Contemporary economic development work by the public sector puts a lot of taxpayer resources to very inefficient use. Instead of providing special incentives to a small number of firms, states and communities should instead focus on creating a better organic environment for all businesses.
Contemporary Economic Development Has a Very Short History
A century ago, most "economic development" efforts were programs to improve the quality of public works like water supplies, electrification, and municipal sewerage. With a century's less regulation on the lawbooks and a much lighter tax burden, both for corporations and individuals, there was little economic incentive for business owners to relocate their firms or to expand anywhere different from where their businesses were already located.
Economic Development Has Become a Self-Sustaining Industry
Today, with tax rates much higher than they were 100 years ago and a paper blizzard of regulations surrounding virtually every business, the field of "economic development" is vastly different. Consider only the number of organizations serving the industry:
- National Association for County, Community, and Economic Development
- National Rural Economic Developers Association
- Council of State Community and Economic Development Agencies
- National Congress for Community Economic Development
- National Association of Counties
- National Association of Development Organizations
- National League of Cities
Viewing Economic Development as a Good in its Own Right Makes it Less Accountable for Results
The usual suspects of economic development -- public utilities, for example -- are still actively engaged in traditional bottom-line population-growth economic development projects, but the field now sustains itself out of an a priori sense of purpose: That "economic development" itself is a good and worthy goal. The problem is that when this sort of mission and purpose is adopted, it becomes a holy war to be waged in its own right. The result is that the costs and benefits of the conditions leading to "economic development" rarely are effectively evaluated.
The self-sustaining nature of the economic development industry should only be expected to keep the juggernaut moving full steam ahead. A wide range of factors are causing local governments and business communities to become more intensely interested in activist community economic development programs than ever before:
What Kinds of "Economic Development" Incentives Deserve Further Critical Examination?
The scope of contemporary "economic development" programs goes far beyond ensuring the best possible environment for business in general. The scope now includes many offerings that differ little from outright welfare handouts:
- Property tax abatements
- Jobs-related tax credits
- Employee training credits
- Direct forgivable loans
- Loan subsidies
- Loan guarantees
- Subsidized infrastructure development
To examine the problem further, consider the environment in which communities and states compete in order to attract businesses by using these incentives:
|Business is Increasingly Open to Significant Geographic Moves|
|Industrial development is no longer the cornerstone of economic development, reducing the dependency of businesses upon immobile plant and equipment||As the US economy has grown since the heyday of the Industrial Age, the service sector has emerged as the dominant segment of the economy, encompassing a substantial majority of all private-sector employment.|
|New methods of manufacturing have reduced dependency on fixed capital stocks||The widespread acceptance of practices like outsourcing, "lean" manufacturing, and just-in-time supply chains has reduced some firms' dependency upon immobile capital and equipment stocks, increasing their ability to relocate or more selectively locate.|
|A large share of firms are managed by non-owners||The old model of the business owner overseeing his or her own factory or shop in a comfortable and familiar hometown is no longer the norm. It has been replaced by a management class with less permanency in the job and in the community.|
|Transportation and other infrastructure categories are generally at a mature stage in most locations||Few locations anywhere in the United States are now more than a short distance from the Interstate highway system. Geographic limitations once imposed by access (or lack of it) to good highways or other forms of transport are now less significant than in the past. 84% of the population now takes its water from public water supplies, indicating that access to basic utility services is relatively homogenous throughout the country.|
|Trade has homogenized both inputs and products across many geographic regions|
|Employees Are Highly Mobile and Adaptable|
|Employees are extremely mobile||More than 22 million Americans out of a total population under 300 million moved between different states in the five-year period 1995 to 2000. Shorter moves (between cities or counties within the same state) are even more frequent. It is safe to conclude that there are reasonably few barriers to individual or family mobility, and that the workforce available in any particular location is at least somewhat fluid.|
|Employees are adopting more flexible work practices||The broad adoption of flex-time, telecommuting, and home-based offices as employment practices, even in large firms, increases the adaptability of large firms to local conditions. A large firm may no longer require a significant office presence in every major city if it can use flexible workplace policies that allow local employees to share in the company's "virtual" office while actually occupying a totally different geographic space.|
|Demand is high for skilled employees|
|Local Governments are Eager to Attract Businesses in the Name of Economic Development|
|Local and state governments must raise significant levels of revenue from taxes in order to fulfill large demand for services|
|Tax competition among communities and states is acute|
Opposition to Conventional Economic Development Programs is Emphatically Not the Same as Opposition to Economic Growth
Opposition to conventional economic development efforts is not the same as opposition to economic growth and development in its own right. In fact, it is quite the opposite. This principled opposition to conventional efforts is based on the conclusion that conventional efforts are inefficient and counter-productive, resulting in less economic benefit and growth than alternative solutions.
