Political and Business Incentives in Programs Like MEGA

Political Incentives to "Do Something" Visible

As noted earlier, Gov. Engler, in the years before he sponsored MEGA, had alluded to the political nature of economic development programs, recognizing that what makes good economics and what makes good politics can often be at odds. His comments find support outside professional political circles.

Peer-reviewed academic literature is replete with similar views, including evidence that government economic development programs are often employed to advance the political interests of a program’s champions, rather than the economic purpose of aiding the polity as a whole.[131] A classic example of this scholarly discussion was provided in 1998 by University of Michigan Professor Margaret E. Dewar (then an associate professor of urban and regional planning).

In her paper "Why State and Local Economic Development Programs Cause So Little Economic Development,"[132] Dewar argued that too many analyses of economic development programs fail to consider the political nature of government economic development programs. She dubbed perspectives that include this political dimension the "political economy" view of economic development, while labeling as a "technocratic view" those analyses that assess economic development programs’ ability to make better use of information, research and technology to improve the economy.

Among other points, Dewar noted that programs from which political supporters would benefit require "quick, visible projects in their efforts to solve their districts’ economic problems. …"[133] By contrast, programs that might be more likely to achieve genuine, lasting economic growth could lose political sponsorship because they are inclined to investigate key issues methodically and thus forfeit the necessary speed and ability to target areas the political sponsors want and need. Dewar concludes:

The problem of making economic development programs work well is more intractable than the technocratic view suggests. The technocratic perspective argues that better analysis of alternative ways to achieve goals, better design of programs, and more information about how economies work and how economic development occurs can make programs succeed. The political economy perspective argues instead that the most common kinds of economic development programs cannot succeed for more than a short time. The programs are abolished if they observe technocratic criteria. If they serve aims that are not related to economic development, the programs survive longer — at least as long as the public story of their operation is maintained — but they have few economic development effects.[134]

In other words, programs that give elected officials the opportunity to show their constituents how hard they are working to bring them jobs are likely to last longer. Unfortunately, they are probably less likely to be effective.

Political Incentives and MEGA

The discussion above suggests that politicians, whose popularity and re-election depend on good publicity, will tend in general to favor programs that will allow them to be seen as "fighting for every job,"[135] as a news release by state Republicans put it in October 2003. This dynamic favors economic development projects with a higher public profile, such as those that benefit well-known or exciting new businesses, even if these efforts are not particularly effective.

There is evidence that such political incentives play a role in MEGA. An analysis of this evidence also suggests why bad publicity, potentially the most powerful political disincentive for a poorly designed program, tends not tend to counterbalance the political attraction of high-profile, but ineffective projects.

MEGA and "Jobs!"

"Political Value" and "Press Value"

Consider the following where the political allure of high-profile job programs appeared to play a role in political support for MEGA.

On October 27, 2003 Republicans from the state House and Senate held a press conference to announce their newest job stimulus plan. Its accompanying press release announced, "Republicans Vow: ‘We Will Fight for Every Michigan Job,’" and "Legislative Leaders Announce Jobs and Economic Stimulus Plan: Creating Manufacturing Jobs, Spurring Business Investment top GOP Proposal." The nine-part plan to stimulate Michigan’s economy and create jobs — popularly known as the "Jobs I" package — included reauthorization of the MEGA Act, which was set to expire at the end of the year. Driving home the "jobs" theme, state House Speaker Rick Johnson’s first quote in the press release read, "Michigan and its workers are losing jobs, and that is unacceptable."

We have obtained what appears to be an internal strategy document of GOP leaders regarding the Jobs I and II legislative packages. What the five column spreadsheet includes and excludes provides a sense of what was most important to these legislators.

The first three columns contained the general idea the GOP was advancing, a description of the program that Republicans were proposing and the current status of the program or proposed legislation. Interestingly, however, the next two columns contained descriptions of the "Political Value of Idea" and the "Press Value" of the idea. In the eight pages of Speaker Johnson’s internal strategy document, the economic or job-creating value of the House Republicans’ programs is mentioned only intermittently, and only under the brief bill descriptions and the discussions of the "political" and "press" value of the measures.[136]

In the following links, we have reproduced four pages from the "Republicans Vow" news release described above, including the first page of the GOP strategy document describing the political and press values of its "jobs" legislation (these four pages are Graphic 9). We also show the first pages of the three news releases discussed earlier (see "Three Major News Events" in "MEGA's Track Record"); these are labeled Graphics 10, 11 and 12.

