What's Killing California?

California has a case of the same disease that felled the Rust Belt. Will the patient survive?

California Failin'

The troubles of California, and their causes, are a widely discussed topic these days. America's most populated state by far, its successes and failures always loom large in the national consciousness. In the last year we've seen the state face a massive $42 billion budget deficit and the humiliation of having to issue IOU's as payments. Its pensions are radically underfunded and there are other long term structural budgetary problems. Parts of the state were ground zero for the housing collapse and among the highest foreclosure zones in the country. Unemployment, high everywhere, is particularly so in parts of California. California, the place people once moved to, is now the place the move from, as the state is experiencing net domestic out-migration, leading to the prospect of losing a representative in Congress for the first time in its history. A complicated political system has led to decision making paralysis. Even disasters like wildfires have been played up.

There are no end to explanations for this which, unsurprisingly, tend to follow people's political beliefs. To those on the right, California is the ultimate blue state, with high taxes, an anti-business mindset, and environmental and other regulations designed to send people and businesses fleeing for the exits. To those on the left, California's problems are the comeuppance for decades of unchecked sprawl, the ultimate car culture, and unchecked exploitation of resources. Whatever your particular policy pet peeve, California must be it.

But is this really the case?

The real problem could be much more simple and yet much more terrifying in its implications. California has simply now outgrown its youth and is now well into its middle age. Like the Rust Belt before it, California is now old. As with people as they age, "chronic lifestyle diseases" hit places too. These are: unfunded liabilities, the end of growth economics, and institutional rigidity, each of which builds on the one before it.

Unfunded Liabilities

I've long noted that places have an incredible tendency to accumulate unfunded liabilities, most of them of the "off balance sheet" variety. The temptation to defer problems into the future is simply too great for most governments to resist, hence structural imbalances build up over time. The sources of these liabilities are many, but here are some key ones:

• Deferred Infrastructure Investment. As populations and development grow, infrastructure is built with a lag and generally there is a lack of funds for completion. As a result, cities and states end up with deficient infrastructure for their size, leading to all sorts of problems such as traffic and transit congestion. Clearly, California is suffering here.
  
• Infrastructure Maintenance. Similarly, cities build some infrastructure, then "sweat the assets" as long as possible. Infrastructure is often not well-maintained, and the periodic capital refresh unbudgeted. Condo associations do reserve studies and set aside funds to meet future capital needs such as roof replacements to avoid painfully huge special assessments, but government do not. I have yet to see any city or state that even has a schedule of major assets and infrastructure with needed maintenance and replacement timeframes, much less funding for any it. California's Golden Age infrastructure is now aging, and it is facing repair bills merely to maintain what it has.
  
• Underfunded Pensions. Politicians love to sweeten public sector pensions. This buys both labor peace and a powerful political constituency. These are seldom funded at adequate levels - and with the rapid growth in life extending technology, it's questionable whether any level of funding is sufficient - leading to major problems downstream. California's pensions are unfunded by upwards of $300 billion.
• Other Redevelopment Costs. When ever homes and buildings are shiny and new, things are great. But what happens when your building stock gets old like in Rust Belt inner cities, and often no longer meet the functional and technical demands of the modern day, such as sizes, layouts, energy efficiency, etc.?
  

Add this all up, and it's a huge bill that eventually comes due. The most important thing to understand about this is that the bill attaches to the territory, not to the people. So residents and businesses can avoid paying up simply by leaving for another jurisdiction. It's like being able to run up a huge credit card bill in someone else's name, then skip town.

This ability to run up massive deferred and unfunded liabilities, then leave, sticking other people with the bill, is one of the most powerful forces driving greenfield development. Even if there weren't a drop of subsidies to, say, suburban expansion, the financial incentive to escape the huge liabilities of central cities and older suburbs is a key incentive on its own.

This why I've said it is critical to find ways to prevent governments from accumulating these liabilities in the first place.

The End of Growth Economics

Look at companies and industries. There is a standard growth curve to them. They start out in incubation and infancy, then, if successful, on to growth, then finally to maturity and decline. Why would we think that what is true for firms would be different for places? Why would we think that cities or states are immune from the forces of creative destruction? The answer is, they aren't.

