Full Steam Ahead for State’s Economy

A rebound in domestic auto sales, fewer taxes and regulations, and a right-to-work labor market are propelling continued growth in Michigan. But headwinds loom at the national level.
Illustrations by Julie Tenenbaum

Nothing portends a better year ahead for the state than steady growth in vehicle sales from the Big Three. And in that regard, at the end of the third quarter, Detroit’s automakers had plenty to cheer about. Not only are combined auto sales posting double-digit gains over 2012, but total auto and truck sales for the industry are hitting annual rates of 16 million to 17 million units. If maintained for a full year, this pace would rival record sales from the halcyon years of 1999 to 2006.

Clearly, nothing succeeds better at propping Detroit’s image, spirit, and recovery prospects than the continuous expansion of auto sales. Add to this the turnaround in the market share of domestic vehicles sold since the recovery from the 2008-09 global financial crisis and there’s extra cause to hail the economic outlook for 2014 and beyond.

Detroit’s pullout from the abyss has been profound. After plummeting to a 40-year low in auto sales during the national recession (auto sales in 2009 collapsed to 9.5 million units), calendar year 2013 vehicle sales, by contrast, could hit well over 15.6 million.

Even better news is that the Big Three can sock away tremendous profits at far lower volumes of vehicle sales than ever thought possible in the pre-recession era. Serious attention to embracing greater flexibility on production lines, shedding portions of onerous and noncompetitive labor contracts, and adopting the latest proven efficiencies and 21st century technologies have brought tangible rewards. The 2009 bankruptcies of General Motors and Chrysler also removed billions of dollars of debt, while the United Auto Workers agreed to shoulder more employee benefits through relatively new trust funds.

Click here to see what Michigan business leaders forsee for 2014, part 1…

Combined profits for Ford and GM over the past three years have surpassed $51 billion. Although it is too early to bet the farm, some auto industry analysts now believe the Big Three can profit even when production levels are geared to vehicle demand as low as 12 million units. If true, such a remarkable transformation of a hometown industry would stand in bold relief to the Big Three’s former inability to generate profits, even when overall industry sales surpassed a robust 16 million units. Profitability, after all, is the seed for new investments in local plants and equipment, payroll employment, higher compensation, and stronger economic multiplier-effects for each new dollar entering the metro Detroit and Michigan economies.

Michigan’s leading automakers have invested heavily in modernizing production for the decade ahead. The list includes Ford’s $500-million renovation of its Flat Rock assembly plant — now a second location for building the popular Fusion — and the Dearborn Rouge plant’s renovations for the top-selling F-150 series. Chrysler Group, meanwhile, has invested in plants and products in Sterling Heights (Avenger and Chrysler 200), Detroit (the highly acclaimed Jeep and Jeep Grand Cherokee), and Warren (Ram 1500). As a result, the automakers have re-established a strong local presence for job-creation and income growth.

GM, too, is gaining market share and generating additional profits. The encouraging sales trend will help southeast Michigan and its supplier base reassert the growth image that leads to upgraded investor ratings for public sector bond instruments. GM’s Orion plant (Chevy’s Sonic and Buick Verano), Hamtramck plant (Chevy Volt, Malibu, and Impala), and Flint truck plant (home to the Sierra and fast-selling Silverado) provide breadth and depth in reconstituting the Detroit area’s economic and financial roots.

Clearly, the growth potential for jobs, population, and wealth in metro Detroit and Michigan is considerably brighter when automotive profitability is revitalized. What’s more, major investments in R&D programs in the region from the likes of Toyota and Hyundai have added icing to the cake.

Looking Ahead

Given recent sales trends, it’s prudent to ask: Has the span of good fortune run its course for the current business cycle, or will the recent past be a prologue for southeast Michigan?

For the Detroit-area economy, the past becomes prologue when three conditions prevail to underpin a sustained automotive upswing: purchasing power gains of at least 2 to 3 percent per year; stable and affordable loan rates; and expanding consumer confidence. Clearly, each one of these essential conditions reflects and reinforces the expansion of full-time employment.

