An Opportunity Amid Crisis

I was recently contacted by the representative of a consortium of leading industry associations in Massachusetts who asked me to identify the policy changes that, in my professional opinion, would have the greatest impact on increasing job growth in Massachusetts.  What follows is a slightly edited version of my response.

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Your question is an absolutely critical one. Despite what is unquestionably a robust economic recovery for the Commonwealth (MassBenchmarks Current Economic Index, March, 2011):

·  Nearly one in three households are concerned that they or a member of their immediate household may lose a job in the near future (UMass Dartmouth Public Policy Poll).

·  Consumer confidence in Massachusetts has waned recently (MassInsight Consumer Confidence Index).

·  The official unemployment rate for workers in the Construction Industry remains over 18 percent (Profile of Claimants, April 2011).

Much has been written recently about the imbalanced nature of the current recovery, ongoing challenges in blue-collar labor markets, and the struggles of many of the state’s urban communities and regions outside of the immediate Greater Boston area.   In my professional opinion, directly addressing the underlying issues responsible for these imbalances is the most reliable way to improve the Commonwealth’s employment growth.

Some First Principles

When considering policies to increase the number of jobs created in Massachusetts, the state’s policymakers and business leaders should begin by recognizing that:

1)    Fundamentally, the competitive advantage of the Massachusetts economy is rooted in the high skill level and “yankee ingenuity” of its labor force, the deep strength of its world-class health care and institutions of higher education, and its extraordinary scientific research and development capacity. 

2)    State, regional and local education, economic development and workforce development efforts will have the greatest positive impact by:

a)  Improving the ability of communities across the state to produce, attract, and retain skilled workers by working to make all our communities safer, more affordable, and higher quality places to live, work and do business.

b)  Extending the benefits of the Massachusetts Innovation Economy to regions outside of Greater Boston.

c)  Reforming current laws and policies that have the effect of making Massachusetts a more expensive place to live and a more costly place to do business.

Toward this end, I think the Patrick-Murray Administration’s Regional Economic Development Framework represents a thoughtful and principled agenda that is well worth the support of the Commonwealth’s business and legislative leadership.

In other words, Massachusetts does not need a new strategy.  It needs to directly address several major competitive challenges that serve as impediments to economic and employment growth.  Successfully meeting these challenges would have the dual benefit of spurring job growth and improving the quality of life for Bay State residents. 

Competitive Challenge 1- An inadequate supply of housing

Our archaic zoning regulations and local resistance to new housing development remain  major challenges. The current fiscal crisis presents our elected leaders with an opportunity to begin to use state and local aid to cities and town as an incentive to encourage a more progressive attitude towards intelligently planned, well-designed, and much needed housing developments. 

While the housing market in Massachusetts remains moribund, the Commonwealth still has thousands fewer housing units than are required for a healthy market given expected job and population growth.  This structural shortfall serves to keep housing less affordable and makes it more difficult to attract and retain the next generation of workers and their families.  If the Bay State is able to add jobs more rapidly than is expected, this shortfall will only grow larger absent key policy reforms. 

Making it easier to develop more housing would have short-term economic advantages as well.  Recent studies have documented the substantial impact that home construction has on the local and regional economy.  Significantly, the industries and workers that would most directly benefit from more residential development are those that were hardest hit during the recession and have yet to experience many of the benefits of the economic recovery to date. 

In much the same way that they recently proposed changes to health care benefits for municipal workers despite union resistance, I think state leaders must act in spite of municipal resistance to modernizing zoning and land-use policies. Particularly in this challenging fiscal environment, incentives do matter and an approach that rewarded saner and more predictable land-use policies by directly connecting local aid distribution to their adoption could be a significant “carrot” for many cities and towns.

Ideally, reform would focus on the state laws that govern zoning and land-use regulations and provide clear incentives for communities to participate in programs that promote responsible and sustainable commercial, industrial, and residential growth patterns including expedited permitting programs.  Mandatory training for local officials that have oversight of land-use would also encourage a more informed and professional approach to development decision-making at the local level.

Until there is a cost for not modernizing local land-use policies and practices, there will be no substantial improvement in our housing situation and a motivated minority will continue to make it difficult for working families to live in many of our cities and towns.

