Chapter 8 – Page 6 – The OM Blog by Heizer, Render, & Munson

OM in the News: GE’s Once Every 40 Year Location Decision

GE plans to make a decision shortly on whether to move its headquarters of more than 40 years from Connecticut, a choice prompted by what the company considers an inhospitable climate for business in the state. The company has been weighing overtures from other states including NY and Georgia that are eager to lure the $150 billion firm, reports The Wall Street Journal (Sept. 11, 2105).

GE’s considerations expand beyond local issues and tax rates. It is looking at the voting records of each state’s lawmakers on national policy issues, such as the fight to reauthorize the Export-Import Bank. The company considers the bank vital to its exports of heavy machinery. GE never even considered a bid by Cincinnati—where GE is currently shifting hundreds of back-office jobs, and which is also the hometown of CEO Jeff Immelt—because of opposition from some Ohio politicians to reauthorizing the Ex-Im Bank. The same holds true for Dallas.

The company was considering various factors in deciding whether and where to move its head office from Fairfield, where it has been since 1974. GE isn’t approaching the decision lightly. Relocating is “the kind of thing you only think about every 40 years, so you want to make sure you get it right,” said Immelt. Most of GE’s facilities to manufacture heavy equipment like power turbines, jet engines and locomotives are in other states such as South Carolina, Ohio and Texas. GE currently employs 4,900 people in Connecticut, of which 800 work at the corporate headquarters in Fairfield. One of the changes in the Connecticut budget that GE took issue with was a cap on the amount of prior-year tax losses companies could use to offset their taxes. Connecticut officials say the state will make efforts to keep GE at the “right price.”

Classroom discussion questions:

Why is this such a critical decision?
Why did Boeing move its corporate HQ a few years ago from Washington State to Chicago?

OM in the News: Chinese Manufacturers Head for South Carolina

Ni Meijuan (center) at Keer's S.C. factory — Ni Meijuan (center) at Keer’s S.C. factory

Twenty-five years ago, Ni Meijuan earned $19 a month working the spinning machines at a vast textile factory in China. Now at the Keer Group’s cotton mill in South Carolina, Ni is training American workers to do the job she used to do. “They’re quick learners,” she said. “But they have to learn to be quicker.”

Once the epitome of cheap mass manufacturing, textile producers from formerly low-cost nations are starting to set up shop in America, reports The New York Times (Aug. 3, 2015). It is part of a blurring between high- and low-cost manufacturing nations that few would have predicted a decade ago. Textile production in China is becoming increasingly unprofitable after years of rising wages, higher energy bills, and mounting logistical costs.

At the same time, manufacturing costs in the United States are becoming more competitive. In S.C., Keer has found residents desperate for work, as well as access to cheap and abundant land and energy and heavily subsidized cotton. Politicians have raced to ply Keer with grants and tax breaks to bring back manufacturing jobs once thought to be lost forever. “The reasons for Keer coming here? Incentives, land, the environment, the workers,” said Keer’s chairman. “Everybody believed that China would always be cheaper,” said a partner at Boston Consulting. “But things are changing even faster than anyone imagined.” In the U.S., manufacturing wages have risen less than 30% since 2004, to $22.32 an hour. Yarn production costs in China are now 30% higher than in the U.S.

From 2000 to 2014, Chinese companies invested $46 billion on new projects in the U.S., with the Carolinas home to at least 20 Chinese manufacturers. Shrinking manufacturing jobs have spurred a willingness in places like S.C. to work for lower pay, making them increasingly attractive production bases. Global manufacturers have also been drawn to right-to-work states, where there is little unionization.

Classroom discussion questions:

1. Why are Chinese textile manufacturers attracted to the U.S.?

2. Why S.C.?

OM in the News: The Search for Cheaper Labor Leads to Ethiopia

Women at work in Addis Ababa at the GG Super Garment factory

For more than a decade, Asia has dominated clothing manufacturing, churning out cheap clothes on inexpensive labor that are shipped to malls world-wide. But over the past few years, rising production costs in China and several deadly factory accidents like the collapse of Rana Plaza 2 years ago in Bangladesh, have forced apparel companies to hunt for alternatives from Myanmar to Colombia to Ethiopia. Ethiopia was recently identified as a top sourcing destination by apparel companies.

