Full text of Econ Focus (Federal Reserve Bank of Richmond) : Fall 2004, Volume 8, Number 4

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FA L L

2 0 0 4

THE
CREATIVE
CLASS
Are Technology,
Talent, and
Tolerance
the Keys to
Healthy Cities?

Appalachia’s
Changing Economy
Economics of Obesity
An Interview with Al Broaddus
and Tom Humphrey

T H E

F E D E R A L

R E S E R V E

B A N K

O F

R I C H M O N D

VOLUME 8
NUMBER 4
FALL 2004

COVER STORY
13

Why Cities Grow: Economist Richard Florida argues that
cities must attract young, talented workers — what he dubs
the “creative class” — if they want to prosper. Is he right?
And is there anything new about his theory?
Public officials from around the Fifth District believe that members
of the “creative class” are essential to their cities’ economic health.
So many are investing in development projects aimed at making their
downtowns hipper and trendier. But is that what creative people
really want? Economists generally agree that talented workers are
essential to economic growth, but they are not convinced that cities
can lure them in this way. Public money might be better spent on
things that all people — including creative people — want, such as
safe streets and good schools.

FEATURES
17

Our mission is to provide
authoritative information
and analysis about the Fifth
Federal Reserve District
economy and the Federal
Reserve System. The Fifth
District consists of the District
of Columbia, Maryland, North
Carolina, South Carolina,
Virginia, and most of West
Virginia. The material
appearing in Region Focus
is collected and developed by
the Research Department of
the Federal Reserve Bank
of Richmond.

Appalachian Diversification: In the heart of Appalachia,
the people of Southwest Virginia are creating economic
opportunities to replace coal jobs

D I R E C TO R O F P U B L I C AT I O N S

Southwest Virginia did what it was best at — coal mining — for as
long as it could. But when the coal-mining industry took a turn for
the worse, the region was destined for hard times. By the early
1990s, the area’s unemployment rate was approaching 15 percent,
and many people decided to look for work elsewhere. Recently,
though, new firms have opened, bringing hope and jobs to the region.
These trends are promising, but the area still lags the rest of the
state on most economic measures.

SENIOR EDITOR

John A. Weinberg
EDITOR

Aaron Steelman
Doug Campbell
MANAGING EDITOR

Kathy Constant
BUSINESS WRITERS

Charles Gerena
Betty Joyce Nash
E D I TO R I A L A S S O C I AT E

Julia R. Taylor
CONTRIBUTORS

22

The Fattening of America: As we benefit from greater
convenience and efficiency, our waistlines are widening
in the process
There may be economic reasons why a growing number of Americans
are overweight and obese. Food is more plentiful, energy-dense, and
affordable, while technological advances have led to less physical
activity at work and at home. Over time, small changes in calories
consumed and expended may have accumulated into significant
weight gains.

Joan Coogan
Alice Felmlee
H. S. Malek
Eric Nielsen
Christian Pascasio
Karl Rhodes
Jennifer Sparger
Jennifer Wang
Aileen Watson
ECONOMICS ADVISERS

Andrea Holland
Robert Lacy
Ray Owens

26

Above the Minimum: Living-wage statutes are designed to
help low-income workers in Baltimore and other Fifth
District communities, but do they get the job done?
“Living-wage” standards are supposed to help low-income workers. But
in Baltimore and other Fifth District communities, the effects of such
standards have been relatively modest, affecting only a small and
concentrated group of workers.

DEPARTMENTS

C I RC U L AT I O N

Walter Love
Shannell McCall
DESIGN

Ailsa Long
Published quarterly by
the Federal Reserve Bank
of Richmond
P.O. Box 27622
Richmond, VA 23261
Phone: (804) 697-8000
Fax: (804) 697-8287
E-mail: rich.regionfocus@rich.frb.org
www.rich.frb.org/pubs/regionfocus

1 Noteworthy
2 Federal Reserve/The Road to Independence
6 Jargon Alert/Opportunity Cost
7 Research Spotlight/The Economics of Happiness
8 Legislative Update/States Move to Prevent Post-Disaster Price Gouging
9 Short Takes
30 Interview/Al Broaddus and Tom Humphrey
35 Economic History/Labor Pains: Unionization in West Virginia’s Coal Industry
38 Book Review/Too Big to Fail: The Hazards of Bank Bailouts
40 Regional/District Economic Developments
48 Opinion/The Paradox of Voting

COVER ART: KEVIN MACKINTOSH/GETTYIMAGES

Subscriptions and additional copies:
Available free of charge by
calling the Public Affairs
Division at (804) 697-8109.
Reprints: Text may be reprinted
with the disclaimer in italics below.
Permission from the editor is
required before reprinting photos,
charts, and tables. Credit Region
Focus and send the editor a copy
of the publication in which the
reprinted material appears.
The views expressed in Region Focus
are those of the contributors and not
necessarily those of the Federal Reserve
Bank of Richmond or the Federal
Reserve System.
ISSN 1093-1767

NOTEWORTHY
Fed Lending and Moral Hazard

s many of you know
— and as was announced in the last
issue of this magazine — Al
Broaddus has retired as president of the Federal Reserve
Bank of Richmond, after more
than 34 years of outstanding
service to the Bank and the
Federal Reserve System. I am
honored and humbled to have
been chosen to succeed him.
His contributions have been
enormous — and his leadership exemplary.
For the past seven years,
Al’s column has graced the
opening pages of Region
Focus. In this, as in so many
other ways, I hope to live up
to the high standards that
Al has set. There are some
very important challenges
facing the Fed — including,
of course, our ongoing
efforts to maintain price
stability — that I would like
to address in this space.
From time to time, I also
would like to discuss some
broader economic and public-policy issues that may
seem to touch only peripherally on the Fed’s core

A

functions, but which nevertheless are vitally important. One such topic that
comes to mind is the role
that technological growth is
having on wage inequality.
But for my initial
“Noteworthy” column, I
would like to stay fairly
close to home and discuss a
topic that occupies the time
and minds of many people
throughout this Bank and
the Federal Reserve System:
how to provide financial
institutions with sufficient
liquidity without encouraging them to engage in
unsound business practices.
By lending through the
discount window, the Fed
can help stave off financial
crises. For instance, in the
days immediately following
the terrorist attacks of Sept.
11, 2001, the Federal Reserve
System loaned about $46
billion from the discount
window. This was crucial in
helping the nation’s financial
system cope with the disruptions caused by the attacks.
In our financial system, the
discount window has a useful role to play — and not
just in situations as severe
and tragic as 9/11.
But we also need to be
wary of the risks that excessive lending can bring. Fed
lending to a troubled bank
can allow uninsured depositors and creditors to withdraw funds just before the
bank fails. This weakens
their incentive to monitor a
bank’s risk-taking and can
increase the cost of the

bank’s failure to the deposit
insurance fund. And by
weakening this market
discipline, we increase the
chances that a bank will
become insolvent.
Given the substantial
financial safety net — and
the risks it poses to taxpayers — the Fed must be
vigilant in both its lending
practices and its supervision
of financial institutions.
What does this mean in
practice? In the past, the
Fed typically has lent money
to any bank with acceptable
collateral, including many
troubled banks that soon
failed. The Federal Deposit
Insurance Corporation Improvement Act of 1991 —
better known as FDICIA —
placed limits on the Fed’s
ability to lend to undercapitalized banks, but left the
Fed with considerable discretion in extending credit
to banks facing potentially
critical financial problems.
This presents us with a
dilemma: Should the Fed
try to help those at-risk
banks or instead withhold
funds to limit moral-hazard
problems? It’s not an easy
question to answer, but I’m
inclined to say that the Fed
should avoid lending to
unsound banks, even those
on the verge of collapse. It
would be tempting for the
Fed to intervene in such situations but, in my view, it
would in many cases be
unwise.
None of this is to say that
sound, stable banks should

be denied funds. In our
banking system, discount
window lending is important
and useful. The Fed should
continue to use this tool to
help fundamentally healthy
banks meet short-term liquidity needs — but it should
do so judiciously and probably more sparingly.
As President of this institution, the risks associated
with discount window lending is an issue that will
occupy my attention much
over the coming months and
years. As my thoughts evolve
— and as events dictate — I
will have more to say on the
topic. But for now I will close
by reiterating what a pleasure it is to lead theRichmond
Fed and its tremendous staff.
It’s a great challenge that I
look forward to with great
excitement.

JEFFREY M. LACKER
PRESIDENT
FEDERAL RESERVE BANK OF RICHMOND

Fa l l 2 0 0 4 • R e g i o n Fo c u s

1

FEDERALRESERVE

The Road to
Independence
The Federal Reserve
was created by
Congress, but must
retain autonomy
from the political
branches to
effectively execute
monetary policy

Former Federal Reserve
Chairman Paul Volcker talks
with Sen. Paul Sarbanes of
Maryland prior to a 1979
Senate hearing on monetary
policy. The Federal Reserve
is formally independent
of the executive and
legislative branches, but
the President appoints the
Fed’s chairman, who must
report regularly to Congress.

2

AP/WIDE WORLD PHOTOS

BY ERIC NIELSEN

R e g i o n Fo c u s • Fa l l 2 0 0 4

ince this nation’s founding, central
bank independence (CBI) has
been a contentious and oftenmisunderstood issue. Our government
and national character were formed in
reaction to monarchy and centralized
power, yet from the First and Second
Banks of the United States to the
current Federal Reserve System, central
banks have played key economic and
political roles at various points in history.
These banks have been attacked
for being both too powerful and independent of the political structure, as
well as for being too partisan in
setting economic policy. Only through
extensive trial-and-error experimentation, as well as significant economic
scholarship, has the proper role of a

S

central bank within a constitutional
framework become understood and
widely accepted.
Economists, policymakers, and
journalists frequently make reference
to “central bank independence,” but
what is meant by this term? There is
no consensus as to what the definition
of CBI ought to be (see sidebar), yet
broadly speaking, independence is the
ability of the bank to formulate and
carry out monetary policy as best it
can without political intervention.
Independence is a complex blend of
the bank’s enumerated powers, its
structure, and its leadership, as well
as many other factors.
Central bank independence is
important because it allows the government to commit credibly to a
program of low inflation. On their
own, governments have a strong inflationary bias; they often will try to
boost output and employment in the
short run for political gain, even
though eventually such policies lead
to inflation, not sustained growth.
Inflation can also act as a source of
revenue for governments, further
tempting them. Even if a government
promises not to inflate, the public may
remain skeptical, producing high inflationary expectations. By delegating
responsibility for money creation to a
central bank, the legislature can
remove the temptation to abuse its
power and pursue bad monetary
policy for short-run gain. (It is important to note that this temptation to

inflate is particularly acute in a system
of fiat money. When a nation’s currency is backed by a commodity, such
as gold, the ability of the government
to inflate at will is limited. Of course,
such commodity-backed systems have
their downsides as well.)
The Federal Reserve System clearly
demonstrates this delegation of monetary authority by a legislature to a
central bank. The Fed is ultimately a
child of Congress, to which the chairman must report regularly, but it is
free to pursue monetary policy as it
sees fit. As economist Allan Meltzer
of Carnegie Mellon University puts it,
“The Fed is independent within
government, not independent from
government.”
Modern ideas about the importance of central bank independence in
maintaining good monetary policy
took a long time to develop, with
many missteps along the way. After
two initial experiments in central
banking, the United States went
almost 80 years with no central bank.
These early banks failed due to fears
that they were too powerful, too
corrupt, and too free from government oversight.
During the Revolutionary War, the
fledgling U.S. government had difficulty financing wartime expenditures
and resorted to excessive printing of
continental dollars. (This is how the
phrase “not worth a continental” originated.) This prompted the founding
of the First Bank of the United States
(FBUS) in 1791, a private bank with
some special privileges to finance
government debt. Though the FBUS
worked reasonably well, its charter
was not renewed in 1811 largely due to
the belief that such an institution did
not have an explicit constitutional
mandate and fears that it wielded too
much financial power.
After the United States once again
experienced credit problems during
the War of 1812, the Second Bank of
the United States (SBUS) was chartered in 1816. The SBUS was not conceived as a central bank in the modern
sense, though it soon evolved to fill
that role during the 20 years of its
initial charter. It was fairly successful

in its attempts to regulate and stabilize the nascent U.S. banking industry.
When the time came, however, for
the bank to be rechartered, President
Andrew Jackson and Nicholas Biddle,
head of the SBUS, argued fiercely
about the Bank’s place in U.S. governance. Jackson complained that the
bank was run for the private interests
of its shareholders and was not provided for by the Constitution. Biddle
countered by arguing that a central
bank was effective and justified, and
should be separated in powers from
the government, which might abuse
its role in the financial system. Ultimately, Biddle lost the fight, and with
it the Bank. The United States had no
central banking authority until the
Federal Reserve System was founded
in 1913.

The Birth of the Modern Fed
The story of the modern Fed really
begins in 1934, in the midst of the
Great Depression. After its apparent
failure to avert the economic disaster
of the 1930s, the Fed subordinated its
policy role to the U.S. Treasury. Once
World War II broke out, the Fed
further sacrificed independence, propping up government debt by holding
interest rates constant. This policy
was both inflationary and limiting
since it prevented the Fed from taking
other monetary actions. After the war
was over, the Treasury as well as President Truman wanted the Fed to continue supporting their fiscal policies,
but there were critics within the Fed
of continuing this arrangement, and
eventually the conflict escalated into
open argument as each side publicly
contradicted the other about the
direction of U.S. monetary policy.
The dispute was finally resolved by
the signing of the Treasury-Federal
Reserve Accord of 1951. In the Accord,
both parties agreed that the Fed
should be the sole conductor of monetary policy. The disengagement of
monetary from fiscal policy in effect
allowed the Fed to gain back the independence it had lost during the war.
In the period immediately following
the Accord, the modern character and
role of the Fed were formed under the

chairmanship of William McChesney
Martin. According to Robert Hetzel,
a senior economist at the Federal
Reserve Bank of Richmond, “What
happened after the Accord was that
Martin gave effective substance to the
federal character of the Reserve
System by bringing in regional bank
presidents as key members of the
FOMC. So while there was no change
in the law concerning Fed independence, there was an institutional
change.” Furthermore, the Accord saw
the Fed commit to “lean against the
wind” — that is, to adopt monetary
policy with the intention of smoothing out business cycle fluctuations.
Since 1951, the results of Fed policy
have been highly variable. During the
1950s and early ’60s, inflation was
low and steady. But in the late 1960s
and much of the ’70s, the United
States suffered from high and variable
inflation along with high rates of
unemployment. Fortunately, since the
early 1980s, inflation has been generally quite low, and it seems that price
stability finally has been achieved.
Some economists have suggested that
at least some of this variation in performance should be attributed to
occasional partisan political intervention by the Fed.
Others argue that the Fed simply
did not have sufficient economic
understanding during these bad spells
to formulate effective policy. For
instance, under the chairmanship of
Arthur Burns (1970-1978), the Federal
Reserve often pursued unwise monetary policies. Persistently high inflation
coupled with economic stagnation,
derogatorily dubbed “stagflation,” characterized Burns’ tenure.
Economists like Richard Timberlake of the University of Georgia
think that Burns’ Fed was clearly
politically active. Timberlake argues
that by keeping monetary policy loose
throughout 1971, despite rising inflation, Burns boosted President Nixon’s
chances at re-election in 1972 by artificially stimulating the economy. “He
[Burns] made the Fed, at least as far
as he had control of it, an aide of the
Nixon Administration,” Timberlake
says. He further cites Burns’ unortho-

Fa l l 2 0 0 4 • R e g i o n Fo c u s

3

dox and ineffective use of wage-price
controls in an effort to curb inflation.
Other economists such as Hetzel
counter that, though misguided,
Burns’ policies were failures of economic understanding and leadership,
not of political independence. He
argues that most of Burns’ policy blunders were foreseeable results of his
previously stated economic beliefs —
which, in large measure, were representative of the economics community generally during this period. As
Marvin Goodfriend, an economist and

senior vice president at the Richmond
Fed, points out, “The central bank
cannot be expected to do better than
the economists.”
In addition to hewing to questionable economic theories, Burns
also changed his outlook and explanations frequently. This had the unintended policy effect of making it
more difficult for businesses to
understand and predict which policies the Fed was likely to pursue. This
combination of loose policy, high
inflationary expectations, and dimin-

ished Fed credibility set the stage for
stagflation.
The quality of Fed monetary policy
has improved markedly over the last two
decades under the leadership of Paul
Volcker and Alan Greenspan. For
instance, during the presidential election
in 1980, Volcker drastically tightened
monetary policy. This put an end to inflation, although it caused a short but
severe recession. Such actions seem to
indicate that the Fed is more able, or at
least more willing, to follow good policy
regardless of political repercussions.

Measuring Independence

R

E DEPA

TH

A SUR
Y

R e g i o n Fo c u s • Fa l l 2 0 0 4

TRE

4

E

The chief problem facing economists seeking to understand decreased the Fed’s independence from the executive branch.
Economic independence is the central bank’s ability to
the effect of central bank independence (CBI) on economic
performance is the difficulty in ranking and comparing effectively enact any monetary policy it may decide is best.
CBI across countries. Unlike many economic variables, inde- The Fed now has economic independence since it has direct
control over the implements of monetary
pendence is not simply a number, but instead a
T OF T
EN
H
M
policy, but did not through part of its history.
loosely defined concept dependent upon the
T
Until the Treasury-Fed Accord of
specific institutional, legal, and cultural
1951, the Fed was required to support
framework within which a particular
the nation’s fiscal policy, which
central bank operates. No two counremoved a huge array of options
tries, or their central banks, are alike.
from its policy palette.
Essentially, researchers must find a way
The Treasury-Federal
Attempts to rigorously analyze
to compare apples to oranges.
Reserve Accord
CBI are complicated further by culEconomists generally break indetural factors extending beyond mere
pendence down into two subcategories,
The Treasury and
institutional and legal arrangements.
political and economic, which they can
For instance, a country with a long
then examine separately or in combithe Federal Reserve System
tradition of deference to authority
nation. Political independence is the
have reached full accord
may have a less independent central
degree to which a central bank is insuwith respect to policies
bank in practice, regardless of how
lated from short-term political censure.
independent it looks on paper.
Infrequent appointments of bank directo be pursued in furthering
Determining the cultural attitudes
tors, legally mandated independence,
their common purpose
toward central banking within a
and other institutional arrangements
to assure the
given country requires intimate
are taken to correspond with high politknowledge of its history and national
ical independence.
successful financing
identity.
Compared to other countries’
of the Government’s
Studies showing a correspondence
central banks, the Fed has a good deal
requirements and,
between CBI and low inflation, then,
of political independence. It can
need to be taken with a grain of salt.
conduct policy that is contrary to the
at the same time,
The indices used are generally quite
wishes of Congress (at least until Conto minimize monetization
crude. The most popular consist of
gress decides to change the law govof the public debt.
a simple 1 to 4 ranking, and may be
erning the Fed). Additionally, the
subject to researcher bias. Encourchairman of the Fed serves a 14-year
agingly, though, researchers have
term, thus isolating him somewhat
found similar results using a wide
from political threats to his job. At the
same time, informal bonds between members of the Fed and array of ranking schema, indicating that though the specifics
elected officials may jeopardize independence at times. For may be difficult to measure, there is a real underlying
instance, some have argued that former Fed Chairman Arthur relationship between CBI and some aspects of economic
Burns’ friendship with President Nixon may have informally performance.
— Eric Nielsen

What the Data Say
A great deal of theoretical and empirical investigation tentatively indicates
that some form of CBI does indeed
have beneficial long-run effects. For
instance, economist Alberto Alesina of
Harvard University has used various
methods to quantify independence and
has found that, across a wide sample of
countries, greater CBI tends to correspond to lower and less variable inflation. At the same time, research also
indicates that CBI has little effect on
other important economic variables
such as GDP growth.
Like all research, these results come
with major caveats. As discussed in the
sidebar, it is very hard to come up with
a ranking of independence across countries. Though the correlation between
high CBI and low inflation holds for a
wide array of independence indices, the
strength of the results does change.
Although economists and policymakers have made great strides in
understanding the economic importance
of CBI, there is still much work to
be done. There are now major proposals being discussed to further
institutionalize the Fed’s independence
and help protect it from potential crises.
The most prominent suggestion
advocated by many monetary economists is that the Fed adopt an explicit
inflation target as its primary operational goal. Under an inflation target,
the Fed would simply pursue whatever
monetary policies were necessary to
maintain inflation at the desired level.
Over the last 20 years, the Fed has
focused most of its energies on maintaining low inflation, yet there is
nothing in the mandate of the Fed
requiring that it make inflation its main
priority. As Goodfriend puts it, “You
want an inflation target to guard
against the bad old days of high inflation. Independence becomes moot if
the Fed follows an inflation target
because it will be held accountable to
something. Holding inflation constant
would completely determine Fed policy
— there would be no degrees of
freedom to do anything else.”
In addition to a publicly stated inflation target against which actual Fed performance could be compared, the Fed

might also want to make its operating
procedures more transparent. “The issue
for the Fed is that it is not enough that
we have oversight hearings in Congress.
We also have a responsibility to conduct
monetary policy in a way that allows
easy monitoring by the public,” says
Hetzel. “It is incumbent upon us to
make policy in a way that is in the spirit
of a constitutional democracy.”
An explicit inflation target mandate
for the Fed would also help it surmount
another potentially difficult issue: that
of succession and leadership. Many
economists now see the leadership of
the chairman as vital to Fed success.
“A lot of the credibility of the Federal
Reserve System rests in the person of
the Federal Reserve Chairman because
we don’t have any institutional requirements to target low and stable inflation,”
Hetzel says. “There is no obvious answer
to how well we would work under a poor
leader.” As a result, some fear that when
Greenspan retires, a lot of the faith in
the effectiveness of the Federal Reserve
System will retire with him.
Marvin Goodfriend and Robert
Hetzel are not especially concerned,
though. Goodfriend stresses that, over
the last 20 years, a consensus has
emerged within the economics community that the Fed should primarily
strive to maintain low inflation. Such
agreement effectively limits the opportunities for politicians to push for deviations from best practice behavior.
“Intellectuals matter, when they are
united,” Goodfriend says.
New Pressures to Inflate?
Questions about the Fed’s independence
and ability to stave off political pressure
may become particularly pressing in the
near future. Laurence Kotlikoff of
Boston University and Scott Burns of the
Dallas Morning News argue in their new
book, The Coming Generational Storm,
that in the next 30 years, the Social Security and Medicare systems will come
under tremendous pressure as the baby
boom generation reaches retirement age.
These programs’ liabilities are close to
12 times the current national debt, Kotlikoff and Burns estimate.
Without a large increase in the size
or productivity of the American work

force, the government will have
difficulty financing these expensive
programs through the conventional
means of taxation and borrowing.
Kotlikoff and Timberlake fear that the
Fed will be put under tremendous
pressure by the political branches to
use inflation to pay down this debt.
Another potential source for political pressure on the Fed comes from
hard-to-predict geopolitical events
such as terrorism. Several studies have
shown that terrorism imposes enormous costs on the U.S. economy. In the
wake of 9/11, the Fed drastically loosened monetary policy to help the
economy rebound. That action has
seemed to work, but a particularly
severe attack in the future may prompt
politicians to pressure the Fed into
unsound monetary practices.
Such potential pressures on good
monetary policy give the issue of
central bank independence new relevance. The economic performance of
the coming decades could hinge in part
on how well the Fed can insulate itself
from political machinations in the face
of extreme circumstances.
RF