Graphic 9: "Republicans Vow" news release

Graphic 10: "Southeast Michigan Job Bonanza" news release

Graphic 11: "1,160 New Jobs for Michigan!" news release

Graphic 12: "Greater Detroit Area Beats Out Toledo for Webvan Group, Inc. Facility" news release

As discussed above, the cases described in these news releases produced few successes. The nature of the releases and their attention-getting format suggest the "free" and positive publicity that MEGA’s supporters hoped to generate from the MEGA agreements.

A Company Questions MEGA’s Figures

In one instance, a company official felt compelled to disavow jobs claims made in an MEDC press release about the jobs the firm was allegedly creating as the result of a MEGA agreement. The company was Hemlock Semiconductor Corporation, a Hemlock, Mich.-based corporation that is the world’s leading producer of the polycrystalline silicon that is used in solar energy equipment and semiconductor manufacturing. The clarification came in a memo written by an HSC site manager to the company’s employees:

The State of Michigan and Office of the Governor issued a press release announcing the support and approval of Business Incentives (called a MEGA Grant) for our expansion. The local newspapers and TV media picked up this good news, although the press coverage may have confused and amazed a number of folks, particularly around the very large number of jobs created. I’ll cover that next and explain where these numbers came from and what the actual numbers are.[137]

Later the memo continued:

So why the big difference in the press release when we clearly communicated to the State of Michigan and the Michigan Economic Development Corporation (MEDC) that we would be retaining 20 positions and adding 25 positions? The MEGA grant through the MEDC takes a very optimistic look at job creation for a given business opportunity and looks at it over a longer time horizon. So, from our view, we see our expansion’s impact as affecting 45 jobs at HSC and a similar number out in the surrounding community.[138]

In a phone conversation, the site manager confirmed the figures in his memo and stated that he wrote the memo because media coverage of MEDC’s higher job estimates for the MEGA project had created confusion among his employees.[139] "I was getting e-mails left and right" from employees familiar with the project, he said.[140]

According to the MEDC press release on this deal, the company is expected directly to create 60 "new" jobs and indirectly to create another 62 "spin-off" jobs as a result of the MEGA package.[141] The company itself, on the other hand, cautioned its employees to count on 20 jobs being retained, 25 being created directly at the firm and about 45 created indirectly as spin-off.

It is interesting that the firm, while explaining to its employees the discrepancy between its own figures and MEDC’s, did not discuss the issue publicly. It is possible that other MEGA recipients have not been entirely comfortable with the publicly declared MEGA job creation figures, but chose not to express it openly. In any event, the discrepancy between MEGA’s numbers for the project and the company’s own estimates suggests how state officials’ calculations of the economic impact of a MEGA deal may become distorted as a project is publicized.

State Auditors

It is worth noting, too, that the state of Michigan’s auditor general has twice criticized Michigan development agencies for the job creation numbers the agencies have reported. The first time, in 1993, involved a Michigan Strategic Fund report to the state Legislature that "overstated, by 39 percent, the number of jobs created by selected companies that received financial assistance from these two programs in its 1991 annual report to the Legislature."[142]

The second occurrence was in August 2003, and it involved training programs operated by the Michigan Economic Development Corporation. According to state documents, recipients of job training grants investigated by the auditor general were supposed to have created 635 jobs with the help of their subsidies. Instead, the auditor general found a loss of 222 jobs at the firms his office investigated. The auditor general criticized the MEDC for not independently verifying jobs numbers submitted by the companies receiving the grants — an indication that MEDC may be relying too heavily on corporations’ self-reported job creation statistics.

The same may be true of MEGA. As we noted earlier, MEGA appears to rely on firms to provide key economic information, such as expected direct job creation and compensation. These figures are then used by REMI modelers in forecasting the impact of the MEGA deal.

The Challenges of Monitoring Programs Like MEGA

Yet given the volume of news stories in any given day, and given the growing number of MEGA tax credit agreements, it is unlikely that anyone outside the department will notice and publicize any underperformance by the program as it becomes evident. News stories on the issue may not occur for years. The Detroit News story cited earlier, which reviewed MEGA’s job output (see "MEGA Job and Project Performance" in "MEGA's Track Record"), appeared eight years after the inception of the program.

