Financing State and Local Economic Development

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Overview


The contributors discuss alternative methods of financing state and local economic development, including the role of venture capital in urban development, the role of banking institutions in encouraging the growth of small business, and the place of pension funds in economic growth.
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Product Details

  • ISBN-13: 9780822305361
  • Publisher: Duke University Press Books
  • Publication date: 5/31/1983
  • Series: Duke Press Policy Studies
  • Pages: 471

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Financing State and Local Economic Development


By Michael Barker

Duke University Press

Copyright © 1983 Duke University Press
All rights reserved.
ISBN: 978-0-8223-0536-1



CHAPTER 1

FACING REALITY


The initial attraction of capital markets for economic development planners is based on the obvious fact that without buildings, equipment and inventories—the means of production known as capital—economic activity would not take place. It goes without saying that capital formation is crucial to the process of economic growth. Increases in per capita income are largely dependent on growth in the productivity of each worker. In turn, the productivity of labor is largely a reflection of the quantity and quality of capital goods available to work with. It is important to understand from the outset, however, that although capital is a necessary ingredient in a profitable enterprise, it is insufficient in and of itself. Without a good market, good labor, good raw materials and good management, good financing will make no difference. Good money cannot make a bad deal good. Often, in fact, good money can conceal real flaws in markets, management or production until it's too late to repair the damage.

On the other hand, the wrong kind of money—debt instead of equity, for example, or short-term debt instead of long—can totally jeopardize an otherwise good deal, and the lack of capital can keep otherwise good enterprises from getting off the ground. For instance, a rapidly growing, highly profitable $50 million electronics firm in Massachusetts was recently told by its banker that the solution to its perennial money problems was to stop growing. That may have been good from the banker's point of view, but it is hardly salutary from an economic development standpoint. The firm got its new plant financed in Ireland and 300 new jobs were created there instead of in Boston. This is not an isolated example. Very rapid, job-creating growth creates just such an insatiable demand for more and more capital. Without more capital there is no more growth; without more growth there are no new jobs.


THE LIMITED ROLE OF CAPITAL

What then is the relationship between capital and state economic development? To begin with, the actual process of capital formation within a state is dependent on the decisions of private firms to do business there. In the course of initiating a new enterprise in a state, expanding an existing one, or relocating an old one, businesses demand various kinds of financing. The demand for capital, however, largely depends on factors other than capital supply. It depends on whether the state represents an attractive place to invest, given its market conditions and other production costs.

These profound forces must first be understood before we can assess how increasing capital supply or reducing capital costs can help out firms, state or regions.


The Power of the Market Place

The real forces which determine whether or not a state is an attractive place to invest are the enormous interregional and international shifts taking place in populations, purchasing power, labor supply, energy and raw materials in real goods markets on a worldwide basis. The effects of these changes are now visible in declining regions such as the Midwest and Northeast, declining cities such as Akron and Trenton, and declining neighborhoods such as South Boston and East Los Angeles. These areas are competing in a world economy in which they are on the short end of both relatively declining markets (on the demand side) and relatively increasing costs and decreasing availability of such key factors of production as labor, land and raw materials (on the supply side).

The past 30 years have seen major changes in the distribution of population and employment. Since 1950, suburbs have grown faster than either central cities or rural areas. Until 1970, it was also true that metropolitan areas were growing faster than rural ones. Since 1970, however, this trend has reversed itself: rural places are now actually growing faster than metropolitan ones. Indeed, central cities as a group have actually lost population in absolute terms. Expressed in numbers, we see the following picture. From 1960 to 1970, non-metropolitan areas lost 3.2 million people, while metropolitan places gained 4.2 million people. But between 1970 and 1974, rural areas gained 1.5 million people, while the large metropolitan areas (those with over 1 million people) lost 1.7 million residents (Bureau of the Census, 1977; Birch, 1977).

