Manufactures ; Economic conditions - Middle West

Michael Munley

William Strauss

English

Research Papers in Economics

Chicago Fed Letter
Manufacturing sector critical in Midwest recovery
by Michael Munley, associate economist, and William Strauss, senior economist and economic advisor
With the national economy beginning to show signs of life, economists from around the
Midwest gathered to discuss the outlook for the region in 2002. Because the consumer
sector, which remained surprisingly resilient through the downturn, is expected to make
only a modest contribution to economic growth this year, many analysts are expecting
lower vehicle sales and a modestly weaker housing sector. Several factors indicate the
recovery in manufacturing is likely to be restrained.
ESSAYS ON ISSUES THE FEDERAL RESERVE BANK MAY 2002
OF CHICAGO NUMBER 177
In November 2001, the National Bureau
of Economic Research stated that the
U.S. economy had entered a recession
beginning in March 2001. This ended
the longest economic expansion in U.S.
history. With some early indications that
the bottom of the downturn was near,
the Federal Reserve Bank of Chicago in-
vited economists from around the re-
gion to attend an Economist
Roundtable discussion on
February 8, 2002, focusing on
the outlook for the Midwest
economy in 2002 and be-
yond. This Chicago Fed Letter
summarizes the workshop
presentations.
Midwest economy more cyclical
National economic growth had been
running at a torrid pace through the
second quarter of 2000. Real gross do-
mestic product (GDP) growth in the
second quarter of 2000 compared with
a year earlier was 5.2%, the largest in-
crease of the ten-year expansion. Over-
all economic activity slowed dramatically
over the course of the following six
quarters. Between the third quarter of
2000 and the fourth quarter of 2001,
quarterly real GDP growth averaged
0.8% (seasonally adjusted annual rate
or saar), significantly below the 3.7%
(saar) pace that occurred between the
second quarter of 1991 and the second
quarter of 2000.
This particular recession has been very
unusual. One normally associates a re-
cession with a decrease in consumer
spending, which represents two-thirds
of the economy, but this did not occur
during this downturn. In fact, real per-
sonal consumption expenditures during
the second quarter of 2001 through the
fourth quarter of 2001 averaged 3.2%
(saar), with the highly cyclical durable
consumption expenditures increasing
15.7% (saar). Real private residential
investment rose by 1.1% (saar) over
this period. We need to look at the
business sector to find the weakness in
the economy.
Gross private domestic investment ex-
cluding residential investment averaged
losses of 19.7% (saar) during the last
three quarters of 2001. A large part of
the decline in business spending was
due to substantial contractions in busi-
ness inventories that occurred during
2001. A record inventory reduction in
real dollars was set in the third quarter
2001 with a loss of $61.9 billion, only to
be blown away by the following quar-
ter’s $119.3 billion reduction. The fourth
quarter’s inventory contraction was
Recessions are typically charac-
terized by a decrease in consumer
spending, but this downturn was
different.not only the largest real dollar amount
but the largest decline as a percentage
of GDP. In the fourth quarter of 2001,
items taken off the inventory shelves
amounted to a record share, represent-
ing 1.3% of all the goods and services
sold during that quarter.
With a large part of demand for prod-
ucts being fulfilled by depleting stocks,
production fell sharply over the course
of 2001, with manufacturing output
falling 6.1% in the fourth quarter com-
pared with a year earlier. Capacity utili-
zation for manufacturing fell to 73.1%
in the fourth quarter, the lowest rate
since the first quarter of 1983. The large
amount of excess capacity has been a
drag on growth. Additions to capacity
fell to a record low of just above 1% in
early 2002, after having approached
nearly 8% in the late 1990s. This has
also translated into significant declines
in capital goods orders and shipments
over the course of the last year.
While manufacturing has become a
smaller part of the Midwest economy,
it is still the key sector distinguishing
the Midwest from other regions. Man-
ufacturing jobs in the U.S. last year were
3.8% lower than at the beginning of
this expansion, but Midwest manufac-
turing jobs increased by 4.1% over the
same period. As a result, the Midwest’s
share of the nation’s manufacturing
jobs rose from 17.6% in 1991 to 19.0%
last year.
Manufacturing output in the nation
fell by 6.1% in the fourth quarter of
2001 compared with a year earlier, but
the decline in the Midwest was almost
double that figure—11.9%. This dis-
crepancy between the nation and the
region is fairly typical during recessions.
The Midwest tends to have more cycli-
