Business Relocations and the Prisoners Dilemna

As I have written before, one of the favorite past-times of local and state politicians is to hand out grants, subsidies, and tax breaks for businesses to relocate to their district.  Billions and billions of dollars are given out every year to everyone from movie producers to sports teams to Wal-marts in order to "bring jobs" to the local community.

Economists have argued for years that these subsidies are a total waste (more on this below) but the Club for Growth links a great article demonstrating that they are not only a waste, they also are downright fraudulent.

Gov. George Pataki's administration gives millions of dollars every year to
businesses that promise to hire more people or retain jobs. It's a promise that
is often broken.

Almost half of those companies helped by New York taxpayers fell short of the
job targets that are part of their deals with the state, records show.

In fact, a quarter of the businesses took taxpayers' money and loans, then
cut jobs.

The article is quite detailed, but here is one example:

Take the case of Ingram Micro, a global computer-parts wholesaler with a
distribution center near Buffalo.

In 1999, it accepted $675,000 in taxpayers' money and promised to add 542
workers. Instead, it cut its workforce by nearly 400.

The state demanded a penalty of $176,985, but an Ingram spokesman said it has
not paid and is negotiating with the state.

Last month, Ingram Micro announced it will lay off another 120 Buffalo
workers and send the work overseas.

OOPS!  One is driven to ask the obvious question - why are these subsidy programs so popular?  I can think of at least three explanations.

The first explanation is political.  These subsidy programs tend to satisfy important bases from both political parties, thereby ensuring their bipartisan support.  Democrats like the idea of spending government money to create jobs, while Republicans like tax breaks and supporting business.  This explanation is unsatisfying.

The second explanation probably hits closer to the mark, and it is the cynical-political explanation that politicians like buying votes with other people's money.  When they campaign for re-election, politicians like to have a couple of "scalps" they can wave around to show the voters that they are doing something (a consistent history of sober fiscal responsibility seems to be unappealing, I guess).  Being able to say "I brought Microsoft to the town of West Nowheresville" or better yet "I brought 1000 jobs to this community" are political favorites of both parties (Here is what New Yorkers are really paying for - the ability of George Pataki to post on his web site a press release saying "Bedding Company to Create 240 New Jobs in New Baltimore").   These are priceless campaign slogans that didn't cost the politician a dime, since they were funded by taxpayers.

The third explanation comes from economics and is the most interesting.  If you shed any notion of morality or ethics (e.g. that one has no right to give one person's money to another just to make their re-election more likely) then politicians who are approached by a company looking for a handout for business relocation faces what is called the prisoner's dilemma.  Many of you may know what that is, but for those who don't, here is a quick explanation, via the Stanford Encyclopedia of Philosophy:

Tanya and Cinque have been arrested for robbing the Hibernia Savings
Bank and placed in separate isolation cells. Both care much more about
their personal freedom than about the welfare of their accomplice. A
clever prosecutor makes the following offer to each. "You may choose
to confess or remain silent. If you confess and your accomplice
remains silent I will drop all charges against you and use your
testimony to ensure that your accomplice does serious time. Likewise,
if your accomplice confesses while you remain silent, they will go
free while you do the time. If you both confess I get two convictions,
but I'll see to it that you both get early parole.  If you both remain
silent, I'll have to settle for token sentences on firearms possession
charges. If you wish to confess, you must leave a note with the jailer
before my return tomorrow morning."

The "dilemma" faced by the prisoners here is that, whatever the other
does, each is better off confessing than remaining silent. But the
outcome obtained when both confess is worse for each than the outcome
they would have obtained had both remained silent.

I hope you can see the parallel to subsidizing business relocations (replace prisoner with "governor" and confess with "subsidize").  In a libertarian world where politicians all just say no to subsidizing businesses, then businesses would end up reasonably evenly distributed across the country (due to labor markets, distribution requirements, etc.) and taxpayers would not be paying any subsidies.  However, because politicians fear that their community will lose if they don't play the subsidy game like everyone else (the equivalent of staying silent while your partner is ratting you out in prison) what we end up with is still having businesses reasonably evenly distributed across the country, but with massive subsidies in place.

