Sunday, July 15th, 2012

State of Chicago: Explaining the 1990s Versus the 2000s

In my article “The Second-Rate City?” I noted Chicago’s very strong economic and demographic performance in the 1990s and contrasted it with the very poor performance in the 2000s. Then I outlined several problems with Chicago I thought helped drive the struggles. A few people asked a very fair question, saying, “All the negative factors you cite about Chicago (e.g., clout, business climate) were equally as true in the 1990s as in the 2000s, so what really made the difference?” I want to try to respond to that today.

First, let’s ask ourselves, why did Chicago decline into its Rust Belt malaise? Was it some unique to Chicago factor? No, clearly not, as a broad swath of the industrial United States experienced a similar collapse. Likewise, lots of big cities (I mentioned New York before) seemed to be on the fast track to oblivion in the 1970s. In a sense, the city was a victim of outside macro-economic forces and secular trends.

Next, why did Chicago come back? Saskia Sassen helps us understand why. Globalization, which enabled the global distribution of many functions of production, also simultaneously created the demand for new types of functions to help control and manage these far flung networks, especially new types of financial and producer services. These require very specialized, high skill workers operating in dense knowledge networks, which led to agglomeration effects and the emergence of so-called “global cities.”

So, in a sense, the rise of global cities is simply an emergent property of the new global economy. The global transformation that renewed Chicago, New York, London, etc. had little to do with good leadership or great mayors, and everything to do with a historical context that was ripe for repositioning in a new world economy that demanded it. In other words: outside forces again. This includes other secular changes like the start of a new wave of people who prefer urban to suburban living. These forces laid the cities low and they brought them back.

So as I’ve said before, when it comes to Chicago’s transformation, the city was the artifact, not the architect.

The 1990s were a great decade nationally. Combine that with these forces I mentioned, and Chicago really had the wind at its back. It’s easy to do well in that environment. However, when the national economy took at turn for the worse in the 2000s and we experienced a “lost decade,” things were very different. It’s when the tide goes out that, as Warren Buffett likes to put it, you get to see who’s been swimming naked.

In a sense, the 2000s tough times exposed the weaknesses of Chicago in the same way that the financial meltdown blew up so many Ponzi schemes.

Also, I believe there were some particular characteristics about the way the markets changed in the 1990s and 2000s that particularly benefited Chicago in the 1990s and hurt it in the 2000s. I can’t claim to have done a rigorous study on it (though I think there is some good research to be done), but working in the industries affected and living it myself – and having some personal knowledge of various firm employee counts during the period – I feel somewhat qualified to state this as a hypothesis.

I’ve outlined this before, particularly in a very extensive post called “A Better Tomorrow” but I’ll restate it in part here.

There were two main forces that converged on Chicago in the 1990s: the tech revolution and the nationalization of industry. Note that I consider the 1990s really the prelude to globalization, which was the dominant force of the 2000s.

Consider the technology world of 1990. It was an era dominated by staid mainframe shops. By the end of the decade, the world was completely transformed. Just think of some of what we went through: the client/server revolution, the emergence of the web and the dot com boom, the ERP revolution, the Y2K retrofit problem, and the emergence of mobile telephony and laptops as ubiquitous. These were all huge, gut wrenching changes that required not just incredibly large numbers of people skilled in new technologies themselves, but also with tremendous business, functional, and people skills so they could be deployed effectively.

At the same time, the 1990s was the Great Rollup era. Back in the 1980s most cities had their three big local banks, their local electric and gas companies, their local retailers, even their local manufacturers. Only AT&T seemed to be a true national player of the type we know today. Fast forward through the 1990s and industry after industry was subject to national rollups. First was the emergence of “super-regional” banks, which led to today’s huge giants. (It was also when Glass-Steagall fell, arguably to our chagrin). Utilities merged, department stores merged, and major big boxes and category killers like Wal-Mart, Target, Walgreens, Best Buy, and Home Depot developed national footprints. Integrating these businesses, and building scalable processes and technology to manage these huge enterprises, was another gigantic effort.

Both of these worked enormously to Chicago’s benefit. Chicago had always been the dominant location in the interior for professional services, with core sub-industries including: management consulting (e.g., McKinsey), technology consulting (e.g., Accenture), IT/business process outsourcing (e.g., TCS), accounting (e.g., KPMG), and law (e.g., Mayer Brown).

