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WINTER 06 Cover.ps - 2/27/2006 9:41 AM

WINTER

2006

THE

FEDERAL

RESERVE

BANK

OF

RICHMOND

WINTER 06 Cover.ps - 2/27/2006 9:41 AM

VOLUME 10
NUMBER 1
WINTER 2006

COVER STORY
16

Family Portrait: Life is hard in one of just fine fortoughest
Portrait:ousing markets work Baltimore’s most peoneighborhoods. marketsJanice Walker, it’s home producing
ple. But certain But for in the Fifth District aren’t
An inside look at an inner city family reveals the difficulties poor people
homes and apartments that working families can afford
face on a daily basis and over several generations.

FEATURES

16
24

Film at 11: Amid mounting competition, broadcast TV stations
Film at 11: Amid mounting competition, broadcast TV stations
like WRAL-TV in Raleigh are committing to local news as their
like WRAL-TV in Raleigh are committing to local news as their
ticket to profitability – and durability
ticket to profitability —and durability

The hidden economy takes many forms – from challenges. But few
Yes, the local TV news business faces some big scrip currency inarural
Appalachia to walk shoveling still pay off.
broadcasters think quality canin Richmond, Va. — and it’s not always as
sinister as it sounds. But the size of the underground economy is as much
29
in debate as its meaning.

Currency Conundrum: Why are exchange rates out of sync with0
2
other financial indicators?
Sticky of research, including some conducted at the Richmond Fed,
A host Situation: Some prices are slow to change. Are they sticky
enough to affect monetary policy?
sheds light on the “exchange rate disconnect puzzle.”

Nobody doubts their existence, but many question their importance.
34
Some leading economists, including a widely cited Richmond Fed
The Sheepskin sharply divergent viewsdegree is importance of sticky
researcher, hold Dividend: A college about the still the best
prices and of financial success, but that’s not all
predictor their impact on the economy.
Even with rising tuitions, college remains a good deal — for reasons that
24
go beyond income.

The Dollar Dilemma: The falling dollar has made American
38
goods more attractive to consumers abroad, but not everyone
Bottleneck: What the Fifth District’s only oil refinery
is happy about the currency’s slide
explains about high gas prices in thefor many Fifth District firms.
The dollar’s decline has been good news wake of Hurricanes
Whether further
Katrina and Rita depreciation portends wider trouble for the U.S.
economy remains to be River, some of the most fundamental laws of
At the mouth of the Y seen.
ork
economics are on display at Giant Industries’ 570-acre refinery.
26

The Identity Business: Biometrics cluster sharpens West 4 1
Identity Theft: Greater credit options have increased
Virginia’s economic image
The Federal Bureau of Investigation’s Criminal Justice Information
consumers’ financial flexibility — and the ability of criminals
Services information. Still, the share spawned a victimized
to stealDivision in Clarksburg, W.Va., hasof peoplecluster of businesses
related to biometrics, the science of measuring physical characteristics to
remains small
determine identity.
Financial institutions balance the need for privacy with the demand
for low-cost credit.
30

DEPARTMENTS

1 Noteworthy/Rules, Discretion, and the Future of the Fed
2 Federal Reserve/William McChesney Martin, Jr.: A Reevaluation
8 Short Takes
12 Jargon Alert/Endogenous
13 Research Spotlight/Should We Worry About the Current Account Deficit?
14 Policy Update/Federal Terrorism Insurance Program Renewed
15 Around the Fed/Another Reason to Keep Inflation in Check
32 Special Section: Base Closures in the Fifth District
45 Economic History/The Sea Island Hurricane of 1893
48 Interview/Tyler Cowen
54 Book Review/Dealing with Terrorism — Stick or Carrot?
56 District/State Economic Conditions
64 Opinion/Protectionism’s Dangerous Allure

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and analysis about the
Fifth Federal Reserve District
economy and the Federal
Reserve System. The Fifth
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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

John A. Weinberg
EDITOR

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Ray Owens
CONTRIBUTORS

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Eric Nielsen
Christian Pascasio
John Walter
DESIGN

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C I RC U L AT I O N

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Walter Love
Shannell McCall
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ISSN 1093-1767

COV E R D E S I G N : L A R RY C A I N

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NOTEWORTHY
Rules, Discretion, and the Future of the Fed
his issue of Region Focus
appears as the Federal
Reserve System welcomes a new chairman. On
February 1, Ben Bernanke
became only the 14th person to
hold that position in the institution’s 92-year history. The
transition presents an opportunity to look back on the notable
success that the Fed has enjoyed
under outgoing Chairman Alan
Greenspan, and to think about
the future of monetary policy.
The Fed’s effectiveness in securing price stability over the
past 25 years has been unmistakable. Greenspan’s predecessor, Paul Volcker, took a series of bold steps to bring down
inflation from double-digit levels. And since the late 1980s,
early in Greenspan’s tenure, inflation, as measured by the
Consumer Price Index, has dropped from an average of
more than 4.5 percent to about 2.5 percent in recent years.
Just as important, inflation expectations also have become
more stable. Keeping inflation contained over these last two
decades is a remarkable accomplishment. And this low inflation did not come at the cost of real economic growth.
During this period, the U.S. economy experienced the
longest expansion since World War II, bookended by two
brief, mild recessions.
Some observers have identified “flexibility” as the key to
Fed policy under Greenspan. By this, they mean an approach
to policy that is not excessively tied to any one doctrine. They
contrast this trait with an approach to policy that follows a
rigid rule — perhaps such as a numerical inflation target — and
suggest that the success of the last 18 years demonstrates the
virtues of discretionary rather than rules-based monetary
policy. This distinction goes back 30 years to a paper which
argued the opposite, that rules were better than discretion.
That paper was written by Finn E. Kydland and Edward C.
Prescott, who won the 2004 Nobel Prize for economics.
So does the success of apparently discretionary policy in
the Greenspan era prove Kydland and Prescott wrong? No.
It strikes me that those who see recent policy as evidence for
discretion over rules are using the terms differently than
originally intended.
The Kydland and Prescott analysis showed that a central
bank taking a discretionary approach may be sometimes
tempted to ease policy to boost employment and output,
despite the risk of higher inflation. The anticipation that
policymakers will behave this way in the future will drive up
current inflation. The result is likely to be persistently high

T

and ever-rising inflation, with no substantial benefit for
growth and employment.
To get around this problem, Kydland and Prescott said
that policymakers would do better if they could “commit” to
a pattern of behavior that avoids the temptation to ease
policy at the expense of inflation. To work, this commitment
has to be believable, or “credible.” A rules-based policy
involves any tool that allows the policymaker to credibly
commit not to succumb to temptation. One way to achieve
credibility is to adopt an inflation target. But this is not the
only way. What is essential is a consistent pattern of behavior that the public understands and believes will dictate the
central bank’s future behavior.
So has the Greenspan Fed been discretionary or rulesbased? The flexibility that many people emphasize points to
discretion. But I think a careful examination suggests that
Fed behavior in recent decades has been closer to what
Kydland and Prescott would describe as adhering to rules.
This is evident first and foremost in the clear and persistent
articulation of a focus on price stability that has come
through Greenspan’s testimony before Congress and other
official communications. Rule-like behavior is also apparent
in the attention the Fed has paid to the public’s expectations. Most notably, the Fed’s move to greater transparency
in the last 10 years or so has enabled it to craft Federal Open
Market Committee statements that to some extent guide
the public’s expectations about future policy. This sort of
attention to expectations can be every bit as constraining on
policymakers as the announcement of and adherence to a
narrowly defined rule for setting interest rates.
To my mind, building monetary policy credibility has
been the true hallmark of the Federal Reserve under
Greenspan’s leadership. Maintaining such robust credibility
will take continual vigilance. Key to this will be helping the
public understand that we intend to respond to future conditions in a way that keeps inflation low and stable.
Eventually, this may entail adopting a numerical inflation
target or some other more formal, rules-based system. We
have Greenspan’s stewardship to thank for getting us to this
point. Far from being “flexible,” the Greenspan Fed gave up
the flexibility to let inflation get out of control. Instead, it
established credibility for our commitment to price stability.

JEFFREY M. LACKER
PRESIDENT
FEDERAL RESERVE BANK OF RICHMOND

winter 2006 • Region Focus

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FEDERALRESERVE
William McChesney Martin, Jr.: A Reevaluation
During his nearly
20 years as
Chairman of
the Fed, Martin
helped to establish
the institution’s
independence and
to keep inflation
relatively low,
despite numerous
pressures to follow
a different course

William McChesney
Martin, Jr., was sworn in
as Chairman of the
Federal Reserve System by
Chief Justice Fred Vinson
on April 2, 1951.
Thomas McCabe, Martin’s
predecessor, looked on.

2

Region Focus • winter 2006

t is high time that William
McChesney Martin, Jr., is
reevaluated. He was subjected
to virtually unanimous adverse criticism from the economics profession
during his tenure as the longest-serving Chairman of the Federal Reserve
Board, from March 1951 to February
1970 (three months longer than Alan
Greenspan). For instance, all 23 professors who appeared before
Congress’ hearings on “The Federal
Reserve System after Fifty Years”
supported
Chairman
Wright
Patman’s attack on the Fed’s independence and the use made of it.
Four, including Milton Friedman,
favored money rules, and the rest
joined Paul Samuelson in recommending the “coordination of
monetary, fiscal, and debt policies”
under the direction of the Executive.
This was before later monetary
policies and inflations caused us to
look back longingly at the record
under Martin. Christina and David
Romer have summarized monetary
policy over “the past 50 years” as an
“evolution from a crude but fundamentally sensible model of how the
economy worked in the 1950s, to
more formal but faulty models in the
1960s and 1970s, and finally to a

I

model that was both sensible and
sophisticated in the 1980s and
1990s.” Average annual inflation in
Martin’s first decade was 2.2 percent
compared with 7.1 percent and 2.5
percent in the 1970s and 1990s. The
first period was also the least
volatile, with a 0.87 percent standard
deviation of inflation compared with
1.60 percent and 0.93 percent in the
later periods.
Robert Bremner’s recent biography, Chairman of the Fed: William
McChesney Martin, Jr., and the Creation
of the Modern American Financial
System, fills a gap in the history of
central banking, and of the financial
markets generally. This is not only
because of Martin’s importance to
monetary policy through two eventful decades, but also because, as the
first full-time president (at age 31) of
the New York Stock Exchange
(NYSE), he guided its accommodations with the New Deal regulators
who wanted to remake the financial
markets. What we see is a tough and
consistent man. His principles were
those of a conserver — of institutions and the value of money.
Martin’s life is a story of battles
for those principles even when, as
was usual, he was in the minority and
had to use his considerable negotiating skills. He can be viewed as the
most determined fighter in the history of the Fed. Without
downplaying the successes of
Benjamin Strong, Paul Volcker, and
Alan Greenspan, they benefited
from government forbearance and
considerable approval from the academic community. The last half of
Martin’s term, however, was a fight,
with limited help from a divided
Federal Reserve Board, against easymoney administrations supported by
the majority of economists. He was
known at once for his collegiality in

PHOTOGRAPHY: AP WIDE WORLD PHOTOS

BY J O H N H . WO O D

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the Federal Reserve and his firmness
(approaching obstinacy, President
Lyndon Johnson thought) in dealing
with threats from the outside, both
of which contrasted with chairmen
Marriner Eccles and Arthur Burns.
Martin was a conserver even in his
efforts in 1951 on the side of the
Fed’s independence. The reestablishment of the independence that
had been taken away in 1933
(although its subordination was
most obvious in the bond support
program — the “peg” — which
began in 1942) places Martin in
the pantheon of genuine central
bankers. By this I mean those who
focused on price stability instead
of thinking of the Fed’s actions
as part of a coordinated fiscal and
monetary program aimed at multiple
goals. Martin’s overriding objective
at the Fed and NYSE was stability,
cooperatively if possible, digging in
his heels when necessary.
Our knowledge of his conflicts is
mainly from others, with a few from
Martin’s accounts for the Fed’s files.
Evidence of his backbone was shown
during a meeting of the “quadriad”
(President
Kennedy,
Treasury
Secretary Douglas Dillon, Chairman
of the Council of Economic Advisers
Walter Heller, and Martin), when the
“exasperated” President asked
Martin “why he would not agree with
his other advisers” and “Martin
responded that he was the only person in the room that did not work for
the President.”
Martin’s monetary policy was rooted in his background, and his actions
at the Fed are better understood in
light of his behavior at the NYSE in
the 1930s and government service in
the 1940s. The following discussion of
Martin, the man, is taken largely from
Bremner. The economic interpretations are mine. I hope the reader will
agree that Martin’s economic views
were more sophisticated than he was
given credit for.

Early Career
William McChesney Martin, Jr., was
born in 1906. His father was appointed

Chairman of the Board of the
Federal Reserve Bank of St. Louis in
1914, and served as president (called
governor before the Banking Act of
1935) from 1929 to 1941. The St. Louis
Fed district was predominantly rural,
and in his teenage years, junior often

His principles were
those of a conserver —
of institutions and the
value of money.
heard his father “expressing concern
about excessive borrowing by overly
optimistic farmers.” Farm values rose
dramatically with farm prices during
and after World War I, before they
both collapsed in 1921. One-fifth of
the banks in the district (and the
country) failed in the 1920s.
Martin attended Yale, majored in
English, and took some courses in
economics, where, according to
Bremner, he learned “that his father
and other Federal Reserve bankers
were considered hopelessly out of
date because of their misguided
warnings about excessive speculation
in the stock market.” The foremost
economist at Yale during this period
was Irving Fisher, whose pronouncement a week before the Crash that
stock prices had reached a “permanent high plateau” became famous.
Martin’s behavior three and four
decades later demonstrates that he
took the lesson. My job at the Fed, he
would say, is to “take away the punch
bowl just as the party gets going.”
After a brief stint as a bank examiner for the St. Louis Fed, Martin
went to work for A.G. Edwards &
Sons in November 1928, as a “board
boy” who updated stock prices on a
large chalkboard. His uncle, Albert
Edwards, was managing director of
one of the few significant securities
firms away from the East Coast, which
continues today with headquarters
still in St. Louis. Martin soon became

the sole member of a new research
department. During the next few
years he witnessed the financial ruin
of many of Edwards’ clients.
In 1931, he moved to New York as
Edwards’ floor broker at the NYSE.
He took courses in economics and
finance at night school at the
New School for Social Research,
and was a leader in the organization of the Economic Forum
Quarterly. The journal included
articles by John Maynard Keynes
and Josiah Stamp, and Martin
continued as one of the publishers until they sold it in 1934.
Martin began to study for a
Ph.D. in finance at Columbia but
his attention turned to the governance of the Exchange. In May 1935,
he was elected a governor. The
Exchange had been under attack
since the Crash and the new
Securities
and
Exchange
Commission (SEC) pressed for
reforms. Change was resisted by
many, including Richard Whitney,
head of the Exchange, but a few
sought accommodation. Martin was
new and unsullied and found that
“the out-of-town firms were glad to
support me” as a member of the
reform movement.
He would rise quickly to the top
of the NYSE, where he would serve
as president for three years. Much of
his presidency was devoted to preserving the Exchange’s position in
the financial industry and the profits
of its members. He was generous
with promises of audits and stricter
supervision, but there was no significant change in membership or
trading practices, particularly in the
dealer functions of the vilified specialists. Bremner writes of the
failures of Martin’s reform efforts
but one could view his record more
charitably, as resisting the call to
make widespread, and perhaps hasty,
changes.
Martin resigned his position at
the Exchange in 1941, and entered
the Army as a private. He rose to
colonel as he spent the war working
on Russian lend-lease, becoming

winter 2006 • Region Focus

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head of the program in 1945. Being a
Missouri Democrat did not damage
his postwar prospects, and in
November 1945, John Snyder, St.
Louis banker and adviser to
President Truman, asked Martin to
become president of the ExportImport Bank. Bremner describes
Martin’s term at Ex-Im as a succession of run-ins with the State and
Treasury departments as he defended the institution’s independence of
politics.
On Jan. 1, 1949, Martin became
assistant secretary of the Treasury for
International Affairs under Snyder,
who had become secretary in 1946.
He was involved in the negotiation of
currency realignments following the
British devaluation in September
1949, and for the occupied former
enemies. He became Snyder’s confidant on a wide range of policy
matters, and was drawn into the
Treasury’s dispute with the Federal
Reserve.
The Fed was fighting for its independence from the Treasury — not
for the first time. To put the dispute
in historical perspective, the Federal
Reserve Act of 1913 created a System
of 12 district banks with general
oversight by a Board in Washington
whose members were appointed by
the President of the United States
(five members with rotating 10-year
terms, changed to seven members for
14-year terms in 1935). The Federal
Reserve banks were owned by their
member banks, and their heads were
chosen by their boards of directors.
So the Fed was given considerable
freedom from the Executive — if it
chose to exercise it, which is not possible in wartime because it is
duty-bound to support the war
effort. That means the monetization
of government deficits. The Treasury
kept up its pressure on the Fed to
prevent interest rates from rising
after the end of World War I, a policy that caused the consumer price
index to rise 31 percent between
October 1918 and June 1920.
The Fed was relatively free from
early 1920 until Franklin Roosevelt
4

Region Focus • winter 2006

became President in March 1933.
Milton Friedman and Anna Schwartz
have referred to the prosperous and
stable-price 1920s as “the high tide of
the Federal Reserve System.” The
massive falls in money, prices, and
employment during the Great
Depression of 1929 to 1933 produced a
reaction in which the Roosevelt
administration assumed control of
monetary policy.
The only significant changes in the
Fed’s structure were made by the
Banking Act of 1935, under the influence of Mariner Eccles, a Utah
businessman who was attracted to
Washington by the New Deal, and
became Chairman of the Federal
Reserve Board in 1934. The most
important change affecting policy in
the long run was the formalization of
the open market committee that had
been a voluntary vehicle for coordination between Reserve banks. The new
Federal Open Market Committee
(FOMC) consisted of the seven governors of the Federal Reserve Board, the
president of the Federal Reserve Bank
of New York, and four more Bank
presidents on a rotating basis. The
Chairman of the Board also chaired
the FOMC.
Structural changes were irrelevant
while monetary policy was directed by
the Treasury, which decided on a lowinterest war, in particular, a Treasury
bill rate pegged at 0.375 percent, and
an average yield on U.S. long-term
bonds of about 2.4 percent. The
administration’s pressure to maintain
low rates persisted even longer than
after World War I. The peg continued
unchanged until July 1947, and bills
had risen to only 1.14 percent at the
cyclical peak in November 1948,
despite average annual inflation of 10
percent from 1946 to 1948. The long
bond yield was virtually unchanged at
2.44 percent.
Throughout this period the
Federal Reserve tried to negotiate the
freedom to fight inflation. It had
occasional support from Congress but
the administration would not abandon its low-interest policy. The Fed’s
resistance increased with the infla-

tionary pressures of the Korean War
that
began
in
June
1950,
and it broke into open rebellion
as President Truman’s political
position weakened. Martin represented the administration in negotiating
the Treasury-Federal Reserve Accord
that was announced on March 4, 1951:
The Treasury and the Federal
Reserve System have reached full
accord with respect to debt-management and monetary policies to
be pursued in furthering their
common purpose to assure the
successful financing of the
Government’s requirements and,
at the same time, to minimize
monetization of the public debt.

Part of the agreement was Martin’s
appointment as Fed Chairman.

Chairman of the Fed
Although coming to the Fed from
the Treasury, Martin, like Paul
Volcker later, insisted on the independence of monetary policy.
Martin’s long tenure was filled with
conflict but his positions in all of
them redound to his credit when
viewed from later perspectives of
monetary theory and policy. The
distinguishing features of his career
are seen in four conflicts that
extended over the five presidential
administrations during which he
served.
(1) Bills Only. The development
of open market operations as the
main instrument of monetary policy meant that the Fed had to be
concerned with the performance of
the government securities market.
Standards had been set for securities dealers during World War II but
the stability and liquidity of the
market were unthreatened under
the peg. One of Martin’s first
actions at the Fed was to chair an
Ad Hoc Subcommittee “to study
and report on the operations and
functioning of the Open Market
Committee in relation to the
Government securities market”
under the new free-market regime

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

of fluctuating yields. The subcommittee’s objective was effective
open market operations, which
requires “an efficiently functioning
Government securities market
characterized by depth, breadth,
and resiliency.”
This was remarkably similar to the goals of the New
York Stock Exchange, which
regularly publishes “indicators
of market performance” consisting of price continuity,
market depth, and quotation
spreads.
Martin’s
quiet
obstruction of the SEC attack
on the integrity of stock trading was carried over to the
promotion of similar performance in
government securities. His purpose
was to achieve flexibility in the
determination of bank reserves without interfering with the efficient
transfers of saving to investment.
Therefore:

monetary policy meant the readiness
to force sudden and substantial
changes in interest rates, especially
long-term rates.
Outside the interventionist academic atmosphere of the 1950s and
1960s, though, Martin is more easily

that aimed at the triple objectives of
growth, balance of payments surplus,
and price stability by twisting the
yield curve. The Fed would stimulate
long-term investment by buying
long-term securities. At the same
time, it would help the balance of
payments by attracting shortterm investments through the
higher short-term yields that
would result from sales of
short-term securities. The program would not be inflationary
because the added reserves
from purchases of long-terms
would be offset by the sales of
short-terms.
The candidate had promised: “I
have no doubt that any new
Democratic President will find the
Federal Reserve pursuing a somewhat different policy,” and hinted
that Martin might be replaced. After
the election, when the chairman-designate of the President’s Council of
Economic Advisers Walter Heller
called on Martin, the latter warned:
“I’m not going to give up the
independence of the Fed.” But he
added: “There’s plenty of room for
cooperation.”
The administration persuaded
Martin (despite dissents at the Fed)
to nudge short-term rates upward
while keeping long-term rates low.
Operation Nudge turned into
Operation Twist, which would
involve vigorous actions to reduce
long rates. “This is a historic reversal
of policy,” Heller wrote the

When intervention by the Federal
Open Market Committee is
necessary to carry out the
System’s monetary policies,
the market is least likely to
be seriously disturbed if the
intervention takes the form of
purchases or sales of very shortterm Government securities.

Although the subcommittee’s
report correctly pointed out that
“bills only,” as the policy came to be
called, was in “the best central banking traditions,” it was received with
hostility by economists for whom

Harry S. Truman
(1951-1953)

defended. The prevailing IS -LM
policy framework was a comparativestatics equilibrium model for given
expectations. We have learned that
short-term fiscal policies (such as the
1967 tax surcharge) which are known
to be short term are ineffective.
Ephemeral interest-rate policies may
be even less effective. Whether the
aim is reflation or disinflation, effective monetary policy requires the
market’s confidence in its seriousness. Martin’s agreement is seen
below.
(2) Operation Twist. The “bills only”
policy was terminated in 1961 under
pressure from President Kennedy’s
New Frontier program, which
demanded no restrictions on policy
instruments. The last nine years of
Martin’s term were a continuous battle with inflationary administrations.
Kennedy’s advisers were inclined
toward fiscal policy but came up with
a challenging program for the Fed

Dwight D. Eisenhower
(1953-1961)

John F. Kennedy
(1961-1963)

Martin served under these five presidents
during his tenure as the Chairman of the
Federal Reserve Board.

Lyndon B. Johnson
(1963-1969)

Richard M. Nixon
(1969-1970)

winter 2006 • Region Focus

PHOTOGRAPHY: LIBRARY OF CONGRESS: TRUMAN PHOTO, LOC, COPYRIGHT BY EDMONSTON STUDIO; EISENHOWER PHOTO, LOC, COPYRIGHT BY FABIAN BACHRACH

The last nine years of
Martin’s term were a
continuous battle with
inflationary administrations.

5

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

President, “for which Chairman
Martin deserves our appreciation.”
Heller’s satisfaction was premature. Several members of the FOMC
“were strongly opposed to the end of
‘bills only’ [as] a step back toward
political interference in monetary
policy and a pegged bond market,”
wrote political scientist Donald
Kettl, and Martin managed to obtain
and keep the majority’s support for
Operation Twist only by an execution that bordered on the
imperceptible. The administration
was disappointed with Martin’s
“team spirit.” The trouble, Heller
recalled, was that:
… we’d have a meeting with
Kennedy … and before the meeting Bill would be out there buying
those long-term securities, but
afterwards his buying would
flag . ... [CEA member] Jim Tobin
would keep track of this and he’d
say, “Walter, you’d better …
arrange another meeting …
because Martin isn’t buying
enough long-term bonds.” So I’d
call a meeting and sure enough
the purchases would rise again,
and Martin would be able to tell
Kennedy, “We’re doing everything
we can.”

Kennedy’s advisers initially
opposed the Fed Chairman’s reappointment in 1963, but backed away
from that position when they discovered the level of support for Martin
in the business community, both at
home and abroad.
(3) The Vietnam War and the “Credit
Crunch” of 1966. The Federal Reserve
was expected to finance government
spending, and presidents had demonstrated that they would make a
political issue of price and interest
increases. Martin wanted to address
inflation by monetary restraint, but in
addition to political threats, he had to
deal with increasing opposition within the Federal Reserve as the “New
Economists” came to the Board.
Martin tried to steer a course
between the Keynesians and the
6

Region Focus • winter 2006

inflation hawks in such a way as to
combat inflation without endangering the integrity of the Federal
Reserve System. His difficulties
were increased by the absence of
any real discussion, or even understanding,
with
the
Johnson
administration. When Martin publicly warned that inflation might call
for monetary restraint, Johnson’s
Chairman of the Council of
Economic Advisers Gardner Ackley
told the President: “I don’t think
we’ll ever have a Chairman of the
Federal Reserve who is so completely
out of the mainstream of economics.”
Ackley’s own 1959 paper on inflation
had ignored money and “argued that
the inflationary process is essentially
an administrative one. It arises from
a largely autonomous upward
pressure on wage rates relative to
the cost of living, interacting
with administered-price markups
applied to rising wage costs … in
endless chain.”
The Board consisted of Martin,
three Kennedy-Johnson appointees
(George Mitchell and Dewey Daane,
business economists from Federal
Reserve banks, and academic economist Sherman Maisel), government
lawyer James Robertson, appointed
by Truman, and Canby Balderston
and Charles Shepardson, college
deans appointed by Eisenhower. The
Vice Chairman of the FOMC was
New York Fed President Alfred
Hayes. Hayes, Balderston, and
Shepardson were anti-inflationists
who were usually joined by two of the
rotating Bank presidents, while
Robertson, Mitchell, Maisel, and two
other presidents generally favored an
easy-money approach aimed at
keeping employment robust.
This five-to-five split left the
deciding votes to Martin and Daane,
who also leaned toward a policy of
price stability. So, Maisel later wrote,
decisions “generally favored the
more restrictive targets. However,
because a strong minority stressed
broader objectives, as did the administration, moves to restrict credit
were less frequent and more moder-

ate; those in the middle had to be
sure of themselves before they joined
the restrictivists.”
It was in this atmosphere that
Martin urged the administration to
ask Congress for a tax increase.
When promises to do so were not
kept, Martin obtained a commitment to act from a narrow majority
of the Board. With his penchant
for personalizing disagreements,
Johnson announced to Martin: “I’m
scheduled to go into the hospital
tomorrow for a gall bladder operation. You wouldn’t raise the discount
rate while I’m in the hospital, would
you?” Martin paused, and in a reply
that became legendary at the Fed,
said: “No, Mr. President, we’ll wait
until you get out of the hospital.”
Treasury
Secretary
Henry
Fowler’s recommendation that
Martin be replaced by Volcker (at the
time, deputy undersecretary of the
Treasury for monetary affairs) was
not pursued, and on Dec. 6, 1965, the
discount rate was raised. Johnson
was enraged but the Fed kept up the
pressure. Free reserves at member
banks turned negative, and the
Treasury bill rate rose from 4 percent
to 5.5 percent. But inflation was not
touched. In fact, the CPI rose 3.8
percent (at an annual rate) during the
first six months of 1966 compared
with 1.9 percent in 1965. Federal
spending and the deficit continued
to rise. However, the policy of
restraint was ended by a “credit
crunch” at the end of August.
Rising deposit rates threatened
the solvency of institutions making
long-term loans. In addition, banks
and S&Ls lost time deposits because
market rates rose above the legal
maxima on deposit rates. The Fed
gave way and resumed purchases.
Martin resolved that next time they
would stay the course.
(4) Richard Nixon. Though he campaigned on a largely conservative
platform, President Nixon recoiled
from the political costs of ending the
inflation that he inherited. He did
not trust Martin, whom he blamed
for the recession that had cost him

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

the 1960 election, and wanted
Arthur Burns at the Fed. However,
Martin told the President that he
would not step down before the end
of his term on Jan. 31, 1970. In 1963,
Martin had to be persuaded by
Kennedy to accept reappointment
and three times he offered his resignation to Johnson. Why the
difference? Nixon did not seem likely
to pursue more inflationary policies
than his Democratic predecessors.
That may be the answer. Kennedy
and Johnson felt they needed Martin
as a symbol of sound money and
Martin knew it, whereas in addition
to his personal animosity the
Republican President did not feel
the same need for a sound-money
stamp.
Nixon’s Council Chairman Paul
McCracken hoped that inflation
could be slowed without unemployment by a policy of “gradualism,”
when what was needed was just the
opposite: to convince the markets
that something significant was going
to happen. Martin and the majority
of his colleagues had stronger medicine than the Council’s in mind.
Worried about the administration’s
commitment and market expectations, they had raised the discount
rate in December 1968, before Nixon
took office. In February 1969,

Martin apologized to the Joint
Economic Committee for past errors
and said they would not be repeated:

changed direction. The rest, as they
say, is history.

Conclusion
It appears that the Federal
Reserve was overly optimistic in
anticipating immediate benefits
from fiscal restraint … but now we
mean business in stopping inflation. ... A credibility gap exists in
the business and financial community as to whether the Federal
Reserve will push restraint hard
enough to check inflation. The
Board means to do so and is unanimous on that point.

He addressed the apparent lack of
resolve on the part of the government, which “has raised the ghost of
overkill at the first sign of a cloud on
the horizon.” The New York Times
reported: “Martin strongly implied
that this will not happen again and
that restraint will persist even when
there are clear signs the economy is
slowing and in the face of some
increase in unemployment.”
The rate of money growth fell and
unemployment rose, but inflation
remained above 6 percent and the
Fed raised the discount rate to 6 percent in April. The Fed kept its nerve
until February 1970, when in Burns’
first meeting, monetary policy

Martin voiced the same sense of failure in 1970 as in 1941. He had left the
Fed at a time when inflation was on
the rise, as he had left the NYSE
without instituting major reforms. In
his defense, however, he fought inflation as hard and as successfully as
anyone could have done, and he preserved the Fed as he preserved the
NYSE. Bremner may be right when
he says that Martin’s greatest contribution was the strengthening of the
Fed as an independent monetary
authority, although that independence still must be seized.
Skeptical of staff analyses and
forecasts, he never saw any redeeming qualities in inflation. His
statements did not meet the explicit
standards of modern monetary theory, but the positions to which they
referred were consistent with what is
now thought to be the best in theory
and policy. This includes his anticipations of later moves toward the
transparency of the Fed’s intentions
and the willingness to take preemptive actions.
RF
John H. Wood is the Reynolds Professor
of Economics at Wake Forest University.

READINGS
Ackley, Gardner. “Administered Prices and the Inflationary
Process.” American Economic Review, May 1959, vol. 49, no. 2, pp.
419-430.

____. “After the Accord: Reminiscences of the Birth of the
Modern Fed.” Federal Reserve Bank of Richmond Economic
Quarterly, Winter 2001, vol. 87, no. 1, pp. 57-64.

Bremner, Robert. Chairman of the Fed: William McChesney Martin,
Jr., and the Creation of the Modern American Financial System. New
Haven: Yale University Press, 2004.

Kettl, Donald F. Leadership at the Fed. New Haven: Yale
University Press, 1986.

Friedman, Milton, and Anna J. Schwartz. A Monetary History of
the United States, 1867-1960. Princeton: Princeton University
Press, 1963.
Hargrove, Erwin C., and Samuel A. Morley. The President and the
Council of Economic Advisers: Interviews with CEA Chairmen.
Boulder: Westview Press, 1984.
Hetzel, Robert L., and Ralph F. Leach. “The Treasury-Fed
Accord: A New Narrative Account.” Federal Reserve Bank of
Richmond Economic Quarterly, Winter 2001, vol. 87, no. 1, pp. 33-55.

