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State's Economic Development Strategy Failing

December 11, 2008 By Nathan Paine, Fellow

Against the backdrop of Minnesota's declining economic performance, it's time for state economic development strategies that work. Minnesota's JOBZ program, essentially an enterprise zone program, and the Department of Employment & Economic Development's (DEED) Enterprise Network System (ENS) tool represent a top-down, targeted industrial policy with an emphasis on selling Minnesota as a low-tax economy and influencing business location decisions with tax subsidies. Most academic research shows that enterprise zones have no positive impact on employment or income or only temporary positive impact.

Targeted local industrial strategies have a long and unsuccessful history.  New strategies should be developed to facilitate innovation rather than design industry cluster formation.  Minnesota's economic development strategies should aim at facilitating the entrepreneurial discovery process by making investments in human capital (education, workforce training programs, networking) and infrastructure needed to support entrepreneurship.  Minnesota 2020 laid out a comprehensive entrepreneurship plan in 2007. More broadly, Minnesota needs to adopt strategies aimed at cultivating innovation rather than trying to sell Minnesota as a low-cost, low-tax state to influence business location decisions. 

The nonpartisan Legislative Auditor underscored DEED's overstatements in its own JOBZ program evaluation.  Specifically, DEED double counted newly created and retained jobs and failed to recognize that most JOBZ participants would have located and/or expanded in greater Minnesota without tax breaks.  Tax giveaways have a very small impact on business location decisions across long distances.  This is not surprising given that localization and urbanization economies exist.  Subsidizing JOBZ businesses may even lead to reducing employment at other greater Minnesota businesses competing for the same customers. 

But a more fundamental problem with the JOBZ program is that it represents a low-cost, factor/investment driven economic development strategy.  Minnesota's problem is that other regions and developing countries also have low-cost economies (e.g. an abundance of cheap labor for low-skill industries, tax breaks, and business subsidies).  Fixed assets and cheap labor used to be the principal sources of competitive advantage for firms.  Economic development strategies were appropriately focused on physical infrastructure, marketing, and tax incentives to attract businesses and industries.  But following a low cost, industrial targeting strategy (business subsidies and tax breaks) is no longer the right path for increasing per capita income and increasing the quality of life in greater Minnesota.

In this economy, there is a premium put on innovation and the ability to utilize production factors more efficiently.  Innovation means uncertainty and disruption in the economy.  However, the dynamics of creative destruction are critical to economic growth.  In fact, the number of new business start-ups and business failures correlates strongly with employment growth.  The resulting implication is that states need to facilitate innovation.

To achieve strong growth in per capita income, state and local governments need to overhaul their economic development strategies.  JOBZ, the ENS tool, and other targeted industries programs are outdated Industrial Age strategies.  In this information-based economy, the focus needs to be on cultivating innovation in Minnesota.  Job growth will come from fast-growing entrepreneurial firms, not from business relocations through a zero-sum program like JOBZ. 

How should Minnesota facilitate innovation?  First, it is critical that policymakers recognize that innovation does not start with scientific research and proceed to the development and commercialization of new products.  Rather, innovation has its roots in the realization of opportunities.  This is the main reason why research parks have almost universally failed to cultivate innovation and stimulate economic growth.  Innovation relies on intimate knowledge of the current marketplace.  Government officials are too far removed to possess this knowledge which is why the foundations of innovation should be the focus of government rather than attempting to artificially stimulate innovation through research parks or the promotion of targeted industry clusters. 

State and local economic development agencies currently operate by reacting to each new economic twist and attempting to recruit new industries and businesses with business subsidies and tax incentives.  Minnesota should instead invest in the foundations for growth in the knowledge economy.  We know factors that correlate with success in the knowledge economy are strong public education, R&D infrastructure, workforce and skills training, and quality of life.

A progressive state policy would focus on cultivating innovation and include investments in skills training, workforce training and the necessary infrastructure investments.  Bigger investments need to be made in K-12 and higher education, as well as workforce development, so that Minnesotans can be productive and adaptive in the knowledge economy.  This means expanding the Job Skills Partnership Program and making significant investments in other industry-wide and industry-led workforce training programs.  Minnesota should also remove any barriers to innovation.  These barriers include human capital, regulatory constraints, and infrastructure.  Minnesota should promote inter-firm networks, where businesses can collaborate and share information, as sources of innovation.  Minnesota should also co-invest with industry-led research alliances between businesses and universities or federal labs.

Now is the time to act. Minnesotans are resourceful and hard-working.  If we have the right tools, our economy can recover and prosper.

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