Industrial Cities Initiative Profiled in New Report

By Emily Engel and Jere Boyle

Community Development and Policy Studies at the Chicago Fed recently published profiles of a group of 10 cities that experienced significant manufacturing job loss in recent decades.
The Industrial Cities Initiative (ICI) includes, Aurora and Joliet in Illinois; Fort Wayne and Gary in Indiana; Cedar Rapids and Waterloo in Iowa; Grand Rapids and Pontiac in Michigan; and, Green Bay and Racine in Wisconsin. While each city has been blogged about before (see the “BLOG” tab), a complete set of more detailed profiles are now compiled into one report.

Collectively, the profiles provide insights from local economic development leaders on the cities’ actions in the wake of the job loss that have either helped or hindered redevelopment efforts.
The authors and contributors to the ICI do not pass judgment on individual cities. So, while we understand the temptation to simply link directly to just one city’s profile, we encourage readers to start their exploration of the ICI with the Summary.

The ICI looked at cities’ conditions, trends and experiences and concluded that efforts to improve their economic and social well-being are shaped by:

1) Macroeconomic forces: Regardless of their size or location, these cities are impacted by globalization, immigration, education, job training needs, demographic trends including an aging population, and the benefits and burdens of wealth, wages, and poverty;
2) State and national policies: State and national policies pit one city against another in a zero-sum competition for job- and wealth-generated firms; and
3) The dynamic relationship between the city and the region in which it is located: Regional strengths and weaknesses to a large extent determine the fate of the respective cities.

The ICI homepage provides access to the full ICI report, individual ICI city profiles and related research, and blogs from around the country about cities that share a manufacturing legacy.

2013 Michigan Personal Income

By Martin Lavelle

Income received by state residents remains an important and widely followed measure of economic progress.1/ Personal income is income received from all sources (net of contributions to government social insurance programs, such as Social Security and Medicare).2/ State personal income can be broken down into three categories: 1) net earnings by place of residence (e.g., wages and salaries)3/; 2) dividends, interest, and rent; and 3) transfer payments (e.g., Social Security payments). As chart 1 shows, income received by Michiganders used to mainly come from net earnings, but the other two categories, especially transfer payments, have constituted a larger share of income in recent years, particularly after the Great Recession (which started at the very end of 2007 and concluded in mid-2009)/4. After 2011 (when Michigan’s economic recovery started to accelerate), there has been little change in the composition of Michigan personal income.

Chart 1: Breakdown of Michigan Personal Income
Chart 1 Source: Author’s calculations based on data from www.bea.gov.

Personal income growth in Michigan slowed for a second straight year in 2013: Personal income increased 3.5% in 2012 and 2.5% in 2013 after rising 5.5% in 2011./5 When deflated by the Detroit area Consumer Price Index (CPI), Michigan personal income grew 1.0% in 2013, decelerating from its 1.5% growth rate in the previous year. Michigan’s real disposable personal income growth also slowed in 2013: Real disposable income grew a scant 0.1% last year, compared with 1.1% in 2012./6

Michigan’s economy and its personal income reflected national trends in 2013: Somewhat lower growth in take-home pay for employees last year relative to 2012 and the resolution of the so-called fiscal cliff in January 2013 were largely responsible for the slowdown in personal income growth./7 With the exceptions of construction, finance and real estate, and health care, private nonfarm sectors saw slower growth in work earnings in 2013 than in 2012. When weighted by sector, manufacturing was the nonfarm sector that made the largest contribution (0.52 percentage points) to personal income growth in 2013. The government sector was the nonfarm sector that made the smallest contribution (–0.25 percentage points) to personal income growth last year; this occurred mainly because of changes in personal income growth for workers in state and local governments. In addition, changes to fiscal policies contributed to slower personal income growth in 2013. Specifically, the reinstitution of the federal payroll tax rate of 6.2% for personal contributions to Social Security (from 4.2%), as well as higher capital gains and dividend tax liabilities relative to 2012, helped temper personal income growth in 2013.

With respect to personal income growth, Michigan was in the middle of the pack among Seventh Federal Reserve District states in 2013, as table 1 shows; it was also close to the national value. Since 2010, both personal income growth and disposable personal income growth in Michigan were lower than the respective national values./8 With regard to disposable income, this trend may partly reflect fiscal policy changes that occurred in Michigan. Since 2010, Michigan has revised its tax code in multiple ways, including the application of state income taxes to retiree pensions, which has dampened disposable income growth./9

Table 1: Personal Income Growth, Seventh District and United States
Table 1 Source: www.bea.gov.

Table 2 shows Michigan comparing more favorably to the United States in terms of per capita personal income growth in 2013; but Michigan still ranks in the middle of the Seventh District by this measure.
During most of the 2000s, Michigan’s economic growth stagnated, and it fell into a one-state recession between 2003 and 2009. During the recession, per capita personal income growth slowed. In 2000 (when indexed), U.S. and Michigan per capita personal income were virtually equal. Over the period 2000–07 (before the Great Recession began), U.S. per capita personal income increased 31.2%, while Michigan per capita personal income increased 18.6%. However, over the period 2010–13, per capita personal income (as well as per capita disposable income) increased at a higher rate in Michigan than in the nation as whole./10 Michigan’s higher per capita income growth rates may be in part due to changes in its household employment and labor force participation rates. Both rates have been increasing more rapidly as of late.

Table 2: Per Capita Personal Income Growth, Seventh District and United States
Table 2 Source: www.bea.gov.

Chart 2 shows what percentage of the working-age population in the United States and Michigan was employed from 1976 through 2013. The ratios of employment to working-age population in the nation and Michigan fell during the Great Recession and slightly rebounded in the last couple of years. But Michigan’s ratio of employment to working-age population fell more sharply over the past decade (despite the state having lost population) and is now below its all-time low. After losing population during the 2000s, Michigan’s population grew an estimated 0.1% since 2010./11 Meanwhile, the U.S. population has grown an estimated 0.8%.