First and foremost, households require rising incomes to participate in the market for new car purchases. Data suggests that expansions of U.S. new car sales are strongly linked with yearly gains of 2 percent to 3 percent in disposable buying power — that is, income after removing the weakening impact of taxes.

According to the U.S. Bureau of Economic Analysis, this seminal national variable rose 2.5 percent between 2011 and 2012, while it increased 3.1 percent in Michigan and 2.6 percent in the five-state Great Lakes region. Further gains of this magnitude have been posted so far this year, thus suggesting positive outcomes for 2014.

Second, monthly financing costs are critical to all auto sales, but they are especially important in making vehicle loans because car payments are extracted from monthly income. When borrowing costs move higher, they chew into household capacity for new car purchases, just as rising gasoline or heating costs deplete discretionary income. Is it any wonder the stock market and the auto industry applauded when it became clear in September that Janet Yellen, who enthusiastically promotes continuing easy-money (low interest rate) policies, would be tapped for Federal Reserve chairman, replacing Ben Bernanke in 2014?

Third, beyond just the automotive comeback, metro Detroit is experiencing steady gains in retail sales, housing prices, and construction work. Each activity is underwritten by a solid restoration of confidence. Both the Conference Board’s Consumer Confidence Index and the University of Michigan’s Consumer Sentiment Index have gained considerable strength since late summer 2011. For example, the University of Michigan’s index stood at a pathetically weak level of 55.8 in September 2011, but two years later it had risen to 78.6 (August 2013).

Even this jump has left the index far short of its 1999 peak at 112. But two qualifications accompany what today seems like a truncated recovery in confidence. First, the 1999 peak was considered artificial in the sense that it was hyped by extreme monetary stimulation and recklessly loose standards for home-buying. Second, the high-tech stock bubble of the late 1990s was followed by a tailspin in consumer confidence reflecting both the “dot.com” implosion and the 2001 terrorist attacks.

Those hits on confidence and the subsequent 2008-09 recession brought the indices down to virtually half their levels during the 1999 peak. Interestingly, current monetary stimulation on the part of the Federal Reserve is, in large measure, responsible for re-creating those same stock market advances and rebuilding similar confidence levels — those levels are, however, bound to drop when the next economic storm clouds converge.

There are two additional catalysts boosting Michigan’s fortunes in 2014, and one ties into the other. The first is the state’s adoption of right-to-work legislation in late 2012, which became effective in March. This historic event put Michigan on the map as a place with more competitive labor markets. In turn, right-to-work links to the second catalyst: Michigan’s rise in the ranks against other state business climates since 2011. The state’s higher ranking as a more attractive business environment offering greater worker choice and employer flexibility should attract new enterprises over the coming years.

Indeed, the state has moved up in national business and tax-climate rankings, reflected, in part, by additional manufacturing jobs and profits. A recent illustration of the synergy between the business climate and boots-on-the-ground job gains comes from U.S. Labor Department and Tax Foundation reports. The Bureau of Labor Statistics’ data shows that since the end of the recession, the U.S. has gained 500,000 manufacturing jobs, with Michigan leading the way — up another 7,600 in July alone.

The nonpartisan Tax Foundation’s 2013 State Business Tax Climate Index ranked Michigan 12th among the states for attractiveness, noting in particular our business and sales taxes. To improve and to place in the top 10, Michigan now must reduce burdens in personal income tax rates as well as overhaul its burdensome unemployment insurance and property tax regimes.

Click here to see what Michigan business leaders forsee for 2014, part 2…

Looming Headwinds

Without a doubt, Michigan’s economic outlook has a lot going for it in 2014. Yet, headwinds are rising, and Michigan’s notorious reputation for sensitivity to the national business cycle adds urgency for reforms that will spur greater excellence in the business climate and international competitiveness. The outlook isn’t all rosy.

For the past three years, the Federal Reserve has been deliberating setting an end-date to stimulative monetary policies. Some U.S. Treasury rates have already inched up. Yet, lacking steady acceleration in real GDP or full-time employment, here and abroad, the Fed still lacks confidence that the economic recovery can endure a sustained rise in borrowing costs.

