A Threat of Industrial Blackmail

Report Environment

A Threat of Industrial Blackmail

December 30, 1982 26 min read Download Report
Richard B.
Senior Associate Fellow
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c 237 December.30, 1982 A THREAT OF INDUSTRIAL BLACKMAIL Richard B. McKenzie Senior Fellw Before the 1960s, major ifistrial location decisions were, to a consider able extent, shrouded in secrecy. Most firms feared that plblic disclosure of their ongoing location searches would inflate real estate prices When Walt Disney sought in the early 1960s to buy 43 square miles (or 27,443 acres) of orange groves in central F lorida for his planned Disney World, the land was actually plrchased by'several different law firms, most of whan did not knaw Disney was the buyer. These diversionary tactics were justified on the grounds that, if the landuwners knew a single buyer was i n volved and the buyer was Di?ey, they might withhold strategic pieces of property and inflate their prices Marry figns still hold their expansion plans close to their corparate chests: however, beginning most noticeably in the mid-1960 a sizable number of f irms began to change' their industrial location strategy. In contrast to keeping their plans quiet, many firms especially very large ones began announcing their expansion intentions to political leaders within selected commities. While the professed plrps e may have been to find the most advantageous inchtrial site, a hidden motivation for these announcements has always been to pit camunities against me another in a competitive struggle for the jobs and tax bases that are at stake. Cartnunities and states h a ve responded to the canpetitive challenge by offering a wide range of industrial i&cemmts: the issuance of industrial develapnent bonds, which ultimately means the plrchase or lease prices of the land and plants involved are subsidized by goverment; the m a king of federal, state, and local government grants that cover the installation costs of roads and interstate interchanges and of sewer, water, and gas'lines; and the exemption of the industrial property fran local property taxes for several years. State a nd local govermat develapnent boards have even built plants and leased them to firms at nominal rental rates, all in the interest of securing industrial jobs and a greater tax base When Teledyne, Inc planned the construction of a new plant in Swth Carolin a in 1981, it considered locations in Oconee, Anderson, Pickens, and Lwrens counties. Omnee County got the plant, which in full aperation will -2 emplay 500 workers. It won the campetition, however, only by agreeing to build the plant and then lease it bac k to Tel- at favorable rates a concession the other counties were unwilling to offer After acquiring its first U.S. plant to produce Rabbits, Volkswagen found that it did not have the necessary "pollution rights" to operate its Pennsylvania plant. Because p ollution for hydrocarbons in the area of the VW plant had reached the legal ceiling, a hydrocarbon "offset" had to be made in another proihction process before VW could start production VW, the state agreed to keep the area's overall pollution level withi n legal limits by shifting to a31ess polluting but more expensive asphalt processing and road paving method In order to keep In the early 1980s another industrial strategy began to emerge. Rather than pit camunities against one another over the location of new plants, firms began to announce plans to close one or more plants, giving the carranunities affected an opprtunity to bargain Over their clsure. In 1980 General Motors announced that it planned to close two outmoded Fisher Body plants and replace them with a new $800 million Cadillac plant that might eventually emplay as many as 6,000 workers. It informed the city of Detroit that, unless a suitably large land tract (500 acres) could be fmd in the city, General Motoss would have to locate its praposed n e w plant *in another area of the country. Because the proposed new plant could mean Over $8.1 million a year in business tax revenue (even after a twelveyear, 50 percent property tax abatement) and $1.5 millian in wage taxes, Detroit responded by offering to condemn, under its powers of eminent dcnnain, a 250-acre section of the city knm as Poletm encampassing 3,500 mainly Polish residents, 150 businesses, and sixteen churches million of which came fran federal sources.

