States must adapt to thrive in the 'new economy'

In today's globalized, high-tech world, the strength of a state's economy is not based simply on having the lowest costs or providing more generous tax breaks. Rather, states that thrive in the "new economy" will need to foster a comprehensive innovation environment that spurs research and development, technology transfer, entrepreneurial development and the creation and retention of a highly skilled workforce.

To measure how states are faring in this environment, the Information Technology and Innovation Foundation just released their 2014 edition of "The State New Economy Index." The seventh such report since 1999, the SNEI index draws together 25 "success factors" that predict how a state can adapt, innovate and thrive in a constantly changing, globalized marketplace. The report examines the degree to which state economies are knowledge-based, globalized, entrepreneurial, IT-driven and innovation-based.

Read MoreA 2014 scorecard on how America's states stack up

Robert Atkinson
Source: Robert Atkinson
Robert Atkinson

The new reality is that the strategies that propelled us to the top of the global economic pyramid between the end of WWII and the early 1990s won't work any longer.

In the "old economy," American scientists and engineers were at the forefront of global innovation, creating new industries, products and goods that were then mass-produced in lower-cost domestic regions and marketed worldwide. As the global economy evolved, industries seeking lower costs began locating abroad.

Simultaneously, the United States lost its previously unassailable advantage in innovation, with countries such as Germany, Korea and Japan matching or surpassing our innovation potential in many key industries. In essence, the economies of U.S. states have been assaulted on two fronts: with high-tech states being out-innovated and low-cost states being undercut.

When analyzing how states rank in the SNEI, it is clear that some have done better at managing to adapt to this changing landscape. These states tend to have a high concentration of managers, professionals and college-educated residents working in "knowledge jobs."

Their companies tend to be more geared toward global markets, both in terms of export orientation and levels of foreign direct investment. Almost all are at the forefront of the IT revolution, with a large share of their institutions and residents embracing the digital economy.

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Most have a solid "innovation infrastructure," including leading universities and government and corporate laboratories, which foster and support technological innovation. Many attract high levels of domestic and foreign immigration of highly-mobile, highly-skilled knowledge workers seeking good employment opportunities and a high quality of life.

Why states score low

In contrast, many of the states that lag behind on the index historically depended on natural resources, on tourism or on mass-production manufacturing and relied on low costs rather than innovation capacity to gain a competitive advantage.

While some variance can be explained by low incomes, many states have drastically outperformed where income measures would predict them to fall. Arizona, Idaho, Utah and Vermont do significantly better on the SNEI than would be expected by solely looking at per-capita incomes. These states have done reasonably well at attracting and/or growing knowledge-based, innovation industries backed by a growing skilled workforce.

Regionally, the "new economy" has taken hold most strongly in the Northeast, the mid-Atlantic, the Mountain West and the Pacific regions. Conversely, many Southern states have not kept pace, in part because for so long the South sought to win through low costs, not high-innovation, and that strategy doesn't work anymore. Many Midwestern states also lag behind due to the challenges they face in developing more dynamic entrepreneurial business cultures that can spawn the next fast-growing companies.

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States that score poorly in the rankings are not lost causes.

If policymakers insist that supporting new economy success factors become a priority, states can gradually improve both their SNEI score and their economic vitality.

Recommended reforms include:
enhanced financial incentives for innovation, such as research and development tax credits.
support for higher education, particularly for efforts to transfer technology from universities to local companies.
education and training programs that are adapted to the needs of high-growth employers.
improved entrepreneurial support systems.

If all states take these kinds of steps, not only will their own economies do better but so, too, will the overall U.S. economy.

The new economy has transformed how states do business both with each other and the broader global marketplace. Those that succeed will be the ones that can best create innovative and supportive climates that can attract the high-tech industries, entrepreneurs and highly-skilled workers that are the keys to economic health.

—Robert Atkinson, president of the Information Technology and Innovation Foundation