New article in Shelterforce highlights EU state aid rules

Greg LeRoy and I have written an article at Shelterforce explaining the basics of the European Union's rules governing subsidies, or "state aid" in EU-speak. As the article is ungated, and regular readers will remember much of the detail, I will not quote it here. Suffice it to say that the continuing reverberations of Amazon's HQ2 project have opened space to shine a brighter light on economic development subsidies.

In addition, Tim Bartik of the Upjohn Institute has a series of thoughtful tweets commenting on our article. His one reservation with the EU approach appears to be that even with the scaling down of the maximum subsidy allowed for large projects, the amount allowable might still be too high. If I'm not reading too much into his comments, it seems he would favor an absolute dollar cap on subsidies for the largest projects. He also admits in his counterfactual analysis of Foxconn in Wisconsin that the Racine/Kenosha area wouldn't be eligible for the highest level of incentives under the EU rules, so his scenario of a $1.7 billion subsidy being possible isn't fully accurate. In fact, it looks to me that Kenosha and Racine counties are just slightly below the national average for income per capita, and certainly not less than 75% of the average, the key figure that would make an EU region able to have even a 25% regional aid maximum.* The next highest aid maximum allowed in the European Union is 15%, and 34% of that (the scaling factor for investment over 100 million euros) is just 5.1%. Thus, a $10 billion Foxconn project would be eligible at most for a tad over $510 million in subsidies, not $1.7 billion.

I'd love to hear your take on our article.

* More technically, a per capita GDP below 75% of the EU average is required for designation as a "107(3)(a) area," named for the treaty paragraph it is listed in. See Regional Aid Guidelines for 2014-2020, paragraph 150. 25% is the lowest aid maximum in a 107(3)(a) area, while 15% is the highest aid maximum in a 107(3)(c) area, available to regions between 75% and 100% of the EU average, plus a few exceptional situations such as very low population density.

Amazon moves closer to breaking the bank with "HQ2"

Yesterday (Jan. 18), Amazon announced the 20 finalists for its "HQ2" project, that will supposedly create a second headquarters (why?) for the company somewhere in North America, most likely in the United States. With an alleged 50,000 jobs and $5 billion in investment, this development attracted 238 bids from cities and counties in the United States, Canada, and Mexico.

The finalists: Atlanta, Austin, Boston, Chicago, Columbus, Dallas, Denver, Indianapolis, Los Angeles, Miami, Montgomery County (MD), Nashville, New York, Newark, northern Virginia, Philadelphia, Pittsburgh, Raleigh, Toronto, and Washington.

The finalists will now be subject to months of unremitting pressure to give up as much as possible. It will not be pretty. Information asymmetry, capital mobility, and rent-seeking are the hallmarks of the site selection process. In the European Union a set of rules on subsidies limits this competition, whereas in the United States, it's the Wild West. This leads to much higher investment incentives being given in the United States than are given by EU Member States for similar projects even by the same company (AMD/Global Foundries, for example).

Interestingly enough, both the highest-known bid ($7 billion in Newark) and the lowest (0 in Toronto) are still under consideration. (Unfortunately, the other known 0 bid, by San Jose, was rejected.) I can think of scenarios where either might be chosen, but I can't get inside the mind of Jeff Bezos and other Amazon decision-makers. This is the heart of information asymmetry. So again, we have to wait and see what Amazon does. Will the company subject a smaller group of cities to still more torture? Stay tuned!

Now Amazon wants to break the bank UPDATED

On Thursday (October 19), the first stage of the Amazon sweepstakes for a second headquarters, dubbed "HQ2," was completed as cities submitted their bids to the Internet giant. With a possible $5 billion investment and eventually 50,000 jobs at salaries over $100,000, this is one of the very best economic development projects to come along in a long time.

BUT IS IT?* I have a hard time understanding how this project even makes economic sense. Why does a company need two headquarters? Doesn't that defeat the whole idea of having a headquarters as a centralized coordination site? Dean Barber has gone so far to suggest that Amazon will "A/B test" the two headquarters: See which one does better, and close the other one (h/t Greg LeRoy). I can believe it, but as long-time readers know, this is an area where we're looking at the terrible information  asymmetry that bedevils governments in site selection bidding wars. In other words, we have no idea whether Amazon intends to close its existing headquarters in Seattle or close HQ2 if it doesn't work as well as the current headquarters. This is kind of an important point for assessing the impact of HQ2 on the United States as a whole. And then there's the effect that subsidizing Amazon will have on its competitors, which will reduce net job creation and net benefits for the country as a whole. On top of everything, unemployment is pretty low in most states, so why would they want to shell out billions of dollars for this project?

