Click to enlarge.

Click to enlarge.


Will these surprising patterns repeat themselves in the current era of high prices for energy materials? Rural areas are once again finding themselves amidst an energy and food commodity boomlet. Surging agricultural demand from developing nations has contributed to rising U.S. exports and commodity prices. The falling value of the U.S. dollar since 2002 has also contributed, as have the U.S. legal mandates and subsidies for the use of corn-based ethanol as a transportation fuel. In the Seventh District, the growth pattern in farmland prices looks much like the late 1970s and early 1980s, rising at double digits annually through the decade.

In other regions, coal mining and energy exploration activity are buoyant.

However, this time around, conditions would seem to favor central cities versus rural and far suburban areas more than in the 1970s. Rates of crime declined over the 1990s in most major U.S. central cities. Central city schools continue to struggle to educate and graduate low-income students, in particular. Yet, most such school systems enjoy greater financial stability, and many have innovated and expanded their offerings to serve populations who are diverse culturally, as well as economically. Rather than shunning large cities, many highly educated households are finding the older architecture, diverse community, and rich array of amenities in central cities attractive. To some degree, employers have followed educated employees back into central cities; or they have found that the density of the central city makes for more productive business activity in the “new economy,” which rewards face-to-face contacts in conjunction with sophisticated telecommunications. Should these recent trends continue, higher gasoline prices may only add one more advantage to the higher density of older central cities.


These trends may leave some suburbs on the fringe as the losers in the current era. The map below illustrates the average commuting time for suburban areas of the Chicago metropolitan area. Many households who buy or rent in suburban areas choose the low housing prices that such areas offer at the expense of longer trips to work. The sudden rise in gasoline prices may have left many such households with larger shocks to household budgets than their more urban counterparts. The Center for Neighborhood Technology in Chicago has constructed neighborhood maps of U.S. metropolitan areas which estimate average household expenditures for commuter travel. For Chicago and most other metropolitan areas, these estimates show that average household energy expenditures climb on the fringes of metropolitan areas. Even as measured as a share of household income, far-suburban households are more severely affected by rising fuel costs.

Click to enlarge.

Some revisionist interpretations of the 1970s experiences of “urban to rural” turnaround have also been made by analysts such as Paul Gottlieb. And it seems that the turnaround of that period has been overstated by an inherent bias of measurement—the tendency to overstate the population growth of nonmetropolitan counties during periods in which household growth is robust nationally. In such periods, population growth in nonmetropolitan counties can flip their defined status from nonmetro to metro, thereby inflating the measured pace of growth in consistently defined “nonmetro” counties.

Given the experience of the 1970s, it is difficult to draw firm and rapid conclusions concerning whether an era of higher fuel costs will reshape our urban, suburban, and rural landscape and, if so, how. To be sure, higher fuel costs have changed the desirability of work and residential locations. But we also know that households and businesses can adapt to such marked price shocks in other ways than moving. In particular, as today’s fleets of autos and trucks wear out, they will surely be replaced by more fuel-efficient vehicles, thereby allowing many long commutes and delivery trips to resume at moderated cost. Such was the case following the energy price shocks of the 1970s.

Note: Thanks to Vanessa Haleco-Meyer, Bill Sander, and Graham McKee for comments and assistance.

“The Midwest is failing the challenge of globalization, largely because it’s so balkanized, with each state trying to compete in the global economy. Midwestern states are simply too small, too incompetent, too obsessed with the wreckage of the industrial economy, to deal with the problems of the future, like education. It’s time for other players -- cities, businesses, especially universities -- to come together in a concerted regional approach that would leverage the Midwest’s strengths, not undermine them,” said Richard C. Longworth, senior fellow, Chicago Council on Global Affairs and author of the new book, Caught in the Middle: America's Heartland in the Age of Globalism.

Can regionalism boost the prospects of the Midwest? This is a theme investigated in several previous blogs by Bill Testa on this website. When is cooperation and when is competition the right approach in gaining regional advantage? How do you get people to “think regionally”? These questions were at the center of a two-day program that brought together a group of 100 business, academic and policy leaders in Minneapolis on June 26-27. The program was cosponsored by the Committee for Institutional Cooperation (which represents the Big 10 universities as well as the University of Chicago), the University of Minnesota and the Minneapolis Fed and was designed as a companion to two previous conferences in 2005 and 2006 held here at the Chicago Fed. The program had a specific mission—to discuss the role of human capital in the economic development of the region and to investigate whether greater regional cooperation might hold the key to a more vibrant future for the Midwest.

Human capital is a clear determinant of regional fortune. Evidence presented at the conference suggested that this is a two-edged sword for the Midwest. The region is rich in institutions that educate residents and produce valuable research. However, the Midwest is only average when it comes to its share of college educated workers in the regional labor market. There is also ample evidence that the region produces research at a prodigious clip and yet lags in product commercialization and the ability to attract venture capital.

The conference also investigated both the public and private returns to education. A presentation by Lance Lochner of the University of Western Ontario traced the income returns (i.e., the rate of financial return from investment in education) to varying levels of educational attainment. Lochner looked at the average financial returns received by men over the period 1940 to 2000. His findings suggested that returns were highest for high school graduates over this period but that the return to a four-year college education exceeded the returns from two-year college programs. Lochner noted that in addition to increased lifetime earnings, additional schooling improves health outcomes, increases personal satisfaction and often leads to more enjoyable careers.

Paul Glewwe and Amy Damon of the University of Minnesota examined the “public” or social benefits that taxpayers in Minnesota receive when students enroll in the university. The study identified several categories of benefits, including increased state tax revenues, reduced crime, increased civic engagement and lower unemployment. They estimated an annual economic benefit to the state of $672 million versus a cost of $284 million. This is a conservative estimate because it excludes any benefits from research activities and excludes other public colleges and universities in the state.

Another aspect of human capital discussed was the returns to early childhood education. Art Rolnick of the Minneapolis Fed discussed efforts to expand early childhood education access to low-income families in Minnesota. Research from several studies suggests that early childhood education has a significant impact on both economic and academic outcomes. Rolnick offered a model for expanding early childhood programs and suggested that the public returns to such efforts will be substantial. Early education programs would not only focus on child development but also on increasing the resources and training of parents in support of their children.

The focus of the conference shifted in the afternoon to a discussion of whether a regional approach would be best suited to solving policy challenges such as improving the region’s human capital. Lou Anna Simon, President of Michigan State University, suggested that institutions do have ample opportunity to increase cooperation to their mutual benefit. For example, Midwestern universities could cooperate on grant applications to improve their chances of obtaining research funds. Simon said that turf battles are often detrimental to the region’s overall success.

So, who takes ownership of a regional agenda?, Simon asked. Is there a blueprint for creating an organization that can promote regional cooperation? Many regions have looked enviously at the Southern Growth Policies Board as a model. Giving a Midwest example was Frank Beal of Chicago Metropolis 2020, an organization founded eight years ago with the goal of making the Chicago metropolitan region more economically competitive. This initiative emerged from a study conducted by the Commercial Club of Chicago in the late 1990s. The strong commitment, influence and resources of the Commercial Club and its continuing support have been important in helping Metropolis 2020 aggressively pursue change in four areas: the criminal justice system, early childhood education, regional growth and transportation.

Beal offered eight factors in Metropolis 2020’s success that might be applicable to a future Midwestern regional organization. Metropolis 2020:
1. Has a clear blueprint of what the organization wants to accomplish.
2. Benefits from having a relationship with the Commercial Club that provides stature and access to people and resources.
3. Avoids agenda creep. Has a disciplined approach to reviewing new issues or taking on new assignments.
4. Collaborates with other organizations only on its own terms. In practice this means clearly establishing the program goals before inviting others to join.
5. Has mostly older senior professionals on staff. These people are issue experts, and they are doing this work because it matters to them.
6. Does not view government as the problem. Many of the staff have had senior government positions and respect the role government plays in getting things done.
7. Will not tackle an issue unless it is a natural fit with the organization’s expertise. Changing public policy requires expertise.
8. Is ambitious and does not mind tackling audacious goals.

