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February 24, 2012

Alternative financing for state and local governments: Do ‘managed competition’ and asset sales or leases make sense?

By Rick Mattoon

State and local governments are finding themselves in a fiscal bind. According to the National League of Cities’ annual fiscal survey, city governments report that their general revenues will decrease by 2.3% in 2011 and they anticipate a further decline in 2012. In particular, property taxes are falling (estimated to decline by 3.7% in 2011), with additional declines expected in 2012 and 2013. Compounding matters for local governments is the fact that their tax revenue declines are coupled with decreasing or frozen aid from state and federal governments.

State governments don’t seem a whole lot better off. The Center on Budget and Policy Priorities estimated that 29 states face budget gaps for fiscal year (FY) 2012, totaling $44 billion; and it expected this total budget gap to grow throughout the spring as revenue growth slows. This comes in the wake of the previous four years during which cumulative deficits reached $500 billion.

Given this stress on core revenues, it isn’t surprising that state and local governments may be looking to unconventional financing measures to shore up budgets. Two ideas that are frequently mentioned are “managed competition” (the idea of allowing existing government services to be competitively bid out) and asset sales or long-term leases. In the case of managed competition, discrete government services are put up for bid and often existing government units are allowed to bid against outside providers for providing a service such as collecting trash or processing permits or licenses. In the case of asset sales or leases, the idea is to immediately monetize the value of a particular asset that in many cases is not directly related to the core function of local government. In both cases, a clear objective is to improve the efficiency with which either a program or an asset is managed and to free up resources for government to focus on central operations. For example, in the case of Chicago’s lease of the Chicago Skyway, a guiding question was should the city be operating a toll road (i.e., would a city government be more efficient at operating a toll road than a private company and could resources devoted by a city government to maintaining a toll road be better spent elsewhere).

On March 14, the Civic Federation and the Federal Reserve Bank of Chicago will co-sponsor a conference called Beyond Parking Meters—The Future of Public and Private Partnerships in Illinois. (for agenda and registration-- click here). This half-day conference will examine how local and state governments should approach these types of alternative financing and what the pros and cons of these types of arrangements are. Specifically, the program will examine what types of government activities might be best suited to competitive service delivery, as well as what management and labor have learned from such programs. In examining asset sales and leases, key questions will include how to properly value public assets and structure and manage either an asset sale or lease to ensure that taxpayers are protected.

Fortunately, several previous studies are available to help guide any discussion about the privatization of either a public service or an asset by a government. In 2010, the Chicago Council on Global Affairs’ Emerging Leaders Program issued a report titled “No Free Money: Is Privatization of Infrastructure in the Public Interest?”

The key findings from the report were:
• Financial realities mean that privatization will continue;
• An effective policy would balance financial and equity consideration and define what constitutes “the public interest”; and
• Privatization is neither good nor bad but an economic tool that can be used well or badly.

In addition, the report suggests that proper oversight is critical for evaluating the long-term impact of any privatization. A concern is while the upfront savings might be significant, privatization may constrain future government actions. In the case of an asset sale, the asset can only be sold once, and after the proceeds from the sale are spent, future programs might be in jeopardy if they had previously relied on the revenue stream that the asset produced when it was owned by government. Similarly, there may be equity concerns if public access to an asset (such as a toll road) is suddenly limited by higher tolls imposed by the private firm now managing the asset.

When it comes to managed competition, the Government Finance Officers Association (GFOA) issued a best practice statement in 2006.

The statement lists key factors in considering managed competition: service level, cost, efficiency, effectiveness, quality, customer service, and ability to monitor the service providers’ work. The statement emphasizes the need to address stakeholders’ concerns and, in particular, to correctly estimate the in-house versus outsourced cost of providing the service. To do this correctly GFOA suggests governments address the following four factors:
• Determine and use a service definition that includes an analysis of service levels and performance standards to be used.
• Calculate the in-house costs that could be avoided in outsourcing the service. An important element includes estimating the direct and indirect costs related to the service. In some cases, some indirect costs may still exist even if the service is contracted out.
• Estimate the total costs of outsourcing, including the contractor’s bid price, the government’s contract administration costs, any transition costs, and any impact the contract might have on revenue.
• Finally, compare the cost savings from contracting out with the costs incurred to evaluate whether the savings will be significant.

A final source for framing privatization issues comes from the Illinois Commission on Government Forecasting and Accountability. The commission’s report titled “Government Privatization: History, Examples, and Issues” does a particularly good job at providing national and international examples of privatization and describes common measures for correctly valuing assets, such as appraising the net present value, estimating the internal rate of return, and calculating the weighted average cost of capital. These technical measures are critical to getting the valuation of the asset right.

