January 24, 2012
Automotive Outlook and the Regional Economy
by Paul Traub
On Thursday, January 19, 2012, the Detroit Association for Business Economics (DABE) held its annual Automotive and Economic Outlook luncheon. This event is held each January at the Detroit Branch of the Federal Reserve Bank of Chicago in memory of Robert Fish—a past president and founding member of the DABE. Meeting in the Detroit area since 1975, the DABE is a chapter of the National Association for Business Economics (NABE). The DABE meets six times between September and May, and members and guests have the opportunity to hear from experts on various sectors of the economy. As the DABE’s premier event, the annual January luncheon always coincides with the Detroit International Auto Show, and it featured two experts on the automotive sector.
The speakers at this year’s event were Kristin Dziczek, who is the director of the labor and industry group at the Center for Automotive Research (CAR), and George Magliano, who is the senior principal economist for IHS Automotive. Both speakers have more than 20 years of experience in researching the automotive industry and manufacturing. Dziczek’s presentation titled 2011 Detroit 3 – UAW Labor Contracts was an in-depth review of the results of the 2011 UAW (United Auto Workers) contracts and their impact on the labor costs and competitiveness of the Detroit Three automotive manufacturers (Chrysler, Ford, and General Motors). Magliano’s presentation titled US – Light Vehicle Outlook was just that—a concise analysis of what to expect in the coming years from the U.S. automobile industry, particularly in terms of sales of light vehicles (cars and light trucks).
Dziczek provided automotive employment forecasts for the United States and Michigan, as well as an overview of the 2007 UAW contracts and details on the final 2011 UAW contracts. Additionally, she provided insights into issues that the Detroit Three and the UAW will need to address through 2015. Dziczek said that the Detroit Three’s U.S. automotive employment numbers had started falling years before the 2008–09 recession; Detroit Three domestic employment appeared to bottom out in 2009, at about 170,000 employees. She explained that by 2009 the Detroit Three had shed almost 240,000 employees in the U.S., or 58% of their domestic work force, in just eight years. In Michigan, the Detroit Three had seen their employment fall by 112,000, or 52%, over the same period. The good news is that CAR projects total Detroit Three employment in the U.S. to increase by 18%, or 31,000 employees, over the period 2009–15, reaching a level of 201,000. Also, Detroit Three employment in Michigan is predicted to jump by 32%, or 33,000 employees, over the same period, totaling 135,000 by 2015. Based on these forecasts, we can see that CAR is expecting U.S. automotive jobs to reconcentrate in Michigan—at least to a certain degree.
In 2007, the Detroit Three and the UAW were able to agree on labor contracts that Dziczek considered “a game changer.” Important aspects of the contracts included the use of voluntary employee beneficiary associations (VEBAs); a two-tier wage structure that lowered the entry-level hourly wage to $14.00; and no pay increases. To compensate workers for no annual pay increases, the Detroit Three agreed upon a signing bonus of $3,000; lump-sum profit sharing distributions as a percent of an employee’s base pay of 3% in 2008, 3% in 2009, and 4% in 2010 (the last two were suspended in 2009); a cost-of-living adjustment, or COLA (also suspended in 2009); pension increases; and some product guarantees (some of which were never fulfilled). The most significant result of the new labor agreements was that the average hourly labor cost was reduced from $72–$78 per hour to about $50–$58 per hour. All of these changes set the stage for the 2011 labor contracts, which involved some additional changes to the previous contracts that Dziczek called “evolutionary, not revolutionary.” These changes included such cost containment strategies as the elimination of the jobs banks (which paid laid-off workers a high percentage of their salaries for an indefinite period); the continuation of the suspension of the COLA; and no pension increases at this time. Like the 2007 contracts, the 2011 contracts helped keep the Detroit Three’s costs competitive with those of other major automotive manufacturers. Dziczek pointed out that one important issue that bears watching in 2015 is how the two-tier wage structure is addressed. The initial agreement had a cap on the number of entry-level workers—more specifically, only a certain percentage of total employment could be made up of such workers. The UAW would like to see that cap kept in place, while the auto companies would like to see it either increased or removed altogether. Other critical issues include limiting pension liabilities; pushing to increase employees’ share of health care costs; and staying the course on variable compensation (profit sharing versus wage increases).
George Magliano provided a detailed and informative macroeconomic outlook, on which he based his light vehicle forecasts. Magliano explained that, of course, the major risk to his economic forecast is the European debt crisis. According to IHS and Magliano, even though Europe is in a recession, the U.S. economy is expected to continue to grow slowly over the forecast horizon. Magliano’s forecasts for 2012 are as follows: Real gross domestic product (GDP) will grow about 2.0%, employment will rise by 1.2 million, Consumer Price Index (CPI) inflation will remain at 1.5%, oil prices will settle at about $91 per barrel, and housing starts will remain weak (at around 730,000 units). Long-run real GDP growth is expected to settle at 2.5%–3.0%, and payroll employment is predicted to remain below its previous peak (in 2007) until 2015. The slow growth in employment will keep income growth down while households will continue to save more, keeping the long-term trend for consumption at around 2.0 percent.
