Investors turn away from Ohio as heavy use of tax dollars to woo jobs doesn't pay off

9/24/2006
BY JIM TANKERSLEY AND JOSHUA BOAK
BLADE STAFF WRITERS

Second in a series

As he shaves each morning, David Morgenthaler ponders the one investment he can't spin into gold. It matters more to him than Apple computers and Nextel phones. It is the state he calls home.

Mr. Morgenthaler, perhaps America's oldest living venture capitalist, can turn his head past the medicine cabinet mirror and spy Lake Erie, where about 20 percent of the world's fresh water flows toward Niagara Falls. A short drive from his suburban Cleveland house, workers bend metal into sculptures of global commerce. Cars. Boilers. Bearings.

"I ought to be able to figure out how to put this together and make money out of it," the 87-year-old says. "I haven't been able to do it. I'm not innovative enough."

Ohio's economy is suffering, but not for the reasons you've been told. The Blade explores the state's core economic problems and how the men who would be governor plan to fix them.
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  <b>Part 1</b>: <a href=Ohio economy sputters as innovation declines
Part 2: As private investors look elsewhere, state efforts fall short
Oct. 1: Wanted: 1,000 engineers (And other tales of the real "brain drain")" rel="storyimage1" title="Investors-turn-away-from-Ohio-as-heavy-use-of-tax-dollars-to-woo-jobs-doesn-t-pay-off-2.jpg"/>
Ohio's economy is suffering, but not for the reasons you've been told. The Blade explores the state's core economic problems and how the men who would be governor plan to fix them. <br> <b>Part 1</b>: <a href=" http://www.toledoblade.com/apps/pbcs.dll/article?AID=/20060917/NEWS24/60917002" target="_blank "><b>Ohio economy sputters</b></a> as innovation declines <br> <b>Part 2</b>: As private investors look elsewhere, state efforts fall short <br> <b>Oct. 1</b>: Wanted: 1,000 engineers (And other tales of the real "brain drain")

Cleveland-based Morgenthaler Partners funded Apple, Nextel, and 250 other startups. Of the 71 firms listed in its $2.5 billion portfolio, only two are headquartered in Mr. Morgenthaler's backyard. Most Ohio companies don't meet his standards.

Things were different once. Mr. Morgenthaler settled along the Great Lakes after fighting in World War II, passing on a strip of California bungalows and lemon groves now called Silicon Valley. Ohio, Michigan, and Pennsylvania, he says, had the exciting jobs.

Private investors follow opportunity and help economies grow. Their risks show confidence in a state's future. And despite intense tugging by Ohio's government, the state's young companies receive 80 percent less venture capital funding than businesses nationwide.

Today, Ohio still battles a recession the U.S. government says ended in 2001. Only one group of investors bet heavily on the state's economy in the last decade: Ohio taxpayers.

Their returns are less than advertised.

The Ohio Department of Development spent billions of taxpayer dollars chasing its goal of "economic opportunities to improve the profits and prosperity of Ohio's citizens." The Republican and Democratic candidates for governor this fall want to spend even more.

By the government's own accounting, state economic development assistance is responsible for more than 520,000 jobs in Ohio since 1992.

But there's a difference between jobs and prosperity.

The drug testing labs of Phoenix International Life Sciences promised just the sort of high-technology jobs Ohio was courting in 1994. Its Canadian owners helped pharmaceutical companies run clinical trials.

When Phoenix International considered opening a new lab in Cincinnati, the Ohio Department of Development wooed it with a $1.4 million incentive package.

This is how the department invests taxpayer dollars. To spur private development, it gives companies loans, grants, and tax credits for worker training, road and sewer upgrades, and general financial help. Its biggest package on record, totaling $26 million, went to Toledo's new Jeep plant.

The state measures its return in jobs.

Phoenix International delivered 102. The thousands of other recipients of more than $1 billion in direct state assistance from 1992 to 2001 created 183,906 new jobs and "retained" 337,611 others, including 4,744 at the Toledo Jeep plant, state records show. Retained jobs allegedly would have vanished or left without state intervention.

Gov. Bob Taft says Ohio leaders are "not in the business of Soviet-style development," meaning the government doesn't direct the state economy. Judge for yourself: The development department claims a return of 521,517 jobs from its programs, which equals 93 percent of Ohio's net job gain for the same period, according to the U.S. Bureau of Labor Statistics.

That doesn't make Mr. Taft a closet communist. Ohio's economic development measurement is flawed.

Consider what the state missed about Phoenix International. A rival bought it in 2000, closed its Cincinnati lab, and fired all of its Ohio employees. The layoffs came three years after the development department closed its books on the company and dubbed it a success.

"The legislature wants to know cost per job," said Walt Plosila, whom the state hired in 2003 to help plan its technology-based economic strategies. "That's not a good barometer of anything. You want to know the products, the growth prospects, the condition of the market."

Mr. Plosila was Pennsylvania's deputy secretary of commerce during the 1980s. He later helped nurture Maryland's biosciences industry before joining the Battelle Memorial Institute, an Ohio-based technology think tank.

His time in government taught Mr. Plosila that politicians preferred factory ribbon-cuttings to fostering entrepreneurship, a pattern he found historically in Ohio's development department.

Mr. Plosila's team told Ohio leaders to measure their efforts through income growth, university research expenditures, and patents per capita, among others.


Those standards paint a decidedly bleaker picture of Ohio's economy than the development department's job figures.

As recently as 1999, the average Ohio family's income matched the rest of the country, according to the Census Bureau. By 2005, that Ohio family made $54,086, or $1,746 less than the national average.

The state's universities spend $115 per year on research for each person living in the state, which is 20 percent below the national average.

Between 1994 and 2004, Ohio ranked 40th in patent growth, right next to Arkansas.

