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April 27, 2006

Midwest Auto Suppliers at a Critical Crossroads

In regard to the economy, everyone associates the Midwest, especially Michigan, with the Big Three automotive nameplates of General Motors (GM), Ford, and Daimler-Chrysler. Also, most everyone is aware that the Big Three are closing some of their assembly plants, where finished vehicles are produced, in part because they are losing domestic sales to other international assembly companies. But the more acute threat to the Midwest economy comes not from assembly plant shutdowns but from the possible retrenchment in the region’s much larger auto supplier industry—the subsector that produces automobile parts for the assemblers. Automotive suppliers are the lesser known part of the auto sector, even though they employ three to four times as many workers as assembly operations. Today, many Midwest automotive suppliers are operating in bankruptcy or are under severe stress due to their current business environment. To assess the industry’s prospects, the Chicago Fed held a conference on the changing geography and business environment for auto suppliers on April 18–19 at its Detroit branch. Presentations from the event are now being posted on the Bank’s website.

Why are so many Midwest supplier companies beleaguered? There are several factors, including the rising costs of inputs, the restructuring of the traditional assembler–supplier relationships, a shrinking customer base, high labor costs, and heightened import competition.

Most generally, the role and tasks of many supplier companies have become more complex. As Michael H. Moskow stated in his remarks opening the conference, “traditional carmaker–supplier relationships are rapidly changing. Today, assembly companies are requiring more from their primary suppliers in terms of product design, engineering, and cost. But some assemblers and suppliers are finding it difficult to achieve the cooperative relationships now required to produce popular, high-quality vehicles.”

In this regard, some suppliers reported that their relationships are better with some of the new international carmakers than with the Big Three. Representatives from Ford and GM acknowledged that supplier relations have not been as strong as desired and outlined efforts being made to improve their supplier relations.

According to Michael H. Moskow, another challenge “is that many suppliers, particularly in the Midwest, are losing business because their Big Three customers continue to lose market share to foreign nameplate manufacturers located in other regions of the United States, especially the American South. The flipside to this, of course, is the opportunity for suppliers to increase sales to the foreign manufacturers who are producing an ever higher number of vehicles in the U.S. But the transition to new customers may be a formidable challenge for many suppliers. New customer relationships take a long time to build, and the costs of relocating operations closer to new customers or servicing these customers from distant production facilities can be significant.”

In reflecting on the new geography facing Midwest suppliers, Jim Rubenstein and Thomas Klier illustrated the heightened challenge that Midwest suppliers face in transporting parts from Midwest locales to the emerging auto assembly belt. Between 60%–65% of both assembly and parts plants remain in the Midwest today. Yet, assembly plant locales are shifting to the South (from 5 plants in 1979 to 15 today), pulling parts production along. Recently, the “pull” southward on parts production by assembly plant relocation places even greater pressures on Midwest parts suppliers. In particular, there has been a further southward drift in assembly capacity in recent years, well beyond the mid-south locations in Kentucky and Tennessee that were established during the 1980s and early 1990s. As illustrated by Thomas Klier and Jim Rubenstein in the slide below, for some particular types of auto parts, the increased shipping distances from the Midwest make for difficult “one-day delivery” times that are often desirable.

Many Midwest suppliers are also being challenged by import competition. The nominal value of direct imports of motor vehicle parts to the U.S. has more than doubled over the past decade, increasing from $37 billion in 1995 to $84 billion in 2005. So, too, indirect and unobserved parts imports have also climbed in all likelihood. One-half of the loss of Big Three market share since 1995 has come from increased imports of assembled autos. Many of the parts in those same autos were produced abroad as well.

Finally, some Midwest supplier companies are at a competitive disadvantage to both overseas supplier plants and some domestic supplier plants in other regions with respect to wage and benefit compensation, working arrangements, and legacy costs. In response, management-labor relationships are being successfully restructured in this industry. JCI and Metaldyne are examples of supplier companies that have successfully introduced competitive business environments in cooperation with the United Auto Workers, the industry’s major labor union.

