The Real Fraud: Government ‘Economic Development’ Programs

This is Part II of a two-part series. The first part detailed the audit of the Raleigh Business and Technology Center, a “business incubator” in Southeast Raleigh. This part will describe the underlying problem, using the RBTC as an example.

Introduction

In the first part of this series, Civitas uncovered widespread corruption and mismanagement at the Raleigh Business and Technology Center (RBTC). The story featured a varied cast of characters – politicians, seedy businessmen, and scheming board members. Five days after Civitas published “Anatomy of a Fraud,” the Raleigh News and Observer wrote its own cover story echoing many of Civitas’ findings.[1]

With public scrutiny now fully directed at the Raleigh Business and Technology Center, it is time to move beyond the details of this particular case and talk about the underlying problem. This story is not just about one isolated incident, one “bad apple” among the lot. It is a story about a system that enables waste and corruption. In many ways, the scandal at the RBTC is only the latest example of the problems inherent in publicly-funded economic development programs.

Economic Development

In modern American politics, citizens regularly expect the government to intervene in the economy. Small wonder that politicians from both sides of the aisle constantly promise to “create jobs” and “stimulate the economy” while on the campaign trail. Once in office, politicians feel compelled to show something for their promises. As a result, government bureaucracies at every level of government pour public dollars into ill-advised interventions in the market. In the federal government, subsidies prop up dying industries and restrict the flow of international trade. And in North Carolina, a dizzying array of economic development programs wreaks havoc on the market and on our political institutions.

The trend towards economic development programs has even moved down to local governments. A quick search of nonprofits in North Carolina turns up 4,244 results with “development” in the organization’s name.[2] Many of those 4,000 organizations are taxpayer-supported, if not fully funded by public money. Most of these organizations promise to bring “economic development” to their target area. The case of the Raleigh Business and Technology Center is a perfect example of why that doesn’t work.

The Raleigh Business and Technology Center: A Case Study

The RBTC was a “business incubator” – essentially, it was started to offer reduced-rate services to minority-owned small businesses in Southeast Raleigh.[3] Most reporting about the RBTC – including the first part of this article – focused on misconduct at the organization. But even if you put all of that aside and imagine that the RBTC had been a squeaky-clean organization staffed by idealistic, honest, impartial experts (you will need an active imagination for this), it still would have been a bad program.  This is a little hard to explain. The immediate reaction from most people to this assertion is: “You mean even if it really ‘creates jobs’ and protects minority businesses, that’s still a bad thing?”

Well, in a word, yes.

When the City of Raleigh contracted with the RBTC to provide business incubation services, it was effectively picking winners and losers in the market. This is because public funds subsidized RBTC beneficiaries’ overhead costs. Take rent, for example: businesses housed at the Raleigh Business and Technology Center paid only $1.50 per square foot of office space each month. Meanwhile, competitors in downtown Raleigh had to pay around $23.76 per square foot – $14.73 if they set up in the Triangle instead.[4] That gave any business housed in the RBTC a tremendous advantage over prospective competitors, since competitors in the same area would have to pay more than fifteen times what RBTC tenants paid in rent. Add in the subsidized values of telephone services, Internet, janitorial services, conference rooms, and business training, and the advantage becomes even more lopsided.

Government favoritism in the form of economic development programs creates an unfair advantage for some businesses, and undermines the success of hardworking entrepreneurs who do not avail themselves of government handouts. Far from “developing” the economy, this sort of government intervention stymies free competition and uses badly-needed public resources to elevate the private interests of a few cherry-picked businesses.

Economic Development: A Vehicle for Corruption

Government favoritism in the economy inevitably leads to another problem: cronyism. When a handful of government officials control the purse strings, it becomes profitable to befriend those people.

The previous example of the Raleigh Business and Technology Center’s rental rates helps to explain why this happens. Say you’re a small business owner. You don’t want to pay $23.76 per square foot each month for office space. But you realize that if you make a generous donation to a city councilman’s reelection campaign, or give $10,000 to a bureaucrat’s family business, you might end up paying just $1.50 per square foot each month. As long as you end up paying less than the market price in the end, cronyism makes perfect economic sense. Economists call this sort of political jockeying by businesses “rent-seeking.”[5] It’s why there is an army of lobbyists in Washington – and to a lesser extent in Raleigh – cozying up to legislators.

The distorted set of incentives produced by government intervention also creates a different sort of public corruption: the “revolving door.” Matthew Mitchell, an economist at George Mason University’s Mercatus Center, describes it as “the tendency for ex-government officials to find jobs in the industries they once oversaw and for industry insiders to find regulatory jobs overseeing their former colleagues.”[6] Now, why does that seems familiar…?

Lawrence Wray is the poster child for the “revolving door” problem. He was Raleigh’s assistant city manager for twenty years, and became the secretary of the board at the Raleigh Business and Technology Center after retiring from the City in 2010. Wray’s close personal connections with the City Council and other government officials may have been the reason that the RBTC was never audited or inspected for over a decade. It may also be the reason that the city did not cut off the flow of taxpayer money to the RBTC until July 2013, even though city officials were aware that the RBTC had lost its nonprofit status in November 2012.[7]

Conclusion

The RBTC is only the latest in a slew of scandals involving government economic development programs. In June, Civitas and the Raleigh News and Observer identified corruption and waste at the state-funded Rural Economic Development Center.[8] And last month, the state Department of Commerce admitted that it had failed to properly oversee $20 million in Job Development Investment Grant funds.[9] And yet, the reaction from government officials is always one of surprise: it’s like a child who keeps putting his hand on the stove, and then complains when he gets burned.

Perhaps there is some good amidst all this bad news. Surely the corruption, waste, and mismanagement exposed by the audit of the Raleigh Business and Technology Center will cause city officials to rethink their involvement in so-called “economic development” that creates unfair advantages for some businesses while incentivizing cronyism and corruption.

From WNCN:

Mayor Nancy McFarlane announced the city was terminating its contract with the RBTC at the end of July. She says the city will look at starting a new business incubator program within six months.[10]

Or not.