Corporate Welfare: A Better Way?

Nearly all governments give in to the temptation to try to boost employment and/or economic growth. After all, if possible it’s a worthy aim; and I believe it is possible. But it seems clear that tax credits, such as I described previously, are worse than useless. However, Nigeria appears to have found a better way to expand employment by giving businesses money. The idea was a nation-wide contest: small businesses would submit business plans and the winners would receive the equivalent of about $50,000 each, not in off-budget tax credits but in a simple grant. Names were taken off of applications, and judges were selected from outside Nigeria. Some business plans were eliminated and some selected as winners in the judging stage. For the majority of remaining plans, winners were selected at random, which allowed World Bank economists to study the effects of this natural experiment. In the first year of the program (it is ongoing), around $36 million was given out.

Three years after the initial selection, there were significant benefits for those who randomly won compared to the control group (entrants who were randomly eliminated). Of those who submitted a plan to start a new business, winners were 37 percentage points more likely to have started a business and 23 percentage points more likely to have 10 or more employees. Of existing businesses, winners were 20 percentage points more likely to have survived and 21 percentage points more likely to have 10 or more employees. On average, winners purchased more capital for their businesses and earned higher sales and profits than the control group. Just the random winners from the first year of the program are estimated to have created 7,000 more jobs than the control group.

The researchers also found that “personal, business, and business plan characteristics have low predictive power for identifying which entrepreneurs will grow faster, and…respond best to treatment.” That finding argues against the idea that a group of experts, let alone politicians, have the ability to spot businesses that will turn investment into job growth, which is supposedly what governments that give out tax credits are trying to do (unless the goal really is to buy corporate favor). Basically, the government shouldn’t be trying to pick winners because they lack the ability to effectively do so. But nor should government do nothing. The only reason Nigeria’s program has been successful is that the private sector is failing to pair businesses in need of investment with savings. Nigeria’s government came up with an informed policy to address that market failure, with seeming success.

The question of whether this is in fact a better way for anyone else comes down to external validity. Nigeria is much different from a rich country for example. It would naturally cost more to create a job in the US owing to higher wages and other employment costs. Furthermore, rich countries have more developed financial infrastructure and the average person has greater access to the financial sector. As a result, I expect that any failure of financial markets to match savings with investment is much less significant in the US vs Nigeria. But it still exists: the poor (and small businesses more generally) in the US are largely excluded from the financial sector, have trouble accessing credit, etc. There’s room for improvement, and the government picking winners from among big businesses does not work.