostering and facilitating innovation. The Ontario report fails to address innovation policy.

I’m a big fan of Romer. But on this score Crane is again wrong. Innovation, as I point out in Rise of the Creative Class, is not an end-in-itself, but a piece of a much larger and more fundamental category of human existence – creativity. It’s not government that fosters innovation, it’s the place itself. That is the shift our report urges and Ontario needs to make.

By way of background, the entire first part of my academic career was as a student of technological innovation. In 1990, I wrote a book on the limits of an innovation-oriented strategy, called The Breakthrough Illusion. My experience in Pittsburgh showed me once and for all how incredibly advanced and technologically innovative regions can fall behind. And not just Pittsburgh, places like Rochester and even Detroit continue to lead in terms of conventional measure of innovation like patents. Innovative, high-tech industries account for less than 10 percent of GDP – it’s pretty hard to build a robust, balanced, and prosperous economy around those.

That’s why we have come to focus on the 3Ts of economic development. Technology is the first T. It is a necessary but, in itself, insufficient condition for regional prosperity. To achieve sustainable prosperity a region needs two other Ts – talent as Romer’s work points out and tolerance – or openness to new people and new ideas.

Our report also points out that while Ontario does well as the third T, it does not do a good enough job of investing in or leveraging its first two Ts, especially technology. It points this out explicitly and challenges the province to do more.

But a classic 1990s innovation strategy of the kind Crane advocates is too limited – and experience shows it simply will not work.

We’ve run the data – over and over again. We’ve looked closely at measures of technological innovation, of  high-tech industry and the share of scientists and engineers. They are an important part of the economic prosperity equation but not all of it. Without a place that is open, that has an ecosystem that invests in and harnesses talent, that attracts and energizes new people, that creates demand for creative effort, technology and talent simply flow away.   Does Crane really believe that if we somehow build the world’s best innovation policy that would put us on the path to sustained and balanced prosperity? Real, enduring prosperity requires much, much more.

And that’s why Romer’s own thesis advisor, the Nobel-prize winner Robert Lucas, went back to Jane Jacobs. It’s not innovation that drives economic growth, according to Lucas and Jacobs, it is the concentration of creative people using and combining their full talents in real, dense, open places called cities – that, Lucas says, is the real underlying mechanism driving economic growth. And it’s for identifying this fundamental mechanism which he dubs “human capital externalities” or Jane Jacobs externalities that he said Jacobs deserved a Nobel prize of her own.  It’s place that’s the driving force. It’s place that provides the underlying framework and ecosystem for innovation and productivity growth. It does so by attracting people, by enhancing their creative capabilities, by being open to new people and new ideas, and by bringing us together in ways that make us far more innovative and productive than we would otherwise be.

Crane knows better. As someone who cares deeply about urbanism and real places, it’s hard to believe he falls into the trap of believing an absrtact and placeless innovation strategy can somehow bring us the long-run prosperity we need. We can do better than 1980s or 1990s thinking about innovation as the driving force of economic growth. We need to make people and place, not technological artifacts, the center of our dialogue and strategy.

That’s the underlying goal of our work. And it’s a big reason why we decided to set up the MPI in Ontario. Because this is a place which intituitively understands the need to go beyond technology to a broader, fuller approach that understands that enduring prosperity can only come by harnessing the full talent and capabilities of real people in real places. It’s in the very DNA of this province, this city and this place. Our goal at the MPI is to make Toronto a center for the new ideas and new thinking and new empirical research that a fuller understanding of the full gamut of technological, industrial, human, and place-based factors regional prosperity requires.

To do that we must do two things: One, we must tap and harness the full talent capabilities of every single person no matter where they work; and two, we must build a new way of living that breaks with the fordist auto-housing-industrial complex so that we can create large-scale demand for the products and services of the creative age.

That’s the essence of what  we’re up to here.

Paul Krugman was awarded the Nobel Prize in economics today. The announcement reads simply: “for his analysis of trade patterns and location of economic activity.” The award is very well-deserved and fantastic for our field. My hunch is Paul Romer can’t be far behind.