Africa, reports The Wall Street Journal (July 13, 2015), is the final frontier in the global rag trade—the last untapped continent with cheap and plentiful labor. Ethiopia’s garment sector has no minimum wage, compared with Bangladesh, where workers earn at least $67 a month. Garment workers in Ethiopia start at $21 a month. (Chinese garment workers earn $155- $297 a month.) Most countries in Africa benefit from a free-trade agreement with the U.S. And, unlike other emerging economies such as Vietnam and Cambodia, many African countries can grow their own cotton, which shortens production time.

Big apparel makers are willing to go to great lengths to find new, low-cost sources of production. Consumers have been conditioned to expect a plentiful supply of cheap clothing, which has pressured the margins of companies like Wrangler, Lee, and Calvin Klein. Ethiopia holds the most promise for developing garment production in Africa, factory owners and brands say. “Ethiopia seems to be the best location from a government, labor and power point of view,” says one CEO.

Many African countries lack roads to transport finished clothing, and landlocked Ethiopia doesn’t have a port. The workforce is untrained in sewing clothes. But apparel companies remain interested despite those hurdles. They are drawn to not only the cheap labor, but to the inexpensive power, which is the 2nd-biggest factory cost after workers. The Ethiopian government is building a railway to the port in neighboring Djibouti to help exports leave the country more quickly.

Classroom discussion questions:

1. What are the advantages and disadvantages of locating a new plant in Ethiopia?

2. Will Africa be the next China?

OM in the News: And the Winner of Volvo’s New $500 Million Plant is— S. Carolina

A Volvo plant in China. The automaker is hoping to increase its American sales volume, which fell 8% last year.

Volvo just announced that it will build a $500 million factory near Charleston, South Carolina, making it the first time a Chinese-owned automaker will have an auto assembly plant in the U.S. The company said that the plant — its first in the U.S. since entering the market 60 years ago — would eventually employ 4,000 and will open in 2018. The factory will initially be capable of making 100,000 vehicles a year.

Volvo already operates two plants in Europe and two in China. It is hoping to increase its American sales volume. Globally, the company is growing, up 9% last year to nearly 470,000 vehicles — helped by surging demand in China.

Volvo will receive about $200 million in combined incentives, reports The New York Times (May 12, 2015). That includes $120 million in economic development bonds, $30 million in state grants and an additional $50 million of incentives from a state-owned utility company. The firm said it chose the S. Carolina site for its proximity to seaports and the quality of autoworkers and facilities in the region. “One of the main criteria for us was infrastructure,” said the CEO. “South Carolina has people who know the industry, can work in the factory, and who understand our business.” He added that the company was looking long-term at its first production on American soil. “A commitment like this you don’t make for 10 or 15 years,” he said. “It’s designed for decades.”

Volvo’s announcement is the latest in a series of production expansions by foreign automakers in the U.S. In July, VW announced it would spend $600 million to expand its plant in Chattanooga.

Classroom discussion questions:

1. How do these incentives compare to prior offers to automakers?

2. Why is Volvo opening the U.S. plant in S. Carolina?

Guest Post: My North Carolina View of Incentives

Our Guest Post today comes from Coleman Rich, at Elon University, in North Carolina. Coleman is Chair of the Department of Marketing and Entrepreneurship and Senior Lecturer in Operations and Supply Chain Management

Being a Textile Management grad from North Carolina State U., I have seen that incentives played an important role in NC to secure the textile trades from the North. Many towns would pool their money to help secure a mill which would move individuals closer to town and give workers a steady wage. The mills provided housing and staples for their employees.

