De-escalating the “Economic War Among the States” and Reforming the Development Subsidy Game

August 2, 2000. A presentation by Frank J. Mauro, Executive Director, Fiscal Policy Institute, at the Syracuse University Continuing Education Program’s Summer Lecture Series, “The Role of Financial Incentives in State and Local Economic Development.”

Throughout our nation’s history, state and local governments have done much to facilitate the growth and development of the American economy. They built an impressive physical infrastructure and developed the nation’s human capital without which our private sector economy could not have prospered. In fact, almost everything that state and local governments did over the last 200-plus years served, either directly or indirectly, to make the development of the private-sector economy possible. But we did not call these activities “economic development.” We called them internal improvements or public works or education or public safety, but economic development is what they accomplished.

In contrast, most government activities undertaken in the last 30 years in the name of “economic development” have little to do with the development of the economy. Rather, they involve, in one way or another, the use of public resources to either convince businesses to move from where they were located to someplace else OR, in response to such entreaties – either real or purported, to convince them to stay where they are. Economic developers persist in referring to the first of those two activities as job creation, even though the jobs already existed somewhere else. Critics originally referred to this shell game as “smokestack chasing,” but it certainly has not been limited to manufacturing as evidenced by the efforts of various states and localities to “recruit” corporate headquarters’ and financial services’ “back office” operations from New York City.

In a 1979 book entitled The Last Entrepreneurs: America’s Regional Wars for Jobs and Dollars, Professor Robert Goodman of Hampshire College argued that the American economy was characterized by decreasing competition among businesses but increasing competition among state and local governments for businesses to locate in their jurisdictions. Goodman said that this new form of entrepreneurship was really a zero sum game, the net effect of which was to simply shift jobs around, not to increase the size of the pie.

Since Goodman’s book was published, the competition that he described has become more intense and more destructive. Over the last seven years, the Federal Reserve Bank of Minneapolis has taken the lead in calling for a concerted effort to address what it describes as “the economic war among the states.” In an influential 1995 essay, two of the Minneapolis Fed’s senior officers – Mel Burstein, its general counsel, and Art Rolnick, its Director of Research – went a step further than Goodman, arguing that the escalating competition among the states is really worse than a zero-sum game because it reduces the amount of money available to do the things that government must do if our economy is to grow and prosper. Their view is that the business incentives game results in a misallocation of public resources, with money that should be spent on schools, roads and police protection going instead to individual business in a process that is inconsistent with the workings of a free market economy.

From a national economic perspective, not much good comes from the use of governmental subsidies to convince a firm to move from one part of the country to another. The use of public resources to convince a firm to stay put helps to avoid the problems associated with dislocated workers and abandoned buildings. But in the end, regardless of who wins, such bidding wars do not increase the overall size of the economy nor are they an efficient way to use governmental resources to increase industrial productivity.

The political realities of our decentralized system of government, however, require Governors, Mayors and County Executives to, in effect, “compete” with other Governors, Mayors and County Executives. In terms of practical politics, no Mayor or Governor or County Executive can not risk the political fallout that could come from unilaterally disarming in the current environment.

The Minneapolis Fed’s proposal would resolve this “prisoner’s dilemma.” As the title of their 1995 essay, “Congress Should End the Economic War Among the States,” indicates, Burstein and Rolnick believe that Congress should exercise its powers under the commerce clause to save the states and cities from themselves. Their specific proposal, which has been introduced in the House of Representatives by Minnesota Congressman David Minge, is for the federal government to tax away the value of subsidies provided to businesses by state and local governments. This would eliminate the rationale for either providing or accepting such subsidies.

No state has a greater stake than New York in ending the destructive “economic War Among the States.” Over the years, many of the biggest battles in this war have been fought out in New York City. The unusual geography of the New York metropolitan area makes it easier to reach mid-town Manhattan from many New Jersey locations than from most parts of the city itself. And, as a major center of economic activity with a reputation as an expensive place to do business, economic developers from around the country have, for decades, set their sights on the Big Apple. In response, New York State and New York City pump millions of dollars annually into so-called “retention deals” – thus diverting important resources from the public services and infrastructure investments that represent their primary responsibilities in regard to the fostering of private-sector economic development. To end this misallocation of resources, New York State should join with the Minneapolis Fed in seeking a national solution to this problem.

As long as the current environment is allowed to continue, however, New York State and its localities should play the economic development game as efficiently as possible and with as much sunshine and accountability as possible.

  • First, development agencies, at both the state and local levels, should carefully analyze all the costs and benefits of proposed development deals. Some agencies already do such analyses but, even in those cases, improvements are essential to ensure that benefits are not overstated and costs understated.
  • Second, those analyses must be subjected to public scrutiny prior to final action, if they are going to help identify deals, that even in the current context, do not make sense for state and local treasuries or for the economy.
  • Third, Governors, Mayors and County Executives should not use taxpayer funds to create poverty-level jobs that will generate additional taxpayer costs for food stamps, earned income tax credits and other low-income safety net programs.
  • Fourth, perhaps most importantly, New York State and its localities should follow the lead of the increasing number of states and cities that have moved to require accountability in their subsidy agreements. If a subsidy package is premised on a company’s pledge to retain 800 jobs in the city, then a subsidy agreement should indicate what portion of the benefits received should be paid back if the firm later decides to reduce its workforce. Residential and business taxpayers deserve to get the benefits that their elected officials are supposedly “buying” for them with their tax dollars. Unfortunately, in the current environment, many elected officials’ economic development “accomplishments” consist of overly optimistic announcements of new “deals,” with little or no attention being given to what actually happens.

Increased accountability in the economic development game is important but, in the end, it amounts to a classic example of rearranging the deck chairs on the Titanic. The real problem is the very existence of the wasteful competition in which states and cities are currently engaged. It’s a bad game for the states and cities to be playing — a manifestation of the dark side of our federal system. Many Americans know that Justice Brandeis referred to the states as the laboratories of democracy, but few remember his warning that our federal system can also create a competition in laxity. New York should join the Minnesota Fed and others in the emerging effort to have the Congress place some limits on this destructive competition.