What If Americans Invested Stock in Distressed Cities?

Economists have a new idea that could revolutionize how struggling cities attract private funds.
by | April 24, 2015

There is a lot that’s different between the agriculturally based Fresno, Calif., and the business and services-driven San Francisco less than 200 miles away. But perhaps the most alarming difference is the stark divide in their economic directions.

By many measures, San Francisco has recovered from the recession -- unemployment is at 5 percent and median household incomes (now about $75,600 annually) are on the rise again. Fresno’s unemployment rate, meanwhile, is in double digits and median income (about $45,600) is slightly lower than it was in 2008, according to U.S. Census Bureau figures. More than half of single mothers in Fresno live in poverty.

A new white paper highlights the discrepanies between these two areas and others across the country. The paper said the uneven economic progress of metropolitan areas is a national emergency -- “pockets of distress and traumatized workers” face plummeting incomes, stalling career professions and cracking self-confidence."

“We have to look at the harm to people’s lives -- that it’s really a geographic accident of where they’ve been born,” said Jared Bernstein, an economist and advisory board co-chair of the Economic Innovation Group, which published the paper.

Bernstein’s comments came at a panel discussion on distressed cities hosted last week by The Atlantic in Washington, D.C. Bernstein and co-author Kevin Hassett called for a new formula to drive private investment to these distressed regions. They argued that private-sector businesses currently have little incentive to enter economically distressed communities because of the risks involved. After all, no one wants to be the guy who picks the wrong edgy neighborhood in which to flip a house.

But what if the risk was reduced? To that end, Bernstein and Hassett propose using the power of venture capital firms and mutual funds to create a fund or company that specializes in investing in distressed cities.

“I think there’s actually a profit to be made from turning these places around,” Hassett said.

The fund or funds would have tax advantages for investors. It could follow a 401(k)-like structure where investors can put in money from their paychecks before taxes are applied, then pay taxes on their earnings when they withdraw. Or investors could pay a lower capital gains tax on their earnings each year. Such a pooled fund, Bernstein and Hassett argued, would help mitigate the risk for new developers and businesses in distressed areas.

A welcome sign in Fresno, where the unemployment rate is in double digits and median income is slightly lower than it was in 2008. (Flickr/Great Valley Center)

While there are existing incentives for private investment in distressed areas, the paper notes that research on the effectiveness of those programs has been inconclusive. For example, one GAO report on enterprise zones in Maryland that were meant to increase jobs found that business owners located in the enterprise zone said the incentive had little to do with why they created more jobs. A slight exception, the paper said, is the New Market Tax Credit, which offers a tax break to investors who will loan money or services to distressed areas. However the program has become complicated and is not structured to induce the kind of larger-scale investment that can accelerate the revitalization of an entire community, the paper said.

Amy Liu, a Brookings Institution expert on metropolitan economies, said during the panel discussion that recovery programs are also often focused on urban areas. Meanwhile, poverty is shifting to the suburbs. “So we have to rethink what we mean when we talk about the economic challenges of today,” she said.

As far as which areas should be targeted, Bernstein and Hassett are leaving that up to further research. It could be based on economic criteria like unemployment rate, foreclosure rate or even disaster zone status. If their idea is successful, the paper imagines a day when investing in a distressed communities fund becomes as normal as investing in a mutual fund and that the potential for profits will spur more investment.

Bernstein and Hassett also said they hope they’ve created a political middle ground "that has become a rarity in the current political climate" by basing their proposal on markets and enterprise to help narrow the economic gap between the rich and the poor.