This article appears in the Vol. 8, No.1, Winter 1995-96 edition of The Journal of Applied Manufacturing Systems, a biannual technical journal published by St. Thomas Technology Press. This press is associated with the Department of Manufacturing Systems and Engineering at the University of St. Thomas, St. Paul, Minnesota.

THE THEORETICAL BASIS AND PRACTICE of industrial development fluctuates with a changing economy. No longer can industrial development be couched in terms of location marketing, business attraction and location incentives alone. The days of "shoot anything that flies, catch anything that falls" industrial development are over. The new economy demands improvements to basic business climate, selective and disciplined use of incentives, and creative use of support strategies for industrial modernization. No location is inherently bad for industrial development - success depends on identifying and improving upon competitive advantage at the state and local levels.

Industrial Development in Retrospect

U.S. industrial development had its origins in the state of Mississippi in the 1930s. At that time, given improvements in mass manufacturing, new plants were seeking cheap labor, low-tax operating environments. Mississippi's Balance Agriculture With Industry (BAWI) Program was the first modern state economic development program to focus on aggressive marketing and location incentives. Since then the economic development profession has burgeoned to more than 15,000 organizations representing various localities, regions and states that vie for business investment through attraction, expansion and retention.

Competition for business among states has become so intense, some refer to it as the "second war between the states." As an example of the price escalation in this war, Bidding for Business by the Corporation for Enterprise Development notes that Tennessee paid $11,000 for every job created at a major Nissan plant in 1980. Five years later, the state paid $26,000 per job to win the Saturn plant. More recently, South Carolina paid $71,000 per job to land the BMW plant, and Alabama paid $169,000 per job to win the Mercedes plant. Table 1 shows recent incentive comparisons. In a recent statement, 100 Midwest economists called for an end to the economic war between the states, asking state and local leaders to terminate targeted business assistance such as direct grants, selective tax incentives and abatement programs. They recommended comprehensive economic development strategies based on statewide tax relief for all citizens and businesses. But such voluntary and unilateral action has not worked in the past and offers limited future prospects. Some argue that ending the economic war between the states would have a marginal effect at best anyway. In a global marketplace, U.S. states and localities face incentives competition from overseas as well as at home. Finding the legal and contractual means to contain the incentive wars has some value, but the real challenge is to devise industrial development policies and practices that are congruent with a rapidly changing industrial economy. Industrial development today is less about tweaking traditional tools and more about new methods to find and maintain competitive advantage.

Transitions Toward the New Economy

Organizations that wish to foster business growth must rapidly adapt to the economy in the same way businesses have. The new economy embraces macroeconomic and social changes that "include dramatic demographic shifts, increased global competition, the growing impact of new and small businesses on job creation, technological change, and the impact of innovation and entrepreneurship in business formation" (Center for the New West). Or in the words of Indiana's 1994 strategic economic development plan, INvesting IN INdiana:

Markets are going global,
organizations are going horizontal,
decisions are going local,
people are going flexible,
and economic developers are going all out.

America's rise to economic leadership can be traced, in part, to "Fordism"- The mastery of mass production. Fordism is characterized by mass production and mass consumption of highly standardized consumer durables with specialization and division of labor, high-volume assembly line production and "scientific" management. Since the turn of the century, Fordism has served the United States well.

During the '70s, a new production paradigm began to take shape in Japan, Germany, Italy and some high-tech manufacturing areas of the United States. Firms sought to differentiate their products from those of others, drastically reducing the size of production runs, enhancing quality features and aggressively pursuing global market niches. This was made possible by new production, information, and control technologies coupled with more highly skilled, flexible workers. The new industrial economy can be described as flexible markets, flexible systems and flexible people.

