RALEIGH – One of the pioneering thinkers on political economy, Frederic Bastiat, wrote an influential essay more than 150 years ago about how to evaluate public policies. One of his main points was that politicians, just like the rest of us, tend to stumble over things they don’t see, not things they do see.
(Only clowns stumble on purpose. Surely we don’t want to compare politicians to clowns. That would be grossly unfair to the clowning community.)
In politics, unseen snares, sinks, and tree limbs litter the landscape. Even the most astute policymakers, writing their bills or regulations with great care, will generate some unwelcome, unanticipated consequences. Average policymakers do worse than that.
Bastiat believed that the ability to predict such consequences, and take them into consideration, was a critical skill for anyone seeking to practice economics:
There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.
He went on to offer one of the most famous examples in economics: the broken window. A foolish person believes that breaking a window is an act of economic creation because it creates work for glaziers and craftsmen. A wise person recognizes that breaking a window is an act of economic destruction because it forces the owner to expend resources on repairing the window rather than on something he would have considered more valuable in the absence of the vandalism.
North Carolina policymakers should keep Bastiat’s insights in mind when confronted with policy proposals that appear at first glance to confer net benefits. They should consider such proposals carefully, thinking through their implications and pondering their likely consequences.
The John Locke Foundation’s Joe Coletti recently published a paper urging policymakers to do exactly that when it comes to economic-development incentives.
Over the past two decades, North Carolina has become increasingly willing to offer larger corporations preferential tax treatment, subsidized loans, or outright cash grants to locate or expand facilities in the state. Coletti argues that such corporate welfare doesn’t confer net benefits on North Carolina – and that policymakers assume the existence of net benefits because they aren’t looking past the obvious gloss of “job creation.”
To make his point, Coletti compares an incentive grant to the purchase of a lottery ticket:
Most people realize that winning the lottery is not as simple as trading $1 for a $20 million jackpot. You have to factor in the odds of winning, along with the fact that your dollar is worth more today than it will be when the last jackpot dollar would reach your wallet.
With incentives, policymakers often exaggerate the potential revenue gains by using too small a discount rate (to account for the time value of money) and by too often assuming that a corporate location or relocation decision would have been different in the absence of the incentive.
“Until governments decide to stop offering incentives or are forced to stop, they should at least adopt an appropriate financial model to examine the full costs and benefits of those incentives for government revenue,” Coletti said. “A solid financial model is a better place to start than a decision that looks at incentives as a switch that governments must flip to attract business.”
To award government favors without employing a realistic financial model is to set yourself up for a pretty big stumble. Unless you’re wearing a big red nose and trying to get a laugh, it would be best to try a different approach.
Hood is president of the John Locke Foundation.