Incentives are only part of the picture

Probably the most controversial part of economic development is the use of grants, loans and tax incentives by government to entice companies to invest their money in a specific jurisdiction.  I had another conversation this week with a guy who was adamant that “not one single penny” should be used to foster economic development.  “We shouldn’t be picking winners or losers” or something (how’s that working out for you, Mr. PM?).

I have said it before and I’ll say it again.  Incentives are normally not a make or break issue with good economic development projects.  The GM bailout is a widely absurd example and actually stirs great debate among economic development professionals many of whom believe that the huge sum of money could have been better used to promote economic development in other industries.

For example, the auto manufacturers in the southern US (Kentucky, Alabama, etc.) received something like $200 million in ‘incentives’ (mostly tax breaks – not much cash in US deals other than industrial revenue bonds) but this money is spread over 20-25 years (in tax breaks).  So it ends up being up to $10 million per year on a project with a $2 billion upfront investment and $400 million per year in annual operating costs.  Sure it’s a big number but if you use my ROI model, this is a no brainer.  The state and local governments will receive far more incremental tax revenue off the workers in that plant than anything they ‘forgo’ in corporate taxes.  In addition, they were never going to get those corporate taxes anyway if the firm located in Missouri.

In New Brunswick, there are many deals that gave the province a great ROI as well.

Saying that companies make major business investment decisions based solely on government grants or tax incentives is like saying that people will buy a new car because of a $1,000 cash back or some other incentive program.  This is obviously ridiculous.  The $1,000 is an additional inducement but anyone that would shell out $30,000 (and with financing costs $45,000) with the main reason being to get $1,000 up front would be crazy.

I think that very small firms looking for government grants – may be looking for cash flow and without it they couldn’t expand but for larger projects, where companies put in several million or more of their own investment, how could a small portion of that from government be the deal breaker?

We need to limit the temptation to be ideological about it.  Our competitors are offering a wide range of incentive programs to encourage economic development in targeted sectors.  We need to be in the game – but only with programs that demostrate good economic value for taxpayer dollars (or forgone taxes in the case of tax breaks).

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15 Responses to Incentives are only part of the picture

  1. Peter Lindfield says:

    It’s not all about subsidies with the private sector either. Research reveals that firms seeking to determine which site provides the best economics will use three key criteria for their decisions: cost, environment and people. Each criterion represents a set of factors: cost includes cost of labor, cost of management and infrastructure and tax and treasury impact. The metrics used to determine cost include blended specialized skills and IT labor cost, the average cost of infrastructure (leaseholds, utilities, telecom, management, etc.) and corporate tax rates, profile realization (achieving internal benchmarks) and exchange rates. This set accounts for approximately 40% of the decision loading.

    The second set of environmental factors includes risk (economic, political), country infrastructure, cultural compatibility, geographic proximity and security of intellectual property. The metrics used to gauge the value of environmental factors include political and business risk, the degree of government support (which may or may not involve financial support), the relative strength of infrastructure and investments, cultural differences or compatibility compared with the home geography, relative distance (in bands) from the home geography and the relative security of intellectual property. This set accounts for approximately 30% of the decision loading.

    Finally, the people set of factors include human resource experience (including specialized and process experience), the size of the labor market, the education level of work force (relative to the resource requirements), language barriers and literacy rates and employee retention. The metrics employed to measure people factors include CMM SEI and quality ratings, relevant process expertise, available total labor market, expected per capita education level, percent fluency in the target language, country literacy rates and select company retention and turnover rates. This set accounts for approximately 40% of the decision loading.

    One size does not fit all, and there are variations and special factors, but across industries and geographies, the site selection criteria tend to be consistent. The key criterion that cannot be substituted is the size of the work force. A work force that is of inadequate size introduces a greater likelihood of wage competition and increased turnover which can easily cannibalize the target cost structure.

    Government subsidies have a value of approximately 10% in this equation. Clearly, there are exception cases where government incentives have provided the focus of the deal. But the majority of site selections involve decisions that reflect a more comprehensive evaluation of options. Within this context, jurisdictions can make significant investments to attract business beyond simply providing cash incentives (which are becoming more rare), including improvements to education, literacy programs, training support and targeted tax treatment.

    How do we know what works best? Canada was at one time on the forefront of research related to economic development, investment attraction and site selection. The Economic Council, the Science Council, NABST, and other institutions, in collaboration with universities worldwide, were well respected worldwide for the quality of their research programs and reports. Unfortunately, there is much less coordinated research into these areas today with the consequence that we have less expertise focused on new and emerging theories of economic development such as Richard Florida’s creativity perspectives, associational engine models or suboptimality regimes.

