A Conversation With…
The Government Finance Research Center works with researchers from a variety of backgrounds to analyze the role that public finance plays in our lives. In the interviews below, we talk with experts to dig deeper into pertinent topics and get their perspective on the past, present, and future of government finance.
Daniel Chenok, Executive Director of the IBM Center for The Business of Government
From your perspective, what flaw in the budgeting process is particularly available for improvement?
The budget process at the federal, state and local levels often has the executive agency proposing a budget and then the legislature reviewing it, and then changes are made and then the legislature authorizes, and the executive branch implements. Typically, this can take two or even three years for an agency’s budget to be passed after the agency originally proposed it.
So, there’s lots of lag time?
Yes, lag time is a good way to put it. Another issue is not just the time, but the number of players involved. You need to have a certain level of review but depending on how many proposals and reviews are involved, there can be many steps between the agency’s proposal and a final budget document, and all the players involved do not necessarily add value to the budget.
Can you give a good example of how this could be remediated?
At the executive level there’s usually a budget office, a chief financial officer, a legal office, and more. They each have a perspective from which they review the agencies’ proposals. On the legislative side, there’s reviews at subcommittee, legislative and staff level.
They could create a budget with team-based approaches with offices reviewing in a collaborative way, rather than setting up a daisy chain where each office reviews everything individually.
How could this work?
A good process that has been demonstrated as effective gets everyone in a room – a real room or virually – at one time.
Would everyone involved be present?
You need to ferret out who needs to be in the room to make the decision, and who needs to be informed but is not critical to the decision process. In the federal government, for example, an inspector general’s office may need to look at ten percent of the items in a budget. But the office doesn’t need to be involved in the decision-making process for the other 90 percent. There’s a difference between people making a decision and giving people the information they need to know. Determining the key people who need to be in on the decision making, relative to and the people who ought to know about it but don’t need to be in the decision process.
You could envision a lead committee or office model, where one organization takes the lead for the process and then coordinates with other groups, so you don’t need to have several levels of reviews.
But isn’t it difficult telling people that they’re not going to be in the room where the decisions are made?
People who have a heads up on something may not need formal sign off. Of course, you send a proposal out to everyone and invite comment. Many groups will appreciate the chance to comment. They may give you an OK or they may ask you to add X or Y as you make progress.
It’s basically understanding the difference between decision makers and stakeholders. Government processes often lead to risk averse actions, setting up the process to make sure everyone who has a stake in one part are involved in advance in all parts. That creates lots of processes and lots of time and resources.
You can use technology to make the process more transparent and faster. Right now, budgets tend to be produced in PDF files that get passed along from person to person. But distributed technology platforms can have people come together and do the kinds of reviews that used to take weeks and months as you passed paper from one person to another.
Is the technology enough to make major changes?
No, you need an agile team, not just technology.
Can you help to describe what you mean?
An agile team for budgeting brings together key representatives from each organization involved in a particular decision and produces a vision of where they want to go, for example, in developing spending priorities for a particular program. And then they use an iterative feedback process with other stakeholders, in order to develop a spending plan.
You also don’t necessarily have to seek authorization for the full amount for a program. You can budget in increments, in pieces. And you can take the lessons learned from the first increment as you develop a plan for allocating the subsequent sets of funds.
Do biennial budgets help or hurt in creating a more flexible budget?
Biennial budgets are often open to flexibility in the second year. Biennial budgeting can be a good way to focus on the spending level in one year and then the management level in the other year.
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Joshua Franzel, President/CEO, Center for State and Local Government Excellence (SLGE)
Just to kick things off, what do you see as the broader issues being discussed among people who study state and local pensions.
Overall, we see the continued balance government employers are trying to make between comprehensive, quality retirement benefits and underlying benefit costs. While this focus is not new, it now comes against the backdrop of the COVID-19 economy and its impact on government budgets and pension plan financial health.
What have been the big surprises recently?
State and local pension funded ratios have been relatively stable. According to a brief released by SLGE and the Center for Retirement Research (CRR), for state plans, in 2020 they have an average funding level of 72 percent and for the locals they’re at 71 percent. Under expected scenarios, by the end of 2025, state plans will be funded, on average, at 68.2 percent, and local plans will be at 64.6 percent. With more muted assumptions, the ratio for states would be at 65.2 percent and locals at 61.7 percent.
