Nexgen in Syracuse – Throwing Good Money after Bad?

Update:  Note that the Syracuse Post Standard carried the following article on January 4th:  http://www.syracuse.com/business-news/index.ssf/2018/01/ny_taxpayers_built_90m_factory_in_dewitt_for_firm_that_walked_away_didnt_create.html The article quotes ESD spokesman Jason Conwell.  “Conwall said the grant will be contingent on the company meeting its job commitments. Details of the grant’s terms will not be available until the grant disbursement agreement is executed later this month, but they will follow ESD’s standard practice of requiring companies to return a grant, or portions of it, if they fail to meet hiring milestones, he said.”  

Note that ESD General Project Plans, adopted by its Board, generally contain specific job and recapture requirements, and that the plan adopted by the Board in its December meeting does not.  However, as Conwell states, such a requirement could be included in the Grant Development Agreement, which both ESD and the company would sign.  If so, the action would address one of the issues in my commentary, below.

Recently, a news article in the Syracuse Post Standard, “Soraa walks away from $90M factory that NY built; $15M more brings new tenant,” described New York’s attempt to save its investment in a $90 million facility in Dewitt, near Syracuse, originally intended for Soraa, a manufacturer of LED lighting.  In addition to the facility, Empire State Development has awarded a $15 million grant to Nexgen, a power converter manufacturer.  Both the original agreement with Soraa and the construction of the facility, as well as the new grant to Nexgen contain highly questionable features that expose taxpayers to real, unnecessary risks, features that are common to a number of projects undertaken by the SUNY Polytechnic, SUNY Research Foundation and Fort Schuyler Management Corporation, a group of related state sponsored entities.

Soraa

In October, 2015, Governor Cuomo announced that Soraa, an industry leader in ultra-high performance lighting and LED technologies, will relocate its global manufacturing and research and development operations from California and overseas to SUNY Polytechnic’s Central New York Hub for Emerging Nano Industries. This move will create 420 new high-tech jobs in Central New York and is being made possible thanks to a $90 million state investment for the facility’s construction.”

The project, like the Solar City project in Buffalo that I examined in an earlier post, made the SUNY Research Foundation the owner of the facility being constructed. Like Solar City, Soraa was to be responsible for a $1 per year lease payment for the facility, and for shouldering operating expenses related to production.  In my earlier post, I pointed to a major problem with the model used in these projects:

  • “State taxpayers will be exposed to an unusually high degree of risk by the unprecedented structure of the SolarCity deal, under which Fort Schuyler Management Corp., a non-profit subsidiary of the State University’s College of Nanoscale Science and Engineering, is building the factory for the company, and will retain ownership. SolarCity’s up-front capital investment in the project is thus limited, weakening its incentive to remain in Buffalo after its dollar-a-year lease of the building expires in 10 years.”

This issue was present in the deal with Soraa, along with an additional problem – one which left the state’s investment exposed when Soraa pulled out of its deal with the SUNY Research Foundation.  SUNY’s deal with Solar City calls for graduated penalties if the company ceases production at the facility within the first 10 years after completion of the project.  The penalties would allow the state to recapture part of its investment of more than $750 million in the project if the company broke the lease during that time.  But, incredibly, SUNY’s deal with Soraa contained no recapture provision, leaving the state with no return on its $90 million investment in the building and equipment when Soraa decided not to go ahead with production in New York state.

Construction of the Soraa facility was delayed for a time because of the indictment by then U. S. Attorney for the Southern District of New York, Preet Bharara of Dr. Alain Kaloyeros, the head of SUNY Polytech, and of principals of Cor Development of Syracuse, on bribery, wire fraud, and other charges.

According to the Post Standard article, [Howard] Zemsky [Chairman of Empire State Development] said the delay may have been a factor in Soraa’s decision to abandon the local plant. But he said Soraa also is facing competitive pressures from Asian manufacturers. The company ultimately decided not to invest in the DeWitt plant.”

Nexgen Power Systems

The public was made aware of Soraa’s decision when Empire State Development’s Board of Directors approved a $15 million grant to a new occupant for the facility – Nexgen Power Systems.  On December 20th, the Syracuse Post Standard reported that

NexGen Power Systems, a startup company from California, plans to manufacture semiconductors for the electronics industry in the 82,000-square-foot plant in DeWitt, said Howard Zemsky, CEO of Empire State Development.

NexGen has promised to invest $40 million of its own in the facility and to create at least 290 jobs within seven years, state officials said. The company plans to move in sometime around the middle of 2018….

Despite the assurances of state officials, the NexGen deal has the same primary problem as  Soraa and Solar City deals, and some others as well.  Like the earlier deals, in the NexGen deal, New York State, through the SUNY Research Foundation retains ownership of the $90 million facility, leasing it to NexGen for $1 per year.  As a result, New York continues to bear the risk of ownership of the facility if NexGen does not continue to produce products at the Dewitt facility.

Although the Fort Schuyler Management Corporation website does not show an agreement with NexGen that describes its relationship with the company, Empire State Development’s website shows the General Project Plan for the $15 million grant that NexGen is receiving. While “Nexgen promises to employ 290 new full-time permanent employees within seven years of project completion,” the General Project Plan does not include a requirement setting the length of time the company must maintain the jobs or a provision for recapture of a portion of the value of the facility if the company leaves.  As a result, the employment commitment in the ESD grant appears to be unenforceable.  Also, though the Syracuse Post Standard quoted state officials as saying that “NexGen has promised to invest $40 million of its own in the facility,,,” The ESD Board materials contain no reference to any financial commitment by the company.

This raises another concern that is common to the projects undertaken by the SUNY Research Foundation.  Solar City, Soraa and Nexgen have relatively little company capital investment in their New York projects.  Because the state is providing essentially all of the capital costs of these projects, New York is getting very little leverage from the investment of State dollars.  This is in sharp contrast to prior state assistance to businesses – even for large projects like the semiconductor facility operated by Global Foundries in Malta – where ESD provided grants covering $650 million of the $3.2 billion capital investment (The company was also eligible for up to $600 mllion of Empire Zone benefits over 10 years).

Nexgen Power Systems – Company Risks

Nexgen is a startup company, and, there is little publicly available information concerning the production or distribution of established products.  In fact, the company’s website provides no specific information about the company’s financial resources or production capabilities.  Nor does publicly available information show that the company has received venture capital funding to support the $40 million that state officials say that it has promised to invest in operating costs related to production at the facility.

Press reports indicate that the company is a successor to Avogy, a failed startup, that produced laptop chargers that claimed to use the same gallium nitride technology that Nexgen promises to use in its Dewitt facility. One analysis (“Is Avogy Inc. Dead?” on PntPower.com) of Avogy’s failure pointed out, “Avogy developed a GaN/GaN power semiconductor device.  They own several patents in the field…But, according to all the people we discussed with, the distribution of these devices has never been large.”

According to Crunchbase.com, Avogy had received $40 million in a second round of venture capital funding in 2014 from Intel and Khosla Ventures, before disappearing in early 2017.  Court documents indicate that total venture funding for the company was $60,000,000.

Nexgen acquired Avogy’s intellectual property for $200,000. A report on Axios.com states that Khosla Ventures, the venture capital firm that had invested in Avogy, had sued Dinesh Ramanathan, the founder of Avogy and Nexgen.  The report states, “Vinod Khosla’s venture capital firm has sued the former CEO of a failed portfolio company, accusing him of fraud and extortion. But it’s not really about recovering the $60 million that Khosla Ventures invested, since that money is long gone. Instead, it’s about getting back at what Khosla believes is a duplicitous executive by exposing his alleged misdeeds.” The suit argues that Ramanathan engaged in self dealing by rejecting a slightly better offer for the intellectual property than his own bid, and attempted to illegally gain a cash payment from Soraa for the technology.

Nexgen’s website indicates that its core product is a laptop charger that is smaller and lighter than current devices.  The company claims to have switching technology that operates at higher frequencies than current silicon-based technology, reducing the size of inductors and capacitors in the circuit. The website describes the technology this way: “Avogy’s TrueGaN /XX platform…uses high frequency GaN switches in combination with a high efficiency circuit architecture, to enable at a fundamental level, the change required to build small power supplies, safely.”  In the past, gallium nitride based devices have been relatively expensive.

The charger is shown on a page on the Nexgen website that is not linked to the company’s home page.  Originally advertised at $99.95, the device is now available at $29.95 on Rakuten.com.  The charger is also sold on Amazon.com, where it has only three reviews, two of them negative, with comments about sparks and fire hazards.  Amazon.com indicates that the charger’s sales rank is 1,070 in the charger category.  It faces competition from FIXSix, which produces a similar small, laptop charger (FIXSix Dart).

While it was in business, Avogy produced a laptop charger through a subsidiary, Zolt, that claimed to use gallium nitride technology .  However, a teardown published on chipworks.com claimed that the charger used silicon technology, not Gallium Nitride.

