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AUGUST IN THIS 1965 ISSUE Some Perspective on Steel......................................... 3 Electric Power—An Indicator of Manufacturing Activity.................................... 12 FEDERAL RESERVE BANK OF CLEVELAND ECONOMIC REVIEW SU M M A R Y OF STEEL STATISTICS A verag e Annual Rate Iron and Steel as of Change Proportion of Total Industry 194 7-6 4 1947-54 1954-64 19 4 7 1954 1964 Industrial Production Index All Products on . . 4 .0 % 5.1% 3 .7 % Iron and Steel . . 0.7 1.7 0.6 7 .8 % 5 .0 % 5 .2 % 1.2 4.4 4.1 3.5 7.2 6.9 9.1 4.2 4.0 3.6 Imports (a) 5.2 All Merchandise . . Iron and Steel . 20.3 . , Exports (a) . 5.5 Iron and S t e e l ............................. — 0.7 All Exports Less M ilitary . Plant and Equipment Expenditures M a n u fa c tu r in g ............................. 4.3 5.9 3.5 Iron and S t e e l ............................. 4.4 8.8 4.3 0.6 1.7 0.2 0.5 — 1.5 Employment Manufacturing Iron and S t e e l .....................................................................— 0.7 A verage Hourly Earnings Manufacturing . . 4.3 5.7 3.5 Iron and Steel . . 5.4 6.7 4.2 All Industrial Prices 1.7 2.7 1.0 Steel Mill Products 4.5 6.7 2.5 4.1 1.3 4.7 1.6 1.3 — 1.4 M a n u fa c t u r in g .................................................... — 2.7 — 7 .7 — Iron and S t e e l .................................................... - 4 .3 — 7 .7 — 5.3 118 125 135 W holesale Price Index Corporate Profits After Taxes Manufacturing . Iron and Steel . . . . . . . 6.4 6.5 5.3 Corporate Profits as a Percent of Total Assets 1.2 Depreciation as a Percent (b) of Sales M a n u fa c tu rin g ................................... 3.1 3.0 2.1 Iron and S t e e l ................................... 4.1 11.7 1.8 (a) Early postwar import and export figures are not meaningful. (b) Depreciation series are for the years 1 9 4 9 -6 4 ; figures for earlier years are not available. Sources: Board of Governors of the Federal Reserve System; U.S. Department of Labor; U.S. Department of Commerce Note: The read er may be confused by the fact that some of the proportion figures on the table do not seem to be consistent with the growth figures. For exam ple, the proportion of iron and steel to the total industrial production index was higher in 1964 than in 1954 although the industrial production index grew at a greater rate than did the iron and steel component during that period. Such seeming inconsistencies are explained by the fact that the average annual rate of change is based on a number of years, whereas the proportion represents a single y e a r which may be above or below the growth line. The read er should also note that due to the method of calculating the average annual rate of change, using a “ least squares" approach, subperiods are not additive with respect to the period as a whole. For exam ple, in the case of profits after taxes for the iron and steel industry, the average annual rate of change for the 1947-64 period was greater than for either subperiod. AUGUST 1965 SOME PERSPECTIVE ON STEEL An article in an earlier issue of the R ev iew discussed the importance of the auto industry to the total economy.1 In that article, the main focus was on the contribution of autos during the past several years of high production and sales. In this article on steel, the perspective has been broadened and deepened to cover the full postwar period, specifically the years 1947 to 1964. The pattern of steel production, which is compared with that of total indus trial production in Chart 1, clearly indicates the need for long-term analysis. On balance, the iron and steel industry has been losing ground since World War II in its relative importance in the economy. The deterioration has not been steady, however; as the chart shows, strong and sometimes protracted bursts of expansion in output have been inter mingled with steep declines. Under such circumstances, when a few years can be too short for ordinary imbalances to wash out, a short-run view runs the risk of leading to erroneous and inequitable conclusions. A number of pertinent statistical measure ments comparing the steel industry with the 1 See "Some Perspective on Autos," Economic Review, Federal Reserve Bank of Cleveland, January 1965. total economy are summarized in an adjacent table.2 The data are consistent to a significant degree in their implication that steel is be coming relatively less important in most economic sectors and has not exhibited the vigor that has characterized other industry since 1947. 2 In the table and in the text, all series are considered over the full postwar period, or over as much of it as possible where data are incomplete. Two approaches have been taken. The first is the calcu lation of the iron and steel proportion of the total series for selected years, 1947, 1954, and 1964. The second approach is the comparison of average annual rates of change in iron and steel with those of all industry. The average annual rate of change is derived by using the compound interest formula based on logarithms of the data (log Y = log A + [log B] X). Average annual rates of change have been calculated for the 17-year period, 1947 to 1964, and also two interim periods, 1947 to 1954, and 1954 to 1964. The year 1954 was selected as the dividing point primarily because the years from 1954 to 1964 form a period free of major wars and comparatively free of the pent-up demands of consumers following World War II. The fact that 1954 was a recession year makes it less than an ideal year in which to break the series. This disadvantage is partly offset by the use of average annual rates of change, whereby the data for the first and final years of any given period influence the result the same as any in terim year; they do not, by virtue of their position as the beginning or end, determine either the rate of change or the direction of the trend. 3 ECONOMIC REVIEW 1. I NDUSTRI AL PRODUCTI ON and IRON & STEEL OUTPUT IN D E X 19 5 7 -5 9 = 1 0 0 1920 '2 5 '3 0 S o u rc e o f d ata: '3 5 '4 0 '4 5 '5 0 '5 5 '6 0 '6 5 B o a r d o f G o v e r n o r s o f the F e d e r a l R e se r v e S y s t e m The statistics in the table not only measure results but they open the door to an explora tion of the web of economic influences that have had a bearing on the course of the iron and steel industry. Starting with the indus trial production index, each statistical series is taken up in turn. Where appropriate, the interaction of the basic facts represented by the various economic measurements is dis cussed. INDUSTRIAL PRODUCTION INDEX So far as productive volume is concerned, iron and steel were only about two-thirds as important to total industrial production3 in 3 The industrial production index measures production activity in manufacturing, mining, and utilities. 