After such a lapse of time, the officials originally responsible for the deals involved may well have left the program and thus never directly experienced the economic or public relations costs of their earlier decision. At the very least, any counterproductive or inefficient procedures in the department may go unchecked for many years before being scrutinized.

It is also worth noting that the careful qualifications of the University of Michigan REMI models don’t appear to make their way into the many state press releases or newspaper columns about how many jobs and how much new tax revenue may be coming as a result of the latest MEGA deal. They did not appear, for instance, in the news releases above.

Similarly, MEGA officials have cited total job projections with a precision and certainty that belies the tentative assumptions on which the projections are based. For instance, as we noted earlier, an MEDC official has publicly claimed, "Of the MEGA projects that have collected SBT credits for their projects to date, 28,812 total jobs have been created. …"[143] This job total, however, is based in part on indirect job estimates, and in a recent e‑mail communication to us, an MEDC spokesman acknowledged: "[B]oth the REMI analyses and the MEDC recognize that indirect jobs will always be estimates. Even at the end of the credit period, we cannot say for certain that x,xxx indirect jobs were created as a result of the project." This thoughtful and forthright qualification of the estimate stands in contrast to assertive language used in the public statement.

Thus, the strong incentive state officials naturally have to publicize "success" may mean that more cautious language is overlooked. As a result, the projected benefits can appear to be more certain (and thus higher) than they probably are.

This dynamic is general; it is not just an issue in Michigan. Indeed, in late 2003 Ohio’s Toledo Blade opined about a similar situation, declaring that the Toledo region was probably better off without the Toledo Regional Growth Partnership’s former chief, Don Jakeway, who was leaving his post in Toledo to take a job as president and chief executive officer of the MEDC.

In a September 2003 editorial entitled "Jobs promise lost," The Toledo Blade noted that Jakeway "didn’t do much for economic revitalization in northwest Ohio during his six-year tenure here," and that "RGP flaks rattle off a list of projects (the former director) ‘facilitated,’ but we have found that the agency’s claims of jobs created and retained to be overstated."[144] A 2003 Toledo Blade analysis, published around the time of Jakeway’s departure, showed that in 2002, "Nearly one in five jobs that area economic development agencies had claimed to have created either didn’t exist or didn’t meet state criteria for economic development."[145] The Blade also found that area agencies had double-counted thousands of jobs they claimed to have retained.[146]

The Blade’s findings were effectively confirmed in June 2004 when the interim director of the RGP, Eileen Granata, officially "reduced the number of projects for which it takes at least partial credit by 80 percent."[147] According to The Blade, the change was made because the previous methodology did not "accurately reflect the agency’s role in area projects — an issue that has long-bothered critics."[148] The RGP’s accounting changes, according to The Blade, showed the following:

The old accounting system, from 2000 to the present, said the growth partnership or its partners completed 267 projects that created nearly 8,000 jobs. The new tally for the same period, for just the growth partnership, is 52 projects that created about 2,800 jobs.

Ms. Granata said that former director Don Jakeway chose to compile a master list of all regional projects in an effort to cull regional cooperation and dissuade turf wars and credit-taking.

Still the old tallies helped boost the image of the growth partnership.[149]

The point of the preceding paragraphs is to emphasize that there is often no drawback to offering these credits from a public relations perspective. When a deal is struck, press releases are issued emphasizing the program’s apparent accomplishments. If a deal fails outright or comes up short of expectations, often little is said and little is remembered, until perhaps much later, when the officials involved in the original announcements may no longer be in a position to be held accountable.

The lag time is understandable enough. As watchdogs of government programs, journalists and private citizens are forced to review a wide variety of government activities and develop a broad expertise. With economic development programs in particular, they face a serious obstacle to questioning job projections when they are first issued, since the complexity of the economic models involved in projections of job growth will naturally lead most people who are not trained economists to accept the estimated job claims at face value, even if careful calculations by modelers have been embellished somewhat by publicists.

