I recently wrote about about a brainstorm I had while on the air on KAXE, that being the concept of a Government Bubble. After all the positive feedback (not), I doubled down on the idea with a second posting. Never one to rest until I've alienated everyone who may be inclined to read my thoughts, here is another take on this theme.

The Wall Street Journal yesterday had a short and interesting piece headlined "States' Budget Woes Are Poised to Get Even Worse". The article can be summarized as (a) things are bad for state governments, (b) the fixes today are mostly short-term, (c) things are not going to improve quickly, and so (d) when the short-term fix is gone, things will be much worse.

We've been saying this for some time. Most state governments today can realistically aspire to economies that stagnate instead of decline. Robust growth in the coming years is likely to be confined to a few states that rely on commodities (hello North Dakota). From the WSJ:

.....in general most forecasters see a very slow recovery, which suggests a commensurately slow upturn in state revenues. Federal Reserve officials, for instance, see unemployment, at 8.9% at last report, averaging between 9% and 9.5% next year and remaining elevated through 2011; some private forecasters are more pessimistic.

Since most states are funded through a combination of sales tax, income tax and corporate tax, continued struggles in employment and business growth is a serious problem. 

The best outcome they can imagine, some state officials say, is that the stimulus funding allows them to make spending cuts gradually: for example, by relying more on attrition and less on layoffs to cut payrolls. (Unlike the federal government, states generally are required to balance their budgets.)

So states are looking to cut back, to take the federal stimulus money as a short-term buffer to allow them to transition to a new reality of smaller (dare I say, post-bubble) government. This makes sense, until you consider the following:

At the same time, states face growing health-care costs and the need to replenish pension programs funded by decimated investments. And some of the stimulus funds expand programs that will require state money to sustain them after the federal largesse runs out.

The federal money actually expands programs that will need to be funded by more state and local money once the federal money goes away. Government inducing more government - the bubble.

Let me throw out a couple of other dots to be connected, based on some current news. 

  • The Detroit Free Press is reporting on plans to devolve urban Detroit into a collection of rural villages surrounded by farms, fields and meadows. 

The way we have been developing - the very pattern of that development - is not economically viable, especially in small towns where there is a heavy reliance on direct and indirect government subsidy. What is the future of America's small towns in this new reality, where a deflating government bubble removes some or all of that subsidy? 

When our highway building days are over, Detroit is morphing into a series of "small towns" and some cities are just giving up, a wake up call should be sounding across the county. 

The game is different today. Those towns that realize it now, use this time and their shrinking resources to transition to the post-government-bubble world, will be the Strong Towns in the coming years.