Can Government Change a Region’s Growth Path?

Chapter 11

Government’s role in theory

• Economic base model– Government spending needed to alleviate recessions

• Neoclassical model– Government spending crowds out private investment,

or– Boosts one economy at the expense of another

• Endogenous growth model– Provides necessary public goods to promote growth

(education, infrastructure, property rights enforcement)

Why government?

• Redistribute income

• Provide public goods

• Administer fiscal policy programs

Equity and efficiency

• Allocative efficiency

• Technical efficiency

• Distributional efficiency– Pareto Optimality—optimal solution exists

when nobody can improve their situation without harming another.

Investments in public capital

• Highways– Construction phase (direct, indirect, induced effects)– Post-construction phase

• Facilitates mobility of inputs, output, consumers and labor

– Problem: roads go both ways.• Customers outside workers can drive away more easily• Local residents and workers can drive away more easily

– Good roads do not guarantee rural growth, but bad roads guarantee the area will stagnate.

Decreased transportation costs from trade between two cities

Bid-Rent function with decreased transport costs for agriculture

Investments in public capital

• Education– Parental migration effect for K-12– Good quality labor force in 4-9 years– Possible brain drain if more graduates attend

college and do not return– No guarantee investment will help local area– Poor quality schools guaranteed to harm area

since adults with low investment in education generally do not migrate.

Investments in public capital

• Telecommunications Infrastructure– Crucial for rural development– Complementary to transportation

infrastructure, but can’t substitute for it

Government R&D

• Infratechnology—standardization– Federal or international level

• Research university– Firms can access future employees– Potential collaboration with faculty: but

confidentiality?– Spillovers from academic research

Growth through consumption?

• Tourism– Direct, indirect induced impacts– Creates jobs:

• Low pay, low productivity, possibly seasonal, • Secondary labor market

– Intense competition for repeat visitors– Larger city/county budget for police, fire, …– Is the provision of a tourist destination

nonrival or nonexcludable?

Growth through consumption?

• Arts– May attract professionals and skilled workers– Low employment multiplier (1.3 to 1.5)– Merit goods—is this a role for government?– Creates jobs:

• Low pay, low productivity, possibly seasonal, • Many from the secondary labor market

Growth through consumption?

• Sports teams and Stadiums– Often impede economic development– Redistributes households’ entertainment budgets– Fewer local linkages than other entertainment venues

mean a smaller multiplier.– Stadiums and teams are subsidized because of

politics, not economics– Creates jobs:

• Low pay, low productivity, seasonal, • Many from the secondary labor market

Growth through consumption?

• Casinos– Redistribute entertainment budgets if less

than half the gamblers come from outside the region.

– Best locations • Isolated areas near large cities• Next to a state that prohibits gaming

– Creates jobs:• Often higher pay than local alternative

– Few backward linkages so multiplier is small.

Growth through consumption?

• Outdoor Recreation Activities– Outside expenditures negligible (everyone

packs at home for their camping trip)– No empirical evidence of associated

employment growth– Agritourism (Bed & Breakfast, Dude Ranches)

bring in extra revenue to farmers.

Growth through consumption?

• Retirees – Pandora’s box more than panacea– Stable source of spending from young, healthy

retirees on fixed incomes– Countercyclical effect if incomes based on stock

market/interest rates– Creates jobs

• Low paying, retail, service jobs• High-paying industrial or resource-based jobs eschewed in

favor of natural amenities

– May outlive their assets and depend on community for support.

Economic Development Policy

• Resembles Cargo Cults of Pacific (WWII)

• Waves of Economic Development– 1930s: Smoke stack chasing, beggar thy

neighbor strategies for relocating firms– 1980s: Target start-ups, offer business

services, business incubators, fragmented, unorganized

– 1990s: Government as catalyst, uses holistic approach

Controversial legacy

• Create regions reliant on government transfers• Interstate analysis tricky because tax law and

fiscal policies vary among states• Policies from subsequent waves added to

economic development tools, economic development data hard to access

• Surveys used to see if firm would have located without government subsidy: Are these reliable?

Controversial legacy (concl)

• Subsidies for capital expenditure—but capital and labor are often substitute goods. How does this “create” jobs?

• Subsidies of inefficient firms merely prolong their death.

• Subsidizing the financing or interest rates of the firm not necessary unless business is extremely risky. – Financial markets work. – Should tax money create jobs in a risky industry?

Economic development incentive tools

• Tax abatement policies– Empirically little evidence that taxes or subsidies

influence location of high-tech or service firms– Supposedly counteracts high crime rates or high tax

rates (but the land market does that)– Inefficient tax price of public goods for residential

taxpayers– Spatial equity concerns: rural or low-income areas

subsidize urban areas– Cost-benefit analysis seldom includes opportunity

cost of funds– Awarded arbitrary, often upon request

Tax Increment Financing (TIF)

• Urban revitalization tool, but urban areas don’t always need to show unemployment problems

• Small firms and residents may have to relocate to make room for TIF district

• City uses tax revenues paid by a firm to directly assist that firm

• Allows cities to avoid red tape required to get intergovernmental aid– No need for voter approval

Tax Increment Financing (TIF)

• Spatial equity concerns: rural or low-income areas subsidize urban areas

• Overlapping jurisdictions (school districts) lose tax base within the district

• Offers nothing to existing businesses and residents

• Blighted areas may grow at the expense of the rest of the state

• Geographic substitution

Enterprise Zones

• Zones within which firms face fewer restrictions and lower taxes

• Firms have lower production costs and more freedom to innovate

• Main beneficiaries: landowners, building contractors

Enterprise Zones

• Firms may just relocate short distances to participate in the EZs– Backward linkages diverted from initially

viable region– Lower tax revenues mean higher taxes

elsewhere or less government spending– On average local governments in US lose

$59,000 for every job created with an EZ.

Arms race between the states

• Officials feel a need to do something to help the poor

• Beneficiaries easily identified

• Cost per taxpayer relatively small

• Negative effect on lowest 20% of income distribution when such programs are often funded with reduced social programs or increased income taxes.

In favor of local competition

• If it enhances efficiency– Can create agglomeration economies– Can increase use of local public goods and

decrease the average cost of using them– New jobs help retain young adult population

Against local competition

• Specifically contentious if competition is aimed at specific firms– Leads to inadequate levels of public goods and

services or higher taxes for same services– Firms often do not generate the advertised number of

jobs (winner’s curse)– Prisoner’s dilemma game among states– Net benefits spiral downward

• Federal Tax of 100% on all benefits? (Rolnick, 2000)

Appendix: Measuring an Area’s Economic Welfare

index living ofCost

income capitaPer living of Standard

65-16 aged Population

years 65 aged population years 15-0 aged PopulationRatio Dependency

Measuring an Area’s Economic Welfare

15 ageover Population

Employed People ofNumber Ratio Employment

15 ageover Population

mployedNumber Une EmployedNumber Rateion Participat ForceLabor

d) Unemploye Employed(

Unemployedratent Unemployme

Sazama’s index of inequality

5

1

2

5

20q

it

PIEQ qt

where t is the specific year, i is the category (gender, race, etc., if any), q is the income quintile and Piqt is the percentage of people in each category of the income quintile q during year t.

The smaller the index, the less is the inequality

Net Migration

Deaths Births- Population migration Net