READINGS
Alesina, Alberto, and Lawrence Summers.
“Central Bank Independence and Macroeconomic Performance: Some Comparative
Evidence.” Journal of Money, Credit, and Banking,
May 1993, vol. 25, no. 2, pp. 151-162.
Federal Reserve Bank of Richmond Economic
Quarterly Special Isue on the Treasury-Federal
Reserve Accord, Winter 2001, vol. 87, no. 1.
Kotlikoff, Laurence J., and Scott Burns. The
Coming Generational Storm: What You Need to Know
about America’s Economic Future. Cambridge, Mass.:
MIT Press, 2004.
McCallum, Bennett T. “Crucial Issues Concerning
Central Bank Independence.” Journal of Monetary
Economics, June 1997, vol. 39, no. 1, pp. 99-112.
Meltzer, Allan H. A History of the Federal Reserve,
Volume 1: 1913-1951. Chicago: University of
Chicago Press, 2004.
Timberlake, Richard H. Monetary Policy in the
United States: An Intellectual and Institutional History.
Chicago: University of Chicago Press, 1993.
Visit www.rich.frb.org/pubs/regionfocus for
links to relevant Web sites.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

5

JARGONALERT
Opportunity Cost
BY E R I C N I E L S E N

ILLUSTRATION BY TIMOTHY COOK

T

6

here is an old saying, “You can’t have your cake and eat
it too.” Although this bit of folk wisdom may seem
corny, it carries with it significant economic wisdom.
It gets at the heart of one of the most important concepts in
economics: opportunity cost. The opportunity cost of something is simply what you must give up in order to get it.
Resources are always limited, so not all wants can be
satisfied. When you take a course of action, you use resources
that cannot be applied to other projects. The opportunity cost
is the value of those foregone opportunities. For example, if
you decide to spend your money on a new bicycle, you cannot
also spend it on a new computer. Or if you spend an
hour watching television,
you cannot also spend
that time reading a book.
Opportunity cost is
in many ways the most
fundamental idea in economics. Economics at its
core is the study of how
decisions are made about
the allocation of finite
resources in the real
world. If resources were
not limited, there would
be no reason to forego
any desired activity and
all projects could be
undertaken. Every action
has an opportunity cost,
so it is important to try to
understand the full extent of these costs.
Before the emergence of money, people traded goods
directly, which made opportunity-cost relationships more
obvious. One of the main functions of money, then, is to
assign a unit of account to the relative costs of various items.
Rather than having countless hard-to-fulfill barter relationships — such “as one car costs 1,500 pizzas” — you need only
have their prices in dollars. The dollar price of various items
reflects their opportunity costs.
To make an economic decision, you must fully consider the
opportunity costs associated with various options. For example, say you are confronted with the choice of flying or driving
to visit a friend in Chicago. A plane ticket costs $300, while gas
for your car will only be $125. Given those figures, it’s more economical to drive, right? Actually, the answer is not so clear. For
instance, if it takes two days to drive to Chicago and back but
only four hours to fly, a person earning a reasonably good salary

R e g i o n Fo c u s • Fa l l 2 0 0 4

would be better off working the extra day and a half, and then
flying. For a student or someone else with little earning power,
it still might be cheaper to spend the extra time and drive. So
opportunity cost decisions involve many more factors than
simply the dollar costs associated with various alternatives.
Opportunity cost also plays an important role in what economists call the labor-leisure decision. Possibly the most basic
decision you can make is how to divide your time between work
and play. All else being equal, most people prefer leisure to
labor. At the same time, the greater wealth which comes from
working allows us to consume things we like, and gives us
greater freedom as to how
we spend our leisure
hours. You must take
into account the competing desires to have some
money to spend versus
the pleasure of relaxation;
the opportunity cost of
taking a day off is the
amount that you could
have earned if you had
worked. As another old
saying goes, “Time is
money.”
Governments must
also consider the opportunity costs of their
actions. For instance, it
would seem that a natural
way to increase revenues
would be to raise marginal
tax rates — that is, raise the rate at which each additional dollar of personal income is taxed. Although it would appear that a
higher tax rate on a given income stream would yield proportionally higher total tax revenue for the government, that is not
necessarily the case. By raising marginal rates, the government
has altered the labor-leisure calculation; it is now cheaper for
a worker to forego an extra unit of labor in favor of leisure. The
tax increase, then, likely will have the effect of reducing how
much people work — which will tend to dampen or, in extreme
cases, possibly even reverse the expected effect of the rate hike.
In short, many choices have consequences that are not
immediately obvious. But to fully evaluate any decision —
whether it is made by an individual or by the government
— people must consider both “the seen and the unseen,” as
the 19th century French economist Frederic Bastiat put it.
Opportunity costs are often unseen, yet they remain real
and important.
RF

RESEARCHSPOTLIGHT
The Economics of Happiness
BY E R I C N I E L S E N

M

Frank thinks so — at least for some kinds of wealth.
ost people have probably heard of the term Homo
Goods that he dubs “conspicuous” do not permanently add
sapiens, but fewer are familiar with his more
to happiness, he argues. A new car might be nice and excitrational relative, Homo economicus, who is not
ing for a time, but after awhile we start to take it for
emotional or impulsive. He learns quickly, plans ahead, and
granted. On the other hand, “inconspicuous goods,” such as
doesn’t make repeated mistakes. He is useful for economists
vacation time, social interaction, and short commutes,
to study because his intelligent, predictable behavior is commight permanently change happiness. For example, people
paratively easy to model mathematically.
with shorter commutes have lower stress levels, lower blood
Not surprisingly, there are very few real-life examples
pressure, and even lower risk of developing lung cancer.
of Homo economicus. People can be emotional and impulIf houses and cars do not really make us happier, then
sive. The world is very complex, and our capacities are too
why are most of us willing to spend so much money on
limited for us never to be in error.
them? Frank argues that since happiness is essentially
Behavioral economics is the rapidly growing branch of
a question of relative consumption, one person’s spending
economics that seeks to incorporate such human imperimposes negative externalities on others. These externfections into economic thinking. Instead of assuming
alities will cause everyone to try to consume more than
perfect rationality, people are modeled as having
everyone else, instigating a consumption arms-race. If this
“bounded” or imperfect rationality; their decisionmaking
is correct, the implications for policymakers could be
process can be subject to error or systematic bias. To
enormous. By overturning one of the cornerstones of ecocharacterize these less-than-perfect beings, behavioral
nomic theory, a wide array of
economists rely on eclectic
policy actions, such as a prointerdisciplinary tools such
gressive consumption tax to
as surveys, experiments, and
“How Not To Buy Happiness”
discourage spending on concognitive science. These
sumer goods, may become
methods have been applied
by Robert H. Frank.
desirable.
to a wide range of economic
Daedalus, Spring 2004,
There is a strong case
questions, from the pricing
against these conclusions,
of stocks to the hours cab
vol. 133, no. 2, pp. 69-79.
however. Neoclassical ecodrivers choose to work.
nomics uses the concept of
Perhaps the most fundarevealed preference to determental behavioral challenge
mine what people want. People reveal their actual preferthus far has come from economists studying happiness.
ences by the actions they choose. They vote for their preferThese researchers question one of the axioms of
ences with their consumption dollars.
mainstream theory: that greater wealth and consumption
Revealed preference could be a more reliable indicator
bring greater happiness and well-being. For example, in a
of happiness than survey results. When responding to a
recent article titled “How Not to Buy Happiness,” Cornell
survey, people might measure their happiness relative to
University economist Robert H. Frank advances the argusome local norm, which may sound reasonable but would
ment that most consumption goods — houses, cars, and
not capture absolute changes in happiness. For example,
clothes — do not permanently increase happiness.
150 years ago nobody had electric lighting in their homes.
Frank’s conclusions come from some surprising survey
So a person from that era would probably not be unhappy
results. Based on self-reporting surveys in which responabout their lack of electricity. However, given a choice,
dents are asked to rank their happiness, it appears that
people overwhelming want electricity, and it is difficult
there is a paradox at the heart of economics. At any one
to argue electric power has not made us better off in
time, rich people will report substantially higher levels of
real terms.
happiness than poor people. However, as all people
So what lies in store for economics as a discipline?
become richer in tandem, the reported happiness for the
Many of the results of behavioral economics are interesttwo groups does not change. For example, between 1960
ing, to be sure. Yet it is unclear how the work being done
and 1980 Japan experienced a tremendous economic boom,
by Frank and his colleagues can provide a comprehensive,
yet people reported the same levels of happiness after the
alternative way of looking at the world. This is the chalboom as before. Could it be that relative wealth is imporlenge now facing behavioral economics.
RF
tant, and not absolute wealth as economists assume?

Fa l l 2 0 0 4 • R e g i o n Fo c u s

7

LEGISLATIVEUPDATE
States Move to Prevent Post-Disaster Price Gouging
BY C H A R L E S G E R E N A

T

department at George Mason University. Anti-price-gouging
he remnants of Tropical Storm Gaston dumped more
laws prevent this “economic triage” from taking place.
than a foot of rain on central Virginia in just one day in
This means that even businesses with inventories on hand
August, creating raging floodwaters that caused millions
ought to be able to raise prices to market levels. Otherwise, “first
of dollars in damage and killed eight people. Within days, a few
come, first serve” becomes the standard for determining who
parking facilities in downtown Richmond allegedly raised their
gets what. The senior citizen who has a generator powering his
fees because many lots in the city’s Shockoe Bottom
respirator may end up at the back of the line for gasoline and
district were covered in a mass of mud and wrecked vehicles.
get nothing, while the first person in line gets to refuel his genThe threat of rapid markups for goods and services after
erator so that he can keep his entertainment center running.
disasters like Gaston and Hurricane Isabel in 2003 is the
In addition, rising prices signal that an unmet demand exists.
reason why Virginia passed an anti-price-gouging law last April.
This entices new suppliers into disaster-struck communities
North Carolina enacted a similar law in 2003 and the District
with the promise of hefty profits. That’s important because
of Columbia did it 11 years earlier. Lawmakers want to protect
“you need to make sure that new supplies find their way into
consumers from businesses deemed opportunistic.
distressed areas as quickly as possible,”
In fact, not every post-disaster
says Boudreaux. Anti-price-gouging laws
price hike is predatory. Some price
limit price increases, which “discourages
increases are inevitable when a hurriAll’s Fair in Love and War …
suppliers from outside of the disaster
cane or some other calamity throws
and Pricing?
area from putting forth the extra effort
supply and demand out of whack.
There are good economic reasons for
to get vitally needed supplies to that area.”
After a disaster, the total supply of
raising prices of essential goods following
Although higher prices boost the
certain goods and services suddenly
a natural disaster or major storm. But
availability of goods and services in the
drops — there may be less gasoline due
most people seem to think that this pracmedium and long run, one could argue
to power outages at service stations, for
tice is unfair. Consider the responses to
that supply remains relatively constant
example. The disaster also creates a
the following household survey question.
in the short term. Variables that usually
surge in demand for some items like
influence supply, such as the state of
Question: A hardware store has been
generators. In either case, prices of
selling snow shovels for $15. The morning
technology and the number of producthose items tend to rise. Things become
after a large snowstorm, the store raises
ers, can’t change immediately. To make
even more complicated when supply
the price to $20. Please rate this action.
matters worse, flooded roads and power
disruptions coincide with demand
Response: Unfair, 82%; Acceptable, 18%
outages may make it impossible for new
surges, for instance, when people need
SOURCE: Daniel Kahneman, Jack L. Knetsch, and Richard
supplies to reach the market.
gas to fuel their generators.
Thaler. “Fairness as a Constraint on Profit Seeking:
Therefore, higher prices won’t
In such situations, businesses want
Entitlements in the Market.” American Economic
Review, September 1986, vol. 76, no. 4, pp. 728-741.
immediately result in, say, many more
to increase their output, but they can’t
bags of ice getting to many more
unless they take extraordinary measpeople. Instead, only those who are
ures. Goods producers and retailers
willing and able to pay higher prices — no matter how outmay have to truck in fresh supplies from distant sources,
rageous they may seem — will get what they need. Some
while service providers may have to bring in extra help. Since
people may simply go without.
these measures cost money, businesses must raise prices. AntiGovernment agencies and charitable organizations could
price-gouging laws usually permit moderate price increases,
meet unmet demand in the aftermath of a disaster. That way,
which is why some industry groups aren’t concerned about
the higher prices would be spread over a wider population
Virginia’s law. It seems to them like a good compromise that
beyond the individuals in need. However, buyers and suppliboth protects consumers and allows businesses to recover
ers may be less motivated to prepare for future disasters if
their added costs.
they think a white knight will save them, and that doesn’t
But economists like Donald Boudreaux counter that if
always happen.
businesses can’t raise prices beyond a certain level, they
“No serious economist would ever claim that allocation [of
may have to ration goods by limiting purchases. This pregoods] according to prices is perfect,” says Boudreaux. Still,
vents items from going to the people who need them most.
he argues, it is a better way to allocate resources in emergen“You have to make sure that existing supplies in the immecies than the alternatives available with an anti-price-gouging
diate vicinity of the distressed area … are used as efficiently
law in place.
RF
as possible,” says Boudreaux, chairman of the economics
8

R e g i o n Fo c u s • Fa l l 2 0 0 4

SHORTTAKES

La Cooperativa
Educates Members

M

attress banking” has
a competitor in North
Carolina — the Latino Community Credit Union
(LCCU), known informally
as La Cooperativa.
In the central North
Carolina Triangle area of
Raleigh-Durham- Chapel
Hill, criminals know that
working-class Latinos may
keep cash at home or in
wallets instead of in a
bank account. According
to John Herrera, chairman
of LCCU’s board of directors, the credit union is
a community response to
increasing crime against
the Latino population in
Durham, N.C.
People without a deposit
account at a bank, credit
union, or thrift usually have
below-average incomes.
Alternate sources such as
check-cashing outlets provide money orders, wire
transfers, and other financial services that the
“unbanked” require. But
often fees are higher than
those incurred by customers
who have bank accounts.
LCCU’s mission is to
serve the unbanked, says
Herrera. The credit union's
target audience is “hardworking
people
with
muddy boots.” They are
landscapers, hotel workers,
dishwashers, and people
with the repetitive manufacturing jobs — those

who are most likely to be
unbanked.
A conference in 2002 on
the unbanked at the
Chicago Fed noted that “...
recent immigrants … make
up a significant proportion
of the unbanked population.” Although LCCU is
open to anyone, members
are
principally
from
Mexico, Puerto Rico,
Honduras, and El Salvador.
Because the members are
shareholders, they own the
credit union. That concept
is familiar to many Latino
people who have participated in Mexican “tandas,”
informal credit associations
built on community trust.
LCCU gets technical
assistance,
access
to
lawyers, and admission to
credit union groups from
its founders — community
leaders and organizations.
Local churches play a significant role by providing
information about LCCU
to the community.
While realtors have
coined the phrase, “location, location, location,”
LCCU’s motto is “trust,
trust, trust.” That must be
earned by partnering with
area churches and community-based organizations.
According to Herrera, the
primary form of advertising
is word of mouth. LCCU
speaks to the community
in English and Spanish.
From the services of management and tellers to
deposit tickets to mortgage
documents to its web site
www.cooperativalatina.org,

the credit union's business
is bilingual.
LCCU offers the usual
array of credit union products and services, and places
a big emphasis on financial
education. “Everything we
do is financial education.
From the time an account
is opened or a check
cashed, it’s an opportunity
to teach,” says Herrera.
The approach to financial
education is equivalent to a
product cross-selling strategy. Employees always look
for opportunities to present new or related financial
education information.
Free financial literacy
classes are available to
members and nonmembers.
According to Herrera, more
than 85 percent of the credit
union’s members have never
had a bank account, and
new members may not
understand what it means to
earn interest on deposits.
“You can’t start out selling them a CD,” he says.
“You have to explain these
things first.” Credit union
members who want to open

interest-bearing accounts
need a social security number or taxpayer identification number for tax reporting. Classes are offered on
obtaining a taxpayer identification number and filing a
tax return, budgeting, and
managing a checking
account. More advanced
topics include consolidating debt and home-buying.
Classes may be required as
part of the application for
some services. Members
are also given a phone number so they can call from
the comfort and privacy of
their home for answers to
personal finance questions.
As members become
better informed about
money management, they
develop opportunities to
increase personal wealth
by creating a clean credit
history. Responsible members can apply for a
small, collateralized loan.
The Latin0 Community
Credit Union (LCCU) serves
central North Carolina’s
growing Spanish-speaking
population.

COURTESY OF LCCU

SERVING THE UNBANKED

Fa l l 2 0 0 4 • R e g i o n Fo c u s

9

On-time payment of the
loan leads to a good credit
history and credit score,
which are needed to qualify for bigger loans or
mortgages.
In the four years since
LCCU began serving the
unbanked of central North
Carolina, the Latino population has shown its trust.
Herrera says membership
has been growing at the
rate of about 1,300 customers every month. There
are now five branches in
central North Carolina,
with total assets of $17 million. LCCU has been so
successful in its mission
that banks and credit
unions from across the
country have been calling
Herrera for information
and advice on starting their
own programs to serve the
unbanked.
— A I L E E N W AT S O N
SAVES TIME AND MONEY

Check Images
Replace Paper

C

ome this fall, the nation’s check collection
system will fully enter the
21st century.
On October 28, the
Check Clearing for the 21st
Century Act, also known as
Check 21, goes into effect.
The legislation will make
it easier for financial institutions to process checks
electronically by removing
some of the legal impediments to the process.
While electronic presentment has been possible for
many years, it previously
required a standing agree-

10

ment between two institutions.
The process, which
involves the truncation and
scanning of an original
paper check and passage of
its information via electronic image, is projected to
save the industry more than
$2 billion a year once it
becomes commonplace.
Financial institutions will
save time and money by
avoiding the physical transportation of paper checks
and by either transmitting
the electronic image when
there is an agreement or by
providing a substitute check
printed from the electronic
image if there is no agreement. Under the legislation,
these “substitutes” will have
the same legal standing as
the original paper checks.
The Federal Reserve
System clears nearly half of
the current 39 billion checks
written annually. As a result,
the Fed has adapted its
services to meet the change
in processing trends expected to be brought on by
the legislation.
Financial
institutions
processing through the Fed
will continue to have the
option of making either
paper or electronic check
deposits. Those institutions
with imaging capabilities
that submit electronically
will benefit from later processing
deadlines
and
national fees, rather than
those based on geographic
location.
For those items processed electronically, the Fed
will print substitute checks
and also offer the service of
electronic return, giving

R e g i o n Fo c u s • Fa l l 2 0 0 4

financial institutions faster
access to funds and greater
protection against fraud.
If institutions do not
have scanning and imaging
capabilities, the Federal
Reserve Bank will offer
additional services to help
them also realize savings
from Check 21. Those companies can elect to have
checks above a certain dollar amount sorted and processed electronically.
In the end, consumers
may also see the benefits of
the new legislation. Reduced
costs and faster processing
for financial institutions
could mean greater customer
service innovations and
extended deposit times for
their customers. Check 21
does come with a price,
though — with faster processing consumers can expect to see a shorter float
period from the time they
write a check to the time the
funds are withdrawn from
their account.
—ALICE FELMLEEL
GRUNDY MOVES ON

Town Relocates To
Avoid Floods

S

ome communities have
given up the fight to
control the rivers on which they
were built. They’ve sought refuge from severe and repeated
flooding by making a permanent move to higher ground.
Grundy, a former coal
mining boom town in Southwest Virginia, will soon be
one of those communities.
After enduring damaging
floods almost every 20
years, from 1937 to 1993,

Grundy is moving its business district across the
Levisa River to a 13-acre
site donated by Norfolk
Southern Corp.
Relocating Grundy is
tough because of the lack of
flat land. “Most communities
that have flooded have acres
of level land to go back a couple of miles from the river,”
says Grundy’s town manager
Chuck Crabtree. “The way
we were nestled between
mountains, railroad tracks,
the river, and U.S. Route 460,
we had no level land. So
floodproofing Grundy is
very unique in itself.”
The move is paving the
way for a long-awaited
highway project too. At
one time, Grundy, the seat of
Buchanan County, stood
in the way of the Virginia
Department of Transportation’s (VDOT) plan
to continue Route 460 to the
Kentucky state line. But
bypassing Grundy would
have cost VDOT $150 million to $160 million, Crabtree says, and building the
roadway through Grundy
would have destroyed its
downtown. And, there was
little space for existing businesses to relocate in the
mountainous terrain.
Thanks to a partnership
with the U.S. Army Corps
of Engineers (USACE) and
VDOT, relocating Grundy
and extending Route 460,
once financial impossibilities, are becoming realities.
VDOT’s routing U.S. 460
through the old downtown
will cost $77 million — $73
million to $83 million less
than the original proposed
cost. And USACE’s cost in

preparing the relocation
site for development fell
from somewhere between
$200 million to $300 million to about $110 million
as a result of the partnership, according to Crabtree.
Moving a town may
seem like a radical measure.
But for Grundy — with its
dwindling population and
an economy that never rebounded from the flood of
1977 — relocating may be
its only chance. Many
buildings were abandoned
after the ’77 flood, causing
property values to fall.
Federal laws have also
changed, requiring that no
more than half of a building’s appraised value be
spent on repairing it. In
most cases, the amount
allotted was insufficient to
do the necessary work.
“People started going
outside of Grundy for business,” Crabtree said. “We
had an outflow of people on
the weekends, and when
people started going out,
they liked the community
they were going to, and
they started moving.”