Maisel, Sherman J. Managing the Dollar. New York: Norton, 1973.
Romer, Christina D., and David H. Romer. “The Evolution of
Economic Understanding and Postwar Stabilization Policy.”
National Bureau of Economic Research Working Paper no. 9274,
October 2002.
U.S. Congress. “The Federal Reserve after Fifty Years: Hearings
before the Subcommittee on Domestic Finance of the House
Committee on Banking and Currency.” 1964, 88th Congress,
2nd session.

winter 2006 • Region Focus

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SHORTTAKES
BEYOND PLASTIC

Capital One Sticks with Plan
to Buy Hibernia

O

accounts. It’s also a clear-cut survival strategy in a time
when pure-play, or mono-line, credit card firms are
disappearing and big banks are concentrating on the
credit card business.
“The mono-lines are going out of business,” says Tony
Plath, a finance professor at the University of North Carolina
at Charlotte. “Their operating income cycle tends to be
more volatile because their business line is concentrated
in just one or two businesses. They’re also vulnerable
because they can only grow their business in one way.”
— DOUG CAMPBELL

n Nov. 14, 2005, Capital One Financial Corp. became
the 19th-largest bank in the nation. The McLean,
Va., company, known for its credit card and consumer
lending business, had announced in March that it would
pay $5.35 billion for Hibernia Corp. The news was not a
total shock. Capital One had previously said it was interested in buying a bank for several
strategic reasons.
A “DRIVER’S LICENSE” FOR WORKERS?
The whole deal looked shaky
on the scheduled closing date,
however. It was Sept. 1, just days
after Hurricane Katrina ripped
through the Gulf Coast and
flooded New Orleans, Hibernia’s
atching skill supply with
headquarters city. The parties
demand in labor markets
immediately pushed back closing
can be tricky. Work force devela week, and announced a renegoopment and education officials in
tiated sale price of about
the Fifth District hope to bridge
$5 billion with closing set
the information gap with
for November. Under terms of
“employability” certificates. This
the deal, Hibernia becomes a
portable credential aims to
Capital One subsidiary and gives
reduce friction in labor markets.
up its name.
Virginia has awarded more
In a Sept. 20 conference with
than 5,000 certificates since
investors, Capital One’s Chief
2004. With the backing of
Financial Officer Gary Perlin
the Virginia Manufacturers
said that of Hibernia’s more than
Association and other business
300 branches, 21 suffered signifigroups, companies such as
cant damage, but that most are
Northrop Grumman Newport
expected to reopen. As the
News have used the certificate
largest bank in Louisiana, Capital One completed its foray into retail banking
during the hiring process.
Hibernia is expected to play a in November with the purchase of New OrleansVirginia’s Career Readiness
lead role in the reconstruction based Hibernia.
Certificate (CRC) is designed to
effort, serving as a conduit for
ensure that the recipient meets
federal and insurance funds that flow into the region.
certain standards in reading, applied mathematics, and
“We’ve been working very closely with Hibernia to take
information retrieval. Those three skills meet the basic
advantage of those opportunities,” Perlin said.
requirements of 85 percent of jobs, according to the nonAs for Capital One’s overarching plan, Perlin said: “It’s
profit ACT Inc., a testing firm. The certificate includes an
very much in line with Capital One’s strategy of building
exam score and a description of its meaning. Exams are
and maintaining leadership positions in a number of
administered at 44 local work force development centers
national-scale lending businesses in the consumer space.
and at the state’s 23 community colleges.
Hibernia adds to that a local scale deposit business in
Workers armed with a CRC have information on their
Louisiana as well as growth opportunities they have
employability that is widely understood and accepted.
demonstrated they can take advantage of in Texas.”
That can give them greater geographic freedom in the job
Other advantages of getting into retail banking include
search. On the flip side, an employer with operations
the ability to sell credit cards to banking customers, who
in different locations could use the same CRC to
tend to be better credit risks than people without bank
evaluate workers.

Virginia Leads in
Issuing Employability
Certificates

8

Region Focus • winter 2006

PHOTOGRAPHY: COURTESY OF CAPITAL ONE

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Companies have long relied on some sort of credential
PRIVATE ENTERPRISE, PUBLIC SCHOOLS
to signal whether an applicant has the minimum skills for
a job. This credential has usually been a high school
diploma, but that may not be good enough for some
jobs anymore.
“More and more jobs require some postsecondary
hree Baltimore public schools under for-profit
training,” says Jon Erickson, vice president of educational
management since 2000 have made progress,
services for ACT Inc. “At the same time, high schools have
according to federal academic standards. And two of the
had a glut of students, teacher shortages, and a whole
three schools have made it off Maryland’s “needs
bunch of curriculum issues.” His company’s skill assessimprovement” list.
ments are being used to develop a certificate equivalent to
From the beginning, the decision to pay the private
Virginia’s CRC in the District of Columbia, Maryland,
firm, Edison Schools, to manage three failing inner city
West Virginia, the Carolinas, and other states.
elementary schools was controversial.
“Employers have gotten frustrated because credentials
“When they first came in, everyone was in an uproar
don’t guarantee that people have the skills they want,”
because someone was taking over their neighborhood
adds Sondra Stein. She is program manager for a Work
school,” says Zelda Holcomb, Edison’s operations vice
Readiness Credential under development at Equipped for
president and general manager for the Baltimore region.
the Future, an initiative funded by the National Institute
Edison’s contract has been renewed through 2007. The
of Literacy, several trade and
state pays the firm and then
nonprofit organizations, and
Edison Schools in the Fifth District subtracts the total cost for running
governments in five states and
the three schools from the city
the District of Columbia. (D.C.
school system’s funds. In the 2003Elem. Middle High
is involved in the development
2004 school year, the most recent
Allendale, SC
2
1
1
of two different employability
for which data is available, Edison
Baltimore, MD
3
0
0
certificates.)
received $8,880 per pupil to
Stein says that public schools
operate three Baltimore schools,
Charleston, SC
5
2
1
devote more time to developing
according to Mary Clapsaddle of
Washington, D.C.
2
1
1
core academic skills at the
the Maryland State Department of
TOTAL
12
4
3
expense of “soft” skills like
Education’s accounting office.
communication and cooperation
Money for Edison employees’
SOURCE: Edison Schools Web site
that are highly valued in the
retirement comes from the city
workplace. At the same time,
school system. Edison is the
employers have raised the bar for what they need in a worker.
nation’s biggest for-profit manager of public schools, with
That’s why some firms look for employees with an
136 schools in 19 states and the District of Columbia in
associate degree from a community college or a profes2005-2006. The firm earned an after-tax profit of
sional certification. But even this information may
$700,000 on revenues of $411 million for the
be inadequate.
fiscal year ending June 30, 2005. It was the first profitable
While working as chief economist at the State Council
year for Edison, which opened its first four schools
of Higher Education for Virginia, Fletcher Mangum held
in 1995.
focus groups to find out more about the intersection of
Jim Foran of the Maryland State Department of
education and economics. “One of the things we comEducation likes Edison’s work. “The professional developmonly heard from business owners was that a degree
ment, community involvement, the inviting environment
didn’t really tell them what skills a person had,” says
when you go into one of these schools — it looks very difMangum, now a Richmond-based consultant. He worked
ferent than when you go into one of these [other] urban
on the taskforce that developed Virginia’s CRC. “A degree
schools,” Foran says.
was too generic and the quality of the information it conAll three of the schools made “adequate yearly
veyed about the person’s skill sets and educational level
progress,” a benchmark established by the federal governvaried from institution to institution.”
ment. Before Edison assumed management, the three
Mangum says it’s more efficient for government to
public schools in question were among the worst in the
administer a single statewide assessment rather than use
city. “AYP [adequate yearly progress] is a measure the
many tests individually provided by employers.
federal government established for schools showing
“Employability certificates remove a lot of uncertainty from
sufficient progress not to be put into an improvement
the [hiring] process,” he notes. Skeptics of the approach,
activity,” he says. “It’s an assurance to parents that schools
though, note that a decentralized certification system has
are operating well, academics are serious, and children on
served many companies well, and are reluctant to see any
average perform well enough on that benchmark.”
single system crowd out competitors.
— CHARLES GERENA
Edison Schools aims to raise achievement through

Three Baltimore Schools
Improve Test Scores

T

winter 2006 • Region Focus

9

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curriculum changes, technology, professional development, and parental involvement. Holcomb says the
Edison model works. “These are the research-based
techniques for professional development, the structure of
the school, and behavior management,” she says. “It’s
data-driven accountability.”
For example, the schools have encouraged various
adult groups to help out. A group of volunteers, calling
themselves the Mighty Men of Montebello, works with
Montebello Elementary School, a school of nearly
1,000 students, 84 percent of whom receive a free or
reduced-price school lunch, an indicator of poverty.
A grandparents’ club also has been formed at that
school. “We have some people on the board at FurmanTempleton [another Edison school] from the local
church,” Holcomb adds.
The contract will automatically terminate in 2007
because the federal No Child Left Behind Act supersedes
the state legislation under which the state assumed
control of the failing schools. Foran says that even though
the state no longer has the ability to take over individual
schools under the act, the city could become a partner
with Edison Schools or form charter schools, deregulated
public schools that are designed to deliver on goals stated
in the charter.
It is difficult to compare achievement results in Edison
Schools with other schools. A RAND Corporation
research brief, commissioned by Edison, examined Edison
schools and reports: “Edison results relative to comparison schools improve in years four and five, but whether
those improvements ultimately yield net positive effects
is the key question.”
— BETTY JOYCE NASH
NATIONAL FLOOD INSURANCE

Henderson County, N.C., Joins
the Crowd

C

ounty officials in Henderson County, N.C., balked at
joining the National Flood Insurance Program for
years. They figured that by not passing a flood ordinance,
one of the requirements for joining, they were doing the
county’s heavily developed landscape a favor: People
couldn’t get loans to build in flood areas without insurance and so they just wouldn’t build in risky places.
(See “After the Flood” in the Winter 2004 issue of Region
Focus.)
Wrong. Rocky Hyder, Henderson County’s coordinator of emergency management services, says that demand
for property in the scenic mountain county had gotten so
high that the cost didn’t discourage developers from
filling in properties that were technically in flood-prone
areas. And, on top of that, the county was ineligible for
most types of federal disaster assistance after Hurricanes
Ivan and Frances, which hit the county hard in 2004. So,
after four months of controversy, Henderson County

10

Region Focus • winter 2006

commissioners finally passed the county’s flood ordinance
in July 2005.
“Due to the current regulations both at state and
federal level with regard to participation in the National
Flood Insurance Program, and limitations implemented
by state and federal government for disaster assistance
funds, the staff felt like we had to adopt some type of
flood damage prevention ordinance and participate at
some level,” Hyder says. Two enforcement officers were
added to the staff. The law prohibits development in the
flood way, the most vulnerable land near rivers and
streams. About 10 percent of the county’s land lies in a
flood-prone area.
“It also prohibits most development in about
80 percent of the flood fringe, an area mapped on the
flood insurance rate maps,” Hyder says. “The commissioners basically said if you had an existing lot at the time
the ordinance was passed, then 20 percent of the lot
in flood fringe could be modified, but no more than
20 percent, so as not to transfer flood storage to a
neighbor.” When flood-prone areas are filled in one place,
typically land elsewhere along the stream will be affected.
After all, floodwater has to go somewhere.
The National Flood Insurance Program, under the
Federal Emergency Management Agency (FEMA), allows
homeowners to buy flood insurance from private insurers
who are paid to administer the program. The U.S.
Government Accountability Office has found that while
FEMA has kept the program financially sound in general,
the floods of 2004 and 2005 have required FEMA to borrow $300 million, as of August 2005, from the U.S.
Treasury to help pay an estimated $1.8 billion in flood
insurance claims. After Hurricane Katrina, Congress
increased FEMA’s borrowing power from $1.5 billion to
$3.5 billion. As of August 2005, the NFIP had about
4.6 million policyholders in about 20,000 communities.
Since it began in 1968, the program has paid out about
$14.6 billion in claims, mostly through premiums.
The program, though, is not actuarially sound — about
29 percent of policies were subsidized, the GAO reported
in 2003. “As a result of these subsidies, some policyholders
pay premiums that represent about 35 percent to
40 percent of the true risk premium.”
— BETTY JOYCE NASH
WINNING TICKET?

Lottery Coming to North Carolina

N

orth Carolina is set this spring to become the 42nd
state nationwide — and last in the Fifth District —
to operate a lottery. State lawmakers last summer narrowly
voted in favor of adopting a lottery, and Gov. Mike Easley
signed the North Carolina State Lottery Act into law on
Aug. 31. Tickets are tentatively set to go on sale April 5.
As is the case with many other state lotteries, proceeds
from North Carolina’s are chiefly to go to education. The

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finding also weakens the argument that states
state expects to reap
Cashing In
are losing revenue to neighbors who offer
$425 million for educaAbout one-fourth of the U.S. lottery
lotteries; most of their residents weren’t
tional purposes in fiscal
proceeds go to government coffers.
gambling in the first place until the new lottery
2006. Easley has been
came along.
pushing for a lottery
Lottery Sales
Profit
Lawmakers can mitigate the regressive
since 2001, arguing in
(mil.)
(mil.)
nature of the lottery, Kearney says. Low-income
part that the state was
DC
$245
$76
lottery players tend to buy instant “scratch-off ”
losing potential revenue
MD
$1,395
$458
tickets rather than the bigger jackpot “lotto”
to neighboring states
SC
$950
$290
games. “If you want your state lottery to be less
with lotteries. His goal
VA
$1,262
$408
regressive, then you should focus on the bigger
is to use the money to
WV
$1,303
$512
jackpot games or limit how many instant games
reduce classroom sizes.
US
$48,801
$13,902
you offer,” Kearney says.
— DOUG CAMPBELL
North Carolina’s move
SOURCE: North American Association of State & Provincial
Lotteries; Fiscal Year ’04
into state-sponsored
lottery follows South
Carolina, which joined the ranks in 2002.
A DANVILLE TRADITION NO MORE?
Lotteries in the United States generated total sales of
$48.8 billion in fiscal 2004, according to the North
American Association of State & Provincial Lotteries,
with “profits” — or the amount transferred to state
an River Inc., based in Danville, Va., was sold in
coffers — of $13.9 billion.
January to an Indian firm, GHCL Ltd. The price has
In adopting lotteries, states face controversial
not been officially disclosed, but Indian media and other
trade-offs. With the windfall of revenue come questions
sources place the number at about $17.5 million, along with
about propriety of depending on gambling to fund
the assumption of about $80 million in debt. Dan River
education. After all, the chance of winning many lotteries
emerged from Chapter 11 bankruptcy in February 2005.
is worse than one in 135 million. Additionally, as argued
The company, rooted in Danville since 1882, currently
by the nonprofit Tax Foundation, lawmakers can
employs about 1,700 workers in the United States,
sometimes “shuffle other funds so that lottery tax
including roughly 1,100 in the Danville region. Nearly 500
revenue supplants, rather than supplements, existing
of those people will lose their jobs in March due to
funds for education.”
planned cuts in production near the company’s headquarters.
Some economists describe lotteries as a de facto excise
The company has been shedding workers and facilities
tax, in which the cost is borne by those paying for the
for some time. “It is not a new thing,” says Calvin
product. This feeds the problem that a small percentage
Barnhardt, vice president of human resources at Dan
of players accounts for more than half of all lottery sales,
River. “We have, since 2002, closed probably 14 facilities.”
and that those with household incomes of less than
In early December 2005, for instance, the firm announced
$10,000 represent nearly 10 percent of the heaviest
a plant closing in Morven, N.C.
players. (See “The Revenue Game” from the Fall 2002
The firm expects to remain a separate corporate entity
issue of Region Focus.)
to keep its brand names and licenses. “We certainly will be
Additionally, publicly run lotteries tend to have very
looking to capitalize on that very important asset and
high operating costs. So if you aren’t opposed to them for
that’s the name Dan River,” says Barnhardt. “If the name
normative reasons — that is, you think it’s just wrong for
Dan River all of a sudden went away, then you lose that
the government to sanction this activity — then you
continuity and you lose that establishment you have in the
still might want to consider having the state turn the
marketplace. We want to preserve that and use it as a
operations over to a private firm. This would yield a
springboard to offer a wider range of products.”
higher share of “profits” to the state, even after the
North Carolina State University economist Michael
private firm takes it cut.
Walden predicts that the decline in textiles jobs will
continue. Those firms remaining in the United States will
The regressive nature of lotteries is problematic
likely concentrate on niche production of “specialized
in the sense that low-income households aren’t just
textile outputs, where proximity to the U.S. market is
substituting expenditures on lottery tickets for other
important,” Walden says.
forms of gambling; they are spending less on necessities
The news of further textile consolidation comes on the
such as food and clothing. That’s according to a recent
heels of Vaughan Furniture Co.’s recent announcement to
study by Brookings Institution economist Melissa
close one of its two factories in Galax, Va., about 100
Schettini Kearney published in the Journal of Public
miles west of Danville. The closing is due to cheaper
Economics. Kearney concluded that the average
Chinese imports, according to company officials, and will
household reduces consumption by $41 a month in
result in about 200 job losses.
— BETTY JOYCE NASH
response to the introduction of a state lottery. This

Indian Firm Buys Dan River Inc.

D

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JARGONALERT
Endogenous
t most stores, prices are not negotiable. If you want a
new television, you pay the price the store is asking. But
an economist might look at this situation differently.
That’s because the actual price of all consumer goods is partially determined by the purchasing decisions of consumers. In the
economist’s view, prices are not so fixed.
This is a classic case of distinguishing between factors that
are either “endogenous” or “exogenous.” The distinction is crucial to understanding the economy
and economic models. Roughly
speaking, exogenous quantities are
those which are determined from
the “outside.” In the example
above, prices are exogenous for the
individual consumer, since one person’s impact on the equilibrium
market price is negligible. By contrast, prices are not exogenous for
the entire market; they are determined by the interaction of supply
and demand. Thus, for the economy as a whole an economist would
say that prices are endogenously
determined — that is, determined “from the inside.”
In any useful economic model, the distinction between
endogenous and exogenous must be clear. All models must have
at least one exogenously determined element to prevent the
model from becoming hopelessly circular and self-referential.
An economist wishing to create a model of consumer behavior might take prices, preferences, and budgetary constraints as
“exogenous” inputs to determine which goods are purchased
and in what quantities. Yet an economist wishing to model the
overall market for a group of goods would not take prices as
exogenous. He would construct a model in which exogenous
factors in the overall economy, such as productivity, tax rates,
and other determinants of supply interact with “endogenous”
demand to yield a market price for the good. The challenge is to
construct a model that accurately identifies factors as endogenous or exogenous. What is endogenous or exogenous may
change depending on what question is being asked.
In real life it is not always so easy to divide everything into
endogenous and exogenous categories. For instance, is it better
to take government structure as exogenous to economic life, or
to model government structure as emerging, along with the
economy, from still more fundamental factors? Indeed, much
economic debate centers on what one can reasonably take as
exogenous. In many cases the “art” of economics is to find reasonable assumptions about exogenous factors that greatly
simplify analysis.

A

12

R e g i o n F o c u s • Wi n t e r 2 0 0 6

When comparing the economic performance of nations,
economists often look to the structure of government. Places
with healthy economies tend to have well-defined property
rights, advanced legal infrastructures, and democratic governance. Economists have labeled such factors “institutions,” and
a major area of research is finding ways of isolating the differential effects such institutions have on economic performance.
But isolating these effects can be complicated. For instance, it’s
possible that good economic performance leads to the development
of good institutions (reverse causation) and that past institutions
tend to affect present institutions.
One way out of this dilemma
has been to use instrumented
regression. The actual definition of
instrumented regression is fairly
technical, but the basic idea is simple: Find an exogenous condition
that is correlated with the variable
of interest — in this case, institutions — and uncorrelated with any
other aspect of the economy. Then,
through the lens of the exogenous condition, one may examine
the effects of institutions.
For example, in a series of papers on colonial development,
economist Daron Acemoglu at the Massachusetts Institute of
Technology has argued that, during the colonial era, disease
conditions determined the type of institutions imperial
powers established in their overseas possessions. Since it seems
unlikely that disease conditions hundreds of years ago could
have some other effect on current economic performance, one
can attempt to ascertain the importance of institutions by
examining historical disease rates.
“Many economists and social scientists believe that differences in institutions and state policies are at the root of large
differences in income per capita across countries,” write
Acemoglu and two co-authors in a paper published in 2001.
“There is little agreement, however, about what determines
institutions and government attitudes towards economic
progress, making it difficult to isolate exogenous sources of variation in institutions to estimate their effect on performance.
[We argue] that differences in colonial experience could be a
source of exogenous differences in institutions.”
At their core, many economic debates focus on whether to
call a variable exogenous or endogenous. Does democracy promote economic growth? Does capital punishment deter crime?
The most reliable answers come from models in which economists have properly decided what to put in — or leave out. RF

ILLUSTRATION: TIMOTHY COOK

BY E R I C N I E L S E N

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RESEARCHSPOTLIGHT
Should We Worry about the Current Account Deficit?
BY A A RO N ST E E L M A N

portionate share of its growing income on imported goods
y most standards, the American economy looks pretty
and services,” Levey and Brown write.
strong. Gross domestic product (GDP) increased
Under the second scenario, the current account deficit
roughly 3.5 percent in 2005, the unemployment rate fell
results from the difference between total investment in the
to about 5 percent, and inflation remained relatively tame.
United States and domestic savings. But Levey and Brown
Still, some worry that those good data mask a more
argue that neither savings nor investment is well measured.
important truth — that the United States is becoming a
“Capital gains on equities, 401(k) plans, and home values are
heavily indebted nation. These skeptics point to the growing
excluded from measurements of personal savings; when they
current account deficit, which measures the gap between
are added, total U.S. domestic savings is around 20 percent of
what Americans earn and spend abroad. For 2005, the curGDP — about the same rate as in other developed counrent account deficit was roughly 6 percent of GDP. Total net
tries,” they write. (Of course, if home prices decline, as many
foreign liabilities now amount to roughly 25 percent of GDP.
analysts predict, this would weaken the case made by Levey
These figures are large by historical standards. But are they
and Brown.) On the investment side, “intangible” investnecessarily bad? Should we worry about American’s growing
ments, such as on-the-job
current account deficit?
training and new-product
In a recent paper in Foreign
development, are not included
Affairs, David Levey, formerly
“The Overstretch Myth”
in the national account,
the managing director of
even though they are large
Moody’s Sovereign Ratings
by David H. Levey and Stuart S. Brown.
and growing.
Service, and Stuart Brown,
an economist at Syracuse
Foreign Affairs, March/April 2005,
The third approach focuses
University,
argue
that
on international capital moveAmerica’s foreign debt poses
ments. Levey and Brown
vol. 84, no. 2, pp. 2-7.
little threat to the United
predict that, as the U.S. econoStates. Indeed, they claim that
my continues to grow, it will
the current account deficit is increasing largely because of
become an increasingly attractive place for foreign
the strength of the U.S. economy.
investment from China, India, and other developing
Let’s consider why we might be concerned about
countries. This could generate high current account deficits,
America’s foreign debt. By definition, a large current account
but the reasons would hardly be cause for concern.
deficit means that foreign investors and governments are
In a response to Levey and Brown that appeared in a
holding substantial dollar-denominated assets. Should a few
subsequent issue of Foreign Affairs, economists Brad Setser
big holders of these assets decide that they are no longer
of Oxford University and Nouriel Roubini of New York
desirable and sell them, it’s possible that this could set off a
University take a much less sanguine view. They argue that
panic, resulting in a plummeting dollar, rising interest rates,
foreign central banks — mostly in Asia — are not buying
and a shrinking U.S. economy. The net effect could be a globdollar-denominated assets because of strong conditions in
al recession. This scenario is similar to what happened in
the United States. Rather, they are doing so to keep the
Mexico and Thailand in the 1990s. But if it were to occur in
U.S. economy afloat — but that will eventually prove too
the United States, the effects would be much more significostly and come to an end. “Celebrating the United States’
cant because the American economy is so much larger.
real economic strengths while ignoring the real — and
Levey and Brown argue that the current account deficit
growing — economic vulnerabilities associated with
can be explained in terms of three different factors: trade,
unprecedented current account deficits is dangerous,”
domestic savings and investment, or the composition of
write Setser and Roubini.
global wealth. “In each case, though, the risks are far less dire
Ultimately, it’s not clear how big of a risk the current
than they are made out to be,” they argue. “And in many
account deficit poses to the U.S. economy. On this issue,
ways, chronic current account deficits reflect strong ecothere is no consensus among economists. So what should the
nomic fundamentals rather than fatal structural flaws.”
U.S. central bank — the Fed — do in the meantime?
Consider a trade-based account, the central part of which
Continue to focus on its core mission: maintaining price stais the relative strength of the U.S. economy. “In this view, the
bility. If there’s a relatively sure way to induce foreign
United States has a stubborn current account deficit because
investors to shed dollars and dollar-denominated assets, it’s
it grows faster than its trading partners and spends a disproto engage in inflation.
RF

B

Wi n t e r 2 0 0 6 • R e g i o n F o c u s

13

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POLICYUPDATE
Federal Terrorism Insurance Program Renewed
BY J O H N R . WA LT E R

n Dec. 22, 2005, President Bush signed legislation
renewing the Terrorism Risk Insurance Act of 2002
(TRIA), which otherwise would have expired Dec.
31. TRIA was enacted, as a temporary measure, in response
to the attacks of Sept. 11, 2001. It was intended to ensure
the availability of insurance covering businesses’ losses
resulting from any future terrorist attack. The renewal lasts
until 2007.
Following the Sept. 11 attacks, the price of terrorism
coverage rose. The media carried stories of lenders withdrawing support from commercial construction projects because
of these projects’ inability to acquire terrorism coverage at a
feasible price. Observers were fearful of possible macroeconomic effects if construction declined, especially in a then
recession-weakened business environment.
TRIA promised that the federal government would
reimburse property and casualty insurance companies for
most of the claims they paid, above a specified amount, due to
any future terrorist attack. It also required all commercial
property and casualty insurers to offer terrorism coverage to
their customers.
According to the text of the law, its purpose is to “ensure
the continued widespread availability and affordability of
property and casualty insurance for terrorism risk; and allow
for a transitional period for the private markets to stabilize
… and build capacity to absorb any future losses…” By these
measures, the law appears to have been successful. According
to a recent study by the Department of Treasury, the number
of businesses with terrorism coverage increased, and prices
declined, after TRIA was implemented.
The federal government provides reimbursement to firms
if the following two conditions are met: First, the terrorist
attack must produce at least, in aggregate, $50 million in
2006 and $100 million in 2007 in insured losses. Second,
before the Treasury provides any reimbursement the insurer
must have met a deductible which it pays out of its own funds.
Once the deductible is met the Treasury reimburses the
insurer for 90 percent in 2006 and 85 percent in 2007 of its
terrorist claims. The percentage deductible increased from
1 percent of all premiums collected by an insurance company,
immediately following the law’s enactment to 17.5 percent in
the program’s fourth year, 2006, and 20 percent in 2007.
At base, TRIA provides public backing for the liabilities of
private insurance companies, helping insurers to meet their
obligations to their policyholders. Such government backing
is not unusual. For example, the Federal Deposit Insurance
Act of 1933 established the FDIC to back deposits held in
banks. What is unusual about TRIA is that it offers this backing free of charge, unlike the FDIC which charges premiums.

O

14

Region Focus • winter 2006

Since there are no charges associated with TRIA protection, the program provides a subsidy to insurers — and if the
commercial insurance market is competitive, to policyholders
as well. When the government provides a subsidy, economists
worry that too much of the subsidized good will be produced.
Given the subsidy of terrorism insurance, companies may
take less account of the danger of terrorist attack than they
should when making important business decisions. Too many
buildings may be built in risky locations, and too little effort
may be devoted to building structures that would withstand
an attack, or to investing in security efforts. When all such
decisions are combined, the final effect could be greater
exposure to losses due to terrorist attack than would be the
case without the subsidy.
The government could limit these distortions by charging
risk-adjusted premiums for the insurance coverage it provides. (It’s worth noting that this would not solve the problem
entirely. Even if it were priced, government-provided terrorism insurance would likely produce some market distortions.)
The FDIC, for instance, charges higher premiums to banks
judged more likely to fail. By doing so, the subsidy is reduced.
Why does TRIA not include a provision for risk-adjusted
premiums? While the legislative history of the law is unclear
on this point, there are several possible reasons. For instance,
determining the risk could be quite difficult — perhaps more
difficult than determining the risk of bank failure. How much
more subject to terrorist attack is a building in New York than
one in Atlanta, or in Peoria? No one knows the answer
for sure, but a risk-adjusted premium must account for
such differences.
Still, most analysts think that terrorist attacks are more
likely to take place in large cities than in small ones. This has
important implications. Economists have argued that there
exist large economic benefits to bringing workers together in
a concentrated area. But given that terrorist attacks are more
likely in large cities, people have reason to avoid these locations. This could impose significant social costs. If TRIA
makes locating in large cities more desirable, some of those
costs could be offset.
On balance, then, the effects of the federal terrorism
insurance program are unclear. It almost surely has distorted
some firms’ decisionmaking about construction and security.
At the same time, it may have kept some firms from fleeing
major metropolitan areas, despite the advantages of being
in those cities. A fuller examination of its costs and
benefits awaits.
RF
John R. Walter is a research economist at the Federal
Reserve Bank of Richmond.

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AROUNDTHEFED
Another Reason to Keep Inflation in Check
BY D O U G C A M P B E L L

“Avoiding the Inflation Tax.” Huberto M. Ennis, Federal
Reserve Bank of Richmond Working Paper No. 05-10,
October 2005.

“Changes in the Federal Reserve’s Inflation Target: Causes
and Consequences.” Peter N. Ireland, Federal Reserve Bank
of Boston Working Paper No. 05-13, August 2005.

ven people who don’t pay much attention to the
workings of the Federal Reserve System have a vague
awareness that part of the institution’s job is to stabilize
prices. High rates of inflation, it is largely taken for
granted, spell problems for the economy. But why
precisely is that so?
One of the chief reasons is thought to be the socalled “inflation tax.” In times of fast-rising prices,
money loses value — a dollar at some time in the future
probably will buy less of the same good than it does
today. In this environment, consumers begin to expect
that prices will continue to rise. A rich economic literature, pioneered by the early neoclassical economist
Irving Fisher, posits that consumers may be in a hurry to
avoid what they presume will be even higher prices in
the near future.
Pinning down this intuition in a more formal manner
has been elusive, however. Economists have been largely
unable to build mathematical models that demonstrate
the potential harm caused by the inflation tax. In fact,
many models suggest that the welfare costs of high inflation are relatively small.
In a recent article, Richmond Fed economist
Huberto Ennis sets out to directly test Fisher’s hunch
that the inflation tax incites people to spend their
money with undue haste. His model differs from previous ones in that he tries to align the interest of buyers
and sellers to more accurately reflect inflationary pressures on both of them.
What Ennis found is that consumers settle for lowerquality goods, particularly for goods they buy
infrequently. Rushed, consumers have no patience for distinguishing between high-quality or low-quality goods —
it is too costly to spend much time searching for the best
product in an environment where money is losing value.
Such behavior could make the economy less efficient,
Ennis says. If people are willing to buy goods without
spending the usual amount of effort finding the best
quality, then producers may anticipate that they no
longer need to produce goods of decent quality.
“Inflation distorts in many important ways the pattern
of transactions of individuals in a monetary economy,”
Ennis writes. Ennis’ model doesn’t look at the producer
side of the equation, but his findings on buyers’ behavior
suggests it’s worth a look.

W

E

ith the change in leadership of the Federal Reserve
System, economists have been weighing in on the
relative merits of a rules-based or discretionary-based
monetary policy. The rules-based school of thought favors
an explicit inflation target. The discretionary school prefers
more of an implicit target of between 2 percent and 2.5
percent, much as the Fed operated under the leadership
of outgoing Chairman Alan Greenspan.
Peter Ireland, an economist at Boston College and a
consultant to the Boston Fed, created a model that aims to
determine the Fed’s implicit inflation target from 1959
forward. What’s striking is the wide variability. Ireland
found that the implicit target bounced around a lot, from
about 1.25 percent in 1959 to more than 8 percent in 1974 and
1980. Without these target changes, Ireland says, inflation
never would have topped 4.5 percent. By attributing most of
the rise and fall in inflation to Fed policy, “the results
confirm that to a large extent indeed, postwar U.S. inflation
is a ‘monetary phenomenon.’ ”

“Accounting for the Secular ‘Decline’ of U.S. Manufacturing.”
Milton Marquis and Bharat Trehan, Federal Reserve Bank
of San Francisco Working Paper 2005-18, September 2005.

espite a barrage of news stories that suggest domestic
manufacturing is dying off, manufacturing continues
to hold a central place in the national economy. Since the
1950s, manufacturing output has remained constant
relative to overall GDP, for example, even as manufacturing employment and prices have dropped. This has fueled
a debate about the relative causes: faster productivity
growth in manufacturing or increased imports.
In a recent paper, Milton Marquis of Florida State
University and Bharat Trehan of the San Francisco Fed argue
that U.S. consumers hold the key to understanding this
puzzle. They develop a model with two key characteristics:
faster productivity growth and the unwillingness of households to substitute between services and manufactured
goods. Together, the authors argue, these features of the
model “can go a long way to explain” developments in U.S.
manufacturing over the past 50 years. However, the model
cannot account for several notable developments —
for instance, the sizes of manufacturing employment
drops in the late 1960s and early 1970s and again in the
early 1990s.
RF

D

winter 2006 • Region Focus

15

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Three generations of SandtownWinchester residents: Janice
Walker (center, top row), her
grandchildren (clockwise from
left) Kiera, Ashley, Cortany,
Mikeal, Shanna, and Travon, and
her mother Minerva Briscoe.