Along with these shifts in population have come changes in the interregional and intra-metropolitan location of employment. There have been three types of movements: from industrial regions of the U.S. to less industrial regions, from metropolitan areas to rural areas within the same region, and from central cities to their suburbs. The South Atlantic, East South Central and Pacific regions have increased their shares of employment faster than their shares of population, while the Middle Atlantic and East North Central regions have had just the opposite experience. Nationwide, rural area employment has grown faster (or in some cases declined less) than metropolitan employment. Finally, within certain regions of the country, central cities have had absolute declines in employment between 1947 and 1972. This is especially true in the Northeast; in the South and West, even central cities have experienced substantial employment growth. But regardless of regional location, the central cities of large SMS As have held a declining share of metropolitan jobs (Bureau of the Census, 1974; Chinitz, undated).

Behind the changing patterns of population and employment are basic decisions by households about where to live and work, business firms about where to invest, and governmental units about where and how to tax and spend.

People choose where to live and work for a variety of economic, social, physical and personal reasons: the quality of schools and neighborhoods, the availability of jobs and level of taxes, the climate and environmental quality, the proximity of friends and family, and many other reasons.

Business firms, in deciding where to invest, respond not only to shifts in the location of markets for their products, but also to changes in the cost and availability of the capital, labor and land they need for production.

There is some dispute among analysts as to whether people follow jobs or jobs follow people. In other words, has the growth in markets and labor supply due to independent population shifts been more important in determining business location than independent business location shifts in influencing people to move? Although the preponderence of research shows that the interregional movement of jobs and investments tends to follow the migratory patterns of people (Muth, 1968; Wheat, 1973; Steinnes, 1977), this is not uniformly true, and there is evidence to the contrary (Olvey, 1970; Greenwood, 1973).

The interplay of population shifts, market growth and job location can be seen in contemporary patterns of regional growth and decline.

Population shifts to rural areas and the Sunbelt have occurred for a variety of reasons (Morrill, 1978) which in large part reflect deeply embedded ideological values for newness and nature. Although these values have existed for a long time, it has only been more recently that certain conditions have enabled them to be expressed. Among these conditions are the extension of transportation systems allowing people to live in regions just beyond metropolitan areas, and the "metropolitanization of the countryside," whereby rural electrification, television, shopping centers and such have made certain "urban" amenities available in non-urban locations. Conversely, many metropolitan amenities have vanished with the growth of pollution, poverty and crime in the central city. Moreover, retirees, a group of people with a high preference for non-urban locations, have been growing in number as the population ages, retirement comes earlier, and retirement incomes grow. In the background, a reduction in the birthrate has eliminated a population growth factor that previously masked outmigration from metropolitan areas (Alonso, 1978).

These movements of people have to a large degree led job movements. The migration of households has created new market areas and enlarged labor pools in rural areas and outside the Northeast and Midwest (Vaughan, 1977). But beyond this population led change, an independent historical shift in the geographic structure of American industry has been at work. As economist Wilbur Thompson argues, manufacturing employment has traditionally filtered down through a national system of cities. In this system, new industries were born in the old manufacturing belt, and as they matured and became more routinized, they could afford to seek cheaper and often less skilled labor and land and raw materials outside the major manufacturing centers.

Now the birth stage itself has been shifting to places outside the old manufacturing centers (Sternlieb, 1975). Previously remote, small and medium-sized cities of the South and West have become more suitable as sites for starting up new industries and firms. There are two reasons for this. The trend of industrial technology has been to develop techniques which lower the skill level required to produce new products and processes, and thus deemphasize the advantages of old, metropolitan centers. In addition, highway systems in non-metropolitan areas have knitted together clusters of smaller communities into good labor, business services and product markets. At the same time, the cities of the old manufacturing belt have become less attractive as places to incubate new industries. A major problem is that these regions have an infrastructure not well suited to many contemporary firms. For example, the assembly of land may be difficult due to the fact that it has already been so subdivided. The social dimension of this growing unattractiveness is the power of trade unions in the Northeast and Midwest, as well as the extensive social welfare system of those areas, which limits the flexibility of private capital.


