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.”

______________________________________________________________________________________

[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.

______________________________________________________________________________________
[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%.

On December 1, 2011, a group of experts convened to discuss developments in the Midwest economy in 2011 and to look forward to 2012 and beyond. The forum drew upon a variety of perspectives, hosting researchers from across the Midwest and from government, academic, and private institutions. As the conversation progressed, themes began to emerge.

Data from 2011 give a picture of an economy that is recovering, but lacking the vigor needed to return quickly to full employment. The outlook for the Midwest economy for 2012 is more of the same: slow improvement.

Looking beyond the current business cycle, the Midwest will be challenged by the economic fundamentals of a manufacturing-based economy. So far, economic development policy remains disappointing in addressing the challenges of diversification and competitiveness.

Sophia Koropeckyj from Moody’s Analytics noted that growth in the first half of 2011 was accelerating, but that it had slowed in the second half. The tepid pace of recovery means that the rate of job growth remains below the rate of population growth. It may take until 2017 to return to full employment. Koropeckyj highlighted manufacturing employment because it is concentrated in the Midwest relative to the rest of the U.S. She saw growth in manufacturing jobs in 2011, but noted that total manufacturing employment is still far below its pre-recession peak. Exports from the Midwest overseas continue to grow, but with possible challenges from a weak European economy in 2012. However, growth in Asia and South America could provide a backstop.

Ernie Goss from Creighton University provided a perspective on the rural economy that focused on the Plains states. They are doing better than many other parts of the country, driven by a good year for farms and farm-related businesses. Revenues were high in 2011, creating a push for consolidation that is driving up farmland prices (possibly to “bubble” levels). Federal Reserve economist David Oppedahl noted that farmland prices in other Midwestern states to the east are a bit stronger than in the Plains states. Price growth for the most productive land has outpaced prices for less productive land because of reduced recreational demand. While the farming industry did well in 2011, sectors that do not participate directly in the international marketplace (for example, construction) are subject to the same malaise afflicting other parts of the country.

Beth Weigensberg from the University of Chicago’s Chapin Hall discussed the CWICstats Dashboard Report, a quarterly assessment of the economies of Chicago and Illinois. She saw unemployment rise for Chicago and Illinois in the first half of 2011 even as labor force participation fell. Total employment is still 5% below its December 2007 level. Like other Midwest employment sectors, manufacturing employment is slowly rising from a trough in late 2009; it is still 15% below its December 2007 level.

George Erickcek from the Upjohn Institute provided an outlook on Michigan’s economy. Michigan lost 410,000 jobs from December 2007 to the trough in June 2009. It has recovered 85,200 jobs since then. Erickcek estimates that 37,100 (39%) of the new jobs were created by the auto industry. He noted that there has been no structural change for Michigan’s economy over the course of the recent recession and recovery. The auto industry is as important as ever. Even as many call for diversification, the Great Recession does not seem to have pushed Michigan’s economy in that direction.

In the near term, Michigan’s continued reliance on the auto sector will continue to lift the state and other auto-intensive communities in the Midwest. However, the longer term prospects are not so sanguine. As manufacturing growth begins to level off, longer term trends suggest little new employment will be generated by the sector. Some observers are a little more optimistic about the longer term. Federal Reserve economist Bill Strauss argued that rising overseas costs may result in the return of some manufacturing jobs to the U.S.

However, Geoff Hewings from the University of Illinois presented a less optimistic outlook on the region’s longer term future, predicting that the Midwest would continue to underperform the rest of the U.S. in several areas. According to Hewings, the Midwest’s GDP is forecasted to grow by 1.7% annually, compared with the 2.4% annual growth rate forecasted for the U.S. from 2007 to 2040. Over the same period, employment is forecasted to grow annually by 0.5% for the Midwest and 0.7% for the U.S., and personal income is forecasted to grow annually by 1.7% for the Midwest and 2.8% for the U.S.

Additionally, Hewings highlighted several trends that have shaped the Midwest in recent years. States are becoming increasingly interconnected as they fragment and hollow out; typical establishments have lengthened their supply chains by sourcing from more plants for increasingly specialized components (fragmenting) and are now less dependent on sources of inputs and markets within the state (hollowing out). Hewings noted the outsized volume of intra-Midwest trade as evidence; Midwest export trade to other Midwest states in 2007 amounted to $450 billion. Such strong intra-region trade linkages generate benefits for the Midwest economy during good times, but they amplify job losses during downturns. During the latest recession, 1.78 million jobs were lost in just five Midwest states, representing 20% of the total jobs lost in the U.S.

The close intra-region trade linkages in the Midwest sparked discussion about the need for more thoughtful and concerted policy actions within the region. Midwest states continue to play “beggar-thy-neighbor,” by offering selective tax abatements to lure businesses. Given the cohesion of the regional economy, such policies may be counter-productive. In particular, investment in overland transportation infrastructure to compliment the region’s goods-oriented economy would be worthwhile. Such investments should be carefully planned and coordinated both within and across Midwest states.

Selected presentations from the forum can be found on the following website link.

High and rising foreclosures are a big concern in the Seventh District (IA, IL, IN, MI, and WI) and in the country and will continue to be for some time. Our last guest blog on the Midwest economy digs into what reported foreclosure rates really identify. "Foreclosure starts" measure the pace at which homes are entering foreclosure. This rate reflects any deterioration in the ability of homeowners to meet their mortgage obligations for reasons such as job loss, inability to borrow against home equity due to falling home prices, or rising loan payments. Financial troubles may also be caused by life events, such as sudden medical expenses or divorce. Turning to a stock measure, the "inventory rate of homes in foreclosure" counts homes currently in the process of foreclosure. A high rate can reflect a high rate of past foreclosure starts on homes that have not yet been claimed and sold. However, it can also reflect high transition rates of foreclosure. That is, once a home enters foreclosure, it may linger there because process times are extraordinarily long.

To examine these foreclosures in the Chicago area, let's first look at the drop in home values as a widespread reason that many homes have entered foreclosure over the past few years. With property values in the Chicago metro area having dropped about 18% since the beginning of 2004, many homes are currently valued below the cost of their mortgages (meaning owners have negative equity). Being “under water”–the short hand term for a negative equity situation–on a mortgage limits the homeowner’s options to sell or refinance. If owners have to move or cannot afford their monthly payments, this can lead to a default on their loan. Some people may actually choose to default when the amount of their mortgage exceeds the value of their property; this phenomenon is often referred to as “strategic default,” since the borrower still may have the ability to repay the loan.

As seen from the table below, many lower income neighborhoods in Chicago have undergone stark declines in home values. In many neighborhoods, home buyers once snapped up homes in response to the general rise in area home values and in response to ready availability of credit. In some instances, new credit instruments brought in buyers under terms that seemed attractive at first, only to prove temporary or even fraudulent later on. Regardless, as the housing bubble burst, home values plummeted from their peaks.

Percent Change in Median Home Price in Illinois (Compiled by NHSRC Initiatives, Inc. from Multiple Listing Service data)

Click to enlarge.

