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Federal Reserve Bank of Philadelphia
JULY A U G U S T 1981
The Defense Sector:
A Source of Strength
for Philadelphia’ Economy
s
EDITOR’S NOTE: A REGIONAL FOCUS
JULY/AUGUST 1981
Federal Reserve Bank of Philadelphia
100 North S ix th Street
(on Independence Mall)
Philadelphia, Pennsylvania 19106
The BU SIN ESS REVIEW is published by
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The Federal Reserve Bank of Philadelphia
is part of the Federal Reserve System—a
System which includes twelve regional banks
located around the nation as well as the
Board of Governors in Washington. The
Federal Reserve System was established by
Congress in 1913 primarily to manage the
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tions include clearing checks, providing coin
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sures. The Federal Reserve is self supporting
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States Treasury from its operating surpluses.
This issue of the BU SIN ESS REVIEW contains articles by three Philadelphia Fed
representatives to the Economic Development Task Force of the Philadelphia Past,
Present, and Future project.
The first article spotlights the turnaround in Federal spending on national security
programs. It attempts to present a coherent picture of how the Philadelphia region might
incorporate defense industry considerations into its overall economic development
planning. The second article takes on the broad theoretical question, which applies to any
region, of the role that services can play in fostering and sustaining local economic
vitality. Then, focusing on Philadelphia, it shows how employment has changed by sector
in the city and the region, and it analyzes the local impact of growth in the service sector.
The aim of both articles is to improve the information available to policymakers and the
public and to suggest courses of action for the upcoming period of industrial transition in
the region.—J.J.M .
The Defense Sector:
A Source of Strength
for Philadelphia’s Economy
B y Joh n J. MuJhern*
To judge from the press coverage and the
remarks by local officials, September 30,
1980—the day that the U SS Saratoga sailed
up the Delaware River and into the Naval
Shipyard at the foot of Broad Street—was a
great day for Philadelphia and its economy.
And indeed it was. The Saratoga, and the
two giant aircraft carriers that are scheduled
to follow her into overhaul in 1983 and 1985,
should give the local economy a perceptible
boost.
But the carriers, for all their imposing size,
may be less important as a direct source of
employment and revenue than as a reminder
of where defense industry overall fits into
the regional economy. For Department of
Defense outlays are an important part of the
Federal presence in the region, and a part
that could show considerable growth in the
current decade. In fact, based on the Admin
istration’s plans, they might represent the
only areas of significant increase in Federal
spending here over the next few years.
How much growth there will be in Defense
outlays depends in part on how well the
region’s Congressional delegation makes its
case for jobs and contracts. It depends even
more, however, on what the region has to
offer and on how well the offering is marketed
by industry and local government. In an era
when defense is reemerging as a growth
sector, the region that addresses it as an
industrial development issue will be in posi
tion to reap the greatest economic benefits.
•John J. Mulhern, who specializes in organization
and strategic planning, joined the Department of Re
search in 1976. He received his Ph.D. from the State
University of New York at Buffalo.
3
BUSINESS REVIEW
JULY/AUGUST 1981
DEFENSE ACTIVITY
IN PERSPECTIVE
The Philadelphia area has a long history of
defense business, dating back to colonial
times. As the largest city in North America
in the eighteenth century, second in size only
to London in the English-speaking world,
Philadelphia was a dominant commercial
site. When the War for American Indepen
dence broke out, she came forward as not
only the political hub but also the militaryindustrial center of a fledgling nation.
Philadelphia shipwrights built or converted
several of the Continental Navy’s first ships,
Philadelphia chandlers outfitted these ships,
and Philadelphia sailors and marines manned
these ships. Local arsenals cast their guns
and shot, and their gunpowder was produced
in factories along the Delaware. Livestock
and produce for provisions were brought in
from the area’s rich farmland, and cloth for
uniforms and bandages was supplied by
local mills. Philadelphia bankers helped
finance these efforts.
The presence of industries that could sup
port an army and a navy had a measurable
influence on the course of that war and other
American wars, and America’s struggles
provided markets and growth for some of the
region’s principal industries—shipbuilding,
munitions, clothing and textiles, heavy
equipment, and finance. The traces of this
influence can be discerned throughout the
history of the regional economy.1
In more recent times, Philadelphia was a
major industrial supporter of American ef
forts during World War II and the Korean
War. Records indicate that both of these
conflicts generated heavy demand for the
products of Philadelphia industry. After each
period of industrial mobilization, however,
demand for war material would fall off, the
number of civilian and military personnel
employed directly by the Federal government
in defense jobs would shrink, and suppliers
would have to retrench.
The Vietnam standdown also was followed
by large manpower and spending cutbacks;
but however serious their impact on the
defense establishment overall, they left
Philadelphia’s defense-industry infrastruc
ture largely intact. And it appears that many
of the region’s recently displaced defenserelated jobs and incomes could be recouped
during the present decade, giving a muchneeded lift to the regional economy.
THE DEFENSE SECTOR:
HOW LARGE HAS IT BEEN?
By most indicators, the defense sector has
been in decline nationwide since the end of
the 1960s, with national defense purchases
falling to around five percent of gross national
product from over nine percent in 1968. But
even so, defense has remained an important
part of Philadelphia’s regional economy.
One way to get a grip on the size of the
defense sector in the region is to look at total
Department of Defense outlays in Phila
delphia and the seven surrounding counties
that with it make up the Standard Metro
politan Statistical A rea.2 These outlays in
clude direct military payroll expenditures
for members of the Armed Services, payroll
for civilians who work for the individual
Services or DOD, and contracts issued to
area businesses. In 1980, DOD outlays in the
region stood (in nominal dollars) at over $3.1
billion.
The direct payroll portion of DOD outlays
amounted to over $1 billion. Part of this
payroll went to personnel currently employed
at area activities, of whom the majority are
civilians; part of it was compensation for
n
Federal outlay information is taken from publica
tions or tapes provided by the Community Services
Administration of the U.S. Department of Commerce
and the Washington Headquarters Services of the
Department of Defense.
1J. Thomas Scharf and Thomas Westcott, H istory o f
P hiladelphia 1609-1884. Philadelphia: L. H. Everts &
Co., 1884.
4
FEDERAL RESERVE BANK OF PHILADELPHIA
retired, reserve, and national guard person
nel. Payroll appears to make up a fairly
stable Defense outlay core. Even after show
ing some weakness during the 1970s, DOD
salaries made up more than half of all Federal
salary and expense outlays in the region in
1980, or about 3.4 percent of the region’s
total nonagricultural payroll.3
The closing of the Frankford Arsenal in
1977 occasioned a loss of around 3,000 jobs.
But despite these and some other sizable
losses, the Philadelphia city total stood at
almost 26,000 overall in 1980, making it still
one of the largest concentrations of Defense
employment in the nation (see PHILADEL
PHIA RANKS NINTH. . .). Meanwhile,
DOD activities in the other counties of the
region were holding their own or adding
people, reflecting a national trend.4 The part
of the SM SA outside Philadelphia counted a
total of 23,000 DOD employees at the end of
the period.5 Thus DOD total employment
^“Two Urban Initiatives: A Report Card,” summaries
published by the Northeast-Midwest Institute, March
1979, states: “Federal civilian employment dropped by
41,419 in central cities while it increased by 26,559 in
Standard Metropolitan Statistical Areas (SMSAs)—
strong evidence of flight from central cities to the
surrounding suburbs.”
o
J Bureau of Labor Statistics, E m ploym ent and Earn
ings 27, 12 (December 1980], B-8, C-13. Data for
September 1980.
^Manpower figures are taken from Department of
Defense, Distribution o f P erson nel by State, by S elected
L ocation s, 1980. Much of DOD’s employment strength
PHILADELPHIA RANKS NINTH
IN DEPARTMENT OF DEFENSE PERSONNEL
Installation/City
Military
Civilian
Total
San Diego
40,021
18,694
58,715
Arlington
16,863
27,283
44,146
40,237
3,853
44,090
Fort Hood
39,253
3,353
42,606
Washington
15,402
16,204
31,606
Norfolk
15,565
14,671
30,236
Camp Pendleton
25,218
2,215
27,433
Camp Lejeune
24,323
2,684
27,007
Philadelphia
3,103
22,591
25,694
Fort Stewart
22,865
1,878
24,743
Fort Bragg
. . \
*
A
SOURCE: Department of Defense, D istribution o f Personnel by State, by Selected L ocation s, Septemer 30,
1980.
