March 6, 2013
Seventh District Update
by Norman Wang and Scott Brave
A summary of economic conditions in the Seventh District from the latest release of the Beige Book and from other indicators of regional business activity:
• Overall conditions: Economic activity in the Seventh District continued to expand at a slow pace in January and February.
• Consumer spending: Consumer spending increased at a slower rate. Retailers pointed to the negative impacts on household budgets from rising gas prices and the end of the payroll tax holiday as explanations for the slower pace of retail sales. Auto sales were steady for much of the reporting period before increasing slightly over the last few weeks.
• Business Spending: Growth in business spending slowed. Inventory investment declined, and spending on equipment and structures was again limited. Labor market conditions were little changed.
• Construction and Real Estate: Construction and real estate activity was mixed. Demand for residential construction continued to increase slowly, buoyed by ongoing strength in multifamily construction. Although there was some modest growth in nonresidential construction, the level of activity remains weak.
• Manufacturing: Growth in manufacturing production picked up over the reporting period. The auto industry remained a source of strength, with light vehicle sales expected to increase throughout the year. Demand for heavy equipment weakened, with lower coal prices contributing to less mining activity.
• Banking and finance: Credit conditions continued to ease. Credit spreads and financial market volatility remained low and asset quality continued to improve. Banking contacts reported moderate growth in business and consumer loan demand, with pricing relatively unchanged but some loosening of loan standards.
• Prices and Costs: Cost pressures were moderately higher. Contacts noted some upward pressure on raw materials prices, particularly for lumber, drywall, steel, aluminum, and copper. Wage pressures remained moderate.
• Agriculture: Snow and rain continued to boost topsoil moisture levels, although depleted subsurface moisture remained a concern for farmers. Corn, wheat, milk, hog, and cattle prices dipped during the reporting period, while soybean prices moved a little higher.
The Midwest Economy Index (MEI) increased to –0.18 in December from –0.30 in November, but remained negative for the sixth consecutive month. The relative MEI decreased to –0.01 in December from +0.55 in November, primarily because of significantly lower contributions from the Midwest’s manufacturing and service sectors.
The Chicago Fed Midwest Manufacturing Index (CFMMI) increased 0.7% in December, to a seasonally adjusted level of 94.7 (2007 = 100). Revised data show the index was up 2.0% in November. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) moved up 0.8% in December. Regional output rose 6.2% in December from a year earlier, and national output increased 2.7%.
July 13, 2012
Manufacturing: Been down so long, it looks like up?
Those having keen interests in the U.S. manufacturing sector are somewhat encouraged by its performance over the past three years. The sector has bounced back sharply since the end of the severe 2008–09 recession. Job growth in manufacturing is running up 2 percent on a year-over-year basis, and the sector has recovered three-quarters of the output lost during the 2008-09 recession. Encouragement about manufacturing prospects derives not only from the recent bounce, but also from the possibility that the change in direction may represent a turnaround in manufacturing’s fortunes that will be sustained over the longer term. The previous peak in manufacturing jobs took place as far back as the 1990s, so this new direction, particularly if it holds up over a long horizon, would be a welcome change.
To put recent events into proper perspective, it is useful to examine the manufacturing sector’s long-term experience in the United States. Since the mid-twentieth century until the 2000s, the level of jobs in the manufacturing sector has stayed fairly constant, even while real output and productivity have risen briskly. The chart below shows the sector’s climbing real output, with the nation experiencing a five-fold growth in real manufacturing output since the early 1950s through today. Output growth here reflects both the increase in the quantity of goods produced and the improvements in the goods’ quality, such as durability and performance. Over most of this period in the United States, real output growth in manufacturing matched or exceeded the real growth in overall goods and services production. In contrast with this hearty performance of real output growth in manufacturing, the sector’s levels of employment have remained steady over the latter half of the twentieth century—in the range of 17–19 million workers—and then moved much lower until very recently.
Effectively, these gains in output with generally steady employment levels mean that productivity growth in the manufacturing sector has been quite robust. The application of more “know-how” and capital equipment has boosted manufacturing output, but with little need for more accompanying labor. Such productivity improvements, along with cheaper imports, have contributed to falling real prices for many manufactured goods sold in the United States. On the flip side of the same coin, falling prices of manufactured goods have boosted standards of living for U.S. households during the post-World War II era. The ability of American workers to produce more with greater efficiency—as well as to buy more—has translated into real wage gains.
But while such gains have benefited broad swaths of the U.S. population, it is also true that many manufacturing-oriented towns and cities have experienced decline and that manufacturing workers and firms have suffered dislocation. Such changes have led analysts to probe more deeply into the sources of both manufacturing progress and upheaval. Why haven’t rising standards of living done more to sustain manufacturing jobs?
For the most part, there are fundamental aspects to the ways we live that have prevented a large enough rise in our purchases of manufactured goods to outweigh falling labor content (and jobs) in the domestic manufacturing sector. For one, the rising incomes of U.S. households have not lifted the demand for manufactured goods sufficiently. Even with the introduction of new manufactured goods, such as televisions, medical equipment, home computers, and microwave ovens, households have tended to shift consumption toward services, such as medical care, education, and personal services. So too falling real prices for manufactured goods have not sufficiently induced consumer demand for standard manufactured goods, such as home furnishings and automobiles.
To be sure, exports of goods abroad have helped to lift employment in the manufacturing sector. The United States remains a global leader in innovation, as well as research and development (R&D), in many capital goods sectors, especially machinery and equipment. Rapid growth and development of nations throughout the world have raised the demand for U.S.-made capital equipment and certain high-tech products, such as farm equipment, pharmaceutical products, medical equipment, aerospace equipment, and earth-moving machinery. Manufactured goods continue to represent the largest share of U.S. exports abroad, and exports as a share of U.S. gross domestic product (GDP) have risen from 5.8 percent in 2001 to 9.3 percent in 2011.
However, at the same time, imports of manufactured products have also been rising. In fact imports of manufactured products have risen more rapidly than our exports of manufactured products abroad. Some imports become components of U.S.-produced goods that are exported abroad. But for the most part, rising imports displace manufactured goods that might otherwise be produced domestically.
Given these mixed trends, some analysts have argued that the long-standing trend of nearly flat manufacturing job levels and rising production levels was interrupted by a decline in the number of manufacturing jobs beginning in the late 1990s, possibly accompanied by a slower pace of real output growth. From that time until recently, the United States experienced a rising trade deficit in manufactured goods. This was not the first time that the U.S. economy had experienced rising competition with other countries for sales both abroad and within its home markets. In particular, the rise of industrialization in Japan and other "Asian Rim" countries had a significant impact in the 1970s and 1980s on U.S. markets for major product segments in home electronics, steel, and automotive. Such developments were facilitated by globalization factors, including tariff reduction agreements and falling costs for transportation and communications.
The era from the late 1990s through the recent recession and recovery may represent a different order of magnitude in this regard. According to economist Robert Fry of Dupont, the large size of China and its low costs of production—coupled with the production capabilities of other “Asian tiger” nations—brought forward sharp competition for U.S. producers both in markets abroad and within the U.S. marketplace. One recent study conducted by David Autor, David Dorn, and Gordon Hanson lends weight to rising import competition as a significant cause for domestic manufacturing job loss over the past two decades. It does so by examining the varied experiences of many U.S. subregions and their relative exposure to rising imports from low-wage countries. In their most conservative estimates, the authors attribute one-quarter of the decline in U.S. manufacturing employment over the period 1990–2007 to changes in Chinese imports.
Since 1998, U.S. manufacturing employment fell precipitously from the levels that had prevailed through the 1960s, 1970s, 1980s, and the early part of the 1990s. Manufacturing employment fell from its peak in 1998 by over 3 million jobs by 2007 (by one fifth) and then by another 2 million jobs by 2010.
Regional trends in manufacturing also shifted during this time. Whereas job losses had been previously concentrated in the traditional industrial belt extending from western Pennsylvania and New York through the Great Lakes states, manufacturing job losses showed no favorites this time around. As seen below, states of the Southeast had been gaining manufacturing jobs versus the Great Lakes states from the late 1960s through the late 1990s. In contrast, jobs in both regions have fallen in tandem since that time.
As mentioned before, a recent rebound in manufacturing activity and jobs has followed on the heels of the severe 2008–09 recession. To some observers, the recent bounce is a harbinger of a change in direction for the manufacturing sector in terms of employment. Since last year’s tsunami and aftermath in Japan, some multinational corporations are rethinking their supply chains overseas in favor of North American production sites. Similarly, falling energy prices for domestic natural gas are enticing some chemical/plastics production operations back to U.S. shores. And as fundamental operational costs are rising in China and the rest of Asia, it may be the case that, at the very least, the strong wave of production relocation toward developing countries is beginning to slow. However, given the sustained decline that the U.S. manufacturing sector has experienced since the 1990s and during the recent recession, along with many cross currents underway general business activity and structure, analysts will not know for at least several years into the future whether manufacturing activity has truly bottomed out.
Meanwhile, in the near term, overall economic growth has entered a soft patch around the world over the past several months. And as usual, when overall growth slows, the trend tends to be magnified for manufacturing activity. And so, the informational signals on whether U.S. manufacturing has turned around in a major way have become more difficult to read.
Some analysts have challenged the veracity of recent output gains from the manufacturing sector. Output gains may be overstated as final goods are produced here with an increasing amount of foreign content, especially purchased inputs and intermediate parts and components. Susan Houseman notes that such inputs are undercounted (so that final U.S. output as recorded is then overcounted). In a 2009 paper, Houseman and co-authors found that “from 1997 to 2007 average annual multifactor productivity growth in manufacturing was overstated by 0.1 to 0.2 percentage points, and real value added growth by 0.2 to 0.5 percentage points.”(Return to text)
January 4, 2012
Midwest Outlook Workshop
By Thom Walstrum and Norman Wang
On December 1, 2011, a group of experts convened to discuss developments in the Midwest economy in 2011 and to look forward to 2012 and beyond. The forum drew upon a variety of perspectives, hosting researchers from across the Midwest and from government, academic, and private institutions. As the conversation progressed, themes began to emerge.
Data from 2011 give a picture of an economy that is recovering, but lacking the vigor needed to return quickly to full employment. The outlook for the Midwest economy for 2012 is more of the same: slow improvement.
Looking beyond the current business cycle, the Midwest will be challenged by the economic fundamentals of a manufacturing-based economy. So far, economic development policy remains disappointing in addressing the challenges of diversification and competitiveness.
Sophia Koropeckyj from Moody’s Analytics noted that growth in the first half of 2011 was accelerating, but that it had slowed in the second half. The tepid pace of recovery means that the rate of job growth remains below the rate of population growth. It may take until 2017 to return to full employment. Koropeckyj highlighted manufacturing employment because it is concentrated in the Midwest relative to the rest of the U.S. She saw growth in manufacturing jobs in 2011, but noted that total manufacturing employment is still far below its pre-recession peak. Exports from the Midwest overseas continue to grow, but with possible challenges from a weak European economy in 2012. However, growth in Asia and South America could provide a backstop.
Ernie Goss from Creighton University provided a perspective on the rural economy that focused on the Plains states. They are doing better than many other parts of the country, driven by a good year for farms and farm-related businesses. Revenues were high in 2011, creating a push for consolidation that is driving up farmland prices (possibly to “bubble” levels). Federal Reserve economist David Oppedahl noted that farmland prices in other Midwestern states to the east are a bit stronger than in the Plains states. Price growth for the most productive land has outpaced prices for less productive land because of reduced recreational demand. While the farming industry did well in 2011, sectors that do not participate directly in the international marketplace (for example, construction) are subject to the same malaise afflicting other parts of the country.
Beth Weigensberg from the University of Chicago’s Chapin Hall discussed the CWICstats Dashboard Report, a quarterly assessment of the economies of Chicago and Illinois. She saw unemployment rise for Chicago and Illinois in the first half of 2011 even as labor force participation fell. Total employment is still 5% below its December 2007 level. Like other Midwest employment sectors, manufacturing employment is slowly rising from a trough in late 2009; it is still 15% below its December 2007 level.
George Erickcek from the Upjohn Institute provided an outlook on Michigan’s economy. Michigan lost 410,000 jobs from December 2007 to the trough in June 2009. It has recovered 85,200 jobs since then. Erickcek estimates that 37,100 (39%) of the new jobs were created by the auto industry. He noted that there has been no structural change for Michigan’s economy over the course of the recent recession and recovery. The auto industry is as important as ever. Even as many call for diversification, the Great Recession does not seem to have pushed Michigan’s economy in that direction.
In the near term, Michigan’s continued reliance on the auto sector will continue to lift the state and other auto-intensive communities in the Midwest. However, the longer term prospects are not so sanguine. As manufacturing growth begins to level off, longer term trends suggest little new employment will be generated by the sector. Some observers are a little more optimistic about the longer term. Federal Reserve economist Bill Strauss argued that rising overseas costs may result in the return of some manufacturing jobs to the U.S.
However, Geoff Hewings from the University of Illinois presented a less optimistic outlook on the region’s longer term future, predicting that the Midwest would continue to underperform the rest of the U.S. in several areas. According to Hewings, the Midwest’s GDP is forecasted to grow by 1.7% annually, compared with the 2.4% annual growth rate forecasted for the U.S. from 2007 to 2040. Over the same period, employment is forecasted to grow annually by 0.5% for the Midwest and 0.7% for the U.S., and personal income is forecasted to grow annually by 1.7% for the Midwest and 2.8% for the U.S.
Additionally, Hewings highlighted several trends that have shaped the Midwest in recent years. States are becoming increasingly interconnected as they fragment and hollow out; typical establishments have lengthened their supply chains by sourcing from more plants for increasingly specialized components (fragmenting) and are now less dependent on sources of inputs and markets within the state (hollowing out). Hewings noted the outsized volume of intra-Midwest trade as evidence; Midwest export trade to other Midwest states in 2007 amounted to $450 billion. Such strong intra-region trade linkages generate benefits for the Midwest economy during good times, but they amplify job losses during downturns. During the latest recession, 1.78 million jobs were lost in just five Midwest states, representing 20% of the total jobs lost in the U.S.
The close intra-region trade linkages in the Midwest sparked discussion about the need for more thoughtful and concerted policy actions within the region. Midwest states continue to play “beggar-thy-neighbor,” by offering selective tax abatements to lure businesses. Given the cohesion of the regional economy, such policies may be counter-productive. In particular, investment in overland transportation infrastructure to compliment the region’s goods-oriented economy would be worthwhile. Such investments should be carefully planned and coordinated both within and across Midwest states.
Selected presentations from the forum can be found on the following website link.
August 23, 2011
Digging Out of a Hole – A View from Detroit
Digging out of a hole sounds like an oxymoron, but that seems to be what is happening with this particular economic recovery compared with recoveries from past recessions. Rather than the more rapid growth we would expect from the type of recession the U.S. just experienced, the economy is experiencing very tepid growth. The latest gross state product (GSP) data show just how slowly the recovery is proceeding for the Seventh District. 
Even though the District is leading the nation during the recovery in its manufacturing and agricultural sectors, as of the end of 2010 its total output is still lower than it was in 2005. The District is making some progress, but the direction of the recovery does look more like tunneling out of a hole than a vertical assent.
To get a sense of how different this recovery is, we can look at past rebounds from recession. For example, on average, three years after the start of the previous two recessions, the region had already experienced expansion of over 10.0%. By 2010, three years after the start of the 2007 recession, total GSP for the District is still 2.6% below its 2007 level. This hole is pretty deep.
It is important to note that the recession was not evenly distributed across all District states. The following chart shows the GSP for each state in the District indexed to calendar year 2000. It can be seen here that Michigan never really recovered from the 2001 recession. In fact, Michigan’s previous GSP peak was eight years earlier back in 2003.
While Wisconsin, Indiana, and Illinois seem to have tracked each other very closely over the past decade, Iowa has shown the strongest growth of all the states in the District. In fact, Iowa has experienced 21.3% growth since 2000. Its growth has been supported by a rise in agricultural commodity prices and the fact that it didn’t experience a housing price bubble, which has allowed the real estate sector to continue to show growth over the last decade. On the other hand, Michigan’s economy, which has been hurt significantly by declines in auto sales, has shown the weakest growth, its 2010 total GSP is still below where it was in 2000.
The next chart compares real state product growth in the District states from 2009 to 2010 with the nation as a whole.
The District grew at 2.8% in 2010, compared with 3.0% for the nation. Two of the five states grew at rates greater than the nation and four out of five states grew faster than more than half the states in the country. Michigan, which has been struggling for the past decade, actually did quite well growing at 2.9% and coming in at 16th place among all the states. Indiana, Iowa, Wisconsin and Illinois placed 3rd, 13th, 23rd, and 32nd, respectively.
In terms of job growth, the region’s economy may be performing slightly better than the nation overall in 2011. Through June 2011, the District had created jobs at a faster pace (0.9%) than the nation as a whole (0.7%), albeit from a much lower trough.
Michigan, which lost population in the last census, actually led the District in the first half of this year with job growth of 1.9%, it ranked 4th in the nation in growth of nonfarm payroll jobs. On the other hand, Indiana ranked last with employment down 0.4% in July 2011 on a year-to-date basis. Even though Indiana has seen a decline in total nonfarm July 2011 year-to-date, the state has experienced job gains in two sectors, mining and logging (1.5%) and manufacturing (1.2%).
Still, total nonfarm payroll employment in the District remains well below its previous peak. In fact, as can be seen in the following chart, nonfarm payroll employment for the District is still below where it was in 1996. In addition, the nation as a whole has also seen a sharp decline in nonfarm payroll jobs since the start of the latest recession -- nonfarm payroll employment for the country is currently about where it was in 2004.
If we take a closer look at manufacturing employment data for the nation and the District, we see an even more distressing picture. Since 1990, the nation and the District have lost about 35% of their manufacturing jobs. This is equivalent to over 6.0 million jobs nationally, of which the District accounts for about 1.1 million. At its peak in 2000, the District accounted for 19.1% of the nation’s manufacturing employment. By July 2011 its share had fallen to about 18.6%. Also at the peak in 2000, the region had 474,000 auto related jobs, which accounted for about 14.4% of the region’s manufacturing employment. As of July 2011, manufacturing employment in the region was 2.2 million jobs, of which 203,600 or 9.3% were in the auto industry.
Some of the employment declines have come about from labor-saving productivity improvements, but many are the result of declining U.S. auto sales together with declining market shares of the Michigan-based Detroit 3 auto makers and their suppliers.
In the past couple of months total light vehicle sales have been disappointing but, on the bright side, the traditional domestic manufacturers have been doing relatively well. In fact, on a year-over-year basis through June of this year, the Detroit 3 collectively saw sales increase by 15.5% versus an increase of just 7.6% for the industry as a whole. The Japanese manufacturers experienced a decline in sales on a year-over-year basis of 11.6%, largely due to supply disruptions as a result of devastating earthquake in Japan. In addition, some customers may be postponing purchases until the Japanese manufacturers can get their inventories replenished. Thus, absent the impact of the earthquake and related supply disruptions, auto sales overall would have been stronger in recent months.
It remains to be seen when auto sales will regain the positive momentum they had shown earlier in the year but despite recent setbacks, the August 2011 Blue Chip consensus for light vehicle sales for 2012 is 13.6 million units. This is a 30.1% increase from the 10.6 million units sold in 2009 and an increase of 1.4 million units from the July SAAR of 12.2 million units. In addition, Ward’s Automotive is projecting that by 2012, vehicle production in the District will be up by 2.3 million units from its low point in 2009. If these projections are correct we would expect to see some more positive gains in manufacturing employment for our region -- especially Michigan. Meanwhile, we just have to keep digging.
GSP is the equivalent of GDP at the national level – the sum total value of all goods and services.(Return to text)
State rankings include the District of Columbia. (Return to text)
May 19, 2011
What's Behind the Seventh District Resurgence?
Fame and fortune can be fleeting, but over the past year the Seventh District has been leading other U.S. regions in the pace of economic recovery. It is not so much that economic conditions are better here. Rather, it is that the pace of improvement has been quicker. As the map below illustrates, unemployment rates have fallen most rapidly in Michigan, followed by Illinois, and in quick succession by Indiana and Wisconsin.
The rebounding District economy is being pulled along by its two hallmark goods industries—agriculture and, especially, manufacturing. The manufacturing output recovery has far exceeded overall output growth in both the nation and the District. Since the District’s manufacturing concentration exceeds that of the nation, this unbalanced recovery has exerted an outsized effect on the District economy. Moreover, output gains in the Seventh District have outpaced those in the U.S. manufacturing sector overall. The chart below compares U.S. industrial production to its regional counterpart, the Chicago Fed Midwest Manufacturing Index. From their respective troughs in mid 2009, the IPMFG has gained 14.2 percent and the CFMMI has gained 24.2 percent. Jobs in the manufacturing sector have also been rebounding from deep lows. From the first quarter of 2010 to the first quarter of 2011, the District states of Michigan, Wisconsin, and Indiana, in that order, have led all other states in net job growth in the sector.
The fact that the District’s manufacturing has outpaced that of the nation during the expansionary period is not surprising, since the District’s industry composition is highly concentrated in the most cyclically sensitive sectors, such as automotive, primary metals, and basic machinery. Prominent automotive companies GM and Chrysler underwent bankruptcy-like events during the recent recession, in which their production activity dropped severely. Afterward, during their rebirth, these companies have ramped up rapidly to rebuild depleted inventories.
More generally, the process of rebuilding inventories has spurred manufacturing production activity. Inventory-rebuilding is somewhat typical during economic recoveries. At the low point of this past recession, as businesses began to raise their forecasts of national economic growth, they began to rebuild their inventories in earnest in order to meet anticipated product demand for both consumer products and business equipment. Since the trough of the recession in mid 2009, inventory rebuilding has contributed an average .93 percentage points to the growth rate of U.S. GDP. This contribution from inventory rebuilding amounts to one-third of total realized GDP growth from mid 2009 through the first quarter of 2011.
Realized sales of manufactured goods have also benefited District manufacturers of both business equipment and consumer durable goods. The annual pace of U.S. sales of business fixed investment in “equipment and software” have averaged over 14.1 percent so far during the economic recovery. Prominent District producers in this category include makers of farm, mining, and construction machinery, medical equipment, and electrical machinery such as engines and turbines.
Among consumer goods manufacturers that are highly concentrated in the District, the automotive assembly and parts makers are experiencing rapid growth in sales. From annual sales of 10.4 million light vehicles in 2009, the annualized pace of vehicle sales have averaged over 13 million over the first four months of this year. In response, light vehicle production in the U.S. climbed almost 73 percent from the first quarter of 2009 to the first quarter of 2011.
Analysts see more room for growth in domestic light vehicle production and sales. The scrappage rate of the “automotive fleet”-- vehicles now on the road-- has been running very low so that, according to Detroit Branch Business Economist Paul Traub, the average age of the automotive fleet has been rising since 2000. As the existing fleet wears out, demand for new vehicles will grow. In addition, the age and quality-adjusted price of used cars is running high in comparison to prices of new vehicles due to both the slow pace of new vehicle sales since 2008 and the 2009 “Cash for Clunkers” program, which took used cars off the road.
A revival in U.S. exports abroad is a third leg that underpins the manufacturing resurgence in the District. U.S. exports abroad grew strongly from 2004 to 2007 as world GDP growth averaged 5.0 percent per year.  However, during 2008 and 2009, world trade fell dramatically due to the global financial crisis and evaporating availability of credit to finance imports and exports. According to a recent article by Senior Economist Meredith Crowley, “ ….in April 2009, the world economy appeared to be in a free fall. Global trade in goods and services had fallen 15.8 percent over the final two quarters of 2008 and first quarter of 2009. This world trade collapse had been the largest three-quarter decline of the past 40 years.”
Led by economic recovery—principally in Asia and Latin America—world growth and trade recovered sharply in 2010 and into this year, supporting a recovery in U.S. exports. Over the seven quarters of the U.S. economic recovery since mid 2009, export growth has contributed an average 1.25 percentage points to annual output growth. .
Exports of manufactured goods have also rebounded in the District. The District exports capital goods, heavy machinery, and medical and transportation equipment needed by developing countries as they build their own economies. The District’s overall export orientation in manufacturing is very similar to the nation’s, and it has recovered similarly as well. The five District states experienced 48 percent growth in manufactured exports from the first quarter of 2009 through the first quarter of 2011 versus 38 percent for the U.S. Barring any unforeseen stumbles to the expected and continued pace of world economic growth, exports should continue to support economic expansion in both the District and the nation.
The District’s primary agricultural sectors have also contributed mightily to economic recovery. So far in 2011, both corn and soybean prices are trading well above 2010 and well above their previous 5-year ranges. Milk and hog prices are also trading at prices above their previous averages (below).
Production of both corn and soybeans has climbed over the decade, especially corn. Corn usage in meeting production mandates of ethanol fuels has especially spurred both the volume of corn planting and its price. Exports of soybeans and related products have responded to rising global demand, especially in Asia. These developments have acted to lift farm-related incomes and jobs, as well as purchases of farm equipment and traded prices of farmland. As reported by Dave Oppedahl in the AgLetter "At 16 percent, the year-over-year increase in farmland values in the first quarter of 2011 for the Seventh Federal Reserve District was the largest since 2007 and was last surpsassed in 1979.” As also reported, domestic sales of harvesting equipment and large tractors have shown strong gains over the past two years.
One dark cloud has been the cold and wet spring of 2011, which has delayed planting, thereby threatening this year’s crop yields and production.
