Seventh District Update, September 2016

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First, a (repeat) 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.

If you are a Seventh District business leader and would like to share your perspective on current economic conditions with us, you are welcome to participate in the CFSBC. Please send an email with your contact information to thomas.walstrum@chi.frb.org.

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 July and early August, and contacts expect growth to remain moderate over the next six to twelve months.
  • Consumer spending: Growth in consumer spending slowed notably with most segments reporting little change in sales. Auto sales slowed some, but remained strong.
  • Business Spending: Growth in business spending picked up to a moderate pace. Retail inventories were somewhat higher than desired because of softer sales. Current capital expenditures picked up to a moderate pace, while hiring continued at a modest rate.
  • Construction and Real Estate: Activity increased slightly overall. Residential construction and home sales increased slightly. Demand for nonresidential construction picked up some, and commercial real estate activity increased slightly.
  • Manufacturing: Growth in manufacturing production picked up to a moderate pace. Activity continued to be strong in autos and aerospace, and increased in most other industries.
  • Banking and finance: Conditions improved modestly. Equity prices were higher, volatility was low, and loan demand from small and middle market businesses grew modestly. Consumer loan demand increased slightly.
  • Prices and Costs: Cost pressures were unchanged and remained mild. Most energy and metals prices were flat and remained low. Retail prices changed little and labor cost pressures were steady.
  • Agriculture: Already low expectations for farm incomes deteriorated over the reporting period as the potential for a record national harvest pushed prices down further.

The Midwest Economy Index (MEI) decreased to −0.14 in July from −0.04 in June. The relative MEI moved down to +0.03 in July from +0.38 in June. July’s value for the relative MEI indicates that Midwest economic growth was quite close to 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 −18 from −23, suggesting that growth in economic activity remained at a modest pace in July and early August. The CFSBC Manufacturing Activity Index increased to a neutral value from −31, while the CFSBC Nonmanufacturing Activity Index declined to −27 from −18.

Detroit and Chicago: Real Property Value Comparisons

Both Chicago and Detroit have become poster children for city government financial stress in recent years. Chicago’s city and school district alike have been running structural deficits, meaning that the government has been covering its normal operating expenditures by issuing or over-extending debt and running down its assets. Both Chicago’s municipal government and school district face large shortfalls in required contributions for the future pensions of current and retired employees. Both have raised local property taxes as partial steps toward balancing their budgets. In the case of Detroit, the city has only just emerged from Chapter 9 bankruptcy while its school district teeters on insolvency under state-mandated “emergency manager” operation.

Are these places comparable in terms of their outlooks and situation? The value of real property in each place offers one fascinating indicator of the resources available to their local governments, as well as a look into how private homeowners and commercial property owners perceive the general prospects of Detroit and Chicago.

Why examine real property values? In some sense, real estate and improvements are long-lived assets that are largely fixed in place. In the market for these properties, buyers and sellers must assess and incorporate the government fiscal liabilities and service benefits – present and future – attached to these properties in the prices at which they buy and sell. High (and rising) property values may indicate that home owners and commercial property owners expect that the prospects for value in these locations are good and that they will continue to improve. And from the local government’s perspective, high values indicate that there may be room for further imposition of local taxes to fund government services, if need be.

Nuts and bolts

The estimation of the value of real property—land and improvements– in a locality is far from an exact science. The actual sales prices of property can be thought of as one reflection of an individual parcel’s value. However, as we saw during the financial crisis last decade, sales transaction prices can be very volatile, and sometimes speculative. More practically, parcels of property do not turn over frequently, so that transactions prices of all property parcels are not observed in any one year. In practice, then, local public officials often rely on various estimation methods in assessing the value of property for taxation purposes, most of which involve using a sample of information from similar properties that were sold during a year. From the recorded sales price and a property’s particular features such as size, location, age, and configuration, the property assessment office infers the value of each property and, ultimately, the total value of property against which taxes are levied.1 These taxable values are often termed assessed values or sometimes equalized assessed values and often represent some fixed percentage of market or true value.2