Thus, a jobs program’s political supporters can find even questionable claims left unchallenged. As observed, for instance, in a 1997 Wall Street Journal article entitled, "Advocates of Tax Breaks See Software as an Ally," "REMI software is a potent addition to the arsenals of political persuasion. …"[150]

As a further example, consider a claim by MEGA that an aggregate 119,555[151] or more new jobs are being created in Michigan thanks to MEGA’s and the MEDC’s efforts. This figure is the total of the direct and indirect jobs that MEGA deals will allegedly create for as much as two decades into the future. It contains both direct jobs created by the MEGA recipient and indirect jobs resulting from "spin-off" activity associated with the company expansion or relocation. Because of its precision and the economic modeling employed by MEGA, the figure suggests a certain authority.

Perhaps as a consequence, officials will sometimes include the spin-off jobs in press releases, public letters or Op‑Eds as if all these jobs have already been created. Nevertheless, they have not been, and their creation depends on many factors, such as a MEGA company’s success, the company’s ability to actually collect on MEGA tax relief and when it is expected to do so.

MEGA’s Expanding Mission

Since 1995 the MEGA law has been substantively amended five times to expand its depth and breadth. If viewed within the framework of the political incentives faced by MEGA’s supporters, this expansion was predictable.

Indeed, in an early Mackinac Center study of MEGA that was published when MEGA was first proposed, the authors noted, "MEGA incentives would have to continually increase to be competitive. The cost of winning a specific subsidy contest with other states escalates sharply, and it required ever-increasing tax incentives."[152]

The past nine years have borne out the authors’ prediction. As noted earlier, the size and number of MEGA deals, while fluctuating from year-to-year, has generally been on the rise. In 1996, the first full year MEGA was in place, the total value of tax credits offered in just 15 deals was $89.9 million.[153] At that time, a maximum number of 25 MEGA deals were allowed annually.[154]

By 2004, a larger number of MEGA packages was permitted under the law, and MEGA officials that year closed 41 MEGA deals valued at $253.3 million in SBT relief for up to 20 years.[155]

These changes are consistent with the outcome expected under the "political economy" model described by Dewar. State officials would be hesitant to let high-profile or promising new firms leave because of a legal technicality that, after all, they can change. Furthermore, the goal of diversifying Michigan’s economy provides a rationale for granting MEGA packages to new types of firms.

Primary changes (or attempted changes) to MEGA law since 1995 often coincided with publicly expressed concerns over the need to help particular companies — Covisint Inc., Electrolux and Federal Mogul Corp., for example. State officials were vocal about the need to obtain or retain these companies by making changes to MEGA.

Business Incentives to Qua­lify for the MEGA Program

It is not only politicians who face incentives to use economic development programs for ends that may not promote the program’s economic goals. Potential beneficiaries of the program — in this case, businesses — also have reasons to convince MEGA officials (and themselves) that they should benefit from the program. The tax breaks they receive lower their costs, increase their potential profits and give them an advantage in their competition with other businesses.

Such behavior is described as "rent-seeking" by economists and other analysts of public institutions. Broadly defined, rent-seeking describes the phenomenon of people and businesses seeking subsidies, tax abatements or other favors from government that enable them to obtain a higher than normal profit, or "rent." The practice is in no way illegal when it involves generally available government programs like MEGA; it merely involves businesses attempting to participate in programs that are stated to have a broader public purpose, such as helping the economy.

While it is a debatable matter of terminology whether businesses that receive MEGA tax incentives are receiving a "subsidy" — the money they keep from a tax abatement is, after all, their own — it is also clear that being allowed to keep money that would otherwise be paid in taxes on new business activity is a benefit, and it is a benefit not enjoyed by everyone.

Of course, many firms that receive MEGA contracts do not actively engage in such rent-seeking. They have simply been offered a deal that lowers their costs, and they have taken it. Their action is especially understandable given that a tax credit simply allows them to keep more of their own money. In a higher-tax state like Michigan, it would be hard for any rational business manager to act differently.

Nevertheless, rent-seeking exists, and it has generated an economic literature of its own. In fact, corporations often hire business consulting firms and lobbyists to help earn them a better bottom line through government aid.

For instance, Ernst & Young, the multinational accounting and consulting organization, trains businesspeople to secure government economic development assistance and thus improve their balance sheets. In March 2004, Ernst & Young representatives explained this procedure to businesspeople at the State Government Affairs Council in Georgia. The Ernst & Young presentation was entitled, "Turn Your State Government Relations Department from Money Pit into a Cash Cow." ("Government relations departments" typically include the people who work with, provide information to, or lobby government officials, including elected representatives and regulators.) The presentation detailed how firms can secure tax incentives and other government assistance from state and local economic development offices.

