Business Climate in the New Normal

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The Curmudgeon thinks State Business Climate will be a very prominent economic development strategy during the New Normal period–for the wrong reasons. Sadly, that poor withered soul strongly believes that the concepts and methodologies, which underscore business climate as an economic development strategy, are seriously flawed. In his warped mind he sees the business climate strategy rests upon indexes constructed by various groups and institutes who pursue goals other than, or at least in addition to, economic development. These indexes, based upon, and for the most part, advocate one or a related set of public polices (such as tax cuts, workforce initiatives/reforms, innovation, regulatory relief or special, often sector-specific incentives) constitute an agenda for political change. Their implicit assumption is that change in these limited set of public policies can  (1) result in shifts in a state or region’s business climate and (2) that such changes can in the short term and long term affect future economic growth (or cause economic decline). In their always correct mind, a state (or region’s) business climate, done in the politically correct way can account for past economic performance and predict future economic growth or decline.

The Curmudgeon accepts neither assumption and he believes the true story underneath business climate is more complex and complicated. His improper view of business climate requires a recognition that a state’ s business climate and its propensity to economic growth or decline flows from a much larger set a factors than mere public policy, tax codes and industry-specific legislation. Business climate and a state’s competitiveness is much, much more than the right combination of “correct” public policies.

This month the Curmudgeon, drawing from several pieces of  research, wishes to make an introductory foray into the wilds of business climate. He proposes to examine the relevance and predictive power of public policy changes in producing economic growth and enhancing state competitiveness.

On top of the Curmudgeon’s reluctance to leap onto the public policy bandwagon, the Curmudgeon and at least some of the academic and think tank literature have serious questions regarding the methodology used in the development of these indexes. The Curmudgeon questions whether the reader can automatically assume that an index is valid (that they measure what they mean to measure, and, they are, in fact, linked to economic growth, past or future). To compound the issue, it is not clear that even as we write, there exists a consensual methodology with which an objective observer can in fact measure and evaluate the validity of various indexes floating around “out there”. In essence, we are profoundly unsure of even how to critique these indexes and judge their contents and recommendations. In this environment, indexes, whether valid or not, get a “free ride” because they really cannot be proven or disproven and yet given media publicity they must be reacted to and potentially used by economic developers.

In the “real world” of economic development these indexes hit the media (and presumably bombard policy-makers). The indexes scream for “this policy or that policy”; they rank states, cities and regions on supposed past and future performance, fixing blame– and in most cases suggesting that “this policy or that policy” will explain success or be the solution for current problems and economic woes. Readers of these indexes are no doubt prone to assume that  the numbers are what the numbers are; these numbers in the index don’t lie. The media certainly adopt this attitude! So policy makers, economic developers, and competing candidates for public office seize upon these indexes, grab the ones that suit their purposes and off we all go to the proverbial political races. In short, our inability and unwillingness to prove or validate these indexes prompts an increased politicization of economic development. Oh what a revolting development this is!

Policy makers, economic developers, and competing candidates for public office seize upon these indexes and off we all go to the proverbial political races. Oh what a revolting development this is!

This month the Curmudgeon, drawing from several pieces of  research, wishes to make an introductory foray into the wilds of business climate. He proposes to examine the relevance and predictive power of public policy changes in producing economic growth and enhancing state competitiveness. Accordingly he will review several articles which attempt, imperfectly to be sure, to assess these indexes, evaluate their internal coherence and methodologies, and question their linkage with economic performance. The Curmudgeon will counter with his very own,  possibly unique, perspective on not only the limitations of the current business climate approach in practice, but will also hint  on just what “real” business climate actually  includes. The Curmudgeon’s s0-called “real” state business climate will be dealt with in a future article. For this issue, however, he will content himself, and hopefully the reader, with exposing and decrying the increased politicization which use of these indexes has superimposed on the practice and profession of economic development.

An Atypical and Typical  Economic Developer in the Wilds of New York

Back in the good old days when the Curmudgeon earned his living as an ATYPICAL economic developer. Business climate was something he had to endure  and something over which he had no real control. He worked in New York State, a  state notorious for its alleged anti-business climate and to make matters more interesting, he worked in Buffalo, a community upon which climate gave the community the business. The topic of business climate, it could be said, left him cold. Still, every so often, some institute or think tank would disturb his placid world by publishing its scientifically derived ratings of the five hundred best and worst economic development “climates” in the nation. The  Curmudgeon’s community, almost inevitably, was fighting for last place, and within seconds, the Curmudgeon was writing rebuttals and critiques for his local elected officials to issue as a counter-weight to the also inevitable home town newspaper negative reportage which typically would blame everything and everyone for this dismal state of affairs.

