Industrial Policy

MEGA Stumble?

Cross-posted from the Mackinac Center for Public Policy Oct. 28, 2008.

This morning it was reported that Whirlpool Corp. will cut 5,000 jobs from its 73,000 worldwide workforce. Some 300 of the jobs are expected to be lost from two of the firm’s operations (Whirlpool Technologies, LLC) in the southwest Michigan towns of Benton Harbor and St. Joseph, according to a company spokeswoman.

Both of these facilities were the beneficiaries of Michigan Economic Growth Authority tax break deals in 2001, and  represent what  supporters of the Michigan Economic Development Corporation (which oversees MEGA) would call “success stories." Today's news is more evidence that such claims should always be taken with large measure of salt.

MEGA is a state business tax credit incentive program designed to generate economic development in Michigan. Tax breaks and other targeted incentives are granted to companies in exchange for their willingness to “create” or “retain” jobs here.

In 2001 Whirlpool was offered benefits for the Benton Harbor and St. Joseph facilities worth nearly $21.8 million over 17 years. In return, the firm promised to create 385 new jobs. The nominal value of these tax breaks was $3,328 per job per year, but the figure is misleading because it is an average. Many of the incentives — such as $1 million for job training — were available up front, while the average measures incentives per job through 2017.

The jobs claims themselves may also be misleading. Naturally, the MEDC claims that the jobs created by the recipients of such deals would not have happened “but for” the discriminatory tax treatment. But there is no way for the government to know whether a firm didn’t intend to create those jobs anyway, and businesses have become quite savvy about how to game the system to their advantage.  State officials claim to understand the nature of these incentives, but hand them out with great naiveté.

Now Whirlpool is set to eliminate 300 jobs from the facilities that benefited from the 2001 deal. The company won’t say whether these lost jobs are directly related to the 385 created after entering MEGA agreements, but in net terms it hardly matters: Jobs promised earlier in return for tax breaks not available to other businesses are canceled out by jobs lost today.

Incidentally, Whirlpool can’t be blamed for taking advantage of MEGA and related tax break programs offered by the state. The firm would be failing its fiduciary duty to shareholders if it did not. The culpability falls upon the politicians who created these programs in the first place, in spite of mountains of evidence that they are not effective at generating net economic growth.

For example, a 2005 study of MEGA by this author and Mackinac Center adjunct scholar Michael Hicks applied a sophisticated statistical model to the full MEGA record and found that the program had no impact on Michigan employment, the unemployment rate or per-capita personal income. The consensus of economic literature supports the conclusion that such programs don’t work to improve a state’s economy.

They do work well for the bureaucrats who run them and the legislators who attend the ribbon cutting ceremonies when the deals are announced. The latter get to pretend to be “doing something” to improve the economy, while they avoid upsetting entrenched special interests with real improvements to the state’s business climate. If they really wanted improve the economy here legislators would eliminate the uncompetitive Michigan Business Tax and replace it with spending cuts, enact a right-to-work law, and overhaul the state’s oppressive regulatory climate.

Transparent Intentions

On September 26 the author of this blog noticed recently introduced Michigan Economic Growth Authority related legislation that — if adopted — would actually shed more light, as opposed to less, on the work of the Michigan Economic Growth Authority. This came as something of a pleasant surprise.

The amending language mandates that the MEDC report:

·         Number of new jobs required to be created or retained;

·         Amount of capital investment to be made by MEGA recipients; and

·         Number of actual new jobs created and the actual total capital investment made.

In other words, the bill’s author — Nancy Cassis — wants to compare promises made about MEGA performance with promises kept to see if the program is as advertised. Moreover, and perhaps most importantly, her legislation mandates that the Auditor General confirm MEDC claims. In other words, like Toto in the Wizard of Oz, Senator Cassis wants to what is behind the curtain (see photo, left).

For years my colleagues and I have noticed changes in the reporting of information from the Michigan Economic Development Corporation. Several MEGA-related employees work at the MEDC and Authority meetings are likewise held at the MEDC office in Lansing. In nearly every instance the change in data output from the MEDC on its programs resulted in less information and less accountability as opposed to more.

The most egregious case in point involved a very discreet change in the law that allowed the MEDC to wiggle out of scrutiny by the state’s Auditor General. The following description of the change comes from my Viewpoint Commentary entitled “The Wizard of Oz Has No Clothes,” written for the Mackinac Center for Public Policy, earlier this year.

