Monday, July 27, 2015

A valuable lesson in how not to govern a state

So... if you weren't paying attention... and most haven't been and have little reason to... the state of Connecticut is in serious trouble. They're effectively not just bankrupt, they're in the hole so deep they can't even see the top.

20 years ago, they were in great shape, and looking to get better...

So, what the hell happened?

Basically, Connecticut has been a textbook case for "how to kill your economy with government".

...This is gonna be a long one, because I'm not kidding, it really is a by the numbers lesson of exactly what not to do...

CT is in trouble explicitly because of its government.

This is one that even the liberals can't deny... and if you've read much from regional media, even they are generally placing the blame, at least close to where it belongs.

This all started about 20 years ago...

After some rough years in the 70s and 80s while their legacy manufacturing and fishing industires dramadically contracted, and 10 years where their core insurance and financial aervices industries had plateaued; Connecticut went through a huge economic boom in  the mid 90s (as with most of the country, but as a percentage more than anywhere other than MA, CA and TX)

This was primarily due to massive expansion in the financial services sector; as well as the overall technology boom and .com bubble, and smaller booms... or at least swells... in biotechnology and pharmaceuticals, certain elements of the communications, defense, aviation, aerospace, and light manufacturing sectors; and a HUGE boom in the high end commercial real estate and development sectors; all of which CT has traditionally been strong in.

In response to this, the state and local governments very rapidly spent...not just their increased revenue... but decades woth of future revenue as well.

They made revenue and growth assumptions, based on continued growth at that explosive boom rate; creating legislation and programs that depended it... and worse, taking on HUGE amounts of debt, with the assumption that it would be easily paid back with future revenue growth.

At the same time, they made regulations that made it much more difficult and expensive to do business in the state... Because, after all, business was booming, and they could afford it, right?

Well, actually, no.

The state and local governments had increased the burdens of doing business so much, that they made it  nearly impossible for those businesses not in a boom.

They made it particularly difficult for small and medium businesses not primarily driven by discretionary consumer spending; which form the long term economic base of a healthy local and regional economy (about 30% of all private sector employment in this country is from businesses of this type).

Local property taxes and assessments shot up precipitously. Insurance rates skyrocketed. Business to business overheads went up without increased productivity. Legal ahllnd compliance costs went way up. Various individual and business taxes and fees on both the local and state level went up far faster than inflation, or income and revenue growth.

Commercial property costs and new commedical property development went way up in "desireable" areas (even though there wasn't a big increase in demand in most areas). Worse, even though occupancy rates remained stagnant or even crashed, costs still increased significantly in most "less desireable" areas as well.

Similarly,  housing costs and new development shot up in "desireable" areas, even though there wasnt very much overall population growth (CT lost population over the decade), and costs in "less desireable" areas still rose even though occupancy rates fell.

A lot of small businesses, struggling business, and less established businesses just failed. Their costs just became too high for marginal operations to remain viable. At the same time, a number of large legacy business that had been barely viable, became non-viable and finally folded (or in a lot of cases were acquired for short money, then operations were relocated to lower cost markets, contributing both to unemployment and population los).

It became difficult even for established and successful businesses outside of the boom to grow, and very difficult for new businesses outside the boom to get established. The barriers to entry and costs to grow, we're just too high.

In fact,  as early as 1998, it had been noted that in some areas, costs were too high, even in comparison to neighboring or nearby Massachusetts, New York, and New Jersey (with few attractions and advantages to offset those burdens).

The government forgot something critical... They forgot that things change, and people and businesses change and move, in response to changing conditions and incentives.

They forgot basic economics.

Businesses need incentives to stay, that are greater than their incentives to leave. They need incentives to start or grow in one place, that are greater than the incentives in another place. Otherwise they're going to go elsewhere. Simple as that.

When your state is more expensive and difficult to do business in than New York, Massachusetts, New Jersey, and California (every state other than Hawaii in fact)... You're doing something very very wrong.

So, businesses started leaving... or were started elsewhere... or expanded in other states.

The big employers and established big revenue companies were able to leverage their size, power, and government relationships, to get some relief from certain burdens (particularly in the defense, financial, and pharmaceutical industries)... and in general were better able to absorb them... So, for as long as the booms lasted, they were happy to keep doing business. But they weren't actually making sustainable long term business growth and investment in Connecticut.