One final perspective on regionalism was offered by Tom Holmes of the University of Minnesota. Holmes observed that a fundamental challenge to any notion of regionalism is that any region is both arbitrarily defined and composed of a series of sub-regions. And so, depending on the issue, coalitions must form with an ever-changing cast of characters. Often the desire in regionalism is to establish a large umbrella organization to promote a broad regional agenda, but these efforts fail to recognize that the most successful regional policy efforts contract and expand to fit the size and scope of the issue.

The program concluded with the signing of a resolution by all of the attendees. The resolution recognized the shared history of the region and the challenges of adjusting to economic change. Solutions to the Midwest’s economic challenges will require an integrated response by business, public policy and higher education. Specifically, the resolution concludes, “We hereby resolve to actively explore ways to work collaboratively on solutions, bringing our best from business and industry, public policy and higher education, to contribute to a stronger economic future for the region.”

The next step in this investigation of regional cooperation is being sponsored by the Chicago Council on Global Affairs on October 6th of this year. This one-day program will examine the impact of globalization on the Midwest and why thinking regionally should matter. While the ultimate form of regional cooperation is clearly a work in progress, this discussion is clearly gaining momentum and reaching an ever larger audience.

For the past 11 years, sales of light vehicles have consistently been above 15 million units per year, representing an unusually strong run for this industry. Toward the end of 2007, the U.S. market for motor vehicles started to slow down. As the price for gasoline kept rising, recently reaching $4 a gallon, not only did vehicle sales continue to fall, but consumers rather quickly adjusted the mix of vehicles they bought, abandoning full-size trucks and large sport utility vehicles (SUVs) in favor of fuel-efficient cars and crossover utility vehicles (CUVs, or utility vehicles built on passenger car platforms).

However, amid the ongoing turmoil in the auto sector, there has been a bright spot that often gets overlooked. Exports of light vehicles have increased by 52% since 2002, with exports of new vehicles up 21% and exports of used vehicles up almost fourfold (see figure below).

Click to enlarge.

The figure below illustrates how exports of new light vehicles—that is, cars and light trucks, such as minivans and utility vehicles—have substantially outpaced domestic production as well as sales over the last eight years. As a result of this noticeable increase, last year's exports of newly produced light vehicles represented 16% of U.S. light vehicle production, up from 11% as recently as 2002.

Click to enlarge.

What’s behind this rather substantial increase in exports? We first analyze in some detail where vehicle exports are going.

Data available from the U.S. International Trade Commission (USITC) identifies the destination country for exported vehicles. In 2007, new vehicles, representing just over 70% of all vehicle exports, were being shipped primarily to the two North American Free Trade Agreement (NAFTA) partners: Canada received just over half of all new U.S. light vehicle exports, and Mexico took in 12% of U.S. exports (see table below). The strong linkages among the NAFTA countries reflect the fact that the production footprint of each of the multi-plant carmakers is highly integrated across the U.S., Mexico, and Canada. Many vehicle models are being produced at only one assembly plant within North America. It is therefore standard practice to serve the entire North American market from that one location, resulting in cross-border shipments. In fact, analysts often refer to a single North American motor vehicle industry (in terms of production and sales). Other destination regions for U.S.-made vehicles rank far behind North America: In 2007 Europe received 18% of all new vehicle exports from the U.S., and the Middle East came in third with 10%.

Yet the significant increase in new vehicle exports during the last few years followed a noticeably different geographic pattern: Between 2002 and 2007, exports to the NAFTA countries actually fell by 5%. In contrast, Europe received 52% of the net increase of 287 thousand in new vehicle exports over that period; the Middle East accounts for about 40%, likely reflecting spending from increased oil revenues. Incidentally, exports of used vehicles were much more dispersed than those of new vehicles, with each major region of the world receiving at least 10% in 2007 (see table below).

Click to enlarge.

At first glance export growth seems related to the exchange rate value of the U.S. Dollar (see figure below). (Note that the exports of new light vehicles from the U.S. to Canada and Mexico are excluded from this graph.) Subsequent to the dollar’s recent peak in 2002, exports of both new and used vehicles accelerated. However, more is afoot than currency fluctuations. This is evident because exports began to rise a couple of years prior to the dollar’s 2002 peak. By the same token, the strong increase in new vehicle exports took place during the last two years, well after the dollar started to decline.

Click to enlarge.

A better understanding may be found in the global nature of production employed by today’s automakers, many of whom have chosen to produce on U.S. soil. During the 1980s all the major Japanese carmakers opened their first production facilities in the U.S. The German carmakers BMW (Bayerische Motoren Werke AG) and Mercedes-Benz followed during the 1990s, and the Korean carmakers Hyundai and Kia entered during the first decade of the twenty-first century. Yet setting up production operations in the U.S. (or for that matter another country) for a foreign carmaker is neither done quickly nor reversed easily. In fact, the recent response of U.S. exports of light vehicles to currency fluctuations might well reflect the new reality of global production linkages common among today’s international carmakers. Indeed, exports of vehicles from the U.S. include production by many carmakers of different nationalities (unfortunately data on exports at that level of detail are not available). For example, both BMW and Mercedes now operate an assembly facility in the United States. Some of their models are exclusively produced in the U.S. from where they are shipped around the world. BMW recently announced a further expansion of its South Carolina plant, designed to increase its capacity by 50% by 2012. Both Honda and Toyota produce vehicles in North America. Yet the two companies’ production operations are linked not only within North America but also within their respective global operations. And so, rather than reduce production of certain models because of weakening U.S. demand, Honda recently increased exports of U.S.-produced models to Russia. Similarly, Toyota exports its Avalon sedan from the U.S. to the Middle East.

Volkswagen (VW), the largest German carmaker, decided in mid-July to locate a new assembly plant in Chattanooga, Tennessee, returning as a producer to this country after making cars in Westmoreland, Pennsylvania, over the period 1978–1988. Part of the company’s rationale is to increase the proportion of vehicles as well as parts produced in the U.S. dollar region so as to provide a natural hedge for its European base. Once the new factory is in operation, VW plans on exporting more than 125,000 North American-produced vehicles to Europe.

Finally, among the Detroit Three, Chrysler LLC is the most concentrated in North America, and it has been growing its exports overseas. Last year the company exported around 10% of its North American production to countries other than Canada and Mexico.

And so the recent increase in U.S. exports of light vehicles most likely reflects changes to the production system of international carmakers as well as changes in the value of the U.S. dollar. Because of their globally linked production operations many carmakers within North America can now readily shift production to serve overseas markets as demand conditions warrant. That aspect of the global auto industry could act as a buffer to a slowdown in a market like the U.S., which is home to production operations of many international carmakers.

This blog has been reposted as of July 29, 2008, reflecting domestic rather than total exports.

As water levels recede, the region is beginning to take stock of impact from some its worst flooding since 1993. The geographic footprint of this year’s flooding (depicted below) is less extensive than the nine states and 504 counties affected 15 years ago. And as always, an assessment of the short- and long-term impact of this natural disaster on the national and regional economy will be difficult. In this blog, I will look at the effect of natural disasters on economies and contrast current flood conditions with those the region faced in 1993.

Click to enlarge.

How to think about the losses to the U.S. economy

From a conceptual viewpoint of our economy, natural disasters impact our economic well-being in two basic ways. First, they destroy what we have produced in the past—our “capital stock”—including lives, homes, commercial buildings, public infrastructure and property. Second, they often interrupt normal commercial activity and production. Transportation and deliveries do not take place, people cannot get to work and work places become dysfunctional until normalcy is restored.

In a December 1993 Chicago Fedletter, Bill Testa, Gary Benjamin and I wrote, “Perhaps the most meaningful definition of economic loss due to a disaster is the value of output of goods foregone—that is, the total net output that would have been produced had it not been for the disaster. Foregone output results for two reasons. First, natural disasters destroy productive capital stock such as roads, bridges and factories, thereby reducing output until such time as the capital stock is restored. Second, natural disasters can interrupt day-to-day business activity.”

