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January 30, 2006

Midwest payroll job growth—Turning but weak

Sample-based estimates of payroll employment are among the most prominent and timely indicators of regional economic performance. Recent trends in reported payroll data indicate lagging economic performance in the Seventh Federal Reserve District, which comprises all of Iowa and major parts of Illinois, Indiana, Michigan , and Wisconsin . Payroll job growth over the past year varies among these states, with losses in Michigan pulling down the District’s job growth average.

The District’s payroll job performance during the period following the 1990 national recession compared much more favorably to that of recent times. Have the region’s fortunes temporarily turned for the worse? Or is this lagging performance an indication of a structural worsening in the region’s growth path?

Payroll job estimates for December 2005 were released by the Bureau of Labor Statistics on January 24, 2006. While these figures seemingly complete the calendar year 2005, they have not been finalized yet. When the January figures are released (every March), monthly data are revised back for the previous 18 months. Because current data are based on reports from a sample of establishments, the data are later revised or benchmarked to a so-called universe of establishments that report their employment covered by the Unemployment Insurance tax system. The revisions can sometimes be significant and we will examine them during the week of March 6.

Over the past year, this preliminary data suggest that payroll job growth is trending up in all District states except Michigan. However, job growth continues to lag the nation in all District states except Iowa.

Looking back over the past five years to one quarter prior to the onset of the last national recession, there have also been steep job losses. The table below indicates that Michigan’s monthly average payroll jobs declined 6.7% from the fourth quarter of 2000 (prior to the onset of the national recession) to the fourth quarter of 2005. Reviewing payroll jobs data over this same five-year period for other Distict states and the rest of the nation, we can see that there was a 2.8% loss in jobs for the average of all five District states and a 2.2% gain for the remainder of the U.S.

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Such performance is in sharp contrast to results from the previous national recession of 1990–91 and its aftermath. During that five-year period, starting from the national peak quarter, 1990:Q3, District employment expanded by 7.8 percent versus 7.0 percent for the rest of the U.S. At that time, stronger than average payroll job growth emerged in Indiana, Iowa, Michigan, and Wisconsin.

Is the region experiencing a structural change, that is, a performance indicating deep-seated conditions that cannot be expected to reverse themselves? During the early 1990s, several transitory events and conditions were playing to advantages of the Midwest, as well as to the disadvantages of other regions. Among these were the savings and loan crisis and subsequent restructuring that affected parts of the South, the Northeast, and the West, but largely bypassed the Midwest. In addition, the build-down in national defense procurement, along with base closings, diminished income in jobs in some parts of these other regions. So, too, exports were growing and import competition was abating nationwide, following the easing of the dollar’s exchange rate during the late 1980s. In this regard, the high concentration of manufacturing in the Midwest was especially favored by a improving balance of trade.

Manufacturing employment performance generally appears to have been a key factor. In both the nation and in the Midwest, manufacturing employment remained generally buoyant during the 1990s. Since manufacturing was (and remains) so much more concentrated in the Midwest than throughout the rest of the U.S., this sector’s impacts on overall growth were magnified in Seventh District. Moreover, job expansion in District manufacturing actually surpassed the nation. The table below reveals that manufacturing jobs grew over 3% in the Seventh District from the third quarter of 1990 to the third quarter of 1995, whereas it declined by 4% in the nation over these five years.

In the more recent period, 2000–05, manufacturing jobs have declined steeply in both the Seventh District and the rest of the nation; both are experiencing manufacturing job declines at a pace of 17% to 18% during this recent five-year period.

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Have structural changes taken place recently in the Midwest involving manufacturing? We cannot say with certainty. Our examination of the manufacturing sector in 2004 established that manufacturing’s job share displays a long-term and sustained decline in the U.S. so that the region’s recent weakness is not necessarily a permanent turn for the worse (link).However, it is also clear that the automotive industry is undergoing some profound geographic shifts, which do not favor the Midwest (link), and that import competition also looms as a possible contributor to domestic automotive parts travails (link).

There is much that we do not know yet. Still, as the Seventh District crosses the mid-decade mark, with its lagging performance showing little sign of abatement, it is time to raise questions and to analyze the extent to which the region’s growth path has changed.

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Posted by Testa at 4:34 PM | Comments (0)

January 24, 2006

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

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

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

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

  • To what extent are today’s pension systems funded, especially in the Midwest? What are the demographics of the state and local government work force and the attendant size of the potential pension funding stress? What are the resulting implications for general fiscal stress and strain?