Chart 2: Employment-to-Working-Age-Population Ratio: United States and Michigan
Chart 2 Source: www.bls.gov.

When looking at changes in per capita personal income over the past 45 years, one can see how much the United States and the Seventh District have outpaced Michigan. Until 2001, only Illinois was higher than Michigan in terms of its per capita personal income relative to the nation’s (see chart 3). Michigan’s one-state recession during the 2000s becomes evident in chart 3, when its relative measure of per capita personal income diverges from those of other Seventh District states (except Indiana’s). During the 2000s, the income disparity between Michigan and the rest of the country grew quite a bit. This may have been due in part to “brain drain” from Michigan. Research from the Cleveland Fed has found that a state’s knowledge stock—which is composed of the number of patents issued and the number of high school and college graduates—is the main factor explaining a state’s relative per capita personal income over long periods of time./12 Since the end of the Great Recession, it appears Michigan’s per capita personal income growth is at least equal to, if not slightly greater than, those of the Seventh District states and the nation as a whole, but this growth hasn’t resulted in a return to parity with most of them as chart 3 shows.

Chart 3: Per Capita Personal Income Relative to the United States’: Michigan and Other Seventh District States
Chart 3 Source: Author’s calculations based on data from www.bea.gov.

As mentioned before, transfer payments have made up a large share of Michigan personal income growth lately. Indeed, transfer payments have played an important role in lifting income levels in Michigan in recent years. But that has come with a price: Michigan’s Unemployment Insurance Trust Fund has fallen into the red. Consequently, Michigan has taken on loans from the federal government and suffered reductions in Federal Unemployment Trust Act (FUTA) tax credits./13 In addition, Michigan employers are in the process of paying off revenue bonds (issued to pay off Unemployment Insurance Trust Fund liabilities); the bonds are held by the federal government. Such liabilities likely reflect future drains on personal income to Michigan residents as the trust fund is replenished from payroll taxes. In response to stress on the trust fund, the state made other changes to its unemployment insurance program, including cutting unemployment benefits to 20 weeks from 26 weeks in 2011./14 Because employers are paying off revenue bonds, Michiganders face not only the loss of potential income but also potential income growth.

Conclusion

Michigan’s one-state recession in the 2000s lowered employment and employment participation, thereby slowing its per capita personal income growth. In regard to state per capita personal income growth relative to that of the nation’s, Michigan has now reached a point where it has clearly fallen behind most of its Seventh District neighbors. As the national economy continues to recover from the Great Recession, we can ask whether Michigan has now returned to personal income growth rates of the past for the foreseeable future. The answer is yes, but this may not be good enough. Despite the noteworthy amount of positive economic news coming from Michigan since the end of the recession (including the auto industry’s resurgence), its personal income growth has, at best, matched the long-term trend for personal income growth in the United States. At this pace, the Michigan economy is vulnerable in losing further ground during the next national downturn.

—————————————————-
1/ Variations in personal income growth between states can stem from differences in the fortunes of the local industries that are sharply concentrated within each. For example, while analyzing fluctuations in payroll by industry sector, I note that manufacturing is to Michigan as mining is to Montana or as retail trade is to Nevada.
2/ Personal income is typically not adjusted for inflation.
3/ Net earnings by place of residence = Earnings by place of work – Personal contributions for government social insurance + Adjustment to convert earnings from a place-of-work basis to a place-of-residence basis.
4/ Another reason transfer payments now constitute a higher percentage of personal income is new retirees receiving Social Security.
5/ State personal income growth figures for the year’s previous quarters are normally revised with each new quarterly data release from the U.S. Bureau of Economic Analysis (BEA). Benchmark revisions for personal income are usually done shortly after with other BEA benchmark revisions.
6/ Real disposable personal income is after-tax, inflation-adjusted income.
7/ The fiscal cliff was a combination of expiring tax cuts and across-the-board government spending cuts that were scheduled to become effective on the final day of 2012. For further details, see www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2014/cflapril2014_321.pdf.
8/ In 2010–13, annualized personal income growth for the United States and Michigan was 4.3% and 3.8%, respectively. Over the same period, annualized disposable income growth for the United States and Michigan was 3.4% and 2.9%, respectively.
9/ See www.mlive.com/politics/index.ssf/2011/05/gov_rick_snyder_signs_michigan.html.
10/ In 2010–13, annualized per capita income growth for Michigan and the United States was 3.8% and 3.5%, respectively. Over the same period, annualized per capita disposable income growth for Michigan and the United States was 2.9% and 2.7%, respectively.
11/ Since 1978, there is a positive, yet somewhat weak, correlation (0.35) between Michigan real gross state product (GSP) growth and population growth.
12/ See www.clevelandfed.org/research/workpaper/2006/wp0606.pdf.
13/ Go to journals.gmu.edu/newvoices/article/download/67/65.
14/ Ibid.

Michigan increases minimum wage

By Paul Traub

On May 27, Michigan Governor Rick Snyder signed legislation that would increase Michigan’s minimum hourly wage, making Michigan one of seven states together with the District of Columbia that have passed legislation to increase their minimum wage this year. The other six states are Connecticut, Delaware, Hawaii, Maryland, Minnesota, and West Virginia. In addition, 32 other states have considered minimum wage legislation during 2014, with 28 of those considering increases to their minimum wage. 1/ As of June 1, 22 states and the District of Columbia have state minimum wages above the federal minimum hourly wage of $7.25 (see map).

