July 21, 2014
Economic Development in Des Moines, Iowa
By Rick Mattoon
In a forthcoming article in the bank’s Economic Perspectives, I profile the economic development efforts underway in the five largest cities in the Seventh District—Des Moines, Indianapolis, Milwaukee, Detroit, and Chicago. (For a complete profile of all five cities see, Industrial clusters and economic development in the Seventh District’s largest cities.) Each city faces its own unique set of challenges and has a distinctive economic base that has influenced its growth path. In a series of blogs, I would like to summarize some of the major trends in each metropolitan economy, starting with Iowa’s capital city—Des Moines.
The Des Moines MSA (metropolitan statistical area) economy has developed a strong mix between financial and professional service firms and manufacturing. In addition, the city benefits from being the capitol of the state, leading to a high concentration in state government employment. Large employers in the area include Wells Fargo (banking), Principal Financial (financial services), Mercy Medical and United Point Health (both health care), DuPont Pioneer (agribusiness), John Deere (agricultural machinery), Marsh (insurance), and UPS (shipment and logistics).
Des Moines MSA Industry Structure
To get a sense of which industries are most important to the metropolitan area’s economy, we can look at its employment concentration in industries relative to the U.S. Table 1 shows the employment percentage for each industry for both the U.S. and the Des Moines MSA. For example, Des Moines has only two industries where the share of local employment is above the national share of employment—wholesale trade and management of companies. In addition, the table provides location quotients (LQs) that demonstrate the relative concentration of each industry in the Des Moines MSA compared with the U.S. A reading of 1 indicates that Des Moines has the same industry employment concentration as the U.S. As the table shows, Des Moines has significantly above average employment concentrations in two industries—wholesale trade at 1.27 ( or 27% above the U.S. average) and management of companies at 1.17. Additionally, Des Moines’s industry concentrations are roughly in line with the U.S. averages for such important industries as construction, retail trade, administrative and waste services, and arts and entertainment. The industries that are much less represented in Des Moines are agriculture, mining, and utilities (although clearly agriculture is of key importance to Iowa as a whole). Interestingly, two sectors that the city targets for growth, professional and business services and manufacturing, have relatively low concentrations (0.74 and 0.64, respectively). In the case of professional and business services, an issue with the data is that nondisclosure rules do not permit an LQ to be calculated for the important finance and insurance sector, which is likely to have high levels of professional employment.
Des Moines MSA Economic Development Strategy
The Greater Des Moines Partnership led an effort to develop a five-year plan for Des Moines and the capital region. The plan aims to position Des Moines as a midsized city with a specialized industry base. It focuses on an industry and demographic comparison with other similar regions, including Omaha, Nebraska, Madison, Wisconsin, and Denver, Colorado. The plan identifies key clusters in which the region is most competitive and recommends that the region market itself specifically to these sectors: finance and insurance; information solutions; health and wellness; agribusiness; manufacturing; and logistics.
The other elements of the plan are similar to most of the other cities’ development plans in stressing appropriate human capital development and work force training. In particular, the Des Moines plan emphasizes developing an employment and training pipeline that meets the needs of local businesses. There is also a geographic component to the plan, targeting growth along the I-35 corridor.
If one reviews the strategy relative to the data on industry structure, it becomes clear that the targets for development consist of a mix of large employment centers (finance and insurance) and logistics-related wholesale trade, as well as historically important industries, such as manufacturing and agribusiness. Manufacturing does not currently represent a high employment concentration in Des Moines, so its inclusion may signal a hope to revive the sector. Given recent speculation that manufacturing is seeing favorable conditions for reshoring of jobs and activities (due to factors such as lower energy costs), many midwestern cities are hoping to restore some manufacturing activity. Finally, Des Moines also benefits from a stable fiscal situation. While the city’s credit rating was recently downgraded by Moody’s due to unfunded pension obligations, it still has an Aa2 rating. And the state government’s fiscal condition is relatively solid.
Finally, Des Moines’ recent economic performance has been quite strong relative to much of the Seventh District. The following chart shows the year-over-year growth in payroll employment for Des Moines versus the Seventh District average. With the exception of a brief period coming out of the Great Recession, the MSA’s employment growth rate has been favorable. In particular, Des Moines has opened a significant gap with the District since 2013.
The U.S. Bureau of Labor Statistics (BLS) defines LQs as "ratios that allow an area's distribution of employment by industry to be compared to a reference or base area's distribution". (Return to text)
June 23, 2014
Seventh District R&D: Manufacturing the Leader
By Bill Testa
Few would take issue that the U.S. economy is propelled by innovation. To stay ahead of their competitors, virtually all enterprises engage in innovation of one form or another. Such innovations take the form of improvements to products, services, and internal processes of production and delivery. In the case of start-ups or new enterprises, the proportion of activity devoted to innovation can be the dominant activity for years prior to its actual operation and revenue generation. Start-up firms have captured the imagination of cities that are encouraging entrepreneurs in their pursuits. Recently, the State of Illinois has offered funds to expand Chicago’s prominent new business incubator, which is named “1871” in reference to re-building from the great fire of that year. Similarly, the City of Detroit will seek to designate and boost its “TechTown” as a major part of its economic redevelopment.
Many established businesses also engage in innovation, but they do so in a more formal way, that is by budgeting for and performing research and development (R&D). The National Science Foundation tracks R&D funds across all sectors, including the U.S. business sector. Their preliminary estimates for 2012 report that the business sector overall performed 70 percent of the nation’s R&D, amounting to $316.7 billion, followed by federal government (12.2 percent), and universities and colleges (13.9 percent).
In tracking R&D performance as measured in dollars that can be allocated across states, the table below ranks Seventh District states by the dollar amount of R&D for each of four major categories for the latest year available, 2011. The business sector dwarfs others in 2011, accounting for almost 70 percent of R&D performed. By this measure, each District state is ranked above the national average, with Michigan’s sixth place and Illinois’ eighth place figuring very prominently. Based largely on the strength of their performance in the business sector, these states also rank highly in overall R&D performed, at seventh for Michigan and eighth for Illinois. Significant contributions to their rankings are also evident from universities and colleges and federally funded R&D Centers (Illinois), and in the case of Michigan, universities and federal government operations.
Within the business sector, manufacturing companies continue to conduct the lion’s share of R&D. As shown below, manufacturing performed 68.5 percent of private sector R&D in 2011. This is down from previous decades, as several service sectors have grown rapidly. In particular, the software publication, computer systems design, and scientific services sectors now comprise, in aggregate, 19.2 percent of R&D performed.
But rather than these service sectors, manufacturing remains the primary contributor to the Seventh District’s R&D prominence. The far right columns in the table below display the District’s relative employment concentration in leading R&D sectors by individual industry. The first three rows present the employment concentration of leading service industries in R&D performance. With a few exceptions, such as Wisconsin’s high concentration in software publishing at 39 percent above the national average, District state concentrations tend to fall below national levels. In contrast, the manufacturing leaders in R&D activity are much more concentrated in District states. For example, concentrations in non-medicinal chemicals such as industrial chemicals exceed national levels in every District state, as does the machinery industry concentration. Pharmaceuticals and medicinals are strong in Indiana and Illinois, while electronic equipment employment is especially concentrated in Illnois and Wisconsin. Meanwhile, employment concentrations in the motor vehicle industries are off the charts in Indiana and Michigan. And as previously discussed, automotive employment and spending for R&D have become much more concentrated there than the total employment numbers might suggest, as the state has held onto its R&D even as production activities have moved to other states and regions.
Among major R&D performers in manufacturing, the only area in which the Seventh District does not have a significant employment concentration is the computer and electronic products sector. This sector’s products and components are distinguished by “the design and use of integrated circuits and the application of highly specialized miniaturization technologies (which) are common elements….” Manufacturing activity and employment in this sector have tended to concentrate in California, Texas, Massachusetts, and other states outside of the Midwest region.
As regions look to innovation as the wellspring of their economic development, they may be well advised to build on their existing sources of innovation activity. For the states of the Seventh District, the traditional base of manufacturing industries is clearly an important candidate.
Funding patterns differ from R&D performer patterns; the federal government funds almost 30% of overall R&D, with large proportions allocated to the business sector (especially defense contractors) and colleges and universities. The character of R&D also differs across sectors, with colleges and universities typically engaging in “basic” research, an activity that advances science with no specific application. In contrast, businesses more often fund development and applied R&D, activities that are intended to introduce new products or services into commercial use. See InfoBrief, NSF 140307, December 2013.(Return to text)
For individual state profiles with many measures, see http://www.nsf.gov/statistics/states/interactive/show.cfm?stateID=53,14&year=0.(Return to text)
Note: Thanks to Timothy J. Larach for assistance.
December 6, 2013
OECD Chicago Economy Conference
By Emily Engel and Susan Longworth
On Friday September 27, 2013, The Federal Reserve Bank of Chicago hosted the Summit on Regional Competiveness (Summit) with The Alliance for Regional Development (Alliance) and the Chicagoland Chamber of Commerce. The Alliance is an economic development group working to implement recommendations contained in a 21-county, tri-state (Illinois, Indiana, and Wisconsin) analysis completed by the Organization for Economic Co-operation and Development (OECD).
According to the OEDC report, cooperative and regionally oriented economic development offers opportunity for sustainable growth in key industries within the Chicago MSA. Please read our blog from last year to learn more about how ‘Federal Agencies Align to Support Regional Growth'.
The goal of the Summit was to demonstrate that the tri-state region can cooperate to find solutions to the challenges in the OECD report.The agenda included welcome remarks from Daniel Sullivan, Director of Research and Executive Vice President, Federal Reserve Bank of Chicago, and a keynote address from Austan Goolsbee, the Robert P. Gwinn Professor of Economics, University of Chicago’s Booth School of Business (link to http://www.ustream.tv/search?q=ChicagoFed). The emcee for the event was Theresa E. Mintle, President and Chief Executive Officer, Chicagoland Chamber of Commerce. Governors Scott Walker of Wisconsin; Governor Pat Quinn of Illinois; and Governor Mike Pence of Indiana all attended the Summit. Video from the summit is available here.
The Summit addressed the following topics:
• Matching Skills to Jobs in the Tri-State Region—to explore potential regional approaches and programs that satisfy business needs while closing the skills gap;
• Innovation in the Tri-State Region—to explore how best to enhance the region’s performance in innovation-driven business clusters;
• Transportation and Logistics in the Tri-State Region—to explore how connectivity including, air, road, port, and rail transportation can help grow the region’s future as a mega-logistics hub; and
• Increasing the Region’s Competitiveness through Green Growth—to explore environmental factors impacting economic growth and development.
Takeaways from the Summit included the following points.Panelists highlighted the need to brand the region in a manner that capitalized on regional assets like the Great Lakes and a central location. Concerns were raised about balancing municipal needs with regional ambitions. As municipalities struggle to retain and raise revenue and jobs, there is unresolved tension between collaboration and competition that is most acutely felt by local officials.The region’s significant transportation assets were mentioned frequently, along with the need to address growing congestion and manage natural resources, such as the Great Lakes and other inland waterways responsibly. Workforce development was discussed at length and strategies for engaging and training new workers were emphasized. Panelists recognized the increasingly technical nature of today’s jobs and the challenges faced by those seeking higher education.
For the full agenda, please see the Federal Reserve Bank of Chicago’s website.
For more background information, please read the Chicago Tri-State Metropolitan Area OECD report.
November 12, 2013
Michigan Automotive, More Than Production
The dispersion of auto assembly line-type jobs from Michigan to the rest of the U.S. has been widely discussed. But it may be important to examine whether other jobs in the automotive value chain have also dispersed, particularly R&D and headquarters-administrative jobs. It is possible that a sizable part of automotive R&D and administration are spatially separable from production, with important implications for the economic health and growth prospects of Michigan.
To shed some light on this, we use microdata from the IPUMS CPS to track trends in production, office, and R&D jobs in both Michigan and the rest of the U.S. We sort any individual who reports working in the auto industry into one of these three occupational categories. For example, we classify engineers and technicians as R&D and assembly line workers as production workers. (We further classify as “other” those occupations that could fall into multiple categories, such as security or janitor).
Figure 1 shows that total employment in the automotive industry has been relatively steady in Michigan, averaging 413,000 from 1970 to 2005. Since then, there has been a distinct decline; by 2012, Michigan’s auto employment was 262,000. In contrast, auto employment steadily increased in the rest of the U.S., rising from 588,000 in 1970 to a peak of 974,000 in 2007. The rest of the U.S. also saw heavy losses in the second half of the 2000s, with auto employment at 710,000 in 2012.
Trends in the R&D segment of the auto assembly are quite different. As figure 2 shows, R&D employment in Michigan grew steadily until the 2000s, from 28,000 in 1970 to a peak of 90,000 in 2001. Growth in R&D jobs in the rest of the U.S. generally kept pace, though with the exception of a couple years in the early 2000s, the majority of R&D jobs have resided in Michigan.
And so we see that R&D employment has made up an increasing share of overall auto employment in Michigan. In 1970, 6 percent of Michigan’s auto employment was found in R&D. By 2012, this share had climbed to 22 percent. This contrasts sharply with the rest of the U.S., where the proportion of auto employment in R&D grew from 1 percent in 1970 to 6 percent in 2012. Looking more broadly, 46 percent of Michigan’s employment is in either R&D or office occupations, compared with 24 percent in the rest of the U.S. At least by this measure, Michigan remains the nerve center and the creative engine of the U.S. auto industry, even as production jobs have dispersed.
This glimpse of the changed employment composition of Michigan’s auto assembly sector raises further questions. In particular, what is the outlook for Michigan’s R&D activities in light of the shifting geography of auto production activities? And what, if any, public policies might be influential to R&D’s continued success in the state?
cps.ipums.org. IPUMS CPS provides an occupation variable that is unified across changing occupational coding schemes from 1968 to present. The CPS survey combined Michigan and Wisconsin from 1968 to 1976. To allow the time series to extend back to 1968, we calculated by employment category the proportion of worker-years Wisconsin contributed to combined MI-WI totals from 1977 to present. We then used that proportion to scale down the pre-1977 MI-WI employment numbers to represent only Michigan and to scale up the ROUS numbers so to include Wisconsin. (Return to text)
March 22, 2013
Managing Economic Development in Uncertain Fiscal Times
Illinois continues to face a bleak fiscal outlook. Despite the sharp increases in Illinois’s personal and corporate income tax rates, the state still faces $10 billion in unpaid bills and an unfunded pension liability approaching $100 billion. To get back to a sustainable fiscal path, Illinois will require significant revenue increases or spending cuts or, most likely, some combination of both.
A critical point in the discussion on restoring fiscal balance is the impact that policy changes will have on Illinois’s economic development. Despite the recent tax rate increases, Illinois still ranks 27th in the nation when measuring state tax burden as a share of personal income, according to COGFA. However, given that these rate hikes were not sufficient to solve the problem, further revenue enhancements will most likely be needed—at least on a temporary basis. Accordingly, the real question is what will be the cost of future fiscal measures on economic development. In other words, can a state reach a tipping point where uncertainty over future tax rates and spending choices chills economic growth, and if so, is Illinois on the verge of tipping over?
On April 4, 2013, the Civic Federation and the Federal Reserve Bank of Chicago will hold a program examining these issues. Bill Testa, of the Chicago Fed, and Therese McGuire, of Northwestern University’s Kellogg School of Management, will discuss what economists have to say about the relationship between fiscal policy and economic growth. Testa will provide insights on Illinois’s tax structure and the gap between revenues and projected expenditures; and he will also assess the economic competition occurring among Midwestern states, putting it into context of tax rates and incentives . McGuire will summarize the literature on the effect of state tax rates on economic growth and describe what economic development strategies might best serve states. McGuire will also discuss what the cost of fiscal uncertainty is on economic growth. With regard to the tax structure, most academic literature on state tax rates suggests that rates tend to matter only when the other costs of doing business are equal at a competing location (e.g., a neighboring state). However, it is not clear yet if this will hold true for Illinois. On the spending side, much of the literature suggests that it is the composition of state spending that most matters for growth. States that spend more on infrastructure and education tend to do better in terms of economic development. In the case of Illinois, a potential solution might have taxpayers paying more taxes and receiving fewer state services. Accordingly, in regions where economic competition is fierce, such as the Midwest, tax rate imbalances may be reaching that tipping point where future tax increases in certain states can make development in adjacent states more attractive to businesses.
