Economic Development Incentives: Research Approaches and Current Views

By Gorin, Dan | Federal Reserve Bulletin, October 28, 2008 | Go to article overview

Economic Development Incentives: Research Approaches and Current Views


Gorin, Dan, Federal Reserve Bulletin


Economic development incentives--state and local government efforts to encourage economic development--are one of a limited number of tools local policymakers have for stimulating local economies. Some broad measures--investments in infrastructure (such as transportation), human capital (education, for example), and social infrastructure (such as recreational facilities)--may produce significant results over the long term. Targeted measures crafted to attract or retain businesses--usually a tax preference or financial assistance--offer the possibility of a quick payoff.

Public interest in incentives has generally been muted, except when very generous incentive packages, egregious practices, or legal issues have prompted questions about their appropriateness and effectiveness. Policymakers struggling with practical decisions have frequently turned to economists for guidance: Should incentives be offered? If so, how large should they be? And how can an incentive program be designed to increase its effectiveness? Much of the research assessing the effectiveness of incentives has been inconclusive or unsatisfactory, in part because of methodological flaws and inadequate data.

Interest in incentives surged in the 1980s and 1990s as a result of very public bidding wars among localities to entice businesses to their communities. In particular, the dollar amount of incentive packages offered to automobile manufacturers looking to locate new facilities soared during that period. In 1980, Nissan received an estimated $33 million, or $8,000 per anticipated job, for locating a new facility in Tennessee. The amount of subsequent incentive packages handed out to Mazda, Saturn, DiamondStar, and Toyota, among others, rose over the next few years, and by 1987, Toyota was receiving an estimated $150 million, or $50,000 per anticipated job, for locating a new facility in Kentucky. (1) And the incentive packages were growing again before long. Although BMW's 1992 package to locate in South Carolina was reportedly just $150 million, Mercedes-Benz reportedly received $258 million the next year to locate a facility in Alabama. (2)

News accounts of ever-larger incentive packages caught the attention of economists and policymakers as well as the public. An essay entitled "Congress Should End the Economic War among the States" appeared in the 1994 Annual Report of the Federal Reserve Bank of Minneapolis. (3) A few years later, a conference on the same topic brought together policymakers, economists, tax experts, economic developers, and business-site location consultants from around the country to discuss the matter. (4) Many questions were raised, and research goals were identified, among them the goal of establishing good data with which to answer the economic questions.

In the past ten years, case studies, input-output analyses, and other research techniques have addressed some of the methodological flaws of earlier incentives studies. The availability of better data on both incentives and economic activity has also improved analyses of incentives research. The work described in this article illustrates some of the fresh ways that researchers have found to look at the effectiveness of incentives. The focus is not on proving or disproving the effectiveness of incentives as a means of spurring economic development. Rather, the intent is to demonstrate that new ways are being used to advance the discussion.

THE CONVENTIONAL WISDOM, TEN YEARS AGO

In the 1990s, many academics and policymakers expressed skepticism that state and local economic development incentives could induce firms to add jobs or invest in a particular locality. At the time, researchers tended to conclude that incentives were marginally effective at best. Such conclusions appeared to corroborate the general notion that incentives in the form of state and local tax breaks are ineffective because state and local taxes typically constitute a small portion of a business's overall costs. …

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