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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

During a recent visit and tour of Racine, Wisconsin, and vicinity, I was reminded of the difficult challenges that face older manufacturing-oriented cities. It would be tough to find a place as steeped in manufacturing as the Racine area. As recently as 1969, over 40 percent of the Racine metropolitan area’s jobs were to found in the sector—double the national level. Since then, the Racine area’s experience has been similar to that of so many manufacturing-oriented places. Due primarily to job losses in the sector, manufacturing now represents only 20 percent of the Racine area work force, and this is still more than double today’s national average!

Forty years ago, with such a heavy orientation in manufacturing, it would have been risky indeed for Racine area leaders to neglect the needs of this sector and focus their full attention toward diversifying the local economy. Even today, Racine’s makers of household cleaning products, farm machinery, and hydraulic mechanisms used in marine craft remain a vibrant part of its economy.

So, over the years, Racine’s leaders have pursued a dual development strategy of maintaining the region’s manufacturing base to the extent possible, while also trying to shift gears to the growing services sectors of the economy, including residential living, tourism and recreation, and business and professional services. In particular, the region has, on the one hand, worked to rebuild its downtown and neighborhoods and develop its lakefront and riverfront with bikeways, beaches, downtown festivals, and marinas for pleasure boats. At the same time, it continued to pursue manufacturing and distribution through cleanup and environmental remediation of vacant industrial land, development of new industrial sites, aggressive work force training and education, and construction of viable overland transportation for moving freight and materials.

Driving around the City of Racine, one can clearly see the challenges to planning and redevelopment as they relate to region’s economic base and physical footprints. This area was built around manufacturing and heavy industry and has a legacy of neighborhoods with small houses where former factory workers resided and frequented neighborhood stores, meeting halls, churches, and taverns. The challenges lie in creating cohesive links between the parks and revitalized downtown across areas of older factory buildings, railway tracks, and busy highways carrying freight among still-working factory operations and warehouses. At the same time, new land to accommodate today’s spacious industrial development, such as warehousing and distribution, must be fashioned or reclaimed from a hodge-podge of small parcels of varied-use land. Mayors, county officials, town planners, and economic development officials have their hands full in Racine as they do in many towns of the Midwest.

The issues and lessons from such redevelopment efforts are currently being assessed by the Community Development and Policy Studies (CDPS) group at the Chicago Fed as part of their Industrial Cities Initiative (ICI). At the recent inaugural conference to discuss the ICI, I presented some statistical results which, I think, corroborate the sharp challenges of industrial cities such as Racine.

In our statistical analysis of 83 metropolitan areas (MSAs) located in the midwestern states from Iowa and Minnesota eastward to Ohio, we examined two main influences on MSA growth. We measure growth both as per capita income and separately by total jobs. Drawing on the large existing body of research, we demonstrate that an MSA’s initial “educational attainment of the adult work force” apparently exerts a strong influence on subsequent growth in jobs and income across MSAs. Educational attainment has been previously found to be influential for several reasons. For one, places with higher educational attainment have been better able to shift into new industries and occupations when their former mainstays (such as manufacturing) have declined. Further, new business start-ups and entrepreneurial activity appear to arise more easily among work force populations having higher education.

We also tested the degree to which MSAs with higher initial concentrations of manufacturing employment were more or less successful in their subsequent economic growth. What we found was that, even after accounting for the influence of educational attainment, a historical manufacturing orientation tended to depress subsequent growth. Moreover, the effects were long-lived. An MSA’s tendency to host manufacturing 20 years prior continued to depress overall economic growth. For example, we correlated MSA manufacturing concentration in 1969 with subsequent growth during 1990 to 2009 and found that the manufacturing legacy was a significant drag on economic growth and development for the much later period.

All things considered, the redevelopment achievements of many of our older manufacturing cities are remarkable.

A summary of economic conditions in the Seventh District from the latest release of the Beige Book:

• Overall conditions:Economic activity in the Seventh District continued to expand at a moderate pace in late February and March.
• Consumer spending: Consumer spending increased significantly, as retailers reported unseasonably warm temperatures boosted sales.
• Business Spending: Business spending continued to increase and inventories were generally indicated to be at comfortable levels. Labor market conditions continued to improve, although hiring remained selective in many industries.
• Construction and Real Estate: Construction activity increased as demand continued to be strong for multi-family construction and single-family construction edged up some from its depressed levels.
• Manufacturing: Growth in manufacturing production leveled off, but activity continued to increase. The auto industry remained a source of strength, and demand for heavy equipment was boosted by the need to replace ageing equipment.
• Banking and finance: Credit conditions were slightly improved. Volatility and risk premia edged lower, and credit availability for households improved, particularly for auto loans and credit cards.
• Prices and Costs: Cost pressures increased, particularly for energy. Wage pressures also increased, but continued to be moderate. Contacts indicated difficulties in passing on higher costs to customers.
• Agriculture: Unseasonably warm weather jumpstarted field work and corn planting and soybean and cattle prices increased while corn, milk, and hog prices decreased.

