All Commentary
Friday, March 1, 1991

Economic Development or Economic Disaster?

William L. anderson teaches economics at the University of Tennessee-Chattanooga.

In the past decade, Chattanooga’s downtown district has undergone a virtual face lift. Parks have been created, trees have been planted, new buildings have been built, and old ones improved. The city and county governments have constructed a gleaming trade and exhibition center with a high-rise hotel attached, while the Tennessee Valley Authority, a Federally owned utility, built a massive downtown office complex. A city-owned downtown theater was restored to mint condition, recalling the grandeur of 1920s architecture. Construction companies—some owned by blacks—helped renovate downtown store-fronts, making them more attractive to shoppers; and developers rebuilt aging and decrepit office buildings.

Much of this downtown “redevelopment” was financed by grants from the federal government, more specifically, from the Department of Housing and Urban Development (HUD) through the Urban Development Action Grant (UDAG) program, which was touted as a “public/private partnership.” If one were to compare the attractiveness of Chattanooga’s downtown to its less glamorous condition in 1980, one most likely would say that the Federal grants were both necessary and beneficial. That is certainly what local officials, a local newspaper editor, and private civic leaders believe.

In fact, to argue against these grants is to argue against progress and development, according to our leaders, yet that is precisely what we are going to do. Many of the policies for downtown development followed by Chattanooga’s city officials during the last decade have been economically unsound, reflecting a faulty theory of economic development. And Chattanooga’s leaders have simply followed the path set by nearly every large and mid-sized municipality in the United States.

Allocation of Resources

A basic premise of market economics is that people, given the opportunity to make free choices, will use resources in a way that will draw them from lower-valued to higher-valued uses. For example, raw petroleum pumped from the ground is nearly useless as a consumer good; petroleum that has gone through the refining process has a number of highly valued uses such as powering vehicles, heating homes, and helping create electricity. Petroleum is also used to make important products such as plastic, polyester, and nylon.

How does one decide the “appropriate” use for petroleum? After all, oil used for plastics or polyester cannot also be used to heat a home in Maine on a blustery winter day. In short, there are competing uses for oil, uses that are determined by the price system. Producers determine the mix for products according to the level of potential profitability for each. Appropriateness is determined by price, not by political decisions. (In fact, when the Department of Energy controlled domestic oil prices and allocation a decade ago, its “appropriate-use policies” caused considerable dislocations in oil markets.)

The appropriate uses for Chattanooga’s downtown, however, have been decided by a different method, one in which economics has been co-opted by the phenomenon of “political investment.” City officials, encouraged by numerous sectors of the community, have sought to remake the center city into a place that reflects an image of prosperity and sophistication. In this case, “appropriate uses” reflect political, not economic use of resources.

Downtown History

From the turn of the century through World War ii, Chattanooga’s downtown was both residential and a shopping center. Like many other U.S. cities, its downtown was declining by the late 1970s. Shoppers now preferred the many attractive and convenient shopping malls that had sprung up during the decade. By the mid-1980s, Miller Brothers had left its large downtown store, J. C. Penney was gone, and Sears had announced it was leaving for the new regional mall, Hamilton Place. Only one large retailer, Loveman’s, remained committed to the downtown.

But the big retailers weren’t the only ones having financial problems in the center city. Small merchants, too, were struggling, as were the downtown movie theaters, which finally closed their doom. Empty store-fronts dotted the city, causing concern for local politicians and civic leaders. From that concern sprang a number of Federally funded projects to “revitalize” the downtown.

The first large-scale project tore up a section of Market Street, removing on street parking areas, and constructing wide sidewalks patterned after pedestrian malls. For more than a year, a four-block section of Chattanooga’s busiest downtown street was barely passable or closed altogether. The significant effect of the project, ironically, was to drive shoppers from the area. Merchants—who were supposed to receive the primary benefits from the new, attractive downtown—complained that they weren’t making enough money to stay in business. Indeed, some merchants were forced to close. Those who remained became eligible for

Federal funds to redesign their store-fronts. One merchant, in particular, spent large sums of both his own money and taxpayer funds to change the exterior of his two shops. Both were bankrupt within a year. Shoppers complained that the new pedestrian-oriented market center eliminated many parking spaces, making it even more difficult for them to shop downtown.

