OPERATING COSTS
Strategies intended to reduce operating costs for local business have become a large part of the economic development portfolio. Efforts to affect operating costs can represent attempts to address various forms of market failure. It has been argued that an efficient tax system would collect taxes equal to the cost of services provided. Because tax systems are interested in equity as well as efficiency, this does not occur.
The differential between the taxes businesses pay and the cost of services they receive allows political jurisdictions to compete with one another by offering deals. Some argue that this ultimately promotes economic efficiency by reducing taxes to a level that more closely matches the cost of service delivery. This provides a justification for issuing tax breaks or other cost subsidies. Others believe that subsidies are often too generous and cannot be justified on the grounds of economic efficiency.
Supporting research and development can also be justified as a response to market failure. A firm's research and development activities can provide spillover benefits to other firms if these activities lead to new products or the adoption of new technologies. However, when making investment decisions, a firm will consider its own gains - not the spillover benefits. This could lead to underinvestment and a rationale for public-sector support. A similar argument can be made to justify public sector investment to increase agglomeration benefits.
Agglomeration economies provide cost savings to firms in particular industries in larger regions. A dense market leads to lower transaction costs because buyers and sellers can more easily find one another. Agglomeration economies also provide human capital externalities, as the exchange of information and ideas is more likely when firms and workers are in close proximity to one another. In both cases, individual firms will not consider the external benefits and private investment will fail to produce the potential social benefits (Bartik 1990).
Providing business assistance as a means of offsetting costs can also be a response to private market failure. When economic development programs take the shape of business assistance-- for instance, export development or process innovation-- they are essentially providing a service the private sector is failing to provide. This failure may occur because the value of such services is difficult to evaluate before they have been received. Again, the failure of the market to provide needed business assistance is a justification for intervention (Bartik 1990).
Strategies designed to impact operating costs are discussed in terms of those that provide indirect subsidy and those that provide business assistance. Subsidies and incentives refer to direct payments to firms or reductions in taxes or fees. Business assistance refers to programs that reduce company costs by providing needed technical assistance or information services.