GREYFIELD REDEVELOPMENT

Although Grundy’s citizens gave up on the town a
long time ago, the proposed
new Grundy is attracting
new commerce already. A
new Comfort Inn has
almost quadrupled the
taxes paid by previous
downtown businesses, paying out about $50,000
annually, and has created
jobs as well. Verizon has
chosen Grundy as a pilot
project for creating a wireless community. Groundbreaking on the relocation
site is slated for fall 2006,
and retail businesses have
already spoken for the
future buildings, according
to Crabtree.
Grundy has now given
the river back to itself and
reopened the river channel,
transforming the Levisa
into an asset instead of a liability, Crabtree noted.
“It’s not one big fix. It is
a puzzle,” Crabtree said.
“No one would believe the
benefits that have come out
of this. I think we’ll have
the most unique small town
in the country.”
—J E N N I F E R S PA RG E R

Old Malls Seek
New Life

N

TOWN OF GRUNDY CORPS OF ENGINEERS

The business district in Grundy, Va., will be relocated to a 13-acre site
across the Levisa River.

ot far from the shoppers strolling through
the bright corridors of Cloverleaf Mall, there are three
eerily empty buildings filled
with the echoes of times past.
Every department store has
abandoned this once-thriving regional mall in Chesterfield County, Va., along with a
movie theater chain and most
of the food court tenants.
County officials want this
underused, 78-acre property
to be replaced with a mix
of offices, storefronts, and
housing within walking distance of each other. Other
declining malls across the
Fifth District known as
“greyfields” also need some
form of redevelopment.
The rise and fall of
regional malls parallels the
suburbanization of America
during the 1950s and 60s.
Department stores followed
shoppers out of downtown
districts as development
spread beyond cities. Eventually, retailers realized that
putting a few anchor stores
like Sears or J. C. Penney and
an assortment of specialty
stores under one roof created
a safe, climate-controlled environment that suburbanites
liked.
This clustering of retail
gave regional malls an advantage. “From an economic
point of view, [it] reduced
search and information
costs,” notes Mark Eppli,
who holds the Bell Chair in
Real Estate at Marquette
University. Because the mall

offered a plethora of
choices, shoppers could be
confident of finding the
quality or price they wanted.
The result was that stores
could generate more sales
collectively than they could
earn individually.
However, regional malls
in aging, filled-out inner-ring
suburbs have lost customers
as development has continued its outward expansion.
Outer-ring suburbs have
space available for new residential and commercial
development that meets the
market’s needs.
Some of this development has supported new
retail formats that have
taken market share from
regional malls. For example,
Cloverleaf Mall competes
with Regency Square and
Chesterfield Towne Center,
two “superregional” malls
that provide greater variety
in 800,000 square feet or
more of retail space. Then
there is Stony Point Fashion
Park, a “lifestyle center” that
is somewhat smaller, but has
an open-air design and the
kind of upscale food and
fashion offerings that used
to be confined to cities.
Finally, big-box retailers
like Dick’s Sporting Goods
and Circuit City stores provide wider selections of
specific product categories.
Some regional malls have
renovated or replaced some
of their tenants to keep pace
with change. In 2002,
Pennsylvania Real Estate
Investment Trust (REIT)
bought the Roses department store at Magnolia Mall
in Florence, S.C., and reconfigured it for occupancy by

Fa l l 2 0 0 4 • R e g i o n Fo c u s

11

Best Buy, a new food court,
and additional specialty
retailers. Other malls have
been radically remade — in
1998, Talisman Companies
tore down the walls of a failing regional mall in Towson,
Md., and created a strip
center of big-box stores.
In some cases, however,
the whole mall may have to
be scrapped. “There may not
be demand, the neighborhood may not have stepped
up over time, or the other
retail is too close and they
can’t compete,” says Eppli.
While it could be obsolete for retail use, a regional
mall has other qualities that
make it attractive for redevelopment. According to
Douglas Grayson, executive
vice president of development at Pennsylvania REIT,
a mall sits on a large parcel
within a well-populated suburb where land is scarce and
expensive, plus it has existing infrastructure like roads
and utilities. “There is a
high intrinsic value to that
piece of property.”
Realizing that value isn’t
easy, though. “The developer
or owner of the mall almost
never has the unilateral right
to do anything,” explains
Grayson. “The number of
stakeholders that have to be
dealt with to reposition a
property is huge [and each
one] is looking for their
opportunity to profit.” Also,
some of those stakeholders,
or even the mall’s primary
owner, may resist any redevelopment that might eat into
their existing returns, however meager they might be.
That’s why local governments often intervene.
12

They have the money to
assemble the necessary
property rights, tear down
mall buildings, and tie the
project into the surrounding neighborhood. They
also have the power of
eminent domain to take
care of holdouts, although a
Michigan Supreme Court
decision in July may limit
future seizures of private
property for economic
development
purposes.
While local governments
want to stimulate more taxable economic activity,
redevelopment experts say
that efforts to revitalize
greyfields and other obsolete properties must be economically justified.
—C H A R L E S G E R E N A

MALPRACTICE INSURANCE

Conflict Escalates

D

octors and lawyers, with
insurers in the middle,
continue their professional
conflict over rising medical
malpractice premiums.
At issue are medical
malpractice insurance rates
for certain physician specialties, such as obstetrics, that
some doctors say are forcing
them to quit. A Charleston,
S.C., surgeon recently made
a proposal that shocked the
legal and medical community. Chris Hawk, who has
practiced medicine for
26 years, suggested that
the American Medical
Association’s House of
Delegates pass a resolution
that would encourage doctors to refuse treatment to
trial lawyers. It did not pass.
“The physician has a

R e g i o n Fo c u s • Fa l l 2 0 0 4

right to refuse care to anybody,” Hawk says. “The feeling was that it was so damaging from a political correctness viewpoint they didn’t
want to do anything with it.
That may be legitimate, but
on the other hand, it did
get a lot of attention to what
is a very broken system.”
Physicians in many Fifth
District states have lobbied
for caps on noneconomic
damages. In West Virginia,
the state legislature lowered
in 2003 its cap to $250,000
on “pain and suffering” damages. In South Carolina, tort
reform legislation was tabled
earlier this year.
People investigating the
rising rates of malpractice
insurance would agree that
the system is broken, but
disagree about its causes
and policy options that
could help.
The
United
States
General Accounting Office
issued a report in October
2003 that outlined multiple
reasons malpractice rates
have soared. First, insurers’
losses on medical malpractice claims have jumped
in some states since 1998,
more slowly in states that
limit awards. Second, insurers lost money when interest
rates dropped on bonds that
comprised some 80 percent
of their investment portfolios. The higher interest rates
had allowed insurers to
underprice rates in heated
competition for malpractice
business in the 1990s, rates
that did not cover eventual
losses. As a result, today
fewer insurers offer medical
malpractice and, accordingly,
there is less competition.

But the current crisis is
different from previous
malpractice rate cycles,
according to William Sage,
a physician and professor
of law at Columbia University. Sage suggests that
medicine’s success in treating disease has “outstripped the structural and
financial framework of
medical liability.”
A proposal by the
Institute of Medicine in
2002 suggests demonstration projects that would
test replacing malpractice
law with an administrative
system for compensating
patients who have experienced avoidable injury. The
report cites the liability
crisis as a key health-care
policy problem because
many cases of negligence
don’t end up in court and,
conversely, many claims
don’t relate to negligence.
Also, judgments are sometimes inconsistent with the
medical evidence. Finally,
legal and administrative
expenses eat up half the
cost of liability premiums.
The demonstration projects could create a system
outside the courts that
would “provide timely, fair
compensation to injured
patients and promote apologies and nonadversarial discussions between patients
and clinicians.” The projects
would also encourage reporting and analysis of medical
errors.
The idea is to put the
incentives to reduce error in
the right place as well as
compensate patients quickly
for avoidable injury.
—B E T T Y J OYC E N A S H

GROW

DAV I D A L L A N B R A N DT/G E T T Y I M AG E S

WHY CITIES

Economist Richard Florida argues that cities must attract young,
talented workers – what he dubs the “creative class” – if they

want to prosper. Is he right? And is there anything new about his theory?
BY AARON STEELMAN

E

conomics can be used to better
understand a whole host of social
phenomena. But perhaps the
most fundamental issue of all is why
some places prosper while others
stagnate. Often this question is posed
of countries: Why has the United States
outperformed Japan, for instance? But
it also can be asked at the subnational
level as well: Why have some individual
states within the United States done

better than others? And why have some
cities within those states grown more
quickly than their peers? Indeed, this
last question is what vexes community
development officials, many of whom
are charged with revitalizing oncethriving urban centers.
Over the past 40 years — as the U.S.
population has increasingly shifted
from city to suburb — there has been
no shortage of ideas about how to bring

life back to America’s downtowns.
Pedestrian malls, convention centers,
sports stadiums — these have all been
touted as keys to urban redevelopment,
but when tried they often have been
unsuccessful. Today there is a new contender vying for the attention of city
leaders: the “creative class” thesis,
which says that a community’s economic health is directly related to how
attractive it is to young, talented, and

Fa l l 2 0 0 4 • R e g i o n Fo c u s

13

open-minded people. These people
generate ideas, work long hours, and
generally make a city go.
In broad outline there doesn’t
seem much about this argument with
which to quibble. As a descriptive
matter, sociologists have talked
about the “creative class” as a distinct
group since at least the 1960s,
although they haven’t necessarily
used that term. And as a prescriptive
matter, economists have long argued
that human capital, which the creative class is supposed to possess in
abundance, is a key factor in economic growth — and may be more
important now than ever. But when
you scratch below the surface, some
problems arise with the creative class
theory. These problems don’t invalidate the theory in its entirety — in
fact, there is much that is important
and true about the “creative class”
concept — but they do suggest that it
is not the magic bullet that many
urban planners and developers have
been hoping to find.

The Three Ts
If there is a leader of the creative class
movement, it is without question
economist Richard Florida, author of
The Rise of the Creative Class … And
How It’s Transforming Work, Leisure,
Community, and Everyday Life. Florida,
who developed most of his ideas
regarding the creative class while
teaching at Pittsburgh’s Carnegie
Mellon University, has recently taken a
position at George Mason University’s
School of Public Policy. His move
places him just miles from Washington,
D.C., one of the cities that he touts as
a leader in attracting the type of
young, hip workers necessary for a
dynamic, growing community.
According to Florida, economic
development requires “The Three
Ts”: technology, talent, and tolerance.
Many cities have one or even two of
these traits, but all three are necessary for rapid growth because they
work closely together. Florida’s argument goes as follows:
[R]egional economic growth is
powered by creative people,
14

R e g i o n Fo c u s • Fa l l 2 0 0 4

who prefer places that are
diverse, tolerant, and open to
new ideas. Diversity increases
the odds that a place will
attract different types of creative people with different
skills sets and ideas. Places
with diverse mixes of creative
people are more likely to generate new combinations.
Furthermore, diversity and
concentration work together
to speed the flow of knowledge. Greater and more diverse
concentrations of creative capital in turn lead to higher rates
of innovation, high-technology
business formation, job generation, and economic growth.
To measure how well cities fared
on these three measures — technology, talent, and tolerance — Florida
constructed separate indices for
each. Combined, they are used to
determine a city’s overall “creativity
index” score. The cities are then
divided into the following four
groups and ranked: (1) regions with
populations over 1 million; (2) regions
with populations between 500,000
and 1 million; (3) regions with populations between 250,000 and 500,000;
and (4) regions with populations
below 250,000. (For a list of the
rankings of the best and worst cities
in each group, see the accompanying
charts.) Those cities with high creativity index scores should be
expected to do well in coming
decades, while those with lower
scores should be expected to struggle. Not surprisingly, the index has
ignited interest among city officials
who wonder how they can move their
region up the list.

The Memphis Manifesto
In the spring of 2003, representatives
from 47 cities gathered in Memphis,
Tenn., a city that fared particularly
badly on Florida’s creativity index, to
draft the “definitive blueprint for
communities competing for creative
workers and seeking to retain their
own.” The result is what has been
dubbed the “Memphis Manifesto.”

The document is long on vague
notions and flowery language but
short on concrete proposals. For
instance, its number-one principle is,
“Cultivate and reward creativity.
Everyone is part of the value chain of
productivity. Creativity can happen
at any time, anywhere, and it’s happening in your community right now.
Pay attention.” It also implores cities
to “convert a ‘no’ climate into a ‘yes’
climate. Invest in opportunity-making, not just problem-solving.”
The manifesto’s most significant
policy proposal is to “invest in the
creative ecosystem,” by which its
authors mean “arts and culture,
nightlife, the music scene, restaurants, artists and designers, innovators, entrepreneurs, affordable
spaces, lively neighborhoods, spirituality, education, density, public
spaces, and third places.” If you
build such institutions, they argue,
creative, talented 20-somethings will
be drawn to your city, fueling economic growth in the way Florida has
described.
The problem, says Joel Kotkin, a
senior research fellow at the
Davenport Institute for Public
Policy at Pepperdine University, is
that the manifesto ignores the core
functions of local government like
public safety and effective schools.
“The creative class concept is so popular with city officials because it acts
as if there is an easy solution to the
problems they face,” he says. “There
isn’t. Cities need to work on fixing
the basics and providing a reasonable
tax and regulatory environment if
they want to grow.”
In fact, says Kotkin, some decidedly unhip places like Riverside,
Calif.; Des Moines, Iowa; and Sioux
Falls, S.D., are doing quite well while
many of the places that scored well
on Florida’s index have been hurting
in recent years. “Florida’s theory
looked pretty enticing during the
tech boom. But a lot of those places
that he says are models of urban
growth, like San Francisco, are doing
pretty badly now,” he argues. “How
can this theory be right when all the
hip places aren’t growing?”

unique over the conventional. Indeed,
In addition, even if a city can
he has constructed a Bohemian Index,
attract a talented young work force,
which measures the number of writit’s risky to pin your hopes on them.
ers, designers, musicians, actors and
People in their 20s are like a “revolvdirectors, painters and sculptors, phoing door,” says William Frey, a
tographers, and dancers as a share of a
demographer associated with the
region’s total population. He then uses
University of Michigan and the
the Bohemian Index as one of the
Brookings Institution. They tend to
components of his larger Tolerance
hop around a lot, taking advantage of
Index — the third of The Three Ts.
new job and educational opportuniMany creative people, however,
ties. The problem may be especially
have little use for “socially free areas
acute for the creative people
with cool downtowns and lots of dendescribed with so much enthusiasm
sity,” writes Harvard University econin the Memphis Manifesto. “Once
omist Edward Glaeser in a review of
artists get their big break, they don’t
Florida’s book. “I know a lot of crestick around. They go to New York or
Los Angeles,” says Kotkin.
“The type of people who settle
down, establish roots, and
really contribute over the
Regions With Population
long run to a city’s economy
Over 1 Million
tend to be in their 30s or
older. And they don’t particTop 10
Bottom 10
ularly want to live in lofts
Austin, TX
*Norfolk, VA & Detroit, MI
and go clubbing. They want
San Francisco, CA
Cleveland, OH
some quiet and some space,
Seattle, WA
Milwaukee, WI
and so they often go to the
Boston, MA
Grand Rapids, MI
suburbs.”

ative people. I’ve studied a lot of creative people. Most of them like what
most well-off people like — big suburban lots with easy commutes by automobile and safe streets and good
schools and low taxes. After all, there
is plenty of evidence linking low taxes,
sprawl, and safety with growth.”
In fact, the most successful skilled
city in the 1990s, as measured by
population growth, was Plano, Tex.,
not exactly a Bohemian paradise, says
Glaeser. Indeed, the Research
Triangle area of North Carolina,
which has experienced rapid job
growth in high-paying industries, is

America’s Most — And Least — Creative Places

Human Capital or
Creative Capital

Raleigh-Durham, NC
Portland, OR
Minneapolis, MN
Washington, D.C.
Sacramento, CA
Denver, CO

Memphis, TN
Jacksonville, FL
Greensboro, NC
New Orleans, LA
Buffalo, NY
Louisville, KY

Regions With Population
Between 500,000 and 1 Million
Top 10
Albuquerque, NM
Colorado Springs, CO
Tuscon, AZ
Richmond, VA
Columbia, SC
Little Rock, AR
Wichita, KS
Albany, NY
Birmingham, AL
*Allentown, PA & El Paso, TX

Bottom 10
Fresno, CA
Greenville, SC
Scranton, PA
Mobile, AL
Tulsa, OK
Toledo, OH
Fort Wayne, IN
Baton Rouge, LA
Stockton, CA
Youngstown, OH

The idea that talent is crucial
to economic growth is not
particularly controversial
among economists. Adam
Smith, Alfred Marshall, and
Joseph Schumpeter all talked
about the importance of new
Regions With Population
Regions With Population
ideas to economic growth. In
Between
250,000
and
500,000
Below 250,000
fact, Schumpeter described
the “perennial gale of creTop 10
Bottom 10
Top 10
Bottom 10
ative destruction” as the
Madison, WI
Erie, PA
Burlington, VT
Wausau, WI
“essential fact about capitalBoise City, ID
Chattanooga, TN
Corvallis, OR
Mansfield, OH
ism.”
More
recently,
Fort Collins, CO
Hickory, NC
Iowa City, IA
Victoria, TX
Stanford University econoDes Moines, IA
Johnson City, TN
Champaign-Urbana, IL
Sheboygan, WI
mist Paul Romer has made
Santa Barbara, CA
Ocala, FL
San Luis Obispo, CA
Danville, VA
human capital a central part
Lansing, MI
Saginaw, MI
Portland, ME
Houma, LA
of his influential “new
Tallahassee, FL
Visalia, CA
Charlottesville, VA
Lima, OH
growth” theories.
Provo, UT
Evansville, IN
Cedar Rapids, IA
Sumter, SC
But Florida wants to argue
Lincoln, NE
Lakeland, FL
Bryan-College Station, TX
Joplin, MO
that his ideas are new — and
Melbourne, FL
Shreveport, LA
Bloomington, IL
Gadsden, AL
the novel part is how he characterizes talented and creative people. He suggests that
Notes: Cities are listed in descending order. For instance, among cities with populations of 1 million or more, Austin is
ranked as the most creative city, while Louisville is ranked as the least creative city. The rankings come from the overall
talented and creative people are
“Creativity Index” scores compiled by Richard Florida and his colleagues.
drawn to “Bohemian” places that cele*These cities tied.
SOURCE: Richard Florida, The Rise of the Creative Class, 2004 Paperback Edition
brate the new over the traditional, the

Fa l l 2 0 0 4 • R e g i o n Fo c u s

15

“a traditional Nerdistan,” says Fred
Siegel, professor of history at Cooper
Union in New York and author of
The Future Once Happened Here: New
York, D.C., L.A., and the Fate of
America’s Big Cities. The majority of
its residents are not at the cutting
edge of popular culture, even though
they may be tops in their highly creative professions.
Some might argue that this criticism is overly broad — that it overlooks too many obvious examples of
tolerant, Bohemian places with
strong, growing economies to be convincing. And the truth is there are
quite a few such places. But ask yourself what else many of these cities
have in common: Ann Arbor, Mich.;
Austin, Tex.; Madison, Wisc. — these
places are diverse and tolerant, and
their economies are in fact growing
quite rapidly. But they are also home
to large research universities, which
require support services from local
businesses, have massive budgets of
their own, and partner with privatesector firms on a wide array of projects. To some extent, such economic
activity insulates these cities from
broader downturns in the economy.
And in the case of Austin and
Madison, both state capitals, a large
number of relatively stable, high-paying government jobs adds to the
recession-proof nature of their
economies.
When you subtract the number of
university towns from the list of
booming but also Bohemian cities,
that list shrinks substantially. And of
those that remain, it’s not especially
clear what policymakers can do to
replicate their success. Consider
Asheville, N.C. It’s a relatively small
city in the mountains of western
North Carolina, just miles away from
some of the poorer parts of
Appalachia. Yet it has a thriving artistic community and a countercultural
feel. How did this happen? Certainly
not by any grand plan.
Instead, creative types have come
to Asheville for differing reasons for
more than a century, each adding to
the area’s unique culture. In the 1890s,
artisans were drawn to Asheville to
16

R e g i o n Fo c u s • Fa l l 2 0 0 4

work on George Vanderbilt’s famous
book. “There is no one-size-fits-all
Biltmore Estate, many of whom
strategy. Each place has to use the
stayed in the area and continued to
ideas and theories developed in this
hone their skills. During the 1930s, a
book to create the best ‘fit’ for itself.”
number of Bauhaus artists, including
So where does this leave us?
Josef Albers, fled Nazi Germany and
Florida’s strongest ideas — about the
settled in the Asheville region. And
importance of human capital to ecoduring the 1970s, New-Age bookshops
nomic growth — aren’t especially
and offbeat clubs began popping up.
new. And his newest ideas — about
In other words, much of Asheville’s
the importance of creating Bohemian
development was “spontaneous,
enclaves to attract talented people —
organic, and untidy,” to borrow the
don’t appear to be particularly strong.
words of Jane Jacobs, author of the
As a matter of public policy,
classic The Death and Life of Great
Harvard’s Glaeser sums up things
American Cities. City officials may have
nicely: “Mayors are better served by
played some part in fostering
focusing on the basic commodities
Asheville’s growth, but the region’s
desired by those with skills than by
development was fundamentally botthinking that there is a quick fix
tom up, not top down. No manifesto
involved in creating a funky, hip
could have accurately described
Bohemian downtown.” The problem,
or directed the path that Asheville
of course, is that those basic comhas taken. “Local governments alone
modities have proven awfully hard
cannot make a place ‘hip,’” says
to provide in most cities. Perhaps
John Accordino, associate professor
it’s time for economists to think
of urban studies and planning at
creatively about how to deal with
Virginia Commonwealth University.
that issue.
RF
“Usually there are other, more
important factors, such as universities or a natural setting,
READINGS
that have already attracted
Florida, Richard. The Rise of the Creative Class …
artistic folks.”
And How It’s Transforming Work, Leisure,

Sound and Fury
Signifying What?
Like many other proposals
that hold the promise of bettering
society,
Richard
Florida’s theories about the
creative class have been seized
by policymakers eager to help
their cities. And in the process
some of his ideas may have
been distorted by well-intentioned public officials. At least
that’s how he sees it. “What’s
sometimes disheartening is
that some community leaders
seem to conclude the key lies
in attracting creative class
workers, and therefore the
creative class simply needs to
be lured like some sports franchise from another city with
bike trails, music scenes, and
other amenities,” writes
Florida in the preface to the
2004 paperback edition of his

Community, and Everyday Life. New York: Basic
Books, 2002.
Florida, Richard. “Revenge of the Squelchers.”
The Next American City, 2004, Issue 5, pp. i-viii.
Glaeser, Edward. “The New Economics of Urban
and Regional Growth.” In Clark, Gordon,
Maryann Feldman, and Meric Gertler (eds.), The
Oxford Handbook of Economic Geography. New
York: Oxford University Press, 2003, pp. 83-98.
Jacobs, Jane. The Death and Life of Great American
Cities. New York: Vintage Books, 1961.
Kotkin, Joel, and Fred Siegel. “Too Much Froth:
The Latte Quotient Is a Bad Strategy for Building
Middle-Class Cities.” Blueprint Magazine, January
8, 2004, pp. 16-18.
Malanga, Steven. “The Curse of the Creative
Class.” City Journal, Winter 2004, vol. 14, no. 1,
pp. 36-45.
Romer, Paul M. “Increasing Returns and LongRun Growth.” Journal of Political Economy,
October 1986, vol. 94, no. 5, pp. 1002-1037.
Schumpeter, Joseph. Capitalism, Socialism, and
Democracy. New York: Harper & Row, 1942.
Visit www.rich.frb.org/pubs/regionfocus for
links to relevant sites.

This is the first in a
series of articles on rural
economies throughout
the Fifth District.

Next up:
Northeastern
North Carolina

APPALACHIAN
WEST VIRGINIA AND REGIONAL HISTORY COLLECTION, WEST VIRGINIA UNIVERSITY LIBRARIES

D I V E R S I F I C AT I O N

In the heart of Appalachia, the people of Southwest Virginia are creating
economic opportunities to replace coal jobs
BY KARL RHODES

W

hen
the
Woodtech
plywood plant shut down
in Tazewell County, Va.,
Steve Taylor and two other employees
refused to quit. Even after their paychecks stopped coming in August
2002, they kept on working. They
struggled to winterize $36.5 million
worth of equipment. They contacted
potential customers, and they worked
on a business plan to reopen the plant.
Woodtech was in bankruptcy and
so was its parent company, Fancy
Tsuda of Japan. The company’s
primary lender had failed, and its
plant was in sad shape. There was no
electricity, no heat, and no running

water — except the rain that seeped
through dozens of leaks in the roof.
Looking for help, Taylor took his
plan to reopen the plywood plant to
Tazewell County’s Industrial Development Authority (IDA). He didn’t snare
any financial assistance, but he did
catch the attention of IDA board
member Bill King, a former mayor
of nearby Bluefield, Va., who had
cashed out of the cable television business in 1999.
King was so inspired by Taylor and
his cohorts that he resigned from the
IDA board and started investing his own
money in the project. A new company,
Blue Ridge Wood Products, was born.

The story of Blue Ridge Wood
Products showcases the hardworking,
bootstrapping mentality that permeates Southwest Virginia, the geographic center of Appalachia. The
people here are fiercely independent
and self-reliant. They are as rugged as
the mountains that separate them
from the socioeconomic blessings and
curses of big cities. For generations,
their culture produced strong
churches and cohesive families, good
neighbors, and mountain music.
But their culture also valued
manual labor at the expense of formal
education. Many teenagers quit high
school as soon as they could to work

Fa l l 2 0 0 4 • R e g i o n Fo c u s

17

AVERAGE ANNUAL UNEMPLOYMENT RATE

Unemployment in Virginia’s
Coalfield Region
16
14
12
10
8
6
4
2
0
90 991
1
19

92 93
19 19

94 95 996 997 998 999 000
1
2
1
19 19
1
1

3
01 002 200
20
2

SOURCE: Virginia Employment Commission

in the coal mines, recalls Donald
Baker, mayor of Clintwood and chairman of the Virginia Coalfield Economic Development Authority
(VCEDA). “It was a family tradition.
Your grandfather was a miner. Your
father was a miner. You’re a miner, and
your children will end up being
miners. But that’s not the case
anymore.” (For more on the IDA,
VCEDA, and other development
authorities, see the sidebar.)
Coal’s impact on the region’s
culture and economy has decreased
substantially since the late 1970s. New
mining techniques and equipment
have eliminated thousands of jobs in
the seven-county area covered by the
VCEDA. “It took 900 to 1,000
people [in the 1950s] to produce the
amount of coal that 10 people can

produce now,” says Baker, who spent
35 years in the business. “With longwall mining, it’s nothing to produce
2,000 to 3,000 tons of coal in an
eight-hour shift with six to eight
people.”
Baker says the region’s county
governments were slow to promote
economic diversity in the 1970s and
’80s. Looked at one way, this may have
been a reasonable decision. The
region’s residents did what was most
profitable — coal mining — for as
long as they could. But when the coalmining industry took a turn for the
worse, the region was destined for
hard times.
“When things were going OK … no
one seemed to be all that concerned,”
Baker recalls. “All of a sudden one
morning, they woke up and said, ‘We
need to do other things!’ … I think
they let a lot of time slip by.”