Bottom line, modernizing the way in which we manage the use of our land in a manner that fairly balances the needs of our families, growing employers, and legitimate local concerns about growth would have multiple payoffs.  It would serve to improve the long-term competitiveness of the state and create desperately needed jobs in our embattled construction industry.

Competitive Challenge 2- An outdated local aid funding formula

A recent policy brief by the Federal Reserve Bank of Boston’s New England Public Policy Center highlights the need for reform in the formula that the Commonwealth uses to allocate local aid to cities and towns.  The reform proposed by Fed researchers would not redistribute current aid but instead proposes changing the funding formula to ensure that going forward, any new growth in local aid would be distributed based on need (defined as the gap between a community’s cost of providing necessary services and its ability to raise revenue to pay for these expenses).  

Bottom line, reform of the way the state shares resources with cities and towns should, a) hold communities harmless in the current allocation of aid, b) redirect new growth in state-aid to those communities that need it most, and c) provide incentives for communities to adopt policies that encouraged intelligent development and job creation would both encourage short-term job growth and help to “prime the pump” for longer-term job growth.  

Competitive Challenge 3- The Education Gap

The single most reliable and sustainable way that Massachusetts can extend more economic opportunities to its communities and residents is by providing access to high-quality public educational opportunities at both the K-12 and post-secondary level.   Access to quality and affordable educational opportunities helps to ensure that the state’s employers are able to recruit and retain the skilled workers they need to thrive in Massachusetts.

While Massachusetts is a national leader in both K-12 and Higher Education, significant achievement gaps remain, particularly in those public schools that serve low-income students and their families.  At the post-secondary level, the failure of Massachusetts to adequately support its public higher educational institutions has resulted in rising fees and strong incentives to focus efforts on more lucrative out-of-state students.  Left unchecked, these developments present a direct threat to one of the State’s strongest competitive advantages: its highly educated workforce.

While there are no obvious quick fixes to the challenges facing our under-performing K-12 schools and districts, the ability of our communities, particularly our cities, to become economically vital places to live, work, and do business will be greatly hindered until we are able to overcome one of the biggest obstacles to their social and economic development. 

The perception and, in many cases, the reality of poorly performing schools makes it very difficult for our “Gateway Cities” to attract and retain working and middle-class families. It also puts further pressure on those communities and housing markets that are home to quality public schools. This exacerbates housing affordability problems and economic development challenges for communities that both favor and have the necessary infrastructure to support new industrial and residential development. Additionally, a renewed commitment to the Commonwealth’s support of public higher education is long overdue. During these very challenging fiscal times, policymakers must set priorities.

Bottom line, sustainable investment in high quality public education is one very predictable way to ensure that Massachusetts will continue to produce the next generation of entrepreneurs and the human capital required to allow them to grow and thrive in communities across the Commonwealth.  These are the people who will create the vast majority of jobs in Massachusetts if they are given the opportunity to do so.

Concluding Thoughts

As Rahm Emanuel recently and famously noted,

You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things you think you could not do before.

The Commonwealth’s business leaders, elected officials, and policymakers are facing a highly uncertain economic environment and, while the challenges they face are profound, current conditions present them with a rare opportunity to make long-needed changes in the ways in which Massachusetts regulates its land, provides financial support to its communities, and supports public education.  I sincerely hope that this opportunity is not wasted.

Towards a more thoughtful discussion of public pensions

This morning's Boston Globe contains an article by Matt Carroll that purports to highlight an alarming trend in our state pension system -- an increasing number of retirees receiving six-figure pensions.   Despite its title, the article doesn't actually document rising pension costs at the system level but it does contain this quote from the always reliable Mike Widmer:

“There is an urgent need for comprehensive pension reform,’’ said Michael J. Widmer, president of the Massachusetts Taxpayers Foundation. “Soaring pension and health care benefits are cannibalizing municipal services.’’

As usual, it is very difficult to disagree with Dr. Widmer.  However, as any good policy analyst knows, if one wants to evaluate the costs and benefits of a particular policy, one must compare it to an alternative.  In this case the alternative to the state pension system would almost certainly be social security and medicare.  So when I read the article I immediately thought, would the state be better off if its employees participated in those two federal programs instead?  

