Would you like to play an incentives game? Midwest states are.

December 14, 2011

By Niala Boodhoo

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(Photo by Niala Boodhoo)
The Chicago Board of Trade is one financial exchange owned by the CME Group.

The incentives war between Midwestern states has heated up over the past few months, especially between Illinois, Indiana, and Ohio, which are fighting over Sears and the CME Group. Here is a look at how states use incentives to keep or steal companies, and how that effects overall economic development.

Think back to Political Science 101 and what you learned about game theory. If you need some help, think about the premise of one of my favorite 1980s movies: War Games.

Remember the ending? (No? Keep reading.) The movie’s  star, Matthew Broderick, wants to show Joshua, the computer, that there’s no way to win a zero-sum game. He gets the computer to play itself, first tic-tac-toe, then a simulation of a nuclear war between the then-Soviet Union and the United States. In the end, Joshua realizes no one can win.

Keep game theory in mind, because we’ll come back to it later. But that’s kind of what’s happening between Illinois, Ohio, and Indiana. These states have spent the past few months waging an economic incentives war worth millions of dollars and thousands of jobs.

The most recent round ended yesterday, when the Illinois Senate approved more than $200 million in tax breaks – specifically designed to keep Sears and the Chicago Mercantile Exchange from leaving Illinois.

The CME Group owns the Chicago Board of Trade, the Chicago Mercantile Exchange, as well as the Chicago Board Options Exchange.

Last week, at a news conference with Gov. Pat Quinn and Senate President John Cullerton, Chicago Mayor Rahm Emanuel echoed their sentiments that much is at stake.

“Chicago Mercantile Exchange allows Chicago and the state of Illinois to be a leader in the futures and risk management industry,” said Emanuel.

Indiana offered CME a reported $100 million to leave Illinois. Ohio offered four times as much to try to lure Sears.

But it doesn’t just happen with big companies. Indiana’s Economic Development Corporation earlier this year spent $50,000 on ads asking lllinois businesses if they were “Illinoyed” by the state’s taxes.

States find themselves over a barrel when officials feel the need to offer millions to lure and retain companies.

That’s a mistake, said Jennifer Bradley, a fellow with The Brookings Institution’s Metropolitan Policy Program.

Bradley said that in the case of incentives, governors and public officials face a classic “prisoner’s dilemma.”

“Governors would probably all be better off, or state economic development authorities would probably all be better off, if nobody got into these kinds of bidding wars,” she said.

In Illinois, the current tax package for Sears was set to expire. The legislation has extended those credits for 10 years for one set of credits, as well as 15 years for a special taxing district in regards to property taxes.

But Bradley says the effort to win jobs from other states may be misguided. She says most research indicates that 95 percent of a state’s typical job growth comes from existing or new businesses.

And here we’re back to the prisoner’s dilemma: with the current game of incentives, though, no one wants to budge.

“If you can’t count on everybody to do the right thing, then nobody’s going to do the right thing,” she said. “So companies have incentives to ask and individual states have incentives, temporarily, to make the offer.”

But some states are playing differently. Michigan is trying something that might break the Midwest out of this prisoner’s dilemma. In his first State of the State speech in January, Gov. Rick Syner rejected the “up the ante” mindset.

“We need to put more emphasis on economic gardening as opposed to hunting,” he said to much applause. “For those unfamiliar with economic gardening, it means we’ll focus first and foremost on building businesses that are already in the state.”

Since that address, Michigan has eliminated almost all of its tax credit incentives – including its much publicized film incentives.

(We reported on film incentives in our first Changing Gears story last year. You can hear it here.)

“We’re really trying to provide key access to tools that will help a business’s customer base grow as opposed to just providing them money and hoping that they will be able to grow their business,” said Michael Finney, president of the Michigan Economic Development Corp.

For Finney, that means the focus is more on providing help with accessing export markets, debt financing, and the like. He hopes this approach will also make it easier for the Midwest to work together.

“I happen to think if we worked together as a Midwestern region we’d be much more successful,” he said.

It’s not unprecedented for states within a region to cooperate. Take the South.

“Our former director used the term ‘coop-er-tition’,” said Kathy Geltson, Deputy Director of the Mississippi Development Authority. “We cooperate in instances where it makes sense, but there are instances when it’s a true competition.”

She’s talking about several specific alliances Mississippi and several southern states have formed for industries like the automotive or aerospace center. There, the states work together to bring companies to the region, and don’t try to compete, at least in this case, with incentives.

For Michigan, cutting those hundreds of millions of dollars out was a necessity given its fiscal state. But it works – if Michigan can show that this new strategy will still lead to comparable job growth –maybe other Midwestern states will start to follow suit.

Changing Gears is a public media collaboration between Michigan Radio, WBEZ and Ideastream in Cleveland. Support for Changing Gears comes from the Corporation for Public Broadcasting.