Full text of Business Review (Federal Reserve Bank of Philadelphia) : May/June 1982

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

F ederal R e se r v e Bank o f P hiladelphia

M AY-JUNE 1982

The BUSINESS REVIEW is published by
the Department of Research every other
month. It is edited by John J. Mulhern, and
artwork is directed by Ronald B. Williams.
The REVIEW is available without charge.
Please send subscription orders and
changes of address to the Departm ent of
Research at the above address or telephone
(215) 574-6449. Editorial communications
also should be sent to the Departm ent of
Research or telephone (215) 574-6426.
Requests for additional copies should be sent
to the Departm ent of Public Services.

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 W ashington. The
Federal Reserve System w as established by
Congress in 1913 prim arily to manage the
nation’s m onetary affairs. Supporting func­
tions include clearing checks, providing coin
and currency to the banking system, acting
as banker for the Federal government, super­
vising commercial banks, and enforcing
consumer credit protection laws. In keeping
with the Federal Reserve Act, the System is
an agency of the Congress, independent
administratively of the Executive Branch,
and insulated from partisan political pres­
sures. The Federal Reserve is self supporting
and regularly m akes paym ents to the United
States Treasury from its operating surpluses.

FEDERAL RESERVE BANK OF PHILADELPHIA

Margaret Thatcher’s

Economic Experiment:

Are There Lessons
for the Reagan Administration?
By Stephen A. Meyef
tion soared after Mrs. Thatcher took office.
The United States now faces economic
difficulties like those that plagued Britain
before Thatcher w as elected. In response,
the Reagan Adm inistration has put in place
an economic package which it hopes will
reduce unemployment, spur economic growth,
and reduce inflation. President Reagan’s
economic package includes tax cuts and
deregulation to stim ulate output and invest­
ment. The President also has called for slow
growth of the money supply to reduce
inflation.
W hen the U. S. economy slid into recession
during the second half of 1981, many com­
m entators drew ominous comparisons be­
tween Reagan’s policies and Thatcher’s. Will
economic problems in the U.S. worsen
dramatically, as they did in Britain? To
answer this question we m ust look carefully
at the actual economic policies put in place in

W hen M argaret Thatcher became Prime
M inister of Great Britain in May 1979, she
pledged a new direction for economic policy.
Her goal was to reverse Britain’s long-term
difficulties of slow economic growth, low
productivity, and high inflation. She called
for lower taxes and for less government inter­
vention in the economy to encourage more
output and investment, and for slower growth
of the money supply to reduce inflation. Her
supporters expected these policies to lead to
rapid real growth and less inflation. Instead,
the unem ploym ent rate in the United
Kingdom more than doubled, real output of
the British economy fell sharply, and infla* Stephen A. Meyer is Senior Economist in the Money
and Macroeconomics section of the Philadelphia Fed’s
Research Department. He also teaches macroeconomics
and international finance at the Wharton School,
University of Pennsylvania.




3

BUSINESS REVIEW

MAY/JUNE 1982

Britain and the U.S., not at the promised
policies.

Excise taxes on petroleum products, liquor,
cigarettes, and other products were raised
also. In addition, taxes on North Sea oil
production were increased. These tax hikes
were expected to increase total tax revenue
by 4 percent above w hat they would have
been otherwise during the 1979 tax year. 2
Increases in VAT and in excise taxes were
large enough to generate an overall tax hike,
because they were combined w ith hidden tax
increases caused by bracket creep. Britain’s
high inflation during 1979 pushed people
into higher tax brackets at the same time that
tax rates for those higher brackets were cut.
Bracket creep largely undid the cuts in
personal tax rates; so income tax revenues in
Britain stayed roughly constant, in real
terms, from the 1978 to the 1979 tax year.
During the same period the real value of
taxes on consumers’ expenditures rose 21
percent. As a result the real value of taxes
levied on Britons actually rose by 7.5 percent
from the preceding year, which helped to
start a recession.
Taxes were raised further in 1980 and 1981
even though the British economy was al­
ready in a recession. In its 1980 budget the
Thatcher government adjusted income tax
schedules to offset most of the bracket creep
caused by inflation, but it raised taxes on
consumers’ expenditures even more. In
1981, income tax schedules were left un­
changed, so that real income taxes were effec­
tively raised again as inflation pushed people
into higher tax brackets; in addition, excise
and other taxes on expenditure were raised
yet another time. 3

BRITISH FISCAL POLICIES
WERE NOT AS PROMISED
Mrs. Thatcher had promised an economic
program intended to deal with Britain’s
problems of high unemployment and eco­
nomic stagnation, but the policies adopted
were not the promised ones. She had pledged
to cut taxes to provide improved incentives
for individuals to work and to invest, but
actually she raised taxes substantially. She
also had promised to reduce the size and
economic role of the government in order to
return economic resources to the private
sector, but government spending rose.
British fiscal policies pushed the economy
into recession rather than promoting growth.
British Taxes Rose Despite Income Tax
Cuts. To carry out its campaign promise, the
new British government enacted an acrossthe-board cut in personal income tax rates.
As a result, total government revenue was
reduced by roughly 5 percent from w hat it
would have been otherwise. Mrs. Thatcher
also had pledged to reduce the government’s
budget deficit. Because cutting income tax
rates would have resulted in a larger budget
deficit, other taxes w ere raised to make up
the revenue loss. In particular, the valueadded tax (VAT), which is similar to a
national sales tax, w as raised from 8 percent
to 15 percent of value-added on most goods. i
* A value-added tax is levied at each stage of produc­
tion or distribution on the difference between the price at
which a product is sold and the cost of raw materials and
parts which are used to make that product (thus ‘valueadded’). The value added by a retailer is (roughly speaking)
the difference between the retail price and the wholesale
price he paid for the item. The value added by a manu­
facturer is the difference between the wholesale price
she charges for the item and the cost of parts which go
into the item. The value added by the maker of parts is
the difference between the price at which he sells the
parts and his cost for raw materials. Adding up the value
added at each stage, we clearly get the retail price of the
item before tax. Thus a 15-percent tax on value added at
each stage is like a 15 percent tax on total value, that is,




like a 15-percent sales tax.
2 The British tax year, or fiscal year, begins in April
and runs through March of the following year.
3 A detailed presentation of the first budget adopted
by the Thatcher government can be found in The Econo­
mist for June 16, 1979, pp. 63 ff. The British govern­
ment’s budget for the 1980 tax year is discussed in The
Economist for March 29, 1980, on pp. 25-36. A similar
treatment of the 1981 budget appears in The Economist
of March 14, 1981, on pp. 51-65.
4

FEDERAL RESERVE BANK OF PHILADELPHIA

ment spending rose by 3.4 percent in the first
year and by approxim ately 1.3 percent more
in the second year. For the 1981 tax year real
government spending rem ained at roughly
the previous year’s level. M uch of the in­
crease in real government spending since the
new government took office was caused by
large salary increases for government employ­
ees and by growth of transfer payments (such
as unemployment compensation] resulting
from Britain’s recession.
The Thatcher government was only a little
more successful in carrying out the second
element of its program to reduce the eco­
nomic role of the government. The British
government did m anage to sell part of its
interest in several high-technology and
service companies, and it also sold part of its
share of British Petroleum. But the remain­
der of the nationalized firms, including those
in the steel, coal, shipbuilding, and auto­
mobile industries, rem ain under government
control. All of these nationalized firms run
large losses and require growing subsidies
from the central government.
Although the government has not suc­
ceeded in reducing its size, neither has it
allowed its spending to grow as fast as it did
in earlier years. As a result, total tax revenues
have risen relative to government spending
in Britain since Thatcher’s election, making
fiscal policy restrictive. The tighter fiscal
policy could have been offset, at least in part,
by new supply-side incentives. But none were
provided.
Tax Changes Did Not Improve Incentives
To Work. The Thatcher government did enact
an across-the-board cut in m arginal tax rates
on personal income. 4 Cuts in marginal tax
rates on wages and salaries were intended to
provide greater incentives for those already

