New Economic Development Program Risky, Unnecessary

The state Legislature has jumped headlong into yet another economic development scheme. This one authorizes $1 billion in grant and loan subsidies for research in and commercialization of unproven "cutting edge" technologies, in the hope of creating new jobs and wealth in Michigan, among other things.

With this move, today’s political establishment joins a sad tradition: Every governor since Kim Sigler in the 1940s has introduced his or her own targeted economic development plan(s) for diversifying Michigan’s economy. That Michigan is still not sufficiently diversified following decades of government economic adventurism should speak volumes to policymakers. However, the lessons of history appear lost on officials of every stripe. History, economic theory and experience suggest that there are better ways for government to encourage economic growth and development.

This latest episode began in February, when Gov. Jennifer Granholm called for the state to borrow $2 billion over 10 years to finance a "21st Century Jobs Initiative" in hopes (once again) of diversifying Michigan’s economy. The idea was to invest the money in advanced automotive engineering and other high-tech industries to generate economic growth and development.

Senate Republicans countered with a similar, but smaller, $1 billion debt plan. Unlike the governor’s proposal, this proposal did not specifically authorize state government to take ownership positions in private, for-profit companies. However, Republicans in the House put forward a response that did include such equity positions, and their version ( House Bill 5047) has been adopted by the Senate as well.

Patrick J. Wright, senior legal analyst with the Mackinac Center for Public Policy, noted that this violates the spirit of Michigan’s prohibition on direct state ownership in private companies and stocks (except for state employee pension funds). "In the 2002 primary election, voters accepted a legislatively-initiated constitutional amendment to allow any ‘permanent fund’ to hold equities," Wright said. "Voters were told that this would allow more effective management of the state’s natural resources trust fund, state park endowment fund and veteran’s trust fund. But few if any voters realized that another consequence would be to provide future legislatures with a means to circumvent a 154-year-old prohibition against state ownership of private companies for 'economic development' purposes."

The $1 billion fund in the current proposal would come from "securitizing" (or selling) a portion of revenue annually received by the state as part of its 1998 legal settlement with tobacco companies. "Securitization" means the state exchanges future revenue streams for a lump sum of money today. Last year the state received about $274 million as part of the agreement.

The $1 billion would be used to make investments in areas deemed by officials and "experts" on a government "Strategic Economic Investment and Commercialization Board" to have a "high probability of creating jobs in Michigan." Some of these include life science, advanced automotive work in manufacturing and related materials technology, as well as alternative energy research and "medical informatics."

There are at least five major shortcomings with this latest proposal:

First, there is nothing new under the economic development sun. The state constitution today prohibits direct investments in companies (save for pensions and trusts) precisely because Michigan’s first governor floated $5 million in bonds to pay for economic development schemes that failed miserably. Gov. Granholm’s plan called for issuing bonds and using at least some of the money for taking equity stakes in companies. The Republican alternative does the same.

Second, economic theory, logic and evidence suggest that, at best, the state’s investments in particular products, processes or industries will be a wash. Government has nothing to give anyone that it doesn’t first take from someone else. Productive returns on investment will only occur if officials can pick winners from a myriad of investment opportunities. The state’s history of picking winners and losers in the marketplace is not encouraging.

Here’s an example: The Michigan Economic Development Corporation is a quasi-public institution that has taken equity positions in public corporations. Unelected officials at the MEDC are using state resources to purchase equity in corporations and make other investments. According to an audit of the MEDC published in June 2005, MEDC officials have, through September 30, 2004, an investment portfolio worth $9 million less than the investments’ initially cost.

This suggests at least two problems. First, it is another example of unelected officials making investment decisions for the state and choosing poorly. Second, the MEDC is a public agency and, thus, its direct investments in corporations may be a violation of the Michigan Constitution. The MEDC will no doubt argue that it is quasi-public and maintains a "corporate" side which makes its investments legal.

That position is debatable. The MEDC is supported by tax dollars, responds to Freedom of Information Act requests and claims to adhere to the state constitution.

The state’s track record on picking winners and losers in the marketplace is simply not good enough to justify placing $1 billion into the hands of unelected political appointees to "invest" as they see fit — be it in equities, other investments, or in entire industries by providing grants and loans to research areas, universities, nonprofits and corporations it deems worthy. Consider a few examples of dubious government "investments" gone wrong.

