Going that little bit further to clinch the deal that sees a large corporation invest in your state or city is largely seen as a price worth paying throughout the US – and increasingly beyond – to the point where the incentives attached to an investment are seen as a prerequisite by corporate decision makers considering where to locate their business. However, as budgets continue to tighten in the post-crisis environment, many local and regional authorities are re-examining their incentive programmes, and some are turning sour on such deal sweetening.
Economic development incentives have for decades been a popular tool for all levels of governments around the world to attract investment. They will typically include giving tax credits and other incentives if a business promises to move, expand or retain its operations in their locale, and therefore provide jobs for the region.
Real cost of incentives
According to Kenneth Thomas, an associate professor of political science at the University of Missouri-St Louis and author of Investment Incentives and the Global Competition for Capital, the cost of such incentive programmes to US state and local governments is between $50bn and $70bn a year. Away from the US, developing countries sometimes pay far more in incentives than developed countries do for a similar investment. In the Philippines, for example, the cost has been estimated to equal 1% of the country's GDP. “Goias state in Brazil gave Usina Canada $125m in tax breaks for a $25m ethanol facility,” says Mr Thomas.
Matthijs Weeink, director at ICA Incentives, a company which tracks incentive programmes globally, says that businesses find it difficult to determine exactly what locations offer and what the incentives programmes are for. “For example, there are some locations with specific research and development incentives,” he says. His firm has developed a subscription online tool to help companies search incentive programmes. “Of course, incentives should never drive a location decision,” he says. “There are many other factors that come into consideration.”
Economic experts are sceptical, questioning if incentives are truly effective at creating jobs and driving economic growth. “There are several aspects of incentive programmes that lead one to be concerned about their ability to generate good returns on public investments,” says Judith Stallmann, professor of agricultural and applied economics, rural sociology and public affairs at the University of Missouri-Columbia.
Moberly in Missouri, a city of some 14,000 people, issued $39m in industrial development bonds to finance a factory for artificial sweetener manufacturer Mamtek, a project that the company claimed would, within five years, create more than 600 jobs with an average annual salary of $35,000. When the company missed its first payment, construction on the factory halted and the city defaulted on the bonds. Consequently, Moberly’s credit rating was also downgraded by Standard & Poor's. Missouri state had also offered up to $17m in state incentives, but nothing was paid because the deal fell apart before Mamtek received the state money.
In a state of flux
Some states are continuing to give out investment incentives despite their economic budget woes. Illinois, for example, currently has a $13bn deficit and a 48% funding shortfall for its public pension. To help fill the gap, state legislatures raised the Illinois corporate tax rate from 7.3% to 9.5% and personal income tax rate from 3% to 5%, under the condition that the increases would expire in 2015. In response, Illinois-based mobile phone maker Motorola Mobility and truck manufacturer Navistar threatened to move out of the state. But they put the brakes on their decision after they managed to obtain a respective $100m and $65m in financial incentives from the state for staying put.
Machinery and engine manufacturer Caterpillar, retail group Sears Holdings and security and commodity exchange owner CME Group have since threatened to leave Illinois too. Sears claims that it will remain only if it receives roughly $15m a year in incentives from the state. CME Group, which operates the Chicago Mercantile Exchange, is demanding fewer taxes on out-of-state electronic trades.
Similarly, New Jersey offered Panasonic $102m in tax breaks for it to relocate its corporate headquarters to Newark, despite the fact the company was already headquartered in Secaucus, 15 kilometres away. Examples abound while other states up their ante to lure companies to their vicinities.
“Companies have more information about governments than governments do about the companies with which they are bargaining, leading to a tendency for governments to pay more for an investment than they need to,” says Mr Thomas.
Wax and wane
In some cases, particularly where packages involve large manufacturers, the incentives are worth the locales’ investment. “There are examples, such as the BMW plant in Greenville, South Carolina, where economic incentives work. It seems the state had a vision of how it fit into the economy of South Carolina," says Ms Stallmann. She goes on to explain how BMW's plant utilised the previously under-used Port of Charleston.
In this case, which dates back to the early 1990s, BMW got $130m in incentives (about $200m today) including tax incentives, road improvements and job training. In turn, the company invested some $2.2bn in the region and created more than 5000 jobs, not counting the thousands more that were created by the automotive parts suppliers and research facilities that subsequently invested in the area.
But success lasts longer than failure. “Therefore, people might have a bias sample in their heads,” says Ms Stallmann. She points to car manufacturer Volkswagen, which opened a plant in Pennsylvania in 1978 after receiving $70m in incentives. It closed the plant in 1988.
“Volkswagen has recently opened a new plant in Chattanooga, Tennessee, with a different business model,” says Ms Stallmann. “When a plant shuts down, it is more quickly forgotten than the successful ones because they are still there to see.”
Holding to account
In some cases, the company receiving incentives is not able to meet the terms of the package conditions. In the city of Washington Court House in Ohio, for example, YUSA Corp, an auto parts supplier, received a $35,000 development grant from the state of Ohio under the condition that it would expand its plant and employ 816 people. When, after five years, the company failed to meet these terms, the state issued a bill demanding some of the grant money be returned.
Other states are now attaching more strings. Wyoming, for instance, requires a company to pay at least 25% of the cost of any infrastructure improvement.
Much of the problem is that most states have not required firms to report data for the state to evaluate what they have done compared to what was promised. “The states themselves do not have centralised tracing of incentives, as they are often given under multiple programmes,” says Ms Stallmann, whose study entitled Economic Development Incentive Programs: Some Best Practices, co-written with Thomas G Johnson, suggests that incentives be tied to meeting specific goals. “If a company does not meet those targets, then it does not get the money or has to pay it back.”
An even better route, Ms Stallmann suggests, is to tie investment incentives to public infrastructure. “Roads, bridges, internet connections, water, sewer systems, etc. benefits all firms.” Such improvements also become attractive to other firms looking to relocate, and therefore, the investment feeds on itself.