Toward an Office of Struggling Regions

Economic Development for the 21st century

 
 

1. The coordination problem

 
 

The conventional policy arsenal that local governments use for investment promotion, from beggar-thy-neighbor tax incentives to outright crony capitalism, points to the need for a new coordinating institution. The contest over the site location for Amazon’s next headquarters, known as HQ2, is a perfect illustration. More than 200 cities across North America submitted proposals, each offering more outlandish inducements than the last. In essence, state and local governments are stuck in a collective-action problem, which Amazon exploited to extract the largest possible rents in the form of income and property tax abatements, and other bespoke incentives.

This poses a problem for the struggling regions that have the most to benefit from companies choosing to locate in their area, but are in the worst possible negotiation position. City and local governments across the country, and the governments of struggling regions in particular, have a direct interest in coordinating their investment-promotion activities. Yet coordination is costly and constantly threatened by potential defectors.

The federal government could theoretically preempt this dynamic, in much the same way the European Union prohibits state aid “given to entities on a selective basis that have the potential to distort competition and affect trade” without prior approval from the Commission. Nonetheless, this would be inevitably challenged as a violation of state and local governments’ constitutional authority. Given America’s federalist system, state and local governments must unite on their own terms, forming voluntary compacts and joint development agreements. A new institution within the U.S. federal government could provide a crucial role in facilitating such agreements. According to Moody’s economist Adam Ozimek,

This is, in my opinion, a big missing piece of the puzzle for how we help struggling places get more economic development, help big firms find other places to invest other than megacities, and help stop crony capitalism. The alternative is basically trying to stop crony capitalism through moral appeals that aren't in the participants' self-interest. This is doomed to fail.

It would be a bit like the WTO, a bit like a think tank, a bit like a site selection company, and a bit like a local economic development organization.
— Adam Ozimek
 
 
 

2. New markets, old know-how

 
 

Writing for Bloomberg, economics columnist Noah Smith put forward a different but related concept, drawing an analogy to the success of Defense Advanced Research Projects Agency, or DARPA, in filling the market gaps in scientific research:

But despite this record of success in technology, the U.S. government has no equivalent agency that deals with economic challenges. Just as DARPA has exploited many areas of technological whitespace where the private sector needed some assistance, a U.S. office of industrial policy — a DARPA for economic development — might be able to fill many of the economic gaps that are holding the economy back from its full potential.

Smith further suggests such an agency would be staffed with “a group of economists, urbanists and technologists dedicated to gathering data and doing interdisciplinary research on which types of industrial policy give the most bang for the buck.” Its role would be to coordinate federal research and development dollars to second-tier universities in depressed parts of the country, and provide analysis of where non-cash marketing, financing and logistical support for local industries would be most useful.

As a federal agency, such a body would be above the “cluster promotion” policies of state and local governments that often mutually cancel-out in the pursuit of the same cluster. Encompassing the interests of all fifty states would allow such an institution to have the independence and scope required to immunize itself against narrow business interests in any particular region. Rather than prop-up failing firms, its mandate would be future oriented, spurring opportunities that preserve and build on existing know-how.

As the economist Dani Rodrik notes in his paper, Industrial Policy for the Twenty-First Century,

The appropriate policy intervention is focused not on industries or sectors, but on the activity or technology that produces the characteristics of a coordination failure. … The main purpose of industrial policy is to diversify the economy and generate new areas of comparative advantage. It follows that incentives ought to focus on economic activities that are new to the domestic economy.

An Office of Struggling Regions would achieve this both through its coordinative role and through the ability to directly target strategic public investments.

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3. Integrate existing programs

 
 

Combining these two concepts — a coordinating body for investment promotion, and a DARPA for economic development — has the potential to supercharge private investment in struggling regions given appropriate integration with existing programs.

The Opportunity Zones program, for example, allows investors to defer and ultimately waive taxation on capital gains for new investments made within qualified distressed communities. Many Opportunity Funds have already been formed with a “social impact” mandate in mind. An Office of Struggling Regions could conceivably provide leveraged capital to funds aligned with concrete state and local economic development goals, offloading fiscal risk to private-sector counterparts.