Scrutiny of MEDC job creation claims may lead the public to wonder why the department even exists. Perhaps this is why legislators have tweaked language in the state budget guiding audits of MEDC job creation claims. Prior to 2008, boilerplate budget language read that the MEDC "shall work with the office of the auditor general to implement procedures to annually audit the number of jobs claimed to be created by firms." For some reason the text was changed for the current state budget, which reads that the MEDC "may implement procedures to annually audit the number of jobs claimed to be created by firms." What had been mandated is now optional, and the reference to working with the auditor general was stripped away. One has to question the wisdom of allowing the MEDC to audit job creation it claims to have influenced.

In other words, MEDC officials apparently just want us to take their word for it. But we should not because the bureaucrats have an incentive to make the programs they operate appear successful, as if the Great Oz has spoken and jobs have appeared and we should just not presume to question.

The general public may not appreciate why the MEDC tries to avoid such scrutiny, but it should be clear. The more transparent a bureaucracy's work the easier it is for legislators, opinion page editors and others to question the need for a program or department’s existence.

Plastech: Another MEGA "Winner"

Plastech was a wholly owned subsidiary of Plastech Engineered Products, a company that was something of a tier-two supplier to the automobile industry. The company is now defunct and its assets liquidated adding another firm to the list of “winners” chosen by MEGA that turned out to be big losers in the marketplace. Below, you will find a rather optimistic  post on youtube.com detailing the initial bankruptcy announcement.

 

 

 

If you didn’t hear of the companies’ liquidation perhaps it is because the state does not issue “We were wrong!” press releases with apologies from state officials and a recalculation of the jobs that had been forecast  as on the cusp of creation. Can you imagine MEGA officials putting out a press release that read: “MEGA destroys jobs and wealth!” …  and “Rather than creating 555 jobs and new tax revenue as we had foretold, the company failed to meet its job projections, closed its doors, dismissed its staff, drained over $1 million from the state treasury and liquidated its assets. Our poor decisions probably destroyed hundreds of jobs on net balance.”

 

State documents provide conflicting data on just how long the firm has been in business. One document says 1997, the other says 1988 and that it was the recipient of a Blanchard-era Strategic Fund loan. Regardless, MEGA officials thought Plastech was a real comer twice, and offered two subsidiaries (Plastech Romulus and Plastech Frenchtown)  incentives in 2002 and 2003.

 

The first deal, “Plastech Romulus” was to facilitate the firm’s construction and staffing of a new 300,000 foot square facility to manufacture injection molded auto parts. The state offered a property tax abatement of more than $516,000 and $2.8 million in MEGA tax credits. The city of Romulus also kicked in a property tax abatement of nearly $2.2 million. The company was supposed to directly create 400 net new by 2005. University of Michigan economists assumed they would maintain those employment levels through 2011 and create an additional 155 spin off jobs (in retail, etc.) over that period.

 

The second deal, Plastech Frenchtown, was sealed in 2003 and announced with the usual self-aggrandizing press releases issued by the state. This one came with a quote from Governor Granholm:  “Michigan’s leadership in attracting new businesses and expanding our existing manufacturing sector continues today with Plastech’s commitment to the future of our state,” Granholm said. “My administration wants to make Michigan a magnet for economic growth — Plastech’s expansion is evidence that we're making it happen.”

 

No. Governor Granholm and the state’s economic development apparatus is not making it happen. Neither did previous administrations. This Frenchtown deal involved a $500,000 block grant from the state, a $9.9 million MEGA tax credit offer and a Frenchtown Township property tax abatement offer of $8.2 million. The company collected more than $1 million in MEGA tax credit relief before being liquidated and I estimate close to half of the local abatement before going belly up.

 

The state’s economic forecasters estimated that this deal would create a total of 1,898 jobs through 2016, a whopping 990 of them in retail trade, services, and others. This deal had an average “employment multiplier” of 2.1 according to University of Michigan economists, and the Romulus deal an employment multiplier of 1.4.

 

But employment multipliers can be negative too, so there is a very real possibility that these failed deals destroyed more jobs than would have occurred had the state not offered them financial goodies. The accuracy of these forecasts begs the question: "If state-paid economists are honestly capable of telling us how many jobs will be created by different economic sectors (retail, etc.), and as much as 20 years into the future thanks to targeted tax credits, why can’t they foretell a single company’s failure just five or six years hence?" It seems a reasonable question to ask.

 

The answer is that they cannot, and the use of economic forecasting instruments such as REMI computer software probably does little more than provide a quasi-scientific cover for bureaucrats looking to play the industrial policy game at our expense.

