24 Jul 2013  Views on News

Detroit Files for Bankruptcy: HBS Faculty Weigh In

After a long period of economic decline, the city of Detroit filed for bankruptcy protection last week. John Macomber, Robert Pozen, Eric Werker, and Benjamin Kennedy offer their views on some down-the-road scenarios.

 

Once the hub of American manufacturing, Detroit is in a long state of economic decline. The rubber finally hit the road last week, when the city filed for bankruptcy protection. The challenges ahead for those that call the Motor City home are daunting, from a relentlessly declining tax base to a mountain of pension costs. John Macomber, Robert Pozen, and Eric Werker—offer their views on some down-the-road scenarios.

Beyond a Bailout

By: Senior Lecturer John Macomber

Detroit has failed. Why did this happen, might there be more big city failures on the horizon, and what should be done?

Harvard economist Edward Glaeser argues in The Triumph of the City that "our greatest invention [i.e.,cities] makes us richer, smarter, greener, healthier, and happier." That's all well and good, but the success of mankind's greatest invention is not evenly distributed. And when cities are not successful, the economic engine runs backwards, and we become poorer, less educated, suffer from worse pollution, get sicker, and are miserable. We get Detroit.

The demise of Detroit was easy to see and hard to address. Consider the causes: Decline of a major industry, diminution of public revenues, departure of high-impact businesses and high-value taxpayers, disputes over dwindling resources, and disabling levels of obligations to pensioners and other contracts.

Unfortunately, Detroit isn't alone. Stockton, California, and Jefferson County, Alabama, are other recent municipal bankruptcies. Pundits and politicians point to the burden of pension, health, and union obligations on the cost side. True, but not it's not sufficient just to cut costs. The real game is about revenues. Municipal revenues come from economic activity, and increased revenues come from increased economic activity—from the income taxes paid by residents with good jobs, from the tolls paid by drivers, from property and sales taxes. Without revenue, costs can't be covered.

Can cities with high liabilities expect to be bailed out and propped up without limits? Probably not. In the post-Katrina and Sandy world, taxpayers and politicians, afflicted with disaster fatigue, will likely have limited appetite for subsidizing struggling cities like Detroit or Rochester or St. Louis. Steven Rattner's recent New York Times op-ed "We Have to Step in and Save Detroit" notwithstanding, "we" won't be able to step in over and over again.

What, then, should business and civic leaders do about revenue? Since the fabric of cities is woven by the many entities of which they're composed, this is a question that can be broken down into a number of options and investments that bring desired returns. Here are steps that major players working together in metropolitan areas can do to save their cities:

  • When it comes to the elements of soft infrastructure such as education and healthcare, it's essential to create an environment for capital, investment, and entrepreneurship that encourages businesses to start, locate, or invest in a city. As HBS professor Michael Porter has explained in The Competitive Advantage of Nations, political units—whether nations or cities - are in competition with each other and can control their destiny using the analytical tools of business competition. Clusters like the Research Triangle in North Carolina think very hard about focus in order to create a virtuous cycle of complementary successful ventures. The results have been extraordinary. A generation ago, it would have seemed farfetched to predict that Raleigh-Durham would one day be more vibrant than Detroit, then the mecca of American manufacturing.

  • Business, civil society, and municipal leaders also have options in their tool kit regarding land use. This is one of the most powerful—and most controversially applied—techniques in the box. If business and civic leaders are worried about going the way of Detroit and concerned that there is not an unlimited bailout on the horizon, they have to make choices about what land uses to protect and amplify and what to let languish. Perhaps this is heartless in the short run, but this approach improves the chances of thriving in the long run. Remember Chicago's difficult decision recently to close a number of schools, given that there were too many facilities for too few students. The goal is for the remaining students to thrive with more resources per capita, with a focus on developing human beings, not maintaining out-of-date buildings. Although Illinois has serious financial issues, Chicagoland has far more vitality, economic activity, and interaction between downtown and the suburbs than Detroit.

  • In terms of basic infrastructure, (water, bridges, and roads, for example), cities and states have often proved unable to fund adequate maintenance and new construction. On the other hand, well-managed public-private partnerships, where the private sector funds, builds, and operates key public infrastructure, can shift the capital requirement from municipalities to the private sector. When there are adequate revenues to cover financing costs (and when proper oversight makes sure the "rules" are followed), cities can gain a competitive edge since businesses and citizens can benefit from services without their city having to put up the investment capital. The Carlsbad Desalination Project in San Diego County, for instance, is a privately financed project that will provide enough desalinated seawater to provide drinking water for 300,000 San Diegans. The propriety of having private companies provide a public good like water may be controversial, but the economics are not.

  • As for transit infrastructure, American cities like New York, Los Angeles, and Denver have worked with private partners to emphasize public transportation and start to de-emphasize single-driver cars. Despite obvious obstacles (e.g., you live in a suburb or own a store that can be accessed only by car), if the city collectively wants to "win," then infrastructure like this helps more people get to work faster, helps businesses be more productive, makes scarce resources such as fuel and clean air go further, and attracts jobs and workers.

Such a focus on geography, employment, and infrastructure has worked to spur growth, jobs, and opportunities in the likes of London, Barcelona, Beijing, and Singapore. It's not easy, and it's not fun. But the alternative is even worse - a twisting, slow decline that squanders value. At first blush, the natural inclination for many may be to bail out Detroit, but business and civic leaders need to take control of their own destinies by making focused, business-like investments. This approach can help keep dozens of other American cities from becoming the next Detroit.

Helping with Healthcare

By Senior Lecturer Robert Pozen

When Detroit reported $18 billion in liabilities as part of its bankruptcy calculations last week, most people were prepared for the $3.5 billion in unfunded pension liabilities. Many people were surprised, however, to see the much larger amount of $6.4 billion in other post-employment benefits ( OPEB )—primarily obligations to pay healthcare premiums for retired public employees.

