February 3, 2012
Manufacturing as Midwest Destiny
By Bill Testa and Norman Wang
In the Midwest, the terms “industrial” and “cities” are almost synonymous. Though agriculture has been important to growth and development, the region’s economy was built on manufacturing, and the sector continues to be prominent—for both small towns and large metropolis alike.
However, labor and income generated from the region’s factories began to wane 40 to 50 years ago. In response, the region’s cities have undertaken deliberate development strategies to maintain their economic vibrancy. Some strategies have focused on the historic mainstay—manufacturing—while some have focused on diversification into service sectors ranging from tourism to business services and finance. These efforts have met with mixed success, and the industry mix of most Midwest cities continues to be steeped in manufacturing. Accordingly, “Industrial cities” of the Midwest continue to address the same fundamental challenge—that is, how to sustain their communities as manufacturing’s ability to generate jobs and income continues to decline.
The chart below looks at manufacturing’s share of jobs going back to the year 1969. In both the Great Lakes region and in the U.S., the share of jobs to be found in manufacturing has declined by one half or more. A much greater share of workers now find employment outside of the manufacturing sector than are employed by the sector. Importantly, though, the Great Lakes Region continues to be more highly specialized in manufacturing as compared to the U.S.
At a more granular level, the chart below illustrates the many metropolitan statistical areas (MSAs) with higher job concentrations in manufacturing than the U.S. as a whole As seen, these include very populous MSAs, such as Detroit and Milwaukee, but also many smaller MSAs, such as Decatur, Illinois, Jackson, Michigan, and Cedar Rapids, Iowa. Even some of those MSAs with smaller shares, such as Flint, Michigan, have diversified out of manufacturing only under the pain of wholesale loss of jobs, people, and income. (And Flint’s economy continues to decline).
A more systematic illustration of how manufacturing has been a large part of the destiny of the Midwest can be seen in the charts below. On the horizontal axes can be found the share of manufacturing employment for all MSAs of population 100,000 and greater in 1969. The vertical axes measure subsequent (post-1969) total job growth and per capita income for each MSA. The inverse correlations are striking; the general tendency indicates that manufacturing-oriented cities fared worse as measured by growth of income and total employment. Further analysis of these cities (not shown) again indicate that the depressing growth tendency of yesteryear’s manufacturing orientation has not discriminated by population size; both big and small MSAs were similarly affected.
Have any other industry concentrations or preconditions been important in determining the economic fate of Midwestern cities? Other researchers, such as Edward Glaeser, have emphasized that educational attainment of the adult population has been a strong causal determinant or precondition of MSA growth. The reasons for this finding are varied. It may be that this measure represents local workers and community leaders who were most capable of reinventing their home city when damaging shocks to the local economy took place. Alternatively, a large share of college-educated workers may simply reflect that the MSA already enjoyed an economic diversification into other key industries (employing college-educated workers) that did well after 1969. In any event, our analysis suggests that taking “percent of adult population with a college degree or more” into account explains more of the performance variation among Midwest MSAs. Together, the “share of manufacturing jobs” along with the “percent of adult population with a college degree” explain as much as 40 percent of the variation in Midwestern MSA economic growth after 1969.
Looking at these past determinants of growth, can we identify any room for local policy actions to shape the local economy? In the analyses above, we have used very simple measures of a local economy’s “industry mix” to suggest that historical development may have been destiny for many Midwestern towns and cities. Indeed a more careful accounting of each place’s historical industry mix might yield more telling findings and insights. For example, towns steeped in steel production, automotive, or television electronics may have had even less control over their destiny in recent decades. However, a more expansive view indicates that our measures of “industry mix” (above) explain only 40 or less percent of the 1969-2010 variation in performance among Midwest MSAs. This leaves much more performance to be accounted for. It seems that some places have improved their own economic performance through deliberate development policies such as work force training, tax incentives to business investment, land use reform and re-development, or public infrastructure investments.
For these reasons, the Chicago Fed’s “Community Development and Policy Studies” (CDPS) area has launched an investigation into how industrial cities in the Seventh District have taken deliberate steps to fashion their own destinies in more favorable ways. According to CDPS Business Economist Susan Longworth, an initial project step will be to “develop comprehensive community profiles of cities throughout the Federal Reserve’s Seventh District that had populations of at least 50,000 and had 25% or more of their employment in manufacturing in 1960. Research includes in-depth qualitative information, combined with the best available quantitative analyses of the trends and issues impacting these communities to identify policies and programs that promote (or inhibit) economic growth and vitality in industrial cities.”
The declining share of manufacturing is overstated because manufacturing companies have outsourced functions (and jobs) to local service sectors. These include the hiring of factory workers who are on the payrolls of temporary employment firms, as well as outsourcing of maintenance, payroll, and transportation workers to outside (service) firms.(Return to text)
Some well-performing nonmanufacturing MSA economies are fashioned around state government capitols and major universities, such as Ann Arbor, Michigan, Madison, Wisconsin, and Columbus, Ohio.(Return to text)
Some might wonder whether manufacturing orientation continues to influence community growth in more recent years. Our analysis of 1990 to date continues to show such influence widely across the Midwest, although there is tendency of a weakening correlation.(Return to text)
April 12, 2011
Net Migration and Regional Adjustment
By Britton Lombardi and Bill Testa
How do regions adapt following economic calamities that displace large numbers of workers? In the best case scenario, they reinvent themselves. For example, economist Ed Glaeser documents the several times that Boston rose from the ashes following collapse of its shipping and old line manufacturing industries. In a similar vein, Detroit hopes to rebuild as an economy based on logistics, energy, and high-tech manufacturing—especially next generation automotive technology and production.
However, in many more instances, rather than a quick turnaround, cities and regions undergo a painful adjustment period that leaves them smaller than in their heyday. In the process of adjustment, economists have shown that, following an economic shock, unemployment rises for several years before returning to more normal levels. Using the steel- and auto- related job losses in the early 1980s as an example, a paper discusses the long-run effects of massive job losses. The authors found that after an initial spike in the unemployment rate in the impacted local economies, the rate converged back to the national average after five or six years. However, high out-migration (and low in-migration) led to this reduction in unemployment, rather than an increase in new jobs. Similarly, a landmark study found that those U.S. multi-state regions that experienced downward employment shocks returned to a more normal path of employment growth within five to ten years. However, the lost jobs were never recovered.
One lesson from such studies is that the ability to migrate from distressed areas can be helpful in restoring the lives and livelihoods of households that undergo economic displacement. Recently, there has been concern that the migration mechanism is broken or impaired. William Frey and others have documented a fall in interstate migration during the recent recession, along with a longer-term decline over recent decades. Nonetheless, much of the long-term decline is gradual and mobility in the U.S. remains high relative to other nations and continents.
