Taking Care of Business
September 29, 2006 |
Economic development means different things to different people but generally I think most of us equate it to growing the vitality and diversity of our business tax base. Face it, with the income tax structure in Ohio, new jobs — not new houses — is what pays the tax bill and keeps a city afloat. How we get those new jobs or get the current employers here in town to expand their business is the real puzzle. There’s no shortage of opinions but answers are hard to come by. As you’ll read in this article, that’s not unique to Kent, that’s typical of economic development arguments everywhere.
No Easy Answers: Cautionary Notes for Competitive Cities
by Ingrid Gould Ellen and Amy Ellen Schwartz
Leaders of American cities seeking to foster economic growth often look to success stories from other cities, hoping to find models and strategies to replicate. Some favorite strategies include investing in infrastructure, lowering taxes (both overall and in a targeted fashion), building sports stadiums, picking and promoting particular industries (such as “high tech”), and investing in casino gambling. But many benefits of those popular success stories are at best exaggerated and at worst apocryphal. Although the strategies sound appealing, and although each may have worked in particular well-publicized circumstances, as gambling did in Las Vegas, they are typically not successful and policymakers should be cautious in pursuing them.
How Do We Know What Works?
The Dictionary of Modern Economics defines economic development as “improving the standard of living and well being of the population.” In the case of cities, the term is often used more narrowly to mean increasing income or the number of jobs, a perspective that may exclude important “consumption benefits” (or costs) of economic development policies. Consumption benefits are hard to measure, but they may justify some public investments, despite disappointing effects on economic growth. Many Seattle residents, for instance, were pleased when the historic Pike?s Place Marketplace was renovated, regardless of any new jobs or tax revenues.
Measuring the impact of economic development programs, even when they are narrowly defined, is also difficult. Most fundamentally, when income rises, it is hard to know whether a given program caused the rise, or whether higher incomes led the public to demand more of some public service. Infrastructure investment, for instance, appears correlated with economic growth. But does building a new road spur economic growth, or do cities with rising incomes demand better parkways and roads? Disentangling this causality is critical to understanding the effectiveness of economic development investments of all kinds and to replicating successes in the future.
Investing in Infrastructure
Building roads and bridges has long been considered an effective strategy for fueling economic growth. By lowering production costs, more and better roads may attract new firms into the city and encourage those already there to expand. Building the roads also means hiring workers, using supplies, and so on.
Amid claims from engineers that the nation?s infrastructure was crumbling and assertions from a small group of vocal economists (David Aschauer, most notably) that inadequate investment in infrastructure was slowing the economy, government officials argued for big increases in public spending during the early 1990s. Early in his first term, for instance, President Clinton proposed spending $20 billion on a national infrastructure initiative.
More recent research has begun to sort out the direction of causality, and a consensus is emerging that new roads and infrastructure are unlikely to generate much in the way of economic growth. And the message may be getting out. Several cities across the country, notably Boston, Fort Worth, Hartford, New York, Oakland, Pittsburgh, Providence, and San Francisco, are now relocating and even dismantling the freeways and highways once considered essential for a thriving economy.
This is not to say that infrastructure investment is never effective. Econometric measures of the effect of additional infrastructure capture the “average effect” nationwide. Because most areas have adequate infrastructure, the estimated impact is small. But infrastructure investment may be effective in older areas where the stock is aging or in growing areas where the stock is small relative to needs.
All else being equal, lower taxes mean lower costs for businesses, and lower costs, in turn, should attract new firms and spur old ones to expand. Yet it is far from certain that tax cuts spur economic growth. For one thing, lower taxes often mean lower levels of public services. For another, taxes are a relatively small part of the typical firm?s cost of doing business?much smaller, say, than wages and other expenses. Decisions about where to do business depend on many factors, including the characteristics of the local work force, proximity to markets, and so on.
