Preview of the upcoming Summit on Inner City Economic Development in Detroit

In a recent blog, I shared my observations about Pittsburgh’s efforts to revitalize its urban core. Then, I analyzed the extent to which Pittsburgh’s turnaround can serve as a model for Detroit as its city leaders and stakeholders look to revitalize the city’s urban core. While Detroit has begun to replicate the efforts of other cities, such as showcasing the city’s riverfront with the Detroit RiverWalk and collaborating with regional leaders and stakeholders, overall its efforts lag those of other Rust Belt cities. The relatively sluggish pace of Detroit’s efforts to revitalize its urban core are also reflected in the slow development of the city’s business clusters, including new business formation. Meanwhile, other parts of the Rust Belt have advanced the development of their respective business clusters, such as West Michigan’s office and institutional furniture cluster and Pittsburgh’s advanced materials and energy clusters.1

Policy professionals, researchers, and other experts will gather in Detroit for a two-day summit–“Revisiting the Promise and Problems of Inner City Economic Development,”—at the Renaissance Center on September 15th and the Federal Reserve Bank of Chicago—Detroit Branch on September 16th. The summit will look at new research and best practices in the field of urban revitalization. It is sponsored by the W.E. Upjohn Institute for Employment Research, the Initiative for a Competitive Inner City (ICIC), the Federal Reserve Bank of Chicago, Economic Development Quarterly, and Sage Publications. For those interested in attending, there is no registration fee but advance registration is required here.

Day 1 will focus on what’s currently happening in Detroit, with an introduction by the Chicago Fed’s Regional Research staff and a bus tour of Detroit provided by the Chicago Fed’s Community Development & Policy Studies group. The tour will highlight some of Detroit’s successes and challenges in its effort to revitalize its urban core and how the three levers of growth—business environment, clusters, and individual firms—are promoting and complementing the efforts of Eastern Market and Midtown Detroit. Eastern Market’s food cluster is expanding in part because of greater economic growth within the city of Detroit. Part of that growth is originating from the development of an innovation district along Detroit’s major boulevard, Woodward Avenue, which is helping to draw young entrepreneurs to work and live in Midtown Detroit. In addition, the tour will illuminate some of what Detroit must still overcome on the path to renewal. The first day ends with a presentation by Detroit Free Press writer John Gallagher, who will share his thoughts about the city.

The second day of the summit will feature two keynote addresses. ICIC Founder and Chairman Michael Porter will look back on his research of clusters and their competitive advantages in inner cities. Later on, Matthew Cullen, President and CEO, Rock Ventures LLC, will provide insight into how his firm has helped contribute to Detroit’s recent surge in economic development. Other featured speakers include Carol O’Cleireacain, Deputy Mayor for Economic Policy, Planning, and Strategy, City of Detroit. Sessions on the second day will examine new thinking on the competitiveness of inner cities and opportunities for business in the inner city.

Seventh District Update, July 2015

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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 was moderate in late May and June, with the pace of advance appearing to be a bit slower than during the previous reporting period.
  • Consumer spending: Growth in consumer spending continued at a moderate pace. Non-auto retail sales slowed in late May but strengthened in June. Auto sales strengthened further, leading dealers to revise up their expectations for 2015.
  • Business Spending: Growth in business spending remained moderate. Overall, inventory levels were comfortable, though steel service center inventories remained elevated. Both the pace of capital spending and hiring was little changed.
  • Construction and Real Estate: Demand for residential construction was steady. Home sales, home prices, and residential rents all increased modestly. Nonresidential construction activity also increased modestly, while commercial real estate activity increased moderately.
  • Manufacturing: Growth was again moderate, as the auto industry continued its strong advance. Capacity utilization in the steel industry picked up some, but remained low. Sales of heavy trucks grew steadily, while sales of heavy machinery remained weaker.
  • Banking and finance: Credit conditions were little changed. Financial market volatility was slightly higher, while credit spreads declined marginally. Business and consumer loan demand both were little changed on balance.
  • Prices and Costs: Cost pressures were subdued. Energy prices remained low, as did prices of steel and other primary metals. Most retail prices changed little and wages pressures remained modest.
  • Agriculture: Widespread rains damaged crops and restricted fieldwork. Corn, soybean, and wheat prices rose as yield expectations declined. Both higher feed costs and lower prices for hogs, milk, and cattle hurt livestock producers’ margins. Egg prices remained elevated, as bird flu continued to hurt production.

Led by a slight decrease in service sector growth, the Midwest Economy Index (MEI) moved down to +0.17 in May from +0.28 in April. The relative MEI fell to +0.55 in May from +0.86 in April. May’s value for the relative MEI indicates that Midwest economic growth was somewhat higher than would typically be suggested by the growth rate of the national economy.