  • How do public pension systems compare with private pensions and Social Security? Can and should they be structured differently? Most public pensions are still “defined benefit” plans where payouts are guaranteed over the retiree’s lifetime regardless of contributions. Should pension benefits for future retirees be changed to reflect their actual contributions?

  • What will be the likely financial impact of new accounting regulations that will require governments to recognize non-pension retiree expenses such as health care costs as future liabilities?

Solving the pension problem is more than a fiscal issue. Conference speaker Lance Weiss from Deloitte Consulting will talk about the human resource needs of state and local governments and the effect that pensions can have on retaining and recruiting new talent. For many public sector employees, a guarantee of a stable and secure pension has been a key component of compensation programs designed to keep workers in the public sector. Managing the transition to new types of pension programs will be a key human resource strategy for government managers.

Fred Giertz of the University of Illinois and Executive Director of the National Tax Association will contrast public pension programs with those in the private sector and the social security system. Giertz will examine regional differences in accounting standards, financing mechanisms and benefit levels, and discuss the relative health of these pension programs.

Laurence Msall, President of the Civic Federation, will lead a panel that will look at options for improving the health of public pensions. Governments have been attempting new strategies for managing pension obligations, including adopting less generous plans for new employees and offering incentives for employees to take a portion of their pension in a lump sum to limit future payouts. Still, many public finance experts predict that either existing government services will need to be reduced to provide enough revenue to meet pension obligations or taxpayers will be asked to bail out pension programs.

A final concern is the regional aspect of pension underfunding. States in the Midwest face a particular challenge in that much of their state and local work force is older and approaching retirement. In addition, some states face significant funding gaps and future liabilities that will only grow if left unaddressed. It is plausible that the pension problem is more acute in the Midwest, where projections for slow population and tax revenue growth will make it more difficult to grow the region out of the problem. For example research by the University of Illinois suggests that state pension programs should be 97% funded given the rate of income growth; current funding is at 62%. Further, the Civic Federation has found that Illinois has consistently shortchanged its pension contribution since the 1970s. For the state to reach its goal of being 90% funded in the next 40 years, it will need to come up with $275 billion. Illinois’s five major pension funds are currently $35 billion underfunded. Considering that the general operating budget of the state is $43 billion, the size of the deficit seems particularly daunting.

In the end, the future of public pensions is a national issue. Some estimates put the state and local government pension funding gap at nearly $700 billion, compared with a private-sector pension funding gap of $123 billion. Solving this problem will undoubtedly be a large public finance issue facing many states and localities in coming years.

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Posted by Testa at 4:35 PM | Comments (3)

January 18, 2006

China and Midwest Biotech

Many Midwest businesses are scrambling to adapt to the rise of China’s economy in world trade and financial markets. Import competition is especially keen. Some Midwest automotive parts suppliers are watching with concern as China has climbed to the number four exporter to the U.S. behind Japan, Mexico, and Canada (CFL).

How can U.S. businesses successfully adapt to the expansion of the dynamic Chinese economy with its low labor costs and less stringent environmental regulations? One way is to shift some operations overseas, investing in China for export back to the states and/or for sales to the growing Chinese market. So far, China has grown at a spectacular rate by inviting foreign companies to set up shop there. While many U.S. multinationals such as GM, Tenneco, and Motorola have done so, so have smaller producers such as Wahl Clipper (hair grooming products) out of Sterling, Illinois, and Atlantic Tool and Die Co. of Strongsville, Ohio.

Another avenue to survival and adaptation is to partner with Chinese companies on investment inside the U.S. So far, foreign direct investment (FDI) by Chinese companies in the U.S. has been miniscule. A few prominent examples of late may make Chinese FDI seem larger than it is, such as Legend’s purchase of IBM’s personal computer business and CNOOC’s failed attempt to purchase Unocal (petroleum). Over time, it is natural to expect that as Chinese companies grow and mature, they will sometimes find it advantageous to invest overseas. Likewise, foreign investment flows into the U.S. can mean new technologies and new portals to global markets for U.S. products, which often keep American workers productive and well-compensated.

This week I am speaking about biotech in the Midwest to the Midwest China Association (MWCA). The MWCA’s mission is to attract inbound Chinese investment into the greater Midwest. They do so by educating the Chinese business community about the benefits of the Midwest, as well as educating our region about overseas opportunities. The MWCA sees Midwest biotech as one of the future cornerstones of the Midwest economy and aims to gather a portfolio of information that can be used to characterize and market the region to potential Chinese investors and partners.

