Manufacturing and regional policy

The manufacturing downturn that began the current decade affected the Midwest more severely than the rest of the nation. In response to recent manufacturing decline, at least one consortium of manufacturers is now forming on a region-wide basis to share best practices and to promote manufacturing in the Midwest.

As measured by manufacturing employment, the combined declines in the Seventh District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin were very sharp. The chart below shows a decline of 18.7% in the Seventh District since 1999, accounting for a net job loss of 616,900 workers in the sector. The pace of these declines was roughly in line with the national experience. However, because the region is so highly concentrated in manufacturing, the sting of manufacturing decline was sharper here. The second half of the chart below recasts manufacturing job loss in the region, weighting it proportionately by the higher concentration of manufacturing in the region versus the overall United States. In doing so, the index suggests that the impact of the actual 18.7% decline in the Midwest was similar to that of a 25.7% nationwide decline.

Source: Bureau of Labor and Statistics/HAVER Analytics

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Manufacturing job losses may also be magnified in the Midwest to the extent that ancillary activities to manufacturing are lost, such as transportation, warehousing, and the business services purchased regionally by manufacturing companies. Estimates are that, for each $1 of manufacturing production, manufacturing companies spend another 33 cents on purchased services.

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Export Growth Propelling Seventh District

Some of the Seventh District’s slow economic growth earlier in this decade originated with softness in U.S. exports abroad. The manufacturing sector continues to account for the lion’s share of U.S. exports, especially capital goods such as high-tech electronics and computing machinery, as well as industrial machinery and equipment. As global economic growth has recovered, so have U.S. exports abroad. In turn, parts of the manufacturing-intensive Seventh District economy are being carried along.

Nominal U.S. exports abroad experienced rates of decline of 6.3% and 5.2% for 2001 and 2002. Since then, as the economic growth of our major trading partners has generally accelerated, U.S. export growth has responded, averaging 7.7% over the past three calendar years.

As a group, the Seventh District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin are on par to slightly above the nation in export intensity. The chart below measures relative export intensity as the value of exports originating in Seventh District states as a share of total product.

Source: WISER/HAVER Analytics

Michigan and Indiana lead the group due to their sharp industry concentration in automotive activity. Automotive production in North America stretches from Ontario through the Midwest into the mid-South and Mexico, with extensive cross-shipment among NAFTA partners Canada, U.S., and Mexico in both auto parts and finished vehicles.

The table below ranks the principal export industries in each state. Transportation equipment ranks number one in Indiana and Michigan. Moving westward, however, Illinois, Iowa, and Wisconsin all have nonelectrical machinery as their number one export category. Here, products such as industrial equipment and machinery for farming, construction, and mining are dominant.

Source: WISER/HAVER Analytics

Strong export growth has led overall economic growth in the Seventh District over the past two years. As a whole, nominal exports rose 15.2% from 2003 to 2005, exceeding overall U.S. export growth of 10.5%.

Source: WISER/HAVER Analytics

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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.

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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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Midwest labor markets: Not as bad as we thought?

By now, it is common knowledge that the Midwest labor market is softer, on average, than the rest of the nation. In our Seventh District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin, the unemployment rate has been running one half percentage point higher than the nation for the past two years. Reported payroll job growth has been running poorly as well—at approximately one-half the national rate. The Midwest’s manufacturing sector has also been weak, dragged down by ongoing restructuring among domestic car makers and parts suppliers.

This March, a glimmer of better news was delivered by the U.S. Bureau of Labor Statistics, who rebenchmarked revised monthly state payroll job numbers back from December 2005 to January 2004. The BLS rebenchmarks the employment data each year to take into account more comprehensive data that becomes available on the number of jobs in each state.

Recent revisions boosted the two-year growth of total employment for the Seventh District, while the U.S. was revised downward slightly. The chart below displays revisions by state from the fourth quarter 2005 back two years to the fourth quarter of 2003. After revising District jobs upward by 78,000 for the fourth quarter of 2005, job growth was found to be 1.5% versus 1.0% prior to revision. U.S. payroll jobs were revised downward slightly (by 158,000). Even after this convergence, the pace of reported job growth for the District lies at one-half the national pace!

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On the beleaguered manufacturing side, favorable revisions were repeated. District manufacturing jobs were revised upward by 13,000 for the fourth quarter of 2005, which raised the pace of decline from a 1.2% decline to a 0.7% decline. For the U.S., revisions eliminated 54,000 jobs, and lowered the pace of growth from –0.3% to a 0.7% decline, thereby matching the District pace over the two-year period.