4 1964 as in 1947. In 1964, the iron and steel component4 of the industrial production index accounted for 5.2 percent of the total index, down from 7.8 percent 17 years earlier in 1947, and up only slightly from 1954, a re cession year when steel production was more depressed than industry in general. The loss of relative position since 1947 and the limited recovery since 1954 are the more significant in view of the fact that steel production was at an all-time high in 1964. Turning to the figures on average annual growth rates, the following observations can be made: (1) steel production grew less than other industrial output in the entire 1947-64 period, (2) its rate of growth has slowed within the 17-year period, and (3) the slowdown in steel's growth rate is more pronounced than the corresponding postwar slowdown in all industry. The iron and steel index rose at an average annual rate of only 0.7 percent over the en tire 17-year period from 1947 to 1964 as compared with an average annual rate of growth of 4.0 percent for the total industrial production index. If iron and steel are re moved from the industrial production index, the average annual rate of change increases to 4.2 percent. Both the iron and steel series and the indus trial production index showed higher rates of gain in the earlier part of the postwar period (1947-54) than in recent years (1954-64). In both interim periods, however, as in the 17year span, the total industrial production index rose at a considerably higher rate than 4 The iron and steel series includes semifinished and finished steel mill products and ferrous castings and forgings. AUGUST 1965 did the iron and steel component. (As previ ously noted, the actual differences can be seen on the table.) IMPORTS AND EXPORTS5 Imports of iron and steel have been grow ing at four times the rate of total merchandise imports since 1954. Nationwide steel strikes in the U.S. and favorable prices of imported steel have been the principal reasons for the sharp increase of steel imports to the U.S. Growth of imports of steel mill products has come in sharp spurts. Although occasioned by temporary conditions, these spurts were followed by only moderate declines, leaving a substantial net rise. For example, in 1956 (a year that included a 36-day strike in the steel industry) imports of steel products jumped to $201 million, up from $127 million in 1955; volume then eased a little to $197 million in 1957. Again, in 1959 (a year that included a 116-day strike) steel imports climbed to $521 million, more than double the $211-million total of the preceding year. The following year, steel imports receded to $442 million but were still twice as high as in the year preceding the long strike. Currently, another spurt in imports of steel mill products is taking place in the U.S. as steel consumers hedge against the possibility of a steel strike later this year. In spite of a longshoremen's strike which closed the ports for part of the period, imports of steel mill products in the first quarter of 1965 were 33 percent higher than in the same period in 1964. 5 Comparison of the rates of change for both exports and imports has been limited to 1954-64. The 1947-54 period was marked by heavy exports from the U.S. and few imports to the U.S. as a result of World War II. Having once learned the ropes of buying foreign steel when domestic steel was not available, steel users in the U.S. have tended to continue buying steel mill products of for eign countries when they find no difference in quality and when there is a distinct price advantage. In the past, major steel imports have been wire and wire products as well as welded pipe and tubing. During the present inventory building, imports have also in cluded sheet steel in relatively large amounts. If buyers are sufficiently satisfied with both the price and quality of foreign sheet steel, they may continue to buy that item abroad after the present tight supply situation has eased. At the same time that steel imports have been growing vigorously, exports of steel mill products from the United States have been declining. Between 1954 and 1964, exports of iron and steel declined at an average annual rate of 0.7 percent; in contrast, total merchandise exports (less military materials) increased at an average annual rate of 5.5 percent. Moreover, the decline in exports of iron and steel would probably have been even greater in recent years except for increased tie-ins between U.S. foreign aid and foreign purchases of American goods. Both the increase in imports and the de cline in exports of American steel mill prod ucts since 1954 have reflected the expansion of the iron and steel industry in other coun tries, chiefly in Japan and the Common Market nations. During the 1950's, continued growth in capacity and advancement in tech nology of the steel industry in both Europe and Japan made it possible for those countries not only to fulfill domestic requirements for 5 ECONOMIC REVIEW steel but also to seek aggressively markets outside their own borders. Moreover, rela tively lower wages, newer and more efficient equipment, and more flexible export pricing policies have frequently enabled foreign mills to sell steel in the United States at lower prices than those quoted by U.S. steel com panies. In short, expansion of the iron and steel industry abroad has allowed the steel industries of foreign countries to supply their domestic needs, compete against U.S. steel exporters for other foreign markets, and take an increasingly larger share of the U.S. steel market. PLANT AND EQUIPMENT EXPENDITURES Spending for plant and equipment is one of the few areas in which the iron and steel industry has, in relative terms, exceeded manufacturing as a whole since 1947. The sharpest contrast occurred before 1954, when capital spending in the steel industry grew at an average annual rate of 8.8 percent com pared with a rate of 5.9 percent for all manu facturing. In 1954-64, the corresponding rates were 4.3 percent and 3.5 percent. Funds spent on plant and equipment by the iron and steel industry in 1964 amounted to 9.1 percent of the total amount spent for that purpose by all manufacturing, up from 7.2 percent in 1947. Adverse developments in imports and ex ports of iron and steel (as well as in profits) when compared with those of all manufactur ing seem to imply that the efficiency of the iron and steel industry has not kept pace with that of all manufacturing since World War II. It is, nonetheless, a fact that the steel 6 industry has spent proportionately as much, if not more, on new plant and equipment than have other industries. This seeming paradox has lead some observers to reason that at least part of the difficulty stems from the choice of plant and equipment purchased. When replacing worn-out equipment or in creasing its capacity in the early 1950's, the steel industry did not make full use of tech nological advances. Eventually, recognition of a problem situation prompted the steel industry to move toward improved technol ogy. Thus, "steel, for the first time in its his tory, really splurged on research, starting about eight years ago" (1955), and much of the recent spending "shows an embarrassing amount of it going to rectify an unavoidable mistake steel made during the 1950's, when the industry bought 40 million tons of the wrong kind of capacity—the open hearth furnace."6 In the early postwar period, there seemed to be some justification for the course followed by the steel industry in the United States. Steel and steel products were in heavy de mand in all industrial countries following World War II. With most of the responsibility for meeting this demand falling on the U.S. steel industry, it is not surprising that the industry concentrated on producing steel according to methods to which it was geared rather than on taking time to try out techno logical innovations. On the other hand, it was logical for Europe and Japan to incor porate the most modern methods and equip ment when almost completely rebuilding their steel industry. 