Category Archives: Cities

Congestion tolling and privately operated roads—An idea whose time has come?

As our roads become increasingly congested, tolling and privatization of highways will be increasingly important lifelines, especially for large urban economies. The idea that motorists should pay tolls when driving on congested highways has long been advocated by economists. Conceptually, the “public” part of highway transportation is limited to the necessary intervention by public authorities to strategically acquire land for transportation and assure that all have access to travel freely in pursuit of commerce and recreation. However, the individual’s use of a roadway is often “private” in that it imposes congestion costs on other drivers (and some pollution as well). That is, in the motorist’s decision to use a road, the individual driver does not consider the congestion costs imposed on other drivers, thereby leading to the overuse of limited public roadway capacity. As a remedy, congestion tolls bring these individual driving decisions back into line with the greater public good. As the degree of road use (and congestion) varies by time of day and by day of the week, so should the amount of tolls vary accordingly.

After a long hiatus, interest in congestion tolling and privately operated roads has been climbing. European and Asian cities have made innovative headway in congestion fees. Both Stockholm and the City of London have implemented motor vehicle charges for the privilege of access to their central area; so has Singapore. Most recently, New York City has proposed to charge auto motorists $8 for the privilege of driving around Manhattan during peak traffic hours, with higher fees for those driving trucks.

Such actions are largely being spurred by rising congestion—which did not materialize overnight. The Texas Transportation Institute (TTI) creates a “travel time index” that indicates the relative change in travel time from peak traffic to free-flow traffic. In a TTI report, Chicago in 1982 had a travel time index of about 1.2, meaning that given a 40-minute commute during a free-flow period, a person driving during peak hours would drive about 48 minutes (20% longer than it “should” take). This had climbed to 57 percent longer by 2003. In four major cities of the Seventh District, the added time to a commute during peak hours has increased from 14% in 1982 to 46% in 2003.

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Prior to the recent spate of toll programs, some highway authorities experimented with non-price-rationing measures such as “high occupancy vehicle” (HOV) lanes. To curtail congestion, HOV lanes set aside and dedicated freeway lanes to those vehicles, including cars and buses that have multiple occupants. Unfortunately, the results were sometimes disappointing in relieving congestion because HOV lanes merely attracted vehicles that already contained multiple occupants, without prompting a significant number of single-passenger motorists to carpool. So, too, the dedicated HOV lanes, while often uncongested, tended to push even greater congestion onto unrestricted lanes of the highway.

In response, the so-called “high occupancy toll” or HOT lanes have sometimes been called into action. HOT lanes are essentially HOV lanes that allow single-occupancy vehicles to motor in them—but for a price.

What has brought us to this state of affairs? Under the best of circumstances, motorists prefer to drive when and where they choose at no charge. But Americans’ penchant for driving has far outrun our financial ability to build roads. Lifestyle changes have tremendously raised the miles traveled in cars by U.S. households. Rising household incomes have lifted the desires for ever larger houses and lots, which are, in turn, often satisfied by homes located quite far from work sites. In addition, owing to the desire for residential privacy, homes are often built on dead-end or nonthrough streets, which has aggravated traffic on the major arterial roads surrounding residential communities.

Also, the rising trend of two-earner households makes it difficult for both earners to simultaneously live near their workplaces. More generally, there are extensive logistics (and driving miles) for today’s American family to coordinate their many trips for work, shopping, education, and recreation. By one estimate (DOT), highway travel miles climbed 23.4% from 1995 to 2005 in comparison to a population increase of 11.4%. To accommodate such rising traffic, road expansion has climbed by only 2.6% over the same period.

Many observers recognize that improved community land use planning could help curtail our appetite for driving. For example, allowing developers to build high-density apartment-type residences around existing commuter rail stations would allow at least one of a household’s commuters to keep a car parked during the workday commute. So, too, stronger community planning efforts to assure that households of modest means can find affordable housing could help curtail the need for very long commutes. In the Chicago area, for example, policy think tanks such as Chicago Metropolis 2020 and the Metropolitan Planning Council spearhead efforts and programs that promote such community planning. Still, however sensible such planning may be, there has been very little of it implemented in many U.S. cities to date, and so, the increased commuting has often overtaken existing roadway capacity.

In past decades, state governments have often tried to keep pace with rising demands for driving and for far-flung housing by building more roads, including freeways. Several forces are now conspiring to slow such construction, especially tight fiscal conditions. The primary source of highway grant assistance to states, the Federal Highway Trust Fund, is replenished from the federal tax on gasoline. But the tax of 18.4 cents per gallon has not been raised since 1993 so that while revenues do rise somewhat along with vehicle miles traveled, they do not keep pace with rising gasoline prices and higher milage automobiles. Meanwhile, the revenue resources of state governments have also been besieged. Many state gasoline taxes are themselves imposed on a stagnant “cents per gallon” basis, and the voting public strongly resists the raising of gasoline taxes—especially as motor fuel prices have put increased pressure on household budgets over the past three years.

