Driving Indiana’s and Michigan’s Economic Performance

The Midwest economy is lagging the U.S., but some states are doing better than others. These differences may help us understand the reasons for the region’s lagging economy.

Last week in Indiana, I presented some evidence that the entire region is growing more slowly than the nation. Payroll job growth in our Seventh Federal Reserve District is up only 0.6% for September from one year earlier, versus 1.6% in the nation. In some respects, this performance is not surprising since, nationally, manufacturing jobs are still declining (down 1% year over year through September), and the Midwest’s economy is steeped in manufacturing. In addition, the region’s economy is bogged down by the structural change taking place in the automotive industry. Foreign nameplates continue to gain market share from the domestic automakers (previous blog). Since the foreign nameplate companies and their parts suppliers tend to locate in the South, jobs and income are seeping away from the Midwest.

In this regard, comparing the performance between Indiana and Michigan is telling. Though both states rank among the top 3 nationally in manufacturing concentration, the unemployment rate in Michigan stands at 6.1% in Michigan (Oct.) versus 5.4% in Indiana. Year over year, manufacturing payroll job growth is virtually flat in Indiana, but down over 3% in Michigan.

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The economies of both states are automotive intensive, but Michigan to an even greater degree. Indiana’s automotive share dominates manufacturing inside the state, at 16%. But Michigan’s automotive sector accounts for 35% of its manufacturing employment. A weakening automotive sector, then, would be felt more sharply in Michigan.

On top this, the auto sector’s performance in Michigan has been worse. From 2001 to date, automotive jobs have fallen 24% in Michigan, compared to 8% in Indiana.

Indiana’s automotive performance is buffered by having a larger share of foreign auto parts and auto assembly plants than Michigan. According to senior economist Thomas Klier, 29% of automotive parts plants in Indiana are foreign owned, as are 2 of its 3 auto assembly plants.

Auto parts makers tend to locate close to their customers. In Indiana, the foreign-owned parts plants are more likely to supply parts to those automakers who are gaining market share—the foreign nameplates.

Michigan’s automakers are only 17% foreign owned; its only foreign owned assembly plant is the Mazda plant, versus its 15 domestic auto assembly plants.

If the current shifts in market share among automakers continue, it will be imperative for Michigan’s economy to attract investments from the successful auto suppliers and auto assembly companies.

Other performance differences between Indiana and Michigan are intriguing, though one cannot draw any hard conclusions. The chart below illustrates the population growth of the largest metropolitan areas in each state—Indianapolis and the Detroit MSA. Indianapolis’ population growth has exceeded the surrounding areas, and far exceeded that of the Detroit metro area.

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In searching for explanations, manufacturing concentration again comes to mind. As recently as 1969, only 26% of Indianapolis’ overall employment was manufacturing, versus Detroit’s 35%. Generally speaking, “factory towns” have had the roughest road in restructuring. As manufacturing employment shrinks, such cities must re-employ larger shares of their work force in new industries and activities. Otherwise, workers move from the area and create a different set of challenges to the town governments. That is, how to efficiently use and maintain their current roads and buildings for a less populous (and sometimes less wealthy) population.

Governance structures may also explain some of the challenges. Central city Detroit has been buffeted by job, population, and income flight, with concentrated poverty left in the wake. Detroit city leaders have been unable or unwilling to climb above the city’s fiscal problems to re-build its economy. To what extent has this failure come about because the central city was isolated from the rest of the metropolitan area (and state), and left to solve profound problems with its own (meager) resources?

Indianapolis and other cities have taken some modest steps in consolidating local governance to a closer fit with their metropolitan-wide economies. In the late 1960s, Indianapolis moved toward a “Unigov” structure. As Rick Mattoon discusses (working paper), the city’s boundary was expanded from 82 square miles to 402 square miles, with a legislative body responsible for governing the city. Though there remain many independent governments, taxing authorities, and school districts within the city, the consolidated city has six administrative departments below the mayor’s office.

Other Midwest cities with elements of regional governance include Minneapolis–St. Paul, which has a metropolitan sharing of property tax base. Columbus, Ohio, has not consolidated, yet its central city government has been aggressive in annexing land outward toward its interstate beltway. Both metropolitan economies have outgrown the broader Midwest.