It Is Hard to See the Future with Egg on Your Face

Last week a colleague mailed me an article about the degree to which some Michigan economists had been in error in their forecasts about the state economy.  I wasn’t surprised by this as humanity is a complex beast and human actions are fraught with surprises: war, government tax hikes, bankruptcy, and natural disasters — you name it.

What does surprise me is the continued faith that people and government have in long-term, hyper-detailed forecasts of economists and consultants. Regardless of the modern crystal ball they use, such as sophisticated computer software, it is difficult to work around at least two inescapable facts: if you put garbage in you get garbage out; and the many underlying assumptions that are fed into models begin changing the moment the modeler presses the “go” button on whatever computer software they are using.

Let’s use the Michigan Economic Growth Authority program as an example. For each MEGA deal the state has a forecast of the economic impact done by top economists. The model that is used is called REMI and the output the state gets from it include expected spin-off jobs over time, revenue to the state treasury from new jobs, etc. Some of the forecasts are as long as 20 years into the future. My colleague Michael Hicks and I looked at years of data from MEGA and concluded that many assumptions fed into the REMI model appeared to be wildly off the mark.

From our study:

Based on state documents compiled since 1995, we estimate that 127 of

MEGA’s agreements should have produced fully employed facilities through 2004. Of these 127, about 56, or 44 percent, have claimed credits under the program.

The ability to claim credits does not mean, however, that a firm has achieved

the job goals that it projected in its MEGA agreement. For instance, for most MEGA deals, a company must create an initial 75 “qualified new jobs,” usually within a year of commencing operations a particular site. If it does reach this minimum job threshold, it can begin claiming its tax credits, even if it never achieves the job count it originally projected.

 

Many of the 56 cases in which tax credits were claimed did not fully meet

original projections. In fact, only 10 of the 56 can be shown to have created the

number of direct jobs originally projected within the expected time frame — although three of the 10 (Kmart, for instance) have had setbacks following their initial success in meeting the targets.

 

Several of the companies behind those successes stumbled after our study was published as have companies who did receive tax credits for creating some jobs, but ultimately eliminated them. Plastech, which went belly up this year, seems to be a good case in point.

So, how is it that economists who can claim to forecast jobs growth up to 20 years into the future can’t see that in less than 18 months the company whose jobs impact they were hired to model will be bankrupt, as was the case with K mart? The short answer is that they cannot reliably do so.

 

It is difficult to see the future with egg on your face. Rather than continue to try the state should wipe away the yoke of government development programs and their many untenable predictions about some forthcoming economic gift to this or that region or state.

Picking "Winners"

The state of Michigan operates an economic development program known as “MEGA,” or the Michigan Economic Growth Authority.  It is a tax credit program designed to keep good jobs in Michigan and hopefully create more. The program has been a failure and I was reminded of that fact by an article last week in The Detroit News.

In 2005 my colleague and I proved empirically that MEGA did not improve employment, the unemployment rate or per-capita personal income. Perhaps the best illustration of MEGA’s shortcomings involves the Kmart Corporation, picked as a two-time MEGA “winner” that turned out to be a big loser for MEGA’s development mandarins.

This was far from the only deal that the Authority promised great things from that turned out to be a dud. All too often the MEGA has picked economic winners with less forecasting accuracy than "Carnac," Johnny Carson's beloved character (seen below). One has to wonder if MEGA officials are remotely embarassed by the performance of the program they champion, but given their continued use of MEGA the answer may be a resounding "no."

The Michigan Economic Growth Authority twice offered the Troy-based company a host of incentives, once in 1998 and again in 2000. State law requires that the local unit of government participate in the deal in some way.  In the first two deals the state offered a total $30 million in tax credits and an additional $3.7 million in other inducements. The second deal occurred less than 17 months before the company declared bankruptcy. The company was actually able to collect on some state and local incentives before moving from the state.

But the story doesn’t end there.  State officials actually had the temerity to offer a bankrupt Kmart a third deal worth $45 million over just 10 years to keep them in Michigan. Like a bad penny, the Kmart-MEGA relationship returned again. This time, over incentives to raze old buildings and put up new ones in a deal unrelated to the company itself.

Last Friday, the Detroit News reported that the state had refused to provide additional incentives to a developer that wants to build a high-end shopping center where Kmart used to be located. According to the News the state has already provided more than $13 million in tax credits to facilitate the razing of existing buildings but the developer wants more. The state argues that the project doesn’t qualify for more.

But thus far no one seems to have argued that handing out incentives that haven’t worked at this site and at many, many others. What is needed is an economic environment where investors are willing to take risks without MEDC officials interfering in the decision making process.