This article first appeared in the St. Louis Beacon, Sept. 20, 2011 - Missouri is contemplating handing out as much as $360 million in subsidies to create a monument to graft in St Louis. The China Hub project or "Aerotropolis" is being sold as a slam-dunk profitable investment of public money; economic consultants claim the project will generate many more millions of dollars in benefits to Missouri than its cost to the state. But the theoretical models upon which such predictions are based are well known to wildly exaggerate the benefits of such projects.
First, why should state government subsidize a supposedly profitable endeavor? Economists have very clear dictums for when and where government spending can improve market outcomes. The arguments for Aerotropolis satisfy none of these. There is no shortage of private investment funds available, nor does Aerotropolis generate any benefits not also captured by the private sector in the form of wages or profits.
Indeed, the first hint that this project is a boondoggle is the claim that it won't fly without public subsidies. That's another way of saying too many private venture capitalists think the project is a loser and refuse to risk their money. But many state politicians are willing to risk your money, since they likely won't be held accountable for any bad investment. Politicians are not only skilled at avoiding blame: many of them will be out of office by the time the subsidized warehouses at Lambert stand vacant.
This is why government should not try to pick economic winners and hand out money to private firms. The state is unlikely to be as savvy as private investors who have their own skin in the game. Further, "economic development" incentives set up a system that rewards lobbying and cronyism. Would-be entrepreneurs divert their time and expertise from real job creation to angling for a spot at the public trough. And since only predictions about job creation and revenue matter for winning subsidies, the most brazen charlatans, who are willing to promise huge economic payoffs, become wealthy.
Let's look at the ridiculous claims being made about the economic impact of Aerotropolis.
How do economic alchemists turn projects shunned by private investors into massively profitable projects for the state? The magic potion is the "regional economic impact model" that multiplies the benefits of any and all public spending.
But these models are typically bunk. The economic impact predictions generated by such models are based on the assumption that public subsidies have direct and indirect benefits, but only direct costs.
The general claim is this: the state hands money to developers, who hire construction workers, who in turn buy hot dogs; the hot dog vendors then get haircuts, the barbers then buy clothes, etc. Thus one dollar of public investment is assumed to generate many more dollars' worth of economic activity. In this way, a spending program is "multiplied" and, so the claim goes, generates massive indirect economic activity along with the direct impact.
The hitch is that same money might have been spent on some other worthy project or left in taxpayers' pockets; either way, there would have been a similar cycle of spending and indirect benefits. Proponents of state spending projects always seem to forget that these indirect effects likely net out, so shouldn't be counted as a benefit of any proposed project.
Not only are economic impact studies flawed in theory, but recent attempts to empirically validate the predictions generated by these models do not fare well. Of course, the point of these models isn't predictive accuracy; they are used to win favors from government, so the more optimistic the predictions the better!
On the other hand, scientific evidence shows that public spending on things private businesses will not undertake, such as public infrastructure and amenities, can generate positive economic returns. No pie-in-the-sky multiplier-driven increase in economic activity is needed to justify public spending on roads, prisons, museums, parks, public safety, etc.
We believe so many politicians fall for the "economic development" shtick because they need to be seen "doing something" about the dire economic circumstance in our state. Too few politicians want to hear that sound state economic policy is very unexciting: cautiously use public funds where market failures seem to exist and ignore the call of the snake-oil salesmen. But perhaps in a few years when Aerotropolis has been abandoned, the state can use the warehouses built with public subsidies as a museum dedicated to preserving the memory of economic development myths.
Saku Aura is associate professor of economics and Jeff Milyo is professor of social science at the University of Missouri Columbia.