What about the stock of homes that are currently in foreclosure—that is, foreclosure inventories. Remember that the inventory rate measures the number of loans in foreclosure at a given time as a percentage of the number of active loans. This is typically referred to as the “foreclosure rate.” A high inventory rate can contribute to high uncertainty for potential buyers and sellers. On the buy side, potential purchasers can become reluctant, because they do not know the extent to which prices may fall further once homes in foreclosure are put up for sale. On the other side, sellers will be uncertain as to how to price homes for sale, or what prices to accept from buyers.

In comparing inventories across cities and neighborhoods, inventory rates can be a misleading measure of overall home market conditions. That is because high transition times (and inventories) may reflect either high start rates or simply long delays in processing homes that have entered foreclosure.

In Cook County, IL, high inventory rates may partly reflect the latter, where foreclosures are processed through the courts. For an overview of the process, see the timeline below. A foreclosure in Cook County takes about 360 days; in practice that time can actually be significantly longer. Some states, like Michigan, do not require foreclosures to go through the courts, which helps keep the backlog lower. The foreclosure process (either judicial or nonjudicial) varies by state.

Judicial & Nonjudicial Differences in Process Period in the Seventh District: (RealtyTrac)

Click to enlarge.

Illinois is a judicial foreclosure state, which means that foreclosures must be processed through the courts. Court backlogs can lead to long delays. Additionally, during part of 2011 there were temporary freezes in foreclosures initiated by some major banks and mortgage servicers due to concerns about sloppy, or potentially illegal, paperwork in foreclosure cases. Additionally, in 2011 Cook County initiated a mediation program. The goal of the Mortgage Foreclosure Mediation Program is to assist homeowners that are in foreclosure to examine all options to stay in their homes or negotiate the best exit strategy.

Length of Foreclosure Process in Illinois (Based on Information from the NHSRC Initiatives, Inc)

Click to enlarge.

Clearly, there are many issues working together to raise the high incidence of homes in foreclosure. The foreclosure process (and how we measure foreclosure rates) may be adding to uncertainty and delaying resolution. To learn more and for a current snapshot from county-level data that will be updated quarterly, please check out the Foreclosure Snapshot on our website.

Purchasing managers’ surveys—often referred to as purchasing managers’ index (PMI) reports—provide timely information about the economy. In these monthly surveys, manufacturers are asked about their own purchases and their company’s supply chain. More specifically, manufacturing purchasing managers are asked about the directional heading of their businesses’ key indicators, such as new orders, prices, inventory levels, employment, and delivery time. In constructing the PMI, a survey response of “up” is given a value of 1; an answer of “no change” is worth 0.5; and a reply of “down” is worth 0. Once all the surveys have been taken into account, an index value greater than 50 equates to expansion of the manufacturing sector, a value of 50 means there was no change, and anything less than 50 is associated with a contraction in manufacturing. The further a reading is from 50, the more significant the increase or decrease in manufacturing.

Purchasing managers’ surveys cover manufacturing activity from a variety of geographic areas. Among such surveys, the U.S. and Chicago Institute for Supply Management (ISM) Reports on Manufacturing—released at or near the beginning of each month—are viewed as leading indicators of economic activity. It’s natural for PMI reports to be considered leading economic indicators both because the data are timely and because many manufacturing indicators are generally regarded as leading economic indicators. Manufacturing activity often leads the overall economy because of the durable nature of many of the sector’s goods. Inventories can be costly to hold, so that an unexpected buildup of inventories can prompt companies to halt production activity to bring inventories back into line with sales. Consumers, too, may slow their pace of purchases of durable goods like cars and appliances in response to a dimming outlook for income or jobs; when their incomes become impaired, households do not want to be caught with such durable goods, which can be difficult to convert into cash.

PMIs are especially telling in the Seventh Federal Reserve District where manufacturing is more important to economic growth as compared with the U.S. as a whole. For example, 13% of all Midwest nonfarm payroll employment is classified as manufacturing in the year to date. Nationally, manufacturing only accounts for 8.9% of total nonfarm payroll employment. The Midwest derives 11.2% of its personal income earned from manufacturing as opposed to a 7.2% share for the U.S. Arguably, the strongest sector since the start of the U.S. economic recovery in July 2009 has been manufacturing. And because of the stronger manufacturing presence in the Seventh District, we have benefitted from the recovery more than other states and regions. The individual PMI reports throughout the Seventh District support this assertion.

Chart 1 below shows the U.S. and Seventh District PMI reports—which are compiled for Chicago, southeastern Michigan (Metro Detroit), western Michigan (Grand Rapids, Kalamazoo, Holland), Milwaukee area, and Iowa. The chart constructs a 12-month moving average for each PMI report to resolve seasonal adjustment issues. The data go back to 1990, with the earliest PMI data found for Iowa as of 1994[1]. As indicated, the PMI readings generally peaked at the end of 2004 or the start of 2005. From 2005 until the start of the recession in December 2007, manufacturing continued to expand throughout the Seventh District, but at a slower rate; the lone exception was southeastern Michigan, which was impacted by the early stages of auto industry restructuring. Once the recession began, the deceleration in manufacturing activity intensified and became widespread, with PMI readings within the U.S. and the Seventh District falling below 50 during the onset of the financial crisis in the second half of 2008.

According to the National Bureau of Economic Research, the Great Recession ended in June 2009. Looking at Chart 1, the 12-month moving averages of the PMIs bottomed out at or around June 2009. The Chicago economic area noticeably lagged the U.S. and the other Seventh District indexes by a couple of months. Since then, PMI readings have rebounded well above 50, indicating a strengthening manufacturing sector. This is especially so in the Seventh District where PMI readings are at least 4 points higher than the U.S. PMI number.

Chart 1: U.S. and Seventh District PMIs: Total

In isolating the “new orders” component of the PMI surveys below in Chart 2, one tends to see more accentuated swings in manufacturing business cycles. As indicated by survey responses on new orders, the most dramatic dip and ensuing rebound occurring during the most recent recession and its aftermath took place in Iowa, with readings approaching 75 during the recovery phase. All Seventh District PMI new order readings are currently above the U.S. number, indicating that the pace of manufacturing expansion is stronger here relative to the rest of the nation. Additionally, the ongoing rebound in light vehicle sales and business spending on equipment and software bode well for the Seventh District, since there’s a higher concentration of those industries present in the Midwest.

Chart 2: U.S. and Seventh District PMIs: New Orders

Movements in manufacturing activity are often accompanied by swings in the sector’s employment and income. As of October of this year, manufacturing employment is up 2.4% in the Midwest over last year—higher than national employment growth in manufacturing, which was 1.9% October-over-October. A specific employment component of the PMI is reported. PMIs indicate that the pace of employment expansion has been substantial, with PMI readings of around 60 or above. At the sub-regional level, a rapid pace of hiring has been taking place, especially in western Michigan. A striking feature of Chart 3 below is that southeastern Michigan’s manufacturing sector experienced nine years of job losses because of the protracted contraction in the domestic auto industry before beginning to add jobs in 2010.
The rebound in manufacturing employment has contributed to the Seventh District’s unemployment rate falling faster from its peak than the U.S. unemployment rate. The Seventh District unemployment rate is currently 9.3%, down from its peak of 11%, and just above the current U.S. unemployment of 9%.