Fast forward to 2 decades ago. North Carolina was in the running for the Mercedes plant. The Governor met with the Mercedes representatives at Alamance Community College near I-40/85 to discuss incentives for the plant. There was a 1,000 acre site with rail, and Duke Energy would run the power to the plant. The Governor offered over $100 million. But the Germans went to Alabama. We can only imagine how different this area would be if Mercedes had chosen this site.

That one plant created an entire industry cluster in the Alabama and Mississippi area. Since Mercedes announced the Alabama plant in 1993, Honda, Toyota, Hyundai

Dell's 2012 closing of this manufacturing plant put more than 900 people out of work. — Dell’s 2012 closing of this manufacturing plant put more than 900 people out of work.

and Kia also opened factories in that region. I believe incentives rarely work, but you have to “pay to play.” As a state, I would be willing to offer incentives to a large manufacturing company because I believe there is more economic value in supply chain companies locating in close proximity to the manufacturer. Alabama’s network of auto suppliers now tops 130 companies.

Here is a mistake the State made with Dell in Kernersville, NC. Virginia and NC were both bidding for the Dell plant. Virginia offered incentives in the $30-37 million range. Local and state incentives from NC were about $242 million. But the Dell plant closed after 5 years. Why did NC offer more than Virginia in incentives for the Dell plant? After all, as technology was changing and consumers moving toward laptops, this plant was making desktops. Also Dell began to change its business model to compete with HP. Maybe the economic models that the state of NC uses also need to consider product life cycle of the product that will be made in the plant.

But if it wasn’t for incentives, NC would not have been shaped by the tobacco, energy (Duke Power), furniture and textile industries. Those industries could have moved further south to SC and Georgia. As I teach Chapter 8 in the Heizer/Render text, I share all of these points with my class.

OM in the News: Mexico’s Auto Assembly Lines Surge Ahead

When Audi decided to move global production of its Q5 SUV to North America, the prize went to Mexico. Audi now is finishing a $1.3 billion factory in a small town called San Jose Chiapa. Mexico’s low wages and improved logistics were part of the draw. But for Audi, which plans to ship the factory’s output all over the world, what tipped the scales was Mexico’s unrivaled trade relationships. The Audi deal shows that Mexico’s 40 different free-trade pacts give it allure in the global car market, threatening the American South’s industrial renewal.

Seven Asian and European auto makers have just opened, or will open shortly, new Mexican assembly plants, reports The Wall Street Journal (March 18, 2015). Others have made significant expansions in Mexico, among them Nissan, GM, Ford and Fiat Chrysler. This month, VW said it would spend $1 billion expanding a Mexican plant to build a small SUV for the U.S. and foreign markets. All told, auto makers and parts suppliers have earmarked more than $20 billion of new investments. The wave of investment has turned Mexico into the world’s 7th-largest producer of cars—it passed Brazil last year—and the 4th-largest exporter after Germany, Japan and South Korea. Mexico’s current production of 3.2 million cars and trucks will rise more than 50% to 5 million by 2018. It has been more than six years since an auto maker picked the U.S. South for a “greenfield” plant, meaning one where the company didn’t already have facilities. Such projects have all gone to Mexico lately.

Audi is taking some unusual steps to control its risk. First, to ensure quality, the company created a consultancy that fanned out to 160 parts suppliers in Mexico, encouraging some to change plant design or improve weak production processes. The company created an inventory of local sources for every part and for all raw materials used in the Q5, and has required suppliers to source from its list. And Audi now is training 600 people from Mexico at its headquarters in Germany. Visiting on 18-month stints, the Mexicans train on Audi systems and are indoctrinated with the company’s intense focus on quality.

There is an excellent 3 minute video linked to the WSJ article.

Classroom discussion questions:

1. Why are automakers heading to Mexico?

2. What can the U.S. do to entice manufacturers?

OM in the News: Are Location Incentives Worth the Cost?