In the current environment of high unemployment and a weak housing market, some analysts have attributed dampened mobility of the labor force to falling house prices and “negative equity” or underwater households—that is, homeowners who owe more on their existing home mortgage than their home is worth on the market. Some economists posit that negative equity in a home may hamper the ability of the homeowner to move to a new labor market because they are “locked-in” to their existing house by their inability to raise funds to pay off their mortgage. A staff report from the New York Fed found that negative equity does reduce the probability of moving. However, in a rebuttal paper using the same data but differing coding of movers, the author concludes that negative equity does not make homeowners less mobile. If anything, a homeowner with extremely negative equity is actually slightly more likely to move than an individual with smaller negative equity. Using statistical analysis, the author finds that negative equity actually increases the probability of moving by 1 to 3 percentage points; this represents an increase of 10 to 18 percent of the overall probability of moving. Dan Aaronson, has conducted some preliminary research that finds that differences in migration rates of homeowners and renters barely changed during the recession and early parts of the recovery. Since renters should not suffer “house lock,” this evidence suggests that the migration process has not been hampered by falling home prices to a large degree. Similarly, Mark Partridge et al find that the migration falloff in the recent decade may fundamentally reflect heightened risk aversion of U.S. households.
So, how does this all play out in the Seventh District? Despite some impairments to mobility, interstate migration appears to be well underway in the region, especially in those states, such as Michigan, that have experienced the most damaging employment shocks. Michigan has been an outlier in its high unemployment rate, which has been well above those of the rest of the District states since 2004.
As seen below, Michigan started experiencing net out-migration during the recession in the early 2000s. However, the out-migration rate picked up speed around 2004/2005 as Michigan’s unemployment rate started to drift higher than those of the other Seventh District states. Net out-migration from Michigan remained relatively high, at around 8 per 1,000 people, from 2007 through 2009.
To check more recent trends, we turn to data released from United Van Lines and Atlas Van lines as they track interstate movements of U.S. households around the country. They have been tracking this data for a long time and so provide some historical data. In the chart below, we combine both companies’ data to try to produce comprehensive results and remove any anomalies that one company may experience in their sales. We plot the outbound migration gap, or the extent to which the number moving out of the state exceeds those moving in. In the early 2000s, Michigan’s gap is in line with the rest of the Seventh District but, again, starting around 2004/5, Michigan’s gap greatly widened compared with the other states’ gaps, consistent with the unemployment observations above. The gap continued to grow during the recent recession; it recently began to trend back down, but still remains at higher than the rest of the District states’.
Net out-migration is not a preferred solution to economic shocks for many reasons. Moving can be costly in terms of out-of-pocket expenses, and households can suffer from the severing of social ties as well as difficulties in learning how to negotiate daily living in new communities. Nonetheless, mobility can be a helpful part of the adjustment process when it allows workers and households to improve their standard of living and well being following a negative shock to local employment. For this reason, and in response to today's difficult employment situation, researchers are asking whether public policy should intervene to assist those unemployed workers who would benefit from re-location, but who lack the funds to re-locate in search of jobs. One recent idea has been explored by Jens Ludwig and Steven Raphael. They "propose the creation of a "mobility bank" that would help finance the residential moves of U.S. workers relocating either to take or search for work....in depressed areas of the country." These loans would be "amortized over a fairly long period (10 years), and repayment terms be contingent on the borrower's post-move employment and income." The paper suggests that the program costs would compare favorably to alternative federal programs designed to achieved re-employment.
In contrast, Timothy J. Bartik finds persistent effects of shocks on unemployment rates and labor force participation; See here(Return to text)
See here (Return to text)
There may be some sample bias of individuals that actually use movers versus those that rent a truck and move themselves. (Return to text)
July 27, 2009
Migration, Michigan, and Labor Market Adjustment
In part, American households have adjusted to local economic shocks by picking up and moving to regions where job and income opportunities are more abundant. Some of these movements have been broad and steady, such as the shift in population westward from the east over the past two centuries, and the north to south migration during the latter 20th century. Other migrations are more dramatic, such as the migration of African-Americans from agricultural parts of the middle South to northern manufacturing-oriented cities during the 20th century; or the Dust Bowl out-migration to California from parts of the Plains during the 1930s. Other dislocations have been more local, such as those resulting from contractions in coal mining, textile mill, and steel-producing towns in recent decades.
When such migrations take place in response to sharp negative economic shocks, they can be painful and costly both for the households who move and for the communities left behind. Those who migrate are often in desperate circumstances, and so there are high costs associated with loss of friends, family, and knowledge of local living pathways. Shrinking communities do not adjust easily. The least fortunate populations may be left behind to be supported by a tax base that has dwindled. And for those communities with shrinking population, the neighborhood housing and public infrastructures are not easily re-configured to serve smaller populations.
Nonetheless, due to its vast size, common laws, and common language, the United States is often considered to be a place where the ease of spatial mobility facilitates economic adjustments. This is true despite a few institutional impediments, such as non-portable state unemployment insurance systems as well as health insurance tied to workers’ local employers.
Home ownership may be another significant impediment that has grown over time. Since the 1940s, homeownership rates had expanded from 44 percent of households in 1940 to 69 percent by 2005. The sale of a large asset such as a home is typically accompanied by large transaction costs. And today, in the aftermath of the national freefall in home prices, many local housing markets are stagnant as would-be buyers await price stability. Moreover, price declines have left many homeowners “under water,” meaning that the likely sales price of their home would be less than the amount of the mortgage they must pay off at the time of sale. In some instances, homeowners cannot cover such losses from their savings or secure another loan to pay off the mortgage. Consequently, in situations where homeowners do not default and walk away from their obligation, or where households are uprooted due to foreclosure, the soft housing market is likely to slow migration in search of employment..
According to a recent report from the Census Bureau, the rate of interstate migration from 2007–08 was the lowest since 1948. Comparing migration in the year ending mid-year 2008 versus the previous year, 30 states experienced declining net domestic migration.
Other factors lie behind the falling trend rate of interstate migration. The U.S. population is aging, and older households tend not to move as readily. But the more recent falloff is likely tied to the aforementioned economic developments; migration rates have been found to respond to imbalances in regional economic conditions. Demographer William H. Frey notes that, during the middle years of this decade, the fast-growing metropolitan areas in Florida, Arizona, Nevada and California experienced enormous in-migration spurred by both the house price appreciation and the attendant jobs in construction and related economic sectors. Now, in-migration to such places has cooled and even reversed in some places, as home prices and jobs have declined.
More generally the national slowdown in economic activity may also be impeding inter-state migration. In investigating business cycles over the past 60 years, Raven E. Saks and Abigail Wozniak find that labor migration rates rise with cyclical upturns and fall with downturns, especially for younger working age people. These effects are independent of the degree of differences in inter-state economic conditions, and may reflect the shifting costs of job search and job matching that take place over the business cycle.
Despite such costs, migration remains attractive for some households whose local economies are particularly depressed. For example, in Michigan, the national recession has sharply deepened economic trends that have long been underway. Owing to unprecedented restructuring in its automotive sectors, the state’s labor markets have been weakening all decade long, with a cumulative decline of nonfarm payroll jobs of 17 percent. Its current unemployment rate of 15.2 percent leads all other states.
The chart below shows Michigan’s annual rate of net domestic outmigration (in red) juxtaposed against the difference between Michigan’s unemployment rate and the U.S. rate (in blue) . As Michigan’s labor market has weakened over the decade, the rate of outmigration has accelerated . At mid-year 2008, Census figures estimate that the state lost 92,600 in domestic population. Cumulatively, domestic outmigration amounts to an estimated 315,600 over the decade (table below).
