Full text of Econ Focus (Federal Reserve Bank of Richmond) : Summer 2003, Volume 7, Number 3

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»Ready to Lend »Liquid Assets »May I See Your License, Please?
»An Interview with Kenneth Rogoff »NASCAR: Roads to Riches

S U M M E R

2 0 0 3

Dollars and

Defense
Measuring the Economic
Effects of the Military

T H E

F E D E R A L

R E S E R V E

B A N K

O F

R I C H M O N D

VOLUME 7
NUMBER 3
SUMMER 2003

COVER STORY
12

Dollars and Defense: A Closer Look at How Military Spending
Affects Fifth District Communities in Times of War and Peace
The military’s effect on the economy is highly visible during times of war.
But its peacetime effects shouldn’t be ignored either, especially in the Fifth
District. There are many large military bases throughout the region, each of
which plays an important role in the economic life of its community.

FEATURES
20

Liquid Assets: Who should sell hard liquor in the Fifth District –
state-run monopolies or private companies?
State laws regulating the distribution of alcohol vary greatly throughout
the Fifth District. Some states exercise almost complete control over
sales, while others allow private companies to handle this business. Which
type of system is more desirable depends on whom you ask.

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

25

May I See Your License, Please? Excessive Occupational Licensing
Can Cost Consumers Money Without Necessarily Increasing
Quality or Protection
The rules governing who may enter certain professions can be quite
burdensome, limiting the supply of people providing services and raising
prices for consumers. Those who have already obtained their occupational
licenses benefit from this system, but does the public?

Jeffrey M. Lacker
SENIOR EDITOR

Aaron Steelman
MANAGING EDITOR

Rowena Johnson
BUSINESS WRITERS

Charles Gerena
Betty Joyce Nash
P RO D U C T I O N A S S I STA N T

Bridgette Craney
CONTRIBUTORS

28

Seeing the Light: Communities in Catawba County, N.C.,
supported the growth of optical fiber and cable producers to
help maintain the county’s manufacturing sector.

Andrew Foerster
Elaine Mandaleris
Christian Pascasio
Karl Rhodes
ECONOMICS ADVISERS

Small towns throughout North Carolina have suffered as jobs in the textile
and furniture industries have moved overseas. But one area of the state
has been able to attract a new type of industry to replace some of those
vanishing jobs.
31

No Silver Bullet: Tax and Spending Limits, Though Often Useful,
Can’t Cure All Budgetary Ills
Ballot initiatives designed to curb taxes and spending are popular in many
Western states. But it’s not clear that Fifth District states could have
avoided their current fiscal problems by adopting these measures.

DEPARTMENTS

AP PHOTO/RICKY CARIOTI

1 Noteworthy
2 Federal Reserve/Ready to Lend
5 Legislative Update/Budget Deficits and Interest Rates
6 Short Takes
10 Jargon Alert/Asset Bubbles
11 Research Spotlight/The Economics of…Sumo Wrestling
32 Interview/Kenneth Rogoff
36 Economic History/Roads to Riches
40 Regional/District Economic Developments
48 Opinion/Don’t Bring Back the Draft
COVER PHOTO: ©THE STOCKTREK CORP/BRAND X PICTURES/PICTUREQUEST

Andrea Holland
Robert Lacy
Ray Owens
John Weinberg
C I RC U L AT I O N

Joyce Eberly
Nichole Richardson
DESIGN

AURAS Design/
Maureen Alemán
Published quarterly by
the Federal Reserve Bank
of Richmond
P.O. Box 27622
Richmond, VA 23261
Phone: (804) 697-8000
Fax: (804) 697-8287
E-mail: rich.regionfocus@rich.frb.org
www.rich.frb.org/pubs/regionfocus
Subscriptions and additional copies:
Available free of charge by
calling the Public Affairs
Division at (804) 697-8109.
Reprints: Text may be reprinted
with the disclaimer in italics below.
Permission from the editor is
required before reprinting photos,
charts, and tables. Credit Region
Focus and send the editor a copy
of the publication in which the
reprinted material appears.
The views expressed in Region Focus
are those of the contributors and not
necessarily those of the Federal Reserve
Bank of Richmond or the Federal
Reserve System.
ISSN 1093-1767

NOTEWORTHY
Guns and Butter

E

An increase in the
production of
defense-related
goods and services
must necessarily
draw resources away
from the production
of other goods —
more guns mean
less butter at the
national level.

Editor’s Note:
We introduce
“Research Spotlight”
on page 11 of this
issue. This department discusses an
important scholarly
economics article in
a nontechnical way.
Let us know what
you think about the
department and
Region Focus by
sending an e-mail
to: rich.regionfocus@
rich.frb.org.

conomics is all about
trade-offs. Most textbooks introduce the
student to the idea of tradeoffs with a diagram called a
“Production Possibilities Frontier.” This graphic device considers the hypothetical case of
an economy in which only two
goods are produced and shows
the combinations of the two
goods that are technically feasible, given the economy’s
resources and know-how. It
demonstrates the fact that you
can’t get more of one good
without giving up some of the
other. At least since Paul
Samuelson first published his
famous, standard-setting textbook in 1948, it has been
popular to label the two goods
in question “Guns” and “Butter.” This dichotomy, which
probably has its origins in political discussions about the costs
of military build-ups prior to
the First World War, captures
the very real trade-off societies
typically face in the allocation
of resources between national
defense and private consumption goods. This same basic
trade-off applies to all goods
and services produced by the
government.
While choices about military spending are made
through the political process at
the national level, such decisions can have significant
effects on local economies.
This issue’s cover story details
the military’s economic impact
on Fifth District communities,
as well as the economic drain
those communities feel when
large numbers of troops are
deployed overseas. The boost
that a military presence gives

to a local economy may create
the impression that a simultaneous increase in both guns
and butter is possible, contrary
to the trade-off posed in textbooks. This impression would
be mistaken and would result
from a failure to distinguish
local from aggregate effects.
More military spending—more
guns at the national level—can
certainly mean a stronger local
economy—more butter—for
regions with relatively high
concentrations of military facilities. At the aggregate level,
however, the economy has only
a limited amount of resources
available for the production of
all goods. An increase in the
production of defense-related
goods and services must necessarily draw resources away
from the production of other
goods—more guns mean less
butter at the national level.
A production possibilities
frontier represents the set of
choices available to an
economy. While resources and
technology determine this set,
the actual choice to be made
depends on the relative value
that society as a whole places
on alternative combinations of
guns and butter. This sort of
decision problem is easy to
describe in terms of economic
theory, but, in practice, the
social value of increased spending on defense can be hard to
pin down in precise quantitative terms. Most goods are
allocated by markets, and individuals buy the amount they
want, based on their private
valuations. There is typically
no need for society to make a
conscious, collective determination of value. But national

defense comes as close as any
good or service to what economists call a “pure public
good.” The benefits of a dollar
spent on defense are shared by
all citizens. Individuals cannot
make their own independent
decisions about how much
defense to buy.
The public-good nature of
defense necessarily makes military spending a political decision. As such, and especially in
times of war or international
crisis, we sometimes overlook
or set aside the economic
aspects of this decision. And
while the cost (in butter) of
more guns cannot be avoided,
it can be delayed through government borrowing. Since borrowed funds will need to be
repaid in the future, the choice
is actually between taxation now
and taxation in the future. Even
beyond the issue of financing
defense expenditures, the issue
of taxation and government
deficits has been much in the
news recently, as discussed in
our Legislative Update feature.
As that piece makes clear, economists continue to debate the
effects of deficit spending on
economic performance. One
thing, however, is certain. Public
expenditures must be paid for,
regardless of one’s beliefs about
the effects of government
deficits or the efficacy of government spending. Sooner or
later, more guns (or interstate
highways, or cancer research, for
that matter) mean less butter.

AL BROADDUS
PRESIDENT
FEDERAL RESERVE BANK OF RICHMOND

Summer 2003 • Region Focus

1

FEDERALRESERVE

Ready to Lend
The Discount
Window’s Evolving
Role as a Liquidity
Lifeline for
Depository
Institutions

FRB OF MINNEAPOLIS

BY CHARLES GERENA

In the early days of the Federal
Reserve, bankers visited the discount
window when they needed to borrow
reserves unexpectedly.

2

Region Focus • Summer 2003

n the past, people visited their
friendly neighborhood banker to
borrow money for a new house. Now,
consumers can get mortgages online.
In the early days of the Federal
Reserve System, bankers visited the
friendly neighborhood discount window
to borrow reserves when there was a
run on deposits or an unexpected rise
in loan volume. They brought their collateral to a teller window at a Federal
Reserve Bank.
The window doesn’t operate from
the lobby of the Richmond Fed’s downtown office anymore. It occupies a
corner of the 18th floor, where the men
and women of the Loans Department
work the phones and computers to help
depository institutions establish lending
agreements and pledge collateral.
The department’s most significant
activity isn’t processing loans, though.
“We make a handful of loans a month
on average, but we have to be prepared
to lend to hundreds of institutions,”
says Senior Manager Gregory Robinson. “We have to constantly monitor
the collateral that would secure those
loans if institutions come to us.”
Borrowers also don’t have to physically take their collateral to the Fed.
They can pledge assets, such as a portfolio of consumer or commercial loans,
and maintain possession of them.
Amid these and other changes, the
mission of the discount window remains
— to relieve liquidity strains on individual institutions and the banking
system as a whole. Over the years, the
Fed has tried to balance the window’s
role in keeping financial markets stable
against the need to curtail lending that
may unintentionally support financially
troubled institutions.

I

The latest attempt to address this
issue was in January, when the Fed reorganized the window’s operations. To
understand the significance of these
changes, however, they must be viewed
against the backdrop of the discount
window’s continuing evolution.
When the Federal Reserve System
was created in 1913, the discount window
was its primary instrument of monetary
policy. By affecting the amount of
reserves held by banks, the Fed could
influence the amount of money and
credit available in the U.S. economy.
The window provides reserves
through two vehicles — discounts and
advances. With the former, a bank provides the Fed with an asset like a shortterm business loan. In return, it
receives credit equal to the asset’s value
at maturity minus a “discount” based
on the discount rate, which is the interest charged on the loan. When the
asset matures, the Fed returns it to the
bank and receives a cash payment equal
to the maturity value.
An advance is much simpler than a
discount. A bank pays interest at the
discount rate to receive a loan from the
Fed against acceptable collateral. Currently, the window supplies all of its
reserves in the form of advances.
Each of the Federal Reserve’s 12
banks could change the discount rate
in response to economic conditions in
its district. When the supply of money
and credit tightened, it lowered the
rate and made it easier for banks to
increase their reserves. When there
was too much money, it made it harder
for banks to boost reserves. (Today, discount rates across the Federal Reserve
System are normally in sync.)
The discount window remained the

Who Knocks at the Window?

ccording to the team at the
Richmond Fed’s discount window,
large complex banking organizations in the Fifth District don’t frequent
the window very often. “But when they
come, they usually have a big need,” notes
Robinson. “Something has happened in
the financial markets, and they can’t get
the funds that they need.”
A prominent example was Sept. 12,
2001, the day after terrorists struck the
World Trade Center and the Pentagon.
Loan volume reached $45 billion that
day. But there have been other
instances when large banks have
employed the window. For example,
The Bank of New York got a $23 billion
loan in 1985 when a computer glitch
interrupted its transaction processing.
Regional and community banks
usually borrow small amounts of
reserves periodically for less dramatic
reasons, says Rebecca Snider, assistant
vice president of the Loans Department. It can be late in the afternoon
and a bank official realizes that reserves
are running short due to human error
or an operational problem.
But, smaller institutions visit the

A

About 460 of the Fifth District’s 1,300 depository
institutions have lending agreements with the
discount window. The other 11 Federal Reserve
Districts combined have about the same ratio of
institutions ready to use the window—5,500 out
of 16,700.

600

I

764

Total DIs
DIs with
Lending
Agreements

I

800

I

200

I

422
400

325

83
0

I

itory institution wasn’t supposed to
borrow from the window to boost its
normal lending capacity, or to exploit
the spread between the discount rate
and the federal funds rate, which is the
interest that institutions charge to
borrow reserves from each other.
At the same time, alternative sources
of credit expanded like the federal funds
market, which Meltzer believes is more
efficient than window borrowing
because reserves flow to where they are
most needed. Bankers also learned to
manage their reserves better.
Window volume spiked during the
1980s when reserves flowed to troubled
savings and loans, but it has generally
remained low as the discount window
began to be regarded as “a lender of last
resort.” Institutions have obtained
credit from other sources, including the
federal funds market, the nationwide
Federal Home Loan Bank System, and
larger institutions with which they have
a correspondent relationship.

FIFTH DISTRICT DEPOSITORY INSTITUTIONS

Federal Reserve’s dominant monetary
policy tool until the effectiveness of
Open Market operations emerged in
the 1920s. Through this tool, the Fed
buys government securities to pump
money into the financial markets, or
sells securities to absorb money. Open
Market operations are effective only
when financial markets are broad and
deep, and America’s markets had
reached that point.
George Kaufman, director of the
Center for Financial and Policy
Studies at Loyola University, Chicago,
points out several advantages of Open
Market operations. “It reduces the
political pressures on [the Fed] to
assist all entities in financial distress,
in particular, financially weak but
politically strong entities,” he wrote
in a November 1999 paper. “The
private market is less likely to direct
additional funds … to such entities.”
Also, “efficient markets price funds
provided through Open Market operations at the current market rate for the
particular risks involved. In contrast,
funds provided through the discount
window are priced administratively and,
if priced incorrectly, may both misallocate resources and reduce the effectiveness of the assistance.”
As Open Market operations took
center stage at the Fed, the discount
window stepped into the sidelines in
subsequent decades. According to economist Allan Meltzer at Carnegie Mellon
University, the Fed discouraged banks
from window borrowing. “They took
the position that borrowing was a privilege, not a right,” explains Meltzer, who
recently wrote a historical account of
the Federal Reserve from 1913 to 1951.
“In the early days, they would do it by
restricting the kind of collateral that
they would take. Later …they would talk
to banks about [the potential problems
of] continuous borrowing.”
Staff at the discount window
explained that credit was intended only
to meet unexpected shortfalls in
reserves on a limited basis. Also, Federal
Reserve regulations required borrowers
to exhaust all other sources of credit
before coming to the window. A depos-

I

Commercial
Banks

I

Credit
Unions

96
40
I

Savings
Banks

55

12
I

Savings
& Loans

SOURCE: Federal Reserve Bank of Richmond

discount window more often than
larger ones because they have fewer
funding sources with earlier cutoff
times for filing requests, notes Nita
Tinsley, one of the department’s senior
analysts. “We are here ’til the cows
come home, or a half hour afterwards.”
(The window stays open 30 minutes
after the close of Fedwire, which transfers funds between depository institutions until 6:30 p.m.)
Bad weather also accounts for some
window borrowing by smaller institutions. Tinsley says that even when bank
employees can’t make it to work, transactions still post to the institution’s
reserve account. “Bankers don’t know
what their balance is, so they’ll call to
get the balance and borrow to cover
whatever is needed.”
Seasonal changes don’t drive smaller
borrowers to the Fifth District’s discount window as they do elsewhere.
Normally, seasonal credit flows from
the window into agricultural communities because farmers withdraw funds
and request loans at the beginning of
every growing season to plant crops.
This can drain a bank’s deposits and
increase loan volume, explains Robinson. But agriculture is more prominent
in other regions like the Midwest.
Whether it’s a snowstorm or a

Summer 2003 • Region Focus

3

blackout, depository institutions of all
sizes never know when a sudden shortfall in reserves will occur and credit
won’t be available. That’s why Snider
thinks they should establish access to
the discount window before something
happens. Lending agreements have
been executed in just a few days during
emergencies, but it is generally “not a
quick process.”
s of January, more than threequarters of the Fifth District’s 422
commercial banks had lending
agreements with the window. But less than
half of the region’s 96 savings banks and
only 11 percent of its 764 credit unions
have such agreements (see graph on p. 3).
This brings us back to an important
question—why don’t more institutions
use the window? One reason has been
the stigma associated with window borrowing. No one is supposed to know
about the transaction beyond the parties
involved. However, examiners from
various regulatory agencies, including
the Fed, periodically review all of the
loans on a bank’s balance sheet. Therefore, bank officials have hesitated about
using the window too often because it
might serve as a red flag.
Also, the banking industry can often
tell when someone borrows from the
window, which can raise questions about
the institution’s financial strength. “If a
large institution is in the marketplace
looking for a large volume of money and
all of a sudden it drops out, there is an
assumption that it went to the window,
especially if within that district there
was a large amount of borrowing
reported for that week,” says Snider.
Another reason why depository
institutions have been reluctant to
borrow from the discount window is
the time and effort involved with the
application process. Also, it may take
time for window staff to assess the borrower’s collateral. Some forms of collateral are straightforward to evaluate,
such as U.S. Treasury and agency securities, and investment-grade debt issued
by state and local governments. But
consumer and commercial loans can
take longer to review, as well as new

A

4

Region Focus • Summer 2003

types of securities that the Richmond
Fed hasn’t dealt with before.
ast October, the Federal Reserve’s
Board of Governors approved
changes to address the issues that
have been blamed for discouraging
appropriate use of the discount window.
These changes went into effect Jan. 9.
The Fed eliminated the window’s
adjustment credit and extended credit
programs. The former loaned reserves
on a short-term basis while the latter provided loans over a longer time period,
but only under exceptional circumstances. (The seasonal credit program
wasn’t changed.)
Two new programs have taken their
place. Primary credit is extended for
very short terms like adjustment
credit, but Federal Reserve Banks must
charge a discount rate that is above the
federal funds rate. Secondary credit for
banks that don’t qualify for primary
credit must be priced even higher. (In
January, the discount rate for primary
credit was 100 basis points above the
Fed’s target for the federal funds rate,
while the rate for secondary credit was
50 basis points higher than primary
credit.) Previously, adjustment credit
was priced at the discount rate, which
has been consistently lower than the
federal funds rate since 1990.
Pricing window credit above the
market rate is intended to create an
economic disincentive for excessive
borrowing, which is how many central
banks operate their discount windows.
This will substitute for what George
Kaufman calls the Fed’s “gentle persuasion” and scrutiny of borrowers.
Fewer questions, if any, will be asked
when a borrower comes to the discount
window. Any financially sound institution can obtain credit for any purpose.
Also, borrowers are not required to
exhaust all market sources before utilizing the window.
The Board of Governors also
approved these changes to address the
perception that banks resort to window
borrowing only when they are in financial trouble. Plus, it wanted to make
borrowing administratively easier.

L

In 1980, Congress allowed depository
institutions that weren’t members of the
Federal Reserve System to borrow from
the window. But in 1991, in the aftermath
of the 1980s S&L crisis, lawmakers
restricted borrowing by banks that didn’t
meet minimum capital requirements.
“Discount window borrowing was providing capital for banks that were basically insolvent,” notes economist Anna
Schwartz of the National Bureau of Economic Research. “That was not what the
Federal Reserve Act of 1913 intended the
window to be used for.”
What will be the role of the discount window in the future? Most
economists agree that the financial
markets need a back-up source of liquidity during emergencies. However,
others argue that the window has little
value as a monetary policy tool as long
as the Fed can use Open Market operations to influence the supply of money
and credit.
Of course, that could change if the
federal government stops its deficit
spending and resumes generating surpluses. “If we ever ran a series of surpluses and reduced the amount of
government debt,” says Allan Meltzer,
this might leave fewer government securities for the Fed to buy and sell in its
Open Market operations. “There would
have to be another mechanism.” RF
READINGS
Kaufman, George G. Do Lender of Last
Resort Operations Require Bank
Regulation? Chicago: Center for
Financial and Policy Studies, Loyola
University, Chicago, November 1999.
McKinney, George W., Jr. The Federal
Reserve Discount Window: Administration
in the Fifth District. New Brunswick, N.J.:
Rutgers University Press, 1960.
Meltzer, Allan H. A History of the
Federal Reserve. Chicago: University of
Chicago Press, 2003.
Schwartz, Anna J. “The Misuse of the
Fed’s Discount Window.” Federal
Reserve Bank of St. Louis Review,
September/October 1992, pp. 58-69.
Visit www.rich.frb.org/pubs/
regionfocus for links to relevant sites.

LEGISLATIVEUPDATE
Budget Deficits and Interest Rates
BY A A RO N ST E E L M A N

D

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cerns of the popular press and many economists may be misuring the late 1990s, the federal budget went into the black
placed.” Likewise, Charles Plosser has been unable to find a
for the first time in more than two decades. Indeed,
positive correlation between public debt and higher interest
mounting surpluses were projected for as far as the eye
rates in two papers for the Journal of Monetary Economics.
could see. But in 2002, as revenues began to flow into Washington
The reason why some researchers have been unable to find
more slowly and expenditures continued to rise, those black figures
such a correlation might be explained by the “Ricardian equivturned red. No one knows for sure, of course, when this will change.
alence” theorem. This theorem is based on the notion that
But it seems likely that federal budget deficits will be the norm for
people are far-sighted and view deficits as simply postponed
at least the near future.
tax liabilities, which they will eventually have to pay.
Changing fiscal conditions have reignited a debate among
“The Ricardian equivalence theorem can account for the
economists: Do budget deficits cause long-term interest rates
tenuousness of any relationship between government debt and
to rise? Unfortunately, there is no consensus on this issue.
the interest rate. Under certain condi“Despite a long history of analysis of
tions, an increase in the supply of govfiscal policy, there is much less solidly
Federal Budget Deficit as a Share
ernment debt that is not acquired by the
based knowledge than one would like
of Gross Domestic Product*
Federal Reserve and that finances a
about the effects of government deficits
6
nondistortionary change in taxes does
on the economy,” notes Gerald Dwyer
not affect the current and expected
Jr. in an article in the Journal of Money,
future opportunity sets of private
Credit and Banking.
3
agents,” writes Dwyer. “Hence, private
For years, the conventional view was
agents’ current and expected future conthat government debt leads to increases
sumption are unchanged, the increase
in long-term interest rates, which
0
in private saving exactly equals the
decrease capital formulation, which ultiincrease in the deficit, and the increase
mately leads to lower real income. How
-3 I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I
in the demand for government securimight public debt fuel higher long-term
1969
1985
2002
ties exactly equals the increase in the
interest rates? The relationship “seems
*Includes “off-budget” items, such as Social Security
supply of government securities.”
a trivial application of supply and
SOURCE: Office of Management and Budget
Robert Barro has become perhaps the
demand,” Dwyer writes. “If the deficit
leading proponent of the Ricardian
increases, the supply of government
equivalence theorem, first in a 1974 paper for the Journal of
bonds increases; everything else the same, the price of govPolitical Economy and now in his textbook, Macroeconomics.
ernment bonds falls and the interest rate rises.”
None of this means that we should necessarily stop worThere is some evidence to support the claim that deficits
rying about budget deficits. First, as Laubach’s paper demondo, in fact, raise long-term interest rates. In a recent paper,
strates, the evidence isn’t as clear cut as proponents of the
Thomas Laubach, an economist at the Federal Reserve’s Board
Ricardian equivalence theorem might claim. Second, even if
of Governors, wrote that the “estimated effects of government
budget deficits do not lead to higher interest rates, they are
debt and deficits on interest rates are statistically and ecooften the result of unwise government spending — spending
nomically significant: a 1 percentage point increase in the prothat itself can produce distortions in the economy. Such spendjected deficit-to-GDP ratio is estimated to raise long-term
ing should be avoided, no matter its effects on interest rates.
interest rates by roughly 25 basis points.”
In the end, the issue of whether it may be desirable, under
But the positive correlation between budget deficits and
certain circumstances, to run budget deficits involves more
higher long-term interest rates doesn’t always hold up under
important questions than how those deficits will affect interempirical testing. “There are three periods during which the
est rates. It involves setting national priorities. For instance,
federal deficit has exceeded 10 percent of national income. In
we may, as a country, be willing to tolerate budget deficits in
none of these periods did interest rates rise appreciably. Regresorder to finance an important military campaign, as we did
sion analysis applied to data from these three periods has not
during World War II. Likewise, we may decide that it is desiruncovered a positive association between deficits and interest
able to run up some debt to pay the transition costs necessary
rates,” writes Paul Evans in a paper published in the American
to privatize the Social Security system. These are issues on
Economic Review. “There also appears to be no evidence for a
which economics can shed some light. But they can’t be
positive association between deficits and interest rates during
answered by economic analysis alone.
RF
the postwar period. I conclude from this survey that the con-

