The predicament of local government

Local government cannot be a proxy for a productive economy, just as infrastructure spending cannot be a proxy for real growth. The demand for viable infrastructure needs to emerge from a productive land use pattern, just as a healthy and viable local government can only emerge from a productive place. If we want stability at the local level, we need to work to make our places more productive.

A restaurant owner operates for many years with a stable customer base and income. The business is not glamorous, but it is steady and predictable. The revenue covers expenses, including the cost of paying down the loan on the building, and returns a respectable profit to the owner each year. The equity in the building and the ability to sell a business that cash flows comprise the total value of the operation.

One summer a movie shoot is taking place in town, although the owner, not one to get out much, doesn't know. Demand at the restaurant jumps tremendously and there are consistent long lines at lunch and dinner. The owner hires more staff and squeezes the tables but still can't fill all the demand. Not understanding that the demand he is experiencing is a short term stimulus of this one movie, the owner cashes in the equity on the building, borrows what his cash flow will allow and expands the restaurant to capture these new customers.

To make sure his new investment is secure, he needs to make sure he keeps his best two chefs around. He gives them both a raise of 20% and then hires a third chef to help out. He also increases the wages of the entire staff, many of which are getting even more tips now as well. They expand the menu and even start serving breakfast, which is immediately lucrative. Everything seems great until, of course, the movie shoot ends, all of the cast and crew leave town never to return, and the demand at the restaurant returns to normal.

Last week, President Barack Obama made a statement that immediately got the pundits and political spin doctors in a frenzy. You can watch the entire video here (I don't know this source but it is a clean, unedited video of the President's remarks). The entire statement is as follows:

Well, truth of the matter is, as I said, we created 4.3 million jobs over the last 27 months, over 800,000 just this year alone.  The private sector's doing fine.  Where we're seeing weaknesses in our economy have to do with state and local government, oftentimes cuts initiated by, you know, governors or mayors who are not getting the kind of help that they have in the past from the federal government and who don't have the same kind of flexibility as the federal government in dealing with fewer revenues coming in.

And so, you know, if -- if Republicans want to be helpful, if they really want to move forward and put people back to work, what they should be thinking about is how do we help state and local governments and how do we help the construction industry.

Because the recipes that they're promoting are basically the kinds of policies that would add weakness to -- to the economy, would result in further layoffs, would not provide relief in the housing market, and would result, I think most economists estimate, in lower growth and fewer jobs, not more.

I reference this quote not because I have a political point to make (Strong Towns is a 501(c)3 organization and we are strictly non-partisan) or because I want to wade into this sideshow of a dialog we call election year campaigning, but because I want to talk about state and local governments.

Let me start that conversation by saying that I believe President Obama is right. State and local governments do not have the flexibility of the federal government. Generally, state and local governments can't borrow money -- and they certainly can't print money -- to meet their short term obligations. While many have been able to cook their books in regards to pensions and project expenditures for things like highways as if the money will always be there, there is a limit.

I'll also point out that state and local governments, especially the latter, are generally very accountable to the people that elected them. I could call up the mayor of my city and talk to him right now -- I have his cell phone number, actually. I'm probably one or two degrees of separation from the governor of Minnesota and, if I had something really important or really novel, could meet with him or one of his top aides. There is no chance that I will ever meet Barack Obama, let alone his top advisors.

Let me also disagree with what is often put forward as criticism of public sector workers. There is a sense among many of the electorate that public sector workers are generally overpaid, don't work all that hard and don't care -- because of job security -- about the quality of their work. As someone in the private sector that works with both governments and private businesses, my own personal experience has been that any dead weight is spread equally across public and private sectors. Some of the most competent people I have met work in the public sector. Any generalities that would apply to the public sector are more systematic failures (most notably, the lack of natural mechanisms for innovation) than individual ones. In short, I find this criticism overly simplistic and not very helpful.

Let's get back to the restaurant owner. What happens now that the movie shoot is over? We all understand that he likely goes out of business. He has extended himself too far. He did not understand where the demand was coming from and misread the market. If the business survives, it will only be after some brutal cutbacks, some painful readjustments and many years of hard, hard work.