Outmigration is one of several mechanisms by which Michigan workers will adjust to the shocks to their economy and job market, but not the preferred one in most situations because of the adverse impact on households and local communities. National and global economic recovery will help, too, by lifting demand for cars and other Michigan products and services. Other adjustments will involve re-training for emerging local jobs that may come about as new industries and investment opportunities develop in the state.
Note: Thanks to Vanessa Haleco-Meyer for assistance.
Population migration estimates are very uncertain. However, the general patterns and rankings cited and displayed here for Michigan are largely corroborated by alternative estimates that have been made by a state agency in Michigan, as well as by tallies of inward and outward bound shipments reported by residential moving companies. (Return to text)
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.
Click to enlarge.
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.
October 16, 2008
Fresh Water Issues and Conference
Sometimes when I am out speaking to groups about the Midwest’s economic future, someone in the audience will assert that the Great Lakes Region’s past glories will ultimately be restored because “they (other U.S. regions) will run out of water and we have plenty of it.” This assertion may be only partly true, and its fulfillment may require deliberate action and hard work rather than passive waiting.
It is true that the Great Lakes states border one of the world’s largest bodies of fresh water. With regard to surface fresh water, the Lakes are estimated to contain 18% of the world’s supply, and 90% of the U.S. supply (though we share these shorelines with Canada’s Ontario and Quebec provinces).
However, in replying to the “water revival” assertion, I am always careful to temper the sanguine outlook with several “the glass is half empty” caveats.
First, while it is true that water is becoming increasingly scarce in much of the West and even, more recently, in the Southeastern United States, the problem there mostly lies with poor allocation of water among competing uses rather than with sudden scarcity. Especially in the West, most fresh water is used for agricultural irrigation rather than for residential purposes. Since agricultural use of water hardly begins to approach its value for use in human living, it is difficult to imagine that the scarcity will soon present a significant obstacle to growth. Rather than in agriculture, most economic growth in the West is taking place in the service-oriented economies of its large metropolitan areas. Since water requirements for urban households and their typical jobs are light, rising water demands need not be onerous. Indeed, much of the difficulty with scarcity in metropolitan areas arises because available water is not properly priced. When water is underpriced, or priced poorly among different types of users, the resource is invariably wasted. In the case of water, legal and governmental arrangements compound the waste and misallocation. That is because many water users in agriculture can by law only use available water for immediate purposes (e.g., irrigation) and cannot sell it to others for a higher value use such as residential use.
While the water shortages that emerge from such arrangements do present some drag on growth, fast-growing metropolitan areas of the West do ultimately manage to wrest water away from existing uses. And so, looking to the future, it is more likely that existing water will be allocated to its higher value use for residential purposes in the West and will not (much) constrain growth there.
Still, the history of water allocation in many parts of the world is littered with tragic outcomes, as water is diverted by mammoth diversion projects and overused by those zealous users who draw on the “free” resource while imposing scarcity on others. Recently, in documenting historical water diversions into and out of the Great Lakes Basin, author Peter Annin also chronicled the devastation of the Aral Sea in Kazakhstan and Turkemistan. A Soviet program of the 1950s diverted much of the water from the Aral River Basin into agricultural uses. As a result, the Aral Sea has shrunk by 75%, with catastrophic consequences for the environment and the people who lived along its shores. Annin believes that clean water scarcity is on the rise in many regions of the world and throughout the United States. Accordingly, we can expect that tensions and conflicts will increasingly emerge over fresh water use and ownership.
We already have seen such conflicts here. Uncontrolled or ill-conceived withdrawals threaten to expunge water resources from underground aquifers of the American West. According to Mark Reisner, federal government-sponsored water diversion projects have contributed to today’s depletion and water misallocations there. Water resources in the West have been historically commandeered through federal government actions such as the construction of dams and the re-channeling and transport of vast quantities of fresh water.
The lessons for the Great Lakes Basin are plain. As water grows scarcer in faster-growing regions of the U.S., and as political representation of the Midwest wanes with lagging population growth, wholesale water diversions from the Great Lakes Basin may become more likely.
Anticipating such a scenario, ten years ago policy leaders of the Great Lakes began working on an agreement to protect the waters from diversion and depletion. After much wrangling in and among individual states, the agreement was signed by President Bush last week on October 3. The Great Lakes–St. Lawrence River Basin Water Resources Compact arrived on the President’s desk following ratification by the eight states bordering the Lakes and subsequent approval by both houses of Congress. (Ontario and Quebec have adopted parallel agreements).
What does the compact mean for the region’s prospects? The compact does not guarantee that these waters will never be diverted for broader national purposes. However, it does give the region some assurance that it can plan to preserve and develop its natural advantages of abundant water in ways that secure a brighter future. In fact, the compact imposes uniform and stringent conditions on further water withdrawals even within the Great Lakes states and requires the states themselves to implement new management and conservation programs.
With its inland fresh waters now more secure, and as the region must rethink its own water management policies, there is perhaps no better time to consider how the region’s fresh water legacy can best serve its residents. For this reason, on November 10, 2008, the Federal Reserve Bank of Chicago will host a conference on “Fresh Water and the Great Lakes Future” in Detroit. This will be an opportunity for regional leaders to explore the increasing value that these assets hold for our residents for residential, aesthetic and recreational purposes.
As U.S. income and population rise, the recreational and scenic value of open waters, wetlands and other open spaces also rises. But how will these assets be used and what will be the level of demand? And how will this be manifested in migration and growth in income? What sustainable and responsible policies should the region undertake to cultivate its own fresh water legacy and related assets?
Investment in preservation and clean-up of Great Lakes waters presents one set of policy options, as do related decisions concerning regulation, land use policies, and consumptive uses of the waters. So too, both rural and urban communities are moving forward with infrastructure and other economic development programs that promote the recreational and residential advantages of lakes and rivers. These include lively riverfront and lakefront mixed-use developments in downtown areas of big cities, as well as the promotion and development of more rural recreational assets.
Our conference will also investigate the region’s legacy of fresh water treatment technology. During its rapid industrialization and urbanization, much water degradation took place. In some instances, the region’s subsequent adoption of stringent water quality regulation has spawned the growth of associated firms, university research, and associated water treatment technologies. Can our water treatment firms and university researchers grow more prominent, perhaps serving communities in other parts of the world where clean fresh water is less readily available?
September 24, 2008
Supply-side efforts at building skilled workforce
By Britton Lombardi, Associate Economist
Wage growth continues to grow more sharply for educated workers, but how can states and cities build their work force in this direction?
For one, a “grow your own” approach to enhancing the local supply of educated workers may be helpful. States tend to have some advantage in retaining individuals who grew up and went to college within the state. A study found that 54% of students that were both residents of the state and attended college in-state were working in the state 15 years later. The number falls to 35% if the student residents attended college in another state. The percentage drops to 11% for non-residents who attended college in the state. A recent policy report for the Milwaukee area suggests that a potential way for states to make use of this home state advantage would be to increase their high school graduation rate and better prepare their students for college. Even if these students do not attend college, the policy report notes that a rise in the high school graduation rate would raise average incomes and would help fill jobs being left open by retiring baby boomers. Nonetheless, states and cities will see the greatest returns to education if these high school graduates do obtain a college education and either stay in-state or return home after college.
