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Sunday, December 4, 2011

Are Incentives Ever Good Policy?

Most of my work on investment incentives is quite critical of their use. As a result, I often get questions about whether there are any good uses of incentives, or whether states have no choice but to offer them because other states or nations are using them. The research of Tim Bartik sheds important light on this topic, in terms of identifying types of incentives that can have positive national benefits. I consider also some circumstances in which using investment subsidies can be politically justified, as well as the question of whether governments are trapped in the incentive game.

According to Bartik, two types of intervention can have positive national benefits, as opposed to benefits for the local jurisdiction.His work shows that typical "smokestack chasing" incentives, while they have a positive local benefit, have negative consequences for other states, that exceeds the benefit to the state that offers the incentive: hence, a negative net national impact. This is consistent with my work at the theoretical level that governments face a collective action problem in their use of subsidies. It also is consistent with empirical finding in international work that when other countries in your region use incentives, it decreases the amount of investment your country receives.

As I said , Bartik identifies two types of cost-effective incentives: customized training for companies on the demand side, and early childhood education programs and generalized job training programs on the supply side. Neither of these is smokestack chasing, and they make up a small portion of the incentives most states offer. For example, in North Carolina, in fiscal year 2008-9, the state's Economic Development Inventory reports that total economic development spending came to $1.2 billion. Of this, less than $11 million (1%) was spent on all types of training programs. North Carolina has a well-known early childhood education program called Smart Start, which is not considered part of the economic development budget. After a "one-time reduction" (quotes because there was another reduction the following year), the program had $194 million in FY 2008-9, about 16% of what was spent on economic development subsidies.

There is one time when I consider smokestack chasing to be politically justifiable, when it is restricted to locations that meet objective criteria of economic deprivation. This is what the European Union does, and I show in Investment Incentives and the Global Competition for Capital that EU policy has reduced what individual governments have spent on incentives, and only allowed them in the poorer regions of the EU. Some U.S. states have crafted their incentive laws to favor poorer counties, but that targeting usually is weakened over time as big companies say they'll only come if they get the maximum subsidy in a richer county. With no centralized (federal) law to enforce targeting, states have repeatedly weakened it when they do have it. This is one reason I favor federal regulation of incentives.

The bigger reason is that the states don't take the impact of their incentives on other states into account when deciding their policies. Kansas' government is not elected to care if the jobs it "creates" are merely lured across the state line from Kansas City, Missouri, let alone whether Kansas' job creation indirectly reduces jobs in other states. Therefore, the states have to be restrained by federal action to get rid of the scores of billions spent on subsidies annually.

But what should states do until then? Can states unilaterally disarm? I think the answer is probably not, although the province of Alberta in Canada has done so (oil revenues are probably the reason it can do this). But you won't get credit from me for "responsible" policy if you aren't actively working for a federal solution to the problem. And as we saw as recently as 2006 when the U.S. Supreme Court ruled on Cuno v. Daimler-Chrysler, states were actively lobbying Congress to overturn the ruling should it have followed the Appellate Court's ruling in favor of plaintiffs. In other words, states don't want to give up their economic development tools, because they still fail to appreciate how they are bound in a collective action problem that is ultimately only solvable at the federal level.

In the meantime, critics need to highlight the enormous cost in cash and lost government jobs. Local successes do occur, such as the defeat this year of the $360 million Aerotropolis subsidy in St. Louis opposed by the liberal Missouri Budget Project and the libertarian Show-Me Institute. But there is still much work to do in ending the economic war between the states.

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