Chart 3: U.S. and Seventh District PMIs: Employment

When looking at the “supplier deliveries” component of PMI surveys below in Chart 4, a reading above 50 indicates a slowing in the delivery of supplies to (other) manufacturers[2]. Delivery times have recently increased as longer lead times have developed for commodities, especially those coming from areas in Asia affected by last spring’s Japanese earthquake and tsunami, as well as the recent flooding in Thailand. Since the incidence of delays in obtaining materials from suppliers has increased, the supplier delivery number is currently higher than at the beginning of 2011. Longer lead times bring into question the supply chain’s ability to respond to a robust increase in consumer demand that would require a significant increase in capacity utilization.

Chart 4: U.S. and Seventh District PMIs: Supplier Deliveries

During the economic recovery, inventory levels rebounded strongly throughout the Seventh District, as Chart 5 displays. But the pace of adding to inventories has now slowed, along with the overall pace of economic growth. As the economy accelerated early in 2011 according to the initial gross domestic product (GDP) reports, so did inventories in order to satisfy consumer demand. But as economic growth has slowed to a modest pace at best, with early 2011 growth being revised downward, inventory levels have become leaner, reflecting some of the uncertainty and lack of confidence present among consumers as they assess their household budgetary situations and prospects. Inventories are currently lighter on the retail side this holiday season in anticipation of a modest increase in the pace of sales relative to last year.

Chart 5: U.S. and Seventh District PMIs: Inventories

In looking over the PMI reports from various Seventh District locations, one notes that the current readings indicate a manufacturing sector that continues to expand at a faster pace relative to the U.S. as a whole. As the national economy recovers from the Great Recession, the Seventh District economy is rebounding—in some respects ahead of the national economy—largely because of the region’s high concentration in manufacturing production of durable goods. If the current PMI trends hold, one could realistically expect that economic growth in the Seventh District will rival, if not exceed, the nation’s economic growth in the remainder of 2011 and into 2012.

______________________________________________________________________________________
[1]In addition, the earliest southeastern Michigan report was found in January 1990, but there’s a break in the data during 2004 when responsibility for the report switched over from the National Association of Purchasing Management and Comerica Bank to the Institute for Supply Management. (Return to text)

[2]Prior to May 2011, a supplier deliveries index above 50 percent in the Milwaukee PMI indicated faster deliveries, and below 50 percent indicated slower deliveries. Milwaukee’s supply delivery index number in Chart 4 has been adjusted to reflect the other supplier delivery indexes by subtracting the index number from 100 prior to their change in methodology. (Return to text)

The Midwest has benefitted from the recent rebound in manufacturing. Over the past year, total employment in the Seventh District states of Illinois, Indiana, Iowa, Michigan and Wisconsin has increased by just over 145,000 jobs, 40% of which has been due solely to manufacturing.[1] The heavy concentration of job gains in manufacturing and related industries has led labor markets in some areas of the Seventh District to benefit more than others.

Consider the metropolitan areas of Chicago and Milwaukee.[2] Looking at figure 1, one can see that employment levels in the two cities have tended to move in parallel over the past two decades. This is as one might expect for two cities that are so close geographically. However, this correlation has recently faltered. Although the data indicate that the two cities entered the most recent recession in a similar fashion, Milwaukee has seen a much bigger increase in employment during the recovery.

This becomes clearer if one looks at the year-over-year percent changes in payroll employment for each city shown in Figure 2.[3] Early in 2010, both Chicago and Milwaukee saw around 1% job growth. Since mid-2010, job growth in Chicago has returned to near zero on a year-over-year basis, while Milwaukee has seen gains of close to 3% percent for a while before also slipping in recent months to a rate of about 2%. In fact, the Milwaukee metropolitan area’s job growth over the past year stands out as one of the highest in the nation.[4]

What could account for this sudden departure from the historical trend? Table 1 shows the percent change in payroll employment in various industries for each city during two time periods: the most recent recession and its recovery. Looking at the first row, one can see that total employment fell by nearly the same amount in both cities in percentage terms during the recession. Furthermore, the remaining rows demonstrate that the concentrations of job losses during the recession were fairly similar across industries with a few exceptions.

Milwaukee has, however, seen a more pronounced recovery in jobs since the end of the recession. Job growth has been greater for the manufacturing (particularly in durable goods but also for nondurable goods), wholesale trade, education and healthcare, leisure and hospitality, and government sectors in Milwaukee than in Chicago; and only in the professional and business services and transportation sectors does Chicago have the advantage in job growth. Furthermore, decreases in employment in percentage terms in the retail trade and information sectors have been smaller in Milwaukee than in Chicago. Such decreases in the financial sector have been of a similar size in both cities.

To gain more context, one should take note of the relative magnitude of each of these sectors in both cities. Figure 3, which complements table 1, shows the sectoral composition for each city in 2010.[5] Overall, the two labor markets were quite similar in industry concentrations heading into 2011. The biggest differences were in durable goods manufacturing and education and healthcare, where Milwaukee had a higher concentration, and professional and business services and government, where Chicago had a higher concentration.

The industries where Milwaukee has seen greater job growth over the past 12 months relative to Chicago account for nearly 76% of total 2010 employment in Milwaukee. These same industries account for roughly 70% of total 2010 employment in Chicago. In this sense, the sectoral composition of the demand for labor has slightly favored Milwaukee’s core industries over the past year. However, this comparison can be a little misleading as it doesn’t take into account the linkages between sectors. For instance, transportation and wholesale trade in Chicago are likely to be influenced by durable goods manufacturing in Milwaukee.

By looking across a large number of metropolitan areas, we can draw finer distinctions that can help us put the year-over-year job growth of Chicago and Milwaukee into perspective. Figure 4 shows a scatter plot and regression line of year-over-year growth in payroll employment[6] through September of this year versus each sector’s share of total 2010 employment in 37 different MSAs in the Seventh Federal Reserve District.[7]

The first thing we notice is that Milwaukee, represented by the green dot, consistently appears above the regression line, meaning that it performs better than the statistical average MSA in the Seventh District in nearly all the sectors we have data on. In contrast, Chicago, represented by the red dot, is essentially on the line in all cases. This result is broadly in line with our direct comparisons discussed before. In most industries, Milwaukee’s employment gains have exceeded the average gains based solely on industry concentration.

A second thing to take notice of is those industries with positive sloping trends, or those in which a higher concentration is correlated with a higher rate of overall job growth in the past 12 months. These industries are durable goods manufacturing and education and healthcare—two sectors in which Milwaukee has both a large concentration and large increases in employment over the past year. In this sense, our statement about the core industries for Milwaukee providing an advantage in labor demand over the past 12 months is more accurate.

Given the two cities’ past history, Milwaukee is not likely to maintain its advantage over Chicago unless the strength in manufacturing continues to outpace that of the service sector. Indeed, in the past three months, the rate of employment growth in the largest employment sector in Chicago, professional and business services, has picked up, while manufacturing’s rate of employment growth has edged lower in Milwaukee. Regardless, the lessons we can learn from this comparison will make it an interesting one to keep track of in the coming months.