The city'bought the land for approxim ately $200 millim 150 In order to sell the land to General Motors (for a little more than $8 millian) I Detroit in the end had to remove forceably many of the residents of Poletawn. At present, although the buildings of Poletm, including a Catholic church , an emotianal centerpiece in the controversy, have been removed, the prdsed Cadillac plant is not scheduled to be in operation until sametime after 19

85. Given the downward trend.of autanobile sales, the plant may never be built In 1982, because of sever e financial difficulties, International Harvester began to close and consolidate several of its 23 heavy equipnent plants. In one conternplated plant closing, Harvester informed Fort Wayne Indiana, and Springfield, Ohio, that one of the cities would see i t s plant closed, asking at the6same time that each consider buying its plant and leasing it back to Harvester plan a means of securing capital that, because of its heavy indebtedness and the ldng threat of bankruptcy, it could not obtain from private marke t s. By September 1982, each city had offered to buy their respective plan9 for $30 million or above, using a cabination of public and private monies they involved the potential, continued epaploynmt of more than 7,500 workers in cities that were suffering s ubstantially higher unempluyment rates than the national average, the saleleaseback arrangements were eagerly supported by camnunitg leaders. In October 1982, the Fort Wayne plant was selected for closing. Wky Fort W- was selected is much less important t h an the fact that officials of two cities, set in canpetition with one another, were willing Without question, Harvester saw in the saleleaseback 7 Because -3 to pay more for their respective factories than the market would have allawed If that were not th e case, Harvester need not have gone to the governments of Fort Wayne and Springfield in search of a sale-leaseback contract Harvester also announced in 1982 that it was closing its plant in Louisville, Kentucky.

Island Illinois, that it would transfer its terminated rear-end transmission operations at Louisville to Rock Island if Rock Island and the State of Illinois would cover part or all of the $10 million cost of transporting equipnent fran Louisville to Harvester's Rock Island plant. Since the reloca t ion of the transmission works would add agproximately 550 jobs to the conununity's employment base, Rock Island (which, like Fort Wqme and Springfield, was experiencing heavy unemployment at the time) agreed in September 1982 to pay $6 million of the tran s fer expenses. The State of Illinois also agreed to funnel a $1 million grant into Rock Island for retraining Harvester workers who would take the jobs at its expanded facility that the 800 workers then on indefinite furlough at the Rock Island plant which , at its peak, in 1979 employed 3,500) might never be rehired if the local government aid were not forthcoming industries in the private sector sports and even government consolidating many of its field offices around the country attract the consolidated r e gional offices, conmumities have been competing for the regional offices by offering to lease office space to the FAA at nomina1 annual rates. Anderson County, South Carolina, offered in summer 1982 to lease the FAA office space for $1 a year at the count y airport, currently being used as a field office.

Planning and Develapnent Board, remarked Welp not get the regional office but surely no one will undercut us on price At approximately the same time, Harvester told Rock Island and of installing the equipn ent in Crucial to the negotiations was the city's belief Concession bargaining Over closure has not been restricted to basic It is a growing phenomenon in professional In 1982, the Federal Aviation Adhistration began In order to Trey Senn, Executive Direc t or of the Anderson County The mrs of the Washington Capitals, a hockey team that plays its games just outside the nation's capital in Maryland, threatened in June 1982 to take their franchise elsewhere unless four conditions were met by local fans and gov ernments by the end of August 19

82. The conditions were (1) the sale of 7,500 season tickets 2) sellouts for the first seven hane games 3) a reduction in the rent' an the coliseum, and (4) a rection in the entertainment tax on tickets from 10 to one-half of one percent in an eleventh-hour campaign, and the team pledged to stay another year.

All conditions were met Across the U.S similar threats of closure are being made plants apen, firms have asked, or demanded, financial concessions by ccmmities. There is need, therefore, to explore the econmic consequences of concession bargaining by cmnunities(which, understandably, has been termed industrial blackmail The overriding issue is whether or under what circumstances concession bargaining is a boon or bane t o cornnunity reindustrializatian efforts and plant closings are conceptually similar and because the.former will lead in a carrpetitive government envirmat, to the latter, such an investigatim must deal generally with both location and closing concessions bargaining by governments, when it involves taxes imposed on the entire cmnunity and subsidies limited to a segment of the cornnunity, is conceptually To keep Because carranunity concessions on plant locatims Haever, -4 distinguishable fran bargains struc k in private markets first step is a restatement of fundamental market principles.

