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December 22, 2008

The Economic View from the State Budget Trenches

By Rick Mattoon

It is hardly a secret that most state governments are facing tough times. Indeed, state governments are reporting that slower economic activity is affecting revenue collections. A recent fiscal survey by the National Conference of State Legislatures found a combined $140 billion deficit over the current and next budget years. Here, I am reporting the economic news coming straight from the state budget trenches in the Seventh Federal Reserve District.

For most states, some mechanism prompts an economic forecasting commission or other body to provide a prediction on where a state’s economy is headed. This type of forecast is a key component of the state budgeting process and takes advantage of the local expertise on the state’s economic conditions, which are often masked in national or regional forecasts.

Iowa

The Tax Research and Analysis Section of the Iowa Department of Revenue produces an Iowa Leading Indicators Index on a monthly basis. This index provides a useful benchmark for the state’s economic condition. The figure below shows the performance of the index relative to nonfarm employment since 1999. The index’s recent performance has shown seven straight months of decline since its peak in May 2008, and it has fallen at an annualized rate of 4.8%. However, the index score of 105.6 (1999=100) indicates that Iowa’s economy is still performing better than most states’.


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The index has eight components: yield spreads (ten-year Treasury notes vs. three-month Treasury notes), residential building permits, agricultural futures price index, diesel fuel consumption, average weekly unemployment claims, average weekly manufacturing hours worked, new orders index and an Iowa stock market index. Each component has a unique standardization weighting in the index.

Illinois

On November 19, the Illinois’ Commission on Government Forecasting and Accountability issued its economic and revenue update for fiscal year (FY) 2009. The commission is a bipartisan joint legislative committee with a professional staff that provides fiscal and economic information to the Illinois General Assembly.

The commission’s forecast, published in November 2008, is as follows:


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The commission also considers the implications of its forecast for state revenues. The commission suggests that base revenues for FY2009 will be down 1.9% ($550 million) from the previous year. See the following table:


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The commission also has an estimate for the revenue shortfall for FY2009 versus the budgeted expectations. This estimate is more pessimistic with revenues coming in over $1.3 billion short of budget expectations.

Michigan

Michigan’s House Fiscal Agency provides frequent updates on revenue trends and periodic updates on the state’s economy.

The November revenue forecast showed FY2008 year-to-date revenue up 8.2% for 13 major taxes and the lottery. The gains reflect changes to Michigan’s tax structure, particularly for personal income and business taxes.

In addition, the University of Michigan does a statewide economic forecast. The most recent one was released on November 21. The forecast highlights Michigan’s weak labor market conditions and anticipates that employment in the fourth quarter of 2008 expected to fall at an annual rate of –4.7%. The first half of 2009 is not likely to be much better with a predicted annual rate drop of –3.2%. Even with modest recovery in the second half of 2009, employment is forecasted to drop at an annual rate of –2%. Not surprisingly this translates into anemic nominal personal income growth of 0.7% in 2009 and 1.2% in 2010.

Wisconsin

The Wisconsin Department of Revenue issues a quarterly Wisconsin Economic Outlook. This document includes useful detail on employment and income trends in the state and a comprehensive forecast of the U.S. economy. The August report noted the slowdown in the state’s economy and projected that job growth in the state would turn negative this year. After job growth of 0.5% in 2007, declines of 0.5% and 0.4% in 2008 and 2009 are predicted. This anemic job growth will spill over into personal income growth, forecasted to be a weak 3.4% in 2008 and 2.6% in 2009. (The report notes that the 2008 income growth was aided by the federal stimulus action.) In contrast, personal income rose 5.3% in 2007.

The state budget director recently announced that November revenue projections for FY2009–FY2011 were off an estimated $3.5 billion from the June projections. There is now an estimated budget deficit of $5.4 billion (17% of the budget) from fiscal 2009–11 budget years. This is the largest deficit in Wisconsin’s history.

Like other states in the Seventh District, Wisconsin is just beginning to recognize the weakness of its revenue collection. The latest monthly statements for October showed revenues declining –2.5% for the month, although year-to-date revenues are still positive at 2.4%. On an individual tax basis (year to date), the personal income tax is up 5.6% (because of tax law changes), while the sales tax has declined –2.5% and the corporation tax is down –20.8%.

Indiana

Indiana’s bipartisan State Budget Committee issues periodic revenue and economic forecasts for the state. The most recent forecast was issued on December 11, and it predicted the state would collect $721 million less in tax dollars in the current budget cycle compared with a forecast that had been made one year ago. The state’s budget surplus has shrunk from $1.4 billion to $600 million in response.

The more pessimistic revenue forecast is based on an economic forecast produced by IHS Global Insights. The IHS forecast suggested that the current recession would be the longest in post-World War II history and would see unemployment hitting 9% before the state’s economy improves.

Vanessa Haleco-Meyer provided valuable assistance in producing this blog.


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December 12, 2008

Autos: A Further Loosening of the Manufacturing Belt?

This year’s Nobel Prize in Economics was awarded to Paul Krugman for his insights into spatial concentration of economic activity and the relationships among industry clusters, firm or industry-specific economies of scale, and patterns of international trade. In illustrating the flavor of his theoretical work at his Nobel Prize lecture, Krugman explained the surprising prevalence of worldwide trade among goods within the same general product category. Such trade can arise from acute economies of scale in production that are achieved by firms or industries that produce slightly differentiated products. If accompanied by the ability to easily transport and widely export its products, the location of a firm's product or of an industry's production will often become quite concentrated and rooted in particular countries or regions. By way of illustration, the 1860-1970 era of Midwest-Northeast dominance in manufacturing was said to arise from vast scale economies of mass production that came into play during the 19th century, accompanied by sharply lower transportation costs (via railroad) which allowed the manufacturing belt to export its wares to other U.S. regions and to the world. Krugman ended the lecture by discussing how the manufacturing belt had finally been shifting away from the Midwest, most recently the automotive segment. To do so, Krugman drew on the work of our Bank’s Thomas Klier.