Seventh District Update, June 2015

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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 remained moderate in April and early May, and contacts expected growth to continue at a similar pace over the next six to twelve months.
  • Consumer spending: Growth in consumer spending was moderate. Non-auto retail sales were steady, while auto sales continued their strong pace.
  • Business Spending: Growth in business spending remained moderate. Overall, inventory levels were comfortable, though steel service center inventories remained elevated. Both the pace of capital spending and hiring picked up some.
  • Construction and Real Estate: Demand for residential construction ticked up. Home prices and residential rents were up slightly. Nonresidential construction activity was somewhat higher, while commercial real estate activity grew at a strong pace.
  • Manufacturing: Growth was again moderate. The auto and aerospace industries remained a source of strength and capacity utilization in the steel industry increased some. Sales of heavy machinery and heavy trucks again grew slowly.
  • Banking and finance: Credit conditions continued to improve. Financial market volatility remained low and credit spreads declined slightly. Business loan demand ticked up, but consumer loan demand flattened with the exception of mortgage originations.
  • Prices and Costs: Cost pressures were little changed overall. Energy and metals prices were up slightly, but remained low. Retail prices were little changed and wage pressures increased slightly.
  • Agriculture: Corn and soybean planting proceeded rapidly, exceeding the pace of last spring. Higher output pushed down milk prices further, hog prices increased some, and cattle prices remained high. Poultry flocks were hit hard by bird flu, raising egg prices.

The Midwest Economy Index (MEI) ticked down to +0.29 in April from +0.33 in March. The relative MEI edged up to +0.95 in April from +0.90 in March. April’s value for the relative MEI indicates that Midwest economic growth was moderately higher than would typically be suggested by the growth rate of the national economy.

“Early Benchmarking” the State Payroll Employment Survey

One of the most important sources of information we have on current economic conditions is the Bureau of Labor Statistics’ (BLS) Current Employment Statistics (CES) program (also known as the payroll survey). The payroll survey reports monthly estimates of nonfarm payroll employment, hours, and earnings at the national, state, and metro area levels. Because the CES covers only a representative sample of employers, the BLS is able to release the results of the survey in a timely manner (typically three weeks after the reference month at the U.S. level, eight weeks after at the state level, and ten weeks after at the metro area level). At the same time, relying on a survey—instead of a census—means the results are subject to sampling error. The BLS does revise the CES estimates to address sampling error. With each new monthly release, it adjusts the two previous months’ estimates; and once a year in March, it revises the two previous calendar years at the U.S. level and the five previous calendar years at the state and metro area levels.1 In this blog post, I discuss a method pioneered by researchers at the Dallas Fed to predict the once-a-year revisions at the state level as many as nine months in advance. These predictions can provide valuable information, because state-level revisions can be substantial.

For their state CES estimates, the BLS relies primarily (but not entirely) on a sample of about one-third of the universe of employers that participate in states’ unemployment insurance (UI) programs. The information on employment and earnings from all employers participating in UI is eventually reported under the BLS’s Quarterly Survey of Employment and Wages (QCEW) program, with a delay of six months from the reference period. As noted above, in March of each year, the BLS revises state-level CES data for the prior five calendar years, using the previously unavailable QCEW data as a benchmark.2 It is important to note here that QCEW is only a benchmark (not the final answer), because the CES and the QCEW do not cover the same universe of workers. The CES does not count farm workers, but it does count the 3 percent of nonfarm workers who do not receive unemployment insurance. The QCEW only counts workers with unemployment insurance, which includes some farm workers. Because their universes are not exactly the same, the CES and QCEW have different levels. However, they overlap enough that their trends are about the same.

While the BLS rebenchmarks the payroll survey data once a year, the QCEW data are released four times a year (three months at a time). And because the payroll survey uses the QCEW as its benchmark, it is possible to use newly released QCEW data to predict how the BLS will eventually revise the CES data. For example, table 1 shows when the new QCEW data used for the March 2015 rebenchmark became available. Data for the fourth quarter of 2013 were available nine months before they were used to benchmark the CES. And by December 2014, it was possible to have a good idea of how the CES would be revised through the second quarter of 2014, even though the BLS had only revised the CES through the third quarter of 2013.

In what follows, I explain a method for “early benchmarking” the state payroll survey data pioneered by researchers at the Dallas Fed (explained by them here). I then look at how the method performed at predicting the March 2015 revisions for the five states in our Seventh Federal Reserve District.

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The method begins with the last month of CES data that are benchmarked to the QCEW. From then on, monthly changes are calculated using growth rates from the (seasonally adjusted) QCEW, not the CES. Once the QCEW data run out, monthly changes are again calculated using the CES. In essence, the method amounts to substituting in growth rates from the QCEW data that are newly available but have not yet been used to benchmark the CES.

Figure 1 shows the early benchmarking method visually for the Seventh District states using the data available in December 2014.3 The blue line is the CES, where the dashed portion of the line represents months that have not been benchmarked by the QCEW. The green line is the QCEW; and it is clear that while the CES and the QCEW have different levels, their trends are quite similar. The red line is the early benchmarked version of the CES. The solid portion of the red line is the path generated by monthly growth rates from the QCEW, and the dashed portion of the red line is the path generated by monthly growth rates in the remaining CES data.

