Beating Them At Their Own Game: Chapter 1


Site Selection, Incentives, and Jobs

Let's say you're an executive at a medium-sized or large manufacturing company. Your products are sold throughout the United States. Like many American manufacturers, your business has enjoyed especially rapid growth in foreign markets over the past decade. Overall sales are up; projections show that solid growth will continue. Existing production is approaching the limits of the company's capacity. So it's time to expand.

How? You, and other members of the team charged with making the decision, first consider whether the company should simply modernize an existing factory to expand output by increasing productivity. But you quickly realize that won't be enough to meet the demand from your customers.

Perhaps, then, the solution is to enlarge one or more existing plants. Alternatively, you could decide to build a new plant — either near an existing facility, or in another part of the country, or at an offshore location near your most important foreign customers.

If the company is large (say, in the Fortune 500), you will likely have in-house experts whose full-time job is siting and building new corporate facilities. Or perhaps you'll hire a consultant who specializes in such services. In either case, the decision process will involve an exhaustive look at literally dozens of factors in each of numerous broad categories — geographic location, capital investment, workforce, infrastructure and utility needs, operating costs, timetable, and quality of life.

As one illustration, Conway Data Inc. — the publisher of Site Selection, a leading magazine for corporate location executives — compiles a checklist with 21 different sections relating to selection of a new facility site. The list starts with corporate strategy and other elements of pre-search planning, extends through location and site factors such as market and cost data, and ends with questions about leasing versus buying the facility. The details of that checklist show the range of state government policies and programs that are taken into account.

What does all this mean? At least three things:

  • First, and not surprisingly, companies making major investments of their owners' capital (whether public stockholders or private owners) do so very carefully — and many different factors can affect a decision as to whether investing at a particular site is likely to pay off.
  • Elements of both the general business climate (taxes, attitudes of state officials toward industry) and special economic development programs (tax incentives, financing programs) can affect a site selection decision.
  • New York has a chance of winning — but not if we never even play the game.

Getting onto the short list

Site selection executives and economic developers say that, when it comes to decisions about the largest and most important facilities, the early process allows fairly easy winnowing of scores of potential sites using just the broadest questions.

"The focus typically is on macro wage differentials, transportation variations (in the case of manufacturing facilities), and key fatal flaw criteria as developed by the company/consultant, i.e. right-to-work state, proximity to university with engineering school, port facilities, etc.," one leading consultant, Robert Ady of Deloitte & Touche/ Fantus Consulting, wrote in a recent paper. "States with non-competitive tax policies will be eliminated; however, actual tax levies are not typically calculated at this level of location screening."(1)

In the Motorola example described earlier in this report, for instance, some 300 potential sites were identified at the outset. Applying just two or three major criteria — a location on the East Coast, as close as possible to the big markets of the Northeast and mid-Atlantic states, in a state with a "right-to-work" law(2) — narrowed things down considerably for the company.

Then a major question becomes which of the remaining sites are best from a physical standpoint — i.e., are good water, sewer and road connections available? Is a good building already on the site? Or, alternatively, is it clear that one can be constructed on the available land without producing environmental or community problems?

If the list has been pared to one particular region, which of the available sites offer the best workforce?

Those and a few other criteria eliminate all but a handful of sites, which now become finalists for the prize of major capital investment and hundreds or even thousands of new jobs. Having survived so far, each of the remaining candidates is likely to be attractive in many ways.

From an overall cost perspective, these sites will probably be similar. Costs of transportation and materials in a given region usually differ little. Now is the point when costs that are affected by state or local government policies — including taxes, labor costs and economic development incentives — come into play.

"The next level of screening is a very direct comparison and ranking of the three-to-five locations that offer the greatest advantages and the fewest disadvantages for the proposed project," Ady writes. "Now, all taxes, and all tax abatements or incentives affecting the project will be developed, evaluated and compared one finalist location against another."

"Corporate tax impact may be viewed company wide and even worldwide," Ady continues. "Incentives are evaluated against tax levies and personal tax implications are determined for each individual likely to transfer to the new location."

There's no longer any serious debate about whether high taxes limit job growth, especially when they are as far out of line as New York's. (The latest research by economic experts points to what one calls "the 0.6 solution, or that 10 percent lower taxes will raise employment, investment or firm births about 6 percent."(3)) And, as Chapter 2 shows, states' policies regarding labor can make a dramatic difference.

Economists are increasingly concluding that economic development incentives also can play a decisive role in companies' decisions to choose one site over another, particularly when two or more competing sites are in the same region.

