Tag Archives: General Motors

Education, Innovation, and Urban Growth

One of the strongest predictors of urban growth since the start of the 20th century is the skill level of a city’s population. Cities that have a highly skilled population, usually measured as the share of the population with a bachelor’s degree or more, tend to grow faster than similar cities with less educated populations. This is true at both the metropolitan level and the city level. The figure below plots the population growth of 30 large U.S. cities from 1970 – 2013 on the vertical axis and the share of the city’s 25 and over population that had at least a bachelor’s degree in 1967 on the horizontal axis. (The education data for the cities are here. I am using the political city’s population growth and the share of the central city population with a bachelor’s degree or more from the census data linked to above.)

BA, city growth 1

As shown in the figure there is a strong, positive relationship between the two variables: The correlation coefficient is 0.61. It is well known that over the last 50 years cities in warmer areas have been growing while cities in colder areas have been shrinking, but in this sample the cities in warmer areas also tended to have a better educated population in 1967. Many of the cities known today for their highly educated populations, such as Seattle, San Francisco, and Washington D.C., also had highly educated populations in 1967. Colder manufacturing cities such as Detroit, Buffalo, and Newark had less educated workforces in 1967 and subsequently less population growth.

The above figure uses data on both warm and cold cities, but the relationship holds for only cold cities as well. Below is the same graph but only depicts cities that have a January mean temperature below 40°F. Twenty out of the 30 cities fit this criteria.

BA, city growth 2

Again, there is a strong, positive relationship. In fact it is even stronger; the correlation coefficient is 0.68. Most of the cities in the graph lost population from 1970 – 2013, but the cities that did grow, such as Columbus, Seattle, and Denver, all had relatively educated populations in 1967.

There are several reasons why an educated population and urban population growth are correlated. One is that a faster accumulation of skills and human capital spillovers in cities increase wages which attracts workers. Also, the large number of specialized employers located in cities makes it easier for workers, especially high-skill workers, to find employment. Cities are also home to a range of consumption amenities that attract educated people, such as a wide variety of shops, restaurants, museums, and sporting events.

Another reason why an educated workforce may actually cause city growth has to do with its ability to adjust and innovate. On average, educated workers tend to be more innovative and better able to learn new skills. When there is an negative, exogenous shock to an industry, such as the decline of the automobile industry or the steel industry, educated workers can learn new skills and create new industries to replace the old ones. Many of the mid-20th century workers in Detroit and other Midwestern cities decided to forego higher education because good paying factory jobs were plentiful. When manufacturing declined those workers had a difficult time learning new skills. Also, the large firms that dominated the economic landscape, such as Ford, did not support entrepreneurial thinking. This meant that even the educated workers were not prepared to create new businesses.

Local politicians often want to protect local firms in certain industries through favorable treatment and regulation. But often this protection harms newer, innovative firms since they are forced to compete with the older firms on an uneven playing field. Political favoritism fosters a stagnant economy since in the short-run established firms thrive at the expense of newer, more innovative startups. Famous political statements such as “What’s good for General Motors is good for the country” helped mislead workers into thinking that government was willing and able to protect their employers. But governments at all levels were unable to stop the economic forces that battered U.S. manufacturing.

To thrive in the 21st century local politicians need to foster economic environments that encourage innovation and ingenuity. The successful cities of the future will be those that are best able to innovate and to adapt in an increasingly complex world. History has shown us that an educated and entrepreneurial workforce is capable of overcoming economic challenges, but to do this people need to be free to innovate and create. Stringent land-use regulations, overly-burdensome occupational licensing, certificate-of-need laws, and other unnecessary regulations create barriers to innovation and make it more difficult for entrepreneurs to create the firms and industries of the future.

The math really matters in pension plans

Writing in The Wall Street Journal, Andy Kessler, a former hedge fund manager, gets to the heart of the matter on why state and local pension plans are running out of assets (and time): the math is a mess. Economists, financial professionals and some actuaries have been making the case for awhile that the way public sector pension plans value their liabilities is a dangerous fiction.

Today, U.S. governments calculate the present value of plan liabilities based on the returns they expect to earn on plan assets (typically between 7 and 8 percent annually). That’s all wrong. How the assets perform is immaterial to the present value of plan benefits. Instead a public sector worker’s pension should be valued as a risk-free guaranteed payout much like a bond. Unfortunately, when pensions are valued on a “guaranteed payout” basis, unfunded liabilities skyrocket. Some major plans are not just a bit underfunded, they are deeply in the hole.