Clearly, local and state governments will increasingly look to alternative financing structures over the next several years to help balance their service and revenue needs. Making alternative financing arrangements correctly requires appropriate accounting and asking the right questions at the beginning of the process. If you would like to find out more, please join us on March 14.



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February 22, 2012

Understanding manufacturing labor and wage trends

Bill Testa and Britton Lombardi

The number of net jobs held by workers in the manufacturing sector have declined markedly in recent decades—and especially so during the recent recession. Yet, manufacturers bemoan shortages of skilled workers, even while they tout emerging employment opportunities. What is the possible disconnect that is at play in the manufacturing sector? For one, worker shortages may not apply to all categories of workers, but rather to those with high or specialized skills. Across the entire U.S. economy, employers have had sharper needs for workers with greater levels of skills and educational attainment in recent years. And so, manufacturers may find it difficult to meet their own needs in this regard. If this is the case, one place to look for evidence would be in the wages of workers who are now in manufacturing. How have wages and compensation in the manufacturing sector changed over the years?

One of the longest-running data series on manufacturing wages is available from the U.S. Bureau of Labor Statistics (BLS). The BLS provides data on the hourly wage of nonsupervisory and production workers in manufacturing. In the chart below, we show these data with some modification. In particular, we convert the data into dollars of constant spending power using the personal consumption expenditure deflator. The average wage below is expressed in today’s dollars, running from the end of 2011 back through 1947.

In interpreting the wage trend, we must exercise some caution for two reasons. First, the hourly wage data cover a variety of workers, including those involved in fabricating, processing, storing, handling, shipping, maintenance, janitorial services, and recordkeeping. And so, the “mix” of workers across occupations may have been changing over time so that wage comparisons across time periods may be somewhat distorted. Second, the data only report on wage and salary compensation and not on worker benefits, such as deferred retirement benefits and health care insurance. Since the 1980s, health care insurance costs have been generally rising as a share of compensation for the overall U.S. work force—and within the manufacturing industry as well.[1] And so, wage trends alone may understate the changes in overall compensation.

With these cautions in mind, it appears that real wages in manufacturing grew steadily from 1947 through the late 1970s. After a dip in wages near the very end of the 1970s, wages have since remained largely constant.

Much of the policy discussion about job opportunities and compensation in manufacturing is qualified by notions that work in the sector increasingly requires higher-skilled laborers, and that demands for such workers are frequently exceeding the supply of qualified candidates. The BLS data above are not adequate for analyzing the manufacturing labor force by fine classification and skill level; however, the U.S. Census Bureau’s Census of Manufactures data featured below has long differentiated the wage bills of production workers from those of nonproduction workers in the manufacturing sector. The nonproduction category comprises nonline supervisors, along with white collar positions, such as executives, engineers, designers, sales staff, and research and development (R&D) personnel.

This is not to say that all nonproduction workers are more skilled than all production workers, but the general tenor of the classification suggests so, on average. In particular, the annual earnings levels are higher for nonproduction workers (as we might expect them to be). In 1947, the average wage of nonproduction workers was 60% higher than that of production workers; as of 2007, the average wage of nonproduction workers was 70% above that of production workers.

On further inspection of these data back through 1947, we notice a similar pattern of earnings for both production and nonproduction workers in manufacturing. Much like the BLS data on hourly wages, the Census Bureau data on annual earnings of production workers climbed until the late 1970s before flattening out or rising mildly.


Source: Authors’ calculations based on data from U.S. Census Bureau, Census of Manufactures.

However, in contrast to production worker wages, nonproduction worker wages have registered some modest post-1977 growth. This somewhat more robust wage growth of nonproduction workers (relative to their production counterparts) hints at a nearly universal trend among such workers (and occupations) over the past three and a half decades. In other words, the compensation and rewards for gaining higher skills and education have been sharpening in the U.S. economy—and not just in manufacturing. Changes in the industry structure of the U.S. economy have encouraged the growth of work requiring greater skills and education. The advent of new technologies in the workplace—such as the Internet, computing equipment and software, and advanced machinery—have put a premium on higher levels of skills and education. At the same time, global competition in some industries has also dampened low-skilled wages and profits.

Across the entire U.S. work force, the average levels of skills and formal education of successive generations of workers have also been rising markedly for many decades. Under most circumstances, such an increased availability of skilled workers might be expected to put downward pressure on their compensation and wages. Evidently, such effects have been more than offset by rising demands in the U.S. for workers with higher levels of skills and educational attainment.

