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Are Seventh District Labor Markets Still Slack?

By Bill Testa and Jacob Berman

There is no question that the U.S. labor market has been gradually but steadily healing after the Great Recession. The national unemployment rate peaked at 10% in October 2009, but it has since fallen to 6.2% (as of July 2014). The nation experienced a net loss of 8.7 million jobs during the downturn, and finally finished making up for those job losses just this past May. So, undeniably, progress has been made in the labor market, but now the questions facing policymakers and other government officials are how much slack capacity in the employable population remains and whether further tightening of labor market conditions will push up wages and prices.

Recently, short-term unemployment—defined as the share of the labor force that has been unemployed for 26 weeks or less (see below)—has fallen to levels that have been historically associated with robust economic conditions. In contrast, despite post-recessionary declines in long-term unemployment (i.e., the share of the labor force that has been unemployed for greater than 26 weeks), its recent levels remain well above the historical norm. Though high long-term unemployment may be a sign of considerable labor market slack, some argue that the vast majority of the long-term unemployed lack the specific skills and other characteristics to be hired or trained. If this proves to be correct, it would imply that the U.S. labor market is nearing its full capacity.

Source: U.S. Bureau of Labor Statistics, Current Population Survey, from Haver Analytics

In order to provide more useful guideposts for macroeconomic policymaking, economists Dan Aaronson and Andrew Jordan recently investigated the relationships between rising wages and indicators of labor market tightness. In their recent Chicago Fed Letter, the authors find a strong correlation between real wage growth and two prominent measures of labor market slack—medium-term unemployment (i.e., the share of labor force unemployed for five to 26 weeks) and the percentage of the labor force reporting they are working part-time involuntarily for economic reasons (such as unfavorable business conditions or seasonal decreases in demand). Partly because both of these measures of labor slack remain elevated today, the authors conclude that real wage growth in June 2014 would have been one-half of a percentage point to one full percentage point higher under the labor market conditions of the 2005-07 U.S. economy.

While we often speak of the labor market as one monolithic term, labor market conditions vary widely by occupation, industry, and location. In their analyses, Aaronson and Jordan identify statistical relationships between real wage growth and labor market conditions by observing individual states. In the chart below, we see the general pace of employee compensation for both the United States and for the East North Central Region, which includes four of the five states of the Seventh Federal Reserve District.[1] In both the nation and the region, recent growth in labor compensation continues to fall short of that in the pre-recessionary period.[2]

Source: U.S. Bureau of Labor Statistics, Current Population Survey, from Haver Analytics

Also, as seen in the next three charts, Seventh District states generally exhibited signs of greater labor market slack in 2013 relative to the pre-recession year of 2007.[3] Long-term unemployment—both in the Seventh District states and in the nation—has stayed high during the economic recovery. In 2013, the long-term unemployment rate in Illinois was the highest among the District states (followed by Michigan). Notably, Michigan’s long-term unemployment rate had been at a high rate already in 2007 as a result of the severe restructuring of the automotive industry in the past decade.

Source: U.S. Bureau of Labor Statistics, Current Population Survey, from Haver Analytics

Medium-term measures also remained elevated among Seventh District states in 2013. However, they suggested that the District’s state labor markets may be less slack than the national one; in particular, Iowa and Wisconsin, where 2013 medium-term unemployment rates had almost returned to their 2007 levels, showed their labor markets may be improving faster than the nation’s.

Source: U.S. Bureau of Labor Statistics, Current Population Survey, from Haver Analytics

According to the measures of the percentage of the labor force who are involuntary part-time workers, there also appeared to be additional work force supply available in both the Seventh District states and the nation in 2013 as compared with 2007. This was the case for all five District states. Moreover, it should be noted that Michigan, Indiana, and Illinois displayed a higher percentage of involuntary part-timers than the nation did in 2013. Involuntary part-time workers are those who would choose to work more hours if it were possible. Typically, such workers have had their hours cut back in their current job, or they are part-time workers who cannot find a full-time job due to poor economic conditions in their occupation.[4]

Source: U.S. Bureau of Labor Statistics, Current Population Survey, from Haver Analytics