Having done consulting in the retail industry for some years, I often observed the growth curves played out in companies. Category killers came along and grew and grew and grew, seemingly as unstoppable juggernauts. But eventually, they hit the end of their growth phase, and had to endure a period of wandering in the wilderness. The reasons for this are varied - market saturation and consequent over expansion, changes in the marketplace, insufficient infrastructure and operational disciplines, more nimble competitors - but we've seen it played out before our eyes in America. Think McDonald's, Home Depot, and the Gap.

The logic and economics of high growth are fundamentally different from that of operating a more or less steady state or low growth business. In the growth phase, everything is oriented towards expansion, mostly building more infrastructure to keep up with it. Also, scale economics are in your favor. With more people, for example, you are spreading fixed costs across more bodies and more buildings, so you can spend more money and tax less per capita all the same time. Your brand value is expanding with size, etc. That's all great if you can pull it off.

But when something causes growth to take a hit - maybe accumulated liabilities, resource exhaustion, jurisdictional limits, etc - the equation changes radically. You can no longer rely on growth to provide unit cost efficiency. You have to start thinking like an operator. That is an extremely difficult mindset shift and requires a totally different set of skills. From what I've seen, companies have an extremely difficult time doing this. They generally have to struggle for some time, usually bring in new leadership, and undergo painful structuring. Many of them never really recover. But some do. I think of McDonald's, which stopped relying on store growth to fuel its engine, but now relies on product innovation (Angus burgers, coffee, salads, etc) and operational effectiveness.

California, for whatever reason, stopped growing. The trends in domestic out migration make this very clear. The fact that total population has not declined doesn't matter. Most Rust Belt states never actually physically lost population. Their growth simply slowed to a crawl. And it was the most entrepreneurial and high skill classes that fled. In California that his been somewhat masked by outsized productivity in the technology sector and international immigration, but the overall trend is clear. California now has to think like an operator. Welcome to the world of legacy. California is now a gigantic "brownfield".

As California struggles with this transition, the scale economics start to go in reverse. As people and businesses leave, the unit cost of all those unfunded liabilities looms large. Just as growth begets growth, decline begets decline. If you are young and ambitious, why stay in California and pay off all those pensions? All things being equal, it is much better to leave for a more greenfield location, where you can benefit from running up the credit card, not paying off someone else's bill. If not arrested, decline eventually reaches a tipping point, as we've seen in so many Rust Belt cities.

Institutional Rigidity

The third symptom of civic aging is a creeping institutional rigidity that makes change difficult. In established, mature places, there many, many powerful institutions and interest groups. These can often be forces for good, but too often become barriers to change or getting things done. What's more, these institutions were typically created in the past to meet the perceived challenges of that time and age, but survive today in a world that is very different. As most institutions are never sunset, and new ones form over time, there is a gradual accumulation of friction over time. Eventually, the gears and seize up.

These institutions can take many forms. Constitutions and political structures, non-profits, clubs and social networks, various trade-offs and political accommodations and deals from over the years, power structures, corruption, local business practices, unions, recipients of government funding, taxpayer or other advocacy groups, political party organizations, business groups, etc. Much is made of California's many times amended constitution as a barrier to change, but that is only the tip of the iceberg.

As decline sets in, a toxic dynamic takes hold. In a growth mode, it is very easy for everyone to hold hands and sing kum-bah-ya. It's comparatively easy to cut deals to divide the fruits of prosperity. In decline, those deals come back to haunt. The status quo is failing, but people are still profiting from it. Even in Detroit, America's ultimate failed city, so many people and groups benefit from the current system that there is complete paralysis. No one wants to give up an inch of hard won gains, especially since in a dismal region there's little hope of replicating that privileged position or income. Hard times promote solidarity, some say. But the reality is that hard times also often produce selfishness and civic dysfunction as well as people cling desperately to what they have instead of looking boldly forward to the future.

I've seen this shift happen in a few cities. Where once civic boosters dreamed of glory and invested their own money into the city, now they focus on what they can get out of it. So too in California. Everyone knows the Titanic has hit the iceberg, but they are determined to loot as many state rooms as they can before shoving the women and children out of the way and commandeering the life boats.

