Ninth District manufacturing continues expansion ahead of nation

While manufacturers nationwide continue in something of a holding pattern according to recent surveys, manufacturers in three Ninth District states continue to see growth, according to a monthly survey of supply managers by Mid-America Business Conditions Index, published by Creighton University.

The May survey showed overall sentiment in Minnesota and the Dakotas mostly holding in the mid-50s (an index score over 50 indicates growth; below 50, contraction). The index for employment remained in growth territory but saw both positive and negative change from April in the three states (see charts). The overall index for the nation turned negative (at 49), while employment sentiment teetered on the growth fence (50.1).

The Dakotas are taking turns grabbing headlines. In May, South Dakota saw very strong growth in overall sentiment as well as for employment, while its northern neighbor declined marginally on overall sentiment and continued a volatile pattern in employment. Ernie Goss, director of Creighton's Economic Forecasting Group, said that wages have grown very strongly in North Dakota manufacturing, and “nondurable goods manufacturers, especially food processors, are experiencing very healthy growth. On the other hand, durable goods manufacturers are experiencing pullbacks in economic activity.”

The economic impact of closing Minnesota's achievement gap: A theoretical construct

An education achievement gap by race and income has long persisted in the nation and in Minnesota. While there is a clear moral argument for closing the gap, there are some compelling economic ones as well.

Differences in high school graduation rates and achievement scores between white students and Native American, black and Hispanic students in Minnesota are some of the largest in the country. The chart below shows a substantial difference in average math scores of white and black eighth grade students since 2003.

If test scores of black and Latino students and low-income students could be raised to those of white and higher-income students, presumably graduation rates would increase, as would the overall skills of the workforce, leading to productivity gains and stronger economic growth. But by how much, and what net effect would it have for closing these gaps in Minnesota?

A 2009 McKinsey report, using a methodology developed by Eric Hanushek in a 2008 study in the Journal of Economic Literature, projects that national GDP in 2008 could have been 2 percent to 4 percent higher had the United States bridged the racial achievement gap by raising the performance of black and Latino students to that of white students by 1998 after a successful 15-year reform period. The report estimates that GDP could have been 3 percent to 5 percent higher had the United States closed the income achievement gap by raising the performance of students with household incomes below $25,000 to that of students with higher household incomes.

The same framework discussed in the McKinsey report was applied to Minnesota using National Assessment of Educational Progress (NAEP) data for the last five survey years. Closing the racial achievement gap for eighth grade students in Minnesota would improve the state’s overall average math scores by about 2 percent; closing the income achievement gap would improve average math scores by about 3 percent.

Using Hanushek’s estimate – that long-run GDP growth rate increases by 1.3 percentage points per standard deviation improvement in test scores (about 0.6 percentage points per 10 percent increase in average test scores) – closing the achievement gap in Minnesota would translate into a 0.1 to 0.3 percentage point increase in the long-run economic growth rate.

Even a small change in a growth rate over time adds up. For example, if a hypothetical 15-year reform plan could close the achievement gaps, the level of Minnesota’s GDP would diverge from trend, raising the GDP level by 1 percent or more after 30 years and by more than 3 percent to 6 percent after 50 years (see table below).

In terms of dollars, these increases translate to a few hundred million dollars per annum after 15 years from the start of the reform period to a couple of billion dollars after 30 years to more than $10 billion after 50 years. In 2011, Minnesota’s real GDP was $282 billion. However, caution should be used with these projections because it’s unclear whether Hanushek’s estimate applies at the state level.

The calculated economic impact of closing the achievement gap in Minnesota is smaller than the national estimates by McKinsey. One explanation is the lower percentage of black and Latino students in Minnesota (22 percent) relative to the national average (45 percent). Likewise, low-income students also comprise a smaller percent of population in Minnesota than in the nation.

Another explanation could be different assumptions used in McKinsey’s and Hanushek’s models. Although details are not clear, the McKinsey report seems to assume that after the 15-year reform period, the entire workforce achieves the projected gains in cognitive skills commensurate with the closing of the achievement gap in test scores. Hanushek’s paper assumes a more gradual displacement of the existing workforce with higher-quality graduates. Correspondingly, estimates for Minnesota using this assumption yield a smaller impact of bridging the gap.

Even if the economic impact of closing the gap is estimated to be smaller in Minnesota than nationally, it is by no means a trivial one. As anyone planning a retirement learns, small changes in growth rates can have a big impact on the future value of investments, more so for longer-term investments.