Can Higher Education Revive the Great Lakes Economy?

In the Midwest and elsewhere, state government financial support for higher education has been eroding. Public colleges and universities are increasingly being left to their own resources; this raises a number of issues for them and for the Midwest economy.

In a major conference held here this week, Chicago Fed President Michael H. Moskow summed up one dilemma. “….universities today are increasingly forced to rely on their own resources to make budgets balance. But this can restrict access, because schools must often dip into endowments and resort to aggressive tuition hikes to close the gap. If the school is concerned with maintaining academic quality, large tuition increases are often the best option, but in doing so access for (lower income) students may be limited. If on the other hand, the university limits tuition increases, it is often forced to economize and offer reduced services, which can jeopardize quality through large classes and the use of part-time faculty.” (link to speech)

However, if state universities had a free hand in shaping the tuition schedule and financial aid, higher tuition need not be borne by lower income families.

Many state universities charge tuition rates well below the cost of education provision. Meanwhile, the returns of the degree to the students are significant in terms of higher wages and salaries throughout their working life. And especially at state flagship universities, which are highly selective, a large share of students come from high-income families.

Mike McPherson, President of the Spencer Foundation, presented evidence on familial background of the available talent pool of highly selective schools, drawing from a recent book by William Bowen et al. Of children born in 1988 in families where neither parent attended college, only 0.9% went on to score 1200 or higher on the Scholastic Aptitude Test (the common admissions test for highly selective schools). This compares with 6.6% of children in families where at least one parent had attended college, and 14.6% from families in the top quartile of U.S. family income.

The point here is that many more families at state flagship colleges and universities could and would pay more for their education. Of course, unlike private colleges and universities, state flagships are often constrained in raising tuition because they must petition their state governing boards to do so, and such requests often fail to garner political support.

Perhaps that is why many representatives at the conference from public flagship schools instead pushed for a renewal of the “social compact” between public education and the public, in which public financial support would be restored and enhanced. To accomplish this, schools need to do a better job of explaining the many benefits that accrue to the general public from subsidizing the education of the few. For example, economists Kevin Murphy and Robert Topel have documented the societal benefits from public medical research in terms of reductions in mortality and morbidity. These benefits have been enormous in relation to public expenditures—and probably should be promoted (link).

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Chicago’s Exchanges Look to the Future

Last week, the Chicago Board of Trade (CBOT) became a publicly traded company. On the first day after offering its stock, its share price ended the day above $80, well above forecasts of a $45-50 value per share.

The CBOT development was one of many suggesting that the prospects of Chicago area’s futures exchanges have improved in recent years. But to what extent is the turnaround sustainable, and will this growth and success continue for one of Chicago’s hallmark industries?

Chicago’s importance as a financial center is defined by its exchanges and associated dealers and brokers. The Chicago exchanges can claim close to two-thirds of the volume of exchange-traded contracts in the U.S. A major assessment of the exchanges’ importance to the Chicago economy has not been conducted since 1997. (See Civic Committee of The Commercial Club of Chicago‘s Report by the Risk Management Center, “Study of Financial Markets & Financial Services in Chicago,” 1997.) That study reported that 150,000 Chicago-area jobs could be attributed to the exchanges, and $35 billion in funds were on deposit at local banks to support Chicago’s exchange products. Many other linkages to Chicago’s economy, such as the needs of large local companies to balance their financial risks and risk exchanges’ ties with other financial and legal services firms and universities, were articulated in that report.

Chicago’s exchanges had long dominated global trading activity in futures and derivatives. But throughout the 1990s, the Chicago exchange community lost global market share. The figure below shows the growth in volumes of futures and options contracts traded on exchanges from 1987 to 2004. Trading volume at U.S. exchanges languished in the mid-1990s, even while growing rapidly throughout the rest of the world.

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In the 1990s, competing exchanges in Europe and Asia made strong gains in market share. Electronic or computerized exchange facilitated overseas market locations partly by offering trading activity during hours when Chicago floor trading was not active. Ultimately, electronic trading also offered cost advantages for some existing products, while preserving important liquidity, clearing, and price-discovery properties as well. Overseas competitors adapted to and innovated electronic or computer-generated trading more successfully, and therefore captured markets that the Chicago exchanges might otherwise have claimed.

