Two years ago, the Foxconn Corp. signed a controversial contract to build an LCD manufacturing facility in rural southeastern Wisconsin in exchange for up to $3.6 billion in state subsidies.
President Donald Trump announced the deal at the White House, exuberantly sharing a photo-op with then-Gov. Scott Walker and Foxconn’s CEO.
Foxconn and its subsidizers touted studies alleging $39 billion to $78 billion would flow into the state’s economy during the next 15 years. But these studies focused only on the benefits and ignored the costs.
Now, more-realistic calculations suggest that the deal could reduce Wisconsin’s long-run economic growth.
To see how this could happen, it’s helpful to understand why the initial estimates were so unrealistic.
For one thing, like so many estimates provided by economic development consultants, the Foxconn numbers used a “benefits-only” analysis.
That is, they failed to incorporate any cost of the subsidy, treating the funding like manna from heaven. But because every subsidy dollar must first be taxed out of the economy, any valid analysis must include the corresponding cost.
Building on research by Timothy Bartik, we estimate that the $3.6 billion in taxes needed to fund the subsidies will likely decrease Wisconsin’s long-run GDP by about $20 billion during the 15-year life of the handout. And this estimate doesn’t include the local, utility infrastructure and federal subsidies that total another $1.4 billion.
Proponents of such deals generally assume the project wouldn’t move forward without the subsidy.
But, as University of Texas-Austin Professor Nate Jensen put it, “(Assuming) 100% of activity was due to incentives isn’t credible.... It’s like attributing 100% of sales (of a product) to a marketing campaign. By that metric every campaign looks brilliant!”
Bartik’s research finds that the typical subsidy only affects a company’s location decision between 2% and 25% of the time.
Basic economic analysis says that if a bet pays $100 with a 25% probability of winning, then it’s only worth $25. Use that logic and multiply the most realistic estimate — $39.2 billion in additional GDP over 15 years — by 0.25, and the expected payoff from the subsidy is more like $9.8 billion.
The subsidies offered to Foxconn were unusually large, so perhaps they were more influential in Foxconn’s decision.
But given how businesses often choose the best location regardless of the subsidies offered, as Amazon did with HQ2 last year, there’s reason to doubt that Wisconsin’s were decisive.
Even doubling the upper estimate of influence to 50% provides an expected payoff of only $19.6 billion. Comparing that against the economic costs of taxation for the subsidy — about $20 billion — means the expected long-run effect of the subsidy is negative.
Trump and Walker were on hand at Foxconn’s groundbreaking ceremony two summers ago, wielding golden shovels and basking in the media attention.
Since then, however, Foxconn’s plans have gone through substantial gymnastics, and it will now build a much smaller facility. Accounting for the commensurately reduced subsidies and assuming again, generously, that the subsidy was 50% effective, the change increases the estimated economic loss to about $1.2 billion.
Subsidies invite additional, difficult-to-quantify economic losses as well.
They cause companies to make worse investments, including some that shouldn’t be made. They’re anticompetitive, which can increase production waste. And they encourage firms to expend scarce resources seeking the privilege instead of creating value for consumers.
In short, political favoritism is an economic disease that summons a host of additional economic, political and social pathologies.
Over time, this disease has become an epidemic, with more and more politicians embracing corporate handouts.
As a share of GDP, city and state spending on subsidies has more than tripled since 1990, totaling more than $45 billion today. Those funds would do more for economic growth if they were repurposed to fund genuine public goods like education or infrastructure, or to fund broad-based tax cuts available to everyone.
But those sorts of sound public policies do not lend themselves to photo ops with golden shovels. When politics and business combine, it breeds favoritism and even corruption.
Yet fiascos like Foxconn are all too common. Politicians want to “do something” even when, in cases like this one, it’s less than nothing.
Michael Farren is a research fellow and Matthew Mitchell is a senior research fellow with the Mercatus Center at George Mason University. They are the coauthors of the new study “The Economics of a Targeted Economic Development Subsidy” with Jeremy Horpedahl and Olivia Gonzalez.
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