Stadiums, Subsidies, and other Wishful Thinking (Part 2)

As promised, the outrage continues this week with an exploration of wishful thinking economic development policies. Part one of the series is available here.

While there’s some evidence that local government is getting a bit more savvy (or at least is under more scrutiny) on flashy white elephant investments, I’m not sure the same consensus has developed in a similar arena: public subsidies and tax benefits for companies to relocate.

It’s time to seriously pare back our addiction to this type of spending. There are as many cases as there are states of companies being lured in by the use of public money only to fail, leave again, or extract even greater public resources. I’ve previously written about how Texas could lead the way in cooling the economic development arms race (spoiler alert: they haven’t) and referenced before how badly Reno got fleeced by Tesla.

Just one extreme example that hits close to home in New England is Curt Schilling’s 38 Studios. Before he was famous for politically incorrect tweets, I’m told that Curt Schilling played baseball. After his retirement, Schilling started a video game company in Massachusetts with the modest goal of dethroning World of Warcraft, the highest grossing video game of all time. Ambitious, sure, but companies thrive on ambition.

Schilling convinced Rhode Island  that subsidizing his company would turn around the struggling state, then at the height of its unemployment and economic problems. This sort of deal, where one state pays for jobs or offers a low interest loan to a company to relocate over a state border, is absurdly common in the US. I don’t need to tell you where this goes, right? Rhode Island gave 38 Studios a $75 million loan guarantee, and in 2012 the company declared bankruptcy. Litigation has dragged on to determine how much RI is on the hook for.

The New York Times did an excellent post-mortem that will take you through all the steps, but this sums it up well:

If there’s a lesson in all this, it probably has to do with the limits of what any government can — or should — do to bring about growth. Just about every state offers some kind of tax incentive or loan program for businesses looking to relocate. But Rhode Island went further than that; in its zeal to land Mr. Schilling, the state took on the role of venture capitalist, without having the expertise to do it well.

An actual venture capital firm would have been investing in many companies at once, to minimize its exposure, and it would have demanded a sizable equity stake. It would have taken a seat on the board so it could monitor the money closely and, if needed, restructure the company. Rhode Island, instead, threw most of its venture money into a single, highly speculative start-up, insisted that it more than double the size of its work force, and then walked away.

I tend to agree that government cannot and should not be responsible for making investments in individual companies. Even when they have the best of intentions, they don’t have the experience, capacity, or distanced judgment to make wise investment decisions.

While the article makes the point that the state acted inappropriately and ineptly as a venture capitalist, to me the affair brings into question the entire structure: where is the proof that paying firms in the name of providing jobs is a good idea?

One Man’s Investment is Another’s Corporate Subsidy

The 38 Studios story gets more play than others like it because of the personalities involved, but if you get too caught up in the narrative, you’ll miss the larger point.

First, it’s not very useful or interesting to talk about good intentions. I’m sure Curt Schilling thought his company would succeed – he’s also lost tens of millions in the project. When we talk about the use and abuse of the subsidy system, the reasons vary. Some have noble goals, some are greedy, some are just making decisions that are advantageous within the economic system.

Second, it’s not a partisan or regional issue. Republicans and democrats both support a wide range of corporate subsidies. No state that I know of is appreciably leading the pack when it comes to moving away from ineffective corporate subsidies. There’s just too huge a disadvantage to being first.

Instead, what you should take away from the story is that far more likely than a 38 Studios is the everyday transfer of wealth from citizens to businesses. Have a look at Rhode Island’s page on Good Jobs First’s Subsidy Tracker:

RI Good Jobs First Subsidy TrackerThere’s 38 Studios, third on the list, but it is easily outranked by the 30 subsidies given to home state hero CVS Health (from Woonsocket, RI). I’ve talked about the subsidy tracker before, but you should really look at it in your own state.

In the vast majority of cases, when a state or local government provides tax incentives for jobs, they are not creating new economic activity but instead simply relocating it from a different place. Because of measurement issues, it’s also unclear that the incentives themselves are what induces the economic activity at all. It could be that they just sweeten a decision that is already going to be made, squeezing local finances for no local gain. After all, as critics of these schemes point out, the jobs are going to exist somewhere if no one subsidizes them.

Proponents of tax incentives will also point to equity as an advantage. Maybe, even with the above shortcomings, it still makes sense to use the lever taxes to bring jobs to places they might otherwise not go – high poverty or unemployment areas that desperately need to build an economic base. The problem is that tax incentives are rarely used in the areas that fit the profile of a market failure. Even in the rare cases that incentives are used to bring jobs to high-need places, the local governments can ill afford to subsidize the companies, especially if wealthier areas in the hunt bid up the price to attract a business.

A Zero Sum Game

Academics and top level policy makers understand that economic growth actually depends on regional cooperation, but word hasn’t reached everyone. Indiana and Illinois to this day go back and forth on a recruitment border war, boasting about how they will “rip the economic guts” out of each other. This is obviously a point of pride for the politicians, but sounds to me like someone bragging about how much they paid for their used car.

There’s no question government has an important role to play in the economic landscape. The things I’ve outlined above are not criticisms of the federal government investing in basic research, or local and state governments incentivizing the development of new businesses, or even helping existing businesses get to scale. State governments should have a role in investment in workforce and infrastructure, especially in regions with fewer resources, as a means to make them attractive to business. Local governments should work closely to provide services businesses and workers need, which inevitably means the expense of resources.

What we really need is a coalition at the federal level that can help the states help themselves out of addiction to corporate subsidies. Don’t hold your breath for this to happen in Washington. In the meantime, think about what your state could do to get itself out of this dangerous game.