Full text of Econ Focus (Federal Reserve Bank of Richmond) : Second/Third Quarter 2012, Volume 16, Number 2/3

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

SECOND/THIRD QUARTER 2012

THE

Winners and Losers
from Fed Policy

Cities Built
from Scratch

FEDERAL

RESERVE

BANK

OF

RICHMOND

Interview with
John A. List

VOLUME 16
NUMBER 2/3
SECOND/ THIRD QUARTER 2012

COVER STORY
12

Where Have All the Workers Gone? Why are more people
leaving the labor force, and what are they doing?

FEATURES

Region Focus is the
economics magazine of the
Federal Reserve Bank of
Richmond. It covers economic
issues affecting the Fifth Federal
Reserve District and
the nation and is published
on a quarterly basis by the
Bank’s Research Department.
The Fifth District consists of the
District of Columbia,
Maryland, North Carolina,
South Carolina, Virginia,
and most of West Virginia.

17

Pulling Up Stakes: Americans are moving less, and it’s not clear
why — but housing is not the whole story

DIRECTOR OF RESEARCH

John A. Weinberg
EDITOR

20

Aaron Steelman
SENIOR EDITOR

Testing Charter Cities: New cities with better rules might
accelerate economic growth in developing nations

David A. Price
MANAGING EDITOR

Kathy Constant

24

STA F F W R I T E R S

Renee Haltom
Betty Joyce Nash
Jessie Romero

The Sharp Rise in Disability Claims: Are federal disability
benefits becoming a general safety net?

E D I TO R I A L A S S O C I AT E

27

Tim Sablik
CONTRIBUTORS

The Once and Future Fuel: Shale gas promises to bring cheap
energy, but the locals are divided

DEPARTMENTS

Jake Blakewood
Charles Gerena
Ann Macheras
John Merline
Karl Rhodes
Seth Rubinstein
Sonya Ravindranath Waddell
DESIGN

1 President’s Message/The Importance of Bankers
on the Richmond Fed’s Board
2 Upfront/Regional News at a Glance
6 Federal Reserve/Winners and Losers from Monetary Policy
10 Jargon Alert/Balance of Trade
1 1 Research Spotlight/Are New Graduates Left Behind in a Recession?
31 Policy Update/When Do Acquisitions Endanger the Financial System?
32 Interview/John A. List
39 Economic History/The Voyage to Containerization
43 Book Review/The New Geography of Jobs
44 District Digest/Economic Trends Across the Region
52 Opinion/Economics, Uncertainty, and the Environment

ShazDesign
Published quarterly by
the Federal Reserve Bank
of Richmond
P.O. Box 27622
Richmond, VA 23261
www.richmondfed.org
www.twitter.com/RichFedResearch

Subscriptions and additional
copies: Available free of
charge through our website at
www.richmondfed.org/publications
or by calling Research
Publications at (800) 322-0565.
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

PHOTOGRAPHY: AMY DEVOOGD/PHOTODISC/GETTY IMAGES

PRESIDENT’S MESSAGE
The Importance of Bankers on the Richmond Fed’s Board
ike many organizations, the Richmond Fed has a
board of directors. Actually, we have three: one
for the Bank as a whole and one for each of our
branch offices in Baltimore and Charlotte. Historically,
the directors of those boards have come from a wide range
of backgrounds, including businesses representing sectors
across the economy, nonprofit groups, labor organizations,
and academia. Among the directors on our Bank-wide
board, almost invariably, are three chief executives of Fifth
District banks. Why do we, an institution responsible for
regulating banks, have bankers on our board?
This question has both a short answer and a somewhat
longer answer. The short answer is that federal law dictates
that six board members of every Federal Reserve Bank
are elected by its member banks. Of these six, three are
commonly bankers, while three must be non-bankers. These
directors are known as “class A” and “class B” directors,
respectively. For voting purposes, the banks in the District
are classified according to their amount of capital into categories of small, medium, and large; banks in each category
elect one class A director and one class B director. The other
three directors, known as “class C,” are appointed by the
Fed’s Board of Governors. (Still another set of legal rules
determines the selection of the boards of directors for our
Baltimore and Charlotte branches.)
But why does the law provide for bankers potentially to
make up a third of a Federal Reserve Bank’s board? That’s
where the longer answer comes in.
Directors play two roles in the life of a Federal Reserve
Bank. First, the board carries out the classic corporate
governance function, overseeing the Bank’s operations,
budgets, and strategic direction. It manages the Bank’s
internal audit program. It appoints the Bank’s president and
first vice president, subject to the approval of the Board of
Governors. For these roles, because some of our operations
(particularly in the payments area) resemble the operations
of private-sector banks, directors from the banking sector
bring helpful and unique expertise to our board.
Second, the directors of a Federal Reserve Bank assist
the Bank in its function of funneling economic information
about the region into national policymaking. At the
Richmond Fed, the observations of our directors, together
with data from our Research Department’s detailed
surveys of business activity, provide us with a snapshot of
the economic conditions in the diverse communities
around our District. Like other Federal Reserve Bank
presidents, I use this information in combination with
research on important policy issues affecting the macroeconomy to inform the perspectives that I bring to meetings
of the Federal Open Market Committee. All of our directors
— from the banking, non-banking, and nonprofit sectors —

L

provide valuable and complementary points of view in this
regard. Yet if I were to go to a
midsized city in our District
and look for an individual who
knows as much as possible
about the area’s economy,
there’s a good chance that
person would be a banker,
since bankers tend to have
exposure to a diverse range of
economic sectors.
How, then, do we avoid the conflicts of interest that
could occur from having leaders of regulated companies on
our board? Our governance structure is carefully designed to
involve board members only in functions in which it is
appropriate for them to be involved. Class A directors — the
category that may include bankers — do not participate in
the appointment of the Bank’s president and first vice
president, or in the appointment or compensation of any
Bank officers whose primary duties involve bank supervision. No board members take part in making supervisory
policy, which is determined by the Fed’s Board of Governors.
Nor are board members permitted to become involved
in the consideration of any supervisory matters or to
receive confidential information about supervisory matters.
These federal laws are, of course, treated seriously by all
of us — Federal Reserve Bank leaders, directors, and supervisory staff.
In my experience, the rules laid down by Congress on the
composition of Federal Reserve Bank boards and their
powers have benefited the public by bringing the views of
longtime bankers to the boards’ deliberations, while ensuring that supervisory actions such as bank examination
ratings and assessments of applications are free of improper
influence. And we at the Richmond Fed are mindful that
the integrity of our processes — both in reputation and in
reality — is essential to protecting the stability of and the
public’s confidence in the U.S. financial system.
RF

JEFFREY M. LACKER
PRESIDENT
FEDERAL RESERVE BANK OF RICHMOND

Region Focus | Second/Third Quarter | 2012

1

UPFRONT

Regional News at a Glance

Power Partners

Post-Merger, Duke Faces More Scrutiny
It’s official: The nation’s biggest utility is now based in Charlotte, N.C. Duke Energy Corp.
absorbed Progress Energy Inc. of Raleigh in July.
The enlarged Duke will serve 7.1 million electricity
customers — 3.2 million in North Carolina, the rest in
South Carolina, Florida, Indiana, Kentucky, and Ohio.
In North Carolina, Duke’s rates are currently lower
than Progress’ rates, so, for now, Duke Energy Carolinas
and Progress Energy Carolinas will operate as separate
subsidiaries. “Once they integrate, take care of cost
cutting, and eliminate redundancies, and once Duke
Carolinas and Duke Progress Energy rates are on par
with each other, they’ll merge,” says utilities lawyer
Chris Ayers of Poynter Spruill, a Raleigh law firm.
Retail electricity rates in North Carolina are
regulated by the North Carolina Utilities Commission
(NCUC), and determined by firm investments and
operating expenses, among other factors. The merger
puts the regulated share of Duke’s businesses at
85 percent, up from 75 percent.
Cost savings from combined generating systems will
lower fuel and borrowing costs, and are expected to save
customers an estimated $650 million over five years.
Despite the touted cost savings, and falling coal and

Duke-Progress Service

The enlarged Duke Energy
will serve 7.1 million
electricity customers.
SOURCE: Duke Energy

2

Region Focus | Second/Third Quarter | 2012

natural gas prices, Duke wants rate increases later this
year to cope with costs of plant upgrades and replacements and stricter environmental rules. The NCUC
approved a 7.2 percent hike earlier this year.
Electric utilities’ costs may be rising, but demand
growth has been fairly flat, rising 0.7 percent annually
from 2000 to 2010, according to the U.S. Energy
Information Administration. Projections call for
rebounding but still slow demand growth because of
higher energy prices and conservation.
Duke and Progress had to modify merger plans to
assure the Federal Energy Regulatory Commission
(FERC), which regulates wholesale generation, that
competition would not be diminished in North
Carolina. The approved plan includes seven new transmission lines designed to create more competitive
wholesale markets. This allows outside providers to sell
in North Carolina, according to Duke spokesman Dave
Scanzoni. Construction costs are estimated at $110 million over two to three years. Until then, Duke will sell
electricity to new market participants through purchase
agreements with energy trading companies.
A number of cities in eastern North Carolina
opposed the merger because they buy power wholesale
and sell it to their customers. They worry about Duke’s
market power. Their opposition was rooted in the 1970s
decision to help finance two nuclear plants for Progress’
predecessor company, Carolina Power & Light. This
bought them a minority stake in the plants to help meet
expected power demand at a time when wholesale
electricity rates and interest rates were rising. But
cost overruns, especially at the Shearon Harris nuclear
plant, combined with high debt service, haunt their
customers’ electricity rates today. Those customers pay
an average of $136 per month compared to the $104
average that Progress Energy residential customers pay.
The cities buy additional power under a long-term contract from Progress, and so competition really matters.
“Their [the cities’] view was you’ve cut competition in
half,” Ayers says.
The City of New Bern and the City of Rocky Mount
have asked the FERC to re-hear the merger case. “Our
ability to compete for lower cost electricity will be

smaller with the merger,” says New Bern Mayor Lee Bettis.
The cities’ Washington, D.C., attorney, John Coyle, says
the FERC underestimated Duke’s dominance. “What our
complaint is about is how you measure the increase in
market concentration due to the merger,” he says. “The
FERC understated market concentration and therefore
understated what the company had to do to fix it.”
Duke contends that the new transmission lines will
bring competition from outside sellers.
The acquisition also brought controversy over a
leadership switch. Former Progress Energy chief executive

Bill Johnson was slated to head the new Duke Energy.
However, Duke’s former chief executive Jim Rogers
replaced Johnson shortly into the first post-merger board
meeting. NCUC chairman Edward Finley stated at a
July 10 hearing that the commission is investigating why
the leadership changed “within hours of the close of the
transaction and what ramifications or repercussions might
result from these unexpected and unanticipated events.”
Duke Energy Corp.’s lead director Ann Gray testified in
the hearing that the company’s board acted appropriately.
— BETTY JOYCE NASH

Technology Transfer

D.C. and Baltimore Areas Vie with Silicon Valley in Tech Jobs
ecently Forbes ranked the Washington, D.C., and
Baltimore, Md., metro areas ahead of Silicon Valley
on its annual list of best cities for technology jobs.
The Washington-Arlington-Alexandria Metropolitan Statistical Area, which covers Washington, D.C., Northern
Virginia, suburban Maryland, and part of the Eastern
Panhandle of West Virginia, ranked second, and the
Baltimore-Towson area placed fifth, according to the
report published in May. The San Jose, Cal., metro area,
which includes Silicon Valley, finished seventh.
Forbes judged metros by growth in science, technology,
engineering, and mathematics occupations (STEM),
as well as technology industry growth and occupation
concentration. Both the Washington and Baltimore areas
logged an average of 4 percent tech sector growth over the
past two years, while Silicon Valley ended 2011 with
170,000 fewer tech employees than in 2000. The report
credited the “broadness of the tech economy in the greater
D.C. area” as a key to its growth.
“The Washington tech complex boasts substantial
employment in such fields as computer systems design,
custom programming and private-sector research and
development,” Forbes noted.
The region has also drawn strength from public
research and development institutions, such as those in
life sciences and national defense. The Baltimore area is
home to labs such as the National Cancer Institute in
Bethesda, Md., as well as premier life sciences research
schools like The Johns Hopkins University. The
Department of Defense’s IT and communications support
unit, the Defense Information Systems Agency, moved
from Virginia to Fort Meade, about 15 miles south of

R

Baltimore, last year, bringing demand for more cyber
security employees.
“A lot of the core competencies of the region definitely
come from federal influence, but I think that this new
rejuvenation is being driven more by the private sector
than the public sector,” says Robert Rosenbaum, president
and executive director of the Maryland Technology
Development Corporation (TEDCO), a nonprofit that
receives state funds to support growth and entrepreneurship in Maryland’s tech industries. One of its upcoming
initiatives seeks to invest $5.8 million of public and private
dollars to develop commercially viable technologies.
D.C. is also seeking to grow its commercial tech sector.
The District offered $32.5 million in tax incentives over a
five-year period starting in 2015 to homegrown social
media start-up LivingSocial in exchange for the company’s
promise to remain in the city and hire local workers. The
company employs about 1,000 people in the area. Leaders
in the District hope its tech sector will flourish as skilled
workers cluster and attract other tech companies.
That pool of talent may already be in place. According
to the May 2011 Occupational Employment Statistics
from the U.S. Bureau of Labor Statistics, the District
had the highest concentration of computer hardware
engineers in the nation.
New technology also allows for the expansion of
existing industries in new directions, as is the case with
additive manufacturing in Baltimore. The process, often
called “3D printing,” involves creating three-dimensional
objects from cartridges of raw materials. It has helped
reduce production time in prototyping, for example,
but it also opens the door for individuals interested in

Region Focus | Second/Third Quarter | 2012

3

The Object Lab at Towson University in Maryland allows
students to gain hands-on experience with 3D printers. They
learn to create objects for industries that range from
aerospace and defense to art and design.

designing and producing unique crafts.
Michael Galiazzo, president of the Baltimore-based
Regional Manufacturing Institute, says that a recent
conference on additive manufacturing his group hosted
attracted a large number of people from outside of
traditional manufacturing.
“The new wave of manufacturing is going to be much
more connected with the technology transfer to the commercial sector,” he says. Policymakers and residents alike
hope that growth in technology will mean growth in all
areas of the economy.
“When people think of high-tech startups, they think
of scientists working in labs and engineers writing computer code, but those employees don’t run the companies
by themselves,” Rosenbaum says. “As these companies
grow, they will create jobs for all sectors and all types of
employees.”
— TIM SABLIK

Tax Time

Economics of Maryland Income Tax Hike Remains Unclear
aryland’s roughly 300,000 six-figure earners will
bear more of the state’s income tax burden starting this year. In May, the Maryland General Assembly
raised income tax rates, retroactive to January 1, for individuals making more than $100,000 and joint filers
making more than $150,000 per year. That comprises
roughly 14 percent of the state’s taxpayers. Depending
on the income level, rates will increase by 0.25 percentage point to 0.75 percentage point. For a family of four
making $250,000, for example, the new law could translate into an additional $989 in annual taxes.
Affected taxpayers will feel the burden even more
sharply since tax withholding for the remainder of this
year must make up the increase that accrued during the
first half. Although retroactive tax increases are not
unheard of — Connecticut enacted a similar one just last
year — taxpayers can only budget their incomes according
to the tax rates they know ahead of time.
According to the legislators, the $250 million in
revenue resulting from the income tax hike will prevent,
or at least delay, major cuts in state spending, a scenario
some had dubbed the “doomsday budget.” Gov. Martin
O’Malley argued for the importance of state education
spending and efforts to curb rising public university
tuition as imperatives for the tax increase.
Other states have tried increasing tax rates on higher
income earners. New York, in December 2011, raised
income taxes on its millionaires, though it cut taxes for
residents earning between $40,000 and $300,000.
Meanwhile, 64 percent of Californians recently surveyed

PHOTOGRAPHY: OBJECT LAB, TOWSON UNIVERSITY

M

4

Region Focus | Second/Third Quarter | 2012

support a proposed referendum for November 2012 to
increase the tax rate on California residents who earn
more than $250,000 in annual income.
The higher taxes could bring unintended economic
consequences. One is more volatile state revenue. Tracy
Gordon, a tax expert at the Brookings Institution, points
out, “high income individuals themselves tend to have
more volatile income streams,” since they often rely on
income from capital gains and stock options. If states
rely on wealthier residents for more and more of state
revenue, that “does put the state on a little bit of a roller
coaster in terms of revenues going up by quite a lot when
times are good economically, and then also going down
quite a lot when times are bad.” (See “Toil and Trouble for
Revenue Forecasters,” Region Focus, Third Quarter 2011.)
Critics also argue that higher tax rates could drive sixfigure earners out of the state. But theoretical possibility
can differ from reality. Many economists have conducted
empirical research on taxes’ effect on interstate migration, and have generally found a small yet statistically
significant correlation between increases in a state’s
income taxes and more migration from that state. A 2011
study focusing on the proposed “millionaires’ tax” in New
Jersey found that tax-induced migration would not come
“anywhere close to eclipsing the immediate revenue gain
from an income tax increase,” according to economists
Roger Cohen, Andrew Lai, and Charles Steindel of the
New Jersey Department of the Treasury. Nevertheless,
the authors concede, “over time, migration could offset a
meaningful share of revenue boost.”

Maryland might face the possibility of reduced inmigration, as well. People moving to the Washington,
D.C., metro area might decide to live in Virginia instead
of Maryland because of the latter’s tax increase.
A 2010 study found that “differences in state income tax
rates have a statistically significant impact on the probability a household locates in the low tax state within an
MSA,” according to economists William Hoyt of
University of Kentucky, Paul Coomes of University of

Louisville, and Kenneth Sanford of Middle State
Tennessee University.
Nevertheless, “taxes are just one part of the picture,”
says Gordon. Taxes alone neither cause people to move
out nor prevent people from moving in; factors like
education and safety remain relevant. “If people were
weighing the decision to migrate to another state, like
Virginia, they would have to weigh all the factors that
contribute to their quality of life.”
— SETH RUBINSTEIN

Market Benefit

Access to Fresh Food
lectronic payment options are putting more locally
grown fruits and vegetables on peoples’ plates and
more money in vendors’ pockets as farmers markets
increasingly accept electronic benefits transfer (EBT)
cards. The cards are issued by state governments to those
who qualify for the Supplemental Nutrition Assistance
Program (SNAP), formerly known as food stamps.
The technology also allows markets to swipe credit and
debit cards.
Tom Elmore likes selling his home-grown produce to
those who may need it most. He has farmed organically in
Leicester, N.C., for 25 years, and sells at the West
Asheville Tailgate Market, which began accepting EBT,
credit, and debit cards last spring.
“Small farmers, as a general rule, are not particularly
affluent, so we can relate to low-income people,” he says.
“It’s a great thing to sell to a wide range of clientele,
particularly folks who are interested enough in good food
to shop at our market.”
The average monthly SNAP benefit per person in
North Carolina is $124.58.
Less than a quarter of the nation’s roughly 7,100
farmers markets — about 1,548 — are set up to accept the
EBT cards, so the U.S. Department of Agriculture
(USDA) last May announced grants to expand the
program. North Carolina, with about 200 markets, will
receive $109,631 to pay for wireless card readers and
monthly access fees; Virginia has roughly the same
number of markets and will get about $92,000.
A market typically operates one device at a central
location, where customers buy tokens that they then
exchange for products. EBT customers buy tokens in
$1 increments; credit and debit card customers buy
$5 tokens. (The reason for the difference is that SNAP
participants can’t receive change from vendors.)
Some markets charge customers for credit or debit
sales to cover various transaction fees. But the West
Asheville market instead assesses vendors $2 per week in

PHOTOGRAPHY: VIRGINIA DEPT. OF AGRICULTURE AND CONSUMER SERVICES

E

Many farmers markets now accept electronic payments.
Markets in Spotsylvania County, Va., even offer a bonus
match for those using their food assistance benefit cards.

addition to the regular weekly fee, an option the vendor
committee chose to encourage card use.
Mike McCreary manages the Asheville City Market.
His card-related costs will total roughly $5,000 this year,
he says, including bank fees and staff time for recordkeeping. In 2011, the market in downtown Asheville
grossed roughly $700,000, and about 10 percent of
that was token sales. Of that 10 percent, EBT sales represented a third, and the rest were credit or debit sales.
“We are seeing [EBT] sales grow each year,” McCreary
says. “It’s an investment in the future.”
A North Carolina nonprofit, The Leaflight Inc., helps
markets equip, train, and promote EBT use. The cards,
says executive director Robert Smith, help penetrate
“food deserts,” locales lacking fruits and vegetables. “You
may live close to convenience stores with cupcakes, potato chips, and beef jerky, but you might have to travel eight
to 10 miles to get to a supermarket,” Smith explains.
With funds from another nonprofit, the national
Wholesome Wave Foundation, the Spotsylvania Farmers
Market in Fredericksburg, Va., offers $10 in tokens as a
bonus for SNAP customers who buy $10 in tokens or
more, according to manager Elizabeth Borst. “We want to
bring everybody in our community into the farmers
market concept.” Token sales in 2009, for only four
continued on page 30

Region Focus | Second/Third Quarter | 2012

5

FEDERALRESERVE
Winners and Losers from Monetary Policy
BY R E N E E H A LT O M

The Fed seeks to support the
economy as a whole, but some
redistributional effects are
unavoidable

monetary policy. The Fed mandate means it must focus
on broad indicators of economic performance. Any redistribution of wealth that occurs is an incidental but often
unavoidable byproduct. If Fed policy is stable and predictable, its inadvertent redistributional effects will likely
be kept at a minimum.

Low Rates Hurt Savers
feel like a lazy bum,” lamented economics blogger
Scott Sumner in a recent post. “This morning
Ben Bernanke created $250,000,000,000 in new
wealth before I’d even finished breakfast.” The Bentley
University professor argued that the Fed chairman’s speech
that morning had led to about a half percent increase in
stock prices worldwide based on the hopes it created
for further monetary easing. With it came a windfall for
equity investors.
When the Fed injects money into the economy, the
effects are not spread evenly. The first point of impact is the
banking system, where the Fed trades newly created money
for assets. The infusion of cash causes financial institutions
to bid down lending rates, which pushes down other lending
rates in the economy and, the Fed hopes, stimulates the
economy as a whole. Interest-sensitive sectors, like manufacturing and real estate, tend to respond first, with the rest
of the economy in tow. Some sectors, regions, and demographic groups might experience a bigger boost than others
from Fed easing, or higher costs when the Fed tightens.
The Fed’s most important effects on the economy — in
carrying out its congressional mandate of price stability
and maximum sustainable employment — might also affect
households differently depending on whether they hold
inflation-protected assets, have big debts that might be
eroded by inflation, or have labor market skills that insulate
them from a down business cycle.
None of these distributional effects are the intent of

Today’s record-low rates may have helped boost financial
markets, but one group of investors is not happy: savers
holding liquid, cash-like instruments such as bank deposits,
certificates of deposit (CDs), and money market deposit
accounts. The return on these investments is a market
interest rate, driven historically low by the near-zero interest
rate policy that has prevailed since late 2008. Traditional
bank deposits currently pay a hair above zero; money
market accounts pay less than half a percent. A five-year
CD pays less than 1.5 percent, compared to 5 percent before
the financial crisis (see chart below). Household interest
income has fallen by more than $400 billion since the Fed
sharply cut rates during the financial crisis, a decline of
about a third (see chart on next page).
That puts a squeeze on households that rely on interest
income, such as seniors. They tend to have shifted into the
type of safe, liquid assets that produce negligible returns
in a low-interest rate environment. But seniors are affected
differently based on where they stand in the wealth distribution. Lower-income retirees, like the poor of every age
group, hold very little financial wealth to begin with.
People over 60 in the bottom 40 percent of the wealth
distribution tended to hold no more than $3,000 in financial assets, yielding less than 1 percent of their total income,
according to research by Anthony Webb and Richard
Kopcke at Boston College’s Center for Retirement
Research. They studied data from the University of
Michigan’s 2008 Health and Retirement Study (HRS),
which surveys retirement-age households about all sources of income.
Many Asset Returns Move with Fed Policy
The richer portion of the over-60
6
age group — those ranking in the top
5
20 percent in wealth — get about
4
half of their income from financial
investments. But Webb says even
3
5-Year CD Annual Yield
they are spared from low rates
Money
Market
Annual
Yield
2
because they tend to invest more
Rate on Savings Accounts
1
Rate on Checking Accounts
heavily in stocks — at nearly
Federal Funds Rate
0
three-quarters of their financial
2011
2012
2004 2005 2006 2007 2008 2009 2010
investments — than cash-like investSOURCES: Federal Deposit Insurance Corporation, Federal Reserve, Wall Street Journal, Haver Analytics.
ments. “Stock prices fell a lot, but
Monthly data, last observation July 2012.
then came back, and dividends

PERCENT

I

6

Region Focus | Second/Third Quarter | 2012

PERCENT

$BILLIONS

Interest Income Has Fallen with Fed Policy — But So Have Interest Payments
have held up. So if you’re a rich
20
1600
rentier living off your dividend
18
income, your income really hasn’t
1400
16
been affected” by low rates, he
1200
14
says. In fact, Fed policy has proba1000
12
bly helped boost stocks and
10
800
dividends.
8
600
By Webb’s calculations, the peo6
ple over 60 who have really been
400
Personal Interest Income (left axis)
4
burned by low rates are the middle
200
Personal Interest Payments (left axis)
2
to upper-middle classes, houseFederal Funds Rate (right axis)
0
0
holds in the 3rd and 4th quintiles of
1990
2000
2010
1980
wealth that hold between roughly
SOURCES: Bureau of Economic Analysis, Federal Reserve, Haver Analytics. Quarterly data, last observation 1Q 2012.
$30,000 and $160,000 in financial
and mortgages have all fallen to historic lows in the last
assets, yielding between 5 percent and 20 percent of their
few years.
total income. They hold enough financial wealth for it to matHouseholds’ portfolio choices mean two things for Fed
ter to their total bottom line, and have tended to invest very
policy: First, a good portion of the population is “far more
conservatively in cash and short-term investments for which
interested in the Fed’s ability to boost employment than in
the yield has basically gone to zero, Webb says. Still, losses on
the Fed’s ability to boost asset returns,” as Webb puts it. And
investments amount to less than 10 percent of their total
second, if low rates strengthen the economy as a whole,
income in most cases, according to the HRS. Instead, this
the Fed is “helping to improve the returns to savers,” as
group relies heavily on other sources of wealth in retirement
Chairman Bernanke recently told Congress in defense of
such as Social Security, real estate, and pensions. On the other
the effect of low rates on savers.
hand, the wealthiest 20 percent of people over 60 — for
whom financial investments make up half of total income —
lost up to one-fifth of their total income from investment
Inflation: The Cruelest Tax?
losses during the recession through 2011.
People tend to focus on the effect of nominal interest rates
As for the population including all ages, most households
on asset returns, but it’s real interest rates — rates adjusted
simply don’t hold much of their overall wealth in assets that
for inflation — that matter. “Back in the 1980s, we had these
move directly with the fed funds rate. Checking, savings,
wonderful high interest rates. But we also had less wonderful
CDs, money market deposit accounts, and call or cash
high inflation” that ate into returns, Webb points out.
accounts at brokerages consistently amount to around 5 perIn fact, inflation is where the Fed’s effect on the economy
cent of total household assets across the wealth spectrum,
is greatest over time. When the Fed does a one-time easing
according to the Fed’s Survey of Consumer Finances (SCF).
of policy, there’s typically a boost to economic growth and
The SCF surveys 4,500 households, a nationally repreinflation in the short run. Eventually, however, the effect on
sentative sample, every three years about their asset
economic growth dies out, but the effect on the price level
holdings and reports the data by age, income, wealth, and
remains — that is, there has been a permanent increase in
other characteristics. By that measure, families get a quarter
the price level and a one-time increase in inflation. Every
of their net worth from other financial assets — stocks,
other way in which the Fed affects the economy — through
retirement accounts, and other managed assets — and
asset prices, market interest rates, and especially the
half from the nonfinancial assets of houses and equity in
business cycle — is for the most part temporary. After these
businesses. The returns on these assets are tied more to
effects of Fed policy work through the economy, changes
prospects for the overall economy than to Fed policy, though
to the money supply, and therefore the price level, are all
the latter influences the former. But that means their
that’s left.
values have risen as interest income has fallen over the last
Many people assume that general inflation hurts lower
several years.
income households most, and more than one politician in
Moreover, when interest rates fall, households are on the
history has repeated the charge that it is the “cruelest tax.”
winning end of other transactions. As aggregate household
The rich would seem better equipped than the poor to
income has fallen, their interest payments fell by an even
protect themselves from inflation through access to inflagreater percentage (see chart above). Some of that aggregate
tion-protected financial instruments and financial advice.
decline could be due to households having reduced their
But the idea that inflation hurts the poor more than others
overall debt burdens in the aftermath of the recession, but
“is a long-standing myth that must go back 50 years, maybe
it’s also the case that low interest rates suppress household
longer,” says Alan Blinder of Princeton University who
expenses for some of the largest purchases they make:
served as vice chairman of the Fed in the 1990s. For one
durables that require financing, like appliances, cars, and
thing, “the poor basically have no assets whose values can fall
houses. Rates on credit cards, car loans, personal loans,
in real terms because of inflation,” he says.
Region Focus | Second/Third Quarter | 2012