State business climate, to a local economic developer, in a chronically declining Great Lakes community was no cause for any joy. The State  business climate condemned his community to censure, blame and even dishonor and left the Curmudgeon frustrated. He couldn’t move the community to another and better climate, nor could he affect in any material way the overall business climate or the index. The best the Curmudgeon could hope for was to hit the bourbon and imagine working in one of the so-called “best” communities—not that any would ever hire him because only successful economic developers worked in the “best”  communities–and he obviously did not fit into that category.

In any case, this matter of business climate and community ratings struck the Curmudgeon as a wee bit of tomfoolery. The Curmudgeon no more believed his community was the “last”, or his state the worst, simply on the  basis of some non transparent research methodology produced by an entity whose end purposes were less than obvious.

In any case, this matter of business climate and community ratings struck the Curmudgeon as a wee bit of tomfoolery. The Curmudgeon no more believed his community was the “last”, or his state the worst, simply on the  basis of some non transparent research methodology produced by an entity whose end purposes were less than obvious. His natural skepticism grew dramatically when, after assuming a position at the other end of New York State, his new  county was touted the second highest rated innovative/technological county (and New York the second best State) in the nation. Almost reflexively, seeking to turn this good news into a spur to advance several related program initiatives, he drafted a set of comments for the newspaper explaining that our community was good, but could do better. Later conversations with the irate chief local elected official sent the Curmudgeon back to his bourbon. With business climate he couldn’t win, even if he won!

The TYPICAL economic development director, however, was not as passive or reactive to business climate/indexes as was the Curmudgeon. For  most economic developers, business climate and business climate indexes are a prominent strategy in their local economic development  program. As an economic development strategy, business climate is linked to business attraction and recruitment (although it does have business retention implications) and most communities which seriously adopt that strategy take business climate and associated indexes very seriously (as do site  selectors). Community and State business climate, expressed through a marketing/advertising) program is a core element of  their attraction strategy. Climate indexes are a serious matter, either  constituting an endorsement or an obstacle to explain or to discredit. A poor ranking on any one index can hurt the community both with incoming firms and with the infamous attraction-recruitment complex (similar in size, but more powerful than the military-industrial complex). Business climate and indexes are serious matters to most economic developers. Given the dire straits of most communities in these “New Normal” days and given the polarized political environment engaged in a permanent election campaign, business climate, the indexes almost certainly become ammunition or fodder for one or another economic development strategy or initiative.

Business Climate, Business Climate Indexes–and Academic Research

The good news for those seeking positive grist for their attraction mills is that there are more indexes than Greece has debt. Indexes and business climate ratings are all over the place, published it seems on an hourly basis. Incredibly, some indexes actually have respectable reputations. But no matter how prestigious or influential the Index, others beside the Curmudgeon have consistently wondered just (1) what was included within the big tent of business climate/indexes,  (2) can, and to what extent, business climate/indexes be altered through changes in public policy only and (3), most frightful of all, is business climate/indexes really,  really linked to, and predictive of, some form of economic growth. These are kinda fundamental questions!

These three questions have generated a none too-considerable literature, from academia and community-state research institutes. From this  multi-faceted literature, we have selected several research articles which address, in their own way, one or another of the aforementioned key business climate questions. The first review is written by George Bittlingmayer, Liesl  Eathington, Arthur Hall, and Peter Orazem, “Business Climate Indexes: Which Work, Which Don’t, and What Can They Say About the Kansas Economy”, prepared for Kansas Inc  (a state entity whose mission is to strategically build a strong and diversified economy that promotes new and existing industries), June 2005. The questions and the findings of this study have relevance to all fifty states.

Kansas Inc confirms the Curmudgeon’s own perception that  “Numerous organizations rank states on the basis of their business  climates. These rankings are widely discussed in the media and are cited by elected officials, business associations, and consultants…. However, the rankings often conflict and there is little guidance as to which rankings are valid or invalid” (P.1). They assert that “the number and variety of  indexes has increased since 1999” (P.3). For Kansas Inc, the growth in the  number of indexes is the consequence of (1) “advances in information  technology that have lowered production costs” (they are cheap to produce), and (2) and an explosion in the use of such indexes to affect public opinion and policy change (P.4).

To assess validity (i.e. whether the indexes actually account for past growth, and/or predict future economic growth) the Kansas study tests eleven well-known business climate indexes (over a thirty-two year period-1970-2002) asking which indexes are positively correlated with various different measures of economic growth. They draw four measures of growth from the Bureau of  Economic Analysis’ Regional Economic Accounts: county-level wage bill, population and employment changes, and number of nonfarm proprietors (business  formation) as their dependent variables. Interestingly, to explain the relative economic performance between states, they study the neighboring counties (107 state borders) on the borders of each state where the impact of differing business climates should be most apparent and impactful.