While it is clear that goods-producing sectors are driving the District’s economic gains, it is also significant that labor market improvement are concurrently taking place in service-oriented metropolitan areas. Much like other large MSAs, Chicago’s employment composition is not highly concentrated in goods-producing sectors—at least not directly. However, among the 20 most populous MSAs, Chicago’s unemployment rate declines have been among the most precipitous, declining 2.2 percentage points year over year versus .9 percent for the nation (below). Here, the surrounding region’s goods-producing activity has apparently lifted Chicago area business and professional services employment, as well as its leisure and hospitality sectors. Similarly, service-oriented Indianapolis experienced declining unemployment rates of 1.6 percentage points. Meanwhile, those Seventh District metropolitan areas that serve as both financial-service hubs for their surrounding regions and as manufacturing centers in their own right also saw significant unemployment rate declines. The Detroit MSA recorded a 3.5 percentage point decline; Indianapolis MSA a 1.6 percent decline, and the Milwaukee MSA, a 1.9 percentage point decline.
What’s ahead for the Seventh District economy? Much, but not all, of the recent resurgence derives from transitory causes. In particular, the marked U.S. growth rebound from the deep recession to a modest expansion has lifted inventory building of durable goods. But as inventory accumulation returns to normal, this element of growth in demand will ease off. In a similar vein, the return to robust world economic growth is expected to continue, but not accelerate. Accordingly, manufacturing exports will continue to grow, though perhaps at a more subdued pace. Similarly, domestic U.S. demand for manufactured goods and capital equipment is expected to continue but not to greatly accelerate. However, domestic demand for light vehicles to replace the aging U.S. fleet is thought to hold promise for expansion.
The current period of strong prices for farm commodities is being watched with caution by market participants. As developing countries supplement their diets with U.S. farm products, export demand will continue to support farm prices. However, farm commodity prices are also notoriously volatile as they are buffeted by climate events related to surprise crop failures or successes round the world.
 IMF, April 2011. (Return to text)
March 17, 2011
Interpreting the Midwest Economy Index
by Scott Brave, senior business economist
On March 31, 2011, the Chicago Fed will begin releasing on a monthly basis an index designed to measure growth in nonfarm business activity in the Seventh Federal Reserve District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin. This monthly index, called the Midwest Economy Index (MEI), will serve as a regional counterpart to the Chicago Fed’s National Activity Index (CFNAI), available here, and allow for a comparison of national and regional growth trends.
This blog serves as a source of background information on the MEI, detailing its construction and interpretation. In the future, this information will be available at www.chicagofed.org/mei. To receive email updates on the MEI as well as future releases, you can sign up at http://www.chicagofed.org/webpages/utilities/subscribe.cfm beginning March 31.
Background on the MEI
The MEI is a weighted average of 128 state and regional indicators encompassing the entirety of the five states in the Seventh Federal Reserve District. It measures growth in nonfarm business activity from four broad sectors of the Midwest economy: 1) manufacturing, 2) construction and mining, 3) services, and 4) consumer spending.
As with similar indexes of regional economic activity, the majority of the indicators in the MEI are based on data from the Payroll and Household Employment surveys and State Initial Unemployment Insurance claims. However, for the manufacturing and construction and mining sectors, the MEI also captures production indicators, while for consumer spending it additionally includes data on personal income and home and retail sales.
The MEI incorporates indicators that are observed at both a monthly and quarterly frequency. To express the monthly index at a quarterly frequency, we translate all 128 indicators into a common frequency by taking a three-month moving average of the monthly indicators. In this sense, the MEI’s closest national counterpart is the three-month moving average of the CFNAI (the CFNAI-MA3). Every indicator is then given a stationary transformation and standardized to have a zero mean and unit variance.
The weight each indicator receives in the MEI depends upon the relative degree to which it explains the overall variation among all the indicators. In this fashion, greater influence in the index is given to those indicators that are able to best explain broader fluctuations in the Midwest economy. The degree to which this is true for any individual indicator is captured in the absolute value of its weight. A full list of indicators and their weights can be found here.
To be able to incorporate indicators that differ in originating date and reporting frequency, we follow the estimation strategy outlined by Stock and Watson. This strategy is based on a statistical method called “principal component analysis” and is used to create a system of relative rankings, or weights, for the indicators. These weights are re-estimated each month, but in practice change very little given the substantial history of the index.
To illustrate the role played by each of the four sectors and five states, the pie charts below show what percentage of the variation in the 128 indicators explained by the MEI can be attributed to each sector (figure 1) or state (figure 2). Broad fluctuations in Midwest nonfarm business activity have historically been explained by the manufacturing sector and, to a lesser extent, the service sector, as well as by the three largest District states (Illinois, Michigan, and Wisconsin).
Interpreting the MEI
Our motivation in creating the MEI is to better understand the relationship between growth in national economic activity and growth in Midwest economic activity. The MEI is a measure of regional economic activity in much the same way as the CFNAI is a measure of national economic activity. CFNAI values above zero indicate growth in national economic activity above its historical trend, and values below zero indicate growth below trend. Similarly, MEI values correspond to deviations of growth in Midwest economic activity around its historical trend.
Over long periods, Midwest economic activity has tended to track national economic activity—as shown in figure 3, which compares the MEI and CFNAI-MA3. Both indexes in this figure have been expressed in standard deviation units, so that a value of –1 corresponds with growth that is 1 standard deviation below trend.
However, over shorter periods this has not always been the case, particularly around the beginnings and ends of recessions (the shaded regions in the figure as defined by the National Bureau of Economic Research, or NBER). To highlight such differences, we construct two separate index values: an absolute value and a relative value. The MEI (absolute value) captures both national and regional factors driving Midwest growth, while the relative MEI (relative value) provides a picture of Midwest growth conditions relative to those of the nation.
A positive value of the relative MEI indicates that regional growth is further above its trend than would typically be suggested based on the current deviation of national growth from its trend, while a negative value indicates the opposite. To obtain this interpretation for the relative MEI, we use the standardized residuals from linear regressions of each of the 128 indicators on the CFNAI-MA3 to construct the index. This construction accounts for differences in national and regional growth trends and volatility that prohibit comparisons of magnitudes in the figure above.
Figure 4 shows the relative MEI in comparison to the CFNAI-MA3. The unit of measurement is again standard deviation units, so that a value of 1 for the relative MEI indicates that Midwest growth is 1 standard deviation greater than would typically be suggested given the level of the CFNAI-MA3. This figure shows that the Midwest business cycle was particularly pronounced during and after the recessions of the late 1970s, early 1980s, and 2007–09.
Other significant periods in which Midwest growth deviated substantially from national growth include the 2001 recession, which more adversely affected the Midwest region, and the 1990–91 recession, which was milder regionally but was preceded by a period of relative weakness.
Contributions to growth by sector and state
Additional information on the sources of growth in Midwest economic activity can be found by decomposing the MEI and relative MEI into contributions from the four broad sectors of the Midwest economy. The figure below plots the time series of these contributions over the history of the index.
Much of what we see in this figure can be summed up by the following: When manufacturing has thrived, so has the region. However, the contributions of the service sector to Midwest growth over time have become increasingly important. Consumer spending indicators show a similar pattern, making sizable contributions at business cycle peaks and troughs. Finally, the region has historically been less prone to large fluctuations in growth coming from the construction and mining sector than other parts of the nation.
Looking at regional versus national growth, the manufacturing and service sectors explain the vast majority of movements in the relative MEI. However, the contribution of services to the relative MEI is larger than it is to the MEI and nearly equal to that of manufacturing. This feature of the relative MEI reflects the importance of the service sector during periods where the Midwest economy has expanded or contracted faster than the nation. A good example of the former is the early to mid-1990s, while the early to mid-2000s exemplify the latter.
Using only the indicators for the respective states in the Seventh District, we construct state-level contributions to the MEI and relative MEI. Figure 7 plots the time series of these contributions over the history of the index. No single state dominates growth in Midwest economic activity, although Illinois tends to make the largest contribution to both; and growth trends in nonfarm business activity across states are similar, with the exception of the weakness of the Michigan economy over the past decade.
During the recent recovery, all five Seventh District states have made positive contributions at one time or another to the MEI and relative MEI, suggesting that the manufacturing-driven recovery has benefited the region disproportionately. In the future, we invite you to track these developments through the charting utility for the Seventh Federal Reserve District found here.
 See, for instance, Theodore M. Crone and Alan Clayton-Matthews, 2005, “Consistent economic indexes for the 50 states,” Review of Economics and Statistics, Vol. 87, No. 4, pp. 593–603. (Return to text)
J. H. Stock and M. W. Watson, 2002, “Forecasting using principal components from a large number of predictors,” Journal of the American Statistical Association, Vol. 97, No. 460, pp. 1167–1179.(Return to text)
Every indicator is regressed on the contemporaneous value of the CFNAI-MA3. Some indicators are also regressed on the lagged value of the CFNAI-MA3. These indicators are chosen based on the Bayesian Information Criterion, which balances the explanatory power gained by including an additional lag of the CFNAI-MA3 in the regression against the uncertainty introduced from the estimation of an additional parameter.(Return to text)
A handful of indicators exist only at a regional level. To construct state contributions, we omit these variables. Therefore, the state contributions do not sum to the overall index in each period.(Return to text)
December 17, 2010
Can the Great Lakes Region Break Free of its Long-term Slide?
How can we best understand and adapt to the Region’s long term changes? There are three trends that are fundamental to assessing the Region’s economic behavior and prospects. One is the region’s sharp sensitivity to the national business cycle. The region continues to specialize in manufacturing, especially durable goods sectors such as automotive and machinery. For this reason, the region exhibits above-average swings in employment and business activity as the U.S. economy falls into a recession or recovers afterward. The second trend behavior concerns the Region’s long term re-structuring out of manufacturing. Here, it is not so much that the Region’s manufacturing specialization has abated. Rather, since manufacturing productivity gains give rise to fewer workers, and because consumer demand growth for manufactured goods does not compensate for rising labor-saving productivity, the region’s economic base does not keep pace with the nation. Finally, from decade to decade, the Great Lakes Region has experienced pronounced deviations from its overall growth trend. Quite independently of the long term manufacturing trend, and independently from the two recessions of the 2000s, the boom years of the 1990s have given way to longer term realities. In retrospect, the 1990s experience are an aberrantly prosperous time from which to extrapolate the Region’s future. In order to accurately gauge the Great Lakes Region’s challenges and prospects, all three perspectives must be integrated. As a whole, the Regions outlook remains challenged, but there are also opportunities and possibilities for revived prosperity.
Great Lakes and the Business Cycle
Both the nation and the Region’s employment base have been shifting out of manufacturing and toward service sectors. However, this does not mean that the Region’s economic base no longer rests firmly in manufacturing. In relation to the United States, the Region’s employment specialization in manufacturing has perhaps sharpened in comparison. As shown in Table 1, construction of an index of specialization shows some surprising evidence to this effect. Because farm employment in the region consolidated prior to regions such as the Southeast, farm concentration has sharpened here in relation to the nation. The same can be said of manufacturing—both the durables and non-durables sectors. By 2009, both lie well north of average, with durables concentration at 79 percent above the nation. Nondurables has meanwhile climbed to 34 percent above the nation. Here, food processing employment is the Region’s bulwark while, elsewhere, nondurable staples such as textiles have tended to shed jobs.
How can we best understand and adapt to the Region’s long term changes? There are three trends that are fundamental to assessing the Region’s economic behavior and prospects. One is the region’s sharp sensitivity to the national business cycle. The region continues to specialize in manufacturing, especially durable goods sectors such as automotive and machinery. For this reason, the region exhibits above-average swings in employment and business activity as the U.S. economy falls into a recession or recovers afterward. The second trend behavior concerns the Region’s long term re-structuring out of manufacturing. Here, it is not so much that the Region’s manufacturing specialization has abated. Rather, since manufacturing productivity gains give rise to fewer workers, and because consumer demand growth for manufactured goods does not compensate for rising labor-saving productivity, the region’s economic base does not keep pace with the nation. Finally, from decade to decade, the Great Lakes Region has experienced pronounced deviations from its overall growth trend. Quite independently of the long term manufacturing trend, and independently from the two recessions of the 2000s, the boom years of the 1990s have given way to longer term realities. In retrospect, the 1990s experience are an aberrantly prosperous time from which to extrapolate the Region’s future. In order to accurately gauge the Great Lakes Region’s challenges and prospects, all three perspectives must be integrated. As a whole, the Regions outlook remains challenged, but there are also opportunities and possibilities for revived prosperity.
Great Lakes and the Business Cycle
Both the nation and the Region’s employment base have been shifting out of manufacturing and toward service sectors. However, this does not mean that the Region’s economic base no longer rests firmly in manufacturing. In relation to the United States, the Region’s employment specialization in manufacturing has perhaps sharpened in comparison. As shown in Table 1, construction of an index of specialization shows some surprising evidence to this effect. Because farm employment in the region consolidated prior to regions such as the Southeast, farm concentration has sharpened here in relation to the nation. The same can be said of manufacturing—both the durables and non-durables sectors. By 2009, both lie well north of average, with durables concentration at 79 percent above the nation. Nondurables has meanwhile climbed to 34 percent above the nation. Here, food processing employment is the Region’s bulwark while, elsewhere, nondurable staples such as textiles have tended to shed jobs.
The Region’s continued concentration in manufacturing means that national swings in activity are felt unduly by the region’s households. During downturns, as households experience trepidations about their jobs, they try to preserve their household assets in liquid form, and to pay down debt. In particular, households reduce spending on durable goods, bringing down manufacturing sales and production. For example, this past recession, automotive sales fell in half from peak to trough. Domestic production fell even more sharply which, by way of jobs and wages, rippled through automotive households in Michigan, Indiana, Ohio and elsewhere. So, too, this time around, international trade in goods and services plummeted amidst the global financial crisis, bringing down the Region’s exports of machinery and other capital goods.
A general picture of manufacturing’s sectoral importance to the region can be seen from the Chicago Fed’s new Midwest Economy Index (MEI). The MEI is a weighted average of measures of growth in economic activity. Specific measures can be categorized into variables measuring the consumer sector, services, construction, and manufacturing respectively. Manufacturing-relate variables continue to explain much of the deviation of the “Midwest” region from its own growth trend. Figure 1 illustrates the swings in both the MEI and its national activity counterpart, the Chicago Fed National Activity Index. Of particular note, the Region’s overall activity dipped below the nation during the trough of the recent recession. Meanwhile, in the current recovery, due to both quick inventory re-building and to the strong global recovery in world trade and U.S. exports, Great Lakes activity due to manufacturing has been outpacing the nation.
Manufacturing and the Long-term
The performance of U.S. manufacturing companies has been and continues to be highly successful in at least one respect. Rapid productivity gains have been achieved through continual investment in modern technology and the adoption of cutting-edge business practices such as inventory management and global logistics. As a result, real output growth per unit of input in the sector has outpaced services. The source of productivity growth has been technological advancements in manufacturing, such as computerization and assembly line engineering, along with process and organizational advances in logistics and production. Many innovations have, in turn, spilled over into service sectors, lifting their productivity as well. The U.S. standard of living has risen accordingly as these productivity gains have translated into real wage gains for workers.
Nonetheless, these productivity gains have cut a different direction for many communities in the Region. While productivity and competition have lowered the prices of manufactured goods for U.S. households, consumers have responded to lower prices by shifting some of their expenditures to services in addition to the goods. Price-responsive in purchasing manufacturing goods has not been sufficiently great to support the Region’s former employment in manufacturing companies. Export sales abroad have back-filled some of the deficiency, but imports have also penetrated important home markets including autos and consumer electronics. The figures below illustrate first that manufacturing jobs have accounted for a declining share of jobs since at least 1947—declining from over one-third share of payroll employment to under 10 percent today. Secondly, the levels of manufacturing payroll jobs have remained largely flat, declining rapidly since the late 1990s. In the Region, manufacturing jobs have fallen more steeply as job location is now shared with the South and the West. U.S. mfg employment fell from 20.5 million in 1969 to 12.4 in 2009, or by 39 percent. Great Lakes manufacturing employment fell from 5.4 million in 1969 to 2.6 in 2009; or by 52 percent over the period.
The local effects of the downward drift of manufacturing jobs can be seen with great clarity by comparing the performance of the Great Lakes major metro areas in juxtaposition with their own historic concentration in manufacturing. Eleven major metropolitan areas are charted in Figure 4, running east to west from Buffalo and Pittsburgh to St. Louis and Minneapolis. A strong inverse correlation is evident in observing each MSA’s share of payroll employment in the manufacturing sector in 1969 as compared to subsequent growth in total job growth to 2006. Those metropolitan areas having the highest manufacturing job concentration in 1969—such as Detroit, Buffalo, and Pittsburgh, subsequently experienced the worst total job growth. A similar relationship exists between growth in each MSA’s per capita income growth. For Great Lakes communities, manufacturing has been destiny.
False alarms and false starts—the medium term
National business cycles, and the tendency of the Great Lakes Region to amplify them, make forecasting the Region near the time of cyclical episode more uncertain. At such times, the long-term drift in manufacturing seems more helpful in prediction. However, the Region’s performance has not been steady during medium term economic expansions. Rather, performance has been buffeted by special factors and developments such as exchange rate swings, national defense build-downs, savings-and-loan crises, volatile farm fortunes, super-trend national growth, and shocks to specific hallmark industries—especially automotive. In the 1980s, the proverbial bottom fell out of the Region’s economy during the first half of the decade. While much of the nation enjoyed some respite from such events as the micro-electronics revolution, booming oil and gas exploration, and from surging defense re-building, the Midwest languished under a rapidly-rising dollar, trade penetration in steel, autos and machinery, and a farm-debt crisis.
Rapid recovery during the late 1980s made this a distant memory. In fact, by the early 1990s, as the savings and loan financial crisis and defense build-down largely impacted other regions, the 1980s experience came into focus as an aberration to many observers in the Region. In fact, by the mid-1990s, economic performance in the Region returned so such “normalcy” that the lessons of the 1980s were soon forgotten. Import penetration of foreign-domiciled auto makers leveled off amidst the success of Detroit’s new products (i.e. the SUV and mini-van products) and the attendant plunge in real gasoline prices. To be sure, surging imports challenged many domestic markets for manufactured goods, but at the same time, the rapid growth of less-developed nations fed the demand for the Region’s capital goods export industries. High tech manufacturing enjoyed the most rapid growth—mostly outside the Region—during the 1990s. But super-rapid national growth in the U.S. and abroad kept Midwest growth humming.
The Region’s per capita income during these periods can serve to illustrate the marked swings in economic conditions. The chart below depicts the Region’s per capita income as a ratio to national per capita income. A ratio of “one” indicates parity between the Region and the nation. Over the course of the early 1980s as the Region’s unemployment soared above the nation, the region’s relative income plummeted, and remained so throughout the decade. But beginning in the early 1990s, fortunes began to change. By mid-decade, per capita income had once again risen above the nation. Surely, regional hopes were raised during this period to the effect that a new and more robust growth path had been set in motion. However, beginning with the economic recessions of the 2000s, it became less clear whether the 1980s were the norm rather than an aberration, and whether the 1990s were also an aberration, or both.
Further evidence and insight concerning volatile and transitory deviations from the Region’s growth trend can be seen from Figure 5. Here, the Midwest Economy Index and the Chicago Fed National Activity Index chart respective growth deviations from each of their respective trends. Throughout the sanguine years of the 1990s decade, the U.S. economy achieved growth rates above its long term trend. Analysts and observers now attribute this performance in part to exuberance associated with the rise of the internet and advanced telecommunications, which lifted profit expectations to levels that later proved unrealistic. Regionally, rapid national growth exerted a salutary effect on growth in the Great Lakes Regions, as did the aforementioned comeback of Detroit auto makers, as well as booming manufactured exports to the developing world.
A Look to the Region’s Future
The tumultuous years following the turn of the 20th century provide little basis for understanding and forecasting the region’s future. Two recessions during the past decade have obscured the true extent of manufacturing’s long term decline, and hence the Region’s prospects. Manufacturing performs very poorly during cyclical downturns. In the same vein, automotive re-structuring leaves the fate of many automotive communities hanging in the balance--dependent on the success of those few assembly companies (and their suppliers) that are domiciled in the Region.
However, the current recovery suggests some respite in which the region can re-direct and re-build. Presently, export recovery and inventory re-building are lifting some of the region’s manufacturing sectors such as steel and machinery upward from a deep trough. At this time, these forces are expected to continue to some significant extent. And a potential re-balancing of the U.S. economy toward greater sales to the rest of the world might also lift the course of the region in a more fundamental way.
Over the long haul, the Region’s sharp concentration in manufacturing makes it impossible to ignore and abandon. Moreover, there is little need to do so. Almost every advanced economy continues to support a vibrant advanced manufacturing sector. The key here is to focus on advanced, technologically competitive, companies and sectors. The Midwest continues to be a superb location for manufacturing, though the challenges are to modernize and innovate.
Some of the Region’s cities are also transforming in positive and encouraging ways. Throughout the developed world, as well as in some developing countries, economic transformation is well underway in those services that are steeped in information flows, educated workers, entrepreneurs, and innovation. To many observers, it is obvious that these activities best take place in urban areas where face-to-face meetings can take place with great frequency and specialization; and where entrepreneurs can best acquire the ideas, business services, and personnel to grow new businesses. The Great Lakes is the domicile of urbanized population on par with the U.S.—slightly below 80 percent. Yet, many of the region’s cities were fashioned as hubs for production and overland transportation of goods, and not as centers of advanced service and finance. Accordingly, the Region’s cities are sorely challenged to re-configure their infrastructure and governance for a different economy. Such challenges are a tall order during the present time when fiscal conditions are stressed, and when the know-how on how to convert older manufacturing land-use forms to the modern age must be discovered and invented, rather than pulled off of a book shelf (or off of an on-line search).
 This article is drawn from a presentation delivered at the University of Michigan, Ann Arbor, at the Research Seminar in Quantitative Economics, November 19, 2010. (Return to text)
February 19, 2010
Watching for Job Rebounds
According to economists’ reckoning, the recession very likely ended this past summer, meaning that the U.S.’s national output has begun to grow once again (from a deep trough). But for many households, the direction of recovery has much more to do with job growth, job opportunities, and hours worked. And so, the job watch is on. We continued to lose jobs during 2009, but employment is expected to begin to grow again by mid-year 2010. At some point soon, businesses will no longer be able to expand their production of goods and services without hiring. In anticipation, analysts and some households alike are watching current indicators of labor market activity, such as monthly payroll job counts, along with early or leading indicators of labor market turnaround that might foreshadow rising job opportunities.
There are several such indicators available to states and regions. As a measure of current net job growth, the Bureau of Labor Statistics (BLS) releases state estimates with a three-week lag from the previous month, and metropolitan area estimates with a four- to five-week lag. Recent total nonfarm payroll job trends (below) show that job growth in the U.S. has generally been stronger than in the Midwest (and declines have been more severe).
Estimates of total payroll employment are derived from a sample of business establishments that report on employees, hours, and earnings of their workers. The estimates are revised one month following their initial release to include information from late-reporting firms. Since the estimates are based on just a sample of firms, they are also benchmarked (once per year) to a near-universe of business establishments. For example, BLS reports that “the average absolute benchmark revision at the state total nonfarm (jobs) level was four-tenths of a percent (0.4%) in March 2008. The range of percentage revisions across states were –2.8 percent to 1.5 percent.”
Given such imperfections in accuracy and timing, alternative indicators are eagerly watched, especially if they have exhibited some previous power in “leading” or predicting past job market turnarounds.
Among the most timely current indicators is “initial claims for unemployment insurance”. After a one-week “waiting period,” newly terminated workers may file for umemployment insurance (UI). These claims are compiled weekly at the state level and reported in a news release by the U.S. Department of Labor. UI claims are an incomplete picture of the job market in several ways. For one, not all workers are covered by, or eligible for, UI insurance. But most importantly, from a conceptual standpoint, UI claims reflect only “job destruction” and not “job creation.” Newly hired workers are not counted in this administrative-type data.
For the U.S. overall, UI claims have generally been falling. Initial UI claims peaked above a weekly average of 650,000 (seasonally adjusted) for March of 2009. By January of 2010, UI claims had fallen to 467,000. Still, these numbers remain higher than in the recent past. For all of 2007, UI claims averaged 322,000 per month.
The charts below illustrate the recent labor market improvement, as measured by initial UI claims, for the Seventh District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin.
The lines show the time path of UI claims filed for each of the years 2007–09 and January of this year.
State experiences have varied somewhat, though with a similar general pattern. All states experienced a significant surge in claims during the second half of 2008 (blue line), especially during the fourth quarter. Job destruction worsened into the first half of 2009 (red line). But by the fourth quarter of 2009, UI claims had fallen below those of 2008 in every District state. Nonetheless, for the fourth quarter of 2009 and into the first month of January, UI claims in Iowa, Wisconsin, and Illinois remained well above those experienced during in the same period in 2007.
Other indicators also help to presage rising job creation. Observations of “help wanted advertising” measure the demand for labor, indicating soon-to-be-filled employment transactions. The Conference Board tracks national and state online job vacancies on a monthly basis. Their recent release reports a third consecutive month of strong national gains in advertised vacancies. The gains were widespread across U.S. regions, including the Midwest. Ohio was among those states recording the strongest January over December gain since the data series began in 2005. Seventh District states Illinois, Michigan, and Wisconsin all recorded monthly gains of 10 percent or more.
Analysts also follow the “contingent worker” or so-called temporary help employment series to foreshadow an eventual upswing in total nonfarm employment. In situations where general business conditions are improving but still somewhat weak, and before employers are willing to commit to permanent hiring, firms may begin to contract for workers from specialized employment services firms. Employment at such firms is sufficiently prevalent in four of our District states so that monthly data are reported by the BLS. As shown below (red line), employment of temporary workers grew in the second half of 2009 in Michigan, Indiana, Illinois, and Wisconsin.
As another measure of potential labor market tightening, the BLS also reports average weekly hours worked of production and nonsupervisory workers for states and metropolitan areas. During slack production times, firms may choose to ratchet back their employees’ hours rather than to lay them off entirely. If so, once production begins to pick up, and before any new hiring takes place, firms will tend to add back work hours for existing employees. Currently, the BLS reports these data for manufacturing workers only.
