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July 22, 2008

U.S. auto exports on the rise

By Thomas Klier

For the past 11 years, sales of light vehicles have consistently been above 15 million units per year, representing an unusually strong run for this industry. Toward the end of 2007, the U.S. market for motor vehicles started to slow down. As the price for gasoline kept rising, recently reaching $4 a gallon, not only did vehicle sales continue to fall, but consumers rather quickly adjusted the mix of vehicles they bought, abandoning full-size trucks and large sport utility vehicles (SUVs) in favor of fuel-efficient cars and crossover utility vehicles (CUVs, or utility vehicles built on passenger car platforms).

However, amid the ongoing turmoil in the auto sector, there has been a bright spot that often gets overlooked. Exports of light vehicles have increased by 52% since 2002, with exports of new vehicles up 21% and exports of used vehicles up almost fourfold (see figure below).


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The figure below illustrates how exports of new light vehicles—that is, cars and light trucks, such as minivans and utility vehicles—have substantially outpaced domestic production as well as sales over the last eight years. As a result of this noticeable increase, last year's exports of newly produced light vehicles represented 16% of U.S. light vehicle production, up from 11% as recently as 2002.


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What’s behind this rather substantial increase in exports? We first analyze in some detail where vehicle exports are going.

Data available from the U.S. International Trade Commission (USITC) identifies the destination country for exported vehicles. In 2007, new vehicles, representing just over 70% of all vehicle exports, were being shipped primarily to the two North American Free Trade Agreement (NAFTA) partners: Canada received just over half of all new U.S. light vehicle exports, and Mexico took in 12% of U.S. exports (see table below). The strong linkages among the NAFTA countries reflect the fact that the production footprint of each of the multi-plant carmakers is highly integrated across the U.S., Mexico, and Canada. Many vehicle models are being produced at only one assembly plant within North America. It is therefore standard practice to serve the entire North American market from that one location, resulting in cross-border shipments. In fact, analysts often refer to a single North American motor vehicle industry (in terms of production and sales). Other destination regions for U.S.-made vehicles rank far behind North America: In 2007 Europe received 18% of all new vehicle exports from the U.S., and the Middle East came in third with 10%.

Yet the significant increase in new vehicle exports during the last few years followed a noticeably different geographic pattern: Between 2002 and 2007, exports to the NAFTA countries actually fell by 5%. In contrast, Europe received 52% of the net increase of 287 thousand in new vehicle exports over that period; the Middle East accounts for about 40%, likely reflecting spending from increased oil revenues. Incidentally, exports of used vehicles were much more dispersed than those of new vehicles, with each major region of the world receiving at least 10% in 2007 (see table below).


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At first glance export growth seems related to the exchange rate value of the U.S. Dollar (see figure below). (Note that the exports of new light vehicles from the U.S. to Canada and Mexico are excluded from this graph.) Subsequent to the dollar’s recent peak in 2002, exports of both new and used vehicles accelerated. However, more is afoot than currency fluctuations. This is evident because exports began to rise a couple of years prior to the dollar’s 2002 peak. By the same token, the strong increase in new vehicle exports took place during the last two years, well after the dollar started to decline.


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A better understanding may be found in the global nature of production employed by today’s automakers, many of whom have chosen to produce on U.S. soil. During the 1980s all the major Japanese carmakers opened their first production facilities in the U.S. The German carmakers BMW (Bayerische Motoren Werke AG) and Mercedes-Benz followed during the 1990s, and the Korean carmakers Hyundai and Kia entered during the first decade of the twenty-first century. Yet setting up production operations in the U.S. (or for that matter another country) for a foreign carmaker is neither done quickly nor reversed easily. In fact, the recent response of U.S. exports of light vehicles to currency fluctuations might well reflect the new reality of global production linkages common among today’s international carmakers. Indeed, exports of vehicles from the U.S. include production by many carmakers of different nationalities (unfortunately data on exports at that level of detail are not available). For example, both BMW and Mercedes now operate an assembly facility in the United States. Some of their models are exclusively produced in the U.S. from where they are shipped around the world. BMW recently announced a further expansion of its South Carolina plant, designed to increase its capacity by 50% by 2012. Both Honda and Toyota produce vehicles in North America. Yet the two companies’ production operations are linked not only within North America but also within their respective global operations. And so, rather than reduce production of certain models because of weakening U.S. demand, Honda recently increased exports of U.S.-produced models to Russia. Similarly, Toyota exports its Avalon sedan from the U.S. to the Middle East.

