Attracting, retaining, and expanding private sector firms--and the jobs that come with them--has in the last fifteen years become a major competitive enterprise for every state in the nation. Economic development programs at the state and local level have sprouted quickly, and job creation has become a central theme of nearly every political campaign. Plant expansions, relocations and closures are the stuff of headline news, and can have a stunning impact on a community, either positive or negative.

One industrial policy tool widely used in Michigan and elsewhere to help attract business to the state or a particular area is the selective tax exemption, usually in the form of a tax abatement or tax credit. Another tool is the direct subsidy--in the form of loans or direct payments--for capital, job training, research and development, or a variety of other purposes.

In the course of the debate over what role Michigan state government should play in economic development, two distinct philosophies have emerged. The first, a free market approach, recognizes that the costs imposed on commercial enterprise by government policies such as taxation, regulation, and legal liability act to discourage economic activity. Political leaders guided by this principle emphasize restructuring government to impose fewer costs by downsizing, privatizing, reforming tort law, streamlining or eliminating regulatory procedures, eliminating barriers to capital formation, and lowering overall tax burdens.

The free market approach holds that the purpose of government is to provide the legal and protective functions necessary for the economy to operate efficiently. This philosophy recognizes that true wealth is created only by increasing the amount of valued goods and services, not by simply "creating jobs." It focuses on reducing the government-created disincentives to productivity, and seeks to provide equal treatment for all commercial enterprises.

The second philosophy views government as an active player in the economy, often referred to as "industrial policy." In this view, it is the role of government to decide what types of business are needed, what type of training programs are necessary, and where these businesses should be located; to create strategic investment pools to assist businesses that fail to acquire funding in the private market; to subsidize losses, and so forth. It trusts the judgments of state bureaucrats more than those of the individual consumers, workers, bankers, insurers, investors, and managers whose collective decisions form the market economy. It takes tax dollars from citizens and businesses and redistributes them to certain projects or companies that find favor with state officials and their economic development planners. It abandons nondiscriminatory tax policy in favor of selective tax policy that lowers operating costs for certain preferred businesses or investments, often at the expense of others.

One industrial policy tool widely used in Michigan and elsewhere to help attract business to the state or a particular area is the selective tax exemption, usually in the form of a tax abatement or tax credit. Another tool is the direct subsidy--in the form of loans or direct payments--for capital, job training, research and development, or a variety of other purposes. As a 1988 report commissioned by then Senate Majority Leader John Engler declared,

The use of such incentives has now proliferated to the degree that the process of business location in America has devolved into an intense interstate cold war competition--with each state having far more weapons in its arsenal than it needs, but no state willing to unilaterally disarm for fear of losing parity in the battle for business migrants. From a business management standpoint, so many state and local governments now offer discretionary inducements that they have often come to be a prerequisite to, rather than a determinant of, new investment.1

During the 1990 gubernatorial campaign, challenger John Engler criticized incumbent Governor James Blanchard for pursuing the latter agenda, a government directed industrial policy, and with good reason. In the 1980s Governor Blanchard presided over a string of failures with state investment in commercial enterprise. The state-subsidized AutoWorld theme park in Flint went bankrupt; the Michigan Strategic Fund found two-thirds of its direct loans and grants were either delinquent or in deep trouble; the Urban Land Assembly Fund wrote off 38 percent of its economic development as in default or verging on default.

After winning a narrow victory, Governor Engler, despite some notable exceptions, pursued a free-market economic development strategy designed to reduce the costs of Michigan state government for all citizens and businesses. National attention focused on Michigan as the state restructured school financing, cut property taxes, privatized state functions, and streamlined departments. Michigan became a model for dealing with fiscal challenges without raising taxes.

Defining Economic Development

Much of Michigan's recent acclaim is due to the state's dramatic turnaround. But even with unemployment at an astonishing low of 4.1 percent, economic development is still at the forefront of policy discussions. In the last decade the focus of attention has become jobs-and lots of them. Lost in the debate is the true foundation of prosperity. Perhaps the notion of economic development needs a closer look.

Economic growth refers to an increase in real output of goods and services per capita. Economic development describes a broader phenomenon of increasing standards of living and improved quality of life. Obviously, productive employment contributes to economic wellbeing and thus fosters economic development. Economic growth, productive employment, and economic development are the natural consequences of private enterprise in the free market economy. Free individuals and enterprises, acting to maximize their own self-interest, generate employment, development, and improved standards of living. It doesn't require intrusive governmental intervention or exotic policy schemes, only unexciting, mundane protection of private property and free exchange.

Now in his second term, Governor Engler is beginning to advocate selective industrial policy as an economic development strategy in addition to continuing efforts to reduce the general costs of state government. In his State of the State address, Governor Engler proposed creating a new state agency, the Michigan Economic Growth Authority (MEGA), that would grant selective tax credits as a means of defense against other states that attempt to lure away Michigan jobs, and as an incentive for certain out-of-state businesses to expand or relocate in Michigan.

This report examines the MEGA proposal and discusses the merits and problems with such an approach. The report concludes that MEGA is a severely flawed proposal that would not only fail to achieve its goal, but also discriminate against small businesses and retail businesses, increase the costs of state government, hinder further across-the-board tax reform, and set a dangerous precedent for discretionary state-level tax policy.