5
BUSINESS REVIEW
JULY/AUGUST 1981
added up to 2.6 percent of the region’s
nonagricultural jobs in 1980.
More difficult to trace than direct hires are
the jobs that result from contracts issued by
DOD activities to private-sector firms, even
though figures for prime contract awards
($2.1 billion in the region in 1980) are pub
lished with the other Federal outlay numbers.
Philadelphia’s large defense-industry con
tractors are mainly regional offices or sub
sidiaries of conglomerates headquartered
elsewhere, whose records aren’t easy to
get. Further, because many defense prime
contractors subcontract their work to firms
some distance away and because both primes
and subs depend upon a far-flung network of
suppliers, it is very costly to assemble a clear
and complete picture of where contract jobs
and dollars finally end up.7
Some idea of employment at contractors,
however, can be gleaned from Bureau of the
Census surveys of shipments by defenseoriented industries. The 1974 survey, for
example, shows 17,400 employees engaged
in DOD-related work at reporting plants in
the Philadelphia SM SA .8 The 1978 survey
shows 13,700 such employees at reporting
plants.9 Assuming that employment in de
fense-products industries in the region runs
roughly parallel to defense-industry employ
ment nationwide, 1978 probably was the
bottoming-out year, and the next survey
should show more employees than the last.
The fact that Defense contract outlays in the
region have been trending upward with the
Philadelphia consumer price index since the
mid-1970s also suggests stability in defenseindustry employment in the area (see DE
FENSE CONTRACTS IN THE REGION
MOVE WITH THE CPI).
Thus whether measured by total outlays,
direct DOD employment, or contract dollars,
the defense sector appears to have been a
sizable contributor to the regional economy
through the 1970s.
in the region appears to have been in commercial/
industrial-type jobs—those that are similar to jobs in the
private sector rather than being uniquely military. In
1972, for example, 12,800 DOD employees were working
in commercial/industrial jobs in Philadelphia alone,
with the largest concentrations in the Naval Base
complex at the foot of Broad Street, the Defense
Personnel Support Center compound at Twentieth and
Oregon Avenues, the Defense Industrial Supply Center
reservation on Tabor Avenue in the Northeast, and the
Frankford Arsenal. (See Department of Defense,
C om m ercial/ Industrial Type A ctivity Inventory, 197279.] To the north and west of the city were 500 more
employees at the Willow Grove Naval Air Station and
the Naval Air Development Center in Warminster. And
about 1,900 more were on the payrolls at McGuire Air
Force Base and Fort Dix in New Jersey’s Burlington
County. The commercial/industrial employment total
actually had risen slightly to about 12,900 in 1979, the
last year for which numbers are available.
WHERE THE IMPACT IS FELT
The Defense outlays that come into the
region have an obvious direct effect on
firms awarded $180 million in subcontracts overall,
sent $134 million out of state, and received $168 million
in subcontracts from other states. Thus Pennsylvania
was a net gainer. New Jersey was an even bigger
winner, getting over seven dollars back for every sub
contract dollar it sent to other states ($300 million
coming into the state, $41 million flowing out). Depart
ment of Defense, G eographic Distribution o f Subcon
tract Awards, 1979.
^Contractor identities are given in Department of
Defense, M ilitary Prime Contract Awards over $10,000
by State, County, C ontractor, and P lace, which is
issued annually.
8U.S. Bureau of the Census, Shipments of D efen seO riented Industries, 1974, MA-175(74)-1, U.S. Gov
ernment Printing Office, Washington, D.C., 1976, p.
15.
7The Department of Defense now has a program that
traces subcontracts of $10,000 or more to first-tier and
second-tier subcontractors when the prime contract or
first-tier subcontract is expected to exceed $500,000.
According to the latest report available under this
program, which gives final data for 1979, Pennsylvania
^U.S. Bureau of the Census, Shipm ents to F ederal
Government Agencies, 1978, MA-175(78)-1, U.S. Gov
ernment Printing Office, Washington, D.C., 1980, p.
17.
6
FEDERAL RESERVE BANK OF PHILADELPHIA
collar jobs, and that percentage is likely to
rise as more people are hired to meet the
increased workload.
Naval shipyard jobs tend to be very stable,
with low turnover rates. In fact, these jobs
are so stable that until recently many of them
were filled by employees who had signed on
in World War II. Since the mid-1970s, how
ever, the average age of workers at the
Philadelphia Naval Shipyard has fallen to
under 40 years. And average age could drop
further as new workers are brought on.
Of the service-providing activities, some
are in the technical business, such as the
Naval Ship Engineering Station adjacent to
the Shipyard, but most are assigned mainly
to some phase of the logistics cycle—letting
contracts, administering contracts, or man
aging inventories. Employees at these activi
ties are mainly white-collar workers, and
their jobs range from clerical to senior execu
tive.
As at the Shipyard, employment at these
activities is sensitive to volume. The number
of jobs at a contracting activity does not vary
directly with the number of contracts written,
of course. Because of budgetary and admin
istrative constraints, personnel adjustments
occur only with a lag. Productivity improve
ments in contract management and inventory
management also tend to restrain employ
ment from growing apace with volume. But
overall, more defense contracts and more
inventory will show up in more white-collar
jobs at the logistics activities.
Many of these pockets of direct-hire DOD
employment buy housekeeping services,
security, and the like from local suppliers. In
this way they inject some money and some
jobs directly into the private economy. And
they are the source of private-sector jobs in
less direct ways as well.
Defense Jobs Generate Other Jobs. When
the Department of Defense is directed to
overhaul a ship or to procure a production
run of aircraft or tracked vehicles, its plan
ners must consider more than just the selec
DEFENSE CONTRACTS
IN THE REGION
MOVE WITH THE CPI
Millions of Dollars
CPI
2000
1800
1600
1400
1200
1000
(p — i--------1----- 1----- 1--------1----- 1--------1-----1--------u o
- - - - 1972
1974
1976
1978
1980
—
SOURCES: The Philadelphia CPI is provided by
the Bureau of Labor Statistics. Defense contract
outlays include all prime contract awards reported
by the Community Services Administration.
people who are hired to work in DOD activi
ties as well as on firms that sell their products
to the Armed Services and DOD agencies.
They have effects also on workers in sup
porting industries through the jobs they elicit
and on local government through the tax
payments they engender.
Who Works for DOD? The Department of
Defense is not only a large employer but also
a diversified one. Philadelphia has a wide
variety of jobs in its DOD activities, ranging
over manufacturing and services.
Although several kinds of in-house manu
facturing are found in Philadelphia, including
such exotic species as official flag making
for clients ranging from military units to
cabinet officers, by far the largest DOD
manufacturing operation in Philadelphia is
the Naval Shipyard. At the end of 1980 the
Shipyard employed about 10,000 people.
About four out of five shipyard jobs are blue-
7
BUSINESS REVIEW
JULY/AUGUST 1981
DOD direct employment in Philadelphia in
1980 gives a total impact of over 42,000 jobs.
The total for the SM SA is about 80,000 jobs.
Recent discussion of the employment
multipliers for defense industry in Philadel
phia has focused on the number of secondary
jobs that would flow from the Service Life
Extension Program (SLEP) for aircraft car
riers. Wharton Econometric Forecasting
Associates, for example, developed multi
pliers which suggest that, on average, each
SLEP job eventually would generate 1.4
other jobs in the region, for a total impact of
2.4 times the number of direct jo b s.11 As
suming that SLEP required the Philadelphia
Naval Shipyard to bring in about 5,100
additional civilian and military employees,
tion of a shipyard or a prime contractor to do
the work. They must try to take into account
also the subcontractors that may be involved
and the suppliers that may furnish materials.
The reason is that most DOD programs are
supported or supplied by workers outside
the Department of Defense, so that the effect
of each DOD hire or prime contract award is
multiplied through the rest of the economy.