I'm not going to try to prognosticate the HQ2 location (I almost said "the winner," but there is a good chance of overbidding in a public auction with so many competitors), because there is no way to wave away the information asymmetry problem. I think we can be confident that it will be a place that is already a tech hub. CNN offers eight plausible contenders (Atlanta, Pittsburgh, Toronto, Dallas, Austin, Boston, San Jose, and Washington, DC), while the New York Times predicts Denver. Instead, I want to highlight some specific bids that caught my eye.

One of the good stories is Toronto. Both the city and the province of Ontario were quick off the mark to say that while they would certainly do things like facilitating land assembly, there would be no cash subsidies for Amazon. The city's application to the company emphasizes its abundance of tech talent. As a sign that this "no subsidies" talk is not empty, we can point to the announcement earlier this month that Ontario had secured a new investment from Thomson Reuters, adding 400 jobs over two years, scheduled to eventually grow to 1,500 jobs. This project received no financial support at all, only what provincial officials described as "concierge service" (h/t Carpentry of the Heart).

Another major city not getting involved in the bidding war is San Jose. Like Ontario officials, Mayor Sam Liccardo argues that talent availability is the key to attracting businesses. While this tells us nothing about incentives the state of California might provide, it is good to see two of the major potential sites taking an anti-subsidy position.

At the other end of the spectrum, New Jersey is offering $5 billion over 10 years, and Newark will provide another $2 billion over 20 years. This is crazy on a number of levels. First of all, it has a nominal aid intensity of 140%: New Jersey and Newark will pay all the costs of the project and give Amazon some more money on top of that. Second, this is 18 times bigger than the largest subsidy the state has given in the past ($390 million). (We saw the same situation with Nevada and Tesla, but that was only 13 times the state's formerly largest incentive package.) Whether the state is really capable of managing a deal of that size is doubtful; indeed, the $390 million American Dream retail/entertainment project has been under construction for more than 10 years. Third, while not all of the approximately 50 238 bids have yet been revealed, currently the second-highest bid is $500 million from Worcester, Massachusetts (state support is currently unknown), 1/14 the size of Newark's package. This is reminiscent of the disparity in bids between North Carolina and Virginia for a Dell manufacturing facility in 2004: $300 million (nominal) vs. $37 million! Fourth, and finally, this project requires the legislature to tear up the current geographic targeting of the state's Grow NJ subsidy fund, currently restricted to the four poorest cities in the state, Passaic, Paterson, Camden, and Trenton.

Now, we wait. Amazon does not plan to announce its decision until next year. There is plenty of time to announce a list of finalists and subject them to more pressure. I am going to guess that when all first-round bids are revealed, the number 2 bid will be over $1 billion; indeed, there may be several $1+ billion bids. This is going to get ugly before we're done.


*Bonus points if you recognize the literary allusion.

Why subsidize protectionism motivated foreign investors?

The already infamous case of Foxconn in Wisconsin illustrates a dynamic we are likely to witness more before we are rid of the illegitimate Trump regime. One of the regime's hallmarks has been a set of unpredictable trade policies with a definite protectionist tilt. The United States was withdrawn from the Trans Pacific Partnership agreement on January 23. On May 19, the regime officially announced it would renegotiate the North American Free Trade Agreement (NAFTA).

If you're a company dependent on exports to the United States, these are worrisome developments. Given that the country had $2.7 trillion in imports and an overall trade deficit of $502.3 billion in 2016, there are quite a few companies dependent on exporting to the United States. Therefore, the environment is threatening for them at present.

The classic response, as I wrote before, is to protect access to the U.S. market by making your product in the United States. This is what foreign automakers did in the 1980s, in the face of so-called "voluntary export restraints" on Japanese cars. Being committed to a particular site means that a company's bargaining power with the host government is sharply reduced. However, thanks to U.S. federalism, all is not lost for a company that really needs to locate in the United States.

Since each state has access to large revenues and budgets, and because the U.S. Constitution has not been interpreted to mean that location incentives violate the Commerce Clause (read: Cuno v. Daimler-Chrysler), state and local governments are able to reward companies for doing something they would have done anyway: Come to the United States. Even in the Foxconn case, where the firm obviously wanted to be in House Speaker Paul Ryan's district, it created the illusion that it might go elsewhere, which was all it had to do to get Wisconsin to cough up an obscene $3+ billion subsidy. (We won't know how much in total until we find out the cost for local tax increment financing.)

How can this happen? Probably the two biggest reasons are that the company is mobile, especially when it hasn't committed any money yet, and that there is a tremendous information asymmetry working against governments. Lots more information is available on governments and their officials than is available about a company and its true preferences. Even when a corporation is strongly telegraphing its preferred site, you never can be 100% sure that site will be the winner, or that it will be the winner even if it gives no investment incentives. Corporations make up competing sites even when there aren't any (a site location consultant tells me he always recommends that; see Competing for Capital). They exploit their information advantage well. As a result, governments give them investment attraction subsidies and the average taxpayer pays for it.