As seen in the charts below, average weekly hours worked has begun to rise in the U.S. (blue line) and in each District state (red line) except Illinois. Though the manufacturing sector has experienced sharp declines over the past two years, it has begun to recover early in the aftermath of the 2008–09 recession.
Local chapters of the Institute of Supply Management (ISM) also track manufacturing employment through their monthly survey of purchasing managers. ISM Indices are directional only (they do not measure levels), indicating expansion versus contraction of various categories of business activity at their establishments. A reading of 50.0 indicates that, during the previous month, activity was equally balanced between expansion and contraction; readings above 50.0 indicate a greater reported tendency of establishments to expand. The Chicago ISM survey reported at the end of January (for December) that its reading on employment “leapt to the highest level in nearly five years.” In contrast, the ISM survey for Southeast Michigan reported “declines for the third straight month, continuing its downward spiral to (a reading of 36.0).
What to make of these many indicators? An understanding of the wide array of labor market indicators can provide both workers and the unemployed with a better “read” on when labor market opportunities are arising or when they will improve in their region. In contrast, the most followed labor market indicator, local unemployment rates, can be misleading. As more jobs open up, some workers who have been waiting on the sidelines (and not hunting for jobs) will actively seek employment once again. Once they are actively looking, the survey from which the unemployment rate is calculated begins to count them as “unemployed,” thereby raising the unemployment rate even as net job growth is taking place.
And so, in the coming months, the unemployment rate in both District states and the U.S. may continue to climb, even as the labor market situation may be improving in some locales and industry sectors.
 It is also possible to gather UI claims at the local level of geography. For example, initial claims for metropolitan areas are gathered and reported in Ohio. (Return to text)
 These data are also reported for metropolitan areas. These data are also subject to annual revision in March of every year. The data are benchmarked to March of the previous year and projected forward from that benchmark. Hence, the data are re-benchmarked once again the following year, once another benchmark is established (Return to text)
March 12, 2009
Midwest in Recession: Then and Now
By Bill Testa and Vanessa Haleco-Meyer
Longtime Midwest residents may be befuddled by ongoing comparisons of the current national recession with those of 1974-75 and 1981-82. While the headlines suggest this recession compares, so far, with the deepest recessions of the past 50 years, we in the Midwest have a somewhat different perspective. For us, the recessions of 1974-75 and 1981-82 were far worse, at least so far. An exception may be made here for Michigan, which has been experiencing a recession of sorts all decade long.
Statistical comparisons of regional recessions with the nation are difficult for a number of reasons. Arguably, the best basis of comparison can be made using payroll employment data which are available monthly from the Bureau of Labor Statistics. In the charts that follow, we index job levels in states, the Seventh District (Illinois, Iowa, Indiana, Michigan, and Wisconsin), and the U.S. to a beginning value of 1.0. We begin the time series at the quarter in which employment levels peaked in the state, region, or nation. Since employment peaks may differ between a state or region and the U.S., we sometimes begin comparative series at slightly different dates. For example, employment in the Seventh District last peaked in the second quarter of 2007, but the U.S. peaked in the fourth quarter of 2007. (On the charts, the indexed lines will appear to begin in the same quarter). We use seasonal adjustment to iron out variations in employment that typically occur every year.
The chart below compares payroll job growth for the Seventh District versus the U.S. during the 1974-75 downturn, the 1980s downturn(s), and the 2008 downturn. The U.S. economy officially recorded two back-to-back recessionary periods in the early 1980s. Since the episodes took place so close together, and since the Midwest experienced virtually no pause between downturns, we index jobs beginning from the previous peak (1980-Q1 for the U.S. and 1979-Q2 for the Seventh District) through to the final trough.
In examining payroll job performance during these recessionary periods, the first thing to note is that payroll employment dropped more rapidly in the 1974-75 recession (blue lines) than in subsequent recessions. Seventh District payroll job levels fell by 4% in the four quarters following their peak in the third quarter of 1974 (before turning upwards). In comparison, and despite the dramatic declines over the past few months, the current recession has experienced a shallower and slower decline from the previous employment peak (green lines).
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Recent job declines have also been shallower so far than the fairly dramatic declines the Midwest experienced in the 1980s (red lines). After reaching a peak in 1979, payroll jobs in the District fell for four years, reaching bottom in the first quarter of 1983 at 10% below the peak. The U.S. experience of that time was quite different. Following a slight decline in 1980, national employment growth resumed briefly before falling 3% during the 1981-82 recession. Over the entire length of both recessions, the pace of job decline in the Seventh District was more than five times that of the nation.
The dismal experience of having no post-recession recovery is one that the state of Michigan is now experiencing. The chart below indexes payroll job decline and growth circa the 2001 recessionary period. From its second quarter peak in year 2000, Michigan’s employment has fallen by over 10% (green line). The remaining states of the Seventh District—Indiana, Illinois, Wisconsin, and Iowa—have fared somewhat better, but in the aggregate the four-state region only recently regained its previous peak. In contrast, national employment had regained its previous peak by the end of 2004.
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The final charts (below) display the employment experiences of each Seventh District state for the three aforementioned periods. In each state, the 1980s look worse than the current recession. This is even true for Michigan, which underwent a 15% job decline from its peak in the second quarter of 1979 to the fourth quarter of 1982. However, Michigan and its troubled automotive industry enjoyed a big bounce in 1982 when U.S. consumers returned to auto showrooms and began to buy cars at a rapid pace as gasoline prices eased. This time around, Michigan and much of the surrounding Midwest automotive belt hope for a repeat performance. However, Michigan’s current automotive challenges are surely more structural and deeply rooted. It will take more than an upturn in national automotive sales to pull along the state’s employment and income.
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The nation also experienced less serious downturns, during 1969-70, 1990-91, and 2001. See http://www.nber.org/cycles.html. (Return to text)
Payroll employment numbers are subject to revision in March of every year. See http://www.bls.gov/sae/790over.htm#employ. (Return to text)
February 18, 2009
Manufacturing Headwinds Strengthen
The manufacturing sector exerts an outsized impact on the Midwest economy—especially during cyclical downturns. Regional jobs and income are approximately 30 percent more concentrated in manufacturing in the Seventh District than in the nation as a whole. The District’s economy is even more concentrated in durable goods production--both capital goods, such as machinery, and consumer durables such as autos and appliances. Both capital and consumer durables are highly sensitive to cyclical swings. In times of economic contraction, businesses slow their purchases of capital equipment as they struggle with production overcapacity in relation to their current sales. Meanwhile, households slow their purchases of durable goods as they increase their precautionary savings to meet possible loss of jobs and income.
Earlier in the current recession, manufacturing activity had been having a somewhat subdued regional impact. The chart below compares the year-over-year growth of industrial production in the District and the nation during the last two recessions (recessions are indicated by the shaded vertical bars). By way of contrast, in the months leading up to the 2001 recession, production and manufacturing employment began to fall in advance of the recession. During the period leading up to that recession, very strong national and global investment in IT equipment and plant capacity took place. Specifically, the so called “Y2K” effect, coupled with buoyant world growth in response to emerging Internet innovation, spurred investment across many durable goods sectors. During the current recession, manufacturing activity held up relatively well through the first two quarters of 2008 before dropping sharply later in the year.
A closer look at this decline by broad sector would show that 2008’s production strength resided in the capital goods and machinery sectors. In both the Chicago Fed Midwest Manufacturing Index and the national index of production, machinery production remained almost flat. In contrast, slides in automotive production coincided with the general downturn in business activity. In fact, District automotive production fell sharply during the first half of 2008 in response to the gasoline price spike, which depressed sales of the larger vehicles in which the District’s producers tend to specialize.
Meanwhile, ongoing growth in the global economy bolstered capital goods and machinery purchases. Developing nations such as China and India have become important customers for U.S. capital goods, and their continued growth contributed to U.S. export growth. At the same time, high prices for farm, energy, and other commodities also spurred foreign demand for U.S. manufactured mining, construction, and farm equipment. As commodity prices fell off of their mid-summer peaks, so did both domestic and foreign demand for such equipment. So too, as the financial crisis worsened in the fall, and spread to other parts of the world, U.S. exports abroad began to ease. This can be seen below in the two charts of manufactured exports. Year over year through the fourth quarter of December of 2008 (3 month smoothed), exports fell by 4.2% in the nation and by 3.6% in the District.
Note: Emily Engel contributed to this blog entry.
February 3, 2009
Seventh District Labor Markets at Year-end
by Bill Testa and Vanessa Haleco-Meyer
Government agencies regularly report statistics that reflect state and local labor market conditions. These measures are far from perfect in their accuracy, and they often seem to conflict. Yet, these measures currently agree to a negative view of the labor markets in the Seventh Federal Reserve District.
State unemployment rates, using a household sample survey, measure those people of working age who are actively looking for work as a fraction of the work force (both employed and unemployed). Since it is sample based, the measure is imprecise, especially readings for a single given month. The chart below shows that the unemployment rates for the nation and the Seventh District began to move up moderately off of their cyclical lows throughout 2007. During 2008, the unemployment rates accelerated primarily because of net job destruction. The gap between the Seventh District’s higher unemployment rate and that of the nation remained fairly steady in recent years, even as unemployment rates were climbing in each of the District’s states and in the nation as a whole.
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Not all states of the District maintained a higher-than-average unemployment rate over the past few years. As measured in the fourth quarter of 2006 (chart below), Michigan’s high unemployment rate accounted for the bulk of the gap between the District’s rate and the nation’s. By the fourth quarter of 2008, Illinois’ unemployment rate had climbed above that of the nation, and Indiana’s unemployment rate also topped the national average. In contrast, Iowa’s and Wisconsin’s rates of unemployment in 2008 were seemingly lower than those of the overall District and the nation.
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Federal and state government agencies also track and report payroll employment. These data, released on a monthly basis, are drawn from a sample survey of firms that provide information on their employees; and so, unlike the unemployment figures, the data are not counting those in the work force who are self-employed. Since it is only sample-based, the payroll survey, too, contains measurement error. These errors tend to be more pronounced during times of sharp turns in economic direction (such as the present). During economic downturns, some firms may drop out of the sample as they cease operations. This has tended to understate net job declines, since the sampling methods cannot distinguish between a failed firm and one that is simply late or negligent in reporting. State payroll figures are adjusted for such biases during the first quarter, but even with such adjustments, revised figures do not cover the recent months, but are rather “re-benchmarked” up to a point early in the previous year.
The chart below displays the change in total payroll jobs in the fourth quarter of 2008 relative to fourth quarter in 2006. All states except Iowa lost jobs on net. Over much of this two-year period, Iowa continued to enjoy a boom in farm commodity prices and strong production and sales of related equipment. In the chart, job losses in Michigan and Indiana are especially prominent, reflecting their troubles with their automotive sectors. Using this measure, Wisconsin’s job losses seem to be more severe than what its unemployment rate may have suggested.
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Labor market indicators often conflict both because of inherent measurement error and because they measure different features of the labor market. Accordingly, it is often best to gather an array of indicators in assessing labor market conditions. Reported figures from each state’s unemployment insurance (UI) system are also followed. Each state’s UI system records weekly data on new applications or claims for insurance by those who have recently lost their jobs. (Data also report the number of people who have lost jobs and continue to receive unemployment benefits.) These data do not comprehensively reflect labor market conditions. That is because layoffs or other job separation events are only part of the process of net job gain or loss. In particular, job hires or emerging self-employment may be taking place in a state at the same time that job separations are on the rise. The chart below displays changes in initial claims for UI in the fourth quarter of 2008 relative to the fourth quarter of 2006. As compared with the final quarter of 2006, layoffs and other involuntary unemployment events were emerging much more rapidly in late 2008. This is so in the nation and in each of the District’s states. Indiana’s job separations were running especially high late in 2008 as compared with the fourth quarter of 2006—well in excess of the increase experienced nationally. And separations in Iowa have also begun to rise sharply in the fourth quarter.
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The severity and speed with which labor markets deteriorated during the final three months of 2008 has been especially disconcerting. In the District, jobs declined at a 5.1% pace. Nationally, payroll jobs declined at a 3.7% annualized rate during the fourth quarter of 2008 (1.3 million). Since 1960, payroll job decline in the nation has exceeded this pace in only one quarter, that being the first quarter of 1975 (-6.1%). And currently, most forecasts predict economic output to bottom out no sooner than the second half of this year.
Such concerns are especially acute because job markets recovered slowly in the aftermath of the past two national recessions. Slowly recovering job markets often reflect structural imbalances that have preceded and accompanied recessionary periods. The 2001 recession partly reflected the fallout from overspending on technology-oriented enterprises, such as telecommunications, and other capital equipment. Workers displaced from these sectors might have found it difficult to find jobs in new industries, or the impacted sectors themselves were slow to recover and begin hiring anew. This time around, sharp structural imbalances in housing construction and financial services are underway.
Imbalances that can emerge among different multistate regions in the U.S. can also play a role in achieving “full employment.” An industry shock to a particular sector that is highly concentrated in one region may displace workers whose job opportunities may be emerging in another region. Past Midwest experiences are a case in point. The region suffered inordinately through the double-dip national recessions of 1980 and 1981–82. The chart below compares the District’s unemployment rates with those of the nation from two periods: the 1980s and the current decade. By the end of 1982, the nation’s unemployment rate approached 11%, while the District’s unemployment exceeded 13%.
This wide gap of the early 1980s came about from underlying currents having distinct geographical accents. In particular, high oil and natural gas prices were buoying energy exploration activities in many parts of the West and Southwest; rapidly expanding federal spending to rebuild national defense stocks were lifting many regions of the South and West; and the rapidly rising value of the U.S. dollar contributed to moribund exports of farm products and manufactured goods from the Midwest (as well as to stiff import competition).
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In contrast, the recession of 2001 and its immediate economic aftermath had fewer inter-regional differences. As seen above, unemployment rates between the District and the nation were very similar. As the remainder of the decade unfolded, however, the profound structural changes going on in the automotive industry did begin to negatively affect District labor markets; the District’s unemployment rate began to rise higher relative to the national average. The Detroit Three automakers (Chrysler LLC, Ford Motor Co., and General Motors Corp.) and their suppliers experienced significant losses to foreign-domiciled auto plants located in other regions and to imported automotive products as well. While (post-2001) job levels largely recovered in the District, Michigan experienced continuous year-over-year job losses.
Now, amid a sharp regional downturn, employment statistics will be keenly watched to help guide our decisions regarding job search, education and training, local investment, home sales, and migration.
Note: Unemployment rates do not necessarily reflect job trends because working age people can drop out of the work force in response to a lack of job opportunities, thereby lowering the unemployment rate, even though payroll jobs and job vacancies are falling. A worker who drops out of the labor force no longer reports as being “unemployed” in the survey. The reverse can also take place by the same reasoning: Even with a rising number of jobs and employed persons, there can be rising unemployment. (Return to text)
Note: Comparing levels of unemployment between periods can be somewhat difficult. The “natural rate of unemployment,” or normal benchmark for a “full employment economy,” is thought to have been higher in the 1980s than today—by about 1 to 1.5 percentage points. The natural rate depends on demographics of the population, such as age and education (affecting labor force participation rates by age). For a discussion, see study by David Brauer, among others. (Return to text)
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.
December 12, 2008
Autos: A Further Loosening of the Manufacturing Belt?
This year’s Nobel Prize in Economics was awarded to Paul Krugman for his insights into spatial concentration of economic activity and the relationships among industry clusters, firm or industry-specific economies of scale, and patterns of international trade. In illustrating the flavor of his theoretical work at his Nobel Prize lecture, Krugman explained the surprising prevalence of worldwide trade among goods within the same general product category. Such trade can arise from acute economies of scale in production that are achieved by firms or industries that produce slightly differentiated products. If accompanied by the ability to easily transport and widely export its products, the location of a firm's product or of an industry's production will often become quite concentrated and rooted in particular countries or regions. By way of illustration, the 1860-1970 era of Midwest-Northeast dominance in manufacturing was said to arise from vast scale economies of mass production that came into play during the 19th century, accompanied by sharply lower transportation costs (via railroad) which allowed the manufacturing belt to export its wares to other U.S. regions and to the world. Krugman ended the lecture by discussing how the manufacturing belt had finally been shifting away from the Midwest, most recently the automotive segment. To do so, Krugman drew on the work of our Bank’s Thomas Klier.
In a series of journal articles and a recent book, Klier has been documenting and explaining this shifting geography of the North American automotive industry. Such work helps us to understand the situation of the “Detroit” automotive industry today, as does the more general spatial clustering of some industries and firms that has been observed by Paul Krugman and others.
Today in the industrial Midwest, we lament the tarnished star of wealth and income that once elevated our region’s standards of living above those of many other regions. During the glory years of Midwest manufacturing, the Great Lakes region’s share of manufacturing was phenomenally high relative to its population share. The chart below illustrates the rise and sustained dominance of manufacturing activity in the region. It is remarkable that the region sustained this high share of manufacturing, and high per capita income (shown below), even while population was ebbing away to the South and West.
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Per Krugman, manufacturing gained a foothold here as profound economies of scale in industries such as steel and meat packing grew rapidly, along with the ability to export these goods by rail. William Cronon documents these transport advantages for 19th century Chicago for meat packing, farm machinery and lumber in his celebrated book, Nature’s Metropolis. Manufacturing also thrived here due to ready access to abundant natural resources and energy inputs to production, along with the ability to feed, house and transport a large work force to work site factories in the cities.
Once established, the spatial proximity of firms and related industries helped to sustain the region’s manufacturing dominance, as the totality of these firms and industries became greater than the sum of their parts. That is to say, the Midwest’s manufacturing sector became highly productive in part because firms and their suppliers bought and sold to one another in close proximity. Steel makers sold to machinery producers; machinery producers sold to car and truck makers; car and truck makers sold to both steel and machinery producers. These efficiencies played out at much finer detail among many highly specialized suppliers and producers. In this way, transportation costs were minimized and economies of scale and scope were realized within the tight agglomeration of the manufacturing belt. So too, not unlike Silicon Valley of today, mutual proximity created a sharing and dissemination of new ideas and technology that gave producers a leg up in locating within the Midwest.
Klier has researched these spatial relationships within the Midwest automotive industry—both parts and finished vehicles. For much of its history (but with several major eras that either stretched or compacted its geography), North American automotive production has clustered in Michigan and neighboring states, enjoying the insulating benefits of great economies of scale in mass production and mutual proximity of parts suppliers within the industry, as well as proximity to Midwest steel making, machine tooling and other key industries … all the while enriching generations of automotive workers.
Of course, things look very different today, as the Detroit 3 automakers struggle to remain viable in an era of increased competition for dwindling consumer dollars. In part, competition has shaken loose the original industry and its Midwest geography as imported autos finally broke through into the U.S. consumer market during the 1970s gasoline crisis. Foreign-domiciled competitors have since chosen to produce autos on U.S. soil, though not exactly with the same geographic footprint as the original Detroit 3 auto makers. In their recent JRS article, Klier and coauthor Dan McMillen document how the older spatial cluster of automotive parts makers has been giving way to a re-fashioned but densely configured auto cluster sited further South.
This shift in location raises some questions: How do we explain this shift southward? Could (or should) anything have been done about it? Can anything be done about it now? No doubt the cost advantages of spatial proximity and the early economies of scale in automotive manufacturing were highly advantageous. At the same time, however, the very success and unchallenged structure of the domestic industry may have failed to keep the region’s institutions, policies and companies sharp and competitive.
December 3, 2008
Exports and the 2008 Economic Slowdown
Back in the 1930s, policy makers perhaps contributed to the economic downturn by sharply lifting tariffs on imports into the U.S.—the infamous Smoot-Hawley legislation passed on June 17, 1930 that raised import tariffs on over 20,000 goods. In response to these policy actions, our trading partners raised tariffs (and nontariff barriers) on U.S. exports. If the U.S. intention was to keep jobs at home, the effect was probably to aggravate unemployment here and abroad.
In recent years, trading activity with other nations has been a definite engine of growth for the U.S. Exports are contributing much to an otherwise faltering pace of economic growth. Though exports comprise only 12.4 percent of U.S. output, export growth accounted for one-half of the nation’s (2.0) percent GDP growth in 2007; exports accounted for one-third of GDP growth over 2006 and 2007. Indeed, in every year since 2002, the growth of exports has added at least one-half percentage point to national output growth.
Per the graph below, export growth has similarly lifted incomes and output in the Seventh District. Overall, nominal export value climbed by $54.7 billion, or 58.7 percent, from 2003 through 2007, with every District state joining in the expansion. Per the table below, our NAFTA partners, Canada and Mexico continue to be our largest export destinations, with China growing rapidly over the 1997-2007 period.
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The strong role of our NAFTA partners as an export destination reminds us that growth in trade often comes about from the hard policy work involved in negotiating trade agreements with other countries. The graph below illustrates the growing number of countries that now receive exports from producers in Seventh District states. Each District state has added a fair number of trading partners since 1997.
Aside from avoiding the (past) mistake of squelching international trade, the U.S. also has the opportunity to expand its export opportunities in the years ahead. Awaiting enabling legislation from the U.S. Congress, bilateral or two-nation agreements have been negotiated with Panama, Columbia and South Korea. To learn more about these agreements and those that have preceded it, one source of information is TradeAgreements.gov (this web site is a joint effort between the Departments of Agriculture, Commerce, State, Treasury and the Office of the United States Trade Representative).
Note: Vanessa Haleco-Meyer contributed to this weblog.
July 10, 2008
Assessing the Midwest Floods of 2008 (and 1993)
By Rick Mattoon
As water levels recede, the region is beginning to take stock of impact from some its worst flooding since 1993. The geographic footprint of this year’s flooding (depicted below) is less extensive than the nine states and 504 counties affected 15 years ago. And as always, an assessment of the short- and long-term impact of this natural disaster on the national and regional economy will be difficult. In this blog, I will look at the effect of natural disasters on economies and contrast current flood conditions with those the region faced in 1993.
How to think about the losses to the U.S. economy
From a conceptual viewpoint of our economy, natural disasters impact our economic well-being in two basic ways. First, they destroy what we have produced in the past—our “capital stock”—including lives, homes, commercial buildings, public infrastructure and property. Second, they often interrupt normal commercial activity and production. Transportation and deliveries do not take place, people cannot get to work and work places become dysfunctional until normalcy is restored.
In a December 1993 Chicago Fedletter, Bill Testa, Gary Benjamin and I wrote, “Perhaps the most meaningful definition of economic loss due to a disaster is the value of output of goods foregone—that is, the total net output that would have been produced had it not been for the disaster. Foregone output results for two reasons. First, natural disasters destroy productive capital stock such as roads, bridges and factories, thereby reducing output until such time as the capital stock is restored. Second, natural disasters can interrupt day-to-day business activity.”
As that article points out, the impact of the natural disaster tends to have a somewhat unusual affect on the national income accounts—the official way in which we measure the nation’s economic output and income from quarter to quarter. Following the 1993 floods, estimates for the third quarter reduced personal income by $9 billion and forecasted uninsured losses to be $2 billion. Losses to proprietors’ incomes were estimated at another $1 billion.
Remarkably, such initial losses soon appear to translate into economic gains as business and households rebuild. The rise in construction activity and the resumption of business activity often boost gross domestic product (GDP) estimates for future quarters, as households and businesses attempt to rebuild their physical capital and, in the case of businesses, to fill order backlogs. For example, following Hurricane Andrew, annualized GDP growth hit 5.7% in the fourth quarter of 1992, spurred by rebuilding activities.
However, such rebuilding does not reflect an actual economic gain in the broad long-term perspective. In most cases the rebuilding merely replaces lost capital stock—meaning that, in the long term, the nation’s product will not exceed what would have been produced without the disaster. While the immediate burst of economic activity is quite evident, the losses from the foregone output of interrupted and diminished business activity may go largely undetected because the diminished growth takes place in small amounts spread over many years.
Regional economic losses
The ultimate extent of the damage to the region’s economy will in large part depend on who pays for the rebuilding. If the losses are in large part covered by the national government and insurance companies, and if reimbursement is prompt, the region can conceptually restore output and even increase its levels of economic growth. However, if the 1993 flood experience is a guide, it is more likely that the region will absorb a significant share of the disaster-related cost. Because flood insurance was not extensively used, it was estimated that 15% to 25% of the flood costs were borne by state and local governments, not to mention the costs to uninsured homeowners who were forced to rebuild using their own resources. In the most recent floods, it was estimated that only about 1% of Iowans owned flood insurance. In hard hit Cedar Rapids, only 777 of the 4,000 homes damaged or destroyed by flooding were covered. Despite efforts after the 1993 floods to expand coverage, the cost of the policy and the limits of coverage still deter homeowners from purchasing polices. It is estimated that the average cost of a policy in Iowa is $500 per year with coverage only including direct flood damage and not related damage such as water that enters the house through a backed up basement drain. Even if property owners choose to be fully insured, insurance must be paid for. Thus, residents of these regions do bear at least some of the costs in choosing to live and work in disaster prone areas. Currently $2.7 billion in federal flood relief has been approved to aid 2008 flood victims. This does not include the value of low-interest loans and small business assistance as well as the value of crop insurance and private insurance.
Specific categories of losses--Agriculture
In both floods, the greatest concern focused on flooded crop land. In the 1993 floods, nine million acres were submerged by the flood. The lost acreage had been expected to produce 6% of the region’s harvest that year. The estimated crop losses were $7 billion. The states with the largest percentage loss were Missouri 12%, Minnesota 11%, South Dakota 8% and Iowa 7%. In this year’s flooding, damage is heaviest in Iowa where 2 million to 3 million acres of corn and 2 million acres of soybeans were flooded. The American Farm Bureau estimates crop losses at $8 billion for the region, with $4 billion of the total in Iowa. Other states with significant estimated losses are Illinois ($1.3 billion), Missouri ($900 million), Indiana ($500 million) and Nebraska ($500 million). The Bureau points out that it is not only the flooding that will impact crops but also the excessive rainfall that occurred this year.
