A Conversation with John Hood
President, John Locke Foundation
March 9, 1996
John Hood directs the activities of the John Locke Foundation,
a Raleigh, N.C., nonprofit policy institute. The Foundation conducts research
and produces publications on public policy issues relevant to state and
local government within North Carolina. The Foundation's efforts are directed
towards advancing "public understanding of society based on the principles
of individual liberty, the voluntary exchanges of a free market economy,
and limited government."
Role of Government
The two most prevalent justifications for using incentives can be summed
up as follows. On the one hand, one might argue that incentives really do
generate economic development and are a wonderful tool. On the other, those
who consider themselves pragmatists might say, "We're not really sure
about economic benefits, but everybody else seems to be doing it. We'll
be left out if we didn't participate."
The second argument is really a corollary of the first. If incentives don't
actually have a significant impact on economic development, then one state's
lack of incentives versus other states should not be a concern. So if you
don't like incentives, or you don't think they're good public policy, then
the fact that other states are pursuing them is not an argument for you
to pursue them.
simply can't be shown to have a significant influence on general economic
development. There may be political beneficiaries of incentives, which
I'll discuss in a moment, but the economic beneficiaries are very unclear.
Its clear that the firm receiving the money is an economic beneficiary.
But beyond that, benefits are ambiguous.
Obviously, another clear beneficiary is a previously unemployed worker who
lands a job at a new firm attracted to his community by incentives. On the
other hand, suppose that worker was not unemployed, but he was instead employed
at the local textile mill. Let's say BMW arrives and that worker says, "Hey,
that automotive plant's going to be paying high wages, and I'd really like
to work there." So he gets a new job using skills basically comparable
to those he used at the textile mill. Now the textile mill is a loser in
the labor market.
In addition, incentives, being a subsidy, allow the receiving firm to spend
their revenues on other things; maybe one of those is bidding up labor costs.
In this way, the very existence of the incentives supported through the
taxes paid by the textile mill end up hurting the mill.
Similar forces might be at work in the land market. The BMW plant comes
into the community, buys up prime land, perhaps even getting some sort of
land subsidy to do so-- a not uncommon practice. Now, the textile firm was
thinking about building a new facility, but there's no more land. Or, the
asking price of real estate has risen through the demand generated by the
new arrivals. So the textile mill loses again. Not only that, but the losers,
the existing industries, are paying for their punishment: they're the ones
whose taxes have gone to sustain incentives.
Opportunity Costs and Incentives
incentive grant there is an opportunity cost. You're basically redirecting
economic decision-making away from the most efficient processes towards
the most politically expedient ones. The money used, for example, to provide
an under-cost sewer line or to buy up land for an industrial tenant or lower
borrowing costs cannot be used for something else. The question then becomes:
Is the opportunity cost greater than the economic beneficiaries' gain or
indeed is the opportunity cost plus the direct costs of providing that incentive
smaller than that economic beneficiaries' gain?
Based upon experience with economic decisions and markets in general, you've
got to think that the opportunity costs plus the direct costs of incentives
are going to be greater than the benefits. The studies that I have looked
at show very clearly that economic development policies based on subsidies,
particularly incentives, cannot be shown to have any significant impact
on economic performance. I have dared the state or anybody else to produce
a study refuting this point, but nobody ever has. The burden of proof is
clearly on proponents of incentives. If you call yourself a pragmatist and
nothing points to a clearly favorable outcome, you should be able to justify
why you feel compelled to use incentives.
Free vs. Tethered Enterprise
The whole nature of our free enterprise system is that you do not know today
what investments will lead to greater economic value 10 years from now.
You might think you know. You might think that attracting the Mercedes Benz
plant to North Carolina would be a great thing. What you don't know is whether
the Mercedes Benz vehicles are going to sell. Now Alabama has Mercedes.
If the Mercedes sport utility vehicles do not crack the market, do not sell
well, that plant will not exist for long. So what would be -- what is the
actual economic benefit of having a plant that might try out a new product,
but then fail after 5, 6, 10 years? Yes, the wages looked higher when you
first lured it in, but the plant doesn't exist any more.
Government planners are not clairvoyant. No one except a time traveler can
tell me that the opportunity cost of spending incentives on a new plant
are better in this moment than making other sorts of investments that might
generate employment in firms that you don't perceive to be as high-waged
or as high-valued but that have a prospect for surviving over 10 or 20 years.
Isn't it far better to let the market guesstimate -- which is what markets
do -- the best investment on the basis of past performance, on the basis
of the merit of the idea. Firms should risk their own money to test ideas
in the market. Mercedes should be spending its own money to test the idea
that its sport utility vehicle will beat out Chevy and Toyota, not tax revenues.
Although we're talking about "trophy" firms, the same conditions
apply across the board. North
Carolina newspapers are replete with articles about companies that took
incentives and then moved from one North Carolina town to another or from
North Carolina to another state.
Even if you were able, which I doubt, to set up guarantees that the firm
would not receive any benefit until certain conditions were met, incentives
would still distort the market. Private decisions are made on the basis
of the government's allocation of incentives.
Look at Merisel -- a California company that has received incentives to
move its manufacturing site to Cary, North Carolina. Right now, Merisel
is close to bankruptcy; it's very unlikely that they will relocate the plant.