How are states doing in "grow your own" initiatives? The chart below plots state college enrollment versus educational attainment of the workforce. The state’s college enrollment rate is weighted by the state’s average high school freshman graduation rate, which reflects a state's tendency to graduate its high school students. Therefore, the x-axis number is the interaction between the percentage of high school graduates that go to college and the percentage of students that completed all four years of high school. On the vertical axis, we measure educational attainment of the state's workforce as the weighted average of years of schooling per worker. The horizontal and vertical lines in the graph (in blue) are the U.S. averages.
The states positioned in the top right quadrant of the chart have an above average educational attainment per worker and are sending a higher proportion of students to college than the U.S. average. Four of the five Seventh District states (Illinois, Iowa, Michigan, and Wisconsin) reside in this quadrant. Although Indiana (bottom right quadrant) has lower than average years of schooling, the state seems successful in preparing and sending its students to college as seen from its above average enrollment rate. It appears as though the District states, which tend to be high-income states, have been successful in educating their own and sending them to college. There is some slippage in this measurement since a large and variable share of those who enroll in college go on to complete their degree.
Educating a state’s own individuals does not guarantee the young professionals’ retention or return to the state after college. Therefore, states should also focus on the migration of these young professionals into and out of their state, especially as the young, college-educated professional cohort is the most mobile of any cohort in the U.S. A special Census Report calculated that 75% of young and single and 72% of young and married college-educated professionals between the ages of 25 and 39 relocated between 1995 and 2000. Therefore, a part of a state’s future economic success is tied to attracting these young professionals from other states. In the next chart, states are plotted based on their 3 year average net migration rate of young professionals versus the state’s weighted average years of schooling. For the Seventh District, Illinois and Wisconsin (top right quadrant) have average years of schooling above that of the U.S. average and are importers of young educated professionals as seen through their positive net migration rates. Iowa, Michigan, (top left quadrant) and Indiana (bottom left) have negative net migration rates. These states seem to be exporters of young college-educated professionals.
Click to enlarge.
For the two charts above, the educational attainment of the existing work force was put on the vertical axis for two reasons. The educational attainment level reflects the past success of the state’s educational system in producing an educated work force. In addition, educational attainment will vary with the industry mix of the state economies since industries tend to have varying workforce skill demands. In turn, a state's industry mix is determined by a host of historical developments in the state’s development process. Indiana, for example, ranks among the top 3 states in manufacturing concentration, a sector which historically has not required a post-secondary education (though this is changing to some degree).
As states compete for these young professionals, they may need to offer unique opportunities to set themselves apart. From an economic development standpoint, cities can be an integral part of a state’s effort to increase their level of human capital since cities can be the gravitational force that brings young professionals to the state. Based on the table below, 17 of the 20 largest metropolitan areas had a positive in-migration of young well-educated professionals between 1995 and 2000, including two Seventh District metropolitan areas: Chicago and Minneapolis-St. Paul. Cities have the ability to attract young well-educated residents because they still offer powerful benefits to their inhabitants.Cities eliminate the distance between people and ideas by allowing ideas to be shared in both formal and informal settings, thereby increasing the opportunities for innovation. As such, cities have become centers of learning for young college-educated professionals just starting their careers. As studied by Ed Glaeser, professionals come to cities to take advantage of the knowledge externalities provided by interactions with other well-educated and successful individuals to enhance their own productivity. Glaeser found that workers tend to learn faster in cities and enjoy higher wage growth. The density of educated individuals living in a city creates informational spillovers, thick labor markets, and division of labor leading to specialization. Cities also reap the benefits of these individuals through their overall increased productivity and innovation.
Since cities can play an important role in regional economic development, the Milwaukee area policy report suggests a combination of two ways for cities to enhance their efforts to increase their pool of human capital through migration. First, the city should try to enhance the available job opportunities to young professionals that match their career and personal goals, as these individuals want to learn, network, and develop professionally. The report recommends that local businesses and civic organizations join forces to share resources and ideas to spur innovation and growth to create or improve jobs. Secondly, the American city has been transforming into a cultural and entertainment center. Young, college-educated professionals place special emphasis on amenities offered by a city. They expect high-quality and unique recreational opportunities such as restaurants, sporting events, live music, and nightlife venues. Therefore, cities might need to augment or diversify their recreational offerings to retain and attract these young professionals and provide a vibrant and livable city.
These days, states and cities must select from a wide and complex array of economic growth and development policies to find the strategies that are most appropriate for their situation and circumstances. Increasingly, they are favoring policies related to skilled work force availability.
May 22, 2008
Tracking Seventh District Manufacturing
By Emily Engel, Associate Economist
There is a greater concentration in manufacturing among the five states of the Seventh Federal Reserve District than in the nation. For example, as measured by the share of payroll jobs in manufacturing, Indiana ranked first among the 50 states in 2007; Wisconsin, second; Iowa, fourth; Michigan, seventh; and Illinois, 19th. For this reason, we at the Federal Reserve Bank of Chicago tend to closely watch the manufacturing sector. In fact, our watchfulness often becomes close scrutiny during times like the present when the U.S. economy shows signs of slowing. (Manufacturing activity has tended to be highly sensitive to general business downturns.)
The Chicago Fed Midwest Manufacturing Index (CFMMI) is a public statistical release that the Federal Reserve Bank of Chicago has been producing since 1987. This monthly release tracks manufacturing output for the Seventh District states (Illinois, Indiana, Michigan, Iowa, and Wisconsin) and compares it to the manufacturing component of the Industrial Production Index (IPMFG) produced by the Federal Reserve Board of Governors. The chart below, taken directly from the March release of the CFMMI, shows historical data comparing the CFMMI to the IPMFG. Over the decade, Midwest output growth has lagged the nation. During the current slowdown in national economic activity, both the IPMFG and the CFMMI have slowed and declined at a very mild rate in comparison with past episodes.
Industry concentration in specific industrial sectors influences economic performance among District states. In particular, transportation equipment and machinery are bellwethers of state economic performance in the District.
Since the beginning of this decade, the automotive-intensive states of Indiana and especially Michigan have experienced a softening of their labor markets relative to the national average.
Meanwhile, by the same measure, the machinery-intensive states of Illinois and Iowa have outperformed the nation. The remaining state, Wisconsin, deviates from this pattern, being a machinery-intensive state with an unemployment rate that has deteriorated relative to the national average.
The charts below compare these states’ concentration in both machinery and transportation equipment, respectively. Manufacturing activity in these industries is compiled by the U.S. Census Bureau’s Annual Survey of Manufactures (ASM). Specifically, the Census data measure “value added” by manufacturing establishments within each state. Value added roughly corresponds to the value of shipments of manufactured establishments, net of intermediate inputs to production, such as fuel, materials, parts, and components that are purchased from other establishments. In this sense, value added is manufacturing output.
It takes much time and effort for the U.S. Census Bureau to compile these data, so that detailed information on output by specific industry sector and location are issued with a one or two year lag. The data above, for example, refer to 2005 and 2006.
To keep more current than the Census statistics allow, our CFMMI constructs sector-specific estimates of manufacturing output for the overall Seventh District. These estimates are primarily based on data reported on payroll hours worked in manufacturing establishments across the District, and these data are usually available with only one month’s lag. When complete data on value added are issued by the U.S. Census Bureau, we adjust or benchmark our CFMMI data series to correspond to that data.
