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Osborne, DavidEconomic Competitiveness. The States Take theLead.Economic Policy Inst., Washington, DC.Joyce Foundation, Chicago, IL.ISBN-0-944826-00-88788p.; Report taken from the author's book, "The NextAgenda: Lessons from the Laboratories ofDemocracy."Economic Policy Institute, 1730 Rhode Island Avenue,N.W., Suite 812, Washington, DC 20036 ($4.00).Viewpoints (120) -- Reports Descriptive (141)

MF01/PC04 Plus Postage.*Business; Case Studies; Competition; *EconomicDevelopment; Employer Employee Relationship; Exports;Financial Policy; *Government Role; Higher Education;Industry; Labor Economics; Labor Force Development;Low Income Groups; Policy Formation; *State Programs;*Technological Advancement; Technology Transfer*Massachusetts; Michigan; *Pennsylvania

ABSTRACTNew economic strategies used by states are described,

and case studies of the recent innovations in economic developmentpolicies of Massachusetts, Pennsylvania, and Michigan are presented.A number of programs in other states are briefly reviewed, andvarious models of state intervention are evaluated, along with theprinciples that underlie successful programs. Some questions raisedby the economic activism of U.S. governors and state legislators areaddressed. Lessons from the recent experimentation in state economicdevelopment policy are considered, along with the implications forfederal policy of this expansion of state government's role in theeconomy. Appended are a glossary of acronyms and a chart thatspecifies types of competitiveness programs used in these threestates. Specific programs arc identified under the followingcategories: programs to stimulate technological innovation, capitalprograms, programs to help new and small businesses, technologytransfer programs, labor-management cooperation programs, educationand training programs, export program', programs to bring the poorinto the growth process, and the principles of effective economicdevelopment. (SW)

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ECONOMICCOMPETITIVENESSThe States Take the Lead

by David Osborne

Introduction byRobert B. Reich

Economic Policy Institute1730 Rhode Island Avenue NW #812 Washington, D.C. 20036 (202) 775-8810

David Osborne is the author of the forthcoming book, The Next Agenda: Lessons fromthe Laboratories of Democracy, from which this reportwas taken. The book will be pub-lished in Apri11988 by Harvard Business School Press. Osborne is also the author ofnumerous articles which have api dred in The Atlantic, The New Republic ,The New YorkTimes Magazine, Mother Jones, dnd Inc. Magazine, among others.

Publication of this study was made possible by a grant from the Joyce Foundationin addition to financial support provided by the Economic Policy Institute. Thanks toDianne Conley for production assistance. Design by J. Gibson and Co./Wordscape.

Copyright © 1987ECONOMIC POLICY INSTITUTE

1730 Rhode Island Ave, NWSuite 812

Washington, DC 20036

Library of Congress Catalog Card Number 87-82983

ISBN 0-944826-00-8

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INTRODUCTION

by Robert B. Reich

The American economy is in transition. High-volume, standardized production ofeverything from wheat to steel is shifting to developing nations with access to thesame equipment as advanced nations, but whose costs of labor and materials

are substantially lower. At the same time, consumers within advanced nations are demandingmore customized and technologically-sophisticated products and services. Our future stan-dard of living thus depends on the speed and ease with which we move from mass productionto knowledge production, and how many of our fellow citizens we bring along.

But this transition has proven difficult for many Americans. While over 15 million new jobshave been created during the last five years, the vast majority are in low-skilled service in-dustries paying only modest wages. While the American economy has expanded and produc-tivity has gained slightly, average real earnings have stagnated. More troubling still, we areliving off our borrowings from the rest of the world. Were foreigners to stop their lending orthe dollar to continue to fall relative to foreign currencies, our standard of living would drop.Simply to pay back what we owe will require major sacrifice.

The underlying difficulty has persisted throughout the last fifteen years, regardless ot in-flation or recession, high dollars or low dollars, Democratic or Republican administrations,large government budget deficits or smaller ones. The American standard of living has failedto rise from what it was in 1973. In some respects it has fallen: most families now need twowage-earners to support themselves; average family size continues to shrink.

The transition from a mass-production to a knowledge economy has been difficult, in part,because the latter rests upon fundamentally different premises about growth and investment,and the organization of production. High-volume, mass production required heavy invest-ments in plant and equipment and relatively small inveEtments in the skills and technologicalcompetences of the workforce. Growth depended on economies of scale. The organization ofproduction was hierarchical, involving a few people engaged in strategic planning at the top,and many people following orders at the bottom.

The economy toward which we are evolving, by contrast, requires substantial invest-ments in workers' skills. Growth depends on continuous, small-scale innovations in productand process. And the organization of production must be horizontal rather than hierarchical

spreading authority and responsibility throughout the enterprise.The transition also implies a different role for government. High-volume, standardized

production required a system of publ;rt.r-supported primary and secondary education thatguaranteed a steady supply of reliable workers, able and willing to follow directions. It alsorequired that government subsidize basic research of a sort that occasionally yielded majorbreakthroughs, which could then be mass produced. Finally, the old form of productionnecessitated that government smooth out the business cycle so as to minimize unemploy-ment and the accumulation of inventories during downturns. To the extent that macroeconomicmeasures failed to do the trick, government provided unemployment compensation, loans,and other measures to aid workers and companies until demand picked up once again.

But in the economy to which we are evolving, industries based on old methous of produc-tion will never come back. Thus measures to stabilize the economy and to cushion workersand firms from downturns in the business cycle must be supplemented by new measures toease the transition of workers and firms to entirely new products and processes. Our sys-tems of basic education must aim not only for numeracy and literacy, but also for creatii, ity

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and the capacity to collaborate. And since the knowledge and skills people need in order tolead productive lives are continuously changing, education and retraining must be lifelong.Finally, government must not only sponsor basic research, but also nurture smaller -scale in-novations, an-I help move them quickly from laboratory to workplace.

Thus far, the federal government has eschewed efforts to ease the transition to a neweconomy. The Reagan Administration, in particular, has rejected any call for a coherent in-dustrial policy. But the Administration finds itself deeply entrenched in American industry bydefault bailing out troubled banks, taking over pension obligations failed firms, protect-ing industries which have made no commitment to modernize, and providing ever-greatersubsidies to high-technology firms through the Pentagon's back door. As a result, ironically,the Reagan. Administration's industrial policy is far more interventionist than that of anyprevious administration, but its consequences are perverse: older technologies are pre-served, emerging ones are militarized.

As David Osborne reveals in this important study, many of our state governments ex-emplify government's new role in fostering the transition to a new economy. States have ledthe way in reforming basic education, devising methods of retraining older and disadvantagedworkers, designing ways to finance startup businesses that may be too risky f:11- venturecapitalists but promise large social returns, 'incubating' small businesses, pushing technologyout from research laboratories, and creating a range of partnerships between public, private,and not-for-profit sectors aimed at stimulating local and regional economic development.

These experiments among smaller businesses and among state governments defyeasy categorization, for the simple reason that the categories we use to explain economicphenomena are themselves products of an older industrial era. Should small, innovative firmsthat specialize in design or production engineering be classified as service businesses or arethey really more like manufacturers? Are state governments that help finance emerging busi-nesses treading perilously close to socialism or are they spurring capitalism? These oldcategories have become irrelevant: the new businesses are hybrids somewhere between ser-vices and manufacturing, which add value to goods by tailoring them to specific end uses.The new state programs may entail strategic planning and even some state ownership, butthey in no way substitute for the market. Difficulties in describing these phenomena oc-casionally result in confusion and misinformation, if not outright hostility. But it seems a safeguess that as our economy evolves, so too will our abilities to communicate about how it isdoing so.

David Osborne's study for the Economic Policy Institute -- and the larger book fromwhich it is drawn mark something of a milestone in this respect. Although it is still tooearly to say with confidence which of these experiments among state governments havebeen most successful, the encouraging news is that these experiments are going on, andeventuall; will yield an abundance of lessons about how to transform the American economy

efficiently and equitably. Osborne's insights thus signal the beginning of a critically impor-tant effort to collect, sift, and thus to understand what we have learned.

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Robert B. ReichCambridge, Mass.October, 1987

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TABLE OF CONTENTS

INTRODUCTION BY ROBERT REICH i

Chapter I: THE NEW ECONOMY 1

Chapter II: MASSACHUSETTS 9

Chapter III: PENNSYLVANIA 25

Chapter IV: MICHIGAN 41

Chapter V: OTHER STATES 55

Chapter VI: LESSONS OF THESTATE EXPERIENCE 59

GLOSSARY OF ACRONYMS 75

MATRIX OF STATE INDUSTRIALCOMPETITIVENESS PROGRAMS 77

FOOTNOTES 81

CHAPTER 1:

THE NEW ECONOMY

The notion that America has entered a new economic era has become com-monplace. The labels differ; some call it the "post-industrial era," some the"information age," others the "era of human capital." But most agree that

the fundamental organization of the American and international economies thatprevailed for three decades after World War II has changed.

Part of this transition has been the rise of international competition. In 1970,nine percent of all goods used by Americans were imported; by 1980, importsaccounted for 22 percent. In 1960, only 20 percent of all goods produced in theUnited States were in active competition with foreign products; by 1980 a full 70percent were.' In basic, high-volume manufacturing, the rest of the world hasgradually caught up to and in many cases passed the United States. ManyAmerican corporations simply cannot compete against nations where workers arepaid a few dollars a day. Too often, U.S. companies cannot even compete withwell-paid work forces in specialized manufacturing.

We have also been jolted by technological change: the microelectronic revolu-tion has transformed the way in which our economy is organized. Factories havebeen automated; the proportion of the work force dealing with "information" hasincreased dramatically; and the economies of scale in much of the business worldhave reversed, favoring decentralization rather than centralization. These techno-logical changes do not mean that manufacturing is no longer the backbone of oureconomy, that we can simply quit building and selling products and rely on servicesfor our income. They do mean that we can manufacture more with fewer workerson production lines. While the percentage of our work force in manufacturing hasdeclined steadily, the percentage of our gross national product provided bymanufacturing has not.

America's adjustment to the twin realities ofinternational competition and technological

...revolution has been painful. The pain is re-flected in statistics that by now are well known.Average growth rates have dropped from about 4percent in the 1960s, to about 3 percent in the '70s,to about 2 percent in the '80s.2 The annual rate ofproductivity growth has plummeted from 3.3 per-cent between 1947 and 1965 to 0.9 percent between1977 and 1986.3 Since 1960, Japanese productivityhas grown five times faster than ours.4 Unemploy-ment rates, even in good times, have risen from thefour percent range in the 1960s to the seven percentrange in the1980s. Trade deficits have soared to $170billion a year, costing American workers an estimatedfour million jobs.5

It has become increasingly clear that America's

future depends less on our brawn than on our brains.In a world of low-wage labor, our competitive advan-tage lies in our ability to create research break-throughs in the laboratory, to translate thosebreakthroughs into new products and processes, andto manufacture the results using a combination oftechnological sophistication and skilled labor that isstill rare in the dev loping world. America's future,in other words, depends to a great extent on our abil-ity to innovate.

The transition from an industrial economy builtupon assembly-line mah,,tacturing in large, stablefirms to a rapidly changing, knowledge-basedeconomy built upon technological innovation hascreated new opportunities, but it has also createda series of new problems in American life. The mostobvious are those that reflect the loss of our corn-

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petitive advantage in basic manufacturing: idle fac-tories, dislocated worker: , battered manufacturingtowns and regions. Less obvious are the problemsthat inhibit our ability to innovate: a poorly educatedand trained work force; high rates of illiteracy; adver-sarial relations between management and labor; in-adequate supplies of patient capital; and corporateinstitutions that lag behind their foreign competitorsin the speed with which they commercialize the latestresearch breakthroughs, adopt the latest productiontechnologies, and exploit foreign markets.

The issue of international competitiveness hasemerged as a primary focus of Americanpolitics. Just as the evolution of an industrial

economy in the late 19th and early 20th centuriesrequired government to solve new problems andcreate a fundamentally new role, so the impact ofmassive changes in the industrial economy in the late20th century requires new solutions and thereforenew roles for government.

Yet the federal_ government has failed to respond.Jimmy Carter was elected just as the public beganto sense that something had gone wrong with theAmerican economy. Like other national politiciansof his day, he only dimly perceived the realities ofthe new economy. Ronald Reagan owed his electionto the deepening economic crisis, but his solution wasto reach back to the free-market myths of the pre-industrial era. Attempts by an emerging group ofyounger economists and politicians to advocate agovernment role in "industrial policy" similar to therole successfully played by goverrui.ent in Japan andWestern Europe were attacked not only by conser-vative ideologues, but also by more traditional liberaleconomists, who argued on essentially political andcultural grounds that industrial policies that workedelsewhere could not work in the United States.

The industrial policy debate was also sidetrackedby the issue of whether government should attemptto "pick winners" by investing large sums in particularindustries or technologies. The central recommen-dation of some of the better-known proponents ofindustrial policy was a Reconstruction Finance Cor-poration, to make large federal investments intargeted industries. Although many industrial policyadvocates disliked the RFC notion, the proposalserved as a lightning rod for critics, who argued that

government could not predict what w Juld succeedin the marketplace and could not keep political con-siderations out of its investment decisions.

At the state level, dire economic conditions pro-duced a response that was less ideological andmore practk:al and creative. In response to

closing factories and regional distress, a wave ofeconomic activism began to sweep through stategovernment. Governors of both parties initiated pro-grams to improve the competitiveness of theireconomies which, after all, was thc original pointof industrial policy. Some call these state efforts in-dustrial policies. Some prefer the label "industrialstrategies" or "competitiveness strategies." Othersuse phrases such as "entrepreneurial policy" or "in-novation strategy."

Whatever the label, to frame the choice as eitherpicking winners or respecting the free market is tomisunderstand the issue. There is no such thing asa "free" market, independent of government in-fluence. The federal gc -ernment has long targetedspecific firms and industries with loans, taxpreferences, research institutes, and the like. Everytime a government decides to fund research, it mustmake judgments about which areas show the mostpotential for success. This is a far cry from subsidiz-ing a particular product in the belief that it will triumphon world markets, as the British and French did withthe Concorde. But it is an equally far cry from a pure"free market," in which government does nothing butprovide a regulatory framework.

In their efforts to develop approaches appropriateto the new economic era, most states are focusingnot on specific inaustries or products but on pro-cesses, such as technological innovat In, capitalformation, new business formation, the commer-cialization of research, and the adoption of newmanufacturing technologies. They are trying to usegovernment's leverage to reshape the marketplace

to heighten productivity, to quicken the pace ofinnovation, and to sharpen our ability to bring thefruits of our research to market. When they do in-vest directly in firms, the goal is usually to fill gapsleft by private financial markets, such as small busi-ness lending or early stage venture capital. At timesthe importance of a new industry is so obviousas in the case of biotechnology that few question

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the wisdom of government investments in research.But even in the research arena, the goal of most stateprograms is, again, a process: heightened interac-tion between academia and business, so as to speedthe commercialization of research already takingplace.

This new role embraced by state go ve:- rentsinvolves a number of strategies. Some sim-ply change the rules of the game so as to

encourage the capital markets to invest more patientcapital in new and small business, for instance. Somecreate new public-private institutions to fill gaps thatthe private market has trouble reaching. Others forgenew alliances between business and academia, tomove research advances more rapidly into themarketplace. Still others encourage new relationshipsbetween management and labor, to heighten produc-tivity on the shop floor. And some state initiativescreate new social programs some public, someprivate, some partnerships between the public andprivate sectors to meet the needs of Americansfor training, education, housing, child care, and thelike.

This surge of innovation has occurred at the statelevel in part because the federal government hasfailed to respond to the new realities of the post-industrial era. If one looks back in history, however,one sees that a similar dynamic took place during theemergence of America's industrial economy. Thereforms of the progressive era were a response tothe new problems created by rapid industrialization:the explosion of the cities, the exploitation of childlabor, the problems of overproduction and low wagesin new industries based on high-volume manufactur-ing. Many of these reforms appeared first in statesand localities, then were gradually institutionalizedat the federal level, culminating in the New Deal.Many of Franklin Roosevelt's most important in-itiatives, including unemployment compensation,massive public works programs, deposit insurance,social security, and the farm credit system, werebased on successful state programs. "Practically allthe things we've done in the federal government,"Roosevelt once remarked, "are like things Al Smithdid as governor of New York."6

The experimentation taking place in America'sstates has followed no grand plan. It has proceeded

in fits and starts. one state responding to this prob-lem, anot'-er to that. The initial response to theeconomic troubles of the 1970s was a wave of"smokestack-chasing," as governors offered deep taxincentives to lure manufacturing plants to their states.This strategy has been largely discredited amongeconomic development experts. Taxes are relativelyminor items in the calculations made by firms search-ing for a new location, and tax breaks diminish theservices (education, roads, sewers, etc.) that a com-munity or state can support. By creating dependentlocal economies structured around one or two plants,smokestack-chasing also discourages the kind ofeconomic chair. reaction that leads to sustainedgrowth.

Smokestack-chasing remains the economicdevelopment strategy of too many states and com-munities. But gradually it is being replaced by a ne:set of strategies designed to stimulate home-grownindustries. Most of the new state economic strategiesfall within eight categories. They include efforts tostimulate technological innovation; to fill gaps incapital markets; to encourage the growth of new andsmall businesses; to help manufacturing firms keepup with the latest production technologies; to movelabor-management relations toward cooperationrather than confrontation; to stimulate exports; toimprove education and training systems; and to bringthe poor into the growth process. Let us examinethese categories one by one:

1) Programs to stimulate technological innovation. Inthe new economy, high growth areas are almost in-variably clustered around major research universitiesor institutions, out of which new technolDgies andfirms have emerged. When Massachusetts Instituteof Technology Professor John Donovan studied 216high technology companies in the greater Bostonarea, he found that 156 of them had been born in MITdepartments or laboratories.' To help stimulate theinteraction between academic researchers and thebusiness world that is necessary to generate this kindof spin-off effect, roughly half the states have ,:reatedprograms to fund joint business-academic research.8

By offering to match business grants for academicresearch with public money, the states have en-couraged academics to look for businesses interestedin their work and businesses to look for academics

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with research expertise in their fields. Other stateshave created new research institutions or pouredmoney into key research departments at majoruniversities, to bring them to the top of their fields.Still others have funded university research parkspatterned on the Stanford Research Park, throughwhich many of the early semiconductor firms in theSilicon Valley matriculated. Overall, some 40 stateshave created programs to promote technologicalinnovation.'

2) Program to fill raps in capital markets. Capitalmarkets are organized differently in every nation,giving each nation different strengths andweaknesses. In the United States, studies havepointed to several sectors of the marketplace thatare not well served by conventional financial institu-tions. For instance, small businesses have troublegetting long-term loans from banks, primarilybecause the "transaction costs" (the costs of in-vestigatinr, the venture to evaluate the degree of riskinvolved) are too high compared to the return. Inaddition, new and growing firms outside certain ad-vanced technology markets find it almost impossibleto get equity capital. In part, this is because the poten-tial profits, though significant, are not as spectacularas those needed to justify an extremely risky invest-ment. (Venture capitalists assume that a large pro-portion of companies in which they invest will fail;they rely on extremely high profits from the few thatsucceed to cover their losses. Thus they need to seethe potential for high profits in every deal theyconsider.)

State governments have responded with a varietyof efforts to fill the gaps. Some have changed theirfinancial regulations to allow or encourage banks orsavings and loans to make certain kinds of in-vestments. Others have authorized the creation ofnew kinds of private financial institutions, whichspecialize in lending to small and medium-size busi-nesses. Some have provided incentives to banks tolend to small businesses. Others have provided partialfunding for private venture capital firms with specifictargets particularly very early (seed) capital.Others have earmarked some of their publicemployee pension funds for investments in small busi-ness loans or venture :apital. Finally, many stateshave created public development funds of one kind

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or another. In October, 1984, Inc. magazine counted31 new public development funds created by stategovernments in the preceding year alone.1° In 1985,the New York Times counted 20 states with publicventure capital funds."

31 Programs to encourage the growth of new, and smallbusinesses. In 1979, MIT Economist David Birch com-pleted an analysis that has subsequently had moreimpact on state economic policy than any other singlestudy. Using Dun and Bradstreet data on 5.6 millionAmerican firms representing 82 percent of all privatesector employment, Birch found that over half of allnew jobs were created by small, independent firmswith fewer than 21 employees, and 80 percent of allnew jobs were created by firms less than five yearsold.' 2

Birch's data has been challenged, but subsequentstudies have confirmed his general point, and it isnow widely accepted that most new jobs in the U.S.are created by small and young firms. For instance,the annual rate of business formation has more thantripled in the last 20 years, from 200,000 in 1965 toalmost 700,000 in 1985. While employment in For-tune 1000 firms has declined over the past decade,nearly one-quarter of all new jobs are new accountedfor by people who are self-employed or running abusiness more than double the rate of ten years'Igo. Almost as many people run businesses or areself-employed today as belong to unions.' 3

The reasons for this shift have much to do withthe fundamental economic transition we are ex-periencing. Large manufacturing firms are not onlycontracting as they lose market share to foreign com-petition, they are moving their own production off-shore. (During the 1970s, for instance, GeneralElectric eliminated 25,000 jobs in the U.S., whilecreating 30,000 jobs overseas. 14) In addition, themicro electronic revolution has pushed the rate oftechnological innovation to dizzying heights, and newtechnologies are often brought to market by newfirms. Finally, as noted earlier, these newtechnologies are substituting machines for people ata rapid pace, while reversing the economies of scalein mush of the business world.

To some extent, Birch's study has been misusedby statc governments. Small business advocateshave pushed the study so hard that it has become

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identified with the thesis that small business is thekey to economic development However, many smallservice businesses create numerous low-paying jobswhile contributing little to the generation of realwealth. As Birch himself has often stressed, the reallesson is that innovation which often happens inyoung, growing firms is the key to economicgrowth. Most small firms are irrelevar ; they feedoff growth, rather than creating it.

While advocates of laissez-faire policies respond-ed to Birch's findirgs by arguing that there was littlegovernment coula do to help small and young firms,state governments reacted by creating dozens of newprograms that have proved the critics ,vrong. Somestates created loan or venture capital funds for smallor new firms. Many joined with the federal SmallBusiness Administration (SBA) to sponsor SmallBusiness Development Centers, which provide tech-nical and managerial advice to entrepreneurs. A fewmade the deposit of state funds (or public pensionfunds) in banks conditional upon some kind of smallbusiness lending effort by the banks. Perhaps themost popular programs, however, have been smallbusiness incubators: buildings designed to nurturethe growth of start-up firms. Incubators typically rentinexpensive space to start-up firms and provideshared secretarial services, photocopying, account-ing, legal help, conference rooms, technicalassistance, even seed capital. A Commerce Depart-ment survey found that firms hatched in incubatorssucceeded more than twico as often as they failedthe mirror image of survival rates for new firms ingeneral. By mid-1986 twleve states had establishedprograms to sup ort incubators, which nu 'bered 148in the U.S. and Canada.' 5

4) Programs to help manufacturing firms keep up with the

latest production tedinologies. The federal AgriculturalExtension Service has long helped farmers to takeadvantage of advances in agricultural technology.During the 1980s, several states have adopted asimilar model for manufacturing. Typically, the statescreate a network of "industrial extension agents" towork with small and medium-size businesses, whosemanagers seldom have the time to keep up withchanging production technologies, nor the resourcesto adopt them. President Reagan's Commission onIndustrial Competitiveness, chaired by Hewlett-

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Packard President John Young, underscored the needfor such programs. "Perhaps the most glaring defi-ciency in America's technological capability has beenour failure to devote enough attention to manu-facturing or process technology," the commissionconcluded. "It does us little good to design state-of-the-art products if, within a short time, our foreigncompetitors can manufacture them more cheaply."' 6

5) Efforts to move labor-management relations towardcooperation rathu7 than conflict. In an economy largelyinsulated from foreign competition and dominated bystandardized, high volume manufacturing, friction be-tween labor and management was tolerable. Today,we can no longer afford it. With virtually all manufac-turers compethig against low-wage foreign countries,higher productivity is critical. And as we move to flex-ible manufacturing, which requires constant adap-tation on the factory floor, cooperation betweenworkers and management becomes even more im-portant. State governments have not made greatstrides in this direction, but there have been someefforts to mediate conflicts between labor andmanagement, to create local and regional labor-management committees, and to encourage ex-periments in worker ownership.

6) Programs to stimulate exports. For a century,America's industrial powers did not have to worrya great deal about exports. They enjoyed both animmense domestic market for their products andparticularly after World War II weak competitionfrom abroad. While the U.S. relied on these advan-tages, the Japanese and Europeans (and increasing-ly, the Taiwanese, Koreans, and the rest) had to lookto the export market for their growth. Today theJapanese manage exports through huge, sophisti-cated trading companies, while we leave every pro-ducer to his own devices. That may work for a fewlarge corporations, but it does not work for mostsmall and medium-size manufacturers.

To remedy this problem, the states have begunto experiment with export programs designed to helpsmall and medium size businesses market their prod-ucts overseas. They have also created insurance pro-grams and loan funds for exporters. Wisconsin andVirginia adopted "mentor" programs, in which largeexporters work with small companies to help them

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learn to export. The New York-New jersey PortAuthority has even launched a publicly-owned ex-port trading company, to handle all overseasmarketing for ;mall and mediur firms that haveeither never exported or h ,r exported to aparticular region of the wont_ ,wee chapter V). ' 7

7) Efforts to improvu eduction and training sysks. Inthis "era of human capital," as Robert ReLti hasdubbed it, America's competitive advantage lies inthe use of sophisticated technolog; (in both produc-tion and services) and "flexible manufacturing" theproduction of specialty items produced in limitedquantities, which are not so susceptible to cerr.peti-don from foreign, low-wage assembly lines. Both ofthese arenas require workers who can adapt to newtechnologies, learn new skills on the jnb and find newsolutions as problems emerge. When a machine shopbrings in computer-controlled machining centers, forinstance, machinists long skilled in manual operationsmust learn to operate through computer terminals.When Ford or Mazda builds ew auto plant, it looksfor employees who can operate computers, rotatethrough various jobs, recognize and solve problemsthat emerge during production, and suggest im-provements. Technology may be de-skilling manyAmerican jobs, particularly in the service sector. Butin manufacturing, a well-educated, skilled work forceis now c-4.tical to our ability to :ompete.

State governments have put an enormous amountof energy and money into education reform duringthe 1980s most of it justified as a necessary in-gredient of economic growth. They have done lesswell on job training. The difference stems primarilyfrom the simple fact that state governments have longbeen r iponsible for educatk-p, while the federalgovernment has funded most training programs. Asfederal money for training has dwindled, however,the states have begun to respond with new, highlytargeted programs particularly in the area ofretraining for dislocated workers.

8) Efforts to bring the poor into the growth process, Evenin high gro ,vth states, such as Massachusetts,pockets of stagnation remain. most states havesimply focused on increasing the size of the pie, afew have experimented with ways to shift thegeographic pattern of expansion into regions that

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have been left behind. Some have also tried to targetparticular eco. Dmic development efforts to the poor,minorities, or those on welfare. Both of these effortsare important in an economy that is increasingly divid-ed into tiers. While growth centers flourish on bothcoasts, much of the industrial and agriculturalheartland remains in recession. While those witheducation enjoy widening job opportunities, thosewithou* face narrowing horizons.

Not all of these efforts are unique to state govern-ment. The National Science Foundation has fundeda number of University-Industry Cooperative Re-search Centers and Engineering Research Centers,the Export-Import Bank has long helped insure andfinance exports (primarily for large firms), and theSBA has initiated a variety of programs for small busi-nesses. But for the most part, federal economicpolicy remains focused on macroeconomic concerns:monetary policy, fiscal policy, and tax policy. Duringthe sustained prosperity of the post-World War IIperiod, the federal government could afford to ig-nore microeconomic concerns such as new businessformation, regional capital markets, and labor-management relations. Because the Americaneconomy was so much stronger than those of its com-petitors, economists believed that they could fine-tune it into full production simply by adjusting interestrates, budget deficits, and the like. When growthslowed in the seventies and eight:_ s, however, fine-tuning no longer yielded the same results.

In an economy under siege by foreign competi-tion, macroeconomic adjustments are no longerenough. Quantitative factors are important, butqualitative factors have become equally critical. Oursuccess is no longer a result of how much we pro-&Ice, but how well we produce it. The problem isnot simply how much capital is available, but whatkind, and where it goes to what kind of firms. Thechallenge is not only to step up our research efforts,but to make sure that the results are rapidly com-mercialized. The question is not just how manyworkers we have and at what wages, but how wellthey are prepared and now well they work together.

It is to these microeconomic quc'tions that stategovernments have addressed themselves. This ishardly because governors and state legislators havesuperior insight; it is simply because microeconomiclevers are the only levers available. Unable to in-

fluence the economic aggregat of money supplyand interest rates, they focus or n-oblems they canaffect: regional capital markets, toe commercializa-tion of technologies developed at cal research in-stitutions, the needs of local entrepreneurs. Thuswhile national economic debate in the Reagan yearsraged over macroeconomic questions the federaldeficit, the money supply, and tax reform stategovernments were busy reopening the microeco-nomic policy front, which had largely been dormantsince the 1930s.

To provide a more detailed picture of recent in-novations in state economic development policy, thisreport will offer case studies of three of the mostactive states: Massachusetts, Pennsylvania, andMichigan. It ill then briefly review a number of pro-grams in other states. In the concluding chapter, it

will evaluate various models of state intervention anddescribe the principles that underlie successful pro-grams. Finally, it will address some of the question.raised by the economic activism of America's gov-ernors and state legislators among them the na-tional implications of this activity. Should the federalgovernment adopt the most successful programs andspread them to every state? Or are some forms ofmicroeconomic intervention best left to the states?If so, which programs belong at the state level, whichat the federal level? And perhaps most important,can the principles underlying successful state-levelefforts be used to guide new federal efforts to dealwith issues that transcend state borders, such asforeign trade, national capital markets, and the struc-tural problems of individual industries?

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CHAPTER II:

MASSACHUSETTS

Because necessity remains the mother of invention, innovation in ,aconomicpolicy often appears where the pain is most severe. In the mid-1970s, thepain was nowhere more severe than in Massachusetts. Though Massachusetts

today is an unparalleled economic success story, in 1975 national columnists werecalling it "the new Appalachia."

Unemployment was 12 percent. The old mill towns of Lowell and Lawrence andFall River and New Bedford brought back memories of the Depression. For thoselucky enough to have jobs, manufacturing wages had slipped to 93 percent of theU.S. average.' In a state dependent on a growing high-tech sector, the end of theVietnam War and of the Apollo space program had come as a rude shock. To makematters worse, the Nixon administration in what many saw as revenge for thestate's pro-McGovern vote in 1972 had closed or ';nificantly reduced five ofthe state's military installations, eliminating 15,000 jobs.2

The First Dukakis Administration:Filling Capital Gaps

Michael Dukakis, inaugurated as governor inJanuary 1975, was a typical liberal of the late sixtiesand early seventies. His passion was not economicgrowth, but the revitalization of Massachusetts'declining cities. The greatest symbol of his commit-ment was the now famous Lowell Heritage StatePark, through which the state pumped more than $10million into downtown Lowell, spent another $20million on new highways to get people there, andhelped convince the federal government to establisha national park, an effort that brought in another $40million. In 1977, partly because the city and state hadcommitted themselves to the revitalization effort,Dr. An Wang decided to build the first of three WangLaboratories office towers in Lowell. By the mid-'80s, he employed some 9,000 people there, and thelocal unemployment rate hovered just over threepercent.

Lowell was a dramatic success story, but the zealwith which Dukakis tried to force private investmentinto urban centers brought him into repeated con-

*The word "quasi-public" is used to indicate that whileoperating with public funds, most of these institutions arerun by independent boards which included representativesof the private sector. The idea is to use private-sectormethods to achieve public purposes.

flict with business. In western Massachusetts, forinstance, the governor tried to force a developer toput a planned mall in downtown Pittsfield rather thanon the outskirts. When the developer balked, thegovernor minced no words. "There will be no accessto the state highway," he declared. "Forget aboutyour development. We just won't permit it."

Incidents like this quickly brought business angerto a boil and ultimately forced the administrationto rethink its priorities. Massachusetts' foremostproblem in the mid-'70s was not the location of growthbut the absence of growth. "What Massachusettsneeds is a vigorous economic developmentprogramto bring balance to the social programs of the Six-ties and the environmental program of the earlySeventies," the administration concluded, in a ma-jor economic policy civcument published in 1976. "Wemust acknowledge that more jobs and higher incomesare prerequisites to the improvement of the publicwelfare and the enjoyment of our rich natural andman-made environment."

The rethinking process resulted in a series of new"quasi- public" institutions to provide capital for smalland growing companies. In 1974, a group of communi-ty activists led by State Rep. Mel King had proposeda $10 million Community Development Finance Cor-poration (CDFC), to invest in businesses in poor com-munities. Dukakis had endorsed the idea during his'74 campaign, and in 1975 the legislature had passed

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the bill (but failed to app. Jpriate aby .noney). King'sgroup had gone on to develop proposals for :lever?'other quasi-public capital funds and had convincedDukakis to create a Task Force on Capital Forma-tion, which it hoped would endorse them.

The task force documented three gaps in thestate's capital markets. The first was the gap thatCDFC sought to close: small businesses in poor com-munities found it almost impossil- 'e to obtain bankloans or other capital. Second, the task force foundthat the financial markets were unwilling to take therisks associated with long-term lending to small busi-nesses in general. Third, the venture capital r .arketfor young, growing firms a market that had beenborn in Massachusetts and had propelled the growthof its high-tech sector had almost dried up.

The Dukakis administration and the legislatureresponded to the task force report by fund-ing the Community Development Finance

Corporation and creating three new capital institu-tions: the Massachusetts Industrial Finance Author-ity (MIFA), to issue tax-exempt bonds for businessexpansion projects; the Massachusetts TechnologyDevelopment Corporation (MTDC), to provide seedcapital for start-up technology firms; and theMassachusetts Capital Resource Company (MCRC),to provide debt and equity for growing technologycompanies.

