Reich gave the following keynote address on May 22, 1996, at "The Economic War Among the States" conference, National Academy of Sciences, Washington, D.C.
Let me just begin by saying that early in our century, Woodrow Wilson wrote that "The relation of the states to the federal government is the cardinal question of our constitutional system. Every successive stage of our political and economic development gives it a new aspect and makes it a new question." Now, as we look toward the end of this century, rapid technological change and global economic integration are defining this generation's version of the basic question of federalism. How can we ensure that the division of economic responsibilities across levels of government will provide an advantage, not a handicap, as we struggle to sustain America's magnificent post-war accomplishmentsa broadly shared prosperity?
Now I know that my colleague Alice Rivlin talked to you last evening about the economic challenge, the economic successes of this administration. I won't repeat what she has said, but let me just emphasize one particular aspect of her remarks. That is that although there is much to cheer about in this economy, there is still a challenge ahead. The challenge has a lot to do with skills, with education. Almost everybody will agree that there has been a shift in demand in favor of people with skills and against people without skills. You can see it with regard to the global economy, but even if we did not have a global economy, even if we put up a fence around the United Stateswhich by the way I am not recommendingand do not have any kind of exchange with the rest of the world, we would still see that shift in demand in favor of people with skills and against people without skills, largely because of technological change. Computers are your friends if you have the skills to utilize them and develop the value that you are adding through them, but computers and that kind of information technology tend to be your enemies if you do not have skills. They may simply take away your job.
The federal government has a major role to play, and much of what I have done and the president has done and others in the administration have done over the last three-and-a-half years, has been to shore up, make more efficient, make more targeted, make work better the federal role in education and job training. But let's be clearthe states, with regard to education, have the bulk of the responsibility as to locales. Approximately one-third of appropriations go to education, and if you include higher education, not just K through 12, you get almost in some states up to 50 percent and many states to about 45 percent of state appropriations dedicated to education in some sort or another. With regard to the federal role, only 8 percent of the total $369 billion tag that we spend as a nation for educationhigher education, K through 12, job training every yearonly about 8 percent is attributable to the federal government.
Bidding wars that are initiated or conducted by companies or joined in by states or localities can have a pernicious effect with regard to undermining the abilities of states and locales to use their resources to educate and develop the human capital of their workforces. I know that in the information you received for this conference, you have many examples. Let me just point out a couple that come to mind and that I included in my prepared remarks because they seem to me to exemplify some of the problems. If I'm offending anybody here, I apologize in advance.
Tennessee, for example, rightly celebrated when it won the competition for General Motors' huge Saturn plant, but last year, the plant's school district reported that it was 100 classrooms short of what it needed to meet minimum state standards. In the background materials for today's conference, Melvin Burstein and Arthur Rolnick of the Minneapolis Federal Reserve reported that one city had closed 11 schools while assembling an incentive package for a football team. Now even if you're a football fan, there is something perhaps a bit repellent about that kind of trade-off.
The point that I want to make here is that there is increasingly an irony that we have to struggle with when we talk about the development of human capital in this country, and we also, at the same time, recognize the reality of these interstate bidding wars. In fact, let me point to two ironies. One irony is that increasingly states and locales, in order to attract for the long term the kind of business investment that will raise wages, those states and locales have got to invest in the skills of the people living in that area. They also have got to invest in infrastructure. After all, states and locales are engaged in an international contest, not just a national contest but an international contest to attract investment capital to them. As you know, there are, generally speaking, two different ways in which states and locales can bid international capital to them. They can either say come hither international capital because the cost of doing business here is so low relative to the cost of doing business elsewhereyou will make a profit. Come hither international capital because we have such low taxes. We have such minuscule regulations because the cost of labor here is so low you can make money. The problem with that technique for attracting international capital is that there is likely to be some place else around the globe that can always underbid you in terms of lower wages, lower regulations or less regulatory burden, and also lower taxes. The other problem with that technique is it doesn't lead directly or sometimes even indirectly to higher-wage jobs.
The other technique for bidding global capital to your jurisdiction is to say come hither global capital because we have such a terrific workforce, and we have such great infrastructure that our skills and our infrastructure combined with your capital can generate a high return. Now, that second technique is a technique which, I believe, can lead to higher-wage jobs. By stylizing these two techniques, I don't mean to suggest that these are mutually exclusive. It is a continuum that most jurisdictions use a little bit of both, but the emphasis, it seems to me, must be on the latter. Come hither global capital because our skills, our infrastructure, the quality of life here combined with your capital can generate a high return. But you see the irony.