As that article points out, the impact of the natural disaster tends to have a somewhat unusual affect on the national income accounts—the official way in which we measure the nation’s economic output and income from quarter to quarter. Following the 1993 floods, estimates for the third quarter reduced personal income by $9 billion and forecasted uninsured losses to be $2 billion. Losses to proprietors’ incomes were estimated at another $1 billion.

Remarkably, such initial losses soon appear to translate into economic gains as business and households rebuild. The rise in construction activity and the resumption of business activity often boost gross domestic product (GDP) estimates for future quarters, as households and businesses attempt to rebuild their physical capital and, in the case of businesses, to fill order backlogs. For example, following Hurricane Andrew, annualized GDP growth hit 5.7% in the fourth quarter of 1992, spurred by rebuilding activities.

However, such rebuilding does not reflect an actual economic gain in the broad long-term perspective. In most cases the rebuilding merely replaces lost capital stock—meaning that, in the long term, the nation’s product will not exceed what would have been produced without the disaster. While the immediate burst of economic activity is quite evident, the losses from the foregone output of interrupted and diminished business activity may go largely undetected because the diminished growth takes place in small amounts spread over many years.

Regional economic losses

The ultimate extent of the damage to the region’s economy will in large part depend on who pays for the rebuilding. If the losses are in large part covered by the national government and insurance companies, and if reimbursement is prompt, the region can conceptually restore output and even increase its levels of economic growth. However, if the 1993 flood experience is a guide, it is more likely that the region will absorb a significant share of the disaster-related cost. Because flood insurance was not extensively used, it was estimated that 15% to 25% of the flood costs were borne by state and local governments, not to mention the costs to uninsured homeowners who were forced to rebuild using their own resources. In the most recent floods, it was estimated that only about 1% of Iowans owned flood insurance. In hard hit Cedar Rapids, only 777 of the 4,000 homes damaged or destroyed by flooding were covered. Despite efforts after the 1993 floods to expand coverage, the cost of the policy and the limits of coverage still deter homeowners from purchasing polices. It is estimated that the average cost of a policy in Iowa is $500 per year with coverage only including direct flood damage and not related damage such as water that enters the house through a backed up basement drain. Even if property owners choose to be fully insured, insurance must be paid for. Thus, residents of these regions do bear at least some of the costs in choosing to live and work in disaster prone areas. Currently $2.7 billion in federal flood relief has been approved to aid 2008 flood victims. This does not include the value of low-interest loans and small business assistance as well as the value of crop insurance and private insurance.

Specific categories of losses--Agriculture

In both floods, the greatest concern focused on flooded crop land. In the 1993 floods, nine million acres were submerged by the flood. The lost acreage had been expected to produce 6% of the region’s harvest that year. The estimated crop losses were $7 billion. The states with the largest percentage loss were Missouri 12%, Minnesota 11%, South Dakota 8% and Iowa 7%. In this year’s flooding, damage is heaviest in Iowa where 2 million to 3 million acres of corn and 2 million acres of soybeans were flooded. The American Farm Bureau estimates crop losses at $8 billion for the region, with $4 billion of the total in Iowa. Other states with significant estimated losses are Illinois ($1.3 billion), Missouri ($900 million), Indiana ($500 million) and Nebraska ($500 million). The Bureau points out that it is not only the flooding that will impact crops but also the excessive rainfall that occurred this year.

A June 30 estimate by the USDA projected this year’s corn harvest to be down from 86.5 million acres to 78.9 million, or 8.7 percent. However, the impact on prices may be softened if a robust corn harvest occurs, since supplies should be sufficient to meet demand for food, feed and ethanol. Following the USDA report, corn futures fell from $7.55/bushel to $7.25/bushel, significantly off the $8/bushel price recorded on the Chicago Board of Trade in the immediate wake of the flooding. Still, this price is significantly elevated over the early June $6/bushel price.

One big difference between this year’s floods and that of 1993 was the preexisting stocks and prices of corn and soybeans. In 1992, a bumper crop had been harvested. For example, the stock-to-use ratio for corn hit 25% in 1992 and even in the flood year of 1993 ended at 11%. While prices rose, the increase was a modest hike from $2/bushel to $2.50/bushel. Today the corn stock-to-use ratio is only 6%; prices spiked accordingly to $8/bushel immediately after the flood before retreating to the current price. This tightness reflects the increasing demand for corn both for export and for ethanol. Given this, even if the number of acres lost is smaller than in 1993, the impact on prices will need to be closely monitored.

Spillover issues into other agriculture markets also need to be considered, as livestock feed prices are affected. The condition of the fields for next year’s planting will need to be assessed as well.

Structures

Given the smaller geographic footprint, the potential cost of rebuilding and the infrastructure loss is considerably less in this year’s flooding. While Cedar Rapids and parts of Iowa City were severally impacted, much of the flooding was contained within sparsely populated areas. In 1993, an estimated 45,000 to 55,000 private homes were destroyed, and between 35,000 and 45,000 commercial structures were damaged. Similar to today, most of the homes did not carry flood insurance, making uninsured losses the most significant issue. Estimated property and nonagricultural losses totaled $5 billion before insurance.

Another difference with the 1993 floods was the damage to infrastructure. In 1993, 1,000 miles of road were closed, and 500 miles of railroad track were underwater. Nine out of 25 non-railroad bridges were damaged and closed. This time, some highways were closed for several days due to flooding but damage to bridges, locks and other infrastructure was limited. The exception of course is in cities such as Cedar Rapids where infrastructure losses in the downtown are extensive. Cedar Rapids had 1,300 city blocks underwater, forcing 24,000 residents to evacuate. Preliminary damage estimates have been placed at $736 million or roughly $6,095 per capita. This must also be placed in the context of disruption to Iowa’s second largest city of over 120,000 people with a 2005 gross metropolitan product of $11.2 billion.

Transportation disruptions

One of the more immediate problems that flooding causes is transportation disruptions. The 1993 floods were so extensive that barge traffic on the Mississippi was halted for 2 months. In contrast, barge traffic is expected to be affected for 3 to 4 weeks this time. By July 5, the entire Mississippi was reopened to navigation. Railway disruptions were also more severe in 1993. The destruction of rail bridges added four days to rail shipping times for several months while this time rail disruption was minimal for almost all major freight lines. The effected lines caused temporary delays of 1 to 2 days for most shipments.

What happens next?

For towns that were most directly affected, the question is, what does the path to recovery look like? Unlike individual farms and factories, cities’ and towns’ economies are composed of complex interrelationships that have developed over many years. A natural disaster can upset, disrupt and even destroy those relationships so that restoration is often impossible and sometimes undesirable. And so, the form of rebuilding may require careful consideration and evaluation.

Following the 1993 event, many communities and individuals simply choose not to rebuild. Other communities used natural disasters to redefine themselves. An interesting example of a town rebuilding after a flood was Grand Forks, North Dakota. The Minneapolis Fed chronicled the rebuilding of Grand Forks in a September 2006 Fedgazette article. Grand Forks was the victim of flooding in 1997. In April of that year, 80% of the town was submerged. By 2006, the area was largely restored with the region’s economy growing at a faster pace than before the flood. This was due largely to the influx of $600 million in federal disaster aid (approximately $10,000 per resident).

After much painful disruption, lengthy deliberation and hard planning, the flood eventually spurred a new vision for the area. Roughly 1,200 homes in the 100-year flood plain were bought out by the Federal Emergency Management Agency as part of a flood protection plan. The population rebound remained slow until the Army Corps of Engineers finalized a flood protection plan in 2000. Once this occurred, a building boom was unleashed. The city supported this by providing $10,000 forgivable loans for people staying at the same address for a specific period of time. The new housing was more expensive than what it replaced, with the new larger homes carrying average price tags of $138,000 versus the $85,000 homes that had been destroyed.

For business, the greatest disruption was for restaurants, bars, hotels and any business where discretionary spending is important. Many of these businesses had to lay off workers. Other businesses such as banks, health care and manufacturing suffered lost sales but did not suffer drastic employment declines. In fact given the gains in construction jobs, employment in Grand Forks rebounded to its pre-flood level in five months. To some observers, the newly rebuilt Grand Forks with its improved infrastructure and new capital stock is better positioned for growth than before the flood, but this is only true because of significant government subsidies and 10 years of hard work. And of course, it is not true for every household and business impacted by the flood, as many chose to leave Grand Forks.

