Sunday, June 20th, 2010

Chicago and the Epicenter

Crain’s Chicago Business ran a major story assessing the Daley administration’s track record in Chicago last week. The title, “Mayor Daley runs up big debts building his global city; what about the rest of Chicago?,” implies a negative piece, but it has a lot of positive things to say too. The piece includes a quote from a previous major post of mine on the city, talking about how I want Chicago to be less of a generic world city, and find more of its own niche in the world.

I want to expand on that notion today. Some of these thoughts are the beginnings of a major project I have in mind called “The State of Chicago.”

A friend of mine emailed me after seeing the piece and suggested that most of the negatives identified by Crain’s were not unique to Chicago, but were true of almost any global city, thus Daley really can’t be blamed for them. Richard Longworth takes up the theme, agreeing with this, but seeing it in a less sanguine light, asking, “Can Global Cities Work?

I agree with this. The guy at the top always, fairly or unfairly, gets the credit or the blame for what happens on his watch. In a sense, the principal role of the executive is simply to be accountable. But if the President of the United States can’t control the economy, why would we believe the mayor of a city can? As I argued in my previous piece, Chicago’s transformation is principally the result of macroeconomic forces and structural changes in the global economy. The fact that its transformation is far from unique and is broadly shared by most global similar global cities argues as much. Like the collapse of the Rust Belt before it, the rise of global Chicago and its attendant downsides is part of a macro-phenomenon. In that light, Daley shouldn’t get as much blame as he’s frequently assigned, but likewise less of the credit.

In assessing Chicago, there are two main distinctions we need to make. The first is the entity we are looking at. In assessing the mayor’s job, Crain’s looked mostly at the city, as that is what is under the mayor’s nominal control. But the real Chicago is a regional, metropolitan economy, as Brookings and others have pointed out. To really evaluate Chicago, the best way to look at it is as a region. Of course, the city is a major part of that and a healthy core is part of how you grade most regions, but fundamentally looking just at the city (or the greater Loop) isn’t enough.

Second, cities fundamentally ought to be measured not just against their own past, but against peers as well. This is just like how a fund manager should have his performance judged not only on an absolute basis, but versus a market benchmark like the S&P 500. You can appear to be doing well while falling behind on a relative basis. So to really judge Chicago, you should compare it against other tier one global cities. My comp list is New York, Boston, San Francisco, Los Angeles, and Washington, DC, the last of which I’ll admit is somewhat debatable.

There are a huge number of broad similarities between those cities in terms of their transformations, but I’d like to focus today on one area where Chicago is very different, one that illustrates what I mean by a niche.

At GE, Jack Welch famously only wanted to be in a business if he could be #1 or #2. He recognized that when you are the top player, you can reap enormous competitive advantage and extract the greatest value. This plays into Michael Porter’s cluster theory. Places that establish themselves as the top location for an industry cluster are able to create what Warren Buffett calls a “wide moat” business, one that is hard to unseat and which can again extract higher returns.

To that end, I’ve suggested that cities should not try to become the next hub of generic super-sectors like high tech, life sciences, or green tech that are being targeted by everybody. Rather look for more focused segments within these areas where you can carve out a dominant position, or find other industry specialties to own. This is the “microcluster” concept of which I’ve given many examples, such as motorsports in Indianapolis.

How does Chicago stack up here? Ok, I think. I haven’t done the full research, but others have suggested it has dominated some specialties. The futures exchanges are an obvious example. Saskia Sassen noted that despite the fact that most global cities have many jobs in financial and producer services, they aren’t necessarily directly competitive. Rather, they specialize in different things. Chicago specializes in these services for industries and areas related to its argo-industrial heritage. As she put it, “A steel factory, a mining firm, or a machine manufacturer that wants to go global will go to São Paulo, Shanghai or Chicago for its legal, accounting, financial, insurance, economic forecasting, and other such specialised services. It will not go to New York or London for this highly particular servicing.”