Family Portrait
Life is hard in one of Baltimore’s toughest neighborhoods.
But for Janice W
alker, it’s home
BY CHARLES GERENA

16

Region Focus • winter 2006

specific examples. We urge you to keep
this in mind when reading this article.
The family we profile is in many
ways representative of households in
Sandtown-Winchester and other
communities throughout Baltimore.
But, like all families, their story is
unique.
Finally, we would like to thank
Janice Walker and her family. They
have very generously shared their
thoughts, feelings, experiences, and
recollections with us, so that we can
share them with you.

S

heltering herself from the chilly
November winds, Janice Walker
stands behind a gated screen
door on the concrete stoop of her
house. She awaits the arrival of her six
grandchildren from the community
center across the street. It’s almost
dinnertime and it gets dark early.
Janice keeps watch over these children as well as many other
neighborhood kids who hang out at
her small three-story rowhouse every
evening until their parents pick them
up. They live in SandtownWinchester, whose 72 square blocks
in west Baltimore are home to some
of the city’s most economically

PHOTOGRAPHY: SCOTT SUCHMAN

Editor’s Note: The following article
on urban poverty approaches the topic
from a different angle than most articles
that appear in Region Focus. It does
not explicitly discuss the public-policy
issues at stake or proposals for reform.
Instead, it tells the story of one family
in Baltimore’s Sandtown-Winchester
neighborhood. This approach, we hope,
will provide a broader understanding of
the problems facing the urban poor.
When tackling difficult issues such
as urban poverty, one must be careful
not to draw broad conclusions from

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

they can, plus Janice has medical
insurance and receives food stamps
and some cash assistance from the
Baltimore City Department of Social
Services. But she is laid off from her
job every summer, so her compensation falls below the poverty threshold
of $27,159 for a family of seven.
Janice puts off dealing with an
inner ear problem she developed a
few years ago or following up on a
diagnosis of heart palpitations.
Getting a GED or seeking opportunities beyond the backrooms of Johns
Hopkins’ dining halls isn’t on her
radar screen, either.
She says she’s tied up with the kids
right now, so she doesn’t think much
about what she’d like to do, other
than maybe learn how to drive. Her
sister, Causion, says otherwise.
“There are times when [Janice] cries
because she’s tired. She wants a break
and wants to do the things that we
get to do.”
Janice also chooses to remain in
Sandtown-Winchester. In 2000, this
African-American community had 52
percent of working-age adults not in
the labor force. The median household income was $11,000 less than
the city median of $30,000 a year,
and one-third of homes are vacant.
Single women head 64 percent of the
households in Sandtown, while only

half the adults are high school graduates. The neighborhood is poor, and
that’s what makes it an affordable
place for Janice to live.
“I’m not going to go somewhere
and live beyond my means,” she
explains. Janice has a checking
account and a small nest egg to cover
home repairs, and no credit card
debt. She owns no car, relying instead
on friends or public transit to get
around. “I can afford this house ...
and still manage to get extra things.”
She has a cell phone, for example.
Janice’s family is close by. Her
mom and her sister Cynthia are less
than a mile away on Division Street.
Many of her friends live in the neighborhood, and she has come to depend
on local resources like the health clinic on Division and the community
center across from her house on
Mount Street. This past holiday season, someone submitted her name to
St. Gregory the Great Catholic
Church to receive a basket for
Thanksgiving.
Her home is part of a revitalization effort that has slowly spread
through Sandtown since the late
1980s. Even so, the neighborhood has
a long way to go. Police cars patrol
the streets while video cameras
mounted atop light poles keep watch
over hot spots. This fall, officers

Baltimore/Sandtown-Winchester
The 72 square blocks that make up Sandtown-Winchester are home to some of the
poorest streets in Baltimore.

83

BALTIMORE
Sandtown-Winchester

695
95

I n n er

Ha

rb
or

distressed streets. Janice has lived
here almost her whole life.
By the time everybody gets home
at 7 p.m., there are 10 children
crammed into the small living room.
Most of them squeeze into two
leather couches around the TV to
watch “Teen Titans.” Mikeal, 7, sits
on the floor beside a small round
table while his older sisters, 13-yearold Kiera and 15-year-old Ashley, help
Janice prepare dinner.
Tonight’s meal is spaghetti and
meat sauce. Each person gets a bowlful of pasta and a slice of garlic bread,
along with a 32-ounce cup of punchflavored soda. Four children eat at a
wooden table tucked into one corner
of the kitchen while six gather around
a glass table with Janice. There are
only four seats to go around in the
dining room, so some of the kids use
green, stackable patio chairs.
Janice Walker, 50 years old, makes
$12.25 an hour fixing sandwiches at
the Terrace Court Café at Johns
Hopkins University, working nine
months out of the year. She became a
mother at 16 and never finished high
school. She describes her first husband as violent; her second died
suddenly more than six years ago.
Janice’s son, 33-year-old William, is
serving a 35-year sentence for murder.
Her 26-year old daughter, Cynthia, is
a single mother of six who has been
unable to hold down a job. Many of
Janice’s grandchildren have been in
and out of foster care and none of
their fathers is consistently in the picture. So, Janice feeds, clothes, and
shelters six of her grandchildren,
ranging in age from 6 to 15 years old.
Three are from her son’s side (though
Mikeal is actually not a blood
relative) and three come from her
daughter.
For Janice, it was a choice between
making room in her rowhouse in
Sandtown-Winchester and letting the
kids go into foster care. “I don’t think
anyone with a heart and a conscience
could do that,” says Helen Causion, one
of Janice’s three sisters. “Janice wouldn’t
have been able to sleep at night.”
Family members pitch in whenever

winter 2006 • Region Focus

17

scared Janice’s mother out of her
sleep after mistakenly kicking in her
door. Janice makes sure that the kids
go straight from school to home to
the community center, keeping them
off the streets where she and her sisters saw their share of drug dealing
and spilt blood over the past 40 years.
Janice knows she’s poor and has
learned to accept that. “You’re used
to not having certain things. But you
make sure you have your basics,” she
explains. “With me, I make sure that
I pay all my bills. Once I get all of my
bills out of the way, then I see where
I can go from there. If there is something the kids need, I’ll see what I can
do. If I can’t pay my mortgage and my
gas and electric bills, that’s going to
be a problem. That means I have to
get another job.”
This is Janice Walker’s life. It is
filled with hostile surroundings and
heartbreaking choices. It is ultimately
about the difficulties in breaking the
grip of poverty.

***
Janice has just finished loading
a cart with tuna salad sandwiches
when a co-worker pops her head
into the kitchen. She asks if Janice
can prepare today’s special — a
turkey chipotle sandwich — for the
Megabytes dining area upstairs.
“Yeah, how many do you need?”
Janice replies.
“Ten — we don’t know how well it
will move.”
Janice reluctantly fills the order.
“That’s frustrating,” she mumbles to
herself. A few minutes later she is told
to whip up another last-minute order
for several smoked turkeys on focaccia
bread.
Then Janice’s cell phone rings. It’s
the nurse at Gilmor Elementary, one
of the four schools that serve
Sandtown-Winchester. Her granddaughter Kiera has a headache and
needs someone to go home and get her
some medicine. (Baltimore schools
cannot administer medications without a parent’s written consent.)
Janice asks the nurse to put Kiera
on the phone. At first, she angrily
18

Region Focus • winter 2006

tells Kiera that no one is For more than two decades, Janice has worked
home to get her medicine behind the scenes at the dining facilities of
and she can’t leave work to Johns Hopkins University.
do it. “I’ve got to make a living,” she tells her. After
listening for a bit, she offers
to call a neighbor, but that’s
not good enough. Kiera
hangs up.
Such
confrontations
come with the territory for
a grandmother rearing six
children on her own.
“Sometimes I have to
remind them who’s the
boss,” Janice says. “But, on
the same token, I let them
know they can come to me
and talk to me about anything. They tell me stuff
that other kids’ parents
don’t hear.”
For example, Janice talks
with Kiera and her sister
Ashley about boys. She conwhat he is doing and starts looking
stantly tells the girls not to be
through the sales sheets on the table.
pressured into having sex. “Don’t let
“Out of these pictures, what can you
nobody tell you that they’re crazy
pat?” Janice asks Travon, trying to get
about you and madly in love with you,
him to focus. “What can you pat?”
because it doesn’t work like that,”
she repeats, patting herself on the
she says. She speaks, of course, from
head. “That’s a pat.” Travon looks
experience.
blankly at his worksheet and points at
Janice also talks with her granda cat, but he calls it a dog. Then he
children about the importance of
calls it a map.
education. She hopes they will listen,
even though she herself never liked
school and chose to stay home at 16
***
with her newborn son instead of earnJanice and her three sisters were
ing her high school diploma.
raised in and around Sandtown“The kids are always telling me
Winchester. Today Janice lives only a
that they want these high-priced
few blocks from her childhood
jobs,” Janice says. “Cortany talks
homes.
about being a doctor. Well, she has to
Growing up, both of Janice’s pargo to school to be a doctor. I tell
ents worked. Minerva Briscoe,
them that so that they’ll know that if
Janice’s mother, says that her husthey don’t finish school, they’re not
band’s bouts with alcohol abuse often
going to be able to accomplish what
forced her to carry the ball, however.
they want.”
“You couldn’t find a better person
Janice shows off the certificates
than my husband Clarence,” Briscoe
earned by each child, proud of what
says. “But he just loved to drink, he
they have achieved. “When Travon
loved to drink. ... It got to be tiring.”
graduated first grade, I felt really
Janice’s father soon left the family.
honored,” she recalls. “All of my fussSo Briscoe cooked homemade dishes
ing wasn’t in vain.”
at a popular local restaurant called
During a recent homework sesCovington’s, then worked at Western
sion, Travon quickly loses interest in
Electric. For the last 25 years, she has

PHOTOGRAPHY: LARRY CAIN

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with a gun, shooting the other in the
head. “People told me not to go up
there, but I wanted to see,” she says.
“This man lay out there. As he was
breathing, blood was gushing up like a
fountain out of his bullet wound. I
was scared to go out of the house for
months — all I could see was this
man. I could imagine how people
could be traumatized by seeing different things like that.”
While the sisters did what they
could to keep an eye on each other,
Janice assumed the role of mother hen
since she was the oldest. “She made
sure that we all got off to school
because my mom had to leave for
work early,” Causion recalls. “She did
everything that my mom would have
done. ... She was raised to protect.”
But she was still a kid. Janice
admits to being “sneaky” as a teenager.
Her mother describes Janice as being
good-hearted, but temperamental and
stubborn. Briscoe begged Janice to
talk to her about sex, to no avail. “I
was like, ‘How am I supposed to talk
to her about that?’ ” Janice recalls.
“And I didn’t go to her, either. That’s
where I made my mistake.”

and be a mother, if you want somebody to watch the kid you’ll have to
pay for it.’ ” Briscoe stopped paying
for a babysitter and, eventually, Janice
dropped out of high school.
Janice never returned to school
and is the only one among her sisters
without a diploma. Helen Causion
and Sharon Adams earned degrees
from Coppin State University. Today,
Causion is an executive assistant at
Johns
Hopkins
Community
Physicians and lives in Owings Mills,
an affluent community north of
Baltimore. Adams works at Bank of
America as an analyst and lives in a
predominately white neighborhood
in northeast Baltimore. The third
sister, Cynthia Briscoe, graduated
from Carver Vocational-Technical
High School and currently works at
the state’s Department of Juvenile
Services. She still lives in Sandtown.
Janice moved out of her mother’s
house in the mid-1970s. She never
married the baby’s father, though he
tried to help out for a while.
Eventually, though, he became part of
Sandtown’s drug scene and wasn’t in
any shape to help anyone. (These

***
In 1971 at the age of 16, Janice
began dating an older boy nicknamed
Burl who she had a crush on. A few
months later, Janice knew something
was up.
“I started getting sick. I couldn’t
eat and I couldn’t stand the smell of
food,” Janice says. “I had no idea what
was going on [but] my mother knew
exactly what was wrong.” She asked
one of her sisters if Janice was sleeping a lot and throwing up in the
morning. When she said yes, her
mother knew that Janice was pregnant. “That was the worst thing I
could imagine.”
William Lewis was born in July
1972. Briscoe paid a neighbor to
watch him; she wanted Janice to finish high school. But Janice kept
skipping class to spend time with the
baby and his father. “When I found
out that bit of news, I told her, ‘Being
that you’d rather be home with him

Poverty and Education
Almost half of the adult residents in SandtownWinchester haven’t earned a high school diploma,
while less than 5 percent have gone on to college
and graduated.
Educational Attainment, Population
25 Years and Over
83.8

80
68.4

70
60

P ERCENT

been a cook at a home for abused and
neglected children in Catonsville.
“Our father wasn’t in the home
much,” Helen Causion says. “He left
my mom to raise four girls on her
own. We all learned to become independent enough to look out for one
another.”
Back in the 1960s, Sandtown was
just beginning its decline. Up to that
point, it was one of Baltimore’s working-class communities for African
Americans. Music spilled onto the
streets from various night clubs and
venues, including the Royal Theater
where performers like Billie Holliday
and Louis Armstrong played. (In fact,
Holliday was born in Sandtown.)
Briscoe remembers having a good
time at the dance halls along
Pennsylvania Avenue.
Then the assassination of Martin
Luther King Jr. in April 1968 sparked
riots throughout the nation.
Baltimore was especially hard hit, particularly in the city’s western
neighborhoods like Sandtown. The
riots accelerated the flight of affluent
residents to Baltimore’s relatively
stable suburbs and exacerbated
economic problems that were already
developing in some communities.
Briscoe tried to shield her daughters from the growing criminal
activity. Before it started getting dark,
they all had to be back in the house.
If anyone strayed away from the
immediate area, she would come
looking for them.
Briscoe couldn’t protect them from
everything. Drug deals happened
right outside their window. “We still
saw a lot and experienced a lot at a
young age,” Causion recalls. “We’ve
seen people’s bodies laid out on the
street and covered with sheets until
the people from the morgue came to
pick them up. ... We’ve had several relatives killed. [Our uncle] was killed by
the police in a shoot-out right in back
of our house.”
Briscoe didn’t let her daughters see
their slain uncle. But she saw something just as bad. Two men standing
on a street corner got into an argument. One decided to settle things

54.1

50
40
31.4

30
19.1

20
10
0

4.9

SandtownWinchester

Baltimore City

Maryland

High School Graduate or Higher
,
Bachelor s Degree or Higher

NOTE: Sandtown-Winchester data is for Census Tracts 1501,

1502, 1601, 1602, 1603, and 1604, some of which cross over into
surrounding communities.
SOURCE: U.S. Census Bureau, 2000

winter 2006 • Region Focus

19

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Poverty and Income
Households in Sandtown-Winchester earn
substantially lower amounts than those in
Baltimore as a whole and Maryland.
Median Household Income
60

D OLLARS (I N T HOUSANDS )

52,868

50
40
30,078

30
20

18,776

***

10
0

SandtownWinchester

Baltimore City

Maryland

NOTE: Sandtown-Winchester data is for Census Tracts 1501,

1502, 1601, 1602, 1603, and 1604, some of which cross over into
surrounding communities.
SOURCE: U.S. Census Bureau, 2000

days, Burl visits Janice on occasion to
fix things around the house.)
Then in 1978 she married a man
named George. Moneywise, it was
perfect timing. “Financially, I didn’t
want for anything,” Janice says,
although she continued working.
Since George didn’t have any kids
of his own, Janice tried to get pregnant again. Janice gave birth in 1979
to a daughter, Cynthia, named after
her sister.
Meanwhile, Janice’s marriage was
falling apart. “George was a real violent person. ... He was one of those
controlling men, and he was much
older than I was.” They divorced
in 1982.
Janice and her two children moved
into their own place on Division
Street, right down the block from her
mother. They wouldn’t be alone for
long. Her uncle’s two sons moved in,
then her sister Cynthia when she lost
her home to a fire, then her stepsister
Pam when she was evicted from her
house. Janice paid the bills by taking
on multiple jobs.
Her co-workers at Johns Hopkins
recall that Janice was difficult to work
with when she started there more
than 20 years ago. Longtime friend
Gladys Burrell says she was put off
when she met Janice. “Let me put it
this way — saying she was a handful is
20

putting it mildly. She didn’t take any
mess,” Burrell recalls. Now, “she has
mellowed out so wonderfully. I
prayed that she would calm down.”
In 1990, Janice re-married to a
man named Larry Walker. In 1999,
she was planning his funeral. He
choked to death during a diabetic
seizure. “It just tore her to pieces,”
Burrell describes. Janice still visits
Larry’s grave.

Region Focus • winter 2006

Janice moved into her home on
Mount Street in 2004. She tried to
buy one of the houses developed on
Riggs Avenue by a partnership of the
Enterprise Foundation and a coalition of Baltimore churches,
hospitals, and union organizations
called B.U.I.L.D. Each two-story
house has large rooms and patches
of grass in the back and front yards
instead of concrete, perfect places
for the children and Janice’s cookouts. But the homes were snatched
up before she could get one.
So, Janice settled on the Mount
Street home, built in 1920 and sold
by B.U.I.L.D./Enterprise Nehemiah
Development for $71,500 through a
special first-time homeowner’s program. It has four bedrooms, two
bathrooms, and a small backyard,
including a tiny brick patio with just
enough room to hold a grill.
When she bought the house,
Janice assumed that its main
residents would be herself and three
of her grandchildren — Cortany,
Shanna, and Travon, now aged 10, 8,
and 6, respectively.
These are the children of her
daughter, Cynthia. They first came
to live with Janice five years ago,
when Cynthia lost her job and started falling behind on her rent. Janice
and one of her sisters gave her
money, but they later found out that
it was barely enough to cover pastdue payments that totaled in the
thousands. Cynthia eventually
received an eviction notice, forcing
Cortany, Shanna, and Travon to
find refuge with various friends
and relatives.

Although they had a roof over their
head, Cynthia’s kids weren’t in the best
shape and Cortany — then 5 years old
— was missing kindergarten.
Baltimore’s Department of Social
Services intervened, taking the kids
away from Cynthia and placing them
with temporary foster families.
Cortany and Shanna — just 3 years old
at the time — stayed with one family
while 1-year-old Travon went to a different family. “The boys don’t go with
the girls,” Janice says.
Janice didn’t know how bad things
had gotten until her daughter called
her. “She said, ‘Ma, they’re taking the
kids.’ I was like, ‘Huh? Who took the
kids?’ ” Janice contacted the child protective services division and was told
that Cynthia had said she didn’t know
where Janice was. Within days, Janice
was at the courthouse to claim her
grandchildren.
“I was sitting there in the hallway,
and Shanna and Cortany came flying
towards me because they saw me,”
Janice recalls. They immediately burst
into tears. “Cortany said, ‘We don’t
know where Travon is. I kept telling
them to call you.’ ” Travon did show up
minutes later, but they were still frightened. “They said, ‘Don’t let us go,
grandma. Don’t let them take us back.’
The kids were stuck to me like I was a
sticky trap. ... They wouldn’t let me go
to the bathroom or nothing.”
Janice obtained custody of the
three kids, bringing them home to live
with a boyfriend whom they called
“Mr. Charles.” But he wasn’t crazy
about the idea of three youngsters living with him; his own children were
already grown and out of the house. “It
was too much madness for him,” Janice
explains, so the couple went their separate ways, with Janice eventually
settling in her current Mount Street
rowhouse.
Janice hopes things will get better
for her now 26-year-old daughter.
Cynthia has taken parenting classes
and says she is going to school, though
she hasn’t said what she’s studying. She
remains unemployed. “Cynthia hasn’t
finished school, but there is so many
things she could do,” Janice says. “She

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

***
Three more children joined the
Janice Walker household just last
year, these from her son’s side of the
family tree.
William, 33, had been in and out of
jail ever since he was a teenager. Helen
Causion, who took him in for a while,
says: “William was defiant and out of
control. He wouldn’t go to school
because he admired the guys who were
out on the corner selling drugs and
getting involved in all kinds of criminal
activity.” She believes that William and
Cynthia were enticed by the fast
money of drugs and crime. “You know,
there’s two things that come with
that — jail or death. But they didn’t
grasp that.”
William’s home today is with the
Maryland Department of Public
Safety and Correctional Services. He
has served 12 years of a 35-year sentence for gun possession and
second-degree murder. After his 1993
conviction, Ashley, Kiera, and Mikeal
(now 15, 13, and 7, respectively)
moved in with their mother, Carrie.
(William and Carrie conceived
Ashley and Kiera in between jail
terms, according to Causion,
while Mikeal is the product of a
relationship between Carrie and
another man. Carrie and William
are now divorced.)
About a year ago, Carrie lost her
job and apartment due to “circumstances beyond her control,”
according to Janice, who agreed to
take custody of the children
because their other grandmother
couldn’t take them in. Janice
believes they would have been
split up between different foster
families if she didn’t step up,
making it much harder for Carrie to
get them back.
That is how six children ended
up sharing Janice’s Mount Street
home. Crowding is a bit of a prob-

lem but, mercifully, lead paint isn’t.
Three of her grandchildren had elevated levels of lead in their blood from
their previous home.
In addition to other pluses, the
home is across the street from the
Sandtown-Winchester Community
Center. This imposing building was
once part of Coppin State University.
Then it was one of the first renovation projects of Community Building
in Partnership, a coalition of local residents, city officials, and the
Enterprise Foundation formed in the
early 1990s. Now CBP operates the
center, which remains under city ownership. Janice loves it.
“The children go over there and
learn, play, and mingle with other
kids,” Janice describes. Also, “sitting
down to do homework with six kids
was hard.”
Within the building are a variety of
after-school programs, as well as a job
readiness and placement program, and
a Neighborhood Service Center that
administers social services from the
city of Baltimore. When Janice
Walker broke her leg six months ago,
a community center employee pitched
in by taking her back and forth to the
doctor and doing other things.

***

On a brisk fall morning, Janice
takes the day off from work to tend
to “family matters.” Kiera and Mikeal
have a date with a dentist to check on
their fillings. Then, they will go with
Ashley for a trip downtown to the
courthouse. A judge will determine
whether the three children will be
returned to the custody of their
mother, Carrie, William’s ex-wife.
But first, they all have to get to
Total Health Care in time for a 9 a.m.
appointment. Janice hustles the kids
out of the door at 8:30 a.m. so they’ll
have plenty of time to walk the dozen
or so blocks to get there and beat the
crowd. The community health center
on Division Street is funded with
public grants.
Janice and the kids take Riggs
Avenue most of the way to Division
Street. They’re too busy clowning
around and laughing to dwell on the
stark contrasts between new housing,
rundown buildings, and vacant lots
that await redevelopment. One of the
kids does make a big production out
of spotting a dead rat in a gutter.
“Don’t touch that,” Janice admonishes. “It could have disease. Don’t ever
touch anything like that with your
bare hands.”
Nor do they pay much attenPoverty and Labor Force
tion to a group of young men
standing in the middle of an interParticipation
section. But the men notice the
Sandtown-Winchester residents seek work at much
two adolescent girls. Kiera is
lower rates than their counterparts across the city
wearing jeans and a pink jacket
of Baltimore and Maryland.
with grey stripes on the sleeves.
Her hair is neatly braided, though
Labor Force Participation Rate,
she complains that it feels too
Population 16 Years and Older
tight on her head. Ashley is also
80
67.8
wearing jeans plus a pair of sneak70
56.6
ers with rust-colored accents that
60
48.0
50
coordinate with the brown and
40
white stripes on her layered shirt.
30
On top of the shirt is a jeans jack20
et that is cut off at the
10
midsection. Her hair is tightly
0
pulled together to form puffs on
SandtownBaltimore City
Maryland
Winchester
either side of her head.
“Good morning, ladies,” a few
NOTE: Sandtown-Winchester data is for Census Tracts 1501,
of the men say. Janice replies with
1502, 1601, 1602, 1603, and 1604, some of which cross over into
surrounding communities.
a terse “good morning” without
SOURCE: U.S. Census Bureau, 2000
making eye contact. Once they

P ERCENT

knows how to do hair. She can do tattoos.” (In fact, Janice has a tattoo done
by Cynthia, as do two of her other
grandchildren, Kiera and Ashley.) Still,
Janice is not overly optimistic.

winter 2006 • Region Focus

21

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

22

Region Focus • winter 2006

a few things. The store isn’t much to
look at from the outside, and it’s even
dingier inside. Bulletproof glass
divides the small store in half, leaving
a narrow space for customers on one
side and a narrow counter area for the
two Asian workers on the other side.
The walls behind the counter are
filled with goods, mostly shelves with
various permutations of alcoholic
beverage. A mini-ATM is crammed
into one corner and several video
games line the adjacent wall, including a video slot machine that has the
complete attention of an older man.
While Janice withdraws money
from the ATM, the kids occupy
themselves. Mikeal fiddles with the
large, bright buttons of a casino game
without putting in any money, while
the girls decide what they can buy
with the $5 they have to spend. They
ask Mikeal what he wants and end up
buying a bottle of soda, candy, and an
“onion pickle” stored in a plastic bag.
While riding the train and bus, the
kids pass around the pungent slices of
pickle to eat.
It takes about an hour to get from
Janice’s home in Sandtown to the
Juvenile Justice Center downtown.
The subway ride to the Lexington
Market stop is pretty quick, but it
takes awhile to transfer to the #15 bus
that goes to the courthouse.

Music blares from a clothing store
across from the bus stop, prompting
Ashley and Kiera to show off their
latest moves. Janice recognizes a few
of the tunes, but leaves the monkey
business to the girls. “Wiggle it, wiggle it, and jiggle it,” Ashley keeps
singing, long after the tune has
stopped playing.
As the kids’ boredom grows, they
start playing around with the onion
pickle because nobody wants to get
the juices in the bag on them. At one
point, Ashley tries to slip a piece of
pickle into Janice’s mouth. Janice
pushes Ashley away as soon as the
pungent taste hits her mouth. She
warns them that they’ll go back home
and miss seeing their mother, Carrie,
if they don’t calm down.

***

Janice meets up with Carrie on the
second floor atrium of the Juvenile
Justice Center. They sit on one of the
wooden benches near the windows
overlooking North Gay Street.
Others are sitting nearby or milling
around, cooling their heels until they
have to walk down one of the many
long corridors to the courtroom
where someone’s fate will be decided.
Carrie dotes on Mikeal, kissing
him on the forehead and checking his
ears to make sure they are clean. She
asks Ashley to get a wet tissue so
that she can clean him up, which
Poverty and Single Parenting
just makes her mad. Ashley defiSandtown-Winchester has a disproportionate
antly thrusts the palm of her hand
number of families headed by a single mom.
at her mother’s face and walks
toward the bathroom.
Families with Female Householder,
Ashley’s mood has changed
No Husband Present
completely. Until now, she has
80
been animated, outgoing, and full
70
64.4
of energy. But when she comes
60
43.8
50
back and hands over the tissue,
40
Ashley silently plops down on the
30
next row of benches. Her tattooed
20.6
20
back is turned from Carrie and
10
everyone else sitting behind her.
0
(The tattoo is Carrie’s name.)
Baltimore City
Maryland
SandtownAshley opens up a plastic groWinchester
cery bag full of papers and pulls
NOTE: Sandtown-Winchester data is for Census Tracts 1501,
out an orange report cover with
1502, 1601, 1602, 1603, and 1604, some of which cross over into
surrounding communities.
her name written across the front
SOURCE: U.S. Census Bureau, 2000
in big letters. She flips past a

P ERCENT

are beyond earshot, she disparages
the group for just hanging around all
day. “Why are they standing in the
middle of the street like that?” she
tells her grandchildren. “They need to
get a job.”
Even with these diversions, plus a
quick break to pass around a pack of
gum, Janice manages to get everyone
to the clinic with 15 minutes to spare.
The good news is that barely anyone
is waiting at the check-in desk or at
the dentist’s office upstairs. The bad
news is that Kiera’s Medicaid health
insurance hadn’t been renewed.
Without the coverage, the appointment will cost $40. Janice hasn’t
received her paycheck yet. The clinic
can send her a bill, but Janice decides
to reschedule the appointment
instead. Kiera’s mother, Carrie, could
soon be regaining custody, so Janice
figures the bill is her problem.
“It could be a year before it gets
done,” Kiera complains, disappointed
that only Mikeal will see the dentist
today. Janice replies that her mother
will make sure that her teeth are
taken care of too.
“And why does it have to cost so
much?” Kiera whines. “Because the
doctors have to get paid for the work
they do,” Janice answers. “People
have to work to make money.”
After the dentist, Janice takes the
kids home for a quick breakfast
and a respite before heading to the
courthouse. Kiera and Ashley take
turns cooking up some scrambled
eggs and a couple of thick pork
sausages for everyone to eat.
Invariably, the smoke alarm goes
off and someone rushes to plug in
the box fan sitting between the
kitchen and the dining room.
Kiera makes a quick wardrobe
change and unties some of the
braids in her hair before the
family embarks on the long trip
ahead of them. They walk east to
the Upton/Avenue Market subway
station on Pennsylvania Avenue,
with the kids goofing around
loudly every step of the way.
Janice stops at a corner store to
make a quick withdrawal and buy

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

sweatpants, and shackles
around his ankles and
hands. He sits quietly on
a bench to the right of
the master, but flashes
a quick smile and waves
at his family in the rear
of the courtroom. Ashley
glares
back,
sitting
huddled against the
wall in the last row of
benches.
Seeing her father in
shackles is apparently
too much for Ashley to
bear. A short time after
leaving the courtroom, she slumps
down against the wall and starts
sobbing. Janice rushes over to
offer comfort while the others —
including her mother — watch from
nearby. She whispers softly to Ashley
for a little while and caresses her
face. Once she manages to get a
laugh or two from Ashley, she pulls
her up from the floor and tells her
it’s time to go on.
The group trudges over to the
next courtroom where Mikeal’s case
will be considered. While waiting in
the hallway, Ashley walks up to
Janice, stands nose-to-nose with her
and asks, “You’re going to miss me,
aren’t you?” Janice replies playfully
that she won’t miss her one bit, but
Ashley insists that she will and
throws her arms around Janice,
dragging her to one side.
The second case is over just as
quickly. The master rescinds an
order that made Janice the little
boy’s legal guardian. Carrie whisks
away the kids, who barely have a
chance to say good-bye to Janice
before they rush off to the subway.
Kiera and Mikeal will come back to
Janice’s house to live until the school
year is over, visiting their mom on
holidays and weekends. Ashley will
box up her stuff to move in with
Carrie right away. For now, it’s after
5 p.m. and everyone is starving
for dinner.
Janice is left alone in front of the
courthouse. It has been a long day of
sitting and waiting and nodding off.

Janice walks to her house with Kiera,
Ashley, and Mikeal to grab a quick
breakfast before heading downtown
for the children’s custody hearing.