Conclusions

The 2008 flood may seem to be milder in its overall economic impact on the larger region and the nation, but it is just as devastating for those who have suffered it as it was for those in previous floodings. The ultimate costs and impacts can only be known over time as damages become known, as the extent of relief is determined and as households, businesses and towns decide how to respond to the disruption. Most though not all of the agricultural costs and recovery will be known by the end of the growing/harvesting season. In contrast, the recovery and rebuilding process for towns, businesses and households will be protracted and laborious.

Click to enlarge.

Michigan’s economy currently suffers from unfortunate industry composition, with an added dose of structural shocks to several of its prominent lines of business. In particular, the automotive, tourism, and office furniture sectors are highly sensitive to national swings in economic activity. As the U.S. economy slows, such industries tend to decline even more. Moreover, in the case of automotive and tourism, structural changes are tending to further dampen economic production and hiring in Michigan.

Michigan’s economy remains far and away the nation’s most concentrated in motor vehicle manufacturing. Its overall employment concentration lies 8.5 times the national average in combined automotive parts and assembly, with many attendant jobs in manufacturing, distribution, and professional service companies that are customers or vendors to automotive producers.

While U.S. automotive sales remained robust until recently, the former Big Three automakers (now more appropriately called the Detroit Three) and their suppliers have been steadily losing market share to imports and to foreign nameplate producers located elsewhere in the U.S. As of May 2008, market share of the Detroit Three automakers had fallen from 67.8% in 2000 to 47.2%. Prominent parts supply companies, including Delphi, Dana, Tower, and Collins & Aikman, have folded, merged, or are currently trying to emerge from bankruptcy.

Click to enlarge.

With the recent economic slowdown, automotive sales are resuming their cyclical pattern of retrenchment. To some degree, the historical behavior of sales declines was allayed in the aftermath of September 11, 2001, when automakers offered generous sales and financing incentives to prospective buyers. However, today’s slowing economy appears to be leading consumers to avoid the purchase of new autos. As discussed recently at our annual Automotive Outlook Symposium, rising gasoline prices are curbing driving behavior while draining household income.

Click to enlarge.

The recent run-up in gasoline prices has magnified loss of market share and erosion of profitability of the Detroit Three automakers and their suppliers. Over the past year, the Detroit 3 share of domestic sales has fallen by 7.1 percentage points. To some degree, this repeats the pattern of the 1970s when U.S. consumers turned to (imported) foreign-domiciled automakers who offered vehicles with greater fuel efficiency. Domestic automakers are more reliant on trucks than on cars, and they tend to lag foreign manufacturers on fuel efficiency.

Not only the automotive sector has been impacted by rising energy prices. Michigan’s tourism, recreation, and hospitality industry has taken on added importance in the wake of the state’s waning automotive industry presence. Many parts of western and northern Michigan feature attractive scenic and semi-rural locales for retirement, recreational living, and seasonal tourism. In addition to its many inland lakes, the state is endowed with 3,126 miles of Great Lakes shoreline, which is attractive for boating, fishing, and other recreational activities like hiking, cycling, and golf. In particular, the state registers nearly as many boats as Florida or California. Such activities in Michigan are especially related to vacation and seasonal homes. As of the last Census, 5.6 percent of homes in Michigan were of this variety versus a national average of 3.1 percent.

The map below shows recreational counties as designated by demographers Calvin Beale and Kenneth Johnson. The northern tier counties of Michigan and Wisconsin have long been recreational destinations, especially for Michiganders and residents of the greater Midwest region.

Recreational spending is highly discretionary on the part of consumers. As household income falls, recreational spending can be easily curtailed by households in an effort to maintain spending on necessities.

Recent declines in Michigan recreational spending are reflected in data collected by the State of Michigan on sales tax collections imposed on overnight lodging. These accord with declining lodging occupancy rates collected by the industry. Both are down so far in 2008 on a year over year basis. A broader index of Michigan’s tourism activity is displaying a modest uptick for the first quarter of 2008 versus one year ago. However, with rising gasoline prices, the index (and activity) is expected to trend lower in coming months.

Two additional factors may be restraining recreation sector growth in Michigan. Michigan’s recreational counties are characterized by ownership of second homes. The run-up in housing prices and the subsequent rash of foreclosures and price declines have been especially severe in recreational/seasonal home locales. Seasonal home residents who have experienced asset price losses on their second homes may be especially aggressive in re-building their household balance sheets by restraining current spending in the second-home locales.

The second, more obvious, factor affecting recreation this year is rising gasoline prices which raise both travel costs to vacation locales and, in Michigan's case, the cost of boating. However, some domestic vacation locales may benefit from a backwash effect as households choose nearby attractions rather than long distance adventures. Nonetheless, in most instances, the overall effect tends to be a dampening. For these reasons, tourism industry analysts in Michigan are forecasting declines in tourism activity for 2008.

In addition to automotive and recreation sectors, Michigan has a strong presence in the furniture sector. Indeed, Western Michigan hosts the nation’s largest concentration of makers of office furniture. This industry took shape in the late nineteenth century during rapid industrial growth, which was accompanied by rapid growth in office employment. Taking advantage of the region’s abundant hardwoods and skilled immigrant craftsmen, most furniture companies in the area had developed as manufacturers of high-end traditional style home furnishings. However, the labor-intensive wood furniture industry declined in Grand Rapids and other northern centers by the mid-1900s due to competition from Southern producers. In response, the Grand Rapids industry shifted its focus from household to office furniture, led by companies that would become industry giants: Steelcase, Haworth, and Herman Miller.

The U.S. Census reports that the state is the nation’s leading producer of office furniture and fixtures, with 17,000 direct employees in 2005. Broadly defined, the state’s industry share accounts for 24% of the nation’s shipments. (Michigan’s share is larger according to the way that the industry trade association defines the industry).

Michigan’s office furniture companies have been affected by competition from China and other low-cost locales. Despite competitive pressures, the companies have successfully responded in two ways. To some extent, producers have moved or offshored production of select product lines to low-cost locales while maintaining high value added and custom design services domestically. More importantly, these companies are characterized by great innovation in product and processes. They have succeeded and grown by offering custom and advanced products and services.

However, office furniture sales and production have been highly cyclical. The industry experienced sagging sales in the late 1980s and early 1990s when U.S. businesses downsized middle management positions and as the U.S. economy sagged. So too, the “technology bust” years that began the current decade saw a falloff in demand for office systems and furniture, especially in the IT sector.

Click to enlarge.

So far in the current environment, industry production has been holding up well. However, if industry observers are correct, office furniture may be “one more shoe about to drop” in Michigan. An opinion poll of office furniture executives has been flashing negative for the near term outlook, and the industry association has recently lowered its forecast of 2008 production.

If such expectations develop, this would further dampen economic activity and the labor market in Michigan. Cyclicality of certain businesses can be planned for and absorbed by states such as Michigan and its neighbors. However, cyclical episodes in the economy can be exceptionally severe when shocks such as rising energy prices are in play and when longer term structural changes are taking place, as they are in Michigan’s automotive sector.

Thanks to Graham McKee and Vanessa Haleco-Meyer for assistance.

Additional debate has broken out because of dramatic declines in specific industries, such as the automotive industry, which is concentrated in Michigan and scattered throughout many parts of the region. In the face of such stark declines, the question arises as to whether the region must look beyond manufacturing and toward new industries. As the U.S. economy evolves toward advanced services, should the Midwest be following suit at an accelerated pace? And if so, how should the region go about it? For example, should the region’s policy focus on improving the quality of life features to attract highly skilled workers for business services and related industries? Or should the region cultivate new technology and entrepreneurial behavior in an effort to grow new industries?