Most noticeably, this new economy alters criteria for business location decisions and by extension, choices about industrial development. In the old economy, manufacturers considered the cost differentials of four or five factors when deciding where to locate. Access to raw materials and markets, labor availability and supply, and cost and availability of energy and transportation were important factors then. Today's location criteria are more complex. Worker quality, continuing education/training, safety/security and quality of life for managers and workers come into play. Most importantly, as Michael Porter of Harvard University argues, comparative advantage - the merits of alternative sites based on cost comparisons of factors of production - must give way to competitive advantage - those factors that human intervention can improve, such as outstanding public education and training, easy access to public information, interfirm strategic alliances and incentives for R&D and innovation.

New economic growth theories stress that subnational economies grow because of the accumulated increase in an endogenous factor variously titled "technical progress," "knowledge-base" or "human capital." Accumulated know-how and human capital will snowball, whereby growth begets growth. The twin notions of competitive advantage and endogenous factors pose challenges for devising totally new approaches to industrial development. Paradoxically, competitive advantage plus exogenous effects lead to the proposition that successful industrial development is localized. Only at the state and local levels can competitive advantage be truly differentiated, especially in a global marketplace. A discussion follows of state-led public policy priorities to achieve competitive advantage.

Create a Competitive Climate

In a free-market economy, tax policy and regulatory policy serve as de facto industrial policy. Ten years from now, states in the lead economically will be those that paid careful attention to the business climate today. The new economy's highly competitive environment has forced businesses to look constantly for ways to shave costs and improve productivity while adding quality and innovation. Over the past four years, U.S. productivity and resultant earnings growth have been remarkable. One much-publicized business strategy has been downsizing or rightsizing. Though more job layoffs are expected over the next few years, businesses may be nearing the end of payroll cost cutting. They are beginning to consider the costs of energy, transportation, materials and government. It is no surprise then to observe a general decline in the percentage that corporate taxes are contributing to state general-fund revenues. Tax cuts and tax code revisions to encourage economic development have gained state lawmakers' attention, e.g., revisions to: Pennsylvania's corporate profits tax rate, North Carolina's unemployment compensation payroll tax, personal tax rates of small businesses in several states and special tax breaks for the manufacturing and mining industries.

The debate heats up as to whether these tax concessions should be oriented toward individual firms and industries perceived as making desirable location investments or to changes that would benefit broader categories of businesses, regardless of relocation, reinvestment, layoffs or expansion. For example, a cut in personal tax rates would favor corporations and sole proprietorships; elimination of an inventory tax would favor the capital-intense and distribution sectors.

Regulation is another aspect of the state and local business climate receiving attention. A high-performance regulatory system can help every company be more competitive, whereas financial incentives or publicly provided technical assistance programs often serve less than 5 percent of a state's businesses in any one year. A better regulatory system can foster economic productivity and growth by simplifying procedures and reducing time delays for all. Furthermore, regulations that anticipate markets can give a state's firms a head start in developing products and services that are valued later elsewhere or make the state an attractive place in which to live and do business. Regulation might have been designed as a punitive process but, if formulated collaboratively, it can create positive economic and amenity value.

Apply Incentives Selectively

The competitive realities of economic development call for the wise use of incentives. Incentives can no longer be viewed as "sweeteners" or "boosterism" tools. Rather, they must be seen as investments which are analyzed and managed from the perspectives of return on investment and accountability to shareholders - in this case, taxpayers.

But first it is important to sound the alarm about ill-considered and indiscriminate use of incentives:

Fiscal realities of state and local governments demand allocation of scarce resources to public-policy priorities - health, education, welfare, infrastructure, prisons. Economic development budgets are not expanding relative to other state and local budgets. Limited funds for incentives must be used wisely.

Commentators (such as Greg LeRoy, in No More Candy Store) point to the social inequities of untamed incentive use, where large firms appear to benefit at the expense of small ones, workers and taxpayers at the expense of large corporations.