So, are those projections troublesome?
While many governments will have to make larger contributions to the defined benefit retirement plans they sponsor, even with more conservative investment returns through 2025, we expect the vast majority of local and state plans to not have any cash flow issues. That said, for a small subset of plans with the lowest funded ratios, in the absence of substantial benefit reform, they may have cash flow challenges shortly after 2025.
So, as you alluded to in answer to my first question, is it true that the sustainability of benefits in a down economy will require adjustments by the city and state plans?
Yes. For many plans the employer and employee contributions may have to continue to go up. At the same time, we likely will see increased interest in retirement benefit arrangements that adjust contributions and benefits based on the underlying fiscal health of the plans.
What impact might that have on the workforce?
For many positions, wage compensation in the public sector is lower than for similar private sector jobs. So, if you are increasing the costs to employees to support their retirement plans, absent increased wages, you may be decreasing the attractiveness of public sector jobs. We’ve seen evidence of that phenomenon in surveys of HR directors. 85% of state and local HR directors believe retirement benefits offered are competitive with the labor market
That’s quite a conundrum, right?
I think of it as a Rubik’s Cube of challenges. We have seen a wave of pension reform over the past decade that often has reduced the generosity of benefits and increased employee contributions with a focus on improving the financial positions of these public plans – which is important. But many miss that retirement benefits are workforce management tools that help with recruitment and retention – so changes that reduce the overall value of these benefits may impact governments’ ability to develop their current and future workforces.
All in all, despite all the alarming articles about public sector pensions, you don’t appear to be concerned. Is that right?
The sky is not falling. Public Pensions have gone through three economic downturns in 20 years and the vast majority are on sustainable paths, with the understanding that future reforms may happen. Looking forward, given all of the changes that have gone on in the public sector pension space, which may decrease the overall value of these pension benefits for many public sector workers, it is important that we continue to focus on the role of supplemental savings to ensure these workers have secure retirement and financial wellness to assist these workers in making sound financial decisions overall for the short and long term.
Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC; hyperlinks added by Joshua Franzel, subsequent to interview.
“Disasters are becoming more frequent, expensive, and severe. But cost-saving strategies like mitigation are stymied by a lack of data about how much states are spending on these events.” – Colin Foard, Associate Manager, Fiscal Federalism Initiative at The Pew Charitable Trusts
What is happening at the federal level around disaster spending and how does that affect states?
Federal spending on natural disasters is on the rise. Since 2005, the federal government has spent $460 billion on these events. As a result, there have been federal initiatives in recent years that seek to control that growing spending.
That’s an important issue for states, since spending on disaster assistance is highly intertwined across all levels of government: federal, state, and local. That means any change in disaster assistance policy at the federal level will affect state and local budgets. Our research has focused on the fact that the spending debate is happening without a clear idea of how much state and local governments actually contribute due to a lack of comprehensive tracking of disaster spending. That risks shifting costs from one level of government to another—instead of reducing overall spending.
Is this an issue that’s becoming more important over the years?
Yes, absolutely. In the last year, we have seen record setting wildfires in western states, hurricanes in eastern states, and flooding in the Midwest. Every single state has had a federal disaster declaration–the mechanism through which states become eligible for federal aid–since 2015.
And, as more levels of government become involved in paying for a disaster, the more complicated it gets. Although FEMA leads these activities, altogether 17 federal agencies spend money on disaster assistance. Others include Housing and Urban Development and the Department of Agriculture. It’s a similar situation at the state level, with over a dozen different agencies and departments involved.
That makes comprehensive tracking of that spending a challenge, but one worth surmounting, since governments can’t make strategic decisions about that spending. For example, with more information on what each state and local government is spending on each of phase and type of disaster, officials would be able to consider cost-saving initiatives like investing in mitigation before a disaster strikes.
Have any states taken the lead in this important area?
When we first started our research in this area, 23 of the 50 states were able to provide some data about their disaster assistance spending—none of it comprehensive. Since then, several states have implemented policies to capture their total spending on these events.