But she is relieved that some
responsibility will be taken off of
her shoulders.
As the evening approaches,
Janice rushes back to the train
station on Charles Street to catch
the train home so that she’ll be
there when the other grandchildren
leave the community center. She
has worried all day about the kids
getting to the center safely and
talked to someone on her cell phone
a couple of times about it.
Walking back to her house,
Janice stops to talk to a couple of
boys sitting on the steps of the
makeshift church next door, a rowhouse converted for that purpose by
two simple additions: a wooden
cross attached to the front and
cling-on decals in the windows
that look like stained glass.
“The girls are going home to their
mother,” she tells them, so they
won’t be around as much to get into
arguments.
With that, Janice drags herself
up the steps and unlocks the security door. In the back of her mind is
following up with a doctor about
her dizzy spells and heart palpitations. Right now, she has to start
dinner to feed her charges and
other neighborhood kids. She’ll put
off taking care of her problems until
after Thanksgiving.
RF

winter 2006 • Region Focus

PHOTOGRAPHY: CHARLES GERENA

few pages of artwork and poetry,
then finds a blank page and starts
doodling.
Meanwhile, Carrie talks with
Janice about whether the kids will
stay with her so they can continue to
go to the same schools. Janice
reminds Carrie that the whole point
of her taking the kids was to give
Carrie time to get her life straightened out.
The family was told to be at the
courthouse at 1 p.m., but several
hours elapse before a lawyer finally
stops by to fill everyone in. The
details are still being worked out, but
it looks like there should be no problem transferring custody of the kids
to Carrie — she has a steady job at a
local dollar store and a place to live.
Privately, Janice doesn’t think Carrie
realizes what she is getting into.
The group takes a long walk to one
of the overbooked courtrooms and
waits for Ashley and Kiera’s case to
be heard (their case is separate from
Mikeal’s). They create such a loud
ruckus in the hallway that an officer
comes outside and tells them to be
quiet. That admonishment doesn’t
go over too well — Carrie wonders
out loud why the “rent a cop” was
harassing them.
Later, Carrie grabs Mikeal and
scolds him: “If you don’t cut it out,
you’re not getting anything from
me.” Mikeal whines and continues
acting up.
In the first juvenile court case
involving Ashley and Kiera, the
judge — called a master in this setting — must sign off on an order of
supervision that allows the girls to
live with their mother. The mother
must provide access to her home for
visits from social workers until the
supervisory period is over. Then,
they will go back to court in March
to finalize the transfer of legal custody from Janice.
The whole process seems quick
and painless, except for when
Janice’s son, William, is brought into
the courtroom in order to provide
his consent for the agreement. He
enters wearing a plain shirt and

23

I

t’s 9:15 a.m., Wednesday, Nov. 2,
inside the crowded news conference room at WRAL-TV,
Channel 5, the CBS affiliate in Raleigh.
Huddled around a bare table are 12
people – producers, reporters, and various other news employees. At one end
sits Steve Abbott, the assignment editor, tapping away at a computer
keyboard. Standing by the doorway are
three other reporters, notebooks in
hand, waiting to pitch their stories.
The WRAL team — motto:
Coverage You Can Count On — has
already aired three hours of local news
today, beginning with the morning
broadcast at 5 a.m. (In an unusual
relationship, WRAL also produces
newscasts at 7 a.m. and 10 p.m. for its
sister station, WRAZ-TV, the Fox affiliate.) Next up is a half-hour at noon.
Right now, the focus is on the centerpiece evening newscast — and it’s
pretty clear that today is slooow.
Yesterday, a member of the state’s
newly formed lottery commission was
forced to step down, but the item was
already all over the morning papers.
There’s a debate over a landfill in a
nearby suburb, but it’s been going on
for weeks.

24

Region Focus • winter 2006

Amid mounting competition, broadcast
TV stations like WRAL-TV in Raleigh
are committing to local news as their
ticket to profitability — and durability
BY DOUG CAMPBELL

Miriam Sutton, an evening newscast producer, walks over to an easel in
the corner. A white paper sheet lists all
the reporters working that day and the
stories that are likely to get on the air.
So far, just three reporters have assignments next to their names.
Then reporter Amanda Lamb steps
into the room. There’s some new information about a recent arrest in an old
local murder. It turns out that investigators from Michigan are coming to
town for interviews, her sources say.
Across the table, Melissa Buscher
stands up. She’s also on this story.
“We’re going to work the phones,” she
says. At the very least, they expect to
get enough for a “V.O.,” or voice-over
segment. Lamb agrees but is more
insistent that this is big. She lays out
her theory that the region may have a
serial killer on its hands.
To this, Jim Hefner, WRAL gener’s
al manager, guffaws. “You’ve watched
Law & Order too many times,” he says.
Lamb doesn’t miss a beat: “I love this
story,” she says, and then adds with
pride: “The paper today had stuff that
we already had on Monday.”
The meeting continues for another
30 minutes. In a good way, nobody

seems to be in charge, and people in
the room variously get up and leave or
start side conversations. A reporter
pitches a story about a quirky state law
that may leave motorists liable in accidents where they weren’t really
responsible — but nobody is too keen
on this for today. Ditto for a possible
look at a high school policy for athletes
that appears harsher on cigarette
smokers than illegal drug users. A
drive-by house shooting is rejected
when it comes out that the home’s
occupants shot back.
After awhile, people whose questions have been answered simply get up
and leave. By 10:05 a.m., two producers
remain, filling in the final holes on the
day’s lineup.
This scene would not seem out of
place in any number of media newsrooms. What happens at WRAL every
day — from reporters pursuing stories
to directors precisely punching buttons in the control room — is simply
what happens in producing local news.
But what’s happening at WRALTV is growing uncommon. In a time
when budget cuts are squeezing TV
newsrooms, WRAL is letting two
reporters chase the same story, one

PHOTOGRAPHY: COURTESY OF WRAL-TV; RALEIGH, NORTH CAROLINA

FILM AT 11

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

that may not even be worthy of airtime
tonight. The company that owns
WRAL is no national conglomerate;
it’s locally owned. The GM, at many
stations simply a salesman with little to
no background in news, is himself a
former news director and sees fit to
spend almost two hours each day in the
newsroom. Sure, many of the pitched
stories are of the “if it bleeds, it leads”
variety, but just as many are wonkish
government agency stories that usually
are anathema on TV.
This is a calculated strategy. WRAL
is the top-rated station in the Triangle,
No. 1 in the most important news slots,
and the leader in market revenues by an
estimated 16 percent margin.
Broadcast TV stations operate in an
environment where being a clear No. 1
or No. 2 in the market increasingly is
the only way to afford producing local
news. And on the flip side, only local
news can generate sufficient revenues
to keep a station atop its market in ratings. “Even the consultants seem to
recognize that to survive, local TV
news must move beyond just presenting the news well,” authors with the
nonprofit watchdog group Project for
Excellence in Journalism concluded in
their 2005 “State of the News Media”
report. “The news itself must become
more relevant and more substantive.”

The Market for News
Local TV news faces a number of challenges. Not too long ago a federal
license to broadcast TV was akin to a
license to print money, but that’s no
longer the case. The growing number
of “substitutes” offered to people who
otherwise might watch TV is the
biggest threat. Twenty years ago, stations didn’t even have to be that good
at producing local news to guarantee
strong revenues and profits because
local advertisers seeking a mass audience had nowhere else to turn.
Nowadays, mounting competition
ranges from cable TV to the World
Wide Web, plus innumerable other
leisure pursuits. “Our competition is
any activity which uses time,” says
Hank Price, a senior fellow at the
Media Management Center at

Northwestern University and general
manager at WXII-TV in WinstonSalem, NC. “Your chief competition at
11 o’clock is people going to bed.”
Yet for all these difficulties, TV
broadcasters maintain certain clear
advantages. They remain one of a
handful of media that can deliver big
regional audiences; even the 5:30 p.m.
broadcast at WRAL is seen by 128,000
people, or nearly 10 percent of the
entire Triangle market. During the
course of any day, local TV news reaches
a much bigger audience than, say, the
local newspaper. They also face no
threat of new entrants in their business
— the number of over-the-air broadcasters is strictly limited by the laws of
physics and the FCC. Practically
speaking, that number usually confines
to no more than three and sometimes
four competitors who can offer what
remains the No. 1 draw of local TV
audiences — local news.
Also competing in the local news
market are newspapers and radio stations, along with Web sites. All market
participants have suffered audience
declines in the past decades. However,
it’s worth noting that TV news operations appear to have stabilized their
viewership in recent years, with about
59 percent of Americans now saying
they are “regular” watchers of local TV
news. By comparison, the percent of
people calling themselves “regular”
newspaper readers continues to fall,
according to the Pew Research Center
for the People and the Press. And in
terms of attracting the coveted young
audience, almost half of 18- to 29-yearolds polled by Pew say they watch local
TV news — compared with just 23 percent who say they read newspapers.
“Local news can be a real moneymaker for a station. It all depends on how
successful they are in attracting audiences,” says Mark Fratrik, vice president
at BIA Financial Network, a media consulting business in Chantily, Va. “The
classic example is WRAL in Raleigh.
They are local news in Raleigh.”

10:10 a.m.
Cherie Grzech, assistant news director at WRAL and late of a Chicago

newsroom, scans the spare list of
green-lighted stories. “This is going to
be a fun day to put this board together,” she says sarcastically. Grzech paces
into her windowed office. She is one of
only a few newsroom employees with
an office whose door closes; one other
is Rick Gall, the news director. (Even
the anchors, whose low-six-figure
salaries are the largest in the room, settle for their own cubicles.) Grzech
swings her chair to her computer
screen as a morning-side reporter,
Megan Hughes, drops in to go over a
script. Grzech reads aloud, scrolling,
typing and trimming. “Why do your
scripts never look long but always run
so long?” she scolds. Hughes laughs
and scoots out of the office. She’s been
at work since 3 a.m. (The biggest
growth in TV news over the past
decade has happened in the mornings,
with two-hour chunks of local news
preceding the national network
morning shows.)
Why did Grzech leave a high-profile
position in Chicago, the third-largest
TV market, to come to Raleigh, No. 29?
“I came here mostly for what this station stands for,” she says, and on her
fingers ticks off a mental inventory: a
newsroom of 100 people, a dedicated
helicopter, low turnover, and — most
important — strong and direct backing
from the ownership that local news is
what drives everything at WRAL. “It’s
everything you get into journalism
for and you don’t find it in many
local stations.”
Unlike some other media, there is a
vast amount of instant, quantitative
feedback in TV. Every day, stations get
e-mailed their “overnights,” or viewership numbers from the day before.
WRAL generally leads its time slots,
though competitors in morning news
are pretty close. In print media, such
attention to audience is unusual and
even disdained. Grzech sees it differently: “The beauty of this station is we
can do everything the way we want to
do it and still win. Most stations are
thinking about contests and gimmicks.
We had a meeting about the November
book (the fall edition of the quarterly
Nieslen ratings period that is crucial in

winter 2006 • Region Focus

25

RF Winter p26.ps - 2/14/2006 3:21 PM

A Word from Our Sponsor

Above, assignment editors can survey the
entire WRAL newsroom, listen to police
scanners, and coordinate reporters and
camera crews. Right, WRAL-TV begins
the day with its first news report at
5 a.m. Morning broadcasts have seen
the biggest growth in local TV news over
the past decade.

determining advertising rates), and we
decided we weren’t doing any promotion pieces. We’re doing good stories
every day like we always do.”

11 a.m.
Steve Abbott prepares “The Split
Sheet for Wednesday, Nov. 2.” The lefthand column lists the day’s remaining
newscasts at noon, 5 p.m., 5:30 p.m.
and 6 p.m.; the right-hand column is a
list of voice-overs that can be used in
each segment, ranging from “Map
Hanes Job Cuts” to “Warren Animal
Shelter.” Abbott is the assignment editor and his desk is on a raised platform
in the corner of the newsroom. From
his seat he can peer directly into each
cubicle, making it easier to know
who’s available. It’s loud, what with
several police scanners constantly
blaring.
The noon producer, Scott Nagel,
steps up to the desk. He’s looking for
anything resembling breaking news to
fill out his slot and notices the most
bustle happening at Buscher’s and
Lamb’s cubicles. It’s his job, for example, to write the scripts that anchors
read on their teleprompters, endlessly
teasing forward to the next, must-see
story or segment. “What’s every26

Region Focus • winter 2006

body atwitter
about?” Nagle
asks Abbott.
Upon
hearing about the
possible serial
killer angle,
Nagle walks
over to the investigation team.
WRAL has producers for eight
distinct news shows each weekday:
From 5 a.m. to 7 a.m. on WRAL; from
7 a.m. to 8 a.m. on WRAZ, the Fox
affiliate; from noon to 12:30 p.m. on
WRAL; from 5 p.m. to 6:30 p.m. (in
half-hour increments) on WRAL; from
10 p.m. to 10:30 p.m. on WRAZ; and
from 11 p.m. to 11:30 p.m. on WRAL.
Hefner says that adding WRAL news
on sister station WRAZ, which is also
owned by Capitol Broadcasting, was
not a budgetary decision. “WRAL
News is a strong brand in the Raleigh
market. Rather than try to recreate a
brand, we are exploiting it on another
station,” Hefner says.
That said, the economics of adding
more hours to the daily newscast
offerings are undeniably favorable,
since only a handful of extra staffers
and basically no extra equipment are
required to do so. The same logic
applies for the relatively recent
innovation of two-hour local newscasts in the mornings. “The more we
expanded, the more we saw an
appetite for local news, especially in
the morning,” Hefner says. “TV had
left this time period to radio until
about 20 years ago.”

Local television stations make money
in two main ways: local “spot” advertising and national spot advertising. (In
both cases, the automobile industry is
the dominant advertiser.) “Spot” means
that advertisers are buying only in specific markets, rather than blanketing
the United States with commercials.
National spots are
usually brokered on
stations’ behalf by rep
firms. For reps, it’s all
about ratings — stations that can deliver
the biggest audiences
in the most desirable
demographics get to
charge a premium for
their time. Hence the
allegiance to the
almighty Nielsen ratings book.
The other half
of station revenues derive from local
spot advertising, and here stations like
WRAL can gain a distinct advantage.
In times of big news events, ratings
tend to spike for stations with reputations for covering breaking important
stories well. But those stations’ competitors don’t usually experience a
similar bump in viewership. In other
words, a rising tide doesn’t necessarily
lift all boats.
“We all work for the news department, ultimately,” says Quinn Koontz,
WRAL director of sales. “That’s what
’s
our reputation is based on.”
The audience for news is particularly appealing to advertisers. News
watchers, TV managers say, tend to be
better educated and better paid than
other viewers. So even though it might
be a lot cheaper to air reruns of the
“Andy Griffith Show” — and get a
decent audience share — the returns
from a half-hour of more expensive to
produce local news are far higher.
Jim Hefner has been GM at WRAL
since 2001. This is his third stint at the
station; in one incarnation he was news
director. To him, it’s a no-brainer that
WRAL is concentrating on news: “You
don’t have any choice. The one thing
we can do that a cable channel can’t is

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

local news.” Yes, it costs more than
airing syndicated programming, but
stations relying on reruns of “Seinfeld”
or talk shows don’t get the ratings
WRAL does, and that’s not at all
unique. “You look at the No. 1 station
in any market, and it is the station that
has made a commitment to local
news,” Hefner says. “It doesn’t matter
what the network affiliation is. It
doesn’t matter what happens in prime
time. It’s the guy who runs that station
who understands the importance of
local news. Those of us who have
figured it out are doing well.”
This is true to a point, but it is hard
to know whether “quality” news programs outperform those of lesser quality,
since this is a subjective measurement.
One important indicator may be how a
station’s other programming performs
relative to news. While WRAL is consistently No. 1 and does attract some
viewers who switch from other channels
just to watch the news, its day-by-day
performance depends somewhat on
lead-in network and syndicated programming. For example, its market
share is visibly higher on nights when
CBS network programming is strongest,
such as Monday and Thursday.
How well does all this translate into
financial performance? Hefner won’t
say precisely. BIA Financial estimated
WRAL revenue in 2004 at $50.7 mil’s
lion, making it No. 1 in the market by
more than $8 million. In all likelihood,
the station is also very profitable.
Nationally, average profit margins for
local TV stations are estimated at more
than 40 percent. (2005 is expected to
be a down year from 2004 primarily
because of the absence of a national
political campaign, whose ad dollars
helped lift national TV ad spending by
about 10 percent.)
The lion’s share of the revenues
derives from the evening newscasts,
chiefly at 6 p.m. and 11 p.m. At WRAL,
a 30-second commercial during the 6
p.m. news was going for $1,400 in
November; at 11 p.m., it was $1,500.
Both rates are presumably higher than
market competitors because WRAL can
deliver a larger audience. Though newscasts take up typically about five hours

of a station’s daily programming, they
account for almost half their revenue.
The growing number of substitutes
for obtaining local news — and entertainment in general — is taking a toll,
however. The bottom line is that
audience shares for TV evening and late
news fell 16 percent and 18 percent,
respectively, between 1997 and 2003.
This shrinking revenue pie is prompting
some stations to bail out of local news.
“If you’re not No. 1 or a strong No. 2,
you need to look at different business
models,” says Price, the Northwestern
media fellow. “We’re in a transition
period in TV, from the old way to the
new way of doing business. In the
future, we’ll have fewer stations doing
local news.”

The Talent
In the unofficial hierarchy of newsroom employees, anchors are at the
top. They are the public face of the station. Hiring an anchor is perhaps the
biggest decision station management
makes. On-air talent in major markets
is usually represented by an agent and
locked in for two- and three-year contracts, with no-compete clauses. In a
market like Raleigh, anchors can
expect to make in the low-six figures.
Pam Pulner, a Washington, D.C.based agent, represents one of WRAL
’s
evening anchors, Gerald Owens.
Pulner has been in the business for
more than two decades and says that,
despite all the effort that may go into
producing local news, success often
comes down to the truism that “people
watch who they like. If the station
has the best weather equipment — it
doesn’t matter. If you’re not drawn to
that person on the TV, then when it’s
time for the news, will you reach for
the remote and turn to that person?
There’s a lot of work behind the scenes
that goes into making sure that a
station has the people who will make
you do that.”
(This lesson is also key to understanding the central role that weather
continues to play in local newscasts.
Weather tends to account for as much
as one-fifth of any half-hour of local
news, even on days when it’s sunny and

72 degrees. “Weather is the single most
important element in any newscast,”
says WRAL GM Hefner. But in a
world where up-to-the-second weather
updates can be found on the Web and
cable channels, and every local station
airs virtually the same forecast,
the enduring appeal of the local TV
news weather team might seem like a
bit of a puzzle — until you factor in
personality.)
As an anchor, Owens is both a latebloomer and a natural. He worked in
plastics for 13 years before deciding that
his good looks, baritone voice, and
inquisitive personality suited him for
TV news. He rose quickly, landing as
anchor of a morning news show in
Washington, D.C., just a few years into
his broadcast career. Owens came to
WRAL three years ago, deciding that
moving to a smaller market was worth it
because of the reputation of WRAL
and the de facto promotion to evening
news anchor. Walking around town with
him is an event. He draws a lot of stares.
His is one of the region’s most instantly
recognizable faces, trailing perhaps only
Mike Krzyzewski or Dean Smith. Also,
he tends to stand out in a crowd thanks
to his 6-foot, 6-inch frame.
Most anchors earned their stripes as
reporters. To land the desk job requires
a unique personality, a face that at once
conveys authority and affability. Owens
has both. He actually enjoys meeting
fans, shaking hands, and signing autographs. If you don’t appreciate that sort
of thing, Owens contends, you ought
to get out of the business. If viewers
sense that anchors feel superior,
“they’ll watch someone else.”

1:45 p.m.
The afternoon news meeting is under
way. There’s been a fire at a Durham
business, but the helicopter shots show
only charred remains, not flames, so
interest is low around the table. Duke
Energy is reporting profits today;
that’ll get a voice-over. Bonnie Moore,
the managing news editor, is pushing
the tree-trimming story, arguing that it
looks like a neighborhood has been
clear-cut. “It’s a visual story. This is
television, folks!” she says.

winter 2006 • Region Focus

27

RF Winter 28.ps - 2/14/2006 3:22 PM

WRAL team prides itself on offer’s
ing up serious news. But this group isn’t
above trotting out “news you can use”
staples. (And, yes, WRAL employs one
of those ubiquitous “On Your Side”
reporters full-time.) One segment
getting play this week is about how
several WRAL staffers are trying to
lose 10 pounds each. Another is on
blogging in the workplace, a piece
which relies in part on thinly disguised
promotional interviews with WRAL
employees who keep personal blogs.
(Or, if it wasn’t supposed to be promotional, it wasn’t very aggressive
reporting.) And despite avowals of
paying sharp attention to capital politics and government, on this day most
newscasts begin with a crime scene.
That is in keeping with national
pattern. According to the Project for
Excellence in Journalism, “public safety” news accounted for 61 percent of
the opening segments on newscasts
between 1998 and 2002, and overall
made up 36 percent of the entire
broadcasts. It’s a “hook and hold”
brand of news, according to the
Project for Excellence in Journalism,
and the reason for so much sameness
among local TV news broadcasts. As an
economic incentive, crime stories tend
to be easier to find and promote, thereby
pushing stories of possibly greater
significance deeper in the newscast
where they get shorter airplay.
WRAL staffers uniformly say they
came to this station in large part
because they wanted to escape the traditional trappings of TV news. They
tell dark tales about their former jobs
at chain-media outlets. WRAL, in contrast, is locally owned and family
operated by Capitol Broadcasting Co.
More to the point, it’s presided over by
Jim Goodmon, CBC’s chief executive
and the reason virtually every WRAL
employee mentions as at least part of
their motivation for hiring on here.
Goodmon (who is a former director
of the Richmond Fed’s branch in
Charlotte) is a Raleigh native whose
grandfather, A.J. Fletcher, in 1937
launched the WRAL empire in picking
up a 250-watt AM radio station. CBC
now owns several TV and radio sta28

Region Focus • winter 2006

tions, the minor league Durham Bulls
and various real estate holdings. But
WRAL is the flagship and Goodmon’s
personal baby. In 2003, he railed
against proposed new FCC rules to
raise the ownership cap from 35 percent of the nation’s households to
45 percent, in addition to allowing
companies to own multiple stations in
a single market. He said it would be
“the death of localism.” Given the
competitive environment that WRAL
operates in, this view is consistent with
the interests of the station.
In contrast to Capitol Broadcasting,
ownership of most TV stations nationwide is big business. According to the
Project for Excellence in Journalism’s
report, State of the Media 2005, in
2003 the 10 largest TV station owners
had 299 stations with $11.8 billion in
revenue, almost half of all TV station
revenue total. Those are companies
with the financial wherewithal to move
into a market like the Triangle with a
vengeance and make competition even
tougher for WRAL.

4:58 p.m.
The weekday anchors take their seats
— Pam Saulsby, David Crabtree, and
Debra Morgan. They flip open laptop
computers and chat with producers,
directors, and others whom they hear
via earpieces.
The control room has 55 TV screens
stacked against the far wall. Everybody
in the control room faces those
screens, their backs to a wide window
that opens into the studio. “Amanda is
next,” says a calm Michelle Fauver, the
5 p.m. producer and one of four people
in the control room. (The others are
the director, the graphics coordinator,
and the teleprompter feeder.) An
almost quaint “On the Air” light, with
accompanying picture of microphone,
is mounted high on the left wall.
Everything is humming along
glitch-free until about 5:16 p.m. when a
reporter calls in to say he wants to go
live at the scene of a possible drug-lab
bust. This requires Fauver to execute a
number of hairpin moves. She must
alert the QC, or Quality Control, room
to re-steer the station’s satellite to pick

up the incoming live transmission.
“Where’s Stooge?” she says, sounding
increasingly harried. She is looking at a
small screen to her right that will show
her reporter Jason Stoogenke, who is
out at the scene of the drug bust. So far,
it’s just snow. “There’s still no Stooge,”
Fauver says into her microphone,
simultaneously pressing a button that
allows her to speak with anchors. “As
scripted, Deb does the tease.” She
stares at the screen for a few seconds,
seemingly not breathing. “I hate breaking news!”
At 5:25 p.m., an at-first blurry image
of Stoogenke materializes on Fauver’s
screen. “Breaking news, if you’ve got
it,” Fauver orders the graphics coordinator. She presses a button. “Jason
Stoogenke, possible methamphetamine lab, police on the scene,” she says.
The “Breaking News” graphic flashes
across the screen, with complementary
dramatic music, and Saulsby looks up
at the camera: “Breaking news in
Cumberland County where Jason
Soogenke is with police on the scene of
a possible methamphetamine lab.”
Fauver raises a fist: “Nice!” It’s 5:27
p.m., and her job is done for the day,
stepping aside for the next producer,
Miriam Sutton. “Perfect, great job,
bye-bye.”
The next hour is unremarkable.
There is no “breaking news” to muck
up the scripts. Meteorologist Greg
Fishel delivers three nearly identical
forecasts in a row (no rain for a long
time). Tom Suiter rattles off some
sports highlights, expertly removing,
then donning his reading glasses as the
camera goes off and on him.
At 6:32 p.m., the news staff, along
with the technical personnel, gathers
in the newsroom just behind the
anchors’ desk for a post-mortem. “I
think we were good,” Cherie Grzech
says. That’s the consensus, and a
minute later they break.
By 9 a.m. the next day, the ratings
are in.
5 p.m. to 6 p.m.: estimated 124,000
viewers, No. 1.
6 p.m. to 6:30 p.m.: 165,000 viewers,
No. 1.
11 p.m.: 141,000 viewers, No. 1. RF

$
$
$

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

$$$
$$$U R R E N C Y
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$$$ N U N D R U M
Why Are Exchange Rates Out of Sync With Other Economic Indicators?
BY DOUG CAMPBELL

F

lip to the section on exchange
rates in almost any economics
textbook and you will find one of
the profession’s most widely accepted
notions on the workings of global trade.
Gregory Mankiw’s Macroeconomics puts
it as plainly as any: “If the real exchange
rate is high, foreign goods are relatively
cheap, and domestic goods are relatively expensive. If the real exchange rate
is low, foreign goods are relatively
expensive, and domestic goods are
relatively cheap.”
It sounds so simple. An appreciating
dollar, you would expect, would lead
Americans to consume more foreign
products relative to domestic products.
But, in fact, this often turns out not to
be the case, at least in the short run.
Consider the real exchange rate of
the dollar since 2001 — it has depreciated fairly sharply. But during the same
period imports grew — even though
the dollar’s performance should have
sent them in the other direction. (The
difference between “real” and “nominal” exchange rates is important. Real
rates take into account the diverging
inflation rates of the two nations whose
money is being exchanged. So when,
say, an American travels to England, he
needs to consider not only how many
pounds he can buy with a dollar — the
nominal exchange rate — but also
which goods he can buy in England with
those pounds.)
Exchange rates have long been one
of the most difficult macroeconomic
variables to model. As an important
“price” in an economy — particularly
“open” economies dependent on trade

— an exchange rate would seem likely
to have a wide impact on any number of
economic transactions, and thus have a
strong connection with the underlying
economy. In many economic models,
monetary stimulus is supposed to raise
domestic GDP while lowering the value
of the home currency — an implied
correlation between depreciations and
business-cycle expansions.
The problem is that real-life data
don’t clearly show this relationship.
This problem even has a name: the
exchange rate disconnect puzzle.

Early Work
Credit for the discovery of the puzzle
goes to economists Kenneth Rogoff
and Richard Meese. In 1983, they
demonstrated the complete lack of
correlation between real exchange rates
and other economic variables in developed countries. At the time, they were
staff economists at the Federal Reserve
Board of Governors charged with
figuring out not only why exchange
rates moved but also finding a way to
forecast their movements. As Rogoff,
now at Harvard, recounted in a 2002
essay, they produced a model aimed
at answering this simple question:
“We will tell you what money supplies,
interest rates, and outputs are going to
be one year hence. Y have to predict
ou
the exchange rate.”
They failed. But in failing, they sort
of succeeded. What Rogoff and Meese
had done was to make vividly clear that
existing exchange rate models were
largely useless. They discovered that a
simple random-walk model — where

future rate movements have no relation
to past movements — was as good or
even a better predictor of exchange
rates than the day’s standard forecasting models. Rogoff and Meese
concluded that there was no stable set
of variables to explain exchange rates in
any coherent way over 12- to 18-month
horizons. And their conclusion has
stood up over two decades and literally
hundreds of studies. “Basically, the
problem is not simply that it is virtually
impossible to predict exchange rates,”
Rogoff wrote in an e-mail exchange for
this story. “No variable, or set of variables, seems to explain them after the
fact.”
In the late 1980s, economists Alan
Stockman and Marianne Baxter
showed how the disconnect runs both
ways. Just as Rogoff and Meese couldn’t
use macro-variables to explain
exchange rate swings, Stockman and
Baxter demonstrated that exchange
rate volatility seems to have no major,
systematic impact on macro-variables.
Together with the Rogoff-Meese innovation, these remain the most
important advances in understanding
the exchange rate disconnect puzzle.
The puzzle can pose problems for
policymakers. Without a clear understanding of how exchange rates relate to
the economy, how are they to respond
to currency volatility? In less-developed
countries with immature capital markets, exchange rate volatility can cause
significant harm to the economy. It can
trigger the shifting of resources in a
very dramatic way across sectors of the
country in question.

winter 2006 • Region Focus

29

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

30

Region Focus • winter 2006

exchange rate movements. If their
currencies are managed, should they
intervene heavily in foreign exchange
markets to keep them stable? If they are
allowed to float, should the central
bank — like the Fed in the United
States — sometimes try to influence
them through the use of monetary
policy? The answers are elusive in large
part because of the exchange rate
disconnect puzzle and the inability
of economists to produce models
which would suggest clear paths for
policymakers.
Over the years, scores of economists have tried to tackle the exchange
rate disconnect puzzle. Some of the
biggest progress came from the puzzle’s pioneer, Rogoff himself. Just a few
years ago, he teamed with economist
Maurice Obstfeld in trying to explain
why macroeconomic fundamentals are
so out of whack with exchange rate
movements. Their answer, in a 2000
paper, was basically that the
economies of big, industrialized
nations tend to be complicated.
This means that markets are not fully
integrated, so that price changes in
one segment don’t affect those in
others. Together with sticky prices,
this market segmentation can largely
insulate consumers from exchangerate swings. “Only gradually will the
responses of importers and exporters
feed through to the retail level,”
Obstfeld and Rogoff wrote.

The Exchange Rate and Foreign Trade
Despite the dollar’s decline, the trade deficit has continued to rise.
70,000

110

60,000

105
100

40,000
95

30,000
Sep-05

Mar-05

85

Mar-04

90

20,000

NOTE: The red line represents the weighted average of the real foreign exchange values of the U.S. dollar
against the currencies of a large group of major U.S. trading partners, and is plotted against the left Y-axis.
The black line represents monthly data on the trade deficit, and is plotted against the right Y-axis.
SOURCES: Federal Reserve Board of Governors and Bureau of Economic Analysis

M ILLIONS

OF

50,000

D OLLARS

115

Mar-03

The world’s leading industrial nations
began a movement to floating exchange
rate regimes in the 1970s. It was at that
time that the U.S. economic woes led to
the devaluation of the dollar. Since so
many other countries’ currencies were
pegged to the dollar under the Bretton
Woods agreement of 1944, the dollar
devaluation led to waning confidence in
the system, and countries began to exit
it wholesale.
Today, there is no clear consensus
among economists on which is the best
exchange rate regime. Flexible
exchange rate systems are those in
which governments do not intervene in
foreign exchange markets to try to
influence their currencies. This kind of
system carries the virtue of letting the
market determine currency values,
which makes it more likely that a country’s exchange rate bears close relation
to underlying economic conditions.
Additionally, a flexible regime
allows monetary policy to be used on
economic objectives other than influencing exchange rates — most
importantly, price stability.
By contrast, countries that peg their
exchange rate must concentrate “monetary policy” on manipulating the
exchange rate. However, some economists believe that fixed rate systems —
in which a government buys and sells its
currency at the necessary amounts to
keep its exchange rate pegged to some
other currency — are more convenient,
reduce information costs, and foster
international trade by reducing volatility.
Fixed systems are also more immediately

Mar-02

Fixed Or Flexible?

useful in controlling inflation. In fact,
theoretically, fixed-exchange rate
nations should have the same long-run
inflation rates as the country they are
pegging to, thanks to something called
the “purchasing power parity theory.”
This theory, according to Stockman’s
Introduction to Economics, says that
exchange rates change to equalize the
prices of products in all countries over
the long run.
The trade-offs inherent in each
system are evident in the currency crisis
that struck Argentina in 2002.
Argentina had adopted a currency
board regime — in which its peso was
pegged to the dollar — in 1991 as a
means, in part, to fight hyperinflation.
It worked in that regard, immediately
tamping down consumer prices. But in
the mid-1990s, some of its South
American neighbors and then several
Asian countries saw their currencies
decline rapidly. That made the peso,
linked to the dollar, overvalued and in
turn made Argentine exports more
expensive. So in early 2002, Argentina
abandoned the currency peg and let
the peso devalue so that Argentine
products would be cheaper. This led to
another round of inflation and also had
the negative side effect of hurting the
investments of multinational firms that
did business in Argentina.
The Argentine experience is
emblematic of the kinds of choices
policymakers face in trying to handle

Mar-01

But the case is different for welldeveloped countries: Should policymakers there worry about the wobbling
values of their currencies? Or, looking
at the disconnect data, should they
simply conclude that getting overly
exercised about exchange rates is a
waste of time, given their lack of impact
on the underlying economy? In particular, policymakers who worry about
exchange rate movements have to
weigh the relative merits of the two
leading ways to manage their currencies
— through fixed or floating systems.