The Chicago exchanges also innovated and implemented systems of electronic trading, but their strong prior commitment to the open outcry or pit trading method of trading and price discovery perhaps impeded their success. So too, globalization of capital markets enhanced the demand for futures products overseas, along with a desire to trade around the clock. And so, electronic trading and the competitors who used it effectively were more successful in capturing growth in global demand.

But in recent years, Chicago’s two major exchanges, the Chicago Mercantile Exchange (CME) and the CBOT (CBOT), have rebounded strongly. Not only are contract volumes up markedly, but both exchanges have gained market share on their global competitors over the past two years. The CME reorganized from a mutual or member ownership structure to incorporation and public ownership, with an IPO in late 2002. Since that time, product and market expansion, enhanced services, and cost savings and price reductions on trades have boosted the CME’s market shares and sales. As of mid-October, the CME share price had increased ninefold since its IPO.

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Delphi and Midwest Auto Parts

Midwestern communities that host automotive plants are especially concerned at the recent bankruptcy actions of Delphi Corporation. Such concerns are not misplaced, since the geography and problems of Delphi’s operations are similar to those of some other automotive plants.

Delphi, the nation’s largest auto parts supplier, filed for Chapter 11 bankruptcy on October 8. The bankruptcy covers only its U.S. plants; non-U.S. subsidiaries are not included. The company, which had 2004 revenues of $28.6 billion, is looking to the courts to allow it to cut costs by rewriting its contracts with its UAW-represented work force, closing plants, and restructuring its legacy-cost obligations for retirement and health care.

Delphi is a global company. It employs 185,000 people around the world. Of these, about 50,000 are employed in the U.S. Delphi makes a wide range of auto parts, including dashboards, air conditioning systems, electronics, and batteries.

Drawing from a variety of data sources, my colleague Thomas Klier and his research assistant, Cole Bolton, have put together a map of Delphi’s Midwest operations that displays current employment (figure 1). The Midwest is home to about 70% of Delphi’s U.S. employment. The two states with the highest concentration of Delphi employment are Michigan (just under 15,000) and Ohio (just over 13,000).

Figure 1 — click to see larger image

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How Much Are Headquarters Worth?

Earlier this month, Mittal Steel USA announced it will locate its headquarters in downtown Chicago rather than in Northwest Indiana. Mittal USA employs 21,000 workers in 14 states. The parent company, Mittal, headquartered in London, is the largest steel maker in the world.

Mittal’s U.S. headquarters will employ only about 200 people. Even so, the company will reportedly receive $7.5 million in tax credits from the State of Illinois for job training and infrastructure, and the City of Chicago will contribute $2 million toward equipment, furniture, and fixtures. At a cost (undiscounted) of $40,000-$50,000 per job in tax incentives, why are public officials so pleased to have the Mittal headquarters?

For one reason, the Chicago area economy, along with the rest of the Midwest, is lagging the nation in this first decade of the millenium. Moreover, an intense matter of pride and branding of Chicago’s economy is at stake. The Chicago area ranks second only to the New York metro area as a headquarters city (figure 1). And, as reported by Lyssa Jenkens, chief economist of the Greater Dallas Chamber, even Sun Belt cities that are gaining headquarters admire Chicago and New York(Chicago Fed Letter). Yet, although Chicago snagged a big prize with Boeing’s move from Seattle in 2000, the city has lost other headquarters in recent years, such as Ameritech, BankOne, Quaker Oats, and Amoco.

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Hurricane Impacts and Energy Prices

As the water recedes and the human toll accumulates in the hurricane-impacted Coastal regions, discussion has turned to the economic impact. Many areas and communities immediately surrounding the Gulf Coast are experiencing increased business and real estate activity as evacuees try to refocus their lives and homes, even as local governments and charitable organizations struggle mightily to lend assistance and resettle evacuees. Midwest economic activity will pick up in several ways during the coming months, but these will likely be outweighed by rising energy prices—-especially for natural gas, which is used to heat Midwest homes.

