Arthur J. Rolnick - Senior Vice President and Director of Research, 1985-2010
Published April 1, 1994 | April 1994 issue
The following column originally appeared in the Twin Cities Star Tribune, February 28. It was reprinted in the fedgazette with permission of the Star Tribune Co.
A group of Minneapolis area business leaders has commissioned an economic impact study to determine the importance of Target Center and the Minnesota Timberwolves to the local economy.
The results of the study are intended to help government officials decide whether public funds should be used to buy the sports arena.
Since Target Center is estimated to be losing at least $5 million a year, many are concerned that it will close. Minneapolis then will lose the Timberwolves, and the local economy will lose jobs, income and tax revenue.
Most businesses applying for government assistance today have used some type of economic impact study to justify their requests.
But government officials should be suspicious of economic impact studies because they do a poor job of guiding governments in their investment decisions. They lead governments away from providing traditional public goods and down a path to investments that the market has rejected as unprofitable.
Government investments instead should be guided by the principles of public finance, which imply that governments should invest only in public goods that have the highest- yielding benefits.
Perhaps the best way to understand this implication for government investments is to look more closely at what is meant by a "public good."
A public good is one that by its very nature all people consume or one that has external effects. Police and fire protection that promote the safety of a community are an example of the first type of good, because providing the safety for one person in the community does not reduce the amount of safety going to another. Education is an example of the second, because education has benefits to the general public as well as the individual receiving the education.
Most goods do not meet these standards and thus qualify as private goods.
More than 200 years ago, Adam Smith argued that the marketplace, free of government intervention, was the most efficient way to produce private goods. Contemporary economic history, such as the decline of socialist economies in Eastern Europe and the success of market-oriented economies, lends considerable support to his views.
But even Adam Smith recognized that markets will fail to produce the right amount of public goods--too little, for example, in the case of education.
Thus, a key economic role for government is in ensuring an adequate production of public goods. Economic impact studies are not the right tool to help them do that. They make no distinction between public and private goods, and they make no attempt to find the investments with the highest public returns.
In practice, economic impact studies seem to justify government funding for almost any business. They often show that investing government funds in a business has a multiplier effect on the rest of the local economy of three to five times the original amount. Because of the additional taxes generated, these studies often conclude that any public investment in a private business helps to pay for itself.
But while some argue that Target Center has public benefits, such benefits pale by comparison with the public benefits from spending the same amount of money on traditional public goods. Before funding a sports arena, the public should also know the return to the community from investing in schools, roads, housing for the poor, crime prevention and a host of other public goods that many complain are underfunded.
Those who concede that the public benefit from funding Target Center may be small still argue that the impact on the local economy of closing it is too great. If this were true, however, private businesses in the area that stand to gain from keeping the arena open would surely be willing to invest in it, making the need for any government investment moot.
Since no such coalition has stepped forward, the market has obviously rejected the arena as unprofitable. If this is a bad investment for the private sector, it is also a bad investment for the government and a misguided economic development strategy.
Indeed, if economic development is the only issue here, Minneapolis should consider the tax impact of not funding Target Center. The lowest possible tax environment, other things equal, always proves to be the best economic development strategy.
And the city does not need an economic impact study to come to this conclusion either.
Arthur J. Rolnick has been with the Minneapolis Fed since 1970.