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The Regional Economist A Quarterly Review of Business and Economic Conditions Vol. 17, No. 4 October 2009 The Federal Reserve Bank of St. Louis C e n t r a l t o A m e r i c a’ s Ec o n o m y TM The “Man-Cession” of 2008-09 It’s Big, but It’s Not Great c o n t e n t s 4 The Regional 3 Economist october 2009 | VOL. 17, NO. 4 10 The Regional Economist is published quarterly by the Research and Public Affairs departments of the Federal Reserve Bank of St. Louis. It addresses the national, international and regional economic issues of the day, particularly as they apply to states in the Eighth Federal Reserve District. Views expressed are not necessarily those of the St. Louis Fed or of the Federal Reserve System. Please direct your comments to Subhayu Bandyopadhyay at 314444-7425 or by e-mail at subhayu. bandyopadhyay@stls.frb.org. You can also write to him at the address below. Submission of a letter to the editor gives us the right to post it to our web site and/or publish it in The Regional Economist unless the writer states otherwise. We reserve the right to edit letters for clarity and length. The “Man-Cession” of 2008-2009 By Howard J. Wall That men are losing jobs at a much faster rate than women during this recession isn’t a surprise. The pattern is typical. And it’s not just the men in the hard hats who are out of a job—men in almost all categories of work are being affected disproportionately. President’s Message 19 More Freedom, Less Terrorism By Craig P. Aubuchon, Subhayu Bandyopadhyay and Javed Younas The root causes of terrorism might not be poverty and lack of education, as many believe. Rather, the lack of civil liberties, political rights and the rule of law might be more 16 influential. Deputy Director of Research Cletus C. Coughlin By Thomas A. Garrett The simplest way to avoid another devastating housing crash and foreclosure crisis probably is to reduce household borrowing and, then, to keep it low. 21 c o mm u n i t y p r o f i l e Alton, Ill. 12 Cap and Trade: Economics and Politics By Kevin L. Kliesen A Fed economist reviews In Fed We Trust: Ben Bernanke’s War on the Great Panic, the new book by David Wessel, a columnist for The Wall Street Journal. Art Director Joni Williams The Eighth Federal Reserve District includes all of Arkansas, eastern Missouri, southern Illinois and Indiana, western Kentucky and Tennessee, and northern Mississippi. The Eighth District offices are in Little Rock, Louisville, Memphis and St. Louis. B o o k REv i e w In Fed We Trust Managing Editor Al Stamborski Single-copy subscriptions are free. To subscribe, e-mail carol.a.musser @stls.frb.org or sign up via www. stlouisfed.org/publications. You can also write to The Regional Economist, Public Affairs Office, Federal Reserve Bank of St. Louis, Box 442, St. Louis, MO 63166. D i s t r i c t Ov e r v i e w Tax Collections Decline By William Emmons Senior Policy Adviser Robert H. Rasche Editor Subhayu Bandyopadhyay Housing’s Great Fall: Avoiding a Repeat In general, the recession is taking its toll on the collection of sales tax, personal income tax and corporate income tax in the seven states of the Eighth Federal Reserve District. Director of Research Christopher J. Waller Director of Public Affairs Robert J. Schenk 14 By Cletus C. Coughlin and Lesli S. Ott The anti-pollution program in Congress contains desirable economic features. But a key component—an auction process covering all permits for carbon emissions—does not seem to be politically viable. By Susan C. Thomson 22 e c o n o my at a g l a n c e 23 re ader e xchange This city on the Mississippi River north of St. Louis has accepted that its industrial heyday is over. Civic leaders hope that their ambitious efforts to redevelop the riverfront will bring back some of the glory. cover illustration by greg hargreaves/ w w w.munrocampagna.com 2 The Regional Economist | October 2009 p r e s i d e n t ’ s m e s s a g e James Bullard, President and CEO Federal Reserve Bank of St. Louis Is the Rate of Homeownership Nearing a Bottom? T he housing crisis has been central to our current recession. An economist at the Federal Reserve Bank of St. Louis, Carlos Garriga, has devoted much of his research to understanding the intricacies of mortgage markets and loan choices. What insight might his research bring to the current environment? To begin, he has examined the evolution of homeownership rates and their connection with mortgage market innovations. For about a quarter of a century, the homeownership rate hovered around 64 percent. In 1966, it was at 63.5 percent. Twenty-seven years later, in 1993, it had barely budged to 63.8 percent. However, over the past 15 years, a significant change occurred, largely the result of government policy and innovations in mortgage markets. Politicians pushed to increase the homeownership rate on the premise that homeowners are more likely to maintain their property than a renter would. And, of course, almost every version of the American dream includes a house with a white picket fence. In the early 1990s, the Federal Housing Administration (FHA) started to offer mortgage products with low down payments. Prior to this, most mortgage lenders required a 20 percent down payment on all new loans. The rationale for the down payment was to ensure that the home had enough equity to ward off foreclosure if home prices were to fall substantially. To qualify for a low down payment, homeowners had to buy lenders mortgage insurance or private mortgage insurance. In the late 1990s, conventional lending became more sophisticated. To avoid mortgage insurance, lenders offered a second loan (at a higher interest rate) for a portion of the remaining loan amount. The advantage of the combo, or piggyback, loan was that borrowers could increase their leverage at a lower cost since mortgage interest payments could be deducted on their income tax, whereas mortgage insurance premiums were not deductible until 2007. The homeownership rate increased from 63.8 percent in early 1994 to 68 percent in 2002. Over the following three years, the rate increased to 69.2 percent, in the heart of the housing boom. Over this period, subprime lending took off and additional mortgage products were introduced and became popular. These included zero down-payment loans, interest-only adjustable-rate mortgages (ARMs) and payment-option ARMs. The last loan type allowed borrowers flexible monthly repayment strategies, including full amortization of principal with either zero or even negative amortization. “ A natural question is to wonder whether the severity of the price decline will force additional homeowners out.” The bottom soon fell out. Since the end of 2006, nationwide home prices have fallen by as much as 30 percent. The homeownership rate has been steadily declining, too, since then. Through the second quarter of 2009, it was down 1.5 percentage points, to 67.4 percent. This decline reflects a rebalancing: Just as we saw the homeownership rate increase by a little over one percentage point as new mortgage products were introduced, we now see those buyers exiting the market as that equity disappears. Assuming they could just “refinance later,” they found themselves unable to make payments as prices tanked. Additionally, as Carlos recently discussed in the St. Louis Fed’s National Economic Trends publication, refinancing denials started to increase well before the peak of the housing boom, suggesting that lenders were uncomfortable with the values being assessed to homes.1 These borrowers obtained financing through risky tools. If all borrowers who could obtain financing through standard financing options (i.e., not zero downpayment loans, interest-only loans, etc.) had already entered the homeownership arena, they would have already been captured within the 2002 rate of 68 percent. The homeownership rate is now down below the 2002 level; it has remained at roughly 67.5 percent for three quarters (Q4 2008 through Q2 2009). Although further data are needed, this suggests the decline might now have bottomed out, provided the economic environment doesn’t pull down otherwise well-positioned homeowners. A natural question is to wonder whether the severity of the price decline will force additional homeowners out. During the 27 years that the homeownership rate hovered around 64 percent, there were many price fluctuations and yet no change in the ownership rate. The difference is that virtually no homebuyer was highly leveraged; almost all buyers had already paid at least 20 percent of the purchase price of their home. Hence, even as prices fell, homeowners were able to “ride out” the storm. Examining homeownership rates is one small but interesting piece of the puzzle. Government policy helped buoy the homeownership rate to historic highs, and risky lending practices pushed it even higher. Time will tell where the new equilibrium rate will settle, but signs point to a near end in the decline. 1 Garriga, Carlos. “Lending Standards in Mortgage Markets.” National Economic Trends, May 2009, p. 1. See http://research.stlouisfed.org/publications/net/20090501 /cover.pdf. The Regional Economist | www.stlouisfed.org 3 r e c e s s i o n 4 The Regional Economist | October 2009 The of 2008-09 It’s Big, but It’s Not Great By Howard J. Wall keith negley/ w w w.munrocampagna.com B etween the fourth quarter of 2007, when the current recession began, and the first quarter of 2009, men bore 78 percent of the job losses. Over the same period, the unemployment rate for men rose from 4.9 percent to 8.9 percent, while the rate for women rose by only half as much, from 4.7 percent to 7.2 percent. As reported by economist Mark Perry of the University of Michigan-Flint in his blog Carpe Diem, this gap in unemployment rates has no precedent during the post-war period. In light of the disproportionate employment effects of the recession on men, some commentators in the press and elsewhere have labeled the current recession a “man-cession” or even the “Great Man-Cession.” The Regional Economist | www.stlouisfed.org 5 © HO/Reuters/Corbis The 2009 recession has hit the construction industry especially hard. By August, employment in the construction industry had fallen by 19 percent during the recession. In the picture above, workers pave a portion of Route 101 in Exeter, N.H. 6 The Regional Economist | October 2009 The dominant explanation for this phenomenon is that it follows from the severity of the recession across industries. According to Christina Hoff Sommers of the American Enterprise Institute, “Men are bearing the brunt of the current economic crisis because they predominate in manufacturing and construction, the hardest-hit sectors.” Women, on the other hand, “are a majority in recession-resistant fields such as education and health care.” Harvard economist Greg Mankiw echoes this in his blog, conjecturing “that a large part of the explanation is the sectoral mix of this particular downturn in economic activity, including a significant slump in residential construction.” The “Great” Man-Cession or Just a Normal One? Despite the sudden interest in the phenomenon, the relative effects of the recession on men and women are not the least bit unusual. At least since the 1969 recession, men have borne the brunt of job losses during recessions, and, compared with previous recessions, men have actually borne a smaller proportion of job losses in the current recession. Between 1969 and 1991, male employment fell by an average of 3.1 percent during the five recessions experienced during the period. Female employment, on the other hand, actually tended to rise by an average of 0.3 percent during recessions.1 Women have a much larger presence in the work force now than between 1969 and 1991; so, a more-relevant comparison is to the 2001 recession. For that recession, employment peaked in the first quarter of 2001 and bottomed out in the third quarter of 2003, with a total loss of a little more than 2.6 million jobs. Men accounted for 78 percent of those job losses, just as they have during the current recession. So, in terms of job losses, the current recession has hit men in roughly the same proportion as did the previous recession, but by a much smaller proportion than during earlier recessions. Still, according to unemployment rates, the gap between men and women is higher than it has ever been. It is a bit of a mystery as to why the gap in unemployment rates shows much more of a man-cession than is indicated by jobs numbers, but unemployment rates indicate much more than simply changes in