In the charts, we draw on such data from the local and state governments of Detroit, Chicago, and Illinois to estimate the market or true value of real property in both Detroit and in Chicago.3 For Detroit, figures on total assessed property value are published in the city’s Comprehensive Annual Financial Report (CAFR). By law, assessed value must amount to one-half of true value in Michigan. And so, to arrive at our estimates of full value, we simply double the assessed value. We believe that this yields a far upper bound on the value of residential property in Detroit because there is much evidence that, following the steep plunge in Detroit’s property market over the last decade, assessments were not reduced to accord with actual market value in a timely fashion.4

Drawing on prices of homes that recorded sales, the following chart shows that average home prices began to fall in 2004, while assessed value did not begin to fall until 2009.Detroit_Assessed_HomePricesFor Chicago, a prominent local government “watchdog” and research foundation has long been using state and city data on recorded property sales by class of property to estimate full market values.5 The accuracy of these data is believed to be reasonable, though far from exact.6

What do we see?

Due to lags in data availability, the estimates below are representative through calendar year 2014. The charts display total property value across all types, as well as the largest category in both Chicago and Detroit, that being residential property.

As shown here, Chicago real property value rose dramatically during the early part of last decade before dropping off just as dramatically. Detroit’s property values remained flat. However, Detroit’s apparent stability belies the fact that assessed values of residential properties have not been allowed to fall off in tandem with actual market transactions price there. As measured by volume of sales, the market for residential real estate in the city of Detroit became almost nonexistent during this period.7 Few homes were sold using conventional financing; almost all of them sold for cash. By some estimates, prices of homes sold fell by many multiples during this time, though they have since been heading back up in parts of the city.

Even using generous measures, and with rising home prices in some neighborhoods, residential property value overall in Detroit have continued to drift lower in recent years. In contrast, following the steep decline, Chicago property values have begun to recover for both residential and commercial (not shown) property.

Most telling, at over $80,000 per resident, the value of overall taxable real property in Chicago remained markedly higher than that of Detroit as of 2014. By even our generous measure, Detroit’s property values were only about $25,000 per resident.Detroit_Chicago_PropValuesDiscussion

It would appear that, as measured by real estate values, Chicago’s economy and prospects remain much stronger than Detroit’s. And from a local government perspective, Chicago’s taxable resources with which to pay down liabilities and fund public services appear to be much larger. Of course, there are myriad political and institutional factors at play that render such a simple assessment of wealth inadequate to characterize the fiscal capacity of these cities. In both places, for example, property wealth is concentrated in a subset of places such as near the downtown areas and along the waterfronts. Accordingly, it may be difficult to tap available property wealth selectively because existing statute largely requires that tax rates be applied uniformly. And voters and their representatives may be reluctant to allow tax hikes at all. Similarly, there may be different levels of sensitivity to taxation in these two places and among different constituencies. For example, the imposition of new and higher taxation may cause economic activity and investment to decline more sharply in one place as opposed to another.

More broadly, we might ask whether property wealth is a good indicator of potential resources that local governments may draw on to fund services. A look at more U.S. cities may be helpful. The next chart undertakes the same exercise for the most populous cities. Here we see that Chicago continues to look fairly robust by this measure, though less so than the cities of San Diego, Los Angeles, Austin, and New York City.MajorCities_ProvValues

  1. Assessed value of property for taxation purposes is often a fixed percentage of market value across all property parcels, or else it is a fixed percentage across all parcels of a certain type or class such as residential, commercial or industrial. In turn, estimates of full value of all property can be made by taking sample average ratios of “assessed value/sales price” and applying these ratios to all parcels’ assessed values.
  2. Equalized assessed values refers to the practice of further adjusting the totalities of assessed value of property across jurisdictions so that each locale’s assessed valuation represents the same or “equalized” value in relation to (percent)  sales price or true value.
  3. The city of Detroit also taxes tangible personal property of commercial enterprises such as computing equipment and furniture; Chicago does not.
  4. Using sales price and assessed values for a sample of 8,650 residential parcels in 2010, Hodge et al find an average assessment to sales price ratio of 11.47, which suggests an average over assessment or property values many times over. See Timothy R. Hodge, Daniel P. McMillen, Gary Sands, and Mark Skidmore, 2016, “Assessment Inequity in a Declining Housing Market: The Case of Detroit,” Real Estate Economics.
  5. See https://www.civicfed.org/sites/default/files/Estimated%20Full%20Value%20of%20Real%20Property%20in%20Cook%20County%202005_2014.pdf
  6. Discrepancies arise because only sample values of real estate transactions are available in any one year. In addition, full value projections derive from the median value of property in each class. However, the median property value may not represent the entire distribution of property values.
  7. See http://www.urban.org/sites/default/files/alfresco/publication-pdfs/2000739-Detroit-Housing-Tracker-Q1-2016.pdf

Seventh District Update, July 2016

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First, a (repeat) 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.