The future prospects of Nexgen are unknown.  The company may continue to compete in the marketplace with a laptop charger that faces stiff competition from existing products.  It might also manufacture and sell power conversion semiconductors using its technology to product producers.  Whether it can succeed will depend on  a number of factors, including the advantages its technology offers, the price of its products, and its success in developing relationships with product producers and sellers.

Startup Companies and Venture Capital

When New York offered funding for the Global Foundries semiconductor chip fab it was dealing with an established company in an industry, because of the very large capital requirements and production expertise required, that has high barriers to entry.  But, barriers to entry are relatively low in other technology industries, like power conversion.  Additionally, investing in startup companies carries considerable risk, because the companies fail at relatively high rates. As a result, when New York acts as a venture capitalist, its investments carry high risks.

Startup companies often receive funding from venture capitalists, as Nexgen’s predecessor, Avogy, did.  Other sources include angel investors, and business incubators.  In these cases, investors get ownership stakes in the companies.  These investors generally participate in operational decisions of the companies that receive funding.  Financial, industry knowledge, marketing and networking expertise are generally provided.

New York, through the SUNY Research Foundation, does not provide the same kinds of assistance to the companies that it assists.  For example, the Memorandum of Agreement with Soraa made the Foundation responsible for constructing and equipping the facility for up to $90 million.  It also promised to help the company locate additional high technology jobs at the company’s contractors and suppliers in New York State, and to provide training for company staff.

Since New York State does not have an ownership interest in companies like Nexgen and Soraa, it has no real leverage to ensure that assisted companies will employ good financial practices, and is not offering to provide assistance in operational matters, such as developing relationships with product buyers and in product marketing.

As a venture capitalist, New York is in a relatively weak position, because it does not take ownership positions that would provide it some control over assisted companies, and has chosen to make large investments without finding partners to share risk.  By making large investments in a relatively small number of firms, the State’s approach increases the risk to its investments associated with company failures.

Conclusions

Soraa’s decision not to locate at the facility that New York had built for it in Dewitt left the state in a difficult position.  Because the state owns the building and equipment within it, it needed to find a tenant, to ensure that some return would be received on its investment.  Since the building had specialized design features and equipment intended for a company using gallium nitride technology, Nexgen appeared to offer a reasonably good solution to New York’s problem.  But, based on evidence now available, the state appears to be repeating mistakes that put it in the position of needing to find a tenant for a nearly $1o0 million facility.  Most importantly, while the Nexgen promised to employ at least 290 people at the facility, the General Project Plan adopted by Empire State Development does not specify the time period for which employees must be retained  and provides no penalties if the company does not meet its employment target.

At the same time, the State’s $105 million investment provides a very poor return on investment, based on the most optimistic assumptions.  The economic benefit of the project (tax revenues to state and local government plus net resident disposable income) according to Empire State Development’s Benefit-Cost evaluation is only 1.47 to 1, far below ESD’s benchmark for projects of 75 to 1.  The project’s fiscal (tax revenues to state and local governments) benefit cost ratio is negative: .12 to 1.

But, ESD’s benefit-cost analysis is not credible, because it assumes the project will maintain 290 new jobs over seven years.  Since the project plan does not contain any requirement for the period of time that jobs must be maintained, and since there is no recapture agreement in the event that jobs aren’t created, the analysis is based on an assumed set of circumstances that the agreement does not require the company to meet.

Finally, note that the decision to chase 290 high technology jobs in this case carries a high price tag – $105 million, an amount that is substantially larger than the amount ($86 million) that the region will receive in the coming year from the state’s primary regional economic development initiative – the 2017 Regional Council Competition.

New York, like other states has emphasized the pursuit of high technology companies as a key to the state’s future economic well-being.  In New York’s case, most of the state’s spending has been on high technology manufacturing, including the Global Foundries Chip Fab in Saratoga County, Solar City’s solar panel facility in Buffalo, Nexgen’s power converter plant in the Syracuse area, Norsk Titanium in Plattsburgh, and Danfoss Silicon Power near Utica.

But the price tag has been very high; several billion dollars in total, and other than Global Foundries, none of the facilities is expected to employ more than 500 people.  The long term prognosis for these facilities is also doubtful.  Over the past twenty years, employment in the electronics industry in the United States has cratered.  Employment at computer manufacturers in 2015 was less than 20% of what it was in 1998. Electronic component manufacturers employ 42% of the workers that they did in that year.  Semiconductor manufacturers employment is 45% of what it was in 1998.  In New York State, despite the opening of the Global Foundries facility in Malta, semiconductor manufacturing statewide is 17% lower (Source: U.S. Cluster Mapping Project, Institute for Strategy and Competitiveness, Harvard Business School).

Perhaps it is time for policy makers to gain a better understanding which industries are growing nationally and in New York State, and to focus their attention on making sure that New York gets its share of national growth.  The state should also help existing businesses in New York compete by working with them to meet labor, facility and infrastructure needs.




President Trump to Upstate Residents: Move to Wisconsin

Recently, in an interview with the Wall Street Journal, President Trump suggested that upstate New York residents should leave the state for Wisconsin, where a new Foxconn LCD display panel manufacturing plant will be located, creating at least 3,000 jobs.  President Trump said, “I said, you know, Gary, you go to certain sections and you’re going to need people to work in these massive plants that we’re getting, that are moving in. Where do we have the people? You know where we have the people? In New York state that can’t get jobs, in many other places that can’t get jobs. And people are going to have to start moving. They’re going to move to Colorado and they’re going to move to Iowa and Wisconsin and places where – like if Foxconn goes to Wisconsin, which is one of the places they’re very strongly considering – but if Foxconn goes to Wisconsin and they have a very low rate and the governor’s done an excellent job, you’re going to have a situation where you got to get the people. But they’re going to start moving. And I’m going to start explaining to people when you have an area that just isn’t working – like upper New York state, where people are getting very badly hurt – and then you’ll have another area 500 miles away where you can’t – you can’t get people, I’m going to explain you can leave, it’s OK, don’t worry about your house.” Source, “Full transcript: Trump’s Wall Street Journal interview” Politico, August 1, 2017.

It is true that upstate employment performance has been weak, with most upstate metropolitan areas seeing decreases, while a few, like Buffalo, Glens Falls and Albany-Schenectady-Troy had small increases (Source – Bureau of Labor Statistics – Local Area Statistics). Many of the region’s smaller metropolitan areas had relatively large losses:  Binghamton, Elmira and Utica-Rome each lost more than 10% of its population.

On the other hand,   Median household incomes upstate were near the average for rust belt states, and the unemployment rate for upstate counties was the same as the national average in 2016: 4.9% in 2016 (Source: U. S. Department of Labor, Bureau of Labor Statistics, Local Area Unemployment Statistics).

The fact that the average unemployment rate in upstate counties is near the national average shows that the President’s statement, “You know where we have the people? In New York state that can’t get jobs…when you have an area that just isn’t working – like upper New York state, where people are getting very badly hurt,” is unfounded, given that unemployment upstate is no higher than the national average and that median household incomes are near it.  The labor force in upstate New York is stagnant or shrinking in most cases, but few labor force members are unemployed.  Upstate’s problem is not that its residents cannot find jobs, it is that the region’s population and workforce are stagnant or shrinking.

E. J. McMahon, in a recent New York Post op. ed., “Trump’s right, Cuomo wrong about the woes of Upstate” pointed out that many upstate New York counties are losing population.  McMahon argues, “From mid-2010 to mid-2016, nearly 194,000 people moved out of the 50 counties north of the New York City metro region — a net out-migration rate exceeded only by four states. Births and foreign immigrants made up some of the difference, but the total upstate population still dropped by nearly 60,000 people.”  McMahon’s statement is correct – many areas upstate have lost population since 2010 – in fact, 40 of 62 counties in New York State lost population between 2010 and 2016.

New York State is not unique in seeing population declines in some areas.  In Wisconsin, one of the places that the President said “they’re going to move to,” 36 of 70 counties saw population declines between 2010 and 2015.  In Ohio, included for comparison as another rust belt state which claims to have more business friendly policies than New York State, county populations decreased in 62 of 90 counties.

Since counties differ substantially in size within states, a better measure of the economic weakness of an area is the percentage of residents living in counties that are losing population.   In that respect, New York and Wisconsin performed similarly – in 2016, 13.2% of New Yorkers lived in areas with declining populations, while 9.2% of Wisconsin residents lived in declining areas.  In Ohio, 55.5% lived in declining population areas. Reflecting New  York’s regional divide, 61.3% of upstate residents lived in counties with declining populations, while none of the counties in the New York City Metropolitan area had declines.