______________________________________________________________________________________
[1]These figures reflect State employment data through September 2011.(Return to text)
[2]By metropolitan area, we are referring to the U.S. Census Bureau definitions of metropolitan statistical area (MSA) and primary metropolitan statistical area (PMSA), respectively, for Chicago-Naperville-Joliet and Milwaukee-Waukesha-West Allis.(Return to text)
[3]Constructing this figure using the broader household survey measure of employment produces a similar result.(Return to text)
[4]Joe Taschler, 2011, “Milwaukee area’s job growth leads U.S.,” Milwaukee Journal-Sentinel, October 1, available here; U.S. Bureau of Labor Statistics, 2011, Metropolitan Area Employment and Unemployment Summary, release, November 2, available here.(Return to text)
[5]The industry compositions for both Chicago and Milwaukee have changed very little in recent years. The numbers displayed in Figure 3 look essentially identical to the analogous numbers for 2007.(Return to text)
[6]A similar exercise was performed with household employment data and achieved nearly identical results across the 37 MSAs and for Chicago and Milwaukee.(Return to text)
[7]Because of gaps in reporting, the analysis for durable manufacturing contains only 25 MSAs.(Return to text)

In terms of income and population growth, nonmetropolitan counties in the Seventh Federal Reserve District states have had their ups and down over the past few decades. The nonmetropolitan population of the Seventh District has not generally kept pace with its metropolitan counterpart—as in many other parts of the country; the nonmetropolitan areas have continued to (modestly) lose population share in recent decades. Despite this continued share loss in population, nonmetropolitan counties have maintained their standing in per capita income since 1969. This maintenance of per capita income has been achieved amid much upheaval in rural industry structure. Production agriculture has tended to slip in relative importance in many nonmetropolitan counties over the long term, although recent strength in crop prices are lifting fortunes in many rural counties. In places where production agriculture has waned over the long term, manufacturing activity has widely become a backstop. In addition, many nonmetropolitan economies have become more prominent destinations for recreation and retirement.

The U.S. population has been urbanizing throughout most of the nation’s history. At its inception, approximately 95% of the nation’s population lived in the countryside. This rural share diminished to about one-half as the twentieth century dawned, and today it amounts to about one-fifth. In the Seventh District, nonmetropolitan counties also account for around one-fifth of the population—ranging from Iowa’s 42.3% of the total population residing in nonmetropolitan counties to Illinois’s 12.8%.

In recent decades, urbanization has continued in the Seventh District, albeit at a much slower pace than it has done historically. The nonmetropolitan population of the District made up 21.5% of the total population in 1969 versus an estimated 20.3% in 2009. During the 1970s, nonmetropolitan counties actually gained population share over metropolitan counties in the District.

As seen below, the nonmetropolitan population grew at a healthy pace during the 1970s, and dropped steeply thereafter during most of the 1980s. The 1990s saw a pickup in nonmetropolitan population, followed again by decline during the most recent decade.

While the population in the Seventh District has continued to shift to metropolitan counties, nonmetropolitan counties have managed to sustain their relative per capita income. Per the chart below, the average nonmetropolitan per capita income gained modestly on that of the metro areas during the 1970s, and then it slipped behind during the subsequent two decades and has rallied somewhat during the past decade. However, within the past two to three years, rising prices of farm commodities—especially those of corn and soybeans—are lifting incomes in many nonmetropolitan counties of the District. The recent rise in agricultural fortunes, along with the farmland boom accompanying it, will be the subject of an upcoming conference here on November 15.

The fact that per capita incomes in nonmetropolitan counties have kept pace with those of metropolitan counties over the long run is somewhat remarkable given the shrinking role of production agriculture in directly generating income and jobs. Farm productivity has soared as farm operators have been able to produce more crops and livestock with less per-unit inputs, especially less labor hours. By way of illustration, per-acre crop yields for two of the Seventh District’s major commodities—corn and soybeans—have doubled since the mid-1960s. Such productivity has enhanced the diets of U.S. households and, increasingly, those of the developing world as well. However, productivity gains have also served to lower real prices of raw farm products over the long term, as the demand for them has not kept pace with rising production. In the process, farm income employs and supports and fewer local workers and households. In the Seventh District today, farm production directly generates only 1-2% of the District’s output and income.

Manufacturing activity has become a major offset to shrinking farm activity in many of the Seventh District’s nonmetropolitan areas. The maps below show those nonmetropolitan counties where the share of income derived from manufacturing activity exceeds the statewide average. In 1969, 53.13% of nonmetropolitan counties could make this claim. By 2009 65.62% of nonmetropolitan counties could do so.

Declining agricultural employment and income account for part of the rising (relative) importance of manufacturing in nonmetropolitan counties. But so do trends favoring a rural location for manufacturing plants as well as a favorable mix of industries that are already concentrated in nonmetropolitan counties. Generally, manufacturing plant location has come to favor nonmetropolitan locations where land prices and transportation costs may be less expensive. The rise of truck and intermodal transportation has especially favored those nonmetropolitan areas with access to highways, along with connections to the more traditional rural roads originally constructed to convey raw farm products. In addition, manufacturing production that is tied to nearby farm products—such as food and ethanol processing—has also performed well, thereby buoying manufacturing employment in nonmetropolitan areas. As the chart below indicates, food processing employment levels in the Seventh District overall have stayed fairly level since 1990, and they have actually gone up in the District’s three more rural states of Iowa, Indiana, and Wisconsin. Over the same period, total manufacturing payroll jobs have declined by 30%.

In many parts of the Seventh District and throughout the U.S., many rural counties have also come to depend on their scenic assets, such as lakes, rivers, and forests, as the basis for economic growth and development. For many rural counties that experienced population and income declines associated with waning agriculture, forestry, mining, and manufacturing, promotion of recreation and retirement can help their reverse their fortunes.

Since employment and income from such activities as tourism (and retirement) are scattered across many statistical categories, researchers Calvin L. Beale and Kenneth M. Johnson have classified recreation-intensive counties by analyzing a variety of data. Their analysis published in 2002 identifies all such “recreation” U.S. nonmetropolitan counties as defined in 1993 (following the 1990 U.S. Census of Population and Housing). Such recreation counties are identified in each of the five Seventh District states, with many of them located in central and northern Wisconsin and northern Michigan. The authors’ find that population growth was higher in recreation nonmetropolitan counties than in other nonmetropolitan counties that continue to depend on farming, mining, manufacturing, and other economic activities. (According to the authors, the same applies to retirement counties—which are defined as those with significant in-movement of older people in the 1980s—relative to other nonmetropolitan counties.) However, they also point out that there may be downsides to the economic development attendant to recreation. Such development may cause environmental stresses on the land and natural resources. Additionally, it can often be in conflict with more traditional economic agricultural activities, such as the raising of livestock. While such conflicts have arisen in the Midwest, more harmonious relationships between agriculture and tourism can also be seen. In particular, agri-tourism and local agricultural sourcing have been on the rise.[2]

Nonmetropolitan areas of the Seventh District states differ widely in their economic performance and structure. On the average, they struggle to maintain population and economic viability. Even though production agriculture has slipped in importance, it continues to drive the income and attendant economic activities in many rural regions. At the same time, manufacturing, recreation, and retirement are often helpful avenues for many nonmetropolitan counties to develop their incomes and populations.
______________________________________________________________________________________
[1]For a longer treatment of this topic, see the opening presentation at the recent Chicago Fed conference titled Economic Development in Rural Wisconsin.(Return to text)

[2] See the 2010 Chicago Fed conference titled The Intersection of Midwest Agriculture and Rural Development, available here, as well as the 2009 Chicago Fed agricultural event here. (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%.

