Why Chicago is not Detroit

By William Sander and William Testa

Over the past decade, 17 of the 20 largest cities in the United States gained population. Recent academic studies on these trends have attributed them to changes in residential preferences, the location of skilled jobs, and cultural amenities. Both Chicago (third largest) and Detroit (18th) are exceptions to these trends. The population of the city of Chicago declined modestly from 2.9 million in 2000 to 2.7 million in 2010 after increasing during the 1990s. The population of the city of Detroit has declined more drastically over time from a peak of 1.8 million in 1950 to about 700,000 today; the city filed for bankruptcy in 2013. Since 2010, the population of the city of Chicago has increased modestly (1%), while Detroit’s population has continued to decline. Figure 1 shows population trends for Chicago, Detroit, and other Industrial Belt cities, which have traditionally depended heavily on manufacturing for employment. While Chicago remains much larger than the others despite recent sluggish growth, Detroit has seen a dramatic change in its position.

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Due to worsening fiscal problems and a rising homicide rate, Chicago’s prospects have recently been equated with Detroit’s, at least by the popular press. LeDuff1 writes in The New York Times “So Detroit files for bankruptcy…Pay close attention because it may be coming to you soon…Chicago.”  An Investor’s Business Daily editorial notes that “Chicago appears to be following Detroit’s lead to financial disaster.”2 An article in the Financial Times suggests that Chicago’s problems are not too different from Detroit’s.3 And so on.

For one, both places have been severely challenged by loss of manufacturing activity. Detroit and Chicago have lost over 100,000 and 300,000 manufacturing jobs, respectively, since the late 1970s; other midwestern cities (Milwaukee, Cleveland) have not been far behind. The inverse relationship between an historic MSA concentration of manufacturing jobs and subsequent growth from 1969 onward is evident for the most prominent Great Lakes metropolitan areas. More broadly, the growth-retarding effect from manufacturing on U.S. metropolitan areas over the 1960–90 period has been documented in a statistical study by Harvard’s Edward Glaeser.4 As evidenced in figure 2, manufacturing employment losses and depopulation within the central city were contemporaneous in both Detroit and Chicago.

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Declines in manufacturing jobs are a result of improvements in manufacturing productivity as well as the movement of production elsewhere including both suburban areas and overseas. For example, data for Michigan indicates that vehicle production in 2015 was at about the same level as 1990. However, employment in producing vehicles over this period declined by about one-half.

Suburbanization has taken no less a toll on central city manufacturing employment in both Chicago and Detroit alike. In the Chicago metropolitan area, only 9% of jobs are now in the manufacturing sector, while manufacturing accounts for 13% of jobs in the Detroit area. In the city of Chicago, only 6% of jobs remain in manufacturing and 10% in the city of Detroit. As reported by John McDonald for Detroit circa 1950, 61% of the Detroit area’s manufacturing jobs were to be found in the city, with another 13% in adjacent Dearborn, domicile of Ford Motor Company.5 The entire range of the city-suburb split in manufacturing jobs for both MSAs can be seen in figure 3. The advent of controlled access divided highways pulled manufacturing jobs outward within metropolitan areas to take advantage of lower land prices and lower shipping costs.

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Although both Chicago and Detroit lost a large number of jobs in manufacturing, it is also evident from figure 2 that the city of Chicago withstood the manufacturing exodus more robustly than Detroit. Unlike Detroit, its population did not decline apace with manufacturing from 1950 onward. Similarly, it did not experience the same degree of job declines. More recently, for example, over the 2000 to 2010 period, metropolitan Detroit experienced a 21.2% decline in employment, while the Chicago metropolitan area lost 7.7% of its jobs. Indeed, the past decade was disastrous for Detroit relative to Chicago. About one in four workers were unemployed in the motor city by the end of the decade. In Chicago, the unemployment rate peaked at a little more than one in ten workers (see figure 4).

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The resident population of the city of Detroit has also come to be characterized by a much higher degree of poverty and minority population. The share of households in poverty approaches four in ten in the city of Detroit, compared with 23% in Chicago. According to the latest decennial Census, the Detroit population overwhelmingly identifies as “black” (83%), up from 29% in 1960. Owing to the city’s economic collapse and to the suburbanization of (mostly white) population, by 1990 Detroit had become one of the most racially divided metropolitan areas in the United States. Social and economic issues arising from racial polarization since early in the twentieth century have been cited as a major constraint on the growth and development of Detroit and its suburbs.

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Chicago’s racial/ethnic groups also tend to be highly segregated; however, the overall composition of the city’s population is more balanced. Approximately 32% of Census respondents identify as black (including those reporting Hispanic background); 45% report as non-Hispanic white; and 28% as Hispanic. More than 20% of Chicago residents are foreign born. Despite the impression of a balanced population that such figures suggest, racial isolation in Chicago is very similar to that in Detroit when measured on a block to block basis.

Chicago bright spots

Although Chicago has many of Detroit’s problems and more than twice the number of residents living in poverty, Chicago also has many positive features relative to Detroit.

One of the reasons that one might be more optimistic about Chicago’s future is that, in spite of declines in population growth, the city of Chicago has become increasingly attractive to non-Hispanic white college graduates, while the inner-ring of suburbs of Chicago have become more attractive to African-American and Hispanic college graduates. Further, within the city of Chicago, household locations along Chicago’s lakeshore (particularly on the north side of the city), have become particularly attractive to more affluent, college-educated households. Studies indicate that the attractiveness of the city of Chicago to college graduates is at least partly related to growth in skilled jobs in and around the central business district.

Although there are recent indications to the contrary, Detroit has been less successful in attracting resident college graduates. Only 12% of the population twenty-five and older in the city of Detroit are college graduates. In the city of Chicago, 34% of the adult population has at least a bachelor’s degree. In popular areas of Chicago such as Lincoln Park, the vast majority of adults have at least a bachelor’s degree. Further, about half of the twenty-something college graduates in the Chicago metropolitan area live in the city of Chicago, while only 10% of college graduates in their 20s in the Detroit metropolitan area live in the city of Detroit. For college graduates with a school-age child, the percentage living in the city of Detroit is even lower (5%), versus 15% for Chicago. Of the college graduates working in the city of Detroit, only 22% live there. In the case of Chicago, the corresponding statistic is 61%.