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How did the early benchmarking procedure do at predicting the March 2015 CES rebenchmark? Figure 2 shows the revised payroll survey data from March 2015 in black. The QCEW-benchmarked data now go through the third quarter of 2014. Overall, the early benchmarked CES series appears to predict the most recent rebenchmarking of the CES better than the March 2014 rebenchmarked CES series does. This is especially true before the QCEW data run out in June 2014.

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One way to measure the accuracy of a forecast is to calculate its root mean squared error. Table 2 shows the root mean squared error for predictions of the March 2015 rebenchmarked CES using the March 2014 rebenchmarked CES and the early benchmarked CES. The early benchmarked CES performs as well or better at both the District and state levels. At the District level, the early benchmarked CES is typically about 31,000 jobs off, while the March 2014 rebenchmarked CES prediction is typically about 51,000 jobs off. In the case of Michigan, the early benchmarked CES performed substantially better. Figures 3 through 7 show the state-level comparison. Taken as a whole, these results demonstrate that early benchmarking the CES provided a tangible improvement in measuring growth in the Seventh District over the last year or so.

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  1. For example, in March 2015, the BLS revised data for 2013–14 at the U.S. level and 2009–14 at the state and metro-area levels.
  2. While the new QCEW data only cover the previous year, the revisions go back five years because the BLS also recalculates its seasonal adjustment factors.
  3. I calculate the early benchmark series for the Seventh District by summing the early benchmark series for the District states.

Making Value for America: A study by the National Academy of Engineering

Production technology and the nature of work are changing rapidly, giving rise to job declines in the manufacturing sector. In this context, can the U.S. design policies that support manufacturing while providing greater opportunity for U.S. workers? This was the question asked of a study panel at the National Academy of Engineering, which produced “Making Value for America: Embracing the Future of Manufacturing, Technology and Work.”

On May 4, Nick Donofrio, who chaired the study committee, joined a panel of experts at the Federal Reserve Bank of Chicago to present the findings and implications from the report. Donofrio was the Executive Vice President for Technology at IBM and a member of the National Academy. Joining him were panelists Dan Swinney (Manufacturing Renaissance and study committee member), Chad Syverson (University of Chicago Booth School of Business and study commission member), Haven Allen (World Business Chicago) and Craig Freedman (Freedman Seating).

Setting the stage for the program was Bill Testa, Vice President and Director of Regional Programs at the Chicago Fed. Testa focused on the key role of manufacturing in the Midwest economy. Within the Midwest region, the manufacturing job base remains 53% more concentrated than in the U.S. as a whole. However, dramatic declines in manufacturing jobs have led many policymakers to pursue other economic development targets. Since 1969, when manufacturing accounted for roughly 40% of the regional job base, manufacturing employment has fallen to 13.5%. Testa noted that from 2000 through the recession of 2009, manufacturing jobs in the Seventh District states of Illinois, Indiana, Michigan, Wisconsin, and Iowa dropped by 35% or 1.16 million; and only 224,000 or 21% of those jobs have returned during the recovery to date.

Testa commented that some of this trend can be traced to technology and productivity. What took 1,000 workers to make in 1950 can be done by 200 today. Moreover, increasingly workers in manufacturing jobs are upskilling and are required to have the ability to work with advanced technology—and to do so at pay scales set by global competition. Despite the many challenges, Testa argued that the Midwest still holds some advantages for manufacturers, such as a strong supply chain and the infrastructure to move goods efficiently. Recreating the region’s network of rail, road, air hubs, and ports would be difficult elsewhere. Second, manufacturing directly comprises 20% of the region’s overall output, but more importantly is responsible for almost two-thirds of the research and development in the region. Additionally, the region’s universities are well positioned to create innovation in engineering and technical fields that can lead to new products and processes.

Donofrio presented the findings from Making Value for America. Donofrio emphasized that this was not a typical manufacturing study. He suggested that in some ways manufacturing is a 20th century word and that what matters today is not simply making things but adding value through production. Understanding where value is added is critical; and in many cases, value comes from services related to the final product. Specifically, he defined adding value as the process of using ingenuity to convert resources into a service or process that contributes additional value to a person or a society. In particular, the study was interested in how the nature of work is changing. Donofrio quoted former MIT president Charles Vest who said, “Far too much of our nation is waiting for new ways of work to arrive. We hear lots of rhetoric about how the nature of work will change, as it relates to some unknown distant future. The fact is that it is happening now, and we need a broader recognition of this fact and policies and education that reflects it.”

