Full text of Economic Review (Federal Reserve Bank of Atlanta) : March/April 1978, Volume 63, Number 2

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j.eral Reserve Bank of Atlanta
ieral Reserve Station
anta, Georgia 30303

B u lk R a te
U .S . P o s ta g e

jress Correction Requested

A tla n ta , G a .
P e rm it 2 9 2




PAI D

FEATURES:
Real Output Growth and Unemployment, 1947-77 .................19
A long-recognized relationship between the economy's
“ real'' growth rate and the unemployment rate suggests
that smaller productivity gains will make it easier to reduce
U.S. joblessness over the next five years.

The New Minimum Wage:
A Threat to Southeastern Jo b s ?

30

Here's evidence that a minimum wage hike has a more pro­
nounced adverse effect on employment in lower wage
regions like the Sixth District.

Southeastern Loan Demand Revives-At Last!....................35
Banking conditions improved greatly last year in the
District, as a strong and broadly based revival of loan de­
mand coincided with heavy deposit inflows.
D ire cto r of R e se a rch : H a r r y B ra n d t
Ed itin g: P a t r ic ia F a u lk in b e r r y
P ro d u ctio n and G ra p h ics:
S u s a n F T a y l o r a n d E d d ie W

Lee, Jr

E c o n o m ic

2

R e v ie w ,

Vol

L X III,

No

Free

su b s crip tio n and a d d itio n a l co p ies a v a ila b le
upon request to the R e s e a rch D ep a rtm e n t,
F ed era l
G e o rg ia

R e s e rve B a n k
50303

of A tla n ta ,

The attention usually given to residential construction
often obscures the importance of nonresidential construc­
tion. This article points out its significance to the U.S.
economy, historical developments, and prospects.

A tlan ta .

the B an k , an d the a u th o r are cre d ite d P lease
this

40

M a te r ia l herein m a y be re­

p rin ted or a b s trac ted , p ro vid ed this R eview ,
p ro vid e

A Primer on Nonresidential Construction.............. ..

B a n k 's

R e sea rch

w ith a c o p y of a n y p u b lic a tio n in w h ic h such
m a te ria l is rep rinted




Farmland Price Movements............................................. 44

D e p a rtm e n t

Soaring farmland prices can't be justified by the returns to
agricultural production. Rather, expectations of further ap­
preciation of values have been the driving force behind
their rapid elevation.

REAL OUTPUT GROWTH
AND UNEMPLOYMENT, <1947-77
by W illia m N . Cox

Real output must expand significantly to
keep the unemployment rate from rising.
Merely avoiding a recession —a period
when real output shrinks— is not enough.
W hy? For two reasons. First, our labor
force is constantly expanding. If em­
ployment doesn't grow at least as fast as
the labor force, the unemployment rate
will obviously go up. To get an increase in
employment, we need an increase in out­
put. During the 1947-77 period, for ex­
ample, the U. S. labor force expanded at
an average rate of 1.7 percent per year.
Employment growth averaged 1.6 percent,
however, not quite matching the labor
force increase. The shortfall implies that
our unemployment rate must have risen
over the 1947-77 period, and, of course, it
did: from 3.9 percent in 1947 to 7.1
percent in 1977.
During that same 30 years, our nation's
real output actually expanded at a 3.6percent annual rate. W ith annual em­
ployment growth of 1.6 percent, our av­
erage output per worker grew, on average,
by 2.0 percent per year. These figures
illustrate the second reason why real
output must grow significantly to keep our
unemployment rate from rising: Postwar
real output would have had to expand by
about 2 percent per year just to stabilize
the number of people employed; output




growth less than that could have been
accomplished with a reduction in em­
ployment. So our growth of real output
has to exceed the combined growth of the
labor force and output per worker before
we can expect to see the unemployment
rate come down.
This combined growth rate, then, con­
stitutes a threshold of sorts. W e might even
choose to call it the threshold rate of
real growth, except that a prominent econo­
mist named Arthur Okun gave it another
name 15 years ago: the potential rate
of real growth.1
Our purpose in what follows is to
examine the postwar patterns of this
potential, or threshold, growth rate and its
components, both for the sake of a con­
sistent description and to help us assess
what our potential growth rate might be in
the years ahead. W e live in a time when
inflation and unemployment rates are both
too high and economists and policymakers
are much less confident than their
predecessors that suitably enlightened
policies will enable us to fine-tune the
management of our economy. Fearing that
1962 Pro­
ceedings of the Business and Econom ic Statistics Section, A m e ric a n S ta tis tic a l

'A r th u r M O k u n , " P o te n t ia l C N P : Its M e a s u re m e n t and S ig n if ic a n c e ,"

A s s o cia tio n O k u n w a s in terested in th e ra te o f rea l g row th w h ic h w o u ld s ta b iliz e
th e u n e m p lo y m e n t ra te a t fu ll e m p lo y m e n t, th en d e fin e d by an u n e m p lo y m e n t
ra te o f 4 0 p e rce n t V ie w e d in this w a y , th e sum o f la b o r fo rc e g row th an d outputper-worker grow th m easu res th e p o te n tia l g ro w th o f o u tp u t at fu ll e m p lo y m e n t

" How do we add up, compare, and
forecast the effects of widely dis­
cussed influences, such as the de­
cline of the workweek, the baby
boom, and the entry of women
into the labor force? These are
some of the questions we shall
probe below/'
too rapid economic growth will lead to
accelerated inflation and recession and
that growth which is too sluggish will bring
rising unemployment, many policymakers
seek a moderate economic growth path.
One side of that path is defined by the
potential growth rate we have been
discussing, since it is the growth rate our
economy must surpass to keep unem­
ployment coming down.2 That rate has
averaged about 4 percent over the past 30
years. Can we confidently expect the rate
to be 4 percent in the future? How con­
sistent has it been? W hat about the
consistency of its components? How do we
add up, compare, and forecast the effects
of widely discussed influences, such as the
decline of the workweek, the baby boom,
and the entry of women into the labor
force? These are some of the questions we
shall probe below.
An Important Adjustment. Okun's work
tells something else:
For every additional
percentage point the unemployment rate
falls (or rises) from one year to the next,
our real output growth must rise (or fall)
by an additional 3 percent. This three-toone relationship we call Okun's Law; it's
part of every economic forecaster's tool
kit. An example may help. In 1977, we
posted a 7.0-percent average unemploy­
ment rate and a 5-percent gain in real
output over 1976. Okun's Law suggests
that a real growth rate of 8 percent (the 5
we got plus 3 we didn't get) would have
produced an unemployment rate of about
6.0 percent (7.0 actual minus one-third of
the addition to output growth). Going the

2O k u n (Ib id ) e s tim ate d th e re la tio n sh ip at i 2-to-1. Su b s e q u e n t estim ates, n o ta b ly
by G e o rg e P erry (" L a b o r F o rce Stru ctu re , P o te n tia l O u tp u t, and P r o d u c t iv ity ,"

B r o o k in g s P a p e rs on E c o n o m ic A c t iv ity , 1971:3), put the re la tio n sh ip sligh tly
b e lo w three




other way, real output growth of 2 percent
from 1976 to 1977 would have raised the
unemployment rate to about 8.0 percent,
or so Okun's Law tells us.
W hy does it seem to take an extra 3
percent of output growth to get a 1percent reduction in the unemployment
rate? Because both the labor force and
output per worker respond to changes in
the unemployment rate. A falling unem­
ployment rate seems to draw new job
seekers into the labor force: Lower
unemployment makes people more
confident a job search will be successful,
for one thing. For another, tighter labor
markets generally mean higher wages;
available jobs are more attractive. Output
per worker seems to respond oppositely to
unemployment: Employers are very con­
scious of hiring and training costs; they
tend to be cautious both in reducing
employment levels when output falls and
in expanding employment when output
increases. There is a tendency to retain
experienced workers in a business slump
and add to the number of hours each
person works in an expansion, at least until
there is room to believe an expansion will
persist.
So when our economy's real growth rate
accelerates, three things usually happen:
(1) Employment expands, pulling down the
unemployment rate; (2) labor force growth
accelerates, retarding the fall in unem­
ployment; and (3) output per worker rises,
reducing the amount of employment
growth necessary to accomplish the output
acceleration. A 3-percent output accel­
eration contributes only 1 percent to
employment and thus to the unem­
ployment rate, with the other 2 percent
being absorbed by the labor force and
output-per-worker responses. This is what is
referred to when people talk of a "slug­
gish" or "'Sticky" unemployment rate, as
they did during much of 1977.
W e adjust for these responses, as the
reader can see in the algebra in Appendix I,
by turning Okun's Law "inside out" and
assuming that an actual decrease of, say,

" A fa lling unem ploym ent rate
seems to draw new job seekers
into the labor force."

THE POSTWAR EXPERIENCE
(national growth rates e xp re sse d as annual p e rce n tage s)

1947-52 1952-57
Output/Worker (Y/N)

Unadjusted Potential Real Growth
Rate
Unemployment Rate Changes*
Okun’s Law Adjustment
Estimated Potential Real
Growth Rate

1.4

3.8
-0.2
0.3

2.8
-0.6
-0.8

3.1
-0.1
-0.6

3.5
-0.4
-0.5

0.9

1.5

1.1

1.8

1.3
-0.3

1.6
0.3
-0.1

1.0
0.5
-0.6

1.1
0.1
0.3

2.5

1.1
2.1
-0.5
-0.5

2.3
1.8
0.1
0.3

0.7
1.3
-0.6
0.0

2.4
1.7
0.6
0.1

1947-62 1962-77
2.5

1.5

0.7 to 3.9

3.2
-0.3
-0.4

2.3
-0.5
-0.3

1.3 to 3.8

1.2
1.2
0.1
-0.1

2.2
1.7
0.3
0.1

d
i
0

Population 16-to-65(P)
Participation Rate (Lt'/P)
Armed Fo rce s Adjustm ent (L/L()

3.9

1967-72 1972-77

CO

liY / N p J
Civilian Labor Force (L),

2.4

1962-67

o
1

Private Output/Hour (Y/H)p
Private Hours/Worker (H/N)p
Imputed Public-Private
Adjustm ent f* Y/N T