Recognizing that business climate indexes can only be valid if they in fact can explain the relative economic performance between states over different time periods, Kansas Inc arrives at four findings:

“None of the business climate indexes can explain a large proportion of the variation in economic growth across counties. The best performing business climate indexes explained at most 5% of the total variation…, suggesting that most of the variation … is due to factors NOT CAPTURED by state-level business climate measures. This would suggest that business climate is relatively unimportant in driving relative growth among the states”

(1) “None of the business climate indexes can explain a large proportion of the variation in economic growth across counties. The best performing business climate indexes explained at most 5% of the total variation…, suggesting that most of the variation … is due to factors NOT CAPTURED by state-level business climate measures. This would suggest that business climate is relatively unimportant in driving relative growth among the states” (P.10);

(2) Only two (Fantus, Grant Thorton) of the eleven indexes can consistently explain a small amount of the variation in one dependent variable (relative wage bill) over the thirty years (P.11); and

(3) three others (Clemson-Pacific, Small Business Survival, and Tax Foundation) explained smaller amounts of the variation in other dependent variables.

(4) Four of these five indexes mentioned in points 2 & 3 above placed between 70-100% of their weighting on tax and regulatory burden and size of government (P.11). “Therefore, it would seem that relative tax competitiveness seems to matter at the borders” and indexes that “place relatively high weight on tax policies had the most consistent positive effects on relative growth” (P.13), albeit accounting for a fairly small percentage of the variation among states;

(5) Some indexes (Fraser Institute and Corporation for Enterprise Development) not only cannot explain growth at all, but are negatively correlated with all four measures of economic growth (P.12). Indexes that weigh industrial policies “have no ability to explain relative growth…”(P.13)

Finally, Kansas Inc discovers the obvious: that different indexes measure different things, implying that different variables create economic growth (and implicitly and subtlety revealing the existence of differing theories and ideologies which underlie an index). In essence, the great number and variety of indexes measure different variables indicating some confusion and “flexibility” as to which core elements of business climate (and logically public policy) are critical to achieving a successful, competitive and growth-prone business climate. Business climate indexes do not measure or compare the same variables and each presupposes its often unarticulated “theory” as to what causes economic growth.  It should be no surprise that Kansas Inc concludes “most of the indexes are not highly correlated and clearly measure different things” … and “41 of 66 cross-correlations are negative” P.7.

Say it another way, the variety of incompatible indexes strongly suggest there exists no real consensus as to what are the driving forces of local economic growth and that picking an element or index of business climate is almost a matter of self-interest or individual theoretical/ideological choice. Despite the math and sophisticated methodologies, there is no science in business climate.

This plethora of indexes which compare apples to nails provides support for Kansas Inc’s earlier observation that indexes have multiplied in part as yet another  mechanism by policy advocates and ideologues to urge their desired policy changes be implemented throughout the fifty states. Indexes most certainly possess a political and ideological dimension. The only indexes which can claim some small measure of credibility, according to Kansas Inc. are those which focus on tax and regulation–a topic we will return to later in this review.

Another interesting finding revealed by Kansas Inc’s analysis is that whichever the index, and however the index that index defines business climate, the business climate itself does not materially change over time–that business climate is amazingly durable (“business climate is a very persistent phenomenon” (P.17) and does not exhibit meaningful variation as a consequence of changes in policy during the time period (P.6). This finding obviously relates to our second question as to whether policy changes bring about positive or negative changes in business climate. According to Kansas Inc. they don’t! Changes in policy do not seem to result in changes in how a state ranks in economic growth or interestingly on rankings by the same index over time. Winners and losers in an index may move up and down a few notches each year, but the same winners and losers emerge–over decades– despite any changes in policy undertaken in each state.

Winners and losers in an index may move up and down a few notches each year, but the same winners and losers emerge–over decades– despite any changes in policy undertaken in each state.

This durability of business climate over considerable periods of time seems counter intuitive in that some of them must, on occasion, change their policies to addresses their weaknesses and emphasize their strengths–but they don’t!  On closer thought, the durability makes sense if one recognizes that business climate of a particular state is in toto composed of many, many elements, from policies regarding taxes, regulation to educational systems, and that incremental  changes in any one policy are not likely to result in dramatic changes in the state’s overall business climate or, claims to the contrary, economic growth. This durability may even suggest that policies are not the dominant element in a state’s business climate– a topic which, again, we shall come back to and which will be the subject of a future article.

If taxes and regulation are so important, why are some high tax/regulated states economically prosperous?

