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What you are Not Hearing about Detroit’s Bankruptcy

Detroit ‘s bankruptcy is a warning that no city is too big to fail. Cities that fail have knock-on effects that impact business. Detroit is about $18 billion in debt, and will only be able to pay out a fraction of what it owes. Some media reports hint that it’s problems may lead to some form of federal bailout. But is this really likely? What are the likely impacts on business in the region?

Michigan Governor Rick Snyder and his appointed emergency manager, Kevyn Orr, say city pensions are underfunded by $3.5 billion. The two main groups of creditors public employees and retirees, and bondholders argue that they’re entitled to be paid. The investors are likely to make out better, since more of that debt is secured; the city will continue to pay water and sewer bondholders. Most of the pension debt has no similar backstop. The city says that pensioners will have to take a hit, if as it seems likely that the city’s past pension contributions fall $3.5 billion short of covering future payments. As for the $5.7 billion Detroit owes public workers for retiree health care, the plan is for retirees to try ObamaCare.

The city’s mayor, Dave Bing, warned ominously on ABC’s “This Week” TV program: “We may be one of the first. We are the largest. But we absolutely will not be the last. And so we have got to set a benchmark in terms (of) how to fix our cities.”

But Detroit’s problems go far deeper than Bing suggests. Census reports indicate that per-capita incomes in Detroit are barely half the national average and that one-third of the city lives in poverty. The unemployment rate is 16 percent more than twice the national average. The city’s government-run schools have failed, with just 7 percent of eighth graders proficient in reading. It takes police about an hour to respond to calls. The city’s population has dropped by a quarter in just the last decade, as hundreds of thousands have voted with their feet and left. (Michigan was the only state that lost people from 2000 to 2010. ) About 12 percent of the city’s adults have a college degree. A city built to house almost two million people now has 911,000. While Detroit was one of the richest places on the planet in 1950, it is now synonymous with urban poverty.

“There are five more towns like Detroit in Michigan alone,” Meredith Whitney, CEO of investment firm Meredith Whitney Advisory, wrote in the FT. The former senior analyst for Oppenheimer & Co. drew national attention for predicting the housing crisis that led to the financial meltdown. “There are many more municipalities across the country in similar positions. Detroit’s decision last week paves the way for other elected or non-elected officials to make decisions to save their cities and towns, decisions that probably involve politically unpopular actions that may secure their long-term viability.”

The automobile industry was born in Detroit but by the 1970s the industry had overpromised and overspent on pension benefit obligations for its employees. While it’s true that other factors such as Japanese imports were involved, none had as great an impact as uncompetitive labor costs. It is revealing that even as GM had only 54,000 employees in 2009 –down from 500,000 in the 1970s–, the company was still supporting 450,000 retirees who were receiving health and pension benefits.

In addition, many of Detroit’s problems resulted from a lack of political competition. One party, the Democrats, have dominated the city council, and there’s been a Democratic mayor since 1962. One-party government quickly became bad government, featuring “bad fiscal management: unaffordable borrowing, state grant schemes, raising taxes, and deferring public pension contributions rather than cutting city spending,” explain Heritage Foundation’s Alison Acosta Fraser and Rachel Greszler. “But Detroit’s tragic downward cycle has reached its end.”

Is it possible that Detroit will turn the corner despite decades of decline? Even as Detroit struggles, its state, Michigan, has taken a positive step. In December, it passed a right-to-work law, becoming the 24th state to do so. This will introduce competition and make the state a more attractive place for people to do business, and for employees as well. “Workers in right-to-work states enjoy higher wage growth and, when cost of living is factored into the equation, better compensation than their counterparts in forced unionism states,” notes Vincent Vernuccio of the Mackinac Center, a free market think tank in Midland, MI.

The U.S. economy is constantly transforming itself. Today cheaper energy in the form of natural gas is creating a manufacturing revival, onshoring jobs that had once been lost. Hence Detroit’s hostility to that industry and the jobs it would bring is hard to understand. For starters the city needs policies that favor entrepreneurialism and business creation and steer clear of the usual cronyism. Chief Executive’s annual survey of the Best and Worst states for business demonstrates that states with previously poor business environments such as Louisiana and Wisconsin can pull themselves up in the estimation of job creators –given the implementation of the right policies by local political leaders.

The real message of Detroit may be that some state and local governments seem incapable of dealing with the cost of their retirement benefits, even when it becomes apparent they are unsustainable, until the government is virtually insolvent.






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