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“In public administration, there is no connection between revenue and expenditure . . . there is no market price for achievements.”
Fifty years ago, Detroit was the fourth largest city in the United States, with a population of 1.7 million people, and at $8,500 per year, one of the richest cities in terms of per capita income. It was 3.5 times the size of Indianapolis, the 26th largest city, whose income was almost identical on a per capita basis. Today Detroit and Indianapolis are the 11th and 12th largest cities, respectively, with Detroit’s population cut in half from 50 years ago (and losing 3,000 people per year this decade), while Indianapolis has grown by 70% during the same time frame. Remarkably, Indianapolis now has a per capita income 50% greater than Detroit’s.
How did this happen? One answer, according to the Mackinac Center for Public Policy, is that Detroit’s city government is far larger, more regulation prone, and more bureaucratic than Indianapolis’s city government: the ratio of residents to city employees, a key measure of city government productivity, is 50:1 in Detroit, one of the worst in the United States, but is 203:1 in Indianapolis, one of the best. More broadly, the central issue in political economy concerns the optimal delineation of the sphere of government activity versus that ascribed to markets, and in this essay we examine this question from the vantage point of municipalities.
Markets are said to fail in the event of natural monopoly or in the case of public goods such as national defense, where consumption of the good is nonexcludable and nonrivalrous
What does economic theory say about the proper role of government, and how do proponents of larger government attempt to justify their argument? Writers from Aristotle to Locke to Adam Smith have inveighed against government intervention, and indeed, neoclassical economic theory has affirmed the superiority of free markets as the institutional backdrop most conducive to the generation of wealth.
However, allies of big government rely on the modern theory that holds that government provision of goods and services is warranted in cases of market failure or externalities in production. Markets are said to fail in the event of natural monopoly (where average production costs decrease with increasing scale, and hence the most efficient industry structure is a single producer) or in the case of public goods such as national defense, where consumption of the good is nonexcludable and nonrivalrous (e.g., the consumption of national defense services, say, unlike the purchase of a home or an automobile, cannot preclude a “free rider” from enjoying the same services). Meanwhile, a popular example of a negative externality is factory pollution, where property rights are not clearly defined; in all these cases, traditional economic theory offers a prima facie rationale for government intervention or regulation.
The Austrian School of economics does not countenance the received theory in these instances: Ludwig von Mises pointed out, for example, that monopoly could only technically occur in an instance where a scarce resource was controlled by a single party (e.g., the DeBeers diamond holdings approach this), and thus most observed instances of monopoly were in fact generated by government sanction (e.g., public utilities).
Similarly, Austrians point out that public-goods provision as justified by the existence of free riders is often a case of poorly defined property rights. Nonetheless, as Tocqueville presciently warned, the activity of government at all levels of society has not been constrained, not even merely to the provision of public goods: the tendency has been for many indisputably competitive services to be provided by municipal, state, or federal governments, often in the name of redressing alleged social ills such as inequality. Via progressive (and progressively increasing) taxation, this has unduly burdened the public purse at all levels, and led to hardship, particularly in many “Rust Belt” cities.
In this essay we examine the linkage between taxation and the size of municipal government on the one hand, and economic vitality on the other, which is proxied by data involving population or per capita income changes. Via a case study of one Rust Belt city, Akron, Ohio, we review the recent history of how it has fared comparatively in terms of economic vitality. While the picture depicted is bleak and an all-too-predictable consequence of unrestrained growth in government, we then turn to a solution to Akron’s problems–the only viable solution–based on privatization of city services and a lessening of the (tax) burden of government. This discussion is gleaned from well-run cities in the United States. We then conclude with observations about the meaning of these findings for the future of urban America.