How do we know that Foxconn is coming to the United States because it is worried about protectionism? Because it made no economic sense for Foxconn to build here otherwise. There are good reasons Foxconn makes all iPhones in China: land, labor, and just about everything else are way less expensive than in the United States, *and* provincial and municipal governments will give them generous location incentives to favor one over the other. You can't beat that with a stick. But you can beat it if market access is in question.

As long as U.S. protectionism remains ascendant, a growing number of foreign companies will follow Foxconn and hedge their bets to guarantee access to the U.S. market. Due to fiscal federalism, however, the potential advantages from foreign investment (which may not be that great, depending on job losses at existing competitors' facilities) will be diluted or even overwhelmed by the amount of subsidies the newcomers receive. State and local governments need to resist temptation -- to be more precise, we need to find a way politically to make them resist temptation.

H/t to Greg LeRoy for suggesting this article.

Cross-posted at Angry Bear.

Video series for "Rethinking Investment Incentives"

As regular readers will recall, I contributed to the Columbia Center for Sustainable Investment's book, Rethinking Investment Incentives: Trends and Policy Options (Columbia University Press, 2016). Now, the editors have put together a series of video teasers for most of the individual chapters, all of which can be seen here.

As I wrote before, the book offers the perspectives of numerous experts in the field, and you can get quick overviews of the chapters from the teasers. These include the authors of chapters on theoretical analyses of location incentives; overviews of incentive use in the United States, the European Union, and the rest of the world; and control policies both subnational and supranational. I hope you find them of interest!

New book on investment incentives will help shape policies debates for years to come

This past week I received my chapter author's copy of a new book from Columbia University Press, Rethinking Investment Incentives: Trends and Policy Options. Based initially on the November 2013 conference on investment incentives at Columbia Law School, the contributors were put through their paces to upgrade their conference presentations into proper papers. The result is what Theodore Moran of Georgetown University calls in the Foreword "a who's-who of experts across this broad span of topics." He predicts, and I concur, that the work presented in this book will help drive policy discussions around the globe.

The book is divided into four parts. The first discusses theoretical debates on definitions and the effect of these incentives on (especially) foreign direct investment. The second section provides a global overview of the use of incentive incentives, both in major economies and in developing countries. Part III includes practical tools for ensuring program effectiveness as well as value for money. This includes a chapter on cost-benefit analysis, a methodology of which I am highly skeptical. As I have written before, if you end this analysis at the state (or city!) border, you miss many of the indirect job losses inflicted at competing companies by the addition of new subsidized competition. Indeed, according to economist Tim Bartik, very few subsidy programs have positive *national* effects, even if they have positive local effects that will be the only thing considered in the cost-benefit analysis.

Finally, the fourth part of the book considers ways to reduce the competitive use of investment incentives to attract investment. My chapter falls in this section, considering the control of subnational incentives in Australia, Canada, and the United States. (Spoiler: Most of the record is not pretty; Australia was an exception but the policy expired in 2011.) A variety of supranational regulatory efforts, including most notably that of the European Union, are considered in a chapter by Lise Johnson.

Have I teased you enough yet? This book is a must-have if you are interested in investment incentives and economic development; co-editors Ana Teresa Tavares-Lehmann (University of Porto, Portugal), Perrine Toledano, Lise Johnson, and Lisa Sachs (all of the Columbia Center for Sustainable Investment) are to be congratulated for the fine product.

How to deal with the growing incentives competition

This article was originally published in the Columbia FDI Perspectives series of the Columbia Center for Sustainable Investment, #131, September 29. I have left it largely unchanged, except for adding a link and a comment, and correcting a grammatical error.

As I discussed in an earlier Perspective,[1] the use of investment incentives is pervasive and growing. The most recent example [this was completed prior to the Tesla auction] of a big bidding war was when Boeing threatened to move production of its 777-X aircraft out of Washington state, prompting some 20 states to offer incentive packages to the company (including $1.7 billion from Missouri). In the end, Washington gave Boeing a package of tax incentives worth a record-breaking $8.7 billion over the 2025 – 2040 period to stay, and the unions made substantial concessions regarding pensions.

What can be done to control such auctions, which are often international in scope? The most robust control method, regional in scope, is embodied in the European Union (EU) Guidelines on Regional Aid. These rules guarantee transparency, set variable limits (in terms of “aid intensity,” which equals subsidy/investment) for aid levels based on each region’s per capita income, and reduce the value of aid to large investment projects over €50 million. They require projects to stay at least five years and mandate the use of clawbacks for firms that fail to meet their commitments in investment contracts. Moreover, the guidelines provide demerits for firms in a dominant position in their industry, although they do not mandate a particular reduction in aid.