Therefore, to avoid precipitating a recession, this economic forecast assumes, especially with Yellen at the helm of Central Bank, that Fed policy will take a very gradual approach to ending its easy money stance over the balance of this year and into 2014.

The vortex of a second headwind are the enormous cost increases connected with the implementation of Obamacare starting this fall. Detractors — as well as numerous early advocates of Obamacare — now increasingly fret about rising tax rates, fees, penalties, and add-on insurance costs. Growing uncertainty over the timing of the act, coordination of payments, and shortages in the number of physicians and other health care providers, as well as new taxes on medical devices and pharmaceuticals, could prove debilitating to major economic functions as we enter 2014. Economic doubt and uncertainty may reduce the vigor of household spending and could cause firms to hoard cash, as opposed to investing in new plants, equipment, and training programs.

Obamacare is a true sleeper in its possible economic impact. Directly, the act affects the entire health care sector, or 18 percent of the U.S. economy. But secondary impacts could reach tsunami proportions. The reason why we cannot yet appreciate the full economic fallout is that no domestic policy has ever reached so deeply or broadly into the U.S. economy, short of wartime mobilization and wage, price, and credit controls.

The health care act generates a disproportionate impact on the U.S. economy in part because consumers avail themselves of health care services frequently, from drugs to office visits to medical devices. Whether for themselves or family members, threats of higher insurance and out-of-pocket costs often cause households to retrench quickly and profoundly as they seek to save for rainy days and retirement years which may very well lack safety nets like Medicare and Social Security.

It’s no different for Michigan’s corporate sector. According to the latest economic surveys, the buildup of corporate cash is at an all-time high. Firms comprising the all-inclusive Russell 3000 Equity Index reveal balance sheet cash at $3 trillion, not including an estimated $1.9 trillion in cash held by U.S. firms overseas. The anomaly here is that the nearly $5 trillion in cash that’s been placed on the sidelines by wary U.S. firms far exceeds the value of all of the Obama administration’s “economic stimulus programs” combined, with the entire $1.3 trillion in “quantitative easing” policies conducted by the Federal Reserve.

Such corporate cash-hoarding behavior makes sense because it provides companies with time to gain better perspective regarding probable rates of return before pulling the trigger on expensive investment pro-jects. But this is a path to insolvency if it deprives U.S. firms, particularly Michigan’s auto firms and suppliers, of profitable expansion into rising world markets.

Another subtler headwind deals with growing fragility at the very core of the workforce, especially the cohort of workers between 25 and 34 years old. For the first time in living memory, participation rates of eligible workers in the labor market (those able to work) are plummeting. The slump, from 66.4 percent to 63.2 percent in just six years, is breathtaking.

Michigan, and especially the Detroit area, is not immune. Compounding the annual loss of potential GDP growth is a skyrocketing number of former workers now collecting Social Security disability payments from taxpayers. More than 9 million Americans now receive disability payments. Social Security has been paying benefits in excess of its payroll tax intake at such an explosive pace over the past few years that the entire disability system will be exhausted by 2016 (when President Obama is set to leave office).

To fully appreciate the impact of a weakening employment situation on the outlook for 2014 and beyond, it is essential to note the two principal drivers of the adverse trends. First, eligibility standards for collecting unemployment and nonemployment benefits have been loosened, which affects both the amount and duration of benefits paid out. Second, massive increases in government taxes and regulations since the onset of the recession have impaired incentives to hire or reinvest cash on the part of businesses.

The result has been a workforce that remains more than 2 million workers short of levels five years ago. Consequently, more discouraged workers and part-time employees opt to abandon the search for full-time work, thereby assuring continued economic weakness and making poor job prospects a self-fulfilling prophesy, despite the Obama administration’s many stimulus programs.

Finally, Detroit represents a microcosm of yet another serious headwind. Governmental finances across the country are in disarray. Whenever fiscal solvency of the community — much less the entire nation — is at stake, confidence and household budgets will be crimped. As a result, a failure to relieve apprehension over fiscal integrity impairs our credit ratings. Neglecting swift and transparent budget reform in cities like Detroit and Stockton or in states such as Illinois and California merely promotes insecurity. Expedient tax increases impose even more daunting hurdles and dash the hope of ever achieving a pre-eminent business climate.

