FINANCE

Wiewel (1991) conducted a study commissioned by The Illinois Development Finance Authority (IDFA) to provide information on its role and impact on economic development in the state through the issuance of Industrial Revenue Bonds (IRBs). IRBs offer low-cost financing to businesses that want to establish themselves or to expand. The University of Illinois at Chicago Center for Urban Economic Development completed the study in 1991 after conducting interviews with a sample of IRB recipients.

Several key findings were highlighted: 1) job growth occurred at a respectable pace, with an average employment expansion of 48 percent since receiving the IRB; 2) IRB recipient firms reported increasing profitability - 54 percent said they were more profitable after receiving the IRB and 68 percent reported profit rates at or above industry norms; 3) 45 percent of the employment growth experienced by IRB companies included high wage, professional and skilled occupations; 4) minorities and women constituted a large proportion of the work force of IRB recipients; 5) IRB companies were large purchasers of goods and services supplied in the state; 6) industrial lease space had the greatest concentrated development impact, and 7) qualitative responses indicated a general satisfaction with the IRB program.

Florida and Smith (1990) conducted a two-year study to explore the role of venture capital in technological innovation and economic development. They compiled a database on the venture capital industry based on information reported in the Venture Capital Journal over a four-year period. This data was used to conduct analyses of investment flows and co-investment patterns at the local, regional and national levels and to develop statistical measures of the relationship between venture capital and high technology development.

Researchers also did extensive fieldwork to talk with people involved in the venture capital industry and to study the history of the industry. They summarized the major findings of their research in five key points about venture capital: 1) it is extremely concentrated; 2) it is bicoastal in the Northeast and Pacific regions; 3) its investments flow mainly to established high-technology centers; 4) its impact is context sensitive: In areas with an established high-technology base, venture capital fuels the growth of that sector; in areas without such a base, venture capital alone is not likely to stimulate innovation and high-technology development; 5) public policies must recognize that venture capital is only one element of an area's technology base or social structure of innovation.

Based on their findings, Florida and Smith question the role of government involvement in venture capital funds. There is a high failure rate associated with venture investing and the risk may prove too great for public agencies. More importantly, they believe their findings contradict the assumption that underlies public involvement in venture capital funds. They did not find gaps in the supply of venture capital due to imperfect markets and determined that venture capitalists were very adept at finding investment opportunities.

Finally, they state that venture capital is just one of many necessary inputs to technology-intensive economic development. They point to literature that supports the contention that only a limited number of regions have the attributes needed to generate and sustain a high level of high-technology-based economic growth. Florida and Smith assert that increasing the volume of venture capital in areas that lack other necessary inputs is unlikely to have any significant effect on their technological capabilities.

The St. Louis Regional Commerce and Growth Association commissioned a study to explore the importance of locally managed venture capital funds in boosting the number of new business ventures in the area. Consultants reviewed the performance of three locally-managed funds and found strong evidence that they played an important role in financing new business formations and expansions in the region. Moreover, the funds were willing to provide financing when funds managed elsewhere were not (Susman 1986).

They found that in St. Louis and other regions, venture capital funds tend to emphasize the major strengths and predominant objectives of companies and institutions located in specific areas. They assert that the importance of locally managed venture capital funds to new business formations and expansions cannot be overstated.

The Capital Access Program (CAP) was designed and adopted by Michigan in 1986. CAP provides banks with a partial loan loss reserve to absorb higher risks associated with many business loans while staying in compliance with bank regulation. Because of the loss protection, banks can absorb up to nine times the default risk of conventional loans and still be covered against the loss. This has allowed banks significantly to expand their commercial lending activities.

Researchers identified several common characteristics of firms that received CAP loans: most were less than five years old (about 20 percent were start-ups); most had already incurred substantial debt; most were small firms that required less than $100,000 in financing and had demonstrated managerial competence in overcoming challenges, and most provided collateral that was less than required for a conventional loan. The CAP program was shown to be particularly effective in helping new, small firms obtain financing (Laughlin & Digirolamo 1994).

Dunlap, Burkhalter, Watson, and Fitzpatrick (1995) conducted a case study of Auburn, Alabama's Revolving Loan Fund (RLF) to determine what is involved in operating a successful RLF program. At the time of the study, there were six components to Auburn's program: 1) loan guarantee, designed primarily for small businesses; 2) fixed asset direct loan, designed for larger commercial and industrial projects; 3) infrastructure development program guarantee, to enable developers to receive assistance in attaining utility services; 4) working capital loan, also for small businesses; 5) interim loan, to support economic development projects during start-up, and 6) housing development, for affordable housing in targeted neighborhoods.