Volkswagen (VW), the largest German carmaker, decided in mid-July to locate a new assembly plant in Chattanooga, Tennessee, returning as a producer to this country after making cars in Westmoreland, Pennsylvania, over the period 1978–1988. Part of the company’s rationale is to increase the proportion of vehicles as well as parts produced in the U.S. dollar region so as to provide a natural hedge for its European base. Once the new factory is in operation, VW plans on exporting more than 125,000 North American-produced vehicles to Europe.

Finally, among the Detroit Three, Chrysler LLC is the most concentrated in North America, and it has been growing its exports overseas. Last year the company exported around 10% of its North American production to countries other than Canada and Mexico.

And so the recent increase in U.S. exports of light vehicles most likely reflects changes to the production system of international carmakers as well as changes in the value of the U.S. dollar. Because of their globally linked production operations many carmakers within North America can now readily shift production to serve overseas markets as demand conditions warrant. That aspect of the global auto industry could act as a buffer to a slowdown in a market like the U.S., which is home to production operations of many international carmakers.

This blog has been reposted as of July 29, 2008, reflecting domestic rather than total exports.


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Posted by Testa at 8:57 AM | Comments (2)

July 10, 2008

Assessing the Midwest Floods of 2008 (and 1993)

By Rick Mattoon

As water levels recede, the region is beginning to take stock of impact from some its worst flooding since 1993. The geographic footprint of this year’s flooding (depicted below) is less extensive than the nine states and 504 counties affected 15 years ago. And as always, an assessment of the short- and long-term impact of this natural disaster on the national and regional economy will be difficult. In this blog, I will look at the effect of natural disasters on economies and contrast current flood conditions with those the region faced in 1993.



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How to think about the losses to the U.S. economy

From a conceptual viewpoint of our economy, natural disasters impact our economic well-being in two basic ways. First, they destroy what we have produced in the past—our “capital stock”—including lives, homes, commercial buildings, public infrastructure and property. Second, they often interrupt normal commercial activity and production. Transportation and deliveries do not take place, people cannot get to work and work places become dysfunctional until normalcy is restored.

In a December 1993 Chicago Fedletter, Bill Testa, Gary Benjamin and I wrote, “Perhaps the most meaningful definition of economic loss due to a disaster is the value of output of goods foregone—that is, the total net output that would have been produced had it not been for the disaster. Foregone output results for two reasons. First, natural disasters destroy productive capital stock such as roads, bridges and factories, thereby reducing output until such time as the capital stock is restored. Second, natural disasters can interrupt day-to-day business activity.”

As that article points out, the impact of the natural disaster tends to have a somewhat unusual affect on the national income accounts—the official way in which we measure the nation’s economic output and income from quarter to quarter. Following the 1993 floods, estimates for the third quarter reduced personal income by $9 billion and forecasted uninsured losses to be $2 billion. Losses to proprietors’ incomes were estimated at another $1 billion.

Remarkably, such initial losses soon appear to translate into economic gains as business and households rebuild. The rise in construction activity and the resumption of business activity often boost gross domestic product (GDP) estimates for future quarters, as households and businesses attempt to rebuild their physical capital and, in the case of businesses, to fill order backlogs. For example, following Hurricane Andrew, annualized GDP growth hit 5.7% in the fourth quarter of 1992, spurred by rebuilding activities.

