Why Economic Development Incentive Programs Don’t Work

When it comes to economic development programs, most people are quick to hang their hat on the incentive rack. It’s shiny and big and full of promise. Yet, the stark reality is almost all programs of that nature miss the mark on actually creating sustainable growth. Rather than focus efforts on wooing new companies to town perhaps the better solution is to look close to home.

The following excerpt is from The Local Economy Solution by Michael Shuman. It was originally published on GreenBiz and has been adapted for the web.

A growing body of evidence shows that the lion’s share of economic development manifests in “attraction” incentives, and almost all such economic incentives are losers. Politicians and economic developers scoff at this evidence, and too many don’t care about the evidence at all because in the end their mission is not about developing their economies. It’s about generating headlines and protecting Number One’s job.

The economic developer who brings a new company to town with a thousand jobs is treated as a local hero, and the politician who underwrites the effort has a solid pitch for reelection. By the time a community realizes that the deal under-delivered and public dollars were wasted, those responsible have happily moved into other private-sector jobs or retired.

Perhaps I’m too cynical. Perhaps I should credit those economic developers who sincerely believe that their projects can be those one in a million that will beat the odds and enrich their community.

Maybe they’ll focus their subsidies exclusively on high-wage manufacturers. Maybe they’ll impose tough “clawbacks” of the subsidies if the companies don’t deliver on their promises. Maybe their community will be the first with a perfect corporate-attraction track record. Yet none of these so-called “reforms” can possibly fix three deep problems with the incentives game.

Attracting businesses that don’t really want to be there

First, incentives focus exclusively on nonlocal businesses, which are the ones least likely to deliver real benefits to a community. Here’s a simple and amusing exercise to try the next time you chat with an economic developer. Count the number of times he or she utters the phrase “attract and retain.”

My experience is that it trips off the tongue at least once per minute. What’s strange and revealing about this lexicon is that it demonstrates that economic developers are paying no attention to locally owned business. You cannot attract a local business from somewhere else — that would be an oxymoron. And if the only way you can retain a local business is by paying it some kind of special bribe unavailable to other local businesses, then how deep are its roots in the community anyway?

The oversight is not trivial. If you look at the U.S. economy by jobs, about half are in large firms with more than 500 employees and the rest are in small and medium-sized firms. We know that about 99.9 percent of all small and medium-sized firms are locally owned. If you add the 26 million Americans who are self-employed, it’s clear that economic developers are consistently ignoring most of the economy.

Worse, economic developers consistently ignore the most important part of the economy. Locally owned businesses are by far the most significant contributors to a community’s jobs, social equality, sustainability and a dozen other important indicators of success. Indeed, given that one consequence of economic incentives is to make it harder for unsubsidized local businesses to compete fairly against subsidized nonlocal ones, economic development is effectively undermining precisely those businesses it should be most supporting.

Put positively, a smarter approach to economic development is to focus on local businesses because they generate the greatest benefits.

The siren song of corruption

A second inherent problem with the existing practice of economic development is the clear and present danger of corruption. Former Virginia Gov. Bob McDonnell and his wife are now in prison because of the gifts, favors and money they accepted from a slick businessman trying to extract government support for his magical elixir synthesized from tobacco plants.

Public commentators universally denounced the McDonnells for accepting Rolex watches and a $10,000 wedding gift for their daughter, without noticing that the pattern of misbehavior — granting public rewards to politicians’ favorite private companies — is the essence of almost all economic development today. The goal of economic development should be to minimize public subsidies, and to find the lowest-cost ways of activating and spreading private-sector businesses.

The grant-givers can’t identify promising entrepreneurs

Economic development now does exactly the opposite. Its lavish incentives and other programs depend on regular infusions of grants and gifts from government agencies, foundations and wealthy individuals. That those ostensibly committed to promoting free-market entrepreneurship are, themselves, among the least entrepreneurial members of our society is another central contradiction of economic development — and its third inherent problem.

If a sign-wielding beggar had better hygiene, more stylish clothing, a clearer mission and the guts for a bigger ask, he would fit right in with the local economic-development office.

Does it really matter that those promoting the free market depend on government subsidies? I believe it does. When you don’t or won’t “walk the talk,” your credibility and ability to exert a healthy influence on others is impaired. Call me priggish, but I’m skeptical when a preachy vegetarian wears leather boots or a chronic adulterer drones on about family values. If your ostensible goal is to promote an entrepreneurial culture, then you strengthen your message if you can show your capability to meet the rigors of the marketplace as an entrepreneur yourself.

Moreover, charity, whether public or private, is terribly unreliable, and economic-development programs that rely on it are condemned to being equally unreliable. Regions tend to go through their own business cycles, with leaders expanding government programs in good times and cutting them in lean ones (like the years after the financial crisis of 2008).

Governments also go through political cycles, with more progressive administrations creating or expanding programs and more conservative ones cutting them. The same seesawing occurs with foundation grants. Most foundations support a noble cause for a few years and then expect the beneficiary to develop new sources of grants. Wild budget oscillations necessarily follow that make serious program planning exceptionally difficult.

Even the best beggars face the risk of donor fatigue. There’s only so much government and charitable money available for economic development. Yet the challenges inherent in helping every individual and family within one’s region find well-paying jobs, with rewarding work, through environmentally and socially beneficial business — what the real goals of economic development should be — are almost limitless. The only way economic development can possibly begin to fulfill this mission is if it is reshaped to do more with less.