7

It is true that rising food and energy prices disproportionately hurt the poor because they spend a larger
proportion of their income on those necessities. But that is
a different phenomenon than general inflation brought
about by expansionary Fed policy. Commodity prices are
affected primarily by global supply and demand conditions
in those markets, and only indirectly by Fed policy, if at all.
There is one respect in which inflation does target the
poor: They hold more cash as a fraction of consumption,
leaving them vulnerable to an eroding currency. Wealthier
households, on the other hand, tend to consume using other
means like credit cards. In the United States, the middle and
upper classes can get a free short-term loan by charging a
purchase and then paying it off at the end of the billing
cycle; the poor cannot. “If you have a credit card, you put up
the cash later when the inflation rate is higher,” says Gustavo
Ventura at Arizona State University. “In real terms you are
spending a tiny bit less by using a credit card.” The 17 million
adults who lack bank accounts in the United States are
mostly minority and poor, according to the Federal Deposit
Insurance Corporation. Even the poor who have bank
accounts are less likely to use credit cards because it’s a costly service. Since they are more restricted to cash, inflation
acts like a tax on their consumption, Ventura and Andres
Erosa at the University of Toronto found in a 2002 study.
But Ventura cautions that the effect is probably small.
Today’s poor have better access to credit cards and other
means of payment than they had even a decade ago when the
research was conducted. More important, inflation has been
low and stable over the last 30 years, with prices having risen
just 3 percent each year on average. “That’s just not a big
deal” in terms of the inflation tax on cash holdings, he says,
especially considering that nominal wages have grown by
multiples faster than prices.
Therefore, the redistributional impact of the relatively
low and stable rates of inflation we tend to see today is
likely to be small. The picture changes when inflation comes
as a surprise. To the extent that existing lending agreements
don’t take account of unexpected inflation, it causes a
potentially substantial transfer of wealth from lenders to
borrowers, which research shows is more likely to hurt the
rich, not the poor. Matthias Doepke and Martin Schneider,
now at Northwestern and Stanford universities, respectively,
analyzed the likely winners and losers from this effect in a
2006 study. Among broad sectors of the economy — households, governments, and foreigners — they calculated how
exposed each group was to surprise inflation over the last
60 years based on their holdings of nominal assets whose
values are subject to decay when inflation hits.
Given the portfolios those groups tend to hold today, the
research of Doepke and Schneider suggests the household
sector would gain slightly from surprise inflation due to its

8

Region Focus | Second/Third Quarter | 2012

overall indebtedness,
but with dramatically
different results across
ages and incomes. Once
again, older people are more vulnerable due to the typical
assets one holds toward retirement. Surprise inflation tends
to transfer wealth from older, richer households — that are
likely to have loaded up on savings and pared down debt —
to the young. The wealthiest older people are most exposed
to inflation since they hold relatively more long-term
bonds, mostly through pension plans and mutual funds.
Older people among the poor and middle class are also on
the losing end of inflation, but less so because their dominant holdings are in shorter-term instruments such as bank
deposits. The young, especially the middle class, stand to
gain from higher inflation due to their substantial mortgage
debt. But young, poor households also gain through what
they owe in consumer credit.
These trends have changed over time. The household
sector as a whole was the U.S. economy’s major class of
lenders before the 1980s, but that changed with the
explosion of mortgage debt, which peaked in the late 2000s,
and the substantial expansion of unsecured consumer
credit. Foreigners have taken their place as capital has flown
into the United States in recent years. “If the United States
were to inflate now, then much of the cost would be borne
by people in other countries,” Doepke says. Today, an
inflation surprise would be a boon for the government
sector — the U.S. economy’s major net borrower — and a tax
on foreigners.
Taxing foreigners, in effect, through inflation to benefit
domestic governments and middle-class households might
sound like an opportunity for Fed policy. The fact that the
latter groups are indebted following the financial crisis and
recession has led some economists to argue that a bit of
inflation would speed the economy’s recovery by relieving
those burdens. Even they tend to agree, however, that it’s
not a viable long-run strategy. “The basis for these gains
would go away if you started to exploit them systematically,”
Doepke says. Lenders, both foreign and domestic, would
adjust their expectations to a policy of opportunistic inflation, and would demand inflation protection from assets.
What that means is that the government’s borrowing
rates, for example, could be driven much higher. The effects
of such an increase would be far-reaching; the average maturity of outstanding federal debt is only about five years, so
that debt would soon have to be reissued at the higher rates.
After accounting for the likelihood that future borrowing
would be more expensive, inflation erodes government debt
quite slowly, according to a 2011 study by Michael Krause
and Stéphane Moyen at Germany’s central bank.
Doepke and Schneider argued that the scope for redistribution is greater in recent years since both the assets and
liabilities of households have grown larger. But there is
one clear way for the Fed to avoid this redistribution
altogether: “Focusing on low inflation basically minimizes

redistribution that results from inflation,” says Ventura.
Contractionary policy to lower inflation might produce a
windfall for long-term bondholders, for example, but a
consistent, stable inflation rate allows financial market
participants to incorporate the majority of price increases
into contracts. That minimizes the more serious redistribution that results from inflation surprises.

Bearing the Brunt of Disinflation
When inflation reaches unacceptable levels, the Fed
typically pursues contractionary policies — and with
contraction can come a slowing of real economic activity
and employment. The burden of disinflationary episodes
tends to be borne disproportionately by the poor, minority,
and young, who tend to be relatively less productive workers
with fewer skills, and therefore are laid off first. This effect
was visible during the Volcker disinflation, which lasted
from October 1979 to the end of 1982. Willem Thorbecke at
Japan’s Research Institute for Economy, Trade, and Industry
found in 1997 that the episode caused black unemployment
to increase by 9.5 percent and Hispanic unemployment by
7.1 percent, while white unemployment increased only by
4.5 percent.
The basic numbers showing these employment flows are
supported by decades of research. Blinder has co-authored
several studies over the last 35 years arguing that, of the
economic ills the Fed is charged with combating, unemployment is more likely to harm the poor than inflation. For
example, he and Rebecca Blank, now acting secretary of
commerce, found in 1985 that both poverty and income
shares for the bottom 20th percentile of income move
closely with the business cycle. “[H]igh unemployment is
strongly and systematically regressive whereas high inflation
has weak, if any, effects on the distribution of income,” they
wrote. The upside is that the effect works in reverse when
the economy does well: A rising tide lifts the smallest boats
most, an effect to keep in mind when the unemployed are
“drafted to fight the war on inflation,” they argued.
Central bankers are quick to caution that the effects of
monetary policy on employment are inherently temporary
— so while the effect on certain groups is important, it must
be weighed against the substantial long-run benefits of price
stability. But unemployment itself can have lasting effects.
Rutgers University economist William Rodgers found in a
2008 study that spikes in the fed funds rate increase the
length of unemployment spells at all durations, especially
for blacks. Longer unemployment spells can negatively
affect lifetime earnings, job tenure and experience, and
reemployment prospects, he argued. To the extent that this
occurs for any group, it adds to the costs of contractionary
policy.
While these negative effects appear to fall more heavily
on certain groups, Thorbecke argues that doesn’t necessarily
mean those effects should change Fed policy. “It is good to
learn as much as we can about how monetary policy works.
How does it affect asset prices? How does it affect small and

large firms? How does it affect different groups in society?”
But in terms of making policy, “the Federal Reserve faces
constraints. Congress has given it specific targets, and the
Fed needs to focus on these.”
Instead, the distributional costs of monetary policy
might imply a role for compensating disadvantaged groups
through the more targeted tool of fiscal policy. Knowing the
likely winners and losers from monetary policy could help to
inform those types of policy decisions. For example, in their
work showing that surprise inflation benefits the young and
governments at the expense of the old and foreigners,
Doepke and Schneider pointed out that if the federal
government benefited from inflation, Congress would have
a choice in how to allocate the gains. For example, it could
reduce income taxes, which would benefit younger households further, or it could compensate the losers from the
inflation, like older households, through greater safety net
transfers. The average retiree gets about 30 percent of
wealth from Social Security, which is indexed to inflation;
thus, in one way, the government already compensates
households that tend to be on the losing end of rising prices.
(It’s an imperfect mechanism in that reliance on Social
Security falls as wealth — and the adverse effects of inflation
— increases. The poorest 25 percent of retirees hold as much
as 80 percent of their wealth in Social Security.)

Policy Choices with Blunt Tools
The largest redistributional effects from Fed policy appear
to come in times of change: when inflation spikes suddenly;
when it has to be brought down painfully; or when policy
shifts unexpectedly, causing markets to reinterpret Fed
objectives and reassess the economy’s prospects. The Fed
can best avoid those redistributive effects by keeping policy
predictable and stable.
That doesn’t mean there won’t sometimes be uncomfortable circumstances in the short run, such as high
unemployment existing in one demographic group while
overall unemployment is at an acceptable level. The Fed
often finds itself in an analogous position on the other side
of its dual mandate: one in which average inflation is on
target, but the prices of certain goods — goods that make up
a larger proportion of poorer households’ budgets, no less —
are rising quickly. That’s the case when prices for food and
energy spike even though “core” inflation, which omits those
prices, is on track. But outside of emergencies like the
recent financial crisis, the Fed has essentially one blunt
policy tool — interest rates — that has no direct influence
over the price of one good relative to another, nor on unemployment rates for specific groups. That’s why the Fed’s
mandate focuses on the broad economic indicators of
average prices and overall employment and growth. By
attempting to bring down unemployment for one group,
the Fed could very well overstimulate the economy, raising
inflation and throwing off its actual policy objectives.
In the long run, inflation is bad for almost everybody.
continued on page 42

Region Focus | Second/Third Quarter | 2012

9

JARGONALERT
Balance of Trade
ccording to the Commerce Department, U.S.
exports reached $185 billion in June alone, near an
all-time high set in March. Yet the country’s overall
balance of trade was a negative $43 billion, as U.S. imports
reached $228 billion.
The balance of trade is the difference between a
country’s exports and imports. Exports are domestically
produced goods and services sold abroad; imports are the
purchase of foreign goods and services. Between 1960 and
1975, the United States ran a trade surplus. Since then,
however, the country has run large annual trade deficits,
peaking at $753 billion — 5.6 percent of GDP — in 2006.
Falling imports brought the deficit to a nineyear low of $381 billion during the 2007-09
recession, but the gap widened to $560 billion in 2011. Rising oil prices added about
$100 billion to the 2011 deficit.
How can a country buy more goods than
it sells? It borrows from the rest of the
world. In the United States, the balance of
trade makes up the majority of the current
account, which is part of the country’s
international balance of payments. The current account is the difference between
income and expenditures, which, in addition to net exports, includes interest earned
on foreign investments, debt payments to
foreign investors, and net unilateral transfers, such as foreign aid. When the income
from selling U.S. goods is insufficient to
purchase foreign goods, households, firms,
and governments borrow on international
capital markets. The current account deficit thus reflects
net foreign borrowing, and is closely linked to the imbalance
in U.S. trade.
The current account balance corresponds to the difference between domestic saving and investment. Because
the U.S. saving rate is well below the investment rate, the
country relies on foreign capital to finance its investment.
That occurs when the rest of the world sends goods to the
United States in exchange for what is in effect a financial
promise that the United States will send back more goods in
the future. Cash is one kind of promise, but since dollars
don’t pay interest, other countries use those dollars to purchase assets such as U.S. government bonds, stocks, or real
estate. A trade deficit is thus associated with a net flow of
financial assets in the opposite direction, and is equivalent
to having foreigners finance domestic investment.
The balance of trade is affected by both international and
domestic events. One possible explanation for the run-up in

A

10

Region Focus | Second/Third Quarter | 2012

the U.S. deficit during the 2000s is the “global saving glut,” a
phrase coined by then-Fed governor Ben Bernanke in 2005.
In response to a series of financial crises in the 1990s, many
developing countries became net exporters rather than net
importers of financial capital. Rising productivity and a history of financial and political stability made the United
States an attractive home for these investments, leading to
higher equity prices and a stronger dollar. Stock market
wealth made U.S. consumers more willing to buy goods and
services, and the strong dollar made U.S. imports relatively
cheap and exports relatively expensive — contributing to a
larger trade imbalance.
Some observers attribute the trade deficit
to the large decline in manufacturing
employment over the past several decades
and to the slow job growth coming out of
the recession. But running a trade deficit
isn’t necessarily a bad thing. Intertemporal
trade — that is, importing today and
exporting tomorrow — allows a country
to smooth its consumption through
economic ups and downs. From the perspective of the current account, if a
country has a lot of productive investments to make or expects to grow very
rapidly in the future, it makes sense to run
a current account deficit in the present
and pay it back with future surpluses.
Moreover, trade deficits often are a result
of worldwide production being shifted to
its most productive locations.
Although the recession temporarily
slowed the growth of the trade and current account deficits,
concerns remain about when and how the trade imbalance
will be resolved. Some economists fear the United States’
foreign debt is approaching the level where foreign investors
would lend money only at much worse terms than at present.
Others believe that would be unlikely due to the size,
diversity, and resilience of the U.S. economy. Given that
yields on U.S. government bonds have actually fallen
throughout the financial turmoil of the past several years,
it seems unlikely that foreign investors are close to losing
faith in the U.S. economy. If the trade deficit rises toward
prerecession levels, however, policymakers will be watching
closely — but what they should do in response is not so
clear. Attempting to narrow the trade gap through import
restrictions, for instance, would likely hurt domestic
consumers, provoke a backlash abroad, and lower global
economic productivity. Such a “cure” could be worse than
the perceived problem.
RF

ILLUSTRATION: TIMOTHY COOK

BY J E S S I E RO M E RO

RESEARCH SPOTLIGHT
Are New Graduates Left Behind in a Recession?
BY T I M S A B L I K

similar students who graduated into a better economy.
he process of leaving school and searching for that
In contrast, students with the highest predicted wages
first job can be intimidating for any college
earn 7.5 percent lower annual wages in the first year after a
graduate. Graduating into an economy with high
5 percentage point increase in unemployment. But the gap
unemployment poses even greater challenges. Economic
between their earnings and what they should expect to make
studies have documented that availability of jobs and
in stronger economic times drops to less than 2 percent after
opportunities for growth at firms decline during recessions.
four years.
Do students who graduate during a recession suffer a longYoung workers improve their wage and job position by
term disadvantage in the labor market compared to
switching employers more frequently in the first three to
students who graduate in healthier economic times?
five years of their career. Compared to their peers graduatAnd if so, how long does it take them to recover?
ing in healthy economic times, new graduates entering the
Researchers Philip Oreopoulos of the University of
labor market during a recession are more likely to get a job
Toronto, Till von Wachter of Columbia University, and
with a lower-quality employer in terms of total payroll and
Andrew Heisz of Statistics Canada set out to answer that
median wage. The authors find that roughly half of the
question. They look at 20 years of employer-employee
recovery from this initial wage setback can be explained by
matched data on male college students in Canada to
job mobility.
determine if graduating in a recession has an effect on wages
Graduates with higher
earned over 10 years.
expected wages exhibit large
They find that if the unincreases in job mobility in the
employment rate increases
“The Short- and Long-Term Career
first years after graduating, and
5 percentage points (the benchEffects of Graduating in a Recession.”
this allows them to move to
mark the authors use to denote
Philip Oreopoulos, Till von Wachter, and
higher-quality firms and close
a shift from a healthy economy
the wage gap in about four years.
to recession), annual wages
Andrew Heisz. American Economic Journal:
Students with lower expected
are 9 percent lower for graduApplied Economics, January 2012,
wages, however, exhibit only a
ates entering the workforce
slight increase in job mobility in
compared to students graduatvol. 4, no. 1, pp. 1-29.
the first few years after leaving
ing into a healthy economy.
school. This means that they
After five years, that average
are not able to close the wage gap by switching to betterwage gap is 4 percent, and after 10 years, the effect largely
paying firms.
fades out.
In fact, on average, these graduates are never able to fully
Not all students appear to face the same penalty,
recover from the initial impact of graduating during a period
however. The authors use a statistical model to predict earnof high unemployment. The authors use a model that
ings in nonrecessionary times based on college attended and
incorporates search frictions that grow larger as workers
program of study. The estimate of earnings captures college
age. As workers get older, more factors tie them to a
quality and student ability, since each student chooses which
particular location, such as a house or spouse and family,
college to attend and what to study. Highly skilled students
making them less able to move between jobs. Consequently,
are more likely to attend high-quality colleges and choose
graduates with the lowest expected wages, on average, don’t
more challenging and marketable majors, partly accounting
recover from the initial shock of a recession before these
for the higher predicted wages.
search frictions permanently keep them at lower-paying
Whether the predicted wages are more a function of
firms.
college quality, employer demand for a given major, or innate
Oreopoulos, von Wachter, and Heisz stress that these
student ability is unclear. What is clear from the authors’
search frictions are critical for explaining the long-term
analysis is that students with lower predicted wages upon
impact of a recession on new workers’ wages. If search
graduating incur much greater setbacks when entering
frictions did not increase as workers aged, then workers with
the labor market during a recession than students with
the lowest predicted wages would eventually be able to
higher predicted wages. The authors find that students with
overcome the penalty to their wages, given enough time.
the lowest predicted wages suffer 15 percent lower wages
Graduating during a recession hurts the wages of all students
in the first year due to a 5 percentage point increase in
getting their first job, but for some it can depress wages over
unemployment. This effect is also highly persistent: Even
their entire lifetime.
RF
after 10 years, these students earn 7.5 percent less than

T

Region Focus | Second/Third Quarter | 2012

11

S T O R Y

WHERE
HAVE ALL
THE
WORKERS
GONE?
Why are more
people leaving
the labor force,
and what are
they doing?
BY J E SS I E RO M E RO

S

ince September of last year, the unemployment rate in
the United States has declined nearly a full percentage
point, from 9 percent to 8.3 percent. On its face, this is
an encouraging signal about the health of the labor
market. But some of the change is due to a potentially troubling
trend: a dramatic decline in the number of Americans who are
part of the labor force. Prior to the recession, 66 percent of the
population (not counting active duty military or people in a nursing home or in prison) over the age of 16 was in the labor force.
Just four years later, this rate — known as the “labor force participation rate,” or LFPR — has fallen to 63.7 percent. While this
might not sound like a large decline, it is unprecedented in the
postwar era.
The dropoff is all the more striking because it does not
include unemployed workers who are actively seeking work; such
workers are still considered to be part of the labor force. It is only
when the unemployed decide to stop looking for jobs, perhaps
because they have given up on the possibility of finding one, that
they are considered out of the labor force — although they might
still want to work, and would accept jobs if they were offered.
The current low labor force participation rate is the result of
both long-term structural changes, such as an aging population
and decreased demand for low-skill workers, and cyclical factors,
namely the lingering effects of the 2007-09 recession. While it’s
difficult to distinguish between the effects of demographics and
the effects of the business cycle on labor force participation, why
people drop out of the labor force — and what they do when
they’re not working — has important implications for the future
growth of the U.S. economy.

Trend Versus Cycle
Beginning in the early 1960s, the LFPR began a four-decadeslong increase, from less than 60 percent to a high of 67.3 percent
at the beginning of 2000 (see chart). The rise was driven by
greater participation of women and by the entry of the babyboom generation into the workforce, which skewed the
population toward age cohorts that have very high participation
rates. These demographic changes were large enough to counteract the effects of occasional weak labor markets, and during most
postwar recessions, labor force participation held steady or even
increased. That changed a decade ago — the LFPR began to fall
at the beginning of the 2001 recession and never recovered.
Compared to the present, however, the drop then was small: In
the four years following the start of the 2001 recession, the
LFPR declined 1.1 percentage points, compared to 2.4 percentage points over the same corresponding period since the start of
the 2007-09 recession.
Since the beginning of the 2007-09 recession, Fifth District
states have fared both better and worse than the nation as a
whole in terms of labor force participation. In Virginia, labor
force participation has been fairly constant, remaining largely
unchanged since the beginning of the recession. In Maryland,
the rate declined by 2.0 percentage points, while West Virginia
and Washington, D.C., saw declines comparable to the national
decline of 2.4 percentage points. In North Carolina, the LFPR
has fallen by 3.1 percentage points, and in South Carolina it has

PHOTOGRAPHY: AMY DEVOOGD/PHOTODISC/GETTY IMAGES

C O V E R

LABOR FORCE PARTICIPATION RATE (PERCENT)

labor market, with the rest due to demographic factors.
declined by 3.6 percentage points, the largest decrease in the
Economist Willem Van Zandweghe at the Kansas City Fed
Fifth District and one of the largest in the nation.
found that the split is closer to 50-50, as did economists at
Even before the recession, labor force participation had
the Chicago Fed. Van Zandweghe used a model in which the
been trending downward. Teenagers and young adults are
overall unemployment rate is the primary cyclical indicator.
remaining in school longer and are less likely to work while
When he altered the model to include the long-term unemthey are in school. Women’s participation, which fueled
ployment rate, which might be a better gauge of labor
much of the growth in the LFPR after 1960, leveled off in
market weakness, he found that cyclical factors could
the 1990s. And although the participation rate for older
explain as much as 90 percent of the decline in the LFPR.
workers has been gradually increasing due to improved
health and the reduction in defined-benefit retirement
plans, the participation rate for the group as a whole is still
Ins and Outs
much lower than for other demographic groups. The
Whatever the research eventually shows, the fact remains
increasing share of older workers in the population thus
that millions of people who would like to be working have
brings down the overall LFPR. In January, for example, it
given up trying to find a job. According to the monthly
appeared that more than 1 million workers left the labor
Current Population Survey (CPS) conducted by the BLS, the
force, and that the LFPR fell 0.3 percentage point. But the
share of workers not in the labor force who report that
drop was due entirely to revised population estimates based
they want a job now increased from 5.5 percent prior to the
on the 2010 census; there were simply more older people in
recession to 8.4 percent in mid-2011, and remains elevated at
the population than the BLS originally thought.
7.9 percent today — a total of 6.8 million workers. “There’s a
Men aged 25-54 traditionally have been the most
large group of people who are counted as out of the labor
attached to the labor force, but their participation has been
force who we should be trying to find jobs for, and who
falling for decades. Between 1970 and the beginning of the
would want jobs if they were available,” says Rothstein.
most recent recession, men’s LFPR fell from 96 percent
Of the workers who want a job, 2.5 million are considered
to 90.6 percent. At present, the rate is 88.5 percent. One
“marginally attached” to the labor force; they have searched
possible explanation for this decline is relaxed requirements
for a job within the past year, but not within the past four
and increased benefits for disability insurance.
weeks, and are available to work now. (The remaining workIn 1984, Congress authorized changes that made it easier
ers who want a job either have not searched within the past
for workers suffering from ailments such as mental illness or
year or are not available to work.) More than 800,000
muscle pain to qualify for disability insurance. Currently,
marginally attached workers are considered “discouraged
beneficiaries receive an average of $1,150 per month in cash
workers” — they have stopped looking for work because
payments and full Medicare benefits. Because workers stop
they do not believe that any jobs are available for them.
receiving benefits if they demonstrate that they are able to
Other reasons for not looking for work include family
work, the program creates a strong incentive for workers to
responsibilities, attending school or a training program,
exit the labor force permanently. (See “The Sharp Rise in
ill health or disability, or “other,” such as a lack of transportaDisability Claims,” page 24.)
tion or child care.
Although demographic and policy changes have conBetween 1994 and the end of 2007, discouraged workers
tributed to a long-term downward trend in labor force
made up about 8 percent of workers who want a job,
participation, the current decline appears to be too large to
with a high of 11 percent following the 2001 recession.
be explained solely by these factors. “I think the vast major(The BLS made substantial changes to the CPS in 1994,
ity has got to be the recession. There’s just not
enough time for demographics to have changed that
Labor Force Participation, 1950 to Present
much,” says Jesse Rothstein, an economist at the
68
University of California, Berkeley and chief econo67
mist at the Department of Labor for 2010.
66
But it’s difficult to discern the impact of the busi65
ness cycle relative to structural change. “The certain
64
answer I can give you is that they’re both playing a
63
role. If you want me to divide it proportionally and
62
say how important is each, that’s where it becomes
61
much, much more difficult,” says Betsey Stevenson,
an economist at the University of Pennsylvania.
60
Stevenson served as chief economist at the
59
Department of Labor for 2011.
58
1980
1970
2000
1990
1950
1960
A recent report by Dean Maki, an economist at
NOTE:
Shaded
areas
denote
recessions.
Barclays Capital, argued that only about one-third of
SOURCES: Bureau of Labor Statistics, Haver Analytics
the recent decline in the LFPR is due to the weak