Donofrio noted that U.S. employment in manufacturing will never regain its historical levels, but growth will be facilitated by policy that focuses on adding value and innovation. Recommendations from the study focused on three areas—education, collaboration, and being inclusive. A goal is to develop a robust innovation ecosystem that includes business; federal, state, and local governments; economic development organizations; educational institutions; and research organizations. A partial list of recommendations appears in Table 1; the complete list is available at http://www.nap.edu/catalog/19483/making-value-for-america-embracing-the-future-of-manufacturing-technology.

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Chad Syverson kicked off the panel discussion by talking about the university’s role in supporting education at the pre K to 12th grade level. He noted that the University of Chicago has been active in urban education, ranging from the creation of charter schools to the creation of the Urban Education Lab. All of these efforts use rigorous social science evaluation to develop best practices for education.

Additionally, the university works directly to support entrepreneurship through the Polsky Center, which serves as a resource for supporting business formation. Syverson noted that the U.S. has had a 30-year downward trend in new business formation and that the dynamics behind this are not well understood. However, it is though business formation that significant innovation occurs, so the trend is disturbing, he said. Complementary services are provided by the Booth School of Business working with the Chicago Innovation Exchange, the 1871 tech incubator, and directly with businesses to disseminate best practices. Syverson noted that large amounts of value are left on the table when firms fail to keep up with best practices and that significant gains for the U.S. economy can be provided by better educating firms.

Haven Allen described the multitude of programs that can be found in Chicago that create manufacturing networks. These include national efforts such as the Digital Manufacturing and Design Innovation Institute (DMDII) and its related Illinois Manufacturing Labs. A clear goal is to connect local firms to this national network of innovative firms. This requires broad partnerships that include businesses, local community groups, and education. Allen stressed that training is key and that recent apprenticeship programs offered by organizations such as the Jane Addams Resource Center, the University of Illinois-Chicago, and Daley College provide models for supporting work force development. Finally, Allen emphasized that successful partnerships will focus on improvements in people, process, and product.

Craig Freedman offered the perspective of a manufacturer. Freedman suggested that the pace of change means that businesses and their workers need to get smarter at all levels. Business needs to link with education in order to make sure that relevant skills are learned at all grade levels. For example, Freedman cited the Manufacturing Connect program at Austin Polytech as a model that deserves replication. The school is located in the Austin community on the west side of Chicago. The program teaches high school students metal-working skills and provides them with certified credentials upon graduation. Local businesses partner with the school and provide apprenticeships and job shadowing opportunities.

Freedman also praised local training organizations such as the Jane Addams Resource Center, Daley College, and the 1000 Jobs Campaign as helping support critical work force development. Finally, Freedman suggested that more work needs to be done to promote the image of manufacturing as a good career path. Current perceptions of manufacturing are based on outdated notions of the industry that need correcting if young people will be attracted to these jobs.

Concluding the discussion was Dan Swinney. He noted that social inclusion should be a goal of the new emphasis of manufacturing rebirth in cities. He also cited the efforts of the Manufacturing Renaissance and the Manufacturing Connect program in the Austin Community in Chicago. Swinney stressed the importance of bringing these types of programs to areas that have suffered disinvestment. The challenges communities like Austin face are clear in the data. While unemployment in Chicago has fallen to 6.4%, in Austin it hovers near 30%. Similarly, manufacturing job loss in Austin is near 90%. However, to address the challenges faced by communities like Austin, Swinney argued, programs like Manufacturing Connect must be scaled up, since they currently only reach a small subset of students.

2015 Civic Research Forum: Finding New Approaches to Analyzing Urban Data

In partnership with World Business Chicago, the Federal Reserve Bank of Chicago hosted the Civic Research Forum on March 17, 2015. The forum was attended by researchers from a wide range of organizations and agencies throughout Chicago. It offered attendees an opportunity to discuss their current research and their positive and negative experiences with collecting and using data. Rob Paral of Rob Paral and Associates addressed the gathering, discussing his research on demographic trends in Chicago. Moreover, he described his research challenges given the  lack of some key historical data series, as well as the structure of available data sets and surveys. He also encouraged the audience to brainstorm innovative ways of using the accessible data.

Paral explained that his firm helps strengthen relationships between organizations and the broader communities they serve by providing data on the city’s social and economic conditions. He also shared that his firm gathers information on residents’ activities and attitudes. In his presentation, Paral focused on the income data he uses to study demographic trends in Chicago. While socioeconomic and demographic U.S. Census data are available for the 77 Chicago community areas (see map below) dating back to 1930, the data necessary to calculate median household income only go back to 1970. The limitations of these historical data hinder the potential to analyze income developments in Chicago over time (both at the neighborhood level and across demographics).

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According to Paral, constructing income data for Chicago became even more difficult when the U.S. Census Bureau’s geographic grid, which includes the boundaries of blocks, tracts, and Public Use Microdata Areas (PUMAs) changed for the 2010 U.S. Census. The boundaries for these geographic units were redesigned in such a way that researchers could no longer aggregate PUMAs to match Chicago’s geography. Furthermore, beginning with the 2009–13 American Community Survey, it was no longer possible to select the Chicago-portions of census tracts for the few tracts that cover areas both inside and outside of the city limits, like it had been in previous versions. This change made it impossible to construct precise data for some individual community areas by combining data on the component census tracts.