Opposition is mounting within the business community. Existing businesses often complain they do not receive adequate attention from economic development entities relative to the incentives and support provided to newly arriving businesses. Existing businesses are much more concerned about the prevailing business climate and the cost of doing business. They feel overlooked when large handouts are made available to newcomers. Also, at a time of tight local labor markets, a new business may increase labor costs for existing business.

Still, public investments in new business activity can achieve solid rates of return - it all depends on the "magic of multipliers."

Any business investment brings about direct and indirect effects - jobs, income, electric load, etc. Traditional economic developers tend to focus solely on primary jobs, especially those obtained through attraction, and to pay little attention to secondary jobs. There are at least three categories of secondary jobs: those that produce parts and materials used in the new facility's production process, those that produce goods and services consumed by the new facility's workers, and the government and social services jobs financed by tax revenues. All are lumped together in the multiplier effect.

Some industries have much higher multipliers than others. According to a recent report by the Economic Policy Institute, the multiplier effects of manufacturing establishments are significantly higher than those of the service sector. Manufacturing jobs can generate four to four and one-half times more secondary jobs than retail, and two times more secondary jobs than business services.

The following growth strategies make use of multipliers and make sense in the long run:

An existing industry cluster or complex would be enhanced by the presence of another enterprise. For example, higher levels of innovation in local firms might occur if a commercial R&D establishment is attracted to the local area.

A local firm is strengthening global competitiveness through joint ventures with overseas firms. The attraction of new joint-venture operations would benefit that firm as well as its network of local suppliers.

Expanded production contracts and stable employment might be possible for many small firms if an "anchor" (assembler) is attracted to the local area. Anchor developments are a way to capitalize on the area's existing assets.

Despite these growth strategies, well-heeled principles must be applied to avoid incentive misuse. The disciplined use of incentives calls for rate-of-return analysis, formal development agreements, calibration and clawback. The public continues to demand higher performance and greater accountability from government, community leaders and economic development professionals. The following principles, developed by my colleague, James D. Laughlin and me, are offered as a guide to assembling incentive packages.(1)

Outcome-based calibration
All incentives should be linked to development agreements that specify negotiated outcomes. These outcomes should be measured annually and beneficiaries rewarded accordingly. If the goal is to create jobs, incentives should be awarded annually as job creation occurs. Only in this way, can all parties keep the project focused on intended public-policy objectives.

Rate of return
If incentives are investments, then we must know their rate of return. This can be determined by fiscal revenues generated per dollar invested. By calculating this cost-benefit ratio, community decision makers can weigh the merits of a contract.

Performance baselines
This relatively new principle is significant to future incentive design. Many argue that incentives merely reward actions which would have occurred anyway. Instead, incentives should be tailored to apply only to investments above certain base lines. For example, one could design a state training tax credit which rewards firms that increase job training. The Federal Research and Development Tax Credit is designed along these lines.

Clawback
The option for a community to cancel a subsidy if a firm does not comply with minimum requirements is fundamental to any development agreement. In a recent controversial case, Ypsilanti, Mich. failed to win an injunction against GM for leaving the community when $1.3 billion dollars in tax abatements had been made available. In contrast, the city to which GM moved, Arlington, Texas, requires GM to pay back taxes if the development agreement is breached.

Emphasize capital incentives over cash
There is a tendency today to offer firms either cash or free land. Neither is as desirable as capital investment in infrastructure and training. In the latter case, the investment not only benefits the firm, but the community and economy as a whole.

Use incentives to accomplish goals
Incentives are not fair. They are selective and designed to achieve certain objectives. Communities without a strategic plan that addresses the use of incentives find themselves unsure of which types of businesses to help.

Smart Modernization Strategies

Given the rapidly changing economy, industrial development policy must pay greater attention to how firms modernize with haste. Industrial modernization strategies can be categorized under five generic types. Smart states provide a creative mix of these. No one strategy is known to be superior to others. The following discussion includes illustrations from the state of Indiana.

