Free to Move: The Economic Foundations of the States’ Bidding War for Business
In putting together a series of candidate workshops earlier this year(whichis still running) under the heading “Reconceiving Minnesota Conservatism,” I wanted someone very good to lead a session on this question: What ought states and localities do when businesses, in essence, demand ransom in terms of tax breaks and other deals in order to move there or perhaps just stay put?
“You want Richard McKenzie for the workshop,” said Ian Maitland, my American Experiment colleague. He was right, as is clear in this excellent paper by Professor McKenzie, “Free to Move: The Economic Foundations of the States’ Bidding War for Business,” written for the meeting.
Dr. McKenzie, who holds the Walter B. Gerken Chair in Enterprise and Society at the University of California, Irvine, is a remarkably prolific economist, whose next-to-most recent book, Quicksilver Capital: How the Rapid Movement of Wealth Has Changed the World, was one of the reasons Dr. Maitland suggested him.
Plenty has been written, of course, about the communications revolution and the instantaneous flow of information. Likewise, much has been said about the growing importance of trade and its power to blend the world’s economies. But save for Quicksilver, which Dr. McKenzie wrote with Dwight Lee in 1991, much less has been written about the fast — often at the speed of light — flow of capital, by which is meant man-made means of production.
It’s in this frame that Professor McKenzie considers my hostage-taking question, along with related matters of pivotal interest to Minnesota leaders in and out of government — for example, the fundamental importance of job destruction in the service of job creation.
Let me briefly tell you one thing he doesn’t say. His very strong free-market views notwithstanding, he doesn’t say that states and other units of government should never get into bidding wars for businesses — or, presumably, airline maintenance bases and basketball arenas.
Rather, he argues that since fast-moving capital and wealth lead ineluctably to increased competition of all sorts, it stands to reason that governments, too, are compelled to compete more vigorously with each other in a great variety of ways. For instance, not just when pitching for businesses
directly, and not just in keeping taxes low and regulations reasonable overall, but governments also are obliged to compete with one another in areas such as education and other public responsibilities. This leads him to say very welcome things about school choice specifically and the privatization of governmental activities more broadly.
But over and above, what he says about head-to-head-to-head contests among governments for new businesses is just about what the good sergeant on “Hill Street Blues” used to tell his troops every morning, “Hey, be careful out there,” as government has a tendency to make matters worse, not better. Or more fully, given the new demands of the game: “Hey, be careful out there — but be careful boldly.”
In addition to several hundred essays, columns and other pieces, Richard McKenzie is the author of upwards of 20 books, with his most recent volume just out: America: What Went Right in the 1980s. And in addition to the University of California, Irvine, he has taught at the University of Mississippi and Clemson University. He also currently serves as a scholar at the Center for the Study of American Business at Washington University in St. Louis, and at the Cato Institute in Washington, DC.
Professor McKenzie received his B.A. from Pfeiffer College in North Carolina; his M.A. from the University of Maryland; and his Ph.D. from Virginia Tech. A native of North Carolina, he grew up at the Barium Springs Home for Children (which I hope is the subject of another paper that he might consider writing for American Experiment). He lives in Irvine with his wife Karen Albers McKenzie, and is the father of four children ranging in age from 5 to 24.
It was a great privilege to meet and host Dr. McKenzie earlier this month, and an equal one to share this essay with you.
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I welcome your comments.
Mitchell B. Pearlstein
One of the most profound, albeit obvious, observations that can be made about modern business is that American business is no longer just American. Neither is Japanese business simply Japanese, nor German business, German. As never before, business has no nationality. Business is business, something that is done increasingly without regard to the nationality of markets and with growing disregard to the borders that divide one political subdivision from another.
Not too many years ago, “Made in America” and “Made in Japan” labels were instructive. They told buyers where the merchandise was produced. Not any more. Such labels today are probably more misleading than they are informative, mainly because few products are made solely in America or Japan. They are made no place; at the same time, they are made everywhere.
It is a safe bet that any product with a “Made in America” label is only partly made in this country, a fact that means it was also partly (perhaps, mostly) made elsewhere in the world. It is also a safe bet that visitors who pass through the annual Detroit automobile show cannot identify where most of the cars on the floor were produced. Cars that carry Japanese names — for example, Honda — are produced in the United States. On the other hand, cars that carry American names — for example, Buick — are produced in other countries, such as Mexico. Even when visitors are able to identify a car’s country of origin, it is another safe bet that many will not know that a substantial share of the parts of the “American” or “Japanese” cars was manufactured in various places around the world.
The plain fact of modern business is that “national economies” are no longer what they once were, patches of color on a globe with clearly defined boundaries. They are no longer national; rather, they are transnational. If a geographer were to try to redraw the globe with economies of the world outlined, he or she would likely produce a globe that would look more like a marble with the colors running and fusing with one another across the surface, or perhaps a sphere covered with overlapping spider webs that crisscross the national economies of old.
These simple introductory points bring into focus a fact that is all too easy for government officials to overlook, ignore, or even to wish away: The political world must adjust to the new world realities, which include global economic forces that are beyond the control of any single national government, much less the control of any single state or province. The integration of national economies on a global scale is the consequence of two powerful forces afoot. One force is widely discussed — the international trade flows, imports and exports. The other force is not so widely discussed but still is probably the more powerful of the two — the international flow of capital. This latter force can be summed up as the freedom to move, in and out of governmental jurisdictions.