US Map

On September 1, Michigan’s minimum wage will increase from $7.40 to $8.15. As shown in table 1, under the new law Michigan’s minimum wage will continue to grow through 2018 until it reaches $9.25 per hour. From that point forward, the wage will continue to increase by the rate of inflation for Midwestern states up to a limit of 3.5%, so long as the unemployment rate is at or below 8.5% in the prior year.

Table 1

The new law is thought by some to be a compromise by Michigan legislators aimed at preempting a November ballot initiative asking voters to raise the minimum wage to $10.10 per hour, including for those workers eligible to receive tips. Under the new Michigan law, workers who are eligible to receive tips must be paid a wage equal to at least 38% of the minimum wage and will start by receiving $3.10 per hour, rising to $3.52 per hour by 2018. Many employer groups, including the Michigan Restaurant Association, that were opposed to the ballot proposal seem to see the new Michigan legislation as a workable compromise.

Since 1980, Michigan workers have seen the minimum hourly wage increase only six times. Chart 1 shows Michigan’s minimum wage in both nominal and real terms from 1980 through 2014.

Chart 1

After adjusting for inflation, using the personal consumption expenditures (PCE) price index, the minimum wage for 2014 comes out to $6.78 per hour, which is below 1980’s real hourly wage of $7.05 per hour. Throughout the years, increases in the minimum wage have repeatedly done no more than to return the real wage back to where it was in 1980, only to see it fall behind again as inflation ate away at the purchasing power of minimum wage workers. The biggest decline in purchasing power occurred during the 15 years between 1980 and 1995, when the real minimum wage fell by 38%.

One of the biggest complaints about the new minimum wage is that it will hurt small business owners the most. Because higher wages will increase the cost of labor and business owners may not be able to pass all of the increased cost on to their customers, their profits may be adversely affected. Some business owners say that in response to their declining profit margins, they will be forced to cut back on employee hours worked or the number of employees in total. Chart 2 below shows the annual percentage change in the new minimum hourly wage adjusted for inflation. The wage is adjusted using PCE price index estimates of 1.8% for 2014–15 and 2.0% for subsequent years. At first glance, it looks as if wages are going to increase substantially, increasing 8.3% the first year.

Chart 2

In purchasing power terms, Michigan’s real minimum wage has fallen more over the past three decades than it has increased. The new legislation will increase the real minimum wage by 2018 (give the above-mentioned assumptions) to an estimated $7.85 in 2009 dollars, which is equal to a compound annual growth rate of 0.3% since 1980. So one way to look at the most recent increase in the minimum wage is that it will bring the real wage back to where it was 35 years ago. Going forward, the wage is tied to inflation or 3.5% (whichever is lower), helping to a somewhat stable real income for minimum wage workers and protecting their buying power in the process.

1/ David Baily, Karen Pierog and Mary Wisniewski, 2014 “Michigan, in bipartisan move, raises minimum wage”, Reuters, chicagotribune.com, May 27, 2014.

Wells Fargo Chief Economist Gives Economic Outlook at Latest DABE Meeting

By Martin Lavelle

At the latest Detroit Association for Business Economics (DABE) meeting of the 2013–14 season, John Silvia, chief economist, Wells Fargo, presented his outlook on the economy.
Silvia said that he expects the annualized rate of real gross domestic product (GDP) growth to be 2.8% for the remainder of 2014, with the pace of growth accelerating slightly to 3.1% in 2015. According to Silvia’s outlook, the economy is expected to continue to experience steady private sector demand while government consumption and investment rebound with the elimination of some public sector headwinds (e.g., no government shutdown or prolonged debt ceiling debate). However, Silvia noted that one major risk to his forecast is the recent slow growth in labor productivity and real disposable income per capita. If labor productivity growth does not rebound to pre-recessionary rates, future real disposable income growth will be limited, hindering consumer demand, he explained.

In regard to employment, Silvia said he puts added importance on the weekly unemployment initial claims series, which continues to move downward; this trend bodes well for the labor market. Silvia noted he is also optimistic about future employment growth because the employed-to-population ratio has apparently bottomed out and the unemployment rate has generally declined over the past few years. Labor market improvements should help the housing market, which is expected to improve; more specifically, housing starts are anticipated to hit their long-run trend of 1.5 million units in 2018, according to Silvia’s outlook.
Silvia said that he does not expect inflation to pose a threat to the Federal Reserve’s current stance of expansionary monetary policy; he noted that “headline” inflation as measured by the Personal Consumption Expenditures Price Index is not expected to reach the Federal Reserve’s price stability target of 2.0% until next year. However, Silvia pointed out that since the beginning of the deceleration of the current monetary stimulus program, the yield curve has shifted up as medium- and long-term interest rates (including mortgage rates) have increased. /1 This shift in the yield curve has slowed the housing market’s rebound. In addition, Silvia said he is worried that the end of the expansion in the Federal Reserve’s balance sheet will coincide with a drop in stock prices, which would hurt investment.

In closing, Silvia highlighted some short- and long-run fiscal issues that remain risks to his outlook. In the short run, increases in the number of student loan delinquencies are concerning as household formation and consumption may be delayed because of high student debt levels, Silvia said. Additionally, the current decision to not address entitlement programs, such as Social Security and Medicare, poses long-run risks to the country’s economic growth, he argued.
Silvia’s presentation is available here. 2014 05 13 Detroit NABE

/1 A yield curve is the line plotting the yields (or interest rates) of assets of the same credit quality but with different maturity dates at a certain point in time. These assets (e.g., U.S. Treasury securities) typically yield incrementally more at longer maturities.

Michigan’s Automotive R&D Part II

By Thomas Klier, Bill Testa, and Thom Walstrum

The automotive industry is synonymous with Michigan. This relationship was born of an explosion of technological innovation in Southeast Michigan, including the assembly line and key developments in the internal combustion engine and transmission system. Looking at innovative activity today, a hundred years later, it is not far-fetched to state that the geography of automotive innovation in North America resembles that of yesteryear, with Michigan retaining its dominant role. The state has been highly successful to date in sustaining its leading automotive R&D concentration. Yet, for good reason, policy initiatives in the state are aimed at retaining and building on its strength.

