A 2019 evaluation finds positive returns and good practices in Michigan’s flagship incentive program and advances methodologies to improve return on investment (ROI) and but-for estimations.
The Center for Regional Economic Competitiveness, the W.E. Upjohn Institute for Employment Research, and Ellen Harpel of Smart Incentives (Senior Research Fellow at CREC) recently collaborated to assess the effectiveness and return on investment of the Michigan Business Development Program (MBDP). The MBDP incentive provides grants and loans to businesses for “highly competitive projects in Michigan that create jobs and/or provide investment.” The assessment required a detailed analysis of the MBDP:
- Economic return on investment
- Importance in securing projects and generating results for Michigan (“but-for”)
- Program management practices compared to other states
The assessment was made possible by the Michigan Economic Development Corporation’s willingness to provide the research team access to MBDP project documentation. The MEDC team should be commended both for requesting an in-depth assessment of its incentive program and for providing the research team exceptional access to information that enabled a meaningful analysis.
The study estimates that the MBDP has an economic ROI of 3.86. That is, for every $1 the state invests in the MBDP, the program results in a net gain of $3.86 in per capita income for Michigan residents. The Upjohn Institute’s state-level ROI estimation model for incentive evaluation was used to calculate ROI.
Methods used to calculate ROI are not consistent across states or incentive programs, so it is not always appropriate to compare reported ROIs. When examining ROIs using the same methodology applied in this study, however, the MBDP demonstrates a relatively high return because it implements several good practices:
- MBDP targets high multiplier industrieswith extensive networks of suppliers within the state
- MBDP incentives are provided up-front, which increases cost effectiveness, and
- MBDP incentives are relatively modest in size, which increases effectiveness per dollar since incentives tend to experience declining returns as size increases
The study also found that the MBDP incentive played a role in company investment decisionsand that varying proportions of project outcomes can be attributed to the effect of the incentive.
The research team provided a more systematic approach than prior incentive studies in assessing whether incentives helped secure projects and determining the incentive’s effect on ROI. While most states implicitly or explicitly assume that 100% of estimated benefits can be attributed to the incentive, the research team presented alternative approaches for two reasons. First, in practice, it is impossible to know with certainty whether a company would have made an investment without the incentive. Second, many factors – such as workforce characteristics and infrastructure, to name a few – influence business investment decisions. Incentives are considered in combination with these other factors. Therefore, incentives rarely are 100% responsible for an investment. Similarly, they rarely have zero impact. The research team’s methodologies suggest two alternative approaches to hypothesizing the level of influence, one based on cost sensitivity and the other based on the competitive environment plus firm and project characteristics.
In both cases the MBDP generated a positive program ROI.
MEDC’s procedures for pre-award analysis and post-award program management are consistent with standard practices in comparable state programs. That said, no state has a perfect program, and states examined for this analysis face similar challenges around calculating returns, managing compliance, and evaluating performance. States including Michigan have generally made significant strides in their project compliance and reporting procedures.
The assessment concludes with options for continued improvement. The following recommendations are also applicable to other state and local economic development incentive programs.
First, address costs more explicitly in ROI estimations. The research team recommends determining an economic (rather than fiscal) ROI since that is more consistent with the economic development mission. However, economic impact estimates are often viewed with skepticism if they overstate the benefits and ignore costs such as greater public service expenses associated with growth. ROI procedures should reflect multiple costs as well as economic benefits.
Second, account for the incentive’s level of influence on investment decision. ROI measures can overstate benefits by assuming that the incentive is responsible for all positive outcomes. The level of influence of an incentive should be between 0 and 100%. The study’s methods can be used to estimate the importance of the incentive, or estimated benefits can simply be discounted at a series of set levels. For example, what is the ROI if the incentive is responsible for 70% of the decision? Or 50% or 10%?
Third, ROI should be used in concert with other project review criteria to drive decisions that reflect economic objectives. States seek many benefits that cannot be captured in a single ROI calculation. ROI should not be the only factor driving the decision to provide incentives. Lower ROIs should be acceptable when other important goals can be achieved, such as bringing abandoned properties back into productive use, hiring populations with barriers to employment, or encouraging investment in distressed communities.
This article is part of an occasional series examining state and local reports evaluating economic development incentive programs. For more information, the full report from which this article was adapted can be downloaded here.
Source: Michigan Business Development Program Effectiveness Study, prepared for the Michigan Economic Development Corporation, January 2019.