There are four major sectors of the CFMMI: auto, steel, machinery, and resource. The CFMMI is made up of 15 North American Industry Classification System (NAICS) codes of hours worked data. The breakdown of the NAICS codes is given under each graph (such as the one below) on the press release every month. The auto sector components are plastics & rubber products (326) and transportation equipment (336). Primary metal (331) and fabricated metal products (332) compose the steel sector. The machinery sector is made up of machinery (333), computer & electronic product (334), and electrical equipment, appliance, & components (335). There are five categories for the resource sector: food manufacturing (311), wood product (321), paper (322), chemical (325), and nonmetallic mineral product (327). The overall CFMMI is composed of the four sector components as well as these industries: printing & related support activities (323), furniture & related product (337), and miscellaneous manufacturing (339).
As seen by the two sector charts below, taken directly from the March CFMMI release, the District’s output growth paths in the machinery and auto sectors have diverged. While the machinery sector of the CFMMI is slowly outpacing the overall CFMMI, the auto sector of the CFMMI continues to fall below the overall CFMMI. Such developments can help us understand differences in economic performance around the Seventh District.
To see more information about the CFMMI, please check the Federal Reserve Bank of Chicago’s website. Additionally, some of the other Federal Reserve Banks also have manufacturing indexes/surveys. Please see below for some of those links:
Federal Reserve Bank of Philadelphia Business Outlook Survey
Federal Reserve Bank of New York Empire State Manufacturing Survey
Federal Reserve Bank of Richmond Manufacturing Conditions Survey
Federal Reserve Bank of Kansas City Survey of Tenth District Manufactures
Federal Reserve Bank of Dallas Texas Manufacturing Outlook Survey
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.
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.
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.
March 13, 2007
Higher Education and Chicago’s Development
With economic growth lagging in many Midwest communities, institutions of higher education are being asked to play a bigger role in their surrounding regional economies. This past fall, the Chicago Fed held a conference addressing the role of higher education in promoting regional growth and development.
In what ways does higher education fit into the regional development picture? The ways discussed at the conference were many and varied; certainly, one size does not fit all. In places ranging from Silicon Valley to Route 128 in Boston and even to Fargo, North Dakota, universities are transferring technology to industrial facilities in adjacent industrial parks and to fledgling high tech firms. In other places, including Akron, Ohio, and Rochester, New York, universities are active in helping redirect mature but declining local industries into new products and markets. And Indiana’s Purdue University has embarked on an ambitious engagement and outreach mission along several fronts: teaching, discovery, community outreach, and identifying local targets of economic development.
While the conference did not address the university role in Chicago’s growth and development, our outstanding business schools have clearly played a key role. Today, among many fine business programs, the city touts the perpetual top ten national ranking of Northwestern’s Kellogg School of Management and the University of Chicago’s GSB, along with the frequent top ten ranking of Depaul University’s evening MBA program. As we look at Chicago’s industrial and business history, we see how these schools continually pump new life into Chicago’s economy.
For example, advanced business services and corporate headquarters activities are today the hallmark of Chicago’s economy. The city gave birth to some of the most prominent management consulting (NAICS 54161) firms and today continues to host a very significant number of such companies. Chicago ranks third in the U.S. among metropolitan areas in number of management consulting firms, and second in concentration of such firms, at some 120% above the national average.
How did this come about? Writing in the Encyclopedia of Chicago, Christopher McKenna describes the genesis of this Chicago-born industry. “Arthur Andersen, a professor of Accounting at Northwestern University, founded his eponymous firm in 1913. … Arthur Andersen & Co. began to specialize in financial investigations, the forerunner of the modern consulting industry.” And, “instead of employing local banking staff, New York and Boston financiers hired Chicago consultants to analyze the management of Midwestern companies in which they planned to invest.”
Andersen’s initiative was quickly followed in 1914 by Edwin Booz, a recent graduate of Northwestern in psychology. The company eventually became Booz Allen & Hamilton. So too, James O. McKinsey, an expert in cost accounting at the University of Chicago, founded a consulting practice (in 1926) that split off into the firm bearing his name as well as into A.T. Kearney. All became world-wide bulwark companies in what is now a global industry of great strategic importance to the world’s largest companies and businesses.
Jump ahead 50 years to the early 1970s. Chicago’s risk management and risk exchange community was re-invigorated when Leo Melamed, one-time Chairman of the Chicago Mercantile Exchange, launched contract trading in international currencies. Also in the 1970s, a former professor at the University of California at Berkeley, Richard Sandor, helped develop the Chicago Board of Trade’s U.S. Treasury futures contract trading.
Today, Chicago is a global leader in financial futures and options trading, with a 23% global share in exchange-traded contracts measured by volume. In addition to direct employment at Chicago’s exchanges and associated clearing operations, trading activity gives rise to ancillary employment in various Chicago businesses such as banking, brokerage, law, business publication, and computer systems and software.
For this industry too, the University of Chicago figures prominently in the story of its birth. University mentors both espoused the social value of trading financial instruments and also developed mathematical pricing models of assets that served as the basis for some trading. As recently described by Leo Melamed, Nobel Laureate and University of Chicago economist, Milton Friedman was a notable inspiration, teacher, and consultant to the launch of currency futures trading in the early 1970s.
Today, Richard Sandor remains busy in Chicago developing a new industry that addresses global climate change by capping polluting air emissions among member firms and then trading credits for pollution reduction among these firms.
Meanwhile, students from Chicago area business schools, such as Joe Mansueto of Morningstar, have recently grown new industries, this one centering on the tracking and analysis of mutual fund products.
In contrast to places such as the Stanford-Silicon Valley area, Chicago is not especially recognized for research and science-based commercial spinoffs from its universities. But several local universities are attempting to marry their business curriculums with their science and engineering activity. For one, the College of Business at the University of Illinois Chicago (UIC) is training future business leaders by encouraging them to construct business plans for inventions and intellectual property coming out of UIC labs. One recent sale of note involves a product that will possibly halve the time it takes orthodonic devices to straighten teeth.
What does this history imply for public policy? For starters, if we are to interfere effectively for purposes of economic development, we surely must understand the nexus among our assets and institutions. Chicago is clearly a “business town,” and its business schools have not only supported the business climate by training graduates for local companies but also indirectly by spinning off new businesses and industries.
But in considering issues of greatly enhanced public support or subsidy, it would be a mistake to attribute too much to universities alone. That is because causation goes both ways. While Chicago’s business schools have spawned much local growth, so too has local business growth created and supported the growth of universities and business school programs.
A city’s assets and institutions are best thought of, perhaps, as enjoying a symbiotic relationship. Accordingly, local public policy should start by strengthening inter-connections among local enterprises and enterprising people. Government likely has no great ability to pick and choose which particular connections to strengthen. And so, the primary course should be to provide desired and cost-effective public services and infrastructure, especially in transportation and communication. Restrained yet well-designed regulation and taxation should be another part of the mix.
Next, public-private programs and civic partnerships may be helpful in drawing closer social and cooperative connections among our diverse Chicago communities, industries, and civic institutions. As Chicago’s business history has shown, some amazing successes can arise from enterprising partners in a dynamic city.
