Manufacturing in Ninth District more optimistic

After a brief lull in the second half of last year, manufacturers in the Ninth District appear to be getting a second wind of optimism, especially compared with their national peers.

Survey results from the April Mid-America Business Conditions Index show that manufacturers in Minnesota and North Dakota are growing in their overall optimism, while U.S. manufacturers have declined for three straight months and are close to negative in their sentiment (an index score above 50 indicates expansion, while an index below 50 indicates contraction). Minnesota’s index for new orders has also rebounded strongly for the past two months. While South Dakota declined in overall sentiment last month, it remains several points above the United States.

Respondents from these three district states (Wisconsin and Montana are not part of this survey) were upbeat on the employment front as well. After a slowdown in hiring sentiment in North Dakota through the early part of this year, April figures almost jumped off the chart. Hiring sentiment has been more moderate in Minnesota and South Dakota, but both are on a steady upswing, especially compared with the nation, which has been trending down in recent months.

Scores are based on surveys of purchasing managers in these states and are conducted monthly by Creighton University. The U.S. results are also mirrored in a similar but different index of purchasing managers by Markit, a global financial information services company. Markit's survey does not have a district component, but its April survey saw the U.S. index drop to 52.1, the weakest manufacturing expansion in six months.

 

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.

Wisconsin public pensions: Retirees gasping, taxpayers exhaling

When the Wisconsin Retirement System released its annual annuity adjustment for pensioners earlier this month, members groaned while taxpayers breathed a sigh of relief.

The WRS is the ninth largest pension fund in the country. It is also among the country’s best funded plans in terms of long-term assets and liabilities; since 2004, its funding ratio has been near 100 percent. Yet starting May 1, certain WRS retirees will see their monthly checks fall by almost 10 percent—unheard of among the millions of public sector pensioners. In fact, it’s the fourth consecutive year of annuity cuts for some retirees. There are several sources behind this seeming financial contradiction. But the most important is that WRS retirees assume the large majority of investment return risk.

Along with worker and employer contributions, pension funds depend heavily on investment returns on their assets. Pension plans assume a certain rate of return—7.2 percent for the WRS, while many others hover around 8 percent—to project member annuities upon retirement. Most pension plans also average returns over five years to “smooth” volatility. But two of the past five years’ returns have fallen well short of the WRS benchmark, including 2008, when two WRS pension funds lost roughly 30 percent of their combined value (see charts).

When investment returns fall short of this benchmark, all other things equal, unfunded liabilities accrue. For most plans, this gap typically requires additional contributions from government employers (via taxpayers) and often existing workers; by and large, retirees are financially exempt.

In sharp contrast, WRS retirees bear the majority of investment risk and therefore reap both more benefits and more hardship. Unlike many public pension plans, the WRS plan offers no automatic cost-of-living adjustment. Instead, it uses investment returns to pad monthly pension checks on a compound basis. Such a policy worked well for retirees during the 1990s, when heady investment returns led to annual pension adjustments (called dividends) averaging almost 7 percent.

But when investment returns go south—which they did during the 2001 and (especially) 2008 recessions—those dividends can be clawed back to ensure the plan’s long-term financial solvency. But a retiree’s annuity can never go lower than the original amount established at retirement. The investment drop in 2008 was so severe—and compounded by a weak 2011—that the WRS has been forced to take back dividends from its Core Fund (which funds roughly 90 percent of annuities) for four consecutive years. (The smaller Variable Fund has no such annuity floor, and investment gains and losses are fully recognized each year.)

The amount of annuity decrease for a retiree depends on the dividends previously earned. Given three previous years of negative adjustments, the Wisconsin Department of Employee Trust Funds anticipates that close to half of all WRS retirees will see no downward adjustment this year because they have no dividends left to take and are back at their original retirement annuity. This year’s clawback also was larger on a percentage basis because of the shrinking pool of retirees with dividends remaining. After this year’s adjustments, virtually anyone who has been retired since 2000 will be back to his or her original annuity level, according to WRS's latest actuarial report.

The good news for retirees is that this is the last year that 2008 returns will be averaged into investment returns for the Core Fund. Barring another market downturn, retirees should see a little more on their monthly checks next year.

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).

Some oil for the kids, too

Oil has meant many things to North Dakota over the past decade. Along with reversing the state’s population decline, it has pumped new life—students, workers and revenue—into many of the state’s K-12 schools.

The state’s K-12 population has risen from 94,000 in 2007-08 to 99,000 in the current school year, according to the state Department of Public Instruction. Some of the strongest growth has occurred in the 17 western counties in or near the Bakken oil patch. The school district of Williston, the heart of the Bakken, has seen its enrollment rise from 2,100 to 2,800 students over this period.

As a result, school districts are hiring more teachers and other staff. A fedgazette survey of North Dakota school district administrators (with 65 respondents out of about 180 districts statewide) found that more than half added staff last year (see left chart). Employment gains were realized in every quadrant of the state, but were more prevalent in the west. Among 18 respondents in the northwest part of the state, 15 reported employment gains and three reported no change.

School officials have more modest employment expectations for this year—about one-quarter believed they will add school workers (see right chart).

But regardless of location, the large majority are expecting higher revenues. That comes, in part, from higher enrollments, which are part of the education funding formula. But it’s also due to a state education trust that, thanks to fast-growing taxes on oil activity, has grown from $1 billion to $2 billion over the past three years. This after it took more than 100 years to earn the first billion dollars, according to a state source.