(Table with full listing of counties is here:)

 

 

 

The data shows that population changes between 2000 and 2015 at the county level within New York, Wisconsin and Ohio varied significantly.  Like New York, Wisconsin and Ohio had counties that had significant population increases, and others that had large losses. Saratoga, Orange and Rockland Counties all had population increases between 2000 and 2016 that were greater than 10%.  New York’s least populous county, Hamilton, lost 15% of its population – a decrease of 834 residents. Wisconsin and Ohio saw similar variations. One county in Wisconsin had a 38% increase, while another lost 16% of its population.  In Ohio,  One county gained 75%, while another lost 10.5%.

“Business Friendly” Policies and Job Growth

E. J. McMahon argues in his New York Post piece that, “Trump, in effect, was simply prodding upstaters to act in their own best economic interests. …So, taxes aside, what advantages does Wisconsin offer over New York?….While Wisconsin Gov. Scott Walker has been an aggressive deregulator, New York’s regulatory climate in general is notoriously hostile to businesses. The 1970s-era State Environmental Quality Review Act, which has no equivalent in most states, hands a potent weapon to anti-development activists.”

Looking at New York, Wisconsin and Ohio from 2000 to 2015,  there is no evidence of consistent differences in performance that would reflect the effect of “business friendly” policies on job growth.  Instead, it shows that population and job growth vary substantially from local labor market to local labor market within New York State, and in Wisconsin and Ohio.  In each state, some areas are suffering, while others are doing relatively well.  New York had by far the strongest job growth overall between 2000 and 2015, but employment growth in New  York’s rural areas was the weakest of the three states.  Wisconsin’s performance was in the middle in both metropolitan areas and non-metropolitan areas, and Ohio’s was weakest in metropolitan areas, but stronger than New York’s in rural areas.

In a recent post, “Government Policies and Job Growth in the Rust Belt,” I showed that the relative performance of metropolitan areas over the rust belt differed substantially across time periods between 1990 and 2015.  If government policies, like “business friendliness” determined the economic performance of regions we would expect to see consistent advantages for states with states with business friendly attributes like low taxes or lax environmental regulation.  But, we do not.

Upstate’s relatively weak economic performance may be attributed to several factors  – most importantly, its past reliance on manufacturing employment.  In 1970, manufacturing employment was more than 40% of the private sector total in the Rochester and Binghamton metropolitan areas, and more than 35% of the total in Buffalo-Niagara Falls.  Today, in these areas, manufacturing employment is about 10% or less of the total.  In contrast, metropolitan areas that have had stronger growth recently, like New York City and the Albany-Schenectady-Troy metropolitan area, were less dependent on manufacturing.

Manufacturing Mega-Projects and Job Creation

Large manufacturing attraction projects, like the Foxconn plant in Wisconsin, the Solar City project in Buffalo,  and Global Foundries near Saratoga Springs cannot, in themselves be successful approaches to significantly improving the employment rate at the state level.

To encourage Foxconn to locate its facility in Wisconsin with a promise to create 3,000 jobs, the state agreed to provide three billion dollars in tax incentives and to waive environmental regulations  to allow Foxconn, without permits, to discharge dredged materials, fill wetlands, change the course of streams, build artificial bodies of water that connect with natural waterways and build on a riverbed or lakebed.Foxconn would also be exempt from having to create a state environmental impact statement, something required for much smaller projects.” Source: The Washington Post, “The Latest: Wisconsin Foxconn deal waives regulations,” July 28, 2017.

Projects that involve expenditures of as much as one million dollars per job are simply too expensive to replicate on a scale that would be large enough to meaningfully change  a regional economy.  New York’s employment was about 9,100,000 in 2016.  Increasing the state’s employment by even one percent – 91,000 – would cost ninety-one billion dollars at the cost of one million dollars per job for recent projects, assuming that enough large new job attractions were possible to enable that large an employment increase.  In fact, most job creation occurs at existing businesses, not at new facilities attracted because of government subsidies, while very few large manufacturing investments take place in a given year.

At the same time, the focus on attracting manufacturing is largely misguided.  Although manufacturing jobs are important, because they have higher average wages than jobs available to people without college educations in other sectors, manufacturing has been hemorrhaging jobs for forty years.  Mostly because of automation and productivity improvements, and less so because of import competition, manufacturing employment has sharply declined in the United States – from 20,000,000 in 1980 to 13,000,000 in 2016.   Between 2000 and 2015, New York lost 239,000 manufacturing jobs, while gaining 1,878,000 service sector jobs.  Ohio and Wisconsin also lost manufacturing employment, while gaining service sector employment. Because the growth of New York’s already strong service sector was particularly large – 25%, the state’s percentage job growth was much larger than the other states.

Because potential job growth continues to be likely to occur almost entirely in the service sector, focusing state resources on attracting manufacturing employment has a high opportunity cost.  Instead, policies and programs to support existing manufacturers in a region can be useful.

Upstate’s relative economic weakness is partly explained by the changing factors that drive location decisions in manufacturing and service industries. For manufacturers, upstate New York is a less attractive location than it once was because of factors including its location relatively far from the country’s population center, relatively high labor costs, difficult environmental permitting processes and relatively small and tight labor markets.  But, because manufacturing provides only about 10% of jobs upstate and nationally, manufacturing employment is a less significant economic driver than employment in other sectors is.

For high value added service industries, upstate New York suffers from relatively shallow labor markets, its relatively low percentages of college graduates compared to places like New York City and Boston, and the increasing concentration of industries in a few large companies headquartered in major cities.  Although the region has some significant strengths in higher education and health care, it has lost a number of corporate headquarters in financial services, because of the increasing concentration of the industry.

None of the problems faced by upstate New York, or for that matter, those parts of Ohio and Wisconsin that have stagnant economies, are easily resolvable.  But, leaders should recognize that the resurgence of these areas will not result from a policy of attracting manufacturing jobs to them – there are just too few opportunities to attract companies like Solar City, Foxconn or Global Foundries, and the cost is exorbitant.  Instead, leaders need to do what they can to anchor the companies in their area that have the potential to grow.  In most cases, those are service industries.  For these businesses, robust labor pools with appropriate skill sets are far more critical than the financial incentives or permitting issues that were critical to attracting large manufacturing facilities.




Syracuse’s Empty Film Hub

The New York Times carried an article, “Cuomo’s $15 Million High-Tech Film Studio? It’s a Flop,”[1] on August 22nd.  The article points out that the Central New York Hub for Emerging Nano Industries, owned by the Fort Schuyler Management Corporation (FSMC), a non-profit subsidiary of the SUNY Research Foundation, is largely vacant, and has housed only two as yet unreleased film projects creating several hundred temporary jobs.  Currently, the facility employs only two workers, according to the Times.

When the film studio was initially  announced, the press release claimed it would create at least 350 high technology jobs.  The release stated, the Hub “will specialize in providing advanced visual production research and education to support Upstate New York’s rapidly growing film and television industry…. The film industry of tomorrow is being born today in Central New York.”[2]

In an earlier post, concerning the Solar City solar panel factory now being constructed in Buffalo,[3] I pointed out that the economic development model employed by SUNY carried significant risks, and questionable benefits. Among the most significant problems with the Solar City project are:

  • The fact that the SUNY created Fort Schuyler Management Corporation retained ownership of the solar panel factory, and leased it to Solar City, instead of providing a grant to Solar City for construction of the facility.
  • Because a state created entity retains ownership, it carries the risk that if Solar City discontinues operations in Buffalo, FSMC would be stuck with a specialized facility that would have little market value, and significant costs associated with redevelopment.
  • The project also suffers from inflated job creation claims, and enforcement responsibilities for job creation requirements are unclear.
  • FSMC has never disclosed decision processes or benchmarks used in structuring the project.

The Absence of a Lead Organization and Local Partners

The Central New York Hub poses some of the same problems as the Solar City development, along with others.  First, although the release claimed that the Hub would be a research and education center for advanced film production, it never identified the entities that would do research and provide education there.  Instead, it identified a film production company that would do post-production work at the facility, and though that company produced a film there, the use of the site was associated with only one project that was undertaken in the area.  In essence, the Hub was real estate development, without a well-developed business plan to utilize it. Today, no film production is underway, and there is no employment at the site by tenants.

A Convoluted Economic Development Model

The Central New York Nano Hub employs an economic development model used by the SUNY Research Foundation and FSMC that involves developing, and in some cases equipping, facilities for the use of real or potential tenants.  Tenants lease the facilities, in some cases for virtually no cost, with the expectation that they will create jobs.  Because a non-profit (FSMC) that is the child of the State University develops the facility, a state related intermediary (Empire State Development) is required to impose and enforce contract requirements on FSMC, and to disburse money to it.  But, because of the convoluted funding and ownership structure, Empire State Development has no direct relationship with the entities expected to create and retain jobs, complicating enforcement of any job requirements associated with the projects.

In contrast, in the past, economic development entities at the State and local levels provide funding subsidies to entities creating and retaining jobs themselves – manufacturers and service companies – not real estate developers.  Because of this direct relationship, enforcement of job requirements, by withholding or recapturing subsidies, is relatively simple.

