Can't have it both ways

Reply from Mel Burstein and Art Rolnick, authors of the bank's 1994 Annual Report ssay, "Congress Should End the Economic War Among the States" to letters received in response to the Minneapolis Fed's special issue of The Region magazine, "The Economic War Among the States" (June 1996), and in response to columns that have appeared in the fedgazette on the same topic.

Arthur J. Rolnick | Senior Vice President and Director of Research, 1985-2010
Melvin L. Burstein | Senior Vice President and General Counsel

Published October 1, 1996  | October 1996 issue

Mr. Buus cannot have it both ways on economic incentives.

On the one hand, he claims that significant credit to the economic turnaround in North Dakota must be attributed to the "wise and targeted use of economic incentives." On the other hand, he states that he "finds it difficult to believe that any well-managed, competitive business would willingly choose to relocate an operation to a more inefficient location simply to collect some economic incentive."

But, if economic development incentives should be given significant credit for the new businesses coming to the state, well-managed firms must have been enticed from locating somewhere else; that is, economic incentives must matter. However, if well-managed firms cannot be enticed, North Dakota's turnaround would have occurred regardless; that is, economic incentives must not matter. Which is it?

In either case, Mr. Buus' remarks only reinforce our views on the effects of economic development incentives and the economic war among the states. From a national perspective, it is counterproductive, and Congress should end this war. And from a state perspective, governments have little choice but to fight this war until Congress brings it to an end.

Consider the case where well-managed firms choose their locations based solely on economic fundamentals. In this case, economic incentives are unnecessary. Moreover, they reduce the tax revenue available for local governments to provide the public goods and services that are the fundamental building blocks of economic development. To provide these goods and services, therefore, local government must either levy higher taxes on existing firms or reduce public spending. Clearly, from both a national and a state perspective, the public would be better off if Congress ended this bidding war.

Next, consider the case where incentives can influence a business's location decision. Now it is even more imperative for Congress to act. For the right price (that is, incentive), even well-managed firms can be enticed to take their second- or third-best location. Here again, from a national perspective, incentives are counterproductive. Clearly no new jobs are created and indeed some jobs may be lost if location decisions are not optimal. In this case, however, fighting the incentive war does make sense from a local perspective because, if a state decides to unilaterally withdraw, another state can cause that state serious economic damage by luring away some of its best firms.

Mr. Buus, however, should not infer that the economic war is rational from our statement that it may be rational for states to offer incentives. From a national perspective, the bidding war is not rational. Indeed, the meaning of the statement Mr. Buss quotes from our essay is lost when taken out of context. To fully understand that statement, he should have added the following: "... even though it is rational for individual states to compete for specific businesses, the overall economy is worse off for their efforts. Economists have found that if states are prohibited from competing for specific businesses there will be more public and private goods for all citizens to consume."

Hence, North Dakota incentives may deserve credit for the state's economic turnaround, but what North Dakota gained some other state lost, and overall the net cost to the national economy was greater than the net benefit. And that is why we recommend that Congress end this war.