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In may seem incongruous that pace of the the District’s manufacturing sector matched that of the U.S., while the District’s total employment growth was only one-half of the U.S. This results from the fact that manufacturing jobs are much more concentrated in the District—by about 43%. A falloff in District manufacturing activity is also keenly felt across service sectors such as transportation and distribution.

Considerable statistical noise remains in these numbers. Next year, the payroll numbers will be revised once again, and these revisions will include the fourth quarter of 2005. This means that the payroll job performance reported here will also be revised. Stay tuned.

Auto Parts Issues & Conference

A conference discussion on the issues facing automotive companies, workers, and communities will be held on April 18–19, 2006, in Detroit, at the Chicago Fed’s new branch building. The conference will center on the auto supplier industry. Suppliers employ three times as many workers as assembly operations, but as an industry, it is little known to most of us. However, as assembly operations are changing owners and shifting geographically, the responsive behavior of auto suppliers will have important implications and impacts for many Midwest workers and communities.

One of the conference organizers, Thomas Klier of the Chicago Fed, has been studying the behavior and geography of the North American automotive industry for over a decade. During that time, never have the questions and uncertainty about the industry’s future footprint in the Midwest been as portent for the region’s economy as today. The traditional assembly companies (the Big Three) and their (more-sizable) suppliers have been pulling in production from the coastal United States to the Midwest. At the same time, the Big Three and suppliers have seen their market share shifting southward from the Midwest to transplant assembly companies and their suppliers. This leaves the upper Midwest with an ever-greater concentration of the most vulnerable segment of the North American automotive industry.

Thomas offers the following analysis of the shifting geography of Big Three and transplant assembly operations to put this matter into perspective.

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Chicago Survey

Chicago is arguably one of the most-studied places in the world. The origins of this examination likely began with the world’s interest in Chicago’s rapid growth following the Great Fire over 100 years ago, and the subsequent phoenix-like re-birth. Serious sociological study of neighborhoods began with Jane Addams’ documentation of immigrant enclaves here and with the venturing of the University of Chicago’s social scientists outward from Hyde Park. This tradition continues today by social scientists, political scientists, and economists of every stripe. At least two periodic conferences that I know of examine Chicago. Some one-time Chicago self-examinations coming up this year are in celebration of the 97th anniversary of the publication of the great Burnham Plan of Chicago.

And so, any journalist setting out to survey Chicago’s position and prospects is favored in having many people to interview and much source material to draw on. The downside is that, in drawing conclusions and implications, there are also many experts peering over the journalist’s shoulder prepared with well-informed critique. Such a journalist, then, will either be highly accomplished, or else should have a great store of hubris.

Journalist Johnny Grimond of The Economist has just written the first survey of Chicago and its surrounding area for that well-respected magazine since 1980. For the most part, the survey article is about all that could be hoped for by the denizens and students of Chicago. In some respects, it is a love letter to Chicagoans. The prism of comparison of Chicago today to the Chicago of 1980 reveals a city that has moved on from economic despair and survived a period of profound economic restructuring and political turmoil. In this perspective, its achievements are remarkable. Unlike other industrial belt cities, Chicago has survived the greater region’s manufacturing decline and replaced it with high-level service functions and urban livability. Moreover, in doing so, much of its success has emanated from a revived central core outward, rather than becoming solely a suburban ring economy.

Rather than further re-hash the survey article’s findings, I suggest you have a look at it and perhaps contribute your opinions about it here. In my opinion, it will be shame if The Economist‘s survey does not provoke a broader dialog among Chicagoans about the future and what, if anything, to do about it. What do you think are Grimond’s errors of commission and omission in assessing Chicagoland and its prospects? Is Chicago poised for prosperity, or has it merely experienced a short-lived respite from long-term decline?

At the end, Johnny Grimond notes a few possibilities for further success, namely further development of its professional services sectors and better commercialization of its educational and technological assets. However, Grimond is somewhat pessimistic in observing that the Daley era may be coming to an end, with nastier politics ahead and no evident leadership handoff in sight. And like its counterparts, Chicago has not cracked the puzzle of easing inner-city poverty and upward mobility. And so, he concludes that “Chicago’s current success may be about as good as it gets.… Chicago, like almost all America’s older cities, still faces the prospect of decline, or at best stasis, unless it can find the elixir of urban life—how to grow richer without growing bigger.”

What do you think?

Global Chicago: Da Bulls, Da Bears, Diversity

Chicago United is a 38-year old group devoted to “Enriching the economic fabric of the Chicago region by building sustainable diversity in business leadership.” On March 10, I participated as a panelist at the first of a three-part series titled “Chicago: A Global City, A Global Perspective on Diversity.” Together with my co-panelists Paul O’Connor and Saskia Sassen, we addressed whether Chicago had become a global city and, more importantly to the Chicago United audience, whether Chicago was working effectively from the standpoint of diversity as a business imperative in the global marketplace.