Further, median household income in the city of Detroit is only a little over half of median income in Chicago. The poverty rate in Detroit is almost twice as high as Chicago’s, although the city of Chicago has almost twice as many poor residents. The city of Chicago employs about four times as many people as the city of Detroit. About 30% of the jobs in the Chicago metropolitan area are in the city of Chicago, while the corresponding statistic for Detroit is only 14%.

Why Are Chicago’s Prospects Brighter?

For one, Chicago began the era of de-industrialization with a more diversified economy with which to reinvent itself, especially in business services and financial services. In addition to its manufacturing (and goods transportation) prowess, Chicago has long been a purveyor of business and business-meeting services, retail, and financial services to the surrounding Midwest region and beyond. For example, Chicago’s large exchange-traded derivatives industry evolved from the city’s role as a nineteenth century market and wholesale distributor of grain, lumber, and meat. Its highly concentrated management consulting industry owes its twenty-first century success in part to the need of New York City financial houses to closely appraise the operations of Midwest manufacturing companies in the issuance of corporate debt. And the nexus of passenger railroad lines and (later) passenger air travel in Chicago cultivated one of the nation’s leading industries in business meetings and conventions. Accordingly, the profound exodus of manufacturing that occurred from almost all large U.S. cities did not devastate Chicago’s job base to the same degree as happened in Detroit and some other Midwest cities, although some parts of Chicago were hit hard. Admittedly, the Detroit area also maintains very strong business services industries, largely related to the auto industry, but for the most part these services are in suburban locations. In Chicago, many service businesses remain in the city.

Figures 2 and 3 show trends in population and manufacturing in Chicago and Detroit from 1900 to date. In both cities, one can see the spectacular rise in both manufacturing and population to 1950 followed by an equally spectacular decline. However, while population declines in Chicago have been profound, they diverge markedly from the Detroit experience. Nonetheless, much like Detroit, vast neighborhood areas of the city of Chicago were also impoverished by job and population flight to the suburbs, especially those neighborhoods that depended on the middle-income jobs associated with freight and manufacturing. Wages and jobs outside of the central area of Chicago have declined, even while the central area has prospered. Today, many Chicago neighborhoods find themselves challenged in the same ways as neighborhoods in Detroit and other industrial cities by poverty, violence, sub-standard housing, and a lack of immediate and accessible economic opportunities.

Chicago has arguably developed a stronger reputation as a city in which to do business than Detroit and some other midwestern cities. At the turn of this century, Chicago began positioning itself to be one of the emerging “global cities” that had successfully forged commercial connections to other cities of its kind around the world. Global cities are characterized by the most skilled occupations and activities in business services, finance, education, and technology; well-educated residents; forward-looking business leaders; and globally connected transportation and communications networks, among other attributes.

Owing to their strategic importance and global reach, corporate headquarters operations have become a hallmark of success for global cities. Early last decade, Chicago became the global headquarters of Boeing. Since then, the city has attracted Archer Daniels Midland, GE Healthcare, Oscar Mayer, and ConAgra, among others. Relocation of headquarters from the suburbs of Chicago to the central city has also taken place, including United (Air), Kraft Heinz, and Motorola Mobility.

In Detroit, both the IT software company Compuware and Quicken Loans have relocated operations from the suburbs to the downtown area (in 2003 and 2010, respectively). However, the scale of these moves falls far short of similar activity in Chicago.

Some argue that headquarters operations have downsized over time, representing far fewer direct jobs than in the past when headquarters often included back office, research, advertising, and payroll processing operations. However, the presence of headquarters is coincident with a much vaster nearby network of financial and business services, many of which are supported by colocation with the strategic headquarters of corporations.

The upshot then is that, even though the older industrial neighborhoods of Chicago share many of the same challenges as those of Detroit, Chicago has been better able to withstand the decline of industrial production. Whereas the city of Chicago has about four times as many people as the city of Detroit, Chicago has ten times as many jobs in finance, eight times as many jobs in professional services, six times as many jobs in education, and five times as many jobs in accommodation and food services. Since 1998, the Chicago area has gained almost 60,000 jobs in business services, while Detroit has lost over 35,000 jobs in the sector. During this period, Chicago also gained more than 20,000 jobs in colleges and universities, while Detroit gained none.

It is clear that Detroit needs to diversify its legacy industrial clusters as well as to build on them. This focus on industrial rebirth includes further specialization in the auto industry—especially R&D, as well as logistics and transportation, engineering and design, technology start-ups, and business services and finance. Indeed, diversification to a technology-oriented industrial structure has raised fortunes of old industrial regions elsewhere, with the Boston area being a prominent example.

We would note that a number of Rust Belt cities with about as many jobs as Detroit, including Cleveland, St. Louis, Milwaukee, and Pittsburgh have significantly fewer people living in them. This implies that Detroit’s population may not yet have reached a floor. Unlike Detroit, the city of Chicago remains an attractive place to work and live, especially for young college graduates. This could change over time if Detroit can reinvent itself and make further improvements in the delivery of basic public services, especially basic education and public safety. Chicago faces many of the same challenges in improving public services, and in putting its underlying fiscal affairs on a sounder footing.

William Sander, Professor of Economics, DePaul University, Chicago.

William Testa, President and Director of Regional Programs, Federal Reserve Bank of Chicago

A preliminary version of this paper was presented at Inner City Economic Development Summit in Detroit, September 2015.

  1. LeDuff, Charlie. 2013. “Come see Detroit, America’s future.” The New York Times, July 24.
  2. Investor’s Business Daily. 2013. “Emmanuel’s Chicago is on the path to be the next Detroit.” August 7.
  3. Sender, Henny, Stephen Foley, and Richard, McGregor. 2013. “Descent into despair.” The Financial Times. July 26.
  4. Glaeser, Edward, Jose A. Scheinkman, and Andrei Shleifer. 1995.”Economic Growth in a Cross-Section of Cities,” Journal of Monetary Economics 36 (1): 117-143.
  5. McDonald, John F. 2013. “What Happened To and In Detroit?” unpublished paper.