If by the same token, you are underminingas a jurisdiction you're undermining your tax base by giving away subsidies, giving away tax abatements in order to get global capital to come therethen you may find yourself with less funds with which to invest in education and training and infrastructure and other aspects of quality of life. So that's irony number one.
The second irony has to do with the private sector. As I travel around the country, I'm struck by the number of businesses and business leaders that tell me over and over again, "We need skilled people. We are concerned about the educational system." In fact, they say to me very proudly, "We as a company are working with our local schools. We are giving the schools management assistance. We are giving the schools computers. We are trying to help the schools in this region or in the state or even nationally to set educational standards." I'm delighted that the business community is doing that. I commend the business community for doing that, but at the same time, sometimes precisely those same businesses are conducting, wittingly or unwittingly, bidding wars which undermine the tax bases of jurisdictions and make it less possible for those jurisdictions to finance their public schools, to finance advanced education, to provide the infrastructure necessary to attract businesses. So businesses may be engaging, perhaps unwittinglylet's give them, for the sake of the argument, the doubtthey may be unwittingly engaged in a process in which with the one hand they are trying to improve the local schools, but simultaneously the chief financial officer may be engaging in a bidding war which undermines the local tax base, makes it more difficult for the local schools to succeed.
How do we get out of this dilemma? How do we reduce these kinds of zero-sum contests? And I know and understand that you've been talking about what is a zero-sum contest and at the margin there are some difficulties in distinguishing zero-sum from positive-sum and we can get into that in our discussion. But how do we discourage what are clearly zero-sum contests? Number one, and it has been tried with some very limited success, interstate compactsbasically states coming together and trying to agree that they will not engage in those bidding wars. I was involved in one such compact. Years ago the city of New York and the state of New Jersey and the state of Connecticut joined together with much pomp and circumstance in a beautiful room. I remember it was a ceremonial hall and everybody signed these papers and everybody committed that they would not engage in bidding wars for the same businesses. And after all, at that time, it's probably much higher now, at that time New York was spending about $500 million in tax abatements and subsidies, New Jersey and Connecticut between them spending an estimated $300 million a year in the same bidding warstrying to get the same companies. We looked upon this magical parchment as a means of suddenly overcoming these bidding wars and liberating maybe $500 million or $800 million a year for investments and education and infrastructure and all sorts of things that would improve the attractiveness of the region to global capital for high-wage jobs.
Well, that particular agreement lasted, I believe, four days. Why did it last for four days? Because let's be clear about the politicsonce bidding is commenced, it is very difficult for any mortal politician, mayor or governor, to not get engaged with the bidding because the possibility of losing jobs in a highly visible way, or the possibility of getting a company to move to your jurisdiction in a highly visible way, raises the political stakes enormously. Once the bidding has begun, politicians almost invariably have to get into the bidding and that is a political fact of life. And from the standpoint of individual jurisdictions, the bidding can almost be justified economically because, after all, from the standpoint of the individual jurisdictions, the tax abatement or the subsidy may be more than paid for by the tax revenues generated. From the standpoint of the region as a whole, howeverNew York, New Jersey, Connecticutor from the standpoint of the nation as a whole, however, it is nothing but a zero-sum game. Resources are moved around, Peter is robbed to pay Paul, jobs are moved around, but there is very little evidence that anything is added to the region or added to the national economy. So, the bottom line for me on compacts is, yes let's try, they are worth trying. They are very difficult to maintain. They are very difficult to preservenoble idea, good intentions, but hard to police.
Number two possibility. You may not realize it, very few people realize it, but right now the federal government provides a lot of money to the statesnot only block grants but also formula funding. Much of that money carries with it a restriction that says, in effect, this money cannot be used in interstate bidding wars. This money cannot be used simply to attract a business from another state. In fact, much of the grant money that the Labor Department provides, for example, the Job Training Partnership Act money, which is formula funded, carries with it a prohibition on using that money in interstate warfare, in interstate rivalry for economic development or for any other similar purpose. Now, as the federal government moves toward more and more block grants, and if you spend any time on Capitol Hill at all, I spent some time yesterday, I plan to spend at least an hour this afternoon, block grants are in the air. They are very fashionable. There will be more block granting of some sort. As we do more block grants, we have to be very careful that we not open doors to more zero-sum contests. Because as you know, everybody in this roomand we can talk confidentially, can we not? We're all in the same familywhat is described as economic development sometimes degenerates into zero-sum warfare.
We have a bill on the Hill right now. I'm paying very close attention to it because it, in principle, does some very important things. It consolidates all of the federal job training programsall of the 70-odd federal job training programsinto one pool of money. We are very eager to see this pool of money be dished out to individuals, not to states, but to individuals in the form of vouchers that they can use if they lose their job, to attend a local community college, for example, on the terms that suit them. We are not terribly eager to have this money simply go to states in the form of block grants, because there's no reason to suppose that federal civil servants or state civil servants are more or less competent to discover what people need and when they need the training. Particularly, there's no reason to suppose that state civil servants are more competent using federal dollars to provide people with training than federal civil servants are at using federal dollars to provide people with training. So a voucher system makes a lot of sensewe create a market. The problem for us, however, is that there is a lot of resistance to that idea, and the bill that is now in conference at this moment is heading in a direction that I think probably is not a good direction. Not only is it a block grant but it would enable the states to use a substantial part of that job training money for "economic development purposes." Again, in the family here, among us, we know where some of that money is likely to go. It's likely to go to interstate bidding contests for attracting or keeping businesses, not to job training, not to individuals, not to improving the skills of people but into interstate zero-sum games.
The bottom line here, let's be very careful as we move to more and more state responsibility, as we move to devolution of federal responsibilityand that is not necessarily a bad thing. In fact, I think there are a lot of good reasons to do that. Let's be very careful that we are not inadvertently providing the ammunition for more interstate bidding wars which again simply create more possibilities for zero-sum games.
Well, what about the federal government itself. Could the federal government, and I know this is on your agenda, could the federal government simply pass a law that preempts state bidding? It seems to me that it would be very difficult to do that. I am not a constitutional expert, some of you are. You have better ideas than I do about whether the Constitution does permit this. I think it would be very difficult for the federal government to do that politically. Certainly in the current environment I don't see any likelihood that the federal government could do that, but I also think it would be very difficult to do that because it would be hard to determine precisely what is an unwarranted state subsidy or tax break. I can imagine the federal courts crowded with very subtle judgments about where the federal government could preempt, how it could preempt, what it is preempting and why it is preempting. I don't want to rule that out as a possibility. Some of you may think that, that is indeed a very easy and appropriate thing for the government to do. I just want to sound some cautionary notes on that.
Finally, let me say that there is an issue here of corporate responsibility. It is not just a matter of government responsibility, it is also a matter of corporate responsibility. Now, many companies these days, when I ask them, why are you laying off workers even though you are making a lot of money? Why are you paying your executives so much money that it creates bad feelings among your workers, it reduces the sense of team work? Why are you leaving your communities? They tell me, the CEOs, "We have to. The market is making us do it." Well, it is difficult to sustain that argument while at the same time engaging in political lobbying to get tax breaks and subsidies. It's not that the market makes you do it. It's not as if you are somehow justifying what you're doing by some abstract free market. You are actually entertaining and entering the political thicket. You are asking for political favorspolitical favors which many of your competitors will not be able to get. You are, in effect, sometimes distorting the market. You are putting some of your competitors at a competitive disadvantage because they are unable to get the same largess from government. You are, in effect, running counter to what the market might otherwise dictate. So, there may, and I use this word very advisedlyvery subtlythere may be a bit of hypocrisy going on here with regard to this issue of corporate responsibility. If you really are going to play by market rules, if you really believe that you have no choice, then abide by market rules. Don't enter the political thicket and start instigating these kinds of bidding wars. These tax abatements, these subsidies, can be the most insidious forms of corporate welfare because they are difficult to see at the state and local level, unlike some big federal government giveaways, because they do put competitors at a competitive disadvantage if they do not get the same largess, because they rob local jurisdiction and states of the resources that they otherwise might have to invest in people and in infrastructure, and because they are often, in the classic sense of the term, zero-sum games in which jobs are simply moved from one place to another, and there is not a net improvement in job growth or in the quality of jobs.
The Articles of Confederation, our first draft at nationhood, left the separate states in control of commerce, including international trade. In 1783, the Pennsylvania Legislature predicted that the "exercise within the States of the power of regulating and controlling trade can result only in discordant systems productive of internal jealousies and competitions, and ill-calculated to oppose or counteract foreign measures ... ." And indeed, other countries quickly learned that they could play states off against each other to get the best possible deals on trade. The spectacle of weakness through division, state against state, led Thomas Jefferson to write in 1785 that the "interests of the States ought to be made joint in every possible instance, in order to cultivate the idea of our being one nation." And so they were, in the magnificent Constitution of 1789 that curbed commercial rivalry among the separate states in the name of promoting their common welfare.
As Supreme Court Justice Benjamin Cardozo said in 1934, our Constitution "was framed upon the theory that the peoples of the several states must sink or swim together, and that in the long run prosperity and salvation are in union and not division." Precisely. As you continue your work today, I applaud you for your effort to advance the conversation about how to ensure prosperity and salvation in the long run, through union, and not through division.