New York has a modern history of good economic luck. The city was the chief beneficiary of Wall Streets exponential growth starting in the early 1980s. It also has a modern history of finding good political leaders (think: Rudy Giuliani) when its governance has faltered. New Yorks economic luck has run out, but it could still find leadership on its dangerously bloated budgetthe biggest threat today to the citys future.
To see what happens when a city runs out of both luck and leadership, look at Detroit. Last week, the Motor City lost its investment-grade bond rating, joining three other cities, including beleaguered New Orleans, in the junk category. The downgrade, which makes it more difficult for Detroit to raise money for capital projects, is a referendum on Detroits leadership over the last 30 years.
New York can learn an essential lesson here. Detroits problem, at root, is that over three decades, it could never muster the political will to restructure its city budget in response to a harsh but unavoidable reality: that the Midwest was no longer the unrivaled capital of U.S. auto manufacturing. Standard & Poors has slashed Detroits credit rating for the citys inability to regain structural balance in its budget, largely because of too much government spending, given a private-sector economy whose major industry has long been contracting under the weight of an unsustainable business model. Additional rating factors include Detroits ongoing reliance on the . . . automobile industry . . . and a high debt burden that places fixed-cost pressure on operations, S&P analysts noted.
New York could face a similar challenge, as its main private industry, finance, goes through a similar long-term contraction. The citys high-flying financial sector may never regain its size and profitability of the last 25 years, when the dollar and American markets were king, and debt was easy and risk-free.
Plus, during these decades, developing markets like India and China represented a sweet spot for New York. Their emerging economies were starting to make real money, but they didnt have the institutional knowledge or capacity to invest that money or raise their own capitalso they went to New York (and London) for help. Finally, global investors were confident that Wall Street firms possessed the unique expertise to bet huge sums on opaque ventures. Finance, in other words, enjoyed the privilege that U.S. auto-making retained until the 1970s: insulation from global competition. New York thrived in those years because finance thrived.
The next two decades may be very different. Yes, the next few years may seem the hardest, as such bread-and-butter businesses as taking companies public through IPOs, advising on mergers and acquisitions, and underwriting debt stay dead. But even after these core domestic markets slowly recover, New Yorks resurgence as a world financial capital isnt guaranteed. Smaller regions from Asia to Africa to Eastern Europe now can create their own markets when the world begins its slow recovery. Perhaps most damaging, these markets no longer trust New York to be smartest in finance, and for good reason.
New York, then, faces the same danger Detroit didand maybe even worse. Consider: Wall Streets extraordinary profitability allowed New Yorks tax revenues to increase by 41 percent after inflation over the last seven years, feeding unsustainable public-sector pension and health benefits. Mayor Bloomberg increased the citys debt and workforce at unsustainable clips, too. There is no mathematical way to sustain that profligacy.
Yet over the last 18 months, New York hasnt shown the political courage necessary to deal with a challenge of this magnitude. Bloomberg, for example, inexplicably awarded the municipal workforce 4 percent annual raises into 2011 just months ago, well after our economic woes had become clearand he made no requests for givebacks on such things as those costly pension and health benefits, which havent been as generous in the private sector for decades. Bloombergs damaging actions made it harder for New York governor David Paterson and the state-run Metropolitan Transportation Authority to rein in their own benefits costsat a time when the MTA needs every dollar it has to invest in its fragile subway assets.
If New York City continues to vacillateraising taxes as Bloomberg has done on property and letting assets like subway infrastructure deteriorate without addressing the costs of our huge governmentit will lose the middle class that supports competent leadership. Thats what happened in Detroitand New Orleanslong ago.
Whats the good news? New Yorkers sometimes know instinctively when things have gotten out of control. Back in the early nineties, we elected Mayor Rudy Giuliani to fix what seemed like an impossible problemrampant crimethough conventional wisdom said that it couldnt be done. Now, the supposedly uncontrollable problem is the city budget. But just this week, one probable mayoral candidate, Brooklyn/Queens congressman Anthony Weiner, courageously pointed to the biggest problem with the citys budget (besides debt and Medicaid): those unsustainable benefits for city workers, including free health benefits. When it might have been politically safer for Weiner to say nothing, he instead urged the city to ask workers for big givebacks. Whether its five years down the road or 10 years down the road, the days of having a guaranteed . . . pension are probably not going to be around much longer, he said.
Well see if the congressman keeps up this line of argument and if other potential mayoral rivals, like City Comptroller Bill Thompson, follow his lead. Thompson made some encouraging statements on city spending last October, noting that had New York started to tie city spending to [gross city product] growth 10 years ago, my office estimates that the city would have spent roughly $8.5 billion less last year. But Thompson said nothing about necessary reforms to pension and health benefits.
If Thompson and others do follow Weiners example, though, they may be pleasantly surprised by the response from regular New Yorkersas opposed to the politically powerful municipal workforce. The citys inhabitants may well understand by now that things need fixing, and they can still seize the chance for necessary change. They did it nearly 20 years ago with crime, before it got too lateas it surely is now, on both crime and finance, in Detroit.
Nicole Gelinas, a City Journal contributing editor and the Searle Freedom Trust Fellow at the Manhattan Institute, is a Chartered Financial Analyst.