employment status. The rates reflect not only the net number of people who lose their jobs, but also the net number of people who are in the labor force either already employed or looking for a job. During this recession, the male labor force has been shrinking as the number of unemployed men has been rising. The female labor force, in contrast, is actually larger than it was when the recession began, accounting for much of the increase in the gap between the male and female unemployment rates. In sum, the proper perspective on the current recession is that its effect on the employment of men relative to women is very similar to the effects of the 2001 recession and much milder compared with earlier downturns. Although this perspective debunks the notion of this recession being an especially bad one for men relative to women, the fact remains that recessions hit male employment much harder than female employment. Total employment has fallen by 3.1 percent between the fourth quarter of 2007 and the first quarter of 2009, while male and female employment fell by 4.8 percent and 1.4 percent, respectively. Put another way, men lost jobs at 3.4 times the rate at which women did. Despite what has been presumed, however, for the current recession, this is not necessarily due to the different mixes of industries in which men and women tend to be employed. The Role of Industry Mix It’s easy to see the reasons for supposing that the disproportionate job losses for men are due to the disparate impacts of the recession on the goods-producing sector, in which 77 percent of employees in the fourth quarter of 2007 were men. The two hardesthit industries have been construction and manufacturing, which lost 12.7 percent and 9 percent of their jobs, respectively, between the fourth quarter of 2007 and the first quarter of 2009. These two industries also happened to have had two of the three highest shares of male employment. At the other end of the spectrum, two of the three industries that saw positive job growth over the period—the government sector as well as the education and health services sector—are among the three with the lowest shares of male employees. As illustrated by figure 1 Job Losses and the Male Share of Employment MALE SHARE OF INDUSTRY EMPLOYMENT, Q4.2007 % CHANGE IN EMPLOYMENT, Q4.2007 TO Q1.2009 Figure 1, there is a strong negative relationship between the share of male employment and the rate of job growth. A notable exception to this tendency is the relatively small natural resources and mining sector, which has seen strong job growth in the wake of high energy prices. The problem with explaining the mancession only in terms of industry mix is that it’s not really possible to separate the industry-mix effects from other effects. The evidence that something else is going on is that men have been hit disproportionately in almost every industry; that is, within an industry, men have tended to lose jobs at a higher rate than have women. In the service sector, in which men accounted initially for only 46 percent of employment, men lost jobs at 4.2 times the rate that women did (3.1 percent versus 0.7 percent), resulting in the same 78/22 split for the economy as a whole. If the 78/22 split of total job losses were due to male-majority industries being hit hardest, we wouldn’t see the same split in the goods-producing and serviceproducing sectors. Looking deeper into the industry-level numbers, we can see more evidence that the man-cession is more than an industry-mix story. The man-cession in the service sector is laid out in more detail in the table. In the trade, transportation and utilities industry, men began the period holding 59 percent of the jobs. In percentage terms, their job losses were 1.4 times that of women, meaning that they accounted for 67 percent of the industry’s total losses. Similarly, in professional and business services, leisure and hospitality, and “other” services, men lost jobs at 1.3, 1.2, and 5.8 times the rate that women did and, consequently, accounted for a disproportionate share of job losses. In the two industries that gained jobs, women began the period accounting for large majorities of employment and gained disproportionate numbers of new jobs. The education and health industry, which began the period with 77 percent women employees, experienced job growth of 3.3 percent, 80 percent of which went to women. Women accounted for 57 percent of employees in government, which saw a 1 percent increase in employment, all of which was for women. There were two industries that bucked the trend and saw job losses that fell 6 4 2 0 0 –2 –4 –6 –8 –10 –12 –14 Natural Resources and Mining Education and Health Services Government 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 Manufacturing Construction SOURCE: Bureau of Labor Statistics Table 1 The Man-Cession in the Service Sector Share of Industry Employment Q4.2007 Share of Industry Change Trade, Trans. and Utilities % Change Q4.2007 to Q1.2009 Men Relative to Women –4.1 Men 0.59 0.67 –4.7 Women 0.41 0.33 –3.3 Men 0.58 0.49 –3.2 Women 0.42 0.51 –4.4 Information 1.41 –3.7 Financial 0.72 –4.2 Men 0.41 0.39 –4.0 Women 0.59 0.61 –4.4 Professional and Business 0.91 –5.6 Men 0.55 0.62 –6.3 Women 0.45 0.38 –4.7 Men 0.23 0.20 2.9 Women 0.77 0.80 3.4 Men 0.48 0.53 –2.4 Women 0.53 0.47 –2.0 Men 0.48 0.84 –1.9 Women 0.52 0.16 –0.3 Education and Health 1.34 3.3 Leisure and Hospitality 0.84 –2.2 Other 1.23 –1.1 Government 5.82 1.0 Men 0.43 –0.01 –0.03 Women 0.57 1.01 1.7 –0.02 Source: Bureau of Labor Statistics The Regional Economist | www.stlouisfed.org 7 figure 2 % CHANGE IN EMPLOYMENT, Q4.2007 TO Q1.2009 The Man-Cession Across Demographic Groups 4 2 0 –2 –4 –6 –8 –10 –12 –14 –16 8.9 2.4 3.5 4.5 2.7 1.1 5.5 4.1 1.6 24.1 0.9 Men Married Single Women White Black Other Ages 16-19 Ages 20-24 Ages 25-34 Ages 35-44 Ages 45-54 SOURCE: Bureau of Labor Statistics NOTE: The number above or below the bars is the ratio of the change in men's employment to the change in women's employment. Ages 55+ thing else is going on is that disproportionately on women. Whereas men comprised 58 percent of initial employment in the information service industry, they accounted for only 49 percent of the job losses. This industry is relatively small, however, making up only about 2 percent of total employment. In the financial services industry, the job losses fell almost proportionally, with women seeing 61 percent of the job losses while starting the recession with 59 percent of the jobs. men have been hit dispro- The Demographics of the Man-Cession “The evidence that some- portionately in almost every industry; that is, within an industry, men have tended to lose jobs at a higher rate than have women.” 8 The Regional Economist | October 2009 Because men tended to have been affected disproportionately across all industries, whether goods-producing or service-producing, the story behind the man-cession cannot be about industry mix alone. Clearly, then, the man-cession phenomenon is not a story about the goods-producing industries but reflects something much broader about the economy and how firms respond to downturns by deciding which workers they will let go and which they will hire. As we have seen, employment losses are not felt the same by men and women within the same industry, and, in fact, recessions have widely varying effects across demographic groups. Perhaps the male/ female differences within these categories can shed some light on the man-cession phenomenon. Up to this point, all of the data have come from payroll employment series produced by the Bureau of Labor Statistics (BLS) and which are derived from a monthly survey of 150,000 or so employers around the country. These data, however, are not broken down by demographic categories other than sex; so, a different data source is needed. Fortunately, the bureau also surveys households on a monthly basis and categorizes the responses by demographic categories. The employment measures from the payroll and household surveys are not the same in that they cover different types of employment. For example, payroll employment does not include farm employment or self-employment. Although the two employment measures do not coincide perfectly, they do capture the same broad patterns in male/ female employment. In fact, by fortunate coincidence, the household survey indicates the same 78/22 split in the male/female employment losses that arise from the payroll employment data and each of its two major components, the goods-producing and service-producing sectors. Figure 2 illustrates the differences across demographic groups and between men and women within each group. For every demographic group except for those aged 55 and above, fewer were employed in the first quarter of 2009 than in the fourth quarter of 2007, and men fared worse than women within every group. There were, however, significant differences in the impact of the recession across the groups and on men relative to women. Note that the demographic groups overlap a great deal; so, the explanations for the differences across them also often overlap. Further, across groups, employment changes over the period reflect not only the effects of the recession but also ongoing trends in the tendency to participate in the labor market.2 Married men and women saw smaller job losses than did their single counterparts. Moreover, the effect of the recession on the employment of married men was almost nine times that on married women, whereas the effect for single men was 2.4 times that for single women. In part, the fact that married women are the least likely subgroup to see employment losses can be explained by what has been called the “added-worker effect.” 3 According to this effect, some married women enter the labor force during recessions following their husbands’ job losses. The added-worker effect can account for some of the increase in the female labor force during the recession. figure 3 ENDNOTES The Man-Cession By Education Level 1 2 % CHANGE IN EMPLOYMENT Q4.2007 TO Q1.2009 Another explanation for the difference between married and single people is that married people are more likely to have children and are, therefore, more likely to take a new job at lower pay after they lose their old job. Also, much of the differences according to marital status are reflections of other demographic differences that make them more likely to be affected by a recession: Compared with married people, single people tend to be younger and, therefore, have less work experience and lower education levels. The differences across racial categories are intertwined with differences in other categories. Black men, who have less education on average than black women or whites, saw the largest decrease in employment. Black women, on the other hand, have seen the smallest reduction in employment of any of the six sex-race categories. Underlying these differences is the long-term trend of women, especially black women, becoming more likely to be employed. Figure 2 also illustrates the changes in employment across age groups, for which there are significant differences across groups and between sexes within each group. Teenagers, for example, have seen the biggest decrease in employment during the recession, but there was little difference between the percentage decreases for male and female teenagers. In contrast, for the next lowest age group, those aged 20 to 24 years, men saw about a 9 percent decrease in employment, which was 5.5 times the decrease for women. Very large differences between men and women were also seen for ages 25-34 and 45-54. Partly reflecting the ongoing trend of increasing employment, the number of employed people aged 55 and above rose by more than 3 percent during the period. This increase might also be due to the effects of delayed retirements in the wake of dramatic decreases in savings and investments for retirement. The final demographic category is educational attainment, for which there were dramatic differences in male and female employment changes during the recession. For every category, men fared worse than women (Figure 3). Much of these differences reflect the industry-mix effects: Men without a high school diploma, for example, would make up a significant proportion of 2 0 –2 3 –4 –6 See Goodman, Antczak and Freeman. A recent paper by DiCecio et al. reviews the trends in labor force participation, separating out the changes due to trends from the changes due to economic conditions. See, for example, Stephens. DeRiviere has estimated the size of a related effect called the “pin-money” hypothesis. –8 REFERENCES –10 –12 –14 No High School Diploma High School Diploma Some College Men Women Associate Degree Bachelor’s Degree or Higher men in the construction and manufacturing industries, whereas women with associate and bachelor’s degrees would make up a large portion of the education and health industries. Nevertheless, given the differences in education levels between the sexes within other demographic categories, such as race and age, education level is probably an important part of the man-cession story. DeRiviere, Linda. “Have We Come a Long Way? Using the Survey of Labour and Income Dynamics to Revisit the ‘Pin Money’ Theory.” Journal of Socio-Economics, Vol. 37, No. 6, December 2008, pp. 2340-67. DiCecio, Riccardo; Engemann, Kristie M.; Owyang, Michael T.; and Wheeler, Christopher H. “Changing Trends in the Labor Force: A Survey.” Federal Reserve Bank of St. Louis Review, Vol. 90, No. 1, January/February 2008, pp. 47-62. Goodman, William; Antczak, Stephen; and Freeman, Laura. “Women and Jobs in Recessions: 1969-92.” Monthly Labor Review, Vol. 116, No. 7, July 1993, pp. 26-35. Hoff Sommers, Christina. “No Country for Burly Men.” The Weekly Standard, Vol. 14, Issue 39, June 29-July 6, 2009, pp. 22-24. Stephens Jr., Melvin. “Worker Displacement and the Added Worker Effect.” Journal of Labor Economics, Vol. 20, No. 3, July 2002, pp. 504-37. So, What’s It All About? The first thing to take away from this blizzard of data is that the so-called Great Man-cession of 2008-09 is nothing unusual when compared with the previous recession. Even so, a greater than three-to-one employment impact on men relative to women is still large relative to the nearly equal representation of the sexes in the work force. This certainly has something to do with the differences in the industries for which men and women are in the majority, as there is a strong tendency for industries with large shares of men to have been hit hardest by the downturn. These differences, however, are only part of the story, which must be completed by examining the sometimes large differences in the educational and demographic characteristics of men and women. The differences in employment changes between men and women within these groups are usually larger than those across industries. Report Goes In-Depth On Recessions Read more about economist Howard Wall’s research into recent U.S. recessions. His report, The Effects of Recessions across Demographic Groups, looks at employment of U.S. workers for this recession and others going back to 1972. Wall presents a range of demographic categories—sex, marital status, race, age and education. To read the report, go to www. stlouisfed.org/publications/ RecessionDemographics/. Howard J. Wall is an economist at the Federal Reserve Bank of St. Louis. For more on his work, see http://research.stlouisfed.org/econ/wall. The Regional Economist | www.stlouisfed.org 9 t e r r o r i s m Increasing Political Freedom May Be Key To Reducing Threats By Craig P. Aubuchon, Subhayu Bandyopadhyay and Javed Younas © Robin Bartholick /Corbis E ach year, the U.S. State Department publishes Country Reports on Terrorism, which highlights current strategies, outcomes and casualties from U.S. counterterrorism efforts. The 2008 report highlights the growing trend in terrorist attacks abroad, including the September attack against the U.S. Embassy in Yemen that killed 18 people. The continued incidence of terrorism prompts us to consider its root causes. It is popular to single out poverty or lack of education as major factors.1 Recent economic literature, however, points more toward civil liberties, political rights and the rule of law as far greater factors. Measuring Terrorism: What Counts and How Much? Measuring the incidence and type of terrorism is controversial. First, it is important to distinguish between domestic and transnational terrorism. The latter is generally considered any event that involves citizens or territories of more than one country, while the former is a local act carried out by citizens of the target country. (The attack in New York City on 9/11 is a prominent example of transnational terrorism, where foreign citizens carried out the attack. The bombing by Timothy McVeigh in Oklahoma City in April 1995 is an example of domestic terrorism.) It is also important to consider whether the number of incidents or the magnitude of events is more important. This is brought out very clearly in the accompanying graphs reproduced from the work of economists Graham Bird, S. Brock Blomberg and Gregory Hess.2 While Figure 1 shows a drop-off in the number of terrorist incidents, Figure 2 shows a rise in the number of deaths per incident over time. This 10 The Regional Economist | October 2009 demonstrates that terrorists are using more lethal methods and weapons. Poverty and Terrorism A study by economists Alan Krueger and Jitka Maleckova considers the influence of poverty and education on terrorism. Surprisingly, they find no evidence that reducing poverty or improving education would “meaningfully reduce international terrorism.” 3 The authors reached their conclusion based on evidence from three sources: Hezbollah militant activities in the Gaza/West Bank region from 1998 to 2000, individual profiles from members of Israeli Jewish extremists in the late 1970s and from a cross-country analysis using data from the U.S. State Department. Interestingly, the authors found that within the context of the West Bank/Palestinian conflict, individuals who engaged in terrorism were better educated and economically more affluent than the average citizen. This apparently paradoxical result may be better understood when one realizes that individuals’ incomes may correlate with their abilities. To succeed in terrorist attacks in a heavily guarded environment (like Israel), one needs a relatively high degree of skill and ability. Therefore, it is natural for leaders of the terrorist groups to choose more-able volunteers so that a planned attack is more likely to be successful. Another study, by Krueger and economist David Laitin, analyzes the characteristics of nations from which terrorism originates and of target nations.4 They considered incidents of terrorism where the target and source nations of terrorism were distinct. They found that source nations of terrorism were more likely to suffer from a lack of civil liberties and that economic conditions (as captured by GDP per capita) in these nations had no statistically significant relationship with terrorism.5 On the other hand, they find that nations with high GDP per capita were more likely to be targets of terrorism. A 2006 paper by Harvard economist Alberto Abadie also found that the risk of terrorism was not significantly higher for poorer nations once one accounted for other country-specific characteristics such as the level of political freedom.6 The study by Bird and his co-authors comes to a different conclusion. They found that net exporters of terrorism were poorer nations, while terrorist targets (effectively, the importers of terrorism) were rich. Based on this observation, they suggest that economic factors, among others, do have a role in explaining both the origin and the location of terrorist acts. The Role of Political and Civil Rights The aforementioned study by Abadie focuses on the role that political freedom plays in spurring terrorism.7 By studying different nations, he finds that the incidence of terrorism is highest in nations with intermediate levels of political freedom. Highly democratic and also highly autocratic regimes both tend to experience less terrorism. A recent working paper by St. Louis Federal Reserve economist Subhayu Bandyopadhyay and co-author Javed Younas explores the link between terrorism and political and civil rights in developing nations, using a sample of 125 countries. Disaggregating the data between domestic and transnational terrorism, they found that it was only domestic terrorism that was figure 1 endnotes 1 Transnational Terrorist Incidents, 1968-2003 700 INCIDENTS PER YEAR 600 500 2 400 3 4 300 5 200 100 0 1968 6 1973 1978 1983 1988 1993 1998 2003 7 YEAR figure 2 DEATHS PER INCIDENT EACH YEAR Deaths Per Transnational Terrorist Incident, 1968-2003 10 9 8 7 6 5 4 3 2 1 0 1968 8 1973 1978 1983 1988 1993 1998 2003 YEAR SOURCE: Graham Bird, S. Brock Blomberg and Gregory D. Hess For example, Chapter 5.7 of the 2008 Country Reports on Terrorism states the implicit assumption that poverty can lead to terrorism: “High unemployment and underemployment, often a result of slow economic growth, are among the most critical issues in predominantly Muslim countries.” See Bird et al. See Krueger and Maleckova (2003). See Krueger and Laitin (2007). Admittedly, many nations are both sources and targets of terrorism; the focus of this study, however, was on transnational incidents where the sources and targets differed. See Abadie. A common measure of political and civil rights comes from Freedom House, a nonprofit, nonpartisan organization. Freedom House defines civil liberties as the protection of fundamental individual rights against coercion and interference by the state; political rights include the right to participate in the political process and having freedom of speech. On a scale of 1 to 7, Freedom House measures a country’s level of political and civil rights separately, with 1 being free and 7 being not free, for a combined score of 14. For example, in 2005 the United States scored a 1 in both political and civil liberties; Sudan scored a 7 on both accounts. Examples of countries in-between include Argentina (2 and 2), Thailand (3 and 3), and Afghanistan (5 and 5). Chapter 5 of the RAND MIPT publication, “More Freedom, Less Terror? Liberalization and Political Violence in the Arab World” presents a detailed look at the political climate and terrorist activity in Saudi Arabia from 1990 to the present. R eferences related to the level of political and civil rights. Along the lines of Abadie, they found that a transition from autocracy to democracy might be associated with an initial increase in terrorism. These studies suggest that nations may need to be patient on the path to democracy. Giving more political rights to citizens may not immediately reduce terrorism in that country. An interesting example was the 2003 terrorist attacks against Saudi civilians by an Al Qaida affiliate, which occurred against the backdrop of political reform, including the announcement of municipal council elections in October 2003. 8 terrorism. The evidence suggests a closer relationship with the lack of political or civil liberties in origin nations, perhaps because frustrations with existing regimes make people more readily rely on violence. These findings suggest a multipronged approach to counterterrorism policy; military power as well as economic assistance may help the source nations of terrorism to achieve effective reform. All the studies suggest that, in the long run, political reforms that confer rule of law, civil liberties and political rights to developing nations will be the best way to reduce incidents of global terror. Counterterrorism Policy: A Comprehensive Approach Subhayu Bandyopadhyay is an economist at the Federal Reserve Bank of St. Louis. Craig P. Aubuchon is a research associate at the Bank. Javed Younas is assistant professor of economics at the American University of Sharjah, United Arab Emirates. For more on Bandyopadhyay’s work, see http://research.stlouisfed.org/econ/ bandyopadhyay. Because of the highly emotional and traumatizing impact of terrorism, it is important to take a measured and thoughtful look at counterterrorism policy. While still in its early stages, research suggests that economic status or lack of education may not be the most important factors spurring Abadie, Alberto. 