The first was Ohio, which established a system through its Office of Budget and Management and Emergency Management Agency to capture cross-agency disaster costs every time the State Emergency Operations Center is activated. Agency officials collect expenditures on personnel, equipment, state-owed infrastructure damage, and grants and loans to local governments for response and repair costs. Then, they send this information to the state’s Emergency Management Agency.
Virginia took a different approach. Its legislature passed legislation mandating more regular reporting of disaster expenditures by state agencies from the state’s Disaster Recovery Fund as well as contracts executed for disaster needs, to make sure that the lawmakers were kept well aware of what was happening with disaster relief around the state.
What has your research shown about what states are doing in terms of paying for disasters?
While we don’t have a clear idea of how much states spend on disaster assistance, we do know that they use five common budgeting tools to fund that work. There are preemptive mechanisms that allow states to put money aside for future disasters; these include statewide disaster accounts and rainy day funds. State also employ responsive budgeting tools, which allow them to move money around during and after a disaster; these include supplemental appropriations and transfer authority. Another mechanism—state agency budgets—can be used either way.
While most states use a combination of these budgeting tools—all 50 states use at least three of them—they do so in different ways. We believe that understanding those differences can help state governments assess if their current budgeting approaches are able to meet future needs.
What should states be doing in light of the challenges of paying for disaster costs?
We have three primary recommendations for state officials to better manage their spending on natural disasters. First, states should track how much they are spending on disaster assistance—ideally broken down by type of disaster and phase of disaster (mitigation, preparation, response, and recovery). You can’t manage what you don’t track, and this is the clear first step for states to start tackling this problem.
Second, officials should examine how they pay for disasters, compare those strategies to what other states are doing, and then decide if they need to make any changes to be better prepared for future budgeting challenges. Disasters are becoming more frequent, expensive, and severe, and now is the time for government leaders to plan for how they will cover these costs in the years to come.
And third, states should consider cost-saving strategies like mitigation projects, such as elevating buildings or retrofitting infrastructure to reduce the impact of future events. Research from the National Institute of Building Sciences has shown that every federal grant dollar invested in these efforts saves $6 on average in post disaster recovery costs. We expanded on that work to show that this savings varies by state and type of disaster, from $7.33 in savings for high wind projects in New Hampshire to $2 for earthquake projects in Idaho and Indiana as well as fire projects in Arizona and New Jersey. Although the savings varied, mitigation activities in every state for every type of disaster saved at least double per dollar invested.
Can you help us understand the benefits of mitigation with a concrete example?
One example is performing earthquake retrofits of infrastructure. Another is elevating or acquiring flood-prone buildings. For example, North Dakota spent $226 million on flood control in state funds on flood control projects from state fiscal year 2012 to 2016. These activities are all about making investments on the front end to minimize future risk and save on future recovery costs.
Are there any states in particular that don’t need to consider disaster preparedness?
Not at all. Although people often associate disasters with hurricanes in Florida or wildfires in California, this is a 50-state issue. As I mentioned, since 2015, all 50 states have received a federal disaster declaration, the mechanism through which they are able to get federal aid.
And as every state faces the fiscal impacts of the COVID-19 pandemic, understanding the full impact of disaster costs—and how to manage them—is more important than ever.
Are any states acting on Pew’s recommendations related to disaster spending?
Yes, in addition to Ohio and Virginia, North Carolina is another example. After a devastating series of hurricanes officials in that state formed the North Carolina Office of Recovery and Resiliency to coordinate the recovery. Part of their mandate is to provide statewide reporting on how dollars are being spent and report on those expenditures. These are all important steps toward closing the data gap related to what we’re spending on disasters, which is critical to creating forward thinking solutions to manage rising costs.
“It is an open question of whether the desire to sell public assets will be met on the market side. What’s the appetite for risk?” – Phil Ashton Faculty advisor panel member for GFRC; Associate Professor, Urban Planning and Policy, University of Illinois in Chicago
At a time when state and local budgets are a mess thanks to COVID, do other alternatives come to mind in lieu of raising taxes or cutting services?
One anticipated effect of COVID might be increased pressure on municipalities to sell off certain infrastructure systems or assets. While the fiscal effects of COVID are still unfolding, cities have already honed the monetization of infrastructure – leasing or selling toll roads, bridges and other facilities, like parking garages – as ways to fill pressing budgetary gaps. I think those approaches are going to be very tempting in the coming months and years.