Summer 2003 • Region Focus

5

IN THE RED

Pressure on Local
Blood Markets

H

ad a tattoo done recently?
Visited the United Kingdom for more than a few
months between 1980 and
1996? Prospective blood donors
who answer “yes” to these
questions could be temporarily
disqualified because they could
harbor certain infections.
Such screening is necessary to reduce the spread of
disease, but it also reduces
the donor pool. Meanwhile,
blood usage continues to
climb due to the increasing
quantity and complexity of
surgical procedures, notes Dr.
Jonathan Waters,
a blood conservaFacts About America’s
tion advocate who
Blood Supply
directs autotransfusion services at
➤ Collection centers accounted
The Cleveland
for 93 percent of the 15 million
Clinic Foundation
units of whole blood and red
in Ohio. These
blood cells donated in 2001. The
are just a few
American Red Cross is the single
factors that have
largest collector, with commucontributed to
nity blood banks like Virginia
regular shortages
Blood Services, The Blood
in some commuConnection, and hospitals
nities.
accounting for the remainder.
Blood is per➤ U.S. hospitals transfused nearly
ishable — red
14 million units of whole blood
blood cells last
and red blood cells to 4.9 million
only six weeks
patients in 2001. The volume of
refrigerated — so
blood transfused is increasing at a
ensuring
that
rate of 6 percent a year.
hospitals always
SOURCE: National Blood Data Resource Center,
have the right
Food and Drug Administration
amount is difficult. The quantity
demanded by local hospitals
remains steady during the
year, with occasional jumps
in emergencies. But the
quantity supplied fluctuates
because it depends on the
6

Region Focus • Summer 2003

level of donations.
For instance, fewer
donors give blood during
the summer and the holiday
season. The Southeast is no
exception, even though it
ranks near the top in terms
of number of blood banks,
says Marian Sullivan, executive director of the National
Blood Data Resource
Center. “The region tends
to be challenged in supplying red blood cells during
the months that are typically lower for donations.”
Also, bad weather can
keep donors away. East
Coast storms last winter
reduced blood collection in
parts of North and South
Carolina, leaving some
blood banks with only a
day’s supply.
Even on sunny days,
blood shortages can develop
in some areas while surpluses are occurring elsewhere. For example, Sally
Foister says that her organization, The Blood Connection Inc., collects enough
blood for the eight counties
it serves in upper South
Carolina and Georgia. But
Virginia Blood Services
imports 15,000 units a year
to supplement what it collects for hospitals in central
Virginia.
Economist Paul Haas of
Bowling Green State University offers some possible
explanations for differences
in local blood markets. On
the demand side, metropolitan areas with denser populations and regions with
well-known hospitals usually
need more blood. On the
supply side, some blood
banks are better at solicit-

VIRGINIA BLOOD SERVICES

SHORTTAKES

Virginia Blood Services
processes donations, then sends
them to Dallas for testing.

ing donors than others.
It’s hard work to win the
hearts — and blood — of
potential donors. Foister
says some people dislike
needles, while others loathe
answering personal questions during the screening
process. Yet blood banks
don’t pay for blood because
they worry about attracting
too many people from the
low-end of the socioeconomic scale. “You would get
more donors through your
doors that are at a higher
risk of being deferred,”
notes Foister.
More importantly, individuals don’t have to donate
to a blood bank to benefit
from it during times of
need. “People say, ‘I don’t
need to do it because somebody else will,’” explains
Haas. “This is a basic economic principle called the
‘free rider syndrome.’”
Blood markets illustrate
another economic rule —
when prices rise, buyers
normally curb their consumption. As the increased
cost of screening has been
passed along to hospitals,
medical researchers have
found ways to reduce the
need for transfusions and to
recover lost blood.

RESERVISTS DEPLOYED

Businesses Hold
Own — Fill Voids

T

he call-up of reservists
over the past several
months hasn’t had much effect
on business operations, or has
it? The answer depends on
whom you ask.
Large businesses shuffled
workloads or hired temporary workers to cover
responsibilities while those
serving were gone. “At
Capital One, the call-up
peaked in late February and
early March,” says Hamilton

Holloway, media relations
manager at the financial
services company. “Each
area pulled together and
spread out the work.”
Small businesses and the
self-employed had a much
harder time filling the void.
But few reservists own their
own companies. A 2000
survey by the Department
of Defense (DOD) indicated that, of the 75 percent
of reservists who work in
civilian jobs, “30 percent of
reservists worked for government at the federal,
state, or local level; 63
percent worked for a private
sector firm; and 7 percent
were self-employed or
worked without pay in their
family business or farm.”
Businesses are required
by law to rehire those who
serve in the reserves and
National Guard. Yet many
went one step further and
made up any difference
between military and civilian wages.
As of April 16, approximately 25,000 National Guard
members and reservists were
deployed from the Fifth District, according to the DOD.
“The reservists’ numbers are
so small that they’re not
having an impact on employment,” says William Metzger,
chief economist at the Virginia Employment Commission. The latest figures show
a slight drop in civilian
employment in the Hampton
Roads area — which has a
large military presence — but
some of that is due to the
absence of full-time military
personnel who were moonlighting in civilian jobs,
according to Metzger.

While companies have
seemed to handle personnel
shortages well for now, the
need for reservists has not
necessarily ended. The
verdict is still out as to
whether longer or multiple
call-ups may adversely affect
business operations in an
already sluggish economy.
—E L A I N E M A N DA L E R I S

“When we have rains like
this, groundwater sources
are quick to respond.”
While the rainfall helped
groundwater levels recover
in the Fifth District, it was
too much at the wrong time
for the region’s agriculture
industry. “We’ve gotten too
much rain,” notes H. V.
Mangum, information coordinator at the North Carolina State Office of the
federal Farm Service Agency.
“The fields are so wet that
farmers have had to wait to
plant their crops for 2003.”
Wet conditions delayed
the planting of tobacco and
peanuts in the Tar Heel
State by several weeks and
prevented tobacco planters
from fumigating their land.

W AT E R R E S O U R C E S U P D AT E

Rainfall Cures
Drought, But Other
Issues Remain

A

fter much of the Fifth
District suffered from
drought last summer, aboveaverage precipitation in the fall
and winter months replenished
reservoirs and helped communities remove water-use
restrictions. As usual with
Mother Nature, however, her
bounty was a mixed blessing.
Drought conditions had
plagued the region periodically since 1998. Therefore, it
would take many more
months of heavy rain to make
up for the deficits accumulated over that period, notes
Gloria Forthun, regional climatologist for the Southeast
Regional Climate Center.
Still, the fall and winter
deluges helped alleviate the
region’s long-term drought.
State officials in Virginia,
Maryland, North Carolina,
and South Carolina have
indicated that groundwater
sources are being replenished. “The Southeast is
fairly lucky because the
recharge rate is faster than
in other parts of the
country,” explains Forthun.

LAUREN HOBART/FEMA NEWS PHOTO

Anticoagulants
like
heparin reduce bleeding
during surgery, while lasers
seal off blood vessels as they
cut tissue. Blood suctioned
from the surgical field is filtered and packaged for reuse
instead of being discarded.
Blood conservation has
made a big difference with
certain surgical procedures,
according to Dr. Waters. A
liver transplant performed a
decade ago would have
required 200 to 300 units of
blood. The same procedure
requires only two to three
units today.
A widespread reduction
in blood usage would require
changing how doctors practice medicine, notes Dr.
Waters, but it also would
save money and improve
surgical outcomes. “Patients
[who receive fewer transfusions] generally experience
lower operative infection
rates and shorter hospital
stays, which gives hospitals
more available beds.”
—C H A R L E S G E R E N A

Winter storms helped
replenish reservoirs, enabling
communities to remove
water-use restrictions.

Some farmers in South Carolina also couldn’t tend to
their soggy fields. The only
“crops” that appear to have
benefited from all of the
rain are pastures, which had
been dry for years. Now,
there is more food for
poultry and cattle.
While communities cope
with the abundance of rain,
they’re continuing to struggle with the financial fallout
of the five-year drought. In
April, Gov. Mike Easley

Summer 2003 • Region Focus

7

approved $432,000 in
grants to Statesville and
Eden in North Carolina to
reimburse
them
for
increased spending on their
water supplies. Likewise,
Mangum says his agency is
still providing financial
assistance to droughtstricken farmers.
Ultimately, the legacy of
the five-year drought is that
it “woke everybody up,” says
Forthun, prompting state
and local officials to re-evaluate their management of
water resources.
—C H A R L E S G E R E N A

ECONOMIC FREEDOM

Report Measures
Impact of Government Regulation
on Free Markets

W

hat influences economic prosperity and
growth? That’s the $64,000
question for development
officials and business leaders.
Their answers range from
proximity to transportation to
the availability of relocation
subsidies.
In a 2002 report, The
Fraser Institute in Canada
and the National Center for
Policy Analysis in Dallas,
Texas, explored another set
of influences on business
activity. They used a 10-point
scale to score U.S. states and
Canadian provinces on their
“economic freedom,” or how
much government interferes
with the ability of buyers and
sellers to make mutually beneficial transactions.
“The freest economies
operate with a minimal level
8

How the Fifth District Stacks Up
Scores on All-Government Index, 2000

Maryland
North Carolina
South Carolina
Virginia
West Virginia

SIZE OF
GOV’T.
6.9
8.1
7.0
6.9
5.4

LEVEL OF
TAXATION
5.8
6.3
5.8
6.2
4.8

LABOR MKT.
FREEDOM
6.1
6.7
8.1
6.5
6.5

TOTAL
SCORE
6.3
7.0
7.0
6.5
5.6

NATIONAL
RANK
41
15
15
35
50

NOTE: Scores are based on a 10-point scale, with 10 being the best score for a particular set of economic freedom variables.
SOURCE: “Economic Freedom of North America,” The Fraser Institute/National Center for Policy Analysis, 2002

of government interference,
relying upon personal choice
and markets to [determine]
what is to be produced, how
it is to be produced, how
much is produced, and for
whom
production
is
intended,” wrote Amela
Karabegović, Fred McMahon,
and Dexter Samida in the
report. “As government
imposes restrictions on these
choices, the level of economic freedom declines.”
Some would argue that
it’s the government’s responsibility to intervene in the
marketplace when businesses aren’t playing fair or
producing desirable goods
and services such as parks.
“While government can
fulfill useful roles in society,
there is a tendency for [it] to
undertake superfluous activities as it expands,” argues
the report’s authors. “Government spending … reduces
economic freedom once [it]
exceeds what is necessary to
provide a minimal level of
protective and productive
functions.”
Since the size of government influences economic
freedom, it was one of the
variables analyzed in the
report. The authors also analyzed the level of taxation in

Region Focus • Summer 2003

communities and legal
requirements on labor
markets, including minimum
wage laws and occupational
licensing. The result was
economic freedom scores for
U.S. states and Canadian
provinces for each year
between 1981 and 2000.
Over that period, Maryland, North Carolina, South
Carolina, and Virginia
improved their scores on an
all-government index, which
captured the effects of
federal, state, and local government activity on economic freedom. Maryland
improved the most, going
from a score of 4.8 in 1981
to 6.3 in 2000.
West Virginia’s score on
the all-government index
didn’t improve, however.
Fred McMahon, director of
the Centre for Trade Globalization Studies at The
Fraser Institute, says the
Mountain State’s score for
size of government “came
behind six provinces, which
is remarkable given how
much smaller government is
on average in the United
States.” The state’s taxation
score was a little better,
coming ahead of most
Canadian provinces and one
state. “On the labor market

side, West Virginia comes
ahead of all provinces and at
least some states, though it
remains in the bottom third
of the rankings.”
While many factors affect
local economies, McMahon
and the report’s other
authors found that states like
West Virginia with a low
level of economic freedom
tend to be less wealthy, on a
per capita basis, than their
neighbors. This link also has
been demonstrated by The
Fraser Institute’s Economic
Freedom of the World studies,
which have scored nations
around the globe for the last
20 years.
—C H A R L E S G E R E N A

TRAVEL AND TOURISM
I N D U ST RY

Fifth District
Does Well in a
Difficult Year

F

or the travel and tourism
industry, 2002 was a
challenge, to say the least. “We
had to battle a recession, the
aftereffects of the Sept. 11
terrorist attacks, the threat of
terrorism, and conflict in the
Middle East,” recounts Greer
Beaty, director of public

ern states like New York.
As a result, tourism officials in the Fifth District say
they have fared relatively well
during the travel downturn.
Several states managed to
increase their visitor flow in
2002, including North Carolina (up 3.2 percent), Virginia
(up 6.4 percent), and West
Virginia (up 8.5 percent).
Maryland and the District of
Columbia saw slight declines
in visitation for 2002 (down
1.6 percent and 3.6 percent,
respectively). (South Carolina
hadn’t released their 2002
numbers as of press time.)
Officials aren’t sure how
much of these increases were
due to people choosing
domestic destinations over
foreign travel. But they’re
confident that focusing on
travelers within driving distance paid off. “Our equity
in these markets came to
fruition when people wanted
to drive more,” notes Martha
Steger, public relations director at the Virginia Tourism
Corporation.
Some states will continue to focus on regional
tourism, partly because of
the challenges of developing
air service in small markets.
“We fish where the fish are,”
notes Chris Canfield, West
Virginia’s tourism and marketing director. Others are
widening their net, though.
Virginia wants to attract
Europeans to the state
during Jamestown’s 400th
anniversary in 2007, while
North Carolina hopes that
the centennial of the Wright
Brothers’ flight in Kitty
Hawk will be a global draw
this December.
—C H A R L E S G E R E N A

thing — clothing, food,
everything that comes to
market has a price built in.”
Gale Ellsworth, president and CEO of Fairfax,
Va.-based Trailways Transportation System, says the
firm’s charter bus companies
offset the fuel costs.
“When they price those
trips, they calculate in a surcharge for increased fuel
prices,” she says. “And
scheduled route operators
are buying in bulk, but they
have to pass along the rate
hike to the passenger as
well.” Typically, the sur-

PAY I N G AT T H E P U M P

War, Winter, and
Unrest Spike
Gas Prices

G

as prices fluctuated last
spring, spiking up to an
average price of about $1.71 per
gallon at the pump just about
the time U.S. troops invaded
Iraq. It wasn’t just wartime
uncertainty that helped drive
prices, though. Contributing
to the price hikes were an
abnormally cold winter,
especially in the Northeast,
and a strike in Venezuela,
which provides 10 percent of
the United States’ crude oil.
Civil unrest in Nigeria has also
constricted supply, as oil
companies have pulled out
personnel because of fears for
personal safety.
“There are still a lot of
‘ifs’ out there,” says Lon
Anderson, director of public
and government relations
for AAA Middle Atlantic. In
late April, the Organization
of the Petroleum Exporting
Countries increased its production quotas. Also, the
United States is working to
return Iraqi oil fields to full
production.
Summer gas prices are
expected to average $1.46
per gallon, 7 cents higher
than 2002 summer prices
and above the average of
2000 and 2001, according
to the Energy Information
Administration’s short-term
energy outlook.
Price increases typically
are passed on to the consumer, says Anderson. “The
tough thing about oil and
gas prices is they’re a component of virtually every-

TRAILWAYS TRANSPORTATION SYSTEM

relations for the North
Carolina Division of Tourism,
Film, and Sports Development.
“These factors have influenced
people to take shorter trips,
stay closer to home, and drive
rather than fly.”
In response, tourism officials in the Fifth District have
focused on strengthening
their existing market of
regional travelers. “Our advertising focused more on closein markets to encourage
people in the suburbs to make
a trip to Washington, D.C.,”
says Rebecca Pawlowski,
media relations manager of
the city’s Convention and
Tourism Corporation.
In recent years, fewer
people have flown in and out
of the United States. Overseas
arrivals dropped 12.3 percent
in 2001 and 8.3 percent in
2002, while overseas departures fell 6 percent in both
years. Security concerns weigh
heavily on everyone’s minds,
while apprehension over the
state of the economy weighs
on wallets and checkbooks.
State travel and tourism
markets have weathered
these changes differently.
Those that rely on air traffic,
foreign visitation, or business
travelers have faced greater
challenges, while those with
mostly regional tourists have
done better. Much of the
Fifth District fell into the
latter category, according to
state tourism officials.
Traditionally, most travelers to the region arrive by
car, ranging from about 50
percent of travelers in the
District of Columbia to 95
percent in West Virginia.
Visitors tend to come from
within the region and north-

Trailways Transportation
System’s charter bus
companies use a surcharge to
offset increased fuel costs.

charge is roughly the same
percentage as the price
increase, she says. The
charge is removed when
prices drop, she notes.
Someone has to absorb
the price increase. Pity the
poor pizza delivery driver,
though. Pie Works of
Greensboro, N.C., says its
pizza prices are stable and
its delivery drivers, who use
their own vehicles and are
paid a per-trip fee, have
absorbed the increase.
Oh well, maybe they get
good tips.
—B E T T Y J OYC E N A S H

Summer 2003 • Region Focus

9

JARGONALERT
Asset Bubbles
BY A A RO N ST E E L M A N

ILLUSTRATION BY TIMOTHY COOK

A

10

“bubble,” as defined by economist Charles Kindleberger,
is a “sharp rise in price of an asset or range of assets in a
continuous process, with the initial rise generating
expectations of further rises and attracting new buyers.” This, writes
Kindleberger, is “usually followed by a reversal of expectations and
a sharp decline in price often resulting in financial crisis.”
Many observers say that we witnessed such a bubble during
the late 1990s, as the prices of stocks — particularly the stocks
of high-tech companies — shot up dramatically, well beyond
what economists refer to as their “fundamental value.” Most
of those stocks’ prices dropped sharply a few years later, and
investors paid the price for failing to base their decisions on
sound financial analysis. Or so the story goes.
The facts of this case are undeniable,
of course. Equity prices did, in fact, skyrocket and then plummet. But was this
an example of a bubble? More fundamentally, can bubbles exist at all?
At least one economist has questioned whether you can ever be sure
that an asset bubble has existed. One
cannot distinguish between hypotheses
that asset prices are driven by a “speculative bubble and that researchers have
not adequately measured the future
market fundamentals anticipated by
market participants,” writes Peter
Garber. “More generally, data will not
distinguish between a claim that market
participants suffer from some mania
because behavior does not conform to
the prediction of some researcher’s
theory and a claim that the theory is
flawed or misspecified. Because of this observational equivalence, economists who take a position in the debate over the
existence of bubbles are making a commitment that cannot
be based on the analysis of experience.”
Garber analyzes perhaps the most famous of all supposed
bubbles: the “tulipmania” that gripped the Netherlands during
the 17th century. The Netherlands’ well-developed markets
permitted entrepreneurs to experiment and create new varieties of flowers. Those tulip bulbs that produced unique, beautifully patterned flowers commanded high prices. More
common tulips were sold at much lower prices. Prices for rare
tulips, such as the Semper Augustus bulb, remained high from
1634 through early 1637. But in February 1637, prices collapsed
and bulbs could not be sold at 10 percent of their peak values.
“A standard pricing pattern arises for new varieties of
flowers, even in modern markets. When a particularly prized

Region Focus • Summer 2003

variety is developed, its original bulb sells for a high price.
As the bulbs accumulate, the variety’s price falls rapidly; after
less than 30 years, bulbs sell at their reproduction cost,” writes
Garber. Such a pricing pattern raises two questions about
the period 1634 to 1637. First, why did the price of bulbs rise
so quickly? Second, did prices decline faster than should have
been expected?
Garber attributes the rapid increase in price to a general
appreciation of the beauty of rare tulips by the wealthier citizens of the Netherlands. They were simply willing to pay a
lot to obtain the status of owning a renowned tulip. You might
think this is foolish, but it is not necessarily irrational, from
the point of view of the buyer.
As for the drop in prices, the average
annual rate of depreciation from February 1637 to 1642 was 32 percent. This
might seem like a lot. But Garber also
looked at data from the early 1700s and
found that the average annual rate of
depreciation for flowers during this
period was 28.5 percent. It is true that
these latter prices fell from a much lower
peak. Still, the evidence is not compelling that the drop in prices following
“tulipmania” was more severe than
should have been expected.
Finally, Garber writes that “there is
no evidence of serious economic distress
arising from the tulipmania. All histories of the period treat it as a golden age
in Dutch development.”
All this leads Garber to conclude:
“Fascinated with the brilliance of grand
speculative events, economists have huddled in the bubble
interpretation and have neglected an examination of potential market fundamentals.” In short, those who bought
tulips at the peak of the market were not necessarily careless or irrational.
Garber has staked out the most extreme position on the
question of when an asset bubble occurs by stating that you
can never know for sure. One might consider relaxing his
assumption that all traders are rational and instead look at
what happens when just some groups behave rationally, as
economist J. Bradford DeLong and several of his colleagues
have done. Such models may be able to help explain swings
in asset prices. Nevertheless, the next time someone brings
up an example of a supposed asset bubble, it might be useful
to think carefully about the implicit theory behind that claim
before reaching a judgment.
RF

RESEARCHSPOTLIGHT
The Economics of…Sumo Wrestling
BY A A RO N ST E E L M A N

I

“The key institutional feature of sumo wrestling that
f you asked a random person on the street what economists
makes it ripe for corruption is the existence of a sharp nonstudy, you might get a response like inflation or unemployment.
linearity in the payoff function for competitors,” the authors
The reason is pretty clear: such macroeconomic issues are crucially
write. A sumo tournament involves 66 wrestlers competing
important and do, in fact, occupy the attention of many economists,
in 15 bouts each. A wrestler who has a winning record—that
including those in the Federal Reserve System. But there is a group
is, who has won at least 8 of his 15 matches—is guaranteed
of microeconomists who are grappling with many issues beyond
to rise in the rankings, while a wrestler who has a losing
what is normally thought of as the purview of economics—issues
record is destined to fall. A wrestler’s rank determines his
such as crime, divorce, and abortion, among others.
prestige, salary, and the perks that he enjoys. For instance,
The pioneer in this regard is University of Chicago econothe lowest-ranked wrestlers must rise early each morning to
mist Gary Becker. Among his best-known books are The Ecoclean the building and prepare meals.
nomics of Discrimination (1957), The Economic Approach to Human
There is a strong incentive, then, to achieve that eighth
Behavior (1976), and A Treatise on the Family (1981). These books
victory in a tournament. “The critical eighth win … garners
apply the tools of economic analysis to issues that had long been
a wrestler approximately 11 spots in the ranking, or roughly
studied almost exclusively by sociologists and psychologists.
four times the value of the
For instance, in A Treatise
typical victory. Consequently,
on the Family, Becker looked at
a wrestler entering the final
parents’ “demand for chil“Winning Isn’t Everything: Corruption
match of a tournament with
dren.” He used “the price of
in Sumo Wrestling,” by Mark Duggan
a 7-7 record has far more to
children and real income to
gain from a victory than an
explain, among other things,
and Steven D. Levitt. American
opponent with a record of,
why rural fertility has tradisay, 8-6 has to lose,” Duggan
tionally exceeded urban fertilEconomic Review, December 2002,
and Levitt write. “We uncover
ity, why a rise in the wage rate
vol. 92, no. 5, pp. 1594-1605.
overwhelming evidence that
of working women reduces
match rigging occurs in the
their fertility, why various govfinal days of sumo tournaernment programs … have sigments. Wrestlers who are on the margin for attaining their
nificantly affected the demand for children, and why families
eighth victory win far more often than would be expected.”
with higher incomes have had more children, except during
Duggan and Levitt admit that high winning percentages
the past 150 years in Western and developing countries.”
among wrestlers with seven victories is not proof positive of
Not surprisingly, many noneconomists attacked Becker’s
corruption. After all, wrestlers may simply try harder in these
work. It was, they maintained, inappropriate to use “rational
important matches because the benefits of winning are larger.
choice” analysis to think about such intimate personal issues.
But the authors offer evidence against this alternative
People are not always cold, calculating utility maximizers, the
hypothesis. For example, while the wrestler who is on the
critics charged.
cusp of winning his eighth match wins with surprisingly high
In the last 20 years, the practice of “economic imperialism”
frequency, the next time he is paired against that same
has burgeoned, as many younger microeconomists have folwrestler he usually loses. “This result suggests that at least
lowed Becker’s lead to explore new and exciting topics. One
part of the currency used in match rigging is promises of
of the best examples is Steven Levitt, also of the University of
throwing future matches in return for taking a fall today.”
Chicago. Levitt was recently awarded the John Bates Clark
Duggan and Levitt also tested their data against claims made
Medal, which is given to the nation’s most outstanding econby two former wrestlers against specific competitors charged
omist under the age of 40, for his work on crime, corruption,
with rigging matches. Their statistical analysis confirmed the
and education. Among his most cited—and criticized—recent
whistle-blowers’ stories.
papers are “The Impact of Legalized Abortion on Crime” and
One might say, “All of this is interesting. But what does
“An Economic Analysis of a Drug-Selling Gang’s Finances,”
it have to do with economics?” Duggan and Levitt anticiboth published in the Quarterly Journal of Economics.
pate such criticism. They write: “The success of our study in
In the December 2002 issue of the American Economic Review,
documenting the predicted patterns of corruption in one
Levitt and co-author Mark Duggan took on an issue that has
context raises the hope that parallel studies with more sublong been of interest to some sports fans, but which few econstantive economic focus may yield similar results.”
RF
omists have even considered: corruption in sumo wrestling.