Thankfully,  MassBudget (aka the Massachusetts Budget and Policy Center) has already examined this issue at some length.  See their recent analysis for a very nice summary of the relevant issues and facts.

What I learned from reading this report is that the state's contribution to the pension system is about 23%, the rest comes from employees and investment returns -- BUT the system currently has about $20 billion in unfunded liabilities (largely the results of the failure of the State to make its full contribution and poor investment performance during the recent recession).

The other eye-opening finding from the MassBudget report is that if the state were to switch all employees to the social security and medicare systems it would cost the state more on annual basis to pay the payroll tax it now avoids by opting out of the Social Security system.  Of course, if this were to happen the liability for future employees would belong to the federal government rather than the State and employees would pay about half as much (more highly paid employees would save even more but get much less).

As Mass Budget put it,

"One important distinction between public and private sector workers in Massachusetts is that public sector workers are not eligible to participate in Social Security. Thus, state employees and teachers do not contribute the 6.2 percent of their salary toward Social Security. On the employer side, the state also does not contribute 6.2 percent of employees’ salary (up to $106,800) toward Social Security. If the state were to abolish the pension system entirely for new employees and thus be required to participate in Social Security, costs would subsequently increase by about 3 percent of payroll, more than double what it pays now."  Source: Demystifying the State Pension System, MassBudget

Of course it is tough to compare the costs given that the benefits that retirees get from both programs are not the same.  For the record, I think the state benefits are undeniably better than their federal counterparts but you would expect this to be the case given greater employee contributions. 

Now, of course, even though it seems clear the state pension system is more cost-effective in short-run budgetary terms, the full faith and credit of the Commonwealth is behind the $20+ billion in unfunded liability facing the state government and another $10 billion or so for those numerous independent municipal pension boards across the state (yet another strong argument for rolling all municipal workers into the state pension and GIC system).   So, in a very real sense, unless the pension fund returns grow rapidly and consistently, this is money the taxpayers owe the current employees.

So while the idea that Massachusetts employees don't pay their fair share is totally wrong, the fact remains that current pension commitments represent a gigantic drain on future state revenues and definitely will limit the "investment" choices the State will be able to make in the future.  Don't get me wrong, I'm 100% for the pension (for the record I vest in June), but let's not kid ourselves.  The public may be blaming the wrong people but they are right to be concerned about the sustainability of the system in the long run.   

That said, it seems clear that the existing system works better for the state in short-term budgetary terms and for workers in terms of the value of the benefits. The problem for all these programs whether federal or state is a long-term one.  Lest we forget, the federal pension and health care programs have some significant unfunded liability issues of their own.

Bottom line, there are legitimate concerns about our public pension system in Massachusetts and important debates to be had over how we can deal with the very real and profound challenges we face in a fair and financially sustainable way. 

This morning the Boston Globe missed an important opportunity to inform that debate. 

The State of the Massachusetts Housing Market

Last week I was invited to testify before the Joint Housing Committee at the State House in Boston.  They asked me for my assessment of the residential housing market in Massachusetts.  Here, in a nutshell, is what I told them.

The residential housing market remains a threat to the statewide and national economic recoveries

The housing slump in Massachusetts has now entered its sixth year.  While according to the S&P Case-Shiller Home Price Indices it appears that prices may have bottomed out, there are a number of reasons for any optimism to be of the cautious variety.

1)  About 15 percent of Massachusetts homeowners with mortgages are "underwater" or in a negative equity position (owe more on their homes than their homes are worth in today's market).   

While this fact in itself does not mean these homeowners are likely to default -- see Foote, Gerardi and Willen for more on the relationship between negative equity and foreclosure -- it definitely makes these households more vulnerable to default in the event of a disruption in their income (job loss, divorce, death etc) and, in light of continuing difficulties in the labor market, is not an encouraging sign.

Clearly, as the preceding chart makes abundantly clear, it could be much worse.   In states like Nevada, Arizona, Florida and California, the rates are much much higher.   

2)  To date, price declines have not appreciably improved affordability

The pattern in price levels similarly highlights the different trajectories that the national housing market and those states that have had the worst housing bubbles are on as compared to Massachusetts.

