Overcoming Economic Downturns and Fiscal Distress Part V: Business Development and Balanced Budgets
In Part V of ‘Overcoming Economic Downturns and Fiscal Distress’, James Spiotto Discusses the Benefits of Economic Stimulus and Business Development, and a Case Study in Upside Chicago
- Part IV of this series focused on addressing legacy costs, most notably public pension systems, so that investments in needed infrastructure improvement, and funding of essential services, become the solution to fiscal distress and economic downturns.
- In this installment, we look at business development as a means to generate revenue and balance budgets.
- Upside Chicago, a business development project involving new industrial parks, manufacturing jobs, and relocating companies into Chicago and Illinois, serves as a case study and road map for economic prosperity.
by James Spiotto
Business Development and Balance Budgets for State and Local Governments
In the U.S.A., the Current Cost of Energy Has Significantly Been Reduced and the Productivity of the U.S. Worker Has Continually Increased Since 1947:
U.S. workers have the highest productivity of large developed countries — The non-farming business sector had cumulative increases in annual production since 1947 of approximately 145% – the steel industry in the U.S.A. produces one ton of steel using 2-man hours, in China a comparable one ton of steel is produced with 12-man hours, as well as three times the amount of carbon emissions per ton. China’s overall productivity per worker is 17% of that of the U.S.A., and among the larger developed nations the U.S.A. has the highest productivity per worker, as data from the Organisation for Economic Co-operation and Development (OECD) shows below. This chart shows the GDP per hour worked in U.S.A. dollars for each of the G-20 countries from 2001 to 2016. The U.S.A. has been the leading member of the G-20 in productivity since 2004.
How low cost of energy and high productivity has opened the door to new manufacturing jobs — In 2014, 60,000 manufacturing jobs were added to the U.S.A., compared to 12,000 in 2003. In 2014, there was a net increase of 10,000 in manufacturing jobs, with 3 to 4 million manufacturing jobs offshore that could be filled domestically. There is certainly potential for significant reshoring of jobs. Traditionally lower labor cost countries, including China, are now experiencing wage escalation. Recent major U.S. companies that have reshored jobs include Walmart (2,514), GM (1,500), Caterpillar (1,400), Ford (1,400), and GE (1,300). In 2014, U.S.A. ranked second behind only China among the world’s top exporting economies.
The job multiplier for manufacturing jobs — Again, for every new job reshored, there is an indirect and induced economic benefit. For example, the job multiplier would range from 2-6 additional jobs for every one manufacturing job, where related jobs for supply, servicing and transportation can range from .5 to 2.6 or more additional jobs.
Corresponding increase in infrastructure improvements — With increased business activity comes the need for improvement in infrastructure and, as past and recent studies have shown, $1 of hard cost of infrastructure yields an benefit of $3.21 in economic activity over 20 years. With the projected need for $3.6 trillion of infrastructure improvement in the next five years, that spending would correspond to over $10 trillion in economic stimulus over the next twenty years, with a corresponding increase to our current GDP.
Why everyone wants to invest in U.S.A. and U.S. businesses — The eroding currency market, especially for currencies in Asia and Europe has created a dynamic that the U.S. dollar is the strong, safe currency for investment purposes. Given their respective exchange rates with the U.S. dollar, China and the European Union are now highly motivated to invest in the U.S.A. to produce revenues in dollars that will be more valuable to them than investing in businesses in their own country. This motivation of foreign investment in U.S. manufacturing and moving operations to the U.S.A. could make all the difference to any challenges in balancing state and local government budgets.
Business Development and Economic Stimulus, Creating New Jobs and Taxpayers, and Increased Revenue to Balance the Budget:
It is all about revenues — As most governments that successfully addressed financial distress have recognized, while efficiency and reductions or elimination of wasteful expenditures are helpful, it is business development and economic stimulus that create new jobs and increase tax revenues.
Avoiding the death spiral — If you raise taxes and cut services to balance the budget, you may well discover that tax revenues actually go down when individual and corporate taxpayers leave, because they are asked to pay more for less services. If you repeat the raising of taxes and cut in services, it only gets worse. This “Death Spiral” was demonstrated by Bridgeport, Connecticut in the late 1980s and 1990s and Detroit in the decades before 2013.
