Pain Threshold

(The following is an edited transcript of a speech given on Aug. 24 in Mt. Pleasant, Mich., by David L. Littmann, senior economist for the Mackinac Center for Public Policy.)

I was encouraged to keep my remarks brief and positive about Michigan’s future, and to tell only the good economic news about Michigan.

So in conclusion, let me say. ...

But seriously, there comes a time when the economic prospects are so bleak that one must present only the unvarnished reality. True, Michigan hasn’t yet reached rock bottom by any means, but our local and state economies will be at that point within the next three to five years. In economic forecasting, the objective is to offer a one- to three-year forward look at the probable condition of the economy. So from that point of view, it is undoubtedly long overdue that the unvarnished truth be told.

Here’s what I see.

First, some perspective. Where have we been economically, and where are we now? The finest economic measure of the material well-being of a population is personal per-capita income. In the case of the state of Michigan, our situation is calamitous. As of 2004, Michigan experienced its fifth consecutive year as a below-average income state, according to data from the U.S. Bureau of Economic Analysis.

This is an especially nerve-wracking observation for two reasons:

We’ve been losing ground to other states on a trend basis for half a century.
In 2004, we matched the worst year — 1982 — of our performance relative to the rest of the nation. We managed to do this even in the best of economic times for the nation, with a robust housing and auto market to boot! Now, unfortunately, we can be assured that Michigan will see even greater economic erosion in 2005 and 2006 compared with our sister states because we’re entering the portion of the business cycle that traditionally turns vigorously against Michigan.

There’s no state in the union today in greater need of economic and financial reform than Michigan. What people like Bud Schimmel of the Municipal Advisory Council of Michigan did for the city of Ecorse, which had lost the vibrant steel industry that formed its economic base, needs desperately to be done for many cities throughout the state — and, indeed, for the state of Michigan itself.

Our unemployment rate is the highest in the United States, averaging 2 percentage points above the national average — 7 percent vs. 5 percent — although in July, Mississippi actually had a bit higher rate. Our population and employment growth are both negligible; actually, Michigan was the only state in the United States to exhibit a payroll employment decline in 2004. As of midyear, Michigan was showing a loss of some 31,000 jobs from a year ago.

The city of Detroit just slipped from the top 10 population grouping. Wayne County has a net decennial loss. The recent Forbes magazine listing of business climates of the 150 largest metropolitan areas in the country and 168 smaller ones shows nothing competitive in Michigan.

Our per-capita personal income in 2004 was 3 percent below the national average — our fifth year in a row below the norm for the nation, as I mentioned earlier. There has also been a faltering market share for the Detroit automakers, excepting June and July, with the massive purchasing incentives. (You recall them: "Buy one, get one free.") Chances are that 2005 and 2006 will not see a turnaround.

In short, Michigan will remain a relatively poor state — and one that is annually losing ground.

* * *

In 1960, Michigan accounted for 4.3 percent of the U.S. population and employment and had 21 electoral votes. Today, in a statistic not to be confused with dyslexia, Michigan has 3.4 percent of the nation’s population and workforce, with 17 electoral votes. It is losing clout on both economic and political fronts.

You ask, What major reforms could eventually reverse our sinking fortunes? Well, if our immediate goal is to emulate — note that I said emulate, not even catch or surpass — the richest and fastest-growing state economies in the nation, the answers truly are not hard to come by.

From what I’ve observed and studied over the past three to four decades, the two most outstanding features of the pre-eminent state economies in the land are as follows:

Of the three major state taxes — personal income tax, corporate income tax and sales tax — the states that have consistently eaten Michigan’s lunch are those with only one or two such taxes, not all three. Not only are Michigan’s taxes above the U.S. average in their burden on our diminished tax base relative to income levels, but they’ve been on the upsurge on all fronts in recent years, with more onerous taxes being proposed by both the Republican Legislature and the Democratic executive branch.

And yes, by the way, fees are taxes; pushing up effective tax dates is tantamount to tax increases; home transfer levies are taxes; and hiking sin taxes is raising taxes.
The economic growth rate of "right-to-work" states has so convincingly and consistently eclipsed the average growth of non-right-to-work states as to make the whole argument for more workplace flexibility a noncontroversial subject. It resembles the contrast between mandates for a minimum wage, prevailing wage or living wage and a free and competitive labor market.

In short, Michigan’s incentives are upside down.

The handwriting is on the wall. For instance, Iowa’s economy is surging, while Illinois’ is sputtering. That’s largely because from fiscal 2002 to fiscal 2005, Illinois raised state taxes $1.4 billion and increased state spending 31 percent. Iowa reduced taxes by $60 million and increased state spending by 3.3 percent.

The result? In Iowa, income tax collections are up 7.4 percent this year; in Illinois, collections are up 2.9 percent. And get this: Corporate income taxes in Iowa are up 31 percent for the first half of this year, compared to a decline of 8 percent for Illinois. Policy makes a difference!

The laws of economics are everywhere and at all times the same — as ubiquitous and immutable as the law of gravity. Defy the laws of economics, and you eventually pay the consequences. When it comes to incentives, people may be poor — but they ain’t stupid.

