The business of luring business

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The Bush administration, in its fiscal 2006 budget proposal, is expected to call for major cuts in the Department of Housing and Urban Development's economic development programs. HUD's 30-year-old Community Development Block Grant, for example -- which the administration considers particularly ineffective -- could see its $4.7 billion budget slashed by as much as 50 percent, according to news reports. Other programs would be transferred to the Commerce and Labor departments.

Rumors of the proposed changes already have triggered sniping from various special interest groups, such as the National Association of Housing and Redevelopment Officials. In truth, however, the shake-up is well founded and long overdue.

The federal government spends tens of billions of dollars every year on economic development projects. In 2001, for example, the figure was $57 billion. State and local governments spend billions more.

Yet, it is not clear these huge annual expenditures, which have occurred for some four decades, have produced long-term measurable benefits.

Dozens of federal agencies are involved, including the Departments of Agriculture, Commerce, Defense, HUD, Transportation, the Appalachian Regional Commission, Army Corps of Engineers, Environmental Protection Agency, U.S. Maritime Administration, and Tennessee Valley Authority. Even the Federal Communications Commission gets involved, with a special "Indian initiatives program" designed, according to the Commerce Department's Economic Development Administration, to bring telecommunications services "to Indian Country." All together, at least 73 different federal programs parcel out economic development funds, while dozens of city, state and regional economic development offices scramble for the money.

The stated purpose of the economic development offices is to attract new businesses and industries to communities, or keep existing businesses from migrating. They offer various inducements, including direct subsidies, tax breaks, grants, loans,and infrastructure improvements.

Economic development programs are widely popular. As Professor Peter Eisinger of Detroit's Wayne State University has observed, there is "extremely broad agreement as to the desirability of substantial government involvement in the creation of private sector employment."

Yet, the sad truth is such programs rarely have lasting benefits -- for the simple reason they counter good business practices.

The programs' most glaring flaw is that they increase a behavior known to economists as "rent-seeking," a euphemism for business efforts to secure government favors.

Businesses pay lobbyists, lawyers and consultants large sums to help them obtain economic development funds. Unfortunately, this makes less money available for higher priorities, such as capital investment.

Besides, when businesses gain government favor -- as Sematech did when it got $40 million from the $295 million Texas Enterprise Fund to help finance an "Advanced Materials Research Center" in the Lone Star State --recipients gain unfair advantages over other businesses, both direct competitors and those competing indirectly for capital and workers.

While grants and subsidies provide recipient companies and the communities where they operate an economic windfall, the benefits don't always last. When the grants and subsidies expire, the new jobs may disappear as well.

Consider Sykes Enterprises of Tampa, Fla., which opened call centers in several states with fanfare and funding from local and state governments. Putnam County, Fla., for example, awarded Sykes $4.5 million in cash and tax breaks to locate a new call center there. The company, meanwhile, made a business decision to start moving its call centers overseas and, after less than five years, closed the Putnam facility. Similar incidents have occurred elsewhere across the country.

The Government Accountability Office (GAO) in Washington has tried to measure the effect of economic development programs using sophisticated econometric modeling. The agency (then called the General Accounting Office) reported nearly a decade ago, in 1996, that it was "unable to find any study" by any reputable organization "that established a strong causal linkage between a positive economic effect and an agency's economic development assistance." Yet, the spending continues.

Unsatisfying as it may be to the many proponents of economic development programs, government can best promote economic growth and prosperity by sticking to the basics: protecting private property rights, enforcing the law, providing basic services, and keeping taxes and regulations to a minimum. It should then do one final thing: Get out of the way and let the economy work.

Arthur E. Foulkes is a research associate at the American Institute for Economic Research in Great Barrington, Mass.