Rapid increases in the value of Midwest farmland have contrasted sharply with the malaise of other real estate markets. At 17% (see chart), the year-over-year increase in the value of farmland in the Seventh Federal Reserve District for the second quarter of 2011 was the largest recorded since the 1970s, according to a survey conducted by the Chicago Fed and reported in the latest issue of AgLetter. Agricultural land values in Indiana and Iowa climbed 20% or more in a year, while agricultural land values in Illinois climbed almost as much. “Good” agricultural land in the Seventh District rose 4% in the second quarter of 2011 relative to the first quarter of 2011. Bankers in the survey commented that there were more summer auctions of farmland than usual, particularly as demand for farmland remained strong from both farmers and investors. Some bankers expressed concerns about the risks facing farmland markets, especially with regard to declines in crop prices. However, these views formed a minority, as just 2% of responding bankers expected farmland values to fall in the third quarter of 2011 (36% of survey respondents anticipated higher farmland values in the third quarter, and 62% expected no change).

On November 15, 2011, the Federal Reserve Bank of Chicago will hold a conference to explore the factors contributing to these large increases in midwestern agricultural land values and associated cash rental rates. At the conference, experts from academia, the farm industry, and policy institutions will present research on the causes of rapid increases in agricultural land values and cash rents, as well as their interrelationship. The goals of the conference include analyzing demographic and geographical characteristics of Midwest farmland ownership; understanding the dynamics of farmland valuations; assessing the risks facing agriculture and the banking industry from rising farmland values; and discussing policy implications for agricultural lending stemming from current farmland trends. Visit here for additional details.

A report on agricultural land values from the U.S. Department of Agriculture showed similar increases for 2011, as of January 1. There was a 16.2% gain on an acre-adjusted basis for the five Seventh District states from the start of 2010 to the start of 2011, calculated from data in the USDA report. Furthermore, there have been large increases according to surveys in Indiana and Illinois. Wisconsin farmland values have risen too, although not as quickly.

Recent data from the Iowa Farm and Land Chapter #2 of the Realtors Land Institute confirmed that farmland values continued their fast ascent in Iowa. The institute’s survey results indicated that there was a 12.9% jump in Iowa’s agricultural land values between March and September of 2011. Further information about Iowa’s farmland is available from an annual survey conducted by Iowa State University. Michael Duffy from Iowa State University will present on the demographics of farmland ownership at the Chicago Fed conference.

By the end of this year, net farm income for 2011 is projected to have risen $24.5 billion from that of 2010, to $103.6 billion, according to the latest USDA forecasts. This estimated rise in net farm income should help propel farmland values upward even further. This forecasted rise in net farm income is due to anticipated increases of $34.7 billion in the value of crop production and $22.7 billion in the value of livestock production, even though the cost of purchased inputs is projected to rise $28.0 billion. Government payments were forecasted by the USDA to decrease 18% from 2010—to $10.2 billion for 2011.

Higher crop prices have boosted the expected stream of earnings from crop production, supporting further gains in farmland values. According to data from the USDA, crop revenue for 2010 in the Seventh District jumped 34% above that of 2009, despite below-trend corn yields. The Seventh District value of corn for grain produced in 2010 was $31.8 billion, and the value of soybeans was $16.6 billion. In 2011, corn and soybean prices have kept well above the levels of a year ago. Relative to a year earlier, September corn prices were 49% higher and soybean prices were 27% higher, even though crop prices have fallen from summer highs.

The USDA estimated that the nation’s 2011 harvest of corn for grain will be slightly smaller than the 2010 harvest. It also estimated that the five Seventh District states’ 2011 harvest of corn for grain will be 2.4% larger than the previous year’s harvest. Soybean production was estimated to decline 8.1% for the U.S. and 9.9% for the five Seventh District states. Total usage of corn, at 12.7 billion bushels, would result in U.S. ending stocks of 866 million bushels—the tightest in 15 years. Total soybean usage in the U.S. of 3.13 billion bushels would leave ending stocks at 160 million bushels, tighter than a year ago. The USDA estimated price intervals for the 2011–12 crop year of $6.20 to $7.20 per bushel for corn and $12.15 to $14.15 per bushel for soybeans. Based on the midpoints of these projected price ranges, the value of the Seventh District corn crop in the current year would rise 25% from 2010, while the value of the soybean crop would decline almost 1%.

In addition, livestock prices were well above the levels of 2010 in September 2011. Prices for hogs, cattle, and milk were 9.6%, 17%, and 18% higher this September than last September, respectively. The livestock sector has experienced higher revenues, but higher feed costs have limited the rise in income for the sector. The combination of higher revenues for crop and livestock production has been an impetus for the significant increases in agricultural land values seen this year in the Seventh District.

According to the AgLetter covering the first quarter of 2011, farmers tended to outbid investors for agricultural land at auctions, some respondents reported. Although investors often bowed out in the bidding, they are showing growing interest in farmland. This should not be too surprising given the mixed results other investments have been generating in recent years. Jennifer Ifft, a conference speaker, co-wrote a piece that examines the role of investors in California farmland markets. The reporting bankers in the Seventh District thought farmers bought an even higher share of farmland this year than during the prior year; 48% of the respondents saw an increasing share of land purchased by farmers and only 6% saw a decreasing share in the period from October 2010 through March 2011. With 75% of the bankers observing higher demand for the purchase of farmland and just 1% observing lower demand, the market for farmland was ripe for fast rising land values.

This summer there was a set of articles about agricultural land values published in Choices, which was designed to educate readers on farmland. Another good resource on farmland values, from Purdue University, provides an analysis of farmland values, co-written by Brent Gloy (also a presenter at the conference).

Rents for farmland headed up

Seventh District cash rental rates for agricultural land in 2011 rose sharply relative to 2010—the only year over the past five that had an increase of less than 7%. Seventh District cash rents climbed 16% from 2010. Cash rental rates were up 14% in Illinois, 15% in Indiana, 16% in Iowa, 18% in Michigan, and 20% in Wisconsin. After being adjusted for inflation using the Personal Consumption Expenditures Price Index, Seventh District cash rental rates increased 14% from 2010. This increase was the second largest, behind that of 2008, since tracking of Seventh District cash rents began in 1981.

USDA results on cash rents for cropland showed an increase of 8.8% nationwide for 2011, as of January 1. Cash rents in the Seventh District rose 8.3% in Illinois, 7.8% in Indiana, 11% in Iowa, 12% in Michigan, and 7.6% in Wisconsin.

With the increase in Seventh District farmland values matching that for cash rental rates for 2011, there was no change in the price-to-earnings (P/E) ratio for Seventh District agricultural land (see chart). The unchanged P/E ratio indicated relatively balanced demand to purchase versus rent farmland. In an asset valuation model, the present price of an asset should reflect both current profitability and expectations for future earnings. The P/E ratio for farmland can be constructed as the ratio of indexes based on average farmland values per acre and cash rental rates per acre (the latter representing the earnings potential of farmland). Both cash rental rates and farmland values have risen because of higher agricultural prices.

