Local Economic Local Economic Development as a Development as a

Prisoners’ Dilemma:Prisoners’ Dilemma:The Role of Business The Role of Business

ClimateClimate

byby

Stephen Ellis & Cynthia Stephen Ellis & Cynthia RogersRogers

University of OklahomaUniversity of Oklahoma

http://www.ou.edu/cas/econ/http://www.ou.edu/cas/econ/

4/7/99 SRSA Meetings

Why do localities Why do localities continue tocontinue to

compete for firms?compete for firms?

Political incentives?Political incentives? Poor cost-benefit Poor cost-benefit

analysis?analysis? Better than doing Better than doing

nothing?nothing? Competition with Competition with

other states?other states?

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Incentives <=> Pro-business Incentives <=> Pro-business SignalSignal

““You’ve got to have incentives to get You’ve got to have incentives to get your foot in the door” (Carlton, 1996)your foot in the door” (Carlton, 1996)

““North Carolina has one of the North Carolina has one of the strongest economies and one of the strongest economies and one of the best business climates because of … best business climates because of … our aggressive efforts to create and our aggressive efforts to create and keep good jobs” (Governor Jim Hunt, keep good jobs” (Governor Jim Hunt, Lyne, 1998)Lyne, 1998)

4/7/99 SRSA Meetings

The Role of Business The Role of Business Climate:Climate:

““It is increasingly difficult to argue that It is increasingly difficult to argue that business climate, however broadly business climate, however broadly

defined, does not influence defined, does not influence interregional firm location” Wasylenko interregional firm location” Wasylenko

(1991)(1991)

4/7/99 SRSA Meetings

The Prisoners’ DilemmaThe Prisoners’ Dilemma

Everyone wants to offer incentives Everyone wants to offer incentives BUT if everyone offers incentives, there BUT if everyone offers incentives, there

is nothing to gain by doing sois nothing to gain by doing so Competition escalates the value of Competition escalates the value of

offersoffers

““You can’t say no, but you can’t afford to You can’t say no, but you can’t afford to say yes.” (Stephen Goldsmith, Mayor of say yes.” (Stephen Goldsmith, Mayor of

Indianapolis, Schwartz et. al., 1992)Indianapolis, Schwartz et. al., 1992)

4/7/99 SRSA Meetings

Economic Development Economic Development GameGame

Simple ModelSimple Model Single periodSingle period Single firmSingle firm Identical localitiesIdentical localities ““Good” deals onlyGood” deals only

Perfect Planning Perfect Planning WorldWorld

Full disclosureFull disclosure Public Public

accountabilityaccountability Symmetric, perfect Symmetric, perfect

informationinformation Precise cost-Precise cost-

benefit analysisbenefit analysis

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Distinguishing Features of Distinguishing Features of GameGame

The The PlayersPlayers Equivalent with Equivalent with

regard to firm’s regard to firm’s bottom linebottom line

Players make Players make competing bids, scompeting bids, sii

Maximum bid is Maximum bid is value of attracting value of attracting firm, xfirm, x

Role of Business Role of Business ClimateClimate

Localities incur a Localities incur a cost for failing to cost for failing to attract the firm, cattract the firm, c

Cost depends on Cost depends on difference between difference between high bid (shigh bid (sjj) and ) and locality’s bid, c(slocality’s bid, c(sjj--ssii))

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Expected PayoffsExpected Payoffs

If offer high bidIf offer high bid

ppii(s) = 1/h(x-s(s) = 1/h(x-sii)-(1-1/h)c(0))-(1-1/h)c(0)

OtherwiseOtherwise

ppii(s) = -c(s(s) = -c(sjj-s-sii))

where h = number of high bidderswhere h = number of high bidders

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What subsidies will What subsidies will localities offer?localities offer?

Solve through interative dominationSolve through interative domination dominates 0 so rule out 0 bidsdominates 0 so rule out 0 bids ++’ dominates ’ dominates so rule out so rule out bids bids ……(continue pattern)(continue pattern) x is the equilibrium bidx is the equilibrium bid

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Your payoffs with 2 Your payoffs with 2 localitieslocalities

YOURBID

OPPONENT'S BID

0

0 1/2(x-c(0)) -c()

x- 1/2((x-)-c(0))

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Your payoffs with 2 Your payoffs with 2 localitieslocalities

YOURBID

OPPONENT'S BID '

1/2((x--c(0)) -c()

' x-(') 1/2((x-(-')-c(0))

4/7/99 SRSA Meetings

Upshot of GameUpshot of Game

Localities bid the entire value of Localities bid the entire value of attracting the firm to even have a chance attracting the firm to even have a chance at winningat winning

All localities would do better if none All localities would do better if none offered subsidiesoffered subsidies

If none offered subsidies, each would If none offered subsidies, each would want to offer a small subsidywant to offer a small subsidy

If one firm offers subsidies, they all end If one firm offers subsidies, they all end up bidding highup bidding high

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Policy ImplicationsPolicy Implications

Failed PoliciesFailed Policies Unilateral moratoriumUnilateral moratorium Voluntary multilateral moratoriumVoluntary multilateral moratorium

Potential PoliciesPotential Policies Voluntary cooperation in repeated Voluntary cooperation in repeated

settingsetting Federally mandated moratoriumFederally mandated moratorium

4/7/99 SRSA Meetings

Restraint and Refinement Restraint and Refinement are Consistent Goalsare Consistent Goals

Restraint is warrantedRestraint is warranted Incentives competition is inevitableIncentives competition is inevitable Solutions are difficultSolutions are difficult

Refinement of practice is neededRefinement of practice is needed Protect against bad dealsProtect against bad deals Minimize political distortionsMinimize political distortions

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Implications & Future Implications & Future ResearchResearch

Model provides an Model provides an upper boundupper bound on on the benefit to a locality of the benefit to a locality of engaging in incentives competitionengaging in incentives competition

Provides good framework for Provides good framework for extensionsextensions• Formalize dynamics of cost functionFormalize dynamics of cost function• Political economy questionsPolitical economy questions