Where can the MWCA and foreign investors learn about biotech activity and opportunities in the Midwest? Currently, there is no Midwest biotech association that compiles information and markets the region’s industry assets. However, journalist and seasoned industry veteran Michael S. Rosen is a virtual encyclopedia of information on the Midwest biotech business scene (link). And for a more active way of gathering information, the nation’s premier biotech meeting, BIO2006, will be held in Chicago this coming April. Due to its nearby location and Illinois sponsorship, Midwest states will be heavily represented.

As we learned at the December Chicago Technology Forum, past “BIO” meetings have galvanized the host regions, if not spurring them to significant cooperative efforts and partnerships, then at least delivering a more comprehensive and cohesive image and understanding of biotech activity and opportunities in the host region. Past meeting have been held in Philadelphia (2005), San Francisco (2004), Washington, DC (2003), Toronto (2002), San Diego (2001), and Seattle (1999).

How will I characterize the Midwest biotech landscape when I speak to the MWCA? For one, the Midwest is long on research and short on commercialization (CFL). A familiar refrain among biotech wannabe locales across the U.S. is their inability to attract venture capital investment flow and to originate startup companies, which is also true of most locales in the Midwest. However, less common among U.S. biotech wannabe locations are the host of potential assets for commercialization that can be found here in the Midwest.

Our region’s universities and federal labs boast prodigious R&D funding and activity (see figure below). One prominent ranking of world universities’ science capacity reports that the states of Iowa, Minnesota, Missouri, Wisconsin, Illinois, Indiana, Michigan, and Ohio are the domicile of 7 of the top 50 and 12 of the top 100 institutions. Overall academic R&D funding in Midwest states tends to be above the U.S. average, with Ohio, Illinois, Michigan, Missouri, and Minnesota ranking 9th, 10th, 11th, 12th, and 14th nationally in 2004. Licensing revenue from the region’s universities amounted to $197 million for FY2003, with 47 new startup companies created, many of which are biotech in orientation. A young organization, the Midwest Research Universities Network (MRUN), is a collaboration that promises to raise the number of startups emerging from the regions universities and labs.

*The Shanghai Jiao Tong University ranks universities by several indicators of academic or research performance, including alumni and staff winning Nobel Prizes and Fields Medals, highly cited researchers, articles published in Nature and Science, articles indexed in major citation indices, and the per capita academic performance of an institution.

The Midwest also hosts large pharmaceutical companies, including Abbott and Baxter in Chicago, Eli Lilly in Indiana, and large Pfizer facilities in Michigan. So far, although large pharma companies have become the prime buyers of basic research from biotech nationwide, local linkages between these companies and biotech have not always developed.

A “diversity” of biotech arenas also characterizes the Midwest. Aside from pharmaceuticals, companies that design and manufacture medical devices are found here. Minneapolis hosts Medtronic, Inc.; Milwaukee hosts GE Medical Systems (high-end imaging); Indianapolis has Guidant; the area around Warsaw, Indiana hosts the prosthesis industry; and the Chicago area is home to Baxter and Hospira.

Attendees of BIO2006 will also learn about the Midwest’s agricultural biotech sector. Ethanol plants are being built or expanding in the corn belt, and high-end research to more efficiently derive energy products from agricultural feedstocks is taking place at the region’s universities and biotech companies (link). Seed and chemical companies such as Pioneer Hi-Bred and Monsanto are continuing to produce stronger strains and new varieties of crops, as are smaller companies such as Chromatin Inc. in Illinois.

Will biotech become a cornerstone of the Midwest economy? While the outlook is promising, there are no guarantees. Despite all that the Midwest has going for it, some studies indicate that biotech activity is becoming more concentrated in just a few places rather than dispersing (link). So too, Midwest assets are noticeably dispersed and spatially separated across the region, making collaboration more difficult than within some existing biotech centers.

Still, it is a little more likely that the Midwest will realize its tech commercialization ambitions so long as organizations like the MWCA are working to connect Midwest biotech opportunities with potential investors and partners.

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Posted by Testa at 3:35 PM | Comments (0)

January 13, 2006

Bullish on the Chicago Metropolitan Economy

So far this decade, the Chicago metropolitan area's economic performance has been disappointing. As in the surrounding Midwest, job declines during the recent recession were worse here than in the nation as a whole, and this area’s job growth during the expansion has since been lagging. With this lackluster performance, there has been a special disappointment for Chicagoans; the metropolitan region’s economy led the nation and most of the surrounding Midwest during the 1990s. During that time, there was a sense that Chicago’s economy had evolved beyond its role as regional business capital into one as national and global business center.

