April 16, 2014

Seventh District Update

by Thom Walstrum and Scott Brave

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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 picked up in March, and contacts generally maintained their optimistic outlook for 2014.
Consumer spending: Growth in consumer spending increased slightly in March, but remained modest. Sales of winter-related items were stronger than normal, while other sales categories, in particular light vehicles, picked up as the weather improved.
Business Spending: Growth in business spending increased to a moderate pace in March. Growth in capital spending picked up. The pace of hiring increased, and while hiring plans decreased slightly, they remained positive.
Construction and Real Estate: Growth in construction and real estate activity was modest in March. Although conditions improved, residential construction and real estate contacts reported that adverse weather continued to restrain growth. Demand for nonresidential construction grew at a moderate pace and commercial real estate activity continued to expand.
Manufacturing: Growth in manufacturing production increased from a mild to moderate pace in March, with contacts from a number of industries reporting increased activity. The auto, aerospace, and energy industries remained a source of strength. Auto and steel production recovered from the weather-related slowdown, while demand for heavy machinery remained soft.
Banking and finance: Credit conditions were again little changed on balance over the reporting period. Corporate financing costs decreased slightly, as bond spreads narrowed. Banking contacts reported moderate growth in business loan demand and modest growth in consumer loan demand.
Prices and Costs: Cost pressures were mild. While energy and transportation costs remain elevated, they were lower than during the previous reporting period. Wage pressures were slightly lower and non-wage pressures moderated.
Agriculture: The slow arrival of spring-like weather delayed fieldwork, but farmers were generally not too worried about the delay. Soybean prices rose relative to corn. The livestock sector moved further into the black, as milk, hog, and cattle prices increased.

The Midwest Economy Index (MEI) decreased to –0.03 in February from +0.32 in January, falling below zero for the first time since June 2013. Moreover, the relative MEI moved down to –0.01 in February from +0.23 in the previous month. February’s value for the relative MEI indicates that the Midwest economy was growing at a rate consistent with national economic growth.

Posted by Testa at 1:10 PM | Comments (0)

April 3, 2014

Freight movement slows in January, while freight rates remain high—Is it the weather or something else?

By Paul Traub and Bill Testa

The severity of this winter season has had a noticeably negative impact on everything from retail sales to industrial production. Roadway freight operations are no exception.

The effects of the extreme cold and heavy snow, which started last December and has continued into March of this year, seem to be showing up in some recent economic data on freight services. Chart 1 below contains the Transportation Services Index (TSI)[1] for freight in the United States. The TSI contains freight data for most modes of freight transportation, including truck, rail, inland water, air, and pipeline. This index shows that on a seasonally adjusted basis, freight movement dropped in January by 2.8%. Since the data are adjusted for seasonality, the drop in January looks to be even more significant.

Though all modes of transportation have been affected by this winter’s weather, trucking arguably experienced the worst of it. Many firsthand reports (including my own) have indicated that ice and snow shut down routes in states that do not normally face such harsh wintry conditions. Extremely cold weather also made the loading and unloading of trucks more difficult, causing delays and disrupting normal schedules.

This winter’s disruptions to trucking operations were also accompanied by price spikes. According to DAT Solutions, spot rates (excluding long-term contractual prices) for dry vans, which account for the majority of long-haul freight, are up 17.6% from October 2014. These price spikes could be partially due to the severe winter weather and may only be temporary; however, some evidence points to shifting fundamentals that may be contributing to rising cost trends in the industry. Since the U.S. economy reached the bottom of the Great Recession (in mid-2009), the U.S. Bureau of Economic Analysis’s producer price index for long haul truck-borne freight has climbed at an average annual pace of 3.9%.

Many industry experts argue that tightening capacity together with rising costs in the trucking industry are driving up freight prices. As chart 2 shows, according to ACT Research, the so-called active population of heavy-duty (class 8) trucks has been declining steadily since 2007, even while the economic recovery has been ongoing.



ACT Research defines the active population of trucks as those trucks still in service that are 15 years of age or younger. The reason for this distinction is that once a vehicle reaches 15 years of age, it becomes much less likely to be used for hauling meaningful amounts of freight over long distances. So, at the same time the number of freight loads has been increasing on account of the recovering economy, the number of trucks available to carry those loads has been declining.

Another factor affecting freight rates has been the significant increase in truck prices. Truck prices started increasing in 2002 because of federally mandated diesel emission standards that required the costly development of new engine technologies. ACT Research analysts contend that since 2002 the cost of meeting these standards has added an estimated $30,000 to the cost of a new truck—a price increase of about 31%. Rising prices for new trucks have, in turn, made used trucks more attractive, causing their prices to go up as well. The average price for a used class 8 truck was higher in January of 2013 than ever before.[2]

There is yet another factor that is likely to drive up costs for the trucking industry: the projection for a severe shortage of qualified truck drivers. The effects of the shortage, which has been in the making for some time, were somewhat mitigated during the most recent economic downturn. Since then, as freight activity has recovered, the driver shortage has become a more serious problem. A shortage of drivers, coupled with fewer trucks on the road, has tightened freight utilization rates, which are said to be approaching uncharted territory: Some estimates now have capacity utilization rates in the trucking industry in excess of 95%.

If, as I would argue, the recent slowdown in freight activity is due primarily to the severe winter weather, then missed deliveries will need to be managed. But this will not be easy. In the trucking industry, backlogs can be difficult to make up because there is only so much the trucking industry as a whole can ship—and only so much any one truck can haul (due to legal weight limit restrictions on most highways). Making up for the backlogs will result in added demands on a truck fleet that is already running at near-full capacity.

Based on this analysis, it doesn’t look like freight rates will be coming back down any time soon, especially if the economy keeps improving. As businesses moved to optimize their supply chains with techniques such as just-in-time inventory,[3] freight has taken on an increasingly important role in their production processes. As a percent of total logistics expense for private business, trucking-related costs comprise 77.4% of transport costs and 48.6% of total logistics spending.[4] Accordingly, when real gross domestic product (GDP) increases by 1%, some analysts estimate that the truck transportation needed to bring this about increases by 2 to 3%.[5] Should the demand for hauling freight by truck grow dramatically, the trucking industry’s capacity would be strained under the current circumstances. When trucking capacity is strained, prices for those freight hauls that are not under long-term contract can jump. Given the changing fundamentals to the trucking industry discussed previously, some analysts argue that the recent price spikes for shipping freight via trucks will ultimately work their way into long-term contractual prices for hauling freight (which are predicted to reset throughout the year). Some estimates have the increase for contractual freight in the coming months to be in the range of 4% to 6%.

Rising capacity utilization for the trucking industry, increases in the costs of new trucking equipment, higher demand for qualified truck drivers, and a declining number of heavy-duty trucks in operation are some of the reasons that freight prices are on the rise. North American heavy-duty truck production is increasing to meet demand, but recently announced fuel economy standards will continue to add costs to the production of new vehicles—and, in turn, increase their sale prices. So while rising freight rates have historically been a good predictor of improved economic activity, there are other factors at work driving up rates at this time. It remains to be seen how all of this will affect consumer prices, but if these expected freight rate increases cannot be readily absorbed, they will have some impact on the consumer. For these reasons we will be keeping an eye on freight and freight rates in the months ahead—long after the snow has melted.
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[1]Truck transportation makes up a significant portion of the Transportation Services Index (TSI), accounting for 40% of the data used. (Return to text)

[2]Newscom Business Media Inc., 2014 “Used Trucks Cost More than Ever Before”, Today’s Trucking, February 27. (Return to text)

[3]Just-in-time inventory is an inventory strategy employed by firms to increase their efficiency and decrease waste by receiving goods only as they are needed in the production process; this strategy reduces costs associated with carrying large inventories (of raw materials or finished goods, such as cars). (Return to text)

[4]Dan Gilmore, 2013 “State of the Logistics Union 2013”, Supply Chain Digest, June, 20, 2013. (Return to text)

[5]Jeff Berman, 2014 “Truckload capacity trends in 2014 are worth watching, say industry stakeholders”, Logistics Management, Jan. 10, 2014. (Return to text)

Posted by Testa at 3:31 PM | Comments (0)

March 17, 2014

Michigan's Automotive R&D Part II

By Thomas Klier, Bill Testa, and Thomas Walstrum

The automotive industry is somewhat synonymous with Michigan. This relationship was born of an explosion of technological innovation in Southeast Michigan, including the assembly line and key developments in the internal combustion engine and transmission system. Looking at innovative activity today, a hundred years later, it is not far-fetched to state that the geography of automotive innovation in North America resembles that of yesteryear, with Michigan retaining its dominant role. The state has been highly successful to date in sustaining its leading automotive R&D concentration. Yet, for good reason, policy initiatives in the state are aimed at retaining and building on its strength.

The research and development (R&D) activity of private industry is increasingly being recognized as an important part of the innovation that spurs economic growth and competitiveness. Companies undertake R&D both to improve their production processes for cost and quality and to create wholly new products and services.

