It's no secret that Illinois, like the rest of America, has been suffering in this economy. It also has the dubious distinction of probably being in the worst fiscal shape in America. llinois Gov. Pat Quinn appointed a group called the Illinois Recovery Commission to examine the state's future, who recently issued their final report. As is mandatory in this genre of document, the commission devoted a lot of ink to creating a "culture of innovation" in Illinois and putting it in the forefront of new economy businesses.

Illinois may exists as a political geography, but it certainly doesn't exist as an economic one. Thus any report that purports to offer a statewide strategies is to some extent doomed. I can appreciate the political difficulties here, but thankfully I'm free of them. So I'm going to focus on metro Chicago.

The Innovation section makes a number of recommendations such as having the state pension fund invest in startups. Rather than a line by line analysis I want to home in on one idea they had around picking strategic industries for the state. I don't believe in central planning or that government can pick winners and losers. But, the government and private sector organizations can do a lot to create fertile environments for certain types of industries to thrive. Your city can't be all things to all people. At some point you've got to take a stand.

So with that, let's take a look at their sample recommended sectors. Drum roll please…..

• Information Technology
• Biotechnology
• Alternative Energy
• Medical Technology
• Advanced Materials/Nanotech
• Communications/Wireless

I don't know whether to laugh or cry. The best Chicago can do is a warmed over me-too list of the hot sectors du jour that every other city and state are already chasing? While I'll give them the benefit of the doubt that this might possibly have been intended as illustrative, Chicago needs a lot deeper and more serious thinking than this.

Chicago is a huge, tier one city in America and the only interior city with truly global reach. This is a city with real capabilities and advantages it ought to look to exploit. I don't believe it is in such a weak position that it needs to fall back on the equivalent of momentum investing and chasing the crowd. Sure, Chicago can get a "fair share" of those industries, but is this the best it can do?

In that light, I'm going to do some preliminary analysis of where Chicago really can build unique offerings. This is based on the competitive advantages that can be derived from Chicago's unique structural conditions. As with anything, some of these can cut both ways. The key is to turn them into assets. Some of those unique structural conditions are:

• Centrality
• Regional Capital
• Bottlenecks

Centrality

Lots of places are in the middle of the country, but if you think about it, Chicago is the only tier one, really urban city in the middle of the country. All of the others are on the coasts. This provides, and has provided, Chicago with enormous advantages.

The American interior has been dismissed as "flyover country" but this gets at the heart of the dilemma. It is very painful to fly from coast to coast. Flying from NY to LA takes like five and half hours and crosses three time zones. You lose a day doing it. If you need to travel all over the United States, you sure don't want to be based on the coasts. This is where Chicago ought to look to play.

The first step is to do an industry scan to look for ones where Chicago could successfully exploit its centrality advantage. The characteristics are:

1. A significant number of employees who need to fly about the country
2. Not an industry already clearly established in clusters elsewhere
3. Industries that could take advantage of Chicago's unique urban environment

The last one is important because it is the only thing that really distinguishes Chicago from say Dallas. Both are big cities with lots of talent and big airports. But Dallas is a lot cheaper. So look for things that leverage the urban environment and other unique characteristics of Chicago. Here are some examples.

1. Professional Services 2.0. Chicago has long been a hub of professional services. I believe it can continue to be so, but that industry has experienced change that has hurt Chicago and puts its future at risk here. After the exchanges, there is no more important plank in Chicago's economic future than making sure it continues to be the dominant location in America for general professional services. That's why I even put it in the title. I don't see anyone even thinking about this issue though.

Let's take a step back in review some history. Chicago was the traditional interior business capital and always had a large professional services presence. Arthur Andersen started his company here, so it was the HQ of that huge business. While AA itself is no more, its old consulting arm, now called Accenture, is still huge in Chicago, as are many other services firms such as some of America's top law firms. We can define professional services in many ways, but I'd say the core sectors are management consulting (e.g., McKinsey), technology consulting (e.g., Accenture), IT/business process outsourcing (e.g., TCS), accounting (e.g., KPMG), and law (e.g., Mayer Brown). You could draw a broader ring if you wanted, though.

I recommend that you review my post "A Better Tomorrow" for more details, but two huge macro-forces converged to Chicago's benefit in these industries in the 1990's. One was the digitization of business and the other was the nationalization of business.

The 90's were really the core of the technology revolution. We went from a mainframe dominated world in 1990 to the internet dominated world of 2000, with many waves of change in the middle: client/server, PC and mobile phone ubiquity, Y2K, ERP, etc. These drove enormous demand for technology consulting and also business expertise to embed this technology into the fabric of business and organizations. Similarly, the nationalization of business driven by deregulation led to rollups of many sectors like banking, utilities, and retailing, all of which required fundamentally changing the operating paradigm of these entities.