A comprehensive analysis of Michigan’s highest profile economic development program, the Michigan Economic Growth Authority, showed that state promises of job creation have not materialized. The MEGA program authorizes an unelected board to hand out incentive packages to companies that promise to create "x" number of jobs.

A 2005 Mackinac Center analysis showed that of the 127 MEGA deals that were supposed to have created all of their direct jobs through 2004, only 10 created the number of direct jobs originally projected by state officials. After 10 years, the program has had no impact on net employment in the state. What makes legislators think this new program will be any different?

Of course, this is just one failure among many, but one must wonder if legislators ever heard of others, such as the state’s $20 million Optical Imaging Systems/Flat Panel debacle involving the University of Michigan, Vixen Motors or Autoworld, the now-defunct automobile theme park that was supposed to bring jobs and prosperity to Flint.

The third shortcoming of the plan is that the securitization program is basically redundant. Former Gov. James Blanchard’s Research Excellence Fund is practically a smaller, 1980s version of the Granholm/Republican programs. Both programs were designed to facilitate research in the hope of commercializing discoveries produced in universities and nonprofits.

The Research Excellence Fund’s creation was promoted by Blanchard in a 1985 press release which claimed:

The function of state government is to act as a facilitator in encouraging more interaction between higher education institutions and the private sector. Closer ties between the two can result in increased business and job creation. The Research Excellence Fund will make targeted investments in the existing strengths of our colleges and universities in those fields which hold the most potential for future economic benefit for all of Michigan.

But did it? Between fiscal 1986 and fiscal 1990 alone, the state appropriated $130 million for REF in the hope that its research would generate patents and products that could be commercialized and, thus, generate jobs, wealth and employment in the state. The program was discreetly rolled into the basic appropriation of university monies in former Gov. John Engler’s first budget. Engler was never a fan of the Research Excellence Fund.

One has to wonder how many legislators today have even heard of this program, let alone know if it lived up to its expectations. Indeed, if REF was such a job-creating engine, proponents of this plan would be using it as evidence for expanding the initial program. But they can’t. Consider just two of the ways state appropriations were used then to invest in research to facilitate job creation.

• A $23,000 study of new construction in Flint’s downtown — which included "Autoworld," an automobile theme park that went belly up after the study was written.

According to The Detroit News writer Mark Hornbeck, the study reported that such projects made "people feel more positive about the downtown." One has to wonder how they felt watching Autoworld get razed by explosive charges.

• Cindy Merkel of Lake Superior State University reports that the some REF resources were used to create a low-income wellness center. The logic was that if low-income people got healthier as a result, it would reduce businesses’ cost of providing health care benefits to their employees.

The list of research grants is long, but not necessarily distinguished. At the very least, REF failed for its ability to rigorously measure and report its costs and benefits. It likely failed to drive real job growth, too. After all, if REF-related research was creating scores of net new jobs wouldn’t scholars and proponents of such programs be touting its successes?

Legislation to securitize tobacco revenues demands scrutiny of the new program’s success, but even a commitment to do so could prove to be little more than window dressing to distract critics. In the 1985 press release announcing REF, the "proposed administrator of the fund," James Naftaly, assured the public:

[E]ach of the public four-year colleges and universities will be eligible to receive a portion of the fund, however, there will be a rigorous review process prior to grant approval, including evaluation by well-known scientific experts and an economic analysis.

The Mackinac Center for Public Policy expended a great deal of effort last summer attempting to locate anything approaching independent evaluations of past REF grants by scientific experts and corresponding economic analyses. While such materials may exist, this author is beginning to doubt whether any comprehensive, independent appraisal of REF grants were ever made.

The state itself was reportedly set to spend $50,000 in 1991 on a single evaluation to measure the REF program’s success, or lack thereof, but it remains a ghost study. If a study was done its findings have been lost, as neither the state Department of Management and Budget, which oversaw REF, or the state library and archives, is aware of its existence.