Akron, Ohio’s experience with growing government and subsequent economic health
Akron was once a proud industrial city, and home to the largest tire makers in the world. Aligned with manufacturers in nearby Pittsburgh, Cleveland, and Toledo, Akron supplied the automotive industry in Detroit, and was known as the world’s “rubber capital.” The city has been in a long-term secular decline, however, and city government is now dominated by the longest-running mayor in the city’s history–20 years and six terms. A review of this period is in order, therefore, to assess economic growth in relation to the current administrative regime there. For this analysis, the US Census Bureau’s Statistical Abstract of the United States and the Mackinac Center for Public Policy (a Michigan-based institute studying regional economies) are reliable data sources yielding the following observations:
Comparative Statistics from the 2000 Census
Population change, 1990-2000
Population change, 2000-2003*
|High school grads||80.0%||83.0%|
Home ownership %
|Mean house value|
Median household income
Per capita income
Per capita retail sales
Poverty rate, 1999
* Connotes relative decline continuing into 2000s for latest available comparative data; Akron population loss is now -3.2% from 2000 to 2007.
Source: US Census Bureau
In sum, Akron is seriously declining: since 1987, the US economy is 70% bigger in real terms, but Akron has lost 21,000 people. This period has been one of poor leadership, borne of an entrenched government, unfriendly to business and growing both absolutely and relative to other municipalities in size and scale of operation. However, economic decline is not inevitable, and Akron can achieve a strong turnaround, given its considerable assets. Its best–and only–hope, however, lies in replicating what has worked elsewhere, and involves cutting government and increasing the sphere of private sector activity.
Case study of private sector solutions: Indianapolis
Indianapolis in the 1990s provides a lodestar as a model. In the early 1990s the city and local economy were still restructuring from an earlier stagnation in which, as in Akron, durable manufacturing jobs had been lost; the population of Indianapolis was 15,000 less than in 1970. While the city had begun to diversify into services such as health care in the 1980s, only the government sector had grown materially (Indianapolis is the state capital). Further, property tax and county income tax rates had exploded, and were up 25% and 350%, respectively, during the 1980s.
Mayor Stephen Goldsmith took office in 1992, committed to a turnaround based on privatization of city services, and creating a climate more conducive to entrepreneurship. During his eight-year tenure as mayor, the city’s population increased by nearly 50,000 residents, induced by a more business-friendly environment and its corollary, smaller government. The Indianapolis turnaround was engendered via a three-part program:
(1) Creation of the “SELTIC” (“Service, Efficiency, and Lower Taxes for Indianapolis Commission”)–SELTIC was composed of nine private-sector volunteers, primarily leaders in the business community, who in turn chaired subcommittees with more volunteers with various needed functional expertise or skills. SELTIC’s mandate was to study every activity of city government, from wastewater treatment to business licensing. The goal: make every city service higher quality, less expensive, and business friendly–or eliminate it altogether. Best practices were gleaned from other municipalities or the private sector, and benchmarking was done for competitor cities and suburbs. SELTIC reported to Mayor Goldsmith, and became an outreach vehicle for new business recruitment.
This commission was the driver of the ensuing miracle in Indianapolis, and has been copied all over the United States. Under Goldsmith, Indianapolis cut its budget and accrued savings of $480 million in eight years (based on straight-line projections dating to the early 1980s); cut its employee workforce from 4,650 to 3,400 (improving its efficiency ratio of residents to employees to one of the best in the nation, well over 200:1); cut property taxes four times; held its income tax steady after ten years of increases; and saw its municipal debt upgraded to AAA. Finally, unemployment declined from 5.2% to 2.3% during Goldsmith’s eight-year tenure, beating the national averages absolutely and relatively. As a result of this impressive performance, over 3,500 mayors, governors, and councilmen came to Indianapolis to learn how it was done in the late 1990s.
A long literature in Austrian economics details how and why governmental bureaucracies fail in the real world; in brief, there are problems with incentives, and failures to exploit knowledge that can solve problems in society. Further, absent private property, there is no entrepreneurship–what Israel Kirzner refers to as the driving force of the market economy–and thus poor coordination and use of resources. The SELTIC commission provided empirical validation to this thesis, and was an essential part of the revivification of the city of Indianapolis.
(2) Commitment to excellence via privatization–In business or government, monopoly can be inimical to economic growth. Monopolists retard quality and customer service, increase costs, and impede innovation, and America’s best-run municipalities now choose private competition over monopoly wherever able. This was the secret to the Indianapolis boom, which other cities have now replicated, and it is Akron’s best hope for its future.