Paral went on to discuss some of the questions related to income trends in Chicago that he is currently probing. He said his research focuses largely on the period between 1990 and 2010. Over this span, Illinois’s household income increased and then fell rapidly—a trend that was seen nationwide, though not to the degree it was within the state. According to Paral, the average household in Chicago earned 10% less income in 2010 than in 2000. Moreover, while nine out of every ten community areas had less income in 2010 than they did in 2000, some lost much more income than others. For instance, average household income declined by as much as 45% in some community areas, while other areas have seen an increase in income.

Looking at income trends of individual neighborhoods over time reveals interesting patterns about how wealth and poverty shift and consolidate geographically, Paral explained. In 1990, the wealthiest community areas were located in the far Northwest Side, the far Southwest Side, and the downtown and near-north areas. So, Chicago’s wealthiest neighborhoods were fairly dispersed back then. However, wealth became more geographically concentrated over time. In 2000, Chicago’s wealthiest areas were near the North Side and along the lakefront. And in 2008–12, this remained the case. In 1990, the poorest areas were largely consolidated in an area just west and south of the Loop (Chicago’s central business district). But over time, the poor moved farther away from the city center. In 2000, Chicago’s areas of greatest poverty were on the West and South Sides. And in 2008–12, this was still the case. The greatest income losses between 2000 and 2008–12 occurred on the far South Side, while the greatest income gains over that period happened in the “inner ring” areas near downtown (primarily just west and south of the Loop).

Paral said that while median income is the principal indicator he uses to analyze many trends, he also takes advantage of other measures of wealth provided by the U.S. Census Bureau—such as average and total household income—to get more robust views of wealth patterns and distribution across Chicago. Paral explained that by taking the ratio of average income to median income, he is able to assess the extent to which income distribution is skewed in an area—that is, how great the disparities are between the wealthiest and poorest residents in a given neighborhood. For example, a very high ratio of average income to median income suggests that there are some very wealthy residents pulling up the average (even if a majority of that neighborhood’s residents are poor).

As Paral shared, using innovative ways of combining available data, such as this method of studying the ratio of average to median income, has allowed him to examine potential weaknesses in current policies that are based on more-conventional income data and analysis. For example, he questioned the use of census tracts to determine how children are placed into public Selective Enrollment High Schools within Chicago. The current policy assigns each census tract to a socioeconomic tier, where 1 is the poorest and 4 is the wealthiest. The policy is designed to give children of poorer tiers a better opportunity of enrolling in a strong public school. However, some very poor children live in the same tract as very wealthy children. This means the average income is skewed up by these wealthy families, decreasing the chances the poor children have of being accepted into a strong public high school. Paral mentioned several census tracts where this pattern is especially problematic, such as those where there are large public housing buildings nearby very wealthy homes. In such tracts, the gap in median income between one (poor) subsection and another (rich) one can be over $100,000. Yet, because both poor and wealthy households are located in the same census tract, their children have an equal likelihood of entering the city’s best public schools.

The forum ended with the attendees sharing the research they are working on, the data they use, and any challenges they are facing. This portion of the program gave researchers the opportunity to learn of new data sources and approaches to analysis and to meet others in the Chicago research community. The forum sponsors hoped that innovation and collaboration among the attendees would eventually yield more-productive research in the coming years.

Seventh District Update, April 2015

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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 remained moderate in March, and contacts expected growth to continue at a similar pace over the next six to twelve months.
  • Consumer spending: Growth in consumer spending remained moderate. Non-auto retail sales increased modestly, while auto sales increased substantially.
  • Business Spending: Overall, inventory levels were comfortable, though steel service center inventories were exceptionally high. The pace of capital spending picked up some and employment grew moderately.
  • Construction and Real Estate: Demand for residential construction grew slightly. Home prices increased, residential rents held steady, and housing inventories remained near historic lows. Nonresidential construction activity ticked up and commercial real estate activity increased modestly.
  • Manufacturing: Growth was again moderate. The auto and aerospace industries remained a source of strength and most specialty metals manufacturers reported solid order books. However, capacity utilization in the steel industry decreased, and sales of heavy machinery and heavy trucks grew slowly.
  • Banking and finance: Credit conditions improved some. Financial market volatility stabilized and credit spreads declined slightly. Business and consumer loan demand both continued to grow.
  • Prices and Costs: Cost pressures were little changed overall. Energy prices were up slightly, but remained low. Metals prices declined. Retail prices were little changed. Wage pressures increased slightly, while non-wage pressures declined slightly.
  • Agriculture: High stocks of corn and soybeans and slower export growth put downward pressure on most crop prices. Higher output pushed down milk prices, hog prices fell because so many were brought to market, and cattle prices were up as herds are being rebuilt.

