Sunday, July 29th, 2012
This article is part of The State of Chicago.
I now want to transition from a look at historical and current conditions in Chicago to a defense of a couple of my more controversial diagnoses that attepted to explain the problems behind Chicago’s weakness in recent years. These were my observation that Chicago lacks a “calling card” industry, and my claim that Chicago, while a global city, is weak enough in this dimension that it cannot rely on that alone to sustain it.
Today I’ll look at the former. In some rankings I’ve seen, Chicago has the most diverse big city economy in the United States. The flip side of this is that unlike with New York and finance, DC and government, LA and entertainment, etc., Chicago lacks a signature industry that is capable of generating significantly above average returns. That helps explain why on various quality measures (like GDP per capita) it greatly underperforms. Chicago is simply not the epicenter of any important 21st century macro-industry that is capable of generating super-sized returns. I gave a more detailed treatment of this some time ago in a post called “Chicago and the Epicenter” should you be interested. (You’ll note from that post I was already thinking about this series over two years ago).
Pros and Cons
Now being diverse vs. being concentrated in a particular industry has both pros and cons. If you are overly concentrated in a single industry, then you are vulnerable if that industry nose dives – just ask Detroit. Really the big difference between Detroit and Silicon Valley is that the latter’s signature industry is still going strong. Also, excessive specialization in one high value function can actually drive everybody else out as the highest value use bids up real estate into the stratosphere. Perhaps we might say that it operates with positive reinforcement, which isn’t always a good thing.
Very diverse areas, by contrast, aren’t as vulnerable (in theory) to big collapses. It’s slow and steady wins the race, with fewer boom and bust cycles. So there’s definitely value to diversity. Of course the flip side is that you don’t have that unique magnet for talent. No one has to do business in your city. You generally create average level returns and incomes. Indeed, we see all of this in Chicago. And having a diverse economy did not protect it from severe consequences in this downturn.
Does Chicago Want to Just Have a Diverse Economy? No
Some folks touted the diversity of Chicago as a great strength in response to my article, but deep down I don’t believe anybody really believes it. Everything every civic and economic development person is doing every day is predicated on the desire to be specialized.
Consider the trivial example of the culinary arts. Chicago likes to view itself as a rival to anyone when it comes to cuisine. Is this just a matter of Chicago being big? That is, that It has exactly as much fine dining as it is “supposed to” for a city of its size? Is this how locals sell the food scene? No. The entire idea is that Chicago is a special place, where it not only has a great food scene because of how big it is, but because it has something special that let’s it punch above its weight.
We see a similar dynamic at work in the tech sector. Chicago is determined that it wants to be a major American tech hub. Does this mean that it simply wants it’s “fair share” of tech for a city its size? The rhetoric doesn’t sound like it.
For example, at Tech Week Rahm Emanuel noted that Chicago is known as the Second City, but that “three years from now it’ll be known as the startup city if we do everything right.” The recent announcement of Google moving Motorola’s operations from Libertyville to downtown is also portrayed as boosting Chicago’s tech ambitions. Clearly, talk to any tech booster in town, and you won’t here how Chicago is mere “average” in tech for a city of its size – or that ranking as such is their ambition.
Also, if you look at Emanuel’s own economic plan you’ll see that the #1 item in its analytical framework is “Economic Sectors and Clusters.” What is a “cluster” except an industry where a city has a higher than average concentration (i.e., specialization) in that industry? Indeed, the plan uses location quotient, a standard measure of jobs concentration, as a tool to identify areas where Chicago is specialized.
The challenge is that these specialties are pretty weak and pretty general. It would have been nice had the various recent analytical looks at Chicago’s economy looked at how it differs in terms of a lack of high value specialization vs. other tier one cities.
Now, of course Chicago does have some specialties – logistics (particularly around rail/intermodal) for example at the macro level and say the design of super-tall skyscrapers at the micro. However, these either don’t necessarily generate significant high end returns or simply aren’t that big in aggregate.
In any case, it’s certainly not valid for Chicago boosters to cite economic diversity as the city’s key strength on the one hand while everything they do is designed to create specialization on the other. I’d like to see the rhetoric remain consistent.