As these measures indicate, even while labor markets continue to tighten in the economic recovery, there is significant variation across states. According to the charts above, state labor markets in the Seventh District continue to be somewhat slack. Further, the observed pace of wage and employee compensation increases are still below those of the pre-recessionary period.
[1]The Federal Reserve’s Seventh District comprises major parts of Indiana, Illinois, Michigan, and Wisconsin, as well as the entirety of Iowa. The U.S. Census Bureau’s East North Central Region comprises Ohio and the entirety of the Seventh District states excepting any part of Iowa.(Return to text)

[2]Labor compensation includes both employee wages and benefits.(Return to text)

[3]State averages are reported here, though we acknowledge that local conditions and markets for specific skills and occupations differ. The Chicago Fed’s regional research staff keeps abreast of such conditions and markets through local meetings with labor market participants and businesses, as well as through formal surveys.(Return to text)

[4]For a full discussion see Rob Valletta and Leila Bengalli, “What’s Behind the Increase in Part-time Work?(Return to text)

District Economy Update

by Norman Wang and Scott Brave


A summary of economic conditions in the Seventh District from the latest release of the Beige Book:

Overall conditions: Economic activity in the Seventh District picked up in late November and December. Seventh District business contacts were generally optimistic about the economic outlook for 2012, but many also expressed concern about potential weakness in demand from abroad, particularly from China and Europe.

Consumer spending: Compared to last year’s holiday season, store traffic volumes were up significantly in December. Auto sales also increased since the last reporting period. Contacts expected sales to continue to improve in 2012, citing a boost from replacement demand in light of the record high average age of vehicles in the U.S.

Business Spending: Business spending was steady in late November and December and inventory levels were reported to be generally in-line with sales. Hiring remained selective, but the majority of contacts indicated plans to increase employment next year.

Construction and Real Estate: Construction activity was subdued in late November and early December, but there was some improvement in overall real estate conditions as multi-family construction remained an area of strength and nonresidential construction increased moderately.

Manufacturing: Manufacturing production growth increased in late November and December. Demand for heavy equipment remained strong and auto production increased over the reporting period. In the steel sector, inventories at service centers remain near desired levels.

Banking and finance: Credit conditions were little changed during the reporting period. Corporate funding costs, while variable, were largely unchanged on balance. Business loan demand continued to be subdued, and business utilization of credit lines was only up a bit.

Prices and Costs: Cost pressures eased in late November and December. While pressure on costs remained from commodities such as steel and food, it moderated significantly for cotton and energy goods. Wage pressures remained moderate.

Agriculture: Prices for corn and soybean rose in the last half of December, though crop prices generally fell during the harvest period. Milk and hog prices fell during the reporting period, while cattle prices increased.

The Midwest Economy Index (MEI) increased to –0.15 in November from –0.30 in October and remained below its historical trend for the fourth consecutive month. However, Midwest growth outperformed its historical deviation with respect to national growth, as the relative MEI increased to +0.04 in November from –0.32 in October largely on the basis of sizeable gains in consumer spending indicators. Estimates of annual growth in gross state product for the five Seventh District states were at or above the national rate of growth through the third quarter of 2011.

The Chicago Fed Midwest Manufacturing Index (CFMMI) decreased 0.1% in November, to a seasonally adjusted level of 85.8 (2007 = 100). Revised data show the index increased 1.0% in October. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) decreased 0.3% in November. Regional output in November rose 7.1% from a year earlier, and national output increased 4.2%.

Tending the Northern Border

By Martin Lavelle and Bill Testa

Despite the fact that the U.S. is Canada’s largest trading partner and vice versa, northern border crossing conditions have sometimes been given short shrift. Today, in some places along the border, freight and travelers use outdated infrastructure in a post 9/11 world where security concerns have tended to slow cross-border movement. Accordingly, suggestions have been raised on both sides of the border to improve passenger and trade flows between the two countries. The Seventh District’s Great Lakes crossings, specifically the Detroit River crossings, are focal points of the growing debate on how best to improve the U.S.–Canada border.