6Business W eek, November 16, 1963, pp. 144-146. AUGUST 1965 Important technological advances in recent years have applied to all stages of steelmaking: raw material, converting the raw ma terial to steel, and finishing the steel. With respect to iron ore, a major raw material, the United States has made great strides in recent years and is well ahead of other countries in the production of taconite pellets, the most efficient of treated iron ores. A second technological advance applies to the conversion of pig iron into steel. American steel is still produced principally in open hearth furnaces while in Japan and Western Europe the oxygen converter is used for most of the steel produced. Many American steel mills are now turning to the basic oxygen process of making steel as they replace old equipment or expand their capacity, but the number of open hearth furnaces in use con tinues to exceed the number of oxygen con verters by a wide margin. Ingot production in the U.S. expanded by one-third between 1950 and I960, an achievement made possible only by an in crease in basic capacity. Though new, much of the added capacity was old-style as may be seen by comparing the 1950 and 1960 figures in the following breakdown of production by type of equipment, as reported by the Amer ican Iron and Steel Institute: 1950 1960 1964 1 0 0 .0 % 1 0 0 .0 % 1 0 0 .0 % 89.1 87.0 77 .2 Bessemer 4 .7 1.2 0 .6 Basic O xygen — 3.4 12.2 Electric 6.2 8.4 10.0 Total Ingot Production Open Hearth The belated shift to the basic oxygen pro cess is apparent when the 1960 and 1964 figures are compared. Another technological improvement, known as the continuous casting process, eliminates several steps between the steel furnace and the final processing of steel. The steel indus try in this country has begun to invest in the continuous casting process but it still lags behind Europe where the process has had widespread use for several years. Current heavy capital spending with its emphasis on reducing costs rather than in creasing capacity should be helpful to the steel industry in coming years in competing in both home and foreign markets. EMPLOYMENT AND PAYROLLS In 1964, employees in the iron and steel industry made up 3.6 percent of total employ ment in all manufacturing, down from 4.2 percent in 1947. Over the 17-year period from 1947 to 1964, employment declined in iron and steel while employment in total manufacturing showed an increase. The average annual rates of change work out to a decline of 0.7 percent for iron and steel and an increase of 0.6 percent for all manufactur ing. In both cases, the trend of employment has been influenced in part by the trend of production and in part by the rate of auto mation. For all manufacturing, continuous gains in the volume of production apparently more than offset losses of jobs through auto mation. In iron and steel, however, lesser growth in production during the postwar period has been insufficient to overcome the decline in employment resulting from auto mation. While average hourly earnings in the iron and steel industry increased at an average annual rate of 5:4 percent during 1947-64, 7 ECONOMIC REVIEW the corresponding increase for all manufac turing measured 4.3 percent. Moreover, the figures also show that in 1947 iron and steel wage rates were already 18 percent above those for all manufacturing. With the more rapid rate of increase that has characterized steel wage rates in the past 17 years, this margin widened to 35 percent by 1964. As shown in Chart 2, rates of increase were higher in the earlier years than in the later years, both for iron and steel and for all manu facturing. In I960, as a result of fewer hours of overtime, average hourly earnings in the iron and steel industry actually dipped al though other wage rates continued to rise. Since 1960 both sets of average hourly pay rates have grown at approximately the same pace. The similarity of the two series since 1960 may be illusory, however, since they do not reflect fringe benefits which have become increasingly important in recent years. Aver age hourly earnings are calculated on hours paid for rather than on hours worked, and to the extent that the iron and steel industry has more liberal policies on paid vacations and holidays than do most other manufacturers, average hourly earnings for iron and steel may be understated. PRICES The price index of steel mill products rose at an average annual rate of 4.5 percent during the 17 years between 1947 and 1964. The total industrial price index increased at the much slower rate of 1.7 percent during the same period and would of course show an even more moderate rate of increase if the steel component were removed. 8 It is apparent on Chart 2 that 1959 marked the beginning of stability in iron and steel prices as well as in the industrial price index. Although the price index of steel mill prod ucts held steady from 1959 through 1963 and increased slightly in 1964, some decline in the prices of steel actually occurred. The price index of steel mill products is based on published prices and does not re flect discounts of one kind or another result ing from sharp competition in the steel indus try in recent years. Revenue per ton actually reached a peak of $276 in 1959, and has been declining irregularly ever since. In 1964 revenue per ton was down to $259. The decline in revenue per ton of steel, despite the stability of the steel product price index, cannot be accounted for by a change in mix. According to steel analysts, shipments of the more expensive stainless and special steels have been increasing in proportion to total shipments, whereas the proportion of the less expensive semifinished steels has been declining. This situation would ordinarily be expected to produce a rise in revenue per ton. The fact that the opposite has occurred, and revenue per ton of steel has fallen, sug gests that actual prices have been below pub lished prices used in the steel index. CORPORATE PROFITS Any industry must generate profits in order to survive. Production may be sustained for a time at the break-even point; losses may even be temporarily absorbed by firms in a strong financial position. But either of these prac tices is successful only if profits eventually become large enough to compensate for the 2. PRODUCTION, COSTS, and P R O F I T S PRODUCTION IN DEXES IN D U ST R IA L IR O N & STEEL INDEX 1957-59=100 PRICES IN D U ST R IA L IR O N & STEEL INDEX 1957-59=100 ■ V 4m y 100 — 80 r" / < / AVERAGE HOURLY EARNINGS ALL M A N U F A C T U R IN G Dollars r '- 120 / IR O N & STEEL RATIO SCALE '4 7 4.00 '4 9 '51 '5 3 '5 5 '5 7 '5 9 '61 '6 3 40 '6 5 3.00 2.00 PROFITS AFTER TAXES as a % of TOTAL ASSETS wn RATIO SCALE U7 '4 9 '51 '5 3 '5 5 '5 7 '5 9 '61 '6 3 IR O N & STEEl '4 9 '51 53 '5 5 '5 7 12 10 1.00 ■ 6 