State economic development programs needed expense or just wishful thinking?

David Fettig | Managing Editor

Published December 1, 1989  | December 1989 issue

Economic development, it seems, is a state of mind.

In October, Newsweek magazine referred to the Dakotas and Montana, among other states celebrating their centennials, as "America's Outback," adding grimly that "the promise of 1989 is far bleaker than the promise of 1889."

However, just two weeks earlier, the Bismarck Tribune, North Dakota's capitol city daily, ran this optimistic headline above a special section: "The sky's the limit as North Dakota maps the next 100 years."

Meanwhile, two Rutgers academics maintain that the development of the Great Plains states-including much of the Ninth Federal Reserve District-was a mistake and the land should be turned back to the buffalo. (See Articles on the Great Plains for their latest essay on the matter, along with a rebuttal from a Minot-area farmer.)

Plains defenders, however, predict a rural renaissance in the coming century as people grow tired of the crime, pollution and traffic of expanding urban areas.

Can states control their economic future?

Underlying these scenarios-whether bleak or hopeful-is the question of whether states can control their futures through economic development programs. Every state in the Ninth District, as well as every state in the nation, has an economic development program consisting of loans, grants, foreign trade consulting, venture capital, tax credits or industrial revenue bonds. Millions of state government dollars are invested annually in new or expanding businesses for the express purpose of creating or retaining jobs.

Opponents of such programs say the forces of national and world markets will shape the future of states' economies. Besides, they say, most state programs don't actually create wealth, they only move it around—with no net gain. Critics also say that the money could be better spent, for example, on education and the infrastructure. Proponents, on the other hand, say the long-term benefits of increased jobs outweigh the initial costs of the programs. Reflecting that view, nearly two-thirds of the respondents to the recent fedgazette Poll want their state governments "to be actively involved in recruiting, financing and targeting economic development."

Additionally, many state officials believe economic development programs are necessary to overcome barriers—such as credit availability—that keep small, inexperienced or remotely located firms from fully participating in the economy. Those barriers are often called "market failures."

A zero-sum game

For some economists, however, market failures aren't so obvious. Michael Stutzer, professor of finance at the University of Minnesota and former Minneapolis Fed economist, said people often make assumptions about market failures when the reverse is usually the case. For example, he said that just because a small rural town is affected by a dwindling economy doesn't mean the free market has failed; rather, it means the market may have simply resulted in other solutions.

Sometimes states will openly court businesses from neighboring states, and, in some cases, states may try to keep businesses from leaving. But Stutzer maintains that states' attempts to get the best of each other are ultimately ill-fated.

"Jobs and buildings may merely be shuffled among states engaged in a game of robbing Peter to pay Paul—where Paul also robs Peter. This is so-called zero-sum game conjecture," Stutzer wrote in the Spring 1985 issue of the Minneapolis Fed's Quarterly Review.

While Stutzer was specifically referring to industrial revenue bonds in that article, he said the same logic applies to other forms of state-sponsored development programs.

"You can't get something for nothing," he said. "Generally the benefits are not worth the costs."

In a recent paper for the State and Regional Research Center at the University of Minnesota, Margaret Dewar, professor of planning at the University of Michigan, said that state economic development programs aimed at non-metropolitan regions rarely affect a business's initial decision to relocate or expand.

Also, her research revealed that those same programs show little or no positive effects for the states that employ them. And, programs that are not aimed directly at distressed areas of a state are used disproportionately in the state's growing regions, "that is, in the regions with the fewest economic problems." However, even programs aimed at specific geographic areas had little positive impact, according to Dewar.

Some say proper programs can work

But despite her paper's findings, Dewar does not completely reject the idea of state involvement in economic development. The proper programs can have positive effects, she said, and if society is willing to pay the costs, then certain programs should be enacted. For example, she said programs providing earned income credits for below-poverty level workers may be effective development tools.

"But if you're a politician, your picture is not on the front page for those kinds of programs," said Dewar, who believes the best way to stimulate economic development is to address issues of poverty—both rural and urban. "I think it's okay for zero-sum to occur if your intention is to help."

In an article for the October 1989 Minnesota Agricultural Economist, Thomas Stinson, Minnesota's state economist, suggested a proper role for government in shaping a rural development policy:

"Two "market failures" are often noted: 1) there may be insufficient information about opportunities in rural communities available to those seeking a site for expansion or relocation and 2) there may be barriers to the free flow of capital to those willing to invest in rural communities."

In addition to the problem of scarce credit and information, Stinson said, state governments may also have to get involved in research and development. There may be cases where government's role in research could lead to the successful development of a new product, Stinson said—a product that may otherwise have been ignored by private industry.

Stutzer agrees that research may—in some cases—be a proper role for government, but he is generally disdainful of government involvement in economic development. Nevertheless, his 1985 Quarterly Review article lists three suggestions for state and local authorities:

  • Subsidization of in-state competitors should be eliminated.
  • Economic development programs should be tailored directly to a particular goal. For example, a program providing jobs for the hard-to-employ may entail wage subsidies, lower payroll taxes or worker-training programs.
  • And, policies to attract and retain residents, rather than firms, may present more effective means for stimulating economic activity.

In general, Stutzer believes government—from the local to the federal level—needs to address such larger issues as the nation's deteriorating infrastructure, its low savings rate, privatization of government services, and educational quality, among others.

"It's much easier to run an economic development program than answer the hard questions," Stutzer said.

All arguments on the relative worth of state programs aside, there may be a more intangible benefit to such programs, according to Tom Helgesen of the Minnesota Department of Trade and Economic Development. Sometimes, he said, the psychological impact of economic development programs and the positive effects on an entrepreneur's state of mind can be as beneficial as the actual economic effects of those policies.

All states in the Ninth District have made a commitment, in varying degrees, to economic development—as the articles in this fedgazette attest. And those states will likely stay in the business of economic development as they try to shape their economic destiny in the 1990s.