Chip Taylor

Economic development dealmaking

A short article in the Washington Post demonstrates some of the issues involved in the negotiation of business location incentives:

Enticed by nearly $1 million in incentives, biotech company Novavax Inc. said yesterday it is moving its corporate headquarters from Columbia to the Philadelphia area.

The company, which said it employed 175 people as of July 31, did not specify how many jobs it will move out of Maryland, and company officials did not respond to requests for comment.

So, they're moving to grab the $1 million, right? Well... That's not exactly what the CEO says:

In a statement announcing the move, Novavax said the new Pennsylvania facility will "over time allow us to bring research, development, and additional manufacturing under one roof." But it also said 20 scientists working in its vaccine business will remain at a facility in Rockville.

Novavax, whose lead product is a hormone-replacement lotion for women, said it wanted to consolidate its business in Malvern, Pa., near its principal manufacturing facility.

"The Philadelphia region is home to many companies in the biotech and pharmaceutical industry and offers a professional, well-educated workforce that will allow us to recruit top scientific, manufacturing, and commercial talent with pharmaceutical industry experience," Nelson M. Sims, the company's president and chief executive, said in a written statement.

So, if Philly is a better location for Novavax, why were incentives needed to facilitate the move? My view is that they probably weren't, but that they get offered for one or more reasons. First, there is a view that offering incentives provides a clear message about the state's and community's business climate. A big stack of cash is a nice way to extend the hand of friendship and show the relocating firm that government officials are truly interested in their success.

Second, there are the political incentives. As economic development (read, job creation) has become a primary state function, officials try to avoid being seen "losing" a firm that expressed interest in locating in their jurisdiction. Even if the incentive grant results in a net financial loss to the state, community, and taxpayers (as is likely) that loss is nebulous and abstract. A new factory, on the other hand, is concrete and affords the opportunity for ribbon-cutting ceremonies and the like. On net, the chance for political gain outweighs the likelihood of economic loss.

"This is a competitive business and we don't like losing," said Richard W. Story, chief executive of the Howard County Economic Development Authority. "The fact is we are very used to winning, and losing any company is bad," and losing a headquarters like Novavax is especially bad, he said.

This leads into the third thing:

Story said financial incentives were discussed with a Novavax consultant, but he deferred questions about the discussions to the state's Department of Business and Economic Development. Officials there could not be reached for comment.

To extract the incentives from Philly, Novavax had to at least appear to have a realistic alternative -- in this case remaining where they were. Novavax needed officials in their present location to believe that some incentive might convince them to stay. That bargaining had to take place in order to convince Philly officials that they needed to sweeten the pot to get Novavax to move. Of course, this may leave officials in the original location feeling a little cheap and used:

However, Story said, "as we look back on it now this was pretty much a done deal as to where the CEO wanted to consolidate."

That could well be true, although there seems to be a hint of sour grapes, as well.

This whole situation puts the company in an interesting position. They need officials with the power to grant incentives to believe that the incentives are influential in the location decision, lest they decline to offer them. But once the decision is made, they can't say, "Well, they offered us a million dollars, so we're moving." That would make them look like... well... prostitutes.

Those are considerations in the game theoretic view of incentives. Firm officials appear to have the upper hand in the game, because only they possess information about the true importance of the incentives.

Another view of incentives is as a way to discriminate between more-mobile and less-mobile capital in property taxation. Property taxes date back to a time when capital was much less mobile than it is today. Under those conditions, local governments could tax businesses for public services above the level at which they benefit from the services and use the surplus to subsidize services for individuals. Individuals who vote in elections, I might add.

But the ability of local governments to soak businesses for excess taxes has declined as technological advances have made businesses more mobile. Local governments could respond by lowering business taxes across the board. The Oates-Schwab model predicts this would happen; that communities will tax businesses at the benefit level. But they don't do that. Not every business is equally mobile. Instead, they use tax abatements and other incentives to effectively lower the tax rate on mobile capital while maintaining the high rate on immobile capital.

I think both views have a lot of validity. Taken together, they indicate that the use of location incentives as a means of interjurisdictional competition isn't going away any time soon.

In the meantime, I've got a gripe about the way incentives are reported. The top of the article mentioned "nearly $1 million in incentives." They are described more fully later:

Pennsylvania economic development officials said they sweetened the pot, offering what they described as an "aggressive" incentive package including a $400,000 opportunity grant, a machinery and equipment loan of up to $500,000, and $37,500 in custom job training.

That's more like a half million dollar incentive package: $437,500 for the grant and the cusomized training, plus whatever interest reduction they got on the loan. A $500,000 loan isn't nearly the same incentive as a $400,000 grant. Reporters should quit just adding them up as if they were equivalent.