For a city the size of Columbus, Ohio, a collection of microclusters and niches might work. But what about a region of nearly 10 million people like Chicago? The jobs losses in the last decade suggest not. Chicago may have a lock on steel globalization, but how many jobs do this and other similar niches require? The city’s own Central Area Action Plan has a base case scenario of job growth of 3,500 per year, a drop in the bucket for a region with four million jobs. Between 3Q08 and 3Q09 alone, Chicago lost 270,000 jobs. Just that one year loss would take 75 years to recoup at the plan’s growth rate. And the plan says that to hit the number, the central area needs to grow its regional market share.

This gets to the heart of one major difference between Chicago and these other cities. They all have niches. But those peer cities are also the home of one or more of those key 21st century macroindustry super-sectors I mentioned earlier. The reason I advise against trying to compete in those in a generic way is that there are already entrenched competitors, and those competitors are often other tier one global cities.

Consider the following list. It isn’t based on quantitative analysis, but I think foots to conventional wisdom:

City Macroindustry or Equivalent
Atlanta African American Center
Bay Area High Technology, Biotech
Boston Elite Education, #2 Tech Hub
Detroit Automobiles
Houston Energy
Los Angeles Entertainment, Art
Miami Latin American Trade
New York Finance, Media, Fashion, Advertising, Art and Culture
San Diego Biotech
Washington Government

All of these cities are the epicenter of something both large scale and important. What about Chicago? You could argue that it is the #2 financial center, and clearly the exchanges are a powerful asset. But that is the exception that proves the rule – and in my view is not something that reaches the level of these other things.

One important difference between Chicago and other US global cities is that Chicago is not the epicenter of any important 21st century macro-industry. This makes Chicago in the global age very different from Chicago in the industrial one.

Some might say, “So what?” and in fact tout this as an advantage. Chicago is one of the most diverse economies in the country, and diversity is often viewed as good. Plus, the fate of Detroit suggests that being a one trick pony isn’t always a good thing. So let’s look at some implications of this.

One implication might be that Chicago, since it isn’t the wide moat center of one of these industries, creates and extracts less value than its tier one piers. So let’s see if that’s true. The basic measure of economic activity is gross domestic product. The federal government reports this on a metro area basis, with the most recent release being 2008. Here is how those cities stack up on a real, per capita basis:

Metro Area Real GDP Per Capita in 2008 (in 2001 chained dollars)
Source: US Bureau of Economic Analysis

Due to the way the feds define metro areas, the Bay Area and Greater LA are split into two metro areas, so I include both. The Riverside-San Bernardino metro is the so-called “Inland Empire” area that is basically exurban sprawl. It doesn’t really belong on the list, but I’m including it so that I can’t be accused of cherry picking.

As you can see, Chicago’s economic output per person is lower than any of these except the aforementioned Riverside area. In fact, it’s materially lower, except compared to Los Angeles. Even the SF metro, which doesn’t include Silicon Valley, is much higher. Chicago is simply generating less economic output per person than these other places. Now the metro GDP numbers are relatively new, and some people don’t like the data, but this is a real federal statistic.

Let’s also look at the growth in GDP per capita over time. The maximum data series available is 2001-2008. Here’s a plot of these areas over that time, with 2001 set equal to an index of 100:

Real Per Capita GDP 2001-2008, Index with 2001=100
Source: US Bureau of Economic Analysis, Urbanophile, LLC analysis

This is a little difficult to read, but Chicago is the bright yellow line near the bottom. It is in again in last place, save for exurban Riverside-San Bernardino. So Chicago has lower economic output, and is growing it at a slower place.

This is one clear example of the consequences of being a diversified business center. Chicago will generate less economic value than other tier one global cities because it doesn’t have that calling card industry it dominates and from which it can extract super-normal returns.

This shouldn’t come as any surprise. There’s an axiom in finance that concentrated positions build wealth, diversified positions preserve it. Chicago’s great boom period, where it became large, wealthy, and important, was the agro-industrial age, and Chicago specialized in that field. Chicago was the epicenter. It was its beating heart. But no more.

