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May 22, 2012

Global Services and Midwest Prospects

Many have highlighted the importance of increasing foreign purchases of goods produced in the United States as a path to economic growth. In 2009, President Obama called for a doubling of U.S. exports of goods and services within five years, accompanied by the announcement of a National Export Initiative. So far, this goal remains reachable. Since the economic recovery began in mid-2009, U.S. exports have grown at a robust annualized average of 9.1 percent.

The economic recovery and accompanying export growth have been good news for the Midwest. As an important goods producer of both exported manufactured and agricultural products, the region has benefited from enhanced income and economic activity.

But goods are not the only possible exports from the United States. In a series of papers and a recent book, economist J. Bradford Jensen asserts that we should be emphasizing services rather than manufactured goods in assessing and promoting the nation’s export prospects. Further, the United States is particularly suited to export knowledge and skill-intensive services, much as it does manufactured goods of that nature. These would include business and professional services, such as accounting, software, management, public relations, advertising, R&D (research and development), construction, architecture, design, and specialized financial services.

As shown in the charts, the services share of U.S. exports has been growing—from 19.6 percent in 1980 to 29.3 percent in 2011. And the value of services exports has increased dramatically in the past several decades.

Source: U.S. Bureau of Economic Analysis.

Note: Export values adjusted by deflator for GDP.
Source: U.S. Bureau of Economic Analysis.

The extent of data available for specific segments of the services sector has been improving, but it remains inferior to the level of coverage for goods exports. The table illustrates the growth of the specific services exports that are reported by the U.S. Bureau of Economic Analysis.

Note: See link for footnote remarks

As shown here, many service exports have been growing very rapidly. For this reason, analysts like Jensen find the trends encouraging. The prospects for further export growth in these sectors seem bright, because the U.S. has tended to specialize in manufacturing industries that are also skill intensive, such as capital goods machinery and aerospace. As many developing countries continue to grow, they are likely to need just such skill-intensive services. Because many of these services segments need employees who are highly skilled, further expansion of their U.S. operations to serve growing global markets would create more high-paying jobs and income in the U.S.

Still, it is far from a foregone conclusion that robust export growth will materialize. That is largely because receiving countries have placed many restrictions on services imports, including cumbersome occupational standards and licensing, procurement favoritism by home governments, and limited or inadequate protections on intellectual property, such as patents and invention. As cited by this year’s Council of Economic Advisers, a recent study[1] estimated that “the aggregate level of discrimination against services imports in important emerging markets such as China, India, and Indonesia is equivalent to a tariff on these imports of more than 60 percent.” Accordingly, the further opening of global trade in the services arena will require much more international negotiation and agreement.

If services exports do grow markedly in years to come, does the Midwest region have a stake in this growth? If so, it is most likely to be found in the region’s large urban economies. Typically, large city economies have come to specialize in business and professional services. For instance, the Chicago area has been celebrated as a “global city,” in part because of its strong position and linkages in business and professional services, its corporate headquarters of multinational companies, and its world-leading risk contract exchanges and clearing operations.

The still dominant position of Chicago in exchange-traded derivative products is easy to document. Per figures cited by World Business Chicago, for example, Chicago exchanges including the CME and Chicago Board Options Exchange, account for 16 percent of the exchange-traded derivatives activity that takes place around the world.

However, more generally, details on globally traded services are hard to come by. Since data on services exports by individual city are sparse, some researchers have taken an indirect approach to appraising the position of cities in global commercial services. For example, Peter J. Taylor and Robert E. Lang construct city-by-city indexes of global connectivity among the most prominent offices of multinational firms in key services sectors. These service sectors include accounting, advertising, banking/finance, insurance, law, and management consulting. City rankings are constructed by accumulating the size of offices of these prominent firms (if any) in each city. In “Global Network Connectivity,” Chicago is ranks seventh behind Singapore, Tokyo, Paris, Hong Kong, New York, and London. Detroit ranks 85th; and Indianapolis 114th.

In another study, J. Bradford Jensen and Lori Kletzer examine the extent to which specific service industry employment is more concentrated than total employment across metropolitan areas. The notion here is that if, for example, the Chicago area employs more per people (as a share of work force) than the national average, the city’s economy is likely exporting these services. That is, Chicago employs a disproportionate share of workers in financial services not because Chicago area residents consume more financial services, but rather because they work for firms that export financial services to other parts of the nation or the world.