Region Focus | Second/Third Quarter | 2012

2010

13

Workers Not in the Labor Force
or as out of the labor force “is a real
philosophical question,” says Stevenson.
7
“You have to think about a distinction
between people who truly exit the labor
6
force, and people who take a one- or
5
two-month break.”
Looking more closely at the flows in
4
and out of the labor force also reveals
some counterintuitive trends. Because
3
there are many more unemployed
2
workers today than in previous recesWant a Job Now % of NLF
sions, the absolute number of workers
1
Marginally Attached % of NLF
who move from unemployment to nonDiscouraged % of NLF
0
participation has increased substantially.
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
But it’s actually taking longer for workNOTE: Shaded areas denote recessions.
SOURCES: Bureau of Labor Statistics, Haver Analytics; Region Focus calculations
ers to become discouraged than they did
in previous recessions, and on average,
workers are less likely to drop out after being unemployed,
so comparisons to prior years’ data are not possible.)
according to research by Marianna Kudlyak of the
From the beginning of the most recent recession until the
Richmond Fed. Randy Ilg, an economist at the BLS,
end of 2010, the share increased from 8.25 percent to 22 peralso found that unemployed workers are waiting longer
cent. Since then, discouraged workers have remained about
before giving up and leaving the labor force, a median of
15 percent of workers who want a job.
20 weeks compared to 8.5 weeks prior to the recession.
The official number probably understates the true
One explanation for this trend could be the extension
amount of discouragement in the labor market. To be
of unemployment benefits during the recession to up to
defined as a discouraged worker — a subset of the
99 weeks; workers must be actively seeking work in order
marginally attached — a worker must have searched for a job
to qualify, which could encourage them to remain in the
within the past year. More than 3.2 million workers say that
labor force for longer.
they do want a job but that they stopped looking more than
Despite the persistently weak labor market, Kudlyak also
a year ago. These workers are not counted as discouraged
found an increase in the rate at which workers come back
by the CPS, but it’s likely that some of them originally
into unemployment from nonparticipation, possibly
quit the labor force because they were pessimistic about
because many workers who had previously left the labor
job opportunities.
force, such as retirees, lost a significant amount of
In addition, some of the 80 million workers who say they
wealth and thus had to start looking for work. Another
do not want a job now might have dropped out due to weak
explanation could be the “added worker” effect, whereby
job prospects. For example, nearly 50 percent of all workers
nonworking women whose husbands were laid off decide to
not in the labor force report that they are retired. They
try to find a job, as Sahin of the New York Fed, Joseph Song
aren’t classified as discouraged, but some of them likely
of Columbia University, and Hobijn of the San Francisco Fed
decided to retire early rather than continuing to search for a
have suggested.
job. (See “Recession on the Eve of Retirement, Region Focus,
Fourth Quarter 2011.) The average duration of unemployment for workers older than 55 is 60 weeks, compared to 42
Passing the Time
weeks for all workers. “At some point it’s not worth continuSome workers leave the labor force for only a month or two,
ing to look. You say, okay, I’ll just retire early,” Rothstein says.
but others drop out for years, if not permanently. How are
Assessing the condition of the labor market is made more
they spending their time? One recent study by economists
difficult by the fact that, in any given month, there is a great
Mark Aguiar of Princeton University and Erik Hurst and
deal of fluidity between different states of the labor force.
Loukas Karabarbounis of the University of Chicago begins
“There are a lot of issues in trying to think about what it
to paint the picture. The authors examined the results of the
means to be unemployed and what it means to be out of the
American Time Use Survey (ATUS), an annual survey by
labor force. People flit in and out of these states much more
the BLS that asks respondents to log their activities over a
than we thought they did,” Stevenson says. Many workers
24-hour period. Comparing the years 2009 and 2010 to
drop out of the labor force for several months, but then
the years prior to the recession, the authors found that
begin looking for work and reenter the labor market, accordabout 35 percent of the foregone market work hours — time
ing to research by Michael Elsby of the University of
previously devoted to paid employment — were reallocated
Edinburgh, Bart Hobijn and Rob Valletta of the San
to home production, such as cooking and cleaning, home
Francisco Fed, and Aysegul Sahin of the New York Fed.
maintenance, or child care. About 30 percent of the foreDeciding whether to classify these workers as unemployed
gone hours were devoted to sleep and television watching,
PERCENT OF TOTAL NOT IN THE LABOR FORCE

8

14

Region Focus | Second/Third Quarter | 2012

20 percent to other leisure activities such as exercising or
going to the movies, and 10 percent of the time was spent on
education or other civic engagements. Small fractions of
time were devoted to work in the informal economy and to
job search. The ATUS includes all workers — employed,
unemployed, and out of the labor force — so it’s not certain
that these results apply specifically to workers who are out
of the labor force.
About 15 percent of all workers not in the labor force and
8 percent of marginally attached workers are taking care of
family members rather than looking for work, according to
BLS data. For some of these workers, family care is the
reason they leave the labor force, while for others, it’s something they turn to after dropping out. “Men who have been
out of work for a long time and are discouraged might
start to say they’re taking care of their family while their
wives work, rather than saying they’re discouraged,” says
Rothstein.
Many workers who have left the labor force are furthering their education. The share of adults aged 25-39 who cite
schooling as their reason for leaving the labor force has
increased from about 15 percent to about 20 percent since
the end of the recession, and the share of workers aged
40-59 has increased from 4 percent to 6 percent, according
to research by Julie Hotchkiss and Melinda Pitts of the
Atlanta Fed and Fernando Rios-Avila of Georgia State
University. Community college enrollment is especially
countercyclical: A 1 percent increase in the unemployment
rate leads to a 4 percent increase in enrollment, found Julian
Betts of the University of California, San Diego and Laurel
McFarland, executive director of the National Association
of Schools of Public Affairs and Administration. The number of people over 50 enrolled in community college has
increased 12 percent since 2005, with much of the increase
coming since the recession, according to the American
Association of Community Colleges.
The recession also likely accelerated the ongoing trend of
young people opting for school over work, Stevenson says.
“If you’re in school full time and there are no jobs out there,
eventually the returns to applying for another job instead of
doing more of your homework are pretty low.”

Making Ends Meet
Most social safety net programs, such as unemployment
insurance or Temporary Assistance for Needy Families,
require recipients to be working or actively looking for
work. But people who have left the labor force might be
taking advantage of other programs to help make ends meet.
On average, 45 million people per month received aid via
the Supplemental Nutrition Assistance Program (SNAP),
also known as food stamps, in 2011. That represents an
increase of 70 percent since 2007, according to the
Congressional Budget Office. Part of the increase was due to
expanded eligibility, including relaxed work requirements.
Typically, to qualify for SNAP, able-bodied adults must be
working or enrolled in a training program and looking for

work. These requirements were
waived in 2009 and 2010 by
the American Recovery and
Reinvestment Act, and since then
states that qualify for extended
federal unemployment benefits —
46 states in fiscal year 2012 — have
been allowed to waive the requirements. Even without the waiver,
there are a number of exceptions,
such as caring for a child, lack of
transportation, or unsuitable or
limited job opportunities, that
could enable workers who have
dropped out of the labor force to
receive benefits.
The recession also had an effect on enrollment in
Medicaid, a government health insurance program for qualified low-income people. Between December 2007 and
December 2009, the average monthly enrollment increased
by nearly 6 million people, or 14 percent, according to the
Kaiser Family Foundation. Medicaid eligibility is not tied to
employment requirements, making it likely that at least part
of the increase is due to workers who are no longer in the
labor force, and thus have lower incomes and lack employerbased health insurance.
The expansion of benefits such as SNAP and Medicaid
might be a cause of the sharp drop in the LFPR since the
recession, rather than an effect. Economist Casey Mulligan
of the University of Chicago found that more generous
safety net programs have contributed to a decline in the
“self-reliance” rate from 70 percent to 55 percent since 2007.
The self-reliance rate measures the fraction of a household’s
income that is not replaced by transfer payments or subsidies; a lower self-reliance rate implies decreased incentives
to work, since the government provides relatively more
of a household’s lost income. These programs replace much
less income than disability benefits do, however, and thus
might not have the same long-term effects on labor force
participation.
Many workers, particularly older workers, are spending
savings that had been earmarked for retirement. A survey by
the AARP (formerly the American Association of Retired
Persons) found that 57 percent of workers over age 50 had
withdrawn money from their savings account, and 25 percent had completely exhausted their savings. Nearly 20
percent had taken a distribution from a 401(k) or other
retirement account. A survey of workers of all ages by the
Pew Research Center found that 55 percent of workers who
were unemployed for six months or longer withdrew money
from their retirement accounts. While the behavior of the
unemployed might not match the behavior of workers who
have left the labor force, it’s likely that these groups have
resorted to the same financial coping strategies.
Some workers simply might not be making ends meet.
The official federal poverty rate increased to 15.1 percent

Region Focus | Second/Third Quarter | 2012

15

in 2010, according to the U.S. Census Bureau, the highest
rate since 1993. (The official poverty rate does not include
in-kind government benefits such as food stamps in its
income calculations.) There are some workers who will never
reenter the labor force and “will live in poverty for the rest
of their lives,” says Rothstein. Most workers, however, will
likely have to reenter the labor force at some point, albeit for
lower pay. “You’ll see more people coming back and working
in jobs for which they should be overqualified.”

Can the Decline be Reversed?
What happens when these workers do return to the labor
force? The economy created 163,000 jobs in July, barely
enough to keep up with population growth; some observers
are concerned that if a large number of people decide to
start looking for work, the result could be a spike in the
unemployment rate. Demographic changes could offset the
inflow of workers who sat out the recession, however. While
the Congressional Budget Office projects that the size of
the labor force will grow more quickly than its long-term
trend between now and 2016 as the economy rebounds, it
also projects that this growth will be outweighed by
the retirement of the baby-boom generation, which will
continue to push the participation rate down.
In fact, the greater concern may be that the labor force is
permanently smaller. In the long run, a country’s economic
growth depends on the number of people working, and how
productive those people are. All else equal, unless productivity grows very rapidly, lower labor force participation leads
to a lower level of economic activity. That might be part of
the explanation for the slow pace of the economic recovery,
according to recent work by James Stock of Harvard
University and Mark Watson of Princeton University (who is
also a visiting scholar at the Richmond Fed). They found
that the trend decline in labor force participation accounts
for nearly all of the slower GDP growth and half of the slow
employment growth relative to the recovery from the
1981-82 recession.
Some of the decline in labor force participation might be
beneficial, at least in the long run. To the extent that workers have left the labor force in order to attend school, the
effects on growth could be positive. Higher levels of human

capital tend to lead to higher rates of economic growth;
higher-skilled workers not only use existing technologies
more productively but also generate new ideas and new
technologies. Workers with more human capital also earn
higher wages and tend to be more attached to the labor
force later in life, potentially making up for a period of
nonparticipation.
Millions of other workers, however, represent a large
pool of unused resources. What will it take to bring these
workers back into the labor force? If these workers are merely sitting out a weak labor market, then the short answer is
job growth. But simply increasing the number of jobs might
not be enough to bring certain workers back into the labor
force, much less into employment. Research has found that
marginally attached and discouraged workers tend to be
from demographic groups with higher unemployment rates
than average, and are less likely than the unemployed
to transition to employment. In addition, skill “mismatch”
— the idea that the available workers do not possess the
skills in demand by employers — could account for between
0.6 and 1.7 percentage points of the 5 percentage point rise in
the unemployment rate, according to Sahin and Giorgio Topa
of the New York Fed, Joseph Song of Columbia University,
and Giovanni Violante of New York University. This suggests
that mismatch could account for a significant portion of
marginally attached and discouraged workers as well.
For these workers, job training programs might be the
best way to reintegrate them into the labor force. But job
training doesn’t yield immediate effects. “What should we
be training for? For the jobs that will be there in three or
four years?” asks Rothstein. “Adding more job training now is
useful for the long run, but it’s not going to be useful for the
short run.”
In the short run, there are no easy answers. The current
low level of the labor force participation rate is a mix of both
structural and cyclical factors, which makes it difficult to
predict the path of the LFPR in the future, and thus to
predict its effect on the country’s economic growth. As the
economy continues its recovery from the recession, economists and policymakers will be watching closely to see what
labor force participation signals about the health of the
labor market.
RF

READINGS
Aaronson, Stephanie, Bruce Fallick, Andrew Figura, Jonathan
Pingle, and William Wascher. “The Recent Decline in the Labor
Force Participation Rate and Its Implications for Potential Labor
Supply.” Brookings Papers on Economic Activity, vol. 2006, no. 1,
pp. 69-134.
Aguiar, Mark A., Erik Hurst, and Loukas Karabarbounis. “Time
Use During Recessions.” National Bureau of Economic Research
Working Paper No. 17259, July 2011.
Autor, David H., and Mark G. Duggan. “The Rise in the Disability
Rolls and the Decline in Unemployment.” Quarterly Journal of
Economics, February 2003, vol. 118, no. 1, pp. 157-206.

16

Region Focus | Second/Third Quarter | 2012

Elsby, Michael W.L., Bart Hobijn, Aysegul Sahin, and Robert C.
Valletta. “The Labor Market in the Great Recession: An Update
to September 2011.” Brookings Papers on Economic Activity, Fall 2011,
pp. 353-371.
Stock, James H., and Mark W. Watson. “Disentangling the
Channels of the 2007-2009 Recession.” Washington, D.C.:
Brookings Panel on Economic Activity, March 22-23, 2012.
Van Zandweghe, Willem. “Interpreting the Recent Decline in
Labor Force Participation.” Federal Reserve Bank of Kansas City
Economic Review, First Quarter 2012, vol. 97, no. 1, pp. 5-34.

Have Americans lost the urge to move?
BY B E T T Y J OYC E N A S H

A

23-year-old social media manager received a tempting job offer, complete with a salary increase.
It seemed like a next step in the right direction —
up. Except for one thing: The job was in Dallas and he
lives in Denver. “I turned it down,” says the young man,
who asked not to be named. “I love life out here in Denver;
I would not be happy in Dallas.”
What’s wrong with this picture? Americans are known
for their itchy feet. Increasingly, however, many have been
opting to stay put.
Early migrants journeyed west from Europe, then crossed
mountains to farm, mine, and populate vast, empty territories; others poured into the growing cities of the 19th
century. Throughout much of the 20th century, 8 million
blacks and 20 million whites converged on cities in the
Northeast, Midwest, and California from the South for
social and economic reasons.
We move more than people of most other nations.
Our domestic migration rate — roughly 5 percent to 6 percent of the U.S. population moves across a county boundary
annually — both reflects and reinforces our dynamic labor
market.
Domestic migration helps match workers to employers.
It keeps labor markets supple. It smoothes shocks that may
hit one region and spare another. Migration mitigates the
effects of economic restructuring, such as population shifts
that rearranged Americans geographically as the nation
industrialized before and after World War II.
Moving may seem rooted in our national psyche, but the
number of domestic migrants has been trending lower. The
slide started in the 1980s, not with this decade’s falling house
prices and deep recession. The migration slump of the past
three decades is a puzzling and possibly momentous change
in America’s social and economic picture. If the trend
continues, labor market flexibility may be at risk. But the
reasons for it are hard to pin down.

House Lock?
While it is tempting to assume that the recent housing
contraction accelerated the migration decline, since an
underwater mortgage makes moving harder, the data don’t
bear that out. Neither interstate nor intercounty migration
rates fell more for homeowners than they did for renters in
percentage point terms, according to economists Raven
Molloy and Christopher Smith of the Federal Reserve Board

of Governors and Abigail Wozniak of the University of
Notre Dame in a 2011 Journal of Economic Perspectives article.
The authors used data from the decennial Census, two longterm federal surveys, the American Community and Current
Population surveys, and migration data from the Internal
Revenue Service (IRS). Analysis of state-level data showed
no statistically significant correlations between mobility and
the share of homes with negative equity between 2006 and
2009. The authors also found no evidence that migration fell
more in states where housing markets’ sales or prices had
larger declines.
Boston Fed economist Alicia Sasser Modestino and
research associate Julia Dennett found similar results in a
2012 Boston Fed working paper. The authors analyzed IRS
migration data between 2006 and 2009. Such “house lock”
reduces the national state-to-state migration rate by a scant
0.05 percentage point, they concluded. That’s about 110,000
to 150,000 fewer moves across state lines in a year.
Yet house lock is a reality for some. Stacy Pursell runs an
executive search firm, the Pursell Group, based in Tulsa,
Okla. She recruits employees for firms in the veterinary
medicine and animal health industry. More candidates are
refusing good positions, some because they’re underwater
on their mortgages. “I’ve been through other recessions,”
Pursell says, “but I’ve never seen this many people unable to
relocate. Today I talked to a man who paid $650,000 for his
home and could only get $425,000 if it sold today.” He won’t
relocate. Companies have also cut back on relocation packages, making it tougher to find willing migrants. “We will
have candidates enter the interview process only to say, at
the end, ‘I need to wait and stay here.’ Every day I talk to
people who feel stuck in their job.”
A related explanation for declining mobility has been the
severity of the latest recession, which has shrunk household
formation and employment. For example, the number of
households increased at a rate of 1.2 percent compared to a
2.3 percent annual rate of household formation between
2004 and 2007. To the extent that household formation triggers migration, the lower rate of new households could be
deterring would-be migrants.
But the recession was not associated with any additional
fall in interstate migration relative to the downtrend already
under way, according to Greg Kaplan of the University of
Pennsylvania and Sam Schulhofer-Wohl of the Minneapolis
Fed, in a June 2011 Minneapolis Fed staff report. (Some news

Region Focus | Second/Third Quarter | 2012

17

reports this year to the contrary were based on the effects
of a 2006 adjustment to the Census Bureau’s statistical
procedures for its migration data rather than an actual
deepening of the migration trend.)
So, what gives?

Who’s Moving, Who’s Not
Roughly 1.5 percent of the population moves between two of
the four Census regions annually, and another 1.3 percent
move to a different state within the same region, according
to IRS data.
These averages hide differences among groups.
Education, for instance, raises peoples’ tendency to migrate
while age lowers it. Renters are more than three times as
likely to migrate as homeowners; the unemployed are twice
as likely to move as the employed. Those with some college
tend to migrate more than the less educated. Those aged
18 to 24 are about three times more likely to move than
people 45-plus.
Still, mobility rates have declined for nearly every subpopulation since the 1980s, according to the 2011 article by
Molloy, Smith, and Wozniak. Moreover, while U.S. demographics have changed since the 1980s, they have not
changed in a way that would substantially affect overall
migration. The population aged 45 to 64, for instance,
expanded from 20 percent in 1981 to 25 percent in 2010. At
the same time, the fraction of those older than 64 changed
very little. The growth of the aged 45 to 64 group would have
cut aggregate interstate migration by only 0.1 percentage
point, according to Molloy and her co-authors’ calculations.
The rise of the double-income household also does not
seem to be responsible, even though relocating is a greater
challenge for such couples, who need to find two jobs, not
one. The trend toward double-income households was
already largely complete by the time migration slowed. The
percentage of households with dual earners has increased
only modestly since then, from 42.4 percent in the 1980s to
45.6 percent in the 1990s. It was 45.2 percent in the 2000s.
But one segment of double-income households has seen
a greater migration slowdown: the “power couple,” dualincome households in which both partners are highly
educated. While interstate migration rates for other types of
families and for singles changed very little, the migration
rate for college-graduate couples fell from 5.7 percent in
1965-1970 to 2.8 percent in 2000-2005, according to a 2011
working paper by Siyu Zhu, a doctoral candidate, and economist Li Gan, both of Texas A&M University. Two things
affected this group’s migration falloff: Women’s wages
grew and so did homeownership rates, which went from
62 percent in 1960 to 68 percent in 2000. The decreasing
difference in spouses’ earnings, which increases the
opportunity costs of moving, explains half the decline in
the interstate migration rate for families with two collegegraduate spouses in the 1980s and 1990s.
Although education drives migration — people with
bachelor’s degrees are twice as likely to move as those with

18

Region Focus | Second/Third Quarter | 2012

high school diplomas — rates in that group have slowed.
Over the last three decades, college-educated people
have moved at an average rate of 3 percent annually compared to 1.5 percent for those without a college degree.
Between 2001 and 2010, however, those rates have dropped
to 2.1 percent and 1.2 percent, respectively, according to
Molloy and co-authors.
As education levels have climbed, one would expect
migration rates to rise too. Nearly 28 percent of those 25 and
over held bachelor’s degrees in 2009, according to the
U.S. Census Bureau, compared to 20 percent in 1990.
“If I have education, I have more to gain and the benefits of
a move are greater,” says Mark Partridge, an economist at
The Ohio State University.
“I can gain maybe tens of thousands of dollars [from moving], whereas if I have a job that requires less education, the
gains are lower,” he says. But despite rising education levels,
overall migration rates are declining.
Partridge and his co-authors hypothesized that declining
migration could mean that region-specific attributes may
have evened out. That would mean migrants no longer seek
specifics such as a particular climate or economic characteristics of a particular urban center. Goods and services
across the nation are more similar now than ever. If locationspecific characteristics have been capitalized into local
prices, there’s less need to move between regions.
But the authors found only a mild ebbing of natural
amenity-based migration after 2000, Partridge says.
He co-authored an article published in January 2012 in
Regional Science and Urban Economics with Dan Rickman of
Oklahoma State University, Rose Olfert of the University of
Saskatchewan, and Kamar Ali of the University of
Lethbridge.
They did find changes in regional labor markets,
however. Comparing U.S. county population growth and
migration between regions during the 1990s, they noted that
labor flows responded to local economic shocks. After 2000,
though, labor demand was supplied locally through reduced
unemployment or added labor participation or both.
“We didn’t see the job growth sparking population growth,”
he says, which could indicate a shift away from migration
flows across regions to supply labor, an important finding.
“We might be entering a new normal of lower migration”
he says. Maybe the gains from moving, for whatever reason,
have dwindled.
There’s always the possibility that current migration
trends stem partly from the emergence of technology that
has enabled telecommuting. The share of workers who
report working from home is up from 2.1 percent in the 1980
census to an estimated 4.3 percent in the 2010 American
Community Survey. More research is needed, but the
growth in telecommuting seems unlikely to account for
much of the migration decline, since telecommuting is often
done by workers employed locally.
So far, economists know more about what isn’t causing
the migration slide than what is.

The (Im)Mobile Future
Along with telecommuting, America is seeing a rise in a
more exotic species of commuting: long-distance supercommuting, which anchors workers to their home cities.
Researchers at New York University’s Rudin Center for
Transportation Policy and Management studied road
warriors commuting more than 90 miles, one way, to work.
These workers commute from one region to another by car,
rail, bus, or air. For example, more than 3,000 people work
in the New York area, but live in Boston, an increase of 128
percent since 2002. Super-commuters represent 13 percent
of Houston workers, a nearly 100 percent increase over the
same period; 35,000 live in Austin and 52,000 live in Dallas.
Workers leave Houston, too, for Dallas, about 44,300 of
them. In Los Angeles, 6 percent of workers are super-commuters, 36,000 from San Francisco. Nearly 5,000 people
work in Chicago and live in St. Louis. In short, these are
workers who are determined not to move, or cannot move,
and pay a high price to avoid it.
Super-commuting corridors are growing throughout the
nation, according to Mitchell Moss and Carson Qing at the
Rudin Center. Two of recruiter Pursell’s recent candidates
accepted jobs — and extreme commutes — in a distant city
when their company was bought. They rented apartments;
they return home by plane on weekends. “Their families
are back home, halfway across the country,” Pursell says.
While one plans to move when the house sells, the other is
unlikely to move his family.
The question remains: Why the aversion to moving?
Today’s persistent and widespread decline in migration
isn’t related solely to demographics, employment, or the current economy. “This is not a great recession story. It’s not
just a housing story,” Partridge says. “There’s something else
going on.”
Perhaps a clue lies across the Atlantic, in Europe, where
people don’t move as much as Americans do. With the
exception of some Scandinavian countries and the United
Kingdom, the migration rate in every European country
is lower than ours. A mere 1 percent of workers moved
annually within European Union member states between
2000 and 2005, according the Institute for the Study of
Labor in Bonn.
“They are much more attached to their community, culturally,” says Partridge. “Low migration is one reason why
Europe’s unemployment traditionally has been higher than
that of the United States.”
Are Americans feeling the same way, and acting on it?

Are we opting to consume some of our greater prosperity
over the past several decades in the form of greater stability?
Although mobility remains highly valued in America,
every migrant has a story about going home. Migrations produce a “counter current,” according to David Cressy in his
book Coming Over. Modern estimates of the English population of New England in 1640 range from 13,500 people to
17,600. But roughly 21,000 settlers had departed England
for New England during the prior decade. He estimates that
as many as one in six New England migrants may have
permanently or temporarily returned home.
Susan Matt, a history professor at Weber State University
in Utah, argued in her 2011 book Homesickness: An American
History that attachment to place has always been embedded
in the American story. Hidden in the migration narrative,
she wrote, are the people who not only emotionally longed
for home, but actually returned. “Although millions end up
staying, they often set out with the belief that they will soon
return to England, Italy, China, Poland, or Mexico.” Matt
noted, “For many, the American dream has always been to
come to America, get rich, and return home.”
The blacks and whites, too, who migrated north for
opportunity in the last century also got homesick. Many of
those migrants returned south later in the 20th century,
often at retirement, once economic and social conditions
improved.
Geographical attachment, if that’s the force behind the
current mobility decline, may mean a worker has to weigh
cash against the comfort of the familiar. Last year, Susan
Philipp, 53, decided against moving from Las Vegas to
Sacramento where the property development firm for which
she’d worked for 10 years relocated its home office after the
housing bust. She was vice president of the propertymanagement division. It was a good job, but she had lived in
Las Vegas for 25 years. She and her husband enjoy strong
community ties. They have friends — he in his trap-shooting
league and she in her real estate networking group. She also
sits on the county zoning board, a position through which
she helps shape their home city.
“I loved that job. I loved that company,” she says. “But
sometimes you have to look at what makes sense for you in
the long run. And sometimes, it’s just a job.”
RF

READINGS
Cressy, David. Coming Over. Cambridge: Cambridge University
Press, 1987.
Matt, Susan J. Homesickness: An American History. New York: Oxford
University Press, 2011.
Partridge, Mark D., Dan S. Rickman, M. Rose Olfert, and
Kamar Ali. “Dwindling U.S. Internal Migration: Evidence of a

Spatial Equilibrium or Structural Shifts in Local Labor Markets?”
Regional Science and Urban Economics, January 2012, vol. 42, no. 1-2,
pp. 375-388.
Molloy, Raven, Christopher L. Smith, and Abigail Wozniak.
“Internal Migration in the United States.” Journal of Economic
Perspectives, Summer 2011, vol. 25, no. 3, pp. 173-196.