After reviewing a number of studies on the subject, two economists at the University of Iowa concluded in a recent paper that "a majority of the most recent econometric work has found that development incentives can produce growth effects" in terms of jobs.(4) The economists cautioned that more research is needed. But business executives and site location experts, using real-world experience, need no further convincing.

Attitude is important, too

Reasonable levels of costs such as taxes, benefits and energy are important when companies judge how attractive a given location will be over a number of years. Up-front incentives are a slightly different story — they help reduce the immediate capital cost of the project. And the reduced risk, in turn, is important for two reasons. It increases the manager's own comfort level with going ahead with the project in one given location rather than another. And it makes it easier for a division or project manager to sell the corporate leadership on the investment, because the risk to the company's own capital is reduced.

Similarly, costs that are affected by state or local governments are important for reasons that go beyond their impact on the corporate bottom line (important as that is). They send a clear signal about the attitude government officials have toward business. And that's important, as well. More than ever before, the competitive nature of today's marketplace has pushed business people into treating each other — and requiring that they be treated by others — as customers. In management terms, that means assigning the other's needs the same priority as your own, because the other's success is critical to your own. In practical terms, it means doing everything possible to make a business relationship beneficial to the other party as well as yourself.

The myth of 'corporate welfare'

An important issue from the perspective of attitude, as well as that of real cost to the company, is financial incentives.

Low-cost financing, assistance in job training, and outright grants for economic development are designed to produce one result: more private-sector investment yielding more private-sector jobs.

Critics of economic development incentives sometimes resort to rhetorical labels such as "corporate welfare" to portray incentives negatively. Let's think about whose "welfare" really improves as a result of such investments.

In the Motorola case, for instance, the state of Virginia offered some $70 million in incentives. The majority of that, $60 million, is a "performance-based" grant that will be paid out as the company steps up production and employment. Other elements include $5 million for workforce training and $4.6 million in a one-time major business facility tax credit. State leaders also committed $16 million to improve engineering and other programs at Virginia Commonwealth and George Mason universities. (The company expects its workers to take continuing education courses at the two universities, and many graduates of VCU and GMU are likely to go to work for Motorola.)

The new plant's 5,000 workers will earn an average of $35,000; it is likely to stimulate spinoff employment of at least that many jobs at businesses that supply the plant or sell goods and services to the new employees. Annual payroll at the plant alone will pump $175 million into the local economy; a conservative estimate of wages from the spinoff jobs would be in the area of another $100 million, for a total of $275 million.

State and local taxes in Virginia total about 10 percent of personal income. So the state and local government treasuries will directly recoup at least $27.5 million a year, every year, for many years to come, as a result of the new facility.

The economic and tax benefits, in other words, show the incentives to be among the best investments the state of Virginia could make.

Of course, that accounting doesn't include new government spending that will be needed for the schools employees' children will attend, or for other new services. On the other hand, it also leaves out some benefits to state and local governments — for instance, taxes paid by the contractors and workers who build the new plant. Most importantly, the credit side of the above accounting ignores the intangible benefits to the Richmond area and the entire state of Virginia.

The same ratio of high benefits for low cost can be found in New York's first use of the new "JOBS NOW" fund to assist major new business investments. Ace Hardware, headquartered in Illinois, announced in mid-1996 it would locate a $35 million distribution center in Wilton, Saratoga County, creating more than 300 permanent jobs and hundreds of construction jobs. The company had looked at sites in Pennsylvania and Connecticut. Including an appropriation from the JOBS NOW fund and other incentives, state officials made available $1.35 million in grants and loans, according to news reports. Those same reports said most of the new jobs will pay $8 to $13 an hour, while management positions will carry higher salaries.

Conservatively estimating average wages of $10 an hour, that means the typical worker will earn about $21,000 a year, for total payroll of $6.2 million. Even if the number of spin-off jobs is less than half the direct employment, related workers will likely earn at least $2 million more a year. In New York, state and local taxes average $152 for every $1,000 in personal income. So the new jobs can be expected to produce tax revenue of $1.2 million a year.

And that's a conservative estimate of what the Ace facility will produce for the government, every year well into the next century. Compared to a one-time incentive of $1.35 million, it's a pretty good deal.

As so often happens, the Ace Hardware project has additional benefits. It puts a major facility that had been owned by the state, and therefore not subject to local taxes, back on the property tax rolls. Under an arrangement with the Saratoga County Industrial Development Agency, Ace will immediately begin paying property taxes on the land (which the state did not do). After five years, the company will pay taxes on the land and its new building, at a discount that shrinks from 50 percent to zero in the 11th year.

