Clean-Energy-Based Economic Development: Parallel Tracks for State and Local Policy

February 25, 2019
Clean energy can support state and local economic development. Leaders can follow five tracks to leverage clean energy to accelerate economic growth.
Clean-Energy-Based Economic Development: Parallel Tracks for State and Local Policy

Introduction: Export-Orientation and the Federal Role

Track 1: Locational Incentives

Track 2: R&D Spinoffs

Track 3: Cluster Deepening

Track 4: Energy Import Substitution

Track 5: Market Demand

Conclusion: Multiple Tracks and Federal Nudges

Endnotes

State and local policymakers are constantly on the lookout for opportunities to accelerate economic growth in their jurisdictions. Clean energy is a dynamic industry group that has stimulated more than $300 billion in investment globally in each of the past five years, according to Bloomberg New Energy Finance.[1] It is not surprising clean energy is appearing with increasing frequency in state and local economic development strategies. Nearly half of the new governors elected in 2018, for instance, mentioned it in their plans.[2]

This report describes five tracks that state and local policymakers may follow as they pursue such strategies:

  • Offering incentives to manufacturers and other investors
  • Nurturing technology-based start-up companies
  • Deepening existing clusters of related industries
  • Substituting indigenous for imported energy resources
  • Stimulating market demand for clean-energy products and services

The tracks are not mutually exclusive, and two or more are often pursued in parallel. Each track is briefly illustrated with examples, highlighting the interaction of the state and local levels with the federal government where appropriate. The discussion speaks to perennial debates in economic development policy as well as issues particular to clean energy at the moment.

The paper concludes with recommendations for policymakers at all levels. At the state and local level, policymakers should take a long-term, asset-building perspective that leverages existing strengths and sets realistic expectations. Federal policymakers should support their subnational counterparts by providing steady support for the national transition to clean energy, as well as timely information, technical assistance, and R&D funding.

Introduction: Export-Orientation and the Federal Role

Every state and local economy needs imports. Although much trade occurs within each of these economies, many essential and highly valued goods and services must inevitably be sourced from without. Even the largest state economy in the United States, California, is highly dependent on goods imported from other states or countries, such as automobiles and petroleum.

To pay for such imports, state and local economies must receive income from the rest of the nation and the world. Although states and localities do not have their own currencies, their situations are somewhat analogous to nations. Like nations, states and localities typically must earn “foreign exchange” by exporting products customers outside their economy are willing to pay for. And, as is the case for national economies, such exports have a multiplier effect for state and local economies as earnings are spent on indigenous products as well as imports.

These considerations drive state and local governments to focus economic development (ED) policy on potential export industries as well as industries that substitute for imports.[3] The global transition to lower-carbon energy resources is creating opportunities to build new and rapidly growing export industries, while also undermining established fossil-fuel-dependent export sectors and opening the door to energy-import substitution. These industries have thus caught the attention of state and local ED policymakers.

The global transition to lower-carbon energy resources is creating opportunities to build new and rapidly growing export industries, while also undermining established fossil-fuel-dependent export sectors and opening the door to energy-import substitution.

The federal government has little direct influence over state and local ED strategies, but it nonetheless plays an important role in shaping them, particularly those targeting clean energy industries. Federal regulatory, trade, tax, and other policies strongly influence the demand for the products and services offered by these industries. Federal R&D, technology transfer, and other policies, which state and local governments often seek to leverage, impact whether these industries’ offerings are innovative and competitive.

In addition, the federal government is itself an important source of external income for many states and localities, lightening the burden on export industries. When the federal budget is in deficit, as it usually is, the balance of payments between the U.S. Treasury and most of the nation’s regional economies is positive.[4] Even when these funds are spent only on current consumption, as federal health insurance and pension benefits typically are, they nonetheless allow regional imports to be paid for.

Federal programs that state and local ED policymakers draw upon to expand clean-energy exports have a baseline fiscal impact that should be accounted for, regardless of the programs’ specific functions. The U.S. Department of Energy (DOE) is the most important federal agency affecting clean energy in this country. Its annual budget justification includes an estimate of expenditures, by state. While some of this spending is reallocated to other states through subcontracts and other channels, the tables provide a rough sense of DOE’s fiscal impact.[5]

For instance, New Mexico, with its two large national labs, receives about $5 billion from DOE annually. New Mexico’s gross state product is between $90 and $100 billion, so it is no surprise that the state government and its congressional delegation take a great interest in the DOE budget, regardless of how it is used. At the other end of the spectrum, Vermont collects the smallest amount of DOE funds of any state, receiving less than $2 million per year for weatherization and state energy programs.[6]

These federal expenditures are intended to serve national purposes, such as the creation of knowledge to foster progress in energy technologies. But they also support state and local economies, even when they make no other contributions to the creation of export-producing assets.

Track 1: Locational Incentives

The most widely-used ED policy tools in the United States are locational incentives. State and local governments cut taxes and make expenditures to induce external investment in new economic assets.[7] Manufacturing plants are the most common targets of incentives, but R&D laboratories and other economic assets may also be targeted.