The British government raised taxes w hen
Britain was in a recession because it focused
on the size of the government’s budget deficit.
Policymakers appear to have ignored the fact
that much of the government’s budget deficit
was caused by Britain’s worsening recession.
As the British economy turned down, tax
revenues collected by the government fell
below projected levels because personal in­
come and spending fell (in real terms] as
workers were laid off or put on short time.
Lower-than-expected tax revenues meant a
higher-than-expected budget deficit. The
British government apparently interpreted
the larger budget deficit as indicating that
fiscal policy w as too expansionary, and so it
raised taxes in an attempt to reduce that deficit.
These tax increases made the recession more
severe. Mrs. Thatcher was elected on a pledge
to cut taxes. Instead her government raised
the real tax burden substantially.
Government Spending Was Not Cut.
Cutting taxes is not the only pledge that Mrs.
Thatcher was unable to carry out. The
Thatcher government believed that private
individuals and firms would use resources
more efficiently than the public sector. If so,
giving the private sector command over more
resources would increase the efficiency of
the British economy, thus raising productivity
and the standard of living.
Mrs. Thatcher’s program contained two
elements designed to reduce the size and eco­
nomic role of the British government. The
first was a pledge to reduce the real value of
government spending (after adjusting for in­
flation] by one percent per year from 1979 to
1984. The second element was to sell some of
Britain’s nationalized firms to private inves­
tors. So far the government has had little
success in returning resources to the private
sector because it has been unable to imple­
ment either element of its program.
Although Mrs. Thatcher pledged to reduce
the real value of government spending (after
adjusting for inflation] in the 1979 and 1980
tax years, the real value of central govern­




4
The marginal tax rate is the percentage of any addi­
tional income that one must pay to the taxman. When we
speak of someone as being in the 50-percent tax bracket,
we are referring to that person’s marginal tax rate.
5

BUSINESS REVIEW

MAY/JUNE 1 9 8 2

taxes went up). The real purchasing power of
an additional hour of work w as lower after
the tax changes, except for families with
high incomes.
Fiscal Policy Was Restrictive Overall. The
upshot of the tax and spending policies adopted
by the government was a contractionary fis­
cal policy with no offsetting supply-side
stimuli. During the first two years of Mrs.
Thatcher’s tenure, the real value of taxes
levied by the central government in Britain
rose more than twice as much as government
spending. In the 1981 tax year, real govern­
ment expenditures were held approxim ately
constant while real taxes again rose substan­
tially. These tax increases were not offset by
providing greater supply-side incentives; in
particular, the total marginal tax bite on extra
earnings was not lowered. Thus fiscal policy
in Britain has been contractionary, overall.
The restrictive fiscal policy is one reason
why the British economy is undergoing a
severe recession. A nother reason is that
monetary policy was also restrictive—much
more restrictive than the government had
planned.

working to work longer hours, and for those
not working to take jobs. Cuts in marginal tax
rates on interest and dividend income were
intended to provide greater incentives for
people to save and invest. 5
The highest tax rates were cut drastically.
The top tax rates during the 1978 tax year
were 83 percent of wages and salaries and 98
percent of interest and dividends for that part
of total income above £ 30,075 (equivalent to
approximately $51,000). For the 1979 tax year,
Mrs. Thatcher slashed these rates to 60 per­
cent of wages and salaries and 75 percent of
interest and dividends. Similar but smaller
cuts in tax rates were enacted for people at
lower income levels. Most families in Britain
found themselves in one large tax bracket
which stretched from £ 3,700 to £ 12,000 (or
$6,300 to $20,400); for these families the
marginal tax rate was cut from 33 percent in
1978 to 30 percent in 1979.6
Incentives to work, save, and invest may
have been increased by cuts in income tax
rates, but they were reduced by other policies.
While personal income tax rates were cut
substantially, at least at higher income levels,
much of those cuts was eroded by bracket
creep caused by high inflation. The valueadded tax was raised at the same time. Most
workers discovered that if they worked an
extra hour they could take home a slightly
bigger fraction of their extra pay (because
income taxes were cut), but they also discov­
ered that their extra take-home pay would
buy less than before (because consumption
5
All of these are supply-side policies. For a discus­
sion of how these incentives work, and how large they
might be, see Aris Protopapadakis, "Supply-Side Eco­
nomics: What Chance for Success?” Business Review,
Federal Reserve Bank of Philadelphia, May-June 1981.
®The income levels cited here are for the example of a
married couple, both working. Incomes are given in
1979 £ throughout, with the U.S. equivalent required to
achieve the same purchasing power in the U. S. if the tax
systems in the two countries were identical. The tax
rates cited are for income tax only; they abstract from
Social Security taxes, sales taxes, and other taxes.




6

MONETARY POLICY
WAS TIGHTER THAN INTENDED
The Thatcher government pledged to
reduce the rate of growth of the money supply
in Britain gradually, in order to bring down
the inflation rate while avoiding a credit
crunch. The government chose to target a
broad measure of money known as sterling
M 3.7 For the 1979 fiscal year the target rate
of growth of sterling M3 was 10 percent, with
an allowable range of 8 percent to 12 percent.

7 Sterling M3 is defined as currency in circulation plus
sterling denominated checkable deposits owned by the
U.K. private sector plus sterling denominated time de­
posits owned by the U.K. private sector plus sterling
denominated deposits owned by the U.K. public sector.
Thus sterling M3 is a broad monetary aggregate which
includes the equivalents of large certificates of deposit
and other savings certificates.

FEDERAL RESERVE BANK OF PHILADELPHIA

M3 will rise or fall w hen individuals shift
from certificates of deposit issued by banks
to similar instrum ents from other issuers, or
vice versa. But such shifts leave liquidity
unchanged. People chose to shift funds into
bank certificates of deposit and other bank
time deposits and out of other money-market
instrum ents during the second half of 1979
and during 1980, because the British govern­
ment changed regulations governing banks.
The resulting high growth rate of sterling M3
did not represent a high growth rate of
liquidity in the economy. By contrast, the
growth rate of a broader measure of liquidity
which includes both bank deposits and com­
parable m oney-market instrum ents actually
fell in the year after Mrs. Thatcher became
Prime M inister. Growth of this broader
aggregate—PSL2—slowed from 15 percent
per year over mid-1977 through mid-1979 to
12.2 percent during mid-1979 to mid-1980.
A m onetary aggregate constructed for pur­
poses of monitoring the tightness or ease of
monetary policy can quickly become obsolete
when government regulation of financial
institutions changes. Just such a regulatory
change was introduced in Britain in 1979 and
1980 by the Thatcher government: the govern­
ment removed restrictions on banks’ offering
certificates of deposit. This change contrib­
uted to the shift of funds out of money-market
instruments into interest-bearing bank
deposits. Thus the regulatory changes in
Britain contributed to making sterling M3 a
misleading indicator of m onetary policy.
A similar difficulty arose in the United
States early in 1981 when NOW accounts
became available nationwide. As individuals
moved billions of dollars from checking ac­
counts and savings accounts into NOW
accounts, the money supply figures for the
United States were distorted. W hen someone
took funds out of a savings account and put
them into a NOW account, the M1B measure
of the U.S. money supply went up even
though that person’s bank balance was un­
changed overall. U.S. policymakers adjusted