Economists sometimes use factors that they
call employment multipliers when they try—
with greater or less success—to forecast the
number of related jobs that will flow from
hires of a certain kind (see EMPLOYMENT
M ULTIPLIERS: NOT EASY TO CALCU
LATE).
A study prepared for the Federal Reserve
Bank of Philadelphia in 1966 uses a regional
multiplier of 1.64 for government enterprise
overall—a multiplier which is among the
lowest on the list.10 Using this multiplier for
the Philadelphia Metropolitan A rea,” research report
prepared for the Federal Reserve Bank of Philadelphia,
October 1966, p. 4.
11
Wharton Econometric Forecasting Associates, Inc.,
"SLEP Multiplier Analysis with the Philadelphia Quar
terly Econometric Model,” November 30, 1978.
10James R. Westkott, “Employment Multipliers for
EMPLOYMENT MULTIPLIERS: NOT EASY TO CALCULATE
Employment multipliers are notoriously difficult to calculate on a national level, where inter
regional exports and imports do not need to be distinguished explicitly since they are included in the
totals. They are even more difficult to calculate on a regional level for industries that belong to a
national market, since almost any portion of the multiplier effect may be felt only outside the region.
Further, employment multipliers differ from industry to industry at any given time, and they change
at different rates over time. These differences in rates of change have to do with changing production
techniques which result in higher worker output. Improvements in metallurgical methods, for
example, can increase the output per hour of production workers in bearing factories. If demand for
bearings remains constant, fewer workers will be required to meet that demand and the pertinent
multiplier will have to be adjusted downward. At the same time, it may be necessary to adjust a
multiplier upward in another industry—say for firms that manufacture supplies and equipment for
metallurgical research.
Despite the difficulties with employment multipliers, and although they cannot be assessed with a
high measure of accuracy until after the fact if at all, policymakers can’t afford simply to ignore them.
Multipliers must be used at the Federal level in targeted employment-support programs if these
programs are to be kept from missing the mark: using too high a multiplier will cause policymakers to
overestimate the effect, for example, of allocating a certain contract to a labor surplus area, while
using too low a multiplier will produce the opposite result.
At the state and local level, officials who work in industrial development need to have some idea
about the total effect on employment of acquiring a firm of a given kind. If Firm A will bring in 1,000
direct jobs and 500 indirect ones, while Firm B brings in the same number of direct jobs but 1,000
indirect ones, it may be to the point to concentrate one’s resources on acquiring Firm B.
8
FEDERAL RESERVE BANK OF PHILADELPHIA
the increase in secondary jobs would be
about 7,100, raising the total to over 12,000
additional jobs by the end of the program.
This figure would more than offset the loss
of the entire current-year contribution (3,400
jobs) of the Comprehensive Employment and
Training Act program in Philadelphia.12
Complete unanimity on multipliers is hard
to come by. But the consensus seems to be
that, on average, each direct DOD hire will
add at least one and at most two indirect jobs
to the regional economy. And since workers
in DOD and defense contractor jobs, along
with the workers in supporting industries,
pay taxes just as other people do, adding
these workers to the employment rolls helps
to broaden the tax base.
Taxes are raised in different ways in the
different parts of the Philadelphia region. In
Philadelphia itself, the main source of reve
nue is the wage tax, which since 1977 has
been levied at a rate of 4.3125 percent on
earnings received in the city. DOD civilian
direct employment reported by four of sev
eral DOD accounting activities generated
$14.4 million in wage-tax revenue in 1980, or
about 3 percent of the city wage tax. The
total wage-tax take from direct and indirect
jobs is difficult to estimate but must be
considerably larger.
Thus, through the effect of multipliers and
the contribution of both direct and indirect
employment to the tax base, Defense outlays
have an appreciable impact on the regional
economy. And that impact could increase
over the next four years.
12Mayor’s Office, City of Philadelphia, “Proposed
Federal F Y 1982 Budget: Projected Impact on the City of
Philadelphia,” April 1981, p. 2-B. The 3,400 number
represents slots (equivalent to labor years) under Title
II-D and Title VI. Since more than one individual can
occupy the same slot in a given year, it is estimated that
the number of people reached by the program in a given
year could be as high as double the number of slots.
The Naval Sea Systems Command—the Navy bureau
that manages ship and boat construction and repair—
cites studies that show an all-regions multiplier for total
shipyard employment, not just the SLEP increment:
Unlike other labor-intensive industries,
shipbuilding and ship repair employs large
numbers of highly-skilled, relatively highlypaid craftsmen. The payroll of a shipyard,
whether Government-owned and -operated
or privately-owned and -operated, is thus
a significant economic factor for the com
munity in which it is located. Various
analyses of the economic-multiplier effects
of shipbuilding and ship-repair activity
have produced estimates that each dollar
spent on shipwork increases the gross
national product by $3.30 and each person
employed in shipwork generates employ
ment for seven others in supporting manu
facturing and services. (Letter to the author
from John F. Elwyn, Executive Director
for Industrial and Facility Management,
Naval Sea Systems Command, 17 April
1981.)
Assuming that the Yard were staffed to its current
ceiling of 9,650 jobs, the total effect of yard employ
ment would be to keep over 77,000 people on various
military and civilian payrolls, using the Navy multiplier
of eight (seven indirect or induced jobs plus the direct
job).
MORE DOLLARS FOR DEFENSE
The defense sector appears to be on the
verge of a sizable increase in funding. While
the Philadelphia region, especially the city,
is likely to see its Federal grant income fail to
grow or even decline in the next four years,
its core of Defense employment outlays
should get by unscathed. Contract awards to
defense contractors in the region also can be
expected to increase.
A Shift in Outlays. After having dropped
to less than a quarter of total Federal budget
outlays in the late 1970s, Defense now is
estimated to rise to one-third of the total
budget by 1984.13 Based on this estimate,
Defense will be increasing its share of GNP
by about two-tenths of a percent a year on
average, while nondefense outlays will be
losing ground by about one percent of GNP
each year.
13Congressional Budget Office, "An Analysis of
President Reagan’s Budget Revisions for Fiscal Year
1982,” March 1981, p. xiv.
9
JULY/AUGUST 1981
BUSINESS REVIEW
The Congressional Budget Office describes
the year-to-year growth of defense spending
in this way:
delphia is not likely to benefit to the fullest
unless it makes an active effort to retain its
present defense jobs and to go after new
ones.
The Defense Outlook. Many defense ana
lysts anticipate a sharp upswing in DOD
purchases over the next four or five years,
continuing a trend that became visible in
1979 (see DEFENSE PURCHASES TO TAKE
SHARP UPWARD TURN). This increase
Defense spending would grow by
an average of 17.1 percent annually
between 1980 and 1984 [under the
Administration plan], while non
defense spending would be held
to an increase of about one percent
a year after 1981. In real terms,
adjusting for inflation, defense
spending would grow by an aver
age of over 8 percent per year
between 1980 and 1984, but non
defense spending would fall to a
level 15-percent lower in 1984
than in 1980.14
Diverse N otes on the P hiladelphia Experience (Cam
bridge: The MIT Press, 1971), p. 18.
SHARP
ARD TURN
Where are the nondefense reductions likely
to occur? Pretty much across the board. And
they will cut into the region’s Federal grant
income.
In a recent press release, the Philadelphia
city administration has focused on four pro
grams which could suffer losses under cur
rent Federal proposals. These include CETA,
the Economic Development Administration,
Medicaid, and public transit. The projected
loss for 1981 from these four programs
amounts to $48.4 million. Philadelphia might
be able to offset these losses, however, with
revenues from elsewhere.
While the ultimate shape of the Federal
budget is hard to forecast in detail, the shift
toward more growth in spending for national
defense and less for other things may give
Philadelphia certain advantages that other
urban centers do not enjoy. Philadelphia
already has one of the nation’s largest DOD
labor forces. It also has the kinds of instal
lations that will be affected most by a stepup in defense procurements.15 But Phila
Defense Purchases of Goods and Services
Seasonally Adjusted Annual Rate
14“An Analysis of President Reagan’s Budget Re
visions for Fiscal Year 1982,” March 1981.
