May 2, 2013
Robert Solow, an accomplished economist, once said that “you can see the computer age everywhere but in the productivity statistics.” Similarly, the reshoring of manufacturing activities to the U.S. has been highly touted over the past two years, even though the evidence for it has been scarce. As skeptical analysts and journalists alike have indicated, if reshoring were taking place on a large scale, we would expect to see improvements in the U.S. balance of trade in manufactured goods with the rest of the world. Imports of manufactured goods would be waning and/or exports would be rising rapidly. On the contrary, the U.S. balance of payments in manufactured goods shows that little progress has been made in this regard since the years preceding the Great Recession (below).
Still, despite the lack of aggregate macroeconomic evidence to date, there appear to be legitimate prospects for the reshoring of manufacturing activities because of ongoing shifts in the underlying competitive conditions that favor manufacturing production on U.S. soil.
At our recent conference held in Detroit, encouraging and somewhat mixed prospects for re-shoring were presented for a wide spectrum of domestic manufacturing, as well as for two specific industries—chemicals and automotive.
Presenting the broad case for the reshoring of manufacturing activities, Justin Rose of The Boston Consulting Group (BCG), partly drew from a recent report called “Made in America, again.” According to Rose’s presentation, the U.S. share of world manufacturing has remained steady over the past 40 years, and the U.S. still makes over 70% of the manufactured goods it consumes—two facts that may be surprising for some to learn. China has emerged as a chief manufacturing competitor to the U.S. because of its low wages. Yet, on a productivity-adjusted basis, U.S. manufacturing wages have become more competitive with China’s since 2005, said Rose. And in terms of productivity-adjusted wages in manufacturing, the U.S. has a distinct advantage over many developed countries, including Germany, France, Italy, the UK, and Japan, because of its relatively less regulated labor market.
Rose noted that BCG has identified seven manufacturing subsectors that are close to a “tipping point” for reshoring. Further reductions in labor and logistics costs for the U.S. (or further increases in these costs for its competitors) may bring back to American shores a significant amount of manufacturing activity in the following industries: computing and electronics, machinery, electrical equipment/appliances, transportation equipment, plastics and rubber, chemicals, and primary metals. If a significant portion of these seven industries’ manufacturing activity were to return to the U.S., the result would be a gain of approximately $200 million in annual manufacturing output, said Rose.
Of these specific industries identified by BCG, the chemical industry may be the most likely to bring back the bulk of its production to the U.S., according to Martha Gilchrist Moore, senior director of policy analysis and economics for the American Chemistry Council. At our recent Detroit conference, Moore pointed out that the chemical industry will benefit greatly from the enhanced production of natural gas and natural gas liquids that are now taking place in the U.S. The chemical industry is the largest natural-gas-consuming industry in the U.S., and the U.S. shale gas boom is possibly the most important energy development in the past 50 years. Shale gas production has been climbing rapidly since 2005, and now accounts for 30% of U.S. gas production. Along with the gains in “dry gas” production have come supplies of natural gas liquids. These liquids are used as important feedstocks to chemical production. All of these developments are changing the economics of global petrochemical production in favor of the U.S. such that domestic chemical production is expected to increase 7.8% annually through 2020. Having tallied the recent shale-gas-related announcements from the chemical industry, Moore reported that $72–$82 billion of chemical industry investment stemming from shale gas is expected over the next ten years, which will enhance the domestic production of key chemicals such as ethylene, propylene, and butadiene. Most of these investments are expected to take place along the U.S. Gulf Coast, but some important projects are slated for the Midwest.
The automotive industry is another manufacturing subsector that is on the move, as reported by Chicago Fed senior economist Thomas Klier at the conference and in a recent Chicago Fed Letter. However, the motor vehicle industry is on the move to Mexico rather than the U.S. (i.e., it’s reshoring its activities to another part of North America). Klier showed that Mexico has raised its share of North American light vehicle production from 6% in 1990 to 19% in 2012. The growth of light vehicle exports explains virtually all of the increase in Mexico's light vehicle production over the last 25 years or so. Moreover, foreign domiciled vehicle producers are an integral part of Mexico's motor vehicle industry. Last year the three largest producers there were - in order - Nissan, Volkswagen, and GM.
According to Klier, Mexico has become an attractive location in which to manufacture automobiles not only because of its low labor costs, but also because of improvements in its training and infrastructure, and salutary changes in its trade policy over the past two decades. The major changes in Mexico’s trade policy began in 1994, when Mexico, along with the U.S. and Canada, implemented the North American Free Trade Agreement (NAFTA)—which opened Mexico’s market to its neighbors to the north while (temporarily) discouraging auto imports from outside of the NAFTA area. More trade barriers came down for Mexico since 1994; as of 2012, Mexico had signed free trade agreements with 44 countries.
