The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
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 Massive capital spending in the early 1980s, coupled with extensive closings of outdated plants, substantially improved m anu facturing efficiency and competitive ness in the region especially in re cent years when the economy was operating at near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 .