Taking a similar approach, we constructed local area indexes of employment concentration for those service sectors that are reported by the BEA to be internationally traded. The next chart identifies major metropolitan areas of the Seventh District by their employment concentration in these industries. An index value greater than one indicates an employment concentration that exceeds the U.S. average. For example, an index value of 1.20 indicates that the city contains 20 percent more of employment in a particular industry than the U.S. average. In turn, the implication is that those index values greater than one suggest the extent that the metropolitan area exports the service to its surrounding region or elsewhere, nationally or internationally.

Employment data for the core Chicago area are reported with the greatest detail.[2] We see that Chicago continues to be a city with many highly skilled industries, such as management consulting, education, and financial services, as well as its more traditional industries, freight transportation and warehousing.

Source: BLS/Haver Analytics.

Such industry detail is not available for other large metropolitan areas in the Seventh District. However, the following table, with data from aggregated employment categories, shows that these MSAs are also highly concentrated in exportable services.

*Categories include utilities sectors.
Source: U.S. Bureau of Labor Statistics/Haver Analytics.

However, such data give us little detail about which particular services are actually exported abroad rather than sold to neighboring cities, states or regions of the U.S. Accordingly, rather than employment concentration by industry, alternative data sources can give us better insights. Tourism is a case in point. During the course of their visits, foreigners spend on travel and local goods and services, which in turn give rise to domestic jobs and income. The table below ranks cities by their international visitors. As seen, visits are highly skewed toward New York City and a handful of other large MSAs. Chicago ranks 10th in 2001 by the number of visitors from abroad, with 4.3 percent of total visits. Still, this is roughly proportional to the Chicago area’s share of national population.

Source: Office of Travel and Tourism Industries.

U.S. colleges and universities are a leading service sector on the world stage. In turn, students studying here from abroad generate income for domestic workers and households. Per below, all five District states rank highly in hosting international students. Such students give rise to local income in tuition payments, as well as in local living costs for themselves and sometimes for their family members. In examining the largest individual institutions, we see that these benefits accrue not just to the District’s large metropolitan areas, but also to a number of smaller cities.

Source: Institute of International Education.

Source: Institute of International Education.

In conclusion, the Midwest has long known of its global linkages through exports of manufactured goods and foodstuffs. Perhaps one day the region’s exports of services will challenge the importance of its traded goods. With this possibility in mind, the region will want a voice in U.S. negotiations of global agreements that open up services to trade and protect U.S. services exports from unreasonable obstacles abroad. Closer to home, service-oriented cities of the Midwest will continue re-shape their infrastructure and public services to complement emerging services trade.

Note: Thank you to Norman Wang for assistance.


[1]Hufbauer, Gary, Jeffrey Schott, and Woan Foong Wong, 2010. Figuring Out the Doha Round, Washington D.C., Peterson Institute for International Economics.(Return to text)

[2] These data are for the Chicago metropolitan division of the Chicago MSA.(Return to text)

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May 10, 2012

Auto Sales and the Seventh District

by Paul Traub

Continued improvement in U.S. light vehicle sales has been good news not only for the automotive industry, but also for the Seventh District. The chart below plots the percentage change in U.S. light vehicle sales against the percentage change in real gross state product for the District from 1991 through 2010. It should not come as any surprise that these two factors are very highly correlated (correlation coefficient of 0.82, where 1.00 would imply a perfect correlation) since four of the five states in the District currently have automotive assembly plants. If we add Ohio’s assembly production to that of the Seventh District states—Iowa, Illinois, Indiana, Michigan and Wisconsin—the region accounts for roughly 50 percent of the total U.S. automotive production. Given this relationship, we would expect last year’s increase in light vehicle sales (up 10.2 percent in 2011 over 2010) to have a favorable impact on the District’s overall economic growth for 2011—those numbers are due to be released later this year.

And so far in 2012, sales of light vehicles in the U.S. continue to outperform expectations. The seasonally adjusted annual sales rate for April 2012 was reported to be 14.4 million units; year to date through April, the rate has risen to 14.6 million units. In addition, the share of vehicles sold in April that were produced in North America was estimated to be about 77.3 percent. This is a significant increase from February 2009, when the percentage of North American produced light vehicles sold in the U.S. dropped to just 70.5 percent, reaching its lowest share since November 1986; at the same time overall sales volumes were bottoming at levels not seen since 1974.