1957-62

Range of
5-year
Growth Rates

-0.8 to 0.3

0.9 to 2.4
1.0 to 1.8
-0.3 to 0.6
-0.6 to 0.3

4.8
-0.9
-0.4

2.9
1.3
0.6

—
3.5
1.2
0.5

4.3
-1.7
-0.7

3.4
1.8
0.8

3.1
1.5
0.7

3.7
1.6
0.3

3.7
1.6
0.2

2.9 to 4.8
-1.7 to 1.8

4.4

3.5

4.0

3.6

4.2

3.8

4.0

3.9

3.5 to 4.4

‘ Actual changes, not annualized.
Sou rce s: Departments of Com m erce and Labor

1 percent per year in the unemployment
rate must have been accompanied by
something like a 2-percent response in
labor force and output-per-worker growth.
W e can measure actual changes in the
unemployment rate, in the labor force, and
in output per worker. W hat we want to
know, though, is how much real output
growth would have been consistent with
no change in the unemployment rate. (That
is, after all, the definition of the potential,
or threshold, growth rate we seek.) So our
estimate of the potential growth rate
equals the actual labor force growth plus
the actual output-per-worker growth plus
twice the actual change in the unem­
ployment rate.
The 1947-77 Experience. Our postwar
experience with the potential growth rate
is summarized in the table. Every number
in it (except the unemployment rate
changes) is an annual rate of percentage
growth (or decline] during the five- or
fifteen-year period shown.
Turning first to the boldface numbers
and using the 1972-77 column as an exam­
ple, we can see that output per worker
grew 0.7 percent and the civilian labor
force grew 2.4 percent. W e adjust by




estimating that the sum of output per
worker and labor force growth would have
been 0.7 percent higher if the unemploy­
ment rate had held steady rather than
rising at an annual rate of about 0.3
percent. Our estimate of the potential
growth rate for 1972-77, therefore, is 3.8
percent: That real growth rate would
have been necessary, over the 1972-77
period, to hold the unemployment rate
constant at its 1972 level of 5.6 percent. As
it happened, our real growth averaged only
about 2.7 percent, thanks to the 1974-75
recession, and our unemployment rate rose
to 7.1 percent.
Still focusing on the boldface statistics,
we can see that the potential growth rates

" A 3-percent output acceleration
contributes only 1 percent to
employment and thus to the un ­
employment rate, with the other
2 percent being absorbed by the
labor force and output-per-worker
respo nses"

"W e can see that the potential
growth rates were about the same
for the first and second halves Qf
the thirty-year period and that
there is no clear trend in the po­
tential growth rates over the six
five-year periods/'

were about the same for the first and
second halves of the thirty-year period and
that there is no clear trend in the potential
growth rates over the six five-year periods,
although they range more broadly between
3.5 percent to 4.4 percent than do the fifteenyear rates. If we look no further than these
numbers, we might well conclude that for
the 1977-82 period, an extrapolated poten­
tial growth rate of 4 percent would be our
best bet.
It might be. But before we decide that,
we should look at how productivity and
labor force growth behaved individually.
Here we find no such stability but rather
offsetting trends apparently caused by
unrelated developments. Labor force
growth accelerated sharply from 1947-62
to 1962-77. Our potential growth rate
might have jumped just as sharply and
unemployment with it, except for a decline
in productivity growth which offset the
labor force acceleration almost exactly.
The five-year growth rates show the same
trends: labor force up; productivity
down.
Two offsetting growth rates like these
usually lead an economist to suspect a
behavioral relationship between the two.
Are productivity and labor force growth
somehow interrelated, once we adjust for
the reaction of each to changes in unem­
ployment? Can we count on an ac­
celeration in one being offset by a
deceleration in the other? If we can, we
would feel more confident about ex­
trapolating the 4-percent potential growth
rate into the future. To answer this
question, we need to look closely at the
components of labor force and produc­
tivity growth. When we do that, we shall
see that the two seem substantially in­
dependent and that the offsetting growth




patterns, therefore, seem largely
coincidental.
Civilian Labor Force Growth. First, let us
look more carefully at postwar labor force
growth, defining it more carefully to mean
the expansion of the civilian labor force.
As Appendix I shows, we have divided our
labor force growth in each period into
three components: (1) growth of our
working-age population, age 16 and above;
(2) changes in the “ participation rate," or
the proportion of.that population in the
total labor force, including the armed
forces; and (3) fluctuations in an adjust­
ment ratio measuring the proportion of our
total labor force in the civilian labor
force — that is, outside the armed forces.
Qualitatively, we can see that our
civilian labor force would increase by
(1) growth in our working-age population,
(2) an increase in the participation rate
within that population, and (3) a reduction
in our armed forces personnel, some of
whom will be seeking civilian jobs.
Quantitatively, our use of annual growth
rates enables us to compare the effects of
each component on unemployment. Some
of these comparisons are quite revealing in
themselves. For example, we can see that
the much discussed entry of women into
the labor force between 1972 and 1977
contributed (through the overall partici­
pation rate) only a third as much to labor
force growth as did growth in our workingage population (0.6 percent versus 1.7
percent).3 W e can see, too, that higher
participation rates during the past five
years had about twice the effect of our
armed forces reductions during the Viet­
nam wind-down (0.6 percent versus 0.3

"W e can see that our civilian
labor force would increase by
(1) growth in our working-age pop­
ulation, (2) an increase in the par­
ticipation rate within that popu­
lation, and (3) a reduction in our
arm ed forces personnel
3O u r purposes here p re c lu d e a d e ta ile d d iscussio n of the b re a k d o w n of p o stw a r
p a rtic ip a tio n rates bv age and sex, but w e h a ve in clu d e d a 1962-77 su m m ary in
A p pe nd ix II E a rlie r d a ta w e re not c o lle c te d on a d e ta ile d basis

" A lth ou gh the contribution of
the participation rate was fairly
sm all in the 15-year periods, it
has jum ped dram atically since
7972"
percent). The table provides material for
other specific comparisons, which we
leave to the reader.
Our primary interest is to learn more
about why civilian labor force growth has
accelerated. The data in the two fifteenyear columns suggest that most of the
acceleration came from population growth
(which picked up from 1.2 percent to 1.7
percent) rather than from the rise in the
participation rate (0.1 percent to 0.3
percent), which roughly equaled the ef­
fects of reductions in our armed forces
(-0.1 percent to +0.1 percent). Docu­
mented immigration had very little in­
fluence on our working-age population
growth over the past 30 years. The ac­
celeration basically comes from the baby
boom: High birthrates during the 1947-62
period brought large increases in the 16-to65 population 16 years later. When we turn
to assess the potential growth rate com­
ponents in the years ahead, we shall be
interested in what more recent birthrates
suggest and whether we can continue to
ignore the influence of immigration.
Although the contribution of the par­
ticipation rate was fairly small in the 15year periods, it has jumped dramatically
since 1972. Moreover, the 0.6-percent
contribution tabulated for 1972-77 would
probably have been about 0.2 percent
higher had the unemployment rate not
increased at the same time. (Common
sense tells us that it is the participation
rate rather than population growth or the
armed forces adjustment which has
reacted to unemployment changes in the
way we discussed at the beginning of this
article.) When we turn later to guess at the
future, our job will be to judge whether
the participation rate will continue to rise
the way it has for the past five years. Not
surprisingly, the answer seems to rest in
the participation rates of women, which
have gone up dramatically, overcoming a
smaller and less discussed decline in the




participation rate of men. In any case, the
relevant question for us is not whether
participation rates will fall or not but
rather how fast they will grow.
There is little to add here about the
armed forces adjustment —our percentages
measure changes in the ratio of the
civilian labor force to the total labor
force —except to note that the effects on
our potential growth rate have at times
been fairly significant. Future effects will
tend to reflect whether or not we have
another Korean or Vietnamese build-up.
Growth in Output Per Worker. Our
experience with output per worker is
tougher to deal with than the labor force
for two reasons. First is the inherent
ambiguity of effects. Productivity growth
is counted as a good thing in our society.
More output per worker means more
consumption per worker and a higher eco­
nomic standard of living. Higher wages
and profits, undiluted by inflation, are part
and parcel of this higher living standard.
Most economists would find it difficult to
argue that higher output per worker is
something that we don't want.4 Yet in our
peculiar context here, there is no question
that higher productivity growth has per­
verse effects on unemployment unless our
economic growth rate itself rises to offset
the productivity increase. From the stand­
point of bringing the unemployment rate
down, higher productivity has a negative
effect.
Another thing makes the productivity
side more difficult to analyze: W e
cannot decompose it as neatly for

" M ost economists would find it
d iffic u lt to argue that higher
output per worker is something
that we don't w ant. Y e t in our
peculiar context here, there is no
question that higher productivity
growth has perverse effects on
unem ploym ent/'

For a co n tra ry v ie w h ig h lig h ting the essen tial c o n flic t b e tw e e n p ro d u c tiv ity and
em p lo ym e n t, see E F S c h u m a ch e r, S m a ll Is B e a u tifu l, V a n ta g e Books. 1977

A P P E N D IX I
M EA SU R EM EN T OF T H E P O T E N T IA L G R O W TH R A T E
A N D IT S C O M P O N E N T S

W e begin by noting that in any year

(1)

Y

=

( £ ) (f)

L

where Y is real output (GNP in 1972 $)
N is civilian employment, and
L is the civilian labor force.
Y/N is output per worker, and N/L is the complement of our conventional unemploy­
ment rate U. (If U is 5 percent, for example, then N/L is 1 minus .05 = .95.) If we
convert each of these terms to percentage changes at annual rates and denote the con­
version by placing a dot over each term, then

t2)

Y

s

G B + ( f ) +

l

Real output growth, this says, is approximately equal to growth in output per worker
plus growth in the employment rate plus growth in the labor force. This approximation
is very close for small percentage changes like the annual rates we use in this article.
Our interest is not in the actual rate of economic growth Y but rather in the poten­
tial rate of growth —that rate which would have been consistent with no change in the
unemployment rate. Calling this potential rate Y0 , we can see that

l3)

Y“ =

( £ ) o + Lo + °'

where (Y/N)0 is the output per worker we would have had, and Lo is the labor force
growth we would have had, with no change in unemployment. (In such case, of course,
(N/L) would have been zero.)