Other states find incentives for new businesses a good investment. In Ohio, a Job Creation Tax Credit passed in 1993 gives employers a tax credit against the corporate franchise tax based on the state income tax withheld from new, full-time employees. The credit is refundable, meaning companies may collect more than they normally would have paid in tax. Average hourly wages of new jobs must be at least 150 percent of the federal minimum wage, and the project must involve a substantial capital investment. More than 350 company agreements to use the credit have been implemented, with average new employment around 125 jobs. Conservatively assuming average wages of twice the minimum wage, that produces total tax incentives of $17 million.(5)

In 1996, for instance, Valeo Climate Control announced it would build a $22 million facility in Hamilton, Ohio, creating 300 jobs. The state agreed to provide a corporate tax credit of 70 percent of the personal income tax from the new workers' wages, over 10 years. At a minimum, those wages would have to be 150 percent of the federal minimum wage, or $7.13. With 300 employees working 40 hours a week, annual wages would be $4.5 million or more. State income taxes take about 3 percent of the average worker's income; that would be $135,000 a year for the new jobs. That means an annual tax credit to the company of some $95,000, or close to $1 million over the decade.

West Virginia officials and Toyota recently announced a new engine plant creating about 300 jobs. The state provided incentives including a $2 million grant, $10 million in tax credits, $50,000 for local workers to take weekend classes in Japanese language and history, and a construction loan that carries a local property tax exemption. The combination of the Toyota employment and spinoff jobs will generate, each year, local payroll of more than the $12 million or so in direct financial incentives.

Why incentives matter

But, the argument goes, economic development incentives aren't really important enough to affect a major site location decision. Right? Wrong.

Let's keep in mind what motivates the CEO and other executives who will make that decision.

The board of directors and shareholders want the company to maximize return on investment -- both this fiscal year, and in the long run. Economic development incentives can be a powerful indicator that locating in a given state will help do just that.

First, consider the direct financial impact on, for example, a project the size of Motorola's. The company is planning to invest $3 billion — a lot of money even for a Fortune 500 employer. Such a blue-chip company could borrow most of its cost — say, 80 percent — for new physical plant. The remaining 20 percent would represent $600 million of direct equity.

If the company were to pay 8 percent interest on the $2.4 billion it borrowed, annual interest would be something in the range of $192 million a year. Assuming the plant enjoyed a decent profitability — say, 12 percent return on the total capital of $3 billion — it would produce gross income of $360 million a year. After subtracting the debt service cost, net income would be $168 million. Factored against the $600 million of its own equity the company used, the pre-tax return on equity is 28 percent.

Now let's figure the impact of the state's financial incentives — say, $70 million as in the Motorola case. Then, if the incentive is paid up front, the company's equity investment is "only" $530 million. The net income remains the same, but instead of 28 percent ($168 million divided by $600 million), the return on equity is now $168 million divided by $530 million, or 32 percent.

Does that difference of 4 percent matter? It sure does. Chief financial officers of big companies look for differences of fractions of a percentage point when deciding where to allocate capital. Looking at the initial transaction, every dollar of incentive invested by the state means the employer retains a dollar for cash flow or investment elsewhere.

Anyone who has bought a home can easily understand the principle behind the math. Let's say you're selling an existing home and using your equity to put down $60,000 on a new home (just as Motorola might use $600 million of its equity on a new factory). Does it make a difference if the seller or the broker offers to chip in $7,000 (comparable to Virginia's $70 million) to help reduce your down payment and/or monthly payments? It sure does.

The tremendous uncertainty of the marketplace makes incentives all the more important to the company. Due to sales growth that's been lower than projected a couple of years ago, Motorola has moved back the expected opening date for its new facility. For the company's directors and executives, that's a reminder of the risk inherent in any capital investment — especially one as big as $3 billion. The commitment of state incentives makes that still-pending investment less daunting. (At the same time, state officials know the company is serious about the project; Motorola has already invested several million dollars on land acquisition and other initial costs.)

Then there's what may seem the minor matter of expectations. The simple fact is that other states -- the very states that often outcompete New York on traditional business climate factors -- are offering major incentives. The CEO deciding where to invest $300 million, $1 billion, or more must ask his managers which state offers the best deal. New York State and its localities are seeking to sell something to that CEO — to sell a location where the company will put its capital and jobs. In this business or any other competitive arena, the salesperson is not in a position to dictate to the prospective buyer what the sale will or won't include.

Even some observers who say taxes don't matter agree economic development incentives can make a difference in which state attracts major projects.