Detroit is not unique. The unfunded healthcare obligations of most cities are larger than their unfunded pension obligations. To avoid fiscal disasters like this one, other cities should slow down the growth of their unfunded retiree healthcare liabilities.

Last January, the Pew Charitable Trust did a study of both pension and OPEB shortfalls in the 30 largest cities in the United States. The unfunded pension deficits for these cities amounted to $99 billion, while the unfunded retiree healthcare benefits totaled $118 billion.

Why are OPEB deficits higher than pension deficits for most cities? In part, the answer is that OPEB liabilities were for many decades never reported on municipal balance sheets. Without such reporting, it seemed that cities' healthcare promises did not have serious financial consequences.

That came to an end in 2006, when the Government Accounting Standards Board (GASB) required local governments to publicly report their OPEB liabilities. But GASB did not require cities to fund their OPEB shortfalls. As a result, even the worst funded city pension funds are 50% or 60% funded, while almost all cities have minimal advance funding of their healthcare obligations. Instead, these obligations are almost always financed on a pay-as-you-go basis.

On the other hand, from a legal perspective, it is usually much easier for a city to change its healthcare obligations than its pension promises. Indeed, pension obligations that are already accrued for city employees are legally protected by many state constitutions. The key constraint in changing health care obligations, however, is usually political, especially pressure from public employee unions.

If healthcare benefits can be legally reduced, subject to political constraints, what are the most fruitful strategies for cities to pursue? The following seem politically palatable, though their actual impact on a city's finances would depend on how these strategies were implemented:

  • Many cities have reduced retiree healthcare promises for new municipal employees. Unfortunately, it will take years for these reductions to have a material impact on a city's unfunded liabilities. In fact, many cities are downsizing employment, rather than hiring new workers.

  • Cities could require all public employee retirees to join Medicare when they turn 65. While many cities are imposing this requirement, some continue to pay a substantial portion of Medicare premiums for their retirees. Moreover, other cities finance better benefits for their retirees than those provided by Medicare.

  • Cities could require public retirees before age 65 to obtain healthcare through the new state connectors under the Affordable Healthcare Act. Although the federal government offers a range of subsidies for healthcare policies obtained through these connectors, cities would still have to decide who should pay the remaining premiums on these policies.

More dramatically, cities could reduce their retiree healthcare costs by adopting three other strategies, although each would probably trigger a political battle:

  • Cities could change their healthcare policies for retired workers by increasing deductibles and co-payments. They could also cut back on the scope of care provided -- for example, by making retirees pay the full cost of dental work and eyeglasses.

  • They could increase the number of working years for their employees to become eligible for retiree healthcare. In some cities, public employees are eligible after only 10 or 15 years of full-time work; this period could be extended to 20 or 25 years.

  • Finally, cities could begin to fund their healthcare obligations in advance, as they do for their pension obligations. This funding could come partly from general municipal revenues and partly from public employees. Such advance funding would significantly reduce their reported healthcare liabilities and thereby decrease the interest rates on their municipal bonds.

Health care obligations to retired employees are the hidden bombshells of municipal finance. Any changes in such obligations will be politically controversial. Be that as it may, if cities don't begin to reduce these obligations and fund them in advance, there's trouble ahead. They will soon pay higher interest rates on their municipal bonds and ultimately may face a financial crisis like the current one in Detroit. That's not what the doctor ordered.

The Long View

By Associate Professor Eric Werker and Benjamin Kennedy (MBA 2009), Senior Program Officer, The Kresge Foundation

Just what does it mean for a city to go bankrupt?

Bankruptcies are so commonly associated with firms and individuals that we tend to use the same mental models to evaluate Detroit's bankruptcy filing as we do a firm like Circuit City. The Associated Press declared that "Motown Goes Bust," and most commentary described the bankruptcy as yet another nail in the coffin of a city in decline. On the surface, the Motor City does look like Circuit City. Both entities have failed to compete, with management mistakes, in a sector doomed by trends beyond their control. And Circuit City's dark and empty big box stores, like Detroit's boarded-up houses and overgrown factories, remind us of the failings and offer a sense of finality.

That's a neat and tidy narrative to attach to America's largest municipal bankruptcy, but it may be wrong. To be sure, this is an extraordinary moment in the annals of American municipal finance, with serious near-term implications for municipal bond markets and other underfunded pension systems. Detroit's Chapter 9 bankruptcy case will be precedent setting in a variety of ways. But the real story here may not be what happens in the near-term at all. This is where cities differ from firms.

Cities almost never die. A bankrupt firm's assets can be sliced up and repackaged and sold off to partially repay the firm's creditors, and once that process is complete, the entity becomes dissolved. But cities—with some incredible exceptions that prove the rule, like Atlantis or Pompeii—cannot just be dissolved. Places recover from all sorts of catastrophes including natural disasters and wars. Along the spectrum of catastrophic events, a fiscal crisis is not the worst of these; in fact, a fiscal crisis is often an essential ingredient of recovery. Detroit has a precedent in Pittsburgh and a variety of other cities and jurisdictions that have seen their trajectory fundamentally shift in the wake of precipitous economic and fiscal decline.

Long before the American automobile industry was in crisis, American steel producers began to lose out to foreign competition. In the Pittsburgh region, which is to steel what Detroit is to the automobile, primary metals employment dropped by three quarters in the 1980s. Some 150,000 jobs disappeared, devastating the region's population of 2.2 million. But Pittsburgh had a second act (or third, counting the city's reversal from untenable air and water pollution levels in the 1940s).

Pittsburgh's recovery offers a potential model for Detroit. It went on to become a technology hub, anchored in the computer science and robotics coming out of Carnegie Mellon University. It also became a medical hub, driven by the brisk expansion of the University of Pittsburgh Medical Center. The education centers of Carnegie Mellon and Pitt attracted students from all over the world, and the city helped to retain them through its new economy sectors and affordable home prices.