Of course these transactions require agreement between the governments that need money and private sector buyers, right?
Earlier rounds of infrastructure privatization in the 1990s and 2000s were met by willing bidders in the form of investment banks, infrastructure funds, sovereign wealth funds and the like. It is an open question of whether the desire to sell public assets will be met on the market side this time. What’s the appetite for risk? COVID will likely heighten buyers’ attention to the inherent uncertainties of some municipal systems. Not only are there still general uncertainties regarding how long COVID-related shutdowns will last, but certain kinds of activities may rebound more slowly than others. For example, public transit has been hit hard by declines in ridership so it’s going to be hard to see how public-private partnerships would work to the advantage of cities as a way raise new funds. If commuting patterns remain disrupted in the medium-term, then investors may not be excited to get involved in sale-leasebacks or other kinds of arrangements that depend on ridership growth.
So, is there likely to be resistance to public private partnerships currently related to COVID?
The generation of infrastructure deals in the mid-2000s raised a lot of concerns that cities were getting the raw end of the deal. That has translated into a lot more scrutiny for P3s.
Take airports as an example. Chicago tried twice to lease Midway Airport to private consortia. The first time, the financing fell apart in the aftermath of September 2008, when the stock market was in dire straights. The second time, the City responded to political pressure by adopting stricter rules on deal terms including a shorter lease and greater transparency around the deal. The result was almost no bidders were interested, and the city canceled the process. While cities may be under tremendous pressure to do infrastructure deals to address the revenue effects of COVID, the political landscape may be more contentious than it was 15-20 years ago.
This isn’t the only example of why the market may be wary of supporting public sector investments, is it?
There is certainly the question of how financial market volatility will affect buyers’ appetite for deals. After Chicago sold its street parking and downtown underground parking to Morgan Stanley in the late 2000s, the investment bank found itself facing tremendous losses in 2008 and re-chartered as a more traditional bank holding company to access federal support programs. This limited its ability to take on new partnerships. After the market downturns of March and April 2020 I think a lot of investors are similarly focused on repairing their balance sheets and riding the storm rather than aggressive expansion. While we see rumors in the financial press of large private equity firms amassing billions of dollars to purchase “distressed” assets, I don’t know that those firms will see value in partnerships with the public sector.
Is there a future in cities bringing in cash from private public partnerships?
Yes. Even if the landscape for big infrastructure deals has been shaky for some time now, we see emerging partnerships between cities and high-tech firms. Here, the infrastructure isn’t what you typically think of – roads, bridges, rail, sewers, etc. Rather, it is systems like closed circuit television or sensors embedded in the built environment to generate data about urban flows and conditions. Chicago’s Array of Things project is a good example; it is a public-private partnership involving Microsoft, Cisco, and Motorola. The revenue streams that are being capitalized in these partnerships aren’t user fees but data streams that can be sold back to cities to help them better manage urban problems like congestion, security, or air quality. Alternately, in examples like Google’s Fiber initiative or its proposed Quayside development in Toronto, revenue comes from enhanced predictive analytics that allow the firm to better target its advertising products. With the idea of contact tracking becoming so important in the post-COVID environment, I think there will be an explosion of interest in these kinds of sensor- and surveillance-based infrastructure partnerships.
Energy savings and climate change. Chicago has committed itself to reducing the city’s carbon footprint by retrofitting its own buildings with energy conservation measures. But the city couldn’t afford to go to the bond markets to borrow money for these investments; they had to find a way to finance the investments that was off balance sheet. So they turned to an arms-length financial consortium that borrowed money to install energy conserving measures (ECMs) which it repaid by pledging future energy savings. This doesn’t show up as new debt for the city. This is a different kind of privatization than roads or bridges, in that it targets not whole assets but selected parts of building systems that are sold off or pledged to private investors.
But what if the savings are lower than anticipated?
The fixtures are installed by a third-party energy services company (or ESCO) that also provides an energy savings guarantee; this means the city sees no “downside” risk if savings don’t materialize as the ESCO has assured a minimum level of savings. However, those assurances come at a cost, in the form of a financial return to the ESCO that is built into the capitalization of the deal. That means the city doesn’t necessarily see any actual energy savings at all throughout the 14-year life of the deal, as they are pledged to repay both the initial capital loan and the cost of the savings guarantee. The new fixtures may lower the city’s carbon footprint, but its utility bills are simply recommitted to private sector partners as debt service. Further, the deals introduce new kinds of counterparty risks; should the ESCO prove insolvent at any point, the city would have to take the capital loan back onto its books.
