A State of Recession

Michigan may not be mired in just another declining economic cycle. It appears the Great Lakes state is in the midst of an indeterminate downward trend.
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Michigan has suffered more than most states during economic downturns, such as the 1974-75 oil embargo, above.

For the last century and a half, the Great Lakes state has averaged one recession every five years. In fact, since 1857, when official dating of economic cycles first began, Michigan has experienced 33 troughs, followed by 33 peaks in business activity (with many attributed to the cyclical nature of the automotive industry). And it’s these fluctuations in prices, output, income, and employment that have had the most influence on the material well-being of our population. But no two recessions or expansions are identical, of course, including the current recession now five years in the making. They differ in size, length, and composition. But what all recessions have in common are rising unemployment, declining purchasing power, rising inventories of unsold goods, and idle factory capacity.

Conversely, common elements to expansions include labor shortages, growing loan volumes, accelerated prices of raw materials, and fuller capacity utilization in commerce and industry. Due largely to an abundance of natural resources, the state was well-positioned to meet the nation’s growth following the Civil War. Coal, timber, copper, and iron were in abundant supply and, for several decades, the state held a dominant position in contributing to the national economy.

While Michigan’s current position in the business cycle is the most urgent task at hand, the economic downturn can be comprehended more fully by examining the state’s unique economic evolution over the last 150 years and its adaptations to national fluctuations.

Fighting the Status Quo

Between 1857 and 1899, Michigan registered 11 economic cycles, complete with modest to harsh declines in prices, output, and employment. Most pre-Depression cycles reflected intermittent financial panics. These panics were sudden monetary retrenchments that occurred when insufficiently capitalized and collateralized banks failed or were obliged to rapidly contract credit or call in loans from periods of overly expanded lending.

Most history books make these episodes of financial “panic” incomprehensible for most readers. In reality, “panics” of bygone days were incredibly similar to what we’re now witnessing in our present-day, subprime mortgage-lending crisis. By holding borrowing rates at 1 percent for nearly three years, the Federal Reserve (from 2003 to 2005) sponsored “irrational exuberance” by borrowers and lenders. Easy money policies encouraged many financial organizations and individuals to incur liabilities they were unable to afford under normal market conditions. When interest rates (cost of credit) finally accelerated in response to three years of monetary stimulation, the bubble burst. Many housing speculators and financially strapped borrowers halted their mortgage payments or walked away from properties. Asset values collapsed. People felt poorer and spent less. Businesses felt the sting and pulled back on hiring and investments. The same scenario played out during pre-panic downturns.

Yet, by focusing on “panics,” we miss the beauty of Michigan’s expansion and adaptation to periodic turmoil. Most events in the last half of the 19th century strengthened Michigan. For those were halcyon decades of Michigan notoriety and growth. Between 1865 and 1900, Michigan’s lumber industry dominated the state’s economy and produced 160 billion board-feet of pine — enough to build 10 million six-room homes. Indeed, between 1869 and 1899, Michigan out-produced all other states. Michigan’s timber economy peaked in 1888, then quickly declined, especially in the Lower Peninsula, where trees were not quickly replaced.

A rather similar cycle materialized in Michigan’s mining industry. Michigan had viable and profitable iron and copper mining in the last decades of the 19th century and gained the national lead in iron output (10 million tons) in 1900. Peak iron output for the state occurred in 1916 (18 million tons of ore), and then rapidly lost rank to states like Minnesota (Mesabi Range), Montana, and eventually Arizona. Work stoppages and mine closures related to the 1893 Panic definitely damped growth of the iron economy of the Upper Peninsula. Similarly, Michigan’s peak in copper output occurred in 1916 (267 million pounds) and then declined. Soft-coal mining peaked in 1907, at 2 million tons. The largest fish catch on Lake Michigan occurred in 1908 (mostly whitefish), and declined thereafter. Even the number of Michigan farms (not output) peaked in 1910.

Most notably, mining, forestry, and agriculture were all primary (extractive) industries, whose profit, workforces, and entrepreneurship laid the foundation for Michigan’s legendary success in its secondary industry — manufacturing — in the 20th century.

When technology and organization are applied to the output of a rather fixed supply of ore, land, or lumbering, it’s not unusual to reach a point of diminished returns. But in Michigan, this turning point prompted an entrepreneurial search for other means of adding value to products or services. That was its genius, and that’s what accounted for its success.

By the turn of the century, Michigan’s forestry-related industries had already paved the way for furniture production, coachbuilders, and carriage-makers in the western and eastern portions of the state. In central Michigan, paper and pulp byproducts spawned the chemical and pharmaceutical industries. With subsequent developments of electric, steam, and oil-based engines, inventors and engineers became dynamically engaged in putting individuals on wheels in powered carriages.

Better, Faster, Cheaper

Michigan entered the 20th century in a cyclical expansion that began the very first month of the new century (January 1901). By 1904, Michigan led the nation in auto production. How could this be? There were other producers in neighboring locales: Cleveland, Toledo, Indianapolis, and Chicago. Moreover, these places were more on the “beaten path” than peninsular Michigan.