Summer 2003 • Region Focus

11

Dollars

and

D

A Closer Look at How
Military Spending Affects
Fifth District Communities

Defense
in Times of War and Peace

BY CHARLES GERENA

n a sunny yet brisk Wednesday
in Virginia Beach, Va., the
lunchtime rush hits Lynnhaven
Mall. It seems busy for the middle of a
workday, with the usual mix of young
mothers, teenagers, and seniors eating at
the food court or window-shopping.
But business is slower than usual
according to one of the mall’s vendors.
A big chunk of the usual crowd is
missing—the men and women stationed at Naval Air Station Oceana
about a mile away. Approximately
three-quarters of Oceana’s squadrons
were deployed to the Middle East at
the start of Operation Iraqi Freedom.
That’s roughly 3,400 personnel, or onethird of Oceana’s military population.
During times of war when countless
families are without their dads or moms,
it’s easy to see the role that military
installations have within communities
in the Fifth District. But it’s important
to step back and look at the peacetime
effects as well. A hefty amount of payroll
and procurement dollars steadily flows

O

NAVAL AIR STATION PATUXENT RIVER

SH-60 Sea Hawk helicopters from one of
Naval Air Station Patuxent River’s test
squadrons fly in formation near the
mouth of the river. NAS Patuxent River
accounts for one-third of the jobs in St.
Mary’s County, Md.

from the Pentagon into the Fifth District — $44.5 billion in fiscal year 2001
alone. How those dollars are spent —
and the economic activity that they generate — can differ significantly from
community to community.

The Fifth District’s Defense
Establishment
The armed forces have amassed a significant physical presence throughout
the South and West. In the Fifth District alone, installations in Virginia,
Maryland, and the Carolinas house
398,500 military and civilian personnel,
or one-quarter of the national total.
(See map and table on p. 14.)
Economists offer several possible
explanations for the Pentagon’s
regional preferences. One reason is that
military operations are land intensive
and the South had plenty of territory
ripe for development. “Army bases tend
to be out in fairly isolated areas. When
you are firing tanks or artillery, that
doesn’t make for very good neighbors,”
explains Lt. Col. Michael Meese, an
economics professor at the U.S. Military Academy at West Point.
The Air Force and Navy also needed
a significant amount of land. In addition,
they found Southern states attractive for

their coastlines, which provide good
launch pads for air and sea operations.
Yet not every state in the South or
the West is saturated with military
installations. That’s where politics have
made the difference since World War
II. Southern congressmen like retired
South Carolina statesman Strom Thurmond “had a great deal of power in
Washington,” says Albert Parish Jr.,
director of the Center for Economic
Forecasting at Charleston Southern
University. Other senior lawmakers like
Sen. Fritz Hollings of South Carolina
and Sen. John Warner of Virginia have
used their clout to encourage the location of bases in their home states.
Political influence also has steered
a lot of the military’s primary contracts
to the Fifth District. Firms in southern Maryland, Northern Virginia, and
the District of Columbia — all of
which are close to key decisionmakers
on Capitol Hill and at the Pentagon in
Arlington, Va. — capture the lion’s
share of procurement dollars in the
Fifth District. These states and D.C.
garnered $25.1 billion in primary contracts for fiscal year 2001, while companies in North Carolina, South
Carolina, and West Virginia accounted
for another $2.7 billion.

Summer 2003 • Region Focus

13

There are other reasons why so
many primary contracts are filled in the
region. “One reason for the concentration of defense spending is the
change in the nature of defense production,” wrote Robert Atkinson in a
1993 journal article. “Since World War

II, defense procurement has focused
less and less on conventional military
products [like trucks and rifles] and
more on aerospace and electronics
products.” Manufacturers of the latter
products began moving from the
Midwest because they felt neglected by

The Military’s National Footprint
In the fiscal year ending Sept. 30, 2001, the states with the most active duty military and civilian
personnel were in the South and West. The Fifth District alone was home to more than 398,500
personnel, most of whom were stationed in Virginia and North Carolina.

Rank
1
2
3
4
5
6
7
8
9
10

State
California
Virginia
Texas
North Carolina
Georgia
Florida
Maryland
Washington
Hawaii
South Carolina

20
48

District of Columbia
West Virginia

Military
Personnel
107,452
80,613
113,865
85,584
62,013
49,029
29,296
31,833
34,958
38,552

Civilian
Personnel
58,378
76,246
37,511
16,441
31,169
26,539
31,818
22,511
16,699
9,349

Total
Personnel
165,830
156,859
151,376
102,025
93,182
75,568
61,114
54,344
51,657
47,901

% of
U.S. Total
10.2
9.7
9.4
6.3
5.8
4.7
3.8
3.4
3.2
3.0

13,104
504

15,230
1,777

28,334
2,281

1.8
0.1

NOTE: Personnel on temporary duty may be reported at their assigned locations, not their home stations.
SOURCE: Department of Defense, Directorate for Information Operations and Reports

Total Military & Civilian Personnel
Under 50,000
50,000-99,999
100,000-149,999
150,000 or more

14

Region Focus • Summer 2003

local governments, adds David Gold,
an economics professor at New School
University in New York City who
studies military spending. Communities chose to focus on their traditional
industries like auto manufacturing.
At the same time, rural communities in the South and West needed to
replace their lagging agricultural sector.
Local governments actively recruited
large manufacturers, including defense
contractors.
“Defense contractors moved to
[these regions] because they were
attracted there and the governments
wanted growing industry,” explains
Gold. “A lot of places…attracted these
companies with subsidies, tax relief,
and a nonunionized labor force.”

Tracking Defense Dollars on the
Economic Radar
Since the military established its
foothold in Fifth District communities,
it has added an interesting variable to
local and regional economies.
In cities and counties where a military installation accounts for the
majority of economic activity, employment and income levels are subject to
wide swings. “The smaller the initial
community, the greater the influence
that a major military installation will
have,” notes Dick Brockett, associate
director for economic development at
East Carolina University’s Regional
Development Institute. This is similar
to the impact of a large manufacturing
plant in a small town.
Naval Air Station Patuxent River,
which accounts for one-third of the
jobs in St. Mary’s County, Md., illustrates this phenomenon. When the
Navy consolidated its flight testing and
development work at Patuxent River
during the 1990s, numerous high-tech
firms moved to this waterfront community to provide support services.
This spurred the development of office
space near the facility and prompted
the county to revise its transportation
planning. In addition, the influx of
technical jobs boosted the county’s
median household income.
Havelock in eastern North Carolina
could see similar changes in its economy
if the Pentagon decides to house some

Life in the Civilian World
Like many retirees from the armed forces,
Robert Garman likes to get together with his
former comrades. They frequent the officer’s
club at Fort Bragg near Fayetteville, N.C.,
attend church services on base, and support
each other during times of need. “It’s like an
extended family,” says the 71-year-old
lieutenant colonel.
The bond between former members of the
military isn’t the only thing that distinguishes
them in the civilian world. These differences
have interesting economic implications for the
communities in which they reside.
Like civilian workers, military personnel look
for a place to retire where the climate is
pleasant, the cost of living is affordable, and
recreational opportunities are available. But
unlike most civilians, they tend to settle close
to their former employer, Uncle Sam. Virginia
and North Carolina, two states that rank among
the top five states for defense personnel, are
also among the top 10 states for military
retirees (see chart).
Usually, retirees live within driving distance
of where they were last stationed because they
know the community and want stability after
years of moving from place to place. They may
consider relocating, as long as it’s an attractive
locale near another base.
“Military retirees are closely influenced by
accessibility to a major military installation,”
noted Mark Fagan in a September 1992 report on
this demographic group in Alabama, where Fagan
heads the department of sociology and social
work at Jacksonville State University. “Retirees
and their dependents retain many of the benefits
of active duty personnel.” These include access to
discounted goods at military exchanges and
commissaries and free or reduced-cost health
care at bases with hospitals or clinics.
Another thing that military people look for
when they retire is employment opportunities.

of its new Super Hornet squadrons at
Marine Corps Air Station Cherry Point.
In the meantime, however, the absence
of 3,300 Marines and support personnel
deployed in the Middle East earlier this
year added to the economic pain of businesses in this city of 22,000 people.
In communities with a more diverse
economy, growth in defense-related
activity can help counter downturns in
nondefense activity. For example, the

They are relatively young, usually in their 40s
according to Fagan’s research, so they are very
likely to pursue a second career.
When they re-enter the work force,
military retirees bring years of work experience and specialized skills, much of which
have civilian value. “They come from a big
bureaucracy, so they can fit into larger
organizations very well,” says Fagan. “They
also are familiar with organizational behavior.”
As a result, “they increase the labor skills of
the area where they retire.”
High-ranking military retirees may leverage

Homes of the Brave
Veterans of the armed forces tend to
settle in states with a significant military
presence, as shown in the figures below
from fiscal year 2002. The one exception
is the District of Columbia, which ranks
in the top half of states for military
personnel but finished last in terms of
its retiree population.

Rank
1
2
3
4
5
6
7
8
9
10
11
41
51

State
California
Florida
Texas
Virginia
Georgia
North Carolina
Washington
Arizona
South Carolina
Alabama
Maryland
West Virginia
District of Columbia

Retiree
Population
188,642
182,540
173,932
127,784
79,244
73,289
67,377
50,022
50,009
49,610
46,262
9,722
3,185

SOURCE: Department of Defense, Office of the Actuary

188,000 naval personnel and their family
members living in the Hampton Roads
region of southeastern Virginia helped
the regional economy weather nationwide recessions during the early 1980s.
“We regard ourselves as having a
very stable economy because we have
a baseline of [defense] spending, and
the volatility in that spending tends to
not reinforce the business cycle,” notes
John Whaley, deputy executive direc-

these assets to get a job with the Department
of Defense and other federal agencies, join a
defense contractor, or start their own business.
Noncommissioned retirees can usually find a
comparable job in industries like health care
and electronics. “Because of their prior
experience and the work ethic that they
developed, military retirees typically get
employed easily,” adds Fagan.
Despite the employability of military
retirees, studies indicate that retirees tend to
earn lower pay than civilians with similar skills.
Why this is the case is an open question
among economists.
Some suggest that there are some combat
positions that don’t have a direct civilian
counterpart, such as ordnance experts. But
economist David Loughran at RAND, a think
tank based in Santa Monica, Calif., believes
that the difficulties of transferring certain
skills and experience learned in the military
isn’t the whole story.
Loughran points to another potential factor
— military pensions, which can be as high as 75
percent of base pay for 30 years of service.
Given this income, as well as continued access
to base amenities, retirees can afford to pursue
lifelong dreams or interests. “Maybe what they
are trying to maximize is not their earnings,”
surmises Loughran, but other things in their
lives that are more important.
Regardless, military retirees close the
income gap with civilians once their pension
and allowances are combined with their salary.
This buying power adds to a community’s
existing base of retirees, although not all of
their money goes into local economies. “By and
large, I buy at the commissary,” says Robert
Garman, echoing the buying habits of other
veterans. “I pick up some stuff in between
trips. If the milk runs out, I stop at the store.”
—C H A R L E S G E R E N A

tor of economics at the Hampton
Roads Planning District Commission.
“Occasionally, these cycles will come in
sync and we’ll suffer from downturns
in both,” such as in 1991 when
Hampton Roads’ recession was worsened when tens of thousands of troops
were deployed for Operation Desert
Storm. “But usually one of those cycles
tends to offset the other one.”
The level of diversity in a local

Summer 2003 • Region Focus

15

Troubles on the Financial Front
When soldiers are shipped out to war,
sometimes with only a few days’ notice,
settling their financial affairs is probably the
last thing on their minds. As a result, a
checkbook and a pile of bills can suddenly
land in a military spouse’s lap.
That’s what Stephanie Moore has seen
from behind the counter of Express Check
Advance, a payday lender near Naval Air
Station Oceana in Virginia Beach, Va. Since the
Middle East deployments began last March,
Moore says the wives of Oceana personnel
have been coming for advances on their
husbands’ paychecks.
Deployments are just one of the challenges that can compel military families to
turn to payday lenders, pawnshops, and other
high-cost sources of funds.

CHARLES GERENA/FRB OF RICHMOND

One-quarter of the people who sell their
belongings to Cash Converters are military
personnel.

A significant number of soldiers occasionally stumble into a financial ditch, according
to a July 2002 survey of 11,000 active duty
personnel. About 33 percent of respondents of
various ranks admitted they had bounced two
or more checks, had overdue bills, or lost
their utility services during the last 12 months.
Among the privates surveyed, the percentage
in financial distress climbs to 46 percent.
Poor military pay is frequently blamed for
these difficulties. Congress has approved wage
increases several times, including a 4.1 percent
minimum increase for 2003 and a 5.5 to 6.5
percent raise for certain mid-level personnel,
but soldiers still feel underpaid. About 42
percent weren’t happy with their compensation, which includes base pay, allowances, and
bonuses. (A private on active duty for a

16

Region Focus • Summer 2003

minimum of four months makes a base salary
of $13,800 a year, while a sergeant with two
years of experience earns $19,500 annually.)
Pay levels aren’t the only problem. “If
soldiers don’t know how to manage their
money, no matter how much money you give
them they are not going to manage it
correctly,” says Lillie Cannon of the National
Military Family Association Inc., a nonprofit
group that provides a variety of services for
soldiers and their dependents.
In addition, the uncertainties of life in the
armed forces add to the financial stresses on
military families. There are married couples
and single parents who “deal with all of the
[financial matters] that you and I do, and they
are doing it in an environment over which
they have much less control,” describes
Roderick Mitchell, president of the Pentagon
Federal Credit Union Foundation, a financial
literacy organization.
For example, Mitchell says that single
parents struggle to find daycare for their
children that works with their turbulent
schedules. Also, “enlisted people may have
a change in duty station five or six times
during their career,” and each move takes a
financial and emotional toll on their families.
At the same time, military personnel have
financial avenues available to them that
civilians don’t have. These include pay
advances to cover relocation costs, low- and
no-interest loans from relief agencies run by
veterans and volunteers, and access to credit
from military credit unions.
But these avenues have their limits — a
pay advance is available only once, relief
agencies have guidelines for awarding loans
and have limited funds, and credit unions have
a fiduciary responsibility to turn down
borrowers with poor financial histories.
Once they reach the end of their rope,
soldiers find themselves among the many
consumers who turn to payday loans. “They
are young, on moderate incomes, and have
moderate education levels,” describes John
Caskey, an economist at Swarthmore College
who studies consumer finance. “Payday lenders
are not looking for the desperately poor, but
moderate-income people with jobs who are
financially stressed.”
Payday lenders offer privacy for those who
worry about their superiors learning about
their financial problems, which can count

against them for a promotion. They also offer
convenience, since they are often near a
military installation.
This brings up a point of controversy. Are
payday lenders preying on the misfortunes of
the military? The clustering of lenders around
bases would suggest that — 10 storefronts
offer cash advances within a five-mile radius
of Oceana.
But Vicki Woodward of the Community
Financial Services Association of America, a
trade group for payday lenders, argues that if
the military were such an attractive market,
every lender would locate a majority of its
stores near a base. This is not the case with
Advance America, a founding member of the
group. As of April 2003, only 17 of the
company’s 80 Virginia stores were located in
Hampton Roads, the home for 188,000 naval
personnel.
Also, less than 1 percent of Advance
America’s total customers are military
personnel, according to company records. Its
share of military customers goes up in places
with more bases — 1.5 percent in Virginia
Beach and 10 percent in Hampton Roads. But
in both cases these percentages are smaller
than the ratio of each area’s military
population to its total labor force.
More likely, payday lenders near bases are
tapping into the broader community that
includes both soldiers and civilians. “The
military [presence] was not a consideration; it
was the overall population,” says Rob Godbey,
owner of seven Cash Express locations in
Hampton Roads. “We have some military that
come in, but not many. They are not our
focus.”
On the other hand, Tim Oldfield readily
admits that his company, Cash Converters
United LC, opened all five of its Virginia stores
in Hampton Roads because of the region’s
military presence. “A base’s population is
transient. People are coming in and out all the
time,” says Oldfield, who also oversees a store
near Fort Bragg in North Carolina. When
soldiers are reassigned or deployed at the last
minute, they can get quick cash for their
belongings from Cash Converters instead of
paying movers or renting storage space. Also,
the company’s selection of second-hand goods
provides newly assigned personnel with an
inexpensive way to furnish their residences.
—C H A R L E S G E R E N A

CHARLES GERENA/FRB OF RICHMOND

Wages vs. Weapons
Regardless of the military installation
in question, its payroll directly affects
a local economy more than its procurement dollars. That’s because soldiers and their dependents tend to
make their purchases within the community, while procurement dollars tend
to leak out of the community and into
the regional or national economy.

Military families buy a variety of
services locally, from electricity and
other utilities to health care and recreation. They are also encouraged to shop
at local retailers. However, how much
they spend in the civilian economy can
be influenced by where they live.

The Big Guns

5

I

-5

I

0

I

10

I

15

I

20

I

Annual growth in defense spending in fiscal year
2002 reached its highest peak in 20 years, as
measured in real dollars. This put the military’s
budget over the $300 billion mark. However, where
and how the Pentagon aimed that fiscal ammunition determined the effect on Fifth District
communities with a significant military presence.

-10

I

economy is just one factor that determines the effect of military installations.
“What they do [determines] the kind of
people and number of people they hire,”
says Barney Warf, professor of geography at Florida State University. “There
is no such thing as a typical installation.”
Naval ports, air stations, and other
personnel-driven bases focus on training and deploying large numbers of military personnel, mostly enlisted men
and women. A common view is that
enlisted personnel aren’t paid well,
therefore their income affects a community less than their civilian counterparts in the work force.
Still, a 1999 Congressional Budget
Office study found that “a new recruit’s
pay is greater than the pay received by
roughly three-quarters of all 19-yearold male civilian workers with only a
high school degree.”
More specifically, the annual income
of a private with one year of service —
which includes base pay and allowances
for food and housing — beats the
average annual wage of several counties in the Fifth District with personnel-driven bases. They include Craven
County in North Carolina, Lee County
in South Carolina, and Prince George
County in Virginia.
The inflow and outflow of enlisted
personnel at a base is usually balanced.
But when large-scale troop deployments occur, such as those preceding
Operation Iraqi Freedom, the result
can be a lot fewer people around to
spend money. Some families also may
move in with out-of-town relatives for
emotional and financial support.

The opposite happens at bases that
serve a support role during deployments — their populations temporarily
increase. Charleston Air Force Base in
South Carolina added personnel earlier
this year to operate the C-17 cargo
planes that transported supplies, equipment, and personnel to the Middle East.
The new spending that is created is
fleeting, of course, and not all of it
occurs locally. “The temporary personnel spend money at the hotel, eat out
some, and buy gas for their car,” says
Parish. “Still, the majority of their
salary goes back home.”
Things are different at military
installations with a service orientation.
Bases that test new weapons, have
research and development facilities, and
perform back-office operations require
a core group of civilian and military professionals. This group usually isn’t
deployed with troops, providing a stable
work force of well-paid professionals.
Parish points to the Space and
Naval Warfare Systems Center in
Charleston. The systems integration
facility pays its 1,200 workers two and
a quarter times more than the city’s
average wage, which tends to be low
due to the preponderance of tourism
and other service-related employment.

DEFENSE DEPT. OUTLAYS , ANNUAL % CHANGE

The commissary is an attractive
alternative for military shoppers in
Virginia Beach, Va.

’81

’84

’87

’90

’93

’96

’99

’02

SOURCE: Budget of the United States Government, Historical Tables

If a military installation provides
living quarters for families, their
spending may be less likely to reach
civilian retailers. Commissaries and
military exchanges compete well
against grocers and shopping centers
by being convenient and, in some
cases, offering better prices. Also,
private companies like Bank of
America and McDonald’s operate
branches on bases, although some of

Summer 2003 • Region Focus

17

their sales reach the civilian economy
via the salaries paid to local workers
and suppliers.
If military families must live off
base, however, more of their retail
spending will likely occur in the surrounding community. For example,
Naval Air Station Oceana only has 25
housing units for soldiers’ families, so
most of them reside in nearby subdivisions, according to Public Affairs
Officer Troy Snead. They don’t exclu-

the commissary,” notes Snead.
In contrast, a personnel-driven base
spends most of its money on goods
supplied under national procurement
contracts. These include office supplies
that are needed in large quantities, and
specialized parts and equipment,
neither of which can be bought at the
neighborhood Wal-Mart. For instance,
Hampton Roads has several major shipbuilding companies that service the
Navy, but Whaley says these firms and

In the Navy
Each summer, hundreds of young adults arrive
in Annapolis, Md. Their destination is the U.S.
Naval Academy, where these “plebes” will
spend four years preparing for a career in the
Navy or Marine Corps. While the Academy
shares some of the traits of a college or
university, it is not your typical institution of
higher learning.
For the fiscal year ended Sept. 30, 2001,
the Naval Academy spent $304 million. Payroll
accounted for about two-thirds of that total,
while purchases of goods and services
accounted for the remainder. These numbers
may sound impressive, but economist David
Gold of New School University in New York
City believes that military academies in general
are not as economically involved in the
community as other post-secondary schools.
For example, while college students often
hustle to find a job, midshipmen at the Naval
Academy are under less pressure to work
thanks to the generosity of Uncle Sam. Tuition
and room and board are free, basic medical
care is available on campus, and students have
access to discounted goods at military
commissaries and exchanges.
Further, midshipmen have fewer opportunities to open their wallets outside of the
Academy. They spend most of their day on
campus, either in the classroom or on the
training field. They get holidays and short
breaks called liberties, but earn additional time

off only with seniority and good performance.
Once midshipmen venture into the
community, they usually have less money to
spend than a typical college student does.
They receive a stipend of $764 a month, but
are left with only $75 to $100 a month in
their first year — uniforms, books, and other
service charges are deducted first. In contrast,
a recent poll by Harris Interactive found that
college students had $287 in monthly
discretionary income.
The Naval Academy does contribute to
Annapolis’ economy by procuring some of its
goods and services locally. For example, it
spent almost $10 million on utilities and $10.2
million on facilities maintenance in fiscal year
2001. King Hall, which serves meals to
midshipmen, spent $16.9 million, some of
which went to salaries for civilian employees
and food products from local vendors.
Another part of the Academy’s local
impact comes from tourism. More than 1.5
million visitors come to the Academy every
year. Potential students, parents, and educators
attend Academy Admissions Day and
Candidate Visit Weekends, while tourists stop
by the visitor center to learn about the
Academy’s history. One of the biggest draws is
when the Navy’s football team plays a home
game — more than 30,000 fans attended four
home games in fiscal year 2001.

sively shop at the huge Navy Exchange
Mall near the front gate or buy groceries at the commissary because of the
abundance of retail options surrounding Oceana. “If you live a block away
from a 7-11 and need a quart of milk,
you aren’t going to drive all the way to
18

Region Focus • Summer 2003

—C H A R L E S G E R E N A

the region’s naval facilities do most of
their procurement on a national level.
Bases purchase some services locally,
such as building construction and
maintenance. Oceana hired W. M.
Jordan Co. in nearby Newport News
to expand three structures that support

the base’s F/A-18 squadrons.
But most basic services will likely
continue to be awarded through
national contracts, such as transportation. “All branches of the military …
rely heavily upon shipping companies
and, to a lesser extent, airlines to transport military material,” noted Warf in
a 1993 journal article. “Trucking companies frequently contract with the
Army to haul goods overland.”
Military installations that perform
research and systems integration have
a need for technical expertise, creating
a market that may attract high-tech
firms to a community. That is what
Naval Air Station Patuxent River did
for St. Mary’s County. It’s also what
happened in the Charleston, S.C., area,
where defense contractors employ
4,500 people to support the Space and
Warfare Systems Center.
But such an agglomeration of
industry requires time and support to
form, so service-oriented installations
often look elsewhere to fill their needs
in the meantime. “The more knowledge intensive the activity and the
more it involves sophisticated equipment, the more likely [it will be] contracted out of the community,” adds
New School’s Gold.
In general, contract dollars tend to
spread out widely. For example, Arlington, Va.-based CACI International Inc.
utilizes subcontractors throughout the
Northern Virginia region to serve a
prime contract with the Naval Sea
Systems Command. In addition, the
company uses subcontractors from California, Indiana, Connecticut, Oklahoma, and several other states.

