Meredith Whitney's new book explains why The U.S. comeback isn't happening where you think.
In late 2007, Meredith Whitney, then a rising analyst at Oppenheimer & Co., started warning that a looming meltdown in mortgages spelled disaster for many of America’s big banks. Whitney’s contrarian calls proved prescient and made her a celebrity on Wall Street. In her new book, Fate of the States, Whitney, 43, offers another daring prediction. She views America’s future as the tale of two economies so wildly divergent they could exist as separate countries. The housing boom temporarily masked the weakness of such states as California, New York, and Arizona and encouraged their governments to spend recklessly. For Whitney, the future belongs to the unglamorous “flyover” states of the central corridor — Nebraska, Iowa, Indiana, South Dakota — places that never had a housing boom or bust, that benefit from low taxes and low debt, and that maintain the resources to fix their roads and nurture their schools. These are America’s new emerging markets, and they will thrive by pulling jobs and businesses from the old-economy states destined, barring a revolution in leadership, to keep spiraling into decline. Our excerpt from Fate of the States:
It sounded like yet another corporate cutback story.
In March 2009, Tampa Bay-based Sykes Enterprises told city officials in Minot, N.D., that the company was going to have to lay off 200 workers and shutter the call center Sykes had been operating there since 1996. A sign of the bleak economic times — right?
Well, there’s a wrinkle to this particular story. Sykes’s problem, according to the Tampa Bay Times, was not a lack of business. In fact, business was booming. The problem was that Sykes just couldn’t find enough employees in Minot to handle all the demand. The company had originally hoped to expand its Minot call center to 450 workers. But in North Dakota’s booming economy — one in which fast-food joints are paying high school kids $20 an hour and young oil workers are pulling in $100,000 a year — hiring has become a huge challenge for employers like Sykes. “They’d been advertising all the time for employees but just couldn’t find them,” said Minot mayor Curt Zimbelman, noting that true unemployment in North Dakota oil country “probably doesn’t exist.”
North Dakota may be an extreme case, but believe it or not, the U.S. economy is on the road to recovery. There’s just one big problem: The road is unevenly paved. Parts of the country are growing at rates on par with some of the world’s fastest-growing emerging markets, while others are being dragged down by high unemployment and mounting debt loads. The dichotomy is obscured by national economic data that show the overall U.S. economy growing at a sluggish 2% a year. The strong growth of the central corridor is being obscured by the weakness in debt-laden coastal states. From 2008 to 2011, Louisiana’s economy grew 16%, North Dakota’s by 27%, and Iowa’s and Nebraska’s by 11%. All in all, the 17 states that I call the central corridor collectively grew their economies by 8% from 2008 to 2011. The U.S. as a whole grew its economy by 6%. The coasts, which partied during the boom and got hit after the crash, grew theirs by 2%.
The reality is that the central-corridor states, largely skipped over in the boom years, now have more resources to attract new residents and businesses because they are not choking on debt and crazy pension obligations and forced into a dependency on higher and higher tax rates. Not coincidentally, these same states are also investing in the right things: jobs, infrastructure, and education. In an increasingly digital economy unhinged from the demands of geography — corporate titans like Exxon and American Airlines, for instance, no longer need to be headquartered in New York just to be near Wall Street or Madison Avenue — the states that are in the worst financial shape are now struggling to compete.
Consider, for instance, a corporation headquartered in Silicon Valley. The average corporate tax rate in California is over 8.8%, and the average sales tax is 7.25%. The cost of living is higher than in most other states, and social services are vanishing. Moving a business next door to Nevada, with zero corporate taxes and a lower cost of living, seems reasonable enough, and businesses and individuals have been making such moves. And nowadays a state on one side of the country could be competing with a state thousands of miles away. Indiana, for instance, has actually been running print ads in California that show a coffee-shop napkin with the following handwritten message from Indiana: “Admit it, you find me fiscally attractive.”