Unless...let's say we could create some more "stimulus". For example, let's pretend we gave every family in the town a $50 per month voucher (or, if you prefer, a $50 per month tax break) to spend on restaurants. Everyone eats out a little more than usual and the restaurant is spared the nasty downsizing. Economists will rightly point out that each of restaurant's transactions increases the GDP, results in sales taxes being paid, create jobs where wages can then be spent on other goods and has this overall stimulative effect.

None of this negates the underlying fact that the demand for dining out is not real. To keep this business going, the voucher program is going to need to continue indefinitely or there is going to need to be some natural, sustained growth in the local economy that can soak up this excess supply of restaurant capacity.

For local governments, it is not customers that provide the revenue but taxpayers along with those that pay fees. And it is not a voucher for a meal out that has created demand but a series of growth incentives that manifest most clearly in the real estate market. All of the tax incentives for owning a home, new highway spending, grants to local governments to extend and expand utilities, etc... This is why the president mentions, "relief in the housing market." If we want to help cities today, we need to find a way to get the local growth machine going again.

I believe I understand Keynesian economics and I do see how this will help in the short term, but I just can't get past the question of what we do in the long term, especially when the new growth comes with all of the long term liabilities of needing to maintain those highways, plow those roads, mow those ditches, fix those sewers, etc....

This is why the president's statement got me thinking about state and local governments. That combined with the entire state employee union debate in Wisconsin that was in the news last week and Robert Scheer's repeated statements on KCRW's Left, Right and Center (a great podcast I enjoy weekly) that we shouldn't be looking to take away jobs, wages and benefits from government workers but instead working to bring everyone else up to that level. I understand these lines of thinking, but I'm haunted by some numbers.

In 1971, here in Minnesota we had what is called the Minnesota Miracle where the state stepped in and took over much of the funding of local governments. At the time, we were at the tail end of the first life cycle of the Suburban Experiment, where growth and prosperity were at its apex and almost all of the post-WW II infrastructure was still in its first life cycle (no maintenance costs yet). In the Curbside Chat presentation, this is where the Illusion of Prosperity is greatest. It seemed like we could do anything.

Here are some other things that happened around this same period of time:

1965 - Creation of Medicare

1972 - Major expansion of Medicare

1972 - Automatic cost of living adjustments added to Social Security

Go back to the restaurant owner. When everything looked good, he gave raises to the staff. Did the staff deserve the raises? We don't really know, but it is beside the point. The fact that there was more money in the system made the raises possible. Did the staff use the additional money to put their kids through college, help the poor and do other worthwhile things? I'm sure we can imagine that being the case, but again, it doesn't really matter how righteous their spending wound up to be. Without the voucher, it all goes away.

The first generation of the Suburban Experiment -- let's say roughly 1950 to 1975 -- was an understandable reaction to the Great Depression and a second global war. Hindsight is definitely 20:20 and we can see now how the near term prosperity horizontal growth created came with all of these massive long term obligations. The Minnesota Miracle, the creation and expansion of Medicare, the automatic increases in Social Security; these were all positive affirmations of a generation that had been to hell and back, sacrificed, prospered and wanted to make good on all of it. It is tough not to admire and want to nostalgically reclaim this optimism.

Which is exactly what was done in the second generation of the Suburban Experiment, only this time with debt. Public debt -- yes -- but more importantly with private sector debt. The accumulation of debt became so important to our economy -- so important to keeping the entire Ponzi Scheme going -- that we actually allowed it to become predatory as we crossed over into the Suburban Experiment's third life cycle.

We can continue providing the voucher to the residents of the town and keep the restaurant in business. That is what Paul Krugman would suggest we do. (I'll point out again that between the two of us we have only one Nobel Prize for Economics, but I still am highly skeptical of anyone who says the solutions to these complex economic problems are simple.) I can't get over, however, that none of it feels real.

Local government cannot be a proxy for a productive economy, just as infrastructure spending cannot be a proxy for real growth. To be viable, the demand for infrastructure needs to emerge from a productive land use pattern, just as a healthy and viable local government can only emerge from a productive place. If we want stability at the local level, we need to work to make our places more productive. We need to focus on building strong towns.