U.S.–Canada Border Crossing Policy

Over the last few years, the majority of U.S. border policies have focused more on Mexico and the flow of immigrants and illicit activity crossing the southern border into the U.S. The heightened attention on the Mexico border has been a concern both to Canadian officials and those whose economic interests depend on cross-border trade between our two countries. For example, automotive-intensive communities in Michigan and much of the surrounding region are especially keen to see border crossings made easier. Much of the fragile North American automotive industry continues to operate with highly inter-connected supply chains that traverse the border between the Midwest and Ontario.

Responding to these concerns, the Brookings Metropolitan Policy Program and the Canadian International Council held a forum recently on the challenges and opportunities to improve U.S.–Canada border policy and management. Among the experts to speak at the Brookings forum, Christopher Sands of the Hudson Institute discussed his paper characterizing the U.S.–Canada border policies past and present and recommending a broad framework for improvement. Sands specializes in Canada, U.S.–Canada relations, and North American economic integration. He followed up his appearance at the forum with a meeting here at the Bank.

Sands divides the U.S.–Canada border into four separate traffic corridors. The Great Lakes Corridor sees the highest volume of automobile and truck traffic, most notably the crossings at Detroit–Windsor, Buffalo–Niagara, and Lake Champlain, which connects Montreal and New York City. All Great Lakes crossings see heavy volumes of what Sands calls “amateur” traffic, those who cross rarely, usually on vacation. However, these Great Lakes crossings also provide infrastructure support for commercial goods and services to travel back and forth from both countries’ manufacturing centers. The Michigan border crossings directly link the Great Lakes, where 28% of US GDP is produced, and Ontario, where 41% of Canada’s GDP is produced.

Sands’ Policy Recommendations

Precision, decentralization, and consensus, Sands argues, should serve as the framework for future discussions on improving the border. Precision revolves around defining the specific problem and efficiently targeting and solving it. Decentralization refers to engaging local and regional stakeholders in the policy process while taking care not to stall the process by giving any party too much power. Canadian officials tend to agree more on border initiatives because most of the Canadian population lives near the border and is affected by border policy; they don’t have the regional rivalries exhibited by the debates and issues seen in U.S. border cities and their inland counterparts. Consensus occurs when all levels of government agree on the future of the border and how it should be managed.

Michigan’s Aging Infrastructure

Along the Michigan–Ontario border crossings, infrastructure issues have become pressing. Here, the Ambassador Bridge and the Detroit–Windsor Tunnel connect Detroit and the industrial Midwest with Windsor, Ontario, and Highway 401, which heads northeast through the major cities of London, Toronto, and Montreal. Combined with the Blue Water Bridge in Port Huron and the St. Clair rail tunnel just south of it, Michigan possesses some of the more important crossing points, making the state an important player in U.S.–Canada trade. As commercial and passenger traffic continue to cross the border in Detroit, added pressure has been put on infrastructure that is almost 70 years old and isn’t equipped to handle current traffic volumes.

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In recent years, federal, state, and local leaders in the U.S. have advocated for a new Detroit River border crossing approximately 2 miles south of the Ambassador Bridge that would be able to handle increased trade flows as well as implement post 9/11 security upgrades. Adding to the campaign, the Canadian Minister of Transport, Infrastructure, and Communities has publicly stated that Canada’s #1 infrastructure priority is the new Detroit River crossing. Currently, construction on the new bridge complex is scheduled to begin sometime next year, with the opening set for 2013. But first, Detroit and the state of Michigan have short- and long-term issues they must address. The land needed for the new bridge has not yet been purchased by the Michigan Department of Transportation; and critics argue that a new crossing isn’t needed due to slowly decreasing traffic flows. Competing claims for attention have arisen as the Detroit city government and Lansing legislators attempt to agree on expansion and administration plans for Cobo Hall, the region’s premier trade and convention hall, as well as how to contend with education budget deficits and recovery options for a poorly performing state economy.

Independent plans for a competing cross-border bridge in Detroit have further complicated the outlook. The private owner of the Ambassador Bridge has started construction of a second span next to the current Ambassador Bridge, albeit without government permission. (The publicly approved site for the Detroit River International Crossing is Zug Island, 2 miles south of the Ambassador Bridge, which would cross over into southern Windsor, where a new highway accessing Highway 401 is being constructed.) While the private initiative may be advantageous in some respects, its competing site will have the least negative impact on surrounding communities (no displacement of residents anticipated), is the most environmentally friendly, and is the one both nations favor.