This institutional rigidity is another force driving people to greenfield locations. It's a global phenomenon. Consider this Newsweek coverage of a study of Chinese industry that notes much lower levels of corruption and better governance in new cities than old.

An intriguing pattern is that governance is best in coastal cities that had very little industry when reform began in 1978. Shenzhen now has the highest per capita GDP in China. The same holds in Jiangmen, Dongguan, Suzhou--all were industrial backwaters in 1978, and responded to China's opening by creating good environments for private investment and learning from outsiders. Cities that already had industry tended to protect what they had and reform less aggressively.

Jim Russell hypothesizes that this effect of frontier geography explains a lot of the success of the Sunbelt, which industrialized late.

Cities such as Austin, TX and Charlotte, NC have offered a frontier opportunity akin to the one observed in the boomtowns of China. On the other hand, Pittsburgh stagnates. Governmental reform is key for attracting investment and stimulating growth. This is unlikely to happen in Western Pennsylvania, leaving this region at the rear of economic globalization.

For Pittsburgh, substitute California and you've got a pretty good picture.

Writers like Joel Kotkin like to reminisce about the Golden Age of California, and the leadership of that age from enlightened members of both parties like Pat Brown and Ronald Reagan. But you can never go home again. That letter jacket from your high school glory days might still fit, but you're never going back to the state finals. Brown and Reagan were products of their era - an era that no longer exists. While they might be better executives than Gray Davis and Arnold Schwarzenegger, even if you assume they could get elected today - unlikely - I doubt they'd prove much more effective.

It's been said that China will get old before it gets rich. Well, California got rich first - but it still got old. Not old demographically, but old civically. The polity of California is now well into middle age. As with people, places that reach that point experience a mid-life crisis as they look back longingly at the optimism, energy, flexibility, dynamism, and endless capacity for reinvention of youth. That's often a bitter pill to swallow.

Can California Recover?

Can California pull out of this? It's hard to point to a lot of examples that offer hope. But California has a lot going for it. It's got the stunning climate and physical geography. Cities like San Francisco and Los Angeles remain powerful. In addition to the technology and film industries, California also has a robust agricultural sector, legal and illegal, an entrepreneurial immigrant base, as well as an American hub for contemporary art and other creative fields besides the movie business. So there's a lot of assets to build on.

The challenge is that these existing strengths are part of the institutional rigidity. Another way to say "build on assets" is "defend the past". Other than the its physical setting, the assets of California only exist because previous generations didn't build on assets. If they did, Silicon Valley would still be orchards, not the powerhouse of the global technology industry. If a city or state is failing to create new industries, it has economically stagnated, no matter how prosperous it might be or appear for a time.

Looking at the Rust Belt, we do see that tier one global cities have managed to renew their cores. Chicago, New York, and Boston have glittering city centers and a migration back to the city of upscale residents. This is a far cry from the sour days of the 70's. But if you look beyond those zones, you see places with surprisingly unimpressive metro area statistics in many regards. And the states they are in look at lot like, well, California. A handful of metro thriving cores can't energize an entire state or even metro area. Places like New York and Illinois have major structural challenges of their own. And California has already followed this program, with booming regions that are among globalization's winners, with many larger areas of losers. Of course the alternative is worse - look at Michigan, with the same failures and no global city to even partially make up for it.

The global city phenomenon perhaps illustrates the way. Cities that have experienced that boom like to pat themselves on the back. Indeed, there has been some good leadership along the way. But when something happens in most similarly situated cities, you have to look first to a common force acting on them. Chicago, New York, London, etc. all had their own Rust Belt eras and suffered in the 70's and 80's. Starting in the 90's a large number of what we now call global cities had urban core booms. As Saskia Sassen noted, the new networked global economy requires new financial and producer services, that tend to be concentrated in global cities. In effect, the global city is an emergent property of the globalized economy, just like the company town was in a previous era. I noted previously with regards to Chicago that it was the artifact, not the architect.