RATIO SCALE '4 7 A IR O N « ST E E l|^— '6 5 DEPRECIATION as a % of SALES A l l M A N U F A C T U R IN G Percent A l t M A N U F A C T U R IN G Percent '5 9 '61 '6 3 '6 5 So u rces of d a ta : B o ard of G o v e rn o rs of the F e d e ra l R e serve System ; U .S . D e p a rtm e n t of C o m m erce; U .S . D ep artm en t of La b o r ECONOMIC REVIEW period with no profit (or losses). The trend of profits, therefore, is an important guide to the strength of an industry. The iron and steel industry exhibited some growth in profits during the 1947-64 period, but much less than was achieved by all manu facturing industries as a group. In dollar amount of corporate profits after taxes, the average annual rate of increase achieved by iron and steel firms was 1.6 percent for the 17-year period as compared with 4.1 percent for all manufacturing. Similarly, the trend of profits expressed as a percent of assets has been less favorable for iron and steel com panies than for all manufacturing firms. For both groups the ratio of profits to assets has declined but the rate of decline has been steeper for iron and steel than for all manu facturing. In both measurements of profits shown on the summary table, the average annual rate of change for iron and steel in the 1947-54 period matched the rate of change for all manufacturing, while divergent rates of change showed up in the 1954-64 period. However, the divergence did not actually set in until several years of the 1954-64 period had elapsed. As may be seen from Chart 2, the profit trend in iron and steel began to deviate from that of all manufacturing in 1959 and its altered course became more notice able in succeeding years. In seeking a reason for the change in the behavior of iron and steel profits since 1959, it is helpful to look back at some of the series that have a strong influence on profits, name ly, level of production, depreciation costs, prices, and wages. It is apparent from Chart 2 that in recent years all manufacturing has 10 had an advantage over iron and steel in several of the key factors affecting profits. Production in all manufacturing has reached a new high every year since 1958 whereas the increases in iron and steel during that period represent only a recovery of lost ground. Depreciation costs as a percent of sales have risen faster in the iron and steel industry than they have in all manufacturing. Proportionately greater investment in new plant and equipment in the iron and steel industry and changes in rules governing de preciation allowances have accounted for part of the greater increase in iron and steel depreciation costs. Relatively less growth in activity in the iron and steel industry has accounted for the remainder of the increase. Some indication of the relative role of depreci ation costs in the steel industry is provided in the following figures. Y e ar Steel Ingot Depreciation Production Costs Depreciation Cost (mill, of tons) (mill, of dollars) (per ton) 1949 78 1950 97 380 3.92 1951 105 445 4.2 3 1952 93 519 5 .5 7 1953 112 699 6.26 1954 88 773 8.75 1955 117 832 7.11 $ 329 $ 4.2 2 1956 115 844 7.3 3 1957 113 875 7.7 6 1958 85 806 9.4 5 1959 93 799 8.55 1960 99 825 8.31 1961 98 863 8.80 1962 98 1,069 10.87 1963 109 1,144 10 .4 7 1964 127 1,224 9.6 4 (Steel ingot production fig ures are those published by American Iron and Steel Institute; depreciation costs are from the Federal Trade Commission and the Securities and Exchange Commission.) AUGUST 1965 Not apparent on Chart 2, but adverselyaffecting the growth of profits in the iron and steel industry, is the fact that while the price index for steel mill products has held steady in recent years, revenue realized per ton of steel has dropped since 1958. Also, as point ed out in an earlier section of this article, increases since 1960 in wage costs for the iron and steel industry have probably ex ceeded those for all manufacturing even though average hourly rates for both have grown at the same pace. SUMMARY It is not necessarily surprising when an industry, particularly one as old as iron and steel, accounts for a smaller proportion of total manufacturing activity over a period of years. New products (e.g., plastics, television, detergents) are constantly being introduced that either substitute for old ones or are a net addition to total production. Usually the greater growth rates occur in the newer products. An older industry need not neces sarily decline in relative importance, how ever, if new uses are found for its products and if, at the same time, it retains its old markets. The steel industry has apparently lost out on both hands and, in consequence, has assumed a decreasingly important role in the economy since 1947. Not only have there been indications of a lack of innovation in finding new uses for steel, but the substitu tions of materials such as aluminum, concrete, plastics, and glass have made inroads into markets for steel products. The rapid rise in steel prices from 1947 to 1958 undoubtedly was an important factor in the poor showing of steel in the import and export sectors of the economy. How large a part prices played with respect to substitu tions for steel is not easily judged, but cer tainly some substitutions for steel resulted from the sharp increase in prices. During the earlier postwar years, both prices and costs rose faster in steel than in all manufacturing. With the leveling off of prices and the continuing rise in costs since 1959, profits at first declined. Gains in production in 1963 and 1964 were enough to reverse the downward plunge of profits and bring about a recovery of some of the ground lost since 1957. During the 1947-64 period, four reces sions, four strikes, and numerous possibilities of strikes perpetuated the feast and famine pattern of demand for steel that has always characterized the industry. If a semblance of stability in production could be achieved, the showing of the steel industry would improve. During periods of inventory building by steel consumers, old and inefficient steelmaking equipment is brought back into use. Later, while these high-cost steel stocks are being liquidated, the newer and more efficient equipment sits idle. The possibility of the iron and steel industry improving its relative position in the economy appears to rest on success in holding costs and prices so as to meet competition, and success in finding new applications for steel where it can demonstrate a unique advantage. 1 1 ECONOMIC REVIEW ELECTRIC PO W ER-AN INDICATOR OF MANUFACTURING ACTIVITY (Fourth District) Demands for regional economic data from both public and private sources have virtually exploded in recent years, as evidenced by the growth of published (and unpublished) ma terials on regional business and financial con ditions. Each of the twelve Federal Reserve banks, for example, is an important user and supplier of regional data.1 Regional data collected, processed, and published by this bank include those relating to banking and other financial activity, de partment store sales and, most recently, sur veys of plans for capital spending in the Cleveland area, among others. But hereto fore, this bank has published no current measure of overall manufacturing activity in the Fourth District. Moreover, there has been a sparsity of published information, apart from labor force data, on the cyclical behavior of individual Fourth District industries, as well as on cyclical patterns of major metropolitan areas. 