So how do we assess the strength of the current auto sector recovery? The following chart shows the current light vehicle sales recovery compared with those that followed auto industry downturns in 1970, 1974, 1981, and 1991. For comparison purposes, an index for each downturn was created by setting the trough for each cycle to 100. This index comparison shows just how much more severe the initial sales decline was in the 2009 auto recession compared with the average of the previous four downturns. However, it is interesting to see that the current recovery has followed the average of those four recoveries fairly closely, except for two notable points in time. At both of those points in time, there were identifiable events that seem to have had significant effects on the auto industry.

The first event was the Car Allowance Rebate System (CARS), also known as “cash for clunkers.” This was a $3 billion program that was intended to provide an incentive for Americans to purchase more fuel-efficient vehicles by trading in their less fuel-efficient ones. The Department of Transportation reported that nearly 700,000 clunkers were taken off the road during this program, resulting in 684,941 new vehicle purchases. It's difficult to say exactly how many of those sales were incremental purchases, but it resulted in a spike in vehicle sales as purchases were pulled ahead from subsequent months. The decline in the sales rate immediately following the end of the program made it appear as if the recovery in vehicle sales might be stalling.

The second event that stands out clearly is the March 2011 earthquake in Japan. While it is difficult to calculate the earthquake’s precise impact on U.S. light vehicle sales, it is clear that the auto industry’s recovery was adversely affected by the supply disruptions that followed this disaster. Over time, however, this might have added to pent-up demand as consumers waited for product availability from their preferred manufacturers.

Even with these two outliers in the data, this auto sector recovery seems to track average past auto sector recoveries fairly closely for the 12 quarters following the bottom of the cycle.

The recent recovery of the U.S. auto industry has been good for the Seventh District for many reasons, but most notably for employment. Between December 2009 and March 2012, the District has seen a 2.9 percent increase in nonfarm payroll employment, compared with an increase of 2.7 percent nationally. Even better, the District has seen a 9.1 percent increase in manufacturing jobs, compared with an increase nationally of just 4.1 percent. In fact, the Seventh District has accounted for 38 percent of the entire nation’s manufacturing jobs added during this timeframe. And it looks like there may be potential for adding even more jobs in the Midwest if auto sales continue to rise.

The May 2012 Blue Chip consensus for U.S. light vehicles for calendar year 2012 now stands at 14.5 million units having been increased five times since bottoming in October of 2011 at 13.3 million units. That equates to a 1.2 million unit increase in the light vehicle sales forecast. And at 14.5 million units, this forecast is still 100,000 units below the industry’s performance year to date, which implies that there may be further upside potential for auto sales in the coming months. Next year looks even better— 2013 sales of light vehicles are now projected to be 14.9 million units.

This recent surge in sales appears to have taken some of the region’s auto producers by surprise. General Motors announced this week that it is increasing its U.S. light vehicle forecast for 2012 by 500,000 units, bringing its revised forecast up to 14.0 to 14.5 million units. Ford Motor Company’s expectations for this year seem to be even more optimistic, anticipating total sales of 14.5 to 15.0 million units. In fact, according to a recent article in the Financial Times, Ford plans to add 400,000 units of production capacity. However, its market share still might fall, because production increases are lagging demand. And Chrysler announced that it will not be observing its traditional two-week summer shutdown in four of its assembly plants, so that it can produce additional vehicles to address the increase in demand. This news from Chrysler is especially good for the District, which hosts three Chrysler assembly plants—two in Michigan, the Jefferson North Assembly Plant and Sterling Heights Assembly, and one in Belvedere, Illinois.

Even though the pace of this improvement seems to have come as somewhat of a surprise, there were indications that sales were getting ready to improve. As reported earlier this year by R. L. Polk, the average age of cars and trucks on U.S. roads hit a new record of 10.8 years on July 1, 2011. That is up from 10.6 years in 2010. Used vehicle prices have continued to increase, providing the consumer with added equity to use as a down payment at trade-in. Employment levels are slowly improving, helping to improve consumer sentiment, as measured by the University of Michigan’s Consumer Sentiment Index. In addition, Comerica Bank announced that vehicle affordability, as measured by vehicle price relative to median income, recently improved to its best reading since the third quarter of 2009. And finally, higher fuel prices might actually be working as an incentive for consumers to replace their less fuel-efficient vehicles with newer more fuel-efficient ones. So, all things considered, there may be more positive surprises in our future.