Of course, such fiscal problems are not unique to Illinois. Other states and localities have also had fiscal shocks, and much can be learned from how they have restored fiscal balance and tried to promote economic growth. The recent fiscal problems of California have been particularly challenging, forcing the state to make significant budget cuts and income tax increases. Several prominent California municipalities have been forced into bankruptcy; and only recently has the state been able to report a balanced budget. However, evidence suggests that the California economy is beginning to pick up steam. Recent job gains have been running above the national average, with unemployment in the state falling by 1.24 percentage points in 2012 while key housing markets in the state are showing strength. How has California managed its fiscal situation and what has been the impact of its fiscal measures on its economic development strategy? To discuss this, Tom Tait, the mayor of Anaheim, will describe fiscal changes and economic developments at the state and local levels in California.
At the state level, Michigan is another interesting example. Arguably the state has not yet recovered from the 2001 recession and has faced more than a decade of fiscal stress. Throughout this period, Michigan has made many tax and spending adjustments, such as changing the structure of its primary business tax three times. Recently the state has started to show growth again. Mitch Bean, who is with Great Lakes Economic Consulting (and who previously served as director of the Michigan House Fiscal Agency), will discuss Michigan’s roadmap for reaching fiscal balance while encouraging economic growth.
Fiscal measures at the level of localities can have an immense impact on economic growth. What are the terms and conditions that are being attached to current deals to draw business investment, according to local developers and researchers? Are unresolved fiscal issues becoming an obstacle? A panel—comprising Ivan Baker, director of economic development for the Village of Tinley Park in Illinois; Jon DeVries, director of the Marshall Bennett Institute of Real Estate at Roosevelt University; and Stephen Friedman, president of SB Friedman Development Advisors—will provide perspectives on the local development landscape and how fiscal issues affect business location and expansion decisions.
The program concludes with a keynote address by Steve Koch, the deputy mayor of Chicago. Koch has been in this position since September 2012, and his portfolio of responsibilities includes economic development strategy. Prior to his current position, he spent most of his career in investment banking. Koch will discuss how Chicago is stabilizing its fiscal position while pursuing a new economic development strategy. He also will discuss how state fiscal problems affect local governments.
To register for this April 4 program, please visit the Civic Federation’s website.
April 18, 2012
Manufacturing as Destiny, Part II
By Bill Testa
During a recent visit and tour of Racine, Wisconsin, and vicinity, I was reminded of the difficult challenges that face older manufacturing-oriented cities. It would be tough to find a place as steeped in manufacturing as the Racine area. As recently as 1969, over 40 percent of the Racine metropolitan area’s jobs were to found in the sector—double the national level. Since then, the Racine area’s experience has been similar to that of so many manufacturing-oriented places. Due primarily to job losses in the sector, manufacturing now represents only 20 percent of the Racine area work force, and this is still more than double today’s national average!
Forty years ago, with such a heavy orientation in manufacturing, it would have been risky indeed for Racine area leaders to neglect the needs of this sector and focus their full attention toward diversifying the local economy. Even today, Racine’s makers of household cleaning products, farm machinery, and hydraulic mechanisms used in marine craft remain a vibrant part of its economy.
So, over the years, Racine’s leaders have pursued a dual development strategy of maintaining the region’s manufacturing base to the extent possible, while also trying to shift gears to the growing services sectors of the economy, including residential living, tourism and recreation, and business and professional services. In particular, the region has, on the one hand, worked to rebuild its downtown and neighborhoods and develop its lakefront and riverfront with bikeways, beaches, downtown festivals, and marinas for pleasure boats. At the same time, it continued to pursue manufacturing and distribution through cleanup and environmental remediation of vacant industrial land, development of new industrial sites, aggressive work force training and education, and construction of viable overland transportation for moving freight and materials.
Driving around the City of Racine, one can clearly see the challenges to planning and redevelopment as they relate to region’s economic base and physical footprints. This area was built around manufacturing and heavy industry and has a legacy of neighborhoods with small houses where former factory workers resided and frequented neighborhood stores, meeting halls, churches, and taverns. The challenges lie in creating cohesive links between the parks and revitalized downtown across areas of older factory buildings, railway tracks, and busy highways carrying freight among still-working factory operations and warehouses. At the same time, new land to accommodate today’s spacious industrial development, such as warehousing and distribution, must be fashioned or reclaimed from a hodge-podge of small parcels of varied-use land. Mayors, county officials, town planners, and economic development officials have their hands full in Racine as they do in many towns of the Midwest.
The issues and lessons from such redevelopment efforts are currently being assessed by the Community Development and Policy Studies (CDPS) group at the Chicago Fed as part of their Industrial Cities Initiative (ICI). At the recent inaugural conference to discuss the ICI, I presented some statistical results which, I think, corroborate the sharp challenges of industrial cities such as Racine.
In our statistical analysis of 83 metropolitan areas (MSAs) located in the midwestern states from Iowa and Minnesota eastward to Ohio, we examined two main influences on MSA growth. We measure growth both as per capita income and separately by total jobs. Drawing on the large existing body of research, we demonstrate that an MSA’s initial “educational attainment of the adult work force” apparently exerts a strong influence on subsequent growth in jobs and income across MSAs. Educational attainment has been previously found to be influential for several reasons. For one, places with higher educational attainment have been better able to shift into new industries and occupations when their former mainstays (such as manufacturing) have declined. Further, new business start-ups and entrepreneurial activity appear to arise more easily among work force populations having higher education.
We also tested the degree to which MSAs with higher initial concentrations of manufacturing employment were more or less successful in their subsequent economic growth. What we found was that, even after accounting for the influence of educational attainment, a historical manufacturing orientation tended to depress subsequent growth. Moreover, the effects were long-lived. An MSA’s tendency to host manufacturing 20 years prior continued to depress overall economic growth. For example, we correlated MSA manufacturing concentration in 1969 with subsequent growth during 1990 to 2009 and found that the manufacturing legacy was a significant drag on economic growth and development for the much later period.
All things considered, the redevelopment achievements of many of our older manufacturing cities are remarkable.
September 6, 2011
Innovation and the District’s Food Industries, and "Clean Tech" Conference Announcement
By David Oppedahl and Bill Testa
We all eat, yet the variety of what we eat is mesmerizing. Whether we eat the newest power bar developed in a laboratory or the latest organic, heirloom tomato, innovation is essential to food reaching our mouths. Everyone has a stake in the innovation of the agricultural and food industries—from the inhabitants of the rural Midwest, to the research scientists in our nation’s labs and universities, to people around the world who benefit from pest-resistant strains of grain. Agricultural innovations already have enhanced a wide range of products, including nutritional supplements, plastics, and energy materials derived from production agriculture. The future holds even more promise for benefits derived from the agriculture and food pipelines, especially enhanced nutrition, drought-resistant crops, and new functional foods. However, the safety of the food system remains a vital and ever-present concern, as well as a new source of job creation.
A Regional Strength
It is an interesting feature of regional economies that they often continue to be the innovative centers of the industries that were born there. Perhaps this is not all that surprising, since it is innovation that so often drives and sustains industries—innovation encompassing not only the creation of new products to sustain consumer demand, but also the productivity-enhancing technological improvements to fend off competition from other companies, industries, and countries. Yet, as regions search for their own economic renewal, they may overlook their innovative roots, opting instead to recruit or grow the latest hot sector—be it personal computing equipment, homeland defense, information technology, or biotechnology.
Historically, the Midwest economy is as closely linked with agriculture and the food industry as it is with, say, manufacturing. Indeed, the bountiful production and transport of farm products for export not only supported the region’s employment and income throughout most of its growth and development, but also fed the hordes of factory workers who were once needed to operate the region’s factories and mills.
Today, the innovations of production agriculture remain a legacy feature. Nationally, the identifiable value added from innovation in food processing is significant, though far from the top among industries. According to the most recent National Science Foundation survey (2008), U.S. food companies poured $3.18 billion into R&D domestically and another $683 million abroad.
Such expenditure figures are not publicly available for individual regions. But we can look at the Bureau of Labor Statistics’s occupation data for each state to get a sense of innovation-related employment in agriculture and the food industry. These jobs would include: food scientists and technologists; animal scientists; soil and plant scientists; and agricultural and food science technicians. Moreover, unlike the R&D spending numbers, these employment figures include people across the spectrum from government to university, to nonprofit lab, to private business ventures.
Occupational specialties vary from state to state. Also, due to the sample sizes, there are anomalies in the results for specialized occupations for some states. Yet, overall across all of them, the Seventh District states are 31 percent more concentrated in these occupations than the U.S. average; 39 percent more concentrated if we use a broader eight-state definition of the Midwest region (including Minnesota, Missouri, and Ohio). Thus, our region benefits more than the nation from the growth in spending on innovation in the agriculture and food sectors of the economy.
Food Safety is Paramount
As the variety and breadth of our diet expand, so do concerns about food safety. News accounts of foodborne illnessses regularly appear, although the U.S. food system remains among the safest in the world. Public concerns about food safety led to the passage of the Food Safety Modernization Act, signed into law in January 2011. The act will impose new requirements on food manufacturers, processors, packers, distributors, exporters, and importers. It will speed the industry’s movement toward a more science-based food safety system, compelling firms to seek innovative solutions in order to comply and be competitive in dynamic markets.
The academic and government laboratories of the Midwest are important research partners with the private sector. A conference called “Food Safety: Policy Changes, Science-based Opportunities” was held this summer at the Federal Reserve Bank of Chicago as part of a dialog between research institutions and industry in order to further partnerships and generate connections that will improve food safety via innovative technologies and refined systems. It was organized by an array of groups under the auspices of the Global Midwest Alliance.
At the event, David Oppedahl of the Chicago Fed gave an overview of key issues from a regional perspective with regard to food safety. Farming and food manufacturing combined to generate 3.4% of the District’s output in 2008, over 1% more than for the country (see figure 2 at end). Just one form of foodborne illness, salmonella, cost the U.S. economy $2.7 billion in 2010, with almost 1.4 million cases reported. The costs to the nation in medical expenses, lost employment compensation, and premature deaths are significant, although challenging to quantify.
The event’s keynote speaker, Robert Hibbert, K & L Gates L.L.P., compared the food safety system of the 20th Century with that of the 21st Century under the new act. Whereas the former regime involved more reactive regulations and enforcement, the updated food safety system will strive for prevention and traceability. Although resources remain limited, there are plenty of demands on the science and technology: improving process methodologies, enhancing control mechanisms, establishing traceability systems, gathering and exchanging information, and researching virulence in order to establish standards. Challenges to this agenda include the limits of science, expanding the foundation of basic research, communicating risk, and issues with clearances and approvals. Hibbert concluded that firms must “put up with the process,” while at the same time challenging it. An understanding of the emerging regulatory system and business realities will guide the industry toward a safer food supply and improved public health.
A panel on the scientific aspects of food safety was moderated by Paul Sebesta, U.S. Department of Agriculture. The panelists were Rosie Newsome, Institute of Food Technologists, Carla Little, Illinois Department of Public Health, and Todd Ward, U.S. Department of Agriculture. Newsome talked about the Institute’s initiatives and the resources they provide to advance the science of food. Little presented information on her agency’s efforts to ensure a safe food supply for Illinois, while facing increasing complexity in the food chain, globalization, and multi-state outbreaks of foodborne illnesses. Ward outlined the food safety programs at the National Center for Agricultural Utilization Research in Peoria, which focus on developing information and science-based solutions for detecting and removing toxins from food and preventing toxin contamination of food.
Finally, an industry panel, moderated by Matthew Botos, Illinois Science & Technology Coalition, focused on specific firms’ roles in the field of food safety and the opportunities for technological innovators. Justin Ransom, OSI Industries, shared experience gained from running the Food Protection and Quality Systems group, which oversees a global network of food manufacturing plants that handle both raw materials and finished products. Greg West, National Pasteurized Egg Inc., talked about his firm’s rapid growth to meet the demand for safer eggs (especially from restaurants) through innovative technology that maintains the look and taste of fresh eggs while extending shelf life and eliminating salmonella. D. J. Alwattar, Northland Laboratories, outlined his company’s specialized testing expertise, which provides a key component in the industry’s push to meet the challenges of food safety through innovation.
Upcoming Midwest "Clean Tech" Conference Announcement
On September 14, a related meeting at the Federal Reserve Bank of Chicago will focus on innovations in “clean” technology, including those that affect the food industry and agriculture. Organized by the Global Midwest Alliance, “Midwest Clean Tech 2011” will have a particular focus on global issues for innovation partnerships.
August 24, 2009
Waukegan's Economy and Development
By Emily Engel, Senior Associate Economist and Britton Lombardi, Associate Economist
Waukegan, IL, has responded to the challenges of a diminished manufacturing base by looking to its assets and opportunities. Over the past decade, the U.S. has experienced steep declines in manufacturing jobs, especially in Midwest towns—the heart of the industrial belt. Many of these same towns have come to recognize that manufacturing may never be what it once was for them. Therefore, while continuing to tend their remaining industries, they have also been making plans to integrate themselves into the growing knowledge-based economy. In developing workplace and residential amenities, these towns are now targeting a new “creative class” of workers who can possibly revitalize these once manufacturing-dependent areas.
Waukegan, IL, with a population of 92,066 , lies 40 miles north of Chicago, on the coast of Lake Michigan in Lake County. Over the past 40 years, Waukegan has seen a sharp decline in its manufacturing sector. In 1972, Waukegan had 10,100 manufacturing jobs; approximately 15.5% of its total work force. By 2002, manufacturing employment numbers had dropped down to 4,780, making up only about 5% of Waukegan’s work force . During the 1970s and 1980s, Waukegan experienced a number of plant closures, for example U.S. Steel’s mill, which took away a few thousand jobs. Another plant closure was that of Johns-Manville—at the time an asbestos manufacturer. Another local manufacturer, Outboard Marine Corporation (OMC), began downsizing its operations over the past few decades until it filed for bankruptcy in 2000, laying off 7,000 employees from all of its plants. While OMC’s assets were acquired from the bankruptcy court by Bombardier Corporation which moved manufacturing operations north to Pleasant Prairie, Wisconsin, the research & development operations are still located on Waukegan’s lakefront.
Such economic changes have meant, not only diminished employment opportunities, but stresses on the local tax base to finance school and municipal services. At the same time, public service requirements have grown along with the city's swelling population. Waukegan's population expanded by 27% in the 1990s decade alone. As seen below, the most significant change has been the rapid growth of its foreign-born population, which increased 148% between 1990 and 2000. Most of these immigrants are recent arrivals to the U.S. (within the last ten years).
In appraising its opportunities for redevelopment and growth, it appears possible for Waukegan to link its economy to the surrounding prosperity. Towns in Lake County and in nearby Kenosha County have generally enjoyed rising prosperity. As seen below, Lake County has registered consistently higher annual per capita personal income relative to that of the Chicago metropolitan area. The trend seems to show a continued growth in the income gap, as it widened to just over $12,000 in 2007. The second chart below shows that the pace of total employment in the Lake County/Kenosha area has been positive on a year over year basis since 2002, whereas the pace of total employment in the Chicago Metro area only turned positive between 2003 and 2004. The Lake County/Kenosha area’s growth rate reached a plateau in 2005 at 2.0%; although this fell to 0.8% in 2006, it has been steadily rising since then. Even with its own decline in manufacturing jobs, Lake County, between 2001 and 2007, has seen a consistent growth in the number of total jobs; its manufacturing job losses have been offset by new jobs in other sectors.
Accordingly, some Lake County towns are actively transforming themselves by expanding their residential amenities for the workers who occupy emerging jobs throughout the broader region. Nearby towns with a similar manufacturing heritage to that of Waukgean (e.g., Kenosha, WI) have already started implementing development plans emphasizing such amenities—e.g., by building condominiums on the lakefront (namely, HarborPark) and creating city parks along the lake. Besides the growing job base in Lake County itself, Waukegan and other towns throughout the county may be able to attract workers from Chicago and Milwaukee. Waukegan is situated between these two large and prosperous job markets. With appropriate development, greater numbers of new and existing Waukegan residents could one day find themselves commuting to these larger job centers.