Based on such successes, the conference participants hope and cautiously believe that the needed transitions to create a stronger business environment for the Midwest automotive industry will come to pass. Also, they maintain, there are a number of reasons why Michigan and the surrounding areas will remain an important location for the auto industry. These include the region’s abundance of skilled workers and associated training programs; a well-developed infrastructure for logistics and transportation; and a still dominant and highly concentrated network of materials suppliers, research and development, and parts producers—all of which make up the world’s most productive automotive region.

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Posted by Testa at 12:03 PM | Comments (0)

April 17, 2006

Manufacturing and regional policy

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

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

Source: Bureau of Labor and Statistics/HAVER Analytics
Click to enlarge images.

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

Both Midwest manufacturing output and manufacturing employment are growing once again, roughly keeping pace with the nation. However, in the Seventh District, neither recent gains in output nor employment have as yet made up for previous losses.

One response to lagging manufacturing has been the formation of a multi-state coalition of manufacturing organizations named the Great Lakes Manufacturing Council. Initiated by the Detroit Regional Chamber of Commerce, last year the group began working on a regional economic development entity to position the region to compete in the global marketplace.

Last month, the Council traveled west to Chicago to broaden the discussion and partnership among manufacturing stakeholders. Those who are interested in participating or learning more should contact Lisa Katz, Director of Government Relations at the Detroit Chamber.

Click to enlarge image.

To date, the Council has identified these top priorities: 1) clarifying and promoting the region’s manufacturing image to the world and to incoming work force; 2) developing and certifying work force skills relating to manufacturing activities; 3) identifying and sharing best innovative practices and technologies among manufacturers; 4) keeping the vital U.S.–Canada border open and efficient for the flow of goods and people; and 5) articulating infrastructure needs to maintain the region’s advantage in logistics.

Are such efforts worthwhile? The results of such initiatives have been little studied. And the strategic responses of individual companies most likely overwhelm cooperative policy in ultimately determining competitive strength. However, manufacturing operations in the Midwest are tightly linked through supply linkages and through a shared labor pool and transportation infrastructure. And so perhaps the recent time of stress will spur cooperative policies that prove to be helpful in sustaining the region’s manufacturing base in the years ahead.

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Posted by Testa at 10:22 AM | Comments (2)

April 10, 2006

Export Growth Propelling Seventh District

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

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

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

Source: WISER/HAVER Analytics

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

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

Source: WISER/HAVER Analytics

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

Source: WISER/HAVER Analytics

The relative export performance of individual District states from 2003 through 2005 aligns with each state’s particular industry mix. As Thomas Klier indicated in a recent Chicago Fed Letter, weak performance by domestic auto companies is being reflected by flat automotive trade among NAFTA countries. Accordingly, the chart above shows that exports from Michigan have grown at only one-half the pace of the nation and at less than one-third the pace of the remainder of the Seventh District. At the same time, the more capital-goods intensive states of Illinois, Iowa, and Wisconsin are experiencing rapid export growth.

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Posted by Testa at 10:06 AM | Comments (0)

April 5, 2006

Midwest housing activity

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

Click to enlarge image.

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

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

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

Click to enlarge images.

Residential activity and appreciation are determined by more issues than simple demand. For example, high population growth has led to rapid home building in Des Moines, yet home appreciation there has been meager. Land availability and ease or restrictiveness of development can influence the supply of housing and its price. Home-building materials prices and construction labor costs may also be bid up to differing degrees across metropolitan areas.

Most metropolitan areas in the Midwest are little constrained by land availability in comparison to other regions of the country where geographic impediments such as mountains, government land, or oceans constrain development, or where communities themselves are more strongly authorized and motivated to restrict development.

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Posted by Testa at 10:14 AM | Comments (0)