The Great Recession and the sluggish recovery have been a wake-up call for the nation. Americans, both policy-makers and voters alike, believed that we could build a sustainable economy on consumption, on endless acres of condos and starter mansions, and on financial products conjured from mathematical models and wishful thinking.

Clearly, it is time to chart a different path. We need to rebalance the American economy and cultivate the fundamentals that can bring prosperity back: robust exports, low-carbon technology, continuous innovation, and opportunity for all. And the path to a different and better American economy runs directly through our metropolitan areas.

The largest 100 metropolitan areas in the country are home to about two-thirds of the U.S. population and generate 74 percent of our GDP. In fact, metro areas generate the majority of economic output in 47 of the 50 states, including such “rural” states as Nebraska, Iowa, Kansas, and Arkansas. Metros are anchored by cities, but they aren’t synonymous with them. Metros include suburbs, edge cities, boomburbs, exurbs, exit-ramp office parks, strip-mall zones, and even rural areas. They aren’t defined by the number of skyscrapers, Starbucks, or iPads per capita, but are united by a shared economy.

Metros will lead the United States into the next economy because they possess the assets that modern economies need. Metros dominate U.S. trade and logistics. They concentrate the innovative firms, advanced research institutions, venture capital, breakthrough technologies, and skilled workers that will drive the next economy. And they are where networks of universities and community colleges stand ready to educate the next generation of U.S. workers. In short, metros bring together ideas, people, and technology in a virtuous cycle that generates more innovation and attracts still more people.

There is a lot that the federal government could do to lay the groundwork for the flourishing of metropolitan America: Set a price on carbon, invest intelligently in advanced research and development, make transformative investments in infrastructure, and overhaul our immigration laws. (We proposed some of these ideas in a Democracy essay, “Miracle Mets.” [Issue #12]) But no one believes that the federal government will do these things this year or the next. At best, it can attempt some targeted policy interventions around trade, maybe infrastructure, possibly tax reform. While Washington is strangled by partisanship and polarization, states will have to take up the burden of invigorating metropolitan areas and kick-starting the economy. Indeed, rebalancing the economy will require reorienting—radically—the focus of state government.

The role of states as “laboratories of democracy” is a mainstay of American federalist lore and study. States have broad powers over such market-shaping policy areas as infrastructure, energy, innovation, education, and skills training. Successful state leaders, whatever their partisan commitments, are usually forced to get extremely practical extremely fast because they have to balance their budgets and adhere to deadlines. They are also more easily held accountable for those budget decisions, especially when those involve program and personnel cuts. Many state leaders (and their local elected, business, and civic counterparts) are members of what we call a “pragmatic caucus,” in sharp contrast to ideologically driven federal lawmakers.

Yet the traditional assessments of state innovation fail to capture the real economy-building secret of states—namely, their special relationship with metropolitan areas. In the American system, metropolitan areas (and their component parts: cities, counties, suburban municipalities, and rural towns) are all creatures of state law. The state determines everything: the boundaries of cities and municipalities, the extent of their powers, the flexibility or rigidity of powers and borders. In other words, the state government decides who does what, where, and with whom.

States, though, are not accustomed to using their broad powers to unleash fully the entrepreneurial energies and dynamism of their metropolitan areas. In fact, states have often taken the opposite approach, constricting their metros fiscally and governmentally. State leaders need a profound shift in mindset. In the global economy, metros matter more than states, and states will succeed to the extent they can bolster their metro economies. An unintended legacy of the Great Recession may be the most significant restructuring of the mission and focus of state government since the progressive movement a hundred years ago.

The Next Economy

The next economy must have four characteristics: higher exports, to take advantage of rising global demand; low-carbon technology, to lead the clean-energy revolution; innovation, to spur growth through ideas and their deployment; and greater opportunity, to reverse the troubling, decades-long rise in inequality. Metros will take the lead on all four fronts.

Exports are critical now for several reasons. Foreign nations are where the recovery, and thus demand, is strongest. The 30 metropolitan areas that have recovered most strongly from the Great Recession are almost exclusively located in Asia and Latin America—places like Lima, Shenzhen, Santiago, and Guangzhou. The rising nations and their rising metros are now driving global demand for trade and commerce. Brazil, India, and China accounted for 8.6 percent of the global middle-class consumption in 2009, but could account for 26 percent by 2020, according to a recent Brookings study. These consumers are even now contributing to an export surge in the United States: American exports grew 12.7 percent from the third quarter of 2009 to the third quarter of 2010, outperforming the economy’s 3.2 percent growth rate.