Many plan managers disregard the discount rate critique of the actuarial assumptions and persist in underestimating the funding shortfalls by an order of magnitude. In conflating expected asset returns with the value of plan benefits, another troubling behavior has ensued: shifting assets into higher-return/higher-risk vehicles to catch up after market downturns, a problem I note in a recent analysis of Delaware (and they are by no means alone in this approach.)

He gives an analogy to what is happening in Stockton and is certain to visit other California cities to his experience watching GM’s pension plan bottom out. The company’s pension shortfall spiked from $14 billion to $22.4 billion between 1992 and 1993. GM got some advice from Morgan Stanley: invest the money in alternatives and watch expected returns double from 8 percent to 16 percent. Make this assumption and the hole will be filled.

But as Kessler notes, “you can’t wish this stuff away.” Instead:

Things didn’t go as planned. The fund put up $170 million in equity and borrowed another $505 million and invested in—I’m not kidding—a northern Missouri farm raising genetically engineered pigs. Meatier pork chops for all! Everything went wrong. In May 1996, the pigs defaulted on $412 million in junk debt. In a perhaps related event, General Motors entered 2012 with its global pension plans underfunded by $25.4 billion.”

 The debate between economists and government accountants continues.

 

What’s Good for General Motors May be BAD for the Country

Marketplace recently did a segment on the federal government’s announcement that it was getting out of the car business and would be selling off its stake in GM over the next two years. Marketplace reporter Nancy Marshall-Genzer first turned to Cato’s Dan Ikenson who noted that taxpayers would likely “need to assume a loss of $15 to $20 billion.”

Then, she turned to Sean McAlinden of the Center for Automotive Research who believes that taxpayers will break even.

“Is he math-challenged?” she asks. Not when you “look beyond the bailout cost” and consider that the bailout meant government ended up spending less on unemployment checks, that it got more income-tax revenue from auto industry employees, and “Then there’s the trickle-down effect.” To wit:

Without GM, auto parts suppliers would have struggled. Maybe gone under themselves. The carmakers use many of the same suppliers, so assembly lines at Ford would have ground to a halt. Dealerships would have suffered too.

A few things to note:

First, I love that she uses “trickle-down” in the way it should be used: in reference to a top-down government policy that transfers wealth from the taxpayer to well-to-do firms in hopes that the transfer will eventually “trickle down” to the little guy. I’ve long felt that if there were any justice in the English language, policies such as these would be called “trickle-down economics.” More commonly, of course, it is across-the-board tax cuts that don’t transfer wealth but instead abstain from taxing that go by the name “trickle-down.”

Second, as long as we are looking “beyond the bailout cost” let’s also look beyond the “trickle-down” effect (which I find dubious, but I’ll leave that to another day) and consider some additional negative consequences of a bailout. In my paper on government-granted privilege, I catalogue a host of problems that may arise when government bestows favors on particular firms or industries. These include:

  1. Less competition, yielding higher prices for consumers and less economic surplus
  2. X-inefficiency (i.e. higher production costs)
  3. Lower quality goods and less innovation
  4. Rent-seeking (people invest valuable resources asking for bailouts)
  5. Unproductive entrepreneurship (entrepreneurs busy themselves thinking of new ways to obtain bailouts instead of new ways to create value for customers)
  6. Moral hazard (firms are incentivized to make mistakes when they know that mistakes might entitle them to a bailout.
  7. Loss of innovation and diminished long-run economic growth
  8. Increased short-run macroeconomic instability
  9. Increased cronyism, which can erode social trust and diminish the legitimacy of both government and business

You can read my paper for arguments and citations for each of these claims (though this appropriately-titled paper is a good place to start).

Now let me add two more problems that are specific to the auto bailout:

  1. In choosing to give the union’s Voluntary Employee Beneficiary Association greater priority than claims by other unsecured creditors such as suppliers and unsecured bond holders, the Administration’s auto bailout overturned a bedrock principle of bankruptcy law (namely that those creditors with similar claims be treated equally). My Mercatus colleague, GMU Law Professor Todd Zywicki, has written about this with the Heritage Foundation’s James Sherk here, and here. It isn’t clear yet at this point what sort of precedent this will set. But if unions were the winners here, generality and the rule of law seem to have been the losers.
  2. The auto bailout seems to have radically shifted the Democratic Party’s position on the relationship between government and business. As Timothy Taylor pointed out in October, there was a time when Democrats openly mocked Republicans who claimed that “what’s good for General Motors is good for the country.” There was a time when Democrats believed that social safety nets were supposed to catch individuals who were down on their luck, not the firms at which these individuals happened to work. As Luigi Zingales points out in A Capitalism for the People, the Democratic Party’s one-time antagonism to business sometimes proved a healthy check on Republicans who too often confused being pro-market with being pro-business. Now that Democrats, too, think that their job is to help corporate America, there is effectively no organized political check on crony-capitalism.

