Should Cities Compete? The Case Against Federal Contracts

With stagnating wages and declining entrepreneurship across the United States, state and local governments are under increasing pressure to deliver economic good news. Cities are in constant competition, dedicating considerable time and resources to business incentives and vying for federal grants and contracts. Historically, the full extent to which these efforts actually expand output, boost wages, or create new jobs has been unclear. In recent years, researchers have uncovered troubling trends about the impact of business tax incentives for local economic growth. Researchers Michiel Gerritse and Andrés Rodríguez-Pose argue that federal contracts, another fierce source of regional competition, also do little to move the needle on city-level economic indicators.

Contracts account for approximately $400 billion in federal spending every year, financing public goods and services that include infrastructure development, training and consulting services, and manufacturing of defense equipment. Though economic development is not the primary objective of these projects, local decision makers still actively seek them as a means to boost job growth in their districts. To study the return on this effort, Gerritse and Rodríguez-Pose assembled a data set containing public information about all federal contracts exceeding $3,000 that were awarded between the years 2005 and 2014.  This data set was compared to city-level census data to track its impact on job creation, wages and GDP. The granularity of the data allowed the researchers to draw distinctions between the impacts on the cities where recipient firms were located and where the final activity took place (i.e., cases in which infrastructure projects took place outside the city of the contracted firm). To remove city-level variation and ensure their results reflected the true impact of contract spending, the authors used 2005 allocations by industry as a baseline and projected these forward using the average national growth rate of contracting per industry. By projecting future spending in this way, they were able to determine the sensitivity of each city’s economy to overall contract allocation.

Overall, the authors found that one dollar of federal spending was associated with a $1.35 increase in local GDP per capita in the year after the spending took place, indicating a fairly strong rate of return. However, these impacts were short lived and all but ceased after the second year. They were also concentrated in recipient locations with virtually all GDP benefits observed within 200 kilometers (124 miles) of the recipient city. Meanwhile, the locations where activity took place, if different from the recipient location, saw little, if any, increased input. The impact on jobs was likewise mixed. Though the study found no significant impact on wages, contracts did help to both create new jobs and to increase working hours for those already employed, primarily in locations where the activity was conducted. However, because contracts represented only short-term boosts in demand, 60 percent of new work opportunities benefited individuals who were already employed, as firms were more likely to add hours for existing employees than they were to hire new workers.

The reason for such mixed impact could be the design of the contract award process itself. Because economic development is not the primary goal of federal contracts, their presence is not felt evenly across U.S. cities. Urban areas are distinctly more likely to be selected than rural areas, and contracts are heavily concentrated in a handful of regions. Though New York, Los Angeles, and Chicago were not disproportionately favored, expenditure did tend to increase with city size, with contract spending flowing to larger cities with more political connections. Furthermore, state capitals and cities with a strong military presence were most likely to benefit from contract spending: These localities attracted more than $2,000 per capita, compared to the national average of $1,500. Firms within these cities were also more likely to receive contracts for work to be completed elsewhere, which separated the economic impact between recipient and activity locations. Given these patterns, relatively few cities should consider themselves competitive for this type of spending.

While policy makers spend a great deal of effort attempting to bring new capital and resources to their constituents, the impacts of many economic development strategies are not well known. This study highlights serious issues surrounding the pursuit of federal contracts to boost local economies. Though spending may temporarily increase local output, contracts are not designed to be instruments of economic change. For cities with the infrastructure and political clout, the benefits to local firms may be worth the cost to compete. For the rest of America, policy makers should carefully consider their city’s true capacity before they commit their time to chasing funds.

Article source: Gerritse, Michiel and Andrés Rodríguez-Pose. “Does Federal Contracting Spur Development? Federal Contracts, Income, Output, and Jobs in US Cities.” Journal of Urban Economics 107 (2018): 121-35.

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