In a series of journal articles and a recent book, Klier has been documenting and explaining this shifting geography of the North American automotive industry. Such work helps us to understand the situation of the “Detroit” automotive industry today, as does the more general spatial clustering of some industries and firms that has been observed by Paul Krugman and others.

Today in the industrial Midwest, we lament the tarnished star of wealth and income that once elevated our region’s standards of living above those of many other regions. During the glory years of Midwest manufacturing, the Great Lakes region’s share of manufacturing was phenomenally high relative to its population share. The chart below illustrates the rise and sustained dominance of manufacturing activity in the region. It is remarkable that the region sustained this high share of manufacturing, and high per capita income (shown below), even while population was ebbing away to the South and West.


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Per Krugman, manufacturing gained a foothold here as profound economies of scale in industries such as steel and meat packing grew rapidly, along with the ability to export these goods by rail. William Cronon documents these transport advantages for 19th century Chicago for meat packing, farm machinery and lumber in his celebrated book, Nature’s Metropolis. Manufacturing also thrived here due to ready access to abundant natural resources and energy inputs to production, along with the ability to feed, house and transport a large work force to work site factories in the cities.

Once established, the spatial proximity of firms and related industries helped to sustain the region’s manufacturing dominance, as the totality of these firms and industries became greater than the sum of their parts. That is to say, the Midwest’s manufacturing sector became highly productive in part because firms and their suppliers bought and sold to one another in close proximity. Steel makers sold to machinery producers; machinery producers sold to car and truck makers; car and truck makers sold to both steel and machinery producers. These efficiencies played out at much finer detail among many highly specialized suppliers and producers. In this way, transportation costs were minimized and economies of scale and scope were realized within the tight agglomeration of the manufacturing belt. So too, not unlike Silicon Valley of today, mutual proximity created a sharing and dissemination of new ideas and technology that gave producers a leg up in locating within the Midwest.

Klier has researched these spatial relationships within the Midwest automotive industry—both parts and finished vehicles. For much of its history (but with several major eras that either stretched or compacted its geography), North American automotive production has clustered in Michigan and neighboring states, enjoying the insulating benefits of great economies of scale in mass production and mutual proximity of parts suppliers within the industry, as well as proximity to Midwest steel making, machine tooling and other key industries … all the while enriching generations of automotive workers.

Of course, things look very different today, as the Detroit 3 automakers struggle to remain viable in an era of increased competition for dwindling consumer dollars. In part, competition has shaken loose the original industry and its Midwest geography as imported autos finally broke through into the U.S. consumer market during the 1970s gasoline crisis. Foreign-domiciled competitors have since chosen to produce autos on U.S. soil, though not exactly with the same geographic footprint as the original Detroit 3 auto makers. In their recent JRS article, Klier and coauthor Dan McMillen document how the older spatial cluster of automotive parts makers has been giving way to a re-fashioned but densely configured auto cluster sited further South.

This shift in location raises some questions: How do we explain this shift southward? Could (or should) anything have been done about it? Can anything be done about it now? No doubt the cost advantages of spatial proximity and the early economies of scale in automotive manufacturing were highly advantageous. At the same time, however, the very success and unchallenged structure of the domestic industry may have failed to keep the region’s institutions, policies and companies sharp and competitive.


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December 3, 2008

Exports and the 2008 Economic Slowdown

Back in the 1930s, policy makers perhaps contributed to the economic downturn by sharply lifting tariffs on imports into the U.S.—the infamous Smoot-Hawley legislation passed on June 17, 1930 that raised import tariffs on over 20,000 goods. In response to these policy actions, our trading partners raised tariffs (and nontariff barriers) on U.S. exports. If the U.S. intention was to keep jobs at home, the effect was probably to aggravate unemployment here and abroad.

In recent years, trading activity with other nations has been a definite engine of growth for the U.S. Exports are contributing much to an otherwise faltering pace of economic growth. Though exports comprise only 12.4 percent of U.S. output, export growth accounted for one-half of the nation’s (2.0) percent GDP growth in 2007; exports accounted for one-third of GDP growth over 2006 and 2007. Indeed, in every year since 2002, the growth of exports has added at least one-half percentage point to national output growth.

Per the graph below, export growth has similarly lifted incomes and output in the Seventh District. Overall, nominal export value climbed by $54.7 billion, or 58.7 percent, from 2003 through 2007, with every District state joining in the expansion. Per the table below, our NAFTA partners, Canada and Mexico continue to be our largest export destinations, with China growing rapidly over the 1997-2007 period.



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The strong role of our NAFTA partners as an export destination reminds us that growth in trade often comes about from the hard policy work involved in negotiating trade agreements with other countries. The graph below illustrates the growing number of countries that now receive exports from producers in Seventh District states. Each District state has added a fair number of trading partners since 1997.


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Aside from avoiding the (past) mistake of squelching international trade, the U.S. also has the opportunity to expand its export opportunities in the years ahead. Awaiting enabling legislation from the U.S. Congress, bilateral or two-nation agreements have been negotiated with Panama, Columbia and South Korea. To learn more about these agreements and those that have preceded it, one source of information is TradeAgreements.gov (this web site is a joint effort between the Departments of Agriculture, Commerce, State, Treasury and the Office of the United States Trade Representative).

Note: Vanessa Haleco-Meyer contributed to this weblog.


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Posted by Testa at 1:32 PM | Comments (0)