Even with these somewhat conservative assumptions about the economy, all is not doom and gloom for the auto industry. Light vehicle sales are expected to continue to increase over the coming years, driven by the pent-up demand that has been created over the past few years. Another positive for the automakers is that retail vehicle sales, rather than fleet vehicle sales, remain the main driver of growth. This is an important part of the industry’s recovery in that margins on retail sales are greater than those on fleet sales. This factor—along with stronger used vehicle prices, lower vehicle incentives, and reduced cost-pressures on the manufacturers—should help to keep the automakers profitable, even in the face of a slow-paced economic recovery. Magliano said that IHS predicts light vehicles sales will be about 13.5 million in 2012 and 16.2 million in 2015. Going forward, the mix between car sales and light truck sales will move back in favor of car sales (54% car sales versus 46% light truck sales), as the manufacturers deal with impending higher fuel economy standards. With the recent UAW contract concession discussed above and other capacity restructuring, the auto industry has become more profitable, as evidenced by the fact that it is already making money at volumes well below the peaks reached back in the early 2000s. The bottom line is that the auto industry is in the best shape it has been in many years and is therefore well positioned to withstand economic adversity, claimed Magliano.
As evident in these two presentations, there is much to be optimistic about when it comes to the U.S. auto industry—even the prospects for the original domestic manufacturers look better. The domestic auto industry should come out of this latest recession a lot stronger than it was in 2007, as long as the industry’s stakeholders are willing to continue to work together to keep costs in line with those of foreign competitors.
A voluntary employee beneficiary association (VEBA) is a type of trust fund that can be used to provide employee benefits. The UAW agreed to a form of VEBA with the Detroit Three thus removing the liability for health care from the accounting books of the Detroit Three.(Return to text)
A product guarantee is a type of commitment that identifies where future vehicles or components will be produced.(Return to text)
January 11, 2012
Midwest Economy Update
by Norman Wang and Scott Brave
A summary of economic conditions in the Seventh District from the latest release of the Beige Book:
• Overall conditions: Economic activity in the Seventh District picked up in late November and December. Seventh District business contacts were generally optimistic about the economic outlook for 2012, but many also expressed concern about potential weakness in demand from abroad, particularly from China and Europe.
• Consumer spending: Compared to last year’s holiday season, store traffic volumes were up significantly in December. Auto sales also increased since the last reporting period. Contacts expected sales to continue to improve in 2012, citing a boost from replacement demand in light of the record high average age of vehicles in the U.S.
• Business Spending: Business spending was steady in late November and December and inventory levels were reported to be generally in-line with sales. Hiring remained selective, but the majority of contacts indicated plans to increase employment next year.
• Construction and Real Estate: Construction activity was subdued in late November and early December, but there was some improvement in overall real estate conditions as multi-family construction remained an area of strength and nonresidential construction increased moderately.
• Manufacturing: Manufacturing production growth increased in late November and December. Demand for heavy equipment remained strong and auto production increased over the reporting period. In the steel sector, inventories at service centers remain near desired levels.
• Banking and finance: Credit conditions were little changed during the reporting period. Corporate funding costs, while variable, were largely unchanged on balance. Business loan demand continued to be subdued, and business utilization of credit lines was only up a bit.
• Prices and Costs: Cost pressures eased in late November and December. While pressure on costs remained from commodities such as steel and food, it moderated significantly for cotton and energy goods. Wage pressures remained moderate.
• Agriculture: Prices for corn and soybean rose in the last half of December, though crop prices generally fell during the harvest period. Milk and hog prices fell during the reporting period, while cattle prices increased.
The Midwest Economy Index (MEI) increased to –0.15 in November from –0.30 in October and remained below its historical trend for the fourth consecutive month. However, Midwest growth outperformed its historical deviation with respect to national growth, as the relative MEI increased to +0.04 in November from –0.32 in October largely on the basis of sizeable gains in consumer spending indicators. Estimates of annual growth in gross state product for the five Seventh District states were at or above the national rate of growth through the third quarter of 2011.
The Chicago Fed Midwest Manufacturing Index (CFMMI) decreased 0.1% in November, to a seasonally adjusted level of 85.8 (2007 = 100). Revised data show the index increased 1.0% in October. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) decreased 0.3% in November. Regional output in November rose 7.1% from a year earlier, and national output increased 4.2%.
January 4, 2012
Midwest Outlook Workshop
By Thom Walstrum and Norman Wang
On December 1, 2011, a group of experts convened to discuss developments in the Midwest economy in 2011 and to look forward to 2012 and beyond. The forum drew upon a variety of perspectives, hosting researchers from across the Midwest and from government, academic, and private institutions. As the conversation progressed, themes began to emerge.