Of the four new agencies, MIFA was the mosttraditional. It has issued over $3 billion in tax-exemptbonds since its creation and claims to have createdmore than 70,000 jobs. In reality, many cf its proj-ects would have gone forward without the tax-exempt bonds; they were bankable deals that tookadvantage of a public subsidy to lower their cost.Nevertheless, compared to other state bond agen-cies, MIFA has established a solid track record. Ithas restricted its bonds for commercial projects (suchas shopping malls) to downt )wn and neighborhoodbusiness districts, for instance boosting downtownredevelopment and avoiding abuses common in otherstates, such as the use of tax-exempt bonds for golfcourses and suburban shopping malls.

In 1985, MIFA began issuing bonds for pools ofsmaller loans, providing low-interest financing tobusinesses that were previously too small to qualify.In 1986, after federal tax reform restricted the use

of industrial development bonds, it was die first statebond agency to issue taxable bonds for small t-usi-ness loans. By securing guarantees from banks (fora fee), MIFA was able to sell the bonds at low in-terest rates, despite the fact that they were no longerexempt from federal taxes.

The Massachusetts Technology DevelopmentCorporation (MTDC) was the second publicventure capital firm established by a state.

(The first was in Conneqicut.) It makes small($100,000-$250,000), early-stage loans and equityinvestments in technology companies that have beenunable to secure sufficient capital from conventionalsources. Its primary goal is to convince private in-vestors to come aboard. By mid-1986, MTDC hadinvested $7.4 million, and its portfolio companies hadraised more than $96 million in private capital.5

In strictly financial terms, MTDC has beenrelatively successful. By mid-'86, it had expe:iencedgains of over $5 million and losses of just over $1million.6 With investments in only 29 active com-panies, however, MTDC can hardly claim to ha;had a major impact on the Massachusetts economy.Its creators could not foresee that in 1978, just asthey legislated MTDC into being, a nationwide boomin venture capital investment would begin trig-gered by a cut in the capital gains tax rate and a moveinto venture capital by pension funds and other largeinstitutional investors. Nationally, net new funds com-mitted to venture capita: would rise from $39 millionin 1977 to $4.5 billion in 1983. By 1983, nearly 60 ven-ture capital firms would call Massachusetts home,and almost 15 percent of a nationwide pool of $12billion would be invested in Massachusetts com-panies.' Against this backdrop, $7.4 million inve;tedin 29 companies does not appear terribly significant.

In response to this development, MTDC hastargeted what it s' considers to be a capital gap:seed funds for start-up companies with lower poten-tial profits than conventional venture capitalists re-quire. It has also launched a Management AssistanceProgram and a Financial Packaging Program to helpentrepreneurs draw up their business plans, iden-tify the likeliest sources of private (or public) money,and make their cases to investors. Accordiag toMTDC, 62 companies used these services in fiscal1985, of which five received "substantial private-

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sector financing." MTDC actually performs an evenmore important service than this, however: todaya significant percentage of all deals it puts togetherare snapped up by private investors, who are reluc-tant to invest the time required to investigate andpackage small ventures, but who will invest afterMTDC has done the spade work. In this way MTDCis not only filling a small capital gap itself, but en-couraging the private sector to do so.

The origins of the third new capital fund cre-ated in 1978, the Massachusetts CapitalResource Company (MCRC), go back to the

early 1970s, when the Massachusetts legislatureimposed a one percent tax on the life insurance in-dustry's gross income (as opposed to profits). Thelegislature was retaliating against the industry for itsrole in financing a campaign to defeat a proposedgradwited income tax. Since then, industry repre-sentatives had complained repeatedly that the taxput them at a disadvantage when competing againstcompanies in other states.

The Dukakis administration was sympathetic. Butit also knew thanks to a study by the New EnglandRegional Commission that the life insurance indus-try in Massachusetts was investing very little in thehigh-tech firms that were so critical to the state'seconomic future. The administration suggested adeal: if you put together a $100 million CapitalResource Company and invest the money over fiveyears in unsecured loans (meaning that no collateralis promised in ca,e of default) to businesses that can-not get affordable money elsewhere, we'll give youyour tax break. The tax cut would be phased in overfive years but only if MCRC met certain targetsfor jobs created and loans granted each year.

The bill also established strict investment criteriaregarding company size, geographic location andownership (a certain percentage had to be in dis-tressed areas, another percentage owned byminorities, and so on). If the fund failed to meet itstargets, the tax cut could be rescinded and the in-surance companies would be required to pay backtaxes. Although the legislation did not spell this out,its authors' intended to force the life insurance in-dustry a huge reservoir of capital to supportthe medium-size, expanding technology firms thatheld the key to Massachusetts future growth.

I

Insurance industry executives were not pleas-ed. Most believed MCRC would fail, they saw it asthe prices they had to pay for a tax break. FosterAborn of John Hancock, who has chaired MCRC'sfinance committee since its inception, still calls thetactic "high level bribery." But he calls the result,MCRC, "an outstanding success." By 1986, MCRChad loaned over $140 million to more than 100 com-panies. The state uses a conservative formula tocount jobs created, which ignores the ripple effectof a growing company on suppliers and service busi-nesses in the area. By that formula, MCRC hadcreated over 8,000 jobs by 1986.8

perhaps the most notable example of MCRC'simpact was one of its first loans, to WangLaboratories. In 1978, Wang was not yet the

giant company it is today. Its sales were $198 milliona year, and the office word processing systems thatwould make Wang a household name had been onthe market only a year. The potential for expansionwas tremendous the company would more thanquintuple its sales in the next five years but thecapital necessary to finance that expansion wasscarce. Banks had refused to give the firm long-termloans, leaving it dependent upon short-term, revolv-ing credit lines. Its primary bank, the Bank of Boston,was threatening to call in a major loan. "At that point,Wang's product cycle was obsolescing every threeyears," explains Aborn. "It was very hard for a bankerto look into the future and see whether long termdebt could be paid off by operations, because opera-tions were changing too rapidly."

MCRC stepped into the breach. It gave Wang aten-year, $5-million "subordinated' loan meaningthat if the company went bankrupt, MCRC would berepaid only after all other lenders had been repaid.Thus protected, Wang's banks came forward withanother $20 million in long-term debt, arid the restis history.

The MCRC loan was not the only factor in thebanks' decision. "This company was moving, and theycould see the handwriting on the wall," says WangAssistant Treasurer Martin Miller. "But there's noquestion that the MCRC loan helped, because youhad $5 million of debt capital underneath them. Thebanks looked at that very favorably. We were a smallcompany. When you can get somebody not only to

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give you long-term debt, but to give it to you on asubordinated basis that's very hard to get at that stagein your growth."

Wang is now one of the nation's 200 largest busi-nesses, with sales in some 150 countries. In 1985its sales were $2.35 billion twelve times the 1978figure. Even after cutbacks in1985 and '86, its workforce had grown from 4,000 (roughly half of themin Massachusetts) in 1978 to 30,000 (roughly 14,000of them in Massachusetts.,) in 1987.

Wang is a dramatic example, but the process hasbeen repeated on a smaller scale more than 150 times.Not all of MCRC's loans have turned into successstories; as of1986, MC RC had written off $8 millionin loans. But the original $100 million investment hadgenerated a profit of $21 million. In the process,MCRC has helped both the life insurance industryand the banks invest in riskier firms. State economicdevelopment officials believe MCRC has not takenenough risks in its lending. From their perspective,which puts a premium on high-risk investments inpoor communities, they have a point. But Abornargues that a conventional lender in the insuranceindustry would be fired for loans as risky as thosein the MCRC portfolio. "We have responsibly loanedover $140 million, and we still have most of our capitalin place to do it again," he points out. "We have doneit at close to marketplace terms, so we have not takenbusiness away from tax-paying companies like banks.There is no other organization in the state which teasdone anything like this."

tirad the state tried to capitalize MCRC itself,it would have found it impossible to raise

I I $100 million ($10 million for CDFC was astruggle). More importantly, a state loan programwould have had little impact on the investmentbehavior of the private sector. MCRC, in contrast,has helped change the investment patterns of anentire industry. Today, Massachusetts life insurancecompanies routinely invest in the previously shunnedhigh-tech sector so routinely, in fact, that MCRChas shifted more than half of its capital into basic in-dustries such as textiles, paper and fish processing,where long-term subordinated debt and equity areharder to come by. MCRC cannot claim all or evenmost of the credit for the life insurance busmess'schange of heart, but according to Aborn and others,

its success was one of many factors that convincedthe insurance executives that they could profitablyinvest in companies like Wang.

The principle involved here that it is far moreeffective to change private investment patterns thansimply to make public loans has since become acenterpiece of state economic development think-ing. (It was already reflected in a few federal develop-ment institutions, such as the Small Business Admin-istration.) The experts call it "wholesaling," todistinguish it from "retailing," or providing directpublic investments. Not all capital gaps can be filledthis way; some areas are simply too risky for all butthe public sector and a few hardy private investors.But as MCRC has demonstrated, wholesaling canbe extremely effective under the right conditions.And as common sense dictates, the impact of areshaped private marketplace, with its billions ofdollars of capital, can dwarf the impact of a few milliondollars in public loans.

Investing in Poor CommunitiesWholesaling has one other advantage: it avoids

altogether the temptation to make public loans forpolitical reasons a temptation that, when indulged,can discredit an entire economic developmentstrategy. Massachusetts experienced this side of thecoin with the Community Development Finance Cor-poration, which lost almost $4 million out of the first$6 million it invested with a third of the loss onone loan made primarily because of politicalpressures .9

To be fair, CDFC's problems were due as muchto the inexperience of its management and the dif-ficulty of its mission investing in firms located inpoor communities as they were to politics. CDFCis an object lesson in the difficulty of finding workablesolutions to the problems of poor communities. Itis also a testament to the benefits of an experimen-tal approach, under which new efforts are carefullyre-evaluated and refocused after their first four orfive years.

CDFC was conceived as a development bank thatwould invest in businesses owned or sponsored bycommunity development corporations (CDCs).CDCs were an outgrowth of the activism of the1960s, particularly in minority communities. The first

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CDCs were created, with foundation funding, to em-power poor communities to give them the toolsto build from within, by creating businesses,rehabilitating housing i nits, and the like. They wererun by boards made up of community members,which hired professional staffs. A few years into theWar on Poverty, the federal Office of Economic Op-portunity adopted CDCs and began pouring signifi-cant funding into them. In the late '70s a few citiesand states launched modest programs to subsidizethem, and by the time the Reagan administration cutoff federal funding in 1981, most CDCs had becomeadept at securing federal, state, local and foundationgrants, particularly for low-income housing develop-ment. Estimates of their number by the mid-1980svaried from 1,000 to 5,000.

CFDC is a central piece of one of the most am-bitious strategies launched by any state to stimulatedevelopment in poor communities. The other piecesare the Community Economic DevelopmentAssistance Corporation (CEDAC), which providestechnical assistance to CDCs, the Community Enter-prise Economic Development (CEED) program,which provides small operating grants to CDCs, andthe Government Land Bank, a real estate develop-ment bank for distressed areas. Since a managementshake-up at CDFC and a shift in focus at CEDAC :n1983, the system appears to be making headway.

CDFC's initial strategy was bathed in idealism:it would invest in firms launched directly by CDCs,to create jobs and generate income for the CDCs.Unfortunately, all five such ventures rapidly failed.The staff then concentrated on funding businessesreferred to them by CDCs, with the requirement thata representative of the CDC sit on the board. Thatstrategy fared only slightly better; by 1986, loss ratesfrom CDFC's first four years were 84 percent, 42percent, 40 percent, and 85 percent.

The problems were manifold. Few CDCs hadthe expertise to evaluate business plans orprovide technical or managerial assistance

to businesses, much less the ability to recruit solidentrepreneurial talent capable of launching new firms.The CDCs "took every disadvantage you could haveand combined it into one marginal businesses, poorwork forces, everything you could imagine," says CarlSussman, director of CEDAC. In addition, small busi-ness people generally disliked the idea of having

someone from a local community organization sit ontheir board and look at their books. The CDFC staffwas not only inexperienced, it never tried to establishrelationships with banks that might also lend to itsbusinesses. Finally, the staff failed to work closelywith businesses after it invested, to help them sur-vive. CDFC's experience quisidy showed that entre-preneurs in poor communities needed much morethan capital, yet neither CDFC nor CEDAC had theexperience necessary to provide adequate manage-ment assistance, nor the resources to hire first-rateconsultants to do the job. Ironically, an evaluationdone by a consulting firm in 1982 concluded that whileCDFC's presence had stimulated the formation ofmany CDCs, it had distracted them away from hous-ing development, their real area of strength, to busi-ness development, a field in which they generallyfailed.

After receiving the report, tile board firedCDFC's president. In the interim, withan ac-ting president from the administration of Ed

King, Dukakis's successor, it made a $1,325,000 in-vestment to save one of the largest employers hi thealready depressed town of Adams. The administra-tion calculated that if Adams Print Works closed, itwould cost the community 900 jobs, a number largeenough to create intense pressure to save the plant.Political pressure was even brought to bear on thefederal Small Business Administration principallythrough Rep. Silvio Conte, who served on the Housecommittee that oversaw SBA appropriations toreverse its decision not to guarantee a bank loan tothe company. The SBA had insisted that the newowner put $200,000 of his own money into the deal,to insure that he was at significant personal risk.Despite hi,' refusal to put more than $12,500 of hisown money at risk, it bent under the politicalpressures and the deal went through. Eighteenmonths later the company went belly-up anyway, tak-ing CDFC's money with it.

In 1983 the board hired Charles Grigsby, arespected black venture capitalist, as CDFC's newpresident. Grigsby had served as a lending officerand vice president at the Bank of Boston, then found-ed the Massachusetts Venture Capital Corp., aminority enterprise small business investment com-pany (MESBIC). For nine years he had run the only

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minority investment fund in the state; during that timehe had provided the initial capital for the only black-owned bank in New England (in which CDFC alsoinvested heavily).

Grigsby made a series of changes at CDFC. Heminimized the role of CDCs in business development,eliminating the requirement that a CDC represen-tative sit on the board of each company receivingCDFC money. At the same time, he shifted 50percent of CDFC's investments to low- andmoderate-income housing, an area in which CDCsplayed central roles. He negotiated an agreementwith CEDAC that gave CDFC responsibility for alltechnical assistance on business investments andCEDAC the responsibility on housing deals. Heestablished working relationships with the bankingcommunity, bringing banks in on every deal he could.(In such an arrangement CDFC normally providesequity and/or subordinated debt, playing a role similarto MCRC's in the Wang deal.) He launched a loanguarantee program, through which CDFC (afterevaluating the company) guarantees 50 percent ofthe shortfall on bank loans of $50,000 or lessthereby making it easier for companies to securethose loans. And he began riding hard on firms inwhich CDFC invested, as a private venture capitalistwould.

In several major deals, including the black-ownedbank and a minority-owned supermarket (the largestemployer in Boston's black Roxbury neighborhood),Grigsby used CDFC's stock to force out the oldmanagement and bring in new people who turned thebusinesses around. With smaller companies, he sentthe owners to entrepreneurial training courses,brought iii experienced business advisoi to workwith them, and forced them to develop and meetweekly business plans detailing how much would beproduced, how much would be spent, and how muchwould be brought in.

"Companies consider that torture," Grigsby says,"but I consider it technical assistance. To me, it's theonly way to make a small company work out it'sthe only thing that's worked ;n three years here andnine years in venture -apital. It's like AlcoholicsAnonymous: you've got to go in there and confess.I tell them, You're going to write these six checksthis week you sign one more and I'm going to cutyou off."

ithough losses from CDFC's first five yearshave reached almost $4 million, the new port-

_folio assembled since Grigsby took overhas been profitable. Investments made in his firstfull year, fiscal1984, have experienced a six percentloss rate, although Grigsby expects them to hit 10-12percent eventually. (Profits on other deals wouldmore than compensate for such losses.) That figureis appropriate for an institution designed IJ takegreater risks than private banks; were its loss rateslower, one might argue that it was not taking enoughrisks. Indeed. community development activists attimes make that argument today. Certainly comparedto the overall failure rate for small businesses,CDFC's new portfolio is performing well.

CDFC's turnaround under Grigsby demonstratesthe importance of finding experienced investmentpeo2le to run public or quasi-public developmentagencies. Mort; importantly, it shows how criticalhands-on assistance is if small businesses are to suc-ceed. Even if it continues to improve, however,CDFC is too small, and its geographic target is toolarge, to have a significant impact. It has invested$16-$17 million since 1978, and its current portfoliois about $7 million. (Grigsby has tried unsuccessful-ly to get the legislature to recapitalize it with $12million, so that he can launch several new programsand sustain about $3 miiiion in new investments eachyear.)

CDFC's most important function today is probablyas an intermediary between the commercial banksand poor communities. "The tanks now come to uswith deals that they can't otherwise do, but they thinkought to bz: done," Grigsby explains. These areprimarily deals which app,ar sound to the banks, butwhich fall outside the relatively conservative stan-dards they must use to evaluate loans becausethe loans are not fully secured by collateral, for in-stance By subordinating its debt or handling the non-secured portion of the loan, CDFC makes it possi-ble for the banks to take part of the loan. Thus it stret-ches the boundaries of what the private financial com-munity can do in poor communities. It is also buildingthe capacity of CDCs to do low-income housingdevelopment (in Boston, they undertake virtually allsuch development) by providing financing that is dif-ficult to get from banks. CEDAC appears to havefound its niche in housing development as well.

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m he other major player in Massachusetts' com-I munity development system is the Govern-

-1 ment Land Bank, which is essentially a realestate development bank for distressed areas.1° TheLand Bank was originally created by the legislaturein the mid-'70s to help redevelop the military instal-lations closed down by the Nixon administration. Inthis role, for instance, it bought the 140-acre SouthBoston Naval Annex from the federal governmentfor $4.7 million, sold it to the city of Boston'sEconomic Development and Industrial Corporationon a long-term mortgage, and provided resourcesto help transform it into a Marine Industrial Park thatemployed almost 1500 people by 1985.

In1980 the legislature broadened the Land Bank'smandate to deal with three new categories of prop-erty: surplus federal property, surplus state prop-erty, and blighted or substandard propertiesthroughout the state. Today the Land Bank investsprimarily in the six geographic areas, called "Targetsof Opportunity," on which the second Dukakis ad-ministration has focused its economic developmentefforts. Although it has more resources than CDFC(by the end of 1986 it had spent rpugbly $32 millionand had close to $20 million in funds still available),the Land Bank is hampered by the fact that real estatedevelopment requires more capital than small busi-ness investment. With its limited resources, the LandBank has tried to develop a wholesaling strategy bydoing pilot programs which can then be duplicatedby others. In the early 1980s, for example, it initiateda program to rehabilitate abandoned buildings for af-fordable housing; it even pushed a tax bill throughthe legislature to make rehabs more attractive. A;:w years later the Boston Housing Partnershipa consortium of Boston's major banks, the city,several foundations, CDFC, and Boston's CDCslaunched an extensive rehab effort, which has sincebeen replicated statewide by the Dukakis administra-tion. More recently the Land Bank launched aprogram to develop low- and moderate-income co-operative housing, to demonstrate the viability ofhousing coops to others active in the marketplace.It has also rehabilitated commercial buildings in dis-tressed urban centers, provided mortgages for in-dustrial facilities, and financed a small-businessincubator in Fall River. A legislative commission onsmall-business incubators has proposed that it run

a statewide incubator program.The Land Bank invests in partnership with the

private sector, normally sharing a first mortgage witha bank. The Land Bank also makes certain dealspossible for a bank by pi oviding the expertise need-ed to evaluate them "pulling down the learningcurve" for the bank, in Bassett's words. Over thepast decade, it has participated in 35 deals. Only oneof them has gone bad, a $1.5 million loan to a com-pany that restored and reopened a large dry-dockfacility cicsed by Bethlehem Steel in 1982. When theproperty was sold, however, the Land Bankrecouped its loss.

Like CDFC after its reorganization in 1983, theLand Bank's success is mitigated LI its smallsize and large target area. Between the two

institutions, they have invested close to $50 million,spread over about 75 firms and projects. DespiteCDFC's ea.-ly failures, the bulk of the money has beenused wisely, and the state is better off for the invest-ment. Few of the businesses and real estate projectsin which they have invested would have found suffi-cient private financing without them. Their successtells us something about the possibilities of develop-ment institutions in poor communities, while theirlimits tell us that Massachusetts has not yet foundthe best models.

The basic problem is that investing $50 millionin Massachusetts' poorer communities is a bit liketossing a pebble in the ocean. There is a small splash,a bit of a ripple, and silence. Even if the scale werelarger, the system is not really doing what its creatorsintended: building the capacity for ertrepreneurialdevelopment in poor com:nunities. CDFC buildscapacity in individual small businesses, while the en-tire network builds the capacity of CDCs to develophousing. But there is no institution or program thatsystematically builds the capacity to createbusinesses.

Hindsight and experience elsewhere suggest thatthe state might have been wiser to use its $50 millionto finance a comprehensive development institutionin each of the primary Targets of Opportunity. Suchan institution might make conventional bank loans,business loans, venture deals, and real estate in-vestments, while also providing job training, creatingincubators, providing hands-on assistance to local en-

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trepreneurs, and so on." It is impossible to saywhether such an effort would work until a state triesit. But Massachusetts is in many ways the perfectstate to try A: it has the resources, the personnel,and the experience necessary to guide theexperiment.

The King Interregnum

Governor Dukakis lost the Democratic primaryin 1978, a victim of the business community's anger,the anti-government, anti-tax mood that swept thenation in the high-inflation years of the late seven-ties, and the alienation of his own party's left wing.His challenger, Ed King, promised a dramatic reduc-tion in local property taxes, and as governor heenthusiastically supported Proposition 21/2, whichaccomplished that feat. King preserved the newsystem of quasi-public agencies, although he triedseveral times to kill CEDAC axed CEED. 12 King alsopresided at the creation of an important new quasi-public agency, the Bay State Skills Corporation(BSSC).

Bay State Skills is a job training agency, originallytargeted at a shortage of engineers in the state butbroadened when the shortage abated. Job trainingin Massachusetts, as in other states, had long beenfunded primarily by the federal government, throughmore than a dozen different categorical grants. Tothis day the training system in Massachusetts con-sists of 25 separate programs administered by fivesecretaries and two boards most of it funded, andtherefore controlled by the federal government.Although there is pressure from the legislature andthe governor's Office of Training and EmploymentPolicy to rationalize the system, it remains frag-mented and thanks to severe federal budget cin recent years underfunded. Within this chaotic,$370-million system, the Bay State Skills Corpora-tion has emerged as a small, $6-million-a-yeargem. 13

The core of BSSC is a grant program. in whichthe agency matches corporate grants of money, timeand/or equipment to training institutions to set upnew training programs. The institutions includeeverything from graduate schools to vocational-tech-nical schools. BSSC also funds special institutes,again on a matching basis with industry, through

which instructors from academic institutions can learnabout emerging technologies from industrial experts.

BSSC staff members look upon themselves asventure capitalists in the training arena. By offeringstart-up capital (grants are often for 100 percent ofthe first year's costs, 50 percent of the second, anda small portion of the third), they act as catalysts.bringing business and academic institutions togetherto create new training programs that respond to gen-uine demands in the marketplace. Many state train-ing programs are hopelessly out of date, trainingpeople for jobs that no longer exist on equipment thatis no longer used. Yet it is politically difficult for statesto force vocational-technical schools and communi-ty colleges, which do much of the training, to changetheir programs, because that means shutting downcourses and firing instructors. By offering outsidefunding that the academic institutions want, BSSCstaffers argue, they gain leverage, which they canuse to force changes in the curriculum.

The Bay State Si ills Corporation is a demand-driven program that is, it funds only thosetraining programs the business community

is willing to help pay for, and therefore genuineiyneeds. As a result, it is remarkably efficient. Withina year after completing their training, 87 percent ofits trainees find jobs and that figure includeswelfare recipients, dislocated homemakers, thementally rc tarded, and other disadvantaged popula-tions served by BSSC. (The sponsoring firms arenot required to hire the trainees, but they normallydo.) The program's efficiency also stems from itsstatus as an independent, quasi-public agency ratherthan a traditional government bureaucracy, accord-ing to staff members. This independence allows itto operate like a business paying its bills on time,making decisions quickly, and generally talking thelanguage of the private sector.

One caveat must be added, however. Demand-driven programs like BSSC always tend to skimthose who are most job-ready, because they are theeasiest to train and place. In BSSC's case, thistendency is counterbalanced to some extent by itstraining programs for the disadvantage,I. But evenso, BSSC misses those in between the extremes:the working poor; and the unemployed who do not

22

fall into a "disadvaluaged" category, but who also lackthe educational background needed for many ESSCtraining programs.

Bay State Skills could probably be expanded toreach the populations it now misses, using a princi-ple :_t has already adopted: the less job-ready thetarget population, the lower the financial match re-quired from the participating business. By all ac-counts, the model works for even the least job-readypopulations. Its success is reflected not clly in itshigh placement rate, but in the fact that five otherstates have already copied it.

The Second Dukakis Administration:Tcrgets of Opportunity

Dukakis defeated King in the 1982 Democraticgubernatorial primary and was re-elected in thegeneral election. For much of his second term,Massachusetts would enjoy the lowest unemploy-ment rate of any industrial state." In this environ-ment, the instincts hat shaped Dukakis's first fouryears to channel growth into the state's decliningurban centers were far more appropriat:. Whengrowth is no longer the fundamental issue, the loca-tion of growth can be.

With some city centers already rebounding,Dukakis shifted from an urban to a regional focus.The organizing principle of his second term becamethe use of every means available to shift the state'srapid growth into what he called his "Targets of Op-portunity": southeastern Massachusetts, the North-ern Berkshires (northwestern Massachusetts), theNorthern Tier (north central Massachusetts), theBlackstone Valley (the Worcester area), Monta-chusett (the Fitchburg and Gardiner areas), andRoxbury.

Rather than creating a formalized program,Dukakis has followed the ad hoc pattern of Es

...first term, trying to bend every aspect ofof state government to favor his targeted regions.When the legislature was deciding where to put anew Microelectronics Center, Dukakis fought hardfor Taunton, in southeastern Massachusetts. (Helost, but the front-page attention helped Taunton fillits new industrial park and bring its unemployment

rate down from 13.9 to t.5 percent in three years,according to the mayor.)15 Every few months thegovernor led a group of Massachusetts business ex-ecutives on a tour through one of his distressedregions, working to convince them to channel theirexpansion into those areas. He encouraged the for-mation of regional development organizations, withassistance and, at times, money from the state. Hefunded new State Heritage Parks, on the Lowellmodel, in eleven other cities. He secured $12 millionin state funding for a publicly-owned cross-countryski resort and condominium complex in the mostdepressed part of the Northern Berkshires, to bebuilt by a private developer who plans to invest $260million. He created a special $1 million training fundfor use by businesses moving to or expanding insoutheastern Massachusetts. And whenever a com-pany talked of moving out of a target area, or express-ed interest in moving in, his economic developmentstaff put together whatever deal was necessary tosecure the investment tapping the MassachusettsIndustrial Finance Authority, the other quasi-publicagencies, and other state programs.

"The states are perfect for this kind of thing,"Dukakis argued. "We can't set Federal Reservepolicy, we don't deal with trade policy, but this kindof targeted development in distressed areas issomething that the states are particularly suited todo."' 6

Dukakis even focused his new research-and-development effort, the "Centers of Ex-cellence" program, on the state's distressed

regions. While the state is providing $6 million fora Center for Polymer Science at the University ofMassachusetts at Amherst and $1 million for aPhotovoltaics Center at Logan Airport, the Centersof Excellence program will primarily provide matchingfunds for joint business and academic research proj-ects at the state's universities. This effort so far in-volves three "centers without walls," each with atechnology focus and a geographic target: biotech-nology in Worcester; marine science in southeaster.Massachusetts; and polymer science, primarily atthe University of Massachusetts campuses inAmherst and Lowell. The board has also proposeda fourth center in applied technology not for R &D,

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but to help small and medium-size businesses mod-ernize their production facilities and adopt newtechnologies.

In their first round of grants, announced in thefall of 1986, the centers awarded a total of $1 millionto 21 projects, matching roughly $2 million in industryand academic contributions. Dukakis has proposed$3.8 million in state funding for the Centers of Ex-cellence in fiscal 1988. Still in its formative stages,the program is insignificant compared to similar ef-forts in other states, such as Pennsylvania's BenFranklin Partnership. But it has the potential to movein the same direction.

The Commission on the Future ofMature Industries

The other major economic policy initiatives of thesecond Dukakis administration came out of a com-mission that the governor set up in 1983 to negotiatea compromise solution to the nettlesome issue ofplant closings. For five years, the AFL-CIO hadpushed for a bill requiring advance notification of plantclosings. Dukakis had traded support for such a billfor labor's backing in the '82 election. Since his re-election, however, Dukakis has been far moresolicitous of business than he was during his firstterm. Rather than try to push through a bill uniformlyopposed by the business community, he created a38-member commission, including leaders from busi-ness, labor, government and academia, to negotiatea compromise. He sought to broaden the issue byalso asking the commission to develop a comprehen-sive strategy to strengthen the state's so-called"'nature" industries.7

At the time, 15 percent of the Massachusettswork force was employed in mature industries, in-cluding machine tools, needle trades, fabricatedmetals, and transportation equipment. Most of theseindustries were located in Dukakis's Targets of Op-portunity indeed, these regions were distressedlargely because mature industries were in decline.According to research by the commission staff,Massachusetts lost only .5 percent of its employmentbase in plant closings in 1982 and '83. But the percen-tages were far higher in Dukakis's target regions.' 8In four western counties, for example, 17 percent

18

of the manufacturing job base was lost in plant clos-ings and lay-offs between 1980 and '85.19

After months of stalemate over the issue ofman-datory notification of plant closings, a handful of theprincipal commission members from business, laborand government met behind closed doors and workedout a deal. Essentially, labor gave up its demand formandatory notification in return for increased bene-fits for laid-off workers. Business in return agreedto formulate a voluntary "social compact" definingstandards of appropriate corporate behavior in plantclosings including 90 days' advance notice, 90 daysof continued health coverage, re-employmentassistance for displaced workers, and severance pay.While the business members promised a private sec-tor effort to convince corporations to sign the com-pact, the state pledged to deny financing from MIFAor the other quasi-public agencies to companies thatrefused to sign. The state also agreed to set up are-employment assistance program offering counsel-ing, placement and retraining services to laid-offworkers. In certain circumstances if a companywent bankrupt, for instance the state would under-write health and severance benefits. And if a com-pany failed to give 90 days' notice, the state wouldpay for extra unemployment benefits.

Politically, the compromise was an important coupfor the Dukakis administration. Labor was pleased,business was relieved to avoid mandatory notice, andwith rapid economic growth filling the state's coffers,few complained that the public was essentially sub-sidizing the deal. Since then, however, neither thebusiness community nor the administration hasmoved aggressively to market the social compact,and many corporations have not signed it. Nor hasthe state enacted any sanctions for firms that signthe compact, take money from MIFA or another stateagency, and later fail to give notice.

perhaps the act's major weakness was its failureto create a financial incentive for businessesto give advance notification. Indeed, it did

just the opposite. Workers whose companies do notprovide 90 days' notice are eligible for supplementalunemployment benefits from the state. Knowing this,firms concerned about their employees often choosenot to give formal notice. While this helps their

24

workers get supplemental benefits, the absence ofnotice (unless given surreptitiously, as is sometimesthe case) hurts the state's ability to respond with earlycounseling, training and placement services. (it alsoexhausted the legislature's allocations of supplement-al unemployment benefits halfway through the1986-87 fiscal year.) A February 1987 report fromthe state's Division of Employment Security notedthat the percentage of employers who gave no noticeinc:eased from 1985 to 1986. If businesses had to payfor supplemental benefits themselves, they wouldhave a financial incentive to provide early noticeas commission members Robert Reich, Robert Zevinand Joshua Posner pointed out in their comments onthe commission report.

0 nce it had reached a compromise on the plantclosing issue, the administration seemed tolose interest in the broader commission

mandate to help mature industries. When the Dukakisadministration chose to leave the commission'srecommendations out of its legislation, Rep. TimothyBassett, then chairman of the House Committee onCommerce and Labor, put them back in. "I had hopedwe would be able to build the skeleton of some kindof reasonable industrial policy," Bassett explains. "Wehad the trauma of plant closings, but the long termway to buffer and change the economy was to createsome different kinds of institutions that could respondover time."

The new institutions included:

the Economic Stabilization Trust, to provideloans to mature firms that are struggling to turnthemselves around;

a Massachusetts Product Development Cor-poration, to provide venture capital for mature firmsdeveloping new products or processes;

an Industrial Services Program (ISP), to helpdislocated workers and to work with troubled firmsseek;ng to upgrade their production technologies,management, and the like;

a monitoring group to analyze economic trendswithin industries and regions, in order to provide theinformation necessary for intelligent intervention;

and an Industrial Advisory Board, with members

from business, labor and gover--ent, to oversee theprograms and advise the governor and legislature onissues related to mature industries.

