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ESSAYS ON ISSUES

THE FEDERAL RESERVE BANK
OF CHICAGO

APRIL 1991
NUMBER 44

Chicago Fed Letter
Will the Midwest w eather
the storm ?
Since the last recession. Midwest
manufacturers have been translating
new plants and advanced technolo­
gies into production growth that has
exceeded gains made by their
counterparts nationwide (see Figure
1 for a comparison of output
trends). Prior to the mid-1980s,
many Midwest manufacturers could
be characterized as “producers of
last resort”—their plants were the
first to cut production when the
economy slackened and the last to
expand when the economy re­
bounded. Massive capital spending
in the early 1980s, coupled with
extensive closings of outdated
plants, substantially improved m anu­
facturing efficiency and competitive­
ness in the region especially in re­
cent years when the economy was
operating at near full capacity. But,
the U.S. economy has entered a re­
cession during the second half of
1990. With its heavy dependence on
cyclical industries, the Midwest econ­
omy has not escaped the effects of
the national recession. The ques­
tion is whether its improved com­
petitiveness will allow the region to
weather this recession in better form
than during previous economic
downturns.
In 1990, the Midwest experienced
both sides of the business cycle. Its
economic performance over the
year can be used as an initial test of a
widespread expectation that the
region’s improved competitiveness
will strengthen the expansion and
blunt the impact of a recession. This
Chicago Fed Letter reviews the eco­
nomic performance of the Midwest
in 1990 for the manufacturing, serv­

ice, and construction sectors and
evaluates the initial impact of the
current national recession on the
Midwest in the context of previous
recessions.1
Manufacturing set the tone for 1990

The economic expansion over the
first half of 1990 continued the re­
cent pattern of the Midwest outpac­
ing the nation. Based on specific

1977

78

79

’80

'81

'82

again bearing the brunt of a reces­
sion, three factors need to be consid­
ered: how did total hours worked
respond to the decline; how did ma­
jo r sub-sectors within manufacturing
fare; and how did the decline com­
pare with similar periods in previous
recessions?
Consider first the behavior of a key
input to the manufacturing in­
dexes—total hours worked—over the

'83

trough-to-peak values for the Mid­
west and U.S. Manufacturing Indexes
(MMI and USMI), output in the
Midwest was rising at an annualized
average rate of 6.7%, compared to a
national rate of 5.5%. Both indexes
started from a near-term trough level
in December of 1989, but the Mid­
west reached its peak level in June—
just one m onth before the nation.
Over the rem ainder of the year,
manufacturing activity in the Mid­
west declined 8.7% (annualized)—
slightly steeper than the 8.3% rate of
decline nationwide. But before con­
cluding that the Midwest is once

'84

'85

'86

'87

'88

'89

'90

first and second half of 1990. For the
year as a whole, total hours worked
declined by only 2.1% in the Mid­
west, compared to a national decline
of 3.0%. However, during the expan­
sionary part of the year, total hours
worked grew at an annualized aver­
age rate of 2.4% nationally, while in
the Midwest total hours worked rose
10.3%. From the mid-year peak to
the end of the year, total hours
worked nationally declined 7.9%,
while in the Midwest total hours
worked dropped 11.1%.