We Cannot Avoid Economic Cycles but History of Financial Stability Points the Way
In the U.S.A., financial challenges and difficulties in balancing a government budget are not so much caused by the desire to spend more than tax revenues currently generate, but rather by economic cycles such as panics, recessions and depressions. Cycles are exacerbated by unfunded pension obligations that are not sustainable, as well as the adverse effects of failing to fund essential services and needed infrastructure at an acceptable level. The healthy economy of a state or local government goes hand in hand with full funding of essential services and needed infrastructure improvements, and making sure all costs, including labor and pension obligations, are sustainable and affordable. For example, since 1945 we have had 11 economic downturns. In each downturn (except 2008), the upturn/recovery has been helped by increased stimulus, including increased borrowing by state and local governments for infrastructure and capital improvements, assisting increased employment and GDP growth.
United States Economic Trends, 1949-2009 (year-on-year % change)
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Need to Address the Systemic Problems of the Past That Caused Financial Distress
Between 1950 and 2010 there have been over 600 debt restructurings of 95 countries, with the general rule that the same countries attempt restructure more than five times on average, without success. Other countries that have suffered the need for a debt restructuring have generally repeated the process numerous times with band-aids rather than a permanent fix. They merely reduced debt without addressing the systemic problems that caused the financial distress in the first place. State and local governments should always strive for permanent fixes, rather than temporary band-aids that kick the can down the road, often exacerbating the problem.
The Secret That Balanced Budgets Require Services and Infrastructure at the Level Desired
State and local governments in the U.S.A. have a long history of financial credibility, with low default rates. Since 1839, the average annual default rates of state and local governments is only 0.058%. State and local governments, having learned that quick fixes and failure to maintain governmental services and infrastructure at an acceptable and desired level result in a loss of businesses and individual taxpayers, with the accompanying financial distress. Efforts to balance budgets by increasing taxes and reducing government services have been met with the exodus of individual and corporate taxpayers, with subsequent decreases in revenues. There is a constructive relationship to providing government services and infrastructure at acceptable levels, in order to attract new business and residents. This helps stimulate economic development, increasing employment, and increasing revenues. The high-tide of increased numbers and increased revenues raises all boats over time.
UPSIDE CHICAGO — CREATION OF 10-18 INDUSTRIAL PARKS IN THE CHICAGO AREA CREATING 20,000 NEW GOOD JOBS FOR ABOUT 100-140 NEW OR RELOCATED COMPANIES
The Natural Attributes of Chicago for Business Development
- Nation’s Transportation Center — Chicago is the center of commerce, especially in the area of Transportation (major rail, land and air as well as water).
- Major Manufacturing Center. — Chicago is the second largest manufacturing metropolitan area in the U.S.A., and has a long history in manufacturing given its central location and ease of transportation.
- Educated Workforce. — Chicago has an educated workforce and the ability to educate and train workers for the new manufacturing models of the future.
Development of Upside Chicago
Businesses Lead Innovation — The concept was created by local business professionals on a pro bono basis who had experience with operations, manufacturing, finance, insurance and Special Economic Zones, both domestically and internationally.
Use of Special Economic Zone Experience — The factors that produced lower cost for production and distribution of goods that led to the development of the Maquiladora in Mexico and Special Economic Zones in China (and elsewhere) are now present in Chicago.
Significant Cost Saving — For Labor and Freight-Intensive Manufacturing the cost of shipping can be 8-16% or more of Sales Price, while labor can be 15-22% of Sales Price. A savings of 3-6% or more of sale costs is the equivalent of reducing employment cost by about 25% or more.
Project Costs — Chicago’s unique transportation facilities could reduce shipping and handling costs by 4-6% or more of Sale Price, depending on the comparative shipping locations.
Benefit of Managing Agent and Shared Services — Establishing a non for profit special purpose entity that would be the Industrial Parks Coordinating and Supervising Managing Agent (“Park Agent”), that would offer manufacturing sites with cost efficiencies for smaller manufacturing companies, 100-250 employees by shared services (think of as condominiums for manufacturing), where building outside maintenance, public safety, freight services, public safety inspection, insurance (worker compensation and other general liability) etc. are shared costs. This would also facilitate the ability to leverage in negotiation on par with mega manufacturers with 20,000 workers. In addition, all available financing assistance through local government economic development incentives, site improvement assistance, and financing structures would be pursued to the extent appropriate.