Region Focus | Second/Third Quarter | 2012

19

Can new cities with better rules accelerate economic growth in
Honduras and other developing nations?
BY K A R L R H O D E S

ost major cities grew gradually over many years
based on the advantages of their locations. But
down through the centuries, a few cities have
experienced explosive growth driven by novel rules and
social norms.
Legal gambling, for example, quickly transformed Las
Vegas from a desert water stop into one of the world’s most
successful entertainment destinations. Religious freedom
became the main attraction to Philadelphia as it grew
rapidly from a small Quaker village into the largest and
most modern city in the British colonies. A market-based
economy and British common law converted Hong Kong
from a rocky island off the coast of China into a major
center for international trade and finance.
Today, many prosperous cities offer religious freedom,
the rule of law, and free enterprise — not to mention casino
gambling. Yet many people are stranded in nations that lack
the basic institutions that drive economic growth.
Economist Paul Romer, of New York University’s Stern
School of Business, is trying to accelerate the global
evolution of better rules by promoting his concept of
charter cities — largely autonomous metropolises built from
scratch — that would attract the hundreds of millions of
people who are expected to migrate from rural to urban
areas by the middle of this century. Charter cities promise to
offer better institutions than those found in many countries.
Economists recognize the vital role of strong institutions
— such as legal structures, market mechanisms, and financial systems — in the development of prosperous nations.
Romer boils this concept down to the simpler idea of better
rules, most importantly provisions in charter cities for free
entry, free exit, and equal protection under the law. In addition to better rules, each charter city would provide enough

PHOTOGRAPHY: KINGWU/VETTA/GETTY IMAGES

M

20

Region Focus | Second/Third Quarter | 2012

uninhabited land to accommodate millions of people.
Residents could move in and out from host countries and
from other nations around the world. Romer believes this
new competition would accelerate the adoption of better
rules globally.
People have applauded Romer’s idea, which emerged
from his highly influential academic research into how bad
rules and antiquated social norms can slow down the
application of beneficial new technologies. Foreign Policy
magazine named him one of the “top 100 global thinkers of
2010,” and Harvard Business Review listed his charter cities
proposal among its “breakthrough ideas for 2010.”
But Romer wants charter cities to become more than an
interesting concept; he wants to bring the idea to fruition.
So in 2008, he formed a nonprofit organization called
Charter Cities to encourage nations to try it.
The president of Madagascar expressed strong interest
in 2009, but his political rivals forced him to resign
(for unrelated reasons) before he could begin to implement
Romer’s proposal. But as one door closed, another one
opened: A few months later, a coup occurred in Honduras,
and officials from the country’s new administration
contacted Romer. By February 2011, the Honduran National
Congress had amended its constitution to authorize a
special development region — the Región Especial de
Desarrollo (RED). And in July 2011, the Honduran congress
passed a constitutional statute that broadly defined how the
RED would be governed.
To help insulate the special zone from future political
instability, the Honduran congress gave it a high degree of
autonomy, but it stopped short of giving up sovereign control. The land would remain part of Honduran territory, and
the government would place it in a trust to be managed by

PHOTOGRAPHY: WFP/HETZE TOSTA

Can a charter city do for Honduras what Hong Kong did for China?

RED authorities, including a governor and a Transparency
Commission, both appointed by the president of Honduras.
The RED’s ability to govern itself includes the authority
to regulate currency. “Narco-trafficking and bribery are
major challenges in Honduras,” Romer explains. So the
enabling legislation gives the RED the option to ban the use
of physical currency. “The idea was not so much that a cash
ban would be a panacea for crime, but that it could make
illegal transactions and bribery more difficult and costly and
send a clear signal about how law enforcement in the new
zone will be much more stringent.” This cashless option is
an example of how Honduras has adapted Romer’s charter
cities idea to its own circumstances.
Nonetheless, Romer remains at the forefront of the RED
initiative. President Porfirio Lobo appointed him to the
interim Transparency Commission, and its members elected
him chairman. (Romer has pledged not to profit financially
from his involvement in the RED.) Other members of the
commission include George Akerlof, professor of economics
at the University of California, Berkeley and a Nobel
Memorial Prize winner; Harry Strachan, founding partner of
Mesoamerica, a consulting firm based in Costa Rica
and Colombia that makes social investments through its
foundation; Ong Boon Hwee, former chief operating officer
of Singapore Power; and Nancy Birdsall, president and
co-founder of the Center for Global Development, a nonpartisan think tank in Washington, D.C., that develops ideas
and promotes policies to reduce poverty.
Initially, the Transparency Commission would oversee
the RED’s legislative and executive functions, including
the governor. As a check on the commission’s authority,
Honduras retains the power to change the RED’s enabling
legislation with a two-thirds majority of the Honduran congress and a referendum among residents of the RED, but
Romer expresses confidence that Honduras will stay the
course. The Honduran Congress is currently fighting off a
constitutional challenge to the RED while working to determine the boundaries of the zone, which is expected to be

1,000 square kilometers, or about the size of Hong Kong.
Comparisons to Hong Kong are inevitable. Located in
China, the semi-autonomous city-state grew rapidly after
World War II under British common law and a market-based
economy. Seeking to replicate that success, Chinese leader
Deng Xiaoping established four special economic zones that
also prospered, beginning with Shenzhen in 1979. He later
opened 14 additional coastal cities to foreign investment.
“Britain inadvertently, through its actions in Hong Kong,
did more to reduce world poverty than all the aid programs
that we have undertaken in the last century,” Romer says.
There are many differences between Hong Kong in the 20th
century and Honduras in the 21st century, but Romer
believes the basic question remains the same: How can
people in developing countries get better access to jobs in
well-run cities?
“My focus on the potential for new cities in reform zones
is an applied approach that I hope will lead to deeper
insights about the dynamics of rules,” Romer says. “Human
progress is driven by the co-evolution of technologies
and rules.”

Lawyers, Guns, and Money
People can create new cities from scratch, “but it is complex,
and the amounts of money involved can be very large,” says
Homi Kharas, deputy director for the Global Economy and
Development Program at the Brookings Institution in
Washington, D.C. He agrees that better rules could significantly boost economic development in the RED as long as
investors are confident that Honduras will maintain its
commitment to better rules.
“In order for this to work, one has to have some new
institutional structure that enforces long-term credibility,”
Kharas says. “Whether or not that has to be backed up with
military power and support is an open question. It certainly
has to be backed up with legal and judicial enforcement.”
To address that issue, the Transparency Commission
plans to collaborate with partner countries that would help
ensure the rule of law. “I had always imagined that the host
[nation] and the partner countries would agree to the governance arrangement beforehand,” Romer says. But the
Hondurans realized that process could take longer than the
political window they had to move forward. “Instead of
reaching out to their allies beforehand, they drafted enabling
legislation that leaves open opportunities for ample foreign
participation.”
For example, the island nation of Mauritius, off the
southeastern coast of Africa, has agreed in principle to allow
its supreme court to hear appeals from judicial cases in the
RED. Mauritius has become one of the most prosperous
countries in Africa since gaining its independence from
Britain in 1968. It is a stable democracy with free elections
and a positive human rights record. It also has attracted
considerable foreign investment, partly by developing a

Region Focus | Second/Third Quarter | 2012

21

special export-processing zone that eventually led to
lower trade barriers throughout the nation.
The Mauritian commitment is a start, but to attract
enough financing to build a metropolis from scratch, the
RED would need the sanction and protection of the United
States to ensure stability, Kharas says. The United States is
looking for alternatives to traditional foreign aid, particularly proposals that link foreign aid to trade and investment
opportunities, he notes. “But usually those types of activities
start off as small pilots. The difficulty with the charter city
idea is that it is difficult to pilot on a small scale.”
If not the United States, how about Canada? In April
2012, Romer and Brandon Fuller, director of the Charter
Cities nonprofit, broached the subject in a paper published
by the Ottawa-based Macdonald-Laurier Institute, a think
tank that explores Canadian public policy issues. Fuller and
Romer argued that Canada is particularly well-suited to
partner with Honduras. “As a model of good governance in
the Americas, Canada operates according to well-established rules and sensible reform,” they wrote. Based on
survey data from 2007-09, Gallup estimates that 45 million
adults living elsewhere in the world would move to Canada
permanently if they had the chance. Of all the countries in
the world, that preference was second (a distant second)
only to the United States.
Generous immigration policies alone cannot satisfy “this
pent up demand for more Canada,” Fuller and Romer wrote.
But Canada could export its good governance by playing a
strong leadership role in the RED. They suggested many
possible areas where Canada could provide expertise including procurement, border control, customs, taxes, and law
enforcement. The Royal Canadian Mounted Police, for
example, could train and supervise police officers.
In late May, Romer outlined the Honduran initiative for
the Committee on Foreign Affairs and International
Development in Canada’s House of Commons. Some members of the committee expressed interest, but none of them
seemed ready to endorse the idea of Canadian participation.

Migration Power
Early American colonies attracted migrants who were ambitious, courageous, and determined enough to cross the
ocean seeking better opportunities. So it is not surprising
that these colonies prospered in the long run. The same was
true for many American pioneers who pushed west — sometimes at the expense of the indigenous population —
seeking natural resources, greater opportunities, and the
chance to make their own rules in some cases. Romer and
Fuller have contended that developing charter cities could
“re-create the frontier conditions that give people new and
better options” without conquest and coercion.
Today, the mobility of the world’s population is limited
not so much by the availability of arable land but by political
barriers. North Koreans, for example, cannot simply stroll
through the demilitarized zone to South Korea. Likewise,
millions of eager migrants are trapped in African nations

22

Region Focus | Second/Third Quarter | 2012

that are plagued by drought, famine, war, and corruption.
“The gains from eliminating migration barriers dwarf —
by an order of magnitude or two — the gains from eliminating other types of barriers,” wrote Michael Clemens in a 2011
article in the Journal of Economic Perspectives. Clemens is a
senior fellow at the Center for Global Development.
“For the elimination of trade policy barriers and capital flow
barriers, the estimated gains amount to less than a few
percent of world GDP,” he continued. “For labor mobility
barriers, the estimated gains are often in the range of
50 percent to 150 percent of world GDP.”
Kharas notes, however, that the biggest migration gains
are generated by people moving from poor countries to rich
countries. “When doctors go from Mexico to the United
States, their salaries, their value-added, goes up enormously,”
he says. “That same logic does not apply to migration
from poor countries to other poor countries.” Honduras in
particular, with estimated per capita GDP of $4,300 in 2011,
is among the poorest nations in the Western Hemisphere.
To reap substantial economic benefits from migration,
the RED would have to succeed on a scale that would significantly improve the labor market of the entire country,
Kharas says. But if the RED could provide better rules and
opportunities for millions of people, and Honduras only has
about 8 million residents, then why not apply the charter
city concept to the entire country?

Cities From Scratch
It’s often said that the three golden rules of real estate development are location, location, and location. Honduran
officials have yet to define the boundaries of the RED, but
Romer expects them to set aside uninhabited land with
access to the coast.
“Here you are taking a place that was not a prime location
to begin with, and you are trying to make it a special place,”
says Vernon Henderson, professor of political economy at
Brown University. Perhaps better institutions alone will
attract waves of immigrants and foreign direct investment
to the RED, but Henderson doubts it. “You have to give
them other forms of subsidies,” he predicts. “You have to
invest in infrastructure to try to overcome any deficiencies
in the location.”
Henderson says it would be difficult for a poor nation like
Honduras to pump lots of money into a charter city. “I will
be surprised if that actually happens because I think it will
get bogged down politically,” he says. “I understand that
everyone is wildly enthusiastic now, but eventually you have
to turn to the nitty-gritty of how you are going to put infrastructure in there.”
Kharas is somewhat more optimistic about the prospect
of building a city from scratch. The area of mainland China
across from Hong Kong has sprung up from almost nothing,
he notes. And so has the Iskandar project across from
Singapore in Malaysia. Iskandar is an initiative of the
Malaysian federal government and the Johor state government to develop a special economic zone to capitalize on

Singapore’s success. “So it is possible to create new cities
that end up being very dynamic,” he says.
Clearly, location will be important to the RED, but
Kharas is more concerned about how quickly the RED can
achieve economies of scale and the economic and social networks that make cities efficient. On this point, Henderson
agrees. “A lot of the efficiency of working in cities comes
from networks and interchange of ideas and interchange of
goods between firms and what goes on in a dense urban
environment,” he says. If those networks do not develop
quickly, Henderson predicts that the economic base of the
city will be limited to foreign direct investment — laborintensive manufacturers that are looking for cheap labor in a
stable environment where their factories are less vulnerable
to expropriation.
“Investors are concerned about headline-grabbing
expropriation in some parts of the developing world,”
Romer concedes. “But the much more salient risk is death
by a thousand cuts — the ex-post manipulation of contracts
in areas that involve shades of gray, be it by government officials or firms that specialize in exploiting weak governance.”
The RED’s enabling legislation attempts to assuage such
fears by instituting independent law enforcement and
judicial functions and by allowing partner countries to
appoint members to the Transparency Commission. Also,
contract disputes in the RED could be subject to international arbitration and review by the Mauritian Supreme
Court. Critics have charged that achieving stability via
foreign influence and control amounts to neo-colonialism,
but Romer argues that colonialism was based on coercion
and condescension, while charter cities are based on giving
people and governments more and better choices.

Who Gets What?
If the RED can achieve stability, credibility, and critical
mass, it might be able to leapfrog ahead of other Central
American cities that are encumbered by inefficient
rules, just as Hong Kong and Singapore vaulted over more

established Asian cities. If that happens, Honduras would
gain a booming new city, more international credibility,
greater impetus to improve its rules, and a viable alternative
for thousands of Hondurans who take great risks to move
illegally to the United States each year.
Partner countries would support the RED to promote
peace, stability, and prosperity in a developing nation — and
because it’s the right thing to do, Romer says. “Risk has not
kept countries and international financial institutions from
participating in traditional large-scale aid projects in the
past,” he adds. “The important thing now is to recognize
that the traditional approach has had only modest
success and then develop a willingness to try something
different.” By helping to set up better systems of governance, partner countries could have a more lasting impact
on developing countries.
The United Nations expects the urban population in
developing countries to double from 2.6 billion to 5.2 billion
by 2050. “Under conditions of policy-as-usual, people will
flock to slums that surround cities whose governments
either do not want additional residents or are incapable of
accommodating them,” according to Fuller and Romer.
“This needn’t be the case. The coming wave of urbanization
has the potential to dramatically reduce global poverty, and
to do so in a way that is not dependent on aid or charity.”
Romer is staking his growing reputation as a socioeconomic entrepreneur on the idea of charter cites. “The job of
every economist is to make the world a better place,” Romer
told a Honduran newspaper last year. “Some economists do
this by developing theories about how an economy works.
This is what I did in the early part of my career,” he said.
“Now I want to make a practical contribution, a real difference in people’s lives. … My hope is that in the near future,
every family on earth can choose to move to one of several
different cities that are all competing to attract new residents,” he concluded. “It would be the reward of a lifetime
for an economist like me if I could help the world take even
a small step toward achieving this dream.”
RF

READINGS
Clemens, Michael A. “Economics and Emigration: Trillion-Dollar
Bills on the Sidewalk?” Journal of Economic Perspectives,
Summer 2011, vol. 25, no. 3, pp. 83-106.

“Overcoming Barriers: Human Mobility and Development.”
Human Development Report 2009, United Nations Development
Programme, New York: Palgrave Macmillan, 2009.

Fuller, Brandon, and Paul Romer. “Success and the City:
How Charter Cities Could Transform the Developing World.”
Macdonald-Laurier Institute, April 2012.

“Population Distribution, Urbanization, Internal Migration
and Development: An Internal Perspective.” United Nations
Department of Economic and Social Affairs Population
Division, 2011.

“Hong Kong in Honduras.” The Economist, Dec. 10, 2011,
pp. 65-67.
“One-on-One: Paul Romer.” PREA Quarterly, Spring 2011,
pp. 72-78.

Romer, Paul. “Technologies, Rules, and Progress: The Case for
Charter Cities.” Center for Global Development, March 2010.

Region Focus | Second/Third Quarter | 2012

23

Are federal disability benefits becoming a general safety net?
BY J O H N M E R L I N E

ne of the often-told stories of the anemic
economic recovery has been the dreary prospects
for workers. As of July 2012, there were 811,000
more long-term unemployed than when the recession
officially ended in June 2009, and there were 412,000 more
who had given up looking for work. The Bureau of Labor
Statistics’ expanded unemployment measure was 15 percent
in July 2012.
As a result, discouraged workers are increasingly dropping out of the labor force. While the number of people with
jobs has climbed 2.7 million since June 2009, the pool of
Americans who aren’t in the labor force at all has shot up by
7.5 million.
A great many of these people will likely never come back
to the workforce even if the economy does rebound: not
because they’ve aged into retirement but because they’ve
signed up instead to get disability benefits — joining the
federal government’s Social Security Disability Insurance
(SSDI) program. This program, started in the late 1950s, was
meant to provide much-needed benefits to those who were
too disabled to work, but weren’t yet eligible for Social
Security benefits. The current massive exodus of workers to
the disability rolls could have worrisome implications for
the solvency of the SSDI program — which is scheduled
to become insolvent in less than four years — as well as
the federal government’s broader entitlement spending
problem. The shift could also cut the growth potential of the
U.S. economy by permanently shrinking the available pool
of labor.

O

How a Law Changed Incentives
The scale of the issue is significant. In just the first six
months of 2012, almost 1.5 million workers applied to get
into the SSDI program. That’s more than applied in the
entire year in 1998. Last year, SSDI received 2.9 million
applications, which is nearly double the figure from a
decade earlier. Since the economic recovery started, more
than 8 million have applied for disability benefits. If recent
history is any guide, more than a third of those who apply
will get on the program within months.
As a result, the number of SSDI enrollees is climbing
quickly. Through August of this year, more than 653,000
workers were awarded disability benefits, and over the past
three years, more than 3 million joined the program. Even
after accounting for those who exit SSDI — either because
they age into retirement, die, or are removed from the program — the number of workers on disability has climbed by
more than 1.1 million since June 2009, a 15 percent increase.
Today, there are 6.6 people on disability for every
100 people actively working. That’s double the ratio from
20 years ago, and almost three times what it was in 1972.

24

Region Focus | Second/Third Quarter | 2012

Consequently, spending on the program has more than
doubled in the past decade, and SSDI now accounts
for almost 20 percent of Social Security’s budget, up from
10 percent in 1988.
The recent growth in SSDI is part of a longer-term trend.
After remaining relatively flat throughout the 1980s, enrollments and costs started their upward march in the early
1990s (see charts). Coincidentally, that was just about the
time President George H.W. Bush signed the Americans
with Disabilities Act, a law designed to end discrimination
against disabled workers and provide them more opportunities to stay in the workforce.
The growth comes despite the fact that the physical
demands of most jobs have decreased, the average health of
adults has improved, and prevalence of mental disorders in
the country hasn’t changed, while treatments for mental
illnesses have greatly expanded. Research by Mark Duggan
of the University of Pennsylvania and Scott Imberman of
Michigan State University found, for example, that the
health of adults between ages 50 and 64 showed substantial
improvement between 1984 and 2004.
Nor does the aging of the U.S. population appear to be
responsible. In fact, the average age of those awarded SSDI
benefits is lower than it was in the 1980s for both men and
women. The average age dropped to 49.5 in 2010 for men,
from 51.2 in 1980; among women the average age fell to
48.8 years from 51.1. Almost 53 percent of men awarded SSDI
benefits in 1980 were over age 55. By 2010, only 42 percent
were. Among women, 51 percent of those who enrolled in
1980 were over age 55, but just 36 percent were in 2010.
What, then, explains the rapid rise in the ranks of the
disabled? The biggest driver seems to have been a change in
the eligibility rules enacted in 1984. When the program was
added to Social Security, the goal was to have it provide early
retirement benefits for those were “totally and permanently
disabled.”
But the 1984 change “substantially liberalized the disability screening program,” according to economists David
Autor of MIT and Duggan in their extensive review of the
program. The reforms shifted screening rules from a list of
specific impairments to a process that put more weight on
an applicant’s reported pain or discomfort, even in the
absence of a clear medical diagnosis. In addition, workers
could qualify if they had multiple conditions that affected
their ability to work, even if none of the conditions was
disabling on its own.
Not surprisingly, more and more workers were awarded
disability benefits based on ailments that relied more on
patient self-reporting and that often were not easily
diagnosed independently. For example, “musculoskeletal
and connective tissue” problems, which includes back pain,

1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012

$BILLIONS

accounted for just 17 percent of new enrollees in 1981,
Federal Spending on Worker Disability (SSDI) Benefits
but 33 percent in 2010. The share of awarded benefits
based on mental disorders — ranging from schizo140
phrenia to mood disorders such as depression and
120
bipolar disorder — climbed from 10 percent in 1981
to 21 percent in 2010. Mood disorders alone now
100
account for 15 percent of all workers currently on
80
disability.
60
Another driving force, Autor and Duggan found,
is the fact that the value of disability benefits relative
40
to wages has risen “substantially” since the late 1970s,
20
because of the way initial benefits are calculated.
0
That’s particularly true at the lower end of the
income spectrum. When the value of SSDI benefits
and the value of the Medicare benefits that SSDI
SOURCE: Social Security Administration
enrollees qualify for are combined, the share of
income replaced by the disability program climbed
“continue to rise over the next few years by more than
from 68 percent in 1984 to 86 percent in 2002 among lowerotherwise would have occurred.”
income men aged 50-61. A possible indicator of the effect
The fast-growing ranks of enrollees are putting increased
this has had, Autor and Duggan note, is that “the increase in
financial strain on SSDI. According to the latest report from
[SSDI] enrollment during the last two decades was largest
the Social Security actuaries, SSDI is currently scheduled to
for those without a high school degree.”
exhaust its trust fund in 2016, which is two years sooner than
the program projected just a year before. The growth in
The Recession’s Role
SSDI enrollees is also accelerating the drive of Medicare
Still, there’s little question that the last recession and the
toward financial distress; that’s because after two years,
painfully slow recovery have contributed significantly to the
disability enrollees qualify for Medicare coverage. By 2009,
program’s growth in the past four years. According to data
SSDI accounted for $70 billion of Medicare’s budget,
from the Social Security Administration, disability awards
according to the CBO.
were climbing at an average annual rate of less than 2 percent
Then there’s the economic impact of all these lost
between 2003 and 2007. But they shot up 8.7 percent in
workers. Several experts who’ve examined the SSDI pro2008, 10 percent in 2009, and 6.8 percent in 2010.
gram have come to the same conclusion: Workers who get
“The very recent recession of 2008-2009 resulted in an
on federal disability almost never come back to work.
increase in disability incidence that was exceeded only by
As Autor put it, “the program provides strong incentives
the incidence rate in 1975,” Social Security Administration
to applicants and beneficiaries to remain out of the labor
Chief Actuary Stephen Goss told a congressional panel in
force permanently, and it provides no incentives to employDecember. He added that “when employment is good, when
ers to implement cost-effective accommodations that would
employers are trying to employ lots of people, people with
enable disabled employees to remain on the job.”
impairments, like everyone else, find it easier to find a job.”
Moreover, SSDI can keep workers from reentering the
But when employment opportunities are scarce, some
labor force for months, and sometimes years, as they work
people who otherwise could work apply for disability
through the approval process, since by definition they can’t
instead. Duggan, for example, estimates that the higher
get disability if they are still working. A little more than a
unemployment rate in 2011 contributed to 3,000 more
third of those who apply get on the program within four
people applying for SSDI each week than would otherwise
months. Among those who are rejected, more than half
have occurred.
appeal, a process that can take years to complete, during
This is compounded by the fact that there are so many
which time the applicants have to stay out of the job market.
workers who, despite repeated extensions, have exhausted
But since judges overturn the initial rejection 75 percent of
their unemployment insurance benefits. Matthew Rutledge,
the time, it’s not surprising that so many stick it out.
a research economist at Boston College’s Center for
At the same time, the lengthy approval process can
Retirement Research, found that the unemployed are less
impose serious financial harm on those in need. James
likely to apply for disability when their unemployment
Allsup, founder and CEO of Allsup, an SSDI representation
benefits get extended, but are “significantly more likely to
company, told the House Ways and Means Committee,
apply” when those benefits run out.
“An overwhelming majority of SSDI applicants face grave
What’s more, disability applications are continuing to go
financial and personal setbacks while stuck in the federal
up even as the unemployment rate falls modestly, according
disability backlog, including worsening illness, drained
to the Congressional Budget Office. Because of this, the
retirement funds or other savings, the loss of existing health
CBO projects that the number of people on disability will

Region Focus | Second/Third Quarter | 2012

25

10
9
8
7
6
5
4
3
2
1
0
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012

IN MILLIONS

Workers Enrolled in SSDI

NOTE: 2012 figure through August
SOURCE: Social Security Administration

insurance, missed mortgage payments, and even foreclosure
and bankruptcy.”
The loss of all these workers — at least some of whom
presumably could continue to be productive members of the
labor force — can have a deleterious effect on the economy,
“resulting in a loss to society of the economic contributions
those workers could have made,” according to a White
House report.

How to Protect SSDI?
Despite these mounting problems, there seems to be relatively little discussion among policymakers about reforming
SSDI. Reform is possible, however. That, at least, is the
lesson taught by the Netherlands, which confronted a similarly difficult disability problem. The country enacted a
series of reforms in the 1980s and 1990s, which included
benefit cuts as well as incentives for employers who were
asked to bear some of the costs of disability claims by their
workers. In addition, a 2002 reform required employers and
workers, along with a consulting physician, to put together
return-to-work plans. These and other changes resulted in a
sharp drop in the number of Dutch signing up for the country’s disability program in the past decade.
In the United States, some suggest that Congress could
resolve the problem simply by dedicating more of the money
that comes in through the Social Security payroll tax to the
disability program. Currently, SSDI is financed through a
1.8 percent payroll tax, which is part of the overall Social

Security tax. “The current SSDI revenue problem could be
solved by this type of small adjustment,” David Heymsfeld,
a policy adviser for the American Association of People with
Disabilities, wrote in June on the group’s blog.
While technically true, shifting money into the
Disability Insurance program would also hasten the
day when Social Security becomes insolvent (which is
currently expected to occur in 2035), because it would take
money currently dedicated to the Social Security trust fund
and use it to pay disability benefits. At the same time,
shifting the money around would do nothing to resolve the
disability program’s unsustainable growth trend.
Congress has a host of other changes it could
make to the program that would reduce SSDI’s enrollment
and cost growth, according to academic and government
analysts, although each could give rise to questions of
fairness. Among the options would be simply to return
to the pre-1984 eligibility rules, making it harder for people
to get on the program without a specific medical diagnosis.
Congress could also reduce the benefit amounts, which
would in turn make SSDI a less viable alternative than work
for those who are able to perform a job. Or it could restrict
benefits based on income and assets.
Still another option would be to move more people off
SSDI through what are called “Continuing Disability
Reviews.” Aggressive CDRs from 1980 through 1983 cut the
disability rolls by about 10 percent. It’s worth noting, too,
that this decline occurred during the very deep and painful
1981-82 recession, which lasted 16 months and pushed the
unemployment rate up to 10.8 percent.
Autor and Duggan have suggested a more comprehensive
front-end approach, one that extends existing private
disability insurance (PDI) into a universal PDI plan along
the lines of unemployment insurance. The expanded PDI
would provide partial income replacement, rehabilitation
services, and other help for up to 24 months, all geared
toward keeping those with partial disabilities in the workplace, or transitioning them to other suitable jobs. But the
proposal is not without its own challenges, since it would be
complex and would likely meet resistance from business
communities required to buy the insurance.
The bottom line, though, is that once the SSDI Trust
Fund is exhausted in 2016, Congress will have to act in one
way or another to keep the program functioning and
assisting the disabled who need the help.
RF

READINGS
Autor, David H. “The Unsustainable Rise of the Disability Rolls in
the United States: Causes, Consequences, and Policy Options.”
National Bureau of Economic Research Working Paper No. 17697,
December 2011.
Autor, David H., and Mark Duggan. “Supporting Work: A Proposal
for Modernizing the U.S. Disability Insurance System.” The
Brookings Institution and the Center for American Progress,
December 2010.

