Courant’s1 main thesis is that in evaluating economic development policies we should primarily be interested in measuring the effects of those policies on changes in the level and distribution of economic welfare. To support his argument, Courant discusses the ways in which the analysis of the effects of policy on typical outcome measures (e.g. plant openings or employment growth) might or might not contribute to understanding about changes in welfare. In further support, he briefly reviews welfare economic theory in order to explain why policies directed at influencing typical outcome measures may actually decrease economic welfare. Finally, Courant suggests a research agenda for those interested in improving cost-benefit analysis of economic development policies. Although his article is nearly ten years old, Courant’s advice is still valuable to those interested in economic development policy.
Courant points out that politicians like to claim that they have created jobs, so it is no surprise that they will be interested in such measures as employment growth or plant openings since they provide tangible evidence of job “creation.” Researchers, however, have a different reason for focusing attention on those measures2: they may be good proxies for labor demand or economic welfare, or for processes that increase labor demand or economic welfare. But Courant cites two potential deficiencies in using research that focuses on such outcome measures. First, to make productive use of the research, it is necessary to understand the relationship between the output measure under study, such branch plant openings, and the variable of interest, such as economic welfare. He provides as a hypothetical example a study which determines that cutting inventory taxes increases the number of branch plants established by a muffler-parts supplier in a specific Midwestern state. Courant suggests that without further modeling of the state’s economy, the research provides no indication of whether a reduction in the tax will result in an increase in either employment or welfare. In his opinion, most research focuses too much on the impact of policies on the output measures and not enough on actual welfare effects.
Second, Courant points out that most research reveals the average effects of various policy measures and that this knowledge is of little use to policymakers unless their community is average in all relevant respects. He suggests that policymakers should instead be interested in whether their community is more like those that experienced large, small, positive, or negative effects as a result of the policy. In short, Courant concludes that most empirical research provides little useful guidance for designing economic development policy.
To get guidance for developing economic development policy, Courant suggests that we look to welfare economic theory. He explains that the mobility of capital and labor, and the size and openness of local and state economies, limits the ability of local economic policy to increase economic welfare. He summarizes the constraints in a proposition:
If (1) the local economy exhibits the usual diminishing returns to factors (technically, production sets are convex); if (2) existing taxes on mobile factors of production are levied on the benefit principle, if (3) there is no non-frictional unemployment, and if (4) the costs of local economic development are locally borne; any policy that subsidizes local business location must reduce economic welfare in the local economy (p. 867).
When each of the numbered assumptions of his proposition holds, any business subsidy will have costs exceeding its benefits, even if it succeeds in increasing employment. Courant compares subsidy provision under those conditions to creating a gold rush by purchasing gold on the open market and burying it. Someone will find it worthwhile to dig up the gold, and may hire workers to do the work, but the costs of transporting and burying the gold are lost.
Often, however, all the assumptions may not hold. In those cases, there may be opportunities for successful implementation of economic development policy. For example, if assumption (2) doesn’t hold – if taxes on capital are not benefit taxes – then tax abatements, properly structured, can increase both business investment and local economic welfare.3 Similarly, Courant suggests that in areas with high structural unemployment – a violation of assumption (3) – there may be a case for policies that increase demand for unemployed workers, even at the cost of some efficiency, particularly if there is evidence that the increase has long-term effects beyond the initial shock.
The remaining assumption from Courant’s proposition is the absence of market failure in the local economy (1). He points out that when traditional market failures exist such as public goods, externalities, natural monopoly, or information asymmetry then there is a possibility that some government policy might be able to correct the failure and improve efficiency at some cost less than the benefit it provides.4
Courant also discusses market failure in the form of agglomeration or localization economies in which the introduction of new business activity in a local economy decreases the average cost of existing business activity, either through economies of scale or through synergistic interaction with existing businesses. He doesn’t appear very optimistic about prospects for exploiting agglomeration or localization economies, due to the scarcity of accurate and useful information.
Finally, Courant suggests a research agenda for economists and policymakers interested in economic development. First, he suggests performing measurements of the benefits to business and the costs to government of public services. This information can be used by local governments to determine service levels and to set user charges or taxes. Second, he suggests that the costs of incentives be calculated on a case-by-case basis for each level of government participating. This is necessary if each level of government is to determine whether costs are commensurate with benefits. Third, he suggests that it is important to study the distributional aspects of government policies. In other words, don’t just count the jobs “created”; determine who gets them. Finally, he suggests that more work is needed in educating politicians (and the general public) about the relationship between job creation and local economic welfare.
I performed a fairly extensive review of economic development literature for my Master’s thesis. To the extent that Courant’s criticism of economic development literature is valid – and I believe it is – then much of the post-1994 literature I reviewed for my thesis suffers from the same deficiencies.5 That is the main reason that I believe Courant’s article hasn’t diminished in value during the ten years since its publication. I have also frequently seen the article cited in subsequent economic development literature.
In conclusion, I recommend the Courant article to those interested in the evaluation of economic development programs. It gives a good review of deficiencies of typical cost-benefit analysis of economic development programs and suggestions for how to correct the deficiencies and make the analysis more useful to public officials.
1. Courant, P.N. (1994). How would you know a good economic development policy if you tripped over one? Hint: Don’t just count jobs. National Tax Journal, 47, 863-881.
2. Courant provides a rather lengthy list of outcome measures that have been analyzed empirically (p. 864). For the purposes of this summary they all boil down to either employment growth or plant openings.
3. Courant also points out that the best long-term policy, with regard to taxes on capital, is to structure the taxes as benefit taxes in the first place (p. 871).
4. Courant notes public infrastructure complementary with private production as the prototypical example and in a footnote he cites literature concluding that the best economic development policy is good, i.e. effective and efficient, government.
5. Those interested in further reading might begin with these three literature reviews:
Wasylenko, M. (1997). Taxation and economic development: The state of the economic literature. New England Economic Review, March/April, 37-52.
Fisher, R. C. (1997). The effects of state and local public services on economic development. New England Economic Review, March/April, 53-82.
Buss, T. F. (2001). The effect of state tax incentives on economic growth and firm location decisions: An overview of the literature. Economic Development Quarterly, 15, 90-105.
Posted by Chip on May 15, 2004 at 08:02 AM | TrackBack