I have a new paper published that bears on the following important issue: when will local economic development incentives – various types of customized tax breaks or services to individual businesses – be most effective in helping improve economic well-being?

In trying to improve local prosperity, state and local governments, and the federal government, face a choice between labor demand policies – policies that directly try to increase job creation by businesses, the non-profit sector, or government – and labor supply policies, which seek to improve the quantity or quality of local labor supply, which will indirectly encourage the creation of more or better jobs. Of course, governments can also pursue both labor demand and labor supply policies, and in most circumstances both types of policy are needed. But there is a question of which type of policy deserves more emphasis.

Even once we have decided whether local or national circumstances justify more of an emphasis on labor demand versus labor supply policies, there is the important issue of which specific labor demand or labor supply policies will be most effective. There is a wide variety of labor demand policies, and a wide variety of labor supply policies, and not all policies classified in each category will have equal effectiveness in raising employment rates and wages for local residents. (For example, labor demand policies might include both tax breaks for private business, and public employment; labor supply policies might include attracting the “creative class”, attracting other immigrants, and improving the educational system from early childhood through adulthood) But the issue of when to emphasize labor demand or labor supply policies is the initial issue we must address, and that is what I am considering in this new paper.

It might seem intuitively plausible that labor demand policies make the most sense when local economies are constrained by lack of labor demand, and labor supply policies make the most sense when local economies are constrained by lack of labor supply. But these intuitively plausible statements have not, up until now, been backed by much empirical evidence.  To guide wide public policy, we must make sure that we check to see whether our intuitions are still warranted when we look at the data.  In addition, we need to make our intuition more precise with numbers: how much of a difference does the local balance between labor demand and supply make to the relative effectiveness of different policies.

In this new paper, I conclude that policies to boost labor demand will do much more to boost local prosperity if the local unemployment rate is initially high than when local unemployment rate is initially low. Specifically, I estimate that if local unemployment is initially near full employment, at around 4% unemployment, labor demand policies that create local jobs will mostly lead to in-migration. Less than 1 in 4 of these new jobs will boost the employment of local residents.  In addition, because of the in-migration, local governments will face fiscal strains, as in many cases the new infrastructure and public service costs from new residents will significantly exceed the tax revenues generated.

This “leakage” of new jobs away from benefitting local residents, and towards benefitting in-migrants, enormously reduces the benefit-cost ratio of any labor demand policy, whether it is a tax break for a manufacturing plant, or customized job training, or a public works jobs program.

In contrast, when local unemployment is initially high, for example at close to 10%, then about half of new jobs created by labor demand policies will go to local residents. Furthermore, because there will be less in-migration, the job creation will have much greater fiscal benefits for local governments.

These findings obviously have implications for local policymakers: local labor demand policies should be more aggressive when local unemployment is high, and be far more restrained when local unemployment is low. But these findings also have implications for state governments and the federal government. Many federal and state government policies have implications for the distribution of labor demand across different local labor markets. From a labor market perspective, these findings imply that such job redistribution policies should, where possible, lean towards redistributing more job creation towards high-unemployment local economies.

What about local labor supply policies? There is no good evidence on how their effectiveness varies with local economic conditions. Many local labor supply policies, such as preschool and other education policies, are long-term policies. Economists usually assume that in the long-run, labor demand will adjust to match the quantity and quality of labor supply. If so, then in the long-run, local labor supply policies will pay off similarly in a wide variety of local economic circumstances. But there actually is not much in the way of empirical evidence to either support or refute this supposition. This is an area that deserves more research attention.