The development of the Central New York Nano Hub was speculative.  As a result, the SUNY related entity FSMC has created a white elephant – a facility with no real likelihood that it will be used as intended.  Consequently, at this point there is no real expectation of job creation, let alone enforcement of job creation requirements.

A Project without an Economic Development Strategy

Because the Syracuse Hub did not build on the strengths of existing area institutions, such as Syracuse University, or local businesses with expertise in the field, it lacked the essential organizational capital needed to succeed.  This is in sharp contrast to the state supported development of nanotechnology and semiconductor manufacturing in the Albany area, which had strong leadership from Dr. Alan Kaloyeros at SUNY Albany, and relationships with significant technology leaders, including IBM and AMD, as well as semiconductor equipment manufacturers.

The Governor established a process of regional competitions for economic development funding that required the development or regional strategic plans.  The Central New York Regional Economic Development Council developed such a plan, “Central New York Regional Economic Development Council: Five Year Strategic Plan: 2012 – 2016,[4] and has updated it yearly.  The plan identifies the region’s economic characteristics, and develops a strategy to build on area strengths, and remedy weaknesses.  But the development of the Syracuse Nano Hub was done without reference to the plan or the area’s capacity to support film production research, education, or related businesses.  In effect, the project was dropped on the region by the State University, without involvement of local partners.

Implications

Without a disciplined approach to spending state dollars for economic development or for other purposes, taxpayer dollars are likely to be wasted.  Because SUNY, through the Fuller Road Management Corporation, has declined to provide information about how it makes funding decisions, or justification for acting as project developer and facility owner, taxpayers cannot be assured that their money is being used wisely. Because the Central New York Nano Hub was developed without regard to existing regional economic development strategies, it did not build on regional strengths or remedy weaknesses. And, because the project was developed without local organizational commitments and partners, it had no real chance of succeeding.

In the end, the State, through SUNY or Empire State Development, might find a tenant outside the film industry to create jobs in the region by providing additional financial incentives.  But if it does, the Hub will be a government funded facility, paid for by taxpayers, competing with locations developed by area private sector developers.

 

[1] http://www.nytimes.com/2016/08/23/nyregion/in-cuomos-film-hub-vacant-studios-lawsuits-and-little-action.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=second-column-region&region=top-news&WT.nav=top-news&_r=0

[2] https://www.governor.ny.gov/news/governor-cuomo-announces-start-construction-new-central-new-york-film-hub

[3] http://policybynumbers.com/solar-city-the-risk-embedded-in-buffalos-billion

[4] http://regionalcouncils.ny.gov/themes/nyopenrc/rc-files/centralny/final%20CNY%20REDC%20plan%20single%20pages.pdf

 




Rex Smith’s Albany Times-Union Column, “Development Dollars Draw on Politics”

The Albany Times-Union carried a column by its Editor, Rex Smith on August 6th, concerning decision making by NewYork’s Regional Economic Development Councils, questioning whether their efforts are directed at areas of the state with greatest need.  His column may be found here.  The column draws on research that I recently published on this site.  It may be found here:

I have also written about Empire State Development’s use of tax incentives here: and about the Solar City project here:




New York’s Ineffective Business Tax Incentives

In 1987, New York State enacted legislation to create an Economic Development Zones Program, modelled after the enterprise zones concept, championed by Congressman Jack Kemp.  Proponents argued that by reducing taxes in specific geographic areas with high concentrations of poverty and unemployment, existing firms would be more likely to create jobs, and other firms would be encouraged to locate in the areas and create jobs.

Enterprise Zones programs were attractive to policy makers, in part because they were “off budget.”  The programs provided financial benefits to companies that, unlike incentive grants, did not require the appropriation of state budget dollars to pay for them.

There is scant evidence that Enterprise Zones programs have been effective.  See, for example, this GAO report,[1]  which concluded that evaluations of Federal Empowerment Zones and Enterprise Communities could not demonstrate effectiveness, and this study,[2] which was did not show any impact as a result of Enterprise Zones programs in Florida and California.  Evaluations of the New York State program found significant administrative problems, but did not find significant benefits.[3]  The major problem with the Enterprise Zones concept was that because the tax advantages provided by the program were insufficient to offset the perceived disadvantages of inner city locations, the program did not result in job creation within the zones.

The program generated a cottage industry of consultants who advised businesses on how to take advantage of the benefits, by reorganizing in to new organizations so that existing jobs could be counted as new ones and by modifying zone boundaries, creating gerrymanders, to incorporate specific businesses.

But, over the years, the program was expanded and the benefits deepened.  It was renamed the Empire Zones program.  More areas were made eligible, yet the areas that the program was initially intended to benefit – distressed inner city communities in New York State – did not see improved conditions.  In fact, 20 years after the program’s enactment, they were in significantly worse economic condition.  In 1969, upstate cities had poverty rates that were slightly higher than the average for the state.  By 2013, most upstate cities had poverty rates that were more than double the state’s.

poverty cities

(Data for cities with populations of less than 100,000 is not available before 1999)

In the end, Economic Development Zones/Empire Zones became an embarrassment to successive governors and Empire State Development because of the difficulties in policing the abuses of the overly complex program, and its lack of success in inducing job creation.  Successive legislative efforts to “clean the program up” were met with continued creative approaches to exploit it by businesses.  The program was ended in 2010.

Despite the failure of the tax benefits contained in the Economic Development Zones and Empire Zones programs to induce job creation, and despite the administrative difficulties associated with administering the programs, Governors Paterson and Cuomo continued to rely on tax incentives as key elements of their economic development efforts.  Governor Paterson initiated the “Excelsior Jobs” tax credit that focuses on providing benefits to companies in industries that make capital investments and/or create new jobs in manufacturing and other sectors of the economy.  Governor Cuomo proposed the Start-Up NY program that offered tax-free benefits to certain businesses in selected locations connected to universities and colleges.  Both programs were promoted as major initiatives that would significantly improve New York’s economy.  But like the Enterprise/Economic Development/Empire Zones, the programs have failed to create significant numbers of jobs.  And, the job creation figures reported for them contain many jobs that would likely have been created without the loss of tax revenues.

Problems with Business Tax Incentives

Business tax incentives are similar to incentives provided to buyers of electric cars or insulation for their homes, in that people or companies become eligible by doing something that government considers desirable – conserving energy or creating jobs. But, they contain no “but for” test – users of the credits are not required to show that without the credits they would not do what is being incentivized.  As a result, some credits are always wasted on “free riders” — people or companies that would have acted if the credit was not available.

The use of tax policy to incentivize behavior is widespread, and if large enough, credible arguments can be made for their effectiveness.  For example, the available federal tax credit for the purchase of a Nissan Leaf, an electric car, is $7,500.  The advertised price of a Leaf begins at about $30,000.  Similarly, federal credits for energy conserving improvements in households have been as much as a quarter of the cost.  While we do not know how many of the people who purchased Nissan Leafs or weatherized their homes did so because of the availability of financial incentives from government, it is likely that some did.

But, while energy conservation incentives have been designed to be large enough to change people’s purchase decisions, state taxes are too small as components of business revenues to make a significant difference in most cases, particularly given the large differences in wage rates, which are a larger portion of business costs, between the United States and competitive locations.

The Tax Foundation published[4] a comparative analysis of total state and local tax costs for representative businesses in seven industries, including manufacturing, distribution, corporate headquarters, research and development, call centers, and retail.  From their data, I calculated total state and local tax costs as a percentage of firm operating costs, and compared New York with national medians, and with nearby states.[5]  The data shows that state and local tax costs are a very small percentage of total firm operating costs, and that differences between states are even smaller.

NYS VS MEDIAN

New York State had higher total state and local tax costs than the national median for most types of businesses, but the differences ranged from 0.7% more for call centers, to 1.8% more for research and development facilities.  For manufacturers, New York’s total tax costs were lower than the national median, but again the difference between state and local tax costs for manufacturers in New York State and for manufacturers in other states was less than 1% of operating costs.

comparable states

Compared to neighboring states, the picture was similar.  New York state and local tax costs were higher for some businesses, but lower for others.  But, in most cases, variations in other factors in the cost of production could be large enough to significantly change the relative advantage of differing locations.

In many cases, state taxes are too small a component of business revenues to make a significant difference in comparative location costs.  Fifty years ago, American businesses competed with businesses in other locations in the United States.  Differences in wages, construction and transportation costs were relatively small.   Today, with globalization, for manufacturers and other businesses that can move operations offshore, the large difference in wage costs between any state in the United States and in low wage locations outside the United States would swamp differences in company operating costs resulting from differences in state and local taxes.

While manufacturing cost structures vary widely,[6] on average, labor is estimated to account for 21% of manufacturing costs.[7]  In an article examining China’s manufacturing cost advantage, Peter Navarro, Professor of Economics at the University of California, Irvine, estimates that the cost of labor in China, adjusted for productivity differences, is 18% of that in the United States.  As a result, Navarro estimates that manufacturers would save 17% of manufacturing costs by producing in China, compared to the United States.