Philanthropy, seeded by the steel fortunes, played a major role in funding education, culture, and historical preservation projects. City and state government, combined with self-organized private-sector players, played their part by funding technology as well as sticks-and-bricks real estate projects and brownfield redevelopments. In spite of this, Pittsburgh almost went bankrupt. It fell under state receivership in 2004 due to rising pension obligations, and the state of Pennsylvania has had oversight of Pittsburgh's fiscal policy since then. It still has trouble with pension obligations, but by 2009 it was rated America's most livable city by the Economist Intelligence Unit.

Countries, like cities, have gone through their own bankruptcies on the path to recovery. Liberia, a small country in West Africa where one of us advises, did the sovereign equivalent of bankruptcy as part of its post-civil war reconstruction. When Liberia emerged from a decade-and-a-half of war, fiscal obligations were several times higher than income. Its new leaders were able to restructure the country's commercial debt (to three cents on the dollar) and negotiate most of its official debt to be forgiven.

Liberia is not yet in the clear, but it is politically stable, its economy is rapidly growing, and its citizens are returning to lives enhanced by a more egalitarian power structure. Without the fiscal fresh start, investments in infrastructure and human capital would be impossible. Scores of other countries have also undergone debt relief, and it's probably not a coincidence that eight of the twenty fastest-growing countries in the world recently underwent this process.

Every place's recovery has its own unique features, since places, as congregations of people, have an organic quality. Ultimately, places, even if fiscally bankrupt, have assets that cannot be stripped, and these are the assets that must power their recovery. People are enormously resilient, and the permanence of place only serves to stoke this common trait.

So what does this mean for how we think about Detroit? It means we should be taking the long view. Detroit doesn't have to turn things around in a year or even five years. And it doesn't have to reclaim the place it once held among America's largest urban economies. It simply needs to be a better Detroit for current and future residents.

The good news is that Detroit's private-sector leadership already seems to understand what it will take to build back the city over the next several decades. Much of what we see if we look beyond the fiscal calamity in Detroit resembles the essential characteristics of the Pittsburgh recovery. Philanthropic and corporate leadership are working collectively to strengthen the core of the city through physical redevelopment. Medical and educational institutions are doubling down on their commitment to the city. Dynamic entrepreneurs and artists are giving life to a new narrative for the future. Long-time residents are staying in the city, stabilizing neighborhoods house by house. Seen in this context, Detroit's bankruptcy is more prologue than epilogue.

This isn't just good news for Detroit. It's good news for every place around the world that might otherwise be written off because of its fiscal straits.

The economist John Maynard Keynes was right about the ultimate mortality of human beings ("In the long run, we are all dead," he once said.), but when it comes to places, it may be precisely the opposite.

Comments

    • Anyck Turgeon
    • CEO, M-CAT Enterprises

    As I have studied in corporate finance at HBS and have a solid track record as a corporate executive, I understand the value of re-organization and restructuring. Yet, for every debt NOT being completely repaid, crime not being penalized appropriately or stolen assets from crimes like fraud not being recovered, there is a cost that someone else must absorb.

    I concur with Edward Greenspan's recommendations about the necessity to restructure pension and retirement plans to a later age. I think that it will eventually become an inevitable shift which will be most painful to aging baby boomers and generation X.

    Yet, as many of my own Canadian family died from denied healthcare services due to government-imposed restrictions, I would like to remind all that a transfer of risks, burdens and costs (via higher taxes) to the individual via mandatory government programs may result in higher costs and penalties as a result of the additional mid-level administrative layer.

    Having seen various slideshows comparing Hiroshima to Detroit, I also often wonder if the upcoming bubble of corporate, municipal and country-level bankruptcies won't lead us towards an era where there will be so much restructuring that it would not be best to just start back from scratch.

    I concur that places like Pittsburg and Liberia have been able to gain substantial benefits from mostly private investments yet, there have been substantial costs like security and privacy which are not often discussed. In the case of Detroit, can the city be restructured in a such a manner that private investors will feel that there is sufficient benefits? As trade practitioners are disappearing in favor of professional education endeavors, maybe, we can develop a modern educational environment that could fulfill an upcoming gap and deliver value to investors by offering trained trade resources through a comprehensive coop program.

    Prior to restructuring such entities as the city of Detroit, countries like Greece and failing corporations, I would like to see modernization of our accounting and finance principles to reflect today's entire assets and liabilities. For instance, concepts as data valuation are typically not incorporated into financial statements yet, there are costs and benefits to such type of goods. Further, as I see international dissidence on allocation of assets vs liabilities of SEC vs IFRS in Harvard documented cases like PolyMedica, I find it hard to get a reliable financial pulse whenever I look at financial statements. As much as I believe in tech innovation, I also think that upon such city restructuring, our focus needs to be on cash flow statements.

    I concur that the primary focus of this restructuring bankruptcy for the City of Detroit needs to be addressing rapid and on-going revenue generation. Target industries like high-tech, entertainment and automotive have been used before but did not succeed. Given the higher crime rate, additional security concerns and costs will need to be a transferred cost that can also reduce the competitive appeal given the enhanced risks. Revenues will have to mainly come from external resources so, exporting goods and ensuring lower trade barriers may be advisable upon the initial transition stage to ensure profitability.

    As former New Brunswick premier Frank McKenna balanced budget and turned a fishing-based province into a compelling "super-highway", it is important that the next leaders of Detroit understand that the "best social program we have is a job."

    Cash-based revenue generation through proven business leadership and tech innovation will need to be the focus of this much-required municipal make-over. Perhaps, this is an opportunity to restructure Detroit through M&A with other municipalities like Levis successfully did and replace failing, convicted local politicians with finance-based successful leaders.

