Watch Dr. Farren's testimony on YouTube.
Chair Abney, Vice Chairs Slater and Marszalkowski, and members of the House Finance Committee:
My name is Michael Farren, and my research at the Mercatus Center at George Mason University focuses on evaluating government efforts to foster economic development. I am grateful for the invitation to discuss the problems associated with economic development subsidies and the possible solutions available for Rhode Island.
Today, I will illustrate why economic development subsidies remain a problem despite growing agreement that they should be phased out and how an interstate compact offers an opportunity for a cooperative solution.
Academic research shows that economic development subsidies generally fail to achieve their stated goals. That is, they do not result in broad improvements in local and state welfare (although they obviously benefit the companies receiving them). This occurs for several reasons:
- The taxes needed to fund economic development subsidies create a negative economic effect that can reduce—or even exceed—the stimulating effect of the subsidy.
- Subsidies disrupt the normal workings of a healthy market and cause economic waste by
- protecting privileged companies from competition, enabling less efficient production,
- encouraging companies to make excessively risky bets or providing incentives for investment and production that are suboptimal, and
- encouraging companies to spend resources on lobbying rather than on focusing on customers.
- On a national level, subsidies for economic development are, at their very best, a zero-sum game. That is, gains in one location are offset by losses elsewhere. Consequently, the strategy fails improve economic outcomes for all Americans.
Despite these adverse economic outcomes, political-economic analysis suggests that governments continue to pursue economic development subsidies because the subsidies appear to be beneficial for the policymakers who support them:
- Academic research has shown that politicians seem to benefit by being seen as “doing something” to improve the local economy. That is, good intentions and the short-term goal of good optics appear to matter more (especially with regard to reelection campaigns) than the real long-term economic effects (which are hard to accurately measure).
- Most nonacademic studies of economic development subsidies use a “benefits-only” analysis that ignores costs, including the economic impact of the taxes needed to fund the subsidies, creating a culture of misinformation regarding the expected effect of the subsidies.
- The uneven distribution of benefits (which are concentrated on the subsidy recipients) and costs (which are spread out across all other taxpayers) means that the recipients have a strong incentive to lobby for their subsidies, whereas the many dispersed taxpayers have difficulty mounting an effective protest.
- The pressure to offer subsidies is particularly difficult to resist when politicians in other cities and states engage in the practice, creating a prisoner’s dilemma where a policymaker feels compelled to support offering subsidies, even if doing so doesn’t seem right.
There is reason for optimism today. The interstate compact that H 5316 would enter into offers a path out of this self-destructive vicious cycle. The ability of states to enact legislation to enter into a compact is enshrined in the US Constitution, and compacts provide a credible way for policymakers to commit to cooperation. The confidence such a commitment provides is critical because it removes the perceived vulnerability that comes from unilaterally exiting an arms race—even when the arms race causes more harm than benefit.
With the security offered by a compact, forward-thinking policymakers will be able to shift the paradigm to one where states create economic development by fully focusing on becoming great places to live, rather than wasting time courting corporations’ affection.
Thank you for the opportunity to speak to you today. I look forward to your questions.
Michael D. Farren and Matthew D. Mitchell, “Targeted Economic Development Subsidies Don’t Work. An Interstate Compact Could End Them” (Policy Spotlight).
Michael D. Farren and Matthew D. Mitchell, “Interstate Compacts against Economic Development Subsidies: How to Stop the Economic Race to the Bottom” (Research Summary).
Matthew D. Mitchell et al., “Targeted Economic Development Subsidies Don’t Work: Negligible Community Benefits and Economic Development” (Research Summary).