The administration failed to create the kind ofquality economic monitoring function called for by thecommission, and it took two years to organize theMassachusetts Product Development Corporation.But the Industrial Services Program has performedwell. It has set up 46 Worker Assistance Centersin areas where there have been substantial lay-offs

hiring laid-off workers as counselors or outreachspecialists, to make it easier for dislocated workersto use the program. ISP claims this has given theprogram the "highest participation rates in the coun-try." It boasts a placement rate of 78 percent, at 85percent of previous wages or more.2°

The Economic Stabilization Trust andBusiness and Financial ServicesProgram

The most interesting pieces of the ISP package,from an economic development perspective, are theEconomic Stabilization Trust (EST) and the Businessand Financial Services (BFS) section of ISP, whichtogether form a fledgling industrial extension serviceand turnaround bank. EST is a $6 million quasi-publicloan fund, which makes high-risk, low-interest loansto turn around declining firms in mature industries.Between June of 1985 and August of1987, EST made19 loans for roughly $4.4 million. More important thanthe money, however, iF its four-member B'isinessand Financial Services (BFS) staff, which has workedw ith more than 180 companies over the same period.As former BFS and EST Director William Curlierputs it, 'The money is the bait that gets people tocome to you. But then having the opportunity to giveadvice is much more valuable ."21

Currier is a businessman who specializes in turn-arounds. Over the 13 years before he came to EST,he had bought, turned around and sold three com-panies. (After leaving EST in 1987, he bought afourth.) Adamant that BFS use only experiencedbusiness people, he hired a staff with expertise inmanagement, corporate finance, and marketing. Bylate 1986 they were getting inquiries at the rate ofnearly one a day, many from firms that were already

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insolvent or filing for bankruptcy. The calls came fromcorporate owners, from managers, from consultants,even from union members. In i.esponse to an inquiry.a BFS staff member would try to get to the plantwithin 24 hours, to begin analyzing the c,,inpany'sproblems. After a thorough diagnosis, the staff wouldsuggest a variety of remedies, from new manage-ment to new marketing strategies to new products."We take the attitude that there is nothing that can'tbe done, until the heart stops beating," Currier ex-plained. "You've got to be creative and innovative,and you can't take no from anybody."

The experience of Savage Arms, a manufac-turer of rifles and shotguns near Springfield,demonstr- es what happens when the pro-

gram works. In 1985, Savage Arms was on its death-bed The plant was operating with a skeleton staff.Its major bank, Fleet National, was about to call itsloan. Two other local arms manufacturers had filedfor bankruptcy, making other banks extremely reluc-tant to lend. "There was an incredible list of prob-lems," says Currier. "Potential pollution problems,an IRS suit, a Department of Revenue suit, a poten-tial suit against the accountants, the messiest situa-tion you ever saw."

Currier and hit. staff worked closely with the firmfor a year analyzing their problems, trying to con-vince bankers to make loans, talking with potentialinvestors. Eventually the firm found new investors.Over a five month period they, Currier, and FleetNational Bank worked out a deal. Currier insistedon a series of conditions, including new management.When they were met, both EST and another of thestate's quasi public finance agencies made loans. Ayear after the buy-out, Savage Industries as it hasbeen renamed employed 400 people and was aim-ing for sales of $25 million a year. "The company isprofitable, the jobs are secure, and the volume is up,"Currier reported.

EST's purpose to save companies on the vergeof collapse takes it further out on a limb than anyof Massachusetts's other quasi-publics. A November1986 report explained its philosophy:

While we know some of our loans are boundto fail because they are high risk, we analyze

20

the financial contributions of the work force,the local community and the Commonwealth'srevenues which the companies make by remain-ing in business for an additional six months toone year. If we feel the contributions outweighthe amount of the loan and that there is areasonable chance of the loan being repaid, welend the funds. Obviously, this is a risky anddifficult business.

Unfortunately, the Mature Industries Commis-sion failed to insulate EST from political pressures,which makes its investment strategy even riskier.The five-member EST board, which makes all lend-ing decisions, is appointed entirely by the governor;it includes both the secretary of economic affairs andthe director of the executive office of labor. EST isdependent for its funding on annual appropriationsfrom the legislature, unlike the previous generationof quasi-public agencies. This gives legislators enor-mous leverage when they want a loan for a companyin their district.

In its second year, the board bowed to politicalpressure and loaned $1.5 --Mon a third of itsentire portfolio to a company it had originally

turned down. Nine months later, the company an-nounced that it was closing anyway. This was themirror image of the Savage Arms story, a poignantexample of what can go wrong when public invest-ment funds are not well enough insulated frompolitics.

The firm, Morse Tool Company of New Bedford,was an important employer in a depressed comr ni-ty. it had been the beneficiary of a long struggle byits union and the local community to keep it aliveincluding a threat by the mayor to seize it by emi-nent domain when Gulf & Western, its former owner,announced plans to shut it down. Its supporters hadbecome extremely adept at pulling political strings.

When the EST board first turned down MorseTool, a local union official immediately went to thegovernor's office. A state representative from NewBedford had already introduced legislation for aspecial appropriation of $1.5 million. With the unionmounting an effective lobbying campaign, thelegislature voted the special appropriation and the

26

board reversed its decision against Currier'srecommendation. When the owner refused to imple-ment one of Currier's principal conditions for the loan

that he hire an experienced turnaround specialistto manage the situation the board again relented.

U'Alike the Adams Print Works loans at CDFC,however, all EST loans are personallyguaranteed by the company's owner. This

guarantee gave EST enough leverage to force theowner to look for a buyer for the company, ratherthan simply selling off the plant and equipment. Whenhe received bids form two companies, the Dukakisadministration urged the bankruptcy judge to choosethe firm that planned to keep the pant open, eventhough it had offered at least $100,000 less thananother bidder. The judge agreed, and EST rolledover its loan to the new owner. At this writing, then,EST has once again saved 375 jobs in New Bedford

showing just how resourceful government can bein this kind of situation.

Morse Tool's new owners may be able to turnthe company around. Even if they do, however, ESThas set itself up for pressure fr- .1 every legislatorin the state. Eventually, political pressure can kill aprogram like EST. Before Morse Tool closed, threeout of 16 EST loans had gone bad. EST had beenrepaid on one of the three during ailcruptcy pro-ceedings, and total losses were only about $200,000.The program is expected to incur losses at this level,but more experiences of the Morse Tool type couldprompt the legislature (or a new governor) to takea second look. Precisely that happened to a muchlarger program in Alaska, the Alaska RenewableResources Corporation. Dependent on biannual ap-propriations from the legislature, it invested moreto prop up failing firms than to sr -1 new industries

its ostensible purpose. When the losses piled up,it was shut down.

EST is too valuable an experiment to suffer thesame fate. It offers a vivid example of the wrong wayto structure a public capital fund. State governmentsshould provide enough capital for a fund to operatefor five to ten years, then get out of the way. Theyshould also make sure appointments to the board arespread out between the governor, the business com-munity, and labor.

)operative Regional IndustrialLabor-tories

Anotner program funded by ISP deserves men-tion: a small, experimental effort called theCooprative Regional Industrial Laboratories (CRIL)program. Launched by the Executive Office of Labor(EOL), it was designed to involve dislocated workersin economic development efforts to revive their com-munities.22 "The basic idea was that nobody pays anyattention to what the workers know in these situa-tions," explains Michael Schippani, the former E DLstaff member who initiated the effort. "We thoughtthey ought to be at the table. I want the workersinvolved in decisions about where their industry isgoing."

In the Greenfieid area of western Massachusetts,where there had been a series of lay-offs in themachine tool industry, the project funded a joint ef-fort of a group of dislocated workers and the FranklinCounty Community Development Corporation. Call-ing themselves the Machine Trades Action Project,they surveyed the skills of the work force and foundthat a third of the workers expressed an interest instarting their own businesses. As a result, they triedto get funding for a small business incubator, and theyhelped launch an entrepreneurial training course of-fered by ISP's local Workers Assistance Center. Theyalso brought in engineering professors from theUniversity of Massachusetts at Amherst to help localmachine shops upgrade their technology and hireda local businessman to market their products.

In Fall River, a similar Needle Trades Action Proj-ect initiated a new training program, hired an engineerto work with local companies to upgrade theirtechnology, put together marketing campaigns,brought new conti acts to Fall River, and functionedas an informal early warning system to alert stateand local officials when firms are in trouble.

Both of these were creative efforts, with .,ignifi-cant potential. But because they were not partof a larger administration strategy, they had

little access to significant resources or state pro-grams. When the Machine Trades Action Projectdecided the Greenfield area needed an incubator,there v-- , no state incubator program to which it

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could turn. When it wanted to bring engineering pro-fessors in to work with area firms, there was no stateprogram to fund such efforts. Given these obstacles,CRIL's significance probably lies less in its specificaccomplishir.nnts than in its demonstration thatworkers can contribute a great deal to local economicdevelopment programs if they are included.

CRIL's fate demonstrates the importance ofcreating a comprehensive economic developmentsystem, as opposed to a series of innovative but un-coordinated economic development programs. CRILand efforts like it would flourish if a system existedthrough which the administration could build on theiraccomplishments. Consider, for instance, the poten-tial of a system made up of a economic developmentcenters in each of at least six regions. These centerscould coordinate virtually all of Massachusettsdevelopment efforts. They could act as windows forthe quasi-publics; they could house staffs for theregional Centers of Excellence; they could sponsorsmall business incubators; they could create atechnology transfer or industrial extension serviceprograms, to work with small and medium-size busi-nesses. The state could move its Jobs Training Part-nership AA (JTPA) staffs and its small businessassistance enters into the regional centers. Onecould even imagine adding an entrepreneurship train-ing program to work with people who operated orwanted to start a small business, a regional labor-management committee to promote workplacerestructuring along more cooperative lines, or aprogram to assist worker buy-outs and worker-owned firms.

Under this kind of arrangement, local groups suchas the CRIL projects in Greenfield and Fall Riverwould have access, through the regional economicdevelopment center, to all state resources. Thoseinvolved in any local initiative would know exactlywhere to go to get help on the local level. Similar-ly, local business people would have access to vir-tually every economic development tool offered bythe state, simply by walking in the door of theiroriginal center. Those who came in looking for capitalbut also needed entrepreneurship training and in-cubator space, or those who came in looking for in-cubator space but could benefit from contact with alocal professor with expertise in their area oftechnology, would be referred to the right people.

To ensure that the centers were tied into localresources and efforts, their boards could be madeup of local business, labor, government, academicand community representatives.

The Dukakis administration has proposed areorganization that would take a small step in thisdirection. To suggest that it do more may seem uto-pian. But as we shall see, major portions of thesystem outlined above are already working inPennsylvania.

The Impact of Massachusetts'Economic Development Proams

What impact have the state's programs had onthe economy? This is difficult to quantify. There isno objective way to disaggregate the effects ofgovernment programs from the other variablesoperating to influence economic growth. Moreover,progress in economic development must be trackedacross decades, not years. Many people creditDukakis for Massachusetts's turnaround, becausehe was governor when it happened. The reality ismore complex.

Massachusetts' period of rapid growth began in1976 and '77, before the Dukakis programs were inexistence (and, by the same token, before Proposi-tion 2 1/2, to which conservatives often credit theboom). The engine behind that growth as nearlyeveryone knows, was technological innovation. Be-tween 1975 and 1981, high-tech firms generated 81percent of the manufacturing jobs created inMassachusetts. Although multiplier effects vary fromregion to region, one rule of thumb says that everynew manufacturing job generates two other jobs elsewhere in the economy. Computer-related servicesgrew even faster than high-tech manufacturing.23

Many of these high-tech industries were born inthe 1950s. During and after World War II, the DefenseDepartn ent funded the development of one of theworld's first computers appropriately named"Whirlwind" at the Massachusett3 Institute ofTechnology. A generation of graduate students cutth,ir teeth on Whirlwind and its successors, then leftacademia to create the hardware and software com-panies that have made Route 128 famous. When MITPro fessorJohn Donovan studied 216 high tech com-panies in the greater Boston area, he found that 156

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of them had been born in MIT departments orlaboratories. 24

Credit must also go to the pioneers of venturecapital, particularly the founders of AmericanDevelopment and Research, the nation's first ven-ture capital firm. Other factors included a concen-tration of quality higher education institutions and a.nattractive quality of life. Defense spending continuedto play a role as well: when it declined after the Viet-nam War, Massachusetts fell into the worst reces-sion of any industrial state; when it doubled underReagan, the state's economy shifted into overdrive.(It is worth noting that high taxes, which prevailedbefore Prop. 21/2, did not prevent the boom.)

When pressed, Dukakis administration officialsadmit that they have had little impact on overallgrowth rates in the state. They do claim credit,however, for creating changes in the regional pat-terns of growth: the success story in Lowell, theemerging growth of southeastern Massachusetts andthe Worcester area, the revitalization of many olderurban cores. Again, the claim is difficult to evaluate .

New industry is clearly moving into southeasternMassachusetts, but a few miles away in Rhode Island

where the Dukakis programs are unavailablea nascent boom is also underway. Similarly, Man-chester, New Hampshire, not far from Lowell, nowhas the lowest unemployment rate of any Americancity. 25

Logic suggests that much of this growth is a prod-uct of the same regional boom, which has graduallyradiated out from its hub in Boston. Within thisregional economy, Dukakis has no doubt brought in-

vestments into communitie, that would otherwisehave been avoided by the private sector. Despite thelimitations of his strategy, he has had a visible impacton cities like Lowell and Taunton. But travel furtherthan an hour away from Route 128 and the successstories fade suggesting that much of the creditmust go to the Boston regional economy. Dukakishas certainly helped areas like the NorthernBerkshires, but he could have done far more had hetaken a more pro-active, systematic approach.

After a decade of ad hoc experimentation,Massachusetts has the rudiments of a firstrate economic development system. The

task now is to re-evaluate, redesign, and reconstruct.In a way, Massachusetts suffers from having beenfirst. When Dukakis and his staff hammered out theirbasic approach, there were few models in otherstates from which to learn. Ten years later, manyof their programs have been in effect long enoughthat both their strengths and weaknesses are con-spicuously evident.

This maturity creates enormous opportunities,however. Massachusetts has so many tools in placeand so much experience with economic developmentin poor communities and declining regions that it isperfectly positioned for a major step forward. By re-examining its programs and then carefully forgingthem into a coherent and comprehensive system, itcould take the effort to create growth in poor com-munities to a level never before achieved in thiscountry.

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91.

CHAPTER III:

PENNSYLVANIA

In 1979, when Republican Governor Richard Thornburgh took office, the shoehad begun to pinch in Pennsylvania. The state had lost 175,000 manufacturingjobs in the seventies. Its unemployment rate was the seventh highest in the

nation. Per capita income had fallen below the national average. And the worst wasyet to come: between 1978 and 1985, the steel industry would lose nearly 50 per-cent of its 200,000 jobs, while steel production would fall 57 percent. As a group,the state's 40 largest corporations would eliminate 600,000 jobs half their 1979total. In January 1983, as Thornburgh began his second term, unemploymentwould hit 14.9 percent.'

Thornburgh had vowed to make economic development his priority. Unlikemost governors, however, he decided to commission an L-depth study of thestate's economy before he launched any new programs Called Choices for Penn-sylvanians, the study took two years and solicited input from citizens in meetingsthroughout the state. It then served as the "polar star," to use Thornburgh'sphrase, which guided all of his administration's efforts.

To staff the Choices process, Thornburgh chose his Office of Policy and Plan-ning, which was run by a young midwesterner named Walt Plosila. Plosila spentfour years directing the policy office, then moved over to the Commerce Depart-ment, where he implemented many of the new programs he had designed. Duringhis eight years in the administration, Plosila dreamed up 90 percent of Thorn-burgh's economic development initiatives. His creativity and blunt persistenceearned him respect from both sides of the aisle, something rare in Pennsylvania'slegislature.

Dtiring the seventies, Pennsylvania had reliedon smokestack-chasing as the heart of itseconomic development strategy. It had in

fact won the premier smokestack-chasing prize ofthe seventies, a Volkswagen Rabbit plant in theprocess depleting its principal loan fund, the Penn-sylvania Industrial Development Authority, forseveral years.2 But early in the Choices process,Plosila came across David Birch's research on therole of new and small businesses in job creation. Hechecked the data for Pennsylvania and found thatlarge corporations were contracting so rapidly thatall net new jobs in the state were being created bysmall firms.3 Relying on Birch's evidence about theinsignificance of corporate relocations, the Choicesstudy rejected smokestack-chasing and stressed theimportance of new and small businesses. It recom-mended that Pennsylvania seek to modernize its ex-isting manufacturing base and diversify its economy,

25

particularly through the growth of advancedtechnology companies. It also called for new part-nerships between the public and private sectors, aswell as between state and local governments.

Based on the Choices report, the Thornburgh ad-ministration reversed the state's traditional economicdevelopment priorities. Its top priority became themodernization and growth of existing businesses; itssecond became the birth and expansion of new busi-nesses; and in third place came the selective recruit-ment of new firms, particularly in advancedtechnology industries.

Thornburgh's first wave of efforts, undertakenwhile the Choices process was nearing completion,focused on small business. The administration con-vinced the legislature to simplify and lower small busi-ness taxes. The Commerce Department set up aSmall Business Action Center to help businesses dealwith red tape, permits, and the state's various

30

bureaucracies. The administration put up a smallmatching grant to secure 13 Small B'isiness Develop-ment Centers funded primarily by the SBA, to pro-vide technical and management assistance. And thegovernor won passage of legislation to amend thepowers of the Pennsylvania Industrial DevelopmentAuthority (PIDA), which made long-term, low-interest loans to industry for land and buildings. Oncedevoted almost exclusively to large manufacturingcorporations, by 1984 half of all PIDA loans went tobusinesses with 50 or fewer employees.4

The Ben Franklin PartnershipAmong Pennsylvania's greatest strengths, the

Choices report noted, were its universities and itsreservo;r of technological expertise. Pennsylrani-.graduated more engineers than all but two Jtherstates. It had four universities among the nation'stop 50 graduate research institutions, with exper-tise in robotics, computer-assisted design andmanufacturing, electronics, computer science, andadvanced materials. It ranked fifth among the stateson three related measures: the number of scientistsand engineers in the state, the number of workersemployed in advanced technology industry, and theamount spent on research and development. But thestate had failed to capitalize on these assets. The kindof interaction between business and academic institu-tions that had kicked off explosive growth inMassachusetts and in California's Silicon Valley wasmissing in Pennsylvania. Thornburgh and Plosilamade the creation of that kind of environment theirprimary goal.

The vehicle was the Ben Franklin Partnership,designed primarily by Plosila and passed by thelegislature in 1982. The Partnership is essentially amatching grant program. The heart of the programoffers "Challenge Grants" to university-based proj-ects funded by businesses primarily appliedresearch projects. The idea is to provide a carrot toget industry and academia interested in workingtogether on research that might result in a marketable(or improved) product or process.

Several years ago, for instance, a professor ofbiochemistry and biophysics at the University ofPennsylvania, Britten Chance, developed a new typeof nuclear magnetic resoname machine that per-

formed a specialized form of brain and body scan.It could measure the brain metabolism of prematureinfants; it could diagnose peripheral vascular disease(such as hardening of the arteries) in adults; it couldeven evaluate the level of physical conditioningachieved by an athlete. Chance launched a companyand poured his own money into it, but finally reachedhis financial limits. He then applied to the Ben FranklinPartnership, which responded with $330,000 inresearch grants over three years. In 1986 the firm,Phospho-Energetics, Inc., raised $4 million in ven-ture capital. "In five years time," says its president,Roger Wheatley, "we would hope to be a $100 millionmedical instrument company. Without the BenFranklin Partnership, this company would not have.been commercialized. It's the perfect example thistechnology exists at the university, and the state pro-vides some money to get that technology out of theuniversity, into the marketplace."5

While the majority of the research projectsinvolve young, entrepreneurial companies,many also fund efforts to help older firms

adopt new technologies in order to remain com-petitive. When the Partnership was created, a debateraged among advocates of industrial policy over thewisdom of targeting sunrise versus sunset industries.Wisely, Plosila and Thornburgh chose to target both.To underscore their commitment, they adopted theterm "advanced technology" rather than "hightechnology." "What we see in advanced technologyis not simply another Silicon Valley," explains Thorn-burgh. "We see new technology clusters emerging,but of equal importance, we see the spinning in ofnew technology into our traditional industries."

In addition to research, the Partnership alsoawards Challenge Grants for education and trainingprograms and for entrepreneurial development ac-tivities again requiring a private sector match. Ex-amples of the former include programs to train publicschool tea- hers in computer literacy; a center to trainindustry personnel in computer-assisted design; andinternships in industry for vocational education in-structors. Examples of the latter include feasibilitystudies for small business incubators; technicalassistance for small businesses; efforts to start"enterprise forums," in which local venture capitalistsmeet regularly with entrepreneurs who need risk

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capital; and grants to Small Business DevelopmentCenters .6

The program is operated through four Ad-vanced Technology Centers (ATCs), each ina different region of the state. Each center is

affiliated with a major university or universities, butevery higher education institution in the region iseligible for grants. Each center focuses on two tofour technology areas, depending upon the economicstrengths of local universities and the region. Theyinclude robotics; advanced materials; computer-aideddesign and computer-aided manufacturing (CAD/CAM); microelectronics; biotechnology; biomedicaltechnologies; sensor technologies; manufacturing inspace; food and plant production processing; and coaland mineral production and processing. A board madeup of reg ,vial leaders from academia, business,government, and economic development organiza-tions oversees a staff of 10 to 20 at each center.

Rather than imposing a model on each region, thestate allowed each board to craft its own design.Predictably, several of the universities assumed thatthey could use the money as they would any otherresearch dollars: to finance basic research of interestto their faculty. During the first year, the central BenFranklin board rejected both Penn State's and thePhiladelphia center's proposals and sent them backto the drawing board whereupon a state legislatorfrom the Penn State area ti :'_:d to have Plosila fired.To force the centers to focus on projects of valueto business, the board decided to make them com-pete with one another for funding, based on the com-mercial potential of their projects.

The process works like this: every spring eachcenter submits a package of applications for ChallengeGrants, which the state board rates according tocriteria such as potential commercial application;number of jobs created; size of the company (thereis a bias toward small firms, on the theory that largecorporations do not need as much state help); numberof colleges involved in the proposal; and quantity andquality of the private sector match. The rating systemalso ranks the centers according to how well theirpast projects have done on measures such as jobcreation, corporate match, and attraction of venturecapital. Centers with higher average ratings get moremoney. They can then divide their allocation up as

they wish providing smaller grants for some projectsthan originally proposed, for instance, to make themoney go further. Though a few grants have beenin the $300,000 range, most end up under 00,000.7

In its first four years the Ben Franklin Partner-ship funded close to 1,500 projects, which involved128 of the state's 135 higher education institutionsand 2,500 private firms. With its $77 million inChallenge Grants, the state claimed to have leverag-ed $281 million in other investments, the majorityof them from private industry. According to theThornburgh administration, this made the BenFranklin Partnership the largest and most highlyleveraged state technology program in the country.8

While Challenge Grants remain the heart of thePartnership, the Thornburgh administration and thelegislature have added a series of other programsover the past four years. For instance, businessesthat are too small or too new to invest the time andmoney required by a joint business-academic proj-ect can apply for Small Business Research SeedGrants of up to $35,000 a year. This program wascreated in 1983 to make sure that any company, nomatter how small, could take advantage of thePartnership.

Asecond new program, created in 1984, pro-vides $17 million for loans to small business

...incubators. At that time, Pennsylvaniaalready had the most extensive network of incubatorsin the country; by mid-'86, the Partnership hadassisted 27 incubators, providing $4.2 million inChallenge Grants for feasibility studies and servicesto incubator tenants and over $1.5 million in loans.(PIDA had !oaned another $1.7 million to mcubators.)9In 1986 the program was amended to allow grantsas well as loans to incubators in distressedcommunities.

Early experience with the Partnership and withthe incubators underlined how little venture capital

particularly seed capital was available in Penn-sylvania. To address this problem, a third initiativeallocated $3 million for seed venture capital funds,to be linked to the Advanced Technology Centers.The state put together four pots of $750,000 eachand offered them to private venture capitalists whowould match them with at least $2,225,000 each anduse the total for seed capital investments in the

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region. Each Advanced Technology Center "invested"the money as a limited partner in the fund, and willuse its share of the profits for more Challenge Grants.A second round of financing added another $1.5million, divided between two of the originalguarantees and a new fund, in Pittsburgh.' °

The North East Tier AdvancedTechnology Center

Perhaps the best way to understand the BenFranklin Partnership is to take a close look at oneof its centers. The North East Tier AdvancedTechnology Center, at Lehigh University, is oftenconsidered the best of the four although in 1986-'87it placed second in funding, behind the ATC ofSoutheastern Pennsylvania. With a strong engineer-

g school, Lehigh has long enceuraged professorsto work with local businesses, even to start their owncompanies, and Lehigh professors were quick tocapitalize on thc new program. Lehigh's location inBethlehem is also apt; Bethlehem was once a boom-ing center for coal mining and steel production, twoindustries that have all but died in the region. AsBethlehem Steel retrenched, and Mack Truck movedmuch of its prr'liiction south, manufacturing employ-ment in the Lethlehem-Allentown-Easton area fellfrom 107,000 in 1980 to 78,000 in 1986.11

The region's history as a major industrial centerhas shaped the ATC's approach. "Our first priorityis to help the existing industries be competitive," saidformer director Michael Bolton in 1984. "That's whywe call our program advanced technology, not hightechnology. We think the biggest users are going tobe the traditional finns."12

The North East Tier ATC spends 60 percent ofits $7 million annual budget on applied researchgrants, funding roughly 50 projects a year. Examplesinclude research and development on software forautomated manufacturing; automated work cells forindustry; a new recreational vehicle; a new processfor recycling tires; a digital vision system to providequality control in manufacturing; a new design for in-dustrial furnaces, allowing them to burn the region'shigh-sulfur coal; a process to create better visual im-ages of tumors in nuclear magnetic resonance spec-trometers; a computer -aided design process for

Mir

cosmetic bottles; and the introduction of computerto monitor the flow of paper through a large press.' 3

0 ne of the biggest success stories is a firmcalled Polymer Dynamics, which producesshock-absorbent footwear, gloves, and

headgear inserts, as well as industrial vibrationdampeners and related products. Run by BM Peoples,a former car dealer, Polymer Dynamics parlayed a$150,000 grant from BFP into several million dollarsin venture capital and a plant that employs almost100 people. "I met Bill Peoples in the local high schoolgym," remembers Lehigh President peter Likins,who tells the story well.

His kid's a wrestler, my kid's a wrestler. Hiskid was having trouble with his knees, and Billwas complaining about the knee pads, shakinghis head because they just didn't seem to makea knee pad that was compact enough so thatit wasn't an impediment to the athlete's motion,but properly protected the knee from the im-pact of colliding with the mat.

Bill had been a car dealer and sold his facility,and he was hanging around the gym. He startedtalking to people, and he had this bright ideathat he could make a better knee pad. He gotsome polymer products and he got one madeup, and he was going to go into the knee padbusiness. Then the Ben Franklin programbecame visible to him, and he thought, 'Ma,I'll go over there and get some of those pro-fessors, who must know something aboutpolymers, to give me a hand.'

So he connected with the Ben Franklin pro-gram, and he found that his polymer formulawas nonsense, but that there was expertise onthis faculty in polymers that would enable himto devise a product that had the resiliencewithout the bulk that he was looking for. He diddesign a good knee pad he's selling them allover the country and the knee pad led to allkinds of shock absorbers for athletes, shoe in-serts, and now shock absorbers for machines.He's got a plant in the Lehigh Valley IndustrialPark, he's negotiating to buy one of the buildingsfrom the steel company, down here in SouthBethlehem, he's negotiating with the Koreansfor a shoe deal, and he's got serious money fromNew York venture capital interests. The guy

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is just exploding. That's an example of some-thing that probably would not have succeededif Bill hadn't coupled with the faculty. He didn'tsucceed because Ben Franklin put money intohis operations, but Ben Franklin provided forhim the linkage to the faculty, and provided thefaculty a mechanism for working with this crazycar dealer who was trying to start a polymerpiano 4

The Lehigh center's second most importantarea is technology transfer and education. Thecenter funds seminars and workshops on new

technologies for industry people. When a companyrequests specific help, one of the ATC staff takesa look and assigns it to a school. Sometimes it is justa matter of a few days of consulting; at other timesthe company ends up proposing a Challenge Grant.

Perhaps the most active participant is Lehigh'sComputer-Integrated Manufacturing (CIM)Laboratory, which works with about 25 companiesa year, on projects that receive about $2 million inBFP money. The CIM Lab sponsors short coursesfor industry people intensive, five-day seminars onthe latest CAD/CAM technologies, for instance. Butmost of its BFP-funded projects send teams of facultyand students into plants to examine production pro-cesses and help companies adopt new technologies.

These projects range from simple efforts tocreate networks through which all the computer-driven machines in a plant can communicate, to com-plex, year-long campaigns to redesign entire factoryfloors. According to Lab Director Emory Zimmers,a Lehigh professor, most large companies can affordthese services on their own. But with matchinggrants from the Ben Franklin Partnership, small andmedium-size companies can afford the lab's servicesas well.

One typical client makes a sensing device usedto measure pressure or meter the flow of materialin a manufacturing process. Over seven years itsplant had shrunk form 3,500 employees to about 700,as foreign competition ate into its markets. To keepthe plant open, the firm desperately needed to getits costs down. With a $200,000 Ben Franklin grantpaying for about half of the R and D work, the CIMLab sent a team of people in to design a new produc-tion process with 18 robot cells (each cell consistingof one or more robots, plus attached equipment), all

linked by computers. The CIM engineers tested thedesign of the robot cells, as well as the design of theentire factory, through graphic simulation on com-puters. By the time half the robot cells had been in-stalled, the firm had driven its cost per unit belowthose of its competitors.

These projects not only help individual companies,they also help the engineers involved advance thefrontiers of factory automation. "Without these ap-plied research projects," says Zimmers, "there's noproving ground for new, innovative ideas. We reallydo both at the same time when we're doing the short-term project, we are also interacting with the fac-tory and creating new ideas about how factoriesshould run. The factory is our laboratory."15

The North East Tier ATC's third focus is en-trepreneurial assistance. Its staff played a rolein creating the region's new seed capital fund,

which is now housed in its building. It also runs oneof the only "product development" incubators in thecountry an incubator that is limited to start-up firmsinvolved in creating new products. The incubator oc-cupies one building out of eight in a vast researchcomplex that Lehigh University recently bought fromBethlehem Steel, which had been vacating space asit trimmed its research staff. (The state contributed$10 million to make the purchase possible.) Theuniversity plans to expand the incubator into two orthree buildings and use others for a corporateresearch park.

With ten tenants, the incubator offers space atfar below market rates. It also provides a free con-ference room, free computer and computer-aideddesign facilities: shared secretarial services, aphotocopy machine, and access a group of legal, ac-counting, financial, marketing and insurance firmsthat come to the building and offer free consulting.An ATC staff member with decades of business ex-perience has an office in the building and providestechnical assistance of many kinds.

The first generation of tenants spanned afascinating spectrum of advanced technologies. Onewrote computer programs for industrial clients.Another developed the first non-toxic paint stripperon the market. A third developed a new trap for bagworms, which are difficult to eliminate with chemicalpesticides. A fourth wrote software for large clothing

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manufacturers that were adopting computer-integrated manufacturing systems. And a fifth didbiotechnology research to develop new methods toclean up hazardous materials.

For Al Austen, the incubator provided the pushhe had long needed to leave Bethlehem Steel,where he was a research engineer, and start

his own company. Called Innovare, Austen's com-pany does contract research on advanced materials

metals. ceramics and polymers for manufac-turing firms. Austen uses super-cold processing ofmetal powders to create alloys with qualities that can-not be obtained under traditional hot processesa combination of strength and flexibility, for instance,or resistance to corrosion, or conductivity. Withceramics, he works with high temperatures andpressures to produce superior products. In thecourse of his research, he and his team alsodeveloped a programmable, computer-controlledhydraulic press, to extrude (shape) both hot and coldmaterials. Innovare began selling small versions ofthe press in 1987, while developing a marketing planto sell to large manufacturers.

"Our market niche is to serve the sophisticated,rapidly solidified, powdered metallurgy industrycomposites, new deformable ceramics, and so on,"Austen says.16"For those operations you need a newgeneration of processing equipment, and that's whatwe see our role as providing." Because this nicheis on the cutting edge of new technologies, Innovarehas little competition and boundless potential. In 1987it had six employees. "We could be three or four timesas big today if over the last six months I'd been threeor four people, and been able to simply answer re-quests," Austen said. If he succeeds in selling largehydraulic presses to industry, he will build a factoryin the area.

By early 1987, Innovare had received two BFPSeed Grants of $35,000 each, while researchers atLehigh with whom Austen had contracted had re-ceived close to $80,000 in Challenge Grants. (Austenmatched those grants with about $250,000 of In-novare money and equipment.) Without the BenFranklin money, Austen says, he would not haveundertaken the joint research projects with Lehigh:"It wouldn't be affordable. That's part of the feature

of the program to make technology affordable to thesmall company."

Ron Thomas, the founder of Polar Materials, Inc.,also got an invaluable boost from the incubator andthe Ben Franklin Partnership. But Thomas pointsout the program's limitations as well. While theLehigh ATC was instrumental in PMI's research andstart-up phase, it was not terribly helpful when itcame to teaching a scientist how to manage a rapid-ly growing business. "We were very naive as busi-nessmen," Thomas says. "And the kind of problemsthat come up in all these companies are very similar.You're dealing with very, very bright people who aretechnically trained but who don't understand the busi-ness side."17 Because the ATC relied primarily onacademic people for technical assistance, it was oflittle help. Thomas's solution was to bring in a part-ner with a strong business background.

The Western Pennsylvania ATC, in Pittsburgh,has developed an interesting solution to theproblem Thomas describes. It subsidizes

several institutions that provide intensive businessassistance, from experienced business people, tofirms like Inn ovare and Polar Materials. One, calledThe Enterprise Corporation, has four senior staffpeople with graduate degrees and extensive busi-ness experience. They sort through 150-odd busi-ness plans every year, pick 10 to 15 of the mostpromising, and go to work helping entrepreneursrestnicture their business plans, raise venturecapital, find partners for joint ventures, do marketresearch, develop marketing strategies, and so on.Typically, they spend six months to a year worxingclosely with a company and some firms come backlater for another round.

