Subsidies at Sea

A private shipbuilder received million in 'location incentives' to save an abandoned naval yard in South Philadelphia. What did the city get in return?

Phil Rowan was called off his construction site one crisp October afternoon and told to get himself down to the Philadelphia Naval Shipyard. It was an invitation to revisit his past. A third-generation electrician, Rowan had worked at the yard throughout the '80s and early '90s, running power cables to military ships and outfitting the vessels with flood alarms, telephones, and temporary lighting. Those were the best years of his working life, when the overtime flowed and his workmates felt like brothers. "Jobs were jobs, but this was more of a family thing," says Rowan, president of the Philadelphia Metal Trades Council. "We went to baptisms, weddings, bar mitzvahs, the whole nine yards."

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That was before the yard closed in 1995. Now, driving through the familiar gates two years later, he was struck by the silence of the place. Hulking brick-and-glass buildings stood vacant, and tall weeds pushed their way through sidewalks. Wild pheasants scurried amid the ruins. Rowan -- a barrel of a man with a sweeping forehead, thick mustache, and knuckles tattooed LOVE and HATE -- made his way down to Dry Dock No. 5.

There, already gathering by the dock, were dozens of other union leaders. They had been called together for a waterfront meeting with Pennsylvania Governor Tom Ridge and Philadelphia Mayor Ed Rendell, who wanted to secure their support before stepping up to a cluster of microphones and formally announcing a deal that could bring shipbuilding back to Philadelphia. Rowan, who had heard such wishful schemes before, tried not to get his hopes up. "I hope this isn't another false alarm," he thought.

This time, the politicians promised, it was the real thing. The governor and the mayor had just returned from Europe, where they had signed a contract with a Norwegian shipbuilder called Kvaerner ASA. The company agreed to invest $165 million in the Philadelphia yards, build at least three vessels, and hire a minimum of 700 workers.

But Kvaerner's arrival, the union leaders learned, came at a steep price: $429 million. That's how much the city and state had arranged to provide the company as an incentive to come to Pennsylvania. Taxpayer money would build a new state-of-the-art facility, which Kvaerner could eventually buy for $1. Public funds would also train the workers and pay part of their wages.

Rowan was skeptical of a plan that provided such a large public handout to a private conglomerate. But given the decline of the docks, he saw no alternative. Over the years, there had been talk of turning the abandoned shipyard into a racetrack, an amusement park, a subway-car factory. The Kvaerner deal, Rowan believed, might be the final opportunity to reclaim Philadelphia's reputation as a great shipbuilding city, and to restore some of the thousands of jobs lost when the military closed down its operations. "We have to play the hand we're dealt," Rowan concluded. He and his fellow union leaders held an impromptu caucus, and even though they had never discussed wages or working conditions with the company, they agreed to stand beside the mayor and governor as they announced the project.

In doing so, they helped seal one of the biggest government subsidies of the past decade. Like many "location incentives," the Kvaerner deal heaped almost all of the financial burden on taxpayers and little on the company. At the same time, it put the state in the forefront of an escalating national trend: the doling out of public monies to private corporations to create jobs.

 

Every year, state and local governments pour billions of dollars into a frenzied bidding war: a high-stakes competition to lure new employers and keep old ones. The money flows from taxpayers to corporations in the form of grants, tax abatements, low-interest loans, and a whole litany of other financial inducements. Though there's no official tally of how much gets spent on such incentives, the best estimate comes from political scientist Kenneth Thomas, author of Competing for Capital , who puts the figure at an annual $26.4 billion. The subsidies include money spent not only to lure new corporations like Kvaerner, but also to placate existing employers who are threatening to leave.

Subsidies date back to the Great Depression, when Southern states started using public funds to lure industries from the North. Initially, they seemed to make sense: If you help an industry financially, it's more likely to create jobs in your region. But over the years, it has grown increasingly clear that subsidies often benefit corporations at the expense of communities. Incentives may convince new industries to set up shop, but they undercut the local tax base while obligating the city or state to pay for the new demands on roads, schools, and water systems that come with industrial growth.