  2. Anonymous says:

    Agreed with 2 caveats.

    1 you don’t duplicate existing initiatives and provide an unfair advantage

    2 there is a kill plan where no further incentives are provided. In other words, we don’t throw good money after bad simply because we previously invested. There have been several examples of companies focusing more effort on the next grant than on the next customer.

  3. Anonymous says:

    The only ones being ideological are the ones with no respect for taxpayers money advocating their statist views. As I see it, taxpayers should not be on the hook for billions in bailouts, grants and forgivable loans. I thought Mark Milke said it best today regarding the recent auto bailout (put the tax into perspective for auto consumers):

    “In other words, suppose governments, in a rare moment of taxation honesty, added a “GM-Chrysler bailout tax” to every automobile customer’s invoice. This year, a $13-billion bailout billed to non-Chrysler-GM purchases, i.e., to just over 884,000 new auto-mobiles, means each buyer would each face an additional auto tax of $14,705.”

    As ideological as the above statement may be to you 9whatever that means), the bottom line is that corporate welfare (and this bailout) are lousy policy. Plus, it’s also lousy to say let’s try it somewhere else, some other industry (and maybe it will work there?) Come on, surely you can do better then that. lol

  4. The problem is, and I am being sincere here, that you aren’t providing any alternatives. You lay down your position and then don’t provide any alternatives other than New Brunswick should unilaterally disarm and cross its fingers. Show us some jurisdictions that were economically underperforming, $1.7 billion in Equalization and 15 straight years of net out-migration and turned it around by cutting all economic development activities. Then we have a point of reference.

  5. Anonymous says:

    There’s no way of telling 100 per cent either way, David. What I’m proposing is that government’s be more responsible with their spending habits (what they spend their money on) and debt accumulation.

    If money continues to flow from the treasury for useless programs (that fail to measure up to their original mandate), not to mention, the high cost of public servants that administer them, then we have a problem don’t we? I understand where you are coming from as I am pretty much lock, stock and barrel with you on the Irish model and what it could do to transform bureaucracy and the public sector in our neck of the woods. I just don’t believe we are anywhere near there yet as we have still failed to identify (a particular industry that works) and market and promote the hell out of it (either through low taxes and incentives). What i see going on, has gone on, and will continue to go on (without much success). So in the meantime, is it all that bad to lift up a few rocks to see what’s under them.

  6. richard says:

    “their statist views”

    I think that the experience around the world shows pretty clearly that the use of incentives and grants, tariff policies, and other government interventions have been used successfully to promote economic development. Where is the evidence for the contrary libertarian approach? In fact, I wonder how the libertarian approach remains appealing to so many despite the lack of data to support it. Is it because certain ‘think’ tanks endlessly repeat the libertarian refrain, thus attracting another set of gullible recruits?

  7. I am glad we can have a civil discussion around the issues. It’s like things in this world, the law of unintended consequences kicks in.

  8. Anonymous says:

    “Guilible’ recruits. I developed my views and opinions through years and years of being a spectator in this province, country and the world (unlike some that development and tout policies in this province without a broad perspective).

    Much like David has done to form his own opinions, he traveled and read. Let’s just say, my perspectives are not all learned from the pages of the Fraser institute website. 😉 I have read extensively (from both positions — hey, I can even say that I have read all of Savoie’s stuff from journal articles to published books. I enjoy his writings even if I disagree with some of his views. I like to see how his philosophies stack up against more global visions (non-New Brunswickers) such as Corchene, Basiat, Friedman, to name a few.

  9. mikel says:

    The first comment was very thorough (although 40%+40%+30% sounds a little wrong). And people forget that the business world at the level we are talking about is NOT science. We saw one example that fell through in Nova Scotia – the game maker. Turns out, he just ‘really really liked the area’. And it turns out that that is not an abnormality. I frequently mention the situation in Vermont where the IB M Chairman set up a facility near his skiing lodge. It’s been awhile since I read it, but I recall reading an article that showed a VERY high level of home office relocations were right up Richard Florida’s thesis-namely, they were set up in areas where executives WANTED to work.

    But there is a very good example of that ‘libertarian’ economic development model, and by no coincidence its also the world democracy model-Switzerland. You find VERY few government involvements in business-at virtually every level. However, what you DO find is that their system of direct democracy keeps a tight reign on government controls. In the early seventies the Swiss voted in a referendum for government controls because it was a strange situation which saw rapidly increasing inflation.