Both of these generated enormous benefits to Chicago. First, demand for professional services to help companies with the change led to a big expansion in a sector where Chicago was already big. Second, the services firms themselves transformed, becoming national or global to match their client base and organized around industry verticals to reflect the new demand for domain specific expertise. Where once these firms were organized around local office geographies, they were now national or international practices based on industry. This meant their employees weren't primarily serving local but national clients, which of course meant they flew to where ever the client might be.

An explosion of aggregate demand and the need to fly around a lot fit Chicago's value proposition like a glove. Chicago, and also cities like Dallas and Minneapolis, benefited hugely from this massive demand for professional services. Chicago was simply the best place in America for professional services over staffing. That is, it was the best place to hire more people than you needed for the local market, with the idea that you'd send them around to other places to fulfill demand there.

Then another change set in, this one not so good for Chicago. The dot com bust and scandals like Enron set off a transformation of the industry, as did the rise of globalization. First, the digitization of business and national industry rollups were largely completed. This reduced demand growth and even total demand. Also, clients got a lot smarter and a lot more savvy, both in doing things themselves and in working with and getting value out of professional services firms. A significant amount of the work became commoditized, like ERP installations. And most importantly, there was a rise in offshore competition, particularly in the IT/outsourcing sectors. This shook those businesses to their core as most traditional players couldn't adapt in the face of the onslaught of newcomers. And this isn't quite done yet. Law is now going through it as clients become more sophisticated in deal making, work becomes commoditized and offshoring looms. (How long will most Chicago law firms maintain their entire back office operations in the Loop, for example?) These all I believe drove a contraction (or at a minimum reduced growth) in professional services employment in Chicago in these sectors. In the 90's there was massive growth and it was all onshore, with a lot of it in Chicago. In the 00's, the growth was still huge, but all of it was offshore.

My hypothesis is that this professional services story arc explains a lot about Chicago's economy in the last two decades. In a piece earlier this year where he asked "Has the Chicago area lost its mojo?", Chicago Fed economist Bill Testa noted that:

The Chicago area economy and its central city experienced a surprising revival from the late 1980s through the 1990s. The revival led many local leaders to believe that the region had begun a new improved course of growth and development…..Chicago's turnaround following the 1980s was remarkable in that a fundamental restructuring supported it. Specifically, though the metropolitan area shed much of its manufacturing base, its work force shifted increasingly into professional and business services….Chicago's performance in the current decade looks much less sanguine….Chicago's lagging post-recessionary recovery earlier in the decade can also be traced to its hefty professional and business services sectors.

Read the entire thing for full context, as he did not write that piece to make my point, but my explanation of the rise and fall of professional services helps explain a lot of his charts. This would be easy to validate with a market survey. Simply make a list of the major firms in all those sectors I outlined. Ask them what their Chicago based employment was on January 1, 1990, 2000, and 2010. The results would be illuminating.

This notion of broad-based professional services also explains why Chicago's GDP per capita and such is lower than other tier one cities. Those cities I suspect contain more specialized functions. Now Chicago has some of those too, ranging from the exchanges to the design of supertall buildings. But its bread and butter has always been more general services like IT and accounting. This is a very good thing to some extent. I'd rather have one broad based firm with a couple thousand employees producing pretty high value output than a 200-person shop with super-duper high value, for example.

It also explains Chicago's high standing in global city rankings. The GaWC study, for example, is among the most famous. It ranks cities based on whether or not they have a branch office location of one of a specific list of professional services firms. Because Chicago is a professional services capital and dominant interior city of the world's largest economy, one too huge to service from a single capital like New York or Washington, it has lots of these offices so ranks very high on lists that use methodologies like this. But that doesn't make Chicago a sophisticated mega "control node" of the global economy. I've long believed that Chicago's global city status is vastly overrated and this is one big reason why.

My core recommendation to Chicago would be to focus on next generation professional services, or "Professional Service 2.0." Its leaders must ensure that Chicago remains the dominant capital of professional services in the future, and the next generation of that industry. This would involve understanding industry dynamics, the status of Chicago and other Chicago players, and how to position the city as the favored location for staffing. The macrotrends are about low-cost right now, and that works to the advantage of places like Dallas, so Chicago has work to do. How can Chicago beat Dallas? It has to be sure that it's transportation environment, business culture, tax/regulatory schemes, etc are advantaged to this industry. Also, it needs to be able to position its unique urban environment. I give one example immediately below, but superiority in talent recruitment might be another advantage.

Here's one indicator. I looked up on their web sites where the Chicago office locations of some key Indian IT/outsourcing players were. Infosys is in Lisle. Wipro is in Oakbrook Terrace. Tata Consulting Services is in Naperville. I don't know how many people these companies employ in Chicago, but if I were the city I'd make it my business to find out, and to make sure that they view Chicago has their key domestic hub, particularly as they move up the value chain. I have no beef with business in the suburbs. I want Chicago's suburban business centers to prosper, but this is not Chicago's competitive strength. Clearly these businesses are not taking advantage of Chicago's unique urban environment, which leads me to believe this isn't their core growth center of the future. These are some of the firms of the future, so time to get to work.