A June 30 estimate by the USDA projected this year’s corn harvest to be down from 86.5 million acres to 78.9 million, or 8.7 percent. However, the impact on prices may be softened if a robust corn harvest occurs, since supplies should be sufficient to meet demand for food, feed and ethanol. Following the USDA report, corn futures fell from $7.55/bushel to $7.25/bushel, significantly off the $8/bushel price recorded on the Chicago Board of Trade in the immediate wake of the flooding. Still, this price is significantly elevated over the early June $6/bushel price.
One big difference between this year’s floods and that of 1993 was the preexisting stocks and prices of corn and soybeans. In 1992, a bumper crop had been harvested. For example, the stock-to-use ratio for corn hit 25% in 1992 and even in the flood year of 1993 ended at 11%. While prices rose, the increase was a modest hike from $2/bushel to $2.50/bushel. Today the corn stock-to-use ratio is only 6%; prices spiked accordingly to $8/bushel immediately after the flood before retreating to the current price. This tightness reflects the increasing demand for corn both for export and for ethanol. Given this, even if the number of acres lost is smaller than in 1993, the impact on prices will need to be closely monitored.
Spillover issues into other agriculture markets also need to be considered, as livestock feed prices are affected. The condition of the fields for next year’s planting will need to be assessed as well.
Given the smaller geographic footprint, the potential cost of rebuilding and the infrastructure loss is considerably less in this year’s flooding. While Cedar Rapids and parts of Iowa City were severally impacted, much of the flooding was contained within sparsely populated areas. In 1993, an estimated 45,000 to 55,000 private homes were destroyed, and between 35,000 and 45,000 commercial structures were damaged. Similar to today, most of the homes did not carry flood insurance, making uninsured losses the most significant issue. Estimated property and nonagricultural losses totaled $5 billion before insurance.
Another difference with the 1993 floods was the damage to infrastructure. In 1993, 1,000 miles of road were closed, and 500 miles of railroad track were underwater. Nine out of 25 non-railroad bridges were damaged and closed. This time, some highways were closed for several days due to flooding but damage to bridges, locks and other infrastructure was limited. The exception of course is in cities such as Cedar Rapids where infrastructure losses in the downtown are extensive. Cedar Rapids had 1,300 city blocks underwater, forcing 24,000 residents to evacuate. Preliminary damage estimates have been placed at $736 million or roughly $6,095 per capita. This must also be placed in the context of disruption to Iowa’s second largest city of over 120,000 people with a 2005 gross metropolitan product of $11.2 billion.
One of the more immediate problems that flooding causes is transportation disruptions. The 1993 floods were so extensive that barge traffic on the Mississippi was halted for 2 months. In contrast, barge traffic is expected to be affected for 3 to 4 weeks this time. By July 5, the entire Mississippi was reopened to navigation. Railway disruptions were also more severe in 1993. The destruction of rail bridges added four days to rail shipping times for several months while this time rail disruption was minimal for almost all major freight lines. The effected lines caused temporary delays of 1 to 2 days for most shipments.
What happens next?
For towns that were most directly affected, the question is, what does the path to recovery look like? Unlike individual farms and factories, cities’ and towns’ economies are composed of complex interrelationships that have developed over many years. A natural disaster can upset, disrupt and even destroy those relationships so that restoration is often impossible and sometimes undesirable. And so, the form of rebuilding may require careful consideration and evaluation.
Following the 1993 event, many communities and individuals simply choose not to rebuild. Other communities used natural disasters to redefine themselves. An interesting example of a town rebuilding after a flood was Grand Forks, North Dakota. The Minneapolis Fed chronicled the rebuilding of Grand Forks in a September 2006 Fedgazette article. Grand Forks was the victim of flooding in 1997. In April of that year, 80% of the town was submerged. By 2006, the area was largely restored with the region’s economy growing at a faster pace than before the flood. This was due largely to the influx of $600 million in federal disaster aid (approximately $10,000 per resident).
After much painful disruption, lengthy deliberation and hard planning, the flood eventually spurred a new vision for the area. Roughly 1,200 homes in the 100-year flood plain were bought out by the Federal Emergency Management Agency as part of a flood protection plan. The population rebound remained slow until the Army Corps of Engineers finalized a flood protection plan in 2000. Once this occurred, a building boom was unleashed. The city supported this by providing $10,000 forgivable loans for people staying at the same address for a specific period of time. The new housing was more expensive than what it replaced, with the new larger homes carrying average price tags of $138,000 versus the $85,000 homes that had been destroyed.
For business, the greatest disruption was for restaurants, bars, hotels and any business where discretionary spending is important. Many of these businesses had to lay off workers. Other businesses such as banks, health care and manufacturing suffered lost sales but did not suffer drastic employment declines. In fact given the gains in construction jobs, employment in Grand Forks rebounded to its pre-flood level in five months. To some observers, the newly rebuilt Grand Forks with its improved infrastructure and new capital stock is better positioned for growth than before the flood, but this is only true because of significant government subsidies and 10 years of hard work. And of course, it is not true for every household and business impacted by the flood, as many chose to leave Grand Forks.
The 2008 flood may seem to be milder in its overall economic impact on the larger region and the nation, but it is just as devastating for those who have suffered it as it was for those in previous floodings. The ultimate costs and impacts can only be known over time as damages become known, as the extent of relief is determined and as households, businesses and towns decide how to respond to the disruption. Most though not all of the agricultural costs and recovery will be known by the end of the growing/harvesting season. In contrast, the recovery and rebuilding process for towns, businesses and households will be protracted and laborious.
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).
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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).
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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.
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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.
June 5, 2008
2007 Economic Growth in the Seventh District
For nations, gross domestic product (GDP) is the most widely used yardstick to measure economic activity and growth. Conceptually, GDP measures the value of output produced by the market economy within a year or other period. In addition, GDP is defined as output produced within a designated geographic area such as a nation’s boundaries.
There is one more major wrinkle in this measure; GDP is typically reported as “real” GDP, meaning that the dollar values of goods and services are adjusted to reflect price changes. Such adjustments are made so that, for example, output growth reflects real gains in both the quantity and quality of what a nation produces, and not merely dollars transacted.
GDP matters to people, workers, and households because what is produced gives rise to what is earned in wages, salaries, and earnings on capital and savings. Accordingly, in many economics textbooks, the GDP concept is presented alongside its equivalent yardstick, gross national income.
In the U.S., the Bureau of Economic Analysis (BEA) produces data on GDP so that the pace of overall economic activity and its many components can be tracked on a timely basis. More recently, BEA has begun to provide timely GDP estimates for states and regions. On June 5, for example, the BEA released preliminary estimates for states and regions covering the calendar year 2007.
BEA data on GDP growth by individual states for 2007 shows a general economic slowdown that mirrors the national slowdown from 3.1 percent in 2006 to 2.0 percent in 2007. In all, 36 states experienced slowing GDP growth in 2007 versus 2006, with weakness centered in finance and in construction—especially housing.
The BEA’s map, reproduced below, shows several features of GDP growth in the Seventh District states—Illinois, Indiana, Iowa, Michigan, and Wisconsin.
Click to enlarge.
GDP growth in all five states of the Seventh District fell short of the national level in 2007. Michigan recorded a decline of 1.2 percent, marking the state’s second year in a row of economic output decline and its third such year over the past four.
In contrast to Michigan’s ongoing slow growth, many previously high-growth states in other regions experienced sharp declines in growth for 2007 versus their 2006 pace of growth. In particular, Arizona’s growth pace slowed from a 6.7 percent pace in 2006 to 1.8 percent in 2007; California went from 3.8 percent to 1.5 percent, Florida from 3.6 percent to flat, and Nevada from 5.4 percent to 0.6 percent.
The overall pace of growth in the Seventh District states slowed much less dramatically—from a pace of 0.9 percent in 2006 to 0.6 percent in 2007. This can be attributed to two major developments. First, the size of the highly impacted residential construction industry is much larger in high-growth states such as Arizona, Nevada, and Florida. While Midwestern states have experienced similarly sharp declines in housing activity, the impact has been proportionately larger outside of the region.
Another factor is that the U.S. manufacturing sector did not decline to the same extent in 2007 as it has in previous economic slowdowns. The falloff in new home sales and construction has exerted a drag on certain manufacturing industries, such as building materials and home appliances. However, other industries, such as machinery and computing equipment, continue to be buoyed by rapid growth in exports abroad, while others, such as mining and farm machinery, are being lifted by the global surge in commodity demand. For the manufacturing-intensive Midwest, then, the pace of overall economic growth has not slowed as much as it has in most previous episodes.
Another notable trend can be seen from the differing pace of growth within the Seventh District (see map above). Starting from the eastern states of the Seventh District, GDP growth in Indiana and Michigan significantly underperformed the western states of Illinois, Wisconsin, and Iowa. By way of explanation, the sagging domestically domiciled U.S. automotive industry exerts a heavier influence on Indiana and Michigan (and Ohio, too).
May 15, 2008
Foreign Direct Investment in the Midwest--Update
Americans sometimes harbor mixed feelings about investment in enterprises on U.S. soil that are owned and directed by companies domiciled abroad. Yet for the most part, investment from overseas represents a validation of the productive business climate in the domestic economy. Here, our system of law and contracts, along with productive workers and well-conceived public infrastructure, offer conditions that are conducive to value creation. In turn, foreign direct investment (FDI) activities can benefit our workers and households. New investment and ownership often bring new technology and ideas to American shores, thereby boosting our own growth, wages, and standards of living.
In recent decades, FDI has grown rapidly to comprise a larger share of the U.S. economy. As documented in our recent article, the share of employees working for all companies that are U.S. affiliates (those in which a foreign investor owns at least 10%) grew from 1.8% in 1979 to 4.7% in 2000. According to more recent data, this share has remained fairly constant through the middle of the current decade—now 3.9% by that estimate.
Much of recent growth in inbound FDI has resulted from accelerated globalization and rapid world economic growth. Due to a greater ease of communication and lower cost of personal travel and goods shipment, global breadth of enterprises has expanded. General Electric employs 316,000 worldwide, 155,000 outside of the U.S. General Motors employs 335,000 worldwide, 193,000 abroad.
In addition, although the U.S. has maintained its economic prominence in the world economy, the U.S. economy now comprises a smaller share of global production (27% as of 2006). And so, without any countervailing forces, this simple arithmetic would suggest more inbound FDI as a share of the U.S. economy. By one estimate, the U.S. share of global outbound FDI outflows have in fact declined from its 1970 value of 54% of global FDI to 18% in 2006.
While global economic growth is the largest generator of inbound FDI to the U.S., the exchange value of the U.S. dollar versus other currencies can also be influential. The value of the dollar has fallen by 25% since 2002, measured against a basket of currencies weighted by our trade with other countries. For this reason, investment in productive capacity on U.S. soil may look increasingly attractive to foreign-domiciled companies. For one, for those foreign companies that hold their earnings and assets in foreign currencies, the purchase price of physical capital in the U.S. such as real estate, intellectual property, and factories will be cheaper. For companies that now sell into the U.S. market from production facilities abroad, the shifting of production to the U.S. may be advantageous in generating production costs in the same currency as their sales.
Further, for those companies that use their U.S. facilities as a platform from which to export to markets outside of the U.S., earnings on sales will likely be denominated in foreign currency rather than in U.S. dollars. Recent developments in FDI in the U.S. automotive sector may be reflective of these considerations. Several European carmakers are currently considering setting up production in North America, among them Volkswagen and Audi. And exports of U.S.-produced light vehicles have been rising, according to Chicago Fed economist Thomas Klier. From 2002 to 2007, the share of U.S. production that is exported to non-NAFTA countries alone has risen from 3.0% to 11.6%.
In recent years, the state of Indiana has done well by FDI in automotive and other (mostly manufacturing) investments from abroad. The Business Research Center at Indiana University (BRC) has recently issued an extensive report that reviews the global environment for FDI with an emphasis on Indiana and surrounding Midwest states. According to U.S. government data as of 2005, Indiana’s economy ranks 8th in the nation and first in the region as measured by the ratio of FDI to state economic output. (Michigan also exceeds the U.S. average.) As measured by jobs, the United Kingdom and Japan were virtually tied as the number one source of FDI into Indiana, each accounting for 32,000 jobs.
The U.S. government data on FDI for states does not necessarily reflect new investment or added jobs. Rather, most FDI transactions are mergers and acquisitions. For this reason, and because government data are not very timely, the BRC also gathered information from a private vendor on announcements of FDI expansions and new facilities. Since these are announcements rather than completed transactions, we cannot be certain these investments will actually take place. But according to BRC estimates, Indiana will gain nearly 5,000 jobs from 2007 announcements, mostly in the automotive industry. The implication is that Indiana will widen its lead among Midwestern states in the FDI category. An appendix to the BRC report proudly maps the specific FDI projects in which Indiana’s state development agency has completed or participated.
Competing state and local development agencies throughout the Midwest will surely take note.
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.
February 20, 2008
Educated (young) workers and regional growth
By Britton Lombardi, Associate Economist
As the U.S. continues to grow into a knowledge-based economy, human capital and ideas earn a higher premium. Therefore, competition for future economic growth and vitality leaves states and large metropolitan areas vying to attract and retain the young, well-educated population within the U.S., commonly defined as 25- to 39-year-olds with at least a bachelor’s degree. These young and educated adults have certain characteristics that make them particularly appealing to metropolitan areas, such as their especially high mobility and entrepreneurial tendencies.
Among a number of interested parties, policymakers, businesses, and researchers question what attracts these young professionals to certain areas over others. Some of the allure could come from characteristics that are specific to the individual, such as a job offer or personal relationships. However, Yolanda Kodrzycki of the Federal Reserve Bank of Boston, finds that these young professionals also exhibit certain general preferences. They gravitate toward areas that have high job growth, high average pay, and an array of employment opportunities where they feel possibilities and opportunities abound. At this point in their lives, they are the most flexible, and many may still be trying to choose a career path; therefore, a region that will allow them to explore many options is more attractive to these individuals. The payoff to successful “job matching” can be especially high for younger people because payoffs may accrue over a lifetime career supplemented with further learning and development. This implies that certain industry clusters may help attract specialized human capital to a location. A current trend going back two decades has been that cities with a strong technology industry have appealed to a disproportionate number of these young professionals. However, cities that have focused on other knowledge-intensive industries like finance and real estate have done well too. Metropolitan areas that value human capital and maintain a strong regional economy draw in these young and educated individuals.
Besides the direct advantages of high-wage jobs, the clustering of young professionals in an economy provides spillover benefits of knowledge and innovation through networks among firms and workers. Places such as the San Jose area are legendary for frequent job-hopping among workers, who thereby spread innovation more broadly. Such innovations typically involve tacit knowledge and know-how. Looking at patent data, Jerry Carlino has demonstrated how a higher density of skilled workers leads to a higher level of intellectual property.
Aside from economic opportunity, amenities offered by populous urban areas are also thought to attract young professionals. They often prefer to live in lively neighborhood areas within a few miles of the city center and take into account the affordability of this type of housing. Other amenities that appeal to this population include parks or other areas for walking and outdoor recreation, reliable public services including transportation, vibrant neighborhoods, and a dynamic commercial district. However, the extent to which these amenities matter remains the subject of debate and further study.
Warmer climate has been a magnet for the general U.S. population over recent decades. However, cold-weather cities can seemingly compensate with a combination of vibrant economic opportunities and/or big-city recreational and cultural features. The table below, for example, examines working age college-educated migrants from 1995-2000. Although the metropolitan areas that had the five highest net in-migration rates were located in the South and West, both the Minneapolis-St. Paul and Chicago areas posted relatively high net in-migration rates. Indeed, Minneapolis-St. Paul ranked among the top ten highest for that period.
A recent discussion paper issued by the New England Public Policy Center further explores the regional concentration of young professionals using data from the 1980, 1990, and 2000 Censuses and the 2005 American Community Survey (ACS).
The concentration of young, educated workers in any one region depends on the extent that its young residents achieve college education and the region’s ability to retain them, as well as attracting others from around the U.S. and abroad. As of 2005, New England had the highest concentration of young, educated individuals in the nation, with 38.6% of its 25- to 39-year-olds holding at least a bachelor’s degree compared with 30.1% for the U.S. (see table below). However, overall educational attainment in the U.S. increased between 1980 and 2005, especially between 1990 and 2005 when the number of college educated, 25- to 39-year-olds soared by 22%. The Middle Atlantic, East North Central, and South Atlantic regions outpaced New England’s rise, although they began with lower percentages.
The discussion paper further calculates a net migration rate from 2004 to 2005. The rate takes the difference between the gross inflow and outflow of domestic young professionals in relation to the base population of that age group. Migration rates are calculated as described but multiplied by 1000 to make it a rate per 1,000 residents. Using this measure, only the Mountain, South Atlantic, and Pacific regions have positive net migration rates of 20.4, 10.9, and 1.0, respectively. The two Midwest regions, East North Central and West North Central, had the two most negative net migration rates of -9.5 and
Movements of workers to and from abroad have recently become a more integral part of regional work force composition. Using a similar calculation as above, but only accounting for international inflows due to data limitations, New England comes in second highest with international inflows of 14.4 behind only the Pacific with 17.4. The East South Central region reported the lowest inflow of these individuals with 5.1; West North Central comes in second to last with 7.9. The East North Central barely outpaces West South Central as the fourth and third from the bottom with 11.6 and 11.4, respectively. Again, the Midwest appears near the bottom of the rankings, heightening concerns about not only maintaining or attracting domestic young professionals but gaining international ones. In New England’s case, the net inflow of international young professionals seems to offset the region’s domestic losses, but this does not hold true for some of the other regions, including the Midwest.
Although emphasis has been placed on young professionals, the growth in older workers, those aged 55 and above, will be the largest of any working-age group over the next ten years. The older labor force is projected to grow by 46.7% from 2006 to 2016 — more than five times the projected annual growth rate of the overall labor force of 0.8%. This large projected growth rate results from the aging of the baby boom generation into their “golden years” and still participating in the labor force. Older workers may continue to work due to the removal of the earnings test from Social Security, the increased retirement age for receiving Social Security benefits to 67, decreased employer-provided retiree health benefits, and the improved health status of older individuals.
Another reason for employers and regions to focus on older workers stems from the diminishing education attainment gap between young entering workers and older workers. Dan Aaronson and Dan Sullivan document the dramatic overall rise in educational attainment of the U.S. workforce since the 1970s. Educational attainment has been climbing as younger (more educated) cohorts have been displacing older (less educated) cohorts as they retire. Today, younger workers are only as educated, on average, as those that they displace at the older end of the workforce, and their lesser work force experience may put them at a disadvantage in some respects. All the more reason for employers to turn somewhat to older cohorts for tomorrow’s needed work force skills.
As the number of older workers continues to increase, will firms and policymakers shift some of their attention to retaining or enticing these workers by giving them incentives to extend their careers or possibly return to the work force? Older workers offer benefits to businesses that might not be available from young professionals, such as leadership, experience, and specialized skills gained over their lifetime that can increase productivity and output. On the other hand, these older workers have characteristics quite different from those of young professionals. They tend to prefer more flexible work schedules to balance work and family and to be less mobile geographically. Therefore, they may require a slightly different and possibly more demanding set of economic incentives and living amenities.
October 16, 2007
Mid-year jobs report
By Guest Blogger Vanessa Haleco-Meyer, Associate Economist
Economists and policymakers often pay close attention to payroll job numbers because they are among the most current and wide-ranging economic indicators available for states and regions. However, payroll job numbers should be viewed with caution as they are subject to revision; that is, an annual revision is undertaken during early March for the data of the previous five years.
The Midwest—comprising Illinois, Indiana, Iowa, Michigan, Minnesota, Ohio, and Wisconsin—saw moderate year-over-year employment growth in the first half of 2007. The Midwest had 0.2% nonfarm employment growth, while the U.S. had a 1.5% gain (see the figure below). Each state in the Midwest posted growth in jobs, except for Michigan and Ohio.
Most major industry sectors contributed to the Midwest’s sluggish employment growth (see the table below). The region’s manufacturing employment decreased, in large part due to the auto and housing industries’ troubles. Midwest employment expanded in the professional, education and health, and leisure and hospitality sectors, though at a slower pace than in the nation.
Rising by at least 1 percent, the professional, education and health, and leisure and hospitality industries led employment growth in the region. Because these sectors make up a good portion of the Midwest's industry mix (see the table below), they offset declines or tepid growth in other industries.
The Finance Industry
The finance industry also helped sustain overall job growth during the first half of this year. Going forward, this sector’s performance could falter as financial firms react to changing credit conditions. In fact, some lenders have reportedly laid off staff in Chicago, Detroit, and Carmel, IN.
The Auto Industry
Indiana, Michigan, Ohio, and Wisconsin all reported declines in manufacturing; those states were heavily weighed down by the declining production activity in the automotive industry. According to the Chicago Fed Midwest Manufacturing Index, auto production in the Seventh District, which comprises all of Iowa and most of Illinois, Indiana, Michigan, and Wisconsin, declined 2% from the first half of 2006. Light vehicle sales and production in the U.S. decreased during the first half of the year (compared with last year) in part because of the ongoing struggles of the Detroit Three automakers (Chrysler LLC, Ford Motor Co., and General Motors Corp.). Payroll auto employment in Michigan reported an 11% drop year-over-year for the first half of 2007. Wisconsin also reported an 11% drop; however, the auto industry makes up a very small share of Wisconsin’s industry mix. Indiana’s auto employment reported a drop of 4%, and Ohio’s decreased by 7%. Automotive employment declines are not confined to production workers. Last month (on September 6), Volkswagen announced its plan to move its headquarters to Herndon, VA, which would shift 800 jobs away from the Detroit area.
Having discussed some of the major industries across the region, I now turn to the employment performance and outlook for the individual states.
With strong growth in the professional, financial, education and health, and leisure and hospitality industries, Illinois reported about a 1 percent rise in nonfarm employment for the first half of this year compared with last year. These industries’ growth in jobs outweighed small contractions in manufacturing and government employment.
Aside from the drop in manufacturing employment (and essentially no change in the number of jobs in the natural resources and mining sector), Indiana experienced growth in all other sectors. Based on the employment growth in most of its industries, Indiana reported a small increase in total nonfarm employment. Interestingly, the sector with the largest year-over-year growth was construction, even though housing starts and permits both decreased in the first half of the year. Recently, the relationship between housing construction activity and construction employment has remained murky in Indiana and elsewhere. Construction employment has held up better than some might have anticipated.
Iowa reported above a 1% growth in total employment partly due to its strong professional and financial industries. For the first half of the year, Iowa also experienced greater than 1% growth in its construction, information, education and health, and leisure and hospitality industries. Similar to Indiana, Iowa recorded a significant increase in construction jobs, even as home building slowed.
Michigan reported a drop of 1% in nonfarm employment, which is in line with the rate of decline it has experienced since the beginning of 2006. Job losses were widespread across major industry sectors, with the exception of solid growth in the education and health sector as well as the leisure and hospitality sector.
Minnesota reported a 1% growth in total employment largely because of its expansions in the professional and financial industries. While Minnesota saw some declines greater than 1% in natural resources and mining as well as in construction, these industries form only a small portion of the state’s industry mix. These declines were more than offset by the strength in the professional and financial sectors, as well as by the reported 3% gain in education and health and the smaller 1% gain in the trade, transportation, and utilities sector.
Ohio’s overall nonfarm employment experienced a dip. However, this decline was partly offset by the strong growth in its professional as well as its education and health industry. The trade, transportation, and utilities sector also posted a small gain.
Overall, Wisconsin reported a small increase in total nonfarm employment. Other than a decrease in manufacturing and construction, Wisconsin’s other industries expanded in the first half of the year. Manufacturing excluding the auto industry reported a decline of 1.7%.
As measured by payroll employment growth, the Midwest economy continues to expand more slowly than the nation. A general pattern of increasing weakness is evident in contrasting the westward states of Iowa, Minnesota, Illinois, and Wisconsin with Michigan, Ohio, and Indiana in the east (see the figure above). Automotive restructuring there, along with flat nationwide sales in light vehicles, continues to account for a lagging pace of payroll employment.
July 18, 2007
Automotive wages in flux
As the “Detroit 3” automotive companies have experienced shrinking profits and market share, many midwestern communities have experienced falling jobs, income, tax revenues and public services—to say nothing of the households and families working in the industry. This summer, automotive workers and communities are watching closely as the terms of automotive employment—especially wages—are being renegotiated. On July 20, for example, the UAW labor union opens contract negotiations with Ford and Chrysler (July 23 for General Motors) for contracts that will run for 4 years. And earlier this month, auto parts maker Delphi announced settlement terms with its workers as it undergoes operational restructuring. Only four Delphi production plants will remain in operation in the U.S. as its customers will source parts from its overseas operations or from alternative suppliers. Remaining Delphi production workers will be on the receiving end of cuts to health care benefits, employment security, retirement and wages. Wages for production workers will be reduced from $27 per hour to a maximum of $18, $14 for new hires.
How should we view the wage settlements as they are announced in coming months? One perspective is to compare them to average wages for production workers in U.S. manufacturing. Production workers are typically those who have few or no supervisory roles in manufacturing plants; in other words, most assembly line workers would fall into this category. The chart below displays average wages for production workers back to 1967. These wages represent the average in compensation for overtime and regular time. The wages are expressed in current dollars, adjusted over time for changing prices by the Consumer Price Index.
The bottom line shows that, across all manufacturing industries, average wages have remained largely flat since 1967, ranging between $17 and $20 per hour. Wages were rising until 1980. With several deviations, the average wage settled at $ 18.59 in 2005, which is the latest available data from this particular source.
In the same graph, we can see that that production workers in motor vehicle parts industries (blue line) have fared somewhat better over time, but that their wages have been converging with the remainder of manufacturing workers since the 1980s.
Workers in the automotive assembly industry (green line) are smaller in number than those in parts production. In the U.S., there are approximately three workers in parts production for every worker in an assembly plant. Unlike their brethren in parts production, assembly workers’ wages have been generally rising since 1967. By 2005, the U.S. Census Bureau reported an average production wage of $35.84.