Updated Forecasts of Seventh District GSP Growth

Several years ago, the Chicago Fed began providing estimates of annual gross state product (GSP) growth for each of the five states in the Seventh Federal Reserve District.1 The U.S. Bureau of Economic Analysis (BEA) releases annual GSP data for the prior year each June. This post discusses GSP projections for 2015 and presents an alternative forecasting model using quarterly GSP data from the BEA.2

The 2015 Growth Picture

To provide context for our projections, we first take a brief look at the main indicators of our model. Figure 1 shows annual U.S. gross domestic product (GDP) growth and GSP growth aggregated across the five states in the Seventh District from 2005 through 2014. Actual GSP data for 2015 will not be released for another month. However, we can get a sense of what this data is likely to show by comparing the recent histories in the figure. While growth in the Seventh District has lagged behind the nation in recent years, it has tended to follow a similar trend over longer periods. The U.S. maintained an annual growth rate of around 2.4% from 2014 to 2015, providing a reasonable starting point for our estimate of District growth in 2015.

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The Chicago Fed’s Midwest Economy Index (MEI) then provides a useful link between national and regional growth that can give us a sense of the likely persistence of the recent shortfall between District and national growth. As figure 2 shows, the MEI indicated that the Midwest economy experienced growth that was somewhat above trend in the first half of 2015 and slightly below trend in the second half. Additionally, the relative MEI dipped below zero in the third quarter, suggesting that Midwest economic growth was further below its trend than national growth was in the second half of the year. Though the MEI does not explicitly pertain to GSP growth, historically a zero value for the index has been roughly consistent with 1.5% annual GSP growth for the District. In light of this, both the MEI and relative MEI suggest that District GSP growth in 2015 likely rebounded from its 2014 rate of 1.1% to somewhat above its trend rate of 1.5%, but still below the national growth rate of 2.4%.

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Finally, we turn to annualized quarterly growth of state real personal income over 2015which provides an indication of how state-specific factors may have affected District GSP growth in 2015. Figure 3 shows that both Illinois and Michigan experienced strong income growth in the first quarter of 2015. Though the District states generally experienced weak income growth in the second quarter in comparison with the national average, growth rates in the remaining quarters of 2015 were of similar magnitudes to the national rate. Taken together, these data suggest some likely variation in GSP growth rates across the District states, but for the most part, they are consistent with the MEI and U.S. GDP growth data in figures 1 and 2.

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Forecasts for 2015

Our forecasts for 2015 combine the information in the indicators discussed in the previous section to arrive at an estimate of annual GSP growth for the District states and the District as a whole. Since 2011, the Chicago Fed has used the following statistical model to estimate annual GSP growth:

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This model explains the annual GSP growth rate of each Seventh District state as a function of national GDP growth, regional economic conditions as captured by the monthly MEI and relative MEI, and state-specific conditions (specifically, quarterly real personal income growth and annual GSP growth in the previous year).3 We aggregate state projections into a District-wide forecast using each state’s respective share of nominal District GSP.

Figure 4 shows for each District state and the entire District their respective historical GSP growth (blue bars), in-sample fits (orange lines) of GSP growth obtained from our statistical model, and 2015 out-of-sample projections (green lines). With the exception of Iowa, the model predicts an increase in the GSP growth rate for the Seventh District states, as well as the District as a whole. Interestingly, this seems out of line with the national GDP data and the MEI and relative MEI data discussed earlier. It is of note, however, that for 2014 the model also estimated higher GSP growth than what was realized for each state.

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Motivated by our model’s recent shortcomings, we developed a similar model estimated using the experimental quarterly GSP data recently published by the BEA. Figure 4 also contains projections of annual GSP growth (red bars) obtained from this new model. At the time of writing, these data were available through the third quarter of 2015. To obtain a GSP growth projection for all of 2015 with these data, we need only estimate the fourth quarter’s value. Using the new statistical model to obtain this estimate and combining it with the data from the first three quarters, we arrive at an alternative forecast for 2015.

Figure 4 clearly shows a large difference between our two forecasting models. As table 1 further demonstrates, the projections from our new quarterly model (Q4 forecasted column) are below those of our original annual model in every instance, and often by quite large magnitudes. For the District as a whole, our quarterly model predicts more modest GSP growth of 1.6%, compared with 2.5% as forecasted by the annual model. This estimate from our quarterly model is also in line with the previous evidence suggesting growth was slightly above the historical trend of 1.5% but below the national growth rate of 2.4% for 2015.

Table 1. Annual GSP Growth Forecasts for 20154

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To illustrate the sources of the discrepancy between our model forecasts, we plot in figure 5 the annualized quarterly GSP growth data from the BEA (blue bars) for 2015, including our fourth quarter estimates (red bars) and fitted values from the model (orange lines). It is important to note that both our annual and quarterly models use the same 2015 data for the variables that they share in common, with the exception of the three quarters of GSP data that we have for 2015. These data show sharp contractions in GSP for every District state (with the exception of Illinois) in the first quarter. More than anything else, this feature of the quarterly data is the dominant source of the discrepancies between our annual and quarterly model projections. The model fits in figure 5 make this clear, as they demonstrate very large negative residuals in the first quarter and only small misses in the other quarters, reflecting the fact that the declines in GSP in the first quarter are not consistent with the indicators in our statistical model.

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It is possible that the quarterly GSP data for 2015 will be revised upon the release of the annual figure next month. As noted previously, our model predicts weak first quarters for the District states, but not nearly as dramatically as what has been released by the BEA thus far. Considering the apparent inconsistency between the quarterly data and the model, we also generate a forecast for 2015 that uses the fitted values for the first three quarters of 2015 GSP growth instead of the quarterly data. These projections, presented in the Q1–Q4 forecasted column of table 1, are larger than the quarterly model’s estimates using the quarterly values for 2015, but are still below those of the annual model. Moreover, these projections suggest that at 2.0%, District GSP growth improved in 2015 and was closer to the national average, but still below it.

Conclusion

We will continue to monitor the performance of both our annual and quarterly forecasting models. However, based on the results presented here, we intend to report annual GSP growth rates for each District state from our new quarterly model combined with the available quarterly data for the 2015 forecast (as presented in the Q4 forecasted column in table 1). From now on, we will continue to report estimates from this model as long as the quarterly data from the BEA make it possible to do so.

  1. The Seventh District comprises parts of Illinois, Indiana, Michigan and Wisconsin, as well as all of Iowa.
  2. The quarterly GSP data provided by the BEA is still in an experimental phase. For more information, visit https://www.bea.gov/regional/index.htm.
  3. The model is explained in more detail in Brave and Wang (2012).
  4. To allow for “like-for-like” comparisons among District forecasts, we aggregate state-specific annual forecasts to the District level using annual nominal GSP shares. The 2015 projections were aggregated using the 2014 shares.