cal industries. With less than one in five
manufacturing jobs, the region pro-
duced 36.7% of all light vehicles made
in the country. The Midwest also pro-
duces 36% of all the steel in the nation.
These sectors tend to be very procycli-
cal, and Midwest manufacturing out-
put has experienced relatively high
losses as a result.
As has been the case for the nation as
a whole, the housing industry in the
Midwest has been quite robust. Housing
starts in the Midwest were over 17%
higher in the fourth quarter of 2001
than in the same period a year earlier.
This was quite a bit higher than the 2.6%
increase experienced by the nation.
Similarly, new privately owned build-
ings were 9.3% higher in the Midwest
versus 2.4% higher for the U.S. in the
fourth quarter of 2001.
Employment losses in the Midwest dur-
ing 2001 slightly exceeded the national
level. Total employment in the fourth
quarter of 2001 was 0.9% lower in the
Midwest and 0.6% lower for the nation.
The U.S. unemployment rate rose by
1.6 percentage points to a level of 5.6%
between the fourth quarter of 2000 and
the fourth quarter of 2001; the Midwest’s
rate showed the same percentage point
increase, rising from 3.7% to 5.2%.
Midwest economy in the year ahead
The economic news received so far in
2002 has been more positive than
many analysts expected. As it is becom-
ing more apparent that the economy
has reached the bottom of the down-
turn, the question now becomes how
strong will the economic expansion
be? Typically during recessions con-
sumer spending falls and this leads to
an increase in pent-up demand; indi-
viduals do without items, usually dura-
ble goods, during the downturn, and
then once the expansion begins, this
delayed demand fuels large increases
in economic growth. The surprising
for expansionary growth. Many ana-
lysts are expecting lower vehicle sales
and a modestly weaker housing sector
this year.
As already discussed, the downturn has
been led in large part by the manufac-
turing sector, which will need to expand
to generate more positive growth rates
for the economy as a whole. However,
a number of factors suggest that this
sector may experience only a modest
recovery. While inventories have been
pared back sharply, many firms remain
cautious about rebuilding their stocks,
mainly due to concern about consum-
er spending. However, given the con-
tractions that have taken place during
2001, as long as firms stop cutting, in-
ventories will add over 1 percentage
point to GDP growth on an annual basis.
Firms still have substantial excess ca-
pacity, as well as reduced profits, and
this will restrain capital spending in
the near term.
The Economist Roundtable group fore-
cast that employment in the Midwest will
decline by 0.7% during 2002 compared
with 2001 (see figure 1). Four of the five
states in the Seventh Federal Reserve
District are anticipated to experience
a decline. Manufacturing-intensive
Indiana is forecast to lose the most
jobs, shedding 1.2% in 2002. Illinois,
Michigan, and Wisconsin are expected
to show employment declines of 0.8%,
0.7%, and 0.6%, respectively. Only
Iowa is expected to show an increase.
1. Nonfarm payroll employment, annual percent change
Illinois Indiana Iowa Michigan Wisconsin Seventh District
2000 1.2 1.4 0.7 2.1 1.8 1.5
2001 0.0 –0.9 0.5 –0.1 0.2 –0.1
2002f –0.8 –1.2 0.7 –0.7 –0.6 –0.7
SOURCES: Bureau of Labor Statistics data as of February 8, 2002; forecast (f) data from Midwest Economist Workshop participants.
resiliency of the consumer sector dur-
ing 2001 has been the major factor un-
derlying the very mild recession that
the nation’s economy has experienced.
But for this very reason, the U.S. econ-
omy cannot look to consumer spend-
ing to generate significant strength
Illinois
According to a state labor economist,
conditions in southern Illinois have
generally been better than in the rest
of the state. For example, coal mines
are opening or expanding operations,
manufacturers have been adding a fewMichael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research; Douglas
Evanoff, Vice President, financial studies; Charles
Evans, Vice President, macroeconomic policy research;
Daniel Sullivan, Vice President, microeconomic policy
research; William Testa, Vice President, regional
programs and Economics Editor; Helen O’D. Koshy,
Editor; Kathryn Moran, Associate Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago. The views expressed are the
authors’ and are not necessarily those of the
Federal Reserve Bank of Chicago or the Federal
Reserve System. Articles may be reprinted if the
source is credited and the Research Department
is provided with copies of the reprints.
Chicago Fed Letter is available without charge from
the Public Information Center, Federal Reserve
Bank of Chicago, P.O. Box 834, Chicago, Illinois
60690-0834, tel. 312-322-5111 or fax 312-322-5515.
Chicago Fed Letter and other Bank publications