The efforts of officials to secure government help may involve more than training their government relations employees to be alert to opportunities for government help. A review of the official minutes for MEGA meetings between 1995 and the summer of 2004 shows that Ernst & Young consultants attended at least 10 of the meetings, presumably on behalf of clients who were trying to win MEGA tax incentives.

Interestingly, the Gabe and Kraybill study of Ohio economic development incentives alluded to earlier (see "Past Studies of Targeted Tax Incentives" in "Econometric Evaluation of MEGA's Effectiveness") also investigated the effect of government incentives on announced business growth. The authors found that establishments that received incentives were more likely to overestimate employment forecasts than those corporations that had not received incentives.[156]

This finding accords with common sense. Despite businesses’ need to produce numbers that they can actually meet so they can claim the credits, it is probably difficult to expect even the most careful corporate executives to generate only the most conservative and defensible job estimates when they are presented with potentially millions of dollars in tax savings based partly on the job numbers they generate.

Nor is it impossible that some corporate managers will engage in scare tactics by misleading units of government about shipping jobs out of state; a 1998 article in Time magazine documents just such a case.[157] Consider, too, the remarks of former Chrysler head Lee Iacocca, quoted in the 1989 book "Poletown: Community Betrayed":

Ford, when I was there, General Motors, Chrysler, all over the world, we would pit Ohio versus Michigan. We would pit Canada versus the U.S. We’d get outright grants and subsidies in Spain, in Mexico, in Brazil — all kinds of grants. With my former employer (Ford), one of the last things I did was, on the threat of losing 2,000 jobs in Windsor, I got $73 million outright to convert an engine plant. … I’ve had great experience in this. I have played Spain versus France and England so long I’m tired of it, and I have played the states against each other over here. ... You could give a litany of these kinds of things.[158]

Ultimately, businesses may face strong temptations to engage in "hyperbole and puffery,"[159] as a Michigan judge once described it, and some will probably succumb. Together with political incentives that may encourage government officials to dwell more on the size of the potential jobs numbers than on their plausibility, business incentives may lead corporate executives to adopt projections that optimize their chance of receiving a credit offer, thereby reducing the substantive economic development that policy-makers and voters originally envisioned.

Potential Economic Damage from Rent-Seeking and MEGA

The discussion of political and corporate incentives in the discussion above suggests that despite the best intentions and economic and legal design elements, the MEGA program could begin to serve specific, short-term political and corporate interests, rather than the long-term goals that inspired the program. Politicians are tempted to show that they are doing something "important," and businesses may be tempted to reinforce this impression with the public and the Legislature even when the advertised benefits are tenuous.

The impact of rent-seeking may be yet another reason, then, that our economic model of MEGA’s economic effects did not detect any significant impact. And indeed, there is broader evidence that the direct and indirect costs from rent-seeking behavior associated with government programs like MEGA may negatively affect the real rate of state economic growth.

Harold J. Brumm, senior economist with the United States General Accounting Office in Washington, D.C., has studied the rent-seeking phenomenon. In his paper, "Rent Seeking and Economic Growth: Evidence from the States," he argues that "rent-seeking activity retards economic growth, because it merely redistributes wealth; rent seekers (unlike profit seekers in a competitive market) do not create wealth."[160] Brumm examined the effects of rent-seeking on the rate of economic growth from 1985 to 1994 in the 48 contiguous states.

Brumm found a negative correlation between the growth rate of per capita gross state product (adjusted for inflation) and a state’s tax burden, and the degree to which rent-seeking occurs in each state. "The conclusion reached here," he says, "is that rent-seeking activity has a relatively large negative effect on the rate of state economic growth. An implication of this finding is that a state government which promulgates policies that foster sustained artificial rent-seeking does so at considerable expense to its economic growth."[161]

Brumm did not specifically maintain a business incentive rent-seeking variable in his model, but the activities of the MEGA do in fact encourage the very type of rent-seeking behavior against which he cautions. It is not difficult, therefore, to conclude that Michigan might be doing better than it is without the MEGA program. As Brumm notes, "To the extent that economic growth is a desideratum, a goal of public policy should be the restraint of government interventions that create and sustain artificial rents."[162] But that is what programs like MEGA do: encourage the seeking of "artificial rents."