At first blush, it would not seem that rising auto production in Mexico contributes at all to the reshoring of manufacturing activities to the U.S. Rather, it would appear that gains in auto production in Mexico simply divert production away from the U.S. (and its other NAFTA partner, Canada). However, over 37 percent of Mexico’s auto exports are destined outside of North American to Asia, Latin America, Europe and Africa. And since some of the embedded value within Mexico-produced vehicles comes from parts and design that originate in the from U.S., those enhanced exports of finished vehicles from Mexico does augment manufacturing activity to the north. Because NAFTA has helped integrate auto manufacturing activities across Mexico, Canada, and the U.S., gains in production in one of the three NAFTA nations can mean gains in production for the others.
Will evidence of large-scale reshoring ever emerge? The answers to the issues raised by re-shoring will not be settled for quite some time. Shifting patterns of global trade and technological change make for a murky geographic landscape. But at the very least, some of the shifts underway will be toward U.S. domiciles rather than away from them.
Robert Solow, 1987, “We’d better watch out,” New York Times Book Review, July 12, p. 6. (Return to text)
See, for example, Timothy Aeppel, 2013, “Signs of factory revival hard to spot,” Wall Street Journal, April 1, available by subscription here. (Return to text)
These figures represent total manufacturing as stated in nominal dollars. Further analysis from 2003 to date using data that cover specific industry sectors in 2005 chained dollars are similar, though with some sectoral differences. Two sectors have experience shrinking trade deficits: Industrial Supplies (including petro products), and Food, Feeds and Beverages. Three other sectors report widening trade deficits: Capital Goods Excluding Automotive, Automotive, and Consumer Goods Excluding Automotive. (Return to text)
Automotive exports from the U.S. have also been rising markedly, see Thomas Klier. (Return to text)
April 17, 2013
Seventh District Update
by Norman Wang and Scott Brave
A summary of economic conditions in the Seventh District from the latest release of the Beige Book and from other indicators of regional business activity:
• Overall conditions: Economic activity in the Seventh District expanded at a modest pace.
• Consumer spending: Growth in consumer spending edged lower. Some contacts indicated that the end of the payroll tax credit was having an increasingly negative effect on retail sales. Auto sales leveled off but dealers are still optimistic that sales will rise further this year than last year.
• Business Spending:Growth in business spending picked up. Inventory levels increased slightly, and spending on equipment and software and on structures picked up. Labor market conditions improved slightly.
• Construction and Real Estate: Construction and real estate activity increased. Demand for residential construction rose, reflecting both continued strength in multifamily construction and an improving single-family housing market. Growth in nonresidential construction, particularly for smaller retail stores and in the industrial sector, continued to be moderate.
• Manufacturing: Growth in manufacturing production slowed. Mining activity continued to decline. However, contacts indicated that construction equipment distributors and rental companies remain optimistic, pointing to the ongoing recovery in the housing market as a potential source of strength in the second half of the year.
• Banking and finance: Credit conditions remained favorable over the reporting period. Credit spreads and financial market volatility continued to be low. Banking contacts reported moderate growth in business lending, especially to small businesses and for the purposes of expanding and upgrading of facilities.
• Prices and Costs: Cost pressures were roughly unchanged, on balance. Commodity prices were down slightly, and energy prices remained elevated. Wage pressures remained moderate, although several contacts indicated increasing concern over the rising cost of healthcare.
• Agriculture: Cold weather delayed field work during the reporting period, but there was little concern expressed by contacts that planting would be seriously delayed. Corn, soybean, milk, and hog prices decreased while cattle prices moved sideways.
The Midwest Economy Index (MEI) increased to +0.04 in January from –0.10 in December, marking its first positive value since June 2012. The relative MEI, however, decreased to –0.24 in January from –0.18 in December, remaining negative for the second straight month. Estimates of annual growth in gross state product for the five Seventh District states were updated through the fourth quarter of 2012 in this release. The estimate for Indiana was higher than the national rate of growth, while the estimates for Wisconsin, Illinois, Iowa, and Michigan were lower.
The Chicago Fed Midwest Manufacturing Index (CFMMI) increased 0.8% in February, to a seasonally adjusted level of 96.3 (2007 = 100). Revised data show the index was up 0.4% in January. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) moved up 0.6% in February. Regional output rose 5.9% in February from a year earlier, and national output increased 2.4%.Posted by Testa at 1:06 PM | Comments (0)
April 11, 2013
Will Efforts to Fix Illinois Budget Hamper Economic Growth?