What is Chicago’s outlook for 2006? I am optimistic, although there are some defensible reasons for caution. For one, goods producing industries in the surrounding region may continue to pull down Chicago’s service sectors. Chicago’s outsized business and professional service sector continues to serve the Midwest, as do its travel, distribution, and business meeting services. But looking ahead, the Midwest economic outlook is clouded by the prospects for its automotive industry. Nationally, automotive sales growth is not expected to be robust this coming year, especially for the Big Three automakers and their suppliers that populate the eastern part of the Midwest region as well as northern Illinois and southern Wisconsin. Accordingly, this segment of the Midwest cannot be expected to propel Chicago’s service economy in 2006.

There is a second reason to be cautious: National economic growth is expected to moderate modestly in 2006 (link). Since Chicago and the Midwest generally follow national trends—perhaps even follow them in a magnified fashion—there is some doubt that the metropolitan economy’s performance will gain momentum as the national economy moderates.

Still, despite these trends, and with a great deal of uncertainty, I offer some reasons for optimism for those of us who are inclined to be bullish about Chicago.

Not all of the surrounding Midwest manufacturing activity is moribund. The region’s capital goods industries, such as the machinery and equipment industry, are expanding. Looking forward, as national and global economic growth continues, U.S. and world demand for “new tools” and added production capacity tend to lift capital goods sectors. In turn, employment in manufacturing sectors, along with physical expansion of factories, tend to take place with a lag as excess capacity becomes squeezed.

More generally, recently reported data indicate that improvement in Chicago’s labor markets is already underway. During the autumn, Chicago's year-over-year payroll job growth exceeded 1 percent for the first time since the year 2000, while the unemployment rates were down in the fourth quarter (according to preliminary reports).

Chicago’s vaunted business and professional services industry is once more reporting strong employment growth. Though it has much catching up to do from its poor performance in recent years, Chicago’s year-over-year job growth in this sector is exceeding the nation’s.

In the travel and meeting arena, passenger arrivals to the Chicago area and hotel demand continue to recover. Plans for local conventions have edged up for 2006, as have planned developments of new hotel space.

Chicago’s financial exchanges also form a bright spot. 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., and they once dominated global trading as well (link). However, in the 1990s, competing exchanges in Europe and Asia made strong gains in global market share, depressing the metropolitan area’s income and employment. But recently, Chicago’s two major exchanges, the Chicago Mercantile Exchange and the Chicago Board of Trade, 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.

Chicago’s central area remains head and shoulders above all mid-continental contenders as a magnet for attracting younger skilled workers. Such workers are now greatly coveted for regional growth and development. A recent study of the 40 major U.S. metropolitan areas reported that Chicago’s downtown ranks sixth in the share of 25–34 year-olds, and Chicago experienced the third greatest percentage gains in this group (up 28%) during the last decade. Chicago’s downtown has the second highest share of residents with bachelor’s and advanced degrees with 67.6%, only behind Midtown Manhattan (link).

The Chicago area manufacturing sector was hit hard in the early years of the decade, especially in its own high tech hallmarks of IT and telecommunications manufacturers, such as Tellabs and the much larger Motorola. Thankfully, the region’s machinery and equipment sectors have bottomed out because national investment spending has recovered, growing at double-digit rates in 2004 and 2005. Such strong national demand for equipment and software is expected to continue into 2006.

In the high tech start-up arena, a flurry of activity took place in the Chicago area at the end of the last decade. Chicago’s timing was very unfortunate in this regard, coming in at the national peak of activity such that the Chicago region suffered greatly through the subsequent collapse. Now, however, the region’s technology businesses appear to be gathering steam once again for another push at realizing the metropolitan area’s full potential for technology start-ups. Positive developments include the Technology Development Fund of the Illinois Science and Technology Innovation Campus in Skokie, Illinois, and the research park expansion planned by the Illinois Institute of Technology. Tech commercialization policy initiatives are also moving forward. To name but a few of many, the Chicago Biomedical Consortium will be sharing new medical research equipment among Chicago area institutions, and the Midwest Research University Network will be cooperatively fostering start-ups out of Midwest universities and research labs.

The Chicago area economy has not been fortunate in recent years. Its economy is driven by its business service and headquarters functions; its role as distribution hub of the Midwest’s goods and materials; and its business travel/meeting activity. These sectors have been buffeted by weakness in the surrounding regional economy and, more globally, by weakness in manufacturing and business travel/meeting activity. Recent trends portend that Chicago’s performance will catch up with the nation’s somewhat in 2006.