The other international control measure comes under the World Trade Organization (WTO) Agreement on Subsidies and Countervailing Measures. While these rules are more tailored to production subsidies than to investment incentives, the latter certainly come under the purview of the Agreement as well, as illustrated by the EU’s successful complaint against subsidies for Boeing in the states of Washington, Illinois and Kansas.

However, this case also illustrates the limits of WTO subsidy control. The EU has already filed a compliance complaint,[2] and there is little likelihood the United States (US) will comply anytime soon (the US Trade Representative’s office claims that the US has complied, but as long as the state and local tax credits continue in Washington state, that is not correct). Indeed, as mentioned, Washington state has approved a new round of subsidies for Boeing that is likely to initiate a new WTO dispute. 

While the WTO rules require frequent notification of subsidies, there is no penalty for failure to notify, with the result that subsidy notifications are of very uneven quality. Federal states outside the EU frequently make poor quality notifications regarding subnational subsidies. Finally, the TRIMs and GATS agreements regulate performance requirements, but not investment incentives.

What, then, can be done against incentives competition? First, there must be continuing efforts to improve the transparency of location subsidies. This is necessary for jurisdictions to make effective investment promotion policy (especially in a region such as the European Union and the United States, where there are many competing governments) as well as for international policy discussion.

Second, the EU’s example shows that incorporating subsidies rules into regional agreements can be a fruitful way to bring bidding wars under control. For many products, such as automobile assembly and steel, corporate location decisions still focus on a single region, meaning that such rules would be geographically comprehensive enough for a variety of industries. Consequently, major stakeholders—including the Columbia Center on Sustainable Investment, the International Institute for Sustainable Development, the United Nations Conference on Trade and Development, the World Association of Investment Promotion Agencies, the International Monetary Fund, the World Bank, and the Organisation for Economic Co-operation and Development—should unite in promoting location subsidy guidelines within regional trade areas. There are no doubt numerous other non-governmental organizations that would endorse such a move.

Third, WTO notifications should be strengthened. Incomplete notifications should be flagged and countries involved should be pressured to give cost estimates for subsidies at all levels of government. Still, it is difficult to envision that sanctions for non-compliance will be introduced.

Fourth, no-raiding zones could be a first step for countries to negotiate controls over investment subsidies. A no-raiding agreement simply commits a state to not give a subsidy to relocate an existing facility from another state; it would not apply to new investments. Their track record is mixed—several agreements among US states failed quickly, but Australia (2003-2011) and Canada (1994-present) have been more successful.[3] Despite these mixed results, it is easier to demonstrate to policymakers the futility of relocation subsidies, since they create no new jobs, than it is to do for incentives for new investment, which could make this a more feasible first step.

Though national and subnational jurisdictions have incentives to offer location subsidies, these proposed measures would help keep their value to more reasonable levels with a lower likelihood of distorting competition and international investment flows.

---

[1] Kenneth P. Thomas, “Investment incentives and the global competition for capital,” Columbia FDI Perspectives, No. 54, December 30, 2011.

[2] Emelie Rutherford, “EU wants $12 billion in U.S. sanctions over Boeing subsidy spat,” Defense Daily, September 27, 2012.

[3] Kenneth P. Thomas,  “Regulating investment attraction: Canada’s Code of Conduct on Incentives in a comparative context,” 37 Canadian Public Policy, 3 (2011), pp. 343-357; Kenneth P. Thomas, “EU control of state aid to mobile investment in comparative perspective,” 34 Journal of European Integration 6 (2012), pp. 567-584.

 From: Kenneth P. Thomas, "How to deal with the growing incentives competition," Columbia FDI Perspectives, No. 131, September 29, 2014. Reprinted with permission from the Columbia Center on Sustainable Investment (ccsi.columbia.edu).

 
Cross-posted at Angry Bear.

Tesla wants $500 million for its Gigafactory

Leigh McIlvaine (@Leigh M.) of Good Jobs First alerted me to this article on what Tesla Motors wants in incentives to land its $5 billion Gigafactory: $500 million. This massive 6500 worker facility will produce the next generation of batteries in order to introduce a less expensive line of cars in 2017, the Tesla Model 3. This would be a more affordable vehicle than the widely praised Model S, which starts at $69,900.

I'm not joking about the praise: Consumer Reports, my go-to source for product testing due to the fact that it does not accept ads and thus has complete independence, gave the Model S its best-ever score of 99 out of 100 when it tested the car earlier this year. It also leads the magazine's subscriber survey of customer satisfaction, with 99% of owners saying they would buy the car again. This is a vehicle, and a company, that is generating some serious excitement.

It's no surprise that the Gigafactory is generating serious excitement, too. 6500 jobs, a $5 billion investment, and cutting-edge technology is a heady mix for an economic development official. San Antonio, where Toyota makes pickup trucks, jumped into the auction quickly, offering "almost $800 million in incentives." Although Tesla has broken ground at a location near Reno, Nevada, last week CEO Elon Musk announced plans to break ground at one or two other sites as well. The company clearly considers speed to be of the essence.