The research and development (R&D) activity of private industry is increasingly being recognized as an important part of the innovation that spurs economic growth and competitiveness. Companies undertake R&D both to improve their production processes for cost and quality and to create wholly new products and services.

Among mainstay U.S. industries, automotive remains one of the most innovative in this regard. R&D that was both financed and performed by U.S. domiciled automotive companies amounted to $11.7 billion in 2011, representing 5.2 percent of total R&D spending. The R&D intensity of automotive manufacturing (as a share of the industry’s value added) is 15.3 percent, compared with 9.2 for all manufacturing, and 1.7 percent for all private industry.1/

The importance of innovation to automotive companies remains paramount. A recent report by the Boston Consulting Group cited nine automotive companies among the world’s most innovative companies in 2013. The report names several factors behind the innovative burst among automotive companies, including the quickly tightening fuel-efficiency and environmental standards, which have spurred interest in electric and hybrid vehicle technologies. At the same time, auto companies continue to strive to meet ongoing demands for safety, comfort, and performance. Today’s vehicles increasingly comprise advanced electronic and IT components, which are developed both by automotive companies and purchased from technology companies in other industry sectors. By one estimate, “Electronics make up nearly 40% of the content of today’s average new automobile, and their share will continue to grow.” R&D initiatives to enhance the performance and to lower the cost of batteries that may power many of tomorrow’s autos are one example of an important and emerging R&D direction; automatic guidance systems for tomorrow’s (driver-less) cars is another.

Today, Michigan remains the epicenter of automotive R&D in the U.S. The state has maintained its leading place even while production has dispersed throughout the nation. According to data from the National Science Foundation that has been assembled for recent years only, R&D that is both funded and performed by auto companies in Michigan held fast at between 70 and 80 percent of the nation’s total from 1998 to 2011, amounting to $8.87 billion in 2011.

Automotive R&D has propelled Michigan to a leadership position among Midwest states. The table shows Michigan leading the region with $13.7 billion in total business-performed R&D by all industries in 2011, closely followed by Illinois ($12.0 billion), but far ahead of Ohio, Indiana, and Minnesota.2/
Table 1

Michigan is also a leader in employment of auto engineers to support long-term R&D and innovation. Drawing on data from the Census and the more recent American Community Survey, we can see how large Michigan’s share of the nation’s automotive engineers is relative to its share of the nation’s work force. Michigan employs over one-half of the nation’s automotive engineers, but its work force overall represents just 3 percent of the nation’s.

Granted, Michigan’s share of the nation’s automotive engineers has fallen by ten percentage points since 1980; nonetheless, the state has added 18,000 (two thirds) of its engineers since 1980.
Chart 1

The remarkable importance of automotive technology in Michigan (as represented by engineering workers) can also be understood by comparing it with Michigan’s eroding share of automotive production. By overlaying Michigan’s automotive production workers as a share of the nation on the chart above, the strong role of automotive technology becomes clearer. Since 1950, Michigan’s share of production workers has fallen from 54 to 19 percent, a loss of approximately 255,000 jobs.
Chart 2

And while there are many technologically advanced industries in Michigan—including bio-pharma, medical equipment, industrial chemicals, and office furniture—automotive engineering has come to dominate further in recent decades. As the chart shows, automotive engineers once comprised 30 percent of engineers in all industries in Michigan. By 2012, their share had risen to 51 percent.
Chart 3

What is the future of automotive R&D in Michigan; will the region’s extreme concentration in the activity continue? There are no hard and fast answers, yet there are identifiable features that will come into play. On the one hand, there are many historical instances of geographically concentrated centers being very cohesive and long-lived. Once established, such “clusters” tend to grow and feed on themselves. Technology activity is drawn to technology activity. Skilled workers are drawn to activity-rich cities, and companies are, in turn, drawn toward pools of skilled workers. For example, global financial centers such as New York and London have held their dominant positions for many decades, even centuries. The San Francisco Bay area has enjoyed a long run of dominance in the areas of IT and biotech. In a similar way, Michigan’s established leadership in automotive R&D may persist.

On the other hand, company reorganizations and the geographical shifting of activities that tend to be interdependent with technological activities represent risks to Michigan’s position. It may be beneficial for some industries to locate technology and production in close proximity to facilitate (and reduce the cost of) communication and transportation between the two activities. Thus, the fact that Michigan has lost automotive production in recent decades may have negative implications for automotive R&D in the state.

Similarly, co-dependence between R&D and company headquarters activities such as marketing and strategic planning has also been seen as important in some industry sectors. Thus, any major shift in corporate headquarters activity away from Michigan would raise the concern that it might be accompanied by a shift in R&D activity.

Finally, mature industries such as automotive are often severely disrupted by the emergence of wholly new and sometimes unexpected technologies that greatly shake up their organization and geography. For example, the development of aerospace technologies for military uses shifted the locus of related U.S. production from the Northeast to the Southwest and West during the course of the twentieth century. So far, this has not yet taken place as Michigan continues as the U.S. leader in automotive innovation and R&D activity.

End Notes:
1/ For 2011, National Sicence Foundation, National Center for Engineering and Scientific Statistics, Business R&D and Innovation Survey, and U.S. Department of Commerce, Bureau of Economic Analysis
2/ Latest Data available, National Science Foundation, www.nsf.gov/statistics/inbreid/nsf1333f/

Freight movement slows in January, while freight rates remain high—Is it the weather or something else?

By Paul Traub and William Testa

The severity of this winter season has had a noticeably negative impact on everything from retail sales to industrial production. Roadway freight operations are no exception.