Stepping Out of Denial
If anyone doubted that things in Southwest Virginia had taken a turn for the
worse, a 1987 socioeconomic study of
Virginia’s coal counties entitled “Income
Uncertainty and the Quality of Life”
put those doubts to rest. The study,
written by three Virginia Tech economists, found that per-capita income in
the region was only 68 percent of the
state average. And to make matters
worse, the region’s income was “more
variable” and “less evenly distributed.”

The study painted an empirical
picture of Southwest Virginia that was
hard to ignore. The disparities were
dramatic in everything from test
scores and dropout rates to “permits
for mobile homes” and “housing units
with no piped water.”
Newspapers across the country
picked up the story, recalls lead
researcher Thomas Johnson, who is
currently a professor of agricultural
economics at the University of Missouri-Columbia. The study was
prompted by “key activists in the area
who felt that those sort of things
needed to be aired,” Johnson says.
Southwest Virginia had “some devoted
people who wanted to see change.”
The Virginia General Assembly
responded by forming the VCEDA
in 1988. The authority promotes economic diversity in the counties of
Buchanan, Dickenson, Lee, Russell,
Scott, Tazewell and Wise plus the
city of Norton — the same region that
Johnson and his colleagues highlighted
in their landmark study. The VCEDA
is funded by 12.5 percent of the
revenue from the region’s 2 percent
coal severance tax and 37.5 percent of
the revenue from the region’s 2 percent
natural gas severance tax. (Severance
taxes are levied by localities on the
value of coal or natural gas extracted
— or “severed” — from that locality.)
The authority has used that money
to provide $66.5 million in total

Population in the Virginia Coalfield Region
Virginia
Buchanan County
Dickenson County
Lee County
Russell County
Scott County
Tazewell County
Wise County
Norton*
Virginia Coalfield Region

1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
1,854,184 2,061,612 2,309,187 2,421,851 2,677,773 3,318,680 3,966,949 4,651,448 5,346,797 6,187,358 7,078,515
9,692
7,747
19,856
18,031
22,694
23,384
19,653
n/a
121,057

12,334
9,199
23,840
23,474
23,814
24,946
34,162
n/a
151,769

15,441
13,542
25,293
26,786
24,776
27,840
46,500
n/a
180,178

16,740
16,163
30,419
25,957
24,181
32,477
51,167
n/a
197,104

*Norton became a city in 1954. Before then, its population was part of Wise County.
SOURCE: U.S. Census Bureau

18

R e g i o n Fo c u s • Fa l l 2 0 0 4

31,477
21,266
39,296
26,627
26,989
41,607
52,458
n/a
239,720

35,748
23,393
36,106
26,818
27,640
47,512
56,336
n/a
253,553

36,724
20,211
25,824
26,290
25,813
44,791
43,579
5,013
228,245

32,071
16,077
20,321
24,533
24,376
39,816
35,947
4,172
197,313

37,989
19,806
25,956
31,761
25,068
50,511
43,863
4,757
239,711

31,333
17,620
24,496
28,667
23,204
45,960
39,573
4,247
215,100

26,978
16,395
23,589
30,308
23,403
44,598
40,123
3,904
209,298

financing to more than 150 economic
diversification projects since 1988, says
Jonathan Belcher, the VCEDA’s
deputy executive director.
Most of that financing has come
from the authority’s revolving loan
fund, which lends money at or below
prime rate, Belcher says. About half
of the loans go to new industry, while
the other half is divided up among
expanding businesses, infrastructure
projects, land for industrial parks, etc.
“They have changed their dependence on coal mining,” Johnson says.
“It really is amazing when an area can
pull itself back from that abyss.”

Plying a New Trade
During the past 15 years, the VCEDA
has assisted nearly every major noncoal employer in the region, most
recently Blue Ridge Wood Products,
the plywood plant that King is trying
to reopen in Tazewell County.
King began working on Blue Ridge
Wood Products in May 2003. He
struck a deal with the bankruptcy court
to lease the plant from Woodtech’s
creditors in exchange for providing
security and electricity at the plant.
With his own money, King started
hiring a mix of former Woodtech
employees and new workers to patch
the holes in the roof, repair water
lines, and get the HVAC and fire-suppression systems working again. They
also started reconditioning the plant’s
equipment and testing it on logs that
King bought.
At the same time, King was lining
up potential customers, hiring more
workers, and presenting the plant’s
evolving business plan to any lender
who would listen. He needed to
borrow enough money to buy the business out of bankruptcy and get the
plant “over the hump” to profitability.
“We basically had 22 rejections,”
King recalls. They were turned down
by small local banks, large national
banks, and statewide development
agencies. In February 2004, King told
his wife that he was “probably going to
pull out. … I just couldn’t put her
through it anymore,” he says. King
started packing up his office, and he
called the Tazewell County adminis-

trator to let him know
that he was calling it
County Economic Status in Appalachia
quits.
(Fiscal Year 2004)
That’s when one of
the county supervisors
came up with an interesting proposal: If King
were able to buy the
plant out of bankruptcy,
he reasoned, the county
would receive $608,000
in back taxes that
Woodtech still owed.
Why not agree to lend
that money back to Blue
Ridge Wood Products
through the industrial
development authority to
keep the deal alive? Otherwise, the county and
Woodtech’s other creditors would have to find
another buyer, and no
one else seemed likely
Distressed
to purchase a plant that
Distressed counties are the most economically depressed. They
have a three-year average unemployment rate that is at least
had failed before, was
1.5 times the national average; a per-capita market income that is
in poor condition and
two-thirds or less of the national average; and a poverty rate that
was deteriorating rapidly.
is at least 1.5 times the national average; or they have two times
Under the circumstances,
the national poverty rate and qualify on the unemployment or
the prospects of new jobs
income indicator.
and future taxes outTransitional
weighed the risk that
Transitional counties are those below the national average for
King would not be able
one or more of the three economic indicators (three-year averto repay the loan.
age unemployment, per-capita market income, and poverty) but
The county’s pledge
do not meet the criteria of the distressed category.
led to financial commitSource: Appalachian Regional Commission
ments from the Governor’s Opportunity Fund
was born and raised in Gary, W.Va.,
and from the Virginia Tobacco
about 35 miles from Bluefield. He
Indemnification and Community
returned to Appalachia after traveling
Revitalization Commission. And those
extensively with the military. “I’ve
commitments helped King get a loan
been to Turkey, England, and
commitment from the Bank of
Germany,” says Finley, vetoing each
Tazewell — one of the banks that had
country with a shake of his head. “I
previously turned him down.
just love the mountains. I love the
The other breakthrough that helped
people. I love the natural beauty of
secure bank financing was finding an
West Virginia and western Virginia. …
experienced plant manager who was
All of my children and grandchildren
willing to take a chance on the fledgare right here.”
ling company. Enter R.D. Finley, the
manager of a similar plant in Princeton, W.Va. The Princeton plant was
Down Home
shutting down its plywood production,
When people try to define the allurand Finley did not want to move to
ing lifestyle of Southwest Virginia, they
Indiana or Pennsylvania to keep his job.
refer to “family values” more often
“I’m a hometown boy,” Finley says.
than both presidential candidates com“I wanted to stay around here.” Finley
bined. Their most common refrain is:

Fa l l 2 0 0 4 • R e g i o n Fo c u s

19

Per-Capita Personal Income
Virginia Coalfield

Virginia

35

IN THOUSANDS

30
25
20
15
10
5
0
1978

1982

1986

1990

1994

1998

2002

SOURCE: U.S. Bureau of Economic Analysis

“It’s a great place to raise a family.”
That phrase captures many of the
region’s strengths, explains Jessica
Horn, a marketing associate with the
VCEDA. “It’s the low crime rate. It’s
a feeling that you know who your
neighbors are and you feel comfortable
in your neighborhood,” she says. “A lot
of people are here because their families are here. They have that support
system for raising their children.”
Lots of rural areas in all parts of
the country claim to be good places

to raise families, notes Belcher at the
VCEDA, “and by and large that’s
true. But here, we also have the
beauty of the mountains and the
[family-oriented] recreational opportunities,” such as hiking, biking,
hunting, and fishing.
Education is often cited as the
weakest link in the region’s familyfriendly culture, but education is the
main reason why King moved his
family to Tazewell County in 1983.
King grew up in McDowell County,
W.Va., “in the heart of coal-mining
country.” In the 1950 census, the
county’s population peaked at nearly
100,000. Now it’s barely above
25,000. The county had 10 high
schools in the early 1950s, King
recalls. Now it has just three, and that
number soon will drop to two.
“I was very happy with the education I received in McDowell County,”
King says. But “as we lost population,
… a lot of the teachers had [migrated]
to the school system in Tazewell
County. … The math instructor I had
in junior high was down here teaching high school math.”
Tazewell County’s school system
“does a very fine job of preparing kids

By Whose Authority?
Local industrial development authorities —
sometimes called economic development
authorities — have played increasingly prominent roles in promoting economic activity in
Virginia in the past few decades.
Beginning in the 1960s, the Virginia General
Assembly has authorized localities to create
industrial development authorities (IDAs) that
are empowered to acquire, own, develop, and
lease property to spark economic growth. The
General Assembly has enabled these authorities to finance their activities by issuing
tax-free bonds and by accepting loans and
grants from government agencies.
Typically IDAs use these funds to develop
industrial parks and to offer financial incentives to attract new companies and help
existing businesses grow.
These authorities are governed by boards
of residents who are appointed by their local

20

R e g i o n Fo c u s • Fa l l 2 0 0 4

governments. The governing boards and IDA
boards are not allowed to overlap, except in
towns with populations below 3,500. Even in
these small towns, however, members of the
towns’ governing boards cannot comprise a
majority on their IDA boards.
The Virginia Coalfield Economic
Development Authority (VCEDA) is similar to an
IDA, but it is unique in several ways. The General
Assembly created this authority in 1988 specifically to help diversify the economies of
Virginia’s coal-producing counties and city.
The VCEDA takes a regional approach to economic development, and it receives nearly all
of its funding from a portion of the coal-and
gas-severance taxes that its member localities
collect. The VCEDA board is a mix of local and
regional officials, coal and gas industry representatives, and gubernatorial appointees.
— KARL RHODES

to go on to college,” King says. One
of his children scored 800 on the
math portion of the SAT, and all
three of his children graduated from
Virginia Tech.
King was willing to chase educational opportunities for his children,
but he didn’t want to leave Appalachia.
“Walking down the street, people say,
‘Hello!’ and ‘How are you doing?’”
he notes. “That’s the way I like it.
I like to go out of my way to try to
help somebody. I think it’s one of the
things that you are put on earth to do
is to be friendly with people.”
King wears his community pride
on his sleeve. Today it happens to be
the sleeve of a maroon shirt that’s
emblazoned with one bright orange
word — “Risk.” On closer examination, the word is not “Risk” but
“Rish,” the name of a heavy equipment dealer.
As King clarifies the ambiguous
embroidery, two men hustle past him
with fire extinguishers. Smoke rolls
out into the plant as they throw open
giant doors to the drying equipment
and snuff out smoldering pieces of
wood. King takes it all in stride.
“It’s like practicing on a football
team,” he says. “You run this play, and
you run this play. You run it. You run
it. You run it. So when you get in
a game, you know what can go wrong.
… And when your butt’s been between
a rock and a hard spot enough, you
know you are going to find a way out
of it.”
The biggest risk, King concedes,
is investing substantial time, effort,
and money into plant and equipment
that he doesn’t own yet. That’s not
exactly how they draw it up in
business schools, but King saw no
other way to get Blue Ridge Wood
Products going.
“If the deal doesn’t go through, I’m
out seven figures,” he says. And if the
deal does go through, the company
expects to employ 100 people within
a month and 160 to 170 people by the
end of the year. Finley, the plant
manager, relishes that challenge, and
he admires King’s entrepreneurial zeal.
“Here is a guy who doesn’t know
the first thing in this world about the

wood industry. And he told me that
right up front,” Finley recalls. But
King has surrounded himself with
people who do know the business.
Finley says he left a secure job to sign
up with King’s operation because
“that’s the kind of guy I want to work
for. He has put his neck on the line.”
As he waits for his loans to close in
mid-August, King admits that the deal
is risky. But it also has the potential to
turn a nice profit and have a huge
effect on the local economy.
“Some of the biggest mistakes I’ve
ever made were not making decisions
when I had good opportunities in front
of me,” King laments. “I was afraid to
make a decision. I let it set too long. …
It goes back to this: Would I be satisfied on my death bed had I not tried
this deal? No!”

On the Upswing … Slowly
For the past 15 years, economic developers in Southwest Virginia have tried
to diversify the region’s economy and
replace the thousands of coal-related
jobs that are gone for good. In addition to wood products companies,
they have attracted several automotive
parts manufacturers and nearly a dozen
customer-contact centers. They also
have targeted companies manufacturing electronics, pharmaceuticals, and
metal products.
Per-capita personal income is about
two-thirds of the state average, but
that figure has stabilized after years of
decline. Meanwhile, unemployment in
the region has fallen from 14.5 percent
in 1985 to 6.5 percent in 2003. (See the
accompanying graphs.)
Part of that improvement can be
attributed to four prisons that opened
in the region during those years. The
VCEDA did not actively seek those
prisons, but unlike many areas of Virginia, most local residents did not
oppose them either. “We haven’t seen
the not-in-my-backyard syndrome with
the location of the prisons,” says Belcher
at the VCEDA. They provide “steady
jobs, sound jobs that are not likely to go
away anytime soon. And our work force
has adapted well to those positions.”
Most residents also favor construction of a second coal-fired power

plant in Southwest Virginia, according
to Belcher. “We have a work force and
a citizenry that has a background in
coal mining,” he explains. So they view
a coal-fired power plant “as an opportunity that goes hand in hand with the
mining industry that is already here.”
Another new diversification effort
that capitalizes on the region’s existing assets is heritage tourism. Last
year, the authority decided to commit
$2.5 million to tourism projects during
a three-year period.
One of those projects is the Ralph
Stanley Museum & Traditional Mountain Music Center, which is scheduled
to open in October on Clintwood’s
Main Street. The $2 million museum
pays tribute to Ralph Stanley, a local
musician who has become a bluegrass
legend around the world. Housed in a
turn-of-the-century mansion, it will
anchor the western end of The
Crooked Road: Virginia’s Heritage
Music Trail.
With several stops in Southwest Virginia, the trail is expected to attract
thousands of country music fans to
the region, says Baker, the mayor of
Clintwood. Virginia has been losing
tourism dollars to North Carolina, he
says. “I think we missed the boat in the
past. … Now we’re in the mode of promoting [tourism]. It’s what should have
happened several years ago.”

Here to Stay
Some economists argue that spending
tax dollars to promote economic
diversification in Appalachia only
postpones the inevitable outflow of
population to regions that need more
workers anyway. But Appalachian
advocates counter that many people
in the region are not as mobile as
other U.S. residents.
Ron Eller, the former director of the
Appalachian Center at the University of
Kentucky, called residents of the region
a “placed population” in a discussion
published in Appalachia Magazine in
1998. “The larger society, especially in
the late 20th century, assumes that jobs
are available … and that people are free
to move wherever the jobs may be,” Eller
said. “That simply is not the case for
many of the poor in Appalachia. They

don’t have the education to be mobile.
In many cases they are tied because of
a need to take care of a disabled or
older relative or tied emotionally to
their place.”
The people interviewed for this
story are not poor, and most of them
have at least one college degree. None
of them expressed any interest in
leaving Southwest Virginia. In fact,
as the region’s unemployment rate
has declined, the population has
stabilized, and many people are gravitating back to their mountain homes.
At Blue Ridge Wood Products,
King finally closed his loans and
purchased his plywood plant. He
rejects the suggestion that people live
in Appalachia because they lack education. “Growing up in the coalfields,
there were a lot of smart people — a
hell of a lot of smart people,” he
insists. “And a lot of those people are
coming back.”
RF

READINGS
Bradley, David H., Stephen A. Herzenberg, and
Howard Wial. “An Assessment of Labor Force
Participation, Rates and Under-employment in
Appalachia..” Appalachian Regional Commission,
August 2001.
Caudill, Harry M. Night Comes to the Cumberlands:
A Biography of a Depressed Area. Boston: Little,
Brown & Co., 1963.
Hibbard, Walter R. Jr., and Theodore J. Cutter.
Virginia Coal: An Abridged History. Blacksburg, Va.:
Virginia Center for Coal and Energy Research,
Virginia Tech, April 1990.
Kraybill, David S., Thomas G. Johnson, and Brady J.
Deaton. “Income Uncertainty and the Quality of
Life: ASocio-Economic Study of Virginia’s Coal
Counties.” Bulletin 87-4, Virginia Agricultural
Experiment Station, Virginia Tech, September 1987.
Wesman, E.C., Christopher Haycocks, and C.E.
Zipper. “Estimation of Southwest Virginia Coal
Reserves.” Publication 460-139, Powell River
Project, Virginia Tech, June 2000.
Wood, Lawrence E., and Gregory A. Bischak.
“Progress and Challenges in Reducing Economic
Distress in Appalachia: An Analysis of National
and Regional Trends Since 1960.” Appalachian
Regional Commission, January 2000.
Visit www.rich.frb.org/pubs/regionfocus for
links to relevant sites.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

21

the

Fattening
of
TOMI/GETTYIMAGES

America

eeping employees safe at the
DuPont plant in Chesterfield
County, Va., is a top priority.
Keeping them healthy and productive
as they make Kevlar and other materials is equally important, but it hasn’t
been easy.
Linda Frye of the company’s Health
Services department began an effort
four years ago to promote the merits
of healthy living and to help workers
make better choices. For example, the
plant’s fitness center offers a circuittraining program with a personal
trainer for busy people who need an
introduction to exercise. But preventive health services at the plant have
been underutilized, she says. “We can’t
make people exercise,” Frye notes with
some frustration.
In general, there hasn’t been a
shortage of advice for getting healthy,

K

22

R e g i o n Fo c u s • Fa l l 2 0 0 4

from diet plans designed by Nathan
Pritikin and Robert Atkins to workout
videos led by buff celebrities. Still, 65
percent of Americans 20 to 74 years old
are considered overweight compared
to 47 percent in the late 1970s. During
the same 30-year span, the percentage
of the adult population considered
obese doubled to 31 percent.
To determine these figures, the
Centers for Disease Control and Prevention and other organizations used
body mass index (BMI), a ratio of weight
to height. The BMI for an athlete can
be high because muscle weighs more
than fat. Still, it’s a good indicator of
whether someone is carrying excess
weight, which can increase the risk of
death from diabetes, heart disease,
hypertension, and other disorders.
So why do we knowingly endanger
our health? Economists have addressed

As we benefit from greater
convenience and efficiency,
our waistlines are widening
in the process
BY CHARLES GERENA

this puzzling question through empirical research that encompasses the
work of nutritionists, physicians, sociologists, and other experts. Their conclusions don’t excuse us from being
responsible for our well-being. Rather,
they offer insights into the choices we
make and the challenges we face in
making healthier ones.

Energy Equation Out of Whack
According to Eric Finkelstein, an economist with RTI International near
Durham, it’s cheap to be fat in modernday America. Food is more plentiful,
energy-dense, and affordable. Meanwhile, technological advances have
enabled people to live and work almost
anywhere, which means that most
people drive more than they walk. In
short, we are taking in more calories
while burning fewer of them. Over

time, small changes in calories consumed and expended may have accumulated into significant weight gains.
“The data on increasing obesity over
the past two decades … could be
explained by a [net] increase of 100 to
150 calories per day,” notes Alexander
Tabarrok, an economist at George
Mason University. The increase could
result from consuming an additional
can of soda or three extra cookies a day.
Alternatively, “the same gain in weight
could be explained by a more sedentary lifestyle resulting in … fewer calories expended.”
At an obesity summit held in
Williamsburg, Va., last June, economist
and nutrition expert Barry Popkin of
the University of North Carolina at
Chapel Hill described major shifts in
body composition throughout the
developing world. People generally are
eating more animal-based foods and
calorie-rich sweeteners like high fructose corn syrup while consuming fewer
fruits and vegetables. At the same time,
there has been a significant drop in the
level of physical activity.
As a result, obesity is a worldwide
problem. An estimated 15 percent to
20 percent of the population in
England, Germany, New Zealand, and
Australia are considered obese, as well
as 10 to 15 percent of citizens in
Canada, Spain, and Poland.
Yet obesity rates are less than 10
percent in Italy, Sweden, France, and
Japan. And no developed country has
seemed to grow as heavy so quickly as
the United States. Why? A January 2003
working paper authored by David Cutler
and two other health economists
at Harvard University found that
“obesity across countries is correlated

with access to new
food technologies
and to processed
food. … Countries
that are more regulatory and that support
traditional agriculture and delivery
systems have lower
rates of obesity.”

Obesity In The Fifth District
Mirroring national trends, waistlines in the Fifth District
expanded significantly during the 1990s. West Virginia
had the highest obesity rate in the region – 24.6 percent
in 2001 – while Virginia experienced the largest rate
increase between 1991 and 2001 – 98 percent.
Obese Adults 1991

30–
More Calories In

Obese Adults 2001

25–

PERCENTAGE

In America, caloric
intake has been
20–
steadily climbing.
15–
Cutler and others
attribute this trend
10–
to technological advances that have
5–
made the mass pro0–
duction of energyDC
MD
NC
SC
VA
WV
dense
processed
NOTE: Percentage is an estimate of the mean number of state residents
18 years old and over who reported that they were obese. Obesity is
foods possible, often
defined as having a body mass index of 30 or greater.
at lower prices comSOURCE: Centers for Disease Control and Prevention, Behavioral Risk
Factor Surveillance System, 1991-2001
pared to fresh foods.
Barry Popkin also
someone had to make the dough, grate
blames Uncle Sam for tilting the
the cheese, etc. Now a phone call to a
pricing of less healthful foods: “We
pizza parlor can produce a hot pie in
spend all of our time subsidizing corn
minutes.
… dairy products, and animal-based
Food technology isn’t the only thing
products. We have almost no subsidies
that has changed, say researchers at the
for fruits and vegetables, and other
University of Munich. People may now
high-fiber foods.” Other critics say
have higher rates of time preference,
federal subsidies of corn have made it
which means they place a greater
possible for food producers to fill
premium on current satisfaction over
grocery shelves with inexpensive sodas,
future satisfaction. This could have
snacks, and other processed foods that
important implications for public
use corn syrup as a sweetener.
health. “Individuals with high rates of
Aside from being cheaper, foods are
time preference will consume more
available in more flavors and convenhigh-calorie foods … at the expense of
ient forms than ever before. This brings
lower levels of health and utility in the
more of our wants within reach. For
future,” the researchers noted.
example, Cutler gives the example of a
In addition to changing time preffamily craving pizza. In the past,
erences, people may just feel more
rushed than before. Therefore, the
Body Mass Index Formula
short-term demand for convenience
Weight in pounds
BMI = ( Height in inches x Height in inches ) x 703
and immediate relief from hunger may
be more important than meeting one’s
long-term fitness objectives, say some
Body Mass Index (BMI) is a tool for
BMI Weight Status
economists.
indicating weight status in adults.
Below 18.5
Underweight
“As we get more stressed out and
Calculate your BMI using the equation
18.5 - 24.9
Normal
there
are longer intervals between
above, and the weight status table will
25.0 - 29.9
Overweight
meals,
what you know about food and
indicate where you fall on the BMI chart.
30.0 and above
Obese
nutrition has less predictive value of
SOURCE: National Center for Chronic Disease Prevention and Health Promotion
what you intend to do,” explains Lisa
Mancino, an agricultural economist at

Fa l l 2 0 0 4 • R e g i o n Fo c u s

23

the U.S. Department of Agriculture.
“You might have good intentions … but
when you wait five hours between meals
[you] just go with what’s available.” In
fact, many people are willing to pay
more for a prepared meal if it saves time.
Also, many of the medical costs of
overconsumption are borne by society
rather than the obese because of the
third-party payment system for health
care (see the cover story in the Spring
2004 issue of Region Focus). People may
continue to overeat because they are confident that private insurance or taxpayersupported programs will cover the cost
of saving them from disease or death.
There are other reasons why people
could be eating too much. To begin
with, many of the most convenient,
inexpensive food products have
processed wheat flour and other
refined carbohydrates, which some
nutritionists believe can be addictive
to certain people.
Second, there could be a mismatch
between current societal conditions
and past eating preferences. “Through
most of human existence, we lived in
societies where there wasn’t enough
food, so we got used to eating a lot
whenever food was plentiful,” says
Cutler. Now, food is plentiful for many

people, yet we haven’t adjusted our
eating habits.
Finally, the marginal cost of increasing meal portions is very small. The
result is that food producers can offer
bigger portions that consumers view as
a good value.