The answer was a fortuitous synthesis of financial capital (from wealth created by Michigan’s mining and timber industries) and the competitive clustering of entrepreneurial talent (William Durant, Henry Ford, Louis Chevrolet, Ransom Olds, and David Buick, to name a few).

This was also an era that preceded the Michigan income and sales taxes, regulatory burdens, and other heavy environmental and legal constraints on firms and individuals. Labor markets were also free and very competitive.

Michigan’s population grew steadily from 1890 to 1910, but it ballooned by 31 percent between 1910 and 1920. Much of this growth can be pegged to Ford’s promise of a $5 per day wage in 1914, based on his automated assembly-line process. Such generous wages for ordinary labor were unprecedented. But they made perfect sense, given the added productivity and unit-cost reductions that automation made possible. Before the moving assembly line, it took 12.5 hours to assemble a car; afterward, it took 1.5 hours. By 1916, the price of the Model T had fallen to $360, compared with $850 when the vehicle was introduced in 1908. Better, faster, cheaper.

By acquiring a formidable manufacturing base, especially after Ford’s innovations, Michigan was able to draw a phenomenal worker influx from other regions of the country during World War I. As a result, Michigan accounted for 20 percent of all military aircraft made for the United States during the war. Michigan workers turned out 30,000 aircraft engines, and the Ford Rouge plant alone built 60 ships. Such growth in population and diverse manufacturing rendered Michigan more impervious to recession.

During the 1920s, auto prosperity led Michigan’s economy, concurrent with declines in the farm and mining economies. Michigan was a leader in industrial development. In the 1920s, Michigan also benefited from growth in ancillary industries, such as auto suppliers, road and bridge construction, service stations, roadside inns, and dealerships. In fact, by 1923, Michigan ranked eighth in the country in oil output, at 15 million barrels per year.

But there was no way Michigan could overcome the perverse economic impact of the Federal Reserve’s 33 percent contraction of the U.S. money supply between 1930 and 1933. The Great Depression cut Michigan’s average annual personal incomes from $793 in 1929 to just $349 in 1933. Between 1931 and 1933, more than 200 Michigan banks failed, and unemployment in the state rose from an already-elevated 18 percent to an astronomical 46 percent. By 1934, 12 percent of Michigan families were receiving some government support.

In 1935, however, once the U.S. Central Bank reversed course by re-infusing monetary liquidity into the financial system, signs of recovery emerged. Once again, in World War II, Michigan’s population and industrial base grew disproportionately. With 4 percent of the U.S. population, Michigan received more than 10 percent of war contracts and supplied more munitions than any other state. Between 1939 and 1945, Michigan turned out 4 million engines, 200,000 tanks and combat vehicles, and nearly 8,700 heavy bombers.

A lackluster model like the Ford Edsel, also affected the state’s fortunes to a degree.

Many economists predicted a return to recession or depression for the postwar period. They were dead wrong. There were 25 million cars on the road in 1945. Many had become decrepit during the rationing and parts-shortage war years; others were junked shortly thereafter. Pent-up demand, together with good wages paid during the war that couldn’t be spent on normal consumer goods, fueled massive effective demand between 1945 and 1949. Between 1940 and 1955, only three states exceeded Michigan’s rate of population growth. And the state’s auto output peaked in 1955, at 8 million units.

Postwar recoveries in Europe and Japan, however, brought serious auto competition to our shores by the late 1960s. Unfortunately, just as global competition was ramping up, the Big Three automakers were succumbing to frequent work stoppages, long and damaging strikes, greater worker absenteeism, and very expensive wage-and-benefit settlements.

Researchers will debate Michigan’s economic turning point. Undoubtedly, the 1967 urban riots and imposition of a state income tax damaged the state in many ways. By 1975, Lansing was no longer able to balance its annual fiscal budgets. But, as retired Federal Reserve chairman Alan Greenspan remarked in 2007, Michigan’s auto industry reached its critical turning point in 1980. In that painful 1980-82 recession, Americans, who had previously believed in the superiority of U.S. auto technology, now rated Japanese vehicles superior.

Nevertheless, the American auto industry took a long time to respond. It wasn’t until 1986-89 that GM began the first of many “right-sizings” to address efficiency, quality, and shifting domestic demand. Between 1978 and 2008, most new foreign auto plants shifted to southern states, where union membership was voluntary. Ruinously uncompetitive pension and health-care (legacy) costs were finally addressed in 2007. Vehicle quality and styling became competitive on more models. But did these belated acknowledgements of market reality come in time? Today, Michigan’s automakers continue to close plants and shed workers, while losing market share and tens of billions of dollars.

Michigan’s 21st-Century Crisis

Are the problems our state faces in 2008 symptomatic of just another cycle — a “five-year, Michigan-only recession” in the midst of ongoing national growth? The answer, emphatically, is no. True, between 2005 and 2007, Michigan manifested many of the typical symptoms of recession: Unemployment rates moved higher; factories closed; real-estate prices plummeted; after-tax, inflation-adjusted personal incomes declined.

But a closer examination of the data (all of the data) reveals a far more serious and weighty undercurrent — an economic and financial trend. Trends are defined by patterns of activity that affect far more fundamental variables than cycles do because they transcend the timing of cycles.