are available on the World Wide Web at http://
www.chicagofed.org.
ISSN 0895-0164
workers to their payrolls, and construc-
tion has been good. In other areas, con-
ditions have been less positive. For
example, in Decatur and Rockford,
laid-off manufacturing employees are
nearing the expiration of their unem-
ployment benefits, and in Peoria there
are a number of temporarily laid-off
factory workers. Statewide, the number
of manufacturing jobs has fallen to
around the level that existed in 1947.
Most roundtable participants forecast
a moderate recovery for Illinois, with
been down significantly. The only area
that has seen an increase has been sales
tax receipts, but that is largely because
at this time last year there was no gaso-
line tax.
Indiana
According to an economist from the
Fort Wayne area, Indiana’s economy
peaked earlier than the national econ-
omy, entering recession as much as
three months before the U.S. The re-
cession has been focused in durable
goods manufacturing, while some
the university economist, Indiana is
currently facing a $1.3 billion revenue
shortfall, $750 million of which is due
to past tax cuts.
Iowa
According to a university economist,
the recession that began in 2001 had a
very mild effect on the Iowa economy.
Real personal income in Iowa rose 2.0%,
compared with 0.4% in the rest of the
nation and an average decrease of 2.5%
during past recessions.
The outlook for the near term is for
Iowa to weather the current downturn
in good fashion and make a solid re-
covery in 2003. Based on weak proper-
ty-related income, real personal income
is forecast to increase 1.9% in 2002
and then accelerate to 3.0% in 2003.
Nonfarm payroll employment is fore-
cast to recover from the 0.5% increase
in 2001 to grow at 0.7% in 2002 and
then pick up further to 2.3% in 2003.
There is anecdotal evidence of firms
adding workers in 2002, including a
recreational vehicle manufacturer that
has plans to expand its operations and
an insurance firm that will likely be
adding workers in Des Moines. Howev-
er, the downside risk is that the supply
of workers may not be able to meet
the demand. The state’s population
growth has averaged around 0.3%, so
it may need to import many of the
workers to fill those jobs.
In Illinois, the temporary help sector has seen no pick-up
yet in demand from manufacturing or information
technology firms.
the labor economist adding, “I do not
see any clear-cut drivers of growth.”
The current federal budget proposal
calls for a $250 million cut in construc-
tion funds for Illinois. Other industries
are merely steady. The state economy
will probably bottom around the second
quarter, according to the labor econo-
mist. The first area to turn around will
probably be temporary help employ-
ment; contacts in that industry say that
they have seen no pick-up yet in demand
from manufacturing or information
technology firms.
The current consensus outlook calls for
a 0.8% decline in nonfarm payroll em-
ployment. Forecasts for manufacturing
employment ranged from –1.5% to
–2.7%, with the labor economist add-
ing that the decline should be evenly
split between durable and nondurable
goods manufacturing. Forecasts of the
unemployment rate ranged from 6.0%
to 6.3%. A university economist was op-
timistic that Illinois’s unemployment rate
would be below the 6.3% rate forecast
for the U.S., because forward-looking
data (unemployment insurance claims,
hours worked, and housing permits)
for the state all look better than com-
parable data for the rest of the nation.
The economist with the state budget
office noted that state tax revenues have
other industries have continued to see
employment increases. A university
economist observed that Indianapolis
has seen an increase in employment,
while the rest of the state, led by Fort
Wayne, has seen job declines.
The Fort Wayne economist noted that
the high concentration of manufac-
turing jobs and the weak performance
of auto suppliers in the area have ex-
acerbated conditions in northeast In-
diana. Beyond the manufacturing job
losses, commercial construction is
down 30% in Fort Wayne, housing
permits have been flat for the past six
months, initial unemployment claims
are still rising, help wanted ads are
down sharply, and industrial electrici-
ty usage continues to decline steadily.
The university economist forecast that
after dropping 1.1% in 2001, the decline
in total employment will moderate to
0.8% in 2002, and then employment
will increase 1.0% in 2003; though the
economist expects a sharper decline
in manufacturing employment in
2002. Real personal income growth
should moderate from 1.6% in 2001
to 1.4% in 2002, before picking up to
2.4% in 2003. The unemployment rate
forecast is for 5.1% in 2002 and 5.3%
in 2003, compared with 3.6% in 2001.
One of the risks to the forecast is the
state’s budget problems. AccordingP
R
E
S
O
R
T
E
D
F
I
R
S
T
 
