The winner's curse and why cities should prefer not to have Amazon's new HQ

As many readers will know, Amazon has been searching for a location for its second headquarters in the U.S. The Washington Post reported earlier this week (gated, but there is an ungated version on the New Zealand Herald website):

Amazon's search for a site for its second headquarters is now mostly playing out behind closed doors, as officials from 20 finalist locations provide the company with additional materials...

The Amazon search is a serious matter. The chosen city could reap 50,000 jobs and $4 billion in investments from the company. Taxpayers may be asked to foot billions of dollars of subsidies to win the deal. Housing markets and traffic patterns may be dramatically affected by the company's decision. A group backed by the Koch Brothers published a video opposing subsidies for the project. On the other hand, former Virginia governor Terry McAuliffe suggested recently, in an interview, that "whoever wins this thing is going to run for president."

The mayor of the winning city may feel like running for president. But eventually, whichever city wins the affections of Amazon and gets the second headquarters will almost certainly wish they hadn't. Why would I say that? Because of the winner's curse.

Consider a group of cities vying to be the location for the second Amazon headquarters (you can see the shortlist here). Rational city planners (or the city council or mayor or whoever is making the decision to try to woo Amazon) with the same preferences would all have the same valuations (or very similar valuations) for how much economic benefit Amazon will generate for their city (based on jobs growth, for instance). However, not all city planners have the same preferences, and the city planners may make random errors in determining how much value Amazon will provide the local economy, so all of the city planners will have different willingness-to-pay to attract Amazon. In this case, their willingness-to-pay reflects how much in incentives (local tax rebates, subsidies, etc.) they are willing to offer to Amazon in exchange for Amazon locating the second headquarters in their city. For city planners with similar preferences, these differences in willingness-to-pay arise randomly - some will overestimate how much they should be willing to offer to Amazon, and some will underestimate.

Now consider Amazon's decision. They will try to maximise their "economic rent", by choosing the city that will offer them the greatest advantage, which includes the amount of tax incentives and subsidies that are on offer. Cities where the planners have underestimated the value that Amazon will provide will offer Amazon relatively small incentives to locate there, and Amazon won't choose them as a result. The 'winning' city will likely be the city that offers the greatest incentives (the most tax incentives, or largest subsidies, etc.), which will be the city that over-estimates the value that Amazon will provide to the local economy by the most.

So sure, the 'winning' city will get the Amazon headquarters. But they will also win a lot of obligations for tax incentives and subsidies offered to Amazon. Overall, the gain in terms of jobs and tax revenues will likely be less than the subsidies paid to attract Amazon, adding up to a net loss for the city. Sometimes it's best not to win.