Although the U.S. trade deficit is huge, we still manufacture a range of advanced goods that the rest of the world wants, including aircraft (in 2009, exports accounted for more than half of U.S. general aviation manufacturing industry sales), space craft, electrical machinery, precision surgical instruments, and high-quality pharmaceutical products. And we shine in services: Our trade surplus in that sector was $152 billion in 2008.

The top 100 metros dominate U.S. trade, particularly in the fast-growing services sector, and their expertise in fields like chemical manufacturing, computers, and consulting put them on the front lines of commerce with the fast-growing economies of Brazil, China, and India.

The second hallmark of the next economy is low carbon—low-carbon energy sources; infrastructure that can move people, goods, and ideas with less energy; and products that take little energy to build and operate. The United States has been slow to embrace the low-carbon economy. The Recovery Act devoted about $94 billion to renewable energy and green investments, everything from incentives to develop new battery technology to retrofitting public and assisted housing. China, by contrast, allocated $221 billion of its 2009 stimulus funds to renewable energy and other green investments. And China continues to out-invest the United States in key low-carbon categories: China has built some 4,000 miles of rail for fast trains. By 2020, the nation expects to build 10,000 miles of high-speed rail to connect all its major cities. The United States, by contrast, has one arguably high-speed rail line of 456 miles, the Boston-Washington corridor.

Key sectors of the low-carbon economy, like the export-oriented economy, will be primarily invented, financed, produced, and delivered in the top 100 metros. These large metros concentrate a majority of U.S. jobs in solar energy, wind energy, smart-grid systems, smart metering, energy research, engineering, and consulting services. Some 85 percent of jobs in green architecture, design, and construction are in large metropolitan areas, which makes perfect sense, since that’s where most people and buildings are.

But the United States needs to innovate not just in low-carbon technologies, designs, and land-use patterns. It needs to encourage innovation in just about every sector of the economy. Innovation, the third element of the next economy, has been the source of almost all economic growth in this country since the Industrial Revolution. As economist Paul Romer has written, “No amount of savings and investment, no policy of macroeconomic fine-tuning, no set of tax and spending incentives can generate sustained economic growth unless it is accompanied by the countless large and small discoveries that are required to create more value from a fixed set of natural resources.”

Unfortunately, as a share of GDP, total federal funding for R&D was lower in 2008 than it was in 1993. The Recovery Act’s massive infusion of funds, about $50 billion (including both appropriations and tax expenditures), was better than nothing, but it was not, and wasn’t designed to be, a sustained commitment to raise federal support for R&D activities.

The innovations that are happening are happening mostly in metros. One rough measure of innovation is patent rates, and these are much higher in metropolitan areas than outside them. And within metros, new innovations and patents spur yet more: Patent citations tend to occur within the metro areas in which the patent itself originated. Venture capital investments, another proxy for innovation, are almost exclusively made in metropolitan areas.

The fourth critical piece of the next economy is greater opportunity, especially for people without four-year college degrees. An economy that is innovation-driven, export-oriented, and lower-carbon will require workers who are well educated when they enter the workforce and who continually upgrade their skills. Thus the next economy will drive the United States to narrow our persistent educational attainment gap. African Americans and Hispanics will be nearly 40 percent of the working-age population by 2050, up from about 25 percent now. Yet these groups have lower rates of post-secondary educational attainment, including two-year degrees, than whites or Asians. An innovation-driven economy will demand, and reward, more education and skills. The attainment gap is, more than ever, a competitive hurdle.

But if workers can build their skills, the next economy may also create more opportunities for workers to move into well-paying jobs with secure benefits. For example, exporting firms pay workers more and are more likely to provide health and retirement benefits. Alexandre Mas, former chief economist at the Department of Labor, last year told Congress that an increase in U.S. export intensity “has the potential to create hundreds of thousands of new, good-paying jobs” and reduce income inequality by raising the income of many working-class and middle-class employees.

Metropolitan areas also have the potential to speed workers’ wage growth. One study from the Federal Reserve Bank of St. Louis suggests a worker in the Chicago metro area would enjoy wage gains about 15 percent greater over the course of a decade than a comparable worker in the Cheyenne, Wyoming metro area, simply because Chicago is so much larger. Metropolitan areas also seem to increase workers’ productivity levels and earnings, even after they leave the metro, according to research by economists Edward Glaeser and David Maré. All this is not to dismiss the discouraging condition of many school districts in metropolitan areas (usually in their urban cores), nor high unemployment rates in many central cities. But if a person has a job, he or she will probably be better off if that job is in a metro area.