The RLF programs were evaluated on jobs created and retained, economic viability, tax benefits, leverage ratio and availability of funds. The research team determined that the programs had successfully promoted job development and that a significant number had gone to individuals from low- to moderate-income households.

Assessments of economic viability proved sound - there were no defaults on loans from RLFs. They estimated a tax impact of nearly $150,000 annually and found that the leverage ratio (public dollars invested to private dollars invested) ranged from 1:3.18 to 1:5.36. Finally it appeared that the city's professional staff made sound investment decisions that ensured fund availability.

The research team identified five basic guidelines for local governments to follow to reduce financial risk in RLF programs: 1) avoid being the sole investor; 2) ensure that the private sector's investment exceeds its own; 3) secure as much collateral as possible; 4) use sound business principles, and 5) isolate the decision-making process for assessing the value of a deal from political interests.

Bradshaw (forthcoming) studied the California State Loan Guarantee Program (SLGP), a program designed to help businesses that nearly qualify for bank loans (but do not) obtain credit and expand employment and economic activity in the state, particularly in disadvantaged areas. The SLGP guarantees up to 90 percent of the loan, but the guarantee may not exceed $350,000. Because the loan is not fully guaranteed, banks assume some risk and therefore will not loan to businesses at high risk of default. Bradshaw evaluated changes in employment and economic activity by examining firms before and after they received the loans.

In an attempt to be conservative and not overestimate the effects of the program, the analysis was limited to employment change reported while the firm had an active loan. Changes after the loan was repaid were not considered. Findings indicated that firms with loan guarantees expanded employment and paid taxes while experiencing a default rate of less than 2 percent. This occurred during a period of economic recession for the state.

Firms also retained employees who might have been laid off if not for the loan. The program cost the state approximately $3,000 per job; tax revenues generated by firms exceeded program costs. Firms with loan guarantees generated more than double the number of jobs than comparable firms in the state. Bradshaw concluded that loan guarantees are a cost-effective tool to support small business expansion and retention.

Servon (1997) conducted a case study of microenterprise programs operating in three inner city areas. The Women's Initiative for Self Employment (WISE) serves low- and moderate-income women in the San Francisco/Oakland area; Working Capital in Boston targets specific communities, but not specific populations; and Accion New York is based in Brooklyn and targets the Latino population.

Servon writes that microenterprise programs have developed based on the recognition that self-employment is an increasingly important segment of the economy, particularly for groups with restricted ability to participate in the mainstream economy. She notes that microenterprise entrepreneurs face a range of market barriers that constrain the successful operation of their businesses.

In studying the three microenterprise programs, Servon found that access to credit was not the biggest barrier for people trying to start their own business. As a result, all programs offered a wide range of services that are important to their success. She determined that the programs fulfilled their intention of helping poor people. , Yet most participants did not fit the underclass stereotype that attracts much of the media and federal attention - they were individuals who had the means to pursue their goal of self-employment.

The microenterprise programs significantly helped participants establish valuable relationships within the business community and with the public and nonprofit sectors. Servon concluded that microenterprise programs help change the mindset of people by creating a forward motion, giving them the hope they need to take charge of their own lives. While microenterprise programs will not solve urban poverty, they provide a motivated population with services it does not receive elsewhere.

Grueling (1987) provides an early assessment of Tax Increment Financing (TIF). His work was based on interviews with many individuals with direct experience in the use of tax increment financing as well as a review of a wide range of secondary materials. He found several important advantages and disadvantages of TIF.

Among the advantages: 1) TIF can provide significant capital to some types of development projects that are economically feasible; 2) the community (and taxing bodies) do not lose tax revenues that were being collected prior to the development program; 3) property owners do not pay more than the normal tax burden; 4) tax increment bonds, when used, are not counted against the city's bonded indebtedness; 5) development is financed from increased tax revenues the project generates rather than tax subsidies from other areas; 6) once the project is complete and bonds are retired, the full tax base and revenues become available to all taxing bodies; 7) because bonds are required for most TIF projects, economic feasibility is closely scrutinized by the bond market, and 8) in most cases, no public referendum is required of bonds issued for a TIF project.