March 5, 2007
Manufacturing exports continue to excel
Even as much of the Midwest’s automotive industry remains troubled, the region’s overall manufacturing exports continue to impress. In the Seventh District, manufactured exports make up around 7% of gross state product; this is on par with the nation’s economy (also discussed in a previous blog). While this share is not huge, the manufacturing sector’s rapid growth of exports in recent years translates into an outsized contribution to the region’s growth. Export growth of manufactured products will exceed 11% in 2006, which marks the third consecutive year of similar growth. By our reckoning, strong export growth from manufacturing made up roughly one-sixth of the Seventh District's overall output growth in 2006.
What’s propelling these exports? For the most part, it’s been due to continued strong global economic recovery and expansion. Following two years of weak growth in 2001 and 2002, the global economy began to recover. According to estimates gathered and reported by the IMF, the global economy grew by 5.1% in 2006. This followed three years of similarly strong expansion. As of early 2007, forecasts and expectations for this year are equally robust.
Among our major trading partners, Mainland China has exhibited the strongest growth; it has been reporting growth rates of 8% to10% over the past seven years. Accordingly, Seventh District manufacturing exports to China have been growing rapidly at an average annual pace of 9.3% per year since 1997.
The chart below illustrates that Midwestern exports to China have come to represent an increasing share of the region's overall exports to Asia. In 1997, overall goods exports to China, including agriculuture, mining, and manufacturing, accounted for only 13.7% of the Seventh District’s exports to Asia. By last year, however, China’s share almost reached 20 percent. (See black line).
Manufactured goods exports accounted for most of this expansion. Moreover, expanding manufactured exports were widespread across broad industry sectors including transportation equipment, machinery and metals.
The second chart below ranks manufactured exports to destination nations in 1997 and 2006. While Canada remains far and away the region’s predominant export destination, China now ranks fifth, behind Canada, Mexico, the U.K., and Japan. The Seventh District states exported $4.9 billion of manufactured goods to China-Hong Kong last year.
Click to enlarge.
The Seventh District’s manufacturing sector continues to be large and export oriented. This means that global economic growth will continue to figure prominently in the region’s growth. However, this assumes that U.S. policies of open world trade and investment will continue to be expanded. Agreements to open our trade across the globe help develop and stimulate the economies of our trading partners. In response, our trading partners turn to the industrial Midwest for many of their purchases.
February 12, 2007
Sports Franchises and Urban Development
Are there worthwhile benefits to large urban economies from professional sports franchises and events? Critics are especially hostile to the idea of tax breaks, incentives and other public subsidies to sport franchises and events. At best, they claim that local spending on sports events displaces local spending on other activities, with no net impact on expenditure or income. Worse, they claim that public monies spent or foregone to subsidize sports franchises or events could have otherwise been more productively spent on enhanced public education or the like.
In rebuttal, there is another school of thought that posits that the changing nature of urban economies has heightened the value of recreational amenities as a draw for coveted workers. As the productive basis of city economies has shifted away from the manufacturing and distribution of goods, and towards a greater focus on information exchange by skilled and educated workers, some policy analysts argue that the successful workplace location is now driven by where people want to live rather than by its strategic location for moving materials.
In some instances, major league sports teams and professional sports events, such as the Super Bowl, can be counted highly among cities’ “public goods” amenities that attract and retain productive workers. In this, sporting events may be among several amenities whose sum total is more than the some of the parts because a large city’s varied restaurants, museums, cultural diversity, arts, and sports all go into making it “an interesting and exciting place to live.”
The measurable evidence on this effect is sparse, but several statistical studies have found favorable impacts. A thorough and balanced review of studies has been conducted by Mark Rosentraub. No doubt that many subsidies are ill-conceived. But Rosentraub concludes that the net value of a sports investment by the public sector rests on its context and the particular outcomes for the city and county making the investment. For example, the placement of publicly-subsidized stadiums in downtown areas have been found to help enliven and revive struggling downtowns. Another study found that Indiana residents valued the intangible benefits of having the Indianapolis Colts sufficiently to justify public subsidies. And in a statistical study across metropolitan areas, Jerry Carlino and Ed Coulson found that households tend to pay higher housing rents in metropolitan areas that choose to host sports franchises. Apparently, the value of nearby sports activity affects land and housing congestion that arises as greater population is attracted to such sports-minded places.
Among the most intangible, most difficult-to-measure benefits attendant to sporting events are the advertising or marketing values associated with the opportunity to re-cast a city’s image to a national or international audience. Places whose images become distorted or unfairly known due to their past travails may especially view large sporting events as valuable in setting the record straight.
In particular, an enhanced image may be helpful as businesses consider investment decisions and as workers consider various recruitment offers. The City of Detroit, for example, went to great pains and took great pride in successfully hosting the Superbowl XL in their new stadium situated amidst extensive downtown renewal.
This year’s two Super Bowl contestants, Chicago and Indianapolis, likely welcomed the media coverage of their cities deriving from both the Miami telecast and from national pre-game media hype. Chicago has been working to boost its image as a national and global city having superior amenities and functionality. In fact, it is one of two U.S. cities still vying to host the 2016 Olympic Games.
Meanwhile, Indianapolis has been pursuing sports-minded economic development for quite some time. During the 1970s, the city began to boost its support for amateur sports facilities and events, meeting some success in hosting the Pan American Games in 1987 and, among other things, it is now the headquarters locale of the National Collegiate Athletic Association. During times when high-profile events are not taking place in Indianapolis, its sports facilities are often in use by young athletes who come to town (often with their families), patronizing the city’s hotels and restaurants.
Despite scoldings by the majority of public policy analysts, many of which are well-founded, some cities still see gold in them thar’ games!
January 22, 2007
Chicago's Pursuit of the Global Prize
Policy and business leaders in Chicago continue to advance the metropolitan area’s prospects as a global hub for professional and financial services. This initiative arises from both necessity and opportunity. Chicago’s traditional markets, principally in the surrounding Midwest, are not growing rapidly. At the same time, however, the Chicago economy specializes in advanced producer service sectors that are increasingly traded more broadly and, in many cases, internationally.
As the business service center of the Midwest, serving regional markets and industries, Chicago companies’ prospects for growth are somewhat limited. That is so largely for two reasons. First, the Midwest economic base centers on agriculture and manufacturing. Since productivity growth is so very high in these industries, and competition keeps commodity prices low, income and revenue (and attendant jobs) grow slowly. The second reason is climate. As the U.S. economy restructures toward information industries and knowledge workers, service production is being pulled toward locations where workers prefer to live, often milder climes.
However, globalization of the economy has also brought new opportunities to populous information-based cities like Chicago. Large cities often have wonderful amenities that are not dependent on climate, such as sports, restaurants, museums, and cultural diversity. But more fundamentally, it is because expanding global trade in goods, services, and capital requires the complex and specialized functions and industry sectors that are concentrated in large cities, including legal services, logistics, distribution, finance, insurance, business meetings, R&D, and professional business services.
Chicago has been developing such sectors almost since its inception. Today, Chicago features world-leading risk exchanges, universities, business meeting and personal air travel firms, legal services, headquarters facilities, and management consultancies.
During the 1990s, the growth of Chicago’s professional services was robust. According to the data reported on payroll employment, the Chicago metropolitan area added a net 80,000 jobs in the sector from 1990 to 1999, more than the Los Angeles metropolitan area and more than New York City.