What do deals pursued in recent years tell us about the overall trends in the market?
In contrast to the marquee deals of the mid-2000s, what we’re seeing are smaller deals and the repurposing of many of the financial models/approaches to new applications like surveillance and climate change.
Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC
We’re dealing with a sudden and deep economic impasse, largely as a result of the coronavirus outbreak. Do you have any general comments about this national experience?
The big question mark is whether everything freezes now and goes back to normal when the economy opens up again. Or whether there will be longer-lasting economic and fiscal implications. Are we just hitting a pause button? Likely not, there are jobs that are not coming back, state, and local revenues that won’t be recovered and consumer behaviors that are changed for good.
The fast drop in economic activity, coupled with an enormous amount of uncertainty about the return of the virus make comparing this to other recessions very challenging. In this environment, projecting revenue shortfalls for cities is not easy, either from the national perspective or for those working in local government.
But we do have some indications about how specific city revenue structures respond to what’s happening in the economy, and that, combined with projected unemployment, is what we use to project how city finances will fare over the next few years.
Any particularly specific findings?
First, the revenue structure is highly variable from city to city, with some relying more on sales or income taxes, some more heavily on property tax revenue. The health and economic impact of coronavirus was also very uneven across the country. Put them together, and you’re looking at $100 to $150 billion in potentially lost revenues this year alone. That’s roughly 20 percent of cities own revenues and fees.
Also, there are likely going to be big cuts in state aid, as the states are filling their own budget gaps. But our projections don’t include declines in state aid, meaning the fiscal problem may be even worse than we project.
Property tax is still a huge component, but it tends to lag the economy. So, the vast majority of the shortfall is in sales taxes, income taxes, fees and services.
That’s right. We’re finding that cities that rely most heavily on sources like sales, income and fees are feeling the brunt of loss of revenue right now. Cities that rely on property taxes are more likely to feel the brunt over the next year. But regardless of structure, given the broad economic impact, we know that nearly all cities are feeling constrained, whether it’s a pinch or a tight squeeze.
Cities are suspending and deferring fees, charges and taxes as economic stimulus. In addition, even when not deferred or suspended a lot of people can’t pay them.
Are raising taxes, to fill budgetary caps, a feasible solution?
From that perspective raising taxes may not be feasible. If, for example, you raise the sales taxes and everything is closed, it’s not going to make a difference. Also, many cities don’t have the authority to raise taxes on a whim, their ability is controlled by the state.
What about user fees?
Many of the activities for which those are used aren’t there at this point. That includes things like library fees and, many parks and recreation activities, that have been closed. Then there are summer camps, which can be a huge revenue generator. But many have closed.
Just think of all the services cities provide, particularly in the summer months. In addition to the services themselves simply not being offered, we’re finding that cities are more in the mode of reducing financial burdens on residents and businesses, not adding to them with additional fees.
So, then is the only real alterative to be found in cutting services?
Personnel are being affected. Because that is the largest part if a city’s budgetary expenses. And for cities, when personnel takes a hit with furloughs and layoffs like we’re seeing, that equates to diminished services. Not just in parks and recreation, but also in less anticipated areas like public safety include fire, police and emergency medical technicians.
Is there any good data out there to give us a solid idea of the impact of cuts being made?
It’s been an interesting time to collect data! Cities have been very willing to share their experiences with us, from the types of service cuts, impacts on expenditures and budget shortfalls that they are facing. It’s also budget season, so they are trying to figure out a lot of this just as we are. We have a survey out now about local impacts of the coronavirus and will also release our City Fiscal Conditions survey this later summer, which will give us better look at how services and budgets are being affected.
What can cities anticipate from a third coronavirus package?
Federal support is certainly on the minds of state and local government leaders and advocates. We are hopeful that federal support will be available directly to cities of all sizes and be flexible enough to not only cover expenses directly related to corona virus mitigation, but also to help cover revenues lost as a result of swift economic decline. Providing this stability and certainty to cities as they prepare their own budgets will be crucial to a successful recovery.