The natural home for an Office of Struggling Regions would be within the Small Business Administration (SBA). The SBA secretary has been a cabinet level position in past administrations, which the economist Dani Rodrik argues is critical for internalizing the costs and benefits of economic development policy. The narrow jurisdictions of the House and Senate business committees would likewise be well-suited to provide focused oversight.

As discussed elsewhere, the SBA already has many of the facets of an economic development agency, but in ways that would benefit greatly from better integration. For instance, the SBA gives special terms on loans to businesses in “low- and middle-income” (LMI) zones, and has special programs for disadvantaged rural regions. Yet the definitions for such zones seldom align with nor take advantage of other place-based programs.

Additionally, many federal agencies are required to set-aside a fraction of their procurement budgets to support small businesses and struggling regions. This in an uncoordinated approach that leads each program to be less effective than if their efforts were pooled. Mandatory set-asides could be abolished, in favor of a common program that provided agencies with leverage for the same fractional activities.

Social insurance programs could also play an important integrative role. Subsidized employment programs could target job-placements in regions with labor shortages. Self-Employment Assistance programs could link those moving-off of unemployment insurance into SBA mentorship programs. Regions suffering from an economic shock could become automatically eligible for reduced capital costs, and so forth.

Coordination could extend beyond spending decisions to the regulatory realm. The portability of occupational licenses, for example, has been substantially improved through the creation of interstate compacts, like the Nurse Licensure Compact and Interstate Medical Licensure Compact, in which states agree to recognize the licenses of medical professionals issued in member states. A September 2018 report from the Federal Trade Commission highlights ways for extending such harmonization efforts to the national level, be it through model laws or state-led processes of mutual recognition and expedited licensure.

An Office of Struggling Regions would provide a much needed platform for stakeholders in different states to accelerate existing harmonization processes, and investigate all new areas for mutually beneficial cooperation.

If governments make no mistakes, it only means that they are not trying hard enough.
— Dani Rodrik
 
 
 
 

A work in progress

 

Thinking on what an Office of Struggling Regions would look like is clearly in its infancy. But with this new initiative, we intend to raise it into maturity. The unique and difficult challenge of crafting efficient “place-based” economic development policy is simply under-explored in the contemporary policy debate. Bailing out declining coal industries in Eastern Kentucky and West Virginia, or imposing protectionist tariff barriers on key trading partners to the benefit of struggling steel towns in Arkansas or Illinois, is a reactive approach that is unsustainable and ultimately counterproductive. Telling displaced workers to “learn to code” isn’t much better.

Between the reactionary and hands-off approaches to economic development lies a middle ground rooted in mainstream economic theory and volumes of international evidence. Imagine a United States in which:

  • firm-specific tax incentives are curtailed through inter-state compacts;

  • regional economic development agencies form joint partnerships and work together;

  • strategic public investments build human capital in smaller cities while diversifying American manufacturing;

  • disparate programs, from Opportunity Zones to SBA loans, work in tandem to amplify private investment and business development in growth sectors;

  • and effective labor market policy facilitates workers in transition between jobs and across state lines.

This isn’t fanciful. As Timothy Meyer and Ganesh Sitaraman put it in a recent essay for American Affairs, “It’s Economic Strategy, Stupid.” In a case of simultaneous invention, they propose restructuring the Department of Commerce and a variety of other agencies into a single Department of Economic Growth and Security (DEGS) with many of the same goals discussed above.

There’s clearly an appetite for fresh thinking in U.S. economic development policy — one that transcends both the laissez-faire dogma of the old consensus, and the practice of “picking winners and losers” that has rightly tarred the reputation of industrial policies in the past. Stay tuned to the Struggling Regions Initiative as we flesh out the precise reforms needed to revive and diversify America’s economic potential, and work to build a new consensus.

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