SOURCE: Robert A. Gough, Jr., “The Defense
Budget: Issues and Outlook,” materials presented
at the Data Resources Quarterly Outlook Con
ference, New York, April 29, 1981.
Billions of 1972 Dollars
1960 1965 1970 1975 1980 1985
■^Walter Isard and Thomas W. Langford, Regional
Input-Output Study: Recollections, Reflections, and
10
FEDERAL RESERVE BANK OF PHILADELPHIA
will be reflected in direct civilian hires. The
DOD budget calls for increasing civilian
direct hires by 55,000 over 1980 levels by the
end of fiscal 1982.16 Some of these hires
could be in Philadelphia.
Defense-related industry, which supplies
both hardware and services, also makes for
jobs, and here the numbers are spectacular:
DOD budgeters anticipate an increase of
some 445,000 workers over current levels by
the end of fiscal 1983—nearly half a million
new jobs. Philadelphia could have some of
these jobs also.
This defense market will be targeted by
many areas of the country. And so Philadel
phia must be prepared to compete for defense-
industry jobs if it hopes to keep what it has
and to get more. The competition for defense
work is political in some measure, since
statute and regulation can require the Federal
government to pay some attention to local
economic conditions in allocating work or
awarding contracts (see REPEALING THE
MAYBANK AMENDMENT). Also political
is the give-and-take in the legislative and
executive branches that influences the flow
of work and dollars. But part of the competi
tion is just heads-up industrial development
effort, which consists in finding out what the
customers want and seeing that it’s made
available.
What do Defense customers want? At this
stage in their history, the Armed Services
and the DOD agencies want cost-effective
performance and adherence to schedule, and
they want them across the board. These
desiderata put pressure on in-house manu-
lf5News Release, Office of the Assistant Secretary of
Defense (Public Affairs), No. 77-81, March 4, 1981,
Figure 10.
REPEALING THE MAYBANK AMENDMENT:
WOULD IT BRING CONTRACTS TO PHILADELPHIA?
Unlike other executive departments, the Department of Defense is required in most cases to buy
goods and services at the lowest cost. Exceptions are made, however, to channel funds to small and
minority-owned businesses. And an effort has been renewed recently to use DOD contracts to target
aid to what are known as labor surplus areas—jurisdictions with populations of 50,000 or more
whose unemployment rate for the prior two years has exceeded the national average by 20 percent.
The Maybank Amendment, which has been a part of every Defense appropriation bill since 1953,
exempts DOD from having to target procurements to labor surplus areas.
Rescinding the Maybank Amendment might bring more Defense contracts into labor surplus
areas, and Philadelphia is a labor surplus area (along with Bristol Township, Chester City,
Montgomery County less Abington Township and Lower Merion Township, Camden City, and
Gloucester County in this SMS A). But it doesn’t follow that Philadelphia or any other Northeast or
Midwest jurisdiction would gain very much: as of February 1981 there were nearly 1,100 other labor
surplus areas in the country, and more than half of them were in the South and West.* Philadelphia
would have to compete against those other LS As. Also, rescinding the Maybank Amendment might
harm parts of the SMS A outside the city which are not labor surplus areas and which have seen their
share of Defense contracts growing. Burlington County, for example, received over $360 million in
Defense contract outlays in 1980. In Pennsylvania, Delaware County led the way with about $300
million in 1980, reflecting real growth of 16 percent since 1972. Montgomery County, although a
labor surplus area, followed with $173 million and a startling 44-percent real growth for the nine
years.
*‘‘Why the Maybank Amendment Should Be Repealed,” material circulated by the Northeast-Midwest
Congressional Coalition, p. 5.
11
BUSINESS REVIEW
JULY/AUGUST 1981
to senior positions.
In some instances, of course, as with
contracting, contract administration, and
inventory management, all the work is done
in house and there is virtually no competi
tion. Under the supply system of the Defense
Logistics Agency, for example, which pro
cures items used in common by all the
Services, each commodity group is assigned
to one activity, and that activity buys for the
whole country. The Defense Industrial Sup
ply Center, for example, handles commonuse nuts, bolts, rods, and sheet metal for all
the Services everywhere. And the Defense
Personnel Support Center fills the same role
for food, clothing, and medical supplies.
Short of a major base realignment, these
Philadelphia installations have no competi
tion to fear.
In this respect the logistics activities are in
a very different position from the firms with
which they do business. Many of those firms
find themselves in a highly competitive posi
tion, since the Defense Acquisition Regula
tions make cost the overriding consideration
in contract award. All other things being
equal, the low-cost bidder gets the job. Thus
firms in this region must keep their costs in
line—energy costs, labor costs, and the rest—
if they are to compete successfully with
companies in other parts of the country.
Also, they must be able to produce the
goods that will be most in demand. A recent
presentation by Robert Gough of Data Re
sources, Inc., the Massachusetts econometric
forecasting firm, lists the ten industries that
DRI expects to see the largest volume in
creases over the next five years, based on
real military spending growth from six per
cent to nine percent (see TH ESE INDUS
TRIES MAY GROW). Some of these, such as
tanks and tank accessories, clearly are not
the old Philadelphia defense industries. But
others, such as munitions and shipbuilding,
clearly are. If Philadelphia’s shipbuilding
industry were to grow by as large a percentage
as the industry nationwide, it would be
facturing activities such as the Philadelphia
Naval Shipyard, because the Yard has to
compete with other naval shipyards and
with private shipyards. If it can’t be respon
sive, it won’t get the work. Cost-effective
performance has become the main driver in
allocation decisions for in-house DOD work.
And in the extreme case, work that could be
done in house will be farmed out to private
industry if industry can produce more costeffectively. 17
The pressure on DOD to accomplish inhouse work cost-effectively comes from both
the Administration’s budgeters and the Con
gress. It is transmitted to managers in the
field, both civilian and military, in a number
of ways, including through performance
measures that translate into dollars. Under
the merit pay system of the Office of Person
nel Management, which replaced the U .S.
Civil Service Commission, civilian managers
are beginning to compete for shares of what
corresponds to a bonus plan in private indus
try, and the competitors are being evaluted
by quantitative productivity measures on an
annual basis. For military people the mone
tary rewards come less swiftly—but they do
come, in the form of selection for fast-track
career opportunities and eventual promotion
17While concern for cost-effectiveness is not new to
DOD, it seems to receive more emphasis each year as
automated management information systems provide
more and better data in better formats to people at the
policy level. Further, DOD currently operates a well
developed defense management education and training
establishment which teaches its managerial personnel
to use these systems. As defense budgets bottomed out
in the 1970s and as field operations came to be scrutinized
ever more closely, more exacting management pro
cedures became institutionalized. The evolution of
defense management techniques provides the back
ground for recent statements by the Secretary of Defense
such as the following: “We believe we have identified
significant savings from efficiencies and reforms in
current operations. The money saved in this way can
then be applied to enhancing our military capability.”
Statement before the House Armed Services Committee,
March 10, 1981.
12
FEDERAL RESERVE BANK OF PHILADELPHIA
THESE INDUSTRIES MAY GROW
The Ten Industries Most Impacted by an Increase in Military Spending
(Percent change in industrial production from six percent to nine percent growth
in real military spending]
1983
1984
1985
1986
New Military Facilities
1.9
5.0
8.0
13.4
Ammunition, Except Small Arms
1.8
5.0
7.7
12.8
Other Ordnance & Accessories
1.6
4.1
6.4
10.6
Complete Guided Missiles
1.3
3.7
6.0
10.2
Tanks & Tank Accessories
1.4
3.6
5.8
9.6
Small Arms Ammunition
1.2
3.2
5.1
8.5
New Industrial Buildings
0.4
2.0
4.6
8.1
Aircraft Engines & Engine Parts
1.2
3.2
5.0
8.0
Shipbuilding & Repairing
1.2
3.1
4.8
7.9
Aircraft Parts & Equipment
1.1
2.8
4,3
6.8
SOURCE: Robert A. Gough, Jr. “The Defense Budget: Issues and Outlook,” materials presented at the Data
Resources Quarterly Outlook Conference, New York, April 29, 1981.
adding about 1,735 direct jobs by 1986 over
and above those envisaged by the Wharton
study. Based on the Wharton multiplier,
over 2,500 further indirect jobs would be
forthcoming, for a total of 4,164 new jobs in
the region.