The Enterprise Corporation does this work forfree. Occasionally, to make sure a firm genuinelyneeds its help, it asks for a small equity stake in thecompany. The firms are generally too young to af-ford any other form of payment. "No one could makea living doing what we do for fees," says Thomas Can-field, president and CEO of the corporation. "Wefigured out one year that the average salary of theheads of the companies we had helped was$14,000."18

Canfield and his colleagues also sponsor a bi-

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monthly forum in which firms present their businessplans to venture capitalists and a Software Entre-preneurs Forum, in which over 120 software firmsmeet quarterly to address issues specific to theirindustry. They hold conferences, seminars and anannual venture capital fair that attracts dozens of ven-ture firms from outside the region. And in 1985 theyput together the Pittsburgh Seed Fund, one of thefive regional seed funds that received BFP moneyfrom the state.

Another local organization partially funded by theBFP is the Pittsburgh High Technology Council(PHTC). PHTC sponsors publications and studiesto document the growing high tech presence in Pitts-burgh, as well as conferences and meetings to buildthe network. It runs a CEO Network, for instance,through which local CEOs act as mentors for start-up firms. That group has in turn created a $10 millionCEO Venture Fund, for second- stage venturecapital. In 1986, the Ben Franklin Partners Fp offeredit $625,000, which the fund matched three-to-one,to create a subsidiary fund targeted at seed capital.

Evaluating the Ben FranklinPartnership

The Ben Franklin Partnership is probably themost comprehensive economic development institu-tion in the country. If an entrepreneur needsinexpensive start-up space, Pennsylvania has 30incubators, more than any other state. If he or sheneeds technical assistance, each center offers severaloptions. If research is the problem, Challenge andSeed Grants are available, or the ATC staff can helpthe film apply for a federal grant. If capital is the prob-lem, both seed and traditional venture capital fundsare available. If the company needs debt rather thanequity, the ATC can refer them to local bankers whospecialize in their area, or the right state or regionalloan fund. If an older company needs new technologyto survive, teams of experts are available to help."One thing leads to another," explains Walt Plosila."We're trying to build the kind of informal networkyou see in places like Route 128 and the SiliconValley."' 9

Equally important, these services are availablelocally. A business person does not have to travel

to Harrisburg to deal with any of them. In fact, a busi-ness person is hardly aware that he is dealing witha state program. Most of the services theresearch, the technical assistance, the analyses ofproduction processes, the venture capital are notirovided by state programs. The state simply offersa carrot, a matching grant, to help business peopleuse academic resources, or create seed funds, crfinance incubators, or provide technical assistance.Once those resources are in place, the ATCs essen-tially operate sophisticated referral services. The ob-ject as it should be is to change private sectorbehavior in ways that stimulate innovation andproductivity.

The Partnership might have been even strongerhad the legislature passed a Technology AssessmentProgram proposed by Thornburgh in 1986. The ideawas to provide more money ($6.25 million in the firstyear) for the kind of work Emory Zimmers' laboratorydoes with Lehigh Valley manufacturers. Pennsylvaniaalready had a program, which dated from the 1960s,through which eight "technical specialists" at PennState campuses helped small businesses with infor-mation and referrals to university or private-sectorconsultants. But Thornburgh's new TechnologyAssessment Program would have gone much further.It would have provided on-site consulting, low in-terest loans for the purchase of new equipment, andhands-on assistance in integrating that equipment intoproduction lines and training workers to use it.

Supporters of the Ben Franklin Partnershipargue that the proof of its value is the amountof money that business has put into Ben

Franklin projects. In the program's fifth year of opera-tion, private corporations matched $26.45 million inChallenge Grants with roughly $20 million in cash and$48 million in equipment, laboratories, stall time, andthe like. (Another $40 million came from othersources, including the universities, the federalgovernment, and foundations.)2° "Those folkswouldn't be putting their money on the table if itwasn't working for them," says Lehigh PresidentPeter Likins.

BFP enthusiasts also note that firms receivingBFP grants attracted $61.4 million in private ven-ture capital during the programs first four years .21

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"This is not something we thought about that muchwhen we designed to program," says Plosilz. "Buta lot of venture capitalists see us as an imprimatur,because we're turning down three projects for everyone we fund, and we have review committees at eachof the centers. It's a fairly selective process, so we'redoing some of the weeding and screening for theven-ture people. You have to look at this in perspective.In 1983 there was $31 million raised in Pennsylvaniain its entirety for venture capital, and I'm sure mostof it went out of state. Then along comes BenFranklin, and we've got $61 million in our projectsfrom venture firms all across the nation, all in Penn-sylvania."

The Ben Franklin Partnership is also designedto change academia. "The program is a success asa culture transformer," says Likins. "It creates a dif-ferent kind of environment in universities. In 1982perhaps 25 percent of the research money comingto our faculty was from the private sector, and 75percent was from the federal government. Thefederal money has grown, but the state and privatesector money is growing much more rapidly togetherthey now fund half of our research activity. That'sa real shift because the state money is not comingin here to finance a faculty member's exploration ofthe inner workings or their personal curiosity. It'scoming in here to finance a faculty member's pursuitof a concern that has its roots in some company."

Initially, adds Professor Zimmers, some pro-fessors at Lehigh feared that the program wouldmove academic research 'too much from the `R' tothe 'D.' But in reality it helps to focus the researchon more critical issues, both long and short term.People who don't have any contact with industry tendto create a cure for no known disease. They Traskthat by saying, 'Well, I'm 20 years ahead of my time.'In reality, their time never comes."

Another intangible factor is the program's role inmobilizing local business, academic and governmentpeople to work together in new ways. By requiringthe involvement of many players in local boards andconsortia, the state has attempted tc generate a pro-cess that will gather momentum on its own. Becauseit has allowed these local players to shape each centerto fit the region, it has succeeded in very differentenvironments.

fir% he program is not perfect. Not all the centersare equally vital, for instance. Because of therural nature of its territory and its lack of

historic orientation toward the private sector, thePenn State center has lagged visibly behind theothers. Conversely, the other centers could prof-itably use double the money they now get, becausethey each turn down as many solid proposals as theyaccept.

Critics argue that some of the centers havebecome too dominated by the universities. RonThomas, who now sits on the local board whichoversees the Lehigh ATC, feels that Lehigh Univer-sity has gained effective control of the program. Asa result, he says, the research money is too directedtoward academic interests, and participating busi-nesses are suffocating in red tape and bureaucracy."Right now I've got one university (BFP) grant, andif I want to expend over $100, I have to have fivesignatures," Thomas says. 'That would take me atleast six weeks to two months. You fall into thebureaucracy of the university, and it prohibits youfrom accomplishing anything."

Thomas also points out that the universities haverefused to give up their patent rights on any researchtheir professors conduct. Companies sponsoring theresearch have to sign licenses to use the results.Because of this, "as soon as a company like ours getsinto any kind of position of financial strength, it cutsoff that university research, because they're notabout to share their patents with a universityresearcher."

Thomas believes the Partnership would havemore impact if 73 percent of ite funds went to busi-nesses and 27 percent to academics, rather than theother way around. He points to the incubators andprograms like the Enterprise Corporation in Pitts-burgh as the real BFP success stories. "I know a lotof people who would like to start a company and can'tbecause they haven't written a good enough pro-posal," he says. "It's pretty darn easy to write a goodproposal if you're at the university. That's what you'vedone all your life, and you're tapped into all the BenFranklin people. There's a big buddy system."

Others, such as Peter Likins, disagree withThomas. But even Likins agrees that the programhas one glaring weakness: its use of the number of

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jobs created by each project as a major determinantof funding. The Ben Franklin Partnership is notdesigned to create jobs in the short run; it is design-ed to create new products and processes, to heightenproductivity, and to increase the number of start-upcompanies spun off by Pennsylvania universities. Ifthose goals are met, jobs will follow in the long run.Yet funding is partially determined by short-term jobcreation, and the public is told that the Partnershipis a jobs program.

The dangers are twofold. First, when judgedstrictly as a short-term jobs program, the Partner-ship is not terribly impressive. It claims to havecreated or preserved only 10,664 jobs in its first 48months. And second, even that figure must be takenwith a grain of salt, because it is simply impossibleto factor out the impact of Ben Franklin grants onjob creation. In most cases the BFP is just one ofseveral investors. In others BFP intervention mightdestroy jobs in the short run, but save a companyin the long run. "We've received a fair amount ofmoney from the Ben Franklin community," saysThomas. "How can I go back and say that moneycreated these jobs? rve got the jobs, I got the money,so if you want to say that this money created thesejobs, go ahead guys. That's what's happening."

"I think it is dangerous to put the centers in theposition in which they have the impression that themore jobs they report creating or, worse, saving themore money they get," adds Likins. "Because thesethings are very difficult to document accurately andhonestly."

Walt Plosila and the state board recognize theseproblems, but insist that job creation figures arenecessary to get support from the legislature. Plosilaalso argues that the program errs on the conservativeside in counting jobs, if anywhere. Still, virtually theonly negative publicity that the Partnership receivedcame when the Philadelphia Inquirer traced down twocases of exaggerated job claims in an early pressrelease. (The jobs were not counted in subsequentBFP totals.)22

Despite these objections, the Ben FranklinPartnership is recognized throughout the na-tion as a model program. It is comprehen-

sive; it is decentralized; it catalyzes significant private

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investment in important economic activities; and ithas mobilized major local players in new ways. It isalso focused on important targets: the commercial-ization of research, transfer of technology fromacademia to industry, the generation of venturecapital, the birth of new firms, and the integrationof advanced technology into mature industries. Itscontinued success will depend upon the state board'sability to resist the constant pressure from the univer-sities to use the money for basic research, newbuildings, and the like. But the anecdotal evidencesuggests that, to a surprising degree, the board hasdone so. The result is argyably the best single stateeconomic development program in the country.

Pennsylvania's LocalDevelopment Districts

Although Ben Franklin projects have involved 128colleges, community colleges and universities, mostof the program's impact has been, and will continueto be, in areas with major universities. For outlyingareas, the Thornburgh administration created a secon' regional economic development system.

In 1981 the Reagan administration tried to do awaywith the Appalachian Regional Commission and theEconomic Development Administration, which werefunding seven Local Development Districts in Penn-sylvania regional organizations encompassing 52of the state's 67 counties. These organizations wereessentially consortia of local governments which ex-isted to tap federal grant money. Generally held inlow regard by economic development experts, theyspent most of their federal money on highway con-struction and social service programs.23

Budget Director David Stockman's attacks onARC and EDA got Plosila and his staff thinking aboutthe Local Development Districts (LDDs). "Wedecided if these things were going to survive, theywere going to have to be more self-sustaining," Piosilaremembers. "We decided either we would make themaction-oriented in economic development or get ridof them."

The first step was to reroute the federal ARCmoney, over which state governments have a greatdeal of control. Plosila decided to use it to create anew Pennsylvania Capital Loan Fund, for low-interest

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loans of up to $50,000 for busimsses with 50 or feweremployees. The money was designed to be used for"gap financing" to put in the final amount when tradi-tional bank loans, SBA-guaranteed loans and/or otherstate loans were not :Lite enough to make a deal go.Over its first five years, the Pennsylvania CapitalLoan Fund received roughly $7 million in ARC funds,$1 million in EDA money, and almost $30 million instate funds. The state also encouraged the localdistricts to create revolving loan funds of their own(the EDA had also begun to move in this direction),using local government funds, federal block grantmoney and the like. Some districts now have as manyas eight revolving fundr, divided between businessand housing loans. Finally, the state helped the LDDssecure designation as SBA 503 Certified Develop-ment Companies, which allowed them to offer financ-ing through a key SBA program. 24

The next step was a program to help businessestap the nation's largest single market: pur-chases by the federal government. The state

provided funds to train procurement specialists, whocould help small and medium-size businesses landfederal contracts. Next came an export assistanceprogram, along similar lines. Meanwhile, the LDDstaffs some of which are as large as 50 weredeveloping the expertise to provide more generalmanagement assistance.

The Local Development Districts also work withthe Ben Franklin Partnership. They refer companiesto the Partnership, help write their grant proposals,and at times receive BFP grants themselves. Mostof the districts have helped create smallbusiness in-cubators. Several of them function as ServiceDelivery Administrators under the Job Training Part-nership Act, and some have initiated localand regionallabor-management committees. Several have alsobeen instrumental in saving local rail lines abandonedby Conrail. One of the LDDs bought ant rehabilitated80 lines of rail, created an independent Rail Author-ity, and contracted with a short-line railroad companyto operate trains on the line. Another helped a privatefirm buy 100 miles of abandoned lines, which it nowoperates profitably.

The performance of Pennsylvania's LocalDevelopment Districts is mixed. Some have large,

professional staffs and have earned the respect ofbusiness people throughout their regions. Others arestill struggling to make the transition from social ser-vices to economic development. Some of their loansgo to companies that could not get capital elsewhere;others are simply exploited by firms with plenty ofaccess to private capital, because they want6-percent interest rates. "If you look at all the port-folios," admits Ivan Tylawsky, who administers theprogram at the state Commerce Department, "you'llprobably find that they cover the entire range. Someare high risk, some are very safe, some are in be-tween."

The LDD loan funds might be more productiveif some of them were used to cataly1 e. the creationof private-sector institutions to fill the gap betweenbanks and venture capital. (For the possibilities ofsuch a wholesaling strategy, see the Michiganchapter.) Tylawsky points out, howeva, that the loanfunds do function as a carrot; they give the LDD staffscredibility and bring local business people in to seethem. Once a relationship is established, the staffcan help in more important ways, with exports orfederal procurement or management consulting.Tylawsky also argues that the loan funds have hadan impact on local bankers. "Word gets around to thebankers that somebody's loaningmoney to companiesthey're turning down," he explains. "It gets them totake a second look. It's a catalyst on the local scene.You're teaching them how to make money on theloans they're turning down, and your staff is doinga lot of the work necessary to make the business suc-ceed, saving the banker a lot of trouble."

Tylawsky believes that the most important thingabout the LDD system is precisely that it isa system,rather than a single program. Like the Ben FranklinPartnership, the LDDs provide a wide range of ser-vices at the regional level. In the bestcircumstances,they can provide local business people with financ-ing, technical and managerial assistance, aid in land-ing a government contract or exporting a product,or access to a job training program. They can referthem to incubators for inexpensive start-up space,or to the Ben Franklin Partnership for researchgrants, consulting on new technologies they mightneed to remain competitive, and on down the list.

In addition to being comprehensive, the systemis decentralized. Unlike most state bureaucracies the

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LDDs are hands-on organizations, whose staff mem-bers can make quick decisions. They act as in-termediaries between the state and local businesses,delivering services funded by the state but maintain-ing the flexibility of local institutions. The best oneshave enough money to be credible and enough pro-fessional expertise to make a difference in theirregions. In effect, they play the role of local public-sector entrepreneurs, just as the Ben Franklin ATCsdo. This is a role missing in all too many stateeconomic development efforts.

The MILRITE CouncilPennsylvania has long had a reputation as a state

with poor labor-management relations. The realitywas not as bad as the image, but the image keptmanufacturers out of the state. In 1978, leaders ofthe AFL-CIO and the Chamber of Commerce satdown to discuss the problem. Out of those discus-sions grew a proposal for a business-labor-goveln-ment council, funded by the legislature, to work onimproving both the state's labor climate and its overalleconomy. They called it the MILRITE Council, anacronym for "Make Industry and Labor Right in To-day's Economy" and a spin on "millwright" the termfor those who built America's mills.25

The MILRITE Council began by working to formarea labor-management committees and local, in-plant committees to improve cooperation betweenlabor and management, to heighten labor's role indecision-making, and to increase productivity. Thelegislature then appropriated $500,000 a year formatching grants to area labor-management commit-tees and asked the MILRITE Council to administerthe program. By mid-1987 there were 14 area-widecommittees in the state, which had helped launchsome 50 in-plant committees.

Thornburgh virtually ignored the MILRITECouncil, giving it an annual operating budget -If only$200,000, plus $500,000 for grants to Area LaborManagement Committees. Today the grants are toosmall, in many cases, to allow committees to hireeven one staff person of the quality needed to dealon equal terms with corporate executives and laborleaders. More importantly, Thornburgh neverfocused on the issue of labor-management coopera-tion in speeches, in public appearances, or in pro-grammatic initiatives.

r A he MILRITE Council also focused on plantclosings. After a careful study of the issue,it put together legislation to create a $500,000

revolving loan fund to help workers whose plantswere closing study the feasibility of buying the plants.The proposal was expanded by House Democratsinto a $15 million program, which included financingfor feasibility studies and buy-out loans for bothemployee and community groups. In part becauseemployee buy-outs need equity rather than debt, andin part because the regulations have scared off manyinvestors by requiring that employees have the rightto vote their stock within five years, the money hasbarely been tapped. In 1986 the administration con-vinced the legislature to loosen the regulations (allow-ing grants as well as loans, for instance) and to divertsome of the money to other uses.

The MILRITE Council's other major focus hasbeen pension fund reform to fill the state's capitalgaps. In 1982 the council hired two consultants tostudy Pennsylvania's capital markets. After discus-sions with a wide variety of bankers, venturecapitalists, brokers and the like, they conclud 1:1 thatthe private sector was unwilling to arsume the riskof significant financing in two areas: venture capital(particularly seed capital and funds to purchase andturn around mature firms), and long-term, fixed-ratedebt for established marufacturing firms. The At-torney General subsequently ruled that the pensionfunds did not have the right to make venture capitalinvestments, so the council and the administrationworked out legislation that allowed one percent ofpension fund asst ' or $100 million) to be investedin venture capital.

ByJuly, 1986, the two statewide pension fundshad invested $87 million in private venture

...... capital funds. The strategy unfolded in threestages. First, the pension funds invested $30 millionin five private venture funds with particular ex-perience in Pennsylvania, each of which agreed toa goal of investing half the money in the state. Sec-ond, the pension funds invested in the five regionalseed venture funds created to tie into the BenFranklin Partnership. And third, the pension fundsused $40 mi'lion as bait to recruit a major nationalventure firm to create a new Pennsylvania VentureCapital Fund (also with a goal of investing 50 per-

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cent of Lie funds in Pennsylvania).While Pennsylvania was not the first state to in-

vest pension funds in venture capital (see theMichigan chapter), MILRITE's second initiative tofill the state's capital gaps is unique. It .onvinceda group of public and private sector pension fundsto put $63 million into a "Private Placement SeparateAccount," to be managed by Cigna Corp., a large in-surance company. Private Placement Separate Ac-counts are often set up by insurance companies fortax-exempt organizations. In this case, the moneywill be used to make long-term (up to 15 year) loansof $500,000 to $3 million, at fixed interest rates, tomanufacturing firms with sales in the $20 million-a-year range. Thirty percent of the money will go tofirms with credit ratings of BA, 70 percent to firmsrated BAA. Some BAA-rated companies are able toborrow fixed-rate money from insurance companies,in good times, but most BA-rated and many BAA-rated firms would normally be limited to short-term,variable-rate bank loans.

The PeAdsylvania EconomicRevitalization Fund

During the 1922 recession, House Democrats inPennsylvania asked Gail Garfield Schwartz, aneconomic development consultant (and co-author,with Pat Choate, of Being Number One: RebuildingThe U.S. Economy), to study the state's economy.Garfield Schwartz reached conclusions very similarto those of the Choic's study. 'While traditional indus-tries will still be large employers," she wrot^ elong-run job security and expansion will be di eng-ing industries. Therefore, Pennsylvania mustencourage first formations, expansion in existingindustries, new eziterprise, innovation, retooling, andnew product development."26

The House Democrats then put together a $910million proposal, to be financed by a temporary in-crease in personal income taxes. They called it Penn-PRIDE: The Pennsylvania Program for Reco' ry,Investment, Development and Education. In rougalyequal proportions, the new money would havecreated economic development programs, closed thestate's budget deficit, and funded relief efforts aimedat distressed communitie and the unemployed.

Thornburgh condemned the plan as a traditionalDemocratic tax-and-spend approach. He argued thatit would cost too much, would waste too much moneyon social services, and would fail to leverage privatesector action.27

With the unemployment rate remaining indouble digits, however, the pressure to dosomething dramatic continued to build. In

early 1984, the governor and the House Democratscompromised on a $190-million bond issue thatadopted some of the Democratic initiatives andpumped new money into some of Thornburgh'sinitiatives. Called the Pennsylvania EconomicRevitalization Fund (PERF), the three-year programwas passed by the voters in an Apri11984 referen-dum. Some of its elements have been discussedalready, including:

$15 million for employee and communitybuy-outs;

$20 million for small business incubators ($3million of which was later used to capitalize seed ven-ture funds);

and $15 million in new money for the Penn-sylvania Capital Loan Fund, administered by theLocal Development Districts.

In addition, PERF provided:

$3 million for row engineering equipment atuniversities, which required a three-to-one matchfrom university, business, or other sources;

$5 million in new money for the MinorityBusiness Development Authority, which providesloans and surety bonds (to insure firms that want todo business with the state, such as building contrac-tors) for minority businesses;

$50 7 iillion for a Business Infrastructure Pro-gram, which provides loans or grants to localeconomic development agencies for infrastructureimprovements needed to support business expan-sions or re-locations;

$27 million to upgrade equipment in the state'svocational- technical schools and community colleges;

$15 million to create a Youth Conservation Corpsto employ young Pennsylvanians in projects designedto improve public facilities and parks;

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$10 million to provide loan guarantees and in-terest deferrals on bank loans to family farmers;

and $30 million to acquire, rehabilitate or developfacilities for public recreation or community services.

Several problems developed with the PERF pro-gram. As mentioned earlier, the legislature's regula-tions governing the incubator and employee buy-outprograms restricted their use considerably. In addi-tion, interest rates on loans were tied to interest rateson the bonds, which kept them relatively high. Asa result, the Thornburgh administration later fundLd$105 million of the program with general revenues,and in 1986 it convinced the legislature to amend someof the programs and divert some of the unused fundsto other purposes .28

Targeting Distressed Communities

While Richard Thornburgh str. ,sed statewideeconomic development initiatives more andgeographically targ,ed programs less than MichaelDukakis, he nevertheless built preferences fordistressed areas into many of his economic programs.The most important such effort has been his enter-prise zones program.

Enterprise zones, which have been adopted insome form by at least half the states, originatedprimarily as a Republican idea. Rep. Jack Kemppopularized the idea, and President Reagan pushedfor national legislation. The Kemp-Reagan formularelied heavily on tax breaks as inducements for com-panies to locate in poor communities.

There are a number of problems with this ap-proach. First, most analysis suggests that tax breaksalone are not powerful enough to overcome the disad-vantages f locating in the inner city crime, poortransportation, and so on. Second, much long-termgrowth comes from new firms, yet most federal orstate tax breaks are useless to new firms, becausethey generally do not earn profits that can be taxedcuring their first few years. (This is less true of prop-erty tax abatements.) Third, like most tax induce-ments, those in enterprise zones are indiscriminate.They go to companies regardless of whether theywould have located in the target area anyway andregardless of whether they need thr hence theywaste money. Fourth, even if a critical mass of busi-

nesses were to relocate into a zone, many programsdo not require that they hire even a percentage ofzone residents. Hence the people government is try-ing to help might get the increased congestionassociated with new businesses, but few of the jobs.Finally, and most importantly, the Kemp formula ig-nores the complex web of realities the lack ofeducation and training, the social pathologies, thedearth of entrepreneurial capacity that keeps poorcommunities poor.

Enterprise zones remain popular with politicians,because they are easy to pass and administer, andthey provide the appearance of doing something. Butsophisticated economic development practitionerslong ago concluded that if enterprise zones were towork, they would have to build comprehensive localeconomic development networks in poor commu-nities, tied to broader state and federal resources.In a sense, poor communities need heir own ver-sions of Pennsylvania's Local Development Districts,designed to work closely with businesses to ensuretheir survival and growth and to provide extensiveeducation, training and placement services to poorresidents in the area.

It is ironic that while many Democratic governorshave created traditional enterprise zone pro-grams, Gov. Thornburgh, a Republican, rejected

the tax incentive model. Thornburgh and his staffwere -onvinced by the Choices experience that taxeswere not major factors in most corporate relocationsand that most new jobs came from new and small busi-nesses, not from relocations or branch plants. Hav-ing turned their back on the smokestack-chasingmodel for the state, they did likewise when it cameto enterprise zones. Instead they crafted a programthat provides matching grants to local economicdevelopment partnerships. The administration addeda 1-w tax incentives after the program had been ineffect for several years, but they are not the heartof the program.29

Under the program, communities applying fordesignation as enterprise zones must put togetherEnterprise Zone Coordinating Committees, withpublic and private sector involvement and local fund-ing for proposed project:- (revolving loan funds,incubators, economic development staffs, etc.).Usually the committees involve representatives from

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local government, the local redevelopment authori-ty, elle financial community, community-based organ-izations, and in some cases local labor and/or religiousgroups. Each year, new communities compete fordesignation. They are judged according to the quali-ty of their local committees, proposals and matchingfunds. By 1986-'87, the state divided $6.25 millionbetween 34 zones.

In addition, the state gives the zones priority ina series of other programs, from PIDA loans toBusiness Infrastructure Development grants toDepartment of Community Affairs grants. It alsoallows tax exempt bonds to finance commercial andretail projects, like shopping malls, only in enterprisezones a policy copied from Massachusetts.

While Thornburgh's program is clearlysuperior to the standard model, it is notclear that it goes far enough to have a

major impact. With 34 zones, the money has beendiluted. The most important element of the programis probably that it gives the zones priority in so manystate programs and helps local development groupsforce the state bureaucracy to respond to their needs.But experience suggests that development in manypoor communities, particularly in the inner city, re-quires comprehensive local institutions with accessto significant capital resources. Even the best CDCs,while making a positive impact on their communities,have rarely trigg -ed the kind of chain reaction thatleads to sustainer, self-generating development.

This suggests that Pennsylvania's program mightbenefit from adding an entirely new dimension. Cer-tainly additional grants for weak zones would be awaste of money. But for those zones in which strongorganizations or coalitions are in place, the statemight consider creating a special fund from which itcould provide significant matching dollars, on theorder of $5-10 million per zone, to capitalize com-prehensive local development banks.

The state's most distressed areas are the townsant: cities of western Pennsylvania where steel millsor manufacturing plants have closeddown. What Lowell and New Bedford were toMassachusetts a few years ago, the MonongahelaValley and Beaver Valley are to Pennsylvania today.until his last year in office, Thornburgh virtually ig-nored their problems. When Thornburgh focused his

economic development efforts on advancedtechnology and the universities, people in the Monand Beaver Valleys felt abandoned. When he pushedthrough a $25 illion tax credit for new investmentsby mature industries widely known as the "steeltax credit" it was too late. State legislators fromthe Mid Mon Valley finally introduced a resolutionof no-confidence in the Commerce Department.Though it never passed, it led to discussions betweenthe legislators and the Commerce Department, andfinally to a "Renaissance Communities" program.

The new effort, passed in Thornburgh's last yearin office, involved three basic approaches: heightenedtargeting of state grant programs on distressed com-munities; partial state funding for several big proj-ects in the Pittsburgh area, including a new terminalat the airport and a university research park built onthe site of an old J & L steel plant; and what Thorn-burgh has described as 'super enterprise zones" inthe Mon Valley, the Beaver Valley, and the ShenangoValley (tip: Sharon area, about 80 miles north of Pitts-burgh). TI e thid effort, the heart of the program,involved $1 million grants to public-pnvzte economicdevelopment coalitions in four areas (the Mon Valleywas divided into two regions). As in enterprise zones,the grants were designed to stimulate the formationof area-wide organizations, to help them hire staff,and to support their strategies for revival. In addi-tion, the state promised to expedite all applicationsfor specific project grants from these organizations.

Walt Plosila designed the program on the samebasic model he had used for the Ben Franklin Part-nership and the Regional Economic DevelopmentProgram. "We're trying to do a grassroots-up effort,"he explained. "Self-help is what it comes down tr,getting the community together, through a councilthat's an umbrella agency, representing labor, busi-ness, and local economic development groups, todevelop a long term strategy and then work with uson a day-to-day basis to help implement it."

Each of the four areas has taken a differentapproach. The first to develop its strategy wasthe Mid Mon Valley, where the Mid Mon

Valley Progress Council pulled 16 area organizationstogether into a Revitalization Commission. Projectsfunded by the commission during its first year includea Battelle Institute study of what industries might

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be recruited to the area; an effort to market theregion to those industries; an incubator; 2 successfuleffort to get three enterprise zones established inthe area; a labor-management committee; a tourismcampaign; and feasibility studies looking at the poten-tial reuse of the two largest area plants that haveclosed in recent years. In one of these cases, a hugeWheeling-Pittsburgh integrated steel mill, the com-mission worked hard to find a new buyer who mightoperate a slimmed-downed operation. In this effort,however, it was hampered by the absence of anystate program to help in the restructuring of matureindustries. Its other major priority, a new expresswayto finally connect the area to Pittsburgh by limitedaccess highway, also awaits a major state investment.

The expressway symbolizes the real function ofthe Renaissance Communities program: to help thesteel valleys organize themselves to seize what op-portunities appear as the new Piasburgh economygains momentum. Lowell succeeded in Massachu-setts in large measure because local leaders wereorganized and able to sell their city to the state, thefederal government, and private corporations. LikeLowell, the Mon and Beaver Valleys will survivebased on their capacity to exploit whatever growththe regional economy can produce. "It's 30rt of likegetting organized on both c'''.es of a bridge Pnd mak-ing sure the bridge is in = " says Ivan fyiawsky,who oversees the effc Commerce Depart-ment. "Then the traffic. me across."

To be truly effective, .ae Renaissance Com-munities program like the enterprise

will probably have to be taken to a new &men-sion. One million dollars a year in "glue money" isa start, but to make a real dent, the targeted regionswill need more powerful development institutions.In a sense, these areas need their own equivalentof the Ben Franklin centers: major, long-term, com-prehensive institutions designed to address the prob-lems of mature industries and distressed com-munities while building a new entrepr neurial base.

The Impact of Pennsylvania'sPrograms

As with any economic development program, itis difficult to measure the precise iiiipact of Thorn-burgh's programs. Pennsylvania's economy is clearly

changing in the directions sought by the Thornburghadministration. The economy is diversifying awayform its former reliance on heavy manufacturing,which left it extremely vulnerable to foreign com-petition. Services have passed manufacturing as theleading category of employment, and employmentin computer-related industries is growing rapidly. 3°The state's birth rate for new firms, which unti11985was only about half the national average, has alsobegun to rise; in 1986 it grew twice as fast as thenational average. Also in 1986, unemployment fellbelow the national average for the first time sincethe early '70s and stayed there.

How much Thornburgh's efforts have contributedto these developments is impossible to say. As apolitician, Thornburgh likes to paint such statisticsas the "full flowering" of his programs. Perhaps thebest ant:lote to such claims is a 1984 essay he wrotedescribing his economic development strategy. Inthe introduction, he discussed an analogy drawn byDr. Allan Meltzer of Carnegie-Mellon University:

. . . Dr. Meltzer refers to state govern-ment's role in the economy as that of thesk;pper of a rowboat on a stream. The skip-p.!r cannot change the direction of theriver's current; nor can he, except perhapsin a Don Quixote fashion, attempt to moveup river against that current. What theskipper ca- do is assure that the rowboat ismoving on as straight a course down thestream as possible, rather than towards oneshoreline or the other. He also can row theboac slower or faster. In other words, stategovernments, on their own, cannot moveagainst the currents of national and interna-tional economic forces, but they can at-tempt to steer the ship of the state on anarrow, steady and straight course, takingm:_ximum advantage of these national andinternational economic forces as they affectthe currents.31

That is perhaps the best description of whatThornburgh has done. The Ben Franklin Partner-ship, for instance, is an excellent program, but itsrole is to accelerate developments already underwayin the marketplace and even in that role, .6 im-

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pact will only become clear over a 10-20 year period.Pennsylvania is much better positioned for the 1990sthan it was for the 1980s, and programs like the BenFranklin Partnership have certainly pushed that ad-justment along both economically and psycho-logically. Even Pittsburgh, which has been hit so hardby the decline of the steel industry, is remarkablywell-positioned thanks largely to local public andprivate sector leader ship over the last two decades,but with an intelligent assist from the Thornburghadministration.

The unsolved problems remain the many townsthat once lived off steel, coal, or a single manufac-

turer, and as in other states theurban ghettoes. Thoniburgh's enterprise zones andRenaissance Communities program are betterdesigned than most of their counterparts around thenation, but they must be brought up to scale. Andwhile the state does have some capacity to helpmature industries retool and restructure through theBen Franklin Partnership, PIDA, the MILRITECouncil, and other programs, that capacity falls farshort of the need. Still, Pennsylvania has developedwhat is, at this point, perhaps the best state develop-ment system in the country.

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CHAPTER IV:

0 f the three states discussed in this survey, Michigan has been hit hardestby the realities of the new global economy. Michigan is the nation's premiermanufacturing state; it has the highest percentage of the workforce in

manufacturing of any state in the union. Even if one subtracted the auto industry,durable goods manufacturing would still account for a higher percentage of employ-ment in Michigan than it does nationwide.

The recession of the early '80s devastated precisely those industries that formthe backbone of the Michigan economy. Between 1978 and 1982, the auto industryeliminated 110,000 jobs, and steel eliminated 40,000. The manufacturing workfc:ce as a whole shrank by almost 25 percent, losing 283,000 jobs. For four yearsrunning, Michigan had the highest unemployment rates of any state peaking atover 17 percent. By 1985, there were still 59,000 fewer people working in thestate than there had been in 1979.'

During the recession, Americans were routinely treated to televised images ofMichigan families looking for work in Houston. Indeed, there was an exodus.Between 1980 and 1984 the population of Michigan shrank by 187,000. Per capitaincome plummeted from 103.9 percent of the national average in 1980 to 98.6 per-cent two years later. State tax revenues fell so sharply, in real dollars, that in1983, despite deep budget cuts, the state deficit hit $1.7 billion one-sixth oftotal state spending.2

As the recession began, an informal group of business and education leadersconvened to discuss the state's economy. They believed that the state neededa new economic strategy, that it had to diversify its economy and stimulatetechnological innovation, particularly in manufacturing. They took their argumentsto William Milliken, the moderate Republican who had served as go' ernorsince 1969.