The Midwest Economy Index (MEI) was unchanged at +0.49 in February. The relative MEI rose to +0.45 in February from +0.36 in January. February’s value for the relative MEI indicates that Midwest economic growth was somewhat higher than would typically be suggested by the growth rate of the national economy.

Illinois Fiscal Outlook – A Workshop Takeaway

Just how bleak is the long-term fiscal forecast for Illinois? And what are the possible solutions, if any, to the state’s financial troubles? These were among the challenging questions raised at the Illinois Fiscal Outlook Breakfast, held by the Federal Reserve Bank of Chicago and the Institute of Government and Public Affairs (IGPA) on February 27, 2015.

The event was attended by about 75 people from various companies, government offices, and universities across Illinois. Richard Dye, Co-Director of the Fiscal Future Project (FFP) within IGPA, was the primary speaker. He presented IGPA’s latest report, “Apocalypse Now? The Consequences of Pay-Later Budgeting in Illinois: Updated Projections from IGPA’s Fiscal Futures Model,” released in January. Dye was joined by panelists Woods Bowman, Professor Emeritus at DePaul University, Laurence Msall, President of the Civic Federation, and Senator Daniel Biss of Illinois’s 9th Legislative District.

The primary goal of the FFP study is to assess total state spending using a model that investigates the long-run fiscal troubles and consequences of potential state choices. The model allows analysis of a longer term than previous studies have examined, projecting out through 2026. The study expands on previous research that has focused on general spending by assessing the state’s All Funds Budget. Moving funds around within fiscal years or transferring assignments across years can lead to variations in General Funds measurements. These distortions are eliminated using the more-encompassing All Funds Budget evaluation.

The Fiscal Futures Model focuses on the Structural Budget Gap, calculated as the difference between Total Sustainable Revenue (which excludes new borrowing, decreased fund balances, and other one-time sources) and Total Spending. Overall, the study presents a grim outlook for Illinois’s fiscal future. Dye and his colleagues found that the state has run a cash deficit consistently since 2001, contributing to a large and growing structural deficit. They predict that this deficit will remain at about $9 billion for fiscal years 2016 to 2022, reaching $14 billion by 2024 if existing laws and spending trends continue (see figure below). Given that the state’s projected total spending is $74 billion for fiscal year 2016, drastic cuts would have to be made in order to address the deficit. Furthermore, not all spending can be cut due in part to contractual obligations and because cutting other spending would increase unfunded liabilities or decrease revenue from federal matching, which means the possible solutions are limited.

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The primary culprit in this large deficit, according to the FFP, is “pay-later budgeting,” which they define as “Illinois’s persistent practice of spending more than the inflow of taxes and other sustainable revenue can recover.” This essentially means borrowing based on IOUs or other liabilities in order to pay off the current deficit, thereby crowding out other spending. The largest contributors to these accumulated IOUs are unfunded pension liabilities, making up $106.5 billion of the $159 billion total sum. While there is a schedule to pay back some of these IOUs, others, including unfunded retiree health cost liabilities and unpaid bills, have no defined pay-back schedule. This will likely result in more crowding out of spending in the future. Adding to the state’s troubles is the fact that the temporary income tax increase implemented in 2011 expired on January 1, 2015. Spending, however, was not cut to sustainable levels in order to compensate for the reduced income tax revenue. The FFP predicts that Illinois tax revenue will drop $2 billion in fiscal year 2015, and $4 billion in fiscal year 2016, clearly exacerbating the state’s fiscal woes.

The study concludes that eliminating the $9 billion deficit will require either devastating cuts in discretionary spending, a 25% increase in state-controlled revenues, twice what would come from postponing the income tax rate cuts (see figure below), or some unpleasant combination of tax increases and cuts in spending.

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Bowman followed up by highlighting three financial problems that cast a long shadow over Illinois’s fiscal troubles. The first, as previously emphasized by Dye, is the need for sustainable long-term pension funding. The second is legacy costs, which are the obligations to pay for services the state purchased in previous years. Finally, a new Governor and the potential for conflict between a Republican Governor and Democratic state legislature raise new uncertainty regarding feasible political options. Bowman suggested the state might consider a value-added tax, essentially a broad-based consumption tax, that could be relatively elastic with respect to income and act as a sustainable partial solution over time. He concluded with a proposal of placing a surcharge on certain fees, such as fees for license plates, as another temporary revenue enhancement.

Msall highlighted the bad trend by Illinois of failing to tie temporary revenues to temporary spending limits and the long-term harm this can have on the state’s deficit. The Civic Federation designed a Roadmap to lay out parameters of the state’s problems and potential solutions. However, given Governor Rauner’s budget and the drop in income tax revenue that set in on January 1, the goals laid out in the Roadmap, including fixing the fiscal cliff for fiscal year 2015 and controlling state spending, will not be reachable.