Further, Philadelphia firms need not limit
themselves strictly to their traditional defense
emphases. In the modern era of tiered sub
contractors and suppliers, firms find them
selves participating in contract awards in
many different ways. A manufacturer, for
example, may make a repair part for a piece
of mechanical or electrical equipment used
by the Air Force even though it has had no
history of dealing directly with the aviation
industry. DOD contracting officers are en
couraged to seek alternative sources for
many of the items they purchase. The ap
pearance of new sources of supply would be
welcome to them.
But whether firms in this region will come
forward as new or bigger defense-industry
participants may depend on the information
and the assistance they receive from local
industrial development groups. Identifying
firms that might begin supplying defense
requirements or might increase their share of
the market is not an insuperable task, nor is
providing them with the program information
they will need to compete effectively. Much
of this information on both firms and pro
grams is available in the public domain.
Some firms might require tax inducements
13
JULY/AUGUST 1981
BUSINESS REVIEW
and other kinds of creative financing assis
tance to enter this field, of course, especially
small business firms. But the payback could
dwarf other industrial development efforts.
Further, in order to compete successfully
for new defense business, a region must
offer certain advantages. It must have a
reliable source of workers in its school sys
tems—at least as reliable as other regions. It
must have adequate highway and rail access.
A former Pennsylvania Secretary of Com
merce has listed “transportation, taxes,
adequacy of sites, safety, and labor availa
bility” as the items of chief interest in corpo
rate deliberations over where to locate new
facilities.18 These items apply to the private
sector in an obvious way. Because of the
dependence of Defense installations on pri
vate-sector sources, they apply to the public
sector as well.
In short, the upturn in the volume and
pace of Defense procurement offers a re
markable opportunity to the Philadelphia
region as to others. Certain of the DOD
activities in the region will grow even without
much local effort, and Philadelphia’s indus
trial capacity almost surely will have to be
called upon to help attain the goals of a more
ambitious program of naval ship construction
and repair.19 But the region probably won’t
realize all the economic benefits that it could
without a program to identify requirements
and sources, match them to one another, and
assist with financing.
TO SUM UP . . .
Defense business is nothing new to Phila
delphia. DOD maintained its presence in the
region throughout the 1970s, even though it
was eclipsed by growth in other forms of
Federal involvement.
With the new Administration’s adjustment
of programs and spending plans, Defense
outlays show more growth than any other
Federal outlays over the next few years.
DOD activities should be seeing more people
and larger payrolls. And contractors in pri
vate industry should detect a sharp upward
move in new orders for defense products. All
of these changes would tend to boost em
ployment and local government revenue.
Other regions almost surely will be com
peting aggressively for this increased DOD
business. Philadelphia is well positioned to
compete and could realize sizable economic
benefits. The opportunity is there.
the ship-construction business. Shipbuilding industry
work nationwide occupied about 80,000 workers (equiva
lent production workers) in 1980. If current trends were
to continue, the number would fall to under 20,000 in
1987. The new Navy ship construction program would
be large enough to restore employment to current levels
by 1987, but only after a three-year trough; and in that
three-year period, many of the most marketable shipconstruction workers could move into other industries.
The result could be a delay in Navy ship construction,
cost overruns, and difficulty in performing to specifica
tion, since new workers would have to be hired and
trained—a multiyear process—at the end of the trough.
18Summary of statements by Norval D. Reece in John
J. Mulhern, ed., Finding Solutions to P h ila d elp h ia ’s
E con om ic Problems (Philadelphia: Federal Reserve
Bank of Philadelphia, 1979), p. 5.
19Provided, that is, that the capacity is maintained. A
case in point is Sun Ship in Chester, Pennsylvania,
which has the ability to construct both naval and
merchant ships but which recently has withdrawn from
14
FEDERAL RESERVE BANK OF PHILADELPHIA
Can Services Sustain
a Regional Economy?
B y Joh n M. L. G ruenstein and Sally Guerra*
Over the last hundred years, the United
States has seen more and more employment
shift from manufacturing to service indus
tries . Today well over half the nation’s work
ers are employed in service industries, and
the percentage still is rising. This trend has
gone farthest in metropolitan areas, and
some policymakers are concerned that the
shift toward services may not be the healthiest
direction for cities and their suburbs over
time.
Such concern reflects a long-standing view
about how cities grow and prosper. Cities are
assumed to grow by exporting manufactured
goods to outside customers who provide a
steady inflow of revenue in return, and
services are regarded as a spin-off from this
manufacturing export activity. On this view,
the income that city residents earn from
export goods is spent in service establish
ments of all kinds, ranging from barber
shops to restaurants, until it eventually leaks
out through purchases of imports. Thus the
total size of the service sector is limited by
the volume of manufacturing exports. When
service employment reaches a certain multi
ple of manufacturing employment, one local
service firm can grow only at the expense of
another.
This view—the export-base theory—is
appealing because it focuses correctly on the
importance of exports for urban prosperity.
•John M. L. Gruenstein, Research Officer and Econo
mist in charge of urban and regional studies at the
Philadelphia Fed, received his Ph.D. from the University
of Pennsylvania. Sally Guerra, a Research Assistant,
joined the department in 1979.
15
JULY/AUGUST 1981
BUSINESS REVIEW
also have stimulated growth in demand for
services. The increase in the percentage of
women working and the decrease in the
percentage of families with children prob
ably are raising the value of services de
manded. Services that used to be provided by
family members, such as food preparation
and child care, increasingly are purchased
outside the home. The increase in the over65 share of the population also may have
increased the demand for services, especially
health services. It’s probably true also (but
less certain) that as per capita income grows
the demand for service output grows at a
somewhat faster rate than the demand for
manufacturing output, so that the ratio of
service employment to manufacturing em
ployment tends to rise even further.
The shift to services is far more advanced
in metropolitan areas than in rural areas. In
1970 over 66 percent of the jobs in metropoli
tan areas could be found in the service
sector, compared to just about 56 percent of
nonmetropolitan employment (see M ETRO
POLITAN AREAS SPECIALIZE IN SER
VICES). Between 1970 and 1977, employ
ment in both sectors grew faster in nonmetro
politan areas than in others, but the differen
tial between metropolitan and nonmetro
politan growth for goods production was
much higher than for services production.
By the end of the period, over 70 percent of
metropolitan jobs were in services compared
to 60 percent of rural jo b s.2
The strong service orientation of urban
areas can be seen most vividly by looking at
central cities located in the cores of metro
politan areas. In arep o rtfo rth eU .S . Depart
ment of Housing and Urban Development,
Seymour Sachs examined growth in four
But it overlooks the fact that services can be
exported as well as goods and independently
of goods—an important fact for economic
development planning. This view also over
looks the importance of revenue flows such
as Federal transfer payments which have
helped fuel part of the growth of local
services. To the extent that export demand
can grow and perhaps even take the place of
some loss of transfers, going with the flow
by shifting economic development efforts
toward promotion of services could be more
cost-effective than trying to stem the loss of
manufacturing.
THE SURGING SERVICES
Like most other advanced countries, the
United States has been increasing its servicesector share of total national employment
for several decades while the goods-producing
share—agriculture, extraction, construction,
and manufacturing—has been falling.
Most of this shift in employment can be
attributed to differences in labor produc
tivity. Victor Fuchs has calculated that, from
1948 to 1978, employment in the servicesproducing sector grew at an average annual
rate of over two percent, while employment
in industry (here defined to include transpor
tation, communications, and public utilities
along with manufacturing, construction, and
mining) was growing at less than one percent
a year and employment in agriculture was
declining by more than two percent a year.
Because the sectors differ much less in terms
of growth in the value of their products than
in numbers employed, Fuchs concludes that
about 75 percent of the difference in employ
ment growth stemmed from substantially
higher labor productivity growth rates in
agriculture and industry than in services.1
National demographic and income trends
2U.S. Bureau of the Census, S o cial and Economic
C haracteristics o f the M etropolitan and Nonmetro
politan Population: 1977 and 1970, Current Population
Reports, Special Studies P-23, No. 75, U.S. Government
Printing Office, Washington, D.C., November 1978.