"You have to do it because of the interstate competition," said Frank Mauro, executive director of the Fiscal Policy Institute, an Albany-based think tank that is financed by public employee unions and other groups and that has consistently advocated higher taxes. "Right now in the United States, you have to do the positive economic stuff, the firm-specific packages."(6)

What do other states do?

States use a variety of methods to create financial incentives for major investments and new job creation.

For instance, the Nebraska Quality Job Program, enacted in 1995, allows companies to retain up to 5 percent of total wages paid to new employees in the form of state income tax withholding for 10 years. The company can use the retained funds for programs that benefit new employees, such as job training and safety instruction. The program serves companies that invest at least $50 million in qualified property and hire at least 500 new employees, or that plan to invest at least $100 million and hire at least 250 new workers.(7)

The Michigan Economic Growth Authority tax credit program allows firms adding significant employment to take the full value of their employees' state income tax as a credit against Michigan's single business tax. The credits are available for up to 20 years.

South Carolina enacted, in 1995, a "job development fee" that the state collects and reserves on behalf of businesses by diverting a percentage of employees' state income tax. The money (actually the reverse of the usual government "fee") can be used for expenditures such as acquiring and improving real estate, training employees, and improving public and private utilities.

States are also actively involved in promoting training. Illinois' Industrial Training Program reimburses up to 50 percent of a company's costs for instructors and training materials, with employers choosing their own training providers. The program carried a $12.3 million appropriation in 1996. West Virginia's Guaranteed Workforce Program provides training assistance of $1,000 for each employee at a new or expanding company creating at least 10 new jobs within a year.

New jobs: more available than meet the eye

Just how much difference does all this make, anyway? How many jobs do we have a chance to grab — or to watch other states enjoy at our expense?

Far more than we ever thought, according to the latest and most convincing evidence.

A major new study of Census Bureau data reaches a conclusion that's little short of astonishing: Nearly one in five manufacturing jobs are either destroyed or created over an average 12-month period.

"Job creation and destruction rates are remarkably large," economists Steven J. Davis, John C. Haltiwanger and Scott Schuh write in their book, Job Creation And Destruction, published by MIT Press. "Over a typical twelve-month interval, about one in ten manufacturing jobs disappear, and a comparable number of new manufacturing jobs open up at different locations." That combination, they write, adds up to more than 19 percent of all manufacturing positions.

"This simple fact highlights the remarkable fluidity in the distribution of job opportunities across locations in the U.S. economy," the economists add. That "fluidity" means nearly 3.5 million manufacturing jobs are up for grabs in the United States in a given year.

Hard to believe? Job Creation And Destruction relies on solid data — the Census Bureau's Longitudinal Research Database which contains annual and quarterly plant-level data for more than 160,000 manufacturing plants.(8)

The ebb and flow of jobs varies from year to year, of course. During the 1973-1988 period studied for Job Creation And Destruction, annual creation of new manufacturing jobs ranged from 13.3 percent to 6.2 percent. Job destruction was as high as 16.5 percent, during the recession of 1975, and as low as 6.1 percent in 1973.

The economists measured the dynamism of American manufacturing in another way. Using what they termed "excess job reallocation" — that is, changes beyond the net national gain or loss in a given year — they calculated the number of jobs simultaneously being created and destroyed. That averaged out to 15.4 percent, or some 3 million jobs being moved, every year.

"This result indicates that even during years with unchanged total employment, a large fraction of employment opportunities change locations," the authors wrote. "In every year (emphasis in original), more than one in twelve workers switch jobs or employment status as a direct consequence of the reshuffling of employment opportunities across locations."

That combination of job creation and destruction adds up to a massive opportunity — or a potential disaster -- for New York and every other state.

With some 940,000 manufacturing jobs in the Empire State, this means that roughly 94,000 jobs are eliminated each year, assuming our industries track the national average. Yet at the same time, year in and year out, we add almost as many manufacturing jobs in other plants, almost unnoticed. The obvious challenge, then, is to attract more of the new jobs that are now being created in our competitor states — and to make sure that we minimize job eliminations in New York.

Manufacturing is only one part of the economy in New York and nationwide. Despite job losses of recent years here, though, it's still among the most important providers of jobs and income. One in every seven private-sector jobs in New York is in manufacturing, and the economic benefits they provide — in payroll, spinoff jobs, employee benefits and contributions to the community — tend to be higher than those in most other industries.

For these and other reasons, economic development efforts tend to be particularly geared toward manufacturing companies. One of the other reasons: in addition to their special economic benefits, manufacturers are more footloose than many service or trade businesses, which must stay near their clientele.

Incentives and jobs

How much can economic development incentives help improve our chances of attracting those newly created jobs, and of avoiding the loss of others? After all, by their very nature incentives are aimed at a relative few of the state's hundreds of thousands of businesses.