26

Region Focus | Second/Third Quarter | 2012

“Social Security Disability Insurance: Participation Trends and
Their Fiscal Implications.” Congressional Budget Office,
July 22, 2010.
Rutledge, Matthew S. “The Impact of Unemployment Insurance
Extensions on Disability Insurance Application and Allowance
Rates.” Center for Retirement Research at Boston College
Working Paper No. 2011-17, October 2011.

Marcellus Shale harbors
natural gas in varying
depths under parts of
West Virginia, Pennsylvania,
New York, and Ohio.
It also underlies portions
of Maryland, Virginia,
Kentucky, and Tennessee.

Shale gas brings back
cheap energy, but
what’s the risk?
BY B E T T Y J OYC E N A S H

hale deposits are yielding more natural gas than ever,
thanks to advances in drilling technologies. Though
drilling operations can disrupt communities, they
generate business for local merchants and jobs. Mineral
extraction is a two-way street. And it may be a congested
two-way street. Just ask Don Riggenbach.
“I’m glad they’re here, but there’s stuff we have to
endure,” says Riggenbach, president of the Wetzel County
Chamber of Commerce. The county lies along the Ohio
River in northwestern West Virginia, and is a drilling hot
spot. During a brief telephone interview, four dump trucks
hauling gravel rolled down the main road where his business
is located.
By 2035, almost half of the United States’ natural gas may
come from shale. One of the biggest fields, or “plays,” of
shale gas in the world, the Marcellus Shale, sprawls at various
depths under chunks of West Virginia, Pennsylvania, New
York, and Ohio; it also underlies small parts of Maryland,
Virginia, Kentucky, and Tennessee. A different, smaller gas
play underlies several counties in North Carolina.
Though the widespread development of shale gas promises comparatively clean and cheap fuel, along with jobs,
tensions have flared over costs that could be imposed on
society later — long-term effects on environment and
health. All energy production poses some risks; even wind
power, with its turbines, can kill birds and interfere with
radar signals. Resource extraction always involves risk.
And damage often shows up later, sometimes much later.

P H OTO G R A P H Y: D O U G L A S D U N C A N , U . S . G E O LO G I C A L S U RV E Y

S

Fracking
Rising natural gas prices over the previous decade spurred
the innovations that made these hard-to-reach deposits economically viable. Gas was first produced from the Marcellus
formation in 2005, in Pennsylvania. Gas prices peaked in
2008 at $10.79 per thousand cubic feet (mcf); this, along
with oil price spikes, helped drive the natural gas boom.

Drilling speeds and control have enabled the recovery of
shale gas, according to West Virginia University geologist
Tim Carr. Three-dimensional seismic imaging accurately
pinpoints gas deposits. High-pressure sideways drilling, up
to three miles out, puts more shale within reach. Injections
of 3 million to 5 million gallons of chemicals, grit, and water
shatter the shale. The water flows back to the surface; the
grit holds the shale open so the gas can migrate through.
This high pressure drilling with water is known as hydraulic
fracturing, popularly called “fracking.”
Fracking water is 0.5 percent additives, which amounts to
about 15,000 gallons of chemicals in a 3-million gallon injection, according to the U.S. Geological Survey. The recovered
water may hold brine, heavy metals, low levels of radioactive
contaminants from decaying uranium, and volatile organic
chemicals, which can include carcinogens such as benzene.
Water in the Marcellus region also may contain naturally
occurring methane. (Natural gas is composed mostly of
methane.) Though it’s not considered a health threat in
drinking water, concentrated methane displaces air and
poses explosion risks if not well ventilated. Methane from
abandoned gas wells, underground coal mining, underground gas storage reservoirs, and shallow, naturally
occurring gas can contaminate groundwater. It’s hard to
evaluate the risk of gas drilling on water supplies because few
empirical studies exist that use before-and-after well tests.

Public Goods
Many environmental resources, such as clean air or water,
are considered “public goods.” It can be hard to establish
systems of property rights for these goods.
And environmental protection can be expensive. Firms
make trade-offs between profits and the environmental risk.
“Revenues are typically realized quickly, but environmental
damages impose costs over many years,” writes economist
Lucas Davis of the University of California, Berkeley, in a

Region Focus | Second/Third Quarter | 2012

27

paper published in June by the Brookings Institution. Firms
can go out of business or be otherwise unable to finance
cleanup, which leaves the bill with taxpayers.
People worry, for instance, that chemicals in fracking
water can contaminate ground and surface waters.
Underground aquifers supply fresh water for wells, usually in
rural areas; municipal water systems draw drinking water
from rivers and lakes. It’s unclear whether chemicals can
migrate from fractures into aquifers.
Reports of water contamination from hydraulic fracturing have surfaced, but few, if any, peer-reviewed studies have
documented either the problem or its absence. It’s difficult
to definitively link a particular contamination event directly
to shale gas operations, according to Sheila Olmstead, an
economist at Resources for the Future (RFF). In 2011,
though, the Pennsylvania Department of Environmental
Protection fined Chesapeake Energy a record $1 million for
contaminating private wells through improper gas well
casing and cementing.
Michael John is president of Northeast Natural Energy,
based in Charleston, W.Va. “The source of peoples’ water
needs to be evaluated, tested prior to activity undertaken by
us or any other operators in proximity,” he says. “That provides everyone with a baseline as to what the water quality is
in those areas.” West Virginia law now requires pretesting of
wells within 1,500 feet of the well pad.
A 2011 study found measurable amounts of methane in
85 percent of 60 wells sampled in Pennsylvania and
New York, though the study found no evidence of drilling
fluids in well water. The study indicates methane levels
were 17 times higher, on average, in wells located within a
kilometer of active shale gas drilling sites, according to
Stephen Osborn, Avner Vengosh, Nathaniel Warner, and
Robert Jackson of Duke University’s Nicholas School of the
Environment. The chemistry in the well water matched the
methane’s composition from local gas wells.
Some drilling wastewater also ends up in municipal treatment plants, but it’s unclear how effectively it’s treated
there. In its study of shale gas development, RFF is investigating state data from such plants in Pennsylvania. “We
know where the water quality monitors are in relation to
those water treatment plants,” Olmstead says. “If there’s a
signal to pick up, we’re hoping we can pick it up.”
Methane in the air poses risks, too, which could weaken
that bridge to a low-carbon future, says Alan Krupnick, also
an RFF economist. Methane traps even more heat than
carbon dioxide — it’s a potent greenhouse gas. Methane
from gas wells can escape or is burned off at various stages of
production. John notes that drilling companies do not want
to burn methane unnecessarily since they can’t sell the lost
gas, but some methane flaring is necessary, to stabilize the
flow into the pipeline, which avoids unwanted combustion.
Also, wells in various stages of production can emit
chemicals into the air, including benzene and hexane, which
can cause cancer and other serious health effects. A new
EPA rule requires operators to capture air pollutants

28

Region Focus | Second/Third Quarter | 2012

starting in 2015. In the meantime, an estimated 13,000 new
and existing natural gas wells are fractured or re-fractured
each year; about 25,000 new wells are drilled annually.
Though one well may be only the diameter of a bowling
ball, a drilling operation can cover two to 10 acres; they’ve
altered the landscape in Marcellus country.

Expanded Footprint
The image of one lonely pump-jack drawing oil or gas on a
quarter acre has been replaced by shale drilling operations
that can include multiple wells, pipelines, condensate tanks,
and processing stations. (John notes that, to drain the equivalent amount of gas from one drill site today, producers
would have to drill many separate wells on many separate
sites, which would require more roads, more pipelines.)
Though communities may suffer environmental and health
damages, the resource can power the local and national
economy, providing jobs.
In New Martinsville, W.Va., “wet gas” deposits have
sparked a drilling boom. Wet gases are so named because
they can be liquefied into higher-value products such as
ethane and butane. The shale gas boom there provokes
mixed reactions.
“The roads are being torn up because of heavy trucks,
and the traffic through this little town is probably — this
is not an exaggeration — at least three times what it is
normally,” Riggenbach says. “Now we have gas drillers
coming in, not setting down roots, not buying household
items like carpet and refrigerators.” He owns a carpet and
tile business. The increase in traffic, though, means
“gas stations, restaurants, motels are all packed, all busy, and
that’s a good thing.”
Natural gas’ outsized footprint also affects people who
don’t own oil and gas rights to their property. In West
Virginia, surface ownership may have been sliced off from
the underground resource rights more than a century ago.
Morgantown, W.Va., attorney Jay Leon argues that the law
applies 19th century legal concepts to 20th century drilling
techniques.
“The net of that is you’ve got much greater impositions
placed on surface owners: These are very large, industrialscale operations,” Leon says. “In some cases, they go in 24
hour-seven-day-a-week operational cycles and last for
months. Before, they drilled shallow wells, and were off the
property in a month.”
Cases about surface owner rights are making their way
through state and federal courts. At the same time, states
and localities are changing laws as shale gas development
spreads. West Virginia recently changed its minimum setbacks from homes to a distance of 625 feet from 200 feet,
measured from the center of a shale gas well pad.
Pennsylvania recently passed a new law, Act 13, regulating
the industry and instituting user fees. “It was imperative
that rules be modernized and strengthened,” says John
Hanger, who served as secretary of the Pennsylvania
Department of Environmental Protection from 2008 to

PHOTOGRAPHY: NORTHEAST NATURAL ENERGY

2011. “The old laws didn’t reflect the volumes of water, materials, trucks, and the amount of gas now being produced.”
Act 13 also contains a controversial provision that established statewide zoning for oil and gas operations and
preempted local zoning ordinances. From the industry’s
perspective, notes economist Krupnick, uniform zoning
rules are desirable because it’s difficult to deal with a
plethora of localities. But, he adds, people may have
different preferences in different places. (Half of
Pennsylvania’s townships have no zoning laws.)
It’s unusual for the legislature to pass a statewide ordinance singling out an industry, says William Johnson, the
attorney who represents the Pennsylvania townships of
Peters and Mt. Pleasant in a lawsuit challenging the provision. “We’re not against the industry,” he says. “It’s been a
huge economic boom in this state. At the same time, there is
a price to pay for that. We think the removal of local
authority is too high a price, and not a legal price.” This
provision was ruled unconstitutional by the Pennsylvania
Commonwealth Court in July. The state has appealed to the
Pennsylvania Supreme Court.
As more and better science emerges about changes in
water and air quality from shale gas development, and as
economists study public preferences, it will be easier to
understand how people value those changes and compare
costs to benefits. For instance, if regulation is necessary to
mitigate possible damage, then tighter standards would raise
the price people pay for natural gas. How much would
people be willing to pay to cut air pollution, for example?
An 18-month study under way at RFF will highlight, among
other things, which shale-gas activities are associated
with risks that bother people the most, and identify how
regulations and voluntary industry responses can affect
those risks.
As an example of a voluntary response, many energy companies now manage water in a way that lessens the risks of
spills and saves money. Rather than transport millions of gallons to drill sites, some firms keep the water on site or
recycle it or both. That cuts the number of tanker trucks
driving local roads and the risk of rollovers and spills into
surface waters. Chesapeake Energy saves an estimated
$12 million a year in its Eastern Division with recycling,
according to Stacey Brodak, senior director of corporate
development. In northern Pennsylvania, Chesapeake
recycles nearly 100 percent of produced water.
Northeast Natural Energy also recycles wastewater,
according to Michael John. “To the extent that we don’t have
immediate applications for produced fluid, other producers
would have use of it. In the event that’s not an option, our
practice is to transport it to licensed underground injection
wells, operated in a way that places the fluid back at geologically appropriate levels.”
The industry is addressing these and other problems, says
spokesman Travis Windle of the Marcellus Shale Coalition, a
trade group of energy firms and suppliers. “We live here. My
six-week-old kid lives here. My parents have a rig behind

Northeast Natural Energy’s shale gas drilling operation is located in the
Morgantown Industrial Park in Monongalia County, W.Va.

their house. Like everything else, it’s about managing risk.”
Risks that aren’t managed well may leave toxic legacies.
Pennsylvania, for instance, still suffers pollution damage
from before the 1972 Clean Water Act. The pollution from
some orphaned coal mines drains into the Chesapeake Bay.

Staying in the Game
Mineral extraction brings jobs and money, but in cycles. The
natural gas industry in West Virginia employed almost
10,000 workers until 2008, with jobs mostly in construction
and support activities. That number fell below 8,000 during
the recession. Resource-rich states typically tax coal, natural
gas, oil, timber, or other minerals to weather downturns,
to offset the localities’ costs (such as environmental remediation, regulation, and infrastructure repair), and bolster
revenues in general.
The money can help areas, such as the southern West
Virginia coal fields, recover as an extractive industry
declines. For example, coal mining counties have median
household incomes below the state’s average, and family
poverty rates above average, according to a 2011 study by
the West Virginia Center on Budget and Policy. Health outcomes rank among the worst in eight of the 10 counties.
About 36 states impose these severance taxes to balance
the costs and benefits of volatility. West Virginia has levied
severance taxes on oil and gas and coal since the 1980s; the
taxes represented 11 percent of its general fund revenues in
fiscal 2012. Severance tax revenues are falling, though, as coal
production and natural gas prices decline.
The current glut of “dry” natural gas has shifted production away from those wells and into “wet” gas regions like
Wetzel County. A native West Virginian, John has been in
the energy business for 30 years. Of the high oil and wet gas
prices coupled with the low dry gas prices, he quips,
“Our industry is accustomed to boom and bust, but we’re
not used to both at the same time.”
Yet the soft prices don’t bother him. “It’s an excellent
time to accumulate dry gas properties,” he says. Analysts say
demand will rebound, partly through fuel switching for
power generation.

Region Focus | Second/Third Quarter | 2012

29

The Once and Future Fuel
But future shale gas yields are uncertain and evolving.
Original estimates of the Marcellus Shale’s “unproven technically recoverable” gas have been more than halved, from
410 trillion cubic feet to 141 trillion cubic feet, according to
the U.S. Department of Energy’s Annual Energy Outlook 2012.
Revised estimates forecast the Marcellus supply at about six
years’ worth of U.S. gas demand.
The estimates will continue to be tweaked as drilling continues, says John. “It could last for decades. I think it will.
I’m expecting my kids, their kids, and maybe even their kids
to participate in this business for a long time.”
The plentiful supply and low prices may hasten fuelswitching. Trucks running on liquefied natural gas (LNG)
would cut U.S. oil imports and carbon dioxide emissions;
LNG would be cheaper than diesel fuel. (The interstate
trucking industry’s transition to a hub-and-spoke system
may ease the problem of establishing LNG fueling stations.)
Chesapeake Energy, the second largest U.S. natural gas producer, has invested $150 million to develop 150 liquefied
natural gas fueling stations.
Low natural gas prices have also spurred electric utilities
to rebalance energy portfolios to avoid installing carbon
controls. Carbon dioxide emissions from natural gas are
about 45 percent lower per British Thermal Unit (Btu) than
coal — and bring no soot, no mercury. (A Btu is the amount

of energy it takes to heat a pound of cold water by one
degree Fahrenheit.) Dominion Virginia Power predicts
that by 2017, natural gas will represent 23 percent of its
electricity generation, compared to 12 percent in 2011.
“It’s a game changer, there’s no doubt about it,” says Jim
Norvelle, director of media relations at Dominion, parent
company of Dominion North Carolina Power and
Dominion Virginia Power. “For the near future, this
company is building either gas-fired or renewable stations.”
And Dominion plans also to convert its import terminal in
Baltimore to one for exporting LNG, for which demand is
expected to grow, especially in economies such as China’s.
The shale boom, environmental rules, lower economic
growth, and other factors have prompted coal plant closings.
In July, the Energy Information Administration reported
that plant owners and operators expect to retire about
8.5 percent of 2011 coal-fired capacity between 2012
and 2016.
Predictably, shale gas regulations may go too far for the
industry and not nearly far enough for environmentalists.
As costs and benefits become clearer, with more research,
policy tools can better satisfy concerns on both sides. In the
meantime, Don Riggenbach is hoping for Wetzel County
wells to produce big. The sooner royalties from wells, a share
of profits, arrive in area lease-holders’ hands, the sooner he’ll
be selling them new floor and wall coverings.
RF

READINGS
Andrews, Anthony, Peter Folger, Marc Humphries, Claudia
Copeland, Mary Tiemann, Robert Meltz, and Cynthia Brougher.
“Unconventional Gas Shales: Development, Technology, and Policy
Issues.” Congressional Research Service Report No. R40894,
October 2009.
Davis, Lucas. “Modernizing Bonding Requirements for
Natural Gas Producers.” Brookings Institution Discussion
Paper No. 2012-02, June 2012.

UPFRONT

Osborn, Stephen G., Avner Vengosh, Nathaniel R. Warner, and
Robert B. Jackson. “Methane Contamination of Drinking
Water Accompanying Gas-Well Drilling and Hydraulic Fracturing.”
Proceedings of the National Academy of Sciences of the United States of
America, May 2011, vol. 108, no. 20, pp. 8172-8176.

continued from page 5

months, totaled $1,387 for SNAP customers; credit card
sales were $1,835. In the third full year, 2011, SNAP sales
were nearly $8,000; credit card sales were $24,075. “Credit
and debit is huge,” she says.
The Byrd House Market in Richmond, Va., started
accepting EBT, credit, and debit cards last year. The market
is a project of the William Byrd Community House, an
89-year-old social service organization that has added a
small-scale farm to grow produce for its emergency food
pantry. Many Byrd House clientele and staff as well as
students from nearby Virginia Commonwealth University
receive SNAP benefits, says manager Ana Edwards.
Patricia Stansbury of Epic Gardens in Richmond oversees a table loaded with snap beans, onions, arugula,
white radishes, and buckets of fresh flowers. “Where’s the

30

O’Leary, Sean, and Ted Boettner. “Booms and Busts: The Impact of
West Virginia’s Energy Economy.” West Virginia Center on Budget
& Policy, July 2011.

Region Focus | Second/Third Quarter | 2012

baby bok choy?” a customer asks. People of all income levels
and occupations mingle at the market, which started in
2007, from students to moms stretching a food budget to
professional chefs. Shortly after the market opened, a man
wearing black trousers and a white chef ’s jacket had snapped
up the baby bok choy. “Sorry,” she says. “It’s all gone.”
— BETTY JOYCE NASH

Editor’s Note: In the Upfront section of our First Quarter
2012 issue, the article “East Coast Ports Prepare for Bigger
Ships from the Panama Canal” looks at port expansions to
accommodate “post-Panamax” vessels. It should be noted
that the Port of Baltimore, a deepwater port at the northern
fringe of the Fifth District, is preparing to make way for
these large container ships.

POLICYUPDATE
When Do Acquisitions Endanger the Financial System?
BY DAV I D A . P R I C E

n the Dodd-Frank Act of 2010, passed in response to
the 2008-09 financial crisis, Congress directed regulators to carry out a “financial stability review” when
banks and some other financial institutions seek approval
for mergers and acquisitions. Congress did so based on
concerns that the crisis had been driven in part by the scale
of the largest institutions, and the dependence of the rest
of the financial sector on their soundness. The law therefore requires the Fed and other regulatory agencies to
consider whether a proposed merger or acquisition would
lead to increased systemic risks to the stability of the
U.S. financial system. The Fed’s approval in February of
an acquisition by Capital One Financial Corp., a Fifth
District institution, provided some insight into how the
Fed will assess those risks.
Capital One, based in McLean, Va., had requested the
Fed’s approval to acquire ING Bank of Wilmington, Del.,
which had no branches, but which did business nationally
through the Web. Measured by the amount of deposits,
Capital One and ING Bank were the eighth-largest and
17th-largest depository institutions in the United States,
respectively. After the proposed merger, their combined size
would make the resulting enterprise the fifth-largest depository institution in terms of deposits and the 20th largest in
terms of assets.
After Capital One submitted its application for approval
to the Richmond Fed, the Richmond Fed transferred it to
the Board of Governors in Washington, D.C. It did so
because the financial stability review was a new requirement
and because public interest in the case was high, according
to Sabrina Pellerin, bank structure manager at the
Richmond Fed. The Board held several public hearings on
the application and received hundreds of letters pro and con.
The Dodd-Frank Act added the stability review to an
already-existing set of requirements for assessing mergers
and acquisitions. In addition to financial stability, the
Fed was required to determine, among other factors,
whether Capital One’s proposed acquisition would have a
significantly adverse effect on competition, whether its
financial and managerial resources would be adequate for
the acquisition, and whether it had a good record of
performance under the Community Reinvestment Act. In
connection with that review, the Board did not find any basis
to disapprove the application, but it did impose conditions
related to compliance with fair lending and other consumer
protection laws.
With regard to the stability review itself, the Board said it
would consider “a variety of metrics.” The metrics that it
named were the size of the combined firms as a share of the
overall size of the U.S. financial system, the availability of

I

substitutes for any “critical” products and services offered by
the firms, the interconnectedness of the firms with the rest
of the banking or financial system, the extent to which “the
resulting firm contributes to the complexity of the financial
system,” and the extent of its international activities.
But the Board stopped short of specifying numerical
limits on these measures that would lead to disapproval,
apart from limits already written into federal law (such as
the limit of a 10 percent share of nationwide deposits or
nationwide liabilities). The Board also stated that it would
consider qualitative factors, such as the complexity of the
institution’s internal organization, that would shed light on
the likely difficulty of resolving the institution in case of
financial distress. In addition, the Board indicated that
its lists of quantitative and qualitative factors were not
all-inclusive.
Applying this guidance to Capital One’s application, the
Board found that although the acquisition would leave it
“large on an absolute basis,” its assets, liabilities, leverage
exposures, and deposits relative to the U.S. financial system
as a whole — between 1.1 percent and 2.3 percent, depending
on the metric — would be “modest.” Because the business of
the combined firm would be mainly in traditional retail
banking activities that are competitive, the Board determined that the availability of substitutes was not a concern.
The Board also found no issues regarding interconnectedness, complexity, or international activities.
The approach described by the Board in the Capital One
case, with its reliance on case-by-case judgment, was somewhat in contrast with the approach set out in November by
the Basel Committee on Banking Supervision for identifying global systemically important banks. The Basel
Committee’s framework relies on a series of formulas to
arrive at weighted scores that represent a bank’s level of systemic importance. The scores can be overridden on the basis
of supervisory judgment, but only in “exceptional” cases.
The Board did announce numerical cut-offs in its Capital
One decision for one part of its acquisition approval
process: It stated that if a proposal involves an acquisition of
less than $2 billion in assets, results in a firm with less than
$25 billion in assets, or is a reorganization of an existing
holding company, then it “may be presumed not to raise
financial stability concerns” unless there is evidence to the
contrary.
Future acquisition applications referred to the Board
may yield more detailed insight into the Board’s approach.
In an American Banker online poll in February, following the
Capital One announcement, a plurality of 46 percent of
respondents held that “until the Fed actually rejects a deal,
it’s hard to tell whether the line has shifted.”
RF

Region Focus | Second/Third Quarter | 2012

31

INTERVIEW
John A. List

32

Region Focus | Second/Third Quarter | 2012

RF: Could you briefly describe what you mean when you
speak about field experiments in economics — and what
methodological issues should economists be concerned
with in order to do field experiments well?
List: A good place to start is to think about how economists
have used measurement tools in the past. The semiautomatic approach has been to go to your office and write
down a model and then go out and look for data. You don’t
generate your own data, but look for secondary data. After
you find mounds and mounds of data, you then overlay
assumptions on those data to make causal inference. If you
use a propensity score matching model, for example, you
invoke a conditional independence assumption. If you use
instrumental variables, you have exclusion restrictions. If
you use a difference in difference model, you make assumptions about the correlation between the error term and the
regressors. So that’s the typical approach. The overarching
idea is that the world is messy, so we need to write down a
model, go gather mounds and mounds of data, empirically
model those data, and then try to say something beyond a
correlation — try to make a causal statement that’s within
our theory.
About 50 or 60 years ago, Vernon Smith enters the
picture and says that we can learn about economic relationships using laboratory experiments. He starts to run lab

PHOTOGRAPHY: JASON SMITH/UNIVERSITY OF CHICAGO

In the 1950s, Vernon Smith — then teaching at Purdue
University and influenced by the work of Edward
Chamberlin, one of his instructors at Harvard
University — began conducting experiments to see
how people responded to various market incentives and
structures in a laboratory-type environment. At first,
many economists questioned the importance of
those experiments’ results. But by the 1970s, others,
including Charles Plott of the California Institute
of Technology, began using experiments to better
understand decisionmaking in various market settings,
and in 2002 Smith was awarded the Nobel Prize
in economics along with the psychologist Daniel
Kahneman of Princeton University.
In the mid-1990s, John List, who believed that
experimental work had provided unique insights into
human behavior, began conducting experiments of his
own, but in the field rather than in the lab. By setting up
carefully designed experiments with people performing
tasks they are used to doing as part of their daily lives,
List has been able to test how people behave in natural
settings — and whether that behavior is consistent with
economic theory. List’s field experiments, like Smith’s
lab experiments, were initially greeted with skepticism
by many economists, but that has changed over time.
List has published more than 150 articles in refereed
academic journals during the last 15 years, many on field
experiments and related work.
List began his career at the University of Central
Florida, with stops at the University of Arizona and the
University of Maryland before arriving at the University
of Chicago in 2005. While at Maryland, List served as a
senior economist with the President’s Council of
Economic Advisers, working largely on environmental
and natural resources issues. He is co-editor of the
Journal of Economic Perspectives and serves on the editorial boards of several other journals. Aaron Steelman
interviewed List at his office in Chicago in May 2012.

experiments in the 1950s, mainly using undergraduate
students, and he finds some very interesting results. And this
was before many of the measurement tools like instrumental
variables had been fully developed. Economics had a very
Victorian sensibility at that time. Now the beauty behind
experimentation is that you need to make one major
assumption to identify the treatment effect of interest, and
that’s proper randomization. So while the other empirical
approaches typically have assumptions that economists view
as quite contentious, experimentation has one that can be
externally verified.
You can then ask, why don’t we all just run lab experiments with students? For me, a first inclination is not to
gather data in the lab, but go to the field, though I have
always been sympathetic to the laboratory approach. I was
hit over the head when I was working in the White House in
2002 and I was arguing that as we revised the cost-benefit
guidelines we should take into account Danny Kahneman’s,
Dick Thaler’s, and Jack Knetsch’s work that shows
students have reference-dependent preferences in the lab.
Unfortunately, no one at the White House took me too
seriously. So when Glenn Harrison and I wrote the paper for
the Journal of Economic Literature in 2004 on field experiments, our first thought was: What is the first step outside a
typical lab experiment with student subjects that would still
have the environment of the lab but would capture better
the idea of a representative population? And that’s what we
call an artefactual field experiment. The first step is not to
really go outside the lab, but it’s to go and collect data
from a group of experts — farmers, CEOs, members of the
Chicago Board of Trade, whomever is of interest — and run
those people through a typical laboratory exercise. The field
element is the person in this case. You could say, well, you
have now dealt with the issue of representativeness, but it’s
still a very sterile and artificial environment when we gather
lab data.
So the next step that Harrison and I talk about is what we
denote as a framed field experiment. And what that means is
that we slowly add naturalness to the environment by asking
subjects to perform a task that they are used to performing,
using the same stakes that they typically use in their everyday lives. It’s having them do things that they normally do,
but they still know that they’re taking part in an experiment.
The last step in this process is to have randomization and
realism. And that’s what we call a natural field experiment.
In this type of data-generating exercise, I now have what the
naturally occurring data has, which is realism — that is,
I observe people behaving in the markets in which we want
to study. And then I use randomization to identify my treatment effect. We essentially have our cake and can eat it too
with natural field experiments.
Beyond having the power to measure important
treatment effects, the point of all these levels of field
experiments was to see if ideas like reference-dependent
preferences dictated behavior as strongly in everyday life
as the lab evidence seemed to suggest.