How does it work? Indianapolis’s SELTIC started with a “yellow-pages test”: dozens of city services, from janitorial to print shop to sewer billing to golf course management, were analyzed to see if private-sector vendors offered the service in the yellow-pages. If so, a competitive bidding occurred for contracts to provide the service. This is outsourcing with a twist, however, because if the private vendor won the bid, it absorbed the city’s AFSCME (American Federation of State, County, and Municipal Employees) unionized workers. In fact, during Goldsmith’s 8-year tenure, not one city employee became unemployed; the employer merely changed, with Indianapolis insisting that comparable pay and benefits be initially maintained. And in unique arrangements, AFSCME sometimes continued to represent the workers under now-private ownership. Eventually, 75 services were put to competition: sometimes the city employees won the contract; sometimes a private firm won; but in all cases, huge savings and efficiencies emerged. This is how Indianapolis cut 43% (1,200 workers) of its non–public safety workforce, and shaved $480 million from its budget in 8 years. And happily, the public sector union, AFSCME, generally applauded Indianapolis’s public-private partnership excellence, especially when workers received incentive bonuses allowed by new ownership and governance.
The lowered burden of government unleashed the private sector of the Indianapolis economy across the board: per capita income was up by a fourth at decade’s end, and employment growth averaged 1.4% every year during the 1990s. Many cities have copied this formula now for the same reasons: Green Bay, for example, privatized its transit system, with cost savings of 7% annually and improved service quality. Managed competition was instituted in Phoenix and Charlotte for waste collection, Buffalo for recycling, and Dallas for vehicle fleet maintenance. Ditto for Los Angeles golf courses, Riverside County’s libraries, and facilities maintenance in Cincinnati. Virtually every municipal service is easily amenable to competition (if not outright privatization), with impressive results in better quality and efficiency, lower costs, lower taxes, and improving job-creation environments.
From the foregoing, it is clear that Akron needs to seek efficiencies and cost improvements in order to lower city spending. Why? Because taxes must be lowered for Akron to revive. Only 20% of US cities have more onerous tax structures than Akron, and there is a significant correlation between low taxes and job growth. For example, since 1990 Akron has lost 14,000 people, and Green Bay has gained 7,000 with similar demographics; Green Bay’s per capita tax burden is less than half of Akron’s. And, Green Bay’s per capita income is now 25% higher, while its resident/city-employee ratio, again a key measure of municipal government productivity, is 27% better than Akron’s.
Similarly, in 1999, Goldsmith’s last year, Indianapolis had a budget of $545 million (in 2007 dollars), and employed 3,400 (down 1,200 from eight years earlier); Akron’s 2007 budget is almost as big at $490 million, with only 2,400 employees. Worse, Indianapolis had a population then of 780,000–nearly four times that of today’s Akron. Clearly, Akron city government is inefficient and the primary reason for the long-term downdraft in growth, and needs a SELTIC in the manner of Indianapolis.
(3) Transparency–Private-sector innovation brings tools to generate efficiency, quality, and integrity: activity-based costing, performance measurement, audits, and explicit contract requirements were all part of Indianapolis’ success. This enforces a culture of excellence in contrast to, say, Akron’s city managers, none of whom–even in the year 2008 and “post-Enron era”–have written job descriptions against which performance can be judged, according to the city of Akron’s finance director.
As an example, the website for the city of Akron contains the 2007 annual budget in a document of 27 pages; it is impossible to glean details from this summary. Mayor Jim Schmitt of Green Bay, whose website, by contrast, contains a detailed 192-page city budget audited by a third party, summed up what such a culture breeds. Schmitt, who moved his economic development team next to his office and spends over half his time in business recruitment, said that “entrepreneurs know what they’re doing; the best thing we can do is get out of their way.” Their creative ideas and systems, he said, help both private and public sectors become better. Indeed, football wasn’t the only winner in Green Bay this fall: WS Packaging Group, a $380 million-in-revenues manufacturer of labels, coupons, and packaging, has just committed to move to the city, and population is up by over 1,000 in Schmitt’s 4-year tenure.