Seventh District Update, April 2016

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First, a (repeat) special announcement: As a Midwest Economy blog reader, you may also want to sign up to follow our new Chicago Fed Survey of Business Conditions (CFSBC), which is a survey of business contacts conducted to support the Seventh Federal Reserve District’s contribution to the Beige Book. The Chicago Fed produces diffusion indexes based on the quantitative questions in the survey. Click here to sign up for email alerts and click here to view the latest release.

And now, 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: Growth in economic activity in the Seventh District picked up to a moderate pace in late February and March, and contacts expressed renewed optimism about the outlook for growth over the next 6 to 12 months.
  • Consumer spending: Growth in consumer spending maintained a modest pace, though, in contrast to the national data, reports of new and used vehicle sales continued to be strong.
  • Business Spending: Most retailers and manufacturers reported comfortable inventory levels. Current capital outlays and plans for future outlays picked up to a moderate pace. Hiring also picked up to a moderate pace, as did the number of contacts saying they planned to increase their workforces in the future.
  • Construction and Real Estate: Residential construction edged up and residential rents and home prices rose slightly. Demand for nonresidential construction was little changed and commercial real estate activity rose moderately.
  • Manufacturing: While manufacturing production rose at a modest rate early in the reporting period, growth increased to a moderate pace by the end March. Activity remained strong in the auto and aerospace industries and picked up in most other industries.
  • Banking and finance: Overall, financial conditions improved some. Equity markets regained much of their losses from the previous reporting period and volatility subsided. Business loan demand improved marginally and consumer loan demand was little changed, on balance.
  • Prices and Costs: Cost pressures increased some in late February and early March, but remained mild overall. Most energy and metals prices increased, but remained low. Retail prices changed little on balance, and wage and nonwage cost pressures remained mild.
  • Agriculture: Corn, soybean, and wheat prices moved up, and fertilizer prices and land rents moved down, but these changes were not large enough to appreciably improve crop farmers’ earnings prospects.

The Midwest Economy Index (MEI) moved up to +0.07 in February from −0.09 in January. The relative MEI fell to +0.54 in February from +0.73 in January. February’s value for the relative MEI indicates that Midwest economic growth was somewhat higher than what would typically be suggested by the growth rate of the national economy.

The Chicago Fed Survey of Business Conditions (CFSBC) Activity Index increased to –4 from –20, suggesting that growth in economic activity picked up to a moderate pace in late February and March. The CFSBC Manufacturing Activity Index rose to +23 from –19, while the CFSBC Nonmanufacturing Activity Index increased to –19 from –21.

Early Benchmarking the State Payroll Employment Survey—Update

In June of 2015, I wrote a blog post detailing a method called early benchmarking, which predicts how the U.S. Bureau of Labor Statistics (BLS) will revise the state payroll employment survey data when it updates its benchmarks each March (the method was first introduced by our colleagues at the Dallas Fed). The primary source of the revisions for state payroll employment (also known as the Current Employment Statistics, or CES) is the Quarterly Census of Employment and Wages (QCEW). While the BLS only rebenchmarks the CES using new QCEW data yearly, QCEW data are released quarterly, so it’s possible to use new QCEW data to predict how the BLS will revise the CES (this process is explained in detail in my earlier post). Benchmark revisions to the CES can be quite large, and we have found that our early benchmarking procedure typically reduces their size.

The BLS recently released the March 2016 benchmarked data, so we can see how the early benchmarking method performed for the Seventh Federal Reserve District and the District states for 2015. Table 1 summarizes how much employment grew in the Seventh District and District states in 2015 based on when the data were benchmarked using the QCEW. At the District level, the early benchmarking procedure performed marginally better: It underestimated job growth by 32,000, while data benchmarked in March 2015 underestimated job growth by 38,000. Both datasets estimated a 1.1 percent growth rate for 2015.

Early benchmarking is more useful at the state level, because CES sample sizes are smaller. For 2015, the largest error was for Illinois, where the March 2015 benchmarked data estimated that employment declined by 3,000, while the March 2016 benchmarked data indicate that employment actually increased by 51,000. The January 2016 benchmarked data roughly split the difference, estimating job growth of 29,000.

Table 1 - Job Growth

The figures that follow show graphically the differences between the three series summarized in table 1 for the District and District states. The dashed portion of the lines for each series represents data that are not benchmarked using the QCEW. For example, the early benchmarked data are benchmarked using QCEW data through June 2015, while the March 2016 benchmarked data use QCEW data through September 2015. In some figures it is clear that the BLS also revises already-benchmarked data, though these revisions are typically small (Wisconsin is an exception for 2014).

Later this year, we will begin publishing early benchmarked estimates of District and District state employment growth on our website on a monthly basis (coinciding with the release of the Midwest Economy Index). We will be sure to notify our Midwest Economy blog readers when we make the estimates available.

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Can Budget Rules Help Reduce Fiscal Troubles in Illinois?

Fiscal analysts and credit rating agencies have criticized Illinois government officials for their fiscal mismanagement, especially the shifting of debt obligations incurred to pay for current services onto future generations. The growth of unfunded public employee pension obligations has been the most egregious example. Moreover, state and local governments have allowed bills for current services to grow unabated, while existing debt outstanding for capital projects has been refinanced beyond the useful life of the projects themselves.1

At first blush, remedies to such behaviors might seem to be simply a matter of mobilizing the will to balance budgets through spending reductions and tax increases. In some cases, the electorate seeks to discipline elected officials to behave responsibly. However, election discipline and public oversight often fall short. Elected officials may fail to reduce spending because they don’t want to appear to renege on campaign promises; similarly, tax hikes are seen to be too unpopular with the voting public. Accordingly, a helpful alternative is to build in budgetary procedures and practices that assist the public to oversee and discipline the fiscal actions and behaviors of their elected officials.

Given the sorry state of fiscal affairs in many Illinois governments, structural regulatory changes should be considered in order to hold officials accountable and to provide the public with clear and consistent information regarding the state’s financial condition. Regulations constraining fiscal flexibility could force policymakers to act more responsibly and limit their ability to make unrealistic financial promises and disguise questionable fiscal decisions.