Furthermore, this analysis doesn’t take into account benefits to government from closing the achievement gap, such as reductions in remedial education and crime costs, and eventually higher tax revenue, nor does this analysis estimate the cost of a 15-year education reform. Both of these data points are needed to assess whether the government would achieve a positive rate of return from investing in education reform. An analysis by Henry Levin and colleagues suggests that investments in early childhood education and some reforms for school-age children do just that.

And, finally, this is not the only achievement gap whose closure would likely lead to faster economic growth. Nationally, for example, Asian students have the highest average test scores. If, hypothetically, educational reform could boost the performance of white students to the level of Asian students, overall average math scores would increase by about 2 percent, with about a 0.2 percentage point increase in economic growth. Furthermore, if test scores of all non-Asian students were raised to the average of Asian students, average math scores would increase by over 6 percent, with about a 0.6 percentage point increase in economic growth, almost 70 percent larger than the effect of closing the black-Hispanic and white achievement gap. This particular analysis, however, isn’t relevant to Minnesota, where average test scores for Asian students are lower than both Asian students nationwide and Minnesota white students.

Personal income: One Dakota leaps, the other stumbles (kind of)

The Bureau of Economic Analysis just released figures on personal income, and Ninth District states fared comparatively well (see charts). Montana and Minnesota ranked in the top five in per capita income growth, and Michigan was ninth.

But the Dakotas stole the headlines, being the top and—maybe surprisingly—bottom state in terms of both total and per capita income growth last year. North Dakota was head and shoulders above other states, seeing a rise of 9.9 percent in per capita income. The next closest was Ohio, at 3.8 percent. Total personal income in North Dakota rose by 12.4 percent, thanks to strong worker migration to the state as well as rising wages.

Its southern sibling didn’t fare so well last year. In fact, South Dakota was the only state in the union to see a decline in per capita (-1.3 percent) or total personal (-0.2 percent) income. The likely culprit is agriculture, a volatile sector that suggests the state’s 2012 performance is not something to fret over.

Rewind to 2011. Farm income in South Dakota that year hit a record $4.6 billion—more than double 2010 levels—and was a big reason the state led the country in income gains in 2011, at 12 percent. Fast forward to 2012, a year with severe drought that hurt South Dakota ranchers and farmers more than in many neighboring states. Total farm income dropped to $3.3 billion—still a decent year on average. But the $1.3 billion drop in annual farm income last year represents significantly more than the $60 million drop in total state income recorded by the BEA.

Negative equity in homes improving, but not everywhere

Signs of housing and financial recovery are becoming more common, including recent data from CoreLogic showing that the percentage of homeowners with negative equity is slowly dropping in many states.

Despite modest improvements from fourth quarter 2011 to fourth quarter 2012, almost 22 percent of homeowners nationwide with a mortgage owed more on their loan than the domicile was worth (see chart). With the exception of Michigan, all district states have negative equity rates considerably below the national average.

District states also saw decent improvements over the prior year, including Minnesota, whose rate dropped by 2 percentage points. The lone exception was Wisconsin, whose rate rose by 0.8 percentage points and was one of relatively few states that saw rates tick up slightly.

District houses flying off the market

The low inventory of houses is selling at a faster pace.

Every month, Campbell/Inside Mortgage Finance surveys thousands of real estate agents across the country. Its recent January survey revealed that houses are staying on the market for less time and sellers are getting closer to the asking price in Ninth District states (see table). Comments from respondents indicated that the lower end of the market has shifted from the buyer’s advantage of a few years ago to the seller’s advantage today—for example, more offers to buy.

Several real estate agents said they are seeing more people interested in buying a home, and one Minnesota respondent commented that multiple offers occur for most homes listed under $130,000. Agents are hoping this increased demand will bring more homes to the market. It also may be driving the increase in new home construction (see previous blog).

Dusting off the construction hammers

It’s been a long road, but signs of the housing recovery continue to build.

The U.S. Census recently released annual housing data showing that last year saw significant housing growth across the Ninth District and the country (see Chart 1). While growth is good news, the data context is critical. The preceding year was one of the poorest on record. Still, five Ninth District states saw total permits rise at least 20 percent; all but Wisconsin saw permits increase more than 30 percent. Growth occurred in both single-family and multifamily categories; booming North Dakota was the only state to see a bigger increase in single-family permits.

But the show stopper was multifamily permit growth in Minnesota last year, which rose more than 200 percent over 2011. While the state’s outlier growth comes in part from a poor 2011, the 6,700 multifamily permits were the most since 2005. A dearth of new multifamily units since then has led to steadily tighter rental vacancy rates in the Twin Cities and across the state (see Chart 2), and is likely a major factor in the state’s hyper multifamily growth last year.