To me that shows that a state like California needs to look at and understand the macrotrends affecting it and the world, and figure out how to position itself to profit from them. One area it is trying to do so is in the "green economy". I've got a few problems with "green jobs". The first is that the entire concept of a green economy is a transitory one. Likely in a decade or so it will be gone. There will no longer be green industry, but only industry - it will all be green. This immediately prompts the question of whether, since we're not going a very good job of competing in traditional industry, we'll do any better in green industry. Indeed, China and others are already making a move here.

The other aspect of this is the huge gamble California is placing on the environmental trend. That is, it has imposed the strictest environmental controls in the world. There is no doubt this is one factor causing a lot of short term pain. But the state hopes that in the long term this will attract talent and, what's more, position it for future success because other states will be forced into the same painful restructuring for environmental issues in the future and California will be ahead of the game. California's ultimate goal here is clearly to push to federalize its policies to prevent any other states from not following its lead and producing a differentiated product. Because international migration is so much more difficult than domestic, this would, in theory, eventually help staunch the flow of people out of the state. Other states no doubt realize this and will resist the push at the federal level. It remains to be seen how this turns out on many fronts.

Other than that, it is difficult to identify a strategy California has other than more of the same. While the green realm might be a good place for California to put some chips, I don't think piling everything on one square is a good idea, so new ideas are clearly needed.

And these economic strategies will only be ultimately a success to the extent that they enable California to reach an equilibrium and either successfully make the transition to an operator, or somehow reignite growth.

I would suggest that California and other maturing jurisdictions should look to partner with academics in our economics departments, and especially our schools of business, who have studied industry growth and maturity curves, and how to manage that transition over time, strategically and operationally.

Has the United States Reached Maturity?

Given the problems of California and the current Great Recession and associated talk of American decline, it's worth asking the question: has the United States matured? That is, are the life cycle forces that are hurting California now affecting America as a whole?

Let's consider our three harbingers: unfunded liabilities, the end of growth, and institutional rigidity. Clearly, we've racked up huge unfunded liabilities, just like every industrialized nation. I believe we are projecting a deficit of $1.8 trillion this year alone and that doesn't even count off balance sheet problems like social security and medicare. So a definite check mark in that box.

As far as institutional rigidity, clearly we observe some. There is no doubt that it has gotten harder to do things in America and that one of the key advantages of China is its greenfield location and lack of this cruft, not just its low labor costs. Regulatory arbitrage, for example, can be a powerful motivator. Still, I haven't observed a ridiculous amount of change here in my lifetime. At the federal level, it has always been hard to do things in America, by design. I do argue that in some areas we've turned the dial too far. In a country that desperately needs to make transportation investments, it shouldn't take a decade to get approval to build a new transit line, for example. But on the whole the United States still feels like a fairly dynamic society to me.

Which brings us to growth. Clearly we have been in a major recession. The question is whether our best days are behind us. I say clearly No here. America is demographically healthy. Compared to Europe we have comparatively high birth rates, more or less replacement rate, in our native born population. This shows a society with confidence in the future. Also, people from around the world are still voting with their feet to come here. And I believe we'll get back on economic track eventually.

But this is where the warnings signs should be looked for. If growth dries up, I believe the institutional rigidity will enter that toxic cycle and we could be in trouble. Keep an eye on immigration. When people stop wanting to come here - because they don't want to pay taxes merely to pay off yesterday's unfunded liabilities, because they think there are better opportunities elsewhere, or whatever - and especially if Americans start leaving in any material numbers, we'll know we have a major problem on our hands.

Obviously no one can predict the future, but I remain bullish on America.

Detroit: Not the Future of the American City

There's a meme out there that seems to be picking up steam that Detroit represents not so much a unique dysfunction, but rather a harbinger of what is to come for America's cities. Detroit News columnist Daniel Howes said, "Back when Michigan's economy was merely troubled -- before $4-a-gallon gas and frozen credit markets pushed the auto industry into free-fall -- Gov. Jennifer Granholm warned the Big Mitten's deepening economic problems could presage what lay ahead for the nation. I and other skeptics chortled, figuring the collective denial of economic reality, anti-business rhetoric in Lansing, rote acceptance of labor's influence in policy-making, and higher tax loads on individuals and companies here couldn't possibly go national. The combination was too toxic, too self-defeating, too steeped in a last-century worldview that had been discredited by events and chronic failure. But I was wrong."