The existing empirical evidence,albeit imperfect, suggests that although tax cuts may have a small effect on business location decisions, they do not appear to spur much economic growth. They work best in small areas, where they can attract businesses that would otherwise have set up shop nearby. Tax policy, in other words, is most effective in luring businesses from neighbors?not in attracting them from afar. Finally, as city leaders no doubt know, enacting tax cuts takes significant political capital, which may crowd out other interventions, such as altering the mix of taxes, say, toward taxing land value rather than property value.
As with infrastructure, there may be cities where taxes are so high, relative to their suburbs and other cities, that reducing them may be an important first step in a sound economic development plan. But these cases are likely to be the exception rather than the rule.
Lowering Taxes: Special Tax Deals
Another popular strategy among city leaders is granting special tax “deals” to particular firms, either to entice them to locate or to keep them from leaving. Anecdotal evidence suggests that these “sweetheart deals” may be costing cities significant tax revenues. Hard data on special tax deals is scanty, but Timothy Bartik, of the W.E. Upjohn Institute, suggests that in the early 1990s they may have cost as much as $25 to $60 per capita in annual tax revenues in some states.
Whether these tax deals ultimately make sense depends first on what firms would have done in their absence. Special deals can increase growth only if they change firm location decisions. But it is not easy for policymakers to distinguish between firms that require special treatment and those that do not want it. As a result, cities often give special deals to firms that would have chosen to locate or to remain there regardless.
Even when incentives do affect firm location, they may not be advisable. Because taxes have only a small effect on where firms locate, special tax incentives can be effective only if they are relatively generous. By implication, the jobs and income saved or created would have to be on a similar scale to justify the expense.
The political pressure to save and create jobs is intense, and it is tempting for city leaders to offer incentives to keep firms from leaving and to bring in “new businesses.” But the public rarely appreciates the full cost of these tax incentives, and city leaders should balance the political benefits with a concern for the longer-term costs.
Lowering Taxes: Enterprise Zones
Increasingly, cities also offer special deals to firms locating in particular neighborhoods. As of 1995, states boasted nearly 3,000 “enterprise zones.” Today some 87 empowerment zones and enterprise communities participate in the federal program. These programs differ in specifics, but all use tax preferences and other incentives to entice firms to locate or expand in certain neighborhoods.
To date, enterprise zones have yielded disappointing results. Even in small zones, the subsidies tend to be too modest to alter business location decisions. To the extent that they do, they typically draw firms that would have located nearby anyway, implying little increase in overall economic activity in a city, but instead a re-arrangement within it. (Of course, one could argue that the very point of enterprise zones is to redirect investment in this way that is, toward distressed, high-unemployment areas.)
Even if zones generate new investment, they may not create jobs. As Leslie Papke, of Michigan State University, points out, policymakers need to pay close attention to the mix of subsidies offered. If subsidies are targeted to capital, for instance, such as sales tax exemptions for the purchase of machinery and equipment, firms may shift to more capital-intensive production and perhaps reduce employment. If a ready supply of workers is not available to meet the increased demand, the new investment may simply increase wages. Even if new jobs are created, they may not go to local residents. Indeed, residents may be hurt as local land rents increase.
Picking Winners: The High-Tech Strategy
Silicon Valley has become a symbol of the extraordinary benefits that high-technology industries can bring to regional economies. In just a few decades, the birth and expansion of microelectronics firms transformed the Valley from an agricultural community into one of the fastest-growing and most affluent regions in the nation. Not surprisingly, local governments throughout the country are working to attract high-tech start-ups.
But the conditions that gave rise to Silicon Valley and other high-tech regions are quite exceptional and difficult to replicate. One critical ingredient is a skilled work force. Thus, many high-tech firms locate in large metropolitan areas, near major universities or research centers, and in areas with amenities likely to attract professional workers and academic and industrial researchers. High-tech firms also gravitate toward other firms in similar or related industries, where they can learn from one another about new products and techniques and draw from a shared pool of skilled labor. The result is something of a virtuous cycle. Cities and regions that already have high-tech firms are the ones likely to attract more.
