Jun 13 2007 1:03PM | Permalink | Email this | Comments (1) |
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Michigan has spiraled downward into recession over the last three years while the rest of the country has prospered. What went wrong? What can fix it? And what lessons are there in the Michigan experience to help contractors and suppliers keep their state from the same fate?

Michigan lost 5,200 residents in the year ended last June while the US population increased almost three million. 65,000 people (net) moved from Michigan to other states. Another population loss is almost certain to be reported for the year ending this June. Personal income in Michigan increased 8.8% over the last three years, less than inflation and far less than the 13.1% rise for the whole country.

The impact of the sick economy was even larger in the construction market. Michigan lost 16,500 construction jobs, an 8.8% decline while the rest of the country added 990,000 construction jobs, a 14.5% increase. The value of construction starts fell 21% in Michigan but rose 21% for the whole country. These statistics do not capture the reductions in contractor and supplier margins in a shrinking market.

Not surprisingly, Michigan’s state budget and many local budgets are in critical condition. The state budget ending in September is short $800 Million with a $1.6 Billion shortage projected for the next year. $3 Billion has already been cut from initial budgets in the last three years. Michigan’s bond rating has been downgraded with warnings that further downgrades may be necessary.

Slow growth in the auto industry clearly dampened growth in Michigan in the last few years. But the more serious problem has been the flight of auto assembly and parts manufacturing to lower cost areas, first to states further south, then to Mexico and recently to Asia. The high costs came from the decision by the Detroit auto companies fifty years ago to buy labor peace by paying people not to work and to retire early with medical benefits.

These costly labor policies worked when Detroit was protected behind tariff barriers from foreign competition but began to break down several decades ago. The auto companies timidly asked for labor contract changes but were unwilling to endure a long strike to get them. By contrast, Caterpillar with a similar contract with the UAW took two long strikes — one for 6 months and one for 17 months — in the early 1990s to eliminate its high cost labor contracts. Caterpillar is prosperous today. Ford and GM are in critical condition, selling off assets to cover the costs of their UAW contracts. Chrysler was recently sold for less than the value of its cash and assets.

The long dominance of the high labor cost auto industry in southeastern Michigan discouraged other manufacturers from locating in Michigan. While that barrier to Michigan operations is now coming down, it will take a long time to attract enough new industries that offset the job losses in the auto industry. Michigan is having some success bringing technology jobs to Ann Arbor but most of the former auto workers do not have the skills needed for today’s high growth technology industries. Michigan will have to be a bottom feeder, competing for industries looking for low wage locations.

Remember how long it took Pittsburg to recover from the demise of its steel industry and northeastern Ohio from the collapse of its tire industry. Even earlier, recall that it took many decades for New England to recover from the loss of its textile and shoe industries.

The Michigan economy and even more so the Michigan construction market will remain depressed for many years. The auto industry is very cyclical so some good years will be mixed in.

I left Michigan 30 years ago when I realized that the current crisis was inevitable because labor, management and the state government all focused only on their “rights” and refused to see the market realities that define the boundaries of their options. I was an economist in the state budget office and dealt with righteous stubbornness every day.

The auto companies are now too weak to take a Caterpillar style strike to fix their labor contracts. UAW leaders now know that they were too greedy but are unable to give anything back because so many of their members are either retired or about to retire and have no options to replace lost income. The state government is still in denial. Too little money has been put into education and worker retaining and too much money has been spent trying to buy factories with tax concessions.

The current debate over replacing the state’s business tax illustrates that Michigan still does not understand what makes a regional economy proper or decay. The Single Business Tax (SBT), the only value added tax in the US, collects $2 Billion a year but has been repealed as of the end of 2007. No replacement has yet been enacted. Drastic cuts in public services are pending if the revenue is not replaced.

The tax debate is focused on demands for tax cuts for local service businesses. The SBT has a broad base and low rate so all but the smallest businesses have some tax liability. The implicit assumption here is that the state economy will proper if taxes are reduced for small law firms, grocery stores and house cleaning services and raised for larger businesses much more likely to sell goods and services outside of the state. This is backwards and will worsen Michigan’s competitiveness in attracting new jobs. No region ever prospered by subsidizing those who take in their neighbor’s laundry but penalizing those that sell outside the region.