The Midwest Economy Index (MEI) increased to +0.36 in January from +0.20 in December, reaching its highest level since May 2011. Midwest growth continued to outperform its historical deviation with respect to national growth, but the relative MEI decreased to +0.31 in January from +0.45 in December.

The Chicago Fed Midwest Manufacturing Index (CFMMI) increased 1.0% in February, to a seasonally adjusted level of 91.7 (2007 = 100). Revised data show the index was up 2.1% in January. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) increased 0.4% in February. Regional output in February rose 10.1% from a year earlier, and national output increased 5.4 %.

For Chicago (and the U.S.), no one would argue that economic conditions have approached a state of full recovery. Almost three years into the expansionary phase of recovery from the 2008–09 recession, Chicago’s unemployment rate remains lodged near 9 percent. Yet, these three years of expansion may be telling in other ways. That is, comparing Chicago’s current experience with its past recovery experiences can provide insights into the structure and outlook for Chicago’s economy.

As seen in the chart, the Chicago area’s unemployment rate is typically slower to recover from recessions than the U.S. overall. This is somewhat to be expected, since Chicago and Midwest recessions are typically sharp and deep owing to the region’s preponderance of manufacturing companies. Following steep recessionary declines, it takes a while for these and other companies to re-engage the work force.

A further glance at the chart reveals that the Chicago area’s economy was especially tardy in its labor market recovery following the short and shallow recession that ended in the fourth quarter of 2001. The Chicago area’s unemployment rate did not converge with the national rate until very late in 2006. Today, by contrast, ten or more quarters past the end of the national recession, the Chicago area’s unemployment rate seems to be making substantial progress toward convergence with the rest of the U.S.

One of the underlying reasons for this difference in experience is probably the different behavior of the manufacturing sector in these two periods. In the current period, manufacturing has been growing since the end of the recession both in the nation and the Midwest. In contrast, the period surrounding the 2001 recession saw manufacturing declining markedly. From 2000- 2003, the Great Lakes states surrounding Chicago lost almost 700,000 manufacturing jobs on net—representing about one-fourth of all U.S. manufacturing jobs lost in that period.

To be sure, the Chicago economy does not have the deep manufacturing orientation that it once had—at least not directly. Once “hog butcher to the world,” Chicago is now more of a provider of high end business and financial services. Today, Chicago is the capitol of the risk product financial exchanges and a center of vibrant job opportunities in accounting, law, management consulting, business meeting/travel, and corporate headquarters operations. Nonetheless, looks can be deceiving, in that these service operations are often vitally linked to goods-producing service customers. That is, the Chicago economy continues to sell its business services to Midwest and national goods producers, both in agriculture and especially in manufacturing. Accordingly, regional and national trends in goods production continue to matter to Chicago’s economic performance and well-being.

The table lays out the Chicago area’s job performance during the ten quarters following each of the past two recessions. To begin with, as measured by total private sector job growth, we see that Chicago’s overall performance following the 2001 recession was abysmal. During the national recovery, the Chicago metropolitan area (CMA) experienced a jobs decline of –2.6 percent or over 100,000 jobs. In contrast, so far in the current recovery, private sector payroll jobs in the CMA have expanded by 1.2 percent.

Which particular industry sector differences explain this overall performance? In the recent period, the CMA shares some important trends with the national economy. In the aftermath of the housing market collapse, for example, job growth in the construction sector is much weaker. State and local governments also continue to downsize today, unlike the post-2001 expansionary period. So too, financial activities such as banking and real estate continue to shrink during this expansion. The latter presents a challenge for Chicago, as its economy is more concentrated in financial activities than the nation (column 6).

But perhaps the most concentrated industry for Chicago is “professional and business services.” In this sector, and unlike the earlier experience, the region has achieved net job growth of 7 percent this time around, versus a loss of 2 percent at this point in the post-2001 expansion.

(click to enlarge)

A look at the past behavior of this industry reveals that, during the last expansion, CMA employment in business and professional services did not bottom out until almost 2004 (Figure 3 below). Nationally, the sector also performed poorly. However, the national business services sector outperformed Chicago's business service sector, hitting bottom nationally several quarters ahead of the CMA trough.

To understand Chicago’s business services performance, we must look to trends in manufacturing. Chicago remains a major wholesaler, transporter, and warehouser of goods that are produced in the broader Midwest region. It is here in Chicago that all six major North American railroads come together and the largest North American intermodal freight operations (i.e., between truck and rail car) take place. As shown in the table, employment in the CMA’s “transportation and warehousing (and utility)” sector has expanded by 5 percent over the past ten quarters, versus a decline of 5 percent during the post-2001 expansion.

