2. Local Economic Development as a Prisoners’ Dilemma: The Role of Business Climate by Stephen Ellis & Cynthia Rogers University of Oklahoma http://www.ou.edu/cas/econ/

3. 4/7/99SRSA Meetings Why do localities continue to compete for firms? b Political incentives? b Poor cost-benefit analysis? b Better than doing nothing? b Competition with other states?

4. 4/7/99SRSA Meetings Incentives Pro-business Signal b “You’ve got to have incentives to get your foot in the door” (Carlton, 1996) b “North Carolina has one of the strongest economies and one of the best business climates because of … our aggressive efforts to create and keep good jobs” (Governor Jim Hunt, Lyne, 1998)

5. 4/7/99SRSA Meetings The Role of Business Climate: “It is increasingly difficult to argue that business climate, however broadly defined, does not influence interregional firm location” Wasylenko (1991)

6. 4/7/99SRSA Meetings The Prisoners’ Dilemma b Everyone wants to offer incentives b BUT if everyone offers incentives, there is nothing to gain by doing so b Competition escalates the value of offers “You can’t say no, but you can’t afford to say yes.” (Stephen Goldsmith, Mayor of Indianapolis, Schwartz et. al., 1992)

7. 4/7/99SRSA Meetings Economic Development Game Simple Model b Single period b Single firm b Identical localities b “Good” deals only Perfect Planning World b Full disclosure b Public accountability b Symmetric, perfect information b Precise cost-benefit analysis

8. 4/7/99SRSA Meetings Distinguishing Features of Game The Players b Equivalent with regard to firm’s bottom line b Players make competing bids, s i b Maximum bid is value of attracting firm, x Role of Business Climate b Localities incur a cost for failing to attract the firm, c b Cost depends on difference between high bid (s j ) and locality’s bid, c(s j -s i )

9. 4/7/99SRSA Meetings Expected Payoffs If offer high bid p i (s) = 1/h(x-s i )-(1-1/h)c(0) Otherwise p i (s) = -c(s j -s i ) where h = number of high bidders

10. 4/7/99SRSA Meetings What subsidies will localities offer? Solve through interative domination   dominates 0 so rule out 0 bids   +  ’ dominates  so rule out  bids b …(continue pattern) b x is the equilibrium bid

11. 4/7/99SRSA Meetings Your payoffs with 2 localities Your payoffs with 2 localities

12. 4/7/99SRSA Meetings Your payoffs with 2 localities

13. 4/7/99SRSA Meetings Upshot of Game b Localities bid the entire value of attracting the firm to even have a chance at winning b All localities would do better if none offered subsidies b If none offered subsidies, each would want to offer a small subsidy b If one firm offers subsidies, they all end up bidding high

14. 4/7/99SRSA Meetings Policy Implications Failed Policies b Unilateral moratorium b Voluntary multilateral moratorium Potential Policies b Voluntary cooperation in repeated setting b Federally mandated moratorium

15. 4/7/99SRSA Meetings Restraint and Refinement are Consistent Goals Restraint is warranted b Incentives competition is inevitable b Solutions are difficult Refinement of practice is needed b Protect against bad deals b Minimize political distortions

16. 4/7/99SRSA Meetings Implications & Future Research b Model provides an upper bound on the benefit to a locality of engaging in incentives competition b Provides good framework for extensions Formalize dynamics of cost functionFormalize dynamics of cost function Political economy questionsPolitical economy questions