The Old Guns and Butter Debate
Whether they come from military
installations or primary contracts,
defense dollars undoubtedly generate
employment and income in communities throughout the Fifth District and
the nation. But in order for this to
happen, capital and other resources
must be diverted from civilian to
defense-related production.
Such a shift isn’t inherently good or
bad. As Gold explains, that kind of
trade-off occurs whenever capital is
invested in a new economic activity. “If

CHARLESTON AIR FORCE BASE

C-17 cargo planes from Charleston Air
Force Base in South Carolina were used to
fly 3,000 tons of cargo and 400 vehicles
during Operation Iraqi Freedom.

you build an auto plant in South Carolina, people who were previously
looking for employment in agriculture
and small businesses will line up at the
gates of the plant.”
The real issue is whether the economic stimulus of defense spending outweighs the lost value of the goods and
services that would have been produced
if that money went into the civilian
economy. “We don’t know what would
have happened had [defense] funds been
invested … in the infrastructure of our
country or the development of an educational system,” concludes Warf. “The
opportunity costs argument never arises
in debates over military spending. No
other category of federal spending is
immediately off limits.”
Economic activity around a military
installation tends to be similar to the
ancillary businesses that any large,
labor-intensive enterprise attracts. This
includes retail stores, housing, and
health care facilities.
In addition, installations generate
some economic development that
would not have occurred otherwise.
Some hotels cater to the military,
housing reservists who train at bases
on weekends, military and civilian personnel on a temporary assignment who
want to avoid signing long-term leases
at apartment buildings, and families vis-

iting their relatives who are graduating
from basic training.
However, military officials can
actively discourage development near a
base. Robert Beasley Jr., who has leased
industrial property in Virginia Beach for
the last 10 years, recalls when the Navy
purchased deed restrictions on several
large parcels around Oceana. It used
these restrictions to limit development
to small factories, warehouses, and distribution facilities.
Beasley says naval officials didn’t
want offices, retail, or other highdensity development that would put a
lot of people on the flight path of
Oceana’s aircraft. That way, injuries to
civilians would be minimized in the
event of an accident, plus it would
temper complaints about jet noise.
A military installation also can unintentionally discourage industrial development, according to Parish at Charleston
Southern. Large employers can perceive
the base as a tough competitor for a community’s most adept workers.
Some economic development officials tout the potential for defenserelated research and development to
produce commercial spin-offs. While
such spin-offs have occurred — everything from Teflon to the Internet has
its origins in the military — the commercialization process isn’t easy. Some
goods and services are produced for the
military to meet precise specifications
and often must be able to withstand
extreme conditions, regardless of the

costs involved. In contrast, commercial
goods and services need to be broadly
useful and profitable to produce.
Ultimately, national defense must be
judged for more than its economic
effects in communities. Economists
describe it as a classic public good. One
person’s consumption doesn’t diminish
someone else’s consumption, and no
one can be excluded from consuming
it. Therefore, a public good benefits
everyone equally and at no cost to individuals. This is why companies don’t run
armies—they couldn’t make a profit.
As new challenges lie ahead for this
volatile, interconnected world, lawmakers and taxpayers must decide how
they value national defense as a public
good as well as an economic stimulus,
and how much they are willing to sacrifice in return.
RF

READINGS
Atkinson, Robert D. “Defense Spending Cuts and
Regional Economic Impact: An Overview.” Economic
Geography, April 1993, vol. 69, no. 2, pp. 107-122.
Casagrande, David. “Conversion Then and Now.”
The American Prospect, Sept. 1, 1992, vol. 3, no. 11.
Fernandez, Richard L. “What Does the Military
‘Pay Gap’ Mean?” Washington, D.C.: Congressional
Budget Office, June 1999.
Warf, Barney. “The Pentagon and the Service
Sector.” Economic Geography, April 1993, vol. 69, no. 2,
pp. 123-141.
Visit www.rich.frb.org/pubs/regionfocus for links
to relevant Web sites.

Summer 2003 • Region Focus

19

Who should sell hard liquor in
the Fifth District—state-run
monopolies or private companies?

Liquid

Assets
BY KARL RHODES

W

hen George Griffin was
named acting director of the
Department of Liquor
Control in Montgomery County, Md., he
received some advice from a long-time
veteran of county government.
“Our director of management and
budget told me … that this is not a difficult job if you stay focused,” Griffin
recalls. “Just remember that you only
have two primary goals: One is to
promote temperance and the other is
to increase revenue.”
When it comes to the sale of alcohol,
Montgomery County is a control jurisdiction — a state or local government
that exercises monopoly ownership of
distilled spirits either at the wholesale
or retail level, and quite often both.
Montgomery County, for example, has
a complete monopoly over the sale of
liquor, and it is the only locality in the
nation that also controls the wholesale
distribution of beer and wine. All other
control jurisdictions leave beer and wine

20

Region Focus • Summer 2003

sales to private companies that they
license and regulate.
A control jurisdiction is “sort of a
schizophrenic system,” Griffin says.
“The government, in an effort to
control, is actually selling alcoholic beverages to the public for a profit. On the
other hand, it shows the balance that
we try to reach … offering a legal
product to the public and at the same
time ensuring that it’s done so in a way
that doesn’t encourage risky consumption or unlawful behavior.”
The entire spectrum of alcohol regulation and control is represented in the
Fifth District. Virginia and North Carolina are strict control states, while South
Carolina and Washington, D.C., are
among the most open jurisdictions in the
nation. West Virginia franchises its retail
operations to private companies, but it
maintains control at the wholesale level.
Maryland varies by locality.
Each of these systems traces its
roots back to Prohibition. In 1933, after

Prohibition was repealed, the federal
government turned the regulation of
alcohol sales over to the states. Most
people were glad that Prohibition was
over, but they did not want to return
to the proliferation of saloons they had
witnessed before Prohibition.
“It was not uncommon to find one
saloon for every 150 to 200 Americans,
including those who did not drink,”
writes K. Austin Kerr, a historian at
Ohio State University. “Hard pressed to
earn profits, saloonkeepers sometimes
introduced vices such as gambling and
prostitution into their establishments.”
To prevent that from happening
again, the states devised various ways
to regulate the sale of liquor. Eighteen
“control states” established governmentrun monopolies to distribute liquor at
the wholesale level, and the vast majority of these states also controlled retail
liquor sales. Meanwhile, “open states”
allowed private vendors to own and
operate liquor stores and wholesale

Public Spirited
State and local revenues from liquor sales

State
District of Columbia
Maryland
North Carolina
South Carolina
Virginia
West Virginia
Control States Total*
Open States Total*
United States Total

Revenue
(000)
$25,293
37,104
168,676
82,164
139,449
15,716
$1,821,345
$2,794,769
$4,616,115

Population
(000)
572
5,296
8,049
4,012
7,079
1,808
78,958
202,464
281,422

Revenue
Per Capita
$44.22
7.01
20.96
20.48
19.70
8.69
$23.07
$13.80
$16.40

Regulatory
Status
Open
Mixeda
Control
Open
Control
Control b
Control
Open
Mixed

aMaryland has both open and control jurisdictions.
bWest Virginia privatized its stores in 1991, but continues to control wholesale distribution.
*Numbers adjusted for Montgomery County, a large control county in a mostly open state.
SOURCES: Distilled Spirits Council of the United States (2000) and the U.S. Census Bureau (2000)

operations as long as they obtained
licenses and followed the rules.
No state has ever fully converted
from a control state to an open state,
but in 1991 West Virginia took a step
in that direction by privatizing its retail
liquor stores. Similar retail conversions
have been considered recently in Virginia and North Carolina.
“It’s an issue that comes up periodically,” Griffin says. “It particularly
comes up when there are difficult fiscal
times. … People are looking for revenue
sources, even if it may be just a onetime infusion. …If you can sell something off and bring in some money,
somebody will put it on the table.”
That’s what happened during the
recession of the early 1990s, when most
control states switched to bailment
warehouse systems that require distillers to maintain ownership of liquor
inventories until the spirits leave stateowned warehouses. In essence, states
generated one-time infusions of cash
by selling off their wholesale inventories. They also created new revenue
streams by forcing distillers to pay bailment fees to store required inventories
in state warehouses. This was a bitter
pill for distillers to swallow, and it significantly increased the control states’
financial incentive to maintain their
monopolies at the wholesale level. But
maintaining control at the wholesale
level is not as controversial as maintaining control at the retail level, where
states sell liquor directly to consumers.

proposal to sell Virginia’s liquor
stores to private operators died in
last year’s General Assembly, but
the bill’s patron, Delegate Allen L.
Louderback, plans to reintroduce the
legislation in next year’s session.
“I don’t really think we should be in
the business of selling alcohol, and
we’re turning around and having to
figure out ways to help people break
their alcohol addiction,” says Louderback, a Republican from Luray. “We’re
sending a mixed message to the public.
… I don’t believe that the government
needs to be in the business of running
retail operations of any type.”
Members of the General Assembly
were reluctant to privatize Virginia’s
state-run stores last year because they
“were convinced that they were going
to lose all this profit,” Louderback says.

A

“I don’t think they fully understood
that the profit could still be there
regardless of whether we were running
the stores or not.”
The Virginia Department of Alcoholic Beverage Control (ABC) turned
a profit of $46.2 million last year — not
counting the state’s excise and sales
taxes on alcohol, which generated three
times again that amount.
Louderback wants to franchise the
state’s 271 ABC stores to the private
sector in phases over five years, and he
wants to limit franchise ownership to
five stores for any one person or corporation. “I don’t want a private
monopoly any more than I want a government monopoly,” he explains.
Vernon M. Danielsen, chairman of
the Virginia ABC, bristles at the suggestion that small private retailers
would be more efficient than his staterun monopoly. “I have 271 stores,” he
says. “My overhead … to control those
… is a substantial economy of scale.
And I come from the private sector. …
I think I can run ABC with the staff
that we have … as profitably as it can
be run. … And that means that all of
that [profit] goes to the state.”
Monopoly profit is one of two
primary advantages of a control system,
Danielsen says. “The other side of it is
that, in a state-owned store, our
employees are a whole lot more careful
about who they sell to.”
Virginia’s underage enforcement
program employs kids in their late teens
who attempt to purchase alcohol at ABC
stores and at licensed establishments that

Public Consumption
Gallons of liquor purchased in the Fifth District

State
District of Columbia
Maryland
North Carolina
South Carolina
Virginia
West Virginia
Fifth District Total
United States Total

Gallons
(000)
1,687
7,670
8,145
5,707
6,831
1,367
31,407
352,983

Population
(000)
572
5,296
8,049
4,012
7,079
1,808
26,816
281,422

Gallons
Per Capita
2.95
1.45
1.01
1.42
0.96
0.76
1.17
1.25

Regulatory
Status
Open
Mixed a
Control
Open
Control
Control b
Mixed
Mixed

aMaryland has both open and control jurisdictions.
bWest Virginia privatized its stores in 1991, but continues to control wholesale distribution.
SOURCES: Distilled Spirits Council of the United States (2000) and the U.S. Census Bureau (2000)

Summer 2003 • Region Focus

21

sell or serve beer, wine, or liquor by the
drink. “At a [state-owned] ABC store, we
are at least three times better than in the
other stores,” Danielsen says. “In an ABC
store, we’re between 5 and 10 percent
noncompliance. At the [licensed establishments] we are at 25 to 26 percent
noncompliance.” Licensed establishments include restaurants, bars, and clubs
that sell alcohol by the drink and stores
that sell beer and wine for off-premise
consumption.
Louderback counters that privatizing the liquor stores would allow Virginia ABC to focus on enforcement. “It
might be better that we’re not watching our own operation,” he suggests. “It
might even be tighter than the existing situation because … if someone
messes up and loses their franchise,
they could lose a lot of money.”
The market value of the proposed
franchises is another point of disagreement. Louderback predicts that
Virginia’s existing stores would bring
in about $500 million. But Danielsen
says that estimate is on the high side

— even if Virginia ABC eased restrictions on advertising, product mix,
hours of operation, and store appearance. And Louderback doesn’t want to
relax those rules.
“As with McDonald’s or Burger King
or any other franchise, you can set the
guidelines … whether it’s employee dress
or the appearance of the store or the
cleanliness of the store,” Louderback
says. “If they don’t meet those guidelines, they could lose their franchise. I
think that’s a pretty big incentive to
maintain a quality operation.”
Maybe so, says Danielsen, but “the
more restrictions you put on it—and the
restrictions bring it closer to the way it’s
operated now—the less valuable it is.”
est Virginia can shine some
light on the hypothetical
debate in Virginia. The
Mountain State franchised its 155 liquor
stores to private retailers in 1991 on 10year contracts that generated $22 million.
The market for store-bought spirits
is about five times larger in Virginia than

W

What About Beer and Wine?
While the regulation of liquor varies dramatically throughout the Fifth District, the
regulation of beer and wine is very similar.
In control states and open states alike, beer
and wine are widely available for off-premise
consumption at private retailers that maintain
alcohol licenses. States also license restaurants,
bars, clubs, and other establishments that sell
beer, wine, and liquor by the drink.
“As a general rule, there is a great disparity
between what beer and wine [retailers] are
allowed to do…and what distilled spirits
[retailers] are allowed to do,” says Dave
Holliday, vice president for state government
relations at the Distilled Spirits Council of the
United States (DISCUS). “There is a great gap
between what distilled spirits taxes are and
what beer and wine taxes are.”
Holliday also notes a huge difference in
availability—particularly in control states, where
there are only a few hundred off-premise outlets
for distilled spirits, compared to thousands of offpremise stores for beer and wine. “What we
work on a lot is trying to level the playing field
so that beer and wine don’t have such a pronounced market advantage against spirits,” he says.

22

Region Focus • Summer 2003

Control state officials argue that tighter
liquor restrictions are necessary because spirits
are far more potent than beer and wine. “That’s
the reasoning, but it’s wrong,” Holliday says. He
notes that the standard servings of beer (12
ounces), wine (5 ounces), and liquor (1.5 ounces)
contain the same amount of alcohol. And
according to DISCUS numbers for 2000,
residents of the Fifth District consumed nearly
20 times more beer and wine than liquor.
Per capita consumption of beer and wine
are somewhat higher in Washington, D.C., and
South Carolina, where alcohol-related traffic
deaths are higher, but the correlation is not as
dramatic with beer and wine as it is with
distilled spirits.
Two bartenders interviewed for this story
contend that distilled spirits do tend to be
more dangerous than beer and wine. They note
that a standard serving of beer fills up drinkers
more than a typical mixed drink or glass of
wine. They also note that beer and wine are
more often consumed with food.
They agree with the immortal words of
Redd Foxx: “Wine is fine, but liquor is quicker.”
—K A R L R H O D E S

it is in West Virginia, so a valuation
based solely on sales would put the price
of Virginia’s stores at about $110 million.
But Virginia’s population is growing
while West Virginia’s population is
shrinking, and Virginia’s stores are highly
profitable, while several of West Virginia’s stores were struggling in 1991.
“West Virginia had some problems
with its retail operation,” Danielsen
says. “It was not very efficient, and it
was not making much money.”
Keith Wagner, deputy commissioner
of the West Virginia Alcoholic Beverage Control Administration, also
acknowledges that West Virginia
underpriced some of its franchises in
1991. “In the original bidding, there was
no [minimum] price attached,” he says.
“We sold franchises for $100, if that
was the highest bid. … One of our
biggest franchises — in Parkersburg —
was originally sold, I think, for $500.”
When West Virginia re-bid the franchises in 2000, the state put a minimum
price on each territory based on its
average sales during the previous 10
years. Franchisees had to win new competitive bids to retain their 10-year contracts to operate liquor stores in their
territories. “We gave preferential treatment to those who had already held
franchises,” Wagner says, but franchisees like the one in Parkersburg had
to pony up. Those gains, however, were
offset by lower prices for franchises in
regions where the population had
declined, and West Virginia again netted
$22 million for the 10-year contracts.
“Since then, we’ve had two or three
bidding periods because we didn’t sell

all the stores, and we’re getting ready
to have another one for the remaining
14 franchises,” Wagner says. That
bidding period probably will dispose of
five or six more stores, he predicts.
Wal-Mart has expressed an interest
in bidding this time. Unlike many states,
chain stores are allowed to sell liquor in
West Virginia. In fact, Rite Aid is by far
the largest franchisee in the state with
45 stores, the most allowed by law.
Other major franchisees include PharMor and Big Bear Super Markets.
West Virginia has not increased its
enforcement efforts, and Wagner says
it hasn’t been necessary. “In the past 12
years that they’ve been out there, you
can count on one hand the number of
violations for underage sales,” he
insists. “Most of our retail operators
have invested a lot of money in this
business … and they realize that they
could lose their license.”
Overall, Wagner believes West Virginia has come out slightly ahead by
privatizing its stores. Generating $22
million every 10 years has more than
made up for agency profits that are
about $1 million less per year than they
were in 1989.
Also, by selling the stores, the state
was able to eliminate 500 government
jobs, Wagner says. “Of course, the politicians would like to have those jobs back
— those patronage jobs at the liquor
stores — but I think they realize that
this has been good for the private sector.”
dozen years after privatization,
West Virginia doesn’t seem to have
a drinking problem. In fact, its
residents consume less liquor (0.76 gallons
per capita in 2000) than any other state
population in the Fifth District, according
to the Distilled Spirits Council of the
United States Inc. (DISCUS).
ABC officials in other states suggest
that moonshine keeps that number
down, but the black market for white
lightning doesn’t seem to have a major
impact on the state’s highway safety
statistics. In 2001, West Virginia had
0.68 alcohol-related traffic fatalities for
every 100 million miles traveled,
according to the National Highway
Traffic Safety Administration. That’s
not quite as good as Virginia (0.46),

A

Maryland (0.56), or North Carolina
(0.58), but it’s significantly better than
the open jurisdictions of Washington,
D.C. (1.01) and South Carolina (1.27).
South Carolina’s fatality rate is the
worst in the nation. Consumption of
distilled spirits in the Palmetto State
was 1.42 gallons per capita in 2000,
which was significantly above the
national average of 1.25 gallons, according to DISCUS. South Carolina has
three times as many liquor stores per
capita than the Fifth District average,
and there are relatively few restrictions
on how these stores advertise spirits.

through the legislature, and signs are
that it will,” Brazell says. “Then it
would go back to the legislature for ratification in 2005.”
Although South Carolina has the
most alcohol-related traffic fatalities in
the nation, on a per capita basis, that statistic is improving. In fact, the fatality
rate has declined significantly in all 50
states since 1982, improvements that corresponded with laws that raised the legal
drinking age to 21. But while the national
fatality rate fell 62 percent, Washington,
D.C.’s rate jumped 63 percent.
Maria Delaney, director of the Dis-

Yo, Ho, Ho, and a Revenue Flow!
Who gets what from a bottle of rum?

State
District of Columbia
Maryland
North Carolina
South Carolina
Virginia
West Virginia
Control States Average
Open States Average
National Average

Retail Pricea
$10.79
10.49
10.95
11.55
11.44
11.09

State & Local
Revenueb
$1.23
1.00
3.39
1.70
4.25
2.64

Federal
Revenue
$2.15
2.15
2.15
2.15
2.15
2.15

Private Sector
Revenuec
$7.40
7.33
5.41
7.70
5.04
6.29

Regulatory
Status
Open
Mixedd
Control
Open
Control
Controle

$11.25
$11.57
$11.49

$4.08
$1.58
$2.19

$2.15
$2.15
$2.15

$5.02
$7.83
$7.15

Control
Open
Mixed

a Price and tax rates are for a 750-milliliter bottle of 80-proof rum.
b Includes state and local taxes in each state plus wholesale and retail markups in control states.
c Includes indirect taxes paid by the private retailers and wholesalers.
dMaryland has both open and control jurisdictions.
e West Virginia privatized its stores in 1991, but continues to control wholesale distribution.
SOURCE: Distilled Spirits Council of the United States, Bottle Tax Burdens (2001)

Another possible factor is the state’s
use of mini-bottles to serve liquor by
the drink. South Carolina is the only
state in the nation that requires bars
and restaurants to pour distilled spirits
from mini-bottles, says Danny Brazell,
public affairs director for the South
Carolina Department of Revenue.
“One of the reasons why some groups
are looking to change the law is because
they think that when [liquor] is served
this way, the consumer is more apt to
drink too much,” Brazell says. A minibottle holds 1.7 ounces of spirits, while a
standard shot contains 1.5 ounces.
Changing the law would require an
amendment to the state constitution,
which must be approved by voters. The
earliest possible referendum date
“would be November 2004, if this gets

trict’s Alcoholic Beverage Regulation
Administration, declined to speculate
on why D.C.’s fatality rate has gone
from the best in the nation in 1982 to
one of the worst in 2001.
Delaney has been on the job just a
few months, but she is bringing
enforcement ideas to D.C. from her
previous experience in Connecticut.
Starting a program of routine compliance checks such as those employed in
other Fifth District states is high on
her list of priorities.
The first step, Delaney says, is to
educate and train the people who serve
and sell alcohol in the District. In a
series of seminars, Delaney plans to put
the private operators on notice by
saying: “Hey! We’re going to be starting
these [compliance checks]. This is what

Summer 2003 • Region Focus

23

On Every Corner?
Liquor stores in the Fifth District

State
District of Columbia
Maryland
North Carolina
South Carolina
Virginia
West Virginia

Storesa
266
1,057 *
389
872
271
155

Population b
570,898
5,458,137
8,320,146
4,107,183
7,293,542
1,801,873

Fifth District

1,953

27,551,779

Population
Per Store
2,146
5,164
21,389
4,710
26,913
11,625

Regulatory
Status
Open
Mixed c
Control
Open
Control
Control d

14,107

Mixed

aTotal number of liquor stores, including stores that sell other things, as of March 2003
bU.S. Census Bureau estimate for July 1, 2002
c Maryland has both open and control jurisdictions.
dWest Virginia privatized its stores in 1991, but continues to control wholesale distribution.
*In addition to this 2001 number, some localities in Maryland allow an undetermined number of beer and wine
licensees to sell liquor for off-premise consumption.
SOURCE: Alcohol regulation agencies in each state

you need to do. You need to card people.
You can’t rely on your scanning devices.
You can’t rely on a young kid who you
pay $2 an hour.”
Stopping underage drinking will be
a new priority for Delaney and her 11
investigators, but “eminent danger”
investigations will continue to be critically important, she says. “If there’s a
shooting at a location, and the board
deems that there is an eminent danger
to the public … they will do a summary
suspension and actually close the place
down until the next hearing date,”
Delaney explains. At the hearing, the
board will weigh evidence and testimony
and decide on whether or not to revoke
the establishment’s liquor license.
n the eyes of many control-state
officials, Washington, D.C., is the
poster child for the ills of open
jurisdictions. The District has one liquor
store for every 2,146 residents. In sharp
contrast, Virginia has one liquor store for
every 26,913 residents.
“There are a lot of stores in the District, and I think they’ve been very
liberal with their zoning laws and their
licensing laws on the size of the stores,”
says Griffin, the liquor control director
in Montgomery County, Md. “You get a
lot of pint stores and that type of thing.”
The high number of liquor stores,
coupled with extensive newspaper
advertising, contributed to the District’s consumption of 2.95 gallons of
distilled spirits per capita in 2000.