In a recent paper by Richard Dye, David Merriman, and Andrew Crosby, the authors describe four fundamental principles of sound budgetary practice – advance planning, sustainability, flexibility, and transparency – all important areas of improvement for Illinois. The authors then outlined five methods by which Illinois could break its bad habits and adopt more robust budgetary practices.

First, Illinois should refine and expand multiyear budget planning. Currently, Illinois does not have a budget plan that looks far enough into the future, or that covers a wide enough scope of projections to maximize its usefulness as a gauge of fiscal stability. Some improvements have been made; for example, budgetary projections by the Commission on Government Forecasting and Accountability (COGFA) and the Governor’s Office of Management and Budget (GOMB) now cover three years. But they would be more informative and useful if they covered five years. Plans would also better measure fiscal stability if they covered a broader scope of projections. Currently, the plans only cover the general funds, leaving out hundreds of special funds comprising over half of the state’s budget.

Budget planning for a given year could also be expanded to include projected spending from current services, even if it does not affect that year’s balance sheet. This would help the state improve its advance planning by forcing officials to look farther into the future and analyze a broader scope of areas affected by current fiscal decisions. Furthermore, it might help the state address its sustainability issue, by holding today’s politicians accountable for future payments incurred by current services, rather than deferring payment of today’s labor into the future, handing the debt to their successors.

Second, the state of Illinois should require that meaningful fiscal notes accompany any legislation with a significant impact on future revenue flows or spending obligations. Fiscal notes, which are rarely used in Illinois, would include any cost estimates for legislation over a designated period of time. These would help Illinois better document time-shifting in its revenue and expenditures and identify nonrecurring revenue in budget documents. It is much easier for government officials to justify expensive programs or policies when the revenue flow is ambiguous and when one-time revenue sources, such as asset sales, are not disclosed.

Third, the authors suggest that the state should modify cash-only budget reporting to better track significant changes in liabilities and assets. Currently, Illinois relies on single-year, cash-basis accounting, which reports only receipts and payments in the current budget year. Accrual accounting, on the other hand, also covers changes in assets or liabilities that are attributable to that budget year, but not actually implemented until a future year. A cash-only budget allows the state to disguise time-shifting consequences of current fiscal actions. Moving away from this practice would make government spending more transparent by revealing deceptive fiscal actions, such as making payments with temporary revenue sources or promising to return loans in the future without continuous revenue sources to guarantee they’ll be paid.

Along those lines, the authors’ fourth suggestion is that Illinois should identify non-sustainable or one-time revenue sources in its budget reports, allowing the public to gain a better understanding of the time horizons of various revenue sources. Additionally, if the government must label one-time revenue sources, they might be compelled to put more continuous revenue sources toward a stronger “rainy day fund,” which would enable officials to be more flexible in responding to fiscal emergencies.

Finally, the authors argue the state should adopt a broad-based budget frame with meaningful spending and revenue categories consistently defined over time. Inconsistent terminology and accounting techniques make it difficult to track financial conditions and changes over time. For example, it can be challenging to tell how much of a year-to-year change in budget is real versus due to a change in accounting practices.

The state must not only clearly communicate a fiscal plan stretching farther into the future than it currently does, but must also make information more accessible to the public. Fiscal information should be readily available on a timely basis, and online information should routinely provide budget reports, with budget components consistently defined and explanations included when there are transfers between budget categories.

While these five practices would ideally lead to a much more sustainable financial position for Illinois, there are clearly roadblocks preventing Illinois’s government from adopting them, such as political frictions and the momentum of embedded spending and programs. For elected officials, it is often the case that in order to actually deliver upon the programs or actions they campaigned upon, they would need to generate even more debt, for example by borrowing from future budgets to pay off promised pensions today. And because Illinois’s politicians have been accumulating more and more debt for decades, it is unappealing for any of them to be the first to adopt more frugal behavior, perhaps by reducing benefits or scaling down public programs.

In the end, there is no painless path out of Illinois’s current debt crisis for citizens or politicians. But implementing these fiscal practices might serve as a way to ease the transition to better fiscal management, by giving politicians no other option and by providing the public with a more complete picture of where Illinois really stands.

  1. The issues surrounding Illinois’s fiscal conditions, as well as proposed solutions, were discussed at a December 2015 conference, Transparency and Accountability in State Budgeting: Challenges for Illinois and Other States, held at the Union League Club of Chicago. The conference was summarized in a recent Chicago Fed Letter.

Seventh District Update, March 2016

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First, a (repeat) special announcement: As a Midwest Economy blog reader, you may also want to sign up to follow our new Chicago Fed Survey of Business Conditions (CFSBC), which is a survey of business contacts conducted to support the Seventh Federal Reserve District’s contribution to the Beige Book. The Chicago Fed produces diffusion indexes based on the quantitative questions in the survey. Click here to sign up for email alerts and click here to view the latest release.

And now, 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 continued to increase at a modest pace, but turmoil in financial markets led contacts to express greater uncertainty and more pessimism about the pace of growth over the next 6 to 12 months.
  • Consumer spending: Growth in consumer spending continued at a modest pace, though new and used vehicle sales continued to be strong.
  • Business Spending: Most retailers reported comfortable inventory levels. Current capital spending and plans for future outlays both picked up some, but growth remained modest. The pace of hiring also picked up some, but growth remained slow. More contacts noted plans to increase their workforces over the next 6 to 12 months than in the previous reporting period.
  • Construction and Real Estate: Residential construction expanded modestly, and residential rents, home sales, and home prices all inched up. Nonresidential construction activity was little changed. Commercial real estate activity remained strong, fueled by demand from institutional investors.
  • Manufacturing: Gains in manufacturing production continued at a moderate pace. Growth remained strong in the auto and aerospace industries, but was slower in most other industries.
  • Banking and finance: Financial conditions tightened slightly on balance. Contacts reported that concerns about slower global economic growth led to declines in equity markets. Business and consumer loan demand grew slightly.
  • Prices and Costs: Cost pressures continued to be subdued. Commodity prices remained low, retail prices were little changed, and wage and nonwage cost pressures remained mild.
  • Agriculture: Crop farmers continued to cut capacity following another year of low incomes coupled with unexpectedly small declines in input costs.

The Midwest Economy Index (MEI) moved up to –0.15 in December from –0.20 in November. The relative MEI rose to +0.28 in December from +0.08 in November. December’s value for the relative MEI indicates that Midwest economic growth was somewhat higher than what would typically be suggested by the growth rate of the national economy.

