The purpose of this commentary is to paint with a broad brush the new global ecosystem in which Alaska's economy will operate in the years ahead, make some suggestions to guard against the hubris of past success and Black Swans (i.e., high impact events), and generate cognitive discourse on Alaska's fiscal structure and economy.
An effective strategy, according to Dartmouth professor Vijay Govindarajan, manages the present, selectively forgets the past and creates the future. The key to Alaska's success in the economic marathon lies in what we will do today that will ultimately intersect with strategy twenty years from now. We are at a strategic turning point, and have to recognize that Alaska has to make structural changes to accommodate fundamental long-term shifts in funding models. To stay ahead of the curve, we will have to model the uncertainty from strong secular economic headwinds in our paradigm shift.
More than 56 percent of Alaska's state budget and 90 percent of its general fund revenues come from oil (i.e., production tax, petroleum property tax, corporate income tax and royalties from state-owned land). Another 20 percent of the state budget comes from federal funds (Medicare, Medicaid and infrastructure). Investment income (mainly from the Permanent Fund) makes up most of the balance; however, these are not used for general government services. Alaska is one of five states without a state sales tax, one of seven states without a personal income tax, and the only state with neither a state sales tax nor a personal income tax.
One-third of Alaska's economy depends on federal spending, one-third on petroleum, and the remaining one-third depends on drivers such as: mining, tourism, timber, seafood, international air cargo and miscellaneous services. This is commonly known as the "three-legged stool." Federal spending in Alaska is currently $10 billion annually which is the third highest per capita spending in the nation.
The University of Alaska, which is Alaska's fourth largest employer, also depends on federal awards (approximately $175 million without student financial aid and pass- through). These federal grants will become, obviously, much more competitive in the years ahead. Research revenue is vital, as for every dollar of state investment in University of Alaska research, the university generated $5.60 in additional research revenues. In other words, with federal deficits, federal spending in Alaska will be impacted. At present, according to Moody's (moodys.com), the state of Alaska has AAA, stable credit rating but with a relatively high liability ranking based on income and population as a result of the state's petroleum tax based revenue system.
Against the pressures emanating from diminished gross domestic product projections, burgeoning federal deficits which will mean reduced federal aid to Alaska, slowdown in Asian and European economies, the looming so-called "fiscal cliff," declining oil production, rising Medicaid costs, approximately $11 billion in unfunded pension liabilities for the state of Alaska (PERS and TRS), and other macro-economic outlook bring up interesting structural challenges for the state.
So, what can Alaska do so that its budget does not get too squeezed by reduced federal spending and revenues on one side, and increased expenditure pressures on the other side? What can Alaska do to mitigate the fear of a contagion effect and not be at the mercy of the vagaries of outside economic winds? In my view, if Alaska thinks strategically and has the courage and conviction to implement certain ideas contained herein, it will not just survive but will thrive in the years to come. The time to prepare for bad weather is before it hits you, not after it hits you.
Resources do not constrain a state or an organization, imagination does. This is one of the gems of wisdom that I have picked up in my years in academia, local government and the private sector.
Ten Steps to Long-Term Stability
First: The state should have a robust strategic plan with performance metrics to capture outcomes to diversify its revenue base at the earliest. In this direction, the state should mount a big and sustained effort to attract and recruit new businesses. Any business considering Alaska will look at the price of land acquisition and infrastructure. The package becomes attractive for the prospective business if the land is cheap and improvements are already in place.
The state and federal governments own 89 percent of the land in Alaska, while the U.S. average is 35 percent. This structural issue means that while the state's potential property tax base is limited this same structural challenge can be leveraged for resource exploitation and also offering land inexpensively to potential businesses. In this context it is good to remember what Jim Collins, one of America's most influential management thinkers, once famously observed: "Bad decisions taken with good intentions are still bad decisions." Airports, highways, railroad, shipping and distribution centers are important aspects of infrastructure. A potential business will also look at the employee pool as a well-educated work force can minimize startup costs. Labor unions and wage rates are also factors that will go into the calculus. Alaska has an advantage in terms of its tax structure, and a friendly government. While high transportation costs, high utility and energy costs, and harsh weather conditions are huge challenges, the key to attracting business often involves incentives such as tax exemptions, forgiveness of normally enacted impact fees, and credits. The incentive package often is the deciding factor (e.g., Mercedes-Benz factory in Alabama, Volkswagen factory in Chattanooga, Tenn.).
