Economics vs. Finance

imageOver the past few weeks, I have tried to make a very simple point: places have a strategic and economic interest in fostering locally-owned businesses. In addition to creating that unique charm and identity that attracts people and investment, locally owned businesses circulate more money within the local economy and help prevent money from leaking out in the first place. With these economic benefits (not to mention the social benefits associated with business ownership in close relationship with employees and customers), one would think that local governments in particular would be enthusiastic localists, engaging in policies that protect their own business communities from global forces hoping to filter local dollars to a corporate headquarters and on to stockholders worldwide. However, with few exceptions, local government has actively pursued exactly the opposite strategy: abating taxes and using tax funded financing tools to bring in outside companies that often drive out the established local merchant.  So what is going on? Why is this happening?

My guess is this: while cities all have economic development departments, the phrase is often a misnomer, for most are actually confusing economics with finance.  Here’s a good definition of Economics per’s Concise Encyclopedia:

 “Social science that analyzes and describes the consequences of choices made concerning scarce productive resources. Economics is the study of how individuals and societies choose to employ those resources: what goods and services will be produced, how they will be produced, and how they will be distributed among the members of society.”

Compare that to the definition of Finance,

 “Process of raising funds or capital for any kind of expenditure. Consumers, business firms, and governments often do not have the funds they need to make purchases or conduct their operations, while savers and investors have funds that could earn interest or dividends if put to productive use. Finance is the process of channeling funds from savers to users in the form of credit, loans, or invested capital through agencies…”

While the goal of Economics and Finance may appear similar, there is enough of a difference to put them at odds. Perhaps Wendell Berry expresses it best with this example from his essay, “Money vs. Goods”,

 “To encourage spending with no regard at all to what is being purchased may be pro-finance, but it is anti-economic. Finance, as opposed to economy, is always ready and eager to confuse wants with needs. From a financial point of view, it is good, even patriotic, to buy a new car whether you need one or not. From an economic point of view, however, it is wrong to buy anything you do not need.”

A truly economic approach to economic development would be the empowerment of locals by providing the resources necessary to address the needs of society. As I have already written about, such an economic development strategy would involve some combination of the following:

Does this sound like any place you’re familiar with? Yeah, me neither.

This is because under the name of economic development cities are practicing finance – trying to develop a tax base to fund government services. In general, the operating budgets of local governments are funded by some combination of property taxes, sales taxes, and an assortment of utility and other fees. As raising tax rates and fees is universally unpopular, fostering “growth” has been the politically palatable solution for increasing revenue. This form of “economic development” has cities competing with one another for new customers with a variety of tax abatements, financing, and incentives. Incentive packages are sometimes designed on a case by case basis but some cities turn to intricate formulas designed to weigh the cost of the package against the projected return in the form of additional tax and fee revenue. Examples of the factors that are weighed in making this decision can be seen here and here.

While well-intentioned, the financial approach to economic development is not kind to local establishments or the environment because true costs are not taken into account. Oftentimes economic development formulas simply assume that a new development will just add to the economy and little study is done on the effects to existing businesses. Further, because development directly adds to the tax base while nature only does so indirectly in the form of quality of life, the economic development formulas don’t get the economic impacts right.

This topic of economic development is particularly interesting to me, and over the next few blog posts I hope to dive even deeper into the concept. Why are so many places so desperate to attract growth? How can these departments do things differently in order to reap the benefits of a strong local economy?

4 thoughts on “Economics vs. Finance

  1. Pingback: The Economic Cost of a Two-Car Culture | The New Localization

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  4. Pingback: Double Sided: What a Mattress Taught me About the Purposeful Destruction of Wealth | The New Localization

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