It is not clear what cities, especially small cities, can do to promote high-tech growth. Because much of what seems to be important to the high-tech industry is determined regionally and is largely outside a city?s control, the conventional tools to attract new businesses (such as tax incentives) may be especially ineffective.
One of the most popular strategies for generating economic activity is building new sports stadiums and arenas. By investing in a new stadium, the theory goes, a city can spur economic growth and increase tax revenues because of both ticket sales and increased traffic at nearby businesses. But these rosy predictions are rarely borne out.
New stadiums are extremely expensive, often costing upwards of $200 million. And the ticket revenues and related sales come at the expense of businesses elsewhere in the area, such as movie theaters, bowling alleys, and restaurants. Even the money paid to players in salaries rarely contributes to the city economy, because athletes seldom live in the city where they play. The multiple analyses included in Sports, Jobs, and Taxes, edited by Roger Noll and Andrew Zimbalist and published by Brookings in 1997, report no significant effect of sports stadiums on jobs or taxes, and these findings are echoed in more recent research.
Of course, the location of a stadium within a metropolitan area may matter. A basketball arena in downtown Washington, D.C., surely yields a different pattern of economic activity than one in suburban Maryland. But even these effects appear small.
Economic development effects aside, major league sports may still generate important consumption benefits. Taxpayers who never attend a game may nevertheless be willing to pay to keep the home team from leaving or to have a new team take up residence. Although it is difficult to quantify these consumption benefits, they may serve to justify a stadium that doesn?t pay for itself.
The Casino Gamble
The continuing economic boom in Las Vegas as well as the success of tribal casinos elsewhere has made casino gambling an increasingly popular economic development strategy. Detroit residents recently voted to approve the opening of the $225 million MGM Grand Casino, and other cities, such as Joliet, Illinois, and Buffalo, New York, may soon follow suit.
Certainly, Las Vegas has been a remarkable success. But the more sobering case of Atlantic City, together with the pessimistic evidence emerging from the economic literature, suggests that casino gambling is far from a sure bet. The essential difficulty for casinos is the same as that for stadiums?the revenues and jobs may come at the expense of existing businesses.
As before, circumstances may exist under which casinos may be effective. First, casinos that are locally owned are more likely to generate local spending. Second, those that draw revenues from outside are more likely to spur economic growth, drawing new dollars into the local area. In particular, isolated destination spots like Las Vegas that can hold onto tourists for long periods at a time are more likely to fuel growth. Of course, Las Vegas was helped by Nevada?s monopoly on legal casino gambling for many years.
Dollars and Sense
Alas, there is no magic bullet. The most careful research shows that conventional economic development policies, appealing as they may be, typically yield disappointing results. Changing the direction of a city?s economy is difficult, and the ultimate success of particular policies may turn on realities beyond a mayor?s reach. Even policies that seem to work do so in small measure, creating marginal improvements that are never fully satisfying to a public looking for dramatic change.
This is not to suggest that local leaders are without any effective strategies. For example, it may be that policies aimed at improving elementary and secondary education, reducing crime, improving colleges and universities, or changing the mix of local taxes can effectively spur economic growth. At this point, research has little to say about these strategies, in part because most studies to date have focused on economic development policies for states, metropolitan areas, or local jurisdictions broadly defined (including suburban jurisdictions). Thus more research is needed to weigh the effect of such alternative policies specifically on cities.
Finally, in weighing the costs and benefits of various interventions, policymakers may want to look beyond their potential impact on jobs and economic growth. Some economic development projects provide amenities that citizens value. Even if a new school or new road or sports arena fails to deliver as many new jobs as had been hoped, its meaning to the community may well be valued in terms beyond dollars and cents.
Ingrid Gould Ellen is an assistant professor at the Wagner School of Public Service, New York University.
Amy Ellen Schwartz is an associate professor at the Wagner School of Public Service, New York University.