It is likely that Chicago’s vaunted business and professional services sectors are also being led by demand from the surrounding goods-producing customers. The final chart shows a strong correlation (0.88 out of 1.0) between Chicago’s business/professional service job growth and manufacturing job growth in the Great Lakes states that look to Chicago as a regional business hub. The correlation in job growth between Chicago’s own professional services and manufacturing sectors is similarly high, at 0.86).

Midwestern policy leaders need to understand these correlations in order to influence the CMA’s job prospects and economic conditions. Certainly, the CMA economy has an important footprint as a global city that is tied to services and travel around the world. But its economic base remains strongly tied to goods production in the nation and the nation’s mid-section.

This blog serves to expand on our December 2011 Chicago Fed Letter (CFL) by further detailing the estimation process used to produce estimates of annual Gross State Product (GSP) growth on a quarterly basis for the five Seventh Federal Reserve District states. In addition, we preview the estimates of GSP growth for 2011 that will be included as part of tomorrow’s Midwest Economy Index (MEI) release.

Background

Last year, the Chicago Fed began releasing the MEI, a weighted average of 134 state and regional indicators that measures growth in nonfarm business activity. Two separate index values are constructed, the MEI (absolute value), which captures both national and regional factors driving Midwest economic growth, and the relative MEI (relative value), which provides a picture of the Midwest’s economic conditions relative to the nation’s.

MEI values correspond to deviations of growth in Midwest economic activity around its historical trend. Values above zero indicate growth above its historical trend, and values below zero indicate growth below trend. For the relative MEI, a positive value indicates that regional growth is further above its trend than would typically be suggested based on the current deviation of national growth from its trend, while a negative value indicates the opposite.

Together, the MEI and relative MEI provide a picture of the Seventh District’s state economies that is closer to being in real time than does the BEA’s GSP data. By exploiting the historical correlation between GSP growth in each of the five states and the MEI, we are able to produce quarterly estimates of GSP growth ahead of the annual BEA release of GSP data.

Methodology

The statistical model we use to explain the annual growth in GSP for each Seventh District state is as follows:

The model succinctly summarizes the historical relationships between national (real GDP growth), regional (MEI and Relative MEI), and state-specific (lagged GSP and state real Personal Income growth) factors driving each Seventh District state’s GSP growth since 1979.

State-specific growth factors dominate in explaining Indiana’s, Iowa’s, and Michigan’s GSP growth, while national factors dominate in explaining Illinois’s and Wisconsin’s. Regional growth factors, on the other hand, vary in importance from 11% in Michigan to 39% in Wisconsin and are above 20% of the explained variance for Illinois, Indiana, and Wisconsin.

The regression coefficients estimated for our model are listed in the table below. Each coefficient represents the “effect” of each input on GSP growth. For example, a 1% increase in GDP growth leads to about a 0.5% increase in GSP growth across the Seventh District states, with the effect slightly higher for Illinois and Iowa and slightly lower for Indiana and Michigan (second row).

By plugging the latest data for GDP, MEI and relative MEI, state Personal Income, and GSP into the above equation, we can use the regression coefficients above to obtain a GSP growth projection for the current year. The remainder of the blog details how this process works in practice.

Data

To make our out-of-sample predictions of GSP growth using the above model, we need current year values for all the inputs in our regression. Lagged GSP growth is available, but in the first three quarters of a year quarterly GDP growth, state Personal Income, and the monthly MEI and relative MEI only cover part of the year.

To obtain the annual growth rate in state Personal Income and national GDP in the first three quarters of the year, we average the quarterly values available in the current year and take the log first difference from the quarterly average of the prior year. In this respect, once every quarter we are able to make a prediction of annual GSP growth for each state based on year-to-date growth in these measures.

The MEI and relative MEI predictions are similarly constructed using the March, June, September, and December MEI values. Since the MEI and relative MEI represent three-month moving averages, the March MEI number captures the first quarter of activity, the average of the March and June MEI numbers captures the first two quarters of activity, and so forth.

Shown below are the regional (left-hand scale) and national (right-hand scale) growth factors described above. Both the MEI and relative MEI began the year nearly one standard deviation above their historical averages, suggesting that the Midwest Economy experienced rates of growth that were both above-average and higher-than-normal given the level of national growth. During this same period GDP growth was very weak; but over the course of the year, the national economy strengthened while the Midwest economy expanded at a slower rate.

Coming into 2011, there was considerable variation in state-specific growth factors with Indiana standing out as having by far the highest GSP growth rate in 2010 among the five Seventh District states and with Illinois having the lowest. In 2011, however, the state Personal Income data suggest Iowa experienced stronger growth than the other four District states, and Indiana and Illinois were instead clustered closely together with the remaining two District states.