If you are a Seventh District business leader and would like to share your perspective on current economic conditions with us, you are welcome to participate in the CFSBC. Please send an email with your contact information to thomas.walstrum@chi.frb.org.

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 continued at a modest pace in late May and June, and contacts expect growth to remain modest over the next 6 to 12 months.
  • Consumer spending: Growth continued at a moderate pace. Auto sales remained robust.
  • Business Spending: Growth remained modest. Most retailers and manufacturers reported comfortable inventory levels. Current capital outlays remained modest and plans for future outlays declined. Hiring continued at a modest rate, and there was an uptick in expectations for future hiring.
  • Construction and Real Estate: Activity increased slightly overall. Residential construction was little changed, while home sales increased in most locations. Demand for nonresidential construction increased slightly and commercial real estate activity rose modestly.
  • Manufacturing: Growth remained modest. Activity continued to be strong in autos and aerospace, but remained weaker in most other industries.
  • Banking and finance: Developments were mixed. Financial market volatility increased significantly, driven primarily by the United Kingdom’s vote to exit the European Union. Business and consumer loan demand grew slightly.
  • Prices and Costs: Cost pressures were unchanged and remained mild. Most energy and metals prices were flat and remained low. Retail prices were flat and labor cost pressures were steady.
  • Agriculture: Corn and soybean price gains led more farmers to lock in prices for the fall harvest, though the increases were not enough to change contacts’ expectations that farm incomes will be weak this year.

The Midwest Economy Index (MEI) decreased to +0.12 in May from +0.28 in April. The relative MEI declined to +0.53 in May from +0.71 in April. May’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 decreased to −24 from −21, suggesting that growth in economic activity remained modest in late May and June. The CFSBC Manufacturing Activity Index declined to −28 from −17, while the CFSBC Nonmanufacturing Activity Index ticked up to −22 from −23.

Seventh District Update, June 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 slowed to a modest pace in April and early May, tempering contacts’ optimism about growth over the next 6 to 12 months.
  • Consumer spending: Growth in consumer spending picked up to a moderate pace. Retailers in Michigan indicated that sales were the best they had seen in over a year. Auto sales remained robust.
  • Business Spending: Most retailers and manufacturers reported comfortable inventory levels. Current capital outlays and plans for future outlays slowed to a modest pace. Hiring also slowed to a more modest rate, as did expectations for future hiring.
  • Construction and Real Estate: Residential construction rose slightly, and residential rents and home prices rose moderately. Demand for nonresidential construction was little changed and commercial real estate activity rose modestly.
  • Manufacturing: Manufacturing production grew at a modest pace. Activity remained strong in autos and aerospace, but was slower in most other industries.
  • Banking and finance: On balance, financial conditions improved marginally. Market volatility decreased, high yield debt issuance rebounded, and upgrades outpaced downgrades for credit ratings of U.S. public financial firms. Business and consumer loan demand was little changed on balance.
  • Prices and Costs: Cost pressures again tightened some, but remained mild overall. Most energy and metals prices increased (steel in particular), but the level remained low. Retail prices increased slightly, as did wage costs. Growth in non-wage labor costs was steady.
  • Agriculture: Corn and soybean prices rose, improving farmers’ earnings prospects.

The Midwest Economy Index (MEI) was unchanged at +0.25 in April. The relative MEI increased to +0.71 in April from +0.67 in March. April’s value for the relative MEI indicates that Midwest economic growth was moderately 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 decreased to –23 from zero, suggesting that growth in economic activity slowed to a modest pace in April and early May. The CFSBC Manufacturing Activity Index declined to –23 from +27, while the CFSBC Nonmanufacturing Activity Index decreased to –24 from –15.

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).

det_chi_fig4

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.

det_chi_tab1

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%.

fig2

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.

fig3

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:

formula

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

table1_GSP

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.



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