Patents per capita are the most important predictor of state wealth, the Federal Reserve Bank of Cleveland recently concluded in a study that looked back 75 years.

A 273-page report by Mr. Plosila's Battelle team found the Ohio development department failed to encourage the companies most likely to generate valuable patents. The state, it said, is "composed of older, more established firms" that are not designing, developing, and making new products.

Those are companies in which the state's development department has invested most of its technology grants.

The two leading candidates for governor, Republican Ken Blackwell and Democrat Ted Strickland, both say the state must improve its economic development efforts - largely by doing more of the same.

Mr. Blackwell, the secretary of state, wants to lease the Ohio Turnpike to private investors, in hopes of pumping billions of new dollars into stimulus programs.

He also wants to cut taxes, ease regulations, and cap lawsuit awards, areas he calls "the walls we are building to capital investment" in Ohio.

The Fed found taxes have no effect on state incomes. About 47 percent of venture capital deals brokered this year went to companies based in California, a state singled out for high taxes and "low economic freedom" by the Pacific Research Institute, a conservative think thank regularly cited by Mr. Blackwell's campaign.

Mr. Morgenthaler says a company's profit stream is more important to him and other venture capitalists than a state's tax code. His clients - pension funds and college endowments - want a portfolio that will outperform the stock market by more than 5 percentage points.

Mr. Strickland, a congressman from Lisbon, says Ohio's development department will perform better if it spreads its spending more broadly around the state.

Asked how they will measure the results of their efforts, Mr. Strickland and Mr. Blackwell say job growth. Mr. Strickland goes on to say he will measure every state agency, not just the development department, on jobs - specifically, "living-wage jobs."

In Toledo, City Council defines a "living wage" job as about $10.50 an hour with benefits or $12.50 an hour without them.

Mr. Strickland is fond of citing the nonprofit Youngstown Business Incubator as an example of state development success. The incubator, he says, has spawned 160 jobs, at an average salary of more than $60,000. It has licensed 16 patents.

The congressman got those numbers from incubator staff members. The state development department doesn't compile them, even though it gave $2 million to the incubator in the last eight years.

Because it doesn't keep track, the department can't say how many patents, or what types of salaries, or even how many jobs, resulted from its $634 million technology-targeted investments around the state. The state can't even list all the companies those investments funded, just like it can't list what it gets for billions of dollars it forgoes in corporate tax breaks.

The department's director, Lt. Gov. Bruce Johnson, says he evaluates state-assisted companies by additional criteria the state doesn't disclose publicly, including payrolls and access to outside investments, giving preference to "innovative" companies.

He says some department spending on infrastructure isn't easily tied to any measure, but he'd like to see more yardsticks for the rest.

Still, Mr. Johnson says, "The public policy behind having a development department is to help sustain a state's economy. Most people measure that ... with jobs."

Only one arm of the department requires detailed public measurements of its investments.

But even those results are open to interpretation.

In his January "State of the State" address, the term-limited Mr. Taft celebrated his signature achievement: the Third Frontier project, which seeds companies in the "imagine phase" and tracks their progress in income, patents, and research spending.

The 10-year, $1.6 billion program will make Ohio "the best place to innovate and create new high-paying jobs," Mr. Taft told the legislators and statewide officials who filled the House of Representatives in Columbus.

"We're attracting more federal research dollars than ever before, leading to more good jobs for our college graduates," he continued. "We've seen increases over the last four years in patent applications filed, patents issued, and license income received from new products and inventions."

The governor's speech ignored uncomfortable truths about Ohio's economy.

Ohio actually got more research money in the past. In 2003, federal agencies gave the state $2.39 billion for research (2.6 percent of the federal government's total research expenditures), less than half of the $5.56 billion (7.9 percent of the total) it gave Ohio in 1998, according to the National Science Foundation, Mr. Taft's source. Figures for 2004 and 2005 have yet to be released.

Ohio's gross patent numbers are up slightly. But the Fed numbers show the state trails the nation in per-capita patent growth.

Development department statistics show Third Frontier investments have spawned 51 patents and 1,926 jobs with an average salary of $73,716. The department says $115 million from the state has leveraged more than $755 million in private investment.

But Third Frontier hasn't kept its promise to bring more venture capital to Ohio, according to the accounting firm PricewaterhouseCoopers, which reports quarterly on venture funding.

In 2002, the year before Third Frontier, Ohio companies garnered $232 million in venture capital, or about $5 million per deal. During the first six months of this year, Ohio firms got $19 million total, an average of $1.26 million per deal. By comparison, the average venture-supported business nationwide got $7.5 million this year.

David Morgenthaler still drives his Lincoln Continental to work every morning and logs a seven-hour day.

"I don't work heavily into the night anymore," he says. "Unless I'm traveling."

On the side, Mr. Morgenthaler donates his time and wealth to help the economy of his adopted home state.

He finances regional studies, advises the Cuyahoga County Board of Commissioners, and helps a Cleveland business incubator, JumpStart.

Like Mr. Plosila, Mr. Johnson, Mr. Taft, Mr. Blackwell, and Mr. Strickland, he says Third Frontier is key to Ohio's future.

Mr. Morgenthaler's expertise is money, but experience tells him all his investments - and Ohio's - are in people.

Last year, Morgenthaler Partners recruited the top two students from the Harvard University school of business. The first took a position in Massachusetts. The second rejected one in Ohio.

"In your Boston office, I accept on the spot," Mr. Morgenthaler recalled the second student saying. "In your Cleveland office, never."

Mr. Morgenthaler ended the story, paused, and drew a breath.

"That's just heartbreaking to me," he said, "but that's the reality."

Contact Jim Tankersley at: jtankersley@theblade.com or 419-724-6134.