In addition, when the state Legislature passed "Renaissance Zone" legislation in 1996, it included a "report by state research university" mandate that the program be analyzed to measure its effectiveness. But since that time it appears the state has simply ignored its own law. A search by this author turned up no such studies.

Fourth, the Clean Michigan Initiative was promoted as an environmental stewardship program, and in 1998 voters authorized the sale of $675 million in bonds. Much of the money was spent on questionable environmental improvement work such as building swimming pools, roller rinks, tennis courts, ice arenas, "and even renovation of a dairy barn and construction of a fish-cleaning station," according to Diane S. Katz, the Mackinac Center author of a study on CMI. Giving state government a mandate to spend, even on what appears to be carefully monitored programs, can produce highly questionable choices.

Fifth, state initiatives to "create" jobs are a distraction from the fundamentals. Every moment legislators spend trying to concoct yet another program to diversify and improve Michigan’s economy consumes time and energy better spent on fixing the Great Lakes State’s basic economic infrastructure.

Lastly, can any "investment" made by the state come without political strings of some sort? The legislation passed by the House two weeks ago appears to contain some highly questionable political spending. It mandates that $26 million of the tobacco revenues generated from securitization be redirected to the Michigan Forest Finance Authority. The Authority is a legal mechanism the state of Michigan uses to contract for timber-cutting rights on state lands and appears to have nothing to do with creating "competitive edge technologies," as the legislation is sold as doing. The final Senate version of the legislation, passed Oct. 19, maintained this expenditure and also included $2 million for the promotion of movie production in the state.

The language allowing the appropriation for the Michigan Forest Finance Authority was included in an amendment sponsored by Tom Casperson, an Escanaba Republican with constituents who may benefit from a forest industry subsidy. Casperson is widely seen as vulnerable in the next election as a result of his votes to close two Upper Peninsula prisons and to cut funding for Northern Michigan University. Republican leadership has been looking for a way to buttress his standing and this just may be one way to bring Casperson positive publicity.

Consider a report from the Oct. 6 edition of the Michigan Information and Research Service:

. . . Action on the bill also gave evidence to the desire of both caucuses to use the funding to insulate otherwise vulnerable and targeted members. Recall that the House leadership had requested that Granholm give Rep. Tom Casperson (R-Escanaba) credit for saving the police posts? (See MIRS, Sept. 22, 2005).

Only four members of the state Senate voted against the legislation. One of those members, small business owner Laura Toy of Livonia, was quoted in the Oct. 19 edition of MIRS as saying, "We are better served by removing obstacles than engineering a gigantic program where government pretends to know more than the market."

Her observation is backed by a great deal of compelling evidence. One frequently cited study alone should give Lansing’s central planners pause. It is by General Accounting Office economist Harold Brumm, published independent of the GAO by the Cato Institute’s Cato Journal. The study, entitled "Rent Seeking and Economic Growth: Evidence from the States," evaluted the cost imposed on state economies by favor seekers. Rent seeking is a fancy way of saying people and institutions seek higher returns by getting government favors, or "rents," than they would otherwise earn without those favors.

Brumm collected and analyzed data from the 48 contiguous states and found that "rent-seeking activity retards economic growth, because it merely redistributes wealth; rent seekers (unlike profit seekers in a competitive market) do not create wealth." Brumm actually found a correlation between the growth rate of per capita gross state product, adjusted for inflation, a state’s tax burden and how much rent seeking occurs in each state — and the correlation was negative. That is, the more rent seeking, the slower the real rate of economic growth.

By appropriating $1 billion for redistribution ($400 million in 2006), the state Legislature is ringing the equivalent of a rent seeker dinner bell while yelling "come and get it" to every institution or person with the influence to get something for nothing. As Brumm’s research suggests, this could actually slow, rather than accelerate, Michigan’s real rate of economic growth.

Instead of securitizing tobacco revenue for the purpose of letting government bureaucrats attempt to pick winners and losers in the marketplace, officials should work to eliminate or lower the tax burden for all job providers, pass legislation that would make Michigan’s labor climate less hostile, roll back onerous regulations and improve state schools. Only fundamental changes to Michigan’s economic landscape will generate the type of dramatic growth that will be necessary to stave off more bad news for Michigan’s economy.

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Michael D. LaFaive is director of fiscal policy for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.