I often ask audiences at my lectures whether they think city governments should make a profit. I do this because of the reaction, which is immediate and visceral: NO! The overwhelming reaction I get is that city government provides services, and profit should not be a consideration. Many people are appalled by the suggestion.
And, in a way, I understand.
We don’t often think of profit as something worthy of a collective pursuit. In many ways, we have more altruistic notions of what our local governments should be, even if that notion is simply to maintain my own road at a price — in dollars and transaction costs — less than what I would be willing to pay to do it myself.
Yet, what is a profit? In accounting terminology, profit is a condition where revenues exceed expenses. That’s it. If you have more money coming in than you have going out, you are making a profit.
Running government with business principles
As part of my lecture, I explain how Walmart must make a profit — they must have more revenue than expenses — if they want to stay in business. (I specifically choose Walmart and not a company like Amazon or Tesla where the capital markets don’t seemingly care about profits, which says more about the capital markets than those company’s prospects).
The requirement of making a profit is true of Walmart, but it’s also true of an orphanage. While the goal of an orphanage isn’t to maximize profit, no matter how much social good an orphanage does, and regardless of how desperately it is needed, if it doesn’t run a profit, if it's revenues don't exceed expenses, it will also go out of business.
Once you accept this hard, cold reality about an orphanage — which is, literally, a place for helping desperate children — then it’s not much of a leap to grasp the fact that cities, too, must run a profit. Your local government must have more revenue than expenses, year after year, or bad things happen.
When people suggest that we should, “run government like a business,” I agree with them in the sense that we should apply business principles to the running of local government. That big-hearted council member who loves parks and wants affordable housing for everyone is a menace to society if they can’t also understand a balance sheet. That no-nonsense council member who just wants to keep city government focused on building roads and providing parking is a disaster if they don’t grasp a P&L statement.
And, worst of all, when that professional staff member recommends the city take on debt, assume some long-term obligation or undertake some massive project despite not having a basic understanding of the financial implications of their advice, they should be run out of town.
This is why it often provides me a great deal of relief when private-sector business people wind up working in government. One of the best examples is Chris Gibbons, the private-sector businessman who ended up as economic development director in Littleton, Colorado when the city lost most of its workforce in a single plant closing.
He knew right away that they couldn’t use traditional methods of chasing smokestacks and paying companies to relocate there to make up that shortfall, but the need to do something productive prompted him and his colleagues to invent what is now known as economic gardening — the most brilliant approach to local job creation I have encountered. I believe it was his private-sector experience that gave him the grounding in financial reality necessary to make this breakthrough.
So, all things being equal, give me someone with private-sector experience who wants to apply business principles to the art of running the city... but know, this, too, has some serious limitations.
Running government with business values
I had no idea who “mightily credentialed urbanist” Dan Doctoroff was until he was the featured guest on the Freakonomics podcast. That’s okay; even host Stephen J. Dubner suggests he’s not a household name. Still, Doctoroff has been described as a modern-day Robert Moses and, after having listened to the show, it’s clear he is incredibly accomplished. A businessman recruited by the Bloomberg administration to run a number of complex undertakings for New York City, he had a refreshing perspective on local government.
Yet I found myself deeply disturbed by some of the things he said. Here’s probably the most egregious:
“I believe in something I call the virtuous cycle of the successful city. The object of a city should be to grow — and that is grow the number of residents, grow the number of jobs, grow the number of visitors. Because the marginal revenue of those additional people is greater than the marginal cost. And then you can take that net profit, if you will, and reinvest it back in quality of life in the city, in an affordable housing, and education, and safety, and social services and when you do that and you improve quality of life, more people come, perpetuating the virtuous cycle.”
— Dan Doctoroff on Freakonomics, June 6, 2018
This is where the private sector mentality — running government like a business — seems to hurt more than it helps. And it’s not a modest flaw. This kind of thinking is fatal.
But the suggestions that “the object of a city should be to grow” is deeply flawed. Despite the suggestion, the marginal revenue is not greater than the marginal cost, not even in New York City. What Doctoroff calls “net profit” we call a sugar high — a short-term bump in cash flow from the new growth while the community takes on an even greater amount of long term liabilities.
I've called this a Ponzi scheme. I don’t think there’s a better description.
This is fatal because the goal of a city isn’t to grow; that is sometimes a happy side effect, but it’s not the objective. The goal of a city is to endure. To survive. To be around tomorrow and the day after and the day after that.
For humans to prosper within a place, that place must first and foremost be stable. In a competition between stability and growth, local governments must choose stability.
Choosing stability over growth is not a natural disposition for private-sector players. In fact, for the most part, choosing stability over growth in the private sector is a path to stagnation and, ultimately, bankruptcy. Companies that play it too conservative will be out-competed by rivals that are less risk-adverse. We all benefit from that.
We don’t benefit, however, from cities acting this same way.
Nassim Taleb often talks about an ecosystem of restaurants in a community, each one of them pushed to the limits and very fragile, but as a collective, very stable. Individual restaurants come and go, but there’s always a good place to eat.
Cities are not like restaurants, or even an ecosystem of restaurants. When you own a home or run a business in a specific location, you don’t get to choose between multiple cities; you have the one you have. If it fails, you don’t get to replace it with something else. There aren’t multiple cities competing for the land under your house. If your local government fails, you live in a failure.
If the city you are in goes far into debt, you’re stuck with that, regardless of what urgent need may come along. If your city takes on miles of new road and pipe in an effort to grow, that’s now an obligation you have; it’s on your community’s balance sheet and you will forego other things in the future to meet that obligation or there will be dire consequences.
In the private sector, we need people who are willing to take great risks, to run the chance of failure in a competitive effort to grow. That benefits us all. In the public sector, we need people who are obsessed with stability, who shun risk with the recognition that local government is a platform for people to do good things, that the role of the city isn’t to grow but to provide the stable environment necessary for prosperity to emerge.
If a private sector business fails, the ecosystem of businesses becomes stronger and society becomes more prosperous. If a local government fails, people suffer and society becomes less prosperous. There is no symmetry between those two kinds of failure.
Run your city informed by business principles, just don’t run it with business values.
This article originally appeared at StrongTowns.org and is re-published here under a Creative Commons Attribution-ShareAlike 3.0 Unported License.