All Commentary
Thursday, February 1, 1996

The Perversion of Economic Development

Taxpayers Foot the Bill for Business Incentive Packages


In a country known for having forged the world’s highest living standard from what was wilderness scarcely 200 years ago, one would think that “economic development” is a well-understood concept. Unfortunately, it isn’t.

In recent decades, economic development has come to mean something other than the spontaneous, entrepreneurial phenomenon that built America. It is often thought of as a kind of activist, public-policy responsibility of state and local governments. It rarely is defined as a “fair field and no favor” approach in which governments keep themselves unobtrusive and inexpensive so as to give wide berth to free markets. Instead, economic development conjures up notions of bureaucracies and commissions directing resources, subsidizing specific firms, granting special tax breaks to some and not to others, and erecting a vast network of regulatory incentives and disincentives to affect behavior in the economy.

In short, economic development has come to mean what many statists and central-planning types are fond of calling “industrial policy.” They think the marketplace lacks direction and needs the assistance of officialdom. With tax dollars in hand to bestow upon the favored few, bureaucrats claim new prophetical powers of distinguishing the winners from the losers in the marketplace.

Many politicians find this approach attractive because it brings with it the pageantry of ribbon-cuttings and photo opportunities. They love to say, “Look at the jobs I created.”

Ever since 1976, when Pennsylvania successfully lured Volkswagen with an $86 million package of loans, subsidies, and abatements, states have been adopting similar schemes with great gusto and fanfare. Often referred to as “incentive packages,” they have become increasingly generous in spite of dubious results. Indeed, a 1989 report from the Council of State Governments stated emphatically, “[A] comprehensive review of past studies reveals no statistical evidence that business incentives actually create jobs. . . . They are not the primary or sole influence on business location decision-making and . . . they do not have a primary effect on state employment growth.”

They do, however, shift tax burdens onto those who lack political connections, increase the size of state bureaucracy, hinder the prospects of broad-based tax reduction and bestow alarming discretionary powers upon the boards and commissions that hand out the benefits.

Ever conscious of image and the “big splash,” development officials usually devise plans that favor big businesses and discriminate against small firms. They chase smokestacks and auto plants and frown on retail or service firms that might actually have more staying power. Firms that do not qualify for credits or subsidies must compete against those who do, raising a question of fundamental fairness.

In the rush to fashion the next industrial policy contrivance, the bigger picture is shoved aside. Sam Staley, Vice President for Research at the Buckeye Institute for Public Policy Solutions in Dayton, Ohio, explains: “The fact is that the value to a firm of a typical, limited-term incentive package from government pales when compared to such factors as overall tax burdens, a reasonably priced skilled labor force, the relative cost of compliance with regulations, efficient transportation facilities, crime rates, education quality, and the general quality of life. If a state or locality is not competitive in these areas, a business will go elsewhere despite the subsidies and credits dangled before it.”

Indeed, it is widely understood among economists that companies usually make their location decisions first in private, then hold out for the best incentive deals they can get from gullible government officials, playing one off against another.

The claims of government development czars are almost always overblown, in part because they consider only the more visible side of the ledger. The downside factors of state incentive packages—from the anti-competitive effects on non-favored firms to the opportunity cost of forgoing a more general tax reduction—are rarely factored into the equation.

Even when it doesn’t degenerate into a thinly disguised system of political patronage, government placing its judgment ahead of the verdicts of the marketplace is more than just a role of dubious value. It is, indeed, utterly preposterous. No one—political appointees especially—spends someone else’s money as carefully as he spends his own. Any firm or entrepreneur who cannot meet the financial performance standards of private banks or venture capitalists does not suddenly become more likely to succeed by virtue of a government grant or favor.

In reality, government’s involvement in economic development is more likely to simply reward mediocrity, obstruct the evolution of genuine economic growth, and turn a risky private venture into a long-term public charge. Taxpayers foot the bill whether the development czars succeed or not, unlike truly private endeavors where the greatest risk is confined to those most directly involved with the venture. The folks picked to lead state development bureaucracies end up fattening not the economy, but rather, their résumés for their next government job.

Writing in the November 1995 issue of The Freeman (“A Solution to the Incentives War?”), Andrew Cline of the John Locke Foundation in Raleigh, North Carolina, bluntly affirmed what will come as no surprise to the serious economist: “To date, not one incentives proponent has been able to demonstrate that government incentives create a net benefit for the general public.”

Fortunately, a national movement is afoot to get state governments out of this business. Organized by several free-market think tanks in the Midwest, more than 100 distinguished economists recently signed a Joint Resolution on State Economic Development Policy. It urges states to abandon their activist industrial policies and pursue across-the-board policies of tax and spending reduction, deregulation, and freer markets. The resolution is now gathering momentum not only in the Midwest but in other corners of the country as well.

The answer, in any event, is not in Washington and it’s not in picking different people to run state programs. The answer is in educating the public in general and legislators in particular as to the proper role of government and the real meaning of economic development. When that task is accomplished, policies will change.

The bottom line is what every American with a good sense of history really ought to know: economic development is what happens when government protects life and property and otherwise leaves us alone.


  • Lawrence W. Reed is FEE's President Emeritus, having previously served for nearly 11 years as FEE’s president (2008-2019). He is also FEE's Humphreys Family Senior Fellow and Ron Manners Global Ambassador for Liberty. His Facebook page is here and his personal website is lawrencewreed.com.