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May 1, 2012

Recent Energy Price Movements in the Midwest

Households in the region and nationwide have been affected by rising motor fuel prices in recent months; this follows an earlier spike that took place in 2007–08. Such price spikes ordinarily pinch household incomes and spending on non-fuel items. However, at the same time, natural gas prices have been trending downward, thereby providing some relief to household budgets. This is especially true in the Midwest, where most homes are heated with natural gas that is piped in by utility companies. So, to what extent has the favorable trend in natural gas prices been offsetting the unfavorable trend in motor fuel prices?

The chart below displays prices paid by household consumers for both types of fuel[1]. Prices for both natural gas and gasoline have typically moved in tandem. In many instances, this is because the two fuels are substitutes in several important markets and uses. For example, if either petroleum products or natural gas can be used in applications such as heating industrial boilers or homes, the price of one could not easily fall out of line with the other. If it started to do so, consumers would switch to the cheaper product, thereby raising its price.

Sources: Bureau of Labor Statistics /Haver Analytics. Motor fuel price represents regular unleaded fuel as reported in the CPI-U.

However, in the near term, limits on infrastructure for either transporting fuel or using it can allow fuel prices to diverge. Beginning in 2009, petroleum prices began to climb, largely reflecting its scarcity on world markets. And so, motor fuel prices are up sharply “at the pump.” On the other hand, domestic natural gas tends to be more of a locally traded commodity with little ready adaptability for use in highway transportation. In addition, technological developments in on-shore natural gas production have meant that the available supply has been climbing rapidly. On-shore producers of natural gas have used a combination of hydraulic fracturing of gas trapped in shale rock formations, along with horizontal drilling techniques, to greatly expand U.S. natural gas production since 2005. As a result, natural gas prices “at the wellhead” have fallen to near-record lows in recent months. For instance, the spot market price at a well-known trading point called the “Henry Hub”[2] has fallen to close to $2 per thousand cubic feet, far below its average of $5 since 2008.

However, natural gas prices for home uses have not fallen nearly so steeply. That is because the price of home heating fuel reflects much more than the fuel price; it also reflects a sizable infrastructure of pipelines (and underground storage systems) that are necessary to deliver the fuel to far-flung residences. For all of 2011, the estimated price of natural gas delivered to residences averaged $10.80 per thousand cubic feet, which was well over 2.5 times the wellhead price.[3]

Falling prices for natural gas have been very welcome news to Midwest households, who have seen their home utility bills for natural gas edge downwards in recent years. In addition, due to abnormally mild temperatures this past winter, lower consumption of home heating fuel also helped to ease pressures on household budgets. Midwestern households rely on natural gas more than the national average, especially for home heating purposes. As of 2009, an estimated 72 percent of the region’s households received piped gas at their homes versus 57 percent for the rest of the U.S.[4]

However, average annual expenses for home heating do not approach annual expenses for motor fuel—even for midwesterners. At 2010 prices, for example, we estimate motor fuel expenditures to have been 3.2 times average expenses for residential natural gas in the broad Midwest region.[5] For this reason, the declines in residential gas prices since 2010 have not offset the rises in motor fuel. Yet, the boom in domestic production of natural gas, and its moderating effect on natural gas prices at the wellhead, have acted as a stablizing influence on household incomes in the region.

[1]These data are drawn from the Consumer Price Index for all urban consumers nationally. Motor fuel prices represent prices for unleaded regular gasoline. Home heating fuel price reflects piped gas to residences.(Return to text)
[2]The Henry Hub is the pricing point for natural gas futures contracts traded on the New York Mercantile Exchange. (Return to text)
[3]www.eia.gov/naturalgas/monthly/pdf/table_03.pdf.(Return to text)
[4]Estimates derived from U.S. Dept. of Energy, Energy Information Administration (EIA), Fuel Use Survey, table HC1.9. Of those receiving piped gas, over 90 percent use it as their primary space-heating fuel. Due to continued production expansion of shale gas, the Energy Information Administration forecasts continued stable to falling home heating fuel prices in the years ahead. (Return to text)
[5]Per household, the 2010 figures average $2,019 for annual motor fuel and motor oil expenditures, $634 for residential heating. Residential energy expenditures (principally for home heat) are from EIA, State Price and Expenditure Database. Residential motor fuel prices, households, and consumption are from U.S. Department of Labor, Bureau of Labor Statistics, Consumer Expenditure Survey. The Midwest geography is here defined as the states of OH, MI, IN, WI, IL, MN, IA, MO, NE, ND, SD, and KS.(Return to text)

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