The effects of the extreme cold and heavy snow, which started last December and has continued into March of this year, seem to be showing up in some recent economic data on freight services. Chart 1 below contains the Transportation Services Index (TSI)1/ for freight in the United States. The TSI contains freight data for most modes of freight transportation, including truck, rail, inland water, air, and pipeline. This index shows that on a seasonally adjusted basis, freight movement dropped in January by 2.8%. Since the data are adjusted for seasonality, the drop in January looks to be even more significant.

TSI

Though all modes of transportation have been affected by this winter’s weather, trucking arguably experienced the worst of it. Many firsthand reports (including my own) have indicated that ice and snow shut down routes in states that do not normally face such harsh wintry conditions. Extremely cold weather also made the loading and unloading of trucks more difficult, causing delays and disrupting normal schedules.

This winter’s disruptions to trucking operations were also accompanied by price spikes. According to DAT Solutions, spot rates (excluding long-term contractual prices) for dry vans, which account for the majority of long-haul freight, are up 17.6% from October 2014. These price spikes could be partially due to the severe winter weather and may only be temporary; however, some evidence points to shifting fundamentals that may be contributing to rising cost trends in the industry. Since the U.S. economy reached the bottom of the Great Recession (in mid-2009), the U.S. Bureau of Economic Analysis’s producer price index for long haul truck-borne freight has climbed at an average annual pace of 3.9%.

Many industry experts argue that tightening capacity together with rising costs in the trucking industry are driving up freight prices. As chart 2 shows, according to ACT Research, the so-called active population of heavy-duty (class 8) trucks has been declining steadily since 2007, even while the economic recovery has been ongoing.

VIO

ACT Research defines the active population of trucks as those trucks still in service that are 15 years of age or younger. The reason for this distinction is that once a vehicle reaches 15 years of age, it becomes much less likely to be used for hauling meaningful amounts of freight over long distances. So, at the same time the number of freight loads has been increasing on account of the recovering economy, the number of trucks available to carry those loads has been declining.

Another factor affecting freight rates has been the significant increase in truck prices. Truck prices started increasing in 2002 because of federally mandated diesel emission standards that required the costly development of new engine technologies. ACT Research analysts contend that since 2002 the cost of meeting these standards has added an estimated $30,000 to the cost of a new truck—a price increase of about 31%. Rising prices for new trucks have, in turn, made used trucks more attractive, causing their prices to go up as well. The average price for a used class 8 truck was higher in January of 2013 than ever before.2/

There is yet another factor that is likely to drive up costs for the trucking industry: the projection for a severe shortage of qualified truck drivers. The effects of the shortage, which has been in the making for some time, were somewhat mitigated during the most recent economic downturn. Since then, as freight activity has recovered, the driver shortage has become a more serious problem. A shortage of drivers, coupled with fewer trucks on the road, has tightened freight utilization rates, which are said to be approaching uncharted territory: Some estimates now have capacity utilization rates in the trucking industry in excess of 95%.

If, as I would argue, the recent slowdown in freight activity is due primarily to the severe winter weather, then missed deliveries will need to be managed. But this will not be easy. In the trucking industry, backlogs can be difficult to make up because there is only so much the trucking industry as a whole can ship—and only so much any one truck can haul (due to legal weight limit restrictions on most highways). Making up for the backlogs will result in added demands on a truck fleet that is already running at near-full capacity.

Based on this analysis, it doesn’t look like freight rates will be coming back down any time soon, especially if the economy keeps improving. As businesses moved to optimize their supply chains with techniques such as just-in-time inventory,3/ freight has taken on an increasingly important role in their production processes. As a percent of total logistics expense for private business, trucking-related costs comprise 77.4% of transport costs and 48.6% of total logistics spend.4/ Accordingly, when real gross domestic product (GDP) increases by 1%, some analysts estimate that the truck transportation needed to bring this about increases by 2 to 3%.5/ Should the demand for hauling freight by truck grow dramatically, the trucking industry’s capacity would be strained under the current circumstances. When trucking capacity is strained, prices for those freight hauls that are not under long-term contract can jump. Given the changing fundamentals to the trucking industry discussed previously, some analysts argue that the recent price spikes for shipping freight via trucks will ultimately work their way into long-term contractual prices for hauling freight (which are predicted to reset throughout the year). Some estimates have the increase for contractual freight in the coming months to be in the range of 4% to 6%.

Rising capacity utilization for the trucking industry, increases in the costs of new trucking equipment, higher demand for qualified truck drivers, and a declining number of heavy-duty trucks in operation are some of the reasons that freight prices are on the rise. North American heavy-duty truck production is increasing to meet demand, but recently announced fuel economy standards will continue to add costs to the production of new vehicles—and, in turn, increase their sale prices. So while rising freight rates have historically been a good predictor of improved economic activity, there are other factors at work driving up rates at this time. It remains to be seen how all of this will affect consumer prices, but if these expected freight rate increases cannot be readily absorbed, they will have some impact on the consumer. For these reasons we will be keeping an eye on freight and freight rates in the months ahead—long after the snow has melted.

1/ Truck transportation makes up a significant portion of the Transportation Services Index (TSI), accounting for 40% of the data used.
2/ Newscom Business Media Inc., 2014 “Used Trucks Cost More than Ever Before”, Today’s Trucking, February 27.
3/ Just-in-time inventory is an inventory strategy employed by firms to increase their efficiency and decrease waste by receiving goods only as they are needed in the production process; this strategy reduces costs associated with carrying large inventories (of raw materials or finished goods, such as cars).
4/ Dan Gilmore, 2013 “State of the Logistics Union 2013”, Supply Chain Digest, June, 20, 2013.
5/ Jeff Berman, 2014 “Truckload capacity trends in 2014 are worth watching, say industry stakeholders”, Logistics Management, Jan. 10, 2014.