Fewer Calories Out
There is some debate about whether
eating too much is harmful. Richard
Forshee, director of research at Virginia
Tech’s Center for Food and Nutrition
Policy, says research suggests that obese
people can reduce some of their health
risks by getting more exercise, while a
slim person can be at risk from being
a couch potato.
However, socioeconomic changes
have reduced opportunities for physical activity in general, making it harder
to burn calories. “For a variety of
reasons, we are not using as much
energy as we used to,” notes Forshee.
Advances in workplace technology
have occurred, as well as a shift in the
economy from primarily agriculture
and manufacturing to services. Both
trends have been taking place for many
years, though, so they probably account
for only a portion of the population’s
weight gain in the last few decades.

Automation also has transformed
households since World War II. This
may have led people, especially women,
to shift time away from housework to
paid work, which tends to be less physical in nature. Whether this has had a
major impact on the level of physical
activity is hard to judge.
But wouldn’t being more productive
at non-leisure activities leave more time
for biking through a park or hitting the
treadmill at the gym? In fact, RTI’s Eric
Finkelstein says the level of leisure-time
exercise has remained low and stable.
One reason is that while automation has reduced the number of people
and the amount of physical labor
required to perform a task, it has also
increased the workload for the remaining workers. In addition, people have
been willing to work longer hours to
increase their income and, therefore,
their consumption.
More money has been available to
spend on entertainment as incomes have
increased. Still, the more entertaining
forms of exercise like hiking are expensive compared to just jogging around the
block, notes George Mason’s Tabarrok.
Also, “exercise must compete against a
host of other entertainments.” Indeed,
sedentary activities that weren’t widely

What’s The Big Deal?
Throughout the 1980s, fat was the enemy of people struggling to shed excess
pounds and improve their health. In the new millennium, carbohydrates are
supposedly the new culprits behind the nation’s obesity epidemic. However,
some academics argue the real problem is that this “epidemic” has been
blown out of proportion.
Alexander Tabarrok, an economist at George Mason University, sides with
researchers who have found that carrying excess weight increases the risk of
heart disease and many other health conditions. “Eating is fun, however, and
that has to be counted as a benefit,” he says. Therefore, “even accepting the
health evidence, I wouldn’t argue that obesity is a big deal if I thought that
rational consumers were making appropriate choices given their preferences.”
Up until the 20th century, western society considered a large girth as a
sign of prosperity and good health, partly because food distribution was more
difficult and malnutrition was a concern. Moreover, large women were
viewed favorably as child bearers, as well as symbols of beauty depicted by
painters like Rubens and Renoir.
Today, Americans don’t like being fat. In addition to facing ridicule and
discrimination, overweight and obese people are more aware of the relationship between diet, exercise, and health. “The large and growing industry of

24

R e g i o n Fo c u s • Fa l l 2 0 0 4

diet books, drugs, clinics, etc., indicates that people do not want to be overweight,” adds Tabarrok. “Obesity is a problem because obese people think
that it is a problem.”
Actually, skeptics like Paul Campos, author of the book The Obesity
Myth, contend that not every study confirms a negative association
between excess weight and poor health. Some, in fact, suggest that thin
people don’t live as long as those who have excess weight.
Such contradictions point out the challenges of studying complex social
problems like obesity. Researchers usually can’t observe the eating habits of
individuals under controlled conditions. Instead, they have to rely on surveys
and aggregate data about large groups acting in a world full of variables.
As researchers flesh out the consequences of obesity, economists argue
that, ultimately, individuals will choose which lifestyles suit them best. “We
make choices [in our own self interest] and I don’t think our food decisions
are any different,” notes Eric Finkelstein, a health economist at RTI
International near Durham. “As a society we weigh a lot more than we would
like, and there are problems associated with that. But many individuals may
not be making bad choices from their own perspective.”
— CHARLES GERENA

Eating Out
Americans have preferred to eat fewer meals at home
in the last 50 years. According to several studies,
frequency of fast food restaurant use is associated with
higher fat intake and greater body weight. Many fullservice restaurants serve large portions of high-caloric,
inexpensive food.

pollution from tailpipe emission.

Restoring the
Balance

PERCENTAGE

Removing government subsidies on
corn and sugar would
seem to be part of
the
answer
to
Expenditures on Food at Home
80–
America’s
obesity
Expenditures on Food Away From Home
70–
problem. Other possible solutions would
60–
also make it more
50–
expensive to be fat.
Canada
and
40–
several U.S. states
30–
impose a “fat tax” on
soda, snacks, and
20–
other so-called junk
10–
foods. Such a tax
0–
applied more broadly
1950
1960
1970
1980
1990 2000
might
discourage
SOURCE: Economic Research Service, U.S. Department of Agriculture
consumption
of
something that is
unhealthy, similar to taxing cigarettes.
available a generation ago — such as
At the very least, it would generate funds
surfing the Internet, playing video games
for public health campaigns, helping to
and watching television — occupy larger
counteract the billions of dollars spent
chunks of Americans’ leisure time.
on advertising high-calorie foods.
Exercise can be especially costly for
The drawback of these tactics is their
people in sprawling communities dombroad impact. They not only impose
inated by automobile travel. It takes
costs on the overweight and obese, but
time and money for them to get exeralso on those who can have occasional
cise beyond their daily routine, notes
treats and still maintain a healthy weight.
Reid Ewing at the National Center for
Tying weight-related diseases to the
Smart Growth Research and Education
price of health insurance might be a
based at the University of Maryland.
better way to make people bear the
“If [suburbanites] don’t make a point
future cost of eating too much. On the
of getting exercise, they don’t get it,”
flip side, Reid Ewing and others suggest
says Ewing, who recently co-authored
that healthier people could pay lower
one of the first studies on the relapremiums, similar to the “good driver”
tionship between sprawl and obesity.
discounts offered by auto insurers. Of
Of course, suburban development has
course, either premium arrangement
been demanded by homeowners and
would run contrary to the traditional
supported by public policy. Governments
pooling of insurance risks.
have facilitated it through investments
Eric Finkelstein advocates making
in road infrastructure to connect distant
it cheaper to be thin. For example,
communities and incentives to encourgovernment can increase the number
age development in rural areas.
of opportunities for physical activity.
Also, one could argue that sprawl
This could be accomplished by favoring
has been fueled by the subsidization
denser development in land-use policy,
of automobile use. Ewing believes
which would encourage people to walk
that only a fraction of the costs of
from place to place rather than drive.
automobile use are internalized —
Public funding of parks and bike paths,
that is, borne by the user directly. The
as well as increased support for physical
rest are externalities paid for by
education at schools, could also help.
everyone else, such as the cost of

Also, whole grains and produce
could be made more accessible. This
could include funding farmers’ markets
and requiring schools to offer healthier alternatives to students.
Whether they intend to make it
pricier to be plump or cheaper to be
thin, policy prescriptions for obesity
could impose other costs on society
that must be weighed against the
health benefits they produce. For
instance, policies that favor denser
development may, in fact, lead people
to walk more, but they also could
produce sizable distortions in the
housing market.
This underlines the challenges of
understanding and dealing with the
nation’s growing girth. There are no easy
answers, no matter what the makers of
diet pills and exercise gadgets say.
“It is important to recognize the
complexity of the problem we face,”
says Virginia Tech’s Richard Forshee.
“I don’t think there is a single cause
of overweight and obesity. There can
be many different explanations for different people.”
RF
READINGS
Cutler, David M., Edward L. Glaeser, and Jesse
M. Shapiro. “Why Have Americans Become
More Obese?” National Bureau of Economic
Research Working Paper no. 9446, January 2003.
Komlos, John, Patricia K. Smith, and Barry
Bogin. “Obesity and the Rate of Time Preference:
Is There a Connection?” Discussion Paper 200316, University of Munich, July 2003.
Lambart, Craig. “The Way We Eat Now.”
Harvard Magazine, May-June 2004, p. 50.
Mancino, Lisa, and Jean Kinsey. “Diet Quality
and Calories Consumed: The Impact of Being
Hungrier, Busier and Eating Out.” Working Paper
04-02, The Food Industry Center, University of
Minnesota, March 2004.
McCann, Barbara A., and Reid Ewing. Measuring
the Health Effects of Sprawl: A National Analysis of
Physical Activity, Obesity and Chronic Disease.
Washington, D.C.: Smart Growth America,
September 2003.
Philipson, Tomas, et al. The Economics of Obesity:
A Report on the Workshop Held at USDA’s Economic
Research Service. U.S. Department of Agriculture,
May 2004.
Visit www.rich.frb.org/pubs/regionfocus for
links to relevant sites.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

25

ACORN

The campaign for living wages has spread from Baltimore to more than
100 cities around the country, including New Orleans, the location of this rally.

minimum

ABOVE
the

Living-wage statutes are designed to help low-income workers in Baltimore and other
Fifth District communities, but do they get the job done?

B Y J U L I A R. T AY L O R A N D C H A R L E S G E R E N A

T

he year is 1993 and a 30-something
Baltimorean is working as a janitor
for the city’s ballpark. He leaves
work at the end of the day, but instead
of heading to his apartment or house, he
walks to the homeless shelter that he
temporarily calls home. The reason for his
current living arrangement is not
unemployment, but that his wage isn’t

26

R e g i o n Fo c u s • Fa l l 2 0 0 4

enough to keep his family above the
poverty line.
The above example described in a
Baltimore Sun article — while not necessarily representative of the average
low-wage worker’s experience — illustrates the type of decisions that some
have to make. “A lot of people who are
working full-time jobs and [receive]

other assistance still [can’t] get by
with minimum wage. If you work full
time at a minimum-wage job, you [can
still] fall below the poverty line,” says
Erica Schoenberger, an expert in
regional economic development at
Baltimore’s Johns Hopkins University.
In the early 1990s, the city was in
the middle of a fiscal crisis — with

outlays chronically outpacing revenues
— and was under enormous pressure
to outsource activities to the private
sector. This privatization push resulted
in jobs going to private firms that often
paid their employees lower wages than
the government had paid its workers
for performing the same tasks. Some
citizens balked at having their tax dollars being used to employ people at
what they saw as an unfair wage. At the
same time, efforts to increase the minimum were at a standstill in Congress.
The combination created an atmosphere ripe for change.
As Schoenberger explains, “It was
plain the national policy wasn’t going
to change fast enough, so something
had to happen at a local level.” What
happened was the living wage.
The term “living wage” is inherently subjective. Some define it as
a salary that is just enough to keep
a family out of poverty, while others
view it as enough to be self-sufficient.
In many cases, policymakers set the
living wage 50 percent to 100 percent
above the federal minimum wage in
order to meet these fuzzy benchmarks.
It can go even higher for employees
that don’t receive health benefits as
part of their employment package.
In 1994, Baltimore became the first
city in the United States to pass a living-wage ordinance. Employers that
contracted with the city were ordered

to pay their employees a wage of $6.10
per hour, enough to yield an income
equal to the poverty threshold for a
family of four. Now in 2004, those
employers along with companies that
receive tax breaks and other subsidies
must pay their workers at least $8.85 an
hour, substantially above the federal
minimum wage of $5.15.
In the decade since the passage of
Baltimore’s living-wage law, about 100
cities and counties across the country
have adopted similar legislation. On
the surface, the living wage is fertile
ground for controversy. Upon closer
examination, however, the results are
not as plain as either its proponents or
critics would claim. The living wage
has helped some low-wage workers,
but the overall effects have been rather
small. Those who have benefited the
most, it appears, are unionized municipal workers, who because of livingwage laws face less competition from
private firms eager to win government
contracts.

Helping Some Workers …
Despite the country’s overall economic progress in the 1990s, the
salaries of lower-wage workers have
not grown as rapidly as those at the top
of the earnings scale. “There has been
a widening wage inequality. A good
chunk of that has been between the
bottom and the middle,” says econo-

mist David Neumark of the Public
Policy Institute of California. The economic reasons for this are complex.
But the political effects have been
pretty straightforward: Living-wage
movements and other “progressive”
causes have gained steam.
Indeed, many communities with
traditionally large activist populations, including a number of college
towns, have been at the forefront
of the living-wage movement.
Charlottesville, Va., and Durham,
N.C., are just two such examples from
the Fifth District. (Not all communities with living-wage laws resemble
Charlottesville and Durham, though.
See sidebar, “Where the Living Wage
Is Law.”) As David Neumark elaborates, “In a climate of relatively
conservative politics and social policy,
[these] localities have passed” ordinances of their own. “It’s a victory
for very progressive political ideas.”
Communities also had another
impetus to enact living-wage laws. It is
here that the “fairness factor” comes
into play, meaning that those companies receiving something from the government, whether it’s tax benefits or
contracts, should have to “give back”
in the form of higher wages for their
employees.
Jen Kern of the Association of
Community Organizations for Reform
Now (ACORN), which has pushed

Where The Living Wage Is Law
In 1994 Baltimore passed the country’s first living-wage ordinance.
Since then roughly 100 other communities around the nation have
followed suit. Which places have been at the forefront of the livingwage movement and are there similarities among these communities?
Many college towns and other cities with large activist populations
have passed living-wage laws. But they are not alone. According to a
new study by Oren Levin-Waldman, a professor of public affairs and
administration at Metropolitan College of New York, cities with high
immigrant populations and relatively low levels of educational attainment are disproportionately likely to enact living-wage ordinances.
Why? Because there is a substantial number of people who stand to
benefit from such laws, Levin-Waldman argues. In general, these citizens
lack the “requisite education and skills to command higher wages” on
their own, he writes.
There is, however, an alternative explanation, one that is consistent
with research by economist David Neumark. He has found that living-

wage laws tend to benefit unionized municipal workers because they
raise labor costs for private firms that do business with local governments, and thus make it more expensive to contract out government
services. Many of those private firms, which are put at a disadvantage
by living-wage laws, are likely to employ low-skilled immigrant labor.
What does this mean? Perhaps that living-wage laws are common in
the communities Levin-Waldman describes because they protect municipal workers from low-skilled immigrant workers — not because they
benefit those low-skilled immigrant workers.
At any rate, one thing seems clear. Living-wage laws are popular in
these communities for very different reasons than most college towns,
where residents tend to be wealthier and more educated than the
overall population. It seems that in places like Charlottesville, Va., the
living-wage movement may be driven more by ideology than basic
economic factors.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

27

hard for living-wage laws, says that
although there are businesses that
publicly oppose living-wage legislation, some employers support it
privately. She claims that some
employers want to increase worker
wages but can’t afford to do so because

they are in competition with other
businesses. Kern argues that if higher
wages were mandated for all employers, it would take cost competition out
of the equation. (Of course, such a
move would almost certainly increase
prices paid by consumers for various
goods and services.)
Advocates of the living wage also
say that entry-level workers who are
offered higher wages will work harder
and have better attendance, resulting
in a more stable work force. “A higher
wage will bring in a higher quality of
workers. People will work harder when
you pay them more. They take more
pride in their work,” says Burt Barnow,
associate director for research at Johns
Hopkins University’s Institute for
Policy Studies.
Committed workers, in turn, will
rely less on social-welfare programs,
reducing the overall cost to the gov-

How Much They Have To Pay
Municipalities in the Washington, D.C., metropolitan area like Alexandria, Va., and Montgomery County, Md.,
tend to have higher living-wage requirements than other parts of the Fifth District. This makes sense given
the higher cost of living in the region.
Living-Wage
Requirement

Requirement
Applies To

Alexandria, VA

$11.36/hour

Arlington County, VA

$10.98/hour

City contractors working on
June 2000
city-controlled property;
excludes inmates
Companies with county contracts June 2003
> $100,000 for services performed
on county-controlled property

Baltimore, MD

$8.85/hour

Companies with city
construction and mail
delivery firms

Dec. 1994

Charlottesville, VA

$9.00/hour

County contractors, except
construction and mail
delivery firms

Nov. 2001

Durham County, NC

$9.74/hour

County contractors, except
construction and professional
services firms; excludes inmates

June 2004

Montgomery County, MD

$10.75/hour

Companies with county
contracts > $50,000 and
10 or more workers

June 2002

Prince George’s County, MD $10.50/hour

Companies with county
contracts > $50,000 and
10 or more workers

June 2003

SOURCES: Employment Policy Foundation and ACORN

28

R e g i o n Fo c u s • Fa l l 2 0 0 4

Law
Enacted

ernment and taxpayers. If this
reasoning is correct, though, it’s not
clear why higher wages would need
to be mandated. Private companies
would have a strong incentive to
raise wages on their own, if doing so
would result in a more stable, productive work force.

… But at What Cost?
The philosophy behind living-wage
laws may be praiseworthy, but economists have been studying the possible unexpected effects. Their main
concern is that living wages could
squeeze some workers out of the job
market altogether.
The Employment Policies Institute’s director of research, Craig
Garthwaite, puts it simply: “It’s basic
economics — when you increase the
price of a good, people consume less
of it.” The “good” in this case is labor,
meaning companies will not hire as
many workers.
When a city forces a business to
pay their workers higher wages
than they normally would, the policy
may unintentionally hurt the very
people it was designed to help. Many
opponents of living-wage laws argue
that companies will look to find ways
to cut labor costs, such as increased
automation. Think of how gas stations have cut costs by making
stations “self-service,” rather than
having a person pump your gas.
Or companies may try to make up
for some of the higher costs by
increasing the prices of their government contracts. But their leverage
to do so is limited. Since livingwage laws effectively make it more
expensive to contract work out, the
law obstructs rather than aids privatization. This leaves governments in
the position of increasing their own
spending.
Some fear that the increased costs
caused by these laws might make
a city less attractive to outside businesses. No one likes to be told what
to do, and private companies are no
exception. They don’t want to be
forced to raise employee wages.
Concerned about what it might
do to his state’s business climate,

Keeping Your Head Above Water
Workers earning the federal minimum wage haven’t been
able to keep their families above the poverty line since the
late 1970s. Due to the infrequency of minimum-wage
increases, localities have stepped into the fray with livingwage standards of their own.
14–
THOUSANDS OF DOLLARS

Federal Poverty Threshold*

12–

Minimum Wage Income**

10–
8–
6–
4–
2–
0–
00
20

6
199

2
199

8
198

4
198

0
198

6
197

2
197

8
196

4
196

0
196

NOTES:
* The poverty threshold is presented for a three-person family because,
according to the Census Bureau, this is the average family size in the
United States.
** The minimum wage income was based on a person working full-time,
40 hours a day, 52 weeks per year at the federal minimum wage for that
year. For periods when Congress raised the minimum wage midyear, the
wage is the weighted average of the minimum wages in force during
that year.
SOURCE: U.S. Census Bureau, U.S. Department of Labor

Gov. Robert Ehrlich Jr., of Maryland,
last spring vetoed legislation that
would have implemented a statewide
living wage.
Have any of the dire predictions
come true? In their book The Living
Wage: Building a Fair Economy, Robert
Pollin and Stephanie Luce concede
that increased wages may drive up costs
in some areas. But they argue that this
effect is not large enough to make businesses go elsewhere — or to significantly affect government finances.
And according to a survey of
Baltimore city administrators, contract
costs did rise, but in the main the
increases represented less than 1 percent of their total budgets. This is due
in part to the fact that only select contract areas experience coverage by the
living-wage ordinance. The law simply
did not cover areas with the largest
concentration of low-wage workers,
such as social work or home health
care. Since so few workers experienced
an increase in wages, city budgets
remained relatively unaffected.
In general, the benefits to low-

income workers have
been limited as well. A
relatively small share
of workers end up
being covered by living-wage laws, namely
those who work for
companies that do
business with the government. And even
among that group,
only some workers are
affected. Those who
are already making
more than the living
wage remain unaffected. Nevertheless,
even if the measures
help just a small percentage of workers, it
would still be considered a victory for living-wage advocates.

Who Benefits
the Most

According to Neumark’s research, living-wage laws seem to
favor unionized city workers the most.
“Labor relations in the public sector
are [handled differently] than in the
private sector, where there are strikes
when there is a conflict. If you’re the
mayor, you don’t want a strike or the
garbage piling up,” so municipal unions
have a lot of leverage.
In the past, local officials could
counter that power by threatening to
shift public jobs into the private sector unless they received concessions.
But that is no longer a credible
option. “The living-wage law
removes the threat of privatization
because the city would no longer
have an incentive to privatize,”
explains Neumark. Both union workers and those who work for city contractors wind up with similar salaries.
Furthermore, the ordinances
target low-wage workers but not
necessarily low-income workers, lessening the effectiveness of the laws.
For example, a high school student
from a relatively affluent family who
works an entry-level job in the summer to earn spending money is cov-

ered by living-wage legislation in the
same way as workers who are trying to
support families.
For this reason, as well as many others, economists argue that there are
more efficient ways than living-wage
laws to alleviate poverty on a widespread
basis. A better solution, Barnow suggests, is the Earned Income Tax Credit
(EITC), which “targets people with low
earnings. … If you’re in a family with
high income, you wouldn’t be entitled to
it no matter what your job is.”
Still, national organizations such
as ACORN are pushing to bring living-wage laws to cities that do not
have them and to broaden coverage in
those that already do. Many activists,
for instance, would like to see livingwage laws expanded to cover all workers, regardless of employer. This
effectively would raise a city’s mininum wage — a development that
many economists would look at unfavorably. As written, most living-wage
laws have only limited effects on a
region’s economy. But if those laws
were applied to everyone, the effects
on economic growth and employment could become substantial. RF

READINGS
Adams, Scott, and David Neumark.
“The Economic Effects of Living Wage Laws:
A Provisional Review.” National Bureau of
Economic Research Working Paper no. 10562,
June 2004.
Bernstein, Jared. “The Living Wage Movement:
What Is It, Why Is It, and What’s Known about
Its Impact?” In Freeman, Richard B., Joni Hersch,
and Lawrence Mishel (eds.), Emerging Labor
Market Institutions for the 21st Century. Chicago:
University of Chicago Press, Forthcoming.
Levin-Waldman, Oren. “Cities That Pass
Living-Wage Ordinances.” Challenge, SeptemberOctober 2004, vol. 47. no. 5, pp. 56-68.
Neumark, David. “Living Wages: Protection
For or Protection From Low-Wage Workers?”
National Bureau of Economic Research Working
Paper no. 8393, July 2001.
Pollin, Robert, and Stephanie Luce. The Living
Wage: Building a Fair Economy. New York:
New Press, 1998.
Visit www.rich.frb.org/pubs/regionfocus for
links to relevant sites.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

29

INTERVIEW

Al Broaddus &
Tom Humphrey
Editor’s Note: This is an abbreviated version of RF’s conversation with Al Broaddus and Tom Humphrey. For the full interview,
go to our web site: www.rich.frb.org/pubs/regionfocus.

