The effect of fiscal health on innovation in cities.

• Author: Knovanova-Rubicondo, Kseniya M.

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Since the recent economy meltdown, the public sector has undertaken a number of economic recovery initiatives that focus on innovation. Yet, our understanding of the role local government finance plays in innovation is far from perfect. While it is too early to come to conclusions about the strategies local governments are currently using to cope with financial distress, analyzing the extent to which fiscal conditions have shaped the innovative policy decisions of the past might help localities in choosing the best policy approach. With this goal in mind, a recent study of 140 mid-sized U.S. cities in eight states (1) explored the effects of fiscal health on the degree to which they implemented innovations in performance management, using data from a survey conducted by the Government Finance Officers Association. (2) The study considered whether or not the availability of financial resources is a crucial factor for public-sector innovation to occur--in other words, do cities need financial resources to innovate, or is it financial and economic scarcity that stimulates innovation in cities? Are fiscally stressed cities likely to be more innovative than fiscally healthy ones? The research ultimately determined that fiscally healthy cities innovate more.

INNOVATION AND THE GREAT RECESSION

The link between the fiscal health of local governments and their innovations in the recent economic crisis was visible in the way that local economic recovery was largely based on innovations driven by financial resources. The cities, suburbs, and rural areas that make up metropolitan America became more interested in innovation activities, which were viewed as a means "to foster more productive, inclusive, and sustainable growth by better tapping the assets and creativity." (3) Local governments tried to stimulate their economies by increasing revenues or drawing down reserves to maintain spending, and by expanding or accelerating local capital projects, especially those with low long-term operating costs.

While these novel activities were mostly locally generated and designed, the $787 billion American Recovery and Reinvestment Act of 2009 (ARRA) led to another set of innovative initiatives focusing on economic recovery in American communities. These initiatives were designed to: reflect long-term regional goals; cut across jurisdictions and sectors; find ways to create interdepartmental programs to solve wider problems in an integrated fashion; kick off investment by using private-sector partnerships creatively; and maximize performance by using information management and benchmarking. The ARRA was regarded as ah investment in the fundamental elements that lead to prosperity--that is, innovations--that would allow local leaders to maximize the recovery of their communities strategically using ARRA resources. (4) But how does this logic work in practice? Are U.S. cities really dependent on resources to create innovations?

Until recently, relevant studies presented sharply divided perspectives on the relationship between fiscal health (often referred to as "fiscal stress") and innovation. One point of view emphasized the importance of environmental change and performance gaps as stimuli that increase innovative behavior. (5) Thus, an organization is more likely to innovate in a rapidly changing environment than in a steady one. Another viewpoint argued that public organizations faced with a scarcity of resources will engage in maladaptive rather than innovative behavior, becoming more rigid and conservative in their actions. (6) Some argued that the loss of spare resources reduces the potential for fiscally stressed local governments to innovate. (7) Public finance literature also emphasized the importance of monetary resources such as rainy day funds or fund balances for maintaining a balanced budget and preserving financial flexibility, (8) and larger fund balances were thought to allow state governments to survive fiscal stress. (9) These studies indicate...