The second graph below plots the premiums in wages for automotive workers. This premium is expressed as the percent by which wages exceed the average of all U.S. production workers across all industries. As of year 2005, the average wages of automotive assembly workers topped their counterparts by 50 percent. For motor vehicle parts workers, the wage premium has fallen below 20 percent from a peak of 31 percent in 1980. Approximately one-third of workers in the parts industry are represented by labor unions versus three-fourths of domestic assembly workers.
Declining employment has accompanied softening wages in many instances. From a geographic perspective, declining automotive jobs is nothing new for many midwestern states and communities. The industry was highly concentrated in the Midwest throughout the first half of the twentieth century but afterward began to disperse—first to other U.S. states and later around the globe. Considering domestic employment in automotive parts and assembly combined, the next graph shows that the states of Ohio, Michigan and Indiana accounted for over three-fourths of automotive employment through World War II. By 2005, their employment share had fallen under one-half.
During the current decade, the automotive job decline has been precipitous. The final graphic (below) indicates that the three-state decline in automotive jobs has fallen by almost one-third since year 2000, from 576,000 to 383,000 over the first half of 2007.
The reasons for these employment declines are several.
As always, productivity gains are reducing the labor content in automotive production. Labor hours per vehicle assembled by the “Detroit 3” car makers, for example, declined from 24–28 hours in 2002 to 22–23 hours in 2006. Beyond assembly, estimates by Martin Baily of the McKinsey Institute and the Institute for International Economics report that labor hours to produce an auto in North America, including parts, are decreasing at an annual average of 1.7 percent annually since 1987, and are now approaching 100 hours total.
Globalization of production has resulted in both off-shore operations and competitive pressures on domestic producers. Since 1996, the import share of light vehicle sales has increased from 12 percent of sales to 20 percent, year to date. Approximately one-quarter of domestically used automotive parts are now sourced abroad.
Despite some periods of re-concentration over the past 2 decades and the siting of many new plants in various Midwest communities in recent decades, the overall industry continues to disperse to other states, especially in the South.
Note: Thomas Klier contributed to this entry.
June 15, 2007
The Stability of State Economies
By Guest Blogger Michael Munley
In recent years, Fed Chairman Bernanke and other economists have been analyzing the causes of the increased stability in the U.S. economy, a phenomenon known as "The Great Moderation." Most of their analyses have focused on the national economy, noting that the fluctuations, or volatility, in GDP growth, employment growth and inflation have declined noticeably over the past 25 years or so. But a Philadelphia Fed economist, Jerry Carlino, recently wrote a paper that looks at the issue at the state level and finds that every state has shared in the decline in employment volatility.
Increased stability has numerous benefits for both households and businesses. When employment is growing at more stable rates, people can be more certain of their job prospects, which makes it easier to decide whether to buy a new car, for example. Similarly, businesses have an easier time deciding whether to invest in new machinery when they can be more certain about the state of the economy. In turn, better decision-making by people and businesses can minimize the potential waste in the economy created by bankruptcies and other problems that can arise when people make decisions that turn out poorly.
Comparing the average volatility (measured in Carlino’s paper as the standard deviation of quarterly changes in employment) before and after 1984, Carlino’s results show that the states of the Seventh District all had declines that ranked in the top half of all U.S. states. Michigan ranked 2nd with a 63.6% drop in volatility, Indiana 4th with 57.1%, Wisconsin 8th with 52.5%, Iowa 16th with 45.3%, and Illinois 20th with 42.7%.
The following graph illustrates how the volatility in total employment has changed over time in each of the District states, converging toward the national average.
Click to enlarge.
One reason for the relatively bigger declines in employment volatility in the Midwest is our concentration in manufacturing and, specifically, our concentration in durable goods manufacturing. Carlino reports that volatility in U.S. factory employment was cut in half after 1984, whereas the declines in employment volatility in services were much smaller. And by my estimates, the volatility reduction in durable goods manufacturing employment was much sharper than that in nondurable goods.
As a result, Seventh District states ranked in the top half of all states in terms of the magnitude of the decline in manufacturing employment volatility. Michigan ranked 1st with a 66.3% drop, Indiana 3rd with 63.1%, Wisconsin 7th with 56.9%, Illinois 12th with 55.7%, and Iowa 22nd with 48.8%.
I’ve also looked at other state-level data series to see if they too reveal evidence of the Great Moderation. The quarterly changes in unemployment rates show similar reductions in volatility to those seen in employment (though the state-level unemployment data only go back to 1976). Real per capita income also shows a reduction in volatility, but the relative reductions are smaller.
Click to enlarge.
Click to enlarge.
Interestingly, whereas the District’s concentration in durable goods manufacturing seemed to lead to larger reductions in volatility compared with other states, that is not the case with changes in unemployment rates and personal income. As shown in the following table, the Midwest states’ reductions in unemployment and income volatility were rather middling.
Carlino notes that the economists who have been tracking the Great Moderation have proposed numerous reasons for the decline in volatility nationwide. Explanations include better monetary policy, structural changes (such as improved inventory management, the decline of unionization, the redistribution of jobs from manufacturing to services, banking deregulation), and plain good luck, in that the economy has not faced any significant crises like the oil embargo of the 1970s.
Regardless of the causes, it is clear that changes in employment and other variables are much more stable here in the Midwest than they were 25 years or so ago. Yet while lower volatility has its benefits, it does not uniformly deliver positive outcomes. Typically, volatility rises during a recession (as shown in the graphs above) then settles back down when the economy recovers and employment expands again.
However, that has not been the case in Michigan. Its volatility in all three variables increased during the 2001 recession and retreated since then, but the state economy has not recovered. Michigan's employment has been stabilizing around an average decline in jobs (-0.2 percent per quarter over the past five years). Its unemployment is high; in April the unemployment rate in Michigan was 7.1%, the highest in the nation. And per capita incomes in Michigan are stabilizing around slow growth of 0.1% per quarter, which is below the national average and among the slowest in the nation.
If you buy the assumption that the observed volatility affects the confidence of business and household decision-making, this means that Michiganders could be getting more certain that the local economy is heading in the wrong direction.
May 29, 2007
Seventh District Housing Market Update
For several years running, the national pace of investment in housing greatly exceeded historic norms. Accordingly, housing market observers speculated that strong rates of home building and price appreciation would falloff markedly at some point in the near future. Nationally, real residential investment growth averaged 9 percent from 2003-2005; average home prices rose by 6.8 percent in 2003, 10.7 percent in 2004, and 13.1 percent in 2005.
During the first half of last year, the pace of home construction and home price appreciation finally slowed. Since then, home building activity and sales have declined sharply and, by some measures, changes in home prices are now running in negative territory. Since the fourth quarter of 2005, U.S. residential investment has been declining, averaging over 11 percent on an annualized basis. The growth of the OFHEO measure of national average home prices has slowed to 5.9 percent year-over-year for the last quarter of 2006 (new data will be released on May 31).
During the current decade, home prices appreciated in the Midwest as well, though less so than in the nation and much less so than several southern and coastal markets such as San Diego, Las Vegas, and many parts of Florida. For this reason, during the years of strong price appreciation, some observers believed that the Midwest would be spared the eventual price and building falloffs that would unfold in other regions. So far, this does not seem to be the case. Most major residential real estate indicators currently show the Midwest region with comparable or weaker fundamentals than the national average. The chart below illustrates the pace of new home construction starts in the Seventh District states versus the U.S. Measured on a year-over-year basis, home starts in the Midwest have been running below the nation since early 2006.
For the most part, the weaker Midwest economy lies behind its weaker housing markets versus the national average. The current slowing of the U.S. economy has been accompanied by a marked slowing in manufacturing which has, in turn, softened the housing market in many local Midwest communities. In addition, ongoing structural upheaval in automotive-oriented communities is reflected in several housing market indicators including home purchases, home prices, and in foreclosures of existing properties.
Residential real estate market conditions are highly local. The maps below juxtapose home price appreciation and unemployment rates in Seventh District metropolitan areas. Looking at the top map, unemployment rates in many Michigan communities are notably higher than the general pattern in the other Seventh District metropolitan areas. Retrenchment in domestic automotive assembly operations and suppliers in Michigan has resulted in significant work force upheaval. Automotive-oriented communities in other states of the Seventh District—such as Kokomo, Indiana—have had similar experiences. After Michigan, Indiana is the second most automotive intensive state in the Seventh District.
The second map (above) displays year-over-year house price appreciation for the same metropolitan areas. To some degree, areas with a slack labor market are experiencing less home price appreciation. This is especially evident in Michigan and Northwest Indiana where the domestic automotive industry troubles are centered.
The linkage in these states between the local economy and the housing market is consistent with available information on home loans. The pace of loan delinquencies and mortgage foreclosures in both of these states are now running higher than both the nation and other states of the Seventh District.
Home price appreciation is stronger in Chicago and in many other metropolitan areas in Illinois and Wisconsin. In the Chicago area, job growth in business services, travel-tourism, and financial services industries have continued to expand. In other metropolitan areas to the west of Indiana and Michigan, manufacturing tends to be concentrated in more buoyant product lines, such as construction and farm machinery or food processing. As a result, home prices are generally holding up better in those areas.
Labor market conditions fare well in many Iowa metropolitan areas. Yet, average home price appreciation there is generally tepid. To some degree, home price appreciation has been very steady in Iowa over many years and the current pace of appreciation does not differ markedly from the norm of the past 15 years (see below).
Nationally, residential real estate activity continues to adjust downward to align with its rapid expansion of recent years. In particular regions and communities, the extent of adjustment varies with both the stock of existing housing and with local trends in economic growth which drive the demand for housing. Generally, new construction activity and price appreciation have softened in the Seventh District but local conditions can be seen to vary with local economic indicators.
February 26, 2007
Medicaid: In need of reform in Midwest states?
By Guest Blogger Rick Mattoon
The U.S. Medicaid program provides healthcare coverage and long-term assistance to over 41 million low-income families and 14 million elderly people and persons with disabilities, according to the Kaiser Foundation. Given the high and rising costs of medical care, it is not surprising that the Medicaid program typically represents the largest single budget item (roughly 20%) for most state governments, having surpassed K-12 education. As such, the rising expenditures of state Medicaid programs are often the biggest culprit in the imbalance in state budgets from year to year. The question is, given current trends, can states afford Medicaid in the future without structural changes in either the program or in funding?
Medicaid is now funded as a partnership between the federal government and the states. The federal government provides matching funds (FMAP) as determined by a formula with the matching rate varying from 50% to 77% on the dollar. Given this matching feature, states have long been motivated to take advantage of the federal match by expanding their programs. In response, the federal government has tightened up eligible services, leaving many states with sole funding responsibility for certain current program services. In turn, many states have enacted cost containment strategies.
These developments have slowed the growth of Medicaid expenditures of late, holding it to 2.8% in FY2006 from an annual average of roughly 7.7% from 1997 to 2005. States have also enjoyed some respite from Medicaid budgetary pressures with the shifting of many prescription drug expenses to the federal government under the new Medicare Part D program covering prescription drugs. Budgetary pressures also have been eased from the revenue side as widespread economic recovery in the U.S. has often yielded better than expected state revenue growth. However, the respite may prove to be short-lived; states are budgeting for Medicaid growth of 6% in FY2007. Unfavorable trends will continue to put pressure on Medicaid spending including a growing elderly population, rising general health costs and an increasing number of uninsured in the general population.
In addition to addressing funding pressures to sustain existing programs, many analysts believe that Medicaid programs should be refashioned. Recent studies to this effect have been issued by the Medicaid Commission’s report to the Secretary of Health and Human Services and a report from the Deloitte Center for Health Solutions. For example, the Medicaid Commission recommended changes in five critical policy areas. These are:
• Long-term care—including providing incentives for individuals to plan for their own long-term care needs and shifting long-term care toward at-home rather than institutional care.
• Benefit design—providing states with greater flexibility to custom design Medicaid coverage to meet the needs of their covered population. In addition, an incentive system should be considered to reward Medicaid recipients who make prudent purchasing, resource-utilization and life-style health related decisions.
• Eligibility—permitting states to consolidate eligibility categories and increasing federal support for new options for the uninsured to obtain private insurance rather than falling into the Medicaid program. So too, the federal matching program should be scaled to provide a larger match for adding low-income recipients (the intended population for Medicaid) and a smaller match for adding higher income populations.
• Health information technology—including broad support for expanding the use of information technology including having all Medicaid beneficiaries having an electronic record by 2012.
• Quality and care coordination—further expansion of coordinated care programs as well as measuring the effectiveness of treatment by providers.
The Deloitte study suggests that fundamental reform is needed, particularly in the area of actively managing Medicaid programs. The study suggests that policymakers should be guided by six key choices in reforming their Medicaid programs.
• Choice 1. What should be the core function of the state’s Medicaid program?
• Choice 2. Should the program services be directly managed by the state or should it be contracted out?
• Choice 3. Where should the state be on the continuum between “traditional” Medicaid benefits and coverage and free health care for all low-income residents?
• Choice 4. Will the state go beyond simple program administration and use the Medicaid program to actively control the costs and quality of healthcare throughout the state?
• Choice 5. Which cost savings and policy levers will the state use to reduce, or at a minimum contain, the costs of the state’s program?
• Choice 6. To what extent will Medicaid recipients share in the state’s burden of cost reduction?
Clearly when it comes to Medicaid, there is no shortage of potential reforms.
To help investigate these issues, on March 15, the Federal Reserve Bank of Chicago and the Civic Federation are cosponsoring a program to look at the current status and features of Medicaid and how states are dealing with this sizable program responsibility. The conference attendees will hear from Medicaid policy researchers including representatives from the Kaiser Foundation and the University of Illinois, as well as the directors of the Medicaid programs in Illinois, Iowa, and Indiana. A keynote address will be delivered by former Wisconsin Governor and U.S. Health and Human Services Secretary Tommy Thompson. To register for this program please go to http://www.civicfed.org/events/070315_RegistrationForm.pdf.
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.
February 5, 2007
Michigan Labor Market--Still Awaiting Recovery
Following the 2001 national recession, the labor market remained somewhat slack and slow-growing until mid-2003. Subsequently, the national economy accelerated, pulling along labor demand and employment growth. The year 2006 marks the third consecutive year of strong year-over-year employment growth (and falling unemployment) nationally.
Meanwhile, the Seventh District, which includes the state of Iowa and most of Michigan, Indiana, Illinois, and Wisconsin, also experienced an employment recovery. However, the pace of job growth in the Seventh District has fallen somewhat short of the nation over most of the post-recession period. From the fourth quarter of 2001 until the fourth quarter of 2006, payroll job growth is currently reported to have risen by 3.9 percent in the nation, versus 0.7 in the Seventh District states overall.
Much of the Seventh District weakness is confined to Michigan, and recent indications show little sign that the Michigan labor market performance is turning around. As illustrated below by a 3-month moving average of monthly unemployment rates, the U.S. and the rest of the Seventh District states (excluding Michigan) have reported a falling rate of unemployment over much of the past 3 years. Currently, the region’s unemployment rate lies very close to the nation at around 4.5 percent. In contrast, Michigan’s current unemployment rate, after improving in 2005, is now back where it was in 2004.
Click to enlarge.
Unemployment rates are not fool-proof indicators of labor market performance because they are conducted by household surveys which are subject to sampling bias. However, other independent indicators tend to corroborate these survey indicators. Among the other indicators, the survey of payroll employment at business establishments is reported for states by the Bureau of Labor Statistics. It too is based on a survey, and it is revised later as more information becomes available.
Below, year-over-year growth in payroll employment is shown for Michigan versus the District and the U.S. The payroll survey suggests that Seventh District job growth, though slower than the U.S., has shown steady growth over the past three years. Michigan’s year-over-year job growth has continued to decline—at an accelerating pace.
So too, reported information on initial claims for unemployment insurance by laid off (or otherwise severed) workers exhibits the same pattern: deterioration at an accelerated pace over the past three years in Michigan, and improvement outside the state.
In past decades, weak automotive-related performance in Michigan has sometimes been appraised as temporary or cyclical. However, this time around, as indicated by labor market performance in surrounding states, weak economic performance in Michigan appears to reflect structural problems for auto makers and automotive supply companies. Since early 2004, Michigan has lost 17.6 thousand net jobs at auto assembly establishments (a 24 percent decline) and 27.5 thousand jobs in motor vehicle parts production (a 15.8 percent decline).
Overall domestic automotive production is being eroded by imports and by enhanced production and sales of transplant automotive companies who largely produce outside the state of Michigan. Recent employee buyout programs at Ford, General Motors, and Delphi will result in a head count reduction of nearly 100,000 across the U.S. Approximately one-third of those jobs are situated in Michigan.
At least for the near future, the Michigan labor market situations does not yet look to be improving. The Michigan-domiciled auto assembly companies foresee or have announced continued employment reductions and facilities closings in both production and in administrative/R&D employees. Longer term, the Michigan economy's sharp automotive concentration means that the labor market will continued to be driven by developments in the industry.
October 11, 2006
Global Agriculture Conference
On average, rural America has not been faring as well as metropolitan America in terms of population and income growth. Is this trend yet another painful adjustment that can be attributed to globalization?
Globalization policies continue to be closely intertwined with agricultural markets, which have been the historic lifeblood of rural communities in the Midwest. Last month, the Chicago Fed held a conference on “Globally Competitive Agriculture in the Midwest.” The event included the Midwest release of a task force report by the Chicago Council on Global Affairs, Modernizing America’s Food and Farm Policy. Conference discussion concerned how current global trends and policy debates are affecting agriculture and rural communities, and how prospective policies such as the next Federal farm bill and the Doha round of the world trade talks might play out.
During the conference discussion, several presenters expressed the opinion, without challenges from the audience, that globalization was in some way responsible for the lagging economic performance and stark challenges facing the rural Midwest. However, I think that it is somewhat mistaken to confuse globalization with technological advances and associated structural changes now taking place in the production of agriculture.
First, to concede some ground to the opposition, several forces of globalization have hastened structural adjustments taking place in smaller towns and rural communities. In particular, an expansion of the world market for goods and services has sharpened the economic specializations of many countries and their subnational regions. For the U.S., as global markets in goods, services, and capital have been opened up, the domestic economy has shifted away from manufacturing production and less-skilled services such as back office processing, some software production, and call center activity in favor of advanced services such as finance, investment, and management. For such advanced services, the large urban form, rather than the smaller city or rural town, is the more productive and favorable locale. This preference of industries performing such advanced services has contributed to the growth of large metropolitan areas, such as New York, Chicago, Washington, D.C., Atlanta, and San Francisco.
Aside from that, there is little to argue about globalization as a detriment to rural economic growth. And even at that, I would argue that technological advancements, rather than globalization, account for most of the structural changes that are moving us toward an advanced services economy in the U.S. New technologies, particularly their adaptation in wireless communication and in advanced computing, are highly complementary to such service production, with or without globalization. This is evident the world over as wages, salaries, and employment opportunities have risen sharply for those workers who have the education and technical skills to work with advanced communication and technical tools.
While rural areas have not fared as well in advanced services, the net effects of globalization on commodity production and income in rural areas are mixed rather than one-sided. In much of rural America, the local economy is highly dependent on commodity agriculture or on commodity materials such as energy products, minerals, and timber. Here, relentless productivity advances, especially in agriculture, have obviated the need for as much labor as in the past. In turn, lessened labor demand has put pressure on rural growth.
Yet, such labor substitution is hardly related to globalization. It is true that global markets can introduce competition into commodity markets. Yet, on the flip side, falling transport costs and more open markets also increase possibilities for heightened exports and firmer prices for the commodities produced in rural areas. In the Midwest, for example, global exports in soybean and corn have helped to sustain jobs and income. More recently, as developing countries have improved their diets, U.S. exports of beef, pork, chicken, and poultry have grown. Here, the competitive advantage in grain production translates into local livestock production. The processing of grains and livestock (in order to shed weight and volume before exports) is kept close to the location of grain and livestock production, that is, rural communities.
Growing global growth has also boosted prices of carbon-based fuels. As a result, exploration, mining, and production of fuel sources are providing more jobs and lifting income in many rural communities. In corn-producing states, federal subsidies have combined with rising prices of fossil fuels to spur rapid expansion of corn-based ethanol capacity as a viable energy source. As a result, prices for corn have been raised and are expected to remain so. Moreover, ethanol plants are being built near corn production in rural communities, thereby boosting associated manufacturing jobs.
But ethanol production has not been the only source of manufacturing jobs in rural communities. In the Midwest, as shown below, rural and nonmetropolitan counties have been gaining share of manufacturing jobs at the expense of metropolitan counties for several decades. There are several reasons for this shift, but the dominant factor points to technological changes in production. In particular, areas with lower population density are favored for many types of production due to easier transportation access and lower land costs. And if these forces have been accelerated by global competition, rural areas are the beneficiaries. Income from manufacturing is replacing income earned on farms as the dominant economic base across the Midwest.
Click to enlarge.
Of course, rural communities in the Midwest face many challenges in the years ahead. For one, manufacturing production centers sited in rural communities are highly vulnerable to global competition. So, too, commodity prices have historically been volatile such that commodity-based economies have often been whipsawed by downward price swings. Global markets show no promise of easing the variability of commodity price swings.
For these reasons, rural communities are striving to avail themselves of development opportunities as they present themselves. On October 24–25, 2006, the Chicago Fed will be partnering with Iowa groups on an informational conference in Ames, Iowa, called “Expanding the Rural Economy through Alternative Energy, Sustainable Agriculture, and Entrepreneurship.”
The question of whether globalization has been a net plus or a net negative for rural areas is not an easy one. Yet, more than ever, rural communities will want to stay closely attuned to trends and policies related to global affairs.
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.
September 20, 2006
Midwest housing market update
Following unprecedented home price appreciation nationwide in recent years, homeowners are much concerned about price reversal. In their current Economic Perspectives article, Chicago Fed economists Jonas Fisher and Saad Quayyum find that, on average, much of the recent surge in housing can be attributed to fundamentals such as rising income and favorable demographics, as well as innovations in home lending markets that have allowed renters to become homeowners. (Many of these innovations—such as interest-only loans and adjustable rate mortgages—were discussed in detail at the Chicago Fed's Bank Structure Conference this spring. The proceedings of the conference were summarized in the September issue of the Chicago Fed Letter.)
While such arguments may provide some comfort to those who worry about the possibility of a bubble in average U.S. home prices, experiences and current conditions differ widely from place to place. Should Midwestern homeowners be more or less concerned about the cooling of residential real estate markets?
Senior Business Economist Mike Munley has been tracking home price developments in the Midwest. Mike reports that, on September 5, the Office of Federal Housing Enterprise Oversight (OFHEO) released its estimates for home price appreciation in the second quarter of 2006. The report included data on the national average of home price changes as well as state averages.
Home prices for the U.S. increased at a 4.8% annual rate between the first and second quarters, the slowest quarterly appreciation since the end of 1999 and just below the average since 1980. As measured year over year, U.S. home prices were up 10% from the second quarter of 2005, which was also slower than the rate of appreciation has been—it topped out at 14% in the middle of 2005.
Recent home price appreciation here in the Midwest has also slowed noticeably, and the long term back drop has been much less robust. For the most part, home prices in the Seventh District states have been increasing more slowly than the national average of home prices (see figure 1). On a year-over-year basis, price appreciation in every District state lagged behind the national average in the second quarter of 2006, and Michigan had the lowest appreciation of any state in the nation. In comparison to the first quarter, home values in Indiana and Michigan actually declined. (Maine, Massachusetts, and Ohio were the only other states with declines.) However, home values in Iowa managed to rise slightly faster than the national average.
The city-level data told a similar story. Of the District MSAs (Metropolitan Statistical Areas) covered by OFHEO, only Michigan City-La Porte, IN, showed year-over-year appreciation (10.6%) faster than the national average. Of the bottom 20 MSAs in the U.S., 14 were in the Seventh District, and Ann Arbor, MI, was at the bottom with home prices, down 1.3% from a year ago.
The OFHEO home price data is only one of several sources of information about home prices for the U.S. and some cities. The National Association of Realtors (NAR) releases data on the median sale price of existing single-family homes. In general, the two data series tend to tell the same story—that is, the trends in both data series are similar over time. But, their results are often different in a given month (for regional and national data) or quarter (for city data). The NAR data tends to be more volatile. The NAR data set measures exactly what it sounds like: it is the price of the typical home sold during that quarter. Still, the median price depends on the mix of homes sold during that quarter. If, for example, a large number of inexpensive, starter homes were sold in the second quarter, this would lower the median sale price. By contrast, the OFHEO index is designed to track how the value of an individual home changes over time. OFHEO looks at the appraised value of homes each time a new mortgage is taken out—it is updated when a home gets sold or when the homeowner decides to refinance. OFHEO looks at the value of a large number of homes and is able to estimate the index quarterly. One drawback to the OFHEO index is that it only looks at home mortgages serviced by Fannie Mae and Freddie Mac, and those agencies only service mortgages that are less than $417,000—so the OFHEO index excludes most luxury housing.
The NAR publishes price breakdowns for regions and select metropolitan areas (but not states). In the second quarter of 2006, median home prices nationally were up 3.7% from a year earlier, while median sales prices in the Midwest (which includes the Seventh District, Ohio, and some plains states) were down 2.0%. Of the 24 District MSAs covered by the NAR, five (Chicago, Champaign, Milwaukee, Peoria, and Waterloo, IA) beat the national average, and 14 saw home sale prices down from a year ago. Although the NAR data are more volatile, this data series does confirm that home prices in the Midwest have been increasing more slowly than prices nationally.
There are a couple of reasons why home values have been rising more slowly in the Midwest than the rest of the country. Looking over the long term, the Midwest has generally seen slower home price appreciation since the early 1980s. As shown in figure 1, home values nationally have increased an average of 5.4% per year since then, whereas average appreciation in the District states has ranged from 3.5% in Iowa to 5.1% in Illinois. In part this difference reflects the slower population growth in the Midwest than in the rest of the nation. Since 1980, the U.S. population has increased an average of 1.1% per year, while population growth in Seventh District states has averaged only 0.4%. It follows that demand for housing in the District is not growing as rapidly, which in turn puts relatively less pressure on prices.