Al Broaddus and Tom Humphrey joined the Federal
Reserve Bank of Richmond in 1970 as economists.
Both have had long and illustrious careers at the Bank.
Broaddus was named Director of Research in 1985,
a post he held until Jan. 1, 1993, when he was appointed
President of the Bank. After more than 10 years of
heading the Richmond Fed, Broaddus stepped down
from his post in July 2004, when he turned 65, the age
at which Fed presidents customarily retire.
Humphrey has been one of the Bank’s most prolific
economists, publishing numerous articles and books
on monetary economics, macroeconomic theory, and
the history of economic thought, and teaching at
universities throughout the Fifth District as a visiting
professor. He also has served as editor of the Bank’s
scholarly journal, Economic Quarterly (formerly called
Economic Review), since 1975. Humphrey will retire
from the Bank at the end of 2004.
During their more than 30 years of service to the
Federal Reserve Bank of Richmond and the Federal
Reserve System, Broaddus and Humphrey have witnessed significant changes in the way our nation’s central
bank operates. In the following interview they reflect
on those changes, as well as what the future may hold
for the Fed and for them personally. Aaron Steelman
spoke with Broaddus and Humphrey on Aug. 26, 2004.
30

R e g i o n Fo c u s • Fa l l 2 0 0 4

RF: How did each of you join the Fed?
Humphrey: There was a vice president here, who
died a few years ago, named Pete Snellings. I think
Pete was more responsible than anyone else in
bringing me to the Bank. He was my teacher at
the University of Tennessee and he also directed
my master’s thesis there. He and Bob Black, the
former president of the Bank, were really good
friends. They both went to the University of
Virginia, where they got their Ph.D.s, and they
both taught at Tennessee. Wherever Bob Black
went to work, Pete seemed to follow him with a
two- or three-year lag. So shortly after Bob Black
came to the Richmond Fed from the University
of Tennessee, Pete went as well.
Pete was an excellent teacher, and he really
encouraged me. After I got out of school, I
would see him periodically at conferences and
he would keep tabs on me. He would say, “We
have to bring you to the Richmond Fed.” And
eventually he and the research director at the
time, Jim Parthemos, did bring me here.

RF: How about you, Al?
Broaddus: I actually grew up in Richmond. I left
town when I went off to college, and I didn’t
really anticipate that I would come back. But
while I was in the Ph.D. program at Indiana, my
principal teacher was a fellow named Elmus
Wicker, a great monetary historian. Elmus knew
Jim Parthemos, who, as Tom mentioned, was
research director at the Richmond Fed when I
was entering the market. Jim interviewed me and
offered me a job. I also had an opportunity to go
to the Cleveland Fed and an opportunity to go
to the Federal Deposit Insurance Corporation.
So those were the three options. I had a lot of
trouble getting comfortable with the idea of
coming back home but, ultimately, this seemed

to be the place where I would be happiest professionally. Jim Parthemos is a
wonderful scholar, a great research
leader, and a real gentleman too. I think
that was the determining factor in my
decision.
RF: How has the Research Department changed over time?
Humphrey: It has become more academic in orientation, with staff economists encouraged to publish not only in
Bank publications but also in scholarly
journals outside the Bank. The economists here are in an academic-type
setting, and are expected to do the same
things that academics do except teach.
In place of teaching they give policy
advice. So I think that is a fundamental
change. The people we had here when
I first came were fine economists, but they were
business, not academic, economists. They were
not into heavy theoretical and empirical work.
Broaddus: As Tom has said, I think I would put
the emphasis on the word “academic.” The
department has definitely become more academically oriented. But I want to make it clear:
There were very good economists here not only
when we came, but before we came. It’s just that
their emphasis was different. Under the direction of Jim Parthemos, the department began to
focus much more on basic research.
RF: The Richmond Fed has long had a reputation for supporting “hard-money” or
“hawkish” views on inflation. Do you think
that reputation is justified — and if so, what
accounts for it?
Broaddus: Yes, I think it is deserved. This is
an oversimplification, but when we came to
the Fed, you had two camps. There was the
monetarist camp, which was really more of an
outsider group at the time. And there was the
more mainstream, Keynesian camp. The key
distinction, for me at least, was that many in
the Keynesian camp seemed to think that it
was possible to use monetary policy to finetune the economy, while the monetarist camp
thought that we should have a more limited
set of objectives.
For whatever reason, we had more people who
were in the monetarist camp. Bob Black certainly
felt very strongly about keeping a close check on
the growth of the money supply. And Bob

Hetzel, who had studied under Milton Friedman
at the University of Chicago, came to the Bank
in the mid-1970s with a strong monetarist orientation. When I first got here, I had a bit more
of a Keynesian point of view but I was quickly
converted.

Al Broaddus (above left) and
Tom Humphrey reflect on a
lifetime of economics.

Humphrey: I think that the hawkish tradition
is warranted, and I think it goes to the old
classical notion that the principal function of
the central bank is to preserve the value of
money. As long as inflation is a problem, much
of the time you are going to be perceived as
being hawkish if you’re worrying about inflation. But on the other hand, I think the classical economists were very much worried about
deflation too. As a matter of fact, they feared
deflation more than inflation for the adverse
effect it would have on real economic activity,
but deflation just doesn’t happen as frequently
now as inflation. So I think that at this Bank
we are hawkish on inflation because it occurs
more often, but we’re also concerned about
deflation. Our real goal is price stability.
Broaddus: I want to add a quick note about terminology. When we came to the Bank, people
didn’t use the term “hawkish” very much. I think
that whole terminology developed during the
Volcker years when the Fed began to bring inflation down. The people who had this strong quantity theory orientation — and were determined
to not allow inflation to rise again — were
described as hawks, because they were seen as
looking around at the economy for any sign of
inflation so that they could stamp it out.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

31

Humphrey: When
we came to the Bank,
the idea was widespread that inflation
was so thoroughly
entrenched in the
economy that you
really couldn’t do
much to get it down.
More precisely, you
could get it down, but
the costs would be
even greater than the
benefits. So it was better to learn to live with some
inflation than to try to get it down close to zero.
But here in Richmond we thought that if a central
bank could establish credibility as an inflation
fighter — which is a really hard thing to do — it
could actually get inflation down fairly readily,
without great cost to the economy. That was certainly what Milton Friedman and the monetarists
were teaching at the time, and it was in fairly sharp
contrast with the views of some other people
within the Fed and the profession generally. So,
to get back to your question, I think that the
Bank’s reputation as being hawkish is well
deserved and I’m very proud of it.
RF: Both of you have worked at the Fed
during periods of high, erratic inflation as
well as periods of low, stable inflation. What
do you think the Fed has learned from those
experiences?

Al Broaddus
➤ Positions

Broaddus: I think the key thing we learned from
the high-inflation period is how costly it can be
to bring it down. Unless you have credibility, it is
very costly to change expectations from a continuing inflation environment to something else.
And once inflation gets up
to a certain point you lose
credibility. You can’t get it
back just by assertion —
you have to earn it.

Worked as an analyst at the Defense
Intelligence Agency from 1964 to
1966, before joining the staff of the
Federal Reserve Bank of Richmond
in 1970. Served as the Bank’s Director
of Research from 1985 to 1992, and
President from 1993 to 2004.

➤ Education
B.A., Washington and Lee University
(1961); M.A., Indiana University (1970);
Ph.D., Indiana University (1972)

32

R e g i o n Fo c u s • Fa l l 2 0 0 4

Humphrey: I also
think we learned —
although I’m not sure we
subscribed to it in the
Federal Reserve System as
much as the rest of the
profession did, especially
the Keynesian wing of
the profession in the 1950s
and 1960s — that we can’t
really use monetary policy
to fine-tune the real

economy like we can
use it to stabilize
prices. The big lesson
that we have relearned
is the old classical doctrine that the main
objective of monetary
policy ought to be to
stabilize and protect
the value of money.
Also, as Al mentioned, credibility is
very important. If
the Fed has credibility, it can focus in the short
run on keeping disastrous things from happening to the real economy because people will
know that, when push comes to shove, it’s going
to stabilize prices. Credibility is extremely fragile
so you have to protect it. But if you have it, you
have a lot more flexibility for dealing not only
with the problem of maintaining price stability,
but other short-run problems that creep up from
time to time.
RF: The Fed’s actions now garner a great deal
of media attention, from both the financial and
popular press. Indeed, Chairman Greenspan has
gained almost celebrity status. How does this
compare to 1970?
Broaddus: I think that the media have always
paid attention to the Fed. But we now have more
media outlets — for instance, cable television
networks devoted entirely to financial news. That
means that the Fed is naturally going to get more
coverage. Also, I think that beginning in the late
1970s — when Chairman Volcker was working
to bring down inflation — people started paying
more attention to monetary policy. Volcker put
a public face on the Fed, which may have
increased media attention.
Humphrey: I generally agree with what Al said.
But I think the difference may be more stark
than he suggests. When I came to the Bank, the
general public wasn’t really aware of the Fed. To
give you an example, in the 1970s I went to a
conference in Boston. While I was there, I was
looking for the Boston Fed and I was asking
people on the street, “Could you tell me where
the Federal Reserve Bank is?” I asked five or six
people, and they had never heard of it. They
knew where their own bank was, but they had
no idea about the Fed. They thought it was just
another commercial bank. So I think that the
general public was not as aware of the Fed as it
is now. I think that the same is true to a lesser

extent of the financial media. In the early 1970s,
the financial press paid attention to the Fed. But
their coverage was a bit superficial and not nearly
as sophisticated as it is today. There are now
several reporters who seem to know their economics and to really understand what monetary
policy is all about.
RF: Recently, the Fed has taken a number
of steps to enhance the transparency of its
monetary policy decisions. Why has this been
done — and what do you think have been the
consequences?
Broaddus: I think it’s very difficult for a central
bank to have credibility unless it’s transparent.
I think they are two sides of the same coin. We’re
now at a point, I think, where the public needs
to understand that we’re going to give as clearly
as we can our best estimate of where the
economy is heading and where policy is going.
At the same time, there needs to be a recognition that, in making such statements, we are not
locking ourselves in to a particular policy path
— and that if we do things that may be unexpected, we are doing them in good faith and in
reaction to developments in the economy we
ourselves did not anticipate. I think that we’re
pretty close to achieving that understanding.
Humphrey: There was this old idea that secrecy
was a good thing for a central bank — that the policy
analysis and actions were so complex that the
public couldn’t possibly understand them, and so
the high priesthood of the central bank would just
run things without telling why or how they were
doing it. I think that has gone completely out the
window now. Most people accept that transparency
is important, and the real debate is not whether
the central bank should become more transparent
but how fast it should move in that direction.
RF: What do you think is the role of a regional
bank within the Federal Reserve System?
Broaddus: In a democratic society like the United
States, the central bank has to have public
support, and I think that the regional structure
of the Fed helps to build that support. Even
though we have an economy that’s highly integrated nationally, there’s no question that there
are regional economic differences, and it’s important the central bank be aware of those differences when it is making its aggregate policy
decisions. The regional Reserve Banks serve as a
conduit. We gather information from our districts
— in a variety of forms, both formal and anec-

dotal — and present it during discussions of the
Federal Open Market Committee (FOMC). The
regional system, then, gives the public a way to
communicate what is happening on the ground
more effectively to policymakers.
Also, I think that the decentralized structure
promotes a diverse set of views within the
System. Each of the 12 Reserve Banks has its own
staff of economists, and arguably those economists pursue a wider variety of research agendas
than they would if they were all located in Washington. The best of this research ultimately influences the way the FOMC thinks about and
implements policy.
Humphrey: I think Al’s last point is very important. If you believe, as economists do, that
competition is healthy and promotes efficiency
and ingenuity, you want 12 regional research
departments rather than only one located in
Washington, D.C.
RF: Tom, you are one of the few historians
of economic thought working within the
Federal Reserve System. How does your work
fit in with the broader mission of the Fed?
Humphrey: I think it’s good to have historical
perspective. When we take a policy position, it’s
comforting to know that some of the greatest
monetary economists of the past are supporting
you. But going beyond that, history of thought
can illuminate current policy discussions. For
instance, the greatest of all monetary controversies was the debate between the bullionists and
the anti-bullionists that took place in the first
three decades of the 19th century in England.
All the things we worry about today — inflation,
deflation, exchange-rate fluctuations, etc. — were
discussed for the first time then, and were discussed
very well by some of the
greatest minds in the proTom Humphrey
fession. Also, toward the
end of the 19th century,
➤ Positions
Knut Wicksell established
Taught at Wofford College (1960the model we use in central
1963), Auburn University (1964-1965),
banking today of correcting
Tulane University (1966-1968), and St.
price-level deviations from
Andrew’s Presbyterian College (1968target by interest-rate adjust1969), before the joining the staff of
ments. So I think that some
the Federal Reserve Bank of
of the insights and wisdom
Richmond in 1970.
that these old fellows had to
➤ Education
offer are still there to be
B.S., University of Tennessee (1958);
rediscovered; they haven’t all
M.S., University of Tennessee (1960);
been teased out yet.
Ph.D., Tulane University (1970)
Some of the greatest
economists of the 20th

Fa l l 2 0 0 4 • R e g i o n Fo c u s

33

century were historians of thought: Wesley Clair
Mitchell, Jacob Viner, Joseph Schumpeter, Frank
Knight, F. A. Hayek, Lionel Robbins, George
Stigler, Don Patinkin. Even Paul Samuelson,
arguably the greatest pure economic theorist of
the 20th century, has contributed to history of
thought. These economists used history of
thought to inform their policy analysis and
advice, especially Mitchell and Viner. Even
though it’s not practiced or respected very much
today, I think history of thought has an awful
lot going for it. It has ideas and analyses that
have survived the toughest test of all — the test
of time. These timetested ideas can be
used to shed light on
current problems.
That’s why I think
history of thought
is important, in addition to being fascinating in its own
right.
Having said all
that, I think I have
been especially fortunate to have worked
for four Bank presidents who have been
willing to tolerate me
and who think that
history of thought
had something to
offer. I’m reminded
of a story that a fellow who jogs with Al and me
tells. A friend of his came up to him and said,
“Who is that crazy-looking guy I see you running
with? And what does he do?” So he told him, “His
name is Tom Humphrey and he works on the
history of monetary thought.” The guy responded,
“You can make a living at that!” So I think that I
have been really fortunate to have worked with
such a sympathetic group here.
Broaddus: Tom is being too modest. His work
has been crucial to the development of the Bank’s
research department. When people talk to me and
mention Tom, they often say, “How did you
manage to pull that off at Richmond — to have
someone who could devote his time to history of
thought?” The reason is because the leadership
at this Bank — not just me, but the people before
me — saw it as crucially important to having
a good research program. I don’t see how you can
have a complete research department without
having someone looking at things from this
perspective.
34

R e g i o n Fo c u s • Fa l l 2 0 0 4

RF: Tom, in addition to your own work, you
have edited the Bank’s Economic Quarterly and
its predecessor, Economic Review, since the
mid-1970s. What have been some of the more
rewarding aspects of that job?
Tom: I think the most rewarding aspect of the
job is seeing manuscripts take shape, all the way
from a mere idea to a final, published article.
The author gives us the initial draft, then the
referee panel goes to work and tries to improve
it, and I’m kind of an intermediary. I go back
and forth between the authors and referees until
both are satisfied with the end product. To see
that process at work and to see fine, beautiful
articles emerge is a great joy to me.
Also, there are two things that I think are
unique about our publication. First, we are able
to publish longer, more detailed, and more policy-oriented articles in the Economic Quarterly
than most journals are willing to accept. So these
ideas can be expressed more fully than if they
were presented elsewhere. Second, the referees
for papers in the Economic Quarterly are other
economists at the Bank. These people are your
colleagues, and you get to talk to them, instead of
just seeing an anonymous referee report.
Sometimes the discussions get kind of heated.
But I think that everyone understands that the
referees are trying to do the best they can to
improve the papers. The economists here are
genuinely open and receptive to suggestions for
improvement. This give-and-take is really unique
in scholarly publishing and I think it ultimately
results in better papers being published here.
RF: What do you plan to do with your time
after you leave the Bank?
Humphrey: I really don’t know. I’ll do a lot of
reading, of course, and if I can stay healthy I hope
to do a lot of running. I would also like to return
to college teaching.
Broaddus: I am active in a number of nonprofit
organizations, and I will be serving on the boards
of a few public companies. But I have no plans to
stop pursuing my interest in monetary economics and policy. The Federal Reserve is a great institution and I have been privileged to work here.
No matter what I do in the future, I will always
be a Fed person.
Humphrey: What Al said really is true. The Richmond Fed has been a huge part of my life, and I
feel like I will always be part of the institution in
some way. It has been a great run.
RF

ECONOMICHISTORY

Labor Pains
D

major rail lines were completed, coal
production reached 3 million tons. By
the early 1890s, West Virginia had
nearly 9,800 miners producing more
than 10 million tons.
Railroads turned coalfields into
powerful investments, and wealthy
industrialists acquired mineral rights or
outright ownership of fields. Land
bought at $1.50 to $2 per acre in some
areas was worth $100 per acre after the
railroads came five years later, according to historian Ronald Lewis. Rails
could send carloads of coal to the rivers,
where barges shipped the fuel to the
North and East.
By 1900, coal had become king of
the mountain. In 1927 West Virginia
produced about 146 million tons.
Some pioneer coal operators were
keen small businessmen. As late as 1920,
the state’s four largest coal companies
controlled less than 14 percent of the
market. A few mine owners, though,

The long and often
violent struggle for
unionization in
West Virginia’s
coalfields
BY BET TY JOYCE NASH

WEST VIRGINIA AND REGIONAL HISTORY COLLECTION,
WEST VIRGINIA UNIVERSITY LIBRARIES

uring a United Mine Workers
of America strike in the 1980s,
a coal company hired replacements for striking workers. State troopers watched as the nonunion coal truck
drivers passed picket lines. Old-timers
around Matewan, W.Va., say those
trucks would have remained idle “in my
daddy’s day.”
The United Mine Workers of
America today organizes other occupations as well as miners, including
health care workers, truck drivers, and
power plant workers. In 2003, about
23.6 percent of coal miners in the
nation were union members, according
to Barry Hirsch and David Macpherson, who compile union membership
statistics based on the Census Bureau’s
Current Population Survey.
Early union organizing stories are
the stuff of legend, with countless
books and even a Hollywood movie
depicting the “mine wars” of the 1920s.
The labor strife that accompanied the
industrialization of Appalachia mirrored those from around the globe as
a new working class, only a generation
or two removed from agricultural fields
— even slavery — struggled against
long hours, hazardous working conditions, and low wages.

Trails to Rails
Early settlers were few in West Virginia, which broke off from Virginia to
become its own state in 1863. West
Virginia’s isolated mountains, layered
by ice and continental drifts over
millions of years, are slashed by
streams and seams of coal in all but
two of the state’s 55 counties. But coal
was virtually useless until the rails were
laid to transport it. In 1883, when the

hewed to social Darwinism, a sort of
survival of the fittest for business, with
a bit of paternalistic “welfare capitalism”
thrown in for good measure. This meant
that many thought of employment as
a form of charity. The notion partly

Early miners screen coal,
separating slate and removing
clay. By 1893, there were
nearly 9,800 miners in West
Virginia, producing more than
10 million tons of coal.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

35

explains the coal operator’s reaction
when coal miners began to organize.
In his book, In the Kingdom of Coal,
Dan Rottenberg wrote, “By this logic,
it followed that unionization, by distracting and restraining management,
threatened the effectiveness of a business and thus threatened workers themselves (who would lose their jobs if their
employers and investors lost money).
Consequently, in the minds of owners,
almost any countermeasure against
union organizers seemed justified.”
And some operators were former coal
miners themselves. For instance, Jack
Dalton, the feisty owner of 27 mines in
Logan County, W.Va., fought the union.
Boyden Sparkes, who covered West Virginia’s mine wars for a New York newspaper, described Dalton’s opposition to
unions as having a very personal flavor:
“I think that the important thing is that
he used to be a miner, a nonunion miner,
and that he is determined that his miners
shall continue to be nonunion. When the
unions are willing to use force to effect
organization, Jack Dalton is willing to
use force to prevent it.”
As the coalfields expanded, mine
owners recruited labor. Immigration
brought Poles, Slovaks, Italians, Welshmen, and Belgians. Word of work spread
and black people seeking steady work
and escaping Jim Crow laws farther
south poured into West Virginia. The
black population of West Virginia was
about 3,769 in 1860, but grew to 21,584
by 1900 and to 60,400 by 1920.
Historian Lewis has studied this
phenomenon and describes the towns:
“Many early coal towns actually resembled semi-agricultural villages. More
than half of the black migrants who
came to these coalfields had been
sharecroppers and most of the European
immigrants and local white mountaineers had been farmers as well.”
Many men saw the wage-earning
work in the mines as an improvement
compared to squeezing crops from
worn-out soils. They worked for themselves. Mining was independent, supervision was light, with the miner in
control of his hours and pace. He leased
his tools from his employer or provided
36

R e g i o n Fo c u s • Fa l l 2 0 0 4

them himself, built his own explosives,
and generally worked as an independent
contractor. Time spent securing his own
safety and that of others would not
put food on the dinner table, though,
since he was paid only for coal
extracted. And few knew that lung
disease could be caused from long-term
inhalation of coal dust.
Miners couldn’t control the price of
coal and the fairness of those who
weighed it. One practice that shortchanged miners was a system called
cribbing: Mine cars held a certain
weight, but sometimes cars were altered
to hold more than the specified amount.
Ultimately, labor strife erupted over
nearly every aspect of mining, from
miners’ shorted wages to life-threatening working conditions to prices in the
company store, and, of course, to the
right to assemble.

A Miner’s Life
In recent years, economic historians
have reviewed some features of early
mining life. Price Fishback of the
University of Arizona has studied
mining’s dangers, the sanitation in coal
camps, and company stores.
Mining was risky business. Before the
industry’s stagnation in the 1920s when
coal demand dropped after World War 1,
between 1,500 and 2,000 miners were
killed in U.S. coal mines annually. That’s
three to four deaths for every thousand
miners who worked a full year, according to Fishback. But miners who worked
dangerous jobs in the industry got paid
about 14 percent more than similarly
skilled workers outside the mines.
In West Virginia, with its comparatively new and weak state government,
mines were regulated poorly, if at all.
Between 1890 and 1912, the state’s
mine death rate topped all other
mining states. And in 1907, the nation’s
worst coal disaster killed 361 people in
Monongah, W.Va.
Fishback has also studied mining
towns — places where the company
owned the town and everything in it.
In 1924, 80 percent of West Virginia
miners lived in such towns, compared
with 9 percent in Indiana and Illinois.

Although the towns were controlled
by the coal company, the communities
offered recreation and social events,
especially baseball. Companies recruited
players, several of whom wound up
playing in the major leagues.
Another point of contention among
miners were prices at the company
store — and the forms of payment
accepted. Miners were typically advanced wages in scrip redeemable only
at the company store, although Bill
Boal, an economist at Drake University, says his research has found that
some private stores also accepted scrip.
Isolated mining camps and company
stores typically charged more for goods
partly because of transportation costs,
according to Fishback. He has compared
prices of stores in coal areas with stores
in manufacturing areas of nearby cities
in 1922, following the mine wars in
West Virginia. Price differences were
lowest in four union districts. “Price
differentials were also generally low in
nonunion districts, less than 2 percent
in three of the five comparisons,” Fishback notes in a journal article.
But in the remote regions of southern West Virginia, the coal company
controlled nearly all aspects of a miner’s
life, and social tensions simmered.