Subsidies have also proven strangely impervious to the laws of supply and demand. Employment has soared over the past decade, reducing the economic rationale for offering incentives -- yet subsidies have hit record levels, increasing an estimated 60 percent between 1992 and 1996. "Even as we're entering the longest prosperity in the nation's historyÉthe numbers keep going up," notes Greg LeRoy, director of a watchdog group called Good Jobs First, based in Washington, D.C.

That's because corporations are growing increasingly sophisticated at playing the incentives game. Expansion Management magazine teaches executives to "pile your plate high with savings at the incentives buffet." The trick: pitting cities and states against each other to increase the government dole. When General Instrument announced it might leave Hatboro, Pennsylvania, it generated a three-state competition for its 1,250 jobs. "We played Pennsylvania off New Jersey and even Virginia," company vice president Charles Ziccardi told Plant Site Locations magazine. "That's when Pennsylvania decided to kick in $1 million" in grants and tax breaks.

Economic developers point to such deals and claim they've landed XYZ Corp. But companies increasingly use incentives as a way to cut wages and bolster their bottom lines -- often without creating the promised jobs. In 1997, Keystone Powdered Metal raked in $11.6 million to build a new factory in northwestern Pennsylvania. While state officials bragged that they had created 70 new jobs paying approximately $9 an hour, the company simply eliminated better-paying positions at a factory in a neighboring county.

The subsidy business has become so lucrative that corporations can spark bidding wars even when they have no intention of closing up shop. "A lot of these decisions are made on bluffs," says Art Rolnick, research director at the Federal Reserve Bank of Minneapolis. When Marriott International announced it might move its headquarters from Maryland to Virginia, the state agreed in 1999 to hand over $43 million in incentives to keep the company from bolting. The Baltimore Sun later reported that Marriott had already decided to stay by the time it received the subsidy and was simply cashing in on the state's panic. "We were very poor economic development game players," Maryland House Speaker Casper Taylor Jr. admitted when he learned of the bluff.

Companies can even relocate to a community without subsidies -- and then extract what they call "retroactive" incentives. Economic development consultants urge their clients to review their recent relocations and expansions, and then apply for "refund checks" for jobs created during the previous five years. "Consider the sheer wonderment of a young child, who upon taking down the Christmas tree, finds another present hidden under the boughs," urges an article in Expansion Management . "It's the same with incentives. Many states allow for companies to go back and claim all the goodies they were entitled to in the first place."

So where does all the money come from for subsidies? Local officials claim they're borrowing against the growth in their tax base that will occur when XYZ Corp. comes to town. In reality, incentives often come at the expense of real economic development tools, like improvements to roads and schools. In 1992, when Intel announced plans to build a large microchip plant, it released a 104-point "ideal incentive matrix" in six Western states, listing the subsidies it hoped to land. The city of Rio Rancho, New Mexico, jumped at the deal, assembling a package of local and state incentives that included $441 million in property tax breaks. In the end, Rio Rancho won the bidding -- but the subsidy wound up depleting the city's coffers. Without money for construction, three of its five elementary schools were crammed to almost twice their capacities -- largely with the children of Intel employees, whose numbers had doubled. Desperate, officials turned to the state legislature for help, but lawmakers had little sympathy for a city that had excused its leading employer from paying taxes.

In the long run, say critics, public subsidies actually harm workers by undercutting a community's ability to attract businesses. "The number-one determinant of where companies decide to locate is skilled labor," notes LeRoy. "You don't improve your skills base by undermining your school system with property tax abatements and corporate income tax credits."

 

It's hard to imagine a place more hungry for jobs than South Philadelphia, a blue-collar community that rises from the banks of the Delaware River. In its heyday, the Naval Shipyard was the waterfront's gritty jewel, a local landmark more important to neighborhood residents than the Liberty Bell. Built in 1801, it grew into a pulsing, iron-hot source of jobs for generations of workers. "There were machines in there that were staggering in size," recalled Art DiGiuseppe, an engineer who came to the yard in 1962. "The noise was deafening. The activity was intense. People were scrambling, running, doing things. I had never seen anything like that."

