Detroit and the Seven Dwarfs

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1113gaz_detroit_janna-bissettDire warnings may be an inevitable characteristic of any discussion about Detroit, which in July made the largest municipal bankruptcy filing in US history. But Professor Gilles Duranton, chair of Wharton’s real-estate department, sent a positive chill through Irvine Auditorium’s Amado Recital Room during a September colloquium on lessons from that city’s crisis.

The taproot of Detroit’s troubles, as Thomas Sugrue noted at the discussion’s outset, lies in the shriveling of its automotive sector, a trend older than many people realize. “Between 1948 and 1963, Detroit lost 120,000 jobs,” noted Sugrue, the David Boies Professor of History and Sociology. The city’s population peaked at 2 million in the early 1950s, and has fallen ever since. Now it stands at 700,000, spread so thinly over a 140-square-mile area that “it takes nearly an hour for police to respond to an emergency call,” Sugrue noted. “Firefighting is likewise compromised.”

That is a stark reality. Yet in Duranton’s view, the outlook is even starker.

“The problem is that those shocks tend to last for a long time,” he said, referring to the economic impact of the Motor City’s manufacturing bust.

He believes Detroit’s closest historical parallel can be found in the “seven dwarfs of Northern England”—Manchester, Birmingham, Leeds, Liverpool, Newcastle, Sheffield, and Nottingham—manufacturing powerhouses that started declining at the onset of the 1920s, a full 30 years before Detroit began to falter.

“They haven’t come back,” Duranton said matter-of-factly. “In five or six of those cases, decline has stabilized … [but] some places, like Liverpool—which like Detroit have been slower to take the measure of their problems, have suffered from slightly worse governance than the others, and so on and so forth—they are still struggling. They are still declining.

“We are talking here about nearly 100 years of decline.”

In other words, even if Chapter 9 protection helps Detroit dig its way out of an estimated $18-$20 billion in debt, the city may face another half-century before it hits rock bottom.

Or maybe not. Jeremy Nowak, chair of the Federal Reserve Bank of Philadelphia’s board of directors, offered a more hopeful comparison.

“I am reminded that in Seattle in 1971, there was a giant billboard that said: The last person to leave Seattle, turn off the lights,” Nowak remarked. “And that in the 1970s and 1980s, Boston was always on the most-distressed-cities list that anyone put together. So I’m not trying to be Pollyannaish,” he concluded, “but there are examples of these turnarounds.”

The purpose of the colloquium was to examine Detroit’s implosion for lessons that city might glean from others that have faced the brink, and that others might learn from it, to avoid a similar fate.

Put another way: What can a city do to become more like Seattle, and less like Detroit and the “seven dwarfs”?

“The beauty of living in Philadelphia,” quipped panelist Robert Inman, the Richard King Mellon Professor of Finance, “is I’ve had three or four of these things to work my way through and think about over time.”

Inman noted that one of the most hazardous things a city can do is also one of the easiest: borrowing money. This is partly because there are so many ways to do it. The big three are issuing bonds (the dodgiest of which tend to end up in the hands of unsophisticated investors), short-changing municipal pension plans, and deferring infrastructure maintenance.

“The bridge over the Mississippi River in Minneapolis-Saint Paul is a perfect example” of deferring infrastructure maintenance, Inman said, referring to an eight-lane span of I-35 that collapsed in 2007, killing 13 people and injuring 145.

Underfunded pensions represent a particularly thorny problem. Sugrue noted that Detroit cut the size of its municipal workforce in half between the early 1990s and the present day, but that hasn’t relieved the debts it owes to retired workers.

“The municipal worker’s average pension is $19,000,” Sugrue said, adding that police and firefighters get about $31,000. “So we’re not talking about a pension system that’s particularly generous to city employees. But the costs of maintaining it … continue to be serious.”

The costs of failing to maintain it are also steep. State and local employees enrolled in public pension systems are generally not covered by Social Security. And municipal pension funds, unlike most private-sector pension funds, are not federally insured. Further, any loss suffered by pensioners in bankruptcy court will amplify the stress on Detroit’s local economy, insofar as retirees who still reside in the city will have less money to spend in it.

“There’s a remarkable number of cities and states that have debt based on the pension fund liability,” Nowak noted. And “there are pension fund bonds that are just for borrowing against the borrowing. A piece of the private debt in Detroit was for derivatives, interest rate swaps, which was actually a big problem in [Alabama’s] Jefferson County [which filed a $4.2 billion bankruptcy in 2011]. I’m not sure that anyone understood in either place what they were getting into.”