RF: Could you give an example of how this is done?
List: A real problem with artefactual and frame field experiments is that it’s possible that the act of experimentation is
influencing the participants’ behavior. So let’s go through an
example whereby I think I can convince you that I am in a
natural environment and that I’m learning something of
importance for economics. I first got interested in charitable fundraising in 1998 when a dean at the University of
Central Florida asked me to raise money for a center at UCF.
I went out and talked to dozens of fundraising practitioners
and experts, and they had several long-held beliefs about
such things as the benefits of seed money and of using
matching funds. Many charities have programs where they
will match a donor’s gift. So your $100 gift means that the
charity will get $200 after the match.
Interestingly, however, when you go and ask those charities if matching works they say, “Of course it does, and a
2-to-1 match is much better than a 1-to-1 match, and a 3-to-1
match is better than either of them.” So I asked, “What is
your empirical evidence for that?” They had none. Turns out
that it was a gut feeling they had.
I said, well, why don’t you do field experiments to learn
about what works for charity? Let’s say the typical way in
which a charity asks for money is a mail solicitation. So what
we are going to do is partner with them in one of their mail
solicitations. Say they send out 50,000 letters a month. We
will then randomize those 50,000 letters that go directly to
households into different treatments. One household might
receive a letter that says, “Please give to our charity. Every
dollar you give will be matched with $3 from us.” Another
household might receive the exact same letter, but the only
thing that changes is that we tell them that every dollar you
give will be matched by $2. Another household receives a
$1 match offer. And, finally, another household will receive a
letter that doesn’t mention matching. So you fill these treatment cells with thousands of households that don’t know
they’re part of an experiment. We’re using randomization to
learn about whether the match works. That’s an example of
a natural field experiment — completed in a natural environment and the task is commonplace.
I didn’t learn that 3-to-1 works better than 2-to-1 or
1-to-1. Empirically, what happens is, the match in and of
itself works really well. We raise about 20 percent more
money when there is a match available. But, the 3-to-1,
2-to-1, and 1-to-1 matches work about the same.
RF: How does charitable giving in the United States
compare to other countries? And what do you think are
some of the reasons that may explain these differences?
List: I have co-written with Michael Price a recent paper
titled “Charitable Giving Around the World” and something
that we bumped up against right away is that it’s hard to
find good, comparable data around the world. So, with that
caveat in place, two stylized facts jump out. One is that

Region Focus | Second/Third Quarter | 2012

33

people in the United States give at extraordinary rates.
We give roughly 3 percent of GDP every year. And that
represents individual gifts — that doesn’t include corporations. When you compare the United States to other
developed countries, the U.S. is well above other developed
countries. However, when you look at volunteerism, the U.S.
is well below other countries. So we give a lot more money,
but we volunteer our time much less often than citizens in
other countries.
So as an economist I ask, what are the economic reasons
for these patterns? What you observe in other countries is
that governments tend to provide a lot more public goods.
In Europe, for example, their marginal tax rates tend to be
well above ours because they provide more public services or
public goods. When you talk to folks from Europe, what
they tell you is, “I don’t need to give to that particular cause,
because the government already provides it.” If you look at
U.S. history, functions such as helping the poor have varied
over time — during some periods helping the poor was
spearheaded by the government; in others, private organizations did the bulk of the work. So a lot of charitable
organizations were formed and still are active in that space.
That said, in many European countries more individuals are
increasingly willing to give money as, say, public funds for
universities are being cut. I receive phone calls all the time
from European universities that are considering approaching their alumni for donations.
I think economic differences — levels of taxation, the
provision of public goods — can explain a lot of the differences across countries. I think culture also has a lot to do
with it as well, even though “culture” is sort of the catch-all
term that can explain just about everything. Still, it’s true
that we have a culture of giving money in the U.S., while in
other countries they have a culture of giving time. And if you
see that your parents generally give money rather than time,
or vice versa, you tend to do the same thing.
RF: Are there certain types of issues that have features
which make them particularly well suited to field experiment work? And are there some areas that you think
field experiments would yield little to our understanding of those issues?
List: Let’s start with the types of issues we might exclude.
I think that a lot of macro policies, like the effect of interest
rates on the macroeconomy, fit into that category. It’s hard
for me to envision that when you have a policy that affects
the entire nation at once, like a change in interest rates, you
could effectively think about a field experiment that could
give you great insights. And the reason why is because you
don’t have the proper counterfactual. If you could randomize different states into different interest rate environments
and people couldn’t lend across state lines, then you could
maybe get somewhere with a question like that. But when
you don’t have the proper counterfactual, it’s really hard to
envision a field experiment lending many insights. So I think

34

Region Focus | Second/Third Quarter | 2012

there are a lot of questions in which the field experimental
method is not the best approach. It is just impractical for
many important economic questions.
But there are other questions where field experiments
could be very useful. How much discrimination is present in
a market and what is the nature of that discrimination?
Why do people give to charitable causes and what keeps
them committed to the cause? Are prospect theory preferences important in markets and can those with market
experience overcome those biases, or do people learn to
have behavioral biases? What education reforms can work
most cost effectively? What are the best ways to reduce the
racial achievement gap? What public policies can work to
lower teen criminal activity? All of these questions and
many others are fair game using the field experimental
method. Further, I believe that field experiments are the
best approach, to, first of all, find out whether there’s a
causal relationship between variables of interest, and then
also determine the underlying channels for that relationship.
I think field experiments, better than any other approach,
can measure whether it’s occurring and tell you why it’s
occurring.
For instance, it’s really hard to look at mounds and
mounds of data and determine why one person is discriminating against another in a market. Economists have two
major theories. One is Gary Becker’s taste-based discrimination — people discriminate because they have a taste for
discrimination; for example, because they don’t like that
certain person or group, they are willing to forgo profits
to cater their prejudice. Years before that, Arthur Pigou
discussed third-degree price discrimination — entrepreneurs, in their pursuit of profit, will discriminate. With
mounds and mounds of data, it would be very hard for you to
parse those two models. But if you have the correct field
experimental treatments, you cannot only measure if
discrimination exists, but you can decipher which of those
models is at work. I did this in my 2004 QJE paper on
discrimination and in more recent work across several
markets with Uri Gneezy and Michael Price.
RF: Why do you think economists have largely been
opposed to methodological approaches such as field
experiments and do you believe that is beginning to
change?
List: First of all, when economists started using experimentation it was in the lab. And I think many people in the
profession were already skeptical of what we can learn from
laboratory exercises because they were already tainted by
their distrust of psychology experiments. So I come along,
and I say we really need to use the tool of randomization, but
we need to use it in the field. Here’s where the skepticism
arose using that approach: People would say, “You can’t do
that, because the world is really, really messy, and there are a
lot of things that you don’t observe or control. When you go
to the marketplace, there are a lot of reasons why people are

John A. List

List: I think a general statement
behaving in the manner in which they
➤ Present Position
about behavioral economics would
behave. So there’s no way — you
Homer J. Livingstone Professor of
don’t have the control — to run an
be as follows: If I want to take a trip
Economics, University of Chicago
experiment in that environment and
from Chicago to Fenway Park — say
learn something useful. The best you
I want to go watch the Red Sox play
➤ Previous Faculty Appointments
can do is to just observe and take
the Yankees — neoclassical theory
University of Maryland (2001-2005),
from that observation something of
will get me to Cambridge. But I need
University of Arizona (2000-2001),
potential interest.”
behavioral economics to get me from
and University of Central Florida
That reasoning stems from the
Cambridge to my seat in the 25th row
(1996-2000)
natural sciences. Consider the examof Fenway Park. And what that
➤ Education
ple with the chemist: If she has dirty
means is that I think behavioral
B.S., University of Wisconsin-Stevens
test tubes her data are flawed. The
economics is important to explain
Point (1992); Ph.D., University of
rub is that chemists do not use ranbehavior at the individual level, but if
Wyoming (1996)
domization to measure treatment
we want to get into the vicinity of the
effects. When you do, you can balcorrect answer, neoclassical econom➤ Selected Publications
ance the unobservables — the “dirt”
ics can get us there. And then around
Author of numerous articles in such
— and make clean inference. As such,
the margin, behavioral economics
journals as the American Economic
I think that economists’ reasoning on
does really well at pinpointing and
Review, Journal of Political Economy,
field experiments has been flawed for
helping us refine that answer.
Quarterly Journal of Economics,
Econometrica, Journal of Public Economics,
decades, and I believe it is an imporI think prospect theory is a
and Science
tant reason why people have not used
perfect example of a behavioral
field experiments until the last 10 or
manifestation that is important. One
15 years. They have believed that because the world is really
of the most important elements within prospect theory is
messy, you can’t have control in the same way that a chemist
something called loss aversion — people value a one unit loss
has control or a biologist might have control.
much more than a one unit gain. How do you leverage that
That’s what people often think about — the scientific
insight? We have done so in several places. One example is
method. In physics, we have vacuum tubes; in chemistry we
that we — Tanjim Hossain and I — have gone to manufachave very clean test tubes. If you don’t have a very clean test
turing plants in China and they have asked us what are the
tube, then you can’t experiment as the theory goes. And I
best ways to incentivize their workers to work hard. What
think people have generalized incorrectly, and here’s why:
we typically do is we give them a few dollars more if they
When I look at the real world, I want it to be messy. I want
produce at higher levels, and we tell them this is a conditionthere to be many, many variables that we don’t observe and
al bonus. We first give them the money and then say, if you
I want those variables to frustrate inference. The reason
do not achieve that goal, we will take that money away from
why the field experiments are so valuable is because you
you. We find that just by framing, we can increase productivrandomize people into treatment and control, and those
ity by 1 percent. And that occurred for more than just a few
unobservable variables are then balanced. I’m not getting rid
hours; that occurred for six months.
of the unobservables — you can never get rid of unobservYou can say, well, does that work in other walks of life?
ables — but I can balance them across treatment and control
What’s been really hard in the area of education is to use
cells. Experimentation should be used in environments that
incentives to get teachers to try harder. So teachers will say,
are messy; and I think the profession has had it exactly back“Look, I try as hard as I can already.” And we have incentive
wards for decades. They have always thought if the test tube
schemes that have been tried in the United States that don’t
is not clean, then you can’t experiment. That’s exactly
seem to work very well. These incentive schemes tend to be
wrong. When the test tube is dirty, it means that it’s harder
structured something like this: In September we tell you, if
to make proper causal inference by using our typical empiriyour students do a lot better than everyone else’s students,
cal approaches that model mounds and mounds of data.
then you are going to receive $4,000 in the spring. What we
So I think there are two main reasons. People have tradihave found is that doesn’t really work very well. But if we
tionally thought of experimentation through the lens of the
give them the $4,000 in the fall and tell them we will take
lab, and they have not liked that because of perceived
that money away in the spring if your students do not
problems of representativeness of the population or repreachieve, they will perform remarkably better. And one
sentativeness of the situation. And secondly, they have
explanation consistent with such behavior is loss aversion.
flawed thinking about how you identify your treatment
It also works for students. For example, we have comeffect with your field experiment.
pared two groups. First, we have gone into the testing room
the morning of a test and said, here’s $20 and if you improve
your test scores from last fall, you can keep the $20, but if
RF: Under which conditions does prospect theory
you don’t improve, we will take it away. Second, we have told
seem to explain behavior that cannot seemingly be
a different group of students that they will receive $20 after
explained by conventional neoclassical models?

Region Focus | Second/Third Quarter | 2012

35

the fact if they improve their scores. The first group performs much better than the second. And I think this is
because people do have an aversion to losing something.
You can say, OK, how does that affect markets? And
that’s what I have thought hard about. As I found in my 2003
QJE piece on prospect theory, if you go to a market that has
active traders, what you find is that the inexperienced
people trade as though they have loss aversion but the really
experienced ones don’t. And then you ask yourself, well, is
that because of selection or treatment? Maybe some of us
are born with prospect theory preferences, while some of us
are not. Or is it that the market has taught the experienced
traders? Is it that the people who survive don’t have prospect
theory preferences, and if they have them, then they don’t
survive in the market? Now you can test that because you
can randomly give people experience. How I have done that
in a recently published piece in the American Economic
Review is by giving some people free goods and telling them
to go off and trade them and you incentivize them to trade;
in the control group, you don’t give free goods and you don’t
incentivize them to trade. And you look via experimentation
whether the first group exhibits prospect theory preferences after six months versus the second group. What
happens is that the market does weed out those people who
have real biases, but people do learn. So the act of trading
induces people to learn to overcome their prospect theory
preferences.
In the end, is the market price determined by people who
have prospect theory preferences? No. I think behavioral
economics in this form is important to get people to do
things you want them to do, but in determining prices and
allocations in more mature markets, there is not strong
evidence that such preferences importantly influence prices.
RF: To what extent do additional entrants in the certification market tend to improve information provided to
consumers — and which consumers tend to benefit
most from additional firms entering that market?
List: Product certification is used in many markets. And you
can ask yourself, well, is product certification important,
does it improve the welfare of people, does it improve information in the market? When you think about how you
answer these types of questions, it seems like a field experiment is a really good approach to lend initial insights. That’s
what co-authors at the University of Maryland and I did
when we researched in this area when I was a professor at
Maryland. We looked at the market for sports cards and
what you see is that before 1987, there was no third-party
certifier in that market. In 1987 a company called
Professional Sports Authenticator (PSA) enters. They start
informing sports card buyers, sellers, and dealers the quality
of their sports cards. Is it authentic, for example? Does it
have sharp corners? Does it have good centering? And what
they essentially did was develop a scheme that was very
coarse. They gave a card an integer grade of 1 to 10, and what

36

Region Focus | Second/Third Quarter | 2012

you find is that the information they provided is useless to
those really experienced in the sports card markets. Sports
card people who already had experience — the dealers —
already knew the information that PSA provided.
But those really inexperienced consumers received a
wealth of information from that ranking scheme. So when
you think about a market that begins to evolve and when you
have a monopolist certifier, it will provide information to
the market, but only a certain type of individual will benefit
from that information.
So then we observe behavior from 1987 to 1999, and now
two more sports card graders enter the market — Sportscard
Guaranty (SGC) and Beckett Grading Service (BGS).
What these two firms do to secure market share is to offer a
more differentiated product. Now your card can receive a
7.5 instead of just a 7 or 8, which is what PSA offered, and
now that information, in its more detailed form, is adding
insights to even the most experienced people. As a whole,
that increases welfare. And since then the market has
become even more developed, with many other firms
entering. So you see this great evolution of a private
certification market, and because we can overlay a field
experiment on it we can then measure the welfare implications of that evolution.
RF: One of the things that you mentioned in your
2011 Journal of Economic Perspectives paper, “Why
Economists Should Conduct Field Experiments and
14 Tips for Pulling One Off,” is that it’s important to do
field experiments about things that you know well.
This seems like a good example.
List: Absolutely. I started as a sports card dealer back in high
school in the mid-1980s. I didn’t really see it then, but I was
actually running field experiments, because I would start off
the bargaining process differently depending on the characteristics of the potential buyer — whether the buyer was
male or female, young or old, for instance. In a way I had
experimented already with bargaining propensities without
knowing it. And then I arrive at the University of Wyoming
as a graduate student in the early 1990s and I learn that
there’s this emerging literature on laboratory experiments.
So I thought, well, why don’t we study this market using
field experiments? And when I tried to sell that to my
professors at Wyoming no one was interested at first. I said,
I know economic theory, and I know the sports card market
very well. How about if I use that as my laboratory? I never
really imagined that we would care about sports cards in and
of themselves — it’s too small of a market. But it also seemed
like a market that was well suited to these types of experiments because I knew it well, and the broader behaviors that
I was trying to learn about should be generalizable to more
important markets.
So I ended up starting to run my first scientific field
experiments in Denver in the early 1990s for my dissertation
and for future work. I always thought that the main

advantage I had was that I knew my laboratory well — by
knowing how the market functioned, I could implement
various treatments with confidence that my interpretation
of the data was correct. For example, I could run a certain
kind of auction and everyone would find that to be natural.
I knew I could approach dealers and bargain in a way that
they would think there’s nothing unusual happening. I knew
that there were aspects of this market that could tell me
things about loss aversion, about discrimination, about
product certification, about bargaining, and about many
other issues economists found interesting. I don’t think I
could have done that had I not understood the market —
the motives and the values and the preferences of the
participants — as well as I did.
I think that’s one of the two main features that you must
have before you actually go out and run field experiments:
You really need to understand the market so you know what
you are testing and you know how to test it in a natural way.
I think the other main feature is that you always need economic theory as a guide. You are setting up your experiment
based on economic theory and also to test economic theory.
Theory provides a framework to help design the experiments, and the experimental results give you a view of the
theory that you could never have without randomization. In
this way, the theory is a lens into not only the data but also
the world at large.
RF: Your paper with Roland Fryer and Steven Levitt
came to a somewhat ambiguous conclusion about
whether stereotype threat exists. But do you have a
hunch regarding the answer to that question based on
the results of your experiment?
List: I believe in priming. Psychologists have shown us the
power of priming, and stereotype threat is an interesting
type of priming. Claude Steele, a psychologist at Stanford,
popularized the term stereotype threat. He had people
taking a math exam, for example, jot down whether they
were male or female on top of their exams, and he found that
when you wrote down that you were female, you performed
less well than if you did not write down that you were female.
They call this the stereotype threat. My first instinct was
that effect probably does happen, but you could use incentives to make it go away. And what I mean by that is, if the
test is important enough or if you overlaid monetary incentives on that test, then the stereotype threat would largely
disappear, or become economically irrelevant.
So we designed the experiment to test that, and we found
that we could not even induce stereotype threat. We did
everything we could to try to get it. We announced to them,
“Women do not perform as well as men on this test and we
want you now to put your gender on the top of the test.”
And other social scientists would say, that’s crazy — if you do
that, you will get stereotype threat every time. But we still
didn’t get it.
What that led me to believe is that, while I think that

priming works, I think that stereotype threat has a lot of
important boundaries that severely limit its generalizability.
I think what has happened is, a few people found this result
early on and now there’s publication bias. But when you talk
behind the scenes to people in the profession, they have a
hard time finding it. So what do they do in that case? A lot of
people just shelve that experiment; they say it must be
wrong because there are 10 papers in the literature that
find it. Well, if there have been 200 studies that try to find
it, 10 should find it, right? This is a Type II error but people
still believe in the theory of stereotype threat. I think that
there are a lot of reasons why it does not occur. So while I
believe in priming, I am not convinced that stereotype
threat is important.
RF: That raises a related question: How strong do you
think publication bias is in the economics profession?
List: It’s really hard to publish a paper that goes against the
mainstream way of thinking. And I just think about some of
my own experiences, such as the prospect theory paper I
mentioned before, which was published in the QJE in 2003.
The paper, when it started, was a very short exercise showing the power of market experience and because people did
not believe it, I had to continue to do new experiments —
new field tests — and eventually this paper consumed my
life for years and ended up being a 30-page paper. Was it a
much stronger contribution? Absolutely, the editorial and
review process really helped a lot. But the main message was
always contained in a paper that could have been 10 pages.
To overturn the mainstream way of thinking, however, you
have to go above and beyond. And that’s often hard to do
because the burden of proof is on you.
That said, could I tell you right now what are the five
things that I think the profession has wrong? I couldn’t,
because I think the profession has most things right. It
might not have all the details right, but I believe most of the
first-order thinking is right.
I think in many ways, it’s harder to overturn entrenched
thinking in parts of the nonprofit, corporate, and public sectors, where many things are not subject to empirical testing.
For instance, why don’t we know what works in education?
It’s because we have not used field experiments across
school districts. Each school district should be engaged in
several experiments a year, and then in the end the federal
government can say, “Here’s what works. Here’s a new law.”
It’s unfair to future generations to pass along zero information on what policies can curb criminal activities, what
policies can curb teen pregnancy, what are the best ways
to overcome the racial achievement gap, why there
aren’t more women in the top echelon of corporations.
We don’t know because we don’t understand, we haven’t
engaged in feedback-maximization. There needs to be a
transformation, and I don’t know what it’s going to take.
I mean, are we going to be sitting here in 50 years and
thinking, “If we only knew what worked to help close the

Region Focus | Second/Third Quarter | 2012

37

achievement gap, if we only knew how to do that”?
I hope my work in education induces a sea change in the
way we think about how to construct curricula. Right now,
we are doing a lot of work on a prekindergarten program in
Chicago Heights and in a year or two I think that we will be
able to tell policymakers what will help kids — and how
much it will help them. But unless people adopt the field
experimental approach more broadly, it will be a career
that’s not fulfilled in my eyes.
RF: Do you think the market for placement of new
economists works relatively well? I am interested in
both your empirical work on this topic as well as what
you believe you have learned from your own experience.
List: My personal experience is sort of a checkered one.
When I graduated from the University of Wyoming in 1996
I applied for 150 academic jobs. The ASSA meetings that
year were in San Francisco. So I flew to San Francisco from
Laramie, and I’m beaten down. I applied to 150 schools and
only two schools agreed to interview me at the meetings.
One was the University of Central Florida and one was
Montana State University-Billings. So at that point I didn’t
think the market worked very well, because I thought I was
a reasonable economist and I should receive more attention.
But the majority of economists obviously did not agree with
me. I was really lucky that I ended up securing a job at the
University of Central Florida, because I’m not sure really
what would have happened otherwise. My dad is a truck
driver and maybe I would have gone back to Wisconsin and
ended up driving trucks. Luckily enough, I did get an academic job that year.
I continued to do field experiments at Central Florida.
Vernon Smith noticed some of my work and I ended up
moving to the University of Arizona in 2000. Unfortunately,
when I arrived at Arizona, Vernon told me that he was
having problems with the administration and that the entire
experimental group was moving. He wasn’t sure where.
At the time he was talking to Purdue and Caltech. He ended
up going to George Mason. That winter, some people at the
University of Maryland had read a few of my papers on field
experiments and I had a little bit of luck in placing them at
top journals, so they called me. I ended up moving there,
which is close to George Mason and allowed me to continue
doing some work with Vernon’s group.
I then had a really good publication year in 2004, and the
profession started to recognize that I’m writing these papers
that could be paving a new way to think about empirical
economics using field experiments. And that’s when I
moved to Chicago and I’ve been here since 2005.
So in my case you would say the market worked pretty
well. I was coming from a school that was not highly ranked,
so not many schools were interested in me. In fact, if I had
sent my application to Chicago in 1995, I’m sure that they
would not have even opened the envelope because it said the
University of Wyoming on the cover and that would have

38

Region Focus | Second/Third Quarter | 2012

been viewed as a bad signal. I think I got more or less what I
deserved; I got what the market said I should get. What
would have been a sign that the market did not work would
be if I were still at the University of Central Florida with
the exact same number of publications and the exact same
number of projects going on and Chicago still said no
because I graduated from the University of Wyoming.
Now, my own experience got me interested in how this
market actually operates. So I started to do survey work and
field experiments on what determines a person’s success in
this market. What do people look at when they hire Ph.D.s
for the first time? And that’s when I started writing these
articles about what it takes to get an academic interview or
government interview or business interview, because I was
so fascinated and disappointed by my own experience. What
I found in that work were kind of the typical things: It hurt
me not coming from a top 5, top 10, or top 20 school; it hurt
me that I did not have a well-known, Nobel-type economist
writing letters for me; and perhaps what hurt me the most is
that I didn’t have much published research at the time. But
the silver lining is that in the end if you work hard, you can
increase your stock and you can move up. I have aged a lot in
this process. It’s been many years of sleepless nights working
on research. I have loved every minute of it, though.
RF: Do you think your experience is typical in the
respect that you have to make several moves, some of
which might be considered lateral, before arriving
at what might seem like the appropriately matched
institution or department?
List: I do often wonder, did I really have to move three
times to get to Chicago, or could I have just waited and
moved directly here in 2005 or maybe a little earlier from
Central Florida? There is not a lot of evidence on that; there
are some stylized facts. Something like 90 or 95 percent of
people secure their first jobs at departments that are lower
ranked than the departments that they graduated from. This
is because the top schools graduate many more people than
they can hire. And then where you get tenure is typically at a
department ranked lower than where you got your first job.
RF: Which economists have been the most influential in
shaping your thinking about economic policy issues and
how those issues should be addressed?
List: Vernon Smith and Gary Becker, but for different
reasons. Vernon because he got me interested in generating
your own data and framing questions in the appropriate
ways. Gary because he showed me the importance of
having a disciplined way to think about the problem and
understanding that standard neoclassical economics can
go a long way in explaining, or helping us to explain, major
problems. I think above all else, those two traits have shaped
the way I think about policy problems and economics
more generally.
RF

ECONOMICHISTORY
The Voyage to Containerization
BY B E T T Y J OYC E N A S H

How a North Carolina
trucker freed world trade
very seven minutes, a crane at Port Newark in
New Jersey lowered a large metal container — an
aluminum truck body — until it rested on the deck
of an old tanker ship, christened the Ideal-X because it was
ideal for the experiment. It was April 26, 1956.
Five days later, the Ideal-X arrived in Houston, where
cranes hefted 58 containers onto 58 trucks that hauled the
big boxes to their destinations. The voyage to containerization, and to a revolution in global trade, had begun.
The man behind the operation, Malcom McLean, cared
mostly about the math. Cargo in that era typically took a
week’s worth of human labor to load and another week to
unload, at a cost of $5.83 a ton. But McLean’s experts figured
the Ideal-X’s loading costs at 15.8 cents a ton, according to
historian and economist Marc Levinson, author of The Box,
a history of container shipping.
McLean’s big idea was to handle cargo only twice, once at
the shippers’ location and again at the final destination,
never opening the box in transit. “That really cut out a lot of
dockworkers,” says Wayne Talley, a professor of maritime
economics at Old Dominion University. It also cut waste,
damage, and pilfering, which lowered insurance. “The moving of general cargo became less labor intensive and more
capital intensive. It was a major technological advancement,
this simple idea of handling cargo twice.” Ultimately, this
slashed shipping costs, which made it affordable to haul
goods over distances unimaginable at the time.
McLean was an outsider to the maritime industry. A ship
to him might as well have been a truck on water. He’d already
built one freight-hauling empire on land; why not build
another, at sea?

