Jun 25, 2019 in Business

Economic Development Incentives

Introduction

The need to strengthen the territorial focus in the implementation of economic reforms has become one of the main areas of promotion towards the democratization of society in the economic, cultural, political, and social aspects. At the same time, the allocation of rights should be in favor of regional state structures responsible for the implementation of economic reforms and making the life-sustaining decisions. Every major economic region is developing taking into account some patterns: the rational and effective allocation of production; market specialization and integrated development; efficient territorial division of labor, and so on. 

The most important aim of regional policy is to strengthen the market and create the necessary conditions for the region’s activity in a single economic space. The tools of influence to achieve the sustainable economic growth of an area are the economic development incentives. The latter are one of a limited number of tools to stimulate the local economies. The current paper will discuss the economic development incentives, their types, and use in the United States and the EU countries.

Definition and the Types of the Economic Development Incentives

Economic development incentives are the financial aid provided on a discretionary basis to attract or retain business operations owned by large enterprises (Bartick, 2007). Economic development incentives are an integral part of the state policy that promotes the economic growth in underdeveloped areas of the country. The development incentives may include tax incentives, government subsidies, public procurement system, methods of endogenous and exogenous development, regional grants, concessional loans, granting rights of accelerated depreciation, creation of special economic zones, and others. Each of these types requires a detailed review.

The government subsidies as a method of stimulating the economic development of a region are a covering of the part of the cost of industrial buildings, equipment, or land. Government subsidies are granted to entrepreneurs that create or expand manufacturing in a particular area. Typically, subsidies are given to companies in the form of the amount needed for the project or a fixed amount per one new job. The government provides assistance to companies more willingly in case of new construction in the problem area and a significant expansion or radical reorganization of the existing facilities. Slight changes in the production, modernization of individual sections and other similar activities are not funded (Stimson, Stough, & Roberts, 2013).

Another development incentive is the public procurement system. The activity of the state in the shaping of public procurement varies from country to country. However, it was experimentally found that every unit increase in the public procurement accounts for approximately 2.5-3 units of the total growth of the final product. Moreover, 1 unit will account for the growth of the state supply; 0.5 unit will account for the growth of investment in fixed assets and inventories; up to 1.5 unit will account for the growth of personal consumption. The increase in intermediate goods (raw materials, fuel, etc.) will be more about 2.5-3 units. Thus, the total multiplier of the public procurement effect on the gross output could reach 5-6 units (Stimson, Stough, & Roberts, 2013). The existing experience shows that the share of the government consumption implemented through the system of public procurement is quite large in the countries with highly privatized economies. Applying the contract system of procurement, the government is able to assess the extent and appropriateness of the work and select the most promising and least costly projects that can remove social and economic tension in the depressed areas (Bartick, 2007). 

 

The method of stimulating the exogenous development of problem areas includes such forms as national and regional development planning as well as specific programs of regional development. The endogenous method of regional development focuses on the use of natural advantages of individual territories. The advantages may include unique natural resources, favorable economic and geographical position, the accumulated economic potential (production assets, infrastructure), the status of human capital (education, skills, creativity of the population), etc. The choice of the methods to stimulate intra-regional sources of development depends on the features of previous socio-economic development of the problem area. Since both exogenous and endogenous development of the regions need the impact in the form of direct and indirect state control, it is quite difficult to draw a rigid line between these two types of regional development (Stimson, Stough, & Roberts, 2013). One thing is clear: the public spending is much less when the endogenous development is used. The state participates in the endogenous development of the regions through a small financial support to entrepreneurs; improvement of governance structures; customs, tax or administrative incentives; creation of economic activity on the territory of zones with special tax regime; provision of soft loans and accelerated depreciation rights to entrepreneurs, etc.

Tax incentives are an important economic development incentive in all countries with developed market economies. They are expressed in the reduction or complete abolition of tax rates for a period from 5 to 10 years from the beginning of the company activity in the problem area. The incentives encourage reinvestment of profits on the spot. The local tax rates often reach up to tens of percent of the total profit. Therefore, the incentives are of particular interest to the companies operating in the impoverished areas. The developed countries often introduce significant tax benefits if a company creates or maintains a certain number of jobs in the underdeveloped areas (Bartick, 2007).