For this reason, the BSSAINING WI!J!JiIN PRm MARKEX3 Bargaining over resource prices is integral to catrpetitive market After all, bargains made subject to revision are what markets processes. produce. Because bargains can be almost anything the trading parties choose to make them, markets exhibit considerable flexibility, an important advantage since consumer tastes and conditions of production fluctuate. Furthermore when m a de in the knowledge of alternative resource prices and with all costs and benefits considered by the trading parties, the bargains struck in markets give rise to an efficient allocation of resources. Efficiency in the allocation of resources is simply the economist's way of saying resources have been so divided among ccnnpeting uses that the value of the resulting combination of goods and sefyices, as evaluated by those involved in the market transactions, is maximized Market system failures to achieve max i mum efficiency are fully acknowledged in ewdc literature. These failures stem primarily fran the presence of monopoly power and the existence of "external benefits and costs in prodClction and consumption monopolies tend to hold back on production, forcin g their prices.and profits upward. An inefficiency occurs in the sense that consumers would pay a price for additianal units that would more than cover the additional production cost.

Because the monopoly will not allw these additional units to be produced resources migrate to other uses, giving rise to "too little" of the monopolized product and "too much" of other goods (in the sense that consumers wauld prefer more of the monopolized product and less of other things In the interest of maxmizing profits E xternal costs are costs of production not incurred by the producers of the prodClct (and imposed on some third party not involved in the trade yhile external benefits are benefits of consumption not received by the buyer (and received by some third party n ot involved in the trade Where external costs exist and no reasonably inexpensive method is available for internalizing the external cost (meaning the the full burden of production cost is imposed on the pro&cer the good or service will tend to be underpr i ced and oversold. The additimal expense fishermen must incur in fishing the lakes of the country because of "acid rain which in turn is due to pollution, is a classic example of external costs. The polluters can underprice their products because a part of the prodClction cost is imposed on the fishermen, resulting in too many of the polluters' products and too few fish being produced Where external benefits exist and no way can be found to internalize the benefits (meaning sellers can charge for the benefi t s received by others the good or service in question tends to be underpriced and underproduced. A classic example of an external benefit is the security people feel when criminal activity is deterred. If the government were hot involved in police work, th e public would individually buy less police protection than they would if they could charge for the benefits received by others exists in our examples in the sense that consumers would prefer more of one thing and less of something else prices do not refle c t the full costs and benefits of the goods that are traded An inefficiency Again, this result emerges because market 5 Outside of these cases, bargains struck within markets must reflect the considered choices of the participants, meaning each party to th e trade must weigh off the costs and benefits of what he or she does. These trades increase canmunity welfare because of the differences in relative evaluation of what is traded. Each trader has to bear the full cost of what he does, meaning simply he acts (trades) on a comparative analysis of the value of what is forgone with the value of what is received. Presumably, trades only occur when the benefits to each exceed the costs to each their cnvn individual welfares, they may be inclined to impose as many o f the costs of their trades as they can an others. When they are successful in doing that, resource allocations are misdirected trades and overproduction is encouraged potential mtually beneficial trades will be left unexploited; when all benefits are not received by the person who has to incur the costs of production, it stands to reason that fewer costs will be incurred fewer trades will occur Of course, when people seek to maximize As long as people are denied the benefits of their efforts JUSTIFYING Gc m mIma SUBSIDIES The foregoing discussion is relevant for me simple reason: Subsidies to sww industry location or closure decisions are often justified fran an econanic (as apposed to a political or ethical) perspective on what are thought to be "externalit y " grounds. %e whole camunity benefits" is an often heard refrain community is increased, wages of workers rise alang with the campetition for labor, real estate prices go up, and the tax base is expanded. When a plant is subsidized under threat of closure , the argument retains its essential character: When the subsidies work, jobs are saved, wages and real estate prices are kept fran falling, and the tax base is held intact. As the argument is developed, the locatian inducements can have a multiplying effe c t within the wnnnunity: the workers directly affected by the subsidy will tend to spend a sizable share of their incame on locally produced goods and services, the producers of which will buy fran others in the carranunities, and so forth all of whan will pay into the tax coffers After all, when a new plant moves in, the number of jobs in the b Adnittedly, with any particular industrial location inducement, there may be losers as well as winners the growth in personal income may suffer higher rents (becaus e of inflated property values Hwever, proponents of this emncnnic develapnent policy often referred to as "industrialization" or "reindustrializatim policy may reason that over *e course of many such inducements, almost all in the affected camunity will mh l arxe benefit For example, many people who do not share in Although they may affect few jobs directly, government subsidies of sports