Regional differences in home prices also arise from the supply side of the market. In many metropolitan areas, available land for home building is limited by natural barriers such as mountains and waterways. In the face of rising demand for housing, such barriers to expanded supply tend to drive up land and home prices, especially for single-family homes. Further, some areas have chosen to place legal restrictions on home building by imposing growth boundaries or strict zoning requirements and building codes. In some cases where regulations are not well-crafted, evidence suggests that the effect is the same; rising demand for homes is met by rapidly rising prices rather than by expansion of the housing stock. A recent survey report of land use regulations verifies that the Midwest is not especially noted for manmade barriers to housing expansion. Over the long term, the elastic nature of home building in the Midwest region has likely contributed to less pressure on home prices.
More recently, much of the relative weakness in home prices can further be explained by the relatively sluggish economic growth in the region. As I discussed in my recent Mid-Year Jobs Report, job growth here has lagged behind national job growth. That limits income growth in the Midwest, which in turn restricts demand for housing. So while the U.S. has seen a sharp rise in home price appreciation in the past several years, the run-up in the District was less extensive or non-existent. (See figure 2.)
Among states, home price appreciation has recently been running in direct relation to the pace of economic growth. In particular, appreciation has been lowest in Michigan and Indiana, the two states with economies weighed down by structural change in automotive industries.
The figure below illustrates home price appreciation over the past year among metropolitan areas. Those metro areas experiencing depreciation tend to be found in Michigan and in central Indiana. A look back at the metropolitan area map of auto industry job concentration in figure 1 of last week’s blog shows a fairly close correlation between auto-intensity and weak home price appreciation.
The relative stability of home prices in some Midwest locations is a double-edged sword for the region. Homeowners in other parts of the country were able to cash in on the sharp increases in the value of their homes and use those funds to support their spending. Midwesterners weren't able to cash in as extensively, limiting growth in retail sales locally.
On the plus side, given all of the popular concerns about a home price bubble, steady appreciation helps abate those worries here. If a sharp run-up in prices is a warning sign of a potential bubble, that sign is largely absent in the Midwest. But this is not to say that the Midwest is immune from the risk of a slowdown in appreciation or price declines going forward. Certainly, overall economic conditions will feed into home prices, as they have in parts of Michigan.
Less appreciation in home prices can also be advantageous in that it keeps homes here more affordable. According to the NAR's affordability index, homes have historically been affordable in the Midwest in relation to other regions and recently this affordability advantage has improved. Midwestern cities can use this attribute to help attract new businesses and workers.
September 13, 2006
Where is automotive employment in the Seventh District?
Perhaps the most notable economic development taking place in the Seventh District is the market shift away from the traditional "Big 3" domestic auto makers--General Motors, Ford, and (Daimler)-Chrysler--and their parts suppliers. Lost sales are shifting toward the "new domestics" such as Toyota and Nissan and their parts suppliers. The sales gainers tend to be located outside of the Midwest to a greater degree than the Big 3. This shift is documented and analyzed in a recent Economic Perspectives article by Thomas Klier and Dan McMillen. This market upheaval is tending to idle and displace workers in many Midwest communities. Per Klier and McMillen, Michigan automotive employment is down almost one-third since 1979 while southern states such as Kentucky, Tennessee, Alabama, and the Carolinas have experienced a tripling of jobs.
But despite these shifts, Detroit and much of the Midwest continues to be the center of the production. Which particular communities remain most sensitive to future swings in automotive fortunes? The data below attribute automotive employment to particular metropolitan areas in the Seventh District. Those metropolitan areas with green shading had an employment concentration in automotive that exceeded the nation; those shaded in red had a lesser concentration. Looking across metropolitan areas in the entire Seventh District region, an east-west split in auto employment concentration becomes very apparent. The Michigan-Indiana corridor contains most of the metropolitan areas having an above-average concentration. Darkly-shaded metropolitan areas in southeast Michigan are exceptionally concentrated in automotive. So too, an east-west band of metropolitan areas across north central Indiana is steeped in automotive employment.
A numerical listing of automotive employment below shows just how concentrated some communities can be. Metropolitan areas including Detroit/Livonia/Deaborn, Flint, Holland, Saginaw, Battle Creek, and Lansing/East Lansing in Michigan all reported concentrations over 5 times the national average, as did the Kokomo and Lafayette metro areas in Indiana.
The final table below further illustrates the sharp geographic rift in employment fortunes over the 1990-2005 period. As a whole, the state of Michigan lost over 64,000 jobs in automotive, on net accounting for all job losses nationally. Largely due to the Michigan experience, the Seventh District states experienced an 18 percent decline in automotive jobs since 1990 while the remainder of the U.S. experienced a 3 percent gain in similar employment.
September 6, 2006
What industries are key to Midwest economic performance?
Urban economist Wilbur Thompson once said, “Tell me your industries, and I’ll tell you your future.” A region’s industries do tell us a lot about its economy. In the Midwest, manufacturing industries often drive fluctuations and trends in the region’s overall economic growth because manufacturing is a much larger part of its economy, on average, than the rest of the nation’s. So, too, manufactured goods are traded far and wide—that is, they are exported and imported across national boundaries as well as across regions that make up the U.S. economy. Accordingly, shifts in demand for manufactured goods can have an outsized impact on states and communities in the Midwest. For example, a national shift in buying behavior toward foreign nameplate autos, or toward smaller and more energy efficient autos, may well impact automotive production, investment, and employment in some parts of the Midwest region.
On a short-term basis, fluctuations in aggregate economic activity, such as recessions, diminish demands for durable goods such as capital equipment, thereby making the Midwest economy more sensitive to national “business cycle” fluctuations.
So, too, many Midwest manufacturing industries are impacted by global competitive shifts. Production operations of some home appliance manufacturers have shifted to Mexico, for instance.
But how can we identify which particular industries to observe and follow in the Seventh District? First, we must ascertain how concentrated is an industry in a local economy as compared with the national economy. Analysts often construct a “location quotient” to do so. In one such application, each industry’s employment share of total employment in the region is compared with its national counterpart. The comparison is constructed as a ratio with the local share on top. For example, if a locality’s labor force had 20 percent of its workers in manufacturing as compared with 10 percent nationally, the index (ratio) takes on a value of 2.0, i.e., 20/10. Parity with the nation would take on a value of 1.0.
While such an index is useful by way of comparison, it says little about the actual size of a particular industry in a state or region. For this reason, the chart below identifies manufacturing industries in the Seventh District states by relative concentration and by employment size. The horizontal scale depicts the concentration, and it is centered at the index value of one, or parity with the nation. The vertical scale is centered at the value of the median-sized manufacturing industry in the District (as measured by payroll employment).
By construction then, we may quickly characterize the most prominent industries in the District as they are located in the upper right hand quadrant of the graph. For the District, it is clear that transportation, food processing, and machinery are the most prominent industries, with transportation (representing automotive) winning hands down. The fabricated metal products sector also looms large; however, these industries represent many diverse intermediate products that are eventually used to produce more final goods such as autos or machinery. Primary metals, principally steel foundries as designated by the industry code 331 on the chart, is the most concentrated industry (as measured by employment) in the District. Yet, its employment is relatively small in comparison.
Charts for each individual state will soon be available on our Midwest Regional Website. Iowa is reproduced below. As the chart suggests, employment in food processing stands out as the largest and the most concentrated in the state. In large part, this activity represents Iowa’s further processing of corn and soybeans into meals and oils, as well as its meat packing industry, chiefly pork. Iowa’s large and highly concentrated machinery industry reflects its focus on its manufacturing of farm machinery and equipment.
Analysis of the District’s lesser industries can also be informative. In the overall U.S., the computing and electronic products industries have grown rapidly into a large component of overall U.S. manufacturing. In virtually every Seventh District state, for example, employment in this sector exceeds the median manufacturing sector. But at the same time, the states’ concentration of this sector is universally below the national average. In this instance, the sector’s lower concentration and lesser expansion here have contributed to a slower pace of overall economic growth.
Of course, these glimpses are only a superficial beginning to understanding the structure and behavior the region’s economy. For one, individually identified sectors often have important linkages to others that merit further consideration. Such industries as machinery and autos, for example, purchase great volumes of intermediate materials and parts locally, including those found in rubber and plastics, fabricated metals, and machinery (e.g., tool and die and metal cutting machinery). Also, in varying degrees, sectors may purchase local services as diverse as management consulting and transportation. Specific industry linkages can be found in the input–output tables of the U.S., which are produced by the U.S. Bureau of Economic Analysis (BEA).
However, the U.S. input–output tables may often be misleading for regional analysis. That is because specific inter-sector buying and selling relationships will differ greatly and vary widely from region to region. For one, local firms will purchase intermediate goods and services from many possible places. For the most part, we know little about the varying geography of such relationships. In response, the BEA has adapted and estimated the national relationships for individual regions of the U.S. in its RIMS II modeling system. This system and others like it, which are available commercially, are often used to estimate the broader economic impacts of small changes to a community or local industry.
August 30, 2006
Are U.S. and Seventh District business cycles alike?
This question is posed by Michael Kouparitsas and Daisuke Nakajima (K-N) in a current Economic Perspectives article. The answer, in general, is “yes,” and, in their analysis, many additional insights are gained about the structure and behavior of the Seventh District regional economy and its five component states of Illinois, Indiana, Michigan, Iowa and Wisconsin.
The so-called business cycle refers to the way that cyclical fluctuations of aggregate income relate to cyclical fluctuations of individual economic components, such as consumer spending, business investment, and job creation, and the ways that these components relate to each other. In this regard, academic economists have found that national economies around the world behave similarly, and a lesser body of evidence now suggests that sub-national or regional economies do, too.
The K-N article gathers some long time series of data on the overall Seventh District economy along with component parts that are analogs to U.S. economic series. The figure below from K-N juxtaposes the aggregate business cycle of the Seventh District and each state with the overall U.S. economic cycle.
In their analyses, K-N show that the timing of swings in Seventh District state economies is very similar to the nation. Most likely, this is explained by the fact that the economies of the U.S. and the District are affected by common “shocks” such as energy price surges. One exception is a weak tendency for Michigan and Indiana economies to lead the direction of the overall Seventh District by one quarter of a year, perhaps because of those states’ sharp concentrations in durable goods production.
Behaviors of various components of the District economy also mimic their counterparts in the U.S. and world economies. Residential investment and consumption in general tend to lead business cycles. As a leading indicator, average weekly hours of workers in the manufacturing sector also tend to precede swings in aggregate income, as does initial claims for unemployment insurance. Total employment often is a coincident or lagging indicator.
Such information can be further used to construct economic indexes that lead, lag or are coincident with a region’s business cycle. These indexes can be useful for short-term planning and forecasting, especially because there is no timely measure of aggregate economic activity for states and regions that is akin to GDP for the nation.
While the timing of the swings in District state economies are similar to those of the nation’s, there are some differences in the behavior of the states. Iowa’s overall economy is less synchronous with the nation than other District states. Presumably, Iowa’s much larger economic concentration in agriculture means that its economy fluctuates with commodity prices to a greater extent. For Indiana and Michigan, the amplitude of their economic swings are more profound—something that Michiganders, for example, have long tried to consider in their mechanisms to fund state government.
Michael Kouparitsas has previously researched the relative coincidence of business cycles among regions of the U.S (EP article). From a policy perspective, such studies reveal those instances, such as in the U.S., where adjacent regional economies are closely aligned. This alignment indicates that there are gains to having a common currency for our national economy (which we do, the U.S. dollar) as well as gains to conducting a common monetary policy for the overall economy (which we do through the Federal Reserve System). In addition to these policy implications, such research is helpful in understanding particular regional economies such as the Seventh District.
August 24, 2006
How should we gauge manufacturing's importance?
Manufacturing jobs and income are shrinking as a share of the national economy as well as the Midwest economy. Some representatives of manufacturers raise this fact in alarm, worrying that the shrinkage leaves the nation unable to support its needs and wants. But at the same time, some manufacturing advocates sometimes claim that the sector’s is mis-measured and undercounted. Meanwhile, economists mostly applaud diminishing manufacturing jobs as a harbinger of continued enhancements to productivity and standards of living for the average household, pointing instead to rising real output of manufactured goods available at ever-lower prices. How, then, should we think about and measure the economic importance of manufacturing?
To use an agricultural metaphor, manufacturing is no small potatoes for many Midwest communities. In the Seventh District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin, personal income directly coming from manufacturing activity, on average, is more than 50 percent more concentrated than in the nation as a whole. Much of this personal income reflects wage and salary income attendant to jobs in the sector, as shown below. What’s more, such income and jobs are augmented by services related to manufacturing, such as transportation and warehousing, as well as white-collar business services that are purchased locally by manufacturing operations. All of this, of course, means jobs and income to Midwest residents, firms, and households.
It is no small concern to manufacturing workers and communities, then, that income and jobs derived from manufacturing have been shrinking as a share of the economy. However, along with other economists, Senior Business Economist Bill Strauss of the Chicago Fed has pointedly illustrated that what is troubling to those who are discomfited is the very same phenomenon that brings about rapidly rising standards of living across a broad spectrum of households. The perpetual innovation and advances in productivity by manufacturers, accompanied by sharp competition among manufacturing firms, have delivered, on average, cheaper, more customized, more durable, and higher quality manufactured goods to households.
Government statisticians at the U.S. Bureau of Economic Analysis (BEA) calculate prices for manufactured goods purchased in the U.S., and they also do so for a standardized unit of a “real good” including autos, frozen foods, appliances, etc. Qualitative advancements in such manufactured goods are folded into counts of “real goods output,” meaning the total amount—both quantity and quality—of what we buy with our household income.
Over time, such measures show that real output growth by manufacturers in the U.S. and Midwest economies has kept pace with output or total gross domestic product (GDP) growth. Accordingly, if we measure real output produced by the manufacturing sector as a share of the overall economy, the manufacturing share would be virtually constant rather than declining. This is in apparent contradiction to the falling share of income and jobs derived from manufacturing activity.
Yet, in this there is really no paradox when we take into account the fact that the prices of manufacturing goods have fallen even while output has risen. That is, households and businesses are buying a greater “real” quantity of goods, but they are spending less on them overall because falling prices have more than offset the growing quantities being purchased. As illustrated and discussed in the 2004 Economic Report of the President, household and business purchases of manufactured goods have swelled in response to bargain prices, but not enough to sustain the manufacturing sector’s share of total revenue (and income).
A much lesser reason for manufacturing’s falling share is that a greater portion of domestic goods are produced abroad. As the Report illustrates, if the U.S. trade deficit had been hypothetically held to zero while U.S. manufacturing productivity were allowed to improve at its historic rate from 1970 to 2000, the U.S. proportion of employment in manufacturing would be only 14 percent in year 2000 rather than its actual 13 percent. Accordingly, rising productivity in domestic manufacturing accounts for the lion’s share of the decline in manufacturing share of employment from 25 percent in 1970. And yes, even that part of the shift from manufacturing to services related to the rise in imports has helped to buoy U.S. living standards because some goods can be produced abroad more cheaply, thereby allowing U.S. workers to instead produce greater services for domestic consumption.
Manufacturing representatives sometimes claim that manufacturing is not shrinking as share of current economic activity or at least that the shrinkage is being greatly overstated. Rather, the sector is being undercounted because some functions previously performed by manufacturing companies have now been outsourced to service companies. A consistent accounting of manufacturing activity would show it to be more sizable.
This latter assertion is partly true and but it does little to alter the long-term reality that the proportion of income and jobs derived from the manufacturing sector has fallen dramatically over many years. For one, it is true that U.S. manufacturers are increasingly relying on temporary workers rather than on their own employees. In official tallies, these temp workers are attributed to the services sector rather than to manufacturing. Yet, while their numbers expanded by roughly one-half million in the U.S. during the 1990s, according to a study by Estavao and Lach, they still made up only 5 percent of the manufacturing work force.
The outsourcing of functions by manufacturing companies is perhaps more important in mismeasuring manufacturing activity. Greater specialization of business functions, including accounting, marketing, payroll, information technology (IT), human resource management, research and development (R&D), strategic management, and public relations, has taken place such that most businesses—not only manufacturing— have come to outsource an increasing share of such activities. The snapshot below is drawn from data from U.S. Input-Output tables that are estimated by the BEA. In particular, manufacturing companies are shown below to be purchasing increasing amounts of business services in relation to each dollar of their own output since 1982. Not all of this service growth derives from outsourcing from manufacturing companies. Manufacturers are also using more services to deliver goods than in the past. In other words, the knowledge content of final goods delivered to households and businesse is higher than before. For example, pharmaceutical production may require an increasing amount of both R&D and testing services purchased by pharmaceutical companies, as well as legal, advertising and public relations services.
I have constructed a rough accounting of total purchased services by U.S. manufacturing companies from 1958 onward. The construction subtracts the BEA’s measure of manufacturing from the U.S. Census Bureau’s measure of value added in manufacturing. Since the U.S. Census’s value added includes services purchased by manufacturing companies, the difference provides an estimate of purchased services. For the U.S., I find that in the late 1950s, manufacturing companies purchased approximately 16 cents of services for every one dollar of their own output. This had climbed to 30 cents in recent years.
The figure below illustrates the generous and comprehensive measure of “manufacturing activity” for both the U.S. and for the Great Lakes region from 1977 to 2001. The color additions represent purchased services, which are shown to considerably inflate the share of manufacturing in total economic activity—be it GDP or its state equivalent, gross state product (GSP). However, regardless of the inclusion of purchased services, manufacturing activity is shown to be steadily declining as share of output.
To return to the agricultural metaphor, is it appropriate to think of U.S. manufacturing as we do production agriculture? The parallels are often drawn. Production agriculture employed close to one-half of the U.S. workforce prior to the dawn of the twentieth century. Subsequently, tremendous gains in productivity provided magnificent improvements to the American diet while shrinking the size of the sector to 3 percent of the work force. In broad perspective, the remainder of the work force have now been freed to deliver to us a great array of services and goods, even as we eat better.
Although the parallel to manfacturing is instructive in some ways, not all observers would be satisfied in relegating manufacturing to the backwaters of economic history along with agriculture. For one, some argue that the sector continues to be the chief engine of innovation in overall U.S. productivity and innovation growth. While the manufacturing sector has diminished in size, it continues to be responsible for a greatly outsized share of the nation’s R&D. As of 2001, manufacturing funded 44 percent of the nation’s R&D, or $199 billion. This amounts to an innovative intensity that is roughly four times the size of the sector’s own activity.
Moreover, it is also argued that the much of the payoff or “economic returns” to this innovation accrues outside of the manufacturing sector to a great extent. That is, there are large spillover benefits to R&D performed by manufacturers. In particular, as service firms providing health or personal services or business services learn to use new and innovative capital equipment such as IT equipment, medical equipment, or pharmaceuticals, their own productivity continues to grow or accelerate.
In the end, how should we measure manufacturing’s importance to the U.S. economy? The answer is, of course, “in many ways.” For manufacturing communities and workers, it will be helpful to track the diminishing (sometimes growing) shares of manufacturing jobs and income in the economy. Communities will sometimes need to consider how to best transition to new economic base sectors; workers will sometimes need to transition toward new or enhanced occupational skills or even to different locales.
In continuing to track productivity or “real” output growth of manufacturing, nations and regions will gain a better understanding of the sources of national growth and living standards. In this, there are several important public policy arenas. Which particular public policies with respect to public investment in fundamental scientific research and technical education give rise to productivity innovations? What regulatory environment is most fertile with respect to the protection of intellectual property, promotion of competition among global firms, and the flow of workers and their ideas across international borders? How much should we be investing in public infrastructure of importance to manufacturing such as roadways, ports, and air cargo airports? How much and in what ways do open global markets for investments, services, and manufactured goods lift our standards of living?
If we get such questions right, the size of manufacturing of the manufacturing sector will be just right. That is because, in market economies such as ours, both service and goods-producing firms compete, adjust, evolve, and innovate and, in the process, they provide households with the services that they desire. Whether those services emanate from manufactured goods or whether they are provided directly to households by service workers is not at issue.
August 9, 2006
New revised Midwest economy website!
Last fall, we made available our first ever website devoted to understanding and analyzing the Seventh District economy. This month, we have revised our website, adding new features and making it easier to use.
As you first view our new home page, you will see a convenient navigation bar with five major choices, organized under tabs. First and most prominently, the “features” appear as the default page. The "features" page alerts the regular visitor to the most current and exciting developments. Currently, the features page lists our Midwest blog on current issues and conditions, as well as announcements of upcoming conference events to be held here at the Chicago Fed. Senior economist Rick Mattoon has fashioned a conference program for October, which examines the varied relationships between the presence of a local university or college and surrounding economic growth and development. Prior to that event, Dave Oppedahl will conduct an event in conjunction with the Chicago Council on Foreign Relations that will examine developments in global agriculture as it affects Midwest communities and business.
The second tab directs the viewer to our "data page" which displays current trends in employment and output for the District and its states—Illinois, Indiana, Iowa, Michigan, and Wisconsin. The page also includes an interactive tool so that site visitors can construct and customize their own graphs and charts of the region. On the right hand sidebar, don’t miss the District state profiles that have been provided to us by some of the local state economic gurus.
The third tab, “articles,” catalogs the many research articles that we have penned over the past 15 years and which appear in our Bank publication series. These articles continue to be arranged by topic, but we now precede the bibliography with a tool allowing the viewer to jump directly to the section of articles by topic heading. These topic headings include, for example, state and local fiscal analysis and regional agriculture, banking, community development, and education.
The fourth tab leads the viewer to our "special projects." So far, we have conducted long-term projects on the Midwest economy, Midwest infrastructure, and, most recently, Midwest manufacturing. Within each project, the visitor will find both presentations delivered by renowned analysts during the course of the project as well as their conference papers.
Finally, the "conferences" page presents hyperlinked materials from our varied topic areas, including labor, energy, automotive industry, and economic growth, among others. For each conference, a conference agenda reprises the event, such as our automotive parts industry conference held this past April. The agenda lists the speakers such that a particular speaker’s presentation is linked to his or her name. Conference papers, proceedings, and summaries can also be found for most of the conferences.
What is missing? We’d like you to talk to us and to ask us questions about the Midwest economy, our research, and our insights on Midwest policy issues. To do so, visit our “economists” page where you will find our e-mail addresses. We can be found under the “Regional Analysis” banner. Talk to you soon!
August 4, 2006
Manufacturing activity holds an outsized importance in the economy of the Midwest. The Midwest regional economy derives approximately 53 percent more than the national average of personal income from manufacturing. The map below illustrates the relative share of payroll employment in manufacturing across U.S. states.
Five years ago, manufacturing led the U.S. economy into an economic decline. Real output in manufacturing steeply declined even while consumer spending continued to grow, if only weakly. In both the region and the nation, sagging output translated into layoffs and net job losses. From mid-2000 to mid-2003, manufacturing employment dropped 16 percent in the nation and 17 percent in the Seventh Federal Reserve District states of Illinois, Indiana, Iowa, Michigan, and Wisconsin.
To assess the existing conditions and future prospects for manufacturing, the Chicago Fed organized a series of three conferences beginning in late 2003. The Manufacturing Assessment Project’s major conclusions were as follows:
- The manufacturing-oriented national decline beginning in mid-year 2000 was led by sagging exports (reflecting slower global economic growth) and by a precipitous drop in investment spending (driven by a traditional slowdown in growth, as well as excessive investment spending during the late 1990s, especially in high technology communications equipment.)
- The decline in Midwest manufacturing employment was in proportion to the national decline. In the past, the Midwest had experienced a steeper decline than the nation due to the region’s high concentration in manufacturing durable goods—including both capital goods machinery and autos.
- Although manufacturing employment declined proportionately in the region versus the nation, its impact was more severe in the Midwest due to the region’s heavier concentration in manufacturing.
What kept Midwest manufacturing from falling more steeply (as it had done in past recessions) during the economic downturn in 2001? High-tech production activity fell off the map nationally. This hurt some other regions more than the Midwest, because the Midwest economy is not heavily concentrated in computing and communication equipment. In addition, consumer spending on autos was buoyed by low interest rates and by automotive company sales incentives. Finally, continuing foreign competition from very low-wage countries (especially China) affected other regions such as the Southeast more severely, where there is a concentration in low-value-added industries, especially textiles and clothing.
The severity of the 2001 recession and its aftermath led some observers to believe that Midwest manufacturing had taken a negative and permanent deviation from its long- term performance. However, most argued that, aside from the unusual manufacturing orientation of this 2001 recession, there was little reason to conclude that manufacturing performance was in any way inconsistent with long-term trends. In particular, over the long term, strong real output growth in the U.S. has been achieved through robust productivity growth, especially in durable goods production. In the process, the employment share of manufacturing has been declining approximately 2 percent per year since the late 1950s.
The share of income directly derived from manufacturing activity has also been falling. Rising productivity and competitive markets have led to falling prices for manufactured goods in the U.S. Falling prices have stimulated greater domestic demand for manufactured goods, but not enough to offset falling prices. A less important but still significant factor is that a greater share of domestic demand for manufactured goods is being served from offshore.
The Midwest has shared in manufacturing productivity gains and output expansion which, in turn, have ultimately given rise to higher standards of living in the U.S. On the downside, the region’s high concentration in manufacturing employment has contributed to its slower-than-national growth of total employment and population.
An important exception to the Midwest’s similarity to the national economy is the ongoing geographic shift in automotive production from the Midwest to the South Central and Southeast regions. This shift derives from a large sales share shift from the former Big 3 automakers and their suppliers to the “new domestic” automakers, especially Toyota and Nissan, who have tended to move southward.
A follow-up automotive conference this year highlighted how the geographical shift and industry upheaval are affecting the broader automotive parts industry. The following are some of the interesting conclusions that emerged from this gathering:
- The automotive parts industry is three to four times larger than assembly operations as measured by employment.