I

24

Region Focus • Summer 2003

That’s three times the average consumption for the control states of Virginia and North Carolina, according to
DISCUS numbers.
“I don’t think ‘consumption’ is the
right word,” says Delaney, who notes
that many commuters who work in
D.C. buy liquor there and drink it at
home in Virginia or in Maryland. The
District also attracts many tourists who
purchase alcohol but do not show up
in population numbers.
All of those factors combined to
produce $44 of revenue per capita
from the sale of distilled spirits in D.C.
in 2000. That’s more than twice the
per capita revenue generated by any
other state in the Fifth District,
according to DISCUS. But the money
comes with ominous strings attached.
“For every percent increase in
average consumption, there are corresponding increases in alcoholism, sclerosis of the liver, DUI, and fetal
alcohol syndrome,” warns Danielsen at
the Virginia ABC.
D.C.’s high revenue per capita is not
the norm in other open jurisdictions.
Nationally, revenue in open states averages $13.80 per capita, compared to
$23.07 per capita in control states,
according to DISCUS. In the Fifth
District, Maryland’s revenue is just
$7.01 per capita, and it would be even
lower if it weren’t for the profits generated by Montgomery County, a
control jurisdiction.
Montgomery County produces far

more revenue from alcohol sales than
any other locality in Maryland, but
Griffin hasn’t forgotten the temperance
side of his control conundrum. He
notes that the county also has lower per
capita consumption of distilled spirits
(0.80 gallons) than any other locality in
Maryland. As for underage drinking, he
says the compliance rate at the countyowned liquor stores is 98 percent, and
the compliance rate at the licensed
establishments is about 85 percent.
Griffin is proud of Montgomery
County’s overall performance, but he
believes there is room for improvement,
both in his county and across the country.
“I don’t think we’ve ever fully arrived
at a comfortable public policy approach
to alcohol,” he says. “At different times
we’ve had virtually no rules, when
anyone could buy whatever they wanted
whenever they wanted. And then, at
other times, we’ve gone so far as to actually have national prohibition. … Both
approaches were abject failures.”
Seventy years after the repeal of Prohibition, the solution lies somewhere
between, he says. “We’re trying to strike
that balance for the public.”
RF

READINGS
Distilled Spirits Council of the United
States. “Summary of State Laws and
Regulations Relating to Distilled
Spirits,” January 2002.
Pacific Institute for Research &
Evaluation. “The Effects of
Privatization of Alcohol Control
Systems: A Summary of Research on
the Impact of Privatization on
Alcohol Consumption and
Problems,” 2000.
Wagenaar, A. C., and H. D. Holder.
“Changes in Alcohol Consumption
Resulting From the Elimination of
Retail Wine Monopolies.” Journal of
Studies on Alcohol, 1995, vol. 56, no. 5,
pp. 566-572.
West, Douglas S. “The Privatization
of Liquor Retailing in Alberta.”
Report to the Centre for the Study of
State and Market, University of
Toronto, June 21, 1996.
Visit www.rich.frb.org/pubs/
regionfocus for links to relevant sites.

M AY I S E E YO U R

License,

Please?

Excessive Occupational Licensing Can

Cost Consumers Money Without Necessarily
Increasing Quality or Protection
BY BET TY JOYCE NASH

©GREG PAPROCKI/PHOTODISC/PICTUREQUEST

Q

uantavius Bovain, a six-year-old
student at Harbison West
Elementary School in Columbia,
S.C., opens his mouth wide “like an
alligator” as dental hygienist Laura
Hancock cleans his teeth. Hancock
treats Quantavius’ teeth with fluoride
and seals them to deter decay. She works
for a private firm in partnership with the
South Carolina Department of Health
and Environmental Control’s public
health dental program, resurrected in
2000 after the fiscal woes of the early
1990s cut off the service.
Quantavius’ teeth might have gone
untreated were it not for a public
health dental program called Healthy
Smiles Partners. To widen access to
dental care, South Carolina, along with
some other Fifth District states, is
changing current state laws that restrict
the way hygienists work. Previously,
hygienists could only work on premises
with dentists. The change allows
hygienists to work without a dentist on
the same premises as long as it is in a
public health setting. The question
arises, if hygienists can work without
direct supervision in public health settings, why can’t they do so elsewhere,
and reduce the cost of dental services?
Dental care is a luxury for many
low-income people, according to a 2003
report by the Center for Health Ser-

vices Research and Policy at The
George Washington University Medical
Center. Poor people tend to have more
tooth decay and either forgo or put off
dental care until it’s too late to save
teeth. The report cites many reasons
for this, including the state regulations:
“The licensing system and self-regulation by the dental and medical professions have profound implications for
low-income children.”
This is just one example of state
occupational oversight that can stifle
entrepreneurship and raise prices. Such
practices can increase wages for practitioners at the expense of consumers,
economists say. And consumers may
use licensing as a signal of quality when,
in fact, there’s often no evidence that
such regulations are effective.

Born in Babylonia, Reared in
Medieval Guilds
The regulation and licensing of occupations in the United States, practically nonexistent in 1900, has grown to include
some 1,000 occupations regulated today
by one or more of the 50 states.
Licensing in the 1950s affected
about 3 percent of the labor force, but
today licensing affects about 18
percent of all U.S. workers, more than
the minimum wage or unionization,
according to Morris Kleiner, a pro-

fessor of labor policy at the University of Minnesota. In Virginia alone,
the state licenses well over 100 occupations, from auctioneers to wrestlers.
The North Dakota legislature recently
added bikini waxing to a list of cosmetic procedures allowed by law.
Occupational licensure has roots in
ancient civilization (the Code of Hammurabi) and showed up later in
medieval guilds, whose purpose was to
create and keep a monopoly. Some
guilds persisted, however, especially in
the retail trade and small-scale service
enterprises. “It was only with the
appearance of shopping centers and
‘supermarkets’ after World War II that
butchers and bakers lost their professional status, while such groups as
plumbers have managed to keep that
status,” writes medieval historian Lynn
Harry Nelson. The regulatory movement gained momentum during the
Progressive Era, aided by consumer
activists and “muckraking” journalists
who exposed dangerous products and
conditions in the marketplace. Ultimately federal agencies overseeing
certain industries, such as the Food and
Drug Administration, among others,
were created.
Today’s state occupational licensing
rules are promulgated by boards made
up of the people who stand to gain from

Summer 2003 • Region Focus

25

rules that restrict entry to professional
occupations — the members of the profession. While licensing rules vary from
state to state and occupation to occupation, they usually include some combination of prescribed formal education,
experience, a test, good moral character, and citizenship. In some cases, the
rules can even include limitations on
practice ownership, as is the case with
dentistry in Virginia, where only a
dentist can own a dental practice.
“For the occupations, there’s a real
incentive to restrict supply and increase
earnings and increase the perception
of quality within the occupation,”
Kleiner says. “… for consumers, the
benefits of fighting restrictive [regulations] is relatively small. It’s not worth
the effort of going to lobby the legislature or going to the licensing board
trying to loosen restrictions.”

Economists have studied occupational regulation at least since the days
of Adam Smith. In The Wealth of Nations,
published in 1776, Smith questioned
whether long apprenticeships guarantee
good work:
“The patrimony of a poor man lies
in the strength and dexterity of
his hands; and to hinder him from
employing this strength and dexterity in what manner he thinks
proper without injury to his
neighbour, is a plain violation of
this most sacred property. …To
judge whether he is fit to be
employed, may surely be trusted to
the discretion of the employers
whose interest it so much concerns.
The affected anxiety of the lawgiver lest they should employ an
improper person, is evidently as
impertinent as it is oppressive.”

Occupational Licensing and the Internet
Licensing laws grew partly from the idea that
it’s expensive and time-consuming for
consumers to gather information they need
before finding a service. But today, the flow of
information on the Internet reduces the cost
for computer-literate consumers to make
informed decisions about purchases of goods
and services.
And doing business in cyberspace, where no
state lines exist to mark territory, raises plenty
of questions about state occupational licensing.
“There have been several studies of the
impact of the Internet on prices … and
licensing reduces some of the cost effectiveness of those transactions by limiting the
ability of individuals to order or get services
through the Internet…,” says Morris Kleiner, an
economist at the University of Minnesota.
The Federal Trade Commission (FTC) last
fall held a public workshop as part of an
ongoing effort to examine anticompetitive
barriers to Internet commerce, says Jerry Ellig,
acting director of the office of policy planning
for the FTC.
The FTC weighs in when Internet commerce
is stifled because of anticompetitive practices,
such as the case of the Internet-based casket
seller who sued the state of Oklahoma over a
state law requiring casket retailers to hold a
funeral director’s license.
The possibilities for bumping up against

26

Region Focus • Summer 2003

state licensing regulations are endless. For
example, Ellig says some state real estate
appraisal boards want companies who do
automated appraisals to obtain licenses,
although the FTC has not investigated that
situation in depth, he says. The FTC also
intervened recently in a proceeding before the
Connecticut Board of Examiners for Opticians,
who are considering whether Internet retailers
who sell contact lenses to Connecticut
customers need an optician’s license.
“We argued that a firm which only sells
contact lenses and simply takes sealed boxes of
lenses received from a manufacturer and puts
them in an envelope and mails them to
consumers… shouldn’t have to have an optician’s
license,” Ellig says. Opticians are licensed
because they actually make eyeglasses and that
takes skills and training. “But fabricating
eyeglasses is different from taking a marked
box from a manufacturer and matching it to a
prescription and dropping it in the mail.”
Such licensing laws can restrict the
commercial benefits of the Internet, says
Kleiner. “To the extent that other services…,
medical devices, and pharmacy-related products
have similar state occupational licensing-related
restrictions, this may limit the ability of
consumers to purchase products which have
the lowest cost relative to quality,” he says.
—B E T T Y J OYC E N A S H

ost studies examining whether
restrictions improve quality find
few such benefits, according to
a 1990 Federal Trade Commission (FTC)
study, “The Costs and Benefits of
Occupational Regulation”:
“Even in the situations in which
licensing increases the quality of the
licensee-provided service, consumers are
not necessarily better off. Price increases
due to licensing may cause some consumers to ‘do without’ the service, or to
‘do it themselves.’ ”
The FTC study notes the “capture
theory” of occupational regulation,
which holds that professionals seek to
protect themselves from competition
and, in doing so, increase income. Economic theory suggests rules aimed at
limiting entry will cut supply and raise
prices. The FTC report noted a 1982
study that found dental prices to be
about 4 percent higher in metropolitan areas in states limiting the number
of hygienists that dentists can employ.
An alternative to licensing, suggests
Kleiner and the FTC study, is certification. For example, travel agents and
car mechanics are certified, notes
Kleiner. “Licensing by definition is that
you need state permission to do the
work. With certification, others can do
the work but the public knows the
individual has gone through training
requirements.” Certification may also
require testing and education.
Perhaps the best consumer protection is provided by reputation. Some
professions use independent regulatory
agencies, such as Underwriters Laboratories Inc., to advertise that their
products have been tested in accordance with trusted standards.
Another protection for consumers
against deceptive trade practices exists
by statute already, says lawyer Steve
Simpson, who works for the Institute
for Justice, a nonprofit group in Washington, D.C., that investigates regulations that keep entrepreneurs out of
the marketplace. The fear of litigation
often enforces good practice. “The
tremendous amount of liability companies face when they do things wrong
is a huge incentive to do things right,”
he notes. “[Professionals] are much
more worried that they’re going to get

M

BETTY JOYCE NASH/FRB OF RICHMOND

In South Carolina, hygienists may clean
and seal the teeth of low-income children
as part of a public health program.

sued by a customer than that a licensing guy is going to come by and write
them a ticket.”

The Case of Dentistry
Several economic studies have examined
the statutes and regulations governing
dentists. Kleiner, for example, studied
U.S. Air Force recruits to see how restrictive licensing laws affected outcomes of
service, prices, and practitioner earnings.
The study used data from the young
recruits’ first dental examinations after
entering the Air Force, as well as relevant socioeconomic information, including recruits’ home states and income,
among other characteristics. “We tried
to see, if they came from a state that had
tougher licensing requirements, how was
their dentitia at that point in their life?”
Kleiner explains, adding that he and coauthor Robert Kudrle found that restrictions did not improve dental health but
did raise prices of basic dental services.
Similarly, an economic analysis by the
Virginia Department of Planning and
Budget found that proposed regulations
by the Board of Dentistry that limit the
number of dental hygienists per supervising dentist except in public health and
volunteer work settings would have a
negative economic effect. The 2003
analysis states: “Overall, the new proposed regulation continues a set of practice restrictions that both increase costs
and reduce the quantity consumed of

dental care without providing any commensurate public health benefits.”
(States differ in supervision levels, with
about 13 states requiring dental hygienists to work directly under a dentist on
the premises. Virginia and other Fifth
District states are among the few that
currently do not allow general supervision, which allows the hygienist to
perform services while a dentist is not
present, but has authorized treatment
and will evaluate the hygienists’ performance later. However, most of those
states allow hygienists to work in public
health settings under general rather than
direct or indirect supervision.)
The American Dental Association
(ADA) opposes general supervision
because it fails to protect public health,
according to Dr. Laura Neumann, of
the ADA. Most states do not restrict
the number of hygienists a dentist can
supervise, according to the ADA;
however, several Fifth District states
have pending legislation that would
limit that number.

African Hair Braiding
and Caskets
Health professions are but one of many
professions under scrutiny. In 1991, the
Institute for Justice challenged the District of Columbia’s cosmetology licensing regulations in Uqdah v. Board of
Cosmetology. At the time, the District
required African hair-braiding businesses
to comply with extensive training
requirements to procure a cosmetology
license. But the 1,500 hours mandated
had little to do with natural hair braiding, according to the Institute. The legal
effort changed licensing laws in the District and, since that time, has contributed to changes in cosmetology
licensing laws in 14 states.
“As you can imagine, this is a skill
that people learn when they’re young,”
Simpson says. “They learn it as kids and,
rather absurdly, the states try to regulate them when they decide to go into
business doing it.”
The Institute seeks cases in which the
licensing laws are ridiculous, Simpson
says. In 2001, the Institute challenged
regulations that require casket retailers
to be licensed funeral directors, a requirement in some states. That drives up

casket prices, the largest portion of a
funeral’s cost. The 6th U.S. Circuit Court
in Tennessee recently sided with the
Institute; the issue is being challenged in
Oklahoma, too. Simpson says that often
lawmakers are unaware of such economically inefficient regulations.
“A lot of times we’ll bring cases and
the legislators will recognize that these
are absurd laws,” he says. “When you
have an active and organized group like
funeral directors and a disorganized
public, there’s a huge incentive for a
small organized group to get the law
changed and no incentive for the man
on the street to care about it.”
The rationale for occupational
licensing has typically been to protect
public health and safety. Occupational
licensing can be useful when consumers,
for whatever reason, lack information
about or have difficulty determining
professionals’ quality.
But economists continue to question what people are buying for the
higher prices associated with licensing.
“Prices are higher, quality is uncertain, and you don’t know if it’s better
or not,” Kleiner says.
RF
READINGS
Cox, Carolyn, and Susan Foster. “The Costs and
Benefits of Occupational Regulation.” Bureau of
Economics, Federal Trade Commission, Oct. 1990.
Kleiner, Morris M. “Occupational Licensing and
the Internet: Issues for Policy Makers,” for the
Federal Trade Commission Hearings on
“Possible Anticompetitive Efforts to Restrict
Competition on the Internet.” Oct. 1, 2002.
Kleiner, Morris M. “Occupational Licensing.”
Journal of Economic Perspectives, Fall 2000, vol. 14,
no. 4, pp. 189-203.
Kleiner, Morris M., and Robert T. Kudrle. “Does
Regulation Affect Economic Outcomes? The
Case of Dentistry.” Journal of Law and Economics,
October 2000, vol. XLIII, pp. 547-576.
Peltzman, S. “Toward a More General Theory of
Regulation.” Journal of Law and Economics,
August 1976, vol. 19, no. 2, pp. 211-240.
“The Effects of State Dental Practice Laws
Allowing Alternative Models of Preventive Oral
Health Care Delivery to Low-Income Children,”
Center for Health Services Research and Policy,
The George Washington University Medical
Center, January 2003.
Visit www.rich.frb.org/pubs/regionfocus for
links to relevant Web sites.

Summer 2003 • Region Focus

27

Seeing the

Light
Communities in Catawba County, N.C., supported the
growth of optical fiber and cable producers to help
maintain the county’s manufacturing sector.
BY CHARLES GERENA

ntil the growth of the telecommunications industry slowed to a
crawl, 40 percent of the world’s
fiber optic cables reportedly flowed from
one place — Catawba County in western
North Carolina. Factories in Hickory and
Claremont churned out millions of
kilometers of these light-carrying
communications lines, as well as the optical
fibers inside of them.
The initial location of cable and
fiber production in Catawba was more
a product of chance than design.
Through a series of acquisitions and
mergers, locally owned plants ended up
in the hands of three major suppliers
to the telecom industry — CommScope Inc., Corning Inc., and Alcatel.
But executives could have expanded
their firms elsewhere when the demand
for cable and fiber increased. Instead,
they chose to invest in their existing
facilities in Catawba. The county had
several economic advantages, from its
established industrial base to a labor
pool that encompasses a four-county
metropolitan area north of Charlotte.
What ultimately made the difference,
though, was the lobbying of government officials who wanted to keep
industry alive in Catawba County.

U

he production of hosiery, furniture,
and other goods has been an
important part of the county’s
economy, thanks in part to cheap electricity
from Duke Power’s hydroelectric plants
on the Catawba River.
“We have always been heavily manufacturing oriented,” notes Scott Millar,
president of the Catawba County Economic Development Corporation.
There were 575 manufacturers in the
county as of June 2002, the thirdhighest number in North Carolina.
However, Millar says most of the
county’s manufacturers could be classified as small businesses. “There are quite
a few firms that are two-, three-, or fiveperson hosiery operations, or small furniture production facilities,” he describes.
Employment in the hosiery and furniture sectors has been shrinking for
years. Dean McGinnis, Claremont’s city
manager for the last 15 years, attributes
this trend to the same factors that have
hurt many labor-intensive industries —

T

28

Region Focus • Summer 2003

automation and increased competition
from less expensive imports. “We have
not lost a furniture factory,” he notes.
“They have just fallen down in the hierarchy” of employers.
So McGinnis and other officials
throughout Catawba County have been
hunting for other manufacturing
sectors that need workers. In particular, they have coveted producers of
telecommunications equipment, plastics, and other high-tech goods. These
firms are thought to pay higher wages
than producers of textiles and other
“low-tech” goods. They also are supposedly less likely to relocate abroad to
reduce their labor costs. (See sidebar.)
Fiber optic cable and optical fiber
production fit the bill for industryhungry Catawba County. The region
had a foot in the door with Superior
Cable Corporation, which was founded
in Hickory in 1953 and opened a plant
in Sherrills Ford in 1966. These facilities would later be sold to new owners,
providing the foundation for CommScope and Corning’s fiber optic cable
production in the county. Also, CommScope’s Chairman and CEO Frank
Drendel developed strong relationships
within the cable television industry.
As the expansion of long-distance
telecom markets spurred demand for
fiber optic cable and optical fiber in
the 1980s and ’90s, local officials
lobbied cable and fiber companies.
For example, when Alcatel wanted to
expand its optical fiber production in
the early 1990s, McGinnis says that
Claremont got the new factory in 1992
because local officials “offered innovative ideas and incentives.” The county
bought the land for the factory and sold
it to Alcatel, which paid for the purchase
out of future tax payments. The city
built a sewage treatment plant to accommodate the factory’s waste flow.
Then came the rapid expansion of
telecom networks during the latter half
of the 1990s. Backlogged cable and fiber
producers struggled to keep up with
demand. Sensing the opportunity at
hand, Catawba County and local governments stepped up their efforts to
encourage producers “to make their
investments here rather than somewhere
else,” recalls Millar. Grants, work force

The Allure of High-Tech Manufacturing
When recruiting industry, economic development
officials often favor producers of high-tech goods.
For officials in Catawba and other counties in the
Hickory metropolitan area, the focus has been on
fiber optic cable and optical fiber manufacturers.
Are such firms better for a community’s economy
than producers of low-tech goods?
One reason that officials give for targeting
high-tech manufacturers is that workers earn
relatively higher salaries. A June 1999 analysis by
the Bureau of Labor Statistics (BLS) showed that at
least 10 high-tech industries — from communications
equipment to aerospace —paid at least 50 percent
more than the median wage for all industries.
A March 2002 BLS report explained why hightech manufacturers could pay more: they have
achieved higher annual growth in labor productivity compared to the industrial sector as a whole.
“The benefits for workers from growth in labor
productivity are reflected in rising real wages and
other compensation,” wrote economists Christopher Kask and Edward Sieber in the report. “Over
time, trends in real labor compensation tend to
parallel trends in labor productivity.”
Economic development officials also target
high-tech manufacturers because they appear to
be less likely to relocate in search of cheaper
labor. This is a problem that has plagued
communities where furniture and textile factories
once played a large economic role.
But the likelihood of a plant relocating
doesn’t depend on whether the manufacturer is
high-tech or low-tech, argues economist Joseph
Cortright of Impresa, a Portland, Ore.-based
consulting firm. “The issue is whether the plant is
doing routine, mass production or something that

training, and other incentives “were
developed to facilitate their growth.”
riving through the county’s small
communities, it’s easy to see the
growth of the “big three” cable
and fiber producers. CommScope, a fiber
optic and coaxial cable manufacturer
headquartered in Hickory, operates
industrial and research facilities in
Claremont and Newton that occupy over
1 million square feet. Corning runs its
Cable Systems division in Hickory, as well
as two cable plants that total more than
800,000 square feet. Alcatel has corporate
offices in Hickory, produces cable and fiber
at a million-square-foot complex in

D

it is good at doing in a community.”
Cortright says a new product usually requires
continued refinement and customization during
the production process. Therefore, the manufacturer needs engineers behind the scenes and highly
skilled workers on the factory floor. As long as it
finds this valuable human capital and other unique
resources in a community, it will continue to
operate its plant there. As the production process
becomes more standardized, however, the product
can be made by less specialized, low-wage workers
that can be found anywhere in the globe.
Based on this analysis, one could surmise that
high-technology manufacturers are less likely to bolt
from a community than other producers because
their products are more sophisticated. But that’s not
always the case. For example, the manufacture of
compact discs used to be more complicated, says
Cortright. “Now, it is a very routine process,” so the
cost of labor became a more important consideration than the quality of labor. As a result, Sony Disc
Manufacturing shut down its plant in Oregon and
transferred production to other facilities.
In Catawba County, fiber and cable production is still an exacting process. Equipment must
be precisely controlled to produce glass fibers
that have few impurities, that are the correct
diameter, and that have specific physical and
optical properties.
Also, Alcatel and CommScope Inc. operate
research and development centers near their
plants. “That is a very important indication,” notes
Cortright. “It signals that [they are] doing higher
value-added functions in the community, and
those jobs are more likely to stick around.”
—C H A R L E S G E R E N A

Claremont, and operates a research and
development center in the latter city.
Even so, the local economic effects
of large manufacturers can be disappointing in “small communities that
lack the ability to fully absorb those
impacts,” wrote Dennis Roth in a
January 2000 article for the Economic
Research Service of the U.S. Department of Agriculture. “Branch plants in
rural communities may not benefit the
poor and unemployed because they
bring employees with them, hire more
skilled immigrants, or stimulate long
commuting from other communities.”
Indeed, the employment and payroll
effects of Claremont’s two fiber optic

Summer 2003 • Region Focus

29

Fiber Insulation

6

I
I

2

I

4

North Carolina
Catawba County

I

8

I

10

0

I

UNEMPLOYMENT RATE (NOT

SEASONALLY ADJ .)