Business locations are not based solely on cost factors – labor availability, site quality, transportation, quality of life and other factors come into play.  But, available evidence shows that differences in state and local tax levels are relatively small factors in business costs, and that adjusting state tax structures to reduce business tax burdens has limited impact.

Repeating Failed Policies:  The Excelsior Jobs Program

When the Excelsior Jobs program was created in 2010, Governor David Paterson said “I’m pleased that the Excelsior Jobs Program, a streamlined economic development effort that will support significant potential for private sector economic growth, is now available in the marketplace to encourage businesses to grow and invest in New York.[8]

Eligible industries are those that could create net new jobs in New York State, not those, like most retail jobs, that simply move jobs from one company in New York State to another in the State.  The program description states, “The Program is limited to firms making a substantial commitment to growth – either in employment or through investing significant capital in a New York facility…The Job Growth Track comprises 75% of the Program and includes all firms in targeted industries creating new jobs in New York.”  While the program requires a commitment to job growth and/or investment, it does not limit program benefits to firms that would not expand or locate in New York State without the assistance.

The program requires that participants receving credits for job creation or investment have a positive benefit/cost ratio, defined as “total investment, wages and benefits divided by the value of the tax credits, or 10 to 1 or greater.  The program provides a refundable credit equal to 6.85% of new employee wages, or two percent of qualified capital investment, or 50% of the Federal Research and Development Credit.  Various employment and investment thresholds along with an aggregate benefit cap limit eligibility.[9]  Aggregate benefits were initially limited to $250 million annually.

Though the program had a generous dollar allotment for credits, credits actually issued never came near the $250-million-dollar annual limit.  In its best year, it provided $18.4 million in credits. Activity decreased to $745,000 in 2015.  The program has had a small job creation impact.  Empire State Development reports that companies receiving credits during that time period created 15,582 net new jobs, at a cost to the state of $47,357,602. The program’s impact has decreased in each of the last two years, with only 531 jobs credited as being created by companies receiving the tax credit in 2015.[10]

excelsior

Because the program does not have a “but for” requirement, ESD’s job figures certainly overstate the program’s true job impact.  While the exact percentage of “free rider” jobs is not known, one study estimated that nine of ten jobs created by companies receiving business tax incentives would be created without them.[11]  If that is true for the Excelsior Jobs program, the true program impact would be only about 1,500 jobs,  three tenths of one percent of New York’s private sector employment growth during the period.

Additionally, a recently issued audit from the State Comptroller’s office points to issues with ESD’s administration of the Excelsior Jobs Program.  The describes weaknesses in ESD’s processes in evaluating applications in in confirming job creation claims (note that the agency disputes a number of the audit’s findings.)[12]  In particular, the audit noted that “ESD generally authorizes tax credits based on the job numbers and investment costs that businesses self-report without corroborating support….[13]

Why has the program failed to have a significant impact?  The evidence points to the fact that because much of its emphasis is on manufacturers and other companies that could locate outside the United States, it does not offer benefits that are sufficiently large to offset the cost disadvantages of creating jobs in New York State, or anywhere else in the United States.[14]

Repeating Failed Policies:  Start-Up NY

In announcing the Start-Up NY program, Governor Cuomo said, “Upstate New York has seen too many years of decline, and our communities have lost too many of their young people,… We desperately need to jumpstart the Upstate economy and these new tax-free communities will give New York an edge like we’ve never had before when it comes to attracting businesses, start-ups, and new investment. Today’s agreement on the START-UP NY legislation is a major victory for our Upstate communities as we are now set to launch what will be one of the most ambitious economic development programs our state has seen in decades.”[15]

 The promotional materials for the program advertise tax free benefits, and give the impression that the program is relatively easy to access:

“START-UP NY offers new and expanding businesses the opportunity to operate tax-free for 10 years on or near eligible university or college campuses in New York State.

 Partnering with these schools gives businesses direct access to advanced research laboratories, development resources and experts in key industries. 

To participate in START-UP NY, your company must meet the following requirements:

  • Be a new business in New York State, or an existing New York business relocating to or expanding within the state
  • Partner with a New York State college or university
  • Create new jobs and contribute to the economic development of the local community”[16]

The State Comptroller found[17] that between October 2013 and October 2014, ESD committed $45.1 million to advertise the program, generating more than 15,000 applications during the period.  However, despite the heavy advertising for the program, which continued after the period examined in the Comptroller’s report, the program has had almost no job creation impact.

Empire State Development has issued two reports on the program’s progress.  In 2014, companies assisted by the program created 76 jobs, while in 2015, assisted companies created 332 jobs.  The state tax benefits provided per job through the program were even smaller than those offered by the Excelsior Jobs Program, averaging $1,121 per job created (not including local property tax exemptions).[18]  And, because Start-Up NY has no requirement limiting assistance to companies that would not create jobs in New York without the tax credits offered, it is likely that the jobs reported substantially overstates the program’s actual impact on job creation.

starupny

The reality is that Start-up NY is extremely complex, the value of benefits to participating companies is small, the program is available in very small areas, and its requirements are difficult to meet.  One economic development professional described it as “the worst program I ever saw.  I was glad I never had to explain it to a client.”[19]

Effective Approaches to Job Creation and Retention

 The tax incentive based approaches used by the State in its Empire Zones, Excelsior Jobs, and Start-Up NY programs have not met the claims made by the governors that championed them.  But, other economic development efforts of state and local governments have been shown to be effective.  Among them are:

  • Regional Economic Development Councils: Regional councils are required to create strategic plans, set clear goals, and disclose progress in meeting established goals as a condition to receive funding for proposed projects.  While Regional Council strategies and reports vary in quality, some are well grounded and provide good disclosures of project performance.[20]
  • Project Based Assistance: Assistance from the State and localities for plant and equipment capital costs and for customized job training that employs a “but for” test can be effective in inducing companies to create and retain jobs because the amount of assistance offered may be large enough in relation to project size to affect company decisions.  ESD, for example, uses “but for” tests in making grants, employs benefit/cost benchmarks, and monitors company performance in meeting performance goals.
  • Develop Long Term, Well Integrated Industry Development Strategies: For example, New York, through Empire State Development and other agencies, provided substantial assistance to the development of nanotechnology research and development capacity at the College of Nanoscale Science and Engineering, and with local partners, significant financial assistance to the development of the Global Foundries chip-fab facility.  In Buffalo, the State has assisted in the region’s effort to enhance its bioinformatics and life sciences concentration at Roswell Park and related institutions.  Efforts like these take an integrated approach to industry development.
  • Recognize that Retaining Existing Jobs Should be as High a Priority as Job Creation: Because decisions of existing businesses about expansion, contraction or closing can have large effects on a state’s economy, state and local economic development agencies need to focus on understanding the needs of local business and assisting them, where appropriate.
  • Support Entrepreneurship: Evidence shows that entrepreneurial training programs increase business startups.[21]  New York has an existing program, the Entrepreneurial Assistance Program, that focuses on minorities, women, dislocated workers, public assistance recipients, disabled persons and public housing residents.  While the focus on disadvantaged workers is commendable, broader availability could increase the program’s reach.

New York State’s Economic Condition

 There has been longstanding concern about the impact of the decline of manufacturing, particularly in upstate New York.  The region’s population growth has been very slow, while its central cities have seen significant population declines.  Compared to thirty years ago, the residents of upstate central cities are far more likely to live in poverty.  These are all significant concerns.  But, even upstate, the region’s overall economic health is as good as, or better than the average for nearby states.[22]

realgdppc

Each of the Metropolitan areas in New York State, including those in upstate New York had greater growth in real gross domestic product per resident than the average for metropolitan areas in nearby states.  But, the growth of poverty in New York metropolitan areas was below the average for nearby metropolitan areas.

poverty

Private sector wage growth in New York State presented a more mixed picture – Buffalo, Albany, and New York City did better than regional average, while Syracuse and Rochester did worse.

wage

Conclusion

While the economic condition of metropolitan areas in New York State, including those in upstate New York, improved relative to nearby areas, in most cases, some places in the state are in very poor economic condition.  Upstate cities continue to lose population and have increasingly great concentrations of low income populations.  Upstate downtowns have large amounts of vacant commercial space, and upstate cities suffer from blighted, abandoned housing.  Minority group residents of upstate cities have average household incomes that are about one third of white suburban residents.

