Recent Research: What Makes Economies Resilient? Economic Diversity, Experienced Workforce

What leading indicators allow a national, state, regional, or local economy to rebound from an exogenous shock (e.g., economic downturn or natural disaster)?

What risk factors are common among economies that were not resilient to an exogenous shock?

The academic literature defines resilient economies as economies that are able to absorb an exogenous shock with limited negative impact on economic prosperity and their workforce. Several recent studies have identified leading indicators of economic resiliency include age of workforce, diversification of industries, and other key factors. Researchers also have found several risk factors that place economies at high risk of instability in the face of an exogenous shock including household and public fiscal solvency.

In recent studies, the authors identify the importance of governance and local institutions as the key to improving and sustain economic resiliency in the face of exogenous shocks – economic, man-made, and natural. The authors of Local growth evolutions: recession, resilience and recovery emphasize the importance of developing proactive rather than simply reactive policy responses. These efforts should focus on three specific areas, according to the academic literature:

• Workforce demographics;
• Transportation infrastructure; and,
• System diversification and complexity.

Several studies have looked at the composition of the workforce in an attempt to identify common demographic indicators of economic resiliency. In an article, What makes one economy more resilient than another?, researchers from Penn State found that economies higher shares of relatively young workers (aged 25-44 years) on average had lower resilience, suggesting that having a more experienced labor force allowed regions to cope better after the financial crisis. Surprisingly, they also found that there is no clear relationship between having a more highly educated workforce and resiliency. Penn State researchers also found that a higher share of self-employed workers in a county was unambiguously associated with greater resilience.

 While the composition of the workforce remains an important factor, the ability to connect that workforce with jobs is essential. In Local growth evolutions: recession, resilience and recovery, the authors point out that the economies with higher resiliency have made investments in transport infrastructure that are far-reaching and service broad areas. The focus on a far-reach broad system allows residents in more isolated and deprived areas to receive education and training. In economies with low resiliency, these individuals are isolated and discouraged by a lack of economic opportunity.

Another key finding of economic resiliency is the importance of economic diversification and complexity. Penn State researchers found that economies with greater diversity experienced a smaller drop in economic growth/employment due to an exogenous shock. Similarly, more complex economies also avoided large drops in economic growth/employment. Interestingly, while both diversity and complexity reduce the impact of an exogenous shock, complex economies are much more likely to experience a faster recoveries that economies than were more diverse.

The researchers also found a link between complexity and diversity, they  indicated that the interaction between complexity and diversity led to a stronger positive effect with resiliency and recovery for both. This means that the effect of complexity on resilience becomes more positive at higher levels of diversity, while diversity’s impact turns positive at higher levels of complexity. Thus, the most resilient economies are multi-faceted and home to a diverse number of leading industries. 

In addition to focusing on leading indicators of economic resiliency, several studies also have focused on risk factors to economic resiliency. In light of the Great Recession, researchers wanted to find the specific warning signs so that policymakers and economic development professionals can be proactive in addressing these factors.

In a September 2015 study by the Organization for Economic Co-operation and Development (OECD), researchers looked to identify economic resiliency vulnerability indicators. In Economic resilience: A new set of vulnerability indicators for OECD countries and evidence of their usefulness, the authors built a dataset of more than 70 indicators assembled from a number of public data sources that could be monitored to detect vulnerabilities and assess country risks of suffering a crisis. Many of these indicators can be transferred to the state, regional, and local levels to provide timely alerts of economic risks. The risk factors are divided into five categories including:

• Financial sector imbalances – factors include leverage and excessive risk taking, liquidity and currency mismatches which increase liquidity risk, and common exposures of banks;
• Non-financial sector imbalances – vulnerabilities stemming from balance sheet imbalances of households and non-financial corporations that may result in financial instability;
• Asset market imbalances – imbalances mainly related to housing market and equity market misalignments;
• Public sector imbalances – imbalances mainly relate to sovereign solvency risk, including basic fiscal solvency, long-term fiscal solvency indicators, and government debt composition indicators; and,
• External imbalances – indicators include the current-account balance, external debt, FDI liabilities, currency mismatch, external reserves, and the real effective exchange rate.

The authors contend that these risk factors should be complemented with other monitoring tools and in-depth assessments, including expert judgement, to provide a holistic assessment of country risks.

In Quantifying Urban Economic Resilience Through Labour Force Interdependence, the authors contend that there is a strong relationship between system tightness and resilience – system tightness can be thought of as the degree of connectedness, integration or interdependence of the components of a system. In the study, the authors rebuke the common assertion – a system becomes more tightly connected and integrated, its resilience increases. Instead, they found an inverse relationship between tightness and resiliency during the Great Recession. Cities with lower tightness (higher resilience) fared better during the recession with respect to several economic productivity measures. However, in the absence of shocks, those with higher tightness (lower resilience) exhibit superior economic performance.

The authors contend this creates a tradeoff between efficiency and resilience. Policymakers and economic development professionals must create a delicate balance between tightness and resilience to not only spurs economic growth during times of normalcy, but also during times of economic or natural shocks. The authors also highlight the importance of understanding warning signs of exogenous shock by economic development professionals so that they can better anticipate them and develop a response plan.