Another incentive aimed at economic development of the region is a regional grant for entrepreneurs. The grant is given for the construction or expansion of businesses in the area with chronic unemployment and the development of the service sector and research institutions in the problem regions.

The concessional loans in problem areas not only stimulate the launch of the project but also provide the financial position of the companies in the future during the period of loan repayment, thereby reducing the operating costs. The size of concessional loans is limited by a fixed amount and their share in the total cost of the project. Often, the company gets a 2-5 year grace period, which means that the return of the loan begins only within 2-5 years after receiving it. A period for the loan return varies from 10 to 25 years (Stimson, Stough, & Roberts, 2013).

Granting rights for accelerated depreciation is the economic development incentive since it aims at the development of advanced technologies and enterprises in the underdeveloped areas. The great example is the Law for Accelerating Regional Development based on High-Technology Industrial Complexes, which was enacted in Japan in 1983 and is still valid. According to it, private companies which move their production capacities to the future technopolises receive a 30% rate of deduction on the equipment and a 15% rate of deduction on the buildings in the first year of activity (Bartick, 2007).

The creation of special economic zones is an incentive method of selective and polarized politics. Special economic zones are created for 10 to 20 years in economically depressed areas with high unemployment. The criteria for the creation of the zone are the level of per capita income and the unemployment rate that is significantly higher than the national one. For example, 70% of citizens in a depressed area in the USA must have their income below the 80% national average level (Stimson, Stough, & Roberts, 2013). In fact, the economic development incentives in the United States require a detailed examination. 

The Economic Development Incentives in the USA

The role of the state government in stimulating the economic development varies across the United States. 12 of the 50 states have the economic development plan. Examples include Tennessee (Jobs4TN Plan) and Maryland (Charting Maryland's Economic Path: Discovery, Diversity, and Opportunity). In the devising of the economic development plan, a city or a district can take into account the priorities of the state, which leads to a greater degree of vertical coordination (Markusen, 2013).

The most common role of state government in the field of economic development is the devising of programs implemented at the local level as well as providing of tax incentives and loans to businesses to create new jobs in the region. Also, state government can provide technical support to municipalities and provide training programs for entrepreneurs and business representatives (Euchner & McGovern, 2013). Moreover, state government can assist in the planning of economic development in rural areas because of the lack of their own qualified personnel.

There are two organizations involved in the planning of economic development of the United States at the federal level. The Economic Development Administration (EDA), which is a part of the U.S. Department of Commerce, is engaged in economic development of the regions. The EDA’s primary mission is to promote innovation and competitiveness of the American regions that require economic development. Support of economic development is conducted through such incentives as the system of grants, technical assistance, and other measures. It is necessary to pay attention to what kinds of grants are given to the impoverished regions and to what the extent they are supported. One of the key grants deals with development of Comprehensive Economic Development Strategy (CEDS). Availability of the approved strategy gives the region the right to receive the grant for its implementation (Euchner & McGovern, 2013).

Currently, there is another structure that has an indirect impact on the economic development of the problem regions, namely the Partnership for Sustainable Communities. The partnership was created by the Obama administration in 2009 by merging three federal agencies: the Department of Transportation, the Department of Housing and Urban Development, and the Environmental Protection Agency (Markusen, 2013).

The key role of the partnership is the integration of economic development in the traditional spatial planning at the federal level as well as dissemination of this approach on other levels of government. Stimulation of economic development is achieved by an integrated approach to improve the affordability of housing and transport as well as ensure environmental protection.

Activities of the above departments lie in joint consideration of the applications for grants that are measured in terms of sustainable development of territories. An example of funding allocated by the Department of Housing and Urban Development is the Sustainable Communities Regional Planning Grant Program (Euchner & McGovern, 2013).

In the United States, economic development at the state level, as well as the region or city level, is determined by local interests. This fact in most cases increases the likelihood of realization of the developed plans and strategies. Despite this, there are two key drawbacks of the existing system of grants and funding for development of integrated strategies. The first is the lack of comprehensive requirements for the content of the strategy, which leads to the risk of considering it only as a way to obtain further federal funding. The integrated strategy risk becomes unfulfilled without being part of the overall planning process (Euchner & McGovern, 2013).