Indianapolis, and more recently cities like Green Bay, offer a blueprint for the renaissance of Akron:
1. a SELTIC-like commission driving change,
2. demanding a culture of excellence dominated by privatization and competitive bidding, and
3. transparent reporting and openness.
It is a formula by which Akron’s union workers and businesses can win, and it confirms a fundamental verity propounded by Austrian economists with respect to the ironclad nexus between limited government and economic growth.
Municipal governments that grow raise the tax burden on their residents, and this in turn acts as a drag on both the future tax base and economic growth of the area. The decline of Akron, Ohio is a clear example of this, and the resurgence strategy of Indianapolis in the 1990s is the only path to a reversal of fortune in this case. Indeed, a long-term view of this is instructive, as per Detroit and Indianapolis discussed at the outset. While both are Midwestern cities with a heavy industrial base, they are at opposite ends of the spectrum in terms of size and scope of municipal government: the size of government for each city is in inverse proportion to their levels of per capita income. Indianapolis continues to grow, while Detroit’s population is declining on a weekly basis now.
In closing, it is instructive to reiterate why privatization is indeed the only hope for renewal of once proud cities. In his 1944 book entitled Bureaucracy, Mises distinguished between “bureaucratic management” and “profit management.” He explained that neither incentives nor exploitation of useful information are optimal under bureaucratic management, and by definition there could be no rational calculation via profit and loss. Hence, coordination of resources will never be optimally efficient. That is to say, it is in the very nature of government management (bureaucracy) that it will be inefficient, and prone to corruption. Conversely, after privatization, operations and cost efficiencies improve because once incentives are in place and aligned, and people are empowered and incited (by the lure of profit) to utilize “particular knowledge” of markets, methods, competitive conditions, et al., performance improves.
Finally, Mises also warned of a byproduct of bureaucratic management: the “vanishing” of the “critical sense.” He again described this phenomenon in “macro” terms (e.g., the German people giving up on a liberal order during the 19th-century prelude to Bismarck’s socialism), observing how the docility of a whole people could arise in the face of a dictator. But this obviously occurs in enterprises operated by municipalities, too, which are not subject to the competitive whip of profit-and-loss competition. It is perhaps the final guarantor of the certain failure of bureaucratic enterprise, relative to the initiative, entrepreneurship, integrity, and pride witnessed in the private sector. Indeed, the very hope of Akron–and cities like it–is embodied in this latter mindset.
John L. Chapman is an NRI fellow at AEI.
 See Indianapolis Star, December 22, 2007. The figures are $21.6k and $14.7k, respectively, for Indianapolis and Detroit. Additionally, in the last year the unemployment rate in Detroit has fluctuated between 8-9%, while it has remained inside 4% in Indianapolis.
 There are two major drivers of differences in the relative economic efficiency of municipal governments. First, some city executives are simply smarter and more effective in execution. Mises points out that while there is no profit-and-loss accounting (economic calculation) for the services of, say, a police force guarding a large facility, the fact that municipal bureaucracies exist alongside private enterprise may allow observation of economic methods from the private sector (e.g., one city may discern, say, that only 20 policemen could do the job where 30 are employed in a city run by less astute executives). Secondly, some cities simply take on services which may be more effectively provided by the private sector (e.g., golf courses, print shops, fleet maintenance, etc.). And once under city management, the very nature of bureaucratic management, according to Mises–again, devoid of profit-and-loss accounting tools–guarantees less efficient operation. Mises mentions a third reason–often found in municipal government operations–that breeds inefficiency: corruption and racketeering. All these combine to generate diseconomies of scale in municipal government.
 While beyond the scope of this essay, the Austrian literature offers a substantive critique of neoclassical theory with respect to market failure and externalities; see, for example, the writings of Walter Block, Roy Cordato, Randall Holcombe, George Reisman, et al. James Buchanan criticizes the modern theory in his 1968 book The Demand and Supply of Public Goods (Chicago: Rand McNally), and of course developed an entirely new paradigm for viewing these issues (public choice), in which government failure was depicted as the empirical norm for regulatory and interventionist programs which neoclassical theory had predicted to be ameliorative. Nonetheless we briefly summarize the standard theory justifying government.