However, since then, job performance in Chicago has often been much weaker, raising doubts about whether the city’s economic structure has divorced itself from the surrounding region as much as previously believed. The chart below displays year-over-year growth in the professional, technical, and R&D sectors. Employment growth experienced year-over-year declines for most of the 2002-2004 period, before reviving in 2005.
How much of Chicago’s business service economy has expanded to global markets or even to other large U.S. cities in the global network?
We know very little about the geography and changing geography of these hallmark industry sectors. However, one informative study by Peter J. Taylor and Robert E. Lang of the Metropolitan Policy Program at The Brookings Institution measures the prominence of major global service companies among large cities in the world.
Taylor and Lang examine 100 global companies drawn from the business or producer sectors of accounting, advertising, banking/finance, insurance, law, and management consulting. For each city, the sum presence of their offices (weighted by size and function) determines a score for a city’s commercial presence and ties to the global city service network.
According to the Taylor-Lang study, Chicago scores high in its global connectivity, both relative to other U.S. cities and relative to the world’s major cities. Among U.S. cities, Chicago ranks second only to New York. Among world cities, Chicago ranks seventh, behind London, New York, Hong Kong, Paris, Tokyo, and Singapore.
The Taylor-Lang study scores Chicago’s connections with domestic cities such as Atlanta and New York in the same way it scores connections with international cities such as Sydney. This seems correct. International borders can be arbitrary. And to otherwise score border-crossings might bias the results toward cities located on continents where national boundaries are near each other, such as Europe.
The study does provide a separate “hinterland” scale for each city, which tries to measure the degree to which a city’s global connectivity relies on nearby national trading relations. Here, with the exception of New York City, U.S. cities tend to be less international than those on other continents. However, Chicago again scores well. It places third among U.S. cities, behind New York and Miami.
How this relates to Chicago’s recent growth performance and prospects is not clear. The construction of the Taylor-Lang study is creative, clever, and somewhat revealing, but it provides more impressionistic than definitive evidence of global linkages among producer services. Those who would like to draw their own conclusions from the evidence should take a look at the authors’ map of each global city’s linkages, including Chicago. Outside of North America, for example, the map suggests that Chicago's economy links strongly with Zurich, Switzerland, and Sydney, Australia.
Chicago’s employment in business-professional services is once again growing strongly, at a 3% annual year-over-year pace. If the recent period of weak performance reflects some unusual and fleeting conditions such as a post 9-11 falloff in business travel and related business service activity, then perhaps Chicago’s march to global success will now continue.
October 23, 2006
Universities and the Great Lakes Economic Revival
Multi-state U.S. regions are defined in a number of ways. One such grouping is the “Great Lakes Region,” comprising all the states that border the Great Lakes. The states that run east to west are New York, Pennsylvania, Ohio, Indiana, Michigan, Illinois, Wisconsin, and Minnesota (map below). During the nineteenth century, the efficient transportation of materials on the Lakes and connecting canals knitted these state economies together into an agricultural, mining, and manufacturing powerhouse.
As waterways transportation has given way to overland and air transportation, the region’s economic cohesion and linkages have loosened. However, these states continue to share many common and inter-connected manufacturing industries, especially steel, autos, and nonelectrical machinery such as farm and construction equipment. For this reason, as these traditional manufacturing industries account for fewer jobs and less income, these Great Lakes states seem to share a common economic destiny.
The Brookings Institution Metropolitan Policy Program is partnering with many local organizations on a multi-year research and policy initiative to try and boost the economic vitality of the region. During the week of October 23, various Great Lakes cities will host a series of discussions following presentations of a broad “framing paper” called The Vital Center: A Federal-State Compact to Renew the Great Lakes Region.
This initial Brookings paper points out several avenues for the region to pursue, with “Innovative Infrastructure” being the most prominent. With a 33% share of national population, the region is said to generate 32% of the nation’s patents, perform 29% of its R&D, and graduate 36% of the nation’s scientists and engineers. The report calls on public and private research facilities in the Great Lakes to work together to take advantage of these and other “innovation” opportunities.
Further, perhaps because they are mostly fixed in location, highly prominent in stature, and somewhat amenable to public policy, the region’s universities are receiving a lot of attention as potential engines of regional growth. On the plus side, by one ranking, 19 of the world’s top 100 universities are located in Great Lakes states and Ontario, Canada. On the negative side, graduates of the region’s universities are increasingly gravitating to the East and West coasts and other out-of-region locales.
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Two important public discussions concerning the ability of colleges and universities to affect regional growth and development will take place at Federal Reserve Banks this fall. In addressing the question this coming October 30 in Chicago Rick Mattoon, senior economist, has put together the broader agenda.
As Rick notes in his recent Chicago Fed Letter, the involvement of universities in promoting economic growth and development can take many forms. For one, the spin-off of new local businesses through the transfer of technology from university labs has been an important mechanism for some local economies such as those of Boston, Austin, TX, and Northern California. But in other locales, especially where university research is not prodigious, the primary growth vehicle remains the traditional mission of local schools in producing workers with the skills and talents that match the needs of local industries. And between these two poles, localities vary so widely in their economies and types of universities that a broad spectrum of strategies and roles may be most appropriate in catalyzing regional growth.
At the October 30 event, Richard Lester of MIT will lay out his typology of university–economy relations and their attendant avenues for economic growth. This will be followed by case study discussions from around the Midwest and a panel of university leaders.
On November 16–17, the Cleveland Fed will follow up with a more intensive and focused examination of universities’ roles in innovation. The first day’s agenda addresses how university research leads to economic innovation, and what role geography and proximity play in the productivity of both university research and in local economic growth.
On the second day, the Cleveland conference will present case studies of the university–local economy linkages, “geared toward people in the business community.” Participants will “hear experiences and insights from high-level executives who have faced head-on the challenges and triumphs collaboration can bring.”
As the collaborative Brookings project to stimulate economic activity in the Great Lakes gets underway, these Federal Reserve System discussions should be very helpful in considering how the region’s universities can contribute.
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 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 16, 2006
Business services as a growth sector for Great Lakes cities?
As manufacturing activity shrinks and relocates, large cities of the Midwest look to another staple of their economic base, business and professional services. Large cities everywhere typically serve as centers of finance, communication, governance, and varied business services. In the Midwest, business service specializations in cities originally derived from goods production, as surrounding farms and factories looked to cities for financing, advertising, management expertise, product design, legal services, and engineering, as well as computer systems advice, more recently.
In the past few decades, agriculture and manufacturing activity have been shrinking in the Midwest, at least in terms of nominal personal income arising from manufacturing firms. In the overall U.S., for example, personal income derived from manufacturing activity has fallen from 32.9 percent to 15.5 percent from 1969 to 2004. This falloff is especially prominent in large Midwest cities, where manufacturing once thrived due to urban freight transportation advantages and the intense workforce needs of mass production.
Can advanced business services help fill the void in Midwest cities’ economies? There are several reasons to focus attention on these industries. First, there is already a pronounced urban location propensity for business services, so prospects for this sector in large cities are perhaps better than for others; also, in the overall U.S. economy, the business services sector has recently been a growth leader. Finally, many business services employ highly skilled occupations, and they tend to generate high levels of wages and income that may directly and indirectly buoy large city economies.