Total hours worked is a more cycli­
cal measure of business activity than
employment, because it adjusts for
overtime and part-time employ­
ment. With manufacturers aggres­
sively seeking ways to lower unit
labor costs, production changes are
being accomplished through adjust­
ments in hours worked per em­
ployee (e.g., overtime) in addition
to adjustments in employment. In­
deed, manufacturing employment
in the Midwest has yet to return to
its previous cycle peak in 1981. Yet,
as shown in Figure 1, output in the
Midwest last year easily exceeded its
1981 peak and was close to its 1979
peak. To be sure, some of the
growth in output despite sluggish
employment gains can be attributed
to productivity growth, but some
may also be attributed to new tech­
nologies and management practices
that have made manufacturers more
flexible in adjusting hours worked
to production needs. Consequently,
the larger adjustments in total hours
worked in the Midwest relative to
the nation suggest that the Midwest
is becoming more flexible in re­
sponse to changes in the business
cycle, hence more competitive with
other regions of the nation.
The broad scope of the Midwest’s
improved performance is another
encouraging fact. During the ex­
pansionary phase of 1990, all five
major manufacturing sub-sectors in
the Midwest outpaced their national
counterparts, and during the reces­
sionary phases, only one sector—
transportation—did significantly
worse (see Figure 2). The transpor­
tation sector experienced a pro­
nounced surge and slump over the
year, which was linked to a swing in
auto production from a 4.1 million
unit annual rate at the beginning of
the year to a 7.0 million unit rate by
mid-year to 4.8 million units at
year’s end. Yet, it still outperform ed
the national sector over the entire
year. Machinery also slumped in the
second half of 1990, but less than
the national sector. Metal working,
chemicals, and consumer-related
did slightly worse in the second half,
but all three had significantly

2. Manufactiirii
Annualized average rates of change
Trough-to-peak

Peak-to-current

p e rc e n t

Machinery
M idwest
U.S.
Metalworking
M idwest
U.S.
Transportation
Midwest
U.S.
Chemicals
M idwest
U.S.
Consumer-related
M idwest
U.S.

0.3
- 0 .7

-9.7
-11.6

8.9
4.2

-14.7
-14.3

47.8
16.2

-39.4
-27.2

6.3
0.8

-4.5
-4.0

3.9
0.1

SOURCE: Federal Reserve Bank of Chicago.

stronger expansions in the first half of
1990, outperform ing their national
counterparts over the entire year.
Thus, sector performances in the
Midwest generally were quite impres­
sive and indicate that in the region,
improved competitiveness is broad
based and not restricted to a small set
of industries.
The final fact to consider is that the
most recent decline in Midwest m anu­
facturing activity was generally much
closer to the national experience than
in the previous two recessions. For
example, in the 1980 recession,
manufacturing national output
dropped at an annualized average
rate of 2.7% during the first five
months of its specific contraction,
compared to the Midwest manufactur­
ing decline of 20.3% over the same
period. By any standard, the differ­
ence in the rates of contraction be­
tween Midwest and national manufac­
turing at the onset of the 1980 reces­
sion was far greater than at the onset
of the current recession.
During the 1981-82 recession, the
annualized average decline in na­
tional manufacturing activity over the
first five months of its specific contrac­
tion (July-November) was 8.1%. The
decline in Midwest manufacturing
over the first five months of its specific
contraction (June-October) was

11.1%, and for the
same five months that
the national index
declined (July-Novemb er), manufacturing
activity in the Midwest
declined 13.8%.
Again, by either meas­
ure the Midwest expe­
rience was harsher
than the national
experience over the
early phase of reces­
sion in 1981 than is
currently the case.

Taken together, these
three factors indicate
-6.9
the extent of the struc­
-6.0
tural changes that
have occurred in the
Midwest’s manufactur­
ing sector. The region’s image as a
producer of last resort appears to be
fading. To be sure, the region has
achieved its success in production
without a comparably sized expan­
sion of employment. Nevertheless,
the role of manufacturing will re­
main crucial to the overall perform­
ance of the Midwest economy and,
though it may never be the growth
center of high-paying jobs that it
once was, a revitalized manufacturing
sector may support growth in other
sectors of the Midwest economy.
Midwest service sector pulls even
with the nation