In his State of the State address in January, 1981,Milliken embraced their ideas. He created aGovernor's High Technology Task Force, made

up of leaders from government, academia, the finan-cial industry, and the more technology-oriented sec-tors of the Michigan economy. They proposed anumber of new programs: a new state developmentfund, two new research institutes, and a public ven-ture capital unit using five percent of the state's publicpension funds. With bipartisan support, Millikenpushed these initiatives through the legislature.

When Milliken declined to run for a fourth termin 1982, the recession virtually guaranteed that aDemocrat would succeed him. Labor swung behindJames Blanchard, a reln'vely unknown congressman

from the Detroit suburbs. Blanchard's claim to famein economic matters had been his co-sponsorship ofthe Chrysler loan package, an experience that forcedhim to think about the problems of declining industriesand international competition and made him a believerin government intervention to force business/laborcooperation. Blanchard won the election with a cam-paign that stressed whet he called his three themes:"Jobs, Jobs, and Jobs."

To busimbb leaders' surprise, Blanchardembraced Milliken's initiatives and launched an ag-gressive effort of his own. Michigan turned out tobe the perfect labr,Latory for innovation: times wereso bad that nr, one not business, not labor, notthe public at large could defend the status quo.

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Bianchard's First Year:The Short-Term Agenda

With unemployment at 17 percent and a mandateto create jobs, Blanchard needed quick results. Heset up two groups, one to develop a series of pro-posals, the other to ensure that they had heavyweightpolitical backing. The first was a Cabinet Council onEconomic Development, similar to Dukakis'sDevelopment Cabinet and Thornburgh's EconomicDevelopment Committee of the Cabinet. The secondwas a Commission on Jobs and Economic Develop-ment, chaired by Lee Iaccoca and former United AutoWorkers President Doug Fraser and bringingtogether the state's leading corporate executives,labor leaders, and the presidents of Michigan's threemajor universities. Later Blanchard would also createsirilar commissions on entrepreneurialism and smallbusiness, higher education, and job training.

With an agenda developed by the Cabinet Coun-cil and political support from his new commissions,Blanchard quickly announced a first wave of ini-tiatives. He set up a fund to begin rebuilding thestate's infrastructure. He cut small business taxesby roughly $18 million a year. He lowered unemploy-ment taxes for new employees. He reformed thestate's securities laws, making it easier for companiesto issue stock in Michigan and triggering a burst ofnew public offerings. He rewrote a law that had givenMichigan the reputation as the toughest state in thecountry in which to sell a franchise, and within threeyears the number of franchises tripled. He appointeda Small Business Ombudsman, to help small busi-ness people cut red tape and fight the bureaucracy.He created an Office of Women Business Owners^-_-1 a Minority Business Advocate. He supported abill to create five small business incubators and pro-vided funds to get them started. He set up teamsto weed out unnecessary bureaucracy, targeting 800regulations and 17 percent of all state forms forelimination. He even established a Michigan Ex-ecutive Corps, to draft business executives into tem-porary service with state government.

Blanchard's Cabinet Council had been staffedprimarily by people brought in from various depart-ments related to economic development. As thecouncil's proposals were enacted, its staff went backto their bureaucracies to implement the new pro-

grams. This gave the governor a core of managersdevoted to his agenda, just as the council itself gavehim a way to bring his key department heads togetheraround a common agenda. Hence the Cabinet Councilnot only originated the governor's economic develop-ment agenda, it provided a means by which he forcedhis bureaucracy to implement it.

The Path to Prosperity

After the initial flurry of activity, Blanchard andhis Cabinet Council decided they needed to knowmore about the state's economy. They commissioneda careful study by a small group of economists andpolitical scientists similar to the Choices processin Pennsylvania, but far less public. "After the firstyear, we sat back and said, 'How the hell do all thesethings go together, and what the hell is it that we'rereally trying to accomplish?' " remembers LouGlazer, then a deputy at the Cabinet Council. "Afterlearning a lot, we learned we didn't know a lot. Andthat's where The Path to Prosperity came from. Theidea was to provide a thematic whole for stateeconomic development."3

The study group came to conclusions similar tothose of Milliken s High Technology Task Force andThornburgh's Choices report. It argued thatMichigan's future rested upon technological innova-tion; that new and expanding businesses would bemore important than plants recruited from out ofstate; and that the private sector was the engine ofgrowth and innovation. The public sector's role, itsaid, was to encourage and channel private sectorinvestment by reducing the cost of doing business,encouraging entrepreneurship, filling capital gaps,and investing public dollars in areas such as infrastruc-ture, education, research, technology transfer, andthe quality of life. Its report also called for a "coor-dinated human inres'.ment strategy" to train thoseleft behind as plar closed and those left out of thegrowth process altogether, so they could qualify forthe new jobs created by emerging industries.4

In one crucial aspect, however, The Path to Pro-sperity went beyond the Choices study. It carefullydistinguished between Michigan's economic basethe sector of its economy t)' drives its growth byexporting products or services out of state, or byproviding products or services that might otherwise

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come in from out of state and its "local economy"of retail firms, restaurants, and the like. Aftercarefully examining the state's economic base, whichwas heavily dominated by durable goods manufac-turing, i* aigued that the key to future growth wasthe development of advanced, automated manufac-turing. Thus it argued for a more targeted strategythan that chosen by Pennsylvania or other states.

As the authors of The Path To Prosperity sawit, a high-wage manufacturing state likeMichigan had three options. It could "get

poor," letting wages fall so as to attract new in-dustries. It could "get out," shifting from manufac-turing to services and information industries. Or itcould "get smart," using new technologies to pos-ition itself back at "the manufacturing frontier." Bythat, The Path to Prosperity authors meant automa-tion: robots, machine vision systems, laser in-struments, CAD/CAM systems, computerizedmachining centers, flexible manufacturing systems,and the like. Two thirds of the nation's manufactur-ing assembly operations were located within 300miles of Detroit, they pointed out. Michigan alreadyhosted over one third of the nation's major robotusers, and nine of the ten largest robot producershad operations in the state. The state also had adisproportionate share of the nation's machine-visionfirms. With a boost from state government, The Pathto Prosperity argued, Michigan could become the un-disputed home of both the automated "factory of thefuture" and the hundreds of new companies producingtechnologies that went into it just as Detroit hadonce become the home of automobile manufacturersand the Silicon Valley had become the home of thesemiconductor industry.

To achieve this goal, the report maintained, thestate's manufacturers would have to go through atechnological transformation; its entrepreneurswould have to bring hundreds of new technologiesto market; its research universities would have toexcel in engineering and industrial technology; its in-dustries would have to pioneer new labor-management relationships; and its government wouldhave to minimize the disruption cat,ed by the tran-sition from brawn to brains. Blanchard has built hisentire economic development strategy around thereport and its analysis, developing new initiatives or

43

building on Milliken's fledgling programs in all fiveareas.

"We couldn't suddenly say, let's go into aerospace,or let's go into microcomputers," explains Doug Ross,who directed the study and then became Blanchard'sSecretary of Commerce. "You can't do that. You haveto start with what you are, and then figure out howto adapt it and build it toward what you think is hap-pening. The report gives us an economic sense ofwhat the future looks like, which gives some hope,and begins to send signals as to what different in-stitutions are supposed to do. Since ultimately youcan compel almost no one to do anything, you ne -clthose kind of cues."5

In his first year, Blanchard had announced thathe would target three industries for special state ef-forts: auto suppliers, forest services, and food pro-cessing. But The Path To ProsperitVs authors wereskeptical of attempts to target particular industries,and Ross's Commerce Department has since backedoff as well. Now the only significant targets areadvanced manufacturing and new and smallbusinesses.

Blanchard h:-.s created several new programsachieve his goals, chief among them the MichiganStrategic Fund and the Michigan Modernization Ser-vice. Even his recruitment strategy iias beendesigned to make Michigan home of the factory ofthe future. Before we turn to Blanchard's new ini-tiatives, howev, . let us examine the germinationof a seed planted by Milliken: the allocation of fivepercent of the state public pension fund for venturecapital.

Using Pension Funds forVenture Capitol

Dwight Carlson is president of Perceptron: TheMachine Vision Company. His company is preciselywhat the Michigan economy needs: a high tech start-up with pr4ential for rapid growth. It is a classic "flex-ible manufacturing" firm, with a "Theory Z" philosophyto match. "We're all professionals; : all on a firstname basis; everyone is a shareholder through in-centive stock options; and it's a very high perfor-mance environment," says Carlson.6

Back in the late 1970s, the president of the En-vironmental Research Institute of Michigan (BRIM)

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approached Carlson with an idea. Formerly WillowRun Laboratories at the University of Michigan,ERIM was the state's premier advanced technologyresearch institute. Most of its funding came from theDepartment of Defense, in the areas of remote sen-sing, radar, and surveillance. With some 50 high-techfirms spun off from research initiated at ERIM, it wasalready a successful example of the technologytransfer process that Milliken and Blanchard hopedto promote.' Its president had an idea for yet anotherspin-off: to ad :pt the advanced "remote sensing"technologies that ERIM had developed for militaryspy satellites to manufacturing. Carlson liked theidea. Today Perceptron produces machine visionsystems that help manufacturers check their prod-ucts for quality as they move through the assemblyline.

"The initial focus of Perceptron was to solve thefit problem, usually in sheet metal, now more inplastic," Carlson explains. "U.S. products have aquality problem, because they don't fit as well as aBMW or a Mercedes fit. That's true not only ofautomobiles, its true of computers and appliances."In most plants, checking parts for fit is laborious andtime-consuming, done by hand with mechanicalgauges, after the parts have been manufactured. Ifa problem is discovered, an entire day's run mustoften be discarded or reworked something mostmanagers will do only if the problem is acute.

In contrast, Perceptron builds systems that allowparts to be checked as they are built. Imagine aswarm of sensors surrourding a spot on the assemblyline, something like a scaffold cluttered with smallblack boxes. In each black box is a laser, a videocamera, and a microprocessor. The laser projectsa beam on a spot; the cameras record the reflection;and the microprocessor converts that information intodimensional data, revealing fit, contour, the exactposition of holes or studs, and so on.

The data is integrated by a computer andpresented on a screen, where technicians keep trackof it to see if the assembly line is functioning proper-ly. The minute a problem appears, they shut downthe assembly line and repair it. Some systems comewith as many as 120 sensors and perform 200measurements in 22 seconds.

By the end of 1985, Perceptron had sold some

100 systems, for prices ranging from $60,000 to $1million. It was among the industry leaders in sales,and it was the first machine vision firm to have turneda profit. It has hit hard times in the past year, asGeneral Motors' well-publicized problems withautomation have triggered a sudden slowdown insales. But, Carlson has unveiled a second product,a robot guidance system, and has captured perhaps60 to 70 percent of the market for machine visionsystems for assembly and stamping plants. Althoughthat market is now stagnant and several machine vi-sion firms have gone under, Perceptron appears wellpositioned to survive the industry slump.

The Perceptron story is an example of both therebirth of entrepreneurialism in Michigan andthe emergence of the factory of the future.

But it is also an example of the role that state govern-ment is playing in that process: without venturecapital from the state pension fund, Perceptron mightnever have made it into production. One of the pen-sion fund's first venture investments was in Percep-tron; in fact, it participated in both the second andthird rounds of financing, along with half a dozenprivate firms.

But by '84, the capital markets were tight. "Allof the high-tech West Coast darlings of venture cap-italthe personal computer, the software companieswere having real difficulties," remembers Carlson."And as a result, the whole venture capi' al communitywas getting very nervous." Carlson searched formoney for the better part of a year, while Percep-tron's future hung in the balance. Finally the StateTreasurer, who oversees the investment of the pen-sion fund, made a decision: he believed in Percep-tron, and he would do what was necessary to get thecompany over the hump. The pension fund put inanother $2.5 million. Encouraged by that show of con-fidence, Carlson's others sources came up with themoney he needed, and the company moved ahead.8

With five percent of the state's pension funds, or$850 million, to invest, Michigan now runs what maybe the world's largest venture capital fund. It has hadan enormous impact on the state. Ian Bund, one ofthe pioneers of venture capital vi Michigan, puts itthis way:

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In 1978, Michigan had about $6 million ofresident venture capital. By the beginningof 1986, it had in excess of $300 million ac-tually invested and at work. Back in 1980,when I formed the Venture Capital Forum,which is a monthly gathering of venturecapital professionals to work together ondeals, we were able to pull together fourpeople. Tomorrow we'll have our regularlymonthly meeting, and we'll have in excessof 40. Statistically, the industry has gonefrom virtually nothing to what [VentureCapital Journal publisher] Stan Pratt, whois the leading commentator on our industry,desf:ribes as the fastest growth rate in theco untry.9

Bund and other venture capitalists agree that themajor catalyst for this explosion has been the statepension fund. "Would it have happened anyway?" asksDavid Brophy, a professor of finance at the Univer-sity of Michigan's business school and the state'sleading academic authority on venture capital. "I don'tthink so. In previous years, a lot of the venturecapitalists in the country would fly over Michigan,would never think of looking here for deals. PublicAct 55 (which created the state fund) was like bringinga sledgehammer down on a gong. It made a big noise,and a lot of people paid attention to it."1°

Among those who paid attention were prominentventure capitalists on both coasts. When they cameto Michigan to solicit investments by the pensionfund, Treasury officials showed them promising dealsin the state. The res'ilt was an increased flow ofprivate venture capitai into Michigan. Two of the bigfunds even decided to open midwest offices inMichigan.

"Venture capitalists are like everybody else in theworld," explains Brophy.

They smell the cheese, and they're comin'.When I came to Michigan, I was told byeverybody that if there were good dealshere, money would find them 'Money'sliquid, money flows, and Michigan's got lotsof money.' And I said, I couldn't agi .te withyou more, Michigan has tons of money. It'snot mnney that's really lacking, it's the pro-fessional financial manager, the person whocan size up an opportunity, structure a deal

and make it go. If we had those peoplearound here in abundance, I don't thinkyou'd need a Public Act 55. We saw to itthat we'd never have those people by ourreaction to the problems of the early thir-ties, because we just ripped the guts out ofthe financial community here in Michigan.We greatly restricted the banking system,put out of business the only large insurancecompany we had. So we were left with afinancial system that would have done creditto the state of Mississippi, trying to run thesixth largest state in the country. That'swhat we were missing.

How did Act 55 bring those people here?By hitting the gong with that hammer, say-ing there's money here devoted to this pur-pose. It's being professionally managed andprofessionally doled out, and if you can stepup here and pass muster, you can havesome of it. That has put some money in thehands of some pretty skilled professionalpeople. And it has caused the state ofMichigan to become a somewhat attractiveplace to be.

By September 1987 the state had invested $290million roughly two-thirds of it in private venturecapital funds, the other third in 30-odd start-up busi-nesses. most of them in Michigan. (Though itsprimary responsibility is to get the highest return forMichigan's pensioners, State Treasurer RobertBowman believes there are enough ,00d deals inMichigan today to justify concentrating on in-statefirms.) Bowman hopes to earn a 35 percent annualreturn on his investments: "Three out of ten will gobankrupt, three out of ten will be all right, three outof ten will be good, and one, if it goes well, will bean absolute barn burner. We've already turned downseveral opportunities to sell out (our stock in a com-pany) to another investor, one at a 700 percentprofit."'

Michigan is not alone in putting pension moneyinto private venture firms; perhaps a dozen otherstates do likewise. But Michigan was the first stateto invest directly in business start-ups, and it hasmoved more aggressively than the one or two otherstates that do likewise. This is the key to its strategyof getting private venture funds interested in

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Michigan. By co- investing aggressively, by sharingdeals with the largest private funds in the country,it is able to showcase Michigan's start-ups from coastto coast. And by all accounts, the private funds listen.

The state's co-investment strategy also minimizesthe potential of political considerations affecting itsdecisions. "You wouldn't get anybody to co-investwith you if that was the case," says Robert Williamsof Regional Financial Enterprises, a largeConnecticut-based firm. "We wouldn't stay aroundfor two minutes if we saw any of that."12 Percep-tron is a good example. Dwight Carlson sat on thetask force that first recommended that Michigan in-vest pension money in venture capital. If the statewere investing alone, its investment in Perceptronmight lead to accusations of cronyism. But it can easi-ly defend its decision by pointing to major private sec-tor investors who have also judged Perceptron tobe a good risk.

Skeptics might argue that private venturecapitalists would have eventually discoveredMichigan on their own. They may be right, butTreasury Secretary Bowman argues that by speedingup the process, state government played a criticalrole.

I would argue that it's similar to justice:justice delayed is justice denied, and financ-ing delayed, in an internationally com-petitive market, is a loss for the state ofMichigan. You L....ke a state like Californiait's a national economy. Somehow it all fitstogether. But in siates that arepredominantly manufacturing, as we wereand still are, you occasionally have to pusha little here, nudge a little there, to try toshave two years off. Maybe that's all weshaved off this whole race for theautomated factory, but that 24 months couldprove to be the difference between winningthe race and coming in third which is allthe difference in the world.

Brophy adds his own bottom line:

The net result of all this is that we're learn-ing how to finance new and growing busi-nesses high tech, low tech, no tech, itdoesn't matter. That's a residue that's goingto stay with us. Even the banks now I'mgetting all kinds of calls from my banker

friends: 'How do you do venture capital? Iwant to talk to you about this stuff.' Andthat's healthy. If you've got an environmentwhere new companies can form and newideas can be pursued, your chances of sur-viving economic change are a hell of a lotbetter than if you're locked into a kind ofcompany-town philosophy and nobody's do-ing anything out on the edge. You'd betterbe able to finance new companies and helpthem grow if you want representation in theindustry of tomorrow, whatever that maybe. That's going to be the ultimate publicbenefit for Michigan.

The Michigan Strategic FundVenture capital will meet the needs of only a tiny

sliver of Michigan's economy, the few start-up firmswith technologies that are advanced enough to showpromise of dramatic profits. Yet as Brophy points out,Michigan's banks are relatively conservative in theirlending practices. Since the auto industry reachedmatui:t-y, Michigan has been among the least en-trepreneurial states in the union in part becauseof the culture engendered by the big three auto pro-ducers, in part because of the financial markets.Thus, once the venture capital gal) was closed, thereremained a significant gap between venture capitaland the banks.

To fill that gap, Blanchard created the MichiganStrategic Fund, perhaps the most sophisticateddevelopment finance agency in the country. Althoughhe put several public loan programs in the StrategicFund, the heart of the effort is a set of new wholesal-ing programs, designed to change private sector in-vestment patterns.13 "We want to use what moneywe have to help make possible bankable private dealsthat aren't getting made," explains Peter Plastrik,president of the Strategic Fund.

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We want to influence the behavior ofprivate financial institutions, without in-creasing their risk. We believe there aregaps in the private marketplace for in-stance, entrepreneurial capital below theventure capital level. Venture capitalistswant a 35 percent annual return on theirmoney within four or five years, usuallywhen the company goes public. Not every

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company can do that, but those that can'tare often still too risky to get bank loans.Other firms have real growth potential, butlack the zippy technology venture capitalistsare fond of. Small businesses also havetrouble getting capital, because it's toomuch trouble for the banks. So we want tohelp the private sector create new lendingvehicles for small business.' 4

perhaps the simplest and most elegant of theStrategic Fund programs, the Capital AccessProgram does nothing more than offer banks

an incentive to set up insurance funds to cover lossesin their riskier portfolios. If a bank will establish sucha "Loan Loss Reserve," the state will contribute toit. In theory, the existence of an insurance fund willallow banks to make more loans to new businesses,small businesses, and other firms that would notqualify for a conventional bank loan. By September1987, 48 banks had agreed to participate.

The program works like this: the Strategic Fundsets up a reserve fund for each participating bank,to cover losses in a special, higher-risk portfolio. Eachtime the bank makes a loan under the program, thebank makes a contribution to the reserve, the bor-rower matches that contribution, and the statematches the total of those two contributions. Thebank determines which loans carry high risks andnegotiates the amount of the contribution with theborrower. (Their combined payments normally rangefrom three to seven percent of the total loan amount.)It is in the bank's interest not to put :ormal loansin the high-risk portfolio, because it costs the bankmoney to do so. The bank can only withdraw moneyfrom the reserve fund to cover losses on its specialportfolio.

The reserve fund, which ranges from six to 14percent of the value of the portfolio, allows the bankto absorb loss ratios far higher than those on theirother business loans (which are normally under onepercent). This allows the bank to be far more ag-gressive in providing business loans han it former-ly could be. If the loan loss -eserve fund runs out,however, the bank absorbs the rest of the loss. Unlike80 or 90 percent loan guarantees from the SBA, thisforces the bank to evaluate the loan with some degreeof prudence. The program also frees the government

from the task of evaluating loans, something the SBAmust do with most banks. Since the bank makes theunderwriting judgement on its own, no governmentbureaucracy is necessary. The government is simplyproviding a small insurance fund to share the risk,so the bank can stretch its lending net to encompassmore firms.

Asecond Strategic Fund program copies aPennsylvania effort: state money to catalyzethe formation of seed capital funds. While

Pennsylvania demanded $3 in private money forevery $1 in public contributions, however, Michiganrequired that private investors put up only $1 to matcheach $2 in state money. The Strategic Fund chosefour private seed funds, all of which will operatestatewide, and loaned each one $2 million. The loansdo not have to be repaid until the find is dissolved,and the interest rate is 9 percent.

The Strategic Fund has created a similar programto capitalize institutions that fit between seed fundsand banks. These are Business and IndustrialDevelopment Corporations ( BIDCOs), which werepioneered in California underJerry Brown. BIDCOsare private financial institutions which make businessloans but do not accept deposits. Because they arecapitalized by private investors rather thandepositors, they can afford to take greater risks thanbanks. But because they are regulated by stategovernment, like banks, BIDCOs can participate infederal loan guarantee programs, such as thoseoperated by the SBA and the Farmers HomeAdministration.

The idea is to create an entirely new financial in-dustry designed to fill the gap between venture capitaland bank loans, with perhaps 20 or 25 BIDCOsoperating around the state. Plastrik and his staff en-vision the BIDCOs as smaller versions of theMassachusetts Capital Resource Corporation. Theirprimary role will be to make subordinated loans intandem with banks, often with the option to purchasestock if the firm is successful. They could also makeSBA-insured loans, and if they desired, they couldcreate SBA-licensed Small Business InvestmentCompanies or MESBICs, as subsidiaries, to makeequity investments.

In California, where the state provided no start-up capital and the BIDCOs were thinly capitalized,

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they have been relatively cautious, primarily mak-ing SBA-insured loans. To ensure that Michigan'sBIDCOs have enough capital to be more aggressive,the Strategic Fund will invest up to $2 million of equityin each one. The BIDCOs' private investors will berequired to come up with at least twice that much.As each BIDCO becomes successful, the StrategicFund will sell its stock and back out. In addition, thestate pension fund will provide both debt and equityto BIDCOs that meet its criteria, purely for themarket return. Plastrik hopes to use the pensionfund's example to convince private insurance com-panies to follow suit.

The Strategic Fund has two other new pro-grams, both of which are more traditionalretailing operations. One is a Product Devel-

opment Fund, similar to Massachusetts' and Con-necticut's funds. It will provide venture capital fornew products and processes developed by estab-lished firms, taking its return in the form of roy' 'ies.The other is a Minority Business Loan Fund, whichis somewhat akin to Massachusetts' C inmunityDevelopment Finance Corporation. It has maderoughly $1.5 million in investments, usually in theform of subordinated loans, some with an option tobuy stock if the firm is successful. Every compnyin the portfolio is assigned a free consultant of theStrategic Fund's choosing. In addition, the StrategicFund is soliciting investors for a minority-ownedBIDCO Uniike the other BIDCOs, this one will re-quire only X500,000 in private money to get $1.75million in public funds, which will be converted to agrant if she BIDCO meets certain performancetargets.

The Research StrategyBetween its Strategic Fund and its public pensionfund, Michigan has taken a significant step towardclosing its capital gaps. But the transformation of theMichigan economy will take more than new formsof capital. It will also take new ideas, new companiesbent on commercializing those ideas, and new ap-proaches by existing companies. To create seed bedsfor those ideas and companies, Gov. Milliken's TaskForce on High Technology recommended that thestate finance new research institutes in industrialtechnology and in biotechnology.

In similar situations, many states have pouredmoney into existing academic departments, orcreated applied research centers at universities,jointly funded by industry and government. ButMilliken's task force decided that if Michigan's newprograms were to be of real value to industry, theywould have to be independent of academia. Thedesign was a hybnd of two models: on the one hand,the new entities would be research institutes, locatedat or near major universities; on the other, they wouldbe independent institutions, driven by industry'sneeds rather than those of academic researchers(who advance in their professions by excelling in basicresearch). This dual role has led to more difficultythan the task force anticipated.15

The institutes' funding has come primarily fromstate government and from Michigan foundations.The Industrial Technology Institute (ITI) receivedover $50 million from foundations, plus $17.5 millionfrom the state for the first five years. The MichiganBiotechnology Institute (MBI) received $6 millionfrom the state and roughly $23 million fromfoundations.

Located in Ann Arbor, ITI is a critical link in thestate's strategy to target automated manufacturing.Automation Alley, as the stretch between Ann Ar-bor and Detroit is becoming known, already boaststhe largest concentration of machine vision androbotics firms in the nation. ITI is designed to helpthe area research critical mass to make it, in formerdirector Jerome Smith's words, a "Silicon Valley inSo' itheast Michigan for durable goods equipment sup-pliers:16 It is also designed to help Michigan'smanufacturers adopt these new technologies and thusremain competitive. These two goals the develop-ment of new technologie. id the deployment of newtechnologies have proven difficult to reconcile.

Very few research institutes or centers of ex-cellence around the country focus on the pro-cess of manufacturing, rather than on spe lfic

product technologies, such as robotics or software.As such, ITI is an important experiment. Its creatorsbelieved that the state needed some kind of bridgebetween basic research on the application ofmicroelectronics to manufacturing which tookplace mainly in universities and the appliedresearch done by industry. Their convictions were

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based more on intuition than on market research oron a careful look at models in other countries. ButITI's experience has proven their intuitions correct.

If ITI's founders were clear about the niche theywanted to fill, they were not so clear about how ITIcould fill it. They decided to construct a new building,complete with a fully automated model manufactur-ing facility; to hire a staff of 250 by 1992; and to seta goal of over $20 million a year in contract researchby 1992, a level that would make the institute self-supporting. Their "technology development" role wasfairly easy to visualize: ITI would do advancedresearch on new manufacturing technologies, on con-tract with individual firms, consortia of industrialfirms, or government laboratories. The "technologydeployment" role was a bit more difficult. ITI'sfounders believed that the staff couid consult withfirms to analyze their production problems and to helpthem adopt automated equipment; that it could helpmanagers analyze the costs, benefits and effects ofadopting automated systems; that it could analyzenew product designs for industry to assess theirmanufacturability; and that it could teach managershow to adopt new approaches particularly to laborrelLtions required by the new technologies.

ITI's first president, Dr. Jerome Smith, proceed-ed to hire a first-class research staff, whose instinctshave pushed the institution toward academicresearch. ITI has done some important researchwork, and in some cases it has also played the"technology deployment" role. A good example is pro-vided by General Motors' manufacturing automationprotocol (MAP), which is designed to facilitate com-munications between all computerized machines usedin the factory robots, machining centers, machinevision systems, and the like. MAP is essentially ashared operating system and language, akin to theIBM operating system that allows every manufac-turer to produce personal computers which canoperate programs designed for IBM PCs. Wearingits technology development hat, ITI has done con-tract research on MAP. Wearing its technologydeployment hat, it has been recognized by GM andthe National Bureau of Standards as an authorizedtesting center, where companies can test their equip-ment to see if it is fully compatible with the MAPsystem.

This is an important role, which ITI hopes to

duplicate in other areas. Businesses do not establishthese kind of services on their ownfor fear of violating antitrust laws or giving away theirtechnologies to competitors. Smith believes in-stitutes like ITI are the perfect vehicles: they canpinpoint the collective needs of industry, thenestablish the standards and services to fill them.There is no previous model for this kind of thing incomputer technology, according to Smith. "The in-dustrial anthropologists could have a field day on this,"he says. "But I think this is one of the keys to Amer-ican industrial revival."

For the most part, however, ITI has not succeed-ed in fulfilling its founders' vision of a technologydeployment role. Most of its efforts have gone intocontract research. Even here, the institute has hadtrouble proving its value to industry. In 1986, withonly $3.2 million of contract research (and only abouthalf of that from industry), it fell far short of its goals.Virtually none of its research was for small or

medium-size firms, because they could not afford itsrates. Disappointed with these results, the boardbegan searching for a new president who would bebetter able to sell ITrs services to Michigan manufac-turers. It also began to push the idea of formingresearch consortia involving a number of firmssomething ITI had done to a limited extent ratherthan simply pursuing research contracts. Manylaboratories can fulfill research contracts, but few in-stitutions can foster joint research within an industry

a role ITI is perfectly positioned to a play.The Michigan Strategic Fund, which controls the

state money earmarked for ITI and MBI, began asimultaneous effort to force ITI to concentrate moreon technology deployment, particularly in smallerfirms. When ITI applied for a second five-year grantfrom the Strategic Fund, Plastrik and his staff agreedto provide $4 million, but only for specific technologydeployment projects, with specific performancebenchmarks and review processes built in. One pro-ject will develop a software program that can helpdiagnose a firm's needs for new productiontechnologies, much as a medical diagnostic programcan help a physician decipher a complex set of symp-toms. A second will examine why durable goodsmanufacturers have had such trouble implementingmachine vision and other sensing technologies, suchas those developed by Perceptron. A third will create

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a training program for factory managers in computer-integated manufacturing, using ITI's model manufac-turing facility. To encourage ITI to work with smallfirms, the Strategic Fund gave it another $3 millionto do work on contract with Michigan's industrial ex-tension service, to which we will turn in a moment.

The Michigan Biotechnology Institute has ex-perienced similar problems. It was created on theassumption that it could provide research that wouldbenefit the state's forestry, wocd products,agriculture and food processing industries. Dr.Gregory Zelkus, its first director, has put the institutewell on the 1 Ad to its desired status as a world-classbiotechnology rese-rch institution. But defining aneconomic development role a market for its pro-ducts has proven extremely difficult. Again theStrategic Fund has intervened. At the StrategicFund's insistence, MBI plans to create a for-profitsubsidiary to comm- rcialize its : esearchbreakthroughs by licensing them to existing firms,by joint venturing with existing firms, or by creatingnew firms to take t' J market.

It will not be clear whether the revamped researchinstitutes can successfully fulfill their missions for

. some time. One clear lesson has already emergedfrom their experiences, however: technologydevelopment and technology deployment are verydifferent functions, which may belong in different in-stitutions. Once a top-flight research staff is in place,an institution almost inevitably becomes driven bya resew rather than a development agenda.In Jai).., which vigorously pursues the kind of workdone by ITI and MBI, responsibility for technologydevelopment and deployment are generally keptseparate. Michigan would probably be better off ifMilliken's task force had loaned at Japanese modelsand done likewise. As it is, MBI has decided that itneeds separate corporation to take its technologyinto the marketplace, and the Strategic Fund has ear-marked roughly half of its second grant to ITI for workon ccntract with a separate state institution whoseprimary mission is technology development.

When the legislature funde J MBI and ITI. rep-resentatives from Detroit pushed hard for a third in-stitution, in their city. As a result, the legislature alsoappropriated $1.5 million for a Metropolitan Centerfor High Technology, an advanced technologyresearch and incubator center near Wayne State

University. While the other centers had cleartechnology focuses, NICHT simply had a huge,unrenovated building and a vague idea that jobs couldbe generated in the inner city. Predictably, it has notfared as well as the other two institutions. It has failedto attract the "anchor tenant" it wanted a largeresearch firm or project to give it credibility. Atthis writing, it has a dozen or so tenants, but it isstill awaiting the anchor tenant and for enough start-up tenants to ensure success.

The Michigan Modernization ServiceIn the shadows of Michigan's large durable goods

manufacturers lie some 15,000 manufacturing firmswith 500 or fewer employees. (Nearly 10,000 of themhr . 20 or fewer employees.) These smaller com-,anies employ more than half a million people, withan annual payroll of $11 billion. Nearly half of thosejobs are in industries closely linked to automobile pro-duction, such as plastics, primary and fabricatedmetals, and machinery. 17 7 These " foundation firms,"as Blanchard administration officials call them, forma supply chain that makes it possible for industrialgiants such as GM, Ford and Chrysler to function.

Many of these foundation firms are small machinetool operations, which contract to provide com-ponents for larger manufacturers. Studies of themachine tool industry during the difficult years of theearly '80s reveal both great turbulence and signifi-cant vitality among these foundation firms. Between1978 and 1984, the industry lost 2,900 jobs. Yet 53percent of the firms that survived grew in size, addingnearly 10,000 new jobs. In addition, 400 new machinetool companies were born, creating another 5,000jobs.' 8

Another study looked at the characteristics ofgrowing machine tool firms. It found that the fastestgrowing companies were those t la had begun us-ing computer numerically controlled (CNC)machines, the most advanced of all macl...,e tool-.By and large, these successful firms were youngerand smaller than the industry average. Thus a waveof innovation was sweeping through the industry,pushed forward by new firms that embraced the latesttechnologies. ' 9

With the auto makers pushing to cut costs andmoving toward computer-integrate,i manufacturing

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and just-in-time delivery systems, suppliers who arealso using computerized production processes havea great advantage. Yet it is far more difficult for thesmall firm to automate than for the large firm. Theprocess is expensive, it is time consuming, it requirescareful planning, and it requires that the work forcebe retrained to use the new machines. Few of thoserunning small firms have the time or capital necessaryto accomplish this transformation; hence the tenden-cy for new tech ,nologies to be exploited more oftenby start-ups than by existing small firms. (SeeChapter VI for more on this point.)