At its peak during World War II, the shipyard employed nearly 50,000 workers. By the time DiGiuseppe arrived, it was in the midst of a slow economic decline. In 1970, the yard's workers built their last ship. Over the next two decades, with the yard limited to repairing and converting military ships, the workforce dropped to 10,000 -- and the population of the city's south side fell from 328,000 to 253,000.

Yet workers believed the shipyard would never shut down entirely. So the first official reports, in 1991, that Defense Secretary Dick Cheney had slated the yard for closure were met with denial. "It was a self-defense mechanism," says William Keller, a retired longshoreman who now represents South Philadelphia in the state legislature. "They always believed, till the day they walked out the door, that something would happen to save them." At a federal hearing, six women presented an immense plastic bag containing an enormous petition to save the jobs, but the 100,000 signatures made no difference. The yard would close in 1995, after the overhaul of the aircraft carrier John F. Kennedy .

Refurbishing the Kennedy , for some employees, was almost like building their own caskets. "Every day these workers went out," Keller says, "was a day they were closer to not having a job -- and they stayed there right to the end." The morning the carrier was launched, a band played on deck, and workers kept up a festive facade. But the moment the Kennedy's mast disappeared over the horizon, "it became dead quiet," Jon Bergner, the yard's last commander, recalled later. "I turned around, and 2,500 people, who had been so happy and so full of themselves, looked like zombies. Sunken eyes, blank stare, head down, and it was as if somebodyÉreached out and jerked out part of their souls."

Some of the former workers found low-paying jobs as janitors or hardware salesmen. Many of the neighborhood's modest brick row houses, with their distinctive aluminum awnings, went up for sale. Phil Rowan recalls how one man came to the union office every day, lunch pail in hand, and stayed for hours before going home. "He didn't have the balls to tell his wife he was laid off," the electrician says.

For most workers, leaving South Philadelphia wasn't an option. Their lives were often founded on strong family ties and childhood friendships. "These people can't move," says Keller. "The neighborhood is the center of their lives."

 

Governor Tom Ridge had already taken one principled stand against subsidies -- a move that cost him considerable political goodwill. In 1995, only months before the shipyard closed, a German shipbuilding firm called Meyer Werft had promised to turn the soon-to-be-abandoned docks into a world-class facility in return for $167 million in public money. Many local officials considered the offer reasonable, but to a fiscal conservative like the governor, it seemed excessive. At a press conference, Ridge held up a dollar bill, representing the money the state was being asked to invest, and two pennies, representing what Meyer Werft was offering. The deal fell through just days after the shipyard closed its gates.

The failed deal angered many in South Philadelphia. "Did you ever lose a job?" Rep. Keller, the former longshoreman, asked a member of the governor's staff. "Do you know what it's like?" Concerned about alienating Pennsylvania's powerful unions, Ridge did an about-face on subsidies. "He needed this for reelection," says state Rep. John Lawless, a fellow Republican. "His first attempt to save the shipyard was a debacle, and he had labor unions and the city of Philadelphia upset about the loss of jobs."

So when Kvaerner, an $8.5-billion-a-year engineering and construction firm, expressed an interest in the yard in January 1997, Ridge jumped at the deal. For over a year, the state had been courting the Norwegian conglomerate. Company and state officials had flown back and forth across the Atlantic. Kvaerner executives were treated to two Philadelphia Eagles football games, where they had their pictures taken with First Lady Hillary Clinton and heavyweight boxer Mike Tyson.

Finally, Kvaerner said it would consider coming to Philadelphia -- in exchange for $400 million in subsidies. State negotiators were stunned. Kvaerner was asking for twice as much money as Meyer Werft, while promising to create fewer than half as many jobs. But Pennsylvania knew it was in a bidding war -- if it bucked too hard, it could lose Kvaerner. "They were talking to South Carolina," says Manuel Stamatakis, head of the Delaware River Port Authority and one of the state's negotiators. "They were looking at other sites in the United States."

