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Local Economic Development as a Prisoners’ Dilemma: The Role of Business Climate

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/. Why do localities continue to compete for firms?. Political incentives? Poor cost-benefit analysis?

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Local Economic Development as a Prisoners’ Dilemma: The Role of Business Climate

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  1. 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/

  2. Why do localities continue tocompete for firms? • Political incentives? • Poor cost-benefit analysis? • Better than doing nothing? • Competition with other states? SRSA Meetings

  3. Incentives <=> Pro-business Signal • “You’ve got to have incentives to get your foot in the door” (Carlton, 1996) • “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) SRSA Meetings

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

  5. The Prisoners’ Dilemma • Everyone wants to offer incentives • BUT if everyone offers incentives, there is nothing to gain by doing so • 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) SRSA Meetings

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

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

  8. Expected Payoffs If offer high bid pi(s) = 1/h(x-si)-(1-1/h)c(0) Otherwise pi(s) = -c(sj-si) where h = number of high bidders SRSA Meetings

  9. What subsidies will localities offer? Solve through interative domination • e dominates 0 so rule out 0 bids • e+e’ dominates e so rule out e bids • …(continue pattern) • x is the equilibrium bid SRSA Meetings

  10. Your payoffs with 2 localities SRSA Meetings

  11. Your payoffs with 2 localities SRSA Meetings

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

  13. Policy Implications Failed Policies • Unilateral moratorium • Voluntary multilateral moratorium Potential Policies • Voluntary cooperation in repeated setting • Federally mandated moratorium SRSA Meetings

  14. Restraint and Refinement are Consistent Goals Restraint is warranted • Incentives competition is inevitable • Solutions are difficult Refinement of practice is needed • Protect against bad deals • Minimize political distortions SRSA Meetings

  15. Implications & Future Research • Model provides an upper bound on the benefit to a locality of engaging in incentives competition • Provides good framework for extensions • Formalize dynamics of cost function • Political economy questions SRSA Meetings

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