M ARCH 1973=$100

$$$
$$
$$$

RF Winter p31.ps - 2/9/2006 10:45 AM

Richmond Research
Margarida Duarte, an economist with
the Richmond Fed and a former student of Stockman’s at the University of
Rochester, has focused much of her
research on the exchange rate disconnect puzzle. In one recent paper,
Duarte examines what happens when
nations move from fixed to flexible
exchange rate regimes, hoping therein
to learn more about why exchange rates
can be so volatile compared with other
macroeconomic variables. In a second
paper, she develops a model in which
the complicated workings of financial
markets play a significant role in
explaining the exchange rate disconnect puzzle. In both cases, she builds on
a sticky price model developed by
Obstfeld and Rogoff in 1995.
In a paper published in the Journal
of Monetary Economics, she presented a
model that successfully replicated
real-world results. It showed that
“moving from pegged to floating rates
generates a substantial increase in the
volatility of the real exchange rate,”
but not in other variables. This was in
keeping with the vexing data that the
only distinction across exchange rate
regimes is dramatic change in
exchange rate volatility. The model,
Duarte says, usefully explores the
merits of different exchange rate
regimes. It also advances the literature
on why exchange rates are more unstable than other variables. But it doesn’t
get to the other side of the “disconnect” puzzle — what are the sources of
uncertainty that generate substantial
exchange rate instability (and which is
not transmitted to other variables) but

no substantial instability in other
macro-variables?
In a 2005 paper with Stockman, who
is also a former visiting scholar at the
Richmond Fed, the two aimed to answer
that question more directly. Like past
models, theirs sought to tie the determination of exchange rates to consumer
decisions. The twist was to leave a role
for the “asset-price” nature of exchange
rates. By this, they intended to add a feature wherein exchange rates are a)
affected by shocks to the financial markets and b) these shocks only show up in
the financial markets, not in the underlying economy. The results looked much
more like what happens in the real
world. “Now I can generate a much
higher volatility of nominal exchange
rates without that implying high volatility of consumption allocations or high
comovement across these two sets of
variables,” Duarte says.
Rogoff himself continues to study
the problem and says that Duarte’s and
Stockman’s joint efforts are “very promising for understanding some aspects of
the disconnect puzzle.” But all this still
leaves plenty of room for improvement.
Quantitatively, the Duarte-Stockman
model is not an answer to why exchange
rates are more volatile than other
macro-variables. Having identified
asset prices as one of the key variables
in exchange rate movements, economists still haven’t figured out a good
way to model asset prices in keeping
with their behavior in the real economy.
A lot of it comes down to the complexities of drawing up coherent, consistent
models that accurately resemble realworld data. It is difficult to write down

models that account for such things as
idiosyncratic risk, for example. And the
way foreign exchange markets are typically modeled may be too simplified.
A counter-explanation for the
exchange rate disconnect puzzle: That
some currency traders are inexperienced and thus behaving irrationally.
It’s true, Duarte says, that the model
with “noise traders” of economists
Michael Devereux and Charles Engel
generates exchange rate swings that
seem to have no correlation to
economic fundamentals. But proving
that there is a connection between
irrational speculation and the
exchange rate disconnect puzzle
remains another matter. “Either
model may ‘explain’ the data,” Duarte
and Stockman argue, “if only in the
sense of labeling our ignorance, or
might promote better understanding
of the issues. But these kinds of
success have limits: They do not imply
that a model is appropriate for
analyzing welfare, or policies.”
Duarte says, “There’s progress but
it’s slow. We need to model these
economies in a more realistic way so
that idiosyncratic risk matters more.
That’s where we are now.”
Rogoff agrees that progress is being
made. But he tends to think that his
work of more than 20 years ago continues to hold important lessons for
policymakers who “fret endlessly about
exchange rate volatility.”
He says: “The exchange rate disconnect puzzle suggests that, at least for
countries with well-developed capital
markets, perhaps they should take a
more relaxed attitude.”
RF

READINGS
Baxter, Marianne, and Alan C. Stockman. “Business Cycles and
the Exchange Rate System: Some International Evidence.”
National Bureau of Economic Research Working Paper no. 2689,
August 1988.
Devereux, Michael B., and Charles Engel. “Exchange Rate PassThrough, Exchange Rate Volatility, and Exchange Rate
Disconnect.” Journal of Monetary Economics, July 2002, vol. 49,
no. 5, pp. 913-940.
Duarte, Margarida. “Why Don’t Macroeconomic Quantities
Respond to Exchange Rate Variability?” Journal of Monetary
Economics, May 2003, vol. 50, no. 1, pp. 889-913.

Duarte, Margarida, and Alan C. Stockman. “Rational Speculation
and Exchange Rates.” Journal of Monetary Economics, January
2005, vol. 52, no. 1, pp. 3-29.
Meese, Richard, and Kenneth Rogoff. “Empirical Exchange Rate
Models of the Seventies: Do They Fit Out of Sample?” Journal of
International Economics, February 1983, vol. 14, nos. 1-2, pp. 3-24.
Obstfeld, Maurice, and Kenneth Rogoff. “Exchange Rate
Dynamics Redux.” Journal of Political Economy, June 1995, vol. 103,
no. 3, pp. 624-660.

winter 2006 • Region Focus

31

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

S

P

E

C

I

A

L

S

E

C

T

I

O

N

BASE in the Fifth District
CLOSURES
COMPILED BY MEGAN MARTORANA AND DOUG CAMPBELL

f you add up the numbers in the
2005 Base Realignment and
Closure Commission’s final
report, things don’t look good for the
Fifth District. The commission estimates some 17,000 net jobs to be lost
from Maryland down to South
Carolina. That’s even more than
the nationwide net loss of 8,000
estimated jobs to be eliminated in the
BRAC process.
But analysts strongly caution that
the BRAC figures are preliminary
and subject to change. While the
bases targeted for realignment and
closure are now virtually set in stone,
the precise impact on direct employment remains in flux. For example,
the final BRAC report estimated
total job losses in Virginia at 18,770.
But that estimate comes with several caveats. The fate of the Naval Air
Station in Oceana has not yet been
settled, for one thing. Additionally,
there has been no final determination
yet where the jobs scuttled by the
military’s nearly wholesale exit from
leased office space in Arlington and
Alexandria will end up — many are
likely to remain in the nearby metro
Washington, D.C., area. Finally, there
are potentially thousands of classified
functions that may be transferred
into Virginia.
“Virginia is not necessarily a big
loser,” says Dave Dickson, acting
executive director for the Virginia
National Defense Industry Authority.
“We still have a lot of unknowns out
there. All these military installations
are dynamic communities, with
people coming and going all the
time. It drives the economists and
accountants a little batty.”

I

32

Region Focus • winter 2006

There was only one Fifth District
base on the final report’s list of 22
“major closures” — Fort Monroe in
Virginia, which may result in the loss
of 3,564 total direct jobs. Among the
33 nationwide “major realignments,”
which are where major job cuts are
expected to happen, are Walter Reed
National Military Medical Center in
the District of Columbia, Fort Eustis
in Virginia, the Naval Air Station
in Oceana, Va., and Pope Air Force
Base, NC.
All together, the 2005 BRAC
round is intended to save U.S. taxpayers $15 billion over 20 years. Job
losses from base realignments
inevitably cause economic damage to
their local communities, but they are
not insurmountable. Many bases,
which often occupy prime real
estate, are redeveloped for profitable
use. Soon-to-be vacated office
space in Arlington and Alexandria
would seem likeliest for speedy
redevelopment.
On the other hand, only two of
the five major base redevelopments
in the Fifth District since 1993 have
produced enough new jobs from
private-sector investment to restore
the number of civilian jobs lost
post-BRAC. In that regard, the
Charleston Naval Complex in South
Carolina still hasn’t recovered fully
from the 6,272 jobs lost in the 1993
BRAC process, gaining just 2,797
jobs in replacement since. (See
“Redevelopment Boot Camp,” Region
Focus, Summer 2005.)
The Defense Department has
until Sept. 15, 2007, to begin closing
and realigning the installations and
must be finished by Sept. 15, 2011.

Fifth District Highlights
(Note: All figures are estimates, with final
impact depending on a wide variety of
as-yet undetermined factors.)
District of Columbia
Total Direct Job Changes: 7,407 jobs lost
Biggest Impact: Realignment of Walter
Reed Army Medical Center, 5,663 direct
jobs lost
Maryland
Total Direct Job Changes: 8,900 jobs
gained
Biggest Impacts: Addition of 5,361 total
direct jobs at Fort Meade; Addition of
2,829 total direct jobs to the National
Naval Medical Center in Bethesda
North Carolina
Total Direct Job Changes: 145 jobs lost
Biggest Impacts: Gain of 3,663 total
direct jobs at Fort Bragg; Loss of 4,112
direct jobs with realignment of Pope Air
Force Base
South Carolina
Total Direct Job Changes: 334 jobs
gained
Biggest Impacts: Loss of 630 direct jobs
with realignment of the Naval Weapons
Station in Charleston; Gain of 615 total
direct jobs at Fort Jackson
Virginia
Total Direct Job Changes: 18,770 jobs lost
Biggest Impacts: Loss of 11,173 total
direct jobs at the Naval Air Station in
Oceana; Loss of 18,750 jobs from various
leased space in suburban Washington,
D.C., area; Gain of 12,595 jobs at Fort
Belvoir
West Virginia
Total Direct Job Changes: 105 jobs lost
Biggest Impact: Loss of 88 jobs at
Fairmont U.S. Army National Guard
Reserve Center

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

District of Columbia

Northern Virginia

Maryland

1. Bolling Air Force Base
2. Naval District Washington

5. DFAS Arlington
6. Marine Corps Advanced Amphibious Assault

15. Fort Meade
16. Naval Station Annapolis

3. Potomac Annex
4 . Walter Reed Army Medical Center

7. Fort Belvoir
8. Marine Corps Base Quantico
9. Naval Surface Warfare Center Dahlgren

17. Army Research Laboratory Adelphi
18. Naval Surface Warfare Center Indian Head
19. Andrews Air Force Base

10 . Arlington Service Center
11. Headquarters Battalion
Headquarters Marine Corps Henderson Hall
12. Various Leased Space

West Virginia
13. Fairmont U.S. Army National Guard
Reserve Center
14. Bias U. S. Army Reserve Center Huntington

Maryland
13

22
29

21

24 25 23 15
16
10
4 11
1 2 3
5
12 19 20
18 7
6
9
8

WASHINGTON
D.C.

West Virginia
14

BALTIMORE 26

CHARLESTON

Virginia
RICHMOND

27
28

Central and
Southeastern Virginia

31
32
34

35 36
38 37
39 40

42

41

North Carolina
43

CHARLOTTE
49
44

Naval Air Facility Washington
Martin State Airport Air Guard Station
Fort Detrick
Navy Reserve Center Adelphi
National Naval Medical Center Bethesda
Naval Surface Weapons Station Carderock
Aberdeen Proving Ground
Defense Finance and Accounting
Service Patuxent River
28. Naval Air Station Patuxent River
29. PFC Flair U.S. Army Reserve Center Frederick

17

30

33

20.
21.
22.
23.
24.
25.
26.
27.

46

30. Richmond International Airport
Air Guard Station
31. Defense Supply Center Richmond
32. Naval Weapons Station Yorktown
33. Fort Lee
34. Fort Eustis
35. Langley Air Force Base
36. Fort Monroe
37. Naval Amphibious Base Little Creek
38. Naval Support Activity Norfolk
39. Naval Medical Center Portsmouth
40. Naval Shipyard Norfolk
41. Naval Station Norfolk
42. Naval Air Station Oceana

45
47
50
48

South Carolina
COLUMBIA

55

56

57

52

North Carolina
43.
44.
45.
46.
47.
48.
49.
50.

Navy Reserve Center Asheville
Charlotte/Douglas International Airport
Pope Air Force Base
Seymore Johnson Air Base
Fort Bragg
Marine Corps Base Camp Lejeune
Niven U.S. Army Reserve Center Albermarle
Marine Corps Air Station Cherry Point

51
53

54

South Carolina

SOURCE: 2005 Defense Base Realignment and Closure
Commission Final Report

51.
52.
53.
54.
55.
56.
57.

Defense Finance and Accounting Service Charleston
Naval Weapons Station Charleston
South Naval Facilities Engineering Command
Marine Corps Air Station Beaufort
Fort Jackson
Shaw Air Force Base
McEntire Air Guard Station

Legend
Closure
Realignment
Gaining jobs

winter 2006 • Region Focus

33

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

A college degree is still the best predictor of financial success, but that’s not all

W

hen Debbie Barr was a
high school senior in
Sophia, W.Va., she happened to bump into a college recruiter
at lunch. Barr wanted very much to go
to college, but her father had been
injured in a mining accident, and her
family’s income was next to nothing.
She’d written off the idea.
Although Barr was an “A” student,
her high school counselor had never
mentioned college. “The girls got married and had kids,” Barr recalls. “And
this was the 1980s.” Her chance meeting with a Concord College
representative proved fruitful, and
Barr slogged through intimidating
financial aid forms. She earned
her bachelor’s degree in English
Education from Concord, located in
Athens, W.Va.
“I’m trying to push my niece and
cousins [to go to college] because it is
important,” she says. “Wal-Mart can’t
support you all your life.”
Today, Barr is the lead counselor for
West Virginia’s Talent Search, a federally funded effort produced by the
Higher Education Act of 1965. The
idea is to identify low-income sixthgraders and track them through high
school, making sure they build skills
and take college prep classes. Along
the way, the counselors help with
inspiration, study habits, financial aid
forms, and field trips.
To forgo college is a costly choice,

34

Region Focus • winter 2006

despite rising tuition. A college education is pulling in a higher premium
than ever to workers’ paychecks.
Graduates with a four-year degree not
only make more money than nongraduates — 62 percent more in 2003 and
73 percent more over a working life of
40 years — but they’re also more likely
to volunteer, give blood, use a library,
and open retirement accounts than
nongraduates. They’re healthier (less
than 15 percent smoke) and (by some
measures) make better parents.
Economists continue to study the
effects of going to college, just one
institution through which “human
capital” is nurtured. They aim to figure
out how public resources ought to be
directed at helping more young people
enter and finish college.

Education’s Black Box
While more people may be going to
college than ever before, completion
rates have stagnated. A recent study by
the Higher Education Research
Institute at the University of
California at Los Angeles reports that
among freshmen who entered fouryear colleges in fall 1994, 36.4 percent
completed a degree within four years,
compared to 39.9 percent 10 years
earlier and 46.7 percent in the late
1960s. The rate of completion rises
after six years to 61.6 percent.
And income matters. Among poor
students, an estimated 7 percent earn a

bachelor’s degree by the age of 24
compared with 39 percent from the
middle-income group and 52 percent
from those with the highest income.
Usually, people balance the money
they’ll spend on college with the time
in forgone earnings and add up what
they’ll gain by earning a degree. A special report published by the College
Board, “Education Pays,” found that
by the time a graduate is 33, he has
earned enough to make up for tuition
and forgone earnings, if he entered a
public, four-year college at age 18.
Some benefits of postsecondary
education are less quantifiable. For
example, economists Janet Currie and
Enrico Moretti found that higher
maternal education improves infant
health: “Our results add to the growing
body of literature which suggests that
estimates of the returns to education
which focus only on increases in wages
understate the total return.”
But the earnings signal is loud and
clear. In 1979, people with a bachelor’s
degree or higher earned about 45 percent more per hour than high school
graduates — and that difference has
risen over time. In 2003, the average
full-time worker in the United States
with a four-year degree earned
$49,900 compared with $30,800
earned by a high school graduate,
about 62 percent more. Those with
master’s degrees earned nearly twice as
much, $59,500, and medicine and law

PHOTOGRAPHY: GETTY IMAGES AND GEEP SCHURMAN

BY BET TY JOYCE NASH

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

The Economic Keystone
Amber Godfrey, a senior at Virginia
Commonwealth University, is the first
in her family to attend college. Her
parents, who joined the military to get
the training they needed, have encouraged her since she was very young. “I
have a lot more opportunities having
my degree,” she says. “I just know
that’s what we have to do the way our
world is changing. The minimum
requirement is becoming, ‘Do you
have a bachelor’s?’ ” Godfrey, a former
high school basketball player and
“people person,” hopes to work in
sports and entertainment as a public
relations specialist. She just made the
cut as a finalist for an internship with
the National Basketball Association.
College graduates have better outcomes all the way around. But it’s hard
to break inside the black box to figure
out why. Sarah Turner, an economist at
the University of Virginia, asks
whether that’s caused by college per
se. The answer is complicated. “But
there certainly remains a robust premium for the types of general skills
that come out of a college education.”
The hurdles are financial as well as
academic. “Now more than ever if you
are a low-performing, high-income
kid, your odds of going to college are
extraordinarily high,” Turner notes.
Minority students are likely to have
fewer resources, and financial aid simply hasn’t kept up with growth in
tuition, according to Donald Heller of
Pennsylvania State University’s Center
for the Study of Higher Education. He

spells out the problem: Poor and
minority students go to poorer
schools, receive less in the way of academic preparation, and often have no
one to propel them toward college.
“Since they don’t have the experience,
they don’t know how to take the steps
to go to college, how to take the tests,
which math courses to take — a whole
slew of things, the advantages that
largely white middle class has,” he says.
What a drag. On the economy.
Economic research shows that
education contributes to productivity,
adds to personal earnings, and leads
to efficiency. People can adjust to
change in the workplace more quickly,
among other benefits. But sluggish
educational attainment spells trouble.
“Slower growth of the educational
attainment of the workforce directly
reduces economic growth by slowing
growth in labor force ‘quality’
and may have an adverse impact
on the rate of technological
advance,” writes Harvard economist
Larry Katz.
The connection between economic
performance and education is strong.
For example, the U.S. Census Bureau
reports Maryland’s percentage of the
population with a bachelor’s degree at
35 percent, more than 8 percent higher
than a decade ago. During the same
period, total personal income in
Maryland rose by 13 percent, according to the National Center for Public
Policy and Higher Education. And in
South Carolina, where nearly 25 percent
of the over-age-25 population has
a bachelor’s degree, the state’s
per-capita income is $27,153, about
82 percent of the national average of
$33.041 — 44th in the nation. In West
Virginia, 15.3 percent of people over 25
have degrees and per-capita income is
$25,681 — 50th among states.
If a region is looking to build a solid
economic base, then knowledge is the
cornerstone.
Even with rising tuition levels, college is still a good deal, according to
Lisa Barrow and Cecilia Rouse,
authors of the 2005 article “Does
College Still Pay?” published in The
Economists’ Voice. Even though there

are more college graduates — the
share of the population with bachelor’s degrees went from 26 percent in
1996 to 30 percent in 2004 — they
continue to earn more money, indicating increased demand. But average
wages of lower-skilled workers have
gone up recently too. The authors conclude that the economic boom of the
late 1990s explains the rise in average
wages of all workers. Despite that and
the hefty increases in tuition, the
payoff from getting a college
degree continues to outstrip the evermounting costs.
The authors calculated the cost
of an education this way: Take
four years of tuition and fees at a
typical university and then add four
years of lost wages, using average
annual earnings of a high school
graduate. That amounted to about
$107,277. According to the study, the
lifetime boost to wages of a college
degree is about $403,000. Subtract
the cost of college and still wind up
with a benefit of nearly $300,000.
What’s good for the labor market is
good for the economy. And today’s
labor market requires higher-level
skills, says Penn State’s Heller.
“We used to talk about the middleclass lifestyle,” he says. “You could go
off and get a union job and live that
lifestyle, but more and more those
jobs aren’t here anymore. People are
requiring more training to live that
lifestyle.”

Population with a College Degree
The connection between education and economic
performance is strong.
50

45.7

45
40

35.2

33.1

35

P ERCENT

graduates earned almost three times
as much, $95,700, according to
“Education Pays.”
Understanding the relationship
between money and education is central to policy discussions. The
question has prompted economists to
ask whether education is responsible
for the added value or whether it’s a
product of the smart, motivated people (who grew up in middle- and
upper-income families that make early
and continual investments in education) who typically finish college and
make more money.

27.7

30
23.4

25

24.9

20

15.3

15
10
5
0

DC

MD

NC

SC

VA

WV

US

NOTE: Data are for 2004. Percent of population 25 years or

older with a bachelor’s degree or higher.
SOURCES: U.S. Census Bureau and Postsecondary Education

Opportunity

winter 2006 • Region Focus

35

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Barriers to Entry
Many high schools, especially rural
and inner city, just don’t groom students for college. Stanford University’s
Bridge Project found that state high
school tests often focus on different
knowledge and skills than college
entrance and placement requirements,
leaving students in the lurch academically. Guidance counselors are
overworked by state test requirements, often irrelevant to college
preparation.
An even bigger problem is that rising college costs have left some
students priced out of the market. The
problem is, naturally, worse for lowincome kids, arguably the group
needing education the most. And if
they do start, they are unlikely to finish.
“It’s true that more low-income
students enroll in college now than in
the 1970s — but they are less likely to
graduate than their wealthier peers,”
writes Ross Douthat in “Does
Meritocracy Work?” in the November
2005 Atlantic Monthly. Fifty-five percent of need-based Pell Grant
recipients, for example, attended twoyear rather than four-year schools in
2002, compared to 38 percent in 1974.
A 2002 report of the independent
Advisory Committee on Student
Financial Assistance, which counsels
Congress and the U.S. Secretary of
Education, found that nearly half of
qualified high school graduates from
poor and moderate-income families in
2002 did not enter four-year colleges
within two years of graduation and 22
percent, 170,000, did not go to college
at all.
The report, “Empty Promises: The
Myth of College Access in America,”
places the number of students who are
qualified but can’t attend four-year
schools for financial reasons at
400,000. That number isn’t trivial,
says Heller, who worked on the report.
“We know in certain regions, in certain labor markets, there are
shortages,” Heller says. “If we were
able to get these students, we’d be able
to have much more flexibility in labor
markets to ensure we’ve got enough to
meet demand of the work force.”
36

Moving the Mountain
Among Fifth District states, the percentage of college graduates varies
widely, with West Virginia’s 15.3 percent the lowest. The Mountain State’s
low percentage of graduates makes
Debbie Barr’s protégés at Talent
Search a primo resource. (West
Virginia’s population is aging with few
moving in. According to the U.S.
Census Bureau, by 2025, there will be
nearly 19 percent fewer traditional college-age students in the state, the
biggest decline in the nation.)
Educators in the state are working
hard to send students to college.
About 70 percent of West Virginia’s
Talent Search seniors enroll in college,
according to state coordinator Bob
Long of the West Virginia Higher
Education Policy Commission. The
search reaches students with family
incomes of less than $12,000 in 74
schools in 55 counties.
“Historically, all the studies and all
the data show even the bright kids of
low income do not go to college at
the same rates as intelligent kids
from more affluent backgrounds,”
Long says.
West Virginia aims to improve its
college matriculation rate partly by
developing relationships between
each stage of schooling: elementary,
middle, and secondary. The state
jacked up the levels of science and
math classes so students enter college
prepared to take college-level courses
without spending half a year in remedial classes.
In 2004, West Virginia was rated as
a top-performing state in the proportions of high school students enrolled
in upper-level math, 59 percent, and
science, 44 percent, according to
“Measuring Up 2004,” a report by the
National Center for Public Policy and
Higher Education. The state’s Promise
scholarships, funded by lottery proceeds, reward students who maintain a
3.0 average and score 21 or above on
the ACT.
They’re seeing results. Since 1996,
college matriculation rates of West
Virginia high school graduates has
risen from about 47 percent to 59.4

Region Focus • winter 2006

percent, exceeding the national average of 56.7 percent.
“We’re starting to do a good job at
the front end, now we have to focus on
the back end, which is retention,”
Long says. “Student services, including
intervention once students get on
campus, with mentors, is the other
end of the pendulum.”

Lifelong Learning
Many students never make it to fouryear schools. In the 1960s and 1970s,
in an effort to “democratize” higher
education, public policies expanded
community colleges.
“That did more to access in
higher education than any other
movement over the last 100 years,”
Heller says. The community colleges
opened doors especially for minorities
and women. Women today comprise
57 percent of all college students,
and 58 percent of community college
students.
Nearly half, about 46 percent, of
undergraduates attend community
colleges, where the average age is 29.
Community colleges were designed to
give students the first two years of
basic studies, after which they’d transfer to a four-year school to complete a
degree. Ultimately, the mission
expanded to vocational training.
Typically, community college students are the first in their families
to attend college. While community
colleges clearly play a role in human
capital accumulation, the student
retention rates can’t match those of
four-year schools.
In a paper published in 1999 in the
Journal of Economic Perspectives,
Thomas Kane and Cecilia Rouse
found that of all students enrolling in
two-year colleges, more than half don’t
complete any degrees, about 15 percent earn a certificate, another 16
percent obtain an associate’s degree,
and about 16 percent complete a bachelor’s degree. At four-year colleges,
nearly 60 percent complete bachelor’s
degrees.
The community colleges can
respond quickly to demand, though,
especially in economic downtimes.

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

And an associate’s degree holder in
2003 earned $37,600 compared to
the $30,800 earned by a high school
graduate. Enrollment increased
at community colleges by about
5 percent between 1990 and 2004 as
tuition at four-year schools rose.
Overall, today more older students
attend postsecondary institutions
than traditional-age college students,
according to Sondra Stallard, a professor and dean of the School of
Continuing and Professional Studies
at the University of Virginia.
“We’ve had students who left
because they need to work part-time
so they don’t incur so much debt,”
Stallard says. She notes that students
can begin at Piedmont Virginia
Community College and transfer to
the University of Virginia for a lot
less money. The students in the program typically work full-time.

Shelley Tattersall is 42. She had
attended a New Jersey community
college in her 20s, but never finished.
She now works at the University
of Virginia in administration and
needed education to advance. “I
wanted more challenging work and a
degree would give me more options,”
she says.

What to Do?
While the educational premium
seems irrefutable and the argument
that economic growth depends on
capital, physical and human, remains
strong, policy experts differ on the
best way to ramp up educational
attainment.
About 14 states are giving students
merit scholarships. The idea is to nurture human capital and encourage
students to stay in their home states
after graduation from high school and

hopefully even after college.
Eligibility criteria vary from state to
state and include minimum grade
point averages and standardized test
scores. In the Fifth District, South
Carolina and West Virginia offer
merit scholarships.
Problematically, those awards typically go to higher-income students
who would have gone to college anyway. Also, state merit scholarships can
help with rising tuition costs, but
can’t compensate for poor early
schooling, a ragged home life, or rock
bottom confidence.
Debbie Barr has been there. She
remembers her fears: “Could I make it?
What if I get down here and mess up?”
She did make it through, and her
case illustrates the myriad benefits
of an education. “It’s opened up
doors for me to give back to my
community.”
RF

READINGS
Barrow, Lisa, and Cecilia Elena Rouse. “Does College Still Pay?”
The Economists’ Voice, 2005, vol. 2, no. 4, article 3.
Douthat, Ross. “Does Meritocracy Work?” The Atlantic Monthly,
November 2005, pp. 120-126.
Heckman, James J., and Alan B. Krueger. Inequality in America:
What Role for Human Capital Policies? Cambridge, Mass: MIT
Press, 2003.

Kane, Thomas J., and Cecilia Elena Rouse. “The Community
College: Educating Students at the Margin between College and
Work.” Journal of Economic Perspectives, Winter 1999, vol. 13, no. 1,
pp. 63-84.
“Empty Promises: The Myth of College Access in America.” A
Report of the Advisory Committee on Student Financial
Assistance, June 2002.

RF Winter p38/39.ps - 2/9/2006 2:41 PM

Bottleneck

What the Fifth District’s only major oil refinery explains about high gas prices in
the wake of Hurricanes Katrina and Rita
f you want to understand why
gas prices shot up past $3 a gallon immediately after Hurricane
Katrina hit the Gulf Coast, consider
looking at Virginia’s sole oil refinery
— in fact, the only refinery of any
significance in the Fifth District.
Almost everything you need to know
about gas prices can be explained, at
least indirectly, with a visit to Giant
Industries’ refinery in Yorktown, Va.
The 570-acre facility is dotted by
mammoth storage tanks, soaring distillation towers, and miles of pipes.
The plant churns out upward of
60,000 oil barrels a day, which may
sound like a lot but is actually just a
drop in the national bucket of refinery capacity; in fact, it is less than a
half percent of the total U.S. daily
refinery output. If the Yorktown
refinery was shut down — as it temporarily was in 2003 with Hurricane
Isabel and then again this fall after a
fire — national gas prices wouldn’t
even blip. But the way Yorktown
operated in the aftermath of Katrina
provides a vivid picture of how price
changes are a function of economic
rules about supply and demand,

I

BY DOUG CAMPBELL

regulation, and competitive markets.
“Whoever has control of a
resource that suddenly becomes
scarce — in this case, refinery capacity — those people will experience a
substantial increase in profits,” says
Stephen Brown, director of energy
economics at the Federal Reserve
Bank of Dallas. “This is a normal
market phenomenon, much the same
as owning a piece of land that suddenly becomes valuable.”
Of course, there are other things
going on as well. Oil prices, as the
Energy Information Administration
points out, “are a result of thousands
of transactions taking place simultaneously around the world, at all levels
of the distribution chain from crude
oil producer to individual consumer.”
At the same time, the hub of much of
this interaction takes place at
refineries like the one at the mouth
of the York River.

The Refining Process
Yorktown is about 10 miles southeast
of Williamsburg. Giant Industries Inc.
bought the 1954-built refinery in 2002
from BP p.l.c. for about $170 million.

The site employs about 300 workers,
including contractors. Much of the
area is under construction as the refinery is upgraded to meet new clean fuel
laws. Charley Yonker, vice president of
administrative services with Giant in
Yorktown, says the cost of the
improvements is almost equal to the
plant’s acquisition price three years ago.
The Yorktown facility receives
ships loaded with crude oil from
around the world but lately has gotten
a lot of North Sea traffic. After arriving in Yorktown, crude oil is pumped
from the ships via pipes to storage
tanks. There it waits just hours
or a few days until going through a
de-salting process and then being
“charged to the unit,” or moved into
distillation towers.
These towers — there are 20 of
them on the Yorktown site — are
where the main refining process
happens. Refining crude oil is all about
heating and cooling, pressuring and
depressuring to separate crude
oil’s main chemical components —
gasolines, diesels, greases, and
asphalts. When it enters the tower,
crude oil is heated to upward of

Giant Industries owns
and operates Virginia’s
only oil refinery, which
sits on 570 acres and
churns out about 60,000
barrels a day.

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Maxed Out
Yorktown is running at maximum output almost every day. That is why this
summer’s hurricanes made such a sizable — and positive — impact on
Giant Industries’ bottom line.

For a short time, Hurricanes
Katrina and Rita knocked out many
refineries in the Gulf Coast, cutting
the nation’s refining capacity by about
25 percent. Even well into October
about 18 percent of U.S. refining
capacity remained idle because of the
storms. So even though the United
States opened its strategic oil reserve,
easing the shortage of crude oil, there
remained a shortage of refinery capacity. That’s where the bottleneck
happened. Meanwhile, demand for gas
remained relatively stable. From there,
all you need is to look at a simple chart
of supply and demand to see why
prices rose as quantity dropped.
The Yorktown refinery dealt with
the supply disruption by allocating
products to its customers based on
their average “lifting” levels over the
past six months. Instead of being able
to collect a full order, customers took
80 percent or so.
The storms hurt refinery capacity
more than production capacity.
Which means there was crude oil
ready to be refined — but with no
place to go. If there was more refinery
capacity in the United States, the price
hikes might not have been so steep.
Although existing refineries have
expanded in recent years, there has
been no new refinery built in the
United States since 1976. In addition,
some have shut their doors. There
were 324 refineries in 1981 but just 144
today. Over the same time, the volume
of crude oil refined in this nation has
also dropped from 18.6 million to 16.9
million barrels. Meanwhile, demand
has grown about 25 percent over the
past two decades.
Refinery companies blame environmental regulations. “A lot have

decided not to stay in the business. It’s
very capital intensive,” says Leroy
Crow, chief of refinery operations at
Giant. “We spend $80 [million] to $90
million in 2005 at our refineries [on
mandated upgrades] and those
improvements have no payback, no
return on investment.”
The Yorktown refinery’s relative
isolation illustrates the capacity
problem. Building new refineries
requires hard-to-find qualities like vast
acreage, port access, and ample water
and power supplies, not to mention
compliance with increasing environmental rules. With Yorktown as the
only refinery in the Mid-Atlantic, the
gas supply problem was particularly
acute in this region. For a time after
Katrina, Baltimore endured the
highest gas prices in the nation
because the Colonial Pipeline running
up and down the Mid-Atlantic was
virtually dry when four major Gulf
refineries serving it were shut down
with the storm. And when new crude
began hitting the East Coast, it went
first to New York ports.
Brown, at the Dallas Fed, said it
would take sustained prices of more
than $2.50 a gallon at the pump to
make building a new refinery
profitable under current regulations.
Even then, it takes at least five years to
go through a permitting process. That
sharply limits the number of possible
new entrants.