•^Victor R. Fuchs, “Economic Growth and the Rise of
Service Employment,” National Bureau of Economic
Research, Working Paper No. 486, June 1980.
16
FEDERAL RESERVE BANK OF PHILADELPHIA
METROPOLITAN AREAS SPECIALIZE IN SERVICES
METROPOLITAN
Percent
of
Employment
1970
33.5
29.4
Services
66.5
70.6
100.0
Average
Employment
Growth
Rate
(percent per year)
1977
Goods
NONMETROPOLITAN
100.0
Percent
of
Employment
Average
Employment
Growth
Rate
(percent per year)
1970
1977
0.02
44.1
40.6
2.13
3.18
55.9
59.4
4.90
100.0
100.0
SOURCE: U.S. Bureau of the Census, S ocial and E con om ic C h aracteristics o f the M etropolitan and NonM etropolitan Population: 1977 and 1970. Current Population Reports, Special Studies P-23, No. 75, U.S.
Government Printing Office, Washington, D.C., November 1978.
sectors—manufacturing, retail trade, whole
sale trade, and selected services (a defined
subset of services)—for 14 growing and 14
declining cities over the period 1967-72.3 In
the growing cities, the trade and selected
service sectors accounted for 83 percent of
the growth. In the declining cities, manu
facturing accounted for almost 80 percent of
the net loss.
What is most striking about the declining
cities is that although employment in retail
and wholesale trade also declined, the se
lected service sector actually increased sig
nificantly, offsetting about 12 percent of the
loss in the other sectors. And this rise did not
count health and educational services, which
are not included in selected services but
which also grew substantially over the period.
These widespread urban trends are exempli
fied quite clearly in the case of Philadelphia.
q
U.S. Department of Housing and Urban Develop
ment, Office of Policy Development and Research,
“Changing Conditions in Large Metropolitan Areas,”
Urban Data Report No. 1 [data provided by Seymour
Sachs], Washington, D.C., 1980 as reported in U.S.
Department of Housing and Urban Development, 1980
President’s N ational Urban P olicy Report, HUD-583-1CPD, August 1980, Table 3-3. The selected services
covered by the Census o f Selected Services—the ultimate
source of the data—include hotels, personal services,
business services, automotive and other repair services,
amusement and recreation services, dental laboratories,
legal services, architectural, engineering, and surveying
services; they exclude health, education, social services,
and some other miscellaneous service industries.
SERVICE GROWTH IN PHILADELPHIA
Between 1970 and 1980, according to the
17
BUSINESS REVIEW
JULY/AUGUST 1981
A breakdown of employment change by
sector for the SM SA and the nation can give
some clues to the factors that might be
responsible for the shift out of manufacturing
(see SERVICES GAIN, MANUFACTURING
LOSES IN PHILADELPHIA].
The numbers show that even though most
kinds of services registered strong growth in
the region, the growth rate at the national
level was higher in every case. Growth was
fairly close to the national level, however, in
U.S. Bureau of Labor Statistics, the nation at
large saw increases in both manufacturing
and service employment, of 5.1 percent and
36.5 percent respectively. In Philadelphia,
by contrast, manufacturing employment fell
by 19.9 percent while nonmanufacturing
jobs increased by 18.2 percent.4
4U.S. Bureau of Labor Statistics, P hiladelphia Em
ployment Trends, 1980, June 1981. Totals for nonmanu
facturing are taken from earlier BLS reports.
SERVICES GAIN, MANUFACTURING LOSES
IN PHILADELPHIA
Employment Change: Philadelphia SMSA and the United States, 1970-1980
Percentage
Change
1970-1980*
SMSA
U.S.
Total Employment
Private Sector
Contract Construction
Manufacturing
Transportation and
Public Utilities
Wholesale and Retail
Trade
Finance, Insurance,
and Real Estate
Services and Mining
Government
Federal
State and Local
Total Population
Index of Relative
Performance
SMSA vs. U.S. t
PopulationAdjusted Index
SMSA vs. U.S. $
6.6
5.5
-8.1
-19.9
-6.6
27.9
27.7
24.6
5.1
14.2
.83
.94
.83
.74
.76
.82
.94
.84
.86
.93
-13.5
36.8
.63
.72
22.8
41.6
.87
.99
41.3
12.9
-14.7
26.7
-2.2
54.2
28.8
4.9
35.4
.92
.88
.81
.94
.88
1.05
1.00
.92
1.07
11.5
—
*The 1970 data are not strictly comparable to 1980 date in some industries because of redefinition. These
distortions should be small in most cases.
•(■Philadelphia SMSA share of U.S. employment in 1980 divided by Philadelphia SMSA share of U.S.
employment in 1970.
$ Index of Relative Performance for employment category divided by corresponding index for population.
SOURCE: U.S. Bureau of Labor Statistics, P hiladelphia E m ploym ent Trends, 1980, Regional Report 140,1981,
Table 4.
18
FEDERAL RESERVE BANK OF PHILADELPHIA
two sectors (Services and Mining, and State
and Local Government), and relative to popu
lation the region outperformed the U.S. in
employment growth in these sectors.
The fastest growing subsector of employ
ment in services, both for the SM SA and
nationally, was legal services (see LEGAL
SERVICES SHOW LARGEST GROWTH).
For the country as a whole a number of
reasons can be advanced for the rise, includ
ing increased litigation (partly occasioned by
the increased number and complexity of
government regulations), procedural reforms
which increased the number of hearings and
the length of time before trial for many
defendants, and the funding of community
legal service organizations by the Federal
government. In addition, the 1970s likely
saw a larger than usual percentage of students
decide to pursue careers in the law as a way
of furthering social reform. Philadelphia’s
large increase in legal services employment
probably was, by and large, participation in
this national trend.
Business services employment rose by
almost as large a percentage as legal services,
and here the increase was large both in the
number of jobs—about 33,000—and in com
parison to the nation overall. Providing
business services is a traditional role of
urban areas, and improved communications
LEGAL SERVICES SHOW LARGEST GROWTH
Services Growth: Philadelphia SMSA and the United States, 1970-1978
Percentage
Change
1970-1978*
SMSA
U.S.
Hotels, Lodging
Personal Services
Business Services
Health Services
Hospitals
Legal Services
Educational Services
Colleges &
Universities
7.5
-17.8
69.8
58.9
45.4
70.3
39.2
67.2
Index of Relative
Performance
SMSA vs. U.S.
26.7
-5.5
59.3
63.1
39.9
84.2
29.6
49.2
.85
.87
1.07
.97
1.04
.92
1.07
1.12
PopulationAdjusted Index
SMSA vs. U.S.
.94
.97
1.19
1.08
1.16
1.02
1.19
1.24
*The 1970 data are not strictly comparable to 1978 data for some industries because of redefinition. These
distortions should be small in most cases. Services listed belong to the Services and Mining sector shown in
SERVICES GAIN, MANUFACTURING LOSES . . . . but data shown here are not strictly comparable to data
shown there because of differences in collection methods.
SOURCE: U.S. Bureau of the Census, C ounty B usin ess Patterns, 1970 and 1978.
19
BUSINESS REVIEW
JULY/AUGUST 1981
and transportation enhanced the growth of
the public relations, direct mail, management
consulting, testing, data processing, and other
firms that make up this subsector. It is
possible also that changes in organizational
structure for firms in the area, which led to
purchases of services from outside firms
rather than in-house provision, could have
caused some growth in this field.
Educational services, especially those
provided by colleges and universities, were
other big gainers. They grew appreciably
faster in Philadelphia than in the nation at
large. At the national level an increased
demand for higher education was caused by
the maturing of the postwar baby boom—a
trend which has run its course. Probably the
most important factor influencing the local
rise was the presence of many established
institutions of higher learning in the SM SA,
especially in the city. The percentage rise for
educational services employment was even
higher for the city than for the SM SA (see
Appendix).
Health services employment also increased
substantially. Although the raw percentage
rise was smaller than nationally, when ad
justed for Philadelphia’s population decline
the percentage change was greater. The
growth of in-kind income for health services,
both from private health plans and public
sources, principally Medicare and Medicaid,
strongly stimulated medical services employ
ment nationally over the period, and the
Philadelphia area may have gained more
than proportionally from these sources. The
SMSA also had a larger percentage increase
in the over-55 population than did the nation—
another likely factor in stimulating a greater
demand for medical services in the area.