(4)

Y

— Y0 = 3

r±LV

Next, this says that the excess of actual over potential economic growth equals three
times the fall in the conventional unemployment rate or, equivalently, three times the
percentage increase in the employment-to-labor-force ratio.* If we reorder (4) and
substitute (2) into the result, we get




Equation (7) provides a way of estimating the potential growth rate: W e start with
measured growth in output per worker, add measured growth of the civilian labor
force, and correct the sum for the effects of unemployment rate changes by subtract­
ing twice the change in the ratio of employment to the civilian labor force.
W e have also found it analytically useful to break Y/N and L into three com­
ponents each. For L:

181 L■ (t;) (tO'
1,1 ' fe) +(r) +''
where Lj- is the total labor force (including persons in the armed forces) and P is 16and-over population. Here L^/P is the familiar participation rate — the proportion of
working-age Americans in the total labor force. The L/I_t term adjusts for movements in
and out of the armed forces. This breakdown enables us to see, for example, during the
1972-77 period, that of the 2.4-percent annual expansion in the civilian force, 1.7 per­
cent was attributable to the growth of working-age population, 0.6 percent came from
expanded participation of that population, and 0.1 percent came from a movement
out of the armed forces into the civilian labor force.
Our breakout of the productivity term is similar. W e have data for the private sector
on output per hour(Y/H)p and on the average number of hours worked per week (H/N)p.
W e use it by noting that

■» G9 ■ G9. ( f t [ S J
- (•£) ■(ft * a

*

where the third term adjusts for the public-private discrepancy.
Our summary table, then, is based on equations (7), (9), and (11), which when com­
bined give us

*O u r estimates em ploy a factor of three: O f a 3-percent change in the rate of econom ic growth, 1 percent w ill show up in the unem ­
ploym ent rate and the other 2 percent w ill be offset by increases in productivity and the labor force. Estimates of this relationship by
various economists over the past 15 years seem to cluster in the 2.7- to 3.4-percent range. O kun's original estimate was 3.2. The most
recent estimates are toward the low er end of the range and w ou ld suggest our using perhaps 2.7 or 2.8, but w e chose 3.0 because
of a subjective suspicion that the statistical associations w ere in part reflecting coincidental rather than causative relationships.




" Our reading of the 7947-77 ex­
perience, then, is that our stable
potential growth rate reflects a
coincidence of offsetting indepen­
dent factors. Labor force growth
accelerated sharply, partly in re­
sponse to the baby boom and
partly in response to expanded
la b o r f o r c e p a r tic ip a tio n by
women. The offsetting decelera­
tion in output per worker seems
largely the result of shifts in the
composition of our output and
em ploym ent."
description and analysis. The obvious
breakdown is to separate output per
worker into two components: output per
hour and average hours per worker (per
week, per month, or whatever; it doesn't
matter because we are interested in annual
rates of percentage change). W e can get
data to separate these components, and
we have, but only for the private sector.
For government employees, who do not
produce goods and services priced and
valued in private markets, there is no
standard against which to measure
productivity. The builders of our national
income accounts simply estimate govern­
ment productivity growth as zero. Our
nation's productivity statisticians, recog­
nizing the lack of information in our
government-sector productivity figures,
stick to the private-sector data. So shall
we, except that we include an imputed
adjustment to highlight the public-private
discrepancy in coverage.
W hat do these private-sector figures tell
us about the decline in productivity we
mentioned earlier? Overall, we can see
from the 15-year figures that output per
hour is by far the most important of the
two components and has decelerated
significantly. (This is true, incidentally,
even if we attribute a substantial portion
of the "Okun's Law adjustment" to the
output per hour component.) The work­
week reduction has continued through the
30-year period too, though the percentage
decreases have recently been larger.




The reasons for the postwar declines in
the growth in output per hour and the
workweek are largely structural. New
technology and additions to physical and
human capital (plant and equipment;
education and training) exert upward
pressure on output per hour, year after
year. Virtually all the changes in produc­
tivity growth have been related to three
structural shifts: (1) the substantial
movement of workers from farm to non­
farm jobs, which boosted overall produc­
tivity substantially until the early 1960s;
(2) the continuing shift in our nation's
output from manufacturing to service
occupations, which has retarded the
growth of hourly productivity; and (3) the
recent increase in the proportion of
inexperienced workers, whose average
productivity tends to be below that of
their more seasoned counterparts. Studies
by the Bureau of Labor Statistics suggest
that these factors are sufficient to account
for most of the postwar deceleration and
are more important than the effects of
changes in capital investment, labormanagement relations, and the like.5
Basically, then, most of the postwar
productivity slump has come from the
exhaustion of the farm-to-nonfarm transfer,
from continuing shifts from manufacturing
into services, and from the recent reduc­
tion in the experience level of our labor
force.
Accelerated declines in the average
workweek seem to be explained by similar
factors. Until about ten years ago, there
had been a small but consistent shortening
of the average workweek through all

"W e expect the potential growth
rate to fa ll from the 4.0-percent
postwar average to about S V i
percent, since declines in the
working-age population will not
be fu lly offset by increases in
participation rates or output per
worker."
S u m m a r iz e d in K u tsch er, M a rk , and N o rsw o rth y, " T h e P r o d u c tiv ity S lo w d o w n
and th e O u tlo o k to 1985,

M o n th ly La b o r R e vie w , M a y 1977

"A d d itio n s to the labor force
through im m igration (legal or
otherwise) are the biggest ques­
tion m a rk. If our unemployment
rate falls and the supply of entrylevel job applicants decelerates,
such im m igration could push po­
tential growth and unemployment
up s ig n ific a n t ly "
sectors of our economy. Talk was wide­
spread then about the 32-hour week. More
recently, however, such attention has been
diverted to flexible working hours and 4day, 40-hour weeks, perhaps stimulated by
consciousness of higher commuting costs.
Cutbacks in average hours of work have
come, instead, from the shift from manu­
facturing to services and the increase in
part-time employment.
W hat about our imputed discrepancy
between the public and private sectors?
Persistent negative adjustments suggest
that public-sector productivity, as esti­
mated, lagged behind the private sector
until the past five years. W e are reluctant
to say much more about the reasons for
this pattern without further study, but we
cannot resist the guess that the improve­
ment posted for this component in the
1972-77 period reflects recent heavy pay
increases in the public sector rather than a
stalling of productivity declines.
Our reading of the 1947-77 experience,
then, is that our stable potential growth
rate reflects a coincidence of offsetting
independent factors. Labor force growth
accelerated sharply, partly in response to
the baby boom and partly in response to
expanded labor force participation by
women. The offsetting deceleration in out­
put per worker seems largely the result of
shifts in the composition of our output
and employment.
The diversity of these contributions and
influences suggests that we cannot simply
extrapolate our potential growth into the
future. A reasonable assessment of our
future potential growth requires, instead,
that we examine each component in the
light of the influences peculiar to it.




W hat Lies Ahead? W e venture these
prospects with considerable uncertainty:6
1. W e expect the potential growth rate
to fall from the 4.0-percent postwar aver­
age to about 3 1/2 percent, since declines
in the working-age population will not be
fully offset by increases in participation
rates or output per worker.
2. Additions to the labor force through
immigration (legal or otherwise) are the
biggest question mark. If our unem­
ployment rate falls and the supply of
entry-level job applicants decelerates, such
immigration could push potential growth
and unemployment up significantly.
3. The strong deceleration in our workingage population suggests that our potential
growth rate will be falling rather than
rising within the next five-year period,
implying that a constant actual rate of
economic growth throughout the period
would make increasingly more headway
against unemployment as the period
transpires.
Before we elaborate a bit, a couple of
warnings are appropriate. The potential
growth rate we discuss here is based on
the capacity and willingness of our labor
force to expand real output. It takes no
account of other bottlenecks, notably
shortages of physical capital or natural
resources.
Second, we need to recognize the at­
tention economists have recently paid to

“ The strong deceleration in our
working-age population suggests
that our potential growth rate will
be falling rather than rising with­
in the next five-year period, im ­
plying that a constant actu al rate
of economic growth throughout
the period would m ake increas­
ingly more headway against
unem ploym ent as the period
transpires
1978 Report of the President'*
C o u n cil of Econom ic Advisers co n ta in s s im ila r an sw ers to s im ila r q u estion s, in­

6As.this a r tic le goes to press, w e n o tic e th at th e

clu d in g a real p o te n tia l g row th ra te b e tw e e n 3 3 an d 3 8 p e rce n t per ye a r

"O n the productivity side, we
expect output per worker to grow
1.8 percent during the next tive
years/'
natural, or noninflationary, rates of unem­
ployment.7 These studies suggest that if
we push the conventional unemployment
rate below some level, widely estimated at
between 5 and 5 1/2 percent, inflation will
accelerate unacceptably. This work sug­
gests, quite credibly, that Okun's 3-to-1
ratio of above-potential economic growth
to unemployment rate reductions may be
too low as the unemployment rate comes
into the 5- to 5 1/2-percent range, and
forecasters and policymakers should be
prepared to see their unemployment and
inflation hopes disappointed in such a
case. This prospect is pretty well
recognized.
The determinants of the natural, or
noninflationary, level of unemployment
may include the same factors as our po­
tential growth rate: productivity and the
labor force. If so, and if we expect our po­
tential growth rate to slow down, the
natural rate of unemployment may fall
with it, giving us more room to reduce
unemployment without an acceleration of
inflation. This hypothesis, however, is
obviously well beyond the scope of this
article.
How do we get our expectation that the
potential growth rate will fall? On the
labor force side, we start by accepting the
official forecast of 1.3-percent growth in
our 16-to-65 population. This projection is
based on previous birthrates and is not
affected significantly by inclusion of the
over-65 age group. This rate should fall
steadily from 1.7 to 1.1 over the five-year
period.
Participation rates are much harder to
forecast. Studies are pouring out on the
subject, incorporating many possible in­
fluences: childbearing patterns of
working women, school enrollments,
single-parent families, purchasing power of

young workers in relation to their parents,
advantages of working versus public assis­
tance programs, and so forth. Some
analysts, notably at the Bureau of Labor
Statistics, project a much slower increase
in participation rates than the 0.6 percent
experienced in 1972-76. Others see a con­
tinuation of our recent increases.8 Our
subjective judgment, after examining these
forecasts, is that additions will continue to
be strong but not as strong as recently,
perhaps at an 0.4-percent contribution to
civilian labor force growth. As to our
armed forces adjustment, we project no
change there, in the absence of a good
reason to expect anything else.9 Adding
these numbers up, we expect the civilian
labor force contribution to potential
growth to average 1.7 percent: 1.3
percent from population growth and 0.4
percent from participation rate growth.
This is midway between our experience
for the 1947-62 and 1962-77 periods,
respectively.
On the productivity side, we expect
output per worker to grow 1.8 percent
during the next five years. W e accept the
BLS estimate of a 2.4-percent increase in
the private output per hour component,
reflecting a continuing shift from manufac­
turing to services and a gradual seasoning
of the labor force as the influx of inex­
perienced entrants subsides. The work­
week, we expect, will continue to decline
at an 0.4-percent rate: a continuation of
the long-term shift to shorter workweek
service activities, offset partly by a
dropoff in the influx of secondary workers
desiring part-time employment. As to the
public-private discrepancy, we have
estimated a decline of 0.2 percent, ex­
pecting public-sector wage increases to
taper off. This component may fall more
than that, but our doubts here are some­
what counterbalanced by a fear that the
output per hour and workweek projections
may each be (algebraically) a little
high. ■

in t e r e s t e d readers are urged to co n s u lt th ree recen t a rtic le s in th e M o n th ly

