The High Price of Attracting Foreign Investment

When the state of Wisconsin gave Taiwanese electronics maker, Foxconn, $3 billion worth of incentives to build a factory in the Badger State, the criticism was immediate and best summed up by one critical headline calling it, “the worst (deal) in American history.” However, for anyone who has followed the history of foreign direct investment (FDI) in the United States long enough, this type of rhetoric is familiar. In 1985 Martha Layne Collins, the then governor of Kentucky, gave $185 million worth of incentives to Toyota to secure the location of the Japanese car maker’s first plant in the United States. She was accused of “selling the state.”

Only with time can we tell if taxpayers get a raw deal when their elected officials lay down generous incentives to attract foreign investment. But with hindsight, it’s clear that by securing Toyota’s investment, Gov. Collins laid the foundations for economic benefits that went beyond one plant, including further investments by Toyota and a thriving ecosystem of firms that supply and support the Japanese firm. Other states that leveraged incentive packages early on, such as Tennessee, saw a significant return on its bet on Nissan in 1980. Originally promised 3,000 full time jobs, the factory now employs more than 12,000 people within the state, and advocates on the state’s behalf to attract even more automakers including Volkswagen and General Motors. Other states in the region quickly imitated these strategies and deployed similar incentive packages. By 1986, a Japanese Auto Alley had taken shape in the Midwest.

In other words, using incentives to attract an investment is not just about a one-time deal or a single incentive package. And that is precisely the bet Wisconsin and other states are making—that deals like Foxconn’s will have similar flow-on effects.

Still, as Chinese manufacturers increasingly follow the path to America that Japanese companies blazed 30 years ago, they need to expect a potential backlash—not least because the deals they stand to get from local governments are far better for them than what their Japanese predecessors got decades ago.

The first wave of Japanese investment made its mark on the United States in the early 1980s, when Nissan, Honda, Mazda, Mitsubishi, and Toyota, in quick succession established car assembly plants. All five companies received financial incentives from the states they invested in, which, according to an academic paper published by researchers from University of Arizona and University of Kentucky, averaged $22,902 per job the Japanese firms promised to create (See Figure 1), the equivalent of 2,700 working hours based on 1985’s average hourly wage. While there’s no data that shows definitively how much these various incentive packages have inflated since then, it’s certainly worth noting that when Geely became the first Chinese company to build a car assembly plant in the United States, choosing South Carolina as the site of its new Volvo factory in 2015, it was given $224 million worth of incentives, translating into $112,000 per job, the equivalent of 5,500 working hours.

Yet there are some good reasons why today’s investment incentive packages are so much higher than they once were—and could potentially grow even larger. At the heart of this is the fact of increasing competition among states. When Japanese auto makers first started scouting sites to build factories, they focused almost entirely on traditional manufacturing states such as Illinois and Michigan. When Korean auto makers followed the Japanese example in the 2000s, southern states entered the fray, competing fiercely to secure their investment. Alabama gave Hyundai $252 million worth of incentives in 2002, and Kia received $410 million from Georgia in 2006. As Marsha Folsom, the head of Alabama’s Democratic Party put it, “We were like that fella that has a poor credit rating. We had to pay a little more to get people to look at us.”

The First Wave

Figure 1. US State Government Incentives to Japanese Auto Makers in the 1980s
Source: State Incentive Packages and the Industrial Location Decision, H. Brinton Milward and Heidi Hosbach Newman, Economic Development Quarterly, 1989.

Today, competition for quality manufacturing jobs—and the foreign investment that promises to deliver them—is growing more heated. First, the United States has far better transportation infrastructure than it did in the 1980s, which means states that were previously deemed too “remote”—like Arizona and New Mexico—can now compete for investment, significantly widening the options open to foreign firms.

Second, foreign investors consistently rank the availability of quality labor as a top consideration when choosing where to invest. During the 1980s, most incentive packages included funding dedicated to worker training. Since then, America’s quality labor supply has risen significantly across board.

Last but not least, since the 1980s, more than 6 million, about one third of manufacturing jobs in the United States, have disappeared. US manufacturing was among the sectors of the economy most affected by the global financial crisis, and its recovery since has been lackluster. High unemployment has become a key factor driving governors and local politicians to make generous concessions in the name of attracting foreign direct investment—and squeezing out neighboring states in order to secure the privilege.

We’re currently only seeing the early stages of Chinese investment in the United States, with Chinese investment only about 15% the amount that Japan has invested, and with little of that in the greenfield projects that state governments covet and compete over. But it takes little imagination, for example, to foresee Chinese car makers following the path of their Japanese and South Korean counterparts and start moving production to US factories. Rising protectionist pressures are such that it’s politically unfeasible to export large volumes of vehicles from China to the American consumer. But the Chinese auto market is near saturated, which means that growth is going to have to come from abroad.

History is likely to repeat itself in coming years, and the incentives laid out for Chinese manufacturers will be far greater than they were for the Japanese. Only time will tell if they’re worth it.