Greg Mankiw's column inSunday's New York Times makesthe case that competition between governments is a good thing, thatit makes them more efficient in the same way that competition amongfirms does. He paints it as also being about choosingredistributionist policies or not, with Brad DeLong and Harold Pollack both ably making the case that of course governments shouldengage 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 forinvestment leads to economic inefficiency, heightened incomeinequality, and rent-seeking behavior by firms.
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; 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; 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 .
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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