Both the technology and nationalization trends generated huge amounts of demand for new people to manage them, which drove a huge increased demand generally for consultants and other service providers. What’s more, unlike the old back office “data processing” mainframes, the new technology was directly embedded into the fabric of the business. This meant that people working with it needed industry knowledge like never before. Clearly, to help executives merge and manage large national firms, consultants and such needed a lot of industry expertise as well, and needed to be able to serve their clients on a national, not just local basis.

This led to a sea change in the organization of professional services firms. Historically they had been organized by local office practice. But in the 1990s they reorganized along industry lines, with national practices. Instead of a Chicago consultant serving Chicago clients primarily, you’d have, for example, a retail consultant serving retailers where ever they might be nationally.

If you need to fly consultants all over the country to work with clients, where do you want to do it from? The two best options are Chicago and Dallas. So Chicago, with its huge labor market, its urban environment hitting at the emerging youth trend, its status as a major air hub, its central location, and its head start through its already robust professional services sector, became the best location in America for professional services overstaffing. That is, hiring people into a city with the idea that they’ll fly around the country servicing clients coast to coast. I believe this explains why Chicago boomed like nobody’s business during the 1990s. I suspect most major professional services companies doubled or tripled employment in Chicago in this period.

The 2000s were very different. First, the dotcom bust deflated demand for tech generally and Chicago as a hub got blasted. Second, the 2000s really didn’t see the same sorts of technology revolutions that we saw in the 1990s. I believe that things like Web 2.0 were mostly evolutionary. (Smart devices and such may be leading us through another fundamental revolution, but that wasn’t mostly a 2000s phenomenon). Third, the rise of the global age led to the emergence of offshore software development and business process delivery. Thus, much of the new demand, and existing demand, could be satisfied offshore, and didn’t require an army of expensive onshore consultants anymore. This new competition caused traditional firms to have to revamp themselves to become much more efficient internal business operators. (Law seems to be the last holdout, and is in the early stages today of a major shakeup in how legal business gets done).

This hurt Chicago badly. You didn’t need to overstaff in Chicago because you could do it in India. When there was recovery from the dotcom bust, much of it was offshore. I suspect that even 12 years later, there isn’t a single technology consultancy that employs as many people in Chicago as it did in 2000, new companies excepted. Consider that major firms like Arthur Andersen and Whitman-Hart don’t even exist anymore. Many smaller sized internet era firms also experienced the same fate, and Chicago’s “Silicon Prairie” ambitions more or less got wiped out, which cost a huge number of telecom jobs. Also, industries like finance have been subject to increasing centralization in global hubs. Chicago went from being #2 nationally as a financial hub to something further down the chart in a global hierarchy. Chicago retains great strengths in derivatives and risk management generally, but second tier financial hubs like Chicago and Boston have been feeling the pinch.

This, in a nutshell, is what I think explains the difference in performance. The general “wind at the back” of Chicago and big cities in a boomtime economy papered over a multitude of civic sins in the 1990s that the lean years of the 2000 exposed. And the tech/nationalization era of the 1990s particularly benefited Chicago, helping to explain why it rated so highly in that decade.

I’ve got one more piece in my “current conditions” segment of State of Chicago. Then I’ll turn to articulating my rationale for some of the structural weakness factors I outline in the article, then move on to a series of proposed fix-its.

This article is part of the “The State of Chicago.”

25 Comments
Topics: Demographic Analysis, Economic Development, Globalization, Technology
Cities: Chicago
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25 Responses to “State of Chicago: Explaining the 1990s Versus the 2000s”

  1. the urban politician says:

    Interesting and enlightening.

    One wonders,though, that if cities cannot really change their fortunes since they are subject to much larger trends, then why bother trying to find solutions?

    Aside from firing a missile and destroying New York, I can’t see how Chicago can get out of the position it is in right now.

    Having said that, I for one think that Chicago actually can make things better. It has already started, although it may be some time before we see the fruits of the effort. One outstanding weakness is getting the State’s fiscal house in order. Another idea is that the city needs to go through its policies with a fine toothed comb and get rid of ones that are an impediment to small business/investor expansion.

    Rahm is just starting down a long road that needs to be traveled. A lot more is needed.

  2. Carl Wohlt says:

    Great piece.