Msall suggested several possible strategies to reduce the state’s deficit, including retroactively postponing the completion of the income tax rollback. Specifically, the Civic Federation proposes retroactively increasing the income tax rate to 4.25% and 6.0% for individuals and corporations, respectively, as of January 1, 2015. The Roadmap then advises that Illinois roll back the rates to 4.0% and 5.6% for individuals and corporations, respectively, on January 1, 2018. Msall noted that of the 41 states that collect an income tax, only three, including Illinois, do not tax pension income. The Civic Federation sees this as a lost opportunity for additional state revenue and proposes implementing a tax on non-Social Security retirement income for individuals with over $50,000 in total income. The Civic Federation’s plan also supports eliminating the sales tax exemption for food and non-prescription drugs through fiscal year 2019 in order chip away at the deficit. To reduce the impact on low-income individuals, the Roadmap proposes expanding the earned income tax credit, from 10% of the federal credit to 15% by fiscal year 2018.

The widespread problems the state is facing spill over to affect local governments, including Chicago, Msall explained. Based on the current trend, the city may soon be forced to choose between not funding contributions, thereby violating pension laws, or increasing taxes, which would adversely affect the city’s appeal as a place to live. Given the city’s recent credit rating downgrade by Moody’s from Baa1 to Baa2, the choices ahead will be difficult.

State Senator Biss outlined the historical series of irresponsible fiscal decisions and policy actions that have dragged Illinois into its current fiscal deficit. He also highlighted an absence of meaningful spending cuts in Governor Rauner’s budget that would be necessary to compensate for the reduced revenue. Biss described a common problematic habit in electoral politics of searching for large overall fixes to problems the state faces in order to give the outward appearance of progress. This often results in attempts to reform the internal structure of the government in an effort to weed out waste and fraud, which often don’t actually contribute to the financial troubles as much as politicians proclaim. What Illinois needs instead, he said, is to find ways of creating more revenue or cutting actual expenditures.

The undetermined status of Senate Bill 0001, sponsored by Biss, among others, contributes to the current uncertainty about Illinois’s fiscal future. This Bill’s purpose is to implement pension reform that will create substantial budgetary savings and help Illinois make actuarially required payments that are in line with national actuarial standards. However, because the bill is currently under review by the Illinois Supreme Court, the actions available to the state government are unclear. Biss concluded that the only way to dig Illinois out of its deficit is to implement many small to medium changes across society, not necessarily evenly distributed, but carefully prioritized to have the most widespread and effective impact.  For example, Biss said a comprehensive pension reform package is imperative to maintaining the state’s ability to fund key areas of state government. He cautioned that portions of Governor Rauner’s budget unfairly target poor, working-class families by reducing funding to programs that benefit them, including Medicaid, foster care, and community colleges. Regardless of the actions the state does decide to take, the path forward will not be pleasant, he warned. But by committing to a “shared sacrifice” strategy of distributing cuts across the board, Illinois will hopefully be able to make steady progress out of the current fiscal trap.

Seventh District Update, March 2015

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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 remained moderate in January and early February, and contacts expected growth to continue at a similar pace over the next six to twelve months.
  • Consumer spending: Growth in consumer spending remained moderate. Lower energy prices benefitted retail sales, though not as much as some were hoping. The pace of new light vehicle sales held steady, while sales of used vehicles increased.
  • Business Spending: Overall, inventory levels were comfortable, but delays at west coast ports led some manufacturers to increase inventories as a precaution. Both the pace of capital spending and the pace of hiring slowed somewhat, though spending and hiring plans grew steadily.
  • Construction and Real Estate: Demand for residential construction was little changed. Home prices and residential rents both increased, while home sales held steady. Nonresidential construction and commercial real estate activity increased moderately.
  • Manufacturing: Growth was again moderate. The auto industry remained a source of strength. Steel demand grew steadily, and demand for heavy machinery and heavy trucks both picked up.
  • Banking and finance: Credit conditions improved on balance. Equity markets moved higher and volatility declined. Business and consumer loan demand both increased.
  • Prices and Costs: Cost pressures were little changed overall. Delays at west coast ports led some contacts to use higher cost supply routes. Wage and non-wage costs changed little on balance.
  • Agriculture: Corn, soybean, wheat, hog, cattle, and milk prices were all lower. Input costs for spring planting remained elevated, leading some to purchase lower quality seeds to reduce costs. Some marginal ground will be used as pasture or for hay production instead.

Led by continued strength in the manufacturing sector, the Midwest Economy Index (MEI) increased to +0.67 in December from +0.43 in November. However, the relative MEI fell to +0.21 in December from +0.70 in November. December’s value for the relative MEI indicates that Midwest economic growth was somewhat higher than would typically be suggested by the growth rate of the national economy.