So what types of projects is Waukegan undertaking to attract knowledge-based workers? For starters, Waukegan is currently in the process of a large multi-million dollar downtown and lakefront revitalization project. Waukegan seemingly has a myriad of opportunities to build up the community by enhancing currently underutilized resources. The town has 1,400 acres of property and 3.5 miles of Lake Michigan coastline to work with—one of the last remaining underdeveloped lakefront areas in the Chicagoland area. The city already has established assets, too. It boasts two harbors—one built as recently as the mid-1980s and substantially upgraded within the last year. Together, these harbors can hold nearly 1,000 boats of a variety of sizes, and both are relatively quiet and peaceful. Other marina-based businesses nearby offer further amenities for recreational boaters. In addition, the Genesee Theatre, which was the start of the city’s plan to transform the downtown area, finished its renovation in 2003, after being vacant for more than a decade. The total cost of the renovation was $23 million, but now the Genesee Theatre has become a destination spot, drawing attendees from both Illinois and Wisconsin.
In the process of its revitalization, Waukegan has created a master plan to guide its development, which focuses on two main things: being a great city and having great places. The master plan’s guiding principles include an emphasis on transit-oriented development; connections between the downtown and the lakefront; protecting, restoring and enhancing the ravine and park system; ecological restoration to create recreational amenities; improving the transportation framework to provide clear access and establish civic places. As part of its redevelopment effort, the city plans to build up to 3,700 new residential units along the lakefront to take advantage of this vital asset which has been long underutilized. They are looking to restore the facades of the historical buildings in the downtown to bring back the ambiance they once provided; for the most part, Waukegan will maintain their distinctive appearance, but also retrofit their facilities to modern use. The town plans to use tax incremental financing (TIF) dollars to help subsidize these changes, and several projects have already been completed. Along with the buildings, Waukegan has begun improvements to the downtown area by adding 16 blocks of streetscape, and Waukegan Park District has developed a new veteran’s memorial park as a public open space in the downtown. In addition, Waukegan plans to enhance its lakefront area that gives it a distinctive advantage over other cities, especially since it boasts a commuter rail, Metra stop, within walking distance of the lakefront and downtown. Rather than build up all the area around Lake Michigan, the city wants to design a large open space for community use and entertainment similar to Chicago’s Millennium Park, but on a smaller scale,as well as maintaining a public open space along much of the lake shore.
In conjunction with the city’s revitalization, steps need to be taken to clean the Waukegan Harbor further. The harbor was classified as an area of concern (AoC) in 1975 when toxic polychlorinated biphenyls (PCBs) were found in the sediments of the water related to the past industrial uses along the lakefront. During 1993, OMC completed environmental remediation by cleaning up the sediments in and around its property, removing about 1 million pounds of contaminated sediment. According to the environmental protection agency (EPA) website, OMC is not alone as other major remedial actions have been undertaken at Waukegan Manufactured Gas and Coke, Johns-Manville Company, Waukegan Paint and Lacquer, North Shore Gas North Plant, and the Waukegan Tar Pit.” If such actions continue, the goal would be to get the harbor off the AoC list, which would help advance Waukegan’s plans to revitalize the lakefront.
In sum, Waukegan’s city planners want to revitalize and transform Waukegan as a place for people who desire the amenities that a lakefront offers, but perhaps at a more affordable price. Their efforts might make Waukegan also appealing to those who prefer the quieter suburban lifestyle or those who can commute easily to jobs in Lake County, Milwaukee, or Chicago. Waukegan is hoping to rebuild its community and bring residential interest, commercial activity, and people back into a once booming industrial town.
May 21, 2009
What are the opportunities in central cities?
Since at least the 1960s, central cities of large metropolitan areas have experienced challenging times. In many cases, large shares of the population and jobs have shifted from these central cities to their suburbs. More recently, over the past two decades, central cities’ travails have eased somewhat; the declines in the number of households and jobs have abated, and in some instances, these negative trends have reversed. Understanding the reasons behind these trends can be helpful in fashioning public policies to encourage the redevelopment of central cities.
The Chicago metropolitan area's experience may be especially helpful in informing policy throughout the Midwest states. While the Chicago area has shared a common course of development with its neighbors in the Great Lakes region, its central city has outperformed its counterparts over the past 20 years. The population of the Chicago area’s central city has grown by an estimated 1.9%, or 53,000, since 1990. In comparison, the central cities of the eight remaining largest Great Lakes metropolitan areas have clocked a 9% loss. As for employment located in the central cities, from 1990 through 2004, the Chicago area’s city lost 4.6%, while those of the other areas lost 6.5%.
Why have central cities such as Chicago and the Twin Cities experienced some rebound? Two major reasons have been advanced. For one, it is clear that there has been a reawakening of interest in living in central cities that relates to their unique amenities and features. Gentrification in many cities has focused on those neighborhoods that contain interesting architecture and history—not to mention lively entertainment scenes. In addition, big city mayors have capitalized on renewed interest in city living by lavishing attention on amenities such as outdoor recreation, lively shopping and arts districts, scenic streetscapes and waterfronts, and urban festivals.
In a recent study of residential location in the City of Chicago versus suburban areas, Bill Sander and I document the specific characteristics of urban denizens versus suburbanites for both 1990 and 2000. The importance of city services to households is apparent from our findings concerning their demographic characteristics. For example, with an eye on the quality or reputation of city schools, household adults with children of school age are much more likely to choose the suburbs over the city. As for the general importance of amenities, diversity, and built environment, we find higher educational attainment to positively affect households’ decisions to choose central city residence. In 1990, those with a four-year college degree were no more likely to live in the city; by year 2000, such householders were 4% more likely to live in the city rather than the suburbs.
The education-related aspect of urbanization is evident in the changing composition of Chicago’s residents. In 1990, 19% of all working age adults living in the city had attained a college degree. By year 2000, this proportion had grown to 26%. Gains among the younger adults were most striking. As shown below, for adults aged 25–34, the college attainment share had grown to 39% by 2006. Growth since 1990 in college attainment of young adults living in the city reversed the suburban advantage of 1990. On average, by 2006, college attainment of young adults in the city exceeded that of their counterparts in suburban areas. The number of those with a bachelor’s degree residing in the city grew by over 50% over the 1990s (not shown) .
It is a mistake to attribute too much of the rising urbanization of college-educated householders to the siren call of city lights, museums, and lakefront parks. That is because job location also strongly pulls along residential location (and vice versa). Through a job channel, the rising importance of information exchange in the U.S. economy may be the second vital large force that may be reviving central cities. New ideas, their dissemination, and the coordination of a complex worldwide economy have come to dominate economic output in developed nations; therefore, the siting of jobs and meetings of workers in dense configurations, some have argued, augments productivity and value generation. Central city location of work has become more desirable, which has pulled some jobs back toward the center of metropolitan regions.
There is some evidence of this renewed role of central cities. At the same time that many central cities have shed some types of routine production jobs, gains have been made in occupations and industries that are steeped in workers who engage in information exchange and interaction. While the City of Chicago has been shedding manufacturing jobs—one of its historic mainstays—it has largely replaced such jobs with those in nonmanufacturing sectors. As shown below, city job losses are largely accounted for by the manufacturing sector alone; in fact, the city has experienced overall growth in employment net of manufacturing. More specifically, (not shown) over the period from 1991-2002, central city Chicago realized strong job gains in such industry sectors as business services (+34.4 percent), securities and commodities brokers (+61.8 percent), educational services (+25.1 percent), and engineering and management services (+13.6 percent).
In our recent investigation of household preferences for city versus suburban residence in the Chicago metropolitan area, we account for the proximity of households to their place of work. Once we statistically account for those city residents who also have found employment in the city, our estimates of the importance of educational attainment on household location in the city are somewhat smaller than we originally estimated. More importantly, "place of work" statistically explains much of the central city residential location decision. For this reason, we should not put too much emphasis on the importance of household amenities to central city living, nor perhaps should policymakers; jobs and job-attracting features continue to be important.
At this point, not much is known about the extent to which the changing economic structure of central cities is actually generating new jobs in related fields and transforming economic bases. And so, leaders and analysts in other Great Lakes cities are looking at the Chicago experience for insights as Chicago pursues policies to refashion itself as a “global city,” in both its residential amenities and in its attractiveness to highly skilled service industries that trade in world markets. Research initiatives that can discern the importance of the city as a job location from a residential location will be especially helpful to city mayors and other policy makers.
Not all of these gains reflect shifting preferences toward the city. Gains in overall educational attainment of the general population, especially young adults, enlarged the population of those adults that were, in turn, more likely to choose urban residence. (Return to text)
April 27, 2009
“Roads to Renewal” Conference
In the current environment of automotive plant shutdowns, the pursuit of economic adaptation and revival has become urgent for many communities whose livelihoods largely depend on the automotive industry. On April 15, knowledge experts, policymakers, and community representatives gathered at a conference event in Chicago. Its purpose was to explore opportunities to sustain and build on automotive assets in such communities, attract foreign direct investment, support automotive and energy-related research and development (R&D), build advanced manufacturing facilities, and diversify into other related industries. One notable audience participant was Ed Montgomery, newly appointed (National) Director of Recovery for Auto Communities and Workers.
The conference’s morning sessions addressed the forces impacting the Midwest automotive region, along with lessons midwestern communities might draw from the South. Sean McAlinden of the Center for Automotive Research presented a graphic overview of the region’s auto-intensive counties, as well as the market position and outlook for the North American auto industry. Over the past ten years, payroll jobs in the automotive sector have been halved because of wrenching industry restructuring. Communities in Michigan have experienced an outsized share of these declines. Moveover, McAlinden’s long-term analysis and forecast of automotive sales suggests that U.S. light vehicle sales are currently in the early stages of a deep cyclical trough.
The afternoon program asked how communities are responding and adapting to the loss of automotive activity. At one of the afternoon sessions, four economists offered their observations and advice to those communities that are transitioning to a post-automotive economic base. George Fulton, research professor at the Institute for Research on Labor, Employment, and the Economy at the University of Michigan, highlighted the sharp dependence of Michigan’s economy on the Detroit Three automakers (Chrysler, Ford, and General Motors). By his measure, economic concentration in the Detroit Three is 16 times greater in Michigan than the remainder of the United States. In that light, it is perhaps not surprising that Michigan’s overall employment growth has closely tracked Detroit Three domestic automotive sales since 1991, up to and including the recent plunge in sales. For Michigan, Fulton predicts that the sales plunge will be accompanied by a loss of 239,000 jobs from the end of 2008 to the end of 2009—the largest job loss since at least 1956. By the end of 2010, Michigan’s automotive industry will employ barely one-half of its 2007 work force.
In assessing Michigan’s longer-term prospects, Fulton offered a detailed industrial analysis that showed that a fair number of industries have been growing recently. Despite the fact that 641 industry sectors experienced falling job levels in Michigan from 2002–07, 298 industries not only had net hiring outcomes but actually outperformed their counterparts in the overall United States. However, a downside to his findings are that average wages in declining industries outweighed average wages in growing industries by $14,000 per year. In searching for Michigan’s industries of the future, Fulton recommended not only those offering high wage jobs but those having a strong export component, long-term growth potential, and regional advantage (or assets) in providing products or services. In Fulton’s opinion, the automotive industry fulfills these criteria except for its long-term growth potential in Michigan. Instead, Fulton grouped Michigan’s promising industries into three categories: knowledge-based industries (including auto engineering and R&D), tourist-oriented industries, and those sectors supporting higher-income retirees.
Another helpful perspective was presented by George Erickcek, of the W. E. Upjohn Institute for Employment Research. For Michigan and many other Midwest communities, what has been happening in the Detroit-Three-related automotive industry is too big to ignore; in particular, the recent negative experience is much more magnified in intensity, and what that portends for the long term weighs heavily on them. Car and light truck sales reached 16.1 million units in 2007, but are now forecast to go as low as 11 million units in 2009. In responding to plunging sales, Detroit Three producers have curbed year-over-year production by over 60 percent, and the top Three Asian-domiciled producers (Honda, Nissan, and Toyota) have done so by over 50 percent. The long-term outlook for the Midwest reflects structural decline rather than a swift return to activity. As recently as 2001, the Detroit Three controlled 74 percent of U.S. auto sales. By 2008, the share had fallen to 48 percent.
The employment size of the domestic auto supplier industry exceeds that of auto assembly by a factor of three. Domestic auto parts suppliers have been especially impacted by falling orders from the Detroit Three, and they widely report that long-term relations with the Detroit Three have soured in disputes over pricing and delivery terms. In seeking survival strategies, many domestic auto parts makers have attempted to diversify away from the Detroit Three to Asian- and European-domiciled assembly companies with production facilities in North America. More generally, Erickcek referenced the recent Klier and Rubenstein book which outlines three survival strategies available to parts suppliers: They must survive as 1) producers who integrate automotive systems of other suppliers and deliver them to assembly plants, 2) high-tech module developers, or 3) low-cost parts makers.
Given the recent upheaval in the automotive industry, Erickcek noted, displaced workers face strong headwinds in terms of expected earnings losses upon re-employment, slow expected recovery in job openings in the coming years, and age discrimination for older workers as they seek re-employment. Still, even in these difficult times, job opportunities exist because new products are being introduced, new markets are being serviced, and aggressive companies are taking market share from their competitors. To illustrate, Erickcek noted that over the current decade, net job creation in Grand Rapids, Michigan, has typically been negative but that new job openings have tended to exceed net job loss by wide margins.
How can the communities that have been affected by the downturn in the automotive industry help match their recently displaced workers with the new jobs? First, Erickcek recommended that they base their initiatives on a firm understanding of the local labor market and on the particular skills and abilities of displaced workers. Local efforts to identify a newly emerging industry sector and to subsidize its growth in the community is an extremely risky strategy. Instead, communities should determine their community investments in infrastructure and work force training by identifying interactions (and the intersection) of three key elements: the effects of the regional economic structure, global factors, and technological factors on the community and its economic base. In closing, Erickcek cautioned communities from jumping on the bandwagon in trying to attract the “next best thing,” such as life sciences, without a strong foundation for success. Competition is fierce for such prospects, and these industry sectors are often strongly anchored to existing clusters. Importantly, many of such industries are top- heavy with highly educated professionals so that “job chains” may not reach the community’s unemployed and underemployed work force.
Ned Hill, Professor and Distinguished Scholar of Economic Development at Cleveland State University, offered his considered assessment of the realities facing communities with strong ties to the automotive industry. Hill reported trends in automotive production from North America showing that much automotive work will continue to be done in the U.S and North America in the coming years. While world automotive production has grown rapidly since 1999, North American production remains sizable, with modest shrinkage and import penetration.
For companies and plants, Hill emphasized that the keys to survival have changed little from recent years. Successful plants and companies are those that operate with flexible work force policies and that employ workers who labor with flexible work force rules. In the current environment, low debt levels and ready access to capital are important factors in survival. On the national and global stage, Hill argued that the long-term value of the dollar also influences the health of assembly plants. According to Hill, the pending “card check” of the proposed Employee Free Choice Act (EFCA) that is under consideration in the U.S. Congress may exert a pernicious effect on automotive investment in the Midwest, north of Interstate 70. If passed, Hill contended that new plants will gravitate as far as possible from those communities that tend to support labor union representation.
In advising Midwest communities that are being impacted by automotive plant closings, Hill noted that a lot has been learned from the region’s steel plant closings in the 1980s and from defense plant closings. One lesson, said Hill, is that legacy costs—such as overly generous pension benefits and health care—must be shed if new companies are to survive and invest. Hill also cautioned towns and states and the federal government to avoid “lemon socialism.” That is to say, governments are especially inept at knowing which plants and companies that can survive; heavy subsidization of chosen “winners” is usually wasteful and prolongs the agony of readjustment.
In looking to assist new industries, plants, and investments, there is no silver bullet. Yet, communities must mobilize quickly and move toward new realities and opportunities. In doing so, communities must pay attention to market trends and forces, and reinvigorate the assets of their people (their skills) and their infrastructure. In identifying assets to protect when a plant has closed, Hill emphasized that land is the critical asset. Communities would do well to bring land back to the market for redevelopment through brownfield cleanup and land banking. In contrast, towns should be skeptical of fads. Who isn’t targeting wind, bio, solar?
Even with good practices, said Hill, we still have much to learn about community revitalization. The experiences involving mass worker layoffs in the 1980s were not kind. Approximately, one-third of workers retired, one-third successfully adapted, and one-third fell into poverty. Redevelopment has not always been successful. And when it has been, revitalization has often taken a long time—up to 20 years.
In my concluding presentation, I observed that each community has somewhat unique opportunities, assets, and challenges. For this reason, a “one size fits all” revitalization strategy will surely fail. All communities must start with a sound factual assessment of its own situation. In charting its policy course of action, a community must draw on credible information concerning the many demographic and economic trends that are at play. In choosing among policy actions, a community must be cognizant of the successes and failures of similar choices that have been made by others.
