Let's Take Another Look at Government as an Investor

When the now-defunct theme park in Flint known as "Autoworld" opened in 1984, taxpayers had good reason to cross their fingers and hope for the best. Half of the $70 million it took to build and stock the facility came from federal, state and city governments.

Shortly after the 1986 Christmas season, however, the investment went sour and Autoworld bit the dust. The Flint Downtown Redevelopment Authority had to spend nearly $500,000 a year for the next two years for maintenance on an empty building. Until a private foundation came through recently with a generous bail-out, Flint taxpayers were burdened with a $1.1 million-a-year bond obligation through the year 2005. The future of the facility is still very much undecided.

The Autoworld fiasco should raise questions about the wisdom of governments as investors of public money. Once the public sector abandons the neutral role of fostering a healthy environment for enterprise to flourish and takes on an activist role of funding and directing enterprise, it puts every taxpayer at a new, and to some extent involuntary, level of risk. The evidence suggesting that that risk may be too high is mounting.

At the state level, this problem is underscored by recent revelations about the Michigan Strategic Fund. Operated by the Michigan Department of Commerce, the MSF assists in financing for businesses that are too risky to attract loans in the private marketplace. It provides millions in direct loans and bestows actual grants of money for such things as research and development. Supported largely by royalties from gas and oil leases on state lands, the Fund supervises an $81 million portfolio.

In May 1988, when the MSF wrote off its first bad loan--$519,671 to Wolverine Deck Co.--the tip of an iceberg was visible for the first time. Then came $2.75 million lost to the candymaker Fred Sanders, Inc. Now comes an admission from MSF president Peter Plastrik that one-third of the loans managed by the Fund are in or near delinquency and another one-third are in trouble. If your stockbroker or banker handled your money that way, you'd probably take your business elsewhere or even file a lawsuit, but those options are not as viable when the money manager is a public bureaucracy.

According to The Detroit News, New Technology Development Limited Partnership received a $1 million loan in August 1985 but has not made a single payment. The loan is not listed as delinquent because it has been "restructured" to postpone payments. The firm's managing partner is Joseph Levin, cousin to both U.S. Senator Carl Levin and U.S. Representative Sander Levin. Perhaps politics played no part in the affair, but at the very least the Fund has shown an insensitivity to appearances of political influence. The size of so many of its loans suggests a bias toward medium to large-size firms, which do tend to be better connected politically than new or existing small businesses.

The Urban Land Assembly Fund is another state government-to-business transfer program, similar in many ways to the MSF. It loans money to finance economic development and create jobs.
Of nearly $3 million it loaned prior to 1988, roughly 38 percent has been written off, is in actual default, or is verging on default. Of the 9,900 jobs these loans were supposed to create, only about half ever materialized.

Officials who manage these state programs are fond of playing up the occasional "success" story. The Upper Peninsula's Copper Range Company, recipient of a $3 million loan in 1985, is a public relations favorite of the MSF, for example. How such programs are evaluated, however, may itself be defective.

When state auditors last summer put a magnifying glass to the Commerce Department, they found that the department's "efficiency evaluations generally addressed only the number of activities performed, without consideration of cost." Reports to the Legislature by Commerce routinely address only the "quantities of activities" and not the bottom-line effectiveness of tax-funded economic development programs.

"The number of new jobs projected alone is a questionable indicator because the projected new jobs may not actually materialize," the auditors stated. Also, in some cases, "the new jobs may have been created whether or not the company" was even contacted by the department. Furthermore, no consideration is given to the jobs not created or to the firms which don't expand because resources are being siphoned off by government and directed to those favored by the government. The "visible" gets all the attention, especially when it seems to "work," while the less flashy consequences are swept under the rug. The flight of firms out of Michigan in recent years, displaced by the size and intrusion of state government here, is a major component of those consequences.

Even when it doesn't degenerate into a disguised system of political patronage, state government playing investor and allocating scarce capital is inherently a very dubious and risky venture. No one--political appointees especially--spends someone else's money as carefully as he spends his own. Criteria for avoiding bad practices are almost non-existent and penalties for engaging in them anyway are rather scarce in the public sector. Government just isn't very good at separating the likely winners from the probable losers in the economy.

As economist Carl Raschke of the University of Denver has pointed out, an entrepreneur "who cannot meet the financial performance marks of the private banking industry does not magically become more likely to succeed in the marketplace by virtue of receiving a government-engineered loan." The State's involvement is more likely to simply reward mediocrity, obstruct the real workings of sustainable economic growth and transform marginal credit risks into "wards of the money-brokering bureaucracy." Taxpayers foot the bill whether the State succeeds or not, while failing programs take on a life of their own.

Long overdue is a searching public examination of the thinking which has produced the AutoWorlds and the Michigan Strategic Funds. Some, in spite of the record, will say that government should be an active investor, a public bank financing a wide variety of business undertakings. Others will argue that if all that government does is to act as an impartial referee, fostering a safe and relatively burden-free environment for the private sector to do the job, it will have a full-time job with little need to take on another one it is ill-equipped to handle. Count me in the latter camp.