An Analysis by Rick Heffernon
Heffernon is a senior policy analyst at the Morrison Institute for Public Policy. Read Bio (PDF)
It pays when investment foresight is 20-20
These are tough times for policymakers in Arizona. Budgets remain squeaky tight, revenues have shown little bounce, and most state discretionary spending has been cut to the bone.
Viewpoints — The Arizona Republic
Sunday, October 26, 2003
So it comes as little surprise that our political leaders have borrowed a page from the business playbook when considering new public expenditures for economic development projects. Whether it’s building new conference facilities, backing a stadium plan, or providing support for cutting-edge research, their question is: “What’s the return on investment?”
This is good public policy. But return on investment is not as easy to calculate in the public arena as it is in the business world. To paraphrase one observer speaking about the most recent legislative budget session, “I don’t pay attention to promises of return on public investment because I’ve never seen it put money back into my wallet.”
This comment illustrates how widely misunderstood the concept of return on investment has become in public discourse. Like the expression “quality of life” back in the 1990s, “return on investment” has emerged as a popular term without a commonly agreed-upon public definition. Yet it is intuitively clear to most everyone that public projects can provide important and substantial economic benefits.
How should return on public expenditures be defined?
Return on investment has roots in the financial sector. Whether it is expressed as a dollar figure, a percentage of the initial investment, or the time period until payback, return essentially means “net profit.”
Government, however, isn’t in the profit-making business. Its purpose is to perform the functions that the market does not—ensure safety, support education, provide unmet services, build infrastructure and create economic stimulus, to name a few.
When return on investment is used to describe the value of public investment, it actually means “What do we get for our money?” And the answer cannot, or should not, always be preceded by a dollar sign.
People make non-financial decisions regarding return on investment every day. They buy clothes, pay for food, or volunteer their time, and their return on investment is not money, but protection from the elements, satisfaction from hunger or a sense of doing good.
Even business executives must consider non-financial return on investment factors in their strategic plans. Anyone can see that making customers happy and keeping up with the competition are tricky concepts to quantify in dollars, but dearly important to the bottom line.
When it comes to calculating return on public projects aimed at increasing economic growth and development, policymakers have a variety of methods available. They must decide which are most important and agree on appropriate performance measures.
The main calculation that actually returns dollars directly to the public coffers is the fiscal benefit from increased tax revenues. A number of other definitions of public return can also be tied to financial effects, but these are more indirect. Some examples include the economic value derived from additional jobs, better salaries and spending by new businesses.
Two problems vex most methods for calculating public return on investment. First, they don’t easily sum up to one easy-to-understand number. As calculations of different effects over differing time scales, they add together like apples and oranges.
Second, calculations of return don’t usually capture the long-term, broadly based results of wise economic development investments, such as the magnetic attraction that a city generates as it becomes recognized as a great place to live and do business, the business and university networks that begin to link to provide economic advantage for a region, and the rich pool of talented entrepreneurs and innovators that develops to keep an economy vibrant.
And these are what economic growth and development investments are really all about — creating lasting solutions to economic challenges.
For some public investments, the best available measurement option is to wait 10 years and then look back to determine what has changed. Unfortunately, this is little help to those perched at the starting line, trying to peer ahead and decide both how the public’s money should be invested and how its recipients can best be held accountable.
The policy struggle we face right now is figuring out how to provide the kind of early information that policymakers need in order to make good decisions about public investments. This will not only help them make better choices at the initial stages of investment, but it will also give them the confidence necessary to stay the course on promising long-term investments.
Rick Heffernon is developing a new way of assessing return on public investment as introduced in “Seeds of Prosperity: Public Investment in Science and Technology Research.”