The Future of Economic Incentives
Although state and local budgets have been strained by the current economic crisis, incentive funds are still available in many places for the most viable projects.
Tracey Hyatt Bosman, Managing Director and Midwest Practice Leader, Biggins Lacy Shapiro & Company and Noah Shlaes, Managing Director, Strategic Consulting Group , Newmark Grubb Knight Frank (Feb/Mar 09)
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New Negotiating Environment
In 2009, remember that all incentive applications will receive greater scrutiny than in the past. Governments are under extreme pressure to make ends meet and will need to be convinced that the project is a safe investment (i.e., the company has the financial resources to carry through and stay liquid) and that the return on investment (job creation, job quality, and tax revenue) warrants the expenditure of funds.
Those that survive the review process will face a sharper pencil during negotiations. Even markets with money and the political will to spend it will be very focused on good stewardship of scarce funds. "Whereas before we might have thrown in an extra $50,000 just to make sure we won the project, now we're more likely to put out a lower number and keep our fingers crossed," noted one state official. "Companies will need to explicitly tell us what bridge we need to cross."
This year, far fewer companies are pulling the trigger on new investments, so governments show increased interest in smaller projects. We were surprised by the warm response to a recent incentives assignment - a small (two-person, 35,000-square-foot) distribution facility was offered significant up-front cash grants. This was a big change from the environment of two years ago, with one community noting, "In today's economy, all jobs are good jobs."
Sorting Out Retention Incentives
As corporations struggle with reduced demand for service and products, they naturally consider consolidations, reductions, and closings. Requests for proposal (for corporate real estate services) arriving in our offices show a pronounced shift in emphasis, from "strategic planning for future expansion" to "cost reduction and identification of consolidation opportunities." This is at odds with the traditional motivations for granting economic development incentives, namely the expansion of a local economy. In a stalled or shrinking economy, retention is the equivalent of growth, but it presents several challenges.
First, who is eligible for retention incentives? Spending to create new growth is easy to defend, but awards to companies that are already in place are grounds for grumbling among other companies. Successful arguments for retention incentives are usually based on a handful of arguments, consisting of the following:
• We have to make a choice. - Companies considering consolidation across multiple markets have a legitimate argument that the consolidation could be here, or it could be elsewhere.
• We'll be adding jobs somewhere. - The combined entity often ends up larger than the existing facility, when out-of-town components are included.
• This is a big commitment. - Companies may be shifting from a short-term relationship (a leased facility or noncrucial company functions) to capital investment, long-term job training, or development of a specialized facility.
Better Odds, Smaller Wins, More Accountability
The tug-of-war between budget shortfalls and a greater need for economic development continues. A lot is riding on current legislative sessions. While outcomes will vary based on geography, project type, and form of incentive, two principles remain as valid as ever:
1. Good projects will still see active recruitment. Look no further than IBM's 1,300-person technology service center in Dubuque, Iowa, which was accompanied by a $55 million incentive package. Or consider Michigan's approval of $335 million in tax credits for battery manufacturing plants.
2. Incentives do not make a bad location good. Companies consider the entire operating picture when making a location decision. Economic incentives are something they consider very late in the location selection process, when they've created a list of locations that work.
The mechanisms that fund incentives are strained by the current economic crisis, but their justification is stronger than ever, and strong incentive programs endure. They are characterized by increased accountability, tougher scrutiny of projects, and built-in self-funding. For a strong project in genuine need, the world has not changed that much. The authors can be reached by e-mail at email@example.com and firstname.lastname@example.org.