The new economic tension
The world is facing a growing tension between political and economic spheres: Politics remain land-locked, dependent on what happens within a defined space on the globe. For example, the health of Minnesota’s government — its ability to provide services to its citizens — depends on the amount of business that is done within the borders of the state. The same is true of every other state, from California to New Jersey, and it is no less true that the health of the U.S. government is tied to the business that is done within the 50 states.
Business, on the other hand, is footloose, no longer tied to any given piece of land, or defined space on the globe. When many of us were in college, we heard our professors endlessly remind us of the three most important concerns in doing business: “Location, location, location.” For a growing share of state, national and world business, that refrain has lost much of its weight. Much world business can be done — is done — even must be done — independent of location, or at least with location carrying far less weight than it once did.
I daresay that only a minor fraction of the business that is now done in Minnesota must be done here. Much Minnesota business can be done at any number of locations in the world, and some of the most valuable business can be done on boats or at 30,000 feet in the air, by way of completely equipped offices which can be carried in a brief case.
The implications of this new world reality for landlocked governments are stark: Democratic politics and policies are now being controlled, as never before, not by ballot boxes but by footloose capital, what my colleague Dwight Lee and I have dubbed “quicksilver capital”: The capacity of capital to easily move from place to place — from state to state, and country to country — at the touch of a few keys on a computer, at the cost of a telephone call, and literally at the speed of light.1 The power of world capital represents a serious challenge to the sovereignty of governments of all sizes and political persuasions precisely because of its size and importance to prosperity.
The flows through the world’s money market on a daily basis equal the entire flow through the U.S. federal government on an annual basis. As Walter Wriston, former CEO of Citicorp, has mused, “The enormous flow of data has created a new world monetary standard, an Information Standard, which has replaced the gold standard and the Bretton Woods agreements. The electronic global market has produced what amounts to a giant vote-counting machine that conducts a running tally of what the world thinks of a government’s diplomatic, fiscal, and monetary policies. The opinion is immediately reflected in the value the market places on a country’s currency.”2
The growing tension between landlocked governments and mobile businesses is showing up in a variety of ways: In budget deficits which are difficult to cover with tax increases; in radical education reform proposals; in deregulation and privatization movements; and in bidding wars among governments for businesses for the jobs and capital they carry with them. Governments are being forced to rethink and reinvent themselves, because businesses have done so, and businesses have had to reinvent themselves because capital has been reinvented.
Escalating capital mobility
The reasons businesses have been able to reinvent themselves are many. Surely land, which governments oversee, has become less important in production. However, a far more insightful way of reckoning with the change is to recognize that capital, by which is meant man-made means of production, has become far more mobile, far more capable of moving from one place to another, of bounding over national borders. And the growing mobility of capital is attributable to several factors.
First, as suggested, cleared and cultivated land once represented a more significant share of a businesses’ capital, mainly because firms were, to one extent or another, dependent on land for production of crops. Land was and remains, for the most part, immovable.
Second, plants have always been capital, but plants, on average, have become smaller, both in terms of floor space and in terms of the number of workers employed. Many forms of equipment have also been made much smaller, even miniaturized. At the same time, the productivity of plant and equipment has continued to mount. With less to move and fewer workers to leave behind, firms are simply in a better position to pick up and move away (or move in, depending on perspective).
Not too many years ago, we all were dazzled by the power of mainframe computers. Today, the power of those mainframes can easily be fitted into a laptop computer. It is not at all unreasonable to speculate that, if current trends continue, the power of supercomputers will be encompassed in computers that can be worn as watches, if not rings. Today, researchers can buy a CD-ROM disk with the full texts of 1,700 books inscribed on it. Tomorrow, they will be able to buy CDs with 10,000 volumes recorded on them. The point is that everywhere one looks — things, capital — are getting smaller, lighter, and more transportable.
Third, in order to be in a position to move and to be able to flex with ever-changing market conditions, many firms have sought to reduce their expected pay-back period on projects before they undertake investments. They also have sought to greatly reduce the development period for products, recognizing that the old adage — “the early bird gets the worm” — is probably truer today than ever before. The moral is that firms have positioned themselves to be mobile, to get up and leave when conditions warrant it
Fourth, whole businesses have downsized, shucking hundreds of thousands of workers who, because of a growing list of “mandates,” have become a form of fixed cost. Businesses have become “mean and lean,” a phrase intended to convey the message that they have restructured — even reinvented themselves — to be flight-prepared, ready to move with ever-charging market forces.
Fifth, as evident by the recent waves of buyouts and takeovers, the resale markets for whole businesses, not only individual plants and product lines, have become more organized and fluid, with the net effect being that owners do not need to tie their capital to given facilities in given locations. They can sell and move, with the improved resale markets implying that the moves can be made at less cost.
Sixth, and perhaps most important, capital has gone through a metamorphosis of major proportions. Not too many decades ago, capital was epitomized by steel and concrete, and huge factories. Belching smokestacks were capitalism at its finest. This “old capital” was then much like a caterpillar on a large spring leaf, fat and happy, maybe a little sassy.