Second: The state should identify parcels of land that can be zoned/re-zoned for industrial use or brought in the town boundaries as industrial land.
Third: The state of Alaska should make a sustained effort to attract venture capitalists. Alaska will not have a Silicon Valley, but it can take a page out of New Mexico's play book, as New Mexico has many of the same challenges as Alaska. Once the state of New Mexico decided to attract venture capitalists, it created a program in which it committed funds to venture capital firms with the condition that they open an office in New Mexico and invest the same amount as the state was providing. New Mexico also granted some flexibility (flexibility and incentives are the keys for any organization to succeed) whereby if it invested $15 million, the venture capitalist could put up, possibly, $12 million if it brought in other investors. The results have been encouraging thus far, and there is no reason why Alaska cannot try to duplicate something similar.
Fourth: The state should examine the quality and scope of tax incentives (e.g., Film Tax Credit program).
Fifth: The state should enhance the operational commercial spaceport (Alaska Aerospace Corp. in Kodiak) to attract more aerospace companies to Alaska to do business. In this context, Alaska should leverage its large land area and small population. The state should also increase incentives beyond what the Small Business Innovation Research and Small Business Technology Transfer support, equity financing and grants, etc. The development of unmanned- aerial vehicles project at the University of Alaska in Fairbanks is a step in the right direction.
Sixth: Alaska should actively attempt to attract well-educated professionals to take advantage of the new knowledge/ innovation economy. Sell the notion of less pollution, shorter commute and safer schools to attract these professionals. Ultimately, Alaska has to migrate away from its low-tech extractive economy.
Let me give a few examples to expound my thesis. Take Arlington County in Virginia: Arlington was facing challenges from the relocation of tens of thousands of federal government workers, decreased affordability of housing, and rising competition from surrounding areas. So, it forged partnerships with local universities, attracted the ultra-high-speed National Lambda Rail broadband network and begun construction of a fiber network to serve county government and schools. The theme is "Brainpower--Arlington's Alternative Energy."
Or take the example of Austin, Texas, where semiconductor manufacturers and the U.S. government created a partnership called SEMATECH to solve common manufacturing problems, increasing its regional payroll by more than $6 billion in just five years. Austin put College Enrollment Managers into public schools to guide choices made by students. As a result, it has boosted the graduation rate for low-income students to 75 percent.
Or, take the example of Dakota County in Minnesota which has diversified its economy to information technology, food, energy, chemicals and manufacturing. The county is speeding planned fiber build-outs and collaborating to increase science, technology, engineering and mathematics education in kindergarten to 12th grades.
All these can be replicated in Alaska in partnership with the University of Alaska. According to University of California economist Enrico Moretti, each new high-tech job in the U.S. creates--due to a multiplier effect--five additional jobs in the service economy. Just think about that. That is a public policy nugget worth noting. Dr. Moretti's research goes on point out that "an unprecedented re-distribution of jobs, population and wealth is under way." He concludes that "a handful of cities with the right industries and a solid base of human capital keep attracting good employers and offering high wages, while those at the other extreme, cities with the wrong industries and a limited human capital base, are stuck with dead-end jobs and low average wages." The sixty-four-dollar question is: Where do Anchorage, Fairbanks, Juneau and other towns in Alaska want to be on this spectrum?
Seventh: Given the density and population growth projections for Alaska, there should be aggressive marketing for out-of-state students. Most states actively recruit out-of-state students as they bring in significantly higher tuition revenues, and also contribute to local economic development in terms of rental housing, car sales, groceries and demand for student housing (which brings up the scope for public-private partnerships such as what the University of Alaska in Fairbanks is currently doing). Some of these out-of-state students will, after graduation, settle in Alaska and create jobs and businesses. This is why so many well-known universities today such as the University of California, Indiana University, the University of Minnesota and others are actively recruiting out-of-state students.