Until the cash is in hand from the federal government are cities counting on it in forming their financial plans?
While we have good indications that cities will receive additional support, there are a number of questions out there. Most cities are not certain and are not forging ahead assuming they’ll be getting more from the feds
“Data: The often-missing road to reducing the impact of Coronavirus"- David Merriman
With a well-known legacy of outstanding work in fiscal affairs, David Merriman has been concerned about understanding the interplay between good data and society’s efforts to combat coronavirus. Merriman is Stukel Presidential Professor in the Department of Public Administration at the University of Illinois at Chicago and is leader of the Institute of Government & Public Affair’s (IGPA) Working Group on the Fiscal Health of Illinois. He is a member of the GFRC faculty advisory board.
This interview was edited with the approval of both GFRC and Merriman for clarity and accuracy.
How much of a problem is it when cities, states and the federal government lack current, accurate data about coronavirus?
I’m trying to understand the economic effects of the pandemic and its fiscal implications—what will happen to state and local government revenue and spending. I’ve been working with Cook County about its revenue estimates. But it’s incredibly difficult. Even though we’ve shut the state down for almost two months, we do not know the prevalence of coronavirus—how many cases there are in the general population. Since we do not know that, it is it hard to know when we can open the economy. Without knowing when the economy might open it is nearly impossible to predict the effect on government revenues and spending.
But the cost of figuring this out—getting good estimates of prevalence—is a pittance compared to the benefit. Anyone who has any idea of how to get this data should be funded. The money shouldn’t be a difficult challenge, because it’s so important.
You’ve said that it’s “nearly impossible,” to make smart economic policy if you don’t know its fiscal effects. What kinds of knowledge about fiscal effects are most critical?
The first thing you have to get right is what the disease will let us do in terms of economic activity and how long it will go on. The current way we are trying to figure that out seems to be trial and error. The analogy I like is that we’re putting our hands closer to the flame but if we get too close to the flame we get burnt.
And what happens then?
We head back a few steps in the adjustments we’re making.
What’s the one big question we should be able to answer?
Government hasn’t done a good job of communicating why we don’t have a better picture of the presence of the disease in the population. Without this kind of information, it is very difficult to do any other kind of policy analysis.
Aside from the obvious deficits of that kind of data for dealing with the pandemic, has the government failed in other data-related ways?
Government hasn’t done a good job at communicating why we haven’t gotten a better picture. The absence of certainty in the information the public receives endangers trust in the way people perceive government efforts. But if we made a better effort to explain why the numbers are often missing, that would help people understand what is really going on here; and could reduce the risk that some might believe the facts are being hidden.
Aren’t there alternatives to testing the whole population, one person at a time?
People in my field, economics, none of us can understand why there is not more random sampling. Maybe it is just too difficult. But I think that someone with a background in statistics could create a methodology that would lead us to some answers that are far better than those with which we’re working now.
Are there major obstacles to random sampling?
The barrier to doing random sampling is that when you do the sampling in one state or metro area, you’ll get different answers than you will from another. And you have to know many of the various factors that differentiate one place from another.
Creating a random sample is likely to be difficult. But statisticians and epidemiologists can figure out how to do it.
Are there other routes, in addition to a statistical sample, that could get us the numbers we most need to make policies that would lead to fiscal betterment?
One thing I think government has failed on is getting better information from the private sector including credit card companies, utilities, banks and telephone companies. These companies have lots and lots of data.
Can you give us a simple example of a particular kind of data the government could get from private companies that might help?
Well, for example, banks have data about how people are spending their money. No one is going out to eat now but we might want to know to what extent people are ordering food for takeout, to what extent they are purchasing things like clothes on-line. Google or other search companies could even tell us the extent to which people are searching for cars, houses, furniture, and other big purchases even if they are not actually making the purchases at this time. That data could provide an early indicator of the economic activity we might expect as the economy opens up again. All of that could help governments figure out what to expect in terms of sales tax and other revenues.
So, why aren’t we doing that?
I’m not sure if industry has refused to provide it or if governments haven’t gone out to ask for it; It’s hard for me to see how there’s any threat to the proprietary nature of this data. While, for example, credit card companies, have long been paid a great deal of money for sharing data—sharing the type of data governments need in aggregate form should not inhibit sales of the more disaggregated data that the companies generally sell and providing it to governments now would be an important public service.
Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC
“How does Chicago’s industry structure impact its economy?” – Rick Mattoon
An interview with Rick Mattoon, a senior economist and economic advisor in the economic research department of the Federal Reserve Bank of Chicago. He is also an advisory board member for the Government Finance Research Center. He and his colleagues have long been concerned about understanding why Chicago’s economy frequently performs differently than other large cities. Here he discusses the evolution of his thinking. This interview was edited with the approval of both GFRC and Mattoon for clarity and accuracy.
What is the classical thinking about cities with thriving economies?
In the traditional literature, density is an advantage. This is referred to as agglomeration. At an industry level agglomeration is found in so called “clusters,” which supports productivity both within the cluster and across the city economy. That’s because they have an abundance of specialized labor as well as the ability to share key inputs all in one place. So, though a city can be more costly to live in, it is also more productive.
Can you help us define clusters?
First, a cluster isn’t an individual industry. It’s a group of industries agglomerating to a single output. For example, glass manufacturers or tire manufacturers are part of the same cluster as Ford, GM or Chrysler.
So that sounds like a great thing. Why hasn’t it seemed to apply in Chicago (and we presume elsewhere)? Has it applied in Chicago?
It’s really not so much a matter of having clusters, but how the clusters relate to one another across the economy. Do the clusters actually complement each other, or do they compete with one another? For example, Chicago has large consulting sector, and a large financial services sector. They compete with one another for computer or advertising services, and that bids up the prices for those services. The cookbook approach has been that all you want is to have more clusters and bigger clusters are better, but that doesn’t work for all cities. The key question is do the clusters complement each other or compete with each other.
How should the city react to this notion as they plan for economic development?
You have to understand what resources the cluster is going to need. In Boston and San Francisco, they grew very large industries for which they didn’t have the necessary human capital. But they were able to produce the human capital because, as we termed them, they were high amenity cities. High skilled workers have choices in where they want to work so they tend to select cities with great amenities.
That’s good news for Chicago, isn’t it?
Chicago does have amenities, and we’re cheap. But it’s really the legacy industries in Chicago that can be problematic, like finance, insurance and real estate as well as mature food and package goods companies. Legacy industries can still be profitable but aren’t fast growth.
So, how should Chicago take advantage of that?
The city must understand where demand comes for its economy. They have to advance train for growth in new fields.
Can all cities apply this approach?
It’s an illusion that every city can compete. According to most of the literature, human capital is the most important thing for predicting the economic vitality of a city. A city must either produce and retain it for key industries or be able to attract it. One of the reasons Chicago has always had a particular strength in accounting is that University of Illinois has always had one of the best accounting schools in the country. Firms end up chasing workers, they have to go where human capital is.
Of course, human capital isn’t the only factor, right?
Right. It’s important to see where your assets are and seeing where you have an advantage. In Chicago, for example, you have O’Hare Airport, and that leads to strengths in knowledge-based service industries. These types of professional services are what Chicago can trade with the world, but these workers need to be able to get to these markets. O’Hare is city controlled and is a hub for both American and United, in addition to its international terminal. You can’t say the same think of Akron, for example, because people and goods can’t easily get there quickly.
But you’ve indicated that Chicago has often underperformed other cities. Has it made appropriate use of O’Hare?
O’Hare has evolved to support Chicago industries that trade across the US and the world. However, much of Chicago’s historic trade is supported by truck and rail and focused on serving Midwest markets. As the Midwest has shrunk in its relative economic position, you need to pivot to serving markets that are fast growing.
Has Chicago’s economy begun to change to a faster growth model?
Even 10 years ago Chicago had a negligible tech sector. Today, the Fulton Market neighborhood has become a magnet for investment by technology companies and even older firms such as McDonalds who relocated their headquarters to this amenity rich neighborhood. In almost every case, firms that chose this location suggested that the ability to attract high-skilled human capital was the number 1 factor in the selection.
Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC
"Whither Economic Development?"- Josh Drucker
An interview with Josh Drucker, Associate Professor of Urban Planning and Policy, University of Illinois at Chicago, faculty advisor to the Government Finance Research Center, and long-time researcher into and writer about economic development. This interview was edited with the approval of both parties for clarity and accuracy.