The Relative Importance of Capital, Labor and Land

While proximity to growing markets for its products is the dominant consideration in location decisions for most firms, it is by no means the only factor. For example, a venture that exports its products nationwide or worldwide may care more about differences in production costs among various possible sites.

Only when such differences in production costs—as opposed to market proximity—become important factors in investment location can one even begin to talk about the role of capital. For capital, along with labor, land, energy and raw materials is a principal cost of production. Which one of these costs weighs most heavily in an investment location decision depends on a combination of two things, the proportion of total costs accounted for by the particular resource, and the degree to which those costs vary geographically.

Capital appears to strike out on both counts. Total annual capital costs (depreciation, interest and after-tax profits) are generally only about 10 percent of the total value of sales for a corporation (IRS, annual). And while data on interregional differences in the cost capital is limited, what we do know indicates that they are not substantial. One study shows, for example, that the rates for the average business loan typically differ between the North and South by less than three-quarters of one percent (Staszheim, 1969). A more recent study shows typical interregional differences in loan rates to be even less. In November 1977, the average rate of interest charged for long-term business loans was 7.4 percent in New York, 7.6 percent in the Southeast and 7.7 percent in the Southwest (Birch, 1977).

By contrast, labor is the major production cost in most industries. For each dollar of business income in the corporate sector, 83.3 cents goes to wages and salaries and only 13.8 cents for payments to capital owners (net interest and after-tax profits) (Bureau of Census, 1978). Moreover, unit labor costs vary geographically, a result of differences in productivity and wage rates. One researcher found that employment grew faster in regions with the highest ratio of value added to wages (Vaughan, 1977). According to the vice president of the Fantus Corporation, the leading plant relocation consulting firm, "Labor costs are the big thing far and away. Nine out often times you can hang industrial moves on labor costs and unionization."

The costs of other resources, such as land and energy, vary from place to place as well. For example, the South has significantly lower land prices and a slower rate of increase in those prices, whereas land prices in the Northeast and East North Central states are well above the U.S. average (Birch, 1977). For firms that are land intensive, location in one region as opposed to another can clearly have a significant effect on production costs.


The Powerful Impact of Federal Policy

State policy makers concerned with developing an economically sound development strategy have to contend not only with the whole thrust of powerful world economic forces, but with the fact that federal government intervention in those markets (through tax, expenditure and regulatory policy) is far more powerful than any tools available to the state.

In general, the federal government's huge half trillion dollar budget has one of two kinds of effects on economic development. It either affects the level and character of demand at different locations, or the cost and availability of human and material resources used by producers. It causes these effects by decision as to who gets taxed how much and where, who benefits from expenditures, or who is affected by regulation.

How federal policies shape the geography of economic growth in the United States has been catalogued in a recent major survey by the Rand Corporation (Vaughan, 1977). The most important of these policies and their effects, some of which are direct and intentional, and others which are indirect and unintended, are summarized here.

Federal policies that change the pattern of population migration and housing location have a powerful indirect impact on economic development. They influence both the market size and labor supply of regions. Policies of this kind (such as Federal Housing Authority (FHA) and Veterans Administration (VA) housing credit, highway construction, and low-priced energy) have favored migration from the central city to the suburb, large metropolitan areas to rural areas, and older regions to younger regions.

Direct federal expenditures have tended to favor states in the South versus the old manufacturing belt. The latter has historically received much lower per capita public works and defense expenditures.

Specific fiscal and monetary policies vary in their effects. The investment tax credit has worked to the advantage of suburbs, rural areas and younger regions, since new plant construction, whose cost is reduced by the credit, tends to occur in these regions. The same is true cf rapid depreciation allowances which shorten the apparent life of depreciated assets below their real life. Both have the effect of accelerating the redistribution of employment away from historic manufacturing districts in central cities, metropolitan areas and older cities. In contrast, when the personal income tax rate is reduced, the old manufacturing belt benefits because of its still higher per capita money income.