    And virtually ALL ‘incentives’ are at the most tax breaks-in the nineties large sectors of the french pharmaceutical R&D packed up and moved to Switzerland thanks to tax credits. THe country’s emphasis on R&D is also very attractive to ‘high end’ research. However, many asian countries also are largely founded on that libertarian principle, in fact taxpayers are right to be skeptical because money never seems to flow toward PEOPLE, but always to companies.

    The moral of that story is that democracy is the best defense against abuse. In the auto sector we can agree that its a case of ‘too big to fail’, and of course the ‘sane’ policy lesson that should come out of that is “maybe we shouldn’t let companies get so big they cause horrendous damage if they DO fail”. You’ll notice that Toyota and Honda haven’t been complaining all through this-because car makers are essentially car assemplers, and Toyota and Honda get their parts from the same companies which would go bankrupt if the big three goes down the tubes. They’d have to do all that work ‘in house’.

    But thats why ideology is no help, never really has been. This isn’t Switzerland, and nobody can afford to see this entire industry fail. The main reason of course is because like the financial sector in the US, the result would be horrific for governments. Again, the biggest thing is to make sure OWNERSHIP accompanies that debt. If taxpayers are footing the bill, they should be stakeholders, not spectators.

  10. Anonymous says:

    First of all, let’s be careful with the term failure. Many people would consider the fact that GM and Chrysler had obligations far beyond their ability to pay, a failure. All the bailout is doing is providing yet another chance to get it right only this time the taxpayers take most of the risk. Ever heard the definition of insanity as doing the same thing twice and expecting a different result?

    In economics, there is this concept of suppy and demand.
    So if there is demand for cars, someone will eventually respond with supply. So why not provide incentives to the remaining manufacturers to expand their supply here in Canada? $10B is a lot of incentive. Would you rather invest in a proven loser planning to close plants or a proven winner motivated to expand production? Guess we know the government’s answer.

  11. richard says:

    “Friedman”

    Do you mean Milton Friedman, whose contributions have been tested by recent data and found wanting? Sorry, but while people are certainly welcome to their opinions, the world can move forward only by proper data analysis. That’s the problem with libertarians, they are immune to facts and spend their time repeating theories that have failed the data test.

    “Richard Florida’s thesis-namely, they were set up in areas where executives WANTED to work.”

    Is that Florida’s thesis? Don’t think so. In any event, saying why you moved and why you actually moved aren’t necessarily the same thing.

  12. Anonymous says:

    I didn’t say all of Friedman, just some. Same could be said for Basiat as I like his theory “What Is Seen and What Is Not Seen”:

    “There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.”

    And judging from the discussion in here sometimes, I question people’s economic visibility, especially since living a car wreck all over again can’t be a pleasant experience.

  13. Anonymous says:

    Speaking of economist with foresight.lol

    http://www.harperdex.ca

  14. mikel says:

    For rebuttal to Richard, that actually IS Florida’s thesis-if you expand ‘cultural opportunities’ then business investment will follow. In the cases I’m referring to it was high level executives that wanted to live where the amenities they liked were. It’s not a coincidence that Irving has to fly in a HUGE number of high level executives into the oil refinery every week from South Carolina. They simply don’t want to move to St. John. As for the other scenario where “because they say that’s why they moved isn’t necessarily true”, that pretty much makes ALL data analysis impossible. We can’t make analysis of ANY economic development issue because somebody may assume they are lying.

    As for the anonymous comments, the reality is that economics is NOT a natural science. Even the predictions of natural science have been found wanting-Einstein’s theory of relativity simply does not explain the origination of black holes. So to think that economists can ‘foresee’ anything is simply ridiculous.

    In the case of the auto sector, it is crazy to say that it is ‘reliving a car wreck’ when the main prerequisite of the bailout package is massive restructuring. As I’ve said about the US, it may well turn out that the OWNERS of GM will be the United Autoworkers, the employees themselves will be the owners. That makes them even more radical than Toyota, a company FILLED with contradictions. And again, there is ample evidence out there to show Toyota has NOT been a standalone ‘winner’, but that it gets serious aide from the Japanese government, even to the point of inventing their hybrid engine.

    In the economic world NOTHING is certain, and predictions are impossible, thats why GOOD economists are the ones that study the past-even the present can be a difficult prospect, even impossible, since most data is not available. You know they are REALLY bad when they start saying “well, this is what happened in the 1890’s so therefore…”

    But as we’ve seen in this case, the canadian government is essentially simply following the dictates of the american government.

  15. Peter Lindfield says:

    To correct the math in my analysis, the numbers are 30% 40% and 30% respectively.

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