Forecasts

Projections for annual GSP growth made through the second quarter, third quarter, and for all of 2011 in each of the five Seventh District states are displayed below. The growth projections for Iowa, Indiana, Michigan, and Wisconsin exceeded national GDP growth in 2011, while Illinois is projected to be slightly below the national growth rate.

The diversity we see across states is a direct consequence of the results for national, regional and state-specific growth factors mentioned earlier. For instance, Illinois’ relative weakness among the five states stems primarily from modest GDP growth in 2011, on which its forecast heavily depends. Weaker national growth is also responsible for the lower rate of GSP growth for Wisconsin in 2011.

On the other hand, the lower rate of GSP growth for Michigan in 2011 can be traced back to expected mean reversion offsetting the positive contributions of the MEI and personal income growth. Strong regional and state-specific growth factors boost GSP growth in Indiana above Illinois and Michigan, whereas state-specific growth factors, particularly high personal income growth in 2011, keep Iowa’s GSP growth rate steady from 2010 and much higher than the other states in the District.

The variation over the course of the year in our forecasts is also informative. Illinois’ GSP growth forecast strengthened throughout the year as national GDP growth increased. Wisconsin’s GSP growth forecast was also strongly influenced by national factors; but being more affected by regional factors than Illinois, increased only slightly over the course of the year. GSP forecasts for Iowa, Indiana, and Michigan all rebounded in the fourth quarter after weakening in the third quarter, closely mirroring the pattern of the Personal Income data for each state.

Conclusion

Our quarterly estimates of GSP growth can be found as part of the press release for the MEI following the third release of national GDP data for each quarter. The 2012 release schedule for the MEI can be found at www.chicagofed.org/mei.

Motor vehicles tend to be sold near where they are produced. However, when local demand does not suffice to support a dedicated assembly plant, some vehicles are shipped across longer distances, including across oceans. The share of newly produced light vehicles (cars and minivans, sports utility vehicles or SUVs, and pickup trucks) exported from the U.S. to countries other than Canada or Mexico averaged only 4% of U.S. light vehicle production between 1996 and 2011. The share of new vehicles imported from outside the NAFTA (North American Free Trade Agreement) area was somewhat higher over this period, at 19%, as the U.S. has traditionally run a trade deficit in cars and light trucks.[1]

This blog updates our earlier analysis on U.S. vehicle exports and adds some discussion related to vehicle imports.

Exports

During the past two years, exports of new and used vehicles from the U.S. have continued the strong growth exhibited since 2003. After the sharp decline of activity during the latest recession, exports rose again sharply and, by the end of 2011, had nearly matched the pre-recession peak reached in 2007 for new vehicles and in 2008 for used ones (figure 1).

Figure 1

Source: USITC

Table 1 provides more detail regarding destination countries and regions for exports of new and used light vehicles from the U.S. While Canada and Mexico together represent the primary destinations, the relative importance of these two NAFTA partners has fallen a bit since 2007 (representing 55% in 2011, down from 64% four years ago), as most of the growth in exports of U.S. produced new vehicles originated from elsewhere (figure 2). Last year, Germany and China were as important as Mexico as destination for U.S produced new vehicles. Exports of used vehicles, on the other hand, are much more dispersed; Nigeria, Benin, and the United Arab Emirates jointly account for nearly one-third of all U.S. used-vehicle exports.

One of the factors behind this trend is the implementation of new trade agreements, such as the U.S. free trade agreement with South Korea, which was ratified in November 2011 and reduces South Korea’s tariff on passenger vehicle imports from 8% to 4%. Both the Detroit-based carmakers (Ford, General Motors, and Chrysler) and Honda and Toyota have announced a noticeable increase in exports of vehicles produced in the U.S. to South Korea. In the case of the Japanese-based carmakers, the decision to export to South Korea from North America instead of from Japan is likely influenced by exchange rate trends, which have strengthened the yen for some time.

Another phenomenon that has coincided with the increase in the share of non-NAFTA destinations has been the arrival in the U.S. of premium producers, such as Mercedes and BMW, that now ship output from their U.S. locations to countries around the world. While the U.S. and more generally, North America, very likely represent the largest single market for vehicles produced at the U.S. plants of these two producers, they tend to export a much higher share of their the U.S.-based production than a typical mass producer of vehicles. Furthermore, their U.S.-based plants are the sole producers of specific products, suggesting that their role in motor vehicle exports from the U.S. is not being jeopardized by the current lower rates of capacity utilization in the European motor vehicle industry.

Figure 2

Source: USITC

Table 1


Source: USITC

Imports

Data on imports of vehicles sold in the U.S. are available for a much longer time frame. Vehicle imports have averaged 20.6% of U.S. sales since 1980. That share declined rapidly during the decade between the mid-1980s and the mid-1990s—a time when foreign-based producers quickly expanded their production capacity within North America, ramping down their imports of finished vehicles from overseas in turn. This “onshoring” of vehicle production has a corresponding impact on the trade in motor vehicle parts. When an overseas producer’s vehicle assembly plant is first set up in the U.S., the so-called domestic content, that is, the share of parts sourced from within the U.S., is noticeably lower than that of a comparable native assembly plant. Over time, however, the domestic parts content of vehicles produced by foreign-headquartered producers tends to rise significantly.

