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How to deal with the growing incentives competition

This article was originally published in the Columbia FDI Perspectives series of the Columbia Center for Sustainable Investment, #131, September 29. I have left it largely unchanged, except for adding a link and a comment, and correcting a grammatical error.

 

As I discussed in an earlier Perspective,[1] the use of investment incentives is pervasive and growing. The most recent example [this was completed prior to the Tesla auction] of a big bidding war was when Boeing threatened to move production of its 777-X aircraft out of Washington state, prompting some 20 states to offer incentive packages to the company (including $1.7 billion from Missouri). In the end, Washington gave Boeing a package of tax incentives worth a record-breaking $8.7 billion over the 2025 – 2040 period to stay, and the unions made substantial concessions regarding pensions.

What can be done to control such auctions, which are often international in scope? The most robust control method, regional in scope, is embodied in the European Union (EU) Guidelines on Regional Aid. These rules guarantee transparency, set variable limits (in terms of “aid intensity,” which equals subsidy/investment) for aid levels based on each region’s per capita income, and reduce the value of aid to large investment projects over €50 million. They require projects to stay at least five years and mandate the use of clawbacks for firms that fail to meet their commitments in investment contracts. Moreover, the guidelines provide demerits for firms in a dominant position in their industry, although they do not mandate a particular reduction in aid.

The other international control measure comes under the World Trade Organization (WTO) Agreement on Subsidies and Countervailing Measures. While these rules are more tailored to production subsidies than to investment incentives, the latter certainly come under the purview of the Agreement as well, as illustrated by the EU’s successful complaint against subsidies for Boeing in the states of Washington, Illinois and Kansas.

However, this case also illustrates the limits of WTO subsidy control. The EU has already filed a compliance complaint,[2] and there is little likelihood the United States (US) will comply anytime soon (the US Trade Representative’s office claims that the US has complied, but as long as the state and local tax credits continue in Washington state, that is not correct). Indeed, as mentioned, Washington state has approved a new round of subsidies for Boeing that is likely to initiate a new WTO dispute.

While the WTO rules require frequent notification of subsidies, there is no penalty for failure to notify, with the result that subsidy notifications are of very uneven quality. Federal states outside the EU frequently make poor quality notifications regarding subnational subsidies. Finally, the TRIMs and GATS agreements regulate performance requirements, but not investment incentives.

What, then, can be done against incentives competition? First, there must be continuing efforts to improve the transparency of location subsidies. This is necessary for jurisdictions to make effective investment promotion policy (especially in a region such as the European Union and the United States, where there are many competing governments) as well as for international policy discussion.

Second, the EU’s example shows that incorporating subsidies rules into regional agreements can be a fruitful way to bring bidding wars under control. For many products, such as automobile assembly and steel, corporate location decisions still focus on a single region, meaning that such rules would be geographically comprehensive enough for a variety of industries. Consequently, major stakeholders—including the Columbia Center on Sustainable Investment, the International Institute for Sustainable Development, the United Nations Conference on Trade and Development, the World Association of Investment Promotion Agencies, the International Monetary Fund, the World Bank, and the Organisation for Economic Co-operation and Development—should unite in promoting location subsidy guidelines within regional trade areas. There are no doubt numerous other non-governmental organizations that would endorse such a move.

Third, WTO notifications should be strengthened. Incomplete notifications should be flagged and countries involved should be pressured to give cost estimates for subsidies at all levels of government. Still, it is difficult to envision that sanctions for non-compliance will be introduced.

Fourth, no-raiding zones could be a first step for countries to negotiate controls over investment subsidies. A no-raiding agreement simply commits a state to not give a subsidy to relocate an existing facility from another state; it would not apply to new investments. Their track record is mixed—several agreements among US states failed quickly, but Australia (2003-2011) and Canada (1994-present) have been more successful.[3] Despite these mixed results, it is easier to demonstrate to policymakers the futility of relocation subsidies, since they create no new jobs, than it is to do for incentives for new investment, which could make this a more feasible first step.

Though national and subnational jurisdictions have incentives to offer location subsidies, these proposed measures would help keep their value to more reasonable levels with a lower likelihood of distorting competition and international investment flows.

 

[1] Kenneth P. Thomas, “Investment incentives and the global competition for capital,” Columbia FDI Perspectives, No. 54, December 30, 2011.

[2] Emelie Rutherford, “EU wants $12 billion in U.S. sanctions over Boeing subsidy spat,” Defense Daily, September 27, 2012.