Cycles, measured from one peak or trough to the next, average between a couple years to a decade in length, regardless of their “peak-to-trough” severity.
Trends, however, involve movements of population, wealth, and human capital. More significantly, trends are especially insidious because they’re indeterminate in length. Without meaningful and permanent reform in the underlying economic and financial incentives within a state’s borders, trends will persist for decades. For example, even in highly developed, internationally sophisticated trading nations, such as Great Britain, we witnessed horrendous trend declines in activity between 1946 and 1979. Within 33 years, Britain slid from economic and financial preeminence to the status of penultimate economy in western Europe, its average personal income level above only that of Portugal’s.

Michigan, sadly, has entered into a similar trend — a secular decline. Michigan has lost 288,000 private-sector jobs and has shed more than 100,000 people from its population base since the official onset of the current national economic expansion in December 2001. If Michigan were succumbing to a cyclical downturn, then we’d have seen it corroborated in sharply declining auto sales and a national slump over the last five years (2003-2007). This has not been the case.

Instead, the U.S. economy has experienced record job gains, the lowest average unemployment rates in three decades, unprecedented increases in aggregate net wealth, and healthy increases in worker productivity, stock-market appreciation, and steady advances in personal income and spending. As a result, the sale of automobiles has been robust across the nation. In short, the period of Michigan’s economic woes corresponds to extraordinary real GDP expansion for the nation.

In order to differentiate Michigan’s current trend trajectory from just another cyclical swing, let’s examine the cause of Michigan’s business cycle sensitivity in the first place. Michigan’s chief export to other states and to the rest of the world is the motor vehicle. What’s the principal characteristic of the motor vehicle? The passenger car or truck is a large-ticket (expensive) durable good (built to last more than three years). And what’s the primary distinguishing feature between a large-ticket durable good and an inexpensive, perishable product like a loaf of bread? Answer: It’s much easier to postpone the purchase of a new auto when economic and financial times are uncertain. Customers have the option of driving or fixing up the existing vehicle or taking an alternate form of transportation. It is this element of postponability that confers a greater degree of cyclicality on Michigan’s economy than on most other states.

In and of itself, having a highly productive manufacturing industry that accentuates swings of a business cycle is neither a blessing nor a curse. Over the course of the 20th century, productivity gains in manufacturing contributed splendidly to Michigan’s far higher-than-average income levels and growth rates.

If, as is often stated, Michigan’s reliance on the fortunes of the auto industry is to blame for our economic distress, then we would expect to see the plight of our automakers reflected in the U.S. auto sales data. After all, in the post-World War II era, Detroit’s auto industry was an excellent reflection of cyclical activity for the nation. In the 10 business cycles between 1948 and 2001, Michigan’s economy proved to be an excellent coincident indicator of movements in the U.S. economy. Our state was the finest bellwether of affordable credit conditions and growth of real purchasing power in the land.

More to the point, consider the two necessary conditions for a business cycle to be in Michigan’s favor. First, there needs to be low inflation so that the cost of borrowing to finance a new car is affordable. Second, the advance in family income must be rapid and continual enough to lend confidence to those contemplating a new-car purchase. Both of these conditions were vigorously met nationally between 2003 and 2007, which explains why the United States experienced unprecedented vehicle sales and profitability in that portion of the latest business cycle expansion. Inflation and real income gains averaged 2.8 percent, and most long- and short-term financing rates were the lowest in many decades.

In effect, the necessary and sufficient economic conditions, which would’ve underwritten fabulous Michigan prosperity and cyclical expansion — instead coincided with the steepest losses in business activity and population since the deep recession of 1982. Moreover, 2008 will represent the eighth consecutive year in which Michigan’s per capita personal income is below the U.S. average, a predicament unseen since the Great Depression 75 years ago.

While our economy is still susceptible to national cyclical perturbations, its movements no longer reflect primarily the business cycle; nor do its movements mirror national economic expansion. Michigan is caught in a downward trend.

The Road Ahead

Sadly, just as Michigan searches for an economic revival path, the U.S. economy is decelerating. Like Michigan in the 1960s, U.S. policymakers today contemplate further displacement of the productive private sector. At all levels of government, elected officials are enacting higher tax, regulatory, and tort liability burdens. This raises the question: Is America’s economy being Michiganized?

In 1980, Margaret Thatcher and Ronald Reagan recognized the disastrous policies afflicting their economies. They understood that most citizens in developing nations simply wanted to achieve what the U.K. and U.S. economies had achieved 80 years earlier. That’s why these two leaders advocated policies that enhanced incentives and enterprising spirit in the private sector.

Michigan needs similar growth advocacies today to unleash our genius for science and technology in the production and use of abundant domestic energy reserves: oil, gas, coal, and nuclear. Our tax rates should be lowered, while excessive government spending and counterproductive regulations should be curtailed. A “downsized” government sector would liberate human and financial capital to compete more effectively in global markets. From our trials and tribulations over the last 150 years of business cycles, this would be Michigan’s most enduring lesson and legacy to the nation.

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