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Wednesday, June 4, 2014

Another Day, Another Bad Incentive Deal

No sooner had I finished my mini-series on evaluating proposed location subsidies then @varnergreg sends me this story about a new copper tubing manufacturing facility opening in one of the nation's poorest counties, Wilcox County, Alabama. This is clearly the sort of place where I think we should consider using investment incentives, but the sheer size of the subsidy relative to the investment (known as "aid intensity") makes this just another bad deal. Indeed, the subsidy to Golden Dragon Copper is potentially worse than Electrolux in Memphis, where state and local governments essentially gave the company a free plant.

The package includes:
$20 million in state economic development discretionary incentives; $8.5 million in property tax abatements; $5.1 million in sales and use tax abatements; $5.7 million for an industrial road and bridge to support the plant; $1.8 million in worker training services; and site purchase, prep and water and sewer improvements worth about $1 million.
But those are just the small bits. Do you have your calculator out? That comes to $42.1 million so far, a little less on a present value basis because the property tax abatement will be paid over time (unspecified how long in the article).

The biggest part of the subsidy is comprised of "capital income credits worth up to $160 million over 20 years." But, as reporter Dawn Kent Azok goes on to note, "Generally, companies don't realize the full amount because they are tied to income tax liability." Fair enough, but that leaves us with a lot of uncertainty in analyzing the subsidy. If we start at the midpoint and call it $80 million, here is what we come up with.

Obviously it's not a retail project, we know who the investor is, and it is a new facility. However, as countrycat points out, there is an existing copper tubing manufacturer in Alabama, Wolverine. Therefore, the subsidized increase in supply is a definite threat to create unemployment elsewhere in the same state.

For creating our main cost metrics, we'll note that the plant will have 300 workers at full capacity, and the investment is $100 million. You can see where this is a problem: using the $80 million midpoint, we are talking about $122.1 million in subsidies, which comes to $407,000 per job and 122.1% of the investment. Are these large figures? As we can see by consulting the Megadeals database, and as I have discussed more concretely regarding Electrolux (link above), these are extremely large figures. An automobile assembly plant will cost about $150,000 per job with an aid intensity of about 33%. So Golden Dragon will get more than 2 1/2 times as much per job, and 4 times the aid intensity of an auto assembly plant, without requiring the extensive supplier network you'd see with the auto plant.

Moreover, it doesn't pay as well as an auto plant, starting at $15 per hour. No information was given on benefits, so we can't evaluate the project on that basis. There was also no information given on whether the project will benefit from eminent domain.

As noted above, Wilcox County is one of the poorest in the country. This is clearly the biggest positive aspect of the project. It is more than an hour away from Montgomery, according to Google Maps, so we are not contributing to sprawl and there is no public transportation system to link the plant to. I have no information on the company's track record or whether it would have invested without the subsidy (have I mentioned information asymmetries lately?) I don't know enough about Alabama to know how well it enforces subsidy agreements or what the government's opportunity cost might be, but in any event I don't consider them necessary to know to see that this is a bad deal.

The two factors I think are most important here are that it is located in a very poor area, but more decisive is the huge cost, whether measured per job ($407,000 vs. $158,500 for Airbus in Alabama) or relative to the investment. The poorest regions of Europe (think Bulgaria, with 2012 GDP per capita of $6977, vs. $10,903 for Wilcox County) cannot give more than 50% of the cost of the investment (2014 regional aid guidelines, point 172), and for an investment this large that maximum would be reduced by 50% for the amount over about $67.5 million (50 million euros; see point 20 (c) of the guidelines), so 122% (and potentially more) is simply off the charts.

What the Golden Dragon case highlights is that companies know how to extract rents from their location decisions, and that desperation is not conducive to getting a good bargain.

Note: This is one of the situations where conversion of other currencies should not use purchasing power parity adjustment, so Bulgaria's per capita income is expressed in current U.S. dollars. The reason for this is that if a company were choosing between investing in the United States or Bulgaria, it would have to pay the actual wage rates prevailing in the two countries, not wages adjusted for purchasing power.

Cross-posted at Angry Bear.