If the lives of residents of central cities are to be improved, New York must address the factors that create concentrations of economically disadvantaged people.  These include:

  • Schools with high concentrations of economically disadvantaged children. Evidence demonstrates that children from disadvantaged families perform substantially better in schools that have higher percentages of students who are not disadvantaged:  http://policybynumbers.com/why-critics-of-upstate-city-school-performance-miss-the-largest-cause
  • Single parent families face significant obstacles to success, that also damage the prospects for their children: http://policybynumbers.com/category/single-parent-families.
  • Racial segregation is highly related to poverty and poor student performance. http://policybynumbers.com/income-student-achievement.
  • Cities have high concentrations of low income residents living in blighted neighborhoods, because most cannot afford to live in better quality housing. More housing vouchers, additional income supplementation, particularly for part-time workers, and increased job accessibility for low skilled workers would help central city residents find better places to live.
  • Cities need help in tearing down vacant housing, cleaning up and reclaiming vacant industrial sites and rehabilitating blighted neighborhoods.

But, the focus of highly publicized and expensively marketed economic development initiatives in New York State has been on ineffective programs that have led to negligible job creation.  By all accounts they have not succeeded in “supporting significant potential for private sector economic growth” nor do they “give New York an edge, like we’ve never had before.”  While many existing economic development efforts at the state and local level produce tangible results, few of them focus on the places in New York State that have done the worst, from an economic perspective. Given the growing bifurcation of the economic conditions of city and suburban residents, more attention should be given to them.

[1] http://www.gao.gov/products/GAO-10-464R,

[2] http://edq.sagepub.com/content/23/1/44.short

[3] Findings of many of these studies are summarized here:  http://www.cbcny.org/sites/default/files/report_ez_12012009.pdf

[4] http://taxfoundation.org/sites/default/files/docs/location%20matters_0.pdf

[5] The Tax Foundation calculated state and local tax costs as a percentage of net profits.  But since companies seek to minimize overall costs, I compared taxes to total costs. (operating expenses, interest, taxes and preferred stock dividends, but not common stock dividends).

[6] Depending on the capital or labor intensiveness of a manufacturing process, the productivity of labor and labor demand and supply factors.

[7] Peter Navarro, “The Economics of the China Price,” https://chinaperspectives.revues.org/3063, p. 3.

[8] “Governor Paterson Announces Excelsior Jobs Program Launch”  http://readme.readmedia.com/Governor-Paterson-Announces-Excelsior-Jobs-Program-Launch/1717095

[9] https://www.tax.ny.gov/pit/credits/excelsior.htm

[10] http://esd.ny.gov/reports.html

[11] http://www.upjohn.org/publications/upjohn-institute-press/state-enterprise-zone-programs-have-they-worked

[12] http://www.osc.state.ny.us/audits/allaudits/093016/15s15.pdf

[13] Ibid., p. 7.

[14] Manufacturing firms continue to operate in New York and the United States because of other kinds of location advantages, such as labor productivity, the need to be close to markets, or insensitivity to production costs.

[15] https://www.governor.ny.gov/news/governor-cuomo-and-legislative-leaders-announce-agreement-start-ny-legislation-will-implement

[16] http://startup.ny.gov

[17] “Marketing Service Performance Monitoring” Audit 2014-S-10. http://osc.state.ny.us/audits/allaudits/093015/14s10.pdf

[18] The small benefits provided by the program may reflect the fact that many of the firms participating in the program are start-ups, and have little taxable income.

[19] Communication with this writer.

[20] See for example:  http://regionalcouncils.ny.gov/themes/nyopenrc/rc-files/centralny/final%20CNY%20REDC%20plan%20single%20pages.pdf

[21] Benus, J. M., Wood, M. and Glover, N. “A Comparative Analysis of the Washington and Massachusetts UI Self-Employment Demonstrations,” Report prepared for the U. S. Department of Labor by Abt Associates.

[22] Source for this and following tables: U. S. Cluster Mapping Project. http://www.clustermapping.us/region/economic/syracuse_auburn_ny

 




SolarCity: The Risk Embedded in Buffalo’s Billion

.pdf version here:

Note: This post is also published on The Empire Center website.

The decision by the nation’s largest solar panel provider to locate a state-of-the-art manufacturing plant in Buffalo, and to create other jobs in Western New York, could be a needed shot in the arm for a city and a region that’s been declining economically for many years. But there are significant risks and unanswered questions associated with the state government’s willingness to commit the bulk of its “Buffalo Billion” resources to the massive SolarCity factory on the site of the former RiverBend steel plant.

A review of key documents for the project reveals the following:

  • State taxpayers will be exposed to an unusually high degree of risk by the unprecedented structure of the SolarCity deal, under which Fort Schuyler Management Corp., a non-profit subsidiary of the State University’s College of Nanoscale Science and Engineering, is building the factory for the company, and will retain ownership. SolarCity’s up-front capital investment in the project is thus limited, weakening its incentive to remain in Buffalo after its dollar-a-year lease of the building expires in 10 years.
  • The project’s net employment impact has been greatly overstated. Some of the promised 5,000 new jobs to be generated in New York by the SolarCity project will be sales and installation positions that would be created in the state even if the same factory was successfully constructed and operated anywhere else in the world, while others will be jobs at other companies that are not parties to the jobs agreement between SolarCity and FSMC.
  • The relationship between CNSE/FSMC and Empire State Development leaves a number of open questions around the job requirements associated with the project and the responsibility for ensuring that job creation promises will be met.
  • Although FSMC is a state-created entity, controlled by the State University and CNSE, it lacks fundamental mechanisms to ensure transparency and public accountability, including publicly disclosed decision processes, criteria, and analyses of project fiscal and economic benefits and costs.

SolarCity is one of three high-tech companies ultimately controlled by Elon Musk, the visionary entrepreneur who also founded Tesla, a maker of high-performance electric cars, and SpaceX, which makes rockets and spacecraft.

After a series of financial maneuvers designed to improve SolarCity’s financial condition, Musk recent announced that Tesla would acquire the solar panel company. It remains to be seen how or whether the Tesla-SolarCity merger will ultimately affect the Buffalo project.

The Use of Business Location Incentives

The use of financial incentives by governments to attract businesses has long been controversial.

From a critical perspective, incentives can be seen as inefficient and prone to favoritism, because they offer benefits to particular firms chosen by a government agency. Incentives are inherently unfair to competitors who do not receive them. The existence of economic development incentives encourages businesses to game the system by claiming that, without government assistance, they might not locate within a state or expand or otherwise upgrade operations. And by offering targeted incentives to selected companies, governments avoid changes in tax policy that would be more costly, politically as well as fiscally.

From the perspective of elected officials, incentives are often viewed as a necessary evil. By offering incentives to particular businesses that promise to create or retain jobs, the state can avoid giving expensive tax breaks to all businesses. The discretionary nature of such programs reduces the overall cost of business retention and attraction compared to a universally available tax break. And, because most states (and localities) use some form of incentive as an attraction and retention tool, no one dares unilaterally disarm.

However, public money should not ultimately supplant private investment. The purpose of economic development agencies is to encourage private sector businesses to invest their own resources to create or retain jobs. These agencies do so by providing financial assistance for capital projects and worker training. In determining whether to provide assistance, and how much to offer, these agencies must assess how much assistance is necessary, the return on public investment that would result, and the risk that promised outcomes will not be achieved. As public agencies, they must operate in a relatively transparent fashion, providing public information about project assistance, benefits and costs, and company compliance with investment and job commitments.

The largest incentive package in New York’s history—packaged a decade ago by Empire State Development[i] for the AMD/GlobalFoundries semiconductor chip fab in Malta—was consistent with these guidelines. It involved State grants totaling $650 million (and more in potential tax breaks) to create a promised 1,200 jobs.

To be sure, the state’s subsidy of the GlobalFoundries plant was criticized in some quarters as “corporate welfare” and an unprecedented “giveaway.” However, the company’s initial investment of $1.7 billion was much larger than the state government’s.[ii] In seeking to become the site of a planned new chip fab plant—of which there are only a handful in the world—New York faced competition from the State of Saxony in Germany, where the company had an existing facility, and which had made an equally large offer.

The GlobalFoundries plant was paid for and equipped by the company itself, with the state providing a grant equivalent to 27% of the total cost. Ten years later, the plant has been expanded to directly employ 3,600 people, with a total investment for building and equipment of $6.9 billion.[iii]

A Nice Deal if You Can Get It

Governor Andrew Cuomo has favored a new model of economic development financing while championing a number of high-profile, high-technology projects, managed by the State University of New York’s College of Nanoscale Science and Engineering (CNSE) through a non-profit subsidiary, Fort Schuyler Management Corporation (FSMC). The state sends money through the Empire State Development Corporation to FSMC, which builds manufacturing facilities at no capital cost to the companies that will use them.

Fort Schuyler Management Corporation is one of several private non-profit organizations created to facilitate SUNY’s mission. FSMC, for example, was created by the SUNY Research Foundation and the Institute of Technology Foundation at Utica/Rome, Inc (ITSC). Although FSMC and ITSC are private, 501(c)3 corporations, not public entities, each has a Board of Directors whose members largely come from the ranks of SUNY administrators.

