The Road to Recovery

2010 Michigan Economic forecast
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Align government spending with revenueAdopt a more equitable tax systemSupport and retain more college graduatesInvest in cities and communities, especially Detroit. Illustration by Don Kilpatrick III

With or without jobs, most of us in southeast Michigan today cannot recall living through times beset with such economic and financial anxiety. And whether it occurs in 2010 or in the years shortly thereafter, it is almost inconceivable that citizens of Michigan will accept further radicalization away from our roots as a pace-setting economy.

Uppermost in everyone’s mind is whether 2010 will bring new job opportunities to Michigan. Having lost 783,000 private-sector jobs between 2000 and August of 2009 (representing 61 percent of all jobs lost in the U.S. over that period, according to the U.S. Bureau of Labor Statistics), this is a most appropriate concern.

And it is not the only concern. In mid-August, a motorist filling his vehicle at a gas station in Holly told the driver at the pump ahead of him how he once had a terrific job. He’s a heavy-truck operator who used to have constant work. “You know,” said the semi driver, “trucking is everything to the economy … you can tell when the economy is failing when trucking activity is on its back.”

Economically speaking, he’s “spot on” with his analysis. Since the 1920s, freight traffic, including railroad freight car loadings, has provided the finest coincident indicator of economic activity available. Nearly a century later, it is still marvelously indicative of business cycle conditions. In late August 2009, overall freight traffic and tonnage were down 15 percent to 20 percent from their peaks in the 2006-2008 period.

Michigan, of course, with automobile shipments running nearly 40 percent off their peaks, suffers more than the nation. Likewise, truck and rail shipments of overall construction materials, from crushed stone to lumber and wood products, are experiencing fewer loads, as well.

Starting Point: Optimism?

From the point of view of an economic forecaster, 2009 would typically offer an unprecedented case for optimism. The Michigan recession has been so deep for so long that incredible bargains exist for property, financing, housing, autos, and other goods and services. In Michigan, 2010 would be a cinch for 10 percent to 12 percent real economic expansion. After all, even a modest improvement next year would appear as a mammoth gain from a low base in 2009. But will it happen this time around, either nationally or in Michigan?

As of September 2009, there are signs of momentary stability. Housing prices have bottomed; stock markets have recovered some ground, albeit haltingly. Personal saving rates have skyrocketed to 7 percent as a share of after-tax income. This startling turnaround comes after several years of negative savings, which devour accumulated wealth. Higher saving rates traditionally foreshadow recovery, because they restore liquidity to personal and business financial statements. They’re harbingers of renewed confidence and spending capacity.

On the national level, unprecedented quantities of monetary pump-priming by the Federal Reserve and unimaginable amounts of deficit spending by the Treasury and Congress are already infusing the spending and investment streams of the nation. Normally, by now, our economic system would be so flush with liquidity and inundated with “shovel-ready” projects that the GDP would be surging on a rocket trajectory toward outer space.

But these are not normal times. And this is not a normal business cycle. Michigan is no longer in position to lead the nation or the world out of the recession. Nor does Michigan have the industrial base to prosper from a prolonged global upturn. A more appropriate question yields a more modest response: Can Michigan, in 2010, reverse its downward slide in real output, private-sector layoffs, income, and population?

On the Comeback Trail?

In previous recoveries, Michigan became the principal recipient of dollars that represented spending by households from other states. This is because there was great pent-up public demand for Michigan’s chief export to other states and the world — namely, the automobile. Households and firms had already postponed purchasing large-ticket durable goods when economic prospects for financing, for jobs, and for steady income were dicey. On average, our recessions have lasted nine months.

This was time enough for firms and individuals to rebuild their balance sheets, cash, liquidity, and confidence sufficiently to re-ignite spending and investment. They could also take renewed encouragement from generous sales discounts, low financing costs, and several counter-cyclical government programs — including unemployment-insurance payments and tax cuts — that accompanied the later stages of recession.

But this Michigan model of economic decline and resurgence has changed.

Its replacement model comes with a noncyclical imperative: Find new growth industries, based on human resourcefulness and natural resources.

And make it an industry that can price goods and services competitively in a manner that transcends traditional business cycles in a global economy.

An excellent preview of this new paradigm is what may now be emerging in the western portion of Michigan’s Upper Peninsula. Geographically, this is highly ironic, to put it mildly. After all, for three decades, Michigan’s U.P. has recurrently been visited by bouts of double-digit unemployment. It’s a region whose population numbers have risen and fallen but, overall, remained relatively unchanged, even amid statewide and nationwide growth. Also, the U.P. is an area of Michigan that has suffered chronic loss of image, not unlike parts of Appalachia, stemming from geographic isolation and declines in primary and extractive industries such as iron ore, copper, and timber.