Chicago has been transformed by globalization, but it is under-performing in terms of economic output, and probably will indefinitely on its current course.

That’s not to say that the other side is perfect either. Detroit is one example, but perhaps a better one is the San Jose/Silicon Valley area. Their problem is that they are too successful at creating wealth. Four quick stats easily demonstrate. Between 2001 and 2008, San Jose’s: a) real GDP per capita increased by 20.8% b) total real GDP increased by 25.9%, c) real GDP per job increased by 39.6%, BUT d) total employment declined by 9.4%.

San Jose/Silicon Valley is like a gigantic tower that keeps growing higher and higher into the sky while its base shrinks. As we all know, that’s not a stable situation to be in. San Jose is caught in a cycle that is long term unhealthy. It is in progress a modern manifestation of what Jane Jacobs called the “self-destruction of diversity.”

Of course, Chicago is not immune from this just because it isn’t the epicenter of a major super-sector. It exhibits the exact same phenomenon, albeit on a smaller scale. There is actually a certain logic in this. In the Crain’s piece, Tracy Cross says that Chicago fundamentally had no choice but to go upscale and focus on upscale businesses and consumers. I agree that was the logical choice, a point I made in my article that I linked earlier and elsewhere.

But just because it’s logical doesn’t mean it takes you in a long term good direction. I’m reminded of a piece Ryan Avent wrote on disruptive technologies and how that dynamic applies to cities. In it he quotes Clayton Christensen via Tim Berners-Lee talking about how incumbent firms react to disruptive innovations:

Generally, they found it difficult to improve profitability by hacking out cost while steadfastly standing in their mainstream market: The research, development, marketing, and administrative costs they were incurring were critical to remaining competitive in their mainstream business. Moving upmarket toward higher-performance products that promised higher gross margins was usually a more straightforward path to profit improvement. Moving downmarket was anathema to that objective.

There’s an obvious analogies to cities. Avent takes it in a different direction, but you can also see how it applies to global cities. Rather than trying to beat Dallas and such at their own game – a daunting proposition – they go upscale. This works for a while, but generally in industry the incumbents end up totally displaced as their market asymptotically evaporates to nothing as it narrows. The specific example in this case was Digital Equipment Corporation – and we all know where they and pretty much every other microcomputer manufacturer ended up. Only IBM – the New York or London of incumbents – survived.

I won’t pretend I’ve thought through every implication and come up with a preferred course of action for Chicago. But neither has anyone else. My own sense of civic pride wants to see Chicago at the top of the league tables, not the bottom. My gut sense is that it requires not a choice of specialization or diversity, but rather diversity of specializations. Chicago will need to both maintain and enhance its diverse mix of headquarters, general business services, and niche industries, but also complement that with a new 21st century calling card to replace heavy industry. It needs to be a city that is known for something again.

Chicago is clearly in a situation where it both is trailing other tier one global cities in generating economic output, and is to some extent exhibiting the taller but narrower syndrome. Right now, that’s been the outcome by default. I will state again that Chicago has been transformed by outside forces. It is the artifact, not the architect. It’s a passenger, not the driver. It might have a first class ticket in many respects, but that doesn’t mean it’s controlling where it is going.

I think it’s time for Chicago to step up and take a hard a realistic look at itself and its aspirations as a city. It’s time to get out of the back seat, and step up and grab the wheel and try to take charge of its own destiny. But I’m not seeing that happen.

And this is another way Chicago differs from these other global cities. It is in its smug complacency about its transformation and how great it is. Perhaps that’s because it is in a region where so many cities have been all but destroyed, hundreds of miles from next nearest peer, Chicago looks around and feels like it is the big winner. I talk to people in lots of cities, and generally they will admit to quite a few of their shortcomings. I may not see eye to eye with them on everything, but they are at least thinking about what they need to do different. I don’t get that sense in Chicago, outside a handful of areas like reducing corruption and fixing the state’s fiscal situation. The people I talk to in Chicago, often outsiders who don’t have positions that require them to be boosters, are nevertheless almost total cheerleaders for the city. Its challenges and deficiencies are blown off or even celebrated. Like a lot of lakefront types many of them hate Daley – who again is not responsible for where Chicago is today economically – but they sure don’t see many serious problems with Chicago.

