Why Michigan Should Shelve its "Economic Development" Programs

Good afternoon. First, let me say thank you for inviting me to testify today. I have been looking forward to an opportunity such as this for years. I am director of fiscal policy for the Mackinac Center for Public Policy where I have been employed for eight years. I handle economic policy issues for the Center, including the one I am most passionate about, which is economic development.

My remarks today will address basic economics and economic development issues; provide you with some anecdotal and empirical evidence on government’s inability to pick "winners and losers" in the marketplace; discuss the role of the Michigan Economic Development Corporation (MEDC) as a facilitator of state central planning, and explain why the Michigan Economic Growth Authority (MEGA) should be allowed to sunset. I have promised to do all of this in around 20 minutes, so I have to point out that, if you would like more details, you can easily find them on our economic development web module, which you can find at www.mackinac.org/depts/ecodevo/.

Since the Great Depression, governments at all levels have been designing and using a wide array of incentive policies to encourage businesses to do one thing or another, such as moving to a particular state, expanding in a particular state, or giving more training to workers.

This idea of economic development spurred by government handing out economic favors or incentives to those it believes will be future "economic winners" is based upon some fundamental misconceptions.

One of these misconceptions is the idea that the government has anything to give anyone that it hasn’t already first taken from someone else. If the MEDC takes tax dollars from a thousand businesses, and gives them to one, the one firm may have more resources to hire workers and create products — but the other thousand now have less. But this isn’t even a zero sum game. The money taken from others must pay the salaries of state and MEDC employees who run economic development programs. This removes productive investment dollars from the economy.

Two examples come to mind. The first is Boar’s Head Provision Company, a meat products company headquartered in Brooklyn, New York. In 1998 the MEDC’s predecessor agency, the Michigan Jobs Commission, offered Boar’s Head, in exchange for the company’s promise to invest $14 million and "create" 450 new jobs in Michigan, an "economic development package" worth up to $5.1 million in federal, state, and local resources. Armed with these "incentives," the company opened a processing plant near Holland, Mich., on Dec. 13, 1999.

The MJC went ahead and added 450 "new jobs" to the rolls it could claim it was responsible for creating. But when an economy is booming, as it was in 1999, jobs are most likely filled by people who are already gainfully employed elsewhere. This is job shifting, not job creation. And it imposes a cost on employers who lose employees and must go out and hire and train new workers.

In addition, the incentives that helped establish Boar’s Head in Holland came from Michigan taxpayers, including the family of Koegel Meat Company of Flint. Koegel is one of Michigan’s major meat processing companies (Kowalski is another) and has been doing business in our state for almost 90 years. The company has stayed in Flint through good times and bad and has never taken a dime of government money; yet it is now forced to compete against an out-of-state firm that the state government has showered with economic favors. Could anything be more unfair?

Another example the Mackinac Center has pointed to is Cabela’s Retail, Inc. In 1999, the MEDC informed Cabela’s that it would offer the company a package of incentives worth up to $27.8 million for locating a new, 200,000-square-foot store in Dundee, Mich. Cabela’s accepted the offer. Then-Gov. John Engler hailed the deal as a win for Michigan, saying, "The additional tourists and 600 new jobs that Cabela’s will bring in to the state are welcome news."

But proponents of this "economic development" strategy were not counting "net" new jobs; nor were they taking into consideration the harm such deals do to the existing 1,000 sports retailers in the state, including well-known Jay’s Sporting Goods of Clare. Jay’s has been in Michigan since 1968, has grown into a popular tourist destination of its own, and has done so without a dime of taxpayer money. The owner of Jay’s — the widow of Jay Poet, the company’s founder — was flabbergasted when she found out her state government was subsidizing her competition. "It makes you wonder whom you’re working for," she said.

Another misconception underlying the idea of government-sponsored economic development is the assumption that state bureaucrats — central planners if you will — can predict which businesses will be "winners" and which will be "losers" in the marketplace. This is tantamount to saying government bureaucrats know more than Wall Street investment mavens, who spend their professional lives analyzing the workings of business, and still can’t tell which companies will thrive until after the fact. Do government employees know how to foster wealth and create jobs better than business owners, consumers, workers, bankers, investors, and managers, whose collective decisions form our market economy?

There is a substantial body of empirical evidence that shows organizations such as the MEDC, and the incentive programs they operate, are at best a zero-sum game. I would suggest that they’re probably a negative-sum game, especially if you consider the next-best alternative foregone: cutting taxes and other business costs for all businesses, not just for those lucky enough to win special favors from federal, state and local governments.

If state governments can have a positive impact on the economic well being of job providers, employees and taxpayers in general, we should be able to measure some type of statistically significant relationship between what a state spends on its economic development programs and changes in the Gross State Product (GSP) of a state. Gross State Product is the value of all goods and services produced within the geographic area of a state. It is arguably the No. 1 variable economists look at in order to gauge a state’s overall economic well being.

The Mackinac Center has examined spending on economic development programs in all 50 states and compared that spending to the states’ respective per-capita Gross State Products — and found no significant correlation. In other words, we found that a given state’s spending on economic development has no significant impact on the economic well being of that state.

Consider a couple of examples.