While the manufacturing sector gen­
erates most of the cyclical activity in
the economy, the service sector is a
larger share of the economy than
manufacturing and, as a provider of
business services, is linked to the
vitality of manufacturing activity.
Given the service sector’s link to a
troubled manufacturing sector in
years past, it is not surprising that, on
a trend basis, the Midwest’s service
sector has lagged the nation histori­
cally (see Figure 3). However, serv­
ice sector activity is not restricted to
local business services and conse­
quently its growth is becoming less
dependent on local manufacturing.
With the recent strengthening of its
manufacturing sector adding to

severity of a construction slump that
was beginning to affect other regions.
Based on F.W. Dodge’s construction
contract awards data, one of the few
available regional measures of con­
struction activity, the Midwest experi­
enced a decline of 4% in construction
activity last year, compared to an 11 %
decline nationally.2 However, as with
other sectors, construction activity
peaked during the year—expanding
through mid-year but contracting for
the year as a whole (see Figure 4).

other sources growth, the Midwest’s
service sector should also begin to
show new strength.
In 1990, national service sector activ­
ity grew at an annualized average rate
of only 1.5% in 1990—less than half
the growth rate of 1989—due in part
to the national economic slowdown
and layoffs in the financial services
and retail industries. Service sector
growth in the Midwest last year was
also slower than in the previous year.
But more significantly, it kept pace
with the nation for only the second
time in over ten years (the last time
being 1987, which was also a robust
year for manufacturing activity in the
Midwest). The region continued to
lag the nation over the first half of
the year. But when the manufactur­
ing recession began about mid-year,
the service sector slowdown in the
Midwest was milder than in the na­
tion, offsetting the relatively poor
showing in the first half of the year.
Comparisons with past periods
around a cyclical peak are equally
favorable to the 1990 experience in
the Midwest. Over the twelve-month
periods centered on the 1979 and
1981 manufacturing peaks discussed
above, the Midwest’s service sector
grew at a substantially slower rate
than the nation. In fact, the Mid­
west’s service sector declined during
the 1981 period and also declined
late in 1980, while the national serv­

ice sector continued to grow. His­
torically, the service sector has gener­
ally been recession proof nationally
but much less so in the Midwest.
With the national economy continu­
ing to decline in the early part of
1991, the Midwest’s service sector
may yet experience its own recession.
But so far, the region is not only
continuing to expand, but to keep
pace with the nation—something
that the Midwest has rarely accom­
plished in the past.
Construction soft, but Midwest
not overbuilt

Construction activity in the Midwest
is the third major sector to follow a
pattern of expanding in the first half
of 1990 and contracting over the re­
m ainder of the year. The construc­
tion sector has been weak nationally
for several years, due to substantial
overbuilding in the early 1980s. The
problem has been particularly acute
in New York and New England,
where speculative commercial build­
ing has been hurt by weakening
property values over the last two
years. The Midwest never experi­
enced the speculative surge in con­
struction in the early 1980s, because
its economy was severely depressed
and plants were being closed. As the
region entered 1990, the Midwest’s
strength in manufacturing and lack
of commercial overbuilding m eant
that the Midwest would avoid the

Aside from manufacturing construc­
tion, which declined throughout the
year, the breadth of the relative
strength in Midwest construction activ­
ity stands out in sharp contrast to the
nation. Nationally, construction activ­
ity was declining throughout the year
in most major categories (public-re­
lated buildings, such as government,
health, and education, were the pri­
mary exceptions). Overall, the Mid­
west expanded construction activity
by 6% in the first half of the year over
the first half of 1989, compared to an
8% decline nationally. Even the na­
tionally depressed commercial build­
ing segment was expanding in the
Midwest over the first half of the year.
Thus, to the extent that construction
activity is linked to the economic
conditions of the region, construction
activity in the Midwest reflects the
broad improvement in the region’s
economic performance.