Fortunately, not all the downtown redesigning came from the taxpayers. Blue Cross-Blue Shield of Tennessee, a health insurer, purchased the Miller Brothers building and renovated it into an architecturally pleasing office complex. A local developer turned the Sears property into an office building. Both projects have been financially successful, and neither was built at taxpayer expense. But these were exceptions.

At the southern end of the downtown business district is an old railroad freight depot. In the early 1980s it was used as a railroad salvage company where consumers sought bargains by purchasing damaged goods. The large facility wasn’t aesthetically pleasing, but it was a popular place to shop.

Developers from a northern city saw the facility as a potential renovated up-scale shopping center, and set to work using financing obtained through HUD. What emerged was a sparsely attended mall that went bankrupt within a few years—and still stands empty today. According to city officials, the up-scale mall was more economically “appropriate” than the railroad salvage company. Consumers, however, had their own opinions about what was the more appropriate use of the facility.

None of the Chattanooga UDAG projects has met with near the success projected on their grant applications. This is hardly surprising. The Chattanooga experience mirrors that of the rest of the nation, as scores of UDAG projects, including luxury hotels and housing developments have gone bankrupt or faced severe financial problems.

Why the high rate of failure? The answer is found in the price system, which moves resources from lower-valued to higher-valued uses. When given free choice in a market system, consumers decide appropriate uses of resources. In the case of Federally funded projects in our city, however, consumer choice wasn’t considered. Projects were funded not because they seemed to be good business investments, but because they were supposed to create jobs and make the downtown area more attractive.

Capital Malinvestment

These failed UDAG projects are realinvestments of capital. Malinvestment has been used by the Austrian school of economics to describe capitalization during an economic boom that has been triggered by a monetary expansion caused by the nation’s central bank. The tool for monetary expansion is below-market interest rates. In the case of UDAGs, the key to attracting developers has also been the promise of below-market rates of interest. Because a lower (i.e., subsidized) rate of interest means a lower debt service, developers supposedly will have a greater chance of profit.

However, full conventional financing for such projects is usually not available because of their high risks, which reflect their potential profitability. In other words, markets for many of these projects are, at best, weak because of factors that have nothing to do with interest rates. Markets reflect demand and potential demand of consumers, and if demand doesn’t exist, lower lending rates won’t suddenly make those projects more appealing to the buying public.

Profitability, unfortunately, has become subordinate to political wishes. Thus, precious capital has been invested in projects of questionable merit, and taxpayers are the losers. In Chattanooga’s case, the city government did not invest large sums of local tax revenues, so the local liability, while significant, doesn’t threaten the fiscal health of the city. However, politicians from other municipalities, anxious for any downtown development, have staked city funds as well as Federal money for risky projects, and the economic cleanup costs will be very high for many cities.

Supporters of downtown development, when faced with the arguments given here, reply that if millions of Federal dollars had not been poured into Chattanooga’s downtown, then the area would have further deteriorated, thus hurting the city’s image. In other words, while the results haven’t been as successful as projected, leaving the center city to the whims of private, conventionally financed developers would have made things even worse.

Such reasoning, however, begs the question. To move capital from higher-valued to lower-valued uses, as was done with most of the Federally sponsored development, will usually result in long-run problems. Malinvested capital brings about projects that cannot stand by themselves in a market, projects that ultimately must either be permanently subsidized or allowed to fall.

Allowing a free market solution to downtown development, whether in Chattanooga or anywhere else, will not necessarily produce results that mesh with the visions of politicians or civic leaders. Stores may stand empty for a time while developers ponder other uses for the property. What appeals to an investor may not appeal to a city planner. But, in the end, uses that keep the market in mind will most likely be more profitable and beneficial to the city’s development than those based on political wish lists.

  • Dr. William Anderson is Professor of Economics at Frostburg State University. He holds a Ph.D in Economics from Auburn University. He is a member of the FEE Faculty Network.