Industrial Policy vs. Attractive Business Environment

Many states, in desperate hopes of boosting their economies, have resorted to industrial policy as a means of promoting economic development. By that, I mean the states have tried to focus on particular companies or industries, and have used financial incentives to help promote activity in those firms or sectors. Such efforts may work on occasion, but in general, they have serious shortcomings. First, industrial policy presumes that a few bureaucrats in a state government office know what the future will hold, i.e. which firms and sectors have the most promise in the future. What if they are wrong? Second, such economic development plans offer opportunities for political meddling and even rampant corruption. Third, such efforts may lead to a lower cost of doing business for a few firms or sectors, but the state government has to make up for that lost tax revenue in some way. Some of that may be made up by higher economic activity, but often, states find themselves raising overall tax rates while pursuing targeted tax breaks for specific companies. The higher marginal tax rates depress overall economic activity, and thus, the state's economic development policy does more harm than good.

Economic growth generally benefits from efforts to expand the tax base while lowering marginal rates. Thus, states would be better off finding ways to lower the cost of doing business for all firms, and letting entrepreneurs and innovators discover which sectors are most attractive (rather than state politicians). In contrast, many economic development policies today find states shrinking their tax base through selected breaks and special deals, while raising tax rates for all other firms. State after state is pursing such wrong-headed economic development policies.

Of course, I'm not suggesting that states shouldn't provide any assistance to firms who are trying to expand facilities, jobs, etc. I'm just suggesting that states shouldn't be in the business of trying to decide which sector will be the "hot" one in the coming years, and which ones should be favored over others.