2006. “Poverty, Political Freedom, and the Roots of Terrorism.” American Economic Review: Papers and Proceedings, 2006, Vol. 96, No. 2, pp. 50–56. Bandyopadhyay, Subhayu; Younas, Javed. “Does Democracy Reduce Terrorism in Developing Nations?” Federal Reserve Bank of St. Louis Working Paper 2009-023A. Available at: http:// research.stlouisfed.org/wp/2009/2009-023.pdf. Bird, Graham; Blomberg, S. Brock; and Hess, Gregory D. “International Terrorism: Causes, Consequences and Cures.” The World Economy, 2008, Vol. 31, No. 2, pp. 255-74. Kaye, Dalia Dassa; Wehrey, Frederic; Grant, Audra K; and Stahl, Dale. More Freedom, Less Terror? Liberalization and Political Violence in the Arab World. RAND Corp.: Santa Monica, Cal. 2008. See www.rand.org/pubs/ monographs/MG772/. Krueger, Alan B; Laitin, David D. “Kto Kogo?: A Cross-Country Study of the Origins and Targets of Terrorism.” NBER Working Paper, 2007. See www.krueger.princeton.edu/terrorism4.pdf Krueger, Alan B; Maleckova, Jitka. “Education, Poverty and Terrorism: Is There a Causal Connection?” Journal of Economic Perspective, 2003, Vol. 17, No. 4, pp. 119-44. RAND-MIPT Terrorism Incidents Database, 2007. See www.rand.org/ise/projects/terrorismdatabase/. U.S. Department of State. Country Reports on Terrorism 2008. See www.state.gov/s/ct/rls/ crt/2008/index.htm. The Regional Economist | www.stlouisfed.org 11 c l i m a t e c h a n g e Regulating Carbon Emissions: The Cap-and-Trade Program By Cletus C. Coughlin and Lesli S. Ott © Michael Prince /CORBIS I ncreased concentrations of greenhouse gases have heightened concern throughout the world about climate change and global warming. One manifestation of this concern in the United States is reflected in a market-based approach termed “cap and trade” to regulate carbon dioxide emissions; this is contained in the proposed American Clean Energy and Security Act of 2009.1 This legislation requires a 17 percent reduction in emissions of carbon dioxide by 2020 from 2005 levels.2 While there are numerous controversial provisions in this legislation, this article focuses on the economic principles underlying the cap-and-trade proposal.3 Reducing Carbon Emissions Efficiently Various regulatory approaches exist for controlling pollution. A common one is “command and control.” One example in the context of carbon emissions is the Corporate Average Fuel Efficiency (CAFE) standards, which mandate minimum fleet mileage standards for motor vehicles sold in the United States. Generally speaking, economists tend to prefer market-based approaches, such as a cap-and-trade program, to other regulatory approaches for reducing carbon emissions. Various economic reasons exist for preferring market-based approaches. First, all polluters face the same marginal cost of reducing pollution, which is a necessary condition for reducing pollution in the most cost-effective way. For example, say that a polluter is either taxed $15 for each ton of carbon emissions or must have a permit that costs $15 per ton of carbon emissions. In either case, $15 is the price that the polluter must pay to emit one ton of additional carbon emissions. Then, each firm must compare this $15 per ton with its own cost of reducing carbon emissions. 12 The Regional Economist | October 2009 As long as the firm’s incremental costs stay less than or equal to $15, then it will reduce its emissions; if not, assuming it is profitable to do so, then the firm will pay the tax or buy the permit. (Note that part of a firm’s adjustment to the higher price to pollute might entail a cut in its production of goods.) Second, incentives are provided so that pollution is reduced relatively more by firms with relatively lower costs of doing so. In other words, if firms must pay $15 per ton of carbon emissions, then firms that can reduce pollution at relatively lower cost will undertake relatively more abatement than will higher-cost firms. Third, market-based approaches provide incentives for innovative activity that can lower the cost of reducing pollution. Simply put, firms can increase their profits by finding ways to lower the cost of reducing pollution. Under a cap-and-trade program, the quantity of carbon emissions is capped. Given an upper limit on the quantity of carbon emissions, market participants will determine the price of these emissions. The supply and demand diagram in Figure 1 can be used to illustrate the basics of a cap-and-trade program. The horizontal axis measures the quantity (Q) of carbon dioxide emissions abated, while the vertical axis measures the value (benefits or costs) per unit (P) of carbon abated. Note that by capping emissions at some level, an abatement quantity is set as well. The marginal benefit (MB) curve is sloped negatively to reflect that the additional benefit to society of abating more carbon declines. This marginal benefit curve reflects the social benefits of reducing pollution. From the perspective of a polluter, the (private) benefit of abatement is zero. Meanwhile, the marginal cost (MC) curve is sloped positively to reflect the assumption of increasing marginal abatement costs. In other words, as a firm attempts to abate more and more carbon emissions, incremental costs to the firm of additional abatement increase. figure 1 Cap-and-Trade P MC P* MB O Q* Q (emissions abated) Given the curves in Figure 1, the ideal quantity of abatement is indicated by Q*. This quantity of abatement will result in a price of carbon emissions of P* per unit. This efficient outcome reflects the fact that emissions abatement should continue until the point at which the marginal benefits equal the marginal costs. Additional abatement beyond Q* is inefficient because the marginal costs exceed the marginal benefits. In the preceding example, the marginal benefit and cost curves were assumed to be known with certainty. This is highly unlikely as it is very difficult to pin down either the benefits or the costs of reducing carbon emissions. For example, the benefits of reducing the atmospheric concentration of carbon dioxide from 380 to 325 parts per million are not easily calculated. Not surprisingly, widely divergent views are held.4 A more realistic assumption is one of uncertainty, which allows for one’s expectations to differ from what actually occurs. Assume that the expected and realized marginal cost curves are identical, but that the realized marginal benefit exceeds the expected marginal benefit. In other words, the benefits of reducing carbon emissions are higher than originally anticipated. In Figure 2, this is represented by a realized marginal benefit (MBR) curve that lies above the expected marginal benefit (MBE). figure 2 Cap-and-Trade with Benefit Uncertainty MC B P C A MBR MBE O QQ Q* Q (emissions abated) Under a cap-and-trade program, regulators, basing their decision on expected costs and benefits, would require abatement of QQ of carbon emissions. In Figure 2, the ideal level of abatement is Q*; so, the cap-and-trade program would result in too little abatement because QQ is less than Q*. Of course, if the realized marginal benefit curve was at a lower level than the expected marginal benefit curve, too much abatement would occur. The key point in this illustration is that, because of uncertainty, the cap-and trade program is unlikely to produce an ideal outcome all the time.5 Excessive volatility in the price of pollution is also a possibility. When unintended, large adverse consequences result, specifics of the cap-and-trade program will probably need to be modified. Unfortunately, uncertainty comes into play with all regulatory approaches. Who Receives the Permits? After the amount of allowable carbon dioxide emissions is determined, decisions must be made as to who is allowed to emit and how much they are allowed to emit. One approach, which is favored by the Obama administration, is to have the government auction off permits that allow the holder to engage in actions that emit carbon. A fixed number of permits would be auctioned that would be purchased by those who placed the highest value on them. Subsequently, as time passes and circumstances change, those with excess permits could sell them to those who desired more permits. Government sales of the permits would generate revenue, which could be returned to taxpayers or used for other projects, some of which might be directly related to energy and climate change issues. Currently, auctioning all the permits does not appear to be acceptable politically. A House-passed version of the American Clean Energy and Security Act of 2009 would allow 85 percent of the permits to be allocated administratively, while 15 percent would be auctioned.6 Electricity distributors would receive the largest share, while the rest would be divided among energy-intensive manufacturers, carmakers, natural-gas distributors, states with renewable energy programs and others. This compromise was viewed as necessary for passage. Such an allocation would mean that the government would receive little revenue because only 15 percent of the permits would be auctioned and that the initial allocation would probably not go to those who value the permits the most. However, this does not necessarily mean that the permits would not eventually be used by those who value them the most. After the initial allocation of permits, subsequent trading might lead to an allocation of the permits to those who value them the most. Of course, the sellers of the permits rather than the federal government would receive the money from these sales. ENDNOTES 1 2 3 4 5 6 The largest active cap-and-trade program for greenhouse gases is the European Union’s Emission Trading Scheme. In the United States, the Regional Greenhouse Gas Initiative has implemented a cap-and-trade program for greenhouse gas emissions from power plants. Details on this legislation can be found at: www.govtrack.us/congress/bill. xpd?bill=h111-2454. For a discussion of important design issues, see Metcalf. See Economist. Those well-versed in economics will recognize that the welfare loss associated with the capand-trade program in the present example is represented by the triangle ABC. This allocation is to last until 2030, at which time all permits are to be auctioned. REFERENCES Economist. “Cap and Trade, with Handouts and Loopholes.” May 23, 2009, pp. 33-34 Metcalf, Gilbert E. “Market-based Policy Options to Control U.S. Greenhouse Gas Emissions.” Journal of Economic Perspectives, Spring 2009, Vol. 23, No. 2, pp. 5-27. Economics vs. Politics The cap-and-trade legislation illustrates the interplay between economics and politics. Uncertainty about the benefits and costs guarantees that any proposal to regulate carbon emissions will be controversial. While the cap-and-trade program working its way through Congress contains desirable economic features, the prospects for an auction process covering all permits for carbon emissions does not seem to be a viable option politically. Cletus C. Coughlin is an economist at the Federal Reserve Bank of St. Louis. For more on his work, see http://research.stlouisfed.org/econ/ coughlin. Lesli S. Ott is a research associate at the Bank. The Regional Economist | www.stlouisfed.org 13 f i n a n c i a l l i t e r a c y Housing’s Great Fall: Putting Household Balance Sheets Together Again By William Emmons tyson mangelsdorf/www.munrocampagna.com D eclining U.S. house prices have contributed significantly to the deepest global recession and the most severe financial crisis in many decades.1 At the level of individual U.S. households, falling house prices appear to be a significant cause of mortgage defaults.2 At least 7 million mortgage foreclosures were initiated during 2007 and 2008 combined, and all indications are that the rate of foreclosures will remain high for some time.3 Falling house prices have inflicted severe damage on many banks and other financial institutions, such as Fannie Mae and Freddie Mac, the government-sponsored mortgage lenders, because many repossessed houses now are worth less than the mortgage debt they secure. Likewise, the market values of securitized residential mortgages have fallen, imposing losses on investors around the world.4 Continuing distress among millions of homeowners, together with many weakened financial institutions, may delay the economic recovery. Why are house-price declines so dangerous and disruptive? Can we prevent this from happening again? More Damaging Than Stock Declines Perhaps surprisingly, U.S. households’ $4 trillion loss of value since the end of 2006 on the houses they own is far less than the decline in households’ stock-market wealth of $10 trillion that occurred after mid-2007 or the $8 trillion loss of stock-market wealth that occurred during 2000-02. Yet, many economists believe declining house prices have been more damaging than either of the two recent large stock-market declines. Three features of homeownership in the U.S. help explain the severe fallout from declining house prices. First, unlike stock 14 The Regional Economist | October 2009 ownership, homeownership is widespread among households at most income levels. (See Table 1.) About two-thirds of families are homeowners, while only about half owned stock directly or indirectly in 2007, with most stock-market exposure concentrated at upper income levels.5 Second, for the vast majority of households, the value of their house (if