The Detroit Branch’s role in the Southeast Michigan community

By Martin Lavelle

Recently, Detroit’s newly elected mayor, Mike Duggan, visited the Detroit Branch of the Federal Reserve Bank of Chicago to discuss possible avenues of revitalization for the city with our Board of Directors. On this occasion—and as Detroit looks past its fiscal bankruptcy and toward a brighter future—we briefly took stock of the Branch’s role in serving the Southeast Michigan community. Clearly, the Branch is involved in helping the community in a variety of ways. We’re involved in programs with entities such as United Way, Junior Achievement, the Michigan JumpStart coalition, Gleaners Food Bank, Forgotten Harvest, and the Detroit Rescue Mission. Moreover, one of our Bank officers serves on the board of directors of the Plymouth Educational Center Charter School; this school, which is located on Forest Avenue (right behind the Branch), serves over 1,200 students, with the vast majority of them being residents of the city of Detroit. Relatedly, in partnership with the Michigan Council on Economic Education, we host an event called Teacher Night at the Fed, where teachers gain professional development on a subject related to financial literacy and economics while earning continuing educational credits. Many of the attendees at this event teach in the city of Detroit. These are just some of the ways in which the Branch serves Detroit and the wider Southeast Michigan community. There are several other avenues by which the Branch helps the community: Each department—and each employee—devotes a considerable amount of time and energy to serving Detroit and the surrounding areas.
Forgotten Harvest

Detroit Branch employees volunteering for the Forgotten Harvest

The Branch’s law enforcement unit is working extensively with the Detroit’s police department to keep the Branch and the neighborhood in which it’s located as safe as possible. Specifically, along with Federal Reserve Bank law enforcement staff, the Detroit Police Department and Special Response Team/Mayor’s Executive Protection Unit train on our firing range.

Our Supervision and Regulation Department provides oversight to financial institutions in a way that fosters a sound, accessible, and competitive financial system that inspires trust. This department’s staff members conduct examinations of community banks to ensure they are operating in a safe and sound manner; our staff members check that these banks are abiding by all applicable federal consumer laws and regulations while making sure the credit needs of the community are being met fairly and equally.

Our Community & Policy Studies Department, in partnership with the U.S Treasury Department, held an Investing in Detroit conference on aligning federal resources with local resources in Detroit and its community/economic development efforts. In addition, we’ve hosted video conferences with community leaders in other Rust Belt cities that discussed revitalization strategies involving “anchor institutions” (such as medical centers and universities) that draw investment in many forms and considered how arts and culture interact and intersect with anchor institutions to generate economic opportunities and jobs, especially for low- and moderate-income people and areas. Additionally, this department now runs a poll that is part of a study being conducted of small businesses in Detroit and the resources and networks they rely on in their communities. The poll is being used to identify the community resources that business owners use, the barriers to using these resources, and the primary needs of these businesses.

The Detroit Branch Cash Services area plays a major role in the payment system for the state of Michigan. Some of the functions that Cash Services performs include counting, verifying, distributing and destroying currency. The department seeks to provide high-quality, reliable cash services that contribute to the integrity of the United States financial system. On average, the Detroit Branch ships out over $75 million in new U.S. currency notes per day and receives about $66 million per day from the financial institutions within Michigan. The department also destroys about $10 million per day in worn currency notes.

Our research department holds business roundtable meetings, in which we receive regional and national economic updates that contribute to the monetary policymaking process. Every year we host multiple conferences, such as our annual automotive symposium and the multiday conferences that covered natural gas production and possible financial reforms that would restore cities’ financial sustainability. Our economists also give economic updates on our Michigan economy blog as well as in public presentations made at business association meetings and other events. Through such efforts, our economists endeavor to inform and educate the general public about the Federal Reserve’s role in the economy and, more generally, about the latest economic trends and research findings.

The Detroit Branch of the Federal Reserve Bank of Chicago will continue to support the Southeast Michigan community, including the city of Detroit, in all of the previously mentioned ways. And the Branch is committed to assisting Detroit in its turnaround.

The Importance of Manufacturing to the Seventh District and Michigan

By Paul Traub

There has been a lot written about manufacturing returning to the United States from abroad, and there are data to suggest that this is happening. Rising wages abroad, falling energy prices in the U.S., and declining willingness of domestic manufacturers to suffer the delays and poorer quality of overseas supply chains are conspiring to shift some production back to the U.S., a trend called onshoring. At a Federal Reserve Bank of Chicago conference last April, Justin Rose of the Boston Consulting Group (BCG) attested that the U.S. still makes over 70% of the manufactured goods it consumes, while its prospects remain bright as global trends are conspiring to encourage onshoring. However, while U.S. manufacturing output remains hefty and onshoring is undoubtedly taking place, there is some debate as to whether manufacturing jobs are returning to the U.S. in a meaningful way. A recent Forbes article, “Reports Of America’s Manufacturing Renaissance Are Just a Cruel Political Hoax,” makes the case that even though “some reshoring has taken place,” there hasn’t been enough to offset the continued offshoring of manufacturing jobs. This debate is of great importance to the Seventh District and Michigan.

As Chart 1 shows, the United States lost about 33.2% of its manufacturing jobs between 2000 and 2010 compared with a 1.5% decline in total nonfarm payroll jobs. Given the extent of manufacturing job decline during the recession, it wasn’t surprising to see growth in manufacturing jobs exceed total nonfarm payroll growth through 2012 even though that pace of growth slowed somewhat in 2013. In addition, while nonfarm employment is now close to its prerecession peak, manufacturing employment is still down by more than 30% from its 2000 level and 11.0% below its 2007 level.

