By Dr. Brian G. Long, Ph.D., C.P.M.
A newspaper headline proudly reports that “new jobs are coming to town,” and the announcement is a cause for celebration in the local community. However, the next paragraph often describes the tax incentives and/or government grants that were necessary to make the new jobs happen. The justification for the expenditure of government funds almost always relates to “jobs.” Are these expenditures of government funds or tax credits, often in the millions, worth the additional jobs they are supposed to create? The answer is yes and no. In terms of long term economic impact, ALL NEW JOBS ARE NOT EQUAL. Not even close. Let’s look.
At the onset, it is correctly assumed that most new employees who move to town with the new company will be buying groceries, theater tickets, houses, cars, dental work, and other services. Will it expand existing employment? Of course. This is conventional wisdom. One new job helps generate more new jobs, assuming the new employees generally live in the community where they work. But what types of new jobs create the MOST additional jobs? That’s the real question, especially when doling out government money.
Assume for a moment that the “new jobs” are coming from a firm that manufactures, say, water coolers. They will need to hire machinists, engineers, welders, assemblers, accountants, and all of the other employees normally associated with a manufacturing operation—let’s assume 300 people. They will need trucking companies or freight services for both inbound and outbound shipments. And of course, they will pay property taxes on the building they occupy, which helps support employment in the local government.
Categorically, the best job multipliers come from industrial firms that actually produce a physical product AND have a significantsupply chain. In the case of our monthly West Michigan business survey, the companies represented by the survey participants spend about $15 billion every year (that’s billion with a “B”), much of which is spent in West Michigan.
For a product like a water cooler, the usual rule of thumb for a new manufacturing operation is that it should create at least six to ten additional jobs beyond the plant itself. For an expansion of an existing firm, the ratio will be somewhat less, but still significant.
For a manufacturer of water coolers, a whole host of OTHER industrial firms in the area may benefit. First to profit are the industrial distributors, who will soon begin selling the firm industrial supplies like cutting tools, abrasives, cleaning solvents, safety supplies, and more mundanely, office supplies. If the water cooler cabinet is made of steel, a local steel service center may be used for slitting, blanking, pressing, pickling, powder coating, heat treating, and other operations. For specialized fasteners, the firm may contract with local screw machine shop. Standard fasteners may be bought from one of the many local distributors. Plenty of firms in West Michigan boasts a huge expertise in plastic molded parts, so a local contractor may receive the business for bushing, moldings, brackets, and other components. The inside of the water cooler will have switches, wire harnesses, compressors, stainless steel tanks, fans, and many other components that must be procured. In the case of switches and wire harnesses, West Michigan has numerous firms that could be tapped.
Granted, all of the components will not be purchased locally. Some of the components will come from out of town, and except for the trucking company that delivers them, contribute very little to the expansion of the local economy. But at least SOME local firms will invariably benefit, resulting in the creation of far more jobs than the initial announcement of 300 new employees. Also, don’t forget the groceries, cars, and theater tickets that will also be sold to the 300 new residents and their families. So the 300 new jobs cascade into about 2000 additional jobs.
In contrast, take the case of a new retail store that will also employ 300 people. The concept of the new store sounds great, but the economic impact on the community will usually be minimal. Retail sales for any given market area are usually limited by the size of the market itself. In other words, it’s pretty much a zero sum game. When the new store with 300 employees opens and the cash registers start ringing, it usually means taking sales from all of the other competing stores in the area. Exceptions are unique retail establishments that offer specialty products or mega-retailers that can draw customers from many miles away, such as the Mall of America does in Minnesota. Granted, over time, new stores must be built to replace old stores, and the new stores may feed higher taxes into the city coffers. But again, the impact on the local economy is nowhere near as big as the proponents may claim and nowhere near the impact of an industrial firm building water coolers. Granted, retail establishments have a long supply chain, but almost all of the jobs the retailer supports are either out of town, or in the case of Walmart, out of the country.