Our second review article “Business  Climate Rankings and the California Economy, written by Jed Kolko, David  Neumark and Marisol Cuellar Mejia from the Public Policy Institute of  California (mission is “to inform and improve public policy in California through independent objective nonpartisan research), April 2011, asks a rather interesting question “why California’s economic performance is better than its  business climate rankings suggest it should be, and also what this implies for  the usefulness of these rankings?” (P.2). To relate the Public Policy  Institute’s findings to our original questions, the Curmudgeon suggests that this is yet another perspective on the question of whether these indexes possess a reasonable degree of validity, i.e. do they actually measure past and/or future relative economic growth among states. In addition, the Institute offers insight as to just what are the driving elements of a successful business climate and by extension some suggestion as to impact of policy and policy changes on business climate.

Firstly, the Curmudgeon did some fast fact-checking (using BEA) of California’s performance relative to other states (and nations) and California, probably as expected, was always the nation’s largest GNP throughout the last ten years. In fact, it is the seventh largest GNP in the world (assuming the USA is removed). In the period 2005-2009 the USA grew GNP by 11.7% and California, 16.1%. Whatever the business climate of California may be, the Public Policy Institute’s position that California grew at rates exceeding that of the overall USA is supportable. Whether this is really the relevant comparison, should, for instance California be evaluated by comparing it to specific states with presumably different business climates is more open to question. Texas, with a smaller base than California grew 26.7% during this period (interestingly the absolute growth in dollar terms was almost the same) and New York, 10.4% (below USA average and nearly one-third that of California). Whether or not California is a super-growth machine (which the Public Policy Institute goes out of its way NOT to claim) is certainly open to question, but in the war of bad business climates it does quite well and California is always growing above the national average.

The Public Policy Institute generally sees business climate  indexes as falling into one of two basic “types”: (1) “those that measure the business climate in terms of productivity, including measures of the quality of life and human capital, and (2) those that emphasize taxes, regulation, and other costs of doing business”

The Public Policy Institute generally sees business climate  indexes as falling into one of two basic “types”: (1) “those that measure the business climate in terms of productivity, including measures of the quality of life and human capital, and (2) those that emphasize taxes, regulation, and other costs of doing business” (P.2). In so doing, the  authors acknowledge the apple and oranges aspect of this bi-modal  distribution of business climate indexes. As to which set of measures actually constitutes the “real” core state business climate, CPI takes no position. They very subtlety suggest (at least  to the Curmudgeon), however, an underlying tension between these index-clusters, which seemingly, perhaps artificially, divide the fifty states into two covertly competing armies (dare we say the Red and the Blue). Yet, despite a logic which may be evident to the Curmudgeon only, this apparent zero-sum relationship can in real life, at some points in time and under certain conditions, permit both armies to be victorious perhaps simultaneously, and secondly, economic growth might be significant and sustainable if some balance between  the two might be forged. Why do we necessarily have to choose between index-clusters?

The authors observe that generally California does much better in the former (productivity), and miserably in the latter (taxes). They also observe that California has grown wages and output at rates above the national average. To the Curmudgeon, poising the question this way hints that quality of life/human  capital indexes are therefore better predictors of state economic growth.

NOT AT ALL, suggest the Public Policy Institute! They will not pick sides in the industry-cluster debate.

Why Not?

Their review of eleven prominent indexes (including the Progressive  Policy Institute, the Information, Technology & Innovation Foundation  (Kauffman Foundation), the Corporation for Enterprise Development, the Tax Foundation, the Milken Institute, the Small Business & Entrepreneurship Council, the Pacific Research Institute, and the Cato Institute) results in the following conclusion or observation. CPI observes that if one combines both index-clusters into one, every state in the Union did well in one or another of these indexes-clusters. And every

With so many ways to describe the business climate, the RIGHT QUESTION is not only whether the business climate matters for economic growth, but also which, if  any, of the business climate indexes help predict economic growth, and which  policies captured by the business climate indexes are the most important predictors of economic growth

state did poorly on one or another index-cluster. They conclude that: “With so many ways to describe the business climate, the RIGHT QUESTION is not only whether the business climate matters for economic growth, but also which, if  any, of the business climate indexes help predict economic growth, and which  policies captured by the business climate indexes are the most important predictors of economic growth“. (P.8) They are forced now to decide which index-cluster is the superior predictor of economic growth!

To answer this question, the Institute assesses the individual measures associated with each index-cluster and groups them into fourteen distinct variables. They then rank the states on these fourteen variables, and using correlation analysis they construct thirty or so “sub-indexes” which are sets of related variables. CPI then runs further correlations against commonly used measures of  state economic growth (drawn from the National Establishment Time Series data, Dunn-Bradstreet and the Quarterly Census of Employment & Wages). The results of these correlations further confirm their initial finding that there are in fact two macro-industry clusters emerge (actually three) index-clusters: (1) those indexes which emphasize productivity/quality of  life/human capital (5 indexes) and (2) a cluster which emphasizes “taxes and costs” (5 indexes); and (3) a third which does not fit either classification (1 troublemaker). The Curmudgeon urges those who are methodologically inclined to view their Technical Index which is quite exhaustive and descriptive of their methodology and which can offer a more precise description of their research.