Disadvantages include: 1) no increase in tax base until the bonds have been retired; 2) when used, TIF or revenue bonds will be more expensive than general obligation bonds because of the higher risk; 3) TIF has been abused - cities have created large districts in order to capture increments not directly related to the public improvements financed; 4) without some limits (by area or length of time to capture the increment), TIF can extend indefinitely and never return benefits to the community; 5) when increments do not materialize other sources of revenue are required to retire the bonds; 6) citizens have little say on the use of TIF; 7) TIFs are difficult to use with certain development incentives a community might offer, such as tax freezes or tax abatements; and 8) once TIF bonds have been issued, it is hard to change development plans because of obligations to the bond holders.

Man (2001) provides a recent literature review of TIF effects on economic development. A survey of randomly selected municipalities found that the 78 percent of cities that reported the use of TIF experienced increases in property values, while only 2 percent experienced a decline (Forgery 1993). Case studies in Illinois (Davis 1989; Ritter and Oldfield 1990) and Wisconsin (Huddleston 1984) also found that TIF projects stimulate economic development.

Using an econometric model, Anderson (1990) found that cities that had adopted TIF experienced greater property value increases than those that did not. However, he did not address the issue of growth induced or caused by the creation of a TIF program. Man argues that TIF's effectiveness, as an economic development tool, is a necessary but insufficient condition for the policy adoption because the effectiveness criterion does not address whether the benefits outweigh the costs to taxpayers.

Huddleston (1982) found that TIF projects in Wisconsin have a positive fiscal impact on both sponsor and contributor governments, but the expected financial gains to the contributor governments must be considered in the very long term. Lawrence and Stephenson (1995) found that taxpayers in the entire metropolitan Des Moines, Iowa, subsidized downtown activities in the early years of the TIF program. Later they experienced lower property tax rates due to the urban economic revitalization program funded by the TIF mechanism. Man attributes the conflicting findings about the effectiveness of TIF to the differences in uses and structures of TIF programs among jurisdictions and the types of projects funded through TIF.

Chicago's experience with TIF supports this argument. In 1998, city officials announced that more than 4,400 acres (nearly 3 percent of the city's total land area) would be designated as TIF districts. Success in the districts has been mixed. The three districts closest to the central business district are on track to meet their financial goals; those closer to the periphery of the city are lagging.

Within a few years, property values and increment in an industrial TIF district near downtown reached levels that were not expected for about 10 years. Another district, in proximity to downtown and an expressway, has successfully attracted development and several more projects are in the planning phase. In another part of the city, a district that once served the steel industry, property values have continued to decline despite the TIF designation, although projects are pending. In another district, retail activity has increased, but industrial development has been slow to occur (Hinz 2002).

Weber (forthcoming) provides further evidence of the contradictory findings TIF success. Man and Rosentraub (1998) found TIF had a positive effect on median housing values in Indiana; Dardia (1998) determined that TIF had a substantial and positive impact on development in California.

However, Dye and Merriman (2000) found a negative impact of TIF adoption on growth in municipal-wide property values in metropolitan Chicago. They determined that TIF trades off higher growth in the TIF district with lower growth elsewhere. Therefore, municipalities that adopt TIF stimulate growth of blighted areas at the expense of the larger town.

Weber reports that other evidence has shown that TIF is frequently used to move existing retail to different parts of the same region (Redfield 1995). Evaluating the success of TIF is difficult because, like most economic development strategies, it requires an assessment of what would (or would not) have happened if the TIF district had not been created. Further complications arise because each state places different restrictions on the use of TIF, which makes it hard to generalize about the success of TIF as an economic development tool.

What can be established, according to Weber, is that TIF operates well in areas where property values are initially low relative to other parts of the municipality or are growing at a slower pace. In these cases, the value of the property prior to development is low enough to create a substantial increment when property values start to grow.

Weber also points out that TIF is a speculative business. It requires that municipalities finance development based on the belief that costs can be recovered once property values increase. If property values fail to grow at the anticipated levels, municipalities can lose.

Weber cites a case in Battle Creek, Mich., where the Downtown Development Authority struggled to repay the debt assumed to finance development in a TIF district. She also notes that several TIF bonds have defaulted in California and Colorado.

To prevent failure or abuse of TIF, Weber offers suggestions for reform, including more thorough review of TIF proposals by overlapping taxing jurisdictions (taxing bodies who do not receive the additional revenue); legislation that allows overlapping jurisdictions to recapture some of the increased revenue that is not attributable to the new development; and a shift of more risk to private developers.

Houstoun (1996) studied the use of business improvement districts (BIDs) as economic development tools in several U.S. cities. He contends that BIDs have been very successful at most of their assumedtasks and they are remarkably free of controversy.