facilities, such as enclosed stadiums, are also justified on externality grounds. The fans who attend the games and concer t s gain directly: they can see events that they would not otherwise have a chance to attend (or could attend only at considerable expense) and they see them at reduced, subsidized prices argument is made attend if they ever decided to attend. Also, the cam u nity financed sports and fine arts) facility will act as a magnet, attracting more visitors and Hmever, others also gain (there are externalities or so the Because of the stadium, others benefit by knuwing they could 6 more firms and giving rise.to the mu l tiplier effect on job, incomes, and taxes noted above Any subsidy can be viewed by ccmmumity leaders as an investment that is recouped by way of greater incomes and taxes in the connnunity. Residents may have to pay higher taxes to cover the subsidy, but t hey have higher incanes fran which they can pay their taxes. Indeed, if the subsidies are planned carefully, some special industrial location inducements will even lower the average tax rates of the citizenry spreading of the camunity's tax burden. Note w a s made above that the proposed Cadillac plant in Poletm would return approximately $10 million in local tax revenue each year on a local government investment of $50 million (plus cost of services to the GM plant, if it were ever built The greater tax bas e may permit a Empirical analysis of the actual profitability of this form of camunity investment is mixed make their location decisions on the basis of canrmnity concessions camunity inducements are more or less decisive, they tend to affect the choice am o ng camunities within a given state or region of the country; state and local government inducements, in per words, affect in a very minor way interregional location decisions. This is largely because the concessions tend to be widespread, as would be expe c ted in a competitive government environment, and tend to be offsetting. Still, other analysts have argued that inducements can, for the camunities involved, provide a rathfs hefty annual rate of return on the investment, extending up to 87 percent statist i cal debate is, however, largely a side issue for the purposes of this discussion, in which the central concern is whether or not community locational and anti-closing subsidies to businesses tend to prmote efficiency (that is avert market externalities) o r promote inefficiency (create externalities of their m A number of studies have found that fy firms When This There must be an element of truth in the foregoing argument. is some truth to the statement that plants that muve into a community do give rise t o "externalities although not necessarily the kind of externalities that fit the purf6problenatic kind, knawn among econcnnists as "technological externalities Local government subsidies can and often do give rise to jobs, which in turn may give rise to ot h er enploymnt opportunities within the community. The problem is that this tells only part of the story. A complete assessment of subsidies in any form and for any purpose requires a look at the costs of comrwnity develapnent strategies And there Local gov e rnment subsidies to attract or retain industrial plants must come out of the pockets of people, either as taxes or borrowed funds. The drain on these pockets will also have multiplying effects, but in the apposite direction of the subsidies. The relevant q uestions are whether the subsidies give rise to more jobs within the community; whether the costs and benefits of the program through time balance out over the residents and, if they do not, whether taking fran Peter to give to Paul can be justified on et h ical or canrmnity welfare grounds; .and which level or levels of government are best suited for funding industrializatim or reindustrializatim programs. All of these issues reduce to the highly normative, but politically important, question of whether gov e rnments, as a matter of organization prerogative should be allowed to cmpete for industries by providing specially targeted benefits for prospective or distressed firms within carnwnities. The analysis relates directly to the issue of appropriate regulati o n pf government (not hy government As a matter of natianal policy, federal efforts to encourage plant openings or discourage plant closures with federally financed concessions through industrial develapnent bonds and economic develqnent grants must be ser i ously questimed position of the individual "very small" local government that is me of many equally positioned local governments. Fran the perspective of am of these local governments, the "employment and tax base multiplier" justification for wing and cl o sure concessions has (depending on the size of the locality and how other camnunties respond) a measure of validity To see the validity of that positim, consider first the Especially for very small cOmnunities, taxes that are collected fran local resident s would largely have been spent on goods and services "imported fran elsewhere. While me jobs may be lost initially in the caranunity because of a decrease in local purchases by the citizens who must pay the subsidy bill, more jobs Can, but not necessarily will be, added than lost In this idealized "small" cmunity, the costs of the industrial subsidies will, by the virtue of the cmnunity's size, tend to be paid by the beneficiaries of the subsidies (there will tend to be few externalities on the tax or subs i dy side of the industrial concession The subsidy will therefore, tend to be evaluated by the voting residents, as all efficient econdc decisions should be, in light of the full costs and benefits of the proposal. Furthermore, it should be noted that the e m erging competition among many anall local governments can result in lower tax rates and higher quality local government services. These lower tax rates and improved services can stimulate investment Under anall local government competition, a discriminato ry tax and service policy (one that differentially benefits one group of businesses at the expense of other residents and businesses) will be difficult to maintain.