The target and its associated range were to be
lowered by one percentage point each year,
so that by fiscal 1983 the target would be 6
percent money growth with an allowable
range of 4 percent to 8 percent. Inasm uch as
sterling M3 had grown by almost 12 percent
during the 1978 fiscal year, the announced
targets represented moderately tighter mone­
tary policy. 8
By making its tight monetary policy known
in advance, the government was trying to
lower inflationary expectations. The govern­
ment hoped that unions would accept lower
wage increases and firms would post smaller
price hikes if they believed that inflation
would decline. British policymakers hoped
to reduce inflation w ithout causing rising
unemployment and falling sales.
Sterling M3 actually grew by 15 percent in
the year after Mrs. Thatcher took office, so it
might seem that m onetary policy did not be­
come tighter. However, sterling M3 gives a
misleading impression of m onetary policy;
other m easures suggest m onetary policy was
quite restrictive.
Sterling M3 Is a Poor Indicator. By
choosing to focus attention on sterling M3,
the Thatcher government created confusion
about its m onetary policy, because sterling
M3 is not a very good measure of money.
Sterling M3 includes various bank deposits,
such as certificates of deposit, which are not
transactions balances (cannot be spent di­
rectly), but it does not include similar moneym arket instrum ents issued by other financial
intermediaries. Thus the figures for sterling
8 In Britain it is the Prime Minister and her cabinet
who make decisions about monetary policy targets. The
central bank (the Bank of England] exercises consider­
able discretion in carrying out monetary policy, and also
helps the administration in choosing targets. But it is the
Prime Minister who has the final authority to set mone­
tary policy. In the United States, by contrast, the central
bank (the Federal Reserve System) is an independent
agency responsible to the Congress. The President of the
United States does not exercise control over monetary
policy.




7

BUSINESS REVIEW

MAY/JUNE 1 9 8 2

the m easured money supply (M1B) to cor­
rect for this distortion. But in Britain no such
correction w as made to sterling M3; the
British government continued to set its mone­
tary targets in terms of a misleading indicator
of m onetary policy.
Monetary Policy Was Extremely Tight.
Other, better m easures of British m onetary
policy than sterling M3 indicate that mone­
tary policy became much tighter after Mrs.
Thatcher took office. The m onetary base
(currency in circulation plus bank reserves),
which is directly under the control of the
central bank, grew by more than 15 percent
in each of the two years before the election.
In the year after, from M ay 1979 to May
1980, the m onetary base grew much less, by
8.4 percent. Growth of the m onetary base
slowed further during the following year.
From M ay 1980 to M ay 1981, the monetary
base grew by only 5.3 percent. This sharp
decline in the rate of growth of the monetary
base is a signal of tighter monetary policy. 9
The growth rate of M l, a m easure of tran­
sactions deposits, confirms the monetary base
signal that m onetary policy was tig h t.10 The
rate of growth of sterling M l in Britain
slowed from an average rate of almost 19
percent in each of the two years before the
election to 6.5 percent in the following year.
During the second year of Mrs. Thatcher’s
tenure, the rate of growth of sterling M l
slowed further, to 1.6 percent.
Tight m onetary policy not only helped to
push the British economy into its current
recession by driving up the real cost of bor­
rowing funds; it also caused the British

pound to appreciate on international currency
markets, which worsened the recession.
Tight monetary policy drove up interest rates
in Britain and also reduced the expected future
inflation rate, which made British pounds
more attractive. As foreigners rushed to buy
British pounds, they pushed up the price of
pounds in terms of foreign currencies, n The
appreciation of the pound made British
goods more expensive abroad and made
foreign goods cheaper in Britain. Both Britons
and foreigners bought few er British goods as
a result. This decline in demand for British
goods made the recession in Britain more
severe.
Although very tight m onetary policy
helped to cause the British recession, it did
not immediately reduce inflation. In fact, the
inflation rate doubled in the year following
Mrs. Thatcher’s inauguration, but not be­
cause of the new, tighter m onetary policy
(see WHY INFLATION SOARED). Slow
money growth will take longer than a year to
bring down inflation.
RESTRICTIVE ECONOMIC POLICIES
CAUSED THE BRITISH RECESSION
The government’s restrictive monetary and
fiscal policies caused a sharp reduction in
aggregate demand for British goods and ser­
vices. Taxes were raised substantially, as
consumption taxes were raised and real in­
come taxes were not cut. Taxes were raised
much more than government spending. Mone­
tary policy was tightened as well, as indicated
by sharp reductions in the rates of growth of
the monetary base and M l. The effects of
tight money were reinforced by the resulting
appreciation of the exchange rate.
These restrictive demand-management
policies were not offset by new supply-side
incentives. British firms found that declining

®In British terminology, the monetary base is defined
as “Notes and coins in circulation with the public plus
Notes and coin held by banks plusBanker’s deposits held
at the Bank of England.” Data can be found in the Bank of
England Quarterly Bulletin, March 1981, pp. 59-65.
10
British M l is defined as "Notes and coin in cir­
culation with the public plusU.K. private sector interest
bearing and non-interest bearing sight deposits.” Thus
British M l corresponds to U.S. M l.




11
The British pound increased in value from $2.06 per
pound when Mrs. Thatcher took office to $2.40 per
pound at the end of 1980.
8

WHY INFLATION SOARED
Monetary policy became much tighter after Margaret Thatcher became Prime Minister. Policy­
makers expected that tight monetary policy would reduce the inflation rate. But inflation in Britain
nearly doubled in the year after Mrs. Thatcher took office. The consumer price index in Britain rose
by 11.3 percent in the year ending in June 1979 but jumped by 21 percent in the following year, the
first year of Mrs. Thatcher’s tenure. In her second year in office prices rose by another 11.3 percent,
despite the restrictive monetary policy she adopted. Does this mean that tight monetary policy no
longer works to reduce inflation in Britain?
Raising the value-added tax and excise taxes was one cause of higher inflation in the year
following the election. A more important cause is that the rate of growth of the money supply had
accelerated greatly two years before the Thatcher government took office. Speeding up or slowing
down the money supply growth rate usually causes the inflation rate to speed up or slow down one to
two years later. The sterling M l measure of the money supply in Britain (transactions balances) grew
by 10.8 percent in the year ending June 1977, but then it accelerated to a growth rate of 22.2 percent
from June 1977 to June 1978. * From June to December 1978 the growth rate of M l was 16 percent per
year. Economists would expect the year of more rapid money growth to be followed by more rapid
inflation about two years later, in 1979. This is precisely what occurred, as the accompanying Figure
reveals. To a large extent, the rise in inflation which occurred in the year after Mrs. Thatcher took
office was inherited from the previous government.
Not all of the rise in inflation was inherited, however. In June 1979 Mrs. Thatcher announced an
increase in the value-added tax on most commodities from 8 percent to 15 percent. This tax hike was
equivalent to an increase in sales taxes in that it raised selling prices directly. From June to July 1979
the consumer price index in Britain rose by 4.4 percent, equivalent to a 67.7-percent annual rate of
inflation. In March of 1980 the value-added tax and other expenditure taxes were raised again. From
March to April 1980 the British consumer price index rose by 3.4 percent, which is equivalent to an
annual inflation rate of 49.4 percent. During the entire year from June 1979 to June 1980 the
consumer price index in Britain rose by 21 percent. Somewhat less than one-third of this increase
may have been due to the two increases in VAT and expenditure taxes, t
Given the actual monetary policies adopted by Mrs. Thatcher’s predecessor and the new consump­
tion taxes imposed by Mrs. Thatcher herself, the acceleration of inflation that occurred during the
second half of 1979 and first half of 1980 is not surprising. Nor is it surprising that inflation in Britain
slowed in the next year, given the substantial drop in the rate of growth of the money supply which
was engineered by Mrs. Thatcher.

U.K. INFLATION AND MONEY GROWTH
Percent

Percent

*The acceleration of money growth in the U.K. from June 1977 to June 1978 is shown by other measures of
money as well as by Ml.
tFrom June 1979 to June 1980 the price index rose by 21 percent. Excluding July 1980 and April 1981, prices rose
Digitized for
at FRASER
an annual rate of 15 percent over that period. I attribute the difference to increases in VAT.