It's unclear exactly what the company wants financially, and Tesla did not respond to my request for an interview to seek clarification of some important points. To be specific, does it want that $500 million in cash, in the form of property tax breaks over some number of years, land and infrastructure, or what? Most importantly, is Tesla's goal speed plus $500 million, or speed plus the highest bid? The company has sent mixed signals on this question.

As Forbes wrote, "Last week, Musk said that Tesla wanted to make sure a package was right for the winning state, as well as for Tesla." In the article's very next sentence, however, Tesla VP for communications and marketing, Simon Sproule, said, "Any publicly traded company has a fiduciary responsibility to get the best deal for its investment." Musk's comment seems to imply that $500 million is all the company wants. By contrast, fiduciary responsibility has often been used to justify a company going after the maximum incentives possible. Forbes quotes the business editor of the San Antonio Express-News that it was hard to tell if Tesla is conducting "a search (or) a shakedown."

Sproule disputed the shakedown thesis, despite invoking "fiduciary responsibility." How should we think about this project?

On the one hand, we could take Musk's comments as meaning that the company wants $500 million, no more, no less. Given that he expressed it as a percentage of the investment, my intuition is that we should assume that means $500 million in cash or cash equivalents like free land (my guess is that San Antonio's "$800 million" was mainly tax breaks, which would have a lower present value). If that's true, Sproule's contention that the incentive is not really so expensive is actually true in a comparative sense. A 10% aid intensity (subsidy/investment) would be the second-lowest for a large automotive facility in the modern history of megadeals. It would even probably be legal in the European Union under its Regional Aid Guidelines, if it were located in one of the EU's poorer regions. Moreover, the cost per job would be $76,923, substantially below the $100,000-$150,000 level common for most U.S. automobile assembly plants.

Of course, cost alone doesn't make a deal a good one. In particular, if Tesla wants its incentives up front, there is a substantial risk that the project won't ultimately produce 6500 jobs, or that changes in the market could even lead to the Gigafactory closing. New Mexico lawmakers have certainly recognized the importance of this vis-a-vis Tesla. In my email to Tesla, I asked what taxpayer protections, like clawbacks, the company is prepared to accept. Alas, no response, but I will update if I do hear back from Tesla.

On the other hand, if $500 million really is just meant as the minimum acceptable opening bid, all bets are off for saying how (comparatively) good a deal it might be.

Once again, we are confronting the issue of information asymmetry: government officials have less information about what the company really wants than the company has about the various governments, and of course its own intentions. This is a major source of bargaining power for companies shopping around for an investment location. If Musk really means that Tesla will voluntarily limit the incentives it requires, that would be a refreshing change from the typical bidding wars we have seen in so many industries. Or, it could just be business as usual, with the highest bid (adjusted for cost structure at the different locations) winning. We just don't know, but the decision is expected by the end of the year.

Cross-posted at Angry Bear.

Basics: Is That a Good Economic Development Deal? A Checklist UPDATED

In my last post, I discussed one of the most important sets of questions regarding any proposed economic development subsidy: How much does it cost? Is that too much? The answer, assuming that we are not going to overhaul our broken subsidy system overnight, was that we see if we're paying too much by looking at what other states and cities have paid for similar projects.

This presumes, of course, that we know how much the incentive package costs in the first place. There are, unfortunately, far too many cases where total incentives were far higher than what was originally announced to the press. Two noteworthy examples are Nissan in Mississippi and Electrolux in Tennessee. It may take sustained political effort just to keep politicians and economic development officials from trying to pass off this kind of balderdash.

Once we know the cost, we need to ask questions about the benefits of the project and the administration of the project by the relevant government(s). Without further ado, let's jump right in:

1) Is this a new project, or is the subsidy simply being given to move an existing facility from one location to another? If this is a relocation subsidy, just say no. It does the country no good to give subsidies to create no new jobs. Many times, such moves take place within a single metropolitan area (Kansas City, for example). One state's temporary gain creates an incentive for later retaliation. The Job Creation Shell Game has many more examples of these outrages, and points out that states already know how to write legislative language to prevent within-state relocations from being subsidized.

However, just because a project doesn't directly move an existing facility, that doesn't mean the jobs created will all be net new jobs for the national economy; indeed, they may displace existing jobs in the same state or same city. The automobile industry in the U.S. and Canada has shown this dynamic for decades, and the St. Louis retail study mentioned below provides another well-documented example.