Arguably, policymakers in the region should pursue all such avenues toward redevelopment and reinvention that are within the bounds of reason and with careful cost–benefit consideration. But there are also reasons to believe that traditional manufacturing can continue to play an important role in the Midwest economy. Significant opportunities remain for manufacturing enterprises that are both extant and emerging here.

In disparaging manufacturing's prospects, an analogy to production agriculture can sometimes be misleading. In terms of long term productivity gains, some observers are only partly correct in drawing close parallels between the U.S. production agriculture sector and manufacturing. Rapid productivity growth in each sector has pushed down prices of products and lessened attendant labor demands. The world over, rising national income per capita has gone hand in hand with declining shares of a nation’s employment in agriculture, followed by declines in manufacturing. Eventually, such trends lead to a wealthy economy steeped in services. In the typical experience for a developed nation, the share of national employment in production agriculture drops because of startling labor saving productivity on the farm, coupled with unresponsive household demand for raw food products as incomes climb. In the U.S., for example, as our standard of living has progressed, agricultural labor as a share of the work force has declined from 41% around year 1900 to only 2% today.

Some of these same processes are also at work in the manufacturing sector. And so, some analysts reason that manufacturing jobs will similarly disappear; that is, eventually, only a slim manufacturing presence will remain across the nation as whole, leaving us an economically diminished Midwest region.

However, in contrast to agriculture, manufacturing continues to give rise to a significant share of income among the most developed countries in the world. This occurs in spite of the trends toward generating more services production in developed countries and offshoring manufacturing to low-cost countries. Manufacturing’s continuing importance to developed countries’ economies can be seen clearly in an exhibit within the Federal Reserve Bank of Dallas’ 2007 annual report. The report’s exhibit 8 observes nations both by the percentage of their workforce engaged in manufacturing and agriculture and by their average per capita income. Manufacturing resembles agriculture to only a modest extent with respect to these measures. As a nation’s income rises, the share of the workforce engaged in manufacturing does tend to decline; the same applies to agriculture. However, whereas the share of employment in agriculture drops off precipitously as countries grow wealthier, the share of employment in manufacturing declines only modestly and gradually. For even the wealthiest nations, such as the U.S., manufacturing remains a large and vibrant sector.

Manufacturing’s continued strength has much to do with the fact that manufacturing companies need to be knowledge-intensive and highly creative to develop new products. Strong productivity tends to reduce the amount of low-skilled labor required for manufactured goods, and intense global competition for such labor drives down the prices of manufactured goods. That said, as a counterweight manufacturing companies continue to come up with new products. These include consumer products, such as improved electronic appliances, pharmaceuticals, and packaged/processed foods, as well as tools for businesses, such as more advanced computing equipment, mining/construction machinery, and telecommunications.

Some inkling of manufacturing’s high level of knowledge intensity can be seen from figures reported annually on research and development (R&D) of manufacturing companies. Manufacturing companies account for $123 billion of the nation’s $278 billion spent on R&D in year 2003—a 45% national share (see blue bars in chart below). This compares to a 13% share of manufacturing sector output in overall gross domestic product, or GDP (red bars below).


Click to enlarge.

Midwestern manufacturing companies have a strong orientation toward knowledge-intensive manufacturing. The region’s manufacturing companies account for 66% of the region’s R&D versus 19% of the region’s total output.

That the manufacturing R&D share of the Midwest economy exceeds that of the nation can be explained by the larger role of manufacturing companies in our region. Moreover, it may surprise some to learn that Midwest manufacturing is no less “high tech” than the national average as well. The sector’s “R&D intensity” also contributes to the dominant role of manufacturing R&D in the region. In both the region and in the nation, R&D spending makes up about nine cents of every dollar of inputs spent by manufacturing companies (per chart below).



Click to enlarge.

The bulk of the Midwest’s industrial R&D takes place within the region’s hallmark sectors—automotive, food products, electrical equipment, machinery, and chemicals. By our estimates, these sectors make up 42% of the region’s $42 billion of industrial R&D reported for 2003. The chart below characterizes the concentration of R&D by industry sector in the Midwest. Highly concentrated R&D expenditures are denoted by deeper shades. These concentrations are constructed for a state, for example, as an index of R&D taking place in a particular sector relative to the state’s national share of total output. For instance, the state of Michigan scores a deep shade in “Motor vehicles, trailers & parts” because its share of the nation’s R&D in this sector far exceeds the state’s share of overall GDP. Indeed, company activity in motor vehicle R&D in Michigan registered $10.7billion—a national share representing a concentration over 17 times the state’s share of overall economic output in 2003.


Click to enlarge.

Other Midwest states can also be seen to be domiciles of R&D in particular industries. The final column above displays R&D concentrations (as an index number) for the entire seven-state region. In addition to intensive R&D activity in the region’s hallmark industries, the region also scores highly in pharmaceuticals, computer equipment and its design, and aerospace.

And so, if a high degree of ongoing R&D intensity is any indication, manufacturing will continue to play a strong role in U.S. production. Despite its current challenges in automotive production, the Midwest is no exception in this regard. To be sure, the region’s overall population and work force growth have lagged those of the nation. In some part, this reflects the region’s greater concentration in manufacturing—a sector that has experienced outsized impacts from labor-saving productivity and, to some degree, offshoring of activity. Nonetheless, there remains a sizable future to be built by the region’s manufacturing companies.

One public policy effort to further the strength of the manufacturing sector in the region has been initiated as the Great Lakes Manufacturing Council. This coalition will meet this summer “to discuss the image of the Great Lakes region, innovation in manufacturing, the work force and skills needed for manufacturing today and tomorrow as well as the borders and logistics requirements to effectively move goods and services in today’s global economy.” I hope to see many gather at the meeting to discuss (and act) on these issues further.

Note: Thanks for assistance from Graham McKee.

There is a greater concentration in manufacturing among the five states of the Seventh Federal Reserve District than in the nation. For example, as measured by the share of payroll jobs in manufacturing, Indiana ranked first among the 50 states in 2007; Wisconsin, second; Iowa, fourth; Michigan, seventh; and Illinois, 19th. For this reason, we at the Federal Reserve Bank of Chicago tend to closely watch the manufacturing sector. In fact, our watchfulness often becomes close scrutiny during times like the present when the U.S. economy shows signs of slowing. (Manufacturing activity has tended to be highly sensitive to general business downturns.)

The Chicago Fed Midwest Manufacturing Index (CFMMI) is a public statistical release that the Federal Reserve Bank of Chicago has been producing since 1987. This monthly release tracks manufacturing output for the Seventh District states (Illinois, Indiana, Michigan, Iowa, and Wisconsin) and compares it to the manufacturing component of the Industrial Production Index (IPMFG) produced by the Federal Reserve Board of Governors. The chart below, taken directly from the March release of the CFMMI, shows historical data comparing the CFMMI to the IPMFG. Over the decade, Midwest output growth has lagged the nation. During the current slowdown in national economic activity, both the IPMFG and the CFMMI have slowed and declined at a very mild rate in comparison with past episodes.

Click to enlarge.

Industry concentration in specific industrial sectors influences economic performance among District states. In particular, transportation equipment and machinery are bellwethers of state economic performance in the District.

Since the beginning of this decade, the automotive-intensive states of Indiana and especially Michigan have experienced a softening of their labor markets relative to the national average.

Meanwhile, by the same measure, the machinery-intensive states of Illinois and Iowa have outperformed the nation. The remaining state, Wisconsin, deviates from this pattern, being a machinery-intensive state with an unemployment rate that has deteriorated relative to the national average.

Click to enlarge.

The charts below compare these states’ concentration in both machinery and transportation equipment, respectively. Manufacturing activity in these industries is compiled by the U.S. Census Bureau’s Annual Survey of Manufactures (ASM). Specifically, the Census data measure “value added” by manufacturing establishments within each state. Value added roughly corresponds to the value of shipments of manufactured establishments, net of intermediate inputs to production, such as fuel, materials, parts, and components that are purchased from other establishments. In this sense, value added is manufacturing output.

Click to enlarge.


Click to enlarge.

It takes much time and effort for the U.S. Census Bureau to compile these data, so that detailed information on output by specific industry sector and location are issued with a one or two year lag. The data above, for example, refer to 2005 and 2006.