When the thirty sub-indexes are individual correlated with measures of economic growth, “three stand out in having a consistent, statistically significant relationship with our economic growth measures…. These three sub-indexes-the SBTC corporate tax index, the EFINA size of government index, and the EFI welfare-spending index–all fall within the taxes and costs cluster….

None of the sub indexes within the productivity/quality of life cluster has a consistent {and statistically} significant relationship with economic growth…”

None of the sub indexes within the productivity/quality of life cluster has a consistent {and statistically} significant relationship with economic growth…” (PP. 22-23). Positively stated, if there is any policy associated with the business climate literature that has a limited, but persistent, statistical impact on economic growth, it is taxes and spending! This conclusion is congruent with Kansas Inc’s research.

In fact, CPI’s research also supports Kansas Inc’s finding that business climate index rankings usually do not vary over time and that an  observable characteristic  of business climate indexes, no matter how constructed, is that business climate  change little, if at all, over decades (making regression analysis only  marginally useful in assessing business climates). Within a  sub indexes and clusters, “states often rank consistently well or poorly”  despite the reality that comparing the two clusters yields no clear or consistent pattern of states rankings (P.11-12). In summary “states often rank consistently well or poorly on indexes WITHIN each of the two clusters (P.12) and sub indexes and rankings within a cluster do not really change over time, and, the rankings of the various indexes also do not change meaningfully.  If you do well on an index this year, expect to continue to do so in future years.               

This stability and consistency of rankings and indexes over time, in the Curmudgeon’s opinion, suggest that state business climate is amazingly durable, and exceedingly difficult to change-especially if one’s only agent of change are new and different public policies.

The California Puzzle: Can Change in a Single Policy (or a set of related policy changes) Materially Affect a State/Region’s Business Climate?

There are several ways to approach the question “how much does specific public policy(ies) affect a state’s business climate”. In the paragraphs below, our review of the CPI article will suggest that a very key issue in the answer to the question lies in what one includes in the definition of a business climate. CPI will raise the question that what is left out of conventional definitions of business climate may be equally, or even more important, than the public policies usually at the core of these indexes. Non-public policy factors can shape business climate and maybe are more important in affecting the rate of economic growth of that state.

Returning to our review of the California Institute of Public Policy, the authors, Kolko et al,  observe that  California does not do well with either set of clusters, admitting in their  own, more tasteful, way that in fact California stinks in the tax and costs  cluster and is mediocre in the quality of life cluster. Yet, despite recent setbacks in the Great Recession period,  California’s economic growth has been consistently above the national average  for decades. In essence, the authors logically question whether business climate, as measured  by most existing business climate indexes, really captures the driving forces  behind state economic growth. California does not do well in any cluster of  business climate rankings, but yet its economic growth has been consistently above the national average. What gives?

They counter by suggesting that the current crop of business climate indexes LEAVE OUT critical factors which in their view are more important drivers of economic growth than those measures usually included in business climate indexes. Labeling the question of why California has consistently done well economically but is ranked mediocre or poorly in the two business climate clusters “the puzzle”, Kolko et al state that business climate indexes “overlook the possibility that California’s economic performance may depend on factors beyond the reach of policy, such as weather and geography” (P.13) which can offset other favorable and negative policies. Some of these non-policy drivers of economic growth and performance are: disproportionately concentrated sectors (clusters if you must) which prosper or slump depending on the time period; natural features such as climate and proximity to waterways (i.e. current transportation modalities); the shift in the national economy to a service sector economy; the location of natural resources; population density (i.e. rural versus urban); and a natural attractiveness for human interaction (i.e. attractive to tourists). Kolko et al also remind their readers that these frequently overlooked factors VARY WITHIN THE STATE as well as between states (P.14).

“Taking the evidence on business climate indexes at face value, California’s economic growth is held back because of policies that lead to a poor ranking on these indexes. But California is also fortunate to have natural advantages with regard to other factors that boost economic performance. The two forces are offsetting, so despite its relatively poor business climate, California’s economic growth comes in near or above the national average (P.18).

Overlooked aspects of state (and region’s) business climate, in the opinion of the Curmudgeon, go way beyond natural advantages listed by the California Policy Institute. There are, he feels a host of factors which ought to be included into the business climate concept in that in their own ways are quite impactful in affecting the reality and perception of state competitiveness. These factors will be the subject of a future article.

Can any change in public policy (or set of related policies) shift materially the overall state business climate, at least in the short term?

At the outset, the Curmudgeon does not wish to imply, or enter the fray as to whether any of these single policy/related theme proposals are useful or desirable in themselves or able to generate economic or situational (specific firm or even industry growth. His sole issue in the below discussion is whether any public policy (or clusters of related policies) changes can shift materially the overall state business climate, at least in the short term.