Why should we care about economic development?
One reasonable perspective is that everything comes down to economic development. For example, people may think of the environment as being in conflict with economic development, but well-thought out development can positively impact the environment. On the other hand, without taking the environment into account, development can be a negative factor.
The fundamental thing that places do for economic development is to get people jobs. That’s a pretty broad area, jobs. But ultimately, politicians are judged by whether their communities have plans to create opportunities for people.
At what levels of government are there the most thought and control over economic development? For example, how about the federal government?
We should have more planning for our economy at the federal level. But there’s a belief there that it’s the private sector that should be directing the economy instead of the government. The last time the federal government was deeply involved in charting the course of the economy was during the Great Depression, when massive regional projects such as the Tennessee Valley Authority were integrated with creating jobs.
Almost every other developed country has an industrial policy. Though we have industrial policies that affect different industries, we have no intentional, coherent economic plan for the nation as a whole.
And the states?
The states are picking up much of the slack. They direct the activities of public universities, they award science and technology grants, and even the money that they invest from their pension plans – that forms de facto industrial policy. They are much more directed toward building their job base than is the federal government.
Cities and counties?
Very large cities like Chicago and New York can act like states. They have good universities, staff expertise, lots of resources and assets.
For many other cities and counties, I think there is a great deal of innovation in terms of developing their economies effectively. New ideas and approaches often bubble up from the local level, with policies from dedicated manufacturing zones to targeted venture capital funds to innovation districts. The politicians who run cities are often judged by whether they create quality job and career opportunities for residents.
In smaller localities, though, many of the economic development departments are stretched to do more than keep up a website, answer requests for information, and refer inquiries about state programs.
Is there a conflict between the ways in which economic development serves citizens versus companies?
Politically, we focus on satisfying the needs of employees and the needs of employers, and we need to do a better job matching the two. But we separate the two systems. I think we can do a better job of matching people’s talents with the jobs that are available.
Too often, a city will say we want to develop a particular industry, say biotechnology, but the city is in a location that doesn’t produce many biotech-qualified employees. Governments should be in the long-term business of training people for the jobs that are or will be available.
Workforce development most often focuses on individuals. Economic development tends to support corporations. We need both to work in concert.
Should we be putting more emphasis on specific skills learned at universities, rather than liberal arts degrees that may not prepare someone for particularly needed positions?
I don’t think so. Liberal arts degrees can be effective for economic development. Employers want students to be skilled at reading and writing. They also want them to possess numeracy, computer skills, and so on. And then they can move on from there. In fact, lifelong learning is really crucial for improving the whole of the employee-employer matching process. We need to coordinate community colleges, workforce training programs, recertifications, and so on.
Government can subsidize and support these programs, perhaps by providing tax credits to train people. Or certification processes can assure that the programs people enter are genuinely high-quality.
As new needs develop in the economy, are there any particular obstacles to people changing their lives to fill them?
Yes. For one thing, we currently have a tight labor market, with fewer people looking to make changes to fill shortages. And tightened immigration lessens our opportunities to bring in well-skilled or well-trained employees from abroad.
How much of a problem is interjurisdictional competition, through incentives?
Incentives mean that governments forgo revenues that could fund important areas, like education. When neighboring communities are doing exactly the same thing as one another in order to attract jobs, neither secures an advantage, and it prevents the kind of cooperation among communities that can benefit all of them. It’s inefficient. When nearby cities or counties compete, they can easily wind up in a worse spot than if they were able to work together.
For example, Amazon recently asked almost every state in the country to make some kind of incentive bid for its new headquarters. It wound up originally choosing northern Virginia and New York City (Queens), which didn’t offer the largest incentives packages but did present attractive environments, including highly educated workforces, advanced infrastructure, and urban amenities. Yet Amazon was surely able to push the incentive packages they got upward, by creating competition from coast to coast.
Our legal system doesn’t have a ready solution to this issue. In Europe some countries outlaw this kind of competition. But in the United States, state and local governments cannot achieve lasting détente, and our federal government doesn’t have the aspiration to impose it from above.
Interview conducted by Katherine Barrett and Richard Greene, senior advisers, GFRC.