This leaves state government officials in a quandary, since the costs for competing public services, especially health care, education, and prisons, are concurrently squeezing state budgetary funds. State and local governments are hard pressed to even maintain existing highways, let alone fund expansions to curtail growing traffic congestion.

In addition to charging tolls, elected officials are also responding by increasingly turning to the private sector to assume responsibilities that include the financing, planning, marketing, construction, operation, and pricing of roads and bridges. Many combinations and arrangements of these functions are being attempted, from simple outsourcing of management and toll collection of highways to the all encompassing long-term leasing of highways as a publicly regulated private business entity.

Increased congestion and financial stress are not the only reasons behind the privatization and tolling of transportation infrastructure. New and improved technologies for payment of highway tolls have recently come to the fore. In contrast to the driver of yesteryear who had no option but to deal with the delay-plagued coin and cash toll booths, today’s driver can often make payment with little or no slowing down. Toll payments can be made online by transponders carried within vehicles or offline by remiote reading of license plates.

Seventh District initiatives lie at the recent epicenter of these movements in the U.S. In particular, the City of Chicago entered into a 99-year lease to a private consortium in 2005, turning over operational responsibility for and revenue returns from an 8-mile stretch of toll highway called the Chicago Skyway. By many accounts, the City benefited greatly from this transaction, while the public interest of drivers was also well served by enhanced operational efficiencies. The City of Chicago used income from the deal to retire existing debt on the Skyway infrastructure, and with the remaining revenue, it also set up a trust fund and purchased a sizable annuity that will help finance the city’s general operating funds well into the future. The driving public now enjoys rapid roadway maintenance and toll collection and eased congestion, albeit with prospective increases in toll fees.

Following Chicago’s lead, the Indiana Finance Authority leased its east–west toll turnpike for $3.8 billion in 2006. In large part, Indiana will use the proceeds to fund and maintain highway infrastructure throughout the state.

Meanwhile, in an effort to reduce rush-hour congestion around the Chicago area, the Illinois Tollway Authority introduced differential time-of-day pricing for only trucks in 2005. This program also doubled tolls for drivers in autos who choose to pay by cash at toll booths rather than by electronic transponder as they drive through rapidly. Revenues from these schemes are being used for repairs and expansion of the tollway system; they are also being used for the capital costs of new and reconfigured “open road” (or no-stop) toll collection system, which enables vehicles to pay tolls while traveling at highway speeds.

As the Illinois Toll Authority and other examples show, privatization and tolling of roads are separable actions. But in some ways they reinforce one another. Turning one’s operations over to private companies may provide one way to overcome the public’s resistance to congestion pricing, especially in contrast to government authorities who may be encumbered or distracted by non-transportation responsibilities or political constraints (i.e., the lack of political will to appropriately price use of the asset). Privatization potentially may also allow the operational authority to change pricing regimes and payment technologies more quickly in response to changing roadway conditions. Also, cost efficiencies and service quality are presumably improved when private agencies are watching the bottom line, though this has not always proved to be the case.

Still, the issues inherent in privatization schemes are contentious with respect to both purported operational efficiencies and sound fiscal management by governments. In awarding operational and pricing autonomy to private companies, it is not always clear whether the public interest is less than optimally served in favor of the profitability of the private operator. In particular, monopoly-type pricing by a private operator may be worse than publicly directed underpricing of congested facilities. Similarly, the data collected from the publicly rather than privately operated system may be more readily available for systemic public land use and transportation planning across entire metropolitan areas. For these reasons, as they enter into such partnership arrangements, elected officials must carefully craft contract terms and then follow up by monitoring the private companies during the terms of the contract.

Other concerns center on the behavior and actions of governments when they first enter into such agreements. Upfront revenue windfalls from the leasing of public infrastructure may cloud the judgment of governments and elected officials. Without proper disclosure and oversight of government by the public, the sale and leasing of transportation infrastructure to private buyers may pander to the near-sighted proclivities of elected officials. To plug current budget holes, or to plump up current spending for self-motivated reasons, public officials may unwisely commit large revenue streams immediately received from the sale or lease, while concurrently widening future budget deficits by eliminating public revenue streams. As always, the voting public and their representative think tanks must be on guard to oversee the terms of public–private partnership arrangements.

Elected officials must also represent and protect the public’s interests in matters of fairness and equity. Lower-income households are those who will be disproportionately burdened to pay for the use of less-congested roadways. In many ex-urban and suburban places, lower-income households must travel long distances to access their workplaces. Equity concerns are often compelling, since these workplace commutes are often lengthened by land use restrictions undertaken in high-income communities that limit the availability of affordable housing near work sites.

In response to equity concerns, some states and localities are adding capacity and subsidies to public transportation—both light rail and buses. When funding is short, as it usually is, governments often earmark part of highway toll revenues to such dedicated purposes.

However, for many households, public transportation is not an option. According to the 2000 U.S. Census, only 4.7 percent of workers currently use public transportation. The table below shows average usage of public transportation for Seventh District states. Public transportation is, of course, more viable in densely populated places, including large cities such as Chicago. Since large cities also coincide with highway congestion and tolling practices, the use of tolls to fund public transportation subsidies will work better there.