Cash-renting agricultural land, although increasingly with clauses that allow owners to benefit when crop prices increase further, remained the dominant method (80%) in the Seventh District for farm operations by someone other than the owner. With 16% of farmland on crop shares, 1% on a bushel basis, and 3% on other arrangements, there appeared to be an inclination by owners to get more involved in farm operations and garner higher returns in 2011. Illinois remained the Seventh District state with the lowest percentage of cash rentals (68%), even as rentals on a crop share basis diminished (26%). Additional information on cash rental arrangements can be found from the University of Illinois.

Come join us on November 15, 2011, at the Federal Reserve Bank of Chicago to discuss these agricultural trends and the issues that they raise.

Charts:

When we see reports of the rising foreclosure rate in the media, we get the general sense that the housing market is struggling. While this is generally true, many reports do not accurately characterize the varying struggles from one local housing market to the next. Though reports often use them interchangeably, there are multiple measures of foreclosure rate that offer additional information. In particular, it’s important to distinguish between three related housing market measures: the inventory, start, and transition rates. The last is perhaps the least talked about, though it provides important information that affects the foreclosure inventory significantly.

Let’s look at Cook County, IL, to illustrate the differences between these three rates. The inventory rate measures the number of loans in foreclosure at a given time as a percentage of the number of active loans. It is typically referred to as the “foreclosure rate.” In Cook County, this rate was 7.1% as of June 2011.
Behind this rate, however, are two metrics that reflect the two phases of the foreclosure process: 1) the start rate and 2) the transition rate. The start rate represents mortgages going into foreclosure—typically after 90 days of delinquency. Conversely, the transition rate is the rate at which foreclosed mortgages exit foreclosure.

A mortgage may transition out of foreclosure for a handful of reasons, such as a loan modification or a sale. If an area has a low transition rate, mortgages that enter into foreclosure stay in foreclosure for a much longer period. A low transition rate will increase the foreclosure rate, since more and more mortgage will continually be counted as loans in foreclosure. Conversely, if the transition rate is high, that means many loans are exiting foreclosure; thus, the foreclosure rate will be lower, since at any given time there are fewer loans in foreclosure. Cook County’s transition rate was 5.0% as of June 2011.
How do these two rates—the start and transition rates—affect the foreclosure (inventory) rate? If the start rate increases, there is a chance that the foreclosure rate will also increase, unless enough offsetting mortgages leave foreclosure. For instance, in Cook County the start rate was 0.5% as of June 2011.

To illustrate how these rates are related, we are going to examine Cook County, IL, and Wayne County, MI. If you asked most people which county had a higher foreclosure (inventory) rate, they'd probably answer Wayne County, MI (which contains Detroit). However, as you can see from the chart and data below, Wayne County's inventory rate is substantially lower than Cook County’s. The fact that Wayne County has been hit hard comes through only by looking at the start rate. Wayne County’s high transition rate implies that foreclosures have been moving through the system quickly. The main difference between the two counties is that Illinois uses a judicial system for processing foreclosures, whereas Michigan has the ability to use a non-judicial process, which tends to speed up the foreclosure process. Only by breaking down the inventory rate into the start and transition rates do we get a clearer understanding for why Wayne County’s inventory rate is lower than Cook Country’s. Conflating these three rates may lead to a mischaracterization of a county’s foreclosure conditions.

As shown, the foreclosure (inventory) rate is a function of both the start rate and the transition rate. The foreclosure rate, accordingly, reflects the trends in the latter two rates.

Please be on the lookout for our next blog entry on foreclosures, written by a guest blogger, that will focus on the triggers of foreclosure.

To get more information on foreclosures, check out the Foreclosure Resource Center on the Chicago Fed’s website: http://chicagofed.org/webpages/region/foreclosure_resource_center/index.cfm
______________________________________________________________________________________

[1]
This blog draws on three Federal Reserve items that are also recommended readings:
a. Robin Newberger and Daniel DiFranco, 2011, “Beyond the foreclosure inventory: The impact of start rates and transition rates in five counties,” Profitwise News and Views, Federal Reserve Bank of Chicago, April, pp. 2–7, available here;
b. Timothy Dunne and Guhan Venkatu, 2009, “Foreclosure metrics,” Economic Commentary, Federal Reserve Bank of Cleveland, April, available here; and
c. Charts created by the Federal Reserve Bank of New York, available here.

Due to the changes in sample data we are not reporting data before 2006.

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 expanded more slowly in July and August. Seventh District business contacts expressed concern about the economic outlook, noting lower business and consumer confidence.
• Consumer spending: Retailers reported the back-to-school shopping season got off to a strong start with consumers responding more than expected to the increase in early back-to-school promotions. Vehicle sales edged up in July before leveling off in August.
• Business Spending: Business spending continued at a slow, but steady, pace in July and August. Several contacts noted closely watching inventory and staffing levels due to the uncertain economic climate. Labor market conditions weakened, with hiring still slow and unemployment edging up in the District.
• Construction and Real Estate: Construction activity decreased. Residential real estate conditions remained weak, and commercial real estate conditions were little changed, with vacancy rates steady and some remaining downward pressure on rents.
• Manufacturing: Demand for heavy equipment moderated from its robust pace during the first half of the year and auto production increased in July before leveling off in August. Capacity utilization in the steel industry remained at a record high level.
• Banking and finance: Business loan demand fell while credit supply continued to improve both for large and small borrowers. Volatility in financial markets also increased dramatically in early August, leading to moderately higher funding costs.
• Prices and Costs: Elevated commodity prices continued to put pressure on costs in July and August, and several manufacturers reported extended material lead times, particularly for specialty metals. Wage pressures remained moderate.
• Agriculture: Prices for corn, wheat, cattle, soybeans, milk, and hogs all moved higher. Due to hot temperatures and a lack of precipitation, corn and soybean crop conditions declined markedly in the District.

The Midwest Economy Index (MEI) decreased to +0.03 in July from +0.36 in June, and approached its historical trend for the first time in 17 months. However, Midwest growth continued to outperform its historical deviation with respect to national growth, even as the relative MEI decreased to +0.85 in July from +1.05 in the previous month.

The Chicago Fed Midwest Manufacturing Index (CFMMI) increased 0.5% in July, to a seasonally adjusted level of 84.8 (2007 = 100). Revised data show the index increased 0.3% in June. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) increased 0.6% in July. Regional output in July rose 6.2% from a year earlier, and national output increased 4.2%.

We all eat, yet the variety of what we eat is mesmerizing. Whether we eat the newest power bar developed in a laboratory or the latest organic, heirloom tomato, innovation is essential to food reaching our mouths. Everyone has a stake in the innovation of the agricultural and food industries—from the inhabitants of the rural Midwest, to the research scientists in our nation’s labs and universities, to people around the world who benefit from pest-resistant strains of grain. Agricultural innovations already have enhanced a wide range of products, including nutritional supplements, plastics, and energy materials derived from production agriculture. The future holds even more promise for benefits derived from the agriculture and food pipelines, especially enhanced nutrition, drought-resistant crops, and new functional foods. However, the safety of the food system remains a vital and ever-present concern, as well as a new source of job creation.