Rather, for the Curmudgeon the starting point is to define the whole pizza of business climate and not just limit ourselves to a few of its slices. One perspective to assess the impact of business climate is to consider the decision of a resident or a corporation to move or stay in one state or to relocate to another. Both corporations and resident typically will review those slices of the climate that are relevant to them. That is one reason why taxes (and a contracting job base) are consistently related to negative business climate. Taxes (and labor rates) are major factors which a business cannot ignore. Granted some literature regarding corporate relocations clearly and consistently demonstrate that taxes are not a prime factor in corporate relocation decision-making, but the Curmudgeon would counter that OVERALL costs are an important factor. A firm considering a move to a high cost state must evaluate other factors to justify or overcome the hit on earnings and profitability.

In any case, the Curmudgeon would expand the concept of business climate to include: governmental structure and processes, demographic history and sociological and historical culture, climate, natural resources, settlement and immigration patterns, geographic location, ethnicity and religion, as well as patterns of density expressed in the population distribution among city, suburb, small town and rural environments.

For business we could add such hard to measure factors such as: sectoral or industry-related tax structure, also right to work and prevailing wage issues. But lurking in the mists of the corporate/residential relocation decision can also be ease of construction or redevelopment, cost of living, access to alternative logistical modes, synergy with other corporate facilities and the current corporate business plan, access to a local finance system, a measureable access to some increased consumer demand. All these potential factors, all of which defy measurable inclusion in a comprehensive business climate index, strongly suggests that the pizza (what is included in the definition of business climate) must be quite thick if it is able to support all the ingredients potentially desired by corporate/residential decision-makers.

The immensity and interrelational complexity of these various potential, presently overlooked, components of an aggregated state business climate would obviously lessen the impact of public policies. Looking at the potential basket of items in a state/region business climate, the Curmudgeon, excepting tax, regulatory cost and right to work legislation, questions the validity of indexes and single policy advocates belief that change in one area can result in a material impact on aggregate state-wide GNP, educational outputs and the like. The problem, he feels, with these indexes is they can easily be little more than proxies for political and ideological confrontation. In earlier issues of the Journal, the Curmudgeon has danced around, largely avoided, a perception that economic development literature and strategies have become politicized. But now he acknowledges his sense that there are “correct” strategies and “wrong” strategies wherever one turns in the literature. That any strategy actually works is a question that is no longer asked; the correct strategy is assumed to always work. In the present macro-economic environment, we have reason, however, to question whether ANY local economic development strategy CAN work, at least in the short term. Single policy (or related themes, again small business, technology and start ups, entrepreneur and innovation, sustainable and green are only a few examples) adjustments can really mask efforts to achieve political and ideological goals and be an attempt to set a larger agenda.

The sheer number of the elements within a state business climate would warrant a reasonable observation that targeted advantages in some elements of the climate, can easily be offset by unconscious, unrelated and unrecognized (and also unmeasured) disadvantages in other elements.

Even if not correct in this observation, the sheer number of the elements within a state business climate would warrant a reasonable observation that targeted advantages in some elements of the climate, can easily be offset by unconscious,unrelated and unrecognized (and also unmeasured) disadvantages in other elements. A reduction in small business taxation could easily be overwhelmed by increased health care costs, minimum wage, higher fees for services etc. Again, Business especially will tend to look at the aggregated business climate in measuring their costs, and a slice by slice (specific policy) which only affects a fraction of potential relocators is not likely to change the overall business climate picture, or frankly, affect aggregate employment levels of the state (or region) in the short or the long term.

A Statistical Interlude

The California Institute article includes a very pleasant surprise in the form of an  Appendix B which briefly summarizes and critiques several of the best articles  written concerning business climate indexes in the last thirty years. The  reader is therefore referred to this Appendix with the understanding that a bit  of statistical background will be very useful in getting the most from the  appendix. From the Curmudgeon’s perspective, this appendix observes the very first indexes during the 1980’s (indexes which centered  chiefly on taxes) garnered considerable media attention even then, and that academic assessment of these early indexes acknowledged some limited explanatory impact of taxes and costs on employment, and that employment was seemingly affected by the ideologically controversial “right to work” policy.

