Tuesday, June 10, 2008

The Case for Detroit: America's Next Boom Town

This is a piece Andrew Bratt and I wrote about Detroit back in mid-2008.  Though some of the cast of characters have changed (namely Kwame Kilpatrick), the fundamental argument still holds.  America needs to become competitive again and Detroit (Michigan in general) is the foundation for the reset.


Clear your head. What is the first thing that comes to mind when you think of Detroit? Poverty? Crime? Unemployment? Hopelessness? Sadly, those responses have become all too accurate in describing a city that was once the unofficial capital of the American economy. For decades, Detroit was the epicenter of the American manufacturing juggernaut. To paraphrase John Lennon, at a time when the United States was the Roman Empire of industrial production, Detroit was Rome itself.

Today, however, Detroit lies in ruins, crippled by massive layoffs, paralyzed by disintegrating real estate values, and shamed by rampant crime and political incompetence. Detroit is, for lack of a better phrase, running on empty.

And so, with that backdrop, I shall take the bold step of proclaiming that underneath the rubble lies a sleeping giant. So great is this giant that it can, if properly cultivated, spark an American economic renaissance with global ramifications.

I am quite aware that my words may come as a shock to some and a joke to others. I welcome your skepticism as below I set forth an analysis of some prevailing themes regarding the current economic climate and an explanation as to how those factors have created an opportunity for Detroit to be the catalyst for a national resurgence.

Macroeconomic Pressures

The Weak Dollar. The US dollar has fallen to record lows. Since 2000, it has lost almost 40% in value when compared to a basket of six major world currencies. Americans’ reduced buying power has relegated us to the status of depending on investments by foreign nationals from Europe, the Middle East, and Asia. Sovereign funds, institutions, and individuals whose buying power is vastly superior to our own. This so-called “savings glut” has allowed savvy foreign investors to buy US assets -- most recently, large blocks of financial institutions, and real estate -- on the cheap. This international shopping spree, although disheartening and humbling, indicates the international community’s willingness to exploit America’s current economic woes. It also indicates their ability to spot a bargain.

If foreign investors are willing to buy American assets, is it unreasonable to surmise that they would invest in American manufacturing enterprises? We must entice foreign consumers into buying American products again. We need to go back to our roots and rebuild our manufacturing sector while our service sector is rapidly falling out of favor. The service sector is dominated by financials (defined by banks, brokerages and insurance companies) and accounted for 29% of profits for all Standard & Poor’s 500 companies in 2006, according to Bloomberg. Cumulative net income from financial companies in the most recent earnings reports was actually negative.

The China Factor. One of the benchmarks of a capitalist economy is its inherent cyclicality typified by prolonged peaks and troughs. Manufacturing in America’s has, in the years since, slowly and steadily declined. Based on its latest reading, ISM Manufacturing data shows that US manufacturing is contracting[1] and has consistently declined for four years. Is it unreasonable to expect a turnaround in this space at some point? Is it outrageous to consider the US as potentially fertile ground for future industrial and manufacturing activity? I believe not.

It is no secret that China (a capitalist economy in all respects other than name) has become the world’s pre-eminent manufacturing superpower akin to the United States. China’s trade surplus hit a record in 2007 at $262 Billion[2] and it contributes roughly one-third of global economic growth[3]. With its booming economy, China has a burgeoning middle class that will inevitably demand better working conditions, giving rise to increased labor costs. According to many international economists, China’s treasure trove of cheap labor represents its foremost competitive advantage with regard to manufacturing. If history is to be any guide, China cannot expect such labor to remain cheap forever[4].

In addition to this potential increased cost burden on Chinese industry, the global community will soon hold China accountable for its carbon footprint. In a recent study done by the World Bank[5], of the 30 most dangerously polluted cities in the world, 20 of such cities were in China. The inevitable “green-ing” of Chinese factories and processes and the efforts to comply with global environmental mandates will impose additional cost pressures on the industry, thereby reducing China’s economic advantage even further.

Combining the rising labor costs and potential environmental compliance expenses described above with China's growing concerns about its domestic consumer appetite and we see a country that starts to worry about itself a lot more. An estimated 50 million people enter their already 700 million person strong working class every year, and a vast majority of those workers want TVs, designer clothing, iPods, automobiles, and everything else that the middle class hordes. Ultimately, China will need to retain a higher proportion of the goods it produces. This slowdown in Chinese exporting will present an opportunity for the US to rely less on China and even, I daresay, produce goods for China. Imagine that!

The above factors, inducing foreign investment in the Untied States and anticipating the effects of China’s reduction in exportation, I argue, have created a climate that is suitable for an American industrial revolution...and further, the seeds for the renaissance in Detroit.

Microeconomic Conditions in Detroit
Detroit is in the direst of straits. From any angle, the outlook would appear to be bleak. The latest setback for the city is a sex scandal which led to Detroit’s “Hip Hop Mayor,” Kwame Kilpatrick, being indicted for perjury. Beyond such petty, albeit indicative, issues lies a greater economic quagmire that has stymied the metropolitan Detroit area since the collapse of its once formidable automotive empire.

Over the past 20 years, as each of the Big Three has repeatedly reinvented and rebranded itself to varying degrees of failure, Detroit, in response to its ever-worsening financial condition, became desperate for tax revenues. The city’s quest for cash ultimately resulted in the advent of several casinos constructed in the downtown area. Although the tax revenues have been a boon to the city, the casinos have proven to be ineffective in terms of revitalizing the downtown area and rejuvenating an increasingly depressed population. Whereas Las Vegas mega resorts and casinos boast large areas reserved for “high rollers,” the Detroit casinos have attracted a client base that irresponsibly wagers away its social security, pension and disability income. The Detroit casinos, unlike their Las Vegas brethren, have not made Detroit a destination and, as such, will ultimately be considered failures for the city.