BUSINESS REVIEW

MAY/JUNE 1 9 8 2

demand for their output w as not offset by
policies which reduced their costs or
improved their profitability.
Given the economic policies actually
adopted by the Thatcher government, it is not
surprising that the British economy w as hit
by a recession. W ith contractionary fiscal
and m onetary policies and no offsetting
supply-side policy, a recession is the most
likely outcome. British economic policies
were strongly contractionary, so they caused
a severe recession. A fter Mrs. Thatcher took
office the unem ploym ent rate more than
doubled in the United Kingdom, rising from
5.4 percent in May 1979 to 11.7 percent in

January 1982. Real output of the British
economy fell sharply; from the second
quarter of 1979 to the second quarter of 1981
real output (Gross Domestic Product) fell 7.4
percent, and m anufacturing output (other
than oil extraction) fell 16 percent (see Figure
1 ).1 2

Economic events in Great Britain since
Mrs. Thatcher took office lose their m ystery
in light of the economic policies that she

12
Economic data for Britain are provided in Eco­
nomic Trends, published monthly by the U.K. Central
Statistical Office.

FIGURE 1

U.K. OUTPUT AND UNEMPLOYMENT
Index

Percent

SOURCE: U.K. Central Statistical Office, Economic Trends.




10

FEDERAL RESERVE BANK OF PHILADELPHIA

actually adopted. The m ystery is why a gov­
ernm ent that w as elected on promises to cut
taxes and promote private business did the
opposite. 13 Has President Reagan learned
from the British experience, or might the
Reagan Adm inistration also do the opposite
of w hat it promised?

jects that real government spending will rise
by 1.6 percent from its 1981 level. The target
for 1983 is to keep real government expendi­
tures essentially constant. So real govern­
ment spending will be little changed from
1981, if these targets are achieved.
President Reagan won a 25-percent cut in
personal income tax rates spread over three
years, as well as some other minor changes in
personal income taxes. These cuts will be
largely, if not entirely, offset by bracket
creep and rising Social Security taxes. 14
Business taxes were also cut in 1981. Unlike
personal taxes, business taxes were cut in
real terms. The Adm inistration estimates
that despite cuts in tax rates, last year’s tax
package will produce slowly rising total
revenue, in real terms, after a drop in 1982
caused by the recession, is
If the Adm inistration’s targets for govern­
ment spending and taxes are met, fiscal policy
in the United States will be roughly neutral
during 1982 and 1983. Total taxes will not
rise sharply as they did in Britain. Although
the President has proposed some minor tax
changes which would raise a small amount
of new revenues if enacted, he has rejected
proposals to raise other taxes enough to regain
the revenues lost through personal income
tax cuts. In this respect U.S. fiscal policy
differs sharply from that in Britain.
President Reagan’s tax program cut busi­
ness taxes by increasing depreciation allow­
ances and investment tax credits. These
changes will increase the rate of return on

LESSONS
FOR THE REAGAN ADMINISTRATION
The economic policies promised by
President Reagan are quite similar to those
promised by Mrs. Thatcher. Will Reagan’s
economic policies cause a prolonged, severe
recession in the U.S. as Thatcher’s policies
did in Britain? The answ er to this question
depends not on w hat is promised, but rather
on w hat policies are actually adopted in the
U.S.
Are Mr. Reagan’s Policies Really Like
Mrs. Thatcher’s? President Reagan has put
in place a package of macroeconomic policies
w ith four major elements. He proposed and
won personal income tax cuts, faster
depreciation writeoffs in calculating business
taxes, and cuts in government spending. He
also urged the Federal Reserve to continue a
policy of gradually reducing the rate of growth
of the money supply. While President Reagan
won big reductions in Federal government
spending and taxation from w hat they would
otherwise have been, he has made only small
changes, in real (inflation-adjusted) terms,
from previous Federal spending and taxation.
The A dm inistration’s economic program
calls for little change in the real value of
Federal government spending in the U.S. In
1982, the first year in which President
Reagan was free to seek major changes in
Federal programs, the Adm inistration pro-

14 See Stephen A. Meyer and Robert J. Rossana, “Did
the Tax Cut Really Cut Taxes? A Further Note,” Business
Review, Federal Reserve Bank of Philadelphia, JanuaryFebruary 1982.
15 The tax and spending figures used here are taken
from the 1982 Economic Report of the President and
from “Special Analysis B” of the Budget of the United
States Government, Fiscal Year 1983. The numbers given
are the rates of growth in each calendar year of real
Federal government expenditures and receipts (expressed
on a National Income and Products Accounts basis.)

“ The reader who wishes a more detailed description
and analysis of British economic policies and the
resulting recession should turn to Willem H. Buiter and
Marcus Miller, “The Thatcher Experiment: The First
Two Years,” Brookings Papers on Economic Activity
1981, No. 2, pp. 315-380.




11

BUSINESS REVIEW

MAY/JUNE 1982

GNP) fell by 1.2 percent, and the unemploy­
ment rate rose from 7.2 percent of the labor
force in M arch to 8.8 percent by year-end.
Despite the sharp drop in output during the
latter part of 1981, virtually all economic
forecasters predict that the U.S. economy
will begin to recover from the recession during
the second or third quarter of 1982. The con­
census forecast is that real GNP will grow
slowly in the third quarter of 1982, and more
rapidly during the fourth quarter. Is such a
forecast consistent with the actual economic
policies adopted by the U.S. government, or
is the U.S. likely to slide into a severe, pro­
longed recession?
Both fiscal and m onetary policies in the
U.S. were mildly restrictive in 1981. While
the real value of government spending rose
by 4.5 percent from 1980 to 1981, largely as a
result of the previous A dm inistration’s eco­
nomic policies, taxes rose even faster.
Federal revenues rose sharply—5.9 percent
in real terms—because the windfall oil profits
tax was imposed and Social Security taxes
were raised. Monetary policy also was restric­
tive in 1981, at least w hen m easured by the
behavior of M1B. Both fiscal and monetary
policies probably contributed to the reces­
sion which began in mid-1981. But overall
macroeconomic policies in the U.S. are un­
likely to be sharply restrictive in 1982 and
1983. If current projections prove to be right,
the combination of m onetary and fiscal
policies in the U.S. will be roughly neutral.
In Britain, by contrast, both monetary and
fiscal policies became sharply contractionary
in the three years following the election.
Although the economic policies promised by
Mr. Reagan and Mrs. Thatcher are similar,
the actual policies adopted in the U. S. and in
Britain are quite different. Economic fore­
casters are responding to the difference in
actual policies when they predict that the
U.S. will undergo a mild recession rather
than a severe recession like Britain’s.
The U. S., however, could end up with con­
tractionary policies like Britain’s. If President

new busines investment. While it is not clear
how large this effect will be, the President’s
economic policies do offer some supply-side
incentives for new investment. 16 U.S.
policies differ from British policies in this
respect as well: supply-side incentives were
espoused in Britain, but not adopted.
Finally, it is unlikely that m onetary policy
in the U.S. will be as tight as it has been in
Britain. The Federal Reserve System has
announced a target of reducing the rate of
growth of the money supply gradually. The
money supply (then m easured as M1B) grew
by 7.25 percent during 1980. The Fed’s target
was to reduce the growth rate so that it would
be in the range of 3.5 to 6.0 percent during the
following year, after adjusting for distortions
caused by shifts out of savings accounts into
NOW accounts. Shift-adjusted M1B actually
grew by 2.3 percent during 1981. i? Thus
monetary policy in the U.S. in 1981 was
tighter than had been targeted by the Federal
Reserve System. For 1982 the Fed adopted a
target for growth of the money supply (now
called M l) betw een 2.5 and 5.5 percent. In
contrast, the growth rate of British M l was
cut sharply in each of the two years after Mrs.
Thatcher took office. If the Fed achieves its
target money growth for 1982, then U.S.
monetary policy will be less restrictive than
British m onetary policy has been.
Should the U.S. Expect a Recession Like
Britain’s? The U.S. economy slid into reces­
sion during 1981. From its peak in the first
quarter, real output of the U.S. economy (real*
*6 For a discussion of how depreciation rules and
other tax policies affect business investment, see Robert
J. Rossana, “Structuring Corporate Taxes for a More Pro­
ductive Economy,” Business Review, Federal Reserve
Bank of Philadelphia, January-February 1981.
Growth rates for money are calculated as the per­
centage change from the average money supply during
the fourth quarter of the preceeding year to the average
for the fourth quarter of the target year. For example,
money growth during 1981 is calculated from the fourth
quarter of 1980 to the fourth quarter of 1981. This
measure of money growth is what the Fed targets.




