Undermining Competition Is No Way to Compete

Money is tight for state and local governments, and that’s never more obvious than when lawmakers work to finalize budgets before the new fiscal year starts on July 1. A common priority for lawmakers, particularly in the revenue department, is to bring new business to the state. That’s why various state economic development websites claim to offer would-be-entrepreneurs the perfect set of enticements to start or expand one’s businesses.

Even on the national stage, President Obama frequently cites the need to compete with India and China in calling for more spending (or, to use his preferred phrase, “more investment”). Unfortunately, politicians often believe that the way to out-compete other governments is to undermine genuine competition at home by offering some firms and industries an uncompetitive edge.

This week, for example, the D.C. Council unanimously voted to give the daily deal company, LivingSocial, a $32,500,000 get-out-of-tax free card. Two years ago, the state of Illinois offered LivingSocial rival, Groupon, a similar though less-lucrative deal: $3,500,000 in state funds to hire 250 employees. In some industries, these types of special deals are business as usual. Film production companies, for example, can get special tax treatment in 40 out of 50 states. In Virginia, film production companies pay no sales tax on production-related products and are allowed refundable individual and corporate income tax credits. Needless to say, Virginia companies in other lines of work aren’t so lucky.

Interestingly, these types of deals are as likely to be opposed by progressives as they are to be opposed by market-oriented economists. In 2010, the left-leaning Center on Budget and Policy Priorities released a report that was critical of film subsidies. The author argued:

Like a Hollywood fantasy, claims that tax subsidies for film and TV productions — which nearly every state has adopted in recent years — are cost-effective tools of job and income creation are more fiction than fact. In the harsh light of reality, film subsidies offer little bang for the buck.

I couldn’t agree more. Back in March, I also found myself largely agreeing with the left-of-center D.C. Fiscal Policy Institute’s Ed Lazere, as we both lambasted government business incentives on the Kojo Nnamdi Show.

Though special deals for particular firms or industries are often sold in the name of competition, they are exceedingly anti-competitive. When one firm or one industry obtains a privilege from government, it obtains a measure of monopoly power. While the profits of the firm go up, so do the prices that consumers pay. And while it is harder to quantify, would-be competitors who aren’t so lucky to have government’s favor also lose. But that’s not all. Privileged firms tend to offer lower-quality products and they tend to be less-attentive to cost-cutting. Then there is the social waste associated with obtaining privileges: each year, firms expend millions of dollars on lobbying and other political activity in an attempt to obtain privilege. At the societal level, privileges undermine long-run growth and may even lead to short-term macroeconomic instability. Government-granted privileges are often dispensed on the basis of personal connection rather than merit. This, in turn, can undermine the legitimacy of both the public and the private sector. In a new paper, out soon, I document these and other problems with government-granted privilege.

There is nothing wrong with a government and its leaders attempting to compete with other governments. But the best way to compete is to offer a sound,economically free, environment in which any firm that creates value for its customers is free to prosper. It is a good indication that a government has failed to create such an environment if it feels the need to suspend or otherwise alter the rules of the game for certain favored firms and industries.