Industrial extension
The approach of providing technology to communities, industrial resource centers and small-business centers throughout the state is based on the work of Phillip Shapira and others. It draws heavily from the agricultural extension model and is well established in Pennsylvania and Georgia. It is a central ingredient of the Clinton administration's technology modernization initiatives to establish Manufacturing Outreach Centers across the country.

Indiana has two complementary programs: The Indiana Business Modernization and Technology Corporation's Regional Manufacturing Technology Centers (RMEC) and Purdue University's Technical Assistance Program (TAP).

Begun as a pilot program in 1988, RMECs now operate in 14 multi-county regions. They receive joint state-local funding. Each region has a field service agent who assesses technical needs of local clients, provides hands-on assistance in areas of expertise and offers technical referral services. This initiative focuses on distressed companies and is designed to reach company owners and managers and to help them solve practical problems related to technology, training, marketing and financing. TAP provides up to five days of free faculty and engineering graduate-student consultation and is designed to solve technical and managerial problems. In many cases the initial contact leads to long-term research and consulting contracts between the firm and university staff.

Business-to-business learning/ business partnering
Encourage strategic alliances, peer roundtables, networks and coalitions that help businesses to learn from one another, develop collective strength, and increase interfirm collaborative organizations/networks.

In Rebuilding America, John Heinz argues for expanding the concept of manufacturing modernization: "National manufacturing policy emphasizes the creation of manufacturing extension services, which serve firms one at a time. A more profitable strategy would be to develop programs to modernize existing production complexes of firms and suppliers. The federal government could also expand modernization efforts to focus on managerial practices such as work teams, quality efforts, labor-management cooperation and closer customer-supplier relationships."(2)

Business improvement groups are small groups of business owners and managers who meet regularly to discuss and learn from each other about the applications of management tools - quality, organizational development and training. In exchange for an annual fee, members have access to resources such as common consultants and seminar providers that they might not be able to afford individually. Several Indiana communities have established Total Quality Management groups. These are often affiliated with the local chamber of commerce or economic development organization.

Small, niche-oriented trade associations are beginning to form in emerging subsectors where competitiveness is appreciably enhanced through interaction among firms. The Indiana Electronic Manufacturers Association and the Indiana Medical Devices Association are two examples of this specialty industry alliance.

Industry councils promote the general economic health and welfare of an industry sector. These councils have the potential to play a prominent role in marketing and advancing an area's economic growth and could provide valuable information on how the industry might maintain or advance its competitive position.

Many communities have established competitiveness coalitions or quality councils. Across the United States, these organizations have taken many different forms and have equally diverse goals. In Indiana, the cities of Richmond, Vincennes and Columbus have established partnerships among businesses, nonprofits, government agencies and civic leaders to improve the quality of both community and businesses.

In Oregon such an alliance was formed at very low cost - initial state facilitation and a $10,000 start-up grant.

Information access
This means providing more accessible and diffuse information via computer databases and on-line networks; providing information on development issues via telephone hotline(s); and providing information on existing state and regional resources via comprehensive directories.

Some argue that government cannot keep pace with new economic dynamics. If so, government's role is to provide a sound public infrastructure. In today's economy one critical infrastructure is advanced public access telecommunication systems and a wide array of public access information. Indiana has an abundance of on-line information resources: Economic Development Information Network, INTELENET, Indiana Higher Education Telecommunication System, INFORUM and Access Indiana. As yet, the state lacks a single, user-friendly delivery system. In fact, the state's economic development leaders are often overwhelmed both by the sheer amount of data available and the difficult task of finding the correct database for a specific topic. Much of this could be circumvented by one easy-to-use, statewide information network which integrates the multitude of resources available.

One information system gaining acceptance is the Indiana Global Business Information Network housed at the Indiana University Center for Global Business. The result of public and private involvement, this network provides library and economic development information networks with information on international business via books, databases and on-line retrieval systems. The network identifies opportunities for international investment, joint ventures, international standards, conferences and seminars. The Center for Global Business is linked to the statewide network of Small Business Development Centers (SBDCs).