 And, as Ben O’Neill has pointed out here recently, it is not at all clear that free riding is harmful to economic agents, absent coercion.
 A disclaimer is in order: I am not a disinterested observer in Akron. My great-great-great-grandfather settled there in 1831 in a farmhouse still used today; I am a sixth-generation Akron native; and, I am a product of Akron public schools. Akron’s recent fortunes, however, mirror many cities in the Midwest, which are often controlled by one dominant local political party for multiple election cycles, and have witnessed concomitant growth in municipal government and in the range of services government provides.
 The headquarters for Goodyear, Firestone, B.F. Goodrich, General, and many lesser tire companies were once all in Akron; today, only Goodyear (founded in 1898) remains, with a much smaller workforce of management and R&D personnel only. Astonishingly, not one tire is made in Akron any longer, as production has moved to the less-unionized south or overseas. Michelin (France), Continental AG (Germany), and Bridgestone (Japan) are now the world’s biggest tire makers, a position Goodyear held for most of the 20th century. Tires were the main product focus, but other rubber and polymer-based products, for both industrial and commercial use, have long been a part of the mix.
 The mayor of Akron was president of the US Conference of Mayors in 2004, and has been described by the local newspaper, the Akron Beacon Journal, as providing two decades of leadership from which the city of Akron “has substantially benefited.” The same newspaper, however, has criticized questionable practices such as the hiring of “consultants” in unilateral decisions or no-bid contracts, or having a minimum-wage parking lot attendant fired from his job for not recognizing the mayor and insisting on a $5 parking fee payment the mayor tried to evade. The colorful personality of this politician and the details of his perquisite consumption and governance are beyond the scope here, other than to note that his is an entrenched administration, and a classic case to which proponents of term limits point.
 According to the City of Akron 2007 Budget, there are 2,409 city employees, indicating a resident/employee ratio of 86:1.
 A distinction should be made between pure privatization, in which the governmental entity sells (or otherwise relinquishes) a service unit to owners in the private sector (such as when, say, the Thatcher government in Britain sold off state-owned utilities like British Telecom to private investors, and BT became a wholly investor-owned company, traded on the London Stock Exchange), and competitive bidding for outsourced service provision, in which the governmental entity outsources a service to market-based competitors via a bidding process. The latter still involves government management and oversight, but is at least an improvement from the provision of the service by a government-owned or controlled monopoly. Below we detail the case of Indianapolis: 75 service units were affected by the “privatization” push, utilizing that term to include competitive contracting and outsourcing in some cases, while in other cases a private firm won the contract for the service and absorbed the city’s employees into its business. Indianapolis thus reduced city employee headcount from 4,600 to 3,400 between 1992 and 2000. In a minority of cases, the city business unit actually won in an open bid against private contractors, and thus “retained” the business, but the competitive whip of the process itself led to productivity gains of the work unit, postcontract. These units were also able to sell their services to other entities or municipalities, so they became revenue centers, and the employees got bonuses based on unit performance. Clearly, competitive contracting and outsourcing still involves government control over resources that may be best suited to the private sector (why, for example, should a municipal government own and run a golf course?). However, as shown below, the Indianapolis strategy for shrinking city government and the tax burden is tantamount to the reverse of Lenin’s New Economic Policy of 1921: Lenin allowed for market measures and private property and production to flourish after 1921, arguing that conditions only permitted introducing socialism “step by step.” Where possible, Indianapolis privatized completely, while in other cases the breaking up of de facto government monopoly service provision, via competitive contracting and outsourcing, certainly creates the opportunity for eventual privatization by manifestly highlighting service level, cost, and quality improvements.