Here are my thoughts, though I’d like to hear yours as well!

The Chicago metropolitan area (Chicago) lies on the razor’s edge with respect to its future. So-called globalization lies at the heart of what has brought Chicago to its critical crossroads. To put it simply, depending on both its own actions and on the fates, Chicago can possibly become a backwater business capital city of a shrinking and largely unimportant region of the United States. Alternatively, Chicago can become an independent city of global importance, a city that attracts the world’s most talent business makers, artists, policy makers, and idea-creators. As such, Chicago could even become the portal that helps revive a surrounding Midwest region which is sorely in need of revival and re-invention.

Globalization means that the world’s economy has become more integrated and intertwined, and its regions more subject to frequent and profound shifts and changes. This is so because communication costs and transportation costs have fallen dramatically. For example, costs of shipping a ton of cargo dropped by three-fold from 1920 to 1960, and containerization and transport by larger and larger ocean-going ships continue to pressure prices downward today. Air shipping costs have dropped by 80% since the mid-1950s. And while many of us complain about airline deregulation and recent security procedures, personal air travel is now much more affordable to average Americans.

Communications cost declines are even more dramatic. The cost of a three-minute phone call from New York to London was once the equivalent of $350 in 1930 in today’s terms. These same communications facilitate both cargo and personal logistics, as well as propelling traded services, information, and capital around the world.

On top of this, most of the world’s nations have agreed to lower barriers to the flow of goods, capital, intellectual property, and sometimes travel and immigration.

How has globalization impacted Chicago? The pressures and challenges are great. Chicago can be characterized as the business capital city of a shrinking economic region. Chicago was borne of the gathering of farm products and natural resources, the sorting and shipping of these products, the financing of these products, and the supply of business and legal services to farms and agri-businesses throughout the Midwest.

In parallel, Chicago became a great manufacturing city as result of its transportation/hauling capability and facilities. Chicago gathered Midwest resources and transformed them more productively than any place on earth. So did other Midwest cities, but Chicago also became the business capital of these lesser cities in supplying them business, financial, and legal services.

Without belaboring the point, these same activities are today shrinking as sources of household income and jobs for both Chicago and its surrounding Midwest. For the most part, technical progress has diminished the need for workers here in Chicago in these activities, even while the attendant productivity gains have raised standards of living both here and around the nation. Growing world trade and import competition have contributed to local pressures and shrinkage. Prices for commodities and routine manufactured goods have declined, too, as both farming and manufacturing have become hugely productive—victims of their own success. And so, income and job growth generated from these activities are now weaker.

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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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Rural Economies and Globalization

Rural economies in the U.S. are on the front lines of the upheavals associated with globalization. Many rural economic engines are based on commodity production and traded goods—namely, routinized manufactured products and production agriculture. Such industries are coming under competitive pressure from overseas economies that often enjoy significant cost advantages. These are also the types of production activities that regularly experience sharp productivity gains—and attendant labor efficiencies—as a result of technical progress. As a result, many rural work forces are shrinking; rural economies are, on average, underperforming metropolitan area economies. In response, rural areas are searching for ways to become innovative in nature rather than commodity-based as a way to stay vibrant.

The Global Chicago Center of the Chicago Council on Foreign Relations recently convened its second in a series of meetings intended to assist print journalists connect global events with their readerships. The Global Chicago Center has fashioned a web-based guide for media so that local experts on global affairs can be readily sourced by local journalists. This particular meeting in Chicago focused on newspaper journalists in rural regions of the Midwest. Experts and analysts of rural regions met with the journalists to discuss the ways in which globalization is affecting rural economies and what, if anything, can be done about it. For some rural regions, the answer to the latter question is not much.

Due to high productivity on farms, which has helped give Americans the world’s highest standard of living, production agriculture employs relatively few people. Indeed, farmers account for only 2 percent of the U.S. work force and only 11 percent of rural population.

Manufacturing now dominates many more rural counties than does agriculture, but the type of manufacturing activity there is vulnerable to global competition and displacement. Over the past 50 years, manufacturing plants locating in rural areas have been seeking a low-cost environment and high-quality but lower-skilled rural workers. Nonetheless, technological progress and heightened global competition often have an adverse impact on these operations. As the figure below shows, metropolitan economies in the Seventh District are easily outperforming nonmetropolitan areas on average.

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Innovation in Electric Power?