Over the next nine months, landing Kvaerner became something of a crusade. "This is more than creating jobs," Stamatakis says now, recalling the drive to clinch the deal. "It's the revitalization and restoration of an industry." The United States, once the world's leading shipbuilder, now accounts for barely 1 percent of the industry worldwide. "At some point," Stamatakis says, "a decision has to be made as to whether we want to restore some of the prestige and market share that we once had."

Critics of the deal wondered why Pennsylvania would bank so much of its economic development funds on a dying industry. "American shipyards aren't able to compete with the Korean and Japanese yards," says Will Collette, an AFL-CIO researcher who has studied the industry for years. "Although they are commercial enterprises, they're part of the industrial cartel -- essentially state industries. The Korean shipyards could dump ships into their markets in ways the American shipyards couldn't compete."

Analysis after analysis painted U.S. shipbuilding as an industry in trouble. Still, the negotiations persisted -- until October 1997, when Kvaerner and Pennsylvania signed one of the largest incentive deals in state history. All told, the company reaped $429 million: more than half from the state, and the rest from local, regional, and federal agencies. Almost half of the money was earmarked to build a state-of-the-art facility for Kvaerner. The company was not required to spend a single dollar for construction; in fact, it acted as general contractor on the project, enabling it to profit from building its own yard. If Kvaerner stuck around for 99 years, it could purchase the buildings for $1. Kvaerner was required to create 700 jobs initially, but if it tapered its workforce down to 200, as permitted under the deal, the subsidy would amount to $2 million per job.

To Phil Rowan, the union leader, that sounded like a huge outlay. "But I can live with this," he remembers thinking at the time. "We've got a shipbuilder who can compete worldwide." State and city officials were almost giddy about the deal. "The magic of shipbuilding belongs here in Philadelphia," Governor Ridge said at the dockside announcement, ßanked by union leaders. "By year 2000, our goal is to christen that first container ship, to send it down the river and into the seas." Mayor Rendell added a prediction of his own. "I have no doubt," he said, "they will be here for decades and decades and decades."

The deal started to go wrong before ground was broken for the new facility. State officials had predicted construction would generate 8,100 jobs for local suppliers and contractors. Instead, Kvaerner spent much of its public subsidy abroad. The company gave all but one of its first eight contracts for equipment to foreign companies, including $25 million for three cranes from Portugal. Of the first $234 million awarded, barely a third went to in-state firms. "Frankly, the Kvaerner shipyard deal is looking more and more like a raw deal for Pennsylvania when it comes to shipping our citizens' hard-earned tax dollars overseas," state Senator Leonard Bodack said when he learned about the cranes in 1998. Phil Rowan was more succinct: "That crawled up my ass sideways."

But while Kvaerner was exporting public money, its executives were using tax dollars to live in luxury. A review of the project by the state auditor general, released last August, found that the company had spent almost $2 million on "categorically unreasonable" perks for its own officials. Kvaerner's president lived rent-free in an expensive home, leased a BMW 740iL, bought a $6,000 grand piano, and spent $51,000 to renovate his basement -- all with state funds. Under scrutiny from the auditor general, the firm eventually refunded the money, but by the end of 1998, the project was three months behind schedule and $80 million over budget.

Then came the shocker: The next spring, as the steel frame of the new facility was going up, Kvaerner announced that it planned to quit the shipbuilding business. The previous year, the company had lost $176 million, and its stock had plummeted from $41.75 to $8.59. "There are simply no orders," CEO Kjell Almskog told the Philadelphia Inquirer. "It's a little difficult to maintain a shipyard in a situation where we have no orders." Kvaerner said it would hold on to the Philadelphia yard until it found a buyer, but industry experts scoffed at the notion that anyone would purchase the facility. "Shipbuilding is not exactly the flavor of the month," analyst Ole Slorer noted.

