Economic Analysis and Banking & Finance

HICKS: Variables cloud business-location question

September 18, 2010

One of the aspects of economics that interests me is the application of fairly sophisticated analytical tools to workday matters. Take the simple question, “Why do businesses locate where they do?” This is a decidedly less august question than, say, “Why do we have opposable thumbs?”

But there’s a lot more immediate interest in the business-location question, though we don’t have as good an answer as we’d like. The reason for this isn’t that economists lack the tools: experiments, game theory, advanced mathematical modeling or decades of detailed geographic detail. The problem is that the reasons for business-location decisions change from time to time.

Much of the economic research I read and write assesses the reasons firms locate where they do. From this research we can draw some pretty straightforward conclusions. Firms that need local customers (like grocery stores) go where people are. They are not “footloose” in the sense that they can reasonably choose from a variety of locations. For these firms, the density and characteristics of consumers, local traffic patterns and taxes tell almost the whole business-location story. For truly footloose firms, the story is much different.

Production-oriented service firms (like manufacturing and software producers) have an international choice of where to locate. While some, like concrete firms, must carefully weigh the costs of moving their products. The past 50 years have seen the plummeting of transportation costs, so most footloose firms choose their location based on other factors.

Over the long run, and especially during the good times when labor markets are tight, firms worry most about the availability of workers. It isn’t just the labor force, but the right one that makes all the difference. It isn’t simply the wages, but rather the balance of wages and productivity that matters. High productivity attracts high wages; low productivity generates low wages. Firms that need highly productive workers will pay higher wages, and vice versa–-and there isn’t much else to the story. That is why education matters so much.

Research also tells us that businesses choose their location based on regulatory differences, such as environmental restrictions, differences in workplace rules, the likelihood of having to deal with unions and, of course, taxes.

Agglomeration, a $5 word for the effect of economic clustering, confuses the matter. Businesses that benefit from having other similar companies around them care less about other factors (taxes or higher labor costs), because they need the proximity to other firms. Examples of these are software in Silicon Valley, carpets in Dalton, Ga., and, of course, medical devices in Warsaw in north-central Indiana.

Long recessions also confuse the matter. Today, tax burdens (and anticipated changes in tax burdens) matter more than they have in years. This is great news for Indiana, where—alone among the 50 states—we have cut taxes. That’s why Indiana is leading job growth in this recovery, and why Michigan and California are at the bottom.•

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Hicks is director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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