Private technology providers
Fostering a business climate that is conducive to the growth of advanced business services is imperative. This strategy encourages the provision of direct technical and financial assistance. The logic here is that:

• Private providers are more market- and customer-oriented.
• Services are provided only to the extent that manufacturers are willing to pay for them.
• Advanced business services are necessary to any successful manufacturing economy.
• Businesses learn best from other businesses.

As manufacturing and large service firms become more efficient, they downsize (or rightsize) by shedding nonstrategic functions. Support functions, including advanced services, are sold back to the firms by entrepreneurial businesses. Because these firms employ relatively high concentrations of college graduates, their growth helps redress the migration of highly educated graduates to other states. These firms may grow into cross-state and even foreign exporters. In the last 10 years, the share of services in America's total exports has risen from 17 percent in 1980 to 30 percent today.

Proprietary technology
Home-based firms acquire patents, licenses and copyrights that are unique to the firm.

Indiana has a unique version of this strategy - the Indiana Microelectronics Center (IMC) in Fort Wayne. The center works with companies across the state to design, procure and test Application Specific Integrated Circuits (ASICs) for use in the products of Indiana firms. The staff at the IMC offers at-cost services that include the feasibility analysis of ASIC application to a particular product, cost/benefit analyses of proposed ASIC applications, chip design and manufacturing and systems referral.

The center, established in 1989, is now one of only four independent ASIC design-system firms across the country serving as a direct liaison to Hitachi's ASIC design and device manufacturing capabilities. It is the only economic development program of its kind focusing on ASICs as a means of providing unique chip advantages to companies for their products.

According to IMC Director Gerald Michael, no other technology has as dramatic an impact in terms of shrinking products, lowering costs and improving performance and reliability as ASIC technology. In simple terms, ASICs are "custom chips." Until IMC came on the scene, this technology was technically and financially out of reach for most small-to mid-size Indiana companies. To date, of 300 assessments, IMC has helped 25 companies design and produce chips to company specifications.

Conclusion: Moving Upstream

Dan Luria, of Michigan's Industrial Technology Institute, asserts that the U.S. economy has no choice but to "move upstream" via technology, innovation and production. This calls for additional value-added design and engineering, improved productivity and strategic marketing and global positioning. Distinguishing a product from that of competitors becomes all the more important in the new economy even for small and mid-size companies. Industrial development policy and practice must expand beyond traditional recruitment efforts to provide those business climate, selective attraction and modernization services (public and private) that build competitive advantage for states and sub-state areas.

Graham Toft holds a Ph.D. from Purdue University in urban engineering and public policy, bachelor's and master's degrees in civil engineering and a graduate diploma in management. Toft is a strategic planner and research engineer and has been a consultant to more than 40 countries, cities and towns in the areas of strategic planning, economic development and governmental organization. He is also the author of more than 100 articles and technical reports. Recent articles appear in Letters and The Entrepreneurial Economy.

Footnotes

1. J.D. Laughlin and G.S. Toft, "The New Art of War," Letters, Council on Urban Economic Development, Spring 1995.
2. H. J. Heinz II, "Rebuilding America," School of Public Policy and Managenment, Carnegie-Mellon University.

References

1. T. Bartik, "Who Benefits from State and Local Development Policies?," W.E. Upjohn Institute, Kalamazoo, 1991.
2. J. Kayne, "Investing in America's Economic Future: States and Industrial Incentives," National Governor's Association, Washington, D.C., 1992.
3. G. LeRoy, "No More Candy Store: States and Cities Making Job Subsidies Accountable," Federation for Industrial Retention and Renewal and Grassroots Policy Project, 1994.
4. W. Schweke, C. Rist and B. Dabson, "Corporate for Enterprise Development, Bidding for Business: Are Cities and States Selling Themselves Short?" Washington, D.C., 1994.

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