In a recent Chicago Fed Letter we document the fact that average worker skills, as measured by years of school completed, have been on the rise in the U.S. since the 1990s. Using educational attainment (i.e., years of school completed) as a proxy for skills of workers, we find this to be the case in both the manufacturing and nonmanufacturing sectors. In fact, educational gains among workers in manufacturing have outpaced those among workers in nonmanufacturing between the year 1990 and an average of the years 2000–07. For example, while shares of workers who have attained “some college” or at least a four-year degree remains higher (on average) in the nonmanufacturing sector, the gaps in these shares between manufacturing workers and their nonmanufacturing counterparts have closed considerably over this time period.

Have manufacturing wage benefits gone up as more workers “upskill”? In the chart below, which draws on the 2011 Chicago Fed Letter, we see the percent change in wage gains in both sectors—manufacturing and nonmanufacturing. Within each individual sector, patterns of relative wage gains by education are similar. In both the manufacturing and nonmanufacturing sectors alike, wages of those workers having higher educational attainment have increased sharply, while the wages of workers with only a high school diploma and below have languished.

It is also evident that when we compare wage gains at the same level of educational attainment, average wage gains have been stronger outside of manufacturing. Indeed, “upskilling” in manufacturing has taken place, resulting in higher-paying jobs; but for those workers who have similar levels of educational attainment, wage gains in manufacturing have not kept pace with those in nonmanufacturing.


Click to enlarge

Such evidence is far from the last word on wage compensation in the manufacturing sector, but it appears that manufacturing employers have been struggling to compete with nonmanufacturing employers for workers with greater levels of skills and educational attainment. In both sectors, wages have grown more rapidly for those with higher educational attainment. Relative to the nonmanufacturing sector, the manufacturing sector continues to pay a premium to its workers at nearly all levels of educational attainment. However, the manufacturing wage premium has possibly eroded since 1990, as wage gains in manufacturing have not kept pace with nonmanufacturing wages, on average.

Note: Thanks to Norman Wang for assistance.
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[1]As reported by the Employee Compensation Index of the BLS, wage and salaries across all civilian workers in manufacturing industries have increased 5.5% 1981, while total compensation, including benefits, has increased 17.8%.(Return to text)


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February 13, 2012

Great Lakes’ manufacturing job loss in perspective

by Bill Testa and Norman Wang

Residents of the Great Lakes states have been long familiar with the ups and downs of manufacturing jobs and with the shocks to local economic conditions when factories close and whole industries all but evaporate. There are many policy issues attendant to these events revolving around responses such as work force training, industry assistance, and community efforts to diversify these communities’ industry bases. Rather than addressing such issues, we’d simply like to offer a perspective on the extent and nature of manufacturing job loss from the most recent decade to date. The data on job counts in manufacturing show that these losses have been unparalled in many respects.

The data in the chart below display total jobs in the manufacturing sector since 1969 (as constructed by the Bureau of Economic Analysis of the U.S. Department of Commerce).[1] The geography of these jobs (counted in millions) is defined by the BEA as the “Great Lakes Region,” which includes the states of Ohio, Indiana, Michigan, Wisconsin, and Illinois. These five states have long been considered to be the core of the “industrial belt” that more broadly ranges westward from Western New York and Pennsylvania into eastern Iowa and Missouri. And so, the experience of these five states should describe the experience of the nation’s industrial belt.

A look at the chart beginning in 1969 shows that, during the recessions of the 1970s, there were sharp declines and recoveries in manufacturing jobs. But later on, from 1979 to 1983, the bottom fell out, as more than one in five manufacturing jobs were eliminated from peak to trough. Contributing factors were many:

 The nation experienced two (back-to-back) recessions during the early 1980s.
 Interest rates were climbing and the value of the dollar versus foreign currencies rose sharply, which instigated declining domestic investment in capital goods and exports abroad.
 In domestic markets, competition from abroad in industries such as primary steel production and construction equipment was keen.
 The farm economy, an important customer of the Midwest machinery industry, experienced deep declines in income and associated capital investment.
 Defense expenditures were rising, but to little effect in the Midwest region.

The national economic recovery beginning during 1983 was sharp, which lifted Midwest manufacturing jobs somewhat, especially in the automotive sector. However, although the 1990s were also robust in the region, levels of manufacturing jobs remained largely flat, never again approaching their pre-1980 levels.


Source: Bureau of Economic Analysis/Haver Analytics

As the chart also shows, the Great Lakes has experienced its second profound decline in manufacturing jobs over the past 10–15 years. During that time, through two recessions and two recoveries, Great Lakes manufacturing employment has fallen continually. From a 1998 peak of 4.2 million jobs, manufacturing levels fell to 2.7 million in 2010, a decline of approximately 1.5 million. By both absolute and relative standards, the extent of this job loss exceeded that of 1979–83 when 1.2 million manufacturing jobs were lost peak to trough. Rather than the one in five jobs lost of the earlier period, the 1998–2010 experience amounted to a one in three loss of manufacturing jobs.