Among mainstay U.S. industries, automotive remains one of the most innovative in this regard. R&D that was both financed and performed by U.S. domiciled automotive companies amounted to $11.7 billion in 2011, representing 5.2 percent of total R&D spending. The R&D intensity of automotive manufacturing (as a share of the industry’s value added) is 15.3 percent, compared with 9.2 for all manufacturing, and 1.7 percent for all private industry.[1]

The importance of innovation to automotive companies remains paramount. A recent report by the Boston Consulting Group cited nine automotive companies among the world’s most innovative companies in 2013. The report names several factors behind the innovative burst among automotive companies, including the quickly tightening fuel-efficiency and environmental standards, which have spurred interest in electric and hybrid vehicle technologies. At the same time, auto companies continue to strive to meet ongoing demands for safety, comfort, and performance. Today’s vehicles increasingly comprise advanced electronic and IT components, which are developed both by automotive companies and purchased from technology companies in other industry sectors. By one estimate, “Electronics make up nearly 40% of the content of today’s average new automobile, and their share will continue to grow.” R&D initiatives to enhance the performance and to lower the cost of batteries that may power many of tomorrow’s autos are one example of an important and emerging R&D direction; automatic guidance systems for tomorrow’s (driver-less) cars is another.

Today, Michigan remains the epicenter of automotive R&D in the U.S. The state has maintained its leading place even while production has dispersed throughout the nation. According to data from the National Science Foundation that has been assembled for recent years only, R&D that is both funded and performed by auto companies in Michigan held fast at between 70 and 80 percent of the nation’s total from 1998 to 2011, amounting to $8.87 billion in 2011.

Automotive R&D has propelled Michigan to a leadership position among Midwest states. The table shows Michigan leading the region with $13.7 billion in total business-performed R&D by all industries in 2011, closely followed by Illinois ($12.0 billion), but far ahead of Ohio, Indiana, and Minnesota.[2]

Michigan is also a leader in employment of auto engineers to support long-term R&D and innovation. Drawing on data from the Census and the more recent American Community Survey, we can see how large Michigan’s share of the nation’s automotive engineers is relative to its share of the nation’s work force. Michigan employs over one-half of the nation’s automotive engineers, but its work force overall represents just 3 percent of the nation’s. Granted, Michigan’s share of the nation’s automotive engineers has fallen by ten percentage points since 1980; nonetheless, the state has added 18,000 (two thirds) of its engineers since 1980.

The remarkable importance of automotive technology in Michigan (as represented by engineering workers) can also be understood by comparing it with Michigan’s eroding share of automotive production. By overlaying Michigan’s automotive production workers as a share of the nation on the chart above, the strong role of automotive technology becomes clearer. Since 1950, Michigan’s share of production workers has fallen from 54 to 19 percent, a loss of approximately 255,000 jobs.

And while there are many technologically advanced industries in Michigan—including bio-pharma, medical equipment, industrial chemicals, and office furniture—automotive engineering has come to dominate further in recent decades. As the chart shows, automotive engineers once comprised 30 percent of engineers in all industries in Michigan. By 2012, their share had risen to 51 percent.

What is the future of automotive R&D in Michigan; will the region’s extreme concentration in the activity continue? There are no hard and fast answers, yet there are identifiable features that will come into play. On the one hand, there are many historical instances of geographically concentrated centers being very cohesive and long-lived. Once established, such “clusters” tend to grow and feed on themselves. Technology activity is drawn to technology activity. Skilled workers are drawn to activity-rich cities, and companies are, in turn, drawn toward pools of skilled workers. For example, global financial centers such as New York and London have held their dominant positions for many decades, even centuries. The San Francisco Bay area has enjoyed a long run of dominance in the areas of IT and biotech. In a similar way, Michigan’s established leadership in automotive R&D may persist.

On the other hand, company reorganizations and the geographical shifting of activities that tend to be interdependent with technological activities represent risks to Michigan’s position. It may be beneficial for some industries to locate technology and production in close proximity to facilitate (and reduce the cost of) communication and transportation between the two activities. Thus, the fact that Michigan has lost automotive production in recent decades may have negative implications for automotive R&D in the state.

Similarly, co-dependence between R&D and company headquarters activities such as marketing and strategic planning has also been seen as important in some industry sectors. Thus, any major shift in corporate headquarters activity away from Michigan would raise the concern that it might be accompanied by a shift in R&D activity.

Finally, mature industries such as automotive are often severely disrupted by the emergence of wholly new and sometimes unexpected technologies that greatly shake up their organization and geography. For example, the development of aerospace technologies for military uses shifted the locus of related U.S. production from the Northeast to the Southwest and West during the course of the twentieth century. So far, this has not yet taken place as Michigan continues as the U.S. leader in automotive innovation and R&D activity.
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[1]For 2011, National Science Foundation, National Center for Engineering and Scientific Statistics, Business R&D and Innovation Survey, and U.S. Department of Commerce, Bureau of Economic Analysis. (Return to text)

[2]Latest data from the National Science Foundation, available here. (Return to text)

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