To keep more current than the Census statistics allow, our CFMMI constructs sector-specific estimates of manufacturing output for the overall Seventh District. These estimates are primarily based on data reported on payroll hours worked in manufacturing establishments across the District, and these data are usually available with only one month’s lag. When complete data on value added are issued by the U.S. Census Bureau, we adjust or benchmark our CFMMI data series to correspond to that data.

There are four major sectors of the CFMMI: auto, steel, machinery, and resource. The CFMMI is made up of 15 North American Industry Classification System (NAICS) codes of hours worked data. The breakdown of the NAICS codes is given under each graph (such as the one below) on the press release every month. The auto sector components are plastics & rubber products (326) and transportation equipment (336). Primary metal (331) and fabricated metal products (332) compose the steel sector. The machinery sector is made up of machinery (333), computer & electronic product (334), and electrical equipment, appliance, & components (335). There are five categories for the resource sector: food manufacturing (311), wood product (321), paper (322), chemical (325), and nonmetallic mineral product (327). The overall CFMMI is composed of the four sector components as well as these industries: printing & related support activities (323), furniture & related product (337), and miscellaneous manufacturing (339).

As seen by the two sector charts below, taken directly from the March CFMMI release, the District’s output growth paths in the machinery and auto sectors have diverged. While the machinery sector of the CFMMI is slowly outpacing the overall CFMMI, the auto sector of the CFMMI continues to fall below the overall CFMMI. Such developments can help us understand differences in economic performance around the Seventh District.

Click to enlarge.


Click to enlarge.

To see more information about the CFMMI, please check the Federal Reserve Bank of Chicago’s website. Additionally, some of the other Federal Reserve Banks also have manufacturing indexes/surveys. Please see below for some of those links:

Federal Reserve Bank of Philadelphia Business Outlook Survey

Federal Reserve Bank of New York Empire State Manufacturing Survey

Federal Reserve Bank of Richmond Manufacturing Conditions Survey

Federal Reserve Bank of Kansas City Survey of Tenth District Manufactures

Federal Reserve Bank of Dallas Texas Manufacturing Outlook Survey

Click to enlarge.

Click to enlarge.

Much of recent growth in inbound FDI has resulted from accelerated globalization and rapid world economic growth. Due to a greater ease of communication and lower cost of personal travel and goods shipment, global breadth of enterprises has expanded. General Electric employs 316,000 worldwide, 155,000 outside of the U.S. General Motors employs 335,000 worldwide, 193,000 abroad.

In addition, although the U.S. has maintained its economic prominence in the world economy, the U.S. economy now comprises a smaller share of global production (27% as of 2006). And so, without any countervailing forces, this simple arithmetic would suggest more inbound FDI as a share of the U.S. economy. By one estimate, the U.S. share of global outbound FDI outflows have in fact declined from its 1970 value of 54% of global FDI to 18% in 2006.

While global economic growth is the largest generator of inbound FDI to the U.S., the exchange value of the U.S. dollar versus other currencies can also be influential. The value of the dollar has fallen by 25% since 2002, measured against a basket of currencies weighted by our trade with other countries. For this reason, investment in productive capacity on U.S. soil may look increasingly attractive to foreign-domiciled companies. For one, for those foreign companies that hold their earnings and assets in foreign currencies, the purchase price of physical capital in the U.S. such as real estate, intellectual property, and factories will be cheaper. For companies that now sell into the U.S. market from production facilities abroad, the shifting of production to the U.S. may be advantageous in generating production costs in the same currency as their sales.

Further, for those companies that use their U.S. facilities as a platform from which to export to markets outside of the U.S., earnings on sales will likely be denominated in foreign currency rather than in U.S. dollars. Recent developments in FDI in the U.S. automotive sector may be reflective of these considerations. Several European carmakers are currently considering setting up production in North America, among them Volkswagen and Audi. And exports of U.S.-produced light vehicles have been rising, according to Chicago Fed economist Thomas Klier. From 2002 to 2007, the share of U.S. production that is exported to non-NAFTA countries alone has risen from 3.0% to 11.6%.

In recent years, the state of Indiana has done well by FDI in automotive and other (mostly manufacturing) investments from abroad. The Business Research Center at Indiana University (BRC) has recently issued an extensive report that reviews the global environment for FDI with an emphasis on Indiana and surrounding Midwest states. According to U.S. government data as of 2005, Indiana’s economy ranks 8th in the nation and first in the region as measured by the ratio of FDI to state economic output. (Michigan also exceeds the U.S. average.) As measured by jobs, the United Kingdom and Japan were virtually tied as the number one source of FDI into Indiana, each accounting for 32,000 jobs.

The U.S. government data on FDI for states does not necessarily reflect new investment or added jobs. Rather, most FDI transactions are mergers and acquisitions. For this reason, and because government data are not very timely, the BRC also gathered information from a private vendor on announcements of FDI expansions and new facilities. Since these are announcements rather than completed transactions, we cannot be certain these investments will actually take place. But according to BRC estimates, Indiana will gain nearly 5,000 jobs from 2007 announcements, mostly in the automotive industry. The implication is that Indiana will widen its lead among Midwestern states in the FDI category. An appendix to the BRC report proudly maps the specific FDI projects in which Indiana’s state development agency has completed or participated.

Competing state and local development agencies throughout the Midwest will surely take note.

What might such policy actions be? The report lays out a blueprint for Bi-National Great Lakes economic leadership:

● By 2010, Develop a Bi-National Innovation Fund and Strategy
● By 2010, Redevelop North America’s Freshwater Coast
● By 2015, Define and Implement the “U.S.–Canada Border of the Future”
● By 2025, Realize BiNational Great Lakes Carbon Goals and Renewable Energy Standards
● By 2030, Create a Common Market for Commerce and Human Capital

As a long-time researcher, observer, and policy-discussion participant in this arena, I am encouraged to find these ideas being resurrected. As long ago as the 1980s, during the very troubled economic times in the Midwest, many of these same observations and recommendations were advanced.

Two developments dampened forward momentum. For one, the region’s economy enjoyed a strong rebound during the 1990s as surging U.S. economic growth shook the region from its torpor. The region’s flagship companies learned much from their global competitors coming out of the 1980s. While the rebound was welcome and enjoyable, some of the driving force behind fundamental policy innovation in regional development policy was lost through complacency.

The second reason: No region-wide dialogue was created on a sustained basis, and no organizations took on a leadership role in driving forward such a regionwide agenda. The sole exception might be efforts to restore and clean up the region’s fresh waters in the Great Lakes basin, which have progressed thanks to regional organizations such as the Council of Great Lakes Governors, The Great Lakes Commission, and a strong supporting cast.

This time around, inspired by new work, such as the Longworth book and Austin’s study, I believe that we will (very soon) see at least some exploratory efforts towards an enduring pan-regional policy network.

It has become almost hackneyed to proclaim that we live in a knowledge economy driven by innovation. The mantra of current economic development gurus is that the race goes to the smartest and the swiftest. Yet, despite this popular consensus that innovation may be the key factor in determining future growth in the economy, we actually know very little about how to measure innovation and what policies might influence innovation.

To begin with, we need a definition. Most definitions of innovation begin with “big bang” product innovation that alters the course of economies and enhances the quality of life. The invention of the light bulb and the airplane, as well as biotech breakthroughs, are just a few examples. But large gains are also made through process innovations that are often more subtle. The application of information technology to banking and financial firms and the advent of inventory and logistics management in retail trade come to mind. These process innovations change the efficiency with which inputs are used while vastly increasing the scale of output. This leads to goods and services that are faster, cheaper, and better. In fact, when the Chicago Fed studied the turnaround in the Midwest economy in the mid-1990s, we concluded that part of the region’s success was based on improving the efficiency of the existing economic base. Innovation in traditional industries explained much of the turnaround, rather than the creation of wholly new industries or products.