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Posted by Testa at 5:55 PM | Comments (0)

January 6, 2006

Midwest and the Global Economy Part I

From the slow progress being made on the Doha round of global trade liberalization, it would seem that globalization is slowing down. Yet, this is not the case at all. As the 2002 Economic Report of the President articulated, globalization continues to be enhanced by ever-falling costs and technical advancements in communication and transportation. Such developments are magnifying trade flows of merchandise and commodities and, more recently, services such as software, R&D, call services, and data processing. Springing from these developments in information technology and communication, global capital markets are deepening, which in turn further heightens trade in goods and services.

Regional economies, especially that of the Midwest, are being affected by globalization. Tradable goods such as manufacturing and agriculture products play a significant role in the upheavals of globalization. And so, Midwestern households and business would benefit from timely and appropriate adaptation to the globally induced upheavals taking place in industries, companies, and occupations in the region.

Since households continue to learn about globalization from the print media, The Global Chicago Center of the Chicago Council on Foreign Relations and the Ford Foundation are fashioning a project called the Midwest Media Project. The project intends to assist journalists throughout the region to help put local interests in the broader context of global economic developments and events. In this way, Midwesterners can become more attuned to globalization, especially as it relates to the region.

At the first meeting of the project on January 10, researchers and policy leaders are being asked to present globalization topics and information to the attending journalists. In turn, several senior journalists will lead discussions on ways in which global events and trends can be linked to local stories in engaging ways.

I was asked to deliver the overview on the Midwest economy, highlighting the linkages between our region and the world economy. And when I stop to think of the linkages, there are many. For one, given our sharp manufacturing concentration, the Midwest economy is about on par with the nation in terms of exports, and our region’s exports to the world are large and growing. Not surprisingly, it is our “capital goods” that stand out as prominent exports—construction and farm machinery, medical equipment, engines, and electrical equipment. Automotive exports are also prominent, with most of them destined for nearby Canada rather than for far-away locales. As Thomas Klier, automotive expert here at the Chicago Fed has said, “the binational region’s auto industry knows no boundaries.” (Chicago Fed Letter on border conference) Close to 40% of the considerable U.S.–Canada merchandise trade crosses the border in Michigan through the Detroit–Windsor corridor or over the bridge at nearby Huron-Sarnia, much of it being automotive parts and finished vehicles.

Partly owing to this tight automotive production integration, Great Lakes exports to Canada represent 50.4% of the region’s exports versus only 18.2% for the overall U.S. If we were to deduct U.S. exports to Canada from both the Great Lakes region and the U.S., the pattern of export destination by country would be nearly identical for both the region and the overall U.S., with a slight tilt of Midwestern exports to Europe rather than toward Asia.

So, too, without our outsized trade with Canada, the Midwest export propensity is significantly smaller in relation to the rest of the U.S. In addition to the region’s proximity to Ontario, landmark agreements to lower tariff barriers to trade between the U.S. and Canada, such as the AutoPact of 1965 and the Free Trade Agreement of 1989, have maintained the close trade linkages between Ontario and the Great Lakes states.

In assessing a region’s (or a nation’s) propensity to trade, should trade with nearby countries be counted equally as trade with faraway ones? In comparing trading intensities across countries or regions, it seems reasonable to at least keep in mind that national boundaries can be somewhat arbitrary. For example, if the boundaries separating states in the Midwest were national boundaries, the trade intensity between the Midwest states would be enormous (link link), easily dwarfing current international trade flows into and out of each state.

What do such trends suggest for the region’s economic development policy focus? Growing international trade would seem to support trade missions from the region to foreign countries, many of which are sponsored by state governments. However, the Hewings and Israilevich statistics (above) on the larger volume of intra-regional trade flows might alternatively suggest that public policies to enhance or support local commerce might deserve more emphasis. I see no conflict here; these policy arenas are complementary rather than in competition. We can metaphorically think of the highly integrated binational Great Lakes region as a single factory or service company. Our efforts to encourage free flowing and efficient commerce within the region will serve to strengthen our ability to produce goods and services for trade with the world, which in turn will result in more income for the region’s households and businesses.

One example of local policy of this nature is surely the continued attention to keeping our border-crossing infrastructure and procedures with Canada safe—but also fast and efficient (link). On the U.S. side, the Great Lakes economy will be more likely to prosper if it is the center and nexus of commercial trade flows rather than a peripheral player in the national economy.

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Posted by Testa at 10:42 PM | Comments (0)