Bill Testa and Thom Walstrum
A famous quote by a notable economist, Herbert Stein, is that "If something cannot go on forever, it will stop."
An independent “State Budget Crisis Task Force” recently concluded unambiguously that “The existing trajectory of (Illinois) state spending and taxation cannot be sustained.” This follows a growing recognition by many observers and analysts that state government (and many local governments) in Illinois have been running chronic deficits, financing public services each year for many years through added debt. Although the state’s primary funds (the General Funds) were often reported to operate in balance, total state liabilities typically exceeded revenues collected.
As a consequence, Illinois state government finds itself today with hefty unfunded debt obligations—namely unfunded pension liabilities and unpaid bills for current services—amounting to over $100 billion. These debt obligations represent payment claims for government services that have already been delivered. While the state government paid the wages and salaries of its teachers, professors, and state workers at the time that their services were provided, part of the employee compensation for these services was deferred to the future through the promise of retirement income. But, the state government did not put aside sufficient financial assets to pay the promised retirement income and other deferred benefits. Looking forward, no one expects the state’s likely economic growth path to lift tax revenue streams much above recent (tepid) norms.
And so, given anticipated expenditures for new and expanded programs, such as federally mandated health care expansion, expenditures for public services are likely to continue to outstrip available revenues. Agencies that rate the quality of debt for would-be investors have declared the state’s bonded debt to be of the lowest quality among all states. Thus, the state’s debt position can be expected to deteriorate further without significant intervention by the state government. Indeed, elected officials will need to act very soon to restore confidence.
To do so, the state is left with a only a couple options—cuts in spending (including cuts in promised pension payouts) and hikes in taxes and fees. Curbs on the growth of spending are clearly in the cards. Even if the state devotes increasing revenues to paying down its accumulated debt—which it is now doing—it will likely also require sharp declines in public service provision. Already, for example, state aid to public education has flattened out over the past three years. Similarly, the state has trimmed its promised pension benefits for new state employees.
The other possible course of action is for the state to increase tax revenues, so as to chip away at (and eventually eliminate) the debt accumulated for past public services, while covering normal and expected revenue demands of the years ahead. If we compare the overall average tax burden of Illinois with that of its neighboring states over the past 15 years, we find that Illinois actually kept its tax burdens lower than its neighbors’ from FY 1995 through 2010 by deferring its commitments for employee compensation. However, now that debts must be repaid, tax burdens will possibly rise above national and regional norms. Accordingly, a potential downside is a dampening of growth and development as rising taxes, without any accompanying rise in services, diminishes the attractiveness of investment and livability in the state.
How High Are Illinois’s Taxes?
There are many ways to measure and compare tax burdens and many individual taxes that can be compared. But in the aggregate, tax burden can generally be thought of tax revenues collected from households and businesses as a share of the productive commercial activities of the state. Such an aggregate tax rate represents the share of a state’s annual production that is charged by government to pay for public services provided to households and to businesses.
In the following analyses, we construct such an aggregate or average “tax rate” (ATR) for a state in any given year.
State’s tax rate (ATR) = state & local tax collections/state output
Tax revenues are those collected by all state and local governments in a state, rather than by state government alone. The measurement of an aggregate tax rate must include both state and local governments because the split of revenues collected between state and local differs from state to state. In each state, public service responsibilities are assigned differently to state government versus the state’s local governments—school districts, municipal governments, county governments, and special districts such as libraries and park districts. For example, particular public safety responsibilities may be alternatively assigned to the state highway patrol, county sheriff’s department, or a city police force. Given such differences, an “apples to apples” comparison can only be made by combining all revenues within a state into one measure of “state and local government taxes collected.”
In the denominator of our measure of ATR, a state’s annual productive output is effectively measured by annual dollars of gross state product (GSP, the local counterpart of GDP), which represents total annual output from all industry sectors located within state boundaries. So, the tax rate (ATR) is the share of productive output (GSP) that is claimed by state and local government to pay for public services.
Looking at the Illinois aggregate tax rate from 1995 through 2010, we find that Illinois consistently maintained a lower tax rate that the national average (see chart).
In the next chart, we compare Illinois’s ATR to both the U.S. average (green line) and its neighboring states’ ATRs during the same period (blue bars). As well as being lower than the national average, the Illinois tax burden was also lower than those of its neighboring states, with the exception of Missouri and Indiana.
It is generally thought that Illinois was able to maintain a low tax rate because it paid for current services through borrowing rather than through concurrent taxation. As documented by the Fiscal Futures Project, the state’s main borrowing vehicle was to underfund its mounting obligations for employee retirement. In particular, state government in Illinois maintains primary responsibility not only for its own employees’ retirement benefits, but also for those of the bulk of the statewide university system and the local school systems. As of FY 2012, the unfunded pension obligations were estimated at $95 billion for the state’s five pension systems, which amounts to approximately $8,000 per capita. One estimated comparison among states for 2010 reported Illinois to have the lowest funded proportion of pension obligations, with only 45% of reserves available to meet promised payouts.