Source: Bureau of Economic Analysis/Haver Analytics

How does the Great Lakes’ experience compare with that of the rest of the U.S.? The chart above compares job levels between the two, accurately scaled according to their relative manufacturing size in the beginning of the period. Over the entire period from 1969 to 2010, manufacturing jobs declined markedly across the United States. Overall, the Great Lakes decline was only moderately steeper. However, the Great Lakes region’s employment base had been and continues to be more concentrated in manufacturing. Accordingly, manufacturing job losses have a more significant impact on this region’s work force and communities, on average, than they do elsewhere.

To illustrate this point, the table that follows indicates the percentage decline in manufacturing jobs from the previous peak years during the late 1990s (column 1). At the peak, the second column indicates just how prominent the manufacturing sector was as a share of total jobs in particular states, in the region, and in the U.S. The final column “weights” manufacturing job losses by the respective size of the manufacturing sector, thereby illustrating the extent to which manufacturing decline impacted the overall employment base in the state or region.

The chart illustrates this impact. For example, nationally, we see that manufacturing job declines from the peak year (1998) through year 2010 wiped out the equivalent of 3.8% of the total job base of 1998. However, for the Great Lakes Region, the impact was much more severe, at 5.9%—and 7.7% for the hardest hit state, Michigan.


(Click to enlarge)


Source: Bureau of Economic Analysis/Haver Analytics

Comparing these more recent declines with those of 1979–83, we see that the pace of manufacturing job declines in the Great Lakes Region was much steeper than that of the nation during 1979–83. At that time, some other regions were experiencing job gains in both defense-related and aerospace industries and in microelectronics and computing equipment.

In the more recent period since 1998, manufacturing declines have been roughly proportionate in both the Great Lakes Region and in the remainder of the U.S., though still somewhat steeper in the region. During the recovery years in the middle of the last decade, manufacturing jobs continued to decline in our region even while flattening out in the remainder of the U.S.

The Great Lakes’ continuous decline in manufacturing owes much to the performance of its transportation equipment industries—especially automotive, trucks, and trailers. As the next chart illustrates, employment in the transportation equipment industry has fallen by over one-half from its peak in 1999.[2] The net loss of these 400,000 jobs comprises over one-quarter of the region’s manufacturing job losses over the period. Moreover, many more job losses are indirectly attributable to production declines in the transportation equipment sector due to the industry’s intensive sourcing of business services, parts, fasteners, materials, and equipment from within the region.

Both production and employment in the transportation equipment sector bottomed out in 2009, but job gains since then have been very small in relation to the previous net losses. From the trough of the 2008–09 recession, transportation equipment has regained 28,600 jobs in the region, roughly 6.8% of prior net job losses as counted from the peak of the 1990s. Across all manufacturing sectors, the region has regained 135,200 jobs, roughly 8.5% of its previous job losses.


Source: Bureau of Labor Statistics/Haver Analytics

In sum, the Great Lakes Region’s net job losses in manufacturing since the late 1990s have been severe. Relative to the structural changes that took place in the early 1980s, the more recent experience has been worse along every dimension save one—that is, recent manufacturing job declines have been drawn out over a ten-year period rather than the four-year descent of 1979–83. Manufacturing jobs have been growing over the course of the cyclical recovery that began in mid-2009, but these gains are very modest in the context of the entire period since 1969.

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[1]The BEA estimates include full and part-time workers, both those on payrolls and those who are self-employed. Contract workers would be excluded from the manufacturing industry, as they are accounted for in other sources of jobs data.(Return to text)

[2] These data are payroll employment data, provided by the Bureau of Labor Statistics, U.S. Department of Labor.(Return to text)


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February 3, 2012

Manufacturing as Midwest Destiny

By Bill Testa and Norman Wang

In the Midwest, the terms “industrial” and “cities” are almost synonymous. Though agriculture has been important to growth and development, the region’s economy was built on manufacturing, and the sector continues to be prominent—for both small towns and large metropolis alike.

However, labor and income generated from the region’s factories began to wane 40 to 50 years ago. In response, the region’s cities have undertaken deliberate development strategies to maintain their economic vibrancy. Some strategies have focused on the historic mainstay—manufacturing—while some have focused on diversification into service sectors ranging from tourism to business services and finance. These efforts have met with mixed success, and the industry mix of most Midwest cities continues to be steeped in manufacturing. Accordingly, “Industrial cities” of the Midwest continue to address the same fundamental challenge—that is, how to sustain their communities as manufacturing’s ability to generate jobs and income continues to decline.