By the time Kvaerner finished the first section of its first ship last fall, it was clear that taxpayers had been forced to pay for a deal that was flawed from the start. Auditor General Robert Casey Jr. reported that the contract had made it virtually impossible for Kvaerner to lose money, allowing the Norwegian firm to walk away from Philadelphia without taking a financial hit. With three-quarters of the money already spent, the state can recover only $20 million from the company -- far less, the audit by Casey's office noted, than the amount "paid to Kvaerner, its executives, and its affiliates for constructing the shipyard at taxpayer expense."

Supporters of the subsidy attacked the audit, noting that Casey, a Democrat, had gubernatorial aspirations, and pointing out that the state still owns the facility. "We acted like a developer," says Stamatakis, the state negotiator. "We agreed to build the facility and to own it, much like a developer builds an office building and owns it. So all the infrastructure is owned by the governmental bodies, not by Kvaerner."

But with shipbuilding in decline, it may prove difficult to find a company to take Kvaerner's place. "An office building, unlike a shipyard, is something where you could find alternate tenants," says Richard Spiegelman, chief counsel for the auditor general. "Kvaerner could walk away from this, and the commonwealth is left with a large specialized shipbuilding facility."

 

It's a rainy winter day in South Philadelphia, but that's not slowing production at the shipyard. Inside a cavernous fabrication plant painted in kindergarten reds, yellows, and blues, Kvaerner employees are punching computer keyboards, manipulating high-tech machines that lift, cut, and mill steel plates. Each plate is automatically marked with a series of numbers and letters corresponding to its location on the ship, and eventually all the pieces will be methodically welded together. "We're building ships today like we used to build Legos," says shipyard Vice President Rolf Pettersen.

But Kvaerner has already put the facility on the market, and its contract allows it to walk away without completing the first ship it is working on, let alone the two others it pledged to build. "We are not going to turn our back," CEO Almskog has told reporters, "but we are going to exit shipbuilding."

How did Pennsylvania end up giving a nine-figure subsidy to a troubled company in a dying industry? With cities and states locked in a bidding war for jobs, no one wants to give up incentives, for fear it will put them at a disadvantage when a potential employer comes knocking. "Each of our neighboring states is spending a like amount of money trying to steal jobs from us, or keeping us from stealing jobs from them," says Charles Horn, a former Ohio state senator. "It's all a non-value-added competition, because we're just churning these companies around. And we're doing this at a time of full employment."

Economic development has become an arms race: As costly and wasteful as it is, the warring governments are scared to disarm unilaterally. The one celebrated attempt at a cease-fire failed completely. In 1991, New Jersey, Connecticut, and New York state and city signed a pact to stop stealing jobs from one another -- a competition that was costing taxpayers an estimated $800 million a year. "That particular agreement lasted, I believe, four days," recalled Robert Reich, who served as labor secretary under President Clinton. "It is very difficult for any mortal politician, mayor or governor, to not get engaged with the bidding because [of] the possibility of losing jobs in a highly visible way."

To end the competition, advocates are calling for a national moratorium on incentives. Last year, Congress considered a bill to tax businesses that receive public subsidies -- creating, in effect, a disincentive to accept incentives. "Individual states and local governments are powerless to put a stop to this practice," says David Minge, a former congressman from Minnesota who introduced the measure. "Unilateral disarmament in this bidding war could mean the loss of thousands of jobs. Congress is the only entity that can put a stop to the economic war between the states."

But at least one community has voluntarily laid down its weapons -- and discovered that it did not lose a thing. In 1999, Roush Racing promised to build a $75-million stock-car manufacturing complex on the outskirts of Concord, North Carolina -- but only if the county forked over almost $2 million in taxpayer subsidies. "Mr. Roush came and gave all these grandiose plans and said that in order to do it, he would need incentive grants," says Coy Privette, a Republican county commissioner.

Concord would certainly benefit from the sprawling complex, slated to include a manufacturing facility, race shops, and corporate offices. But Privette and his colleagues weren't impressed. "Corporations, if they're good citizens, should want to help us build schools, rather than looking for a free ride," he says. The commissioners offered Roush Racing no subsidies. "And guess what?" Privette says. "They came anyway."