Detroit’s Demise


 

Oh Detroit. All eyes recently turned upon the struggling city with its public declaration of bankruptcy. The Wall Street Journal’s recent article revealed a small glimpse of Detroit’s difficulties.

  • Detroit’s population fell more than 26% from 2000 to 2012 and totals about 700,000—down from almost two million in 1950, according to the census.
  • An estimated 40,000 structures or land parcels sit vacant or empty.
  • The city spent $100 million more than it took in every year since 2008, on average—borrowing the rest.
  • Some 36% of Detroiters lived below the poverty level between 2007 and 2011, the census found.
  • In 2012, Detroit had the highest violent crime rate for a city with more than 200,000 residents, the FBI says.
  • - http://on.wsj.com/13vVDzR

Even before this bankruptcy, Detroit’s unemployment rate was 13.7% in 2006, and in 2008 it’s per capita income was a little under $15K, 54% of the US average. Detroit’s demise has unfortunately been long coming. Once an automobile powerhouse, Detroit has been losing it’s economic prosperity over the last half century with globalization coupled with poor leadership.

DETROIT’S STRONG HISTORY

Detroit was once a prosperous city. Early Detroit took advantage of early transportation advances and grew in tandem with railroad and water networks. “Detroit grew as a node of the great rail and water network long before Henry Ford made his first Model T. Between 1850 and 1890, the city’s population increased tenfold, from 21,000 to 206,000 people. Detroit’s growth was intimately tied to its waterway, the Detroit River, which was part of the path from Iowa’s farmland to New York’s tables. By 1907, 67 million tons of goods were moving along the Detroit River, more than three times the total amount going through the ports of New York or London” (Glaeser, TOC 46). Companies such as Detroit Dry Dock, one of the biggest shipbuilders starting 1872, offered large-scale employment to people like Henry Ford himself. By 1906, Ford has successfully launched the Model N at a bargain price of $500, and ushered in Detroit’s era of the automobile. When a city is home to prosperous businesses, money flows to its employees, and eventually back to the city via spending, taxes, and personal investment in homes and community. Detroit was bumping.

As Glasier points out, however, cities that continuously thrive tend to have a large number of innovative people that that continually iterate, create new products, new jobs, and ultimately perpetuate a robust and healthy city. Large Automobile manufacturing companies, once innovative, promoted the opposite. By consolidating into a large powerhouse and utilizing the more efficient production assembly lines, Ford depraved its employees of actual skills. Furthermore, the size of the major car companies, Ford and Chrysler, yielded efficient economies of scale that acted as large barriers to entree for new comers. By the 1930s, almost no new competitors dared enter the market. “Late-twentieth-century Detroit was dominated by a single industry that employed hundreds of thousands of less-skilled workers in three vast vertically integrated firms” (Glaeser TOC 57). And since Detroit primarily offered low-skilled automotive manufacturing jobs, the Detroit’s population composition shifted in proportion to low-skilled individuals. “Henry Ford’s assembly lines are an example of … the knowledge-destroying idea. By turning a human being into a cog in a vast industrial enterprise, Ford made it possible to be highly productive without having to know all that much. The irony and ultimately the tragedy of Detroit is that its small, dynamic firms and independent suppliers gave rise to gigantic, wholly integrated car companies, which then became synonymous with stagnation” (Glaeser TOC 48-49). But because this was the only way for those major automotive companies to produce their cars, Detroit was temporarily safe.

By the 1950s, Detroit’s advantage through ports and railroads eroded in the wake of declining transportation costs and globalization. It suddenly became possible to find cheaper labor in places such as “suburban factories, like River Rouge, … and China” (Glaeser TOC 50). Increased transportation ease with lower costs allowed cities to import larger quantities of cheaper food instead of grow food in premium city real estate. The same thing happened to Detroit. New technology such as air travel, cheap shipping, and access to cheap labor meant Ford and other major players could produce their products cheaper in other places. Detroit’s unskilled and un-innovative work force suddenly found it self in less demand. Furthermore, Detroit’s companies were no longer the only companies that consumers could purchase from. “Declining transportation costs made it easier for European and Japanese companies to sell cars in the US market. While Detroit’s Big Three had long lost their appetite for radical risk, Soichiro Honda was building fuel efficient little cars. Detroit’s automobile industry stayed afloat with occasional innovations like the minivan and the SUV, but its days of dominance were over” (Glaeser TOC 58).

POOR LEADERSHIP & SUPPY SURPLUS

Detroit’s poor leadership did not help with its unfortunate economic luck. Instead of attracting new labor or companies by making a business friendly environment through economic stimulus, Detroit decided to invest its resources in new buildings and infrastructure. When demand is dwarfed by supply, it makes no sense to make the supply even bigger. When a city in San Francisco experiences way more demand than supply, it makes sense to balance the prices (less it drive out many current inhabitants) by boosting supply. Detroit’s problem is on the other spectrum. It needed people to come in and fill the vacant lots.

Jerome Cavanagh, Detroit’s mayor in from 1962 to 1971, thought it would be a good idea to build more buildings to revitalize the weakening city. His strategy included “razing slums and building tall structures with the help of federal urban-renewal dollars. Detroit’s housing market had peaked in the 1950s and was already depressed with Cavanagh took office. The city was shedding people and had plenty of houses. Why subsidize more buildings? Successful cities must build in order to accommodate the rising demand for space, but that doesn’t mean that building creates success” (Glaeser TOC 53).