1 See Mann, Maurice, "Local Statistical Data, Needs and Adequacy: From the Viewpoint of a Regional Federal Reserve Bank,” in P roceedings of the Business and Economic Statistics Section, A m erican Statistical Association, 1 9 6 4 , pp. 144-149. 12 This article introduces a newly developed series for manufacturing activity in the Fourth District—namely, the use of electric power as a proxy for activity rates in manufacturing in dustries.2 Some comparisons between manu facturing activity in the District and in the nation also are included in the discussion. Before examining the data, however, it may be helpful to consider the relevance of re gional analysis and the reason for emphasis on the District's manufacturing sector. SIGN IFICAN CE OF REGIO N A L ECONOM ICS The graphic representation of a regional economy by economic time series is a pre requisite for understanding the processes of economic growth and cyclical change. Be cause of varying degrees of similarity and interdependence among regional economies 2 A previous article in the Economic Review , "Electric Power as a Regional Economic Indicator," September 1964, dealt with measures of manufacturing activity in the Cleveland area. A forthcoming article will review manufacturing developments in Cleveland and intro duce weighted electric power indexes for the manu facturing sectors of other major metropolitan areas in the Fourth District. AUGUST 196 5 and the national economy as a whole, there are marked differences in regional business fluctuations and growth trends, as compared with both the nation and other regions. Re gional economic indicators, therefore, are use ful in helping to evaluate how subnational economies react to changes in national economic activity. If selected time series can be classified as leading, coincident, or lagging indicators—with respect to either regional or national business conditions — economic understanding and business forecasting can be improved. The foregoing obviously has implications for both public and private policy. Regional analysis helps to identify problem areas or industries, thereby assisting in the evaluation and formulation of policy measures. The various Federal Reserve banks, of course, have a responsibility for keeping posted on regional economic conditions and relating those conditions, in terms of both current standings and changes, to national develop ments—all with a view towards monetary policy considerations. Federal, state, and local governments also have an interest in regional economic analysis for fiscal and planning purposes. Business firms and private planning boards are also interested in regional econom ic data for meeting an assortment of needs. M ANUFACTURING— AN IMPORTANT SECTOR The manufacturing sector plays an im portant role in determining the pace and direction of economic activity, both in the nation as a whole and in many individual re gions. While only about one-third of the Gross National Product emanates directly from the manufacturing sector, effects of manufactur ing activity are pervasive to the extent of influencing significantly employment and in come in other sectors of the economy. In fact, the Federal Reserve Board's monthly index of industrial production, which is weighted 86.5 percent by manufacturing (the remainder being mining and utilities), largely defines the general business cycle and is one of the most carefully watched national economic indicators. In the Fourth Federal Reserve District, which embraces a sizable chunk of the na tion's heavy industrial complex, manufactur ing occupies a pivotal role in major portions of the area's economy. One indication of the relatively larger role of manufacturing in the Fourth District than in the U.S. is that, in 1960, the manufacturing sector accounted for 35.5 percent of total employment in the Fourth District but only 27.1 percent of that in the nation. Current measures of regional manufactur ing activity, either in dollars or in physical terms, are difficult to derive. That is partic ularly the case for the highly diversified manufacturing activity in the Fourth District. In lieu of a "better" indicator, the production inputs of electric power—when properly ad justed for seasonal variations and for inter industry differences in use relative to output —can be used as a proxy for short-run changes in output or activity rates. The elec tric power indexes in this article were de signed for that purpose.3 3 See Appendix for a description of the sources and tech niques of constructing the indexes. 13 ECONOMIC REVIEW CHARACTERISTICS OF ELECTRIC POW ER AS AN ECONOM IC INDICATOR While sole reliance on electric power as an indicator of manufacturing activity may not be appropriate for every industry, the data generally are superior to alternative labor information. The monthly flow of elec tric power, which embraces a major part of the production process in many industries, is reported for virtually the entire Fourth Dis trict.4 By contrast, employment and man-hour data, which are available for only selected portions of the District, are reported for one week in the middle of the month. Moreover, the reported labor inputs include paid sick leave, paid vacations, and paid holidays. One reason for using electric power as an indicator of regional manufacturing activity is that such data conform more closely to the amplitudes of business cy cle fluctuations than do labor force data. Generally, the productiv ity of labor changes considerably more than the productivity of electric power over the business cycle. Adjustments for short-run fluctuations, and for long-run trends, in labor productivity are particularly difficult at the regional level. On the other hand, electric power requirements per unit of output do not vary appreciably during the short run. Sea sonal variations in the overhead uses of elec tric power, such as lighting, heating, and air conditioning, can be minimized by adjust ments on the electronic computer. The major portion of electric energy is used for operating the instruments of production; changes in power input thus presumably re flect short-run adjustments in output. Of 4 Because many utilities practice "cycle billing," the power data do not cover a precise calendar month. 