Jay and I were just discussing the OM in Action box in Chapter 8 (Location Strategies) called “How Alabama Won the Auto Industry.” We are working on the 12th edition (due out Jan.1, 2016) and debating the value of the $253 million in incentives that brought Mercedes to Alabama. The recent article in The Wall Street Journal (March 13, 2015), called “Corporate Giveaways Are Not a Good Deal for North Carolina” helped enlighten our debate. For years, N.C., like many states, has had a system under which the governor can dangle tax breaks and grants to companies considering relocating to the state. As the pot of money available for these corporate incentives is about to run dry, the governor is urging state legislators to sign a bill for more funding.

The bill would increase the amount available to award this year by $15 million. If that sum sounds relatively modest, consider 2 points. First, each new grant can last up to 12 years, meaning the extra $15 million could increase the program’s payout by $180 million. Second, N.C. has already issued more than 200 grants since 2002 that will deprive state coffers of an estimated $157 million in the next 2 budget years alone. Outstanding liabilities for corporate incentives–$1 billion!

Proponents argue that other states are playing the incentives game, and businesses expect to trade tax cuts for jobs. That claim deserves a closer look. A recent report summarized the results of 55 peer-reviewed articles on the impact of targeted tax incentives, and the results are not encouraging. More than 70% of the studies found that incentives either did not substantially contribute to economic performance or produced mixed results. As an example, in 2011, $20 million of state money helped lure Chiquita Brands from Cincinnati to Charlotte. But after a recent buyout, Chiquita plans to close the headquarters, and community leaders are now working to recover as much money as possible.

There are other steps lawmakers can take that are much more likely to boost the economy: Ensure the delivery of high-quality services such as schools and roads while lowering costs, flattening taxes and repealing unnecessary regulations.

Classroom discussion questions:

1. Argue the pros and cons of such incentives.

2. Discuss the OM in Action box on Mercedes on page 331.

OM in the News: Move Over, Silicon Valley

In Chapter 8, Location Analysis, we discuss the interesting topic of clustering (see Table 8.3). Clustering is basically locating near competitors so as to take advantage of major resources found in that area. The perfect example is how software and high-tech firms head to Silicon Valley, Boston’s Route 123, and Bangalore (India). Our colleague, David Greenberg, just emailed from India that Tel Aviv belongs near the top of the list and sent the adjacent graphic. He adds: “Aside from Israel as No 2, what I found interesting is that Waterloo, Ontario is on the list. There’s an implication here that a single successful startup (Blackberry, Microsoft) is enough to build a cluster (Waterloo, Seattle)”.

Like the U.S., Israel puts entrepreneurs, successful or not, on pedestals, which allows them to attract the best minds to work with. Some Israeli high-tech innovations: voice mail (1984), multislice CD scanners and cardiac stents (1992), ICQ instant messaging and VoIP “voice over internet” (1995), USB flash drives and computer vision software for road navigation (1999), the pillcam (2001), and Intel mobile technology (2003). More than 90 Israeli firms are listed on NASDAQ–2nd only to the U.S.

Classroom discussion questions:
1. What ecosystem is needed for success in high-tech?

2. Name several other clusters that are not high-tech.

OM in the News: Mercedes Heads South

Mercedes is moving down south, writes The Wall Street Journal (Jan. 7, 2015), uprooting its USA’s headquarters from its longtime perch in New Jersey with plans to relocate it to an Atlanta suburb. Wooed by lower costs, proximity to a Mercedes-Benz factory, and government incentives, the car maker turned down a significant incentive package from New Jersey to keep its U.S. headquarters in Montvale, where it had been running operations since 1972. Mercedes is joining several other auto makers to have moved operations and corporate headquarters to the South to take advantage of low union membership in right-to-work states, low corporate taxes, and easy access to well-maintained highways, rail lines, ports and airports.

“We think the infrastructure in the States has changed,” said CEO Dieter Zetsche. “The South is much more relevant than it used to be.” A site selection consultant added that New Jersey has the country’s most appealing incentives policy, but it was outweighed by the cost-savings and convenience of moving to the U.S. South. He said that the move would reduce Mercedes’ costs, including real estate, energy and property taxes, by about 20%.