The largest of the technology projects—SolarCity, a solar panel manufacturer—like other CNSE/FSMC developments, is financed in a completely different way than earlier business attractions in New York state.[iv] The CNSE/SUNY-related 501(c)3 non-profit is building and equipping the solar panel factory at a total cost to the state of $959 million, including $200 million for environmental remediation of the former steel plant site on which the factory is being built. Fort Schuyler will continue to own the facility once it is completed.

The SolarCity project originally promised 1,450 jobs at the manufacturing facility. In late 2015, however, the commitment was reduced by almost two-thirds to 500 jobs, which must be maintained for five years after creation. Specifically, SolarCity promises[v] to “employ and hire as [SolarCity] employees, personnel for a minimum of 1,460 jobs headquartered in the City of Buffalo, New York, with…500 of such jobs for the manufacturing operation at the manufacturing facility over the initial two (2) years of the collaboration commencing on the Manufacturing Facility Completion date…[SolarCity] commits to the retention of these jobs for a period of no less than five (5) years.”[vi]

In addition, the company promises, “in addition to the 1,460 jobs [above], to employ for a minimum of 2,000 jobs over the five years of the collaboration following manufacturing completion to be located in New York State. [SolarCity] commits to the retention of these jobs for a period of no less than five (5) years.”

Finally, SolarCity promises to employ 5,000 people in total in New York state (which may include sales and installation support jobs) by the 10th anniversary of the factory completion date.

As long as SolarCity meets the agreed-upon job requirements, it has access to a fully equipped facility, totally free of capital costs. (It is also eligible for significant tax breaks)[vii]. As a result, no private capital dollars towards the cost of the facility and its equipment are leveraged by the state’s contribution of more than $900 million in public dollars. In effect, they are a gift to SolarCity from the people of the State of New York, for a lease cost of $1 per year.

Here is the language of the Memorandum of Agreement[viii] (MOA) governing the project:

[Fort Schuyler Management Corporation] is responsible at its cost to achieve manufacturing facility completion, including to acquire all manufacturing equipment and to provide for all manufacturing equipment to be delivered to the manufacturing facility. Once manufacturing facility completion has been achieved, including all manufacturing equipment has been acquired and delivered to the manufacturing facility, [SolarCity] is responsible at its cost to achieve manufacturing equipment commissioning and full production output, provided however, that the cost of manufacturing equipment commissioning shall be funded by [Fort Schuyler Management Corporation].

[SolarCity] shall lease the manufacturing facility and manufacturing equipment for the manufacturing equipment from [Fort Schuyler Management Corporation] for a period of ten years for the sole consideration of one dollar $1.00 US per year….

To understand the value of this gift, recognize that for SolarCity to undertake the project itself, it would have two alternatives. It could go to the credit market and attempt to sell bonds, perhaps at junk bond interest rates, given the young company’s limited track record. Or, it could sell part of itself, by issuing additional stock. Either approach would result in existing owners holding a smaller portion of the company.

Because SolarCity has access to free capital from New York State to construct and equip the manufacturing facility that it will operate, the financial risk to the company’s operations is greatly reduced. As long as it meets the contractual employment target for ten years, it need not worry about paying substantial fixed costs.

Through Fort Schuyler, New York State will face significant risks, however. And unlike the company’s shareholders, FSMC and New York State will not receive a direct financial benefit from any profits that SolarCity generates.

Shifting Risk to New York State

The first risk that New York faces is that the company will be unable to meet its employment objectives or fail outright, despite the state’s huge investment. The SolarCity MOA contains a rigid set of job creation and retention requirements for a ten-year period that will be difficult to enforce.

The MOA’s recapture requirements provide that in any year that the company fails to meet its employment mandate, it must pay a penalty of $41.2 million. Because of the long 10-year term of the job creation and maintenance requirements, it is quite likely that a significant recession could occur during the contract period. But because the job maintenance requirements do not include any tolerance for such an event, there is a significant likelihood that the company will be in default at some point during that period.

A 30 percent federal tax credit for residential solar installations is scheduled to begin ramping down after 2019, hitting 22 percent before expiring after 2021. But even assuming that credit is extended, SolarCity plant’s output is likely to be highly cyclical. During recessions, consumers tend to postpone discretionary spending, including home improvements such as solar panel installations. Imposing the required penalty at a time when the company is faced with reduced revenues because of a recession may weaken the company’s financial position to a significant degree, creating pressure on FSMC to renegotiate the agreement to reduce employment targets. Or, if the employment penalties are imposed, the company’s long-term health may be weakened.

Similarly, since SolarCity operates in a competitive environment, it may find it to be difficult to maintain its market position over a full 10 years—a relatively long period, particularly for firms operating in environments where technology is rapidly evolving. For those reasons, economic development agencies typically offer smaller amounts of financial assistance to companies and impose contractual job requirements for shorter time periods—in many cases five years. Even with these shorter job commitments, contract enforcement policies often provide some leeway for adverse events affecting assisted companies.

It should be noted that SolarCity’s operating position has not been robust. The company has lost more than $50 million in each of the last four years and, as of late June, was is in the process of awaiting a cash transfusion in the form of a proposed acquisition by Tesla Motors, another company founded by Elon Musk. While net losses are not uncommon in emerging technology companies bringing new products to market, the nature of these ventures is inherently riskier than that of more established operations.

The contract also contains provisions providing for recapture if the company totally ceases operations, as in the event of bankruptcy. But if that occurs, Fort Schuyler will be one among a large group of creditors, none of whom is likely to be made whole.

Proponents of the approach used to finance SolarCity might argue that state ownership of the facility provides a significant advantage to state taxpayers. But in fact, public financing and ownership of the entire facility create a significant liability for the Fort Schuyler Management Corporation and potentially to New York taxpayers.

Assume, for example, SolarCity meets all of its commitments, occupying and operating the new plant for 10 years—but, in year 11, the company decides it would be more profitable to make the solar panels in China. Having met its commitment to New York, the company can walk away from the facility, having risked no capital of its own to build and equip it. Because SolarCity has no capital investment at stake, leaving it would not affect the company’s balance sheet in a negative way. Nor would it face the task of disposing of the property, or of paying the cost of remediating any new environmental impacts.

Under this scenario, Fort Schuyler would be stuck with a facility that was designed and equipped for a specific purpose, for which it would be unlikely to find a tenant. Like the many abandoned industrial sites in Western New York, it would require demolition and potentially an environmental cleanup, the cost of which could be borne by New York taxpayers.

Changing and Inflated Job Commitments

The language of the MOA makes clear that 2,000 of the required jobs in the first five years are not manufacturing related, but are instead in part “to support downstream solar panel sales and installation activities within New York State.” In other words, SolarCity can count these salespeople and solar panel installers towards its promise to locate 3,400 jobs in New York within five years of completing the new factory. But salespeople and solar panel installers are not moveable employees—they must be located near the markets that they serve. If SolarCity built the same plant in Pennsylvania, it wouldn’t employ fewer installers or salespeople in New York.

Similarly, the agreement with SolarCity specifies that the company must commit to employ 5,000 people total in New York state by the 10th anniversary of the factory completion date. But, in addition to the sales and installation support jobs that are included in the first-five year requirements, the agreement allows support jobs at SolarCity contractors and suppliers to be counted toward meeting the contract requirements (Section 4.4 (c) of the Agreement).[ix] And the agreement makes the SUNY Research Foundation along with SolarCity responsible for attracting and retaining the jobs. As a result, many of the 5,000 jobs that SolarCity commits to at the end of 10 years may neither be at the facility that New York State ultimately is paying for, or at the company that it is assisting.

There are justifications for states to offer economic incentives to companies to encourage them to locate employees in a state that they might not otherwise choose, but there is no real justification for giving incentive dollars to companies for employees whose locations depend on where their customers live. Nor should incentive deals count employment gains at companies not contracted by a state-related entity to create or retain jobs.

But given the shrinking job numbers at the solar panel facility, perhaps it is not surprising that SolarCity and CNSE/FSMC were anxious to find ways to make the impact of the project appear to be larger, including jobs that would not necessarily be located in New York state, and jobs at other companies in New York that contract with and supply the company.

What is the Real Value of the Project and Who Will Enforce Employment Requirements?

 One of the more curious aspects of the SolarCity project and others managed by FSMC, including a light-emitting diode manufacturing facility in the Utica area, is the funding mechanism and the assignment of compliance responsibilities.

Empire State Development’s board package for April 21, 2016[x] for SolarCity includes a cost-benefit analysis for the project. ESD’s analyses are rigorous, and are based on a widely used economic model. The published result was surprising: an economic return of 54 cents for each dollar invested in the project. In other words, for every two dollars invested in the project, the state is expected to lose one dollar. There is an explanation for this, however, because the analysis published by ESD includes only the impact of construction-related activity, not the ongoing employment at the facility.

It appears that ESD’s analysis did not include the impact of ongoing employment because ESD’s contractual relationship is with Fort Schuyler Management Corporation, not SolarCity. Since ESD has no relationship with SolarCity, it is not a party to job commitments or enforcement of them.