14 course, the changes may not be in equal pro portion in every industry. In those industries that have been shifting to relatively more mechanized processes of production, electric power may have a long-run upward bias with respect to output. Where the electrifica tion of industry per unit of output has been fairly stable for some time, electric power may have a long-run downward bias if there have been significant quality improvements in the products. Fortunately, these opposing biases tend to be offsetting in the composite indexes for total manufacturing, durable manufactur ing, and nondurable manufacturing. Whether any long-run bias, on balance, remains in the District indexes cannot be determined. There fore, a strict comparison of District indexes with the national Federal Reserve indexes is not necessarily valid. Despite this, however, the national production indexes shown in the following charts serve as a convenient frame of reference for examining cyclical fluctua tions in the Fourth District's manufacturing sector. TOTAL M ANUFACTURING— U.S. AND FOURTH DISTRICT Chart 1 shows annual averages of U.S. and Fourth District manufacturing activity during the 1957-64 period. The level of and year -toyear changes in the District electric power index with respect to the F.R.B. index of manu facturing are consistent with the relationships shown in the indexes of production worker man-hours.5 5 Production worker man-hours for the Fourth District are represented by the total for Ohio and the Pittsburgh metropolitan area (approximately 90 percent of the en tire District's manufacturing activity). The man-hour data are not weighted by the relative importances of major industry groups, and are not adjusted for in creases in labor productivity. AUGUST 1965 l. MANUFACTURING ACTIVITY - An n u ally U n ite d States an d Fo urth D istrict IN D EX 19 57-59 = 10 0 Two important points emerge from an in spection of Chart 1. First, the recessions of 1957-58 and 1960-61 affected District manu facturing more adversely than total U.S. manufacturing. Second, since the 1957-59 base period the manufacturing sector has grown relatively less in the District than in the U.S., although the gap apparently has narrowed somewhat since early 1963. Short-run fluctuations in manufacturing ac tivity, as illustrated in Chart 2, are more pro nounced in the District than in the nation as a whole. The reason is that durable goods industries account for the major portion of cyclical swings in total manufacturing, while nondurable goods industries demonstrate a higher degree of stability over the short run. As shown in Table I, the weight of durables in total manufacturing is considerably larger in the Fourth District (73.4 percent) than in the U.S. (55.6 percent). The District's durable goods and nondurable goods industries, re spectively, are listed in order of relative im portance during the 1957-59 period. Note that the top five durable goods industries, both in the U.S. and in the District, belong to the metalworking group. But the primary metals industry has almost three times the weight in District manufacturing as it has in U.S. manufacturing. That fact is important in assessing this region's manufacturing activity because primary metals output encounters more volatile fluctuations than do other sectors. To gain additional perspective on District manufacturing, the index points contributed by the primary metals industry have been de leted from the index for all manufacturing. The remaining index points, plotted in Chart 2, thus represent productive activity in all manufacturing exclusive of primary metals. It is evident that the deletion of primary metals from all manufacturing ..leaves a smoother series for the District — one that conforms more closely with the national F.R.B. index. During the 116-day steel strike, which began in July 1959, manufacturing activity ex pri mary metals declined considerably less than all manufacturing (in both the nation and the District). Shortages of steel materials caused production curtailments in other metalwork ing industries. (Those cutbacks are detailed in the charts for individual industry groups that appear later in this article.) 15 ECONOMIC REVIEW TA BLE I 1957-59 Proportions of V alu e Added by M anufacturing 4th District U.S. Manufacturing t o t a l .............................................................................................................................................................................................1 0 0 .0 0 % 1 0 0 .0 0 % D u r a b le .........................................................................................................................................................................................................................7 3 .3 8 55.61 N o n d u r a b le ..............................................................................................................................................................................................................2 6 .6 2 4 4 .3 9 S .I.C .* Durable Manufactures 33 Primary m e t a ls ...................................................................................................................................................................... 2 2 .0 8 8.04 35 Nonelectrical m a c h in e r y ............................................................................................................................................... 1 1 .7 7 9.7 5 37 Transportation equipm ent............................................................................................................................................... 10.99 11.79 36 Electrical m a c h in e ry .......................................................................................................................................................... 9.3 8 7 .3 7 34 Fabricated metal p r o d u c t s ......................................................................................................................................... 9.0 2 6.21 32 C lay , glass, and stone p r o d u c t s .............................................................................................................................. 6 .0 7 3.4 6 39 Miscellaneous m an ufactu res......................................................................................................................................... 1.29 1.75 25 Furniture and f i x t u r e s ..................................................................................................................................................... 1.19 1.78 38 Instruments and related p ro d u cts.............................................................................................................................. .8 4 1.98 24 Lumber and wood p ro d u c ts......................................................................................................................................... .5 7 2 .0 0 19 O rd n a n c e ................................................................................................................................................................................. .1 8 1.48 Nondurable Manufactures 20 Manufactured foods and b e v e r a g e s .................................................................................................................. 7 .1 5 11.86 28 Chemicals and p r o d u c t s ............................................................................................................................................... 5 .4 0 8.7 7 30 Rubber and plastics p r o d u c t s ................................................................................................................................... 4 .6 9 2.3 0 27 Printing and publishing.................................................................................................................................................... 