The Chicago Fed Survey of Business Conditions (CFSBC) Activity Index edged down to –19 from –17, suggesting that growth in economic activity continued at a modest pace in January and early February. The CFSBC Manufacturing Activity Index rose to –7 from –18, while the CFSBC Nonmanufacturing Activity Index declined to –25 from –16.

Introducing the Chicago Fed Survey of Business Conditions (CFSBC)

On January 13, 2016, the Chicago Fed published the inaugural release of its Survey of Business Conditions (CFSBC). This new data product offers a series of diffusion indexes that track a broad set of topics related to the business conditions of firms in the Seventh District: overall activity (or product/service demand), outlook for the U.S. economy, current and planned hiring, current and planned capital spending, and wage and nonwage cost pressures.

The indexes are derived from questions included in a survey of Seventh District business leaders (started in March 2013) that was originally designed to support the Chicago Fed’s contribution to the Beige Book. Table 1 shows that CFSBC respondents come from a variety of industries, with the largest representation coming from the nonfinancial services sector and the manufacturing sector. The survey has averaged about 75 respondents over its history, though more recent surveys have averaged about 100 respondents.

CFSBC - 1 - Tab1

While the Beige Book is explicitly an anecdotal (or qualitative) account of current economic conditions, we decided to also include quantitative questions in our survey so that we can calculate indexes. These questions follow a seven-point scale. For example, here is our question about product/service demand:[1]

In the past four to six weeks, demand for my firm’s product or service has

  • increased substantially.
  • increased moderately.
  • increased slightly.
  • not changed.
  • decreased slightly.
  • decreased moderately.
  • decreased substantially.

The diffusion indexes we calculate from questions such as the one above are designed to be leading indicators, capturing changes in the prevailing direction of economic activity. The formula for the indexes is:

CFSBC - 4 - Formula 2

In many ways, this is a very traditional formula for a diffusion index, but we make an important adjustment that we would argue improves it: we measure individuals’ responses relative to their respective average responses. To calculate a respondent’s average response to a question, we assign numerical values ranging from +3 to –3 along the seven-point scale, and take the average across all responses. We then count a response as positive if it is above a respondent’s average response and negative if it is below a respondent’s average response. For example, if a respondent’s average response is +1.5, substantial and moderate increases are counted as positive responses and all other answers are counted as negative responses. Given our formula, the index ranges from +100 to –100 and will be +100 if every respondent in a given survey has an above-average response to a question and –100 if every respondent has a below-average response.

Calculating the indexes using a survey participant’s average response as a baseline—also known as detrending—allows us to correct for two types of potential biases. First, individuals may interpret phrases such as “substantially increased” differently, so that our numerical scores have different meanings for different people. Second, the industries and firms represented in our data may have different growth trends than the overall economy, which could bias the indexes because we do not have a random sample of respondents. For example, because manufacturers represent a sizable share of our respondents, our index could overrepresent trends in the manufacturing sector. The share of manufacturing output and employment in the U.S. economy has been declining for decades, so that in general, trends in the manufacturing sector are becoming less and less representative of trends in the overall economy.

Respondents’ respective average answers to a question can be interpreted as representing their historical trends or long-run averages. Thus, when we summarize respondents’ detrended responses by calculating diffusion indexes, we interpret zero index values to indicate that, on balance, the activity indicators are growing at their trend rates (or that outlooks are neutral). Likewise, positive index values indicate above-average growth (or optimistic outlooks) on balance, and negative values indicate below-average growth (or pessimistic outlooks) on balance.

For a concrete example of how we interpret the diffusion indexes, consider figure 1, which shows the CFSBC Activity Index (which is based on the question about product/service demand). It shows that 2013 was a bumpy year, with growth in activity about at trend on average. According to the index, 2014 started slowly (as you may recall, there was a lot of bad weather in the winter of 2014–15), but growth was consistently above trend for the rest of the year. Activity then slowed throughout 2015 to the point that growth was below trend by year’s end.

CFSBC - 2 - BBAct

We’ve found that the CFSBC Activity Index seems to do a good job of tracking U.S. real gross domestic product (GDP) growth, so that the index may be a good early indicator of the current state of the economy. Figure 2 shows this relationship, where I’ve aligned a zero value of the CFSBC Activity Index with the average of real GDP growth over the comparison date range. In general, the CFSBC Activity Index is positive when real GDP growth is above average and negative when real GDP growth is below average.

CFSBC - 3 - ActGDP

Because we use the results of the CFSBC to write our contribution to the Beige Book report, we will be releasing the CFSBC index data in conjunction with the Beige Book schedule. The Beige Book is released at 1:00 p.m. ET on the Wednesday two weeks before FOMC meetings, which take place eight times per year. The CFSBC index data are released two hours later.

For a more detailed description of the diffusion indexes and their properties, see the Chicago Fed Economic Perspectives article titled “The Chicago Fed Survey of Business Conditions: Quantifying the Seventh District’s Beige Book Report.”

[1] The full set of questions used for the CFSBC indexes is available here.

Recap of the Federal Reserve Bank of Chicago’s 29th Annual Economic Outlook Symposium

Please note: this is a cross-post from the Chicago Fed’s Michigan Economy blog.

On December 4, 2015, the Federal Reserve Bank of Chicago hosted its 29th annual Economic Outlook Symposium (EOS). The EOS allows economists, business leaders, financial analysts, and other experts to gather and share their respective views on the U.S. economy and individual sectors especially important to the Midwest economy. Also, EOS participants are given the chance to submit their respective projections for the year ahead. These projections are subsequently used to come up with a consensus (median) forecast for real gross domestic product (GDP) and related items.

This blog entry is a summary of what was presented at the latest EOS. For a more in-depth look into what was presented, please click here to read the Chicago Fed Letter for the event. Most of the presentations that were delivered during the EOS can be found here.