they own one) is much larger than their stock portfolio (if they have one) or any other investment. The median value of a house was about $191,000, while the median stock holdings among households with a portfolio were $35,000, both measured before the recent declines. Third, houses usually are financed, in part, with mortgage debt. (See Table 1.) For all but the lowest quarter of family incomes, a majority of homeowners have mortgage debt. Leverage, or borrowing to finance an asset purchase, causes the owner’s gains and losses on the asset to be magnified.6 Thus, families are more likely to own houses than stocks; for most home-owning families, the value of their house far exceeds their stock portfolio; and housing often is a leveraged investment. Declining house prices, therefore, directly affect more families—and more significantly—than does a falling stock market. Why This Time Is Different High rates of homeownership and mortgage borrowing are not new developments in the U.S. What seems to have made this house-price decline so severe is, first, that house prices rose so far, so fast—especially in some areas, such as California, Nevada, Arizona and Florida—and then fell hard and fast. Second, the amount of mortgage debt taken on by millions of households appears, in retrospect, to have been excessive. House prices, therefore, have declined more than at any time since the 1930s precisely when many more households were vulnerable to the magnified effects of high leverage than ever before. Chart 1 shows the ratios of house prices to per-capita personal incomes in Florida and Missouri, examples of “boom” and “quiet” markets, respectively. Average house prices in Florida rose much faster after 2000 than incomes, and those prices have fallen sharply since 2006. Not surprisingly, foreclosure rates in Florida have skyrocketed, as shown in Chart 2. House-price-to-income ratios and foreclosure rates also increased and then decreased in Missouri, but by much less. Meanwhile, the burden of servicing all types of debt averaged across all families rose from 10 percent of family income in 1989 to about 12.5 percent in 2000 to almost 15 percent in 2007.7 These three years correspond to the respective peaks of the past three economic expansions, just before recessions began and house-price growth slowed. It’s clear that a long-term trend toward larger debt burdens occurred across the U.S., making many households more vulnerable to economic and financial shocks. As most house prices fell after 2006, mortgaged homeowners’ equity fell even faster. Homeowners overall have lost almost $5 trillion of homeowners’ equity through the first quarter of 2009, even though house values fell only about $4 trillion. The greater decline in homeowners’ equity reflects the fact that, as house prices fell after 2006, mortgage debt continued to rise until recently.8 Considering only homeowners with mortgage debt (about two-thirds of all homeowners), the average loss of homeowners’ equity is in the neighborhood of 70 percent, due to the magnifying table 1 ENDNOTES Homeownership and Mortgage Borrowing By Family Income Category 1 Family or individual income category in 2007 Number of families in this category (millions) Of which, number of families that are homeowners (millions) Of which, number of families that have mortgage debt (millions) Percent of families in this income category that are homeowners (%) Percent of homeowning families in this income category with mortgage debt (%) Less than $20,000 23.2 10.1 3.4 43.7 33.9 $20,000 to $39,999 27.6 16.1 8.1 58.5 50.4 $40,000 to $79,999 31.3 23.6 16.7 75.3 70.9 $80,000 or more 28.2 25.8 20.6 91.3 79.9 Total population of families 110.4 75.6 48.9 68.5 64.6 2 3 4 5 6 SOURCE: 2007 American Housing Survey, Bureau of the Census. chart 1 chart 2 Ratio of House Prices to Per-Capita Personal Income Mortgage Foreclosure Rate 8 AVERAGE LEVEL IN 1991 EQUALS 100 % OF 1ST-LIEN MORTGAGES ENTERING FORECLOSURE (ANNUAL RATE) 12 180 10 160 Florida Missouri Florida 8 140 Missouri 6 120 4 100 80 7 2 0 90 95 00 05 10 SOURCES: Federal Housing Finance Agency and Bureau of Economic Analysis. Quarterly data through Q1 2009. effects of leverage. Of course, many homeowners have defaulted on their mortgages already and, unfortunately, many more are likely to do so—particularly if house prices continue to fall and the unemployment rate rises further. Lessons Learned One clear lesson from the housing crash and foreclosure crisis is that house prices can fall sharply, even on a nationwide basis. Remarkably, it had become almost an article of faith earlier in this decade among many mortgage lenders and borrowers that house prices would not fall significantly, even in overheated markets. It was assumed that most homeowners simply would wait to sell their houses until demand recovered, rather than dumping their properties into a falling market. As it turned out, defaults increased sharply in 2006 and 2007. Banks and other owners of foreclosed properties did sell a large number of houses, even in falling markets. This unleashed a downward spiral of house prices which, in turn, contributed to more defaults. 90 95 00 05 10 SOURCES: Mortgage Bankers Association. Quarterly data through Q1 2009. Another key lesson is that mortgage borrowing can be excessive. Rather than focusing merely on the affordability of the initial monthly payments a household must make, it clearly is necessary to plan for any increases that could occur and to build in a margin of safety for unexpected financial stresses, such as unemployment or unexpected medical or other expenses. The simplest way to avoid another devastating housing crash and foreclosure crisis probably is to reduce and maintain much lower levels of household leverage. Not only might less mortgage borrowing make households better able to withstand any future house-price declines or any other financial shocks that might occur, but it also might reduce the chance of house prices again rising to unsustainable levels. For a discussion of the role of falling house prices in the economic downturn and financial crisis, see Bernanke. See Hatzius. See Mortgage Bankers Association. See Kohn. See Bucks et al. and Census Bureau. During the early part of this decade, when house prices generally were rising, the homeowners’ equity of any household with mortgage debt increased faster, on a percentage basis, than the value of the house itself. For example, a doubling of the value of a $100,000 house on which there is a $50,000 mortgage results in a tripling of homeowners’ equity (from $50,000 to $150,000). After house prices began to decline in about 2006, the same magnification effect has been working in reverse. See Bucks et al. See Federal Reserve Board. REFERENCES Bernanke, Ben S. “Four Questions about the Financial Crisis.” Speech presented at Morehouse College, Atlanta, Ga., April 14, 2009. See www.federalreserve.gov/newsevents/ speech/bernanke20090414a.htm. Bucks, Brian K.; Kennickell, Arthur B.; Mach, Tracy L.; and Moore, Kevin B. “Changes in U.S. Family Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances,” Federal Reserve Bulletin, February 2009. See www.federalreserve.gov/pubs/ bulletin/2009/pdf/scf09.pdf. Census Bureau. “2007 American Housing Survey.” See www.census.gov/hhes/www/ housing/ahs/ahs.html. Federal Reserve Board. Flow of Funds Accounts. See www.federalreserve.gov/releases/z1/ default.htm. Hatzius, Jan. “Beyond Leveraged Losses: The Balance-Sheet Effects of the Home-Price Downturn,” Brookings Papers on Economic Activity, Fall 2008, pp. 195-227. See www. brookings.edu/press/Journals/2009/brookingspapersoneconomicactivityfall2008.aspx. Kliesen, Kevin. “Survey Says Families Are Digging Deeper into Debt.” Federal Reserve Bank of St. Louis The Regional Economist. Vol. 14, No. 3, July 2006, pp. 12-13. See www. stlouisfed.org/publications/re/2006/c/pages/ debt.cfm. Kohn, Donald L. Comments on “Financial Intermediation and the Post-Crisis Financial System” by Hyun S. Shin et al., at the Eighth Annual Bank for International Settlements Conference, “Financial System and Macroeconomic Resilience: Revisited,” in Basel, Switzerland, June 25, 2009. See www. federalreserve.gov/newsevents/speech/ kohn20090710a.htm. Mortgage Bankers Association. National Delinquency Survey of May 28, 2009. See www. mortgagebankers.org/ResearchandForecasts/ ProductsandSurveys/NationalDelinquencySurvey.htm. William Emmons is an economist at the Federal Reserve Bank of St. Louis. For more on his work, see www.stlouisfed.org/banking/pdf/SPA/ Emmons_vitae.pdf. The Regional Economist | www.stlouisfed.org 15 CO M M UNIT Y P RO F I L E Alton Comes to Grip with Industrial Decline The Argosy Casino brings not only a lot of cash but a lot of color to Alton’s riverfront. In 1991, the casino became the first attraction since a master plan was drawn up to redevelop the stretch of the city along the Mississippi River. Article and photos by Susan C. Thomson T hrough the 1980s, a railroad bridge, a two-lane highway bridge and a lock and dam, all decrepit with age, dominated the riverfront at Alton, Ill. After the various agencies in charge slated all three eyesores for demolition, the city—25 miles north of St. Louis and across the Mississippi—set to work on a master plan to re-create the riverfront along lines that were more image-enhancing. In 1991, the plan was done, and the riverfront got its first new attraction—the Alton Belle, Illinois’ first floating casino. Arriving as the city was fast losing its longtime industrial base, the boat came as a welcome shot of economic adrenalin, bringing the city hundreds of new jobs and a wellspring of new revenue from its local shares of state casino taxes. To build on those gains, the city imposed its own separate per-person tax on boat customers. Although the casino was privately financed, the next big riverfront improvement—a marina—received a hand from the city in the form of $5 million in bonds, repayable in part from marina revenue. 16 The Regional Economist | October 2009 Since opening in 1996, the facility has been expanded three times; nearly 300 boats can dock there now. The latest and most ambitious riverfront projects yet are a $4.4 million amphitheater and a $2.5 million pedestrian bridge. The amphitheater, which seats 4,000 under a canopy, opened in May with a Miles Davis jazz festival, named for one of Alton’s favorite sons. The bridge will span the railroad tracks and four-lane highway that separate the riverfront from Alton’s downtown; it is slated for completion in November. The city financed the bridge and amphitheater with a combination of tax increment financing (TIF) money on hand and $5.5 million in TIF-backed bonds, all made possible by a TIF district consisting of the city’s downtown plus some other commercial and industrial properties. The city earmarks for development all real estate taxes collected in excess of the amounts in effect when the city enacted the district in 1994. The city has used TIF money to spruce up several downtown blocks with new lights, sidewalks and plants. Developers can also Alton, Ill. by the numbers Population....................................................... 29,393 * Labor Force..................................................... 13,968 ** Unemployment Rate.............................10.3 percent ** Per Capita personal Income Madison County....................................... $33,585 *** * U.S. Bureau of the Census, estimate July 1, 2008 ** HAVER (BLS), June 2009 *** BEA/HAVER, 2007 Top Employers St. Anthony’s Health Center.................................... 851 † Alton Memorial Hospital......................................... 842 † Alton Community Unit School District No. 11......... 835 † Argosy Casino......................................................... 549 † American Water...................................................... 