For more discussion about rental markets in Minnesota and the rest of the Ninth District, see the July 2012 fedgazette.

An economic development idea worth patenting?

What helps economies grow? That question vexes economists, economic development professionals, policymakers and local government officials looking for something to generate faster growth in local and state economies.

Innovation is widely believed to be important for local economies because the invention and introduction of new ideas can create long-lasting effects for business. But getting your hands around that notion and turning it into pursuable policy might be another matter.

Some equate innovation with patents. A recent Brookings Institution argued that “inventions, embodied in patents, are a major driver of long-term regional economic performance.” The study mapped patents nationwide and found that U.S. patent levels have been increasing in recent decades, and an increasing concentration of patents is coming from the top 20 metropolitan statistical areas (MSAs).

But do high patent levels lead to measurably better economies? The Brookings report did not answer that question definitively, and there are enough struggling metros in the top 20—Detroit, Philadelphia, Phoenix—to suggest that it’s not a perfect correlation. California has four of the top eight MSAs in patent production, yet all of them have high unemployment rates; San Francisco took the top patent spot, but its average unemployment rate from 1990 to 2011 ranked 161st of almost 360 MSAs analyzed.

Among 24 MSAs in Ninth District states (including 10 in Wisconsin that are located outside Ninth District boundaries), there was a wide range of patents per thousand workers (see Chart 1). Rochester, Minn., lapped much of the competition several times over—it ranked third best nationwide in patents on a population basis, thanks mostly to being home to an IBM campus. Wisconsin MSAs, many of them manufacturing hubs, also tended to rank high. But patent levels at a majority of MSAs in district states were less than one per thousand workers; only one in three regional MSAs was above the national average of 0.6 patents per thousand workers.

Not surprisingly, the top ranking MSAs tended to have a larger share of technology jobs as a share of all employment, as well as a higher proportion of workers with degrees in science, technology, engineering and math (so-called “STEM” degrees; see Charts 2 and 3. In the four scatter graphs, the MSAs from Chart 1 are rank-ordered, so low-ranking Great Falls = 1, high-ranking Rochester = 24).

However, patents themselves are not a particularly good predictor of economic growth over time. As Charts 4 and 5 demonstrate, there is virtually no relationship between recent patent trends and either growth rates per worker or unemployment rates.

None of this means that patents and other innovations are not valuable to local economies. It only means that local economic activity is a complex recipe, and patents are likely only one ingredient for faster growth.

More evidence that businesses expect to grow, increase hiring

Signs are upbeat that the Ninth District economy will continue to grow, according to a recent poll of more than 300 business contacts from across the district (see methodology below).

For starters, 40 percent plan to increase employment at their firms, and nearly three-quarters of these firms cited expected high sales growth as the most important factor. Only 7 percent plan to decrease employment. In the same survey a year ago, 38 percent planned to increase employment and 10 percent planned to cut jobs.

Other important factors cited for new hiring were overworked staff, improved financial condition of firms and the need for additional skills. The majority of respondents plan to use word of mouth and advertising to get new employees. Twenty-eight percent plan to use a recruiting firm, and surprisingly few (9 percent) plan to raise starting pay.

For those respondents not planning to hire additional people this year, most expected low growth sales and a desire to keep operating costs low. Many reported difficulty finding skilled candidates. Though fiscal policy developments were not a factor for most respondents, 35 percent said they had a detrimental effect on hiring and 4 percent said they would increase hiring plans.

The survey also asked about wages and benefits; 36 percent expected wage growth of 2.5 percent or more, and a similar amount expected positive wage growth of less than 2.5 percent (see Chart 1). Respondents generally believed benefit increases would be larger than those for wages (see Chart 2).

 

Methodology: On Jan. 15, the Minneapolis Fed invited, via email, about 1,000 Beige Book contacts from across the Ninth District to answer the special question in a web-based survey. By Jan. 31, 303 contacts had filled out the survey. The respondents come from a variety of industries (see table below).

A rough road for townships

When springtime comes around this year, the harsh winter effects on roads will become obvious. So too will the effects of lagging state aid for roads to local governments.

The matter is particularly problematic for township governments. Roads make up the single largest expenditure for most of the thousands of township governments that provide public service to the rural expanses spanning the Ninth District. So when budgets get tight, rural roads are heavily affected.

In November, the fedgazette surveyed township officials on the subject of tight budgets and their consequences for public services (see January fedgazette). Among almost 150 respondents (about 85 percent from Minnesota, and the remainder from the Upper Peninsula of Michigan), more than two-thirds identified roads and transportation as the service most affected by tight local budgets (see chart).