A Metro Agenda for States

Metros, for all their economic power and next-economy advantages, are largely unrecognized in law and politics. Local governments are creatures of the states, and states have rarely seen fit to create metropolitan governments that would link up the constituent elements of metros, or to enable localities to do it themselves. In state legislatures, metro representatives tend to fragment along geographic and party lines, with suburban legislators often siding with rural representatives against city concerns. Executives and legislators feel pressure to spread state largesse thinly and evenly across the state, rather than concentrating big investments in infrastructure and innovation in their metros. Political discourse, driven by micro-targeting (and insufferable labels: NASCAR dads, Mama Grizzlies), further chops up metropolitan populations and undermines a sense of shared interests among both voters and their representatives.

Yet metros matter. States (and the federal government) may not be required to tend to their metros’ needs by law or custom, but economic reality dictates that states must do a better job of supporting the places where most of their citizens live, work, learn, and create.

Germany shows how this should be done. The German state of Bavaria has spent some €4 billion to build up its innovation and high-tech strengths, and a huge share of that money has gone to greater Munich, in the form of funds for university R&D, new technical universities, support for tech transfer (which is how ideas move from university labs to marketable products), venture capital money, a high-tech manufacturing center, and three business incubators. The state sold stock it held in a variety of companies to raise the money for this ambitious agenda, so the funding mechanism isn’t transferrable to the United States, but the principle of economy-shaping, metro-focused investments is. Even in more fiscally constrained times, Bavaria continues to support its leading metro. One of its more recent initiatives brings together venture capitalists, researchers, and businesses to support particular industry clusters.

Along similar lines, the German state of Baden-Württemberg allowed its major metropolitan area, Stuttgart, to create an elected regional assembly, so that the 179 municipalities in the Stuttgart region can work together on business development, including support for regional industry clusters like biotechnology, energy, and auto. Stuttgart’s fortunes roughly track that of the worldwide auto industry, so the recession hit it hard. But as autos bounced back, it did as well: It had the highest income growth of any Western European metro between 2009 and 2010.

An intense focus on metros is not only the appropriate response to the political realities of the moment. It is also fundamentally consonant with the demands of the next economy. The consumption economy minimized the differences between metros. Communities followed a uniform “Starbucks and stadia” recipe, irrespective of market location or condition, using a mostly uniform set of tools allowed by their states. The next economy, by contrast, accentuates what is unique about different metros, even those located in the same regions of the country: Raleigh specializes in life sciences; Charlotte, finance; Atlanta, transport production. States are better positioned than the federal government to appreciate and govern for their metros’ distinctive strengths.

How can states nurture and capitalize on their varying metro advantages while struggling to close budget gaps in the hundreds of millions or even billions of dollars? They will not be able to make big, ambitious investments this year to advance the next economy in their metros. But they can do a few things that will make their metros stronger, and states like Michigan, New York, Colorado, and Tennessee are likely candidates to make these moves, given their newly elected, intensely pragmatic governors. First, they can take a bottom-up, “at your service” approach to their metropolitan areas, delivering investments and adjusting rules so that metros can use state resources more easily in pursuit of their own visions. Second, states can help metros get better at exporting, including making more things for the world market and improving infrastructure to speed the flow of those goods around the globe. Finally, states can pass new bond issues or even targeted taxes to invest in innovation in metropolitan areas.

Make Metros Central

State leaders need to understand and embrace what it means to have a metropolitan-led economy. Specifically, they need to align state resources in the service of metropolitan priorities. Any successful corporation rewards departments that are strategic in focus and disciplined in execution. States must do the same.

No U.S. state has $4 billion to replicate what Bavaria did for Munich. But states can examine the money that already goes to their metros—through transportation agencies, economic development programs, workforce training, and the like—and make sure the money can be used for what metros have identified as their top priorities.