Let me give a concrete example of the magnitude of the impact of bringing in out-of-state and/or international students. According to the 2012 RKA Report to Canada's Department of Foreign Affairs and International Trade, the 218,200 international students in Canada paid an annual expenditure of $8 billion into the Canadian economy, which translated to 86,570 jobs. Marketing (such as promoting that the University of Alaska tuition rates are below the average tuition at public four-year institutions in the Western Interstate Commission for Higher Education region) is key to overcoming the "fear" factor about the Alaska climate. But, this can easily be accomplished if the university programs are nationally ranked in the U.S. News and World Report. (I always say that were Princeton or Harvard or Stanford located on another planet, they would still attract many thousands of applications for each slot!) The University of Alaska Scholars program and the new $400 million Alaska Performance Scholarship Endowment set aside for college scholarships are strategic steps in the right direction.
Eighth: At its peak, Alaska's North Slope was producing 2.3 million barrels a day. Since then it has declined significantly. Although Alaska has, according to the USGS, more than 5 billion barrels of discovered oil reserves and another probable 6 billion barrels in undiscovered resources, it is now losing investments (due to ACES tax) to Wyoming, Texas, North Dakota and Louisiana.
The 2012 Annual Energy Outlook of the U.S. Energy Information Administration ominously observes that the Alaska North Slope oil production could shut down as early as 2035. It is reasonable to conclude, therefore, that absent a Black Swan event, the downward trajectory of Alaska's oil production curve will begin to create a noticeable reduction in state spending. Extractive resources, such as oil, have a greater variability of price than service or industrial products which make Alaska's revenues more sensitive to market fluctuations such as might occur over the next ten years in the U.S. demand for refined oil products like gasoline as alternative energy takes over.
Furthermore, although Alaska has enormous potential for shale gas (estimated at 80 trillion cubic square feet by United States Geological Survey) in the Shublik, Kingak and Bookian rock units, the prohibitive costs of developing infrastructure in the Arctic coupled with foreseeable market prices and the now more abundant supply of natural gas in other states make it much less likely that Alaska'snatural gas will be developed for U.S. markets in the near future.
Nonetheless, this could be a card Alaska can play if technology, supply and market conditions change in the future. It is estimated that there is potential for a $2 trillion positive impact on the U.S. economy from shale oil and gas developments in the Lower 48 states. However, as this could also lead to a long term drop in oil prices, once again Alaska would be adversely impacted financially according to Energy Policy Research Foundation Inc. and the Alaska Office of Management and Budget FY12 -FY22 forecast. With 90 percent of Alaska's government funded by oil revenues, there is a "fierce urgency of now" to diversify Alaska's revenue streams. The good news, according to Towers Watson and Co., is that the amount of capital being raised by the larger private equity firms to invest in energy, especially natural gas, has doubled in the past three years to $33 billion.
Ninth: As Alaska spends a high proportion of its budget on transportation/infrastructure and energy, it might consider, much like Georgia and other states have already done, having a special-purpose local-option sales tax (SPLOST) as a funding mechanism to permit communities to tax themselves for a specific purpose.
Tenth: Alaska should invest in the Polar Fiber project (which connectsLondon and Tokyo via the Arctic Ocean and the Bering Strait) as this has the potential, due to time zone differentials, to develop Alaska as a communications and data hub. Increasing the utilization of broadband in Alaska (currently, Alaska's average cost for broadband is higher than the national average, and the average download speed is second to last in the nation) would be a catalyst for the economy. The efforts of Connect Alaska in leveraging technology to stimulate economic growth, especially in the commodities market, are a step in the right direction.
All Economics is Local
At the end of the day, all economics is local. Let us take a look in the rearview mirror, reaffirm our pioneer roots and then contemplate the pioneering economic possibilities of what we could be in the transformational decades to come. We have to stop playing checkers and start playing chess--think long term. Since dreaming small or dreaming big takes the same energy, we must dream big. Some see things as they are and ask "Why?" Others, like me, see things as they are and ask "Why not?"
Dr. Ashok Roy is vice president for finance and administration and chief financial officer for the University of Alaska. This commentary first appeared in the October 2012 print edition of Alaska Business Monthly magazine. It is used here with permission of the publisher. www.akbizmag.com. The views expressed here are Dr. Roy's and not necessarily those of the university.
By DR. ASHOK K. ROY