12

FEDERAL RESERVE BANK OF PHILADELPHIA

The recent behavior of the British economy
shows that contractionary m onetary and
fiscal policy, used in combination, will cause
a recession. Because British officials focused
on misleading indicators—the government
budget deficit as a measure of fiscal policy
and sterling M3 as an indicator of monetary
policy—they adopted more restrictive
economic policies than they intended. By
adopting restrictive policies when their
economy was already in a recession, British
officials made the downturn longer and more
severe. Unless U.S. policymakers do the
same, by raising taxes and cutting money
growth further in 1982, the U.S. should be
able to avoid a severe and prolonged
recession.

Reagan and the Congress decide to undo the
tax cuts adopted in 1981 or to raise other
taxes in an attem pt to reduce the govern­
m ent’s budget deficit, then fiscal policy in the
U.S. would become contractionary. And if
the Federal Reserve w ere to adopt a more
restrictive m onetary policy than it chose at
the beginning of this year, m onetary policy
would become contractionary, too. If the
United States turns to sharply contractionary
m onetary and fiscal policies in 1982, the U. S.
economy could yet be forced into a deep
recession. But if the U.S. continues with
roughly neutral macroeconomic policy, as
most economic forecasters think it will, we
are unlikely to undergo a prolonged, severe
recession of the British variety.




13




FEDERAL RESERVE BANK OF PHILADELPHIA

From Centralization
to Deconcentration:

Economic Activity Spreads Out

By Gerald Carlino*
Prior to the 1970s, the U. S. witnessed a net
flow of migrants from its rural to its urban
areas. Since 1970, though, this long-standing
tendency has been reversed, and the turn­
around has placed the nation’s major metro­
politan centers, especially those in the North­
east and M idwest, in a degree of economic
jeopardy.
Some observers have attributed this dra­
matic change to growth in the mining and
recreation industries out in the countryside.
Others focus on the increase in the number of
older people w ho can live where they want
and on their preferences for rural living. But
it seems far more likely that recent innovations
in the technologies of production, transpor­
tation, and comm unication have been the
decisive factors in making rural counties

better able to compete for economic activity.
These innovations not only are the basis for
rural employment growth but also serve to
reduce the cultural isolation of nonmetro­
politan locations.
PEOPLE AND JOBS
HEAD FOR OPEN SPACE
The United States has a long history of
increasing population concentration in
urban areas, i In the 1950s, for example,
m etropolitan areas saw their populations
increase by well over two percent annually,
while populations elsewhere were just

1
The expressions ‘metropolis’ and ‘urban area’ and
their corresponding adjectives are being used to designate
standard metropolitan statistical areas (SMSAs). In
general, SMSAs are statistical constructs used to repre­
sent integrated labor market areas which consist of the
counties containing a central city of at least 50,000 people
along with any contiguous counties, if such counties
meet certain economic considerations.

‘Gerald Carlino is Senior Economist in the Urban and
Regional section of the Philadelphia Fed’s Research
Department. He received his Ph.D. from the University
of Pittsburgh.




15

BUSINESS REVIEW

MAY/JUNE 19 8 2

holding their own.
In the 1960s, people slowed their drift
toward the cities, and urban population
growth dropped to an average of a little more
than one and a half percent per year. M ean­
while, growth in nonm etropolitan areas was
inching upward, averaging close to half a
percent per year for the decade.
The historical pattern reversed itself
suddenly and dram atically during the last
decade in m any areas of the country. Be­
tween 1970 and 1980, the growth rate of
metropolitan populations fell to a little less
than one percent per year while the nonmetro­
politan rate jumped to better than one and a
half percent, exceeding the m etropolitan rate
for the first time in 160 years (see POPU­
LATION GROWTH SHIFTS TO NON­
METROPOLITAN AREAS).
Likewise, employment is growing more
rapidly outside urban areas. In 1970, for
example, m etropolitan places accounted for
70.6 percent and nonm etropolitan ones 29.4
percent of employed persons. By 1977, how­
ever, the SMSA share of employment was
down to 68.8 percent, while the nonmetro­
politan share was up to 31.2 percent. The
share of total employment located in non­
metropolitan places increased for all but two
employment groupings. The gains in nonmetropolitan employment shares were gen­
erally largest in the goods production indus­
tries; but there were large gains in the non­
metropolitan share of service employment as
well. 2
M ovement of people and jobs out of the
central cities is nothing new, and this move­
ment is continuing. But the shift out of
traditional m etropolitan areas is quite new,
and the shape of things to come is likely to be
far more complex than the traditional ar­
rangement of thinly settled suburbs sur­
rounding densely populated core cities.

DECONCENTRATION
PERVADES THE SCENE
W hat makes the current shifts so different
from past ones is the effect on places that are
outside the influence of m etropolitan areas.
To be sure, people and jobs are continuing to
spill out of the central cities into both the
nearer and the more distant suburbs. But now
rural areas far removed from urban concen­
trations are growing, too. 3 Further, the smaller
the unit of either sort, m etropolitan or non-

2
U.S. Department of Commerce, Current Population
Reports, Special Studies P-23, No. 75.

3 The term ‘rural’ is used for counties not in or adjacent
to a metropolitan area.




POPULATION GROWTH
SHIFTS TO
NONMETROPOLITAN
AREAS
Annual Rates of Population Change
by M etropolitan
and Nonm etropolitan Location

Percent

3.0

2.0

1.0

0

1950-60 1960-70 1970-80

SOURCE: U.S. Department of Agriculture EDD,
ESS, Population Studies Group.

16

FEDERAL RESERVE BANK OF PHILADELPHIA

metropolitan, the faster its growth is likely to
be. These trends are found in all parts of the
country. And the evidence suggests that some
form of deconcentration is occurring in all
the industrialized countries, not just in the

three times faster, for example, than in the
largest nonmetropolitan places. This relation
of small size to high growth holds even when
the data are partitioned into adjacent and
nonadjacent nonm etropolitan counties (see
SMALLER NONMETRO PLACES GROW
FASTER).
Likewise, the smaller the metropolitan
place the faster its population growth rate is
likely to be. During the past decade, the popu­
lation growth rate for the smallest size category
of SMSA (few er than 250,000 people) was
over 15 times as large as the population growth
rate for the larger (over 3,000,000) SMSAs
(see SMALLER METRO PLACES GROW
FASTER, TOO, overleaf).4

U . S .

While counties bordering metropolitan
areas are the country’s fastest growing places,
other nonm etropolitan places also are
growing rapidly. From 1970 to 1980, popu­
lation increased faster in nonm etropolitan
places (15.8 percent) than in metropolitan
ones (9.8 percent). Nonmetropolitan counties
which are adjacent to metropolitan counties
showed the fastest growth of all (17.4 percent).
But nonadjacent nonm etropolitan counties
also saw rapid grow th—at a 14-percent rate
(see NONMETRO COUNTIES SHOW
LARGEST POPULATION GROWTH).
This tendency tow ard growth in small
places holds up even when the microscope is
trained on areas smaller than county size.
Population in unincorporated places grew

4 These figures may overstate the growth of the smaller
metropolitan places since, at the start of the 1970s, many
of these small SMSAs still were classified as non­
metropolitan. During the decade, many nonmetropolitan
places gained enough people to be reclassified as metro­
politan. Thus some of the faster growth registered by the

NONMETRO COUNTIES
SHOW LARGEST
POPULATION GROWTH

SMALLER NONMETRO
PLACES GROW FASTER
Nonm etropolitan Population
by Size of Place: 1970 and 1975

(Thousands of people)
1970

1980

Percent
Change

Total U.S.