530 SOURCES: Self-reported. † Includes part-time get TIF grants of $7,500 for each new business or residential unit created in downtown buildings, which are up to 150 years old. In the past four years, 30 new apartments or condos and 10 new offices have resulted. A number of new shops and restaurants have also opened in an area that fell on hard times after Alton Square Mall opened on the edge of town in 1978 and became the go-to local shopping place. The city’s investments have turned the once run-down downtown and unsightly riverfront into what Brett Stawar, president of the Alton Regional Convention & Visitors Bureau, describes as a string of pearls for tourists. The necklace also includes the 15-year-old Clark Bridge, whose swooping yellow cables shine in the sun, making a photogenic background for the riverfront. The fourlane highway bridge was funded by the state and federal governments. Another “pearl” is the new lock and dam, erected two miles downstream from the riverfront by the U.S. Army Corps of Engineers. The complex, which includes a river-themed museum, logged 61,791 visitors in just the first six months of this year. The convention and visitors bureau, which gets the biggest share of its funding from cuts of the city’s taxes on hotels and restaurant food and drink, also promotes Alton’s longtime historic and natural assets. These include the spot where Lincoln and Douglas last debated in 1858, several significant Civil War-era sites, three picture-book 19th-century residential neighborhoods on the National Register of Historic Places, and scenic river bluffs where American bald eagles come to feed every January and February. The birds have grown into an industry, luring 10,620 tourists to eaglerelated events this year—more than double the number of two years ago. As a measure of tourism’s growth, Stawar cites the 70,700 room nights Alton’s three hotels sold last year, a 9 percent uptick from 2007. He says they were quite often completely booked. No count exists of the tourism jobs created, and they are too dispersed for any single tourism employer to make the city’s list of top employers, now led by Alton’s two hospitals. Both are expanding—Alton Memorial Hospital with a $45 million addition and St. Anthony’s Health Center with a $70 million one. “Health care has been great for the local economy,” says Philip S. Roggio, the city’s director of development and housing these past 20 years. “Health care is generally recession-proof.” Alton was a manufacturing town for most of the 20th century, but no more. Glassmaker Owens-Illinois shut down in 1983, Smurfit-Stone Container Corp. closed its paperboard mill in 1998 and Laclede Steel liquidated three years later. From thousands at their peaks, the plants were down at the end to hundreds of jobs each—all lost. After the state of Illinois declared the glass company’s 153-acre property a brownfield, the city contributed $6 million in TIF-backed bonds to a private developer’s $18 million cost of cleaning up the site, tearing down old buildings, installing utilities and turning it into a modern business park. In 2001, New Jersey-based American Water opened a call center in the park, choosing it for its central U.S. location over five other sites in different states. The center, which operates around the clock serving the utility company’s customers in 32 states and Ontario, has been steadily adding employees. In 2003, a group of local investors bought Laclede’s former 400-acre site and, on part of the parcel, opened Alton Steel Inc., a maker of specialty steel bar products. Even with the new company and business park, Alton has been left with acres of Many remnants of Alton’s industrial heyday mark the city. As in downtown and along the riverfront, the city is prepared to use TIF to redevelop these vacant sites. The Regional Economist | www.stlouisfed.org 17 The Beall Mansion, built in 1903, is located on Millionaire’s Row in Alton. The mansion is now a well-known bed and breakfast. Among the sites promoted to tourists is this monument to Alton’s Elijah P. Lovejoy. He was an abolitionist publisher who was slain by a pro-slavery mob in 1837. The $4.4 million amphitheater opened in May on the riverfront. In the background is the 15-year-old Clark Bridge, a landmark in the St. Louis area, thanks to its unusual cablestay design and bright yellow cable wrappings. Downtown is getting spruced up, thanks in no small part to tax increment financing. These two buildings had been candidates for demolition; with TIF incentives, developers turned them into 11 apartments and two stores. abandoned, falling-down factory buildings. As with downtown and the riverfront, the city stands ready to use TIF money to improve these properties, Roggio says. The city also has its redevelopment sights trained on Alton Square Mall, where vacancies, declining sales and deferred maintenance have taken their toll. To turn it around, the city created a special taxing district, which added a cent to the mall’s sales tax rate. The city has pledged up to $1.5 million of the extra money to the mall’s Texas owner for renovations. As those proceed, the city is pursuing deals to add a 12-screen movie theater to the mall and to lure a new hotel/conference center to town. “If we’re going to grow tourism,” says Stawar, “we have to have more hotels.” Downtown and the riverfront remain works in progress. Downtown is still dotted with empty buildings, but more TIF grant applications are pending. On the riverfront, a floating restaurant has been for sale since closing more than a year ago. At the casino, now called the Argosy, business is off—enough that the boat’s staff is down by about half from a decade ago, according to the general manager, Rich Laudon. He blames the economic downturn, competition from newer casinos around the St. Louis metropolitan area and a statewide ban on public smoking that went into effect Jan. 1, 2008. Nevertheless, 18 The Regional Economist | October 2009 Alton’s $5.7 million share of state taxes on the boat added up to about 22 percent of the city’s operating budget last year, and the total $414,000 from the city’s separate head tax on casino customers went into a fund for special city projects. Meanwhile, on the strength of a $200,000 grant from the National Scenic Byways Program, plans are afoot for a new riverfront attraction—a “flood memorial plaza.” With a sculpture, fountain and exhibits, it will be dedicated to the heroics of Alton’s citizens in times of rising Mississippi waters. Construction could start next year. Dale Blachford, president of Liberty Bank and an Alton resident for only five years, says that, unlike some locals, he sees “more of the positives than the negatives” about the city. Overall, he sees a city that has been slowly and successfully “reinventing itself” these past 20 years and, of necessity, continues to do so. “It takes time,” he says. Alton Mayor Tom Hoechst also takes a long view, focused on the future. “We’re still suffering from the old days when the industrial jobs were so plentiful,” he says. “Those jobs are gone, they’re not coming back and people have to get used to that fact.” Susan C. Thomson is a freelancer. d i s t r i c t o v e r v i e w ILLINOIS INDIANA St. Louis Louisville MISSOURI Recession Takes Toll on Eighth District Tax Collections ARKANSAS KENTUCKY Memphis Little Rock MISSISSIPPI By Thomas A. Garrett A midst the current recession, declining state tax revenue and an increasing demand for government services—such as Medicaid, unemployment insurance and various other social programs—are putting increased pressure on state government budgets. State governments estimate a $230 billion gap between expected expenditures and expected revenue between fiscal year 2009 and fiscal year 2011.1 That figure represents roughly 12 percent of total annual state government revenue (about $1.8 trillion) for recent years. One culprit behind these gaps is the large decline in states’ major sources of tax revenue—personal income, corporate income and taxable retail sales.2 Revenue from these taxes for fiscal year 2009 was down 6.6 percent, 15.2 percent and 3.2 percent, respectively, from fiscal year 2008 levels.3 As with states across the country, tax revenue for each of the seven states in the Eighth Federal Reserve District is generally lower as a result of the current recession. Table 1 lists state revenue from the sales tax, the personal income tax and the corporate income tax, all for fiscal year 2008 (prerecession) and fiscal year 2009. In addition, the percentage change between the two fiscal years is given. Total state tax revenue for the 50 states combined and for the seven District states combined is also included. In four of the seven District states, sales tax revenue for fiscal year 2009 was lower than in fiscal year 2008. Illinois experienced the largest decrease (–7.5 percent), followed by Tennessee (–5.5 percent) and Missouri (–3.7 percent). Sales tax revenue in Arkansas increased by 1.1 percent between fiscal year 2008 and fiscal year 2009. In total for the seven states, the percentage decline in sales tax revenue (–3.8 percent) was slightly greater than the decline for all 50 states (–3.2 percent). The decline in sales tax revenue for the seven states was less than the decline in personal income tax revenue (–5.1 percent) and corporate income tax revenue (–20.3 percent). Personal income tax revenue declined in six of the seven District states between fiscal year 2008 and fiscal year 2009. Illinois and Tennessee experienced the largest declines of –8.8 percent and –30.1 percent, respectively. It is important to note that Tennessee’s personal income tax only applies to dividend and interest income, not wage income (which is the largest component of personal income) as in the other six states. Thus, a reduction in Tennessee’s much smaller personal income tax base yields a larger percentage decrease than an equal reduction in other states. Mississippi was the only state to experience a positive, albeit small, increase in personal income tax revenue (0.4 percent). As a whole, the decline in personal income tax revenue in the seven states (–5.1 percent) was less than that of the 50 states (–6.6 percent). Corporate income tax revenue declined in all seven states from fiscal year 2008 to fiscal year 2009. The largest declines were in Kentucky (–44.4), Illinois (–22.0 percent) and Missouri (–21.1 percent). Of the seven states, Indiana experienced the smallest decline in corporate income tax revenue (–9.7 percent). For the seven states, corporate income tax revenue decreased by a greater percentage (–20.3 percent) than did sales tax revenue (–3.8 percent) and personal income tax revenue (–5.1 percent). In addition, the decline in corporate income tax revenue for the seven states was TENNESSEE The Eighth Federal Reserve District is composed of four zones, each of which is centered around one of the four main cities: Little Rock, Louisville, Memphis and St. Louis. about 33 percent greater than that of the 50 states (–20.3 percent versus –15.2 percent, respectively). Total tax revenue (defined here as sales tax revenue + personal income tax revenue + corporate income tax revenue) for each state is shown in the last three columns of Table 1. All seven states experienced a decline in total tax revenue between fiscal year 2008 and fiscal year 2009, with the declines ranging from a high of –9.6 percent in Illinois to a low of –2.2 percent in Mississippi. The decline in total tax revenue for the seven states (–6.0 percent) was slightly less than that of the 50 states (–6.1 percent). Differences across the States Although the majority of Eighth District states experienced a decline in revenue from the three major taxes, the magnitude of the decline across states is quite different. One reason is that various tax bases may be more affected by an economic slowdown than others, and this effect may be different across states. For example, a reduction in retail sales will reduce sales tax revenues, whereas a reduction in employment will more likely influence personal income tax revenue and corporate income tax revenue. Thus, the degree to which an economic contraction affects consumption, employment and income in each state can explain part of the difference in the performance of the three tax revenue sources across the states. A related reason is the degree to which each state relies on, as a percentage of total tax revenue, each source of revenue. As seen in Table 2, the seven states each rely on each source of revenue to varying degrees. For example, 25 percent of total tax revenue in Missouri is from the state’s sales tax, The Regional Economist | www.stlouisfed.org 19 Table 1 Tax Collections, Eighth District States ($ millions) Sales Tax Revenue State FY2008 FY2009 Arkansas 2,111 2,135 Illinois 7,215 6,674 Indiana 5,534 5,426 Kentucky 2,878 Mississippi 1,947 Missouri Tennessee Personal Income Tax Revenue % Change FY2008 FY2009 % Change 1.14 2,345 2,271 –3.16 –7.50 10,320 9,417 –8.75 –1.95 4,838 4,726 –2.32 2,878 0.00 3,483 3,365 1,950 0.15 1,542 1,548 1,931 1,860 –3.68 5,210 5,084 –2.42 6,851 6,475 –5.49 292 204 –30.14 Corporate Income Tax Revenue FY2008 Total Tax Revenue FY2009 % Change 318 258 –18.87 1,860 1,450 –22.04 910 822 –9.67 –3.39 435 242 0.39 501 403 459 1,620 FY2008 FY2009 % Change 4,774 4,664 –2.30 