Mercedes has a plant in Alabama, which builds about half the vehicles it sells in the U.S. and is expected to reach an annual output of 300,000 vehicles next year. Last April, Toyota said it would relocate its U.S. operations to a new campus in Plano, Texas. South Korea’s Kia Motors opened a plant near Columbus, Ga. in 2010. A year later, Volkswagen opened a plant in Chattanooga, Tenn. Other operations include BMW’s plant in South Carolina and Hyundai Motor’s plant in Alabama.

Mercedes’ decision to move as many as 1,000 jobs from the state is another body blow for New Jersey’s labor markets. Recently billboards pleaded “Bergen County (hearts) Mercedes-Benz #Please stay.”

Classroom discussion questions:

1. Why are location decisions such as this so important to the state and to the company?

2. Why did Mercedes decide to relocate?

OM in the News: Iowa–Home of Corn and Facebook

Facebook's servers require only 75 employees in this massive facility — Facebook’s servers require only 75 employees in this massive facility

Among the big draws in Altoona, Iowa, population 15,000, are Adventureland, a Bass Pro Shop, and the Prairie Meadows casino. “And now,” says The Wall Street Journal (Nov. 15-16, 2014), “it has Facebook’s new data center.” The social network just opened the $300 million facility, a move that highlights the intense competition and lavish tax breaks available from small communities looking for technology bragging rights. Nearly 3 times the size of the city’s sole Wal-Mart, Facebook’s warehouselike structure is packed with refrigerator-sized stacks of computer servers and thick coils of cables. The Altoona facility was built on millions of dollars of tax breaks and about 18 months of negotiation.

Facebook isn’t Iowa’s first high-tech catch. Microsoft is spending $2 billion on a data center nearby in Des Moines. Google is expanding a facility in Council Bluffs.

States and cities long have vied against each other to lure factories, sports teams and corporate headquarters. Iowa, the county’s largest producer of corn and soybeans, is among more U.S. states rolling out a green carpet for those farming bits and bytes. Officials say data centers broaden their tax base, create well-paying technical and construction jobs and confer bragging rights that will lure companies with bigger hiring plans. They also contribute to the local economy without stressing infrastructure such as roads and sewage plants.

But it remains an open question whether the cost of these facilities in tax breaks and services works out in their favor. Altoona provided Facebook a 20-year exemption on paying property taxes, and Iowa agreed to $18 million in sales-tax refunds or investment-tax credits through 2023. Facebook pledged to spend at least $300 million on the project and create jobs paying $23.12 an hour. “For the tax breaks they often receive, the centers produce few jobs or spinoff benefits,” said an Iowa State U. prof. Tech companies aren’t looking for incentives alone. Availability and pricing of electricity, which can exceed 2/3 of the cost to run a data center, are among the most important factors.

Classroom discussion questions:

1. Are these unusual incentives?

2. What are the risks to each side–Altoona and Facebook?

OM in the News: Tesla and the Mother of All Factory Chases

After pitting five potential host states against one another in a quest for hundreds of millions of dollars in incentives, Tesla Motors reports in The New York Times (Sept. 5, 2014) that it has struck a deal with Nevada for construction of a sprawling factory to build batteries for electric cars and the power grid. To secure the deal, Nevada paid dearly. The package of tax breaks totals about $1.25 billion over 20 years. Gov. Brian Sandoval acknowledged that there were concerns over the deal’s cost, but said that the agreement would “change Nevada forever” and that he expected the enormous tax breaks to pay dividends down the road.

Whether it will work that way is not clear. But the prospect of having such a large plant nevertheless set off “the mother of all factory chases,” according to an industry expert. The deal goes beyond tax breaks. It means Tesla would pay no sales tax for 20 years, no property tax and payroll tax for 10 years, and it would receive other tax credits tied to job creation and development. Nevada will also grant Tesla discount electricity rates for 8 years and make millions of dollars in road improvements around the factory site.

An important element for Tesla is the anticipated cost reduction is moving the fabrication of various components to a single spot, making the factory more of a campus than a single operation. Today, bringing the main components of the battery together is expensive. CEO Elon Musk describes the current system as “being put in a box, and then on a truck and then on a boat, and going through customs and stuff like that.” Still, analysts question whether the plant’s vast size will result in the huge price cut, an essential element of making the factory useful. At the heart of the strategy is to build a kind of battery that resembles the ones used for years in laptops and hand-held electronics.

Classroom discussion questions:

1. Referring to the incentive issue in Chapter 8, discuss Nevada’s decision.

2. Who is taking the most risk in this location decision?

OM in the News: America’s Car Capital Will Soon Be… Mexico

By 2020, Nissan plans to produce a million cars a year in Mexico

“Seemingly overnight,” writes Forbes (Sept. 8, 2014), “Mexico’s automotive output has soared, bolstered by a flood of investment from foreign-based carmakers, including Nissan, Honda, VW and Mazda.” With $19 billion in new investment, production has doubled in the past 5 years to an estimated 3.2 million vehicles. The reason is simple: Mexico has some of the most liberal free trade arrangements in the world. It has agreements with 44 countries, making it an ideal export base for automakers from Europe, China, Japan and America. (The U.S. has agreements with only 20 countries.) The result: 80% of the cars built in Mexico are exported to other countries..

In recent weeks Infiniti, Mercedes and BMW have all detailed plans to build cars in Mexico, with Hyundai-Kia just around the corner. Audi is midway through construction of a $1.3 billion factory that will build luxury SUVs starting in 2016. Currently the world’s 8th-largest auto producer, Mexico is on pace to surpass Brazil this year. By 2020 Mexico should behind only China, the U.S., Japan, India and Germany, with an annual production of 4.7 million vehicles. Automakers like the young (average age: 24) and comparatively cheap (about $40 per day) Mexican workforce. But there are plenty of other reasons. European carmakers say Mexico’s dollar-dominated currency gives them a natural hedge against fluctuating exchange rates.

Nissan has led the way with its massive new 21-million-square-foot factory. It took just 19 months for the $2 billion plant, one of the largest industrial investments ever made in Mexico, to get up and running, a record for Nissan. Production of the Sentra began last November and was quickly ramped up to full capacity of 175,000 vehicles a year, operating 23 hours a day, 6 days a week. Some 3,000 jobs were created, and another 9,000 at supplier companies. The boom in Mexican production is already rattling the North American auto industry. Today 40% of all auto-sector jobs are in Mexico, up from 27% in 2000. Canada and the Midwest have taken the brunt of the job losses.

Classroom discussion questions:
1. Why Mexico?

2. What are the supply chain implications?

OM in the News: China’s Latest Export–Manufacturing Jobs

Huajian Shoes’ factory outside Addis Ababa is part of the next wave of China’s investment in Africa. It started with infrastructure, especially the kind that helped the Chinese extract African oil, copper, and other raw materials to fuel China’s industrial complex. Now China is getting too expensive to do the low-tech work it’s known for. African nations such as Ethiopia, Kenya, Lesotho, Rwanda, Senegal, and Tanzania want their share of the 80 million manufacturing jobs that China is expected to export, reports BusinessWeek (July 28-Aug. 3, 2014).

At Huajian’s factory, wages of about $40 a month are less than 10% of what comparable Chinese workers make. But just as companies discovered with China when they began manufacturing there in the 1980s, Ethiopia’s workforce is untrained, its power supply is intermittent, and its roads are so bad that trips can take 6 times as long as they should. “Ethiopia is exactly like China 30 years ago,” says Huajian’s CEO, whose company supplies such well-known brands as Nine West and Guess. Frustrated by “widespread inefficiency” in the local bureaucracy, the company is struggling to raise productivity from a level that is about a 1/3 of China’s. Transportation and logistics that cost 4 times what they do in China are prompting Huajian to set up its own trucking company.