Indiana’s Mitch Daniels is not the only central-corridor governor mounting a full-on assault on states like California, Illinois, New York, and New Jersey in a bid to lure individuals and businesses. Companies are relocating and channeling investment dollars from struggling states to strong ones like never before. Toyota announced in 2012 its factory-expansion plans in Indiana, investing $400 million to move the production of its Highlander to Indiana from Japan. Boeing plans to close a plant it had operated since 1929 to move all future operations to Oklahoma and Texas. Google, Amazon, and eBay are investing hundreds of millions to build out facilities not in California, but in business-friendly Texas.
For communities struggling with onerous debt, high taxes, and stubborn unemployment, there’s an ominous precedent. In 1950 the city of Detroit boasted a population of 1.8 million people. Just 60 years later its population has been reduced to a mere 600,000. Why? Jobs exodus, political and social instability, and steeply reduced social services create a self-perpetuating downward spiral that many cities find impossible to escape. This is how Detroit, once America’s sixth-most-populous city, devolved into a welfare city — another American ghost town. The contexts may be different, but stories like Detroit’s are playing out all over the country. For Motor City and others like it, bankruptcy is a very real prospect.
Back in December 2010, I was pilloried in the financial press when I went on 60 Minutes and warned that there would be 50 to 100 large municipal bond defaults. It was a wide-ranging interview. When Steve Kroft asked about municipal bond defaults, I told him that they were coming and that investors would be wise to ignore conventional wisdom. “When individual investors look to people that are supposed to know better,” I told Kroft, “they’re patted on the head and told, ‘It’s not something you need to worry about.’ It’ll be something to worry about within the next 12 months.”
Muni bond defaults did increase 400% in 2011, to $25 billion from $5 billion in 2010, according to the Distressed Debt Securities newsletter. But for the record, I never said those 50 to 100 defaults would all happen in 2011, which was how my critics spun the story. Kroft had not even asked me for a time frame. He wanted to tell the story of the state and local budget crisis, and what I told him was that the crisis would become a big deal — “something to worry about” — within 12 months. Twelve months after the 60 Minutes story aired, I wasn’t the only one worrying, as headlines from Bloomberg Businessweek, Time, the Associated Press, and the National Journal attest.
But while defaults and bankruptcies are important stories, they remain mere symptoms of and sideshows to something much bigger and more important. A geographic sea change is occurring in the United States, with economic power shifting away from longtime coastal strongholds — states still hung-over from the housing bust — and toward the more “fiscally attractive” central corridor. These so-called flyover states contributed 25% of U.S. GDP in 2011, up from 23% in 1999. A two-percentage-point increase may not sound like a lot, but it’s huge — $300 billion in GDP. With such a large headstart in the recovery, the central corridor should continue to drive the U.S. economy for years and even decades to come.
Despite so many dreary economic headlines, the potential still exists for a powerful recovery in the United States. Manufacturing is bouncing back, adding some 500,000 new jobs since 2010. The growth rate of our biggest economic rival, China, continues to slow, and Europe seems stuck in a Japan-in-the-2000s-style malaise. Domestic oil and gas production is increasing for the first time in over 20 years. We now boast the lowest natural-gas prices in the world, which is a giant magnet to global manufacturers. Clearly there’s a lot to like. However, if states don’t have the money to build business-friendly infrastructure and to educate and train their people, their communities will suffer because of it. The real estate industry that transformed the nation over the past 30-plus years has now left much of it weakened, sparing only those states that it ignored during the bubble. The damage can be fixed, so long as states get serious about digging themselves out of debt. Good leaders acting quickly are the only hope for the worst-off states, for they’ve been left with the smallest margins of error. As my grandfather used to say, you can’t expect to make a lot of money if you owe a lot too.
Excerpted from Fate of the States: The New Geography of American Prosperity, by Meredith Whitney, to be published in June 2013 by Portfolio, a member of Penguin Group (USA) Inc. Copyright © 2013, Meredith Whitney
This story is from the June 10, 2013 issue of Fortune.