    In any case, this article is a great thought-provoking jewel which should push all of us to excel through open exchanges and the opportunity to architect a brilliant future for generations to come based on national and global needs.

     
     
     
    • Rob Houck
    • Partner, Eaton & Van Winkle

    I have only skimmed the above postings so far, but I did not spot the role of race in the fate of Detroit. I could connect some dots, from labor shortages in WWII to Motown to foreign auto makers building their plants in anti-labor states, but that would probably be too simple. Still, someone should (please) address these aspects. BTW, I think repeatedly about the shock of my South African friend (and Oxford PhD holder) when he heard my wife explain that we Americans finance our school systems with local property taxes. He asked, how can we educate the poor with such a system?

     
     
     
    • Barry Shere

    Re: Beyond a Bailout The "departure of high-impact businesses and high-value taxpayers, ... and disabling levels of obligations to pensioners and other contracts" were not the causes of Detroit's demise. The causes were the people whose management of the city encouraged high-impact businesses and high-value taxpayers to flee and who commited to disabling levels of obligations, along with the abetting electorate. Macomber says "Detroit has failed" and "the natural inclination for many may be to bail out Detroit." That seem a most unnatural inclination to me. Also, I've worked in the private sector for many years, in a number of companies. There are no OPEBs from my current employer, or from any previous employer as I recall. I've also noticed that government employment has gone from the least desireable employment to the most during my work life - and I guarantee that the impetus wasn't creative satisfaction.

     
     
     
    • Will Wilkin
    • Co-Owner-Operator, Made In USA Solar LLC

    None of these smart professors has acknowledged the elephant in the room: that Detroit's bankruptcy is ultimately a result of America's disastrous so-called "free trade" policies. At least John Macomber notes in passing that one of the causes of Detroit's woes is the "decline of a major industry." But there is practically zero analysis of this macro trend that has affected most manufacturing industries and also brought many millions of individual bankruptcies, plus fiscal crises at the municipal and state levels across America.

    Detroit is emblematic of the crisis of American automobile manufacturing, which itself is emblematic of the larger historical disintegration of American manufacturing in general. To quantify this, consider that Manufacturing and Technology News reported in September 2011 that during the previous ten years, the US lost 54,621 factories, and manufacturing employment fell by 5 million employees.

    So-called "free trade" policies incentivize corporations to move their operations offshore, where wages are much lower and regulations much weaker. Often American jobs have been moved to countries with state-dominated economic systems that offer them wage supports, free or cheap land, easy finance and tax credits, and other incentives --usually requiring technology transfers and partnerships with state-owned companies in those countries.

    When these formerly "US corporations," now globalized corporations with zero loyalty to any country, offshore their production for U.S. markets, they reduce U.S. GDP, jobs and tax base for quick profits and large executive bonuses. This increases the US trade deficit and undermines American prosperity and our long-term ability to create wealth in the USA.

    And the problem continues, with the Obama administration proposing to make it worse through two more "free trade" treaties that will be the biggest yet: the Trans-Pacific Partnership (TPP) with Asian countries and the Trans-Atlantic Trade and Investment Partnership with the European Union. Obama's trade representatives have been writing these treaties in extreme secrecy, bringing in over 600 corporate representatives to write the terms even while denying Members of Congress information on those terms.

    In his book "The Failure of Laissez-Faire Capitalism and the Economic Dissolution of the West," Paul Craig Roberts presents much data to show the over 17 million jobs deficit that has come about from the "free trade" deindustrialization of America. He also gives deep critique to the theoretical justifications for so-called "free trade" policies, arguing that Ricardo assumed capital would stay in its home country and that comparative advantage was therefore the result of differences in unique national characteristics, especially different geography and climate, and was therefore an exchange of DIFFERENT goods where the particular countries had comparative advantages in those particular goods. Think Portuguese wine traded for English wool.

    Today's so-called "free trade" is NOT based on comparative advantage but rather absolute advantage gained especially through labor arbitrage (exploiting wage differentials). PCR explains that globalization has made capital and technology globally mobile and these are the dominant factors in production today, not geography or national characteristics. Consequently 3rd world workers are easily made as productive as first world workers simply by moving the technology and capital to poor countries, where the huge pools of surplus labor and low standard of living serve to keep wages at a fraction of America's.

    Ultimately we need to replace so-called "free trade" with BALANCED TRADE. This would effectively require globalized corporations to invest and employ in the USA if they want to sell their products here. By legislating an Import Certificate (IC) system to license all imports, and issuing IC's in the same value as exports, we could balance our trade. This would divert our chronic $600 Billion annual trade deficit into a $600 Billion annual stimulation of American manufacturing, creating millions of manufacturing jobs directly and many millions more jobs through manufacturing's multiplier-effect.

    Ken Davis, former Assistant Secretary of Commerce, explained in an interview earlier this year how such a policy could transform our economy and revive American prosperity:

    http://oxford-ct.patch.com/groups/will-wilkins-blog/p/bp--lets-think-big-again-a-growth-program-to-put-amerd32960a623

    When will our leading schools of business acknowledge the loss of patriotism in American business management and, ultimately, in Congress itself? When will the US Congress reject the lobbyist money and lucrative revolving door of cushy jobs offered them by the globalized corporations? They could start by rejecting the TPP and the US-EU "free trade" deals and instead demand a balanced trade policy to replace the so-called "free trade" that has dismantled so much of our productive economy.

     
     
     
    • Rob Jones
    • CEO, InclusiveWorks LLC

    Rob Houk raises a valid point, I think, and injects a realism into the discussion. The similarity of all eggs in it, and a corresponding municipal bankruptcy filing. That's Pittsburgh in the 1970s. But culture (including race) is more than just a red herring issue.

    Detroit can learn some things from the varied methods and madness of Pittsburgh's slow path to recovery, it's post facto metrics, and perhaps from some of its socio-political (i.e., economic development) strategies that helped the recovery happen. That's the clich? answer, but not the whole story.