  3. Nat says:

    Interesting read and one that I don’t disagree with. Chicago really wasn’t the architect of its resurgence in the 90s nor was it an architect of its stagnation in the 00s. So the big questions are: what can it do to fight external forces and what can it do to differentiate itself from the NYCs and Londons of the world? The region is the home of global consumer brands such as Kraft, Motorola, and Wrigley (prior to acquisition from Mars), but is this enough? The area is the regional hub of accounting, consulting, finance, and law, but is that enough? The local exchanges are kings of derivatives/ futures/ commodities, but will that necessarily hold if Chinese interests continue to buy up agricultural production? From the 60s to 90s, we witnessed the consolidation of business and professional services that diminished the importance of urban areas like Cincinnati and St. Louis. Fortune 500 presence and the Big 4 employment base in both cities are nice measuring sticks of this. Today, there are far fewer influential companies in both cities, and the Big 4 employee count has either stagnated or declined as more things have been shifted to Chicago or out of the midwest entirely. Is that Chicago’s destiny (on a larger scale)?

  4. Racaille says:

    “If you need to fly consultants all over the country to work with clients, where do you want to do it from? The two best options are Chicago and Dallas. So Chicago, with its huge labor market, its urban environment hitting at the emerging youth trend, its status as a major air hub, its central location, and its head start through its already robust professional services sector, became the best location in America for professional services overstaffing. That is, hiring people into a city with the idea that they’ll fly around the country servicing clients coast to coast. I believe this explains why Chicago boomed like nobody’s business during the 1990s”

    And of course that is what is happening again with the building boom that is happening downtown. The problem with cities like NYC and LA is that they are based on monocultures…finance and entertainment, respectively. Chicago is hyper-diverse and just like in the past it will be location, location, location. NYC is played out and basically living on “borrowed” time…literally. LA, is well LA ,and good luck trying to prove that it is actually a livable city.

  5. Jeff Leitner says:

    Terrific piece, Aaron. “…when it comes to Chicago’s transformation, the city was the artifact, not the architect.” Smart.

  6. BelmontRes says:

    Racaille, there is no “building boom” downtown, or anywhere in Chicago. There’s a massive housing bust. You can track new housing permits here- http://censtats.census.gov/bldg/bldgprmt.shtml

    As you can see, there’s practically nothing permitted in the last three years. To be fair, there isn’t much of a housing boom anywhere in the U.S. lately, though NYC & LA have much higher rates of construction (Chicago can’t really match up with any of the individual NYC boroughs alone, in terms of 2012 housing starts, to say nothing of citywide).

    But I’m not sure why housing construction is a proxy for economic diversity or long-term health. Is Phoenix the model city?

  7. Racaille says:

    Dear Belmont,

    “Racaille, there is no “building boom” downtown, or anywhere in Chicago.”

    You clearly have no idea of what you are talking about.

    http://www.domu.com/blog/apartment-projects-under-construction-update

    Quote:

    “this year and next, eight new towers will add nearly 3,150 apartment units to the market.”

    Perhaps I should be doing some research for Mr. Renn.

  8. Matthew Hall says:

    What important companies did Cincinnati or St. Louis have in 1980 that they don’t today? What is “big 4 employment base”? How has Cincinnati had slightly more population and economic growth as a percentage of the total size of it’s metro than Chicago? There are many untested and questionable assumptions in Nat’s comments.

  9. Ron says:

    there is no “building boom” downtown, or anywhere in Chicago.”

    Belmont, why bother making stupid comments when you obviously have no clue wtf you’re talking about? Did you think no one would notice how clueless you are? All those cranes in the air downtown and you’re going to try and tell me there’s no building boom downtown or anywhere in Chicago? It’s not the huge boom we saw several years ago but it’s a pretty impressive mini we’re experiencing. It’s a boom big enough to rival many small/mid cities’ skylines. Also, that Domu list doesn’t even mention all the projects that are going on at the moment or all the ones waiting to break ground.

  10. JM says:

    Aaron, I didn’t see it until recently having a kid…but aren’t Chicago’s abyssimal schools part of the problem here? It is an issue that touches much of what ails the City. It contributes to the spike in crime. But moreover, it creates a brain/tax base drain from young(ish) families forced to decide to gut it out in the City or move to the burbs. In the 90’s those families were easily replaced by a stream of young professionals coming to town. These days, that has stopped, exposing a problem that has festered for decades. While far from ideal, New York has grappled with and made far more progress with their system, while Chicago has doubled down on stupid.