Since the mid-1990s, the import share of U.S. sales has been trending up again as additional companies have entered the U.S. market. The small car segment, of heightened interest to consumers in times of rising gas prices, represents a relatively small share of the overall market in the U.S. and many of the small vehicles sold in the U.S. tend to be produced overseas. However, the import share of U.S. vehicle sales has declined by 4 percentage points during the past two years (figure 3) despite rising gas prices --gas prices were rising from the beginning of 2009 through May of 2011. Figure 3 also illustrates that cars continue to represent a large majority of imported vehicles.

Figure 3: import share in US light vehicle sales (blue line) and car share in US vehicle imports (red line)

Note: Imports are defined to originate in non-NAFTA countries.
Source: Ward’s autoinfobank

Figure 4 shows that the decline in the vehicle import share results from a decline in imports from Asia, as European imports have continued their steady increase exhibited over the last 15 years. Japan, by far the largest source country of U.S. vehicle imports from Asia, was negatively affected last year by the earthquake and subsequent tsunami. However, the decline in imports starts earlier than that, suggesting a contributing role of the yen/dollar exchange rate, which started a steady decline (strengthening of the yen) in 2007. In fact, while the share of U.S. light vehicle sales represented by imports from Asia peaked in 2009, the share of U.S. sales represented by vehicles produced in North America by Asian headquartered carmakers continued to rise through 2010, barely showing a decline in 2011. By the end of February 2012, that share had reached 30.4%, surpassing the previous peak from 2009 (29.9%). In other words, the share of U.S sales represented by North American production of foreign headquartered carmakers did not experience the same decline as that of vehicles imported from Asia.

Figure 4: Import share of US light vehicle sales by region of origin

Source: Ward’s autoinfobank

Combining both of these developments, rising exports of new vehicles, up 50% since 2009, and declining imports of light vehicles, nearly flat since declining by a million units between 2007 and 2009, have resulted in the smallest U.S. trade deficit in light vehicles since 1998 (see figure 5).

Figure 5: U.S. vehicle imports and exports

Note: The data for exports and imports are drawn from two different sources and don’t necessarily match up perfectly.

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[1]Data on imports, sales, and production, are from Ward’s Auto Group, Auto Infobank, online database; data on exports are from the United States International Trade Commission website. Note that the definitions in both data sets don’t match perfectly. Ward’s data are based on individual vehicle models and their size classes. The trade data on vehicle imports are defined, at the most disaggregated level, by fourteen 10-digit codes and distinguish passenger vehicles from vehicles for the transport of goods, engine type, and engine capacity.(Return to text)

As the U.S. economy has shown signs of recovery, attention has shifted to the European sovereign debt crisis and its impact on European economic activity, along with its spillover effects on the rest of the world. In the Midwest, where the manufacturing sector has been leading the ongoing economic recovery, concern has arisen that another recession in Europe could dampen economic activity here too.

What effect might a European recession have on international trade and the manufacturing sector in the Midwest? What do we know from past experience about the sensitivity of trade to changes in economic activity? A recent paper from Chicago Fed economist Meredith Crowley studied the causes of recent trade collapses, especially the Great Trade Collapse during 2008 and 2009. Crowley tested three factors that could potentially affect international trade: declining aggregate demand, financing difficulties, and rising trade barriers. In the past five of six U.S. recessions, the U.S. and the world suffered trade declines as economic activity fell in the two to four quarters before the trough of these recessions. Crowley notes that the elasticity of imports for the U.S. ranged from 1.5 to slightly more than 2 , which implies that imports respond more than proportionally to changes in income and demand (an elasticity of 1 would indicate a proportional response). Based on her own and others’ research, she concludes that a drop in demand is the most important factor in determining trade declines. Trade financing exerts a more modest affect on trade, while rising trade barriers have not been an issue recently.

We might expect similar declines in European demand for imported goods from the U.S. and elsewhere in response to a recession there. How would such developments be felt outside of Europe? To get a sense of how the Midwest, specifically the Seventh District, might be affected, we can ask how exposed the region currently is to trade with Europe—since any drop-off in trade is likely to be somewhat in proportion to current trading patterns. The Seventh District comprises all of Iowa and most of Illinois, Indiana, Michigan and Wisconsin. As seen below in Chart 1, exports to Europe grew for both the U.S. and the Seventh District during the 2000s, but still accounted for less than 2% of GDP for the U.S. and of gross state product (GSP) for the Seventh District in 2010. Therefore, exports to Europe account for a relatively small portion of the region’s economic activity. For 2010, the region’s exports to Europe were worth $31.5 billion, including agriculture and livestock products, oil, gas, minerals, and ores, as well as manufactured goods[1].