More importantly, the Appendix outlines a series of statistical  and methodological concerns regarding indexes and the studies which attempt to assess them. In essence, a methodologically non-sophisticated economic developer ought to be sensitive to the lack of an accepted methodology with which to conduct and evaluate business climate indexes, their claims, and even their underlying methodology. Issues such as “reverse causality”, time lags between  dependent and independent variables, and unclear and conceptually imperfect  independent and dependent variables are individually serious deficiencies and are often unacknowledged limitations on both the index itself and the academic study which evaluates the index. These methodological failings affect the credibility of business climate claims and projections. Repeating the concerns of Fisher (2005), Kolko  et al. observe that “often business climate indexes … fail to measure  accurately what they claim to; that including economic outcome measures in indexes that purport to predict economic outcomes is circular; and that index construction often involves weighting components arbitrarily rather than based on their actual predictive power” (P.23). Indeed, Kolko et al critique our previously-cited Kansas Inc. After describing Kansas Inc’s methodology, which employs only a single year of each business climate index for each of four ten (or twelve) year time periods, Kolko et al wonder, if in fact, Kansas Inc may have tripped over a  “reverse causality” problem. (P.24).

The Curmudgeon senses that business climate and business climate indexes are yet one more instance of the excessive reliance and deference to math, modeling and statistics which seem to permeate local economic development. More interesting, perhaps, than the lack of a methodological consensus about how to assess and evaluate the business climate indexes, are the findings of a long-standing, but until recently largely ignored, literature on individual decision-making. Asking the questions “can we make good decisions on the future?”, “how do we make choices and decisions at all”, psychologically based research (mirroring much found in the highly touted sub discipline of behavioral economics) can be applied to how we react to business climate indexes and their claims and predictions. Relying upon a fascinating, if long-winded, work by Nobel prize winning, Daniel Kahneman, Thinking, Fast and Slow (Farrar, Straus & Giroux, October 25, 2011), and a review of this soon to be released work by Christopher Chabris (Wall Street Journal, October 23, 2011, p. C7), the Curmudgeon discovered that this research “showed that even trained research psychologists had poor judgment about statistical inferences: The sample sizes of their experiments were often too small to support their conclusions” and that “crucial policy decisions are often based on statistical inferences, but … (such decision makers) pay more attention to the content of the messages than to information about their reliability”. “The effect is ‘a view of the world around us that is simpler and more coherent than the data justify.” This, to the Curmudgeon, explains much of the magic surrounding business climate indexes and the public policies they endorse.

Further, in a typically ungenerous moment, the Curmudgeon might be tempted to observe that in regards to indexes, the math and statistics, while incredibly sophisticated, obscure an underlying failure to understand the complexities inherent within the data itself (especially the dependent variables, such  as employment growth in a state) and the data’s relationship to the independent variables (such as taxes, number of patents, etc.). The Curmudgeon senses that business climate and business climate indexes are yet one more instance of the excessive reliance and deference to math, modeling and statistics which seem to permeate local economic development–and especially academic studies of it. Statistics and modeling equations to those not proficient in these incantations give the appearance of a confirmed proof which cannot be argued with. After all, the numbers are what the numbers are. How they are arrived at, God only knows. The Curmudgeon gently suggests that Economic Developers should not place such blind faith on R squareds, statistical significance,  or modeling equations if only because researchers poorly understand the individual data points in their datasets. The data are aggregates, sometimes averages, and the aggregate figure almost always masks the apples and oranges inherently created by fifty states, and simply “summarize” the complex interactions of 300 million + individuals and literally thousands of jurisdictions. There is a lot of “detail” hidden in a data set (Oklahoma’s GNP number probably contains elements which are not found in a Massachusetts’ GNP and each are probably assembled differently). More respect and thought ought to be paid to both assumptions and interpretations made in the analysis of such data.

A statistical study of past standings found that the Red Sox then had a 99.6% probability of making the playoffs (John Authers, Financial Times, Oct 2, 2011). Also, Nate Silver, a noted baseball statistician estimated in his New York Times blog that the chances of the Red Sox failing to make the postseason were 287 MILLION to 1.

A final example of the limitations of statistical analysis rises from the Curmudgeon’s recent frustration with Beantown Baseball! The Curmudgeon recently took great comfort when his favorite home town team, the Boston Red Sox started the month of September 10 games ahead. A statistical study of past standings found that the Red Sox then had a 99.6% probability of making the playoffs (John Authers, Financial Times, Oct 2, 2011). Also, Nate Silver, a noted baseball statistician estimated in his New York Times blog that the chances of the Red Sox failing to make the postseason were 287 MILLION to 1. (John Authers, Financial Times, Oct 2, 2011). The Curmudgeon is NOT presently watching the Red Sox in the playoffs or world series and instead is using his free time to go to the movies and watch Brad Pitt in his new film, Moneyball (did you catch the sarcasm related to Moneyball?). Statistics don’t lie, they just don’t mean what we think they mean and they are NOT predictive, only suggestive, so long as the assumptions are correct and there are no Black Swans or Red Sox.

Rankings and indexes are simple concepts and are seemingly justified by statistics and a methodology which is boring, non understandable to the methodologically unsophisticated (Curmudgeon included) and easily ignored. But Economic Developers should question this stuff more rigorously. That is not all they should do: Equally important, as well shall discuss below, Economic Developers should be much more sensitive that the indexes and rankings can be easily bent to (1) appeal to politicians and the media and (2) justify programs, policies and ideologies desired by various economic development advocates.