How Some Contemporary "Economic Development" Projects Harm the Community
|Economic development schemes force some businesses and business owners to subsidize direct competitors||It's virtually impossible to identify a new business attracted by economic-development programming that enters a community without any competitors in the market. By definition, a lack of competition in such a market would have guaranteed the new firm a monopoly and thus would render contemporary economic development incentives completely moot -- a monopoly being the best incentive of all. Instead, the case is much more often like that of West Des Moines, Iowa, where a $54.9 million incentive package was used to attract a $118 million expansion by the home mortgage and consumer credit divisions of Wells Fargo. That publicly-funded incentive package was funded in part by the tax dollars of shareholders and employees of competitor Principal Residential Mortgage , already headquartered in Des Moines. Certainly the consumer-credit division employees of Citigroup's Des Moines office were not refunded their share of tax dollars used to prepare the package deal for Wells Fargo.|
|The tax burdens imposed by economic development initiatives on the community at large creates a disincentive for existing businesses to invest||Given that every business has finite resources with which to invest and grow, every tax dollar taken out reduces that business's ability and incentive to pursue growth. Some tax costs will always be required in order to provide certain basic and necessary local services (police and fire protection, for instance), but the excess taxation required to fund economic development incentives will have a negative effect on the ability of existing businesses to grow and expand.|
|Increased competition for local workforce||Tax-funded economic development incentives have the perverse effect of increasing demand (and thus costs) for employees at the expense of existing employers.|
|Credit hazards (moral hazard)||The fact that a business requires a subsidized or government-guaranteed loan is enough to establish that it represents a credit risk great enough to make it relatively uncompetitive for private-sector funding. How, then, is it an efficient allocation of taxpayers' resources to force them (since taxes aren't a voluntary proposition) to subsidize especially risky investments?|
|Existing residents and businesses are forced to invest their tax dollars into programs not of their choosing, often with little or no appropriate oversight||The public-sector employees who manage economic-development programs, grants, and guaranteed loans are not business or investment experts. The market for that kind of expertise is sufficiently strong that good investment professionals will be hired by private firms to manage investments in return for profit-sharing and dividends -- not publicly-funded economic development programs. Governments and economic development agencies are very good at hiring boosters and cheerleaders, but they are entirely uncompetitive at hiring investment managers.|
|Wrong metrics used||It's difficult to find an economic development package that doesn't discuss the impact on "jobs" supposedly generated in the community. While the number of jobs supposedly created by an incentivized business expansion or relocation (and "jobs's" attendant cousin, "economic impact") makes for easy headlines and ready-made sound bites, they are terrible measures of value. Unfortunately, the public language of economics is rarely sophisticated enough to move beyond "jobs", and enormous money is to be made by over-estimating the value of "economic impact."|
Communities Should Consider Pursuing More Reliable Organic, Endogenous Growth
As a practical matter, economic growth is usually enhanced most by the presence of a few significant conditions:
- Rule of law
- Minimal taxation
- Minimal bureaucratic interference with markets
- Widespread access to quality education
A strong case could be made that it would be more fair to do so as well, but that isn't necessary in order to make the economic case. Efficiency alone seals the argument: There are 50 states in the Union, and the Census Bureau counts some 36,000 municipal and town governments. Most of those are, to one degree or another, competing with all of the others to attract businesses. Surely it would be a more efficient use of taxpayers' resources for each of those governments to simply focus on delivering the most attractive overall environment for businesses in general than to compete for the attention of suitor firms on a case-by-case basis.