Matewan
Daisy Nowlin’s parents came to Mingo
County, W.Va., in 1898 hoping for work.
Her uncle entered Stone Mountain Mine
in the town of Matewan at 9 years of age.
“They worked them like slave labor,”
Nowlin, now 75, says. “But they worked
because they had to work. That’s the only
way they could put food on the table.”
Ultimately labor tensions exploded.
In May 1920, the mining company
dispatched private detectives from the
Baldwin-Felts agency to evict striking
miners from company-owned houses.
Matewan sheriff and former miner
Sid Hatfield, a former sweetheart of
Nowlin’s mother, tried to stop them. Ten
people were killed that day outside the
town’s railroad depot, including seven
detectives, two miners, and the town’s
mayor. (Hatfield was killed by detectives
from the same agency a year later.)

WEST VIRGINIA AND REGIONAL HISTORY COLLECTION, WEST VIRGINIA UNIVERSITY LIBRARIES

Today, Matewan has rebuilt and
relocated the depot, turning it into a
museum to remind people of its railroad
and labor history. The “Matewan Massacre,” as it came to be known, was only
one bloodstain in a long line of labor
struggles, including mining struggles, in
U.S. labor history. Those include the 1914
Ludlow Massacre in Colorado when
striking miners were attacked by hired
mine guards, killing 20 people. Nineteen
people had died in 1897 in northeastern
Pennsylvania when striking miners were
killed by police. And widespread rail
strikes in 1877 led to riots in several
cities, while 10 people were killed by
Pinkerton detectives during a steelworkers’ strike in 1892 in Pennsylvania.
The union exerted little influence in
the Mountain State before 1910, according to Richard Brisbin, a political
scientist at West Virginia University.
The UMWA had organized miners in
Pennsylvania, Ohio, Indiana, and Illinois
between 1890 and 1900. But repeated
attempts in the 1890s to organize West
Virginia’s miners failed until 1902, when
the UMWA organized the coalfields
around Charleston. Coal operators
banded together and hired guards to
prevent union activities. Southern West
Virginia mine owners aimed to block the
union in an effort to keep production
costs down and gain coal market share.
By 1906, union membership was
about 12 percent but began falling for
several years, until 1918, when organizing began to bear fruit and membership
grew to about 20 percent. By 1921, 32
percent of coal miners belonged to a
union. In 1912, Paint Creek operators
tried to de-unionize their mines,
leading to violent strikes and the
re-unionization in the fields around the
Coal River, a tributary of the Kanawha
River. Miners fought for the right to
organize, an end to blacklisting organizers, an end to the practice of using
mine guards, and a stop to cribbing.
Striking miners also wanted scales
installed at all mines, along with a
union inspector to prevent cheating,
and alternatives to company stores.
The coalfields calmed during World
War I, when a boom in production and

The National Guard was called out to
quell violence between striking miners and
company-employed police at Cabin Creek,
W. Va., in 1912.

“Eastern coal was the thing. And
it wasn’t mobile. As long as they were
able to organize all the mines, they
could shift income from mine owners
to workers,” notes Barry Hirsch, a
professor of labor economics at Trinity
University in San Antonio, Texas.
But coal’s power of that era has
eroded under competition not only from
other fuel sources but also from other
areas. Environmental concerns have
pushed Wyoming’s low sulfur coal to the
top in the past 20 years or so. Also, productivity gains have reduced the demand
for mine labor. By 2002, the number of
people working in the coal industry in
West Virginia had fallen to 44,274 from
a 1948 high of 125,000. Recently, though,
demand and prices have begun to rise
for West Virginia coal, higher in BTUs
and closer to East Coast markets than
coal from other sources. Demand for
miners is growing, says Dan Miller, vice
president of the West Virginia Coal
Association. State-sponsored programs
are training a new generation of miners.
“There are a disproportionate number
of coal miners in their 40s and 50s,”
Miller says. “We have to convince a new
generation of young people that it’s a
good career.” And whether it’s a union
career will be up to the miners.
RF

increased wages filled coffers. A national
recession after the war sparked layoffs
and wage cuts. This set the stage for the
UMWA, with its legendary leader John
Lewis, to begin serious efforts to organize southern West Virginia coalfields.
Mine operators sealed off hollows and
resisted the union any way they could.
Their struggles culminated in the
Battle of Blair Mountain after thousands
of miners marched on Logan County at
the southern tip of the state. In the end,
federal troops were called in to quell violence. Though the violent strikes spotlighted the miners’ cause
nationwide, they failed to bring
READINGS
union recognition. Union memBoal, William. “Estimates of Unionism in West
bership plummeted from nearly
Virginia Coal, 1900-1935.” Labor History,
50,000 in 1920 to about 600 in
Summer 1994, vol. 35, no. 3, pp. 429-441.
1929, partly a result of the
Corbin, David A. (editor). The West Virginia
national anticommunist mood
Mine Wars: An Anthology. Charleston, W. Va.:
that swept the nation after the
Appalachian Editions, 1990.
Great War.

Enter the New Deal
UMWA membership stalled
until federal legislation —
specifically, the National Industrial Recovery Act of 1933 and
the Wagner Act of 1935 —
established what is now the
basis of current labor laws. By
1935, according to Boal’s
research, 100 percent of West
Virginia’s coal was mined under
union contract, compared to
virtually zero in 1930.

Fishback, Price V. “Did Coal Miners ‘Owe
Their Souls to the Company Store’? Theory and
Evidence from the Early 1900s.” Journal of
Economic History, December 1986, vol. 46, no. 4,
pp. 1011-1029.
Lewis, Ronald L. “From Peasant to Proletarian:
The Migration of Southern Blacks to the
Central Appalachian Coalfields.” Journal of
Southern History, February 1989, vol. 55, no. 1,
pp. 77-102.
Rottenberg, Dan. In the Kingdom of Coal.
New York: Routledge, 2003.
Visit www.rich.frb.org/pubs/regionfocus for
links to relevant sites.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

37

BOOKREVIEW

Market Discipline
TOO BIG TO FAIL:
THE HAZARDS OF
BANK BAILOUTS
BY G A RY H . ST E R N A N D
RON J. FELDMAN
WA S H I N G TO N , D.C .:
BROOKINGS INSTITUTION
P R E S S , 2 0 0 4 , 2 3 0 PAG E S
REVIEWED BY
H. S. MALEK

few months ago, as I was
researching the size distribution of U.S. commercial banks,
I ran across Too Big To Fail in our Bank’s
library. The book, written by Gary Stern
and Ron Feldman of the Federal Reserve
Bank of Minneapolis, addresses one of
the more important issues facing policymakers today: how to deal with large
corporations that have been deemed so
important to the U.S. economy that the
government doesn’t dare let one go
bankrupt.
The term “too big to fail,” hereafter
referred to as TBTF, has been around
since at least the mid-1970s. But it didn’t
enter common parlance until 1984,
when Congress held hearings on the
financial problems of Continental
Illinois Bank. The banking sector, of
course, is vital to the American economy
— and fears that the collapse of one
institution would lead to the fall of others has inspired much TBTF policy.
Indeed, because of past bailouts, many
investors now believe that large banks
are subject to implicit government protection. Such protection may produce
short-run stability, but the moral-hazard
problems that arise from TBTF policies
can produce major net costs. “While the
fiscal flows of the savings and loan
bailout in the United States equaled
$150 billion, lost output from the savings and loan crisis — largely attributed

A

38

R e g i o n Fo c u s • Fa l l 2 0 0 4

to moral hazard and poor resource allocation — was on the order of $500 billion,” Stern and Feldman write.
In essence, TBTF banks become 100
percent insured by the government,
warping price mechanisms within financial markets. The higher premium that
otherwise would be demanded by riskaverse depositors is depressed by
implicit government insurance, and
TBTF banks enjoy a government
subsidy for their risk-taking. Market
discipline evades the TBTF bank,
leading to suboptimal performance.
Independent of failure, there is an
inefficient use of capital — and when
you add a bank bailout to the mix, the
costs can skyrocket.
In today’s world of increasing bank
consolidations there is some urgency for
formulating good policy. Stern and
Feldman are cognizant of the serious
obstacle posed by systemic risk in correcting the present distorted incentive
structure. Accordingly, they couple ways
to preempt contagion and limit creditor
losses with a credible commitment to let
big banks fail.

Preempting Contagion
In Chapter 5, titled “Why Protect
TBTF Creditors?”, Stern and Feldman
present potentially surprising arguments about bank runs. Historically,
they claim, many bank failures have not
produced the widespread ripple effects
one might have expected. “Brief, rapid
disruptions weed out poorly run or
weak competitors and discipline banks
as to future exposures. Banking panics
are simply a form of the invisible hand,”
Stern and Feldman write. Still, they
acknowledge that many people will not
be convinced that intervention may be
unnecessary. So in Chapter 10, titled

“Reducing Policymakers’ Uncertainty,”
they introduce targeted reforms aimed
at lessening the chances — and costs —
of contagion.
One of these potential reforms is scenario planning. By simulating bank failures, bank supervisors can examine the
implications of cross-firm exposure for
creditor solvency. Then they can test a
wide range of resolution options, and
pick the one that minimizes coverage
provided to uninsured creditors without
creating excessive financial instability.
“Almost as important as the planning
itself is the disclosure of scenario planning to bank creditors,” write Stern and
Feldman. The mere fact that such planning is taking place would inform creditors that the wisdom of TBTF policies
is being questioned and that alternatives
are being considered. This would likely
make those creditors more vigilant in
monitoring banks’ activities.
What’s more, the suggestion for
greater transparency in scenario planning “reflects lessons we take away from
the experience of monetary policy,”
Stern and Feldman write. “During the
period in which the U.S. central bank
established and maintained greater
credibility with regard to price stability,
it also made its analysis and objectives
more transparent. The greater transparency may have helped the Federal
Reserve to establish its credibility. In a
similar vein, going public with steps that
make coverage of the uninsured less
likely could establish credibility in
reducing TBTF coverage.”

Limiting Creditor Losses
The most direct way to limit the chance
of a bailout is to reduce the expected loss
to a creditor. This in turn limits the
probability of systemic risk. To accom-

plish this, policymakers must be willing
to close weak but solvent banks, Stern
and Feldman argue. This is not a new
concept. A provision of the Federal
Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) allows
policymakers to take “prompt corrective
action” (PCA). Stern and Feldman find
this reform “attractive on a conceptual
basis” but argue that there are flaws in
the way PCA is triggered.
They suggest that PCA triggers must
meet four conditions. They must be (1)
largely outside the manipulation of the
bank; (2) reflective of the current risk
profile of the institution; (3) feasible to
calculate routinely and to observe; and
(4) set to close banks likely to fail while
allowing those likely to survive to stay
open. Also, “although it may appear
obvious, to be effective, the early closure
regime must take real steps to
remove the discretion of supervisors,”
the authors write. The current PCA
triggers do not meet those conditions
and thus do too little to limit losses by
shutting down insolvent banks, Stern
and Feldman argue.
In addition to instituting more
robust PCA triggers, Stern and Feldman
would like to see a coinsurance system
instituted for deposits at large banks
that exceed the current FDIC insurance
limit of $100,000. The idea is fairly simple. “Under a coinsurance scheme, the
insured has to bear some of the loss
rather than have the insurer pick up 100
percent of it,” the authors argue. “For
example, the government could give
itself the right to provide coverage to
the uninsured under extraordinary circumstances up to a capped amount (say,
75 percent of their funds).”
Stern and Feldman consider some
possible objections to coinsurance, but
one topic they don’t address is the
potential problem caused by discount
window lending by the Federal Reserve,
an issue raised by former Richmond Fed
President Al Broaddus at the Chicago
Fed’s 2000 Annual Conference on
Bank Structure and Competition. Coinsurance and other attempts at reintroducing market discipline can be undermined if the Fed makes last-minute

loans to failing banks. In effect, the bank
passes on the loss to the Fed as uninsured creditors flee.
Also, coinsurance is not costless to
provide, since it involves more insurance
for large banks than they currently
receive. One could envision a number of
ways of funding such a system — for
instance, charging large banks an additional deposit insurance premium — but
the authors have little to say on the
issue. Certainly, should these ideas move
toward becoming policy, the allocation
of the costs of giving explicit special
treatment to large banks would need to
be considered.
Establishing Credibility
Throughout the book Stern and
Feldman make it clear that they regard
many of the FDICIA reforms as positive — though insufficient — steps
toward limiting the problems associated
with TBTF policies. Although FDICIA
substantially increased the likelihood
that uninsured depositors would suffer
losses when their bank fails, it also provided for a “systemic risk” exception.
This exception threatens the government’s ability to credibly commit to
closing troubled banks. Ending that
exception and taking a harder line could
help establish much-needed credibility.
But taking a hard line requires putting
your money where your mouth is — or
in this case, not putting up any money
when a bank goes down.
Getting creditors to believe that regulators will allow unsound banks to fail
will not happen overnight. Still, policymakers must find a way to “establish
credibility even when they face a history
of actions that undermine the goal.”
(Again, Stern and Feldman point to the
experience of Federal Reserve monetary
policy during the 1980s and 1990s as an
example of an institution earning credibility despite initial skepticism by
market participants. During that time,
the Fed established its commitment to
achieving price stability following a
relatively long period of high and
variable inflation during the 1970s.)
Putting the uninsured on notice by
establishing an easily monitored com-

mitment and then sticking to it would
help do the trick.
The optimal form of this commitment is not obvious to Stern and
Feldman, though they offer some ideas.
For instance, they suggest appointing
“conservative” bank regulators — “that
is, policymakers who have demonstrated
a predilection for giving serious consideration to the costs of TBTF bailouts
and an ability to reject bailouts where
appropriate.” This is similar to the
appointment of “inflation hawks”
within the Federal Reserve System —
people who took the issue of price
stability seriously and were willing to
take necessary, if unpopular, actions to
achieve that goal. In short, “personalities matter in establishing credibility,”
write Stern and Feldman.
The payoff from establishing credibility could be large. A “virtuous circle”
might arise in which banks would take
on fewer risks, presenting policymakers
with fewer opportunities to bail them
out. Outside of random shocks, the system converges to a situation where
bailouts are no longer expected.
Stern and Feldman have written a
book that is informed by the best basic
research available but which should also
be easily digestible by policymakers and
non-economists more generally. Indeed,
people particularly rushed for time
could profit from reading Chapters 1
and 14, which summarize the book’s
major points. But hopefully many will
take the time to read the entire book —
and to take seriously the proposals contained within. The subject may seem dry,
but it is important. The problems associated with too big to fail policies are
simply too large to ignore.
RF

Fa l l 2 0 0 4 • R e g i o n Fo c u s

39

District Economic
BY ROBERT LACY

Our monthly surveys
of District businesses
indicate that manufacturing shipments
and services firms’
revenues were moderately higher during
the second quarter.
Payroll employment
generally expanded
as well, with growth
particularly strong
in Virginia. Retail
trade remained a
soft spot, however,
and higher prices for
gasoline, steel, and
some building materials continued to
boost raw materials
costs for manufacturers and builders.

Did You Know. . .
Georgia may be
the Peach State but
neighboring South
Carolina often
produces more
peaches. Growers
in South Carolina
expect to harvest
140 million pounds
of peaches this year,
about 30 million
pounds above the
harvest expected
in Georgia. The two
states vie for secondplace honors in the
nation each year;
most peaches
consumed in the
United States are
grown in California.

Fifth District economic activity expanded at
a solid pace in the second quarter of 2004,
as services sector output picked up and employment gains mounted. Manufacturing shipments
and new orders continued to rise, and housing
activity remained strong despite an increase in
mortgage interest rates. And while prices for
some raw materials used in manufacturing and
construction moved higher, overall price inflation in the District was contained.

Manufacturing Expansion on Track
Growth in manufacturing activity slipped a
notch in the second quarter but remained
generally strong. Industry contacts said that
shipments and new orders rose at a solid pace
and told us they expected growth to continue
for the remainder of the year. In the words
of a plastics manufacturer in North Carolina,
“We are clearly seeing signs of an expanding
economy: longer lead time on raw materials;
raw material price increases; and decent,
though not great, new order activity.”
Higher steel, oil, and building materials
prices caused a spike in raw materials prices in
April. According to our monthly manufacturing
survey, total raw materials prices increased at
the strongest pace in several years. By June,
however, price increases had eased back to
about 2 percent.

Better Job Growth
Growth in payroll employment in the District
picked up in the second quarter of 2004. While
the pace slowed in May, when only 18,000 jobs
were added, it surged again in June with the
addition of 40,000 District jobs.
The services sector continued to lead
the way in job growth. Professional, business,
health, education, and financial services jobs
were substantially higher in most District states.
The District’s unemployment rate was 4.8
percent in the second quarter of 2004, down
from 5.5 percent a year earlier. Both Maryland
and Virginia had unemployment rates below 4.0
percent in June.

Housing Buoyant

Gray Skies

District housing markets remained upbeat
despite somewhat higher mortgage interest
rates in the second quarter. According to the
Federal Home Loan Mortgage Corporation,

It was a rainy summer in much of the region.
Washington, D.C., Richmond and Norfolk, Va.,
and Charlotte, N.C., received over 16 inches of
rain between June 1 and mid-August, about
three times the normal rainfall.
While South Carolina received less than
most areas farther north, the state received
enough rain to end the drought that prevailed
through the spring. The agricultural sector in
South Carolina received a boost from improved
soil conditions and, as of August, crops were
developing at or ahead of schedule. But excessive rain damaged crops in other areas of the
District. On the Eastern Shore of Virginia soybean fields were waterlogged, and corn stalks
were in danger of falling into the mud.

Peach Crop Production (Million Pounds)
200

South Carolina

Georgia

160
120
80
40
0
1997

40

average interest rates on 30-year fixed-rate
conventional mortgages rose from 5.5 percent
in March to 6.25 percent in June. With the
exception of Maryland, the number of building
permits issued in District states trended higher
during the period.
Real estate agents in particularly hot markets such as in Northern Virginia told us that
sales activity was so frenzied that some home
buyers were waiving inspections and appraisals
and offering to pay sellers’ closing costs. On
the construction side, home builders reported
shortages of wallboard, plywood, and insulation in some areas.

R e g i o n Fo c u s • Fa l l 2 0 0 4

1998

1999

2000

2001

2002

2003

Developments
Nonfarm Employment

Unemployment Rate

Personal Income

Second Quarter 2004

(Percent)

First Quarter 2004

DC
MD
NC
SC
VA
WV
5th District
US

Employment
(Thousands)
670
2,519
3,841
1,836
3,582
727
13,175
131,119

% Change
(Year Ago)
0.8
1.5
1.2
1.5
2.6
-0.1
1.6
1.0

2nd Qtr.
2004
7.3
3.9
5.4
6.5
3.5
5.3
4.8
5.6

DC
MD
NC
SC
VA
WV
5th District
US

2nd Qtr.
2003
7.1
4.5
6.5
6.8
4.1
6.3
5.5
6.1

Fifth District

DC
MD
NC
SC
VA
WV
5th District
US

Income
($ billions)
28.2
213.5
247.5
112.2
260.7
45.4
907.6
9,510.1

United States

Nonfarm Employment

Unemployment Rate

Personal Income

Change From Prior Year

First Quarter 1992 - Second Quarter 2004

Change From Prior Year

First Quarter 1992 - Second Quarter 2004

4%

8%

3%

7%

% Change
(Year Ago)
5.1
5.8
5.8
4.8
6.7
4.1
5.8
5.2

First Quarter 1992 - First Quarter 2004

9%
8%
7%

2%

6%

6%

5%

4%

1%

5%

0

3%

4%

-1%

2%

-2%
1992

1995

1998

2001

2004

3%

FRB—Richmond
Services Revenues Index

1992

1995

1998

2001

2004

1%

1995

1998

Housing Units Authorized

FRB—Richmond
Manufacturing Shipments Index

First Quarter 1994 - Second Quarter 2004

1992

(12-Month Average, in thousands)

First Quarter 1994 - Second Quarter 2004

40

40

8

30

30

7

20

20

10

10

0

0

-10

-10

2

-20

-20

1

2001

2004
MD
NC
SC

VA
WV

6
5
4

-30

3

0

-30
1994

1996

1998

2000

2002

2004

1994

1996

1998

2000

2002

2004

2002

2003

2004

NOTES:

SOURCES:

1) All data series are seasonally adjusted.
2) FRB-Richmond survey indexes are diffusion indexes. Positive numbers represent expansion, negative
numbers contraction.
3) State nonfarm employment estimates are based on surveys of establishments. These employment
figures differ from those used to calculate state unemployment rates.

Income: Bureau of Economic Analysis, U.S. Department of Commerce, http://www.bea.doc.gov
Unemployment rate: LAUS Program, Bureau of Labor Statistics, U.S. Department of Labor,
http://stats.bls.gov
Employment: CES Survey, Bureau of Labor Statistics, U.S. Department of Labor, http://stats.bls.gov

For more information, contact Robert Lacy at 804-697-8703 or e-mail Robert.Lacy@rich.frb.org.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

41

DISTRICT OF COLUMBIA

BY ANDREA HOLLAND

Supporting this theory, 2000 revenues from venturebacked businesses in the District of Columbia
contributed 2.4 percent toward gross state product,
and the number of workers equaled 10,850, or 1.7 percent of the total work force. Three years later,
revenues at these firms were up 33 percent (the fastest
growth rate districtwide), and job numbers had
expanded 16.5 percent in spite of the 2001 recession.
In contrast, aggregate employment in the District
of Columbia rose only 2.2 percent during the same
time period.
In light of the above findings, recent investment
activity has been discouraging. District of Columbia
businesses have struggled to attract capital this year,
and had raised only $12 million at the end of the
second quarter. By comparison, inflows had reached
$44.5 million by midyear 2003.
With only two investment deals recorded in the
second quarter, the District of Columbia ranked 26th
nationally by deal volume. The lion’s share of the
funding, $11.5 million, was awarded to a telecommunications firm, and the remaining $0.5 million was
granted to a software firm. By stage of financing, 96
percent of the capital was expansion funding for an
already up-and-running business, and the remaining
4 percent was listed as seed funding, which provides
new firms with the backing necessary for their initial
development. Geographically, the second-quarter
funding originated in California, the District of
Columbia, Illinois, and Maryland.

42

R e g i o n Fo c u s • Fa l l 2 0 0 4

Venture Capital Investment
80
MILLIONS OF DOLLARS

enture capital is an alternative source of funding
for fledgling companies that are oftentimes
perceived as more risky and lack the capital to
develop their own product. Investment of this type is
important because, if successful, it could boost the
number of cutting-edge companies, which in turn,
stimulates employment and wage growth in the
higher-paying knowledge sector. Furthermore, a
recent joint study by DRI-WEFA and Venture
Economics suggested that venture-backed companies
may be more immune to economic downturns than
are traditionally funded businesses.

V

60
40
20
0
01

02

03

04

1st Quarter 2001 - 2nd Quarter 2004

Shaded Area Represents Recession
NOTE: No bar represents a zero or close to zero value.
SOURCE: PricewaterhouseCoopers/Thompson Venture Economics/National Venture Capital Association MoneyTree Survey
TM

2nd Qtr
2004

Nonfarm Employment
Manufacturing
Professional/Business Services
Government
Civilian Labor Force

Unemployment Rate
Building Permits, NSA
Home Sales

Percent Change
at Annual Rate From
1st Qtr
2nd Qtr
2004
2003

670.4
2.5
144.5
230.8
300.7

0.3
5.5
1.9
0.8
-4.9

0.8
-3.8
3.0
-0.5
-0.8

2nd Qtr
2004

1st Qtr
2004

2nd Qtr
2003

7.3
760
17.9

6.5
153
16.5

7.1
539
14.9

NOTES:
Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics
Manufacturing, thousands of jobs, not seasonally adjusted (NSA); BLS/Haver Analytics
Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics
Government, thousands of jobs, SA; BLS/Haver Analytics
Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics
Unemployment Rate, percent, SA; BLS/Haver Analytics
Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics
Home Sales, thousands of units, SA; National Association of Realtors®

U

MARYL AND

BY ANDREA HOLLAND

nvestment by venture capitalists is a means of
turning a concept into a product for entrepreneurs
without the needed startup capital. Venture funding
accounts for a modest share of Maryland’s financial
market; its major importance lies in the nurturing of
future businesses, which if viable, could translate into
better employment opportunities. In addition, a recent
study by DRI-WEFA and Venture Economics suggested that the presence of venture-backed firms could
have a stabilizing effect on a state’s economy because
employment at venture-backed businesses appeared to
be less susceptible to recessionary periods.