However, such rebuilding does not reflect an actual economic gain in the broad long-term perspective. In most cases the rebuilding merely replaces lost capital stock—meaning that, in the long term, the nation’s product will not exceed what would have been produced without the disaster. While the immediate burst of economic activity is quite evident, the losses from the foregone output of interrupted and diminished business activity may go largely undetected because the diminished growth takes place in small amounts spread over many years.

Regional economic losses

The ultimate extent of the damage to the region’s economy will in large part depend on who pays for the rebuilding. If the losses are in large part covered by the national government and insurance companies, and if reimbursement is prompt, the region can conceptually restore output and even increase its levels of economic growth. However, if the 1993 flood experience is a guide, it is more likely that the region will absorb a significant share of the disaster-related cost. Because flood insurance was not extensively used, it was estimated that 15% to 25% of the flood costs were borne by state and local governments, not to mention the costs to uninsured homeowners who were forced to rebuild using their own resources. In the most recent floods, it was estimated that only about 1% of Iowans owned flood insurance. In hard hit Cedar Rapids, only 777 of the 4,000 homes damaged or destroyed by flooding were covered. Despite efforts after the 1993 floods to expand coverage, the cost of the policy and the limits of coverage still deter homeowners from purchasing polices. It is estimated that the average cost of a policy in Iowa is $500 per year with coverage only including direct flood damage and not related damage such as water that enters the house through a backed up basement drain. Even if property owners choose to be fully insured, insurance must be paid for. Thus, residents of these regions do bear at least some of the costs in choosing to live and work in disaster prone areas. Currently $2.7 billion in federal flood relief has been approved to aid 2008 flood victims. This does not include the value of low-interest loans and small business assistance as well as the value of crop insurance and private insurance.

Specific categories of losses--Agriculture

In both floods, the greatest concern focused on flooded crop land. In the 1993 floods, nine million acres were submerged by the flood. The lost acreage had been expected to produce 6% of the region’s harvest that year. The estimated crop losses were $7 billion. The states with the largest percentage loss were Missouri 12%, Minnesota 11%, South Dakota 8% and Iowa 7%. In this year’s flooding, damage is heaviest in Iowa where 2 million to 3 million acres of corn and 2 million acres of soybeans were flooded. The American Farm Bureau estimates crop losses at $8 billion for the region, with $4 billion of the total in Iowa. Other states with significant estimated losses are Illinois ($1.3 billion), Missouri ($900 million), Indiana ($500 million) and Nebraska ($500 million). The Bureau points out that it is not only the flooding that will impact crops but also the excessive rainfall that occurred this year.

A June 30 estimate by the USDA projected this year’s corn harvest to be down from 86.5 million acres to 78.9 million, or 8.7 percent. However, the impact on prices may be softened if a robust corn harvest occurs, since supplies should be sufficient to meet demand for food, feed and ethanol. Following the USDA report, corn futures fell from $7.55/bushel to $7.25/bushel, significantly off the $8/bushel price recorded on the Chicago Board of Trade in the immediate wake of the flooding. Still, this price is significantly elevated over the early June $6/bushel price.

One big difference between this year’s floods and that of 1993 was the preexisting stocks and prices of corn and soybeans. In 1992, a bumper crop had been harvested. For example, the stock-to-use ratio for corn hit 25% in 1992 and even in the flood year of 1993 ended at 11%. While prices rose, the increase was a modest hike from $2/bushel to $2.50/bushel. Today the corn stock-to-use ratio is only 6%; prices spiked accordingly to $8/bushel immediately after the flood before retreating to the current price. This tightness reflects the increasing demand for corn both for export and for ethanol. Given this, even if the number of acres lost is smaller than in 1993, the impact on prices will need to be closely monitored.

Spillover issues into other agriculture markets also need to be considered, as livestock feed prices are affected. The condition of the fields for next year’s planting will need to be assessed as well.