La b o r R e view :

De ven s, " L a b o r F o rce Trends: A B ib lio g r a p h y ," O c t o b e r 1977:

Be d n a rz ik and K lein , " L a b o r F o rc e Trends: A Syn th esis and A n a ly s is ," O c to b e r
1977: an d Fu lle rto n and Fla im , " N e w L a b o r F o rc e P ro je c tio n s to 1990,"
in Jo b s Fo r
A Lo o k to the Fu tu re , A m e ric a n A ssem b ly on M a n p o w e r G o a ls for

7See, fo r exam p le, A rth u r M O k u n , "C o n flic t in g N a tio n a l G o a ls

A m e ric a n s :

A m e ric a n D e m o c ra c y , 1976




D e c e m b e r 1976
9M a n p o w e r le v e ls in th e v o lu n te e r a rm y m a y m o v e in response to lo w er
u n e m p lo ym e n t, h o w e ve r

A P P E N D IX II
LA B O R FO R CE P A R T IC IP A T IO N RA TES B Y AGE
(p e rce n t)

Year

Total

16-19

20-24

25-34

35-44

45-54

55-64

65 and
over

1962

Female
Male
Total

38.0
82.8
59.7

39.1
57.7
48.5

47.4
89.1
68.2

36.4
97.4
66.5

44.1
97.7
70.2

50.0
95.6
72.3

38.7
86.2
61.5

9.9
30.3
19.0

1967

Female
Male
Total

41.2
81.5
60.6

41.7
59.2
50.5

53.4
87.5
70.5

42.0
97.4
69.4

48.1
97.4
72.2

51.8
95.2
72.8

42.4
84.4
62.4

9.6
27.1
17.2

1972

Female
Male
Total

43.9
79.7
61.0

45.9
59.9
53.0

59.1
85.9
72.5

47.6
95.9
71.4

52.0
96.5
73.7

53.9
93.3
72.8

42.1
80.5
60.2

9.3
24.4
15.6

1977
(est.)

Female
Male
Total

47.9
78.1
62.4

50.7
60.2
55.5

66.8
84.7
75.8

57.0
95.3
76.0

57.9
95.9
76.4

55.7
91.7
73.1

42.0
75.4
57.7

8.3
20.2
13.2

update

Now available:
, a monthly publication that features a brief summary of
Sixth District business conditions plus statistical tables and charts.
Free subscriptions available upon request to Information Center, Research Department, Federal
Reserve Bank of Atlanta, Atlanta, Georgia 30303. Please include a complete mailing address with
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THE NEW MINIMUM WAGE:
A THREAT TO SOUTHEASTERN JOBS?
by C h a rlie C a rte r

On January 1 of this year, the first of four
scheduled increases in the Federal
minimum wage took effect, lifting the
basic minimum from $2.30 per hour to
$2.65. The new law calls for further up­
ward adjustments to $2.90 in 1979, $3.10
in 1980, and finally to $3.35 in 1981.
Advocates heralded the new law as a
major step to protect working Americans
from poverty. Many economists, however,
contend that such legislation is selfdefeating in that it reduces demand for
entry-level workers —those it's designed to
help.1 Also, its "ripple effect'' on above­
minimum wages may dampen the demand
for higher paid workers and add to in­
flation, as employers attempt to pass on
higher wage costs by raising prices.
The economic literature on the subject
of minimum wages is voluminous, dating
back to the passage of the original Fair
Labor Standards Act in 1938.2 Previous
studies have focused largely on the effects
of increases in the minimum wage on
employment, unemployment, and the labor
force participation rates of various
demographic groups. Although specific
conclusions vary from study to study,
there is general agreement that, on a
national scale, elevations of the minimum
wage reduce employment, raise unem­
ployment (see Chart 1), and discourage
labor force participation, especially of
youths and nonwhite workers. There is
'F o r exam p le, see Ja m e s F R agan , J r , 'M in im u m W a g e s and the Y o u th Labo r
M a rk e t,

T h e R e view o f E c o n o m ic s an d Sta tistics, V o l 59, M a y 1977, p 129

2For a re v ie w of p re vio u s e m p iric a l studies, see |ohn M

Peterso n and C h a rles T.

Stew art, J r . E m p lo y m e n t E ffe c ts o f M in im u m W a g e R a te s (W a s h in g to n , D C
A m e ric a n En terp rise In s titu te fo r P u b lic P o lic y R esea rch ), A u gu st 1969




also some evidence that increases in the
minimum wage force up wage rates
already above the minimum, as unions and
other groups demand comparable pay
raises.
Regional Effects? W ith few exceptions,
earlier research on the effects of the mini­
mum wage has been nationwide in scope
and has not dealt with possible regional
differences in its impact. But it stands to
reason that any adverse effects of an
increase in the minimum wage would be
more pronounced in low wage regions. A
uniform national minimum will be higher
relative to average earnings in a low wage
area. And since a greater proportion of
workers covered by minimum wage laws
receive no more than the minimum pay in
such an area, an increase will affect a
larger fraction of its work force. Thus,
raising the minimum wage to elevate living
standards nationally may worsen unem­
ployment in low wage regions.
The low wages of the southeastern
United States relative to other regions of
the U. S. make it a useful testing site for
the above hypothesis. In M ay 1976, about
34.2 million wage and salary workers
nationwide were paid on an hourly basis,
according to the Census Bureau s Current
Population Survey. Their median hourly
earnings were $3.35, and the mean was
$4.06. But the 6 million hourly workers in
Administrative Region IV (Alabama,
Florida, Georgia, Kentucky, Mississippi,
North Carolina, South Carolina, and
Tennessee) had a median wage of only
$3.12 per hour and mean earnings of $3.52
per hour, significantly less than the

CH A RT 2
DISTRIBUTION OF HOURLY WAGES,
U.S., REGION IV* (MAY 1976)

U. S.

■
D U

national averages. Almost two-thirds of
U.S. hourly wage earners were paid at least
$3 per hour, while only slightly over half
of the Region IV workers earned that
much (see Chart 2).
The Bureau of Labor Statistics earnings
data show that the average hourly earnings
of manufacturing production workers are
also lower in the southeastern U. S. than in
the nation as a whole. As recently as Sep­
tember 1977, mean hourly wages of
manufacturing production workers in the
six Federal Reserve District states
(Alabama, Florida, Georgia, Louisiana, Mis­
sissippi, and Tennessee) were only $4.80,3
about 17 percent less than the average
$5.75 paid to factory workers nationally.
To test our hypothesis, regression
analysis was used to estimate the effect of
changes in a minimum wage variable on
changes in unemployment rates. Changes
in output were added to the equation in
order to measure the effect of changes in
3T he m ea n h o u rly w a g e fo r th e Sixth D is tric t is th e a vera g e o f h o u rly earnings i
e a c h o f th e six states w eig h ted by th e state's m a n u fa ctu rin g e m p lo y m e n t




R e g io n

Less than
$2.50/hour

I
| $4.00-4.99
I....... I

$2.50-2.99

F7\

$5.00-5.99

$3.00-3.99

□

$6.00 and over

• R egion IV in c lu d e s A la b a m a , F lo rid a . G eo rg ia , M iss is s ip p i,
K e n tu ck y , N o rth C a ro lin a , S o u th C a ro lin a , a n d T en n es s ee.
SO U RC E:

S p e c ia l ta b u la tio n s p ro vid ed by U .S . D e p a rtm e n t of
Labo r, B u re a u of La b o r S t a tis t ic s , s u m m a ry d ata
p u b lis h e d in W eekly and Hourly Earnings Data from
the Current Population Survey, S p e c ia l L a b o r F o rce
R ep o rt 195, 1977.

general economic activity on unem­
ployment rates. W e estimated one such
equation for the U. S. as a whole and
another for our low wage region, the Sixth
District. In addition, we calculated two
similar equations using the national
unemployment rates of white and non­
white teen-agers. The minimum wage
variable used was not the minimum wage
per se but rather a coverage- and industry
employment-weighted average ratio of the
minimum wage to average hourly earnings.
The Appendix explains the data and
methodology used in greater detail.
TEST RESULTS
General Impact. The equations we esti­
mated suggest that increases in the mini­
mum wage are associated with rises in

unemployment rates, both in the U.S. and
in the Sixth District (see the table for sta­
tistics). However, that relationship is statis­
tically significant only for the Southeast.
The equation calculated for the District
implies that a 10-percent advance in our
minimum wage variable would raise the
area's jobless rate by half a percentage
point within two quarters, barring changes
in production levels and other economic
factors. Plugging the December 1977 value
of District average hourly earnings and
the proportion of workers covered in 1976
into the equation shows that the January 1
35-cent per hour elevation of the basic
minimum wage will push the recent Dis­
trict unemployment rate of 6 percent to
6 V2 percent by June, unless offset by eco­
nomic growth. Judging from current labor
force estimates, District employment
would be 60,000 higher at midyear if the
minimum wage had not been increased.

Should the estimated relationship hold
through 1981, the increases scheduled
would cost the District a total of 144,000
jobs.4
The lack of statistical significance of the
relationship between the minimum wage
and the jobless rate on the national level is
not entirely a surprise. Previous studies
have found that an elevation of the mini­
mum wage affects the unemployment rates
of certain demographic groups more than
others. Thus, at the national level (and to a
lesser extent in the Sixth District), a higher
minimum wage may draw older, more
experienced workers, particularly women,
into jobs previously held by younger, lower
skilled workers. Higher minimum wage

‘ This fou r-year e s tim a te is based on assu m p tion s th a t a ve ra g e h o u rly earn ing s w ill
grow b y 7 p e rc e n t per y e a r and th a t th e sh ift o f e m p lo y m e n t from m a n u fa c tu r­
ing to s e rv ic e in d ustries w ill c o n tin u e a t its h isto ric trend rate.