203,301

226,500

11.4

Metropolitan

148,887

163,503

9.8

54,424

63,002

15.8

Adjacent

28,033

32,901

17.4

Nonadjacent

26,391

30,101

14.0

Nonmetropolitan

Average Annual
Percent Change
1.96

Incorporated places
Under 2,500
2,500 to 9,999
10,000 to 24,999
25,000 to 49,999

1.16
0.66
0.66
0.62

Total

1.38

SOURCE: Compiled from J. F. Long, "The Deconcentration of Nonmetropolitan Population,” a paper
presented at the 1978 Annual Meeting of the Popu­
lation Association of America, Atlanta, Table 1.

SOURCE: U.S. Department of Agriculture,
Economic Development Division, ESS, Population
Studies Group.




Unincorporated places

17

BUSINESS REVIEW

MAY/JUNE 1 9 8 2

SMALLER METRO PLACES GROW FASTER, TOO
Population Growth by M etropolitan Size
and M ajor Region: 1970 and 1978
Average Annual Percent Change of Population
Total

Northeast

0.73

-0.17

Over 3,000,000

0.09

1,000,000 to 3,000,000

North Central

South

West

0.24

1.53

1.53

-0.36

0.04

0.38

0.89

0.92

-0.41

0.13

1.66

1.76

500,000 to 1,000,000

0.91

0.81

0.36

1.15

2.44

250,000 to 500,000

1.26

0.43

0.48

1.70

2.06

Less than 250,000

1.37

0.64

0.65

1.56

2.69

Metropolitan*

* According to 1979 SMSA definitions.
SOURCE: Bureau of the Census, Current Population Reports, “Population Characteristics,” SeriesP-20, No. 350,
Table 14.

The trend toward faster growth of nonm etropolitan places is found in all regions of
the country—in the Frostbelt as well as in
Sunbelt states (see THE TURNAROUND
PHENOMENON IN THE THIRD DIS­
TRICT). During the 1970 to 1978 period,
nonm etropolitan places in the West experi­
enced the largest inflow of people (0.89 per­
cent per year) followed by the Northeast (0.67
percent), the South (0.60 percent), and the
North Central (0.17 percent) regions.
Thus, while the well publicized shift of
population from the more heavily urbanized
Frostbelt to the more rural Sunbelt has aug­
mented the deconcentration tendency, it is
not the prim ary cause by any means. The
more im portant demarcation may not be the

Mason-Dixon line or the M ississippi River
but metropolitan-nonm etropolitan.
There is evidence also that deconcentra­
tion is not limited simply to the United States.
Daniel Vining of the University of Pennsyl­
vania and Thomas Kontuly of Boston Univer­
sity suggest that this phenomenon is occur­
ring sim ultaneously in most other industri­
alized countries. “A summary of recently
published statistics,” they say, “shows an
actual or imminent population decline in the
great metropolitan regions of many, if not
all, of the major industrialized nations (Japan,
France, Great Britain, Sweden, Norway, Italy,
and the USA).” 5
No doubt about it: deconcentration of
population and employment is a pervasive

smaller SMSAs really should be attributed to the rapid
growth of nonmetropolitan places too. But the overall
picture remains the same: the smaller the unit, the faster
its growth is likely to be.

5 D. R. Vining and T. Kontuly, “Population Dispersal
from Major Metropolitan Regions: An International
Comparison,” International Regional Science Review3,
1 (1978), pp. 49-73.




18

FEDERAL RESERVE BANK OF PHILADELPHIA

THE TURNAROUND PHENOMENON
IN THE THIRD DISTRICT
In the three states of the Third Federal Reserve District—Delaware, New Jersey, and Pennsylvaniametropolitan population growth declined substantially while nonmetropolitan population growth
was either already strong or on the increase over the past three decades.* But while these states
reflect the national pattern of faster nonmetropolitan population growth, turnaround occurred in two of
the states in advance of the national trend.
New Jersey, for example, appears to have gone through its turnaround before 1950, and Delaware
was seeing its adjacent nonmetropolitan counties chalk up their highest population growth rates
even before 1960. Metropolitan areas in Pennsylvania continued to dominate through the 1960s, but
the 1970s slowed the Keystone State’s metropolitan population growth to the point of turning it
negative.
The turnaround in employment growth hit all three Third District states before 1970. Pennsylvania
was the last to see this change (in the period 1962-70); New Jersey and Delaware already were
experiencing larger nonmetropolitan employment growth at the outset of the 1950s.

POPULATION AND EMPLOYMENT GROWTH
IN DELAWARE, NEW JERSEY, AND PENNSYLVANIA
Average Annual Percentage Change
Population
1950-1960 1960-1970 1970-1980

Total Employment
1951-1959 1962-1970 1970-1979

Delaware
Total
Metro
Nonmetro
Adjaeentt
Nonadjacent

4.03
4.05
4.00
7.34
1.93

2.28
2.55
1.66
2.47
0.98

0.86
0.34
2.09
1.99
2.20

2.04
2.78
3.00
0.28

7.76
4.61

2.44
2.64

New Jersey
Total
Metro
Nonmetro

2.55
2.45
5.22

1.82
1.64
5.96

2.70
-0.04
5.21

0.91
.05
3.67

2.90
2.92
5.62

1.77
1.71
7.04

Pennsylvania
Total
Metro
Nonmetro
Adjacent
Nonadjacent

0.78
0.97
0.06
0.06
0.03

0.42
0.50
0.12
0.16
-0.08

0.06
-0.11
0.80
0.80
0.58

-0.32
-0.09

2.36
2.47

1.65
0.71

—

—

-0.54
-1.16

5.04
4.90
—

—

3.13
2.65

2.08
2.17
—

—

1.99
1.46

* The Third Federal Reserve District includes two-thirds of Pennsylvania, half of New Jersey, and all of
Delaware.
t'Adjacent’ means next to a metropolitan area. All nonmetropolitan counties in New Jersey are adjacent.
SOURCE: U.S. Department of Agriculture, Population Studies Group.




19

BUSINESS REVIEW

MAY/JUNE 1 9 8 2

—

trend that is having a profound economic
impact on the U.S. and other countries.
Suburbanization and the attendant losses
suffered by central cities may receive most of
the attention, but deconcentration is a
phenomenon even larger in scope.