E

PHOTOGRAPHY: A .P. MOLLER-MAERSK

Four Lanes to Sea Lanes
McLean worked in the early 1930s at a gas station where he
heard truckers got five dollars for hauling the station’s oil
from Fayetteville, 28 miles away. It sounded like good money,
so he borrowed the station owner’s rusted-out trailer to do
the job. By 1940, he had 30 trucks on the road and was grossing $230,000 a year. Five years later, his fleet had grown
more than fivefold.
Trucking boomed. Long-distance truck traffic more than
doubled between 1946 and 1950, according to Levinson.
McLean expanded by leasing routes or buying companies.
He grew his truck fleet in part by recruiting World War II
veterans who could use government loans to buy their
trucks, then work for him as independents. Between 1946

Malcom McLean stands at the Port Elizabeth, N.J., terminal
of Sea-Land, the container shipping company he founded.
A native North Carolinian, McLean’s instinct for efficiency
had helped him build a successful trucking firm before he
entered the shipping business. His big idea was to handle cargo
twice and twice only, which led to lower shipping costs.

and 1954, McLean Trucking routed goods from Atlanta to
Boston.
McLean watched every expenditure. McLean Trucking
installed diesel instead of gasoline engines. Operators
bought only at gas stations agreeing to discount fuel. The
Winston-Salem, N.C., hub automated and transferred
freight between trucks by conveyor belts. The firm paired
new drivers with experienced ones, who received bonuses if
a trainee went accident-free the first year. This cut insurance
and repair costs.
To add routes, McLean had to deal with federal regulations that controlled routes, rates, and even the types of
goods hauled. The Interstate Commerce Commission (ICC)
required proof that rates were neither too high nor too low.
McLean mastered the art of showing that his proposed
lower rates would turn a profit on a route that he wanted.
For instance, he convinced the ICC that his administrative,
marketing, and terminal costs were lower for cigarettes than
other products; that enabled him to haul cigarettes from
Durham, N.C., to Atlanta at half the rate other truck lines
charged. By 1954, McLean Trucking ranked third in after-tax
profits of all U.S. trucking firms, according to Levinson.
As road conditions and traffic worsened, McLean

Region Focus | Second/Third Quarter | 2012

39

worried about possible competition from
coastal ship operators, whose low rates had
been subsidized since the Merchant
Marine Act of 1936. Coastal operators also
could buy surplus wartime cargo ships for
next to nothing, which tempted McLean.
(McLean opted against subsidies when he
entered shipping, says Chuck Raymond,
who worked at McLean’s firm, Sea-Land
Service, from 1965 until its owner CSX
sold it to Maersk in 1999. McLean thought
people worked better and harder without
the cushion. He also wanted to avoid
another layer of federal interference.)
McLean acted to head off this potential competition
from cargo ships. Why not haul truck trailers via ship,
unloading at trucking hubs? By 1953, he’d located a terminal.
Later, he took one of McLean Trucking’s top salesmen,
Paul Richardson, to a New Jersey pier and showed him a
container-loaded ship, according to Richardson’s oral
history transcript. “He said to me, ‘Paul, did you ever see one
tractor pulling 226 trailers?’ I said, ‘No sir.’ And he said,
‘There’s one right there.’ ” Richardson was to become SeaLand’s national sales manager and eventually its president.
McLean’s instincts matched his imagination. “He had a
huge ability to visualize how things could be done better,”
Raymond says, “and had the guts to try it.”

Rocking the Boat
McLean grasped that the choke point of the transportation
business was where the modes of transport come together,
recalled one of Sea-Land’s chief naval architects, Charles
Cushing, in an oral history. Once that could be automated,
then shipping costs would fall.
Cargo in that era appeared dockside either as bulk, commodities like grain, or as breakbulk, separate goods of all
shapes and sizes. Everything from bananas to whiskey to fine
china showed up in bags, barrels, or boxes. Longshore labor
handled the goods, some of which required crates, that
members of the cooper’s union built. Each job required its
own tradesmen.
“There were thousands of people out on these piers,”
Cushing remembered. “The longshoremen would come
down and there would be gangs in every hold. And there
were hordes of people working on these piers to move a very
modest amount of cargo. And it was just horrible … logistically, industrially, in every possible way.”
And expensive. Freight costs in 1961 were 12 percent of
the value of U.S. exports and 10 percent of U.S. import value,
according to Levinson — in effect, a trade barrier. Most of
the costs lay in transferring loads.
McLean bought his way into coastal shipping with the
purchase of the Pan-Atlantic Steamship Corp. But the ICC
ruled against the transaction after protests from railroad
firms until McLean sold the trucking company.
Although McLean had first envisioned trucks rolling

40

Region Focus | Second/Third Quarter | 2012

trailers on and off ships, he soon realized that wheels, beds, and axles would
consume precious space. Trailers
instead could be stacked. Using old
tankers minimized risk because they
could carry oil on return trips.
But in those early days, proper
equipment had yet to be designed or
tested. McLean hired an engineer,
Keith Tantlinger, and flew him to
Mobile, Ala., home of Pan-Atlantic.
According to Cushing, “Tantlinger was
the mechanical genius in house, devising cell guides and devices for flipping
containers down.” He invented corner fittings into which a
specially designed lock could slide. Containers could be
stacked and locked to those underneath. Cranes latched
onto the fittings to hoist the big boxes. These inventions
may have hastened industry modernization because McLean
relinquished the patents in the early 1960s, at Tantlinger’s
urging.
The aluminum container’s roof, though only one thirtysecond of an inch thick, would support a man jumping on it
because of the way it was riveted, Tantlinger promised. On
delivery day, McLean, shipyard officials, and Tantlinger
scheduled breakfast together. No one showed but
Tantlinger, according to Arthur Donovan and Joseph
Bonney in their book The Box that Changed the World.
(Donovan is a professor emeritus of humanities at the U.S.
Merchant Marine Academy; Bonney is transportation
finance and economics editor at the Journal of Commerce.)
When Tantlinger finally headed to the shipyard, he found
McLean and the others atop container roofs, jumping.
McLean Industries was not the only maritime shipping
firm testing the waters of container transport at the time,
but few carried container-only loads. Trailer Marine
Transport used wartime surplus landing craft to carry truck
trailers from Florida to Puerto Rico; Seatrain had ferried
railcars to Cuba since the 1920s. Another firm, Matson
Navigation, in contrast to McLean’s relatively free-wheeling
approach, had cautiously begun researching standardized
loads by 1956, but did not convey its first fully loaded
container ship between Los Angeles and Oakland, Calif., and
Honolulu, until 1960.
During the fall of 1956, McLean used idle time during an
East Coast dockworkers’ strike to widen decks and expand
hatches of surplus wartime freighters to add to his fleet.
These ships would carry 226 containers, each 35 feet long, by
the following year, about four times the number the Ideal-X
had carried in 1956. No one knew how a stack of containers
might sway or shift or even whether the containers could be
crushed. Before the first trip, Tantlinger stuffed chunks of
modeling clay into the cell corners to indicate how the loads
had moved. Upon the ship’s return, the clay in the corners
had moved no more than five-sixteenths of an inch, demonstrating the stacks’ stability.

Though container shipping seemed poised for success,
many thought it impractical, a passing fad. The prospect of
automation also created labor strife. Port authorities, too,
were divided about whether to configure facilities to accommodate large-scale container shipping or rely on traditional
“finger” piers that jutted into the water. In 1962, containers
accounted for a mere 8 percent of the freight at the Port of
New York and 2 percent of West Coast freight. From 1957
through 1960, slack demand hurt Sea-Land’s container
business, and it lost $8 million, according to Levinson.
McLean borrowed to buy more surplus tankers; these
ships could haul 476 containers, eight times as many as the
Ideal-X had carried on that first voyage. Richardson developed detailed cost comparisons among modes — truck,
ship, and train — to show shippers annual savings.
Once shippers tried the service, they were sold on the
container concept. Cushing noted, “Here is one guy taking it
[cargo] off your hands with one document, and then it’s
gonna show up at your consignee, by the way, faster, sooner,
with less cost ...”
Sea-Land Service, as McLean’s Pan-Atlantic had been
re-christened, established California routes, and so became
the first carrier to haul goods on both the Pacific and
Atlantic coasts. Sea-Land snapped up two ships from a
bankrupt former competitor in Puerto Rico; the commonwealth was a lucrative shipping market, partly on account of
tax incentives that lured labor-intensive manufacturers.
Now the primary carrier, Sea-Land built two new terminals
in San Juan and opened routes to two additional Puerto
Rican ports.
Chuck Raymond today is a transportation consultant for
private equity firms. He saw his first Sea-Land ship in Puerto
Rico in 1964 during his “sea year” with the U.S. Merchant
Marine Academy at Kings Point, N.Y.
“I saw this ugly, ugly ship come in with containers stacked
up on deck, with wings out to each side — those were the
cranes. Then the next day, I saw that ship going out,” he
remembers, told in a telephone interview. He was incredulous. “I was used to a ship taking six or seven days to unload.”
Right away he sought the name of the company — Sea-Land.
“I wrote him [McLean] a letter and said I wanted to work
for him.”
On the day of his interview, a driver pulled up to the limo
stop at the Newark, N.J., airport, as arranged. “A fellow
rolled down the window and said, ‘Are you Chuck Raymond
from King’s Point? Hop in the car; I’m taking you over to
Sea-Land.’ ”
The driver quizzed Raymond about his background, how
and why he chose the U.S. Merchant Marine Academy, and
why Sea-Land interested him. “When we pulled up in the
parking lot, they waved this guy through, and then we pulled
into a spot with a sign that read M. P. McLean.” The trip was
on his regular route to work, McLean explained, and it
would save taxi fare.
“Here was a guy who was already an icon in the industry,”
Raymond says. “And he was trying to save a nickel.”

Making Money, Losing Money
Always seeking opportunities, in 1966 McLean offered a
package shipping deal — containers, chassis, trucks, and
terminals — at a fixed price per ton to the military in
Vietnam, according to Levinson, in an effort to bring order
to a supply chain that was in chaos, logistically. McLean was
convinced that containerization could solve the problem.
“Like everything else Malcom McLean did,” according to
Levinson, “venturing into Vietnam entailed considerable
risk in hopes of a large reward.”
It paid off. On each round trip from the West Coast to
Cam Ranh Bay, Sea-Land made more than $20,000 per day.
McLean also wanted to make the return voyage pay — with
goods from Japan. By 1968, Sea-Land had started its
Yokohama-to-California run, its ships loaded with Japanesemade electronics.
But McLean was never short on dreams. Now he wanted
a fleet of big, fast ships that could circumnavigate the globe
in 56 days. No idle fantasy, such ships could furnish the
company a competitive advantage after the Suez Canal
closed during the 1967 Arab-Israeli War. Sea-Land’s biggest
competitor on the North Atlantic was U.S. Lines, with ships
that could carry about 1,200 containers, yet still travel at
22 knots, 50 percent faster than any in Sea-Land’s fleet.
To help pay for Sea-Land’s new SL-7s, in 1969, R.J.
Reynolds Industries, of McLean Trucking’s hometown of
Winston-Salem, N.C., bought Sea-Land.
The timing couldn’t have been worse for these fuelhungry ships. “We built the SL-7s and set transatlantic speed
records several times,” Raymond remembers. But oil prices
started their steep climb in 1973. “It cost a quarter of a
million to run those ships one way.” And in 1975, the Suez
Canal reopened, unexpectedly soon, eliminating any speed
advantage. Reynolds took a $150 million loss on the SL-7s,
and sold them in 1980 to the U.S. Navy.
McLean left the day-to-day management of Sea-Land in
1970, started selling his stock in 1975, and departed
Reynolds’ board in 1977, “unhappy with Reynolds’ bureaucratic ways,” according to Levinson. The tobacco
conglomerate had criticized Sea-Land’s operations from the
start and tightened the reins. After going through the books,
according to its chief naval architect at that time, John
Boylston, the Sea-Land managers were brought into a meeting where the Reynolds people “chewed us out for a good
hour” over sloppy accounting. “They said we’d technically
been out of business two or three times in those first six or
seven years and simply hadn’t known it.”
But Sea-Land’s entrepreneurial culture kept the company
nimble, Boylston remembers. Decisions could be made
quickly and sometimes deals were sealed with a handshake.
“If you didn’t take advantage of the growth opportunities,
then somebody else was going to do it very quickly.”
McLean worked up other ventures — a hog farm in
North Carolina, a residential development named
Diamondhead on the Mississippi Gulf Coast — but couldn’t
stay out of moving freight. A year after resigning as an RJR

Region Focus | Second/Third Quarter | 2012

41

director, he bought U.S. Lines for $160 million. This time
McLean planned bigger but slower ships that could carry
more freight in an effort to cut per-unit costs. But by 1985,
crude oil prices had dropped from about $30 a barrel to
about $10 per barrel, erasing much of the ships’ advantage.
Overcapacity, meanwhile, brought rate wars on some routes;
U.S. Lines went bankrupt in 1986. Sea-Land, which had been
acquired by CSX Corp., bought the ships. Charlotte-based
Horizon Lines still operates Sea-Land’s domestic routes.
McLean died in 2001. Today, ships and containers
continue to super-size; ships can barely fit through the
Panama Canal, which is undergoing expansion. And intermodal shipping, where freight is loaded from ships to
double-stacked trains and trucks, is commonplace.
The containers killed a way of life, in which jobs often
were passed from father to son. Worldwide, 70 percent of
dockworkers lost cargo-handling jobs, notes Talley. Labormanagement agreements at two ports on both coasts
ultimately funded early retirements, among other provisions, to mitigate painful job losses.

Efficient shipping expanded trade. Labor-intensive
manufacturing is channeled to low-cost countries. Cheaper
finished goods, of which shipping costs are now a negligible
component, cross borders, making consumers better off.
Even tiny companies can sell to global markets, easily and
cheaply.
“I use the example in class of a pair of $120 Nike tennis
shoes made in China. Of that $120, the transportation cost
will be a little over $1 — it’s virtually costless,” Talley says.
“Without containerization, there would not be a Wal-Mart
or a Home Depot.”
As for McLean, he saw how freight could be shipped
better, faster, and cheaper, and grasped the simple idea that
low-cost shipping could stimulate more shipping. Back then,
Levinson says, people thought freight volume was more or
less fixed. If more moved by water, then less would move by
train. “McLean understood that was fallacious and that, in
fact, people might start shipping more goods if there were
more and cheaper ways to ship.”
He got it right and reshaped the world’s economy.
RF

READINGS
Boylston, John, Charles Cushing, and Paul Richardson. Interviews
by Arthur Donovan, 1995-1998. Containerization Oral History
Project, National Museum of American History, Smithsonian
Institution, Washington, D.C.
Donovan, Arthur, and Joseph Bonney. The Box That Changed the
World: Fifty Years of Container Shipping — An Illustrated History.
E. Windsor, N.J.: Commonwealth Business Media, 2006.

FEDERAL RESERVE

Levinson, Marc. The Box: How the Shipping Container Made the
World Smaller and the World Economy Bigger. Princeton, N.J.:
Princeton University Press, 2006.
Talley, Wayne K., ed. The Blackwell Companion to Maritime
Economics. W. Sussex, England: Wiley-Blackwell, 2012.

continued from page 9

“Someone said that a strong macroeconomy is the best
welfare policy,” Thorbecke says. Many studies have documented that, across countries and time, higher inflation is
associated with more poverty and lower incomes at the
bottom of the income distribution. There’s not a lot the
Fed could do about distribution even if it wanted to,
Blinder says, unless Congress gave the Fed different kinds of
tools, like tax and transfer policies. “But that’s way beyond
the purview of the central bank.”

In other words, while there is little doubt that the Fed’s
policies have unintended distributional effects, that doesn’t
make monetary policy a suitable tool to pursue distributional goals. A host of economic research suggests that the
Fed should focus on price stability and avoid unpredictable
policy shifts. Those measures are favored primarily because
of their long-term economic benefits, but they also tend to
minimize the redistributional effects that can result from
monetary policy.
RF

READINGS

42

Blank, Rebecca, and Alan Blinder. “Macroeconomics, Income
Distribution, and Poverty.” National Bureau of Economic
Research Working Paper No. 1567, February 1985.

Doepke, Matthias, and Martin Schneider. “Inflation and the
Redistribution of Nominal Wealth.” Journal of Political Economy,
December 2006, vol. 114, no. 6, pp. 1069-1097.

Erosa, Andres, and Gustavo Ventura. “On Inflation as a Regressive
Consumption Tax.” Journal of Monetary Economics, May 2002,
vol. 49, no. 4, pp. 761-795.

Rodgers, William. “African American and White Differences in the
Impacts of Monetary Policy on the Duration of Unemployment.”
American Economic Review: Papers and Proceedings, May 2008,
vol. 98, no. 2, pp. 382-386.

Region Focus | Second/Third Quarter | 2012

BOOKREVIEW
Cities Growing Apart
THE NEW GEOGRAPHY OF JOBS
BY ENRICO MORETTI
NEW YORK: HOUGHTON MIFFLIN
HARCOURT, 2012, 252 PAGES
REVIEWED BY DAVID A. PRICE

n the late 1990s and 2000s, numerous writers foretold
the disappearance — or at least the shrinkage — of
geography as a force in labor markets for knowledge
workers. With the rise of the Internet and overnight
delivery services, America seemed to be on a brink of a
future in which software coders, marketers, and their
counterparts in other professions would work from a beach,
a backwoods cabin, or whatever location suited their
humors. Companies, too, would be able to locate anywhere.
Yet markets for these workers seem to be moving in the
opposite direction: The economic influence of geography is
alive and growing. Not only that, but as the wages of moreeducated workers relative to those of less-educated workers
have been rising, the geographic concentration of more-educated workers in certain areas is widening the economic
disparities among entire cities. That is the story told by
University of California, Berkeley economist Enrico Moretti
in The New Geography of Jobs.
Although there have always been differences in cities’
economies, those differences are now increasing systematically and becoming self-reinforcing, Moretti reports. Cities
with already-high levels of education in the 1980s, like Boston
and San Francisco, have seen the educational levels — and
prosperity — of their workforces increase further; education
and pay in less-educated cities have been falling behind.
Moretti calls this trend the Great Divergence. It is
driven by the geographical clustering of companies that
comprise what he labels the “innovation sector” — industries based on highly skilled knowledge workers, such as
information technology, life sciences research, finance, and
some advanced manufacturing. Companies in the innovation sector have tended to be drawn into clusters to get
the widest choice of skilled workers and to benefit from a
shared commercial infrastructure of specialized service
providers, among other reasons. Areas with such clusters, he
notes, include Los Angeles for entertainment, Manhattan
for finance, Seattle for software, and the Raleigh-Durham
area for medical research.
Educated workers, in turn, are drawn to innovationsector cities, both for their own jobs and, in the case of
married workers, for those of their spouses. Moretti cites
research by UCLA economists Dora Costa and Matthew
Kahn showing that a society-wide increase in the pairing of
highly educated people has made it more critical for those

I

couples to settle in an area where they can both find quality
innovation-sector jobs.
Although innovation-sector jobs normally comprise only
a small part of a local economy, perhaps one-tenth, Moretti
sees them as foundational; they support the metro with the
prosperity that makes its way to local services industries.
As manufacturing jobs have moved abroad, the ability of the
manufacturing sector to serve this foundational function has
dropped off. Thus, cities that have been the most successful
in making the transition from manufacturing to innovationsector industries have seen higher pay for their workforces
in general, both the innovation-sector workers themselves
and services workers.
How, then, does a city develop an innovation sector?
What did policymakers do to transform California’s agricultural Santa Clara Valley, for instance, into Silicon Valley?
Moretti reports that the usual prescriptions are risky at best.
The benefits of having a top university, for example, tend to
be greatly overstated. Tax breaks and subsidies to draw desirable companies may succeed in attracting the companies
and benefiting the local workforce, but the bidding war for a
company can lead to a package with costs to the locality that
exceed its benefits. The development strategy of appealing
to educated workers with culture and a vibe of coolness is
also problematic, he finds. There are plenty of cool cities,
like Berlin, with lots of jobless educated workers, while
other cool cities, like Seattle, became cool only after they
became prosperous.
The New Geography of Jobs is a readable and cogent synthesis of Moretti’s work and that of other labor and regional
economists. Still, it is disquieting that the consensus model
within which he is operating rests on a vision of tomorrow’s
economy in which 10 percent or so of Americans work in the
innovation sector while the rest of us pour their coffee,
polish their nails, and sell their homes. Underlying this
vision is a bet that the United States will retain a comparative advantage in innovation-sector work over the long term.
It’s a proposition for which the historical record gives mixed
support. With U.S. policymakers having accepted the loss of
low-end manufacturing on the ground that Americans would
always have high-end manufacturing, and then resigning
themselves to the loss of much high-end manufacturing as
well, what is the likelihood of that story playing out again at
the level of “creativity” or “innovation”? Even with America’s
advantages of the moment in innovation industries, how
much should America rely on the assumption that it will
dominate them in the long term — at least to the extent that
the innovation sector can sustain a broadly middle-class
economy? Should a healthy city, and a healthy society, hedge
that bet?
RF

Region Focus | Second/Third Quarter | 2012

43

DISTRICTDIGEST

Economic Trends Across the Region

Dimensions and Drivers of Metro Area Growth:
How Do Fifth District Metros Stack Up?
BY A N N M AC H E R A S A N D J A K E B L AC K WO O D

etropolitan areas across the country vie to be
the fastest growing, the most attractive to
younger generations, and the most suitable for
new business. Growth provides a city with tax revenues to
finance maintenance and enhancements to infrastructure,
public spaces, cultural amenities, education, and other
benefits, perpetuating the positive cycle that attracts even
more businesses and skilled workers to remain competitive. A city with a stagnating or contracting population will
soon find fewer of its young people returning home after
college because of a lack of employment opportunities.
Indeed, the quality of life that comes along with a healthy
job environment and plentiful options for cultural and
recreational activities requires a critical mass of population to support and participate in the life of the city.
Growth in a metropolitan area can be measured in various ways. The most obvious is an increase in the population,
but of course, growth in the number of residents is not
beneficial in and of itself unless there are productive opportunities for work. Both population growth and income
growth are important for assessing the vitality of metropolitan areas. By looking at data on drivers of growth for
different metro areas in the Fifth District, we can get a
better understanding of where the region’s growth is likely
to be strongest in the future (see chart).

M

4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
-0.5

SOURCE: U.S. Census Bureau

44

What causes some metropolitan areas to grow more quickly
than others? Many factors matter, but their relative importance evolves over time. For example, many metros thrived
due to natural advantages such as proximity to waterways for
easier transportation of goods or access to nearby natural
resources for production. This was particularly true when
manufacturing activity dominated the economy, but it does
not matter as much in the more diverse economy today.
More recently, metropolitan areas in the South and West
have benefited from migration based on their climates,
which are considered more favorable than those of their
counterparts in the North. Beyond these place-specific
elements, a major focus in urban economics research has
highlighted the importance of agglomeration economies,
more generally referred to as economies of scale, as a
contributor to the growth of metropolitan areas.
Agglomeration effects relate to the size and density of
the city, known as urbanization economies, or to the concentration of a particular industry within a city or region,
referred to as localization economies. Increased urbanization provides firms across industries with the variety of
business services and easy access to specialized labor that
improve productivity. An example of this is the wide range of
industries that have thrived in New York City, where
industries as different as financial services and fashion
design can benefit from an array
of service providers, such as law
firms that offer specialized
legal counsel to sophisticated
businesses, as well as from a
highly educated pool of labor.
Similarly, localization economies
offer firms within the same and
closely related industries benefits
from knowledge spillovers, access
to a common specialized labor
pool, and economies of scale in
accessing intermediate goods.
In Upstate South Carolina,
growth in companies that produce automotive parts and
equipment has flourished since
BMW established an automotive
assembly plant in Spartanburg
in 1994. These companies, which

Raleigh-Cary, NC
Myrtle Beach, SC
Wilmington, NC
Charlotte, NC-SC
Greenville, NC
Winchester, VA-WV
Durham-Chapel Hill, NC
Harrisonburg, VA
Charlottesville, VA
Columbia, SC
Burlington, NC
Hagerstown-Martinsburg, MD-WV
Asheville, NC
Washington, DC
Greenville-Mauldin-Easley, SC
Greensboro-High Point, NC
Richmond, VA
Winston-Salem, NC
Charleston, SC
Anderson, SC
Salisbury, MD
Spartanburg, SC
Hickory-Lenoir-Morganton, NC
Morgantown, WV
Fayetteville, NC
Lynchburg, VA
Jacksonville, NC
Goldsboro, NC
Florence, SC
Blacksburg, VA
Virginia Beach, VA
Roanoke, VA
Rocky Mount, NC
Baltimore-Towson, MD
Sumter, SC
Cumberland, MD-WV
Parkersburg-Marietta-Vienna, WV-OH
Huntington-Ashland, WV-KY-OH
Charleston, WV
Danville, VA

PERCENT CHANGE

Fifth District Metros: Average Annual Population Growth, 1990-2010

Understanding the Drivers of Regional Growth

Region Focus | Second/Third Quarter | 2012

Fifth District Metros: Educational Attainment, Percent of Population 25+, Bachelor’s Degree or Higher
50

Washington, DC
Durham-Chapel Hill, NC
Charlottesville, VA
Raleigh-Cary, NC
Baltimore-Towson, MD
Wilmington, NC
Charlotte, NC
Charleston, SC
Richmond, VA
Blacksburg, VA
Columbia, SC
Morgantown, WV
Asheville, NC
Virginia Beach, VA
Roanoke, VA
Winston-Salem, NC
Greenville-Mauldin-Easley, SC
Greenville, NC
Harrisonburg, VA
Greensboro-High Point, NC
Fayetteville, NC
Salisbury, MD
Myrtle Beach, SC
Winchester, VA-WV
Lynchburg, VA
Burlington, NC
Spartanburg, SC
Hagerstown-Martinsburg, MD-WV
Charleston, WV
Jacksonville, NC
Anderson, SC
Florence, SC
Hickory-Lenoir-Morganton, NC
Huntington-Ashland, WV-KY-OH
Sumter, SC
Parkersburg-Marietta-Vienna, WV-OH
Goldsboro, NC
Cumberland, MD-WV
Danville, VA
Rocky Mount, NC

PERCENT

now number over 150, benefit
45
40
from a skilled local workforce
35
and nearby university and
30
community college programs
25
20
that support ongoing training
15
and research needs for the
10
5
automotive cluster. Moreover,
0
when firms and their workers
operate in closer proximity to
each other, they are afforded
opportunities to learn from
each other and apply expanded knowledge to production
or to the provision of services.
It makes sense, then, that as
SOURCE: U.S. Census Bureau
production has shifted toward
services and toward goods
that rely on more skilled labor and greater technology, the
importance of agglomeration effects has likely overtaken
the contribution of natural advantage in explaining growth
across metropolitan areas.
Agglomeration economies drive growth in metropolitan
areas, but what matters most in creating these economies?
Improvements in data collection and estimation methods
have allowed for empirical research that clearly connects the
importance of human capital to metropolitan area growth.
Population growth in metropolitan areas with high educational attainment has far surpassed growth of metropolitan
areas with low educational attainment. A 2004 study by
Edward Glaeser of Harvard University and Albert Saiz of the
University of Pennsylvania found that metropolitan areas
where less than 10 percent of adults had bachelor’s degrees
in 1980 grew by 13 percent in the 1980-2000 period, while
metropolitan areas with a higher share of college-educated
adults (more than 25 percent) grew almost three times as
fast, at an average rate of 45 percent (see chart).
The researchers tested the direction of the relationship
as well. They looked at the question of whether skilled workers flock to the cities that are already growing or whether
cities grow because they have a higher share of educated
workers. They found that many variables are positively correlated with metropolitan area growth, including a warmer
and drier climate, but that the human capital related variables have the most significant effect. Furthermore,
measures of human capital matter for growth even when
controlling for other important variables. On the other
hand, when they considered the possibility of reverse causality — that differences in growth rates predict the percentage
of the population with a college education — they found
that this holds for only a small number of declining metro
areas and found no support for this in growing metro areas.
Using an alternative approach to analyze the growth path
of metropolitan areas, economists from the St. Louis Fed
and the University of Oregon found in a 2008 article in
the Journal of Urban Economics that different factors may
influence growth in metropolitan areas during periods of

low growth versus periods of high growth. They found that
human capital plays an important role in high-growth
phases, but does not seem to matter as much in low-growth
phases. (However, the share of employment engaged in
manufacturing is a significant contributor to declining
growth when the economy is in a low-growth phase.)
Another area of economic research on urban growth
focuses on clusters of occupations in a metropolitan area and
how they can be classified to provide additional information
on the level of knowledge within the area, beyond the simple
share of college-educated adults. This research stresses the
fact that college graduates are not all alike, representing
a broad array of skills, and that some of the occupation
clusters, such as those that demonstrate a high level of
knowledge about commerce and information technology, are
stronger predictors of growth than other occupations.