3.82 5.4 8 26 Paper and p ro d u c ts.......................................................................................................................................................... 2.4 3 3.9 7 29 Petroleum p r o d u c t s .......................................................................................................................................................... 1.06 2.28 23 A pp arel p ro d u c ts................................................................................................................................................................ 1.04 4 .1 5 22 Textile mill p ro d u c ts.......................................................................................................................................................... .4 7 3.35 31 21 Leather and p r o d u c t s ..................................................................................................................................................... Tobacco p ro d u c ts................................................................................................................................................................ .4 4 .1 2 1.28 .9 5 ^Standard Industrial Classification, U.S. Bureau of the Budget. Source: Table II lists some magnitudes of change in the primary metals industry during recent years, and reveals the impact of those changes on total manufacturing. Between the first quarter of 1960 and the first quarter of 1961, sharp cutbacks in primary metals output con tributed significantly to the overall declines in U.S. and District manufacturing activity. Although the F.R.B. index of manufacturing peaked in January 1960, followed by a peak in the District's index one month later, the nation's manufacturing output ex primary metals did not begin a sustained decline until 16 See Appendix July of that year.6 In contrast, the District's manufacturing output ex primary metals be gan to decline in March 1960. Inclusive or exclusive of primary metals, however, manu facturing activity declined nearly twice as much in the District as in the nation during the 1960 recession. Between the first quarter of 1961, and the first quarter of 1962, the strong recovery in 6 Based on an examination of many economic time series, the National Bureau of Economic Research has desig nated May 1960 as the peak month of that phase of the business cycle. AUGUST 1965 TA BLE II Changes in Output O ver Selected Periods* Period Covered All Manufacturing U.S. 7 .7 % 4th D. Primary Metals U.S. 4th D. All Manufacturing ex Primary Metals U.S. 4th D. I Q '6 0 — I Q '61 — — 1 4 .3 % — 3 4 .4 % — 3 1 .5 % — 5.1% I Q '61 — I Q '62 + 1 3 .1 + 1 5 .8 + 4 2 .2 + 3 6 .9 +11. 1 + 1 0 .7 I Q ' 62 — III Q ' 62 +2.7 — 3. 2 — 14.9 — 15.3 +4.2 +0.4 I Q ’6 3 — I Q ' 65 + 1 6 .2 + 2 0 .3 + 3 1 .4 + 3 2 .6 + 1 5 .0 + 1 7 .2 — 8.7% *U.S. output changes computed from F.R.B. production indexes. Fourth District output changes computed from electric power indexes. Source: See Appendix U.S. and Fourth District manufacturing ac tivity was reinforced by significant gains in primary metals output. The latter was partly attributable to the stockpiling of steel inven tories as a hedge against a possible strike in that industry. Following the steel labor settle ment early in 1962, output of primary metals declined once again as excessive steel inven tories were liquidated. The reduction in steel operations between the first and third quarters of 1962 retarded the moderate advance in the nation's manufacturing output, but caused a setback in the District's manufacturing ac tivity. As seen in Chart 2, the District index for all manufacturing ex primary metals was on a virtual plateau during the first half of 1962. A period of renewed expansion in manu facturing began in the first quarter of 1963, but was interrupted by another phase of steel inventory liquidation in the latter half of the year. Since the first quarter of 1963, gains in the District's manufacturing activity (in cluding and excluding primary metals) have been slightly larger than those in the nation as a whole. In recent months, however, the expansion in manufacturing has slowed some what as steel production began to level off and motor vehicle production began to sim mer down after the recoupment of strikeimposed losses during the fall of 1964. DURABLE AND NONDURABLE MANUFACTURES Chart 3 presents the contrast between the cyclically sensitive durable goods industries and the more stable nondurable goods in dustries. Although the general contours of the national and District indexes for durable manufactures resemble the patterns for all manufacturing, short-term fluctuations in out put for the durables sector are larger than changes for all manufacturing. The District's heavy orientation towards durable manufactures means that production, employment, and income in manufacturing are easily exposed to swings in business ex penditures for producers' equipment and to the uncertainties of consumer outlays for dur able goods. Conversely, the stabilizing in fluence of nondurable manufactures is rela tively less important to District manufacturing. Unlike durable manufacturing, the weight of the largest industry within the District's nondurables sector is not disproportionate to that industry's weight in the nation's nondur ables sector. Moreover, the two largest non durable goods industries, manufactured foods 17 ECONOMIC REVIEW TA BLE III District. Accordingly, the close conformity of 1957-59 Shares of V alu e Added District's index of nondurable manufactures to the F.R.B. index of nondurable manuFourth District factures is not surprising. by N ondurable M anufacturing Industry U.S. F o o d s ............................................................... 2 6 .7 % C h em icals......................................................... 19.8 Foods and c h e m ic a ls ............................. 4 6 .5 Source: See Appendix and chemicals, account for approximately the same shares of value added by nondurable manufacturing in both the U.S. and in the 2. 18 2 6 .9 % 20 .3 47 .2 M AJOR INDUSTRIES IN THE FOURTH DISTRICT pace ancj direction of activity in the District's major durable and nondurable goods industries can be represented by fluctuations in the consumption of electric power. The AUGUST 1965 3. COMPONENTS of MANUFACTURING ACTIVITY U n i t e d S t a t e s a n d F o u r t h D is t ri c t D u ra b le G oods IN D EX 1 9 5 7 -5 9 = 1 0 0 150 14 0 13 0 ANNUAL AV R AG F .R.B .INDEX of DURABI E M/ NUFACTURES, U.S 120 110 10 0 l l Ev 11111 ruVVCK mlsEA 01 DHRARI F M A N U F A C T U R E m 90 80 70 RATI 0 SCAL E SEAS ONAll Y ADJl STEO __ '57 58 ’59 ’60 ’ 61 N o n d u ra b le IN D EX 1 9 5 7 -5 9 = 1 0 0 ’62 ’63 '6 4 '65 66 Goods 15 0 AN MUAL AV R A G E 14 0 F R.B.INDEX of NONDURABLE 130 MANUFACTU RES, U.S. 120 .