    For example, while diversification of the employment base and tax revenue base became crucial to recovery and is now what most would consider a given in any such recovery, there was a cultural adjustment period of quite a few years during which Pittsburgh's economic development focus was finding new steel and manufacturing to simply replace the vanished companies. There was a phase, perhaps a decade or more of cultural shock and denial during which the region sought economic solutions that tended to look like the past realities. The Pittsburgh region, for more than a decade post-collapse, pursued rebuilding rather than transforming. It wasn't until organizations like Urban Land Institute, CMU's Richard Florida and others began to emphasize the 'unbrowning' of Pittsburgh's abandoned industrial sites that the focus shifted to alternate utilizations, diversification and incubation. Detroit can shorten that grieving phase by internalizing such lessons learned.

    Pittsburgh is a small town, just over 310,000 at this point, less than half its 1952 population of 655,000. It's taken more than 30 years of recovery to get this far and stabilize with what and who is left after the 1970s crash. Duplicating what Pittsburgh did in terms of raw numbers won't make a hill of beans worth of difference for Detroit at more than three times Pittsburgh's size -- unless Detroit is prepared to take a full century to get out of bankruptcy and recover to the point Pittsburgh has. And while the Burgh has transformed, it is far from out of the woods yet, by the way, and will continue to compete with Detroit for some of the same transformational industries and organizations.

    But when you examine some other stats, Detroit might glean more from looking harder at other models of regrowth and redevelopment if race/culture issues are factored in. As far as applicability of general strategies and methods for recovery, Pittsburgh's population is 27% Black, and conservatively, more than 60% of Pittsburgh's Blacks are living at or near poverty, so they can't really be counted as having been part of the 'economic recovery' of Pittsburgh. The recovery, regional strategy and all, was not for Blacks. So Detroit, over 80% Black, may want to look elsewhere for more culturally appropriate models and solutions, or said another way, strive for what I've termed CultureNeutral(tm) solutions.

    The hard reality is that Detroit's woes are just beginning. The ripple effects of the bankruptcy are immutable, something they can look to towns like Pittsburgh to try to anticipate and manage the downward trends. But Detroit isn't even close to hitting bottom yet. Government's first focus should be on building parachute infrastructures and social systems that will facilitate a "soft landing" for their constituents, as opposed to futile economic and socio-politically deadly attempts to reverse the process of decline.

    A clearly racial element of Pittsburgh's decline was the white flight that left behind a 27%-black urban core and a 70% white population of diminished economic capacity. The left-over population had to bear the costs of sustaining or improving the urban core infrastructure and emptying and deteriorating housing stock while those who fled continued to commute into Pittsburgh's urban core for jobs, recreation and its cultural amenities. And yet, those same suburbanites then pointed back to deride Pittsburgh for its fiscal structural insolvency which led to bankruptcy. That just widened the urban-suburban cultural schism, which became intractable, and still roils on. Detroit may not experience a similar population decline, at least not as quickly as Pittsburgh did after its fiscal demise, and the cultural aspects of any "flight" might be more class than race based. Therefore Detroit's social systems are likely to be strained to an even greater extent than Pittsburg h's in their attempts to sustain an economically floundering citizenry...which raises another issue.

    The philanthropic community may not be a proportional to Pittsburgh's. Pittsburgh was flush with foundations and private philanthropists -- not black, by the way -- who had more money than God when the steel industry pulled up stakes. (Some called it an "industrial collapse," but that's not quite what it was, really.) The corporate and private philanthropists filled a void left by the abandonment of manufacturing and the vanishing F-500s. There were more than two dozen F-500 HQs in tiny little Pittsburgh in its heyday, reduced to merely a handful today. The role of corporate philanthropy in supporting the maturation of the quasi-municipal economic development arena and the strategic management of political leadership in the absence of industry itself was breathtakingly powerful. I don't have a sense of what the philanthropic infrastructure look like in Detroit. I would guess it's robust enough. But with an 80% black population, my guess is that it's not likely to look quite the same as Pittsburgh's moneyed masters of banking, energy and transportation in the 1970s and beyond.

    Detroit's problems are just beginning, but they're going to take on a whole different flavor from Pittsburgh's because of the reverse racial and cultural picture, almost a cultural photographic "negative" of the Pittsburgh demographic, size notwithstanding. So, while there's an 'intellectual framework' of lessons learned which Detroit could cobble together from Pittsburgh's demise and rise from the ashes, the cultural contrasts are going to make Detroit's framework for recovery look and feel much, much different, their struggle more daunting and perhaps even intractable.

    Which reminds me a favorite quip of a former co-worker, fond of quoting the physicist Ernest Rutherford. "We have no money, therefore we must think." That's probably a good mantra for Detroit, and would fit nicely on billboards all around the city.

     
     
     
    • Wayne Wood
    • CEO, RevenuePerform.com

    It's almost ironic how this article focuses on the "heart" of the problem being about poor financial decisions, yet overlooks the fact the suburbs of Detroit are thriving mecca's of revenue and home to the now profitable auto industry. There not a revenue generation problem here. These a people problem here. Walk any shopping mall just 20 minutes from the "heart" and the arteries appear to be flourishing very well. The real crime here is the fact that the very society who grew up in the city, abandoned it. Detroit's bankruptcy is a stain on society and yet again we will saddle these errors on the Y generation to figure it out. The real reason why the city went bankrupt was that society saw the signs of a heart "attack" coming and abandoned it.

     
     
     
    • NVDSRAJU
    • WELLWISHER, INDIVIDUAL

    I adore the US way of working and optimistic always. It is sad to cause bankruptacy of a great city like detroit. At first it should not have been allowed. Having been so, it is time to find remedial measures. The re-constrcution, in the larger interest of entire US is imminent. It calls from sacrifices form all concerned, be it lenders or beneficiaries.