_ A P P E N D I X ___________________________________________________
Methodology. Data limitations prevented our duplicating the approach commonly used in
national scale tests for minimum wage effects in our regional test.* The specific equations we
estimated are
% AU = aD+ bQ% AM INW + cD% AGNP + eGand
% ADU = a, + bi % ADM INW + c ,% A D IP I + e1(
where U and DU are unemployment rates for the U. S. and Sixth District, respectively; GNP is
the Gross National Product in 1972 dollars; DIPI is the Federal Reserve Bank of Atlanta's
District Industrial Production Index; and the e's are error terms. MINW is the minimum wage
variable for the U. S. and is defined as follows:

Ej
E
where E
MB
AHE
CB
MN
CN

mb
Ir[A-----H Ej

I
J

MN
(CBi) + ------ (C N j)l
AHE,

=
=
=
=
=
=

private nonfarm payroll employment,
basic minimum wage,
average hourly wage of production workers,
proportion of nonsupervisory workers covered by the basic minimum wage,
minimum wage applicable for newly covered workers,
proportion of nonsupervisory workers covered by the minimum wage applicable for
newly covered workers, and
i = major industry division—wholesale and retail trade is considered a separate
division.
DMINW, the District minimum wage variable, is computed in the same way, except that
average hourly earnings and the industry employment proportions are Sixth District averages.
* F o r an e x p la n a tio n o f th e b e h a v io ra l m od el used in n a tio n a l studies, see la c o b M in ce r, "U n e m p lo y m e n t E ffe c ts of M in im u m W a g e s ,” Jo u rn a l o f P o lit ic a l

E c o n o m y , 1976, V o l 84, N o 4, P art 2 (U n iv e rs ity of C h ica g o ), pp S87-S104




levels are perceived as a deterioration in
employment prospects. Since the newly
discouraged workers would be primarily
comprised of unemployed persons, the
exodus from the labor force may offset
some of the impact of the minimum wage
hike on the jobless rate. Thus, a minimum
wage hike may cause changes in the
demographic distribution of employment
which do not show up as an increase in
the total unemployment rate.
Another explanation for the weakness of
the relationship between the national mini­
mum wage variable and the unemploy­
ment rate may be that the impact is
primarily on hours of work. If employers
respond to a raising of the minimum by
cutting back hours worked rather than the
number of employees, it will not alter the
unemployment rate. And since increases in
the basic minimum are usually accom­
panied by a rise in overtime pay, some

employers may even add new employees
to eliminate overtime.
Effect on Youths. The impact of the
minimum wage on youth unemployment is
startling (see Chart 1). Our test results
show that a 10-percent increase in our
minimum wage variable will raise the
unemployment rate of whites age 16-19 by
7.4 percent and that of nonwhite youths by
6.4 percent. The 1978 elevation of the
minimum can be expected to swell teen­
age joblessness from the recent rates of
14.7 percent for whites and 34.7 percent
for nonwhites to 16.1 percent and 37.7
percent for whites and nonwhites, respec­
tively, by midyear. W ith about 8.6 million
white youths and 1.2 million nonwhite
teen-agers in the national labor force,
those increases mean that 156,000 fewer
youths will be employed in June. When all
the minimum wage raises of the next four
years are considered, youth job losses may

To test the effects of the minimum wage on youths, we also estimated the following equations:
% A UYW = a2 + b2 % AM INW + C 2% A GNP + e2
% A U Y n = a3 + b3 % AMINW + C 3% A GNP + e3,
where UYW and UY n are the national unemployment rates for white and nonwhite workers age
16-19, respectively.
The data were quarterly; the test period included the first quarter of 1970 through the sec­
ond quarter of 1977. Only the output data were seasonally adjusted. The estimating technique
used was ordinary least squares.
The Minimum Wage Variable. The form of the minimum wage variable was selected for its
sophistication and wide acceptance in the literature. “ Deflating"' the nominal minimum wage
by hourly earnings transforms the flat, steplike increases in the minimum into a rachet-like
series of small rises. That's because inflation and productivity gains tend to gradually raise the
general level of wages, eroding the effectiveness of statutory increases in the minimum wage.
Since the legal minimum for newly covered workers is not as high as the rate set for pre­
viously covered employees, only a weighted average of wage ratios for the two groups could
accurately represent the relationship between the minimum wage and the general wage level.
The weights used were the proportions of nonsupervisory workers covered previously and
those covered as a result of extensions of the law (separate pairs of proportions were
calculated for each industry division). In order to assign greatest importance to the industries
which account for the largest shares of private nonfarm employment, the coverage-weighted
wage ratios for each industry were also weighted by industry employment.
Measured in this way, the effective minimum wage rose from about 37 percent of national
earnings in 1970 to 40 percent in 1976, an increase of 9 percent. In contrast, if coverage and
employment distribution were ignored and only the basic minimum were considered, the wage
ratio declined 2.5 percent during that period.




NET EFFECTS OF CHANGES IN THE MINIMUM WAGE AND OUTPUT
ON UNEMPLOYMENT RATES, 1970:1 - 1977:1V
(regression coefficients of equations and variables as
defined in the Appendix)
Unemployment
Rate Equation

Constant

% A M IN W

.029
(3.840)

.075
(0.395)

% A DMINW

R

Durbin-Watson
Statistic

-2.788
(4.786)

.416

2.13

% A GNP

% A DIPI

United States:
All Workers
Youths (Age 16-19)
Whites

.049
(4.457)

.724
(2.642)

- 4.422

.492
(5.248)

2.15

Nonwhites

.031
(2.924)

.642
(2.444)

- 2.820

.340
(3.493)

2.14

.450

1.93

Sixth District:
All Workers

.038
(2.537)

.643
(1.580)

- 1.675
(3.757)

Absolute values of t-statistics are in parentheses. Fora two-tailed test, critical values are 1.314(oc = 0.1),1.70(oc = .05), and 2.46 (oc = .01).

reach 470,000. The potential dramatic
effects are particularly disturbing in light
of the already extremely high jobless rates
of youths.
The Role of Output. The output vari­
ables in our test equations (constant dollar
GNP for the U. S. and industrial produc­
tion for the Sixth District) are important
because increases in output tend to create
jobs, offsetting the effect of the minimum
wage on the unemployment rate. Indeed,
our tests confirm that production affects
unemployment inversely and significantly.
More specifically, the unemployment
rate is more sensitive to real output growth
nationally than in the Sixth District. A 4percent rise in real GNP reduces the U. S.
jobless rate by about an 0.6 percentage
point, but a similar increase in District
industrial production lowers the southeast­
ern unemployment rate by roughly an 0.4
percentage point.5 The jobless rate of
white teen-agers shows a greater response
Th e D is tric t In d u s tria l P ro d u c tio n Index is designed to m ea su re the o u tp u t of
m a n u fa c tu rin g industries o n ly S in c e m a n u fa ctu rin g p ro d u ctio n a cc o u n ts for
o n ly a sm all share o f th e to ta l o u tp u t of th e D istrict (w h e re as n a tio n a l G N P is
d esign ed to m easu re the o u tp u t of all sectors), th e lo w e r s e n s itiv ity o f the
D is trict u n e m p lo y m e n t rate to ch an ges in the p ro d u ctio n index is not surprising




to output gains than does the rate for
nonwhite youths: that 4-percent real GNP
growth improves the white rate by 16
percent and the nonwhite rate by 11
percent.
Conclusions. Our evidence gives some
support to a widely held belief that in­
creases in the minimum wage adversely
affect unemployment rates. The impact is
greater in low wage regions like the
Southeast and on youths, especially non­
whites. On the other hand, an elevation of
the minimum wage does not significantly
raise the jobless rate on the national level.
Changes in the demographic composition
of employment and a discouraged worker
effect may explain the lack of response.
Our estimates of the number of District
and teen-age jobs to be lost because of
minimum wage hikes do not reflect the
effects of other major influences on labor
markets: output changes, labor force
participation rates, and monetary and
fiscal policy. Although not tested here,
increases in the minimum wage are likely
to reduce hours worked and raise output
prices. Hopefully, future studies will probe
further into these other probable effects. ■

SOUTHEASTERN
LOAN DEMAND
REVIVES—
AT LAST!

by Joh n M . G o d fre y

As the southeastern economy moved into
its third year of expansion, the region's
banks picked up strong momentum. With
liquidity positions rebuilt, Sixth District
banks were in the advantageous position
of experiencing strong deposit inflows
concurrently with robust credit demands
from many types of borrowers during 1977.
As a result of this favorable balance of
conditions, southeastern banks reported
strong gains in interest income that gen­
erally flowed through to the bottom line as
higher earnings.
Loan Demand Recovers. The most
significant — and welcome —development
to occur last year was the strong and
broadly based pickup in loan demand. Not
since 1973 had banks been in a position to
really sell their major product —the direct
extension of credit to households and busi­
ness firms. In 1975 and 1976, the only
significant growth in bank credit had been
acquisitions of U. S. Treasury securities.
Overall loan demand had been weak, with
borrowing primarily limited to households.
W ith expenses exceeding taxable income,
many banks had been unable to take full
advantage of the tax exemption on income
from their large holdings of state and local
government securities. Higher yielding gov­
ernment obligations thus had become
more attractive in bank portfolios.
Bank loans in the District rose 14
percent last year and were advancing at an
even faster pace in the latter half of the
year. The strongest loan growth occurred
in Alabama, Florida, and the southern half




of Mississippi. W hile bank lending had
advanced satisfactorily at the medium­
sized and smaller banks in 1976, it had
remained weak at the larger banks until
late in that year. Since then, the lending
increase at the larger banks has been
below that of the other banks. W hile the
credit expansion has been less rapid than
the nearly 25-percent rate of the mid1970s, most bankers would rather not
repeat that experience.

CHART 2
COMMERCIAL AND INDUSTRIAL
LOANS REBOUND____

I

I

i

i

V ///A V //A
D u rab le G o o ds M an ufactu rers

%
N o nd u rab le G oods M an ufactu rers

M inin g and the E xtra ctiv e In d u strie s

PW h olesale and Retail Trad e

y/y/A
WZ&m i

Va m

.