The so-called Common Schools Trust Fund distributed about $92 million to school districts in the 2011-13 biennium—about 5 percent of statewide education expenditures—and trust fund officials have said they expect that figure to go up considerably in the next biennium.

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.

Government workers feeling brunt of job loss

Government jobs have long been known for their comparatively high job security. During and shortly after the recession, government employment actually rose slightly while private employment plunged (see previous blog post), thanks in large part to the federal stimulus plan that funneled billions of dollars to local and state government budgets to stave off further unemployment in the economy.

But with that stimulus gone, government employment has fallen by about 2 percent, or roughly 18,000 jobs, across Ninth District states from the first quarter of 2010 to the first quarter of 2012, according to data from the Bureau of Labor Statistics.

But there was considerable volatility in government employment even before the recession. An analysis of total government employment (federal, state and local) shows that almost half of the counties in district states saw a net decrease in government workers from 2001 to 2007 (see Chart 1). Some (unknown) portion of the decrease is likely due to the wind down of the 2000 decennial census; the number of federal workers dropped by almost 1,300 during this period while overall government employment rose by 12,300. About 85 percent of the job gains occurred in state government, where jobs are not as geographically widespread.

 

The federal stimulus temporarily pumped up government payrolls in the district, adding 18,000 net public workers from 2007 to 2010, half of them at the local level. But once the stimulus funds ran dry, the pink slips came out. By the first quarter of 2012, district states had shed almost 19,000 government jobs, about two-thirds of which were local government workers; another one-quarter of losses were federal workers, likely the result of another census winding down. Job losses were seen in 62 percent of district counties analyzed (see note at end).

The past two years have been particularly rough on counties with large employment bases, with all of them seeing at least a nominal decline in the most recent period (see Chart 2, right-most panel). But many saw earlier cutbacks, and some even declined in spite of stimulus funds (see other two panels). Many of these larger counties are in Minnesota and Wisconsin, where state and local budgets have been see-sawing since the 2001 recession. Larger counties in the Dakotas and Montana generally fared better in terms of government employment, in part because they are seeing strong population growth, which tends to induce more government services and subsequent employment.

Much more on local government budgets and employment will follow in the forthcoming January fedgazette.

 

 (One methodological note: County-level data can be hit or miss for a given quarter, particularly among smaller counties. Almost one-third were missing valid counts in one or more of the dates analyzed. As a result, the scatter-plot analysis above includes 244 out of a possible 355 counties in the Upper Peninsula of Michigan, Minnesota, Montana, North Dakota, South Dakota and all of Wisconsin, only the northwestern one-third of which is part of the Ninth District.)

A long road back for wood products firms

There’s good news for the Ninth District’s wood products industry: After years of retrenchment caused by the housing collapse and subsequent recession, the bleeding appears to have stopped.

Sawmills and manufacturers have reported increased output and revenues this year as the U.S. economy slowly improves, increasing demand for construction lumber and other wood products. After bottoming out in 2010, industry employment in Minnesota, Wisconsin, South Dakota and Montana rose slightly last year, according to government labor figures (see chart).

The bad news is that the industry has a way to go to recover thousands of jobs lost over the past decade. Montana saw the steepest drop in wood manufacturing jobs; employment fell by more than half between 2001 and 2010. The state’s sawmills were already in decline before the housing crisis, due to rising operating costs and log prices.

Employment in Minnesota and Wisconsin followed a similar downward path after the housing crash as demand sagged for oriented strand board, paperboard and office paper. Wood products workers in South Dakota fared better; during the housing downturn, many firms shifted their focus to the home remodeling market, shoring up sales and preserving jobs. But wood products manufacturers in the state still shed about 250 jobs over the past decade.

It’s questionable whether wood products employment will ever return to the levels seen at the height of the housing boom. In recent years, rising productivity has reduced the number of workers needed to run sawmills, paper mills, particle board plants and other forest products operations. Neiman Enterprises, a large sawmill operation in the Black Hills of South Dakota, has ramped up its lumber production since 2010. But over the same period, investments in automation have allowed the firm to reduce its headcount, said resource manager Dan Buehler.

And in western Montana and the Black Hills, a persistent infestation of mountain pine bark beetles has killed millions of pine trees, threatening to restrict future log supplies. (For much more on the impact of the pine beetle outbreak on the wood products industry, watch the fedgazette website for the upcoming article, “The beetle and the damage done.”)

Research Assistant Dulguun Batbold contributed to this Roundup post.

Beige Book, Minneapolis: Ninth District economy slowly improving

The Ninth District economy expanded modestly during late summer and early fall, according the most recent Beige Book released this week by the Federal Reserve Bank of Minneapolis.

Each of the 12 Federal Reserve district banks drafts a similar report, which in sum are a summary of regional economic conditions across the country, in preparation for the Oct. 23-24 Federal Open Market Committee meeting, where interest rates and other monetary policy issues are decided.

In the Ninth District, improved activity was seen in construction and real estate, consumer spending, tourism and professional services. Energy and mining continued to perform at high levels, while agriculture varied widely, with crop farmers generally in better condition than animal producers. On the softer side, manufacturing activity slowed in late summer, and wage increases remained subdued, although stronger increases were reported in some areas. But labor markets tightened somewhat, and price increases were generally modest.

For those interested in other regional, national or historical Beige Book reports on economic conditions, the Minneapolis Fed offers everything in one spot.