  11. Nat says:

    Matthew:
    “Big 4″ refers to the 4 largest accounting firms. As someone employed by these firms over the past 3 decades, I can tell you the trend has been for more commoditized tax and audit functions to remain close to clients in cities like Cleveland, Cincinnati, St. Louis, etc, while the high margin, highly specialized niches have migrated to progressively larger cities, where these activities (and subject matter expertise) are conducted on a regional basis. There are some exceptions, eg, Indianapolis may be stronger in legal or healthcare to serve its clients, Cincy maybe more consumer products/brands rich in expertise (P&G), but that is the overall trend.

    Fortune 500s lost in STL: TWA (not HQd, but huge presence), McDonnell Douglas, AB, May (acquired by Cincy’s Federated). Others include AG Edwards (now part of Wells), all locally owned and operated banks (Mercantile, Boatmen’s, etc.)

    Cincy has fared better but the bottom line is that just about all older mid sized cities have gone through and are continuing to go through this trend. It comes down to critical mass of knowledge-based workers, labor markets, economies of scale, etc. As competition increases among urban areas, jobs/HQs tend to go to the most knowledge-rich area for a particular industry. The businesses that tend to stick tend to be locationally-tied (legal community in a state capital, tourism, oil&gas near an energy producing region, rail companies where they play a more vital role, and so on). Or a local flagship company is acquired by its big city competitor, or a NY or SF-based PE shop with cash, and so on.

    Chicago, and the Midwest as a whole, need to figure out what they do best in a post-industrial world and develop in those areas. What I suspect we’ll see, over time, is that simply being the biggest in a given region in the country won’t be good enough. Not when the world is getting smaller and HQs can administer increasingly well from more remote locations like NYC, London, China, etc.

  12. the urban politician says:

    JM,

    The problem isn’t Chicago’s ‘abysmal schools’.

    The problem is Chicago’s ‘abysmal culture’.

    Its worthless public-employee unions continue to act as if this is 1950 and that Chicago is America’s second largest city.

    This is making it very difficult, despite earnest efforts by leaders such as Rahm, to effect any sort of meaningful change. Just look at the negotiations taking place between the City and the CPS right now.

    In addition, you have an African American leadership that is completely disinterested in the city’s fiscal well-being and far more interested in funneling money to black businesses, whether or not it is based on merit or not. Unfortunately, until the black population drops much further, Chicago must play ball with these leaders (one of who is having a mental breakdown right now). Just look at all the ridiculous posturing that took place around Metra’s Englewood Flyover project.

    If Chicago can kick these two ‘legacy leeches’, as I like to call it, I really think it will be far better off.

    I would also like to add that most of the commentators here really don’t have a clue what is happening in Chicago other than what is being posted here or in an occasional article, although I suspect one or two, including Aaron, have a better picture. I guarantee you that there is a lot of pent up demand to live in the city, but it basically is not being satisfied because 1) most of the major new construction is occurring downtown, and only a select few developers have the ability to complete such endeavors, 2) many multi-unit buildings in desirable neighborhoods are being deconverted or demolished into luxury single family homes, which are selling for high prices, 3) the cost of renovating a foreclosed multi-unit property is very high and requires commercial financing, appetite for risk, and experience (which not a lot of people are willing to take on).

    So in the end, there are whole neighborhoods (far beyond just Lincoln Park and Lakeview) where young people simply can’t find apartments. At some point, when the banks clear out their inventory of foreclosures and begin seriously lending again, I believe we will start to see that demand get serviced.

  13. Racaille says:

    “I would also like to add that most of the commentators here really don’t have a clue what is happening in Chicago other than what is being posted here or in an occasional article, although I suspect one or two, including Aaron, have a better picture.”

    Really?