John Reed gets in on the theme in a long piece over at the FT titled "Rust Sleeps: Can We Glimpse an American Future in the Travails of Detroit?" Per Reed, "Instead, Michiganders, despite being self-deprecating to a fault, make a point their countrymen won't want to hear: Detroit is no longer the nation's worst-case scenario, but on its leading edge, the proverbial canary in the coal mine. 'It's like the rest of the country is getting to where Detroit has been,' said Peter De Lorenzo, who writes the acerbic and very funny Autoextremist.com blog. That means that smug mock-horror is no longer the appropriate reaction to the frozen corpse. Instead, get ready for a shock of recognition."

Speaking of the Autoextremist, who is required reading btw, he said last week, "Several years ago, I called Detroit and the declining U.S. auto industry 'the canary in the coal mine' for the rest of the nation. The lack of a national health care program, the nation’s growing uncompetitiveness in the face of a burgeoning global economy, the steady erosion of this country’s manufacturing base and so on were issues that were going to catch up to the rest of the country eventually."

With a deep recession ravaging much of the country and doing severe damage especially in the industrial heartland, this has a surface appeal. And no doubt this recession has accelerated the train wreck of any number of places like Detroit that already faced a strategically untenable position.

But I do not believe the rest of America is heading the direction of Detroit. Detroit's problems are unique, deep, and longstanding. It is tempting to say that Detroit's problems are of recent origin, or maybe date them back to the 70's oil shocks or the riots of 1968. But the reality is, Detroit's problem far pre-date those events. Consider this view of Detroit:

"Virtually all of Detroit is as weak on vitality and diversity as the Bronx. It is ring superimposed upon ring of gray belts. Even Detroit's downtown itself cannot produce a respectable amount of diversity. It is dispirited and dull, and almost deserted by seven o'clock of an evening"

That was written by Jane Jacobs - in 1961. And she wasn't the only one who noticed something wrong that year. Time Magazine ran an article, "Decline in Detroit" discussing the matter.

"Detroit's decline has been going on for a long while. Auto production soared to an all time peak in 1955—but there were already worrisome signs. In the face of growing foreign and domestic competition, auto companies merged, or quit, or moved out of town to get closer to markets."

This article is a must-read - it was published October 27, 1961

In The Economy of Cities, Jacobs cites the collapse of Detroit to a one industry town and the cessation of the development of new businesses resulting from a focus on large scale efficiency in manufacturing as a fatal flaw that doomed this once thriving city. She dates this to the 1920's. Again quoting, "Detroit had a high rate of development through most of its history and a very high rate indeed at the time the automobile industry was being developed there. But since 1920, Detroit has had an exceedingly low rate."

Ironically, in the same book Jacobs uses Detroit as an example of good urban development, showing its progression from flour mills, to copper processing, to steam ship engine manufacture. There was a plethora of industries that developed and flourished in Detroit. But when the auto industry started to consolidate, something when wrong and the system that had sustained Detroit's development stagnated.

Beyond that, Detroit seems to suffer, and to have long suffered, from dysfunctional leadership - not just governmental leadership, but leadership across the board. Reading about the financial travails of the Detroit Institute of the Arts, I was shocked to discover they had an endowment only 1/3 the size of the Indianapolis Museum of Art. Detroit is one of America's largest cities - it was in the top 5 in America for a long time I believe - and for long one of its most prosperous. The auto industry generated fantastic wealth in Detroit. Why did so little of it make it back into the cultural infrastructure of the city? This is but one example.

This has been going on so long that it is hard, honestly, to blame the leaders there today. They were born into a system that is so bad, it would take truly heroic leadership and change to move the ball. How does one effect racial healing, or a rapprochement between city and suburb? It seems like a daunting prospect for even the most well-intentioned.

I don't have the time to make an exhaustive study of the matter - though someone should - but it seems to me that Detroit is a fairly unique case. There are probably some other places that are suffering as much and will continue to suffer after the recession is over, but I don't think the rest of America is headed on the Road to Motown. Most of America lacks Detroit's long, institutionalized decline, stagnated one-industry economy, and terrible historic culture of leadership.

More Detroit

Detroit: Do the Collapse

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."