Factories made of steel and concrete still dot the landscape, but their economic dominance seems to be more a feature of the underdeveloped, or rather miss-developed, economies of Eastern Europe than of the Western world. The caterpillar has turned into a butterfly. The critical assets of companies are no longer steel and buildings. They are more often than not the information and the brainpower at the companies’ disposal for creating the quintessential company asset — good ideas for doing things better, faster, cheaper and more profitably at the most favorable location on Earth (and it won’t be too long before we can add, “in space”).
These new, largely intangible forms of capital — information, brainpower, knowledge, good ideas and creativity — are the most flighty and elusive forms of all. They can be sent around the world at modest cost and at speeds that make jets seem slow. They can even be sent in all directions at once with the cost of their transportation varying little with the frequency with which they are sent out and the distance that they are moved.
Almost daily, we hear or read reports about the thousands of illegal and undocumented immigrants who in the dark of night steal past the guards who patrol the southern borders of the United States. The reporters don’t seem to realize that millions of undocumented foreigners slip past the border guards in broad daylight every day of the year. These hordes of undocumented immigrants are welcomed with outstretched American checkbooks, and few rouse any concern. How do they come in? The new-fashioned way — that is, electronically, along rapidly expanding communication networks that extend to the corners of the globe. Many come by way of phone calls, and others by way of faxes. The largest proportion probably enter the U.S. market via personal computers.
When American employers hire workers in Ireland or Barbados to do the computer work that is sent to them by overnight courier or electronic hookup, those workers enter, de facto, the American labor force. Similarly, a German or Japanese engineer who calls contacts in the United States to solve a problem or to plot strategy for a new computer chip or factory has slipped by American border guards. These workers may not have a corporal presence here, but their brains certainly do. They mix and mingle with American resources for productive ends, just as surely as they would have had if they had acquired green cards and flown in.
Partisans in the immigration and related policy debates this year are still mired in the mind of bygone centuries, during which a person actually had to move body and soul into another country to work there. Little do they know that times have changed — dramatically.
The brainpower that flows into this state and country on a daily basis is not material in the literal sense, but it is no less important to value-added production than is steel and concrete. Indeed, given the relative prices paid for good ideas and the dedication of firms to producing them, it appears that the economic value of those ideas far exceeds the economic value of steel and concrete.
Changing government’s mindset
There are good reasons for government officials to recognize the changes in the nature and mobility of capital. First, businesses must be mobile — by which I mean prepared to move to the most cost-effective location for production in the world (not just the state or nation), and they must stay alert to changing opportunities. Businesses know that if they do not seek out the most cost-effective location, then their competitors surely will. To remain inattentive to relative cost conditions at home and other places is to risk loss of market share, if not demise. Government policymakers can no longer relax with the thought that they have their capital, and continue to develop policies without fearing the loss of what they have.
Second, officials must realize that their policies can substantially affect the amount and type of capital that is created in a given jurisdiction as well as that which remains and expands in that jurisdiction. Much has been made in recent years about the extent to which the emergence of the global economy has forced American business to become more competitive, meaning they can no longer price and develop their products to meet national standards; they must meet the highest standards in the world, which is a demanding order. Little has been made of the fact that the global economy has had much the same impact on governments at all levels, although many governments appear resistant to thinking differently about policies they adopt.
Because of the increasing mobility of capital, landlocked governments have been thrown into a competitive fray for the world’s capital stock. In order to attract capital and keep the capital they have, they must begin to think, as never before, competitively.
Politicians and policymakers have always had a political worry that their actions would cause the voters to turn them out of office. They now have an added economic worry: That their policies will cause the capital in their districts to get up and move and will cause emerging capital to go elsewhere. Politicians and policymakers must realize that the growing mobility of capital translates into an increase in the responsiveness of capital to policies — whether in the form of taxes, expenditures or regulations and mandates — which are unattractive or unduly onerous to business.
Decades ago when capital was tied to a place, governments could be complacent; they could treat the capital in their jurisdictions — the plant and equipment, concrete and steel, that might stretch for miles — as if they were fiscal oil wells, something that could be tapped, taxed and drained more or less at will. That is no longer the case. Capital no longer has to sit there and take it; it can move away.
Therein lies a tightening economic constraint on the fiscal and regulatory authorities of governments, as well as on political/democratic decision-making. Therein lies the overwhelming reason governments around the world were forced in the 1980s to rethink their approaches to doing business with business, to realign their taxes and regulations, and to become more congenial to business.
The Reagan-Thatcher phenomenon
In many people’s minds, Ronald Reagan and Margaret Thatcher were directing world events during the 1980s by redirecting their countries’ economic policies. Their critics charge that during the 1980s, the “blind” were leading the “dumb.” I disagree, but not for reasons others give. In my view, it is far more accurate to say that Reagan and Thatcher were responding to economic forces footloose in the world. They somehow heard the clarion call of escalating capital mobility on an international scale and intuitively, if not explicitly, understood that the phenomenon ultimately meant that they must enable businesses in their countries to become more competitive by making their countries’ policies more competitive.