Those local firms and residents who feel they are discriminated against in the taxes they p ay or the services they receive retain the option to move elsewhere. The smallness of the political units insures the existence of locatim cp?tians. If the concessions do not result in lower taxes and higher quality services, then the concessions will ten d not to be made. Cancessions in the "small government" political environment tend to be a part of a positively game, an argument developed in some detail by econamist Charles Tiebout. This is because concessions that are unproductive on balance will reduc e the overall competitiveness of the camunity and thus became counterprochctive; the local government would then have to makeconcessions to offset its relatively higher taxes, thereby pratlpting the exodus of firms and residents. Any differences that exist in the way local governments treat firms, in such a competitive government environment, must reflect differences in the costs of collecting taxes or providing services to different types and sizes of businesses. To reemphasize a fundamental point, if a "s m all" local camnunity attempts on balance to help me business group at the expense of another, the group that is penalized will me elsewhere, saddling those who are the I beneficiaries of the concessions with the entire tax burden mall governments make con c essims, externalities of a sort tend to exist.'Ke governments that make the business concessions force other governments to make similar concessions. Hmever, these "externalities" are market signals like prices; they induce governments to operate efficien t ly and aid in allocating public resources among canpeting uses As a community bemes larger and more inclusive of the country's citizenry, concession bargaining bemes progressively more questionable fran both efficiency and equity perpectives for the camun i ty that makes the concessions. In a very large ccmnnunity for example, a country the size of the United States the funds for the concession will be drawn from people who, by definition of the conmunity's size, would have spent most of their incane within t he ccmununity. Ary concession, then, tends to result not in an increase in the tax or mployment base for the camunity (Le country but a locational shift in the tax and employment base within the ccnnmunity. While a shift in the tax and employment base may be a legitimate objective of government, the point here is that, as the carorwnity becanes larger, the multiplier argument developed above tends to lose its force. The concession may have a positive multiplier effect within sectors of the ccnnmunity; but the taxes will tend to have a negative offsetting multiplier effect within other sectors in this larger community. Given these conclusions, critical questions abound when any reindustrializatim proposal is tendered at the federal. level.