2014 in Review: Strength in Manufacturing Led to Solid Growth in the Seventh District

With much of the regional economic data for 2014 now available, it is a good time to look at how the Seventh District[1] economy performed last year. While the District had a slow start to the year because of the harsh winter weather, it recovered well in the spring, and finished the year on strong footing. By many measures, 2014 was the best year for the District since the Great Recession ended. The unemployment rate reached new lows, job growth was at its highest, and the average Midwest Economy Index (MEI) reading was the second highest since 2009. A deeper look into the MEI and employment data reveals that manufacturing activity led the way, with particular strength coming from the auto industry. The strong finish to 2014 gives us hope that 2015 will be another solid year on the path to full recovery from the Great Recession.

I begin the review by looking at the overall performance of the District’s economy. GDP is the conventional measure we use to track overall performance, but state-level GDP data are published with a six-month lag. For a more up-to-date measure, I use the MEI, which tracks District GDP closely, but is published with only a one-month lag. A positive MEI reading indicates above-average growth, and a negative reading indicates below-average growth. Figure 1 shows the evolution of the MEI since 2008, where the blue line is the overall MEI and the red line is the contribution of manufacturing activity to the MEI.[2] For 2014, the trends for both lines dipped to about average growth at the beginning of the year, but activity picked up starting in April and remained well above average for the rest of the year. Manufacturing activity has played a very important role in driving overall economic activity since the recovery from the Great Recession began, and this continued in 2014, when manufacturing activity contributed an average of 70% to the MEI’s positive readings.

MEIMan

I now turn to economic indicators from the labor market. Figure 2 shows the unemployment rates for the United States as a whole and the Seventh District since 2008. The unemployment rate in the Seventh District improved considerably in 2014, falling from 7.3% in January to 5.8% in December and nearly closing the gap between the Seventh District and the rest of the country.

Unemployment

Looking beyond the unemployment rate, we can see in Figure 3 that other measures of labor underutilization also improved in 2014. The four-quarter moving average of the long-term unemployment rate fell from 4% in the first quarter of 2014 to 3.1% in the fourth quarter, while the share of workers who reported working part time for economic reasons fell from 4.9% to 4.3%. Unfortunately, both of these rates are still elevated. The long-term unemployment rate was 2% and the part time for economic reasons rate was 3.2% before the recession hit in 2008.

Underutilization

Finally, I look at payroll employment growth.[3] Figure 4 shows overall employment growth by quarter for the United States and the Seventh District states since 2008. The first quarter of 2014 was positive but weaker than the following three quarters, reflecting the pattern in the MEI. Overall, the Seventh District added about 345,000 jobs in 2014, the most in any year since the Great Recession.

Employment

Payroll employment data are disaggregated by industry, providing one way to understand the sources of growth in 2014. Table 1 shows growth rates for 11 top-level industries sorted by the percentage of overall employment they represent in the Seventh District. I also report each industry’s contribution to the overall growth rate, which is the industry growth rate multiplied by its proportion of total employment. The two largest contributors for the Seventh District are professional and business services and manufacturing, followed by construction and education and health services. Together these four industries contributed about two thirds of the employment growth in the Seventh District in 2014.

2014Review-T1

Next I take a closer look at the two biggest contributors, professional and business services and manufacturing. I start with manufacturing. There are four sub-industries that are large enough in all five District states for the payroll survey to be able to report them. These industries represent 54 percent of all manufacturing employment in the District. Transportation equipment (auto, aerospace, railroad, and ship) was easily the strongest performer, registering a 6% growth rate and contributing about 40% of all the employment growth in manufacturing.

2014Review-T2

The Professional and Business Services industry has three sub-industries that are large enough to be covered in the payroll survey. Table 3 shows solid growth for professional, scientific, and technical services as well as administrative and support services. It is important to note here that the administrative and support services industry includes labor services firms that contract out temporary workers. Many temporary workers end up at manufacturing firms, suggesting that manufacturing growth was actually stronger than the payroll data indicate.

2014Review-T3

The Seventh District economy did well in 2014. While we are still not at the point where we would consider the economy to be fully recovered from the Great Recession, the District made a lot of progress, and the strong finish to 2014 bodes well for 2015.

[1] The Seventh District is comprised of northern Illinois, northern Indiana, all of Iowa, the Lower Peninsula of Michigan, and southern Wisconsin. The analysis in this post uses data that cover the entirety of the five District states.

[2] The other sectors in the index are construction and mining, services, and consumer spending. A positive difference between the MEI and MEI manufacturing lines means that overall activity in the other sectors was above trend, while a negative difference means they were below trend.

[3] The payroll data come from a monthly survey of one third of businesses and are significantly revised once a year using the Quarterly Census of Employment and Wages, which covers the universe of businesses contributing to unemployment insurance. The data for 2014 have not been revised yet. To get as clear of an idea as possible of what the benchmarked data will be for 2014, I use a slightly modified version of the early benchmarking method described here.



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