Chart1

Comparing U.S. employment with that of the Seventh District and Michigan (Chart 2), we see a slightly different picture. While total nonfarm employment for the District has improved, it is still 4.9% below its 2000 level and Michigan is still down 12.8%. Manufacturing employment is well below 2000 levels in both the District and Michigan, –28.9% and –38.2%, respectively. However, there has been some progress in the District since the recession, especially in manufacturing jobs. While the District has seen total nonfarm jobs grow by 4.2% since 2010, manufacturing jobs have improved by more than twice that rate, increasing by 8.7%. Michigan has seen total nonfarm employment grow by 5.5% for the same period, with manufacturing jobs increasing an astonishing 17.0%.

Chart2

Obviously, this is important to the Seventh District and Michigan economies, given the relative heft of the manufacturing sector in the region. Charts 3 and 4 use nominal data to create manufacturing’s share of total output for the United States, the Seventh District, and Michigan. The charts show that while manufacturing has been declining steadily since 1997, the District and Michigan remain more dependent on manufacturing than the nation as a whole. The charts also illustrate that manufacturing has made somewhat of a rebound since the end of the recession. In fact, the manufacturing shares of both the U.S. and the district are very close to where they were just prior to the recession.

Chart3

Chart4

Much of the District’s growth in manufacturing output is related to growth in light vehicle sales, which reached their lowest levels in almost three decades during the 2008 recession. Still, the growth is quite impressive. Chart 5, which uses data from the Bureau of Economic Analysis (BEA), shows how the District accounts for almost half of the nation’s motor vehicle and parts manufacturing and this share has remained fairly constant over the last 15 years. Michigan accounts for more than half of the District’s and about 25% of the nation’s motor vehicle and parts output.

Chart5

Chart 6 shows that U.S. light vehicle production fell about 6.0 million units from the peak in 2000 to just 5.6 million units in 2009. Between 2009 and 2013, light vehicle production rebounded by 5.2 million units or 94%. This would do a lot to explain the District’s manufacturing growth over the past four years.

Chart6

Motor vehicle and parts employment has been declining for a number of years, due to outsourcing and increased use of automation in vehicle assembly plants. As Chart 7 shows, a simple calculation of dividing the total U.S. motor vehicle and parts employment by the number of light vehicles produced in the U.S. reveals that in 2013, there were only about 74% of the number of employees it took to produce the same number of vehicles in 2006. Since the economy started to recover in 2009, the motor vehicle and parts sector has seen an increase of about 140,000 employees, while increasing total vehicle production by 5.2 million units.

Chart7

Based on projections from Ward’s Automotive, light vehicle production is expected to increase another 800,000 units by 2015. If these projections are achieved, this will certainly help the District’s overall economic output, but its impact on total employment will be more modest than that seen from 2009 to 2013. Still, we can expect the overall economic impact from the growth in production to be positive for the Seventh District and Michigan.

What’s after Bankruptcy? Lessons in Governance Reform and Financial Planning from Other Cities

By Martin Lavelle

On November 7–8, 2013, the Federal Reserve Bank of Chicago, Detroit Branch and the Citizens Research Council of Michigan hosted a two-day symposium on municipal bankruptcy, with the aim of uncovering what could be learned from cities that have experienced and are currently experiencing fiscal struggles. Local experts were given the chance to comment on presentations by national experts regarding Detroit’s July bankruptcy filing. This blog summarizes key information from the conference.

Day One

The first day’s discussion centered on the current state of local governments that have already gone through financial difficulties and lessons that could be learned from past crises.

Michael Pagano, College of Urban Planning & Public Administration, University of Illinois–Chicago, argued that Detroit’s case is unique and isn’t necessarily the beginning of a wave of municipal bankruptcies. Cities are still required to balance their budgets annually. Part of the budget pressure Detroit currently faces stems from cuts in state revenue sharing, which began in 2000. Further pressure on Detroit’s finances came from drops in property values which, combined with drops in sales and income tax revenues, put major constraints on Detroit’s budget.

According to CLOSUP’s September survey of municipal governments, fewer jurisdictions are reporting declines in state aid, though almost half still report decreases in state revenue sharing, according to Debra Horner, CLOSUP, University of Michigan. With property tax revenue growth flat, local governments are reducing their spending through shifting more health care costs to employees and increasing intergovernmental cooperation. Between 25% and 50% of Southeast Michigan’s local jurisdictions are less able to meet their fiscal needs, fewer than Saginaw (more than 50%), but more than Western Michigan (fewer than 25%). Fewer than half of Michigan’s local jurisdictions feel they can’t meet future needs within their current spending structure, with fewer reporting they can improve their service delivery and that significant structural reform to public finance is needed.

Robert Inman, Wharton School, University of Pennsylvania, argued that Detroit has to set up the right set of institutions and incentives that will create the appropriate fiscal culture. Inman said fiscal crises result from weak demographics, a weak economy, and weak public policies. Wage and benefit increases without compensating marginal productivity increases is a “recipe for disaster,” said Inman, something Detroit pensioners face under Chapter 9 bankruptcy. Detroit’s decaying infrastructure (physical and human) equates to borrowing money indirectly while contributing to losses in property values. Detroit and other fiscally troubled cities should have the option to privatize when necessary, Inman said, and to create neighborhood and business improvement districts but not tax businesses to cross-subsidize residential services.

Municipalities should devote more time to place-making, according to Anthony Minghine, Michigan Municipal League. When municipalities diminish their service level in order to pay workers’ pensions, it leads to lower property tax revenues, which further erode service delivery. Minghine said the municipal government financial model is broken, except in high-income areas. He added that Michigan’s emergency manager law is a law of destruction, not construction. Once a municipal government starts to experience financial difficulties, it becomes hard to end that cycle of financial dysfunction.