A Regional Strength

It is an interesting feature of regional economies that they often continue to be the innovative centers of the industries that were born there. Perhaps this is not all that surprising, since it is innovation that so often drives and sustains industries—innovation encompassing not only the creation of new products to sustain consumer demand, but also the productivity-enhancing technological improvements to fend off competition from other companies, industries, and countries. Yet, as regions search for their own economic renewal, they may overlook their innovative roots, opting instead to recruit or grow the latest hot sector—be it personal computing equipment, homeland defense, information technology, or biotechnology.

Historically, the Midwest economy is as closely linked with agriculture and the food industry as it is with, say, manufacturing. Indeed, the bountiful production and transport of farm products for export not only supported the region’s employment and income throughout most of its growth and development, but also fed the hordes of factory workers who were once needed to operate the region’s factories and mills.

Today, the innovations of production agriculture remain a legacy feature. Nationally, the identifiable value added from innovation in food processing is significant, though far from the top among industries. According to the most recent National Science Foundation survey (2008), U.S. food companies poured $3.18 billion into R&D domestically and another $683 million abroad.

Such expenditure figures are not publicly available for individual regions. But we can look at the Bureau of Labor Statistics’s occupation data for each state to get a sense of innovation-related employment in agriculture and the food industry. These jobs would include: food scientists and technologists; animal scientists; soil and plant scientists; and agricultural and food science technicians. Moreover, unlike the R&D spending numbers, these employment figures include people across the spectrum from government to university, to nonprofit lab, to private business ventures.

Occupational specialties vary from state to state. Also, due to the sample sizes, there are anomalies in the results for specialized occupations for some states. Yet, overall across all of them, the Seventh District states are 31 percent more concentrated in these occupations than the U.S. average; 39 percent more concentrated if we use a broader eight-state definition of the Midwest region (including Minnesota, Missouri, and Ohio). Thus, our region benefits more than the nation from the growth in spending on innovation in the agriculture and food sectors of the economy.

Food Safety is Paramount

As the variety and breadth of our diet expand, so do concerns about food safety. News accounts of foodborne illnessses regularly appear, although the U.S. food system remains among the safest in the world. Public concerns about food safety led to the passage of the Food Safety Modernization Act, signed into law in January 2011. The act will impose new requirements on food manufacturers, processors, packers, distributors, exporters, and importers. It will speed the industry’s movement toward a more science-based food safety system, compelling firms to seek innovative solutions in order to comply and be competitive in dynamic markets.

The academic and government laboratories of the Midwest are important research partners with the private sector. A conference called “Food Safety: Policy Changes, Science-based Opportunities” was held this summer at the Federal Reserve Bank of Chicago as part of a dialog between research institutions and industry in order to further partnerships and generate connections that will improve food safety via innovative technologies and refined systems. It was organized by an array of groups under the auspices of the Global Midwest Alliance.

At the event, David Oppedahl of the Chicago Fed gave an overview of key issues from a regional perspective with regard to food safety. Farming and food manufacturing combined to generate 3.4% of the District’s output in 2008, over 1% more than for the country (see figure 2 at end). Just one form of foodborne illness, salmonella, cost the U.S. economy $2.7 billion in 2010, with almost 1.4 million cases reported. The costs to the nation in medical expenses, lost employment compensation, and premature deaths are significant, although challenging to quantify.

The event’s keynote speaker, Robert Hibbert, K & L Gates L.L.P., compared the food safety system of the 20th Century with that of the 21st Century under the new act. Whereas the former regime involved more reactive regulations and enforcement, the updated food safety system will strive for prevention and traceability. Although resources remain limited, there are plenty of demands on the science and technology: improving process methodologies, enhancing control mechanisms, establishing traceability systems, gathering and exchanging information, and researching virulence in order to establish standards. Challenges to this agenda include the limits of science, expanding the foundation of basic research, communicating risk, and issues with clearances and approvals. Hibbert concluded that firms must “put up with the process,” while at the same time challenging it. An understanding of the emerging regulatory system and business realities will guide the industry toward a safer food supply and improved public health.

A panel on the scientific aspects of food safety was moderated by Paul Sebesta, U.S. Department of Agriculture. The panelists were Rosie Newsome, Institute of Food Technologists, Carla Little, Illinois Department of Public Health, and Todd Ward, U.S. Department of Agriculture. Newsome talked about the Institute’s initiatives and the resources they provide to advance the science of food. Little presented information on her agency’s efforts to ensure a safe food supply for Illinois, while facing increasing complexity in the food chain, globalization, and multi-state outbreaks of foodborne illnesses. Ward outlined the food safety programs at the National Center for Agricultural Utilization Research in Peoria, which focus on developing information and science-based solutions for detecting and removing toxins from food and preventing toxin contamination of food.

Finally, an industry panel, moderated by Matthew Botos, Illinois Science & Technology Coalition, focused on specific firms’ roles in the field of food safety and the opportunities for technological innovators. Justin Ransom, OSI Industries, shared experience gained from running the Food Protection and Quality Systems group, which oversees a global network of food manufacturing plants that handle both raw materials and finished products. Greg West, National Pasteurized Egg Inc., talked about his firm’s rapid growth to meet the demand for safer eggs (especially from restaurants) through innovative technology that maintains the look and taste of fresh eggs while extending shelf life and eliminating salmonella. D. J. Alwattar, Northland Laboratories, outlined his company’s specialized testing expertise, which provides a key component in the industry’s push to meet the challenges of food safety through innovation.

Upcoming Midwest "Clean Tech" Conference Announcement

On September 14, a related meeting at the Federal Reserve Bank of Chicago will focus on innovations in “clean” technology, including those that affect the food industry and agriculture. Organized by the Global Midwest Alliance, “Midwest Clean Tech 2011” will have a particular focus on global issues for innovation partnerships.

Digging out of a hole sounds like an oxymoron, but that seems to be what is happening with this particular economic recovery compared with recoveries from past recessions. Rather than the more rapid growth we would expect from the type of recession the U.S. just experienced, the economy is experiencing very tepid growth. The latest gross state product (GSP) data show just how slowly the recovery is proceeding for the Seventh District. [1]

Even though the District is leading the nation during the recovery in its manufacturing and agricultural sectors, as of the end of 2010 its total output is still lower than it was in 2005. The District is making some progress, but the direction of the recovery does look more like tunneling out of a hole than a vertical assent.

To get a sense of how different this recovery is, we can look at past rebounds from recession. For example, on average, three years after the start of the previous two recessions, the region had already experienced expansion of over 10.0%. By 2010, three years after the start of the 2007 recession, total GSP for the District is still 2.6% below its 2007 level. This hole is pretty deep.

It is important to note that the recession was not evenly distributed across all District states. The following chart shows the GSP for each state in the District indexed to calendar year 2000. It can be seen here that Michigan never really recovered from the 2001 recession. In fact, Michigan’s previous GSP peak was eight years earlier back in 2003.