Hurricanes and other natural disasters are often accompanied by interruptions in economic activity and are followed by upswings and regional diversions in economic activity. Parts of the Midwest have felt the disruption through our ties to the Gulf Coast economy. Shipment delays and sharp price spikes for petroleum-based chemicals have slowed production for Midwest manufacturers of tires and furniture. Midwest grain shipments down the Mississippi were delayed and diverted by Hurricane Katrina, though they have now largely resumed or been diverted in other directions.

In other ways, the hurricane impacts are boosting Midwest economic activity. Some evacuees have taken refuge in Midwest communities, and now reside with relatives or in donated facilities. In response, government operations such as schools must bolster their payrolls. The added spending of the new families will be an infusion into Midwest income and spending streams.

As for “export” industries, mobile and trailer home construction in northern Indiana and other areas of the Midwest have been called into hot demand by FEMA. Emergency workers, evacuees, and homeowners who are in the process of rebuilding their properties must have housing—-at least temporarily. And the region’s manufacturers of earth-moving and construction equipment, such as Caterpillar, and makers of other rebuilding tools, such as electric equipment and generators, will experience some added sales. And of course, flood-damaged autos and homes will require such Midwest staples as motor vehicles and home appliances. Chicago also has gained several upcoming conventions dropped from the New Orleans calendar.

But rising natural gas prices loom large as the Midwest approaches the home-heating season, due to supply disruptions from the Gulf. Other cold-weather regions, such as New England, burn home heating oil. The Midwest enjoyed low home heating bills from the late 1980s to the mid-1990s when natural gas prices were very low and gas utilities were paying about $2 to $3 per thousand cubic feet of natural gas (mcf). But in recent years, natural gas prices have been rising because of higher demand for gas from electricity utilities and from its use as a substitute for petroleum.

In the regional newsletter of the Federal Reserve Bank of Dallas, veteran energy economist Steve Brown investigates the relationship between petroleum prices and natural gas prices (Southwest Economy July/August 2005). Although the two fuels are no longer common substitutes in electric generation, Steve finds that the two fuel prices continue to move in tandem—-with two exceptions. Natural gas prices are higher in the winter, and they also depend on how much is stored during the summer for use in the winter. In the Midwest, natural gas is stored in the summer in underground aquifers, salt caverns, and abandoned gas wells. According to Brown, if 10 percent less gas is stored now than the average in the previous five years, natural gas price prices will go up 23 cents nationally.

What can cause these shortfalls in stored volumes? Winter cold snaps for one, whereby vendors drain their stored reserves to meet demand. Cold snaps contributed to price spikes during the winter of 2000-2001 and 2002-2003 when the spot price approached $10 and $12 per mcf. Abnormally hot weather during the summer can also contribute to a shortfall. The hot spell in the Midwest this past summer increased natural gas prices and slowed storage as some electric power generators fired up on natural gas to feed air conditioning units. And finally, of course, supply interruptions such as those from Hurricanes Katrina and Rita can slow the pace of storage. This is a particular problem for the Midwest since most of our natural gas supplies come from the Gulf Coast area.

How much will natural gas prices rise this winter as a result of the Gulf hurricanes? Not quite as much as current rises in spot market prices and contract prices for future delivery suggest. During the heating season, gas distributors blend new spot market purchases with the natural gas already purchased and stored or pre-contracted. Likewise, the delivered price to homes reflects a price blend of the stored gas, as well as gas purchased under long-term contract, with augmented or spot market purchases. A colder-than-normal winter, or low volumes of stored or pre-contracted gas, would tend to tilt the blend toward higher-priced spot market purchases, which could deliver a ruder heating bill shock to Midwest households.

The figure below shows that reported spot prices do follow the acquisition, or “city gate,” prices that gas distribution utilities pay for natural gas. This past summer, and intermittently since 2000, the measure of spot price was running roughly double that of the 1990s. Due to the current supply disruptions, the prices for delivery under futures prices on the NYMEX were running double that of this past summer at over $14 for December 2005 and January 2006 delivery, though falling in the years thereafter.