BUSINESS CLIMATE AS AN LOCAL ECONOMIC DEVELOPMENT STRATEGY /BLUE STATE VS RED STATE

The reader may have sensed that most literature on business climate tends to sidestep and backslide to avoid belling the all too obvious Cheshire cat: the business climate concept has built itself around politically charged, controversial public policies.

Perhaps this is because business climate and indexes have come to be a convenient substitute or proxy for the “environment” of our communities, be they cities, villages, counties or even regions.

Business climate indexes have come to be a convenient substitute or proxy for the “environment” of our communities, be they cities, villages, counties or even regions. Business climate is for local economic developers the sum total of usually evil factors which affect their success and cause many failures–factors which they cannot easily, or at all, change.

Business climate is for local economic developers the sum total of usually evil factors which affect their success and cause many failures–factors which they cannot easily, or at all, change. For those states and local economic developers who believe they are “winners” in business climate, indexes can be a quite useful and convenient weapon/justification/publicity point in their pursuit of ever more “victories” and success statistics. In either instance, business climate has become an actual economic development strategy.

Usually one tends to think of business climate as determined at the state level.

Sub state governments and communities are, a la Dillon’s Law, for the most part creatures of the state. Most of the elements which go into the business climate pizza are primarily impacted, if not outright determined by the state and its legislature. If so, business climate than can usually be thought of by local economic developers either as (1) a local versus the state initiative/strategy to correct policy and cost consequences of bad state policy (which affect one’s jurisdiction attractiveness/competitiveness negatively; or, (2) a strategy conducted by state officials (and frequently regional entitities), which are competing with/recruiting from other states, to capture and retain business, residents, and economic growth. Of course, for those states which are consensually regarded as blessed by business climate indexes (increasingly a very scarce few these days), this distinction between local versus state strategy and state versus state strategy can be muted. Certainly, in suggesting this tension/cross variance perhaps inherent in the application of a business climate economic development strategy, the Curmudgeon is aware that whenever an opportunity exists for different levels of government to work together for common purposes, they will. Whatever the tension between local and state, a common front vis a vis outsiders is absolutely required.

Yet further complicating this implementation of local business climate strategy is the reality that such a strategy has been heavily politicized, more so in recent years and in the New Normal. The emergence of rival business climate public policy counter indexes and strategies (innovation/clusters versus tax cutting and deregulation, for instance) raises the specter of Blue and Red economic development which (1) divides professional practitioners in an already polarized political landscape and provides fodder in the ideological debate bandied about by opportunistic politicians, (2) which encourages simplistic solutions and silver bullets easily translated into campaign sound bites and campaign donations, and (3)which further raises unrealistic expectations and policy goals (another name for campaign promises), which, when unsuccessful, can only be explained away at a later date by a deceptive use of statistics, manipulated performance results, or further political/ideological blame-shifting.

The emergence of economic growth, business climate public policy counter indexes and strategies raises the specter of Blue and Red economic development.

Again, the Curmudgeon is not saying that these business climate strategies are nothing but masked political and ideological conflict, but he is saying that such political and ideological issues permeate the practice of business climate as an economic development strategy. Frankly, it’s hard, in the Curmudgeon’s opinion, to argue that politics and changes in public policy, be they for economic development or for mental health, cannot be viewed separately from politics, partisanship, and competing candidates. Changing public policy is political (and hence ideological) by its nature. Therein lays the rub with all single policy/related theme changes to overall state business climate (this includes tax and cost as well as quality of life, productivity or sector based policy adjustments). Sooner or later such policy changes become planks in a platform, a paragraph in a campaign contribution request, a sound bite on a TV commercial, a rousing metaphor or slogan in a speech, and a element in a the track record of an incumbent or “aspiring to be” administration. Business climate can be ammunition for local politicians running against the state and a strategy for governors to claim jobs and programs benefiting  individual regions or communities. And economic developers wonder why they are surrounded by politics in their daily professional lives? Are they blind! In tough times they have become politics personified, and there is no better example than the distortions unleashed by business climate indexes.

Accordingly, this section is the Curmudgeon’s initial explicit introduction articulating his concern that his profession has more than drifted or overlapped into politics, but is becoming in a time of great economic distress a “player” between competing political parties (even candidates) and ideologies. This concern, triggered in this instance by business climate and indexes, and alleged but fundamentally unproven economic development strategies and policy changes to promote local and state economic growth, can only in the long run polarize us and diminish our capacity to be perceived as neutral experts reflecting a professional body of knowledge– it brings us very close to the pitiful condition the economist profession has fallen into.

Oh what a web we weave!

 

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