For a while, the expansion of optical fiber and
cable production in Catawba County helped
compensate for labor reductions at textile
makers and other manufacturers. But the
downturn in fiber and cable made the county
fare worse than the state in 2001 and 2002.

’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02

SOURCE: Employment Security Commission of North Carolina

cable plants are widely dispersed. The
city has only 1,000 residents, so the
facilities draw laborers from throughout Catawba County and the broader
Hickory metropolitan area, which also
includes the counties of Alexander,
Burke, and Caldwell.
Factory workers spend some of their
salaries at commercial establishments
in town. McGinnis says this has helped
stimulate commercial development.
Still, most of their pay goes back home
at the end of the workday.
The money spent by the manufacturing plants themselves also leaks out
of rural areas, argues Roth. “Because a
branch plant has many economic linkages outside the local community, its
activities create a much smaller multiplier effect than its urban counterparts.”
For example, several suppliers of
equipment and components have
located sales and service offices in
Catawba County, including a Canadian
maker of fiber production systems
named Tensor. But not many of them
operate factories nearby. “They have
mostly showrooms and small R&D
facilities” in Catawba, says Ken Luterbach, sales and technical manager at
Tensor’s office in Hickory. Most of
their production is done elsewhere in
the United States, Canada, and Europe.
Nevertheless, Catawba’s cable and
fiber plants contribute substantially to
30

the local tax base. Revenue from utility
surcharges, property taxes, and other
levies paid by plants helped small cities
like Claremont expand municipal services like fire and police protection.
While some of this added capacity was
needed to keep plant managers happy,
residents also reaped the benefits.

Region Focus • Summer 2003

ow that the telecommunications
industry is retreating, however,
the economic punch of Catawba’s
cable and fiber plants is growing weaker.
Capacity far exceeds the demand,
especially on long haul networks. Less
than 30 percent of all long haul fiber was
activated by 2001, according to a report
by the Telecommunications Industry
Association.
This has led to fewer communications lines going into the ground and,
subsequently, less demand for fiber
optic cable and optical fiber. Worldwide fiber production fell an estimated
50 percent in 2002, with the steepest
drops in North America and western
Europe. In a recent report for KMI
Research, Patrick Fay noted that the
fiber market has shifted to Asian countries like China where networks are in
earlier stages of development.
Not surprisingly, cable and fiber producers have scaled back their production. Corning and CommScope have
laid off hundreds of their plant workers
and engineers in Catawba County.
Alcatel has scaled back its R&D activities in Claremont and mothballed its
fiber plant, but continues to produce
cable from an adjoining facility.
This retrenchment has added to the
job losses in Catawba County’s manufacturing sectors. Not adjusted for seasonal
changes, the county’s jobless rate shot up
from 3.5 percent in January 2001 to 9.1
percent in January 2003. “At one point
last year, we were recognized for having
the highest percentage rate change [in
unemployment] over the previous 12
months in the nation,” says Millar. “It has
been a difficult pill to swallow, from
feeling invulnerable to having to look at
a lot of other opportunities.”
Telecommunications analysts and
executives say it will take a while to
absorb the industry’s excess capacity.
But fiber optic cable and optical fiber

N

producers remain cautiously optimistic.
A core demand still exists for their
products, driven by the need to
improve the quality of networks. Glass
fibers transmit data with fewer errors
than copper wires, thus reducing the
need to re-send data and increasing
network performance.
While many long haul networks are
fiber based, Corning executives and
others believe that the telecom industry is still in the early stages of replacing copper with fiber. Operators of
short haul networks, which transmit
data between local loops in communities, are still making the transition.
And, many of the local loops that
connect homes and businesses to
central switching stations haven’t been
upgraded. But in order for telecom carriers to broadly embrace optical fiber,
there must be greater demand for the
high-bandwidth services that require
the capacity and quality of fiber.
Despite these challenges, local officials don’t regret fostering cable and fiber
production in Catawba County.
“We have not written off the telecom
industry,” says Millar. “Cable and fiber
producers have invested in their work
forces and facilities here, and I feel that
they will invest here again as they
achieve their growth plans in the future.”
Meanwhile, the county will keep searching for new industry.
RF

READINGS
Fiber Optic Network Capacity and
Utilization. Arlington, Va.:
Telecommunications Industry
Association, September 2002.
Kask, Christopher, and Edward
Sieber. “Productivity Growth in
‘High-Tech’ Manufacturing
Industries.” Monthly Labor Review,
March 2002, vol. 125, no. 3, pp. 16-31.
Roth, Dennis. “Thinking About Rural
Manufacturing: A Brief History.”
Rural America, January 2000, vol. 15,
no. 1, pp. 12-19.
2002 Worldwide Markets for Optical
Fiber and Fiberoptic Cable. Providence,
R.I.: KMI Research, December 2002.
Visit www.rich.frb.org/pubs/
regionfocus for links to relevant sites.

No Silver
Bullet

Tax and Spending Limits,

Though Often Useful, Can’t

BY BET TY JOYCE NASH

©C. SHERBURNE/PHOTOLINK/PHOTODISC/PICTUREQUEST

T

hink you can balance your state’s
checkbook better than your state
legislators can? In 24 states—none
in the Fifth District—citizens can collect
signatures and pass tax-and-spend limits
(or other laws) via the ballot box. Alas, the
limits have not immunized participating
states from current financial illness.
For instance, in 1994 Colorado instituted spending limits by constitutional
amendment, the Taxpayer Bill of Rights
or TABOR. The amendment stipulates
that tax increases be approved by voters.
It also limits growth in state spending
and limits tax increases to inflation plus
the population growth and says excess
revenue must be refunded. But Colorado is in the midst of its worst fiscal
crisis in more than 50 years.
Nationwide, states are still in the hole
by about $21.5 billion in the current fiscal
year, 2003, according to the National
Conference of State Legislatures. And in
2004, 41 states expect a cumulative gap
of more than $78.4 billion.
“What really happened is the
revenue disappeared,” says Nicholas
Jenny, senior policy analyst with the
Nelson A. Rockefeller Institute of Government’s Fiscal Studies Program. The
National Association of State Budget
Officers’ Stacey Mazer observes that
Wyoming, a state operating with taxand-spend limits driven by voter initiative, is weathering the crisis nicely
but for different reasons.
“Their sources of revenue aren’t personal income but resources,” she says,
referring to the state’s coal, oil, and gas
production. “They’re one of the few
states without a budget problem [but]
I would not attribute it to the [tax-andspend limit] initiatives.” States whose
budgets depend on personal income
taxes have fared the worst, she says.

Historically, most of the states with
constitutional authority to use voter
initiatives are west of the Mississippi
River. The first such effort took place
in South Dakota in 1898 at the dawn
of the Progressive Era. Eighteen states
followed in the next 30 years and six
more followed in the last half of the
20th century. The concept didn’t catch
on in the East probably because Easterners were afraid that newly arrived
immigrant populations would upset the
status quo. Today, the Eastern states
that permit voter initiatives are Florida,
Maine, Massachusetts, and Mississippi.
“The populist movement was strong
in the West, where many people
believed that corporations and business
interests controlled state governments,” says Alan Tarr, of the Center
for State Constitutional Studies at
Rutgers University. Also, Western states
were just putting their constitutions in
place at the turn of the last century.
“[That] gave an opportunity to make
direct democracy part of the original
constitutional design.”
Research by John Matsusaka, an
economist at the University of Southern California, shows that state spending was about 4 percent per capita
lower in states with voter initiatives
than in pure representative states. Matsusaka used 30 years of data to compare
fiscal behavior in states that permit
voter initiatives and states that allow
only legislators to pass laws. While
spending in voter initiative states was
lower, local spending was higher. “After
one controls for income, population
density, metropolitan population, population growth, mineral production,
ideology of U.S. senators, and federal
aid, initiative states have lower combined state and local direct general

Cure All Budgetary Ills

expenditure, spend more locally and
less at the state level, and rely less on
taxes and more on charges to generate
revenue than pure representative
states,” explains Matsusaka.
“The initiative process in theory and
practice can have an effect on fiscal
policy independent of there being a
TEL [Tax and Expenditure Limitation],” he says. “Simply the fact that it’s
out there and it’s a threat has an effect
on the way the legislature behaves.”
Barry Poulson, an economics professor at the University of Colorado, attributes that state’s current fiscal crisis partly
to changes in the tax system, namely a
flat tax enacted in the late 1980s that
increased income taxes as a source of
revenue. And that’s made revenues more
volatile, according to Poulson. Colorado’s constitution includes tax-andspend limits but also includes an
amendment that mandates spending for
public education.
“It is fair to say that no one predicted
how these constitutional constraints
would impact state fiscal policy in the
current recession, nor is it clear how to
unravel this constitutional puzzle,”
Poulson notes. Poulson advocates a
budget stabilization fund linked to a
revenue limit. In good times, surplus
revenue could go to a rainy day account
and a portion to tax refunds and cuts.
He further suggests that constitutional
constraints on taxes and spending could
be nonbinding in recession years and
become binding again in good times.
Colorado’s experience could be
instructive to Fifth District states considering solutions to fiscal problems.
Properly constructed, there seems to
be some evidence that tax-and-spend
limits may check government growth.
But they are not a panacea.
RF

Summer 2003 • Region Focus

31

INTERVIEW

Kenneth
Rogoff
The International Monetary Fund (IMF) was founded
in 1945, along with its sister institution, the World
Bank, in an effort to stabilize the international economic order. In recent years, the IMF has come under
intense scrutiny from a wide range of sources. It has
been the target of anti-globalization activists, who have
taken to the streets to protest the organization’s policies, and of the Nobel Prize winning economist Joseph
Stiglitz, who has taken the IMF to task on a panoply of
issues in his book Globalization and Its Discontents.
In August 2001, Kenneth Rogoff took a two-year leave of
absence from Harvard University to become the chief
economist at the IMF. (He will rejoin the Harvard faculty
in the fall of 2003.) During his academic career and earlier
stints with the IMF and the Federal Reserve’s Board of
Governors, Rogoff established himself as an expert on
international finance, debt, and monetary issues. His
1985 article for the Quarterly Journal of Economics, “The
Optimal Degree of Commitment to an Intermediate
Monetary Target,” spawned a vast literature on central
bank design. And his textbook, Foundations of International Macroeconomics, co-authored with Maurice
Obstfeld, is widely used in graduate classes.
Rogoff is also an expert chess player, obtaining the lifetime title of International Grandmaster (the highest
rank awarded by the World Chess Federation) in 1978.
He retired from tournament competition at the age of
25 to focus on his economic research. Aaron Steelman
interviewed Rogoff at the IMF’s headquarters in
Washington, D.C., on April 15, 2003.
32

Region Focus • Summer 2003

RF: How does the IMF’s role differ from the
World Bank’s?
Rogoff: The two organizations are quite similar
in some ways. They are both, broadly speaking,
United Nations (U.N.) family institutions. But
they have different voting structures than the
U.N. Votes in the IMF and the World Bank are
loosely weighted by size of economic contribution to the global economy, so that the European
countries, Japan, and the United States have a
disproportionately large vote. The IMF and the
World Bank also have interlocking boards of
directors, so some people sit on both boards.
As for how they differ, the IMF is charged
with trying to promote global financial stability
and growth, while the World Bank directs its
efforts at alleviating poverty. The IMF provides
support to the World Bank in working toward
that goal, but that is not our primary mission.
Importantly, the IMF is only allowed to lend to
sovereigns, whereas the World Bank does not
face any such restriction. It is also worth noting
that the World Bank is also much larger in terms
of staff and budget than the IMF.
So what does it mean, in practice, to
“promote global financial stability”? Part of what
we do is constantly loan paid-in capital to emerging markets and developing countries. For
instance, in the 1990s we made some large loans
to South Korea, Thailand, and Indonesia, and
more recently we have loaned to Argentina,
Brazil, and Turkey. But there are also many
smaller loans out there. It’s not unusual for us
to have so-called “programs” going in 30 or 40
countries at one time. The important issue we
look at in assessing the size and structure of a
program is whether an individual country’s problems might pose systemic risks to the global
financial system.
Such lending is the headline activity of the
IMF, but there is also another big element to
what the IMF does. We provide a forum for
countries to meet and provide information—both
formally and informally—to one another. This
allows policymakers to exchange ideas about best
practices during noncrisis periods. In fact, many
of our staff papers deal not with crisis issues but
instead with more general macroeconomic issues.
Finally, of course, every member country must
submit themselves to bilateral review of their economic policies every year or two.

RF: When you came to the IMF,
were there certain economic issues
that you thought should be the focus
of your department’s research?

So what does it
mean, in practice,

Summer 2003 • Region Focus

SCOTT SUCHMAN

Rogoff: I think it’s very important,
when coming to a job like this, to have
to “promote global
an open mind and to realize that some
of the best ideas come from the
financial stability”?
bottom up. You have to really listen
to people and to give people room to
Part of what we do
be creative. But, yes, there are some
specific issues that I wanted us to
is constantly loan
work on, such as exchange rates for
developing countries. Before I came
paid-in capital to
to the IMF, I had done a lot of work
on industrialized countries but I had
emerging markets
never really worked on low-income
countries, and it quickly became
and developing
apparent that they have many interesting special problems. For instance,
countries.
the amounts of international aid going
to poor countries are very large as a
percentage of their overall budgets—
we’re sometimes talking 10 or 20
percent. How do you manage this macroeconomically? Also, consider Africa. Many of those
empirical, policy bent than you would see at a unicountries are subject to huge commodity price
versity seminar series.
shocks. How do you conduct monetary policy
when your main export—which produces, say, 80
RF: The IMF has been attacked from all sides:
percent of your country’s income—can vary up or
from the left for pushing “neo-liberal” policies
down by more than 40 percent? These are very
in developing countries, and from the right for
interesting questions that just never would have
creating moral hazard problems as a result of its
occurred to me if I hadn’t come here.
lending. How would you respond to such critics?
We are also interested, of course, in the international financial architecture and all that entails:
Rogoff: The most important thing for us to do,
capital controls, the international bankruptcy
and it’s the honest truth, is not to respond to the
court, and other issues. And I’m very interested
critics but to listen to them. Indeed, broadly
in new open-economy macroeconomics, an interspeaking, the IMF and the World Bank are quite
est that grows out of my work with Maury Obstreceptive to criticism and have made some serious
feld. When I came here, the Fund had a model
changes over time. In 1980, for instance, the
that was, I think, very effective at looking at what
World Bank was not in favor of free trade. Simioccurs if there is an oil or global productivity
larly, the IMF was much more Keynesian 25 years
shock. But the model was 20 or 25 years old, so I
ago than it is today. It’s not easy for these instiwanted to replace it with a newer model, and we
tutions to move quickly—you need to achieve conhave made a lot of progress in that direction. I
sensus among a large number of board members,
must say, though, that much of what we have been
some of which represent a large number of counable to accomplish is because other places—such
tries—but the critics have made a difference.
as the European Central Bank and the Federal
The second thing that I want to say is that
Reserve Bank of New York—have been refining
almost everyone in academia has some criticisms
their own models. Not surprisingly, I would say
of the World Bank and the IMF. I sure did. I
that most of the work we do has more of an
33

wrote some of the first papers on moral hazard
and IMF lending in the late 1980s with Jeremy
Bulow. We took a fairly cynical view of the whole
process. I also wrote a paper with Maury Obstfeld called “The Mirage of Fixed Exchange Rates”
that said it was a disaster to support fixed
exchange rates, which was conventional wisdom
at the time. This view, which has now by and large
become the conventional one, is an example of
why one has to resist always trying to come down
somewhere in the middle on debates, which is a
natural tendency in an institution like this.
RF: It’s pretty surprising that 25 years ago free
trade would have been a controversial idea at
the World Bank or IMF, since liberal trade policies were so widely accepted by the profession
as a whole.
Rogoff: You have to understand that the institutions are governed by their member states. A lot
of countries will say that if you look at the history
of the industrialized world, many countries have
had protectionist policies. Even today, the United
States and the European Union
remain quite protectionist in some
areas, albeit far less than most
developing countries. I think that
is very unfortunate. It strengthens
In the 1990s,
the hand of protectionists in
developing countries who say,
certainly, I think
“Look—today’s rich countries got
that way by using protectionist
countries looked
policies. Why are you so sure that
we should reduce our trade barriat the financial
ers? Shouldn’t we protect our
infant industries?” So, the free
liberalization
trade position, which economists
will say is obviously correct, will
of the United
not be so obvious to some of the
people from our member states.
States and asked
This is a good example where the
middle ground was not right. Free
how they could
trade was, in many ways, the
radical position 25 years ago, even
follow that type
though it was right. And I think
that some of the people who still
of framework.
remain skeptical of liberal trade
policies are coming to the realization that globalization is something that you can’t really stop.
RF: Your open letter to Joe Stiglitz drew a lot
of attention from economists, but may not be
as familiar to others. Could you briefly
describe what you had to say in response to
the criticisms he has made of the IMF?
34

Region Focus • Summer 2003

Rogoff: I think that it’s a very passionate and
angry book, which is part of its effectiveness. It
is directed at a broad audience and it clearly hits
a chord with many people. Certainly if you asked
professional economists if they agreed with some
of the arguments in the book, they would say yes.
It covers a laundry list of problems with the IMF,
from the left, from the center, from the right,
from outer space. And as Jagdish Bhagwati said
in his review, if you launch enough missiles, you’re
bound to hit some targets. In that regard, I would
highlight the issue of premature financial liberalization being something that one wants to be very
wary about. I certainly agree with Joe on that,
though I also think that if Asian countries had
genuinely flexible exchange rates in the 1990s, we
might have only seen a mini-Asian crisis instead
of a full-blown one. And Stiglitz’s book agrees with
the general proposition of having an international
bankruptcy court, an idea the IMF has advanced
over the past couple of years.
But there are some areas where I think he takes
very odd positions. For example, let’s say you have
a country in a severe debt crisis that has been cut
off by its lenders. Should the IMF criticize the
country for not engaging in countercyclical fiscal
policy? Or if a country’s exchange rate is under
attack, I don’t think it should respond to it by
printing more money.
In general, I have trouble summarizing my take
on the book, because it draws in everything
anyone has ever written. But, at the end of the
day, when you set aside the personal attacks on
the competence, intelligence, and moral character of the IMF staff, there are clearly some welltaken points in the book.
RF: The IMF gets a lot of attention for its
efforts to help prevent and deal with crises. But
there are some very important issues that can’t
be characterized as crises, but which still probably lower the standards of living of millions of
people—such as Europe’s rigid labor market
policies. What sort of counsel can you provide
to member countries on these types of issues?
Rogoff: We have an analytical piece on that very
topic in the April 2003 issue of World Economic
Outlook. We ask what are the costs to Europe
because of its labor market institutions— and what
would be the gains if those institutions were
brought to U.S. levels? We use two different models
to look at those issues. We come up with estimates
that Euro-area unemployment would fall about 3
percent and output would be 10 percent higher if
those institutions were brought to U.S. levels. That
doesn’t prove that they should make these changes,

because there are transition costs and allocative
issues, not to mention some noneconomic concerns that might affect Europe’s decisions.
We can present our analysis and try to create
a dialogue, but it’s really hard to do much more
than that. We don’t have much traction with
developed countries on these types of issues. It’s
also important to note that countries do look at
each other and notice when certain countries are
growing and they ask what it is that they are doing
correctly. That doesn’t mean that they will change
their policies overnight. But it can have an effect.
In the 1990s, certainly, I think countries looked
at the financial liberalization of the United States
and asked how they could follow that type of
framework. And they were much more affected
by this than by anything that the IMF might have
told them about the issue.
RF: What do you think are the prospects for
economic liberalization in the Middle East?

RF: In the 1980s, Japan was the envy of the rest
of the world. What has happened to its
economy?
Rogoff: Japan has a lot of banks that are not
fully functional, because they have a great deal

RF: Are there certain skills that you
acquired playing chess that have
helped you as an economist?
Rogoff: It’s hard to say. When I was
an academic I did a number of papers
that involved game theory. I find that
game theory comes very naturally to
me, whereas algebra is something I can
do, but I wouldn’t describe myself as
very facile with it. So I definitely think there is
some connection between my chess career and
my ability with game theory. Also, it’s certainly
true that, in my current position working on
policy issues, I find myself drawing on chess analogies. That’s because, in chess, there is seldom a
“right” answer. You very much need to consider
what the other person is thinking. You’re not just
objectively looking at the board— you are trying
to understand the other person. And in a policy
environment, when you’re discussing a problem
or negotiating a program, you are doing much the
same thing.
RF

Summer 2003 • Region Focus

SCOTT SUCHMAN

Rogoff: Growth in the Middle East has been very,
very poor. Per capita GDP over the past 20 years
in the Middle East region as a whole has fallen by
1.6 percent a year. It has been the worst performing region in the world—and this includes the oil
countries. There’s another chapter in the World
Economic Outlook that looks at how much higher
growth could be in the Middle East if institutions—here we are talking about corruption, political rights, and other related issues—were brought
into line with the world average, forget about the
industrialized average. It concludes that the Middle
East could see gigantic income changes.
The Middle Eastern countries have very large
public sectors with very large budget deficits. They
have very shallow banking systems. And they have
very serious issues with corruption. These are fundamental problems that need to be addressed.
There is a role for regulation and for government intervention in certain areas, but most countries don’t have the balance right. They have too
much state involvement and state control. The
Middle East is a region where this is particularly
problematic. That said, we believe that such governance issues have to be decided by the people
of these countries themselves. All we can really
do is provide technical analysis and demonstrate
that their economies are performing very poorly.

invested in real estate and equities. And, as we
know from Ben Bernanke’s work on the 1930s,
when the banking system goes awry, it’s very hard
to get it back into shape. Many corporations are being supported by
banks which are themselves insolvent.
Kenneth Rogoff
Banks are keeping these corporations
➤ Present Position
afloat when, in fact, they should be
Economic Counsellor and Director of
folded. Also, Japan’s weak social safety
the Research Department, International
net doesn’t give them the ability to
Monetary Fund
absorb changes as well as the United
States can. Eventually, they will need
➤ Previous Positions
very deep restructuring of their
Faculty appointments at Harvard
banking system. It’s going to be
University and Princeton University;
painful, but until they do that, they
Economist, International Monetary Fund;
will not have growth.
Economist, Board of Governors of the
Another big problem is deflation,
Federal Reserve System
which is aggravating the problems that
➤ Education
the banks have. I think the Bank of
B.A., Yale University (1975); Ph.D.,
Japan should end deflation, and I think
Massachusetts Institute of Technology
that it would be very straightforward
(1980)
to do it—they need to be more aggressive with their monetary policy. Even
➤ Selected Publications
if they ended deflation, I recognize that
Co-author, Foundations of International
they would still have many problems.
Macroeconomics (Cambridge, Mass.: MIT
But it still would be a big step forward.
Press, 1996); author or co-author of
Japan also has dire fiscal problems,
numerous scholarly articles in such pubin part because they have run deficits
lications as the American Economic
in an effort to try to jumpstart the
Review, Journal of Political Economy,
economy. And, moreover, they have an
Quarterly Journal of Economics, Journal
even more urgent aging problem than
of Monetary Economics, and Journal of
does the United States; Japan’s labor
International Economics
force is already falling.

35

ECONOMICHISTORY

Roads to Riches
How Stock Car
Racing Became a
Huge Sport—
and Business

B

INTERNATIONAL MOTORSPORTS HALL OF FAME

BY AARON STEELMAN

aseball is America’s national
pastime. But stock car racing is
its fastest-growing sport, with 10
million fans attending live races across
the country each year, and another 250
million watching them on television. It
wasn’t that long ago, however, that stock
car racing was a relatively small sport
centered in the Southeast.
According to oral histories of the
sport, the first stock car race took place
in a cow pasture in Stockbridge, Ga.,
in the mid-1930s. Several moonshiners
were debating who had the fastest car
and who was the best driver. They
decided to settle it by racing around a
quarter-mile dirt track in the middle of
a farmer’s field.