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The use of congestion pricing, privatization, and new payments technologies remain in their infancy. Yet, because of the ever-increasing demand for driving, accompanied by little highway expansion and poor land use planning, heavy congestion will soon be a reality in many communities. For this reason, the Federal Reserve Bank will hold a one-day workshop this June to understand how pricing schemes, public–private partnerships, and emerging payment mechanisms can be used to address congestion and efficiency in commuter networks.

Sports Franchises and Urban Development

Are there worthwhile benefits to large urban economies from professional sports franchises and events? Critics are especially hostile to the idea of tax breaks, incentives and other public subsidies to sport franchises and events. At best, they claim that local spending on sports events displaces local spending on other activities, with no net impact on expenditure or income. Worse, they claim that public monies spent or foregone to subsidize sports franchises or events could have otherwise been more productively spent on enhanced public education or the like.

In rebuttal, there is another school of thought that posits that the changing nature of urban economies has heightened the value of recreational amenities as a draw for coveted workers. As the productive basis of city economies has shifted away from the manufacturing and distribution of goods, and towards a greater focus on information exchange by skilled and educated workers, some policy analysts argue that the successful workplace location is now driven by where people want to live rather than by its strategic location for moving materials.

In some instances, major league sports teams and professional sports events, such as the Super Bowl, can be counted highly among cities’ “public goods” amenities that attract and retain productive workers. In this, sporting events may be among several amenities whose sum total is more than the some of the parts because a large city’s varied restaurants, museums, cultural diversity, arts, and sports all go into making it “an interesting and exciting place to live.”

The measurable evidence on this effect is sparse, but several statistical studies have found favorable impacts. A thorough and balanced review of studies has been conducted by Mark Rosentraub. No doubt that many subsidies are ill-conceived. But Rosentraub concludes that the net value of a sports investment by the public sector rests on its context and the particular outcomes for the city and county making the investment. For example, the placement of publicly-subsidized stadiums in downtown areas have been found to help enliven and revive struggling downtowns. Another study found that Indiana residents valued the intangible benefits of having the Indianapolis Colts sufficiently to justify public subsidies. And in a statistical study across metropolitan areas, Jerry Carlino and Ed Coulson found that households tend to pay higher housing rents in metropolitan areas that choose to host sports franchises. Apparently, the value of nearby sports activity affects land and housing congestion that arises as greater population is attracted to such sports-minded places.

Among the most intangible, most difficult-to-measure benefits attendant to sporting events are the advertising or marketing values associated with the opportunity to re-cast a city’s image to a national or international audience. Places whose images become distorted or unfairly known due to their past travails may especially view large sporting events as valuable in setting the record straight.

In particular, an enhanced image may be helpful as businesses consider investment decisions and as workers consider various recruitment offers. The City of Detroit, for example, went to great pains and took great pride in successfully hosting the Superbowl XL in their new stadium situated amidst extensive downtown renewal.

This year’s two Super Bowl contestants, Chicago and Indianapolis, likely welcomed the media coverage of their cities deriving from both the Miami telecast and from national pre-game media hype. Chicago has been working to boost its image as a national and global city having superior amenities and functionality. In fact, it is one of two U.S. cities still vying to host the 2016 Olympic Games.

Meanwhile, Indianapolis has been pursuing sports-minded economic development for quite some time. During the 1970s, the city began to boost its support for amateur sports facilities and events, meeting some success in hosting the Pan American Games in 1987 and, among other things, it is now the headquarters locale of the National Collegiate Athletic Association. During times when high-profile events are not taking place in Indianapolis, its sports facilities are often in use by young athletes who come to town (often with their families), patronizing the city’s hotels and restaurants.

Despite scoldings by the majority of public policy analysts, many of which are well-founded, some cities still see gold in them thar’ games!

Chicago’s Pursuit of the Global Prize

Policy and business leaders in Chicago continue to advance the metropolitan area’s prospects as a global hub for professional and financial services. This initiative arises from both necessity and opportunity. Chicago’s traditional markets, principally in the surrounding Midwest, are not growing rapidly. At the same time, however, the Chicago economy specializes in advanced producer service sectors that are increasingly traded more broadly and, in many cases, internationally.

As the business service center of the Midwest, serving regional markets and industries, Chicago companies’ prospects for growth are somewhat limited. That is so largely for two reasons. First, the Midwest economic base centers on agriculture and manufacturing. Since productivity growth is so very high in these industries, and competition keeps commodity prices low, income and revenue (and attendant jobs) grow slowly. The second reason is climate. As the U.S. economy restructures toward information industries and knowledge workers, service production is being pulled toward locations where workers prefer to live, often milder climes.

However, globalization of the economy has also brought new opportunities to populous information-based cities like Chicago. Large cities often have wonderful amenities that are not dependent on climate, such as sports, restaurants, museums, and cultural diversity. But more fundamentally, it is because expanding global trade in goods, services, and capital requires the complex and specialized functions and industry sectors that are concentrated in large cities, including legal services, logistics, distribution, finance, insurance, business meetings, R&D, and professional business services.

