Bribing Business to Hire Workers

A big-push program the size of the Tennessee Valley Authority would be unthinkable today. But smaller big pushes are very common, in the form of a myriad of federal and state subsidies to attract private investment to struggling communities. Virtually every time a company announces plans for a new headquarters, a lab, or a large production facility somewhere in the United States, the bidding begins. States compete aggressively by offering larger and larger enticements in the form of tax breaks, subsidized loans, local infrastructure, export assistance and financing, workforce training, and area marketing.

These subsidies can be incredibly large. Panasonic recently received more than $100 million ($125,000 per job) to move its North American headquarters to Newark, while Electrolux was given $180 million ($150,000 per job) in tax abatements for its new establishment in Memphis. Mercedes received a $250 million incentive package ($165,000 per job) for locating in Vance, Alabama. Total state spending on local economic development amounts to $40 billion a year, significantly more than the cumulative federal spending for the Tennessee Valley Authority over its thirty years of government subsidies. These subsidies are one of the rare issues that Democrats and Republicans tend to agree on. Although their rhetoric about government intervention sounds different, blue and red states both engage in efforts to bribe businesses to come to their jurisdictions. Rick Perry’s $200 million “Emerging Technology Fund” for Texas companies is similar to initiatives in California, New York, and Massachusetts. The federal loan guarantee program that Solyndra took advantage of was started in 2005 under George W. Bush and was expanded in 2009 by Barack Obama.

 While politicians and the companies they subsidize usually extol the benefits of these deals, critics complain that they are a huge waste of public money. Is spending $150,000 per job really the best way to help the residents of Memphis? What if we just wrote checks to those residents instead? With two colleagues, I have studied what happens to local communities when their bid to attract a large employer by offering subsidies is successful. When firms are considering where to open a large plant, they typically begin by looking at dozens of possible locations. They narrow the list to roughly ten sites, from which two or three finalists are selected. In our study we compared the experience of the counties that the company ultimately chose (the winner) with the runner-up counties (the losers). For example, when BMW decided to open a new plant in the United States in the 1990s, the decision of where to locate it came down to two finalists: Greenville-Spartanburg, South Carolina, and Omaha, Nebraska. BMW chose Greenville-Spartanburg, partly because of an incentives package worth $115 million. In this case and others, the losers were counties that had survived a long selection process but narrowly lost the competition. They can therefore tell us how the winner county would have fared if it had decided not to bid.

 Our data show that in the years leading up to such a bidding war, winners and losers were similar in terms of employment, salaries, and productivity. But afterward, winners experienced a surge in productivity. These productivity gains, which appeared to reflect knowledge spillovers, were particularly large for existing plants that shared similar labor and technology pools with the new plant. We concluded that by making existing producers more productive, a new plant generated an important benefit—a positive externality—for the rest of the establishments in the county. This higher productivity led to more jobs and higher wages. Thus the provision of subsidies might be seen as a way to internalize this externality.

While the theory is clear, in practice these policies do not always work the way they are supposed to. The provision of the subsidy should be commensurate with the magnitude of the social benefit. But when dozens of similar counties are desperate to attract investment from outside, their bids often become so generous that they can exceed the social benefits to the community. Mayors and governors have an incentive to bring the new company to town, no matter what the cost. When they are successful, front-page stories in local newspapers tend to focus on the hundreds of future local jobs, not on the fine print of the financial packages offered. When they are unsuccessful, local politicians are lambasted for not doing enough for the local economy. All of this can lead local governments to overbid. In such a case, the only winners are the owners of the company being courted, since state and local governments end up stuck with the bill. And even when these subsidies make economic sense for a particular county, they do not always make sense for the country as a whole, as competition among municipalities for a given company can turn out to be a zero-sum game for the nation.