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Comparing U.S. regions (Chart 2), the Great Lakes region (which includes Illinois, Indiana, Michigan, and Wisconsin, but adds Ohio and excludes Iowa) lies close to the middle in terms of export exposure to Europe. The Seventh District’s export-to-GSP percentage is almost identical to that of the Great Lakes region, at 1.88% versus 1.91%. The Mideast has the greatest exposure to Europe, with exports accounting for 2.65% of GSP, while the Plains have the least exposure, with only about 1.4% of GSP going to Europe.

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What do we export to Europe? As shown in Chart 3, chemicals, machinery and transportation equipment, and computer and electronics account for about 70% of all Seventh District exports to Europe. How does the District’s overall export mix compare with other U.S. regions’?

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The Seventh District’s exports to Europe tend to be more heavily concentrated in three product categories—chemicals, nonelectrical machinery, and transportation equipment. Of our top 10 categories, we overlap with the rest of the U.S. in six of them (Table 1, non-overlapping categories highlighted in red).

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More importantly, our top trade categories are in sectors (industrial goods, such as machinery and equipment, and industrial chemicals) whose sales tend to rise and fall disproportionately with swings in overall business activity. A recent National Bureau of Economic Research working paper noted the procyclical nature of traded goods, specifically durable manufactured goods, and again found that the majority of the decline in international trade was due to a decline in demand for manufactured goods. The authors also find that the decline in the trade of durable goods versus nondurable goods (soft goods like food and clothing) accounted for a larger portion of the decline in total manufactured goods demand in both the recent Great Trade Collapse and the 2001 recession. Therefore, the Seventh District’s reliance on nonelectrical machinery as a top export (21.1% of total exports) could make our region somewhat more susceptible to the negative effects of a European recession than the rest of the U.S., where nonelectrical machinery accounts for a smaller proportion of exports (7.4%).

So, although the Seventh District economy’s exposure to Europe through the export channel is somewhat limited, a slowdown in Europe may be expected to hurt our region’s exports more than those of other regions that export less sensitive products. Exports and imports have historically been sensitive to overall economic conditions. In some cases, such as the 2008–09 global recession, trade declines can be severe.

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[1]Export data is pulled from the International Trade Administration’s TradeStats Express. Of total Seventh District world manufacturing exports, Seventh District sends about 48% to North America (Mexico and Canada), 19% to Europe, 17% to Asia and 7% to South America. For information on the District’s major trading partners by individual nation, see this blog. (Return to text)

A summary of economic conditions in the Seventh District from the latest release of the Beige Book and from other indicators of regional business activity:

• Overall conditions: Economic activity in the Seventh District continued to expand at a moderate pace in January and early February.
• Consumer spending: Growth in consumer spending slowed in January and early February. Contacts indicated that activity was boosted by clearance sales and also some isolated improvement in the luxury segment. Auto sales were up in January, but down slightly in early February.
• Business Spending: Business spending increased in January and early February and inventories were indicated to be at comfortable levels. Labor market conditions improved, although hiring remained selective.
• Construction and Real Estate: Construction activity was up slightly in January and early February as multi-family construction remained an area of strength and nonresidential construction continued to trend up moderately. Commercial real estate conditions improved with vacancy rates edging lower.
• Manufacturing: Manufacturing production increased further in January and early February. Demand for heavy equipment remained strong and the auto industry also continued to be a source of strength. Manufacturers of specialty metals reported solid order books.
• Banking and finance: Credit conditions were slightly improved from the previous reporting period. Financial market volatility declined and risk premia moved lower across a number of asset classes. Banking contacts indicated that loan growth continued at a moderate pace with demand from larger businesses being stronger than that from small to mid-sized companies.
• Prices and Costs: Cost pressures were largely unchanged in January and early February, but the volatility of commodity prices remained a concern for many contacts. Wage pressures continued to be moderate.
• Agriculture: Corn, soybean, wheat, hog, and cattle prices rose during January and early February. Input costs for agriculture continued to increase, led by sharply higher rental rates for cropland.

The Midwest Economy Index (MEI) increased to +0.09 in December from –0.13 in November, rising above its historical trend for the first time in five months. Midwest growth also outperformed its historical deviation with respect to national growth, as the relative MEI increased to +0.31 in December from –0.06 in November.