Since the 1980s, foreign-owned auto manufacturing plants have been the object of intense competition among U.S. jurisdictions offering locational incentives. The center of gravity of the U.S. auto industry has shifted as southern states attracted the lion’s share of these plants.

The electric vehicle (EV) industry, a cornerstone of the transition to cleaner energy, seems likely to be targeted in the same way as it expands. An early example is Tesla Motors’ “gigafactory” for EV battery production, which was won by Reno, Nevada, with the help of a reported $1.25 billion incentive package after a national site selection process (see figure 1).

Figure 1: Breakdown of Tesla’s Reported $1.25 Billion Incentive Package From Nevada[8]

Locational incentives have been widely criticized as unnecessary and even counterproductive giveaways.[9] Current officeholders get to cut the ribbon on any new plant they attract, while their successors must cope with reduced tax revenues. Companies typically state that other factors (such as Reno’s proximity to Tesla’s assembly plant in Fremont, California) outweigh incentives when making site selections, but they nonetheless play locations off one another to maximize offers. The federal government could in principle stop such “races to the bottom,” but in practice it has chosen not to do so.[10]

Locational incentives have been widely criticized as unnecessary and even counterproductive giveaways. Current officeholders get to cut the ribbon on any new plant they attract, while their successors must cope with reduced tax revenues.

Research suggests incentives are usually economically irrational—their costs outweigh their benefits over time.[11] However, some large manufacturing plants provide benefits that spill over to suppliers and catalyze enough additional growth in the surrounding region to offset the cost of incentives. Auto suppliers may cluster around assembly plants, for instance, as has been the case in South Carolina near BMW’s factory.[12] Reno is banking on a similar effect from its support for Tesla.

Track 2: R&D Spinoffs

“Entrepreneurial” ED strategies are often contrasted with incentive-based strategies.[13] Rather than trying to recruit one-time, large-scale investments from outside the region, these strategies seek to grow export-generating assets organically from within. Start-up firms that capitalize on ideas generated at universities and government laboratories are the key agents of development in this approach. Entrepreneurial strategies usually rely on outside investment in the form of federal R&D spending, accruing over a period of years. This spending provides an important part of the seed capital for asset creation (as well as having a fiscal impact).

Several regional economies, including San Francisco, San Diego, Seattle, New York City, and Washington, D.C., have leveraged federally funded biomedical R&D to create biotechnology industries.[14] Federally funded energy R&D has spawned fewer conspicuous state and local ED success stories. The state of New York’s effort to build an energy storage manufacturing industry across several regions may become one. The state is drawing on the materials and systems expertise of the Brookhaven National Laboratory as well as six DOE-funded Energy Frontier Research Centers as part of its strategy. It has also made significant investments of its own in energy storage through the New York State Energy Research and Development Authority (NYSERDA), one of the few dedicated state-level energy R&D organizations (figure 2).

Figure 2: New York State’s Energy Storage Industry Assets[15]

The impediments to entrepreneurial ED strategies that seek to leverage DOE R&D spending have been extensively debated. A large portion of DOE spending is devoted to nuclear weapons, environmental remediation, and basic science projects that rarely spin off promising growth companies. DOE regulations and practices often create disincentives for would-be entrepreneurs. Energy start-ups tend to be capital-intensive and slow to mature, and have difficulty differentiating themselves from incumbent commodity producers—making them poor prospects for venture capital investors who provide significant capital for rapid growth in other industries.[16]

New York’s energy storage manufacturing strategy seeks to bridge this “commercialization valley of death” by supporting “state-of-the-art prototyping, product development, commercialization, and testing facilities” that complement DOE’s basic and applied research funding.[17] Whether its strategy (and similar strategies pursued by other states such as Colorado) will succeed in the face of intense competition from China and other international locations—as well as Nevada and other domestic locations offering incentives—remains to be seen.[18]

Track 3: Cluster Deepening

The third track that may lead to clean-energy-based ED involves deepening existing state and local strengths, rather than recruiting assets from the outside or growing new ones. Geographical clusters of related industries have been observed since the days of Alfred Marshall in the late 19th century. The natural spillovers into adjacent growth sectors of skills, knowledge, reputation, and capital that have accumulated through prior clustering may be accelerated by state and local ED policies.[19]

Figure 3 displays clusters in clean energy and other “clean economy” industries as defined by the Brookings Institution’s Metropolitan Policy Program in 2011. Solar-panel manufacturing relies on many of the same materials and processes as semiconductor manufacturing, so it is not surprising that Silicon Valley in California was a hotspot for this sector (although most solar panels are now imported into the United States). Raleigh, North Carolina, has leveraged its electronics manufacturing and systems-integration expertise into an emerging “smart grid” cluster.

Geographical clusters of related industries have been observed since the days of Alfred Marshall in the late 19th century. The natural spillovers into adjacent growth sectors may be accelerated by state and local ED policies.

Figure 3: Clean Energy and Other “Clean Economy” Clusters[20]