2) Is this a retail project? This, too, is an automatic disqualifier. As Greg LeRoy of Good Jobs First like to say, retail is not economic development; it's what happens after you have economic development. Egregious cases like the wealthy St. Louis suburb of Des Peres (median household income of $90,000 in 1990), which in 1997 gave a $29 million subsidy to a local mall to attract a Nordstrom's, are legendary. But in the most comprehensive regional study of its kind, the East-West Gateway Council of Governments, the regional planning organization for metropolitan St. Louis, documented that from 1990 to 2007, local governments gave $2 billion in subsidies to retail. In that time period, retail employment grew by only 5400, which can probably be fully explained by income growth in the metropolitan area. In any event, these jobs vanished with the Great Recession.

Possible exception: Good Jobs First lists one possible exception: "Except in the rare instance where there is a true dearth (a low-income neighborhood without a grocery store, for instance), retail should be built without taxpayer aid." Amen to that.

3) How many jobs will be created? This is obviously the most common justification for incentives that government officials give. Once we know how many jobs are supposed to be created, we can calculate cost per job, an important comparison metric. It also gives us a clear benchmark to see if the proposed investor is living up to its commitments. But beware: Job numbers can be manipulated. Not only is indirect displacement possible, but the rosy numbers the company, consultants, and government throw around can be misleading. Only be concerned with what the company will be held responsible for, which almost(?) always means direct jobs. Consultants will bandy about model-based predictions of "indirect" and "induced" jobs, but if a company's subsidy won't be cancelled or cut for failure to meet those predictions, don't get distracted by them.

4) What are the pay and benefits for this job? The higher the better, obviously, and one more reason that retail should almost never be subsidized, since its job quality is usually substandard. Worker training is another positive characteristic an economic development can provide.

5) Does the project require the use of eminent domain? This is usually a disguised subsidy, since the possibility of a court deciding the value of a person's property gives the buyer more leverage in negotiating with property owners. Not to mention that the trauma of forced relocations is a highly disturbing one.

6) Does the area that will host the project have objective evidence of economic deprivation, such as high unemployment or low per-capita income? If not, the subsidy probably isn't needed, and just raises the subsidies that genuinely deprived areas will have to pay to land investments.

7) What is the track record of the company involved? Is it known for bad labor, environmental, or other practices? Demerits for problems here.

7a) Is the company's identity hidden by a site location consultant? It's worth saying "no" to this pernicious practice. Information asymmetries are bad enough already in the site location process without having taxpayers being deprived any way to evaluate the company involved.

8) What taxpayer protections are built in? Does the city or state have strong requirements on job quality and other best practices, and will it enforce them through clawbacks of the subsidies (requiring repayment) if necessary? This should be second nature to states, but in the past few years, Tennessee has negotiated at least three megadeals (Electrolux, Wacker Chemie, and Hemlock Semiconductor) that specifically excluded clawbacks from the agreement, even though clawbacks are on the books in Tennessee.

9) Would the investment go forward even without the subsidy? If so, obviously you don't want to give the subsidy. In practice, of course, you'll never really know. Did I mention information asymmetries?

10) Does the project connect to the public transportation grid? Alternatively, is it contributing to urban sprawl?

11) What is the opportunity cost to government? The total amount of state and local subsidies is more than enough to hire every public-sector worker laid off since the beginning of the Great Recession. Could the money going to the subsidy be better spent on education, health, or infrastructure?

To summarize: Just say no to subsidized relocations, subsidies to retail, anonymous investors, and subsidies in rich locations. Calculate the cost per job and aid intensity of the proposed project and compare them with those of similar projects. Then comes the more difficult task of estimating the benefits of the project (jobs, training, wages, etc.), where it is necessary to carefully examine claims made by proponents, which will always err on the side of overpromising. Dig into the proposed investor's track record. Companies rarely change their spots, with British Petroleum being a egregious example. And always ask if the money could get more economic development bang for the buck if spent on things like infrastructure, education, and health.

Good luck!


By the way, if you've got disagreements or suggestions, I'd love to hear them.

UPDATE: Phil Mattera of Good Jobs First let me know that I missed points 6, 9, and 10 in my original post. I can only plead temporary insanity.

Cross-posted at Angry Bear.

Basics: Is that a good economic development deal? Using the Megadeals database

It's a familiar situation: business and government officials are promoting a new economic development deal which naturally includes subsidies for the investor. They may be touting a consultant's study touting massive ripple effects and fantastic taxpayer return on investment. Should you believe them?

Of course not. Consultants, whether they technically are working for the company or the government, don't get paid to say deals don't make sense. Or at least they don't if they want future contracts with the company or city/state/province/country paying them.