Benefits to Improving the Organic Environment for Business Rather Than Using Targeted Economic Development Incentives
|Loyalty||Firms started in and owned by residents of a community are more likely to be loyal to that community in the long run than firms that were wooed by special incentives and temporary financial deals. There may be 50 ways to leave your lover, but there are 36,000 ways for a company to leave your town.|
|Lower moral hazard||The one advantage that local banks will always have over their larger national and regional competitors is that they have a keener ability to identify credit risk. A credit manager with close contact to the community is better able to assess the moral hazard risk that a local loan applicant will gamble away a loan than a credit manager who has no other information on the applicant than what appears on a standardized form. Lenders and governments similarly have less ability to evaluate firms from "the outside" than they do local firms.|
|Organic growth makes the local economy more robust||Organic business growth -- growth that takes place because the environment was good, rather than due to special incentive packages -- is better at weeding out bad investments and inefficient projects. Given that the objective of most contemporary "economic development" is to enhance the economy of the local area as a whole, it would be rational to encourage the development of a robust business sector, rather than staking large gambles on flash-in-the-pan projects that, as noted above, are likely to be unusually risky.|
|Better business mix appropriate to local conditions||Assuming that the basic conditions (rule of law, low taxation, minimal bureaucracy) are the same in two different communities, each will develop a unique mix of businesses that is especially suited to conditions in that place. This is a basic acknowledgement of Ricardian equivalence. The presence of special incentives designed to attract particular businesses or industries distorts the local mix and, all else equal, causes that mix to be less efficient than what would be optimal. This effect is especially acute because the public-sector employees who administer the incentive programs are unlikely to be especially good at recognizing the role of competition in refining and balancing the private sector.|
|No subsidies required||"Corporate welfare" is as dirty a phrase in contemporary politics as any other. Most contemporary economic development incentives are exactly that: welfare. It's much wiser and much less subject to abuse to simply create a good environment for all businesses, free of special packages and offers.|
|NIMBY effect diminished||The NIMBY (Not In My Back Yard) effect rears its head whenever a proposed project could be perceived as harming the environment or other desirable aspects of the community. A business environment in which there are no special deals for outsiders to enter a community helps to diminish the impact of NIMBY concerns, since local business owners have no special incentive to "dump" their problems on their own hometown.|
|Pay-as-you-go for infrastructure||Many economic development packages, especially when they involve large expansions or new construction, include significant subsidies for the improvement of infrastructure -- like water, sewer, and street construction. Without that set of incentives in place, communities have to apply a rational, pay-as-you-go approach to the development of those services.|
|Home bias for educated young residents helps attract good entrepreneurial projects||Whether it's admitted out loud or not, many people exhibit a strong home bias -- a preference for their own communities, states, and nations, as well as for the firms that come from them. This effect exists among young people as well. Since a sizeable number of eager entrepreneurs come from the ranks of the young, communities with the best organic environments for business development are better able to attract and retain energetic new companies.|
Economic growth itself is usually a profoundly good thing -- it is what makes living in 2004 so much better than living in 1904. But much of the time, energy, and financial investment made in contemporary "economic development" is very bad at actually achieving efficient economic growth. Instead, it is a complex of subsidies, bad investments, salesmanship, and chicanery that often has the impact of harming the very people who pay for it. It would be for the good of both the communities that hope for economic development and the nation at large if the question of economic development became one of how to create the best environment for all businesses rather than of how to best package sets of special incentives for individual firms. The people involved in contemporary economic development are certainly just as good and well-intentioned as everyone else, but their industry is in dire need of substantial and systematic change.
This essay was written without any prior knowledge of, or reference to, an article by Arthur J. Rolnick of the Federal Reserve Bank of Minneapolis, entitled "Winning Battles, Rather Than the War, On Economic Development Subsidies". That said, Rolnick's article is substantially similar in terms of content and well worth reading.
Corporate tax accountant Joe Kristan uses other examples from Iowa to argue the same case against tax favoritism to drive "economic development."