That's exactly what we need; a relative handful of employers are especially important, to judge from the evidence gathered by Davis et al. They found that both good and bad news on the job front tend to be concentrated: More than two-thirds of annual job creation and destruction occurs at startups, shutdowns, and continuing plants that expand or contract by at least a quarter of their initial workforce.

"Job creation (or destruction) is far from evenly spread among the set of growing (or shrinking) plants," the economists wrote. "Instead, most job creation occurs at relatively few plants that grow much more rapidly than the typical growing plant. Likewise, most job destruction occurs at relatively few plants that contract much more sharply than the typical contracting plant."

Critics of economic development incentives sometimes complain about targeting assistance to larger businesses. Smaller businesses, they say, are the ones producing the new jobs, while most Fortune 500 companies have scaled employment back in recent years.

In many cases, that's simply not true. And even where it is true, it's generally beside the point.

Big is beautiful

Many small businesses, after all, sell the majority of their products or services to larger businesses. And others base their business on sales to people who, in turn, work for or sell to larger companies. Just ask the owner of a restaurant or clothing shop in lower Manhattan whether it matters how business is for the big Wall Street firms.(9)

The authors of Job Creation And Destruction, in fact, say their research shows it's a "myth" that small businesses create most new jobs. Studies that have found so are usually based on data that do not match authoritative figures from the U.S. Bureau of Labor Statistics and other sources, according to the book.

One reason job creation and destruction in the manufacturing sector is so dramatic is because industrial employment is concentrated in relatively large plants, Davis et al. found. In 1986, the average manufacturing employee worked at a facility with nearly 1,600 workers. More than two-thirds of industrial firms had 500 or more workers. That's why changes in employment levels tend to be concentrated in larger plants, as well. Firms with at least 500 employees accounted for 60 percent of job creation, and 61 percent of job destruction.

The new study shows another reason economic development incentives help keep and create jobs: the more capital-intensive a plant is, the more stable its employment will be. It takes more investment up-front, in other words, to produce the jobs that will be most secure five or 10 years into the future. Helping companies make those major investments is precisely the purpose of most economic development incentives.

Even if they do not, on their own, create most new jobs, smaller businesses are tremendously important to our economy for a number of reasons. They represent our future big businesses, the ones that will employ thousands upon thousands of workers. The companies that in a few years will be the next IBM, Eastman Kodak or Computer Associates are smaller businesses today. And businesses that will not grow so large are also vitally important; they allow millions of individual New Yorkers to create their own opportunity. Recognizing the importance of big businesses doesn't mean dismissing the value of smaller ones — we want New York to produce and attract all the businesses, large and small, we can get.

1. Robert M. Ady, comments on "Taxation and Economic Development: The State of Economic Literature," paper presented at symposium on "The Effects of State and Local Public Policies on Economic Development," Federal Reserve Bank of Boston, November 8, 1996.

. "Right-to-work" laws prohibit mandatory union membership as a condition of employment(without affecting voluntary membership).

3. Michael Wasylenko, "Taxation and Economic Development: The State of the Economic Literature," paper presented at symposium on "The Effects of State and Local Public Policies on Economic Development," Federal Reserve Bank of Boston, November 8, 1996.

4. Peter S. Fisher and Alan H. Peters, "Tax and Spending Incentives and Enterprise Zones," paper prepared for symposium sponsored by the Federal Reserve Bank of Boston, Nov. 8, 1996.

5. At $9.50 an hour, 40 hours a week, the typical job eligible for the credit pays (again, conservatively estimating) $19,760 a year. For 43,750 jobs, that's total new payroll of $864 million. State personal income tax on that amount would be about $26 million. Tax credits to the new businesses are typically around 65 percent of the personal tax, for a net of just less than $17 million.

6. Quoted in "Beyond Tax Cuts And Deregulation," Empire State Report, December 1996, p. 35.

7. This and the following programs are described in Ideas That Work: Job Creation, and Ideas That Work: Tax Policy, National Governors Association, Washington, D.C., 1996.

8. Leading economists from universities such as MIT, Yale, Stanford and the London School of Economics are using phrases such as "landmark study" and "essential reading" to describe Job Creation And Destruction.

9. Big businesses, of course, are uniquely able to benefit society in ways that go beyond the economic ones. For instance, several multi-national drug companies whose size made huge research investments possible developed the new breakthrough therapies for AIDS.

Back to Introduction Next Chapter


Chapter 2

Chapter 3

Chapter 4

Go to The Public Policy Institute