The second drawback is the definition of Economic Development Districts (EDD) that are eligible for federal funding. The territorial boundaries of these regions are determined by local jurisdictions themselves. In practice, this leads to the superimposition of different territorial units on each other. Thus, the economic development regions may partially cover the planning districts. The basis of EDDs determination can also include the metropolitan statistical area. Memphis, in this case, is the most striking example of intersection of territorial entities. The boundaries of the economic development region do not coincide with the planning district or the metropolitan statistical area. Thus, despite the fact that self-identification can be beneficial in many cases, the solid methodology and policy coordination must stand behind it (Markusen, 2013).

Obviously, not all the efforts of the U.S. federal government work equally well. It managed to achieve significant results in the spread of an integrated horizontal approach to planning at the federal level, as well as at the level of states, regions, and cities, through a competitive grant system. However, there are some difficulties in implementation of the policy undertaken by the Economic Development Administration. Grants for the development of an integrated development strategy are often just the means to gain access to further federal funding (Euchner & McGovern, 2013). Moreover, definition of the Economic Development Districts is so pervasive that it creates many self-formed territories and organizations involved in the planning, which consequently get quite rarely realized. 

The Economic Development Incentives in the EU Countries

There are many tools that have different meanings for different EU countries. From the point of view of the EU historical development, there are five large classes of development incentives:

  1. The funds going to contain new enterprises in overpopulated areas;
  2. The spatial distribution of the activity of the state in economic development;
  3. Stimulation of the companies’ activity through financial support;
  4. Formation of the infrastructure;
  5. Soft measures to promote development (Adams, Harris, & Alden, 2012).

Currently, the role of the funds used for containing and spatial distribution of the activity of the state in economic development has substantially decreased. Instruments of restraint were used in France (in the case of Paris and its suburbs) and the United Kingdom (in the case of London and South East region). However, the United Kingdom refused this policy in 1970 (Brooks, Donaghy, & Knaap, 2012). In the following years, the French government applied the policy to encourage the development of business mainly outside the capital region and displacement of companies outside the French capital. At the moment, only France and Greece stimulate the development of industry located away from the overpopulated capitals.

In recent decades, the role of economic activity of the state as an economic development incentive has declined. Privatization in production has deprived the government of the possibility to influence through making decisions about investments in this production. There is another important aspect relating to the economic activities of the state, which eventually lost its role as an economic development incentive, namely public procurement. In some EU countries (Italy, Germany, the United Kingdom), there is a policy of preferred purchases from suppliers in certain areas. Subsequently, the European Court called these actions illegal as they are the cause of national discrimination (Adams, Harris, & Alden, 2012).

At present, most EU member states use the last three groups as economic development incentives. Financial incentives include grants for certain amounts of investments, loans, subsidies in connection with the creation of jobs, etc. The methods are designed to make companies interested in the investing in impoverished or underdeveloped areas. These tools are widely used in almost all EU countries. The soft infrastructure elements include support for information networks, consulting activities, scientific research, and so on (Brooks, Donaghy, & Knaap, 2012).

The most underdeveloped countries of the European Union (Ireland, Greece, Portugal, and Spain) have a much wider set of policy instruments. Such a broad approach reflects greater depth of regional problems. They have funds established to encourage the development of regional policy, namely Structural Funds and the Integration Fund. These structural funds address issues that go beyond the investment in manufacturing, namely support for the development of infrastructure and creation of an enabling environment for effective business development. The Integration Fund is engaged in major projects in infrastructure development that are directly related to transport and environment (Brooks, Donaghy, & Knaap, 2012).

Structural Funds have the greatest impact on regional policy in Germany and Italy. In 1992, there was the revision of the regional policy in Italy undertaken to allow co-financing from the Structural Funds (Adams, Harris, & Alden, 2012). In Germany, the development incentives are based on the provision of assistance to the regions combined with the measures of the business support. The priority of expenses is the support of productive investment to create a favorable business environment.