I

Venture Capital Investment

MILLIONS OF DOLLARS

500
400
300
200
100
0

01

02

03

04

1st Quarter 2001 - 2nd Quarter 2004

Shaded Area Represents Recession
SOURCE: PricewaterhouseCoopers/Thompson Venture Economics/National Venture Capital Association MoneyTree Survey
TM

2nd Qtr
2004

Nonfarm Employment
Manufacturing
Professional/Business Services
Government
Civilian Labor Force

Unemployment Rate
Building Permits, NSA
Home Sales

2,518.8
145.4
372.1
461.5
2,948.2

Percent Change
at Annual Rate From
1st Qtr 2nd Qtr
2004
2003

4.4
1.8
12.3
1.0
1.0

1.5
-2.2
2.8
-0.4
1.5

2nd Qtr
2004

1st Qtr
2004

2nd Qtr
2003

3.9
7,636
146.0

4.1
5,875
141.5

4.5
8,849
124.0

NOTES:
Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics
Manufacturing, thousands of jobs, SA; BLS/Haver Analytics
Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics
Government, thousands of jobs, SA; BLS/Haver Analytics
Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics
Unemployment Rate, percent, SA; BLS/Haver Analytics
Building Permits, number of permits, not seasonally adjusted (NSA); U.S. Census Bureau/Haver Analytics
Home Sales, thousands of units, SA; National Association of Realtors®

To illustrate this point, employment at venturebacked firms grew from 95,000 to 104,300 from 2000
to 2003 — an increase of nearly 10 percent. By comparison, total payroll growth in Maryland measured
only 1.3 percent. Revenues also forged ahead; venturebacked firms recorded a 21.8 percent rise during the
same time frame.
Realizing more fully the long-term benefits of venture
capital investment, the most recent readings have been
particularly heartening. According to data from the
MoneyTree survey of venture capital spending, midyear
capital inflows to Maryland firms in 2004 outpaced
activity recorded in the first two quarters of last year.
Second-quarter disbursements into Maryland businesses totaled $39.8 million, and with 20 deals on
the books, the state ranked 8th nationally by deal
volume. Within the state, Montgomery, Anne
Arundel, and Baltimore City attracted the most capital. Montgomery County alone recorded eight deals,
ranking 20th nationwide. By business type, software
firms garnered the majority of the funding, with nine
deals totaling $25.8 million. Close behind was the
biotechnology industry, which captured five deals in
the amount of $10.5 million.
By stage of investment, 60 percent of the businesses
that received capital were classified as seed, startup,
or early stage — firms which have not yet fully established operations. This is encouraging, as an increase in
new deals could suggest increased investor confidence.
The remaining 40 percent of the businesses were in the
expansion and later stages — additional funding which
is usually used to solidify a firm’s current standing.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

43

hN O R T H

CAROLINA

BY ANDREA HOLLAND

To highlight this point, venture-backed businesses
in North Carolina employed 165,500 persons in 2000,
or 4.2 percent of the total work force. Over the next
three years, job numbers at these firms expanded
2.7 percent despite the 2001 recession. In contrast,
aggregate employment in North Carolina contracted
3.3 percent during the same time period, marking the
greatest loss districtwide.
Armed with this knowledge, the most recent reports
from North Carolina’s venture market have been somewhat uninspiring. Firms have had to look hard and long
to secure available capital this year despite a recovering
economy. Compared to total capital captured
by midyear 2003, investors have injected substantially
less into North Carolina businesses during the first two
quarters of 2004.
Second-quarter capital inflows into North Carolina
totaled $81.8 million. By volume, deals totaled 11 in
the second quarter, placing North Carolina 18th
nationwide. The counties pulling in the largest
number of deals were Durham (ranked 24th nationally),
Wake, and Guilford. The health-care services industry
courted the most cash, with one deal totaling $55 million. Telecommunications firms came in second, with
three deals garnering $9.5 million.
By stage of funding, second-quarter investment into
seed companies — businesses that have no viable product and are still working on concept development —
was zero in North Carolina, suggesting that potential
investors remain hesitant. The majority of the funding,
84 percent, instead went to firms in the expansion and
later stages.

44

R e g i o n Fo c u s • Fa l l 2 0 0 4

Venture Capital Investment
250
MILLIONS OF DOLLARS

private donation made to a promising business
with many prospects but no capital is known as a
venture capital investment. The aggregate level of investment injected into a state is critical, but
just as important are the possible downstream effects
on the economy such as the creation of higher-paying
jobs. According to a recent study by DRI-WEFA and
Venture Economics, a solid knowledge-skilled employment base in historically goods-producing states such
as North Carolina could help soften payroll losses
during periods such as the 2001 recession.

A

200
150
100
50
0
01

02

03

04

1st Quarter 2001 - 2nd Quarter 2004

Shaded Area Represents Recession
SOURCE: PricewaterhouseCoopers/Thompson Venture Economics/National Venture Capital Association MoneyTree Survey
TM

2nd Qtr
2004

Nonfarm Employment
Manufacturing
Professional/Business Services
Government
Civilian Labor Force

Unemployment Rate
Building Permits, NSA
Home Sales

Percent Change
at Annual Rate From
1st Qtr
2nd Qtr
2004
2003

3,841.0
583.4
441.2
654.8
4,199.9

3.6
-2.5
17.4
3.4
0.2

1.2
-4.5
5.2
2.4
-0.6

2nd Qtr
2004

1st Qtr
2004

2nd Qtr
2003

5.4
24,664
337.4

5.7
22,329
281.7

6.5
20,776
270.3

NOTES:
Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics
Manufacturing, thousands of jobs, SA; BLS/Haver Analytics
Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics
Government, thousands of jobs, SA; BLS/Haver Analytics
Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics
Unemployment Rate, percent, SA; BLS/Haver Analytics
Building Permits, number of permits, not seasonally adjusted (NSA); U.S. Census Bureau/Haver Analytics
Home Sales, thousands of units, SA; National Association of Realtors®

SOUTH CAROLINA

o

BY ANDREA HOLLAND

n return for investing in higher-risk, private
companies that lack the capital to develop and market
their own product, venture capitalists typically expect
greater-than-average returns in the future. Investors,
however, aren’t the only ones who could potentially win.
The existence of a strong venture capital industry
could result in significant benefits for the economy,
particularly in light of South Carolina’s historically
strong ties to the goods-producing sector.

I

Venture Capital Investment

MILLIONS OF DOLLARS

14
12
10
8

According to a recent, joint study released by DRIWEFA and Venture Economics, successful venturebacked companies generally expand faster and create
more jobs than businesses in other sectors. If this holds
true, the maturation of venture-backed companies in
South Carolina could help promote a higher-paid and
higher-skilled work force.

6
4
2
0

01

02

03

04

1st Quarter 2001 - 2nd Quarter 2004

Shaded Area Represents Recession
NOTE: No bar represents a zero or close to zero value.
SOURCE: PricewaterhouseCoopers/Thompson Venture Economics/National Venture Capital Association MoneyTree Survey
TM

2nd Qtr
2004

Nonfarm Employment
Manufacturing, NSA
Professional/Business Services, NSA
Government
Civilian Labor Force

Unemployment Rate
Building Permits, NSA
Home Sales

1,836.0
271.2
191.9
330.4
2,055.3

Percent Change
at Annual Rate From
1st Qtr
2nd Qtr
2004
2003

2.7
1.6
18.0
-0.7
2.5

1.5
-2.6
2.2
1.0
2.8

2nd Qtr
2004

1st Qtr
2004

2nd Qtr
2003

6.5
11,249
165.5

6.4
9,474
152.1

6.8
9,471
134.0

NOTES:
Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics
Manufacturing, thousands of jobs, not seasonally adjusted (NSA); BLS/Haver Analytics
Professional/Business Services, thousands of jobs, NSA; BLS/Haver Analytics
Government, thousands of jobs, SA; BLS/Haver Analytics
Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics
Unemployment Rate, percent, SA; BLS/Haver Analytics
Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics
Home Sales, thousands of units, SA; National Association of Realtors®

In addition to accelerating job growth, the DRIWEFA and Venture Economics report also suggested
that the existence of venture-backed firms could result
in fewer payroll losses during future recessionary periods as knowledge-based jobs were more recession
proof than labor-intensive jobs. Employment data
from South Carolina seem to back up these findings —
venture-backed companies do appear hardier.
Notwithstanding the 2001 recession, venture-backed
employment in South Carolina contracted only 0.7
percent (the only decline districtwide) from 2000 to
2003. In contrast, aggregate employment in South
Carolina fell 2.6 percent during the same time period.
In light of the above findings, the most recent reports
rolling in from South Carolina’s venture capital
market were disappointing: The state continues to
trail behind all other Fifth District jurisdictions when
it comes to attracting capital. Further, inflows into
South Carolina businesses have grown increasingly
sporadic since the end of the 2001 recession. For
example, investment deals were recorded in only three
quarters out of the year in 2002. By 2003, that number
had dropped to two quarters. The most recent data
from 2004 have been no more encouraging: State
businesses received zero funding in the second quarter, down from a modest $0.3 million deal recorded in
the first quarter of this year.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

45

uVIRGINIA
BY ANDREA HOLLAND

To illustrate this point, employment at venturebacked firms in Virginia grew from 310,200 to 333,200
from 2000 to 2003 — an increase of nearly 7.4 percent,
even with the backdrop of a recession. By comparison,
total payrolls in Virginia contracted 0.5 percent over
the same time period.

Venture Capital Investment
400
MILLIONS OF DOLLARS

enture capital investment is the private funding
of early stage, high-risk businesses that are lacking
their own capital. In addition to playing a vital role
in the nurturing of new companies, the venture capital
industry also promotes innovation, economic growth,
and better employment opportunities. Also, a recent
study DRI-WEFA and Venture Economics suggests
that employment at venture-backed companies appears
to be less susceptible to fluctuations in the business
cycle, and as such, the existence of venture-backed firms
in a state economy could have a stabilizing effect during
recessionary periods.

V

300
200
100
0
01

02

03

04

1st Quarter 2001 - 2nd Quarter 2004

Shaded Area Represents Recession
SOURCE: PricewaterhouseCoopers/Thompson Venture Economics/National Venture Capital Association MoneyTree Survey
TM

Realizing more fully the long-term benefits of venture
capital investment, recent reports on activity have
been auspicious. Virginia has maintained a vibrant
venture capital report in recent years, despite the fact
that disbursements in the first and second quarters of
2004 came in a bit under those recorded during the
same time frame last year.
Second-quarter capital inflows into Virginia businesses totaled $80.1 million, and deal volume numbered 19, consigning the state to 9th place nationwide.
Within Virginia, localities receiving the most money
were Fairfax (ranked 19th nationally), Alexandria, and
Arlington. By business sector, the software industry
attracted the most deals and venture funds totaled
$26.4 million. Telecommunications businesses were
the second most appealing to investors, capturing
three deals and $2.6 million in the second quarter.
By stage of investment, 58 percent of the businesses
receiving capital were classified as seed, startup, or
early stage — firms that have not yet fully established
operations. The preference to support fledging firms
is encouraging, as an increase in deals on riskier
projects could suggest a rise in investor confidence.
The remaining 43 percent of the businesses were
either expansion or later stage; in these cases funding
is typically used to further develop the operations of
an up-and-running enterprise.

46

R e g i o n Fo c u s • Fa l l 2 0 0 4

2nd Qtr
2004

Nonfarm Employment
Manufacturing
Professional/Business Services
Government
Civilian Labor Force

Unemployment Rate
Building Permits, NSA
Home Sales

3,582.1
297.3
574.5
647.7
3,844.3

Percent Change
at Annual Rate From
1st Qtr
2nd Qtr
2004
2003

2.9
2.2
4.6
2.3
1.1

2.6
-3.3
5.4
1.7
2.0

2nd Qtr
2004

1st Qtr
2004

2nd Qtr
2003

3.5
17,237
200.4

3.5
14,931
174.8

4.1
15,801
171.0

NOTES:
Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics
Manufacturing, thousands of jobs, SA; BLS/Haver Analytics
Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics
Government, thousands of jobs, SA; BLS/Haver Analytics
Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics
Unemployment Rate, percent, SA; BLS/Haver Analytics
Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics
Home Sales, thousands of units, SA; National Association of Realtors®

WEST VIRGINIA

w

BY ANDREA HOLLAND

enture capital is funding supplied by private
investors to high-risk businesses that are unable
to obtain financing through more conventional methods. The existence of a strong venture capital industry could result in significant benefits for a state economy, particularly those with historically strong ties to
the goods-producing sector, such as West Virginia.
According to a report released by DRI-WEFA and
Venture Economics, successful venture-backed companies generally expand faster and create more jobs
than traditionally funded businesses. If this holds
true, the maturation of venture-backed companies
could help foster a higher-paid, higher-skilled work
force in West Virginia.

V

Venture Capital Investment

MILLIONS OF DOLLARS

14
12
10
8
6
4
2
0

01

02

03

04

1st Quarter 2001 - 2nd Quarter 2004

Shaded Area Represents Recession
NOTE: No bar represents a zero or close to zero value.
SOURCE: PricewaterhouseCoopers/Thompson Venture Economics/National Venture Capital Association MoneyTree Survey
TM

2nd Qtr
2004

Nonfarm Employment
Manufacturing
Professional/Business Services
Government
Civilian Labor Force

Unemployment Rate
Building Permits, NSA
Home Sales

Percent Change
at Annual Rate From
1st Qtr
2nd Qtr
2004
2003

727.1
69.4
56.9
141.0
796.9

2.4
-2.9
0.7
-3.2
0.1

-0.1
-1.4
1.4
-1.6
0.9

2nd Qtr
2004

1st Qtr
2004

2nd Qtr
2003

5.3
1,544
31.6

5.4
1,255
31.8

6.3
1,315
25.8

NOTES:
Nonfarm Employment, thousands of jobs, seasonally adjusted (SA); Bureau of Labor Statistics (BLS)/Haver Analytics
Manufacturing, thousands of jobs, SA; BLS/Haver Analytics
Professional/Business Services, thousands of jobs, SA; BLS/Haver Analytics
Government, thousands of jobs, SA; BLS/Haver Analytics
Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics
Unemployment Rate, percent, SA; BLS/Haver Analytics
Building Permits, number of permits, not seasonally adjusted (NSA); U.S. Census Bureau/Haver Analytics
Home Sales, thousands of units, SA; National Association of Realtors®

The DRI-WEFA and Venture Economics study also
suggested that the presence of venture-backed firms
could result in shallower employment losses in future
business cycle downturns. Data show that knowledgebased jobs at venture-backed firms are more recession
proof than West Virginia’s more traditional laborintensive jobs. Illustrating this, venture-backed
employment in West Virginia grew 18.4 percent (the
fastest growth rate districtwide) from 2000 to 2003,
despite the 2001 recession. In contrast, aggregate
employment in West Virginia contracted 1.4 percent
during the same time period.
In light of these findings, recent reports on capital
inflows have been generally upbeat. Though not traditionally thought of as a repository for venture capital,
investments into West Virginia’s capital market have,
with the exception of the last three quarters, steadily
risen since the end of the 2001 recession. In line with
higher inflows, revenues from venture-backed companies grew 27.9 percent from 2000 to 2003, marking the
third fastest growth rate districtwide.
West Virginia businesses raised $0.5 million from
April through June 2004. The second-quarter deal
apportioned expansion funding into a software business in Berkeley County — expansion and later stage
funding is usually used to solidify the current standing
of an already operating business. With only one deal
in the second quarter, West Virginia ranked 33rd in
terms of deal volume nationwide.

For more information regarding state summaries, call 804-697-8273 or
e-mail Andrea.Holland@rich.frb.org.

Fa l l 2 0 0 4 • R e g i o n Fo c u s

47

OPINION
The Paradox of Voting
BY A A RO N ST E E L M A N

T

So to fully understand why people vote requires us to
his fall, more than 100 million Americans will vote
move beyond economics and into the realm of social
in the presidential election. To many observers, this
psychology. Most people have a natural desire to be part of
number is appallingly low. The fact that only
a group. They want to know that others share their basic
50 percent or so of eligible voters will show up at the polls
views and sentiments. Voting allows them to do this.
is surely bad for democracy, they argue. But to many econAt the very minimum, by casting your vote for a majoromists, the number is surprisingly high. In fact, given the
party candidate, you will know that millions of others
rational-choice models that most economists employ,
made the same choice as you. And for many people the
it’s hard to understand why any individual voter would
experience of voting will involve much more. Prior to
cast a ballot.
going to the polls, they may attend rallies for their preAccording to the rational-choice perspective, a potential
ferred candidate or enter into discussions with other likely
voter should make the following calculation. Multiply the
voters. They will get some benefit from this interaction,
benefits (B) he would receive if his preferred candidate were
and may even gain some friends. Voting, then, can be seen
to win the election by the probability (P) that he would cast
as a social act.
the deciding vote. If that figure exceeds the costs (C) he
This process may be even more important for people who
incurs — the time it takes to register to vote and go to the
vote for minor-party candidates. Such candidates often
polling place, as well as the effort required to become well
hold views well outside the mainstream of American politics.
enough acquainted with the candidates’ positions to cast an
The people who support those candiinformed vote — then voting is rational.
dates, then, probably have fewer
The voter gets more out of the act
chances each day to interact with likethan he puts in.
“Given the rationalminded people. A presidential election
The problem is, C is almost always
allows them to meet people with similarger than B x P. “The standard
choice models that
lar views — and to know that they are
conclusion that is reached from the
not alone.
application of such a model is that in
most economists
Voting might also be seen as a
an election with a large number of
cheap
insurance policy. Although
voters the rational citizen decides not
employ, it’s hard
the chances that your vote might
to vote,” writes André Blais of the
actually tip the balance of an elecUniversity of Montreal in his book
to understand why
tion are virtually zero, the regret you
To Vote or Not to Vote? The Merits and
would feel if the race ended in
Limits of Rational Choice Theory. “The
anyone would cast
a tie might be very great. You could
cost of voting is small, but the
insure yourself against this unlikely
expected benefit is bound to be
a ballot.”
— though quite expensive — possismaller for just about everyone
bility simply by going to the polls.
because of the tiny probability of castWhat does this all mean? Well, one
ing a decisive vote.”
could come away with a number of lessons. My take is:
Does this mean that rational-choice models of electoral
Go ahead and vote if doing so will bring you satisfaction.
participation should be abandoned entirely? And, if so, what
But don’t let some busybody tell you that voting is your
should we use instead?
moral duty.
It seems clear that rational-choice theory doesn’t fully
Most of us agree that people have an obligation to help
explain why people vote. But that doesn’t mean that it is
others. But it’s hard to understand how any action that
without merit. Rational-choice models predict that people
neither benefits nor harms other people could be conwill vote in higher numbers when the stakes are high and/or
strued as immoral. And make no mistake about it, your
the election is close. Both, in fact, are true. Turnout increases
vote almost certainly will not affect the well-being of
when voters’ B and P values increase.
others. It will add only one more number to an already
Still, even when the election is both important and close,
enormous tally. If you want to do something constructive,
the chance of any single voter actually influencing the outcome
consider spending the hour you would take voting to do
remains tiny. Consider the 2000 presidential election. This
volunteer work or visit friends and family. The payoff
was probably the tightest election that most people will ever
almost certainly will be higher.
RF
witness — yet no single vote came close to proving pivotal.

48

R e g i o n Fo c u s • Fa l l 2 0 0 4

NEXTISSUE
The Evolving Banking Industry
In the late 1990s, during the middle of the tech boom,
many predicted that conventional banking practices were
on the decline. People would conduct more and more
transactions online, and rarely if ever set foot in actual
brick-and-mortar banks. That prediction was partially
correct. Online banking has grown over the last
five years — but it has not revolutionized the industry.
In fact, banks are opening branches at a brisk pace
and enhancing their physical presence throughout
their market areas. What’s happening in the retail banking
industry — and why?

Equine Economics
Kentucky may be the “horse capital of the world,” but
the horse industry has left hoof prints throughout the
Fifth District as well. Maryland and Virginia are home to
important races, breeding farms, and equestrian centers.
And the Carolinas and West Virginia boast significant horse
populations of their own. We’ll take a look inside this
unique industry.

Interview
A conversation with economist Frank Sloan,
director of Duke University’s Center for
Health Policy, Law, and Management.
Research Spotlight
Is good journalism also good business? An
analysis of America’s newspaper industry.
Federal Reserve
Many within the Federal Reserve System
and the economics profession more generally have argued that the Fed should adopt
an “inflation targeting” system. How would
such a system work — and what are the
possible benefits as well as downsides?

Port Development
Competition is intense among ports along the Eastern
seaboard, with each vying for additional cargo volume.
Some ports, such as Charleston, S.C., argue that physical
expansion is necessary to accommodate ever-larger ships.
But many of these waterfront areas are also popular spots
for residential and commercial development. How can
cities most effectively reconcile the interests of these
important, yet quite different, sectors?

Visit us online:
www.rich.frb.org/pubs/regionfocus

• To view each issue’s articles
ACC Expansion
The Atlantic Coast Conference used to have seven member
schools and was based entirely within the Fifth District.
But over time the conference has expanded and is
welcoming two new members, Miami and Virginia Tech,
this year and yet another, Boston College, in 2005.
The current round of expansion will bring the total
number of members to 12. The ACC is not alone. Other
conferences have expanded recently as well, picking
off the most attractive schools from rival conferences.
What are the economic forces behind the consolidation
of college athletic conferences?

• To add your name to our
mailing list
• To request an e-mail alert
of our online issue posting
The Winter 2005 Issue will be
published in January.

Trends & Outlooks
Highlighting Business Ac tivity in the Fifth Distric t

or over a decade, the Richmond Fed has conducted monthly surveys of manufacturing, retail and
services firms in the Fifth District on their current levels of business and outlook for near-term future
activity. Over that period, respondents’ assessments have proven to be an accurate gauge of economic
conditions in the Mid-Atlantic region.

F

Manufacturing Surveys
The Manufacturing Survey receives responses from
approximately 100 businesses whose type, size and
location match the profile of overall manufacturing
in the District. Respondents provide information on
current activity, including shipments, new orders, order
backlogs, and inventories. Manufacturers also supply
information on employment conditions, prices, and their
expectations of business activity for the next six months.

Manufacturing Shipments Index
50.0
40.0
30.0
20.0
10.0
0.0
-10.0
-20.0

Service-Sector Surveys
Representative retailers and services firms are also polled
each month with about 100 responses. Retailers provide
information on sales revenues, big-ticket sales, inventories,
and shopper traffic. Contacts at services firms report on
their revenues. Both sets of respondents also provide
information on employment and wages at their firms as
well as information on prices and their anticipated
demand for the coming six months.

-30.0
1996

1997

1998

1999

2000

Seasonally adjusted

2001

2002

2003

2004

3-month moving average

Service Revenues Index
2
1.8
1.6
1.4
1.2
1
0.8

In both surveys, respondents indicate whether measures
of activity rose, remained unchanged or decreased. Their
responses are converted into diffusion indexes by
subtracting the percentage of reported decreases from
the percentage of increases.

0.6
0.4
0.2
0
2002

2003

Overall Services

2004

Retail

Interested in an update on District Manufacturing and Service-Sector conditions?
Check out the Regional Economic Surveys by the Richmond Fed today!
www.rich.frb.org/research/regional/surveys/
Federal Reserve Bank
of Richmond
P.O. Box 27622
Richmond, VA 23261

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