     
     
     
    • Ashok Malik
    • Consultant, M& A Consultants

    Detroit shall survive, we all know. But what is SURVIVING? Will it be ever able to provide its citizens the same growth & social security that was may be 15years back? Maybe YES maybe NO. All depends on political will and citizens, especially those who made their fortune in Detroit. There is a lesson here for INDIA. Putting Social Program's ahead of sound economic policies & making citizens dependent on the state rather than empowering them may be a vehicle going Detroit way. GOOD EDUCATION TO EMPOWER IS THE KEY. WISE LEARN FROM OTHERS MISTAKE.

     
     
     
    • G.P.Rao.
    • Founder Chairman, Spandan, Chandigarh, India., Spandan, Foundation for Human Values in Management and Society, Chandigarh, India,

    Two statements from The Long View of Eric Werker and Benjamin Kennedy deserve responses. That Detroit private sector, and philanthropic and corporate, leadership are already working collectively to strengthen the core of the city is indicative of the increasing awareness of the public consciousness in addressing the civic issues directly. This also perhaps reinforces the tenet of initiative of The Giving Pledge. At deeper level, the statement that "it simply needs to be a better Detroit for current and future residents" implies two issues: The issue of humankind's wanton or otherwise destruction of required balance between and among human institutions on the one hand, and, the nature's 'domain' of beautiful, delicate and difficult balance of the universe, on the other. The second issue is the need for correction to start from self - both at individual and institutional levels. As Mahatma Gandhi, for instance, observed we need to remake ourselves G.P.Rao.

     
     
     
    • Bill Barker
    • Retired attorney, The Dow Chemical Company

    I feel both the faculty and most of the commenters are overlooking how dire the economic situation is. Perhaps two or three percent of Detroit's geographic area of 139 square miles is economically sound and viable, perhaps two miles along Woodward Avenue from the river to the New Center, plus one GM and one Chrysler automobile plant, and most of the employed people in those areas live outside the city. Allegedly almost half of the population is functionally illiterate and the Detroit Public Schools are mostly disfunctional in spite of efforts of at least two intelligent and motivated leaders over recent years. There simply is no income foreseeable from outside Detroit, public or private, to support infrastructure or other improvements of economic significance in the disaster area with any hope of generating more future income. Unemployment is estimated at more than 30% of working age people. Most of them have no real skil ls to offer an employer. The faculty has to realize there is a ring of prosperity to the north and west of the Detroit city limits-- crossing them either way takes one in to a different world. I dislike saying any problem is insoluble, but after over fifty years of observation, conversations with some of Detroit's political and business leaders, sad to say I do not see a solution for the dead and dying parts of Detroit assuming no outside entity bails it out. Only a living entity capable of changing and growing should be bailed out, and outside the small economically viable parts of the city it is difficult to see how any bailout would really help. This is not Pittsburgh.

     
     
     
    • adrian matadeen
    • Chief Executive Office, Fatz Express Packaging Services Ltd

    By defn a bankruptcy occurs when an entity assets is less than its liabilities and there is not sufficient cashflow to service the debt obligation .

    This behooves one to ask what are the circumstances that can led an entity onto such a slippery slope and but by the Grace of God there go I.

    I first came to Detroit in June 1991 after driving from Toronto in a U Haul van with three University of Toronto buddies heading to Los Angles .I remember it was 3AM on a Sunday Morning and completely dead the downtown core was , no one no cars nothing on the street. You sense the dying , it was palpable. Windsor its Canadian counterpart across the bridge was alive and filled with sparkle and activity .

    I propose the gap was created by the creativity and identity of Detroit burghers became so diluted to be no longer relevant to the alive and living . How did this lost of imagination occur , and this leads me to the door of the Mayor and both state and Federal leadership failing to properly partner with Big Business properly and not having any impact on SME in the city and its suburbia .

    Car business is all about imagination , to bad the Mayor office did not tap into this as it ought to . I look at Detroit as a case book of hierarchy ethos and the living Peter Principle .

    Adrian Matadeen

     
     
     
    • Eric Budd
    • Sr. Consultant, Budd Performance Group

    The role of mis-management and corruption in city government cannot be underestimated. The ethical issues that are in play should be explored if the city is to turnaround.

     
     
     
    • James Forrest, HBS 1975B
    • Chairman, Shore Capital Partners

    Well, well, well. You lecturers have entirely ignored the causes; doing so makes the lessons much clear, much less obvious. I live in the Detroit Metro, so let me enlighten you, though it is not a politically correct viewpoint. he chickens have finally come home to roost. Detroit's citizens elected the worst politicians from the Democratic party that they could find, and these guys (and gals) gave away, and gave away, and gave away the store over the past 50 years. Elected politicians believed they had the right to plunder the city's assets, and nepotism, graft, fraud, pay for non-existent jobs, and outright theft resulted. Add to that persistent dependence upon welfare, ridiculous salaries, costly pensions and especially health care, corruption, and an overwhelmingly anti-business environment and you have this result. In fact, for the past 50 years Detroit spent money like a first-world country, but operated like a third-world country where the rule of law was optional, not the foundation of the society.

    Kevin Orr has done an amazing job in a short time to identify the real liabilities of the city, both funded and unfunded. Do you think Detroit is the only city in this situation? Think again. This is a sad, sad story that has been and is being duplicated in countless Democratically governed cities around the country. (Perhaps you have seen the chain e-mail listing the ten poorest U.S. cities with a population of at least 250,000: Detroit, Buffalo, Cincinnati, Cleveland, Miami, St. Louis, El Paso, Milwaukee, Philadelphia, and Newark. Besides all having poverty rates between 24 percent and 32 percent, these cities share a common political factor: Only two have had a Republican mayor since 1961, and those two (Cincinnati and Cleveland) haven't had one since the 1980s. Democratic mayors have had a lock on City Hall despite these once-great and prosperous cities stagnating on their watch.) How about Chicago in particular (see recent article published in Crain's Chicago Busines s)? Newark? San Francisco? Keep watching the news over the next few years, you will see more. You will also see the same lessons applied to states such as Illinois, California, New Jersey, etc. Key lesson number one: mismanagement kills enterprises whether they be private or public. Key lesson two: there is no such thing as a free lunch; mathematics are objective, and cannot be ignore, and everything that is happening was known to anyone with even a minor understanding of modeling.

