Guest Article: The Question of Economic Development Incentives

This article originally appeared on the Economic Development Foundation of Rhode Island’s blog.

By Scott A. Gibbs, President, Economic Development Foundation of Rhode Island

As economic development strategy options expand and diversify, there is a concurrent debate around whether limited public funds should be used to incentivize business and private commercial real estate investment. This is not a new debate, and some research raises questions regarding the return on public investment from economic development incentives. Nevertheless, an estimated $500 million of economic development incentives are awarded annually. The when, why, and how of the decision process granting incentives are foundational to well-designed economic development incentives.

The question of economic development incentives can be addressed using the four parameters of (1) commercial real estate investment fundamentals, (2) strategy alignment, (3) economic and fiscal impacts, and (4) performance monitoring.

Commercial Real Estate Fundamentals

Commercial real estate is a risky business, particularly as it relates to investment real estate. These risks are many ranging from capital market volatility, construction costs, public sector regulatory and entitlement regimen, economic base strength, and prospects for asset appreciation in the near and mid-term. In markets like Rhode Island, these risks are particularly acute, and significant gaps in project capital stacks and projected returns on invested equity are significant barriers to new investment.

It is important that public and nonprofit entities clearly understand these risks in making decisions regarding incentives. How will the market value the asset including projected cap rates? How will debt-capital markets underwrite the project? Based on anticipated valuations and conventional capitalization, what’s the magnitude of gap in the project capital structure? How much equity will the investor commit based on projected returns and alternative investment options of similar risk? These questions need to be investigated and answered if the awarded incentives respond to investor needs while balancing same with public constraints.

Strategy Alignment

It is assumed that the public or non-profit entity has an economic development strategy. If not, the entity has no basis for selecting projects to support, including level of support. Given economic development strategies are ubiquitous among economic development programs, a critical question is whether the project – regardless of its merits – is aligned with adopted strategies. This may seem rudimentary, but it is not unusual for an economic development program or political leader to be quickly distracted by new, shiny objects.

It is possible that opportunities emerge that are not captured by the economic development strategy, and which offer compelling benefits to a community. If this is the case, fully understanding the opportunity and its need for incentives must be clearly formulated and articulated. If not, then what basis will a community have the next time a new, shiny object appears? Nevertheless, public funds are limited and the ability to fully leverage these funds to maximize public benefits requires maintaining focused on adopted strategies.

Economic and Fiscal Impacts

Undertaking economic impact analyses for sub-regional and local levels is difficult given employment and multiplier benefits frequently transcend municipal boundaries. Nevertheless, understanding the local and regional economic base including strengths and weaknesses is important to guiding investment and incentive decisions. Without this knowledge, a community could be committing limited public resources to an initiative with questionable prospects for ongoing viability.

Investments are typically local in nature and the fiscal benefits and costs associated with these investments are definable. Consequently, communities should use fiscal impact studies to assist in guiding investment and incentive decisions. This is particularly true for larger projects. The costs to undertake these studies are nominal in context of overall project costs. Software applications can be licensed by a community or non-profit and can have value in the decision process assuming that staff is appropriately trained. If not, organizations such as Camoin Associates can offer invaluable services in understanding the fiscal and economic impacts of a project.

Performance Monitoring

It’s not uncommon for communities to underperform in monitoring whether supported projects live up to the hype and promises. It is incumbent that reporting systems be in place to ensure reporting requirements are followed. Monitoring whether benefits are realized as well as timely reporting of potential issues that could compromise a project’s or business’ viability are prerequisites to designing appropriate public responses to resolve problems. For larger projects, putting in place claw back provisions may be appropriate to protect public interests.

Not to be dragged into the politically polarizing debate around investment incentives, the decision to offer investments is local. It is imperative that communities establish rigor in both assessing the need for incentives and maximizing the value of resulting economic benefits to the public and municipal coffers. Establishing this rigor will enhance the political support of initiatives and the public benefits associated with same.

The Economic Development Foundation of Rhode Island offers an important resource to public and non-profit economic development organizations to enhance professionalism and accountability. For more information, contact them at 401-658-1050.