Chicago has been developing such sectors almost since its inception. Today, Chicago features world-leading risk exchanges, universities, business meeting and personal air travel firms, legal services, headquarters facilities, and management consultancies.

During the 1990s, the growth of Chicago’s professional services was robust. According to the data reported on payroll employment, the Chicago metropolitan area added a net 80,000 jobs in the sector from 1990 to 1999, more than the Los Angeles metropolitan area and more than New York City.

However, since then, job performance in Chicago has often been much weaker, raising doubts about whether the city’s economic structure has divorced itself from the surrounding region as much as previously believed. The chart below displays year-over-year growth in the professional, technical, and R&D sectors. Employment growth experienced year-over-year declines for most of the 2002-2004 period, before reviving in 2005.

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How much of Chicago’s business service economy has expanded to global markets or even to other large U.S. cities in the global network?

We know very little about the geography and changing geography of these hallmark industry sectors. However, one informative study by Peter J. Taylor and Robert E. Lang of the Metropolitan Policy Program at The Brookings Institution measures the prominence of major global service companies among large cities in the world.

Taylor and Lang examine 100 global companies drawn from the business or producer sectors of accounting, advertising, banking/finance, insurance, law, and management consulting. For each city, the sum presence of their offices (weighted by size and function) determines a score for a city’s commercial presence and ties to the global city service network.

According to the Taylor-Lang study, Chicago scores high in its global connectivity, both relative to other U.S. cities and relative to the world’s major cities. Among U.S. cities, Chicago ranks second only to New York. Among world cities, Chicago ranks seventh, behind London, New York, Hong Kong, Paris, Tokyo, and Singapore.

The Taylor-Lang study scores Chicago’s connections with domestic cities such as Atlanta and New York in the same way it scores connections with international cities such as Sydney. This seems correct. International borders can be arbitrary. And to otherwise score border-crossings might bias the results toward cities located on continents where national boundaries are near each other, such as Europe.

The study does provide a separate “hinterland” scale for each city, which tries to measure the degree to which a city’s global connectivity relies on nearby national trading relations. Here, with the exception of New York City, U.S. cities tend to be less international than those on other continents. However, Chicago again scores well. It places third among U.S. cities, behind New York and Miami.

How this relates to Chicago’s recent growth performance and prospects is not clear. The construction of the Taylor-Lang study is creative, clever, and somewhat revealing, but it provides more impressionistic than definitive evidence of global linkages among producer services. Those who would like to draw their own conclusions from the evidence should take a look at the authors’ map of each global city’s linkages, including Chicago. Outside of North America, for example, the map suggests that Chicago’s economy links strongly with Zurich, Switzerland, and Sydney, Australia.

Chicago’s employment in business-professional services is once again growing strongly, at a 3% annual year-over-year pace. If the recent period of weak performance reflects some unusual and fleeting conditions such as a post 9-11 falloff in business travel and related business service activity, then perhaps Chicago’s march to global success will now continue.

A Chicago-Milwaukee Region?

Could cities located near one another, Milwaukee and Chicago for example, enhance their respective growth and development through closer linkages? Why might a greater Chicago–Milwaukee metropolitan area want stronger ties, and what policies, if any, might be considered to bring about such a union?

There are several reasons why larger metropolitan areas are generally leading U.S. economic growth. In recent decades, larger metropolitan areas have typically become more specialized in managerial and technical occupations, while smaller metropolitan economies have become more specialized in production activities. For example, one recent article found that those U.S. metropolitan areas having a population above 5 million had increased their concentration of management to production workers to 39 percent by 1990 from 10 percent in 1950. In part, this increasing concentration in larger cities is due to advances in communication and transportation that have allowed companies and organizations to administer and manage from a central location or to travel easily to multiple production locations.

In this light, it is understandable, then, that larger cities have also tended to grow more rapidly in terms of income and/or population. That is because specialized professional and managerial occupations tend to pay more than production. Moreover, since at least the late 1970s in the U.S., economic returns to labor, including wages and salaries, have generally been growing faster for managerial, technical, and other occupations attendant to higher educational attainment.

A second reason for such shifting specialization and growth owes much to the growth in work force participation of women. In the U.S., the labor force participation of working age women rose from 37.7 in 1960 to almost 59.6 percent today. Moreover, the educational attainment of women has also been rising such that it now exceeds men among the younger age cohorts. Since young singles tend to marry someone with similar education, this has given rise to growing numbers of “power couples” who often must find not one, but two, specialized jobs in the same labor market. Because large metropolitan areas have both deep labor markets and more specialized occupational opportunities, these places have become magnets for such “power couples.” In turn, firms respond to the greater labor supply of professionals by siting their establishments in larger metropolitan areas, and thereby transform local economies.