- The auto supplier sector is paralleling the geographical shift toward the South by automotive assembly plants.
- Foreign ownership of auto parts companies is increasing.
- Both assembly plants and parts makers seem to avoid union and hostile or overly costly labor market environments, if they can do so.
- The challenge for the Midwest’s retention of the parts and assembly industry does not appear insurmountable. Shortages of skilled workers in the South are possibly forestalling more rapid investment there. So too, the bulk of the industry remains in the Midwest so that the region’s locational pull continues to be strong. Domestic auto companies are also strategically restructuring to be more competitive.
What has transpired since we began the Manufacturing Assessment Project?
Investment spending has recovered, pulling both regional and U.S. manufacturing output growth along with it. Nationally, high-tech/info-tech production has also recovered.
In the Midwest, machinery and other basic capital goods production have greatly recovered and some sectors continue to expand. Regionally, basic industrial equipment such as electrical, construction, and mining equipment are growing strongly, while automotive production continues to flag. This has created an east-west tilt, favoring economic growth in the western part of the Great Lakes economy in relation to the auto-oriented states of Ohio, Indiana, and Michigan.
As global growth has recovered, U.S. exports have also recovered, pulling along domestic manufacturing output—especially capital goods exports. Export growth in the Seventh District has outpaced the nation.
Domestic light vehicle sales have been largely flat during the current decade at 16-17 million units per year. Sales shares have continued to shift away from the former Big 3 and their suppliers, so that many states and communities that now host related production facilities remain in crisis.
Today’s robust manufacturing output growth is largely being achieved through strong productivity growth and with little expansion in the work force. As indicated by the charts below, these productivity trends are playing out in both the nation and the region. The region’s higher concentration in manufacturing may be retarding its employment and population growth in relation to the U.S., even while it is lifting household incomes and standards of living across the nation.
July 25, 2006
Mid-year jobs report
Looking west from Ohio to Iowa and Minnesota, there is a distinct falloff in economic growth, at least according to recent reports on payroll employoment. With only a three-week lag, the Bureau of Labor Statistics reports their estimates of payroll employment monthly for individual states. The reported monthly figures for June 2006, now complete the second quarter of this year.
The table below displays year-over-year payroll job growth in the seven Midwest states and the U.S. Note that job growth in all states except Iowa and Minnesota fell short of the U.S. growth of 1.4 percent.
One reason that explains lagging job growth in many Midwest states is their heavy concentration in manufacturing industries. As the Chicago Fed’s Midwest Manufacturing Index suggests, real output growth in manufacturing has been growing strongly now for 3 years in both the nation and in the Midwest. In general, U.S. manufacturing growth has been buoyed by strong domestic demand for capital investment goods and by growth in U.S. exports. Some notable (and growing) Midwest capital goods sectors are mining and construction machinery, farm machinery and equipment, heavy trucks, and electrical equipment. However, strong output growth in manufacturing does not typically propel much payroll job growth because real output gains are generally being achieved through higher productivity rather than through more labor input.
With respect to total payroll employment, the three easternmost states of Ohio, Indiana, and Michigan show the weakest year-over-year growth. Further to the west, job growth in Illinois and Wisconsin have been stronger, with still stronger growth for Iowa and Minnesota.
For some states, such as Illinois, recent payroll job growth is especially encouraging since growth had been lagging since the last recession. Along with Indiana, Michigan, and Ohio, Illinois employment has not yet re-attained its previous peak which occurred in the year 2000.
Illinois' job gains are being led by growth in professional and business service industries even while manufacturing employment has been declining. The Chicago-area economy, which comprises the bulk of Illinois, has been shifting into business and financial services while moving away from manufacturing. Chicago’s business and financial services depend on customers in surrounding manufacturing-intensive states but they also serve some global and national markets.
At the other end of the spectrum, Michigan’s recent job performance remains very much in a league of its own, even when compared to other Midwest states. The chart below indexes total payroll jobs to the first quarter of 2001. While the rest of the region has almost re-attained its former employment peak, Michigan employment remains 6 percent to 7 percent below its previous peak.
The troubles of domestic automakers Ford and GM, and their automotive parts suppliers, have been weighing down growth in Michigan. Since the year 2000, their combined share of U.S. light vehicle sales has declined from 51.1 percent to an average 41.3 percent year-to-date in 2006.
These companies are highly concentrated in Michigan. In addition to their global headquarters and many research facilities and part suppliers, for example, Ford and General Motors together maintain 12 of their 34 U.S. assembly plants (35%) in Michigan. For this reason, Michigan residents are closely following the strategic plans of these companies as they attempt to restore growth and profitability.
July 11, 2006
Interstate Income Convergence and Development Policy
These days, there is some concern over rising income inequality among workers and households in the United States, especially slow wage growth at the bottom of the income distribution. In contrast, from a longer-term perspective, America's general experience with household well-being has been strongly positive—both across time and geographically. Over the 20th century, household incomes have risen many times over. Reports from the Federal Reserve Bank of Dallas document American progress in tangible living standards, such as gains in homeownership, rising income, shorter work weeks, and rising life expectancy.
In its 2005 Annual Report, the Federal Reserve Bank of Cleveland takes a geographic perspective on economic progress. Here again, a longer-term perspective is very positive. Against the backdrop of rising national standards of living, the report finds increasing geographic income equality rather than inequality. In particular, average incomes across U.S. multi-state regions, and among states in general, have been profoundly converging rather than diverging.
The causes and mechanisms of this income convergence are worth exploring in identifying possible lessons and directions for economic development policy today. What factors and policies can keep states and regions out in front of the race for economic well being? States in the Midwest are especially concerned that they are falling behind economic growth and well-being of some other states in the South and West.
In its methodological approach, the Cleveland Fed analysis attempts to explain the lack of full convergence of interstate per capita income since 1934. Neoclassical economic theory predicts that full economic convergence will take place in a flexible market economy, such as the U.S. economy. If, as we generally believe to be the case in the U.S., states share the same technologies in production, and if factors of production (labor and capital) are mobile across regions, then wages and household incomes should converge. Such convergence takes place over time as workers migrate toward better jobs and income or as capital investment follows greater returns in lower-cost regions. (There are other variants of the economy’s flexibility that achieve the same result).
As the Cleveland Fed’s chart below shows, in the U.S., state per capita income has mostly converged since 1930—it has converged from a standard deviation of around 0.4 to a mostly flat standard deviation of 0.15 since the late 1980s. Much of this convergence reflects rapid growth and economic progress in the formerly underdeveloped southern states. In the South, major public investments in education and roads, accompanied by private investments by manufacturing companies and more recently by services, have brought up incomes close to national norms and eliminated many areas in dire poverty.
States of the Seventh Federal Reserve District have historically enjoyed average incomes above the nation. However, in recent years, per capita income growth in the District has lagged the nation's average. (The Midwest web page allows visitors to build customized charts of state personal income). The chart below illustrates that District states' per capita income remained at more than 10 percent above the nation's average during the early 1950s. By the late 1970s, relative income had converged to levels only 5 percent above the nation. A more preciptious decline took place from the late 1970s to 1983 when relative income first fell below the national average, and remained there throughout the 1980s. The more prosperous times of the 1990s lifted the region's incomes above parity for awhile only to fall below once again in the current decade.
As the second chart below reveals, all five states of the Seventh District have experienced relative declines since 1969.
Since full convergence of state incomes has not taken place, it may be the case that public policies are feasible to push a state’s per capita income above or below average. The Cleveland Fed’s statistical model comes up with fairly strong evidence in identifying variables that explain or at least correlate well with why states fail to fully converge with the national average. The strongest explanatory variable is “utility patents”—a proxy or general stand-in for states’ innovation and entrepreneurial activity. Apparently, local innovation can keep incomes high in a region as new firms (and high paying jobs) are spawned or through some other mechanisms.
The second strongest explanatory variable explaining lack of full convergence is differences in educational attainment among the states’ work forces as measured by high school and college education attainment. Presumably, while U.S. workers are mobile in moving to other states in search of higher wages, this migration mechanism is imperfect or slow to adjust. Accordingly, some economic returns from public investment in college education may accrue to the students’ home region (and therefore income convergence is incomplete). Education is also considered to be complementary with “patents” or innovation in economic growth because a highly educated population can more easily learn and adapt new technologies.
The important third variable is “industry specialization.” Places with concentrations of manufacturing had higher incomes early on, but this has since tended to dampen income growth over time (and has tended to do so persistently). Presumably, a region’s workers cannot or do not adjust quickly (e.g., move away or retrain) to the negative shocks that have affected such industry sectors.
What can we take away from such an analysis? The Cleveland Fed intends this initial research to be directional rather than prescriptive. That is, it offers guidance and direction for further research that is needed to identify viable and specific public policies.
In some sense, the research findings are also corroborative. That is, the findings are very much in the mainstream of current economic development policy discussion. How to innovate? How to educate? Which policies will continue to enhance growth? And ultimately, which particular policies toward educational attainment and entrepreneurship are effective and cost-effective?
What do the findings have to say specifically about Seventh District states and other Midwest industrial states? The side-by-side charts below illustrate the findings for each state. The left-hand chart lists the actual per capita incomes of each state in 2004 in relation to the national average. The right-hand chart lines up this same listing of states with the Cleveland Fed’s model of predicted per capita income. The particular contribution of each explanatory factor to the prediction—innovation, education, and industry mix—are also illustrated.
The Cleveland Fed analysis predicts Ohio, Michigan, Illinois, and Wisconsin to have higher per capita incomes than they actually do have in 2004. (Iowa and Indiana are right on par.) Predictions that are stronger than actual for these Midwest industrial states derive from their high research and patenting activities.
Why, then, are Midwest states lagging in their incomes despite their strong innovative traditions? The possible explanations are thus far elusive. It may be that the model’s enumerated patents are mismeasuring (overcounting) actual innovation taking place in the Midwest region, since patents are sometimes assigned to the headquarters of a firm in a region, even though the innovative activity takes place elsewhere. In an increasingly global economy, with large multinational companies, this data problem may be worsening over time.
Another possibility is that patents in the Midwest’s particular industries have lower economic returns lately as compared with patents in those industries (e.g., microchips or software) that are more specialized in other states and regions.
Yet another possibility has been most intriguing to Midwest leaders in economic development thought and policy. Is it the case that some other feature of Midwest behavior or policy is failing to commercialize research innovations that are taking place or available here?
Again, the possibilities are myriad. Among them, some researchers have pointed to superior mechanisms that have been crafted in successful regions, including Massachusetts, North Carolina, and California, whose universities have been successful in transferring research and development from the laboratory to commercial enterprise. The Federal Reserve Bank of Cleveland will take a closer look at this proposition during its November conference on the university’s role in technology transfer. At its October 30 conference, the Chicago Fed will also be taking up this issue as it investigates several possible roles that the university might take in regional economic development.
June 7, 2006
The recent influx of foreign born into the United States has drawn attention on several public policy fronts. The U.S. Congress is currently considering a tighter border policy with Mexico, in part due to concerns of national security and the rule of law. In addition, the surge in foreign born (and their offspring) figures into debates over the sources of the widening wage and income disparities in the U.S. and in the slow growth of wage rates and income at the bottom of the income distribution.
On a more positive note, the foreign-born population is accounting for approximately one-third of U.S. population growth, somewhat more if the newborn children of recent immigrants are counted. The possible benefit of a more rapid population growth stems from the fact that the U.S. labor force market is already tightening rapidly and promises to tighten further as the “baby boom” generation retires. Slow growth of the work force can ultimately slow the overall pace of economic growth, especially if accompanied by slow growth of workers with specific skills. Indeed, for many regions, one key economic challenge and opportunity is to facilitate education and skills acquisition of the foreign born. As of 2005, the U.S. Department of Labor reports that 28 percent of the foreign born aged 25 years and older had not completed high school versus 7 percent for the native-born.
Prior to the 1990s, as shown by the chart below, the Seventh District region, which includes much or all of Illinois, Indiana, Iowa, Michigan and Wisconsin, had not attracted immigrants to the same extent as many other U.S. regions. Still, as shown by the second chart below, strong growth in immigration has taken place here in recent years. So too, the Chicago metropolitan statistical area (MSA) has remained an exceptionally strong magnet among metropolitan areas. Chicago ranked 5th in foreign-born population according to the 2000 Census of Population, with 17 percent to 18 percent of its population foreign born. And since that time, the Chicago metro area has ranked among the top 10 metro area gainers in numbers of both Asian and Hispanic population.
Recent immigrants (as well as members of other ethnic and minority groups) are, to a greater extent, relocating to new areas of opportunity and high growth. According to recent report by demographer William Frey, “Hispanic and Asian populations are spreading out from their traditional metropolitan centers” and expanding their presence in new destinations, including suburbs and rural areas. In part, this dispersion may be an added impetus to current public policy attention concerning U.S. immigration and border control policies.
The chart below confirms for the Seventh District the dispersion of immigrants and foreign born. All Seventh District states experienced healthy growth of foreign-born population. However, the two states with the lowest proportions of foreign-born population—Iowa and Indiana—experienced the largest population growth rates over the decade of the 1990s at 110 and 98 percent respectively.
The Seventh District experience also confirms that immigrants are now following opportunities in employment and housing to a greater extent rather than simply following their historic well-worn path to the largest U.S. metropolitan areas and their central cities.
The final chart (below) distinguishes the growth in foreign born in each state’s largest metropolitan area from the rest of the state. In those large metropolitan areas where economic growth has been leading state economic growth and where unemployment is generally low, growth in the foreign-born population has exceeded the remainder of the state. This experience has particularly characterized the picture in Des Moines, Iowa, Indianapolis, Indiana, and Chicago, Illinois. In contrast, the Milwaukee, Wisconsin, and Detroit, Michigan metro area economies have both lagged their respective states and so have their respective growth rates of foreign born population.
In choosing their nation of destination, immigrants have in the past, “voted with their feet” in search of greater freedom and economic opportunity. Within that destination, immigrants often tended to follow well-worn paths, disembarking in cities and communities where their fellow immigrants had preceded them. In contrast, immigrants to the U.S. are today choosing to disembark directly where economic opportunities are greatest. For this reason, the growth rate of the foreign-born population has become yet another indicator in gauging the success of metropolitan areas.
How well immigrants adapt to their new communities, and how well communities adapt to them, will be part of the future equation of success or failure of many U.S. regions.
February 7, 2006
Foreign Direct Investment in the Midwest
Recently, companies from China have begun to explore direct investments in the Midwest and elsewhere around the world(link). Direct investment differs from portfolio investment, such as investment in U.S. Treasuries, in that direct investors have an equity interest that allows them to have some hand in the operation of the enterprise and its assets. Though direct investment from China is miniscule so far, past experiences with other emerging nations, such as Japan, suggest that the growth prospects may be large. Beginning in the 1980s, Japanese companies began to heavily invest in the Midwest, especially in automotive assembly and parts operations. Many of these ventures brought new capital and new ideas to the region’s economy, thereby easing the region’s adjustment to competitive decline and import competition. Such investments continue today as in the case of Toyota, which is scouring the nation—including Michigan—in siting a planned engine production facility. Can investors and partners from China and other emerging countries play a similar role in the Midwest in the years ahead?
Part of the globalization phenomenon has occurred through the integration of capital markets, including direct ownership of companies by overseas parents. Data from the U.S. Bureau of Economic Analysis records foreign direct investment (FDI) transactions, along with characteristics by location of foreign-owned companies and their affiliated establishments in the United States. As a result, FDI in the U.S. may be either an acquisition of existing operations or a new investment, such as the building of a new manufacturing plant. The figure below displays wage and salary employment of FDI affiliates as a share of total employment in both the Midwest and in the rest of the U.S. It is telling us that this share has doubled in both the Midwest and the U.S. over the past 25 years.
By this measure, the Midwest has kept pace with the U.S. In one respect, this is surprising since the Midwest is far way from the coastal economies, where one might think that access to and linkage with global companies would be more intensive. On the other hand, most FDI takes place in the manufacturing sector, which is more concentrated in the Midwest relative to the rest of the U.S.
From which countries does our FDI originate? Inbound FDI has been taking place for a long, long time, back to our country’s founding when you stop to think about it. For this reason, it may not be surprising that most of our FDI is today domiciled in Europe (table below). As of 2000, Europe made up two-thirds of FDI employment at foreign-affiliated establishments in the Midwest, with over one-half of these domiciled in Germany or in the United Kingdom. The remaining one-third of FDI employment is equally split between Asia and the Americas. Almost all of the Americas’ FDI originates with Canadian companies, while almost all of Asia’s FDI originates with Japanese companies.
Over time, Japan’s FDI has been replacing Europe’s and Canada’s in the Midwest (table below). From 1980 to 2000, FDI employment at Japanese affiliates grew from 14,000 to 190,000 in number, thereby boosting Japan's share of the region's FDI from 3.4% to 15%. With this growth, Japan’s FDI displaced Canada’s for the number three spot behind those of Germany and the United Kingdom.
By now, the origin and legacy of Japanese FDI in the Midwest is well known. Japanese automotive assembly and parts plants in the U.S., such as Denso, Honda, and Toyota, demonstrated that their successful production and distribution technologies were not derived from location or cost advantages abroad. Rather, their affiliates' success proved that the quality and cost efficiencies of their products could be duplicated in the U.S. This lesson was not lost on other manufacturers in the U.S. or worldwide. Japanese methods were copied and often improved across many industries. For many companies based outside of Japan, successful imitation and adaptation, along with investment from Japanese companies themselves, eased the transition to global competition and helped revive local production activity.
The map below displays the location and number of foreign-affiliated automotive parts plants in the eastern United States. Clearly, the Midwest has held its own in attracting these plants, which in turn suggests that the Midwest continues to be a desirable location for manufacturing production.
(courtesy of Thomas Klier)
Click to enlarge.
Can inbound FDI from China serve the same purpose as FDI from Japan? To date, Chinese inbound FDI has been miniscule. As of the most recent tally, only 4,000 payroll workers in the entire U.S. were employees of Chinese affiliates versus almost 6 million from FDI affiliates from all nations combined.
So, too, the source of China’s emergence as a global producer differs greatly from those of Japanese and many European manufacturing companies. Although China is rapidly evolving its economy to integrate more sophisticated technology (link), China’s initial strength is as the low-cost producer for the world, not as the innovator. Unlike Japan, China’s rapid rise owes much to its openness to a huge influx of FDI into China by other Asian nations and the U.S. in search of low cost production there. Accordingly, Chinese companies’ interest in Midwest locales will probably be less focussed on production. Rather, these firms will more likely be interested in activities such as local product research and design for distribution to U.S. markets, with most of the production remaining in low-cost China.
A recent story by journalist Michael Oneal (link) documented one such instance, that of Chinese affiliate Wanxiang, which is headquartered in Elgin, Illinois. Wanxiang’s originator is reported to be scouring the Midwest for troubled manufacturing operations, including auto parts suppliers, to acquire or with which to partner. One such partnership has resulted in Wanxiang taking an equity interest in Rockford Powertrain Inc., a supplier of heavy-duty driveline components to U.S. off-road equipment makers. Thanks partly to the partnership, the operation is now on a sounder financial footing. However, as part of its restructuring, its nonassembly production has been outsourced to China, while the U.S. operation concentrates on design, engineering, customer relations, assembly, and distribution. Overall employment has declined so far, especially in production, although the company is looking to grow.
What are we to make of China’s initial (and thus far miniscule) FDI overtures in the Midwest? First, China’s character as low-cost producer rather than as innovator likely means that the volume of China’s overseas FDI interest will be limited, at least for a while. Second, much like all potential FDI opportunities, partnering with Chinese companies on operations in the U.S. can sometimes be a successful strategy for domestic companies in preserving or expanding jobs and income. However, in China’s instance, the resulting production employment prospects in the Midwest are not likely to be as expansive as they have been from FDI partnerships with Japanese and European companies.
If Midwest manufacturing companies are to succeed, they will need to find their own best pathways. In some instances, success will be achieved by partnering with foreign companies on U.S. soil; in others, it will mean investing abroad to serve emerging market opportunities (link). Above all, innovation will be key to the success of their organizational structure, management, process technology, distribution, and new products.
January 18, 2006
China and Midwest Biotech
Many Midwest businesses are scrambling to adapt to the rise of China’s economy in world trade and financial markets. Import competition is especially keen. Some Midwest automotive parts suppliers are watching with concern as China has climbed to the number four exporter to the U.S. behind Japan, Mexico, and Canada (CFL).
How can U.S. businesses successfully adapt to the expansion of the dynamic Chinese economy with its low labor costs and less stringent environmental regulations? One way is to shift some operations overseas, investing in China for export back to the states and/or for sales to the growing Chinese market. So far, China has grown at a spectacular rate by inviting foreign companies to set up shop there. While many U.S. multinationals such as GM, Tenneco, and Motorola have done so, so have smaller producers such as Wahl Clipper (hair grooming products) out of Sterling, Illinois, and Atlantic Tool and Die Co. of Strongsville, Ohio.
Another avenue to survival and adaptation is to partner with Chinese companies on investment inside the U.S. So far, foreign direct investment (FDI) by Chinese companies in the U.S. has been miniscule. A few prominent examples of late may make Chinese FDI seem larger than it is, such as Legend’s purchase of IBM’s personal computer business and CNOOC’s failed attempt to purchase Unocal (petroleum). Over time, it is natural to expect that as Chinese companies grow and mature, they will sometimes find it advantageous to invest overseas. Likewise, foreign investment flows into the U.S. can mean new technologies and new portals to global markets for U.S. products, which often keep American workers productive and well-compensated.
This week I am speaking about biotech in the Midwest to the Midwest China Association (MWCA). The MWCA’s mission is to attract inbound Chinese investment into the greater Midwest. They do so by educating the Chinese business community about the benefits of the Midwest, as well as educating our region about overseas opportunities. The MWCA sees Midwest biotech as one of the future cornerstones of the Midwest economy and aims to gather a portfolio of information that can be used to characterize and market the region to potential Chinese investors and partners.
Where can the MWCA and foreign investors learn about biotech activity and opportunities in the Midwest? Currently, there is no Midwest biotech association that compiles information and markets the region’s industry assets. However, journalist and seasoned industry veteran Michael S. Rosen is a virtual encyclopedia of information on the Midwest biotech business scene (link). And for a more active way of gathering information, the nation’s premier biotech meeting, BIO2006, will be held in Chicago this coming April. Due to its nearby location and Illinois sponsorship, Midwest states will be heavily represented.
As we learned at the December Chicago Technology Forum, past “BIO” meetings have galvanized the host regions, if not spurring them to significant cooperative efforts and partnerships, then at least delivering a more comprehensive and cohesive image and understanding of biotech activity and opportunities in the host region. Past meeting have been held in Philadelphia (2005), San Francisco (2004), Washington, DC (2003), Toronto (2002), San Diego (2001), and Seattle (1999).
How will I characterize the Midwest biotech landscape when I speak to the MWCA? For one, the Midwest is long on research and short on commercialization (CFL). A familiar refrain among biotech wannabe locales across the U.S. is their inability to attract venture capital investment flow and to originate startup companies, which is also true of most locales in the Midwest. However, less common among U.S. biotech wannabe locations are the host of potential assets for commercialization that can be found here in the Midwest.
Our region’s universities and federal labs boast prodigious R&D funding and activity (see figure below). One prominent ranking of world universities’ science capacity reports that the states of Iowa, Minnesota, Missouri, Wisconsin, Illinois, Indiana, Michigan, and Ohio are the domicile of 7 of the top 50 and 12 of the top 100 institutions. Overall academic R&D funding in Midwest states tends to be above the U.S. average, with Ohio, Illinois, Michigan, Missouri, and Minnesota ranking 9th, 10th, 11th, 12th, and 14th nationally in 2004. Licensing revenue from the region’s universities amounted to $197 million for FY2003, with 47 new startup companies created, many of which are biotech in orientation. A young organization, the Midwest Research Universities Network (MRUN), is a collaboration that promises to raise the number of startups emerging from the regions universities and labs.
*The Shanghai Jiao Tong University ranks universities by several indicators of academic or research performance, including alumni and staff winning Nobel Prizes and Fields Medals, highly cited researchers, articles published in Nature and Science, articles indexed in major citation indices, and the per capita academic performance of an institution.
The Midwest also hosts large pharmaceutical companies, including Abbott and Baxter in Chicago, Eli Lilly in Indiana, and large Pfizer facilities in Michigan. So far, although large pharma companies have become the prime buyers of basic research from biotech nationwide, local linkages between these companies and biotech have not always developed.
A “diversity” of biotech arenas also characterizes the Midwest. Aside from pharmaceuticals, companies that design and manufacture medical devices are found here. Minneapolis hosts Medtronic, Inc.; Milwaukee hosts GE Medical Systems (high-end imaging); Indianapolis has Guidant; the area around Warsaw, Indiana hosts the prosthesis industry; and the Chicago area is home to Baxter and Hospira.
Attendees of BIO2006 will also learn about the Midwest’s agricultural biotech sector. Ethanol plants are being built or expanding in the corn belt, and high-end research to more efficiently derive energy products from agricultural feedstocks is taking place at the region’s universities and biotech companies (link). Seed and chemical companies such as Pioneer Hi-Bred and Monsanto are continuing to produce stronger strains and new varieties of crops, as are smaller companies such as Chromatin Inc. in Illinois.
Will biotech become a cornerstone of the Midwest economy? While the outlook is promising, there are no guarantees. Despite all that the Midwest has going for it, some studies indicate that biotech activity is becoming more concentrated in just a few places rather than dispersing (link). So too, Midwest assets are noticeably dispersed and spatially separated across the region, making collaboration more difficult than within some existing biotech centers.
Still, it is a little more likely that the Midwest will realize its tech commercialization ambitions so long as organizations like the MWCA are working to connect Midwest biotech opportunities with potential investors and partners.