What's a taxpayer to do? First, you need to know that uncontrolled subsidy competition like we have here in the United States is going to systematically provide higher subsidies than will a rules-based system like that of the European Union. The EU's state aid rules guarantee transparency, restrict location subsidies to the poorest regions, and cap the amount of subsidy a project can receive based on two principles: 1) The richer the region, the lower the maximum subsidy allowed (with 0 as the maximum in many regions); and 2) For large projects, the maximum subsidy is reduced below the region's normal percentage cap (determined under the first principle) with a 50% cut in the cap for projects over 50 million euros and a 66% cut for the subsidy on the amount invested over 100 million euros. So you need to remind elected officials and economic developers of the need for transparency and real limits on subsidy use.

Realistically, though, we are a long way away politically from having rules like the EU's. Right now, we're making progress on transparency but not so much on substantive rules, not even anti-piracy agreements. What do we do to evaluate investment incentives now?

The goal in bargaining is to get the most benefits for the least cost. How do we know if the cost is high or low? This is where the Good Jobs First Megadeals database comes in. We can use it to compare the cost with similar deals made elsewhere in the United States. You can use Subsidy Tracker if you want to look at smaller deals, but for my purposes in this post I can't deal with a quarter of a million projects, so I am sticking with Megadeals.

Projects vary widely in size, so to compare different subsidies we need metrics, or standardized ways of measuring them. Knowing the gross cost  of a subsidy is not enough (and technically, using the present value of the subsidy rather than its gross cost would be better, but would not solve this problem). As I wrote in a report for the North Carolina Budget and Tax Center, $1 million would be a large subsidy for a call center, which needs little more than computers and phone lines. But $1 million would be miniscule for an automobile assembly plant, which can cost as much as $1 billion to build.

The good news is that we don't have to reinvent the wheel to obtain these metrics. Two good ones already exist, cost per job (subsidy divided by the number of jobs) and what the European Union call "aid intensity" (subsidy as a percentage of investment). The EU's rules set limits as discussed above in terms of aid intensity, but using both metrics together is even more illuminating.

Better news still is that the Megadeals database already contains the data needed to calculate both cost per job and aid intensity. Since you can download Megadeals in spreadsheet form at the link above, I did just that and then added two columns (cost per job and aid intensity) to create a spreadsheet with these metrics. Based on an informal conversation we had in March, Christopher Lau, a Senior Advisor in the Ontario Ministry of  Economic Development Trade and Employment, in an effort outside of his official capacity, added a chart grouping all the automotive investments together. This is on the larger of the two spreadsheets at the link below:

https://sites.google.com/site/middleclasspoliticaleconomist/megadeals-with-metrics

Christopher's chart (see below) lists all the projects from largest to smallest aid intensity, so it's a good place to begin to see the range for an auto plant. We can see from the list that the aid intensities are pretty tightly bunched from 15% to 41%, with no gap greater than 4 percentage points within that range. We can presume that anything above 41% is overpriced, especially the Gestamp project, since a stamping plant is one of parts facilities you would hope to have locate near an assembly plant, which means you would normally subsidize it less than an assembly plant.

Even  within the 15-41% range, we shouldn't conclude all are reasonably priced given the situation states and cities are currently caught in. We would want to factor in when the facility was built, focusing on the most recent experience when discussing a potential new project. We would want to know the location, the size of the project and the number of jobs created. And we need to remember with regard to jobs that if we build a new assembly plant, its output will reduce the sales and jobs at existing facilities, so the country's net job gain will be much less than the total employment at the new plant.

This post illustrates how we can use the Megadeals database to help evaluate the cost of a proposed subsidy deal. In my next post, I want to reiterate all the best practices that should be attached to any deal before we can say that it is a relatively good one under the United States' current Wild West subsidy system.



Source: Calculated from the Good Jobs First Megadeals spreadsheet.

 Note: Christopher Lau's analysis in this article is his own and does necessarily reflect the views and opinions of the Ministry in which he is employed.

Cross-posted at Angry Bear

Columbia U. Conference Shows Incentives Pervasive but Controls Work

Day one of the Columbia International Investment Conference in New York has concluded, and the takeaways are very clear. The topic is investment incentives, prompted by Louise Story's "United States of Subsides" series last December. Story moderated panel 1, which covered the pervasiveness of subsidies. How widely used are investment subsidies? As the presentations made clear, they are used by virtually every country in the world. That is depressing takeaway number one.

The second big lesson is that for most types of foreign direct investment, the use of incentives has no effect at all. Resource companies, companies seeking strategic assets, and companies needing to sell in a particular market are coming regardless of the use of incentives. (I would qualify the last part to say that only applies when coming to markets that aren't divided into a number of competing jurisdictions, such as the US and EU, where the member states can engage in subsidy wars, related but gated article here.) It is only for "efficiency seeking" or cost minimization investment that incentives can make some difference in location decisions.