Karl A. S cheld, S en io r Vice P re sid e n t an d
D irecto r o f R esearch; David R. A llardice, Vice
P re sid e n t a n d A ssistant D irecto r o f R esearch;
C arolyn M cM ullen, E ditor.
Chicago Fed Letter is p u b lish e d m o n th ly by th e
R esearch D e p a rtm e n t o f th e F ed eral Reserve
B ank o f C hicago. T h e views ex p ressed are th e
a u th o rs ’ a n d are n o t necessarily th o se o f th e
F ed eral Reserve B ank o f C hicago o r th e
F ed eral Reserve System. A rticles m ay be
re p rin te d if th e so u rce is c re d ite d a n d th e
R esearch D e p a rtm e n t is p ro v id ed w ith copies
o f th e rep rin ts.
Chicago Fed Letter is available w ith o u t ch arg e
fro m th e Public In fo rm a tio n C e n te r, F ed eral
Reserve B ank o f C hicago, P.O . Box 834,
C hicago, Illinois, 60690, (312) 322-5111.

ISSN 0895-0164

Looking to 1991 and beyond

1
:;;v :

.
i

Given the industrial structure of the
Midwest economy, there is no way
the nation can enter a recession with­
out the region following suit. The
region has too many cyclical indus­
tries, most notably the auto industry.
And, of course, the current recession
has only just begun and much can
still happen both nationally and re­
gionally. But to date the single most
important finding of this review of
the Midwest economy is that the
region performed well relative to the
nation during 1990 and entered this
recession in much better shape rela­
tive to the national experience than
ever before. The most likely expla­
nation for the Midwest’s good for­
tune is consistent with widely held
expectations—that the improved
competitiveness of Midwest produc­
ers has not only enhanced the m anu­
facturing sector’s performance, but
has supported economic activity in
the service and construction sectors.
In December of 1990, business
economists and analysts attending
the Federal Reserve Bank of Chi­
cago’s fourth annual Economic Out­
look Symposium discussed the out­
look for 1991. The consensus fore­
cast was for a mild recession for the
national economy, with manufactur­
ing declining through the first half of

Chicago Fed Letter
F E D E R A L R E S E R V E B A N K O F C H IC A G O
P u b lic I n f o r m a tio n C e n te r
P .O . B o x 8 3 4
C h ic a g o , I llin o is
(3 1 2 )3 2 2 -5 1 1 1

60690

,

Cum ulative rates of change
January through June
M id w e s t*

January through December

U.S.

M id w e s t*

U.S.

p e rc e n t

Total

6

-8

-4

-11

Residential

7

-8

-5

-14

Nonresidential

5

-9

-7

-13

M anufacturing

-28

-42

-31

-42

Commercial

2

-13

-17

-19

Education and science

18

7

19

6

Hospital and health treatm ents

28

3

22

1

T he Midwest is represented by the East North Central region of the U.S., which includes Ohio,
Illinois, Indiana, Michigan, and Wisconsin.
SOURCE: F.W. Dodge, C onstruction Potentials Bulletin.

1991.*23 Auto sales and production are
expected to remain weak in the first
half, but should lead the economic
rebound in the second half of the
year—almost the inverse of the eco­
nomic pattern in 1990. For the rea­
sons discussed in this Fed Letter, the
Midwest can expect to follow this
mild recession scenario. But more
importantly, if the Midwest stays on
its current track, it will come out of
this recession in better shape than in
past recessions. And, it will start its
recovery at a higher level of eco­
nomic activity, relative to the nation,
than in past recoveries. Building on
a firmer foundation should lead to

brighter economic prospects for the
Midwest.
—Robert Schnorbus
and Philip Israilevich
^ h e M idw est is d e fin e d h e re to consist
o f In d ia n a , Illinois, Iowa, M ichigan, a n d
W isconsin.
2F.W. D o d g e ’s M idw est re g io n is sim ilar
to th e d e fin itio n u se d elsew h ere in this
discussion, w ith th e e x c e p tio n th a t O h io
is in c lu d e d a n d Iow a is e x c lu d e d .
3See th e F eb ru ary , 1991 Chicago Fed Letter
fo r a d iscussion o f th e 1991 co n sen su s
o u tlo o k .