NASCAR’s Roots

Early NASCAR races were held at small
tracks throughout the Southeast prior to
the construction of the super speedways at
Daytona Beach, Fla., and Talladega, Ala.

36

more power for their frequent getaways
from the police on the windy back
roads of the South.
It wasn’t long before farmers realized that there was money to be made
from charging admission to stock car
races. They fenced off their pastures
and put up gates. “The drivers’ payout
continued to climb, too, and eventually the cash prize at the checkered flag
was worth as much as running moonshine from Wilkes County [N.C.] to
Charlotte,” writes Robert Hagstrom in
The NASCAR Way: The Business That
Drives the Sport.
Probably the most famous bootlegger to ever race stock cars was Robert
“Junior” Johnson. He ran whiskey for
his father, Glenn Johnson, who had a
successful moonshine operation in
western North Carolina. Johnson
would go on to win 50 races on the
Winston Cup series sponsored by the
National Association for Stock Car
Auto Racing (NASCAR).

Region Focus • Summer 2003

That first race drew a modest
crowd, but word quickly spread. Soon
hundreds of people began to attend
similar races featuring the best drivers
in the area, many of them moonshiners. Producing and distributing moonshine was illegal, of course. Those who
delivered it from the stills to the customers were wary of being caught by
the police — or “revenuers,” as moonshiners called them. So these drivers
souped up their cars to gain a little

Moonshiners from Appalachia were the
early stars of stock car racing. But the
sport may have remained stuck on the
dirt tracks of the rural South if it hadn’t
been for Bill France, known to most as
“Big Bill.” France was an auto mechanic
and part-time stock car driver in Maryland who, in the mid-1930s, moved to
Daytona Beach, Fla. Daytona was
already well known to racing fans. Its
long, hard-packed beaches made it a
good location for drivers to try to set
new land speed records. Each year,
racers from around the world flocked
to Daytona to try to post faster speeds
— and hopefully to break the 300
miles-per-hour mark, long seen as the

need to be assured that they weren’t
laying their lives on the line for
nothing. So NASCAR decided to guarantee the purses at all events it sponsored. This meant that racetrack
owners would have to put down a
deposit with NASCAR before the race
would be held. Also, in order to assure
sustained interest in the sport over the
course of the year, NASCAR established a points system. Drivers would
accumulate points at each race,
depending on how they fared, and at
the end of the year, a national champion would be crowned.
In its first year, NASCAR sanctioned three different divisions,
depending on the make and models of
the cars: Strictly Stock, Modified
Stock, and Roadsters. Strictly Stock
cars had to be full-size American cars
with standard hoods, fenders, bumpers,
and grilles. In other words, they would
be the types of cars that average people
drove on a daily basis — except they
would be equipped with fantastically
powerful engines. Today, NASCAR
sponsors a dozen series, including
several regional stock car series and the
Craftsman Truck Series. But the two
most popular, by far, are the Winston
Cup Series, where you will find the
best-known racers competing, and the
Busch Series, which features up-andcoming drivers. The Busch Series is to

INTERNATIONAL MOTORSPORTS HALL OF FAME

holy grail of the sport. But strong winds
prevented drivers from hitting this
mark, and by 1936, many drivers had
decided to take their cars to the Bonneville Salt Flats of Utah instead.
France, who had set up a service
station shortly after arriving in Florida,
realized that there was a void to be
filled. Many people still wanted to see
racing in Daytona, and the local business depended on the tourists coming
to town each year. So he organized and
promoted beach races in Daytona in
the late 1930s. Those races were successful and France started setting his
sights higher. He wanted to establish a
racing series, with events throughout
the Southeast. The problem was
money. He needed a sponsoring organization to get things off the ground, so
he helped form the National Championship Stock Car Circuit (NCSCC)
and later the unfortunately named
Stock Car Auto Racing Society
(SCARS). Both organizations were
short-lived. But they gave birth to
NASCAR in late 1947.
The organizers of NASCAR realized that their sport was plagued by
some shady businesspeople. For
instance, racetrack owners would often
overstate the sizes of the purses or not
pay them at all. This left the sport in a
precarious position. If stock car racing
was going to succeed, drivers would

“Big Bill” France was the guiding force
behind the creation of NASCAR.

the Winston Cup what Triple-A baseball is to the major leagues. Typically, a
Busch Series race will be run on a Saturday and a Winston Cup race the following Sunday.

The Super Speedways
Even after NASCAR was founded,
many of the races were still run on dirt
tracks. Those tracks, to be sure, were
in better shape than the cow pasture in
Stockbridge, Ga., where stock car racing
began. But they were a long way from
what we think of as modern, professional raceways. In 1949, Harold Brasington went to Indianapolis to watch
the Indianapolis 500. He wondered why

NASCAR 2003 Winston Cup Series
Feb. 8* ............................................Bud Shootout (FL) †
Feb. 13 ............................................Gatorade 125’s (FL) †
Feb. 16 ............................................DAYTONA 500 (FL)
Feb. 23....................North Carolina Speedway (NC)
Mar. 2.................Las Vegas Motor Speedway (NV)
Mar. 9......................Atlanta Motor Speedway (GA)
Mar. 16.................................Darlington Raceway (SC)
Mar. 23......................Bristol Motor Speedway (TN)
Mar. 30 ........................Texas Motor Speedway (TX)
April 6 .....................Talladega Superspeedway (AL)
April 13..........................Martinsville Speedway (VA)
April 27.............................California Speedway (CA)
May 3* .......................Richmond Int’l Raceway (VA)
May 17*...........................................The Winston (NC)†
May 25* ...................Lowe’s Motor Speedway (NC)

June 1 ...............................Dover Int’l Speedway (DE)
June 8 .......................................Pocono Raceway (NY)
June 15.......................Michigan Int’l Speedway (MI)
June 22....................................Infineon Raceway (CA)
July 5*..........................Daytona Int’l Speedway (FL)
July 13..............................Chicagoland Speedway (IL)
July 20.......New Hampshire Int’l Speedway (NH)
July 27.......................................Pocono Raceway (NY)
Aug. 3..............Indianapolis Motor Speedway (IN)
Aug. 10................Watkins Glen International (NY)
Aug. 17.......................Michigan Int’l Speedway (MI)
Aug. 23*....................Bristol Motor Speedway (TN)
Aug. 31.................................Darlington Raceway (SC)
Sept. 6* .....................Richmond Int’l Raceway (VA)
Sept. 14 .....New Hampshire Int’l Speedway (NH)

Sept. 21............................Dover Int’l Speedway (DE)
Sept. 28...................Talladega Superspeedway (AL)
Oct. 5........................................Kansas Speedway (KS)
Oct. 11*.....................Lowe’s Motor Speedway (NC)
Oct. 19...........................Martinsville Speedway (VA)
Oct. 26 ...................Atlanta Motor Speedway (GA)
Nov. 2..............................Phoenix Int’l Raceway (AZ)
Nov. 9 ....................North Carolina Speedway (NC)
Nov. 16..............Homestead-Miami Speedway (FL)
*Night race
†Nonchampionship point events
Schedule is tentative and subject to change;
visit www.nascar.com for updates.
SOURCE: Richmond International Raceway

Summer 2003 • Region Focus

37

a 500-mile race was possible for openwheel cars, but not for stock cars, and
could think of no compelling reason. So
he decided to build a paved, 1.25 mile
oval track with grandstands that would
seat 9,000. The location would be his
hometown of Darlington, S.C. This
seemed improbable for two reasons.
First, a paved — and, at that time, long
— track seemed unnecessarily extravagant. Second, Darlington was a tiny
town. But with the help of investors and
Big Bill France, Brasington completed
construction of the track in the summer
of 1950. That Labor Day, the first
Southern 500 was run.

NASCAR PUBLIC RELATIONS

INTERNATIONAL MOTORSPORTS HALL OF FAME

Robert “Junior” Johnson
(left) ran moonshine in
North Carolina before
becoming one of the early
stars of NASCAR.
California native Jeff
Gordon (above) has won the
Winston Cup championship
four times since 1995.

Few people really thought that
9,000 people would show up for the
inaugural race at Darlington. If half
that many came, Brasington thought it
would be a success. But the event
proved more popular than anyone had
imagined. On race day, roughly 25,000
people came to Darlington. Since the
grandstands could hold only about a
third of the crowd, the organizers
started selling seats on the infield area.
It was, in many ways, a logistical mess
for Brasington. But one that he was
certainly willing to handle. It also
showed France the potential of stock
38

Region Focus • Summer 2003

car racing. He started to think of ways
to tap into the sport’s growing popularity. One idea: the super speedway.
To turn this idea into reality, France
returned home to Daytona. He secured
financing for a 2.5 mile track. This was
the same lap distance as drivers ran at
the Indianapolis 500, an event that
France hoped his Daytona race would
eventually rival. “The shape of the
Daytona course, though, differed from
Indy or anyplace else. It was a tri-oval,
conceived by France to allow for an
unobstructed view of the track from
the grandstands,” writes Joe Menzer in
The Wildest Ride: A History of NASCAR.
“The track was banked at a stunning
thirty-one degrees in its top big turns,
and at eighteen degrees in the apex of
the swift dogleg that would run past
the grandstands. Asked why the degree
of the bank was set at thirty-one
degrees, France replied simply, ‘Because
they couldn’t lay the asphalt any
steeper.’ There was no place else like it
in the entire world of racing.”
The track struck awe in the drivers.
Here finally was a track where they
could see what their cars could do.
NASCAR drivers had not been able to
break the 140 miles-per-hour mark. But
at the initial Daytona 500, run on Feb.
22, 1959, the average speed of the winner,
Lee Petty, was over 135 miles per hour.
The track also struck fear in the
drivers. In fact, as Petty would later
remark about the first Daytona 500,
“There wasn’t a man there who wasn’t
scared to death of it.” Petty himself
would be involved in a horrible accident at Daytona just a few years later.
His car flew 150 feet into the air, soared
over the guardrail, and landed in the
parking lot. He suffered a crushed
chest cavity, a broken collarbone, and
a broken leg. Petty, the winner of 54
races from 1949 to 1960, more than any
other driver during that period, would
race only six more times before retiring. His son, Richard, though, would
become perhaps the best and most
famous of all NASCAR drivers.
Daytona was great for spectators.
With a parking lot that could hold
35,000 cars, grandstands that could seat

18,800, portable bleachers that could
accommodate 6,500 more, and an
enormous infield that could house
75,000 fans, Daytona was not just a
race, it was an event.
Ten years after building the track at
Daytona, France would construct what,
in some ways, was an even more
impressive course at Talladega, Ala. At
2.66 miles long and a lane wider than
Daytona, Talladega became the fastest
speedway, with drivers eventually
posting speeds over 200 miles per hour.
Still, the Daytona 500 remained the
signature event on the NASCAR
circuit. When network television finally
broadcast its first stock car race in 1979,
it was from Daytona. To many, this may
have seemed only a trifling advance for
the sport. But it was much more. Cable
television, which in 1979 was only in its
infancy, would bring stock car racing
into the homes of millions of Americans, dramatically boosting the popularity and profitability of the sport.

The Business of NASCAR
Unlike most team sports, there is no
amateur draft in NASCAR. Nor do you
have to finish in the top 125 on the
money list to keep your playing exemption, as you do in golf. In NASCAR, if
you can convince someone that you are
good enough to race competitively and
to pay for your team of mechanics and
crew chiefs, you are ready to go. A
company may have three or four teams.
For example, in 1996, Hendrick Motorsports had teams for three drivers: Jeff
Gordon, Terry Labonte, and Ricky
Craven. Each of Hendrick’s teams cost
about $7.5 million to operate that year.
Another $7.5 million went into joint
efforts, such as car development. How
does Hendrick pay for this? Far and
away the biggest source of income
comes from corporate sponsors who
pay to advertise on a team’s car and uniforms. About 55 percent of Hendrick’s
revenues in 1996 came from sponsorships. That year, the top sponsors were
DuPont, Kellogg’s, and AnheuserBusch. Roughly 10 to 15 percent came
from race winnings (which are split
50/50 between the driver and the

INTERNATIONAL MOTORSPORTS HALL OF FAME

Richard Petty, known to many fans as simply “The King,” is arguably the greatest
NASCAR driver of all time, having won 200 races, including seven at the Daytona 500.

organization), 10 percent from the sales
of collectibles, 10 percent from
research projects sponsored by General
Motors, and 10 percent from leasing
engines to other drivers.
Why are sponsors willing to put up
so much money to sponsor a NASCAR
team? According to Rubbermaid, which
sponsors Kurt Busch’s No. 97 car, the
answer is a high degree of brand loyalty
combined with ideal demographics.
More than 75 percent of NASCAR fans
are in the 18-to-54 age bracket and,
according to Rubbermaid, about 40
percent will switch to a product if it
becomes a NASCAR sponsor.
“Since birth, NASCAR has understood how expensive it is to participate
in stock car racing. Whereas baseball,
football, and basketball all started with
a fairly low operating base, which
allowed owners to make a decent profit
on their investment, the sport of stock
car racing began with a substantial
financial burden,” writes Hagstrom. “In
order to survive, the sport had to
master the sponsorship relationship.
Today’s fans know how important the
sponsors are; so do the drivers.”
Team owners also understand that
it pays to take advantage of economies
of scale. That’s why many sponsor multiple teams. Consider Hendrick Motorsports. Rick Hendrick, the company’s

president, owned car dealerships
throughout the South before entering
the world of NASCAR in 1984. At first,
Hendrick had just one driver: Geoff
Bodine. Later, Tim Richmond, Darrell
Waltrip, and Ken Schrader entered the
fold. All those drivers eventually left —
Richmond died and Bodine, Waltrip,
and Schrader went on to other companies — but the business advantage
of running more than one team had
become clear to Hendrick. So he
quickly recruited new drivers to his
company. “I related racing to the automobile business,” Hendrick told Stock
Car Racing. With his car dealerships,
Hendrick had learned that by “being
able to share information we were more
successful. I could think of no reason
why the same theory wouldn’t work in
NASCAR.” Since Gordon signed with
Hendrick, he has won four Winston
Cup championships and is now mentioned in the same breath with such
all-time greats as Richard Petty and the
late Dale Earnhardt.

The Framework for Success
A few years after Big Bill France organized NASCAR, he founded Bill France
Racing Inc. It was this company that
officially owned the track at Daytona —
and which now goes by the name of the
International Speedway Corporation

(ISC). The two organizations —
NASCAR and ISC — are often thought
of synonymously, mainly because they
are both still run by the France family.
But according to Doug Fritz, president
of the Richmond International Raceway,
it’s important to distinguish between the
two. NASCAR, Fritz says, is the sanctioning body for the sport. In other
words, it is a league office, much like the
one headed by David Stern of the
National Basketball Association or Paul
Tagliabue of the National Football
League. ISC, on the other hand, is a
publicly held company that owns 12
major racetracks — including Fritz’s
track in Richmond — and promotes
more than 100 events each year.
Over time, ISC has branched out
from the Southeast and built tracks in
once-unlikely places such as San
Bernardino County, Calif., Phoenix,
Ariz., and Kansas City, Kan. In addition, Tony Stewart, the 2002 Winston
Cup champion, is a native of Indiana.
And Gordon, arguably the sport’s
biggest star, also hails from outside the
Southeast; he was born in California.
Stock car racing, according to one
author, has gone “From Moonshine to
Madison Avenue.” And while long-time
fans and employees of the sport may
think that statement is a bit hyperbolic,
there is some truth to it. Certainly, the
sport has come a long way since that
first race in a Georgia pasture.
RF
READINGS
Golenbock, Peter. American Zoom: Stock Car Racing
From the Dirt Tracks to Daytona. New York:
Macmillan, 1994.
Hagstrom, Robert G. The NASCAR Way: The
Business That Drives the Sport. New York: John Wiley
& Sons Inc., 1998.
Howell, Mark D. From Moonshine to Madison Avenue:
A Cultural History of the NASCAR Winston Cup
Series. Bowling Green, Ohio: Bowling Green State
University Popular Press, 1997.
Menzer, Joe. The Wildest Ride: A History of NASCAR
(or How a Bunch of Good Ol’ Boys Built a BillionDollar Industry out of Wrecking Cars). New York:
Simon & Schuster, 2001.
Visit www.rich.frb.org/pubs/regionfocus for
links to relevant Web sites.

Summer 2003 • Region Focus

39

District Economic D
BY ROBERT LACY

Fifth District economic growth was
modest in the first
quarter of 2003 as
consumers and businesses adopted a
“wait and see” posture toward spending in light of political and military
developments in
Iraq. Employment
levels were little
changed from a year
ago, although unemployment rates did
inch lower. With the
Iraq war over, Fifth
District businesses
expect economic
conditions to
improve, but few
anticipate a quick
turnaround.

Did You Know. . .
Most people who
work in the District
of Columbia don’t
live there. They reside
in Maryland or across
the Potomac River
in Virginia instead.
According to the
2000 Census, 279,000
people who worked in
D.C. claimed residence
in Maryland, and
another 191,000
claimed residence
in Virginia. Two
Maryland counties —
Prince George’s and
Montgomery — were
home to one out of
three D.C. workers.
40

Economic growth in the Federal Reserve’s
Fifth District was modest in the first quarter
of 2003. Consumers tightened purse strings
amidst a host of worries: war in Iraq, threats
of domestic terrorism, and continued job
layoffs in manufacturing. Many businesses hunkered down as well, opting to delay capital
spending and new hiring in the face of considerable economic uncertainty.

The path of manufacturing was less direct.
District manufacturers appeared to be
rebounding early in the first quarter of 2003
— both shipments and new orders surged in
January. But shipments flattened in February
and March, and new orders began to tumble.
Manufacturing employment also fell — once
again. Five percent of manufacturing jobs in
the Carolinas were lost in the last year alone.

Subpar Economic Growth

Mixed Signals in Labor Markets

District retail and services businesses we
survey reported sluggish business conditions
in most sectors during the first quarter of
2003. Activity was particularly weak in February, partly as a result of unusually severe ice
and snow storms in the region. But the economic uncertainty stemming from political
and military developments in Iraq and the
threat of domestic terrorism also dampened
growth throughout the quarter.
District retailers tell us their revenues continued to slip and that employment edged
down in recent months, and their comments
are borne out by the data. According to the
Bureau of Labor Statistics, retail employment
in Fifth District states in March was below the
level of four years earlier. And because of the
uncertainty associated with the conflict in
Iraq, the retail outlook was also cloudy. A men’s
clothing retailer in Charleston, W.Va., captured
the sentiment of a number of Fifth District
retailers in April, reporting “We’re stuck in the
mud until we get the war over. …”

The average unemployment rate in Fifth District states was 5.1 percent in the first quarter
of 2003, well below the national rate of 5.8
percent. What’s more, the regional rate has
drifted down since peaking at 5.5 percent in
the first half of 2002, indicating some
strengthening in the regional economy.
But the Labor Department reports that
payroll employment in the region was off 0.2
percent in the first quarter compared to a year
ago, suggesting weaker economic conditions.
Employment in government and some services industries — health care and education,
for example — expanded over the year. These
gains, however, were more than offset by
declines in the goods producing sector, particularly in manufacturing.
Such contrasting views of labor market conditions can be reconciled in part by recognizing that some workers may have become
discouraged about job prospects and left the
labor force. While the ranks of the unemployed have declined in the Fifth District over
the last year, one would like to see more job
growth before concluding that labor market
conditions have turned around.

Workers in Washington, D.C.
Where They Live

Virginia
28%

Maryland
42%

Other
2%

Region Focus • Summer 2003

DC
28%

Waiting for a Lift
The fall of Baghdad and the end of widespread
conflict in Iraq in April brought renewed hope
that economic growth would pick up again.
Fifth District manufacturers remain cautious,
however, reiterating that the manufacturing
sector was struggling before the war in Iraq and
was unlikely to rebound quickly with the end
of the conflict. As of May 2003, we were still
awaiting evidence of acceleration in growth.

c Developments
Nonfarm Employment

Unemployment Rate

Personal Income

First Quarter 2003

Percent

Fourth Quarter 2002

DC
MD
NC
SC
VA
WV
5th District
US

Employment
(Thousands)
666
2,471
3,830
1,803
3,482
734
12,986
130,596

% Change
(Year Ago)
0.7
-0.2
-0.5
0.2
-0.3
-0.1
-0.2
-0.1

1st Qtr.
2003
6.4
4.3
6.0
6.1
4.1
5.7
5.1
5.8

DC
MD
NC
SC
VA
WV
5th District
US

1st Qtr.
2002
6.5
4.5
6.9
6.0
4.3
5.7
5.5
5.6

Fifth District

DC
MD
NC
SC
VA
WV
5th District
US

Income
($ billions)
24.3
201.4
233.1
105.6
243.9
43.2
851.6
9,035.0

United States

Nonfarm Employment

Unemployment Rate

Personal Income

Change From Prior Year

First Quarter 1992 - First Quarter 2003

Change From Prior Year

First Quarter 1992 - First Quarter 2003

4%

8%

3%

7%

% Change
(Year Ago)
4.4
5.4
4.1
4.4
4.5
3.8
4.5
3.9

First Quarter 1992 - Fourth Quarter 2002

9%
8%
7%

2%

6%

6%

5%

1%
5%

4%

0

3%

4%

-1%

2%

-2%
1992

1994

1996

1998

2000

2002 2003

3%

1992

1994

1996

1998

2000

2002 2003

FRB—Richmond
Services Revenues Index

FRB—Richmond
Manufacturing Shipments Index

First Quarter 1994 - First Quarter 2003

First Quarter 1994 - First Quarter 2003

1%

1992

1994

1996

1998

2000

2002

Fifth District Employment
Selected Industries—Change From Prior Year
First Quarter 2000–First Quarter 2003

40

40

6%

30

30

4%

20

20

10

10

0

0

-10

-10

-20

-20

-4%

-30

-30

-6%

Health/Education Services

Leisure/Hospitality

2%
0

1994

1996

1998

2000

2002 2003

-2%

1994

1996

1998

2000

2002 2003

Professional/Business Services
2000

2001

2002

NOTES:

SOURCES:

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

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

2003

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

Summer 2003 • Region Focus

41

DISTRICT OF COLUMBIA

BY ANDREA HOLLAND

tructural changes within the U.S. economy in
recent decades made the existing economic classification system increasingly obsolete and necessitated
the development of a new system. In response, the
Standard Industrial Classification (SIC) system — in
place since 1941 — was replaced by the new North
American Industry Classification System (NAICS).
Payroll data for the District of Columbia were converted to NAICS in March 2003, with the release of
the January 2003 Current Employment Survey (CES).