January 26, 2009
Foreign Born, Educational Attainment, and Entrepreneurship
By Britton Lombardi and Bill Testa
Attracting immigrants to the Midwest may be an especially lucrative objective from a regional economic development standpoint. As discussed in previous blog entries, the growth performance of metropolitan regions has been strongly linked with the educational attainment of its work force, especially college level attainment.
Educational attainment of the immigrant population in the U.S. tends to be skewed toward the high end (though it is also bifurcated—skewing toward the lower end as well). The high educational attainment of immigrants owes much to the top-notch university system found in both the Midwest and the nation, which brings many of the world’s brightest to our doors. Afterward, our market-based economy provides ample opportunities and rewards to talent, hard work, and new ideas of immigrant workers and entrepreneurs.
So far, even as the nation has experienced an upswing in immigration, the foreign born population in the Midwest lags well behind that of the nation. As the chart below suggests, the region’s large metropolitan areas host a much smaller share of foreign born, with the exception of Chicago.
A closer look below reveals that the Chicago metropolitan area has attracted both the highly educated and the less educated. The share of Chicago’s foreign born who hold a college degree is below the U.S. average. In contrast, in the remaining metropolitan areas of the Midwest, the foreign born population includes a greater share holding at least a bachelor’s degree in 2007. According to sample data from the U.S. Census Bureau, an incredible 50 percent of Pittsburgh’s working age population who were foreign born hold at least bachelor’s degree. Detroit, Cincinnati, St. Louis, and Columbus are not far behind.
Overall, however, the foreign born tend to lift Chicago’s average college attainment due to the city’s high overall propensity to attract immigrants. The Detroit area also rates highly in this regard, coming close to the national average.
Metropolitan areas in the region may also prize the foreign born for their tendency to start new businesses. The foreign born are, on average, business owners and self-employed at about the same rate as native born, though their experiences and bahaviors are quite varied. In a recent study, Maude Toussaint-Comeau finds that self-employment of immigrants varies by country of origin and by differences in personal and human capital characteristics. Immigrant-owned small businesses often contribute importantly to urban revitalization and community development.
Many more of the (immigrant) college educated concentrate their studies in technical and scientific fields than their native-born counterparts. A report estimates that in 2005, 41 percent of science PhD workers in computer, mathematical, architectural, engineering, and science occupations were foreign born. As a result, many fast-growing scientific and technical firms in IT and software have been founded by foreign born (and often U.S. educated) entrepreneurs. Another study estimated that between 1995 and 2005, 52.4 percent of the engineering and technology start-ups in Silicon Valley had one or more foreign born key founders. For our region’s foundering metropolitan economies, such firms would be truly welcome.
Our reading of the same data source above shows that entrepreneurship of the foreign born in the region’s metropolitan areas lies close to national averages. This is true of both college-educated foreign born and overall foreign born. Again, these tendencies vary across metropolitan areas.
However, the overall paucity of foreign born in the region tends to depress their importance as entrepreneurs. As the chart below suggests, again only Chicago manages to climb above the national average in this regard. The Detroit metropolitan area comes in a respectable second place.
Competition in attracting technical and educated immigrants can be fierce. At a time when skilled and educated workers are most in demand in the U.S., our immigration policy focuses heavily on family re-unification rather than criteria related to occupation or skill. And, to the extent that we do allow immigration based on applicants’ job skills, we cap such visas at levels far below what employers require. In the past two years, the quota for H-1B (skill-based) visas was met quite quickly. For fiscal year 2007, the H-1B cap was met two months after the application process opened, and for fiscal 2008, the cap was met in just under one day.
Metropolitan areas in the region differ in their overt recruitment of the foreign born. One way involves enhancing the process of assimilation into the fabric of the area for recent immigrants and foreign born residents. Pittsburgh has created the Welcome Center for Immigrants and Internationals to create a welcoming environment and to provide necessary resources and information, such as advice for small business owners and career counseling services. Indianapolis organized the International Center of Indianapolis to provide relocation and training services to both attract and retain well-educated immigrants. Indianapolis, too, has developed a Welcoming Center that connects recent immigrants with well-established immigrants to facilitate community integration. In the Chicago area, the Chicago Council on Global Affairs organizes events, speakers, and task forces to raise international awareness and to expand Chicago’s perception as a top tier global city. One such program in the past included a Mexican American Task Force that provided recommendations to businesses, governments, and other interested parties of ways to utilize the strong Mexican community as an economic asset.
Metropolitan areas have also taken to outwardly promoting their international diversity and available opportunities. Many cities participate in “Sister Cities” programs to build relationships with foreign cities to increase their international profile and potentially attract foreign investment, as well as visitors. Just to list a few: Chicago has 27 sister cities spread out across the world, while Detroit has 7, Columbus 8, St. Louis 14, and Milwaukee 5. Additionally, metropolitan areas promote their diversity and opportunities through cultural festivals and events. For example, Pittsburgh held “Global Pittsburgh Celebration,” a month-long celebration that worked to raise awareness about Pittsburgh’s global assets and technology, as well as showcasing the abundant opportunities for foreign-born entrepreneurship and innovation in the area.
January 8, 2009
Growth and Great Lakes Cities
For half a century or more, the industrial belt of the Great Lakes and Midwest has lagged counterpart regions in much of the South and West. Large midwestern metropolitan areas arguably offer the best prospects for relief from this historical pattern. The reasons are rooted in a fundamental restructuring of the global economy that favors cities. In underdeveloped countries, rapid urbanization and the emergence of large cities have gone hand in hand with economic growth and progress. And in developed countries on all continents, two factors have lifted growth opportunities for large cities. Foremost, technological gains in transmission of information have intensified the productivity of cities because of their role as meeting places. Face-to-face communication complements digital information flows. As business people can more easily transmit and receive information via electronic devices, their time has been freed so that they can engage more intensely and broadly in in-person dialog and social interaction. In other words, carrying one’s office in the palm of one’s hand allows one to leave the physical office to better explore opportunities and ideas. Cities tend to maximize these encounters in person. Enhanced and cheaper air travel lends a helping hand.
A second factor, the opening of global trade and capital markets, has increased the possible scale and opportunities for large cities. Cities tend to function best in managing and administering far-flung markets. More open and intensive global trade has tended to broaden the reach and scale by which successful cities can perform such functions in finance, advertising, research and development, law, and company management. For this reason, some analysts believe that they can identify the emergence of “global cities” that have succeeded in such opportunities.
To date, large cities of the Great Lakes have not fully benefitted from these “new economy” trends. Migration to regions with warmer climates has slowed these cities’ work force and population growth—a trend also reflected throughout the remainder of the region. But more fundamentally, many if not most of the region’s large urban economies were built not on the service industries that benefit from the ongoing global changes, but rather on the manufacture of goods and associated freight transportation. These cities’ transition to services and knowledge-based economies has proven difficult because manufacturing-oriented places must overcome and replace larger portions of their economic base. Manufacturing-oriented income in the region has withered because of global competition, falling real prices for manufactured goods, and technical advances that have allowed goods to be produced with less labor. To these obstacles, technical changes in the production processes themselves may be added: Such changes have made the more-densely populated parts of large cities especially difficult places in which to manufacture, compared with those far suburban and rural places, where land is cheap and the transportation of materials is more convenient. The growth-retarding effect from manufacturing on U.S. metropolitan areas over the 1960–90 period has been documented in a statistical study by Edward Glaeser.
Have the relative growth rates of midwestern metro areas coincided with the degree of their original manufacturing orientation? The charts below display employment concentration in manufacturing for the eleven largest metropolitan areas in the industrial belt on the vertical axis. The horizontal axis displays each metropolitan area’s total job growth on the first chart and real per capita income growth on the second chart. The inverse correlation of economic well-being with initial manufacturing concentration is quite evident. A simple correlation between job growth from 1969 through 2006 and the manufacturing orientation in 1969 is a strongly negative 0.8. Similarly, the correlation between manufacturing and per capita income growth is -0.7.
What might be some other reasons behind varying performance of these metropolitan areas? For one, even within the manufacturing sector, industry mix (and related performance) varies markedly. For example, the Twin Cities’ manufacturing base included emerging medical instruments and computer equipment during this time period, while Detroit hosted sagging domestic auto production.
Other observers wonder about the role that the metro core or central city has played in its relative growth and development. Due to marked suburbanization within metropolitan areas, and fixed central city boundaries, some cities such as Cleveland and St. Louis became relatively small islands of population; today, the city population accounts respectively for only 20.9% and 12.5% of these two metropolitan areas. As such, cities such as these were left largely alone to provide public services to low-income populations—and to do so with a rapidly diminishing tax base. Accordingly, some researchers speculate whether growth and development suffered as a result of this trend—not only in the city but in the entire metropolitan area. In contrast, central city Columbus and Indianapolis began with a broader geography and richer tax base with which to provide public services and development-oriented infrastructure.
While Midwest cities have many challenges to overcome, there are also assets on which to build. As widely shown and increasingly recognized, the most important overall determinant of regional growth performance has been the educational attainment of its population and work force. This is not surprising given the structural changes that have taken place in the emerging economy—changes which place a greater emphasis on information exchange and the development of creative ideas. For Midwest metro areas, and as discussed by Timothy Dunne in a recent Economic Commentary, educational attainment may be more important than for other regions. To succeed in overcoming the shocks that rocked their industrial bases, educational attainment in Midwest metro areas may have been most helpful in adaptation and re-invention. Tim Dunne displays charts similar to those above which indicate a weaker correlation between educational attainment and growth in warm weather metro areas as compared to cold weather climes. In considering educational attainment of the populations, the table below displays the ranks of Great Lakes metropolitan areas among 118 metropolitan areas in 1970 and 2006. The two local leaders in 1970 college attainment, Columbus, Ohio, and the Twin Cities also experienced the fastest employment growth. While Pittsburgh ranked low in college attainment in 1970, its gains in this metric since then have been the most rapid. Perhaps not accidentally, Pittsburgh’s growth in per capita income also outpaced other cities in the region.
As for policy, while the region’s goods-producing industry mix has left behind a legacy of a slow-growing industrial base, the region also boasts top-notch colleges and universities. With regard to elementary and secondary education, the region maintains a healthy income base with which to support its schools. Similar to most other parts of the country, the region’s educational challenges are to have its students to perform much better, especially in central cities and lower-income communities.
Note: Vanessa Haleco-Meyer contributed to this weblog.
October 16, 2008
Fresh Water Issues and Conference
Sometimes when I am out speaking to groups about the Midwest’s economic future, someone in the audience will assert that the Great Lakes Region’s past glories will ultimately be restored because “they (other U.S. regions) will run out of water and we have plenty of it.” This assertion may be only partly true, and its fulfillment may require deliberate action and hard work rather than passive waiting.
It is true that the Great Lakes states border one of the world’s largest bodies of fresh water. With regard to surface fresh water, the Lakes are estimated to contain 18% of the world’s supply, and 90% of the U.S. supply (though we share these shorelines with Canada’s Ontario and Quebec provinces).
However, in replying to the “water revival” assertion, I am always careful to temper the sanguine outlook with several “the glass is half empty” caveats.
First, while it is true that water is becoming increasingly scarce in much of the West and even, more recently, in the Southeastern United States, the problem there mostly lies with poor allocation of water among competing uses rather than with sudden scarcity. Especially in the West, most fresh water is used for agricultural irrigation rather than for residential purposes. Since agricultural use of water hardly begins to approach its value for use in human living, it is difficult to imagine that the scarcity will soon present a significant obstacle to growth. Rather than in agriculture, most economic growth in the West is taking place in the service-oriented economies of its large metropolitan areas. Since water requirements for urban households and their typical jobs are light, rising water demands need not be onerous. Indeed, much of the difficulty with scarcity in metropolitan areas arises because available water is not properly priced. When water is underpriced, or priced poorly among different types of users, the resource is invariably wasted. In the case of water, legal and governmental arrangements compound the waste and misallocation. That is because many water users in agriculture can by law only use available water for immediate purposes (e.g., irrigation) and cannot sell it to others for a higher value use such as residential use.
While the water shortages that emerge from such arrangements do present some drag on growth, fast-growing metropolitan areas of the West do ultimately manage to wrest water away from existing uses. And so, looking to the future, it is more likely that existing water will be allocated to its higher value use for residential purposes in the West and will not (much) constrain growth there.
Still, the history of water allocation in many parts of the world is littered with tragic outcomes, as water is diverted by mammoth diversion projects and overused by those zealous users who draw on the “free” resource while imposing scarcity on others. Recently, in documenting historical water diversions into and out of the Great Lakes Basin, author Peter Annin also chronicled the devastation of the Aral Sea in Kazakhstan and Turkemistan. A Soviet program of the 1950s diverted much of the water from the Aral River Basin into agricultural uses. As a result, the Aral Sea has shrunk by 75%, with catastrophic consequences for the environment and the people who lived along its shores. Annin believes that clean water scarcity is on the rise in many regions of the world and throughout the United States. Accordingly, we can expect that tensions and conflicts will increasingly emerge over fresh water use and ownership.
We already have seen such conflicts here. Uncontrolled or ill-conceived withdrawals threaten to expunge water resources from underground aquifers of the American West. According to Mark Reisner, federal government-sponsored water diversion projects have contributed to today’s depletion and water misallocations there. Water resources in the West have been historically commandeered through federal government actions such as the construction of dams and the re-channeling and transport of vast quantities of fresh water.
The lessons for the Great Lakes Basin are plain. As water grows scarcer in faster-growing regions of the U.S., and as political representation of the Midwest wanes with lagging population growth, wholesale water diversions from the Great Lakes Basin may become more likely.
Anticipating such a scenario, ten years ago policy leaders of the Great Lakes began working on an agreement to protect the waters from diversion and depletion. After much wrangling in and among individual states, the agreement was signed by President Bush last week on October 3. The Great Lakes–St. Lawrence River Basin Water Resources Compact arrived on the President’s desk following ratification by the eight states bordering the Lakes and subsequent approval by both houses of Congress. (Ontario and Quebec have adopted parallel agreements).
What does the compact mean for the region’s prospects? The compact does not guarantee that these waters will never be diverted for broader national purposes. However, it does give the region some assurance that it can plan to preserve and develop its natural advantages of abundant water in ways that secure a brighter future. In fact, the compact imposes uniform and stringent conditions on further water withdrawals even within the Great Lakes states and requires the states themselves to implement new management and conservation programs.
With its inland fresh waters now more secure, and as the region must rethink its own water management policies, there is perhaps no better time to consider how the region’s fresh water legacy can best serve its residents. For this reason, on November 10, 2008, the Federal Reserve Bank of Chicago will host a conference on “Fresh Water and the Great Lakes Future” in Detroit. This will be an opportunity for regional leaders to explore the increasing value that these assets hold for our residents for residential, aesthetic and recreational purposes.
As U.S. income and population rise, the recreational and scenic value of open waters, wetlands and other open spaces also rises. But how will these assets be used and what will be the level of demand? And how will this be manifested in migration and growth in income? What sustainable and responsible policies should the region undertake to cultivate its own fresh water legacy and related assets?
Investment in preservation and clean-up of Great Lakes waters presents one set of policy options, as do related decisions concerning regulation, land use policies, and consumptive uses of the waters. So too, both rural and urban communities are moving forward with infrastructure and other economic development programs that promote the recreational and residential advantages of lakes and rivers. These include lively riverfront and lakefront mixed-use developments in downtown areas of big cities, as well as the promotion and development of more rural recreational assets.
Our conference will also investigate the region’s legacy of fresh water treatment technology. During its rapid industrialization and urbanization, much water degradation took place. In some instances, the region’s subsequent adoption of stringent water quality regulation has spawned the growth of associated firms, university research, and associated water treatment technologies. Can our water treatment firms and university researchers grow more prominent, perhaps serving communities in other parts of the world where clean fresh water is less readily available?
September 24, 2008
Supply-side efforts at building skilled workforce
By Britton Lombardi, Associate Economist
Wage growth continues to grow more sharply for educated workers, but how can states and cities build their work force in this direction?