Detroit can attest firsthand to the wisdom of negotiating viable public worker contracts. Having failed in that basic responsibility, all of southeast Michigan must deal with greater public skepticism regarding the capacity to provide essential local government services. At the national level, persistent crises over raising the debt ceiling result in threats to end funding of major programs, including those operations providing citizens deterrence from life-threatening foreign aggression.

Overcoming each of these headwinds demands a more mature, longer-term vision on the part of the citizenry and their elected officials. Historically speaking, this has happened in times of crisis and, presumably, can happen again.

Maintaining Recovery

A strong offense is Michigan’s best defense against ever-present threats to growth. In particular, state and local governments would be wise to tighten their budget belts and live within their means without raising fees, taxes, or engaging in large-scale borrowing or bonding projects. Like Michigan, Detroit’s recent decades are replete with projects and programs that, in retrospect, have proven unnecessary, duplicative, unsavory, and bankrupting.

Michigan’s public sector should be initiating means of performing services more efficiently. This imperative takes on urgency in light of the many fiscally troubled school districts and municipalities across the state. Detroit will not be helped in the long run by further burdening non-Detroit taxpayers. For example, rather than subsidizing industries that should be self-supporting in the marketplace, Lansing must shed industrial policies that benefit narrow interests rather than the taxpayers of the entire state. Likewise, Detroit’s already-blinkered reputation for licensing, permit issuance, and inspection “services” gives further impetus to outsourcing.

A far more promising path for achieving durable prosperity is the encouragement of private sector activity. Michigan has improved its business climate of late; Legislative progress now makes it easier to tap energy resources such as oil, gas, and shale fields (on-shore and offshore). More entrepreneurial activity from tech startups, private transportation operators, and others should be promoted, but not with special carve-outs and subsidies.

In many ways, Detroit now has a cleaner slate on which to write its renaissance than most other public sector bodies in Michigan. The city could tap its private sector to provide cost-effective services such as trash-hauling and water and electrical utilities. This would free Detroit to focus more effectively on delivering the services government is expected to provide, such as protection of life and property. In that way, the city will meet the rising quality-of-life expectations of residents before extending its reach beyond its expertise and resources.

As always, a healthy U.S. economy will help Michigan and Detroit in 2014. But so will the still unfolding liberalization of state work rules. Michigan’s new right-to-work legislation could underwrite a growth premium for decades to come.

A recent study by the Mackinac Center for Public Policy concludes that being a state with right-to-work laws conveys, on average, numerous growth advantages: States with right-to-work flexibility gain an employment growth premium of 76 percent (41 years of data: 1970-2011); a personal income growth premium of 75 percent (64 years of data: 1947-2011); and a 54 percent population growth premium (64 years of data: 1947-2011).

Michigan remains an economic bellwether for the nation at large. Like Michigan, Detroit can bounce back from adversity. The foundation and critical mass supporting a good 2014 economy are in place. The Big Three’s market share has turned the corner, as have profits, employment, and the supplier base. S&P/Case-Shiller’s Home Price Index for the Detroit area has rebounded quite well this year. Although Detroit’s area average home prices are lower than at the outset of the 2008-09 recession, the year-over-year percentage price gains during 2013 have been nearly 50 percent faster than for comparable single family homes in the U.S.

The nation will undoubtedly experience an increasingly shaky path in 2014. Rising borrowing costs, federal budget battles between Congress and the Obama administration, uncertainties pertaining to health care costs, and outcomes of the midterm elections will all play out in an international arena that’s becoming more confrontational. Combined, such factors dampen real GDP expansion possibilities.

But if Michigan policymakers continue to strive for higher national rankings among state business climates, then chances are that our main industries will outperform their U.S. counterparts, and will thereby avoid recession. To achieve this economic magic implies revisiting the forces that brought so many decades of pre-eminent growth to Michigan and Detroit in the first place — namely, greatly reduced public sector spending, taxes, and regulations. In short, Michigan must endorse and re-engage the dynamics of the competitive markets around us. Only then will Michigan notch another year of meaningful economic expansion. db

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