[3] Kenneth P. Thomas,  “Regulating investment attraction: Canada’s Code of Conduct on Incentives in a comparative context,” 37 Canadian Public Policy, 3 (2011), pp. 343-357; Kenneth P. Thomas, “EU control of state aid to mobile investment in comparative perspective,” 34 Journal of European Integration 6 (2012), pp. 567-584.

From: Kenneth P. Thomas, “How to deal with the growing incentives competition,” Columbia FDI Perspectives, No. 131, September 29, 2014. Reprinted with permission from the Columbia Center on Sustainable Investment (ccsi.columbia.edu).

Cross-posted from Middle Class Political Economist.

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Tesla wants $500 million for its Gigafactory

Leigh McIlvaine (@Leigh M.) of Good Jobs First alerted me to this article on what Tesla Motors wants in incentives to land its $5 billion Gigafactory: $500 million. This massive 6500 worker facility will produce the next generation of batteries in order to introduce a less expensive line of cars in 2017, the Tesla Model 3. This would be a more affordable vehicle than the widely praised Model S, which starts at $69,900.

I’m not joking about the praise: Consumer Reports, my go-to source for product testing due to the fact that it does not accept ads and thus has complete independence, gave the Model S its best-ever score of 99 out of 100 when it tested the car earlier this year. It also leads the magazine’s subscriber survey of customer satisfaction, with 99% of owners saying they would buy the car again. This is a vehicle, and a company, that is generating some serious excitement.

It’s no surprise that the Gigafactory is generating serious excitement, too. 6500 jobs, a $5 billion investment, and cutting-edge technology is a heady mix for an economic development official. San Antonio, where Toyota makes pickup trucks, jumped into the auction quickly, offering “almost $800 million in incentives.” Although Tesla has broken ground at a location near Reno, Nevada, last week CEO Elon Musk announced plans to break ground at one or two other sites as well. The company clearly considers speed to be of the essence.

It’s unclear exactly what the company wants financially, and Tesla did not respond to my request for an interview to seek clarification of some important points. To be specific, does it want that $500 million in cash, in the form of property tax breaks over some number of years, land and infrastructure, or what? Most importantly, is Tesla’s goal speed plus $500 million, or speed plus the highest bid? The company has sent mixed signals on this question.

As Forbes wrote, “Last week, Musk said that Tesla wanted to make sure a package was right for the winning state, as well as for Tesla.” In the article’s very next sentence, however, Tesla VP for communications and marketing, Simon Sproule, said, “Any publicly traded company has a fiduciary responsibility to get the best deal for its investment.” Musk’s comment seems to imply that $500 million is all the company wants. By contrast, fiduciary responsibility has often been used to justify a company going after the maximum incentives possible. Forbes quotes the business editor of the San Antonio Express-News that it was hard to tell if Tesla is conducting “a search (or) a shakedown.”

Sproule disputed the shakedown thesis, despite invoking “fiduciary responsibility.” How should we think about this project?

On the one hand, we could take Musk’s comments as meaning that the company wants $500 million, no more, no less. Given that he expressed it as a percentage of the investment, my intuition is that we should assume that means $500 million in cash or cash equivalents like free land (my guess is that San Antonio’s “$800 million” was mainly tax breaks, which would have a lower present value). If that’s true, Sproule’s contention that the incentive is not really so expensive is actually true in a comparative sense. A 10% aid intensity (subsidy/investment) would be the second-lowest for a large automotive facility in the modern history of megadeals. It would even probably be legal in the European Union under its Regional Aid Guidelines, if it were located in one of the EU’s poorer regions. Moreover, the cost per job would be $76,923, substantially below the $100,000-$150,000 level common for most U.S. automobile assembly plants.

Of course, cost alone doesn’t make a deal a good one. In particular, if Tesla wants its incentives up front, there is a substantial risk that the project won’t ultimately produce 6500 jobs, or that changes in the market could even lead to the Gigafactory closing. New Mexico lawmakers have certainly recognized the importance of this vis-a-vis Tesla. In my email to Tesla, I asked what taxpayer protections, like clawbacks, the company is prepared to accept. Alas, no response, but I will update if I do hear back from Tesla.

On the other hand, if $500 million really is just meant as the minimum acceptable opening bid, all bets are off for saying how (comparatively) good a deal it might be.

Once again, we are confronting the issue of information asymmetry: government officials have less information about what the company really wants than the company has about the various governments, and of course its own intentions. This is a major source of bargaining power for companies shopping around for an investment location. If Musk really means that Tesla will voluntarily limit the incentives it requires, that would be a refreshing change from the typical bidding wars we have seen in so many industries. Or, it could just be business as usual, with the highest bid (adjusted for cost structure at the different locations) winning. We just don’t know, but the decision is expected by the end of the year.

Cross-posted from Middle Class Political Economist.

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