For example, why w ould a country the size of the U.S. be interested in funding concessions that would divert jobs from cities and towns in Kentucky or Idaho toward cities and towns in Michigan? What is the market failure involved Indeed, the movement of firms fran Michigan to Kentucky may be a clear indication that the market is working well, sending out the right signals. To the extentathat federal funding of concessions is not uniformly distributed government can distort signals, giving rise to a government imposed extern a lity funded husiness subsidies are a means of offsetting union imposed wages that country second policy a means of adjusting regional pricing signals to reflect true regional cmprative advantages that are obscured by uniform wage rates. Since costs are la r gely subjective, it could be asked whether government is capable, even conceptually, of appropriately assessing whether government subsidies will not delay the the breakdown of uniform wage signals, and whether the implied redistribution of incane (which m ay very well be fran the relatively poor to the relatively rich) is in line with social objectives expressed by an array of other government policies funding is distributed uniformly across cmnunities, with no implied redistribution of purchasing power, t h e federal funding will lead 5~ a cmpetitive bidding war ammg camunities (as federal funding has of the funds being realized in subsidies to the owners of footloose capital (and the more mobile the capital, the greater the subsidy Sane investment will be s t imulated by the federal funding; hmever, some investment will be deterred by the taxes involved. And there is a question whether subsidizing business according to the mobility of capital should be a national objective. The subsidies will certainly encoura g e capital.mobility Economists Jmes Buchanan and J. E. Moes have argued that federally .are heldligid above canpetitive levels and are standardized across the Federal subsidies are seen fran this perspective to be a If government concession with most -9 wh i ch is viewed as the source2ff major social problems by advocates of reindustrialization policies G In larger canrarmnities, business concessions have a greater potential for being a negative sum game. One group can seek concessions, imposing their cost on the rest of the camnunity. In terms of the national copranunify, people have few havens to which they can run and escape the tax burden imposed by the concessions. Indeed, it is the people's relative inability to avoid the tax burden of redistributive pro g rams that offers a central government monapoly power, that is, the power to charge higher than competitive tax rates, to provide laver than carrpetitive services, and to differentially benefit one group at the expense of another group. This progressive in a bility of people to move as the inclusiveness of government is increased has led advocates of welfare programs to contend that redistributive programs should be a function of the federal government. When applied to business location and closing decisions, hawever, the issue of the ethics of the redistributive objective must be raised. The concession subsidy can easily benefit the relatively high income workers, managers, and stockholders of firms at the expense of the rest of the comunity, many of whan may have laver incanes than those who benefit from the concession. Indeed, the high noncmpetitive wages of the workers involved may often be the source of the emnarnic difficulties of companies contemplating closure.