T ra n s., Com m ., and Other P u b lic U tilitie s

C o n stru ctio n F irm s

S e rv ice F irm s

. . . WHILE LOANS TO NONBANK FINANCIAL
FIRMS REMAIN WEAK

1

F in a n c e C o m p a n ie s and F a cto rs

O ther F in a n c ia l In stitu tio n s

22 L a rg e B a n k s

I

I

I

100

50

0




I
+

M IL . $

5

0

I

I

100

150

Loan demand in 1977 was strongest from
households. Consumers' use of bank credit
for purchases advanced nearly 20 percent,
as they financed new and used automo­
biles, home improvements, and other retail
purchases. Only in the area of mobile
home credit did consumer instalment cred­
it decline. Even though bank consumer
lending rose throughout the District, Ten­
nessee banks cut back on their extensions
of consumer credit in late summer,
responding to uncertainties generated by a
court decision that more strictly enforced
the state's usury ceiling.
Household borrowing was not limited to
financing retail purchases. Home mortgage
credit rose, too, as purchases of new and
used single-family homes posted large
gains. The sharp rise in real estate credit
was not attributable only to home mort­
gage loans, however. Loans to finance
commercial properties increased strongly
at the larger banks in Tennessee, Georgia,
and Florida. Loans to finance land devel­
opment and construction loans were up at
the larger banks in Alabama and Louisiana.
The major turnaround in bank credit
demand last year reflected an upsurge in
business borrowing. Increased use of busi­
ness credit lines while other credit
demands were heavy was partly respon­
sible for the advance in bank prime lend­
ing rates during the year. They rose from a
low of 6 1/4 percent in early 1977 to 7 3/4
percent by the end of the year. The higher
interest charges and expanding business
loan volume added significantly to banks'
interest income.
The resurgence in business loans was
most apparent at the larger banks. Com­
mercial and industrial loans had risen
slightly over $100 million in 1976, but
strength had been evident only in lending
to textile and apparel goods producers,
wholesale and retail trade firms, and the
mining and extractive industries. Last year,
however, business loans jumped nearly
$600 million (about 13 percent), expanding
in all major industrial and commercial
loan categories. In contrast, at large banks
nationally, growth was about one-half the
District rate. Those categories showing
strong net loan increases in 1977, as com­
pared with reductions or only weak gains
in 1976, included durable goods manu­
facturers, transportation, communication

CH A R T 3
SECURITY ACQUISITIONS SHIFT
BIL. $

‘ INCLU DES M UNICIPAL S EC U R ITIES AND FEDERAL
AGENCY ISSU ES.

V____________________ J
and other public utilities, construction
firms, and the services industry. Lending
also continued to the business customers
who had been heavy borrowers in the
previous year. This broad base for business
credit expansion gave regional banks a
much better balance in their loan growth.
W hile commercial banks enjoyed in­
creased business from their commercial
and industrial firms, even the larger banks
found that financial institutions such as
finance companies were weak, if not
inactive, customers during the last three
years. (Lending to these borrowers includes
both direct loans and purchases of com­
mercial paper issued by these companies.)
Loans to sales and personal finance
companies and business factors dropped
about $31 million during 1977, the same as
in the previous year. Since most banks
price their direct loans to finance com­
panies at the prime rate or above, they
have in many cases priced themselves out
of this loan market. The prime rate has
recently been set at 125 basis points above
the commercial paper rate. As a result,




finance companies have been borrowing in
the commercial paper market at the lower
rates and repaying their bank loans. Other
financial institutions — primarily mortgage
and insurance companies, bank holding
companies, savings and loan associations,
and REIT s— increased their bank borrowing
by only $28 million in the past year follow­
ing a $78-million reduction in 1976.
W ith the revival of overall loan demand
in 1977, District banks had less need to
increase their holdings of securities to
obtain earning assets. District banks added
to their holdings of U. S. Government
securities by only 4 percent during the
year, in sharp contrast to their more than
doubling these holdings in the previous
two years. Despite this small advance in
government holdings, banks did make
some portfolio adjustments that reflected
changing credit conditions. They sharply
pared their holdings of Treasury bills in
favor of higher yielding intermediatematurity notes. Positions in long-term
Treasury bonds were unchanged.
W ith taxable income up, District banks
once again made modest additions to their
municipal bond portfolios. Since banks
can most effectively utilize tax-exempt in­
come only when they have taxable income,
the strong advance in interest income
and a reduction of loan loss expenses paved
the way for many District banks to return
to the municipal bond market as active
purchasers.
Deposit Inflows Advanced. The con­
tinued overall strengthening in deposit
inflows was a major factor in enabling
District banks to meet last year's revival in
credit demands. Total member bank de­
posits rose $4.1 billion, a brisk 10.4-percent
gain. Furthermore, last year's dollar growth
in deposits exceeded the net increase of
the two previous years combined.
The change in the distribution of the
deposit gains was as important as the
magnitude. Demand deposit inflows ac­
celerated sharply in the District, just as in
other parts of the country. Larger checking
account balances provided banks with a
more ample supply of interest-free funds
(although these funds are not without
some cost to the banks) and are but one
further indication that the region's house­
holds, business firms, and governmental
units required more funds to transact a

higher level of spending and financial
transactions.
Although gains in passbook savings were
considerably lower than those of the two
previous years, they were certainly ade­
quate. Growth in savings accounts is
important because it helps ensure a
relatively stable and low-cost deposit base.
But since this single source of deposits had
been supplying about three-quarters of the
banks' net deposit gains in recent years, the
more diversified deposit inflows in 1977
were beneficial.
For the first time since 1974, District
banks posted net gains in time deposits, as
both the smaller denomination time de­
posits and larger “ money market" type
deposits rose. The smaller denomination
time deposits gave many consumers, busi­
nesses, and governmental units the op­
portunity to obtain higher interest yields
by leaving their money on deposit for
longer periods. W hile time deposits add to
banks' interest expenses, they do help to
ensure that these funds will not be sud­
denly withdrawn, should the return on
competing financial instruments rise. The
strongest inflow of time deposits came
from those deposits maturing in four years
or more. They were up nearly $700 million,
a 20-percent gain. The District's smaller
banks, where the competition from non­
bank thrift institutions is less, accounted
for most of the advance.
The expansion of long maturity time
deposits must have been a particular relief
to many banks, since they collectively
faced the prospects of about $700 million
in "wild-card" deposits maturing during
the July-October period. These "wild-card"
deposits were originally issued with fouryear maturities in the summer and early
fall of 1973, when they carried no man­
dated interest ceiling rates. By 1977, the
interest on a number of these "wild-card"
deposits exceeded the Federal Reserve
Regulation Q interest ceiling rates and/or
the current rate that many banks were
willing to pay. Aside from a special situa­
tion in Louisiana, District banks were able
not only to maintain their longer maturity
time deposit levels but also to add to them
throughout the rollover period.
As is typical when loan demand is rising,
the larger District banks began increasingly




CH A RT 4
DEPOSITS STRENGTHEN

b il .

$

S a v in g s

N et D em and

2.0

—

— 1.5

1.0

—

— 0.5

BIL. $

L a rg e Tim e*

S m a ll Tim e*

’74

’75

’76

’77

‘ ISSU ED IN DENOMINATIONS
OF UNDER $100,000.

’74

’75

’76

’77

‘ ISSU ED IN DENOMINATIONS
OF $100,000 AND OVER.

to acquire funds through managed deposit
liabilities. By selling negotiable CDs and
other large denomination time deposits,
they raised about $500 million in "money
market" funds. The majority of these funds
were obtained in the last quarter of the
year when lending was quite strong. W hile
banks expanded their managed liabilities

(after letting them decline by nearly $1.5
billion over the two previous years) to the
year-end level of $4.5 billion, the volume
was nearly $1 billion below the peak
reached in early 1975. And, in recognition
of the more interest-sensitive nature of
negotiable CDs, banks significantly in­
creased their average maturity. Over the
last year, all of the $270-million net in­
crease in outstanding CDs was in
maturities of over 90 days.
The Outlook for the Coming Year. Many
of the conditions that had made for an
improving and favorable banking climate
had begun to change by late 1977. And
while these developments do not neces­
sarily mean that 1978 will be an adverse
year for banking, it may not be as easy a
year as 1977. Banks have already begun to
experience a deceleration of inflows to
household and business savings and short
maturity time deposits because of rising
yields on competing financial instruments.
Slower growth in these types of deposits




may force banks to rely more heavily on
expensive longer maturity consumer time
deposits and on money market deposits.
Banks may also trim their most liquid
holdings of government securities and
depend more upon such managed
liabilities as Fed funds.
Not only might banks find deposit
growth becoming harder to achieve, but
overall loan demand might well be strong
during the year. Heavy use of bank credit
by business customers, along with con­
tinued strong credit demands from house­
holds, might result in new loan volume
exceeding last year's. Banks may also find
that the spread between their net interest
return and their net cost of funds will
narrow during 1978, but the higher volume
of loans should allow them to report
earnings gains for the year. This year will
most likely be a year of good, solid growth
for banks, but bankers will have to work
harder to achieve that growth than they
did in the calmer environment of 1977. I

A PRIMER ON
NONRESIDENTIAL CONSTRUCTION
b y B. F r a n k K i n g

Over the years, construction analysts have
concentrated on home building, while
general information on nonresidential
construction has remained obscure. This
article is an attempt to remove some of
the obscurity by providing rather simple
answers to some broad questions about
nonresidential construction.
How important is nonresidential con­
struction? Despite the impressions given by
analysts' emphasis on housing, the nonresi­
dential sector accounts for a majority of
construction spending. In 1976, nonresi­
dential projects accounted for almost
three-fifths of the value of new construc­
tion put in place in the United States. The
major types of construction contributing to
this spending were streets and highways,
schools, water and sewer systems, public
utilities, and private nonresidential
buildings, such as offices, warehouses, and
stores.
In the economy as a whole, nonresi­
dential construction is also relatively
important. The $86 billion spent on non­
residential construction in 1976 was equal
to about 5 percent of the Gross National




Product. This was only slightly less than
expenditures for motor vehicles and parts
and slightly above spending on petroleum
and coal products. Employment accounted
for by nonresidential construction is more
difficult to measure because employment
data lump some employment in the
residential sector with that in the nonresi­
dential sector. However, the number of
people at work on nonresidential con­
struction in late 1977 was probably
between 2.5 and 3.0 million, about as
many as worked for the Federal Govern­
ment in civilian jobs.
Does the output of nonresidential
construction vary as widely during the
business cycle as activity in residential
building and durable goods production?
Spending for nonresidential construction
would seem likely to behave in much the
same way as spending for residential
buildings and for durable goods. Because
most nonresidential projects are marginal
additions to a large capital stock, they
may be postponed when investors recog­
nize that conditions are unfavorable.
Conversely, they may be built more

^

CH A R T 1

CHART 2

^

N O N R E S ID E N T IA L C O N S TR U C TIO N ACCOUNTS
FOR A MAJORIT Y OF C ON S TR U C TIO N ACTIVITY

N O N R E S ID E N T IA L C O N S T R U C T IO N SHOW S
LESS CYCLICAL CHA N GE TH A N R E S ID E N T IA L
B U IL D IN G OR D U R A BL E GOODS O U T P U T *
%

□

ECONOMIC R E C E S S IO N S

a

ECONOMIC E X PA N S IO N S

Chg.,

A n n . R t.