Data from 2011 give a picture of an economy that is recovering, but lacking the vigor needed to return quickly to full employment. The outlook for the Midwest economy for 2012 is more of the same: slow improvement.
Looking beyond the current business cycle, the Midwest will be challenged by the economic fundamentals of a manufacturing-based economy. So far, economic development policy remains disappointing in addressing the challenges of diversification and competitiveness.
Sophia Koropeckyj from Moody’s Analytics noted that growth in the first half of 2011 was accelerating, but that it had slowed in the second half. The tepid pace of recovery means that the rate of job growth remains below the rate of population growth. It may take until 2017 to return to full employment. Koropeckyj highlighted manufacturing employment because it is concentrated in the Midwest relative to the rest of the U.S. She saw growth in manufacturing jobs in 2011, but noted that total manufacturing employment is still far below its pre-recession peak. Exports from the Midwest overseas continue to grow, but with possible challenges from a weak European economy in 2012. However, growth in Asia and South America could provide a backstop.
Ernie Goss from Creighton University provided a perspective on the rural economy that focused on the Plains states. They are doing better than many other parts of the country, driven by a good year for farms and farm-related businesses. Revenues were high in 2011, creating a push for consolidation that is driving up farmland prices (possibly to “bubble” levels). Federal Reserve economist David Oppedahl noted that farmland prices in other Midwestern states to the east are a bit stronger than in the Plains states. Price growth for the most productive land has outpaced prices for less productive land because of reduced recreational demand. While the farming industry did well in 2011, sectors that do not participate directly in the international marketplace (for example, construction) are subject to the same malaise afflicting other parts of the country.
Beth Weigensberg from the University of Chicago’s Chapin Hall discussed the CWICstats Dashboard Report, a quarterly assessment of the economies of Chicago and Illinois. She saw unemployment rise for Chicago and Illinois in the first half of 2011 even as labor force participation fell. Total employment is still 5% below its December 2007 level. Like other Midwest employment sectors, manufacturing employment is slowly rising from a trough in late 2009; it is still 15% below its December 2007 level.
George Erickcek from the Upjohn Institute provided an outlook on Michigan’s economy. Michigan lost 410,000 jobs from December 2007 to the trough in June 2009. It has recovered 85,200 jobs since then. Erickcek estimates that 37,100 (39%) of the new jobs were created by the auto industry. He noted that there has been no structural change for Michigan’s economy over the course of the recent recession and recovery. The auto industry is as important as ever. Even as many call for diversification, the Great Recession does not seem to have pushed Michigan’s economy in that direction.
In the near term, Michigan’s continued reliance on the auto sector will continue to lift the state and other auto-intensive communities in the Midwest. However, the longer term prospects are not so sanguine. As manufacturing growth begins to level off, longer term trends suggest little new employment will be generated by the sector. Some observers are a little more optimistic about the longer term. Federal Reserve economist Bill Strauss argued that rising overseas costs may result in the return of some manufacturing jobs to the U.S.
However, Geoff Hewings from the University of Illinois presented a less optimistic outlook on the region’s longer term future, predicting that the Midwest would continue to underperform the rest of the U.S. in several areas. According to Hewings, the Midwest’s GDP is forecasted to grow by 1.7% annually, compared with the 2.4% annual growth rate forecasted for the U.S. from 2007 to 2040. Over the same period, employment is forecasted to grow annually by 0.5% for the Midwest and 0.7% for the U.S., and personal income is forecasted to grow annually by 1.7% for the Midwest and 2.8% for the U.S.
Additionally, Hewings highlighted several trends that have shaped the Midwest in recent years. States are becoming increasingly interconnected as they fragment and hollow out; typical establishments have lengthened their supply chains by sourcing from more plants for increasingly specialized components (fragmenting) and are now less dependent on sources of inputs and markets within the state (hollowing out). Hewings noted the outsized volume of intra-Midwest trade as evidence; Midwest export trade to other Midwest states in 2007 amounted to $450 billion. Such strong intra-region trade linkages generate benefits for the Midwest economy during good times, but they amplify job losses during downturns. During the latest recession, 1.78 million jobs were lost in just five Midwest states, representing 20% of the total jobs lost in the U.S.
The close intra-region trade linkages in the Midwest sparked discussion about the need for more thoughtful and concerted policy actions within the region. Midwest states continue to play “beggar-thy-neighbor,” by offering selective tax abatements to lure businesses. Given the cohesion of the regional economy, such policies may be counter-productive. In particular, investment in overland transportation infrastructure to compliment the region’s goods-oriented economy would be worthwhile. Such investments should be carefully planned and coordinated both within and across Midwest states.
Selected presentations from the forum can be found on the following website link.