Furthermore, workers always have an mion of attracting employers or If workers cannot preventing their employers from moving elsewhere simply by accepting laver wages and allaving the company to remain cost cmpetitive lower their wages sufficiently to att r act or retain their jobs, then resources in the firm, including the employees, should move elsewhere. If in the absence of the concession workers cannot regain employment at approximately the sane wage, then their wage is artificially high because of rest r ictions on the labor market and the concessian bemes a means by which workers in the camunity Le country) who may be earning competitive wages.are forced, by way of the tax and subsidy system, to prop up the wages of other workers that are above competiti v e levels In short, as a camunity becomes larger, concession bargaining is likely to create problems of externalities rather than reduce thm. The political decisions made to subsidize one set of firms will cane at a cost that is "externalized" by wq of the tax system to the rest of the population all groups enter the concession game, asking to be treated like other groups with special government programs, the autccnne can be more resources spent in the political arena attempting to shift caranunity resource s around fran one group to another and fewer resources and less income in the private sector If In highly competitive government environments, concessions on plant closings (such as the concessions that Detroitmade for GM and Springfield made to Internatio n al Harvester) are a natural, expected outgrawth of concessions on plant locations. Knwing that a camnunity is sufficiently eager to attract new employment opportunities and additions to its tax base that it provides tax and benefit concessim for prospecti v e industries, existing industries will see value in the threat of withdrawal from the carnwnity. All other conditians equal, a city should be at least as eager to keep its industrial base as it is to build on its base; it should, therefore, be willing to m ake the same concessi- to existing firms, all relevant conditions equal, as to prospective firms. There will, therefore, be a tendency for each firm to view itself as the marginal firm When concession subsidies are initially provided, the$ may indeed be e x pected to affect marginally the level as well as the distribution of industrial investment will become more generous and/or the quantitative and distributimal impact of any given funding level on investment should dissipate, as all firms contemplating a l o cation decision learn how to take advantage of concession bargaining and as existing firms that may not be contemplating an expansion or a move learn that concession bargaining Over expansians qan be amlied to concession bargaining Over closings. Accordin g ly, Over time, funds intended to affect marginal investment decisions will be soaked up by what would have remained, in the absence of the concessions, infrmarginal investment decisians. Alternately, the budget for concessions can be expected to escalate a s inframarginal, as well as marginal, business location decisions are subsidized But with the passage of time, the concession benefits URGE VS. SMALL FIRMS The problen with concessions stems fran the monopoly power assumed by governments (which arises bec a use of the difficulty, Le cost of relocation The concessions can be discriminatory in the sense that the tax burden is imposed on one group of residents at the expense of another group. The groups that benefit are likely to be those that have the politica l clout to redistribute income in their own favor large-scale employers whose enployees represent a voting block and whose withdrawal may be a severe hardship to the carromunity. International Harvester's proposal to Fort Wayne and Springfield that they bu y and lease out Harvester's plants attracted the attention of coaranunity leaders not because it was the only firm about to leave those cities in 1982; there were probably many plants that shut dm in those cities that collectively were responsible for more jobs. Harvester, however, received the favorable attention because of its comnand over a block of jobs, city voters, and tax base These groups are likely to represent The uneven economic and political power among various employers means The larger employe r s will receive favorable tax treatment that the fundamental tax principle that "equals should be treated equally" will be violated independent of the cost of providing the services or collecting the taxes addition subsidies that tend to favor "large" firm s will, in themselves encourage larger firms than cost and technolw conditions would dictate generating a market inefficiency of its own In Industrial location strategies have changed significantly in recent decades. This change has occurred partly in resp o nse to the willingness of the federal, state, and local governments to use taxpayer monies to subsidize industries. A central argument of this paper has been that subsidies intended -11 for industrial expansions will eventually be used to prevent plant cl o sings This is because firms, sooner or later, will learn that commities willing to subsidize the attraction of new jobs should be just as willing to subsidize the retentian of existing' job Federal government involvement in industrial locatian decisions, b y way of tax-exempt industrial develqanent bonds and econanic developnent grants issued by local and state governments, has escalated dramatically Over the past two decades. In 1960 the dollar volume of industrial develment bonds (IIIss mounted to only $4 6 million (although double the level of 1957 by 1967 the dollar volume had reached $1.5 billian; by 1979 the dollar volume was $7 billion. Federal econdc regional develqment grants fran the Ccmerce Department to states have risen equally dramatically fran $ 127 million in 1969 to $500 million in 1981, and a substantial portion of these grants (how mch cannot be calculated with precision) has been used to aid cammities in financing industrial concessions Additional econanic develqanent funds are no doubt, inc l uded in the budgets of other federal departments This rapid increase in IIXs and federal grants, however, is descriptive of a natural tendency of competitive caranunities to make use of all inducementsat their disposal to attract industry. It also reflect s the defensive posturing of cammities interested in insuring that they do not lose their competitive positim and do not lose their existing tax bases Those figures on IDBs and econdc develqanent grants also represent a redistribution of the tax burden in t his country that is difficult to justify on efficiency or welfare grounds. Perhaps, it is time that centralized specifically federal, efforts to affect business expansion and closing decisims be revaluated. Given that subsidies to affect expansions will i n evitably be converted to subsidies to prevent closings, it follows that such subsidies will be granted to large, politically powerful fisms. It is difficult to understand w& the federal govesnment, especially, should, as a matter of economic develment pol i cy, beme involved in redirecting the flow of jobs fram those workers and cammities who are willing to remain canpetitive to others who must be subsidized to canpete L Richard McKenzie is a Senior Fellow at The Heritage Foundation an leave fran Clanson Uni v ersity where he is Professor of Econanics is drawn fran a forthcoming book entitled 4 2 (Pacific Institute for Public Policy Research This essay Notes lEdward L. Prizer The Disney Decade," Orlando Land, October 1981 pp. 29-63 200 an acre. Once it was know n that Disney had bought the Disney World tract, prices of surrounding land jumped six to seven times the previous selling price Disney ended up buying the acreage at an average price of 21nterview with Trey Senn, executive director of the Anderson County Planning and Development Board, Anderson County, South Carolina, September 9, 1982 3See Bruce Yandle The Emerging Market in Pollution Rights I Regulation July/August 1978 pp. 21-29 4The entire extent of the new plant closing strategy is not known.