In short, Philadelphia showed considerable
strength in services even as its manufacturing
employment was ebbing away. These facts
are not compatible with the manufacturing
version of the export-base theory, but they
can be accommodated by a restructured
version.
RETOOLING THE EXPORT THEORY
The export-base theory was developed to
deal with manufacturing economies. But it
can be applied to service-oriented economies
if external sources of demand for services
can be identified and if associated revenue
flows can be detected.
The Shape of the Theory. The main pre
miss of the export-base theory is that the
growth of cities is determined by what they
sell elsewhere. Thus the theory divides the
economy of a city into two sectors—export
and local. Firms in the export sector sell their
wares mainly to customers outside the city,
both in the immediately surrounding area
and in other cities. Detroit’s automobile in
dustry and Pittsburgh’s steel plants are prime
examples of export sectors. The local sector,
however, produces mostly for city customers.
Places like beauty salons, auto repair shops,
and pizza parlors belong to the local sector.
The smaller the city, on this theory, the
more important the export sector is likely to
be, because export earnings are used to pay
for imports. Since smaller places are less
self-sufficient—that is, since their residents
must buy more kinds of goods and services
from elsewhere—their imports are relatively
large. So, in general, their exports must be
larger, too. But whether large or small, all
cities clearly must export something of value
to pay for agricultural supplies and other
goods and services produced outside their
boundaries.
In the export-base theory, city growth is
fueled by the rest of the world’s demands for
the city’s products. “Trenton makes, the
world takes,” as the sign by the railroad says.
Growth in exports feeds back into the city’s
economy, multiplying the initial effect on
the exporting industry.
Suppose Detroit’s car sales rise. Then
workers and others who receive income
from auto plants will have more to spend,
and much of it will get spent and respent in
the local economy. Retail stores, restaurants,
and other local service providers will find
20
FEDERAL RESERVE BANK OF PHILADELPHIA
their incomes rising, and they, too, will
increase their purchases. Another source of
this multiplier effect is purchases of parts
and business services from other companies
by the auto plants themselves as business ex
pands. Since some of these purchases will be
for imports, the process doesn’t continue
forever. Gradually, the extra dollars brought
in by increased export earnings leak out of
the local economy into imports, but not
before the initial increase has been multiplied.
Together these induced effects {through higher
incomes) and indirect effects [higher local
business purchases) will result in the re
spending of export dollars again and again in
the local economy before they are siphoned
away.
The dark side of the theory is the effect of a
decline in the demand for exports. Here, too,
the effect is multiplied, but now in a down
ward direction. As auto workers lose overtime
and get laid off, and as auto plants stop
buying from their suppliers, the initial loss of
Exportation of Services. One reason
manufacturing often is identified as the ex
port sector and nonmanufacturing as the
local sector of an urban economy is that
where a product is consumed is confused
with where the money comes from to pay for
it. Unlike most exported manufactured goods,
which are bought and consumed outside the
producing city, many exported services are
consumed within the city of origin. Tourist
services offer a prime example. Although
these services may be consumed in Phila
delphia or Atlantic City hotel rooms and
restaurants, they are as much export items as
Detroit’s autos. The key thing is that the
money comes from outside.
Another reason for thinking of the export
sector as manufacturing is that doing so used
to get much closer to the truth. A hundred
years ago, transportation technology was
oriented more toward moving freight than
toward moving people, and communications
technology could handle far less information
than it can now. As transportation and
communications have developed, the possi
bility of exporting services of all types has
increased tremendously.
income is multiplied, drastically worsening
the economic situation.
In this form, the theory is simple, elegant,
and persuasive, but it focuses on economies
that are based on manufacturing rather than
on services. And in urban areas, the service
sector has been growing even as local em
ployment in manufacturing has been falling
off. This growth in the urban service sector
can be explained only in part by trends in
national productivity, demography, and in
come. A retooled export-base theory is
needed to explain the remainder.5*
The growing importance of service expor
tation from metropolitan areas has been
investigated by Richard V. Knight of Cleve
land State University. From 1940 to 1960,
adjusted median family incomes in metropolitan areas
could help explain higher levels of service employment
there, but again the trend during the 1970s was in the
wrong direction to explain relative services growth: real
family incomes fell in metropolitan areas between 1970
and 1977, especially in central cities, while growing in
nonmetropolitan areas. Differences in demographic
trends also offer little help as an explanation. The
percent of the population over 65 and the percent of
families without children both were lower in metropoli
tan than in nonmetropolitan areas during the 1970s. It is
true that both categories increased substantially in
metropolitan areas, which certainly increased services
employment. But these increases relative to the popula
tion basically paralleled national trends, and thus they
do not provide an explanation for the urban orientation
of services growth.
5If productivity, demographic, and income trends
had moved farther toward services in metropolitan
areas than in nonmetropolitan areas, they might help
explain the greater urban specialization in services. In
general this does not seem to be the case. Although the
level of manufacturing productivity is higher in metro
politan areas, nonmetropolitan areas have been experi
encing faster rates of manufacturing productivity growth,
especially over the 1970s. This would tend to work
against the strong relative performance of metropolitan
areas in the services over that period. Higher inflation-
21
JULY/AUGUST 1981
BUSINESS REVIEW
export growth and import substitution, if
demand is being generated by net transfers
of income to local residents. A retirement
community, for example, could have virtually
no exports but still have a thriving local
service sector financed by private and gov
ernment pension payments, dividends, social
security, and transfer income flowing to
local residents from elsewhere. Metropolitan
areas, and particularly older central cities
that have been net recipients of transfers,
may have seen higher ratios of service em
ployment to manufacturing employment than
other parts of the country. It seems virtually
certain that increasing Federal transfer pay
ments helped support some of the growth of
local service employment in the most dis
tressed cities even as manufacturing jobs fell
off precipitously.7
Thus the exportation of services and net
transfers into a region can generate income
flows that act like those generated by manu
facturing exports: they can be spent and
respent in the local economy in the same way
as income from manufacturing exports. So
flows from service exports and those from
transfers have the same local multiplier
effect.8 But transfers are radically different
according to his estimates, the services (in
cluding trade) increased their share of total
metropolitan employment in export activities
from 36 percent to 44 percent. The largest
components of these export services were
business-oriented services such as finance
and transportation, which rely on large trans
fers of information and frequent face-to-face
contacts. Most of the trade in services was
estimated to occur among metropolitan areas:
in 1960 about one-third of metropolitan ser
vice requirements were estimated to be im
ported, and most of that third came from
other SM SA s.6
A related source of growth in services is
import substitution. If service producers in
one area start providing services that resi
dents had been importing from other areas,
then the local service sector will grow. In
general, import substitution is associated
with growing areas. As population thresholds
are reached, it becomes economical to pro
vide all kinds of specialized services, ranging
from those of full-service hospitals to those
of gourmet restaurants, that residents used
to get elsewhere. Since the population of
nonmetropolitan areas has been growing
faster than that of metropolitan areas, import
substitution probably has shifted some ser
vice employment growth away from the cities.
But certain service sectors in certain metro
politan areas probably have grown through
this mechanism.
The Effect of Transfers. Another source
of growth for urban service employment is
demand fueled by transfer payments and
related income flows into the local economy.
The local sector can grow faster than the
national economy, even in the absence of
7Some evidence points to transfers as an important
factor. From 1970 to 1977, public assistance income
rose from 1 percent to 2 percent of aggregate income in
central cities, while in nonmetropolitan areas it went
from 0.7 percent to 0.9 percent. But the percentage of
income from all sources other than wages, salaries, and
self-employment—which would include social security
and other public and private transfers along with public
assistance—rose faster and to a higher level in non
metropolitan areas than in either central cities or
suburbs.
^Richard V. Knight, E m ploym ent Expansion and
M etropolitan Trade (New York: Praeger, 1973). Knight’s
calculations assume that income flows into SMSAs
from other sources—taxes, transfers, and investments—
are zero. Thus if positive net transfers have helped fuel
some metropolitan service growth, his export figures
would be too high.
