Our latest Freakonomics Radio episode is called “No Hollywood Ending for the Visual-Effects Industry” (You can subscribe to the podcast at iTunes or elsewhere, get the RSS feed, or listen via the media player above.)

In their chase for a global audience, American movie studios spend billions to make their films look amazing. But almost none of those dollars stay in America. What would it take to bring those jobs back — and would it be worth it?

Below is a transcript of the episode, modified for your reading pleasure. For more information on the people and ideas in the episode, see the links at the bottom of this post. And you’ll find credits for the music in the episode noted within the transcript.

* * *

One of the big winners at the 2013 Academy Awards was Life of Pi.

Suraj SHARMA as Pi Patel (clip from Life of Pi): My name is Pi Patel. I have been in a shipwreck. I am on a lifeboat alone – with a tiger.

The film was based on a novel by Yann Martel. It won four Oscars that night – including Best Director, for Ang Lee. It had been nominated for eleven Oscars, including Best Visual Effects. How amazing were the visual effects?

WESTENHOFER: There was a scene near the end when the tiger and Pi have been at sea for a long time and they’re both starving and near death.

That’s Bill Westenhofer. He was the visual-effects supervisor on Life of Pi.

WESTENHOFER: And we show the tiger in a very emaciated form. And I think it was India that said they wouldn’t allow the filming of the movie because they thought we had starved the tiger. And we had to show them that all that Suraj Sharma, the actor playing Pi, was doing was holding a blue sock, and that it was a complete digital creation on top.

What does it take to make a film with digital tiger so real that you can’t tell it’s not a real tiger?

WESTENHOFER: We had 1,300 people working for about a year. I was on it for about three years. And there were some other artists as well, smaller team that was on it for that length of time.

All their work, and creativity, were acknowledged:

Samuel L. JACKSON (clip from the 2013 Academy Awards): And the Oscar goes to Life of Pi! WESTENHOFER: It’s funny, they tell you when you get nominated for the award that you have 45 seconds to give your acceptance speech. WESTENHOFER (clip from the 2013 Academy Awards): The irony is not lost on any of us up here that in a film whose central premise is to ask the audience what they believe is real or not real, most of what you see is, well, it’s fake. That’s the magic of visual effects. I want to thank… WESTENHOFER: And I had a speech that – it’s a big thing to win awards, so you want to thank as many people as possible. WESTENHOFER (clip from the 2013 Academy Awards): To my family to all the sacrifices they made. Gabrielle, I love you so much. WESTENHOFER: And then I also wrote a few words that I wanted to say about the state of the industry. So I timed out some of the speeches that have gone before me, and I know there was at least one that went 60 seconds. So I said, “I can do the full version of the speech.”

What was in “the full version of the speech?” Westenhofer wanted to address the elephant in the room. The fact that the visual-effects company he worked for, Rhythm and Hues, was at that moment going through a bankruptcy. And that several hundred visual-effects artists had protested outside the Oscars, claiming their industry was being crushed by outside economic and political forces. That’s what Westenhofer planned to get into …

WESTENHOFER: But, sure enough – at 45 seconds, the lights started flashing, and then I believe the – all though I didn’t hear it on stage, I believe the Jaws theme came on and played over me. WESTENHOFER (clip from the 2013 Academy Awards): Finally, I want to thank all of the artists who worked on this film for over a year – including Rhythm and Hues. Sadly, Rhythm and Hues is suffering severe financial difficulties right now. I urge you all to remember – WESTENHOFER: And they took me off stage before I was able to say the final few things that I wanted to say. DUBNER: And we should say, they actually cut your mic, right? And we could see Nicole Kidman in the audience kind of empathizing for you that your mic went to zero. I assume you realized that your words were no longer being heard before they grabbed you? WESTENHOFER: No. No, you can’t hear that. You can’t tell on stage. I did finish saying everything on stage. DUBNER: Oh you did? WESTENHOFER: The people – within four feet of me heard it all. DUBNER: But the other billion or so didn’t. All right, so what did you say then? WESTENHOFER: Well, I was just going to point out that, you know, we had just received this Academy Award and I worked for a company that at that time was going through a bankruptcy. So I wanted to just give a shout-out that visual effects is a industry and it’s ironic that at a time when the box office was reaching new highs, that visual effects was struggling to keep its head above water. And that the state of the industry was potentially putting those artists at risk and we could start to lose the very art that we were being recognized for at the time.

[MUSIC: Fooling April, “Too Late” (from Three)]

Today on Freakonomics Radio: the visual-effects components of movies have become larger and larger. So why is the industry – in the U.S. at least – so much smaller? Our episode features: the disgruntled former visual-effects guy:

Daniel LAY: I said, “Wow, that’s great we’re making a lot of money.” And she said “Actually, we’re not making any money at all.”

The studio executive:

Chris DeFARIA: The economics of the whole visual effects industry changed dramatically.

And the big-time director:

Bryan SINGER: It has everything to do with tax incentives! Come on, who’s fooling who?

* * *

The Academy Award that Bill Westenhofer won for visual effects on Life of Pi was actually his second Oscar. He also won in 2008 for The Golden Compass.

WESTENHOFER: As a kid I was drawing and painting and making flipbooks. I think I wanted to be an animator.

But then he fell in love with movies.

WESTENHOFER: I was 9 years old and Star Wars came out. I even bought a bunch of action figures and would make little videos at home with a super cheap camcorder.

In high school, he got interested in computers; he stuck with it during college and grad school. Just as he was trying to figure out his career, another landmark movie came out.

WESTENHOFER: When Jurassic Park came out I said I have to get out to L.A. now. Because to be able to see dinosaurs for real was the most amazing thing. And I said that’s what I want to do.

Westenhofer moved to Los Angeles in 1994, got some work on TV commercials, and then on films. He was a digital artist on the 1995 film Waterworld and a CGI supervisor – that’s computer-generated imagery – on the 1996 film Kazaam.

WESTENHOFER: I started going on sets more and more and finally lucked out with Babe: Pig in the City came along and they needed some help supervising the movie. And I’ve been doing that ever since.

Westenhofer worked on movies like Men in Black II, Elf, The Chronicles of Narnia. His career rise paralleled the rise in visual effects generally. A rise in both the supply side, as the technology got better and better; and the demand side, as movie audiences loved the effects. By 2013, the year Westenhofer won his second Oscar for Life of Pi, visual effects accounted for about a third of the production budget on the top box-office movies – roughly double what it had been a decade earlier. But this did not necessarily translate into more money for the people who actually made the visual effects.

WESTENHOFER: I started in 1994 and the margins just continued to get tighter and tighter and tighter.

So tight that on that Oscars night in 2013, when Westenhofer accepted his award, he felt compelled to warn the world that his employer was in bankruptcy and his industry was under assault.

[MUSIC: Justin Marcellus, “Aerital” (from Pulsatronic Oberheim)]

DUBNER: So that was a few years ago. Despite – forget about the fact that your speech wasn’t heard other than by a few people within hearing distance, and by people listening to this now – were your warnings heeded? Were they ignored? And what is the state of the industry now compared to then a few years ago? WESTENHOFER: Well, it’s pretty much left Los Angeles. A lot of the people who worked on Life of Pi are now either not working in visual effects or have moved to Canada.

How did this happen? To answer that question, we’ll talk to a number of people from different segments of the film industry food chain. It’s an industry with many different players, with different and often competing incentives. You’ve got the studios and production companies that finance and distribute the films; the directors and their allies, who try to make the film they want while not blowing out the producers’ budget too badly; and the visual-effects firms – and many other subcontractors, of course – who typically bid for jobs and are then locked into that amount no matter what actually happens during production. We’ll start with … this guy:

Bryan SINGER: Hello, my name is Bryan Singer. I’m a film director and producer and writer. I’ve done such films as The Usual Suspects, a majority of the X-Men films, a film called Valkyrie, with Tom Cruise .

Singer grew up making home movies for fun. But he remembers the exact moment he decided to become a director.

SINGER: It wasn’t until I had seen the film E.T... Pat WELSH as E.T.: E.T. phone home. Henry THOMAS as Elliot: My God, he’s talking now. SINGER: I was about 16 years old and they were profiling Steven Spielberg’s life on the TV show 20/20 and I saw that there was this Jewish kid, like me, who was – didn’t get good grades in school and he had a drawer full of 8 millimeter films just like me. And I thought, “Wow, he made this amazing film. And I want to be just like that guy.”

It took a while. He made a short film, then a low-budget feature; The Usual Suspects came out when he was 29.

Kevin SPACEY: He tells him he would rather see his family dead than live another day after this.

This was 1995. The Usual Suspects opened doors for Singer.

SINGER: I always knew that I wanted to get into science fiction and fantasy. I didn’t realize I would do it through comic books but a friend of mine Tom introduced me to the idea of the X-Men. I had not been a fan of the comic. I didn’t know the comic very well. But the themes about tolerance in it I found very interesting and I was very drawn to the characters. So I started to study the X-Men quite heavily and I had a meeting with its creator Stan Lee and its producer Lauren Shuler Donner. And it was during that meeting I started thinking, “Wow this is Stan Lee. This is the man who created Spider-Man and The Fantastic Four and The Hulk and all these characters and he’s an icon.” And he loved The Usual Suspects and went off on it and treated me so nicely. Well, I owed it to him to at least give this some thought. So that night I gave it a lot of thought. How could I make this comic book universe seem real and seem like it could actually happen? Like what if mutants really did exist in our society? And I kind of cracked a few ideas and I basically signed a deal to start developing the material in 1996.

The Usual Suspects had cost about $6 million to make. The X-Men movie he signed on to had a budget of $75 million. And a lot of that money was for special effects – an art that Singer would have to learn a lot about.

SINGER: Both George Lucas and James Cameron at that time opened up a lot of their doors to me.

Singer spent time at George Lucas’s famous visual-effects company ILM, or Industrial Light & Magic.

SINGER: And then I also visited the set of Titanic and watch a lot of how the visual effects were done on Titanic. And so that was a great education.

Titanic was at that point far and away the most expensive movie ever made. But, in retrospect, it was a harbinger of Hollywood’s future.

DeFARIA: For me it was around the time of the making of The Matrix movies.

That’s Chris DeFaria, president of the DreamWorks Feature Animation Group. Before that, he was at Warner Brothers, where he was heavily involved in making The Matrix franchise.

DeFARIA: Suddenly, quite suddenly, it really feels like overnight, visual-effects budgets went from let’s say five percent of the budget, maybe, which means $5 to $8 million on a typical movie. They suddenly jumped up into the 50s and 60s. And it happened because the audiences were rewarding these huge blockbusters.

[MUSIC: Justin Marcellus, “Distant (Guitarscapes Mix)” (from Transitional Motions)]

Bryan Singer agrees – visual effects, or VFX, exploded in filmmaking in part because customers, especially global customers – couldn’t get enough.

SINGER: VFX budgets have ballooned because of the audience’s palate. The audience has a great expectation for realism. They want shots, visual effects – whether it’s a planet exploding or it’s something as simple as a robot of some kind – they want it to feel completely real. DeFARIA: And it happened because a number of really progressive, interesting filmmakers came into the into the market here and they had some understanding of new tools out there – what were CGI tools. DUBNER: I would love you to just help us a little bit because what we civilians call “visual effects” and also you know a lot of people know the phrase CGI, which stands for “computer generated imagery,” yes? DeFARIA: That’s that is. And then everybody also calls things special effects too, which is actually something different. DUBNER: Yeah. Can you just give us a brief taxonomy on what’s what? DeFARIA: Well, “special effects” typically is something that can happen kind of in the real world around you, everything from a door slam to an explosion to a fake bullet going through someone’s chest. “Visual effects” are those things that are not visible to the eye or can’t be seen by the camera. So those are the things that often we would use post-production tools for and often that points to a lot of those being created with CGI. So CGI is creating things , they could be anything from an explosion to a car to a person to pretty much anything that’s created in a computer. And then composited into photography. SINGER: And to create that in the computer takes a lot of time and engineers and brilliant, brilliant men and women who sit at computers for hours and hours and days and months to create a simple single effect at some points. And that just takes rooms and rooms that are vast – and I’ve visited them on many occasions – filled with people creating these effects and that’s just very very expensive. DeFARIA: And in that time the economics of the whole visual-effects industry changed dramatically.

To untangle the economics of the visual-effects industry, and the changes therein, let’s start with the demand side: audience dollars.

SEYMOUR: What are the 50 top films of all time? If we don’t allow for inflation and just look at the numbers, then all of them are visual-effects films.

Mike Seymour is a visual-effects artist, a lecturer at Sydney University, and co-founder of the website FXGuide.

SEYMOUR: It’s just no question. You go down the list. The only ones that you wouldn’t say aren’t visual effects are 100 percent animated films.

But, Seymour says, it’s a mistake to think of box-office dollars as the only measure of a film’s economic power.

SEYMOUR: That’s only a small proportion of the money that’s actually made from a film. You can have a moderate successful Pixar film like Cars that can make billions more in merchandising.

Merchandising that includes toys, clothing, video games, on and on. Given that huge downstream earnings potential, you’d think this would be great news for the visual-effects companies working upstream that create the templates for all that merch. But that’s not the case.

SEYMOUR: Not a year goes by that we don’t lose visual-effects companies.

This is especially true in Hollywood, which has seen a massive exodus of visual-effects jobs.

WESTENHOFER: There are a few companies still around but movie production, for the most part, does not happen in Los Angeles.

Bill Westenhofer again, who won the Oscar for Life of Pi while working for the visual-effects company Rhythm & Hues. Now, there may be any number of reasons why any one firm goes bankrupt. The director Bryan Singer:

SINGER: What I think happens very often is the companies get spread thin. There’s a lot of work load that comes in, it comes in very fast and it’s all tied to a release date. So you’re pushing now programmers, you’re pushing artists, and you’re pushing these incredibly talented folks into overtime and that costs money.

But Rhythm & Hues was hardly an anomaly. According to Mike Seymour’s tally in FXGuide, the year Life of Pi won that Oscar.

SEYMOUR: This gets repeated over and over again. Companies working really hard, doing good work, but just not being able to survive in terms of margin to be able to continue going on. That seems like a non sequitur, right?

Of the four industry leaders founded in the 1970s – Apogee, Dream Quest Images, Boss Films, and ILM – only ILM remains. But not as an independent: it was acquired in 2012 by Disney.

SEYMOUR: It’s no lack of visual effects. It’s really complicated. It’s not an easy job. Why aren’t these guys able to charge a fortune and drive Ferraris and stuff? The answer is they just don’t. They’re on wafer-thin margins. They really suffer by the structuring of the industry.

All right, let’s get into the structuring of the industry.

DeFARIA : The drying up of the L.A.-based or the U.S.-based visual effects business was driven by several forces.

That, again, is DreamWorks executive Chris DeFaria.

DeFARIA: One was an increasing standardization of tools and techniques.

As film-making became more and more digital, the nature of the visual-effects industry changed.

DeFARIA: What had been kind of a small in-your-basement kind or garage business with guys often with you know powder burns on their hands and grease marks on their shirts was replaced by CG artists.

And, importantly, standardization meant the barriers to entry fell. CGI was all about computers and software – which, of course, get cheaper over time, easier to use, and can be used anywhere. This meant more competition, which meant smaller profit margins for visual-effects companies. Another big factor is how visual-effects work is contracted by the producers and studios. The director Bryan Singer:

SINGER: It’s very arbitrary, I’ve got to tell you. We literally look at a visual effect and we assess what kind of effect it is. Whether it’s a sentinel robot from “X-Men: Days of Future Past” or it’s a Wolverine’s claws coming out of his hands. Something simple, and we just attach a figure to it. “That’s a $10,000 shot.” “That’s a $15,000 shot.” “Oh that, one – well that’s got five Sentinels and transforming in it. That’s an $80,000 shot.” “Oh that’s got a whole city exploding. Well, that’s a $140,000 shot.” And these effects literally just get labeled and placed into a budget and then that budget is summed up into a total and that total becomes the bid. DeFARIA: It’s a little like saying to a contractor, “Build me a tall, good-looking building that works really well.” And then you go away and you come back and you pay them for it. SINGER: And on a big movie, a big visual-effects movie that bid can be somewhere between $60 and $80 million. DeFARIA: The script says, “A spaceship lands, aliens get out, and they mow down the entire countryside full of cows.” And you go, “Wow, okay that’s a shot we’re not going to get in camera. It’s a visual-effects shot. You have to build the asset of the spaceship. We’re going to do CG cows because we can’t be cruel to animals. I don’t really want to go to Indiana and shoot this, so we’re going to shoot it in a parking lot and we’re going to paint in all of the ground plane and all of that. And you start breaking down the shot into its elements. At that point then that becomes a document someone can bid on. SINGER: And you bring that bid to various effects houses, because very often not one effects house can handle one movie by its release date. And it’s just a number. But at some point you have to pick a number because you have to pick a budget and you have to deliver it and someone has to sign off on it to get a green light on your movie. And so you get into this sort of situation where, “Wow, that $60,000 shot actually cost $85,000 worth of manpower. So how can we reduce somewhere else or can we?” DeFARIA: And the hard thing where the rubber hits the road – or where the rubber fails often to hit the road – is that we go out and we make a change as a studio for creative reasons, very good legitimate creative reasons, or we don’t shoot it in the parking lot as described because we found ourselves in Indiana and therefore we want to change the definition of the shot after we’ve shot. At the same time we have to stay on the crippling schedule, which was already budgeted. And it becomes really difficult to make those changes. And so a lot of the business ends up being that thing that you get into where we all agree to, “Okay, you guys are going to lose on this shot. Make it up on the other one. You might lose on this show. Make it up on the other show.” SINGER: And that’s where visual-effects companies sometimes get in trouble. DeFARIA: It becomes a, you know, kind of a barter system or a horse-trading game, which is a tough way to do business.

It’s one thing for a studio executive like Chris DeFaria, or a director like Bryan Singer, to recognize this as “a tough way to do business.” But it’s a lot tougher for the visual-effects firms. Because the studio and the producer and the director have a lot more leverage than the visual-effects firms. How does that lack of leverage play out for the visual-effects firm bidding on a film?

SEYMOUR: I’m going to keep coming back to the same people to bid on the same projects.

Mike Seymour again.

SEYMOUR: If I am going to take a hit on this one, I’m not going to make too much of a fuss about it, in one sense, because I’ll never work with you again, and I suddenly lost a seventh of the industry. And in the case as we have right now, because they’re very good at what they do, Disney dominates. So I would really not want to annoy Disney, because Marvel films are the backbone of visual-effects right now. So now, of course, is Marvel a good company? Absolutely. And are their films terrific? No question. But you’re going to be continuing to make these films, whether they’re Star Wars films or Marvel comic films. And I want to keep working on them. So I’m in a really awkward position when it comes to negotiating. WESTENHOFER: Movie-making is a business.

That’s Bill Westenhofer.

WESTENHOFER: And if, you know, if you can find a way to get the job done elsewhere for a cheaper rate, they’re going to pursue that.

Things might have worked out differently if visual-effects companies had pushed years ago to get a piece of the back-end of the films they help make. But that never became the norm. Or if they had colluded to keep up their margins. But that didn’t happen either. The studios, meanwhile – well, an antitrust law suit alleged that Hollywood’s biggest studios did collude to fix wages and not poach animation and visual-effects employees. DreamWorks, Fox, Sony, and Disney have all by now settled the case, paying hundreds of millions of dollars in damages. But still – that hardly explains why Hollywood has hemorrhaged visual-effects jobs during a time when visual-effects spending has been booming. So … why? You might think it’s because all those visual-effects jobs migrated to places where labor is much cheaper. That, of course, is what’s happened with a lot of American industries. But in this case, a lot of jobs migrated to places where labor isn’t cheap.

SEYMOUR: Why would Hollywood have lost a huge amount of business to London? It’s one of the most expensive cities in the world to live. Why would it have gone to Canada, which again isn’t some low-income area?

That’s coming up on Freakonomics Radio. Also: if you really want to blame someone for the hollowing-out of California’s visual-effects industry, who you gonna blame?

DeFARIA: Alright so, like I hear where this interview is going and I’m concerned that you’re digging me up as the villain in your scenario.

* * *

Daniel Lay grew up in Los Angeles reading comic books, playing video games, and loving movies that had loads of visual effects.

LAY: And at some point people said, “Well, you’ve got to kind of take what you love to do and turn it into a career.”

In college, at UC-San Diego, he studied visual arts and computer science.

LAY: As I came out of school, my dream was just to maybe work for a video-game company like Electronic Arts. And to my surprise, companies like Sony Pictures Imageworks were calling me and saying, “Hey, would you like to come work with us?”

And he did. His first project was the first animated film made by Sony Pictures Imageworks. It was called Open Season.

TRAILER ANNOUNCER (clip from Open Season trailer): Martin Lawrence. Martin LAWRENCE as Boog: Oh, yeah! Don’t mess with the Boogster. TRAILER ANNOUNCER: Ashton Kutcher. Ashton KUTCHER as Elliot: I come in peace…

Now, to clarify: when you hear “Sony Pictures Imageworks,” you might imagine that Sony, and probably the other big Hollywood studios, have their own visual-effects outfits. That’s what I thought – and I’d asked DreamWorks executive Chris DeFaria about it.

DUBNER: Now I understand studios have VFX shops. Yes? Some do, some don’t? DEFARIA: No, they don’t. The studio you might be thinking of is Sony, who maintains a visual-effects vendor. That vendor in theory is no different than we at the studio – we have a lighting department. That doesn’t mean that we get lights for free. Those lights are available to anybody to rent and the visual effects department at Sony is not really a department of the studio. It’s an adjunct, a separate business. SINGER: There was always the theory that studios should have their own visual effects houses.

That’s the director Bryan Singer.

SINGER: They’ve always tried. And for some reason they’ve always failed because of this paradigm which is visual-effects hnouses seem to lose money.

Okay, so back to Sony Pictures Imageworks – “not really a department of the studio” – but, in any case, the place where young Daniel Lay got his first gig, on Open Season.

LAY: On that film I was brought in as what they call a render wrangler. So they really test you to see how much you love the industry, because I would work from 4pm to 2am every night just kind of watching the artists’ renders, which took hours and hours to do. So a kid like me out of school was just kind of watching those, making sure that everything was okay. And in the morning time, they had their shots ready to review. Lay started moving up the ladder. LAY: There was this little film called I Am Legend, which starred Will Smith, and they needed what they call hair and cloth artists, to help do cloth animation on all the zombies on that project. Will SMITH as Robert Neville (clip from I Am Legend trailer): Sam, we got to go! LAY: So that was kind of my first big swing at actually working on the shots there.

Lay went on to work on many films, for several visual-effects firms.

LAY: I would say Shrek Forever After, I Am Legend, and Tron: Legacy, X-Men First Class, those were kind of the big films that I’ve worked on that were probably more famously known to a lot of my friends.

Famous yes – but lucrative? Lay recalls a conversation he had with his manager at Sony Pictures Imageworks in 2007.

LAY: She goes, “You know, we have done so much business this year.” And I said “Wow, that’s great we’re making a lot of money.” And she said, “Actually, we’re not making any money at all.” And I was like “What? Are you kidding me?”

It was around this time that Lay noticed a huge shift in his industry.

LAY: Sony started opening up facilities in New Mexico and there was a lot of people moving there and, from what I understood, they said, “Well, it’s because of the tax incentives.” And I came back to that same manager and I’m like, “What is it? Are taxes so much lower in New Mexico that California can’t compete?” And it was explained to me by this manager that, “Well, the reason why is that they’re not essentially taxes that we’re talking about here, we’re actually talking about government subsidies, where the government of New Mexico was essentially paying for 25 percent of the visual-effects production costs to the producers of the film.”

Twenty-five percent off the top! Think about that. If you’re the studio or the producer or even the director, that’s hard to resist. And it wasn’t just New Mexico offering deals like that.

THOM: Almost all states, about 44 or 45 states, created programs at some point over that time frame.

That’s Michael Thom, a political scientist at the University of Southern California. The time frame he’s talking about is 1998 to 2013.

THOM: The first big incentive program was in Hawaii.

Thom was curious about the overall economic effect of such programs.

THOM: Many of the research studies that were published were either funded by the industry or only looked at one particular state. And so there was the space open to kind of look at the whole 50 states and see, do they work? And so I decided to look.

He did look, and published a study called “Lights, Camera, but No Action?”

THOM: And so this study looked at all 50 states and how motion-picture employment and wages changed kind of with and without the incentives depending on how much they spent, how long they were in place and controlling for other factors, like you know the growth of the industry, the growth of the economy, and so on.

Thom concluded that most film incentive programs, quote, “had little to no sustained impact on employment or wage growth.” Nor did they help build a permanent filmmaking industry in those places. Thom’s findings are in line with a lot of economic research about the efficacy of tax and incentive programs.

THOM: As a rule, targeted incentives like this, given by state governments and sometimes by local governments, don’t work – and the motion picture industry incentives are no exception.

So the incentives may not work, financially at least, for the places that offer them. But if you run a movie studio – well, why wouldn’t you exploit them? If New Mexico or Florida or Iowa are essentially offering rebates for you to move your production there, why not? You don’t have to move to New Mexico or Florida or Iowa. You can stay in L.A., with the sun, and the restaurants. And when a new state offers an even better deal – well, time to move production again. How are all these deals happening?

[MUSIC: Chauncey Canfield, “Invisible Pattern” (from Music For Walking Around)]

THOM: So the motion-picture industry, through the Motion Picture Association, has no shortage of lobbyists.

But also, as Daniel Lay points out, the politicians who make these decisions have incentives that play right into the movie industry’s needs:

LAY: They need a very simple way for them as politicians to point to “Hey, look at me, I’m creating policies that create jobs.” And the film industry is a very footloose industry. So if you let’s say have an election coming up in two years and you want to create jobs very quickly, you could do that with the film industry. And it makes them look really good, right? To be around all these movie stars – “Look at this!” THOM: Yeah, the celebrity factor probably cannot be ignored here. Manufacturing tax credits aren’t sexy. No movie star shows up to you know push manufacturing tax credits or research and development tax credits. But if a movie star shows up, even if it’s for a day, and local media picks it up, state media, regional media picks it up, suddenly it’s become this symbol. And it’s a symbol of success at least in the minds of the voters, maybe even legislators. There’s no counterweight to that except for these admittedly dry, often boring academic studies that would maybe give people a fuller idea of what’s happening here.

So what, exactly, was happening here?

LAY: There’s sort of this race to the bottom… THOM: … and the bottom is that states end up spending more and more and more on these incentives but they get less and less and less back. LAY: You know, the studios are very good at getting states and various jurisdictions and various countries to start competing against each other to offer them more free taxpayer money. THOM: And that bidding war is exactly what happened late 90s, really more through the mid-late 2000s, was that not only were states that already had these incentives spending more , the ones that weren’t players in this space created new programs and then upped their investment. It’s hard to win that fight especially when the returns are diminishing.

All this can help explain the kind of chaos Daniel Lay went through some years ago. His employer, Sony Pictures Imageworks, had opened a visual-effects facility in New Mexico.

LAY: A producer could get 25 percent back on their visual effects project if they could do it in New Mexico. So Sony started sending a lot of workers there.

By 2010, Lay was working for a different firm, Digital Domain, which was building a facility in Florida.

LAY: The state of Florida was offering millions and millions of dollars to open an animation and visual effects facility there.

And by now, he says, Canada had gotten into it.

LAY: So they were offering essentially 60 percent of the labor cost. So if you could get a worker to move there, and they were making let’s say $100,000 a year, as a producer you could get 60 percent of their salary back if they’re a resident of that province there, British Columbia. So, what happens was, well, quickly in New Mexico they realized it’s a lot more lucrative to go to Canada, so all those people who moved there, who bought homes, they ended up sort of losing their jobs, and being told “you have to move to Canada or you’re going to lose your job.” So they realized, OK we’re out of the job, so they ended up trying to stay in the States, and I remember stories of people from New Mexico who were laid off who were driving towards Florida and during that time, Digital Domain goes into bankruptcy because they’re trying to build this huge facility in Florida to get those subsidies in Florida, but they’re borrowing massive amounts of money. So, at the same time they’re working on these underbid visual-effects projects, so they’re losing money like crazy. And as those people arrive in Florida they realize the company went bankrupt. Guess what? The company you were hired for doesn’t exist anymore, or they’re almost out of business, so you don’t have a job. So, here are these people, lost their jobs in New Mexico, on their way to Florida, and they just find out on the way they lose their job. It was just amazing to me.

By now, the race for movie-making jobs had gone fully global.

That again is Chris DeFaria – who’s now with DreamWorks but for years worked at Warner Brothers – on a portfolio that included the Harry Potter films. The first one was released in 2001.

DeFARIA: At the time, the U.K. had a program in place called sale – leaseback, that offered you know to sell tax loss to somebody else. And therefore in some respects get a rebate for work you’re doing there. It then transformed into a real formal traditional rebate system and that’s what exists today in the U.K.

The sale-leaseback system, begun under the Blair Administration in the late 1990s, presented a tax loophole that investors could take advantage of. Just recently, for instance, it was revealed that the Royal Bank of Scotland avoided around £1 billion in taxes by investing in films, including Harry Potter films. One British newspaper named this scandal “Harry Potter and the Bank with the Magically Vanishing Tax Bill.” That old system was replaced in 2007 with a more formalized incentive program called Film Tax Relief, which has gotten only more generous since it began. Among other perks, producers can claim a cash rebate of up to 25 percent.

DeFARIA: So when we were doing the Harry Potter movies we were really for the most part bidding U.K. companies, because we’re going to get a rebate back on that. So we bid the you know five companies in the U.K. We would often bid one company in Australia, which had a good rebate system in place. A company in Canada and then often one in L.A. Though it’s kind of tough to make the LA and California ones work – but those companies worked tirelessly to try to bring their prices in line with what we’re rebated prices around the world. DUBNER: And how did the rebated prices work? Was there a list price that the firm would offer and then the government is actually taking off the top to make the retail price to you? DeFARIA: Well, the practical part of it is that the you bid the work and so you can go bid work let’s say in a California company and then a U.K. company and they both come in at $1,000 for a shot. Then you just when you calculate it you realize you’re going to get probably 22 percent of that back from the U.K. government after you tell them what you spent so now suddenly their bet is vastly more competitive. DUBNER: Right, so I’ve read you talking about the opportunity for big savings in taking visual effects for Harry Potter, the Harry Potter series to London. You said in the beginning, “We literally couldn’t find a way to spend $1 million on visual effects in London. I don’t know if you like hearing that qu0te read back to you. That was from 2009, but talk to me about that for a moment. How much how easily could you have spent that $1 million in L.A.? DeFARIA: Well, I guess what that quote refers to is that at a time when the U.K. government described this program, we needed to move suddenly a lot of work to London, it would be advantageous to us. But there just was not the companies that there were in Los Angeles there. So there just simply was not the way to get to do the work there. DUBNER: So there is now, obviously? Yes? DeFARIA: There is now a huge infrastructure there, massive companies. But I think what I think what you’re referring to though is it that without a doubt I guess the infuriating thing about the U.K. rebate is it really worked in that it is set up a visual- effects industry in the U.K. that would not have come about any other way.

So unlike the American states whose incentive deals didn’t lead to many permanent jobs, the U.K. built what is, for now at least, a large and lasting film-production industry. How important were the government subsidies? A 2012 study estimated that production spending in Britain would fall by about 70 percent were it not for the subsidies. A weakened pound may have drawn even more American business. Last year, Hollywood spent a record $1.7 billion on movie productions in the U.K., including the upcoming Star Wars: The Last Jedi, The Mummy, and Dunkirk. Which means even a two-time Oscar winner like Bill Westenhofer no longer does much work in L.A.

WESTENHOFER: I own a house in Los Angeles – but this past year as an example, I only was here for about three months out of it. The rest of my time was in London working on the current project Wonder Woman. DUBNER: Do you have a family or anything like that in L.A.? WESTENHOFER: I do. I have my wife lives here. Two sons, my daughters are now in college and one’s post-graduate, so they are – they’re living outside, but I still have family in Los Angeles. But it is – it is a challenge. It’s hard to do this kind of work and have to be away for so long. And just – in the past, filming itself is a worldwide thing, you know, you always go to locations to film, but I was always balanced by having post-production take place in Los Angeles. So I could – I could sell that to the family and say, “Yes, I may be gone for five to six months, but then I’ll be back for a year and a half.” And now it’s more and more becoming that the whole thing is being done elsewhere.

Again, it’s not just in Britain. The director Bryan Singer:

SINGER: My visual-effects supervisor had to sleep literally in the studio because he had conference calls all over the world in four separate time zones, so he couldn’t afford to go home to his wife and family because he had to be there for these calls that were coming in and for these viewing sessions that were coming in on single shots. They were being farmed out to companies on all corners of the earth.

One of the most popular corners is Canada. As we heard from Daniel Lay, Canada years ago started recruiting Hollywood business. By 2000, so much work had gone to Canada, especially British Columbia, that it came to be called Hollywood North. Vice President Al Gore, putting on his “America First” hat during his run for president, asked the Commerce Department to investigate why so many American jobs had moved north. One of the big conclusions: tax subsidies. American filmmakers can get a huge share of their visual-effects labor paid for by Canadian taxpayers.

[MUSIC: Lucy Bland, “Plumb” (from Down to Sea Level)]

SINGER: We will literally move a team to Canada to do the work because we’ll get the rebate from their work even if they’re a team from here because Canada offers the incentive.

In recent years, most of the big California visual-effects companies have moved some or all of their operations to British Columbia, including Daniel Lay’s original employer, Sony Pictures Imageworks. There are now roughly 50 digital-effects and animation studios in the Vancouver area. Bill Westenhofer gets it; but he doesn’t like it.

WESTENHOFER: It’s unfortunate that in the – especially in this day we’re discussing trade agreements in many other industries that you know, one could argue that subsidies are a bit unfair.

Daniel Lay, who’d worked his way up the ladder in the visual-effects business, came to feel the same way. He felt he and his friends and colleagues were being exploited, living under the constant threat of their jobs moving to another state or country. He decided to try and do something about it. He started a blog called VFX Soldier.

LAY: A soldier within the trenches of the visual-effects industry who was giving his point of view of how things were really going on in the industry.

Lay got support from visual-effects artists around the world. Encouraged by the response, and increasingly alarmed by the exodus of jobs from his hometown of Los Angeles, Lay started pushing harder. He led protests at media events, including the Academy Awards. But protests and blogging weren’t really moving the needle. He began looking for real leverage. Unionizing, for instance.

LAY: However, there have been some reservations on that because the vendors that we work for are only making five percent margins, and so the concern is that, Well, if we unionize, it’s going to cost them more money and they may go out of business.

He thought about a political approach – trying to get the U.S. Trade Representative to argue on behalf of American workers at the World Trade Organization.

LAY: And there are trade agreements that we’ve all signed. WTO, many of these trade agreements banned the use of these subsidies. And so I went to these international trade law firms to discuss that, and it turned out that it seemed to gain some interest from some major law firms there.

One big problem:

LAY: This WTO route, going through the U.S. Trade Representative, that is going to be very, very tough to do, because the MPAA has a lot of lobbying power there, and it’s a political route.

The MPAA being the Motion Picture Association of America. Which represents the major Hollywood studios. Who, remember, have all the incentive in the world to lower production costs by seeking out international subsidies that inherently work against the interests of American employees. But Daniel Lay did not give up. He thought there might be an avenue through the courts. He used his blog to crowdfund some money from visual-effects artists.

LAY: I had some vacation time. I flew down to Washington, D.C., and I started meeting up with attorneys who specialize in international trade.

Under international trade law, he learned, goods that are subsidized by foreign governments can be seen as anti-competitive, and could therefore be eligible for what’s known as a countervailing duty – essentially a tariff that’s levied when the subsidized good is imported.

LAY: The reason why the countervailing duties route was interesting was because it is actually the least political route for success here. So all you have to do is go to court and if you prove to the court that you have the support of the domestic industry and that domestic industry you can prove is being harmed by international subsidies. If the court agrees with you, that’s it. The duty gets put into place.

But international trade law is tricky. The issue was whether movie visual effects are a service or a good.

LAY: The law firm there told us, they said “Daniel, one of the big problems that you have is, remember, visual effects, we don’t know if this is a good or a service.” And I asked why do you need to know that? They said “Well, these duties can only be applied to goods.” So sneakers, softwood lumber, things that you can drop on your foot. Visual effects, these are ones and zeros, this is digital, this is a novel approach to what you’re doing. We need to prove to the court that visual effects is an actual product, a good. And that’s the only way to apply that by law. To apply these duties by law defines that, it must be only applied to a good, not a service.

Lay says there were some legal precedents that might have helped his cause – if, that is, he could get his day in court. To do that, he’d have to prove that he had the support of the visual-effects industry.

LAY: And so in order to enlist the support of the industry, I needed to create a professional organization, a trade organization. And that was essentially what me and a number of professionals decided to do in the industry and as we did that, we needed to raise the money to help pay the law firm to prosecute this case. And as we did that, a number of artists were just simply either out of work or they had to move to Canada and they just simply didn’t have the funds to continue doing this. So within a year just unfortunately we just didn’t have funds. We had the vehicle, we had the car, we had the direction we wanted to go to, we had the destination, we just needed money for gas and unfortunately just couldn’t raise enough money to prosecute the case.

[MUSIC: Edgaz, “White Flag” (from Shining Hour)]

Daniel Lay no longer works in the visual-effects industry; he’s in the tech industry now. Which means he got to stay in his native California. A state where very few visual-effects companies remain.

WESTENHOFER: The saddest thing is more – it’s almost more emotional.

Bill Westenhofer again.

WESTENHOFER: You know, Los Angeles, if you ask – ask anyone in the United States or the world what is Los Angeles known for? And you’d say the movies. It’s kind of a core identity. And the truth is that less and less of that is actually taking place here because of the way the economics have worked out.

We asked Chris DeFaria at DreamWorks what he thinks of how things have shaken out.

DUBNER: So I’m sure you are friends with or at least friendly with a lot of these visual-effects artists and owners of these firms. Do you – we talked to Bill Westenhofer. I don’t know if you know Bill personally? DeFARIA: I know Bill. I know Bill well. He did Cats and Dogs for me many years ago and many other movies since. DUBNER: Gotcha. Okay, so Bill is famous for having while accepting the Oscar for his visual-effects work on Life of Pi, his firm was going bankrupt. So I’m just curious. How do you feel about – I’m not asking you to profess guilt about the industry moving away. It’s plainly not your fault. And you’ve described that it’s a very complex ecosystem with a lot of players, most of whom you have no control over whether it’s the government of California or the government of Britain. But how do you as a filmmaker, who is obviously still in L.A. and gets to and gets to enjoy still being there when this work for even someone like Bill gets offshored where he’s now spending most of his time working in London. How do you kind of reconcile that job flow out? DeFARIA: That’s an interesting question. Well, let’s see. One is that my passport is equally worn from traveling around the world tracking this. “Reconcile” is a funny word. I mean I guess if you want me to say that I bear responsibility for it, I think that’s a pretty naive assessment of what’s going on here. I mean there’s not there isn’t a moral choice here. And with a publicly traded company, I don’t think you’re in the position to say we’re going to ignore the economics that our competitors are enjoying, right? In some effort is to remain here. I think the responsibility for this falls on everybody. I think that sure the you know movie studios desire to try and find a way to make movies less can be blamed though I don’t understand that is an unsound practice for a company whose job is to make a profit. The companies that were here, many, some that went out of business. They did not respond to this. They didn’t respond with better management or with changing some of their own internal economics. A lot of them and they didn’t think they would admit it were a bit of a head in the sand on this. I think the government, both federal government and the state government, failed for political reasons to respond to the changed environment here and failed to actually understand the value of the industry that was leaving. I think that foreign governments that have offered the incentives you know have, in some respects, I don’t know they’ve while it may have benefited companies like Warner Brothers or Paramount or Fox, right? Because they do their work over there. I’m not sure that in the long term it’s going to actually benefit their states, their nations. You know I think there’s mistakes made all around. I you know I feel – of course, I feel bad. Everybody feels bad that people that had a living here right now don’t anymore. But at the same time it did not come unannounced and it did not sneak up and that I think there are plenty of people that could have intervened at a different point to keep some of this business here. But then you really have to ask yourself in the end of the day would that have been the right thing to do? DUBNER: Is it true that as a young man, you voiced Peppermint Patty? DeFARIA as Peppermint Patty: What’s this?! A piece of toast, a pretzel stick, popcorn. What kind of a Thanksgiving dinner is this? DeFARIA: Possibly. DUBNER: Possibly? I’d think you’d be in a hurry to claim credit for that. That’s awesome. DeFARIA: All right. So like so. So I hear where this interview is going. I’m concerned that you’re trying you’re digging me up as a villain in your scenario. DUBNER: Oh really? DeFARIA: Yeah. DUBNER: Because I’ve got you being Peppermint Patty now? That’s where it took the turn to villain? DeFARIA: Because every villain needs a quirky tic? Don’t they? Something they can – DUBNER: Oh exactly. I was wondering if you could still do the Patty voice at all though? Or did you just totally outgrow that? DeFARIA: I outgrew it quite some time ago. Yes. DUBNER: How old were you when you did that? DeFARIA: Eight, maybe – DeFARIA as Peppermint Patty: Don’t you know anything about Thanksgiving dinners? Where’s the mashed potatoes? Where’s the cranberry sauce? Where’s the pumpkin pie?! DeFARIA: – eight or nine? Yeah and it’s been a while. DUBNER: And did you want to be a performer? Was that kind of your dream at that point? DeFARIA: No. I wanted to be cool and just like that sounded cool. That was it. My ambitions were fairly low at that point and they remain so. DUBNER: Alright, I’ll give you one more question since you think I’m heading you down the villain road. I promise we’re not trying to create a villain here. Let’s say that you could have persuaded the California government or even the federal government here to do some kind of either or you know countervailing tariff or countervailing subsidy or whatnot, that’s not necessarily the right thing to do either, is it? DeFARIA: No, I don’t think it is. It’s a no-win game. I think that what you the lesson here and I would hope is that we as a community of filmmakers, as an industry that needs to make a profit, as a government that needs to take care of its citizens, that we can look down the line because there’s plenty of lines to look down right here. What we had was we had a real exodus of work that drove technology and development in areas of imagery and CGI that are both you know applicable to other markets and hugely important to you know underwriting or at least supporting you know the community here of really smart art and technically savvy artists. That loss is going to be a hard one to get back. And I think its implications are certainly outside the film business, but that’s where I think the government has to have a role and we approached the California legislature many times and said, “Look I know it’s hard to stem the flow here but we would love you to take a look at the high-tech jobs that are associated with visual effects because they’re just they’re so transferable to other areas of growth in our economy. We didn’t get back what we needed you know and so in some respects I lay a little bit on them. DUBNER: When you say “look down the line” it sounds like you’re talking about other elements of the industry that are in you know danger or susceptible to this kind of wage pressure. What are you talking about there? DeFARIA: Well I’m talking about let’s – off the top of my head feature – film animation. The Pixars, DreamWorks, Disneys – these companies, which employ thousands of people at really terrific artist-oriented high-paying jobs are going to be – I can feel them the push to get them out of California. Already Sony, that used to have a massive footprint in Culver City, has moved three-quarters of its animation capacity to Vancouver, who is offering a massive subsidy. And here’s the – and the hard part about animation is it the best, brightest, and most talented artists are here in Los Angeles. But as these you know when you get corporate consolidation in the media business and you get an increase you know pressure to make the numbers work, you know that’s the one I see coming down the line.

[MUSIC: Fooling April, “Too Late (Instrumental)” (from Three)]

We reached out to Los Angeles mayor Eric Garcetti about this job loss. “No industry has been hit harder by runaway production than visual and special effects,” he told us. “When we fought to pass the California Film and Television tax credit, we made sure that productions that opt to create visual effects in L.A. get an additional five percent credit. But that’s not enough — which is why we are exploring expanding the incentives for visual effects when we return to Sacramento to urge the state legislature to renew the credit.” In other words, if California had the money to buy back those jobs from London and Vancouver and elsewhere, maybe it could, or would. If you’re an American visual-effects artist, you might say: Yes, please, do that! But, if you’re just a taxpayer? Not so appealing.

Given what we’ve learned today about the labor intensity of creating visual-effects, we asked Bill Westenhofer for any closing thoughts for us laypeople to consider when we’re watching a movie.

WESTENHOFER: If people sit in the theater and watch the credits roll to the end, you will notice the number of people involved in visual effects can often be several times larger than the number of people involved in the rest of production. And these are people like myself that I’m still working in this industry – even though I have to go to London for several years. It’s something that we really love, we really love to create amazing things, and it’s – We aren’t begging for recognition, but if – a lot of times there’s a kind of an instant gratification these days and people expect that a film can be made with perfect visual effects every time, and – we try our best to get everything right. But if we don’t, it’s – there are still a lot of people who work really hard to get that done and just appreciate that fact.

Coming up next time on Freakonomics Radio: it takes a special entrepreneur to disrupt the kind of industries that haven’t been disrupted…

AGRAWAL: I’m in the business of taboo. My job is not to be afraid to talk about things.

And we’ve got her – Miki Agrawal, empress of the 3 Ps: periods, pee, and poop. That’s next time on Freakonomics Radio.

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Freakonomics Radio is produced by WNYC Studios and Dubner Productions. This episode was produced by Greg Rosalsky. Our staff also includes Shelley Lewis, Christopher Werth, Stephanie Tam, Merritt Jacob, Eliza Lambert, Alison Hockenberry, Emma Morgenstern, Harry Huggins, and Brian Gutierrez. You can subscribe to Freakonomics Radio on iTunes, Stitcher, or wherever you get your podcasts.