     
     
     
    • Tsegga Siyoum Medhin
    • Manager, IBM

    I enjoyed this eloquent article especially your reference to Liberia. Many of the Emerging/Growth Market countries have given us an opportunity to learn from them, where Quite a few countries have resurrected not only from their destroyed economies, but their humanity. Delighted to learn you are one of their advisers, and even more appreciative that they leveraged it to make a difference. I wish that for many African nations. I too am optimistic and hopeful that the rise of engaged citizenship, awareness of good governance and financially austere governments will paint a new narrative not only in Detroit but across the globe and a better future for us all.

     
     
     
    • Aim
    • Drilling Engineer, N/A
    • Reviving economy through manufacturing industry is ill-advised as automation will barely absorb 10% of even 90's employment base, not mentioning 70's.
    • Innovation of processes and technology results during manufacturing of goods, but that offshored innovation is easily recoverable in nowadays transparent (spying) society.
    • Technological capability has far superseded that of a human's and thus natural rates of unemployment need to be re-adjusted. This is especially true for countries/cities such as Detroit who have not invested in "We have no money, therefore we must think". No value delivery, no employment. No employment, no taxes. Period.
    • Achille'ian and Herculian times of doing anything are long over. This century is a century of teamwork and expecting a few well elected leaders to change the tide of bankruptcy is a clear underestimation of stupidity of mass at large. And thus the only way of saving a city in a long run is by increasing its mean educated population up to the world standards, so that they can find employment.
    • Last, but not least to the Mayors and people of Detroit: There are a lot of sacrifices that need to be made in the face of such financial difficulties. You are not equipped with such patience or understanding, had you been, you would not have gotten into this mess in the fisrt place. It is in your best interests to choose an extra-ordinary path towards recovery: Abandon the ship!
     
     
     
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited

    The present deplorable state of the economy of Detroit throws signals for many other cities the world over. This development is the result of a strong belief that the losses would somehow be covered by the Government. It is true that what applies to a corporate or an organization does not strictly apply to a city which can recover in due course even if it takes decades. Nevertheless, it should be an eye opener for the controllers of various state bodies that they need to behave like professions keeping tight controls and taking timely steps whenever some untoward development takes place. There has to be a real change of vision and things cannot be taken for granted.

     
     
     
    • M B NEACE
    • CEO +Prowessor Emeritus, TheRainMakers-TBL+Mercer University

    ALL civil, thriving communities are underpinned by strong, effective education, beginning with early childhood. That requires a least four inputs: good teachers, effective administrators, supportive community and most of all - parents. Parents are involved, or should be, from the day their children come into this world. Parents are the key, not teachers, at this early stage. For a child to start school not knowing how to spell their name, lacking basic speaking, reading, civil skills will not succeed, regardless of how good teachers are. It takes all four for Detroit, St. Louis, Atlanta and a host of others cities to succeed.

     
     
     
    • Clifford Baker
    • Chair, Neffel Corporation

    Human hubris and greed, along with poor management on the part of those involved with the decision making processes in both business and government... have we forgotten that these factors formed the foundation as well as provided the brick and mortar that built the current precipitous economic condition for Detroit, as well as other cities around the country.

    Though I do agree that a mutually beneficial compact between business and government can provide a lasting solution, I don't believe a viable working platform can be arrived at, instituted, and successfully maintained without first arriving at a fundamental change in ethics on the part of all involved.

    As long as the established and long sustained attitude in the mind of business leadership (whether conscious or unconscious) is, for example, that the purpose for the existence of a business is to provide value to its investors at the expense of all other stakeholders within the business and society at large, the current state of affairs is, in my view, insolvable.

    As long as people in government choose to ignore the fact that they, in their positions, whether by voter mandate or appointment, swear an oath to uphold a constitution and to participate in activities aimed at the betterment of the people placed under their protection, rather than serving special business interests who, for all practical intent and purpose, offer bribes in the form of campaign contributions in order to sway the decisions of politicians that ultimately benefit investors, the current state of affairs is, in my view, insolvable.

    I think we, as a society, need to take our heads out of the sand and take an honest, yet fair, look at the conditions that currently exist in both business and government that perpetuate existing detrimental conditions, with the intent of implementing necessary change.

     
     
     
    • John Macomber
    • Senior Lecturer, Harvard Business School

    This is a thoughtful, wide-ranging collection of well-argued responses, and a spirited conversation. We appreciate your testing our ideas. Four concepts are particularly useful to other cities as they attempt to avoid going down the same path as Detroit. What can the other cities attempt to do, while their business, civic, and political leaders are still in control? These ideas from the discussion are notable and might be do-able:

    ? Modernize accounting and finance principles to reflect today's entire assets and liabilities. With respect to financial matters, that kind of fresh air review is bracing in both urban and corporate settings - and leads to better decisions because it forces earlier decisions. Obviously the political inclination is to kick the can down the road, at every level: city, state, federal. But the liabilities are real. It's not one of those problems that gets better with time; the Detroit calamity has been forecast for decades. Beyond financial considerations, the proper accounting of a cost for externalities like air pollution's effect on public health, or poor education's effect on future earnings, are often modeled by academics. Cities and business leaders have a chance to use these tools to create a common, objective finance roadmap - and to avoid becoming Detroit.