In 1996 Michigan ranked 9th among the states in per-capita spending on economic development programs. Yet, in that same year, Michigan ranked a distant 24th in per-capita GSP. By contrast, Texas was ranked 50th, or dead last, in per-capita economic development spending. Yet, it outpaced Michigan with a ranking of 18th in per-capita GSP. If economic development programs were as valuable as proponents claim, they should correlate more strongly with higher GSP. In other words, Michigan should rank above Texas in per-capita GSP because of its far greater spending per capita on economic development programs.

Five years later, in 2001, Michigan ranked 20th among the states in per-capita economic development expenditures and 30th in per-capita GSP. By contrast, California ranked 41st in per-capita economic development expenditures, yet beat Michigan by 22 ranks, scoring a ranking of 8th in per-capita Gross State Product.

One program associated with the MEDC that deserves to be singled out for comment is the Michigan Economic Growth Authority, or MEGA. MEGA is a 1995 creation of the Engler administration. It was sold to the Legislature and the public as a "jobs-creation/retention" program. MEGA has the power to grant tax credits to companies that promise to create or retain "X" number of jobs in the state. The MEDC, working in concert with MEGA, often arranges for other incentives as part of MEGA deals. To date, the MEGA program has offered as much as $2.7 billion worth of incentives to fewer than 180 companies.

In 1999 and again in April 2002, the Mackinac Center examined MEGA job-creation claims and found that the program left much to be desired. From April 1995 through December 2000, MEGA could claim credit for only 1.4 percent of all the jobs created in the state — and those numbers are probably inflated.

There are several problems with MEGA job claims. First, MEGA officials cannot prove that the companies involved would not have expanded or moved to Michigan without MEGA assistance. Nor can they prove that companies would not have "retained" their jobs in Michigan without special tax favors and other incentives. MEGA officials simply rely on the word of company executives in front of whom they have just dangled millions in financial incentives and expect them to be really, really, honest.

MEGA officials counter these arguments by saying company representatives must sign an agreement stating that MEGA made the difference in their decision to start or expand a project in Michigan — but, of course, this proves nothing. Among the first group of MEGA recipients was Waldenbooks. That company’s executives, it was later learned, put deposits on homes in Michigan even before the law creating MEGA was passed. They were coming to Michigan anyway and just sought and received MEGA favors as the economic icing on the cake for their change in location.

The second problem with MEGA job claims is that the agency’s officials can’t prove that so-called "new" jobs were not filled with people who had already been gainfully employed elsewhere in Michigan and just shifted to firms receiving MEGA favors. When this happens, the firm losing an employee to a MEGA company must then go out and find and train a new worker, at considerable cost to themselves.

A third problem is that the analysis MEGA employs for making its job-creation forecasts is questionable. MEGA’s economic analysts — University of Michigan economists under contract with the state — do not take into consideration important data, such as the costs and benefits of local property tax abatements, in their computations; factors that probably would lower their estimates of real job creation in Michigan. Unfortunately, it is impossible to determine the degree to which job-creation claims are overstated, since both the MEDC and the University of Michigan have refused to allow critical review of their forecasts.

A fourth problem with MEGA is the opportunity cost our state incurs by placing its faith in the efficacy of such programs: The state of Michigan could cut taxes for all Michigan businesses, not just for the favored few, and do far more to help the economy. Fewer than 180 companies have benefited from the Single Business Tax relief offered through the MEGA program, yet there are more than 102,000 Michigan businesses that have SBT liability. Cutting taxes for all of these businesses would very likely create as many, if not more, jobs than has been credited to MEGA.

Finally, MEGA is simply unfair. Most of the firms chosen by the politically appointed MEGA board to receive tax credits have in-state competitors that do not receive tax credits or other special treatment.

Proponents of programs such as MEGA and departments such as the MEDC defend their position from a variety of different angles — but the most repeated reason for maintaining these policies has been that to not have them would constitute a form of economic "unilateral disarmament" in the face of challenges from other states. The idea is that we must maintain an arsenal of tax and other incentive programs simply because other states do.

But if Ohio wants to engage in counterproductive economic development policies, let it. What MEDC and MEGA create are job announcements, not real jobs.

Economist Terry Buss of the National Academy of Public Administration in Washington, D.C. reviewed hundreds of economic development studies involving state tax incentive programs. He concluded that studies were split on the issue of program effectiveness, but most reported negative results. His review highlighted one 1996 study conducted by the state of Washington on its own tax incentive programs, which reported that "there appears to be little correlation between the amount of tax benefit received by participants in the tax incentive programs and the growth in employment which resulted."

Peter Fisher of the University of Iowa is an economic development expert and the co-author of the book, "Industrial Incentives: Competition Among American Cities and States." When interviewed recently by the Detroit News, Fisher was asked point blank whether Michigan could afford to "unilaterally disarm" in the "incentive wars" that states have been fighting ferociously for 20 years.

His response was the best I’ve heard yet. He said, "Of course you can unilaterally disarm when you’re talking about an incentive, like the MEGA tax credit, which isn’t very effective anyway."

Thank you for your time, and I would be happy to answer any questions.

Note: Michael LaFaive is fiscal policy analyst for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich.