Regional President Speech

For release on delivery 9:30 a.m. EDT April 23, 1993 Testimony on the Economic Conditions in the Midwest Economy and the Opportunities for Rural Development Remarks of Silas Keehn, President Federal Reserve Bank of Chicago Before the Congress of the United States Joint Economic Committee April 23, 1993 New Albany, Indiana Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Congressman Hamilton and Members of the Joint Economic Committee: I am pleased to have this opportunity to be with you today. You have asked that I comment on the status of the Midwestern economy with some emphasis on the rural challenges facing the region. Condition of the Midwest Economy For purposes of geographic definition, I define the Midwestern region to consist of all of the States of Indiana, Illinois, Iowa, Michigan and Wisconsin which, for the most part, comprise the Seventh Federal Reserve District. These five states account for about 14 percent of the nation's GDP and 18 percent of U.S. manufacturing employment. This region produces some 45 percent of the nation's automobiles, 30 percent of the trucks, 38 percent of the nation's steel and more than 40 percent of the country's farm machinery. Farmers in this region account for nearly a fifth of the nation's annual sales of farm commodities and half of the corn, soybeans and pork produced nationwide. Some of the largest manufacturing, retailing and financial service firms in the United States are headquartered in the region. With the exception of defense activity and certain computer-related production, given the size and diversity of the Midwest economy, it is not surprising that it mirrors the economic challenges and opportunities in the U.S. economy as a whole. As in the nation, recent Midwestern performance has improved, but the pace of improvement continues to be impeded by further financial and industrial restructuring. Restructuring problems are not a recent development in the Midwest. The recession of 1981-82 was Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis devastating to Midwestern industry. The Midwest lost nearly 1.5 million jobs during the back-to-back recessions of the early 1980s, accounting for a sizable portion of the nation's job loss of some 2.5 million workers over this period. Somewhat like our recent experience, expectations that the cyclical downturn would be followed by the usual rapid recovery in Midwestern employment were disappointed. A vigorous recovery followed the 1981-82 recession and some of the cyclically sensitive jobs returned, but many jobs were lost forever as a result of structural change. Intense competition and changing markets, both domestic and international, have forced firms, particularly those involved in the manufacture of durable goods, to put heavy emphasis on productivity as a way of reducing manufacturing costs. Midwest manufacturing firms have invested an average of 5 to 10 percent more in equipment per production worker annually than firms in the rest of the nation. Estimates of the relative improvement in Midwestern manufacturing suggest that efficiency in the Midwest improved about 20 percent more than in the rest of the nation. These improvements, brought about by the very painful process of restructuring, have put these firms in a better position to compete in the domestic and international markets. Today, I am reasonably optimistic about the current outlook for the Midwest economy. The level of economic activity in the Midwest has improved and the outlook is positive. Auto and light truck production in the first quarter of this year was about 21 percent higher than last year and second quarter production schedules, while somewhat reduced from initial levels, have been set about 10 percent ahead of last year. This translates into a domestic automobile production level of about 6.2 million - 2 - Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis cars and 4.6 million light trucks at an annual rate. We currently forecast that sales of cars and light trucks this year will total about 13.5 million units, an increase of almost 4 percent from last year. The steel industry, very important to the Midwest and most particularly Indiana, has shown improvement and mills in the Midwest are currently operating at about 85 percent of capacity; industry forecasts suggest that some 85 to 86 million tons of steel on a nationwide basis will be shipped this year. The machine tool and equipment industries, also important to the Midwest, have shown signs of improvement with industry sources forecasting 8 percent growth for this year with a 5 percent increase in exports and a 7 percent decline in imports. Employment in the Midwest has increased from the low levels reached at the bottom of the last recession and unemployment levels in Midwestern states, except Illinois (as of March, the latest month for which data are available), were running under the national average. The latest data available for Indiana (February 1993) shows that its unemployment rate (6.1 %, saar) was almost 1 percent below the national average (7.0%). But significantly, the employment increases in the District have been more modest than the overall increase in economic activity. This dichotomy results from the enormous productivity efforts on the part of Midwestern companies to retain the competitive positions obtained at such great cost. While this has very beneficial effects in an overall economic context, it raises in my mind the question of the sustainability of this expansion; personal expenditures have been moving ahead at rates higher than the increases in disposable income. Unless there is a commensurate increase in employment and a resulting increase in disposable income, - 3 - Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis it will be very hard to maintain this higher level of personal consumption that has been so fundamental to the growth in the economy over the last few quarters. My remarks about the restructuring of the Midwest industrial sector also apply to the region's agricultural sector. While the financial condition of the farm sector today is vastly improved from that of the mid-1980s, it exhibits a cautious approach to spending and continues to go through considerable restructuring to achieve greater production efficiencies. The agricultural sector in the Midwest still operates with a vivid awareness of the devastating setbacks suffered by farmers and agri-business firms as the "agricultural credit crises" of the 1980s washed out the excesses that developed during the "boom" of the 1970s. The subsequent improvement in farm earnings and the level and quality of farm debt has been substantial, placing the industry on much more solid footing for the 1990s. Yet the actions of farmers and agri-business firms reveal a mood of uncertainty and caution. This mood is tied in part to the painful memories of the 1980s. It also reflects the continuing focus on trimming the federal budget deficit and the implications for the safety net provided in farm income and price support programs. The cautious mood of farmers is also related to concerns about the longer run prospects of export markets which are vital to U.S. agriculture. Banking and Credit Conditions and the Midwest Midwestern banks in general and Indiana banks in particular continue to show improving earnings and capital. In 1992, the average return on equity for commercial banks in the Midwest was up slightly from the level in 1991 but slightly below the - 4 - Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis national averages. The average return on assets last year was also higher but, again, slightly below the national average. But in a longer context, Indiana banks, on average, over the last five years have consistently exceeded the national averages with respect to returns on assets. The improving health of Midwest banks is further attested to by the fact that there has been a 70 percent decline in the number of lower rated banks in the Midwest since the end of 1986. A key factor in the improving condition of banks in the Midwest has been the gradual winding down of their asset quality problems. Nonperforming loans first stabilized and then declined, reflecting the improving economic conditions and further chargeoffs of the worst loans. Indiana banks have done even better than those in other states of the Midwest. Over the past five years, nonperforming loans for commercial banks in Indiana never exceeded 2 percent of total loans and as of the end of 1992 stood at only 1.4 percent of loans. I would note further that banks in the southern part of the state as of year-end 1992 had an even better record with only about one-half of one percent of their loan portfolio nonperforming. The somewhat better condition of Midwestern banks led to relatively better credit availability during the past three years. This health not only meant that fewer banks were forced to reduce their lending, it also eased the adjustment for borrowers at banks that were facing capital and asset quality problems. At a recent meeting of our Small Business and Agriculture Advisory Councils, I again carefully reviewed the question of the adequate availability of credit for these very important economic sectors with the Council members. The view continues to be - 5 - Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis that banks have become much more careful in the loan extension process; that credit standards have been raised, documentation requirements have been made more demanding, and spreads and fees have risen. But, most importantly, our Council members almost universally felt that adequate credit was generally available for borrowers with good credit qualifications. Indeed, some members reported that banks in their areas are aggressively seeking loans. On the other hand, many Council members were concerned that environmental regulations are making certain types of transactions unbankable. Leery of the potential liability, some banks have shied away from a credit whenever an environmental issue is even a remote possibility. Those banks that are willing to proceed are very demanding in their requirements for complete and costly environmental studies. Both our Agriculture and Small Business Advisory Councils feel strongly that environmental regulations are and will continue to impede the extension of credit to these key sectors. From the perspective of the Midwest's banks, the restructuring of credit markets is now largely complete. Credit terms have ceased to tighten, asset quality is on the rebound, and most District banking organizations have now built up their capital positions to a level that they can now focus more of their attention on the business of lending. Rural Development in the Midwest One of the key themes of your hearing today is that of rural development. The research program at the Federal Reserve Bank of Chicago has made a special effort - 6 - Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis to recognize the key importance of agricultural and rural issues in the Midwest economy. For example, we publish an Agricultural Newsletter and a recent article in our Economic Perspectives publication examined the issue of trends and prospects for rural manufacturing. As I see it, one of the primary challenges for rural areas during the post-World War II era has been to replace jobs lost by the declining labor force needs of natural resource intensive industries. As productivity has increased in farming and mining, or as natural resources are exhausted in forests and fisheries, the movement of labor into other activities or the outright loss of jobs has been the result. Our research has found that manufacturing has become the primary economic base for many rural counties in both the Midwest and in the rest of the nation. At the same time, service firms, retailers, and other industries are abandoning remote counties and are centralizing their operations in urban areas. While, as I have noted, the farm sector's economic condition has stabilized following the correction of the 1980s, farm jobs -- especially those as a full-time occupation -- continue to disappear as smaller farms consolidate into larger units. In sum, as one writer has put it, "many small rural towns . . . have been transformed from farm service centers into minor cogs in the national manufacturing system." I think that rural communities can benefit from this trend toward enhanced manufacturing employment. First, we have passed through the 1980s when both agricultural and natural resource-based industries fell on hard times. Second, the process of decentralization of manufacturing has enabled rural areas to replace part of their lost job base. One statistic I feel illustrates this point rather strikingly -- that is, - 7 - Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis that over the last twenty years, rural counties in the Midwest have had a rate of manufacturing job growth greater than that of the metropolitan counties and that manufacturing has become the element of stability of the employment composition in several rural counties. Over this twenty-year period, metropolitan manufacturing jobs have declined by 20 percent, while rural counties have seen their manufacturing employment rise by about 15 percent. Currently, it is estimated that about one-fourth of all manufacturing jobs in the Midwest are located in rural counties. This compares with just under 20 percent in the late 1960s. This is not to imply that all rural counties have fared well in the 1980s with regard to manufacturing job growth. There are still a significant number of rural counties that have not been able to benefit from this relocation of industrial activity. Southern Indiana provides an example of this diversity in rural performance. For example, the three counties of Dubois, Jackson and Jennings all experienced rates of personal income growth over the decade of the 1980s in excess of the Indiana average growth rate. In contrast, Jefferson and Union counties experienced more difficult times and benefitted less from the decentralization of manufacturing. It is likely that the trend in the movement in manufacturing activity toward rural areas established over the latter part of the 1980s will continue into the 1990s as export markets grow and in a relative sense, the region suffers less from the reduction in the nation's defense industries. The experience of the 1980s shows widely divergent shifts in the Midwest in terms of the shift of manufacturing activity toward rural counties. Questions remain regarding the reasons why some counties have prospered and others not. Answers to many of these questions are limited by the lack - 8 - Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis of sufficient information on the relative cost and productivity of individual industries in urban versus rural locations. The dilemma for the rural policy maker is to establish policies and programs that will be of benefit to those rural areas that have been unable to attract and benefit from the industrial development. This program delivery will be constrained by the ever scarce resources at the state and federal level. But the trends that I have reviewed indicate that there are opportunities to enhance the prospects of these areas. I thank you for your time and attention and will be pleased to respond to questions from the panel. - 9 - Digitized for FRASER https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis

Silas Keehn (1993, April 22). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19930423_silas_keehn

@misc{wtfs_regional_speeche_19930423_silas_keehn,
  author = {Silas Keehn},
  title = {Regional President Speech},
  year = {1993},
  month = {Apr},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19930423_silas_keehn},
  note = {Retrieved via When the Fed Speaks corpus}
}