Frank Shafroth, George Mason University, said state governments can and should play an important role in preventing municipal bankruptcies. Prevention should come through preemptive responses to deteriorating financial conditions, not through reactions to already dire financial situations. In the case of Central Falls, Rhode Island, it has been more expensive for the state after the bankruptcy filing because state law did not require Central Falls to accept state assistance. Even though Rhode Island volunteered help by offering the expertise of former city managers for no charge, it wasn’t enough to prevent Central Falls’ bankruptcy. Shafroth expressed concern that Michigan’s current intervention system with local governments will not begin soon enough.

Joyce Parker, The Municipal Group, brought Ecorse, MI, successfully out of her emergency management through place-setting and engaging the community in the place-setting process. Parker was able to get city residents to overcome the anger and distrust that sometimes accompanies the appointment of an emergency manager and contribute to the process of setting Ecorse on a sustainable financial course. While serving as Ecorse’s emergency manager, Parker did have to decrease staffing levels, but was able to accomplish some cost-cutting by sharing resources with other local governments.

Day Two

The second day’s discussion turned to the impact a municipal financial crisis can have on investors and how state governments might intervene in local governmental finances.

Lisa Washburn, Municipal Market Advisors, reported that Detroit’s financial troubles did not surprise investors because the city had been plagued by out-migration, high poverty, significant tax burdens, structural budget deficits, and political corruption, thereby prompting state assistance. However, Michigan’s unwillingness to provide direct monetary assistance surprised the investor community, because the state had a long history of credit oversight and of prioritizing debt repayment. Investors questioned how the state could execute such a poor communication strategy and get involved too late in Detroit, seemingly encouraging Detroit to go bankrupt and default. After Detroit’s bankruptcy filing, some Michigan municipalities’ debt issuances were forced to accept higher yields and even higher risk spreads, yet Washburn argued that Detroit’s bankruptcy does not pose systemic risk to the municipal bond market. She noted it may be harder for Detroit to reenter the municipal bond market because of its debtor-in-possession financing and the time it may take the city to emerge from bankruptcy.

From a neighborhood investor’s perspective, Bill Pulte, Pulte Homes, who has done extensive work in removing blight from Detroit’s Brightmoor neighborhood, said Detroit must be cleaned up before any turnaround plan can work. Pulte reported that no one can make a profit currently in Detroit’s real estate market, in part because of Detroit’s 100,000 vacant structures and its 100,000 vacant parcels. In the past, federal funds for demolition went to many contractors, working in different parts of Detroit. Now, Detroit will receive $52 million from the state and $150 million to accelerate blight demolition in an effort that will be more coordinated.

When it comes to state intervention in municipal finances, Stephen Fehr, Pew Center for the States, indicated that 19 states can intervene in distressed localities, but only a handful of these states are really active. States should oversee local governments in order to ensure public safety, avoid negative stigma, and block the distress from spreading to neighboring towns, Fehr said. He noted that Detroit is similar to Camden, NJ, in that both cities have been the focus of various state and federal efforts, as well as service sharing. New Jersey’s state government, under Governor Chris Christie, approves local budgets and debt payments.

North Carolina arguably has the most effective intervention program, which resulted from bankruptcy filings by multiple local governments in the early 1940s. An outside board reviews data sent in periodically by local governments. A state commission then reports on the status of local governments. The board recommends that local governments maintain an 8% fund balance. If the fund balance falls short of that target, warning letters go out to those governments.

Eric Lupher, Citizens Research Council of Michigan, pointed out that since the 1960s, Michigan has had legislation that allows for state intervention into local government finances, but not state monitoring. Public Act 436, passed into law by Michigan’s State Legislature late in 2012, allows the state to take some initiative when intervening into local government financial dealings. Lupher asked whether the scoring of local governments’ fiscal conditions should be taken over by an outside firm, like Munetrix. He said state governments should want to prevent local government finances from worsening because of the economic impacts financial struggles have on cities and the state. One way to protect against financial emergencies could be for the state to teach local governments best budgetary practices. In the case of Detroit, Lupher argued that the state should uphold its constitutional pledge and protect pensions through the creation of a Michigan Benefit Guaranty Corporation. [1]

Arguably, the biggest takeaway from the conference was that states should be more involved with local government finances so financial emergencies can be avoided. Intervening too late in a municipal government’s financial emergency may be more costly for state government post-crisis. Also, state governments should want to be informed about the condition of municipal governments’ finances, particularly in the larger population areas that help drive economic growth. It is very difficult for Michigan to achieve strong state-wide economic growth if its largest city, Detroit, is experiencing significant financial distress.

[1] A Michigan Benefit Guaranty Corporation would be similar to the Pension Benefit Guaranty Corporation (PBGC), which protects more than 40 million American workers in more than 26,000 private-sector defined benefit pension plans. The PBGC is headed by a director who is appointed by the President and confirmed by the Senate (pbgc.gov).

November Light Vehicle Sales Reach Seven Year High

U.S. light vehicle sales for November jumped to 16.3 million units on a seasonally adjusted annual rate (SAAR) basis. This makes November the largest sales month on a SAAR basis since February, 2007. Some analysts attribute November’s strong performance to a month-end surge in sales and to the fact that Black Friday landed on the final weekend of the month. Among the automakers, GM remained in the lead with an 18.0% market share year-to-date. The remaining leaders were Ford (15.7%), Toyota (14.4%), Chrysler (11.5%) and Honda (9.8%). Chrysler Y/Y sales increase of 15.8% was the largest of top five manufactures. Fuel prices fell again in November; down 6.1% for regular fuel all grades on a year over year basis, helping to keep pickup truck and SUV sales strong. Lower fuel prices also helped push the YTD combined Detroit Three market share up to 45.2%, its highest level since calendar year 2007. In addition, the YTD share of domestically produced light vehicles (those produced in North America) increased to 78.0%, its highest level since calendar year 2005.