There are several reasons to keep an eye on the greater Chicago and Milwaukee areas to examine the prospects that they will someday become a single labor market and benefit from the attendant economies of larger scale and scope of such a merger. The Chicago and Milwaukee areas are only 86 miles apart, as measured from city center to city center. The Chicago metro area is more populous at 9.4 million as compared to 1.5 million in Milwaukee, but together they yield a population of 11.0 million.

Historically, Chicago–Milwaukee work force linkages have been limited. Only 13,000 Milwaukee residents commute to Chicago, daily, as of year 2000, up from 1,600 in year 1990. The reverse commute is even smaller. However, commuting in both directions is growing rapidly.

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Still, a closer look at some important subsectors of professional industry workers is suggestive of the greater work force that may soon arise from combination. The chart below combines industry employment for Chicago and Milwaukee metro areas across several professional, management and business service sectors. As combined, for example, employment in the Chicago–Milwaukee “computer systems design” sector would rank second to New York, allowing Chicago to bypass both the San Francisco and the Los Angeles metro areas. Other sectors of mutual benefit in Chicago and Milwaukee can be seen at the Midwest Economy website.

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While such stronger within-industry labor markets might be advantageous, the additional attraction across multiple sectors may be greater still. For households with members having differing but specialized occupations, the possibilities for a multiple match of people with jobs in a combined Chicago–Milwaukee metro area labor pool could be great. This would enhance companies’ ability to attract and retain skilled labor in both regions.

So too, not all jobs within the professional and business services sectors require the very highest educational attainment. For example, according to recent estimates of the U.S. Bureau of Labor Statistics, office and administrative support jobs comprise one-third of all employment in the combined professional services, finance, and management of companies when measured in industry sectors. So too, spin-off employment would also generate a wide range of local employment as the spending of added service professionals ripples through the local economy. This feature is especially important since job needs are great for lesser-skilled labor in both markets.

How might Chicago and Milwaukee push along their destiny as a combined metropolitan area? One low-cost way is to publicize their mutual proximity in marketing each region to prospective employers and to job recruits. Both Chicago and Milwaukee are highly active in economic development marketing. Of course, private sector employers and employment intermediaries may also be effective in spreading such information about the greater breadth of employment opportunities.

Another policy avenue may be greater investment in transportation between the metro areas that would facilitate commuting flows. Both interstate highways and train transportation are now in service. The possible labor market advantages of easier and more dependable auto and passenger train travel might weigh significantly in the consideration of any future roadway/rail expansion and maintenance decisions. Combined efforts in applying for federal transportation grant monies to serve a large and more closely-integrated Chicago–Milwaukee market might also be effective—for both personal travel and for freight transportation including railroad.

Milwaukee’s major airport is also located between downtown Milwaukee and downtown Chicago. At a time when the Chicago area’s air travel capacity is strained, better access to Milwaukee’s Mitchell field could be advantageous.

Other cooperative ventures and ideas have yet to be identified. The absence of organized efforts to do so is a bit puzzling in the Chicago–Milwaukee corridor. In contrast, the advent of the trade agreements between Canada and the U.S. has sparked any number of private and private-public associations to promote natural trade flows across the border within local corridors. As the chart below shows, the progress of employment growth has not been especially robust in either metropolitan area over the past 15 years. Perhaps a little détente along the Illinois-Wisconsin border might be advantageous to all.

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Seventh District Cities: Their Business & Professional Services Sectors

Large Midwest cities, especially Chicago, are highly attentive to the opportunities that accompany globalization. Many large cities, such as London, Los Angeles, Paris, Hong Kong, and New York, are benefiting from heightened globalization. This is because big cities operate on a global scale, especially with respect to business and professional services such as international export, finance, law, business meetings and travel, entertainment and tourism, accounting, advertising, public relations, R&D, and management consulting. Accordingly, large Midwest cities would like to extend the global reach of their business and professional services as a way to revitalize their economies.

What is the industry base and recent performance of business and professional services for large Midwest cities? Let’s look at the varying depth and breath of these sectors in each of the largest cities in the Seventh District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin.

A common yardstick for these sectors combines various business and professional service industries into a single “professional services” index, including information and communications (NAICS 51), finance and insurance (52), business and professional services (54), and the management of companies (55). The index further indicates a city’s concentration of business and professional services as compared to the overall U.S. economy. The index is constructed as a ratio of the business and professional services’ share of employment in a particular Midwest city to the same share for the nation. For example, and index value of 1.52 for a particular city would indicate that its concentration of professional services employment exceeds the overall nation by 52 percent.

Such indexes are shown below for each of the largest metropolitan areas in the Seventh District states of Iowa (Des Moines), Wisconsin (Milwaukee), Illinois (Chicago), Indiana (Indianapolis), and Michigan (Detroit).

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We might expect that large urban economies would be concentrated in these services because such sectors are highly specialized in nature and can only be supported by the large and varied market and work force that big cities offer. In this respect, we see that the relative concentration of these service industries among the five cities does (roughly) correlate with population size. The larger metropolitan areas of Chicago and Detroit are more concentrated in professional services than the less populous metropolitan areas of Indianapolis and Milwaukee. As an exception, however, Des Moines, with a population less 600,000 (the Chicago area is 15 to 16 times more populous), leads the five metropolitan areas with a service concentration that is 70% to –80% higher than the overall U.S.