How Will Paying Off the Debt Affect Illinois’s Competitive Tax Position
Would raising taxes to meet Illinois’s public service needs (and pay off its debt) dampen economic growth? To answer this question, we look at estimates of expected gaps between Illinois’s revenues and ordinary spending. We recognize that Illinois will need not only to pay off pension-related debt, but also to meet other revenue demands for public services and other past-due bills. The state has been running in deficit, and will continue to do so to some degree, irrespective of the pension problem.
These estimates of future spending streams (and possible revenue needs) are from the Fiscal Futures Project (FFP). The FFP has consolidated the many State of Illinois Funds from which expenditures are financed. In addition, the FFP has examined past trends to predict future spending, and it has also incorporated expected new revenue demands related to, e.g., the Affordable Health Care Act. In our analysis, we take their projected average gap between spending demands and expected revenues for the years between 2011 and 2023. In particular, the gap reported in the final column in the table illustrates the hypothetical case in which Illinois cures its accumulated deficit through revenues alone. Under this scenario, the state incurs its ongoing service expenses as expected and pays down its accumulated unfunded pension liabilities on a 30-year schedule. If so, and without any new revenue enhancements, the state would run at a $12 billion per year annual deficit of expenses over revenue. This estimate is arrived at by assuming that Illinois’s recent hike in its personal income tax is allowed to expire, as it does under the current statute. The average gap is estimated to amount to 1.9 percent of GDP as measured for FY 2010.
To illustrate the effect on Illinois’s ATR of this further 1.9 percentage point claim on the state’s economy, we add this to the ATR that was actually in effect (on average) from FY 1995 through FY 2010. As seen by the red addition to the tax rate for Illinois in the following chart, the payment gap could potentially hike Illinois’s ATR by 22% percent and leave the state with a higher tax rate than its neighboring states and the nation.
It is clear from this exercise that, had public services been funded on a “pay as you go” manner, the state’s average tax rate would have been significantly higher than those of its neighbors and the nation for decades. Since public services would not have changed by using this method of payment, but taxes would have been higher, Illinois’s economic growth would likely have been lower. Going forward, at least part of Illinois’s accumulated debt will be paid for through revenue enhancements, which will push the state’s ATR above its long-run average, likely raising it relative to those of neighboring states
How much will this impede Illinois’s economic growth? Public taxes and services are not typically the most decisive factor in state growth and development. Indeed, many studies that have estimated the responsiveness of local growth to state-local tax differences find, on average, only a small to modest responsiveness of growth to state-local tax burdens. However, a tax rate hike of this size, which is conservatively estimated, would likely exercise a moderating overall influence on growth and development. And for some types of business activity, especially those that could easily escape the burden of taxation by moving across a nearby border, the impacts may be greater.
 Per the State Comptroller, “there are over 602 active funds, four funds comprise what is commonly referred to as the General Funds. These four include the General Revenue Fund, the General Revenue - Common School Special Account Fund, the Education Assistance Fund, and the Common School Fund.” By one estimate, these General Funds comprise approximately 41 percent of the state’s consolidated funds.(Return to text)
 The Illinois Commission on Government Forecasting and Accountability reports unfunded obligations for state pension funds of $94.6 billion for fiscal year (FY) 2012. Unpaid bills are estimated to be at $7.8 billion at the end of FY 2013, possibly growing to $21.7 billion by FY 2018. (Return to text)
 As of January 1, 2011, newly hired employees covered by state plans have had their age for full retirement benefit raised, cost of living adjustment trimmed, and maximum pension amounts capped, among other changes. (Return to text)
 The federal government also imposes taxes and sends grants-in-aid to state and local governments. These differ from state to state, and they are excluded here. States also share tax collections with their local governments (to varying degrees), which is another reason to combine state plus local tax collections in each state for comparison purposes. (Return to text)
 These estimates of likely hikes in the ATR are conservative, given the high levels of debt that are excluded from the calculations. State government also carries very high levels of unfunded retiree health care liabilities, amounting to approximately $40 billion dollars. Unfunded pension liabilities for governments overlying the city of Chicago amount to another $23 billion, while no comprehensive estimates are available for the many underfunded local municipal pensions throughout the rest of the state. Moreover, ordinary “bonded” state and local government debt levels across Illinois rank among the highest in the country—8th among 50 states in per capita terms. (Return to text)Posted by Testa at 12:03 PM | Comments (0)