Electric power is often considered the most transformative technology of the past 100 years. Its near universal adoption in our homes and workplaces (e.g., to power appliances, communications, and computers) is indeed remarkable. As a result, the electric industry today boasts $600 billion in assets in the U.S., as well as yearly sales of $260 billion (double that of the telecom industry). However, many believe that the business model by which the U.S. and Midwest produces and delivers electric power is outmoded and subpar. Movement toward a more competitive framework can be expected to produce innovations that would achieve significant cost reductions, greater reliability, and a cleaner environment.

The executive director of the Northeast-Midwest Institute, Dick Munson, has recently written a book entitled From Edison to Enron, which recounts the history of electricity and suggests an innovation-based vision for the future of the power industry.

In it, Munson describes major shifts in the electric power industry since its inception. At the dawn of the twentieth century, Chicago mogul Samuel Insull combined many small neighboring electric generation facilities, which achieved economies of scale and balanced loads throughout the day. In doing so, Insull was able to lower prices and increase reliability, thereby expanding the market and use of the product. At the time of his company’s peak in the 1920s, it served 4 million customers in 32 states.

Insull’s innovations transcended the physical production process. Tired of dealing with (and compensating) many local governments for the rights to serve fragmented local markets, Insull successfully pushed for state level regulation of electric power. And so, the state-regulated monopoly model eventually became the national norm. This bargain provided reliable power at regulated prices to consumers in return for state-sanctioned rates of return on investment for utility owners.

Though this model remained intact for most of the twentieth century, Insull’s business empire eventually collapsed amidst charges of corrupt business practices. Munson draws a thoughtful parallel between Samuel Insull’s business and Kenneth Lay’s Enron Corporation. Laying aside the later collapse of Enron, its futuristic business model for electric power production and delivery, trading across the broad geography of the United States, continues to shape the industry today. It is a model of competitive power production and, in some instances, competitive delivery, in which individual power producers have the incentive to innovate because they have a broad market in which to sell their product.

What are the possible gains (i.e., possible innovations) in following this new business model? According to Munson, the costs to businesses of power interruptions are on the order of $120 billion per year under the existing state-regulated monopoly model. Yet, under this older model, almost no research and development (R&D) takes place by the industry. At a recent book chat at the Chicago Fed, Munson said, “Last year, R&D expenditures by the dog food industry exceeded those of public utilities.”

Munson believes that we are on the verge of a vast array of innovations, if only they are not blocked by existing legislation and the old business model. In particular, progressive techniques for co-generation and other recycling of energy and waste energy are capable of producing remarkable efficiency gains. For instance, Scandanavian countries such as Finland are leading the way in co-generation, achieving upwards of 80% energy efficiency in electric power–heat production. And from an environmental perspective, efficiency gains from such techniques are every bit as “clean” as those touted from alternative fuels.

The Great Lakes region could become a leader in reforming its power industry if it chose to do so. However, if the region is to acheve a workable model of competition, a large and well-managed infrastructure must be put into place which would allow buyers and sellers to readily trade electric power (link).

In the meantime, the monumental price-spike disaster in California five years ago, following its experiment to decouple power production from the distribution of electric power, continues to give policymakers great pause. For instance, Illinois passed the Restructuring Act of 1997 that began to decouple power generation businesses from the power delivery and service businesses. In northern Illinois, very large customers (e.g., big corporations) began to negotiate their own purchases of electric power, while their local utility company typically maintained the responsibility for delivering it. For smaller customers, particularly residential customers, decoupling was deferred until 2007, and rates were frozen (actually lowered 20 percent) until that time. In the meantime, independent power producers were encouraged to get on to the delivery network. After 2006, the utility company, Commonwealth Edison (CE), will act as a purchasing agent for residential customers, buying power from independent producers through an auction process and passing along both distribution charges and power costs to consumers.

After the rate freeze expires, CE will require a rate increase to pay for its infrastructure investments in the distribution system since 1997. In 2005, some critics feared that the particular process by which CE would bid for power would raise customer rates unduly. And so, the prospect of a price spike for residential customers when the price freeze expires contributed to an outcry over CE’s plans to move to the auction process in 2007. Nonetheless, plans for this next phase of deregulation were approved by the state’s regulatory authority.

Much like residential and small customers in most of the nation, those in Illinois have enjoyed a long period of stable or declining prices. From 1995 to 2005, the real or inflation adjusted price of electric power has declined by an annual average of 4.4 percent. Of course, electric bills have climbed along with the increasing consumption of electricity in powering home electronics and electrical appliances.

The chart below displays average electric revenues (so-called average prices) for providing electric power to residential customers in the Seventh District states. Price rises since have been tame or have declined in real terms.

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