 Indeed, there is an undeniable connection between local tax rates and population growth. In 1980, according to the National League of Cities, per capita income of city residents nationwide was 90% of their suburban counterparts. That figure had imploded to 59% by the end of the decade, after heavy tax-rate increases in most municipalities were tried to make up for a declining tax base; a primary reason for the decline was departure of residents to suburban areas with more favorable tax regimes. In Indianapolis, this problem was still manifest a decade later; for example, the net property tax burden on an $80,000 house in Indianapolis in 1999 was $1,474. The same house was assessed only $1,074 in adjacent Carmel, Indiana, or $1,037 in Greenwood, another suburb. In downtown Indianapolis the property tax rate was $12.63 per $1,000 of valuation; surrounding townships averaged $7.51. Source: City of Indianapolis, 1999, A Competitive City.
 The bond rating improved because agencies saw (a) the deep cuts in spending and smaller government (city payroll went from 4,600 to 3,400 in 8 years), (b) cutback on regulations and licensing (i.e., the SELTIC commission and Goldsmith were pro-entrepreneur and eliminated red tape), (c) lower rates and an improved tax base borne of a better climate for the private sector, and (d) increasing entrepreneurship–new business formation and population started growing again, and after earlier population losses there were 50,000 more people in Indianapolis at decade’s end. This materially helped Indianapolis’ long term financial posture by lowering financing costs.
 The works of Ludwig von Mises (e.g., Socialism, 1927; Bureaucracy, 1944; and Human Action, 1949) of course are replete with this theme, and in general, the impossibility of economic calculation in a socialist society (of which municipal government is a microcosm). As one example of this, the SELTIC commission identified pothole paving as a service which might be outsourced to private vendors. The commission inquired of the city’s roadway maintenance department what it cost to fill a pothole on average, and received the reply that the department did not know. There were no activity-based costing tools in place to gauge this, and no incentives to economize on labor or material costs. This was obviously one of the 75 services identified as candidate for privatization.
 Actually, at the end of his eight-year term, Mayor Goldsmith’s operating budget for the city was $18 million lower than his first year, and straight-line projections coupled with real decreases yielded over $600 million in savings. The city had dramatically downsized, and become one of America’s most efficient. The lower taxes that accompanied a declining budget sparked business growth.
 Of course many Austrian economists hold this to be a weak proposition; even police services can be privatized. For example, Murray Rothbard’s 1970 book, Power & Market (Kansas City: Sheed, Andrews, & McMeel) offers an excellent theoretical defense of this thesis.
 See the budget at http://ci.akron.oh.us/finance/07bud_in_brief.pdf. According to the finance director of the city of Akron, the city is audited by the State of Ohio, where more detailed records of city spending can be obtained.
 Green Bay’s budget can be found at http://www.ci.green-bay.wi.us/forms/financial_report.pdf.
 The book is a continuation of Mises’s theme in the socialist calculation debate, which referred to the “macro” issue of economic efficiency under capitalism and socialism; Mises (and Hayek) held that rational calculation–and, by extension, efficient utilization and coordination of scarce resources–were impossible in a socialist society, absent property, prices, and profit-and-loss accounting, along with a void in entrepreneurial exploitation of both tacit and explicit knowledge. But in Bureaucracy, Mises also extends this analysis to management of enterprises, both private and public, and the consequences of the absence of profit-and-loss accounting tools and incentives for management. His observations are embodied in usually ineffective government management practices observed today. See Bureaucracy (published in 1944 by Yale University Press, New Haven).
 As one example of the 75 services outsourced, privatized, or opened to competitive bidding, vehicle fleet maintenance trimmed its workforce by 29% in the first four years of bidding, spending fell from $11.1 million in 1992 to $9.1 million in 1995 (which equaled the 1988 budget), turnaround time for cars went down even though the fleet size had increased due to the advent of take-home police cars (workers began to operate in worker-managed teams, and ended featherbedding practices–the number of cars serviced within eight hours jumped from 70% to over 80%), and billable hours per mechanic rose an impressive 21%. The number of annual written complaints about the department decreased from 149 to 5 in this timeframe. This all came about once incentive and information problems, always latent under bureaucratic management, were eliminated.
Municipal governments that grow raise the tax burden on their residents, and this in turn acts as a drag on both the future tax base and economic growth of the area.
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