For one, a “grow your own” approach to enhancing the local supply of educated workers may be helpful. States tend to have some advantage in retaining individuals who grew up and went to college within the state. A study found that 54% of students that were both residents of the state and attended college in-state were working in the state 15 years later. The number falls to 35% if the student residents attended college in another state. The percentage drops to 11% for non-residents who attended college in the state. A recent policy report for the Milwaukee area suggests that a potential way for states to make use of this home state advantage would be to increase their high school graduation rate and better prepare their students for college. Even if these students do not attend college, the policy report notes that a rise in the high school graduation rate would raise average incomes and would help fill jobs being left open by retiring baby boomers. Nonetheless, states and cities will see the greatest returns to education if these high school graduates do obtain a college education and either stay in-state or return home after college.
How are states doing in "grow your own" initiatives? The chart below plots state college enrollment versus educational attainment of the workforce. The state’s college enrollment rate is weighted by the state’s average high school freshman graduation rate, which reflects a state's tendency to graduate its high school students. Therefore, the x-axis number is the interaction between the percentage of high school graduates that go to college and the percentage of students that completed all four years of high school. On the vertical axis, we measure educational attainment of the state's workforce as the weighted average of years of schooling per worker. The horizontal and vertical lines in the graph (in blue) are the U.S. averages.
The states positioned in the top right quadrant of the chart have an above average educational attainment per worker and are sending a higher proportion of students to college than the U.S. average. Four of the five Seventh District states (Illinois, Iowa, Michigan, and Wisconsin) reside in this quadrant. Although Indiana (bottom right quadrant) has lower than average years of schooling, the state seems successful in preparing and sending its students to college as seen from its above average enrollment rate. It appears as though the District states, which tend to be high-income states, have been successful in educating their own and sending them to college. There is some slippage in this measurement since a large and variable share of those who enroll in college go on to complete their degree.
Educating a state’s own individuals does not guarantee the young professionals’ retention or return to the state after college. Therefore, states should also focus on the migration of these young professionals into and out of their state, especially as the young, college-educated professional cohort is the most mobile of any cohort in the U.S. A special Census Report calculated that 75% of young and single and 72% of young and married college-educated professionals between the ages of 25 and 39 relocated between 1995 and 2000. Therefore, a part of a state’s future economic success is tied to attracting these young professionals from other states. In the next chart, states are plotted based on their 3 year average net migration rate of young professionals versus the state’s weighted average years of schooling. For the Seventh District, Illinois and Wisconsin (top right quadrant) have average years of schooling above that of the U.S. average and are importers of young educated professionals as seen through their positive net migration rates. Iowa, Michigan, (top left quadrant) and Indiana (bottom left) have negative net migration rates. These states seem to be exporters of young college-educated professionals.
Click to enlarge.
For the two charts above, the educational attainment of the existing work force was put on the vertical axis for two reasons. The educational attainment level reflects the past success of the state’s educational system in producing an educated work force. In addition, educational attainment will vary with the industry mix of the state economies since industries tend to have varying workforce skill demands. In turn, a state's industry mix is determined by a host of historical developments in the state’s development process. Indiana, for example, ranks among the top 3 states in manufacturing concentration, a sector which historically has not required a post-secondary education (though this is changing to some degree).
As states compete for these young professionals, they may need to offer unique opportunities to set themselves apart. From an economic development standpoint, cities can be an integral part of a state’s effort to increase their level of human capital since cities can be the gravitational force that brings young professionals to the state. Based on the table below, 17 of the 20 largest metropolitan areas had a positive in-migration of young well-educated professionals between 1995 and 2000, including two Seventh District metropolitan areas: Chicago and Minneapolis-St. Paul. Cities have the ability to attract young well-educated residents because they still offer powerful benefits to their inhabitants.Cities eliminate the distance between people and ideas by allowing ideas to be shared in both formal and informal settings, thereby increasing the opportunities for innovation. As such, cities have become centers of learning for young college-educated professionals just starting their careers. As studied by Ed Glaeser, professionals come to cities to take advantage of the knowledge externalities provided by interactions with other well-educated and successful individuals to enhance their own productivity. Glaeser found that workers tend to learn faster in cities and enjoy higher wage growth. The density of educated individuals living in a city creates informational spillovers, thick labor markets, and division of labor leading to specialization. Cities also reap the benefits of these individuals through their overall increased productivity and innovation.
Since cities can play an important role in regional economic development, the Milwaukee area policy report suggests a combination of two ways for cities to enhance their efforts to increase their pool of human capital through migration. First, the city should try to enhance the available job opportunities to young professionals that match their career and personal goals, as these individuals want to learn, network, and develop professionally. The report recommends that local businesses and civic organizations join forces to share resources and ideas to spur innovation and growth to create or improve jobs. Secondly, the American city has been transforming into a cultural and entertainment center. Young, college-educated professionals place special emphasis on amenities offered by a city. They expect high-quality and unique recreational opportunities such as restaurants, sporting events, live music, and nightlife venues. Therefore, cities might need to augment or diversify their recreational offerings to retain and attract these young professionals and provide a vibrant and livable city.
These days, states and cities must select from a wide and complex array of economic growth and development policies to find the strategies that are most appropriate for their situation and circumstances. Increasingly, they are favoring policies related to skilled work force availability.
September 11, 2008
By Graham McKee and Bill Testa
It’s very clear by now that wages and incomes have risen sharply for U.S. workers who have attained greater education. One recent study indicates that the premium of hourly wages of college graduates over those with only a high school diploma has climbed from just over 30% in 1950 to over 60% today. This lesson has not been lost on recent high school graduates. The U.S. Bureau of Labor Statistics reports that in October 2007, 67.2% of the class of 2007 high school graduates were enrolled in a postsecondary educational program.
So, how have rising returns to education affected the economic growth and well-being of places? Not surprisingly, eminent scholars have proffered that those local economies having highly educated work forces have outperformed as measured by relative income and employment growth. In particular, research papers by Edward Glaeser (and others) provide documentation that a large initial work force share having a college degree in a metropolitan area tends to give rise to strong subsequent growth in jobs and income.
Metropolitan areas and other local areas in the Northeast and Midwest have taken especial note. Here, the economic performance of many cities has been hampered by an industrial composition steeped in traditional manufacturing. While the skill and educational requirements of factory jobs have been notably climbing as of late, the economic structure of many Midwest places has not developed from a strong base—that is, one having the advanced business, finance, and professional services that tend to employ highly educated and highly compensated workers.
One place in the region where we still might expect to observe the propulsive power of educational attainment would be in the Midwest’s college and university towns. Both nationally and regionally, colleges and universities have enjoyed rising demand for their services—both research and teaching. Per the graph below, enrollments as a share of the U.S. population continue to rise during the current decade, reaching almost 6.5%—a level of 18 million by October 2007 (versus 8.2 million in 1970). So, too, research and development (R&D) performed by colleges and universities has also climbed over same period, rising from a 9.2% share of all U.S. R&D in 1970 to a 13.7% share in 2006. More recently (measured in nominal dollars), university R&D rose by 50% over the period 1999–2006.
Such trends have driven direct employment in academia higher. According to surveys conducted by the American Association of University Professors, over the past three decades, “while the number of tenured and tenure-track faculty has grown 17 percent, the ranks of contingent faculty (both part and full time) and full-time nonfaculty professionals have each tripled, and the count of administrators has doubled.”
In addition to direct employment, university research has often acted as a catalyst for growth in the private sector. Technology transfer from university labs to start-ups and early stage firms has become a growing activity. Moreover, many such firm start-ups take root locally in university towns themselves. The emergence of industrial research parks adjacent to or close by universities offer testament to this phenomenon—with those in proximity to Stanford University and the Massachusetts Institute of Technology (MIT), as well as the Research Triangle Park in North Carolina, being the prominent prototypes.
To identify those Midwest metropolitan statistical areas (MSAs) in the Great Lakes region where universities make up a large share of economic activity, we look at the R&D expenditures of all universities in each MSA in seven states—Illinois, Indiana, Iowa, Michigan, Minnesota, Ohio, and Wisconsin. On a per capita basis, the top ten metropolitan areas by R&D expenditures for 1979 are reported in the graphs below (by rank from highest to lowest). How did these metropolitan areas subsequently perform as measured by population growth and per capita income?
In answering this question, it must be recognized that much more than university activity has transpired in these metropolitan areas. Even metropolitan areas that we tend to associate with major universities (e.g., Lafayette, Indiana, with Purdue University) are major manufacturing and commercial centers in their own right. And so, we cannot then simply attribute their relative demographic and economic growth over the past few decades to university presence with much confidence. Nonetheless, on the whole, it is interesting to note that these metropolitan areas outperformed the seven-state region, on average, over the 1979–2006 period. As shown below, average population growth of university towns (see black vertical line below) has easily outgrown the average population growth of all metropolitan areas in the region (see horizontal maroon bar). The per capita income performance of university towns has not been as sharp (below).
The comparative growth of these Midwest university towns, as shown in the graphs, perhaps reveals the local benefits from higher educational activity. Still, the questions and issues related to the economic development of such places remain difficult. How can university locales best leverage local universities for growth? Host cities have been active along a number of fronts. To name a few, localities have developed complementary real estate adjacent to campus to stimulate retail and residential attractiveness. Universities have also partnered in commercial parks and ventures to stimulate private business investment and further research activity, and in some instances, the region has partnered with a local university to train the local work force in specialized areas or to develop technology and know-how into a local industrial specialty.
Given these observations, more challenging questions remains. How can the positive effects of university R&D spillovers benefit states and even multistate regions? (That is, how can such spillovers in university towns spill over more widely?) And even if such spillovers were realized, how much and what types of public support should be proffered to colleges and universities? And if colleges and universities are to receive subsidies based on the impact of their economic development on broad regions, how should the costs of public support be allocated among the various subregions who share in the subsequent benefits?
August 2, 2008
A Resolution (Revolution?) for the Midwest
By Rick Mattoon
“The Midwest is failing the challenge of globalization, largely because it’s so balkanized, with each state trying to compete in the global economy. Midwestern states are simply too small, too incompetent, too obsessed with the wreckage of the industrial economy, to deal with the problems of the future, like education. It’s time for other players -- cities, businesses, especially universities -- to come together in a concerted regional approach that would leverage the Midwest’s strengths, not undermine them,” said Richard C. Longworth, senior fellow, Chicago Council on Global Affairs and author of the new book, Caught in the Middle: America's Heartland in the Age of Globalism.
Can regionalism boost the prospects of the Midwest? This is a theme investigated in several previous blogs by Bill Testa on this website. When is cooperation and when is competition the right approach in gaining regional advantage? How do you get people to “think regionally”? These questions were at the center of a two-day program that brought together a group of 100 business, academic and policy leaders in Minneapolis on June 26-27. The program was cosponsored by the Committee for Institutional Cooperation (which represents the Big 10 universities as well as the University of Chicago), the University of Minnesota and the Minneapolis Fed and was designed as a companion to two previous conferences in 2005 and 2006 held here at the Chicago Fed. The program had a specific mission—to discuss the role of human capital in the economic development of the region and to investigate whether greater regional cooperation might hold the key to a more vibrant future for the Midwest.
Human capital is a clear determinant of regional fortune. Evidence presented at the conference suggested that this is a two-edged sword for the Midwest. The region is rich in institutions that educate residents and produce valuable research. However, the Midwest is only average when it comes to its share of college educated workers in the regional labor market. There is also ample evidence that the region produces research at a prodigious clip and yet lags in product commercialization and the ability to attract venture capital.
The conference also investigated both the public and private returns to education. A presentation by Lance Lochner of the University of Western Ontario traced the income returns (i.e., the rate of financial return from investment in education) to varying levels of educational attainment. Lochner looked at the average financial returns received by men over the period 1940 to 2000. His findings suggested that returns were highest for high school graduates over this period but that the return to a four-year college education exceeded the returns from two-year college programs. Lochner noted that in addition to increased lifetime earnings, additional schooling improves health outcomes, increases personal satisfaction and often leads to more enjoyable careers.
Paul Glewwe and Amy Damon of the University of Minnesota examined the “public” or social benefits that taxpayers in Minnesota receive when students enroll in the university. The study identified several categories of benefits, including increased state tax revenues, reduced crime, increased civic engagement and lower unemployment. They estimated an annual economic benefit to the state of $672 million versus a cost of $284 million. This is a conservative estimate because it excludes any benefits from research activities and excludes other public colleges and universities in the state.
Another aspect of human capital discussed was the returns to early childhood education. Art Rolnick of the Minneapolis Fed discussed efforts to expand early childhood education access to low-income families in Minnesota. Research from several studies suggests that early childhood education has a significant impact on both economic and academic outcomes. Rolnick offered a model for expanding early childhood programs and suggested that the public returns to such efforts will be substantial. Early education programs would not only focus on child development but also on increasing the resources and training of parents in support of their children.
The focus of the conference shifted in the afternoon to a discussion of whether a regional approach would be best suited to solving policy challenges such as improving the region’s human capital. Lou Anna Simon, President of Michigan State University, suggested that institutions do have ample opportunity to increase cooperation to their mutual benefit. For example, Midwestern universities could cooperate on grant applications to improve their chances of obtaining research funds. Simon said that turf battles are often detrimental to the region’s overall success.
So, who takes ownership of a regional agenda?, Simon asked. Is there a blueprint for creating an organization that can promote regional cooperation? Many regions have looked enviously at the Southern Growth Policies Board as a model. Giving a Midwest example was Frank Beal of Chicago Metropolis 2020, an organization founded eight years ago with the goal of making the Chicago metropolitan region more economically competitive. This initiative emerged from a study conducted by the Commercial Club of Chicago in the late 1990s. The strong commitment, influence and resources of the Commercial Club and its continuing support have been important in helping Metropolis 2020 aggressively pursue change in four areas: the criminal justice system, early childhood education, regional growth and transportation.
Beal offered eight factors in Metropolis 2020’s success that might be applicable to a future Midwestern regional organization. Metropolis 2020:
1. Has a clear blueprint of what the organization wants to accomplish.
2. Benefits from having a relationship with the Commercial Club that provides stature and access to people and resources.
3. Avoids agenda creep. Has a disciplined approach to reviewing new issues or taking on new assignments.
4. Collaborates with other organizations only on its own terms. In practice this means clearly establishing the program goals before inviting others to join.
5. Has mostly older senior professionals on staff. These people are issue experts, and they are doing this work because it matters to them.
6. Does not view government as the problem. Many of the staff have had senior government positions and respect the role government plays in getting things done.
7. Will not tackle an issue unless it is a natural fit with the organization’s expertise. Changing public policy requires expertise.
8. Is ambitious and does not mind tackling audacious goals.
One final perspective on regionalism was offered by Tom Holmes of the University of Minnesota. Holmes observed that a fundamental challenge to any notion of regionalism is that any region is both arbitrarily defined and composed of a series of sub-regions. And so, depending on the issue, coalitions must form with an ever-changing cast of characters. Often the desire in regionalism is to establish a large umbrella organization to promote a broad regional agenda, but these efforts fail to recognize that the most successful regional policy efforts contract and expand to fit the size and scope of the issue.
The program concluded with the signing of a resolution by all of the attendees. The resolution recognized the shared history of the region and the challenges of adjusting to economic change. Solutions to the Midwest’s economic challenges will require an integrated response by business, public policy and higher education. Specifically, the resolution concludes, “We hereby resolve to actively explore ways to work collaboratively on solutions, bringing our best from business and industry, public policy and higher education, to contribute to a stronger economic future for the region.”
The next step in this investigation of regional cooperation is being sponsored by the Chicago Council on Global Affairs on October 6th of this year. This one-day program will examine the impact of globalization on the Midwest and why thinking regionally should matter. While the ultimate form of regional cooperation is clearly a work in progress, this discussion is clearly gaining momentum and reaching an ever larger audience.
June 17, 2008
Manufacturing's role in the Midwest future?
Across the Midwest, perhaps no economic development issue looms as large as the diminishing role of manufacturing. The Midwest’s once rapid population growth and lofty standard of living largely evolved from the industrialization that took place over the past 150 years. Yet, in recent years, job levels in manufacturing have declined. And as a share of overall payroll employment in the region, manufacturing has fallen from 29% in 1969 to 12% in 2007.
Additional debate has broken out because of dramatic declines in specific industries, such as the automotive industry, which is concentrated in Michigan and scattered throughout many parts of the region. In the face of such stark declines, the question arises as to whether the region must look beyond manufacturing and toward new industries. As the U.S. economy evolves toward advanced services, should the Midwest be following suit at an accelerated pace? And if so, how should the region go about it? For example, should the region’s policy focus on improving the quality of life features to attract highly skilled workers for business services and related industries? Or should the region cultivate new technology and entrepreneurial behavior in an effort to grow new industries?
