Politicians have used subsidies to entice businesses to move to their region since the 1930s. But this has led to state and local governments becoming trapped by a prisoner’s dilemma of their own making.
The prisoner’s dilemma is perhaps the best-known lesson of game theory, and there’s growing evidence that policymakers of all stripes understand that the interstate and intercity competition for jobs is a real-world example of this unhappy situation.
The basic concept was developed in 1950 by Merrill Flood and Melvin Dresher of the RAND Corporation. The game works something like this: two prisoners are on trial for burglary, but the police do not have the evidence to convict and sentence either of them to any more than one year in jail.
A clever detective decides to separate the two prisoners and offer each a choice: if one of them confesses to the crime and turns in their partner, then the confessor will be released and serve no time while their partner serves ten years. If neither confesses, then they will both be imprisoned for a year; however, if both prisoners confess then they will both be jailed for 8 years.
The prisoners are placed in an impossible situation—with no information about their partner’s strategy, each option is dangerous for them.
The prisoner’s dilemma is a good representation of the situation in which government officials find themselves when businesses solicit subsidies to relocate or expand in a jurisdiction.
In the case of targeted economic development subsidies (TEDS), the site location consultants and businesses act as the clever detective by playing local governments against each other, revealing only limited (or sometimes false) information to extract more of what they want.
Government officials face an unenviable choice. Declining to offer subsidies may suggest to voters that their political representatives aren’t trying to improve the local economy. On the other hand, a large offer may signal that the politician is indeed serious about helping the local community, even if the effort to attract the company fails. A fundamental problem driving this issue is a public that widely believes that subsidies do indeed attract businesses.
Politicians often justify their subsidy offers by saying they need to cultivate a friendly “business climate”, but evidence shows that TEDS are correlated with a higher-tax environment that would likely be less appealing to businesses. A better approach would be to use the subsidy funds to reduce taxes and/or focus on the provision of pure public goods to make the city or state more appealing to all businesses, rather than focus on high-profile subsidy-seekers.
Local policymakers seem trapped in a vicious cycle where they see their counterparts in other cities and states as competitors in a race to attract new businesses. No politician wants to be seen as not trying to attract new business (or support existing businesses) and thereby lose out on potential (or currently existing) jobs. The default solution in most cases is to offer targeted subsidies, and as soon as one government breaks ranks to do so every other government feels the need to follow suit.
Industry leaders, politicians, and economic development officials know intuitively that this is a prisoner’s dilemma, and below we have gathered some quotes illustrating what they have to say about it:
Jim Edgar, “As Companies Seek Tax Deals, Governments Pay High Price,” New York Times, December 1, 2012:
“If you’ve got some states doing it, it’s hard for the others not to do it. It’s like unilaterally disarming.”
Sean O’Byrne, “As Companies Seek Tax Deals, Governments Pay High Price,” New York Times, December 1, 2012, speaking on the Kansas City “border war” between Kansas and Missouri:
“I just shake my head every time it happens, it just gives me a sick feeling in the pit of my stomach. It sounds like I’m talking myself out of a job, but there ought to be a law against what I’m doing.”
Alan Peters and Peter Fisher, “The Failures of Economic Development Incentives” 75 Journal of the American Planning Association 1 (2004), 27-37 at 32:
“Moreover, no matter what their economic conditions, most states and cities in the U.S. appear to believe that they are competing with each other for new investment. Wealthier places may be induced to make use of the ﬁscal advantages they have.”
Stephen Ellis and Cynthia Rogers, “Local Economic Development as a Prisoners' Dilemma: The Role of Business Climate,” Vol 30, No 3 (2000), 315-330 at 317:
“If a locality succeeds in attracting a firm, the nature of competition forces it to give the firm, in the form of incentives, all of the benefit derived from attracting the firm to the locality. Consequently, localities do not gain by competing for firms but they can lose by not competing. Localities are thus compelled to compete, not because they stand to gain anything, but because they can't afford to send a negative signal about their business climates.”
William Fulton, “Why States Keep Playing the Losing Tax-Incentive Game,” Governing, March 2013:
“And therein lies the biggest problem with America’s decentralized economic development incentive system: It may or may not work. In fact, there’s considerable evidence that it doesn’t work, but it operates kind of like the ante in a poker game. Throwing the money into the pot doesn’t mean you’ll win the game. All it means is that you get to play.”
Greg LeRoy with Philip Mattera & Kasia Tarczynska, “Ending the Economic War among the States: A Strategic Proposal,” at 1, February 2019:
“The costly competitions between states, as well as localities, when corporations (often represented by secretive site location consultants) stage auctions for economic development projects, compelling governments to offer huge tax breaks and other subsidies. Public officials in the competing locations are placed in a “prisoners’ dilemma,” forbidden by decades of practice from communicating with each other, lest they be blacklisted on future auctions. Worse than zero-sum, this is a net-loss game in which governments everywhere overspend, losing revenue that would otherwise support education, infrastructure and other public goods and services that benefit all employers.”
Birgit Klohs, “Amazon vs. everybody and Michigan’s place in tax break wars,” Michigan Advance, February 24, 2019:
“We all play this game. If Michigan were to unilaterally disarm, it would push development to other parts of country.”
And perhaps the most apropos quote, although not specifically regarding targeted economic development subsidies, is this:
“Strange game. The only winning move is not to play,” Joshua, WarGames
(This will be an ongoing project to collect such quotes. If you have suggestions we’d appreciate submissions to [email protected]).
Photo Credit: Martin Lopez/Pexels.