On the latter point, as formally defined by the North American Industry Classification System (NAICS), the “professional and technical services sector,” NAICS sector 54, tends to employ an above-average share of highly-educated (and highly paid) workers. As described by federal government statistical agencies (Census and BLS), the sector’s industries employ many executive and technical occupations, namely those found in research and development, legal services, management consulting, accounting, advertising, engineering, public relations, and product design.
In the analysis that follows, a focus on the NAICS 54 sector is advantageous because its services are almost exclusively sold to other businesses rather than to households, and many of these services can be sold to customers located far away. In thinking about regional economies, such tradable services may offer a wide scope for possible growth and development. Moreover, data covering employment in the sector are available for geographic regions as small as metropolitan areas.
Rapid growth characterizes the business services sector. The chart below illustrates that as a share of total payroll employment, “professional and technical services” has expanded from 4.2% to 5.3% from 1990 to 2005. The sector’s average annual growth of 3.0% per year easily exceeds that of total payroll job growth (1.3%), adding 2.5 million jobs to the U.S. economy since 1990.
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Business services’ urban orientation can be conveniently described by an index of employment. The concentration index is the ratio of two shares. For the ratio, the numerator is the business services sector’s share of total jobs in a particular region. The denominator is the business services sector’s share of total jobs in the overall U.S. And so, for example, if the sectoral share of total jobs in a particular region is equal to the sectoral share of jobs in the U.S., the index will take on a value of one. To the extent that a region’s share of jobs found in business services exceeds the nation’s, the index takes on a value greater than one, and so on.
Such a concentration index is constructed below for the most populous metropolitan areas in the U.S. The top five metropolitan statistical areas (MSAs)—New York, Los Angeles, Chicago, Washington, D.C., and San Francisco—are, taken as group, more than 50 percent more concentrated in business services jobs than the overall U.S. Moreover, an hierarchy of this concentration by city size is evident as we expand the index to include less populous metropolitan areas. Though still well above parity with the nation, the indexes of the top ten and top 20 most populous metropolitan areas lie below the concentration of the top five most populous metropolitan areas.
Time trends in business services employment also tell us some important economic features. Most prominently, the concentration of business services employment in large urban areas has been falling (i.e., business services jobs have been spreading out toward smaller cities) in the U.S. since 1990. Apparently, the greater ability and lower cost to communicate electronically over time has allowed smaller cities, as well as other nonurban settings, to win out over large, densely populated cities that more easily facilitate face-to-face interactions.
It has been observed that business services employment dipped more than the overall employment during the recessionary periods of the early 1990s and 2000–03. Such cyclical sensitivity to the general economy has long characterized so-called blue-collar and production employment, but its emergence for occupations in business services was somewhat novel during the recession of 1990–91 and its aftermath, when labor market restructuring of mid-level managers and other white-collar occupations took place. In the more recent recessionary period, white-collar employment declines in business services were associated somewhat with the slackening of investment in information equipment and associated services. More generally, many business services may be characterized as “investment goods” by companies, meaning that their purchase tends to slacken during recessionary and subsequent recovery periods, when firms no longer need to expand their own production capacity.
Midwestern metropolitan areas have generally followed these national trends and characteristics of NAICS 54 employment, although there have been some exceptions. For one, as shown below, some of the region’s large metropolitan areas are generally less concentrated in business services as measured against the national employment structure. In part, this follows from the higher manufacturing intensity of Midwest cities; by construction, if a region’s employment base is high in one sector, that concentration must be offset in the others. And so, although Des Moines, Milwaukee, and Indianapolis are centers of business services in relation to the surrounding Midwest areas, their employment base is less concentrated in business services (as narrowly defined) than is the U.S. employment base.
The Chicago and Detroit metropolitan areas register as the most concentrated in business services among large metropolitan areas in the Midwest, with Columbus, Pittsburgh, and Minneapolis–St. Paul also registering concentrations well above the national average.
Owing to its reputation for automotive manufacturing, it will surprise some to find that the Detroit metropolitan area claims the largest concentration in business services. In fact, in this regard, Detroit leads the Chicago area, which is generally renowned as the region’s services and financial capital.
A closer look at the employment structures within the general category of business services raises some interesting and serious questions about the growth prospects of business services for large metropolitan areas in the Midwest. The bar chart below displays the concentration indexes for each detailed business services category, comparing the Detroit MSA with the Chicago MSA.
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Chicago and Detroit specialize in different sectors of business services. The Detroit MSA scored highest for “architectural and engineering services,” while Chicago scores lowest in this category. This specialization’s high score in Detroit reflects the product engineering completed for the automotive industry, much of which is driven by local demand by domestic automakers. However, some of Detroit's business services have evolved to serve global customers as well. Another one of Detroit’s employment concentrations, scientific research and development (R&D), also largely reflects Detroit’s reputation as a global research and design center for the world’s prominent automakers. Toyota, for example, has recently announced a new $150 million R&D facility to be built near Ann Arbor, Michigan.
The Chicago MSA’s most significant specialization is “management and technical consulting.” The Chicago area is the domicile of major offices of world-renowned management consulting firms, including Accenture, Booz Allen Hamilton, McKinsey & Company, and A.T. Kearney. Facilitated by the strong air travel connections at Chicago’s O’Hare International Airport, these firms’ consulting operations are able to serve clients throughout the region, the nation, and the world.
As the Midwest’s historic industry specializations decline in size, especially manufacturing, such business and professional services will be increasingly important in maintaining the region’s size and high household incomes. But to what degree are such industries derivative and dependent on local manufacturing itself? If sales to local firms dominate these sectors, then the prospects are possibly dimmer because productivity gains in goods production continues to shrink the nominal share of income derived from manufacturing and agriculture.
The recent employment performances in business services in Detroit and Chicago offer some clues regarding the degree to which business service firms in the Midwest have expanded their customer base beyond the immediate region. The evidence suggests that business services in these cities do continue to depend on midwestern customer demand in an important way. Midwest employment growth has been lagging significantly since the 2001 recession. At the same time, as the chart below suggests, local employment in the professional and technical services category has also dipped to a greater degree than the national employment, suggesting that the demand for these services derive from local rather than national or global markets. Moreover, further analysis of the employment data suggest that these cities' steeper-than-national-average declines did not result from any unfortunate mix of industry subsectors in Chicago and Detroit. In particular, had Detroit's individual industries under the NAICS 54 category each grown at the national rate from 2001-2004, the larger sector's decline would have totalled only 2.1 percent rather than the actual 7.3 percent decline. And similarly for Chicago, rather than the actual 9.7 percent decline over the period, the NAICS 54 employment decline would have amounted to only .8 percent. And so, though the evidence is not definitive, it appears from this performance that the NAICS 54 sector in Chicago and Detroit continues to serve regional markets to some considerable degree.
Professional and technical services continue to be important national growth sectors that merit a close watch by Midwest economic analysts. Nationally and regionally, these sectors continue to grow as goods producers and other businesses expand their use of such specialized services and as they outsource some business services that were previously conducted in-house. Regionally, given the slower pace of business expansion in the Midwest, the growth prospects for large Midwest cities, such as Detroit and Chicago, would probably be more robust should their business services firms expand their markets throughout the nation and the world.
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.