Guest post: Greg Mankiw doesn’t understand competitio​n for investment

by Kenneth Thomas of Middle Class Political Economy

Greg Mankiw doesn’t understand competitio​n for investment

Greg Mankiw’s column in Sunday’s New York Times makes the case that competition between governments is a good thing, that it makes them more efficient in the same way that competition among firms does. He paints it as also being about choosing re-distributionist policies or not, with Brad DeLong and Harold Pollack both ably making the case that of course governments should engage in redistribution.

As author of Competing for Capital, however, I am more interested in the question of whether government competition for investment leads to more efficient outcomes. The answer, in short, is that it does not. Indeed, competition for investment leads to economic inefficiency, heightened income inequality, and rent-seeking behavior by firms (a further cause ofinefficiency).

Mankiw claims:

…competition among governments leads to better governance. In choosing where to live, people can compare public services and taxes. They are attracted to towns that use tax dollars wisely….The argument applies not only to people but also to capital. Because capital is more mobile than labor, competition among governments significantly constrains how capital is taxed. Corporations benefit from various government services, including infrastructure, the protection of property rights and the enforcement of contracts. But if taxes vastly exceed these benefits, businesses can – and often – move to places offering a better mix of tax and services.

Mankiw doesn’t stop to think about what this competition looks like in the real world. To attract mobile capital, immobile governments offer a dizzying array of fiscal, financial, and regulatory incentives to companies in sums that have been growing over time for U.S. state and local governments, as I document in Competing for Capital and Investment Incentives and the Global Competition for Capital. His discussion centers on the reduction of corporate income tax rates, which is surely a part of the competition, but which is no longer an issue when an individual firm is negotiating with an individual government.

At that level, the issues then become more concrete: Can we keep our employees’ state withholding tax? Can we get out of paying taxes every other company has to pay? Will you give us a cash grant? The list goes on and on. As governments make varying concessions on these issues, you then begin to see the consequences: discrimination among firms (especially to the detriment of small business); overuse and mis-location of capital as subsidies distort investment decisions; a more unequal post-tax, post-subsidy distribution of income than would have existed in the absence of incentive use (a corollary of the fact noted by Mankiw that “capital is more mobile than labor”); and at times the subsidization of environmentally harmful projects. Moreover, many location incentives are actually relocation incentives, paying companies at times over $100 million to move across a state line while staying in the same metropolitan area, with no economic benefit for the region or the country as a whole (Cerner-OnGoal, now in Kansas rather than Kansas City, is a good case in point).

Once upon a time, about 50 years ago in this country, companies made their investment decisions based on their best estimate of the economic case for various locations without requesting subsidies. On the rare occasion when a company did ask for government support, it was at levels that would appear quaint today. For example, when Chrysler built its Belvidere, Illinois, assembly plant in the early 1960s, it asked for the city to run a sewer line out to the facility–and it even lent the city the money to do it.

Today, companies have learned that the site location decision is a great opportunity to extract rents from immobile governments, and invest considerable resources into doing just that. An entire industry has sprung up to take advantage of businesses’ informational advantages over governments–and, indeed, intensify that asymmetry–to make rent extraction as effective (not “efficient”!) as possible.

Finally, let’s reflect on the force that makes this process happen, capital mobility. The fact that capital has far greater ability to move geographically than labor does, and that governments of course are geographically bound to one place, is a source of power for owners of capital. Modern economists, especially conservatives and libertarians, often have great difficulty acknowledging the role of power in market transactions, though their ostensible hero, Adam Smith, did not. To treat this power as a natural phenomenon rather than a social one, as Mankiw does, is dangerously close to saying that might makes right. But that’s not the way things are supposed to work in a democratic society, or a moral one.

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