Midwestern states along the northern border have keen economic interests in a national border that is secure, yet speedy. Because these interests are somewhat more diffuse throughout most of the remaining states, Midwestern residents would do well to take part in border-improving policy discussions.

How should states tax business?

As much of the Midwest economy struggles to boost its economic performance and as Midwest governments try to maintain funding for public services, the subject of state and local business taxes arises. This summer, the state of Michigan replaced its innovative but contentious “single business tax” with two lesser taxes, one on business income and the other on business gross receipts. Meanwhile, Illinois’ Governor Blagojevich proposed a hefty tax on business gross receipts that was to begin in 2008. That tax proposal was defeated even as the Governor railed against the interests of high-powered lobbyists “who eat fancy steaks” and “shuffle around in Gucci loafers.” These and other new developments in state–local business taxation will be discussed and analyzed by some of the nation’s leading tax experts at a Bank conference this coming September 17.

What are business taxes, and how should they be viewed? By definition, and in accounting for them, business taxes are any taxes collected from businesses and legally imposed on business revenue, property, assets, sales, right to do business and inputs to production. Measured in this way, business taxes are estimated in a recent study by Ernst & Young to have been $554 billion in 2006, accounting for 45 percent of state–local government tax collections. By this reckoning, their share of these tax collections has fallen by only a couple of percentage points since 1990.

The table below, drawn from the same study, displays business tax collections by type for Seventh District states and the U.S. The following graph allocates property taxes by type into shares of the total collection. Property taxes, which are largely administered and collected by local governments, comprise almost 50 percent of business taxes. Seventh District states have historically drawn on these sources since local governments tend to be prominent here and because the Midwest economy has historically concentrated in property-rich sectors, namely agriculture and manufacturing.

It may surprise many to find that “retail” sales taxes on business transactions rank second in business tax share. Though it is often thought of as a tax primarily levied on consumers at the point of final sale, many intermediate purchases of goods and services between businesses (B to B) are not exempted from it. By one estimate, as much as 40 percent of retail sales tax collections in the U.S. may be collected from B to B sales.

Click to enlarge.

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In fashioning business-type taxes, policymakers seem to be motivated in two primary ways. First, business taxes are often seen as a popular and expedient way of raising revenue for public services and do so at the expense of the business owners. There is a common notion that such taxes are “progressive” and are drawn from the wealth of well-to-do individuals. However, business-type taxes are imposed on certain transactions and not people per se. For example, a particular tax may be called a “retail” tax if it is imposed on telephone or electricity consumption, implying that the consumer is bearing the burden. But, the same tax may be called a “gross receipts” tax when levied directly on the public utility, implying that unidentified “business owners” are bearing the burden of the tax. Yet, in every action in collecting either tax, they are identical. “Who puts the nickel in tax collection box” makes no difference in real impact.

Similarly, while a business tax may be legally written to fall on the purchase of a business input or on the income of a corporation, behavioral adjustments take place in response to the tax that ultimately shift the final burden of the tax. Most commonly, excessive taxes are shifted forward into the prices of goods purchased by consumers—rich and poor alike; or taxes may be shifted backwards onto people who own the factors of production—laborers as well as nonworking households of various income strata.

If it is true that business taxes are shifted, why do we see that business organizations and business owners vigorously fight business tax hikes in state legislatures and in local city councils? Part of the answer is that taxes are only shifted in the long run. In the meantime, because business operators and owners cannot quickly adjust their behavior in response to tax hikes, the tax burdens may indeed fall heavily on them personally. Only after varying periods of time may businesses fully take offsetting actions, such as reducing investment and labor, retrenching production, or moving to other locales. And looking forward, many opportunities for business expansion may be nullified because of disincentives that are attendant to the expanded taxation.

In this light, the other major consideration of policymakers comes to the fore. State and local policymakers worry about their competitiveness in setting business tax policy. In the United States, “tax competition” is highly active among state and local governments. As localities compete for both jobs and tax revenues, taxes do not generally stray too far out of line. Outwardly, states keep their general business tax structures in line with their neighbors so as not to discourage business investment. So too, states and localities often offer generous and other selective tax abatements.