8The only differences would stem from the differences
in income and tastes of the recipients of these various
flows and any restrictions on the use of transfers, as for
health service payments, leading to different patterns of
consumption of local and imported goods and services.
Social security recipients, for instance, have different
spending patterns from most wage earners. Thus the
local income multiplier for a dollar generated by one
inflow probably would differ somewhat from the multi
22
FEDERAL RESERVE BANK OF PHILADELPHIA
from exports when viewed from an economic
development perspective.
For sectors where export demand might
grow at the national rate of population growth
rather than at the local rate, prospects could
be strong. Business services could fall into
this category for the Philadelphia SMSA,
given that their growth rate here has been
higher than the national rate, as could certain
health services. Some local health services
employment growth probably has been fueled
by exportation, and national demand is likely
to continue to grow, given the overall aging
of the population and the continuing upsurge
of new medical technology. But to the extent
that local growth has been fueled by Federal
transfer payments, especially Medicaid,
proposed cutbacks could make the future
distinctly less rosy.
Demographics and a changing Federal
thrust will have effects on other fast-growing
sectors. Most of the baby-boom population
now is beyond college age, so that cutbacks
in educational employment seem fairly likely
unless a rising share of the population opts
for higher education. Continued legal ser
vices employment growth could be clouded
over the long run by the current thrust
toward deregulation, at least to the extent
that deregulation is successful in reducing
the complexity and scope of government
interaction with business. But the recent
lifting of the ban on advertising of legal
services could continue to open new markets
for lawyers and other legal professionals
well into the 1980s.
Thus understanding which factors will
drive future local services growth is vital to
formulating sound regional economic devel
opment policies. And application of the
export-base theory to services offers a useful
tool for achieving this understanding.
LESSONS
FOR LOCAL DEVELOPMENT POLICY
What is the message that economic de
velopment planners in Philadelphia and else
where can derive from applying the exportbase theory to services?
The first lesson is that the service sector’s
share of employment will continue to grow
locally and nationally. A resurgence of
manufacturing employment large enough to
take up any appreciable slack in the local
labor market seems almost as unlikely as a
massive rise in farm employment, and for
much the same reason: stronger productivity
growth in manufacturing and agriculture,
while benefiting consumers greatly by in
creasing real purchasing power, eliminates
jobs in these sectors. Further, there has been
a dramatic shift in the location of manu
facturing activity out of this region, which
policymakers may decry but probably can’t
reverse. This is not to say that attempts to
stimulate certain kinds of manufacturing
jobs should not be made. The New England
region has benefited greatly from growth in
high-technology industries, for example, and
benefits do spill over through the multiplier
effects to other sectors. The Middle Atlantic
also could gain from hi-tech manufacturing
industry.
The second lesson is that the service sec
tor’s growth is not merely parasitic on manu
facturing but is a dynamic force for economic
development in its own right. Firms that
generate service exports and replace service
imports are as vital to target as any others.
Such firms can open their doors and expand
locally without decreasing employment at
other local firms.
A third lesson is that local service indus
tries which have relied heavily on Federal
and state transfer payments as a source of
growth may face a rocky future. Continued
growth could depend on replacing some
transfer revenues with revenues from other
sources, particularly export demand. Un
fortunately, too little is known about the
plier for a dollar from another inflow. But in general,
services exportation and transfers work substantially
through the multiplier without changing its overall
value very much.
23
JULY/AUGUST 1981
BUSINESS REVIEW
the goods and service sectors thus provides
another reason for development-minded pol
icymakers to focus on services.9
In short, the manufacturing sector and the
service sector both are important contributors
to the health of urban economies. Both
sectors should be given a careful look by
those interested in urban economic develop
ment. But like it or not, the bulk of new
employment will be in services. Better moni
toring of the service sector and a better
appreciation of the interlocking nature of the
local economy will be required if develop
ment efforts are to be targeted in the most
cost-effective ways.
relative strengths of the various forces driving
the several service industries, especially at
the regional level. Until better information is
available, economic development planners
will be flying relatively blind when they try
to target development efforts and cope with
impending changes in the service sector.
While the export-base theory can be ap
plied to the service sector, it fails to capture
certain features unique to that sector. Chief
among these is the fact that the service sector
is a vital ingredient in an area’s business
climate overall. Restaurants, cultural facili
ties, sports and entertainment, good public
services, and a wide variety of business
services provide a desirable framework for
the growth of new businesses and the attrac
tion of a labor force. The role of the local
service sector in attracting and stimulating
jobs in export industries long has been recog
nized as an important factor in long-run
urban growth by economists and urbanologists. The complex interconnectedness of
9Beyond the export issue there are many extremely
important questions concerning the services’ suitability
as abase for urban economic development. Can the new
jobs created match the skills of unemployed city residents?
Can the service jobs provide an adequate tax base for
local governments? Can services anchor neighborhood
economic development? Does shifting to services damp
en the effect of the business cycle on the local economy?
AP»
, AFT©
24
FEDERAL RESERVE BANK OF PHILADELPHIA
APPENDIX*
PHILADELPHIA SHOWS
STRENGTH IN SERVICES
EVEN THOUGH TOTAL EMPLOYMENT
AND POPULATION SLIP
From 1970 to 1980, total employment in the city of Philadelphia declined by 15 percent—a loss of
almost 140,000 jobs. While this loss contrasts with the overall job gain in the SMSA, the city’s
Employment Change, 1970-1980
Philadelphia City and the United States
Percentage
Change
1970-1980
City
U.S.
Index of Relative
Performance
City vs. U.S.
PopulationAdjusted Index
City vs. U.S.
Total Employment
-15.0
27.9
.66
.85
Private Sector
-17.3
27.7
.65
.83
Contract Construction
-38.3
24.6
.50
.64
Manufacturing
-42.9
5.1
.54
.69
Transportation and
Public Utilities
-22.1
14.2
.68
.87
Wholesale and
Retail Trade
-18.8
36.8
.59
.76
Finance, Insurance,
and Real Estate
-6.6
41.6
.66
.85
Services and Mining
19.2
54.2
.77
.99
Government
Federal
State and Local
-4.2
-20.3
8.2
28.8
4.9
35.4
.74
.76
.80
.95
.97
1.03
Total Population
-13.4
11.5
.78
—
SOURCE: U.S. Bureau of Labor Statistics, Philadelphia Employment Trends, 1980, Regional Report 140,1981,
Table 4, 5,
relative pattern of change across sectors was similar to the SMSA’s. The largest loss—about 43
percent, representing over 100,000 jobs—was in manufacturing, while the only nongovernment
gains were in services. Even the Finance, Insurance, and Real Estate sector, which showed gains in
the SMSA at about half the national rate, declined in the city.
Employment gains were concentrated in health services (particularly hospitals), legal services,
and educational services. Educational services actually outperformed the nation and the SMSA
over this period, with growth in employment at colleges and universities especially strong. But
business services jobs grew only about four percent—good from the point of view of the city’s
overall employment loss, but weak relative to the SMSA’s growth rate, which exceeded the national
growth rate of almost 60 percent. Since growth in health, educational, and (to some extent) legal
services has depended more heavily than that in business services on transfer flows, prospects for
continued services growth in the city may be less promising than for the SMSA.
Services Growth, 1970-1978
Philadelphia City and the United States
Percentage
Change
1970-1978
City
U.S.
Index of Relative
Performance
City vs. U.S.
PopulationAdjusted Index
City vs. U.S.*
Hotels, Lodging
-35.2
26.7
.51
.62
Personal Services
-38.5
-5.5
.65
.79
Business Services
3.9
59.3
.65
.79
42.2
63.1
.87
1.06
Hospitals
36.7
39.9
.98
1.20
Legal Services
60.3
84.2
.87
1.06
Educational Services
58.9
29.6
1.23
1.50
71.6
49.2
1.15
1.40
Health Services
Colleges &
Universities
SOURCES: U.S. Bureau of the Census, C ounty Business Patterns, 1970 and 1978.
*The 1970 data are not strictly comparable to 1978 data for some industries because of redefinition. These
distortions should be small in most cases.
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