This article originally appeared in the Charlotte Business Journal.
North Carolina can improve its dismal 9.4% unemployment rate – currently fourth worst in the nation. To understand what that takes, however, requires an understanding of what makes a state’s economy thrive relative to those of other states.
States that thrive are the ones with the highest rate of sustainable, growing businesses along with a robust level of new business creation. In short, states with more business “births” and fewer business “deaths” or downsizing will experience healthy growth. And with economic growth comes jobs.
North Carolina is in need of several policy reforms if it wants to turn around its economy, that first and foremost involve these two key areas: encouraging more business startups, and enabling more sustainable companies.
First, how can North Carolina ensure more companies are sustainable, and growing?
Companies that downsize or close do so because they failed to efficiently meet consumer needs. That is, they were unable to provide a good or service at a price consumers were willing to pay. Such situations may arise simply due to poor management, but more likely occur because the entrepreneurs speculated poorly in regards to anticipating what consumers would be willing to pay for their product relative to what their products would cost to produce.
Conversely, those businesses that thrive over time are those that most successfully align with consumer preferences.
An economy is a series of exchanges between consumers and entrepreneurs. Entrepreneurs, for their part, engage in an unending process of attempting to discover the most efficient means of meeting consumer demands. This process is full of trial and error, with each success or failure informing the economy’s next adjustment to production.
This constant process of discovery through trial and error results in the most efficient allocation of scarce resources into sustainable production patterns aligned with consumer desires. When production patterns are in harmony with consumer preferences, the economy enjoys sustainable growth.
That harmony, however, can be disrupted by government interference. North Carolina distorts the entrepreneurial response to consumer demands by offering a myriad of targeted tax breaks and taxpayer subsidies, under the guise of “economic development.” Such government-granted privileges encourage businesses that otherwise would not exist if they were left to play by the same rules as other businesses. By responding – at least in part – to state economic development programs, entrepreneurs are no longer making decisions based exclusively on profitable opportunities in response to consumer demands.
Moreover, by being exempted from a business expense paid by most other companies (i.e. taxes), the privileged businesses will be willing to pay more for resources, thus bidding up the price on certain inputs. This has the effect of driving up the cost of doing business for other companies more aligned with consumer preferences, forcing some of them to downsize or go out of business.
The result is a greater share of North Carolina businesses not aligned with true consumer preferences, but rather propped up courtesy of political favors. Recent headlines bring Solyndra to mind. Obviously, that is not a recipe for increasing the number of sustainable businesses in the state.
Secondly, what stands in the way of a more robust rate of new business formation in North Carolina?
The simple answer is this: incentives matter. When potential entrepreneurs evaluate whether or not (and where) to start a new business, a significant part of their decision rests on their after-tax return on investment. For those starting a business it is understandable to expect a certain return – otherwise the reward becomes insufficient given all of the effort, time and risk involved.
Here in North Carolina, however, we have the highest top marginal income tax rate in the region, and eleventh highest nationally. A higher tax rate means a lower return on investment for entrepreneurs. In a time when capital is extremely mobile, more and more potential business owners will decide the after-tax rate of return is insufficient in North Carolina and decide to open up shop elsewhere. Moreover, less mobile resources, including low-skilled workers, are stuck here in a poor-performing state with fewer job opportunities because entrepreneurs are fleeing for greener pastures.
The time is right for North Carolina to tear down the barriers to economic growth. Eliminating government privileges to certain companies will help ensure more businesses enjoy sustainable success, and lower tax rates will encourage more new business creation. That would be a great start.
Six months from now, North Carolina will have a new Governor and many new state legislators. All of them will promise they have the answers to solving our state’s economic woes. But how many of them will be wise and bold enough to remove the political obstacles to sustainable, healthy economic growth?
Brian Balfour is Director of Policy with the Civitas Institute in Raleigh (www.nccivitas.org)