This of course made the government keep thinking that everything was good, and they kept running up their tab, and tightening the screws on businesses and citizens.

...and then the boom slowed

New and small business development essentially halted. Larger established businesses did not bring more business into Connecticut or grow their operations in the state, and started contracting and relocating operations elsewhere. Businesses outside the state chose not to bring new operations there...

...Unless of course they could wangle a legislative favor and get some incentives and relief...

Which of course the government were all too happy to continue doing... After all, it gave them more power, and more money, and more secure political positions.

And from the government's point of view, all was still rosy...

But those companies still made preparations to move their operations out of state the second anything changed... and they expanded operations anywhere other than CT.

... and then the boom ended.

It actually ended right around October of 2000 or so... though most didnt notice it until mid to late 2001, when both companies and governments, came to the inescapable conclusion that actual realized revenues as of the end of q1 and q2 (as opposed to booked revenues, which may be commonly booked from 30 to 180 days before they begin to be realized... or longer... or in many cases never) were down well below their estimates for 2000, and were tracking lower for the rest of 2001 and into 2002.

... and then September 11th happened...

At the same time, the fed cut interest rates to effectively nothing (anything lower than inflation is actually effectively lower than nothing... which they've mostly been at since then by the way, minus a couple years at "slightly more than nothing" from the end of 2004 to the beginning of 2008. It's been at an actual 0% since 2008), and the property boom that had started in 1996-7 with the .com bubbles halo "wealth effect", suddenly kicked into ludicrous speed.

Between 9/11 and the property bubble... somehow people didn't notice that we were actually in a recession in every sector not dependent on the "wealth effect" or debt driven consumer spending.

After the .com bust and 9/11, most American and international big businesses (outside of certain elements of the financial, mineral extraction, energy, transportation, housing, consumer goods, luxury goods and retail sectors, all of which were riding the bubble), changed their operational patterns dramatically to cut costs and reduce risk (as had happened in the early 70s and mid to late 80s in response to major changes in the marketplace). 

At the same time, small business growth slowed dramatically across much of the country, in response to shifting geographic patterns of development, increased risks, and higher costs of doing business. Small businesses that were not driven by the "wealth effect", were largely stagnant. The startup market collapsed, and outside of a few momentarily hot sectors and minibubbles, became nearly dormant in comparison to what it had been between 1989 and 2000.

Venture capital went into a strange mode where capital pools were building, and risk aversion and command and control mindset dominated... But at the same time, in an effort to drive market beating returns, crazy amounts of money would be pumped into anything analysts thought would be a market maker or primary sector driver, without regard for underlying value... Chasing issues up high and fast, and then dumping them hard once profit taking hit (essentially a legal form of pump and dump).

Everyone's risk tolerance went WAY down, except for those in active bubbles.

Most big businesses started aggressively reducing their exposures to risk, and slashing their legacy and high cost operations, especially in high cost markets like the northeast. High cost low margin operations and businesses were divested or shut down. Big companies got bigger, seeking to leverage scale and reduce risk by acquiring viable but marginal operstions, and small but growing operstions. New development was directed to lower cost, lower risk markets like Texas, Florida, south Dakota, and to a lesser extent Georgia, North Carolina, and Virginia.

Meanwhile,  collectively, Americans were going insane, and running up a massive property and debt bubble,  peaking at the end of 2006 and just kinda floating there til 2009, before popping completely, in the banking bust.

... And during this time, the CT government spent even MORE and took on even more debt, and turned the screws even tighter on businesses and citizens...

...all in expectation that the "prosperity" of the property and consumer spending bubble would result in significantly increased revenues.

It didn't.

In fact, the insurance and other financial services industries that had long been the core of Connecticuts revenue base were damn near destroyed between 2005 and 2009.

Discretionary consumer spending driven businesses had massively over expanded in the bubble, and suddenly began to contract, or fail, wholesale.

Most of the legacy heavy industry of Connecticut manufacturing cities was killed off in the previous 20 years, except those dependent on government contracts.

The fishing business had long been non-viable because of poor catch rates, high costs, and crippling regulation.

And of course, the property development business completely collapsed.

Between 1997-9 or so and 2009, most viable medium and large businesses (outside of a boom industry) that could leave... did.

Well... unless they got a special incentive from the government to stay (Pfizer... you wouldn't even believe....)