A few ambitious metros are working with the Brookings Institution and RW Ventures, a regional economic development consulting firm, to create business plans to assess the market position of the regional economy, and propose strategies to improve performance. Minneapolis-St. Paul’s business plan aims to create an entrepreneurship accelerator to address the region’s troublingly slow growth rates for productivity, wages, and employment, and reform a business culture too oriented toward old-fashioned large companies rather than smaller, more nimble start-ups. But to be most effective, the region also needs the state to better align its workforce-development programs to the needs of growing industries so that new businesses have a ready supply of workers. To that end, the region’s business plan calls for focusing the efforts of the BioBusiness Alliance of Minnesota and the state’s FastTrac training, resources, and credentialing initiative on optimizing the work- and entrepreneurship-readiness of the region’s workforce.

Another regional business plan, Puget Sound’s, focuses on amplifying the region’s growing expertise in cutting-edge energy-efficiency technologies and systems. The region needs the state of Washington to provide some funding to construct a testing and demonstration center, to connect the Puget Sound initiative to other statewide energy-efficiency programs, and to allow state buildings to be energy-efficiency demonstration sites.

States also have to help individual local governments act in concert and behave more like single metropolitan economic units than they are now. Having lots of local governments means lots of duplicative services—and lots of opportunities for real-estate developers and companies to play municipalities against one another as they bargain for tax abatements—and less traction in the global economy. At the very least, states should change their tax laws so that companies making in-state moves can’t get local tax abatements. This will keep individual municipalities from ruinous competition that just moves economic assets around, rather than actually making the metropolitan economy larger.

Spend Smarter, Make More

International exports are a powerful source of job growth in metros. Between 2003 and 2008, the exporting industries in the seven large metropolitan areas in Ohio increased their employment by 32 percent, while overall net employment growth in these metros was almost zero. In 2010, exports grew faster than the economy as a whole.

Yet states have invested little in expanding exports. Instead, they have spent tens, even hundreds, of millions of dollars a year in tax abatements and subsidies to lure businesses into their states. In fiscal year 2009-2010, Tennessee spent more than $55 million on recruitment; in 2009, Michigan gave the movie industry $117 million in motion picture tax credits. But according to research by economist Jed Kolko, more than 95 percent of new jobs in states come from expansion of existing businesses or the growth of new ones. Thus the best way to create new jobs is to grow them at home rather than poaching them from elsewhere.

States should take some of their business incentive funds and shift them to supporting exporting companies through simple steps like funding trade missions and competitive grants for groups (trade associations, university centers, local governments) that want to provide training, marketing, and other services to bolster firms’ export capacity. At the very least, states can leverage the resources of other organizations, from nonprofits to the federal government, involved in export promotion. Our colleague Emilia Istrate has found that for a state investment of $5 million in 2009, Pennsylvania’s Center for Trade Development has been able to help generate (and verify) more than $450 million in export sales, supporting 6,500 Pennsylvania jobs, and producing approximately $25 million in local and state tax receipts.

Supporting manufacturing is another way to bolster exports, job growth, and metro-led innovation. True, manufacturing as a share of U.S. employment and the U.S. economy has dropped dramatically from where it once was, but even so, most of our exports are manufactured goods, and metropolitan areas with a big share of manufacturing jobs tend to have higher patent rates than other metros. Manufacturing industries also have higher rates of product and process innovations than non-patenting companies and conduct some 70 percent of all of the nation’s industrial R&D.

Susan Helper, an economics professor at Case Western Reserve, and Howard Wial, an economist at Brookings, have proposed that states create manufacturing centers in key metros that will conduct research into new manufacturing technologies and educate businesses about technology-driven management and organizational changes. Small and mid-sized businesses that make up so much of the manufacturing supply chain are in desperate need of this kind of help because they don’t generally conduct their own R&D. If U.S. manufacturing is to be more innovative and more competitive, it has to start with these businesses. These centers can get started with a state investment of $9 million a year, or less than 10 percent of what Michigan spent last year to cajole the film industry into the state.

Governors and state leaders can boost exports and near-term job creation by overhauling their state infrastructure banks or establishing new ones. State infrastructure banks are revolving funds for transportation projects, capitalized with state and federal funds. They offer loans and other forms of credit assistance to public and private entities developing highway and transit capital projects. Infrastructure banks could be critical for putting together the complicated financing for modern ports and gateways, but many of the 33 states that have these institutions use them as piggy banks for regular transportation projects. Instead, states should use their banks for the kinds of projects that will speed the flow of their goods abroad, connect workers to jobs, and create the infrastructure for new, green vehicles. These projects should be chosen on the basis of return on investment, not political log-rolling.