Yet today, there is a flow of wealth and tourism into the U.P. from the contiguous states of Wisconsin and Illinois, as well as from Minnesota. According to mBank President Kelly George, the successful Pure Michigan tourism campaign (assisted by falling gas prices induced by the recession) has spurred new individual loan volume, business loan production, and tourism — especially in the western counties of the Upper Peninsula — during 2009.

The comparatively mild impact on the U.P. of the sharpest national downturn since the Great Depression is testimony to a population that has learned to operate under conditions of adversity. Their adaptations include transitioning to chipping, waste management, and excavation work when logging and lumbering stumble. When quarrying peters out, workers diversify into recreational activities.

Economy, Yes. Politics, No.

Nevertheless, viewing the entire Michigan economy as of late summer 2009, the only net job gains have occurred in the public sector, along with subsidized sectors such as film production, ethanol plant construction, and (possibly) an expansion of a mid-Michigan prison facility. So the question remains: Can Michigan, especially southeast Michigan’s economy, become a magnet for creative growth absent the redistribution of private-sector taxpayer resources?

The economic outlook for Michigan in 2010 and beyond must begin with an unequivocal end to the long downward spiral of this decade. Stability comes before renewed growth, just as crawling usually precedes walking. Private entrepreneurs will not view Michigan as a situation ripe for profitable operations until the fiscal threats posed by our $3-billion annual budget deficits are removed. Nor will venture capitalists be willing to commit their private wealth, organizational talents, or labor forces to a scene where their incomes and profits are subject to onerous taxes like Michigan’s 2007 selective tax hikes (i.e., the Michigan Business Tax).

In order to realize an economic recovery, Michigan policies must be viewed as catalysts for improving business profit margins and household disposable income. That is to say, Michigan’s economic turnaround is partly dependent on a long-term commitment to lower taxes and a much leaner, cost-effective public sector. Lacking a hard-and-fast contract of this caliber with Michigan’s firms and citizens, we’ll be guaranteeing a deeper economic quagmire and conferring intractable wealth erosion on our heirs.

2010: The Road Ahead

Given what we know about the economic and political policies already in place, along with what the latest six months of actual activity have wrought, it’s reasonable to assume that Michigan’s economy in the second half of 2009 remains in decline. But perhaps the pace of decline has slowed from losses sustained in the first half of the year.

Lacking upward momentum as a prelude to 2010, we cannot escape the basic laws of economics. Even if the U.S. economy were to recover nicely over the balance of 2009 and into early 2010, the onset of expansion would entail rising energy prices and more onerous lending and borrowing costs than we’ve experienced over the last two years. Even slightly higher inflation rates would translate into rising interest rates. This development, alone, would snatch away the meager gains in discretionary income required to sustain new employment, quality profits, or real spending power.

But this is the least of our worries. In addition to the costly specter of nationalized health care, any lapsing of tax cuts and the possible passage of the Waxman-Markey energy tax bill (so-called cap-and-trade) would be devastating to family incomes and to Michigan’s gross state product.

According to the Heritage Foundation, these two sources of threats to family income would cost the average U.S. family of four an extra $1,241 per year in energy bills and an extra $3,368 in higher taxes, fees, and retail prices.

For Michigan, this scenario implies the following: a loss of $319 billion in gross state product over the next 25 years (or nearly $13 billion per year) and another 131,000 layoffs in the private sector (averaging more than 5,200 permanent job displacements annually).

Any further round of tax increases, from any source, or imposed upon any income group, is an immediate coup de grace for any incipient recovery.

Presently (and quite unfortunately), such a scenario has a 75 percent to 80 percent probability of materializing. Nationally, the result would be a “secondary recession” from which Michigan could not escape. A double-dip recession, appended to 2008-09’s mini-depression, would be extraordinarily severe. Economic consequences for Michigan would be catastrophic. Michigan’s unemployment rates would rise above 20 percent; our gross state product would shrink by as much as 10 percent; our bankruptcies would increase by another 5 percent; and our annual rate of population loss would increase above 2.5 percent.

Moreover, it goes without saying that state and local budget deficits and the $53 billion unfunded pension and health-care liabilities would place Michigan on a possible path to bankruptcy and insolvency. Truly, GM’s recent bankruptcy is a hint to the wise to get our economic ship of state into financial order.

State Bankruptcy Probable, But Not Inevitable

Michigan’s prospects for a 2010-11 economic turnaround are bleak and there is a growing awareness that the current business climate is hurting profits, entrepreneurial spirit, and, therefore, job creation. Such sentiment, mixed with economic pain that’s no longer viewed as transitory, usually manifests itself in dramatic changes in public policies. Major changes in elected officials and their advocacies can be expected in 2010.

Among urgent legislative and regulatory changes, these new faces will be obliged to freeze and roll back most government budgets — not just at the state level, but at local and school-district levels, as well. With the possible exception of 1850, November 2010 could prove to be the most defining moment in our state’s history.