Arguably, policymakers in the region should pursue all such avenues toward redevelopment and reinvention that are within the bounds of reason and with careful cost–benefit consideration. But there are also reasons to believe that traditional manufacturing can continue to play an important role in the Midwest economy. Significant opportunities remain for manufacturing enterprises that are both extant and emerging here.
In disparaging manufacturing's prospects, an analogy to production agriculture can sometimes be misleading. In terms of long term productivity gains, some observers are only partly correct in drawing close parallels between the U.S. production agriculture sector and manufacturing. Rapid productivity growth in each sector has pushed down prices of products and lessened attendant labor demands. The world over, rising national income per capita has gone hand in hand with declining shares of a nation’s employment in agriculture, followed by declines in manufacturing. Eventually, such trends lead to a wealthy economy steeped in services. In the typical experience for a developed nation, the share of national employment in production agriculture drops because of startling labor saving productivity on the farm, coupled with unresponsive household demand for raw food products as incomes climb. In the U.S., for example, as our standard of living has progressed, agricultural labor as a share of the work force has declined from 41% around year 1900 to only 2% today.
Some of these same processes are also at work in the manufacturing sector. And so, some analysts reason that manufacturing jobs will similarly disappear; that is, eventually, only a slim manufacturing presence will remain across the nation as whole, leaving us an economically diminished Midwest region.
However, in contrast to agriculture, manufacturing continues to give rise to a significant share of income among the most developed countries in the world. This occurs in spite of the trends toward generating more services production in developed countries and offshoring manufacturing to low-cost countries. Manufacturing’s continuing importance to developed countries’ economies can be seen clearly in an exhibit within the Federal Reserve Bank of Dallas’ 2007 annual report. The report’s exhibit 8 observes nations both by the percentage of their workforce engaged in manufacturing and agriculture and by their average per capita income. Manufacturing resembles agriculture to only a modest extent with respect to these measures. As a nation’s income rises, the share of the workforce engaged in manufacturing does tend to decline; the same applies to agriculture. However, whereas the share of employment in agriculture drops off precipitously as countries grow wealthier, the share of employment in manufacturing declines only modestly and gradually. For even the wealthiest nations, such as the U.S., manufacturing remains a large and vibrant sector.
Manufacturing’s continued strength has much to do with the fact that manufacturing companies need to be knowledge-intensive and highly creative to develop new products. Strong productivity tends to reduce the amount of low-skilled labor required for manufactured goods, and intense global competition for such labor drives down the prices of manufactured goods. That said, as a counterweight manufacturing companies continue to come up with new products. These include consumer products, such as improved electronic appliances, pharmaceuticals, and packaged/processed foods, as well as tools for businesses, such as more advanced computing equipment, mining/construction machinery, and telecommunications.
Some inkling of manufacturing’s high level of knowledge intensity can be seen from figures reported annually on research and development (R&D) of manufacturing companies. Manufacturing companies account for $123 billion of the nation’s $278 billion spent on R&D in year 2003—a 45% national share (see blue bars in chart below). This compares to a 13% share of manufacturing sector output in overall gross domestic product, or GDP (red bars below).
Click to enlarge.
Midwestern manufacturing companies have a strong orientation toward knowledge-intensive manufacturing. The region’s manufacturing companies account for 66% of the region’s R&D versus 19% of the region’s total output.
That the manufacturing R&D share of the Midwest economy exceeds that of the nation can be explained by the larger role of manufacturing companies in our region. Moreover, it may surprise some to learn that Midwest manufacturing is no less “high tech” than the national average as well. The sector’s “R&D intensity” also contributes to the dominant role of manufacturing R&D in the region. In both the region and in the nation, R&D spending makes up about nine cents of every dollar of inputs spent by manufacturing companies (per chart below).
Click to enlarge.
The bulk of the Midwest’s industrial R&D takes place within the region’s hallmark sectors—automotive, food products, electrical equipment, machinery, and chemicals. By our estimates, these sectors make up 42% of the region’s $42 billion of industrial R&D reported for 2003. The chart below characterizes the concentration of R&D by industry sector in the Midwest. Highly concentrated R&D expenditures are denoted by deeper shades. These concentrations are constructed for a state, for example, as an index of R&D taking place in a particular sector relative to the state’s national share of total output. For instance, the state of Michigan scores a deep shade in “Motor vehicles, trailers & parts” because its share of the nation’s R&D in this sector far exceeds the state’s share of overall GDP. Indeed, company activity in motor vehicle R&D in Michigan registered $10.7billion—a national share representing a concentration over 17 times the state’s share of overall economic output in 2003.
Click to enlarge.
Other Midwest states can also be seen to be domiciles of R&D in particular industries. The final column above displays R&D concentrations (as an index number) for the entire seven-state region. In addition to intensive R&D activity in the region’s hallmark industries, the region also scores highly in pharmaceuticals, computer equipment and its design, and aerospace.
And so, if a high degree of ongoing R&D intensity is any indication, manufacturing will continue to play a strong role in U.S. production. Despite its current challenges in automotive production, the Midwest is no exception in this regard. To be sure, the region’s overall population and work force growth have lagged those of the nation. In some part, this reflects the region’s greater concentration in manufacturing—a sector that has experienced outsized impacts from labor-saving productivity and, to some degree, offshoring of activity. Nonetheless, there remains a sizable future to be built by the region’s manufacturing companies.
One public policy effort to further the strength of the manufacturing sector in the region has been initiated as the Great Lakes Manufacturing Council. This coalition will meet this summer “to discuss the image of the Great Lakes region, innovation in manufacturing, the work force and skills needed for manufacturing today and tomorrow as well as the borders and logistics requirements to effectively move goods and services in today’s global economy.” I hope to see many gather at the meeting to discuss (and act) on these issues further.
Note: Thanks for assistance from Graham McKee.
April 29, 2008
Someone Call the Doctor—Regions Without Borders?
Two fine studies have been released this year that can guide the slow-growing Midwest in finding its “way forward.” At a time when national sentiment has been running high to tighten national borders between the U.S. and other nations, both reports strongly argue for lowering restrictions on nearby borders—namely those between Midwest states and between the U.S. and Canada along the Great Lakes border. So too, cooperative strategies across local borders are urged to address the Midwest’s economic challenges.
Accomplished journalist R.C. Longworth recently published an insightful and accessible book containing lucid explanations and gripping Midwest stories that bring to life how global upheaval and technological changes have affected the Midwest economy. From farm to factory, from small town to metropolis, Longworth tells stories of the region, its places, and its people. To gather his observations, he spent months traveling around the region. And, having been born and raised in small-town Iowa and covered the region and the world for a major Chicago newspaper, Longworth knows where to look!
More importantly, Longworth understands today’s basic mechanisms of economic change—and their impacts on places and people. To be sure, owing largely to technological advances in communication and transportation, the world has “gone flat” in one sense. Goods and services can be produced anywhere and delivered right here, thereby exposing Midwest workers to competition and upheaval.
However, these same changes have concurrently made the economic landscape “more spikey” than ever. Those places that have succeeded in the new environment are well-advantaged mountains of economic specialization and formidable scale. Such places include large metropolitan areas and mega-cities composed of several proximate cities that draw the best and brightest talents together and that produce advanced services in high-valued legal, consulting, technology, administration and the arts. They also include emerging manufacturing regions such as the mid-South—home of foreign-domiciled auto production.
What holds back the Midwest from such invention and re-invention? Longworth believes many Midwesterners still do not understand globalization and instead cling to ideas and strategies that attempt to bring back the region’s glorious form and past. Looking at its reflection in today’s global looking glass can help the region to find new directions—to imagine a new Midwest economic landscape.
In searching for the correct policy framework to re-work the region, Longworth also believes that national governments are too “clumsy … to cope with a post-national world. … But that the smaller building blocks—cities, counties and states—are too weak and isolated to swing much weight by themselves in an economy that spans the globe.” Accordingly, the Midwest must put aside some long-standing boundaries and competitive behaviors such as inter-state tax competition and balkanized transportation systems. Instead, Longworth calls for extensive regionwide dialogue to achieve creative and cooperative policies.
The region has common interests and goals, but fails to recognize and act effectively. To move forward, regionwide conversations must take place, perhaps assisted by a region-wide publication—electronic or print or both. To be a wellspring of new ideas and policies, the Midwest must have at least one think tank of its own to see the region’s greater possibility for growth and re-invention. Longworth calls on regional foundations, research universities, public leaders, and Reserve Banks to move quickly and boldly in this direction. The Southern Growth Policies Board —founded in 1971—may be one model to draw on as the region fashions its own organization to serve as the fountain for cooperative development.
Not all of Longworth’s immediate prescriptions are intangible. The region is rich in the assets of wealth creation such as highly skilled professionals, cultural and recreational draws, and global company centers. But in observing successful regions in the age of globalization, Longworth sees that proximity and scale count for much in marshalling diverse assets into globally meaningful centers. He proposes that the region consider bold interpersonal transportation systems such as high speed rail.
Another recent study—this one from the Brookings Metropolitan Policy Program—also analyzes the new global economic paradigm and how the Midwest must adapt to its challenges. John Austin and his co-authors take the regional approach to global economic adaptation one step further by recognizing that, for the Midwest, the lowering of national border barriers is acutely important. Along the Great Lakes, Canada’s people and resources closely hug the border and are closely integrated with the Midwest economy. Over two-thirds of cross-border trade between Canada and the U.S. takes place among Great Lakes states and the Provinces of Ontario and Quebec. The region shares many industries that span the border. Automotive, steel, biotechnology, and recreation/tourism are closely linked in their supply chains, transportation infrastructure, and work force. Such industries and their region could benefit from something more like the European Common Market approach.
But according to Austin, at a time when the Midwest must maximize its advantages to achieve competitive prominence, border restrictions have been rising rather than falling. As border security measures have increased,, border-crossing times have been rising, along with general doubts and uncertainty concerning the openness of the border. So too, cooperative initiatives to clean-up the region’s shared water resources are not moving along fast enough. More generally, the region does not recognize its shared interests—especially the great potential to grow and develop through joint study and policy action.
What might such policy actions be? The report lays out a blueprint for Bi-National Great Lakes economic leadership:
● By 2010, Develop a Bi-National Innovation Fund and Strategy
● By 2010, Redevelop North America’s Freshwater Coast
● By 2015, Define and Implement the “U.S.–Canada Border of the Future”
● By 2025, Realize BiNational Great Lakes Carbon Goals and Renewable Energy Standards
● By 2030, Create a Common Market for Commerce and Human Capital
As a long-time researcher, observer, and policy-discussion participant in this arena, I am encouraged to find these ideas being resurrected. As long ago as the 1980s, during the very troubled economic times in the Midwest, many of these same observations and recommendations were advanced.
Two developments dampened forward momentum. For one, the region’s economy enjoyed a strong rebound during the 1990s as surging U.S. economic growth shook the region from its torpor. The region’s flagship companies learned much from their global competitors coming out of the 1980s. While the rebound was welcome and enjoyable, some of the driving force behind fundamental policy innovation in regional development policy was lost through complacency.
The second reason: No region-wide dialogue was created on a sustained basis, and no organizations took on a leadership role in driving forward such a regionwide agenda. The sole exception might be efforts to restore and clean up the region’s fresh waters in the Great Lakes basin, which have progressed thanks to regional organizations such as the Council of Great Lakes Governors, The Great Lakes Commission, and a strong supporting cast.
This time around, inspired by new work, such as the Longworth book and Austin’s study, I believe that we will (very soon) see at least some exploratory efforts towards an enduring pan-regional policy network.
April 21, 2008
Innovation: Measurement and Policies
By Rick Mattoon
It has become almost hackneyed to proclaim that we live in a knowledge economy driven by innovation. The mantra of current economic development gurus is that the race goes to the smartest and the swiftest. Yet, despite this popular consensus that innovation may be the key factor in determining future growth in the economy, we actually know very little about how to measure innovation and what policies might influence innovation.
To begin with, we need a definition. Most definitions of innovation begin with “big bang” product innovation that alters the course of economies and enhances the quality of life. The invention of the light bulb and the airplane, as well as biotech breakthroughs, are just a few examples. But large gains are also made through process innovations that are often more subtle. The application of information technology to banking and financial firms and the advent of inventory and logistics management in retail trade come to mind. These process innovations change the efficiency with which inputs are used while vastly increasing the scale of output. This leads to goods and services that are faster, cheaper, and better. In fact, when the Chicago Fed studied the turnaround in the Midwest economy in the mid-1990s, we concluded that part of the region’s success was based on improving the efficiency of the existing economic base. Innovation in traditional industries explained much of the turnaround, rather than the creation of wholly new industries or products.
In January 2008, the Advisory Committee on Measuring Innovation in the 21st Century Economy issued a thoughtful report on how we might define and measure innovation. The report postulates that, while innovation is critical to the economy, “the nexus between innovation and growth is one of the least understood areas of economic life.” To bring clarity, the committee defined innovation as “the design, invention, development, and/or implementation of new or altered products, services, processes, systems, organizational structures, or business models for the purpose of creating new value for customers in a way that improves the financial returns to the firm.” The report then set about suggesting proxies for measuring innovation.
The committee rejected the notion of coming up with a single, all encompassing measure. Given that the economy and individual firms do not innovate the same way at the same time, the committee felt a single measure would lead to policy distortions. For example, it might be inappropriate to legislate public policy supporting an industry or firm that is going through a rapid period of innovation over an industry whose innovation breakthrough might be several years away. However, the report suggests a clear starting point by emphasizing that we need a better measurement of total factor productivity (TFP)—the change in productivity left over after accounting for the growth in labor and capital. Total factor productivity does provide a measure that can be augmented and refined by several policies to expand data collection on firm investment in key factors such as research and development, technology, and human capital.
So what policies did the Committee specifically suggest? Here is just a partial list:
• Develop annual, industry-level measures of total factor productivity by restructuring the National Income and Product Accounts of the United States (NIPAs);
• Create a supplemental innovation account for the NIPAs in order to expand the categories of innovation inputs and allow those inputs to be tracked as they flow between industries;
• Improve service sector data and increase survey coverage to provide the data needed to improve estimates from the integrated gross domestic product/productivity accounts and supplemental innovation account;
• Improve measurement of intangibles, particularly intellectual property; and
• Better leverage existing data and increase access to enhance research on innovation.
In addition the committee recommended the business community:
• Institute firm-level measurements of innovation to test the correlation on firm performance; and
• Develop and implement best practice in innovation management and accounting.
Another interesting local approach is a new innovation index developed by the University of Michigan at Dearborn’s Center for Innovation Research. This index tracks six subindexes that reflect the state of innovation in Michigan and will be reported on a quarterly basis. The six measures are:
• Trademark applications,
• Innovation workers (measured as a percentage of the labor force),
• Small Business Administration (SBA) loans,
• Venture capital,
• Incorporations, and
• Gross job creation.
The index is benchmarked to 100 for the first quarter of 2007. The most recent reading of the index is 95.8.
These efforts at measuring innovation in the economy continue to be a messy process, but the potential dividends of better understanding and calibrating the role of innovation in economic growth is certainly an important step forward. Hopefully better innovation metrics will help guide policymakers and business leaders to make appropriate investments that will strengthen economic growth.
The Department of Commerce continues the dialogue by hosting a summit in Chicago on May 22 discussing actions to be made to secure America's competitiveness.
March 13, 2007
Higher Education and Chicago’s Development
With economic growth lagging in many Midwest communities, institutions of higher education are being asked to play a bigger role in their surrounding regional economies. This past fall, the Chicago Fed held a conference addressing the role of higher education in promoting regional growth and development.
In what ways does higher education fit into the regional development picture? The ways discussed at the conference were many and varied; certainly, one size does not fit all. In places ranging from Silicon Valley to Route 128 in Boston and even to Fargo, North Dakota, universities are transferring technology to industrial facilities in adjacent industrial parks and to fledgling high tech firms. In other places, including Akron, Ohio, and Rochester, New York, universities are active in helping redirect mature but declining local industries into new products and markets. And Indiana’s Purdue University has embarked on an ambitious engagement and outreach mission along several fronts: teaching, discovery, community outreach, and identifying local targets of economic development.
While the conference did not address the university role in Chicago’s growth and development, our outstanding business schools have clearly played a key role. Today, among many fine business programs, the city touts the perpetual top ten national ranking of Northwestern’s Kellogg School of Management and the University of Chicago’s GSB, along with the frequent top ten ranking of Depaul University’s evening MBA program. As we look at Chicago’s industrial and business history, we see how these schools continually pump new life into Chicago’s economy.