The relative size and contribution of individual service industries among Midwest cities is varied. For example, the figure below displays many of the particular business and professional service industries in the Des Moines area, both their relative concentration (horizontal axis) and their absolute levels of employment (vertical axis). Des Moines’ extremely high concentration of insurance carriers (4.8 times the nation) contributes greatly to its high overall concentration.

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Similar charts for the remaining metropolitan areas can be found on our Midwest Economy web site. The Chicago area economy is strong in advertising and management consulting services. Detroit is a leader in engineering and testing labs. Milwaukee is highly concentrated in the establishments that manage and administer companies.

Though Indianapolis’ population and work force ranks third largest of the five metropolitan areas, its overall business and professional service concentration ranks last. However, Indianapolis is catching up in this regard. Since 1990, employment in this broad sector has climbed by almost 40%, which is double the pace (or more) of Chicago, Detroit, and Milwaukee.

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Indianapolis is diversifying into service sectors. At the same time, many of the rural areas and smaller cities surrounding Indianapolis are becoming more concentrated in manufacturing—a sector that is not generally generating as many additional local jobs and income of late. The overall effect is that Indianapolis is having an easier time of it than many of its neighboring communities.

Population Ranks of Midwest Cities

Have you ever heard of Zipf’s Law? I’ll bet you haven’t. Zipf’s Law states that there typically appears to be a numerical regularity between the population size and population rank of cities within any particular region or nation. Specifically, within a region or nation, multiplying any city’s population size by its rank among cities will yield a constant number throughout the distribution. For instance, if the most populous city in a nation has a population of 10 million, the constant should be 1.0 multiplied by 10 million; the second largest city should have a population of 5 million so that 2 times 5 million yields 10 million once again; and so on.

As a fun way to display the size distribution of metropolitan areas in the Great Lakes, we tried to fit Zipf’s Law to the size distribution of metropolitan areas for the (census) year 2005. Guess what? We found that Zipf’s Law nailed it.

For the statistical trial, we chose the Great Lakes region which is defined by the Bureau of Economic Analysis as the states of Ohio, Michigan, Indiana, Illinois and Wisconsin. As it turned out, and as shown in the chart below, Zipf’s regularity applies very closely to the population distribution of Great Lakes metropolitan areas.

My prior thinking was that this region, which we think of as the industrial belt, was a cohesive economic region with close ties among firms and workers. In fact, there is no economic theory at all behind the Zipf’s Law and its relationship between population size and rank. Yet, in choosing a region, I thought it to be a promising trial to choose a region in which we might expect to find the statistical regularity if it was undergirded by economic linkages.

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In the rank distribution, the Chicago metropolitan area leads the pack with approximately 9.4 million. The Detroit area comes in second with, as might be expected, a population of one-half of Chicago’s at 4.5 million. The third metropolitan area, Cleveland, does not quite fit, dropping down too far with a population at just over 2 million. Still, the remaining distribution fits well enough so that G. K. Zipf’s regularity retains our fascination.

Perhaps it is only the statistical geeks among us who love this sort of analysis. Still, almost everyone loves a good horse race. So, for the rest of you, here is a comparative graph of the population growth for the top 10 most populous Great Lakes metropolitan areas from 1990 to 2005. And the winner is … Indianapolis, with a population growth of 27 percent , 346 thousand. What a town!

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Midwest housing market update

Following unprecedented home price appreciation nationwide in recent years, homeowners are much concerned about price reversal. In their current Economic Perspectives article, Chicago Fed economists Jonas Fisher and Saad Quayyum find that, on average, much of the recent surge in housing can be attributed to fundamentals such as rising income and favorable demographics, as well as innovations in home lending markets that have allowed renters to become homeowners. (Many of these innovations—such as interest-only loans and adjustable rate mortgages—were discussed in detail at the Chicago Fed’s Bank Structure Conference this spring. The proceedings of the conference were summarized in the September issue of the Chicago Fed Letter.)

While such arguments may provide some comfort to those who worry about the possibility of a bubble in average U.S. home prices, experiences and current conditions differ widely from place to place. Should Midwestern homeowners be more or less concerned about the cooling of residential real estate markets?

Senior Business Economist Mike Munley has been tracking home price developments in the Midwest. Mike reports that, on September 5, the Office of Federal Housing Enterprise Oversight (OFHEO) released its estimates for home price appreciation in the second quarter of 2006. The report included data on the national average of home price changes as well as state averages.

Home prices for the U.S. increased at a 4.8% annual rate between the first and second quarters, the slowest quarterly appreciation since the end of 1999 and just below the average since 1980. As measured year over year, U.S. home prices were up 10% from the second quarter of 2005, which was also slower than the rate of appreciation has been—it topped out at 14% in the middle of 2005.