    “Arthur Lloyd, executive vice president of Ivanhoe, said the rate of job growth in Chicago made the city an attractive investment opportunity. Mr. Shannahan, of Hines, estimated that about 10,000 new jobs were announced in 2011, and said, “That’s a great record for the downtown.”

    http://www.nytimes.com/2012/07/11/realestate/commercial/chicago-loop-attracts-development-of-new-office-space.html?pagewanted=all

  14. Matthew Hall says:

    If business services and management can be done from anywhere, why not somewhere cheaper? Educated workers can be lured to cheaper places just like companies. Macy’s, Kroger,P&G, and some of the constellation of engineering companies in Cincinnati have bought operations from more expensive places. P & G bought Gillette from Boston, Kroger and Macy’s bought dozens of local retailers around the country, General Cable in Cincinnati just bought German and Brazilian companies who work in areas of fiber optic and other communication cables. Besides DHL’s operation in Cincinnati, another air freight company is negotiating a state subsidy to move from Connecticut to Cincinnati’s airport right now. These examples run counter to Nat’s suggestion that economic activity will concentrate in fewer and fewer centers of maximum profitability.

  15. @JM, Chicago has school problems, but name a big urban district that doesn’t. I don’t think schools differentiate Chicago too much here.

  16. Matthew, things can’t always been done as effectively from cheaper locales. That’s why NYC, DC, and Silicon Valley continue to thrive. Cincinnati will still have accountants and consultants and such serving that local market, but increasingly the big consultancies consolidated back into hub cities like Chicago. That’s actually brought an uptick back to Chicago’s market of late.

  17. Peter says:

    “Chicago has school problems, but name a big urban district that doesn’t. I don’t think schools differentiate Chicago too much here.”

    Exactly.

  18. BelmontRes says:

    Urban Politican, if there is such a great need for apartments, then why is the citywide vacancy rate over 10% per the Census ACS, which is far worse than the national level, and those of other major cities?

    I would argue that Chicago has a tremendous glut of apartments, especially at the luxury level. You can rent a one bedroom in a brand new West Loop or South Loop highrise for far less than a tiny studio in a walkup in some outer, anonymous neighborhood in one of the coastal cities.

    The RE market seems very weak in Chicago relative to that of other major U.S. cities. Property is cheap, and interest isn’t very strong.

  19. As the housing bubble collapsed, it fueled demand to rent, not buy. Belmont, from what I saw before I left, the apartment market was doing pretty well in Chicago. This is true in cities across America. Pick up the paper even in places like Columbus and Cleveland and hear about apartment shortages. There’s a lot of construction going on out there in downtowns across America. I bet if you adjusted for relative population size, there’s not much special about Chicago’s recent apartment construction, though I do believe the market is doing well. This is just another national trend.

  20. Peter says:

    BelmontRes, not sure where you get your stats, maybe you make them up. Apartment vacancy in Chicago is less than 5%. From a market report from Marcus & Millichap:

    Vacancy: Strong demand and a second consecutive year of limited construction will support a
    50-basis point drop in vacancy this year to 4.1 percent, the lowest year-end level in 11 years. Driven
    by the release of pent-up demand, vacancy plummeted 100 basis points during 2011.

    Rents: Rents will continue to gain momentum in the second half of 2012. For the entire year,
    asking rents will rise 2.6 percent to $1,093 per month and eff ective rents will surge 3.6 percent to
    $1,027 per month. Last year, asking rents rose 1.7 percent while eff ective rents gained 2.0 percent.

  21. the urban politician says:

    Peter,

    Your article shows that Chicago’s job market rebounded more strongly than any other city besides Houston in the last year.

    In addition, just today the fifth largest accounting firm in the US just announced they are relocating their headquarters to Chicago.

    Chicago’s unemployment rate is really dropping like gangbusters, and as we have discussed before, has already caught up with New York.

    Aaron, while I admit that it is far too early to celebrate, it’s time we acknowledge that the 2000-2010 period that you continue to discuss is already becoming old news.

  22. the urban politician says:

    For anyone who doesn’t want to read Peter’s article and (perhaps) are all too giddy with the idea of Chicago’s decline, let me post an interesting quote from it:

    “Since last year, the number of people without jobs dropped more in Chicago any other U.S. big city, according to the study. Right now there are 28,000 more people with jobs in Chicago compared to a year ago, and the number of workers looking for a job dropped by almost 20,000.
    Houston was the only U.S. city that created more jobs than Chicago.”

    Aaron, time to move back from Rhode Island. The ship isn’t sinking anymore ;)

  23. Peter says:

    “In addition, just today the fifth largest accounting firm in the US just announced they are relocating their headquarters to Chicago.”

    Yep, the sky is falling.

  24. Matthew Hall says:

    Why this focus on accounting? It is one of dozens of different types of economic activities.

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