In January 2008, the Advisory Committee on Measuring Innovation in the 21st Century Economy issued a thoughtful report on how we might define and measure innovation. The report postulates that, while innovation is critical to the economy, “the nexus between innovation and growth is one of the least understood areas of economic life.” To bring clarity, the committee defined innovation as “the design, invention, development, and/or implementation of new or altered products, services, processes, systems, organizational structures, or business models for the purpose of creating new value for customers in a way that improves the financial returns to the firm.” The report then set about suggesting proxies for measuring innovation.

The committee rejected the notion of coming up with a single, all encompassing measure. Given that the economy and individual firms do not innovate the same way at the same time, the committee felt a single measure would lead to policy distortions. For example, it might be inappropriate to legislate public policy supporting an industry or firm that is going through a rapid period of innovation over an industry whose innovation breakthrough might be several years away. However, the report suggests a clear starting point by emphasizing that we need a better measurement of total factor productivity (TFP)—the change in productivity left over after accounting for the growth in labor and capital. Total factor productivity does provide a measure that can be augmented and refined by several policies to expand data collection on firm investment in key factors such as research and development, technology, and human capital.

So what policies did the Committee specifically suggest? Here is just a partial list:
• Develop annual, industry-level measures of total factor productivity by restructuring the National Income and Product Accounts of the United States (NIPAs);
• Create a supplemental innovation account for the NIPAs in order to expand the categories of innovation inputs and allow those inputs to be tracked as they flow between industries;
• Improve service sector data and increase survey coverage to provide the data needed to improve estimates from the integrated gross domestic product/productivity accounts and supplemental innovation account;
• Improve measurement of intangibles, particularly intellectual property; and
• Better leverage existing data and increase access to enhance research on innovation.

In addition the committee recommended the business community:
• Institute firm-level measurements of innovation to test the correlation on firm performance; and
• Develop and implement best practice in innovation management and accounting.

Another interesting local approach is a new innovation index developed by the University of Michigan at Dearborn’s Center for Innovation Research. This index tracks six subindexes that reflect the state of innovation in Michigan and will be reported on a quarterly basis. The six measures are:
• Trademark applications,
• Innovation workers (measured as a percentage of the labor force),
• Small Business Administration (SBA) loans,
• Venture capital,
• Incorporations, and
• Gross job creation.

The index is benchmarked to 100 for the first quarter of 2007. The most recent reading of the index is 95.8.

These efforts at measuring innovation in the economy continue to be a messy process, but the potential dividends of better understanding and calibrating the role of innovation in economic growth is certainly an important step forward. Hopefully better innovation metrics will help guide policymakers and business leaders to make appropriate investments that will strengthen economic growth.

The Department of Commerce continues the dialogue by hosting a summit in Chicago on May 22 discussing actions to be made to secure America's competitiveness.

Unlike most U.S. states, Michigan’s economy has not enjoyed any net growth during the entire decade. Decline in the state’s automotive industry has kept its economy reeling. In some ways, this experience is reminiscent of conditions from two decades ago. At that time, the domestic automotive industry struggled with energy and gasoline price spikes that had begun during the mid-1970s. Much as today, the automotive fleets of Chrysler, General Motors, and Ford—known then as the Big Three—had been designed on the larger side, which was better suited to a bygone era of cheap gasoline. Accordingly, auto sales by domestic producers were sharply impacted by OPEC (Organization of the Petroleum Exporting Countries) gas price spikes, by a federal gasoline rationing program, and by imports of small, fuel-efficient vehicles from (then mostly Japanese) competitors.

Even so, by the beginning of the 1980s, Detroit was making a comeback with its own small cars; back then, the tail winds from a strong U.S. economy was lifting overall automotive sales. Alas, a second global energy price spike, along with two U.S. recessions during the early 1980s, exerted a horrific effect on Michigan and on the Midwest manufacturing belt. Foreign markets were of little help during this era of a rapidly rising dollar, and the region’s agricultural sector experienced profound declines in prices and land values.

The chart below overlays the payroll job trends of that era with that of the past seven years. Following a peak in Michigan job levels in 1979, jobs declined at a pace of over 2% per year for the next four years before bottoming out at the beginning of 1983. In comparison, the recent payroll job decreases in Michigan have been less dramatic, with a cumulative decline of 5 percent from 2001 to date. Similarly, the average state unemployment for all of Michigan had reached 16 percent by 1983, over double what it is today (see chart below).


Click to enlarge.

Click to enlarge.

However, it should be noted that Michigan’s economic decline in the current decade has gone on much longer than its decline of the early 1980s. By 1983, Michigan’s payroll employment had begun to climb once again as U.S. consumer purchases of autos rose and as excess inventories of autos were sold off. While recent declines have been less precipitous, the cumulative effect has been no less profound. Annual employment in Michigan has not climbed over the past 7 years, and now stands at over 6% below its level at the beginning of 2001.

How did Michigan households adjust to diminished job and income opportunities in Michigan during the 1980s? In part, Michigan workers and their families left the state in search of opportunities in other regions. Households decide to migrate based on more than local conditions. That is, they also base their decisions on labor market conditions in alternative regions of the country. Although the overall U.S. economy was experiencing recessionary conditions during the early 1980s, Midwest labor markets were far and away more affected. For instance, rising energy prices were spurring economic investment (and jobs) in energy-producing regions, such as Texas–Louisiana and in the western coal fields. Meanwhile, the first surge in high-tech computing production was underway in New England and California, and strong economies were emerging in regions where post-1970s defense spending was growing. The chart below illustrates the difference in unemployment rates between Michigan and the overall U.S. at that time. Michigan’s unemployment rate was 5–6 percentage points above the nation’s from 1980–83.


Click to enlarge.

As the chart below suggests, more households had been moving out of Michigan than moving in throughout the 1970s, with a net out-migration exceeding 50,000 per year by 1974–75. However, this number tripled by 1981–82, exceeding 150,000 per year. Economic recovery eventually unfolded in Michigan, but it did not pull along net migration into Michigan until the early 1990s.

Click to enlarge.

Today, labor market conditions in Michigan, while the worst in the U.S., look mild compared with that of the 1970s and 1980s. Still, the pattern of continual payroll job losses since 2001 gives the impression of long-term structural decline rather than a short-term episode. So far, the pace of out-migration from Michigan has reported to be milder as well, averaging -20,000 per year from 2001 to 2006. A contributing factor for restrained out-migration may be the difference in the age demographics of the population between then and now. Historically, those aged 20–39 have been much more likely to pull up stakes and move out of state. Michigan’s population has aged, with only 37% of the adult population of prime (moving) age today versus 48% in 1980.

Still, out-migration from Michigan may yet increase somewhat. Out-migration from the state has been picking up lately as the decade wears on and employment continues to decline. United Van Lines (UVL) has been tracking data on in-movements versus out-movements of its residential moves by state for many years, and these data tend to accord fairly well with government statistical trends on net migration of population. Recent UVL data for 2007 suggest that out-migration of households exceeded in-migration by a 2 to 1 ratio, while the level of net out-migration of moving trucks is approaching the previous trough experienced in 1981.

Many policy leaders and local communities in Michigan are determined not to let the state’s growth fall further into negative territory. There are concerted initiatives to diversify the region’s economy toward technology industries, services, and recreation-tourism. For example, three of Michigan's universities—the University of Michigan, Michigan State, and Wayne State—are teaming up to fashion a research corridor that will further stimulate innovation in the state. The research synergies of the three hope to improve technology transfer, share resources, and attract jobs to the state.

Such efforts may well turn around the state’s fortunes over the long term. But following a long and difficult decade for many of the state’s residents, the road ahead does not look any easier—at least for the immediate future. As the U.S. economy slows during the first half of 2008, domestic automotive sales (and production) are also expected to soften.

It is timely, then, that new information on goods exports for individual metropolitan areas has just been released by the International Trade Administration (ITA), based on U.S. Census Bureau data. Exports figure prominently in regional economies such as ours that are steeped in manufacturing and agricultural production. On a national scale, the ERP describes the many benefits of export activity. In addition to high-paying jobs and incomes, exports spur U.S. producers to innovate to compete with in global markets. So too, as U.S. producers expand to serve global markets, they can often achieve low-cost economies of scale, thereby reducing prices for consumers.

