Chapter 10: Targeted Subsidies: Visible Benefits, Unseen Costs

In Chapter 10, Matthew Style discusses the implications of targeted subsidies on economic development and interstate competition in the United States.

First, Style points out that “from January 1980 to August 2022, US manufacturing employment decreased from 19.82 million workers to 12.85 million.” He then explains that – despite this loss in manufacturing jobs – the United States is much more productive than it was in 1980. This is representative of an overarching trend in the United States away from manufacturing and toward a digital and automated economy.

As the author points out, when products can be produced with fewer resources, the freed-up resources can then be redirected to alternative purposes, increasing productivity. This creates little issue when the resource in question is, for example, aluminum that would have been used for airplanes but instead is used in soda cans. However, when the resource in question is human labor, this creative destruction can lead to the devaluation of workers’ skills as well as unemployment and hardship.

As Style points out, “economic reasoning classifies manufacturing as part of the tradable sector of industries, meaning industries that generate value in their home market but compete outside of it.” In other words, when external competition eliminates local manufacturing jobs, the entire community may suffer from the decline of incoming revenues that would have otherwise been spent within the community. This community stagnation resulting from declining American manufacturing is how the Midwest came to be referred to as the “rust belt.”

It is no surprise then that voters look to the government to subsidize waning industries to sustain the communities dependent on them. The popularity of such deals can be explained by the contrast between the visible benefits and unseen costs of subsidies. While the buildings constructed and the jobs created by subsidies can be easily seen, the unseen costs include deadweight losses from taxes and diversions of public funds from alternative uses.

Another important unintended consequence of subsidies is the competition it creates amongst states. Because states have the power to provide subsidies to attract and retain corporate investment within their borders, a “race to the bottom” occurs as states compete amongst each other by offering better and better deals to would-be corporate investors. In many cases, this competition creates little new corporate investment, but instead simply relocates capital and jobs from one state to another or prevents it from moving. This can result in a negative-sum game in which the collective efforts and resources expended by states to attract limited corporate investment outweigh the actual value of the investment ultimately secured by the "winning" state.

Style then reviews the academic literature on targeted subsidies, which finds little evidence that they improve economic outcomes like incomes or poverty rates and suggests that they have negligible impacts on employment growth.

As an alternative to targeted subsidies, Style argues that states should improve their business environments generally by uniformly lowering and simplifying taxes, providing infrastructure improvements that can be utilized by multiple firms, and investing in education and training programs to enable workers to adjust to modern labor market conditions. To directly address the problems created by targeted subsidies, he suggests that an interstate compact be created to prevent states from engaging in the race to the bottom of harmful subsidy competition.