For example, advanced business services and corporate headquarters activities are today the hallmark of Chicago’s economy. The city gave birth to some of the most prominent management consulting (NAICS 54161) firms and today continues to host a very significant number of such companies. Chicago ranks third in the U.S. among metropolitan areas in number of management consulting firms, and second in concentration of such firms, at some 120% above the national average.
How did this come about? Writing in the Encyclopedia of Chicago, Christopher McKenna describes the genesis of this Chicago-born industry. “Arthur Andersen, a professor of Accounting at Northwestern University, founded his eponymous firm in 1913. … Arthur Andersen & Co. began to specialize in financial investigations, the forerunner of the modern consulting industry.” And, “instead of employing local banking staff, New York and Boston financiers hired Chicago consultants to analyze the management of Midwestern companies in which they planned to invest.”
Andersen’s initiative was quickly followed in 1914 by Edwin Booz, a recent graduate of Northwestern in psychology. The company eventually became Booz Allen & Hamilton. So too, James O. McKinsey, an expert in cost accounting at the University of Chicago, founded a consulting practice (in 1926) that split off into the firm bearing his name as well as into A.T. Kearney. All became world-wide bulwark companies in what is now a global industry of great strategic importance to the world’s largest companies and businesses.
Jump ahead 50 years to the early 1970s. Chicago’s risk management and risk exchange community was re-invigorated when Leo Melamed, one-time Chairman of the Chicago Mercantile Exchange, launched contract trading in international currencies. Also in the 1970s, a former professor at the University of California at Berkeley, Richard Sandor, helped develop the Chicago Board of Trade’s U.S. Treasury futures contract trading.
Today, Chicago is a global leader in financial futures and options trading, with a 23% global share in exchange-traded contracts measured by volume. In addition to direct employment at Chicago’s exchanges and associated clearing operations, trading activity gives rise to ancillary employment in various Chicago businesses such as banking, brokerage, law, business publication, and computer systems and software.
For this industry too, the University of Chicago figures prominently in the story of its birth. University mentors both espoused the social value of trading financial instruments and also developed mathematical pricing models of assets that served as the basis for some trading. As recently described by Leo Melamed, Nobel Laureate and University of Chicago economist, Milton Friedman was a notable inspiration, teacher, and consultant to the launch of currency futures trading in the early 1970s.
Today, Richard Sandor remains busy in Chicago developing a new industry that addresses global climate change by capping polluting air emissions among member firms and then trading credits for pollution reduction among these firms.
Meanwhile, students from Chicago area business schools, such as Joe Mansueto of Morningstar, have recently grown new industries, this one centering on the tracking and analysis of mutual fund products.
In contrast to places such as the Stanford-Silicon Valley area, Chicago is not especially recognized for research and science-based commercial spinoffs from its universities. But several local universities are attempting to marry their business curriculums with their science and engineering activity. For one, the College of Business at the University of Illinois Chicago (UIC) is training future business leaders by encouraging them to construct business plans for inventions and intellectual property coming out of UIC labs. One recent sale of note involves a product that will possibly halve the time it takes orthodonic devices to straighten teeth.
What does this history imply for public policy? For starters, if we are to interfere effectively for purposes of economic development, we surely must understand the nexus among our assets and institutions. Chicago is clearly a “business town,” and its business schools have not only supported the business climate by training graduates for local companies but also indirectly by spinning off new businesses and industries.
But in considering issues of greatly enhanced public support or subsidy, it would be a mistake to attribute too much to universities alone. That is because causation goes both ways. While Chicago’s business schools have spawned much local growth, so too has local business growth created and supported the growth of universities and business school programs.
A city’s assets and institutions are best thought of, perhaps, as enjoying a symbiotic relationship. Accordingly, local public policy should start by strengthening inter-connections among local enterprises and enterprising people. Government likely has no great ability to pick and choose which particular connections to strengthen. And so, the primary course should be to provide desired and cost-effective public services and infrastructure, especially in transportation and communication. Restrained yet well-designed regulation and taxation should be another part of the mix.
Next, public-private programs and civic partnerships may be helpful in drawing closer social and cooperative connections among our diverse Chicago communities, industries, and civic institutions. As Chicago’s business history has shown, some amazing successes can arise from enterprising partners in a dynamic city.
February 14, 2007
The auto region continues to reshape
By Guest Blogger Thomas Klier
On Wednesday, February 14, DaimlerChrysler AG announced a restructuring of its North American Chrysler Group. Adjusting its vehicle production capacity to continued market share losses, the company will eliminate shifts at three different assembly plants (Newark, DE, and Warren, MI, in 2007, St. Louis, MO, in 2008) and idle the Newark plant in 2009 (that plant is identified in figure 1 by a blue star).
Conversely, Toyota Motor Corporation, in response to strong growth in the North American market, is about to announce where it will build its next vehicle assembly plant in North America. The company is looking to expand its footprint of production facilities to meet its goal of achieving 60% of local production. Several weeks ago a story appeared in the Wall Street Journal identifying a handful of locations that are being considered by the company (identified in figure 1 by the red stars).
What are the main drivers underlying a decision to locate an assembly plant? This blog suggests a number of influences.
First, let’s briefly outline the current industry geography. Today there are 68 full-size assembly plants (plus two currently under construction) producing cars and light trucks, such as minivans and sport utility vehicles, in the U.S. and Canada. Figure 1 shows them all with the exception of the lone West Coast plant (the GM-Toyota joint venture called NUMMI, which is located in Fremont, California, in the San Francisco Bay area).
The striking feature of figure 1 is the high degree of clustering exhibited by this industry. The vast majority of the plants are located in the interior of the country, extending south from Michigan and Ontario in a rather narrow band. In addition, one can see the importance of transportation infrastructure. It is a key location factor for manufacturing industries, such as the auto sector, which are operating based on lean manufacturing principles. Interstate highways and rail lines (the map only shows interstate highways) are enabling assembly facilities to connect with their supplier base on a just-in-time basis.
In a second quarter 2006 issue of Economic Perspectives, Thomas Klier and Daniel P. McMillen analyzed how the geography of assembly (as well as auto parts production) facilities has evolved in the U.S. and Canada since 1980. They identify noticeable changes in the industry’s geography. These changes, however, occurred gradually, in evolutionary fashion over the last three decades.
Two major trends have shaped the footprint of today’s assembly facilities: Foreign-owned assembly plants gravitated towards the southern end of the auto region, preferring warmer climes and a work force that had not previously been employed in auto assembly. With two exceptions, all of foreign-owned assembly plants operating today have been so-called greenfield plants, i.e., newly constructed plants on land that was previously not a manufacturing site. The domestic assembly facilities, on the other hand, re-grouped in the northern end of today’s auto region after decades of serving the major population centers directly. They began shutting down their coastal plants in the late 1970s in response to the changing economics of transportation costs associated with serving the national market.
And so today’s auto region with a clearly defined north-south extension came about. Concentration of locations remains very important for this industry: Assembly plants need to be near their supplier base. Yet there are reasons for them not to be right next to one another. Assembly plants are large manufacturing facilities drawing their work force from an area larger than the immediate vicinity. Notice in figure 1 how many of the 50-mile circles drawn around assembly plant locations do not overlap.
How do the latest developments fit the ongoing re-shaping of the auto region described above? Chrysler, in line with recent restructurings last year by GM and Ford (plant closings in Georgia, Michigan, Minnesota, and Virginia as indicated by the other blue stars on the map), is trimming a production facility at the periphery of its manufacturing footprint. As a result, the domestic vehicle production has recently become more concentrated in the Midwest than it has been for many decades. For example, the announced closing of the Delaware assembly plant leaves only one vehicle assembly facility in the Northeast (there were six as recently as 1980). Should Toyota choose one of the locations mentioned in the press, it could best be described as "in-fill" development. It would fill a gap in the auto region which was extended considerably further south by assembly plants that located in Mississippi, Alabama, Georgia, and South Carolina during the 1990s.
And so the combination of recently announced plant closures and a soon to be announced plant opening are reinforcing the shaping of an auto region that is located in the interior of the country, with a north-south orientation, extending northeast into Ontario.
What are the implications of this analysis for Michigan and the Midwest? In Michigan especially, intense discussion is under way concerning what role, if any, public policy can play in shaping the region’s future. Currently, the competitive struggles of the domestic automotive companies (formerly known as the Big Three) and their suppliers are affecting the Midwest economy. Surely, much will depend on individual companies’ abilities to restructure and find ways forward. However, as the research by Klier and McMillen suggests, at the same time as traditional automotive companies are retrenching, they are also regrouping closer to the traditional (midwestern) center of the automotive industry. Actions speak louder than words in many instances. Here, locational decisions strongly suggest that the Midwest remains a highly productive place to manufacture automotive parts and vehicles. The region’s advantages lie in the fact that: 1) it is already the center of production so that proximity to suppliers makes it cost effective in many respects, 2) its transportation infrastructure is highly developed to serve manufacturing, and 3) its existing work force is highly skilled and trained in these industries. Accordingly, in addition to moving in new economic directions, local policy actions to help restore the region’s place in manufacturing seem not misplaced.
January 22, 2007
Chicago's Pursuit of the Global Prize
Policy and business leaders in Chicago continue to advance the metropolitan area’s prospects as a global hub for professional and financial services. This initiative arises from both necessity and opportunity. Chicago’s traditional markets, principally in the surrounding Midwest, are not growing rapidly. At the same time, however, the Chicago economy specializes in advanced producer service sectors that are increasingly traded more broadly and, in many cases, internationally.
As the business service center of the Midwest, serving regional markets and industries, Chicago companies’ prospects for growth are somewhat limited. That is so largely for two reasons. First, the Midwest economic base centers on agriculture and manufacturing. Since productivity growth is so very high in these industries, and competition keeps commodity prices low, income and revenue (and attendant jobs) grow slowly. The second reason is climate. As the U.S. economy restructures toward information industries and knowledge workers, service production is being pulled toward locations where workers prefer to live, often milder climes.
However, globalization of the economy has also brought new opportunities to populous information-based cities like Chicago. Large cities often have wonderful amenities that are not dependent on climate, such as sports, restaurants, museums, and cultural diversity. But more fundamentally, it is because expanding global trade in goods, services, and capital requires the complex and specialized functions and industry sectors that are concentrated in large cities, including legal services, logistics, distribution, finance, insurance, business meetings, R&D, and professional business services.
Chicago has been developing such sectors almost since its inception. Today, Chicago features world-leading risk exchanges, universities, business meeting and personal air travel firms, legal services, headquarters facilities, and management consultancies.
During the 1990s, the growth of Chicago’s professional services was robust. According to the data reported on payroll employment, the Chicago metropolitan area added a net 80,000 jobs in the sector from 1990 to 1999, more than the Los Angeles metropolitan area and more than New York City.
However, since then, job performance in Chicago has often been much weaker, raising doubts about whether the city’s economic structure has divorced itself from the surrounding region as much as previously believed. The chart below displays year-over-year growth in the professional, technical, and R&D sectors. Employment growth experienced year-over-year declines for most of the 2002-2004 period, before reviving in 2005.
How much of Chicago’s business service economy has expanded to global markets or even to other large U.S. cities in the global network?
We know very little about the geography and changing geography of these hallmark industry sectors. However, one informative study by Peter J. Taylor and Robert E. Lang of the Metropolitan Policy Program at The Brookings Institution measures the prominence of major global service companies among large cities in the world.
Taylor and Lang examine 100 global companies drawn from the business or producer sectors of accounting, advertising, banking/finance, insurance, law, and management consulting. For each city, the sum presence of their offices (weighted by size and function) determines a score for a city’s commercial presence and ties to the global city service network.
According to the Taylor-Lang study, Chicago scores high in its global connectivity, both relative to other U.S. cities and relative to the world’s major cities. Among U.S. cities, Chicago ranks second only to New York. Among world cities, Chicago ranks seventh, behind London, New York, Hong Kong, Paris, Tokyo, and Singapore.
The Taylor-Lang study scores Chicago’s connections with domestic cities such as Atlanta and New York in the same way it scores connections with international cities such as Sydney. This seems correct. International borders can be arbitrary. And to otherwise score border-crossings might bias the results toward cities located on continents where national boundaries are near each other, such as Europe.
The study does provide a separate “hinterland” scale for each city, which tries to measure the degree to which a city’s global connectivity relies on nearby national trading relations. Here, with the exception of New York City, U.S. cities tend to be less international than those on other continents. However, Chicago again scores well. It places third among U.S. cities, behind New York and Miami.
How this relates to Chicago’s recent growth performance and prospects is not clear. The construction of the Taylor-Lang study is creative, clever, and somewhat revealing, but it provides more impressionistic than definitive evidence of global linkages among producer services. Those who would like to draw their own conclusions from the evidence should take a look at the authors’ map of each global city’s linkages, including Chicago. Outside of North America, for example, the map suggests that Chicago's economy links strongly with Zurich, Switzerland, and Sydney, Australia.
Chicago’s employment in business-professional services is once again growing strongly, at a 3% annual year-over-year pace. If the recent period of weak performance reflects some unusual and fleeting conditions such as a post 9-11 falloff in business travel and related business service activity, then perhaps Chicago’s march to global success will now continue.
December 15, 2006
A Chicago-Milwaukee Region?
Could cities located near one another, Milwaukee and Chicago for example, enhance their respective growth and development through closer linkages? Why might a greater Chicago–Milwaukee metropolitan area want stronger ties, and what policies, if any, might be considered to bring about such a union?
There are several reasons why larger metropolitan areas are generally leading U.S. economic growth. In recent decades, larger metropolitan areas have typically become more specialized in managerial and technical occupations, while smaller metropolitan economies have become more specialized in production activities. For example, one recent article found that those U.S. metropolitan areas having a population above 5 million had increased their concentration of management to production workers to 39 percent by 1990 from 10 percent in 1950. In part, this increasing concentration in larger cities is due to advances in communication and transportation that have allowed companies and organizations to administer and manage from a central location or to travel easily to multiple production locations.
In this light, it is understandable, then, that larger cities have also tended to grow more rapidly in terms of income and/or population. That is because specialized professional and managerial occupations tend to pay more than production. Moreover, since at least the late 1970s in the U.S., economic returns to labor, including wages and salaries, have generally been growing faster for managerial, technical, and other occupations attendant to higher educational attainment.
A second reason for such shifting specialization and growth owes much to the growth in work force participation of women. In the U.S., the labor force participation of working age women rose from 37.7 in 1960 to almost 59.6 percent today. Moreover, the educational attainment of women has also been rising such that it now exceeds men among the younger age cohorts. Since young singles tend to marry someone with similar education, this has given rise to growing numbers of “power couples” who often must find not one, but two, specialized jobs in the same labor market. Because large metropolitan areas have both deep labor markets and more specialized occupational opportunities, these places have become magnets for such “power couples.” In turn, firms respond to the greater labor supply of professionals by siting their establishments in larger metropolitan areas, and thereby transform local economies.
There are several reasons to keep an eye on the greater Chicago and Milwaukee areas to examine the prospects that they will someday become a single labor market and benefit from the attendant economies of larger scale and scope of such a merger. The Chicago and Milwaukee areas are only 86 miles apart, as measured from city center to city center. The Chicago metro area is more populous at 9.4 million as compared to 1.5 million in Milwaukee, but together they yield a population of 11.0 million.
Historically, Chicago–Milwaukee work force linkages have been limited. Only 13,000 Milwaukee residents commute to Chicago, daily, as of year 2000, up from 1,600 in year 1990. The reverse commute is even smaller. However, commuting in both directions is growing rapidly.
Still, a closer look at some important subsectors of professional industry workers is suggestive of the greater work force that may soon arise from combination. The chart below combines industry employment for Chicago and Milwaukee metro areas across several professional, management and business service sectors. As combined, for example, employment in the Chicago–Milwaukee “computer systems design” sector would rank second to New York, allowing Chicago to bypass both the San Francisco and the Los Angeles metro areas. Other sectors of mutual benefit in Chicago and Milwaukee can be seen at the Midwest Economy website.
While such stronger within-industry labor markets might be advantageous, the additional attraction across multiple sectors may be greater still. For households with members having differing but specialized occupations, the possibilities for a multiple match of people with jobs in a combined Chicago–Milwaukee metro area labor pool could be great. This would enhance companies’ ability to attract and retain skilled labor in both regions.