Structures

Given the smaller geographic footprint, the potential cost of rebuilding and the infrastructure loss is considerably less in this year’s flooding. While Cedar Rapids and parts of Iowa City were severally impacted, much of the flooding was contained within sparsely populated areas. In 1993, an estimated 45,000 to 55,000 private homes were destroyed, and between 35,000 and 45,000 commercial structures were damaged. Similar to today, most of the homes did not carry flood insurance, making uninsured losses the most significant issue. Estimated property and nonagricultural losses totaled $5 billion before insurance.

Another difference with the 1993 floods was the damage to infrastructure. In 1993, 1,000 miles of road were closed, and 500 miles of railroad track were underwater. Nine out of 25 non-railroad bridges were damaged and closed. This time, some highways were closed for several days due to flooding but damage to bridges, locks and other infrastructure was limited. The exception of course is in cities such as Cedar Rapids where infrastructure losses in the downtown are extensive. Cedar Rapids had 1,300 city blocks underwater, forcing 24,000 residents to evacuate. Preliminary damage estimates have been placed at $736 million or roughly $6,095 per capita. This must also be placed in the context of disruption to Iowa’s second largest city of over 120,000 people with a 2005 gross metropolitan product of $11.2 billion.

Transportation disruptions

One of the more immediate problems that flooding causes is transportation disruptions. The 1993 floods were so extensive that barge traffic on the Mississippi was halted for 2 months. In contrast, barge traffic is expected to be affected for 3 to 4 weeks this time. By July 5, the entire Mississippi was reopened to navigation. Railway disruptions were also more severe in 1993. The destruction of rail bridges added four days to rail shipping times for several months while this time rail disruption was minimal for almost all major freight lines. The effected lines caused temporary delays of 1 to 2 days for most shipments.

What happens next?

For towns that were most directly affected, the question is, what does the path to recovery look like? Unlike individual farms and factories, cities’ and towns’ economies are composed of complex interrelationships that have developed over many years. A natural disaster can upset, disrupt and even destroy those relationships so that restoration is often impossible and sometimes undesirable. And so, the form of rebuilding may require careful consideration and evaluation.

Following the 1993 event, many communities and individuals simply choose not to rebuild. Other communities used natural disasters to redefine themselves. An interesting example of a town rebuilding after a flood was Grand Forks, North Dakota. The Minneapolis Fed chronicled the rebuilding of Grand Forks in a September 2006 Fedgazette article. Grand Forks was the victim of flooding in 1997. In April of that year, 80% of the town was submerged. By 2006, the area was largely restored with the region’s economy growing at a faster pace than before the flood. This was due largely to the influx of $600 million in federal disaster aid (approximately $10,000 per resident).

After much painful disruption, lengthy deliberation and hard planning, the flood eventually spurred a new vision for the area. Roughly 1,200 homes in the 100-year flood plain were bought out by the Federal Emergency Management Agency as part of a flood protection plan. The population rebound remained slow until the Army Corps of Engineers finalized a flood protection plan in 2000. Once this occurred, a building boom was unleashed. The city supported this by providing $10,000 forgivable loans for people staying at the same address for a specific period of time. The new housing was more expensive than what it replaced, with the new larger homes carrying average price tags of $138,000 versus the $85,000 homes that had been destroyed.

For business, the greatest disruption was for restaurants, bars, hotels and any business where discretionary spending is important. Many of these businesses had to lay off workers. Other businesses such as banks, health care and manufacturing suffered lost sales but did not suffer drastic employment declines. In fact given the gains in construction jobs, employment in Grand Forks rebounded to its pre-flood level in five months. To some observers, the newly rebuilt Grand Forks with its improved infrastructure and new capital stock is better positioned for growth than before the flood, but this is only true because of significant government subsidies and 10 years of hard work. And of course, it is not true for every household and business impacted by the flood, as many chose to leave Grand Forks.