To see this clearer, lets take the example of Major League Baseball (MLB).  We all know that cities and states have been massively subsidizing new baseball stadiums for billionaire team owners.  Lets for a minute say this never happened - that somehow, the mayors of the 50 largest cities got together in 1960 and made a no-stadium-subsidy pledge.  First, would MLB still exist?  Sure!  Teams like the Giants have proven that baseball can work financially in a private park, and baseball thrived for years with private parks.  OK, would baseball be in the same cities?  Well, without subsidies, baseball would be in the largest cities, like New York and LA and Chicago, which is exactly where they are now.  The odd city here or there might be different, e.g. Tampa Bay might never have gotten a team, but that would in retrospect have been a good thing.

The net effect in baseball is the same as it is in every other industry:  Relocation subsidies, when everyone is playing the game, do nothing to substantially affect the location of jobs and businesses, but rather just transfer taxpayer money to business owners and workers.

This subsidy game reminds me of the line at the end of the movie Wargames

A strange game.  The only winning move is not to play.

Postscript:  As a libertarian, I have gone through phases on targeted tax breaks.
There have been times in my life when I have supported tax breaks of
any kind to any person for any reason, by the logic that any reduction
in taxation is a good thing.  I know there are many libertarians that
take this position.  Over time, I have changed my mind.  First,
targeted tax breaks seldom in practice reduce the overall tax burden -
they tend to be made up somewhere else.  Second, these tax breaks tend
to be gross examples of the kind of government coercive technocratic
meddling in commerce and individual decision-making
that I despise.
Almost always, they are trying to get individuals to do something they
would not otherwise do, so in practice they tend to be distorting and
carry all kinds of unintended consequences (as well as being
philosophically repugnant).

Update 9/29/05:  We are suddenly getting a bunch of visitors from Econ.Aplia.com, which I presume is related to a university assignment or blog post somewhere.  Can someone email me in at the email in the right bar if folks are coming here from a particular site or university.  Just curious.

Update 9/30/05:  Thanks to a couple of emailers, the cat (err, bulldog?) is out of the bag and I know that Yalies are in the house.  Welcome.  I don't know if they teach free-markets any more in college, but your welcome to look around and take a walk on the libertarian dark side.  Good luck with economics, even if you did pick the wrong school.  --Coyote, Princeton '84, Harvard MBA '89

Update Again:  By the way, I discuss here the odd issue of why I and so many people misspell "dilemma" as "dilemna", as I did in this post.

  • http://chocolateandgoldcoins.blogspot.com Michael H.

    Hi Coyote
    Very nice post.
    This is an issue that upsets almost everyone; it is a wonder politicians choose to do this. Actually it's not a wonder. All that help to these companies will "pay off" for the politicians someday (probably sooner than later).

    I read that the 6th Circuit Federal Appeals Court struck down one of these deals recently under the commerce clause. I think that might be judicial activism but I like the idea of Congress outlawing these deals under commerce clause. Governments should not be using the people's money to make special deals with companies.
    Here is a link to the Ohio case I mentioned above: http://www.cbpp.org/2-18-05sfp.htm

  • http://www.slackermanager.com/slacker_manager/2005/05/the_carnival_of.html Slacker Manager

    The Carnival of the Capitalists for May 30th '05

    Welcome to the May 30, 2005 volume of The Carnival of the Capitalists, Capitalism meets Satisficing and welcome to the Slacker Manager. “Slackers are opportunists. They’re very good at seeking out and doing what they enjoy. Problem is, the

  • http://www.halfsigma.com Half Sigma

    "I read that the 6th Circuit Federal Appeals Court struck down one of these deals recently under the commerce clause."

    Haven't read about it, but before I read your comment I was thinking about whether the Commerce Clause might prohibit these sorts of activities.