An Open Letter to Michigan Legislators: Privatize Economic Development

Dear Legislator:

I am very pleased to introduce this special edition of Michigan Privatization Report, dedicated to economic development policy. As an economist who has studied urban and regional economic development policy for almost 20 years, I am heartened to see the Mackinac Center take on these issues with such focus and thoroughness.

Historically, government's role in economic development has focused primarily on providing "public goods"-products and services such as roads or sewer systems that have typically not been provided by the private sector. In recent years, governments at all levels have embarked on a new strategy: giving money and tax relief to specific companies for specific purposes.

While government-driven state and local "economic development" policy schemes have been used in the United States for more than a century, the scale of recent economic development efforts is unprecedented. Many states have created dozens of programs that, in effect, give some officially approved businesses preferential status over other, similar businesses. These programs, as shown in the page 8 story on Cabela's Retail, result in direct government subsidies to competitors.

Government programs often start out with good intentions. They are billed as tools to encourage job creation and investment. They also provide a visible political benefit as elected officials cut the ribbon on a brand new factory or store presumably subsidized by one of the economic development programs.

But these programs, in turns out, have an Achilles' heel that works against their effectiveness. The effects of targeted tax incentive programs are zero-sum: Luring a company from one locality to another simply displaces jobs and investment. The programs don't create wealth, they simply redistribute it.

In addition, the programs are not costless: Someone is paying higher taxes to offset the tax break given to someone else. In short, one business's tax relief is another resident's tax burden.

Not surprisingly, most academic studies have concluded that targeted business incentive programs have little impact on economic growth or development. To the extent they have an impact, the programs offset anticompetitive features of the local tax system. Many states and localities, for example, grant tax abatements because property tax rates are high relative to their competitors. Unfortunately, with selective economic development programs, the reforms aren't broad-based-only a few companies capable of managing the political bureaucracy and approval process benefit.

These programs, however, face other problems that further limit their effectiveness. Economic development officials are not endowed with a unique or specialized understanding of how the economy works. They cannot reliably predict which businesses will succeed and which ones will fail.

Yet, that government bureaucrats can divine a level of knowledge unavailable to the most savvy Wall Street analyst is the underlying assumption upon which economic development programs are based. Economic development agencies are expected to grant selective incentives based on their belief that a business will do well. They must pick "winners" and "losers."

Even this issue fails to grapple with the most salient weakness of these programs-equity. These programs are inherently unfair. In fact, their very nature is to discriminate-to select some business for advantage over others no less worthy.

Businesses do not have equal access to the process by which these decisions are made. Indeed, the vast majority of businesses will never even have the opportunity to submit an application for special tax favors. Only those businesses knowledgeable of the state's application process, which possess staffs able to fill out the many forms involved, lobby state legislators and bureaucrats, and negotiate favorable terms, have a reasonable chance of securing the benefits. The vast majority of small- and medium-sized businesses lose out with these programs. They pay higher taxes to support the state's subsidy of their competitors.

Instead, state economic development policy should focus on creating a favorable climate for all investment and job creation. A state-orchestrated industrial policy-where public officials determine which investors and businesses deserve preferable treatment-will not achieve this goal. An economic development policy that relies on bestowing benefits on some businesses may create a "favorable" environment for those businesses, but this will be at the expense of the vast majority of Michigan businesses.

Michigan residents should recognize the limited benefits and inequities inherent in an economic development policy focused on giving tax breaks and subsidies to a select few businesses. Instead, they should look toward broad- based tax and regulatory reform to create a business climate that encourages statewide investment and job creation.

Michigan legislators would do well to consider the recommendations in this MPR and privatize targeted economic development programs in favor of continued overall tax and regulatory relief.

Dr. Staley is president of The Buckeye Institute for Public Policy Solutions in Ohio and an adjunct scholar with the Mackinac Center for Public Policy.