So too, not all jobs within the professional and business services sectors require the very highest educational attainment. For example, according to recent estimates of the U.S. Bureau of Labor Statistics, office and administrative support jobs comprise one-third of all employment in the combined professional services, finance, and management of companies when measured in industry sectors. So too, spin-off employment would also generate a wide range of local employment as the spending of added service professionals ripples through the local economy. This feature is especially important since job needs are great for lesser-skilled labor in both markets.
How might Chicago and Milwaukee push along their destiny as a combined metropolitan area? One low-cost way is to publicize their mutual proximity in marketing each region to prospective employers and to job recruits. Both Chicago and Milwaukee are highly active in economic development marketing. Of course, private sector employers and employment intermediaries may also be effective in spreading such information about the greater breadth of employment opportunities.
Another policy avenue may be greater investment in transportation between the metro areas that would facilitate commuting flows. Both interstate highways and train transportation are now in service. The possible labor market advantages of easier and more dependable auto and passenger train travel might weigh significantly in the consideration of any future roadway/rail expansion and maintenance decisions. Combined efforts in applying for federal transportation grant monies to serve a large and more closely-integrated Chicago–Milwaukee market might also be effective—for both personal travel and for freight transportation including railroad.
Milwaukee’s major airport is also located between downtown Milwaukee and downtown Chicago. At a time when the Chicago area’s air travel capacity is strained, better access to Milwaukee’s Mitchell field could be advantageous.
Other cooperative ventures and ideas have yet to be identified. The absence of organized efforts to do so is a bit puzzling in the Chicago–Milwaukee corridor. In contrast, the advent of the trade agreements between Canada and the U.S. has sparked any number of private and private-public associations to promote natural trade flows across the border within local corridors. As the chart below shows, the progress of employment growth has not been especially robust in either metropolitan area over the past 15 years. Perhaps a little détente along the Illinois-Wisconsin border might be advantageous to all.
December 4, 2006
Chicago Plans for Freight
The Chicago area economy developed on its ability to move freight. With heightened global trade, Chicago area freight transportation has grown rapidly and it is projected to continue to do so, leading to added congestion on highways that are shared by automobile drivers and trucks alike.
This raises important questions as to how the Chicago region should plan future modifications to its transportation infrastructure. The answers are not completely obvious for several reasons. To some degree, Chicago’s economy is shifting toward high-valued service production and away from freight-laden manufacturing. As a result, the value of Chicago’s existing roadways to bring workers to and from their offices is rising in relation to their value for moving goods around and through Chicago. And even with some concerted and likely expensive actions to expand and reconfigure infrastructure, there does not appear to be room for all roadway (and rail) traffic.
Building roadway capacity to serve all possible traffic is not an option. To do so would be too expensive in both construction costs and in taking up limited urban land. Yet, the region will want to act to maximize its ability to handle as much freight (and auto traffic) as possible. And so, in addition to some expansion of transportation capacity, the region will need to determine the most critical infrastructure to repair and build. So too, the region will need to engage in more efficient planning on the location of housing and commercial activity in order to economize on overall travel demand. Finally, more rational operational and pricing policies allocating existing transportation infrastructure will need to be adopted.
Rising global trade has dramatically added to cross-continental freight traffic through Chicago from imported goods landed on the East Coast going west and from the West Coast headed east. Much of this freight activity takes place in Chicago’s large railroad yards and side tracks. Chicago is also a major destination and transfer point for freight carried by truck. Because highway overpasses and underpasses for rail have not been constructed everywhere or they are of insufficient height, auto and truck traffic becomes further congested and delayed.
Adding to local truck-related congestion is the fact that, in order to accommodate rising freight traffic in a cost effective way, goods are now hauled in standardized containers. These containers are often transferred between transportation modes within Chicago, especially by “lifting” containers from truck to train and train to truck. According to World Business Chicago, the Chicago area now ranks among the top five cities in the world in container “lifts” behind Hong Kong and Singapore, where freight lifts mainly take place onto and off of large ocean-going vessels.
The strongest impulse of local policymakers is to find ways to keep transportation flowing through Chicago and possibly build on it as the opportunities arise. By one estimate, rail freight companies and their suppliers employ about 37,000 workers in the Chicago area, while trucking accounts for another 50,000 jobs.
In addition, proximity and low-cost access to delivered goods support income and jobs in related industries. The Chicago region and surrounding Midwest continue to host one of the nation’s largest concentrations of manufacturing establishments, in part due to these transportation advantages for bringing in raw materials and shipping out more-finished products. So too, Chicago remains a major center of wholesale and warehousing operations for its own manufacturing companies and for the greater Midwest region. Even aside from these related industries, as the nation’s third most populous metropolitan area, Chicago needs significant local freight capacity just to supply goods to its own consumers and households. Such freight-carrying ability translates into lower cost of living and greater variety of goods in generally attracting workers and other residents.
Further opportunities for Chicago to handle freight are in the offing. Much global freight now travels through the Panama Canal. Over the next few years, the canal will reach maximum capacity, while its ability to handle large vessels is becoming somewhat obsolete. Although Panama is planning to upgrade the Canal, during the interim the demands on overland inter-continental freight as a possible alternative will rise considerably. Here, Chicago’s history as a railroad town figures prominently, since the nation’s major railroad lines converge in Chicago. Much of the nation’s long-haul railroad freight now travels through the Chicago region, with much of it being transferred from one line to another, or to and from another mode of transportation, especially trucks.
To make headway in accommodating freight, local initiatives have been formed as public–private partnerships. One such partnership is the CREATE rail infrastructure improvement program. The program is a cost-sharing partnership among the Chicago region’s railroads, the City, and the State of Illinois, which will loosen bottlenecks in railroad freight flow through the city.
More comprehensive approaches are also underway to plan for and accommodate more transportation. A new agency (CMAP) has recently been created, consolidating the Chicago area’s existing transportation planning agency with its land use authority. It is anticipated that more careful and coordinated consideration of the region’s land use, housing, and transportation will reduce overall highway travel demand in the region by both cars and trucks. Freight traffic considerations and opportunities are also explicitly on CMAP’s agenda as the agency works to promote collaborative planning in the Chicago region.
From a cost–benefit standpoint, it would be foolish, even it were feasible, to expand infrastructure to meet all possible freight traffic. Land is scarce and expensive in Chicago, which argues against unlimited expansion of land for use in freight transportation. Local benefits of infrastructure expansion may be especially limited for freight that flows through Chicago without off-loading. In these instances, the benefits of Chicago’s freight capacity are more national in scope, or perhaps of benefit to the broader Midwest region. For this reason, projects such as CREATE are requesting that the federal government as well as private freight carriers help finance local infrastructure.
New pricing policies that charge freight users for roads and rail can also help to ration limited roadway capacity and allocate it toward its highest value use. For example, the Illinois State Toll Highway Authority now charges higher fees for driving during peak traffic times on its highways in and around Chicago. At the same time, electronic payment of tolls helps to speed both cars and trucks through toll stations. In looking for further improvements, policy makers in the Chicago region can examine a host of models and experiments from around the world that are pricing highway congestion, often in combination with privatized ownership or operation of transportation infrastructure.
The Chicago region cannot probably accommodate all of the nation’s freight needs in coming years, nor would it want to do so. Still, Chicago’s built legacy of infrastructure affords it opportunities for further growth and development in the freight arena and in spin-off economic development activities. Through thoughtful planning and evaluation, cost-effective operation, and well-structured pricing mechanisms, the Chicago Region can realize a broader scope of development opportunities.
October 5, 2006
Each autumn, I have traveled down to the Indianapolis area to deliver a local perspective on the economy to the Indiana Economic Development Forum. This autumn, the Forum addresses the theme of “work force training and education.” As I survey Indiana’s economic performance over the past 15 years, it strikes me that Indiana is on the right track with its strategic focus on boosting work force training and education. So too, where feasible, an emphasis on technology transfer, firm growth, and entrepreneurial activity may be needed to create matching job opportunities for the more highly skilled Hoosiers.
Indiana and its neighboring Midwestern states rank near the top in manufacturing concentration. Even so, as the figure below shows, the deep recessions of the early 1980s sharply shifted the region’s share of manufacturing jobs elsewhere (right axis, green line). As the steel and auto industries waned here, the computer and military equipment industries grew elsewhere.
The figure also reveals the period’s depressing effects on the region’s per capita income as a result of manufacturing job loss and slow recovery (left axis, blue line). Since then, per capita income, as compared to the national average, has not fully recovered in the Great Lakes region, nor in Indiana, for that matter.
However, Indiana’s job growth and share of manufacturing jobs have recently out-performed the surrounding region (bottom chart). Indeed, even though the level of jobs has declined, Indiana has exceeded its 1980s share of the nation’s manufacturing jobs. Consequently, while the relative per capita income in the Great Lakes region has taken a dive over the last few years, Indiana’s income has remained about the same in relation to the national average.
Something is going right in Indiana, or at least it is going a little better than in surrounding Midwestern states. But given the notably stronger performance gains in Indiana’s share of the nation’s manufacturing jobs, shouldn’t its per capita income be rising a bit, rather than being stuck in place?
The answer again likely lies in today’s broad economic trends. Indiana’s manufacturing wages lie below its Midwestern neighbors. This can be seen in the figure below, which illustrates the higher hourly earnings of production workers in Michigan versus Indiana. Perhaps the state’s favorable wage environment for employers, along with other business climate attractions, partly explain its job share gains in manufacturing, even as per capita income gains are not quite so robust.
Another reason for less robust progress in Indiana’s per capita income can be found in service sector versus manufacturing wage trends. While average wage levels in manufacturing tend to exceed average service sector wage rates in the nation, service sector wage growth has been catching up to manufacturing.
How can Indiana improve its living standards? In our market-oriented economy, higher wages and earnings are currently being paid to those with higher skills and education. For this reason, investment in education and work force training are one important part in achieving higher income for Hoosiers.
In addition to higher skills, there must be job opportunities available for those enhanced skills and training. Sometimes, such local job opportunities do emerge as new firms and capital investment migrate into states in search of favorable work force skills and education. However, in other instances, skilled workers move out of state in search of greater opportunity. To forestall this loss of skilled workers, Indiana and other states are pursuing not only work force training and education, but also local technology transfer from technical universities along with the encouragement of entrepreneurial ventures.
July 19, 2006
Honda and tax incentives
Honda recently decided on a site in Indiana for its new North American auto assembly plant over sites in Ohio and Illinois. Indiana offered Honda generous incentives of EDGE tax credits, training assistance, and real and personal property tax abatements totaling up to $41.5 million. In addition, the state will provide infrastructure support for water, wastewater, and road improvements of approximately $44 million. This offer was generous relative to packages that have been offered lately by northern states to woo automotive plants. Did the incentives swing the deal for Indiana? And how can states hope to recoup these upfront costs and revenue losses? More importantly, is society well served by such raw-knuckled competition among states for production facilities? The answers are not definitive, but, though often condemned, the use of fiscal incentives may not be such a bad thing.
Large offers of this nature have become commonplace. Speaking at the Chicago Fed’s recent symposium on the automotive parts industry, Sean McAlinden of the Center for Automotive Research reported that the state of Georgia offered Korean carmaker KIA a package estimated to be worth $409 million. This was noticeably larger than the recent average offers of $57 million in tax incentives for automotive assembly plants for northern states and $44.2 million (plus free or subsidized infrastructure and job training) for southern states.
On completion of such deals, company representatives often proclaim that the incentives did not determine the choice of location, but were rather a sweetener or a comforting pledge of good faith. Professional site selection analysts tend to echo these sentiments. Taking such statements at face value, why do states offer such high stakes packages?
No doubt, there are benefits at the ballot box to those elected officials who can brag about bringing jobs and income to the state. It has been argued that these benefits, especially for investment projects that loom large in the media, result in overly generous offers and poor decision-making by state officials. This is one reason that some states enact legal requirements making the terms of such deals easily available to public scrutiny.
But how can states afford to make such offers? One reason is that the public service costs of hosting businesses are usually lower than the taxes paid by them; that is, there is typically a fiscal surplus inherent in state business tax systems that allows state officials to discount the public tax and service bills on new investment. When I examined the likely costs of public services provided to businesses in a 1996 study, I found that, across all U.S. regions, direct business taxes tended to exceed the value of direct service benefits provided to business by a ratio ranging from 1.5:1 to 2:1. This excess may allow room for governments to lower business tax bills through selective incentives.
Even so, opponents of the use of selective tax abatements may argue that incentives were unnecessary and that businesses have an information advantage in bargaining with states for incentives even when they will end up choosing the same location in any event. Certainly, the proclamations of businesses that afterwards contend that incentives were not a primary consideration in their location decision bear this out. If so, states are arguably better off refraining from incentives and instead spending the business tax bounty on public services or returning personal taxes to state residents.
In the case of auto plants, it is interesting to note that even if individual states “give away the store” in luring a particular auto assembly facility, the end result may ultimately benefit the state’s economy. The reason is that the assembly plants typically attract auto parts suppliers to the area. As Chicago Fed economist Thomas Klier has shown (below), a typical assembly plant can draw a significant nearby supplier base. For recently opened assembly plants in North America, an average of 19 to 20 direct suppliers have typically opened up within 60 miles of the plant. More generally, assembly plants tend to pull in many more supplier plants within several hundred miles, and supplier plant employment generally exceeds assembly plant employment by around 3.5:1.
It is true that in the case of the Honda assembly plant in Greensburg, IN, many of the supplier plants will be outside Indiana’s border and tax reach. However, if all or many adjacent states are successful in attracting assembly plants, the spillover benefits of taxation and income will accrue in roughly equal measure to the states. A so-called cluster of automotive production capability may be achieved for the multi-state region.
But are the incentives necessary to achieve or preserve the region’s cluster of automotive plants? At least for highly capital-intensive industrial activities such as manufacturing, the so-called business climate of the state is paramount. Placement of an expensive investment by a company in a state must be based on a strong conviction that future government leaders will not expropriate the facility’s value through regulation, over-taxation, or non-cooperation in future land use and public infrastructure needs. The situation is not unlike making investments in a foreign country. When the capital investment is fixed and not easily moved, confidence in local government is a key factor in assessing investment risk.
In this regard, Honda’s decision to locate in Indiana rather than Ohio is understandable. While proximity to its large suppliers in Ohio and vicinity was a compelling reason for considering Indiana, the desirability of diversification among government entities may have also been a factor. As for the incentive package, there is surely more to a favorable state business climate than a flashy offer of tax incentives. But at the same time, the offer of a fiscal incentive package may be a strong signal to the business that its presence will be valued. In addition, a sizable and highly visible tax incentive package may represent an implicit acknowledgment by the state that the investment is wanted, making it more difficult for future political leaders to renege on the state’s cooperative relationship with the company.
Of course, implicit tax incentive contracts of this sort work both ways. Companies that receive generous tax incentive packages, but later do not deliver on promised jobs and investments, are easy targets for retribution by state officials. In many instances today, “clawback” provisions are included upfront that eliminate favorable tax treatment if companies do not deliver.
Even so, the “gold standard” by which public policies must be judged is whether the state could possibly do better. Opponents of tax incentives for business argue that, because of such tax breaks, critical public services such as education remain underfunded. In particular, public education suffers, contributing to sub-par income growth and exacerbating social problems such as crime, poor electoral participation, and poor public health. If we accept this view, the economic returns to the practice of competitive business tax incentives are not optimal; the economic returns from any short-term job and income gains to the local economy are less than the foregone returns that greater education spending would bring locally and nationally.
In rebuttal, one might argue that business taxes are not the only possible source of revenue for highly valued public services such as education. An ideal of government is one in which citizens understand both the value of public services provided and the real costs of these benefits and, subsequently, make their choices known at the ballot box.
With the tendency among governments to over-tax business activity, the electorate may believe that they are getting a free ride for public services—that they are not in fact paying for these services. But they are usually mistaken. People and households end up (indirectly) paying for public services in any event. After all, business taxes are ultimately reflected in higher product prices paid by state residents or in lower wages and salaries paid to employees.
So why do many voters and even some policy analysts advocate the taxation of business activity to finance public services that primarily benefit households? Some argue that Americans like their taxes hidden and furthermore that this is a reasonable way for governments to finance high-payoff public services. But this approach has risks. If taxes and prices for public services are hidden, can the citizenry really make sensible decisions about what levels, types, and extent of services government should provide? What do you think?