Tax competition serves not only to keep business taxes from being punitive, but in the competition for local investment, localities are often forthcoming in allowing commercial use of land and providing public services to business. In fact, because businesses do directly use public services such as roads, refuse disposal and public safety services, it is clear that business taxes should seldom or never be reduced to zero but should rather cover related costs. Other similar “business generating” costs that have been advanced in this regard include pollution-type taxes, which are more common in Europe, and the business benefits of allowing “limited liability” organization, which may impose costs on governments if businesses fail catastrophically or in unanticipated ways.

Some observers and analysts believe that local governments do not manage well the negotiations with savvy business firms for selective tax subsidies. For this and other reasons related to tax competition, insufficient revenues will be raised to fund basic services to households, such as public education. Accordingly, efforts to limit competition by statute have been advocated, along with proposals to assist governments in bargaining more effectively with arbiters of mobile capital investment.

Is the limiting of tax competition necessary to save governments from themselves? The answers are not yet clear. However, it can be said that local governments are competing on more than the basis of tax competition alone. Several studies have indicated that the quality of life and other household amenities are increasingly the determinants of metropolitan area growth. Local leaders, and especially big city mayors, have responded to this trend by building infrastructure and offering amenities to attract workers—especially educated and skilled work force—to their cities. Such efforts range from festivals and parks to school reform and public safety. Younger people are often the focus, since they are more mobile in their migration patterns. In tandem, cities often couple amenity initiatives with employment strategies such as college internship programs with local firms, recruitment fairs and regional marketing.

Governments also compete in providing public services to business, and they also construct the regulatory and legal environment in which businesses operate. In considering where and whether to invest, businesses must often look to an uncertain future. In choosing where to invest, they accordingly prefer to have some certainty with respect to state and local government behavior toward business activity. They may ask themselves: Do the state and local governments seem to be committed to standing as an attentive and steady partner in providing services as businesses’ needs change over time? Or has the past record of state and local government been punitive and myopic in expanding business taxation when revenue shortfalls arise?

Midwest housing activity

The Midwest Builders Show and Conference met recently in Chicago. Home builders and home owners alike are quite attentive to the slowing home markets in the Midwest and in the United States. During the past 4 to 5 years of low or falling mortgage rates, home appreciation in most markets has been very strong, as has home building. Because Midwest population and income growth have been lagging the nation, home appreciation and new home construction in most parts of the region have not kept pace with the national average. The chart below documents the relative appreciation rates for median-priced homes in the Seventh District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin.

Click to enlarge image.

The benefit of lagging Midwest residential real estate is that, if national home activity and appreciation levels off or declines, the impact on Midwest communities and households will not likely be as severe as in places where such real estate has become inflated by speculative purchases. Strong housing markets have driven more of the employment growth in these regions so that a general cooling in housing construction may bring a modest convergence in employment growth rates. Re-building areas such as parts of Florida, Mississippi and New Orleans are excepted, of course.

Speculative activity aside, there is little doubt that a region’s fundamental economic growth also determines residential building activity and appreciation. The charts below examine recent residential appreciation and building (i.e., permits for building) in large metropolitan areas of the Midwest. Both of these measures are plotted on the horizontal axis versus a growth index on the vertical axis. The growth index is an equally weighted sum of population growth (annual year over year) and employment (fourth quarter year over year) from 2004 to 2005.

Job and population growth in Minneapolis-St. Paul and Chicago have led home appreciation; lagging economic growth in Detroit and Cleveland has done little for their respective residential markets.

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Economic Development Strategy

What is regional economic development? Economic development is a set of strategies (EDS) that try to improve the well-being of people who live in an identified place. Conceptually, the place may be a region of the world, a nation, a sub-national region, a state, metropolitan area, city, or neighborhood. In the United States, EDS are most often applied to geographic areas that are smaller than the national level, especially from communities on up to states or multi-state regions.

We can think of several very general EDS along the following dimensions:

  1. Enhancing economic opportunities for people in a specific geographic area through heightened labor demand (e.g., usually through jobs development or the attraction of firms and capital); i.e. “bringing jobs to people.”