- 110 .Lrf > 100 v 90 // NO WHIID A R I 1 M AIIIIC AfTHDC S , 4D 80 70 RAT 0 SCAl E ’57 '58 SEA! ONALL Y ADJl STED 59 ’60 ’61 ’6 2 '6 3 ’64 ’65 ’66 Source of d a ta : see a p p e n d i x leading industry, primary metals, is sub divided into ferrous metals and nonferrous metals because of different characteristics of production. Ferrous metals production, which typically accounts for over four-fifths of the District's primary metals output, is clearly the most volatile portion of the industry. The sharp swings in the index for ferrous metals are attributable to the peculiarities of the basic iron and steel industry—namely, actual and anticipated steel strikes and alternating periods of artificially high and low output. The latter have been prompted by inventory stock piling in anticipation of strikes and by sub sequent inventory liquidations after labor settlements. The irregular use of power in electric arc furnaces also causes some erratic changes in the indexes. It should be em phasized that the foregoing factors have tend ed to distort the true seasonal patterns for ferrous metals during the 1958-65 period. Operations in the District's second major industry, nonelectrical machinery, are pri marily dependent upon business outlays for new equipment. From a relatively high level in 1957, activity in the nonelectrical ma chinery industry dropped sharply in 1958. As was the case for the nation's nonelectrical machinery industry, recovery in the District's counterpart began in the third quarter of 1958 and proceeded upward until mid-1959, when production began to ease during the steel strike. The 1960 recession in nonelec trical machinery activity began earlier and ended earlier in the District than in the nation. Although new. orders for nonelectrical ma chinery (nationwide) began to rise late in 1960, the F.R.B. index for nonelectrical ma chinery did not begin to recover until April 1961. By contrast, the District's recovery ap pears to have been under way about one quarter earlier. After a year of sidewise move ment in 1962, a sustained upswing began early in 1963 as previous business uncertain ties faded and the investment climate im proved. The production of transportation equipment in the District includes not only motor vehicles and parts, but also aircraft and parts. As evidenced by the decline in electric power use from the 1957 level, activity in the in dustry was reduced sharply during the 195758 recession. The recovery that began in the third quarter of 1958 was interrupted by the 19 4. 57 ’ 58 ’ 59 S o u r c e of d a t a : s e e a p p e n d i x '6 0 ’ 61 ’62 '6 3 ’ 64 '6 5 ’66 ’57 ’ 58 S o u r c e of d a t a : s e e a p p e n d i x '5 9 ’60 ’ 61 62 ’63 ’64 '6 5 '6 6 ECONOMIC REVIEW steel strike of 1959. After output was re couped in the early months of I960, produc tion receded to a more sustainable pace for several months. The ensuing decline in the District index for transportation equipment, beginning in November 1960 and ending in March 1961, coincided with the decline in the F.R.B. index for transportation equipment. Since early 1961, activity in the industry gen erally has followed an upward trend, although there have been occasional periods of labormanagement disputes causing production cut-backs. Particularly evident is the autumn 1964 strike in the auto industry and the re bound in production during the months that followed. Recent activity started to taper off in the second quarter 1965, probably reflect ing largely the pace of automobile production. Of the District's five largest durable goods industries, electrical machinery appears to be the least sensitive to short-run changes in business conditions. Compared with the per formances of other metalworking industries in the District, output of electrical machinery apparently declined only moderately during each of the past two recessions. The upward course of expansion, which began in the third quarter 1961, was marked by hesitation dur ing the first three quarters of 1962. But, be ginning in October 1962, the expansion in electrical machinery activity was revived and has been maintained to date. The pace of activity in the District's fab ricated metal products industry encountered 22 significant changes, as measured by the shifts in electric power inputs during the past two recessions and during the 1959 steel strike. In 1962, the index moved erratically down ward. Beginning in early 1963, the industry recuperated from the generally unfavorable experience of the previous year and has followed a relatively steady upward course to date. The District's most important nondurable goods industry, manufactured foods and bev erages, is also the most stable industry over the business cycle, and is virtually recessionfree. The moderate upward trend of electric power use in this industry, however, is below the average for all manufacturing or for non durable manufactures. On the other hand, growth of electric power utilization in the chemicals, paper, and printing industries is well above average. These industries also face a comparatively stable demand for their products, although the 1957-58 recession appears to have affect ed chemicals' activity more adversely than the other industries. Rubber and plastics is one of the District's nondurable goods industries that is sensitive to changes in demand, partly because tire output depends largely upon the fortunes of the motor vehicle industry. Accordingly, since mid-1961, the rubber and plastics industry has enjoyed a vigorous upward phase of activity. AUGUST 1965 APPENDIX The electric power data used to develop the series in this article were furnished by the following investor-owned utilities: Ohio Cincinnati Gas & Electric Company Cleveland Electric Illuminating Company Columbus and Southern Ohio Electric Company Dayton Power and Light Company Marietta Electric Company Ohio Edison Company Ohio Power Company Toledo Edison Company Western Pennsylvania Duquesne Light Company Pennsylvania Electric Company Pennsylvania Power Company West Penn Power Company Eastern Kentucky Kentucky Power Company Kentucky Utilities Company Union Light, Heat, & Power Company West Virginia (Panhandle region) Monongahela Power Company Wheeling Electric Company The cooperation of those utilities, and of the reporting firms that generate portions of their electric power requirements, is grate fully acknowledged by the Federal Reserve Bank of Cleveland. The electric power data for each of the 21 major industries (listed in Table I) were con verted to 1957-59 index bases and seasonally adjusted by Census method X-9. The indexes for individual industries were aggregated in to broader groupings with each industry weighted for importance according to its rela tive share of value added by manufacture, as shown in Table I. Value-added data for each Fourth District industry, derived from the 1 9 5 8 C ensu s o f M an u factu res, were ad justed to 1957-59 proportions by dividing value added in 1958 by the 1958 annual average of the electric power index for the corresponding industry. This procedure as sumes that the changes in value added be tween 1957 and 1958 and between 1958 and 1959 were proportionate to the change in electric power consumption over those periods. The production indexes for U.S. manu facturing are computed by the Board of Gov ernors of the Federal Reserve System. The production worker man-hour data used in Chart 1 were compiled from A n n u al Surveys o f M an u factu res and the C ensu s o f M an u factu res for 1958 and 1963. The 1964 man-hour data, which were linked to the 1963 indexes, are from the Bureau of Labor Statistics, the Ohio Bureau of Unemployment Compensation, and the Pennsylvania Bureau of Employment Security. 23 Fourth Federal Reserve District
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