Conclusions

The 2008 flood may seem to be milder in its overall economic impact on the larger region and the nation, but it is just as devastating for those who have suffered it as it was for those in previous floodings. The ultimate costs and impacts can only be known over time as damages become known, as the extent of relief is determined and as households, businesses and towns decide how to respond to the disruption. Most though not all of the agricultural costs and recovery will be known by the end of the growing/harvesting season. In contrast, the recovery and rebuilding process for towns, businesses and households will be protracted and laborious.


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Posted by Testa at 1:59 PM | Comments (1)

July 2, 2008

Michigan—Brakes and Shocks

Few outside the state of Michigan are fully aware of its economic woes. Nationally, the U.S. economic slowdown, housing market decline, and rising gasoline prices have captured the headlines. Even within the Midwest, spring and early summer flooding have dominated our news. Somewhat lost in the shuffle, Michigan payroll jobs are down more than 10% from their peak in June, 2000, representing over 486,000 jobs. Recent developments are no more encouraging. The state's (preliminary) unemployment rate rose by 1.6 percentage points in May, to a seasonally adjusted 8.5% percent—topping the U.S. rate of 5.5% by 3 full percentage points. Preliminary statistics estimate that payroll jobs in Michigan fell by 68,000 over the month (seasonally adjusted). Minus Michigan, reported U.S. employment would have grown by 19,000.


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Michigan’s economy currently suffers from unfortunate industry composition, with an added dose of structural shocks to several of its prominent lines of business. In particular, the automotive, tourism, and office furniture sectors are highly sensitive to national swings in economic activity. As the U.S. economy slows, such industries tend to decline even more. Moreover, in the case of automotive and tourism, structural changes are tending to further dampen economic production and hiring in Michigan.

Michigan’s economy remains far and away the nation’s most concentrated in motor vehicle manufacturing. Its overall employment concentration lies 8.5 times the national average in combined automotive parts and assembly, with many attendant jobs in manufacturing, distribution, and professional service companies that are customers or vendors to automotive producers.

While U.S. automotive sales remained robust until recently, the former Big Three automakers (now more appropriately called the Detroit Three) and their suppliers have been steadily losing market share to imports and to foreign nameplate producers located elsewhere in the U.S. As of May 2008, market share of the Detroit Three automakers had fallen from 67.8% in 2000 to 47.2%. Prominent parts supply companies, including Delphi, Dana, Tower, and Collins & Aikman, have folded, merged, or are currently trying to emerge from bankruptcy.


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With the recent economic slowdown, automotive sales are resuming their cyclical pattern of retrenchment. To some degree, the historical behavior of sales declines was allayed in the aftermath of September 11, 2001, when automakers offered generous sales and financing incentives to prospective buyers. However, today’s slowing economy appears to be leading consumers to avoid the purchase of new autos. As discussed recently at our annual Automotive Outlook Symposium, rising gasoline prices are curbing driving behavior while draining household income.


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The recent run-up in gasoline prices has magnified loss of market share and erosion of profitability of the Detroit Three automakers and their suppliers. Over the past year, the Detroit 3 share of domestic sales has fallen by 7.1 percentage points. To some degree, this repeats the pattern of the 1970s when U.S. consumers turned to (imported) foreign-domiciled automakers who offered vehicles with greater fuel efficiency. Domestic automakers are more reliant on trucks than on cars, and they tend to lag foreign manufacturers on fuel efficiency.

Not only the automotive sector has been impacted by rising energy prices. Michigan’s tourism, recreation, and hospitality industry has taken on added importance in the wake of the state’s waning automotive industry presence. Many parts of western and northern Michigan feature attractive scenic and semi-rural locales for retirement, recreational living, and seasonal tourism. In addition to its many inland lakes, the state is endowed with 3,126 miles of Great Lakes shoreline, which is attractive for boating, fishing, and other recreational activities like hiking, cycling, and golf. In particular, the state registers nearly as many boats as Florida or California. Such activities in Michigan are especially related to vacation and seasonal homes. As of the last Census, 5.6 percent of homes in Michigan were of this variety versus a national average of 3.1 percent.