Recent home price appreciation here in the Midwest has also slowed noticeably, and the long term back drop has been much less robust. For the most part, home prices in the Seventh District states have been increasing more slowly than the national average of home prices (see figure 1). On a year-over-year basis, price appreciation in every District state lagged behind the national average in the second quarter of 2006, and Michigan had the lowest appreciation of any state in the nation. In comparison to the first quarter, home values in Indiana and Michigan actually declined. (Maine, Massachusetts, and Ohio were the only other states with declines.) However, home values in Iowa managed to rise slightly faster than the national average.

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The city-level data told a similar story. Of the District MSAs (Metropolitan Statistical Areas) covered by OFHEO, only Michigan City-La Porte, IN, showed year-over-year appreciation (10.6%) faster than the national average. Of the bottom 20 MSAs in the U.S., 14 were in the Seventh District, and Ann Arbor, MI, was at the bottom with home prices, down 1.3% from a year ago.

The OFHEO home price data is only one of several sources of information about home prices for the U.S. and some cities. The National Association of Realtors (NAR) releases data on the median sale price of existing single-family homes. In general, the two data series tend to tell the same story—that is, the trends in both data series are similar over time. But, their results are often different in a given month (for regional and national data) or quarter (for city data). The NAR data tends to be more volatile. The NAR data set measures exactly what it sounds like: it is the price of the typical home sold during that quarter. Still, the median price depends on the mix of homes sold during that quarter. If, for example, a large number of inexpensive, starter homes were sold in the second quarter, this would lower the median sale price. By contrast, the OFHEO index is designed to track how the value of an individual home changes over time. OFHEO looks at the appraised value of homes each time a new mortgage is taken out—it is updated when a home gets sold or when the homeowner decides to refinance. OFHEO looks at the value of a large number of homes and is able to estimate the index quarterly. One drawback to the OFHEO index is that it only looks at home mortgages serviced by Fannie Mae and Freddie Mac, and those agencies only service mortgages that are less than $417,000—so the OFHEO index excludes most luxury housing.

The NAR publishes price breakdowns for regions and select metropolitan areas (but not states). In the second quarter of 2006, median home prices nationally were up 3.7% from a year earlier, while median sales prices in the Midwest (which includes the Seventh District, Ohio, and some plains states) were down 2.0%. Of the 24 District MSAs covered by the NAR, five (Chicago, Champaign, Milwaukee, Peoria, and Waterloo, IA) beat the national average, and 14 saw home sale prices down from a year ago. Although the NAR data are more volatile, this data series does confirm that home prices in the Midwest have been increasing more slowly than prices nationally.

There are a couple of reasons why home values have been rising more slowly in the Midwest than the rest of the country. Looking over the long term, the Midwest has generally seen slower home price appreciation since the early 1980s. As shown in figure 1, home values nationally have increased an average of 5.4% per year since then, whereas average appreciation in the District states has ranged from 3.5% in Iowa to 5.1% in Illinois. In part this difference reflects the slower population growth in the Midwest than in the rest of the nation. Since 1980, the U.S. population has increased an average of 1.1% per year, while population growth in Seventh District states has averaged only 0.4%. It follows that demand for housing in the District is not growing as rapidly, which in turn puts relatively less pressure on prices.

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Business services as a growth sector for Great Lakes cities?

As manufacturing activity shrinks and relocates, large cities of the Midwest look to another staple of their economic base, business and professional services. Large cities everywhere typically serve as centers of finance, communication, governance, and varied business services. In the Midwest, business service specializations in cities originally derived from goods production, as surrounding farms and factories looked to cities for financing, advertising, management expertise, product design, legal services, and engineering, as well as computer systems advice, more recently.

In the past few decades, agriculture and manufacturing activity have been shrinking in the Midwest, at least in terms of nominal personal income arising from manufacturing firms. In the overall U.S., for example, personal income derived from manufacturing activity has fallen from 32.9 percent to 15.5 percent from 1969 to 2004. This falloff is especially prominent in large Midwest cities, where manufacturing once thrived due to urban freight transportation advantages and the intense workforce needs of mass production.

Can advanced business services help fill the void in Midwest cities’ economies? There are several reasons to focus attention on these industries. First, there is already a pronounced urban location propensity for business services, so prospects for this sector in large cities are perhaps better than for others; also, in the overall U.S. economy, the business services sector has recently been a growth leader. Finally, many business services employ highly skilled occupations, and they tend to generate high levels of wages and income that may directly and indirectly buoy large city economies.

On the latter point, as formally defined by the North American Industry Classification System (NAICS), the “professional and technical services sector,” NAICS sector 54, tends to employ an above-average share of highly-educated (and highly paid) workers. As described by federal government statistical agencies (Census and BLS), the sector’s industries employ many executive and technical occupations, namely those found in research and development, legal services, management consulting, accounting, advertising, engineering, public relations, and product design.