The exam ples here are intended to illustrate the problems posed by such a strategy 5See "The Rape of Poletown Inquiry, August 3 and 24, 1981, pp. 11-12 ee "Springfield-Worker We'd Just Like to Have Some Answers and Fort Wayne: Community Spirit Evident, But May No t Be Enough Dayton, Ohio 11 Journal Herald, August 14, 1982, p. 1; and "Indiana City Offers Deal to Keep Harvester Plant," Washington Post, August 11, 1982 According to a Wall Street Journal report; Springfield offered a 30-million sale-leaseback plan on a 15-year-old plant at a time when Fort Wayne had put together a $g-million offer on a 60-year701d plant later countered, however, with a $31 million sale-leaseback offer.

Towns Fight to Keep Harvester Plants, Knowing That Only One Will Remain Open,"

Wall Street Journal, September 8, 1982 p. 35 Fort Wayne Two 8i'Oh'io'WinsbBid fox Harvester over Old Fort Wayne Plant New Telephone interview with Neal Nielson, City Manager of Rock Island York Times, September 28, 1982, p. D-5.

Illinois, August 16, 1982 Interview with Trey Senn, see note 2 llKen Denlinger What Capitals Need Is a Power Play Like Pollin's,"

Washington Post, August 25, 1982 p. D1 12Alternatively, it may be said that an efficient market outcome occurs when resources cannot be rearranged among the ir alternative uses without reducing the total value of the goods and services produced 13For a survey of the literature on the effectiveness of industrial development bonds, see Thomas L. Martin Tax-Exempt Development Bonds Arguments and Evidence Concern i ng Their Effect on Business Mobility Clemson, S.C.: Economics Department, Clemson University, 1982 especially Section 111. 141bid. 15James R. Rinehart Rates of Return on Municipal Subsidies to 16"Technological externalities" are contrasted in economic lit e rature with "pecuniary externalities of some basic defect in the market's ability to internalize all costs and benefits without government interventfon. Pecuniary externalities are financial costs imposed on others in the market because of the operation o f the market as a pricing system enter the market, prices will rise, imposing in the process a greater financial or pecuniary burden on buyers who were in the market prior to the demand increase and who still want to buy the good at the higher price. Techn o logical externalities result in misleading pricing signals and, therefore, misallocation of resources. Pecuniary externalities are the pricing signals that give market directions to resources Industry," Southern Economic Review, Vol. 29 (1961 pp. 297-306.

Technological externalities arise because When demand goes up because more buyers i I 17Charles M. Tiebout A Pure Theory of Local Expenditures Journal of Political Econom9, 1956, pp. 416-424 18Again, these are pecuniary externalities 19James M. Buchanan a nd J.E. Moes A Regional Counter-Measure to National Wage Standardization," American Economic Review, Vol. 50 (1960 pp. 434-438 20Martin, "Tax-Exempt Development Bonds 21See Barry Bluestone and Bennett Harrison, The Deindustrialization of America (New York : Basic Books, 1982 Chapter 4 221f subsidies are concentrated on firms that are failing, larger firms will be able to shift the sources of their revenues among plants in different communities justifying" subsidies in a way that smaller firms with only one location cannot T. -7 7 y c s.~y h I V L r..x s i


Richard B.

Senior Associate Fellow

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