Third, one of the biggest cost of incentives consists of funds given to firms that were coming to your location even if they had not received the subsidy, according to Louis Wells, the panel 2 moderator. He says most studies place this at 60% to 70%. A more recent study by Peter Fisher (p. 8) says that a more typical figure for the amount of jobs is only about 9%, versus the 30-40% implied by Wells. This means that the real cost per job of projects is at least 2.5 times as large as reported cost per job, and may be up to 11 times higher. And don't forget that there is also a big opportunity cost based on the value of other possible uses of the funds given away. As I have pointed out, all the public sector jobs lost since December 2007 could be replaced if incentives were abolished.

Fourth, the good news is that there are control methods that do work. I have written before about this, and a conference presentation by Investment Consulting Associates (p. 3) illustrates this with a comparison of incentives in the United Kingdom and the Czech Republic. Recall that European Union state aid policy aims to direct bigger incentives to poorer regions of the EU. ICA's database shows that the mean incentive was more than twice as large ($8.61 million vs. $3.41 million) in the Czech Republic than in the UK; the  mean "aid intensity" (subsidy/investment) was 36% in the Czech  Republic compared to just 15% in the UK; and mean cost per job was $67,088 in the Czech Republic versus only $20,288 in the UK. These are precisely the outcomes the European Commission wants to achieve with the state aid rules, creating a reliable bias in favor of poorer regions (and at the same time the poorer regions have subsidy limits holding down what investors can receive).

Tomorrow (Thursday, November 14) will have panels on "What are the alternatives" and my panel, "The way forward," where we will discuss EU rules and other methods of controlling out-of-control incentive wars. You can follow the action on Twitter at #CIIC13.

Cross-posted at Angry Bear.

Columbia U. Conference on Investment Incentives

On November 13 and 14, the 8th Annual Columbia International Investment Conference will be held in New York City. Sponsored by the Vale Columbia Center on Sustainable International Investment, the conference is titled: "Investment Incentives -- the Good, the Bad, and the Ugly: Assessing the Costs, Benefits, and the Options for Policy Reform."

The meetings will focus primarily on location subsidies for foreign investment, and primarily in developing countries. But there will also be plenty of coverage of North America and the European Union, as well as discussion of global institutions and regimes. Louise Story, author of the very valuable New York Times series, "The United States of Subsidies," will moderate the first panel.

As the conference materials lay out in greater detail, "The aim of this year’s Conference is to advance our understanding about the role that incentives have played in attracting and retaining foreign direct investment; the policy rationales supporting or discouraging various types of incentives; the strategies that may be more effective at achieving the objectives of host governments; and the potential for future coordinated action on these issues."

I will be speaking during the Thursday afternoon panel on the topic of controlling investment incentives (what else?). There will be an outstanding roster of panelists, both academics and practitioners. If you're interested in the topic and will be in the vicinity, you should attend. Registration is free, but also required in advance. You can register at the link above.

EU Proposes Tighter Rules on Investment Incentives

The European Commission's Directorate-General for Competition is the EU equivalent of the U.S. Department of Justice Anti-trust Division plus units for controlling domestic subsidies to industry. According to a new policy briefing from the European Policies Research Centre at the University of Strathclyde, DG-Competition has released a draft of new regulations on "regional aid" (subsidies to firms in poorer regions of the EU) that, among other things, includes tighter rules on investment incentives.

EU rules on subsidies to business have long fascinated me because they present a stark contrast to the totally unregulated bidding wars for investment we see here in the United States. As I have shown, EU Member States have been able to obtain investments with far lower subsidies than U.S. states have, even for the same company! A big part of this is due to the rules on regional aid, which specify the maximum subsidy each region can give to a business, and reduce that maximum for investments over € 50 million. The proposed rules for 2014-2020 go further than ever before.

The big change is that large firms would only be eligible for regional aid in areas with gross domestic product per capita below 75% of the EU average, that is, only in the poorest areas of the European Union (plus so-called "outermost regions" like French Guyana). Currently, countries are allowed to give subsidies in regions that are only poor relative to national standards, and every Member State has areas that qualify to give investment incentives to large firms.

This would be a gigantic change, as many whole countries would no longer be able to give investment incentives to large firms. These countries are:

Belgium
Denmark
Germany
Ireland
France (except for outermost regions)
Cyprus
Luxembourg
Malta
Netherlands
Austria
Finland
Sweden

 These countries would still be able to give regionally based investment subsidies to small and medium sized enterprises, which are defined as companies with fewer than 250 employees and either sales of less than or equal to € 50 million annually or a balance sheet of less than or equal to € 43 million.

If we did this in the United States, it would be the equivalent of saying that every part of the country with at least 75% of average per capita income would be barred from giving investment incentives, which of course would mean the poorest areas could give less than they do currently. This is obviously a political non-starter; we have to focus now on transparency and ending subsidized job piracy. But it's interesting to look ahead sometimes and see what kind of controls on subsidies are technically feasible.

Thanks to Fiona Wishlade, director of the European Policies Research Centre,  for sending this report to me.