The Chicago Fed Midwest Manufacturing Index (CFMMI) increased 1.7% in December, to a seasonally adjusted level of 87.4 (2007 = 100). December’s growth was broad-based; all four major industry sectors of the index indicated growth in production activity. Revised data show the index was unchanged in November. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) increased 1.5% in December. Regional output in December rose 8.4% from a year earlier, and national output increased 4.6%.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bureau of Economic Analysis/Haver Analytics

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

Source: Bureau of Economic Analysis/Haver Analytics

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

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

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

(Click to enlarge)

Source: Bureau of Economic Analysis/Haver Analytics

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

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

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

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

Source: Bureau of Labor Statistics/Haver Analytics

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

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

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

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

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

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

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

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

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

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

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

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

On Thursday, January 19, 2012, the Detroit Association for Business Economics (DABE) held its annual Automotive and Economic Outlook luncheon. This event is held each January at the Detroit Branch of the Federal Reserve Bank of Chicago in memory of Robert Fish—a past president and founding member of the DABE. Meeting in the Detroit area since 1975, the DABE is a chapter of the National Association for Business Economics (NABE). The DABE meets six times between September and May, and members and guests have the opportunity to hear from experts on various sectors of the economy. As the DABE’s premier event, the annual January luncheon always coincides with the Detroit International Auto Show, and it featured two experts on the automotive sector.

The speakers at this year’s event were Kristin Dziczek, who is the director of the labor and industry group at the Center for Automotive Research (CAR), and George Magliano, who is the senior principal economist for IHS Automotive. Both speakers have more than 20 years of experience in researching the automotive industry and manufacturing. Dziczek’s presentation titled 2011 Detroit 3 – UAW Labor Contracts was an in-depth review of the results of the 2011 UAW (United Auto Workers) contracts and their impact on the labor costs and competitiveness of the Detroit Three automotive manufacturers (Chrysler, Ford, and General Motors). Magliano’s presentation titled US – Light Vehicle Outlook was just that—a concise analysis of what to expect in the coming years from the U.S. automobile industry, particularly in terms of sales of light vehicles (cars and light trucks).

Dziczek provided automotive employment forecasts for the United States and Michigan, as well as an overview of the 2007 UAW contracts and details on the final 2011 UAW contracts. Additionally, she provided insights into issues that the Detroit Three and the UAW will need to address through 2015. Dziczek said that the Detroit Three’s U.S. automotive employment numbers had started falling years before the 2008–09 recession; Detroit Three domestic employment appeared to bottom out in 2009, at about 170,000 employees. She explained that by 2009 the Detroit Three had shed almost 240,000 employees in the U.S., or 58% of their domestic work force, in just eight years. In Michigan, the Detroit Three had seen their employment fall by 112,000, or 52%, over the same period. The good news is that CAR projects total Detroit Three employment in the U.S. to increase by 18%, or 31,000 employees, over the period 2009–15, reaching a level of 201,000. Also, Detroit Three employment in Michigan is predicted to jump by 32%, or 33,000 employees, over the same period, totaling 135,000 by 2015. Based on these forecasts, we can see that CAR is expecting U.S. automotive jobs to reconcentrate in Michigan—at least to a certain degree.

In 2007, the Detroit Three and the UAW were able to agree on labor contracts that Dziczek considered “a game changer.” Important aspects of the contracts included the use of voluntary employee beneficiary associations (VEBAs[1]); a two-tier wage structure that lowered the entry-level hourly wage to $14.00; and no pay increases. To compensate workers for no annual pay increases, the Detroit Three agreed upon a signing bonus of $3,000; lump-sum profit sharing distributions as a percent of an employee’s base pay of 3% in 2008, 3% in 2009, and 4% in 2010 (the last two were suspended in 2009); a cost-of-living adjustment, or COLA (also suspended in 2009); pension increases; and some product guarantees[2] (some of which were never fulfilled). The most significant result of the new labor agreements was that the average hourly labor cost was reduced from $72–$78 per hour to about $50–$58 per hour. All of these changes set the stage for the 2011 labor contracts, which involved some additional changes to the previous contracts that Dziczek called “evolutionary, not revolutionary.” These changes included such cost containment strategies as the elimination of the jobs banks (which paid laid-off workers a high percentage of their salaries for an indefinite period); the continuation of the suspension of the COLA; and no pension increases at this time. Like the 2007 contracts, the 2011 contracts helped keep the Detroit Three’s costs competitive with those of other major automotive manufacturers. Dziczek pointed out that one important issue that bears watching in 2015 is how the two-tier wage structure is addressed. The initial agreement had a cap on the number of entry-level workers—more specifically, only a certain percentage of total employment could be made up of such workers. The UAW would like to see that cap kept in place, while the auto companies would like to see it either increased or removed altogether. Other critical issues include limiting pension liabilities; pushing to increase employees’ share of health care costs; and staying the course on variable compensation (profit sharing versus wage increases).