THE POPULATION AGES
Changing Age Distribution
of Population: 1970-1977
Age Group

PEOPLE LEAVE, BUT WHY?
There must be some reason, most analysts
would say, for this change in people’s be­
havior. Economists contend that the expla­
nation should be connected with some new
economic advantage to nonm etropolitan
living. W hat incentives do people have for
making this adjustment in where they live
and w ork—w hat incentives that they didn’t
have before?
Aging Is Not the Cause. M any observers
contend that the changing age distribution of
the population is, for several reasons, a source
of rural growth. The aging of the baby-boom
cohort, for instance, brought a large increase
in the num ber of college-aged people. Over
the period 1970 to 1977, there was a 16.2percent increase in the num ber of people 18
to 24 years old (see THE POPULATION
AGES). Colleges and universities tend, it is
argued, to employ a great deal of land and
therefore choose relatively cheap sites—
nonmetropolitan locations. So, this argument
runs, the increased demand for educational
services occasioned by more college-aged
people leads to increased employment oppor­
tunities in rural places.
The role of higher education in nonmetropolitan growth, however, should not
be overemphasized. Places of higher educa­
tion tend to have m etropolitan as well as
nonm etropolitan locations. While the em­
ployment opportunities associated with the
growth of higher education may be potentially
attractive as explanations for rapid rural
population growth, their role has yet to be
confirmed by rigorous studies.
A nother factor frequently cited as the key
to explaining nonm etropolitan growth is the
8.3-percent increase in the 65-years-and-over




■ fcs

Percent Change

Under 5 years
5 to 13 years
14 to 17 years
18 to 24 years
25 to 34 years
45 to 64 years
65 years and over
Total population
(in thousands)

6.4

SOURCE: U.S. Department of Commerce, Current
Population Reports, “Social and Economic Char­
acteristics of the Metropolitan and Nonmetropolitan
Population: 1977 and 1970,” Special Studies P-23,
No. 75, compiled from Table 1.

cohort. People who have location-indepen­
dent sources of retirem ent income may be
migrating to amenity-rich, low-cost locations,
many of which are nonm etropolitan.
While some studies report migration of
retirees as a significant factor in rural growth,
others do not. C.J. Tucker of Atlanta
University, for example, using the 1970
census and the 1975 Current Population
Survey, found that while some part of the
trend reversal could be attributed to a
changing age distribution, most of it came
from shifts in migration patterns in all age
categories. 6 Age isn’t the answer.
Industry Growth Isn’t the Whole Answer,
Either. Other w riters argue that the growth
of the extractive and recreational industries
underlies much of the rural renaissance.

®C. J. Tucker, “Changing Patterns of Migration Be­
tween Metropolitan and Nonmetropolitan Areas in the
United States: Recent Evidence,” Demography 13, 4
(1976), pp. 435-443.
20

FEDERAL RESERVE BANK OF PHILADELPHIA

Their scenario suggests that the changing
energy picture has resulted in a renew al of
domestic sources of energy, which should
give rise to rapid employment growth in
several
resource-rich
nonm etropolitan
regions. The coal regions of Appalachia,
w ith their newly created mining jobs, are a
prime example.
Outdoor recreation has become another
growth industry. A general increase in
income has raised the demand for recrea­
tional goods and services, as well as the
demand for second homes, in amenity-rich
regions. Since most of the areas well
endowed with recreational amenities are
nonm etropolitan, the increase in recreation
business could be yet another source of rural
employment growth.

In fact, there is little evidence that these
industries have grown faster in nonmetro­
politan places. Indeed, according to data
published by the Census Bureau where the
mining, entertainm ent, and recreation
industries are concerned, employment is
growing faster in metropolitan locations
than in nonm etropolitan ones—the only
sectors where this has occurred over the
period 1970-77 (see EMPLOYMENT GROWS
FASTER IN NONMETRO AREAS).
While the finding that the mining industry
is growing faster in m etropolitan areas is
interesting, we should not push it too hard.
There are several qualifications one must
make regarding these data. To begin with,
they are based on samples and are therefore
subject to sampling error. That is, the result

EMPLOYMENT GROWS FASTER IN NONMETRO AREAS
Percent Distribution of Employed Persons 16 Years Old and Over,
by Industry Group and Type of Residence: 1970 and 1977

Industry
Agriculture, forestry
& fishery
Mining
Construction
Manufacturing
Transportation, communica­
tions & other public utilities
Wholesale trade
Retail trade
Fire
Business services
Personal services
Entertainment and
recreation
Professional
Public administration
Employed

Percent
Change
1970 to 1977

Nonmetropolitan
1970
1977

Metropolitan
1970
1977

Percent
Change
1970 to 1977

71.4
59.9
34.0
29.8

72.1
58.0
37.2
33.2

1.0
- 3.2
9.4
11.4

28.6
40.1
66.0
70.2

27.9
42.0
62.8
66.8

-2.5
4.7
-4.9
-4.8

25.0
20.1
29.1
17.6
19.2
32.0

27.9
22.1
30.3
19.5
20.5
34.8

11.6
10.0
3.8
10.8
6.8
8.8

75.0
79.9
70.8
82.4
80.8
68.0

72.1
77.9
69.7
80.5
79.5
65.2

-3.9
-2.5
-1.6
-2.3
-1.6
-4.1

21.3
27.6
24.0
29.4

19.5
29.2
25.9
31.2

- 8.5
5.8
7.9
6.1

78.7
72.4
76.0
70.6

80.5
70.8
74.1
68.8

2.3
-1.6
-2.5
-2.6

SOURCE: U.S. Department of Commerce, Current Population Reports, special Studies P-23, No. 75, Compiled
from Table O.




21

BUSINESS REVIEW

MAY/JUNE 1982

life. What is different is that these prefer­
ences now seem to be easier to satisfy than
they used to be. The question is, why?

that mining employment is growing faster in
urban places could be simply a statistical
artifact. Another problem is that the data
report employment by residence rather than
employment by establishment. Thus people
residing in urban places but commuting to
work in nonm etropolitan ones would be
counted as part of urban employment. Finally,
Calvin Beale of USDA, a previous proponent
of the growth of mining as a significant factor
underlying the rural revival, has more recently
softened this view. In a statem ent before the
House of Representatives Subcommittee on
Economic Development he claims that “if
one considers all rapid growth areas, mining
is the major cause of growth in only a minority
of cases—media attention on these cases
notw ithstanding.” 7
In short, while development of the extrac­
tive and recreational industries may have
contributed to growth in some rural places,
this hasn’t been the leading influence for
deconcentration.
The Call of the Wild, or Maybe Main
Street? Another popular explanation of the
rural renaissance is an alleged shift in prefer­
ences toward nonm etropolitan living.
Newsweek’srecent cover story—“Am erica’s
Small Town Boom”—reports on new rural
arrivals who, though they make only half as
much money as they did in the big city, are
compensated by the “cry of a loon” on nearby
lakes.8
But there is nothing new about such prefer­
ences. Indeed, suburbanization has always
been an attem pt on the part of those tied to
cities to have their cake and eat it too—to
have the benefits of a m etropolis while
maintaining some of the amenities of a rural

TECHNOLOGICAL CHANGE
UNDERLIES DECONCENTRATION
Businesses tend to go where they can
prosper. In the nineteenth century, the state
of technology placed certain limits on a firm’s
prosperity that could be overcome only by
locating near other firms. But many of those
limits have been overcome in this century by
technological changes.
Forces for Concentration. The nineteenthcentury city tended to be highly concentrated,
containing as much as 90 percent of total
employment w ithin a one-mile to three-mile
radius of its central business district. 9
Manufacturing activity tended to concentrate
in these cities because of interindustry link­
ages and the need to keep transportation
costs as low as possible. It was advantageous
for nonm anufacturing enterprises (banking,
finance, and insurance, for example) to join
the cluster if they supplied business services
to local firms or consumer services to their
employees. This process led to the spatial
concentration—or w hat economists call
agglomeration—of people and jobs.
In the printing industry, for example,
firms tended to gather in large cities such as
New York to share certain products or
services that individual firms could not
purchase economically if they were isolated. io
Demand for commercial printing was
important, and the big cities had it, for
example, in the form of newspapers, other
publishing, general-use office products, and
specialized products for the legal and financial

7C. L. Beale, “Population Change in Rural America
and Implications for Economic Development,” state­
ment before the Subcommittee on Economic Develop­
ment, House Committee on Public Works and Transpor­
tation, November 19, 1981.
®“America’s Small Town Boom,” Newsweek, July 6,
1981.

9 This section draws and extends the arguments in a
paper by Alex Anas and Leon Moses as well as one by
Charles Leven, both found in Leven, The Mature Metro­
polis.
* 9 E. TobierandM. A. Willis, “Has New York’s Printing
Industry Bottomed Out?” New York Affairs 6,2 (1980),
pp. 59-69.