Manufacturers coming here don’t have to worry about finding new workers. The population of 96 million is Africa’s second-largest after Nigeria’s. Cheap labor and electricity and a government striving to draw foreign investment make Ethiopia more attractive than many other African nations. “It could become the China of Africa,” says a Johns Hopkins prof.

Classroom discussion questions:

1. Why is China exporting manufacturing jobs?

2. What are the advantages and disadvantages of locating in Ethiopia?

Good OM Reading: Reshoring Revisited

A recent study, Where in the World, compiled by the Entrada Group, provides some interesting insight as to why small- and mid-size manufacturing executives are now ranking the U.S. and Mexico as “prime locations” for lower-cost production of goods bound for North America.

Here are some of the findings from Entrada’s survey:

Proximity is appealing — While the U.S. is the most attractive low-cost manufacturing location among all respondents (at 33%), it’s worth noting that among respondents from companies that already manufacture in 2 or more locations (their headquarters plus one), Mexico and the U.S. tied as the top choice, each with 23% of the response.
Experience with expansion matters — Respondents from companies that currently manufacture at 2 or more locations revealed a greater appetite for future expansion to a low cost location or locations, when compared to firms producing solely at their headquarters. Of companies that manufacture in 2 or more places, 67% said they plan additional expansion in the future, compared to just 33% of single-location manufacturers that plan future expansion.
Quality and the bottom line both count — While respondents overall rank high-quality production as the most important factor when choosing a manufacturing destination, low operating costs was tops among companies when reflecting on motivation for past expansion, by more than 2-to-1 over high-quality production.
Cost savings are not always realized — Companies that expanded to a “low-cost manufacturing location” achieved their goals to a large extent just half of the time, with half realizing just moderate savings or worse.
Today China is the most common low-cost location, followed by Mexico — More than half of survey respondents (51%) currently manufacture product in China, with 35% manufacturing in Mexico, the 2nd-greatest response.
China, Mexico not “either-or” — Out of firms that manufacture product in China, 40% also produce in Mexico. Indeed, for many manufacturers, a presence in both countries makes sense for delivery to regional markets.

Good OM Reading: An Analysis of State-Provided Benefits in Location Decisions

Competing for businesses by offering companies targeted benefits is a popular policy among the governments of American states. As we discuss in Chapter 8, benefits come in many forms, including business tax credits for investments, property tax abatements, and reductions in the sales tax paid by the recipient businesses. Policymakers sometimes establish “enterprise zones” to facilitate these benefits, granting them to companies that hire people and invest in the zones. The purpose of benefits is to promote employment, innovation, economic growth, and revitalization.

Despite their good intentions, policymakers often overlook the unseen and unintended negative consequences of targeted benefits, according to a new study titled The Political Economy of State Provided Targeted Benefits (May, 2014). The paper analyzes two major, neglected downsides of these policies: (1) they lead to a misallocation of resources, and (2) they encourage “rent-seeking.” The authors, both at George Mason U., argue that these negative consequences of benefits are likely to outweigh any benefits.

Targeted benefits are by no means a new policy in the U.S. During the “railroad era” in the 1800s, many American cities provided subsidies to railway companies to attract their business. As railroad expansion slowed in the early 1900s, local governments’ role in luring particular companies to their locales diminished. But in recent decades, the trend has been a steady increase in the number of state governments offering various tax benefits to businesses. The 1980s has been called the “decade of industrial recruitment and state incentive packages.” Surprisingly many states do not evaluate their benefits programs consistently.

The study examines the systemic effects of targeted benefits on market competition and the incentives facing both companies and politicians. It concludes that benefits cause a misallocation of resources as governments use them to change the composition of economic activity and to attempt to increase overall economic activity. It also finds they lead to cronyism as firms seek to secure benefits from the government.