How Cities Compete For Business

by Henry Farrell on June 27, 2013 · 1 comment

in Political Economy

Local economic development theory argues that it’s usually a bad idea for cities to offer special incentives to try to attract businesses. These incentives weaken the fiscal position of the city, but often provide freebies for location decisions that the businesses would have taken anyway. So why do cities do it? In a new paper, Nate Jensen, Edward Malesky and Matthew Walsh argue that these bad decisions are driven by voters. Voters know enough to want to vote for politicians who take active steps to attract business to the city, while not knowing enough to realize that the costs of these active steps often outweigh the benefits. Jensen et alia argue that this theory is supported by evidence of real differences between cities run by elected mayors, and cities run by managers responsible to a council. They argue that managers are more insulated from electoral politics than mayors, and hence less likely to take wasteful decisions to offer incentives.

We test the impact of electoral institutions on a dataset of over 2,000 project-level incentives (icaincentives.com 2013), finding significant support for our electoral pandering hypothesis. Elected mayors: offer 14% more money than council-managers overall and 20% on a per-firm basis($822,000 on the average project); are 16% more likely to offer an incentive to an individual firm; and are 7.6% less likely to have an oversight program in place for the use of investment incentives. The larger generosity of elected mayors is facilitated by the fact that they face less oversight in the targeting of incentives and requirements on the size of incentives than comparable cities subject to council-manager systems.

{ 1 comment }

Peter Hovde June 28, 2013 at 2:12 pm

This is one achilles heal of competitive federalism theories that analogize jurisdictions to firms competing in a market-decisionmakers are trying maximize different things.

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