July 2, 2019

How Opportunity Zones Can Help the South Reach Its Full Potential



Economic divergence between urban and rural economies is as much a story about the South as the struggling Rust Belt. As the Wall Street Journal highlighted in a recent feature, the South’s decades-long convergence to the rest of the country has halted since the Great Recession:

In the 1940s, per capita income in the states historians and economists generally refer to as the South — Louisiana, Mississippi, Alabama, Georgia, the Carolinas, Virginia, West Virginia, Oklahoma, Arkansas, Tennessee and Kentucky — equaled 66.3% of the national average, according to historical data reconstructed by University of Kent economist Alex Klein and The Wall Street Journal. By 2009, that had climbed to 88.9%. That was the high-water mark. By 2017 it fell back to 85.9%.

It is true that incomes in the South have stopped gaining ground on the rest of the country, but the story is more complicated. The South is also home to some of the fastest-growing cities in the country, among them Atlanta, Charlotte, Raleigh, and Charleston. While their West Coast and Northeastern counterparts have enacted restrictive zoning laws that drive up the cost of living and deter in-migration, these fast-growing metros have so far avoided that temptation and remain magnets of economic opportunity. At the same time, places outside these cities have been struck by high poverty, job loss, and other forms of social hardship, driving overall regional economic outcomes away from the rest of the country.  

The self-sorting of workers from struggling towns to places offering higher wages and living standards is an important driver of national growth. Policymakers in the South should continue to facilitate the migration of workers to the booming cities of the Sun Belt, but they must also pursue smart place-based policy to assist the communities that migrants leave behind. It is not a fact of life that vast swaths of the region are destined to succumb to stagnation and lag the rest of the country, and with a careful reconsideration of longstanding economic development practices, the South can reverse their divergence and spur more broad-based growth.

The Pitfalls of State Enterprise Zones

State and local governments in the South have long seen low taxes and right-to-work laws as a sound formula to compete with Midwestern cities for manufacturing jobs. As the South transitioned away from an agricultural economy marred by institutional racial discrimination, this formula was successful at attracting industries from states with higher taxes and labor costs. Per capita income in the South steadily rose relative to the rest of the country, approaching that of the Midwest by the turn of the century. But as the world economy globalized, tax abatements and cheap labor-costs ceased to be a competitive advantage for regions in a country as wealthy as the United States.

Important to this old formula were aggressive tax incentives. Some of these incentives were firm-specific, while others conferred tax advantages to doing business within the boundaries of a particular area. The latter took the form of State Enterprise Zones, an incentive scheme that became widely popular in the 1980s and 1990s.  Alabama’s Enterprise Zone program is one such example, offering benefits to businesses locating in counties with fewer than 25,000 residents. Among the benefits are business tax credits of up to $2,500 for new hires within zones, temporary exemptions from the state’s business privilege tax, and exemptions from sales and use taxes on qualified investments. Nonetheless, economists have generally been skeptical of targeted tax incentives, questioning their ability to change firms’ decisions and their potential to slow down healthy internal migration.

Empirical evidence has been unforgiving to state-level Enterprise Zones. Programs across the country — with a diverse set of structures and incentives — have largely failed to significantly reduce poverty or increase employment in targeted communities. A generous set of incentives in California that included hiring credits for businesses of up to $36,000 per worker over five years failed to spur job growth in selected zones. Texas’ more modest Enterprise Zones increased employment by between 1 and 2 percent in selected Census block groups, but also caused a significant increase in property values that may have offset the effect of these gains for renters.

State Enterprise Zones pose additional challenges for Southern states and municipalities shackled by low fiscal capacity. With a comparatively small taxable income base, these state and local governments provide fewer social services to begin with, so doling out large tax incentives is more likely to come at the expense of important infrastructure and human capital investments that are important for longer-run regional growth. This may also be why nationally-administered place-based incentives register more favorably in empirical analyses, albeit with a high degree of inconsistency. Not only are federal programs removed from state balanced budget requirements, they can also keep benefits relatively concentrated while diffusing costs across the national economy.