In the analysis that follows, a focus on the NAICS 54 sector is advantageous because its services are almost exclusively sold to other businesses rather than to households, and many of these services can be sold to customers located far away. In thinking about regional economies, such tradable services may offer a wide scope for possible growth and development. Moreover, data covering employment in the sector are available for geographic regions as small as metropolitan areas.

Rapid growth characterizes the business services sector. The chart below illustrates that as a share of total payroll employment, “professional and technical services” has expanded from 4.2% to 5.3% from 1990 to 2005. The sector’s average annual growth of 3.0% per year easily exceeds that of total payroll job growth (1.3%), adding 2.5 million jobs to the U.S. economy since 1990.

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Business services’ urban orientation can be conveniently described by an index of employment. The concentration index is the ratio of two shares. For the ratio, the numerator is the business services sector’s share of total jobs in a particular region. The denominator is the business services sector’s share of total jobs in the overall U.S. And so, for example, if the sectoral share of total jobs in a particular region is equal to the sectoral share of jobs in the U.S., the index will take on a value of one. To the extent that a region’s share of jobs found in business services exceeds the nation’s, the index takes on a value greater than one, and so on.

Such a concentration index is constructed below for the most populous metropolitan areas in the U.S. The top five metropolitan statistical areas (MSAs)—New York, Los Angeles, Chicago, Washington, D.C., and San Francisco—are, taken as group, more than 50 percent more concentrated in business services jobs than the overall U.S. Moreover, an hierarchy of this concentration by city size is evident as we expand the index to include less populous metropolitan areas. Though still well above parity with the nation, the indexes of the top ten and top 20 most populous metropolitan areas lie below the concentration of the top five most populous metropolitan areas.

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Time trends in business services employment also tell us some important economic features. Most prominently, the concentration of business services employment in large urban areas has been falling (i.e., business services jobs have been spreading out toward smaller cities) in the U.S. since 1990. Apparently, the greater ability and lower cost to communicate electronically over time has allowed smaller cities, as well as other nonurban settings, to win out over large, densely populated cities that more easily facilitate face-to-face interactions.

It has been observed that business services employment dipped more than the overall employment during the recessionary periods of the early 1990s and 2000–03. Such cyclical sensitivity to the general economy has long characterized so-called blue-collar and production employment, but its emergence for occupations in business services was somewhat novel during the recession of 1990–91 and its aftermath, when labor market restructuring of mid-level managers and other white-collar occupations took place. In the more recent recessionary period, white-collar employment declines in business services were associated somewhat with the slackening of investment in information equipment and associated services. More generally, many business services may be characterized as “investment goods” by companies, meaning that their purchase tends to slacken during recessionary and subsequent recovery periods, when firms no longer need to expand their own production capacity.

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Manufacturing exit tough on Midwest central cities

If current trends continue, manufacturing activity will soon become extinct as a part of central city economies. The reasons for this exodus are largely the result of shifts in the technology of many types of production activity. Central cities—especially in the Midwest and Northeast—are generally densely populated and somewhat congested. Such conditions are not ideal for production activity. Many central cities vigorously attempt public policies to preserve manufacturing jobs, but the opposing forces appear to be very strong.

At one time, many central cities were the preferred locale for manufacturers. The reasons can be boiled down to two, transportation of laborers and transportation of materials.

As for labor, factories were once teeming with laborers. But due to labor-saving productivity gains, today’s factories are sparsely populated even though they produce many times more output. Senior Business Economist Bill Strauss calculates that today it takes 200 U.S. manufacturing workers to produce the same amount of product as 1,000 workers in 1950. Accordingly, during those earlier labor-intensive times, the transportation of manufacturing workers to the job site figured much more heavily into the factory cost equation. Transportation efficiency once was served by factory neighborhoods in central cities where workers could more easily commute by walking, driving, or by public transportation. The higher living density of central cities also meant that public services such as education and sanitation could be delivered cheaply to workers. Of course, it is not only manufacturing technology that changed. Better highways and rising standards of living (translated into higher car ownership) have also contributed to the ability of factories to staff their factories with (fewer) workers who live farther away. In turn, this opens up factory sites in suburban and rural areas.

Better highways, road vehicles, and logistics technology have also made the transportation of production material to central cities less attractive in comparison to areas of lower population density. Economically, railroads once dominated long-haul truck transportation of materials and components used in manufacturing, as well as the shipment of finished goods to other final markets. The technology of rail favors convergence into a central location (i.e., central cities) rather than the dispersed locations that are served by the crisscross pattern of our now ubiquitous highways. Over time, construction of divided highways and the advent of trucks having features such as refrigeration, trailers, and easily transferred containers have facilitated factory sites served by roads rather than by rail. Accordingly, factory sites can now better take advantage of the low land costs of rural and suburban areas rather than being restricted to those of the central cities.

The City of Chicago exemplifies the central city experience with manufacturing jobs. The chart below shows that, by one reckoning, manufacturing jobs in the city have declined from 367,000 in 1976 to under 100,000 today—a loss of approximately 10,000 per year. In contrast, the employment experience of Chicago’s suburban areas has been much milder.

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