The new data series on metropolitan exports covers goods only. This means the importance of exports to metropolitan economies is understated in the data because exports of services such as medical, tourism, banking/finance, and transportation now account for 28% of U.S. exports. Moreover, metropolitan areas typically specialize in such services, with ongoing shifts toward service concentration now underway.

Despite our lack of data on service exports, a metropolitan area's rank order in goods exports very likely reflects its local service exports as well. In the production process, manufacturing companies purchase many services ranging from finance to management consulting, transportation, design, law, R&D, and advertising. The value of these services become part of the value of the final goods for export, and many of these services are purchased locally. Accordingly, in many instances, a host of value added products from surrounding service companies lies behind a metro area’s goods exports.

Given the Midwest region’s prowess in durable goods manufacturing, it comes as no surprise that metropolitan areas in the Seventh District originate considerable goods exports. The chart below shows export values for several metropolitan areas. The Detroit area leads with a reported $43.3 billion in exports in 2006, comprising 74 percent of Michigan’s exports abroad (see right axis). Detroit’s automotive trade with Canada remains considerable. Currently, the rising value of the Canadian dollar is pressuring production towards the U.S. side of the Michigan–Ontario corridor.

The Chicago area’s total goods exports approached $30 billion in 2006. In addition to traditional heavy manufacturing and food products, Chicago exports medical supplies and equipment and pharmaceuticals.

Click to enlarge.

Click to enlarge.

In order to gauge the relative importance of exports to metropolitan areas, we make use of recent BEA (Bureau of Economic Analysis) estimates of total metropolitan area product. Dividing a metropolitan area’s exports by its gross product yields a rough measure of each region’s income share that is earned by producing goods for export abroad. By this measure, we see in the chart below that Peoria, Illinois, home of construction equipment manufacturer Caterpillar, derives over 50% of its income from producing goods for export. While this is a useful indicator, it does overstate Peoria’s share somewhat because Caterpillar and other Peoria manufacturers assemble final goods using component parts and services from other parts of the Midwest, the nation, and the world. So part of the measured value of Peoria’s exports reflects the embedded value added of goods and services produced elsewhere. For larger regions, such measures tend to be more accurate since the intermediate components are more likely to be produced within the region.

Click to enlarge.

The next chart shows export intensity for all of the Seventh District metro areas. Most lie above the U.S. average in export intensity. Open markets abroad are an important part of the economic vitality of these communities.

Click to enlarge.

Where do District metro areas export? The ITA provides the destination by both country and general region of the world. Canada and Mexico—our NAFTA partners—predominate as export destinations for metro areas (chart below). Europe also remains important, especially Germany, France, and the U.K. In Asia, Japan figures prominently, with China as the fastest growing export destination.


Click to enlarge.

Finally, the ITA data offer a finer breakdown, indicating both the specific industry categories of exported goods and their destination. As one example, the next chart displays export patterns for the Milwaukee metro area. True to its industry structure, the Milwaukee area exports durable goods such as electrical equipment (e.g., medical scanners and electronic controls) and nonelectrical machinery (e.g., small engines and construction equipment). All major regions of the world (and trading blocs) are destinations for Milwaukee exports.

Click to enlarge.

The outlook for Midwest exports remains strong. As the 2008 ERP suggests, foreign income growth is likely the strongest impetus to U.S. export growth. As developing nations raise their standards of living, their appetite for manufactured goods rises sharply, as does their demand for food products.

The 2008 ERP also indicates that U.S. exports are very sensitive to income growth abroad. In part, that is because developing countries are investing heavily at home both to produce goods for export and to serve rising domestic demands. For that reason, they purchase capital goods—those that are needed to expand production capacity such as machinery and equipment. Since capital goods are needed to expand production capacity, a slowing economy ratchets down purchases of capital goods and an accelerating economy ratchets up purchases. The U.S. economy specializes in capital goods, such as those produced in Milwaukee and Peoria.

But what generates the income growth in developing countries that, in turn, propels their demand for U.S. exports of capital goods? In part, trade agreements allow developing countries to generate income (from sales abroad) and thereby raise living standards by lowering tariff and nontariff barriers to export sales abroad.

The ERP reports export sales from the U.S. to regions of the world with which the U.S. has recently signed trade agreements. In almost every instance, subsequent export growth to the trade agreement nations well exceeded overall export growth.

Of course, these agreements also make it easier for foreign nations to sell into U.S. markets. In many instances, such foreign competition displaces firms employing domestic workers. Though the overall process of expanding trade is vital to raising living standards both here and abroad, the related labor market upheaval often gives rise to anti-trade sentiment.

Estimates of import sensitivity by individual metropolitan area are problematic. Imports are counted and tracked at the U.S. border and no further. But in a 2003 article, I constructed some rough estimates of import sensitivity by examining a metro area’s industry mix and then weighting a metro area’s industry mix by the degree to which imports had penetrated U.S. markets. I found that large metropolitan areas were not experiencing growth in trade sensitivity to the same degree as smaller and medium-sized metro areas. However, this may be explained by the growing service orientation of large metro areas. Since many of these services do become embedded in the value of manufactured goods, the trade orientation of large metropolitan areas may be understated by my (goods-based) estimates.

Vanessa Haleco-Meyer contributed to this entry.

Plenty of evidence is emerging that state and local governments are headed into a major fiscal pinch. Tax revenues are decreasing across the board, as everything from corporate profits to employment declines. The big question is how well are the states positioned to weather this storm? Is there anything different in the nature of this economic slowdown that will make circumstances more difficult?

Based on some preliminary evidence, the future looks challenging. The Center on Budget and Policy Priorities released a survey of state budget conditions on February 25, 2008. The survey reported 25 states having budget deficits for fiscal year 2009. Specific estimates of the magnitude of the deficits were available for 21 states. These particular states report an aggregate gap of between $36 billion and $38 billion, representing roughly 8% to 9% of total general fund spending. Of the states in the Seventh Federal Reserve District reporting a gap, Illinois has a $1.8 billion deficit (6.6% of general fund); Iowa, $350 million (6%); and Wisconsin, $652 million (4.8%).

The center’s report notes that one of the more vexing fiscal problems is the current instability of property tax revenues related to the housing downturn and mortgage foreclosures. In the 2001 recession, states were able to push expenditures on to local governments because property tax revenues were relatively stable. In the current housing crisis, it is more likely that local governments will be asking state governments for help.

The report also finds that states are rapidly drawing down rainy day funds. These fund levels peaked at 11.5% of annual state spending in fiscal year 2006 and are estimated to decline to 6.7% of state spending by the end of this fiscal year. It is unlikely that this is sufficient to see the states through even a shallow recession.

A final national development is that at the February meeting of the National Governors Association, the governors requested that the federal government offer a fiscal stimulus package for the states aimed at financing infrastructure investments. It is unlikely that this will go anywhere. In the 2001 recession, the federal government offered a $20 billion aid package to the states. Half of the $20 billion was earmarked for a temporary increase in the share of federal support for Medicaid programs, with the remaining half set aside for general grants based on population.

A closer look at the impact of the housing downturn on state and local revenues

The fallout from the subprime loans and foreclosures has had a negative effect on state and local revenues. The United States Conference of Mayors (and the Council for the New American City) hired the consulting firm Global Insight to estimate the implications of the mortgage crisis. The firm estimates that U.S. gross domestic product (GDP) will be $166 billion lower than otherwise because of the crisis and that 524,000 fewer jobs will be created. The firm further estimates a $1.2 trillion decline in property values in 2008.

The report provides estimates of metropolitan growth rates and changes in tax revenues for selected metros and states. For example, the estimated real gross metropolitan product (GMP) growth rate for metro Chicago in 2008 will be 2.23%. This represents a 0.56% reduction, or $3.9 billion decrease, attributable to the mortgage crisis. Metro Detroit’s real GMP growth rate is estimated at 1.3%. A reduction of 0.97% is attributable to the housing slowdown representing a $3.2 billion decline in GMP.

As for changes in tax revenues, the following table provides the fiscal impact estimates for ten states.