And getting out is painstaking work that pays meager dividends for elected officials, whose fate at the ballot box hinges more on visible accomplishments in the present than averting vague fiscal risks into the distant future.

“I just ran something at the Aspen Institute for a group of people that included six mayors,” Nowak remarked. “One or two of them are really doing a good job [with pension funds]. But they know there’s no political future in solving these problems.”

Inman suggested that Detroit adopt a mechanism that has helped Philadelphia grapple with that dynamic.

“The best thing, in some sense, for the finances of the city of Philadelphia out of the 1990 financial crisis was PICA,” he said. The Pennsylvania Intergovernmental Cooperation Authority is an administrative body created by the state’s general assembly to enforce fiscal discipline on the city, empowered to levy taxes to resolve budget shortfalls. “It’s the gorilla in the closet,” Inman said. “It gives the mayor the cover he or she needs to be tough in budget situations.”

Inman also recommended modifying state balanced-budget rules. In most cases, these rules involve “prospective budgeting: Send me a balanced budget, I’ll put it on the shelf, thank you very much, goodbye,” as Inman put it. “What we want is ‘retrospective balanced budgeting’: I’m going to watch you four or five times during the year; and, if you’re running in arrears, I’m going to ask you to raise your taxes or cut your spending.

Jeremy Nowak expanded the discussion of solutions by focusing on ways Detroit might be able to turn some of its impairments into competitive advantages.

“Interestingly, in downtown the land has become so cheap that money’s coming in and starting to buy it,” he noted. “There is a pretty robust industrial design sector and a little bit of a technology sector … and there’s a very robust art scene.”

Detroit should “do everything [it] can to invest in and encourage this small but pretty energetic technology and design and arts group,” he said.

Nowak noted that any city’s fate is closely tied to its ability to attract and retain people between 35 and 55 years old—“prime productivity age.” But he argued that luring 22-to-34-year-olds—particularly highly educated ones—can be a critical first step.

“In Seattle,” he pointed out, “there are eight adults with a bachelor’s degree or higher for every one adult without a high school diploma. In Detroit it’s about 0.5 to one.

“By the way, in Philadelphia it’s only about 1.5 to one,” Nowak added.

Sugrue, a Detroit area native, was skeptical that “attracting hipsters to the midtown area is going to be the ticket for Detroit’s transformation.”

“Thus far,” Sugrue said, “those investments and the repopulation of those neighborhoods is infinitesimally small. Midtown would fit into a few blocks in Brooklyn. It’s going to be a long time before Detroit has enough of those artists and high-tech people to really turn the city around. The fundamental question for Detroit is what about the 640,000 or so mostly working-class, some poor, African Americans living in the neighborhoods that by and large are not benefiting from the trickle down of revitalization in midtown and downtown.”

The historian argued that the most powerful potential catalyst of a turnaround—and one that’s played that role in the past—is an actor that has at best ignored, and at worst abetted, Detroit’s demise: the federal government.

New York and Cleveland “faced situations in many respects as grave as Detroit is today,” said Sugrue, “but in a very different political climate.” In the case of New York, the federal government “stepped in with very substantial resources to help the city get through its fiscal crisis. Cleveland had support from the state of Ohio. Detroit is essentially being left to fend for itself in bankruptcy court. This is contextually a really big difference.”

Duranton, the real-estate economist, concurred.

“Let me be very, very French here,” the new arrival to Wharton said. “I’m always amazed in countries when a big part of the social-safety net is done at the very local level, like in this country. Because the French person in me, plus the rational economist, say it should be—if at all a problem—a national problem … For people who are really at the bottom, there should be something, some mechanism at the national level for them that goes over and above the dysfunctionalities of City Hall in Detroit.”

A comment from the audience spurred Inman to hone that classically liberal lament into an argument for how shifting the onus of poverty more firmly onto the federal government, and situating responsibility for infrastructure with regional governments, could enable city governments to reconceive of themselves as “businesses.”

“The importance of cities to developing economies is the potential to be productive centers for economic activity,” Inman said. “If poverty is not an issue for cities like Detroit or Philadelphia, and the resources are given to the city to remove that obligation, the city can become a much more efficient and productive center.”

“The dilemma,” he added, “is the national government isn’t going to take over the poverty problem.”

That dilemma applies to many cities. Nowak called Detroit’s bankruptcy “a watershed moment nationally,” both for its unprecedented scale and the fact that the underlying problems are widely shared.

So what is the biggest lesson from Detroit?

“The basic one is other cities should pay attention,” said Inman. “This could happen to you if you screw it up.” —T.P.

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