In November of 1850, Michigan held a state constitutional convention where one of the crucial issues was the proper role of government in society. The earlier 1835 constitution had mandated that government support internal improvements such as investments in canals and railroads.

These early investment projects in Michigan became embroiled in special-interest politics, waste, graft, and fraud. The subsequent failure of the canal and railroad projects bankrupted many participants, drained the budget, and drove Michigan finances into disrepute.

Thus, in that fateful year, Michigan voters overwhelmingly ratified the new constitution. Yes, 160 years ago, Michigan learned from its own history. It meant that the successful building of railroads and the development of resources — lumber, copper, and chemicals — would all be done in an exemplary and profitable fashion by private enterprise, without direct interference or subsidies from Lansing.

Will Michigan now repeat that wisdom?

Michigan’s 21st-century interventions and interferences in the market system are deterrents to progress. State budgets are in poor condition. Our first economic priority must be a revisit of 1850.

The Mackinac Center for Public Policy in Midland has researched the literature pertaining to government-run operations throughout the 50 states and around the world. For more than 20 years, the Center has documented the efficacy of policies that improve public-sector operations, such as labor, education, and regulatory programs, as well as agriculture, construction, and prisons. Cost-benefit studies on the environment, health care, and pensions are all in the center’s repertoire for everyone to see and for all citizens — be they experts or interested bystanders — to read, ponder, and perhaps help implement. Like businesses, governments, too, must eventually embrace the long-term imperatives for survival, doing things better, faster, cheaper, safer, and more transparently. These five disciplines, if captured at all levels of Michigan government, would certainly create a leadership model for the United States.

The Mackinac Center has published 101 suggested improvements to state budgeting that could save taxpayers more than $2 billion annually. In addition, a recent study by two researchers at the Center identified potential savings exceeding $5.6 billion annually. They showed two astounding results: First, they calculated that if Michigan’s public-sector workers were obliged to adopt the same kind of “defined-contribution” pension system used by private-sector employees for decades (rather than the ruinous and now seriously under-funded “defined-benefit” techniques prescribed in most government employee contracts), then the state would no longer be able to foist upward of $53 billion in largely unfunded pension or health-care liabilities on taxpayers. In addition, the study documents the billions of annual savings that would accrue to wallets of taxpaying citizens if government employee total compensation (wages and benefits) were made equivalent to compensation in the private sector for the same kinds of work and skill levels.

Without policy changes that encourage private-sector growth and initiative and remove public-sector waste and fraud, Michigan will be slow to recover. That is the conclusion of Detroit Renaissance and the Michigan Business Leadership Council from the first-ever survey of 60 of the state’s most prominent CEOs.

As of mid-year 2009, results of the survey found that more than two-thirds of respondents believed Michigan’s economy would continue deteriorating through year-end 2009, even though 80 percent were predicting stability or growth for the U.S. economy over that same six-month period. Similarly, 80 percent of the CEOs predicted continued deterioration for Michigan through 2010.

These CEOs represent a cross-section of industries across Michigan. Economic forecasters operate at their own peril if they ignore feedback from surveys reflecting the sentiments of the real players in the marketplace — namely, business leaders and their current or laid-off workers.

And Yet …

Michigan confronts two quite different scenarios:

The pessimistic outlook for our economy beyond 2010 sees Michigan as a troubled state whose firms increasingly become smaller or more oriented toward cost-containment and rightsizing rather than focusing on growth strategies, and which is increasingly dependent on government funds and jobs subsidized by U.S. taxpayers via Washington. Already this year, we’ve seen many signs of this possible outcome: the nationalization of GM and Chrysler; the push for ethanol plants and other heavily-subsidized “green” industries; and the earnest effort to bring high-security-risk prisoners from Guantanamo to Standish, Mich.

The more optimistic and the more likely transition, however, will be a growing recognition of great “ground-floor opportunities” afforded by Michigan’s current economic distress. Entrepreneurs like builder George Paulson, of GTP Building & Development, overflowing with optimism, energy, imagination, and expertise in all facets of construction, have never allowed bad times to impair their vision or initiative. Paulson, for example, has seen many business cycles during his family’s decades of home-building and refurbishing, mostly in repeatedly hard-hit southeast Michigan. His reaction? To partner with trusted associates in order to garner some of the least-expensive financing in a lifetime, to find once-in-a-lifetime income-generating properties, and to pursue his vocation as well as his avocational dreams with a vengeance.

When it comes right down to brass tacks, I’d place my forecasting bet on the George Paulsons and, therefore, Michigan’s post-2010 revival. The reason is that people grow weary of the “blown away” economic promises and posturing by politicians. Once the workers of Michigan witness what people can do for themselves, and discern the stark reality of what governments have done to them, they will support incentives for all entrepreneurship — not just the breaks for special-interest groups who fund the next re-election campaign.

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