California offers a good model for an infrastructure bank. With an initial state investment of $181 million in 1999, California’s Infrastructure and Economic Development Bank has relied on interest earnings, loan repayments, and other fees—not the state treasury—and has supported more than $400 million in loans.

New Money for New Ideas

It sounds like heresy in the current environment, but state leaders should also consider going to voters in 2012 (when the economy has lifted a bit and the costs of budget cuts have been made clear) to ask for bond issues or dedicated tax sources to support big, bold initiatives. Voters understand the need for smart, targeted investments to promote their future prosperity.

In Ohio, for example, voters last spring approved, 62 percent to 38 percent, a $700 million bond issue to preserve the Third Frontier, the state’s premier technology-based economic development initiative. The Third Frontier program makes small investments in start-up companies at critical points in their development. Third Frontier and similar initiatives in other states were designed to address a basic failing of venture-capital (VC) markets, which is that VCs rely on shortcuts and familiarity and other efficiencies to maximize returns while minimizing their expenditures of time and effort. Compounding this problem of limited horizons, VCs are less and less venturesome these days, which leads them to invest in companies that have solved many of the problems that bedevil very early stage endeavors and have established a bit of a track record. Third Frontier and sister programs correct for these flaws in the venture-capital market by providing capital to local start-ups in their formative stages. An independent analysis found that the state’s $681 million expenditure so far has yielded $6.6 billion in economic activity, including 41,300 jobs, since 2002.

At a time when 42 percent of Ohio voters expressed sympathy for the Tea Party’s goals, the state’s Democratic-led House and Republican-controlled Senate voted in favor of putting the measure on the ballot. The Ohio Business Roundtable was a critical force in backing the initiative. There are opportunities at the state level to subvert the partisanship that has practically immobilized Washington.

Every state should offer its voters an opportunity to support market-shaping investments tailored to its metro strengths: perhaps clean energy in Colorado, transformative infrastructure in California, advanced manufacturing in Michigan. There are projects and ideas everywhere that private capital can’t identify because of inadequate information. This is where states can step in.

The Next Federalism

American federalism is a political system, an economic arrangement, and a powerful narrative about how a vast, diverse country should work. Sometimes the federal government is the protagonist, as in times of war or acute economic crisis. Sometimes states are at the forefront of the story we tell about the nation.

But metros have been conspicuously missing from that narrative. They don’t have a place in federal or state constitutions. They are not governed by a single executive, but are loosely knit together by overlapping networks of business, civic, philanthropic, nonprofit, and elected leaders. They are less powerful politically but more powerful economically than states. Simply put, we need a new way of thinking about governance and the economy that accounts for the economic power, informal structure, and diversity of America’s metros.

In this new story, states are still formal partners with the federal government. But states are also partners with their metropolitan areas, and welcome the force of metropolitan innovation and economic might. Communities not within the metro orbit would also likely benefit from state attention to the intertwined needs of places, rather than adherence to particular program boundaries.

This is a very different way of thinking about the relationship between the state and its subdivisions. This is home rule turned on its head, with metros driving state priorities and investments, rather than states deigning to grant localities some independent powers. Most state legislatures are legendarily hostile to the state’s major metros—see Albany, New York, or Springfield, Illinois. Why would governors and state legislators ever want to put themselves in the service of metros?

Frankly, they might soon find they have little choice. Metros are poised to lead in growing export sectors like computers, pharmaceuticals, and services; in innovation and the scientific breakthroughs that move us to a low-carbon economy; and in the new, diverse workforce. Skeptics will say that rural legislators will never countenance the primacy of metropolitan areas. But given the decentralization of population and jobs, the towns and counties many rural legislators represent are now included within defined metropolitan boundaries. Fifty percent of America’s rural population now lives within metropolitan areas. Even those rural areas beyond metropolitan space can benefit from metropolitan strength, given the spatial geography of economic and energy supply chains (think rural solar farms serving metropolitan energy grids)— they’ll see that a rising metro tide gives a fiscal lift to rural boats. In addition, budget gaps in the billions of dollars may concentrate the mind of state lawmakers, prodding them to put fiscal health above party or cultural or racial divisions.

Between 1787 and 1790, states decided, for a variety of reasons including significant economic benefits, that they should cede some of their sovereignty to the federal government—which, at that time, was itself kind of a creature of the states, like municipalities are today. In 2011, states face a version of the same choice. The wise ones will embrace their metro-led future.