19,395 17,541 –9.56 11,282 10,974 –2.73 –44.37 6,796 6,485 –4.58 –19.56 3,990 3,901 –2.23 362 –21.13 7,600 7,306 –3.87 1,328 –18.02 8,763 8,007 –8.63 7 State Total 28,467 27,398 –3.76 28,030 26,615 –5.05 6,103 4,865 –20.29 62,600 58,878 –5.95 50 States 214,217 207,358 –3.20 276,155 257,805 –6.64 50,772 43,034 –15.24 541,144 508,197 –6.09 SOURCE: National Governors Association and the National Association of State Budget Officers (2009). Total tax revenue is the sum of the three individual taxes. Table 2 whereas over 78 percent of total tax revenue in Tennessee is from the state’s sales tax. Tax Revenue as Percentage of Total Tax Revenue (2008) Similarly, 69 percent of total tax revenue in State Sales Tax % Personal Income Tax % Missouri is from the personal income tax, Arkansas 44.2 49.1 compared with only 3.3 percent in TennesIllinois 37.2 53.2 see. Thus, equal drops in retail sales activity (assuming constant tax rates and exemptions) Indiana 49.1 42.9 will influence total tax revenue much more in Kentucky 42.3 51.3 Tennessee than in Missouri. Mississippi 48.8 38.6 Looking Ahead States will continue to face budget pressure until economic conditions improve. Improvement in revenue streams from the sales tax, the personal income tax and the corporate income tax is dependent upon, broadly speaking, increased consumer spending and greater employment and business investment. Slow or stagnant growth in one or more of these areas will hinder growth in total tax revenue, especially in those states that generate the majority of their tax revenue from only one or two taxes. Certainly, there are factors other than the three major taxes that will influence a state’s fiscal health. Increased federal money to state governments as a result of the American Recovery and Reinvestment Act (the stimulus package) may provide a temporary boost to state government revenue. Reductions in expenditure on various statefunded programs, such as higher education, social services and corrections, have occurred in dozens of states in fiscal year 2009, with further cuts likely in the next year or two. Finally, many states are considering tax increases in fiscal year 2010 and fiscal year 2011. 20 The Regional Economist | October 2009 Missouri 25.4 Corporate Income Tax % 6.7 9.6 8.1 6.4 12.6 68.6 6.0 Tennessee 78.2 3.3 18.5 50 States 39.6 51.0 9.4 NOTE: Percentages are computed using the data in Table 1. Numbers may not add up to 100 percent due to rounding. Regardless of the actions taken by state governments to shore up their balance sheets, only an economic recovery will provide for growth in state tax revenue. As long as state governments rely on revenue sources that are linked to economic performance and fail to adequately save during prosperous times, it is certain that states will once again find themselves facing budget shortfalls during the next economic slowdown. E ndnotes 1 2 3 Thomas A. Garrett is an economist at the Federal Reserve Bank of St. Louis. For more on his work, see http://research.stlouisfed.org/ econ/garrett/. All tax data presented here are from National Governors Association and the National Association of State Budget Officers. State governments obtain revenue from sources other than sales taxes, personal income taxes and corporate income taxes. These sources include excise taxes, user fees, federal government transfers, license fees and selective sales taxes (sales taxes on specific goods, such as tobacco). About 40 percent of general fund revenue is from the personal income tax, 33 percent is from the sales tax and 8 percent is from the corporate income tax. The fiscal year for most states, including all of those in the Eighth District, ends June 30. The exceptions are: Alabama and Michigan, Sept. 30; Nebraska and Texas, Aug. 31; and New York, March 31. R eferences National Governors Association and the National Association of State Budget Officers. The Fiscal Survey of States, June 2009. See www.nasbo. org/Publications/PDFs/FSSpring2009.pdf. B OO K r Ev i e w In Fed We Trust: New Book Focuses on the Fed in the Eye of the Storm By Kevin L. Kliesen (The author’s book review of In Fed We Trust takes the place of our usual National Overview feature, which will return in the next issue.) T he nation’s economic policymakers are entrusted with helping to ensure economic and financial stability. Often, though, a policymaker’s thought process is clouded by the storm and stress of the crisis. In his book In Fed We Trust: Ben Bernanke’s War on the Great Panic (published in August 2009 by Crown Business), the Wall Street Journal’s David Wessel walks us through a detailed, behind-the-scenes narrative that attempts to portray the difficulties facing Federal Reserve policymakers (and those in the federal government) as they formulated an evolving response to the financial crisis that roughly began in August 2007. From Page 8: This is the story of the Bernanke Fed abandoning “failed paradigms” in order “to do what needed to be done.” It is a story of what the Fed saw and what it missed, what it did and what it didn’t, what it got right and what it got wrong. It is a story about Ben Bernanke deciding to do whatever it takes. Above all, it is a story about a handful of people—overwhelmed, exhausted, beseeched, besieged, constantly second-guessed—who found themselves assigned to protect the U.S. economy from the worst economic threat of their lifetimes. Heading into the last few months of 2009, it appears that these efforts have produced some tangible benefits: The economic and financial headwinds that have hammered the U.S. economy over the past year or so appear to be calming. Indeed, a majority of economists believe the recession that officially began sometime in December 2007 has finally ended. Riders on the Storm As the book’s subtitle suggests, much of the narrative is focused on the Federal Reserve’s response to the financial crisis—what Wessel calls the Great Panic. The design and implementation of these policy responses are seen mainly through the lens of Chairman Ben Bernanke and his key colleagues on the Federal Open Market Committee. Wessel also added a second subtitle to the book: How the Federal Reserve Became the Fourth Branch of Government. By this, Wessel has in mind the Federal Reserve’s special lending powers that were invoked under Section 13(3) of the Federal Reserve Act. Under the auspices of “unusual and exigent circumstances,” the Federal Reserve—via the three special lending facilities named Maiden Lane I, II and III—helped to finance the purchase of Bear Stearns by JPMorgan Chase and to prevent the failure of American International Group (AIG). Wessel also relates how Bernanke and other Federal Reserve officials urged the government’s other key economic players to take aggressive actions at key moments in the Great Panic. These included policies designed to stabilize the nation’s 19 largest depository institutions deemed too systemically important to fail. In Fed We Trust is an entertaining read, but it is generally written from a Washington, D.C., and New York City perspective. Indeed, the key Federal Reserve officials in the narrative are Bernanke, Govs. Don Kohn and Kevin Warsh, and then-New York Fed President Tim Geithner. Wessel refers to them as the four musketeers. At times, the four musketeers wanted to move faster and more aggressively than other policymakers did. This created some tension with policymakers who advocated a more cautious approach. Among the latter was a group of several Federal Reserve District Bank presidents who “were determined to show their manhood by talking tough about inflation and economic rectitude.” In perhaps the unkindest cut of all, those District Bank presidents, many of whom found intellectual support from prominent academics like John Taylor of Stanford University, were derisively labeled “presidents from the flyover states” by “internal foes.” Age of Delusion? Former Fed Chairman Alan Greenspan is another prominent person whom Wessel takes to task. In the chapter titled “Age of Delusion,” Wessel argues that the Greenspan Fed not only kept interest rates too low for too long, but it ignored important warning signs from the booming housing market. Wessel is also upset that Greenspan largely ignored former Federal Reserve Gov. Ned Gramlich’s warnings about the subprime market. In short, Wessel believes Greenspan put too much faith in the financial markets and financial institutions. Some of these criticisms are fairly easy to make with the benefit of hindsight. Some may even be true. For example, Taylor, among others, has argued that monetary policy was excessively easy for too long in 2003-2004. But even if Wessel is correct in asserting that the Fed should have taken a more aggressive regulatory stance against subprime mortgages, it is difficult to The Regional Economist | www.stlouisfed.org 21 e c o n o my a t a g l a n c e Eleven more charts are available on the web version of this issue. Among the areas they cover are agriculture, commercial banking, housing permits, income and jobs. Much of the data is specific to the Eighth District. To go directly to these charts, use this URL: www.stlouisfed.org/publications/re/2009/d/pdf/10-09-data.pdf. 5 4 4 3 2 0 –2 1 0 –1 –6 –2 –8 –3 04 05 06 07 08 09 All Items Less Food and Energy 04 06 05 4/29/09 5-Year 10-Year 20-Year .30 6/24/09 .25 8/12/09 .20 9/15/09 Sept. 11 05 06 07 08 .15 09 Sept. 09 Oct. 09 Nov. 09 Dec. 09 Jan. 10 Feb.10 CONTRACT MONTHS 6 9 5 8 4 PERCENT PERCENT I N T E R E S T R AT E S 10 7 3 10-Year Treasury 6 2 5 1 Fed Funds Target 04 05 06 07 08 0 09 U . S . A G R I C U LT U R A L T R A D E 04 05 06 07 08 09 NOTE: On Dec. 16, 2008, the FOMC set a target range for the federal funds rate of 0 to 0.25 percent. The observations plotted since then are the midpoint of the range (0.125 percent). FA R M I N G C A S H R E C E I P T S 75 190 60 170 Exports 45 August 1-Year Treasury August NOTE: Beginning in January 2003, household data reflect revised population controls used in the Current Population Survey. BILLIONS OF DOLLARS 09 .35 C I V I L I A N U N E M P L O Y M E N T R AT E 30 Imports 0 August 08 .40 NOTE: Weekly data. 4 07 RATES ON FEDERAL FUNDS FUTURES ON SELECTED DATES PERCENT 3.0 2.5 2.0 1.5 1.0 0.5 0.0 –0.5 –1.0 –1.5 –2.0 –2.5 –3.0 CPI–All Items NOTE: Percent change from a year earlier. 15 Crops Livestock 150 130 110 Trade Balance 04 05 06 August 07 08 NOTE: Data are aggregated over the past 12 months. 22 The Regional Economist | October 2009 2 –4 I N F L AT I O N - I N D E X E D T R E A S U RY Y I E L D S P R E A D S Moral Hazard and Other Issues In Fed We Trust is an admirable effort to clarify how policymakers cope with the massive amounts of uncertainty during periods of turmoil. Indeed, one of the lessons, as Wessel recounts, is that economic conditions can change rapidly and be contrary to the expectations of policymakers. Most policymakers know this and design their policies accordingly. Yet, while this book provides key insights into the policy process during the height of a panic, Wessel gives short-shrift to the moral hazard and potential inflationary consequences raised by, among others, the District Bank presidents from so-called flyover states, who do not fare well in this narrative. What has yet to be determined, and, admittedly, what Wessel and others cannot know with certainty, at this point is the legacy of the Federal Reserve’s innovative responses to the crisis. 6 6 BILLIONS OF DOLLARS conceive that this would have made much of a difference in mitigating the Great Panic. If there is empirical evidence to the contrary, Wessel does not cite it. 8 NOTE: Each bar is a one-quarter growth rate (annualized); the red line is the 10-year growth rate. PERCENT In his new book on the Federal Reserve’s response to the recent financial panic, author David Wessel writes that Fed Chairman Ben Bernanke (above) and other key Fed officials wanted to move faster and more aggressively than did other policymakers during the so-called Great Panic. CONSUMER PRICE INDEX PERCENT PERCENT REAL GDP GROWTH 09 90 April 04 05 06 07 08 NOTE: Data are aggregated over the past 12 months. 