Price Gouging?
Stock in Giant shot up 45 percent in
the wake of Hurricane Katrina.
Net earnings jumped from $6 million
in the third quarter of 2004 to
$46.6 million in the same 2005 period.
Jacques Rousseau, oil industry analyst

PHOTOGRAPHY: GIANT INDUSTRIES

800 degrees Fahrenheit, causing it to
vaporize. As the vapor rises along the
tower’s 10-or-so stories, it condenses
and collects at different vertical
points. Gasoline components, for
example, are lighter in molecular
weight and rise high in the tower
before condensing. Catalysts can
be added in the process as well to
promote certain chemical reactions.
The resulting products are pulled off
the tower via pipes at ascending
heights. The parts that don’t vaporize
make tar and asphalt. The whole
process can take as little as eight
hours.
Yorktown makes three grades of
gasoline, two grades of diesel,
kerosene, fuel oil, propane, and coke
(a high-carbon reside that can be used
as a boiler fuel to make steam or
electric power). Giant Industries sells
to a wide variety of fuel companies,
ranging from major oil brands to
independents like convenience store
chain Royal Farms, which is based
in Baltimore.
For gas products, Yorktown sends
out most of its output via barges that
dock at its pier and usually head north
to New Jersey. There, the gas is
pumped into storage tanks where the
gas firms add the final additives before
trucking them to the pumps. A smaller
portion of Yorktown’s gas is picked up
by trucks, whose travel radius is about
150 miles. Additives in this case are
added on-site.

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Lower-Atlantic Gas Prices
Prices spiked following the hurricanes, but then moved back to pre-storm levels.
350
Hurricane
Hurricane Katrina makes Katrina makes
landfall on
landfall on August 29, 2005 August 29, 2005

C ENTS /G ALLON

300
250
200
150
100

1/21/06

10/21/05

7/21/05

4/21/05

1/21/05

10/21/04

0

7/21/04

50

NOTE: The Lower Atlantic region: Florida, Georgia, South Carolina, North Carolina, Virginia, and West Virginia.
Maryland and the District of Columbia are considered part of the Central Atlantic region.
SOURCE: Energy Information Administration

at Friedman Billings Ramsey in
Arlington, Va., uniformly raised stock
price estimates on the companies he
follows after the hurricanes and
predicted that the impact would be
long term. “It is important to keep in
mind that the hurricane’s impact on
inventories should have a long-lasting
effect, and refiners are likely to have
difficulty replenishing gasoline and
distillate stocks in 2006,” Rousseau
wrote in a note to investors. He also
cited refinery downtime for regulatory
upgrades and removal of the controversial component MTBE from the
gasoline pool as factors that will
continue to dampen supply.
Oil companies like Giant are
unapologetic about the windfall,
describing it is part of the up and
down industry cycle. “This works both
ways,” Crow says. “In 2002, you
couldn’t give gasoline away. The
market is what the market will be.”

Downstream
About 44 percent of the price of gasoline is determined by the price of

crude oil. The next highest portion of
gas prices comes in the form of federal
and state taxes, about 27 cents of every
dollar. Refining accounts for roughly
15 percent. And the smallest portion,
about 14 percent, is for the so-called
“downstream” activities of marketing
and distribution. Baltimore-based
Royal Farms is a typical midsize gas
retailer. But unlike big oil companies
that have their own refining operations, retailers like Royal Farms were
largely left out of the Katrina bonus.
In general, the wholesale cost of fuel
increased faster than retail prices. The
supply disruption drove prices up at
the pump in large part because
retailers like Royal Farms paid higher
prices for their wholesale products to
ensure they had enough for their
customers, and enough to pay for
“future, more expensive gasoline deliveries,” says the American Petroleum
Institute, an industry trade group.
An economist would put it this
way: Even if the retailer bought gas at
$2 a gallon today, if he knows that he
will be buying it at $3 a gallon in the

near future, then it behooves him to
raise prices. In this way, he replaces
inventory in a cost-effective manner.
Meanwhile, the higher price signals
that the resource is growing scarce
and dampens demand. In any case,
retailers ended up with no profit
advantage because of the hurricanes,
industry participants say.
“If anything, we did worse than a
normal year,” says Rob Rinehart, chief
of gas operations at Royal Farms.
Rinehart notes that the states of
Delaware and Maryland, among
others, are subpoenaing records of
convenience retailers. “I believe they
will find cries of price gouging to be
unfounded in the retail sector,” he says.
But that didn’t stop lawmakers in
Washington from holding hearings to
question oil company executives about
their post-hurricane profits. With consumers complaining about spiking gas
prices, politicians responded by
proposing taxes on oil firm “windfall
profits” and warned against what they
termed “price gouging.”
It is true that many oil firms profited handsomely in the wake of the
hurricanes. Whether that’s something
that should be legislated away, though,
is not so obvious. Many energy economists believe the market should be
largely left alone.
“I guess there’s a political definition [of price gouging] — that if the
change in prices is high enough that
constituents call and complain,”
Brown says. “But as an economist, I
have a hard time defining what price
gouging is. Prices are signals that
there’s scarcity. They tell people to be
using less gas.”
RF

READINGS
Brown, Stephen P.A., and Mine K. Yücel. “Gasoline and Crude
Oil Prices: Why the Asymmetry?” Federal Reserve Bank of Dallas
Economic and Financial Review, Third Quarter 2000, pp. 23-29.
Conaway, Charles F. The Petroleum Industry: A Nontechnical Guide.
Tulsa, Okla.: PennWell Books, 1999.
Peltzman, Sam. “Prices Rise Faster than They Fall.” Journal of
Political Economy, June 2000, vol. 108, no. 3, pp. 466-502.

40

Region Focus • winter 2006

“Oil Market Basics.” Energy Information Administration, U.S.
Department of Energy.
“Virginia Energy Patterns and Trends.” Virginia Department of
Mines, Minerals, and Energy.

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

IDENTITYTHEFT
Greater credit options
have increased
consumers’ financial
flexibility — and the
ability of criminals
to steal information.
Still, the share of
people victimized
remains small

W

hen Lisa Cook of
Columbia, S.C., tried to
open her first checking
account, somebody had already beat
her to it, using her Social Security
Number but a different name.
“It was $600-some in the red,”
Cook says. That was the first of about
$98,000 in debt amassed under her
Social Security Number. Cook, who is
26, was one of 2,148 people in South
Carolina reporting identity theft to the
Federal Trade Commission in 2004,
roughly a third of them between the
ages of 18 and 29.
After more than a year of fending
off bill collectors, navigating voice-mail
mazes for credit reports, making investigative trips to the imposter’s town,
copying fees, frustration, and

heartache, Cook is repairing her financial records.
“I was building my own credit,” says
Cook. “My mom told me if you don’t
have credit, you don’t have anything.”
The imposter was eventually caught,
charged, and imprisoned.
Assimilation of personal data has
been a useful tool in allocating credit
— let’s face it, your Social Security
Number is recorded and used as an
identifier by everyone from doctor to
landlord to employer. The data are a
prime target for resellers as well as
thieves, and have become relatively
easy to mine.
Between electronic records and the
ubiquity of credit cards, it’s not so
shocking that financial crimes would
blossom. And for the fifth year in a row,

identity theft was at the top of the
FTC’s fraud complaint list. But what
is identity theft? Does it include plain
old credit card thievery? If so, survey
data indicate that there were about
10 million victims in 2003. Or is
it something larger — like using a
person’s Social Security Number to
establish new accounts?
The challenge facing financial institutions and regulators alike is finding
the proper balance between protecting
consumers and making credit readily
available. Nobody wants to hamper the
efficient credit market that the free
flow of data has created. But as online
transactions and services grow,
consumers, banks, and regulators are
paying closer attention to identity
theft and the mounting cost of

winter 2006 • Region Focus

PHOTOGRAPHY: GETTY IMAGES

BY BET TY JOYCE NASH

41

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

LEGISLATIVE AND
REGULATORY ACTION
The Identity Theft and Assumption
Deterrence Act of 1998
●

Makes ID theft a federal crime with
penalties of up to 15 years and a
maximum fine of $250,000

●

Establishes victim status so he
can seek restitution if there is a
conviction

●

Establishes the Federal Trade
Commission as the central agency to
collect complaints, referrals, and
resources

Gramm-Leach-Bliley Act of 1999
●

Requires financial institutions to
protect information collected about
individuals

●

Requires financial institutions
to give consumers privacy notices
that explain the institutions’
information-sharing practices

●

Gives consumers the right to limit
some information sharing

Fair and Accurate Credit
Transactions Act of 2003
●

Requires account numbers on credit
card receipts be truncated to prevent
confiscation of names and numbers

●

Requires major credit-reporting
agencies to provide consumers with
a free copy of credit report annually

●

Permits victims of ID theft to place
an “alert” on credit files

●

Rule making in progress

preventing it. The crime has spawned
its own industry of solutions and
consultants, including identity theft
insurance.

The Costs of ID Theft
Overall, identity theft cost businesses
and financial institutions $52.6 billion
in 2004, according to a Javelin Strategy
and Research survey. And that’s just
money lost; that doesn’t count the
complex systems put in place to fight
it. Javelin is a consulting firm for
the financial services and payments
industry. The survey, similar in
methodology to the FTC’s 2003
Identity Theft Survey Report, was
sponsored by financial services firms,
including Visa USA and Wells Fargo
Bank. The survey polled 4,000 people,
including 507 fraud victims.
It’s important to distinguish
between credit card fraud and true
identity theft, cautions John Hall, a
spokesman with the American Bankers
Association. “It’s the difference
between crime and murder,” he says.
“You don’t just lump them together.”
Fraud involving general-purpose
credit cards averages less than
0.06 percent of sales today, thanks
to sophisticated detection and
monitoring. Merchants who do
business online report decreases in
lost revenue from payment fraud, from
3.6 percent in 2000 to 1.8 percent
in 2004. Federal law limits consumer
liability to $50 per card.
Account takeover or new account
fraud, like Lisa Cook’s, is more troubling and a major hassle for the victim.
Thieves steal what’s in the account and
use a creditworthy identity to get
more; often their victims are relatives.
Not always, though. Lisa Cook’s
imposter was as different from Lisa as
night is from day — in sex, race, age,
and residence. He was able to get credit
at stores where she was not. And he
bought two cars, got a business license,
and several loans from payday lenders.

Credit Where Credit Is Due
SOURCES: Federal Trade Commission and

Privacy Rights Clearinghouse

42

Region Focus • winter 2006

Economists view credit favorably. It
gives people greater financial choices
and allows them to “smooth” their con-

sumption patterns over time. The
growth in affordable, available credit
stems largely from the flow of personal
data in the national credit reporting
system. The information provides
lenders with many pieces to evaluate
who gets credit and who doesn’t and,
most importantly, to reduce uncertainty
and price the credit according to risk.
Economists William Roberds of the
Federal Reserve Bank of Atlanta and
Charles Kahn of the University of
Illinois have studied credit and identity
theft and recently published a working
paper about it.
“Any successful payment system,
credit card … cash or whatever has to
have some way of tying the person in
the transaction to somebody’s
records,” Roberds says in an interview.
While instances of identity theft
enrage consumers, no doubt about it,
regulators are thinking long and hard
before imposing strict rules on the
data-gathering activities. According to
Roberds and Kahn: “This reluctance
stems, in part, from the notion that the
collection of personal data is essential
to the process of allocating credit.”
Society may ultimately have to
decide on a rate of identity theft that
balances its preference for privacy with
its tolerance for transaction fraud, the
authors say.
“The take we have on credit card
fraud, identity theft, is that it’s sort of
the byproduct of something good,”
Roberds says. “The something good
is the fact that credit cards and debit
cards and other types of payment
systems have a good feature, allowing
merchants to share identifying
information on you.”
By virtue of the fact that you have a
credit card, your credit record is tied to
you and allows you to engage in transactions you otherwise might not —
that’s the good side. “But the bad side
is, once a mistake is made, once somebody gets a hold of your credit card
number and uses it to tie you to transactions that they’re involved in, that’s a
down side of that system,” Roberds says.
Roberds and Kohn created a model
that showed the upside outweighs the
downside. “That’s pretty much the way

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Identity Theft Victims By State
The District of Columbia’s rate of identity theft is the
highest in the nation. Credit card fraud, at 28 percent
of all cases nationwide, is the most common form of
reported identity theft.
180

166.6

V ICTIMS

POPULATION )

160
140

OF

Worrisome data losses in 2005 among
businesses, including several banks and
data firms, set off a wave of publicity
that raised questions about the security of personal data. Charlotte-based
Bank of America lost a backup tape
with information on 1.2 million
accounts, and Bank of America and
Wachovia, among other institutions,
also lost data through dishonest insiders, according to Privacy Rights
Clearinghouse, which maintains a list
of data breaches.
Bank of America and Wachovia say
they notify customers if data have been
compromised. Among Fifth District
states, North Carolina alone requires
notification in case of data breaches, as
of Dec. 1, 2005.
While the losses are undesirable,
Julie Davis, spokeswoman for Bank of
America, says that as far as the bank
knows, none of the information has
been used. “So while the tapes were
lost, it really was a case of lost tapes and
not stolen data.”
The banking industry has come a
long way since about 2000 when
banks were afraid to “even mention
the words ‘identity theft,’ ” according to Ariana-Michele Moore, a
senior analyst at Celent, a financial
services consulting firm. Banks today

including the Federal Reserve, has told
banks by the end of 2006 to complete a
risk assessment and implement any
technology necessary for added security, including customer authentication,
verification of new customers, monitoring, and reporting.
“We, like the other financial institutions, are going through that
assessment activity as we speak,”
Wachovia’s Scott says. “Based on that,
we’ll use that information to apply the
appropriate controls to where we think
it needs to be best implemented.” He
would not say how much the extra
actions would cost.
Bank of America, with the biggest
pool of online customers nationwide,
about 14 million, in 2005 introduced
SiteKey. Spokeswoman Davis says it
had been in the works for two years.
SiteKey customers choose from among
thousands of images and then create a
phrase unique to them. They also select
from a list of challenge questions.
When logging on, customers look for
the icon and phrase to pop up and then
enter a password. “If you’re at another
computer, it asks you a challenge question,” Davis explains. “The bank
validates you before you log on. It lets
the customer know they have indeed
reached Bank of America.” Even if an
ID and pass code have been stolen
through spyware (malicious software
that can take over certain computer
operations without the user’s knowl-

100

N UMBER

The Buck Stops Here

are educating consumers and
employees, monitoring transactions,
and using complex and expensive
software systems to pick up the latest cyber scams. They sometimes
offer free services to identity
theft victims, such as account
monitoring.
But they can’t reveal all their tactics, says Nessa Feddis, senior federal
counsel at the American Bankers
Association. “The banks do a lot
more than what we can say,” Feddis
says. After all, they don’t want to
publish a road map for criminals.
Steve Scott, Wachovia’s director of
corporate information security, says
that when credit card numbers get
exposed somehow online, “not only do
we have to deal with the fraudulent
activity that comes with those cards
but we also have to deal with the
customer.”
While banks can’t discuss nuts and
bolts of preventive strategies, they’ve
ramped up responses as the threats
have escalated. Those include everything from the simplest and cheapest
consumer and employee education to
thorough investigation of partners.
Wachovia sends teams to supplier
sites to review security. “Then we
measure that against our own standards and requirements,” Scott says. “If
there are gaps, then we work with
those vendors to close that gap and
those could be deal breakers.”
Scott won’t say how big a problem
identity theft is at Wachovia. “We all
know it’s a problem and we’ve had to
rise to meet that ... the identity theft
creates more work for us.” In general,
he says, “there’s a lot more energy being
put around knowing the customer, a lot
more process being put in place to
make sure we have valid identification.” A delicate balance exists between
security and convenience. “Customers
still want services that are dependable,
available, secure, and easy to use,”
Scott says. Sometimes that’s a hard
combination. Customer acceptance
and usability are the biggest drivers.
The Federal Financial Institutions
Examination Council, comprised of
representatives from five agencies

( PER 100,000

it’s worked out in the real world,”
Roberds says. “We worry about identity
theft, but we don’t want to give up our
credit and debit cards.”
The model indicates that in an
economy where information is
shared and there are more buyers,
there is also more provision of
credit. “People would be generally
better off than in an economy where
you didn’t have this information
sharing,” he notes.
Credit has lowered the cost to
merchants to do business on credit
and likewise cut the cost to them of
providing credit to customers. “It’s
expanded the set of transactions that
can be done on credit,” he says. “But
the downside is we have these two
prevalent types of fraud that have to
be kept in check.”

120

83.0

80

65.8

63.6
51.2

60

34.2

40
20
0

DC

MD

NC

SC

VA

WV

SOURCE: Federal Trade Commission

winter 2006 • Region Focus

43

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

edge) or e-mail scams that link to bogus
Web sites, the account would be
unavailable to an imposter.
Davis, like Scott of Wachovia,
would not discuss how much SiteKey
has cut into the bank’s bottom line or
how big a problem identity theft is for
Bank of America.
Even with risks associated with spyware, consumers might do well to bank
online, along with 44 percent of all
Internet users and 25 percent of adults
who now do so. “Because I’m logging
onto my account daily or weekly, I would
be the first to notice, ‘Gee, I didn’t write
that check,’ ” says Celent’s Moore.
Still, cyber crimes are increasing
and that is expected to slow e-commerce growth rates by 1 percent to 3
percent, according to Avivah Litan of
the information technology research
firm Gartner Inc. Phishing attacks, for
example, reached an estimated 73 million U.S. adults in the 12 months ending
May 2005, a 28 percent increase over
the previous 12-month period.

Social Insecurity
While data dissemination and malicious Web work has driven identity
theft, most thieves still get their information the old-fashioned way. In cases
where the method was known, the
Javelin Survey reports 68 percent of
information was gleaned offline compared to 11.6 online. The most
common methods include lost or
stolen wallets, misappropriation by
family or friends, and mail theft. That’s
how Lisa Cook’s imposter got her
Social Security card — her wallet had
been stolen.
It’s no wonder that Social Security

Numbers as identifiers have come
under increased scrutiny. “It’s overwhelming when you look at the big
picture of identity theft and the opportunity,” notes Ariana-Michele Moore
of Celent, referring to peoples’ relationships to organizations. Between
landlords, employers, background
checks for even volunteer work, it’s
important for people to realize how
available their personal information
may be.
Social Security Numbers (SSNs),
names, and birth dates, are the prized
identifiers for identity thieves,
according to the U.S. Government
Accountability Office in reports in
2004 and 2005 that examine the exposure of SSNs. The numbers were first
used in 1936 to track workers’ earnings,
but now SSNs are collected widely. The
GAO reports the numbers are often
available in public records, especially
state and local government records.
The GAO reported in 2004 that state
agencies in 41 states and the District of
Columbia displayed SSNs in public
records. This was also true in 75 percent of U.S. counties. It has been used
on drivers’ licenses and insurance
cards, including Medicare and government- issued insurance cards.
Data resellers, credit reporting
agencies, and health care organizations
use SSNs. Information resellers may
obtain the numbers from records,
including court records such as bankruptcies, real estate transactions, voter
registrations, and professional licenses
or from business clients. In 2003, the
GAO investigated Internet-based
information resellers to determine
what information might be available.

The investigators paid fees and supplied several resellers with legitimate
SSNs, and in return received information based on those numbers, such as a
name, address, telephone number.
During the investigation, none of the
Internet-based resellers bothered to
verify who they were or whether they
were using the information for the purpose they’d indicated.
As Lisa Cook discovered, if a thief
has your Social Security Number, he’s
got a good head start on fraud.
Twenty-nine percent of identity theft
victim complaints in 2004 came from
people aged 18 to 29, according to the
FTC. In the European Union, identity theft isn’t as big a problem, and
some experts have suggested it’s
because Social Security Numbers
aren’t universal identifiers. In
Europe, residents have national identity cards and Social Security
Numbers are used solely for
retirement benefits. Privacy laws
keep businesses from sharing and
selling personal or private financial
information. Of course, the price
they pay is slower credit decisions.
But some “red flag rules” are
coming, under the Fair and Accurate
Credit Transactions Act, the law
passed in 2003 that gives consumers
one free annual credit report for
the asking.
Lisa Cook is still asking herself how
the thief got away with using his name
with her number for so long. She’d built
up a good report by paying her bills on
time.
“I already had stuff on there [credit
report], but it was all good, until he
came along.”
RF

READINGS
Bovbjerg, Barbara D. “Social Security Numbers: Federal and State
Laws Restrict Use of SSNs, yet Gaps Remain.” Government
Accounting Office Document GAO-05-1016T, September 15, 2005.

Kahn, Charles M., and William Roberds. “Credit and Identity
Theft.” Federal Reserve Bank of Atlanta Working Paper 2005-19,
August 2005.

Cheney, Julia S. “Identity Theft: A Pernicious and Costly Fraud.”
Federal Reserve Bank of Philadelphia Payment Cards Center
Discussion Paper 03-18, December 2003.

“National and State Trends in Fraud & Identity Theft, January December 2004.” Federal Trade Commission, February 1, 2005.

Duncan, Joseph W. “Congress Faces Critical Decision About
Consumer Credit Legislation (The Fair Credit Reporting Act of 1970
and 1996).” Business Economics, July 2003, vol. 38, no. 3, pp. 62-71.

44

Region Focus • winter 2006

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ECONOMICHISTORY
The Sea Island Hurricane of 1893
BY B E T T Y J OYC E N A S H

efore hurricanes carried
names and price tags, like
New Orleans’ Katrina (estimates start at about $100 billion) and
Florida’s Andrew ($44 billion) and
South Carolina’s Hugo ($12 billion), a
nameless storm slammed the islands
clustered off Georgia and South
Carolina. These islands were home to
descendents from Africa, former
slaves who were of the Gullah language and culture. Beaufort County,
S.C., which includes many sea islands,
got the worst of it.
It would be tempting to compare
the “big blow” with Katrina, as the
nation watches money and effort
being plowed into rebuilding New
Orleans. But that would be facile
and off the mark. Still, history is
sobering, if not always perfectly
instructive.
With little communication and no
means of evacuation from the bridgeless islands, upward of 2,000 people
(only two of them white) died in
the 1893 storm. But starvation following the hurricane was an equal
opportunity problem, with blacks
and whites alike on survival rations,
and only Clara Barton’s American
National Red Cross to help feed and
clothe them.
The storm of 1893 was one of three
big hurricanes to hit coastal South
Carolina in one decade, but it was the
1893 big blow that sank Beaufort
County into an economic slumber
and great migration, from which it
didn’t begin to awake until the government invested in the Marine
Corps base on Parris Island in the
run-up to World War II, according to
Lawrence Rowland. He is professor
emeritus of history at the University
of South Carolina at Beaufort, and
has written a history of the county.
Today, Beaufort County is prospering, with the highest per-capita

PHOTOGRAPHY: CLARA BARTON NATIONAL HISTORIC SITE - NATIONAL PARK SERVICE

B

income in the state. Although there’s
little industry to speak of, three military installations account for about a
third of the economy. Tourism and
real estate are the other two legs.
Where starving black people 112
years ago dug ditches to reclaim
flooded fields, half-million dollar
homes and golf courses edge coastal
marshes and rivers on dozens of
islands strung out along the coast.
Descendents of barefoot farmers
who scratched out a living 112 years
ago cross the bridge to resort town
Hilton Head, Rowland says. There,
they work in service industries
created by retirement and tourism,
or perhaps they work for the government at wages 40 percent higher than
everyone else in the county.

The storm killed
more than 2,000
people and plunged
Beaufort County,
S.C., into an
economic decline

Before the Storm
Phosphate mining was the biggest
industry in Beaufort County when
the storm crashed the coast on Aug.
27, 1893, with its 15-foot seas.
Phosphate, used in fertilizer, was
discovered in rivers in and around
Beaufort County around 1867,
according to Rowland. From about
1870 until 1893, 60 percent of the
phosphate produced in the United
States came from South Carolina,
and half of that was mined in
Beaufort County. People could earn
something like $2 to $5 a day, a decent
wage at the time. “The vast majority
who worked there were freedmen,
black Sea Islanders,” Rowland says.
Most of Beaufort County was
black, according to the 1890 Census,
about 31,400 people. There were
about 2,700 white people living in the
county at the time.
“Absolutely the history of
Beaufort County would have been
different if the hurricane hadn’t
wiped out the phosphate industry,”
he says. “How remarkably prosperous

Clara Barton (forefront, third
from right) and her American National
Red Cross distribute food on Lady’s
Island, one of the Sea Islands.

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it was before 1893 and then drifted
into abject poverty over the next
30 years.”
Most Sea Islanders, freed from
slavery when the Union captured
Beaufort County in 1861, kept plots
of sweet potatoes and vegetables to
feed their families, and one of cotton,
used to obtain cash. There were some
black merchants and professionals,
mostly in the town of Beaufort.
White people farmed, owned businesses, worked as doctors and lawyers
as well as in the maritime trade or on
the railroads as machinists, Rowland
says. Most whites lived inland. The
black people who lived on the islands
typically lived in frame homes, with
shutters against the wind. The
swampy, mosquito-ridden islands
were magnets for disease.
“Roofs were made of rough-hewn
native wood shingles, chimneys of
worn bricks,” write Fran and Bill
Marscher in The Great Sea Island
Storm of 1893. Bill Marscher’s grandparents lived through the storm, and
the newspaper stories he found as a
child inspired and informed the
book. “On the islands’ sandy two-rutted roads, the people traveled by
foot, by horse, or by two-wheel ox
cart.” It took a boat to leave the
islands.
The phosphate industry was on
the wane even before the hurricane
hit, as huge and efficient deposits had
been discovered in Florida in 1888,
Rowland notes. But the hurricane
nailed the industry for good in
Beaufort by destroying the barges
and boats and other infrastructure.
The cotton industry, too, had
declined under competition from
Egypt and India. The long fibers of
Sea Island cotton, almost like silk,
had brought premium prices until
growing international supply drove
prices down. However, most of the
Sea Island farmers grew a bale a year
just to bring in a little cash. The
storm did away with that too.
Rowland believes the hurricane
accelerated migration from the county.
“You can see it happening [in census
data] and I believe the principal
46

Region Focus • winter 2006

reason was the hurricane in 1893. It
was not the only hurricane. There
were five hurricanes in 10 years in the
Sea Islands.”
Another pre-storm investment
was the U.S. Naval Station at Port
Royal, tucked on the Beaufort River
off the Port Royal Sound. By 1901,
the naval jobs were gone. “What happened, in essence, was that after the
hurricane the Navy wasn’t sure they
wanted Port Royal Sound anymore,”
Rowland says, adding that politics
also played a role in that decision.
“Here were all these jobs, the naval
shipyard, and phosphate; by 1901
they were all gone,” he said. That
threw the county into a depression
from which it didn’t recover until
after World War II.

The Human Suffering
The winds of August 27, 1893, exceeded 115 miles per hour and brought in a
high tide of perhaps 15 to 20 feet or
more in places. The storm killed
more than 2,000 of some 31,400
black people in Beaufort County.
No federal or state money flowed.
South Carolina’s Gov. “Pitchfork”
Ben Tillman first advised people to
plant turnips. The work of relief was
left to the fledgling American
National Red Cross and its president,
Clara Barton. The storm destroyed
people, homes, and land. And it did
away with the remnants of South
Carolina’s rice plantations.
“The killer hurricane, another
‘strong force,’ hit the state’s coast in
the worst possible place — the flat,
remote Sea Islands,” according to the
Marschers’ book. “It hit at the worst
possible time — near the end of
harvest season, on high tide. Its violence was most ruthless against the
nation’s most vulnerable citizens —
former slaves and their offspring,
the Gullahs.”
There was no way to get word to
people living on the islands off South
Carolina and Georgia, even though
ships’ reports telegraphed from
Washington sent storm banners flying in Charleston, Savannah, Ga., and
Wilmington, N.C.

Here is a firsthand account from
the diary of Margaret Weary, of the
Beaufort Industrial School for Girls:
I was so busy that evening cooking supper I never minded the wind and rain, nor
the great roaring of the waves, till I
looked out through the shutter and saw
the sea all around the house. Then we
were all frightened, as we saw the waves
rushing up to the door. Ma seized my little
sister, Grace, wrapped her in a blanket and
ran to a neighbor’s house on the hill.
Brother and I jumped out into the water
and ran as fast as we could, but I fell
down into the water, my brother picked
me up, and we pressed on through the
waves till we reached the house where Ma
was. The water had come up all around
that house, too, and so we had to run to
another, up on higher land, and there
stayed all night.
Next morning we went home, but
there was no house there, nor anything
left. All had been washed away into the
marsh, and the sedge and sea weed were
piled up all around higher than my head.
We saw dead cats and dogs, dead horses
and hogs all along the shore, and some
dead men and women and children. We
saw one dead woman holding on to a timber of her house by her teeth.
Many of the Gullah believed in
spirits, and if someone drowned, his
soul was in limbo. And there were
many, many in limbo.
Survivors were in a limbo of their
own, with no food, water, clothing,
dwellings, nor even soil in which to
plant crops.

Clara Barton Returns
It was four days before even Gov.
Tillman found out about the extent
of the island damage from a telegraph
pleading for relief. The governor
responded by asking for donations.
Local relief committees formed, and
railway cars of food arrived in
Beaufort, with 2,500 loaves of bread,
25 pounds of corned beef, 100 boxes
of soda crackers, 50 barrels of grits,
and five barrels of molasses.
“Although the governor expressed
compassion and pleaded for donations from the public, he grossly
underestimated what it would

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

The chief field agent for the American
Red Cross, Dr. Hubbell, looks over
ditches dug by hurricane survivors.
The flooded lands needed to be drained
so crops would grow.

take to relieve the suffering . . .,” the
Marschers write. The governor
suggested that the islanders could
eat fish. But, of course, they had
no boats.
Finally, the governor, with overwhelming evidence of the calamity,
called on the American National Red
Cross three weeks after the storm.
Clara Barton, founder and president,
took charge.
Barton had spent nine months
during the Civil War on Hilton Head,
then occupied by Union forces. She
arrived in mid-September to sick,
sleep-deprived, hungry, naked people
who had only water from brackish
wells to drink, no food, and no
shelter.
Barton had to feed 30,000 people
with a mere $30,000 in donated
funds, until spring crops could be harvested. Her appeals to the state
Legislature and U.S. Congress were
denied.
Barton, who was 72 at the time, set
up warehouses in Beaufort, her desk a
dry goods box with a homemade
drawer. Each family of seven was
given a peck (eight quarts) of hominy
grits and one pound of pork weekly.

People who worked digging ditches
and building homes or otherwise
helping out could earn double
rations. Donations of seeds, food,
money, and clothing poured in from
the North. She established sewing
circles.
Still, starvation hung over the
county like a black cloud, even into
June 1894 — 10 months after the hurricane. Racial tensions broke out
when whites in Bluffton claimed they
weren’t getting food because they
were white, not black.
Eventually, the residents made
headway. They constructed homes,
dug ditches to drain the land, and
planted spring crops. Barton folded
her relief operation in May of 1894:
“If it is desirable to understand when
to commence a work of relief . . . it is no
less desirable and indispensable that one
knows when to end such relief, in order to
avoid, first, the weakening of effort and
powers for self-sustenance; second, the
encouragement of a tendency to beggary
and pauperism, by dependence upon others
which should be assumed by persons
themselves.”

A Throwback: St. Helena Island
St. Helena Island today is one of the
few without the golf resorts, the big
homes, and immaculate landscaping
of the retirement villages that have
sprung up on the coast in the last 40

years. Driving along, you might see a
couple of small shops or an art gallery
by the side of the road or pass a truck
loaded with watermelons headed for
market.
St. Helena, for one thing, is largely
still black-owned. It’s the home of
Penn Center, a former school for
black children dating from the
Civil War era, which now serves
as a repository for research and
gatherings about the Gullah culture.
The land has been hard for outsiders
to develop because it’s chock-full
of tiny plots, with unclear title to
ownership. After the Civil War,
Rowland explains, many freed
slaves bought land there in federal
government sales.
“St. Helena may have been the
largest concentration of independent black landholders in the state,”
he notes. “It’s created an awful lot of
‘heirs’ land’ where there are so many
heirs, one can’t determine the
owner, and that’s retarded real
estate.”
And so without the strip malls
and lush subdivisions, the traffic
roads are calm, even on a brilliant
October day when marsh grasses glow
in the distance.
With another “big blow” . . . well,
the story would be different today.
While early warning systems could
help mitigate the cruel loss of life of
1893, the economic price tag would
be calamitous, given the population
and escalating development. Were
the storm of 1893 to hit today, the
damage is forecast at $50 billion,
given current population and
buildings.
Rowland, a Beaufort native, has
moved to higher ground on Dataw
Island, 25 feet above sea level. Just
in case.
RF

READINGS
Barton, Clara. The Red Cross. Washington, D.C.: American
Historical Press, 1904.

Harris, Joel Chandler. “The Sea Island Hurricanes.” Scribner’s
Magazine, vol. 15, no. 1, January 1894.

Chazal, Philip E. The Century in Phosphates and Fertilizers: A Sketch of
the South Carolina Phosphate Industry. Prepared for the Centennial
Edition of The Charleston News and Courier, April 20, 1904.