Based on the Path to Prosperity group'sanalysis of the Michigan economy, the Blan-chard administration decided the public sec-

tor could play a critical role in helping foundation firmsadjust to the world of automated manufacturing. Itbegan by creating a new Technology DeploymentService a small group of consultants, most of themfrcm the private sector, who work closely withfoundation firms that are considering installingcomputer-based production technologies. Theseagents carefully assess the client firm, draw ip a50-60 page report recommending a plan of action,and refer the firm to private-sector consultants ifnecessary. TDS also contracts with "trainingassociates" at community colleges, who draw updetailed training plans for the firms and help themapply to a small training fund set up by the administra-tion for this purpose. In the program's first year, TDSrepresentatives delivered 45 reports and trainingplans and secured training for 2,400 employees. TDSalso developed a pool of 75 private-sector "manufac-turing technology consultants" to which it refersclients with more complex problems.2°

Blanchard also created a Technology Transfernetwork. TNN is a netwo:k of agents at Michigancolleges and universities who are available todiagnose problems for foundation firms and to referthem to others with the technical expertise to help

whether at a university, through state govern-ment, or in the private sector. It is essentially aninformation and referral service, whereas TDS is aconsulting service that actively works with busi-nesses for up to six months at a time.

In the same division of the Commerce Depart-ment as TDS, Blanchard created an Office for NewEnterprise Services (ONES) to work with en-

trepreneurs who are trying to start their owntechnology-oriented companies. ONES helps themwrite business plans, formulate marketing strategies,and find potential sources of financing, both publicand private. For firms with strong business plans,it acts as an advocate with state funding sources. Inits first year, roughly half of its clients were relatedto manufacturing.

In 1987, the Blanchard administration is expan-ding TDS and ONES. It is adding a marketing func-tion (to help with export promotion, for instance);a staff to help TDS clients lima financing; and aresearch center. The new entity, called the MichiganModernization Service (MMS), will also include a"Leadership Education Program" to provideworkshops and edLational programs for managers,union leaders and entrepreneurs on subjects suchas new technologies, cost-benefit analysis, themanagement of rapid growth, and so on. Half ofMMS's core staff has moved to the ITI building inAnn Arbor, and MMS will contract with ITI to per-form some of its functions thus bringing their ser-vices to the world of foundation firms. In1988 MMSwill add a program to help Michigan firms and unionsadopt more cooperative labor-management systems,which will work in cooperation with the Departmentof Labor's grant program for area labor-managementcommittees.

Recruitment StrategiesBlanchard has not only developed new economic

programs built around the themes of technologicalinnovation, the factory of the future, and wholesal-ing, he has built an industrial recruitment effort con-sistent with these themes. Blanchard asked a teamat the University of Michigan's Institute for Laborand Industrial Relations to develop an 'aput-outputmodel of the state's economy, through which the statecould estimate the effects of any new i,kint on totalearnings, jobs, and state and local tax revenuesand thus the appropriate level of financial incentives.

In 1984, Blanchard used this model to f^shion apackage of property tax reductions, job training sub-sidies, and infrastructure developments worth morethan $120 million to convince Mazda to build a newplant in Flat Rock. The model indicated that Maz-da's long-run contribution to the state's economy

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would outweigh the financial subsidies. In addition,Blanchard saw the Mazda plant as a psychologicalturning point for the state. "Mazda was importantbecause it got coverage," he explains.

People here were used to believing the pro-paganda, that Michigan was somehow a badplace, that we were dying, that nothingwould work. There was a sense ofhelplessness. But Mazda was a majortransformation, because we were able toget the most modern auto plant in theworld, in competition with South Carolina, aright-to-work state. That shook everybodyup. Then we were able to come in with allthese dozens and dozens of weekly ex-amples of things that were happening thatwere good for Michigan in terms ofeconomic development, not just in manufac-turing, and they're now being covered bythe press. If you look back, that was theevent which turned things. 21

In contrast to the Mazda deal, Blanchard laterwithdrew from the bidding for a Mitsubishi plant whenIds input-output model showed that the long-termbenefits would not outwe'rth the subsidies Mitsubishiwanted. The real breakiniough for Michigan camewhen GM put its Saturn plant up for bid in 1985,however. In their efforts to land Saturn the mostsought-after plant of the decade Blanchard and hisstaff put together perhaps the most unusual state of-fer ever made to lure an industrial plant.22

GM launched Saturn to build an entirely new carin an entirely new way to rethink the entire pro-cess of automobile manufacturing. Saturn's execu-tives brought the same "clean sheet" approach to theirlabor bargaining with the UAW: there would be nolayoffs at the plant, hierarchical distinctions wouldbe minimized, time clocks would be done away with,and participatory decision making would be the rule.

If Saturn and the UAW were creating a new kindof partnership on the assembly line, Blanchard'saides reasoned, why not offer a new partnership

outside the plant as well? "We were trying to say toSaturn: 'You've rethought so much of your way ofdoing business that it only makes sense that you dothe same with state government, that you begin awhole new relationship with state government, a longterm partnership that has the flexibility to change

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your way of doing business,' "explain: Pete Plastrik.The partnership would be embodied in a new publicauthority called a "Manufacturing Innovation Part-nership" (M1P), through which Saturn, the UAW, thelocal community and the state would invest in newtraining programs, new R&D strategies, new rela-tionships with Saturn's suppliers, and new efforts todevelop the local community.

For a plant that would have five percent of its workforce in retraining at any one time, the state offeredto invest $100 million in training ever ten years, mostof it to build and operate a new "Saturn Institute" onthe plant grounds. Jointly designed and run by Saturn,the UAW, Saturn's suppliers, and the state, the in-stitute would provide not only training and educa-tion, but child care, recreation, counseling, retireeprograms, even health and fitness programs.

Nearby the MIP would construct a "SaturnIndustrial Park" for suppliers, built to Saturn'sspecifications to facilitate "just-in-time" deliveries tothe plant. In addition, the state would put $50 millioninto a fund to support research and development inindustrial technology particularly joint venturesbetween Saturn, its suppliers, and state research in-stitutions such as ITI. The money would also pro-vide development capital and technical consultationsfor small manufacturers who needed to upgrade theirtechnology to sell to Saturn.

For the local community, the MIP would have a$5 million development fund, for projects such assmall business incubators, housing, neighborhooddevelopment, or recreation facilities. Finally, thestate would put up $100 million over ten years fora "Clean Sheet Development Fund," to be used forany unanticipated investments the partners felt werenecessary.

On the regulatory side, the proposal was equallysurprising. Since the company pledged no layoffs,the state offered to rebate all of its unemploymenttaxes. Since Michigan's workman's compensationtaxes were high, the state would allow Saturn andthe UAW to opt out and negotiate their o wn system.On environmental matters, Michigan would minimizeinterference by operating far more than usual ontrust. It would reduce monitoring, give the company"maximum discretion" in applying the best availabletechnology to control pollution, and jointly financeadvanced pollution control research. Finally, to en-sure a minimum of red tape all ,round, Blanchard

promised to appoint a "Saturn Regulatory Om-budsman."

0 verall, counting $200 million in property taxabatements offered, the package would havecost the state at least $500 million over ten

years. Aside from the property tax abatement, "allof our investments were intended to be ways ofbuilding the asset base in Michigan, rather than justsubsidizing GM," says Plastrik. "With the training,we would be building a manufacturing elite inMichigan. With the R&D money, we would becreating engineering expertise here, which is the keyto being a leader in advanced manufacturing."

As it turned out, however, Michigan lost the plantto Tennessee, primarily because Tennessee had alocation more central to the anticipated Saturnmarket. But Michigan's proposal did succeed incatapulting a high-wage, high-cost state into the finalthree. Roger Smith, chief executive officer of GM,called it the most innovative proposal he received.And Michigan won a consolation prize, the Saturnheadquarters and R&D center. While this facility willnot create as many jobs as the actual plant, it willhave other advantages for the state. It will be farmore likely to become the source of innovative spin-off companies than an assembly plant would, forinstance."

The Impact of Michigan's ProgramsIn contrast to Governors Dukakis and Thorn-

burgh, Jim Blanchard has been in office only since1983. As a result, it is difficult to assess the impactof his economic development efforts. Gov. Milliken'sdecision to use public pension funds for venture

capital investments clearly sparked a venture capitalboom in Michigan, but it is too early to tell how suc-cessfully the state's entrepreneurs will be able tocapitalize on the new financing. It is even harder tojudge the impact of Milliken's Industrial TechnologyInstitute and Michigan Biotechnology Institute; bothare still in their formative years. Blanchard's key ini-tiatives the Michigan Strategic Fund and MichiganModernization Service were not put into plz...:e until

1986 and '87. Although both appear quite sophisti-cated on theoretical grounds, many of the specificprograms involved are barely off the ground.

Blanchard does appear to have had at least apsychological impact on the - ?erall business climatein Michigan. With his tax cut for small business, hisworker compensation reforms, his reform a' thestate's securities and franchise laws, hls efforts toreduce bureaucratic regulations and paperwork, andhis appointment of a Small Business Ombudsman,he has successfully changed the image that manyMichigan business people have of government. Hisefforts have earned praise from trade associationsrepresenting businesses large and small, andMichigan's business formation rate has increased.Blanchard has also financed an extensive promotioncampaign that paints Michigan as a state on themanufacturing frontier, a state in which rapid in-novation is creating new technologies and state-of-the-art manufacturing capability. Whether or not thiscampaign has attracted new investment to Michigan,it appears to have had some impact on thos. 1 thestate. Blanchard has given both the state's leadersand its people a more positive vision of the future,a reason to believe in Michigan-. In economic develop-ment, that is half the battle.

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CHAPTER V:

OTHER STATES

Massachusetts, Pennsylvania and Michigan are leaders on the economicdevelopment front, but they are not alone. At least half a dozen otherstates have developed active, relajvely comprehensive economic

development agendas. And most states are now pursuing at least two or three ofthe new initiatives pioneered over the past decade. The most popular are tech-nology programs, small business programs, and capital fluids.'

It should also be noted that education reform, which has been widespread, hasalmost always been presented by governors as a necessary element of economicdevelopment. Indeed, education reform economic development have been thetwo top priorities for most governors in tne 1980s. Infrastructure repair, anotherdominant theme in the 1980s, has also been seen as a necessary underpinning ofany economic development efforts.

The following pages will provide a thumbnail sketch of economic developmentefforts in a few of the more active states in recent years, including Indiana, Ohio,New York, Arkansas, Minnesota, and Montana. Although tnis sampling is by nomeans exhaustive, it should serve to provide a sense of the breadth of innovationin state economic development, as well as a brief introduction to a few programsthat differ from those in Massachusetts, Pennsylvania, or Michigan.

IndianaIn 1983, the Republican administration of Gov.

Robert Orr collaborated with the Indiana StateChamber of Commerce which was run by Orr's1980 Democratic opponent on a lengthy study ofthe Indiana economy. The resulting report, called InStep With the Future, recommended a far-reachingstrategic plan for the state. Lt. Gov. John Mutz, whoruns the Commerce Department and has been thekey goiernment sponsor of Indiana's new strategy,successfully pushed many of the report's recommen-dations (and some of his own proposals) through thelegislature.2

Among the most innovative results was theestablishment of a new public-private partnership,the 68-member Indiana Economic DevelopmentCouncil. The council is responsible for strategicplanning, the recommendation of new economicdevelopment programs, and the evaluation of existingprograms. It is funded jointly by the state and theChamber of Commerce. Its members, appointed bythe governor, are drawn from business, labor,government and academia ensuring broad private

sector input into policy formation. The governor ischairman of the board; the lieutenant governor is chiefexecutive officer.

Indiana has created three public-private corpora-tions to concentrate on the development of newbusinesses. The Corporation for Innovation Del, elop-ment is a private venture capital company designedto invest in Indiana businesses; the state capitalizedit by granting a 30 percent tax credit to its investors.The Corporation for Science and Technology is aprivate, non-profit corporation funded by the stateto invest in Indiana firms that are creating new prod-ucts and to provide advice about new technologiesand product development. By mid-1986 it had in-vested roughly $20 million in some 30 projects Theinstitute for New Business Ventures, a third private,non-profit corpo....ion funded by the state, providestraining, technical assistance, and workshops for en-trepreneurs seeking to create new businesses.These three institutions work closely together; allare located in the sam building, along with the In-diana Economic Development Council, the Chamberof Commerce, and the Department of Commerce.

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Indiana has put roughly $25 million a year intonew training programs. One focuses on dislocatedworkers; another concentrates on retraining workersin basic industries such as autos, steel and durablegoods; and a third provides customized training fornew and expanding industries. The state has alsoliberalized its laws governing public pension funds,so that they can invest in state housing bonds andin the Corporation for Innovation Development.Finally, it ha... passed legislation restructuring itsbanking system, which formerly did not allow branch-ing beyond county lines.3

Ohio

Ohio is yet another state that conducted a majorstrategic planning process and published an economicblueprint. Some of the resulting programs borrowfrom experience in neighboring Pennsylvania, par-ticularly the Ben Franklin Partnership model.Democratic Gov. Richard Celeste, elected in 1982,quickly created the Ohio Thomas Edison Program,which provides matching grants for joint busi-ness-academic research institutes and some seedcapital for advanced research projects. Like the BenFranklin Partnership, the program is run throughregional "Advanced Technology Application Centers"

although Ohio has more centers than Pennsylvaniaand limits each center to one technology focus. Inits first three years the Edison program received $80itlion in state .funds.'

Ohio has also created an industrial extension ser-vice. Called the Ohio Technology Transfer Organiza-tion (OTTO), it has 34 technology tr; nsfer agentsbased at the state's two-year community colleges.Another Ohio program, the Office of Labor-ManagemLit Cooperation, provides grants to localcommunities that create Area Labor-ManagementCommittees, as well as t,.. -egional centers designedto promote the concept of la)or-management coop-eration through research, ii.brmation, training andtechnical assistance.

One other Ohio program deserves mention. In1983, the state treasurer launched a Linked DepositsProgram, in which the state deposits its funds inbanks that agree to use the money for small busi-ness loans. The state accepts an interest rate of upto three percent below the market rate for certificates

of deposit, and the bank agrees to lend the moneyto small businesses at up to three percent below thegoing rate.

New YorkNew York probably spends more money on

economic development than any other state, althoughit does so with less coherence than many. Roughly20 different state agencies have some role ineconomic development; they spew out financing fora wide variety of programs, with a bias toward largeprojects such as convention centers and sportsstadiums. But within this unwieldy framework area number of newer programs worthy of note.

One is the New York Science and TechnologyAuthority, which houses a complete menu of tech-nology programs, including a seed capital fund; nine"Centers for Advanced Technology," which provegrants for industry-univet ity research in one areaof technology; a handful of Regional TechnologyDevelopment Organizations, which act as localeconomic development agencies for technologyfirms; an Industrial Innovation Extension Service;grants for businesses doing feasibility studies of newproduction technologies; a Roster of Retired Scien-tists, Engineers and other Experts, to assist newand emerging technology companies; and a programto help businesses secure federal Small BusinessInnovation Research grants.

Perhaps the most innovative New York pr- gramwas launched not by state government but by thePort Authority of New York and New Jersey, anindependent agency. Called XPORT, it is the nation'sfirst publicly-sponsored export trading company. Itsstaff of 20 works with small and medium-size com-panies, on three year contracts, to help them breakinto new export markets. For a small fee, )(PORThandles all aspects of the export process: findingoverseas distributors and buyers, providing exportlicenses, securing export insurance, and so on. Inaddition, XPORT's New York clients have access tobelow-market-rate export loans from the state's JobDevelopment Authority. Clients pay XPORT apercentage of their export sales (normally about tenpercent); thus if the program is unable to sell theirproducts, the effort costs them nothing. By 1986,XPORT had worked with 70 companies.

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New York recently created perhaps the mostsophisticated state program to support employeeownership in the country. Called the Center forEmployee Ownership and I ...rticipation, its staffworks with companies and unions to perform pre-feasibility studies of potential employee buy-outs, toprovide technical assistance of all kinds, and to helpsecure financing for buy-outs from the state's JobDevelopment Authority. It is also working to catalyzethe formation of Local Ownership D' 'elopment Cor-porations, wEch would do similar their ownregions.

Finally, recent legislation created an Industrial Ef-fectiveness Program that will focus on revitalizingmanufacturing industries in New York. One relatedprogram that is already underway funds demonstra-tion projects in which the state will work withmanagement and labor in specific industries.Demonstration projects will focus on efforts toupgrade technologies, retrain the work force, cxpandexports, and the like. The first project, no N1 beingorganized, is in food processing.

ArkansasAmong the southern states, Arkansas has created

one of the more comprehensive economic develop-ment efforts of the 1980s. Governor Bill Clinton, aDemocrat, is better known for his education reformcampaign, but he has also reformed an economicdevelopment system that was once a national modelfor smokestack chasers.

One new element is a fledgling Arkansas Scienceand Technology Authority, which makes basic andapplied research grants, provides seed capital to newventures, and funds incubators. Another is a neweffort to encourage the investment of some of thestate's $2 billion in public pension funds in Arkansas.Under one program the pension funds buy SBA-guaranteed loans from the banks, which promise touse the money to make new SBA-guaranteed loans.Under another the pension funds buy large certi-ficates of deposit, while the banks pledge to use themoney for business loans.

Clinton pushed through a series of bills relaxingthe regulatory restraints on Arkansas banks, to en-courage them to invest in businesses. He alsoreplicated Indiana's Corporation for Innovation

Development, although the 25 percent tax credit pro-vided has not yet stimulated enough private invest-ment to get the new fund off the ground.

Unlike most states, Arkansas has successfullyrevamped its vocational-technical training system.Over the course of five years it has increased thesystem's funding by 78 percent, established perfor-mance standards (such as job placement rates forgraduates), and shut down 34 obsoletecourses, whilecreating 40 new ones. Clinton has also tripled fund-ing for literacy courses, an important move in a poorrural state like Arkansas.

MinnesotaSinre the late seventies, Minnesota has created

a series of new economic development programs,including a Small Business Finance Agency, a Minne-sotz Economic Recovery Fund, an Agri-ProcessingLoan Guarantee Fund, a Minnesota Rural FinanceAdministration, a Northeast Minnesota ProtectionTrust Fund (to help the depressed Iron Range), anda Minnesota Export Finance Authority (a loan guar-antue program for small exporters). Most of theseare classic retailing operations, but DemocraticGovernor Rudy Perpich's Council on Entrepreneur-ship and Innovation recommended a number of moreinnovative programs. Among the most interestingis the Enterprise Development Program, a $600,000a -year matching grant program. Under this effort,local business-education-government coalitions applyfor matching grants of up to $180,000 to create newcenters to provide technical and managerialassistance to entrepreneurs.

Perhaps the most important of Perpich's innova-tions, however, is his reform of the state's WorkersCompensation system.5 Whereas most states havesought to bring down costs by cutting back benefits,Minnesota restructured the incentives in its system,so as to discourage litigation and encourage workersto return to work. For instance, if a partially disabledemployee accepts a new job offer, he receives hisdisability payment in a lump sum. If the worker re-jects a job offer, the payment is doled out in in-stallment.. This creates an incentive for the worker(and for his or her attorney. who stands to be paidmore rapidly out of a lump-sum award) to rejoin thework force. In addition, the state no longer regulates

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insurance rates under the system, companies areiw free to shop for the best rates from private in-

curance companies. The result of all this is declininglitigation rates and shorter periods of disability.

MontanaIn 1975, Montana oters created a 30 percent

severance tax on coal mined in the state and dedicated50 percent of the revenues to a trust fund to helpthe state cope with the environmental and social im-pact of coal mining. In 1982, another ballot initiat yededicated 25 percent of the coal tax trust fund to in-state investments o create economic development.Democratic Governor Ted Schwinden used the op-portunity to create a comprehensive new investment

program called "Build Montana," under which a newMontana Economic Development Board makes long-term, fixed -rate loans to businesses, in cooperationwith participating banks. Another program createda 25 percent tax credit for investments in venturecapital firms that buy equity in Montana firms,stimulating the creation of half a dozen r,ew venturefunds.

Schwinden has also funded a new MontanaEconomic Reporting and Forecasting System, at theUniversity of Montana, to give the state the capacity'..t) track and forecast economic developments.Another new university -based program is a Centerfor Business and Management Development, atMontana State University, which provides trainingand workshops for business people.

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CHAPTER VI

LESSONS OF THE STATE EXPERIENCE

What lessons can we draw from the recent experimentation in stateeconomic development policy? Which of these dozens of new programsappear to have the most constructive impact on our economy? And what

are the implications for federal policy of this expansion of state governme ac's rolein the economy?

Before we address these questions, it is worth reminding ourselves that thenew state programs are only one part of the picture. While it is important thatAmerica fashion new tools with which to heighten its international competitiveness,these tools will not work unless we also address the fundamentals which underliethe health of any economy: its fiscal and monetary policy; the quality of its educa-tion system; its infrastructure; the stability of its financial system. If federalpolicies push the dollar to record levels, programs to stimulate productivity inmanufacturing will be overwhelmed by an avalanche of inexpensive imports. If 25percent of young Americans cannot read and write, conve .tional training programswill be unable to prepare them for quality jobs in the changing economy. If oururban transportation systems are in such bad shape that businesses cannot rely onthem, our cities will see their efforts to nurture new businesses overwhelmed byyet another wave of flight to the suburbs.

In an economy whose health requires knowledge-intensive industries and advanced technologies,

. these fundar mtals become ever more impor-tant. During the industrial era, manufacturers look-ed for cheap labor, inexpensive land, low taxes, andeasy transportation to their markets. Today, theylook for solid school systems that produce literateworkers workers who can be trained and retrainedas technologies change. They look for high qualityuniversities and research institutions, to provide thesupply of new ideas and technical expertise they needto stay ahead in changing international markets. Theylook for an attractive environment and quality of life,to attract and keep the highly-educated employeesthat make them successful. And of course they lookfor reasonable interest rates, tolerable inflationlevels, stable tax rates, and predictable internationalexchange rates, so they can make long-term in-vestments with some degree of certainty about thefuture. Any government ti t ignores these basicswill be wasting its time worrying about more targetedeconomic development efforts.

These new realities explain why smokestack-chasing has been largely discred:Led Subsidizingfirms to locate in one area or another has always beena zero-sum game, from a national perspective. Butfor some areas particularly those with low wages

it has attracted employers. Today, however,growth companies are more likely to be interestedin an educated work force and a critical mass ofreseL.ch institutions than in tax concessions. By of-fering subsidies, states a:- d cities are spending thevery resources necessary to pay for education,research, and the like. And without these fundamen-tals, states that attract businesses this year are likelyto lose them next ye.. to Third World nations witheven lower wages and taxes.

What Works and WhyThe preceding chapters have provided brief

evaluations of many of the programs discussed. Us-ing the eight categories outlined in Chapter I, thissection will amplify those observations particularly

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in areas less extensively covered already, such asjob training and efforts to bring the ioor into thegrowth process.

Programs to stimulate tecloological innovagon.1 Moststate efforts in this area have been aimed atstimulating interaction between businesses anduniversity researchers. Because the U.S. excels atbasic research but not at moving researchbreakthroughs into production, this is a rational goalfor state government. Four models exist: the match-ing grant model, the research institute model, theacademic department model (in which academicdepartments are given new funding and encouragedto interact with indust j), and the university researchpark model.

The first model seems preferable, with the BenFranklin Partnership providing the best specific ex-ample. The Partnership has the advantage of beingdecentralized, focused on more than one technologyin each region, comprehensive, highly leveraged, andfunded according to criteria which reinforce valuessuch as private sector funding, job creation, andresearch work with small firms.

The research institute model is less desirable,because it is difficult to ensure that research institutepriorities will be determined by industry needs ratherthan by academic preferences. This problem can beavoided by making the research institutes dependentupon private funding End contracts, but then tilt- ytend to be too expensive for small and new firms,which are important seedbeds of innovation. Indeed,large corpurdtions often treat university researchcenters and institutes almost as philanthropies; theyprovide money, but they keep their importantresearch to themselves. Most small and medium-sizecompanies, on the other hand cannot afford to do theirown research. For them, joint projects with univer-sities provide their only access to serious research.

The academic department model is the leastdesirable, unless it is a first stage necessary to im-prove the quality of a research faculty and is followedby specific technology transfer programs. Thedangers of simply pouring money into academicdepartments are obvious: most academic faculty livein a world whose iacentives have nothing to do witheconomic competitiveness. The research that will

move them ahead in their professions is unlikely tobe directly useful to industry.

The research park model is also questionable.Putting corporate research departments in physicalproximity to universities does not guarantee thatthere will be significant interaction. Nor do researchparks necessarily spin off companies; ResearchTriangle Park in North Carolina, perhaps the mostfamous university research park, has generated vir-tually no spin-offs over several decades.2 Withoutmechanisms to stimulate technology transfer and theformation of new companies, research parks maybecome little more than attractive settings for cor-porate research departments.

Programs to fill gaps in capital markets.' State capitalprograms have been the subject of lengthy discus-sion in preceding chapters. As that discussion hasindicated, their experiences have been mixed. Toomany re-aiil public money; too few wholesale privatemoney. And of those that retail, too few are well in-sulated from political pressures.

One fact of life discovered b: those who run publiccapital funds is that capital is not a panacea. Too oftenthe real problems with a business lie elsewhere; ashortage of capital may be simply a symptom. Aslending programs have evolved, their managers havelearned that they must provide intensive manage-ment assistance along with their loans, particularlywhen they are dealing with small businesses. Thisis extremely important. States that sponsor lendingprograms for small or minority-owned businessesshould treat the technical assistance component asthe most important element of their strategy.

One other point needs to be made about capitalfunds. Many states lend money to businesses atbelow-market interest rates, believing that thismakes a significant difference in their ability to ex-pand. At times it does, but on average, capital costsare such a small part of a business's overall expensesthat a few percentage points less on a loan does notmake or break a project. Many companies could pro-ceed with a bank loan, but prefer the subsidized publicloan because it saves them a bit of money. Unfor-tunately, it is extremely difficult to tell the differencebetween those who truly need lower interest ratesto justify an investment and those who do not. Below-

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market rate lending programs, by their nature, tendto waste a state's resources.

Other state programs emphasize the availabilityof capital, rather than the cost. They provide market-rate loans (or equity investments) to companies thatcannot get private sector investments becausethey are too small, because they do not have enoughcollateral, because they are minority-owned, becausetheir potential returns are not quite high enough tosuit a venture capitalist's needs, and so on. Thisstrategy of filling capital gaps encourages new playersto enter the game, rather than merely subsidizingthose who are already playing. In particular, it im-proves the odds for new and small firms preciselythe kind that make bankers nervous. Programs thatchannel capital to these firms can be of great impor-tance. Given the choice of subsidizing firms, manyof which can get private capital at slightly higher rates,or providing non-subsidized, market-rate capital tofirms that cannot find private capital, states shouldlean towards the latter strategy. The long-term ben-efits are likely to be much greater.

Programs to encourage the growth of new and small busi-

nesses. Many of these programs, such as incubators,small business development centers, and small busi-ness ombudsmen, make sense. Others particularlytax reductions for small businesses have been tooindiscriminate to be effective. David Birch, the MITprofessor whose research first drew attention to therole that small businesses play in creating jobs,estimates that only 12 to 15 percent of small busi-nesses are "entrepreneurial" that is, they have thepotential for significant growth. The rest employ afew people and will never do more.4 Even some smallgrowth companies are best understood as part of thelocal economy, rather than the state's economic base(a small restaurant or dry cleaning chain, for in-stance). If they went out of business, the demandfor their services would simply shift to other localbusinesses, which would expand to meet it. Thusperhaps 90 percent of any subsidy broadly providedto all small businesses such as a lower tax rate

will be money wasted. Most state loan, equity andincubator programs recognize this distinction andtarget specific firms. But tax breaks and technicalassistance can be indiscriminate, and often are.

Programs to help manufacturing firms keep up with thelatest production technologies. Previous chapters havediscussed five "industrial extension" models:

the Economic Stabilization Trust and Businessand Financial Services program in Massachusetts,which uses loans and hands-on managementassistance to turn around mature firms (this mightbe called the "turnaround model");

the Ben Franklin Partnership model of matchinggrants to engineers and consultants who work withmanufacturing firms (the "challenge grant model");

the Industrial Technology Institute, in Michigan(the "applied research institute model");

the Michigan Modernization Service, which con-tracts with private consultants to prepare detailedplans for the introduction of new technologies andthe retraining of a business's work force, as well ashelping the firm secure financing and find newmarkets (the "industrial extension agent model");

and the Ohio Technology Transfer Organizationand the Michigan Technology Transfer Network,which are information and referral services run outof universities or community colleges (the "academicreferral model").

Of these, the Ben Franklin Partnership and theMichigan Modernization Service appear to be thebest, because they are both activist and comprehen-sive. Massachusetts' program is also activist andcomprehensive, but its target mature firms on theverge of collapse is too narrow. It should be com-plemented by programs which help manufacturersbefore they reach such dire straits.

The activist, comprehensive models are bestbecause the clients of industrial extension services

managers of small and medium-size manufactur-ing operations need more than information or ad-vice from an academic expert. They need hands-ontechnical help, usually for an extended period of time.The process is simply too fraught with problems tobe handled by most managers alone. Those who havepurchased personal computers know how difficult andtime-consuming it can be to sort through all theavailable information, choose the appropriate hard-ware and software, and teach themselves to use it

especially when time and finances are short. The

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process of installing computerized technology in amachine shop or manufacturing plant multiplies thosedifficulties a hundred times.

A study conducted by Jacques Koppel, formerdirector of the Technology Management Center inPhiladelphia, illustrates the problem. Koppel and histeam spent 18 months interviewing the managers of90 small and medium-size companies in the machinetool, electronic component and medical device in-dustries. They found that only ten percent had anyplans to introduce computers or other forms of ad-vanced technology into their production processes.The reasons were revealing:

The problem is not one of availability. It'sthat the new manufacturing technologies in-timidate and confuse most managers, who thusresist adopting them. Even when thesetechnologies are acquired, management isusually ill-prepared to implement themeffectively.

Compounding the problem is the reality thatthese technologies are computer-based, andmanagers and engineers schooled in anotherera often find them baffling. They have Cficultyidentifying the type of system that could mostbenefit their operations. And even if a firm canmatch a particular technology with a particularapplication, they often canript distinguish be-tween the dozens of available products both'iardware and software that would best suittheir needs.

...When companies make investments innew tools whether modest or relativelylarge-scale without an overall strategy fortheir use, the well-documented result is Islandsof automation." Sophisticated technologies ac-quired at random sit scattered on shop floors,contributing only a fraction of their potentialworth toward manufacturing a better product.In one company we visited, a $90,000 robot satidle for most of two years because the equip-ment it was supposed to load was 25 years oldand kept breaking down.5Add to this the problem of retraining workers to

operate computer-controlled machines and it is ob-vious that the adoption of new technologies is nota casual process. It requires industrial extensionagents who will work with the company for months,help arrange training, and provide to trouble-shooting needed to help the company join themicroelectronic age.

Efforts to move labor-management relations towardcooperation- rather than conflict. This is an area in whichstates have not yet done enough. The MILRITECouncil in Pennsylvania was a ftrst step. But evenif it had been more strongly surported by the gover-nor, the model was inadequate. States should pursueefforts similar to those in Pennsylvania, but theyshould go further, acting as brokers rather thansimply as passive facilitators of new labor-management relations. By bringing the authmityand resources to the table, governments can con-vince both sides to do more than they otherwisewould. When government does use public resources,however, it should secure long term commitmentsfrom businesses to keep their plants open and to in-vest in the area.

In addition, states should seek to bring labor inas a c.ntral actor in economic development efforts,as the Cooperative Regional Industrial Laboratories(CRIL) program has in Massachusetts. This is im-portant not only to improve the caliber of these ef-forts and to ensure that the interests of workers areconsidered, but to ensure that they enjoy broaderpolitical support than in the past.

Programs to stimulate exports. The best of the stateexport programs appears to be XPORT, the NewYork-New Jersey Port Authority's export tradingcompany. As in the industrial extension area, expor-ting is so difficult that small and medium-sized firmsneed more than advice; they need comprehensiveservices over an extended period of time.

It may be that government's most constructiverole in stimulating exports would be as a catalyst forthe formation of private-sector export trading com-panies. If this is true, this may be an area in whichthe federal government is better equipped than thestates. Few private trading companies would wantto limit themselves to clients in one state; thus anystate that subsidized the creation of trading com-panies would only capture a portion of the benefits.The clusest thing to this model, XPORT, was createdby an institution that serves two states and one ofthe busiest ports in the country.

Efforts to improve education and training systems.°Education reform is a broad topic on which much hasbeen written in recent years; an evaluation of dif-

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ferent state approaches is beyond the scope of thisrep: / t. Training is equally important, but has notreceived the same degree of attention. Yet our train-ing systems are certainly as weak as our educationsystems.

Training is crucial for several reasons. One is thenature of the changing economy. As discussed in theintroduction to this report, our competitive advan-tage today lies in advanced technologies and flexiblemanufacturing, both of which require workers whocan adapt to new technologies, learn new skills onie job, and craft new solutions as problems emerge.Yet many Ametican workers do not have the basiceducational background and coping skills necessaryto play such roles. In addition, many Americanworkers are now forced to undergo dramatic careershifts as basic manufacturing plants close or cut backand no similar jobs become available. For both thesereasons, training is more important than it has everbeen.

Another factor has to do with demographics. Thebaby boom is now fully integrated into the work force,and the cohort behind it is relatively small. Accord-ing to Pat Choate, 85 percent of those in the laborforce in 2001 will have been in the labor force in1985.7This means that by the time the states began to thinkabout education reform, most of their future workerswere already out of school. Those people needtraining.

A third reason why training is so important to-day has to do with our ability to adopt newtechnologies and to embrace new relationships in theworkplace, to heighten productivity and increase flex-ibility. If workers know that retraining is availableand they will be able to find another skilled job thatpays well, they are less likely to resist such efforts.If they know that there is a good chance they willbe able to find nothing but a low-paid service job, theywill rarely embrace new technologies orrelationships.