09 R e a d e r e x c h a n g e ask AN economist Silvio Contessi has been an economist in the Research division of the Federal Reserve Bank of St. Louis since 2007. His main expertise is international economics with a focus on multinational firms and international factors movement. Recently, Contessi also has studied the behavior of commercial banks during the financial crisis. In his free time, he enjoys unwinding at the gym and in the park, playing guitar and sand volleyball, and chilling at the pool. For more on his work, see http://research. stlouisfed.org/econ/contessi. Fed Flash Poll Results Whenever a new issue of The Regional Economist is published, a new poll is posted on our web site. The poll question is always pegged to an article in that quarter’s issue. Here are the results of the poll that went with the July issue. The question stemmed from the article “Digging into the Infrastructure Debate.” which of these comes closest to your list of infrastructure priorities? 16% Roads, sewers, schools, health care, mass transit. Mass transit, alternative fuel, Internet, roads, sewers. 52% 16% Internet, mass transit, alternative fuel, sewers, roads. Why would a firm want to become a multinational? Let’s be clear about what we mean by a multinational. This is a firm that extends beyond the borders of an individual nation and operates with affiliates and branches in at least two countries. A multinational organizes phases for producing goods and services to sell in different countries. For example, many car companies have mastered the so-called international segmentation of production, which works like this: A Toyota vehicle assembled in San Antonio may have been designed at the Toyota design center in Australia; the vehicle’s aluminum-wheel components may have been produced in Delta, British Columbia; and its other components may have been produced in yet another location. Other multinationals replicate entire production processes in different countries. Consider Coca-Cola. If you are visiting Poland, the Coke you drink probably was produced in a plant in Lodz, Poland, not in the United States, although the brand and the company hail from the U.S. International business scholars and economists have observed that firms become multinationals to exploit three broadly defined sets of advantages. The first is ownership advantage. Multinational firms usually develop and own proprietary technology (the Coca-Cola formula is patented and kept extremely secret) or widely recognized brands (such as Ferrari) that other competitors cannot use. Multinationals often are technological leaders and invest heavily in developing new products, processes and brands, while usually keeping them confidential and protected by intellectual property rights. Maintaining stronger protection of these elements helps firms enjoy greater profits from innovation. Second, consider localization advantage. Multinationals usually try to build facilities that produce and sell their products in locations near the consumer (the Polish consumers of Coke in our example). This helps reduce transportation costs or helps the company fit in better with local tastes and needs. Proximity to demand also helps firms adapt their products and services to different markets. At the same time, they also may take advantage of lower production costs (for example, labor costs, energy, sometimes even lower environmental standards) or more abundant production factors, such as expert engineering or greater raw materials). For example, the Polish affiliate of Coca-Cola also owns bottling plants in the Beskidy Mountains region of Poland, which is rich in mineral water for making other beverages. Finally, multinationals want to internalize the benefits from owning a particular technology, brand, expertise or patents that they find too risky or unprofitable to rent or license to other firms. Enforcing international contracts can be costly or ineffective in countries in which the rule of law is weak and court procedures are long and inefficient. In these cases, the company also may risk losing its ownership advantage, which it has created at a substantial cost. Schools, health care, roads, sewers, mass transit. 8% 8% Roads, power (pipelines, electricity grid, etc.), sewers, Internet, mass transit. 835 responses as of 9/14/2009 This issue’s poll question: How has the threat of terrorism affected the way that your company does business? 1. It has had no effect at all. 2. We keep up to date with the latest news on terrorism threats. 3. We are branching out only to areas with low threat levels. 4. We’ve had unpredictable disruptions in our supply chain due to terrorism threats. 5. Our company specializes in products designed to combat terrorism. After reading “Increasing Political Freedom May Be Key To Reducing Threats,” go to www.stlouisfed.org to vote. Anyone can vote, but please do so only once. (This is not a scientific poll.) New Editor The Regional Economist has a new editor, Subhayu Bandyopadhyay, an economist in the Research division of the Federal Reserve Bank of St. Louis. Bandyopadhyay joined the Bank in 2007, but had been a visiting scholar at the Bank on multiple occasions earlier this decade. Bandyopadhyay has taught at West Virginia University and the University of Maryland. He has also been a visiting professor at the University of the Andes, in Bogota, Colombia, and a research fellow and visiting scholar at the Institute for the Study of Labor in Bonn, Germany. He has a Ph.D. in economics from the University of Maryland; a master’s in economics from the Jawaharlal Nehru University in New Delhi, India; and a bachelor’s in economics from Calcutta University, India. A native of India, he has lived in the United States since 1987 and is a U.S. citizen. Bandyopadhyay’s research interests include international trade, development economics and applied microeconomics. Bandyopadhyay succeeds Michael Pakko, who left the Bank to become the chief economist and state economic forecaster at the Institute for Economic Advancement at the University of Arkansas at Little Rock. The Regional Economist | www.stlouisfed.org 23 PRSRT STD US POSTAGE PAID ST LOUIS MO PERMIT NO 444 n e x t i s s u e Exiting the Recession Although the recent recession has been the longest and deepest since the 1930s, some economists believe that the Federal Reserve’s response to the financial crisis prevented an even worse outcome. With economic and financial conditions on the mend, many economists and others are increasingly turning their attention to the legacy of the Federal Reserve’s aggressive actions to assist and stabilize fragile credit markets. Foremost among the concern of many is how to prevent an unwelcome surge in inflation. What is the Fed’s exit strategy? Find out more in the January issue of The Regional Economist. economy at a The Regional glance Economist OCTOBER 2009 6 6 5 4 4 3 2 0 –2 2 1 0 –4 –1 –6 –2 –8 04 05 06 07 08 –3 09 CPI–All Items All Items Less Food and Energy 04 4/29/09 5-Year 10-Year 20-Year .30 6/24/09 .25 8/12/09 .20 9/15/09 Sept. 11 05 06 07 08 .15 09 Sept. 09 Oct. 09 Nov. 09 Dec. 09 Jan. 10 Feb.10 CONTRACT MONTHS I N T E R E S T R AT E S 10 6 9 5 8 4 PERCENT PERCENT 09 .35 C I V I L I A N U N E M P L O Y M E N T R AT E 7 3 10-Year Treasury 6 2 5 1 Fed Funds Target 04 05 06 07 08 0 09 U . S . A G R I C U LT U R A L T R A D E 04 05 06 07 08 09 NOTE: On Dec. 16, 2008, the FOMC set a target range for the federal funds rate of 0 to 0.25 percent. The observations plotted since then are the midpoint of the range (0.125 percent). FA R M I N G C A S H R E C E I P T S 190 60 170 BILLIONS OF DOLLARS 75 Exports 45 August 1-Year Treasury August NOTE: Beginning in January 2003, household data reflect revised population controls used in the Current Population Survey. BILLIONS OF DOLLARS August 08 .40 NOTE: Weekly data. 30 Imports 15 0 07 RATES ON FEDERAL FUNDS FUTURES ON SELECTED DATES PERCENT PERCENT I N F L AT I O N - I N D E X E D T R E A S U RY Y I E L D S P R E A D S 3.0 2.5 2.0 1.5 1.0 0.5 0.0 –0.5 –1.0 –1.5 –2.0 –2.5 –3.0 06 05 NOTE: Percent change from a year earlier. NOTE: Each bar is a one-quarter growth rate (annualized); the red line is the 10-year growth rate. 4 VOL. 17, NO. 4 CONSUMER PRICE INDEX 8 PERCENT PERCENT REAL GDP GROWTH | Crops Livestock 150 130 110 Trade Balance 04 05 06 August 07 08 NOTE: Data are aggregated over the past 12 months. 09 90 April 04 05 06 07 08 NOTE: Data are aggregated over the past 12 months. 09 U.S. CROP AND LIVESTOCK PRICES / INDEX 1990-92=100 195 Crops Livestock 175 155 135 115 95 75 August 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 commercial bank performance ratios U . S . B an k s by A sset S i z e / second Q U A R T E R 2 0 0 9 All $100 million$300 million Less than $300 million $300 million$1 billion Less than $1 billion $1 billion$15 billion Less than $15 billion More than $15 billion Return on Average Assets* 0.04 0.19 0.18 0.11 0.14 –0.68 –0.29 0.14 Net Interest Margin* 3.30 3.75 3.79 3.64 3.71 3.47 3.58 3.22 Nonperforming Loan Ratio 4.39 2.89 2.74 3.44 3.12 4.33 3.77 4.64 Loan Loss Reserve Ratio 2.94 1.56 1.55 1.72 1.64 2.28 1.98 3.32 R E T U R N O N AV E R A G E A S S E T S * 0.07 NET INTEREST MARGIN* 0.66 1.13 –0.04 1.09 –1.00 –.75 –.50 –.25 .00 .25 .50 .75 1.00 1.25 1.50 Second Quarter 2009 PERCENT Second Quarter 2008 1.54 1.23 2.40 .75 3.22 Second Quarter 2009 4.0 5.0 2.91 5.25 6.00 1.99 1.27 1.20 1.24 1.58 1.60 Tennessee PERCENT Second Quarter 2008 NOTE: Data include only that portion of the state within Eighth District boundaries. SOURCE: FFIEC Reports of Condition and Income for all Insured U.S. Commercial Banks * Annualized data 1.70 1.27 Missouri 5.30 2.05 1.30 1.23 Mississippi 4.50 3.0 Second Quarter 2008 1.39 Kentucky 3.00 3.75 2.0 1.51 Indiana 1.89 1.50 2.25 1.0 Illinois 3.16 .00 0.0 Arkansas 1.90 1.92 3.23 3.22 Eighth District 1.65 1.34 0.79 3.30 3.60 L O A N L O S S R E S E RV E R AT I O 2.90 1.70 3.76 3.97 Second Quarter 2009 N O N P E R F O R M I N G L O A N R AT I O 1.83 4.08 3.96 Tennessee 0.07 3.87 Kentucky Missouri 0.50 –0.74 3.46 Mississippi 1.02 –0.29 3.62 3.62 Illinois Indiana 0.89 0.91 3.97 3.95 Arkansas 1.03 0.97 –0.46 3.59 3.69 Eighth District 0.70 2.00 2.02 .00 .50 1.00 1.50 Second Quarter 2009 2.00 2.50 3.00 3.50 4.00 Second Quarter 2008 For additional banking and regional data, visit our web site at: www.research.stlouis.org/fred/data/regional.html. regional economic indicators nonfarm employment growth * / second Q U A R T E R 2 0 0 9 year-over-year percent changE United States Eighth District † Arkansas Illinois Indiana Kentucky Mississippi Missouri Tennessee Total Nonagricultural –4.0% –4.1% –2.3% –4.6% –5.1% –4.3% –3.1% –2.7% –4.6% Natural Resources/Mining –4.9 5.8 10.1 3.0 2.5 10.0 0.0 –2.0 #NA Construction –13.7 –12.0 –4.8 –13.5 –13.1 –18.5 –5.7 –9.6 #NA Manufacturing –11.7 –13.2 –10.5 –11.8 –17.1 –15.4 –11.0 –10.9 –12.6 Trade/Transportation/Utilities –4.6 –3.9 –4.9 –3.9 –4.1 –3.3 –3.0 –2.7 –4.9 Information –4.9 –5.0 –9.8 –6.3 –2.9 –2.2 –2.5 –1.5 –8.4 Financial Activities –5.0 –4.0 –5.3 –4.7 –2.6 –2.8 –5.4 –2.2 –5.0 Professional & Business Services –6.6 –6.6 –3.0 –8.0 –7.7 –5.6 –8.9 –3.4 –6.3 2.2 1.9 5.2 0.7 2.9 0.7 1.8 2.0 2.4 Leisure & Hospitality –2.4 –1.7 1.5 –3.6 0.8 0.5 –3.0 –2.4 –1.7 Other Services –2.2 –2.7 –2.0 –1.7 –4.0 –2.4 –2.0 –3.6 –3.3 0.5 0.5 2.1 0.1 –0.5 –1.2 2.2 1.3 1.1 Educational & Health Services Government * NOTE: Nonfarm payroll employment series have been converted from the 1987 Standard Classification (SIC) system basis to a 2002 North American Industry Classification (NAICS) basis. † E ighth District growth rates are calculated from the sums of the seven states. For Natural Resources/Mining and Construction categories, the data exclude Tennessee (for which data on these individual sectors is no longer available). district real gross state product by industry–2008 U nemployment R ates United states....$11,524 billion II/2009 I/2009 United States 9.3% 8.1% 5.4% Arkansas 6.9 6.4 4.9 Illinois 9.9 8.5 6.4 Indiana 10.4 9.6 5.4 Kentucky 10.5 9.3 6.2 Mississippi 9.3 9.1 6.7 Missouri 8.8 8.4 5.7 10.5 9.1 6.2 Tennessee | district total....$1,408 billion chained 2000 dollars II/2008 Information 4.8% Financial Activities 17.1% Trade Transportation Utilities 20.8% Professional and Business Services 11.9% 8.1% 17.9% Manufacturing Education and Health Services Leisure and Hospitality 3.5% 10.0% Construction 2.9% Other Services 2.2% Natural Resources and Mining 1.6% Government H ousing permits / second quarter REAL PERSONAL INCOME* / first QUARTER year-over-year percent change in year-to-date levels year-over-year percent change –47.0 –24.2 –65.6 Illinois –36.6 –34.0 Indiana –31.8 2009 –45 0.2 1.5 0.3 1.2 –15 2008 All data are seasonally adjusted unless otherwise noted. 0 PERCENT 1.9 2.1 1.1 0.3 Tennessee –30 1.8 0.8 –0.3 Missouri –37.6 –41.1 –60 –0.2 Mississippi –43.7 –40.0 –75 1.6 Kentucky –31.9 –40.7 0.8 Arkansas –15.2 –47.1 –43.3 0.1 United States –32.1 –0.5 2009 0.0 0.5 0.8 1.0 1.5 2.0 2008 *NOTE: Real personal income is personal income divided by the PCE chained price index. 2.5