Marscher, Fran, and William Marscher. The Great Sea Island Storm
of 1893. Macon, Ga.: Mercer University Press, 2004.

winter 2006 • Region Focus

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INTERVIEW
Tyler Ipsum
LoremCowen
People generally agree that markets are the most
efficient way to allocate resources. In short, they
deliver the goods. One exception, some critics say,
is culture. Markets respond to mass demand and,
as a result, produce inferior, homogenized art.
Consider movies. Hollywood makes plenty of
special effects laden blockbusters but neglects
thoughtful dramas and documentaries.
You might be tempted to dismiss such arguments
as mere snobbery. After all, a lot of this criticism
boils down to one person wishing to substitute his
own (supposedly refined) preferences for another’s
(supposedly gauche) tastes. But there is a larger
point to be made, says Tyler Cowen, an economist
at George Mason University. We don’t live in an
either-or world. Many different types and forms
of art can — and, in fact, do — peacefully coexist.
Markets cater to a multiplicity of wants, and
nowhere is this more apparent than in the United
States. To borrow from the title of his forthcoming
book, we live in a world of both good and plenty.

Aaron Steelman interviewed Cowen on the George
Mason campus in Fairfax, Va., on November 21, 2005.

48

Region Focus • winter 2006

Cowen: When I first started learning about economics in the
1970s, economic conditions were very bad. We had sluggish
growth and high inflation. My early work tended to focus on
macroeconomic and monetary questions because they seemed
very pressing and important. But for the past 20 years, macroeconomic conditions generally have been good, and the
policies pursued by the country’s central bankers have
improved a great deal. This, obviously, is wonderful. But, in a
sense, it has made those fields much duller. Don’t get me
wrong: I don’t think all the key problems and questions have
been solved, but their policy relevance has become less pressing.
My professional interest in the arts began to emerge about
15 years ago when I spent some time in New Zealand. Their
central bank had one of the first versions of inflation targeting,
and I was hired as a consultant to come in and look at that.
While I was there, I realized that I didn’t want to do just
money and macro. So I started thinking about some of the
niche areas in microeconomics. One of these was the arts. I
thought that this was an area that had been underexplored and

PHOTOGRAPHY: LISA HELFERT

Cowen started his academic career largely pursuing
topics in monetary economics. But his interests
have always been eclectic, and in the early 1990s,
he began to shift his attention toward the economics
of culture. The result has been a string of books and
papers that examine the current state of the arts
and the conditions under which they flourish. In
addition, since 2003, he and his colleague Alexander
Tabarrok have maintained one of the most
popular economics blogs, marginalrevolution.com.

RF: How did you become interested in looking at the arts
from an economic perspective?

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

where I had some original things to say. I started my work on
the topic around 1990. The output came quite a bit later
because there was a lot of work involved, more than just doing
conventional economics. I spent five or six years writing my
first book in the area, In Praise of Commercial Culture, and from
there my next few book projects became pretty clear. They
were just extensions of that first book. In fact, much of their
content came from chapters that had been cut from the
original manuscript of the first book.
RF: What are your thoughts on the “cost disease” as it
relates to the arts?
Cowen: In the mid-1960s, William Baumol and William
Bowen advanced the hypothesis that the arts would experience
lower productivity gains than other sectors of the economy, and
therefore would suffer from the “cost disease.” The analysis gets
a little complicated, but one thing I have tried to argue is that
the initial assumption that productivity gains would be low
simply isn’t true. If you look at music, in the last century we
have seen the introduction of radio, compact discs, and now
MP3 files. In addition, it’s easier than ever to order music
through places like Amazon, and it’s cheaper to sample many
different types of music. Also, the reduced cost of travel has
made it more affordable to go to concerts and experience live
music. So I think the cost of consuming music has fallen
dramatically, and people enjoy much more music in a much
more comfortable way than they did in the past.
Consider how people consumed music throughout most of
the 19th century. There were no recordings until the latter part
of the century — and the recordings that were available were
much more expensive than they are today. Instead, people had
to travel by wagon, often for many hours, to see a live performance. And when they got there, the acoustics often weren’t very
good. It was simply very difficult to listen to music. So I think
that the premise of the argument made by Baumol and Bowen
has been overstated. Some subsectors will experience a lower
than average rate of productivity growth. But, on balance, there
is plenty of room for the arts to reap productivity gains, and we
have seen it time and again.
RF: Looking at the music industry today, we see that while
the cost of traveling to concerts has been going down over
time, the cost of concert tickets has been going up. Are
artists trying to make up some of the revenue they are
losing through illegal downloading of their studio albums
by raising the price of attending a live show?
Cowen: Yes, I think so. The people who download illegally
tend to be younger listeners. That means you are left with a
market of older listeners, richer listeners, and less price-elastic
listeners. So for concerts and some CDs, the cost will go up.
I think we have moved from a regime where de facto copyright enforcement was too strict to one where it is too relaxed.
Illegal downloading, in one form or another, will continue.
Lawsuits will put a dent in it, but it won’t fundamentally stop it.

As a result, commercial music won’t dry up, but some margins
will get squeezed. World music will do just fine. Jazz will do just
fine. And classical will do just fine. The average listener of those
types of music is going to purchase it, not download it illegally.
But if you think about popular music, there is one segment
that I think will be hurt: musicians with moderate-size fan
bases whose work requires a lot of studio time. It will be very
hard for them to recoup their production costs. Popular groups
that don’t spend much time in the studio will do fine. They
don’t require a lot of capital, and they earn a lot of their money
from touring anyway. And the huge superstars, like Madonna or
Eminem, will be fine also. Their CDs will sell because there’s a
fraction of the population that will always want to be part of the
club, so to speak. So, as I said, I don’t think illegal downloading
will mean the end of commercial music. But some segments of
the market will be hurt quite badly.
RF: People who support the National Endowment for the
Arts (NEA) and the National Endowment for the
Humanities (NEH) claim these agencies are necessary to
remedy market failures that are present in the arts. What
do you think of that argument?
Cowen: I think that the American way of subsidizing the arts
has mostly been indirect, through the tax treatment of nonprofit organizations, through the public funding of universities,
through copyright laws. Those policies have done quite a bit to
remedy the market failure problems that do, in fact, exist in the
arts. But direct subsidies have not been at the forefront of the
approach. And those direct subsidies, in purely quantitative
terms, are very small.
I think the more important issue is how tax reform would
affect nonprofits and the arts. To me, that’s a more fruitful
debate than how the NEA should spend its money. For
instance, the President’s tax commission came up with a
proposal to reduce tax deductions for some kinds of nonprofit
organizations. In my view, that would be a mistake. I have a
Tocquevillean sympathy for the proliferation of intermediate
institutions which we call American civil society. I think the
strength of those institutions enables us to get by with less
government intervention than many other developed nations.
So in the long run, if we moved to a truly flat tax system that
removed the favorable tax treatment for nonprofits, I think we
would harm the decentralized production of ideas and art.
RF: I would like to consider the issue of market failure
more broadly. How widespread, in your view, are examples
of market failure? And have economists who generally
favor a hands-off approach to public policy not adequately
addressed those cases where market failure arguments
are plausible?
Cowen: I believe market failures are virtually everywhere. The
key question is comparative: Where will government do better?
I think of myself as a libertarian, and compared to public opinion as a whole, my views certainly are libertarian. But the case

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for the market is empirical, and I think that there are plenty of
cases where it is desirable for the government to do something.
One example is the avian flu, which I hope we will get to later. I
also think, though, that there are many cases of market failure
where the government shouldn’t do anything. In principle, we
could come up with programs that would improve social
welfare, but in practice those programs would be difficult to
implement effectively. Also, I think there is a good argument for
the notion that a government can do only a limited number of
things well. In the big picture, you have to choose priorities, and
that means you have to let some share of market failures slide.
RF: Please tell us about your next book, Good and Plenty.
Cowen: The book is coming out in the spring from Princeton.
In it I attempt to unify the economic perspectives on the issue
of art with the aesthetic perspectives, and to ask what are the
types of policies that would produce a system of artistic
production that is both efficient and aesthetically pleasing. I
argue that the American system, to a considerable degree, does
that. It is not perfect on either dimension. But on the two taken
together, I think it does better than any other. In one sense,
then, the book is a defense of and apology for the American
system. And in another sense, it’s a return to the classic social
science question of how America and Europe relate to each
other, and what are their relative virtues and drawbacks.
RF: Is there a real danger that globalization will lead to
the effective loss of some cultures’ most important and
distinguishing characteristics? And if so, is this something
that we should worry about?
Cowen: There are plenty of cases of small, indigenous cultures
using the market to make a living without people having to
migrate to big cities. That being said, I think it’s true that some
very small cultures — their language is spoken by 50,000 people
or fewer, they have their own tribal rituals, etc. — are, in fact,
disappearing. But I think they are disappearing largely for good
reasons. People want jobs, access to antibiotics, and better
schools for their children, so they move to urban areas.
However, those people are not completely abandoning their
identities or ceasing to be creative. They are blending with their
new cultures, rather than being overtaken by them. We see this
in places like Mexico, Brazil, and Nigeria, where people
are moving from rural to urban areas. This process, by itself,
doesn’t bother me, as long as it is being driven by economic
growth. I think it’s hard to dismiss people’s desires to improve
their own lives and the lives of their children, and for many, this
is what moving to cities means.
RF: Your last answer suggests that it is sometimes difficult
to divorce normative concerns from positive economic
analysis. What do you think is the proper role for
normative evaluations in economics?
Cowen: I don’t think we have ever had a good welfare economics.
50

Region Focus • winter 2006

When you think of
Paretian theory, it’s very
useful, but we never have
been able to explain to
the common man or
to philosophers why
efficiency should be the
only relevant value. As
economists, we have
taken a real beating on
this, time and again, and
we have lost those
debates. For example,
when Richard Posner
debated wealth maximization with Ronald
Dworkin in the early
1980s, I think it’s pretty
clear that Dworkin got the better of that exchange, yet economists are still looking at wealth maximization.
So I think there are a lot of interesting normative issues in
economics. I’m not sure we will ever have definitive answers,
but I think we should be willing to entertain more values than
what is possible by doing simple Paretian analysis. This is important for its own sake, but I think it would also help us
understand why economic recommendations are often found to
be unpersuasive. In my work on the economics of the arts, I
have come across this all the time. Most people don’t accept the
efficiency argument at all. They want art for art’s sake. I would
like to think that we have some way of speaking to people like
that and developing a common language. And I think that
a good system for the arts would do well on both economic
criteria and aesthetic criteria.
RF: Why do you think so many people object to the way
economists think about rationality?
Cowen: Well, I think there is some blame on both sides
here. Economic models of rationality are centered around selfinterest. It’s true that you can factor in altruism in these models
to some extent, but the self-interest idea remains paramount.
And that may not be entirely realistic. But I also think that
many people don’t like these models because they strip away a
veneer of self-deception. You often hear the claim that various
social phenomena are so complex that they can’t be explained
by mere self-interest. Perhaps, but I think that is a way of
whitewashing some very unpleasant things that go on in society.
RF: You clearly have a significant interest in cuisine. And
many people clearly value your opinions on the topic —
your “Ethnic Dining Guide to the Washington, D.C. Area”
is now in its 19th edition. How can economics help us
understand food and the way people eat?
Cowen: This relates to my work on globalization and culture
more generally, which asks the question: Does greater trade,

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

less interventionist, more marketinvestment, and migration across bororiented approach to social policy?
ders give us more or less diversity? And
Do their arguments become futile?
a great deal of those debates are about
➤ Present Position
food. For instance, you see a great
Holbert C. Harris Professor of
many people who are upset about
Cowen: I don’t think so. Free-market
Economics, George Mason University
McDonald’s and Pizza Hut establisheconomists are unlikely to see their
➤ Previous Faculty Appointments
ing restaurants around the world. So
most preferred policies enacted. But
University of California, Irvine
my attention was drawn to the food
their work can help slow down or even
(1987-1989)
area, and I think from an economic
stop very bad ideas from becoming
standpoint, it offers a case study of the
policy. So their arguments do matter.
➤ Education
diffusion of innovation.
That’s important. Still, there is a
B.S., George Mason University (1983);
Why is barbecue in Lockhart,
broader issue here. As social scientists,
Ph.D., Harvard University (1987)
Texas, so much better than barbecue in
our foremost concern should be trying
➤ Selected Publications
Fairfax, Virginia? The answer is not
to understand the world. That means
Author or co-author of several books,
immediately obvious. One would
asking and perhaps answering very
including Explorations in the New Monetary
think that there is considerable
hard questions. Trying to convince the
Economics (1994), In Praise of Commercial
demand in both areas, yet the markets
public — and especially trying to get
Culture (1998), Creative Destruction: How
are very different. In part, I think it
people to march in lock step — should
Globalization Is Changing the World’s
has to do with the spread of social
be a secondary concern.
Cultures (2002), and Good and Plenty: The
customs and regional identity. And, in
Having said that, I don’t want to
Creative Successes of American Arts Funding
part, I think it has to do with differing
give the impression that academics
(forthcoming), and papers in such journals
legal and regulatory structures; for
should look only to the frontiers of
as the American Economic Review, Journal of
instance, Lockhart’s barbecue estabtheir disciplines. For instance, the
Political Economy, Public Choice, and Ethics
lishments would not meet the fire,
work being done in economics now
health, and safety codes that exist in
is very rigorous and very good. But
➤ Other Activities
many areas, including Fairfax. Also,
if I have one criticism of the
Serves as General Director of the James
why do some types of food lend themprofession, it’s that there is too
M. Buchanan Center for Political
selves to chain establishments while
much emphasis on doing highly
Economy and the Mercatus Center, both
others do not? For example, most
specialized research and not enough
at George Mason University. Maintains the
doughnut shops now are part of
emphasis on consuming what is
economics blog, marginalrevolution.com,
chains, but barbecue chains generally
already out there. Most of us could
with his colleague Alexander Tabarrok.
haven’t done very well. To understand
benefit a great deal from a better
that question, you need a fair amount of economics. So what I
understanding of work that has already been done.
hope to do with my work in this area is to use food as a vehicle
for discussing larger economic truths, and to reach an audience
RF: You wrote a paper called “Why Only Nixon Can Go to
China” that was published in Public Choice. Can you talk
of people who might read books about food, but not necessarily
about that paper and some more recent applications where
books about economics.
the argument is relevant?
RF: Some people have argued that globalization will
induce more countries to adopt the type of “neoliberal”
Cowen: The basic premise of that paper is that it often requires
policies that characterize the United States, and abandon a
a politician who is believed by the public to be tough on a
more interventionist approach. How has your work on
particular policy to make a significant change in that policy. In
globalization led you to think about that issue?
short, Nixon was able to open diplomatic relations with China
because he was seen as such a staunch anticommunist. But
Cowen: I don’t necessarily agree. My prediction is that, in
George McGovern would have had a hard time doing the same
general, welfare states will increase in size in most places
thing because his anticommunist credentials were not as strong.
around the world. We can expect most areas of the world to
We see a similar thing happening now with fiscal policy. The
become wealthier because of globalization as well as other
Republicans campaigned on a platform of fiscal austerity. But
reasons. And if you look at countries that are wealthy, they tend
even on domestic discretionary items, they have been spending
to have very generous welfare states. Also, I believe that the
through the roof. There are two possible mechanisms by which
human desire for security is extremely strong, even when it is
this can happen. One is a signaling argument. If the party that
not efficient or rational. So as long as we experience economic
you think ought to naturally oppose a policy instead supports it,
growth, I think we can expect welfare states to grow.
some people will think that it must be really important and that
we must really need it.
RF: If the process you described in your previous answer is
The second is an interest-group argument. If you think of
correct, what does that mean for economists who favor a
parties on each side of the spectrum as having natural interest

Tyler Cowen

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groups — Democrats have unions, Republicans have Wall
Street — then the party and the interest group have a long,
ongoing relationship, and the interest group is going to be
reluctant to break it. So even though the Republicans’ interest
groups might oppose increased federal spending, they are going
to tend to stay quiet, but if Democrats were in power, they
would scream bloody murder. The
same thing is true on the Democratic
side. Clinton was basically for free
trade and fiscal restraint, and he was
fairly moderate on regulation. Many
Democratic interest groups didn’t
like those policies, but they weren’t
particularly vocal in opposition
because they felt they had no place
else to go.

clear to us that blogging would become important, but there
was very little in the way of economic blogging. Even now, there
are relatively few economic blogs compared to many other
areas. We thought this would be an opportunity for us to jump
in and help define what economic blogging would be. It would
be educational, but it also would be fun. And unlike a lot of blogging, it wouldn’t consist of personal
attacks or partisan politics. Instead,
we would try to push the frontiers of
how we think about economic issues
and see how well that could be
communicated in this new medium.
It’s gone very well for us. We
have found an audience, and
judging by the comments we
receive, a well-informed, thoughtful
audience. It’s given us a way of
communicating to people who we couldn’t have reached any
other way. And I think I have learned more working on the
blog than I would have with any other use of the time. The
success of the blog actually makes me nervous. I get up every
morning and wonder who is going to read us. In a way, that has
a disciplining effect — it makes you think hard about an issue
before writing about it, rather than just throwing down your
first thoughts on a topic.

What policies would yield
a system of artistic production that is both efficient
and aesthetically pleasing?

RF: Please tell us about your debate with David Friedman
over the economics of a stateless society.
Cowen: David Friedman wrote a book called The Machinery of
Freedom: Guide to a Radical Capitalism, which is very stimulating.
He makes the claim that all services — including police, courts,
and final adjudication — could be privatized. I’m skeptical that
this would work. I’m willing, for the purposes of argument, to
accept Friedman’s claim that it would have a certain stability. But
I think that the final level of adjudication is a type of natural
monopoly. Once you imagine these private insurance and
protection companies collectively making deals, it’s a short step
from that to widespread collusion, and you would be back to government. So what I tried to do was to give the anarcho-capitalist
argument its fairest hearing, but even then I don’t think it would
work. I believe you would quickly wind up with government
again, so I think of government as a constraint, not a choice.
Also, when you look at places without government, they
tend to have many undesirable characteristics. Think of
Somalia. Friedman, of course, would point to other examples,
like medieval Iceland. But those examples don’t show what
he believes they show. There is a critical watershed in the
developed world in the late 19th century. For the first time you
get large institutional structures — in particular, big business
and big government. Medieval Iceland did work fairly well, but
it didn’t have large-scale structures. So to say that it didn’t have
government I view as a correlate with the fact that it didn’t have
a lot of other things either. To think that system would work in
the post-1870 world, I believe, is just not true. You might begin
in a world without government, but things would quickly
evolve so that government would be present.

RF: As a senior faculty member, how would you advise a
more junior colleague who is considering starting a blog?
Cowen: I wouldn’t necessarily discourage blogging. My guess is
that junior faculty who end up blogging get more research done
than those who don’t. But that’s not because of the blog per se.
Rather, it’s because those people are probably more ambitious
and have more fertile ideas than the typical junior faculty
member. So, on average, they would have been high producers
anyway, and the blog simply complements their scientific work.
That said, I think that academics who blog have more of a
generalist approach to their work than those who don’t. Their
professional interests usually are not in highly arcane, technical
areas, but in fields with more general applicability. And insofar
as there is an antigeneralist bias in the modern academic world
— and I think there is — bloggers tend to suffer. There is a
recent high-profile case of a blogger who was denied tenure
that I think is consistent with this argument. His professional
work was, by most accounts, very good and the volume was
certainly large, but he didn’t mine a narrow field over and over
again. That was probably a more important factor than the
blog in his tenure decision.

RF: Why did you and Alex Tabarrok decide to launch
marginalrevolution.com? What have been some of the
principal benefits of maintaining the blog? And what, if
any, have been the downsides?
Cowen: It has been about two years and three months since
Alex and I launched marginalrevolution. At the time it seemed
52

RF: You have written quite a bit about the avian flu.
What is the potential magnitude of that problem? And
what, in your opinion, should policymakers do — and not
do — in response?
Cowen: Right now, there is more H5N1, a particularly
dangerous strain of avian flu, in more birds in more parts of the

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world than ever before. It’s also the case that many humans are
catching H5N1 from birds, especially in southeast Asia. So it’s
already a serious problem. In the countries where the disease is
most widespread, the poultry industry is very important, and
most people are exposed to birds regularly. It’s a major health
issue. But the even bigger danger is that the virus mutates so that
it’s transmitted from one human being to another. We’re not sure
what kind of mutation would be required for human-to-human
transmission, or how likely that is, so we don’t know the
probability of there being a pandemic.
It’s believed that the 1918 flu virus — which was a form of
avian flu — killed 50 to 100 million people worldwide.
Transportation is much better now and people move around the
world with much more ease, so it’s possible that the virus could
spread more quickly. And even though the world has much
better health care, if there was a surge of demand for services,
most people would not be helped, especially in relatively poor
countries with large populations, such as China and India. So
there’s potential for catastrophe.
The question of what we should do is difficult. We don’t have
many good remedies at our disposal in the short run. Most of
our vaccines now come from abroad, but in a pandemic they
wouldn’t be exported. So we would be at loose ends. In the long
run, we should do more to help the vaccine industry. When it
comes to antiviral drugs and vaccines I would argue that we
should protect rather than confiscate intellectual property. I
would buy the vaccines using government money at a favorable
price, because if the government just seized them, companies
would have little reason to produce them the next time around.
In the short run, the best we can do is to have well-functioning local health care institutions, especially emergency rooms
with good backup plans. Let’s say your emergency room is
booked up with people who have already contracted the flu.
How do you deal with everyone else? Should they stay at home?
Do they get sent to another part of the hospital? We are starting
to do planning, but we are very much behind.
There are many proposals that put a lot of faith in building up
a stockpile of the vaccine. I’m not saying we shouldn’t do that,
but I think it’s probably overrated. If a pandemic came, the
chance that the stockpile would be allocated efficiently and in
time is small. Also, some people have called for quarantines, but
that wouldn’t work in a country like the United States. When
discussing this, I think it’s important to distinguish between
“isolating” and “quarantining” people. Isolation would mean
keeping an infected person in a different wing of the hospital. I
think that makes sense. Quarantine is when you try to close off a
particular area — all traffic, commerce, movement — usually
through the use of the military. But if a pandemic came, it would
hit virtually every major city in the country at the same time. It
would be so geographically dispersed that quarantines would be
futile. Also, there’s the simple question of where you draw the
line. Consider Fairfax. Is it Route 236? Is it I-95? Is it the Beltway?
You don’t know how far it has spread, so the line is arbitrary.
So the bottom line, I think, is that we need to have some
humility. If a pandemic occurred soon — and, as I said, no one
knows the probability of this occurring — we would be in real

trouble. There is no magic bullet. But we can use economics to
help us prepare for the long run, so that in, say, 10 years, we would
be in a better position to deal with this problem. Also, some of
the things that I mentioned we could do in the short run — such
as improve our local health care institutions — would help us
deal with any catastrophe, including another terrorist attack.
So that would pay off whether or not there is an avian
flu pandemic.
RF: George Mason has a reputation of being perhaps the
most market-oriented Ph.D. granting department in the
country. Please tell us a little bit about the series of events
that led to the department’s current complexion.
Cowen: Jim Buchanan, Gordon Tullock, and the Center for
the Study of Public Choice came here in 1983. That was a
big group all at once. And obviously the people who recruited
them — which included some economists who were
sympathetic to the Austrian School — liked the work they
were doing. Then a few years ago, Vernon Smith and his
colleagues doing research in experimental economics arrived.
So you had three groups of economists — the Public
Choicers, the Austrians, and the experimentalists — who
were all pretty friendly to a market-oriented approach to
economics. In the meantime, both our department and the
law school began to attract a number of people who were
interested in doing law-and-economics work. So there were
some cluster effects, I think. Academics benefit from being
around people who share similar research programs, and we
have seen that happen at George Mason.
RF: Early in your career, you tended to publish mostly in
journals, many of them quite prestigious, but most of your
work recently has appeared in book form. Has this been a
deliberate choice?
Cowen: Yes. I think journals have become less receptive to “big
idea” papers that can spark a serious debate and literature,
and more inclined to publish papers that make incremental
contributions to an existing literature. There is certainly value
in the latter type of work, but it interests me less now.
There is also something about writing a book, where
you live with a topic for several years, that I find personally
attractive and exciting. If there is something that I am really
interested in, I don’t want to let go of it until I have been able
to say what I want about it. With papers, you can do follow-ups,
but they just are gone too quickly for my satisfaction.
RF: Which economists have influenced you the most?
Cowen: Hayek influenced me from a very early age. Thomas
Schelling was a mentor of mine in graduate school. And my
colleagues have been extremely influential. We have very
stimulating conversations every day. Also, I would say that
reading broadly in philosophy, fiction, and other areas outside
of economics has influenced my thinking and my work.
RF

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BOOKREVIEW
Not by Bullets
Calculated Risk Alone
DEALING WITH TERRORISM — STICK OR CARROT?
BY BRUNO S. FREY
NORTHAMPTON, MASS.: EDWARD ELGAR PUBLISHING, 2005, 182 PAGES
REVIEWED BY AARON STEELMAN

man straps a bomb to his body, walks into a crowded market, and detonates it, killing himself and
dozens of others. Is he rational? If you’re like most
people, you probably doubt it. But consider: The terrorist
has goals and acts systematically to attain them. Bruno
Frey, an economist at the University of Zurich, says this
makes him rational — and, as a result, subject to economic
analysis.
In his book, Dealing with Terrorism — Stick or Carrot?
Frey argues that conventional approaches to dealing with
terrorism are flawed. Relying on coercion — especially the
use of force against terrorists and countries that harbor
them — can be counterproductive. Instead, he would like
to see incentives used to induce terrorists to refrain from
violence and to prevent potential terrorists from joining
organizations like Al Qaeda.
Such a reorientation of policy would turn “the whole
interaction between terrorists and the government” into a
positive sum game, in which both sides benefit. The
government would expend fewer resources on costly
military interventions. And the terrorists would be given
an opportunity to alter their current circumstances, which
otherwise could lead to eventual incarceration or death.
Frey calls this the “economic
approach” to analyzing terrorism. Its
guiding principle is that terrorists
“compare the costs and benefits
of alternative actions.” When the
benefits of engaging in terrorism rise,
they engage in more of it. And when
the costs rise, they engage in less of it.
The key is to reduce the benefits that
terrorists receive from engaging in violence — and, in the process, increase
the opportunity costs of those actions.

A

The Proposals
Frey has three general proposals to
either reduce the frequency or effectiveness of terrorism. First, to
encourage decentralization — in the
economy, government, and society
generally. A country with multiple
power centers makes a terrorist attack
less devastating. On Sept. 11, 2001,
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Region Focus • winter 2006

terrorists were able to bring down the World Trade Center
buildings, structures that were strongly associated with
Western market capitalism. In that way, it was a significant
symbolic blow. But it did not fundamentally cripple the
American economy, which is quite decentralized, with production and decisionmaking taking place all over the
country. Countries with more centralized economies —
especially those in which government plays a strong role
and economic activity is isolated to a few geographic
areas — would probably face greater turmoil following a
terrorist attack.
Second, to divert attention from terrorist groups.
Consider the Palestinian Islamic Jihad (PIJ). It would like
to see the destruction of the state of Israel and the establishment of a Palestinian state in its place. Members of the
PIJ engage in suicide bombings and other terrorist attacks
to further those goals. By taking such extreme action and
having it broadcast around the world, these terrorists
believe they can sway others who believe in their cause to
support them and/or to scare those who oppose them to
seek a compromise.
Frey suggests that when such an attack occurs, the government should simply decline to state which particular
organization is responsible. This, he believes, would reduce
the benefits that the PIJ would reap from such an act,
because multiple groups with multiple goals, some of
which are not necessarily consistent with the PIJ’s, could
plausibly claim credit for the attack. The act itself will have
been successful, but it will have done
less to further the larger goal.
In addition, terrorist groups are
often in intense competition with
each other, even when they have
similar beliefs. For instance, they may
compete for the same group of possible new recruits. If one organization
believes that another can “free ride”
on a terrorist attack the first group
commits, it’s less likely to commit
such an attack. By denying an organization credit for a terrorist act, you
can deny it some of the attention and
prestige it desires.
Third, to provide positive
incentives for actual and potential
terrorists to not engage in violent acts.
By expanding the horizons of a potential terrorist, you can decrease the
benefits and/or increase the costs of
engaging in terrorism. If you are a

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potential member of, say, Al Qaeda but get to know
Westerners and understand their cultures and systems of
government, you may become less likely to become a
terrorist — for at least two reasons. First, you might sympathize less with Al Qaeda’s goals. This reduces the psychic
benefits you receive from joining a terrorist group. Second,
you might come to believe that it is possible to
improve economic conditions for you and your family.
This increases the perceived opportunity cost of engaging
in terrorism.
But how can potential terrorists actually gain such
exposure to new cultures? On a micro level, Frey argues
for a vigorous student exchange program. On a more
macro level, he argues for reducing or eliminating
sanctions against “rogue” states in an effort to bring them
back into the international community. In addition, he
argues that repentents should be welcomed. Terrorists
who are serious about renouncing their actions and willing
to provide information about their former associates
should be given reduced punishments and guaranteed
secure futures.

But Will They Work?
Frey’s framework of analysis is persuasive. But some will
remain skeptical, and argue that terrorists just can’t be
reasoned with in the way that Frey argues. Instead, the only
thing they understand is violence — and we must adopt
policies that recognize this ugly fact.
Is that necessarily inconsistent with an “economic
approach” to dealing with terrorism? Arguably not. By
using force or the threat of it, governments are raising the
costs of engaging in terrorist activity — do so and you face
the possibility of being killed or sent to prison. This
clearly affects the decisionmaking process for terrorists.
It’s similar to taxing other activities deemed undesirable,
such as smoking, only the consequences are much greater.
Military intervention, then, can be seen as broadly
consistent with Frey’s overall strategy of relying on incentives to alter behavior — although it does conflict with his
more specific proposals. It’s difficult to engage in military
action without singling out a specific organization as
responsible for terrorist activity. In addition, it’s inconsistent with offering terrorists incentives to resist from
further attacks and to reintegrate them back into peaceful
society. In short, “deterrence policy is difficult to combine
with the positive approaches,” Frey offers.
Moreover, war is expensive — in terms of both blood
and treasure. Just as important, it may exacerbate the problem. By invading and then occupying foreign countries, you
can create great anger throughout a region — and, hence,
breed a whole new generation of terrorists who otherwise
might have been less receptive to joining groups like Al
Qaeda. So the use of force can raise the costs that terrorists
face, but this approach has high costs, direct as well as indirect, of its own. Overall, it’s better to use carrots than
sticks, Frey argues.

Why Haven’t They Been Adopted?
If that’s true, then why do governments resort to sticks
rather than bring out the carrots? Partly, Frey argues,
because governments don’t want to be seen as weak.
Better to act quickly and forcefully in response to a
terrorist attack than to wait and consider what would be
the most effective overall policy. (Indeed, even if
governments do employ some of the policies that Frey
suggests, they are unlikely to make them known, lest
they be seen as appeasers. So while Frey is unable to
offer many examples of his proposals working in practice
— something that might help persuade skeptics —
that doesn’t necessarily mean that such examples
don’t exist.)
The carrot approach might also be unpopular because
some of the key agencies within government — the
military, the intelligence community, and the police —
benefit from the use of force, Frey argues. They receive
more resources and prestige. This argument is consistent
with a standard “public choice” analysis: People in
government are self-interested and enact policies that
benefit them and their agencies. But is it right? In the case
of U.S. antiterrorist policies, the facts don’t seem to
support this analysis.
There certainly were important public figures who
favored going to war in Iraq, especially among civilian
members of the Departments of Defense and State. But
arguably the most prominent and articulate opponents of
intervention were some of the very people who Frey states
had an interest in going to war — military leaders, both
active and retired. They argued that the direct costs of
intervention were going to be larger than projected. They
warned that intervention would not rid the Middle East of
terrorists — that, in fact, it might increase their number.
And, finally, they argued that it was hubristic to think that
the United States could mold other countries in its image
through the use of force.
This has significant implications for Frey’s approach to
fighting terrorism. It suggests that public opinion was
more important in the drive to war than the self-interested
behavior of government officials. The public supported
military intervention, and got it. Polls suggest that a
majority of people are having doubts now, and this, too,
may affect the course of the war.
This means that government doesn’t necessarily
act according to a logic of its own, and that it’s possible
to implement noncoercive antiterrorist measures.
This should gratify Frey. On the other hand, it means that
he needs to convince a large share of the public that
his approach has merit. He has his work cut out for him.
It’s one thing to believe that a specific military intervention is unwise or being prosecuted badly. It’s quite another
to believe that, as a general rule, carrots can be substituted
for sticks. The former, no doubt, should be employed
more widely. But the latter, for better or worse, are a tool
that people will always be tempted to use.
RF

winter 2006 • Region Focus

55

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

DISTRICT ECONOMIC OVERVIEW
BY RO B E RT L AC Y

T

he Fifth District economy
expanded at a somewhat
quicker pace in the third
quarter of 2005. Services and retail
activity was particularly brisk,
boosted early in the period by accelerating automobile and light truck
sales. Manufacturing output rose as
well, with shipments and capacity
utilization at least moderately higher
during the quarter. Labor markets,
however, were not as upbeat: Yearover-year payroll job growth eased
and the District’s unemployment rate
inched up during the period.
Higher energy prices were much in
the news in the third quarter but did
little to slow consumer spending. Retail
gasoline prices rose above $3 per gallon
in the wake of Hurricane Katrina in
early September, and energy analysts
warned that heating bills could be
exceptionally high this winter. Still,
consumer spending was steadfast
despite the developments in the energy
sector. Retail spending heading into the
holiday sales season was generally good.