Basically, the entire states primary industries and major private sector employers; failed, contracted dramatically, fled the state, or got special considerations which made them revenue neutral (or even net negative due to state spending or subsidy comittments).

Between this and the collapse of consumer spending, small business failures and contraction, high unemployment, and all of the other ripple effects; Connecticuts economy has contracted by between 11% and 15% overall from its peak in 2006-2008 (depending on how you calculate it and  whose numbers you believe).

That's the worst in the country by a large margin by the way.

The picture is much worse when you look exclusively at the private sector economy, which has contracted over 20% (it may be more than 25% or even more depending on whose estimates you believe)

Excluding those companies in the financial sector and other large businesses whose revenues are primarily realized out of state, and those with negotiated tax breaks... Who knows...

The states taxable revenue base has certainly fallen dramatically, by any measure.

... but the government kept spending as if the state were growing, while massively increasing state debt year over year. In fact, state employment and state expenditures INCREASED EVERY YEAR since 2006.

After 2009, any sane government would have slashed the burden and expense of doing business in their state in order to promote growth and attract new business. That's exactly what most of the states I noted above did (all but Virginia, which made it harder, but boomed on increased government spending).

After 2009, any sane government would have looked at their situation and said "hey, those big expensive projects and new spending that we'd planned on? Yeah, we have to put that on hold".

Again, that's what most states did, outside of the "stimulus money".

Not Connecticut.

From 2008-2010, Connecticut lost 120,000 jobs... about 8% of total jobs in the state. During those same two years, government sector employment (outside of indian gaming industry employment, which is counted as government employment) ACTUALLY INCREASED BY 9%

In the face of total collapses in private sector employment and revenues, and an already overwhelming debt burden, Connecticut actually INCREASED spending, and acquired MORE debt... Counting on state and federal government spending to "stimulate the economy" and Kickstart growth.

It didnt.

Then... and this is my favorite bit....

....when some folks both at the city and state levels, finally woke up and tried to restore some rationality and sanity to the situation... cut spending, layoff non essential staff, cancel new programs, reduce scheduled spending increases, put pending projects on hold etc...


That's not a joke... look it up... and it's not just once either... the absurdity of it would be hilarious, if it weren't tragic.

Now they have the worst debt to revenue ratio in the country... and it's not getting better anytime soon.

Regardless of what Connecticuts government officially says (they concluded they had 0.6% net economic growth in 2014), they are facing what everyone honestly examining the situation knows to be net annual outflow of private sector jobs, income, economic output, and population; with resulting decreasing revenue, and increasing debt load. They're in a coffin corner.

In the next two years, large job losses at GE, Pfizer, General Dynamics, and Sikorsky, are going to stagger the states economy even further

... and rather than stop the bleeding and make it attractive to stay in or come to CT, they have doubled down and continued making it worse.

Rather than cut their regulatory and tax burden, making an overall lower cost to do business for ALL businesses, they are desperately trying to o woo specific large employers to come to the state, with tax and regulatory breaks.

The employers weren't biting, because CT did that before and then screwed those companies 4 to 12 years later.... And besides, there's really no advantage to doing so.

Even if they offer a company 100% corporate income tax free operations, and free land to build their facilities (I did mentione Pfizer earlier didnt I?); CT can't give employers the advantages they get in Texas or Florida:

A government they know actually is pro business, and a generally low cost of doing business; lower total tax burden, lower regulatory burden, lower property costs, lower development cost, lower insurance and benefit costs, lower legal costs and risks; and most significantly, a much easier time (and therefore much lower cost) attracting and retaining quality staff at substantially lower cost per employee (because in addition to lower overheadsm these states have a much lower cost of living, much better weather, and much less constrained lifestyles, providing a considerably higher effective standard of living for a given salary).

Of course,  Connecticuts government somehow never got the lesson, that if you took the same breaks from the ridiculous tax and regulatory burden you were going to give to a company promising to bring 5000 jobs into the state.... and you gave them  to EVERY company in the state already... you wouldn't have to beg big companies to come in, and then have to pander to fhem for decades... Small and medium businesses would flourish again, while costs to everyone for everything in the state would go down, and the economy would not just recover, but soar.

... because they just don't think that way...

It's not command and control, it's not collective, it's not a single big thing they can take credit for, it's not one guy they can cut a deal with, or one guy they can control...

... it doesn't fit the narrative...

But... It actually works...