As the following chart illustrates, absolute price levels in Massachusetts rose significantly higher during the so-called "housing bubble" period, declined more slowly during the downturn, and have only recently appeared to have leveled off.

 

The fact that price declines have been relatively and comparatively moderate is, of course, not much consolation to the thousands of homeowners across the Commonwealth who have lost their homes to foreclosure.  It does, however, help to explain how we could be experiencing price declines of this magnitude without improving affordability in any significant way.

Two very insightful articles in a recent issue of MassBenchmarks (by Koshgarian and Vaisanen respectively) help to shed some light on how this seemingly counter-intuitive situation is playing itself out.  They remind us that it is not absolute price levels but rather the relationship between prices and incomes that is the key to affordability.  As discussed above, prices have only fallen to 2003 levels and income growth for most households has been anemic in recent years.  That is not a recipe for greater housing affordability for the vast majority of households in Massachusetts.

Bottom line, while price declines to date have undeniably created opportunities for potential buyers with relatively high incomes and good credit, for most renters, homeownership in Massachusetts remains well out of reach and tens of thousands of households (owners and renters) across the Commonwealth continue to spend greater than 50 percent of their income on housing costs (see Koshgarian for more details).

3)  Foreclosures are putting downward pressure on housing prices

Foreclosures in Massachusetts are no longer simply an urban problem.  As the Masachusetts Housing Partnership's Foreclosure Monitor noted late last year, " The gradual movement of distressed properties away from urban areas has reached a tipping point as there are now more distressed units in the suburbs and rural communities.”

The spread of bank-owned properties (REOs) has the insidious effect of muting a recovery in housing prices in many areas of the state.  The heavy price discounting typically associated with the these kinds of properties makes it more difficult for both traditional home sellers and for homeowners who have seen their home equity dwindle and, in a significant number of cases disappear altogether.   

This helps to fuel a "vicious circle" in which declining prices threaten to push more households into a negative equity position and, combined with an uncertain job market,  provides prospective buyers with a strong incentive to either use their market power and/or wait for further price declines.   Additionally,  the most common ways in which "comparable sales" data are used in mortgage lending make it difficult for buyers who may be willing to pay more to obtain financing and further limit the potential for price appreciation. 

While Massachusetts is clearly in much better shape than many other states in this regard, it is by no means immune from the impacts of these forces.  

4) The housing decline has dramatically reduced housing production exacerbating a structural shortfall in housing supply

According to a recently released report prepared by a research team that includes yours truly and several colleagues from the UMass Donahue Institute, UMass Boston and Northeastern,  Massachusetts has an inadequate supply of housing in most of its regions and faces an estimated structural shortfall of over 29,000 units.  

Even during good times Massachusetts doesn't produce a lot of housing in part due to our archaic land-use regulations and zoning codes and, a widespread local resistance to development of any kind....especially the sort that is expected to attract children.   

No doubt our inadequate housing supply combined with a dramatic decline in housing starts has helped to limit housing price declines in Massachusetts.  However,  the large reductions in real estate development activity have taken a serious toll on the blue collar end of the national and Massachusetts labor markets leading to what Andy Sum and his colleagues recently termed "A Depression in Blue-Collar Labor Markets in Massachusetts and the US".

I concluded my testimony by suggesting that state policymakers focus their efforts in the near-term on assisting those households who have been most directly and negatively affected by these conditions and break the vicious circle described above.  I also echoed concerns raised earlier in the hearing by CHAPA's Aaron Gornstein that these efforts will be severely hampered should proposed cuts in federal housing programs be enacted.

In the medium to long term, I advised the committee members to focus their attention on attacking our chronic housing affordability problems by prioritizing economic development programs and policies that serve to increase the opportunities to earn higher incomes  and make long-overdue changes to Chapter 40A to reduce the regulatory restrictions that have artificially limited new housing development in the Commonwealth.  This of course is easy for me to say and not so easy for anybody to do in the current fiscal and political environment.

While the most recent state employment report and other indicators provide some good reasons to feel hopeful that a solid economic recovery is underway in Massachusetts, whether it will be sustainable and continue to be as imbalanced as it has been will depend in an important respect on what happens in the housing market.