Economic Growth Continues
Services businesses generally reported
strong sales gains in the third quarter.
Retail sales rose throughout the period, and were especially strong in July
and early August as attractive price

Economic activity rose
at a somewhat quicker
pace in the third quarter,
though growth in
employment moderated.
incentives spurred automobile and
light truck sales. Higher fuel prices
caused a run-up in costs for airlines
and trucking firms in September and
prompted fuel surcharges in a variety
of businesses, but demand remained
relatively strong for most types of
services.
Residential real estate markets
continued to flourish, and home
prices rose at a rapid pace in many
localities in the third quarter.
According to the Office of Federal
Housing Enterprise Oversight, house
prices in the District of Columbia,
Maryland, and Virginia were more
than 18 percent higher than a year ago.
Price appreciation and sales growth
eased in some housing markets,
though. The pace of construction also
slowed: The number of residential

3rd Qtr.
2005

56

Moderate Job Growth
Employment growth in the Fifth
District for the first three quarters of
2005 was below the pace nationwide.
Third-quarter payroll employment in
the District was 1.2 percent higher
than a year earlier, somewhat short of
the 1.7 percent pace nationwide.
Across the District, employment
gains continued to be centered in
services industries, while manufacturing employment generally declined.
In North Carolina, the District’s most
industrialized state, there were 8,100
fewer manufacturing jobs in the third
quarter compared to a year earlier.

District Income Growth
Bests Nation’s

Economic Indicators
Nonfarm Employment (000)
Fifth District
U.S.
Real Personal Income ($bil)
Fifth District
U.S.
Building Permits (000)
Fifth District
U.S.
Unemployment Rate (%)
Fifth District
U.S.

building permits issued in Fifth
District states in the third quarter
was 5.8 percent higher than a year
earlier, down from a 10.5 percent
pace in the second quarter.
Manufacturing shipments rose in
the third quarter, as did new orders
and capacity utilization, albeit at
a moderate pace. But District
manufacturers had to cope with
surging petroleum-based raw
materials prices and shortages
of materials originating from the
hurricane-damaged Gulf Coast region
in September. While materials
shortages soon eased, raw materials
prices escalated through November.

3rd Qtr.
2004

Percent Change
(Year Ago)

13,374
133,961

13,211
131,731

1.2
1.7

888.7
9,176.5

860.2
8,959.5

3.3
2.4

63.8
575.4

60.3
531.0

5.8
8.4

4.9%
5.0%

5.0%
5.5%

R e g i o n F o c u s • Wi n t e r 2 0 0 6

In contrast to employment growth,
real personal income growth in the
Fifth District continues to outpace
growth nationwide. Income growth in
the Fifth District was 3.3 percent
above year-ago levels in the third
quarter, surpassing the 2.4 percent
U.S. pace. On a real per-capita basis,
growth was strongest in Washington,
D.C., with a year-over-year gain of 4.7
percent. Per-capita personal income
in the District of Columbia was
$56,119 in the third quarter, tops in
the Fifth District.

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Nonfarm Employment

Unemployment Rate

Real Personal Income

Change From Prior Year

First Quarter 1992 - Third Quarter 2005

Change From Prior Year

First Quarter 1992 - Third Quarter 2005

First Quarter 1992 - Third Quarter 2005

4%

8%

8%
7%

3%

7%

6%

2%

5%

6%

4%

1%

3%

5%
0

2%
1%

4%

-1%

0%

-2%
93

96

99

02

05

3%

93

96

99

02

05

Fifth District

-1%

93

96

99

02

05

United States

Nonfarm Employment
Metropolitan Areas

Unemployment Rate
Metropolitan Areas

Building Permits

Change From Prior Year

First Quarter 1992 - Third Quarter 2005

First Quarter 1994 - Third Quarter 2005

Change From Prior Year

First Quarter 1992 - Third Quarter 2005

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

30%

9%
8%

20%
7%
10%

6%
5%

0%

4%
-10%

3%

-20%

2%
93

96
Charlotte

99

02

Baltimore

93

05
Washington

96
Charlotte

FRB — Richmond
Services Revenues Index

99

02

Baltimore

97

99

01

Fifth District

Washington

03

05

United States

Washington D.C. — Baltimore Metro Area
Consumer Price Index

FRB — Richmond
Manufacturing Composite Index

First Quarter 1994 - Third Quarter 2005

95

05

January 1997 - September 2005

First Quarter 1994 - Third Quarter 2005

40

40

200

30

30

180

20

20

10

10

0

0

-10

-10

120

-20

-20

100

160
140

-30

-30
95

97

99

01

03

05

80
95

97

99

01

03

05

97

98

99

Energy

00

01

02

03

04

05

All Items

NOTES:

SOURCES:

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

Income: Bureau of Economic Analysis/Haver Analytics
Unemployment rate: LAUS Program, Bureau of Labor Statistics, U.S. Department of Labor,
http://stats.bls.gov.
Employment: CES Survey, Bureau of Labor Statistics, U.S. Department of Labor, http://stats.bls.gov.
Building permits: U.S. Census Bureau, http://www.census.gov.

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

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RF Winter2006 v6.ps - 2/8/2006 12:16 PM

STATE ECONOMIC CONDITIONS
BY A N D R E A H O L M E S

District of Columbia
ccording to the recently released report on real gross state
product (GSP) for 2004, the District of Columbia’s economy expanded second fastest among Fifth District states. But
the 2004 performance has not been repeated as strongly this
year. While 2005 economic activity has expanded, third-quarter
indicators were generally flat. Payroll and household financial
conditions in the District of Columbia were little changed from
the second quarter, and growth in the residential real estate
markets expanded at a slower pace.

A

PERCENT

75

50

25

0
US

Goods-Producing Industries, excluding Durable Goods
Durable Goods

Services-Providing Industries, excluding FIRE

Finance, Insurance, Real Estate (FIRE)

Government

NOTE: Durable goods industries contribute only 0.2 percent of the District of Columbia’s GSP,
and as such, are not readily visible in the above chart.
SOURCE: Bureau of Economic Analysis

The latest estimates from the Bureau of Labor Statistics
(BLS) survey of business establishments reported that thirdquarter job numbers contracted 0.1 percent in the District of
Columbia. Losses at education and health services, financial
activities, and trade, transportation, and utilities establishments
outweighed job gains in other services-providing sectors. Payroll
activity on the smaller, goods-producing side of the economy
also moderated somewhat. Construction jobs backed off
1.1 percent in the third quarter, perhaps reflecting softer demand
for new housing.
In line with fewer construction jobs, District of Columbia
third-quarter permit authorizations (sometimes viewed as an
indicator of future activity) were also well below the year-ago
level. Likewise, sales of previously owned homes contracted at a
quicker pace for the third straight period. Rapid home price
acceleration in the District of Columbia has likely
contributed to the slowdown in home sales. The District of
Columbia recorded a 21.5 percent jump in house prices in the
third quarter — the largest increase districtwide.
The moderation recorded in the District of Columbia’s housing markets does not appear to stem from a weakening of
household conditions — third-quarter indicators of household
58

Region Focus • winter 2006

ouble-digit growth in real estate activity and professional services were key factors in driving Maryland’s
GSP up 4.8 percent in 2004 and have helped pave the way for
solid growth so far in 2005. In the latest readings, economic
activity continued to gain ground in the third quarter. The
most recent reports suggest that employment activity and
household conditions in the state continued to improve,
though growth in the residential real estate market moved
ahead at a slower clip.
Maryland businesses boosted payrolls by 2.0 percent in
the third quarter — the largest percentage increase recorded
districtwide. Nearly all industry sectors tacked on jobs,
with professional and business services and government
establishments adding the most. The only sectors that
didn’t see a rise in employment were leisure and hospitality
and manufacturing, where payrolls were trimmed by
0.3 percent and 2.2 percent, respectively.

MD Sector Contribution to 2004 GSP
100

75

PERCENT

100

5E

U Maryland

D

DC Sector Contribution to 2004 GSP

DC

financials remained generally on track. Personal income
expanded 0.3 percent, marking the second-strongest growth rate
districtwide. The majority of the increase hailed from the
government sector, with government earnings accounting for
more than 45 percent of the third-quarter total.
The importance of the government sector to the District of
Columbia’s economy was apparent in the recent measures of
GSP. According to the U.S. Bureau of Economic Analysis (BEA),
the government’s contribution to 2004 economic growth in the
District of Columbia amounted to nearly 35 percent.

50

25

0
MD

5E

US

Goods-Producing Industries, excluding Durable Goods
Durable Goods

Services-Providing Industries, excluding FIRE

Finance, Insurance, Real Estate (FIRE)

Government

SOURCE: Bureau of Economic Analysis

In line with rising payrolls, earnings rose in almost all of
Maryland’s industry sectors in the third quarter, boosting
total personal income in the state. Compared to a year ago,
third-quarter personal income expanded 3.4 percent,
outpacing the nationwide gain of 2.4 percent.

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

h

North Carolina

gainst the backdrop of a 4.4 percent increase in state
economic output in 2004, North Carolina’s economy
continued to make headway through the third quarter
of 2005. The labor and real estate markets advanced at a
quicker pace, and nearly all indicators of household financial
conditions improved.
According to the BLS establishment survey, business
hiring in North Carolina advanced by 14,600 jobs in
the third quarter, the largest net gain districtwide. The
professional and business services sector added the majority
of new jobs, while the manufacturing sector trimmed the
most — the 2.7 percent reduction in payrolls marked the
largest quarterly loss in two years.
Despite continued job losses in the manufacturing sector,
North Carolina’s economy remains most dependent on nondurable manufactured goods among District states, with
that sector accounting for 19 percent of 2004 GSP.
Expansion in the sector has been sluggish though,
contributing only one-tenth to total GSP growth in 2004.
In contrast, strong expansion on North Carolina’s
services side of the economy has helped keep household
employment conditions bright. In the third quarter, the BLS
household survey continued to suggest a generally upbeat
tone. Though the jobless rate rose 0.4 percentage point to
5.6 percent — well above the national and districtwide rates
— much of the gain was spurred by a 36,567 person surge in
the labor force, the largest quarterly gain since early 2001.
Personal income is another telling measure of household
financial conditions. Compared to a year ago, third-quarter
personal income expanded 2.7 percent in North Carolina,
just above the national growth rate of 2.4 percent.

A

NC Sector Contribution to 2004 GSP
100

75

PERCENT

The improving tone of the labor market was also reflected
in Maryland’s jobless rate. Large gains in the labor force in
the third quarter held the jobless rate at 4.3 percent. By
comparison, the national rate of unemployment stood at
5.0 percent.
Consistent with the nationwide trend, Maryland’s real
estate market advanced at a slower pace in the third quarter.
Compared to the second quarter, new permit applications
were fewer and existing home sales moved forward at a
slower pace. Even with the decline in sales, however, the
median price of an existing home was 19.3 percent higher in
the third quarter than a year ago, marking the fifth-fastest
increase nationwide.
Real estate-related activities are a vital part of the
Maryland economy. As shown in the chart, output generated
by finance, insurance, and real estate enterprises
contributed nearly 22 percent to total 2004 GSP, a larger
share than recorded in any other District jurisdiction.

50

25

0
NC

5E

US

Goods-Producing Industries, excluding Durable Goods
Durable Goods

Services-Providing Industries, excluding FIRE

Finance, Insurance, Real Estate (FIRE)

Government

SOURCE: Bureau of Economic Analysis

Rising personal incomes and more moderate home price
acceleration have led to sustained growth in North Carolina’s
residential real estate markets. Third-quarter existing home
sales in North Carolina were 11.7 percent higher compared to
year-ago levels and the number of new building permits
issued expanded 6.9 percent over same period.
North Carolina’s housing market has been buoyed by
more moderate home price escalation in recent years
than in other District states. The most recent data from
the Office of Federal Housing Oversight reported that a
median-priced home in North Carolina was only 6.9 percent
more expensive than it was a year earlier. As such, the state
ranked last districtwide and 37th nationwide in terms of
annual home price acceleration.

o South Carolina
S

outh Carolina ranked 28th nationwide in terms of GSP
growth in 2004. Despite the comparatively soft reading,
however, the 2004 estimate marked the fourth straight year
that the state’s economic growth rate strengthened.
Likewise, after getting off to a relatively slow start in 2005,
economic activity in South Carolina has steadily gained
momentum over the year. In the third quarter, labor market
and conditions firmed further — and unlike activity in a
number of District states — the housing market continued
to advance steadily.
South Carolina payrolls rose 0.4 percent in the third
quarter, a turnaround from the 0.7 percent contraction
recorded a quarter earlier. On the services side of the
economy, job growth was recorded in all sectors except
government, which posted a modest loss. In contrast, all
goods-producing sectors (natural resources and mining,
construction, and manufacturing) saw employment declines.
Though goods production has declined as a share of total
economic output, it still plays a pivotal role in South

winter 2006 • Region Focus

59

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SC Sector Contribution to 2004 GSP
100

PERCENT

75

50

25

0
SC

5E

US

Goods-Producing Industries, excluding Durable Goods
Durable Goods

Services-Providing Industries, excluding FIRE

Finance, Insurance, Real Estate (FIRE)

Government

SOURCE: Bureau of Economic Analysis

districtwide. The persistence of strong home sales growth
could reflect the relatively slower appreciation of South
Carolina’s housing stock — the third-quarter 11.1 percent
jump remained below the districtwide increase of 15.7 percent.

u Virginia
n the third quarter, the BEA reported that the value of all
goods and services produced in Virginia last year reached
$302 billion — the largest economy among District jurisdictions. Moreover, economic growth in Virginia outstripped that
of all other District states in 2004 and ranked third nationally.
With the groundwork already laid, the employment situation
and financial conditions at Virginia households forged ahead in
the third quarter. Activity decelerated in the real estate markets
though, perhaps signaling a return to a more sustainable level.
Compared to the second quarter, Virginia businesses
boosted payrolls by 1.6 percent, or 14,267 jobs, in the third

I

60

Region Focus • winter 2006

VA Sector Contribution to 2004 GSP
100

75

PERCENT

Carolina’s economy — accounting for more than a quarter of
the state’s 2004 GSP of $124 billion.
Outside of job growth at South Carolina businesses,
indicators of household employment in South Carolina also
perked up. The third-quarter jobless rate inched lower,
dropping 0.1 percentage point to 6.3 percent — the lowest
rate since late 2002.
In contrast to the turnaround in payroll and household
employment conditions, measures of personal income in
South Carolina softened in the third quarter. Personal
income fell 0.1 percent compared to a quarter earlier, the
second-weakest reading among District jurisdictions.
More positively though, the residential real estate market
continued to gain ground in the third quarter, outpacing
activity in most other District states. Third-quarter building
permits were 23.5 percent higher over the year, and existing
home sales posted an 18.1 percent gain, the strongest increase

50

25

0
VA

5E

US

Goods-Producing Industries, excluding Durable Goods
Durable Goods

Services-Providing Industries, excluding FIRE

Finance, Insurance, Real Estate (FIRE)

Government

SOURCE: Bureau of Economic Analysis

quarter. The bulk of the employment gains occurred on the
services side of the economy, which according to the BEA,
generated nearly 70 percent of total GSP in 2004.
The employment situation at Virginia households also
remained upbeat — the jobless rate held firm at 3.6 percent,
the lowest rate districtwide and more than a full percentage
point below the national rate of 5.0 percent.
Robust economic growth and better employment
prospects have helped boost incomes at Virginia households. In the third quarter, personal income expanded
0.4 percent, the highest growth rate districtwide.
In real estate markets, Virginia households and businesses
trimmed activity from the elevated levels seen recently,
as did businesses. At the household level, third-quarter sales
of existing homes backed off 1.5 percent compared to a
quarter earlier. And on the business front, applications for
new building permits declined sharply. More telling, both
measures came in below levels recorded a year ago, signaling
the possibility that the real estate market is near its peak.
The trailing off of sales from their peak comes on the
heels of a rapid acceleration of home prices in Virginia.
According to the Office of Federal Housing Oversight, the
median-priced home in Virginia was 18.7 percent above
year-ago levels in the third quarter, ranking seventh
nationally in terms of annual home price acceleration.
Signs of a cooling market, however, were evident in this
measure as well. Compared to the second quarter, home
prices advanced at a slower pace, marking the first period of
moderation in a year.

w West Virginia
he U.S. Department of Commerce recently reported
that West Virginia had the 43rd fastest-growing economy
in 2004. Manufacturing remained the largest private
sector segment of the economy, contributing 11.4 percent

T

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

WV Sector Contribution to 2004 GSP
100

75

PERCENT

to GSP. This sector, however, contributed the least to
economic growth — contracting 0.5 percent in 2004 and
dragging overall growth lower. Fast-forward to the third
quarter of 2005 and the state seemed unable to shake off
2004’s lackluster performance. Economic conditions
in West Virginia appear to have retreated further, with
third-quarter indicators of employment and household
financial conditions weakening. Not all news was downbeat,
though. Real estate activity, sustained by some of the lowest
home prices in the nation, continued to move forward.
According to the BLS establishment survey, payroll
employment retreated 0.7 percent in West Virginia during
the third quarter, the weakest reading among District jurisdictions. Nearly all sectors trimmed jobs, with the largest
losses recorded in manufacturing and leisure and hospitality.
The less upbeat tone was mirrored in the BLS survey of
household employment. West Virginia’s jobless rate moved 0.8
percentage point higher in the third quarter to 5.6 percent, coming in well above both the national and Fifth District averages.
The decrease in jobs coupled with an increase in unemployment partly explains West Virginia’s somewhat muted
income measures. Compared to a year ago, personal income
expanded only 2.6 percent in the third quarter, the slowest
increase districtwide.
Despite modest personal income growth, third-quarter
home sales and new permit authorizations remained well
above year-ago levels. Still though, the most recent data from

50

25

0
WV

5E

US

Goods-Producing Industries, excluding Durable Goods
Durable Goods

Services-Providing Industries, excluding FIRE

Finance, Insurance, Real Estate (FIRE)

Government

SOURCE: Bureau of Economic Analysis

the Office of Federal Housing Oversight reported thirdquarter home price appreciation of only 10.4 percent in West
Virginia, the second-slowest growth rate districtwide.
Limited home price acceleration during the most recent
boom may help insulate West Virginia homeowners should
the market self-adjust. In addition, the state would be further
cushioned as real estate-related business activities play a
comparatively small role in West Virginia’s overall economy.
As shown in the chart, output generated by finance, insurance, and real estate enterprises contributed only 13 percent
to total 2004 GSP, the smallest share recorded districtwide.

Behind the Numbers: Do Surveys Matter?
People who watch the U.S. economy rely on a number of indicators to help them understand how things are going. The
problem with some of these indicators — especially regional
ones like Gross State Products and manufacturing employment — is the lag time between the periods they measure and
when they are released. That makes the Federal Reserve Bank
of Richmond’s manufacturing and retailing surveys, published
on a monthly basis, especially valuable. The surveys provide
information on business activity that might not have already
shown up in other economic data. The Richmond reports are
closely watched in large part because the composition of the
Fifth District economy — with a good mix of manufacturing
and services business — is similar to that of the broader,
national economy.
The Richmond’s manufacturing survey is distributed to
about 200 manufacturing managers in the Fifth District during the second week of each month. Managers are asked
whether their shipments, new orders, and employment
increased, decreased, or didn’t change over the past month.
Other sections ask about inventory levels and price trends.
The results are published in the form of a diffusion index, in

which “0” represents the level of business activity the previous
month. Positive numbers, then, suggest growth and negative
readings suggest that the level of activity decreased.
But how useful are these surveys in helping economic policymakers? After all, if the survey results are driven chiefly by
factors that don’t tell us much about where we are in the business cycle’s two- to five-year fluctuations in output,
employment, and income, then policymakers don’t learn much
that is helpful in making decisions about monetary policy.
So do the surveys matter? That’s the question that
Richmond Fed economists Raymond Owens and PierreDaniel Sarte try to sort out in a recent paper in the Federal
Reserve Bank of Richmond’s Economic Quarterly.
Their analysis demonstrates that most of the survey index’s
movements are directly tied to the overall business cycle, not
extraneous factors like seasonal swings or long-term trends.
That means when business managers respond to the
Richmond manufacturing survey, they are essentially telling
policymakers something about where the country is in the
business cycle. For policymakers, that kind of information
is priceless.
— DOUG CAMPBELL

winter 2006 • Region Focus

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State Data, Q3:05
DC

MD

NC

SC

VA

WV

681.7
-0.1
1.6

2,576.0
2.0
2.1

3,894.9
1.5
1.1

1,832.9
0.4
0.1

3,644.4
1.6
1.3

743.4
-0.7
0.9

2.5
5.4
1.3

138.5
-2.2
-3.3

573.5
-2.7
-1.4

263.8
-0.7
-2.0

298.6
0.3
-0.4

62.0
-6.2
-1.2

Professional/Business Services Employment (000) 147.2
Q/Q Percent Change
0.9
Y/Y Percent Change
2.7

391.0
2.9
4.5

450.1
6.7
4.1

188.6
3.0
-2.5

588.0
0.2
1.0

59.2
6.3
1.7

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

231.9
2.9
0.9

467.8
2.5
0.7

660.3
2.3
-0.1

331.5
-1.3
0.0

658.1
1.7
0.9

143.4
-1.1
-0.1

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

299.6
-0.7
0.6

2,944.3
2.3
2.1

4,342.8
3.4
1.8

2,075.6
1.5
1.2

3,935.0
3.0
2.9

797.8
2.5
1.2

6.4
7.7
8.4

4.3
4.3
4.3

5.6
5.2
5.4

6.3
6.4
6.9

3.6
3.6
3.7

5.6
4.8
5.4

27.6
0.3
3.4

210.0
0.3
3.4

238.1
0.1
2.7

108.4
-0.1
2.8

260.4
0.4
4.2

44.2
-0.2
2.6

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

182
-99.8
-45.7

7,628
-48.3
2.6

25,794
-13.6
6.9

13,361
-18.3
23.5

15,301
-41.2
-5.1

1,529
-4.1
4.3

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

571.2
21.5
20.5

468.5
17.4
19.3

302.2
7.9
6.9

289.0
11.1
8.5

427.9
18.2
18.7

222.1
10.4
10.7

Sales of Existing Housing Units (000)
Q/Q Percent Change
Y/Y Percent Change

10.0
-21.9
2.0

139.7
0.4
-3.0

253.6
32.5
11.7

120.6
7.2
18.1

184.9
-1.5
-3.6

39.4
-3.7
5.1

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

Unemployment Rate (%)
Q2:05
Q3:04
Personal Income ($bil)
Q/Q Percent Change
Y/Y Percent Change

NOTES:
Nonfarm Payroll Employment, thousands of jobs, seasonally adjusted (SA) except in MSA's; Bureau of Labor Statistics (BLS)/Haver Analytics, Manufacturing Employment, thousands of jobs, SA in all but DC and SC; BLS/Haver Analytics,
Professional/Business Services Employment, thousands of jobs, SA in all but SC; BLS/Haver Analytics, Government Employment, thousands of jobs, SA; BLS/Haver Analytics, Civilian Labor Force, thousands of persons, SA; BLS/Haver Analytics,
Unemployment Rate, percent, SA except in MSA's; BLS/Haver Analytics, Personal Income, bil.chn. 2000$, BEA/Haver Analytics, Building Permits, number of permits, NSA; U.S. Census Bureau/Haver Analytics, Sales of Existing Housing Units, thousands of
units, SA; National Association of Realtors®

62

Region Focus • winter 2006

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Metropolitan Area Data, Q3:05
Washington, DC MSA
Nonfarm Employment (000)
Q/Q Percent Change
Y/Y Percent Change
Unemployment Rate (%)
Q2:05
Q3:04
Building Permits
Q/Q Percent Change
Y/Y Percent Change

Baltimore, MD MSA

2,938.3
0.8
2.9

1,288.4
1.4
1.4

797.1
-0.2
3.1

3.4
3.6
3.7

4.6
4.5
4.6

5.3
5.0
5.3

7,822
-80.1
-19.9

2,490
-20.3
-0.9

6,094
21.5
3.6

Raleigh, NC MSA
Nonfarm Employment (000)
Q/Q Percent Change
Y/Y Percent Change
Unemployment Rate (%)
Q2:05
Q3:04
Building Permits
Q/Q Percent Change
Y/Y Percent Change

Unemployment Rate (%)
Q2:05
Q3:04
Building Permits
Q/Q Percent Change
Y/Y Percent Change

Columbia, SC MSA

268.8
-0.4
0.6

281.6
1.2
2.5

345.1
-2.5
0.6

4.5
4.3
4.2

5.2
4.8
5.5

5.5
5.3
5.9

1,186
-12.7
-17.4

2,618
9.5
16.5

1,846
-38.9
4.6

Norfolk, VA MSA
Nonfarm Employment (000)
Q/Q Percent Change
Y/Y Percent Change

Charleston, SC MSA

Charlotte, NC MSA

Richmond, VA MSA

Charleston, WV MSA

763.7
2.0
1.1

617.2
-0.7
2.8

148.7
-4.9
-0.1

4.2
4.1
4.1

3.8
3.7
3.9

5.0
4.9
4.5

2,582
3.2
8.0

2,666
43.2
10.2

82
-79.6
-16.3

For more information, contact Andrea Holmes at 804-697-8273 or e-mail Andrea.Holmes@rich.frb.org.

winter 2006 • Region Focus

63

RF Winter2006 v6.ps - 2/8/2006 12:16 PM

OPINION
Protectionism’s Dangerous Allure
BY D O U G C A M P B E L L

the prominence of textiles in the Southeast is a direct
conomists often sound insensitive when talking
result of the industry’s early 20th century shift from
about international trade. The United States is
higher-cost locales in the Northeast.
losing tens of thousands of textile manufacturing
Economists are not blind to all this. They just take these
jobs, putting many able-bodied citizens out of work. But
changes in context. Trade both creates and destroys jobs. But
economists assure us that, in the long run, there is no
on balance, the overall U.S. economy would be much better off
substitute for free markets and open competition across
with fewer barriers to trade. In such a world, each nation can
borders. It’s all there in the theory of comparative
specialize in doing what it does best, be it sewing T-shirts or
advantage, which demonstrates that trade is mutually
developing new gene therapies.
beneficial. If American workers aren’t making fabric, that’s
The failure of economists to convince people that
because they’re better at making more lucrative
removing trade barriers is a smart move has to do with the
microchips — and now we can buy fabric at cheaper prices
dispersed benefits and concentrated costs of liberal trade
from overseas sources. If not microchips, then software.
policies. The people of Danville bear, in the short term, a
And so forth. Why do so many people — from all walks of
disproportionate amount of the
life — fail to grasp these economic
pain in the transition from textile
arguments?
It is a mistake to use
production to the provision of some
In part, it’s because those arguother good or service. Their probments aren’t very comforting in the
protectionist policies as
lems are large and easy to see — and
near term. In December, with the
a way to postpone the
will be well-documented this year as
purchase of textile maker Dan River
unemployment claims inevitably rise
Inc. and the expected shipping of
expiration dates of
and workers seek new paychecks.
many of the company’s remaining
some U.S. jobs.
1,100 local jobs overseas, economists
In contrast, you won’t see headwere presented with another opporlines about gradually falling prices
tunity to sound indifferent to a
of T-shirts and other apparel, even
region’s pain. Southside Virginia used to be a textile boom
though lower prices can have a large aggregate positive
area, with Dan River alone once employing more than
effect on the economy. Nor will most people immediately
14,000 workers. Now, an Indian firm — Gujarat Heavy
understand that the departure of Dan River and similar
Chemicals Ltd. — has purchased Dan River’s dwindling
companies will provide real incentives for people to
assets, less than two years after the Danville-based
obtain new skills that are valued in a changing economy,
company filed for Chapter 11 bankruptcy protection.
which ultimately will raise living standards. This
There can be no sugarcoating the loss. Unemployment
disconnect helps explain why there is relatively little in
in Danville is 7.2 percent, already nearly twice the state
the way of a groundswell for free trade. To economists,
average. Aging Dan River workers will find it difficult to
support for freer trade is almost universal. But among the
secure new jobs that pay as well or with similar benefits. To
public, skepticism remains widespread.
them, comparative advantage is little more than a fancy
In matters of trade, it’s a mistake to think of nations as
theory, and free trade far from a good deal.
enemies, with one country’s gain another one’s loss. It is
This is hardly a new trend. The Fifth District, along
equally a mistake to use protectionist policies as a way to
with the entire country, has watched textile and apparel
postpone the expiration dates of some U.S. jobs. Doing so
jobs move to lower-cost venues such as Asia and Latin
diverts resources from new, growing industries, and
America. In the past decade alone, the United States has
instead directs them toward keeping dying U.S. industries
lost more than 909,000 textile and apparel industry jobs.
afloat — at least for a while.
Some industry representatives point out that the big
None of which is immediate consolation to the
drop-off started just after the adoption of NAFTA. With
people of Danville. But it’s worth keeping at the
quotas for apparel and textile products now lifted among
forefront of the region’s plans for economic development.
members of the World Trade Organization — including
We’ve said this before: Ultimately, the only protection a
China — it’s no surprise that the shifting continues. A lot
worker has in the labor market is cultivating valuable
of the upheaval is concentrated in the Southeast, home to
skills that many employers will bid for. The exit of
most of this nation’s textile and apparel jobs, with North
Dan River is not so much about giving up as it is about
Carolina accounting for the highest portion. Of course,
moving on.
RF

E

64

R e g i o n F o c u s • Wi n t e r 2 0 0 6

WINTER 06 Cover.ps - 2/27/2006 9:41 AM

NEXTISSUE
The Other Road Rage

Interview

Everybody wants congestion-free roadways, but at what cost?
We take a look at the economics of road building and the
innovative solutions, some involving the private sector, that
may soon gain traction in the Fifth District.

We talk with Raymond Sauer of Clemson
University about the economics of sports.

Antidumping
Even as the use of tariffs and quotas has declined, a
relatively unheralded instrument of trade protection has been
flourishing. Antidumping policy in the United States promises
to shield U.S. manufacturers from unfairly priced imports. But
many economists believe that such remedies have little to
do with predatory pricing and end up hurting more domestic
businesses than they help.

Jargon Alert
“Marginal.” It might describe the movie you
just spent $8 to see. But it’s also a key concept
in economics. We’ll explain what it means.

Research Spotlight
How should artists respond in an era of
rampant copyright infringement?

Boatbuilding
Boatbuilding remains a viable, if somewhat less economically
important, industry in coastal North Carolina. We examine its
unique place in the economy and how it aims to survive in the
21st century.

Baby Blues
The average wage of women with children is 11 percentage
points lower than women without children. A Richmond Fed
economist investigates whether mandatory leave measures are
an appropriate policy response.

Visit us online:
www.richmondfed.org
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and web-exclusive content
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mailing list
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of our online issue posting

Give us your feedback!
Click on our Web site and join us for an online survey

The Spring 2006 issue will be
published in April.

WINTER 06 Cover.ps - 2/27/2006 9:41 AM

Region Focus 2005
WINTER 2005, VOL. 9, NO. 1

Cover Story

Cover Story

Banks Branching Out

Affordable Housing

It’s All About Location,
Location, Location

SPRING 2005, VOL. 9, NO. 2

Cover Story

SUMMER 2005, VOL. 9, NO. 3

Highlighting Business Ac tivity in the Fifth Distric t

Are Home Prices Soaring
Beyond Your Reach?

Federal Reserve

Federal Reserve

Inflation Targeting

New Times for Fed
Branches

Interview
Frank Sloan
Health Care Economist
Duke University

Interview

Thomas Schelling
Nobel Laureate Economist
University of Maryland

Cover Story
Off to a Smart Start

Is Sarbanes-Oxley Working
as Planned?

The Economics of Early
Childhood Development

Federal Reserve

Federal Reserve

“How Not to Stop
Inflation” by Milton
Friedman

FALL 2005, VOL. 9, NO. 4

Under Scrutiny

After Greenspan

Interview

Robert Whaples
Economic Historian
Wake Forest University

Interview

Robert Moffitt
Labor Economist
Johns Hopkins University

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