Comparing Drivers of Growth Across Metros
Metropolitan areas in the United States grew on average
at a rate of 1.2 percent from 1990 to 2010, a period
sufficiently long to examine how base-year attributes, such
as educational attainment and industry mix, correspond
with slower or faster growth in population. For a simple
examination of these key variables, the metropolitan areas
were combined into four groups based on quartiles of population growth from 1990 to 2010. Each quartile contains 90
metropolitan areas, for a total of 360 for which the data is
complete over the period. The summary information on
educational attainment, industry mix, and population
growth revealed some interesting patterns that align
reasonably well with the economic theory (see Table 1).
The slowest-growing group of metropolitan areas had the
lowest level of educational attainment in 1990, with 75.2 percent of the population over age 25 having graduated from
high school and 16.6 percent holding a bachelor’s degree or
more. The average annual population growth for this group
of metros was only 0.1 percent from 1990 to 2010. Further,
the industry mix for these areas was heavily weighted toward
manufacturing, which accounted for more than 20 percent

Region Focus | Second/Third Quarter | 2012

45

Table 2

of employment in 1990. In contrast, the fastest-growing
25 percent of metropolitan areas started the period with
nearly 20 percent of the population over age 25 holding a
bachelor’s degree or more and a much smaller share of
employment, only 13.8 percent, engaged in the manufacturing sector. Population growth for this group of metros
averaged 2.4 percent annually from 1990 to 2010, more than
20 times faster than the slowest-growing group.
The comparison of metropolitan areas using the indicators from the starting year suggests that higher growth rates
occurred where skilled workers were already more concentrated. When we review the same growth determinants for
the end of the period, we find that the same relative advantages hold up, as the faster-growing half of the metropolitan
areas had higher levels of college attainment (see Table 2).
In addition, we have information on occupation mix
for 2010 that we do not have for the earlier base year.
As measured by the number of workers per thousand, the
fastest-growing metropolitan areas had a higher share of
workers in knowledge intensive occupations in 2010.
Combining computer science and mathematical occupations as well as architectural and engineering occupations,
the slowest-growing metropolitan areas averaged 31 workers
(per thousand) engaged in this type of work, while the
fastest-growing metropolitan areas averaged 37 workers in
these highly skilled occupations. Thus, a worker in a
fast-growing area is 20 percent more likely to be in a
knowledge-intensive occupation than a worker in a slowgrowing area. Conversely, the slowest-growing metropolitan
areas had a much higher concentration of production
workers per thousand employed — 83 workers compared to
59 workers in the fastest-growing areas.
Growth in per capita income is often viewed as an indicator of growth and economic development because it
suggests an improvement in standard of living and not just
an increase in the number of inhabitants. To explore the
relationship between income growth and the key growth
indicators, we divided the metropolitan areas into four
quartiles based on average annual growth in per capita
income from 1990 to 2010. Similar to the findings for
population growth, the share of college-educated adults
Table 1
Growth and 1990 Baseline
Variables
Average annual population
growth, 1990-2010
Percent high school graduate
and above (1990)
Percent bachelor’s degree
or above (1990)
Manufacturing share of total
employment, 1990
Professional and business
services share of total
employment, 1990

Metropolitan Areas Grouped by Average Annual
Population Growth, 1990-2010
Bottom 25% 2nd quartile 3rd quartile

Top 25%

.11

.81

1.3

2.4

75.2

75.5

76.6

75.1

16.6

19.2

20.3

19.6

20.4

18.3

16.3

13.8

6.9

7.6

7.5

7.8

SOURCES: U.S. Census Bureau and Bureau of Labor Statistics

46

Region Focus | Second/Third Quarter | 2012

Summary for 2010
Percent high school graduate
and above
Percent bachelor’s degree
or above
Manufacturing share of total
employment
Professional and business
services share of total
employment
Patents per 100,000
population

Metropolitan Areas Grouped by Average Annual
Population Growth, 1990-2010
Bottom 25% 2nd quartile 3rd quartile Top 25%
87.3

86.0

87.0

84.3

23.0

25.6

27.3

26.2

11.6

11.1

10.0

7.7

9.7

10.2

10.8

11.3

22

39

27

24

Management worker share*

40

43

42

42

Computer and mathematical
worker share*
Architectural and
engineering worker share*

15

19

20

20

16

17

17

17

83

76

72

59

Production worker share*
*Per 1,000 workers

SOURCES: U.S. Census Bureau and Bureau of Labor Statistics

increased as we moved from the slower-growing metropolitan areas to the group that had higher income growth. This
is not surprising, since college-educated workers tend to
earn higher wages than less-educated workers. Also, the
share of employment in manufacturing declined when we
compared metropolitan areas with slower per capita income
growth to those areas with higher income growth, similar to
the comparison for population growth.

Fifth District Metropolitan Area Growth
Within the Fifth District, there are 40 metropolitan areas
for which we have data to make similar comparisons of the
key growth drivers (see Table 3). Annual population growth
for 1990 through 2010 averaged 1.3 percent for Fifth District
metropolitan areas, compared with a slower 1.1 percent for
other metro areas. Per capita income growth was the same
for Fifth District metros and non-District metros, however,
with average growth at 3.8 percent.
Educational attainment at both the high school and
college level was lower for the Fifth District in the base year
of 1990. The percentage with a high school diploma or above
was 71.3 percent for Fifth District metros, but 76.2 percent
for other metro areas. The share of college educated was
18.1 percent in the Fifth District metros and 19.1 percent in
other metro areas. The base year share of employment in
the manufacturing sector was nearly 21 percent in the Fifth
District metros, but not quite 17 percent elsewhere.
If we fast forward to 2010, college education attainment
in Fifth District metros had largely caught up to the nonDistrict metros, with both running at just over 25 percent.
The difference in manufacturing concentration also diminished substantially, although it was still a bit higher in the
Fifth District metros than it was for non-District metros
(11 percent compared to 10 percent). As might be expected,
because of the Fifth District metro areas’ higher concentration in manufacturing, they had a higher share of production
workers per 1,000 employees. The Fifth District metro

Table 3

areas also had a higher share of computer and mathematical
workers compared to metros outside of the Fifth District.
Two Fifth District metropolitan areas — Burlington,
N.C., located in the north central part of the state, and
Danville, Va., in Southside Virginia — can serve as a case
study illustrating the effect of educational attainment.
The two had a nearly equal population in 1990: 108,213 for
Burlington and 108,711 for Danville. Population remained
nearly flat in Danville over the period from 1990 to 2010,
while Burlington experienced an average annual population
growth rate of 1.7 percent over this period, higher than the
average rate of growth for all metropolitan areas nationally.
Both metropolitan areas were dependent on textile manufacturing and have undergone structural shifts in their
economies toward nonmanufacturing sectors. In 1990, manufacturing accounted for just over 21 percent of employment
in Burlington and 16 percent in Danville, but by 2010 the
concentration in manufacturing had declined dramatically
in both areas, to 8.4 percent and 6.4 percent, respectively.
Burlington and Danville differ in other ways, not the least
of which is the location of Burlington on a major interstate,
I-85, connecting Richmond and Atlanta. In addition to its
proximity to major interstates, Burlington and Danville also
differ in terms of the higher education institutions that are
located within each metro area or within a reasonable
driving distance. The Burlington metro area is home to Elon
University, with an annual on-campus enrollment of
approximately 5,000 students, whereas Danville is home to
Averett University, with an annual residential enrollment of
only 1,000 students. Moreover, while both metro areas enjoy
proximity to the larger research universities in the
Greensboro metro area, including Wake Forest University
and UNC-Greensboro, only the Burlington metro has
the distinct advantage of a relatively short commute to
Duke University and the University of North Carolina at
Chapel Hill. In addition, the Burlington metro area is also
close to the Research Triangle Park, which provides a unique
collection of research and development facilities with a
heavy concentration of knowledge intensive industry.
Notwithstanding these fortunate accidents of geography
enjoyed by Burlington, the two metropolitan areas are also
distinguished by important differences in human capital
within their borders. As measured by completion of high
school or attainment of a bachelor’s degree, educational
achievement for adults was much lower in Danville in 1990.
Neither metro matched the all-metro area average of 76 percent high school or above and 22 percent bachelor’s or
higher for the population age 25 and older. Burlington had a
college graduate percentage of 15 percent compared to only
10 percent in Danville, while the high school graduate and
above shares were 68 percent and 57 percent, respectively.
Fortunately, both metropolitan areas made substantial
progress over the subsequent 20 years, and by 2010 high
school educational attainment nearly converged in the two
metro areas, with just over 81 percent of the adult 25+ population holding at least a high school degree in Burlington,

Growth and Key Variables

Metropolitan Areas Grouped by Average
Annual Population Growth, 1990-2010
Fifth District
2010

1990

Other (non-District)
1990
2010

Average annual population growth,
1990-2010
Per capita personal income, average
annual growth, 1990-2010
Percent high school graduate
and above

71.3

84.9

76.2

86.3

Percent bachelor’s degree or above

18.1

25.4

19.1

25.5

20.8

10.8

16.7

10.0

7.5

12.2

7.4

10.4

Manufacturing share of total
employment
Professional and business services
share of total employment

1.3

1.1

3.8

3.8

SOURCES: U.S. Census Bureau and Bureau of Labor Statistics

relative to 78 percent in Danville. The differential in college
graduate achievement also held up in 2010, but both metros
raised this share as well, to near 21 percent for Burlington
and 15 percent for Danville. Further, the level of knowledgebased occupations in Burlington’s workforce outpaced the
mix in Danville in 2010, with 24 workers per thousand
engaged in computer science and mathematical occupations
or architectural and engineering occupations, compared to
11 workers in Danville. While other factors may also be
important, it appears that Burlington had a clear advantage
over Danville in terms of education and skill levels and this
contributed to a faster pace of population growth.

Implications for the Future
Metropolitan areas need to pay close attention to the educational opportunities and outcomes provided in their region
in order to promote a growing, dynamic economy that
attracts the knowledgeable workforce required for today’s
industries. Our review of metropolitan area data for the
period from 1990 to 2010 confirms that metro areas which
started with a higher concentration of skilled workers tended to grow by far the fastest in population over this
two-decade period.
The fastest-growing metropolitan area in the Fifth
District, Raleigh-Cary, North Carolina, is a microcosm of
this effect. It ranked fifth nationally for population growth
from 1990 to 2010, growing at an average annual rate of
3.8 percent. Raleigh-Cary posted very high rates of educational attainment for the adult population (25+) at the
beginning of the study period, with 81 percent holding at
least a high school diploma and 30 percent holding a bachelor’s degree or higher. This skilled population attracted even
more knowledge workers over the years, as the educational
attainment rates reached 91 percent for high school and
41 percent for college-educated graduates by 2010. While
Raleigh-Cary is an exceptional case, other metropolitan
areas within the Fifth District have gained ground. Yet based
on the comparison of Fifth District to other (non-District)
metro areas, there are still opportunities for investment in
human capital to continue to attract knowledge workers
and the learning and innovation they foster.
RF

Region Focus | Second/Third Quarter | 2012

47

State Data, Q1:12
DC

MD

NC

SC

VA

WV

735.5

2,583.3

3,957.9

1,851.0

3,709.8

762.5

Q/Q Percent Change
Y/Y Percent Change

-0.2

0.7

0.7

0.7

0.3

0.3

1.6

1.8

1.2

1.4

1.1

1.8

Manufacturing Employment (000s)
Q/Q Percent Change
Y/Y Percent Change

1.0
0.0
-6.3

111.1
-0.4
-2.5

437.3
0.9
0.9

221.2
0.6
4.6

228.1
0.0
-0.7

48.8
-1.2
-1.3

Professional/Business Services Employment (000s) 151.3
Q/Q Percent Change
-0.2
Y/Y Percent Change
1.7

406.3
1.9
3.2

516.3
0.7
2.1

226.9
-1.4
2.4

667.1
0.7
0.5

63.5
1.3
2.9

Government Employment (000s)
Q/Q Percent Change
Y/Y Percent Change

246.0
-1.0
-1.9

510.0
-0.1
1.0

702.0
0.4
-0.1

340.0
0.9
-0.4

715.0
0.2
1.0

154.8
0.8
2.6

Civilian Labor Force (000s)
Q/Q Percent Change
Y/Y Percent Change

347.7
0.9
0.5

3,083.6
0.1
0.4

4,683.7
0.3
1.0

2,155.9
-0.2
0.1

4,342.2
0.1
1.4

803.3
0.2
0.3

9.8
10.2
10.0

6.5
6.7
7.2

9.9
10.5
10.4

9.1
9.8
10.5

5.7
6.2
6.3

7.1
7.8
8.1

40,034.2
0.3

261,840.3
0.3

306,693.3
0.2

138,570.6
0.2

328,991.9
0.3

55,027.4
0.0

1.5

0.6

0.0

0.4

0.8

1.6

Building Permits
Q/Q Percent Change
Y/Y Percent Change

260
-83.0
-63.6

3,011
-3.1
24.7

11,126
39.5
31.3

4,417
4.2
23.8

6,572
53.8
12.6

384
-8.8
5.5

House Price Index (1980=100)
Q/Q Percent Change
Y/Y Percent Change

577.8
0.3
3.2

410.0
-1.7
-1.1

303.4
-1.5
-2.3

306.6
-1.8
-2.2

397.1
-1.5
-0.6

213.9
-1.6
-1.8

Nonfarm Employment (000s)

Unemployment Rate (%)
Q4:11
Q1:11
Real Personal Income ($Mil)
Q/Q Percent Change
Y/Y Percent Change

48

Region Focus | Second/Third Quarter | 2012

Nonfarm Employment

Unemployment Rate

Real Personal Income

Change From Prior Year

First Quarter 2002 - First Quarter 2012

Change From Prior Year

First Quarter 2002 - First Quarter 2012

First Quarter 2002 - First Quarter 2012

8%
7%
6%
5%
4%
3%
2%
1%
0%
-1%
-2%
-3%
-4%
-5%
-6%

10%

4%
3%
2%
1%
0%
-1%
-2%
-3%
-4%
-5%
-6%

9%
8%
7%
6%
5%
4%
3%
02

03 04

05

06

07

08 09

10

11

02

12

03 04

05

06

07

08 09

10

11

Fifth District

12

02

03 04

05

06

07

08 09

Unemployment Rate
Metropolitan Areas

Building Permits

Change From Prior Year

Change From Prior Year

First Quarter 2002 - First Quarter 2012

First Quarter 2002 - First Quarter 2012

First Quarter 2002 - First Quarter 2012

03 04

05

Charlotte

06

07

08 09

Baltimore

10

30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
02

Washington

03 04

05

06

Charlotte

07

08 09

Baltimore

10

FRB—Richmond
Manufacturing Composite Index

First Quarter 2002 - First Quarter 2012

First Quarter 2002 - First Quarter 2012

30
20

20

10

11

12

0

-50
03 04

05

06

07

08 09

10

11

12

02

08 09

United States

First Quarter 2002 - First Quarter 2012

-30

02

07

16%
14%
12%
10%
8%
6%
4%
2%
0%
-2%
-4%
-6%
-8%

-40

-30

06

Change From Prior Year

-20
-20

05

House Prices

-10

-10

03 04

Fifth District

0

10

02

Washington

FRB—Richmond
Services Revenues Index

30

11 12

40%

11 12

40

10

Change From Prior Year

13%
12%
11%
10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
02

11 12

United States

Nonfarm Employment
Metropolitan Areas
7%
6%
5%
4%
3%
2%
1%
0%
-1%
-2%
-3%
-4%
-5%
-6%
-7%
-8%

10

03 04

05

06

07

08 09

10

11

12

02

03 04

05

Fifth District

06

07

08 09

10

11 12

United States

NOTES:

SOURCES:

1) FRB-Richmond survey indexes are diffusion indexes representing the percentage of responding firms
reporting increase minus the percentage reporting decrease.
The manufacturing composite index is a weighted average of the shipments, new orders, and employment
indexes.
2) Building permits and house prices are not seasonally adjusted; all other series are seasonally adjusted.

Real Personal Income: Bureau of Economic Analysis/Haver Analytics.
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.
Building permits: U.S. Census Bureau, http://www.census.gov.
House prices: Federal Housing Finance Agency, http://www.fhfa.gov.

Region Focus | Second/Third Quarter | 2012

49

Metropolitan Area Data, Q1:12
Washington, DC
Nonfarm Employment (000s)
Q/Q Percent Change
Y/Y Percent Change

Hagerstown-Martinsburg, MD-WV

2,434.6
-0.1
1.5

1,286.8
-2.1
1.4

97.7
-1.6
0.0

5.5
5.7
5.9

7.0
7.1
7.8

8.3
8.7
9.3

3,947
-11.6
-5.0

1,323
-12.9
22.6

125
-3.8
0.0

Asheville, NC

Charlotte, NC

Durham, NC

169.1
-0.9
2.1

826.4
-1.1
1.3

275.4
-0.8
1.9

8.0
8.4
8.6

10.0
10.7
11.1

7.8
8.2
8.0

223
1.8
-22.3

2,796
97.9
95.7

1,037
61.8
127.4

Raleigh, NC

Wilmington, NC

344.1
-0.6
1.7

512.2
-0.8
2.3

133.2
-2.1
-0.2

Unemployment Rate (%)
Q4:11
Q1:11

10.2
10.9
11.0

8.1
8.6
8.5

10.2
10.8
10.4

Building Permits
Q/Q Percent Change
Y/Y Percent Change

725
18.7
11.7

2,309
35.5
111.3

751
80.5
93.1

Unemployment Rate (%)
Q4:11
Q1:11
Building Permits
Q/Q Percent Change
Y/Y Percent Change

Nonfarm Employment ( 000s)
Q/Q Percent Change
Y/Y Percent Change
Unemployment Rate (%)
Q4:11
Q1:11
Building Permits
Q/Q Percent Change
Y/Y Percent Change

Greensboro-High Point, NC
Nonfarm Employment (000s)
Q/Q Percent Change
Y/Y Percent Change

50

Baltimore, MD

Region Focus | Second/Third Quarter | 2012

Winston-Salem, NC

Charleston, SC

Columbia, SC

204.6
-2.0
1.4

295.7
-0.3
2.2

348.6
-0.6
2.0

9.4
9.8
10.1

7.6
8.1
8.5

7.8
8.5
8.6

341
-23.5
69.7

1,032
-16.7
43.5

836
35.3
6.4

Greenville, SC

Richmond, VA

Roanoke, VA

303.2
-1.2
1.6

611.5
-0.5
1.9

154.0
-2.0
0.2

Unemployment Rate (%)
Q4:11
Q1:11

7.4
8.0
8.7

6.4
6.8
7.1

6.1
6.6
6.8

Building Permits
Q/Q Percent Change
Y/Y Percent Change

522
27.6
21.1

1,021
52.6
67.4

82
-8.9
-23.4

Virginia Beach-Norfolk, VA

Charleston, WV

726.2
-1.7
0.5

146.6
-1.6
0.9

113.7
-1.0
1.5

6.6
7.0
6.9

6.6
7.4
7.5

7.7
8.2
8.4

1,897
91.6
63.8

31
72.2
29.2

31
24.0
675.0

Nonfarm Employment (000s)
Q/Q Percent Change
Y/Y Percent Change
Unemployment Rate (%)
Q4:11
Q1:11
Building Permits
Q/Q Percent Change
Y/Y Percent Change

Nonfarm Employment (000s)
Q/Q Percent Change
Y/Y Percent Change

Nonfarm Employment (000s)
Q/Q Percent Change
Y/Y Percent Change
Unemployment Rate (%)
Q4:11
Q1:11
Building Permits
Q/Q Percent Change
Y/Y Percent Change

Huntington, WV

For more information, contact Sonya Ravindranath Waddell at (804) 697-2694 or e-mail Sonya.Waddell@rich.frb.org

Region Focus | Second/Third Quarter | 2012

51

OPINION
Economics, Uncertainty, and the Environment
BY J O H N A . W E I N B E RG

estimates about its magnitude and the associated present
his issue of Region Focus features an article on the
and future costs. The estimates of the effects range from
debate over using “fracking” to extract natural gas
catastrophically negative (due to rising sea levels and meltfrom shale deposits. The process, as the article
ing ice sheets) to slightly positive (due to greater crop yields
points out, is controversial and the analysis complicated.
in some parts of the world). Given such uncertainty about
Critics claim that fracking could make drinking water
the effects of global warming — combined with the certain
unsafe and, in some cases, may increase the potential for
large costs of significantly curtailing economic activity that
earthquakes. Proponents argue that such claims are
is believed to lead to global warming — one could make a
exaggerated and that fracking could tap unused resources
case for not taking widespread preventative measures.
and boost the nation’s energy supply, driving down prices
But, at the same time, there is also a strong case for being
in that sector. In addition, there are the jobs that would
somewhat more aggressive in pursuing policies — including
accrue to the communities where fracking would take place
being more vigilant about internalizing social costs — that
— the same communities that might be hardest hit by
could reduce the probability of significant global warming
environmental problems.
that would impose enormous costs on future generations.
The reason that I italicized “might” in the previous
Some economists and ethicists would object to enacting
sentence is that, as an economist, I don’t really know how
any policies that might make the present population poorer
likely it is that fracking could cause such environmental
— including those aimed at curbing global warming — in an
damage. And if such damage were to occur, I don’t know
effort to aid future generations. The reason, they would
how costly it would be. The best that I can do is to rely on
argue, is that such policies could have perverse redistribuexpert opinion from scientists who have studied fracking —
tive effects. Although the recovery
but even they cannot be sure about
from the financial crisis and recesthe costs. So I am left in a quandary
Why should a poorer
sion has been sluggish, it is likely
about how to evaluate the issue.
population sacrifice some
that the economy will eventually
In general, when economists are
prosperity to aid
rebound and continue to grow on its
asked to address environmental
long-term trend path of roughly
questions, they are inclined to
wealthier populations?
3 percent a year. What this means is
say that property rights should, if
that our children will be wealthier than us, and their
feasible, be assigned in a way that will “internalize” the social
children wealthier than them. Why should a poorer populacosts of any private activity. In the case of fracking, though,
tion sacrifice some prosperity to aid wealthier populations,
we don’t know with certainty if the activity will contaminate
critics would ask?
drinking water until after companies have started work;
It’s a good question, and one that’s inherently hard to
we also don’t know if it will contribute to earthquakes.
answer. Almost everyone would agree that we should avoid
Both could have enormous costs — costs that firms might
regressive policies — those that benefit the relatively rich at
be unwilling to bear if they knew of them in advance. So it is
the expense of the relatively poor. But in the case of global
very hard to make the calculation of how much, if at all,
warming, we just don’t know if our actions today might
to effectively tax firms that wish to engage in fracking.
impose costs on future generations that are so large that
This, potentially, could be an argument for delaying firms
they would be unable to effectively mitigate them. To not try
from acting at all. Until scientists can give us more precise
to address such a possibility would be irresponsible. That
estimates of the costs of fracking, we may decide it would
doesn’t mean we should take drastic and reactionary steps,
be better to wait. Those costs could be larger than the
such as severely taxing or outright prohibiting the use of
benefits of tapping the additional energy — and thus larger
fossil fuels. Such actions would be even more irresponsible
than the firms themselves would want to bear if they
than denying that global warming may exist and its future
had such information today. I make this point not as an
costs might be significant. Instead, it means seeking
environmental scientist, or environmental economist, but
appropriately cautious remedial actions that would not
simply as an economist who recognizes the challenges of
significantly alter our way of life but potentially save
doing cost-benefit analysis for this kind of problem.
future generations from tremendous harm. Think of it as a
Such considerations are useful when thinking about how
catastrophic-care insurance policy.
RF
to address other environmental issues, including global
warming. As with the potential dangers of fracking, I am not
in a position to say whether the earth is warming. Most
John A. Weinberg is senior vice president and director
scientists believe that it is, but they have widely varying
of research at the Federal Reserve Bank of Richmond.

T

52

Region Focus | Second/Third Quarter | 2012

NEXTISSUE

2

l

h

w.

Mobile Payments

Federal Reserve

For many Americans, the mobile phone has replaced a number
of formerly indispensible items: the desk calendar, the
Rolodex, and the morning paper. In some countries, the cellphone has also largely replaced the wallet when it comes to
exchanging money and paying for goods and services. As the
United States also begins developing mobile payment options,
how will consumers benefit from carrying their own personal
bank in their phones? And what security and regulatory
concerns need to be addressed for mobile payments to gain
widespread acceptance?

Stress tests are a tool to help regulators
determine whether banks have sufficient
capital to withstand a downturn in the
economy. The Fed has conducted several
major rounds of stress testing since the
2008 financial crisis. What are the benefits
and costs of stress tests? Are they here
to stay?

Vocational Training
Some nations prepare their youth for the workforce with highly
developed programs of skills training and apprenticeships.
The United States, in contrast, tends to steer students toward
general education, which arguably sets the stage for later
learning and on-the-job training. But some say we should draw
more from the vocational approach.

Economic History
Several areas of the Fifth District are
major centers of video game development,
including the Hunt Valley region of
Maryland; Fairfax County, Va.; and Cary, N.C.
What brought the video game industry
to these areas? Have agglomeration effects
benefited the companies?

Policy Update

Where Does the Federal Government
Get the Money It Spends?
Since the advent of the personal income tax in 1913, the United
States has relied on an evolving mix of taxes and borrowing to
pay its bills. How are Americans paying for federal programs
today, and who is likely to pay more in the future?

A new Maryland law prevents employers
from requiring employees and job applicants to divulge passwords for social media
accounts. Similar legislation is pending in
Congress and in at least 13 states.

Visit us online:
www.richmondfed.org
• To view each issue’s articles
and Web-exclusive content
• To view related Web links of
additional readings and
references
• To add your name to our
mailing list
• To request an e-mail alert of
our online issue posting

Federal Reserve Bank
of Richmond
P.O. Box 27622
Richmond, VA 23261

Change Service Requested

To subscribe or make subscription changes, please email us at research.publications@rich.frb.org or call 800-322-0565.

July 2012
Unsustainable Fiscal Policy:
Implications for Monetary Policy
August 2012
TARGET2: Symptom, Not Cause, of
Eurozone Woes
Look for our next Economic Brief
Can Orderly Liquidation Solve the
Problems of Bailouts and Bankruptcies?

To access the Economic Brief and other Fed resources visit:
www.richmondfed.org