Target Manufacturing Businesses — The main focus would be lower skilled jobs with higher shipping and handling costs, such as auto reclamation, parts re-manufacturing (roughly 2,100 companies in U.S.A.), recyclers (about 3,000 companies in USA, 103,000 employees), return processing (or on-line sales return processing), data storage and processing centers, etc. Given the projected savings (from reduced shipping costs and shared services savings, as well as possible governmental incentives), it would be very attractive to these companies to move to Upside Chicago.
Sufficient Workforce — There is more than sufficient supply of high quantity low skilled and semi-skilled workers in Chicago area — the commutable area has at least 1.4 million workers. Strong employee base is a crucial metric when firms make location decisions.
Attraction of Industrial Parks — Companies can envision themselves in a clean, modern, safe, digitally wired, next generation industrial park, as opposed to being attracted to disparate (perhaps) degraded individual site. Park companies will bond with each other for the benefit of all. They will learn from each other with regard to workers, safety, security, environmental compliance, security etc. The bundled economics benefits of Upside Chicago gives small companies the benefit of a larger enterprise, and increased capacity to invest time in other areas, by reducing or eliminating time which would have been spent negotiating individually on shared services provided by the Park Manager.
Benefits of Using Foreign Trade Zone Status (With Alternation Site Framework) for Upside Chicago and Other Projects
A city of public corporation can apply for Foreign Trade Zone (FTZ) status, requiring approval by the Departments of Treasury and Commerce.
- Foreign Trade Zone Act 19 U.S.C. §81(u).
- Foreign Trade Zone Board Regulation 15 C.F.R. §400.
- Custom Regulation 19 C.F.R. §146.
Alternation Site Framework (ASF) gives participating zones greater flexibility to a much simpler, faster minor boundary modification procedure, to designate locations where companies are ready to use FTZ. FTZs maintain and create jobs and foreign business involvements in the U.S., as opposed to in a foreign country by customs/tax financial savings. They stimulate American economic growth and development, by encouraging companies to continue to expand their operations domestically. Companies that operate in FTZs import parts, material, components, or equipment for manufacturing, and they finish the goods or parts for distribution in the U.S., or to be later exported.
The benefit of FTZ status is that the custom duties on foreign parts, materials, components, or equipment imported by the company operating in the FTZ either are eliminated or substantially reduced or deferred, so that generally the only duty is on the finished product. This is a significant reduction in overall duty expenses. This applies to foreign products admitted into the FTZ for storage, exhibition, assembly, manufacture, and processing.
Projected Economic Benefits of Upside Chicago Concept: Upside Chicago and the goal of creating 20,000 new manufacturing jobs (with additional indirect and induced jobs) should over the long run
- Create 44,000 jobs more or less (direct, indirect and induced job multiplier).
- Increase state and local taxes by $426 million or more.
- Help improve infrastructure and government services with increase tax revenues in addition to the Industrial Park site improvements and infrastructures.
- Produce an estimated economic benefit of the Industrial Park Program of over $8 billion.
Economic and business development, combined with maintaining a balanced budget and fully funded provision of essential government services and infrastructure is the best strategy to deal with inevitable economic downturns and changing fiscal times. The increased revenues for economic and business development creates the high tide of revenues for the ship of government to navigate through financial distress, and provide for economic and operational recovery. Whether the approach to economic development is through Foreign Trade Zones, an industrial park proposal, or attracting high tech, med tech, digital, or other businesses that produce high-paying jobs, the goal is the same; to remove economic obstacles and stimulate economic growth for the benefit of the citizen taxpayer. In the next article of the series, we review what assistance is provided by the State of Illinois to its local governments. We also examine the promise of additional assistance and aid in pending legislation on the 2017 legislative calendar for the Illinois General Assembly.
James E. Spiotto, Co-Publisher © James E. Spiotto. All rights reserved. The views expressed herein are solely those of the author and do not reflect the position, opinion or views of Chapman and Cutler LLP or Chapman Strategic Advisors LLC.
Up next…Oversight and Assistance Currently Offered by the State of Illinois, and Possible Remedies Provided by Pending Legislation
Click here to read the introduction to this series, “How State and Local Governments Can Overcome Economic Downturns and Fiscal Distress”
Click here to read Part I: The Gathering Storm
Click here to read Part III: Solving Financial Distress with Economic Development
Click here to read Part IV: The Need to Successfully Address Public Pensions