FIGURE 1

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Michigan Auto Woes

Michigan’s traditional heavy reliance on the domestic auto industry has been troubling its economy over the past five years. While GM and the other domestic auto makers have “kept America rolling” with continued auto sales and sales/finance incentives, the state of Michigan has shown the worst performance among the states. Michigan’s unemployment is the second highest at 6.7 %; and it holds the bottom spot for year-over-year payroll job performance with a 1.1 percent loss as of August. It is the only state to have lost jobs over this period. What are policy makers to do? The state’s heavy reliance on the automotive sector makes efforts to diversify a long-term and risky proposition at best. In the short term, hopes ride on a turnaround for the domestic auto makers and their upstream auto parts manufacturers, while long-term bets are being placed on new industries.

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Light vehicle production in the U.S. has continued to average around 12 million vehicles since 2000. However, as discussed by Thomas Klier (Chicago Fed Letter) earlier this year, it is the geographic shift of production from Michigan and other parts of the upper Midwest southward that is adversely affecting Michigan’s economy. A shift southward has accompanied the slippage in sales share of the domestic nameplate automakers—GM, Ford and Chrysler, which has fallen from a 65% share of domestic sales in 2000 to 58% in August, 2005. Rising imports into the U.S. have contributed to this slippage, with the import share rising from 17% to 20% percent of domestic sales. And so-called “transplants,” which are foreign nameplate companies producing vehicles in the U.S., have captured the rest of the rising share from Big 3 auto makers. Transplant production largely takes place in the South. Michigan hosts only a single transplant(Mazda), which is partly owned by Ford, whereas it hosts 17 domestic assembly plants. Ohio is also laden with domestic assembly and parts makers, but it has two Honda plants as an offset. Indiana is the third state in the Midwest auto troika, and it hosts an Isuzu plant in Lafayette and a recent Toyota plant in Princeton in the southwest part of the state.

As a result, from 2000 through July, 2005 year-to-date, Michigan lost 42% of its auto assembly jobs versus a 14% loss in the U.S. located outside of the three Midwest auto-intensive states. Ohio assembly jobs are down 25% over the same period, while Indiana is actually up one-third.

Auto parts are a larger part of the story, since there are four times as many jobs in parts as assembly operations. Parts makers tend to be located near the assembly plants for historical reasons, and more recently because “just-in-time” production requires proximity for many parts such as seats and sub-assemblies. Michigan’s parts employment is down 34 percent since year 2000, versus 19 percent in the rest of the U.S.

These job losses are felt more keenly in Michigan since, even among the Midwest troika of auto states, Michigan is by far the most dependent on automotive. Michigan’s job base is 7 times more concentrated than the nation in automotive parts, versus 5 and 3 for Indiana and Ohio.

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Chicago — Regional capital or global business center?

The Chicago economy is expanding, but the pace of growth is disappointing compared with that experienced during the 1990s. This lagging performance raises some questions about the future. Will Chicago merely serve a supporting role as a services center for the surrounding Midwest, or can Chicago’s businesses expand their reach to more rapidly growing national and global markets?

Robust growth of jobs, income, and population during the 1990s left intact Chicago’s role as capital city of commerce for the broader Midwest, and then some. Some observers of the Chicago economy, including me (Global Chicago book), argued that Chicago was outgrowing its regional character. It was becoming a global city, with market ties and cultural recognition above and beyond the Midwest. This view boded well for the region’s long-term prospects, as the shrinkage in surrounding Midwest manufacturing and agriculture income would not hold Chicago back from a favorable performance among global cities.

However, those rosy predictions are somewhat at odds with the reality of Chicago’s performance over the past 4-5 years. The Chicago area is undoubtedly participating in the U.S. economy’s expansion. The airports are at capacity once again, hotel occupancy rates are climbing, some of the risk exchanges are swaggering a bit with profitability and outreach to foreign markets, and commercial office vacancy rates have leveled off. But the Chicago area economy continues to lag the U.S. economy. This follows a recession that hit the Chicago metropolitan area more severely than it hit the nation overall. Year over year (as of August), the Chicago area’s payroll employment grew just 0.8 percent, compared with 1.7 percent for the nation. The unemployment rate for August stood at 5.9 percent versus the nation’s 4.9 percent (figure 1). This extends a weak performance from year 2000. Annual data show that payroll employment declined -4.1 from 2000 to 2004, versus a -0.2 decline for the nation.