The map below shows recreational counties as designated by demographers Calvin Beale and Kenneth Johnson. The northern tier counties of Michigan and Wisconsin have long been recreational destinations, especially for Michiganders and residents of the greater Midwest region.



Recreational spending is highly discretionary on the part of consumers. As household income falls, recreational spending can be easily curtailed by households in an effort to maintain spending on necessities.

Recent declines in Michigan recreational spending are reflected in data collected by the State of Michigan on sales tax collections imposed on overnight lodging. These accord with declining lodging occupancy rates collected by the industry. Both are down so far in 2008 on a year over year basis. A broader index of Michigan’s tourism activity is displaying a modest uptick for the first quarter of 2008 versus one year ago. However, with rising gasoline prices, the index (and activity) is expected to trend lower in coming months.

Two additional factors may be restraining recreation sector growth in Michigan. Michigan’s recreational counties are characterized by ownership of second homes. The run-up in housing prices and the subsequent rash of foreclosures and price declines have been especially severe in recreational/seasonal home locales. Seasonal home residents who have experienced asset price losses on their second homes may be especially aggressive in re-building their household balance sheets by restraining current spending in the second-home locales.

The second, more obvious, factor affecting recreation this year is rising gasoline prices which raise both travel costs to vacation locales and, in Michigan's case, the cost of boating. However, some domestic vacation locales may benefit from a backwash effect as households choose nearby attractions rather than long distance adventures. Nonetheless, in most instances, the overall effect tends to be a dampening. For these reasons, tourism industry analysts in Michigan are forecasting declines in tourism activity for 2008.

In addition to automotive and recreation sectors, Michigan has a strong presence in the furniture sector. Indeed, Western Michigan hosts the nation’s largest concentration of makers of office furniture. This industry took shape in the late nineteenth century during rapid industrial growth, which was accompanied by rapid growth in office employment. Taking advantage of the region’s abundant hardwoods and skilled immigrant craftsmen, most furniture companies in the area had developed as manufacturers of high-end traditional style home furnishings. However, the labor-intensive wood furniture industry declined in Grand Rapids and other northern centers by the mid-1900s due to competition from Southern producers. In response, the Grand Rapids industry shifted its focus from household to office furniture, led by companies that would become industry giants: Steelcase, Haworth, and Herman Miller.

The U.S. Census reports that the state is the nation’s leading producer of office furniture and fixtures, with 17,000 direct employees in 2005. Broadly defined, the state’s industry share accounts for 24% of the nation’s shipments. (Michigan’s share is larger according to the way that the industry trade association defines the industry).

Michigan’s office furniture companies have been affected by competition from China and other low-cost locales. Despite competitive pressures, the companies have successfully responded in two ways. To some extent, producers have moved or offshored production of select product lines to low-cost locales while maintaining high value added and custom design services domestically. More importantly, these companies are characterized by great innovation in product and processes. They have succeeded and grown by offering custom and advanced products and services.

However, office furniture sales and production have been highly cyclical. The industry experienced sagging sales in the late 1980s and early 1990s when U.S. businesses downsized middle management positions and as the U.S. economy sagged. So too, the “technology bust” years that began the current decade saw a falloff in demand for office systems and furniture, especially in the IT sector.


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So far in the current environment, industry production has been holding up well. However, if industry observers are correct, office furniture may be “one more shoe about to drop” in Michigan. An opinion poll of office furniture executives has been flashing negative for the near term outlook, and the industry association has recently lowered its forecast of 2008 production.

If such expectations develop, this would further dampen economic activity and the labor market in Michigan. Cyclicality of certain businesses can be planned for and absorbed by states such as Michigan and its neighbors. However, cyclical episodes in the economy can be exceptionally severe when shocks such as rising energy prices are in play and when longer term structural changes are taking place, as they are in Michigan’s automotive sector.


Thanks to Graham McKee and Vanessa Haleco-Meyer for assistance.


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Posted by Testa at 11:57 AM | Comments (0)