* * *

Twenty-first century global imperatives are for better, faster, cheaper and greater resource mobility. Michigan, instead, sees little threat to its future, if the state is judged by its lack of effort at reform or remediation.

Fortunately, state and local think tanks have cataloged the fiscal and economic reforms that have worked and those that have failed throughout the United States and elsewhere in the world. Over the years, I’ve associated with dozens of these inspiring think tanks. We have here in Michigan the premier such organization in the country — one that has contributed volumes of highly respected, peer-reviewed research and empirical studies to policy improvements in the fields of health care, education, the environment, the economy, prison systems, energy, transportation and labor markets.

I’m referring to the Mackinac Center for Public Policy in Midland, Mich.

Under Larry Reed’s leadership for nearly two decades, they’ve been warning, cataloging and educating on the threats that are now quite apparent to policymakers, politicians and constituents alike.

As with most problems, when the pain gets bad enough, and the population gets angry enough, the policymakers will turn to the constructive alternatives that have been proposed by these magnificent, reform-minded nonprofit organizations. I must tell you that from my perspective, however, Detroit and Michigan have not reached that pain threshold yet.

This is not surprising. I recall as though it were just yesterday what Gov. William Milliken told me three decades ago: "Dave, you’ve got to remember that the most difficult thing for people to accept is change."

But, realistically, I ask you, What change is feasible when most of what you hear or read about focuses on the following?

First, blaming our economic plight on China, India, Japan, Enron or oil? The real source of concern has been, is now, and will continue to be, our own smug, obtuse policies that contribute to an uncompetitive business climate relative to the other 49 states — especially those states located mostly, though not exclusively, in the South and West.
Second, this perpetual fiscal insanity of wanting to raise more tax revenue to enable state and local governments to toss more scarce resources into areas of their special interests, rather than empowering all citizens and firms, and rather than improving statewide incentives for attracting capital and human workforce inflows and maintaining them here, regardless of giveaways elsewhere.

Only through more efficient government will there be resources left over to promote the generalized incentives necessary to compete in a global economy. And by "efficient government," I mean a government that is fiscally prudent and that focuses on the two priorities of government service: protecting the lives and property of its citizens.

* * *

We are on a sinking economic trajectory.

Think about it. Michigan’s economy does best when inflation is low and when financing rates are lowest. Already the United States has passed its peak growth rates in this business cycle, including auto sales — 16.8 million unit light-vehicle sales or better, year after year, over this national economic recovery period.

The United States has passed its maximum dynamic expansion portion of this business cycle. Just how much longer do we think Michigan’s auto or housing industry can expect interest rates to remain at these remarkably low — 40- to 45-year-low — levels? How much longer do we think Michigan’s auto- and manufacturing-based economy, as currently constituted, can withstand the debilitating effects of $2.70 per gallon gasoline and related oil and gas expenses in their industrial processes?

Might we have expected by this late date that labor contracts expiring in 2007 would have been urgently revisited when it comes to legacy costs, such as defined-benefit pensions and health care costs, which weigh so heavily on our competitive posture? I tell you that for the auto industry, the challenges we’ve seen already pale in comparison to what’s ahead. And I assure you that the Koreans in Alabama and the soon-to-appear Chinese are bound to give the Japanese and Germans a run for their money over the next three years.

Remember, more now than ever before, technology, capital and even labor are mobile and fungible. Investment capital goes where it’s invited and stays where it’s welcome. Remember, too, that there is special motivation for those who now rush to get where we were 50 — or, in China’s case, 80 — years ago.

And in this respect, Michigan’s greatest curse is no different from that afflicting old Europe, Latin America and many other economically stuck-in-the-mud states in our country.

Namely, complacency.

* * *

Let me conclude on a positive, though somber, note.

The national economy is still doing quite well and has momentum to expand throughout 2006, despite rising costs of capital, elevated energy prices, a lackluster prospect for equities and uncertainty with regard to another terrorist attack. Firms are consolidating, and labor is downsizing.

But government continues to grow. This top-heaviness — I call it Michigan’s "economic obesity" — results in greater long-term burdens for the remaining taxpayers in the state, both firms and individuals. For the city of Detroit, and for similarly troubled cities from Pontiac to Kalamazoo, there must be greater focus on limiting spending to only the most basic services.

And while Michigan’s economy has been especially challenged by the industrializing nations of the world, what’s new about that? When challenged, we need to be more, not less, fleet-footed in our adaptability — and fleet-footed in government policy, no less than private-sector labor and management.

Today, the way to differentiate our competitiveness from that of the other cities and states is to provide the best business and living climate — not just to this or that special industry or interest group, but to anyone and everyone who wants to compete here. Today more than ever, the marketplace is not blind, and it is not deaf. Entrepreneurs and workers know keenly and immediately where their labor and capital will be treated best.

When Michigan and Detroit figure this out, our economic prospects will indeed change for the better. Thanks for your invitation and attention.

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David L. Littmann is senior economist at the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.