Figure 1

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Ethanol and Midwest Rural Communities

Those who are interested in the prospects of Midwest rural areas will want to peruse the presentations from Dave Oppedahl’s recent conference on “Ag Biotech and Midwest Rural Development.” Right now, the papers and presentations are posted (see conference link). Dave will soon be summarizing the conference for an upcoming issue of Chicago Fed Letter.

One topic of the conference was the rising prominence of ethanol production in rural communities, and the associated economic benefits. Ethanol raises hopes in many rural communities because of agriculture’s shrinking role in supporting rural jobs and income. But while ethanol production appears to be a boon to many rural communities, some question the efficacy of the subsidies for the overall nation.

As both Dave Oppedahl and I covered in our September 8 presentations, production agriculture has been shrinking profoundly as the basis for income and jobs in many rural areas, and government support payments make up sizable shares of what remains. But while direct income and jobs are shrinking in production agriculture, some rural income and work is being created downstream in transportation of the voluminous crops, along with financing and service support of production agriculture. In addition, related manufacturing has become more important in many Midwest rural counties in the form of “food processing,” such as oil seed crushing, meat processing, packaged foods, and prepared packaged foods. It is somewhat insightful to consider how we count the processing of food in our economic statistics and in what particular industry we place food processing. If food is prepared (grown) on the farm, it is agriculture. If it is prepared in a factory as a frozen meal, it is “manufacturing.” If it is prepared in a grocery store at the deli department, it is retail. And in a restaurant, it is in the services industry. And if it is prepared at home, it is not counted in our measure of national output, GDP, at all!

The concentration of food processing (manufacturing) in rural counties in the U.S. has doubled since the 1970s and accounts for about one-fifth of rural manufacturing earnings according to the U.S. Bureau of Economic Analysis. Economies of transportation is one reason that much of the processing activity remains in rural areas. By processing raw farm product near the farm, the products shed weight and volume before delivery to market.

In this regard, the ethanol industry is closely akin to food processing. This alternative fuel to gasoline is most widely processed from corn, and done so nearby to corn production. In production of ethanol, Iowa is the leading state, followed closely by Illinois (these two states also lead the nation in corn production).

The domestic market for ethanol was encouraged by the Clean Air Act Amendments of 1990. Concerns about urban ozone pollution, relating largely to breathing difficulties, led non-attainment areas to require additives to gasoline that diminished emissions of compounds that are thought to be precursors to (ground level) ozone formation. Today, such encouragement primarily takes the form of a federal $0.50 per gallon tax exemption at the wholesale level for ethanol as compared to gasoline. Some states such as Minnesota and Iowa add additional incentives.

As a result, ethanol demand has more than doubled since 2000 and annual production will likely exceed four billion gallons for the year 2005. At the September 8 conference, John Miranowski of Iowa State University reported that 30 new plants ethanol plants have been added over the past 3 years, with many more in progress or on the drawing board.

Many rural communities have welcomed and encouraged ethanol plants for the associated jobs and income at the plant. And again, the economics of transportation savings has meant that local corn farming operations typically receive higher prices than they would otherwise. In addition, some of the by-products from the ethanol processing can be used as livestock feed. This livestock production too contributes to the local community’s economy. And as usual, some enterprising economists have estimated the indirect and “multiplier” impacts of an ethanol production atop the direct local economic impacts.

From a national perspective, the advantages and sustainability of the ethanol industry are not very clear. We don’t know how well ethanol would compete in an unfettered marketplace, without subsidies. At the oil prices of two years ago, and without the very large subsidies, ethanol production today would have been much lower. However, at today’s petroleum prices, ethanol is looking more attractive. Further, some would argue that, as the infrastructure to transport and distribute ethanol are developed and attain greater scale, ethanol might find a place in the market without its very large subsidies.