Other global cities aren’t taking anything for granted. Andy Grove wrote a famous book called Only the Paranoid Survive. Other cities seem a lot more paranoid than Chicago. Silicon Valley knows it has problems. As a report by their leaders put it, “Silicon Valley has entered a new era of uncertainty, with a set of vulnerabilities that could compromise our long-term prosperity. Our continued ability to import and develop talent, fund innovation, and rely on state government for overall support are seriously in question. We are a region at risk.” Concerned about losing ground to London and other global financial centers, New York City commissioned McKinsey to help it figure out how to retain its leadership position.

But Chicago? Other than Longworth and a handful of others, I’m not seeing anything along these lines. In an every more complex, rapidly changing, globalized, competitive world, not only is Chicago not seeking the answers, it isn’t even asking the big questions.

For an index to my Chicago-related postings, click here.

To download the data behind these charts in Excel format, click here.

Topics: Economic Development, Public Policy, Strategic Planning
Cities: Chicago

55 Responses to “Chicago and the Epicenter”

  1. Ironwood says:

    As I’ve written before in comments to this blog, the discussion at hand can take on very different implications based on the time frame we’re adopting. Chicago is a very new city, even by U.S. standards, if we’re including NYC and Boston. By world standards, it’s a very, very young city. How many macro business cycles has Chicago actually been through, compared to, say, London?

    If we base trends (and action plans) based on arcs of a decade or so, we tend to get very different answers than we do if we analyze in terms of 50-year or century patterns.

    I say this to remind everyone about all the dire and virtually useless thing people were prognosticating about Chicago and cities in general as little as 30 years ago — the late 70s and early 80s — a blink ago, for those of us who were entering our professional careers as planners back then. People were still grappling with women entering the workforce, for chrissake. No one had heard of the internet. An African American in the White House? Yeah, when cars fly. The Berlin Wall was ten years away from being torn down; China was on almost no one’s radar. People were taking note of a small but promising “back to the city” movement. NYC lost ONE MILLION people in the 70s and nearly went bankrupt. Everyone figured it was a goner. And probably a third of the readers of this blog weren’t born or hadn’t graduated from kindergarten yet.

    If we take a slightly longer [and less alarmist] time frame, say, another 30-50 years, what stands out are not mini-trends but the biggies, like climate change, demographics, water, the ascendancy of China and Asian economies, changes in energy production and consumption as we are forced off oil … These things are going to happen no matter what civic leaders do between now and then. And these are the factors that are going to determine the fate of Chicago and all other cities.

    I love the micro-analysis on this blog. But I’d love to see some more longer-range perspective — both looking back and looking forward — in trending out what’s next and what can be done to capitalize on it.

    Thanks, Aaron, for another provocative post!


  2. Nathanael says:

    Chicago’s a railroad center.

    It seems to have forgotten this and failed to invest in that much, and railroads have moved their HQs elsewhere.

  3. Alon Levy says:

    Did BNSF really move from Chicago and Saint Paul to Fort Worth because of Chicago’s rail bottlenecks?

  4. John says:

    I think maybe the GDP should be normalized by some kind of cost of living measure. My impression is that someone in Chicago may get paid less for doing the same job as someone in one of the coastal Tier 1 cities simply because people need more money for housing in places like LA, SF, and NYC. I think Chicago’s economic output per capita may be fine, but we’re just not getting paid as much for it in dollars. Does that really matter though if we don’t need as many dollars for the same quality of life?

  5. John, I’d probably normalize income to cost of living, but not economic output. Though some have argued they are related. That is, more productive workers are the only ones who can afford to pay the high prices of expensive areas. Also, areas get expensive because of the high value workers they have (assuming outputs eventually translates into income), and the area is valuable precisely because it contains so many high value workers.

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