The new federal Opportunity Zones created by the Tax Cuts and Jobs Act of 2017 will be an ambitious test of whether place-based business tax incentives can work better when administered at the national level, but states should be cautious in what they tack on to this program. There has been movement in well over a dozen states to place additional Enterprise Zone-like incentives in communities designated federal Opportunity Zones, but governments in the South should avoid squandering their limited fiscal space on ineffective place-based benefits and instead rethink their targeted economic development strategies with an eye towards workforce development and long-run productivity growth.

How Southern States Can Take Advantage of Opportunity Zones

Opportunity Zones have the potential to attract an enormous amount of capital to stagnant regions, but this by itself may not translate into substantial gains for workers. State and local governments should consider three supplemental policies to push this influx of capital towards investments that generate well-paying jobs.

Manufacturing Extension Services

Like the Upper Midwest, the South has been rapidly bleeding manufacturing jobs since the 1990s. Even as the national job market recovered from the Great Recession, manufacturing jobs have not returned. But despite global competition, automation, and other forces pressuring American manufacturing, it is hardly inevitable that these trends must destroy manufacturing altogether.

One way the South can breathe new life into its once-vibrant manufacturing sector at a relatively low cost is through manufacturing extension services, which offer customized consulting to small and medium-sized manufacturers struggling to compete. These partnerships offer companies business advice, best management practices, connections with suppliers, and help implementing new technologies.

An existing national service, the Hollings Manufacturing Extension Partnership (MEP), a decentralized national network of public-private partnerships, has proven to be incredibly cost-effective. According to one estimate from the Upjohn Institute, the federal investment in this program paid for itself more than 14 times over in 2018 alone. State and local governments can beef up their centers and prepare smaller manufacturers for export markets — thus spurring firms to increase their productivity to international standards, and thereby raise wages.

Place-Based Scholarship Programs

As college graduates flee struggling communities in the South for fast-growing cities, increasing college attainment should be a top priority for policymakers. The benefits to this are not limited to graduates themselves, as higher rates of college attainment have spillover effects that increase the wages of other workers, including larger effects for workers with less education.

A model for accomplishing this goal are place-based scholarship programs, sometimes referred to as “promise scholarships,” that make long-term promises of generous financial aid to public school graduates. The first such program, in Kalamazoo, Mich., for instance, caused large increases in college attainment among eligible students. Promise scholarship programs elsewhere, when not placing onerous restrictions on scholarship awards, have been shown to significantly increase college attainment. While the cost of such programs may be too burdensome for local governments in hollowed-out communities, states could conceivably implement these policies in federally-designated Opportunity Zones. Universities can also take the lead, as in the case of the Johns Hopkins “Baltimore Scholars” program, which provides special tuition support for students admitted from Baltimore public schools.

Community College Sectoral Training

Vocational training programs administered by community colleges and tailored to the demands of regional labor markets have been quite successful in boosting employment and wages among low-wage, less-educated workers across the country. In contrast to narrower, firm-specific training programs, sectoral training also gives trainees flexibility to move among firms. A 2010 study of multiple sector-focused vocational training programs found sizable increases in employment and wages among participants compared to a control group. An analysis of the Project QUEST training program in San Antonio, Texas, found participants experienced substantial earnings increases that persisted nine years after they completed the program.

Viewing community colleges as springboards to four-year institutions for some students and as tools for preparing others for in-demand jobs that do not require a bachelor’s degree can attack labor market deficiencies on multiple fronts, assisting workers across the income distribution. Investments in public research colleges, particularly those located in smaller cities, can help otherwise declining regions attract and retain educated workers while creating employment opportunities for less-educated rural workers within commuting distance of the schools. 

Conclusion

Low fiscal capacity hampers the efficacy of state-level Enterprise Zones and firm-specific tax incentives by crowding out scarce tax revenues that state and local governments in the South could use to pursue alternative policies. Fortunately, the national Opportunity Zones legislation has removed the need for poorer states to double down on tax-based incentive schemes. For Opportunity Zones to reach their full potential, Southern governments should rethink their economic development strategies and make the sorts of investments that will ensure new capital inflows are complemented by better-equipped workers and higher-productivity businesses.