Chicago is a city that has been a success in professional services and has the unique characteristics that give it the platform to be an even better success tomorrow. What's more, unlike a typical internet startup, these businesses still scale with people, and have the potential to be large scale employers with lots of high talent people and high value jobs – and even high tech ones in a sense. And the very nature of having to constantly renew their revenue base makes them act like traditional "corporate citizen" type businesses that invest back in the community. Owning a good chunk of the future of this industry is job number one for Chicago. But the city is going to have to fight for it. Other places aren't just going to hand over the keys.

2. Corporate Showplace. Various companies, including those aforementioned consultancies often set up laboratories or centers of excellence or demo centers or whatever you want to call them to bring in customers and show them the cool new stuff they are working on. This is another space Chicago should dominate.

Think about it. Again, it's easier for national customers to get to Chicago. People want to come to Chicago – certainly a lot more than they want to go to a meeting in Dallas. It's a great place to entertain people. In short, these are the same factors that drive Chicago's convention business. These operations are like mini-convention centers, only have the added benefit of being paid for by private entities. Chicago should make sure it is the best place in America to locate these facilities.

3. Sales. Clearly, sales is another are in which Chicago excels. Not as glamorous as high tech perhaps, but often high value. Chicago's culture of hustle, of being, as my friend put it, "a city that runs on testosterone" fits perfectly with an aggressive sales culture. Clearly Chicago is already the regional sales center, but looking to beef this up somehow would be a plus. It also fits with the above corporate showplace idea.

These are relatively straightforward extensions. Actual research would need to be done to develop further target areas, but I believe there are many possible ones.

The other key here is to make sure flying from Chicago stays convenient. That means completing the O'Hare Modernization Program of course. But the terminals are in dire need of upgrading. Unfortunately, some of them are relatively new, but weren't designed with today's travel realities in mind (e.g., international terminal T5). Contrast O'Hare's terminals with the new ones in Indy and Detroit, and there's a big difference. If Chicago wants to be a world class city, it needs a world class airport, and whatever the architectural merits of Helmut Jahn's United Terminal (which I like), O'Hare just isn't it. The city needs to replace its entire terminal infrastructure. The OMP has something on this, but the push for a dubious new western terminal complex makes me question whether they are on the right track.

Regional Capital

Chicago is also relatively unique in that it is a regional capital. Chicago is clearly the main city of the greater Midwest. The only analogous situation is that of Atlanta, a city that I believe is very similar to Chicago in many respects. One might consider Boston the capital of New England, but it exists in the long shadow of New York, and outside of greater Boston itself, New England just isn't that big.

One might think this would be something Chicago would want to take advantage of. Unfortunately, the opposite is the case. Chicago seems to see being the capital of the Midwest as baggage it would like to get rid of. That's one key difference versus Atlanta. Atlanta self-consciously sees itself as the "Capital of the New South", a clearly Southern city, but one transformed and reinvented for the 21st century and ready to lead a transformed region forward. That's true whatever my reservations about their current performance.

But Chicago seems embarrassed about being the Midwest. It seems to view being the capital of the Midwest in the same way it does its old manufacturing heritage. If you read the rest of the recovery report, or pretty much any other document about Chicago, you'll see lots of obsession over (and self-congratulations about) making Chicago a "global city". It's global, global, global, global. Now, Chicago clearly is a city with global reach. And no doubt the global agenda is an important plank in the city's future success strategy. But the idea that Chicago can simply turn its back on the Midwest is a mistake.

For one thing, Chicago's economy is still dependent on the Midwest to a greater degree than it might want to admit. Back to the Testa piece:

It is more difficult to draw the conclusion that the Chicago area had successfully restructured its jobs base away from its surrounding region to become a global city. Whether Chicago had become more of an interconnected global financial and business center, such as New York or London, is still an open question. As seen above, for much of the 1990s, the Chicago region's per capita income made little if any gains on the Great Lakes region. Rather, by way of explanation, the surrounding Midwest region was also experiencing a comeback of the same degree…The Chicago regional economy continued to restructure toward high-skilled service provision, but its linkages may have remained somewhat parochial. That is, the Chicago area's own growth appears to have been achieved through the provision of professional and transportation services to its traditional Midwest business partners.

As you might be gathering, that Testa piece is a must read for any Chicago leader.