He identified five primary reasons for the general success of BIDs: 1) there is no substitute for the collective self-interest of business and property owners to guide economic development; 2) for the first time, these areas have one or more professionals in charge of watching the details of the commercial environment; 3) they offer a predictable income stream, making it possible to plan multi-year services or infrastructure improvements; 4) because all who benefit pay, the assessment represents a minor share of the occupancy costs; 5) BIDs operate in most cases as nonprofit corporations, free from government rules and politics yet accountable to those they serve.

Despite the many successes, Houstoun offers two important cautions: the public and private partnership inherent in BIDs can sometimes lead to conflict; and BIDs face inherent conflict because of their dual roles as marketers and measurers of economic and social conditions.

The Center for Urban Policy Research at Rutgers University (1997) led an effort to evaluate the Economic Development Administration (EDA) Public Works Program, which provides grants for infrastructure improvements. The study included 205 projects that received their last payment in fiscal year 1990. According to the researchers, the projects were completed and structures associated with them were either occupied or soon to be occupied; therefore, at the time of the study - six years later - they had been sufficiently established to make their evaluation possible.

Public works projects included buildings, industrial parks, roads, water/sewer and marine/tourism projects. They were assessed based on the number of jobs created or retained and the amount of private and public sector funds that were leveraged. The research team found the following direct impacts: 96 percent of the projects produced permanent jobs six years after completion; 84 percent leveraged private sector investment; on average, each project produced 327 direct permanent jobs for every $1 million of EDA funding; $3,058 in EDA funds was spent per job created or retained; not including public projects, for every $1 million in EDA funding, $10.1 million was leveraged in private sector investment; for every $1 million in EDA funding, another $1 million was leveraged in federal, state or local investment; 15 full-time construction jobs were created per $1 million in EDA funding.

The study also identified several favorable indirect impacts related to job creation and tax revenue. On average, there were twice as many jobs six years later then at the project's completion. Researchers also found that EDA public-sector economic stimuli successfully create private-sector jobs and low levels of cost.

The study concluded that most of the public works projects achieved EDA's objective of giving communities the necessary framework to expand their economic base and generate jobs and private investment in many areas that would not have experienced these benefits without EDA assistance.

An evaluation of the Appalachian Regional Commission's (ARC) Infrastructure and Public Works Program (Brandow 2000) also produced positive findings. The evaluation included a representative sample of public works projects, interviews with project managers and local stakeholders, analysis of project outcomes and economic impacts and a baseline economic analysis of the impact areas to assess the relative contribution of each project.

The study examined 99 projects, initiated and completed between 1990 and 1997, with $32.4 million in ARC funding. Among the projects were industrial parks and sites, water and sewer systems, access roads and business incubators.

Researchers found that 82 percent of the projects met or exceeded expectations regarding the number of new businesses served; 78 percent met or exceeded expectations regarding the number of businesses retained; 72 percent met or exceeded expectations for jobs created; 82 percent met or exceeded expectations for jobs retained, and all projects met or exceeded expectations regarding the number of new and existing households served.

Each dollar of ARC funding helped leverage $2.62 in other public funding and each dollar of total public funding leveraged $16.65 in private investment. Researchers estimated an increase in state income tax revenue of $14.3 million; an increase in state/local sales tax revenue of $13.9 million; and an increase in local property tax revenue of $29.2 million. They also found that the new jobs led to increased personal income for residents of the affected counties. All types of projects performed well and there was some indication that the projects contributed to overall economic improvement in the affected counties.

In general, projects put back into use sites that had been symbols of community blight. A large number of projects were aligned with regional strategies or developed industry clusters, and many were used to support traditional industries. Some projects addressed long-standing infrastructure issues that met basic necessities and solved environmental problems. Local representatives also believed many projects had indirectly improved the quality of life in the area. ARC investments demonstrated very significant impacts on local project areas relative to overall growth patterns-- 42 of the 76 project areas had job growth rates above the U.S. average for that time period.

Keys to successful capital market strategies

If economic development programs that seek to affect capital markets are to be successful, they must be able to promote or provide financing in situations where conventional lending markets will not. Most finance programs target perceived gaps in capital markets. They should not step into situations where conventional lenders or private investors will meet demand. Policymakers should understand that these types of loans are associated with high levels of risk and failure. They should be prepared to accept losses. Many studies have shown that by providing additional services, failure rates can be reduced. While access to capital can be a problem for many start-up businesses, they also benefit from a wide range of supportive services.

see corresponding section in Strategies & Tools