  • 2015 forecast review: Real GDP growth in 2015 was slightly weaker than expected in the consensus outlook from the previous EOS held in December 2014. Growth in real personal consumption expenditures was slightly higher than anticipated, partly because of stronger than expected growth in light vehicle sales. However, real business fixed investment grew at a significantly slower rate than predicted. New home construction just missed forecasted activity levels. The unemployment rate was lower than originally projected, while inflation (as measured by the Consumer Price Index) came in well below the predicted rate.
  • Outlook for consumer spending: According to Scott Brown (Raymond James & Associates), consumer spending is forecasted to slightly decelerate in 2016 in part because of headwinds from rising energy prices (he expected oil prices to average around $50 per barrel by year-end). The pace of job growth has been strong, but is expected to moderate this year.
  • Outlook for financial services: Brown also noted that credit conditions are fairly tight, but they should ease. The (then-anticipated) interest rate hike in December by the Federal Open Market Committee (FOMC)—the Federal Reserve’s monetary policymaking arm—shouldn’t dampen lending for a while, Brown said.
  • Auto industry outlook: According to Yen Chen (Center for Automotive Research), U.S. light vehicle sales and production are expected to peak in 2018 (at around 18.6 million units and 12.2 million units, respectively) before falling slightly. Auto loan debt is expected to surpass student loan debt as the highest form of household debt, excluding mortgage and home equity debt, over the coming years. Meanwhile, Mexican light vehicle production capacity is expected to increase by over 2 million units in the next seven years largely because of lower labor costs (thereby reducing the U.S. share of North American production).
  • Steel industry outlook: Robert DiCianni (ArcelorMittal USA) indicated that U.S. steel consumption is projected to modestly increase in 2016, based on his analysis of several steel-intensive sectors of the economy. For instance, the pace of growth in residential construction is expected to accelerate, while year-over-year growth in nonresidential construction is anticipated to level off. Moreover, both U.S. auto sales and North American auto production in 2016 should be similar to their respective levels in 2015. Global steel consumption is expected to increase slightly in 2016 after decreasing last year. The slowdown in Chinese steel consumption has been a major factor in the decelerating rate of global steel consumption in the past few years.
  • Heavy machinery outlook: Glenn Zetek (Komatsu America Corp.) stated that U.S. demand for earth-moving equipment is at healthy levels, though demand has slowed significantly in states where energy production had been intense over the past few years. Equipment demand for single-family residential and transportation projects is expected to increase in 2016. But heavy machinery demand for nonresidential projects should moderate this year; the prospects for equipment demand to complete such projects look more promising over the next couple of years, as nonresidential fixed investment is expected to move up moderately and equipment usage is near its mid-2000s peak. Equipment usage for mining, energy, and rental needs are predicted to decrease.
  • State and local government debt outlook: According to John Mousseau (Cumberland Advisors), municipal bond yields for the highest-rated securities with maturities greater than ten years are higher than comparable U.S. Treasury bonds—the opposite of what’s normal. Even with Detroit’s bankruptcy and other cities’ and states’ latest financial struggles, municipal bond quality generally remains higher than corporate bond quality. Interest rate increases won’t be terrible for issuers of municipal bonds because historically, municipal bond yield increases failed to match the size of federal funds rate increases.

Conclusion: 2016 economic outlook

According to the latest EOS consensus outlook, U.S. real GDP growth in 2016 is expected to increase slightly above its historical trend. Inventory levels are expected to rise at a slower pace. Residential investment is projected to rise at a strong pace, with slow and steady improvement predicted in new home construction. Growth in business fixed investment should continue at a decent pace, with moderate growth anticipated in industrial output. The dollar is estimated to slightly appreciate versus major currencies, which should increase the U.S. trade deficit to levels not seen in the past decade. Forecasters expect interest rates to rise, but remain at relatively historical lows. The unemployment rate is predicted to edge slightly below current levels. Inflation is expected to move up (closer to the FOMC’s inflation target) as oil prices strengthen slightly.

Seventh District Update, January 2016

blog_image_7th_D

First, a special announcement: As a Midwest Economy blog reader, you may also want to sign up to follow our new Chicago Fed Survey of Business Conditions (CFSBC), which is a survey of business contacts conducted to support the Seventh Federal Reserve District’s contribution to the Beige Book. The Chicago Fed produces diffusion indexes based on the quantitative questions in the survey. Click here to sign up for email alerts and click here to view the latest release.

And now, 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 continued to increase at a modest pace, but contacts were optimistic that growth would pick up some over the next 6 to 12 months.
  • Consumer spending: Growth in consumer spending continued at a modest pace, though new and used vehicle sales continued to be strong.
  • Business Spending: Most retailers reported comfortable inventory levels. Current capital spending and plans for future outlays both picked up some, but growth remained modest. The pace of hiring remained slow, though more contacts noted plans to increase their workforces over the next 6 to 12 months than in the previous reporting period.
  • Construction and Real Estate: Residential construction edged up, and residential rents, home sales, and home prices increased slightly. Although commercial real estate activity slowed some, it remained strong and broad-based. Commercial rents increased slightly.
  • Manufacturing: Gains in manufacturing production picked up to a moderate pace. Growth remained strong in the auto and aerospace industries and picked up slightly in most other industries.
  • Banking and finance: Financial conditions tightened slightly on balance. Contacts noted greater illiquidity in the bond market, growth in small and middle-market business loan demand slowed slightly, and consumer loan demand was little changed.
  • Prices and Costs: Cost pressures continued to be subdued. Commodity prices remained low, retail prices were little changed, and wage and nonwage cost pressures remained mild.
  • Agriculture: District farm incomes declined as the large harvest pushed product prices down faster than input costs.

The Midwest Economy Index (MEI) moved down to –0.17 in November from –0.14 in October. The relative MEI rose to +0.13 in November from –0.32 in October. November’s value for the relative MEI indicates that Midwest economic growth was slightly higher than what would typically be suggested by the growth rate of the national economy.

The Chicago Fed Survey of Business Conditions (CFSBC) Activity Index declined to –17 from –12, suggesting that growth in economic activity continued at a modest pace in late November and December. The CFSBC Manufacturing Activity Index rose to –20 from –37, and the CFSBC Nonmanufacturing Activity Index fell to –16 from zero.

Understanding the Seventh District’s economic slowdown in 2015

As I noted on this blog in February 2015, 2014 was a pretty good year for the Seventh District. Real District gross state product (GSP) grew 1.2%, the unemployment rate fell from 7.3% to 5.8%, and payroll employment grew 1.5%. The strong finish to 2014 led me to feel quite optimistic for how 2015 would turn out. Unfortunately, it has become increasingly clear that economic activity in the Seventh District has steadily slowed as 2015 has progressed. While the District is certainly not in recession, it is now likely growing at a below-trend pace. In this blog post, I provide evidence of the slowdown and explore how the fortunes of District states’ signature industries have both contributed to and helped mitigate the slowdown.