Many states have done a good job of creatingspecial worker assistance centers or emergencyteams to respond to plant closings asMassachusetts did with its Industrial Services Pro-gram. These efforts provide training to those laid off,help in finding new jobs, supplemental unemploymentbenefits, even financial assistance in moN.ng toanother area. But the states have not created similar

programs to help workers threatened bytechnological change in plants that are not closing.Government has responded to highly visibleemergencies, but has failed to create the ongoingretraining and re-employment systems needed by"dislocated" workers who lose their jobs one by one

the kinds of systems that can help businesses andemployees adjust before the crisis comes.

Training by itself will not produce growth, createjobs, or end poverty. Other efforts are necessaryto do that, as this report has argued. But a great dealof training and retraining is necessary to lubricatea npidly changing, advanced-technology economy.It is also necessary if we are to have a chance of bring-ing the poor and disadvantaged into the mainstreamof that economy.

In general, the states have not tackled the difficultjob of rationalizing their chaotic training systems,although several states appear to h-_. an the verge

of doing so. This is one of the primary challenges fac-ing state governments ;and the federal government)today. Efforts to meet that challenge should be guidedby a number of principles.

First, wholesaling is as important in the area oftraining as it is in development finance. The publicsector does not and in the future will not payfor more than a fraction of the training provided toAmerican workers. Hence the public sector mistseek to create incentives that encourage private cor-porations to do more and better training asMichigan did with its Saturn proposal.

Second, states should unify their dozens of train-ing programs into one coherent system. This doesnot mean that all programs should be combined intoone. Indeed, the states must learn how to serve verydifferent populations: those who need remedialeducation and basic social skills; those who needspecific skills necessary to handle specific jobs; andthose who need more general "coping skills," to givethem the knowledge and self-confidence necessaryto handle rapid change and a variety of workplacedemands. It does mean that for the individual whoneeds training, the system should ideally have oneentry point. Those who need training should be ableto visit one office in their local area, have an inter-view with one person who assesses their needs, andbe steered to the appropriate program. The same

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"case worker" should follow the trainee through tocompletion of training and placement in a job.

Third, publicly subsidized training programsshould be demand-driven. In the past, governmenttraining normally focused only on the supply side ofthe equation: the worker. Programs were set up totrain the poor or black or young or unemployed, butfew efforts were made to see that when tneygraduated, jobs were available. Today states arefocusing on the demand side as well. They arecreating programs that train people only for specificjobs promised by corporations, or that pay trainingcontractors only after those trained have been placedin jobs. This is the direction in which our trainingsystem should move. To minimize "creaming," statesshould create demand-driven programs that servespecific populations, such as welfare recipients, theunemployed, the poor, and minorities. The Bay StateSkills Corporation has shown that this can be done,simply by increasing the public subsidy as the targetpopulation becomes more difficult to train &id employ.

Fourth, state training systems should beperformance-based although not to the pointwhere they can only meet performance criteria bycreaming, as has happened with JTPA. Programsshould be evaluated and funded based on their place-ment rates, the quality of jobs secured for trainees,the wage rates secured, and the population served.This information shottld be publicized widely, to helpthe public act as intelligent, consumers. States shouldalso apply performance standards to theirvocational-technical schoois, as Arkansas and Floridahave done. Programs that fail to meat the standardsshould be shut down; those that excel should be ex-panded. This is extremely difficult to do, becausevocational-technical systems in most states are en-trenched, resistant to change, and politically power-ful. To reform them, states must lay off hundredsof instructors, train hundreds more, and buy a greatdeal of new equipment. But it can be done asArkansas has demonstrated.

Fifth, public programs should only train peoplefor "good" jobs ie., jobs that pay decent wages andhave benefits. (The definition of "decent" will varyfrom one region to another, of course.) Studies in-dicate that the poor live a life of constant shuttlingin and out of "secondary market" jobs unskilledpositions in marginal firms, with pay at or near

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minimum wages and few benefits. Except in extremecases, training programs designed to fill these un-skilled jobs are not necessary; they simpiy replacethe untrair _d poor with the trained poor. In the pro-cess they waste public money and raise false hopesamong those trained. When training programs enablethe unemployed, or those in secondary market jobs,to move into primary market jobs, they break thiscycle. They also open up positions in the vacated sec-ondary market jobs thus having as mch impacton the unemployed poor as training programs for sec-ondary market jobs.

Sixth, states should link their training programsto their economic development systems. Most statesprovide a variety of benefits to businesses: loans,tax-free bonds, tax breaks, loan guarantees, evenequity investments. When they do so, they shouldask in return that the company hire and train certaintargeted groups. Obviously, government must beflexible in this area; a new high-tech company receiv-ing equity from a state program cannot be expectedto train a semi-literate high school dropout to workin a laboratory. But a few states and cities are begin-ning to work out flexible mechanisms. Arkansas re-quires that manufacturers receiving certain benefitshire a percentage of low-income workers.Washington, D.C., Portland, Ore., and other citiesuse "first-source" agreements, in which corporationsreceiving public benefits agree to use lists suppliedby the government as their first source of interviewsfor new jobs. And New York has begun informal, firm-by-firm negotiations in which companies receivingstate money agree to hire welfare recipients.

Seventh, states should reform they unemploy-ment insurance systems so that benefits can be usedto pay for retraining and re-employment. In moststates today, unemployed workers are ineligible forunemployment benefits if they are enrolled in train-ing programs a requirement designed to ensurethat they are actively looking for jobs. This isbackwards. An unemployment insurance systemshould encourage retraining, not discourage it.California has not only passed such reform legisla-tion, it has set aside a small portion of the payrolltax that business pays to finance unemployment in-surance to create a customized retraining programfor employees who are about to be laid off or whoare already unemployed.

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Finally, states should broaden their concept oftraining to include training for self-employment andentrepreneurship. These programs may be relevantto only a small percentage of the potential trainingpopulation, but they make sense as one arrow in astate's quiver. To maximize their effectiveness, theycould be linked to ,dready existing small businessdevelopment centers, incubators, and the like.

Several experimental programs in this areaalready exist. The Hawaii Entrepreneurship Train-ing and Development Institute, a private, non-profitinstitution, provides intensive 12-week training ses-sions, internships with established firms, and otherprograms for poor and unemployed people who wantto start their own small businesses. In Minneapoiis-St. Paul, the private Women's Economic Develop-ment Corporation has successfully helped many poorwomen, some of whom were on welfare, to securebank loans and start businesses. The Washington-based Corporation for Enterprise Development(CfED) is developing pilot projects in seven statesto help small groups of welfare recipients set up flyown businesses home day-care, messenger sFvices, word processing, and the like.Efforts to bring the poor info the growth process. 8 Fewstates have given this much of a try. Massachusettshas done the most, and its efforts have served todemonstrate,. how difficult a task this is. Indeed,'ringing the poor into the growth process is thetoughest challenge on the economic developmentagenda. It requires a comprehensive and distinctstrategy, linked to the larger economic developmentstrategy but made up of separate, highly targetedprograms. Without such a "second track," even thebest economic development program will do little forthe poor.

Most of the new economic developmentstrategies are designed to speed up the eransitionfrom an industrial to a post-industrial economy. Theyseek to increase technological innovation, encouragethe automation of manufacturing, and nurture thegrowth of new industries built around advancedtechnology. These processes often work to the fur-ther disadvantage of the already disadvantagedthose who do not have the education or culturalbackground necessary to participate in advancedtechnology enterprises. A robust economy will bringsome of the poor along, in construction and service

jobs. But in the new economy, a rising tide will notlift all boats.

Many of the disadvantaged understand this.Workers in basic industries, minorities in the innercity, and the poor in rural areas know that new pro-grams like the Ben Franklin Partnership or theMichigan Strategic Fund are of little use to them.Often, they are openly hostile to such efforts. Manyworkers equate "technological innovation" with thedestruction of jobs. Thus a second track for uie disad-vantaged is necessary not only on social grounds,but to ensure broad political support for the firsttrack. In a sense, each track is dependent up: -_ theother. Without the second track, the first may failfor lack of political support. Without the first, the sec-ond may fz.: for lack of economic growth.

Afull discussion of the possible elements of thesecond track takes us beyond the scope of this

...report. But a few observations are possible.The goal of development efforts in poor com-

munities must be to support an entrepreneurial pro-cess within those communities, a process that isgenerated from within and can at some point becomeself-sustaining. Growth does not occur because newbuildings are constructed or housing is renovated inan area; growth occurs because people begin creatingsomething (-_,f economic value, earning income, andreinvesting in the creation of more value. As ex-perience has demonstrated time and time again, themost attractive housing developments or urbanrenewal projects create no real growth if they arefilled with or surrounded by people who are unableto generate economic activity. They may improvelives, but they will not create a process through whichpeople can pull themselves out of poverty.

This means that the principal actors in anydevelopment process must come from within thecommunity. Outsiders can help. But without localcommunity members in the driver's seat, little morethan charity is possible. The most important role forgovernment, then, is to help local people gain amomentum of their own to help build the capacityof local entrepreneurs, community ,anizations andinstitutioas.

A nurher of state governments, including thoseof Mi. ssachuseas, New York, Florida, Minnesota andOhio, offer small subsidies to CDCs and related

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neighborhood organizations. Some provide technicalassistance of one form or another. These effortsshould be improved, enlarged, and, when possible,broadened to encompass other local actors, includinglocal entrepreneurs. Some of the most notable suc-cess stones involve private-sector or quasi-publicdevelopment organizations that go beyond the CDCmodel. These include South Shore Bank in Chicago,whose creators have use.-1 the bank and three af-filiates a CDC, a real estate development corpora-tion, and a MESBIC to turn around a blackneighborhood; the Kentucky Highlands InvestmentCompany, a CDC which used federal anti-povertymoney (unti11981) to fund a venture capital fi rm thatnow creates 250 jobs a year; and the Delta Founda-tion, a not-for-profit foundation in Mississippi thathas for-profit subsidiaries such as a revolving loanfund, a MESBIC, and a real estate developmentarm. 9

When viable local institutions, entrepreneursand networks exist in a community, majorpublic investments can have the impact

governments have long hoped for. At that point,government must be prepared to invest significantresources in housing rehabilitation, public works, jobtrair 'ag, community service corps, and the like.

Large public investments are necessary for thesimple reascn tha- most of the private sector will notinvest in poor comr. unities. But government can,and should, steer some private capital into theseareas. It can help create partnerships in which ma-jor private corporations and foundations join withgovernment to fund intermediary organizations thatinvest in poor comm; 'lies. (The Boston HousingPartnership is one example.) It can encourage sociallyminded investors, including corporations, founda-tions, religious groups and individuals, to invest insuch intermediary organizations. It can offer tax ad-vantages for investment in poor communities, as thefederal government still does in housing. It can useits regulatory powers to require that banks and otherfinancial institutions invest in poor communitiesas the federal government does, to a limited extent,through the Community Reinvestment Act. And itcan extract quid pro quos from the private sectorwhen it grants regulatory or tax benefits, as citiesare beginning to do through "linkage" programs.

(Under one model, private developers who receiveregulatory permission to d lucrative downtownprojects are required to co. ibute to a developmen;.fund for poor communities, or to invest in a develop-ment project in that community.) As with public in-vestments, of course, these efforts will pay off onlyif viable institutions exist in poor communities to makeuse of the investments.

finally, government must overhaul its entiresocial v, elfare system, so that its fundamen-tal mission is to move people into the economic

mainstream, rather than to maintain them outsideit, in poverty. Our social welfare system was origi-nally designed, during the 1930s, to serve those whocould not expect to participate in the economicmainstream: the elderly, the disabled, and widowswith young children. Most of its clients were assumedto have no capacity to work; hence they needed statesupport. Over the years, however, the system hasbroadened to serve more of the poor, while socialchanges have brought women more fully into theworkplace and increased the number of singlemothers. Meanwhile, the stable industrial structureand steady growth on which the system dependedhas disappeared. Yet the fundamental structure ofthe system has not adapted to these new realities.It is time to change that structure, to revamp socialservices as ar. integral part of economic development.As the National Governors Association recently urg-ed, it is time to change from a social welfare model,which provides income maintenance and leaves jobsas an afterthought, to a model in which jobs areprimary and income maintenance is secondary.

The most obvious example is elfart reform.Massachusetts, California, Maryland, and otherstates have developed programs designed to providewelfare recipients with education, training, job place-ment, and often child care and health coverage fora period of time after they begin working. The basicprinciple in most of these ograms is the same: whenpeople go on welfare, the frst step should be toassess their needs and abilities and to develop a planto help get them back to work. From that assess-ment, people are steered to training and basiceducation programs, jOii search clubs, intensive("supported work") programs for those who have themost difficulty, and so on. One important element,

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necessary to ensure that welfare recipients do notactually suffer an income drop by going to work, isa state subsidy for child care and health coverage.

Another ingredient of welfare reform againnoted earlier involves linking welfare and economicdevelopment programs by asking businesses thatreceive public subsidies to hire and train welfare reci-pients. In a slightly different model, Pennsylvaniaoffers tax incentives to firms that hire welfare re-cipients. Minnesota offers a six-month wage subsidyto employers who hire welfare recipients or otherunemployed people not eligible for unemploymentinsurance. If the employers do hot keep the personon after the subsidy expires, they must return 70percent of the subsidy.

Housing is a second arena in which government'ssocial welfare orientation is gradually changing. Tradi-tionally, housing programs have simply providedapartments or housing subsidies for the poor. Thisis the welfare approach to housing. It amounts to littlemore than charity; it often separates poor peoplefrom the economic mainstream; and it fostersdependence. Over the past decade, however, declin-ing resources have forced governments to seek newstrategies. In particular, they have begun to look toCDCs, which have evolved into effective housingdevelopers. They have also begun to let residentsof public housing manage the buLuings themselves.Thus government housing programs are beginningto shift from charities to efforts which build the capaci-ty of local institutions and actors.' °

Education and training programs should also berestructured to function as part of a comprehensiveeconomic development strategy in poor com-munities. To do this, they should be tied to localdevelopment organizations, including CDCs,economic development corporations, and models likeSouth Shore Bank. Corporation for EnterpriseDevelopment recommends that states finance"Neighborhood Learning Centers" in poor com-munities." These would provide remedial education,job training and placement, and job creation throughbusiness development initiative s. The CDC affiliatedwith South Shore Bank in Chicago has launched avariety of programs that encompass all these ac-tivities, including an incubator and an effort to helpwomen on welfare become self-employe6 OtherCDCs sponsor many components of the

Neighborhood Learning Center model as well.Still other models have been developed in Europe.

In Great Britain, several hundred "Information andTechnology Centers" offer training in high-technologycareers to unemployed 16- to 18-year-olds. Somehave even created viable businesses such as com-puter repair operations.' 2 Elsewhere in Europe "in-dustrial workshops" integrate drop-in centers for theyoung and unemployed with job training, incubatorspace, technical assistance, and other economicdevelopment activities.13 These are glimpses of what:s possible if education and training concepts in poorcommunities can be shifted from the social welfaremodel to the development model.

The Principles of Effectiv' EconomicDevelopment

The specific development programs created byany particular state are less important than the wayin which they are carried out: what principles guidetheir formation; how they fit into an overall strategy;and what principles underlie that strategy. he natureof the system whether each piece works togetherto create a coherent whole is far more importantthan the specific programs that make it up.

No form?! methodology of economic developmentexists." State efforts have been thoroughly ex-perimental, fashioned by practitioners who havelearned by doing. By looking carefully at their efforts,however, one can identify five principles that oftenspell the difference between success and failure.

1) State governments are most successfu when they take

time to thoroughly analyze the regional economy beforeailing. It is critical that policy makers understand thedifference between the economic base and the localmarket economy, that they recognize the strengthsand weaknesses of their economic base, and that theydevelop initiatives which grow naturally out 'losestrengths and seek to remedy those weakn:sses.

2) The fundamental goal of gover . fit should be to change

private seitor investment patterns, not to substitute public

for private investment. The amount of public moneyspent is a poor measure of the vzlue of an economicdevelopment program. Even the largest government

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capital funds, training programs and the like aredwarfed by private capital markets and trainingex-penditures. If government can use wholesalingstrategies to change private sector investmentpatterns, it will hav a far greater impact than if itsimply sets up public programs. Wholesaling can beaccomplished in a number of different ways:

Government can catalyze the creation of newinstitutions or programs, as when Pennsylvania andMichigan initiated the creation of private BIDCOsand seed venture funds, and Massachusetts con-vinced the insurance industry to launch theMassachusetts Capital Resource Co-npany.

Government can broker priv-le sector actionsby bringing different parries together, as when theBen Franklin Partnership and other state programsoffer matching giants to bring businesses togetherwith academic researchers.

Government can leverage private sector actionwith small public investments, as in Michigan's LoanLoss Reserve program.

Government can change the rules by which 'hemarketplace operates, as when Michigan relaxed itsregulations dealing with public stock offerings andfranchise businesses, or many states amended theirlaws governing the investment of public pensionfunds.

While most of these examples deal with financialmarkets, the same models apply in other areas.Massachusetts' Bay State Skills Corporations is acatalyst, broker, and leveragt. r in the job trainingarea. The Michigan Modernization Service catalyzesand leverages private sector investments in newtechnology.

Government should retail its money only whenthe private market will not enter an area. Thismay be because it is a poor community where

risks are high; because the private investor knowsthat his competitors will also reap the rewards of hisinvestment (as in the case of much basic research);or because the private sector refuses tr believe thatthe returns will outweigh the risks (as in the case,perhaps, with worker-owned firms).

But even wnere retailing is justified, government

can use public-private partnerships to leverageprivate investment and teach private investors howto invest in an area. This is the strategy employedby Massachusetts' Community Development FinanceCorporation and Government Land Bank. By co-investing with banks, these government programsare teaching the private sector how to exploit theprofitable opportunities that exist in poor com-munities and sharing the risk when necesst ry tojustify private investment. Michigan's public peasionfund unit does the same thing with private venturecapitalists, introducing them to a market they haveavoided.

3) The task of building local capacity and mobilizinglocalactors is critical. As noted above, economic develop-ment occurs in an a:. 2 only if local institutions andentrepreneurs begin investing in the area, reapingprofits, and reinvesting those profits initiatinga chain reaction that becomes self-sustaining. Noamount of new roads, sewers, plants, conventioncenters or even businesses financed by overnmentwill do that, unless local actors become entrepre-neurial themselves. Hundreds of southern towns thathave recruited large manufacturing plants can testifyto this fact. If no self-sustaining development pro-cess is touched off, the town will be no better off whenthe plant shuts down or moves again than it wasbefore the plant was built. Economic developmentis not the process of creating new facilities; it is theprocess of stimulating new activity by individuals,by small companie- by large companies, by com-munity development corporations, by chat bers ofcommerce, even by local governments.

There is no better way to mobilize local leadersthan to bring tlicm together to create new programs.This creates new relationships (between workersand managers, between financiers and manufac-turers, between academics and business people), itfosters new ideas, and it creates a climaL4, in whichpeople begin to see foat change is possible andgovernment is there to support change. In addition,programs are far more likely to be successful if localpeople feel ownership of them than if theyare handeddown from above. In many ways, the process bywhich a new economic development program isdeveloped is as important as the program itself.

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4) Government should credo comprehensive but decen-fraud iteifilOpMiii iiiiadiOIES. Economic develop-ment is a local process. Yet most state bureaucraciesare not well equipped to respond to the varied needsof thousands of local businesses. The best solutionis a network of decentralized intermediary organi-zations. These organizations use state resources andcarry out state objectives, but they have tie flex-ibility to respond to a wide variety of specific, localproblems. They also enjoy the daily 'ontact neededto become rooted in and develop credibility in localcommunities, and they have tune capacity to makedecisions quickly. The best examples are Penn-sylvania's Advanced Technology Centers and LocalDevelopment Districts.

These intermediary organizations should be ascomprehensive as possible. The needs of local ac-tors in the economic arena are practically infinite.Well-designed programs which address one of thoseneeds for seed capital, for instance are impor-tant. But the same entrepreneur who needs seedcapital may need managerial assistance, or a researchcontact at the local university. If economic develop-ment resources are spread among a dozen differentorganizations, they will be difficult for local businesspeople to use. If they are carried out under the sameroof (even if by different staffs), access is muchsimpler. They will also be simpler for governmentto advertise, as Pennsylvania has discovered withits Ben Franklin Partnership.

5) Economic development programs should not be static.

Ideally, they should have built-in feedbackmechanisms that force them constantly to adapt tochanging circumstances. ThL marketplace does notstand still. Too often, government programs do.Capital funds targeted at specific gaps sometimes failto adjust when those gaps close. Training and voca-tional programs emphasizing specific skills oftencontinue unchar-xl, long after those skills becomeoutdated. By building in performance standards andother measures that flag changes in the marketplace,and by structuring programs in ways that preserveflexibility and minimize bureaucracy asMassachusetts has been able to (11 with its quasi-public agencies governments can design programsthat adapt rather than calcify.

The Federal Role

For nearly 60 years, American liberals havelooked to Washington for solutions to the nation'sproblems. Even conservatives who have become ac-climated to national power often assume that nogovernment program is truly important until it is car-ried out by the federal government. Thus it is com-mon, particularly in Washington, to assume that theexperimenta'ion taking place at the state level todayis important pin -rily bL .use it will provide modelsfor new federal programs.

At the state level, in contrast, many governors,legislators and policy-makers fear this impulse. Theycomplain that the federal government is too far fromthe problems addressed by state government to actintelligently and to remain accountable to local voters.They argue that Congress has proven itself unableto discriminate between the needs of one region andthose of another that it cannot target programsto areas of need, but inevitably spreads them aroundfor all to share. And they speak from bitter ex-perience about what poor partners federalbureaucrats make, because they are so often unwill-ing to let local actors control programs.

This is clearly an important issue. There is adanger that the federal government, in a rush of en-thusiasm for American "competitiveness," will simplyround up the best state programs and legislate theminto federal law. If this happens, without a carefulsorting of the appropriate level for each form of in-tervention, we will create a new round of problems.

Let us begin this discussion, with a simple obser-vation. The American economy, indeed theworld economy, is made up of a series of

regional economies, each of which radiates out froma city or network of cities.'5 Each regional economyis unique. Each has a different mix of industries, adifferent labor market, a different set of educationalinstitutions, even different capital markets, despitethe existence of national and international financialmarkets. In this country, the governmental unit thatmost closely matches the regional economy is thestate. The fit is hardly perfect. Regional economiesradiating out of Boston and New York each spill intothree states, for instance, while California encom-

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passes perhaps half a dozen distinct regionaleconomies. But short of a utopian scheme to redrawstate lines, the current states are the closest thingwe have to government with jurisdiction over specificregional economies.

Macroeconomic policy deals with questions that,for the most part, are national in scope: fiscal andmonetary policy, tax policy, trade policy.Microeconomic policy deals, in contrast, with mat-ters that vary a great deal from one regional economyto another. While Indiana may ha7e a severe shor-tage of risk capital, Massachusetts and California donot. While Massachusetts may have a tight labormarket, in which employers will pay for trainingbecause they are desperate for workers, Michigandoes not. While Pennsylvania may have strongengineering schools and research institutions, Arkan-sas does not. Hence the design of any program thatinvolves microeconomic intervention must be specificto one region. 'Cookie cutter' models imported fromone state to another or crafted solely in Washington

will not do the job.

past experience suggests that the federalgovernment is not well equipped to developdifferent models in different regions of the

country. Nor is it good at limiting its efforts to thoseregions that need them most; when money is involv-ed, every legislator seeks a share for his or herconstituents. The Economic Development Ad-ministration was created to stimulate developmentin poor communities; the definitions of 'poor' wererewritten until 80 percent of the nation was eligiblefor EDA grants. The Appalachian Regional Commis-sion was set up to address the particular problemsof Appalachia; the definition of 'Appalachia' was stret-ched until all of Pennsylvania was eligible except forPhiladelphia and its environs.

There are also problems of scale. Federal pro-grams, because of their size, will normzly be morebureaucratic than state programs. In any institution,size leads to bureaucracy and rigidity. Federal programs will also be less directly accountable to thevoters than most state or local efforts.

At the same time, there are limits to what canbe achieved at the state level. States cannot deal withmacroeconomic policy. Nor can they deal well withproblems affecting entire industries, because

industries cross state lines. Labor-management rela-tions are embedded :a a network of federal legisla-tion and judicial interpretation, leaving statespowerless to effect mar.y basic changes. Muchregulation of capitPlmar!.ets is national in scope. Thecapacity to export is dependent on many factorsbeyond the control of state governments. And inmany areas involving regulation and taxation, stateseither cannot act alone, for fear of driving businessaway, or should not act alone because state-by-stateregulation (of product safety standards, for instance)would create administrative nightmares for business.

Finally, states have a resource problem. Becausestates feel that they are competing with one anotherfor industry, there are severe pressures to keeptaxes low. This makes it difficult for any state to comeup with the funding necessary to deal with certainproblems that require substantial investment, suchas job training and low-income housing. In addition,regions that need the most investment, such asAppalachia, have the least ability to make that invest-ment. Poverty is a vicious cycle; if we are to redis-tribute resources from wealthy regions to poorregions, the federal government will be instrumental.

These realities suggest a relatively simple ruleof thumb. In the microeconomic arena, whenthe appropriate model differs from one region

to another, programs should be run by the states.The federal role should be to provide financial sup-port; to create financial incentives for states to act;to offer subsidies to poor states; to evaluate stateefforts; and to experiment with new models. Whenproblems transcend the capacities of individual states,on the other hand, the federal government shouldcreate its own programs.

The former category would ordinarily includemost industrial extension programs (except thosetargeted at large, multi-state firms); many programsto nurture the growth of new and small businesses,such as incubators and small business assistance taro-gr- ns; most programs to fill gaps in regional c.ii,,talmarkets; most education and training programs; andmost efforts to bring the poor .to the gro Nthprocess.

In these areas, the essential federal role shouldbe to provide matching funds to create incentives forthe states to sponsor prograras. The Democratic

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Policy Commission, two-thirds of whose memberswere state and local officials, recently recommend-ed a Strategic Investment Block Grant for states inwhich the unemployment rate exceeded the nationalmedian by ten percent.16 The idea might well be ex-tended to other areas, such as welfare reform, lowincome housing, and job training. (ITPA already bearssome resemblance to this model; it is funded by thefederal government but the programs are rui. bystates and local organizations.)

The block grant idea could be further refined,however, by adopting a challenge grant model torilocate the money. Rather than simply dividingfederal funds up equally between those states whichqualify, the federal government could set up criteriaby which to judge state applications for funding. Theywould be related to two factors: the degree of need(unemployment rates, poverty rates and median in-come), and the quality of the state program (thedegree of wholesaling and private investmentleveraged, the degree of targeting to poor com-munities, the degree to which economic developmentprograms are decentralized, and soon). States wouldbe funded according to how well their programs metthese criteria thus rewarding areas of need butalso creating incentives for states to design effec-tive programs. In addition, the greater the difficultyof leveraging private capital in a particular arena, thehigher might be the federal share of funding. Thusfor low-income housing, or job training for welfarerecipients, the federal government would finance farmore of the total costs than for technology programsor capital funds. This kind of mechanism would createincentives for states to act while allowing the federalgovernment to exercise some quality control. Butit would leave the job of actually designing and run-ning programs to the states.

The federal government could also improve t!-Aequality of state programs by prohibiting theuse of federal money or tax exemptions to lure

plants from one state to another. It could change avariety of regulations to allow more flexibility at thestate level; for instance, it could permit the use ofwelfare grants and unemployment benefits for train-ing, wage subsidies, self-employment efforts, andthe like. And it could improve both state and federalefforts by upgrading its capacity to collect data on

and analyze the American economy. Fed, datacollection and analysis i- hopelessly fragmented andout-of-date, leaving those engaged in economicdevelopment at every level to fly blind mu -h of thetime.

The second category -- areas in which theprimary responsibility must be at the federal level

would include international trade, intervention innational capital markets, responses to the problemsof entire industries, environmental policy, and basicresearch. It would also include a host of areas shapedby federal law, such as an`Hrust policy, questions in-volving patents and trademarks, bankruptcy law, andso on. These legal frameworks play an enormous rolein shaping the American economy, and tr ey must bedealt with in any effort to enhance ow economiccompetitiveness.

Finally, in several areas both the federal and stategovernments have important roles to play. In labor-management relations, for instance, state govern-ments can do a great deal. But in some industries,such as auto production, bargaining is essentially na-tional. In addition, labor relations are shaped by aweb of laws and judicial precedents, many of whichare national in scope. If we are to move from anadversarial model to more cooperative relationships,in which workers have mare control over decision-making and management has more flexibility re-garding work rules and job classifications, that legalframework must be addressed.

There will also be situations, particularly thoseinvolving national unions that do not allow agreat deal of flexibility to their locals and

national management that does not allow a great dealof flexibility to local management, in which the federalgovernment must act as a broker. Many industrieshave pushed hard in recent years for changes in workrules, while unions have pushed hard for job security.The federal government might be able to improvethe bargaining process and encourage a more co-operative culture by bringing resources for retrain-ing and re-empl ,yment to the table. It might revampthe unemplo; ment insurance system to encouragefirms to move surplus workers to special projectsduring recessions, as the Japanese do, rather thanlaying them off. Experience demonstrates thatworkers with increased job security are far more will-

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7 5

ing to help companies improve productivity. Finally,a number of economists have suggested that if partof workers' and managers' wages were paid in theform of bonuses, based upon increases in produc-tivity, profits, or value added per hour of work,workers and managers would be more committedto the long-term health of their companies. LesterThurow has proposed that the federal governmentnudge firms in this direction by exempting bonusesfrom payroll taxes.' 7

Another area in which the states and the federalgovernment must share responsibility is ap-plied research. When local business people

and academics are intimately involved in shaping ap-plied research programs, the programs are far morelikely to respond to genuine needs than if they hadbeen crafted in Washington. But there are someneeds that state programs simply cannot meet. Con-sider, for instance, a large-scale project to design anew production process or a new generation oftechnology, in which most of the major corporationsactive in an industry participate. One example is theMicroelectronic and Computer Technology Corpora-tion in Austin; another is a proposed $250 millionresearch effort in semiconductor manufacturing,known as Sematech. Because these y ojects are na-tional in scope, benefiting an entire industry ratherthan local businesses, state governments haveneither the incentive nor the resources to subsidizethem. In addition, they require wai,Ters under federalantitrust law. Such projects will seldom get off theground without some involvement by the federalgovernment.

The fe decal government is already a major playerin applied research in addition to funding half of allbasic research done in the United States. The Na-tional Science Foundation, for instance, has spon-sored a series of center s designed to stimulate jointresearch by industry and academia. Recent amend-ments to the Stephenson-Wydler Act encouraged thefederal government's 400 research laboratories tofoster the commercialization of their research. Andthe Defense Department finances a ManufacturingTechnology Program to encourage inn ovations in newproduction processes, an Industrial ModernizationIncentive Program to speed up the adoption of newproduction processes, and several large projects in

the development of adanced computer technology.These federal programs need to be pulled togetherand rationalized under an institution similar to theNSF, whose purpose is to provide matching grantsfor large applied research projects that lie beyondthe capacity of state governments. There is no sensein allowing the r)efense Department, whose basicresponsibility is not economic competitiveness butnational defense, to play this role by default.

yet another area in which both the federal andstate government have responsibilities is in-tervention in our capital markets. Despite the

recent dismantling of barriers to interstate banking,our banking system remains decentralized, with eachstate having different institutions and markets. Butmuch of the rest of our capital markets are nationalin scope; hence any efforts to improve their opera-tions must come from Washington.

One problem that the federal government mightaddress is the short-term perspective forced on manycompanies by the nature of our capital markets. Thefact that American firms rely on equity more thandebt creates incentives for corporate managers tofocus on short-term profitability rather than long-term market position since the stock market reactsso strongly to short-term factors such as quarterlyearnings. Even the venture capital markets havebecome more focused on the short term over thepast decade; most venture capitalists now look fora three-to-five year return. In Japan, by contrast,capital markets encourage corporations to keep theirlong-term health uppermost in mind. "This is becauseequity in Japan is held mainly by the banking sector,which is also the provider of business debt," accordingto Susan Friedman, former research director ofMassachusetts' Mature Industries Commission, andS.M. Miller, a professor at Boston University. "Asa result, bankers are less concerned about short-termprofitability than they are with the ability of companiesover the long term to pay back their loans and re-main viable well into the future. Concentrated equityownership gives them the ability to influence cor-porate strategy."' 8

The federal government could attack this prob-lem in many ways through legislation, throughFederal Reserve Board policy, or through regulatorychanges. Some economists argue that the Glass-

72

Steagall Act, which prohibits commercial banks fromowning securities, should be repealed. Friedman andMiller suggest several other reforms that might en-courage investors to be more patient. 1 9 Tax policy,for instance, could reward stockholders who holdsecurities for longer than a set period of time, saythree years. The European Common Market re-quires labor representation on corporate boards ofdirectors, in part to ensure that spokespersons forthe long-term interests and viability of the firm arepresent. And in Sweden, companies are required toallocate a percentage of their income to a fund thatcan be used only at particular times (usually duringrecessions) or long-term investments.

Michael Kieschnick, a former economic policyadviser to Jerry Brown, ex-governor ofCalifornia, has recommended a number of

other intriguing ideas. One is a capital gains taxincentive for investment in start-up companies,particularly if the gains are reinvested in additionalstart-ups.2° Another is a federal effort to create asecondary market for business loans, similar to thesecondary markets for mortgage loans establishedby the Federal National Mortgage Association, theGovernment National Mortgage Association, andthe Federal Home Loan Mortgage Corporation.Kieschnick's mechanism would be a TechnologyDevelopment Mortgage Assistance Corporation("Teddie Mac"), which would package and insurepools of long -term, fixed rate loans to high technologycompanies and other firms modernizing their capitalbases. It would sell securities backed by those pools

and partial!, insured by Teddie Mac and theoriginating lender to institutional investors likepension funds and insurance companies. The pointis to make long-term capital from institutional in-vestors available to small and medium-size busi-nesses, and to provide a way for banks and savingsinstitutions to resell business loans and thus increasetheir volume of such loans.21

A few states have attempted to respond to theproblems of particular industries, but this is anotherarea in whicl, the federal government must take thelead, simply because most of those industries are na-tional in scope. The state of Michigan can work withthe auto industry by offering an inn( ative partner-ship based in one plant. But if it attempted to address

the overall problems of the industry, it would haveno leverage anywhere but Michigan, while the ben-efits of its investment would be spread over manystates.