22

FEDERAL RESERVE BANK OF PHILADELPHIA

the substitution of electronic for m echanical
processes. These improvements have further
reduced the relative im portance of transpor­
tation costs and of large skilled labor pools, n
A case in point is NCR, formally the Na­
tional Cash Register Corporation. Between
1969 and 1977, NCR moved from a line of
mechanical cash registers to point-of-sale
term inals based on microcircuitry, sharply
reducing the num ber of component parts in
the final product. Assembling a 5,000-part
m echanical register had required a large
skilled labor pool such as that at the Dayton
plant. The new m achine, however, is much
easier to assemble and can be handled by a
smaller, less skilled labor force. Where
workers in Dayton used to do 70 percent of
NCR’s U.S. production, they now do 15 per­
cent. According to the W ashington Post, this
deconcentration “would have been economi­
cally undesirable before the advent of the
m icrocircuit.” 12 This example shows how
the economies of agglomeration which
favored concentration in centralized locales
have been weakened by changes in production
technology.
Changing Transportation Technology.
Changes in transportation technology also
helped to produce first suburbanization and
now deconcentration. Before the invention
of the automobile, rail transport was the most
rapid and efficient m ethod of moving people
overland. Residential choice, however,
tended to be restricted to the vicinity of the
tracks radiating from the central city. The
increase in automobile ownership and the
improvement in urban roads after World War
II brought significant reductions in transpor­
tation costs (including time) and attracted
people to the suburbs. The motor truck meant

industries. But so was supply, of both
m aterials and labor. Printing equipment
needed to be provided with paper and ink in
volume, and it required highly skilled labor
for operation, maintenance, and repair.
The city of a century ago represents one
way of bringing the factors of production
together. It depended on the technology of its
tim e—steam and then electric power, over­
land transportation in the form of trains and
trolleys, high-grade m echanical equipment.
In many respects, this technology continued
to dom inate economic organization in
Am erica through the period of World War II.
But in the intervening years, U.S. industry
has found new ways to organize itself and
new ways to operate—ways that make use of
still newer technologies that permit firms
and individuals to participate in the same
production process even though they aren’t
always in the same place.
Changing Production Technology. A
frequently cited factor in the movement of
m anufacturing away from central cities is
the development of assembly line techniques.
The assembly line requires a horizontal flow
of goods, which uses more land than previous
methods. Horizontal plants are more costly
to construct in the existing built-up central
cities but much less expensive to build on
large, vacant suburban lots.
More recent innovations in production
technology have made locating in a metro­
politan center still less important. The
production process has been divided, for
example, into a sequence of individual
operations. This increase in the num ber of
stages in the production process has given
firms the ability to split off and relocate
phases of their operations that do not require
central city or even m etropolitan locations.
According to Daniel Garnick and Vernon
Renshaw of the Bureau of Economic Analy­
sis, the deconcentration pattern is also ex­
plained by developments in m iniaturization
and light-weight materials, the reduced
numbers of movable parts in equipment, and




D. Garnick and V. Renshaw, “Competing
Hypotheses on the Outlook for Cities and Regions: What
the Data Reveal and Conceal,” unpublished
manuscript.
12 “How Technology Altered NCR and Dayton,” The
Washington Post, January 8, 1978.
23

MAY/JUNE 1982

BUSINESS REVIEW

the agglomeration economies available to
economic activity from locating in metro­
politan (especially large) centers. A research
project recently conducted at the Federal
Reserve Bank of Philadelphia attempted to
measure agglomeration economies for the
aggregate of all m anufacturing firms for the
80 largest SMSAs for two time periods—
1957-69 and 1970-77. This research revealed
that a weakening of agglomeration economies
led to a 7-percent decline in the optimal popu­
lation size of cities—the size at which the net
advantages of being close to other business
activities are at their greatest. The optimal
size now appears to be just a little over
3,000,000 people—a result consistent with
the Census Bureau’s finding that nationally it
is the 3,000,000-plus cities which are declin­
ing. 13 This evidence supports the view that
the economic forces which led to concentra­
tion of economic activity in cities have peaked
and are dissipating. The result is deconcen­
tration.

that economic activity no longer had to be
tied to railroad siding locations. All these
developments gave firms an efficient and
dependable form of transportation outside
the more congested central city and brought
jobs to the suburbs as well.
Continuing improvements in transporta­
tion technology have helped to encourage
deconcentration. The interstate highway net­
work has connected many previously remote
rural counties w ith the old m ainstream and
with one another. Moreover, the increased
size and efficiency of trucks, as well as the
expansion of high-speed thruw ays, are in­
creasing still more the economic viability of
nonm etropolitan business locations.
Changing Communications Technology.
The nineteenth-century city was spatially
concentrated partly because people and firms
were not able to communicate very effectively
over long distances. The telegraph could
transmit information, but it was unable to
accommodate a high volume of messages.
When the prim ary means of relating compli­
cated pieces of information were the messen­
ger and face-to-face meetings, the benefits of
concentrated location patterns were obvious.
The advent and improvement of the tele­
phone aided suburbanization. The telephone
permitted a firm to locate in the suburbs while
maintaining contact with both customers
and suppliers in the city.
A more recent revolution in technology
has improved long-distance communications
and contributed still further to deconcentra­
tion. Low-cost long-distance WATS lines,
improvements in inform ation storage and
retrieval systems, and the use of document
transmission equipment allow branch plants
to be located in rural communities while
maintaining good comm unications with the
corporate office located, for example, in
New York or San Francisco.
Technological change not only has in­
creased the economic viability of deconcen­
tration, it also has reduced the advantages of
concentration. In other words, it has reduced




CONCLUSION
The very kinds of forces which gave rise to
suburbanization also have made rural loca­
tions economically attractive. Technical
innovations in information storage, retrieval,
and transmission have reduced the economic
advantage of locating closely related activi­
ties near one another. Improvements in cars,
trucks, and planes have lowered transporta­
tion costs. And the interstate highways have
opened up virtually any location to business
development and residential use.
The impact of deconcentration on the old
cities, of course, is another matter. Many
different trends are at work, and nearly all
tend to make small look beautiful. The urban
infrastructure (schools, port facilities, public
utilities, and mass transit systems) in cities

13 G. A. Carlino, "The Role of Agglomeration Econo­
mies in Metropolitan Decline,” Federal Reserve Bank of
Philadelphia, Research Paper No. 71, 1981.
24

FEDERAL RESERVE BANK OF PHILADELPHIA

such as New York, Boston, Philadelphia,
Pittsburgh, and St. Louis were designed to
service a certain num ber of people and jobs.
As population and employment leave these
cities, excess capacity develops and the tax
base erodes. The cities then are forced into
disinvesting in those assets (via under-main­
tenance and depreciation). M eanwhile, just
the opposite is occurring in the expanding
regions: excess demand pressure for social




capital plagues the new regions experiencing
rapid growth.
In short, the basic economic forces at work
in deconcentration have proven their strength.
They appear to represent long-term trends.
Thus the outlook for the future of the U.S.
and other industrialized countries is further
shrinkage in larger centers of population and
employment combined w ith further growth
in the smaller centers.

25

FROM THE PHILADELPHIA FED




•

•

•

This new pamphlet compares
creative mortgage financing
methods with the conventional
mortgages. Copies are available
without charge from the Depart­
ment of Consumer Affairs,
Federal Reserve Bank of Phila­
delphia, P. O. Box 66, Philadel­
phia, PA 19105.

This new pamphlet presents
some highlights of financial plan­
ning tools authorized by the
Economic Recovery Tax Act of
1981. For your free copy write the
Department of Consumer Affairs,
Federal Reserve Bank of Phila­
delphia, P.O. Box 66, Philadelphia,
PA 19105.




100 North Sixth Street
Philadelphia, PA 19106