Why a Calling Card Industry Matters
If you look at how businesses behave, you start to see why a calling card industry is important, especially for a city like Chicago. For example, former GE CEO Jack Welch said he only wanted to be in a business if he could be #1 or #2 in that market. Warren Buffett likes to talk about what he called “wide moat” businesses like Coca Cola – ones that have built barriers against competitors such that they retain significant competitive advantage over the long term and thus can generate superior economic returns.
It’s difficult for a city to generate those types of returns if it has no real competitive differentiator. If there’s nothing that enables a particular industry to thrive in your city better than somewhere else, then really you are just playing a commodity game. Those types of businesses tend to be brutal, low margin, and dominated by producers who have the lowest costs and most operational efficiencies, Wal-Mart for example.
Clearly cities like Dallas have mastered that market. Chicago is not a low cost producer and hardly as business friendly or efficient as many other places for Joe Average type businesses. So why are businesses going to locate there? There really isn’t a great answer to that question right now. The entire focus seems to be on global city/talent magnet/Loop. That’s an important piece of the puzzle to be sure – and not to be neglected. But as I’ll demonstrate in subsequent pieces, it’s not enough.
Often cities carve out a specialized basis of appeal based on the unique agglomeration environment in a cluster or major signature industry. If Chicago doesn’t have that, and isn’t the cheapest place to do business, it has to find another basis of competitive advantage to build its fortunes on.
I won’t rehash this since I already addressed some of this in a piece I called “Chicago’s Structural Advantages.” The idea is to look at structurally unique factors about Chicago and attempt to find ways to leverage them. The biggest advantage Chicago has it that it’s the only large, traditionally urban type city in the US interior.
Now, the city would no doubt say that it’s current talent/Loop/global city strategy is based on this, but I really don’t think it is. For example, the push into tech is basically a me-too type effort and I don’t see Chicago as well placed to punch above its weight in digital type startups. I’m sure it can do well to some extent, but it should. Chicago is the third largest city in America after all. That alone dictates it should be big on an absolute basis in most things. But I don’t see it as Silicon Valley II. For all the economic development “usual suspects” like tech, life sciences, and green industry, I suggest Chicago’s best strategy really is to get a “fair share” of these and not worrying about trying to build a fortress franchise.
My biggest recommendation instead is to focus on creating what I call “Professional Services 2.0” That is, the next generation of professional services in America. As I noted previously, Chicago may be the best place in America to fly people around the country. Why not leverage that?
Indeed, we are seeing an uptick in professional services, but I see this as a natural revival, not as a result of any particular strategy on Chicago’s part. Which is fine, actually. But I also see weak spots. For example, the Indian outsourcers like Infosys, Tata, etc. don’t seem to see Chicago as their main US hub (or at least they didn’t last time I worked). Newer models of onshore consultancy seem not to be coming out of Chicago, but out of traditional innovation hubs. For example, firms like Slalom and Point B are both based in Seattle.
This suggests Chicago has work to do, but it doesn’t seem to be really focused on this. Professional and business services is part of Emanuel’s economic plan, but is clearly subservient to headquarters attraction. There needs to be much more focus on services for its own sake – Chicago should absolutely OWN the space.
In any event, that’s one example of how Chicago might move forward.
Diversity and Specialization Not Necessarily Opposed
Lastly, one final note on diversity vs. specialization. Sometimes diversity and specialization are posited as opposites, but in some cases it isn’t necessarily true. You can have a diversity of specialties, for example. That is, your city has multiple areas in which it has a dominant type position. I supposed you could call it a specialization conglomerate, though that’s a corporate approach that’s a bit out of favor.
I’ll illustrate this using a dusted off 2×2 matrix I put together a while back called the “Diversity-Tradeability Matrix.” It doesn’t look at specialization per se, but rather tradeability, or the ability of an economic activity to be performed elsewhere (such as offshore), which we might view as really the core of what we’re hoping to get at through specialization – the wide moat position.
Here’s the matrix with the resulting four typologies of cities:
And here’s how I mapped example cities into the grid:
So in a sense you can have the best of both worlds, though I’d argue New York is overly specialized in finance. (Please keep in mind this is but a rough cut take. For example, a true global city would have non-tradeable services that are in some way related to servicing globalization, for example).
For Chicago, I’d argue the city most belongs in the Regional Business Center category. It’s mostly a diversified regional capital like Atlanta moreso than a global city like New York, though of course it has global city parts to it. But it’s a Regional Business Center with a high cost profile, which creates the challenge.