If the move toward market-based solutions for social problems in the 1980s had been limited to the United States and the United Kingdom, the critics’ charge that it was “all Reagan’s and Thatcher’s fault” might be given credence. However, the movement was world-wide, stretching from all of Europe to Australia to New Zealand and back to Chile. And from the United States to Poland and the former Soviet Union, covering the full ideological spectrum from highly capitalist economies to fully socialist ones.
In my view, many governments have not yet fully faced up to the fact that the world has changed; that they, governments, do business within a given parcel of land. On the other hand, businesses do business — must do business and can do business — on most any parcel of land. All the while, they, businesses, must treat governmentally imposed taxes and regulations as any other cost of doing business and must respond accordingly; that is, move elsewhere if governmentally imposed cost conditions warrant it.
What does that critical observation mean for governments? For the state of Minnesota and for the cities of Minneapolis and St. Paul, among others? In general, the observation means that governments must realize that their role is one of “greasing the skids” for businesses which operate or might operate in their area; it is one of making sure that state and local policies do not hamper the competitiveness of the businesses which operate inside their borders.
For Minnesota and this community, it is difficult for me to give more concrete advice. Others who actually live here and who do the work of state and city government are in a far better position to say how budget lines and regulations should be reconstituted. However, there is value in recognizing the broad picture of how the world is being reconstituted and then seeking the several implied general rules which will necessarily guide actual policy selections.
First, it is abundantly clear that politicians and policymakers across the land, especially those in Minnesota, must recognize explicitly that governments have become active competitors for the world’s capital base. Having absorbed the meaning of that observation, it is equally clear that politicians and policymakers must change their way of thinking and doing business. In bygone eras, politicians and policymakers could sit around glibly chatting about what they wanted to do, or what their constituents would allow them to do, totally disregarding what other governments in other parts of the country and world were doing. They were free to follow their fondest wishes because capital could not move, except at a snail’s pace.
If an interest group wanted an added tax or a subsidy, the only relevant issue had typically been whether politicians had the votes. Now, they have to think twice, if not three and four times, about such matters. More to the point, they must think competitively, which is something they are not yet used to doing. Politicians and policymakers must, like all good businesses, begin to ask, “What are our competitors doing?” For that matter, “Who are the relevant competitors?” “What will the market bear?” “What is the responsiveness of our customer/citizen base?” “Does the proposal make economic sense” That is, does it make a profit in a well-defined bottom-line or in some broad social sense?
In the end, officials and policymakers must realize that the governments they lead can no longer be satisfied with meeting the best of policy and delivery standards in this state or even this country. They must begin to look around the world to determine who has the very highest standards for government performance and begin to seek to meet those standards. This is because, as in business, governments are in competition with “the very best” in the world for the capital they need. They must seek to lead, not follow, in the policy formulation process. They must realize, at the very least, that the growing mobility of capital necessarily makes cuts in tax rates potentially more attractive.
The new world economic order certainly means that government officials must look long and hard at proposals to raise tax rates, because higher rates can spell a lower tax base and less revenue, exactly opposite of that intended.3 Clearly, if the path of higher tax rates is followed, state and local officials must double their efforts to ensure that expenditures more than compensate for the higher taxes. Regardless, they must temper the extent of their tax-rate increases.
Soaking the rich and redistributing wealth
Washington is buzzing with glib talk about “soaking the rich,” which means making them pay their fair share of taxes (whatever that is), and/or “making businesses pay” for whatever fringe benefit is deemed valued by workers. I suspect that such talk has also been heard in this state and city. Those making the reform proposals don’t get it. They don’t realize that the “rich” are generally rich because they have control of an unusual amount of physical and human capital that can be sent hurdling to other points on the globe if they feel soaked. Moreover, escalating capital mobility means that businesses do not have to pay for the mandates imposed upon them; they can simply pass along the costs of the mandates to their workers in the form of lower pay and other fringe benefits.
In his 1983 book, The Next American Frontier, Secretary of Labor Robert Reich wrote eloquently about how the country desperately needed an “industrial policy,” through which governments would tax some firms in order to help others. By 1991, he had recognized the force of capital mobility on a global scale. In his book The Work of Nations, he retreated from his full-blown industrial-policy agenda, arguing that the country could not afford to tax some firms for the benefit of others. Why? Capital was too mobile. The taxes would drive some firms away, and the subsidies for other firms could easily be transferred abroad. That part of his message was right on target, something everyone should read.
Nevertheless, Reich continued to argue that what we need to do now is raise the taxes on the wealthy, reasoning that people are not mobile. He overlooked the fact that the brainpower and knowledge of what he calls the “fortunate fifth” of the population is some of the most mobile of capital; it can be sent overseas in literally a flash. Clearly, we can still tax those who bring their incomes back home. However, we will have lost in the process the brainpower that is so crucial to a modern economy.
The point that needs to be remembered is that intentionally redistributive policies must be developed with the utmost care. Officials and policymakers must take care to ensure that their efforts are not out of line with policies in place elsewhere, and are designed to effectively serve some noble, broad, social objective, not strictly the narrow interests of those who are on the receiving end of the redistribution. Otherwise, officials and policymakers can expect to find their fiscal troubles mounting as capital moves elsewhere or is created elsewhere in the world.
Those who are concerned about the plight of the poor must realize that there are economic limits to how much society can do for them, given the mobility of capital. Similarly, the poor must realize that there are limits to how much they can expect from the benevolence of governments and those who are not poor.