Subsidies are sometimes justified for the alleged environmental benefits to ethanol in reducing urban ozone. But to the contrary, others argue that today’s engines burn so much more cleanly that there are no ozone benefits to burning ethanol rather than gasoline in urban markets. In addition, ethanol evaporates more readily in comparison to gasoline, thereby possibly aggravating urban ozone. In rebuttal, many point out that ethanol is advantaged because it does not release as much carbon into the atmosphere, and thereby helps out “global warming.”

Energy security is also an elusive idea. Buffer stocks of vital materials are an alternative to subsidizing domestic fuel industries, and possibly less costly. So too, in other countries such as Brazil, ethanol can be produced more cheaply than in the U.S., from cane sugar. Even if ethanol displaces a small portion of our imported petroleum, would we not find that we can securely and cheaply import ethanol from South America? At least one conference participant suggested that domestic ethanol interests may soon be fighting for further trade protections against ethanol imports.

In all likelihood, we will never know the answer as to how ethanol would fare on a level playing field, or whether subsidies already in place are justified on the basis of non-market considerations such as environmental features and energy security. That is because ethanol’s future in the U.S. seems quite robust since the recent federal energy bill has mandated consumption of 7.5 billion gallons in the U.S. by 2012. As one visitor to our bank commented, “apparently, U.S. industrial policy is not quite dead.”

Surprisingly, despite the many analytic tools that economists have to inform public policy, no one at the conference could report that there had been any comprehensive and respectable benefit-cost study conducted to evaluate subsidies and mandates for ethanol production and use. There has been a prominent debate as to whether the ethanol production process consumes more energy than it produces. But the study results are highly sensitive to the assumptions of each researcher as to what is the corn yield per acre of land, for example. But even aside from these vagaries, the “energy balance” approach is not really very helpful in deciding the issue–the way a market test would be helpful. In the generation of electricity, for example, there is an enormous loss of energy as scientifically defined. The heat content of coal used, for example, is far more than the electricity produced. Yet, it goes without saying that electricity is quite valuable, and end users are willing to pay for it. As for spillover benefits relating to the environment, economists are learning to use shadow prices obtained from surveys, for example, to put dollar values on environmental emissions so that lower pollution can be evaluated using a value yardstick.

Whether or not national ethanol policy would be seen favorably by a thorough cost-benefit analysis, many rural communities would welcome an ethanol plant, and some will get that chance.

The Midwest Economy “Blog”

Anything resembling an opinion or viewpoint contained in the blog are my own, and do not necessarily represent the views of anyone else at the Federal Reserve Bank of Chicago or in the Federal Reserve System.

Coming topics:

Impact of biotech on agriculture

Midwest economic conditions and recent hurricanes

Chicago area economy

Funding and access to higher education

Midwest Economy

Hello midwesterners and those interested in the Midwest’s economic growth and development. My name is Bill Testa, and this is an introduction to my Midwest Economy Blog.

In this blog, I will offer some current information on the Midwest economy, as well as analysis of important public policy issues and even an occasional prediction or two. In this effort, I will be looking for those of you who share my keen interest in the Midwest economy to contribute not only your attention and readership, but also your thoughts and information. Those of you who do respond, as well as those who only listen, will help us all to enrich our understanding and knowledge of this region. And as time passes, we will also have an extensive compilation of information and experts to draw on as the Midwest encounters new issues and economic challenges.

Unlike some economists who sponsor blogs, I am neither a Nobel prize winner nor a renowned media personality. However, I have been following and analyzing the Midwest economy for over 25 years, most recently as the director of Regional Programs in the Chicago Fed’s Economic Research Department. The most burning questions that keep me up at night include: Why do some regions grow faster than others? What are the prospects for the Midwest and other regions? What can we do to influence our economic destiny? What roles, if any, do state-local governments and public-private partnerships play, or should they play, in the growth and development process?

At the Chicago Fed, my interest in the Midwest economy is shared by a talented and varied group of economists. Some of them—such as Rick Mattoon, Thomas Klier, Yukako Ono, and Mike Munley—are part of my Regional Team, while some are in other areas of our Research Department, including our Chief Business Economist, Bill Strauss, and our agricultural/rural specialist, Dave Oppedahl.