As for the Scandinavian countries, there are following differences in the aspects of the regional policy. In a narrow sense, this policy includes measures for development of business and economy. A broad aspect of the economic development incentives involves a set of actions by the government in the field of communication, transportation, education, and health care that are essential for sustaining communities in sparsely populated regions. For example, the scope of public services was enlarged in order to achieve an equal level of services in all regions in Finland in the period from 1960 to 1970 (Adams, Harris, & Alden, 2012). The northern regions had the highest needs as compared to the others. Many hospitals, health centers, and primary schools were built there to provide more employment of population. In Sweden, the political programs, which did not directly relate to the economic development incentives, sometimes were proposed taking into account the interests of regional development. The example is the program in the field of education, which involves paying much attention to the development of small and medium-sized colleges. 

Also, the companies involved in the long-term programs of strategic highways construction are required to provide a detailed report every three years, indicating the impact of their activities on the surrounding region. An important feature of the Nordic countries is that regional policy even in a narrow aspect implies a broader meaning than in other EU states (Brooks, Donaghy, & Knaap, 2012). For example, if one takes into account specific characteristics of problematic regions, in particular their harsh climatic conditions, there exist such forms of long-term support that are not implemented in the EU (e.g., the concession of transport and social security).

The Nordic countries are working hard to expand the scope of the economic development incentives. For example, the regional policy in France has a broad interpretation and includes a range of policy measures for regional development. One of the laws in the field of regional development creates a large variety of policy instruments, namely the regionally differentiated taxation, infrastructure, measures to promote regional development, etc. Also, there is a state system of contracts for planning regions which provides assistance to the poorest regions. Netherlands and Austria have low importance for the development incentives; however, these countries are trying to conduct a regional policy that goes beyond financial assistance to the companies (Brooks, Donaghy, & Knaap, 2012). In the Netherlands, the basis of the development incentives in the narrow sense is investments, and more generally, there is a set of measures to create a favorable business environment and infrastructure. In Austria, there are broad policy measures for development of regional policies. The policy of the Austrian regional economic development should include support for the development of business environment and local factors such as transport, education, and standard of living (Adams, Harris, & Alden, 2012).

In Denmark, the major issue of economic development incentives is set in the “framework of measures” that includes a list of services that the company can benefit from. However, the services do not involve the transfer of funds or support of any company. Such measures, which include access to a set of technical and commercial services, are held throughout the country. Denmark is the only EU country, which has not conducted a program for the promotion of development of individual regions since 1991 (Adams, Harris, & Alden, 2012). Such a refusal is due to a set of reasons. The latter include unemployment in Copenhagen, which has reached dimensions of the national average; the size of the budget deficit that imposed restrictions on the public spending; the center-right coalition government that selected the market approach as a solution to problems, and so on. However, Denmark has a single state system of social security and functioning financial mechanisms aimed at avoiding the disparities in economic development of individual regions, which may lead to the differences in levels of income and social opportunities.

The economic development incentives in such countries as Belgium, Luxembourg, and the United Kingdom include the measures to create a favorable business environment. In the United Kingdom, policy measures of spatial development fall into two categories:

  • The regional industrial policy;
  • The policy that includes a range of spatial development programs (for the urban and rural development), which were previously implemented separately from each other and are now configured to work together.

An important feature of the last policy is the emphasis on the development of individual regions and increase of their competitiveness. The financing within this policy uses the distribution of public funds between companies on a tender basis (Brooks, Donaghy, & Knaap, 2012).

Analyzing the policy of regional development of EU member states, it can be said that the promotion of regional development is the core of the regional policy of the EU countries, excluding Denmark. It can be explained by the fact that the rules of the support provided in the EU involve assistance to the large-scale projects, particularly in problem areas only. One of the elements of the Nordic countries’ policy is the assistance in development of a favorable business environment, but this policy is conducted largely at the national level rather than the regional one. 

Conclusion

The economic development incentives are the state and local government efforts to encourage economic development in the impoverished or underdeveloped areas. The incentives are aimed at ensuring a balanced social and economic development of the country, reduction of regional disparities in social and economic status of the region and the quality of life. The provision of a balanced socio-economic development of regions requires synchronization of regional policies and implies the use of such development incentives as tax incentives, government subsidies, public procurement system, regional grants, and others. 

Summarizing the domestic and foreign experience in the implementation of the selective regional policy, it can be concluded that the United States applies a diversified set of development incentives, while the European Union countries are characterized by the use of incentive methods aimed mainly at the exogenous development of the problem regions.

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