George Magliano provided a detailed and informative macroeconomic outlook, on which he based his light vehicle forecasts. Magliano explained that, of course, the major risk to his economic forecast is the European debt crisis. According to IHS and Magliano, even though Europe is in a recession, the U.S. economy is expected to continue to grow slowly over the forecast horizon. Magliano’s forecasts for 2012 are as follows: Real gross domestic product (GDP) will grow about 2.0%, employment will rise by 1.2 million, Consumer Price Index (CPI) inflation will remain at 1.5%, oil prices will settle at about $91 per barrel, and housing starts will remain weak (at around 730,000 units). Long-run real GDP growth is expected to settle at 2.5%–3.0%, and payroll employment is predicted to remain below its previous peak (in 2007) until 2015. The slow growth in employment will keep income growth down while households will continue to save more, keeping the long-term trend for consumption at around 2.0 percent.

Even with these somewhat conservative assumptions about the economy, all is not doom and gloom for the auto industry. Light vehicle sales are expected to continue to increase over the coming years, driven by the pent-up demand that has been created over the past few years. Another positive for the automakers is that retail vehicle sales, rather than fleet vehicle sales, remain the main driver of growth. This is an important part of the industry’s recovery in that margins on retail sales are greater than those on fleet sales. This factor—along with stronger used vehicle prices, lower vehicle incentives, and reduced cost-pressures on the manufacturers—should help to keep the automakers profitable, even in the face of a slow-paced economic recovery. Magliano said that IHS predicts light vehicles sales will be about 13.5 million in 2012 and 16.2 million in 2015. Going forward, the mix between car sales and light truck sales will move back in favor of car sales (54% car sales versus 46% light truck sales), as the manufacturers deal with impending higher fuel economy standards. With the recent UAW contract concession discussed above and other capacity restructuring, the auto industry has become more profitable, as evidenced by the fact that it is already making money at volumes well below the peaks reached back in the early 2000s. The bottom line is that the auto industry is in the best shape it has been in many years and is therefore well positioned to withstand economic adversity, claimed Magliano.

As evident in these two presentations, there is much to be optimistic about when it comes to the U.S. auto industry—even the prospects for the original domestic manufacturers look better. The domestic auto industry should come out of this latest recession a lot stronger than it was in 2007, as long as the industry’s stakeholders are willing to continue to work together to keep costs in line with those of foreign competitors.

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[1]A voluntary employee beneficiary association (VEBA) is a type of trust fund that can be used to provide employee benefits. The UAW agreed to a form of VEBA with the Detroit Three thus removing the liability for health care from the accounting books of the Detroit Three.(Return to text)
[2]A product guarantee is a type of commitment that identifies where future vehicles or components will be produced.(Return to text)

A summary of economic conditions in the Seventh District from the latest release of the Beige Book:

• Overall conditions: Economic activity in the Seventh District picked up in late November and December. Seventh District business contacts were generally optimistic about the economic outlook for 2012, but many also expressed concern about potential weakness in demand from abroad, particularly from China and Europe.
• Consumer spending: Compared to last year’s holiday season, store traffic volumes were up significantly in December. Auto sales also increased since the last reporting period. Contacts expected sales to continue to improve in 2012, citing a boost from replacement demand in light of the record high average age of vehicles in the U.S.
• Business Spending: Business spending was steady in late November and December and inventory levels were reported to be generally in-line with sales. Hiring remained selective, but the majority of contacts indicated plans to increase employment next year.
• Construction and Real Estate: Construction activity was subdued in late November and early December, but there was some improvement in overall real estate conditions as multi-family construction remained an area of strength and nonresidential construction increased moderately.
• Manufacturing: Manufacturing production growth increased in late November and December. Demand for heavy equipment remained strong and auto production increased over the reporting period. In the steel sector, inventories at service centers remain near desired levels.
• Banking and finance: Credit conditions were little changed during the reporting period. Corporate funding costs, while variable, were largely unchanged on balance. Business loan demand continued to be subdued, and business utilization of credit lines was only up a bit.
• Prices and Costs: Cost pressures eased in late November and December. While pressure on costs remained from commodities such as steel and food, it moderated significantly for cotton and energy goods. Wage pressures remained moderate.
• Agriculture: Prices for corn and soybean rose in the last half of December, though crop prices generally fell during the harvest period. Milk and hog prices fell during the reporting period, while cattle prices increased.

The Midwest Economy Index (MEI) increased to –0.15 in November from –0.30 in October and remained below its historical trend for the fourth consecutive month. However, Midwest growth outperformed its historical deviation with respect to national growth, as the relative MEI increased to +0.04 in November from –0.32 in October largely on the basis of sizeable gains in consumer spending indicators. Estimates of annual growth in gross state product for the five Seventh District states were at or above the national rate of growth through the third quarter of 2011.

The Chicago Fed Midwest Manufacturing Index (CFMMI) decreased 0.1% in November, to a seasonally adjusted level of 85.8 (2007 = 100). Revised data show the index increased 1.0% in October. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) decreased 0.3% in November. Regional output in November rose 7.1% from a year earlier, and national output increased 4.2%.