    ? Be strategic around comparative advantage and free trade. As circumstances change, comparative advantage changes. This is well known to all around the Great Lakes where energy from coal and proximity to iron ore and shipping was a major advantage...fifty years ago. The globalization of labor (which lowers market labor costs) makes the changes happen even faster. Using the tools of microeconomics of competitiveness, cities like Raleigh-Durham, New York, and even Houston and Chicago have looked ahead to what will make up future comparative strength, and invested in those assets - letting other industries languish - but in advance of this reset being terminally painful. This is not hard to visualize. It's hard to accomplish.

    ? Engage core and suburbs and the ring of prosperity. In the 21st century, a city or urban agglomeration must be defined with a large view in order to thrive. Otherwise, petty politicking and beggar-thy-near-neighbor tactics carry the day. One hears examples over and over of non-connected transit lines, of commuters extracting value from downtown, of the hollowing-out. The American cities that will thrive in 2030 will be thinking TODAY -- before the stakes get bigger and more bitter -- of how to think and act regionally, create value, and share value. Smart metropolises will be applying this thinking to regional transit (more coordinated) and layers of government offices (less redundancy in city, county, and state offices). International competitors like Singapore have the benefit that the city and the nation are one; there are no policy gaps or local/federal dust-ups or downtown/suburbs arguments. Major American cities need to compete with that level of effectiveness.

    ? Beware of human hubris and greed, along with poor management. We can all stipulate that avarice, venality, incompetence, and self-dealing are bad for society. Our conversation here won't be able to fix those human traits, or un-do decades of damage. But going forward, assuming competence and good intent, we can imagine work-arounds based on analysis, long-view thinking, and an alignment of political, civic, and business leaders.

     
     
     
    • Clif Carothers
    • CEO, U.S. Air Ambulance

    Throughout the past 60 years, as Detroit's major industry dispersed, so did its educated population. Half of Detroit's remaining citizens now are functionally illiterate and either earning minimum wage or are unemployed. Without traditional options to earn a living wage, citizens have turned to a subculture of gang violence, crime, and failing schools.

    What is needed is to bring taxpayers back to the city. Yet failing schools, high crime, and low skilled workers is not a calling card. The jobs that these Detroiters could qualify for pay much less than America's minimum wage in the international market.

    So we have a catch 22 problem. To bring businesses back to Detroit, the city must become more livable but to become more livable, Detroit must attract businesses back to the city.

    The solution to this riddle is wage subsidies. Wage subsidies allow businesses to pay illiterate workers a living wage that incentivizes exchanging the subculture of violence for economic growth. Wage subsidies allow businesses that can hire low skill workers to locate within Detroit while remaining competitive. Wage subsidies allow economic growth to rapidly return to the city, expanding its tax base.

    Who will pay wage subsidies? Those that benefit, including city, state, and federal governments, will pay, yet will be rewarded tenfold for their payments through increased revenues, decreased costs to police and house criminals, and through perpetual growth of citizens' earning power as schools dramatically improve.

    How can wage subsidies be optimized? Lowest cost to implement will be through a wage subsidy auction, allowing business to compete for subsidy amounts for new hires. More meat on the bone of this idea can be found at Jobvoucherplan.com

     
     
     
    • Stan Tims
    • Product Management, IBM

    Question: What causes any kind of bankruptcy? Answer: Spending money you don't have until you don't have any more. City management didn't know that their tax base had steadily declined, and has been doing so for decades? City management didn't know their pension obligations and spent money on entitlements and salaries instead of funding those obligations? City management didn't know that health care costs have been steadily rising for their staff incessantly? Irresponsibility? Definitely. Incompetence? Likely. Sadly, the Chrysler federal bailout has led the city management of Detroit to expect the same. The gravy train must come to a complete stop. There is no reason to assume that Detroit should have a "recovery", much less believe that the next set of rascals could possibly manage the city out of its dire straits. It is far too far gone. Yes, the entire city may become a wasteland, but that is the most l ogical and most financially prudent course. Our municipal governments need a shock of a wake-up call -- a message to be sent to all the rest. If you don't start practicing fiscal accountability now, the same will happen to you and the city you love.

     
     
     
    • Rob Houck
    • Partner, Eaton & Van Winkle

    I admit that the following thoughts are probably old and only new to me. I also am willing to admit that unions and poor city government play an important role in Detroit's demise. But have we seen much discussion about the nature and function of cities in general and the US policies that shape cities? Zoning, public transportation, schools, property and other taxes, public services, infrastructure generally, etc. all play a role. By their nature, public facilities are....well...open to the public. Just who IS that public and how important is it to other members of the public? (Here is my race but also economic class comment again.) And what is the motor which drives the economic viability of a city? For Detroit, it was the automobile and the proximity of semi-skilled workers to plants. If the plants go away or the necessity of proximity to the plants does, then people have no need to live close by, especially if the plants are not aesthetically attractive. Even if they are, if mobility is inexpensive and schools (for example) are better away from the plant, then one moves away. A further consideration is the cost of alternative housing. If building new is as inexpensive as renovation of old housing stock, then the consequences are clear. As American industry has changed from unskilled or semi-skilled assembly line jobs to highly skilled telecommuting or non-polluting white collar jobs, the employer can build the new, clean "plant" near facilities (schools, night life, culture) that help attract the desired kind of worker. My main alternative model to the US's is Germany, where all sorts of public policies shape the functioning and viability of cities. The unification of Germany has led to mass migration from east to west with the exception of Berlin, whose whole nature and population have changed dramatically in the last 20 years. Americans, though, have financed their cities as if there wo uld be no serious, long term decline in population or revenue. Obligations to former workers have not taken these ups and downs into consideration. I am sure that - if these factors are clear to me, a mere commercial lawyer - there must be many in the audience for this newsletter who can point us to more thoughtful analyses of these factors. And to policies which can at least soften the blow to cities which are the victims of changes in the local economy.