C
L
A
S
S
 
M
A
I
L
U
S
 
P
O
S
T
A
G
E
 
P
A
I
D
C
H
I
C
A
G
O
,
 
I
L
P
E
R
M
I
T
 
1
9
4
2
P
u
b
l
i
c
 
I
n
f
o
r
m
a
t
i
o
n
 
C
e
n
t
e
r
P
.
O
.
 
B
o
x
 
8
3
4
C
h
i
c
a
g
o
,
 
I
l
l
i
n
o
i
s
 
 
6
0
6
9
0
-
0
8
3
4
(
3
1
2
)
 
3
2
2
-
5
1
1
1
R
e
t
u
r
n
 
s
e
r
v
i
c
e
 
r
e
q
u
e
s
t
e
d
F
E
D
E
R
A
L
 
R
E
S
E
R
V
E
 
B
A
N
K
 
O
F
 
C
H
I
C
A
G
O
C
h
i
c
a
g
o
 
F
e
d
 
L
e
t
t
e
r
Michigan
During 2001, the Michigan economy
entered one of its more moderate re-
cessions. Nonfarm payroll employment
fell 0.2%, real personal income rose a
modest 0.1%, and the unemployment
rate rose from 3.6% to 5.0%—but was
the lowest rate recorded during any
recession since 1970. Employment con-
ditions in Michigan’s industries were
varied. Manufacturing employment fell
4.2%, led by an 8.2% drop in transpor-
tation equipment jobs; however, the de-
clines were moderating toward the end
of the year. Services employment in-
creased 0.2%, but declines were becom-
ing more severe at the end of the year—
particularly in tourism-related services.
Two economists, one from Detroit
and the other from the state govern-
ment, provided forecasts for 2002. Both
expect employment conditions to firm
in the second half of 2002, but gener-
ally to be weak for the year. Employment
for the entire year should drop by
0.7%, but at the end of the year the
number of jobs should be about equal
to the number of jobs at the end of 2001.
The economist from Detroit added that
cyclical conditions may contribute to
further manufacturing job losses, while
financial, insurance, and real estate
and trade employment “will probably
be okay.” Given the weak employment
outlook, real personal income is fore-
cast to be flat, and the unemployment
rate is forecast to rise to 6.5%, the
highest rate in nine years.
There are two main risks to the forecasts.
One is that the strong dollar will lead
to a large deterioration in the domes-
tic vehicle share of total sales and con-
tribute to higher job losses. The state
economist forecasts that the domestic
share of the market will inch down from
82.0% to 81.7% in 2002, but a strong
dollar could lead to a larger decline. The
other risk is the fallout from Kmart’s
bankruptcy. With its headquarters in
Troy, MI, Kmart employs around 25,000
people in the state. Current estimates
have Kmart closing 30% to 50% of its
stores nationwide, but one economist
speculated that the fallout could be worse
because of over-capacity in retail and
because Kmart does not have a signifi-
cant niche in the industry.
Wisconsin
An economist from the department
of revenue noted that in 2001, Wisconsin
suffered a fairly mild recession. Non-
farm payroll employment was up 0.2%,
the unemployment rate inched up to
4.3%, and real personal income in-
creased 3.1%. The only severe deterio-
ration was a sharp 3.5% decline in
manufacturing employment.
The outlook calls for 2002, on average,
to be a weaker year than 2001. Nonfarm
employment is forecast to fall 0.6%,
the unemployment rate is expected to
increase to 5.2%, and real personal in-
come growth should slow to 1.1%. The
economist commented that “we’re not
seeing anything happy” for manufactur-
ing employment and forecast a 4.9%
drop in factory jobs. This would imply
six consecutive quarters of decline in
manufacturing jobs.
In 2001, state tax receipts reflected
national trends: a dichotomy between
sales taxes and income taxes. Sales tax
receipts continued to grow strongly,
though the economist noted that much
of the growth was due to strong vehi-
cle sales. Income tax revenue, based
on withholding taxes, dropped signifi-
cantly, reflecting layoffs and slower job
growth in the state.
Conclusion
The challenge facing the Midwest
economy will be how quickly and ro-
bustly the manufacturing sector recovers.
There are a number of factors that seem
to indicate that, while we have turned
the corner on the economic downturn,
the recovery will be more restrained this
time than we would typically expect.

Manufacturing sector critical in Midwest recovery

http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2002/cflmay2002_177.pdf

Manufacturing sector critical in Midwest recovery

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics