Detroit: Do the Collapse

I enjoy swapping "war stories" about work as much as the next guy. I've heard a lot, but some of the most incredulous came from a college buddy who used to work for General Motors. He was a manager level employee in field operations, but was often called in to work auto shows and the like. What was his job at the auto show you might ask? Well, at one Chicago Auto Show, his first responsibility was to make sure the hotel room for the executive was prepped correctly. This exec had very specific detailed requirements as to the brands of soft drinks, liquor, chocolates and cigars that needed to be on hand when he arrived, so it was my friend's job to make sure this happened. After that, he got his company Escalade and went to O'Hare to pick up said exec's wife, whom he then spent much of the afternoon ferrying around on a Michigan Ave. shopping trip.

There's a lot more in this vein, but that should give you a flavor of the auto industry. Even if you assume a lot of this is exaggerated for effect or outright BS, I've heard so many similar type things from people who've been associated with the auto industry that there must be a kernel of truth in it somewhere.

I lead with this because it is so common to blame the UAW and its $73/hour or some such wage packages for the problems facing the Big Three. And indeed in the modern era that is not sustainable. But there has been particularly little focus on the management excesses of the auto industry, and the corporate cultures of those companies, and by analogy that of Detroit.

Detroit represents the American urban decline story in its purest form. The Detroit region and indeed the whole state of Michigan is in serious trouble. Of all the cities of the Midwest that are are struggling, I think it has one of the toughest roads ahead. It it is fighting terrible structural problems that hobble its ability to compete. The linkage of its fortunes and its public image to automobiles is of course a big problem. The auto industry not only brings many image stigmas, it is also an industry that is undergoing a painful restructuring. Until that restructuring is complete, the city and state can never recover.

The model here is Pittsburgh, which, with the disappearance of the steel industry in the 70's and 80's underwent a civic catastrophe the likes of which few places have ever seen absent being overrun in war. Today, while Pittsburgh still has serious problems, it seems to have hit the inflection point and many of the indicators for that city are now positive. I think there's a powerful lesson there. Until Detroit hits what traders call the point of "capitulation", there's little chance of the city reversing its fortunes. That's a painful reality. The auto industry and the city and state must work through their restructuring before things can turn positive.

Beyond the auto-industry dependence and branding, Detroit also famously suffers some of the worst racial polarization in America. Moreso that most Midwest cities, Detroit has a rich black cultural heritage, and it already has a powerful image in the public mind as a black city. Those who know me know that I think that there is a big opportunity for Midwestern cities to put their black communities at the center of their civic growth strategy. I'm astounded almost no one has done this. Just look at what having a robust and engaged black community in Chicago has done for that city. Without that robust black infrastructure, no President Barack Obama from Chicago in the White House. The problem for Detroit is while it has great assets in this regard such as its Motown music legacy, the racial polarization of the region vitiates them. Healing that divide is critical to the future success of the city. The antics of Kwame Kilpatrick, the disgraced and jailed former mayor of the city, only adds to the problem by reinforcing stereotypes. He also illustrates the feckless leadership in the city proper.

But there's another structural problem as well, one that is not often remarked upon or considered. Namely, Detroit is just plain too big. With a metro area population of 4.4 million (effectively even higher since Canada isn't included), Detroit is the second largest metro in the Midwest by a good margin and one of the largest cities in the country. This creates a gigantic mouth to feed. And it makes it just incredibly difficult to turn the ship around. Detroit and the state of Michigan (and Ohio) are the size they are because large volumes of unskilled labor were needed in their factories. Without those factories, the need for the people evaporates. There is simply no raison d'etre for a city the size of Detroit in Michigan today. One reason Indiana is faring much better than Michigan and Ohio despite having lower educational attainment levels and a higher dependence on manufacturing is that it is half the size of those states. This makes its problems much more tractable. One of the biggest problems facing Michigan and Ohio is simply the sheer size of those places. (Illinois is big too, but its population is heavily concentrated in Chicago, which creates a different dynamic).

Any realistic plan for tackling the challenges has to face up to these structural dynamics and put together a strategy for addressing them. Unfortunatley, that hasn't been a hallmark of local thinking. This isn't limited to Detroit. I see it repeated in so many similar places. No one wants to admit that their glory days are behind them, that their future is dimmer than their past. That's not the American way. It's not the type of forward thinking optimism that we're used to in this country. But for any number of cities, Detroit being one of them, dealing with the present involve acknowledging that you can never recapture the past.

This is antithetical to how civic leaders are trained to think. Indeed, we see lots of the same types of programs in Michigan and Detroit that we see in every state. Lots of talk about assets, lots of marketing and hype, some small victories - new companies, new jobs, a big research grant, etc - but ultimately not enough to move the needle. I don't want to lecture too much here. I realize this is a hard and painful thing.

There's an organization called Detroit Renaissance that appears to be a primarily corporate vehicle for trying to renew Detroit. I actually happen to think they've got some good ideas. They have a podcast series called "50 CEO's on the D", which is where the CEO's of the 50 companies that are behind this come in and talk about some aspect of the city and why it is great. One of the things that always comes through for me is how much these people love Detroit and are passionate about the city. I've seen it in others as well, even those who left. A friend of mine in Chicago who grew up in Grosse Pointe still talks about how much she wants Detroit to succeed and how much she still cares about it. So there is a reservoir of deep feelings about Detroit. But what that does is often to cause people to not be able to realistically evaluate the situation and instead adopt a "failure is not an option" approach and say that Detroit and Michigan is going to be the next new hip place or the big center of some brand new innovative industry. But the reality is that Detroit is poorly placed to achieve this and it would be better served to adopt strategies designed to slowly bringing the city back to health, even if that means abandoning these super-sky-high ambitions for the time being.

The recipe for Detroit and Michigan is something like this:

• Complete restructuring of the auto industry
• Heal the racial divisions
• Adopt an active shrinkage strategy to reduce the population of the city and state
• Adopt a regional hub strategy with Grand Rapids as the focus of western Michigan and Detroit as the hub of the east.
• Continue the good things that are being done on tourism, which can be an ever increasing industry along the Great Lakes and in the north and UP. This is already being done.
  
• Restructure state government to be more business friendly, lower tax, and lower cost.
• Continue to seek to leverage the economic development potential of U of M and State. This is already being done.
• Create realistic sector specific approaches where Detroit and Michigan are well suited to compete.
  

This is going to be painful. But it is going to be painful regardless of what anyone does. The restructuring of the auto industry is going to happen. It's only a matter of how long and painful it will be.

Regarding restructuring, the auto manufacturers are in denial. GM says bankruptcy is not an option. I've got news for GM, bankruptcy is the only option. It is physically impossible to restructure the domestic car manufacturers without it. Among other things, restructuring implies rationalizing dealer networks, something that illegal under state franchise laws passed by legislatures that are in the dealers' back pockets.

I've seen estimates that 2-3 million jobs could be lost and that chaos would ensue if the auto makers went bankrupt. That's probably true if GM, Ford, and Chrysler just waltz down to the court house and file. But it is not the case if they have a government sponsored, pre-packaged bankruptcy. Still, I think it is likely a very large number of jobs are going to be shed across the automotive value chain. Possibly a million or more.

This is a terrifying number to contemplate. But it has to happen and it will happen. It is just a matter of how long it takes to get there. Eventually market forces will drive it. The domestic auto sector simply employs far too many people. The future of the auto industry looks a lot like the steel industry: continued large production volumes, but with a significantly smaller labor force and market based pay and benefit packages. Notably, every US steelmaker except USX went bankrupt.

I've been involved in a lot of conversations and listened to presentations on the auto crisis, and there is remarkable consensus among the people I've talked to on what should be done. It centers around a government backed, special purpose, pre-packaged bankruptcy that accomplishes the following:

1. Capital restructuring. All equity and junior debt holders are wiped out. Senior debt holders are forced into a debt-equity swap. The auto makers should emerge from bankruptcy relatively debt-free.


2. Strategic restructuring. The domestic auto makers have too many models and too many brands. They should dramatically reduce these. Focus on building one great car instead of "brand engineering" to rebadge the same car multiple times. This involves a significant reduction in the quantity of dealerships.


3. Re-evaluation of the survival of a standalone Chrysler. Perhaps the healthy Jeep, mini-van, and Ram truck franchises could be sold off and the rest of the company wound down.
   


4. An infusion of outside management talent. I'm not saying you have to decapitate the leadership of these companies. But I think Alan Mulally has shown that you can bring in an outsider who can make a huge difference. That guy is the biggest reason that Ford is in the best shape right now. He's done amazing things. Had Ford brough him in 10-15 years ago, the industry might be in a different position today. If Congress forces Mulally out, it would be a tragedy. There is an incredible solipsism in the auto industry. Even one of its fiercest critics, the amazingly awesome Peter DeLorenzo at autoextremist.com, has drunk the kool-aid on this one. He says the auto industry is unlike any other in the world. This implicitly seems to argue that only an insider can run a car company, but Mulally is proving it doesn't have to be that way. (I know DeLorenzo loves Mulally). The reality is that the auto industry needs to be a lot less unique and a lot more like any other major industrial concern. Boeing and GE have long lead times, etc. in many of their businesses and have done very well. The auto makers need to recruit - potentially with a dose of patriotic arm twisting from President Obama - absolute top talent to see through the restructuring: strategic talent, operational talent, financial talent, organizational talent, etc. Again, this isn't a wholesale purge of the current management, but an influsion of new blood is clearly needed.


5. A massive change in the corporate cultures. This is the hardest to change, frankly. But arguably it is the most important for achieving lasting success. The culture of perks and hierarchy, of having to make sure you listed the names in the right order on an internal memo, has just got to go.


6. Labor force restructuring. All future pension accruals to be terminated and replaced with 401(k)'s, termination of retiree health benefits, elimination of the jobs bank, required employment levels, and restrictive work rules. Everyone is put into the lower scale in the existing two-tier wage structure agreements.


7. Federal assistance. The feds have a key role to play. One, in guaranteeing the ongoing operations of the company and providing DIP financing during bankruptcy. It also needs to federalize the auto-business by using its interstate commerce powers to blow away state franchise laws and other restrictions on auto operating practices such as bans on direct sales. The most important role for the federal government is to provide transitional assistance to people affected by the radical labor changes above. Someone who took early retirement at 55 in the good faith belief that they had health insurance should not be left out in the cold. The feds should extend Medicare or a similar type of health coverage is available to those who need it. Not gold plated you don't pay a dime for anything coverage, but solid, quality health coverage. Similarly, through the PBGC, the feds should be sure no one take a huge writedown on their vested pensions. And there should be assistance to older workers who would be adversely affected by the switch from defined benefit to defined contribution plans. And the feds should provide job training and other educational opportunities to those displaces, as well as relocation assistance (see below). These programs should apply to the entire value chain, not just the OEM's.
   

This sounds straight forward but it is a clinical description of what amounts to dropping a nuclear bomb on the industry. It sounds simple, but the human toll is going to be terrible. Again, that toll is coming regardless of whether this plan is adopted or not. Even if the feds just hand the companies funds to get through the crisis, that only delays the day of reckoning. For many older workers, that might be just fine with them. Part of the problem is that there is a perverse incentive whereby older workers are made not to care about the long term future of the company. If they just hang on long enough to make it to retirement with full benefits, even if that means GM long term fails, that may be personally beneficial for them. I'm not saying people are out there promoting it, but there are game theory reasons to believe this might be an incentive.

If one thing has been made clear by this auto crisis it is that the nation has lost its sympathy for Detroit, and even for labor. I know that particularly baffles the UAW. But it is understanable. Once the UAW could be seen as the vanguard of labor rights. What the UAW got for its members, the rest of American labor might hope to see themselves one day. Today, nobody believes that. Instead, the UAW is the defender of the last bastion of entrenched labor privilege. They are indeed a labor aristocracy. This is why they are no longer loved.

Even so, we can't lose track of the fact that there are real human beings, labor and management, with real trauma in their lives. Even if they are at least partially to blame for the mess they are in, that doesn't mean they deserve what they are getting. It's like a Greek tragedy: the suffering is disproportionate to the crime. And there but for the grace of God go you and I. I also work in a restructuring industry, and may yet join the auto workers in their pain.

The stories you hear in the Detroit papers are heartbreaking. One that really stuck with me was about people losing their life's possessions when they couldn't pay the rental fees on storage lockers. People who had already lost their homes to foreclosure put their possessions in storage, only to lose them too as the storage companies auctioned them to pay the bills. I'm not an emotional guy, but this makes me sick to my stomach. I don't know about you, but I don't think this should be happening in a country like America. People who made decisions in good faith, who showed up to work every day, who did the right things to care for their families, shouldn't be left to lose everything because of the action of economic forces they can't understand or control. Not in America. That's why we absolutely need a federal safety net program here. Michigan alone can't fund this.

Which brings us to the next point: urban shrinkage. Just like the auto manufacturers themselves, Detroit and Michigan need to get smaller, a lot smaller. It doesn't help to retrain people for different jobs if there aren't any jobs to be had. In my view the biggest piece of assistance that the federal government can give is relocation assistance. Help people sell their homes - buy it from them if you have to - and give them enough money and support to get re-established in a different part of the country where there are better economic opportunities. I know this sounds radical and heretical, but shrinkage has to be part of the puzzle, especially for Michigan and Ohio. It's already happening naturally. Detroit has net outmigraton of 58,000 people per year. If this were tripled, in 10-15 years the population could start getting reduced to something more manageable. Detroit would be much better off with a popoulation of 2.5-3 million instead of 4.4 million. I don't think it will get that far, but some shrinkage is key. Without it, the chronically unemployed will be a huge loss to the state, and also the inability to find meaningful employment will rob the people themselves of their dignity and potential.

I can't say I fully endorse this yet, since I haven't thought through the implications or how exactly it would work, but I think the federal government needs to step up with a major "controlled shrinkage" program for the greater Rust Belt. This is really embracing the Youngstown strategy at scale, with serious federal money behind it. It will be politically challeging if not impossible. But since I'm just a blogger, I can at least put the idea forward.

Cities need to be categorized. Some, like Columbus and Kansas City, are doing well and can be invested in as growth cities. Others, like Cincinnati, are below national average in growth, but are growing. They need different strategies. And many places are struggling, Detroit, Cleveland, and especially many of the smaller industrial cities, and an active shrinkage program should be put in place to put them on a sustainable base. This involves abandoning the pretense that these cities will become thriving urban meccas on par with the Charlottes and Austins and Denvers of this world. It means active relocation assistance to help people resettle elsewhere. It means funds to acquire land and "decommission" parts of the urban fabric. This is what Youngstown is trying to do by actively encouraging people to leave certain areas, with plans to rip out the infrastructure later. Perhaps large portion of the city of Detroit could be turned into nature reserves in this way. (Google "urban prairie"). And there would be significant investment in brownfield cleanup. Infrastructure funds are targeted at renewal in select areas, not in capacity expansion for growth or for some type of large scale urban transformation.

In terms of government restructuring, Michigan needs federal assistance to fund its industrial transition. But it needs to adopt a more business friendly approach, and find ways to lower the cost of doing business. One other radical idea: why not a mass commutation of the sentences of certain types of non-violent offenders in the prison system, such as those convicted for minor drug possession? Michigan spends more on prisons that most states. It spends more on prisons than it does on education. No state can survive like that. While violent criminals surely need to be locked up, can the state afford to lock up everyone else? Changes to sentencing and prosecution can make this change permanent over the longer term. In the shorter term, some type of controlled release program might be better. There'd possibly be a short term uptick in spending to fund probation officers, drug and alcohol treatment, etc, but in the long term corrections spending would decline.

As for Detroit sector specific industries, there are many possibilities:

• Clearly, automotive R&D will continue to be big. The auto industry is not going away in Detroit.
• Music. Detroit has one of the strongest legacies of music of any city in America, from Motown, to electronica, to hip-hop. Many popular acts have come from Detroit. But I don't think Detroit has figured out how to monetize this. Nashville figured it out. Detroit also needs to figure it out, though I won't pretend this is easy.
• The Detroit Renaissance Aerotropolis plan is a very good one. Detroit has a fabulous airport. They need to aggressively defend their hub (which admittedly the shrinkage strategy is harmful to), and look to develop airport related industries.
• Being the entry port for cross-border traffic to Canada. A huge portion of the goods that flow between the US and Canada go through Detroit. Significant infrastructure spending can be directed to relieving bottlenecks. How can Detroit monetize this?
• What commercial potential could come out of Ann Arbor?
  

There have to be a few others out there. I do not believe chasing the same creative class/biotech dream as everyone else is going to work for Detroit. Certainly not enough to really change the game there.

For the other items, talking about Grand Rapids as a hub is beyond the scope of this already too long post, but clearly large cities are the entities best positioned to compete the global economy. The state should concentrate its resources where it has a chance to win. Tourism is a no brainer. Michigan is already a great tourist destination. As for improving race relations, honestly, I won't profess to have the answers on that one. It is one of the great challenges bedeviling our country.

Perhaps my ideas sound radical. And indeed they might not be right to implement. But they are certainly ideas that should be explored. Radical problems often call for radial solutions. And with eight straight years of recession, Michigan can't afford to be taking any options off the table.

There is a lot of good reading out there on Detroit. I mentioned Detroit Renaissance earlier.

Here is a report called Roadmap to Michigan's Future by a group called the Millenium Project at the University of Michigan. Not surprisingly, investing in education is high on their list. Clearly, this needs to be a focus in Michigan, but my view is this report envisions too sharp a pivot for the state. This is the "we will dramatically transform ourself into knowledge economy" ambition that I think is probably a bridge too far for the state until the restructuring I mentioned is completed. Still, good ideas that should probably be pursued in parallel.

There's another organization called Michigan Future. They published a very interesting report called A New Agenda for a New Michigan. It is also of the dramatic transformation variety.

I'll also note the New Economy Initiative. This is a $100 million fund to help transform southeast Michigan. It helps fund Detroit Renaissance among other things. They don't seem to write reports themselves, but it is notable that John Austin of the University of Michigan and the Brookings Institution, is the director.

One of my favorite reads is Detroit News columnist Daniel Howes. He's pretty good at calling it like it is in Michigan, though like DeLorenzo, he backs the bailout.

Also in the Detroit News recently, "Michigan asks What's Next?" And the editorial board begs for a bailout.

Here's an example of what I mean on changing the ambition level. Detroit wants to build a big rail transit system. This is a variation on "silver bullet" thinking where Detroit will build light rail on Woodward and suddely life will be pumped into the city. It's possible I guess. But while that strategy might be appropriate for higher growth locations like Columbus, I don't think it is where declining cities like Detroit need to be spending their money. Detroit has much higher priority needs than this.

Coverage on the auto crisis from the Chicago Tribune.

Lastly, there is no better source of information about the automobile industry than the aforementioned autoextremist.com. It more than lives up to its billing as "the bare-knuckled, unvarinshed, high-octane truth."