Shocking incentive failure rate in North Carolina

@sandymaxey points me to a new report from the North Carolina Justice Center that is making my head spin. Picking Losers shows that the state's flagship development program, the Job Development Investment Grant (JDIG), has seen 62 of its 102 projects fail in the period from its inception in 2002 until 2013. That is, 60% of the projects failed to meet either their job, investment, or wage goals, and had to have their awards canceled.

60%! This isn't baseball, where a .400 batting average is outstanding, a feat that hasn't been accomplished since Ted Williams in 1941. Let me tell you about a different failure rate: Investment Quebec takes equity stakes in a number of tech start-ups and other new companies. When I interviewed the director in Montreal in 2007, their failure rate was only 20%, a figure he considered needed to be reduced. In North Carolina, we are talking about a failure rate three times as high, despite giving the awards to firms that should not be nearly so risky.

One such firm was Dell Computers. In 2004, the company conducted a bidding war for a new computer manufacturing plant between Virginia and North Carolina. But North Carolina's analysis of the project was so out of whack that in nominal dollars it offered almost $300 million ($174 million present value) compared to Virginia's offer of $37 million. The plant shut down completely in 2010.

Here's the paradox: North Carolina has some of the best taxpayer protections in the country; indeed, state and local governments lost only a few million dollars when Dell failed. The state is rigorous about canceling awards and clawing back monies already paid out. But the problem is that the state's economic analysis of potential projects is simply atrocious. The 60% failure rate is one sign of this. The Dell fiasco, analyzed by the NC Justice Center and the Corporation for Enterprise Development in 2007, shows another aspect of fanciful economic modeling.

What can be done? I've written before about the weakness of economic development cost-benefit analysis. Even by that low standard, North Carolina's performance is breathtaking. Report author Alan M. Freyer suggests that the Legislature needs to resist calls to expand JDIG or create another fund with the same purpose, maintain its jobs standards, focus on expanding industries, vastly improve its evaluation of potential projects, and focus help on rural counties. I would add that the state should reverse its cuts to education, one of North Carolina's economic development crown jewels to date, and restrict its subsidies only to those types shown to have a positive national impact, primarily customized training for companies and generalized training for individual workers. Improving skills increases workers' income, and it also strengthens the U.S. economy as a whole, as opposed to simply building up a company's bottom line.

Cross-posted at Angry Bear.

Boeing moving 2000 jobs from Washington state

Via @BlogWood, I learned that Boeing is going to move 2000 skilled jobs away from Washington state, despite just receiving $8.7 billion (with a B) in subsidies for the years 2025-2040. Really, I'm speechless. "Chutzpah" is one of the more printable words I can think of to describe this.

You will recall that the state's legislators were angry when their $2 billion (present value of $3.2 billion over 20 years) 2003 subsidy for the Dreamliner did not stop Boeing from putting a Dreamliner assembly line in South Carolina. So the 2013 subsidy was supposed to guarantee that Boeing couldn't do this again.

Boeing's response no doubt will be that these jobs are in the Defense division, not in civil aircraft. Thus they are not covered by either the 2003 or the 2013 subsidy. This has already been hinted at by a commenter on the Business Week article, wraiths13@yahoo.com. This is true, but cold comfort: It's still a reduction of Boeing's footprint in Washington.

Let's take a similar example in North Carolina. In May 2010, American Express announced that it was building a $400 million, 50- to 150-job, data center in Greensboro, without incentives. Why would it not want incentives? Take a guess.

Here's mine, which seems to be pretty widely shared: American Express already knew that it was going to close its call center in Greensboro, at the cost of 1900 jobs, which it announced in January 2011. Thus, it would have been subject to clawbacks of any incentives it received for the data center, so why bother negotiating for incentives it couldn't keep?

What American Express knew it couldn't do in North Carolina is exactly what Boeing is now doing in Washington. This suggests the Washington has weaker job creation requirements than North Carolina, which ties subsidies to the total number of jobs in the state, not just at one location. So Washington has combined the nation's largest-ever subsidy with weak performance requirements. Meanwhile, Boeing has done nothing to earn the benefit of the doubt regarding its motives. This is just one more indication that the company will try to find a way to worm its way out of commitments directly covered by the incentive packages. When that happens, try not to act surprised.

Cross-posted at Angry Bear. 

Basics: Let's Debase the Dollar!

A lot of people, especially conservatives, complain about the so-called debasement of the U.S. dollar. For example, Craig R. Smith, who is apparently important enough to be interviewed by "FOX News, CNN, CNBC, ABC, NBC, CBS, PBS, CBN, TBN, Time, The Wall Street Journal, The New York Times, and Newsweek," wrote a book last year that claims the value of the dollar has fallen by 98% in the 100 years since the income tax and Federal Reserve were established in 1913. He predicts terrible economic calamity will be the result of this debasement. Smith is not alone in this view; evidently Rep. Paul Ryan shares it, too (h/t Paul Krugman).

Mind you, this is a slight overstatement according to Bureau of Labor Statistics (BLS) inflation data (www.bls.gov, series CUUR0000SA0, set date range for 1913 to 2013). This shows that the Consumer Price Index has increased from 9.8 in January 1913 to 233.5 in June 2013, which implies a decline in the dollar's purchasing power of only 96%. To put it another way, according to the BLS, today's dollar is worth 4 1913 cents, while Smith says it only worth half as much, 2 1913 cents. Either way, sounds pretty awful, right?