Coleman Young, Detroit’s mayor from 1974 to 1994, implemented still more poor economic remedies. In attempts to combat racist segregation and blatant inequality, he raised taxes and unintentionally drove out many richer citizens and businesses. To complement driving out the demand of housing and infrastructure, he created yet more supply by building more. “In 1987, Detroit opened a monorail system, the People Mover, at a cost of over $200 million (more than 425 in 2010 dollars). The three-mile system carries about 6,500 people each day and requires about $8.5 million a year to subsidies to operate. …. it fills only a tiny fraction of its seats… The streets below the People Mover are generally empty and could accommodate fleets of buses” (Glaeser TOC 62). In the 1970s Detroit built the Renaissance Center at $350 million, and then sold to GM for less than $100 million in 1996. In 1981, Coleman and GM replaced 1400 homes and moved 4,000 residents with new high-tech GM factory that employees 1,300 people over 465 acres. Instead of attracting prosperity, Detroit was wasting valuable resources on expanding supply beyond demand, driving down prices and wealth, and further weakening the market.

REAL ESTATE

An already limping Detroit was further beat down in the 2000s with the real estate boom and bust. Subject to cheap credit and institutional predatory lending from major banks, Detroit became dangerously levered in the early 2000s. “Subprime lending hit Detroit like an avalanche of Monopoly money. The city was bombarded with radio, television, direct-mail advertisements and armies of agents and brokers, all offering what sounded like attractive deals. In 2006 alone, subprime lenders injected more than a billion dollars into twenty-two Detroit ZIP codes. In 48235 ZIP code, which includes the 5100 block of West Outer Drive, subprime mortgages accounted for more than half of all loans made between 2002 and 2006. Seven of the twenty-six households on the 5100 block took out subprime loans. Note that the only a minority of these loans were going to first-time buyers. They were nearly all refinancing deals, which allowed borrowers to treat their homes as cash machines, converting their existing equity into cash.” (Ferguson AoM, 241). The Case-Shiller index reveals that Detroit’s housing value increased 50%, even in the wake of a depressed economy. It is no surprise that when interest rates rose, many could not afford their new payments and defaulted on their loans. “As early as March, 2007, about one in three subprime mortgages in the 48235 ZIP code were more than sixty days in arrears, effectively on the verge of foreclosure” (Ferguson AoM, 245). “According to the Census Bureau, 86% of central-city Detroit’s housing stock was built before 1960. The average house in the city is valued at $82,000, which is far below the cost of new construction” (Glaeser TOC 64). A quick scan on websites like Zillow and Redfin shows that some places in Detroit are even worth $400. Detroit, its economy, and its real estate market were delivered another crippling blow.

IS DETROIT FINISHED?

Is Detroit finished? Perhaps, but perhaps not. There are many current great cities that experienced severe troughs. Boston and New York, for example, both experienced severe low points in the 1970s.

Boston never historically had a strong natural economy. Founded by Puritans who strongly valued studying God’s word through the Bible, Boston luckily had a strong foundation in education. It’s first economy, however, was a Ponzi scheme that sustained itself by selling goods to new settlers moving into the area. Once that collapsed, Boston in 1647 was lucky enough to find commerce in shipped food and wood to the southern cash crop colonies. However, when ships became faster, Boston was yet again left in the dust. After several reinventions that included yet-again trading, manufacturing, it’s abundant schools pumped out people knowledgeable in engineering, computers, financial services, management consulting, and biotechnology. Numerous entrepreneurs created brand name companies such as Raytheon Missiles, Fidelity Investments, Boston Consulting Group, and more, that are today fuelling Boston’s thriving economy and city. Boston’s key to success was a strong education system that built a population of students, then entrepreneurs, then businesses, then prosperity.

New York, which declined as a city in the 1970s, roared back as a result of entrepreneurship that largely happened in the financial services. “In 2008, more than $78.6 billion was paid to employees in the sector the US Census Bureau quaintly calls Securities, Commodity Contracts, and Other Financial Investments and Related Activities” (Glaeser TOC 56). Heroes such as Michael Bloomberg created the Bloomberg terminal, and New York’s economy, and New York itself, has been roaring ever since. New York has attracted so many more inhabitants than it can house, that the average price of a 1200-2000 square foot home is $490K, compared to Houston’s median price of a 3-4 bedroom house at $161K.

What Detroit needs to do is attract companies. Just like how the Bay Area became the go-to spot for technology companies with its abundant financing and talented labor, so much Detroit become a magnet for some type of industry. Currently, it lacks any strong incentive for companies to go or stay in the city. Without job offers, Detroit has less of an incentive for people to move or remain, either. “Detroit needed … human capital: a new generation of entrepreneurs like Ford and Durant and Doge brothers who could create a new industry, as Shockley and the Fairchildren were doing in Silicon Valley” (Glaeser TOC 53).

Investing in education will likely yield dividends in the future by creating, instead of attracting already educated talent. But this can take a long time — Boston was fortunate in that its early founders in the 1600s planted the seed of education. Furthermore, education is a long-term play, and long-term strategies don’t necessarily address the today’s problems of slashed pensions and high crime rates. What can Detroit do today, or in the next few years, to turn the city around? I don’t know, but I do wish Detroit’s current mayor, David Bing, good luck.


Edward Glaeser’s “Triumph of the City”
Niall Ferguson’s “The Ascent of Money: A Financial History of the World”

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