S

DC Employment Composition by Sector
First Quarter 2003

Construction 2.0%
Manufacturing 0.5%
Natural Resources/Mining 0.0%
Trade/Transportation/
Utilities 4.5%
Information 3.8%
Government 38.2%
Financial
Activities 5.0%

The production-based NAICS data present a fresh
view of the District of Columbia’s work force. Jobs are
classified as either goods-producing or service-providing. In early 2003, 97.8 percent of all jobs in the District
of Columbia were grouped under service-providing and
only 2.2 percent were classified as goods-producing.
With its large share of service jobs, the District of
Columbia ranks first in its percentage of professional
and business services and information jobs in the Fifth
District. And as the nation’s capital, it also has the
largest portion of government jobs. On the flip side,
the District of Columbia hosts the Fifth District’s
smallest percentage of manufacturing, construction,
and natural resources and mining jobs.
Although aggregate payroll numbers remain roughly
unchanged under NAICS, a number of the District of
Columbia’s former goods-producing jobs have been
reclassified as service-providing. For example, the portion of manufacturing jobs shrank from 1.7 percent to
0.5 percent because printing and publishing jobs were
moved from manufacturing (goods-producing) to the
new information (service-providing) sector.
Because national job weakness has been centered in
manufacturing, the District of Columbia’s sparse
dependence on goods-producing jobs enabled it to
weather the current recession better than other Fifth
District states. In fact, since the recession began in the
first quarter of 2001, the aggregate employment level
has steadily increased. Most recently, first-quarter payrolls in the District of Columbia were 1.8 percent
higher than in late 2002, and the unemployment rate
dropped off 0.1 percentage points.
News also remained generally favorable in the District
of Columbia’s residential real estate markets. New
building permit activity was particularly strong in the
first quarter — fueled in part by favorable interest
rates and strong wage and salary growth.
42

Region Focus • Summer 2003

Professional/
Business Services
23.0%
Leisure/
Hospitality
8.0%

Education/Health
Services 15.0%

SOURCES:
Bureau of Labor Statistics/Haver Analytics
Personal Income, U.S. Department of Commerce, Bureau of Economic Analysis/Haver Analytics

1st Qtr
2003

Nonfarm Employment
Manufacturing
Professional/Business Services
Construction
Civilian Labor Force
Home Sales

Unemployment Rate
Housing Permits

Percent Change
at Annual Rate From
4th Qtr
1st Qtr
2002
2002

666.0
2.8
139.9
12.0
304.2
13.7

1.8
-13.1
2.5
-36.7
2.8
-39.0

0.7
-11.6
0.9
12.8
-0.8
-2.8

1st Qtr
2003

4th Qtr
2002

1st Qtr
2002

6.4
619

6.5
394

6.5
54

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

Construction totals include natural resources and mining employment.

U

MARYL AND

BY ANDREA HOLLAND

MD Employment Composition by Sector
First Quarter 2003

Natural Resources/Mining 0.0%

Construction 7.0%
Manufacturing
6.6%
Trade/
Transportation/
Utilities
19.7%

Government 19.6%

Leisure/
Hospitality
8.8%

Information 2.2%

Education/Health
Services 14.3%
Professional/Business
Services 15.3%

Financial
Activities 6.4%

SOURCES:
Bureau of Labor Statistics/Haver Analytics
Personal Income, U.S. Department of Commerce, Bureau of Economic Analysis/Haver Analytics
Metro Area Office Vacancy Rates, CB Richard Ellis/Haver Analytics

1st Qtr
2003

Nonfarm Employment
2,471.3
Manufacturing
154.5
Professional/Business Services 360.9
Construction
165.7
Civilian Labor Force
2,929.1
Home Sales
132.3

Unemployment Rate
Housing Permits

Percent Change
at Annual Rate From
4th Qtr
1st Qtr
2002
2002

-0.1
0.4
-4.6
-14.8
4.0
14.5

-0.2
-3.7
-0.3
4.7
1.3
4.0

1st Qtr
2003

4th Qtr
2002

1st Qtr
2002

4.3
5,931

4.2
6,488

4.5
6,908

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

Construction totals include natural resources and mining employment.

fter 60 years of use, the Standard Industrial
Classification (SIC) system was recently replaced
by the new North American Industry Classification
System (NAICS). The movement to upgrade the SIC
system stemmed largely from increasing difficulty in
classifying new industries, a byproduct of the SIC system’s somewhat vague demand- and supply-side
approach to classification. In contrast, NAICS uses a
production-based concept of classification — an
establishment is assigned to an industry based on
“how” it produces or provides, not “what” it produces
or provides.

A

Maryland employment numbers were converted to
NAICS with the release of the January 2003 Current
Employment Survey (CES). The updated job numbers
show that Maryland is dominated by service-providers
— firms in the category accounted for over 87.2 percent of total employment in early 2003. Within
Maryland’s service-providing domain, trade, transportation, and utilities jobs account for the largest
portion of total employment, followed closely by government and professional and business services.
Maryland held the largest percentage of construction
jobs in the Fifth District under the SIC classification
system, and the state’s lead widened with the conversion
to NAICS. Construction’s share increased partly
because highway maintenance workers — grouped in
government under SIC — were moved into construction under NAICS. Maryland also ranks first in the
Fifth District in its portion of financial activities jobs;
this new sector encompasses most of the SIC finance,
insurance, and real estate sector and adds a smattering
of jobs formerly grouped under the SIC services, transportation, communications, and public utilities sectors.
The latest data point to continued weakness in
Maryland’s overall job numbers. The leisure and hospitality sector was especially hard hit, due, in part, to
adverse weather conditions early in the year. In line
with the slight contraction in payrolls, Maryland’s
unemployment rate inched up 0.1 percentage point to
reach 4.3 percent in early 2003.
But on a more positive note, total personal income grew
at a 5.7 percent annual rate in the fourth quarter, easily
outpacing the national and Fifth District growth rates.
Likewise, new home sales peaked at 132,300, up 4 percent over the year, and metropolitan area office vacancy
rates declined for the first time since early 2002.

Summer 2003 • Region Focus

43

hN O R T H

CAROLINA

BY ANDREA HOLLAND

he Standard Industrial Classification (SIC) system
was developed at a time when manufacturing
dominated the U.S. economy. Since then, changes in
the economy have diminished the role of manufacturing but boosted the significance of other industries. To
reflect these changes, the SIC system was replaced by
the North American Industry Classification System
(NAICS) in the late 1990s. Shortly afterward, the
Bureau of Labor Statistics (BLS) began the multiyear
task of integrating the new system across their statistical programs. North Carolina payroll employment
data were converted to NAICS in March 2003, with
the release of the January 2003 data.

T

The proportion of North Carolina service-providers
rose under NAICS while the share of goods-producers
lost ground. The majority of jobs transferred into the
service-providing domain came from the manufacturing sector — construction and natural resources and
mining payrolls remained relatively unchanged.
In contrast to SIC, NAICS uses a production-based
concept of industry classification. As a result, a number of manufacturing jobs not directly linked to production were extracted and redefined as service-providing “auxiliary establishments.” Auxiliary establishments provide management or support services to
other organizations within the same company. While
the SIC system grouped auxiliary establishments in
the same industry as the parent company, NAICS classifies them according to the services they provide. For
example, accounting divisions at North Carolina furniture manufacturers are no longer classified under
manufacturing. Instead, they now reside under financial activities, a service-providing sector.
With the shift to NAICS, manufacturers now employ
less than a fifth of North Carolina’s work force, and
payroll numbers in the sector continue to dwindle.
Factory payrolls declined 5.1 percent in early 2003,
marking the twentieth consecutive quarter of contraction. But aggregate payrolls edged only slightly lower
and the unemployment rate dropped sharply — jobs
added in trade, transportation, and utilities, professional and business services, leisure and hospitality,
and education and health services helped offset large
losses in the goods-producing industries.

44

Region Focus • Summer 2003

NC Employment Composition by Sector
First Quarter 2003

Natural Resources/Mining 0.2%
Construction 5.8%
Government 18.0%
Manufacturing
17.0%
Leisure/
Hospitality
9.0%
Trade/
Transportation/
Utilities
19.8%

Education/Health
Services 11.4%
Professional/Business
Services 11.4%

Information 2.1%
Financial
Activities 5.3%

SOURCE:
Bureau of Labor Statistics/Haver Analytics

1st Qtr
2003

Nonfarm Employment
3,829.8
Manufacturing
619.0
Professional/Business Services 417.3
Construction
213.0
Civilian Labor Force
4,157.8
Home Sales
257.1

Unemployment Rate
Housing Permits

Percent Change
at Annual Rate From
4th Qtr
1st Qtr
2002
2002

-0.1
-5.1
3.2
-7.6
0.2
10.8

-0.5
-5.8
1.0
-7.2
-0.8
3.4

1st Qtr
2003

4th Qtr
2002

1st Qtr
2002

6.0
17,122

6.6
20,963

6.9
18,858

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

SOUTH CAROLINA

o

BY ANDREA HOLLAND

SC Employment Composition by Sector
First Quarter 2003

Natural Resources/Mining 0.3%
Construction 6.3%
Government 19.2%
Manufacturing
16.2%

Leisure/
Hospitality
11.0%
Trade/
Transportation/
Utilities
20.0%

Education/Health
Services 10.1%
Professional/Business
Services 10.0%

Information 1.6%
Financial
Activities 5.2%

Nonfarm Employment
1,802.5
Manufacturing
281.7
Professional/Business Services 174.0
Construction
109.8
Civilian Labor Force
2,026.2
Home Sales
131.4

Unemployment Rate
Housing Permits

To address these concerns, the SIC system was
replaced by the North American Industry Classification System (NAICS) in 1997, and South Carolina payroll data were converted to the new system in March
2003. The updated employment data reveal that South
Carolina has the least diversified work force in the
Fifth District outside of North Carolina.
Manufacturing jobs account for the bulk of South
Carolina’s goods-producing domain. Although North
Carolina still ranks first in its share of factory employment, South Carolina has narrowed the gap with the
conversion to NAICS.

SOURCES:
Bureau of Labor Statistics/Haver Analytics
Personal Income, U.S. Department of Commerce, Bureau of Economic Analysis/Haver Analytics

1st Qtr
2003

he Standard Industrial Classification (SIC) system
was implemented in 1941 to help gauge economic
activity. It classified industries by either their production process or market group. A drawback to this
approach was that if two end products had similar production processes — but were sold in different market
groups — they could still end up being classified in different industries. Over the years, the introduction of
new technologies exacerbated this problem and
reduced the accuracy and usefulness of the SIC system
in tracking industry data — employment conditions in
particular.

T

Percent Change
at Annual Rate From
4th Qtr
1st Qtr
2002
2002

-3.6
-10.3
-19.7
-3.9
9.1
11.4

0.2
-3.9
-1.6
-1.1
3.6
10.5

1st Qtr
2003

4th Qtr
2002

1st Qtr
2002

6.1
8,439

6.2
6,711

6.0
8,136

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

The service-providing domain is also more concentrated by industry in South Carolina than in other
Fifth District jurisdictions. The state has the smallest
percentage of education and health services and information jobs. In contrast, the state has the largest percentage of leisure and hospitality jobs.
Aggregate payrolls in South Carolina were reduced by
over 16,000 in the first quarter of 2003 — the largest
drop in over a year. But not all of the economic news
was bad for South Carolina. Total personal income
grew at a 3.8 percent annual rate in the fourth quarter
of 2002, outpacing the growth rate nationally.
Likewise, new home sales rose 10.5 percent over the
year. And despite the significant drop in payroll numbers, the unemployment rate declined 0.1 percentage
points to reach 6.1 percent in early 2003. The disparity
between the two indicators of employment conditions
stem from the use of two different surveys to gauge
employment conditions — one asks establishments,
while the other tracks households.

Summer 2003 • Region Focus

45

uVIRGINIA
BY ANDREA HOLLAND

he Standard Industrial Classification (SIC) system, in use for more than 60 years, was gradually
phased-out beginning in 1997 and replaced with a new
classification scheme. The push for change stemmed
from the SIC system’s inability to portray significant
structural changes to the economy that have occurred
over time. Specifically, the system had difficulty in
classifying new, service-oriented industries. Replacing
SIC is the new North American Industry Classification System (NAICS), which uses a production-based
concept of classification—establishments are assigned
to an industry based on “how” they produce or provide
not “what” they produce or provide.

T

Virginia payroll numbers were converted to NAICS
beginning in March 2003. The updated figures show
that Virginia’s employment distribution is the most
diversified in the Fifth District. Job numbers are relatively balanced across most sectors, and Virginia ranks
at neither the top nor bottom in terms of employment
share by industry. The largest sectors in Virginia are
government and trade, transportation, and utilities.
Alternately, the natural resources and mining supersector employs the smallest proportion of Virginians.
A significant change under NAICS is the creation of
the new information sector. Although this category
currently accounts for only 3.1 percent of total
employment in Virginia, the number of information
jobs in the state nearly doubled in the 1990s, before
dropping off sharply in 2001. The new sector is a
fusion of industries, which under the SIC system were
spread across manufacturing, communications, business services, and amusement services. Recent data
suggest possible improvement at Virginia’s information establishments — payrolls were up 0.5 percent in
the first quarter, the first gain in two years.
But other data reveal that overall payroll conditions
were not as rosy in the first quarter. Aggregate employment in Virginia fell by 1.8 percent in early 2003 — the
largest quarterly decline recorded since late 2001. The
unemployment rate also rose 0.2 percentage points in
the first quarter of the year. But the fourth-quarter
personal income figure was 4.5 percent higher over the
year, matching wage and earnings growth for the Fifth
District as a whole. Consumers transferred some of
these earnings into the housing market — new home
sales reached a record level in early 2003 and were 3.7
percent above year-ago levels.

46

Region Focus • Summer 2003

VA Employment Composition by Sector
First Quarter 2003

Natural Resources/Mining 0.3% Construction 6.2%
Manufacturing
Government 19.3%
9.5%

Leisure/
Hospitality
9.3%

Trade/
Transportation/
Utilities
19.2%

Education/Health
Services 11.2%
Professional/Business
Services 16.4%

Information 3.0%
Financial
Activities 5.5%

SOURCES:
Bureau of Labor Statistics/Haver Analytics
Personal Income, U.S. Department of Commerce, Bureau of Economic Analysis/Haver Analytics

1st Qtr
2003

Nonfarm Employment
3,482.5
Manufacturing
313.4
Professional/Business Services 541.5
Construction
205.5
Civilian Labor Force
3,793.0
Home Sales
170.2

Unemployment Rate
Housing Permits

Percent Change
at Annual Rate From
4th Qtr
1st Qtr
2002
2002

-1.8
-7.2
-1.7
-7.8
6.0
8.4

-0.3
-3.3
-1.2
-4.3
1.7
3.7

1st Qtr
2003

4th Qtr
2002

1st Qtr
2002

4.1
13,278

3.9
14,262

4.3
14,341

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

WEST VIRGINIA

w

BY ANDREA HOLLAND

WV Employment Composition by Sector
First Quarter 2003

Natural Resources/Mining 3.4%
Construction 5.1%
Government 20.9%

Manufacturing
9.8%

Leisure/
Hospitality
9.5%

Trade/
Transportation/
Utilities
20.2%
Education/Health
Services 15.9%
Information 1.9%
Financial
Professional/Business Activities 4.6%
Services 8.7%
SOURCES:
Bureau of Labor Statistics/Haver Analytics
Personal Income, U.S. Department of Commerce, Bureau of Economic Analysis/Haver Analytics

Nonfarm Employment
Manufacturing
Professional/Business Services
Construction
Civilian Labor Force
Home Sales

Unemployment Rate
Housing Permits

1st Qtr
2003

Percent Change
at Annual Rate From
4th Qtr
1st Qtr
2002
2002

733.5
66.4
59.0
34.7
806.6
27.8

2.6
-6.9
12.1
22.7
6.4
-19.0

-0.1
-4.8
4.9
0.2
-0.9
-2.8

1st Qtr
2003

4th Qtr
2002

1st Qtr
2002

5.7
860

6.2
992

5.7
894

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

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

or over 60 years, the Standard Industrial Classification (SIC) system was the primary tool used to
determine the industry category of individual businesses. But changes in the economy over time diminished the SIC system’s ability to accurately portray the
structure of the U.S. work force — creating the need for
a new method of industry classification. Recognizing
these deficiencies, the federal government replaced the
SIC system with the North American Industry
Classification System (NAICS) in 1997. Shortly after,
the Bureau of Labor Statistics began the multiyear task
of converting their existing statistical programs to
NAICS, but it was not until March 2003 that state payroll data were converted to the new system.

F

The new payroll data show that West Virginia has the
smallest share of professional and business services
and financial activities jobs in the Fifth District. On
the flip side, the state has the largest percentage of
trade, transportation, and utilities employees and the
second-largest share of leisure and hospitality payrolls.
Under NAICS, some of West Virginia’s trade-related
employees were reclassified into the newly created
leisure and hospitality supersector. More specifically,
because NAICS uses a production based concept of
classification, eating and drinking places (formerly
under the SIC retail trade division) were relocated
under leisure and hospitality.
West Virginia also ranks first among Fifth District states
in its share of education and health services and natural
resources and mining employment. Under the NAICS
system, the mining and agriculture, forestry, and fishing
divisions were absorbed into the natural resources and
mining sector — a fusion of industries that profit from
extracting resources from the environment. Most recent
data show a moderate pickup at these establishments —
467 jobs were added in the first quarter, marking the first
quarterly expansion since late 2001.
Other measures suggest positive economic news for
the state. After contracting throughout 2002, the
aggregate employment level in West Virginia rose 2.6
percent in early 2003 and the jobless rate dropped 0.5
percentage points to 5.7 percent. Total personal income
grew at a 3.9 percent annual rate in the fourth quarter,
outpacing activity nationally. Downside risks were still
evident, though. Real estate conditions remained sluggish in West Virginia in the first quarter of the year;
new home sales dropped off and building permit
authorizations eased moderately.

Summer 2003 • Region Focus

47

OPINION
Don’t Bring Back the Draft
BY A A RO N ST E E L M A N

F

would join the military on his own and the wage he actually
or most of American history, the U.S. military has been
receives. “This implicit tax in kind should be added to the
populated by volunteers. During the two World Wars,
explicit taxes imposed on the rest of us to get the real cost of
the Korean War, and the Vietnam War, however, a draft
our Armed Forces,” explained economist Milton Friedman. By
was used. During the late 1960s, many people began to question
ignoring such costs, one could argue that “the construction of
the efficiency and fairness of conscription. Eventually, these
the Great Pyramid with slave labor was a cheap project.”
skeptics — including some prominent economists — persuaded
Conscripts also tend to serve fewer years than volunteers.
President Nixon to allow the draft to lapse. Since July 1, 1973,
Indeed, during the Vietnam War, most conscripts left the milthe United States has once again had a volunteer military.
itary once they were legally able. In contrast, most volunteers
But not everyone is convinced that this is a good idea. In
today sign on for more than one hitch. This results in signififact, following the terrorist attacks of Sept. 11, 2001, a growing
cantly lower training costs. What’s more, volunteers, on
number of people — from across the political spectrum —
average, enter the military with greater skills than conscripts,
have been calling for Washington to reinstate the draft. These
further reducing training costs.
supporters of conscription employ many arguments. But there
Also, by keeping the cost of labor artificially low, a draft
are three claims that stand out above the rest.
encourages the military to use enlisted men for tasks that could
First, an army of conscripts would be cheaper than an army
be done by machines. With conscription,
of volunteers. Charles Moskos, a sociolo“it pays to hoard labor, to use it wastefully,
gist at Northwestern University, and Paul
and to adopt capital-to-labor-ratios that
Glastris, editor of The Washington Monthly,
“One strength of the
are too low,” stated economist George
bluntly state, “Draftees would not have to
Hildebrand.
be offered the relatively high wages and
volunteer army lies in
The racial balance of the military is
benefits that it takes to lure voluntary
not,
in fact, skewed toward one particurecruits (an increasing number of whom
its compatibility with our
lar group. In a recent report opposing the
are married with families).”
heritage of individual
reinstatement of the draft, the DepartSecond, the volunteer army relies too
ment of Defense stated, “Today, black
much on the labor of the poor and minorifreedom; indeed, no other
recruits closely parallel their representaties, especially blacks, and a draft would
tion among the youth population.” What’s
help correct this inequity. Gail Buckley,
alternative is.”
more, blacks “tend to be concentrated in
author of American Patriots: The Story of
administrative and support jobs, not in
Blacks in the Military from the Revolution to
E C O N O M I S T J A M E S C. M I L L E R III
combat jobs.” Blacks account for 21
Desert Storm, writes, “The military may be
percent of the enlisted force, but make
all-volunteer, but … poorer whites and
up only 15 percent of combat troops.
minorities enlist. Why should those who
Finally, it’s hard to rebut the claim that young people are
can’t afford to go to college be the only young people who have
“soft” or don’t fully appreciate the importance of America’s
to go to war?”
military and traditions. Those are essentially value judgments.
Third, young people don’t appreciate the freedoms that
How much weight you give to them depends on your perthey enjoy as Americans, and if they were required to serve in
spective. But such claims must be balanced against another
the military, they might become less complacent. Stanley Kurtz,
important and widely held value: individual freedom. Most
a research fellow at the Hoover Institution at Stanford Unipeople would agree that the government should have a comversity, has summed up this sentiment nicely. After Pearl
pelling reason to force someone to do something he otherwise
Harbor, “America’s men simply took it for granted that they
wouldn’t. And it’s not clear, for the reasons stated above, that
would serve. In fact, they were eager to fight — to strike back
forcing people into military service is such a reason. Indeed,
for what had been done to America,” Kurtz writes. “But the
as Doug Bandow, author of Human Resources and Defense Mantruth is, many young people no longer share the eagerness of
power, has asked rhetorically: “Is a military healthier if it relies
the ‘greatest generation’ for battle.”
on those who desire to serve and succeed or if it is forced to
Let’s take these arguments in turn. It is true that the govinclude those who desire to escape at any price?”
ernment would not have to pay conscripts as much as volunAmerica’s experience with a volunteer military hasn’t been
teers. But this does not mean that a conscript army is “cheaper”
perfect, to be sure. But our country is safer and freer under
in any real sense. By drafting a soldier you are imposing a tax
such a system than under conscription.
RF
on him, equal to the difference between the wage at which he

48

Region Focus • Summer 2003

NEXTISSUE
No Vacancy?
The real estate market in the Fifth District was booming just
a few years ago. But some of the hottest spots have now
turned relatively cold. And a few that missed out on the
boom are experiencing rapid growth. What explains this
reversal of fortune? And what might the future hold?

Media Consolidation

Interview
A conversation with Mickey Levy, chief
economist at Bank of America.
Jargon Alert
Economists often argue that public policies
should be subjected to “cost-benefit analysis.”
An examination of what that means.

The Federal Communications Commission recently loosened
rules that restrict newspapers from owning television stations
in the same market. How will this change affect media
companies in the Fifth District? And will it silence important,
alternative voices?

Legislative Update
Federal lawmakers recently cut taxes on
dividends. How might this feature of the tax
bill affect the economy?

The Business of Trees

Research Spotlight
Allocating the commons: The case of parking
on public roads.

Many people think that only environmentalists value trees.
But a growing number of business people are showing that
this isn’t true. For instance, the Fifth District is home to many
privately owned and managed forests. Find out why.

Economic Education
The Federal Reserve System has an extensive economic
education program, designed to increase economic and financial
literacy among teachers, students, and the general public. We’ll
look at what the Richmond Fed does to achieve this goal.

The National Road
In the early 19th century, Congress earmarked funds for the
National Road, which linked Cumberland, Md., to Wheeling,
W.Va., and points west. The road opened Midwestern markets
to Eastern merchants and stimulated economic growth along
the route. It also provided a glimpse at how interstate highways
would alter the American landscape in the 20th century.

The Fall 2003 REGIONFOCUS will
be published in October.
Articles will also be available
online at www.rich.frb.org/
pubs/regionfocus.
To receive an e-mail notice
when each new issue of
REGIONFOCUS can be viewed
online, please contact
rich.regionfocus@rich.frb.org.

The Challenges of

Corporate
Governance
T

he strength of corporate governance arrangements in American
corporations became a subject of
hot debate in 2002 as accounting scandals
unfolded at several large firms. The attention received by the scandals and the legislative response —Congressional passage
of the Sarbanes-Oxley Act—may give the
impression that the American system of
corporate governance was fundamentally
flawed. Is that impression true?
In the Richmond Fed’s 2002 Annual
Report feature article, “Accounting for Corporate Behavior,” a senior Bank economist
looks at the debate in terms of the fundamental challenge in governance arrangements—a company’s need to align the
incentives of managers with those of widely
dispersed shareholders. He contends that
there are strong market forces that lead managers to adopt governance structures that
encourage investors’ trust. And, if those
forces fall short, government intervention
alone may not bring about dramatic changes
in corporate behavior.
The Annual Report also includes a message
from the president and first vice president,
in which they discuss the national and Fifth
District economies, and an overview of the
Bank’s 2002 financial activity.

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

The Bank’s 2002 Annual Report is available
free of charge by contacting:
Public Affairs
Federal Reserve Bank of Richmond
P.O. Box 27622
Richmond, VA 23261
Phone: 804-697-8109
E-mail: Research.Publications@rich.frb.org
Or by accessing the Bank’s Web site at
www.rich.frb.org/pubs/ar/2002

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