A Ranking of State Governments' Efficient Use of Expenditures to Encourage Small Firm Births

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ABSTRACT

We assume state governments are rational in their budgeting behavior. If this is true, then it is intuitive that they would allocate their expenditures so as to receive the maximum possible benefit for the least cost. Within the parameters of this study, we assume state governments work to receive the maximum number of firm births for the least amount of expenditure. Using regression analysis, we attempt to determine common state government expenditures that indirectly promote firm birth. We then employ non-parametric efficiency testing to rank states by their relative efficiency in using the significant expenditures to promote firm births. The regression results reveal three positive and significant expenditures in determining small firm birth, while relative efficiency rankings based on the use of these target expenditures indicate how states compare to their peers in terms of efficient expenditure use.

INTRODUCTION AND BACKGROUND

It is not an earth-shattering revelation that state governments consistently work to attract new businesses to their states and to retain businesses currently operating within their borders. In his 2005 state address, Indiana Governor Mitch Daniels was quoted as saying "Government does not create jobs; it only creates conditions that make jobs more or less likely." Soon after this statement was made, Indiana replaced its Department of Commerce with the Indiana Economic Development Corporation (IEDC) with the goal of developing and retaining businesses within the state. Kentucky has also taken similar measures to demonstrate a commitment to economic development through the establishment of the Cabinet for Economic Development. This cabinet serves a purpose very similar to that of the IEDC, with both entities working to foster the formation and retention of small- and largescale firms alike. In their 2001 study, Goetz and Freshwater suggest that states' increased attention to firm births is appropriately focused, since the economic development policies adopted by states are increasingly considered significant influences of economic development patterns.

State governments appear to be greatly concerned with their ability to encourage firm births. Researchers have increasingly credited firm births with advances in technological innovation, job creation, and as a result, regional economic growth and development (Schumpeter, 1934; Birch, 1981; Kirchhoff and Philips, 1988; Reynolds and Maki, 1990; Davidsson, Lindmark and Olofsson, 1994; Reynolds, 1994; Luger and Koo, 2003). Because firm expansions create jobs and consequently promote regional economic growth, studies such as these have touched on the heightened emphasis. In their 1988 study involving firm births and expansions, Kirchhoff and Phillips revealed that from 1976 to 1984 firm births accounted for nearly three times more new job creations than expansions. Given that firm births were found to be responsible for approximately 74% of new job creation, the state governments' focus on fostering firm births appears reasonable.

The literature related to state economic development policy appears to be centered on the nature of the programs states incorporate to foster business development (Bartik, 1991; Isserman, 1994; Bradshaw and Blakely, 1999). Birley (1986) indicates that governments at all levels integrate strategies to foster entrepreneurial activity and firm birth, while Baumol (2002) contends that both politicians and practitioners are aware of the significance of entrepreneurship in spurring new employment and innovation. Thirdparty organizations such as the Corporation for Enterprise Development (CFED) are also concerned with economic development, and rank the business climates of states relative to their peers in their Development Report Card for States. This report evaluates each state's economy, along with many other elements the CFED considers to be essential factors in economic development. …