However, they do have some land which they are selling at a great profit
in Cary. More important, I know very well that there are private actors
in the market in the Raleigh/Durham area who have started making investment
decisions based on Merisel's arrival. There are firms who expected to sell
services to Merisell, maybe realtors who started poking around. Let's say
that Merisel doesn't show up, and we never spend any of the government incentive
money on Merisel. You have still used government power to bait people into
making speculative expenditures that will eventually accrue to nothing.
Now in the private marketplace, people make speculative expenditures all
the time that don't pan out. They hear a rumor that a firm is coming, and
they try to position themselves to sell the land. This is what economic
development is all about -- a lot of speculative expenditure. I am not going
to weep any tears for those who lose out by speculating, but isn't it a
problem if your government is baiting you into making the wrong kinds of
The Proper Role of Government
Furthermore, there are opportunity costs on the government side. Governor
Hunt and the Department of Commerce spend
an incredible amount of time chasing industrial relocations and defending
incentives and otherwise promoting this idea. This is time and money that
could be spent otherwise -- pursuing educational reform, cutting taxes,
reforming regulations to reduce their cost, things like that. There is even
a political opportunity cost that is not satisfied by simply creating rules
that keep money from going to a firm unless they create a certain number
of jobs by certain date.
You really have to start from fundamentals. What is the purpose of government?
What is its role? And when you do that, you will determine that business
recruitment, not just incentives, I mean more generally business recruitment
activities themselves, are probably not a government function. They are
not public goods in the classical sense.
What the state does in this area is interfere. They step forward and place
political considerations in favor of economic ones. I have heard stories
of this in North Carolina just recently where a company may be looking for
a site in an urban area and then state recruiters step in to direct them
towards a rural site, even though that may not be in the best interests
of either the firm or the rural community in question. And of course they
are doing that for political purposes. The state through its intervention
is trying to spread opportunities, to redistribute income, which may or
may not be the economically efficient investment. The state is disrupting
the natural relationship between firms and economic developers in the private
To assume that every business in the community or in the state benefits
every time there is a relocation is not to understand economics very well.
Let firms who believe they have an advantage or benefit to be gained from
a development activity pursue their interests. Don't force those who believe
they will not benefit from that activity to fund it. For example, if the
Raleigh Chamber of Commerce states as its goal to generate higher wage jobs,
and you as a manufacturer believe that will deplete your pool of available
labor, you have the choice to stop belonging to or supporting the chamber.
At least you can't be forced to fund your own competition, which is not
true when the government gets involved.
There are private actors who have a huge motivation to participate in and
promote economic development whether the state does it or not -- economic
developers who work for banks, utility companies, insurance companies, chambers
of commerce... Realtors and developers are obviously another group. Banks
spend a lot of time trying to counsel potential borrowers on how to run
a successful business, which is perfectly logical. These are the people
whose livelihoods are made or broken out of fostering new business, whether
recruiting companies from out of state or creating new companies right here.
The most productive way to think about government's role here is to think
about what legitimate services can governments or should governments provide
at all. If you decide that public education is a legitimate public purpose,
which I think it is, then you provide it. The general road system is something
else that necessitates some sort of taxed fund for obvious practical reasons.
I'm still not arguing that these are economic development functions; I'm
saying that these are functions the government can serve and serve well,
and they may or may not involve economic development. Roads may just as
well involve me being able to go see my mother which is probably not perceived
of as an economic development function; nevertheless, it's a legitimate
function of government to provide a road that will take me to my mother.
Political Development Incentives
Now I mentioned the
political advantages and benefits of incentives earlier. Incentives
are not designed to create jobs. They are designed to create job announcements.
The real reason why incentives are important is that they orient economic
development towards big bundles of jobs for which politicians can take credit.
It's impossible for a politician to take credit for creating a handful of
jobs in a hundred different firms in their area directly. It's physically
impossible. You can't create a media event at each workplace. The media
will stop going after about 3 or 4.
However, if you can get a thousand jobs in one chunk, you can go cut the
ribbon, and you get the credit. I'm bi-partisan about this, whether its
[former North Carolina Republican] Governor Martin or [current Democratic]
Governor Hunt who shows up at a plant to cut a ribbon and gets a big story
in the Raleigh News and Observer. Subsequent follow-ups will be on page
6B, business section, if at all. Then the governor runs a political ad that
claims, "Under my term as governor, North Carolina has created so many
new jobs." There's the picture of the governor in front of the plant.
What isn't shown is the analysis of jobs created versus jobs lost. Incentives
have the extraordinary capacity to link a politician very specifically with
an economic development gain. There we have the real purpose for incentives.
When the commerce department says they are trying to create jobs, one would
think that they would have numbers since they've been trying to do this
for over a decade. But they don't have that
information; only in the last month have they begun to make an effort
to amass it. Which tells me very clearly they don't care. The horizon is
the news cycle, the political cycle, both of which are short-term and emphasize
the initial announcement not subsequent actual economic performance.
Economic development occurs over a much longer period than either the media
or political cycle, so the temporal and ideological distance between political
purpose and importance of incentives and their economic purpose and importance
is crucial to understanding the debate. It's absolutely crucial.
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