Of course not. This is another example of something I wrote almost two years ago: "When someone tries to get you to focus on only one part of a complicated picture, it's a safe assumption they are trying to mislead you." The most obvious omission of the "debasement lobby" is the fact that pay levels have risen a lot since 1913. A single dollar does not buy as much as it did in 1913, but people get paid a whole lot more dollars per hour/week/year than they did, then, too!

What actually matters is not how much the dollar is worth, but the ratio of what people get paid to what the dollar is worth. If your dollars earned rise faster than the value of the dollar falls, that is the very definition of rising real wages! And the Lord knows I'm well aware of falling real wages for the majority of workers since 1972; a post I did on that subject is my second-most read of all time.

Ultimately, what the debasement lobby is mad about is inflation. Smith claims that "real everyday price inflation is running at 7 percent or more per year..." Krugman has been doing yeoman's work on this issue. We should note that the BLS has been calculating the consumer price index since 1919 and probably knows a little bit about what it's doing. If you want to doubt its validity anyway, Krugman points us to MIT's Billion Prices Project, which comes up with results very similar to those of the BLS.

So high inflation is not the problem we face. Low inflation is. With inflation so low, people get no relief from their debts, and have to reduce their debt as much as possible. When that happens, they buy fewer goods and services, so unemployment gets worse, and it's already bad enough at 7.4% in July. Government could offset weak private spending with jobs programs, but Republicans have made it clear that they aren't going to pass any jobs bills, so that route is shut off for now.

As a result, millions of people are needlessly unemployed, still at near-record levels of long-term unemployment, and states like North Carolina are cutting unemployment benefits sharply. Shameful.

Let's debase the dollar!

Cross-posted at Angry Bear.

New Report Highlights Flaws of North Carolina Mega-Incentives

My new report for the North Carolina Budget and Tax Center, Special Deals, Special Problems--An Analysis of North Carolina's Legislature-Approved Economic Development Incentives, has just been published. It covers a range of issues I've emphasized here before as well as some basic considerations reporters really need to pay more attention to.

North Carolina has some of the best economic development practices in the country, in terms of online transparency, performance requirements, use of clawbacks for non-performance by companies, sunset clauses for tax expenditures, hard caps for many tax credit programs (see my report on these points), etc. The state publishes an economic development inventory I consider to be of very high quality and consistent with international definitions of a subsidy. The most recent edition shows that in the 2008-9 fiscal year the state spent about $1.2 billion on economic development, enough to hire 24,000 people at $50,000 a year in wages and benefits.

At the same time, however, the state has persistently had problems in overvaluing potential investments and consequently offering wildly excessive subsidies for them. The best known case is Dell in 2004, when Virginia offered the company a $37 million incentive package, while the state and local bid from North Carolina came to almost $300 million on a nominal basis ($174 million present value). Other deals discussed in the report are Google ($260 million nominal value, $140 million present value), Apple ($321 million over 30 years nominal value, no present value calculation available), and a provision in a 2011 special incentives bill to allow Alex Lee Inc. to keep $2 million it should have forfeited for not keeping job promises. This last case illustrates how special legislative deals weaken the state's performance requirements; this case will make future companies think that there may be no penalty for non-performance.

Reporters take note! This publication describes useful techniques for comparing the size of incentive packages regardless of project size or payout period of the incentive. From the European Union I borrow the term "aid intensity," which measures the size of the incentive relative to the amount of the investment or the number of jobs created. The idea is that a $1 million incentive would be large for a call center but a rounding error for an automobile assembly plant. As a result, we need a standardized way of comparing incentives.

While in this country one can sometimes find cost per job analyzed for some subsidy packages, the EU actually uses the subsidy/investment metric as its primary measure of aid intensity. In my last post I discussed a mall redevelopment which could conceivably have an aid intensity of 96%. For comparison purposes, we should note that the highest aid intensity allowed for large firms anywhere in the European Union, is 50%, and that is only allowed in the poorest regions of the EU, mainly in eastern Europe. (Richer regions have lower allowable maxima.) A region's maximum is cut by half for large projects over 50 million euro, and by 66% for spending over 100 million euro.

The other important concept is present value, a familiar one to accountants and economists, but not widely understood among the general public. The basic idea is simple: receiving a dollar today is worth more than receiving a dollar next year, which is worth more than receiving a dollar in two years, etc. Since incentive packages can pay out immediately (with a cash grant) or over a period of 30 or more years, we need to use present value to properly compare the size of incentives with different payout periods. This requires finding a a "discount rate" by which to reduce future payments. We then use the present value as the numerator in calculating aid intensity to be able to compare across different sizes of projects.

Using Google as an example, this $600 million project will receive $260 million over 30 years and create 210 jobs. As mentioned above, this is its nominal cost, before discounting the future dollars. Following the practice of a 1990s study by the Organization for Economic Cooperation and Development to compare subsidies among its then 23 members, I used a discount rate equal to the 10-year Treasury bond yield to come up with a present value of $140.6 million. Then the aid intensity is $140.6 million/$600 million, or 23%, and the cost per job at present value is $669,489. We can then use these two measures of aid intensity to compare the incentive to that given for other projects and inform our judgment of whether it was a better or worse deal than other states have made, in the current context where states make such deals all the time. Of course, I believe there should be limits placed on state and local governments so we can sharply reduce net incentive spending, which has few national benefits--but that is a long time in the future.

North Carolina provides an intriguing case study because it does so much right in economic development, but it makes special deals outside its statutory incentive programs. The result is high costs and weakened bargaining position in the future. It's a case we can learn a lot from.

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.