For that matter, everyone associated with government — all those who draw from government in various forms (me included) — must accept the tightening grip of the economic, as distinct from the political, limits to what governments can do. Hence, every proposed program must be evaluated in terms of the other programs which will have to be given up. To work within those limits, people of all political persuasions must begin to ask how can government services be provided more effectively and at lower cost, not so much because that is a way of reducing government involvement in the economy (which might be helpful), but as a way of government doing more for the benefit of capital — for the purpose of attracting more capital and of inducing the creation of more home-grown capital which will have less reason to leave.
Proponents of privatization of various government services — from garbage collection to the distribution of public housing units to the provision of education — make an important point: Just because a service must be funded by the public treasury, it need not be delivered by public agencies. The proponents’ goal is to make government more efficient by choosing from an array of alternative delivery systems (government included). I share that objective, but I urge that the privatization movement be seen in a broader context, namely as a strategy for making governmental jurisdictions more competitive vis a vis other governmental jurisdictions, and for increasing the likelihood of the existing capital base remaining and additional capital flowing in.
Privatization and competition
In my view, governments don’t have much choice about privatization; they must do it (unless they come up with other possibly more productive strategies for increasing their competitiveness). The proponents and opponents in the debate over school vouchers have both missed an obvious point: Public schools are rapidly losing their privileged monopoly position; they are becoming competitive, as people and capital become progressively more mobile across school districts. The growing competitiveness is vividly revealed in the attention so many people give to the comparative scores on national exams in various states and countries.
We know we have to improve the public education system, or else the country will suffer from a failure to produce the capital of the future and from a failure to attract capital from other parts of the world. American public schools are now having to compete with each other, simply because Americans can move to alternative school districts and many are doing so, with harsh effects being felt by those school districts which have not gotten their education act together.
From my perspective, the only relevant remaining unsettled question in the educational voucher debate is no longer whether the voucher system will be broadly accepted as a part of the country’s education system, but when it will be accepted. It will be accepted. Why? Those states and local governments which seek to prosper by making their jurisdictions more attractive (or less unattractive) to capital will seek the benefits of an even more competitive educational system by overriding the objections of the public education establishment and installing the voucher system. Of course, it may be that the public education establishment may switch to support of the vouchers, mainly because they too can benefit from working and living in a more prosperous economy. At any rate, when some states begin to adopt the voucher system, other states will surely follow suit. They will have to do so in order that their jurisdictions will remain competitive.
Accordingly, Minnesota presented a competitive challenge to the rest of the country last decade by being a leader in instituting public school choice, an experiment that has forced other states to follow suit. Similarly, Minneapolis-St. Paul has issued another challenge to many other communities around the country and world by discarding the traditional bureaucratic management system for public schools and turning over day-to-day operations to a private company whose officials will be paid based on performance. That move was reported in the Los Angeles Times and many other newspapers around the country — for good reason.4 I submit that this state’s experimentation with educational innovation was a direct consequence of reports in the early 1980s of the economic difficulties the state was then facing and may still be confronting (although reviews on the State of Minnesota appear to be mixed) regarding the firms and jobs which are leaving the state.5
At the same time, the very fact that the city and state continue to experiment with new approaches to education should be causing other communities to take notice and ask, “What do the officials in this city know that we don’t know? How will Minneapolis’ actions affect our ability to compete in the world market for capital; that is, plant, equipment, headquarters and jobs?” Indeed, those are the types of questions that people in this community probably had to ask of other communities and that led them to the reforms which have been put in place.
By the same token, in spite of the criticism Wisconsin is having to endure, it has competitively challenged surrounding states (if not all states) by daring to impose — on an experimental basis in two counties — a two-year limit on payments to welfare recipients.6 Other states in the Midwest must recognize the Wisconsin experiment as a two-barrel threat: Wisconsin’s welfare limit can make government (and doing business) in that state more efficient. In addition, because the payment limits may send welfare recipients to other states, the Wisconsin experiment can make government (and doing business) in other states more inefficient.
Regardless of how inattentive they may be, communities all over the world are being led, to paraphrase the venerable Adam Smith, as if by an “invisible hand” toward reforms which are market based, because they are market driven. The power of those market forces may be tempered somewhat, from time to time, by political decisions, but it is certain that they will not be denied.
States and communities (and countries) ought to begin to actively work with those market-based forces, recognizing that ultimate economic security comes from having a more productive and lower-cost venue than can be had elsewhere. This means officials need to rethink their efforts — paradoxically. In the past, they have devoted most of their energies to asking, “How can we create and save the most jobs?” Instead, they should begin to ask, “How can we begin to help business promote cost-effective job destruction?” This, not to kill off jobs for jobs’ sake or to put people out of work. Rather, the purpose should be to ensure that the cost of production is lower than elsewhere in the country and world.
Economic development strategies designed to make firms more productive mean enabling them to operate “leaner and meaner,” which implies fewer workers for any given output level, which, in turn, will inevitably mean, at times, that jobs will be destroyed. Job destruction, ironically, is often times the most effective way to have a healthy growth rate in jobs. Those American firms and industries which have found ways of producing more with less (including fewer workers) should be praised, not damned as they so often are. We all must remember that, historically, job destruction and economic prosperity have always gone hand in hand.