January 6, 2006
Midwest and the Global Economy Part I
From the slow progress being made on the Doha round of global trade liberalization, it would seem that globalization is slowing down. Yet, this is not the case at all. As the 2002 Economic Report of the President articulated, globalization continues to be enhanced by ever-falling costs and technical advancements in communication and transportation. Such developments are magnifying trade flows of merchandise and commodities and, more recently, services such as software, R&D, call services, and data processing. Springing from these developments in information technology and communication, global capital markets are deepening, which in turn further heightens trade in goods and services.
Regional economies, especially that of the Midwest, are being affected by globalization. Tradable goods such as manufacturing and agriculture products play a significant role in the upheavals of globalization. And so, Midwestern households and business would benefit from timely and appropriate adaptation to the globally induced upheavals taking place in industries, companies, and occupations in the region.
Since households continue to learn about globalization from the print media, The Global Chicago Center of the Chicago Council on Foreign Relations and the Ford Foundation are fashioning a project called the Midwest Media Project. The project intends to assist journalists throughout the region to help put local interests in the broader context of global economic developments and events. In this way, Midwesterners can become more attuned to globalization, especially as it relates to the region.
At the first meeting of the project on January 10, researchers and policy leaders are being asked to present globalization topics and information to the attending journalists. In turn, several senior journalists will lead discussions on ways in which global events and trends can be linked to local stories in engaging ways.
I was asked to deliver the overview on the Midwest economy, highlighting the linkages between our region and the world economy. And when I stop to think of the linkages, there are many. For one, given our sharp manufacturing concentration, the Midwest economy is about on par with the nation in terms of exports, and our region’s exports to the world are large and growing. Not surprisingly, it is our “capital goods” that stand out as prominent exports—construction and farm machinery, medical equipment, engines, and electrical equipment. Automotive exports are also prominent, with most of them destined for nearby Canada rather than for far-away locales. As Thomas Klier, automotive expert here at the Chicago Fed has said, “the binational region’s auto industry knows no boundaries.” (Chicago Fed Letter on border conference) Close to 40% of the considerable U.S.–Canada merchandise trade crosses the border in Michigan through the Detroit–Windsor corridor or over the bridge at nearby Huron-Sarnia, much of it being automotive parts and finished vehicles.
Partly owing to this tight automotive production integration, Great Lakes exports to Canada represent 50.4% of the region’s exports versus only 18.2% for the overall U.S. If we were to deduct U.S. exports to Canada from both the Great Lakes region and the U.S., the pattern of export destination by country would be nearly identical for both the region and the overall U.S., with a slight tilt of Midwestern exports to Europe rather than toward Asia.
So, too, without our outsized trade with Canada, the Midwest export propensity is significantly smaller in relation to the rest of the U.S. In addition to the region’s proximity to Ontario, landmark agreements to lower tariff barriers to trade between the U.S. and Canada, such as the AutoPact of 1965 and the Free Trade Agreement of 1989, have maintained the close trade linkages between Ontario and the Great Lakes states.
In assessing a region’s (or a nation’s) propensity to trade, should trade with nearby countries be counted equally as trade with faraway ones? In comparing trading intensities across countries or regions, it seems reasonable to at least keep in mind that national boundaries can be somewhat arbitrary. For example, if the boundaries separating states in the Midwest were national boundaries, the trade intensity between the Midwest states would be enormous (link link), easily dwarfing current international trade flows into and out of each state.
What do such trends suggest for the region’s economic development policy focus? Growing international trade would seem to support trade missions from the region to foreign countries, many of which are sponsored by state governments. However, the Hewings and Israilevich statistics (above) on the larger volume of intra-regional trade flows might alternatively suggest that public policies to enhance or support local commerce might deserve more emphasis. I see no conflict here; these policy arenas are complementary rather than in competition. We can metaphorically think of the highly integrated binational Great Lakes region as a single factory or service company. Our efforts to encourage free flowing and efficient commerce within the region will serve to strengthen our ability to produce goods and services for trade with the world, which in turn will result in more income for the region’s households and businesses.
One example of local policy of this nature is surely the continued attention to keeping our border-crossing infrastructure and procedures with Canada safe—but also fast and efficient (link). On the U.S. side, the Great Lakes economy will be more likely to prosper if it is the center and nexus of commercial trade flows rather than a peripheral player in the national economy.
November 22, 2005
Driving Indiana’s and Michigan’s Economic Performance
The Midwest economy is lagging the U.S., but some states are doing better than others. These differences may help us understand the reasons for the region’s lagging economy.
Last week in Indiana, I presented some evidence that the entire region is growing more slowly than the nation. Payroll job growth in our Seventh Federal Reserve District is up only 0.6% for September from one year earlier, versus 1.6% in the nation. In some respects, this performance is not surprising since, nationally, manufacturing jobs are still declining (down 1% year over year through September), and the Midwest’s economy is steeped in manufacturing. In addition, the region’s economy is bogged down by the structural change taking place in the automotive industry. Foreign nameplates continue to gain market share from the domestic automakers (previous blog). Since the foreign nameplate companies and their parts suppliers tend to locate in the South, jobs and income are seeping away from the Midwest.
In this regard, comparing the performance between Indiana and Michigan is telling. Though both states rank among the top 3 nationally in manufacturing concentration, the unemployment rate in Michigan stands at 6.1% in Michigan (Oct.) versus 5.4% in Indiana. Year over year, manufacturing payroll job growth is virtually flat in Indiana, but down over 3% in Michigan.
The economies of both states are automotive intensive, but Michigan to an even greater degree. Indiana’s automotive share dominates manufacturing inside the state, at 16%. But Michigan’s automotive sector accounts for 35% of its manufacturing employment. A weakening automotive sector, then, would be felt more sharply in Michigan.
On top this, the auto sector’s performance in Michigan has been worse. From 2001 to date, automotive jobs have fallen 24% in Michigan, compared to 8% in Indiana.
Indiana’s automotive performance is buffered by having a larger share of foreign auto parts and auto assembly plants than Michigan. According to senior economist Thomas Klier, 29% of automotive parts plants in Indiana are foreign owned, as are 2 of its 3 auto assembly plants.
Auto parts makers tend to locate close to their customers. In Indiana, the foreign-owned parts plants are more likely to supply parts to those automakers who are gaining market share—the foreign nameplates.
Michigan’s automakers are only 17% foreign owned; its only foreign owned assembly plant is the Mazda plant, versus its 15 domestic auto assembly plants.
If the current shifts in market share among automakers continue, it will be imperative for Michigan’s economy to attract investments from the successful auto suppliers and auto assembly companies.
Other performance differences between Indiana and Michigan are intriguing, though one cannot draw any hard conclusions. The chart below illustrates the population growth of the largest metropolitan areas in each state—Indianapolis and the Detroit MSA. Indianapolis’ population growth has exceeded the surrounding areas, and far exceeded that of the Detroit metro area.
In searching for explanations, manufacturing concentration again comes to mind. As recently as 1969, only 26% of Indianapolis’ overall employment was manufacturing, versus Detroit’s 35%. Generally speaking, “factory towns” have had the roughest road in restructuring. As manufacturing employment shrinks, such cities must re-employ larger shares of their work force in new industries and activities. Otherwise, workers move from the area and create a different set of challenges to the town governments. That is, how to efficiently use and maintain their current roads and buildings for a less populous (and sometimes less wealthy) population.
Governance structures may also explain some of the challenges. Central city Detroit has been buffeted by job, population, and income flight, with concentrated poverty left in the wake. Detroit city leaders have been unable or unwilling to climb above the city’s fiscal problems to re-build its economy. To what extent has this failure come about because the central city was isolated from the rest of the metropolitan area (and state), and left to solve profound problems with its own (meager) resources?
Indianapolis and other cities have taken some modest steps in consolidating local governance to a closer fit with their metropolitan-wide economies. In the late 1960s, Indianapolis moved toward a “Unigov” structure. As Rick Mattoon discusses (working paper), the city’s boundary was expanded from 82 square miles to 402 square miles, with a legislative body responsible for governing the city. Though there remain many independent governments, taxing authorities, and school districts within the city, the consolidated city has six administrative departments below the mayor’s office.
Other Midwest cities with elements of regional governance include Minneapolis–St. Paul, which has a metropolitan sharing of property tax base. Columbus, Ohio, has not consolidated, yet its central city government has been aggressive in annexing land outward toward its interstate beltway. Both metropolitan economies have outgrown the broader Midwest.
October 20, 2005
Delphi and Midwest Auto Parts
Midwestern communities that host automotive plants are especially concerned at the recent bankruptcy actions of Delphi Corporation. Such concerns are not misplaced, since the geography and problems of Delphi’s operations are similar to those of some other automotive plants.
Delphi, the nation’s largest auto parts supplier, filed for Chapter 11 bankruptcy on October 8. The bankruptcy covers only its U.S. plants; non-U.S. subsidiaries are not included. The company, which had 2004 revenues of $28.6 billion, is looking to the courts to allow it to cut costs by rewriting its contracts with its UAW-represented work force, closing plants, and restructuring its legacy-cost obligations for retirement and health care.
Delphi is a global company. It employs 185,000 people around the world. Of these, about 50,000 are employed in the U.S. Delphi makes a wide range of auto parts, including dashboards, air conditioning systems, electronics, and batteries.
Drawing from a variety of data sources, my colleague Thomas Klier and his research assistant, Cole Bolton, have put together a map of Delphi’s Midwest operations that displays current employment (figure 1). The Midwest is home to about 70% of Delphi’s U.S. employment. The two states with the highest concentration of Delphi employment are Michigan (just under 15,000) and Ohio (just over 13,000).
Delphi’s Midwest footprint is very typical of the overall auto supplier industry; the Midwest is home to 61% of auto supplier plants located in the U.S. (figure 2) with other plant concentrations in the southern states, Ontario, and Mexico.
This remarkable concentration in the Midwest has historically been lucrative for the region. But now, the traditional hub of the auto industry is facing some serious challenges, and Delphi is something of a bellwether.
Challenges to U.S.-produced automotive parts are either directly or indirectly linked to international trade and investment, though ongoing shifts in the domestic geography of parts production also play a role. First, the sales of the traditional “Big 3” domestic auto assembly companies have been giving way to transplant sales. Transplant vehicles are produced in the U.S. by foreign companies and, in some cases, their supply chain of parts reaches overseas to a greater extent than Big 3 auto production. The U.S. light vehicle sales share accounted for by these foreign nameplates has risen from a 15% share to a 22% share during the past decade.
In addition to having global supply chains, this sales shift threatens Midwest parts plants because the transplants and their parts suppliers tend to be located south of the traditional auto states of Michigan, Indiana, and Ohio.
At the same time, imports into the U.S. of light vehicles produced in countries other than Mexico and Canada have increased their market share by 8 percentage points (to 19%) over the past decade. Imported cars do not usually contain U.S. produced automotive parts.
And finally, parts for domestic vehicles—including those produced by the Big 3—are increasingly sourced overseas, with China’s share growing fast, albeit off a small base.
These international developments and regional shifts will be analyzed further by Thomas Klier in a Chicago Fed Letter to be released later this fall. (The CFL is now available -- link.) In addition, Klier is organizing a conference in the Detroit area to further assess the directions and challenges of domestic automotive parts producers.
To be sure, Delphi has some unique characteristics concerning its relative wage and benefit costs that are not mimicked by other domestic parts operations. But the scale and geography of struggling Delphi are enough to focus Midwest attention on both the similarities and the differences.
September 23, 2005
Ethanol and Midwest Rural Communities
Those who are interested in the prospects of Midwest rural areas will want to peruse the presentations from Dave Oppedahl’s recent conference on “Ag Biotech and Midwest Rural Development.” Right now, the papers and presentations are posted (see conference link). Dave will soon be summarizing the conference for an upcoming issue of Chicago Fed Letter.
One topic of the conference was the rising prominence of ethanol production in rural communities, and the associated economic benefits. Ethanol raises hopes in many rural communities because of agriculture’s shrinking role in supporting rural jobs and income. But while ethanol production appears to be a boon to many rural communities, some question the efficacy of the subsidies for the overall nation.
As both Dave Oppedahl and I covered in our September 8 presentations, production agriculture has been shrinking profoundly as the basis for income and jobs in many rural areas, and government support payments make up sizable shares of what remains. But while direct income and jobs are shrinking in production agriculture, some rural income and work is being created downstream in transportation of the voluminous crops, along with financing and service support of production agriculture. In addition, related manufacturing has become more important in many Midwest rural counties in the form of “food processing,” such as oil seed crushing, meat processing, packaged foods, and prepared packaged foods. It is somewhat insightful to consider how we count the processing of food in our economic statistics and in what particular industry we place food processing. If food is prepared (grown) on the farm, it is agriculture. If it is prepared in a factory as a frozen meal, it is “manufacturing.” If it is prepared in a grocery store at the deli department, it is retail. And in a restaurant, it is in the services industry. And if it is prepared at home, it is not counted in our measure of national output, GDP, at all!
The concentration of food processing (manufacturing) in rural counties in the U.S. has doubled since the 1970s and accounts for about one-fifth of rural manufacturing earnings according to the U.S. Bureau of Economic Analysis. Economies of transportation is one reason that much of the processing activity remains in rural areas. By processing raw farm product near the farm, the products shed weight and volume before delivery to market.
In this regard, the ethanol industry is closely akin to food processing. This alternative fuel to gasoline is most widely processed from corn, and done so nearby to corn production. In production of ethanol, Iowa is the leading state, followed closely by Illinois (these two states also lead the nation in corn production).
The domestic market for ethanol was encouraged by the Clean Air Act Amendments of 1990. Concerns about urban ozone pollution, relating largely to breathing difficulties, led non-attainment areas to require additives to gasoline that diminished emissions of compounds that are thought to be precursors to (ground level) ozone formation. Today, such encouragement primarily takes the form of a federal $0.50 per gallon tax exemption at the wholesale level for ethanol as compared to gasoline. Some states such as Minnesota and Iowa add additional incentives.
As a result, ethanol demand has more than doubled since 2000 and annual production will likely exceed four billion gallons for the year 2005. At the September 8 conference, John Miranowski of Iowa State University reported that 30 new plants ethanol plants have been added over the past 3 years, with many more in progress or on the drawing board.
Many rural communities have welcomed and encouraged ethanol plants for the associated jobs and income at the plant. And again, the economics of transportation savings has meant that local corn farming operations typically receive higher prices than they would otherwise. In addition, some of the by-products from the ethanol processing can be used as livestock feed. This livestock production too contributes to the local community’s economy. And as usual, some enterprising economists have estimated the indirect and “multiplier” impacts of an ethanol production atop the direct local economic impacts.
From a national perspective, the advantages and sustainability of the ethanol industry are not very clear. We don’t know how well ethanol would compete in an unfettered marketplace, without subsidies. At the oil prices of two years ago, and without the very large subsidies, ethanol production today would have been much lower. However, at today’s petroleum prices, ethanol is looking more attractive. Further, some would argue that, as the infrastructure to transport and distribute ethanol are developed and attain greater scale, ethanol might find a place in the market without its very large subsidies.
Subsidies are sometimes justified for the alleged environmental benefits to ethanol in reducing urban ozone. But to the contrary, others argue that today’s engines burn so much more cleanly that there are no ozone benefits to burning ethanol rather than gasoline in urban markets. In addition, ethanol evaporates more readily in comparison to gasoline, thereby possibly aggravating urban ozone. In rebuttal, many point out that ethanol is advantaged because it does not release as much carbon into the atmosphere, and thereby helps out “global warming.”
Energy security is also an elusive idea. Buffer stocks of vital materials are an alternative to subsidizing domestic fuel industries, and possibly less costly. So too, in other countries such as Brazil, ethanol can be produced more cheaply than in the U.S., from cane sugar. Even if ethanol displaces a small portion of our imported petroleum, would we not find that we can securely and cheaply import ethanol from South America? At least one conference participant suggested that domestic ethanol interests may soon be fighting for further trade protections against ethanol imports.
In all likelihood, we will never know the answer as to how ethanol would fare on a level playing field, or whether subsidies already in place are justified on the basis of non-market considerations such as environmental features and energy security. That is because ethanol’s future in the U.S. seems quite robust since the recent federal energy bill has mandated consumption of 7.5 billion gallons in the U.S. by 2012. As one visitor to our bank commented, “apparently, U.S. industrial policy is not quite dead.”
Surprisingly, despite the many analytic tools that economists have to inform public policy, no one at the conference could report that there had been any comprehensive and respectable benefit-cost study conducted to evaluate subsidies and mandates for ethanol production and use. There has been a prominent debate as to whether the ethanol production process consumes more energy than it produces. But the study results are highly sensitive to the assumptions of each researcher as to what is the corn yield per acre of land, for example. But even aside from these vagaries, the “energy balance” approach is not really very helpful in deciding the issue--the way a market test would be helpful. In the generation of electricity, for example, there is an enormous loss of energy as scientifically defined. The heat content of coal used, for example, is far more than the electricity produced. Yet, it goes without saying that electricity is quite valuable, and end users are willing to pay for it. As for spillover benefits relating to the environment, economists are learning to use shadow prices obtained from surveys, for example, to put dollar values on environmental emissions so that lower pollution can be evaluated using a value yardstick.
Whether or not national ethanol policy would be seen favorably by a thorough cost-benefit analysis, many rural communities would welcome an ethanol plant, and some will get that chance.
The Midwest Economy “Blog”
Anything resembling an opinion or viewpoint contained in the blog are my own, and do not necessarily represent the views of anyone else at the Federal Reserve Bank of Chicago or in the Federal Reserve System.
Impact of biotech on agriculture
Midwest economic conditions and recent hurricanes
Chicago area economy
Funding and access to higher education
September 16, 2005
Hello midwesterners and those interested in the Midwest’s economic growth and development. My name is Bill Testa, and this is an introduction to my Midwest Economy Blog.
In this blog, I will offer some current information on the Midwest economy, as well as analysis of important public policy issues and even an occasional prediction or two. In this effort, I will be looking for those of you who share my keen interest in the Midwest economy to contribute not only your attention and readership, but also your thoughts and information. Those of you who do respond, as well as those who only listen, will help us all to enrich our understanding and knowledge of this region. And as time passes, we will also have an extensive compilation of information and experts to draw on as the Midwest encounters new issues and economic challenges.
Unlike some economists who sponsor blogs, I am neither a Nobel prize winner nor a renowned media personality. However, I have been following and analyzing the Midwest economy for over 25 years, most recently as the director of Regional Programs in the Chicago Fed’s Economic Research Department. The most burning questions that keep me up at night include: Why do some regions grow faster than others? What are the prospects for the Midwest and other regions? What can we do to influence our economic destiny? What roles, if any, do state-local governments and public-private partnerships play, or should they play, in the growth and development process?
At the Chicago Fed, my interest in the Midwest economy is shared by a talented and varied group of economists. Some of them—such as Rick Mattoon, Thomas Klier, Yukako Ono, and Mike Munley—are part of my Regional Team, while some are in other areas of our Research Department, including our Chief Business Economist, Bill Strauss, and our agricultural/rural specialist, Dave Oppedahl.
And if you are a true Midwest economy buff—as I am—you will find your way here—to our newly launched Midwest Economy web page. This new page features content galore, including our own vast archive of published analysis organized by subject area. You can also access regional data to create your own analysis; or link to other related web sites. Also, the site features our many past conferences, along with the presentations of renowned experts on the Midwest economy, state-local finance, economic growth, and a host of special topics concerning economic growth and development.
“Ag Bio” Conference at the Chicago Fed
Last week, Dave Oppedahl, our agriculture and rural specialist, held a conference at the Bank addressing agricultural biotechnology and rural development prospects in the Midwest. The best-known of these technologies are so-called bio-fuels, such as ethanol (which is largely refined from corn in the U.S., but it is largely refined from sugar cane in other countries like Brazil), and GMOs or genetically modified organisms, such as pest-resistant and herbicide resistent grains. Dave’s chief interest in these technologies and their prospects are how they will affect the well being of Midwest agriculture and rural communities.
New biotech products linked to agriculture are but one of several avenues by which rural counties hope to revive their fortunes and sustain their populations. Historically, family incomes in rural counties were supported by agriculture, mining, and forestry—especially agriculture. The U.S. Bureau of Economic Analysis compiles figures on the shares of personal income that derive from various industry sectors, and they estimate that as recently as 1969, 935 “rural” or nonmetropolitan counties counted on agriculture for 20% or more of personal income. By 1999, the number had fallen to only 235.
The problem has not been so much a failure of sagging production, or vulnerability to foreign producers, as it has been rising productivity itself. Improved strains of agriculture and better/more mechanized farming methods have increased yields astronomically. Since 1947, U.S. real farm product is up over 3.5 times. But despite rising real product, prices for farm products have fallen steeply, because the demand for raw agricultural products has not kept pace with rising production and productivity. In 1950, corn in the U.S. cost five times its price today as measured by inflation-adjusted dollars. Falling prices (along with labor-saving productivity) have come to mean meager farm earnings and jobs in most nonmetropolitan counties. In 1870, over 50% of the U.S. work force could be found in agriculture, but this had dwindled to 13% by 1947, and to 2% today.
In our Seventh Federal Reserve District states of Iowa, Illinois, Michigan, Wisconsin, and Indiana, farm earnings comprised 13% of personal income in 1969, but had fallen to only 2.8% by 2002. Of course, such productivity gains, along with urbanization of population, have also created the world’s highest standard of living for the average American.
But in generating income and jobs, many rural communities have not found a sufficient replacement for agriculture. (Though some, of course, have become suburbanized by nearby metropolitan area expansion, while others have redeveloped toward service industries and manufacturing). Consequently, the decline of agriculture-related income in nonmetropolitan areas has often been accompanied by lagging population growth or even outright declines. In the U.S., nonmetropolitan population grew at around one-half the pace of metropolitan counties from 1969. With falling population, many rural towns have been challenged to sustain essential services such as health care, schools, and retail. And in relation to metropolitan standards of living, rural personal incomes have fallen. Per capita income in nonmetropolitan counties in the Seventh District, for example, declined from 85% of the nation’s average in 1969 to 80% in 2002.
What’s a rural area to do? In our part of the Midwest, two distinct avenues to re-development are most prominent—manufacturing/distribution and retirement/recreation.
What other development paths are you seeing around the Midwest? Please share your thoughts and observations with us.
Bright prospects as a haven for retirees and recreational visitors can be most commonly observed in our northern states of Michigan and Wisconsin. Places such as Walworth and Door Counties in Wisconsin, and the northwest coastline of Michigan are perhaps the best-known in this regard. The map below illustrates those nonmetropolitan counties that have experienced hikes in population since 1969 (shown in blue, declines shown in green), and the “north woods” pattern in Wisconsin and Michigan is quite evident. (A map of second homes from the 2000 Census would show much the same effect). In many such places, the choice to develop tourist or retirement centers is not without its downsides. Recreational and retirement homes, and attendant commercial activities, often change the very character of rural towns, sometimes to the consternation of its original residents. Many towns on the periphery of large and sprawling metropolitan areas also face many of the same difficult choices: How much to grow, and in what directions?
For other rural places, manufacturing jobs have helped them survive and allowed many farm households to earn sufficient income off the farm to sustain their rural lifestyle. In fact, manufacturing jobs have actually been growing in the nonmetropolitan counties of the Seventh District, even while they have been shrinking fast in metropolitan areas. Compared with 1969, when the concentration of manufacturing jobs in the Seventh District nonmetro areas was about the same as the U.S., these counties are now, on average, 75% more concentrated in manufacturing than the national economy overall. Apparently, in the face of cost competition from abroad and from the American South, manufacturers have found the rural Midwest desirable in terms of land and labor costs, labor quality, and access to rail and roads.
As the map below shows, manufacturing has become a staple of the economic base of nonmetro counties throughout the Seventh District states. (Orange-colored counties have a manufacturing concentration above the U.S. average). It is surprising that the preponderance of nonmetro counties in Indiana are concentrated in manufacturing. Morton Marcus, Director Emeritus of Indiana University’s Business Research Center, describes the common confusion between manufacturing and farming in Indiana this way, “For a century, the state has been considered an agricultural state when its reality has been as a manufacturing state. Hoosiers and citizens of other states refer to Indiana as part of the Corn Belt ignoring the massive steel and automotive parts industries in the state. Local economies that have depended on manufacturing for decades are still thought of as farm-serving towns. Workers, who derive the bulk of their income from factory jobs, imagine themselves as independent farmers because they own some acreage and plow or harvest after working hours at the plant of some global firm.”
This is not to say that life is a bed of roses in those nonmetropolitan areas that are oriented toward factories. Recent plant closings over the past five years in places such as Galesburg, Illinois (Maytag), and Thompson’s picture tube plant in Marion, Indiana, have been caused painful labor dislocations for the towns and their workers.
More troubling still, earnings per job in nonmetro counties have not kept pace with metropolitan earnings. Apparently, the search for lower costs and lower wages is responsible for some of the urban to rural shift of manufacturing jobs. Does this mean that these same jobs are those that are most vulnerable to foreign competition and labor-saving technological change? Some analysts believe that many rural manufacturing jobs are at the end of a geographic “product cycle,” meaning that well-paying jobs are spawned in urban areas, but outsourced first to U.S. nonmetropolitan areas as their technology and production methods become routinized and subject to competition from abroad. Recently, there is little evidence of a shift in favor of metropolitan areas in the Seventh District. Manufacturing employment declines since 2000 in the District’s nonmetro counties have given back most of what had been gained since 1970s, but the pace of decline has been the same as in metropolitan counties.
What about the economic development promise of so-called “ag biotech”? What has been its impact so far? And what is on the horizon? We learned a lot from Dave Oppedahl’s September 8 conference. Before I share some observations with you from that conference, think about your own impressions of this phenomenon… and tune in later this week to compare your theories and experience with the information delivered at the conference on September 8.
Later this week…
Further discussion from the Chicago Fed’s recent conference “Ag Bio and Rural Economic Development, and
The Chicago Area’s economic performance…