And if you are a true Midwest economy buff—as I am—you will find your way here—to our newly launched Midwest Economy web page. This new page features content galore, including our own vast archive of published analysis organized by subject area. You can also access regional data to create your own analysis; or link to other related web sites. Also, the site features our many past conferences, along with the presentations of renowned experts on the Midwest economy, state-local finance, economic growth, and a host of special topics concerning economic growth and development.

“Ag Bio” Conference at the Chicago Fed

Last week, Dave Oppedahl, our agriculture and rural specialist, held a conference at the Bank addressing agricultural biotechnology and rural development prospects in the Midwest. The best-known of these technologies are so-called bio-fuels, such as ethanol (which is largely refined from corn in the U.S., but it is largely refined from sugar cane in other countries like Brazil), and GMOs or genetically modified organisms, such as pest-resistant and herbicide resistent grains. Dave’s chief interest in these technologies and their prospects are how they will affect the well being of Midwest agriculture and rural communities.

New biotech products linked to agriculture are but one of several avenues by which rural counties hope to revive their fortunes and sustain their populations. Historically, family incomes in rural counties were supported by agriculture, mining, and forestry—especially agriculture. The U.S. Bureau of Economic Analysis compiles figures on the shares of personal income that derive from various industry sectors, and they estimate that as recently as 1969, 935 “rural” or nonmetropolitan counties counted on agriculture for 20% or more of personal income. By 1999, the number had fallen to only 235.

The problem has not been so much a failure of sagging production, or vulnerability to foreign producers, as it has been rising productivity itself. Improved strains of agriculture and better/more mechanized farming methods have increased yields astronomically. Since 1947, U.S. real farm product is up over 3.5 times. But despite rising real product, prices for farm products have fallen steeply, because the demand for raw agricultural products has not kept pace with rising production and productivity. In 1950, corn in the U.S. cost five times its price today as measured by inflation-adjusted dollars. Falling prices (along with labor-saving productivity) have come to mean meager farm earnings and jobs in most nonmetropolitan counties. In 1870, over 50% of the U.S. work force could be found in agriculture, but this had dwindled to 13% by 1947, and to 2% today.

In our Seventh Federal Reserve District states of Iowa, Illinois, Michigan, Wisconsin, and Indiana, farm earnings comprised 13% of personal income in 1969, but had fallen to only 2.8% by 2002. Of course, such productivity gains, along with urbanization of population, have also created the world’s highest standard of living for the average American.

But in generating income and jobs, many rural communities have not found a sufficient replacement for agriculture. (Though some, of course, have become suburbanized by nearby metropolitan area expansion, while others have redeveloped toward service industries and manufacturing). Consequently, the decline of agriculture-related income in nonmetropolitan areas has often been accompanied by lagging population growth or even outright declines. In the U.S., nonmetropolitan population grew at around one-half the pace of metropolitan counties from 1969. With falling population, many rural towns have been challenged to sustain essential services such as health care, schools, and retail. And in relation to metropolitan standards of living, rural personal incomes have fallen. Per capita income in nonmetropolitan counties in the Seventh District, for example, declined from 85% of the nation’s average in 1969 to 80% in 2002.

What’s a rural area to do? In our part of the Midwest, two distinct avenues to re-development are most prominent—manufacturing/distribution and retirement/recreation.

What other development paths are you seeing around the Midwest? Please share your thoughts and observations with us.

Bright prospects as a haven for retirees and recreational visitors can be most commonly observed in our northern states of Michigan and Wisconsin. Places such as Walworth and Door Counties in Wisconsin, and the northwest coastline of Michigan are perhaps the best-known in this regard. The map below illustrates those nonmetropolitan counties that have experienced hikes in population since 1969 (shown in blue, declines shown in green), and the “north woods” pattern in Wisconsin and Michigan is quite evident. (A map of second homes from the 2000 Census would show much the same effect). In many such places, the choice to develop tourist or retirement centers is not without its downsides. Recreational and retirement homes, and attendant commercial activities, often change the very character of rural towns, sometimes to the consternation of its original residents. Many towns on the periphery of large and sprawling metropolitan areas also face many of the same difficult choices: How much to grow, and in what directions?

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