I'm not totally sold on the idea that Chicago's 90's rise was attributable to regional comeback. But clearly Chicago is still linked to the Midwest in ways it doesn't like to acknowledge. Richard Florida has talked about how local professional and business services got rolled up into these regional centers like Chicago. Clearly, providing services to the surrounding region is a part of what makes Chicago tick. Chicago can't thrive as the only regional atoll that doesn't get swallowed up by rising sea levels. Just like Ann Arbor can't get away with pretending it's not in Michigan, Chicago has to recognize that it is where it is and make the best of it.

And there's no shame in being a regional capital. It's not bad to be like Barcelona. By the way, Barcelona has global aspirations too. It just hasn't sacrificed its Catalonian ones to get there. In fact, it realizes that in a world of ever more generic global cities, its Catalonian language and heritage are an asset. Chicago should take notes.

The first step for Chicago is to start taking its role as regional capital seriously again. The second is to start caring more about the fate of the greater Midwest. The third is to figure out how to take advantage of greater collaboration with this region.

In recent major Crain's piece on Mayor Daley's tenure as mayor, Paul O'Connor, formerly head of the regional economic development agency World Business Chicago said, "So we get the headquarters of the windmill company, and Indiana gets the jobs building the windmills. Why?" This is the type of zero-sum thinking that is killing this region. That scenario might not sound so great if you want the whole pie for yourself. But consider an all too easy to imagine alternative scenario: Sunnyvale, CA gets the headquarters and Guangzhou gets the factory. The Midwest division of labor seems a lot more attractive seen in that light.

I've did an extensive four part series on this previously called "Reconnecting the Hinterland" that talks about this. Re-establishing something of a regional hierarchical division of labor, if such a thing is possible, is something we should be looking at. I noted in that series that Chicago has among the steepest cost gradients in America. That it, costs plummet the minute you get outside of Chicago. It's just a quick South Shore train ride to South Bend, Indiana, for example. And only a three hour drive to Indianapolis, the cheapest major housing market in America. Most other tier one cities offer nothing like this to exploit. (DC does have some limited advantages here with nearby Richmond, as someone pointed out to me).

You can read my previous series with some starter ideas on extended labor markets and professional services collaboration and onshore outsourcing. (Hint: remember those discussions with Infosys, Wipro, and TCS I said the region should be having?)

Bottleneck

Chicago is a transportation bottleneck. It's famous for the length of time rail traffic takes to make it through town. O'Hare is famously congested. It's expressway traffic is famously bad. It's just an overall famous bottleneck.

Today bottlenecks are considered bad things but in the past they were often good things for cities located near them. In fact, bottlenecks often drove the very creation of cities. Louisville was founded at the Falls of the Ohio. Chicago itself was located at a gap separating the Great Lakes and Mississippi River watersheds, and is also located at the tip of Lake Michigan, which blocked east-west travel.

So why don't more people try to figure out how to use being a bottleneck to their advantage? I won't claim that it would be easy. The world has changed a lot and there are generally options to by pass bottlenecks. But that means we have to think harder, because even with things like the CREATE rail plan, the bottlenecks aren't going way.

One obvious idea to me is that Chicago ought to focus on transportation innovation as one of its target industry segments. Chicago is the transportation hub of America, and is clearly a major center of distribution, even though lacking a major port.

I think about this in the most broad sense, ranging from urban street design to intelligent highways to financing approaches to operating practices to governance, etc. There's plenty of high tech in here, which gives lots of potential angles for Chicago to establish businesses in that sector.

Unfortunately, I don't see a lot going on here. The Skyway deal was a home run, showing some leading practice applied domestically. So good news there. Chicago used to be in the forefront of American urban cycling infrastructure, but no more. Chicago had widely deployed ITS systems when I first moved to Chicago in 1992, but hasn't done much in the space since. Today it is Boston opening up its transport data and letting its tech developers create the most leading edge applications. New York is America's urban transportation infrastructure leader. Los Angeles is leading the way on things like computer optimized traffic lights, HOT and congestion pricing, etc.

Of all my recommendations, this is the most speculative, since there's little of it in Chicago today and it will require a big mindset change. I've constantly pointed out the low quality of design of things like Chicago's street lights or the bus shelters. These aren't per se bad, but they are conservative, backwards looking, and frankly suburban. It's hard to make the mental leap from forward looking design and high design aspirations to matters like transport innovation. But the reality is that the mindset that makes the banal design possible is the same one that has caused Chicago to lose some of the leadership in transport innovation it once had. You want to build a culture of innovation? Start here.

This is one where, in the city at least, with a mayor who can make things happen if he simply wills it, Chicago is positioned to shine. Chicago should be looking to make itself into the transport innovation center of America. Particularly in a state strapped for cash, this is a must.

Hopefully these ideas spark additional and more serious thinking about where Chicago should be positioning itself for the future. Again, this is a city with vast resources and a lot of unique structural elements that could play to its advantage. There's no need for Chicago to pursue a me-too strategy when it had a lot more scope to step up, seize control of its own destiny, and set the agenda that other people want to follow.