When a multi-state industry is suffering the ef-fects of foreign competition, for instance, only thefederal government can help. Often that help hastaken the form of trade protection. In cases of dump-ing and other unfair trade practices, such a responsemay be justified. But in general, the federal govern-ment should be encouraging troubled industries todevelop plans to restructure themselves into world-class competitors, then providing what is necessaryin the way of retraining investments, loan guaranteesand the like to make the restructuring possible. "Inthe rest of the world," writes Thurow, "it would becompletely normal to ask the members of a sick in-dustry the firms, the unions, the suppliers, thebanks, the communities to sit down and deter-mine what part of the industry could be saved andhow the industry could work together to strengthenitself. Competing firms might for example work outa shutdown of the most technologically obsoletefacilities in such a way that it did not alter the relativecompetitive strength (market shares) of the firmsbeing asked to shut down excess capacity."22 Thurowadvocates a government restructuring board to playthis role and a public investment bank to provide upto half the capital necessary in any majorrestructuring.

Robert Reich has suggested anothermechanism to deal with problems d over-capacity in industries such as steel. Under this

scheme, the United States would help establish aninternational "adjustment fund" to reduce capacity inbasic steei.22 Nations would pay into the fund basedupon their share of steelmaking capacity; they couldwithdraw from it based upon the amount of capacitythey reduced in any given year. The withdrawalscould be used for severance payments, retraining,re-employment assistance, and economic develop-ment efforts to stimulate the growth of new industriesin the affected areas. Within the U.S., the govern-ment might establish a business-labor- government-community board to negotiate the precise use of suchfunds.

Federal policy to encourage restructured and

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more efficient economic sectors must recognize thesocial costs, as well as the benefits involved. Whensuccessful, economic restructuring often has the ef-fect of increasing the dislocation experienced byworkers and communities. For example, in the 1940sand 1950s the successful federal efforts to increaseproductivity in agriculture led to sudden and dramaticmigration of rural Southern blacks to Northern cities.Many of today's urban problems (poverty,joblessness, social strife) can be traced to lack ofan-ticipatory planning during this earlier restructuring.

finally, the federal government could learn agreat deal from the success that state govern-ments have had in rationalizing their

economic development efforts. Massachusetts,Pennsylvania and Michigan have all created someform of economic development cabinet, made up ofevery department whose responsibilities overlap witheconomic matters. These cabinets heighten thevisibility of economic development and allow gover-nors to enforce their priorities throughout thebureaucracy. They provide a central staff whose vi-sion is firmly on the over all goal of economic growth,rather than on the parochial concerns of a transpor-tation or commerce or labor department. Clearly,some variant of this mode! is needed at the nationallevel.

Within the federal behemoth reside dozens anddozens of programs that help shape the Americaneconomy; indeed, the federal government has morethan $1 trillion in loans and loan guarantees outstand-ing. But each of these programs operates in-dependently. Viewed as a whole, the federaleconomic apparatus is a bundle of conflicting im-pulses, with no overall rationality, no co: -sion, noguiding strategic vision. One solution often pu.. forthis to copy Japan's Ministry of International Trade andIndustry. Another would be to copy the states by

creating an economic cabinet with its own staff.These examples only scratch the surface of what

the federal government could do to heighten Amer-ican competitiveness. More important than specificproposals, at this point, are the principles that shouldguide federal intervention the same principles thatwe have drawn from the experience of state efforts.These are the real lessons of state level experimen-tation for the federal government: not what it shoulddo to intervene in the marketplace, but how it shouldintervene. Federal programs should be built on solidanalysis of the economy; they should seek to changeprivate investment patterns rather than substitutingpublic capital for private; they should insulate publicinvestment funds from political manipulation; theyshould build local capacity; they should create feed-back mechanisms; and so on. These principles definethe appropriate methodology for a new wave offedera' economic activism.

The principle underlying this entire discussion,of course, is that government does have an activerole to play in the economy. While Washington hasbeen mired in an ideological stalemate over this issue,governors from both parties have embraced it. Thegovernors' activism differs from the traditional liberalresponse to economic troubles an emphasis onsocial welfare. But it also differs from the traditionalconservative approach, in which government pur-ports not to interfere with the workings of the "freemarket." It respects the market, but it recognizesthat markets do not operate freely or perfectly. Thenew activism flows from the tedrock assumption thatgovernment must facilitate the workings of themarket correcting flaws, changing rules, and alter-ing the trajectory of private investment. That is thereal lesson of the state government experience inthe 1980s: government does indeed have a role, butthe old role models are obsolete. New designs areneeded and the states are providing them.

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GLOSSARY OF ACRONYMS

ARC Appalachian Regional Commission

ATC Advanced Technology Centers (PA)BFP Ben Franklin Partnership (PA)BFS Business and Financial Services section of ISP (MA)BIDCOs business and industrial development corporations (MI)BSSC Bay State Skills Corp. (MA)CAD/CAM computer-aided design / computer-aided manufactureCDC community development corporationCDFC Community Development Finance Corp. (MA)CEDAC Community Economic Development Assistance Corp. (MA)CEED Community Enterprise Economic Development program (MA)CNC computer numerically controlled [machine tools] (MI)CRIL Cooperative Regional Industrial Laboratories (MA)EDA Economic Development Administration

EOL Executive Office of Labor (MA)

ERIM Environmental Research Institute of MichiganEST Economic Stabilization Trust (MA)

IAB Industrial Advisory Board (MA)ISP Industrial Services Program (MA)ITI Industrial Technology Institute (MI)JTPA Jobs Training Partnership ActLDD Local Development Districts (ARC- and EDA-funded)

MAP Manufacturing Automation Protocol (General Motors) (MI)MBDC Massachusetts Business Development Corp.MBI Michigan Biotechnology Institute

MCHT Metropolitan [Detroit] Center for High Technology (MI)MCRC Massachusetts Capital Resource Co.MESBIC minority enterprise small business investment companyMIFA Massachusetts Industrial Finance AuthorityMIP Manufacturing Innovation Partnership (MI)MIT Massachusetts Institute of TechnologyMMS Michigan Modernization Service

MPDC Massachusetts Product Development Corp.MSF Michigan Strategic FundONES Office for New Enterprise Services (MI)OTTO Ohio Technology Transfer OrganizationPERF Pennsylvania Economic Revitalization Fund

PIDA Pennsylvania Industrial Development AuthoritySBA Small Business Administration

SDA Service Delivery Administrators (under JTPA)TDS Technology Deployment Service (MI)TTN Technology Transfer Network (MI)

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79

STATE INDUSTRIAL

COMPETITIVENESS PROGRAMS:MASSACHUSETTS, PENNSYLVANIA,

MICHIGAN

PROGRAMS TO STIMULATE TECHNOLOGICAL INNOVATION

Applied Research CentersMatching Grant ProgramsResearch ParksComprehensive Technology ProgramsSmall Business Innovation Research Grants

CAPITAL PROGRAMS

Industrial Revenue Bonds 111

Business Loan Funds El IITurnaround Banks for Mature IndustriesPublic or Quasi-Public Venture Capital Funds El

Public or Quasi-Public Seed Capital FundsPublic Pension Fund Investments in Venture Capital 1111

Tax Incentives For Investments in Private Ventui.e.Capital FundsPublic Pension Fund Investments in Business LoansPublic Investments in Private Seed Capital Funds III

Public Investments in Private BIDCOs (business andindustrial development corporations) III

Loan Loss Reserve ProgramsLinked Deposit Programs

PROGRAMS TO HELP NEW AND SMALL BUSINESSES

Business Assistance Centers El IN

Small Business Incubator ProgramsSmall Business Ombudsmen/Regulatory Assistance El

Procurement AssistanceRegulatory Changes to Help Small Businesses IIEntrepreneurial TrainingComprehensive Entrepreneurial Assistance Programs III

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80

MA PA MI

TECHNOLOGY TRANSFER PROGRAMS (TO HELP MANUFACTURING

FIRMS KEEP UP WITH THE LATEST TECHNOLOGY)

Industrial Extension Services M

Academic Referral Services 31

Applied Research Institutes on ManufacturingTechnology 111 NMatching Grant ProgramsComprehensive Technology Transfer Programs

LABOR-MANAGEMENT COOPERATION PROGRAMS

Grants to Labor-Management Comni;ttees 111

Tripartite Labor-Management-Government BoardsTechnical Assistance for Employee Ownership 111

Financing for Employee Ownership

HUMAN CAPITAL (EDUCATION AND TRAINING) PRCGRAMS

Public K-12 Education ReformHigher Education InitiativesVocational-Technical Education ReformAdult Literacy ProgramsComprehensive Reform of Job Training SystemsNew Job Training Programs IN

Adjustment Programs for Dislocated Workers IIDiversion of Unemployment Insurance to TrainingWage Subsidies for On-the-Job TrainingTraining Vouchers

EXPORT PROGRAMS

Technical Assistance for ExportersExport Trading CompaniesExport FinancingExport InsuranceMentor Programs

PROGRAMS TO BRING THE POOR INTO THE GROWTH PROCESS

Employment and Training Programs forWelfare RecipientsIncentives for Employers to Hire Welfare Recipients IIUse of Welfare Grants as Wage SubsidiesEnterprise ZonesMinority Loan Programs IN II

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81.

Administrative Grants for Community Development

MA PA MI

CorporationsTechnical Assistance for Community DevelopmentCorporationsPrograms Which Use Community Organizations asHousing Developers IPrograms Which Use Community Crganizations inEconomic Development IIReal Estate Development BanksCommunity Reinvestment noliciesTargeting State Grants and Loans on Poor Communities IILocal Community Development Banks

THE PRINCIPLES OF EFFECTIVE ECONOMIC DEVELOPMENT

Performance of a Study of the State. EconomyA Focus on Wholesaling IIA Focus on Building Local Capacity M

Creation of Comprehensive, Coordinated EconomicDevelopment Systems Ill

Creation of Decentralized Development InstitutionsCreation of Market Feedback Mechanisms II

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R2

FOOTNO fES

Chapter Introduction

1. Nine percent, 22 percent, and 70 percent figures:Robert B. Reich, The Next American Frontier, New York,Penguin Books, 1944, p. 121. Twenty percem figure:Allegheny Conference on Community Development, AStrategy For Growth: An Economic Development Programfor the Pittsburgh Region, Pittsburgh, 1984, Vol. 1, p. A .

2. U.S. Department of Commerce, National Income andProduct Accounts, Preliminary Second Quarter 1987(GNP); Revised Estimates; 1984-first quarter 1987; NewsRelease, July 24, 1987. 1959-1983 GNP calculations:Economic Report of the President 1987, p.253.

3. Statistics for the years 1947-1932 are from Lester C.Thurow, The Zero-Sum Solution, New York, Simon andSchuster, 1985, p. 50. Statistics for the years 1983 -1986are from The Boston. Globe, February 3, 1987, p. 34.

4. David Jones, ed., Building the New Economy: Statesin the Lead, Washington, T1 , Corporation for Enter-prise Development, 1986, d 78.

5. Thurow, op. cit., p. 31 Thurow estimates that in 1A4the trade deficit of $123 billion cost American workersthree milEsm jobs.

6. Arthur M. Schlesinger, Jr., The Age of Roosevelt, VolIII: The Politics of Upheaval, Boston, Houghton Mifflin,1960, p. 520.

7. James Botkin, Dan Dimancescu, and Ray Stata, TheInnovators, New York, Harper and Row, 1984, p. 135.

8. James Gollub, Financing Innovation. in Enterprise:Beyond Venture Capital, Menlo Park, Stanford ResearchInstitute, 1985, p. 35.

9. W John Moore, "High-Tech Hopes," The Notional Jour-nal, November 15, 1986, p. 2769.

r. Bruce G. Posner, "Inc.'s Fourth Annual Report on theStates," Inc., October, 1984, p. 108.

11. New York Times, Jan. 27, 1985, p. 12F.

12. David Bitch, The Job Generation ess, Cambridge,M.I.T. Program on Neighborhood d Regional Change,1979.

13. The data on business incorporations are from Birch,"The Atomization of America ;' Tnc., March, 1986, p. 21.(Birch':. source is The Commerce Department, which col-lects business incorporation data from secretaries of statein the 50 s ates.) The data on Fortune 1000 firms andnumbers of people self-employed or running businessesare from Roger J. Vaughn, Robert Pollard, and BarbaraDyer, The Wealth of States: Th. Political Economy of StateDevelopment, Washington, Council of State Planning Agen-cies, 1985. (Their sou' es are The State of Smc1l Business,Small B iiness Administratio-, Washington, 1983, and

Empioyment and Training Report of the President, U .S .

Department of Labor, various years.) They report thatone-sixth (17 percent) of those in the work force now runa business or are self-employed. According to the Bureauof Labor Statistics, 17.5 percert of the work force belong-ed to a union in 1986.

14. Reich, op. cit., p. 263.

15. Commerce Department survey: The Washington Post,Sept. 23, 1985, Business Section p. 27. Twelve states:Mt. Auburn Associates, Final Report and Recommenda-tions to the Massachusetts Special Legislative Commiss.onon Small Business Incubators, Somerville, MA., 1986, p.ii. Number of incubators: The Washington Post, rune 30,1986, Business Section p. 1, citing the National BusinessIncubation Association.

16. Tice Washington Post, Feb. 17, 1985, p. E6.

17. For more information on state export programs se'State Erport Promotion Activities, U.F. Small Business Ad-rninist_ ion, October, 1984, and RI International, In-novations in Industrial Competitiveness at the State Level,President's Commission or. Industrial Competitiveness,December 1984.

Chapter II: Massachusetts

1. Ronald F. Ferguson and Helen F. Ladd, "Economic Per-formance and Economic Development Policy inMassachusetts," Discussion paper D86-2, John F.Kennedy School of Government, Harvard University,May 19F fhis paper is a chanter of a forthcoming tookon state economic development efforts prepared by theCommittee for Economic Development: R. Scott Foster,ed., The New Economic Role of the States: Strategies InA Competitive World Economy, New York, Oxford Univer-sity Press, 1988.)

2. "1975-1985: The Massachusetts Government LandBank Tenth Anniversary Report," The MassachusettsGovernment 'lank, Boston, MA, 1985, p. 3.

3. Neal R. Peirce, Jerry Hagstrom, and Carol Steinbach,Economic Development: The Challenge of the 1980s, Coun-cil of State Planning Agencies, Washington, D.C., 1979.

4. An Economic Development Program for Massachusetts ,Massachusetts Office of State Plannint,, 1976, pp. 2,5

5. "Massachusetts Technology Corporation An^ualReport, 1986," p. 5.

6. Ibid. , p. 2. MTDC's gains include over $4 million instock holdings from companies that have gone public.These were technically considered "unrea!:zed gains" as

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1 1986, because of MTDC's accounting procedures.

7. See Ferguson and Ladd, op. cit., p. 69, and jamesBotkin, Dan Dimancescu, and Ray Stata, The Innovators.Harper and Row, New York, 1984.

8. Sources for the discussion of MCRC include interviewswith Foster Aborn, Belden Daniels (who staffed the TaskForce on Capital Formation), Frank Keefe (the directorof the Office of State Planning and chairman of Dukakis'sDevelopment Cabinet), Michael Barker (who then workedfor Keefe), Martin Miller, and other Wang Laboratonesspokesmen. See '-.rgruson and Ladd, op. cit., pp. 67and 162, and MCR. - .nual reports.

9. Sources for the discussion of CDFC include interviewswith Charles Grigsby, Belden Daniels, Carl Sussman,Beth Siegel, and others; Belden Daniels, Beth Siegel andSteven Klein, The Community Development FinanceCorporation: A Review and Actiar Plan, Counsel for Com-munity Development, Cambridge, MA., 1982; a casestudy of the Adams Print Works deal prepared at the JohnF. Kennedy School of Government, Harvard University,by Howard Baker-Smith, Lucy Gorham, Lindsay French,and Frederick Mayer, under the supervision of RobertB. Reich; Margaret Pantridge, "Anatomy of a Bailout,"TheBerkshire Review, January 25, 1985; and other articles.

10. The discussion of the Land Bank is based on inter-views with Timothy Bassett, Beth Siegel, and others, aswell as "1975-1985: The Massachusetts Government LandBank Tenth Anniversary Report," op. cit.

11. The best example of this model is the Shorebank Cor-poration in Chicago, which owns a bank, a real statedevelopment firm, a CDC, and a MESBIC. Since it wasestablished in 1973, Shorebank has been quite successfulin turning around a black community that appeared head-ed for the bottom. See David Osborne, "Bootstrap Bank-ing," Inc., August 1987, pp. 69-72. Shorebank can be con-tacted at 7054 S. Jeffrey Blvd., Chicago, IL, 60649.

12. Carl Sussman, intervi .w with author.

13. The discussion of the Bay State Skills Corpc .ation isbased on the "Commonwealth Employment ForumReport," Massachusetts Office of Training and Employ-ment Policy, 1985; "The Massachusetts Job Training andPlacement Puzzle," Ma. Senate Committee on Ways andMeans, 1986; Ferghso, and Ladd, op. cit; and interviewswith Catherine N. Stratton, Associate Secretary for theMassachusetts Office of Training and Employment Policy;George Hughes of the Bay State Skills Corporation, andothers.

14. Charles Kenney, "Why Not the Duke?", The BostonGlobe Magazine, January 4, 1987, p. 19-36.

15. See Davii Broder, "New Deal-Making Politics:Massachusetts Governor Develops a Machine,"Washington Post, Feb. 10, 1986.

82

16. Michael Dukakis, interview with author.

17. For background on the Mature Industries Commis-. ion see Ferguson and Ladd, op. cit., pp. 112-122; andSamuel Leiken, "The Governor's Commission on theFuture of Mature Industries: A Study of Public Govern-ance," case study at Kennedy School of Government, un-published (available from Samuel Leiken, director,Massachusetts Product Development Corporation.) Thisdiscussion is based on these publications, plus interviewswith Timothy Bassett; George Carpenter, MassachusettsAFL-CIO; and former commission staff members BethSiege!, Susan Friedman, and Tom Jones.)

18. Leiken, op. cit.

19. Internal memorandum from Massachusetts ExecutiveOffice of Labor.

20. "Report on the Acti dies of the Massachusetts In-dustrial Services Program," Industrial Services Program,Nov. 4, 1986, and ISP public relations office.

21. The discussion on the Economic Stabilization Trustand Business and Financial Services is based on interviewswith William Currier, George Carpenter, Jack Clark (Ex-ecutive Office of Labor), George Coughlin (current BFSdirector), Ge. Robert Friedman (former CEO of SavageArms), and others; reports from the ISP office; LucienRhodes, "Against All Odds," Inc., November 1986, pp.109-108, and Evelyn Murphy, "Bay State Success Story:Helping Ailing Industries," Boston Globe, August 18, 1987,p. 28.

2g.. The discussion of the Cooperative Regional IndustrialLaboratories program is based on interviews with MichaelSchippani, Jack Clark, Beth Siegel, Michael Kane, (direc-tor of the Northern Tier Project), and William Schweke(of the Corporation for Enterprise Development).

23. Economic Strength, Fiscal Stability: the Governor'sBudget Recommendations for Fiscal Year 1986, Ccm-monwealth of Massachusetts, 1985, Vol. 1: Narrative,section titled "The Economy."

24. Botkin et al.; op. cit., p. 135.

25. Boston Globe, Feb. 1, 1987, p. 1.

Chapter Pennsylvania

1. The statistics on Pennsylvania's economy are fromseveral sources: Choi.. for Pennsylvanians (TechnicalEdition), Pennsylvania State Planning Board, Harrisburg,1980; Garfield Schwartz Associates, Inc., "Challenges toPenn.,,lvania: An Overview of Economic Prospects,"House Democratic Economic Studies Report, Vol. 1, No.1, April, 1983; "Economic Revitalization in Pennsylvania

84

and Michigan," internal memo prepared by Thornburghadministration, Aug 15, 1986; and interviews with WaiterPlosila.

2. Walter Plosila, interview with author. For more detailon the Volkswagen deal see Peirce, Hagstrom and Stein-bach, op. cit., pp. 20-21.

3. Walter Plosila, interview with author.

4. Ibid., and Choices for Pennsylvanians: Status Report,Governor's Office of Policy Development, Harnsburg,1985, p. 3.

5. Roger Wheatley, interview with author

6. These examples are drawn from the "Ben FranklinPartnership Challenge Grant Program for TechnologicalInnovation 34 Month Progress Report," published by theBen Franklin Partnership Board, March, 1986 -hereinafter referred to as the "34 Month Report."

7. The discussion of the challenge grant funding processdraws on interviews with Roger Tellefsen. former exec-utive director of the Ben Franklin Partner ip, WalterPlosila, Rep. Tom Murphy, and others.

8. "Ben Franklin Partnership Challenge Grafi!: ProgramFor Technological Innovation 42 Month Progress iZeport,"published by the Ben Franklin Partnership Board in De-cember, 1986 hereinafter referred to CI:: the "42 MonthReport."

9. Pennsylvania has the most extensive network of in-cubators: National Business Incubation AssociationReview, volume 1, issue 2, p. 1. Statistics on Ben FranklinPartnership investments in incubators: ibid.

10. Walt n- Plosila, interview with author.

11. William K. Stevens, "Economy Tops PennsylvaniaAgenda," New York Times, January 21, 1987.

12. Quoted in Will Lepkowski, "Lehigh: One University'sApproach to Rejuvenating U.S. Industry," Chemical andEngineering News, May 14, 1984, p. 40.

13. These examples are drawn from the "North East TierBen Franklin Advanced Technology Center AnnualRepc. , 1984-1985."

14. All quotes from Peter Lihins re from an interviewwith the author.

15. AU quotes from Emory Zimmers are from interviewswith the author. The information on the CIM Laboratoryis also based on interviews with Douglas Sunday, a CIMLab engineer.

16. All quotes from Alfred Austen are fron- interviews withthe author.

17. All quotes from Ron Thomas are from interviews withthe author.

18. Phoma.:, Canfieid, interview with author.

19. All quotes from Walter Plosila are from interviews withthe author.

20. These statistics come from the "42 Month Report"and other Ben Frankl: Partnership publications.

21. "48 Month Report," Ben Franklin Partnership.

22. Frederick Cusick, "A State Agency Takes Credit forJob- Creating Relocations," Philadelphia Inquirer, Nov.25, 1984, p. B7.

23. Ivan Tylawsky, "Enterprise Development inAppalachian Pennsylvania," The Entrepreneurial Economy,(newsletter published by the Corporation for EnterpriseDevelopment in Washington, D.C.), September, 1984,pp. 5-6.

24. The discussion of Pennsylvania's Local DevelopmentDistricts is based on interviet- . with Walter Plosila; IvanTylawsky; Harold Grossm_n, executive director of theEconomic Development Council of Northeastern Penn-sylvania (EDCNP); Dsmnis Robinson, Rcbert Hormel, andJerome Bohinski of the SEDA Council of Governments(SEDA-COG); several business people who have dealtwith LDDs; and publications by the Pennsylvania Commerce Department, EDCNP, and SEDA-COG.

25. The discussion of Cie MILRITE Council is based oninterviews with Robert Coy, its former executive direc-tor; Walter Plosila; former Pennsylvania Revenue Com-missionerJames Scheirer; Julius Uehlein, president of thePa. AFL-CIO; State Rep. Tom Murphy; others who haveparticipated in MILRITE programs or events; andMIL RITE Council publications.

26. Garfield-Schwartz Associates, op. cit.

27. Gov. Richard Thornburgh, interview with author.

28. For the Thornburgh administration'; proposedchanges, see the "Report to the Pennsylvania House ofRepresentatives and the Pennsylvania Senate on Progressof Programs Funded by the Pennsylvania EconomicReblization Fund and Administered by the Departmentof Commerce," Pennsylvania Department of Commerce,March 1, 1986. Not all of these recommendations passed.

29. The discussion of Pennsylvania's enterprise. zones isbased on interviews with Walter Plosila, George Werner,Rep. Alan Kukovich, Tom Cox, director of tile Northsidearnmunity Development Council in Pittsburgh, andothers; Choices for Pennsylvanians: Status Repo,4 . op -it.,and newspaper articles.

30. "Economic Revitalization in Pennsylvania andMichigan," op. cit.

31. Richard L. Thornburgh, "State Strategies and Incen-tives for Economic Development," The Journal of Lawand Commerc?, Vol. 4, No. 1, p. 1.

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Chapter IV: Michigan

1. Statistics on the Michigan economy are from "EconomicRevitalization in Pennsylvania and Michigan," op. cit.;Charles Bartsch, Reaching for Recovery: New EconomicInitiative In Michigan, Northeast-Midwest Institute: TheCenter for Regional Policy, Washington, D.C., 1985; TaskForce For a Long-Term Economic Strategy for Michigan,The Path To Prosperity; and John E. Jackson, "EconomicDevelopment in Michigan: Choosing an EconomicFuture," a chapter of R. Scott Fosler, ed., op. cit.(forthcoming).

2. Statistics on population and per-capita income: Bartsch,op. cit; statistics on he state deficit are frk,in interviewswith Robert Bowman, state treasurer, and Robert Naltaly, chief budget officer.

3. Lot. Glazer, interview with author.

4. lask Force for a Long-Term E,.onomic Strategy forMichigan, ob. cit.

5. Doug Ross, interview with author.

6. All quotes from Dwight Carlson are from an interviewwith the author.

7. Jackson, op. cit , p. 12.

8. Dwight Carlson, Robert Bowman, interviews withauthor.

9. Ian Bund, interview with author.

10. All quotes from David Brophy are from an interviewwith the author.

11. All quotes from Robert Bowman are from interviewswith the author.

12. Robert WilliamF interview with author.

13. Sources for the discussion of the Strategic Fund in-clude interviews with Peter Plastrik, Lou Glazer, SteveRhode (a member of the Strategic Fund staff), Doug Ross,William Schweke, James Bassett (president of theMichigan Chamber of Commerce), and other s, as well ason documents from the Strategic Fund.

14. All quotes from Peter Plastrik are from interviews withthe author.

15. The discussion of Michigan's research institutions isbased on interviews with Jen- le Smith, Peter Plastrik,James Kenworthy (of the Strategic Fund staff), andothers, Bartsch, op. cit.; documents provided by theMichigan Strategic Fund; and Marietta L. Baba and Stuart

Hart, "Portrait cf a New State Initiative in IndustrialInnovatior: Michigan's Industrial Technology Institute,"in Denis 0. Gray, Trudy Solomon and William Hetzner,eds., Technological Innovation, North-Holland Press,Amsterdam, 1986.

16. All quotes form Jerome Smith are from an interviewwith the author.

17. Jack Russell, "On Base Modernization: The Contribu-tion of a State-Sponsored Extension Service," MichiganModernization S-r vice, 1986, p. 1.

18. Jackson, op. cit., p. 12.

19. Muriel Converse, Ann Thomas, and John Jackson,Financing Small Manufacturers of MetalworkingMachinery and Equipment, Institute for Sodal Research,Ann Arbor, 1984; reported in Jackson, op. cit., p. L.

20. The discussion of the Technology Deployment Ser-vice, the Technology Transfer Network, the Office of NewEnterprise Services and Michigan Modernization Serviceis from interviews with Jack Russell, Peter Pla3trik, JamesKenworthy, and documents from TDS, TTN, ONES andMMS.

21. All quotes from Gov. James Blanchard are from an in-terview with the author.

22. The description of the Saturn proposal "Manufactur-ing Innovation Partnership: A Partnership, Not Just a Bid,"Michigan's oroposal to General Motvs. This is an inter-nal Blanchard administration document, which was notreleased to the press.

23. Jackson, op. cit., p. 31.

Chapter V: Other States

1. For more information on state economic developmentprograms, set ..':evitalizing State Economies, Washington,D.C., National Governors Association, 1986; Fosler, ed.,op. cit. (forthcoming); and DeWitt John, National Govt. r-nors Association, forthcoming.

2. Charles R. Warren, "Economic Development in Indiana:A Strategic St.--,,." This is a chapter in Fosler, ed., op. cit.(forthcoming).

3. For a description of the banking legisiation, see JohnM. Mutz and Beiden H. Daniels, "Reregulating IndianaBanks to Stimulate Economic Development," The En-trepreneurial Economy, May, 1984, pp. 7-8.

4. Paul Ryder, testimony before the IntergovernmentalRelations and Human Resources Subcommittee of theHouse Committee on Government Operations, op. cit.,pp. 317-328. See also publications from the Ohio ThomasEdison Program, and Sandra M. Slezak, "Thomas AlvaEdison Partnership Program," The EntrepreneurialEconomy, May, 1985, p. 10-11

5. Ted Ka 'erie and William A. Blazar, "A Qualit PublicSector As A Strategy For Economic Growtt ." fromFosler, ed., op. cit., (forthcoming,.

84

Chapter VI: Lessons of the State Experience

1. For overall treatment of these programs, see DavidR. Jones, ed., Building the New Economy: States in theLead, Washington, D.C., The Corporation for EnterpriseDevelopment, 1986, pp. 43- 60; Gray, Solomon and Hetz-ner, eds., op. cit.; and Ted Lyman and Douglas Henton,Promoting Advanced Technology Appropriate to a State'sEconomy: Beyond 'High Tech' Highways, Menlo Park, Ca.,SRI Laternational, 1985.

2. Technology and Growth: State Initiatives InTechnological Innovation, Washington, D.C., NationalGovernors Associatio.:, 1985, p. 64.

3. For an overall view of this issue, see Hansen, op. cit.;Michael Kieschnick, Venture Capital and Urban Develop-ment, V ...shington, D.C., Council of State Planning Agen-cies, 1979; Lawrence Litvak and Belden Daniels, Innova-tions in Development Finance, Washington, D.C., Conn-ell of State Planning Agencies, 1979; Jones, ed., op. (4.,pp. 1-23; r-rnoration for Enterprise Development,"Transforming Dangers Into Opportunities: Strategies forResponding to Financial Deregulation," 1985; and James0. Gollub, Financing Innovation in Enterprise: BeyondVenture Capital, Menlo Park, Ca., SRI International,1985.

4. David Birch, "Matters of Fact," (interview), Inc., April1985, p. 32.

5. Jacques Koppel, "Manufacturers Must Face the M sic,"High Technology, March 1986, p. 12.

6. For useful views of this issue, Fee Jones, ed., op. cit.,pp 24-42; and Tom Chmura, Investing in People: NewDirections in Developing Human Capital To Meet the Needsof a Dynamic Economy, Menlo Park, Ca., SRI Interna-tional, 1985; and Pat Choate and J. K. Linger, The HighFlex Society, New York, Alfred A. Knopf, 1986.

7. Choate and Linger, op. cit.

8. For Jsefill examinations of this subject see HughO'Neill, Creating Opportunity: Reducing Poverty ThroughEconomic Development, Washington, D.C., Council ofState Planning Agencies, 1985; Jones, ed., op. cit., pp.124-173; Investing in Poor Communities, Washington,D.C., Corporation for Enterprise Development, 1985;Steve Quick ani Robert Friedman, The Safety Net as Lad-der: '1, --isfer Payments and Economic Development.

9. For information on South Shore Bank see DavidOsborne, "Bootstrap Banking," Inc., Lugust 1987, p.69-72, or contact South .,nore Bank's management at 7054S. Jeffrey Blvd., Chicago, T',, 60649. For information on

Kentucky Highlands and the Delta Foundation see O'Neill,op. cit., or publications from the National Congress ForCommunity Economic De\ ,:lopment, 1612 K Street,N.W., Suite 510, Washington, D.C., 20006.

10. For information on new housing programs, see MaryK. Nenno, New Money and Mew Methods: A Catalog ofState and Local Initiatives In Housing and CommunityDe v eloPment - 1979-1986, Washington, D.C., NationalAssociation of Housing and Redevelopment Officials,1986; Decent and Affordable Housing for All: A Challengeto the States, Washington, D.C., National Governors'Association, 1986; and John Sidor, State Housing In-itiatives: A Compendium, Washington, D.C., Council ofState Community Affairs Agencies, 1986.

11. Jones, ed., op. cit., p. 160.

12. Ibid., p. 161.

13. Mt. Auburn Associates, op. cit., p. 133.

14. For the closest things to overall texts on stateeconomic development see, in addition to other publica-tions cited in these notes, Robert Friedman and WilliamSchweke, eds., Expanding the Opportunity To Produce:Revitalizing the American Economy Through New Enter-prise Development, Washington, D.C., The Corporationfor Enterprise Development, 1981; Vaughan, et al., op.cit. and Peirce, Hagstrom and Steinbach, op. cit.

15. See Jane Jacobs, The Economy of Cities, New York,Vintage Books, 1969, and Cities and the Wealth of Nations,New York, Vintage Books, 1985.

16. "Opportunity for Every American," Democratic PolicyCommission, Report of the Committee on the Industrialand Entrepreneurial Economy, 1986.

17. Thurow, op. cit., p. 161.

18. Susan Friedman and S. M. Miller, "The Reconstruc-tion of Finance: Implications of Industrial Policy," in AlanGartner, Colin Greer and Frank Riersman, BeyondReagan. Alternctives for the '80s, New lurk, Harper &Row, 1984.

85

19. Ibid.

20. Kieschnick, op. cit., p. 51.

21. Politics and Markets, newsletter of the Gallatin In-stitute, Nov. 28, 1983.

22. Thurow, op. cit., p. 18.

23. Robert B. Reich, ?mei-view, World Policy Journal,Fall, 1984, p. 16.

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