To date, FSMC has published[xi] few relevant documents on its website. Since FSMC is a private, non-profit corporation, it initially claimed not to be subject to the public meetings and freedom of information requirements that state entities must meet.[xii] FSMC does not publish cost-benefit analyses of its projects, so we have no idea if the project will generate a positive economic return to the state if it is executed as the contracts specify over 10 years.

But, it turns out that the Memorandum of Agreement on Fort Schuyler’s website provides that “Once the process is complete, ESDC’s role evolves into acting as compliance agent on behalf of the State of New York, with all expenditures being submitted as invoices to ESDC…. Furthermore, ESDC requires quarterly or yearly reports on employment and investment targets as outlined in the GDA, and reserves the right to withhold funding if targets are not met on a pre-determined schedule.”

So ESD is responsible for contract compliance between CNSE/FSMC and SolarCity, even though ESD not a signatory to the Agreement. This is necessary because, as noted, FSMC is a separate, private entity that owns the facility and equipment that will be leased to SolarCity. Though the contractual jobs commitment is between Fort Schuyler and SolarCity, FSMC would have a perceived conflict of interest if enforcing the contract’s job-creation provisions affected the company’s ability to meet other contractual commitments with Fort Schuyler.

ESD’s board ultimately is providing state funding for the plant. The directors’ materials for the SolarCity project, dated April 21, 2016, include this statement: “Although there is no job creation or retention requirement for this project, this effort is expected to create more than 5,000 jobs …”.[xiii] In a separate reference to the project, page 10 of the same ESD board materials states: “There is no recapture based on the created jobs.” Thus, at this point, ESD’s board actions do not reflect the terms of the agreement between SolarCity and CNSE/FSMC.

The fact that a state-related entity owns SolarCity’s manufacturing facility and its equipment complicates the enforcement of job requirements. The language contained in ESD’s latest board action suggests that unresolved issues exist regarding the means by which job-related contract enforcement will be implemented.

In the same regard, the contract between Fort Schuyler and SolarCity does not make clear which entity, the public Empire State Development Corp. or the private non-profit FSMC would receive and retain any repayments made in the event of the failure of SolarCity to meet contractual requirements. Repayment provisions in earlier contracts by Empire State Development, such as that with AMD/GlobalFoundries, provided that repaid money would be returned to a state entity.

Undiversified Risk for Western New York and New York Taxpayers

The commitment of three-quarters of a billion dollars of state money to a factory and equipment for SolarCity, and an additional $200 million for cleanup of the former steel factory site on which it is located, is being done in pursuit of a worthy goal. The Western New York economy, and that of Buffalo, in particular, continues to be among the weakest in New York state. For that reason, the decision to put a particular focus on the area’s needs is sensible.

But, the approach taken raises risks and questions in several ways:

  • First, by committing a huge portion of “the Buffalo Billion” to one project, there is a great risk that most of the dollars available to help the region’s economy will go to waste.
  • Second, by choosing to build and equip the SolarCity facility without cost to the company, New York and SUNY/CNSE fail to leverage any private sector capital investment in the building and its equipment. In effect, since Fort Schuyler owns the means of production managed by SolarCity, this is a form of socialism for the benefit of a particular company.
  • Third, because the company has not invested its own capital in the facility, it has less reason to remain in Buffalo after the lease period ends than if it had invested its own money.
  • Fourth, because Fort Schuyler owns the building and equipment, this state-related entity has assumed the liability that will result from its ownership if SolarCity fails or leaves after the lease term.
  • Fifth, because the agreement between SolarCity and CNSE/FSMC inflates the company’s job commitment with local sales and installation jobs, and jobs that are not at SolarCity, the project job impact is overstated.
  • Finally, the relationship between CNSE/FSMC and Empire State Development leaves a number of open questions around the job requirements associated with the project and the responsibility for ensuring that job creation promises will be met.

Every time government assists a business, by providing a financial incentive, it assumes risks. Companies operate in a competitive market in which the demand for their products or services may decrease or disappear. This can be the result of a variety of factors ranging from poor management, to changes in consumer tastes, to the development of newer technologies that obsolete existing products. The locations of markets may shift, or the cost of production in a particular location may become increasingly uncompetitive because of factors like labor and materials costs in other locations, exchange rates, or the cost of shipping. Finally, assisted companies may game the state, by asserting the need for incentives to retain or create jobs within New York’s borders, or by claiming that they will hire or retain more employees than they actually intend to.

Because the SolarCity project is being carried out by a private non-profit corporation, accountability safeguards used by public agencies have not been implemented. While state entities like Empire State Development provide public records of decision processes, and full information about project benefits and costs, this information has not been available until recently for SolarCity and other FSMC-managed developments, and even now does not provide project benefit/cost information. This is true, despite the fact that the SUNY related non-profits are owned and directed by boards of directors whose members are largely representatives of New York State agencies.

Economic development carries inherent risks. Decision makers must evaluate them when deciding how many public dollars, if any, to commit to a project. And, they must consider, when helping a company make a large capital investment, how much risk they are willing to assign to taxpayers, and how much can be avoided by structuring assistance packages and compliance requirements. In this case, the public has little information about how decision makers evaluated risks and benefits, and why a SUNY related entity (FSMC) chose to assume so much of the cost and risk associated with the development of the solar panel manufacturing facility for SolarCity.

All of this suggests some recommendations:

  1. Despite their “private” status, FSMC and other non-profits operated by SUNY should be subject to the same transparency requirements as public entities. They should publish meeting proceedings and board materials on their websites; and they publicly disclose all available information about benefits and costs, and about criteria used in making project decisions.
  2. The decision of FSMC to keep ownership of manufacturing facilities and equipment should be reconsidered, because public ownership creates a significant liability for FMSC and New York State in the event that the company fails or decides to terminate the lease at the end of its term.
  3. To ensure a reasonable return for taxpayer-funded assistance, and to maximize company stakes in assisted projects, public investments should seek to leverage private capital investment in plant and equipment, not replace it. Companies that receive public assistance should be required to make a significant capital contribution to the cost of facilities and equipment.
  4. Job commitment requirements should be constructed to provide real benefits to New York state. Companies should not include local sales and installation forces in commitment numbers, and should not include employment at companies that are not part of the assistance agreement with the state related entity.

[i] Empire State Development is New York’s lead economic development agency. The author was a senior executive there between 1995 and 2007.

[ii] A portion of the state’s indirect subsidy (for GlobalFoundries) took the form of promised corporate tax breaks, whose value has likely been diminished by the Legislature’s 2014 vote to phase out all corporate taxation of manufacturing companies.

[iii] http://www.globalfoundries.com/newsroom/press-releases/2012-press-releases/2014/03/01/globalfoundries-extending-fab-8-to-meet-strong-customer-demand

[iv] Other projects managed by FSMC are financed in much the same way. They include a hub for nanotechnology related film and television in Syracuse, and a computer chip commercialization center in the Utica area.

[v]http://static1.squarespace.com/static/547d03b1e4b04c7d4872dd01/t/56d73336ab48def0679be13a/1456943926737/Riverbend+-+Ninth+Amendment+signed.pdf

[vi] In these quotations, “SolarCity” has been substituted for the name of the predecessor company, “Silevo,” which had the original agreement with CNSE/FSMC.

[vii] The agreement with SolarCity provides that the property be included in a Start Up zone, eligible for generous tax incentives. See Section 4.8 of Amended and Restated Agreement…

[viii]http://static1.squarespace.com/static/547d03b1e4b04c7d4872dd01/t/56d73267ab48def0679bd8e5/1456943719940/Silevo+Amended+Restated+Agreement+-+fully+executed+%289-4-14%29.pdf

[ix]http://static1.squarespace.com/static/547d03b1e4b04c7d4872dd01/t/56d73267ab48def0679bd8e5/1456943719940/Silevo+Amended+Restated+Agreement+-+fully+executed+%289-4-14%29.pdf Note that the fact that some of the jobs counted towards the job creation requirement are not at entities that are part of the agreement may make it difficult get data from them to verify claims about employment levels at their locations.

[x] Available on Empire State Development’s website at: http://esd.ny.gov/PublicMeetings_Notices/2016/04212016_ESD_BM_materials.pdf (pp. 60-96)

[xi] Note that after public pressure, in a press release dated June 22, “Fort Schuyler Management Corporation Board of Directors Unanimously Votes to Open Meetings to Public” FSMC agreed to open its meetings to the public, agreed that it was subject to FOIL, and agreed to publish documents online.

[xii] To the contrary, Robert Freeman, the head of New York’s Committee on Open Government has opined that FSMC is subject to the State’s Freedom of Information Law.

[xiii] http://esd.ny.gov/PublicMeetings_Notices/2016/04212016_ESD_BM_materials.pdf  (pp. 67-69)