Below are comments that respondents gave the fedgazette permission to share with readers.

“Road work suffers the most, dirt roads don’t get as much attention as they should. … (Residents) are not happy; they want the roads smooth but don’t realize the money isn’t there.” Cheryl Lincoln, clerk, Richardson Township, Minn.

“We blade the roads less often and also remove snow less often. We also cannot afford to apply as much gravel to our roads.” Jo Ann Kolbaske, clerk, Bismarck Township, Minn.

“With the retirement of a full-time employee, the position was eliminated in our road department. Our former four-person department continues with three people to operate and maintain 63 miles of roads in addition to 90,000 linear feet of sanitary sewer line.” Rhonda Peleski, clerk/treasurer, Thomson Township, Minn.

“Our largest expense is roads. There have been no improvements or upgrades. (We’re) trying to hang on to the status quo. The public would like to see road upgrades and improvements, such as paved roads, improve drainage issues and dust control. The number one issue would be more gravel for roads. We also have one bridge in jeopardy, (but) no money for repair.” Dave Tangen, clerk, Hawley Township, Minn.

“Gravel used for our township roads is becoming scarce, (and) the price per cubic yard is rising dramatically. The price for chloride that we use for dust control is going out of sight.” Daniel New, supervisor, Hudson Township, Minn.

“There is not enough money to keep up our roads and bridges the way we need to. There are no pluses when you have to cut services in the townships. Road ditches will fill up with brush and less money for rock on the roads. Soon it will need to be addressed, but what can we do? Still no money. … (T)he budget has to increase to keep up with some of the services, but we can’t keep up with them all.” Dave Tart, supervisor, Forestville Township, Minn.

“We do not blade our roads as often and only spot-gravel our roads. Snow plowing is important in our township. … The roads have more washboards and are slippery when it rains. If we get a lot of snow, that could be an issue to get the snow plowed off.” Lori Handyside, clerk, Clover Township, Minn.

“The cost of road maintenance is always on the rise. Our roads are being hammered by ever increasing size of farm machinery. They were not built to withstand the weights being put on them now.” Dale Kulberg, supervisor/chairman, Brookfield Township, Minn.

Another angle on 2013 business expectations

January is a time for economic forecasts for the coming year, and the Minneapolis Fed has already released its 2013 regional outlook, along with its business poll and manufacturers survey. These surveys showed that respondents generally expect more of the same; they have a moderate outlook for the growth of sales and hiring at their firms.

A separate ad hoc poll, conducted by the Minneapolis Fed about the same time as the above polls, provides further support for this modest outlook for 2013. The survey asked firms about capital expenditure plans and inventory levels, which are closely tied to firms’ expectations. Responses from 72 businesses, from a variety of industry sectors, showed an outlook mostly consistent with the Minneapolis Fed’s forecast.

More than half of respondents reported that their capital spending stayed the same in the second half of 2012 (see Chart 1), which is about what one might expect with continued growth. However, more firms reported decreases in capital spending than increases. The majority of firms reported that capital expenditures were primarily for replacement and maintenance of existing equipment. But more than 40 percent of respondents said that most or some of their capital spending was going toward expanding capacity.

Among firms that said they were expanding capacity, the most common reason given was improved sales prospects, cited by just over a quarter of all the firms surveyed, followed by 19 percent who said current capacity was stretched too thin. Another 11 percent of firms also reported that their current equipment is not well suited to their future needs.

Slightly more than a quarter of firms surveyed reported that they were cutting capacity. Of those, about half cited reduced sales prospects. Current excess capacity and increased costs were each blamed by just over a third of firms trimming capacity.

Respondents appeared more optimistic about inventory levels (see Chart 2). Nearly two-thirds of all firms surveyed reported being comfortable or very comfortable with current inventory levels. The survey asked if there were signs of excessive inventories due to sluggish demand, and 80 percent reported no sign. Further, most district firms seem optimistic about their future demand prospects. More than half reported that they were optimistic or somewhat optimistic that they may be ready to build inventories; only 9 percent said they were pessimistic.

One final positive note: This survey was conducted late in 2012, before the resolution of the “fiscal cliff.” At the time, nearly two-thirds of respondents said uncertainty about the future was curtailing current capital spending, and more than half specifically cited the state of demand in the face of fiscal contraction as a source of uncertainty. With at least temporary resolution of that uncertainty, for better or for worse, the outlook may have brightened. Maybe.