Opportunity for Detroit

The Detroit casinos, notwithstanding their numerous flaws, will provide the city with an estimated $170 million in tax revenues annually. Nevertheless, the city’s incompetent administration has squandered such revenues and utterly failed to make the improvements to the city’s infrastructure as they promised all those years ago. The key, then, for Detroit’s rejuvenation, lies between strange bedfellows: the city’s ability not only to receive significant amounts of tax revenue, but also to motivate employers to relocate to Detroit.

These two items do not necessarily go hand-in-hand. Companies will not relocate to Detroit for the purpose of providing tax revenue to the downtrodden city. Rather, the city must make an investment in itself by luring those companies into relocating to Detroit and negotiating favorable tax arrangements. Corporations, both domestic and international, should see Detroit as an opportunity to establish additional American roots, at prices that could not be obtained anywhere else in the US. Over time, enough companies will begin calling Detroit home and the city’s bargaining power will change. For now, though, the city must accept it has little leverage and make every effort to bring in new businesses to Detroit. If that means taking further losses, the city must be willing to make this sacrifice in the hopes that it will, eventually, lead to the renaissance Detroiters have long anticipated. These additional losses will pay dividends in the long run and Detroiters should take solace in knowing that, for once, there truly is a light at the end of the tunnel.

Detroit, with all of its flaws, is a microcosm of the larger American economy. For far too long Detroit was complacent with its technology, its skills and its outlook for the future. It is this lackadaisical attitude that doomed Detroit’s automobile industry and is currently jeopardizing America’s place in the global economy. Detroit’s failures are a prediction of things to come for the United States at large and thus, to correct the problems, Detroit needs exactly what the US needs…Industries. Real, healthy, thriving industries. Detroit needs to be a throwback economy based on manufacturing and production. This course of action will help rebuild Detroit, and more importantly, re-shape the nation. Starting from the bottom of the bottom and working our way up, Detroit needs to rebuild and retool, with a focus on attracting corporations.

We need to end the outsourcing, even if it means lowering the minimum wage. Is it really necessary to outsource something to Asia when you have a full workforce sitting in idle that will gladly work for less than the minimum wage? (Please see recent US employment statistics) Recently, there has been a backlash against outsourcing, as some companies have absorbed the additional costs associated with operating their facilities in the US for the sake of establishing goodwill. In Detroit, however, companies can have the best of both worlds. They will save money because the state and local tax benefits while also achieving great publicity for their “investment in urban re-development.”

Although Detroit is currently in a state of suspended animation with respect to its economic outlook, it does not mean that the city lacks the infrastructure necessary for mass production. On the contrary, Detroit has everything that is necessary for an urban and suburban region to thrive. It has an international airport strategically situated between Detroit and Ann Arbor, home to the University of Michigan, consistently one of the world’s greatest public universities and also the location of a new office for the Internet behemoth Google. Larry Page, the billionaire co-founder of Google and University of Michigan alumnus, anticipated the opportunity to invest in the Greater-Detroit area and took advantage of it. The rest of corporate America should follow suit. Would you bet against Google?

Michigan’s proximity to the Great Lakes is advantageous, as industrial developments require access to water. Additionally, there are thousands of able, forcibly-retired machinists, assembly-line workers and engineers, many of whom do not want, and frankly cannot afford, to move to Florida or Arizona to spend their golden years. These are able-bodied potential employees who possess skills which will translate into any type of manufacturing occupation. According to the US Bureau of Labor Statistics, over 700,000 people in Michigan’s manufacturing sector made initial jobless claims since 1998. That is coincidentally roughly the same number of people that live in Detroit proper.

The next step in turning around Detroit is defeating the misconception that the city and surrounding areas have become wastelands. This is, of course, a necessary step in completing the renaissance, as the metropolitan Detroit area has suffered a negative population growth since the 1960’s. We need to hearken back to the glory days of Detroit, when the city bustled with activity, not to mention the thousands who commuted in from the suburbs each morning. Detroit is, by all accounts, quite inhabitable. The state of Michigan contains more than 11,000 inland lakes, in addition to the Great Lakes. Northern Michigan is a popular vacation spot because of its stunning natural beauty and abundance of world-class golf courses. As for the city itself, Detroit, for all its flaws, still boasts a lively urban flavor, high quality restaurants, theatres and numerous professional sports teams.

Though some disagree that Detroit contains desirable aesthetics for living, I will conclude by summing up my arguments with a quote. Life-long Detroiter and successful professional investor, Sam Valenti III, said something that has resonated with me for years: "Old venture capital money from the West Coast and Wall St. money from the East Coast will eventually join forces and find its way back to the ‘North Coast,’ where our first technology boom happened...Detroit." It appears that now, more than ever, this concept could come to fruition. The West Coast is still nursing its hangover from Silicon Valley’s tech boom and bust at the turn of the millennium. The East Coast is in the 5th inning of a financial crisis that has left Wall St. in a state of paralysis. With both coasts showing little promise for new economic activity America needs a catalyst. To find this catalyst we must “think outside the box,” to use a cliché, and Detroit could not be further outside the box. Detroit is not even in the proverbial shape universe at this point.

Hopefully, the foregoing has shed some light on an area that has seen far too many dark days of late. The mess that is Detroit can and will be cleaned up. It will take time and effort but it is only with time and effort that true greatness is ever achieved. The country needs to re-focus to see beyond the current issues…first stop, Detroit.

[1] http://www.ism.ws/ISMReport/NonMfgROB.cfm

[2] http://www.chinadaily.com.cn/china/2008-01/11/content_6387775.htm


[4] http://www.businessweek.com/magazine/content/06_13/b3977049.htm


No comments:

Post a Comment