Saving Flint

According to a recent article in the British Telegraph, Flint, Michigan once had 79,000 workers for General Motors and now has 8,000. The population of the city has fallen from 200,000 to 100,000. The unemployment rate is 20%. Young people are leaving in droves in search of jobs and better prospects elsewhere. Large parts of the city are emptying out, leaving at least 4,000 abandoned homes. Although the city has demolished 1,000 of them, 3,000 remain standing. Whole neighborhoods are crumbling rapidly.

So what to do? The normal political response is to take public actions to “save” places like Flint.  The urban renewal programs 50 years ago were designed to arrest the decay of older American cities such as St. Louis and Detroit – typically built in the nineteenth century and with decaying housing stock and outmoded land use patterns based originally on streetcar systems of transportation. Many federal billions were spent in futile efforts to reverse the market verdict, reflecting a refusal to accept that these old city neighborhoods were outmoded and their highest value economic use was as cheap housing for poor people. A “slum” was a pejorative term in those days for old housing – in many cases not all that bad structurally – that people with lower incomes could afford. But for American politicians, every part of every city should be thriving. If not, the government had to do something.

Reflecting the failures of past programs to “revitalize” the inner cities, the Brookings Institution now identifies 50 cities, most of them in the industrial “rust belt,” that need to shrink significantly to survive. After decades of failed efforts to halt downward economic forces, there has been a new acceptance that some American cities simply must get smaller. Facing its dire problems, city planners in Flint have finally come to accept this. The current economic crisis and the large number of foreclosures emphasize the need to rethink urban strategies that automatically assumed upward growth for every city.

One Brookings study proposes that the government adopt a program of “land banks” – government would acquire the land in old declining neighborhoods and then turn it over for redevelopment. It sounds unfortunately like of the thinking that was on exhibit in New Haven, Connecticut, leading to the Kelo Supreme Court case.

A much better approach would be to leave redevelopment to be determined in the market by the collective actions of property owners in a neighborhood area and land developers. Property owners could be facilitated in organizing a collective land bargaining association that would then solicit developer bids for the whole neighborhood. If a high enough bid was forthcoming, and if a large supermajority of property owners – say, 80 percent – voted to accept the offer, the neighborhood would be turned over to the private developer. A whole new neighborhood land uses compatible with present day market economics would result. It is possible that in places like Flint, a few neighborhoods might even be turned back to urban farming of high value local products. Whatever the result, market forces rather than urban planners would decide.

Detroit’s Road to Recovery

Even as General Motors is undergoing bankruptcy proceedings in hopes of reinventing itself with a viable business model and saving the jobs of its Detroit employees, analysts remain skeptical about the corporation’s future success.

A Detroit News editorial wisely advises that Michigan should move forward from this difficult time rather than attempting to preserve GM workers’ jobs for as long as possible while the company continues its likely slow decline:

Michigan’s entire focus must be on creating a business climate that makes the state attractive for job creators in a wide range of industries. It can’t afford to focus on any one segment in hopes of finding the next Big Three. Its future will depend on making itself irresistible to investors across the spectrum.

This perspective is grounded in historical evidence, according to a recent series in The Economist called “Business in America.” In the past, recessions have offered an opportunity for entrepreneurial innovation:

Firms founded during tough times have to be tough. Although more firms typically start up in fat years, Paul Kedrosky of the Kauffman Foundation found that each bad year in America since the second world war produced just as many firms that have subsequently grown large enough to list their shares. He concludes that firms that begin in bad times are more likely to turn out to become economically important: think of Microsoft, Apple, and Krispy Kreme doughnuts.

If Detroit and Michigan can succeed in creating an attractive business climate through maintaining a favorable regulatory climate and lowering corporate tax rates, the area could foster new industries that may profit from some of the capital that becomes available from the auto industry, the current low rental rates, and the environment of creative destruction.

By supporting the common belief that GM is too big to fail, the federal government is probably just slowing the company’s eminent disappearance. At present, this policy appears favorable to Detroit constituents who are supporting federal assistance to auto makers. If instead, however, the city were allowed to organically develop a variety of new businesses to take the former auto giant’s place, opportunities for future growth would be permitted, and business people could take advantage of a situation that has potential to be favorable to new start-ups.