15

DURABLES
RESIDENTIAL

10
5

NONRESIDENTIAL

r f1

+
0

10
15
‘ Covering August 1957-September 1977 Period

TOTAL CONSTRUCTION EXPENDITURES, 1976

quickly than the need for them is growing
when conditions are considered more ad­
vantageous. Thus, taking a simple view,
one would expect real nonresidential
spending to be falling off more sharply
than total spending during an economic
downturn and rising more rapidly during
an expansion, just as residential building
and durable goods output do.
These expectations about timing are
borne out in business cycles since 1957.
Spending for nonresidential construction
has varied with the business cycle, but its
changes have been considerably less than
changes in either residential construction
spending or durable goods output. In real
terms, its fall in recessions was less than
half that of residential building and only
about one-fifth that of durable goods
output. In expansions, its gains were less
than one-eighth as much as either resi­
dential or durables expenditures.
In pursuing reasons for the smaller
variation in nonresidential spending, two




lines of speculation appear fruitful. For
both public and private spenders, time lags
between the start and the end of nonresi­
dential projects are generally long (cer­
tainly longer than for most residential
projects or durables production).
Recessions have been short. Sponsors of
nonresidential projects have shown a
strong affinity for completed projects;
thus, nonresidential projects started near
the end of expansions continue to induce
spending in recessions. In the next ex­
pansion, there is little need to catch up.
Further, about two-fifths of the spending
in this category of construction is paid for
by the public sector. Public construction
spending has had little cyclical variation.
Apparently, both national and subnational
governments react slowly or not at all to
tax problems caused by recession. Until
the last recession, state and local govern­
ments' credit market access seemed
assured. They also seemed to be successful
in many cases in raising taxes to complete
planned projects. Thus, governments were
able to continue to finance construction
projects.
W hat major trends have occurred in
nonresidential construction spending in
recent years? The late 1960s are a relevant

Real s p e n d in g w as up in only one year
sin ce 1968.

- l^

O ~

[__ i

t

U

Ann. %

Chg.

-

+5

L I.

-

0

-

S p e n d in g in the p u b lic secto r w as weak,

— 0

]_ |l__I (0) U

------ 5

--10
as h igh w ays and sch o o ls had large d e clin e s.

H ig h w a y s

S c h o o ls

I

I

n

(0)

-D N m U

-

ED

u

+5

0
------ 5

------10
------ 15

Private se cto r s p e n d in g has recovered only s lu g g is h ly
from the recen t re cessio n .

m

i__ i

,

i— i
1

i
i




NONRESIDENTIAL CONSTRUCTION

i

'C o n s t ru c t io n of p riv a te schools, a m in or exp en d itu re sector, has fa lle n even
m ore a b ru p tly than p u b lic sch o o l co n s tru c tio n d u rin g this p eriod

CH A RT 3

o

starting point because several longer term
developments which still have major in­
fluences became apparent then. Since
1968, real spending on nonresidentiai con­
struction has fallen. It moved up during
only one year— in the early 1970s — but
then plunged more steeply than before.
This rather long period of decline is mainly
accounted for by a steady contraction in
public outlays.
Most types of public construction have
been rather flat in real terms since 1968.
Spending for water and sewer systems has
risen steadily, but spending in the two
categories that accounted for a majority of
public construction in the late 1960s —
streets and highways and educational
facilities — has moved steadily downward.
In 1968, such expenditures made up almost
three-fifths of public construction; in 1977,
about two-fifths. Nearly two decades of
building streets and highways to accommo­
date rising automobile and truck use and
of building schools to accommodate rising
school populations reached a climax in
1968. Highways began to catch up with the
use. Spending on the interstate system
began to slow as more and more was
finished. Crowded transportation corridors,
neighborhood resistance, and opposition
based on continued encroachment on
urban tax bases also curbed highway
building. More public funds began to shift
toward mass transportation. School
populations began to level off, then to
fall. These two declining sectors account
for the persistent drop in public con­
struction since the late 1960s.*
Private nonresidentiai construction has
behaved more cyclically than public since
the late 1960s but has only recently made
a weak move toward recovery from the
recession that ceased in the housing in­
dustry almost three years ago. No major
type had regained its 1973 real output
level by 1976, and none improved much in
1977. Commercial building and public
utilities construction, particularly that of
electric generating facilities, were hard hit
during the continuing recession in this
industry. Excesses resulting from the major
overbuilding of commercial buildings that

v-

1691

i ’7 1 »

i ’731

» 75 i

r

77

occurred from the late 1960s through at
least 1973 have not yet been completely
worked off. Electric utilities' spending has
been slowed by the recession, higher
electricity prices and the resulting decline
in peak-load growth, seemingly stricter
public service commissions (possibly
reacting to lower projections of peak-load
growth), nuclear uncertainties, and other
delays.
W hat does the past tell us about future
trends? The future growth of nonresidentiai
output is likely to be tied closely to de­
mand for schools, highways, offices and
stores, and energy. Demand for the first
two seems likely to continue to fall. The
school-age population will diminish for a

while longer at least. The back-to-school
movement by adults may limit the effect
of this decline on school construction but
is unlikely to overcome it. At the same
time, no large, new highway building initia­
tives are on the horizon. Further decreases
in spending may be partially offset by
increased needs to repair the interstate
system. Mass transit construction may
make up for some of the loss in highway
building.
Construction of private nonresidential
buildings seems more likely to pull out of
its slide in the near future. Permits and
contracts for these buildings have risen in
recent months as the economic expansion
has caused more idle space to be oc­
cupied. Public utility spending, particularly
in the energy field, is an enigma. Although
real spending picked up some in 1976,
recent moves toward further conservation
and higher prices of electric energy lead
one to question whether power plant
building may not have entered a long
period of decline similar to that of high­
way and school expenditures. On the other
hand, the dollar value of contracts for
electric generating plants awarded in 1977




was much greater than in 1976 and more
than twice the value of such contracts in
1975. Further, although not on line now,
substitute energy sources are certain to
require a great deal of construction over
the long haul.
This primer has approached four ques­
tions. The simple answers provided are
only a starting point for analysis of non­
residential construction.
How important is nonresidential con­
struction? Quite important as a source of
demand, employment, and capital.
How has spending in this sector moved
over the business cycle? Much less volatile
than spending for residential buildings or
durable goods.
W hat have expenditure trends been?
Overall, downward in real terms for the
past ten years, with particular weakness in
the public sector and long-delayed recov­
ery from the most recent recession in the
private sector.
W hat does the future hold? Continued
weakness in the public sector is likely.
There are signs of limited recovery in the
private sector. ■

FARMLAND
PRICE
MOVEMENTS
by G e n e D . S u lliv a n
Prices of farm real estate have soared
during the 1970s. Demand for rural land
has appeared to be nearly insatiable in
some areas of the country. In many cases,
prices of farmland tracts have reached
well above levels that returns from fore­
seeable agricultural production can justify.
Questions are rife in the current en­
vironment. Where are prices rising most
rapidly and why? How long can they
continue to go up? W hat happens if they
stop increasing or even decline? This
analysis cannot answer all these questions
decisively. But it focuses on information
about factors that will have heavy in­
fluence on farmland developments.
Where Farmland Prices Have Increased.
From 1971 to 1977, average prices per acre
of farm real estate nearly doubled for the
combined District states (see Table 1). The
gains were most rapid in Florida and
Georgia, where prices more than doubled.
Louisiana and Mississippi farmland showed
the lowest rates of increase; however,
Louisiana's land prices were the second
highest in the District at the outset of the
period, and that position was retained in
1977 (see Chart 1).
U. S. farmland prices rose even more
rapidly in the 1971-77 period, although the
average remained below the average price
for the District states (see Chart 2). The
faster rate of gain in the U. S. was largely
attributable to unusually strong increases
in the midwestern states. For example,
land prices tripled in Iowa. Although pre­
liminary data for November indicate that
the national rate of increase slowed in
1977, substantial gains continued in the
Midwest.
Returns from Agricultural Production
Often Fail to Justify Land Values. The
continued uptrend in farmland prices has




been puzzling to many observers in view
of the decline in the returns from agricul­
tural production in recent seasons. In the
southeastern states, for example, sales of

FARM REAL ESTATE PRICES
($ p e r acre )'

1971
1972
1973
1974
1975
1976
1977

Ala.

Fla.

Ga.

La.

Miss.

Tenn.

Average2
District
States

U.S.

227
238
270
337
370
410
437

378
404
466
613
692
732
783

256
292
333
432
486
488
524

350
382
406
474
518
545
590

238
242
271
344
386
388
411

277
303
349
421
477
507
556

284
306
346
436
487
509
548

202
218
245
303
343
390
456

'Prices as of March 1 for 1971-75; as of February 1,1976 and 1977.
2Weighted by 1974 Census estimates of land in farms in each state.
Source: USDA, Farm Real Estate Market Developments, M arch 1977

agricultural products at recent prices
frequently have not generated sufficient
returns above production outlays to repay
the interest cost of funds borrowed to
purchase land.
For soybeans, the largest single use of
cropland in the District, the estimated
costs of production, excluding land, were
$121 per acre in 1977.1 At an average yield
of 23.5 bushels per acre, the estimated
cost per bushel was $5.15. During the fall
of 1977, soybean prices averaged $5.38 per
bushel — only slightly above the estimated
cost per bushel. Growers who borrowed
money at 8.5 percent interest to purchase
land at the average 1977 price of $550 per
acre had little money from soybean returns
to apply to the $47 annual interest charge
per acre. Lenders would normally expect
some repayment of principal as well as
interest. The lack of returns for loan repay­
ments suggests that farmland prices have
reached levels that cannot be justified by
returns from agricultural production.
Whether or not he had a debt outstand­
ing, an owner should have earned at least
$47 from an acre of cropland to compen­
sate for the forgone opportunity to invest
$550 in an alternative that would have
paid 8.5 percent interest. The average
return from land employed in soybean
production in 1977 did not equal the

opportunity cost of invested funds. And
unless the support price is raised substan­
tially from its $3.50 level in 1977, the
intended expansion in plantings indicated
for 1978 is expected to exert continuing
downward pressure on prices. While
returns from other crops may be higher,
the land on which crops, such as cotton,
corn, and peanuts, are produced usually
commands prices well above the average.2
Appreciation in Land Values. The initial
major thrust for the rise in land prices was
the high farm profits associated with
worldwide shortages of food in the early
Seventies. More recently, the source of the
upward push has apparently been expecta­
tions of further increases in the value of
the asset itself. Investors are willing to
purchase a future stream of income at a
discounted present value. That is to say, if
one anticipates a given annual return from
an asset over a span of years, that income
stream has a determinable value in the
present. It is not the sum of the expected
dollar income in all future periods, be­
cause a dollar to be received one year
from now is worth less than a dollar of
current income. A dollar received currently
could be placed in an interest-earning
investment which would yield $1.06 at the