While we wait for the GSP data for 2015 to be released (due out in June), arguably the best overall indicator we have for 2015 District economic activity is our Midwest Economy Index [1] (I should note here that we will be releasing a new survey-based activity index later this month). Figure 1 shows values for the MEI from 2014 to the present. The index was well above zero throughout 2014, indicating that growth was consistently above trend. Just as 2015 began, the index began to decline, and it entered negative territory in June. The most recent reading of the MEI (for November 2015) indicates that District growth is somewhat below trend.

1-MEI

Some important indicators included in the calculation of the MEI are payroll employment, the regional Purchasing Manager Indexes (PMIs) [2], and per capita personal income. Not surprisingly, they also largely suggest that economic activity in the District slowed in 2015. Figure 2 shows that while District payroll employment grew by an average of 23,000 jobs per month in 2014, the pace of growth slowed to only about 12,000 new jobs per month in 2015. Figure 3 shows the simple average of the five PMIs available for the Seventh District. This average also indicates that economic activity declined notably starting in 2015. As a counterpoint, figure 4 shows that the pace of growth in real personal income per capita has not slowed much in 2015: The annualized growth rate for 2014 was 3.08% and the available data for 2015 (through Q3) indicate that the annualized growth rate has only slowed to 2.94%.

2&3-Emp&PMIs

4-RIPC

While the preponderance of evidence suggests that Seventh District economic activity slowed in 2015, it turns out that the experiences of individual states within the District have been quite different. Figure 5 shows the sum of the contributions to the MEI for the eastern states of the District (Indiana and Michigan) and the sum for the western states of the District (Illinois, Iowa, and Wisconsin). Growth in 2014 was above the District’s long run trend in both sub-regions, but the western states outperformed the eastern states. The pace of activity in the eastern states picked up steadily through the first half of 2015 and has since slowed to near the District’s trend. This experience contrasts quite notably with that of the western states. Activity in these states began to slow at the end of 2014 and continued to slow until the middle of 2015, at which point conditions improved some.

5-WEMEIs

One approach to understanding the different experiences of eastern and western District states is to do an economic base analysis for each state. Such an analysis identifies the industries whose employment is especially concentrated in a state (and therefore likely quite important for the state’s economy) by calculating a location quotient (LQ). A location quotient is the ratio of the share of employment in an industry in a state to the share of employment in an industry in the U.S. as a whole:

Formula

As an example, if the machinery industry’s share of employment in Michigan is 1.3% and the machinery industry’s share of employment in the U.S. is 1%, then the location quotient is 1.3, and we say that the machinery industry is 30% more concentrated in Michigan than in the U.S. as a whole.

For this blog post, I calculate location quotients for each state for each of the 3-digit NAICS industries that are available from the Bureau of Labor Statistics’ (BLS) payroll employment survey.[3] I then consider the industries in each state with a location quotient greater than 1.5. This approach successfully identifies the signature industries one typically thinks of for each state in the District. For example, the analysis picks up Michigan’s auto industry, Indiana’s steel industry, and Illinois’s, Iowa’s, and Wisconsin’s machinery industry.

Table 1 shows the high-location quotient industries for Indiana and Michigan, along with the percentage of overall employment the industry represents and the year-over-year employment growth rate of the industry from November 2014 to November 2015. With the exception of the primary metals industry (where employment fell by 0.93%), employment grew for all of Indiana’s high-LQ industries and was solid for most of them. The story is even clearer in Michigan, where the auto industry dominates. Employment in the transportation equipment industry grew 4.59% over the past year.

To summarize the overall growth of District states’ flagship industries, I calculate the average growth rate for the industries, weighted by their relative size. Employment in Indiana’s flagship industries grew 1.35% over the past year, while employment in Michigan’s flagship industries grew 3.38%. Thus, even though the pace of growth in economic activity slowed in Indiana and Michigan in the second half of 2015, it was still a good year for both states.

6-Table 1

The story is more mixed for the states in the western part of the District (table 2). Machinery (and the fabricated metal producers who support them) has not faired well in the past year: Illinois, Iowa, and Wisconsin all saw notable declines in machinery and fabricated metal employment (with the exception of Wisconsin’s machinery employment, which was flat). However, Iowa and Wisconsin were helped by strong growth in other flagship industries (food products in both Iowa and Wisconsin and finance in Iowa). Illinois has few other flagship industries to help it, though it’s worth noting that Chicago has fared much better than downstate Illinois because of its concentration in business services and finance. Average employment growth for Illinois’s high-LQ industries was dismal (-2.04%), while growth was solid for Iowa’s (1.58%), and slow for Wisconsin’s (0.73%). Thus, although some flagship industries have done well in the western states in the District, the struggles of the machinery industry appear to have put quite a damper on their economic performance.

7-Table 2

So we see that the overall slowdown in the District in 2015 was not a shared experience across District states. The eastern states (Michigan and Indiana) did notably better than the western states (Illinois, Iowa, and Wisconsin) and these differences are relatively consistent with the performance of states’ flagship industries. What does the future hold for these flagship industries? At the moment, it’s hard to find much evidence that there will be a significant reversal of fortunes in 2016. The auto industry is likely to continue to benefit from steady growth in the U.S. economy and low gasoline prices, while the machinery industry is likely to continue to suffer from weaker global growth and depressed commodities prices (which hurt demand for both mining and agriculture machinery).

That said, while flagship industries certainly play an important role in a state’s economy because of all the related industries that support them, there are still many industries that are not closely related to them. For example, Iowa’s contribution to the MEI has been negative for most of 2015 (not shown), likely because of the struggles in the farming industry (see the Chicago Fed’s latest AgLetter for more details). The converging trends in the MEI (figure 5) suggest that these other factors are also making their presence known.

[1] The MEI is a weighted average of 129 Seventh District state and regional indicators measuring growth in nonfarm business activity from four broad sectors of the Midwest economy: manufacturing, construction and mining, services, and consumer spending.

[2] The PMIs included in the index are for Chicago, Iowa, Detroit, and Milwaukee.

[3] Data are not available for all 3-digit NAICS industries because there is not sufficient employment in some industries in some states for the BLS to be able to cover them accurately.



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