Labor supply has been influenced in subtle and complex ways. Unemployment insurance and welfare have increased the cost and reduced the availability of unskilled labor in old established industrial areas, where such payments are relatively high. Federal labor law has fostered the growth of trade unions, whose relative vigor in the old manufacturing belt has put this area at a labor cost disadvantage relative to the less unionized South.

The most important federal impact on the interregional cost of production has resulted from the development of an interstate highway system. These highways have opened up areas of the country (for firms using truck transportation) which otherwise would not have been potential industrial sites, particularly in Mountain and Southern states.

Interregional transportation costs have been affected by regulatory policy as well. Federal regulation of rail freight rates has kept them artificially high, to the disadvantage of older rail-based cities. This has caused firms to locate or expand in areas served well by trucking and in sites closer to growing markets outside old central cities and metropolitan areas.

Energy availability in the Northeast has become a more serious problem than need be as a result of federal price regulation reducing the incentive for producers in the South and West to supply it outside their home states. At the same time, these policies have also kept the price of energy down for firms in the Northeast.


(Continues...)

Excerpted from Financing State and Local Economic Development by Michael Barker. Copyright © 1983 Duke University Press. Excerpted by permission of Duke University Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

Contents

COVER PAGE,
TITLE PAGE,
COPYRIGHT PAGE,
TABLES,
FIGURES, EXHIBITS, AND CHARTS,
FOREWORD,
INTRODUCTION,
PART I INNOVATIONS IN DEVELOPMENT FINANCE,
1 FACING REALITY,
2 STATE POLICIES AND ECONOMIC DEVELOPMENT,
3 THE CAPITAL AVAILABILITY PROBLEM,
4 GOALS AND TOOLS: FORMS OF STATE INTERVENTION IN CAPITAL MARKETS,
5 OPTIONS FOR FINANCING BUSINESS ENTERPRISE: INFLUENCING PRIVATE FINANCIAL MARKETS AND INSTITUTIONS,
6 OPTIONS FOR FINANCING BUSINESS ENTERPRISE: CREATING STATE-OWNED FINANCIAL INTERMEDIARIES,
7 OPTIONS FOR FINANCING HOUSING AND INFRASTRUCTURE,
8 TARGETING CAPITAL TO COMMUNITIES,
PART II PENSION FUNDS & ECONOMIC RENEWAL,
INTRODUCTION,
1 PENSION INVESTMENT AS A DEVELOPMENT TOOL,
2 FINANCIAL, LEGAL, AND ORGANIZATIONAL CONSIDERATIONS,
3 PORTFOLIO INVESTMENTS TO PROMOTE JOB CREATION,
4 PORTFOLIO INVESTMENTS TO PROMOTE AFFORDABLE HOUSING,
5 IMPLEMENTING DEVELOPMENT-ORIENTED INVESTMENT,
PART III VENTURE CAPITAL AND URBAN DEVELOPMENT,
1 SMALL BUSINESS IN THE U.S. ECONOMY,
2 VENTURE CAPITAL AND URBAN DEVELOPMENT,
3 POLICY CHOICES,
PART IV BANKING AND SMALL BUSINESS,
INTRODUCTION,
1 THE PERFORMANCE, GROWTH, AND FINANCING OF SMALL BUSINESS,
2 FINANCING SMALL BUSINESS: A REVIEW OF PRIVATE RESOURCES,
3 FINANCING SMALL BUSINESS: A REVIEW OF PUBLIC RESOURCES,
4 BANKING REGULATION AND AND SMALL BUSINESS FINANCE,
5 FINANCING ENTERPRISE DEVELOPMENT: NEW DIRECTIONS IN PUBLIC POLICY,
BIBLIOGRAPHY,
INDEX,
CONTRIBUTORS,

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