Likewise, government officials often spend all of their efforts trying to attract firms and, where possible, erect barriers (for example, onerous plant-closing laws) to their exiting. They should contemplate the prospects that easing exit barriers can be a way of increasing the emergence and inflow of new business. Firms that must be footloose to meet their competitors in their product markets will not ignore the costs of exiting from markets in their relocation decisions. Also, new firms will consider the costs of closing down in their decisions to expand. In other words, loose talk about increasing the costs of plant closures in order to “save” jobs should not be accepted simply because of good intentions. The former Soviet Union did a magnificent job of “saving” jobs for more than 70 years, and look where its jobs program landed the several republics involved in that not-so-grand social experiment: in the exalted ranks of Third-World economies.
The bidding war for firms
Whenever I’m asked to appear at conferences like this one, and to talk on the assigned topic, I am invariably asked about the current trend of state and local governments to bid for businesses (or plants or jobs). The concern is legitimate. For at least the past 20 years, more and more municipal and state governments have been actively pursuing companies all over the globe that have, in effect, plants and jobs for sale. Governments have been forced to do so. Capital has become crucial to local economic prosperity, and, as has been argued here, capital has become progressively more mobile over the years.
Understandably, firms have begun to realize that they have more than their goods and services to sell; they have their location decisions that can be put up for state and municipal auction. Moreover, many firms realize that their competitors have put their location decisions up for sale, which means all must follow suit or suffer a competitive disadvantage, given that those firms that do sell their location decisions for the price of tax abatements, worker retraining programs, and subsidized loans will have lower costs than those firms that resist, for whatever reason.
Accordingly, a new economic phenomenon has emerged with force since the early 1980s. “Economic development posses” from many communities and states, often headed by governors, are scouring the world for discontented firms that are ready and willing to move and to listen to a “better deal.” At the same time, firms have radically changed the way they make location decisions. They no longer do them quietly for fear that the news will drive up land prices in the targeted sites. Rather, they broadcast their intentions to move in the media with the expectation that government officials will come a-courting, pockets lined with government-backed economic incentives.
Both Federal Express and United Airlines put their proposed maintenance facilities up for sale to the states. Both Indiana and Tennessee had for years demonstrated a willingness to provide incentives for the placement of foreign automobile plants in their states and willingly offered hundreds of millions in tax breaks and subsidies. Although he had been critical of his predecessors’ efforts to attract foreign plants in his 1988 campaign, Indiana Gov. Evan Bayh was, nonetheless, willing to offer United $291 million in incentives in 1991.7
BMW put its proposed U.S. assembly plant up for sale in 1992. After a fiercely competitive battle, South Carolina “won” (if that is the right word), but only after agreeing to provide BMW with keys to its public treasury, from which the automaker will be able to draw at least $130 million in benefits.8 Among the benefits provided, the State of South Carolina agreed to evict 100 families from BMW’s choice plant site and then lease the land back to BMW for $1 a year, all for the purpose of subsidizing luxury car sales.
Not to be outdone, in 1993 Mercedes Benz put its proposed U.S. assembly plant up for bids. As most in this room remember, Alabama “won” the bidding war. I put won in quotation marks again because in order to win the state had to outbid some 20 other states for the plant, agreeing to buy the land on which it would sit (and leasing it back to Mercedes for $1 a year), as well as 2,500 Mercedes vehicles which would be driven by state employees. Alabama also had to pay for a training center for the company’s workers, and then cover the Mercedes payroll while its workers are trained. The state even agreed to put the Mercedes emblem above the scoreboard free of charge during a nationally televised football game between the Universities of Alabama and Tennessee. The total cost of the package: something over $300 million.9
What should communities and states do? The answer is simple: They must join the competitive fray in one way or another. They cannot hold back the force of capital mobility. The genie is out of the bottle, but unlike the genie in Aladdin, this one can’t grant people their fondest wish.
Was the deal the State of Alabama made with Mercedes Benz a good one? Frankly, I don’t know; I have no way of knowing. I was not a party to the negotiations, and I do not know all of the particulars of the agreement or the details of the forecasts on which Alabama made its offer. Even if I had all that information, I don’t know if I could, or would want to, render a judgment. The making and taking of offers often depends crucially on intangible factors; for example, differences in attitudes among competitors and the symbolism of the deals.10 What I can say is that if the deal was not a good one for Alabama, the market will not be very forgiving.
This means that in their search for businesses, communities and states must act very cautiously and judiciously for a number of reasons. The mobility of capital requires that they strike deals that are profitable in the strict sense of that term: The benefits to the states and taxpayers must exceed the concessions which are made. If the costs are greater than the benefits, then communities and states can be assured that the deals they make with firms like Mercedes Benz will make it tougher for governments to provide the agreed-upon benefits. Mercedes Benz might move in, but other capital will move out and still more capital that might have moved there will go elsewhere.