The chart below looks at manufacturing’s share of jobs going back to the year 1969. In both the Great Lakes region and in the U.S., the share of jobs to be found in manufacturing has declined by one half or more. A much greater share of workers now find employment outside of the manufacturing sector than are employed by the sector.[1] Importantly, though, the Great Lakes Region continues to be more highly specialized in manufacturing as compared to the U.S.

At a more granular level, the chart below illustrates the many metropolitan statistical areas (MSAs) with higher job concentrations in manufacturing than the U.S. as a whole As seen, these include very populous MSAs, such as Detroit and Milwaukee, but also many smaller MSAs, such as Decatur, Illinois, Jackson, Michigan, and Cedar Rapids, Iowa. Even some of those MSAs with smaller shares, such as Flint, Michigan, have diversified out of manufacturing only under the pain of wholesale loss of jobs, people, and income. (And Flint’s economy continues to decline).[2]

A more systematic illustration of how manufacturing has been a large part of the destiny of the Midwest can be seen in the charts below. On the horizontal axes can be found the share of manufacturing employment for all MSAs of population 100,000 and greater in 1969. The vertical axes measure subsequent (post-1969) total job growth and per capita income for each MSA. The inverse correlations are striking; the general tendency indicates that manufacturing-oriented cities fared worse as measured by growth of income and total employment. Further analysis of these cities (not shown) again indicate that the depressing growth tendency of yesteryear’s manufacturing orientation has not discriminated by population size; both big and small MSAs were similarly affected.[3]

Have any other industry concentrations or preconditions been important in determining the economic fate of Midwestern cities? Other researchers, such as Edward Glaeser, have emphasized that educational attainment of the adult population has been a strong causal determinant or precondition of MSA growth. The reasons for this finding are varied. It may be that this measure represents local workers and community leaders who were most capable of reinventing their home city when damaging shocks to the local economy took place. Alternatively, a large share of college-educated workers may simply reflect that the MSA already enjoyed an economic diversification into other key industries (employing college-educated workers) that did well after 1969. In any event, our analysis suggests that taking “percent of adult population with a college degree or more” into account explains more of the performance variation among Midwest MSAs. Together, the “share of manufacturing jobs” along with the “percent of adult population with a college degree” explain as much as 40 percent of the variation in Midwestern MSA economic growth after 1969.

Looking at these past determinants of growth, can we identify any room for local policy actions to shape the local economy? In the analyses above, we have used very simple measures of a local economy’s “industry mix” to suggest that historical development may have been destiny for many Midwestern towns and cities. Indeed a more careful accounting of each place’s historical industry mix might yield more telling findings and insights. For example, towns steeped in steel production, automotive, or television electronics may have had even less control over their destiny in recent decades. However, a more expansive view indicates that our measures of “industry mix” (above) explain only 40 or less percent of the 1969-2010 variation in performance among Midwest MSAs. This leaves much more performance to be accounted for. It seems that some places have improved their own economic performance through deliberate development policies such as work force training, tax incentives to business investment, land use reform and re-development, or public infrastructure investments.

For these reasons, the Chicago Fed’s “Community Development and Policy Studies” (CDPS) area has launched an investigation into how industrial cities in the Seventh District have taken deliberate steps to fashion their own destinies in more favorable ways. According to CDPS Business Economist Susan Longworth, an initial project step will be to “develop comprehensive community profiles of cities throughout the Federal Reserve’s Seventh District that had populations of at least 50,000 and had 25% or more of their employment in manufacturing in 1960. Research includes in-depth qualitative information, combined with the best available quantitative analyses of the trends and issues impacting these communities to identify policies and programs that promote (or inhibit) economic growth and vitality in industrial cities.”

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[1]The declining share of manufacturing is overstated because manufacturing companies have outsourced functions (and jobs) to local service sectors. These include the hiring of factory workers who are on the payrolls of temporary employment firms, as well as outsourcing of maintenance, payroll, and transportation workers to outside (service) firms.(Return to text)
[2]Some well-performing nonmanufacturing MSA economies are fashioned around state government capitols and major universities, such as Ann Arbor, Michigan, Madison, Wisconsin, and Columbus, Ohio.(Return to text)
[3]Some might wonder whether manufacturing orientation continues to influence community growth in more recent years. Our analysis of 1990 to date continues to show such influence widely across the Midwest, although there is tendency of a weakening correlation.(Return to text)


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