When Local Governments Subsidize Firms: Some Guidelines

Certain cities and metropolitan areas have been lagging in economic growth for decades, while others have surged ahead.  US regions used to be converging in economic terms, but this pattern has halted. These changes have been contributors to patterns of growing inequality, as well as to political divisions. This raises an obvious question: Can "place-based" public policy be used to stimulate the economy in slower-growth areas?  

I've written from time to time about proposals along these lines. For example, a couple of years ago Benjamin Austin, Edward Glaeser, and Lawrence H. Summers considered the problem and some of the options. For example, they pointed out that while additional infrastructure spending may be useful for other purposes, it's not clear that it's a tool that works well for touching off a wave of growth in a slow-growth area. They end up advocating geographically-targeted employment subsidies for jobs in certain geographic areas. 

Some of the proposals have focused more on spreading out research and development efforts across the country, through some combination of R&D funding at universities and technology centers. For example, last year Jonathan Gruber and Simon Johnson proposed that cities be able to bid for how they would used federal funds to support a local tech center. An independent commission would determining how the funds would be allocated, but the funds would go only to cities with a population of at least 100,000 workers from age 25-64, where the college-educated share of such workers is at least 25%, and where the mean home price is less that $265,000, and the commute is less than 30 minutes. The commission would also look at  measures of patents/worker in that area, as well as whether the area already has highly-ranked graduate school programs in science and tech areas. Robert D. Atkinson, Mark Muro, and Jacob Whiton made a broadly similar proposal for "growth centers" along these lines. 

The Summer 2020 issue of the Journal of Economic Perspectives offers a couple of other perspectives on place-based policies. Timothy J. Bartik  writes about "Using Place-Based Jobs Policies to Help Distressed Communities," with a particular focus on the $60 billion or so that state and local governments spend each year on incentives for businesses to locate in their area, mostly in the form of cash and tax incentives to specific companies. Bartik points out that moving people to different locations is hard, and economic and social problems in certain areas are persistent; thus, the potential payoff from additional jobs in depressed areas is high. But Bartik also points out that local politicians often prefer to offer relocation subsidies to a few large firms, who often don't even locate in the actually distressed areas. Thus, he offers some suggestions for how to make this approach cost-effective: 

First, place-based jobs policies should be more geographically targeted to distressed places. The benefits of more jobs are at least 60 percent greater in distressed places than in booming places. But our current incentive system does not significantly favor distressed places. 

Second, place-based jobs policies should be more targeted at high-multiplier industries, such as high-tech industries. Governors may claim they want to build the future economy, but state and local governments in practice do not target high-tech. One caveat: high-tech targeting should consider how to increase the access of current residents to these jobs. One model is Virginia’s recent offer for Amazon’s “Headquarters II.” Virginia’s offer included a new Virginia Tech campus in northern Virginia and increased funding at state colleges for tech-related programs. These education programs increased the odds that Virginia residents would fill Amazon’s jobs. 

Third, incentives should not disproportionately favor large firms, especially given the renewed concern in economics over excess market power in product markets and labor markets (Azar, Marinescu, and Steinbuam 2017; Gutiérrez and Phillippon 2017). 

Fourth, place-based jobs policies should put more emphasis on enhancing business inputs. Customized business services, infrastructure, and land development services have the potential to be more cost effective than incentives as ways to increase local jobs and earnings. 

Fifth, place-based policies should be a coordinated package of policies attuned to local conditions. One area may need more infrastructure; another, training; and still another, better land development processes. Place-based policies are complementary. If the local nonemployed are more skilled, job growth increases employment rates more. If more jobs are available, it is easier to design effective training programs. Business inputs are complementary—boosting infrastructure helps growth more if the local economy also has customized business services.

In another essay in the Summer 2020 JEP, Maximilian von Ehrlich and Henry G. Overman consider "Place-Based Policies and Spatial Disparities across European Cities." They point out that across the European Union, as in the United States, spatial disparities in income are large, persistent, and growing. The EU has a "cohesion" policy that seeks to reduce these differences by targeting certain metropolitan areas with subsidies, mainly for infrastructure and physical capital, but also to a more limited extent for employment training and subsidies to firms, They find that these policies have been modestly effective in ameliorating the ongoing trends, although not in reversing it. They also find that such subsidies tend to be more effective in areas that already have a relatively high number of educated workers. 

The economic forces that have led certain areas to be economically distressed for long periods of time are obviously powerful and slow to change. As I consider the proposals, I keep running into questions of political economy. Is it possible for the political system to do place-based targeting in a cost-effective way?  After all, the areas most in need of such targeting are also frequently the areas that currently lack economic and political clout. 

When national governments try to target assistance to distressed areas, it's common to see a dynamic where the definition of "distressed" keeps getting wider and wider, until it includes all major cities and all 50 states. A proposal for spreading R&D more widely across the country or starting "tech centers" or "growth centers" is likely to run into similar problems. When it comes to eligibility for employment subsidies, big companies know how to play the bureaucracy for maximum eligibility, while small companies do not. When state and local government think about business incentives, they have a bias toward a high-profile and costly deal where the governor or the mayor can shake hands with a CEO of a prominent company, and where there will be a ceremony to stick a shovel in the ground at the site of a new plant. There also seems to be a bias toward building physical infrastructure, surely in part because of behind-the-scenes lobbying for such contracts and also because of the photo opportunities for politicians when such projects are completed. 

In short, I can believe that well-targeted and well-designed incentives could have benefits that exceed  costs for areas that have experience long-term and persistent economic distress. I'm not confident that the political system can enact a large-scale version of such a program. It would require that the political representatives of metropolitan areas and states with high per capita incomes see it as in the interest of their own area to actively support efforts to launch economic growth in other areas.