Ideas in Development

The key factors of production are no longer land, labor and capital; instead, it’s stuff, knowledge and organization (this is a bit of an exaggeration!).

Under the endogenous growth theory and social infrastructure—institutions, laws and practices that favor production over diversion and corruption, an economy open to trade and competition, stable economic institutions, workforce skills, an entrepreneurial culture, good governance, and sufficient investment in higher education, research and development, amenities, education, training, the physical infrastructure, et cetera—plays the key role, separating the winners from the losers. ²

I see this framework meshing nicely with the earlier entrepreneurial model of state economic development.  Here’s the dynamic as described by Roger Vaughan in his book The Wealth of States:

Economic development is a process through which wealth is created. Wealth is generated by innovation. Innovation is spurred by know-how—both formal and tacit. Know-how is embodied in people as human capital. In a market economy, human capital serves profit-making. Development is a profoundly human process. People who combine resources in new ways and to ends are usually called entrepreneurs. Entrepreneurs generate “gales of creative destruction” (Joseph Schumpeter’s phrase)—both the benefits and hardships and opportunities that characterize capitalism.

Are business attraction strategies an element in this larger theory? Sure. Selective use of economic incentives can attract or retain businesses that will foster innovation and long-term growth.

Now, let’s consider some examples of endogenous development options, which are documented in a variety of scholarly studies:

• Universal Preschool:Economist Timothy Bartik crafted a study that compared the jobs and income effects of spending an equal amount of monies on universal preschool to business subsidies on the state and national levels. In the short-run, of course, incentives out-performed preschool (they’re toddlers, after all!). But, over the long haul, preschool in a state yielded a comparable return – 3 bucks on the dollar – in job creation, earnings, gross state product, and state and local tax revenues. Early childhood education had a far superior benefit to cost ratio, nationwide, since incentives in the vast majority of cases, at best, decide where the jobs are going to be, but rarely create net new employment. In fact, the ratio was negative – for every public dollar invested in attraction subsidies only 62 cents were generated. ³ Other research on the Perry Preschool Program followed the fortunes of actual preschoolers for 40 years. By also counting social returns, such as lowered crime costs, the returns surpass Bartik’s projections – $17 is generated per dollar invested in the long-term Perry experiment and study. ⁴
• Manufacturing Modernization: A rigorous research project (1999) that used a quasi-experimental design comparing Pennsylvania’s Industry Resource Councils’ (IRC) customers to a control group, found that this manufacturing modernization program raised output and productivity significantly, increased the state’s GSP by close to $2 billion, led to $120 million in additional tax revenues, and yielded a 22 to 1 return on public funds invested in IRC’s. ⁵ A 2004 study by Deloitte Touche corroborated these findings. ⁶ An ongoing National Institute of Standards and Technology (NIST) study of state-run manufacturing extension partnerships (MEPs), like the IRC’s, document for fiscal year 2004: improved productivity for three-quarters of MEP clients, creation and retention of over 43,000 jobs, helping to increase sales by $.5 billion, leveraging over $941 million in private investment, and saving $721 million in costs. ⁷
• Incumbent Worker Training: California’s Employment Training Panel Program, an incumbent worker training program, generated $400 million of state income on a state investment of $68 million. These benefits include: savings in unemployment insurance costs, increases in trainees productivity, jobs retained, increased worker earnings and job creation in other in-state firms. ⁸
• Technology Development and Transfer: High tech-based funding and transfer programs have delivered as well. In 2004, evaluators of the Maine Technology Institute Program found that “MTI programs have catalyzed more than $20 in federal research and development support or every $1 of MTI funding. Over a quarter of MTI-funded projects have already resulted in products that are on the market . . . MTI recipients are mostly very small companies . . . but saw employment grow by 11% in the first year . . . They had significant success in developing new products leading to intellectual property . . . MTI-grant assistance have secured nearly $95 million in private debt and equity financing.” ⁹ A 2003 assessment of the “granddaddy” of this whole field of state technology-based economic development, Pennsylvania’s Ben Franklin Technology Partners (BFTP), showed that BFTP has altered the environment in which technology-driven firms operate by investing in more than 20,000 companies during the last 20 years, leveraging state monies by more than 23 to 1, creating higher wage jobs, boosting the Pennsylvania economy by $8 billion between 1989 and 2001, and yielding an additional $400 million in tax revenues. ¹⁰
• Entrepreneurship Promotion: We do not have good figures of entrepreneurship promotion efforts, which are hard to document (you are trying to show the effects on business creation, after all). But we do have credible research on the difference that higher rates of entrepreneurship make in regional, state and national economies. For example, a major study for the US Small Business Administration and the Edward Lowe Foundation described “the connection between innovation and entrepreneurship as drivers in economic development. Regional variation in entrepreneurship (new and young growing firms) was large during the period from 1990 to 2001. The most entrepreneurial regions had better local economies form 1990 to 2001 compared to the least entrepreneurial. They had 125% higher employment growth, 58% higher wage growth, and 109% higher productivity. This general finding held individually for large, medium and small sized regions but was most pronounced for large regions. The most entrepreneurial regions were associated with higher levels of technology . . . 54% more of R&D . . . 67% more patents per labor force participant . . . 63% higher percentage of hi-tech establishments.” ¹¹

The point of all this social science is not that business attraction subsidies and programs should be terminated tomorrow. It is that a state should compare traditional incentive packages to other economic development options. The state may consider a more balanced portfolio of development programs than they currently have. Plus, these alternative economic development policies appear to generate a higher yield on taxpayer dollars than business location incentives. In essence, policymakers should be asking: “What is the best alternative use of money, time and effort we are proposing to spend?” and “what are we forfeiting by doing what we propose to do?” ¹²