While Wisconsin, Indiana, and Illinois seem to have tracked each other very closely over the past decade, Iowa has shown the strongest growth of all the states in the District. In fact, Iowa has experienced 21.3% growth since 2000. Its growth has been supported by a rise in agricultural commodity prices and the fact that it didn’t experience a housing price bubble, which has allowed the real estate sector to continue to show growth over the last decade. On the other hand, Michigan’s economy, which has been hurt significantly by declines in auto sales, has shown the weakest growth, its 2010 total GSP is still below where it was in 2000.

The next chart compares real state product growth in the District states from 2009 to 2010 with the nation as a whole.

The District grew at 2.8% in 2010, compared with 3.0% for the nation. Two of the five states grew at rates greater than the nation and four out of five states grew faster than more than half the states in the country. Michigan, which has been struggling for the past decade, actually did quite well growing at 2.9% and coming in at 16th place among all the states. Indiana, Iowa, Wisconsin and Illinois placed 3rd, 13th, 23rd, and 32nd, respectively.

In terms of job growth, the region’s economy may be performing slightly better than the nation overall in 2011. Through June 2011, the District had created jobs at a faster pace (0.9%) than the nation as a whole (0.7%), albeit from a much lower trough.

Michigan, which lost population in the last census, actually led the District in the first half of this year with job growth of 1.9%, it ranked 4th in the nation in growth of nonfarm payroll jobs. On the other hand, Indiana ranked last with employment down 0.4% in July 2011 on a year-to-date basis.[2] Even though Indiana has seen a decline in total nonfarm July 2011 year-to-date, the state has experienced job gains in two sectors, mining and logging (1.5%) and manufacturing (1.2%).

Still, total nonfarm payroll employment in the District remains well below its previous peak. In fact, as can be seen in the following chart, nonfarm payroll employment for the District is still below where it was in 1996. In addition, the nation as a whole has also seen a sharp decline in nonfarm payroll jobs since the start of the latest recession -- nonfarm payroll employment for the country is currently about where it was in 2004.

If we take a closer look at manufacturing employment data for the nation and the District, we see an even more distressing picture. Since 1990, the nation and the District have lost about 35% of their manufacturing jobs. This is equivalent to over 6.0 million jobs nationally, of which the District accounts for about 1.1 million. At its peak in 2000, the District accounted for 19.1% of the nation’s manufacturing employment. By July 2011 its share had fallen to about 18.6%. Also at the peak in 2000, the region had 474,000 auto related jobs, which accounted for about 14.4% of the region’s manufacturing employment. As of July 2011, manufacturing employment in the region was 2.2 million jobs, of which 203,600 or 9.3% were in the auto industry.

Some of the employment declines have come about from labor-saving productivity improvements, but many are the result of declining U.S. auto sales together with declining market shares of the Michigan-based Detroit 3 auto makers and their suppliers.

In the past couple of months total light vehicle sales have been disappointing but, on the bright side, the traditional domestic manufacturers have been doing relatively well. In fact, on a year-over-year basis through June of this year, the Detroit 3 collectively saw sales increase by 15.5% versus an increase of just 7.6% for the industry as a whole. The Japanese manufacturers experienced a decline in sales on a year-over-year basis of 11.6%, largely due to supply disruptions as a result of devastating earthquake in Japan. In addition, some customers may be postponing purchases until the Japanese manufacturers can get their inventories replenished. Thus, absent the impact of the earthquake and related supply disruptions, auto sales overall would have been stronger in recent months.

It remains to be seen when auto sales will regain the positive momentum they had shown earlier in the year but despite recent setbacks, the August 2011 Blue Chip consensus for light vehicle sales for 2012 is 13.6 million units. This is a 30.1% increase from the 10.6 million units sold in 2009 and an increase of 1.4 million units from the July SAAR of 12.2 million units. In addition, Ward’s Automotive is projecting that by 2012, vehicle production in the District will be up by 2.3 million units from its low point in 2009. If these projections are correct we would expect to see some more positive gains in manufacturing employment for our region -- especially Michigan. Meanwhile, we just have to keep digging.
______________________________________________________________________________________
[1]GSP is the equivalent of GDP at the national level – the sum total value of all goods and services.(Return to text)
[2]State rankings include the District of Columbia. (Return to text)

Two years following the end of the national recession, the national unemployment rate remains above 9%. Part of the explanation stems from the financial crisis element of the recession. In the past, aggregate demand (including new hiring) has tended to bounce back only slowly under similar circumstances, in which household wealth has declined sharply and traditional lending channels have continued to struggle. This time, other potential influences are being suggested. One point of debate is the potential impact of house lock, which is a decline in household mobility that is said to hamper job search. In particular, due to a high degree of underwater mortgages (where the mortgage debt level exceeds the current sales price of the home), working age adults may be constrained from long distance job-related moves by their inability to pay off their existing residential mortgage.

A new Chicago Fed Letter examines whether house lock has, in fact, contributed significantly to a higher than expected unemployment rate. To start, the authors lay out the background of concerns about house lock against the backdrop of the pickup in job openings during late 2009 and 2010 that has failed to translate into increased hiring rates.

To further analyze labor mobility, Aaronson and Davis compare the residential mobility of renters versus that of homeowners. The idea here is that, if house lock is important, the mobility of home owners would decline relative to that of renters, who are unencumbered by mortgages. In their analysis of the U.S., the authors define a household move as the relocation of a household across a state border. They further measure the migration rates of renters versus owners, in the preceding four months. In their results, they find no statistically significant changes over time in the difference between the tendencies of moving between renters versus owners.
To further explore this dynamic, Aaronson and Davis evaluated separately the five states that experienced the steepest house price declines (California, Florida, Nevada, Arizona and Rhode Island), postulating that the larger the decline in home prices, the more likely households would have negative equity, thereby reducing their ability to move. But even in these states, they find that homeowners do not appear to have changed their migration behavior relative to renters.

Midwest

How does the Seventh District compare if we apply the same methodology as Aaronson and Davis? First, as seen from the chart below, the Seventh District seems to have had a varied experience in the past decade’s run up in home prices. In general, home prices did not rise as much as the U.S. average, though in some instances, the home price falloff was just as steep. In Indiana, Iowa and Wisconsin, home prices did not fall much from their peak. However, Illinois did experience a similar pattern to the U.S., and in Michigan home prices have actually fallen below their 2000 levels.

On average, did the Seventh District experience some level of house lock during the most recent recession? Aaronson and Davis were willing to run their methodology for the Seventh District states for us, and the results are shown below. The four-month migration rate for Seventh District homeowners fell from 0.0024 to 0.0017, a 0.0007 decline (annualized, this would be 0.0007*3=.0021 or just over two-tenths of a percentage point). At the same time, renter migration rates barely increased, moving from 0.01 to 0.012. The last row, called “Difference,” compares the patterns between renter and homeowners and shows that the difference between the two is relatively small over time and statistically insignificant for the Seventh District states.

And so, the experience of house lock in the Seventh District states appears to be consistent with that of the rest of the U.S. That is, while the continued home market weakness is detrimental in other regards, it does not appear to be a primary driver of lingering unemployment.

It is true that District homeowner migration rates fell slightly during the recession. This is consistent with past downturns; migration rates tend to be procyclical in nature, falling during recessions and rising during expansionary periods as job opportunities become more abundant.