What about, say, a new apartment building? Granted, expensive new buildings will pay lots of taxes, which is why the proprietors angle for tax credit incentives. Once built, it is obvious that the supply chain for a new building is going to be very limited, but the “pitch” will be made that the expanding population needs a convenient place to live, assuming, of course, that the population is actually expanding. Hence, the city fathers are left with balancing the needs of the citizenry with discounted property tax incentive offered to close the deal. In a tight market, the apartment building will probably be built anyway, with or without a government incentive. The tax incentive may be wasted.
The permanency of the jobs is also a major consideration. Take the case of a major highway construction projects. Dozens of workers may flood the area during the peak of construction, and many local businesses from gas stations to repair shops to restaurants may temporarily benefit. But when the project is complete, the employment goes back to the previous norm. In short, except for a couple additional maintenance jobs, there are seldom any residual jobs for the longer term.
Because of the absence of residual jobs, there has been much discussion about offering film subsides to Hollywood producers to entice them to shoot movies in Michigan. Granted, several hundred “extras” may be hired on any given day, and all local hotels, restaurants and bars may see a large but temporary surge in business. But when the filming is done, so are the jobs. The long term economic impact is practically nil, given the millions of tax dollars the state may have been dished up to bring the production to Michigan. But some people think it is “cool” to have a few Hollywood celebrities running around town for a few days.
What about jobs in the service industries? These may be good jobs to bring to a community because many, but not all, service jobs require higher level skills – and higher pay if they are bankers, brokers, or architects. A good example is the Medical Mile in Grand Rapids. In fact, many service jobs, especially those brought in from out of town pay very high salaries. However, compared with typical industrial firms, the supply chain for the service industry is usually fairly short. They are good jobs, but the multiplier is not nearly the multiplier for industrial jobs.
So here is the bottom line. When judging the impact of new jobs for any given market, the length and complexity of the supply chain is most important. In the case of industrial firms, they will almost always only locate where there are enough industrial distributors and fabricators to meet there needs, and where they can attract, transfer, or locate enough accountants, engineers, assemblers, and tradesmen to fill the jobs. Service jobs almost always have shorter supply chains, but if the service is unique like those found in the some of the medical and financial field, they pay levels may be high and many customers may be drawn from out of town. But something like a new cleaning service may again be a zero sum game that will result in no significant number of new jobs.
A major one time construction project may have a slightly longer impact on jobs, but it is the residential and commercial construction companies that complete a series of houses and new buildings year after year that support local supply chains and local jobs. In the current market, a residential housing contractor are going from one new home project to the next as fast as they can—and for the foreseeable future. For them, the supply chain is the local lumber yards, plumbing distributors, electrical distributors, and landscapers. This is not a long local supply chain, but the dollars involved can be very large.
Finally, let’s come back to the controversial concept of tax incentives and subsidies. When are they wise investments for governments to make? Although term “crony capitalism” is attached by the detractors to having the government pick winners and loser, there are many times when the government investment more than pays for itself. But his requires some significant number crunching and an honest assessment of the TOTAL number of new jobs that will be created, IF ANY. These numbers almost always cannot come from the firm making the request, because such estimates are notoriously inflated. So some practical analysis is in order.
Last but not least, our state competes with other states for new jobs. By now, most everyone has seen the New York State ads that offer no property tax and no sales tax for the next TEN years for selected new businesses in selected locations. You can bet that these are jobs with long supply chains. Does it take incentives to move jobs to Michigan? Regrettably, in the field of plant location in 2015, this is just how business is done. Our state MUST have a few carrots to sweeten the pot, or face losing the new jobs to another state that offered some kind of incentive. It’s a little like buying a car. No one expects to pay sticker price or fall for the argument the “we need to treat all customers alike.” So it is with selling Michigan jobs. And this is why the concept of luring jobs with tax incentives is a slippery slope, and the proper use of incentives is essential.