Moreover, it is probably natural for states to think that they can calm the “bidding war” for businesses by “cartelizing” their efforts, by states adopting “voluntary guidelines” that would “de-escalate” the bidding, which was proposed by Illinois Gov. Jim Edgars at the August 1993 meeting of the National Governors’ Association. However, such guidelines will likely be ineffective, mainly because they do nothing to eliminate the competitive pressures. Governors who are willing to sign such guidelines also will be governors who likely will violate them. They will have two worries which likely will render the guidelines ineffective. First, they must worry that some other governor will, above or below the table, violate them. Second, they understand that they are in an international competitive game and must worry that even if states in this country do not make competitive offers, then states in other countries will.
“Fewer jobs the better”
In meeting the domestic and international competition, communities and states must be cautious for another, not so obvious reason. Because of political forces, many of the bidding wars likely will involve large plants with large job bases, and “jobs” per se can become a new form of political currency. When spent by politicians, jobs will be allocated within a state along political power lines, not according to cost-effectiveness criteria. After all, “jobs” have become the raison d’etre for many public policies emanating from the halls of Congress and state capitols.
Firms with a lot of jobs are not always the firms that will be around in the future; many will fold simply because they have lots of jobs to sell (and too little productivity). Popular wisdom notwithstanding, the world economy suggests that the most viable firms in the future will be those with very few jobs. The fewer the jobs, the better, but I suspect that economic development boards have a sharply contrasting rule that guides their searches — which has a way of being translated to the more inefficient, the better.
In addition, we should not be surprised if, when politicians are negotiating for jobs, they look for jobs to be created and saved within their particular jurisdictions and concede greater cost-effectiveness in production elsewhere in order to garner the votes jobs carry with them. I suspect that in agreeing in 1991 to split the location of its maintenance facilities between Duluth and Hibbing, Northwest Airlines was responding, in part or whole, to political, not economic, pressures, as it sought an array of subsidies from the state.11 In other words, I suspect that the politics of the moment will cause many states to make some poor investments.
Communities and states should also remember that most of the job growth in the country is occurring not in large firms (they are all downsizing), but in small firms; those most unlikely to be candidates for special deals and offers by economic development boards. Unless undertaken with great care, bids for large plants can stifle the growth of small plants, primarily because small firms will be forced to cover the costs of subsidies provided to large firms, and because the small firms will be hamstrung in their efforts to compete with the large firms which have secured the subsidies. The net growth in jobs in Alabama will not be equal to the 1,500 jobs which will be available in the Mercedes plant, plus the jobs in satellite industries. It likely will equal that total minus some number of jobs lost in small firms which do not benefit from the existence of the Mercedes plant, but which will be forced to help Mercedes pay its bills.
As stark as these problems might be, there is a more ominous reason that communities and states should proceed cautiously in their competitive battles for plants, headquarters and jobs. Communities and states that by their agreements indicate they are willing to pay firms to move in are also communities and states which should be willing to pay firms to stay and to ensure that they stay afloat when they face financial difficulties.
If the State of Alabama is willing to pay to have 1,500 jobs move in, it should be willing to pay to keep 1,500 from moving out — and profit-hungry firms, with footloose capital being wooed by other states and communities, should be expected to bargain with their governments over staying put. Consequently, communities and states cannot continue to evaluate their agreements with only the particular costs and benefits at issue (as appears to have been the case in South Carolina). They must consider the prospects that they will have to up their payments to keep other firms which threaten to move out.
Michigan has for a long time indicated a willingness to pay firms to move in. That fact obviously didn’t escape the attention of the folks at General Motors, which in 1980 announced plans to close two of its Fisher Body plants in Detroit and replace them with a new $630-million Cadillac plant. Its plant-closing announcement was accompanied with none-too-subtle threats to move the plant out of the city, unless a suitable site could be found. Six thousand jobs were at stake, a fact that caused state and city officials to launch a campaign that ended with the condemnation of a section of the city known as Poletown, encompassing 327 acres, 127 businesses, 16 churches, and 1,753 residences — and the expenditure of literally tens of millions of federal, state and city tax dollars partially for the benefit of GM stockholders.12
As mentioned, in 1992, facing financial dissolution, Northwest Airlines talked the State of Minnesota into providing it with upwards of $838 million of various forms of government support, mainly in the form of low-interest, subsidized loans, for the purpose of building maintenance facilities at Duluth and Hibbing.13 The state also agreed to give Northwest $38 million in corporate-income tax rebates and $7.5 million in rebates of sales taxes paid on construction materials and new equipment, provided Northwest would hire 1,500 workers at the new maintenance facilities and maintain its work force in the state at 18,000.14
Everyone knows that New York and California are having economic difficulties, caused in part by the downsizing in the defense establishment and in part by what businesses see as an anti-business climate. Over the last year, the State of New York awarded over $30 million in tax cuts (each) to security companies Morgan Stanley and Kidder, Peabody when they threatened to move to New Jersey.15 The State of California has been scrambling to slow the out-migration of businesses. Fearful that Walt Disney might cancel its planned expansion of its Disneyland theme park, move it elsewhere, or even close it down, the State of California and the City of Anaheim agreed to make $800 million in infrastructure expenditures that would extensively benefit Disney.