2lt is d iffic u lt to m a k e g en eral statem en ts a b o u t lan d v a lu e s on the basis of
a vera g es M o s t a g ric u ltu ra l statistics v a ry w id e ly a ro u n d th eir a ve ra g e v a lu e s
T h at is p a r tic u la rly tru e of p ro d u ctio n costs a n d y ie ld s or o u tp u t per a cre T h ose
farm ers w h o o b ta in abo ve-a verag e y ie ld s an d h a ve b elo w - averag e costs ca n , of
'S e e W

F W o o lf and B | V id rin e , D A E R e s e a rch R e p o rt 526, L o u isia n a

cou rse, ju s tify m u ch high er p rices fo r lan d th an c a n th eir less e ffic ie n t c o u n te r­

A g ric u ltu ra l E x p erim en t S ta tio n , Ja n u a r y 1978 Costs v arie d both a b o v e and

parts Thus, land p rices th at are u n re a s o n a b ly high fo r a ve ra g e or in e ffic ie n t pro­

b e lo w th e in d ica te d figure, d e p e n d in g up on th e ty p e o f farm and th e m eth o d of

du cers m a y be q u ite ju s tifia b le fo r a b o ve- a v erag e p ro d u cers It is th e la tte r w h o
are re p o rte d ly b idd in g m ost b risk ly fo r p ro d u c tiv e land

p ro d u ctio n




TABLE 2
GROWTH IN PRICES OF FARM REAL ESTATE
1971-77
Trend Rate1
of Growth
($ per acre)
Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee
District States
United States

38
75
48
41
33
49
48
43

Compound Annual2
Growth Rate(%)
12.8
14.4
13.5
9.4
11.1

13.0
12.6
15.1

' Derived from a straight line equation of type y = a + bx where y is the
estimated land value, x is the year number where 1971 = 0,1972 = 1,
etc.; a is the estimate of y when x = 0, and b is the estimated change
in y for each 1-unit change in x. See Appendix for each equation. ^
2Derived from an exponential equation of the type y = abx where y and
x are as defined above, a is the value of $ when x is 0, and b is the
percentage change in y for each 1-unit change in x. See Appendix for
each equation.

As the rate of appreciation in land
values became apparent during the past
seven years, the ranks of land purchasers
were undoubtedly enlarged by investors
whose bid prices were keyed to antici­
pated gains in asset value rather than the
actual return from agricultural production.
The record shows that such investors have
certainly not been disappointed since 1971.
It has been increasingly reported of late
that foreign investors are frequently
numbered among potential purchasers of
land.
W hat price for land is justifiable on the
basis of expected appreciation in value
alone? The technique of determining the
present value of a future stream of income
provides an answer.
Land prices in District states have been
increasing at an average rate of $48 per
year since 1971 (see Table 2). The present
value of a perpetual $48 annual income
stream, discounted at 8.5 percent interest,
is $565,3 only slightly above the average
price recorded for 1977. When average
annual taxes on farm real estate are con­
sidered, the present value of farmland is
approximately equal to the 1977 price. The
average price of $284 per acre in 1971
provided an outstanding bargain to pur­
chasers whose land value appreciated to
$548 per acre by February 1, 1977. An
asset offering a return of that magnitude
after six years would have had a dis­
counted present value of $336 in 1971.4 It
was not until 1973 that average land prices
3W h e n a n n u a l in co m e is c o n s ta n t a n d c o n tin u e s in p e rp e tu ity, th e p re se nt v a lu e
of fu tu re in co m e is d e rive d by using th e eq u atio n :

V =

I

—
i

w h e re V is p resent v a lu e , I is c o n s ta n t a n n u a l (n et) in co m e, and i is th e
d is c o u n t (c a p ita liz a tio n ) rate. Fo r th e a p p re c ia tio n in lan d v a lu e s in th e D is tric t
states (ig n o rin g taxes and o th e r o w n e rs h ip costs o f land), th e p re se nt v a lu e per
a cre is
$48
V = ---- = $565.
085

‘T h e present v a lu e of a g iven in c o m e in a fu tu re y e a r is g iven by

I

V = -------(1 + i)n -

w h e re V and i are as d e s crib e d in fo o tn o te 3, I is fu tu re in co m e , and n is th e

end of a year. Alternatively, one could
obtain $1 after one year by putting less
than $1 (about 94 cents) in an account
earning 6 percent annual interest.




n u m ber of yea rs b e fo re th e in c o m e w ill b e re c e iv e d

A ssu m in g lan d w a s sold

a t th e a v e ra g e p ric e per a c re in D is tr ic t states in 1977, its p re se nt v a lu e in 1971
w o u ld h a ve been

E FFEC TS OF LAND PRICE CHANGES ON FARM REAL ESTATE ASSETS
SIXTH DISTRICT STATES, 1971-77
Value of Farm Real Estate
Land in Farms*
1971
1977
mil. acres

billion $

Alabama
Florida
Georgia
Louisiana
Mississippi
Tennessee

12.0
13.2
14.0
9.1
14.4
13.3

2.7
5.0
3.6
3.2
3.4
3.7

5.2
10.4
7.3
5.4
5.9
7.4

Total Sixth District States

76.0

21.6

41.6

'Taken from 1974 Census of Agriculture and used with average prices to calcutate values in 1971 and 1977.

actually reached that level. By 1977,
however, investors had bid land prices
much closer to the level that was justified
by the experienced rate of annual appre­
ciation. Only in Florida and Georgia were
prices still substantially below that level.
Effects of Rising Land Prices. One of the
most immediate and direct effects of rising
land prices is their influence on the asset
positions of the balance sheets of farm
owners. As land prices rise, the estimated
value of total assets increases, almost in
direct proportion. The value of real estate
accounted for 74 percent of total U. S.
farm assets in 1977. Rising land prices
pushed up the estimated value of farm
real estate in the Sixth District states from
$21.6 billion in 1971 to over $41 billion in
1977 (see Table 3). Florida was the leading
state in both value and gain, although it
ranked fourth in farmland area.
The increase in asset values raised
proprietors' equities along with it and
enabled farmers to expand borrowings,
using the higher valued real estate as col­
lateral. Total farm mortgage debt (shown
in Chart 3) advanced about in pace with
farm real estate values during the period.
The rise in outstanding farm mortgages
from $3.4 billion in 1970 to $6.1 billion in
1976 represented a sharp increase in farm
loan volume by lenders in Sixth District
states as well as greater interest expenses
for land owners (who paid rates on new
loans averaging between 8 1/4 and 10
percent during the period). If it continues




to grow at its 1970-76 trend rate, farm
mortgage debt will climb nearly $500
million annually, as owners utilize their
rising equity in land to obtain the capital
needed for production.
W ill Appreciation Continue? W ill farm­
land prices continue to escalate? How
much higher can they go in the absence of
returns of agricultural production to sup­
port these values? If values stop increasing
from year to year, will prices then plunge
to the levels that production returns can
support? These are difficult questions that
are currently being asked by a broad
spectrum of people associated with farm
real estate markets.
Factors that could produce continued
rapid increases in value include:
1. an increase in inflationary expec­
tations that would cause investors to turn
to land as a hedge against loss of value in
financial assets. Competition among
potential land purchasers for available
tracts would essentially guarantee a
continued upward push on values.
2. a growing demand for farmland
located near urban areas for future ex­
pansions of residential areas, office parks,
and industrial parks. This has already been
an important influence on land prices,
particularly in the states of Florida,
Georgia, and Louisiana.
3. the possibility of higher production
returns. Should prices of farm products
again rise as rapidly as they did in 1973
(e.g., if world shortages of food crops

should recur), the increased returns from
agricultural production would swell the ex­
pected future income stream and produce
even greater appreciation.
On the other hand, a halt in the esca­
lation of land values, or even a substantial
reduction in the expected rate of ap­
preciation, could trigger deflation. In such
a case, investors would reduce bids to the
values that production returns would
justify.
Before the passage of the Agricultural
Act of 1977, prices of many agricultural
products had dropped sharply and ap­
peared to be headed for still lower levels.
That situation, compounded by droughtreduced crop yields in the Southeast, may

have slowed the rate of growth in District
land prices from 1977 to 1978. In 1975 and
1976, a severe reduction in cattle and calf
prices was no doubt responsible for the
slower rate of growth evident in farmland
prices within the District. Despite the long
period of adversity in cattle production,
however, prices of land only leveled; they
did not decline. Thus, it is not certain that
a downturn will accompany the recent
poor returns to crop production. However,
if the agricultural legislation that supports
prices and incomes of producers of major
crops were to expire or become less
supportive in the future, the threat of
farmland price deflation would be sub­
stantially greater. ■

-A P P E N D IX --------------------------------------------------------------------------------------Equations were fitted to annual average land prices from 1971 to 1977. V ariab les are
defined in footnotes to Tab le 2. The co e fficie n ts of determ ination (r2) sign ify the pro­
portion of variation in Y explained by changes in X.
Trend Equation

Exponential Equation
Alabama

Y = 211.929 + 38.357X (r2 = .978)

Y = (221.390) (1.128)X (r2 = .973)
Florida

y = 356.464 + 74.892X (r2 = .965)

Y = (347.050) (1.144)X (r2 = .954)
Georgia

Y = 257.036 + 48.179X (r2 = .950)

Y = (265.485) (1.135)X (r2 = .936)
Louisiana

Y = 342.357 + 41.357X (r2 = .988)
A

Y = (350.279) (1,094)X (r2 = .985)
Mississippi

A

.X (r2 = .924)
Y = (232.319) (1.111 )^

Y = 226.500 + 33.071 X (r2 = .933)
Tennessee

Y = 265.750 + 49.036X (r2 = .988)
A

Y = (277.394) (1.130)X (r2 = .981)
District States

Y = 273.236 Hr 47.764X (r2 = .971)

Y = (283.394) (1.126)X (r2 = .961]
United States

y = 179.143 + 43.000X (r2 = .973)




Y = (194.063) (1.151)X (r2 = ,99V