    The marketing and promotion of regions are common EDS, along with more fundamental fashioning of a region’s business climate to attract investment and firm start-ups. An understanding of decisions about firm location and investment location is important for those regions that attempt to hike local labor demand by lowering firm costs of doing business through favorable tax or fiscal incentives. A useful introductory collection of essays on firm location decisions and economic policy can be found in Henry W. Herzog, Jr., and Alan M. Schlottmann, 1991, Industrial Location and Public Policy, Knoxville, TN: University of Tennessee Press.

  2. Improving workforce skills and education, thereby creating opportunities for people to qualify for existing jobs.

    The literature here is vast and varied. For a broad policy perspective, see the essays on returns to education by Nobel Laureate James J. Heckman. Among his recommended policy interventions are to “catch ‘em while they’re young” (invest in early childhood education), though his writings are nearly comprehensive concerning other possible actions such as adult workforce training and the efficacy of school reforms (e.g., voucher programs).

  3. Accomplishing both of the above for an economically depressed area.

    Perhaps to meet the most common demand for an economic development strategy a region would need to employ a dual approach. That is, to raise local work force skills at the same time that local job opportunities are created for those skills. Obviously, this is a tall order, especially in that these two achievements most likely must take place in the same time period.

  4. Linking more closely existing jobs or labor demand to available workers through several means.

    These would include providing easier transportation (more convenient commuting), greater affordable housing closer to job sites, and improved labor market information or lower transaction costs for filling or matching existing jobs. The so-called jobs mismatch hypothesis suggests that housing segregation or residental building patterns isolate low-income workers from job opportunities.

    For an introduction to academic studies of jobs mismatch, see Katharine L. Bradbury, Yolanda K. Kodrzycki, and Christopher J. Mayer, 1996, “Spatial and labor market contributions to earnings inequality: an overview – Special Issue: Earnings Inequality,” New England Economic Review, May-June.

  5. Having people migrate to outside regions of greater opportunity.

    Such a strategy is seldom advanced by politicians and policymakers. Local residents, even in depressed areas, rarely want to leave their home regions, and local politicians do not often find it in their interests to encourage “their votes” to migrate. Yet, migration is an important mechanism to improve well-being on the world stage, and in highly mobile places such as the U.S.

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Looming Crisis or Tempest in a Tea Pot? State and Local Government Pensions

State and local government pension obligations have been growing at a rapid rate. Payouts from major public pensions rose by 50% from 2000 to 2004 to $118 billion according to the U.S. Census Bureau . While this payout only represented a little less than 2.5% of total 2003 state and local government spending, the picture may worsen as aging government work forces reach retirement age in greater numbers.

There are nearly 14 million state and local government workers and six million current retirees who are owed more than $2.3 trillion dollars in eventual pension payouts by more than 2,000 different governments. Strains to make these payouts will be especially acute for those governments that have not kept their contributions current in funding obligations and where economic growth is lagging, such as parts of the Midwest. In such regions, government cannot outgrow its obligations through economic and population growth, but must rather dig deeply into current spending on public services or raise taxes to meet the pension obligations of the past. Not a promising recipe for a revival of growth and development in lagging regions.

How this pension crisis occurred and what can be done about it will be the focus of a half-day program organized by Rick Mattoon to be held at the Chicago Fed on February 28, 2006 (conference announcement and agenda)and cosponsored by the Civic Federation and the National Tax Association. At this event, pension experts will describe the current condition of state and local public pensions and offer some solutions for returning fiscal balance. Issues that will receive particular scrutiny will include:

  • To what extent are today’s pension systems funded, especially in the Midwest? What are the demographics of the state and local government work force and the attendant size of the potential pension funding stress? What are the resulting implications for general fiscal stress and strain?
  • How do public pension systems compare with private pensions and Social Security? Can and should they be structured differently? Most public pensions are still “defined benefit” plans where payouts are guaranteed over the retiree’s lifetime regardless of contributions. Should pension benefits for future retirees be changed to reflect their actual contributions?
  • What will be the likely financial impact of new accounting regulations that will require governments to recognize non-pension retiree expenses such as health care costs as future liabilities?

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