Recognizing that fact, Taco Bell, which is headquartered in my hometown, Irvine, California, has taken note of the willingness of city and state governments to buy firms and to keep them from moving out of town. The lease on Taco Bell’s gleaming office tower in Irvine will be up in 1996, a bit of news which has prompted the company to announce that it is considering a move. No one can be sure how serious Taco Bell is; everyone, however, understands why they are taking bids. The firm wants to make money, and it just might be able to make more money by selling its location decision than by selling tacos. Taco Bell also needs to stay competitive in a fiercely cost-conscious fast-food market, and it must make sure that its market share is not harmed by firms which receive special treatment that Taco Bell doesn’t get.
What should communities and states do? My advice remains: Be very careful. The problem of attracting and retaining business is fraught with more complications than appear on the surface. At the very least, consider the full breadth of the possible bargaining process. Recognize that you are dealing with mobile capital that will become only more mobile as the years pass. If you agree to provide benefits — in the way of direct subsidies or tax abatement — make sure that you have reasonable long-term commitments from the firms. That sounds like obvious advice which is not worth giving, but it is unbelievable the number of communities which worked out deals with firms in the 1970s and 1980s but minimized — or zeroed out — the firms’ commitments to stay and make sure the public’s investment paid off. Communities and states have been playing with fire without ever thinking about the need for hoses.
The new world economic order is for real. Capital mobility is for real. The more intense competition within both the public and private sectors is for real. As indicated by their renewed emphasis on quality and on restructuring and reinventing themselves, American firms are well on their way to full adaptation to their global competitive challenges.
American governments have begun, albeit at times grudgingly, to be responsive to the economic forces at work in the world. What governments need to do is to think anew about the policies which will work effectively to promote the development of the income and wealth base practically everyone wants.
Successful governments will be those which get ahead of the (international) learning curve; which no longer just respond to what everyone else is doing, but which seek to actively promote a local environment that allows businesses to be competitive with the best in the world. As paradoxical as it might seem, the new world order requires job destruction through efficiency improvements, and lots of it. This is a position that doesn’t sit well with many of our nation’s public and private leaders, but it is a position that squares with real-world experience on a daily basis.
1 See Richard B. McKenzie and Dwight R. Lee, Quicksilver Capital: How the Rapid Movement of Wealth Has Changed the World (New York: Free Press, 1991). Many of the empirical claims made in this paper are extensively documented in this book.
2 Walter B. Wriston, The Twilight of Sovereignty: How the Information Revolution Is Transforming the World (New York: Charles Scribner’s Sons, 1992), p. 9.
3 The tie between higher state tax rates and slower economic and job growth has been studied by David L. Littman, “States Tax Constituents Away,” Wall Street Journal, March 8, 1991, p. A10; and Gerald W. Scully, Constitutional Environments and Economic Growth (Princeton, N.J.: Princeton University Press, 1992).
4 Rhonda Hillbery, “Private Firm to Run Schools in Minneapolis,” Los Angeles Times, November 5, 1993, p. A4.
5 See John Herbers, “Costs Cited in Loss of New Companies,” New York Times, April 12, 1983, p. D1; and Harvey Meyer, “Goodbye Minnesota,” Minnesota Ventures, May/June 1992, pp. 21-31. The fact that Minnesota has lost manufacturing jobs may explain some of the interest in Center of the American Experiment’s program (see Peter Applebome, “South Raises Stakes in Flight of Jobs,” New York Times, October 4, 1993, p. A12).
6 See “Welfare Reform, Done Harshly,” New York Times, November 8, 1993 (editorial), p. A14.
7 E. S. Browning and Helene Cooper, “States’ Bidding War over Mercedes Plant Made for Costly Chase,” Wall Street Journal, November 24, 1993, pp. A1 and A6.
8 See Lyn Riddle, “Former Textile Town Draws International Fare to the New South,” Los Angeles Times, August 25, 1992, p. A5; and Doron P. Levin, “What BMW Sees in South Carolina,” New York Times, April 11, 1993, p. F5.
9 Helene Cooper and Glenn Ruffenach, “Alabama’s Winning of Mercedes Plant Will Be Costly, with Major Tax Breaks,” Wall Street Journal, September 30, 1993, p. A2; and Browning and Helene Cooper, “States’ Bidding War over Mercedes Plant Made for Costly Chase,” pp. A1 and A6.
10 As Alabama Governor Jim Folsom told Wall Street Journal reporters, “Because of our image problems, we were continually being written off when people were looking for sites. Mercedes’ decision to come to Alabama is worth billions of dollars in public relations to us. Now I think we’ll be looked at in a different light” (Browning and Cooper, “States’ Bidding War over Mercedes Plant Made for Costly Chase,” p. A6).
11 John Myers, “It’s Duluth & Hibbing,” Duluth News-Tribune, May, 13, 1991, p. 1A.
12 Detroit bought the property for about $200 million ($150 million of this amount coming from the federal government) and sold the property to GM for slightly more than $8 million. See Sheldon Richman, “The Rape of Poletown,” Inquiry, August 3 and 24, 1981.
13 Jeff Cole, “Northwest Lands the Deal,” Saint Paul Pioneer Press, December 12, 1991, p. 8A.
14 John Myers, “Checchi Expected to Solidify Deal with Duluth, Hibbing Today,” Duluth News-Tribune, May 30, 1991, p. 1A.
15 Browning and Cooper, “States’ Bidding War over Mercedes Plant Made for Costly Chase,” p. A1.